bmrt. U i^atiiti^^^rtitifa ^ te M^ LUi i atti^^ I-IQ /fA) BOUGHT WITH THE INCOME FROM THE SAGE ENDOWMENT FUND THE GIFT OF Henrg m. Sage 1891 A-^^-'i^Mi diri 5931 Cornell University Library HG221 .S43 1910 olin 3 1924 030 178 291 The original of tiiis 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/cu31924030178291 MONEY AND BANKING BY WILLIAM A. SCOTT, Ph.D. Director of the Course in Commerce and Professor of Political Economy in the University ofWisconsin FOURTH EDITION: REWRITTEN, REARRANGED AND ENLARGED NEW YORK HENRY HOLT AND COMPANY 1910 COPYEIGHT, 1910, BY HENRY HOLT AND COMPANY Iho CAMELOT PRESS, 444-46 PEARL STREET, NEW YORK PREFACE The present edition of Money and Banking has been pre- pared with two primary purposes in view : firstly, the pre- sentation of a fuller treatment of the subject of banking, especially of the banking systems of the chief countries of the world, than was given in previous editions, and secondly the rearrangement and restatement of portions of the sub- ject matter of previous editions. To these ends the entire book has been rewritten with the exception of Chapters I, II, III, XVI and XVII which, with slight modifications, are reprints of Chapters I, II, III, XIV and XV of the old editions. Chapters VI, X, XI, XII, XIII, XIV and XV are entirely new, and Chapters IV, V, VII, VIII, and IX embody the substance of Chapters IV, V, VI, VII, VIII, IX, XI, XII and XIII of former editions with modifications, rearrangements and considerable new material. Additions have been made to the references so as to in- clude recent books, but no attempt has been made to give complete bibliographies of the subjects treated. The refer- ences have been selected with the needs of American students primarily in view. As in previous editions those at the close of the chapters are sometimes abbreviated, full titles being given in the Appendix. When an author's name with- out title is given, reference is made to the first book listed under the name in the Appendix. In the preparation of this edition the author has re- ceived valuable assistance from his colleague, Professor Richard T. Ely, and from his former students, Professors R. H. Hess and G. D. Hancock, now Professors respect- ively in the Universities of Minnesota, and Washington and Lee. Wm. a. Scott. University of Wisconsin. July, 19 10. II CONTENTS Chapter I THE NATURE AND FUNCTIONS OP MONEY 1. The Standard op Value 2 2. The Medium op Exchange 6 3. Credit as a Medium of Exchange 4. The Relation Between the Standard op Value and the Medium op Exchange 13 Chapter II THE MEDIUM OP EXCHANGE: ITS CHARACTERISTICS AND COMPOSITION, AND THE RELATION BETWEEN ITS CONSTITUENT ELEMENTS 1. The Importance of an Accurate, Convenient, and Safe Currency 14 2. Characteristics of a Good Currency 16 3. The Composition op Modern Currencies 18 4. Gresham's Law 24 5. Standard and Subsidiary Coins 28 6. The Concurrent Circulation op Metallic and Paper Money 30 Chapter III THE STANDARD OP VALUE AND PRICES X. The Unit op Value and Prices Defined 32 2. The Relation BETWEEN the Standard OP Value AND Prices 33 3. Primary and Secondary Standards 34 4. Characteristic Features of Standards op Value 37 S- The History op Standards and Units of Value 40 6. The Importance of Stability of Value in the Standard. . 43 7. Difficulty op Securing a Stable Standard op Value... 46 8. The Interpretation of Prices 46 V vi Contents Chapter IV THE VALUE OF THE STANDARD PACE 1. Demand for the Primary Standard 50 2. Supply of the Standard Commodity S^ 3. The Value op Secondary Standards 58 4. The Quantity Theory 61 Chapter V THE ELEMENTS OF THE MEDIUM OF EXCHANGE 1. The Purpose and Importance of Coinage 66 2. Units of Value and Methods op Reckoning 69 3. The Size, Weight and Fineness of Coins 72 4. The Naming and Stamping op Coins 74 5. Seigniorage 75 6. Inconvertible Government Notes 79 7. Convertible Government Notes 81 Chapter VI CREDIT 1. Meaning op the Term 9a 2. The Advantages of Credit 93 3. Credit Instruments 95 4. The Foundations op Credit 99 5. Credit and Prices 102 Chapter VII BANK CURRENCY 1. Origin and Development of Banking Institutions 105 2. Deposits 108 3. Loans and Discounts 108 4. Deposits as Currency 109 S- Bank Notes no 6. The Advantages of Bank Currency in Contents vii Chapter VIII CLEARINGS AND THE EXCHANGES ^^^^ 1. Local Exchanges ii6 2. OuT-OF-TowN Exchanges 117 3. Bankers' Balances 120 4. The Balance op Indebtedness between Communities. . . 121 5. The Rate op Exchange 123 6. Foreign Exchanges 125 Chapter IX THE REGULATION OF COMMERCIAL BANKING I. Incorporation 131 ■^. Capital and Surplus 132 3. Double Liability op Stockholders 134 4. Regulation op Investments 134 5. Regulation op Reserves 138 6. Regulation op Note Issues 141 7. Public Inspection and Supervision 145 8. Importance op Honesty, Wisdom, and Discretion in Bank Opficials 150 Chapter X BANKING IN THE UNITED STATES 1. The Earliest Banks 153 2. The First United States Bank 155 3. State Banks in the Period 1791 to 1811 157 4. The Period 1811 to 1816 159 5. The Second United States Bank 160 6. The Establishment OP the Independent Treasury System. 162 7. The Growth and Reputation op State Banks 163 8. Origin AND Development op the National Banking System 176 9. State Banking since the Civil War 185 Chapter XI BANKING IN CANADA 1. Epochs in the History of Canada 191 2. Early Conditions 192 3. The First Banks ^94 4. Restraining Influences on Banking Excesses 197 5. The Experiment with Free Banking 200 6. Steps Toward the Uniform Regulation op Banking... 202 viii Contents PAGE 7. The Issue op Provincial Notes 204 8. The British North American Act op 1867 in its Relation TO Banking 205 9. The Bank Acts of 1870 and 1871 209 10. The Decade 1870 to 1880 and the Revision of 1880... 211 11. The Decade 1880 to 1890 and the Revision of 1890... 214 12. Recent History 218 Chapter XII BANKING IN ENGLAND 1. The Early History of the Bank op England 220 2. Country Banking and the Act of 1826 221 3. The First Banks of Deposit 223 4. Discount Brokerage as a Special Branch of Banking. 224 5. The Bank Act of 1844 225 6. The Joint Stock-Banks and Concentration 229 7. The Present Functions op the Various Groups op Bank- ing Institutions doing Business in England 230 Chapter XIII BANKING IN FRANCE 1. Origin and Early History of the Bank of France. . . . 238 2. Banking in the Provinces 242 3. Effects of the Revolution of 1848 243 4. The Bank of Prance since 1848 245 5. Other Banking Institutions since 1848 249 6. The Present Position op the Bank op France 253 Chapter XIV BANKING IN GERMANY 1. The Period Preceding 1848 257 2. The Period 1848 to 1870 259 3. The Period 1870 to the Present Day 261 4. Mortgage and Cooperative Banks 267 5. The Present Organization of the Banking Business in Germany 270 Chapter XV THE MONEY MARKET i.. The Central Markets 273 2. The Central Reserves 274 3. Bank and Market Rates 276 Contents ix PAGE 4. Bank Notes and the Money Market 281 5. Peculiarities of the New York Market 282 6. Some Peculiarities of. the London Market 287 7. Some Peculiarities op the Paris Market 289 8. Some Peculiarities of the Berlin Market 292 Chapter XVI THEORY OF BIMETALLISM 1. The Nature and Purpose of Bimetallism 296 2. The Bimetallists' Arraignment of the Monometallic System 299 3. The Compensatory Action op the Double Standard.... 300 4. The Weak Points in the Theory of Bimetallism 303 5. National and International Bimetallism 308 Chapter XVII THE HISTORY OF BIMETALLISM J.. Early European Experience 310 2. Currency Reform in England and the Act of 1816 315 3. Bimetallism in France to 1865 318 4. Bimetallism in the United States to 1873 325 5. The Fall in the Value of Silver after 1875 330 6. The Latin Union 334 7. Bimetallism in the United States since 1873 336 8. The International Conferences 338 9. The Present Status op Bimetallism 342 Appendix I LIST OP REFERENCES 347 Appendix II STATISTICAL TABLES A. Statistics of the Production op the Precious Metals. 362 B. Statistics of Coinage in the United States 363 C. Statistics of Coinage in France 365 D. Surplus op Imports op Gold and Silver into British India 368 E. Annual Average Rates op Discount op the Banks op France and Germany 3^9 Appendix III THE PAR OF EXCHANGE AND GOLD POINTS OF THE CHIEF CENTERS OF FOREIGN EXCHANGE 37° INDEX 371 MONEY AND BANKING CHAPTER I THE NATURE AND FUNCTIONS OF MONEY Money is one of those terms which political economists have borrowed from popular speech and found ill-adapted to their purposes. In spite of numerous attempts to make a suitable definition, it still lacks the precision and definite- ness of meaning which should characterize scientific termi- nology. Popular usage is tolerably consistent and clear, but fails to include under the term all the instrumentalities which belong together in any scientific treatment of the subject, and political economists are not agreed regarding the point to which the popular meaning of the term should be extended. Even if these difficulties were removed, how- ever, one not easy to overcome would still remain. All are agreed that under the head money we must include both the standard of value and the medium of exchange, two instrumentalities which perform very different functions, and the distinction between which is apt to be minimized, if not entirely overlooked, when an attempt is made to include them under one definition. In order to avoid this difficulty and to promote clear- ness of thinking, we shall discuss first of all the functions of the standard of value, and the medium of exchange, and, so far as possible, defer the use of the term money until the student is prepared to form an independent judgment regarding the meaning which ought to be attached to it. 2 Money and Banking I. The standard of value. — A standard of value is any commodity by means of which people measure and express the value of other commodities. For example, when we say that a pair of shoes is worth five dollars and a coat ten, we measure and express the value of these two com- modities by means of another which, for this purpose, we call a dollar. In the United States this standard commodity '"is gold, and to 23.22 grains of it, many years ago, Con- gress gave the name dollar. If our ancestors had ac- quired the custom of comparing the value of everything with that of a bushel of wheat, by always finding out for how many bushels each article would exchange, then wheat would have been our standard of value, and Congress might have decided to call a bushel of wheat a dollar, in- stead of a few grains of gold. The acquisition of the habit of using some one com- modity as a standard of measurement and a means of ex- pressing the values of all others is characteristic of every people who have advanced beyond the most primitive stages of civihzation, and is explained by the need for a common language ,of value, which made its appearance very early in the history of commerce and which demanded satis- faction before trade could play an important part in eco- nomic processes. This need may be best appreciated by imagining ourselves reduced to a state of barter. Each one would then be obliged to trade the commodity or service which is the result of his special activity directly for the various commodities and services which he needs or de- sires. A shoemaker would needs exchange shoes directly for flour, butter, sugar, meat, etc. ; the farmer would have to barter wheat and cattle for groceries, clothes, and agri- cultural implements; the laborer would have to trade his services for whatever he and his family need, etc., etc. The difficulties which would be encountered under these The Nature and Functions of Money 3 circumstances are many, but one of the greatest and the most fundamental would be due to the fact that each per- son would have a language of values peculiar to himself and difficult of comprehension by his fellows. This difficul- ty may be illustrated as follows : — Suppose that A is a producer of wheat, B a cattle-breeder, C a shoemaker, D a tailor, and E a manufacturer of sugar. Each, having frequently bartered his product for each of the other commodities, would have an accurate idea of their relative values, but would be able to express that idea only in terms of his own commodity. A, for example, would think and speak of value in terms of wheat. If he had frequently traded 100 bushels of wheat for an ox, 5 bushels for a pair of shoes, 10 bushels for a coat, and i-io of a bushel for a pound of sugar, the figures 100, 5, 10, and i-io would represent to him the relative values of these and serve as a means of expressing them. If, on other occasions, he were compelled to give no bushels of wheat for the same sort of ox as before cost him only 100, he would conclude that the value of beef had risen, and would measure the rise by comparing the figures 100 and no. In fact, this method of expressing values would not only be natural to A, but it would be the only one possible. On the assumption that he produces wheat and wheat only, and barters it for whatever else he needs or desires, his knowledge of values would not extend beyond the ratio of exchange of wheat with other commodities. B, C, D, and E would each likewise have one means and only one of expressing the relative values of com- modities, namely, the figures which represent the ratio of exchange of his product with each of the others. B, for example, might express the value of wheat, shoes, coats, and sugar by the fractions i-ioo, 1-20, i-io, and i-iooo, the portions of an ox exchangeable respectively for a bushel 4 Money and Banking of wheat, a pair of shoes, a coat, and a pound of sugar, or by the figures lOO, 20, 10, and 1000, representing the number of bushels of wheat, pairs of shoes, coats and pounds of sugar exchangeable respectively for one ox. C's expression for the relative values of wheat, cattle, coats, and sugar would be the figures 1-5, 20, 2, and 1-50, representing the number of pairs of shoes and fractions of pairs exchangeable respectively for a bushel of wheat, an ox, a coat, and a pound of sugar, or the figures 5, 1-20, 1-2, and 50 representing the amount of wheat, cattle, coats, and sugar equivalent in value respectively to one pair of shoes. Under the same conditions of value, D who has only coats for trading, would have to pay for a bushel of wheat i-io of a coat, for an ox 10 coats, for a pair of shoes 1-2 a coat, and for a pound of sugar i-ioo of a coat; and E, who barters sugar, would pay for a bushel of wheat 10 pounds, for an ox 1000, for a pair of shoes 50, and for a coat 100. '^ It is thus evident that in a state of barter each man would have an accurate numerical expression for the values of all the commodities on the market, but one peculiar to himself, and consequently unintelligible to others, or at any rate capable of being made intelligible to others only by a mathematical calculation. In describing values A could only give the amount of wheat each commodity is worth; B, the amount of beef or live cattle ; C, the number of pairs of shoes; D, the number of coats; and E, the amount of sugar. If a dealer should attempt to establish in this com- munity a store for the purchase and sale of all the goods produced, he would be obliged to quote the price of each article in terms of all the others in order to meet the needs of his customers. Were commerce at all active and large in amount, this would mean an interminable price-list and an amount of calculation which would require more time The Nature and Functions of Money 5 than all the other business of the establishment, to say noth- ing of the liability to error and the consequent danger of loss. It is safe to say that under such conditions commerce would never have assumed very great proportions or played a very important role in the world's history. The difficulty which these traders have met is that of a variety of meth- ods of expressing values, and the remedy is the acquisition of a method common to all. The difficulty is similar to that which people speaking different languages would meet in trading, if no one understood the speech of the other. Each trader's language of value is peculiar to himself and not understood by his fellows. What is needed is a com- mon language intelligible to all. ■i " The acquisition of such a language is accomplished through the use of a single commodity as the standard for comparing and reckoning values. In our hypothetical com- munity, for example, any one of the five commodities could be used for this purpose. On the assumption that sugar is consumed by every one and consequently frequently bar- tered for every other commodity, each person would know the value of his product in terms of this one, and would be able to express that value in a form intelligible to others. If A should always describe the value of his wheat by stat- ing the number of pounds of sugar a bushel would buy, and B, C, and D in the same manner should express the value of cattle, shoes, and coats, each would readily under- stand the other, and comparisons and calculations of values would be easy and simple. The figures in which such com- parisons and calculations were expressed would always refer to multiples or subdivisions of a pound of sugar, and would constitute a language of value understood by every member . of the community. If, in discussions of value, for conve- nience or any other reason, a special name were given to a pound of sugar, for example, the name dollar, franc, mark, 6 Money and Banking or pound sterling, the language of value would become that employed in the United States, France, Germany, or Eng- land at the present day. The capacity to serve as a standard of value is pos- sessed by all commodities which are widely used and con- sequently frequently bought or sold. In primitive societies custom has usually caused the selection of that commodity as the standard which is most widely known and most highly esteemed among the people who have occasion to trade with each other, and in more highly civilized communities con- siderations of convenience and economy have usually dic- tated the selection of one among several articles which might conceivably be employed for this purpose. What- ever the commodity may be, however, and by whatever pro- cess selected, its function as a standard is simply that of furnishing the community with a means of measuring, ex- pressing, comparing, and recording the values of the va- rious articles of commerce. 2. The medium of exchange. — The phrase medium of exchange describes a group of instrumentalities which serve as a go-between in commercial transactions. In the- United States, it includes, gold, silver, nickel, and copper coins, several varieties of government notes, bank-notes, checks and drafts, bills of exchange, and several other kinds of documents less commonly used. Each of these is appro- priately called a medium of exchange because it is used as a go-between in the exchange of commodities. For ex- ample, suppose a farmer brings butter and eggs to market, and wishes to exchange them for groceries. In all proba- bility he will not make the exchange directly, but through the medium or by the mediation of coins; that is, he will trade his butter and eggs for coins and then trade the coins for groceries. A laborer wishes to exchange several days' work for a coat, but he will rarely find a tailor who The Nature and Functions of Money 7 needs his services, and who will, therefore, be able and willing to trade a coat directly for a certain number of days' work. Instead he will trade his services with some one who needs them for coins or government notes or bank- notes or both, and then trade the coins or notes for the coat. It is possible, and it often happens, that a considerable period of time intervenes between the first trade and the last. The farmer may sell his produce a whole year or even longer before he trades the coins or notes received for other commodities. Indeed, he may never himself com- plete the trade, but transfer the right so to do to some one else. In any case the coins, notes, or other documents re- ceived will be used in buying other things and will thus ful- fil their mission as a medium of exchange. In the same way people use checks, drafts, bills of exchange, and va- rious other documents. Like the standard of value, the medium of exchange owes its existence to certain wants which were felt very early in the history of commerce, and upon the satisfaction of which further progress depended. These wants are three in number, namely : that for some means of exchang- ing commodities of unequal value, that for some means of accumulating wealth in such a form as to make it avail- able at any time for the purchase of any and all com- modities, and that for facilities for borrowing and lending. The first of these may be illustrated as follows: A farmer has an ox for sale and desires a pair of shoes. He may succeed in finding a man who has shoes for sale and wants beef, but the ox is worth twenty pairs of shoes and he wants but one, and very likely the shoemaker wants only a few pounds of beef instead of a whole ox. Mani- festly the trade cannot take place unless the farmer is will- ing to take nineteen pairs of shoes which he does not want and the shoemaker twenty times' as much beef as 8 Money and Banking he wants, or unless the farmer is wiUing to kill his ox, to hand over to the shoemaker an amount of beef equal in value to the shoes and to keep the remainder. Of course there might be other people in the community quite willing to take the beef which neither the farmer nor the shoe- maker wants, but that would not help the matter unless these traders should happen to want the various commod- ities which their neighbors might be willing to give in ex- change for it. On the assumption that the farmer wants only a pair of shoes and the shoemaker only a few pounds of beef, the willingness of other people to buy the surplus might not improve the situation. The need of some means of accumulating wealth is ob- vious. Frugal people wish to make preparations for the future, and if the aggregate of their products exceeds that of their consumption, they are able so to do, provided some means of saving exists. The most obvious one which sug- gests -itself is that of hoarding surplus products, but this is a very precarious method in case the products in question are perishable, or are subject to frequent fluctuations in value or are so bulky that the process of hoarding them is very expensive. Most of the ordinary products of in- dustiy are subject to one or more of these contingencies. Hence, in the absence of some special provision for the accumulation of wealth, the risks involved are so great as to prevent saving on any large scale. The need of facilities for borrowing and lending is equally obvious. A farmer may have no accumulations to tide him over the period during which his crops are grow- ing, or he may wish to keep his produce for a rise in price, or he may wish to extend his agricultural operations by more fully stocking his farm, by the use of superior imple- ments, or by the cultivation of more acres. In any one of these cases he needs to borrow, and inability so to do might The Nature and Functions of Money 9 seriously interfere with his prosperity. In an advanced in- dustrial community there are always people quite compe- tent successfully to carry on industrial operations, who do not possess the requisite capital, and many people, on the other hand, who have capital but do not wish to engage in industry. Facilities for borrowing and lending are needed to bring these two classes together for their mutual profit and that of the community. This need might equally well be illustrated by the case of a really sound business man who has temporarily met with misfortune, or by that of a young man capable of profiting by an education but lacking the funds necessary for its acquisition, or by many other situations which will readily occur to the student upon reflection. Let us now inquire how a medium of exchange satisfies these wants. Our assumed case of the farmer and the shoe- maker will assist us. It will be remembered that these two persons found difficulty in exchanging their products on account of the wide difference in value between the far- mer's ox and a pair of shoes. If, in the community to which these two traders belonged, there had been some one durable commodity which was an object of universal desire and consequently daily bought and sold and sure to be in general demand in the future, the way out of their difficulty would have been easy. Even though he might not have wanted it for his own consumption, the farmer would have been quite willing to accept this commodity in payment for the balance due him from the shoemaker, simply because he would have been able to trade it at any time for anything he might chance to want. The shoe- maker, likewise, would not have been seriously inconve- nienced by the surplus beef, provided he had been able to sell it to his neighbors for this highly exchangeable com- modity. By way of illustration let us suppose that gold 10 Money and Banking is a commodity well known and highly valued by every member of the community and considered so very precious that no one doubts the continuance of its value and high estimation through future generations. Being very dur- able and possessing great value in small bulk, it can be easily kept for any length of time, and, on account of the belief in the continuance of its value, every one feels safe in keeping it by him, and is confident that at any time in the future he can dispose of it for whatever he may desire or need. Being also readily divisable, it is easy to ar- range for equivalents of almost any value. Under these circumstances, then, the farmer would have been quite will- ing to sell his ox for the pair of shoes and the balance in gold, and the shoemaker would have been willing to sell to his neighbors in exchange for gold the beef which he did not want, neither one perhaps intending to consume the gold itself, but being confident of his ability to exchange it at any time for whatever he might chance to desire. Since other traders under similar circumstances would follow the example of the farmer and the shoemaker, all the members of the community would speedily acquire the habit of tak- ing gold in exchange for their produce, even when they did not need it for consumption, because they could exchange it for whatever they might chance to want at any time more easily than their own product. When any commodity comes to be generally used in this way, it becomes by that fact a medium of exchange. In our illustration the medium of exchange obviated the difficulty of exchanging two commodities of unequal value, namely, an ox and a pair of shoes. It is evident that it might also be used as a means of accumulating wealth, and also for facilitating borrowing and lending. Being by its very nature a commodity which every person is willing to take at any time in exchange for his goods, no risk would The Nature and Functions of Money ii be involved in hoarding it; and people who had succeeded in accumulating it could loan it to others who needed for any purpose to make immediate purchases and lacked the means. The people discussed in our illustration would nat- urally keep their savings in the form of a hoard of gold. The various commodities of their own production or manu- facture being perishable and, perhaps, of uncertain value and consequently incapable of being hoarded, would be ex- changed for gold, which could be kept without loss and readily sold for other commodities whenever desired. This hoarded gold could also be loaned to others who need to make immediate purchases but lack the means. In this case, of course, some guarantee that the gold would be returned when wanted would have to be given, but, granted the requisite degree of confidence between man and man, the gold would make possible the loan with all of its con- ceivable advantages to both borrower and lender. 3. Credit as a medium of exchange. — The three wants which we have been considering are frequently, and at the present time commonly, satisfied by means of credit instru- ments in one form or another. The methods of employing these instrumentalities as a medium of exchange are vari- ous, but only the simplest one can be appropriately explained at this point. Modern commercial processes are conducted by means of a large class of middlemen who intervene between exchangers and relieve them of the greater part of the work involved in trading their products. Among these are shopkeepers who purchase goods, giving the sellers credit on their books for the value of their sales, and sell them again at such times and in such amounts as are de- sired, debiting buyers with the amounts of their purchases. Inasmuch as the buyers and the sellers are frequently the same persons, these merchants are a means of overcoming the difficulties of barter discussed in the preceding section, 12 Money and Banking and their book accounts serve as a medium of exchange. By way of illustration let us suppose that a primitive community has already acquired a standard of value, and that some very reliable person, in whose integrity and wealth everybody has perfect confidence, establishes a gen- eral store, and agrees to buy from the producers everything they have for sale and to sell these same commodities to others at such times and in such quantities as are desired. After the harvest A brings his wheat to the store and re- ceives credit on the books of the storekeeper for the amount agreed upon, this amount being stated in terms of the pre- vailing standard. Subsequently he purchases various com- modities, such as sugar, shoes, coats, meat, etc., and is debited by the storekeeper with the amounts of his pur- chases, these amounts being likewise stated in terms of the standard. It is evident that the difficulty involved in ex- changing commodities of unequal value is not here met, because it is not necessary that A's account should balance on the occasion of every purchase or sale. It is also evi- dent that A could accumulate his savings in the form of credit on the storekeeper's books, and could borrow by overdrawing his account; that is, by accumulating an un- covered debit balance. In this case the book account serves precisely the same purposes as the gold in our previous il- lustration. It obviates the difficulty of exchanging com- modities of unequal value, and it furnishes a means of making savings and of borrowing and lending. At first sight there does not seem to be much resemblance between this primitive storekeeper and the great merchants and bankers of the present day. But as a matter of fact they are performing the same functions as he, and by means of more complicated machinery they are using credit of substantially the same sort as he. Like his, their book accounts satisfy the three fundamental wants which we The Nature and Functions of Money 13 have been discussing and which are felt by all traders how- ever primitive or advanced. 4. The relation between the standard of value and the medium of exchange.— Though the functions of the stand- ard of value and the medium of exchange are quite dis- tinct, they may be performed by the same commodity. In a primitive community this is usually the case, because uni- versal exchangeability, a quality essential to both, is rare- ly possessed by more than one commodity, and that one, therefore, must necessarily serve in both capacities. At the present time, however, the standard of value is only one element of a very complex medium of exchange, consisting of several commodities and a considerable number and va- riety of credit instruments. Why this is so will be made clear in the two following chapters. REFERENCES The topics included in this chapter are discussed in most textbooks under the head "The Functions of Money," but they are rarely treated in such a way as to show the true relation between money and the fundamental wants of traders, and to emphasize the distinction be- tween the functions of the medium of exchange and that of the stand- ard of value. The following references are typical of the usual method of treating the subject: Mill,* Political Economy, bk. ill, ch. vii; WaJker, Money, ch. i, and Money Trade, and Industry, chs. i, ii, and iii; Jevons, Money and the Mechanism of Exchange, chs. i, ii, and iii ; Nicholson,' Money and Monetary Problems, pt. i, ch. ii. In Laugh- lin, The Principles of Money, ch. i and in Merger's article entitled, "Geld" in the Handworterhuch der Staatswissenschaften, the subject is well treated. See also Kinley, Money, ch. v ; Taylor, Some Chapters on Money, ch. i; Johnson, Money and Currency, chs. i and ii; Knies, Das Geld; Knapp, Staatliche Theorie des Geldes, ch. i; and Nasse, "Das Geld und Miinzwesen" in Schonberg, Handbuch der politischen Oekonomie. For a collection of definitions of money see Roscher, Principles of Political Economy, Lalor's translation, v. I, bk. li, ch. iii, note 5, and Hildebrand, Theorie des Geldes, p 5. CHAPTER II THE MEDIUM OF EXCHANGE: ITS CHARACTERISTICS AND COMPOSITION, AND THE RELATION BETWEEN ITS CONSTITUENT ELEMENTS The term universal exchangeability, which we have just used to describe one of the essentials of a medium of ex- change, signifies that quality or combination of qualities which renders a commodity or a credit instrument univer- sally acceptable to people in exchange for their goods or services. In a primitive community this quality or com- bination of qualities is the capacity to satisfy some funda- mental want or wants, such as those for food or clothing or armor, but in a more highly developed state of society certain credit instruments quite incapable of serving as objects of general consumption possess universal exchange- ability, and none of the commodities which constitute the medium of exchange enters into the consumption of every person, though all of them are extensively used for a va- riety of purposes and are highly esteemed by every one. It is, therefore, evident that other considerations besides the capacity to serve as an article of general consumption concur in the selection of the constituent elements of the modern medium of exchange. Among these, accuracy, con- venience and safety in commercial transactions are of prime importance. I. The importance of an accurate, convenient, and safe currency.— The kind of accuracy which we must here con- sider is that which concerns the acquisition of the exact equivalent for a commodity sold or the giving of an exact equivalent of a good bought. Many other kinds of ac- H The Medium of Exchange 15 curacy are of the first importance in business, but this only is significant in the present connection. As compared with former times, commerce is nowadays conducted on a large scale and with small margins. The difference between the buying and the selling price is often so small that a few cents added or subtracted in each transaction mean riches or ruin to a large concern. Hence it is absolutely neces- sary that very close calculations be made, and that these calculations be realized in the commercial transactions which follow. Inasmuch as practically every trade involves the use of the medium of exchange, this being the universal equivalent given for goods bought and received for goods sold, it is evident that this medium must be of such a charac- ter as to render possible the transfer from buyer to seller of the exact amount agreed upon. Otherwise the closest and most careful calculations might be of no avail. The importance of a convenient currency may be appre- ciated by considering the disadvantages which the use of a medium consisting of a single element such as gold or silver would involve. For large payments the weight of the metal would render transportation difficult, expensive, and slow ; and for very small payments, say of a few cents, the amount of metal would be so small that it could not be put into the form of a coin which would be usable, and, if the scales were necessary in every exchange, the rapidity absolutely essential in numberless transactions of everyday life would be impossible. Imagine, for example, the difficulties of travel and of conducting a ticket-office at a busy railway station, if in making small change gold had to be weighed and the infinitesimal amounts preserved and carried about by the passengers. Imagine also the expense and inconvenience which would be involved in traveling abroad or in taking long trips at home, if one were com- pelled to carry the amount needed for the entire journey 1 6 Money and Banking in the form of gold or silver, as would be the case if one of these metals should constitute our only form of cur- rency. Indeed a convenient currency is quite as essential to commerce as are suitable machines for manufacturing, locomotives for railways, or improved facilities for any other business purpose. By a safe medium is meant one the use of which does not involve loss. It is desirable, therefore, that the value which it is the purpose of the exchangers to transfer should be always and under all circumstances obtainable through the currency by which the exchange is accomplished, and that the various elements of the medium should be so se- lected and manipulated as to protect merchants against loss under all circumstances. For example, it is highly desirable that a form of currency should exist which can be sent through the mails or by express without subject- ing the parties concerned to loss in case of accident to the train or the ship. So far as possible, also, protection against robbers and against the ordinary accidents of com- mercial intercourse should be secured. 2. Characteristics of a good currency. — In order to meet the demands of modern commerce in the respects which have been indicated, the medium of exchange must possess the following characteristics: — A. It must consist pf elements representing many grades of value. — In the United States we need means of payment ranging in value from at least one cent to one hundred thousand dollars, and European nations have found money of even smaller denominations useful. By combination of diflferent elements of the medium it should be possible to represent the exact value of any and every commodity, and the exact amount of the various payments necessary in com- mercial transactions, and that, too, with the greatest celer- ity and without difficult . calculations. If a commodity ig The Medium of Exchange 17 worth twenty-six dollars and thirty-two cents, for example, we should be able to combine from the constituent ele- ments of the medium exactly twenty-six dollars and thirty- two cents of value. If one should wish to make a payment of a million dollars, it should be possible so to do without burdening oneself with a heavy load of metal or running the risk of making mistakes in counting. B. It must he easily and safely transportable in any and all amounts. — For the purposes of modern commerce cur- rency must frequently be sent by mail or express or freight. It must be carried about in people's pockets and portman- teaus, and stored in banks, treasury vaults, places of busi- ness, and the houses of the people. The material or mate- rials of which it is made are, therefore, a matter of great importance. What is suitable for one sort of currency is quite unsuitable for another. A heavy, bulky substance might serve well for small change, but would be an ex- pensive means of making payments in distant places. A commodity possessing great value in small bulk would answer well for large payments and for hoarding, but would be useless for purposes of retail trade and for small purchases generally. Anything possessing high intrinsic value would subject the owner to the danger of loss in case it were sent tiirough the mails or by freight or express. It is, therefore, evident that we need in our currency com- modities of different degrees of value as well as instrumen- talities which possess little or no intrinsic worth. C. It mHist be easily recognised, durable and certain in its value. — The various denominations of a currency should be recognizable and distinguishable from each other at sight. Otherwise mistakes will be frequent, fradulent prac- tices easy, and rapidity in making change impossible. Met- als used for currency purposes should be put up in the form of coins with their values plainly stamped upon their 1 8 Money and Banking faces; and the coins of different denominations should be distinguishable by their size, colour, design, or other easily recognizable features. The metals used in the manufac- ture of coins should also be capable of receiving and holding an easily recognizable stamp. The fact that the medium of exchange is used as a means of saving and that it must pass from hand to hand year in and year out explains the need for durability. Any com- modity which wears out readily would sOon lose a portion of its value and become worthless for further service as a medium, to say nothing of the loss, expense, and incon- venience involved in its use. If it were perishable, it would be useless for purposes of hoarding and accumulation. Absolute certainty of value is also essential to a good medium. If one does not know the exact value of what he is to receive in payment, he will hesitate about selling, or he will raise the price of his commodities or services in a degree sufficient to recoup him for any possible loss from over-estimating its value. A medium of uncertain value, therefore, is sure to obstruct trade and to cause spasmodic and speculative fluctuations in prices. The five characteristic features of a good medium which we have just described enable us to explain the chief com- ponent elements of modern currencies. Generally speaking it is true that those elements have survived and become permanent parts of currency systems which have proven to be best adapted to the ends they serve. Arbitrary power directed by ignorance or self-interest has exerted an un- favorable influence here and there and from time to time, but in the long run the necessities and the convenience of the commercial world have triumphed in the survival of the fittest. 3. The composition of modern currencies. — The currency of every important commercial nation at the present time The Medium of Exchange 19 is composed partly of metallic and partly of paper instru- ments. The metallic portion consists of coins and may be classified as follows: (o) from the standpoint of the materials employed in its manufacture, as gold and silver coins and those of cheaper metals; and (b) from the stand- point of the relation between its various elements, as stan- dard and subsidiary coins. The paper portion may be classified as government currency and bank currency. The currency of the United States, for example, consists: {a) of gold coins of the denominations twenty, ten, five, and two-and-one-half dollars; (&) of silver coins of the de- nominations one dollar, fifty, twenty-five, and ten cents; (c) of a coin made of nickel of the denomination five cents ; and {d) of a copper coin of the denomination one cent. Our paper currency consists of several varieties of notes issued by the national government, for example, of green- backs, Sherman notes, silver certificates and gold certifi- cates ; of notes issued by national banks, and of several other varieties of bank paper, of which checks and drafts are the most important. The currency of other countries is sim- ilarly constituted, the chief difference being due to the ab- sence of government notes in many of them. A. The utility of several varieties of coins. — The first characteristic of a good currency described above explains why we need coins of different denominations. Payments of all sizes, both large and small, are necessary and several varieties of coins are needed in order that they may be made accurately and conveniently. If the silver dollar were the only coin we possessed, it would be impossible to pay for purchases of the value of a few cents, and accurate pa)mients of any size which involve fractions of a dollar could not be made. Moreover, in large payments the weight of the silver would be burdensome and expen- sive, and the counting of it would require time which the 20 Money and Banking existence of money of large denominations might save. The need for coins of large and small denominations ex- plains the use of gold, silver, and cheaper metals in their manufacture. Convenience demands that coins of large denominations should be manufactured from some metal the value of which is very high. For this reason, the world over, gold is used for coins of higher denominations than one dollar. In our country, as we have seen, twenty-, ten-, five-, and two-and-one-half-doUar coins are of gold ; in Eng- land the sovereign and half-sovereign are made from this metal ; in Germany the twenty- and ten-mark pieces, and in France the twenty- and ten-franc pieces. On account of its much lower intrinsic value, silver is well suited for coins of denominations ranging from ten cents to one dollar. Accordingly England uses silver for the manufacture of her sixpences, shillings, florins, half-crowns, and crowns; Germany in the manufacture of her five-, two-, and one- mark and her fifty-pfennige pieces, and France in the manu- facture of her five-, two-, and one-franc and fifty-centimes pieces. For coins of lower denominations than ten cents, fifty pfennige or fifty centimes, silver is not well adapted, because the coins are so small as to be extremely inconven- ient. Holland has two silver coins of lower denominations than our ten-cent piece, but they are so tiny that they are difficult to handle, easy to lose, and hard to distinguish. Experience has led to the abandonment of such small silver coins in nearly all nations, and to the use instead of copper or bronze for the smallest coins, and of nickel for the coins intermediate between the smallest and those of about the value of our ten-cent piece. The practice of the great na- tions regarding these smaller coins is not identical except in the one point that they use metals cheaper than silver in their manufacture. Besides their value several other qualities should be The Medium of Exchange 21 noted in any attempt to give a complete explanation of the selection of gold and silver as the chief monetary metals of the world. Among these the most important are the dur- ability, divisibility, and homogeneity of these metals and their adaptability to the art of coinage. When slightly hardened by the admixture of small quantities of other sub- stances, gold and silver coins will endure the wear and tear of modern commercial usage with but small loss of sub- stance, and are but slightly, if at all, affected by the atmos- pheric elements which cause other metals to rust and sub- ject them to chemical changes which in time result in their complete destruction. They are also capable of being re- fined to such a degree and are so easily divisable that coins exactly alike in weight, fineness, and form can be made from them. In the form of coins they can also receive and retain a stamp which is easily recognizable. As compared with other metals, moreover, the value of gold and silver has been remarkably steady throughout long periods of time. In fact, no other metals are known which possess in the same degree of perfection as these the peculiar combi- nation of qualities required in the manufacture of coins. B. The utility of paper currency. — The characteristic feature of paper currency is the fact that it does not con- tain in its own substance the value expressed by the fig- ures or statements on its face, but simply represents the obligation of some public or private corporation or of some person to pay the amount indicated. The secret of its cir- culation has already been suggested.* If people have entire confidence in the ability and willingness of the issuing party to pay the obligations on demand, and if they meet a real currency need, they will circulate. The measures necessary to secure and maintain the confidence of the public in this sort of currency will be discussed under the appropriate * Chapter i, pp. ii and 12. 22 Money and Banking heads in succeeding chapters. We shall here point out simply its superiority for certain purposes over other forms of currency. The comparative inexpensiveness of paper currency is obvious. It costs only the value of the paper and the labor of printing. Compared with the expense involved in the mining and assaying of the metal and in the minting and the wear and tear of coins manufactured from such val- uable materials as gold and silver, this is significant, to say nothing of the loss involved in withdrawing immense quan- tities of these valuable metals from ordinary consumption. When considerable sums need to be transported from one part of the country to another or from one country to another, the economy of paper currency is still more appar- ent. If it were necessary to transport several millions of dollars from Chicago to London, the express charges on the necessary amount of gold or silver would be very high, while a draft for the amount can be sent in a letter for two cents. While not so obvious, the superiority of credit currency, under certain circumstances, in the respects of convenience and safety is important. In the making of large payments it is much more convenient to write a check than to hand to your creditor the requisite amount of gold or silver or even of bank-notes or government notes, and it is more conven- ient to hand him bank-notes or government notes of large denominations than coin. When one is making a long journey and on this account finds it necessary to carry on his person considerable sums, he appreciates the superior convenience of paper currency. The claim of superior safety cannot be made for all forms of credit paper, but it can be made for checks and drafts and certain forms of notes issued by express companies, postoffice departments of governments, etc. The loss of a check or a draft or The Medium of Exchange 23 of certain forms of money orders through theft or other means does not involve the loss of the sum indicated on its face. Being made payable to a definitely specified per- son, and careful records being kept by the issuing parties, duplicates are obtainable. Moreover, the use of credit cur- rency in its various forms obviates the danger that would otherwise be involved in carrying about large quantities of gold and silver. The police force of every large city would needs be largely increased if the actual transfer of coin of the required value were necessary in every transaction. Every railway and steamship company and every private mercantile establishment would also need to provide it- self with heavy safes and a small army of police for pur- poses of protection. The temptation to robbery thus oc- casioned would doubtless largely increase crime, and thus diminish the general security of the community. Certain forms of paper currency also possess the very desirable quality of elasticity; that is, the quantity in cir- culation automatically adjusts itself to the needs of com- merce, increasing when more money is wanted and decreas- ing when the need that called it into existence has passed away. An element of this sort is essential to a perfect currency because the need for money varies greatly from year to year and in different seasons. In the United States the needs of different sections of the country are subject to seasonal variations, and the volume needed for the entire nation is larger in times of great commercial activity, and smaller during periods of depression. No one has sufficient foresight to be able to predict the degree of these changes, and only occasion- ally, as in the case of certain of them which depend upon crop movements, can the dates be even approximately fixed. It is necessary, therefore, that certain forms of currency should, as it were automatically, move from place to place, 24 Money and Banking and increase and decrease in quantity. As will appear in later chapters, only certain varieties of paper currency possess this desirable quality. The movements of coin in both the directions indicated are far from automatic, its entrance into and withdrawal from circulation requiring considerable time and the manipulation of the machinery of government. The superiority of credit currency in the respects mentioned accounts for its extended use in all modern commercial nations, and for its increasing use as commercial operations grow in extent and magnitude. It must not be forgotten, however, that its superiority is confined ta certain of the uses of a medium of exchange, and does not extend to all. In retail trade and for the making of change and for small payments everywhere coins still excel in con- venience and safety, and there is no reason to expect that their use will ever cease. 4, Gresham's law. — The concurrent circulation of metal- lic and paper currency and the use of coins made of differ- ent metals involves a difficulty the removal of which only time and long experience have made possible. This diffi- culty may be illustrated as follows : Suppose that, at the time of the minting of gold and silver coins, the relative value of these metals is i to 20 ; that is, one ounce of gold is exactly equal in value to twenty ounces of silver, and that accordingly twenty times the weight of silver is used in the manufacture of five silver dollars as of gold in the manu- facture of a five-dollar gold piece. For example, suppose that 125 grains of gold be put into each of the five-dollar pieces and 500 grains of silver into each of the one-dollar pieces. Suppose that the proportions of the two metals used in the manufacture of all the other coins be precisely the same. Under these circumstances the market value of the metallic content of each and every coin would be exactly The Medium of Exchange 25 expressed by the stamp on its, face, and five silver dollars, ten silver half-dollars, and twenty silver quarter-dollars would be equivalent in market value to each other and to a five-dollar gold piece. Let us suppose further that, in order to avoid all possibility of inconvenience or difficulty in the circulation of these coins, a law is passed conferring upon them the so-called legal-tender quality ; that is, decla- ring that in the payment of debts and the making of pur- chases of all kinds five silver dollars, ten silver half-dollars, twenty silver quarter-dollars, and a five-dollar gold piece shall be equivalent. For a time we may suppose that all goes well, everybody giving and receiving indifferently gold and silver coins in the proportions indicated, the gold coins being naturally used in large pa)nTients and the silver in small. Soon, however, the value of one or both of the precious metals changes, so that on the markets twenty-five ounces of silver instead of twenty are needed to purchase an ounce of gold. What now will happen to the coins which have been declared by law equivalent in the making of purchases and the payment of debts? Will people con- tinue indifferently to give and to receive five-dollar gold pieces and five silver dollars in payments of the amount of five dollars ? Certainly not. They will sell the gold coins as metal or hoard them for future use, and make their pay- ments in silver alone. If we suppose that the majority of people are unaware of the change in the value of the metals or through habit or ignorance continue indiflferently to pay out the gold and silver which comes into their possession, we may be sure that the money-changers and the bullion- dealers will be sufficiently shrewd and wide awake speedily to drain the currency of all of its gold. The same difficulty may result from the concurrent cir- culation of metallic and paper money. Suppose that the government has issued notes in denominations of five, ten, 26 Money and Banking twenty, fifty, etc., dollars and made them legal tender at their face value; that is, declared a five-dollar note equiva- lent to a five-dollar gold piece or to five silver dollars in the payment of debts and in all other kinds of financial transactions, a ten-dollar note to a ten-dollar gold piece or to two five-dollar gold pieces or to ten, silver dollars, etc., etc. If the people have perfect confidence in the govern- ment's ability and willingness to pay, and it is perfectly easy to procure gold and silver coin with the paper without loss or difficulty of any kind, they will continue to give and to receive the notes and the coins indifferently; but if they should lose confidence in the government or should for any reason prefer coin, they would avail themselves, whenever possible, of the advantages of the legal-tender law by pay- ing out their notes and retaining their gold and silver for the purpose of hoarding or in order to sell them as bullion or for any other use in which they could realize their full value. Under these circumstances it is evident that coins would speedily disappear from circulation and the govern- ment notes remain in full possession of the field. The difficulty involved in the disappearance of under- valued coins from circulation has been experienced over and over again in the monetary history of the world and in a variety of forms. Now one class of coins has been removed from circulation and now another, and frequently all kinds of metallic money have disappeared before the advent of depreciated paper. In the early years of the last century our currency consisted exclusively of silver, because gold was undervalued at the mint. Later on, after the discovery of the gold-mines of California and Australia, gold dimin- ished in value very greatly, and our silver speedily disap- peared from circulation. During our Civil War and for many years after its close depreciated government notes prevented the use of gold and silver coins for monetary The Medium of Exchange 27 purposes. Sir Thomas Gresham, one of the most famous directors of the English mint, formulated the experiences of his time along this line into a law which has ever since borne his name.* Poor money, he said, always drives good money out of circulation. By poor money he meant money w'hich was not worth its face value, and the process which he described as the driving of the good money out of cir- culation was simply the disappearance of the coins of supe- rior intrinsic value from circulation as money because they could be more profitably used in other ways. This so-called Gresham's law is simply the expression of a universal ex- perience which has as its cause the commercial instinct com- mon to all men and which urges them to make the most of their possessions. The operation of Gresham's law is always accompanied by inconvenience and loss. In the first place, it renders impossible the realization of the advantages of a complex currency. If the gold disappears from circulation, the com- munity has no coins suitable for the making of large pay- ments. If the silver goes, it becomes difficult or impossible to make small change. If government paper drives all the coin from circulation, the community suffers from a com- bination of ills, which will be described in subsequent chap- ters. In the second place, the operation of Gresham's law interferes seriously with prices. When people begin to make use of their legal rights by the employment of the depreciated element in the payment of debts, persons of all sorts who have goods for sale and persons who are making loans which are to be paid back in the future will protect themselves against the depreciated currency by raising the prices of their goods to at least *This law was discovered at least two centuries before Gresham's time, being clearly stated in Oresme's "De Origine, Natura, Jura et Mutationibus Monetarium" published in the fourteenth century. 28 Money and Banking the extent of the depreciation and by so adjusting the terms of the loan as to avoid loss. The result, therefore, will be a general rise of prices. If the depreciation be a certain fixed amount which can be readily calculated, as will be the case with a coin whose intrinsic value is less than its face value, the shock to prices may be but a single one and the new level may be as stable as the old. If, however, the depreciation is more or less uncertain and per- haps in part due to speculation, as is liable to be the case with certain forms of credit currency, the interference with prices is liable to be continuous and the new level to be very unstable. Such conditions are sure to breed specula- tion of the most dangerous sort, and, if long continued, seriously to shake that confidence between man and man which is essential to the maintenance of the credit system, thus creating conditions favorable to crises and other forms forms of commercial disaster. 5. Standard and subsidiary coins. — How to prevent the operation of Gresham's law and thus to avoid the evils which it involves has been a most difficult problem. Dur- ing the middle ages its solution was sought in vain, and the monetary history of every European country during several centuries exhibits a succession of fruitless attempts to retain in concurrent circulation gold, silver, and copper coins of the various denominations needed for commercial and governmental purposes. Finally, however, the solution was found, and no nation nowadays needs to be troubled by Gresham's law. So far as the concurrent circulation of coins made of different metals is concerned, the operation of this law is avoided by the device of making certain of the coins subsidiary to others which are called standard. In many countries at the present day the gold coins are the standard ones, and all others are made subsidiary by treat- ing them in the following manner : The Medium of Exchange 29 (a) By reducing the quantity of the metal in them ti) such an extent that their intrinsic value is much below their face value; (k) By limiting the quantity of them to the actual needs of the community for coins of these particular denomina- tions ; (c) By limiting their legal-tender quality to small sums; and (d) By making them redeemable in the standard coins. The explanation of the efficacy of these measures is ob- vious. So long as the silver, nickel, and copper coins are redeemable at their face value in gold coins, no one will hesitate to take them at that valuation, no matter how much below it their actual intrinsic value may be. The lowering of their intrinsic value by diminishing the amount of metal used in their manufacture, therefore, does not pre- vent their circulation at par, but it does prevent their dis- appearance from circulation in case of a considerable in- crease in the market value of the metal of which they are composed. For example, if an ounce of gold is equal in value to twenty ounces of silver, and the five-dollar gold piece weighs 125 grains and the one-dollar silver piece 400 grains, the value of the metal in the silver dollar is worth only eighty cents. So long, however, as the government stands ready to give a five-dollar gold piece for five silver dollars, each silver dollar will continue to circulate at its face value, and the value of silver would needs rise more than twenty-five per cent, before the operation of Gresham's law would drive the silver coins out of circulation. The disappearance of the gold coins by the operation of Gre- sham's law and the impoverishment of the government on account of the demand for the exchpnge of silver for gold is prevented by the limitation of the quantity of subsidiary coins minted and by making them legal-tender for small 30 Money and Banking sums only. So long as the quantity of such money in cir- culation does not exceed the actual need for it for com- mercial purposes, there will be no disposition to demand its redemption, and so long as its legal-tender quality is lim- ited, no one is obliged to receive it in large quantities, and consequently its general substitution for gold in the cur- rency is rendered difficult, if not impossible. Indeed these four regulations place the control of the substitution prac- tically in the hands of the government, at the same time giving it the power to prevent the operation of Gresham's law and to protect itself against loss. The laws passed by the various nations for the regula- tion of their subsidiary currencies differ considerably in details, but they all embody these principles. Special ex- ceptions are sometimes made, as, for example, in the case of our silver dollars and the five-franc pieces formerly minted by the states of the Latin Union, but such excep- tions must not be regarded as in any sense an abandon- ment of these principles or a demonstration of their use- lessness. On the contrary, the unfortunate experiences which have usually followed attempts to make exceptions in the application of these principles have confirmed their validity and demonstrated the danger of their violation.* 6. The concurrent circulation of metallic and paper money. — All forms of paper money are characterized by the possession of the credit features briefly explained in the first chapter. Each and every one represents and in some way expresses the obligation of some individual, corpora- tion, or government to pay the sum indicated on its face. The intrinsic value of these notes is, of course, practically nothing. Why, then, do they circulate side by side with *The reasons for mak'.ig these exceptions and the unfortunate ex- periences which have followed them will be treated in the chapters on Bimetallism. The Medium of Exchange 31 silver and gold coins without displacing them or being dis- placed by them? Attempts to answer this question have probably given rise to more controversy than any other sub- ject in the range of monetary science, and it is not best in this chapter to enter into a discussion of the various pertinent questions; but it is desirable to call attention at this time to the fact that the principles which we have dis- cussed in the preceding section may be applied here. For example, if the paper money is made redeemable on de- mand at its face value in standard coins, it will readily cir- culate without danger of depreciation. If the quantity issued does not exceed the demand for it for currency pur- poses, and its legal-tender quality be limited, there will be no danger of its substitution for coin in large quantities or of the disappearance of coin from circulation. Without entering in any way into the discussion of controverted questions therefore, we may understand at least one meth- od of maintaining in concurrent circulation metallic and paper currency. The application of these principles to the various forms of paper currency issued by governments and banks, and the danger of their violation in this case as well as in that of silver and gold coins, will be made clear in the appropriate place. REFERENCES On Gresham's law see Laughlin, ch. jcii; Johnson, pp. 194-196; Kinley, ch. iv; Jevons, ch. viii; Nicholson, Money and Monetary Prob- lems, ch. iv, and Political Economy, v, II, ch. xiii. On subsidiary currency see, for a discussion of the principles in- volved, Laughlin, ch. xv; Nicholson, ch. iv; Mill, bk. Ill, ch. x; Nasse, ch. vii; and Report of the Monetary Commission of the Indianapolis Convention, §§ 42 to 45. For the regulations of the various States see Norman, Complete Guide to the World's Twenty-nine Metal Monetary Systems; Watson, History of American Coinage, ch. xxi; and Lejeune, Monnaies, Poids et Mesures des Principaux Pays du Monde. CHAPTER III THE STANDARD OF VALUE AND PRICES. I. The unit of value and prices defined. — In the first chapter the standard of value was defined as that com- modity in terms of which the values or ratios of exchange of all other commodities are expressed. It was also shown that these expressions of ratios always take the form of figures which represent multiples and subdivisions of a de- finite portion of the standard. The portion of the standard which is selected as the basis of measurement is usually given a specific name, such as a dollar, a pound sterling, a franc, a mark, or a lira, and is called the unit of value. The quantity thus selected is purely arbitrary, as well as the name given to it. The technical term which has been universally adopted for the numerical expression of the values of commodities in terms of the standard is price. When, for example, we wish to say that the ratio of exchange between wheat and gold is as one bushel of wheat to 23.22 grains of gold, we say that the price of wheat is one dollar per bushel, because in the United States we have adopted 23.22 grains of gold as our unit of value, and have named it one dollar. When we wish to express the fact that the ratio of exchange between a pair of shoes and gold is one pair of shoes to 1 1 6. 10 grains of gold, we simply say that the price of a pair of shoes is five dollars, because 1 16.10 is five times 23.22, our unit. In England these ratios or prices are ex- 32 The Standard of Value and Prices 33 pressed in tenns of pounds, shillings, and pence, in France in terms of francs and centimes, and in Germany in terms of marks and pfennige, because these nations have adopted these names for their units of value and subdivisions res- pectively. 2. The relation between the standard of value and prices. — Remembering that prices are simply the numerical expression of the ratios of exchange between every other commodity and the standard commodity, we may easily explain the immediate causes of their fluctuations. Since the ratio of exchange between two commodities is simply the relative quantities that exchange for each other, it is evident that this ratio will change whenever the worth of either of the commodities changes. If wheat is being ex- changed for shoes from time to time, and it becomes for any reason more valuable, it will exchange for a larger number of shoes; if it becomes less valuable, it will ex- change for a smaller number. Likewise if shoes become more or less valuable, the ratio of exchange with wheat will change. By parity of reasoning, prices, which are the expression of the ratio of exchange between the standard and commodities, may change from any one of the follow- ing four causes or from various combinations of these: (a\ from a rise in the value of the commodities the prices of which are in question; (b) from a fall in the value of these commodities; (c) from a rise in the value of the standard commodity; and (d) from a fall in the value of the standard commodity. The first and fourth of these causes will result in a rise of prices, and the second and third in a fall. By way of illustration of these propositions, let us con- sider the possible causes of changes in the price of wheat. Remembering that gold is our standard and that Congress has decreed that 23.22 grains of gold shall be called a 34 Money and Banking dollar, by definition we know that when wheat is a dollar a bushel, 23.22 grains of gold are exchanging on the mar- kets for one bushel of wheat. If subsequently, for any reason, the value of wheat should increase, that is, if people should desire it more intensely, or some new use for it should be discovered, or the supply of wheat should be- come short, the value of gold remaining unchanged, the price of wheat would certainly rise, since it would require more than 23.22 grains of gold to purchase a bushel. If wheat had just doubled in value, it would require 46.44 grains to make the purchase; that is to say, wheat would sell for two dollars a bushel. If, on the other hand, the value of wheat should diminish one-half, a bushel could be pur- chased with one-half the former amount of gold, and the price of wheat would be one-half of a dollar per bushel. Re- versing the terms of our illustration, and assuming that the value of wheat remains unchanged, and that of gold rises and falls, we obtain corresponding results. When the value of gold rises, less gold will be required for the pur- chase of a bushel of wheat, and its price will rise. When the value of gold falls, more will be required for the pur- chase of a bushel of wheat, and its price will rise. If both wheat and gold were changing in value at the same time, it is evident that the result would be either rising or fall- ing or stationary prices, according to the direction and amount of the changes. If gold should fall in value in exactly the same degree and at the same time that wheat was falling, prices would remain stationary. If, on the other hand, the changes were in opposite directions, the gold falling and the wheat rising, the rise in the price of wheat would be very great. Conversely, if gold were ris- ing in value and wheat falling, the price of wheat would fall very rapidly. 3. Primary and secondary standards. — In order to avoid The Standard of Value and Prices 35 confusion in the interpretation of prices it is necessary to distinguish a special class of value standards to which the adjective secondary may be applied. The commodity stand- ard, the function of which we have described in the pre- ceding pages, may be called primary. Secondary stand- ards are based upon the primary in the sense that their value is derived from them and that their independent ex- istence is impossible. In other words, a community may have a primary standard of value without a secondary, but cannot have a secondary standard without a primary. Secondary standards usually consist of government notes which have been made legal-tender, that is of promises to pay, put into circulation by the government, and by law made receivable for all debts public and private. The ef- fect of a legal-tender law of this sort is to compel creditors to accept government notes for the sums due them and to permit debtors to pay their debts by presenting or tender- ing these notes. In succeeding chapters we shall explain how such notes may take the place of all other forms of money, and why people, though compelled to accept them for payments due, ordinarily discount them, that is, re- ceive them at less than their face value. It is discounted or depreciated notes of this sort that become secondary stand- ards and in the following manner : — Suppose our government were to issue notes of the va- rious denominations, one dollar, two dollars, five dollars, ten dollars, fifty cents, twenty-five cents, ten cents, etc., and by law compel us to receive them in all payments, the notes containing upon their face a printed statement to the effect that the government promises at some not specified future date to pay to the bearer the sum indicated. Sup- pose further that, fearing lest the government might not keep its promise or that it would be slow in payfng, or for some other reason, we should be unwilling to accept a dol- 36 Money and Banking lar note for more than fifty cents, a two dollar note for more than one dollar, a ten-dollar note for more than five dollars, etc. The result would be that prices would be doubled and these notes would become a secondary stand- ard. A farmer whose wheat is worth one dollar per bushel would now demand a two-dollar note for it, and, if these notes constituted the only available money, he would hence- forth quote his wheat at two dollars per bushel instead of one, knowing that he must receive these depreciated gov- ernment notes in payment. When everybody had acquired the habit of quoting prices in terms of this depreciated paper, all prices would have doubled and the government notes would have acquired the quality of a secondary stand- ard of value. It should never be forgotten, however, that under such circumstances the use of the primary standard would not be discontinued. It would needs be constantly used to test the depreciation of the notes and in foreign exchanges. The expressions one dollar, five dollars, fifty cents, etc. printed on the notes would mean nothing until they were referred to the unit of value defined by statute as a certain amount of the primary standard. The community would have two sets of prices, one quoted in terms of the primary and the other in terms of the secondary standard, the dif- ference between the two measuring the extent of the depre- ciation of the notes. When a community possesses a secondary standard of value it is subject to fluctuations in prices from three in- stead of two sets of causes, namely, from changes in the value of commodities, from changes in the value of the primary standard, and from changes in the degree of de- preciation of the secondary standard. In such a com- munity, even though commodities and gold were relatively stable in value, great fluctuations in prices might result The Standard of Value and Prices 37 from changes in the degree of depreciation of the govern- ment notes. 4. Characteristic features of standards of value. — The danger of confusing primary and secondary standards ren- ders desirable a more detailed account of the characteristics of the former. Among these the most important are the following : — A. A high degree of utility for purposes of ordinary con- sumption. — No commodity can serve as a primary stand- ard of value which is not highly prized for purposes of ordinary consumption, so highly prized indeed that it is or may easily become an object of universal desire. The truth of this proposition rests upon two facts which become self- evident the moment one grasps the real nature of a stand- ard. The first is that people can get into the habit of quoting the value of their commodities in terms of some one commodity only after they have learned the ratios of exchange between sa'id commodities and the one in question by means of frequent exchanges. It is manifestly impos- sible to express a ratio which you do not know, and there is no conceivable way of knowing a ratio of exchange except by actually making exchanges and observing the terms in which they are made. It is equally evident that such knowl- edge could become common only after practically every- body had frequently traded his products for the one in question. For convenience of expression we shall here- after speak of a commodity for which people generally are anxious to trade their products and services as one pos- sessed of a high degree of exchangeability. The second fact upon which the truth of the proposition we are defending rests is that such general and frequent trading of all sorts of goods for some one commodity as is necessary to fit it for the work of a standard implies the possession by said commodity of very great utility for pur- 38 Money and Banking poses of ordinary consumption. That every person in a community should frequently trade his products or ser- vices for a commodity which to him is useless it is impos- sible to conceive. It is necessary, however, to emphasize the truth at the very beginning of our study, because the failure to grasp it is responsible for a great deal of fal- lacious reasoning and a number of monetary heresies. B. Serviceability as a medium of exchange. — In primi- tive communities the same commodity serves both as a standard of value and a medium of exchange, for the reason that a high degree of exchangeability fits it for both services. With the growth of commerce, however, the credit method of conducting exchanges, explained in the first chapter, has come into extensive use, and nowadays the medium of exchange everywhere consists of credit in- struments and a number of different commodities besides that which serves as the standard. Nevertheless it is still important that the standard should constitute an element of the medium of exchange. This becomes evident when we recall the regulations necessary to maintain in con- current circulation several varieties of coins and paper cur- rency. As explained in the preceding chapter, subsidiary coins and paper currency must be redeemable directly or indirectly in some one kind of coins, and it is best that these latter coins should be made from the commodity which serves as the standard of value. The statements on the faces of the coins and notes in circulation always refer to the standard commodity. A five-dollar government note or bank-note is a promise to pay a specified amount of this commodity; and while the statements on the faces o£ the coins do not formally constitute promises to pay, the figures always refer to specific amounts of this same commodity; and if they circulate at the value indicated by these figures, it is because they are either directly exchangeable for that The Standard of Value and Prices 39 specified amount of the standard commodity or redeemable in an amount of some other commodity exactly equivalent to this in value. The difficulty connected with the redemp- tion of the various elements of the medium in other com- modities than the standard is the fact that the quantity of such commodities receivable in payment for a ten-dollar note or a dollar or fifty-cent coin would vary with the price of the commodities. Suppose, for example, that all elements of the medium were made redeemable in silver, gold being the standard of value. When silver was worth a dollar an ounce it would take ten ounces to pay a ten- dollar note, and when its price was fifty cents an ounce it would take twenty ounces to redeem the same note. It would always be necessary to determine the price of silver in gold before the payment of the note or the redemption of the coins could be accomplished.* When all forms of currency are made redeemable in the standard commodity, on the other hand, the quantity payable for a ten-dollar note is unchangeable, since ten dollars means ten times the unit of value called the dollar, and this unit is defined by law to be a certain number of grains of gold. If, then, the standard commodity be put up in coins of convenient sizes and denominations, it con- stitutes as nearly perfect a material for redemption as it is possible to obtain. It follows that a good standard of value must be a commodity which possesses the qualities needed in the manufacture of coins, such as durability, divis- ibility, homogeneity, malleability, etc. * The student must not allow himself to be deceived by indirect sys- tems of redemption. We may make notes redeemable in silver dollars at their face value without reference to their intrinsic value, and no difficulty will be experienced provided the silver dollars are them- selves directly or indirectly redeemable in gold. Under such a system the notes are really redeemable in gold, but by an indirect or roundabout process. 40 Money and Banking C. Capacity to he easily and cheaply hoarded and trans- pprted. — The extensive use of the standard commodity as material for redemption renders important its capacity to be easily and cheaply hoarded and transported. The com- modity used for the payment of notes and the redemption of coins must be frequently transported between different countries and different parts of the same country, and the question of expense of transportation thus becomes an im- portant matter. If the redemption material is bulky and of low value, the expense of transportation will be high; if it is very valuable, that is, possessed of a good deal of value in small bulk, these expenses will be much lower, in- deed may be relatively insignificant. In subsequent chapters we shall explain the necessity of paying balances between banks in the same and different countries in the standard commodity, and consequently the need many banks, and sometimes the national treasury, feel for keeping large amounts of this commodity on hand in their vaults. A bulky commodity is much more expensive to store than one of high value. It thus becomes evident that of two commodities otherwise equally well fitted to serve as a standard of value, the more valuable one has the advan- tage in the particulars just described. Great financial in- stitutions which are obliged to handle large quantities of the standard commodity possess great influence in the deter- mination of what that commodity shall be, and, for the reasons mentioned, among others, are quite certain to fa- vor the more valuable commodity. 5. The history of standards and units of value. — The number and variety of commodities which at various times have served as standards are great. Various kinds of grain, rice, cattle, salt, tobacco, skins of animals, cacao, and va- rious metals, of which the most important are lead, iron, copper, silver, and gold may be mentioned. Of these, gold The Standard of Value and Prices 41 has best endured the various tests, and is now the standard in all the great commercial nations. Since commerce has been playing an important role in the affairs of nations, silver has been its only competitor. These two metals are better fitted for the work of a standard in all the respects we have mentioned than any of the other commodities. On account of their durability, divisibility, adaptability to the coiner's art, and high value, they are preeminently fitted for service as a medium of exchange, and their great beauty and consequent adaptability to purposes of ornamentation made them objects of universal desire very early in the his- tory of civilization. Custom and law have also long fav- ored them. The victory of gold over silver in compara- tively recent times is due chiefly to its superior value and its consequent extended use in international exchanges and in the payment of balances between banks. Legislation has also favored it, but largely for this reason. It is equally as good as silver in all other respects, and much better in this very important one. Of secondary standards history presents us with numer- ous examples. During the years 1790-1796 France had such a standard in the depreciated government notes which displaced all other forms of money and which were issued by the Revolutionary governments as a means of meeting the extraordinary expenses of the time. During the years 1793-1821 the notes of the Bank of England, not being redeemable on demand in coin, depreciated and became a secondary standard. So comparatively slight was the depre- ciation of the notes during the greater part of the period, and so gradual their introduction as a secondary standard, that many people believed them to constitute the primary standard, and a number of theories in support of this con- tention gained currency. During our Revolutionary and Civil wars depreciated government notes came into general 42 Money and Banking circulation as money and served as secondary standards. In all of these instances silver or gold continued as the pri- mary standard, and prices were commonly quoted in these metals as well as in the depreciated paper. The history of units of value is too complicated and in many cases too obscure to warrant any extended account here. The English pound sterling has probably had the longest continuous history of any of the units of value em- ployed by modern nations. It dates back at least to the later Saxon period, and probably still farther. The name pound, however, has been the only really permanent ele- ment. For many centuries it consisted of silver, but the amounts which it represented were repeatedly diminished until from a pound's weight it ultimately fell to a few ounces. It was not represented in the form of a coin until modern times. In 1816 it was changed to gold and has remained unaltered to the present day. In France the same system of reckoning as in England, with the French names livre, sou, and denier instead of pound, shilling, and penny, was employed until 1795, when the modern franc was adopted as the unit. As in England, the amounts of metal represented by these names constantly diminished, and they were even less frequently represented in coins. In Germany the same system with the names pfund, schilling, and pfennig was originally employed, but a number of in- dependent and widely different systems were developed in the free cities and independent principalities of the Middle Ages, and it was not until 1873 that the mark, consisting of .398247 of a gramme of gold, became the unit of the whole German Empire. In the United States the dollar has been the name of the unit since colonial times. Up to the estab- lishment of our own coinage system it meant the Spanish milled dollar, but the act of 1792 defined it in terms both of silver and of gold, the ratio between the two being reckoned The Standard of Value and Prices 43 as 15 to I. Its content in pure gold at that time was fixed at 24.75 grains, but in 1834 it was diminished to 23.22 grains, and has remained unchanged since that date. It is by no means necessary that the unit should be re- presented in a coin, although it is desirable, as we have shown, that some coins should be made from the standard commodity. For example, though gold is the standard of value in this country and our unit, the dollar, is defined in the statutes as 23.22 grains of pure gold, we do not coin a gold dollar as its representative for the reason that it would be too small for convenient use. Our dollar coin is, there- fore, made of silver. The same is true of the present French and German units. While the franc and the mark are both defined as a certain number of grains of gold, the coins designated by these names are, for convenience's sake, made of silver. The English pound sterling, being a very large unit, is represented in a gold coin called the sovereign, which is of convenient weight and size for purposes of gen- eral circulation. 6. The importance of stability of value in the standard. — The vital part which the standard of value plays in the de- termination of prices suggests the importance of stability of value in the commodity which is to perform this function. Fluctuations in prices ought, if possible, to correspond ex- actly with fluctuations in the value of commodities. If we could be perfectly sure that every change in the price of a commodity represents and exactly measures a change in the relation between its demand and supply, producers would be able to determine with a considerable degree of accuracy the results of prospective increases or decreases in the supply of their product, and would thus secure a sound basis for the management of their concerns. Under these circumstances, too, political economists and sociologists would be able accurately to translate price statistics into 44 Money and Banking vital changes in our economic life, and thus to trace causes to their effects with a certainty and a degree of accuracy now unknown. To the extent, however, that changes in prices are due to fluctuations in the value of the standard, an element of uncertainty is introduced into all calculations based on prices. Without a special investigation, always difficult, sometimes impossible, and never accurate, one does not know whether a given change in prices is due to a cause operating upon the commodities whose prices are under consideration, or upon gold. If a manufacturer, for ex- ample, on account of a rise in the price of his product, which in reality has been caused by a fall in the value of gold, concludes that the demand for his product has greatly increased, and, on the basis of a calculation founded on this conclusion, proceeds to enlarge his factory and increase his output, he is quite sure to suffer loss and possible bank- ruptcy. The increased supply of goods which he throws upon the market as a result of his mistake would really not be needed and he would be obliged to sell them at a sacrifice. If his loss should chance to be great enough to cause bankruptcy, and if his concern were a very large one, and connected in a business way with banks and other large enterprises, his fall might carry others down with him in a constantly widening circle, and a great commercial crisis be the result. Uncertainty in business affairs of the kind we have been describing can only be completely removed by a standard whose value never changes; that is, by one whose value is absolutely stable. The proof of this is the fact previously stated, that outside of changes in the values of the com- modities themselves, the only cause of price fluctuations is a change in the value of the standard. A second reason for desiring stability of value in the Standard commodity is the fact that defbts are nearly always The Standard of Value and Prices 45 measured and expressed in its terms. In this country prom- issory notes, bonds, stocks, and all contracts calling for payment by one party to another at some future date are drawn in terms of dollars and cents. Each of these docu- ments contains the promise of some individual or corpora- tion to pay some other individual or corporation a specified number of dollars at some period in the future. It is very evident that if these dollars change in value before the date of maturity of the document, the essential character of the contract is changed. If they rise in value, debtors must pay more; if they fall, less. The effect upon creditors, of course, is directly the reverse. For example, a farmer, whose land is mortgaged, must pay to his creditors more value than he intended if the value of the standard rises, and less if it falls. If the amount of the mortgage is $5000. and the value of the standard doubles before the mortgage matures, he will be obliged to pay double the amount of value he intended or an amount of produce which would have been worth $10,000 at the time the mortgage was made; if the value of the standard diminishes one-half, the mortgagee will receive no more than the equivalent of $2500 at the time the mortgage was made. The mass of indebtedness at the present time is so enormous that a comparatively slight change in the value of gold transfers millions from the pockets of debtors into those of creditors or vice versa. It sometimes happens that the people of an entire section of the country are debtors to a much greater extent than creditors or vice versa, and hence that a change in the value of the standard seriously interferes with the prosperity of the entire community or unjustly enables one region to draw tribute from another. The interests of an entire nation may be dominantly on the side of the creditor class or the debtor class, and international relations thus seriously affected by changes in the value of the standard 46 Money and Banking commodity. The only way in which justice in money mat- ters between man and man, section and section, and nation and nation can be attained, therefore, is by means of a standard which is absolutely stable. 7. Difficulty of securing a stable standard of value. — However desirable a stable standard of value may be, its attainment is very difificult. Not only does no commodity exist the value of which is absolutely stable, but other necessary qualifications limit the choice. We may not select a commodity for a standard simply because its value is stable in a high degree. It must possess the other quali- fications mentioned as well. Fortunately, however, these other qualifications contribute toward stability of value. Other things being equal, a commodity which is an object of universal desire, and consequently widely and generally used, is less liable to fluctuations in value than one which satisfies the wants of only a few people. The use of a com- modity as a medium of exchange also is liable to steady its value, since it is possible to substitute other things for it if its value tends upward, and to substitute it for other things if its value tends downward. The quantity of the com- modity thus used acts as a sort of reserve fund which is used from time to time to steady the market. It seems probable, therefore, that the commodity which has survived the various tests of actual experience, and is now the stand- ard of value of the commercial world, is as stable in value as any single commodity which could be selected. That it comes far short of being an ideal standard, however, will be made evident in succeeding chapters. 8. The interpretation of prices. — The facts which have been presented in the present chapter should help us to appreciate the difficulty involved in the interpretation of present prices and of price statistics. The market price of any commodity is certain to be the result of at least two The Standard of Value and Prices 47 sets of circumstances, namely, those which determine the demand and supply of the commodity, and those which determine the demand and supply of gold. In a country which possesses a secondary standard a third set of cir- cumstances enters in, namely, those which determine the depreciation of the paper currency. Suppose, for example, that we are asked to interpret a change which took place in the market price of wheat in the United States between the years 1863 and 1865, the price in the former year, for ex- ample, being quoted at $1.10 per bushel and in the latter year at $2.50 per bushel. If we desire to know what caused the great rise in the price of this commodity, we are obliged to investigate, in the first place, the demand and supply of wheat during the period, in the second place, the demand and supply of gold, and in the third place, the depreciation of the government notes which constituted the currency of the period. The changes of price may have been due entirely to any one of these sets of causes, but it is more probable that it was due to the operation of all the causes combined. An investigation of this kind is necessarily very difficult. It is not easy to determine at any particular time precisely what is the demand or the supply of a commodity such as wheat. It is still more difficult to determine and accurately to measure at any particular time the demand and supply of gold. The depreciation of the notes is also difficult to determine. At the best, in such a case, it is usually possible only to establish a certain probability in favor of one explanation or another, but it is rarely pos- sible to obtain absolute certainty. The interpretation of certain price statistics present even greater difficulties. The statistical tables which are usually found in public documents, and upon which interpretations of price changes are based, contain averages of the prices of the commodities in question over a certain period of 4-8 Money and Banking time and on a particular market. For example, the London Economist publishes annually a statement of the average prices on the London market of twenty-two commodities, and compares the average each year with that of a number of preceding years. At the same time it presents also an average of the prices of the twenty-two commodities, and much use has been made of these statistics in the discussion of monetary questions. It is evident from the facts pre- sented in this chapter that the interpretation of the meaning of the average price of a commodity for a certain period of time is even more difficult than that of a specific quotation for a particular moment. Besides the various considera- tions mentioned in the preceeding paragraph, we have now to struggle with the confusion of averaging a number of quotations. In the average one cause may offset another, and the meaning of the result can only be obtained by un- ravelling all of these changes. Suppose, for example, that we average the daily price quotations of wheat for a par- ticular year. One day the price is high as compared with the preceding, another day it is low. The difference is now great, now small. These specific fluctuations, as we have seen, are due to various causes, now affecting the de- mand and supply of wheat, now the demand and supply of gold. It is difficult, as we have seen, to measure and un- ravel these various causes in the case of a specific quota- tion. How much more difficult is it to solve the problem when we have combined more than three hundred of these quotations in a single average! If it is excessively diffi- cult to interpret the average price of the individual com- modity, how nearly impossible it must be correctly to in- terpret an average of the prices of a number of commodities. The purpose of statistics of average prices is usually to indicate changes in the purchasing power of the unit of value. The average of the daily quotations of wheat for a The Standard of Value and Prices 49 year gives us an idea of how much wheat on the average during the year in question a dollar would buy, and when we combine the prices of twenty-two commodities for a year we have a result which indicates to us the average amount of those twenty-two commodities which a dollar would command during the year. A knowledge of the pur- chasing power of the unit is useful for many purposes, but it renders little, if any, assistance in the determination of changes in the actual value of commodities or in the actual value of gold. If we wish to determine whether the ratio between the demand and supply of gold or of any other commodity has changed during a series of years, only a minute and careful investigation into the various circum- stances which have entered into the determination of said demand and supply will suffice. REFERENCES The nature and history of standards of value are treated in Laugh- lin, ch. iii; Jevons, ch. iv; Taylor, chs. v and vii; Knies, ch. iv; sec- tion V of Manger, article "Geld" in the Handworterhuch der Staats- wissenshaften and in his Grundsdtse der V olkswirthshaftslehre, ch. viii. On the importance of stability of value in the standard commodity see Walker, Money, Trade, and Industry, ch. iii, and Money, ch. i; Nicholson, pt. I, ch. ii, §§ 4, 5, and 6; and Ross, The Standard of De- ferred Payments, Annals for November, 1892. Price statistics and their interpretation are treated in Laughlin, ch. vi ; Nicholson, pt. II, ch. vii ; Schoenhof, A History of Money and Prices, ch. i ; Walsh, The Meas- urement of General Exchange-Value, especially chs. v, vi, and xiv; Falkner, introduction to the Aldrich Report on Retail Prices and Wages and his The Theory and Practice of Price Statistics in the Publications of the American Statistical Association, v. Ill, pp. 119-140. CHAPTER IV THE VALUE OF THE STANDARD The standard commodity is no exception to the general laws of value. Marginal utility, costs of production and de- mand and supply operate in this case in precisely the same manner as in others. For a discussion of these laws the student is referred to general treatises on political economy. In this chapter we shall treat only the peculiar influences which lie back of them in the case of this particular com- modity. I. Demand for the primary standard. — It is necessary to treat separately primary and secondary standards. The reason for this, if not obvious at this point, will soon ap- pear. From the standpoint of demand the peculiarity of the standard commodity consists in the fact that a very large, usually the largest, part of it comes from its use as a stand- ard of value and a medium of exchange. It is probable that between 70 and 80 per cent, of the present demand for gold comes from these sources, and from 20 to 30 per cent, from its use for purposes of ordinary consumption, such as jew- elry, plate, ornamentation, dentistry, etc. These proportions may and do constantly change. The point to be firmly grasped at this stage in the discussion is the fact that in the case of the standard commodity there are always two main sources of demand, namely, its service for ordinary con- sumption purposes and its service as a standard of value and a medium of exchange. Neither of these sources should at any time be neglected, since neither of them is ever suspended. To the extent of its magnitude one is just as so The Value of the Standard 51 potent as the other, and at a given time the total demand ■which operates together with the total supply in the deter- mination of its value is the sum of the separate demands which come from its various commodity and monetary uses. There is nothing in the ordinary consumption uses of gold or of any other standard commodity that calls for special treatment in this chapter, but the elements of demand which come from its monetary uses require further con- sideration. As a standard of value a commodity performs its chief function by lying in the vaults of banks and certain government treasuries, like those of the United States, as security for the redeemability of the various forms of credit currency that constitute the bulk of the medium of ex- change. How large a sum is needed for this purpose it is impossible to say. It depends primarily on the state of confidence. If men generally trust each other and freely accept each other's promises to pay, the amount required is very small. Indeed, it is conceivable that it might be re- duced almost, if not quite, to zero. If confidence between man and man becomes impaired in any degree, the amount required is larger and it may become enormous. At any given time it is determined chiefly by the judgment of bankers. Sometimes, as in the case of most of the banking institutions of the United States, the laws fix a minimum, in the form of a percentage of their deposits, below which bankers are not permitted to allow their reserves to fall, but only a part of these reserves can be regarded as an insurance fund of the kind we are describing. A part of them i'S also required to meet the ordinary demand of the community for a particular form of currency. This fact brings us to the consideration of the second source of the monetary demand for the standard commodity, namely, the demand for it as a medium of exchange. 52 Money and Banking In a preceding chapter it was shown that coins of dif- ferent denominations are essential elements of a good medium of exchange. If the standard commodity is used in the manufacture of some of these coins, as it always is, a demand for it results, measured by the amount of such coins needed. The amount depends upon a great variety of circumstances, many of which are subject to purely arbitrary changes. Among the most important of these are: the presence or absence of other forms of currency of the same denominations; the capacity of such other forms of cur- rency to satisfy the needs of commerce ; and the aggregate value of the commodities to be exchanged within a given time by means of currency of these particular denomina- tions. The manner in which the substitution of other forms of currency affects the demand for the standard commodity is well illustrated by the practices of the various countries at the present time. For example, in England there is no form of ordinary hand-to-hand credit currency in circula- tion below the denomination of five pounds or twenty-five dollars. Consequently the entire demand for money of denominations between the silver crown, worth about one dollar and twenty cents, and the five pound bank-note must be supplied by coins made of the standard commodity, gold. In Scotland a large part of this demand is supplied by means of one pound bank-notes, and in the United States we use for this purpose not only bank-notes of denomina- tions five dollars and above, but various forms of govern- ment notes of denominations from one dollar up. If we should cease to use credit currency of these denominations, a demand for gold coins to take its place would appear and the total demand for gold would be to that extent increased. If the Bank of England should be permited to issue one pound notes against securities, and should actually do so, The Value of the Standard 53 there would be a decrease in the use of gold coins in Eng- land and^a corresponding decline in the demand for gold in that country. It is obvious that no form of credit currency can take the place of coins made of the standard metal in their use as a medium of exchange unless it is capable of performing that service quite as well as or better than such coins. In order to do this, the public must be assured of the ability of the issuer to redeem such currency on demand in the standard commodity, it must be equally as convenient or more con- venient than standard coins, and the public must be able to obtain it by means no more onerous than those required for obtaining such coins. Not all forms of credit currency are capable of meeting these requirements, but many are, and the ingenuity of man in inventing such forms has by no means been exhausted. The composition of the currency and the habits of the people in the use of its various elements being for the time fixed, the magnitude of the demand for the standard metal as a medium of exchange is determined by the total value of all the commodities simultaneously to be exchanged by means of standard coins. Suppose, for example, a thousand commodities worth on the average a dollar a piece are going to be simultaneously exchanged by means of standard coins. It is obvious that coins to the amount of one thou- sand dollars will be required for that purpose. Several points involved in this proposition should be carefully noted. First, the word simultaneously employed in this connection is important. If groups of commodities are exchanged one after the other instead of simultaneously, the same coins may be used again and again. This fact is frequently emphasized by the statement that the rapidity of the circula- tion of coins is an element in the determination of the demand for them. If in a given time, say a day, a thousand 54 Money and Banking dollars' worth of coins are used four times, they would per- form the same amount of work as four thousand dollars' worth used once only during the day. If, therefore, we consider a unit of time, such as a day or a week, the demand for standard coins will depend upon the rapidity of their circulation as well as upon the total value of the goods ex- changed. The use of the word simultaneously in our propo- sition concentrates attention on the goods to be exchanged at the same time, and it is obvious that the same coins cannot do two pieces of work at once. Another point to be carefully noted is the fact that the prices of goods are a factor in the determination of their total value, and consequently of the monetary demand for the standard commodity, equally important with their quan- tity. If the average price of each of the thousand commpdi- ties had been two dollars instead of one, two thousand in- stead of one thousand dollars' worth of coins would have been required to accomplish their exchange. The determi- nation of prices is, therefore, antecedent to the determina- tion of the monetary demand for the standard commodity. This statement reveals a relation between this source of demand and prices which requires further elaboration, since it is frequently misunderstood. In a previous chapter we have shown that prices are the numerical expression of the ratio between the value of the conventional unit of any good and of that amount of the standard commodity fixed by statute as the unit of values. We have now shown that one element in the determination of the demand for the standard commodity, and hence in the determination of its value, and hence in the determina- tion of prices, is the amount needed for monetary purposes, and that into that amount prices also enter as a determining factor. This looks like reasoning in a circle, but the ar- rangement of these various influences in their proper order The Value of the Standard 55 as regards time of operation will show that in reality it is not. At a given date, for example, the values of each class of goods and of the standard commodity have been determined by the various elements entering into the supply and the demand of each one, including in the case of the standard commodity the demand for it for monetary purposes. Prices are the numerical expres- sion of the values thus determined. In the next period of time, that is, in the one immediately succeeding that just considered, these prices will enter into the determina- tion of the monetary demand for the standard commodity, either increasing it or decreasing it or maintaining it as be- fore, and in this way together with all the other influences affecting its demand, help to determine its value, which, when thus determined, will play its usual role in prices. The starting point in this process of action and reaction is the value of the standard commodity for ordinary pur- poses of consumption, since, as we have already shown, a valuation based upon these uses must necessarily have pre- ceded its use either as a standard of value or a medium of exchange. In the process of time this valuation has been greatly changed by its monetary uses and it is constantly being so changed, but this fact does not alter the fundamen- tal character of its demand for ordinary purposes of con- sumption or justify the neglect of this demand in the con- sideration of the processes of valuation. In this connection it is well to remember that the mone- tary demand for the standard commodity, while very real and very potent, is peculiar in that it may be arbitrarily mpdified by the substitution of credit currency for it in the medium of exchange and by changes in the regulations per- taining to bank reserves. The former process has been illustrated in a preceding paragraph ; of the latter our own history furnishes many examples. Between the years 1863 56 Money and Banking and 1879 government notes not redeemable on demand in coin were the chief element of the bank reserves of this country. After the resumption of specie payments in 1879 coin was again used, but even up to the present time green- backs and gold and silver certificates are available for that purpose. If Congress should pass a law, as it might, for- bidding the use of anything except gold coin for this pur- pose, the demand for gold would be largely increased. If it should supply an additional amount of greenbacks and permit them to be held as reserves, a considerable diminu- tion in the demand for gold would result. A change in the limitation at present established by law on the amount of reserves banks must hold or in the places at which they are permitted to keep them might very materially affect the demand for this metal. The use of gold as a store of value is often mentioned as one of the sources of its demand. By this is meant its em- ployment in hoards for the purpose of preserving and safe- guarding property. This is certainly one of its uses, but one continually diminishing in importance and in normal times of no great influence. Other means of preserving and safe-guarding property, such as its use for production purposes through the various processes of loan and invest- ment, are far superior and are now-a-days generally em- ployed. In times of uncertainty and distrust, however, this use of gold may become important and a disturbing ele- ment of considerable significance. 2. Supply of the standard commodity. — The supply of every commodity, regardless of its uses, is subject to con- ditions some of which are peculiar to itself, and to this rule gold and silver, the sole standard commodities in use at the present time among civilized peoples, are no exceptions. From the point of view of durability these metals stand at the head of the mineral kingdom. On this account, in pro- The Value of the Standard 57 portion to the amount annually produced, the quantity in existence tends to accumulate more rapidly than that of • other commodities, the loss from wear and tear and actual destruction in the process of consumption being relatively small. In consequence of this fact the amount of these metals in the world at the present time is very great, the process of accumulation having been going on for many centuries. The form, too, in which a very large proportion of it exists, — opiate, jewelry, bars, coins, etc., — is such that its transfer from one use to another can be very easily made. The supply of either of these metals, which in connec- tion with the demand determines their value, is the amount offered for sale at a given time, and not the entire mass ac- cumulated through the centuries; but the existence of this mass constitutes a potential supply which exerts a steadying influence on its value, since any change tends to cause a transfer to or from this mass to the market. If the market value of the metal tends to rise, coin, plate, jewelry, etc., may be melted and sold as bullion, thus increasing the sup- ply, and in the opposite case, bullion may be transformed into coin, plate, jewelry, etc. and the market supply dimin- ished. These changes in supply to a degree counteract the tendency of the market price to change and thus contribute toward stability of value. The portion of this mass, which exists in the form of coin, may be very easily moved to the bullion market, little or no change in form or fineness being required, and bullion may be transformed into coin at the mints of some countries without any cost to the owner and with very little loss of time. Another consequence of the durability of the precious metals and of the consequent steady increase in the mass accumulated has doubtless been a gradual fall in their value, at least since the discovery of the mines of South America 58 Money and Banking in the sixteenth century. There can be little doubt that their supply as compared to the demand for them at the present time is greater than at any other period in the world's history. The same statement could probably be made concerning most other commodities. This is but another way of saying that the wants of people are better supplied now-a-days than ever before. It is, however also probable that the degree of decline in the value of the pre- cious metals has been greater than in most other commodi- ties. The evidence of this is the tendency of prices to rise. A comparison of the recorded prices through long periods of time of a commodity like wheat, reveals this tendency, as does also a comparison of the averages of the prices of groups of commodities. 3. The value of secondary standards. — Secondary stand- ards have already been described as discounted or depre- ciated notes which, in accordance with Gresham's law, have taken the place of coin in the medium of exchange, not only as hand-to-hand money, but as a basis of other elements of the currency. We shall now consider the chief causes and consequences of the difference in value between these notes and the primary standard in existence at the time. Being actual or implied promises to pay, these notes are credit instruments and their value is subject to the laws governing such instruments. The most fundamental of these is the result of the loan feature which characterizes them. When a government issues such notes it is really forcing a loan from the people, a loan of the services and commodities for which it gives the notes in payment. When, in the ordinary processes of commerce, a person re- ceives these notes in pa3Tnent for goods or services, he is in reality making a loan, since what he has obtained in return for his property is a promise to pay the standard commodity, which promise is not redeemable on demand The Value of the Standard 59 but at some date in the future. For loans interest must be paid, and since these notes are non-interest-bearing their value necessarily depreciates, the amount of depreciation depending upon the rate of interest and the length of the period during which it is calculated. But how is this rate of interest and the length of this period to be determined? On the face of the notes the date of their redemption is usually not indicated, and in most cases a considerable period of time elapses before a date is fixed by the public authorities. During all this time people can only speculate regarding the time at which the notes will be redeemed and their speculations will vary according to the course of events likely to affect the ability and willingness of the responsible party to pay and according to the various de- grees of their optimism or pessimism. During our Civil War, for example, the United States notes, which became a secondary standard of value soon after their issue in 1862, fluctuated with the varying fortunes of the armies in the field and the financial condition of the government. After the war the element of risk diminished as the financial con- dition of the government improved, and after the passage of the resumption act in 1875 the date for the redemption of the notes became definite. It is evident, therefore, that both the element of risk, which always enters into the determina- tion of the rate of interest, and the length of the period during which the interest is to be reckoned are speculatively determined in the case of inconvertible notes, and on this account their depreciation is liable to wide and frequent variations. The monetary services performed by these notes tend to obscure the influence of the loan feature and introduce new factors into the determination of their value. The ability of a person to pay his debts with them and to use them in the purchase of other commodities renders possible a con- 6o Money and Banking tinual shifting from one person to another of the risks and possibilities of loss involved in their possession, but the fact that, so long as industry and commerce continue, every person must receive them in payment for the goods and services he sells offsets any advantage which might other- wise be derived from this possibility. Ultimately each person must assume a share of the risks and losses involved in the use of such notes, and their depreciation to the full extent warranted by such risks and losses would be inevita- ble, were it not for the fact that their serviceability for monetary purposes creates a new demand for them which affects their value. The possible extent of this demand is the amount of coin in use for monetary purposes plus the amount the increase in prices, due to the depreciation of the notes, would occasion. However, it would rarely, if ever, be so great as this. Coin does not cease to be useful for many monetary purposes when such notes come into competition with it. At a premium measured by the de- preciation of the notes they are as useful as ever and may continue to be used whenever such premium can be real- ized. The notes will take their place only in those uses in which this premium cannot be realized, namely, as hand-to- hand money within the territory in which they are legal- tender. For that element of bank reserves which consti- tutes an insurance fund against future contingencies, such as the shattering or destruction of confidence between man and man, for international payments, and as a store of value the use of coin will continue to be as profitable as ever. The tendency of this monetary demand is to diminish the depreciation to which the notes are normally subject, but it is impossible to determine the magnitude of its in- fluence in this direction. As we have seen, the most potent causes of depreciation are subjective and hence impossible The Value of the Standard 6i of exact measurement and there is no way of determining the magnitude of the monetary demand for them at a given time. The actual depreciation of the notes, or the premium on the standard commodity, which is the same thing, is a known quantity, obtainable from market quotations, but the various influences which have determined it cannot be separated and measured. The market records which are available for study indicate that the monetary demand has rarely, if ever, been sufficient to prevent depreciation. In- deed, whenever and wherever such notes have been ex- tensively employed their depreciation has been great and subject to frequent and wide variations. 4. The quantity theory. — The value of the standard is ordinarily explained by a theory which assigns to the money supply so peculiar an influence on its value that the name quantity theory is commonly given it. In many important particulars this theory is out of harmony with the explanation given in the preceding paragraphs. On this account it demands attention at this point. Various methods of stating and defending this theory have been employed which the student is advised to examine with the aid of the references given at the close of this chapter. Only its essential features will be indicated here. A recent writer has described them in substantially the following manner : At a given time there is needed in a country a certain amount of money value or utility, that is, "utility in a form possessing universal and immediate acceptability." This amount "depends upon the volume of transactions, upon the population of the country, the quantities of goods they produce and exchange, their customs with regard to the use of credit as a medium of exchange, their business organization, their methods of production and exchange, 62 Money and Banking and their habits with regard to the keeping of money on hand." * This need or demand for money value creates the supply of money value, since all the goods the sale of which pro- duces this demand are offered in exchange for the money of the country regardless of its amount, and, being use- ful for no other purpose, all the money of the country is offered for them. ** These two aggregates being exchanged each for the other, their values are equal, and the value of a unit of the money supply equals the total value of the goods offered for sale divided by the number of units and varies inversely with this number. For example, if the amount of money value needed is looo and the number of money units 500, the value of a single unit is 2 ; if the num- ber of units be increased to 1000, the value of each falls to i ; and if the number be decreased to 100, the value of each rises to 10. In this description the word money means standard coins and the substance of the entire statement may be ex- pressed in three propositions : (i) At any given moment a certain quantity of com- modities is offered in exchange for standard coins, the quantity being determined by the various circumstances mentioned above; (2) The total value of the standard coins regardless of their number or of their value as bullion will equal the total value of the goods offered in exchange for them; (3) The total value of the unit will, therefore, equal the total value of such goods divided by the number of units in the supply and will vary inversely with that number. In order to make very clear the lack of dependence of the value of the monetary unit on that of the bullion con- * Johnson's Money and Currency, p. 19. **Ibid, pp. 27, 28. The Value of the Standard 63 tained in it, another writer* illustrates the theory by as- suming the money of a country to be composed of dodo bones, the nearest approximation to an absolutely worthless thing he could think of. Under this assumption, if the number of dodo bones were 1000, the value of each would be one one-thousandth part of that of the goods offered in exchange; if the number were reduced to 100, the value of each would rise to one one-hundredth part of that of the goods, and so on. Regarding the first proposition it should be observed that the exchange of any good or goods for standard coins im- plies the previous possession of value by the latter. It is unreasonable to suppose that any one would trade a com- modity which he valued for one that had no value what- ever. The dodo bone assumption is, therefore, impossible, since such a worthless thing could never come into use as standard money. This truth has been obscured by the monetary use of inconvertible notes. These notes, how- ever, are always actual or implied promises to pay, and the amounts are always stated in terms of the prevailing stand- ard. They constitute secondary standards, and the satis- factory explanation of their value is impossible without reference to the value of the primary standard which has been previously and independently established. It is obvious that exchanges between goods in general and the standard commodity will take place at the beginning on the basis of the value already established by their respective demands and supplies for ordinary consumption purposes, no other basis being possible, and that the extent of the monetary demand for this commodity can only reveal itself quantitatively on the basis of prices thus established. For example, if there are 1000 commodities, and the aver- age price of each is one dollar, there will be a demand for *J. Shield Nicholson. 64 Money and Banking $1000, if the average price of each is two dollars, there will be a demand for $2000. It is obviously impossible to know what the demand will be before the price of each commodity is determined. That demand once revealed and made effective by the offering of goods for the standard commodity on this basis will become an element of the total demand and will affect its value, and through that value prices, and through these the monetary demand again. The proportion of the monetary demand to that from other sources makes no difference in the valuation process or in the fundamental character of the value of the standard commodity for purposes of ordinary consumption. The utility of the standard commodity for these purposes is the basis of its utility for monetary purposes. The latter could not exist without the former and for all time con- tinues to have vital relations with it. If the prices of the commodities exchanged are deter- mined by comparisons of their values with that of a stand- ard independently determined by its supply and demand, in which its use for ordinary purposes of consumption is a fundamental factor, then the total value of the monetary supply is not independent of the number of units in circula- tion, as is stated in the second of the above propositions, but is proportional to that number, being equal to the product of it and the value of the unit. Furthermore, the number of units in use for monetary purposes is in the first instance a result of the level of prices established by the above men- tioned comparisons, and enters into the determination of the value of the unit in the succeeding period of time only to the extent that it constitutes an increase in the demand for the bullion of which it is composed. The statement that the value of the unit equals the total value of the goods exchanged for standard coins divided by the number of units they represent is an identical proposi- The Value of the Standard 65 tion which has no significance, if the second of the above propositions be not true, and is objectionable in so far as it leaves the impression that the value of the unit is derived solely from the demand for it for monetary purposes and is independent of the supply and demand for bullion. The chief objections to the quantity theory may, there- fore, be summarized as follows : 1. It underestimates the importance of the bullion value of the standard commodity and incorrectly explains the relation of that value to the value of the standard coins. 2. Its statement of the relation of the quantity of money to its vajue is incorrect and misleading. 3. Its explanation of the sources of the value of the monetary unit being incorrect, it fails to recognize the existence of secondary standards and consequently correctly J to explain the value of inconvertible notes. 4. It may be added that on account of these errors it has given support to a widespread belief in the efficacy and importance of changes in the volume of the circulating medium which is erroneous and dangerous. REFERENCES This subject is ably and exhaustively treated in Laughlin, chs. vii, viii and ix. For other criticisms of the quantity theory see Miss Hardy . "The Quantity Theory of Money and Prices," Jour, of Pol. Econ., March, 1895; ^it£hell, "Quantity Theory of the Value of Money," ibid., March, 1896; Willis, "Credit Devices and the Quantity Theory," ibid., June, 1896; Hazell, "Quantity Theory of Money from the Marxist Standpoint," ibid., December, 1898; Scott, "The Quantity Theory," Annals, March, 1897; Farrer, Studies in Currency, ch. v; White, Money and Banking, bk. 11, ch. xvii; and Schoenhof, The History of Money and Prices. For statements and defense of the quantity theory see Johnson, Money and Currency, chs. ii, iii, vi, xiii; Kinley, Money, ch. viii; Walker, Political Economy, §§ 169-175; Money, chs. iii-viii; and "The Quantity Theory," Quart. Jour. Econ. v. ix; Nicholson . Money and Monetary Problems, chs. v-vii; Mill, Political Economy, bk. in, chs. viii and ix; and Kemmerer, Money and Credit Instruments in their relation to general prices. CHAPTER V THE ELEMENTS OF THE MEDIUM OF EXCHANGE In Chapter 11 the currencies o£ modern times were ana- lyzed into their constituent elements and their general char- acteristics pointed out. We shall now consider each element separately, beginning with the metallic. I. The purpose and importance of coinage. — Metals now- adays serve the purposes of money chiefly in the form of coins. Originally doubtless, and occasionally in historic times, they were used in a crude state, the requisite amount being weighed out on the occasion of each exchange or passed from hand to hand in quills or other crude recep- tacles capable of being used as instruments of measure- ment. The great advantages of coins, however, led to their universal use in very early times, and at present their manu- facture constitutes a business of no small magnitude and of great social significance. A coin may be defined as a piece of metal or combina- tion of metals bearing a stamp indicative of its weight and fineness, and other devices designed to render counterfeit- ing difficult, to prevent clipping and sweating, and some- times to serve educational, artistic, or patriotic purposes. The explanation of their universal use may be found in the fact that, in order to transact business rapidly and accurate- ly, it is absolutely necessary that the money metals should be put up in accurately labelled packages of convenient size and weight, so that any amount, large or small, can be transferred from one person to another or from one place to another without the waste of time and danger of error 66 The Elements of the Medium of Exchange 67 which weighing the metals or measuring them in any other way would involve. If gold and silver in its pure state had to be weighed in every transaction, commerce on a large scale, in which rapidity and accuracy are essential and even slight losses in each exchange ruinous, would be im- possible. A properly made coin always contains a fixed amount of metal of an invariable degree of fineness, and is so marked that we may know its exact weight and contents at sight without resort to the scales or the melting-pot. In making exchanges, therefore, it is only necessary to count and handle them, processes which may be performed very rapidly if their denominations, sizes, and weights are con- veniently arranged. Among the prime considerations in the manufacture of coins are honestly and accuracy. Inasmuch as they must pass from hand to hand throughout the length and breadth of the land and among rich and poor, learned and ignorant, those who understand their nature and those who do not, and must be accepted by everybody at the value represented by the devices placed upon them, absolute confidence in the honesty and accuracy of their manufacture is essential. If the stamp placed upon the coins were false, for example, people would soon discover the fact, and refuse to accept them, or, if compelled by law, protect themselves by refus- ing to sell their goods and services or by raising their prices. In any case commerce would be seriously obstructed and perhaps entirely destroyed. Inaccuracy in their manu- facture is almost equally harmful. Two coins of the same denomination and made from the same metal should be exactly equivalent to each other in weight and fineness. Otherwise the superior coins would soon be culled out and melted up and the currency be constituted exclusively of the inferior ones. Moreover, the process of exchanging coins for each other simply for the purposes of gain in- 68 Money and Banking terferes with their legitimate use and obstructs commerce. Owing in part at least to its great importance, the right of coinage has been considered from very early times as the prerogative of the sovereign. Throughout Europe, how- ever, during the Middle Ages it was frequently granted to petty princes and free cities, and in consequence very much abused. In order to make the money received go very much farther than it otherwise would in the payment of debts and the purchase of commodities, debasement was frequently practised ; that is, baser and cheaper metals were substituted for a part of the gold and the silver, the old weight and name being retained. Another method em- ployed to accomplish the same end was the reduction of the weight and the size of the coins. These practices were equivalent to a partial repudiation of debts, and so far as the sovereign possessed and exercised the right of fixing prices, they also amounted to the levy of a tax upon the merchants with whom these sovereigns dealt. In partial justification, or at least explanation, of this abuse, it should be said that the laws of value were unknown to the royal personages of the Middle Ages, and that they generally believed that they possessed both the right and the ability to fix the value of money arbitrarily. The debasement of coins and the diminution of their weight, therefore, were not considered as criminal acts, but as the exercise of a sovereign right and a sovereign power. Not until com- merce was developed to such an extent as to make its im- portance understood by kings and princes did the voice of the merchant class make itself heard in protest against these practices, and correct ideas regarding the nature and func- tions of money become a part of the common knowledge of business men and other well-informed people. The pro- cess consisted in the gradual withdrawal of the right of coinage from all private persons, and in the development The Elements of the Medium of Exchange 69 of the strictest integrity in the manufacture of coins on the part of public authorities. At the present time coinage is exclusively a government function, and in no one of the great nations would debasement or other dishonest prac- tices be tolerated. When much worn by usage or in any other way defaced or reduced in weight coins are usually withdrawn from circulation by public authority and re- minted. Perfect confidence is thus ensured. Since the laws of every nation contain an accurate description of the mate- rial, weight, fineness, and devices of its coins, and the mints execute these laws with perfect integrity, there is no oc- casion for ignorance, and no danger is involved in accept- ing metallic money at its face value. In the preparation and maintenance of a good coinage system several important problems arise, in the solution of which all nations have been guided by substantially the same considerations, though their practices differ consid- erably in detail. Of these we will discuss the selection of units of value and methods of reckoning, the size, weight, and fineness of coins, and their names and devices. 2. Units of value and methods of reckoning. — Two sys- tems of reckoning are at present in use, which we will desig- nate as the English and the decimal. The former is the older of the two, having been employed everywhere in Europe during the Middle Ages, while the latter is the one in common use at the present time. According to the Eng- lish system the unit is the pound sterling, which is divided into twenty parts called shillings, each of which is further divided into twelve parts called pennies, and these again into four parts called farthings. A pound is, therefore, equal to twenty shillings or two hundred and forty pence or nine hundred and sixty farthings. The names applied to the unit and its subdivisions have been different in the different countries, and the weight and materials of the 70 Money and Banking coins have changed many times. For example, the names common in Germany were pfund, schilling, and pfennig, and in France livre, sol or sou, and denier. It is probable that the English unit originally was a pound weight of silver, while at the present time it is fixed by law at 1 13.001 grains of pure gold. Everywhere except in England this cumbrous system has been abandoned for the decimal, according to which the unit is divided into one hundred parts. In the United States, for example, we call our unit a dollar, and the hun- dredth part of it a cent; in Germany the name of the unit is a mark, and of the hundredth part a pfennig, the same name formally applied to a two-hundred-and-fortieth part of the old unit. The corresponding names in France are franc for the unit and centime for the subdivision ; in Italy lira and centesimo; in Austria krone and heller, formerly ■fiorin and kreutser; and in Russia ruble and kopeck. The prevalence of the decimal system is due to its superior con- venience. It is much easier to multiply and divide by ten and its multiples than by twelve and twenty. In the determination of the size and name of its unit of reckoning each nation has been influenced by a variety of considerations, many of which have been peculiar to itself. It is diiificult to change a system already in vogue, and con- sequently historical precedents have been often followed. In the United States the fact that a Spanish coin called a dollar was in general circulation at the time our monetary system was established and for many years previous to that date, doubtless was the determining factor in the choice of our unit. In Europe the so-called franc system is the most widely extended, partly on account of the dominant in- fluence of France among the nations of the Latin race, and partly on account of the inherent merits of the system itself. In consequence of the very different circumstances by which The Elements of the Medium of Exchange 71 the several nations have been influenced, a large number of units, however, are now in use. From the point of view of size they may be grouped into four main classes. In the first class belongs the English pound sterling, which is the largest of all, being equivalent to nearly five of our dollars. To the second class belong the United States and Canadian dollar, the Russian ruble, and the peso of several of the South American States. Of these our dollar may be re- garded as typical. To the third class belong the old florin of Austria, the florin or gulden of Holland, and the krone of the Scandinavian countries and Denmark. As a type of this class may be taken the Dutch gulden, which is worth about forty cents of our money. In the fourth class belong the units of Germany, France, Spain, Italy, Belgium, Swit- zerland, and the new unit of Austria-Hungary. Of these the French franc, worth about twenty cents of our money, may be taken as a type. It must be remembered that the units of the countries here classed together are not identical. Our dollar and the Russian ruble, for example, differ in value by more than forty-eight cents but they have this in common, that, with the exception of the English, they, together with others of the same class, are the largest units now in use. The German mark and the French franc diflFer in value by about five cents, but they are both rela- tively small, while the Dutch gulden and the old Austrian florin, though not identical in value, in size range between the United States dollar and the French franc. In the determination of the coins to be minted the size of the unit and the method of reckoning are important. As a rule the nations with small units have coins of lower denominations than those with large, the smallest repre- senting one-hundredth part of the unit. The countries which use the franc system for example, usually have a coin about equivalent to one-fifth of a cent. The other 72 Money and Banking fractional coins which are most common wherever the deci- mal system is used represent values equal respectively to two, five, ten, twenty, or twenty-five and fifty times the smallest coin. In France and Belgium, for example, there are five-, ten-, twenty-, and fifty-centime pieces; in Ger- many, one-, two-, five-, ten-, twenty-, and fifty-pfennig pieces; in Austria-Hungry one-, two-, five-, ten-, twenty-, and fifty-heller pieces ; in the United States one-, five-, ten-, twenty-five-, and fifty-cents pieces, etc., etc. Experience has shown that coins of these denominations are most con- venient for purposes of reckoning and making change. In the English system the subdivisions are quite different, the coins in most common circulation being the half-penny, penny, sixpence (equivalent to six pennies), shilling (equiv- alent to twelve pennies), and two-, two-and-a-half, five-, and ten-shilling pieces. The large coins almost universally represent five, ten, twenty, and sometimes fifty times the value of the unit, paper money being used for the higher denominations. 3. The size, weight, and fineness of coins. — The denomi- nations of the coins once determined, the size, weight, and substance are dictated chiefly by convenience, and in this respect the different systems exhibit remarkable similarity. In the countries with the small units the smallest coin and those representing two, five, ten, and twenty times its value are made of cheap metals, such as copper, bronze, or nickel ; those representing half the value of the unit or fifty times the value of the smallest coin, the unit, and its multiples up to five, are made of silver, and the coins of higher denomi- nations of gold. In other countries coins of corresponding value are made of the same metals. In the United States, for example, the one-cent piece is copper, the five-cent piece nickel, the ten-, twenty-five-, and fifty-cent pieces and the dollar coins are silver and the others gold. In England the The Elements of the Medium of Exchange 73 penny, half -penny, and farthing are bronze, the sixpence, shilling, two-, two-and-a-half, and five-shilling pieces silver, and the coins of higher denominations gold. In Germany the one-, and two-pfennig pieces are copper, the five- and ten-pfennig pieces nickel, the twenty- and fifty-pfennig, one-, two-, and five-mark pieces are silver and the other coins gold. In France the five- and ten-centime pieces are copper, the fifty-centime, one-, two-, and five- franc pieces silver, and the coins of higher denominations gold. In- deed, as nearly as the size of their respective units will permit, the coins of the various nations correspond to each other in size, weight, and substance, a fact which clear- ly shows the universal dominance of commercial interests in monetary matters. Despite the fact that the manufacture of coins is a government monopoly the world over, and de- spite the differences in the history, political characteristics, and economic and social policies of the different nations, common commercial needs have given to their coinage systems the same general features. In order to render gold and silver coins more durable and thus to protect them as much as possible from loss by abrasion, the pure metal is usually mixed with copper or, in the case of the gold coins, sometimes with a mixture of copper and silver. This admixture is known as an alloy, and the metal thus hardened is known as standard gold or standard silver to distinguish it from the pure metal. The most common practice at the present time is to use nine parts of pure gold or silver to one part of alloy, and the coins manufactured from metal of this standard are said to be nine-tenths fine. The process of increasing largely the proportion of alloy to pure metal is called debasement, a practice which, as we have previously noted, was very common in the Middle Ages and was one of the reasons 74 Money and Banking for making coinage a government monopoly and for sur- rounding it with all possible safeguards. 4. The naming and stamping of coins. — The naming of coins is a purely arbitrary matter, and practice varies wide- ly in this particular. The tendency in modern timse seems to be toward employing the names used in the system of accounting. For example, in this country we commonly call our gold coins two-and-a-half-dollar, five-dollar, ten- dollar, and twenty-dollar pieces. The official names, how- ever, are the quarter-eagle, half-eagle, eagle, and double- eagle, these names being derived from the figure of an eagle stamped upon one side of the coin. In England the practice of employing special names is more common, her gold coins being universally known as the sovereign and half-sovereign, and her silver coins as crowns, half-crowns, florins, shillings, and sixpences. With the exception of the two last mentioned all these names are derived from devices on the coins or from old customs. Until compara- tively recent times this practice was almost universal, the names of the reigning monarch or of the king who first ordered the coin minted being the most commonly employed. As examples may be mentioned the French Napoleons, the Prussian Friedrich d'ors, and the English George d'ors. Such devices as the figure of an angel, a lamb, a pig, and the rising sun gave names to coins of considerable impor- tance in the Middle Ages. Special names are frequently conferred upon coins by popular usage ; as, for example, in this country the names nickel and copper for our five-cent piece and penny. Our twenty-five-cent piece, or quarter of a dollar, is known by various peculiar names in different parts of the country. Besides the purpose of ornamentation the devices stamped upon coins are designed to serve as means of pre- venting "sweating" and clipping and of rendering easy the The Elements of the Medium of Exchange 75 detection of abrasion. The milled or indented edge, the practice of stamping both sides, and the circular form of coins are explained in this way. So far as possible, it is also desirable to use designs which are difficult to copy and which may thus aid in the detection of counterfeits. 5. Seigniorage. — The expenses of coinage are paid in two different ways. Sometimes individuals are permitted to bring gold or silver bullion to the mints and have it trans- formed into coin absolutely free of charge. In such a case the expenses of coinage are paid out of the ordinary reve- nues of the government and are a charge upon the nation as a whole in the same sense as other ordinary public ex- penditures. Sometimes, however, governments exact pay- ment for coinage in the form of the retention of a certain percentage of the bullion brought to the mint by private individuals. This practice is entirely similar to that fre- quently employed by millers in rural districts. Farmers who take wheat to the mill usually receive in flour some- thing less than the full product, the miller retaining a cer- tain amount as payment for his services and the use of his mill. In the same way when private individuals bring gold and silver to the mint, governments sometimes exact a toll in the form of a certain percentage of the metal deposited. The amount thus exacted is called seigniorage, and the prac- tice of meeting the expeditures of coinage in this way is ordinarily known as the taking of seigniorage. At the present time the amounts exacted are usually sufficient simply to pay the actual expenses of the process, but formerly it was common to take much larger sums. During the Middle Ages persons who possessed the right of coinage not infrequently retained a considerable portion of the metal which was brought to them. On account of the peculiar notions ©f that day regarding the power of monarchs to fix arbitrarily the value of money this prac- 76 Money and Banking tice was not considered in any sense improper, and was not supposed to involve any particular injury to the public. In- deed, the business of minting was looked upon as a proper source of public revenue, and as much as possible was made out of it. In order to distinguish between the practice of merely paying necessary expenses by means of this toll and of ex- acting an additional amount for the purpose of gain, a French writer, M. Chevalier, proposed that the former prac- tice be known by the name of brassage and the latter by the name of seigniorage. M. Chevalier's suggestion, however, has not been generally followed, and the term seigniorage has ordinarily been employed to apply to both practices. It would be better, however, not to use the term seniorage to apply to certain gains accruing to the government from coinage. It is now the universal practice to refuse to pri- vate individuals the right to have silver transformed into subsidiary coins, and since their intrinsic value is always less than the value at which they circulate, a considerable gain may accrue to the government from their manufacture. The amount of profit thus derived, however, is diminished and may be entirely offset by their redemption in standard money, to which the government is usually obligated by law. In any case, the gain cannot properly be classed as a charge made to cover the expenses of coinage, and should, therefore, be separately considered and not confused with seigniorage. Our government, for example, has derived some profit from the manufacture of silver dollars, coins which until recently could not be classed as subsidiary. To put such profits in the same class with tolls exacted from persons who bring gold to the mint is to confuse two very different things, and such confusion is almost sure to arise when the term seigniorage is applied to both. In view of the fact that this term is often used to mean things so very The Elements of the Medium of Exchange 77 diflferent, the student should always identify the sort of charge or profit referred to, and consider it separately and on its own merits. Whether or not it is desirable to take seigniorage is still a moot question. It is claimed, on the one hand, that coins perform a special service, and, therefore, possess a higher degree of utility than the bullion they contain, and that this should be represented by an increase in their value equal at least to the expense of their manufacture. It is frequently said that there is no more reason why a coia should represent the exact value of the material out of which it is made than that a steel rail should have the same value as the iron it contains. It is also urged that the taking of seigniorage acts as a check upon the melting-down and exportation of coin. In case the government freely trans- forms bullion into coin, metal-workers are quite as apt to secure the gold and silver needed for their purposes by the melting-down of coins as by the purchase of bullion upon the open market. Whenever for any reason, too, there is a demand for gold for exportation, coins are quite as apt to be sent as bullion, if their market value is precisely the same. If no seigniorage is charged, it is urged, the govern- ment is thus obliged to incur an unnecessary expense in the manufacture of coins which in many cases remain in circulation for only a short period; and since coins are designed for purposes of circulation only, it is urged that some check should be placed upon their illegitimate use. The advocates of the abolition of seigniorage, on the other hand, emphasize the importance of a perfectly free movement of the precious metals from country to country and from the arts to the mints and vice versa. A proper distribution of the precious metals throughout the world demands that they should flow freely from one country to the other whenever there is even a small difference in value 78 Money and Banking between two markets. Any obstruction of this free move- ment is sure to produce an artificial level of prices, and thus to contribute to a lack of stability in the business world. It is equally important, it is claimed, that a proper distribu- tion of metals between their various uses should take place, and, hence, that no more gold should take and retain the form of coin than is necessary for the economical transac- tion of the commerce of the world. Every encouragement possible, therefore, should be given to the melting-down of coins for use in the arts whenever for any reason their quantity is excessive. In reply to the argument that the people should not be burdened with the expense of mint- ing coins which are destined for the melting-pot or for ex- portation, it is said that the government is quite as much justified in furnishing the community with good metallic money at the general expense as in furnishing a good judi- cial system or any other public service. In order properly to weigh these arguments a number of considerations are necessary which must be deferred to later chapters of this book. It is possible here, therefore, only to state clearly the nature of the questions involved. First of all, it should be noted that at the present time the problem of seigniorage concerns only standard coin. There is no difference of opinion among economists or statesmen regarding the proper treatment of subsidiary coins, and, as we have already said, it is questionable whether the term seigniorage should be applied to the gains arising from the minting of these. That gold is the stand- ard of value of the most important nations of the present day and that its more extended use in this capacity is prob- able are facts which also affect the question, especially when the constantly increasing use of credit money is con- sidered. Since gold is suitable only for coins of large de- nominations, and since many forms of paper money can, The Elements of the Medium of Exchange 79 therefore, be conveniently substituted for it in the ordinary circulating medium, the chief use of this metal tends to a greater and greater extent to become that of paying bal- ances between different countries and between different localities in the same country. For this purpose properly assayed and stamped bars of bullion can be used quite as well as coins. The nature of the question has also changed somewhat on account of the increasing importance of the freedom and ease of movement of gold which is involved in its more extended use in the payment of balances. For these reasons the importance of the seigniorage question has somewhat diminished, and the power of governments great- ly to enhance the value of coins by such a charge is also much less than formerly. 6. Inconvertible government notes. — By these are meant government notes not directly or indirectly convertible on demand into standard coins. The most noted historical examples of this form of currency have been issued by governments in times of fiscal exigency, and have consti- tuted a forced loan. They have been issued in fixed de- nominations, made legal tender, and otherwise fitted for circulation as money in order to increase their service- ability as a fiscal agency rather than for the purpose of pro- viding commerce with an ideal monetary instrument. Few people nowadays would recommend their use as a medium of exchange except as a kind of last resort when other fiscal means have failed and a government is forced to adopt not such measures as it would, but such as it must. Nevertheless it is important and instructive to note the dis- advantages of this form of currency, this being the price the people must pay for its use. Why such notes depreciate, take the place of metallic currency, and become a secondary standard of value, has been explained in Chapter IV. The disadvantage of this 8o Money and Banking procedure is the rise and unsteadiness of prices which result. One more source of price fluctuation, namely, variations in the depreciation of the notes, is added to the two which may be regarded as normal, namely changes in the value of commodities and in that of gold. This cause of price movements is much more capricious than the other two, since subjective influences are more potent in this than in the other cases. The result is uncertainty in all commercial calculations. No one knows what the value of money may be from day to day or week to week. The only certainty is that prices will be unstable and subject to changes from purely subjective influences. Every business man must either suspend operations or become a speculator. Shrewd guessing and chance take the place of sound calculation and enterprise. The effect of this sort of thing upon in- dustry is always injurious and sometimes deadly. Even the best habits are not always proof against the insidious influences of speculation in ordinary times, but, when sound business methods are rendered impossible by a fluctuating currency and men are compelled to speculate in order to live, commercial virtues are rendered inoperative and gambling is given a clear field. Even moral sensibilities be- come blunted under such circumstances, and business men and public servants practise and countenance actions which in normal times would not be tolerated. Witness the grad- ual smothering of the sentiment of financial honor and integrity and the appearance of a number of theories in support of public dishonesty in the French legislative bodies during the regime of the assignats and the mandats, and the rapid decay of legitimate industry under the blighting influence of the fever of speculation which reigned during that period.* Witness also the greenback heresy in the *See Andrew D. White's pamphlet on "Paper Money Inflation in France," The Elements of the Medium of Exchange 8i United States and the wild monetary theories which clouded the vision of many of our public men and of a considerable portion of our population for more than a generation, the evil effects of which have not yet ceased to trouble us. These are the legitimate fruits of inconvertible government notes, and they render the infliction of that kind of cur- rency upon a people one of the greatest of national calam- ities. 7. Convertible government notes. — This class of notes is characterized by the fact that they are redeemable on de- mand in coin, and are thus exempt from the defect of de- preciation. Two varieties should be distinguished and sepa- rately considered : — A. Silver and gold certificates. — These may be described as notes issued to take the place of certain coins, and com- pletely covered by the deposit of said coins in the public treasury. As typical of these may be taken our silver and gold certificates. The former were issued to take the place of silver dollars, which were not readily accepted by the people, but which the Bland Act practically compelled the Secretary of the Treasury to force into circulation. This act ordered the coinage into silver dollars of not less than two nor more than four million dollars' worth of silver monthly. Partly on account of their inconvenient size and weight, these coins were speedily transferred to the treas- ury in the payment of public dues and tended to remain there in lieu of gold or other forms of currency. The ex- pedient was therefore tried of issuing certificates of con- venient denominations and making them redeemable on demand in silver dollars, a number of which, exactly equal to the face value of the certificate issued, being stored away in the vaults for that purpose. The expedient succeeded, and these notes have constituted a part of our circulation from that time until the present day. Our gold certificates 82 Money and Banking are similar in character, except that they are issued in large denominations and are redeemable in gold. The utility of this class of notes cannot be questioned. They are more convenient than the coin they represent, and they obviate the loss which is necessarily occasioned by the wear and abrasion of coins in circulation. In these respects, however, they are no better than other forms of paper cur- rency of the same denominations and like them redeem- able in standard money. The real problem, therefore, con- cerns the desirability of the manufacture of the classes of coins which they represent. Regarding gold coins there can be and there is no question in the United States. So long as this metal continues to be our standard of value we shall need to put it up in the form of coins, and since, in such cities as New York, Chicago, Philadelphia, and Bos- ton, large sums must daily be transferred between banks in the payment of balances, gold certificates in large denomi- nations must be regarded as a useful and economical de- vice. Regarding silver dollars a just decision is not so easy to reach, and opinions are divided. Gold monometallists, as a rule, believe that, if they are to be retained as a per- manent part of our currency, they should be reduced to the grade of a subsidiary coin, and assimilated in weight to our half- and quarter-dollars and dimes. B. Treasury notes. — The second variety of convertible government notes referred to above is characterized by the fact that, while the government guarantees their redemption in standard coin, it does not keep on deposit for that pur- pose the face value of the notes and does not retire them when once redeemed, but treats them as cash and pays them out again for ordinary expenses or in exchange for stand- ard coin. A good illustration is furnished by our so-called greenbacks and Sherman notes. The former is an in- heritance from our inconvertible currency period. When The Elements of the Medium of Exchange 83 specie payments were resumed in 1879, something over $346,000,000 of the old notes were left in circulation. The Secretary of the Treasury was ordered to redeem them on demand in gold, but was denied the power to retire them. The Sherman notes were issued under authority of an act in 1890 directing the Secretary of the Treasury to purchase every month at its market value 4,500,000 ounces of silver, and to issue in payment therefor treasury notes redeemable either in gold coin or silver dollars at his option. Since the act also made it the duty of the Secretary to main- tain all forms of our currency at a parity with gold, and since the metallic value of silver dollars was at the time but little more than half their face value, the redemption of these notes on demand in gold was a practical necessity. As in the case of the greenbacks, the Secretary was also forbidden to retire these notes. Before the repeal in 1893 of the clause of this act authorizing the monthly purchase of silver bullion about $150,000,000 worth of notes were issued. The act of 1900 provided for the gradual retire- ment of these notes. Consequently only a small quantity are at the present time in circulation and these will be grad- ually withdrawn. Treasury notes similar to these in es- sentials have been circulated from time to time in other countries, but ours is the most notable attempt permanently to maintain a circulating medium of this sort. In considering the merits and defects of this variety of notes, it should be observed that the only rational purpose of their employment as a permanent part of the currency is to supplement coin. Unlike the silver and gold certifi- cates considered in the preceding section, they are not in- tended to circulate in the place of certain classes of coins. On the contrary, they are only partially covered by a coin reserve, and they are issued for the purpose of expanding the currency. 84 Money and Banking In a previous chapter attention was called to the im- portance of elasticity in at least certain of the paper ele- ments of the currency, on account of the fact that coin does not automatically move from place to place and in- crease and decrease in quantity in response to the changing needs of commerce. It should here be noted that treasury notes of the sort we are discussing do not possess this very desirable quality. Indeed, they are quite as inelastic as metallic money. Their issue must be authorized by law and their quantity strictly limited. It would be quite un- safe and opposed to all the canons of sound finance to per- mit the Secretary of the Treasury or any other public officer to issue them at his discretion, and, even if such power were granted, the notes could not be speedily sent to the places where they might be In greatest demand or their quantity adjusted to commercial needs. Being entirely un- able to measure the monetary needs of dififerent localities, at the very best he could order more notes printed when in his opinion the currency needs expansion, and pay them out in the ordinary course of business. It would be the merest chance, however, if the persons or the localities to which the government payments were due were those in need of more currency. When, as is and always must be the case, the quantity to be issued is fixed by statute, an increase beyond such limit, however much needed, is only possible after the slow-moving legislative machinery has been put into operation arid more notes authorized. Moreover, their withdrawal from circulation by redemption in coin, when the need for them has passed, does not contract the cur- rency, but simply substitutes coin for the notes. The in- elasticity of such notes, therefore, must be conceded, and their maintenance as a permanent element of the currency justified on some other ground, if at all. The second defeat of convertible treasury notes is the The Elements of the Medium of Exchange 85 fact that they impose upon the government the necessity for keeping on hand a reserve of standard coin sufficient to meet at any and all times the demand for redemption. There are two objections to the assumption by government of such an obligation. The first is that it may be a source of great expense. The coin reserve must be accumulated by taxation or loans, and in either case the people must pay the bill. If, as has been proposed, in order partially to overcome this difficulty, the notes are never paid out except in exchange for standard coin, their utility as a means of expanding the currency is destroyed, the quantity of notes put into circulation being exactly equal to the amount of coin withdrawn. It has been claimed that the expense of a coin reserve is more than offset by the profit accruing to the government from the payment of a portion of its obligations by means of non-interest-bearing notes only partially covered by the reserve. This seems to be the case when we consider simply the beginning of the history of the notes. If the reserve amounts to but one- third of the issues, there is obviously at the beginning a clear profit amounting to two-thirds of their face value. Suppose, however, that the redemption of the entire issue should be demanded three times in the course of a year. The original reserve would be exhausted when one-third of the notes had been redeemed once, and must be replenished from one of three sources : either from money coming into the treasury through the channels of its ordinary receipts, from the product of a special tax, or from the sale of bonds. The first source obviously cannot be relied upon. It is rarely practicable for the government to exact standard coin for all payments due to it, especially when it is trying to circulate its own notes. It would be the merest chance, therefore, if the requisite amount of standard coin were paid in by the government's debtors. 86 Money and Banking But certainty on this point would not remove all diffi- culties, since the coin paid in might be required for ordinary- expenses, in which case it would not be available as a re- demption fund. Even the adoption of the policy of surplus financiering would not insure the existence of a coin sur- plus just at the times when redemption of notes might be demanded. The levy of a special tax for the replenishment of an exhausted reserve is quite out of the question. The machinery of taxation is necessarily slow in its operation, and cannot be relied upon to furnish funds for sudden exi- gencies, such as the one we are considering. The sale of bonds in such an emergency seems, therefore, to be necessary, and this involves the payment of an annual interest charge which may much more than counterbalance the profit accruing from the original issue of the notes. If, according to our assumption, redemption three times in the course of a year were demanded, and bonds payable one year or more after date were issued to procure the necessary coin, in the course of a year the face value of the bonds outstanding would be three times as great as that of the notes, and the expense incurred by the govern- ment would be treble the ordinary rate of interest on the face value of the notes. If we assume with the advocates of this form of cur- rency, that redemption in large quantities is an unusual and rare occurrence, and consequently that the expense involved in the issue of bonds for the replenishment of the reserve is not often incurred, we must still remember that danger from this source is always imminent, and hence that such notes at the best always introduce an element of uncertainty into the finances of the government. Whenever for any reason the reserve falls below its ordinary limit, the ability of the government to maintain specie payments is placed in question. No one knows what the Secretary of the The Elements of the Medium of Exchange 87 Treasury may do or what action Congress may take. A "panicky" feeling is, therefore, liable to be produced, which is certain to affect the value of all sorts of negotiable se- curities, to render business unstable, and, if other disturb- ing circumstances concur, to produce a commercial crisis. Our own experiences with these notes illustrates the ob- jections which have been mentioned, and furnishes the best argument against their use. Though the amount of the gold reserve was not fixed by law, it early become cus- tomary to keep on hand at least a hundred millions of dollars. Between 1879, the date of the resumption of specie payments, and 1890 the Secretaries of the Treasury were aided in the maintenance of this reserve by an annual sur- plus of revenues over receipts and by a constantly increas- ing demand for currency, occasioned in part by our rapidly expanding commerce and in part by a decrease in the cir- culation of bank-notes. In spite of these favoring cir- cumstances, however, in 1885 and 1886 * the reserve fell to near the danger point and occasioned anxiety. In 1890 occurred two events which soon disclosed the danger to which Congress had subjected the treasury and the country when it assumed the obligation to maintain a currency of convertible treasury notes. One was the passage of the Sherman act, to which reference has already been made, and the other was the discontinuance of the policy of sur- plus financiering occasioned by the passage of the so-called McKinley bill. The former act added in three years $150,- 000,000 of new notes to the $346,000,000 of greenbacks, thus dangerously increasing the burden placed upon the gold reserve, and the latter soon substituted an annual deficit for the former surplus. The gold reserve showed the effect of the changed conditions. It fell in 1892 to $114,000,000, in October, 1893, to $81,551,385, and in 1894 to $68,000,- * Taussig's "Silver Situation." 88 Money and Banking ooo.* The "panicky" conditions thus produced, combined with various other circumstances, brought on a crisis in 1893, which was accompanied by a large foreign demand for gold. The result was the establishment of the so-called "endless chain," which revealed in the most complete fashion the true nature of our currency of treasury notes. The gold reserve was first reduced far below the $100,000,- 000 limit by the redemption of notes. The treasurer was, then, compelled to sell gold bonds in order to replenish it, and the redeemed notes were put again into circulation in the usual manner. This process was four times repeated, and it was discovered that, in some instances at least, the very firms who had purchased bonds and thus transferred gold to the Government withdrew it very soon thereafter by presenting notes for redemption. In all, bonds to the amount of nearly $300,000,000 were issued, and the end- less chain was temporarily broken by a contract with a syndicate of bankers by which they agreed to supply gold to the treasury in the payment of bonds sold them at profit- able rates, and to prevent, so far as possible, the presen- tation of notes for redemption. The danger of the repeti- tion of this humiliating and expensive experience was par- tially removed in 1900 by an act which fixed the minimum gold reserve at $150,000,000 and took from the Secretary of the Treasury the power to reissue redeemed notes ex- cept in return for gold coin. As has already been re- marked, the efficiency of a regulation of this sort depends upon the extent to which it transforms the notes into or- dinary gold certificates, and its necessity accordingly is a proof of the practical impossibility of maintaining a cur- rency of this sort without endangering the safety of our financial institutions and the credit of the government. A comparison between these notes and subsidiary coin *Noyes's "Thirty Years of American Finance." The Elements of the Medium of Exchange 89 may be instructive. They are alike in having an intrinsic value less than their face value, and in being maintained at par in the circulation by redemption on demand in gold. They are unlike, however, in the fact that the intrinsic value of subsidiary coin is considerable, while that of gov- ernment notes is practically nil, and in the fact that the former are not likely to be presented for redemption, while the temptation is very great to secure the redemption of the latter whenever gold is greatly needed. These differ- ences are a sufficient explanation of the reason why sub- sidiary coinage is safe and treasury notes dangerous. In the case of the former the government assumes a risk equal only to the difference between their intrinsic and their face value, while in the case of the latter the government has no security whatever for the risk assumed. Nothing can take the place of subsidiary coins in the circulation, and consequently the demand for small change may be relied upon to keep them in circulation, provided the quan- tity issued is not excessive, while bank-notes, silver and gold certificates, and gold and silver coin can easily be made to fill the place of treasury notes in the circulating medium, and their presentation for redemption is facili- tated by the fact that in no other way can gold coin for exportation or any other purpose be so easily and cheaply obtained. The conclusion to which we are forced by the considera- tions presented in this chapter is that no form of paper cur- rency based entirely or largely upon government credit is to be recommended. Subsidiary coins of relatively high intrinsic value and gold or silver certificates represented dollar for dollar by gold and silver coin do not belong under this head and, consequently, may without danger be made permanent elements of a currency system. Incon- vertible government notes, however, or convertible notes QO Money and Banking based upon a partial reserve are dangerous, the former in a degree which renders their use a national calamity, and the latter to such an extent that the nation which employs them may confidently expect occasions when its treasury will be embarassed, if not humiliated, by them and its credit system seriously disturbed and perhaps thrown into the paroxysms of a commercial crisis. REFERENCES The nature and purposes of coinage are discussed in Laughlin, ch. ii ; Kinley, ch. iii ; Jevons, ch. vii. ; Walker, Money, ch. ix ; and Lexis, "Munzwesen," in the Handworterbuch der Staatswissenschaften. On the details of the monetary systems of the various States, see Tate, Modern Cambist; Norman, Universal Cambist and Complete Guide to the World's Twenty-nine Metal Monetary Systems; Muhle- man. Monetary Systems of the World; "The World's Currencies " in Sound Currency, v. vii. No. 8; Haupt, Arbitrages et Parites; and Lejeune, Monnaies, Poids et Mesures des Principaux Pays du Monde. On the subject of seigniorage see, in addition to the above refer- ences, Johnson, pp. 187-194; Martin, Seigneurage and Mint Charges; Seyd, The Question of Seigniorage and the Charge for Coining; and Nasse, ch. vi. Inconvertible government notes are condemned by all political econ- omists, but the objections to them are not always identical with those given in the text. The following discussions are valuable: Walker, Money, chs. xiv-xvii, and Money, Trade, and Industry, chs. viii and ix ; White, Money and Banking, 2d ed. bk. 11, ch. iii ; Mill, Political Econ- omy, bk. in, ch. xiii ; Johnson, chs. xiii and xiv. ; Wagner, Die rus- sische Papierwdhrung, chs. i-vii; and Hertzka, W'dhrung and Handel. On the history of our own experience with this sort of currency, see Mitchell, A History of the Greenbacks; Laughlin, pp. 477-490; Knox, United States Notes, chs. i, ii, iii, and ix ; Linderman, Money and Legal Tender in the United States; Sumner, History of American Currency, ch. i; Davis, Currency and Banking in the Province of Massachusetts Bay; and Report of the Comptroller of the Currency for 1879. On our experience with silver certificated see Taussig, Silver Situation in the United States; Noyes, Thirty Years of American Finance, ch. iv; and Knox, ch. x. The history of our greenbacks and treasury notes is ad- mirably presented by Noyes ; see also ICnox, chs. ix and xi, and Pro- fessor Laughin's Report of the Indianapolis Convention, pt. in. The Elements of the Medium of Exchange 91 On French experience see White, Paper Money Inflation in France; Courtois, Histoire des Banques en France; Vuhrer, Historic de la Dette Publique en France, v. i, chs. xiii and xiv. For the experience of other countries see Wagner, Die russische Papierw'dhrung; Ferraris, Moneta e corso Forsoso; and Kramar, Das Papiergeld in Oesterreich seit 1848. CHAPTER VI CREDIT As a basis for the discussion of bank currency, an element of the medium of exchange still to be considered, the subject of credit requires a more complete explanation than has been given it in the preceding chapters. I. Meaning of the term. — The word credit is used in dif- ferent senses in ordinary parlance and in scientific writings, and many attempts to formulate a definition of it have been made.* These definitions differ chiefly in the em- phasis they place upon one or another aspect of credit trans- actions but they agree substantially in the phenomena they are attempting to define, namely an exchange transaction in which one person parts with goods or valuables on condi- tion of receiving a return for them in the future. The es- sentials of this phenomena are the exchange and the element of time or the fact that the second part of the transaction is deferred or follows the first after the lapse of an ap- preciable interval. Exchange in political economy means a trade or a giving of one commodity for another. Two goods, two persons, and two transfers are always involved. It is in transactions of this kind and of this kind only that credit appears. There is no credit element in a gift or a robbery or in any kind of a transaction in which the trading of goods is not the essential feature. But credit does not appear in all exchange transactions; only in those in which one of the transfers is deferred. If goods are sold and paid for on the *For a list of typical definitions, see, Laughlin's "Money," p. 72, note. 92 Credit 93 spot the transaction is not one of credit. If they are sold on time, that is, to be paid for at some future date, credit appears and the trade becomes a typical credit transaction. Loans are also credit transactions, since they are transfers of economic goods, one of which is deferred to some future date. The reason for calling this kind of an exchange transac- tion credit is because it implies trust or confidence, and the word credit is etymologically connected with this idea. No one willingly parts with his goods or valuables on condi- tion of a future return unless he feels confident that the return will be forthcoming. The basis of this confidence will be considered later. 2. The advantages of credit. — The advantages of credit may be considered from the standpoint of the person who employs it or from that of the nation. A person employs credit either to procure an immediate gratification of wants, to increase his capital, or to render the capital he already possesses more efficient. The first use may be illustrated by a hungry man without means who buys food on time or makes a loan and purchases food With the proceeds, or by a student who runs in debt for food, clothes, books and other things he consumes during the period of his education, or by a high-liver who buys an automobile on credit or by means of borrowed funds. The magnitude of this class of credit transactions is small compared to that of the second and third classes. In all the great nations of the world a large proportion of the capital employed in industrial and commercial enterprises is obtained by means of credit. Every great corporation borrows a part of its working capital; in a sense the funds represented by the capital stock of all corporations are obtained by means of credit. Private persons and partnerships engaged in business bor- row continually. The custom of selling goods on time is 94 Money and Banking almost universal. It is chiefly the result of the lengthening of the process of production by the introduction of more and more highly capitalistic methods and of the extension of the territory over which commerce is carried on. The continual introduction of more and more highly specialized machinery, and the division of the process of manufactur- ing into a larger and larger number of units has greatly lengthened the period of time intervening between the be- ginning of the production of a commodity and its comple- tion. Credit is used as a means of bridging over this period. For example, the cotton manufacturer may find it advan- tageous to purchase his cotton on the condition that he pay for it after he has turned it into cloth and placed this on the market, or, what amounts to the same thing, to borrow the funds needed for the purchase of the cotton. The whole- sale dealer can operate with much less capital in hand, if he is able to bridge over the period of time which must elapse between the purchase of his goods from the manu- facturer and their sale to the retailer by means of a loan or a purchase on time. When the buyer and seller of goods are widely separated a longer time is required to ship and market the goods and credit is used to bridge over this period. The use of bank deposits, one of the most impor- tant forms of credit, is another means of increasing the efficiency of one's capital. From the standpoint of the nation the chief advantages of credit are the more complete utilization of its human and natural resources and the increase in the efficiency of its capital. The talents, skill, aptitudes and tastes of the various people constituting a nation vary widely, and, in order completely to utilize these for purposes of production, it is necessary that its capital and natural resources should be placed in the hands of those best fitted to employ them. Credit is a means to this end. It enables the man who has Credit 95 great ability as an organizer and director of industrial pro- cesses to secure the capital and natural agencies needed for the utilization of his special ability, and it also enables the capital of the man who has little or no capacity to use it to further the work of production in the most efficient man- ner. These advantages of credit have so much impressed certain writers that they have regarded the increase of a nation's capital as one of the functions of credit. This, however, is an error. Credit cannot create capital. It can facilitate the process which terminates in its creation and can increase its efficiency. 3. Credit Instruments.— In order effectively to use credit a variety of written documents have been devised to which the name credit instruments has been given. Those in com- mon use either take the form of open accounts or book credit, promises to pay or orders to pay. An open account is a statement of a series of credit transactions in which what is received by a person and what he parts with in return is recorded in such a form as to make comparisons between the two easy and the striking of a balance at any time possible. A person is said to be debited with what he receives and credited with what he parts with, and the balance at any time represents what he owes or what the person with whom he is dealing owes him. The credit trans- actions between a grocer and a farmer may be repre- sented by such an account, the farmer being debited on the grocer's book with the amount of his purchases and credited with the amount of his sales. At the end of a month or a year a balance between the debits and the credits may be struck and the amount paid by the farmer to the grocer, in case the debits have exceeded the credits, or by the grocer to the farmer in case the credits have exceeded the debits. Another extensively used form of open account is the bank deposit. In this the customer of a bank is credited with 96 Money and Banking the money, checks, drafts, notes, etc., sold to the bank and debited with the checks he draws against it. Written promises to pay are expressed in different forms according to the character and needs of the parties to the contract. Of these the most common are promissory notes, bank notes, certificates of deposit, government notes and bonds. A promissory note is an unconditional written promise of one person to pay on demand or at a fixed or determinable future date a sum of money to another person or to his order or to bearer, that is, to any person who may present it. Various forms are in common use. One is the fol- lowing : $100.00 March 5, 1908. Six months after date, for value received, I promise to pay to John Doe One Hundred Dollars, with in- terest at six per cent, per annum until paid. (Signed) Richard RoE. A bank-note is an unconditional promise of a bank to pay to bearer on demand a certain sum of money. The follow- ing is an example: The Exchange Bank of Madison will pay to bearer Five Dollars on demand. Cashier President A "certificate of deposit" is "in effect a promissory note given by a bank to a depositor, acknowledging the receipt of the deposit and promising to pay it to the depositor." Credit 97 Governments sometimes issue promises to pay in a form essentially like that of a bank-note. The so-called "green- backs" or United States notes at present in circulation in the United States are examples, as are also the silver and gold certificates and the Sherman notes. Bonds are promises to pay issued by an industrial or public corporation to persons who lend it funds. Those of industrial corporations are frequently secured by mort- gage upon some or all the property of the concern, and for the payment of bonds of states and other public bodies certain taxes or other revenues are sometimes pledged. This particular kind of credit instrument is issued in a variety of forms and known by different names according to the character of the security, the rate of interest paid, the length of the period of time before maturity, the pur- pose of its issue, etc., etc. A bill of exchange may be defined as an unconditional order addressed by one person called the drawer to another called the drawee requiring him to pay a third person called the payee a sum named. The drawee may be asked to in- dicate his willingness to pay the bill by writing his name across its face, in which case he becomes the acceptor. Bills of exchange may be made payable at sight, that is, on presentation to the drawee, in which case they are called sight bills, or after the lapse of a designated period of time, in which case they are called time bills. In case this period is short, say ten days or less, they are sometimes called short bills, and long bills if the period is longer than this. If the bill is drawn upon a banker, it is called a banker's bill, if it is drawn upon a merchant and represents goods shipped and consigned to him it is called a trade bill. According to the character of the goods involved, these latter are frequently called cotton bills, grain bills, etc. The term draft is commonly applied in this country to a banker's g8 Money and Banking bill drawn by one banker upon another. In case such a bill represents a loan transaction, it is frequently called a finance bill. A check is a bill drawn by a depositor against his credit account at a bank. According as the drawee lives in the same country as the drawer or in a different state or country, the bill is known as a domestic or a foreign bill. Other terms and classifications are employed dependent upon the peculiar customs and laws of the different cen- ters at which bills are drawn and negotiated. The chief differences in the form of these credit instru- ments are due to the peculiarities of the uses to which they are put. Some of them are designed to serve as a general medium of exchange, and to this end must be payable to bearer, must be issued in fixed and convenient denomina- tions, and must be made universally acceptable. To this class belong various kinds of government notes and bank notes. Others are designed to serve as a medium of cer- tain kinds of exchanges only, and these need to possess the qualities essential to these particular uses. Certain kinds of bank deposits, for example, are intended to be used as a medium of exchange between people who have access to banks, and who find coin, government notes, bank notes, etc., inconvenient for some of their purposes as, for example, in the making of large payments and payments at a dis- tance. The check was designed to be used in connection with this kind of deposit, also bank drafts, circular letters of credit, etc. Some credit instruments are designed pri- marily to meet the needs of people who want to make in- vestments, as, for example, bonds and various kinds of promissory notes. Within each of these groups sub-groups may be distingxiished in which the forms of the credit in- struments are still further differentiated to suit more highly specialized uses. For example, checks, drafts, and letters of credit are designed to meet different needs, though they Credit qq may be considered together for the purpose of contrasting them with govei-nment and bank notes. A great variety of bonds is employed to suit the needs of different classes of investors. The same may be said of promissory notes and trade and bank bills. The process of differentiating credit instruments to meet new needs and better to adapt them to old uses is continually in progress. 4. The foundations of credit. — The utility of a credit in- strument in facilitating the transfer of capital depends quite as much upon the security back of it as upon the suitability of its form. If there is doubt regarding the fulfillment of the obligation it records, its usefulness will be impaired, possibly completely destroyed, however per- fect its adaption in form to the purposes it was designed to serve. It is this element of security we are now to consider. In its completed form every credit instrument records the obligation of some person to pay to another a specified sum, usually described in terms of the prevailing standard of value. The fulfillment of that obligation obviously depends upon the ability and willingness of this person to pay the debt thus contracted and upon the social arrangements for compelling payment in case of default. A person's ability to pay depends primarily upon the amount and the saleability of the wealth in his possession at the time his debt falls due. Obviously he cannot hand over to another what he does not possess, but to the extent of his pos- sessions he is able to satisfy creditors, provided those pos- sessions are saleable. At the time the obligation is con- tracted his ability to meet it is not necessarily measured by the amount and saleability of the wealth then in his pos- session. In the interval before the maturity of the debt he may lose what he had at that time or he may acquire more. In the usual case of a loan made for productive purposes, 100 Money and Banking the wealth likely to be produced in the interval is the chief element in the determination of his ability to pay. The saleability of wealth depends upon its form and upon the condition of trade. Some forms of wealth are so constantly and so generally needed and the machinery for marketing them is so perfect that they can be sold at any time, while other forms for which the demand is not so general and so constant or for the sale of which the machinery is not so perfect cannot be so easily and quickly sold. On account of these differences some forms of wealth are better adapted to credit operations than others. There are no forms, however, which may not be so used under certain circumstances. The phrase condition of trade refers to the degree of perfection of the operation of the machinery of commerce, that is, of the transportation and banking systems, of the produce and stock exchanges, of the arrangements for buying and selling, for the adjust- ment of supply and demand along all lines, and for the regulation of the relations between labor and capital, etc., etc. This machinery may work perfectly or it may be more or less impaired. For one reason or another it occasionally almost completely breaks down. The foundations of credit are then seriously undermined whatever be the forms or the amount of the wealth in the hands of the debtors. A person's willingness to pay his debts is an important factor in his credit, since few people would continue to lend or sell goods on time to a man, however great his financial ability, who compelled his creditors to resort to legal pro- cesses to obtain their dues. He must also be willing to pay promptly as well as ultimately, if he expects to have credit commensurate with his wealth. The laws of all civilized nations provide for the collection of debts which have been legally contracted by putting the creditor in possession of a sufficient amount of the property Credit loi of the debtor to satisfy his claim. These laws are the result of a long process of development and are calculated to meet almost any contingency that may arise. They are essential to the existence of a highly developed credit sys- tem such as the great nations of the virorld enjoy at the present time. Serious imperfections in such laws or laxity in their enforcement are evidence of backwardness in civil- ization and seriously obstruct the commercial and industrial life of a people. The fact that the amount promised to be paid is usually expressed in terms of the standard of value is probably responsible for a widespread belief that credit is based on standard money. This is not true in the sense that the amount of a person's, a corporation's, or a nation's credit is measured by their command of standard coins. It is measured rather by their wealth, productivity, integrity, legal arrangements for the collection of debts, etc. Neither is this statement true in the sense that the payment of the obligations contracted must ultimately be met by means of standard money. Most of them will ultimately be can- celled by an offset of similar obligations. The process by which this is accomplished will be fully explained in subse- quent parts of this book. It is, however, true that standard coins and the standard commodity play an important role in the credit system of a country. For reasons explained in the previous chapter there is in every country a demand for standard coins. The demand usually takes the form of requests addressed to banks for the encashment of credit instruments which serve as a medium of exchange. It is of prime importance to the credit system of a country that the banks be able to meet these demands and to this end they must keep on hand an adequate supply of standard coins or be able readily to procure a supply. What constitutes an adequate supply 102 Money and Banking varies with the same bank at dififerent times and with different banks at the same time and has no fixed relation to the magnitude of credit transactions. If the supply is inadequate, that portion of the credit system which de- pends upon the banks for its support is in danger of break- ing down, and if it does break down or becomes seriously impaired, a crisis ensues with all its attendant suffering and losses. The kernel of truth in the claim that credit is based on standard money is revealed by these facts. A sup- ply of standard coins equal to the demands of the com- munity for that kind of money is essential to the main- tenance of the credit system, but these demands are variable and may be modified by various expedients. The presence of wealth in the many forms required to satisfy the peo- ple's needs and its possession by the persons who have assumed the obligations expressed by credit instruments is equally essential to the maintenance of the credit system, and for this there is and can be no substitute. Upon this we may rely even when standard money fails, and the various methods of obtaining substitutes for standard money have this in common, — that they directly or indi-' rectly liquidize or transmute into currency other forms of wealth. 5. Credit and prices. — The extensive use of credit instru- ments as a medium of exchange has given them an in- fluence over prices which it is important to note. The nature of that influence has been explained in the preced- ing chapter where it was shown that the demand for the standard commodity is affected by the extent to which sub- stitutes for standard coins are provided. It is in their capacity to serve as such substitutes that credit instruments exert influence on prices. If the form and security of these instruments is such as to render them universally acceptable they may perform all the functions of standard coins in the Money and Banking 103 medium of exchange and completely take their place in these uses ; that is to say, they may serve the public as hand- to-hand money and the banks as reserves. They cannot serve as a safety fund or guarantee for the ultimate re- deemability of the credit portion of a currency, and in this use only are they incapable of serving as a substitute for standard coins. The extent to which credit instruments will be substituted for such coins depends upon custom, statutory regula- tions, and the condition of trade. The influence of cus- tom is seen in the differences in the extent to which green- backs and other government notes are used as hand-to- hand money on the Pacific Coast and in other parts of this country. They are equally available everywhere, but the people on the coast prefer to use gold, probably because they have become accustomed to it. The influence of statutory regulations may also be observed in this country where banks are permitted to count in their reserves balances to their credit in other banks and various forms of government notes; also in England where the absence of statutory regulations has left the joint-stock banks free to use as their reserves balances in the Bank of England, Bank of England notes and short time loans, as well as coin. The condition of business is of prime importance in this connection. If the machinery of commerce is impaired, confidence between man and man is likely to weaken, fear to accept credit in- struments, lest the obligations they represent may not be met, to spread, and the presentation of credit instruments for encashment in standard coins to take place. This means the withdrawal of credit instruments from their use as a substitute for standard coins and a consequent increase in the demand for the latter. This happens in times of crisis and is the chief cause of the extreme money strin- gency which characterizes such periods. 104 Credit REFERENCES The nature of credit and its relation to prices are discussed in Laugh- lin, ch. iv; Kinky, ch. viii; Johnson, chs. iii and xv; Jevons, ch. xxvi; Nicholson, ch. vi; and Macleod, Theory of Credit, v. ii, pt. i, ch. xii, and Theory and Prartice of Banking, v, i, ch. iv, sec. ii. In the first three mentioned books also bibliographies of the subject may be found. A discussion and description of credit instruments is given in Cleve- land, Funds and Their Uses, and in Macleod, Theory and Practice of Banking, v. i, ch. iv, sec. iv. Various classes of bonds with their characteristics as financial in- struments are treated in Lough, Corporation Finance; and Lownhaupt, Investment Bends. CHAPTER VII BANK CURRENCY The most widely used forms of currency at the present day are supplied by commercial banks whose functions and operations must now be described. I. Origin and development of banking institutions. — First of all we must note the fact that these institutions have changed very much in character since their origin, and consequently now-a-days perform many functions unknown to those of former times. The first banks seem to have arisen in connection with the business of exchanging money. In ancient times and especially in the Middle Ages the varieties of coins were greater even than at the present day, and they were much less perfectly and honestly minted. Specialists were, therefore, required to determine their exact value and equivalence, and to exchange coins of one mintage for those of another, and their services were in great demand at fairs and other places where merchants of different nations met for purposes of trade. Inasmuch as they kept their boxes or chests of coins on benches or "banken," the name bankers came to be applied to them. On acount of their technical knowledge and the fact that they were obliged constantly to keep on hand considerable quantities of the precious metals, this business in the early Middle Ages was usually carried on by goldsmiths, but later it was sometimes assumed by the governments of large commercial cities, as, for example, by Amsterdam in 1609, by Hamburg in 1619, and by Niirnberg in 1621. Of these latter the Bank of Amsterdam was the most im- 105 io6 Money and Banking portant and may be regarded as typical of these early in- stitutions. In the early seventeenth century the city of Amsterdam was the center of the international trade of Europe, and accordingly the coins of all nations were there in circula- tion. These were of so many varieties and forms and of such different degrees of reliability, and some of them were so worn and defaced by long usage and the practice of clip- ping, that merchants found it difficult to keep themselves in- formed regarding their true worth and were exposed to the danger of great loss if they accepted them at their face value. The city, therefore, established a bank to which merchants took their coins, receiving therefor credit to the amount of the value of the metal they contained. Pay- ments were then made by transferring credit on the bank's books from one person to another. That is to say, a person who owed a sum of money to another accompanied him to the bank and ordered the amount transferred from his own account to that of his creditor. Bank money, as these book accounts or the written orders to transfer them were called, thus acquired a premium over the debased and mutilated coins in circulation, and for generations constituted the basis of all the foreign exchanges of the city. It was the means of substituting order for the financial chaos which reigned previously, and contributed greatly to the pros- perity of Dutch commerce. On account of the fact that these early bankers were obliged to provide themselves with strong boxes and other facilities for protection against robbers, fire, etc., it became customary for other persons to entrust to them their money and other valuables for safe-keeping, and after a time this feature of their business became quite as important as money-changing and ultimately more so. A third function was assumed when bankers acquired the habit of loaning Bank Currency 107 at interest the funds left with them for safe-keeping. This was made possible by the fact that their receipts, which were supposed to represent actual cash on deposit in their strong boxes, and which were redeemable on demand, were quite as readily accepted in payments as coin and thus cir- culated from hand to hand as money. Considerable quan- tities of coin thus remained with the bankers for long periods of time without being called for, and they finally acquired the habit of loaning it out at interest for short periods of time, keeping on hand only a quantity sufficient to meet current demands. From the earliest times also, bankers have been the chief agents through which intermunicipal and foreign exchanges have been conducted. As dealers in coin and bullion they had outside connections and a knowledge of outside affairs not possessed by other merchants, and were, therefore, in a position to undertake the settlement of accounts between people living in different places by means of orders drawn on bankers in other countries or other cities with whom they had regular business transactions. As keepers of other people's money they also promoted saving, and banks thus became in time the chief savings institutions of the country. The relative importance of these various functions has changed considerably with the development of industry and commerce, and a differentiation has taken place between in- stitutions, some specializing in one direction and others in another. For example, at the present time money-changing has become relatively unimportant, and is carried on only by a few banks situated in those places where travellers from one country to another need to exchange coins, and often by establishments not now-a-days regarded as banks in the proper sense of that term. Some institutions emphasize the promotion and facilitation of saving almost exclusively, and are hence called Savings Banks. Others provide special io8 Money and Banking facilities for the safe-keeping of securities of all sorts, and are therefore called Safe Deposit Companies. Some banks specialize in the conduct of foreign exchanges, and others do almost exclusively a domestic business. Commercial banks, as the most numerous class is now called, specialize in the conduct of exchanges, and it is with these that we are chiefly concerned in this book. Their principal operations will now be described. 2. Deposits. — Customers of a commercial bank sell to it their surplus cash and credit instruments representing pay- ments due them from other persons, and make loahs from it secured by their personal notes due in the future. For the amounts due them as a result of these transactions they are credited on the books of the bank in a form known as deposits. This credit account usually attested also by a little book kept by the depositor, known as the pass book, gives the customer the right to call upon the bank for legal- tender money, or for a transfer to the credit of some other person of all or some part of the amount due him. Some deposits give the right to demand payment at any time with- out notice and others only after the lapse of a certain time from the date of demand. Time deposits, as the latter are called, are sometimes also attested by a special instrument known as a certificate of deposit, in which the terms of the contract between the bank and the customer are carefully specified. When the depositor wishes to make use of his right to secure payment from the bank, he writes an order, tech- nically known as a check, for the amount desired, payable to himself or to some other person, which order, when presented to the bank, is either paid in cash or credited to the account of the payee. The amount thus paid or credited is then debited to the account of the creditor. 3. Loans and discounts, — Making loans and discounts is ^ Bank Currency 109 a function correlative with that of conducting deposit ac- counts. It may be described as the process of advancing funds on the security of personal notes and bills of ex- change, payable at some future date, the funds advanced consisting of cash or of deposits subject to check, or, as the exchange of cash or deposits subject to check for such notes and bills. The term discount is properly used to describe this process when the interest charge, the consideration the bank receives for making the advance or exchange, is paid in advance or at the time the transaction takes place. The term loans is broad enough to include discounts as well as advances the interest on which is paid when the note or the bill falls due. In addition to their own notes or bills of exchange per- sons securing advances may transfer to the bank as security other credit instruments or forms of property with the right to collect or sell them for its reimbursement in case the note or bill in question is not paid when due. Loans thus secured are called collateral loans and the securities or property deposited collateral. For this purpose high class bonds and stocks, real estate mortgages, and bills of lading and warehouse receipts representing goods in transit or in store are widely used. In financial centers the securi- ties listed on the stock exchanges, sometimes called stock exchange securities, constitute desirable collateral on ac- count of their ready salability. 4. Deposits as currency. — By means of loans, discounts and deposits, banks conduct exchanges of commodities with as great and in most cases with greater facility, economy and safety than they are conducted by means of hand-to- hand money. This fact may be made clear by the following illustration : Suppose five customers of a bank, whom we shall call A, B, C, D, and E, each having commercial trans- actions with the other, have their notes discounted each to no Money and Banking the amount of one hundred dollars and receive in compen- sation credit balances at the bank, each to that amount. A then buys a bill of goods of B valued at one hundred dol- lars, but, instead of paying him in coin or government notes, gives him an order on the bank. This order may be simply a verbal command to transfer A's balance to B's credit, or it may be a written order to that effect. In either case A's balance at the bank is reduced to zero and B's in- creased to two hundred dollars. B now contracts an obliga- tion in favor of C to the amount of one hundred dollars, and pays him in like manner, thus reducing his balance to the old figure and raising C's to two hundred dollars. Next in order C makes a hundred dollar purchase of D, D of E, and E of A, each paying by a transfer of credit on the bank's books in favor of his creditor. The result is that at the end of the five transactions each man has a balance of one hundred dollars at the bank, and is thus in a condi- tion to repeat the process just described, and business to the amount of five hundred dollars has been transacted without the use of coin or government notes. The deposit account thus serves as means of payment or currency, and must be regarded as an element of the medium of exchange coordinate with hand-to-hand money. 5. Bank notes. — Besides the deposit account, certain banks, known as banks of issue, make use of so-called bank- notes. These are promises of the bank to pay specified sums to the bearer on demand. They are designed to serve as hand-to-hand money and hence are issued in such de- nominations as are convenient for this purpose. They are usually printed on specially prepared paper, though they may be written, and are signed by the responsible officers of the bank, in this country by the president and the cashier. In many respects bank-notes and deposits resemble each Bank Currency iii other. Both represent obligations of the bank to pay on demand. Both are used in making advances to customers or in exchange for promissory notes and bills of exchange. Both serve as means of payment and are therefore elements of the medium of exchange. They differ in that the bank note is payable to bearer and is issued in fixed denomina- tions, while the deposit is made available by means of checks, which are orders instead of promises to pay, which are drawn for any amount to suit the transactions in which they are used, and which must be presented to the bank for payment or acceptance before their validity can be tested. On account of these differences bank notes serve as hand-to- hand money, while deposits are used in large payments and in payments^t a distance. For many purposes, of course, they may be used indifferently. The relative importance of these two banking devices, measured by the extent of their use, has greatly changed during the last century, the deposit account having every- where and continually gained over its competitor. In great commercial centers ~at the present time more than fifty per cent, of all exchanges are probably made by its means. In the early days of banking in this and other countries the deposit as a checking account played a very inferior role, bank-notes being essential to the existence of banking institutions and being consequently almost ex- clusively employed. In this country the dominance of the deposit dates less than half a century back. 6. The advantages of bank currency. — Bank currency, as the deposit account and bank-notes may be called, is in certain respects superior to other forms. Besides being able to transform their notes and bills of exchange into funds immediately available for purposes of commerce, business men derive great advantage from its superior con- venience, safety and elasticity. This is due, in the first 112 Money and Banking place, to the fact that this currency exists in a variety of forms, each adapted to definite commercial needs. The check, for example, is a very convenient and safe means of making large payments. It takes less time to write into the printed forms, now furnished by all banks, the name of your creditor, the amount to be paid him, the date, and your own signature, than to count out a large number of notes or coins, and in this way the danger of loss from mistakes in counting is also avoided. Your creditor finds the check more convenient and safe than coin or notes, because it is less bulky, and, if he chances to lose it, he can procure a duplicate and direct the bank not to honor the original if it is ever presented for payment. Furthermore, the stub of a check-book constitutes a convenient record of expenditures. For payments at a distance, as in another town or country, banks furnish a convenient currency in the form of drafts, that is, orders of one bank upon another to pay to the person named or to his order a specified sum. These can be conveniently and cheaply sent by mail, and, if lost, like checks, can be duplicated. For travelers in foreign countries banks furnish so-called letters of credit for any amount needed. These enable the holder to obtain at any place of commercial importance any sum he may de- sire in the money of the country in which he is traveling. These, too, can be duplicated if lost. The commercial letter of credit makes it easy for merchants to pay for goods bought in any part of the world or to receive payment for goods sold without inconvenience, delays or danger of loss. Bank-notes, which may be issued in any and all denominations, can be used in all ordinary commercial transactions; they are more convenient than coin for all purposes except small change, and are quite as convenient as government notes, being in all external respects identical with them. Bank Currency 113 By the elasticity of bank currency is meant its capacity to adaptitself, as it were automatically, to the varying needs of commerce. We have just learned that banks are able to supply the various forms of currency needed, and it only remains to show that they can also supply these in the amounts, at the times, and in the places required. The amount of bank currency depends primarily upon the needs and desires of the customers of banks, among whom now- a-days are to be found all business men and large numbers of people otherwise engaged or living without labor. As we have already shown, it is created by the processes of discount and deposit, and enters into circulation when the customers of banks pay out the notes received or make use of their credit balances by transferring them to others by means of checks. So long, therefore, as banks are able to continue discounting the paper of their customers the amount of bank currency can be increased, and, assuming that banks exist in sufficient numbers in all places where business is carried on, this currency will come into circula- tion in the places where it is in demand and at times when it is needed. Any business man can get the money he needs, at the times and in the exact form that he needs it, provided his banker will discount his notes. The only limit to the increase of bank currency, therefore, is the capacity of banks to discount mercantile securities, and within that limit its increase is in direct response to business needs. Besides the capacity to increase at the right time and place, an elastic currency must possess the capacity to decrease when the need for it has passed away. This quality also bank money possesses in a high degree. Credit balances, which by means of checks are made to serve the purposes of a medium of exchange, diminish in magnitude -when discounted notes fall due and are not renewed, cus- tomers meeting th^ir obligations to the bank by checking 114 Money and Banking against their accounts or by transferring to it the owner- ship of cash which has been left on deposit elsewhere. Sup- pose, for example, thai a merchant has for three months been using a credit balance obtained by the discount of his own notes. The date of their maturity having arrived, he must pay them. In case he no longer needs the use of the bank's credit, he will do this by drawing a check against his account in favor of the bank, having previously made preparation for this by allowing a sufficiently large balance to accumulate. In case, however, he still needs more money than he possesses, he will probably meet the matured note by discounting a new one or by securing the renewal of the old one. It would, of course, be possible for him to accumulate cash in his own tills to an amount sufficient to pay his notes, but in that case the money would probably have been taken from banks by checks drawn against the accounts of his customers. The almost universal custom of depositing each day the money received, however, prevents the general adoption of this method of payment. It is thus evident that a decrease in the need for money in any com- munity will result in the decrease of customers' balances by the payment of matured discounts, no business man being willing to continue the payment of interest to a bank for the use of funds which he no longer needs. The process by which bank-notes are withdrawn from circulation, when they are no longer needed, is similar to the one just indicated. Like other forms of money, they are deposited in the banks, and cannot again be circulated until some one of the bank's customers is willing to take them in satisfaction of the whole or a part of his credit balance, or as a loan against a discounted note. In the former case they are substituted for another form of bank money, and in the latter they constitute a real addition to the currency. When, therefore, they are transferred to Bank Currency 115 the bank in final payment of discounted notes, they effect as real a diminution of the volume of the currency as the final extinguishment of an equivalent amount of credit balances, and when they accumulate in the tills of the banks they are ultimately redeemed and destroyed. REFERENCES Most of the topics discussed in this and the following chapters on banking are treated in the following standard works : Bagehot, Lombard Street; Macleod, Theory and Practice of Banking; Gilbart, History and Principles of Banking; Hankey, Principles of Banking; Dunbar, History and Theory of Banking; Wagner, Beitrage zur Lehre von den Banken, and Der Kredit und das Bankwesen; Scharling, Bankpolitik; Courcelle-Seneuil, Traite' Theoretique et Pratique des Operations de Banque; and Wolowski, La Question des Banques. The following more recent books, some of them widely used as texts, should also be consulted: White, Money and Banking; Fiske, The Modern Bank; Conant, Principles of Money and Banking; Bolles, Money and Banking, and Finance; Sayous, Les Banques de Depot, les Banques de Credit et les Societes Financieres; and Obst, Geld- Bank-, und Borsenwesen. On the origin and development of banking institutions see especially Macleod, v. i, ch. iv. sec. i; Bagehot, ch. iii; Gilbart, v. i. chs. i and ii; Conant, Principles, bk. v, chs. i and ii ; and Jager, Die dlteste Banken und der Ursprung des Wechsels. . On the details of the various banking operations see Fiske and Bolles for the United States ; Sayous for France; Macleod v. i, chs. vi. and vii, and v. ii, ch. xvii, sees. 12-19; and Gilbart, v. 1, chs. xv and xx, for England ; Buchwald, Die Technik des Bankbetriebes and Wagner, Lehre, chs. ii and iii, and his Kredit, ch. ii, for Germany. See also Scharling, ch. i, sec. i, and ch. ii sec. 2; and Courcelle-Seneuil bks. 11 and ill. CHAPTER VIII CLEARINGS AND THE EXCHANGES One of the chief functions of modern commercial banks in the conduct of exchanges is the making of payments be- tween persons residing in the same or in different towns. This branch of their business requires a more detailed de- scription than could be presented in the preceding chapter. In this connection the word exchange has acquired a tech- nical meaning, being applied to documents like checks, drafts and bills of exchange which are used for the mak- ing of payments between different places. Business men thus speak of the purchase and sale of exchange, meaning thereby the negotiation of such credit instruments as are required in the making of the necessary transfers of cash or credit. I. Local Exchanges. — Exchanges between persons resid- ing in the same place, or local exchanges, as we may call them are for the most part conducted by local banks. The hand-to-hand money used is deposited in these institutions from time to time to be drawn out as needed, and other payments are made through checks against customers' bal- ances. Checks, drafts and other credit instruments received from outside are either directly deposited to the credit of customers or discounted and the proceeds credited. Checks, drafts, bills of exchange, and similar instru- ments received by one bank and drawn upon others must be collected. In the case of those drawn upon local in- stitutions in small places this is done by the direct presen- tation of the paper to the bank on which it is drawn and n6 Clearings and the Exchanges 117 the receipt of the amount due in current funds. In larger places, especially in big cities, this method of procedure being dangerous and expensive, an institution called the clearing-house has been devised to take its place. The es- sential feature of this is a room conveniently situated, in which certain bank clerks meet every day at a specified hour. This room is usually furnished with desks, one for each bank, arranged in a semicircular or circular form. At a specified time the clerks deposit the checks belonging to each bank at the proper desks, and receive those drawn against the institutions they represent. The clerk at each desk then prepares a balance-sheet by entering in debit and credit columns respectively the aggregate of the checks, drafts and bills of exchange which his bank holds against each of the others and the amount which it owes to each. By footing up these aggregates he is able to determine the total amount due by or to his bank, as the case may be. These balance-sheets are then sent up to the central desk, presided over by the master of the clearing-house, and ac- counts between the various banks 'are there settled, it being necessary simply for those from whom payments are due to pay the amount in one form or another to the master of the clearing-house, and for those to whom sums are due to receive the amounts from him. The balances are paid now in one way and now in an- other. In some clearing-houses banks are required to pay in cash; in others they are permitted to carry accounts with the clearing-house ; and in still others the balances are paid in drafts on some large institution which has extensive con- nections with all the banks in question, and which sometimes is the manager of the clearing system. 2. Out-of-town Exchanges. — Banks are also the chief agencies for the conduct of exchanges between persons who do not reside in the same place. If a person buys goods ii8 Money and Banking beyond the limits of his home town he often pays for them by sending a draft purchased from a local bank and drawn either upon a bank in the place in which the goods were purchased or upon a bank in some other place which has frequent business relations with this one. In order to render this service to their customers banks are obliged to keep funds on deposit in other cities, not necessarily in every city in which the customers may desire to do business, but in certain commercial centers through the banks of which arrangements may be made for the conduct of ex- changes with any place desired. The banks selected for this purpose in this country are usually called correspondents. In countries in which branch banking is practiced a great deal of business of this kind is conducted between the cen- tral institution and its various branches. By way of illustration let us consider the way in which a small city in Wisconsin conducts its exchanges with the outside world. We may assume that its banks have corre- spondents in Milwaukee, Chicago, and New York. Its out- of-town business results from the purchase and sale of goods and the adjustment of credit relations between its inhabitants and outsiders. Purchasers of outside goods will pay for them by sending checks on a local banker, by buying drafts on Milwaukee, Chicago or New York, pro- vided exchange on these places is acceptable to their cus- tomers, or, if not acceptable, on other places, such drafts being furnished by the correspondents of the local bank. These payments do not necessarily correspond in time with the purchases. Some are deferred. On a particular date the demand for exchange due to purchases comes from those made on time in the past, the payment for which falls due on that date and from those made on a cash basis. To this demand must be added that arising from the adjustment of credit relations with outsiders. Under this head belong Clearings and the Exchanges 119 loans made to outsiders and investments in outside enter- prises. Gifts to outsiders or transfers of property from any cause would also add to this demand. To meet these drafts the banks have the checks, drafts, bills of exchange, etc., drawn on outside institutions and sent to the city in payment for goods sold, on account of loans, gifts, and other transfers of property to citizens, and on account of investments of outsiders in local enterprises. These credit instruments are deposited with the local banks and sent by them to their correspondents for collection. Whether or not they will be sent to Milwaukee, Chicago, or New York, or distributed between the three places will de- pend in part upon the location of the banks on which these instruments are drawn or at which they are payable and in part upon the condition of the local banks' accounts with their correspondents. Instruments drawn on Milwaukee or on banks in towns which do their banking business chiefly through Milwaukee will usually be sent to correspondents in that city, and the others, on the same principle, to Chi- cago and New York correspondents. Certain checks and drafts may be indifferently sent to either place, in which case the condition of the banks' balances in these three cen- ters will determine the distribution. In the United States New York exchange is in the great- est demand because this city is the commercial and finan- cial center of the country. It has commerce with nearly, if not quite, every city in the United States and with the most important places in foreign countries, and more in- vestments are made through its agency than through that of any other place. Every town is, therefore, able to use New York exchange and on this account people are more apt to call for payment in that medium than in any other. In the middle west Chicago exchange has wide currency and in the southern Mississippi valley and the Southwest 120 Money and Banking St. Louis exchange. On the Pacific Coast San Francisco exchange is widely used. The selection of the location of a bank's correspondents is determined by these facts. It must supply the demand of its customers and must there- fore be able to sell exchange on some or all of these centers. 3. Bankers' balances. — It is obvious that on a given date the balance between the drafts made by the banks of a town on their correspondents and the credits made in their favor through collections and deposits of checks and drafts may be in their favor or against them. In the former case their balances with their correspondents will increase and in the latter case decrease. A succession of favorable balances might result in large accumulations and a succession of unfavorable balances in the overdrawing of their accounts. The^ existence of such balances render possible the movement of money from one place to another, since the creditor banks may demand from the debtor banks payment in cash. Whether or not they will do so depends upon their ability profitably to use at home more cash than they already have, and this depends upon the relative local and outside demand for loans and hand-to-hand money. When banks are loaning heavily to local customers their deposits increase and more cash is needed in the reserves, and, when there is an increased demand for hand-to-hand money, a relatively larger number of checks are presented for encashment and they are obliged to increase the per- centage of reserves to deposits, unless they are able to meet this demand by increased issues of notes, a resource not open to the banks of the United States under existing con- ditions. If the home demand for loans and for hand-to- hand money does not justify the banks in calling for ship- ments of currency from their correspondents, they may loan surplus funds in the cities in which their correspon- dents are located, or in other cities, or leave them on de- Clearings and the Exchanges 121 posit with correspondents at such a rate of interest as may be agreed upon. In this case these funds will be loaned by the correspondents instead of by the local banks, and the rate of interest paid by them will be sufficiently below the local rate to guarantee a fair profit on the transaction. In case the home demand for loans or cash or both exceeds the funds banks have at hand, or on deposit with their corre- spondents, they may arrange with the latter for overdraw- ing their accounts, either by drawing drafts upon them without sending exchange or cash sufficient to pay them, or by ordering shipments of currency to them in case the need is for hand-to-hand money rather than credit. Cor- respondents will grant such accommodations only on condi- tion of the payment of a rate of interest on adverse balances equal to or in excess of the local rate plus the expenses of the transaction. 4. The balance of indebtedness between communities. — From the above description it is obvious that the procedure of banks in the matter of receipts of money from and ship- ments of money to out-of-town institutions depends upon the relative demands of their community and those with which they are commercially connected for loans and hand- to-hand money. The tendency is for the loan funds in the possession of banks to be so distributed that there will be no profit in shipments of money or transfers of credit from one place to another. Such an equilibrium, however, is seldom established, and if it exists is certain to be speedily disturbed by fluctuations in commercial, credit, and gift rela- tions over which the banks have little or no control. The fundamental causes of currency movements must, there- fore, be sought in such fluctuations. Commercial relations between communities are revealed most clearly by what is called the balance of trade, by which is meant the difference between the totals of the sales to 122 Money and Banking and the purchases from outsiders. When the total of sales exceeds the total of purchases, the balance of trade is said to be favorable, and in the opposite case unfavorable. Credit relations are revealed by balancing mutual loans and investments, and gift relations by balancing gifts and other transfers of property for which no return is expected. A combination of these balances results in making a given community either a debtor of or a creditor to other com- munities. It is for the adjustment of these debit and credit balances that shipments of money from place to place are made. At this point the queries naturally arise whether the money funds of a community may not be completely ex- hausted by the payment of adverse balances and how much is required for this purpose. An examination of the various elements which determine the balance of indebtedness will show that there is no danger either of the exhaustion of money funds or of their reduction below minimum re- quirements. The balance of trade, the balance of loans, and the balance of investments are all three adjustable. Long before a community could be deprived of the mini- mum amount of cash needed for bank reserves and hand- to-hand money, prices, interest rates, and opportunities for profitable investments would have so changed as to anni- hilate the unfavorable balance. The first effect of ship- ments of currency to other centers is the decline in the reserves of banks, which, if continued, will result in a rise of interest rates and a contraction of bank loans. The withdrawal from business men of the loan accommodations to which they have been accustomed will force them to diminish their purchases and will stimulate their efforts to sell. If this is not sufficient to redress the unfavorable balance, loans from outsiders may be increased or the fall in local values due to the increased anxiety to sell property; Clearings and the Exchanges 123 may induce outsiders to increase their investments in the town. The proper adjustment will ultimately be brought about by a change of prices. If those of the place at which the balance of indebtedness is adverse are sufificiently re- duced, increased sales to and increased investments by out- siders will remedy the difficulty, and such a reduction will result from the pressure to meet obligations caused by the currency drain. The influence of currency movements on relative prices must not be confused with the fundamental causes of price changes discussed in Chapters III and IV. We are here concerned with the adjustment of the relations between the demand and the supply of the same goods in different places. In those chapters we discussed the relation between the demand and the supply of gold and other commodities. Movements of currency from place to place are but one phase of the operation of the general principle that people sell in the dearest and buy in the cheapest market, the result of which is a tendency toward the equalization of the prices of the same commodity in different markets. The price problem discussed in Chapters III and IV is the funda- mental one which remains after prices as between different markets have been adjusted and have reached a state of equilibrium. 5. The rate of exchange. — Shipments of currency from place to place involve expenditures for express charges and insurance and the loss of interest during the period of transit. This latter item is explained by the fact that banks are unable to count as part of their reserve, and hence to use as a basis for loans, money in the possession of an express company. On account of these expenses, a bank which is asked to sell exchange on a place in which it has no balance, or to which it cannot without expense trans- fer a portion of its balance in some other place, must charge 124 Money and Banking a premium for such drafts, unless it can buy in the home town exchange on that J place at par. Under the opposite circumstances a bank may be willing to sell drafts at a discount, since this may be the most profitable way of using a surplus balance with its correspondent. This would be the case, for example, if its reserve were low and its sur- plus with the correspondent large. Rather than pay the expense of a currency shipment, it could afford to sell drafts at any discount less than that expense. The maxi- mum premium it could charge in the opposite case would be the expense of sending money to cover its draft, since rather than pay a higher premium customers would ship cash for themselves. The rate of exchange on a place, as the price of drafts is technically called, may, therefore, fluctuate between a point above par, determined by adding the expenses of shipment to the face value of the draft, and a point below par determined by subtracting that amount. The actual premium or discount is fixed by com- petition between the buying and selling banks of a place, those in a position to sell exchange competing with each other for the custom of those buying, in case exchange is at a discount, and, in case it is at a premium, the buying banks bidding against each other for the drafts the sell- ing banks are willing to dispose of. The cost per $1000 of currency shipments between New York and Chicago is usually about 50 cents; between New York and St. Louis, 60 cents ; between New York and New Orleans, 75 cents; and between New York and San Fran- cisco $1.50 (Johnson, p. 82, note). In this country the ex- pense of currency shipments is sometimes saved by the operation of our independent treasury system. The central government has sub-treasuries in which its funds are kept in Philadelphia, New York, Boston, Baltimore, Cincinnati. St. Louis, New Orleans, Chicago, and San Francisco, and Clearings and the Exchanges 125 when it has occasion to make transfers for its own pur- poses it may sell drafts on certain sub-treasuries at par, thus saving banks the expense of shipping currency on their own account. 6. Foreign exchanges. — ^The foreign exchanges are man- aged in essentially the same manner as the domestic. There are some peculiarities, however, which demand special treatment. One of these is due to the fact that different nations have different units, and sometimes different stand- ards of value, and it is, therefore, necessary to translate the language of values of one into that of others. In the case of nations with the same standard this is accomplished by calculating the so-called par of exchange, that is, the exact equivalence of the unit of one nation in terms of the other. That between the United States and England, for example, is $4.866565, the result obtained by dividing 113.- 0016, the number of grains of pure gold in the English pound sterling, by 23.22 the number of grains of pure gold in our dollar. Our par of exchange with France is 19.294 cents, the quotient of 4.4802, the number of grains of pure gold in the French franc, divided by 23.22. Our par of exchange with any gold standard country is obtained by dividing the weight in grains of its unit of value by 23.22. Between countries having different standards of value, for example, between gold and silver standard countries, instead of the par of exchange, the relative market values of the two metals serve as the basis of commercial trans- actions. In exchanges between the United States and China, for example, the value of the amount of silver con- tained in the tael, the Chinese unit estimated in our dollars is the basis. Until recently Mexican exchange was based upon the price on our markets of the amount of silver con- tained in the Mexican silver dollar. If a nation has a sec- ondary standard, its depreciation must be calculated in ad- 126 Money and Banking dition to the par of exchange or the relative values of the primary units, as the case may be. The rates of exchange between foreign countries are based upon the par of exchange, if one exists, or upon what takes its place, if one does not exist, and fluctuates be- tween points above and below this figure determined by adding or subtracting the expense of shipping the forms of currency acceptable in the country in question. In gold standard countries these are called the gold points, since they are the rates at which gold is likely to be imported or exported. The expense of shipping gold is made up of the same items* as that of shipping currency between cities situated in the same country, that is, of express or freight charges, insurance and interest during that period of transit. Between New York and London these items ordinarily amount to about two cents per pound sterling. If, there- fore, the price of sterling exchange, as exchange on Lon- don is called, rises above $4,886 in New York, it will be profitable for bankers to sell exchange on London and ship gold as cover, and if it falls below $4,846, it will be profit- able to buy exchange on London and import gold. In New York, consequently, $4,886 is called the gold export point on London and $4,846 the gold import point. At important commercial centers like New York, Lon- don, Paris, Berlin and Vienna several different rates are quoted on the same market corresponding to the different kinds of foreign bills offered for sale. In New York, for example, rates are regularly quoted on at least three classes * These items vary in amount from time to time. Express and freight charges and insurance are tolerably stable, though during the last quarter of the 19th century they fell considerably between New York and London and other points (Johnson, p. 90, note). The inter- est item changes more frequently on account of the fluctuation of interest rates and the diminution of the period of transit caused by increase in the speed of steamships. Clearings and the Exchanges 127 of bankers' bills, namely, cables, demand and sixty days, and on several classes of trade bills.* The differences be- tween these quotations are chiefly due to the interest item, which is larger in some cases than in others. In a cable, for example, this item is eliminated, the amount of the bill being placed at the disposition of the purchaser in a few minutes' time. In the case of a demand bill interest must be subtracted for the period intervening between the sale of the bill and its presentation for payment, and in that of a sixty day bill for sixty days. In the negotiation of trade bills the rate at which interest is reckoned varies with dif- ferent classes of bills on account of variation in the element of risk, which is greater in some cases than in others. Gen- erally speaking, the rate charged on trade bills is higher than on bankers' bills and that charged on bills drawn on unim- portant and little known houses higher th^n on houses of ex- tensiire international reputation. The rate on sight bills is usually taken as the basis for reckoning the rate on all classes of time bills, the interest item calculated as just in- dictated being subtracted from the sight rate. On account of the importance of London as an inter- national commercial and financial center, sterling exchange is the most important medium of international payments. It is to the world's foreign commerce what New York ex- change is to the domestic commerce of the United States. Banks in every part of the world have correspondents, agencies or branches in that city, and in consequence ex- change on any part of the world may be more easily and cheaply negotiated there than elsewhere. The actual rates of exchange between any two countries are determined by the relation between the demand and ♦The student should examine the quotations as given in such periodicals as The Wall Street Journal, The New York Journal of Commerce, The Commercial and Financial Chronicle, and Bradstreets. 128 Money and Banking supply of foreign bills, and this by the trade and credit rela- tions of the two countries. In New York, for example, bills on London are constantly being drawn against goods exported and on account of foreign investments in Ameri- can enterprises, foreign loans to us, and other transactions which make Englishmen and other foreigners our debtors, and London bills are constantly in demand to meet our in- debtedness to foreigners created by imports of foreign mer- chandise, investments in foreign enterprises, loans to for- eigners and other transactions which call for payments from New York to Englishmen and other foreigners who transact their American business through London. If the amount of London bills offered exceeds that demanded, sterling exchange will be below par, and under the opposite conditions, above par, the actual amount below or above being determined by the competition of sellers in the one case and of buyers in the other. If this competition forces the rate to the gold points, bankers will find it profitable to ship gold, and these shipments will affect bank reserves, the volume of loans, rates of interest, prices and invest- ments in the two countries in the manner indicated in the preceding section in which the influence of currency move- ments between cities of the same country was described. Some of the items entering into the international bal- ance of indebtedness cannot be statistically measured, and on that account their importance is sometimes underesti- mated or even entirely overlooked. Since all ships clearing from American ports are obliged to declare their cargoes and all goods entering the country to pass through our custom houses, the amounts of our exports and imports of merchandise, gold and silver are registered with a consid- erable degree of accuracy, but the same cannot be said of a long list of other items which figure largely in our inter- national balance, such, for example, as purchases and sales Clearings and the Exchanges 129 of stocks and bonds, international investments in other forms, payments and receipts of interest and dividends, bankers' balances, ocean freight rates paid and received, expenditures of tourists and immigrants, expenses for em- bassies and consulates, purchases of public property from foreigners and sales to them, and some other items of less significance and frequency of occurrence. These items sometimes reach large aggregates and profoundly influence foreign rates of exchange. This is particularly true of international transactions in stocks and bonds and of fluc- tuations in bankers' balances. On the stock exchanges of important financial centers, like New York, London, Paris and Berlin, purchases and sales of stocks and bonds for foreign account constitute a regular branch of business, and, by the use of the cable, so- called arbitrage houses buy in one market and sell in an- other whenever a difference in the quotations of a given security on the two markets offers opportunity for a profit. When New York stockbrokers or arbitrage houses sell securities in London they draw bills on the purchasers and sell them on the market in precisely the same manner that an exporter of wheat or cotton draws against the cargo he ships and realizes the proceeds of his sale by negotiating his bills. In like manner purchases of securities in London create a demand for sterling exchange to be used in pay- ment. The amounts of such purchases and sales, however, are nowhere accurately recorded and their influence on the rate of exchange cannot be accurately measured. That it is frequently great, however, sometimes dominating all other influences, cannot be doubted. Such international movements of securities frequently prevent gold shipments, the high interest rates which usually accompany a money stringency lowering stock quotations and stimulating sales on foreign exchanges. 130 Money and Banking Bankers' balances with foreign correspondents are quick to respond to international financial influences, particular- ly to differences in the rate of interest ruling at different centers. For example, if interest rates in New York are considerably above those in London, London bankers may order their New York correspondents to draw upon them and to invest the proceeds in New York paper. Such or- ders increase the supply of London bills on the New York market. If London rates are the highest, New York bankers may bid for sterling exchange in order to use the proceeds to lend in London. On the markets of continental Europe such influences are very potent, particularly in the determination of exchange rates on London. In New York they are very important at times, but are not so persistent and regular in their influence as they are in such cities as Paris or Berlin. REFERENCES. On currency movements see Laughlin, ch. x ; Kinley, chs. vi and vii ; Taylor, ch. iv; and Conant, Principles, bk. 11, ch. vi. On the domestic and foreign exchanges see Johnson, ch. v; Clare, The A B C of the Foreign Exchanges, and A Money Market Primer and Key to the Foreign Exchanges; Goschen, The Theory of the For- eign Exchanges ; Macleod, The Elements of Banking, ch. vii, and The Theory and Practice of Banking, ch. vi ; Margraff, International Ex- changes; Le Touze, Traite du Change; Pallain, Les Changes Etrangers et les Prix; Hertzka, Wechselkurs und Agio; Schraut, Die Lehre von den auswartigen Wechselkursen; Obst, Wechsel- und Scheckkunde and Organisation des Zahlungsverkehrs; and Lexis, Die Fixierung des Wechselkurses in den Silberwahrungsldndern; and Nachod, Die Or- ganisation des Reisekredits, Kreditbrief, Circularkreditbrief und Rei- sescheck, in Conrad's Jahrbuch, 3d F., v. 81, p. 289, and v. 82, p. 823, respectively. The clearing systems of the most important countries are treated in the following books : Cannon, Clearing-Houses ; Howarth, Our Clear- ing System; Seyd, London Bank and Bankers^ Clearing-House Sys- tem; Easton, The Work of a Bank, ch. vii ; BoUes, Practical Banking, pt. Ill; and Rauchberg, Clearittg-und Giro-Verkehr. CHAPTER IX THE REGULATION OF COMMERCIAL BANKING Commercial banking plays so important a role in the economy of modern nations that its regulation with a view especially to the safe-guarding of the interests of the public, is a matter of prime importance. The methods at present employed in the different countries will be described in some detail in succeeding chapters. In this one certain principles which have been revealed by experience everywhere will be discussed. I. Incorporation. — It is generally admitted now-a-days that no one ought to be permitted to engage in the banking business without special authority from the state. The reason for this is the need, in the interests of safety, of the public regulation and supervision of this business. Experi- ence has shown that this can best be secured by the require- ment of incorporation through special charter or in accord- ance with general laws, such charters or laws prescribing the conditions under which the business must be carried on. Without incorporation it is difficult, if not impossible, to separate banking from other lines of business, and con- sequently to know precisely who are engaged in it and how it is being conducted. Under such conditions certain per- sons are sure to escape the regulations prescribed by law and designed for the safe-guarding of the public. As between incorporation by special charter or under general laws practice in the past has varied widely, but general banking laws are fast becoming the rule the world 131 132 Money and Banking over. They prevent favoritism and secure uniformity. Only in the cases of highly specialized institutions of pecul- iar character, like the great central banks of Europe, is the special charter method of incorporation likely to survive. The differentiation of the banking from the general in- corporation laws of a state, that is, those applicable to other kinds of industrial corporations, is also desirable on account of the peculiarities and public importance of this business. Such differentation is rapidly becoming the rule in this country. 2. Capital and surplus. — One of the most common re- quirements imposed by banking laws in this and other coimtries is the accumulation of a minimum amount of capital and surplus. By the former is meant a fund con- tributed directly or guaranteed by the stockholders or pro- prietors, and by the latter an additional fund accumulated from profits. Such funds are primarily desirable for the purpose of safe-guarding the interests of customers. They represent the stake of the proprietors in the business and the possibility of their loss contributes toward conserva- tism of management. In case of failure, such funds are available for the payment of depositors and noteholders and other creditors, who are to this extent guaranteed against loss. Surplus funds may also be accumulated as a means of meeting temporarily losses without infringing upon the other resources of the bank, and for the equalization of dividends. The laws of most nations now require a certain paid-up capital as a condition preliminary to the starting of a com- mercial banking business and the accumulation of a surplus fund equal to a certain percentage of the capital from the profits earned from year to year. Our national banking act, for example, requires a minimum capital of $25,000 of national banks in towns the population of which does not The Regulation of Commercial Banking 133 exceed three thousand inhabitants, of $50,000 of those in towns whose population is between three and six thousand, of $100,000 of those in towns whose population is be- tween six and fifty thousand, and of $200,000 of those in towns whose population exceeds fifty thousand. In most of the states of the Union banks with less than $25,- 000 capital are permitted in small towns, but most of them prescribe a certain minimum as a necessary condition of engaging in the banking business. Regarding the surplus fund the requirement of the na- tional banking act is that before the declaration of a divi- dend each association shall carry one-tenth of its net profits of the preceding half-year to its surplus fund, until the same shall amount to 20 per cent, of its capital stock. Similar provisions have been incorporated in the banking laws of the various states. The efficiency of these funds as a means of reimbursing bank creditors in cases of failure depends upon their pro- portion to the total volume of such obligations, and upon the form and safety of their investment. The regula- tion of this proportion is usually left to the discretion of the banks themselves, the chief exception being the re- quirement made by our national banking act, the Canadian banking act, and some others, that the total volume of notes issued shall not exceed the capital stock. Inasmuch as the chief obligation of most commercial banks at the present day is to depositors, and in case of failure the greatest losses fall on them, it may be questioned whether some proportion between the total deposits permissible and the capital and surplus funds ought not to be fixed by law. In practice this proportion varies widely. In fact, bank of- ficials usually expand their deposits to the greatest extent possible, consistent in their opinion with safety, regardless of the amount of the bank's capital and surplus. It must 134 Money and Banking be admitted that the safety of the depositor does not depend primarily upon the size of these funds, but this is no reason why they should not be made to contribute toward such safety to a greater extent than they now do. In the investment of these funds security is the prime consideration, though their speedy transformation into cash when occasion demands is also important. The investment of these funds is usually subject for the most part to the same regulations as the other investments of the bank. The chief exception in this country is the requirement of our national banking act that a certain portion of the capital must be invested in government bonds, one- fourth in the case of banks with a capitalization of $150,000 or less, and not less than $50,000 in the cases of larger banks. The practice of investing the whole or a considerable part of the capital and surplus in high class bonds is widespread, though rarely required by law. 3. Double liability of stockholders. — Another means of safeguarding the interests of bank creditors is the require- ment, found in our national banking act and in the banking laws of many of our states, that, in case of failure with inadequate assets to meet all liabilities, stockholders may be assessed to an amount equal to their holdings of capital stock. In the case of other industrial corporations the rule is that the liability of stockholders is limited to the amount of their subscriptions. The exception to this principle in the case of banks is justified by the public character of their .business and by the importance of public confidence in them. Losses on account of failure seriously shatter such confidence and tend to undermine the entire business, a re- sult even more disastrous to the public than to the bankers themselves. 4. Regulation of investments. — In the selection of its loans, discounts and other securities, besides safety, the The Regulation of Commercial Banking 135 dates of maturity, and ready saleability are prime considera- tions with a commercial bank. In order to meet its daily obligations, it must be able to command cash or funds in the form of checks or drafts on other institutions. The latter are available for building up credit balances with cor- respondents, and the former may be used for this purpose and also as a reserve. Occasionally also a bank must be able to command extraordinary amounts on short notice. These funds come to the bank from three main sources, namely, the daily deposits of its customers, the payment of their maturing notes, and the sale of securities upon the open market or to some special institution, such as, in Europe, the great central banks. Of these three resources, the second should be chiefly relied upon. It is the only one completely under the bank's control. When a note or bill falls due the bank has a legal right to demand its pay- ment in current funds, and it is also free at such a time to grant or to refuse a new loan. The amount of the daily deposits depends upon business conditions and the will of customers, and is therefore uncertain, as is also the ability of the bank to rediscount with another institution or to sell securities on the open market. It is, therefore, a matter of prime importance to a commercial bank that it should carry a large portfolio of notes and bills so arranged as to maturity that it is able each day to command such funds as it needs with a large margin for contingencies, and rapidly to change the direc- tion and the amount of its investments as circumstances dictate. Of these notes and bills those are greatly to be preferred which originate in the regular processes of every- day commerce, since the payment of these follows the com- pletion of these processes. Those which represent per- manent investments, or fixed rather than circulating capital, on the other hand, depend for their payment on profits 136 Money and Banking which are contingent on the successful management of an entire business and are therefore uncertain. Notes and bills based on certain forms of commerce, even though regular, such as speculation on 'Stock and produce ex- changes, are also objectionable, except when protected by wide margins and held in comparatively small quantities. The element of risk in these forms of commerce is very great and they are liable to sudden interruptions and fluctuations, which render the payment at maturity of the paper based upon them much more uncertain than that of paper based upon the more stable forms. It is impossible to lay down any fixed rule regarding the proportion of a bank's total investments that should take the form of bills and notes of the kind above indicated. A safe one to follow, however, is that these together with the holdings of cash and cash items should at least equal the total deposits. The investment of the capital and sur- plus may safely take the form of high class bonds, since these funds exist for the ultimate protection of customers and for contingencies of rare rather than of everyday oc- currence. Such bonds may also be quickly sold for cash at times when good policy dictates the renewal of notes falling due or the extension of this form of investment. As a main reliance for banks, however, bonds or any form of security representing fixed capital are impossible. The main function of commercial banks is the balancing of debits and credits which arise in the ordinary everyday forms of commerce, and bills and notes are the form which these debits and credits assume. Their absorption by the banks is, therefore, necessary. Bonds and stocks, on the other hand, represent savings or exchanges one part of which is completed only after the lapse of years. If banks generally opened deposit accounts in exchange for these, they would be assuming obligations which they could not The Regulation of Commercial Banking 137 possibly meet, since the only debits which would normally come from these investments are interest and dividend pay- ments, and these accumulate too slowly to enable a bank to meet the demands of its depositors. The regulation of bank investments by law is a difficult matter and only possible to a very limited extent. The discretion and skill of bank officers must be chiefly relied upon. In this country legislative attempts along this line have taken the form chiefly of defining the business of banking in such a way as to prohibit dealings in ordinary merchandise, of limiting real estate investments and loans on real estate security, and of requiring the investment of a certain portion of the capital in public securities. Our national banking act, for example, describes the business permitted to national banks as that of discounting and negotiating promissory notes, drafts, bills of exchange, and other evidences of debt; of receiving deposits; of buying and selling exchange, coin and bullion; of loaning money on personal security; and of obtaining, issuing and circulating notes. (Sec 5136). By exclusion this section prohibits dealings in ordinary merchandise and loans on real estate security. Another section (5137) permits the pur- chase, holding and conveying of real estate for the fol- lowing purposes only: "First, such as shall be necessary for its immediate accommodation in the transaction of its business ; second, such as shall be mortgaged to it in good faith by way of security for debts previously contracted; third, such as shall be conveyed to it in satisfaction of debts previously contracted in the course of its dealings; fourth, such as it shall purchase at sales under judgments, decrees, or mortagages held by the association, or shall pur- chase to secure debts due to it. "But no such association shall hold the possession of any real estate under mortgage, or the title and possession of any 138 Money and Banking real estate purchased to secure any debts due to it for a longer period than five years." (Sec. 5137.) As previously noted, the act also requires the invest- ment of a portion of the capital of national banking as- sociations in government bonds. A further restriction is imposed in Sec. 5200 by the pro- vision that no association shall loan to any person, firm or corporation an amount to exceed ten per cent, of its unim- paired capital and surplus and in no case to exceed 30 per cent, of its capital. The above provisions regarding real estate investments have been generally incorporated in our state banking acts, but as a rule these acts permit, within limits, loans on real estate security, and much larger loans to single persons, firms or corporations, and do not require investments in government or any other bonds. In the laws of foreign countries different provisions may be found. In Germany, for example, banks of issue are required to cover the circulating notes one-third by cash and two-thirds by bills of exchange maturing in not more than ninety days and bearing at least two solvent names. The laws regulating the Bank of France prohibit its in- vestment in bills of exchange secured by less than three names and maturing in less than ninety days and prescribes the classes of other securities in which it is permitted to in- vest. The banking laws of Canada are carefully drawn in this particular. 5. Regulation of reserves. — The amount of cash required by a bank varies from time to time and the needs of dif- ferent banks at the same time are not the same. The chief source of the demand upon a bank for this form of currency is the need of customers for hand-to-hand money, and this depends in part upon the kinds and volume of the trans- actions in which they are engaged, and in part upon the The Regulation of Commercial Banking 139 habits of the community. It, therefore, varies with the seasons and is greater at times when certain kinds of payments, like those for dividends, interest, rents, wages, etc., fall due than at others. In this and most other countries the spring and fall are seasons of large demand, the former because agricultural activities are then starting, and the latter on account of the movement of the crops. At the beginnings of the quarters, especially of the first and the third, this demand is also great. Interest on enormous issues of government and corporation bonds then fall due and dividends are most apt to be paid at those times. In Scotland half-yearly payments, such as rent, interest on loans and mortgages, wages of farm servants, etc., cus- tomarily fall due in May and November, thus causing an unusual demand for cash at those times. The extent to which people use hand-to-hand money in- stead of checks is also partly a matter of habit and of the enterprise of the banks. Until considerably after the first quarter of the nineteenth century the banks of England catered chiefly to the government and its employees, the nobility and the great merchants. The joint stock bank of discount which appeared in the thirties gradually changed this custom, however, and made banks popular among all classes, thus enormously increasing the proportion of bank currency to cash used in the ordinary transactions of the people. In this country banks have been popular almost from the beginning of their history, and bank currency, at first in the form of notes and later in the form of deposits, has constituted the larger part of our currency for nearly a century. With the multiplication of banking institutions, however, and their easier accessibility to people in small towns and country districts, the use of bank currency is con-, stantly increasing. The people of the continent of Europe have been more backward in this particular than the Eng- 140 Money and Banking lish and the American, but the use of the deposit account is yearly becoming more and more popular there and bank- notes for many years have been widely used. For the cash which it needs the ordinary bank depends upon the deposits of its customers and upon drafts on its correspondents. Any excess coming from the former source is usually shipped to correspondents and any de- ficit supplied by them. The task of supplying the entire country with hand-to-hand money is thus transferred to the great financial centers in which are located the institu- tions that act as final correspondents for all other banks, — in this country to New York, in England to London, in France to Paris, in Germany to Berlin, etc. How this problem is solved in this and certain other countries will be discussed in a subsequent chapter. Here it is sufficient to say that the regulation of the reserves cannot be disasso- ciated from the regulation of loans and discounts and note- issues. The volume of the former must be so arranged as to keep the deposits within such limits that the cash avail- able will be adequate to meet the demands of depositors. To meet these demands, however, properly secured bank notes are nearly as efficient as coin or any other form of hand-to-hand money, and hence the method by which they are supplied and regulated is vital to this discussion. In most countries no attempt is made directly to regulate the amount of the reserves by law. To this rule, however, the United States is a prominent exception. Our national banking act requires that banks in country towns shall keep a reserve of 15 per cent, of their deposits, of which at least two-fifths must be in cash in their own vaults and the re- mainder on deposit with approved national banks in certain specified cities known as reserve cities. Banks in these cities are required to keep a reserve of 25 per cent, of their deposits, of which at least one-half must be in cash in their The Regulation of Commercial Banking 141 own vaults and the remainder on deposit with approved national banks in the so-called central reserve cities. Banks in these cities must keep 25 per cent, of their deposits in cash in their own vaults. Similar requirements are imposed upon other banks by the laws of the various states. The efficiency and desirability of such laws are open to question. That they are not essential to sound banking is demonstrated by the experience of other countries. As an objection to them may be urged the impossibility of classi- fying banks according to their real needs for cash. Dif- ferent localities make very different demands upon their banking institutions, much depending in this respect upon the nature of the business carried on and something upon the customs of the region. Hence, when all banks are placed in three classes, one of two results is quite certain to follow. Either the limit set by law will be so low as to afford no real protection, or it will be in some cases so high as to seriously interfere with the accommodation which the banks ought to be able to render to the business of the community. The weight of this objection becomes more apparent when we consider the effects of the clause requiring banks to stop discounting as soon as their cash reserves fall below the legal limit. This regulation makes these reserves practically useless at the time when they are most needed. Cash reserves are most apt to be infringed upon in times of incipient or actual crisis, and it is precisely on such occasions that banks should be able to accommo- date business men to the greatest extent possible, that they should be able indeed to discount first-class securities in even greater amounts than in ordinary times. The pro- vision in question, however, absolutely prevents this, and thus is apt to exaggerate the conditions which characterize such periods of industrial unrest. 6. Regulation of note issues, — In the legal regulation of 142 Money and Banking the banking business most states have distinguished be- tween depositors and noteholders and have granted special protection to the latter. The chief reasons for this prac- tice consist in the peculiarities of bank-notes to which refer- ence has already been made and for present purposes may- be summarized as follows : (i) Notes circulate freely from hand to hand without endorsement, and, if issued in the proper denominations may answer nearly all the purposes of currency, even taking the place of coin. They are, therefore, less liable to be pre- sented for redemption than other forms of bank currency, and in consequence make fewer demands upon the cash reserve. If unrestricted in their operations, bankers are thus tempted to neglect their reserves and unduly to extend their loans. Long and bitter experience has shown that bankers are unable to resist such temptation, and that un- restricted and unregulated note issues are a fruitful source of bad banking and commercial disaster. (2) In order that bank-notes may perform their legit- imate functions they must be rendered absolutely safe. They are the only form of bank currency which can serve as hand-to-hand money, but unless they are perfectly safe their circulation at par is sure to be restricted to the im- mediate locality in which they are issued, and consequently their general use as a medium of exchange obstructed. Among the various means employed for the special pro- tection of noteholders may be mentioned the prior lien upon assets, the safety fund, the mortgaging of special assets, the government guarantee, and the limitation of the total issues. By the prior lien is meant the requirement by law that in case of insolvency the claims of noteholders shall be sat- isfied out of the assets before those of any other creditors. The safety fund method is best illustrated at the present time in Canada. The banking laws of that country require The Regulation of Commercial Banking 143 each bank of issue to contribute five per cent, of the amount of its issues to a fund kept and administered by a pubhc official. In case of the failure of any bank its notes may be paid at once out of this fund, in which case the amount thus abstracted is replaced from the assets of the bank. If they are insufficient, the deficiency in the amount nec- essary to bring the fund to five per cent, of the remaining issues is made up by an assessment on the other banks. In this case the prior lien and the safety-fund systems are combined. By the mortgaging of special assets is meant the require- ment that banks of issue shall hold certain specified securi- ties, the proceeds of the sale or of the collection of which, in case of insolvency, shall be used for the satisfaction of noteholders' claims. This is the method employed in this country. National banks, the only ones which issue notes, are required to deposit government bonds with the Comp- troller of the Currency, who then prepares and sends to each bank notes to the par value but not to exceed the market value of the bonds deposited. The government guarantees the payment of the notes, and in case of the failure of the bank with inadequate resources uses the bonds as a means of indemnifying itself for the expense involved. This method was also employed by many of our states during the period in which state banks were issuing notes. Usually national bonds, the bonds of the state in question, and other specially designated bonds, and some- times real estate mortgages, were accepted as security. The guarantee of the ultimate payment of the notes by the state does not necessarily accompany the mortgaging of special assets, and it might easily be used independently or in connection with other methods. It cannot be recom- mended, however, in any case in which adequate provision 144 Money and Banking for indemnifying the state against possible loss is not made. Some limitation on the total amount of issues is common even when other methods of protecting noteholders are also employed. National banks in this country and the banks of Canada are not allowed in any case to extend their issues beyond the amount of their paid-up capital stock. In France the law sets a definite limit beyond which the issues of the Bank of France are not permitted to go, but from time to time this limit has been raised. The Bank of England is permitted to issue £18,450,000 in notes on the deposit of securities to that amount with the issue depart- ment of the bank and any amount beyond this figure in ex- change pound for pound for gold coin or bullion. Banks of issue in Germany are assigned a fixed quota which they must secure by means of first-class bills of exchange and cash in the proportion of not less than one-third of the latter. Beyond this quota they must secure their issues either by 100 per cent, of cash or pay a tax of five per cent, to the government. The relative advantages and disadvantages of these methods of protecting noteholders must be judged from the standpoint of their influence on the elasticity of the issues, as well as from that of safety. From this point of view the plan of mortgaging special assets in the form used in this country is defective. The requirement that govern- ment or other bonds must be purchased and deposited with a public official before notes may be issued, and the surrender of the notes, or of an equivalent amount of cash, in exchange for the bonds before notes can be retired renders their volume entirely independent of the needs of commerce, since those needs bear no relation to the profita- bleness or unprofitableness of investments in bonds or to the desirability of holding or selling such bonds once in The Regulation of Commercial Banking 145 the bank's possession. In order to render the quantity of the issues responsive to the varying needs of the community for hand-to-hand money, banks must be able to issue notes freely in the discounting of bills and the payment of depositors, and to retire them freely when the need for them has passed. The only protection to noteholders not inconsistent with such freedom must therefore be based upon such assets as normally come into the possession of commercial banks in the performance of their daily duties. All the other methods above described are free from this, objection, and it is possible by combining two or more of them also to render the security to the noteholders perfect from the standpoint of safety. 7. Public inspection and supervision. — Publicity is an im- portant safeguard against unsound banking, and it also assists banks in obtaining the confidence of the public. So important to a bank is it that the people generally should believe in its soundness and stability that it is probable that self-interest would lead them to publish their accounts or in some other way keep the community in- formed regarding the nature of their business. In most states, however, it has been found best to enforce publicity in one form or another, the most common method being to require the publication of banks' accounts. In the United States national banks are required annually to make to the Comptroller of the Currency at least five reports of. their resources and liabilities. The dates for these are not specified in advance, the Comptroller being permitted to call for them whenever he sees fit. When submitted they must be published in a newspaper in the place where the banking association is established. In Germany banks of issue are required to make weekly reports which are published in the periodicals. The Bank of France is com- pelled by law to furnish to the government every six months 146 Money and Banking a full statement of its operations, and a balance-sheet of the bank is published in the official journal every Friday. The accounts of the Bank of England are also regularly published in the financial journals of the kingdom. In addition to the requirement that bank accounts must from time to time be submitted to public inspection, some provision for supervision and examination by public of- ficials is common. The Comptroller of the Currency in the United States is authorized, and indeed directed by law, to inspect the national banks at frequent intervals. He has full authority to call for all books and securities, and to make as full and complete an examination as he desires. In the great state banks of Europe provisions for special in- spection are rendered unnecessary by the appointment of public officials to the immediate control of these institutions. The governor and two sub-governors of the Bank of France are appointed by the ministry. The Imperial Bank of Ger- many is under the direct control of a board of curators composed of the Chancellor of the Empire, who is presi- dent, and four other members, one named by the Emperor and the other three by the federal council. This body meets every three months and examines reports regarding the bank's condition and the operations which are being carried on. The immediate administration of the Imperial Bank is confided to a board of directors appointed directly by the Imperial Government from a list nominated by the federal council. The Bank of England in form is a purely private institution, its directors being appointed by the stockholders, but on account of its intimate connection with the English government it is practically under the direct supervision of government officials. The efficiency of the practice of publishing accounts as a safeguard against unsound banking depends largely upon the ability of the public to interpret these statements when The Regulation of Commercial Banking 147 they appear. It is desirable, therefore, that we should examine a typical bank account and note the manner in which the chief operations of banking are revealed in its items. The following has not been copied from any report, but contains the essential items, and may be regarded as t)rpical : Liabilities. Resources. Capital $100,000 Loans $265,750 Surplus 20,000 Bonds and Stocks 10,000 Undivided Profits 2,750 Real Estate 15,000 Deposits 264,000 Other Assets 8,000 Cash Reserve 88,000 $386,750 $386,750 The most important items in this account have already been explained. By capital is meant the funds originally contributed by the stockholders and it stands here under the head of liabilities because the officers of the bank are re- sponsible to them for its use and must distribute the divi- dends on the basis of it. It should be noted, however, that capital stock is not payable on demand, and is thus a very different sort of liability from deposits and notes. By sur- plus, is meant the profits which have been earned, but which are not distributed in the form of dividends, but left with the bank in order to strengthen its resources. The accumulation of a surplus amounts to an increase of the bank's capital. The imdivided profits are the profits not yet distributed but which will be available for distribu- tion to the stockholders when the outstanding loans have matured. The deposits, as was explained in a previous chapter, are the sum total of the credit accounts on the books of the bank in favor of its customers, some of which have originated in loans and others in the deposit of actual cash. Turning now to resources, we note that the item 148 Money and Banking loans is represented in the bank's safes and portfolios by the notes of business men and corporations, falling due, some perhaps in thirty, some in sixty, and some in ninety days, and by the bills of exchange it has purchased. The term bonds and stocks and real estate are self-explanatory, the latter being represented chiefly by the building and grounds occupied by the bank. Under the head other assets are included the various items of miscellaneous property which in one way and another have come into the possession of the bank, possibly through the foreclosure of mortgages or other means not necessarily involved in the prosecution of the bank's peculiar business. The cash reserve is the cash on hand available for the payment of depositors and the meeting of other cash obligations. As variations of this typical account it should be noted that banks of issue add to the items falling under the head Liabilities that of notes or issues; that instead of the term loans we often meet the term discounts; and that under the general head Deposits may be distinguished current ac- counts and time deposits, and sometimes deposits of other banks and private deposits. The Bank of England uses the term rest instead of surplus. The relation between these various items may best be revealed by considering the effects upon this account of the most important daily operations of the bank. Suppose that new loans to the extent of $3000 are made, which are to mature on the average in sixty days and to bear interest at six per cent. Three items of the account must then be changed. The loans will be increased to $268,750 the deposits to $266,970 ($264,ooo+$2,97o, which is $3000- $30, the discount for sixty days), and the undivided promts to $2,780. It should be noted that the cash reserve now bears a smaller proportion to the demand liabilities than before. The Regulation of Commercial Banking 149 Suppose next that depositors draw upon their accounts to the extent of $10,000, receiving their pay in cash. The item deposits will then stand at $256,970 and the reserve at $78,000. This again reduces the proportion of the re- serve to demand liabilities. If these depositors had accepted bank-notes instead of cash, the result would have been different. The reserve would have remained as before ; the deposits would have been diminished to the extent of $10,000, and a new item of $10,000, namely notes, consti- tuting also a demand liability, would have been introduced on the side of liabilities. In this case, the proportion be- tween reserve and demand liabilities remains unchanged. Let us suppose next that loans to the extent of $10,000 fall due and are paid in cash. The item loans will then stand at $258,750, having been reduced to the extent of $10,000, and the cash reserve will have been increased to the same extent. The payment of these loans might equally well have been accomplished by a corresponding diminution of the item deposits. If the persons whose notes have fallen due are also depositors, they may hand to the cashier of the bank their checks for the amount. It is noteworthy that in either case the proportion of reserve to demand liabilities is increased. A fourth supposition will enable us to appreciate the effect of investments in long-time securities. When the accounts of the bank were in the condition represented by the statement on p. 147, suppose that $50,000 had been in- vested in bonds and stocks. The cash reserve would have been reduced to $38,000, thus enormously diminishing its proportion to the demand liabilities, and in no respect in- creasing the bank's ability to command cash on short notice, except through the plan of throwing its bonds and stocks upon the market for sale. It thus becomes evident that many of the essential fea- 150 Money and Banking tures of the banking business are revealed in such simple statements of aggregated items as have been described. The proportion of the capital and the cash reserve to the other liabilities, the extent of the bank's ability to meet cash demands made upon it and the aggregate of such liabilities, the amount of the total resources invested in mercantile securities as distinguished from stocks, bonds, etc., the extent of liabilities to other banks as well as of the claims upon them, ought all to become clear upon the examination of such an account. Adequate provision for supervision and examination by public officials ought to guarantee the correctness of the accounts, and make bank officials careful regarding the character and soundness of the men whose paper they discount. 8. Importance of honesty, wisdom, and discretion in bank officials — Since the chief reliance of a bank, beyond its actual reserve, must be placed upon the short-time business paper which it holds, it follows that the best security for its safety must be the honesty, wisdom, and discretion of its officers. Upon these rests the responsibility of selecting the bank's creditors. If these are reliable, if they always meet their obligations when they fall due, and if their business is sound, the bank will be safe, provided a proper proportion between the demand liabilities and the cash reserve is maintained. What this proportion should be is a matter which, as we have shown, must be left to the dis- cretion of bank officials. In this connection it is interesting to note that the interest of bankers as a class is in the maintenance of sound rather than loose methods. To no group of business men is an unimpeachable reputation for financial soundness and reliability more vital. The banker's stock in trade is his credit. If that goes, his business is ruined. Under these circumstances he is like a retail merchant with no goods The Regulation of Commercial Banking 151 upon his shelves. He has nothing to sell. He is really much worse oflf than the merchant, since the latter can stock up his store with fresh goods which will tempt the public to buy, while the banker can rarely buy back his lost or shat- tered credit. There is no such thing in the market for sale, and if he ever recovers it, it will be by the slow process of a life of business integrity, thus convincing the public that he is worthy of confidence. In view of this fact, bankers are apt to be conservative and to constitute a check each upon the other. REFERENCES For the methods actually employed in the regulation of commercial banking in this country the national banking act and the banking laws of the various states t.hould be consulted. An excellent digest of the latter has recently been compiled by Mr. Samuel A. Welldon and pub- lished by the National Monetary Commission. The annual reports of the Comptroller of the Currency and of the banking departments of the various states are also valuable. For foreign countries consult the pub- lications of the National Monetary Commission, especially Koch, Ger- man Imperial Banking Lams; Flux, The Swedish Banking System; Conant, The National Bank of Belgium, and the Banking System of Mexico; Landmann, The Swiss Banking Law; The Beichsbank, 1876- igoo; and Interviews on the Banking and Currency Systems of Eng- land, Scotland, France, Germany, Switzerland, and Italy. Consult also Macleod, v. 11, chs. xviii and xix; Dunbar, History and Theory of Banking, chs. vi-xi; Report of the Monetary Commission of the Indianapolis Convention, pp. 244-246; Gilbart, The History and Principles of Banking, v. i, ch. xxi; Wagner, Zettlebankgesetzgebung, ch. ii, sec. 3, and ch. iii, sees. 2 and 4, and his Kredit und Bankwesen, ch. ii, sec. 2; Scharling, Bankpolitik; Hague, Bank Reserves, and Stewart, A Composite Bank Statement, in Journal of the Canadian Bankers' Assn., v. i, p. 107, and v. xi, p. 40, respectively. CHAPTER X BANKING IN THE UNITED STATES During the early years of the history of this country every community suffered from the lack of an adequate medium of exchange and from an insufficiency of capital. The degree of the need felt for these two essentials of in- dustrial progress was greatest on the frontier, but it was everywhere present, even in the largest towns. Before the adoption of our present constitution, and for many years thereafter, our supply of specie came from foreign countries as the result of the operation of our foreign commerce, and what we obtained in this way was chiefly used in the opera- tions of the government and in the purchase of foreign com- modities. The supply was almost always short of the de- mand and in frontier communities frequently nil. As for capital, the majority of the settlers on the frontier had little more than the bare necessities for a farming estab- lishment in the wilderness. The accumulation of anything more was a slow process on account of the lack of adequate markets for their produce, a situation the remedy for which had to wait for the development of means of transportation adequate to connect scattered communities with each other and with the older countries beyond the seas. The colonial governments put forth their best endeavors to supply these needs, and the people attempted to help themselves. Unfortunately both confused the need for a currency with that for capital with the result of attempting to make the same instrumentality answer both purposes. The most commonly employed expedient was bills of credit IS2 Banking in the United States 153 issued in a form suitable for circulation as money. The colonial governments frequently made such issues on their own credit, using the notes in the payment of their expenses or loaning them to people on mortgage or personal se- curity. Private individuals and associations often did the same thing. The notes thus issued circulated within a lim- ited territory only and at a depreciated value, thus perform- ing very imperfectly the functions of a medium of ex- change, but they were considered so much better than noth- ing that the people resented attempts made by the English government to interfere with their right to use them. Dur- ing its early years the Revolutionary war was chiefly fi- nanced by similar notes issued by the Continental Congress. In spite of the extended use of these notes and the sen- sitiveness of the public regarding interference with their right to use them, their imperfections as a circulating me- dium were so well understood by well informed people at the time of the adoption of our constitution that the con- vention which framed that document incorporated in it a clause prohibiting the states in the future to emit bills of credit or to make anything except gold and silver coin legal tender in payment of debts. It also gave to the federal government the exclusive right to manufacture such coins. However, the needs which were primarily responsible for the issue of these bills of credit remained and clamored for satisfaction for many years after the new government went into operation, and the means devised for their satis- faction were banks of issue chartered by the federal gov- ernment and by the states, or established by private indi- viduals under authority of the common law. I. The earliest banks. — The pioneer institution of this type was incorporated by the Continental Congress Dec. 31, 1781, under the name of the Bank of North America. The plan for it was devised by Gouverneur Morris, but its pro- 154 Money and Banking motion was chiefly the work of Robert Morris, then Super- intendent of Finance. Feb. 7, 1784, the legislature of Mas- sachusetts chartered a similar institution under the name of the Bank of Massachusetts, and later in the same year the bank of the State of New York was started in New York City by Alexander Hamilton and others, which, how- ever, did not obtain a charter from the state until 1791. In 1790 the legislature of Maryland chartered the Bank of Maryland; in 1791 the Bank of Providence was char- tered in Rhode Island; and on Feb. 25 of the same year Congress chartered the Bank of the United States. In the details of their organization and of their business these and other banks subsequently formed differed consid- erably and sometimes widely, but in general characteristics they were alike. Their principal business consisted in the exchange of their own non-interest-bearing notes, payable on demand, for the interest-bearing notes of merchants, farmers and others payable at future dates, and frequently for the securities of the United States, the various states and the private corporations of the time. They also re- ceived deposits and conducted checking accounts for cus- tomers and bought and sold domestic and foreign exchange. On account of the great and almost universal need for capital, deposits were very small, nearly every person want- ing more than he possessed and desiring from banks loans rather than a place of safe-keeping for surplus funds. The notes issued by the banks circulated as money, and, though they were supposed to be payable on demand in specie, and usually required by their charters or by general laws so to be paid, they were not expected to be presented for pay- ment unless the need for specie was very urgent. This ex- pectation was based partly upon experience, and partly upon public sentiment, which was wide-spread to at least the middle of the last century, that it was unfair, if not Banking in the United States 155 dishonorable, to demand specie of a bank except under special circumstances. The charters of these banks uni- formly provided for the accumulation of a capital fund by- contributions from the proprietors, a portion of which was required to be paid, generally in part at least in specie, be- fore the bank should be permitted to do business with the public. 2. The first United States Bank.— The Bank of the Uni- ted States was the greatest of these early institutions and served as a model for many others. In addition to the fundamental needs already described, special ones peculiar to the time and to the United States government, account for its establishment. These were strongly and convincing- ly urged by Alexander Hamilton in a report on the sub- ject presented to Congress Dec. 13, 1790. On account of the scarcity of specie and the local character of the cir- culation of the banks chartered by the states there was great need of currency that would be uniform in value and equally acceptable in all parts of the country. The govern- ment also needed safe places for the deposit of its revenues as they were collected at the various seaports and interior towns, means of transferring funds from one part of the country to another, and facilities for obtaining loans to meet temporary exigencies. Hamilton showed that a na- tional bank would satisfy these and other needs, and that without one they were likely to remain either in whole or in part unsatisfied. There was great opposition to his plan on account of the belief of many that the constitution did not confer upon Congress the right to grant charters of incorporation and on account of the monopolistic character of the proposed institution and for various other reasons, but Hamilton's arguments finally prevailed to the extent of inducing a majority of Congressmen to vote for the char- ter and President Washington to sign it in opposition to 156 Money and Banking the advice of the Attorney General and the Secretary of State. The chief features of the institution authorized by this charter were the following: A capital stock of $10,000,000 of which $8,000,000 was to be subscribed by private individuals, paid one-fourth in specie and three-fourths in evidences of the public debt, and $2,000,000 by the federal government ; a directorate of twenty-five persons who should be citizens of the United States, and should be elected by the stockholders according to a plan which gave small holders relatively more votes in proportion to their shares of stock than large ones ; foreign stockholders were handicapped by not being eligible as di- rectors and by not being allowed to vote by proxy ; the total indebtedness of the bank, including its note-issues, were not to exceed $10,000,000 over and above the deposits; it was permitted to sell but not to buy public stock, and was prohibited from dealing in anything "except bills of exchange, gold or silver bullion, or in the sale of goods really and truly pledged for money lent, and not redeemed in due time, or of goods which shall be the produce of its lands;" it was prohibited from loaning to the federal gov- ernment more than $100,000 or to any state more than $50,000 without being previously authorized so to do by law, and from loaning any sum to any foreign prince or state; it was required to make statements of its condition to the head of the treasury department when required but not oftener than once a week, and to submit to his inspec- tion such books and accounts as were necessary for the verification of such statements, provided, that he should not have access to the accounts of the bank with private persons; its notes payable on demand in gold and silver were to be receivable for all payments to the United States ; its main office was to be located in the city of Philadelphia, but the directors were authorized to establish offices of Banking in the United States 157 discount and deposit wheresoever they might think fit; the Hfe of the corporation was to continue until March 4, 181 1, and during that time no other bank was to be chartered by- Congress. In pursuance of authority conferred by the charter, the directors established branches at Boston, New York, Balti- more, Washington, Norfolk, Va., Charleston, Savannah and New Orleans. The government used the bank as a depository for its funds and frequently borrowed from it, at times, under authority conferred by law, in amounts greatly in excess of the $100,000 mentioned in the charter. The government received dividends on its stock in excess of eight per cent, per annum and finally sold it at a good premium. Throughout its history the bank redeemed its notes on demand in specie and supplied the country with a much needed uniform currency. That its services to com- merce in general were great and all that its promoters ex- pected, is probable, though the data which has come down to us concerning its career is insufficient to form the basis of a positive judgment regarding the matter. 3. State banks in the period 1791 to 181 1. — State banks steadily increased in numbers throughout this period. There were more than thirty in existence in 1800, and more than eighty in 1810. Most of them were in New England, New York and Pennsylvania, but no state was without them. They furnished banking facilities to com- munities not reached by the United States bank and its branches, and supplemented and even competed with that institution in the cities in which these branches were located. The growth of these institutions was fostered by the state governments which frequently contributed a portion of their capital stock, and by the spirit of speculation which was widespread. Many, possibly all, of them attempted to perform functions for which they were unfitted, namely, 158 Money and Banking that of furnishing fixed capital to farmers, manufacturers, merchants and others interested in the transportation and other enterprises of the time. To this end they issued notes in exchange for investment securities maturing after long periods of time, the ultimate payment of many of which depended upon the increase of enterprises only just started or merely planned at the time and which could not possibly become income-producing before the lapse of years. For the redemption of notes thus issued the banks made no adequate provision in the capital fund collected from their stockholders and none was forthcoming from the individ- uals and corporations whose names were on the securities held, or from the stock markets of the time. They were, therefore, forced to resort to devices to prevent their notes being returned for payment, such as the putting of them into circulation in distant states or cities, the location of the issuing offices in inaccessible places and the in- vention of obstacles of one kind or another to prevent or delay the payment of the notes when .they were presented. Fraud was also practiced. Many banks were established merely for the purpose of launching some enterprise in which the promoters were interested and without any equip- ment for serving the public or any purpose of rendering such service. In such cases the capital subscribed was fre- quently represented simply by stock notes and the note issues by the securities of the enterprise or enterprises in which the promoters were interested. These notes were paid to the people who furnished the materials and labor required and through them entered into general circulation. Having practically nothing at stake, the promoters made large profits so long as the notes were not returned for re- demption and had nothing to lose from refusal to redeem them when they were so presented. Banking in the United States 159 4. The period 181 1 to 1816.— The charter of the First United States Bank expired in 181 1 and a bill authorizing the continuation of its existence for another twenty years failed to pass Congress. The objections to the bank urged in 1790 were revived and the state banking interests were in strong opposition. Some of Hamilton's arguments in its favor, presented in 1790, did not apply with equal force in 181 1 on account of the multiplication of state banks, and the fact that a large part of its stock was owned by foreigners, operated powerfully against it at this particular time because of our strained relations with England. The prospective and actual removal of the competition of this powerful institution resulted in a rapid increase in the number of state banks. One authority * estimates the number established between Jan. i, 181 1, and Jan. i, 1815, at one hundred and twenty. "The state of Pennsylvania alone, by a single act of the 21st of March, 1814, created forty-one banks with a capital of about $17,000,000, thirty- seven of which went into operation" (Ibid.). In 1812 war was declared against England and the struggle on land and sea thus inaugurated and continued for two years near- ly destroyed our foreign commerce, financially embarrassed the federal treasury and, combined with other influences, in 18 14, caused the suspension of specie payments in all parts of the country except New England. In the middle states, the south and the west, bank-notes fell to a discount varying according to the reputation for soundness of the issuing institution and its distance from the commercial centers; specie disappeared from circulation; prices rose; and speculation became rampant. The embarrassment of the Treasury was greatly increased by the necessity of re- ceiving its revenues in depreciated notes of local currency ♦Pitkin's Statistics, p. 429. i6o Money and Banking only and by the necessity of depositing its funds in non- specie-paying state banks. 5. The second United States Bank — The remedy for these unfortunate financial conditions, proposed and ulti- mately adopted, was a second United States Bank, the char- ter for which was enacted into law in 1816. It was mod- eled after that of the first bank differing from it in the following particulars chiefly : its capital was fixed at $30,- 000,000 that of the first bank being $10,000,000; of the twenty-five directors the President was authorized to select five, whereas in the case of the first bank the government voted its stock like any other stockholder; the section pro- viding for the establishment of branches was much more specific and elaborate in the second than in the first char- ter, the bank being required to establish a branch in the District of Columbia when Congress should demand it and one in any state upon application of its legislature and on condition that at least two thousand shares of its stock be held in said state ; a penalty for the suspension of specie pay- ments was imposed, the amount being fixed at 12 per cent, interest per annum on the obligations of the bank; there was no such penalty specified in the first charter; the funds of the United States were to be deposited in the bank, unless the Secretary of the Treasury should direct otherwise, in which case he was obliged to lay before Congress his reasons for such action. No provision regarding this mat- ter appeared in the first charter. The amount which might be loaned to the United States Government without further authorization from Congress was fixed at $500,000, this amount in the first charter having been $100,000. Con- gress reserved the right to inspect the books and to examine into the proceedings of the bank through committees ap- pointed by either house for that purpose. No such clause appeared in the first charter. Banking in the United States i6i The organization of this tjjank was completed during the last half of 1816 and by the end of 1817 branch offices had been established at New York, New Orleans, Boston, Ports- mouth, N. H., Providence, R. I., Pittsburg, Pa., Baltimore, Washington, Richmond and Norfolk, Va., Fayetteville, N. C, Charleston, S. C, Savannah, Ga., Louisville and Lex- ington, Ky., Cincinnati and Chillicothe, O., and Middletown, Conn. Subsequently branches were opened at Hartford, Conn., Mobile, Ala., Nashville, Tenn., Portland, Me., St. Louis, Mo., Buffalo and Utica, N. Y., Burlington, Vt., and Natchez, Miss. One of the first tasks imposed on the bank was the securing of the resumption of specie payments throughout the country. This it ultimately accomplished aided by an agreement with the state banks by which the transfer of the public deposits was facilitated. During the years 1818 and 1819 the management of the bank was bad and the commercial crisis through which the country passed in those years created conditions unfavorable to its devel- opment and reputation. Under the able administration of Nicholas Biddle, however, who became its president in 1823, the bank became a strong and highly useful institu- tion, checking the tendencies of the state banks toward overtrading and other unsafe practices, aiding the govern- ment in the conduct of its financial affairs and furnishing commerce with a uniform currency convertible on demand into specie and with better facilities for loans and for do- mestic and foreign exchange than it ever before enjoyed. Because of the bad management of early years, mis- takes of judgment and policy occasionally made subsequent- ly and various circumstances over which its officers had no control, the bank made many enemies who became strong enough in 1834 to defeat a bill introduced into Congress providing for its recharter. The most formidable of these enemies were the state banks, the people, principally poli- 1 62 Money and Banking ticians, whose personal interests and feelings had been in- jured from time to time by the measures Biddle and his associates had found it necessary or desirable to execute in the interests of the bank, and President Jackson. The latter was possessed of a deep seated antipathy against and a fear of all banks and some of his party associates and advisors, who were violent enemies of this particular insti- tution used their influence to convince him that it not only ought not to be rechartered, but that it was an unsafe place for the government deposits. The war against the bank began in earnest in 1832 during the campaign for Jackson's election to the Presidency for a second term and resulted in the removal of the public deposits in the autumn of 1833 and a defeat of the bill for recharter in 1834. After the expiration of its charter the bank continued to operate for a time as a state institution under a charter granted by the legislature of Pennsylvania. 6. The establishment of the Independent Treasury Sys- tem. — After the withdrawal of the government deposits from the second United States Bank the public funds ware placed in selected state banks conveniently located in dif- ferent parts of the Union. The crisis of 1837 brought most of these into a state of suspended specie payments and many of them into bankruptcy. The public deposits were thus rendered either unavailable or payable only in depre- ciated state bank notes, and the government suffered greatly from the resulting financial embarrassment. Out of the agi- tation which followed sprang our Independent Treasury System. The act for the establishment of this system was passed in 1840, repealed in 1841, and reenacted in 1846. The main provisions of the latter act were as follows : So-called sub- treasuries were to be established at Philadelphia, New York, Boston, Charleston, St. Louis, New Orleans, San Francisco, Banking in the United States 163 Denver, Carson City and Boise City * to be presided over by assistant treasurers. In the safes and vaults to be pro- vided at these places and at the main treasury at Washing- ton were to be kept the funds of the government, receiving and distributing officers being required to deposit therein, instead of in banks, whatever funds should come into their hands after Apr. i, 1847. All payments to and from the government were to be made in coin. Provision was made for the transfer of funds from one sub-treasury to another and for the other necessary details of the system. This method of managing the public funds subsequently modified in important particulars has continued to the present day. 7. The growth and reputation of state banks. — State banks increased rapidly in numbers throughout the period of the life of the second United States bank and down to the outbreak of the Civil War. Their distribution among the various states and territories varied considerably in different years, but every state was fairly well supplied at most times. To the student the most interesting and important phase of the history of these institutions not yet considered is the effort of the various states or of the banks themselves to provide safeguards and suitable regulations for the business. In this work the states of Massachusetts and New York were leaders. In the former legislation with this end in view began as early as 1792 and has continued at intervals down to the present day. It was not always consistent and was frequently ineffective, but it improved with time and on the whole does credit to the state. This legislation was incorporated in charters granted to banking institutions and in general laws of which the most important were passed in 1805, 1806, 1809, 1829, 1835, and i860. Charters were *By subsequent acts the sub-treasuries at Charleston, Denver, Carson City, and Boise City were discontinued, and others established at Balti- more, Cincinnati, and Chicago. 164 Money and Banking granted by nearly every legislature during the early years, and while they had many features in common there was diversity in many particulars. Among the most instructive portions of this legislation were those which aimed at compelling banks to secure from their proprietors a stock of capital and to regulate the mag- nitude of their business in accordance therewith. It was easy to induce people to subscribe for bank stock, but quite another matter to compel them actually to pay the amounts subscribed. A very common practice with bank proprietors in Massachusetts and elsewhere throughout the union was to give to the bank their notes for the whole or a large part of their stock subscriptions, expecting to pay the interest out of profits and never to pay the principal. Banks thus started had to depend wholly or largely upon deposits for their stock of cash and, if these were meager, and they usually were in the early days, they did business almost ex- clusively with their own notes, which were forced into cir- culation in as large quantities as possible and their pay- ment evaded by every possible device. In a charter of the Union Bank incorporated in 1792 it was prescribed that the capital stock should be paid in three instalments and that any subscriber who did not pay at the times designated should forfeit previous payments and his right to subscribe. In another charter granted in 1795 a less stringent provision was incorporated to the effect that after any instalment had become due no stock- holder should be allowed to borrow at the bank until his share had been paid. Such provisions being easily and frequently, if not commonly, evaded or actually violated, in many charters granted later it was provided that the bank should make no loans whatever until satisfactory evi- dence had been presented to the Governor and Council that the entire capital stock had been actually paid in coin and Banking in the United States 165 was actually present in the vaults of the bank. This regu- lation was sufificiently stringent, but its enforcement had to be provided for. To this end oaths of directors to the effect that the requirements of the law had been met were required in the charter of the State Bank granted in 181 1 and in that of the New England Bank granted in 18 13 it was provided that commissioners appointed by the Gov- ernor should actually count the cash as well as take the affidavits of directors that the cash on hand belonged to the bank and was intended to be used in its business. Such regulations were at times violated with impunity by false oaths and by the borrowing of coin for the commissioners to count. The proper enforcement of these and other laws had to wait for the development of a better and stronger public sentiment and for an all-round improvement in the efficiency of the state government. Logically connected with the legislation just described is that which aimed at limiting the liabilities of banks to some proportion of the capital stock. In the act of 1792 amending the charter of the Bank of Massachusetts it was provided that note issues and money loaned by a credit on the books or otherwise should not exceed double the amount of the gold and silver actually deposited in the bank and held to answer demands against the same. The charter of the Boston Bank incorporated in 1803 provided that debts to or from the bank should not exceed double the amount of the capital stock paid in, a provision incorporated in many other charters granted before 181 1. After that date, and previous to 1829, the limit on note-issues most often imposed was 150 per cent, of the paid up capital. In some cases, however, it was 100 per cent, and in a few 50 per cent.* The general law relative to banking passed in 1829 fixed it at 125 per cent. ♦Sound Currency, v. ii. No. 13, p. 256. 1 66 Money and Banking A further means of limiting note issues as well as of compelling banks to keep on hand a stock of specie was a provision first incorporated in the charter of the Union Bank granted in i8i i imposing a payment of 24 per cent, per annum on the notes of a bank in case of its failure to redeem them on demand. Most charters subsequently granted also contained this provision. Scarcity of specie was an obstacle to the enforcement of this provision and was to a considerable extent respon- sible for another group of laws regulative of the denomi^ nations of bank-notes. The act of 1792, to which reference has already been frequently made, prohibited the issue of notes below the denomination of $5. The charters of the Nantucket and Merrimac banks granted three years later, however, authorized the issue of notes of denomina- tions as low as $2. In 1805 the law was modified so as to permit the issue of $1, $2 and $3 notes to the extent of five per cent, of the paid up capital. In 1809 the amount of such notes permissible was raised to 15 per cent, of the paid up capital. It was reduced to ten per cent, in 1812 and again raised in 1818 to 25 per cent., at which point it re- mained so long as state banks continued to issue notes. In the absence of a sufficient amount of specie in circulation notes of low denominations were needed for small change, and legislation yielded to the demand thus created, but it is probable that the satiation of the popular need for small change by such notes tended to prevent the importation and maintenance in the circulation of a sufficient amount of specie. Indeed the chief argument urged in favor of the prohibition of notes of low denominations is the inducement thereby of a large circulation of specie, a portion of which being normally kept on deposit with the banks enables them to redeem their notes on demand, provided the volume put out be kept within proper limits. Banking in the United States 167 Other important legislative provisions related to the pub- licity of bank operations. The act of 1792 required that a statement of the banks' affairs be made to the Governor and council every six months; that of 1805 provided that bank statements be made under oath, and that of 1806 men- tioned the items of information which such statements must contain. The responsibility of directors for the enforce- ment of laws in the cases of their respective banks also received the attention of the Massachusetts legislators. In the charter of the Massachusetts bank, as amended in 1792, they were held personally liable for the debts of the bank in cases of violation of the laws unless they had been absent at the time, or had protested and given notice thereof to the Governor of the state. The general bank act of 1829 made the directors liable in their individual capacities for debts of the bank in excess of the limit fixed by law. These and a large number of other legislative provi- sions represent the efforts of the legislature to throw proper safeguards about the banking business. Private effort was also efficient in this direction, probably more so than public. Its most conspicuous success was the so-called Suffolk system for the clearing and redemption of bank-notes, de- veloped by the Suffolk bank of Boston which was chartered in 1818. Up to that time the notes of country banks had been at a discount in Boston varying with the distance of the issuing bank and the difficulty of collection. The notes of the Boston banks passing everywhere at par were kept out of circulation by these depreciated notes, being col- lected by the country banks and returned to Boston as de- posits. To such an extent had this substitution of local for Boston notes proceeded that in 1818 the circulation of the Boston banks was only about one-twenty-fifth of the total for New England, while their capital was more than 1 68 Money and Banking one-half of that of all the other banks in the same region. In order to attract to itself the business of the country- banks the New England Bank in 1813 offered to redeem country bank-notes at a discount represented by the actual cost of returning them to the place of issue for collection, a charge considerably less than that frequently exacted. The Suffolk bank entered into competition for this business by offering to redeem at par the notes of any bank that would keep with it a fixed deposit of five thousand dollars plus a sum sufficient to redeem such of its notes as might be presented. This plan promising, if generally adopted, to maintain the circulation of the country bank-notes at par, interested the other Boston banks as well as the Suf- folk, and resulted in their combining with it to force reluc- tant banks to accept the Suffolk's offer. The means em- ployed was the contribution of a fund for the purchase of the notes of such banks and for their speedy return to the issuing bank for collection. Subsequently the forcing pro- cess was aided by legislation in Massachusetts and some of the other New England states.* By these methods and their own interests most of the banks in the New England states were ultimately induced to accept the Suffolk's offer and this bank thus became a clearing agent for the notes of the entire region. After a time banks in Providence and Newport aided in the work. Under this system the bank-notes of New England were kept at par and redeemable in specie on demand except during, and for a time after, the crisis of 1837. Banks were thus compelled to keep adequate reserves of specie and to this end to restrict their operations in various direc- tions. Withdrawal from the system became a sign of * See an act of the Massachusetts legislature passed in 1845, provid- ing that no bank should pay over its own counter any notes but its own. Banking in the United States 169 weakness and exposed a bank to the penalty of the return of its notes for redemption in specie at frequent intervals, and sometimes to the refusal of the Suffolk to receive its notes under any conditions, a circumstance which threat- ened ruin, since it deprived the notes of currency. The Suffolk system remained a power in New England to the time of the establishment of the national banking system. In 1855 the Bank of Mutual Redemption estab- lished by the country banks was chartered as a competitor, and after a time attracted the greater part of the business, but the plan for clearing and redeeming notes established by the Suffolk, persisted as long as the state banks con- tinued to issue notes. In New York State attempts to safeguard the banking business in the period preceding the Civil War resulted in some contributions to the art well worthy of description in this connection. The first of these in order of time was the so-called safety-fund system for the mutual insurance of bank-notes. In 1829 a law was passed requiring every bank which thereafter should be rechartered or newly char- tered, to contribute three per cent, of its capital, one and one-half per cent, to be paid annually, to a fund to be used for the payment of the debts of failed banks. In case of the reduction of the fund by such payments it was to be replen- ished by fresh contributions paid at the same rate as the original ones. The principle involved in this legislation is the mutual responsibility of each bank for the debts of the others in case of failure. A free field for the operation of this plan was left open for a few years only. In 1838 a new method of securing the note-issues of banks was authorized by law, a method which proved more popular than the safety-fund system and ultimately took its place. According to this law banks were permitted to secure their notes by the deposit with a 170 Money and Banking public officer, known as the comptroller, of bonds of the United States, or of the state of New York or of bonds of other states approved by the comptroller and equivalent to five per cent, bonds of the state of New York, or of mort- gages on improved, productive and unincumbered real estate worth double the amount of the mortgage, exclusive of the buildings thereon. In case a bank organized under this system should continue in default of the redemption of its notes for a period of ten days, the comptroller was authorized to sell these securities left on deposit and apply the pro- ceeds to such redemption. By an amendment passed in 1840 bonds of other states were removed from the above list, and in 1863 the privilege of depositing real estate mort- gages was taken away. Another important provision of the act of 1838 extended this privilege of issuing circulating notes against the de- posit of the above mentioned securities to any person or association of persons who might make application for the same or conform to the regulations prescribed. Hereto- fore the privilege of banking in New York State had been conferred by special charter only and in 1804 and 1818 laws were passed prohibiting people without such charters ' from carrying on the business of banking in the state. In the granting of these charters political favoritism, bribery and other forms of corruption and fraud had played a leading role, and the free banking principle was introduced as the remedy. It was undoubtedly efficient in this direc- tion, but its immediate effect was a rapid increase in the number of banking institutions, and the undermining of the safety-fund system by the removal of the incentive to new banks to join it and by offering inducements to those al- ready operating under it to withdraw and reorganize under the new law. The constitution granted in 1846 prohibited the granting of special bank charters, thus compelling all Banking in the United States 171 institutions to be established in the future to organize under the free-banking law. Experience with the safety-fund system was thus con- fined to the new banks organized and the old ones rechar- tered in the period 1829 to 1838, and after that date to such of these banks as did not reorganize under the free-bank- ing law. The crisis of 1837 was fatal to banks all over the country. Two operating under the safety-fund system failed in that year, and two others soon after. During the years 1840 to 1842 eleven more failed, the payment of the debts of the first three of which exhausted the fund accumulated in accordance with the act of 1829. The num- ber of banks operating under the system was so small in comparison to the number of failures that the replen- ishment of the fund was too slow to enable the comptroller to meet the demands made upon it. The amendment of the act in 1842 providing that after the payment of the obligations already incurred, notes should be made a first lien on the fund, and a provision in the constitution of 1846 making note-holders preferred creditors of all failed banks, came too late to give much relief. The results of the operation of the free-banking act were far from satisfactory during the early years. There were many failures of banks organized under it, and the proceeds of the sales of securities lodged with the comp- troller were often insufficient for the redemption of the notes at par.* Many institutions organized under it were not banks in any proper sense since they issued notes only and offered no loan, deposit or exchange facilities to the *In the pamphlet already referred to Mr. Root states that 26 of these banks had failed previous to 1844, and that their circulation had been redeemed at the average rate of y(\ cents on the dollar. The Superintendent of Banks in 1854 stated that bonds and mort- gages sold under the provisions of the free-banking act had not realized more than 75 per cent, of their par value. 172 Money and Banking public. For example, some persons in New York City and outside of the state purchased on credit the requisite securi- ties, deposited them with the comptroller and used the notes issued to pay for them, redeeming the notes subsequently at a discount of one-half per cent. This proceeding was made possible by a law passed in 1840 requiring all country banks to redeem their notes in New York City or Albany, but permitting such redemption at a discount not to exceed one-half per cent. The persons above mentioned, therefore, had simply to adopt the device of dating their notes at some interior point to enable them to work their profitable scheme. In order to prevent this practice a law was passed in 1844 prohibiting persons from transacting the business of bank- ing in any place except their residences. In New York as in Massachusetts bank failures, fraudu- lent practices under the cover of law, and actual violations of law suggested amendments and new legislation. The new state constitution of 1846 contained provisions mak- ing stockholders liable for the debts of their banks to the amount of their capital stock in addition to what had al- ready been paid in, making note-holders preferred creditors in cases of insolvency, requiring the registration of circu- lating notes, and prohibiting the passage of a law author- izing the suspension of specie payments. A law was passed in 1848 requiring all banking associations to receive de- posits and to make loans as well as to issue notes. Under the operation of these and other laws, and as a result of experience in administering the laws and in detecting fraud- ulent practices, conditions gradually improved and became fairly satisfactory before the passage of the national bank- ing act in 1863. The number of failures decreased and the losses from such failures as did occur were greatly reduced. A comparison between the safety-fund and bond-security systems on the basis of New York's experience does not Banking in the United States 173 furnish conclusive evidence for or against either one. The safety-fund system was not without competitors long enough to enable its merits to be fully demonstrated and it was handicapped by the fact that the amount of the fund was made proportional to the capital instead of to the cir- culation of the banks and by the fact that all the debts of an insolvent bank instead of simply its outstanding notes were paid out of the fund in case the liabilities were greater than the assets. In spite of these drawbacks, however, the security to note-holders under this system was greater than that rendered by the bond-deposit system during its early years. As afterward amended, the latter system left little to be desired in this direction. This same doubtless could have been said of the safety-fund system had it been given a trial under the conditions suggested above. On account of insufficient data no comparison of the two systems on the basis of costs can be made. From the point of view of elasticity the advantage is with the safety-fund system, the expansion and contraction of note-issues under this system corresponding with the expansion and contraction of business, while under the other there is no connection between the two.* The free-banking system was popular in the west. It was introduced into Ohio in 1845, into Illinois in 1851, into Indiana in 1852 and into Wisconsin in 1853. It did not flourish in Ohio on account of the competition of a strong bank already in successful possession of the field, but in the other states it was given an extended trial. The results, in the period before and during the Civil War, were far from satisfactory. In Illinois and Indiana this system was accompanied by speculation and fraud on a large scale. A large number of the banks authorized under the acts * See Mr. Root's pamphlet 'for a comparison of the results of the two systems, 174 Money and Banking passed in these states were note-issuing institutions and nothing more, the proprietors profiting from the interest paid on the bonds deposited with the state, said bonds hav- ing been directly or indirectly purchased with the notes for the security of which they were deposited. The free- banking laws in these states authorized the issue of notes by any group of persons after the deposit with a desig- nated state officer of certain specified securities. Provided the securities could be purchased from a broker on time, they could be deposited as provided by law, the notes se- cured and the broker paid with the proceeds. If the broker, as was likely to be the case, did business in New York, Boston, Philadelphia or some other distant place, the notes would enter into circulation at a point far distant from the home of the issuing bank, and would not be likely to return to it for redemption until after the lapse of a con- siderable portion of time. When they did return, the bank either went to the wall without a struggle or redemption was evaded by the location of the office of the bank in some inaccessible place, or by other devices. The final result was the sale of the securities by the state official charged with that duty, usually at a price considerably below the face value of the notes issued, or their direct exchange for the notes which were usually in the hands of brokers who had purchased them at a heavy discount. In any case the innocent public was fleeced to the advantage of the brokers and bank proprietors. In addition to the fraudulent practices perpetrated under cover of these laws, difficulty was often experienced on account of the overvaluation of the securities deposited and fluctuations in their value. When a bona fide bank failed, the sale of the securities held often did not realize a sum sufficient for the redemption of the notes that had been issued against them. This difficulty was generally experi- Banking in the United States 175 enced at the time of the outbreak of the Civil War the bonds of the southern states having been deposited as se- curity for note-issues in many of the states operating under this system, notably in Wisconsin. These and other defects of the free-banking system, re- vealed by early operations under it, especially in the West, were due to defects in the laws themselves and in their ad- ministration, and were capable of correction. The principle of free-banking does not necessarily involve the bond or special security system of note-issue and even that system was capable of great improvement as the experience of New York State and later of the United States shows. In frontier communities like Indiana, Illinois and Wisconsin in the fifties, any system under state control was likely to fall into bad hands, to be badly administered and conse- quently abused, the administration of laws however good in such states being almost necessarily lax, and the art of law-making necessarily imperfect. We must also remem- ber that the principles of sound commercial banking were not well understood by the bankers and legislators of those days. They had to be learned in the hard school of ex- perience. Previous to the Civil War some thirteen states had ex- perience with banks owned and operated in whole or in part by their respective governments. The history of these banks emphasizes the truth just suggested that our unfor- tunate early experiences with banking institutions were due more to ignorance of banking principles, bad administra- tion of state laws and regulations devised by the banks themselves than to defects in the systems tried or in the laws designed to regulate and safeguard them. The major- ity of these state-owned and state-managed banks were bad failures, but a few were great successes. Notable among the former were the Mississippi Union Bank and the State 176 Money and Banking Bank of Alabama, and among the latter the state banks of Indiana and South Carolina. These banks were to a con- siderable extent modelled after the United States banks, and in the methods of their organization, and in the laws by which they were to be controlled, differed considerably, but not enough to account for the wide differences in their fates. These differences were chiefly due to the men into whose hands their administration and control fell. The state banks of Indiana and South Carolina were well ad- ministered by honest and capable men, the others were badly, and in some cases, dishonestly administered. 8. Origin and development of the national banking sys- tem. — The outbreak of our Civil War in 1861 was respon- sible for the next important step in the development of banking institutions in this country, namely, the establish- ment of the national banking system. Since 1836 the state banks had had the field entirely to themselves and since 1846 the federal government had managed its own finances through the independent treasury system, using only gold and silver coin in payments and receiving its revenues in that form only. One of the early consequences of the out- break of hostilities was the partial disorganization of the exchange system of the country by the severing of com- mercial, including banking, relations between the northern and southern states and a little later by the suspension of specie payments by the banks of most of the states. This was followed by a rapid expansion of note issues and their substitution for coin in the general circulation. At this time the federal treasury was confronted by a serious problem. Its expenditures, enormously increased by the war, greatly exceeded its revenues from all sources and no adequate plan for meeting past deficits and provid- ing for future needs, either through borrowing or taxa- tion or a combination of both, had been devised and adopted Banking in the United States 177 by Congress. In his annual report of December, 1861, Sec- retary Chase suggested that a market for government bonds might be created by permitting the issue of bank-notes on the security of such bonds and an adequate provision of specie. His suggestion was incorporated in a bill proposed by Mr. Spaulding, chairman of a sub-committee of the House Committee on Ways and Means, but differences of opinion regarding the wisdom of the measure and its in- adequacy to meet the immediate and pressing needs of the Treasury, led to its postponement and to the passage on Feb. 25, 1862, of an act authorizing the issue of $150,000,- 000 of legal-tender notes in denominations suitable for cir- culation as money. This act was followed July 11, 1862, Jan. 17, and March 3, 1863, by others authorizing an in- crease of this class of notes to $450,000,000 in addition to the fractional currency issued to supply the demand for small change. These notes speedily depreciated, became a secondary standard of value, and took the place of coin in bank reserves and as redemption material for bank-notes. The latter, of course, circulated at the same discount as the government notes and fluctuated in value in correspondence with them. The bill proposed by Mr. Spaulding and embodying the suggestion of Secretary Chase was again brought before Congress in the early part of 1863, and enacted into law Feb. 25th. It authorized the organization of banking as- sociations with a minimum capital of $50,000, of which not less than one-third should be invested in government bonds. Said bonds, when deposited with an officer to be known as the Comptroller of the Currency, authorized the association to secure circulating notes to 90 per cent, of their face, but not to exceed 90 per cent, of their market, value. The total amount of such notes authorized to be issued in the entire country was fixed at $300,000,000 to be distributed 178 Money and Banking among the states and territories, one-half according to population, and one-half having due regard to existing bank capital and resources. The maximum amount to be issued by any association was limited to the amount of its paid up capital stock. The notes when issued were to be receivable for all government dues except duties on imports and for all government obligations except interest on the public debt and in redemption of the national currency, and were to be accepted at par by all banks in the system. Each bank was required to redeem its circulation on demand in lawful money, and in case of default, the bonds on deposit were to be forfeited to the United States and the notes paid by the Treasurer. These associations were authorized to transact the various kinds of business belong- ing to a commercial bank under the following limitations : They were not to hold real estate except to the extent neces- sary for the accommodation of their business or such as may have come into their possession in satisfaction of debts owed them; they were not to loan to any one association or person an amount to exceed one-tenth of their capital stock actually paid in, exclusive of liabilities on bills of ex- change and with such liabilities not to exceed one-fifth of their capital stock; they were not to loan on security of their own stock; and they were not to be indebted to an amount exceeding their capital stock actually paid in and unincumbered, except on account of notes in circulation, deposits, bills of exchange or drafts drawn against moneys actually on deposit to their credit and liabilities to stock- holders -for dividends and reserved profits. They were re- quired to keep a cash reserve of not less than 25 per cent, of their deposits and outstanding notes, three-fifths of which might be deposited with associations in nine principal cities named in the act. At the discretion of the Secretary of the Treasury they might be designated depositories of public Banking in the United States 179 money, except receipts from customs. They were required to furnish the Comptroller with quarterly reports of their condition and to submit to inspection by persons appointed by him. Provision was also made for the conversion of state banks into national associations. During the first two years of its history the progress of the system was slow, owing chiefly to defects in the law and to the disinclination of state banks to enter it. The first difficulty was partially removed by an act approved June 3, 1864, which contained the following new provi- sions : A classification of national banks into three groups according to their location in New York City, in any one of nineteen of the principal cities of the country mentioned in the act, generally known thereafter as reserve cities, or in other towns. Banks in New York City and reserve cities were to keep a reserve of 25 per cent, of their deposits and note-issues, one-half of which, in case of the reserve cities, might be kept on deposit in the city of New York. For other banks the reserve was fixed at 15 per cent, of deposits and note-issues, of which three-fifths might be kept on deposit in New York City or in the reserve cities. These banks were also required to select an association in New York City or in some one of the reserve cities through which to redeem their notes at par, the previous act requiring only that the banks should redeem their notes over their own counters. Until specie payments should be resumed this act permitted not more than one-sixth of the notes issued to be of denominations below $5, raised the minimum capi- tal requirement to $50,000 in towns the population of which does not exceed six thousand, to $100,000 in towns of from six to fifty thousand inhabitants, and to $200,000 in towns of over fifty thousand inhabitants, provided for the taxa- tion of shares by state authority, raised the minimum amount of bonds to be deposited with the Comptroller to i8o Money and Banking $30,000, provided for the accumulation of a surplus equal to 20 per cent, of the capital stock, required security for gov- ernment deposits in the form of the deposit with the Comptroller of government bonds and otherwise, modified the clause relative to the permissable liability of a single firm or individual to a bank so as not to permit such liability to exceed one-tenth of the capital stock actually paid in, bills of exchange drawn against actual values and com- mercial paper actually owned and discounted not to be con- sidered as money borrowed, and made more complete provision than the previous act for the conversion of state into national institutions. All things considered, the reluctance of the state banks to enter the system was natural and it was not entirely over- come until the war closed and pressure was put upon them in the form of a tax on their note-issues. This tax, amount- ing to ten per cent, on their circulation, was imposed by an act passed Mar. 3, 1865. Though it did not go into effect until Aug. I, 1866 its influence was immediate. To Nov. 25, 1864 only one himdred sixty-eight state banks had entered the system, but during the year 1865 seven hundred thirty-one entered, and by the end of 1868 only two hundred forty-four state banks still remained in existence. Until the passage of the act for the resumption of specie payments Jan. 14, 1875 the limitation of the total circula- lation and its distribution among the states were subjects of agitation and legislation. By the end of the year 1868 the limit of $300,000,000 fixed in the acts of 1863 and 1864 had been nearly reached, * and the states of New York, Massachusetts, Connecticut and Rhode Island had more than their legal share. To remedy these difficulties and to * According to the reports made to the comptroller the total circula- tion amounted to $280,129,558 Oct. i, 1866; to $291,093,294 Jan. i, 1867; to $294,377,390 Jan. I, 1868, and to $295,769,489 Oct. i, 1868. Banking in the United States i8i provide for the future expansion of the system, an act was passed July 12, 1870, increasing the limit for the country as a whole from three hundred to three hundred fifty-four million dollars and providing for the withdrawal of $25,- 000,000 from banks located in states having more than their proportion for redistribution among those in states having less. The execution of this act was rendered difficult, indeed almost impossible, by the imperfection of the machinery for the retirement of outstanding notes. According to the laws at the time in force such notes had to be collected and returned to the issuing bank or to its redemption agent, but there was no easy and speedy means of accomplishing this. An act passed June 20, 1874, supplied a remedy and modified the law in other important particulars. It made the Treas- urer of the United States the redemption agent for all the banks and to this end required the deposit with him of a fund equal to five per cent, of the outstanding issues, which fund, however, could be counted as a part of the legal reserve. It repealed the provision requiring a reserve to be kept against circulation, and increased to $55,000,000 the amount to be withdrawn from banks in states having an excess. In order still further to facilitate the retirement of circulation, it provided that banks might deposit lawful money with the Treasurer of the United States in exchange for an equal amount of bonds held, the notes to be subse- quently cancelled as they came into the hands of the Treas- urer, and permitted any bank to reduce its holdings of government bonds on deposit with the Comptroller to $50,000. The act providing for the resumption of specie payments, passed Jan. 14, 1875, removed the limitation on the total amount of the circulation and thus put an end to the dif- ficulties arising therefrom, and from the attempts properly 1 82 Money and Banking to distribute it among the states. The danger of currency inflation which had been the cause of this Hmitation was removed by the provision that for every one hundred dol- lars of new bank-notes issued eighty dollars of the United States notes should be retired until the total amount out- standing should be reduced to $300,ocx),ooo, and by the requirement that on and after Jan. i, 1879, said United States notes should be paid in coin on demand. In the period preceding the resumption of specie pay- ments United States notes and bank-notes were rival forms of currency in the sense that the advocates of one were us- ually opponents of the other. During the Civil War the United States notes were generally regarded as a temporary financial expedient to be dispensed with at the earliest pos- sible moment and, when the national banking system was established in 1863, it was expected that the notes issued by these associations would constitute the chief paper ele- ment in our hand-to-hand currency. In accordance with this idea, an act passed in 1866 authorized the gradual re- tirement of the United States notes, but this policy was checked two years later by another act which deprived the Secretary of the Treasury of the authority to retire any more notes. From that time until Jan. i, 1879, a continuous warfare was waged in Congress between the advocates and the opponents of the resumption of specie payments, the outcome of which was the compromise embodied in the resumption act of 1875 by which national bank-notes were to be gradually substituted for the excess of United States notes in circulation over $300,000,000. An act passed May 31, 1878 modified the compromise by forbidding the further substitution of bank-notes for United States notes and by providing that the United States notes still remain- ing in circulation, amounting at the time to $346,681,016, should not be returned, cancelled or destroyed, but reissued and kept in circulation. Banking in the United States 183 During this same period, 1875-1879, the circulation of the national banks decreased from $354,128,250 to $323,- 791,674 * on account of the profit to be derived from the withdrawal of bonds on deposit with the Comptroller and their sale on the open market at the premium then ruling. For the same reason it subsequently decreased to the low minimum of $123,000,000 in Oct., 1890, varying up and down between these dates and subsequently in accordance with the price of government bonds. The bond security feature of the national banking act, therefore, quite as much as the retention of the United States notes has contributed to the defeat of one of its original purposes, namely, the supply of the country with an adequate note circulation. Such a circulation must be elastic, varying in magnitude in correspondence with the current needs of commerce. A bond-secured circulation like ours cannot thus vary, since there is no connection between the volume of currency needed and the profitableness of bank investments in gov- ernment bonds. On the contrary it becomes a disturbing element since its fluctuations in volume are not infrequently opposed to the interests of commerce, increasing when it ought to decrease and vice versa, and, like the United States notes, taking the place in the general circulation of coin much needed as a basis for the credit system of the country. In spite of the failure of the system of note-issues im- posed upon the country by the national banking act, the banking system which it inaugurated, all things considered, ha:s been a success and a great improvement over anything the country had experienced before. One of its chief merits has been uniformity. National banks wherever located, and they have been established in every state of the Union, and in small as well as in large towns, are sub- *Comptroller's Report for 1879, p. xiv. 184 Money and Banking ject to the same obligations administered from a single cen- ter, the office of the Comptroller of the Currency. Ac- cumulating experience has rendered this administration more and more efficient and gives promise of a closer ap- proximation to perfection in the future. Defects in the act revealed by such experience have from time to time been remedied. Besides the amendments already described should be mentioned: The act of March 3, 1869, providing for five reports annually at dates to be fixed by the Comptroller instead of the quarterly reports previously required; the act of July 12, 1882, reducing the minimum amount of bonds to be deposited by banks having a capital of $150,000 or less from one-third to one- fourth of their capital ; the act of March 3, 1887, providing for an increase in the number of reserve and central reserve cities; and the act of March 14, 1900, which authorized the establishment of banks with a minimum capital of $25,000 in towns of three thousand inhabitants or less, increased the amount of notes to be issued against the bonds deposited from 90 per cent, to 100 per cent, of their par value and diminished the tax on cir- culation from one per cent, to one-half per cent, on condition that the new two per cent, bonds authorized by the act should be deposited as security for circulation in lieu of the other issues at the time extant. Another feature of the system, regarded by some as a merit and by others as a defect, is the centralization which it has permitted, and to some extent, promoted. The law permits country banks to keep three-fifths of their reserves on deposit in reserve cities and reserve city banks to keep one-half of theirs on deposit in the central reserve cities of which at present there are three, New York, Chicago and St. Louis. Banks have generally availed themselves of this privilege with the result that certain national banks in New York City hold a considerable fraction of the reserves Banking in the United States 185 for the entire country. These reserve-holding banks act also as correspondents for the institutions for which they hold reserves and in this capacity receive on deposit funds needed for the conduct of their out-of-town exchanges and their surplus funds, that is, funds for which profitable em- ployment cannot be found at home. The latter practice is due primarily to the importance of New York City as a commercial and financial center, but it has been facilitated and encouraged by the features of the national banking act just described. The administration of these funds is an important trust. They are subject to draft from the banks to which they belong and are certain to be diminished whenever the need for funds outside of New York City is increasing and to be increased under opposite conditions. They should, there- fore, be so employed as always to be available when needed and the nature of their employment should be such that their withdrawal will not seriously affect important interests. The development of deposit-banking has been the chief factor in the success of the national system. It has ren- dered steady growth possible in spite of the erratic and clumsy operation of the note-issuing function. This devel- opment has been the result of the growing wealth of the country and of the ingenuity of American bankers in devis- ing such ways and means of employing deposits in the ex- changes of the country as for most purposes have rendered them more economical, safe and convenient than any other form of currency. On account of this development the im- portance of national banks as purely commercial institutions operating on the basis of deposits has steadily increased relatively to their importance as note-issuing centers. If their right to issue notes were taken away, they would not only survive but prosper, probably quite as much now. 9. State banking since the Civil War. — The development 1 86 Money and Banking of deposit banking was also primarily responsible for the revival of the state banks. After 1868 they increased in numbers steadily but slowly to 1886, since which time their growth has been rapid. As banks of deposit they again became competitors of the national institutions. In this competition they have usually had the advantage of a smaller capital requirement, the privilege within limits of loaning upon real estate security and more liberal laws regarding the magnitude of loans permitted to a single in- dividual or firm. * On the part of the national banks the profits from note- issues and the prestige of the national system have been advantages. The balance of advantage in favor of the one system or the other has varied in different localities and at different times. The following table indicating the number of national and state banks which responded to the call of the National Monetary Commission for statements of their condition on April 28, 1909, represents with a considerable degree of accuracy the distribution of the two classes of institutions throughout the Union at that date : * Several of the states do not fix any minimum capital requirement, and of those which do $10,000 for banks in small towns is the most common. Regarding investments on real estate security the state banking laws are very liberal, most of them (38) imposing no restric- tions whatever. Four allow loans on first mortgage security only ; two limit the amount of such loans to fifty per cent, of the capital and de- posits; and others restrict such loans to the home state or limit their amount to a certain percentage of the value of the property mortgaged. Regarding restriction of loans to a single individual or corporation, sixteen states have no provision whatever and twenty-five' have pro- visions that are more liberal than those of the national banking act. For details see Welldon's Digest of State Banking Statutes included in the Reports of the National Monetary Commission. Banking in the United States 187 State Maine New Hampshire. . Vermont Massachusetts. ... Rhode Island. ... Connecticut New York New Jersey Pennsylvania Delaware Maryland Dist. of Columbia. . Virginia West Virginia North Carolina. . . . South Carolina. . . . Georgia Florida Alabama Mississippi Louisiana Texas Arkansas Kentucky Tennessee Ohio Indiana No. of No. of Nat. Bks. St. Bks. 77 57 9 SO 196 22 3 81 7 430 199 182 21 790 127 27 4 102 36 II 114 207 94 142 70 274 32 202 102 437 39 94 7S I7S 31 302 35 178 S28 390 43 200 148 405 88 306 371 412 250 257 State Illinois Michigan Wisconsin. . . . Minnesota. . . . Iowa Missotiri North Dakota. South Dakota. Nebraska Kansas Montana Wyoming Colorado New Mexico. . . Oklahoma. . . . Washington. . . Oregon California Idaho Utah Nevada Arizona Alaska Hawaii Porto Rico. ... Philippines No. of No. of Nat. Bks. St. Bks. 412 97 129 266 319 125 133 93 215 211 43 29 113 41 242 69 69 149 42 20 II 13 2 4 I 389 335 455 623 282 964 432 407 62s 757 50 39 82 26 608 185 105 320 99 55 24 32 II 10 8 Legislation regarding state banks since the Civil War has tended in the direction of the more careful regulation and the better safeguarding of the business. The national banking act has undoubtedly served as a stimulus and to some extent as a model. Such requirements as the ac- cumulation of a surplus fund from earnings, double lia- bility of stockholders, a minimum cash reserve and an ad- ditional reserve on deposit in reserve cities, the organization of a banking department, regular reports and examinations, limitation of real estate holdings and restrictions on loans are already very common and seem destined to become 1 88 Money and Banking universal. A few of the states have gone beyond the re- quirements of the national banking act, especially in the matter of protecting depositors. Of these the most note- worthy is Oklahoma which has inaugurated a system of compulsory insurance of deposits. The desirability of such legislation is generally questioned and its effects are problematical. Next to improvement in the state banking laws the most noteworthy movement in this field since the Civil War has been the development of a new type of institution known as the trust company. In some of the older states the begin- ning of institutions of this type dates beyond the Civil War, but their rapid growth in these states and their spread throughout the Union belong to the period under considera- tion. At the beginning of the year 1910 they were to be found in at least thirty-nine of the states and their total number exceeded one thousand. As the name implies, most of these institutions were originally incorporated for the purpose of administering trusts of various kinds, such as the management and settle- ment of estates, the management and investment of funds left to windows, orphans, public institutions etc., the reg- istration and transfer of corporate securities, the under- writing and marketing of stock and bond issues, etc., etc. These still remain the chief branches of their business, but in most cases they have associated with these the collection and investment of savings, and in many states the business of commercial banking. Lending on real estate security is a favorite form of investment with them, and in this con- nection some of them issue bonds and do a business some- what resembling that of the mortgage banks of Europe. The development of trust companies has been accom- panied in most states by special laws for their regulation. In many cases, especially in the early days of the move- Banking in the United States 189 ment, these pertained almost exclusively to the trust fea- tures of their business and permitted the performance of banking functions either entirely without regulation or under regulations quite different from and, usually, more liberal than those imposed upon banking institutions. The result was unequal competition between them and banks, friction, and agitation for the modification of the laws per- mitting such injustice. In consequence, in recent years especially, state legislatures have busied themselves with the problem of harmonizing their banking and trust company laws. The tendency now seems to be in the direction of making suitable regulations for each branch of business carried on by both classes of institutions and of requiring compliance with those regulations by any institution, how- ever named, which transacts that kind of business. * Concentration, which has been so prominent a feature of recent banking history in European countries, has also ap- peared in the United States, although the prohibition of branch banking by our national banking act and by many of our states has been an obstacle of no slight proportions. The movement, so far as it has been realized here, has oc- casionally taken the form of amalgamations, but more often of concentration of stockownership of institutions remaining independent in form or of the establishment of community of interests between previously competing in- stitutions or between those that naturally supplement each other. The concentration of ownership of state and national banks and trust companies located in the same town is a phenomena of frequent occurrence in every part of the country. In New York City this movement has extended farthest, most of the state and national banks and trust companies of that city being really controlled by a few groups of financiers who are also the controlling forces in the railroads and the trusts of the country. I go Money and Banking REFERENCES The most elaborate treatises on the history of banking in the United States are Knox, A History of Banking in the United States, and Sum- ner, A History of Banking in the United States, the latter published as V. I of the History of Banking in all the leading Nations. A good brief account is given in White, 2d. ed. chs. iv. to xiv. Special periods, phases and institutions are treated in Barnett, State Banking in the United States since the passage of the National Bank- ing Act, J. H. U. Studies, Feb. and March, 1902; Conant, Modern Banks of Issue, chs. xiii, xiv and xv; Dunbar, History and Theory of banking, ch. ix; Gouge, Short History of Paper Money and Bank- ing in the United States; Elliott, Funding System, Ex. Docs, i Sess. 28th Cong., No. IS ; Gallatin, Considerations of the Currency and Banking Systems of the United States; Report of the Comptroller of the Currency for 1876; Catterall, The Second Bank of the United States; Holdsworth and Dewey, The First and Second Banks of the United States; and Kinley, The Independent Treasury. In Sound Currency published a few years ago by the Reform Club appeared the following monographs worthy of note : in v. 11, White, National and State Banks; and Root, New York Bank Currency, New England Bank Currency and States as Bankers; in v. iv. Root, The First United States Bank and The Second United States Bank; in v. V, Garnett, Banks of Issue in Illinois; Harding, The State Bank of Indiana; and Root, Early Banks of Issue in Wisconsin; in v. vii^ Stackpole, State Banking in Maine; and in v. x, Millsaps, History of Banking in Mississippi. See also Merritt, The Early History of Bank- ing in Iowa, and Hadden, History of the State Banks and Early Banking in Wisconsin. Convenient summaries of laws pertaining to banking in the United States are: Dunbar, Laws of the United States relating to Currency, Finance and Banking from 1789 to 1891, and Weldon, Digest of State Banking Statutes published by the National Monetary Commission. On Trust Companies and their development see Kirkbride and Sterritt, The Modern Trust Company; Cator, Trust Companies in the United States, J. H. U. Studies, xx, p. 269; Herrick, Trust Companies, Bankers' Magazine for 1904 and 1905 ; and Noyes, The Trust Company, Pol. Sci. Quart, v. xvi, p. 250. See also references at the close of ch. xv. CHAPTER XI BANKING IN CANADA Inasmuch as the history of banking in Canada has been influenced by the general political history of the country, it will be necessary to preface our, account with a brief state- ment of the grand divisions of Canadian history. I. Epochs in the history of Canada. — Previous to 1791 the settlements in Canada were governed directly by Eng- land through a governor and council. In that year a change was made by the organization of the four provinces of New Brunswick, Nova Scotia, Lower Canada and Upper Canada, and by conferring the power of constitutional government upon each one of these provinces. From that time until 1 84 1 each of these provinces had a legislature of its own and substantial legislative independence, the Governor-Gen- eral exercising advisory and in some instances veto powers. In 1841 the provinces of Upper and Lower Canada were united into the Province of Canada, so that from this date until 1867 there were three instead of four provinces in what is now the Dominion of Canada. In 1867 was passed the so-called British-North American Act, which provided for the federation of the existing provinces and the forma- tion of new provinces in the future. Under the operation of this act the province of Canada was again sub-divided into the provinces of Quebec and Ontario, and subsequently the new provinces of Prince Edward Island, Manitoba and British Columbia were added and the Northwest territories divided into five districts. Corresponding with these main divisions are some fea- tures of the banking history of Canada. Until 1867 the leg- islative authorities in regard to banking were those of the in- 191 192 Money and Banking dividual provinces, the only unifying institution being the English government, operating through the Governor-Gen- eral. From 1 84 1 to 1867 in the two chief provinces, that of Upper and Lower Canada, there was legislative unity, and as a result unification of banking legislation was accom- plished during that period throughout the most important part of what is now the Dominion of Canada. The most prominent features of banking legislation since 1867 have been the passage of a series of general banking acts, the result of which has been the unification of banking regula- tions throughout the Dominion and the development of a banking system in some respects peculiar to Canada and in all respects interesting and instructive. 2. Early conditions. — The economic and social history of Canada has been very similar to that of the United States. In both cases it began with small communities isolated to a considerable degree and living necessarily under primitive conditions. The early methods of ex- change in Canada have been admirably described in the following manner by Professor Shortt, formerly of Queen's University, Kingston: "Owing to the nature of the physical and geographical conditions of the first settlers in Upper Canada, the means of communication being very imperfect, the settlers had lit- tle or no choice as to the places in which they might pur- chase supplies or dispose of their products. Even though there had been an abundance of circulating medium, their trade would still have been essentially one of barter, an exchange of their surplus products with the nearest mer- chant for a limited range of goods. Many functions were united in one person in those days. All kinds of goods were supplied by one merchant ; all kinds of surplus products were purchased and exported by the same merchant. Where mills were erected the leading merchants commonly owned them. In many places in Up- Banking in Canada 193 per Canada, during this period, a typical trading center consisted of a flour mill, still, saw-mill, general store, tavern and blacksmith shop. In more important places a woollen mill or at least a carding machine were added. Very often all these were owned by one man. Typical representa- tives of such establishments were the Napanee Mills in the east, and the Albion Mills near Ancaster in the west. Even in the earliest stages of the settlements the im- porter was also the exporter, and barter the natural system of trade. Supplies were required by the settlers throughout the year, while their products came in for sale mainly in the autumn; hence to equalize matters it was customary for the merchants, on the one hand, to give credit for supplies, to be paid for in products later on, or on the other hand, in the case of those who brought products in advance, to issue due-bills or bons, to be ultimately redeemed in goods, or partly in goods and partly in cash. These bons were usually made payable on demand, though not necessarily payable in cash. Together with ordinary promissory notes, which enjoyed a considerable local circulation, they supple- mented the metallic money in the settlements, and, under the circumstances of the time furnished a fairly effective medium of exchange. All things considered, we cannot but admit that in the early years of the upper province these local media of exchange were much more manageable, if not more secure, than any bank notes could have been. "The merchants, for their part, in obtaining their goods and disposing of their accumulated products, usually dealt with a few large importers at such places as Queenstown and Kingston. The merchants in these places also acted as bankers and bill brokers for the local merchants, receiving deposits, obtaining from their customers orders drawn upon various persons, and permitting their customers to draw orders upon them. These wholesale merchants sold as much as possible of the produce sent to them to the govern- ment agents for the supply of the military and Indian posts, exporting the remainder to Montreal, and importing from Montreal the supplies with which they furnished the local merchants. As the imports were greater than the exports, the balance vv^as met by bills of exchange on London from 194 Money and Banking the commissariat officers, vouchers for pensions, and other miscellaneous bills coming from all parts of the province. The larger importers in Montreal acted also as bankers for the wholesale men in the upper province, receiving deposits, making payments to order, and not infrequently advancing loans or credits to be met later on by produce, exchanges, or cash, though we find very little of the latter passing." (The Early History of Canadian Banking, pp. 6 and 7.) This primitive method of exchange was never perfect and was soon outgrown. Complaints were early made of the power which these banker merchants obtained over the prices of the farmers' products and of the disadvantages under which government operations, particularly of a mili- tary character, were placed as a result of these restrictions. The representatives of the English government in Canada early proposed means of freeing the settlers and the public officials from their dependence upon the merchants. These took the form either of paper money or banking expedients, but none of them were adopted until the declaration of war between the United States and England in 1812. During this period there were issued in Canada a species of paper money known as army bills. The quantity issued was sufficient to provide for the most pressing currency needs of the provinces, and the conditions under which these issues were made were such as to prevent their serious depreciation. The advantages which, came from the circula- tion of these notes and the scarcity of currency which suc- ceeded their retirement were chiefly responsible for the success of the banking propositions which were made as a remedy for the financial difficulties of the time. 3. The first banks. — In all. the provinces requests were made for bank charters at a comparatively early period, but the first one which was actually granted was in the province of Upper Canada and led to the establishment Banking in Canada iq5 of a chartered bank in that province in the year 1817. Previous to 1825 five banks in all were chartered in the four provinces; three in Lower Canada, and one each in Upper Canada and New Brunswick. Two private insti- tutions were also established, one in Upper Canada and one in Nova Scotia. These latter institutions were short- lived and the subsequent development of banking in Canada was based upon the five chartered institutions. The pro- visions of these early charters are, therefore, basal and must be briefly described. For the three banks in Lower Canada the following char- ter provisions* were typical: ( 1 ) Charters were to continue for ten years. (2) The directors were to be British subjects. (3) Dividends were to be declared as often as one- half yearly, but only when profits were earned. In paying dividends no encroachment should be made upon the capital. Directors were obliged to submit a clear statement of the bank's position to the share-holders at the annual meeting. (4) Banks might receive deposits, deal in bills of ex- change, discount notes, buy silver coin, bullion, etc., but might not engage in any business other than banking. (5) Banks could not lend money directly upon real property ; they could, however, take such property as further security for loans already made. They were not permitted to lend money to a foreign country. (6) They were permitted to issue notes to circulate as money, but no limit upon this right, other than that placed upon their general obligations, was fixed. (7) The government might require at any time, for the protection of the public, a statement under oath of the position of the bank. *These were taken from Walker's "Banking in Canada," pp. 428 and 429. 196 Money and Banking (8) Tranfers of shares in the bank were not to be valid unless registered in the stock-book of the bank, and the bank was given a prior lien on the stock for ordinary- debts due to the holder. (9) The total liabilities were not to exceed three times the capital stock actually paid in, and directors were per- sonally liable if they permitted such excess. (10) Any director might save himself by publicly pro- testing within eight days after the transactions causing the excess took place. (11) The share-holders were exempt from any liability except that of payment for the stock for which they had subscribed, with a penalty of five per cent, for non-payment after instalments matured. (12) Voting by shareholders was not in exact propor- tion to shares held, the number of votes diminishing by scale as the holdings increased, so that while one share gave one vote, ten shares gave only five, and thirty shares only ten; no holding gave more than twenty votes. In the nature of its charter the Bank of Upper Canada did not differ materially from those of the lower province. One essential difference was the fact that the government was permitted to subscribe for 2000 shares of the stock of this bank and was allowed to name four of the fifteen directors. Provision was made in the charter of this bank also for periodical instead of occasional reports to the government, one being required each year. It is claimed by Professor Shortt that the charters of these early banks were closely modelled after that of the Second Bank of the United States rather than after those of the Scotch banks, as has been frequently asserted. They certainly bear more similarity to the former than to the latter, and on account of the close relations which existed between the two countries it is perfectly natural that they Banking in Canada 197 should have copied after their nearer neighbor whose eco- nomic conditions so closely resembled their own. Between the years 1825 and 1837, as the need for bank- ing institutions developed, other charters were granted, modelled upon those already described. Five banks in all were chartered in the province of New Brunswick, one in Nova Scotia, two each in Upper and Lower Canada, and one, the Bank of British North America, was chartered in England with authority to do business in all the provinces. The only peculiarities worth mentioning in the charter pro- visions of these new banks are indicated in the fact that the Bank of Nova Scotia introduced into Canada the principle of double liability for stockholders, that the Bank of British North America was not permitted to issue notes below the denomination of one pound, or four dollars, and that La Banque du Peuple of Montreal was not a pure joint-stock institution of the modern sort, but a combina- tion of a partnership and joint-stock company. It had twelve partners, who were subject to unlimited liability, and it was permitted to have an indefinite number of asso- ciates or stockholders whose liability did not extend beyond the payment for the stock for which they subscribed. 4. Restraining influences on banking excesses. — The student of banking history in the United States will be sur- prised at the small number of banks established in Canada during this period, while across the border such institutions were increasing in numbers with great rapidity. The ex- planation of the difference in this respect between the two sections is to be found in the restraining influences which were operative in Canada and not in the United States. In the former country the same tendencies were at work as in the latter. There was agitation for the introduction of the principle of free banking, criticism of the conserva- tism of the chartered banks, accompanied by claims that the igS Money and Banking bank capital and the circulating medium of the country were inadequate, and other evidences of those ideas regard- ing credit and currency which seem to be characteristic of frontier communities. In Canada these tendencies were checked in part at least by the attitude of the English gov- ernment, which had the right of veto over bank and other forms of legislation. The process of securing a bank charter consisted in its passage by both houses of the provincial legislature, and its signature by the Governor- General, whose right, however, to append his name was con- ditioned upon the consent of the privy council of the Eng- lish government, which practically meant the committee for trade. The early charters were frequently delayed for two or three years by the delay of the home government in granting its consent, and as early as 1830 a set of regula- tions were prepared and submitted to the legislature through the Governor pertaining to the conditions under which the home government would be willing to give its consent to the granting of bank charters. These regulations have been summarized by Mr. Walker (p. 437) as follows: "i. Bank charters to be forfeited by suspension for sixty days consecutively or during a year. 2. Note issues to be dated where issued and to be re- deemed in specie there and at the head ofiEice. No branch need redeem notes issued at any other branch or the head office. 3. One-half the capital to be paid in at commencement, the remainder at discretion. 4. The directors not to become liable on obligations to the bank exceeding one-third the total discounts of the bank. 5. Bank not to hold its own stock or lend money thereon. 6. Half yearly statements to the Government of average assets and liabilities made from weekly balance sheets with particulars of dividends and reserved profits. Special re- Banking in Canada 199 turns might be called for, and must be verified under oath if required. 7. Share-holders subject to double liability. 8. Banks not to lend on real estate." While these regulations were subsequently incorporated into the charters of most of the banks, there was severe opposition at the time of their presentation, chiefly on the ground that the colonies objected to interference in their banking affairs by the home government. However, the pressing of restrictions of this sort upon the attention of the provinces, and the discussion and opposition which it aroused, tended to restrain the granting of bank charters and to spread correct and sound ideas regarding banking institutions among the people. Another restraining influence, especially in Upper Can- ada, was the disinclination of the directors and stock- holders of the bank of Upper Canada at Toronto to en- courage the formation of rival institutions. This bank, as we have seen, partook to some extent of the nature of a provincial institution, inasmuch as the province owned a part of its capital. Its promoters and the members of its governing body were either provincial officials themselves or the powers behind the throne, and they were able directly or indirectly to control legislation, and accordingly they op- posed the multiplication of bank charters. Another restraining influence was the crisis of 1837 with its lessons regarding the danger of unprotected bank-note issues. Fortunately for Canada, this crisis came before the forces working towards inflation and unsound banking had gained the upper hand. Here, as in the United States, all the banks ultimately were forced to suspend specie pay- ments and resumption was not general before 1839. There was severe depression of trade and general commercial dis- tress here as elsewhere. 200 Money and Banking 5. The experiment with free banking. — ^The struggle be- tween the tendencies which favored undue bank expansion and these restraining influences retarded the development of new banking institutions up to about 1850. In that year a law was passed inaugurating the experiment of free banking on substantially the same principles as obtained at the time in the state of New York. It will be remem- bered that the free-banking act of New York state intro- duced into this country not only the principle of freedom of banking under a general law, but also that of note issues based upon public securities. These principles gained favor in Canada and became ultimately the expression for the tendencies opposed to the existing chartered institutions and in favor of more rapid bank expansion. The law of 1850 provided for the formation of banks with a minimum capital of £25,000, with the right to estab- lish one office only, and to issue notes to the amount of the par value of the provincial securities which they might hold. Provision was also made for the incorporation of this principle in part into the charters of existing banks by per- mitting an extension of note issues beyond a proposed min- imum on condition of the deposit of provincial securities. This experiment failed, only five banks ever having or- ganized under these provisions, and of these, three re- tired their circulation and secured special charters within five years, and the other two led a checkered career for a few years and then disappeared from the field. The bank of British North America, which was forbidden by its original charter to issue notes below one pound or $4, was the only chartered bank which took advantage of the act, and that for the reason that it gained thereby permission to issue notes below this limit. Mr. Breckenridge, in his treatise on Canadian banking, clearly shows that it was un- profitable for the other chartered banks to accept the princi- Banking in Canada 201 pies contained in this act. The necessity of tying up a por- tion of their capital in provincial securities bearing a rate of interest considerably below that which could be obtained by ordinary bank loans rendered the proposition distasteful, because unprofitable. It should be noted that this experi- ment was probably due quite as much to the desire of the provincial government to provide a good market for its securities as to the apparent success of the experiment in New York or the devotion of any large section of the population to the principles involved. The failure of this experiment became evident as early as 1855, and accordingly at this time there was a resumption of the process of bank expansion through special charters which had characterized the earlier period. Between the years 1855 and 1866 twenty-five new charters were granted in the various provinces and about fifteen new banks came into existence. With the exception of four or five banks, which sooner or later failed or were deprived of their charters, these banks have continued their existence down to the present day, either as independent institutions or as parts of other institutions with which they have amalga- mated. The cause of this comparatively rapid increase in the number of banking institutions is to be found in the ex- pansion of Canadian markets, due to the reciprocity treaty made in the early so's with the United States, to the in- crease of population, especially in the western districts, and to the industrial expansion which was occasioned or aided by the construction of railroads. The charters of the banks granted during this period and the changes introduced into those of the older banks upon the occasion of their renewal show decided improve- ments over the earlier charters. These were due in part to the principles recommended by the Committee for Trade of Her Majesty's privy council, and in part to the experi- 202 Money and Banking ence gained by the banks themselves. As early as 1830 the danger of permitting private bankers to issue without re- striction notes of low denominations was appreciated, and a law was passed in Lower Canada prohibiting the issue of notes for less than $5 by any except a chartered bank, and later on the chartered banks were prohibited from issuing notes below 5 sh. or $1. In 1837 the same restric- tions were enacted into law in the province of Upper Canada, the four private banks then in existence being in- cluded with the chartered banks in the list of those having the right to issue notes of denominations as low as 5 sh. or$i. 6. Steps toward the uniform regulation of banking. — When the provinces of Upper and Lower Canada were united in 1841, a committee on banking and currency was appointed which reported upon incorporating the following restrictions into the charters of the banks upon the occasion of their renewal: "ist. The amount of capital of the company to be fixed; and the whole of such fixed amount to be subscribed for within a limited period, not exceeding eighteen months from the date of the charter or Act of incorporation. 2nd. The bank not to commence business until the whole of the capital is subscribed, and a moiety at least of the subscription paid up. 3rd. The amount of the capital to be paid up within a given time from the date of the charter or Act of Incor- poration, such period, unless under particular circumstances, not to exceed two years. 4th. The debts and engagements of the company, on promissory notes or otherwise, not to exceed at any time thrice the amount of the paid-up capital, with the addition of the amount of such deposits as may be made with the company's establishment by individuals in specie or Gov- ernment paper. 5th. All promissory notes of the company, whether is- Banking in Canada 203 sued from the principal establishment or from the branch banks, are to bear date at the place of issue, and to be pay- able on demand in specie at the place of date. 6th. Suspension of specie payments on demand at any of the company's establishments, for a given number of days (not in any case exceeding sixty) within any one year, either consecutively or at intervals, to forfeit the charter. 7th. The company shall not hold shares in its own stock, nor make advances on the security of their own shares. 8th. The company shall not advance money on security of lands, or houses, or ships, or on pledge of merchandise, nor hold lands or houses, except for the transaction of its business; nor own ships or be engaged in trade, except as dealers in bullion or bills of exchange; but shall confine its transactions to discounting commercial paper and nego- tiable securities and other legitimate banking business. 9th. The dividends to shareholders are to be made out of profits only, and not out of the capital of the company. loth. The company to make up and publish periodical statements of its assets and liabilities (half-yearly or yearly) showing, under the heads specified in the annexed form, the average of the amount of its notes in circula- tion, and other liabilities at the termination of each week or month, during the period to which the statement refers, and the average amount of specie or other assets that were available to meet the same. Copies of these statements are to be submitted to the Provincial Government, and the company be prepared, if called upon, to verify such state- ments, by the production, as confidential documents, of the weekly or monthly balance-sheets from which the same are compiled. And also to be prepared upon requisition from the Lord's Commissioners of Her Majesty's Treasury, to furnish in like manner such further information respect- ing the state or proceedings of its banking establishments as their Lordships may see fit to call for. nth. No by-law of the company shall be repugnant to the conditions of the charter or Act of Incorporation, or the statutes of the province. I2th. As the insertion in charters or Acts of Incorpora- tion of provisions relating to the detailed management of 204 Money and Banking the business of the corporation has, in several instances, been found to render the documents complicated and unin- telligible, and has been productive of great inconvenience, it is desirable that such insertion should be avoided, and that the provisions of such charters or Acts of Incorporation should be confined, as far as practicable, to the special powers and privileges to be conferred on the company, and the conditions to be observed by the company, and to such general regulations relating to the nomination and powers of the directors, the institution of by-laws, or other pro- ceedings of the company, as may be necessary, with a view to public convenience and security. 13th. No company to be allowed to issue its promissory notes payable on demand, to an amount greater than its paid-up capital." * The recommendations of this committee were adopted, and when the charters of the banks were renewed these recommendations were incorporated together with the prin- ciple of double liability of shareholders, which up to this time had been in force only in the provinces of New Bruns- wick and Nova Scotia. It will be observed that under these regulations a distinction is made between the notes of the bank and its other liabilities and the principle introduced that the note-issues should be limited by the amount of the paid-up capital of the bank ; a principle which has apparently become permanently established in Canadian banking legis- lation. 7. The issue of Provincial notes. — The failure of the Canadian government to improve the market for its securi- ties through the free banking system rendered some other scheme to that end desirable, if not necessary. The con- struction of railroads and other internal improvements had greatly increased its expenditures, and a large floating debt had accumulated of which it was necessary to make some ♦Walker, pp. 443, 444. Banking in Canada 205 disposition. A considerable part of this debt was owed to the bank of Montreal, which since 1861 had been the gov- ernment's banker. Among the suggestions made for the improvement of the government finances was the estab- lishment of a provincial bank. But this did not meet with the approval of the legislature, and finally the expedient was adopted of authorizing the Governor in Council to issue provincial notes to the maximum amount of $8,000,000. These notes were to be payable in specie on demand at Montreal and Toronto and to be legal tender. They were to be secured by bonds of the province and specie, of which the latter should amount to 20 per cent, until the issues ex- ceeded $5,000,000, and to 25 per cent, for any excess above that amount. The plan included a provision for the retire- ment of the issues of the banks and a substitution of these notes in their place. In order to induce the banks to accept this arrangement, the government offered to pay any bank, which would voluntarily resign its right to circulate notes, five per cent, per annum of the amount of its notes outstand- ing on April 30, 1866, until the date of the expiration of its charter, and to allow it the time preceding Jan. i, 1868 for the complete retirement of its issues. The government further agreed to pay to such banks, for the issue and re- demption of the government notes, one-fourth of one per cent, every three months on the average amount kept in circulation, and to release them from the requirement of in- vesting ten per cent, of their capital in provincial bonds. The only bank which accepted this arrangement was the Bank of Montreal, which at that time, as we have seen, held a large part of the government's floating debt and was practically the government's banker. 8. The British North American Act of 1867 in its relation to banking.— The passage of the British North American act in 1867 began a new epoch in the history of Canada. 2o6 Money and Banking Under its provisions the four original provinces were fed- erated, and one legislature from this time on took the place of the various local bodies, and legislation in regard to banking and currency became the prerogative of the Do- minion. In consequence, the era of provincial banking ends with the passage of this act. The problem before the first Dominion legislature with reference to money and banking was by no means simple or easy. There were at the time 19 banking institutions in operation in the old province of Canada, now the provinces of Ontario and Quebec, 5 in Nova Scotia, and 4 in New Brunswick. Uniform regulations had been introduced for the banks of the two provinces of Ontario and Quebec as a result of the union, in 1841, of the old provinces of Upper and Lower Canada. There was a considerable degree of similarity between the bank charters of the provinces of Nova Scotia and New Brunswick and those of Ontario and Quebec, but important differences, nevertheless, interfered with the unification of the banking system. The privileges of the banks in each province were purely local and their circulation and business also largely local. Two of the banks, namely, La Banque du Peuple of the old province and the Bank of British North America, were operating under charters which differed from those of all the others and contained many peculiar features. The Bank of Mon- treal was the largest institution in the country, having a paid-up capital of $6,000,000 as against $4,000,000 of the Commercial Bank of Canada, the next largest institu- tion, and numerous branches in various parts of Canada. It was the government's bank and the only institution which had taken advantage of the opportunity to retire its circula- tion offered by the provincial note act of 1866. The rela- tions of this institution with the other banks were not altogether friendly on account of the great privileges which Banking in Canada 207 it enjoyed. The charters of most of these banks expired in a few years after the passage of the British North American act and consequently an opportunity was offered for such modification in their charters as the Dominion legislature might think proper. Besides the problem of unification and improvement of the banking system, the Dominion legislature was called upon to legislate regarding the paper money issues of the old province of Canada and of the province of Nova Scotia. The latter province issued a provincial currency early in its history and had maintained that form of currency con- tinuously up to the date of its union with the other prov- inces. The banks in that province had not been permitted to issue notes in denominations below $20 in order to leave room for the circulation of the provincial notes. In Can- ada, as we have already seen, provincial notes were placed in circulation the year previous to the union and most of the banks were issuing notes in denominations as low as $1. Much depended upon the way in which the new legisla- ture settled these financial problems. Any measures adopted were certain to be taken as precedents for the fu- ture and were to constitute .the foundation upon which future legislation must be built. The legislature seemed to realize this fact, -and its earliest measures regarding the banking and currency system were of a temporary character, designed simply to give the legislature time thoroughly to consider the problem before any permanent measures were adopted and to make such changes as were rendered necessary by the substitution of the Federal for the provincial legislatures. As early as 1868 various plans were submitted for the unification of the banking system. Among these the most important was that of the Minister of Finance, Mr. Rose, who desired to introduce the main features of the national 2o8 Money and Banking banking system of the United States. This plan was debated at great length and quite uniformly opposed by the banking and commercial interests of the Dominion. The bill which embodied it was, therefore, withdrawn, and the Minister of Finance retired in favor of another man who was inclined to consult the bank experts in regard to matters of this sort. The result of the deliberations of the Minister of Finance and his associates in and out of the legislature was the preparation of a bill regarding banks, which was enacted into law on the I2th day of May, 1870. Before describing this act, however, it will be necessary to note the disposition made of the notes authorized to be issued by the provincial note act of 1866. This is indicated in the following summary of regulations : "(a) The management of the Dominion note circula- tion directly by the Government. (b) The establishment of branch offices of the Receiver- General's Department in Montreal, Halifax, St. John's and Toronto, for the issue and redemption of notes. (3) The authorized extension, by Order-in-Council on report of the Treasury Board, of the issue to $9,000,000 in amounts of not more than $1,000,000 at a time, and at intervals of not less than three months. (d) The requirement that the Receiver-General should hold specie and Dominion debentures to cover the outstand- ing circulation ; the debentures to be issued and held for the purposes of the Act, or to be disposed of temporarily or absolutely in order to provide specie for redemption; the debentures not to exceed 80% of the circulation, the specie, as a rule, to be a sum equal to 25% of the debentures, and never less than 15%. (e) Provision for the issue of any amount required by the public convenience, so long as the excess over $9,000,000 should be covered by equivalent amounts of specie." * The effect of this provision was to do away with the * (Breckenridge, "The Canadian Banking System, 1817-1890," Pub- lications of Amer. Ec. Ass'n., vol, x., p. 252.) Banking in Canada 209 anomalous position occupied by the Bank of Montreal and to restore that institution to something like its original position. It also authorized the increase in the quantity of notes to be issued and a slight change in the security by which they were backed. 9. The bank acts of 1870 and 1871.— The act of 1870 took the form of a series of restrictions which it was provided should be introduced into the charters of existing banks whenever they were renewed and into those of all new banks, together with such others as were provided by exist- ing legislation. The chief provisions of the act may be summarized under the following heads : ( 1 ) Capital. No bank was to be permitted to begin busi- ness or to issue notes until $200,000 of its capital should have been paid up and the fact certified to by the Treas- ury Board. Twenty per cent, of the subscribed capital beyond this amount should be paid each year after the beginning of business. This paid-up capital must not be impaired by any distribution of dividends, and whenever for any reason impaired, the amount should be made good forthwith by calls on the shareholders for any unpaid por- tion of their capital stock and by the application of all net profits. No division of profits by way of dividend or bonus should be permitted to exceed eight per cent, per annum un- til a reserve fund, after deducting any bad or doubtful debts, equal to 20 per cent, of the paid-up capital stock should be accumulated. (2) Note issues and reserves. The amount of note-is- sues by any bank was not to exceed the amount of the bank's unimpaired, paid-up capital, and no note of less denomina- tion than $4 was permitted to be issued. The notes of the bank were to be received in payment at any of its offices, but should not be payable in specie or Dominion notes at places other than those specifically named in the note 210 Money and Banking itself, one of such places being always the bank's chief city of business. There was no provision fixing the proportion of cash reserves to liabilities, but the bank was required to hold usually one-half and not less than one-third of its cash reserve in Dominion notes. (3) Loans on security of stock and to directors. Banks were forbidden to make loans on security of their own stock, and were to have a lien upon the shares and unpaid dividends of debtors for any overdue debt. Discounts or advances to any director or firm of which a director was a partner should not exceed one-twentieth of the total discounts of the bank at the same time. (4) Double liability of stockholders. In case the pro- perty or assets of any bank should be insufficient to pay its liabilities, the shareholders were made liable for the defi- ciency to the amount of their respective shares, in addition to any amount on those shares not yet paid up. (5) Votes of shareholders. Contrary to the preceeding practice, each share of stock was permitted one vote. (6) Returns to the government. Banks were required to make monthly returns to the government of their assets and liabilities in an expanded and improved form prescribed in detail in the act. They were also required to furnish the Minister of Finance each year, before the date appointed for the opening of Parliament, a certified list of their shareholders, the stock held by each, and their residence. (7) Charter period. The principle of revision of char- ters every ten years was introduced, and accordingly the charters of all banks newly incorporated or renewed were to expire at the end of the session of Parliament next after the ist of January, 1881. Inasmuch as this act took the form simply of a number of restrictions which should be incorporated into the char- ters of new banks or of old ones when renewed, it did not Banking in Canada 211 contain all the provisions which were regulative of banks and did not secure any uniformity in the internal manage- ment of the various banking institutions. Such uniformity was desired by the bankers, and in order to obtain it an act was passed in the following year incorporating the provi- sions of the act of 1870 and such others as were provided by existing legislation and were designed to secure uniformity in banking matters. The principal modifications introduced into existing legis- lation by this new act were the provisions that the maximum amount of capital subscribed for a new bank must not be less than $500,000, and that the maximum paid in before commencing business must not be less than $100,000, and that an additional $100,000 must be paid in within two years. The act further revised the previous legislation regarding the use of warehouse receipts as a security for bank loans, and authorized banks to make loans on the security of the stock of other banks, and of municipal, state and corporate securities within Canada, and the public se- curities of foreign countries. 10. The decade 1870 to 1880 and the revision of 1880. — The first decade after the passage of the new bank- ing act is notable on account of the contrast between the prosperity of the first part of the period and the depression of the latter part. Commerce and industry expanded very rapidly in Canada in the years 1867 to 1874. There was a rapid growth of population, a rapid extension of the rail- way system, a large increase in the products of agriculture, and expansion along all lines. A natural result of this was a considerable increase in the number of banking institu- tions. Nineteen all told began business during this period. A considerably larger number of charters than this were granted, but many were forfeited for non-usure on account of the inability of the projectors to secure the requisite 212 Money and Banking amount of capital within the time appointed. The largest number of these institutions was established in the years 1872 and 1873. The crisis which passed over the United States in 1873 affected Canada, but in a much less degree. In that country it inaugurated a period of depression rather than one of severe crisis. The result, however, so far as banking in- stitutions were concerned, was disastrous. A number of banks were obliged to cut down their capitals and greatly to diminish the magnitude of their business, while still others completely succumbed and either went into voluntary liquidation or failed. The year 1879 was the most disas- trous of all, the largest number of failures having taken place in that year. All told, five banks failed during this period in the provinces of Ontario and Quebec, one in New Brunswick, and two in Nova Scotia. The paid-up capital of the banks reporting to the government, which in 1875 had reached a total of $66,800,225, had decreased by 1881 to $59,677,363. (Breckenridge, App. i.) The unfortunate experiences of 1879 and the years im- mediately preceding it are chiefly responsible for the modi- fications made in the bank act by the revision of May 7, 1880. Though all of the banks which failed ultimately paid their note-holders in full, with one exception, and most of them paid a large percentage of the debts owed to their other creditors, in 1880, at the time this revision took place, the prospects for meeting any large proportion of their obligations were gloomy in the cases of most of the banks. Agitation for a radical modification of the banking system was, therefore, revived, and it was again proposed that the system in vogue in the United States should be in- troduced. The bankers successfully opposed this scheme, however, and also convinced the government that it would not be profitable to provide for the inspection of Canadian Banking in Canada 213 banks by public authority. They argued that on account of the size of the banks, the large number of their branches, and the variety of commercial paper which they held, it would be impossible for any public official to make an ex- amination of a Canadian bank which would be thorough enough to reveal its actual condition. They further argued that the fancied security which a favorable report of such an officer, based upon inadequate knowledge, would pro- duce, would result in bad banking and ultimately in disaster. The only successful supervision and inspection for such banks, they claimed, must come from the proper organiza- tion and skillful manning of the banks themselves. The banks recommended that note-holders should be secured by a first lien upon all the assets of the bank, and that the use of the title "bank" in any form should be pro- hibited to any except incorporated banks. An act which was finally passed May 7, 1880, incorporated these rec- ommendations and in addition raised the limit of the lowest denomination of bank-notes which were thereafter per- mitted to be issued from $4 to $5, and required that any bank upon the request of one of its customers must pay out one- and two-dollar Dominion notes to the extent of at least $50. Considerable modifications and improvements were also made in the clauses of the act pertaining to warehouse receipts. Two years later some further slight amendments were made, the chief ones being that the penalty for viola- tion of the law, which had previously been forfeiture of charter, was in some cases changed to a money indemnity, and instead of prohibiting to any but incorporated banks the use of the title banking company, banking house, etc., such institutions were prohibited from the use of these titles except when they added the word "unincorporated." The decade now under consideration is also interesting on account of certain legislation passed with reference to 214 Money and Banking the Dominion notes. In 1872 a modification was made in the amount and kind of security to be held for these notes. Previously, for all notes issued in excess of $9,000,000, dollar for dollar of specie was held. It was now made law- ful to hold for this excess not less than 35 per cent, in specie. In 1875 a still further modification was made to the effect that for any excess above $9,000,000 and less than $12,- 000,000 50 per cent, should be held in specie, and for all sums in excess of $12,000,000, dollar for dollar in specie. In 1876 the laws regarding the Dominion notes were extended to the provinces of Prince Edward Island, British Columbia, and Manitoba, and branch offices of the Receiver-General for the administration of the note system were established at Charlottetown, Victoria and Winnipeg. The act of 1880 raised the limit of notes to be only partially covered by specie to $20,000,000. Not less than 15 per cent, of this amount was to be covered by gold, not less than 25 per cent, by gold and Dominion securities guaranteed by the United Kingdom, and the remaining 75 per cent, or less by Do- minion debentures issued for the purpose. II. The decade 1880 to i8go and the revision of i8go. — The decade 1880 to 1890 resembles its predecessor in that the early part of the period was characterized by bank ex- pansion and the latter by losses and failures. Neither the amount of the expansion nor of the subsequent depression was so great or so serious as in the preceding decade, and considering the period as a whole, there was an increase rather than a diminution of banking resources. During the period four new banks were established in the provinces of Ontario and Quebec, and one in the new province of Mani- toba. Owing to agitation for increased loan facilities for farmers, there was a large increase in the number of branches established in rural districts and especially in the new western provinces. Manitoba proved to be the chief Banking in Canada 215 center of expansion during this period. A veritable boom of large dimensions struck the province in the early part of the period and was followed by the usual crash in the latter part. This was the chief single cause for the bank losses and failures which characterized the later 8o's. As in the previous decade, several banks wrote off losses and received authority to diminish their capitals. Four banks failed or liquidated in the provinces of Ontario and Quebec, one in New Brunswick, and one in Nova Scotia. The experiences of this period brought out clearly several defects in the existing banking system. Whenever a bank failed its notes at once fell to a discount, even though there was reasonable certainty of its ability ultimately to pay them in full. Existing holders, who were obliged to realize upon them at once, suffered loss in consequence. A further defect was seen in the fact that the banks had not made pro- vision for the redemption of their notes in all parts of the Dominion and were not compelled to do so by law, and in consequence their notes were not everywhere at par. The failures of this and the preceding decade had also shown that a paid-up capital of $100,000 was not sufficient in all cases to guarantee the genuineness of the enterprise. These defects were patent to the bankers themselves, and even before the period for revision arrived a movement was started among them to increase the number of redemp- tion agencies and in other ways to secure the maintenance of the notes at par throughout the Dominion. Mutual agreements regarding the reception of each other's notes were made by bankers in various localities, and by discus- sion and careful thought they provided material for the formulation of a revision act in 1890. The chief changes made by this act were the introduction of a bank circulation redemption fund, the establishment of numerous redemp- tion agencies in the chief commercial centers of the Do- 2i6 Money and Banking minion, the increase in the minimum capital requirement, and the enlargement and more careful definition of the loan powers of the banks. "The Bank Circulation Redemption Fund" was intro- duced primarily for the purpose of preventing the de- preciation of bank-notes between the date of suspension and that of the liquidation of the notes of a failed bank. The law provided that each bank must maintain with the Minister of Finance and Receiver-General a fund equal to five per cent, of the average of their notes in circulation forthetwelve months prior to theprecedingfirstof July, which fund should be held solely for the purpose of redeeming the notes of banks which were in a state of suspension. Upon this fund the government pays three per cent, interest to the bank. In case of suspension the bank is required to pay interest upon its notes at the rate of six per cent, up to the date named for their redemption. If after two months from the date of suspension the bank's liquidators are not pre- pared to redeem the notes, the Minister of Finance is authorized to redeem them out of the fund, the notes so redeemed having the same rights against the estate of the bank as other notes. In case the payments by the Minister of Finance on account of redemption exceed the contribu- tions of the suspended bank to the fund, the other banks shall be called upon to recoup the fund pro rata to the amounts to their credit, such contributions, however, not to exceedforanyoneyearonepercent.of the average circulation. In order to maintain bank notes at par in every part of the Dominion, provision was made for the establishment by each bank of redemption agencies at Halifax, St. John's, Charlottetown, Montreal, Toronto, Winnepeg and Vic- toria. Redemption was to take place on demand at these agencies as well as at the head ofKce of the bank and any other places designated. Banking in Canada 217 Regarding capital, the requirement made in this act was that no new banks should be organized without a subscribed capital of at least $500,000 and a paid-up capital of not less than $250,000. The general powers and business of a bank are defined in the act in the following terms, (Section 64): "A bank may open branches, agencies and offices, and may engage in and carry on business as a dealer in gold and silver coin and bullion, and it may deal in, discount, and lend money, and make advances upon the security of, and may take as collateral security for any loan made by it, bills of exchange, promissory notes and other negotiable securi- ties or the stocks, bonds, debentures and obligations of municipal and other corporations, whether secured by mort- gage or otherwise, or Dominion, provincial, British, foreign and other public securities, and it may engage in and carry on such business generally as appertains to the business of banking; but, except as authorized by this act, it shall not, either directly or indirectly, deal in the buying or selling or bartering of goods, wares and merchandise, or engage or be engaged in any trade or business whatsoever; and it shall not, either directly or indirectly, purchase or deal in or lend money, or make advances upon the security or pledge of any share of its own capital stock or of the capital stock of any bank, and it shall not, either directly or indirectly, lend money or make advances upon the se- curity, mortgage or hypothecation of any land, tenements or immovable property, or of any ships or other vessels, or upon security of any goods, wares or merchandise." Succeeding sections authorize the bank to hold various forms of real property when they come into its hands in the process of enforcing the payment of the debts due to it. Sections 73 and 74 authorize the advance of money on ordinary warehouse receipts and bills of lading, and the 2i8 Money and Banking act specifies in considerable detail the methods by which such loans shall be efiEected. Another interesting section of the act pertains to the rate of interest which may be charged. Banks are au- thorized to take any rate not over 7%, and are not subject to any penalty or forfeiture for usury. In discounting bills payable at its own branches, a bank may not charge any addition of interest or commission beyond the following rates: For 30 day bills }i of 1%, for bills running over 30 days and under 60 days, J^ of 1%, over 60 but under 90 days, ^ of 1%, for 90 and over, }4 of 1%. For bills not payable at points where it has branches, it may charge not to exceed J^ of 1%. Another section prohibits the use of the titles bank, banking company, etc., except as authorized by the terms of this act. 12. Recent history. — The act just described added the finishing touches to the Canadian banking system. In the revision of 1900 no modifications of principle were intro- duced, amendments taking the form rather of improvement of details. Regarding note issues the act provided that no bank in a condition of suspension shall issue or re-issue its notes, and that the notes redeemed from the fund after the contribution of the suspended bank has been exhausted shall bear interest at three per cent, until repaid out of the assets of the bank. It further authorized banks to issue notes in denominations of one pound sterling and multiples there- of in any other British possession than Canada, such notes to be redeemable at the office or agency of the bank in such colony or possession. Provision was also made for the pur- chase by one bank of the assets of another and for the making of loans on security of standing timber and on the rights or licenses held by persons to cut or remove such timber. An interesting change was introduced by the act of 1900 Banking in Canada 219 in the methods of winding up and administering the affairs of a suspended bank. By an act passed by this same legisla- ture the Canadian Bankers' Association was incorporated, and the bank act provided for the appointment of a curator by this Association to take charge of the affairs of a sus- pended bank. It further granted to this Association au- thority to supervise the making, delivery and destruction of bank-notes. The Canadian Banker's Association, thus given a part in the administration of the banking system of the country, in its membership includes nearly all the banks, and includes among its main functions the publication of a periodical known as the Journal of the Canadian Bankers' Associa- tion, and the provisions of means for the education and training of bank officials. This Association has already done admirable work and is destined to play a constantly increasing role in the banking history of the Dominion. REFERENCES The chief works on the history of banking in Canada are Brecken- ridge, The Canadian Banking System, 1817-1890, Pubs. Amer. Econ. Asn. vol. X. numbers i, 2 and 3, and The History of Banking in Can- ada, published by the National Monetary Commission; Walker, Bank- ing in Canada, in vol.. m of History of Banking in all the leading Nations; and the following articles by Professor Adam Shortt pub- lished in the Journal of the Canadian Bankers Association : The Early History of Canadian Banking, vols, iv and v; Canadian Currency and Exchange under French Rule, vols, v and vi; and The History of Canadian Currency, Banking and Exchange, vols, vii to xiv. The Journal of the Canadian Bankers' Association published quarterly since 1893 is the best source of information on all phases of Canadian banking history and practice. See also Conant's Modern Banks of Issue, ch. xvi; and White, ch. xv. CHAPTER XII BANKING IN ENGLAND During the middle ages and early modern times banking was carried on in England at first chiefly, if not exclusive- ly, by Jews and later by Italians called Lombards, and later still by the so-called goldsmiths or workers and dealers in the precious metals. There were no incorporated institu- tions engaged in this business previous to the establishment of the Bank of England in 1694. These early private bankers were located chiefly in London. In the country vil- lages and smaller provincial towns banking was not much developed before the middle of the eighteenth century. I. The early history of the Bank of England. — The Bank of England was incorporated by Parliament in pursuance of a plan devised by a Scotchman named Wm. Patterson, an important feature of which was a loan to the government of £1,200,000 at seven per cent, interest. On account of the great need for funds caused by the war which William and Mary were then waging against the exiled Stuarts and their con- tinental backers, the loan of such a sum at so favorable a rate of interest, and the prospect of further financial as- sistance from the new institution, were inducements suffi- cient to secure the assent of Parliament to certain special privileges to be enjoyed by the incorporators. These were : limited liability, that is liability on the part of each stock- holder for the debts of the bank only to the extent of his holdings of stock; and the use of the government balances. The right to issue notes was also specifically granted in the original charter, but was not prohibited to other in- 220 Banking in England 221 stitutions or persons. The bank, however, coveted this also as a special privilege and in 1697 secured the passage of an act which bound Parliament not to grant banking privileges to any other institution during the continuance of her charter. The terms of this act, not being sufficiently clear, and attempts to infringe upon this privilege having been made, another act was passed in 1708, the most im- portant clause of which was as follows : "That during the continuance of the said Corporation of the Governor and Company of the Bank of England, it shall not be lawful for any body politic or corporate what- soever, erected or to be erected (other than the said Gov- ernor and Company of the Bank of England), or for any other persons whatsoever united or to be united in cove- nants or partnerships, exceeding the number of six persons, in that part of Great Britain called England, to borrow, owe or take up any sum or sums of money on their bills or notes payable at demand, or at less time than six months from the borrowing thereof." This act left private bankers and partnerships of less than six persons free to issue notes and to carry on all other branches of the banking business, and the records of the Bank of England during the first century of her history indicate that, in spite of her privileges, these private bank- ers more than held their own in competition for the busi- ness of merchants and other private individuals. During all this period the balances due the government constituted the bank's chief liability, and loans to the government her chief resource.* 2. Country banking and the act of 1826. — About the middle of the eighteenth century private bankers began to appear in the provincial towns. By the end of the century three hundred or more were in existence and during the * For statistics see Lawson's History of Banking, pp. 44 and 45. 222 Money and Banking next few years their numbers increased very rapidly. These bankers issued notes freely, before 1777 in such denomina- tions as they desired, frequently below one pound, and at times, if not ordinarily, were far from conservative and discriminating in making loans and in granting credit to the various enterprises then competing for public favor. Especially during the Napoleonic wars and the years im- mediately succeeding, when specie payments were sus- pended, they greatly abused their privileges and contributed to the speculation which preceded the crisis of 1825. The failure of many of them at this time and during the period of depression which followed, revealed the fact that they were greatly undercapitalized and sometimes entirely with- out capital resources and that the property of their proprie- tors was inadequate to meet their obligations. The issue of notes of low denominations was also seen to have been a dangerous privilege, these notes having quite generally taken the place of coin in the circulation. A widespread demand for reform followed, resulting in 1826 in a new law which provided among other things that banks with an unlimited number of partners might be established in any place in England distant more than sixty- five miles from London and that the Bank of England might establish branches in any place in England. The pur- pose of this law was the encouragement of the establish- ment in provincial towns of banks with a larger and finan- cially stronger proprietary than was previously possible under the limitations imposed by the act of 1708. The privilege of extension into the provinces granted to the Bank of England was designed in part to compensate her for the further limitations imposed on her monopoly and in part to give the provinces the advantages of a closer and more direct contact with her. Taking advantage of the provisions of the act, the Bank Banking in England 223 of England established branches in Gloucester, Manchester and Swansea in 1826, in Birmingham, Liverpool, Bristol and Leeds in 1827, in Newcastle in 1828, in Hull and Nor- wich in 1829, and in Portsmouth in 1834. Provincial joint-stock banks were incorporated at first in small numbers only, but after 1833 more rapidly. In the year 1836 upwards of forty were established, and by 1844 their number exceeded one hundred. After the passage of the act of 1826 the number of private banks decreased from over four hundred to less than three hundred in 1844, some of them having been absorbed by the new joint-stock institutions, and others forced to the wall by their competitors or by inherent weak- nesses. The new banks were not immune from failure and their methods differed little, if any, from those of their private competitors. Their chief superiority consisted in their greater ability to meet their obligations in case of failure, the number of their proprietors being greater and each one being responsible for the debts of the bank to the full extent of his property. 3. The first banks of deposit — In 1834 another type of joint-stock bank appeared in the city of London, one des- tined to prevail and to become second in importance only to the Bank of England. This was the incorporated bank of deposit without the right to issue notes and catering to the varying and growing needs of commerce in all of its branches instead of to the landlord and official classes. The London and Westminster Bank, opened for business March 10, 1834, was the first of this type to be established. Its founder was a Mr. Gilbart who believed that the clauses of the various charters of the Bank of England defining her exclusive privileges did not prohibit this kind of a joint- stock bank even in the city of London, and the surround- ing territory. This interpretation was adopted by Parlia- 224 Money and Banking ment and expressed in a clause of the bank charter act of 1833 which reads as follows : "Such banking company con- sisting of more than six persons may carry on their trade in London or within sixty-five miles thereof, provided they do not borrow, owe, or take up in England, any sums of money on their notes payable on demand or at any time less than six months from the borrowing thereof, during the continuance of the privileges granted by this act." The practicability of successfully conducting a banking business on the basis of checking accounts instead of note issues had already been demonstrated by the private bankers of London who had ceased to issue notes many years be- fore and whose deposit and exchange business had become sufficiently important even in 1775 to warrant the estab- lishment of a Clearing House. The London and Westmin- ster Bank differed from its joint-stock provincial predeces- sors, established in accordance with the provisions of the act of 1826, not only in that it did not issue notes, but in that it had a relatively large paid-up and a still larger sub- scribed capital, and it differed from the private banks of London not only in the fact of incorporation, but in that it catered to the needs of a new and different constituency, the ordinary tradesman and people of moderate and small means. Other banks of the London and Westminster type early established in London were the London Joint-Stock Bank, opened in 1836, and the Union Bank of London, The Lon- don and County Bank and the Commercial Bank of Lon- don, opened in 1839. The Marlybone Bank started in 1836 and the Metropolitan Bank started in 1839 of this same type were badly managed and failed in 1841. 4. Discount brokerage as a special branch of banking. — Early in the nineteenth century discount brokerage became an independent branch of business in London and has con- tinued as such to the present day. In 1807 a Mr. Overend Banking in England 225 entered into partnership with two other gentlemen for the establishment of a firm for the purpose of serving as inter- mediaries between merchants who drew bills of exchange and bankers who discounted them. Mr. Overend had pre- viously become an expert in this business through his con- nection with a private banking firm in Norwich, and the new firm developed it to large proportions and made it an impor- tant part of the financial machinery of the great metropolis. Other private firms entered the field and in 1855 the Na- tional Discount Company was incorporated for this pur- pose. The discount firm or company buys or sells bills on commission or deals in them as a grocer does in tea, keep- ing such a portion of its own capital as It deems best in- vested in this form or combines both branches of the business. London merchants may and frequently do sell their bills to a discount firm instead of to a joint-stock or private bank, and banks which desire investments of this kind normally go to the discount firms for them instead of buying direct from the issuers. 5. The bank act of 1844. — In the years 1836 and 1839 Eng- land suffered from panics, each of which was preceded by rash speculation, accompanied by severe money stringency and followed by business depression. Much of previous legislation pertaining to banks had been inspired by the belief that these institutions were largely responsible for crises, and by the hope that proper legal regulation of the banking business would prevent these disastrous occurrences. In addition to the enactments of 1826 and 1833 authorizing the establishment of joint-stock banks of issue in the prov- inces, and banks of discount in London, there had been others prohibiting the circulation of bank notes of denomi- nations below five pounds and making the notes of the Bank of England, so long as they were paid on demand in legal coin, legal tender, except as between the bank and the 226 Money and Banking public. The Bank of England had also adopted the policy of keeping in its vaults a coin reserve equal to at least one-third of its demand obligations, and of regulating its note issues in accordance with the state of the foreign ex- changes, increasing them when the exchanges were favor- able and decreasing them under opposite conditions. The crises of 1836 and 1839 convinced Parliament of the inad- equacy of these measures and of the desirability of a more efficient and direct regulation of note issues by the govern- ment, the majority apparently believing that the inability of the Bank of England under existing laws properly to regulate such issues was the chief cause of these crises. The act of 1844, also known as Peel's act, was the rem- edy devised by Parliament. It created in the Bank of Eng- land an issue department and a banking department, the former to have exclusive charge of the issue of notes and the latter of all other branches of the bank's business. It authorized the transfer to the issue department of govern- ment and other high class securities held by the bank to the amount of £14,000,000 to serve as backing for a like amount of notes and permitted the issue of notes in excess of that amount on condition only that an equal amount of coin be kept in the vaults for their redemption, or that the Cabinet authorize an increase against securities to take the place of notes of joint-stock or private banks authorized by the act, but afterward abandoned. Fourteen million pounds being the estimated amount of Bank of England notes normally required to supplement the notes of the private and joint-stock banks, and the coin normally in cir- culation in order that the needs of the country for hand- to-hand money might be satisfied, it was intended that the chief business of the issue department should be to exchange notes for coin and vice versa as one form of currency rather than the other should be desired by the public. Banking in England 227 At this time two hundred and seven private and seventy- two joint-stock banks were issuing notes subject to no limitation as to the amount they might put into circulation or the character of their assets. The Act of 1844 changed this situation by fixing as the maximum Hmit of the issues of such banks the amount of notes they had outstanding on April 12, 1844, ^i^d by forbidding the issue of notes by any private or joint-stock bank that should be organized in the future. It provided further that in case any of these banks should relinquish its right to issue notes, it could not again resume, but that, in that case, the Cabinet, by an order in Council, might authorize the Bank of England to increase its issues against securities by an amount two- thirds as great as that thus relinquished. After 1844 the number of private and joint-stock banks of issue gradually decreased, partly doubtless because of the limitations imposed upon them by the Peel act, but chiefly because of the competition and better adaptation to the needs of the times of joint-stock banks of the London and Westminster type. No longer able to enlarge their business through expansion of note issues, and being for- bidden access to London and the surrounding territory so long as they continued to issue the quota assigned by the act of 1844, the joint-stock banks of issue had much to gain and little to lose by relinquishing their issues and re- organizing under the other form. This was particularly true after 1858 when the privilege of limited liability and various other advantages were extended to banking cor- porations of the London and Westminster type. As we have already noted, a decline in the number of private banks had set in before the passage of the Peel act, the effect of which doubtlessly was to hasten the rapidity of this move- ment. The following table shows the number of each class of banks registered on the first of January of each of the years indicated: 228 Money and Banking Year 1844 1849 1853 1858 1863 1868 1873 1878 1883 1888 1893 1898 1903 1908 1909 Private Banks of Issue 211 182 169 IS3 I4S 129 119 110 103 91 68 38 19 12 II Joint-Stock Banks of Issue 72 66 66 63 63 56 S6 S2 46 42 37 31 21 IS II As the issues of private and joint-stock banks have been relinquished, the Cabinet, from time to time, in pur- suance of the authority conferred by the act of 1844, has added to the amount of notes the Bank of England is per- mitted to issue against securities. The following table* in- dicates the dates of the Council orders and the amounts of the increase in each case : The Peel act, 1844, limited the issues against securities to, £14,000,000 Council Order Dec. 7, 1855, increased the limit by 475,000 Council Order July 10, 1 861, further increased the limit by 175,000 Council Order Feb. 21, 1866, further increased the limit by 350,000 Council Order Apr. i, 1881, further increased the limit by 750,000 Council Order Sept. 15, 1887, further increased the lirait by 450,000 Council Order Feb. 8, 1 889, further increased the limit by 2 50,000 Council Order Jan. 29, 1894, further increased the limit by 350,000 Council Order March 3, 1900, further increased the limit by 975,000 Council Order Aug. 11, 1902, further increased the limit by 400,000 Council Order Aug. 10, 1903, further increased the limit by 275,000 £18,450,000 ♦Quoted from Bankers Mag., Jan. 1904, p. 29. Banking in England 229 6. The joint-stock banks and concentration. — During their early history the non-issuing joint-stock banks, that is Banks of the London and Westminster type, were bitterly opposed by the Bank of England and the private banks of London and many obstacles were placed in the way of their development. Gradually, however, by resort to the courts and to Parliament they not only won the right to existence, but a satisfactory legal status. Since 1857 they have en- joyed the right of registration under the so-called com- panies' acts which confer the privilege of limited liability and other advantages of great value. By studying the finan- cial needs of commerce and industry and catering to them in a spirit of helpfulness and liberality, they have greatly enlarged the functions of banks, extended their operation to new classes of the population and won for themselves the lion's share of this growing business. According as their offices are located exclusively in Lon- don, in both London and the provinces, or exclusively in the provinces, they are commonly designated as Metropoli- tan, Metropolitan and Provincial, or Provincial Banks. A typical bank in any of these groups has a main office and several branches. The London and Westminster, for ex- ample, has its head office at 41 Lothbury, E. C, a west end office at i St. James Square, S. W., and thirty-five branch offices in other parts of London. The London City and Midland Bank, of the Metropolitan and Provincial group, has its main office in Threadneedle St., seventy or more branches in London and its suburbs, and four hun- dred or more offices in the provinces. The Manchester and Liverpool District Banking Company, belonging to the Provincial group, has its head office in Manchester and more than one hundred offices elsewhere, including one in London. For many years the leading institutions of these groups 230 Money and Banking have been growing in size through absorption of other insti- tutions, extension of branches and increases in the magni- tude of their branches. For example during the thirty years ending with 1906, two hundred forty-four banks were absorbed through amalgamation, the number of banking offices in England increasing during the same period from about three thousand * to seven thousand five hundred and seven. 7. The present functions of the various groups of bank- ing institutions doing business in England. — At the present time the functions of these various institutions are to a degree specialized and their inter-relations are such as to constitute them one great financial mechanism. At the cen- ter of the system is the Bank of England. The governing body of this institution consists of a Board of Directors of twenty-four members, a Governor and a Deputy-Governor. The board is chosen nominally by the stock-holders, but in reality is self-electing, the prac- tice being that the youngest members retire after a year's service and are uniformly reelected at the end of the year. Young men of great promise in the old established business firms of London are chosen to fill vacancies. The Gover- nor holds office for two years and is regularly succeeded by the Deputy-Governor whose place is taken by the oldest Director who has not held office. Directors who have held the offices of Deputy-Governor and Governor are perma- nent members of the board and constitute what is known as the Committee of the Treasury which, though its powers are indefinite, form an executive cabinet of great influence.** Since the passage of Peel's act, the division into an issue and a banking department has been maintained. The pri- mary function of the issue department is the exchange of *See Bankers Mag. v. 85, pp. 168 and 278. **Bagehot, ch. viii. Banking in England 231 notes for gold and gold for notes, the quantity of notes outstanding for many years having been greatly in excess of £18,450,000, the present limit of issues against secu- rities.* The business of the banking department resembles that of other banks of deposit, but is peculiar on account of the relations of the Bank with the government, and with other banking and financial institutions. The English government is her largest single customer, public deposits for the last decade having averaged about 19 per cent, of the total, and her holdings of government securities during the same period averaging about 35 per cent, of the total of all her interest-bearing assets. The government's account with the bank is not only large, but it it peculiar in its fluctuations, and on this account presents to the management problems unlike those confronting other banks. For example the government deposits increase rapidly and its balance becomes large during the tax collect- ing season, and regularly decreases during the remainder of the year. At periods when interest on the public debt is due large drafts must be met. Government deficits are apt to occur at tolerably regular intervals, which must be met by loans from the bank, or on the open market. Extraordinary events like the financing of a war bring peculiar duties and obligations, such as the flotation of large government loans and the supply of large quantities of specie for public use. Next to the government the most important of the Bank of England's customers are other bankers. The leading joint-stock and private banks and discount firms of London have accounts with her and the credit balances on these ac- counts constitute a very important element in their reserves. They regularly keep on hand in their vaults only such *The Bank statement for May i8, 1910, showed total issues of ^55.167,905 against which were held government debts and other secur- ities to the amount of £18,430,000 and gold coin and bullion to the amount of £36,717,905. 232 Money and Banking amounts of coin as are required to meet daily needs, de- positing any surplus with the Bank and checking against their balances to meet deficiencies. The provincial as well as the Scotch and Irish banks proceed in the sartie way, us- ing as their reserve agents, if not the Bank of England her- self, some London joint-stock or private bank, which acts as intermediary in the transfer of cash between them and the Bank. The Bank of England thus holds the reserves of the entire country, and the administration of this fund is one of her chief public functions. The Bank of England also does business with people other than bankers, but ordinarily such persons deal with joint-stock or private banks, because these offer better terms and better accommodations. The Bank of England does not pay interest on deposits and will only discount the highest class of bills, namely, those secured by the names of at least two responsible British subjects, and maturing in compar- atively short periods of time.* Joint stock and private banks pay interest on time deposits and discount various grades of paper which the Bank of England rejects. Their rates of discount are also regularly below that of the Bank of England. The relative magnitudes of the business done with Banks and with private persons is not revealed to the public. The Bank publishes a balance sheet on Friday of each week which states the amount of the public deposits, but groups all the others under the head "Other Deposits." This practice has continued since 1877, previous to which time the bankers' balances were separately reported. *In answer to a question of the United States Monetary Commis- sion in 1908 one of the Directors of the Bank stated that the maximum period of maturity of the bills discounted by the Bank was four months and exceptionally six months, and that the average period was forty to fifty days. "Interviews on the Banking and Currency Sys- tems, etc.", p. 20. Banking in England 233 Another peculiar feature of the Bank of England is her relatively large capital and surplus fund and cash re- serve. The proprietors' capital, as it is called, amounts to ^i4,SS3>ooo> and her surplus for many years has not fallen below £3,000,000. The two combined are normally in ex- cess of £18,000,000 and constitute on the average not far from 25 per cent, of the total liabilities of the bank. The greater part of this fund is invested in government securi- ties. For the greater part of a century it has been the rule of the Bank not to allow her cash reserves to fall below 33 J^ per cent, of her deposits. Her practice, however, has been considerably better than this. The average percentage of her reserves to her deposits for ten year periods since 1845 is as follows:* 1845-1854 52% 1885-1894 45% 1855-1864 42% 1895-1904 49% 1865-1874 43% 1905-1909 47% 1875-1884 44% During this entire period the yearly average has never fallen below 30 per cent, and in two years only, 1857 and 1866, as low as this. In no other year has the average ever fallen below 33 per cent, and since 1882 it has never fallen below 40 per cent. Since the passage of Peel's act on three occasions only has the reserve fallen to so low a point as to threaten the suspension of specie payments by the Bank. These were Oct. 25, 1847, Nov. 12, 1857, ^"d ^^7 12, 1866. On these occasions the Cabinet assumed the responsibility of permitting the Bank to issue notes against securities in excess of the amount authorized by existing law, subse- quently obtaining from Parliament the passage of acts of authorization. "^ Figures from 1845 to 1890 are quoted from Palgrave, Bank Rate in England, France and Germany, p. 86, those for the later periods were computed from the weekly bank statements. 234 Money and Banking The joint-stock banks serve the English merchant, manu- facturer and ordinary citizen, and attract the major por- tion of the custom of these classes. They conduct check- ing accounts and make advances to their customers, receive time deposits and pay interest on them, buy and sell foreign and domestic exchange, make collections of dividends and interest due in England or abroad, act as agents in the pur- chase and sale of domestic and foreign securities, provide places of safe keeping for these and other valuables, and in general cater to the financial needs of the ordinary citizen. They also act as agents for country and foreign banks and for municipalities, and other public corporations in England or her colonies. The chief item in their assets is usually loans and ad- vances to their customers and discounted bills, the latter as a rule being drawn by foreigners and endorsed by a foreign bank. London is the largest market in the world for this class of bills and, on account of the fact that they mature in short periods of time and are usually paid at maturity, they constitute an excellent form of investment for banks. Another important item is usually described as money at call and short notice. This, for the most part, represents loans at call made to London discount houses on the security of trade bills and advances to operators on the stock market for the period between settlements which on the London exchange are made twice each month. The cash on hand and the balance at the Bank of England are usually stated in a single aggregate, the latter being re- garded and treated as the equivalent of cash. Government, colonial and municipal bonds and high-class securities of British Corporations are also held by joint-stock banks in amounts commonly, at least, equal to their capital and surplus funds and not infrequently in excess of these. The proportion of capital and surplus funds to total Banking in England 235 liabilities naturally varies considerably among the different banks and from time to time in the same bank. During recent years on the average it has not been far from ten per cent, in the case of representative institutions. The percentage of cash on hand and in the Bank of England to deposits has also varied considerably. In estimating the resources of joint-stock banks avail- able to meet current demands, their loans at call, their bills and their stock exchange securities must be considered. In case of demands in excess of cash holdings and the bal- ance at the Bank of England, a bank may call its loans to brokers and discount houses, rediscount bills with them, or sell securities on the stock exchange. Ordinarily it will resort to these measures in the order named. The propor- tion of cash on hand, at the Bank of England, and at call, to deposits including notes in the hands of the public, for all the banks of the United Kingdom during the decade 1 896- 1 905, probably fairly represents the normal condition of the joint-stock banks. It was reported by the Bankers Magazine to be as follows : 1896 23% 1901 27 % 1906 27-4% 1897 24% 1902 28 % 1907 27-5% 1898 24% 1903 26 % 1908 27.7% 1899 24% 1904 27 % 1909 29 % 1900 23% 1905 27-4% The functions of English private banks cannot be easily differentiated from those of the joint-stock institutions. Their business is essentially the same, but they often cater to special customers such as the nobility and the ofificisi classes. Some of the oldest and most famous private bank- ers of London have served certain great families for gene- rations and owe their prestige and their peculiarities chiefly to this fact. Many of them also do a large business with 236 Money and Banking country banks. On account of the peculiarities of their constituencies their assets are less uniform than those of joint-stock banks and some of their problems are peculiar. Like the joint-stock institutions, however, they depend up- on their balances with the Bank of England, loans at call, rediscounts of bills and sales of securities for the satisfac- tion of their needs for cash. The bill brokers and discount houses deal chiefly with merchants who have bills to negotiate, and with foreign bankers. The extensive imports of British and especially of London merchants, some of them destined for consump- tion in the British Isles and others for shipment to other parts of the world, create an enormous volume of London trade bills, a common method of settlement for such im- ports being the sale of drafts drawn by foreigners who sell goods upon the English merchants who buy them. These drafts reach the London market through foreign banks with London offices or agents, and are bought for investment or resale by the bill brokers and discount houses. Domestic bills reach them directly through the merchants who draw them or through other banks, and are also ex- tensively dealt in. The merchants and bankers who thus deal regularly with discount houses carry accounts with them which are essentially the same in nature as the cur- rent accounts of other bankers. The capital of the discount houses is small relative to the volume of their business. They borrow heavily from joint-stock and private banks on the security of their bills, relying upon rediscounts with the Bank of England to meet unusual demands. For many years banks organized, owned and chiefly operated in foreign countries and the English colonies have operated in England, chiefly in London, by branch offices or agencies, Most nations and all the colonies are thus Banking in England 237 represented and in recent years the number and resources of this class of institutions has increased rapidly. Jan. i, 1908, the number of foreign and colonial banks with offices in England was one hundred and six, while in 1885 it was only twenty-two.* The chief business of these institutions is the negotiation in London of the paper sent there by their principals, the execution for their clients of orders of purchase and sale of government and other securities, the collection and sale of foreign drafts, and, in the case of the colonial banks es- pecially, the making of advances on merchandise sent to their respective countries. In the case of the Indian banks the negotiation of Council bills, that is bills drawn on the government of India by the India office in London, is also important. REFERENCES On the history of banking in England see Macleod, A History of Banking in Great Britain in v. ii of a History of Banking in all the leading Nations, and The Theory and Practice of Banking; Gilbart, The History and Principles of Banking; Bagehot, Lombard Street; Lawson, History of Banking; Phillips, A History of Banks, Bankers and Banking; Francis, History of the Bank of England; Andreades, A History of the Bank of England; Warren, The Story of the Bank of England; Conant, Modern Banks of Issue, chs. iv and v ; Dunbar, ch. x ; and White, 2d ed., ch. xv. For the workings of the English system see Interviews on Banking and Currency Systems of England, Scotland, France, Germany, Swit- zerland and Italy and Withers, Palgrave and others. The English Banking System published by the National Monetary Commission; Jaffe, Das Englishe Bankwesen; and references at the close of ch. xv. ♦Bankers Magazine for May, 1885 and Jaa 1908. CHAPTER XIII BANKING IN FRANCE The history of joint-stock banking in France began with the brilliant, but disastrous experiments of John Law in the early years of the eighteenth century, but the first in- stitution of the modern type to be established was La Caisse d'Escompte which was chartered in 1767. After a short life of two years this institution was succeeded by another of the same name which lasted until 1793. At that time the French government was in the midst of a series of ex- periments with inconvertible government notes which proved disastrous and, for the time being, prevented the establishment of other banking institutions. In 1796 a third La Caisse d'Escompte was chartered and in the fol- lowing year an institution known as La Caisse d'Escomptes du Commerce. In 1797 still another joint-stock bank was chartered under the name Le Comptoir Commercial. All these banks were located in the city of Paris. In 1789 there was established in the city of Rouen Le Societe Gene- rale du Commerce de Rouen. I. Origin and early history of the Bank of France. — These institutions did not fully meet the needs of com- merce and the government, and accordingly when he be- came First Consul, Napoleon devised a plan for a larger and more serviceable institution and embodied it in a decree issued Jan. 18, 1800, establishing the Bank of France. The business the institution was to perform was described in the following terms : 238 Banking in France 239 «i 1. To discount bills of exchange and drafts to order, bearing the signatures of at least three French citizens or foreign merchants of acknowledged reputation and sol- vency. 2. To undertake collections for the account of private citizens and public establishments and to make advances in cases of such collections as may appear to be secure. 3. To receive, on account, cash deposits and collections in behalf of private citizens and public establishments, and to honor checks and drafts drawn upon the bank against the amounts standing to the credit of account-holders. 4. To issue notes payable to bearer at sight, and notes to order payable within a certain number of days after sight. These notes, as issued by the bank, shall be so pro- portioned to the reserve cash in the vaults of the bank, and with such regard for the maturing of negotiable paper held by the bank, that the bank can at no time be exposed to dan- ger of delaying payment of its obligations when presented. 5. To open a Department for Investments and Savings, wherein all sums offered in excess of fifty francs should be received for repa)mient at stated periods." The administration of the Bank was entrusted to a Board of Regents of fifteen members and a Board of Censors of three members, both to be appointed by the two hundred chief stockholders, and a Central Committee of three mem- bers to be chosen by the Censors and the Regents, which to- gether constituted what was called the General Council of the Bank. The Regents were to hold office for five years, one-fifth retiring each year subject, however, to reelection, and the Censors for three years, one retiring each year, but eligible for reelection. The capital was fixed at 30,000,000 francs divided into 30,000 shares of rooo francs each. During the Napoleonic regime these original statutes were several times modified notably in 1803, 1806 and 1808. The chief provisions of the act of 1803, dated April 14, gave the new bank the monopoly of note issues in Paris; 240 Money and Banking prohibited the establishment of banks of issue in the depart- ments without the authorization of the state; increased the capital to 45,000,000 francs; and provided that seven of the fifteen regents and the three censors be chosen from those stockholders who were manufacturers or merchants, and that a council of twelve stockholders engaged in com- merce in Paris be selected by the Censors to give counsel and advice regarding discounts. The act of 1806 was the result of a crisis through which the bank passed in 1805. Through bad management it became the possessor of a large amount of the paper of a firm engaged in furnishing supplies to the government and the failure of this firm obliged it to apply to the state for the privilege of temporarily suspending the redemption of its notes in specie. This request was denied but it was permitted to limit for a time the amount to be redeemed each day. This experience convinced Napoleon of the de- sirability of closer supervision of the institution by the state. The act of April 22, 1806, accordingly abolished the Central Committee in whose hands the direct management of the bank's affairs had been placed and substituted for it a Governor and two Sub-governors to be appointed by the Emperor. It further provided that three of the Regents must be selected from the Receivers General. The Gover- nor was made the presiding officer of the stockholders as- sembly, of the General Council, and of all committees; was given the exclusive right to appoint and dismiss the clerks and subordinate officers of the bank; and his approval of all the paper admitted to discount was required. Among other important provisions was the requirement that the so-called statutes of the bank, i.e., the detailed provisions for its administration to be drawn by the General Council, must be submitted to the Emperor for approval and that the capital be doubled by the issue of 45,000 new shares. Banking in France 241 The statutes of the bank under the new organization, approved by the Emperor in a decree dated Jan. 16, 1808, contain among other regulations, one permitting the substi- tution for the third signature, previously required on all bills admitted to discount, of collateral in the form of bank stock or of five per cent, consolidated state funds, provided the bill originated in a sale of merchandise, and another permitting the bank with the authorization of the Govern- ment to establish branches in the provinces. In accordance with this latter provision branches were authorized in Rouen, Lyons and Lille by decrees dated June 24, 1808 and May 29, 1 8 10. During the period which intervened between 1808 and the downfall of Napoleon in 1815 the fortunes of the bank were closely connected with those of the Government. Serious crises occurred in the years 18 10 and 18 14, the former one caused by the interference with commerce oc- casioned by the blockades, and the second by the first de- feat of Napoleon. During both of these periods the bank held large quantities of government paper and its reserves ran low. In 18 14 it was obliged to resort to the expedient adopted in 1806, that of refusing to redeem more than a small portion of its notes per day. In 1818 the bank also passed through a crisis occasioned by the operations of the Government in connection with the public debt. The Gov- ernment of the restoration was unable at first to secure the confidence of the investing public, and therefore turned over to the bank the management and security of the public debt, granting to it as security the returns of certain taxes and a considerable number of bonds which it was author- ized to sell in case of need. The bank thus undertook the responsibility of paying the interest on the debt and of carrying through measures for its refunding. The experience of the bank during the last years of the 242 Money and Banking Napoleonic regime convinced it that close connection with the Government was on the whole disadvantageous, and that it would gain from a reduction of its capital and the closing of its branches. It accordingly petitioned the new Government for permission to close its branches, to reduce its capital to 67,900,000 francs, and to make such modifications in its organization as would put its direct management in the hands of representatives of the stock- holders, reserving to the Government simply the right of supervision. The first two of the bank's requests were granted, and accordingly the three branches were closed and a sufficient quantity of the Bank's stock purchased to reduce the capital to the desired figure. 2. Banking in the Provinces. — The closing up of the branches of the Bank was accompanied by the authoriza- tion of independent banks of issue in a number of the cities of France. In the year 18 17 one such bank was opened in Rouen, in 1818 two were opened at Nantes and Bor- deaux respectively. For many years, however, provincial banking remained chiefly in the hands of private bankers where it had been since the beginning of banking operations in the middle ages. It was these bankers who served as intermediaries between the lesser merchants and the Bank of France, supplying the third signature required on bills admitted to discount by that institution. Their unreliabil- ity in times of crisis, however, was illustrated during the revolution of 1830 when they temporarily withdrew from business and left the mercantile classes without the credit accommodations necessary for the conduct of commerce. On this occasion the government of Louis Philippe came to their aid by the establishment of local discount offices called Comptoirs de'Escompte, and this experience directed attention to the need for better banking accommodations in the provinces. In 1835 two additional local banks of issue Banking in France 243 were established at Lyon and Marseilles, and in 1836 the Bank of France petitioned the Government for permission again to open branches and for the exclusive right to issue notes in all places in which such branches should be es- tablished. The Government acceded to the Bank's request, but continued also the policy of organizing independent banks. In 1836 branches of the Bank of France were opened at Rheims and Sainte Etienne, and in June of that year and August of the year following independent banks were organ- ized at Lille and Havre. In Oct., 1837, and Jan., 1838, branches of the Bank of France were opened at Saint Quen- tin and Montpellier, and in June and November, 1838, in- dependent banks were opened at Toulouse and Orleans. A tenth independent bank was authorized at Di j on Aug. 4, 1 839, but it was never put into operation. Branches of the Bank of France were organized in 1840 at Grenoble and An- gouleme, in 1841 at Besangon, in 1842 at Caen, Chateau- reux and at Clermont-Ferrand, in 1844 at Miilhouse, and in 1846 at Strasburg and Le Mans. 3. Effects of the revolution of 1848, — At the time of the outbreak of the Revolution in 1848, there were in operation in the departments eleven branches of the Bank of France, and nine independent banks of issue. As a result of the Revolution the Bank was obliged to suspend specie pay- ments, and by an ordinance of the Provincial Government its notes were made legal tender throughout the country, on condition that they should not exceed in magnitude 350,- 000,000 francs. The nine departmental banks were also permitted to suspend payments, and their notes were made legal tender in the departments in which they were located. During the period of enforced circulation of bank-notes which followed, the advantages of the monopolization of the issue function by a powerful central institution were re- vealed in an impressive manner. The issues of the local 244 Money and Banking banks depreciated in varying degrees and the circulation of each was limited to the department in which it was lo- cated, thus exposing commerce between departments to heavy losses and subjecting it to great inconvenience. The notes of the Bank of France on the other hand depreciated to a slight extent only and circulated at a uniform value throughout the country. This circumstance was sufficient to turn the tide of public sentiment, so far, at least, as it was represented in the government, in favor of a single bank of issue, and accordingly a law was passed author- izing the absorption of the nine departmental banks by the Bank of France, and granting to the latter institution a monopoly of note-issues. These nine provincial banks be- came branches of the Bank of France, the capital of which was in consequence increased from 67,900,000 irancs to 91,250,000 francs. Another important effect of the Revolution of 1848 was the establishment of a number of Comptoirs d'Es- compte. These were organized on a plan somewhat differ- ent from that followed after the Revolution of 1830. The capital needed was furnished one-third by the state, one- third by the municipality in w'hich it was located, and one- third by private individuals. As in 1830 they served as intermediaries between the commercial classes and the Bank of France by supplying the third signature needed to render the bills of exchange originating in the ordinary processes of commerce available for discount. Altogether sixty- seven of these temporary discount offices were opened in various parts of France. Twenty-three went out of exis- tence with the expiration of their charters, but forty-four continued to operate under the combined auspices of the state, the municipalities and the private individuals who furnished their capital, until 1853, after which several of them were reorganized on a purely private basis. Notable Banking in France 245 among these was the Comptoir d'Escompte de Paris which is one of the four leading credit institutions of contem- porary France. These Comptoirs d'Escompte thus mark the beginnings of a new type of banking institution, name- ly, one without the right of issue, catering to the interests of the mercantile and industrial classes and intermediating between them and the Bank of France. 4. The Bank of France since 1848. — Besides the acts al- ready described, the chief landmarks in the legislative his- tory of the Bank of France are those of June 30, 1840, June 9, 1857 and Nov. 17, 1897. The law of 1803 fixed the date of the expiration of the privileges of the Bank at Sept. 24, 1818, and that of 1806 extended its lease of life for twenty-five years beyond that date, i. e., to Sept. 24, 1843. The acts of 1840, 1857 ^^^ ^^97 granted extensions re- spectively to Dec. 31, 1867, Dec. 31, 1897 and Dec. 31, 1920. The original capital of the Bank was 30,000,000 francs, but it was increased to 45,000,000 francs in 1803 and to 90,000,000 in 1806. On the occasion of the closing of its first branches the Bank was allowed to purchased 22,100 of its shares, thus reducing its capital to 67,900,000 francs. After the revolution of 1848, when the local banks of issue were absorbed, this was increased to 91,250,000 francs, and again in 1857 to 182,500,000 francs, at which figure it still remains. The accumulation of a surplus fund was required by the law of 1803 which provided that all earnings in excess of six per cent, should be invested in five per cent, consolidated government stock for the benefit of such a fund. This regulation was modified in i8o6 so as to permit two-thirds of the excess of the earnings above six per cent, to be added to the dividends. Laws of July 4, 1820 and Dec. 6, 1831, permitted a part of the surplus then accumulated to be dis- tributed among the stockholders and another passed May 17, 246 Money and Banking 1834, fixed the amount of the surplus at 10,000,000 francs in Rentes plus a sum sufficient to cover the value of the Bank's premises. The law of June 9, 1857, added to this fund any premium that might be realized from the disposal of the 91,250 new shares which were authorized to be sold and any profits realized from a rate of discount in excess of six per cent. Subject to the statues regarding discounts and advances and redemption in specie on demand, from the beginning the officers of the Bank have been allowed a great amount of freedom in the regulation of note-issues. Previous to the Franco-Prussian war no limitation was placed upon the maximum amount of the issues except during the period of suspension following the Revolution of 1848. After the outbreak of the war with Prussia the Bank was again per- mitted to suspend specie payments on condition that the total amount of notes outstanding should not exceed 1,800,- 000,000 francs. This limit was raised to 2,400,000,000 francs August 14, 1870, to 2,800,000,000 francs Dec. 12, 1870 and to 3,200,000,000 francs July 15, 1872. The Bank resumed specie payments in 1878 but the principle of plac- ing a maximum limit on its note-issues was retained, this limit being raised, however to 3,500,000,000 francs Jan. 30, 1884, to 4,000,000,000 francs Jan. 25, 1892, to 5,000,- 000,000 francs Nov. 17, 1897, and to 5,800,000,000 francs Feb. 9, 1906. By its first statutes the discounts of the Bank were lim- ited to paper bearing the signatures of at least three solvent persons and maturing in not to exceed ninety days. In 1808 a modification was made by the permission to accept in place of the third signature, in cases in which the paper represented genuine mercantile transactions, collateral in the form of bank stock, or of five per cent, consolidated state funds. The only changes made in these early statutes Banking in France 247 in later times have consisted in the enlargement of the list of securities that may be accepted as collateral in place of the third signature. The law of May 21, 1840 allowed the acceptance of all classes of securities issued by the French government; that of Mar. 26, 1898 added warehouse re- ceipts to the list; that of Jan. 13, 1869, added securities of the French railroads, and bonds of the city of Paris, the Credit Foncier and the Societe Algerienne; and that of Feb. 28, 1880, added the bonds of all French cities and departments. In addition to discounting bills of exchange and other commercial paper the Bank is permitted to make loans on collateral. The decree of Jan. 16, 1808, restricted the col- lateral that might be accepted to French government se- curities maturing at fixed dates, gold and silver bullion and foreign monies. The law of May 17, 1834, enlarged this list so as to include all classes of securities of the French government. Obligations of the French railroads were added to the list by the law of Mar. 3, 1852, those of the city of Paris by the law of Mar. 28, 1852, those of the Credit Foncier by the law of June 9, 1857, those of the Societe Algerienne by the law of Jan. 13, 1869, and those of all the French cities and departments by the law of Feb. 28, 1880. From the beginning the Bank has served as banker for the French government. In this capacity it has received the public funds on deposit at its various offices in Paris and the departments, transferred and paid them out at the times and places at which they were needed, discounted the government's paper, and made temporary loans to it, and managed the public debt and the metallic circulation of the country. The terms and conditions on which these ser- vices are performed are carefully regulated by law and have been many times changed usually in the interest of 248 Money and Banking the government. Space will not permit a detailed discus- sion of them here. Generally speaking it may be said that the chief privilege enjoyed by the state over private indi- viduals consists at the present time of a permanent loan without interest of 180,000,000 francs. It has enjoyed this privilege only since 1897. Previous to that date special ad- vances were from time to time authorized at special rates, one for example in 1857 of 60,000,000 francs at three per cent, and an additional one in 1878 of 80,000,000 at one per cent. When the period for the enjoyment of its special privileges was prolonged in 1897 to 1920 it was provided as one of the conditions that these advances should be increased to 180,000,000 francs and that the payment of interest should cease. In the establishment of branches the Bank has moved slowly and usually under pressure of the government. In the year 1848 there were twenty-four in operation, and be- tween that date and 1857 seventeen more were established. The bank act passed in that year authorized the govern- ment, after a period of ten years, to require the Bank to establish branches in all the departments in which none exis- ted, and this act was supplemented in 1873 by another passed Jan. 27th requiring the government to arrange with the Bank for the opening of eleven new branches by Jan. I, 1875 and of seven others in each of the years 1875 and 1876. In 1897 there were in all ninety-four branches in operation, and the bank act passed in that year required an increase in the number to one hundred twelve during the two succeeding years. For the increase of its facilities for transacting business in the departments the Bank has estab- lished agencies and so-called auxiliary offices in a number of towns in which branches are not located. The number of these is greatly in excess of that of the branches and has increased fairly rapidly in recent years. The report Banking in France 249 of the Bank to its stockholders for 1909 indicates that at the close of that year there were in operation one hundred twenty-eight branches, sixty-nine auxiliary offices and three hundred and five agencies, making together with the Cen- tral Bank five hundred and three places at which the Bank did business. The administrative machinery of the branches is pat- terned after that of the central office at Paris to which every branch is strictly subordinate. Indeed the branches constitute simply the machinery through which the business of the Bank in the departments is transacted and are not in any sense independent institutions. The agencies in the so-called villes rattachees are attached to the branches for administrative purposes and are available only for discount and a few other purposes. The auxiliary offices are opened only on certain days each month for the transaction of a limited line of business only. 5. Other banking institutions since 1848. — The Comptoir d'Escompte, mentioned in a preceding paragraph, proved to be the type of institution destined to dominate the com- mercial life of France on the financial side. When it was reorganized as a private bank in 1853 it had a capital of 20,000,000 francs which was increased to 40,000,000 francs in i860 and to 80,000,000 francs in 1870. Its rapid ex- pansion began about i860 through the opening of branch offices in foreign countries and later in the departments and various parts of Paris. About this time also appeared competitive institutions of the same general character, of which three are deserving of especial mention since with the Comptoir d'Escompte they constitute the four leading banks of contemporary France. The oldest of this trio is the Credit Industrial et Commercial established in 1859 with a capital of 60,000,000 francs and modeled after the great joint-stock banks of England. In 1863 the Credit 250 Money and Banking Lyonnais was established first as a local institution of the city of Lyons with a capital of 20,000,000 francs, but des- tined to outstrip all the others and to become one of the largest private banking institutions in the world. The So- ciete Generale, the youngest of the three, was established in 1864 with a capital of 120,000,000 francs. The growth of these institutions has been rapid. The Comptoir d'Escompte became seriously involved in the af- fairs of the copper trust and, when that failed in 1888, was obliged to go into liquidation. It was reorganized, how- ever, Apr. 1889, under the name of Le Comptoir Na- tional d'Escompte de Paris with a capital of 40,000,000 francs, which was increased to 75,000,000 francs in 1891, to 100,000,000 francs in 1895, to 150,000,000 francs in 1900 and to 200,000,000 francs in 1909. The Credit Lyon- nais increased its paid up capital to 25,000,000 francs in 1872, to 37,500,000 francs in 1875, to 50,000,000 francs in 1879, to 200,000,000 francs in 1891 and to 250,000,000 francs in 1900. It has also collected a surplus fund which since 1907 has amounted to 125,000,000 francs. The So- ciete Generale increased its paid up capital to 120,000,000 francs in 1895, to 160,000,000 francs in 1899, to 200,000,- 000 francs in 1903, to 250,000,000 francs in 1905, to 300,- 000,000 francs in 1906 and to 400,000,000 francs in 1909. The capital of the Credit Industrial was raised to 80,000,- 000 francs in 1900 and to 100,000,000 francs in 1909. The magnitude of the business of these four institutions has grown with a rapidity at least equal to that of their capital. The discounts, deposits and advances of the four institu- tions combined, in the year 1890, attained a greater magni- tude than that of the corresponding items of the Bank of France and in recent years the Credit Lyonnais alone has surpassed the Bank of France in the magnitude of all these lines of business. Banking in France 251 This growth has been accompanied by the establishment of branch offices and agencies on a large scale. In 1905 the four institutions besides their head offices, had one hundred seventy-eight other places of business in Paris and its suburbs, five hundred seventy-four in three hundred sixty-two provincial towns, and forty-seven in the French colonies and foreign countries. In the establishment of branches these institutions have not pursued identical policies. The Credit Industrial et Commercial has confined its operations to Paris and its suburbs, and the Societe Generale to France, with the ex- ception of a branch in London and one in San Sebastian, Spain, while the Comptoir d'Escompte and the Credit Lyon- nais have extended their branches into the French colonies and foreign countries. In their expansion outside of Paris and the larger French provincial towns, so far as possible, they seem to have avoided competition. In their foreign expansion, for example, the Credit Lyonnais and the Comp- toir d'Escompte have avoided the establishment of branches in the same places, the only exceptions being London and Brussels. The other foreign branches of the latter are in provincial England (Liverpool and Manchester), the Uni- ted States (New Orleans), India, Australia, Tunisia, Mad- agascar and Morocco, while those of the former are in Spain, Portugal, Switzerland, Russia, Turkey, Asia Minor, Egypt and Algeria. In provincial France all except the Credit Industrial et Commercial are represented. In 1905 all. three had offices in sixty-three towns, two of them in eighty-two other towns, the Comptoir d'Escompte and the Credit Lyonnais in nine, the Comptoir d'Escompte and the Societe Generale in eight, and Credit Lyonnais and the Societe Generale in sixty-five; in twenty-two towns the Comptoir d'Escompte alone was represented, and in twenty 452 Money and Banking the Credit Lyonnais alone and in one hundred seventy-five the Societe Generale alone. In the process of expansion into every town of any im- portance in France, and into the colonies and foreign coun- tries with which the French people chiefly trade, and even into the suburbs and chief sections of Paris and the larger towns, these four institutions checked the growth of smaller institutions and absorbed a considerable number of those already in existence. There are still surviving a number of unincorporated private banks, some of them of high stand- ing and considerable importance, and a fair number of joint-stock institutions of local importance with head offices in the chief provincial towns and branches in the outlying districts. In Paris and some of the larger towns there are also branches of foreign banking houses and some French banks organized primarily for the prosecution of foreign or other special kinds of business. The work of all these minor institutions may be regarded as supplementary to that of the Bank of France and of the four great credit in- stitutions just described which together constitute the es- sential and most important parts of the banking machinery of the country. Among French financial institutions of first grade de- veloped since 1848, must be mentioned the Credit Foncier established in 1852 for the purpose of extending credit based on mortgage security to landowners and particularly to farmers. In its organization it was modeled after the Bank of France, and in its business methods, after insti- tutions established for similar purposes in Germany. It was intended to serve as an intermediary between land- owners wishing to borrow on mortgage security and people with capital to invest by supplying the latter with a form of bond more readily negotiable than a mortgage, and secured by its own capital and credit, as well as by real estate mort- Banking in France 253 gages received from borrowers. It was given authority to operate throughout France by means of branches and to absorb two or three smaller institutions previously au- thorized. Its original constitution and the scope of its operations have been several times modified, notably in 1869 by a decree of Aug. 9 authorizing it to receive de- posits and make advances for short periods, not to exceed 90 days, on the same kind of securities that the Bank of France was permitted to accept for the same purposes. This decree brought it into the category of commercial banks, though its main business has continued to be that of issuing bonds and with the proceeds making long period loans on real estate security. At the present time the Credit Foncier is one of the largest and most influential financial institutions of France. Jan. I, 1910, its capital amounted to 200,000,000 francs, its surplus to over 20,000,000 francs, its loans secured by mortgage to over 2,000,000,000 francs, and its loans to com- munes to very nearly the same figure, and its advances on other securities to over 38,000,000 francs. Its total re- sources at that date amounted to 4,764,683,983.43 francs, an aggregate exceeded only by that of the Bank of France. 6. The present position of the Bank of France. — The his- torical sketch contained in the preceding sections has made clear the special functions of the Bank of France relative to the conduct of the financial operations of the govern- ment and to the currency, but further explanations are needed to indicate its present relations to the other financial institutions of the country. The limitations imposed by law on the Bank's power to discount and to make advances prevented it from fully satis- fying the needs of the rank and file of the industrial and commercial classes. Most of these have always been, and still are, unable to supply three signatures to the paper they 254 Money and Banking want to discount and to furnish the kinds of collateral re- quired as a substitute for the third signature or as a basis for advances. A field for other banking institutions has, therefore, always been open, and has been occupied, very in- completely to be sure until recent times, but quite satis- factorily since the development of the great credit. institu- tions of the present day. The Bank's practice of not pay- ing interest on deposits has also tended to strengthen the bonds between these other institutions and the people. In catering to the banking needs of the masses, however, these other banks have not been able to dispense with the aid of the Bank of France. Not possessing the right to issue notes, and being unable to attract deposits sufficient to supply them with the necessary working capital, they have been obliged to depend upon her for funds for current uses, as well as for the means of meeting the exigencies of abnormal times. These they have been able to secure through rediscounts and advances. A large part of the bills regularly presented to them for discount can be made acceptable to the Bank of France by adding their own endorsements or by putting up the kind of collateral prescribed in the Bank's statutes. The same kind of collateral, readily obtainable by banks though not regularly in the possession of the ordinary busi- ness man, together with the foreign coin and bullion com-i ing into their possession through regular customers or purchases on the market, may be used as a basis for loans. By availing themselves of these means they have become an intermediary between the industrial and the commercial world and the Bank of France which, with the growth of the great banks, has tended more and more to become a bank- ers' bank. Its doors are still wide open and its services available directly by any citizen who can or will comply with the conditions for doing business which the law com- pels it to impose, but the ordinary business man finds the Banking in France 255 other banks alone able to satisfy all his needs and more economical and convenient in most cases in which he has an option between them and the Bank of France. Moreover these banks, especially the four largest ones, have exhibited considerable ingenuity in adapting them- selves to the needs of the public. They have added to the functions of commercial banking, strictly so-called, those of acting as agents for the marketing of public and corpora- tion securities and sometimes of promoting new enterprises. In this capacity they have connected themselves with the stockmarkets and have become the regular avenues through which their customers make investments. They usually keep on hand a choice selection of high class securities which they can turn over to buyers on short notice and they regularly execute orders for the purchase and sale of such securities as they cannot themselves supply. Through their luxuriously appointed offices and their careful attention to the comfort of their customers they have also added con- siderably to the strength of their purely commercial appeal. The Bank of France also exerts an important influence over other institutions in the exercise of its function of guardian of the country's specie reserve. This function has not been directly conferred upon it by law, but it is a natural consequence of the possession of a monopoly of note-issues and of its service as a bankers' bank. It is com- pelled by law to redeem its notes in specie on demand and, as we have seen, the other banks mainly depend upon it for their supplies of cash. Being also the banker of the gov- ernment it has become perforce the central monetary reser- voir of the country and has been obliged to assume the re- sponsibility of protecting that reservoir against the assaults of other financial centers. This it does by raising or lower- ing the rate of discount and by availing itself of the option permitted it by law to pay its notes either in gold or in 256 Money and Banking silver five franc pieces. By the former means it may af- fect the discount rate of the other banks. Since they are obliged to secure funds from the Bank of France they must adjust their charges to the public to the Bank's charges to them. Ordinarily, therefore, the market rate of discount responds to movements in the Bank rate, and thus the Bank may exert a regulative influence on all those departments of commercial and industrial life which are affected by the cost of obtaining funds through commercial discounts and loans. REFERENCES On the history of banking in France see Liesse, Evolution of Credit and Banks in France, published by the National Monetary Commis- sion; Des Essars, A History of Banking in the Latin Nations in v. Ill of a history of Banking in all the leading Nations; Conant, Mod- ern Banks of Issue, ch. iii ; Dunbar, ch. viii ; Courtois, Histoire des Banques en France; Bousquet, La Banque de France et les Institutions de Credit; Flour de Saint-Genis, La Banque de France a travers le Siecle, and Sayous, Les Banques de Depot, les Banques de Credit et les Societes Financieres. The various laws and statutes which have regulated the Bank of France since its foundation are published in a volume entitled Lois et Statuts qui regissent la Baiu^ue de France. On the relations of the Bank of France with the French govern- ment see Pommier, La Banque de France et L'Etat depuis sa creation jusqu'a Nos lours. On the details and workings of the French system see Interviews on the Banking and Currency Systems of England, Scotland, France, Germany, Switzerland and Italy and Patron, The Bank of France in its relation to National and International Credit published by the Na- tional Monetary Commission. See also the references at the close of ch. xv. CHAPTER XIV BANKING IN GERMANY Banking in Germany has passed through three stages of development. During the first, extending to about the year 1848, the business was confined almost exclusively to private bankers and to a few banks of issue, of which the Bank of Prussia was the chief. During the second, extending from 1848 to 1870, incorporated banks entered the field on a relatively large scale extending the scope of the business as well as its constituency and greatly increas- ing the number of institutions. Most of the great privat& banks of the present day date their beginnings to this epoch. The third period, extending from 1870 to the present day, is characterized by the foundation of the Imperial Bank and its development into a great central institution ranking in importance and functions with the Bank of England and the Bank of France, and by the concentration of about 80 per cent, of the commercial banking business of the country into the hands of eight great institutions with head offices in Berlin, and by the expansion of these institutions into foreign territory. I. The Period preceding 1848. — In Germany, as elsewhere in Europe, banking functions were performed by indi- viduals and unincorporated firms from very early times, and, with the exception of municipal institutions of the type of the old bank of Amsterdam, developed in Hamburg and Nuremberg in the early years of the seventeenth century, 257 258 Money and Banking they seem to have had the field to themselves until 1765 vifhen Frederick the Great established a state bank in Berlin. This institution developed into the Bank of Prussia which was later transformed into the Imperial Bank of Germany. Its original constitution was several times modified by acts and decrees the most important of which was passed Oct. 15, 1846. By this act the capital of the bank was raised to 10,- 000,000 thalers and provision was made for the accumula- tion of a surplus amounting to 50 per cent, of the capital. Its maximum note issue was fixed at 15,000,000 thalers, and it was provided that these must be covered one-third by coin or silver bullion, one-half by bills of exchange running not more than three months and provided usually with three and at least with two good signatures, and the remainder by loans on collateral. Its discounts were limited to the class of bills just described, but it was permitted to make loans on the security of merchandise and public securities at a maximum rate of interest of six per cent. Its government was entrusted to a governor appointed by the state, and a board of directors consisting of five persons and a president appointed also by the state. The stock- holders were represented in the management by a committee of fifteen whose authority, however, was confined to con- sultation with the directors and the governor. Expansion into the provinces by the establishment of branches began early and was continued until the Bank was thus represented in all the important towns of the kingdom. October 14, 1772, Frederick the Great established another institution destined to become important, namely the so- called Seehandlungs-Sozietat. Its purpose was stated to be the promotion of "the transportation business by sea under the Prussian flag," and the furtherance of "the busi- ness of exportation and importation, particularly with Spain and all other places in which reasonable prospects for such Banking in Germany 259 business should appear." As a matter of fact it became the chief agent of the Prussian government in a number of industrial and fiscal undertakings and ultimately added banking to its functions. Since the transformation of the Bank of Prussia into the Imperial Bank it has served as the chief financial agent of the Prussian government and of the various institutions conducted under the aus- pices of that state. Frederick the Great also laid the foundation of a sys- tem of land banks which have played an important role in the economic history of Germany. On account of the great need of capital for the improvement of agriculture, and the inability of the agricultural classes, impoverished by his wars, to command it unaided through loans, he es- tablished credit associations based on the principle that all the members of an association, together with all the lands in their possession, should jointly become security for the money borrowed and employed by each one in the improve- ment of his lands. This principle has since been widely ap- plied through banking institutions differing from each other considerably in other respects. Outside of Prussia banks were established in Bremen in 181 7, in Liibeck in 1819, in Stettin in 1824, in Munich in 1835 and in Leipzig in 1838. 2. The Period 1848 to 1870.— About the middle of the nineteenth century German industry, as distinguished from agriculture, began to develop rapidly under the stimulus of railroads, the first line of which was constructed in 1835. According to reliable estimates the amount of capital in- vested in railroads increased from 1,038,000 marks in 1850 to 4,072,167,621 marks in 1870. * During the same period the annual production of pig iron increased from 208,000,- ♦Engel cited by Diouritch in his I'Expansion des Banques Al- lemandes a I'Etranger, p. IS. 26o Money and Banking ooo to 2,029,000,000 kilogrammes, and that of coal in even greater proportions. Joint-stock companies became popular as a result of this movement, two hundred ninety- five with a capital of 2,405,000,000 marks having been es- tablished in Prussia in the period 1851-1870 against one hundred two with 638,000,000 marks capital in the period 1826-1850.* The growth of banking institutions was a natural result of these industrial changes, but the direction which it took was determined partly by a reaction against the monopoliza- tion of the issue function by a few banks, which doubtless was connected with the political agitation in favor of popu- lar rights which characterized the opening years of the period. In 1836 all bank-note issues were suppressed in Prussia in order to leave a free field for government notes. Later the Bank of Prussia was allowed to resume its issues and in the early forties an agitation was started in favor of extending the privilege to private institutions. The bank act of 1846, which greatly increased the capacity of the Bank of Prussia to serve the public, not being sufficient to quiet this agitation, an act was passed Sept. 5, 1848, au- thorizing the establishment of private banks of issue, but limiting their aggregate circulation to 7,000,000 thalers. The movement in favor of private banks of issue extended beyond the bounds of the Kingdom of Prussia. During the period under consideration such banks were established at Berlin, Breslau, Posen, Magdeburg, Dantzig, Cologne, Konigsburg, Gorlitz, Gera, Frankfurt a/m, Sonderhausen, Hamburg, Liibeck, Gotha, Meiningen, Bucheburg, Hanover, Bremen, Leipzig and Oldenburg. Some of them were the work of speculators and their bad management resulted even before ' the Franco-Prussian war in an agitation in *Engel cited by Diouritch in his I'Expansion des Banques Al- lemandes a I'Etranger, pp. 15 and 16. Banking in Germany 261 favor of the monopolization of the right of issue by larger institutions. Besides these banks of issue there was established during the period a considerable number of banks of discount. The first of these was the Schaffhausensche Bankverein, established at Cologne in the year 1848. The next was the Diskonto gesellschaft established at BerHn in 1851, fol- lowed by the Bank fiir Handel und Industrie established at Darmstadt in 1853. In 1856 appeared the Berliner Handels- gesellschaft, the Hamburg Vereinsbank, the Norddeutsche Bank and the Schlesischer Bankverein. To this list was added the Deutsche Genossenschaftsbank in 1864, the Bar- mer Bankverein and the Magdeburg Bankverein in 1867, the Breslauer Diskontobank, the Deutsche Bank, the Ham- burger Kommissions-und Diskontobank, and the Rheini- sche Kreditbank in 1870, the Bergisch-Markische Bank, the Braunschweigische Kredit-anstalt, the Breslauer Wech- selbank, the Deutsche Vereinsbank, the Kolner Wechsel- und Kommissionsbank, and the Konigsberger Vereinsbank in 1 87 1, the Deutsche Effekten-und Wechselbank, the Dresdener Bank, the Essener Kredit-anstalt and the Aache- ner Diskontobank in 1872, and in 1873 the Deutsche Union- bank. * These banks catered primarily to the new industrial es- tablishments of the period. With the exception of some of the larger private firms the other institutions clung to old methods and continued to operate within the old tradi- tional field, which was much narrower, with the result that they were soon outdistanced by their more enterprising rivals. 3. The Period 1870 to the present day. — At the close of ♦According to a table published in the Deutsche Ockonomist, xxiv, 1906, p. 36, sixty-five joint-stock banks of the type of these were es- tablished up to 1870. Diouritch, op. cit., p. 20. 262 Money and Banking the Franco-Prussian war in 1871 Germany entered upon a regime of unification which included her monetary and banking systems. By acts passed in 1871 and 1873 pro- vision was made for an Imperial coinage and for its substi- tution for the local systems then in use and in 1875 an act was passed for the purpose of unifying the banking system. The latter act provided for the establishment of an Imperial Bank and for the limitation and the regulation of the issues of all other banks enjoying the issue privilege. As a foundation for the Imperial Bank it authorized the purchase of the Bank of Prussia. Its capital was fixed at 120,000,000 marks and provision was made for the accumu- lation of a surplus equal to 25 per cent, of the capital. Its. ad- ministration and supervision were entrusted to a board of curators, a board of directors and a central committee of stockholders. It was made the duty of the board of cura- tors, which was to consist of the Chancellor of the Empire and of four other persons, one to be appointed by the Emperor and the other three by the Imperial Council, to exercise supervision over the conduct of the Bank's affairs, and to this end complete reports regarding its operations were to be submitted at meetings held quarterly. The board of directors was to consist of a president, a vice president and seven other members to be appointed for life by the Emperor on the nomination of the Imperial council. To this body was entrusted the administration of the Bank, the appointment of subordinate officers and clerks being made a duty of the president. The Central Committee represents the stockholders who appoint it at their regular annual meetings. This committee is required to meet at least once each month and to receive reports regarding the Bank's operations and condition. Its powers are advisory only, except in the matter of the amount of securities to be purchased, and in that of business with the government, in Banking in Germany 263 which it has the right of veto. From its members the Cen- tral Committee is required to select three representatives whose duty it is to attend all meetings of the board of directors and from time to time, in the presence of a mem- ber of that board, to examine the books of the Bank and to witness the counting of the cash. The business of the Bank was defined in the following terms: "a. To buy and sell gold and silver coin and bullion. b. To discount, buy and sell bills ef exchange whose maturity shall be three months at the longest, and for which usually three, and in no case less than two accredited vouchers shall stand good; furthermore, to discount, buy and sell bonds of the Empire or of any German state, or do- mestic municipal corporations, provided such bonds mature within three months at the longest and conform to the new standards of value. c. To grant interest-bearing loans for terms no longer than three months, upon movable security (lombard, or deposit loan business), such as: Gold and silver, coined or uncoined; interest-bearing or non-transferable bonds ma- turing within a maximum term of three months, whether of the Empire, a German state, or of domestic municipal corporations; also interest-bearing non-transferable bonds on which the interest is guaranteed by the Empire or by any one of the German states; upon capital stock and stock priority shares, fully paid up, of German railway companies in actual operation; and on mortgage bonds of provincial, municipal, or other land credit institutions of Germany that are subject to State control including shares of German mortgage banks to an amount never exceeding three-fourths of their market value; upon interest-bearing non-transfer- able bonds of foreign states, and foreign railway priority bonds, covered by state security, in amounts not exceeding 50% of their market value ; upon bills of exchange of recog- nized soundness, after deducting at least 5% of their market value ; on pledges of native merchandise, in amounts within two-thirds of their value. 264 Money and Banking d. To negotiate collections for the account of individuals, institutions and governing boards; and upon security, as before mentioned, to furnish payments, and make orders or conveyances on the branch banks or on correspondents. e. Upon prior security, to buy in behalf of outside parties, effects of all kinds, including the precious metals; and after delivery to sell the same. f. To receive moneys in circulation or on deposit, with or without interest ; but the sum of interest-bearing deposits must not exceed that of the capital stock and reserve fund. g. To accept the custody or other management of objects of value." The Imperial Bank was further placed under obligation to receive and make payments, without compensation, for the account of the empire or for any of the German states. It was permitted to issue notes on condition that it hold at least one-third of the quantity in circulation in cash, and the other two-thirds in discounted bills maturing in not less than three months and signed with the names usually of three, but at least of two solvent persons; and on condition that it pay a tax of five per cent, per annum to the govern- ment for all issues in excess of an amount equal to its cash holdings plus a fixed sum, later placed at 250,000,000 marks. The Bank was permitted to establish branches in every part of the empire, and required so to do when directed by the federal council or the Imperial Chancellor. With regard to the thirty-two other banks of issue in existence at the time, provision was made for their con- tinuance as independent banks under existing regulations or as parts of the Imperial system. Banks which chose to remain outside of the Imperial system were forbidden to establish branches or agencies or to circulate their notes outside of the state in which they were located. Banks which chose to enter the Imperial system were forced to conform in regard to their issues to substantially the same Banking in Germany 265 regulations as those imposed upon the Imperial Bank, and the amount of uncovered issues were fixed for each bank. The empire also reserved the right to deprive each bank of the privilege of issue upon giving one year's notice, Jan- uary I, 1891, or any tenth year thereafter. It agreed, how- ever, not to exercise this right except in the interest of the unification of the banking system of the empire or as a punishment for the violation of law. As was contemplated by the framers of the act, its effect was gradually to bring about the monopolization of note issues by the Imperial Bank. Before the close of the year 1877, fifteen of the thirty-two original banks of issue had given up their right and the quota assigned to the Imperial bank increased by the same amount. In 1886 another bank ceased to issue, in 1887 still another, in 1889 two more, in 1890 one, in 1891 four, in 1894 one, in 1902 two, and in 1905 one leaving only four in the entire empire. The growth of the Imperial Bank has been as rapid as could have been expected. Its capital has been raised to 180,000,000 marks. Its branches, which numbered at the beginning about two hundred, had increased by 1899 to three hundred ten, by 1900 to three hundred thirty, by Jan. I, 1903 to three hundred fifty-four, and by Jan. i, 1910 to about five hundred. The magnitude of its business in all lines has increased and it has become in every sense of the word the center of banking operations in the German Empire. Its authorized untaxed note circulation previous to 1899 had been raised to 293,400,000 marks by the re- nunciation of the right of issue by other banks, and by a law passed June 7, 1899, it was still further raised to 450,000,- 000 marks. Since that date it has been raised to 472,800,- 000 marks- by the renunciation of the right of issue by three other banks. An act passed June, 1909, provided that begin- ning with 191 1 the untaxed issues might be increased to 266 Money and Banking 550,000,000 marks with a supplement of 200,000,000 marks additional at the ends of March, June, September and De- cember when the pressure upon the bank is greatest, the aggregate uncovered circulation to be limited to 618,000,- 000 marks, when the tax-free issue is at the former figure and to 818,771,000 marks at the ends of the quarters when the tax-free issues are raised to 750,000,000 marks. Next in importance to the growth of the Imperial Bank, and the gradual disappearance of most of the other banks of issue, is the concentration of most of the purely commercial banking business of the country in the hands of nine large institutions. Five * of these were in existence when the period opened, and the four others were very soon after established, the Deutsche Bank with a capital of 15,- 000,000 marks, and the Comraerz and Disconto Bank with a paid capital of 15,000,000 marks in 1870; the Dresdner Bank with a paid capital of 9,600,000 marks in 1872, and the National bank fiir Deutschland with a paid capital of 20,000,000 marks in 1881. During the first three years of the period there were also established a large number of other joint-stock banks,** but the crisis of 1873 revealed the weakness of most of them and marked the beginning of the process of concentration which has continued to the present day. The nine institutions just mentioned possessed the vitality and power requisite not only to withstand the force of the crisis, but to take advantage of it by absorbing their weaker brethren. Between the years 1873 and 1879 they grew enormously in influence and resources while at the latter date only one hundred twenty-seven of the two *The Bank fiir Handel and Industrie, the Disconto gesellschaft, the Berliner Handelsgesellschaft, the A. Schaffhausensche Bankverein and the Mitteldeutsche Kreditbank. **The Deutsche Ockonomist v. xxiv, 1906, p. 35, places the number established between 1871 and 1873 at one hundred thirty-two. Cited by Diouritch p. 29. Banking in Germany 267 hundred and two banks in existence at the end of 1872 still survived as independent institutions. * In the decade 1880 to 1890 the financial center of Ger- many was transferred from Frankfurt a/m to Berlin, and these banks made the Imperial city the center of their opera- tions. From here they proceeded to extend their influence over the entire empire and into the German colonies and foreign countries by the establishment of branches and agencies, by the purchase of controlling interests in provin- cial banks, by the creation of banks independent in form but actually controlled by them, by the establishment of a community of interest between themselves and other banks in other ways and by connecting themselves in a vital manner with the rapid industrial and commercial development of the country. They thus became the heads of eight groups of banking institutions controlling between them about 80 per cent, of the banking capital of the empire.** Of these groups those headed by the Dresdner Bank, the Dresdner Bank and the A. Schaffhausenche Bankverein (consoli- dated), the Disconto gesellschaft, and the Bank fiir Handel und Industrie are much the largest, their combined capital and deposits in 1906 amounting to 8,231.47 millions of marks out of a grand total of 9,565.64 millions for the eight groups, and of 11,394 millions for all the banks of the country. 4. Mortgage and Cooperative Banks — Besides these com- mercial banks there have developed in Germany a consider- able number of mortgage banks and a large number of cooperative banking associations. These institutions exist primarily in the interests of classes not served by the com- mercial banks such as landowners, peasants, artisans and small tradesmen, and they also extend credit to small towns * Diouritch p. 30. **Ibid, p. 37. 268 Money and Banking and other small political corporations. The mortgage bank secures funds mainly by the sale of bonds, and lends them on real estate security or to small towns or other local politi- cal corporations, putting up the mortgages and the securities it receives as well as its own capital as security for its bonds. Some of them lend primarily to owners and dealers in city real estate, and others to farmers and owners of large country estates. Still others lend considerable amounts to small towns and other local political corporations. The cooperative societies differ considerably among them- selves in minor particulars, but they are all based on the principle of mutual responsibility of each member for the obligations of the society. The most popular of these are the Schulze-Delitzsch associations so called because they were first organized in a town called Delitzsch by a Doctor Schulze. The earliest of these date back to 1848 and were organized for the purpose of purchasing merchandise such as sugar, coffee, grain, wines, cigars, etc. Others were afterwards organized for production as well as sale, and later still others for the purpose of stimulating saving and extending credit to their members. These latter constitute at the present time an important group of banks for the people. Members are required to purchase one share of the capital stock, the amount of which varies between different societies, and in most societies each member is responsible to the full extent of his property for all the debts of the or- ganization. A law was passed May i, 1889, permitting the limitation of the liability of members to a fixed sum, but few societies have availed themselves of it. During the early years of their history most of the funds lent to their members were borrowed from outsiders but, as they became more popular, their deposits increased, and at the present time many of them find difficulty in investing the funds Banking in Germany 269 left with them without going outside of the circle of cus- tomers whom they are designed primarily to serve. The so-called Raffeisen system of cooperative banks dates back to 1864, when Frederick William Raiffeisen founded in Heddesdorf, Prussia, the so-called Heddesdor- fer Darlehnskassenverein. Other associations of the same kind were established in 1868 and each year thereafter. These associations were designed primarily to serve peas- ants and small farmers, while the Schulze-Delitzsch socie- ties originally operated chiefly among artisans and small tradesmen of towns and cities. Both have extended their membership beyond the classes for which they were origi- nally designed, however, and cannot now be differentiated on the basis of the character of their membership. The Raiffeisen societies begun without capital and, when they were compelled by law to accumulate a capital stock, they kept the amount small. It was the purpose of the founder to assist peasants and small farmers to escape from the exactions of money lenders of the usurious type, and to secure credit which, in most cases, would otherwise have been impossible on any terms. To this end he appealed to the same principle as did Schultze-Delitzsch, namely, the ability to borrow money on good terms, provided all the members of a society assume liability for its debts to the full extent of their properties. Inasmuch as it was credit- needy people whom he wished to serve he did not approve of the plan of requiring the purchase of shares of capital stock as a condition of membership. On account too of the differences in the needs and capabilities of the classes served these two kinds of organizations also differed in the length of the periods for which loans were granted, the Schulze-Delitzsch societies granting short-period and the Raiffeisen long-period loans. The Raiffeisen societies within a given district are or- 270 Money and Banking ganized into unions each one of which has a bank which receives on deposit the surplus funds of the societies, grants them loans and in other ways renders them all possible assistance. As a central bank for all of these unions, and for other cooperative associations, agricultural loan com- panies, savings banks, etc., in the Kingdom of Prussia there was established in 1895 the Preussische Central-Genossen- schaftskasse. Its capital of at first 5,000,000 marks, after- ward increased to 20,000,000 and then to 50,000,000 marks, was furnished by the Prussian State. In 1906 it was again increased by 2,400,000 marks subscribed by the various unions of the Raiffeisen system. In the other Ger- man states the Raiffeisen societies have established relations with commercial banks similar to those established in Prus- sia with this institution. Until 1904 the Schulze-Delitzsch societies had a central bank of their own known as the Deutsche Genossenschaftsbank. At that date this bank be- came embarrassed and was absorbed by the Dresdner Bank which now serves as the central association for the Schultze-Delitzsch societies. Unlike the Raffeisen associ- ations each of these societies deals directly with the cen- tral bank. 5. The present organization of the banking business in Germany. — To some extent the various groups of institu- tions already described are competitors. They all receive deposits and they all discount certain kinds of bills of ex- change, but in the main their fields of operation are dis- tinct and different. The Imperial Bank transacts the bank- ing business of the Imperial Government, administers the country's specie reserve and regulates the circulating me- dium. Its other functions such as the care of deposits, the granting of credits and the transfer of funds are purely subsidiary or supplementary. The great Berlin banks are Banking in Germany 271 the chief banking servants of the leading industrial and commercial agents of the country and the pioneers of Ger- man industrial and commercial expansion in foreign coun- tries and the German colonies. The independent private and provincial banks chiefly serve special groups and purely local interests. The mortgage banks and cooperative so- cieties supply banking facilities to farmers, peasants, arti- sans, and small tradesmen, and extend credit to those who deal in real estate and to the smaller political corpora- tions. In spite of their separate functions, however, all these institutions are vitally connected with each other and with the Imperial Bank. The cooperative and mortgage banks derive no insignificant part of the funds they lend from the great Berlin banks and the Imperial Bank by direct sales to them of their securities, by rediscounts and loans on collateral. With these they also deposit their surplus funds. The Berlin banks use the Imperial Bank as their reserve agent, frequently obtaining funds from it through rediscounts and sometimes through loans on collateral and employ its so-called giro-system* for the transfer of funds from one part of the country to another. The Imperial Bank is thus the center and balance wheel of the entire sys- tem. It is the central cash reservoir from which all are supplied and to which all surpluses flow. Through the dependance on it of all other credit institutions it is able, at least to a degree, to hold them in check, when they are inclined to extravagance, and to stimulate them, when they are sluggish. Its rate of discount affects all other market rates and its attitude toward a financial enterprise is rarely, if ever, without influence on its fortunes. ♦The name given to the system of transferring credits between the central ofifice and the branches, or between the different branches. 272 Money and Banking REFERENCES On the history of banking in Germany see Wirth, The History of Banking in Germany and Austria-Hungry in v. 11 of a History of Banking in all the leading Nations; Conant, Modern Banks of Issue, ch. viii; Dunbar, ch. xi; Reisser, Zur Entwicklungskeschichte der deutschen Grossbanken mit besonderer Rilcksicht auf die Konzentra- tions-bestrebungen, to be published in translation by the National Mone- tary Commission; The Reichsbank 1876-1900, Renewal of Reichsbank Charter, and German Bank Inquiry of 1908, published by the National Monetary Commission; Diouritch, L' Expansion des Banques Alle- mandes a L'Etranger, ch. i; Jeidels, Das Verhaltniss der deutschen Grossbanken zur Industrie, mit besonderer Berticksichtigung der Eisenindustrie; Poschinger, Die Banken im deutschen Reiche, Oester- reich und der Schweiz and Bankwesen and Bankpolitik in Pressen; Hecht, Bankwesen und Bankpolitik in den sUddeutschen Staaten, 1819- 187s and Die Mannheimer Banken, 1870-1900. Nasse and Lexis, article Bank in Handworterbuch der Staatswissenschaften; Warschauer, Die Konzentration im deutschen Bankwesen and Die Organisation des Kon- zentration im deutschen Bankwesen and Die Organisation des Scheck- verkehrs in Deutschland, Conrad's Jahrbuck, 3d F., v. 88, p. 45, and v. 89, p. 590; and Model, Die Grossen Berliner Effektenbanken. On the cooperative banks see Peters, Cooperative Credit Associations, U. S. Dept. of Agriculture, Div. of Statistics, Misc. Ser. No. 3, 1892; Wolff, Peoples Banks; and articles in the Handworterbuch der Staats- wissenschaften by Marchet on Darlehnskassenvereine and by Criiger on Kreditgenossenschaften. See also references at the close of ch. xv. CHAPTER XV THE MONEY MARKET In the preceding chapters the development and present state of the machinery through which the exchanges of the chief countries of the world are effected have been described. The connection of that machinery with other parts of the financial mechanism and some of the features of its opera- tion remain for consideration in the present chapter. I. The central markets. — ^As we have seen the central agency of the banking system of each country is located in its chief commercial center, in this country in New York, in England in London, in France in Paris, and in Germany in Berlin. In each European country that agency is the central bank, but in New York it is the group of banks which constitute the Clearing House Association, usually known as the Associated Banks, arid the branch of the United States Treasury there located, known as the New York Sub-Treasury. In each of these centers there are also one or more stock exchanges for the facilitation of the purchase and sale of securities of public and private cor- porations and brokerage firms who act as intermediaries in the purchase and sale of commercial paper. These ex- changes and brokerage firms are essential parts of the the money market machinery, since they supply the means for the investment of surplus funds, and for the speedy liquidation of those investments in case of need. In each of these centers also there are markets for the purchase and sale of the precious metals together with the machinery 274 Money and Banking for their refining and sometimes for their minting into coin. These central markets serve as reservoirs and distributing agents for the currency and surplus loan funds of their re- spective countries, administer their reserves of specie and conduct their foreign exchanges. The facilities they have, and the methods they employ for the accomplishment of these tasks, will now be described. 2. The central reserves. — The central reserves held by the controlling institutions of these markets are subject to draft from bankers in the interior of their respective countries, from foreign bankers and from local customers, and those of the Associated Banks of New York are also subject to draft from the New York Sub-Treasury. They may be replenished from the same sources. The interior move- ment, as the ebb and flow between these institutions and the interior of the country may be called, depends upon the volume and the course of domestic commerce in all its branches, the foreign movement upon the volume and course of foreign commerce, and the local movement upon the volume and course of the commerce of the city in which the institutions in question are located. The movement be- tween the Associated Banks and the sub-treasury in New York depends upon the relation between the receipts and expenditures of the government, and upon the discretion of the Secretary of the Treasury in the use of his power to deposit funds in the banks. A knowledge of the volume and fluctuations of these various currency movements is essential to a proper admin- istration of these reserves. In order to supply this knowl- edge, statistics of the shipments of currency to and from the Associated Banks, the interior, foreign countries and the sub-treasury are compiled and published in the financial journals of New York, and similar statistics relative to The Money Market 275 England, France and Germany are published in the finan- cial journals of those countries. They indicate that in some of their fluctuations these movements, especially the in- terior and the foreign, are regular and in a degree predict- able, and in others erratic and unpredictable. In all four countries for example, the interior movement is subject to seasonal influences as is also, to a greater degree in some than in others, the foreign movement. The sub-treasury movement at New York is very erratic. Changes in trade and industrial conditions constitute elements of uncertainty in all the movements in all four countries. The chief problem connected with the administration of these reserves is their adjustment to the varying demands upon them caused by these fluctuating movements. It is a problem not susceptible of a rule of thumb solution, but two points in connection with it are obvious. One is that the banks which administer these must, at all times, keep on hand larger amounts of cash than other banks. Being the ultimate sources of supply for their respective countries they cannot meet a deficit by drafts on other domestic in- stitutions. For temporary purposes one market may draw upon another, but in the main and in the long run each must rely upon its own supply. The second point is that these banks should keep a large part of their resources in a liquid form. To this end loans subject to call or maturing in short periods of time are best adapted. Such loans are available in all these centers, but in some they are more abundant and better fitted for this purpose than in others. In New York those most widely used are loans made to operators on the stock ex- change subject to call, and secured by stock exchange collateral, and 30, 60 or 90 day loans secured in the same way. In the European centers bankers bills and high class commercial bills are more widely used. 276 Money and Banking 3. Bank and market rates. — The rates charged on these loans and in discounting bills are the best barometers of money market conditions and serve to some extent as regu- lators of the reserves. On the European markets the official rate of discount of the central banks is known as the bank rate and the rates charged by other institutions for standard loans and discounts on the open market are known as market rates. On account of the absence of a central bank in New York only market rates are quoted. In fixing these rates the state of the central reserves is the most important single factor. In New York the con- nection between the two is so close that the chief fluctua- tions of the rates are regularly the opposite of those of the reserves of the Associated Banks. The chart on p. 277* representing average conditions during the period 1896- 1906, clearly indicates this. On the European markets the connection is not quite so close, but it is none the less real. On account of the domi- nance there of central banks and other methods of control, rates do not so quickly and frequently respond to changes in the reserves, but the connection between the two is nevertheless vital. The reason for this connection is the same in all cases. It is the effect of changes in rates on the movements of currency and on the volume of loans and dis- counts. Loan funds, like ordinary merchandise, tend to seek the best markets. Consequently, when rates are raised at any of these centers, these funds are attracted thither, or any tendency to flow away is checked. On the other hand, within the market itself, borrowers will be deterred by the higher rates, the volume of loans diminished, and the percentage of reserves to deposits increased. Loan and * In the cases of the rate curves an upward movement means a rise and a downward movement a fall, while in those of the reserve curves the opposite is true. See the figures at the left of the chart. The Money Market 277 discount rates are thus regulated in accordance with the law of demand and supply like the prices of commodities '■MILX ■ C —^ a K rt >• < >* h =2 u m>SJlXAs.gZ — 230 — 1 d. ^ — < P. P L_^ IT. — Zi =^ — ■^■, f. / A g 7^ 1 1" -V 1 ~~/ Vn- ■/^ ij . — ^^s — \— F^ ^ bp ■ 1 ■/• •'-- . <—^ :S— —\ ?= ap"' ^/)7— -^^ - — -;;^ T'" ^^ — ^■ N to^>i / . ^ f^~~ 4— V — -/ ^ zz^ .O-Tia^ of — — 1 1 — tI — U ^ --;/ — i sJ^ — T^— \ K/^ V c. "/ ' •" ■■) h^ z!!!^ ;^ and bank reserves at the money market centers act as sup- ply barometers. In each market are various classes of loans, the rates on which differ in accordance with the length of the period of the loan and the character of the security on which it is based. In New York the market rates are classified under the three heads call loans, time loans and commercial paper. The call loans are secured by stock exchange col- lateral and are subject to payment on twenty-four hours' 278 Money and Banking notice; time loans are also secured by stock exchange col- lateral and include 30, 60 and 90 day, 4, 5, 6, and 7 months' notes; and commercial paper is based on personal security consisting of a single or of two names and designated ac- cordingly as single and double-name-paper. Ordinarily the rates on call loans are the lowest, those on time loans higher, and those on commercial paper highest. The following diagram represents normal conditions in the period 1896- 1906. T.§ —00 CO — as — 00 tH CO ^— 1-1 fM — — T-H =g 10 1 — ^ — g — a^ 1— 1 -%- "~*7 — — 7— r 3"6— _5— i g. \ -^ — \— ^ P — / 7/~ -^^— — 4— vtA ^ N ^ ' =^ — r \/=\ -4- OiV ^- s /^ -v^ ^- -'k\ h?^ J—— _\_5 ^ -ri- r^ y— \ A=Commercial paper, 60 day B=6o day time C=Call loans at stock exchange Within the time loan and commercial paper groups, the longer the period of the loan, the higher the rate. The ex- planation of these differences is the importance from the banker's standpoint of control over his resources. The call loan enables him to meet the demands of depositors and to take advantage of more favorable market conditions upon very short notice. The longer the period of the loan, the The Money Market 279 more difficult it is for him to meet unforeseeable conditions and he accordingly demands remuneration for this disad- vantage in the form of higher rates. The explanation of the higher rates on commercial paper is the inferior charac- ter of the security back of it. This consists of the solvency of the persons whose name or names are signed to the paper, while, in the case of the other two classes of loans, the bank has in its possession first-class bonds or stocks listed on the stock exchange which can be sold on very short notice, if the loan is not paid at maturity. If a commercial paper loan is not paid at maturity, legal proceedings are nec- essary in order to obtain the right to sell the property of the person or persons whose names are signed to it, and there may be uncertainty concerning the existence of such prop- erty or its adequacy to pay the debt. On the London and Continental markets the classification of rate-quotations is not the same as in New York. In London, besides the bank rate, are regularly quoted the rates on so-called floating money, on three, four and six months bank bills and on three, four and six months trade bills. Fortnightly loans are also quoted. Floating money includes loans made subject to call secured by first-class collateral, usually bills of exchange; bank bills are drawn on banking and trade bills on commercial houses of high standing. Fortnightly loans are made to operators on the stock exchange on the security of bonds and stocks there listed for the purpose of enabling them to tide over the period between the settling dates on the exchange which oc- cur at the middle and end of each month. The differences between the rates charged on these classes of loans are not so great as in New York, but the same principles are il- lustrated, the elements of time and of security operating there in the same manner as in New York. In each group, for example, the longer the period of the loan, the higher 28o Money and Banking the rate tends to be. The element of security shows itself in the tendency of the rates on bank bills to be lower than those on trade bills. The rate on fortnightly loans is us- ually above the other rates and in this respect seems to be an exception to the principle illustrated by the only loans analogous to it on the New York market, namely call loans on the stock exchange. The element of time, however, constitutes an important difference between these two classes of loans, and the bank and trade bills with which they are compared rank as higher classes of securities in London than do time loans and commercial paper in New York. All things considered, the fortnightly loan is not regarded in London as so good an investment from the banker's stand- point as bank or trade bills or floating money. As we have seen, the bank rate has no analogy in New York. It is usually the highest rate on the market, though at times it falls below some or all of the others. As a barometer of market conditions, however, it is more signifi- cant than any of the others. In London it is fixed by the directors of the Bank of England at their weekly meetings and is used primarily as a regulator of the reserves, being raised when it is considered desirable to increase the Bank's holdings of cash, or to check a tendency to fall, and lowered under opposite conditions. Its influence over the reserves is due largely to the custom almost universal in England of paying interest on depositors' balances at the rate of one and one-half per cent, below the Bank rate, provided that does not advance beyond four per cent. Since market rates on loans tend to vary with the rate paid on deposits, the Bank rate affects all the others, and its rise tends to attract funds or to check their outward flow, and its fall to stimulate a movement in the opposite direction. The fact that it is usually above the other rates is due to the ultimate depend- ance of the other banks upon the Bank of England for cash The Money Market 281 and to the great prestige of that institution. In order to supply their needs, other financial institutions directly or indirectly must borrow from the Bank, and this puts her in a position to charge slightly higher rates than those ruling on the market. The rates of the Bank of France and of the Imperial Bank of Germany are regulated in accordance with the same general principles as that of the Bank of England. In the details of their precedure these banks differ from each other on account of the peculiarities of their respective markets. 4. Bank notes and the money market. — On account of the varying demands of commerce caused by changing seasons, the periodicity of dividend, interest and other payments, ups and downs of business prosperity, commercial crises, etc., each market is called upon to supply larger amounts of hand-to-band money at some times than at others. In order to be in a position to do this, either the reserves at the slack seasons must be greatly in excess of what is needed, or the banks must be able to create hand-to-hand money to meet the extra requirements. The plan of keeping large reserves during the slack seasons is impracticable be- cause it involves loss to the banks. At such times they are certain to tempt borrowers by lowering the rates, and this stimulates speculation and other unsound business ventures. When the period of excess demand comes, on the other hand, they are apt to burden legitimate business with ex- cessive rates and sometimes with an actual shortage of funds, as the alternative of overstraining their credit. These excesses with their unfortunate, and sometimes dis- astrous consequences, can only be avoided by giving to the central reserve holding banks the right to issue notes against commercial assets. Such notes will supply most of the needs for hand-to-hand money as well as coin, and the per- mission to issue them against commercial assets puts them 282 Money and Banking within the reach of every commercial bank conducting a legitimate business. Those located outside the central market can rediscount such securities there and those within can issue the notes directly to the original makers of the paper, or to the brokers who act as intermediaries in its sale. When the season of excess demand passes, the surplus of discounted paper will be paid, thus reducing the total vol- ume, the surplus notes will accumulate in the banks in the form of deposits and will ultimately find their way to the issuers for retirement. Indeed to supply the elastic element of the hand-to-hand money of a country is the chief function of bank-note issues. Coin and government notes are inelastic because the sources of their supply are not responsive to the varying needs of commerce. The production of the precious metals, the chief source of the supply of coin, depends upon dis- covery, cost of production and demand in the arts, which have no connection with currency needs, and all forms of government notes, except those completely covered by coin and consequently in the changes in their volume subject to the same laws as coin, increase and decrease in response to the needs of governments, or to the will of legislative bodies or executive officials. It is worthy of note in this connection that bank-notes best perform their functions at the money market centers. It is here that the pressure for the supply of the varying needs of commerce is felt, being transmitted thither from all other points, and being impossible to shift to other places. For this reason the concentration of such issues in one or in a few institutions located at the central money market is desirable, a practice common in Europe but yet to be adopted in the United States. 5. Peculiarities of the New York market. — ^Differences be- tween the monetary, banking and credit systems, and be- The Money Market 283 tween the commercial practices of the different countries, are responsible for certain peculiar features of their central money markets. Those of New York are due to the lack in this country of an elastic system of bank-note issues, and of a central bank, to our independent treasury system, and to the circulation of a large amount of overvalued silver and various kinds of government notes. As previously stated, bank-notes are issued in this country only against the deposit of government bonds and their volume consequently varies with the price of these securities and with the circumstances which make it desirable or un- desirable for national banks to come into existence. They do not, therefore, play the role of an elastic element in our hand-to-hand currency, but rather that of an erratic variable, causing it to increase and decrease without refer- ence to commercial needs and frequently at variance with them. The effect of our independent treasury system is much the same. The balance between the receipts and expendi- tures of the government, the chief cause of the augmenta- tion or depletion of money holdings by the Treasury De- partment, depends upon the productiveness of taxes and other sources of revenue in comparison with the appropria- tions made by Congress and the expenditures resulting there- from. This balance varies from one budgetary period to another, there being sometimes a surplus and sometimes a deficit, and from day to day, and month to month, there is no predicting what it will be. Unless the Secretary of the Treasury intervenes and exercises his authority to deposit funds with the banks, during the surplus-accumulating periods, money may accumulate in large quantities in the New York Sub-Treasury, thus depleting the market supply, and, when these accumulations are being reduced, the market may be surfeited with funds. Even when the Sec- 284 Money and Banking retary of the Treasury sees fit to intervene, his power is limited by the willingness and ability of the banks to supply the security required. Even then the exercise of his dis- cretion introduces an element of uncertainty which renders unavoidable the erratic character of the influence of which we are speaking. The result of this lack of an elastic element in our cur- rency and of the influences causing erratic variations in the amount of hand-to-hand money in circulation is wide fluc- tuations in the reserves of the Associated Banks and in money rates. The chart on page 278 indicates the extent of these fluctuations in recent years in terms of annual averages, and that on page 277 indicates average con- ditions for each year. The actual fluctuations are much greater than these charts, based on averages, in'dicate. The following table re- presenting the maximum and minimum of the typical rates in recent years, better reveals their magnitude : Date Call Loans at Stock Exchange 60 Days Time 60 Days Double Name Commercial Paper Miniminn Maximum Minimum Maximum Minimum Maximum 1900 I 25 2i 6 3i Si 1901 I 75 3 6 3 s 1902 2 3S 3i 6 4 6 1903 I 15 3i 6 4i 6 1904 i 6 li 4^ 3i Si 190S i4 125 2i 8 3* 6 1906 li 60 3i 10 4i 7 1907 I 125 3 16 S 8 1908 f 20 ij 10 3 8 1909 I ' 2 Si 3 Si On account of the absence of a central bank, there is wanting in New York the steadying and unifying influence The Money Market 285 of a bank rate and the bulwark to confidence which the great European banks form. The banks associated in the Clearing-House act as a unit and in harmony on many mat- ters of great importance, but they cannot approximate the unity and quickness of action of a single institution. In rate making, loaning and discounting, and in the manipula- tion of their reserves within legal limits, they act in- dependently, except on rare occasions in times of crises, when the Clearing-House Association decides upon ex- traordinary measures. The most they can then do is tem- porarily to combine their reserves through the issue of clear- ing-house certificates.* They do not and cannot bear the responsibility directly or indirectly assumed by the central banks of Europe to supply the market with funds against the rediscount of first-class bills. The interests of the public as opposed to those of in- dividuals or groups of individuals lack adequate representa- tion on the New York market. In the European markets these interests are cared for by the government through its direct or indirect control of the central bank. Their sole representative in New York is the Secretary of the Treas- ury, whose power, as we have seen, is quite limited. The result is that the New York market is subject to manipula- tion for the benefit of special interests and at the expense of the public. The circulation of the government notes, familiarly known as greenbacks, is a feature of our money market worthy of note. These notes, amounting to $346,681,016 redeemable on demand in gold by the United States Treas- *These are certificates issued against specified securities deposited with the Clearing-House Association and receivable for clearing-house balances. They usually bear a high rate of interest and are some- times issued in denominations small enough to make them available for general circulation. 286 Money and Banking ury and legal tender for the payment of all debts public and private, except duties on imports and interest on the public debt, constitute a fixed element in our currency and are available for use as bank reserves. By their presenta- tion for redemption it is possible at times for the banks to throw upon the Treasury the burden of supplying the market with gold. The ability of the Treasury to meet this obligation depends upon a reserve of $150,000,000 in gold kept for that purpose and, in case of its depletion, upon the right to borrow gold by the issue of bonds. A similiar obligation is imposed on the government by the circulation of more than five hundred million silver dollars or silver certificates representing them. The bullion value of these coins varies with the price of silver, but for many years it has been less than one-half their face value. The responsibility for making good this difference is imposed upon the Treasury by the legal requirement that it must at all times maintain the circulation value of these coins at a parity with gold. For the meeting of this obligation no gold reserve is maintained nor has the right to issue gold bonds for this purpose been granted by Congress. The Treasury is protected only indirectly and very imperfectly by legal provisions requiring the retirement of greenbacks and national bank-notes of low denominations, and the issue of the bulk of the silver certificates in these denomina- tions. By this means it is hoped that the silver currency may be kept constantly in use and its return to the govern- ment prevented. The peculiar feature of our money market, due to the circulation of these greenbacks and silver dollars, is the placing of the responsibility for the maintenance of gold payments upon the Treasury without equipping it with the means of meeting this responsibility under all possible conditions. The gold reserve of $150,000,000 once ex- The Money Market 287 hausted, the only resort of the Treasury is the borrowing of gold by means of bond issues. In times of monetary stringency and sharp international competition for gold, precisely the times on which such a situation would have to be faced, such a proceeding would at the best be slow and expensive and might be impossible. Knowledge of the weakness and unprotected character of the Treasury under such conditions contribute toward a panicky feeling on the money market whenever these conditions are feared or ap- proximated, and thus helps to create the kind of a situation which it should be the chief function of the guardian of the public interests on the money market to prevent. 6. Some peculiarities of the London market. — The Lon- don market owes its chief peculiarities to the central position which England occupies in international commerce, to cer- tain features of her banking system, and to the magnitude of English investments in foreign securities. For more than a century London has served as a clearing house for international commerce. Through the colonial system of England, her free trade policy, her early estab- lishment of, and persistent adherence to, the gold standard of value, her great wealth, and the genius of her people for commerce, London merchants have established trade con- nections with every part of the world and are able to per- form the function of an intermediary for foreign mer- chants in other parts of the world more economically than those of any other country. The volume of this kind of business performed by them has long been enormous and shows no tendency to diminish in spite of the increasing competition of other centers. One result of this commercial eminence has been to make London the chief market in the world for foreign bills of exchange, and control of this market has given her a command of the monetary, particu- larly of the gold, resources of the world possessed by no 288 Money and Banking other city and at the same time has subjected her to drafts from every quarter. She has thus become the central money market of the world. In the performance of this function the manipulation of the rate of discount of the Bank of England plays the leading role. On account of their ready saleability and their high character in other respects, the bankers of the chief continental markets fill their portfolios with London bills whenever local paper is inadequate for the profitable employment of their funds, a common condition of things, especially in France, Belgium and Holland. On account of its influence on the market rate, the rate of the Bank of England, however, is the chief determinant of the profit- ableness of these investments. Accordingly when that rate rises, London paper is purchased in increased quanti- ties, and when it is lowered, it is sold and new investments diminished in magnitude. In the one case the power of London to draw gold from the continental centers is in- creased, a balance in her favor being created or an adverse balance diminished or annihilated, and in the other the power of these centers to draw on London is enhanced. The gold supply of the London market is thus more elastic than that of any other. This fact renders less serious the consequences of the inelasticity of the English system of bank-note issues. As was pointed out in a preceding chapter, with the exception of a small amount of notes issued by a few joint-stock and private banks, the magnitude of which cannot be increased and which diminishes very slowly, the Bank of England issues all the notes in circulation under the limitations im- posed by the bank act of 1844 and subsequent orders in council issued in accordance with its provisions. As a result of these limitations the volume of bank-notes in cir- culation normally increases only when a corresponding The Money Market 289 amount of gold coin is paid into the issue department of the Bank and decreases only when a corresponding amount of gold coin is paid out. The total volume of the circulating medium, therefore, is not affected by them in any way, and the only elasticity in this country's hand-to-hand money is due to the gold element. In the determination of London's command over the gold supply of the world, an important factor is the magnitude of the investments of Englishmen in foreign securities, and the international character of the London stock exchange. For many years the savings of the English people have been in excess of the amount that local enterprises could profit- ably absorb, and they have consequently sought and found employment in the colonies and in other countries, chiefly in the form of investments in high-class securities, such as government, municipal and corporation bonds, and the stock of railroad, mining and other large industrial corporations. The amount of such securities at all times in the country and especially in the vaults of London financial houses is very great, and, whenever the need for funds is pressing, a part of them may be sold and the balance of indebtedness thus influenced in favor of England. The London stock exchange renders the sale of these securities easy and rapid. It lists and supplies facilities for dealing in them as other markets do in national and other local securities. It is connected by telegraph with the other important stock exchanges of the world, and its brokers transact business for people in other countries as well as for Englishmen. It is, in fact, an international market and contributes in no small degree to the inter- national importance of the other financial institutions of the city. 7. Some peculiarities of the Paris market. — In France the issues of the Bank of France perform the function which 2go Money and Banking properly belongs to bank-notes, that is their volume responds automatically to the varying needs of the country for hand- to-hand money. The other financial institutions of the country, notably the great banks of discount, supply their needs for cash by drawing upon balances regularly kept with the Bank of France, and by rediscounting bills which come into their possession in the ordinary course of their opera- tions. An increased demand for cash anywhere in the country thus normally takes the form of the presentation to local banks by merchants and manufacturers of their bills for discount and of their transfer through rediscounts to the portfolios of the Bank of France, which may meet the demands made upon it by the issue of notes. The payment of these bills, without the discount of a corresponding amount of new ones, brings the notes back to the Bank for retirement. The operation of the system is illustrated ,by the diagram on p. 291, which indicates a general correspondence be- tween the circulation and discount curves of the bank. It should also be noted that the fluctuations in the volume of the note-issues correspond with variations in the sea- sonal demands for currency. On account of the elasticity of her note-issues, the re- serves of the Bank of France, which constitute the central coin reserve of the country, are less directly connected with the seasonal and other temporary variations in the currency needs of the country than are those of the Bank of Eng- land or of the Associated Banks of New York. In the protection of her gold reserves the Bank of France is aided, temporarily at least, by the legal-tender laws of the country which enable it at discretion to meet cash obligations with silver five-franc pieces, the bullion value of which is much below their circulation value, as well as with gold coin. These silver coins are no longer minted, The Money Market 291 but a large quantity of them are in circulation and in the vaults of the Bank, and, whenever it is desired to check an CIRCULATION AND DISCOUNT CURVES, BANK OF FRANCE ?; rr. < —'^ — ij f: — 1?, (- r> ' — J ' fc p^ < ^ ^ — ^ — < 17,477,800 20,602,800 17,422,020 4,514,120 50,943,360 9,831,060 108,006,930 112,538,240 221,379,540 177.326,540 38,639.490 9.550.127,530 59,996,010 75,000,000 52,661,315 16,464,285 1,821,420 5,060,606,240 60,609,988 . 50 75,000,000.60 52,661,315.00 16,464,285.00 1,821,420.00 6,733.445 00 1.159.859-50 154.37900 8,910,583.00 5,763,624.00 370.00 4,000,000 . 00 8,000,000.00 44,000.00 40,000,000.00 14,852,874.00 5,601,571.998.35 368 Appendix II Surplus ov Imports op Gold and Silver into British India * Years 1 835-: 1836- 1837- 1838- 1839- 1840-: 1841- 1842- 1843- 1844- 1845- 1846- 1847- 1848- 1849- 1850- 1851 1852- 1853- 1854- : 1855- 1856- 1857- 1858- 1859- 1860- 1861- 1862- 1863- 1864- 1865- 1866- 1867- 1868- 1869- 1870- 1871- 1872- 1873- 1874- X875- 1876- 1877- 1878- 1879- 1880- 1881- 1883-1884 836. 837. 838. 839. 840. 841 . 842. 843- 844. 845. 846. 847. 848. 849. 850. 851. 852. 853. 854. 855. 856. 857. 858. 859. 860. 861 . 862. 863. 864. 865. 866. 867 . 868. 869. 870. 871. 872 . 873. 874. 875- 876. 877. 878. 879. 880. 881 . 882. Gold $ 1.694,590 2,098,620 2,154,350 1,294,625 1,133,215 686,560 828,115 1,053,805 2,032,615 3.550,500 2,722,380 4,234,745 5,195,580 6,744,590 5,584.965 5,766,470 6,338,065 5,861,505 5,307,215 3,656^450 12,531,225 10,456,070 13,915,365 22,132,265 21,421,170 21,162,845 25,922,125 34,240,795 44,491,530 49,199,820 28,622,380 19,211,640 23,047,335 25,796,760 27,960,585 11,410,605 17,826,720 12,716,810 6,913,190 9,367,675 7,725,655 1,036,750 2,340,645 4,480,865 8,752,470 18,275,995 24,219,920 24,654,355 24,316,580 Silver $ 8,059,480 6,694,410 9,834,720 13.225,650 8,252,355 7,008,350 6,416,140 14,762,225 18,477,210 9,942,805 4,662,450 6,891,245. 2,470,955 1,569,520 6,368,035 10,586,125 14,326,785 23,025,120 11,528,720 148,000 40,971,875 55,366,235 61,094,740 38.641,710 55.737,815 26,640,045 45,432,280 62,750,755 63.983,595 50,393,990 93,343,365 34,815,370 27,969,805 43,005,110 36,601,685 4,709,68s 32,564.135 3,523,220 12,256,915 23,211,010 7,776,775 35.994,360 73,381,675 19,853,470 39.348,715 19,462,870 26,895,250 37,401,135 32,030,765 ♦Quoted from Laughlin's "History States," pp. 252-3. of Bimetallism in the United Statistical Tables 369 E Annual Average Rates op Discount op the Banks op France AND Germany prom 1844 to 1878 * Date 1844. 1845- 1846. 1847. 1848. 1849. 1850. 1851. 1852. i8S3- 1854. i8ss- 1856. i8s7. 1858. i8s9- i860. 1861. 1862. 1863. 1864. 1865. 1866. 1867. 1868. 1869. 1870. 1871. 1872. 1873- 1874. 1875- 1876. 1877. i8f8. Baok of France. An. Aver, of Min. Rate Discount Average rate of 34 years. 4 4 S 4 4 4 4 3 3 4 4 S 6 3 3 3 5 3 4 6 3 3 2 2 2 3 S S s 4 4 3 2 2 o o o o o o o 3 4 6 8 10 3 14 9 12 II IS 13 10 13 13 14 10 10 19 14 2 2 6 o 8 S 4 o o 2 o o o o 7 9 6 II 2 3 o 4 7 I I I 7 II 6 2 o o 8 3 9 10 2 o 2 3 2 Bank of Germany. An. Aver, of ^lin. Rate Discount £ s. d. 7 13 16 13 o o 5 7 I 18 IS 2 4 o o o I 6 18 4 o o 4 17 2 5 19 7 13 3 8 6 o 7 10 3 10 o o o o 5 5 10 7 7 3 o o o 6 S II s o o II 7 9 8 4 8 7 3 7 8 10 ♦Quoted from Palgrave's "Bank Rate in England, France, and Germany," pp. 88-91 and 98-101. APPENDIX III THE PAR OF EXCHANGE AND GOLD POINTS OF THE CHIEF CENTRES OF FOREIGN EXCHANGE* London Name of Centre Par Gold -importing Point Gold-exporting Point Berlin 20.43 12.107 4.866 25.225 20.53 12.17 4.90 25.34 20.32 12.02 4.83 25.12i Amsterdam New York Paris Paris London . . . Berlin New York . Amsterdam 25.225 123.46 518.26 208 . 32 25-i2i 122.90 515.75 207. 16 25-34 124. 14 523.05 210. 16 Nkw York London Paris . . Berlin. . Berlin London . . . Paris New York. . Amsterdam 20.43 81.00 419-79 168.74 20.33 80.56 415-25 168.25 20.53 81.37 423-30 170.50 •Quoted from Haupt's "Rehabilitation de 1' Argent," p. 9. INDEX Accounts: book as a form of credit, 95. Arbitrage Business: 129. Associated Banks: of New York City, 274, 285. Balance of Trade: 121, 122. Balance of Indebtedness: between communities, 121-123 ; interna- tional, 128, 129. Balance Sheet: analysis of a bank, 147-150. Bank : of Amsterdam, 105, 106 ; of Hamburg, 105; of North Amer- ica, 153, 154 ; of Nuremberg, 105 ; ■of Maryland, 154; of Massa- chusetts, 154, 155; of Provi- dence, 154 ; of Prussia, 258, 260 ; of State of New York, 154. Bank Accounts: analysis of typi- cal balance sheet, 147-150. Bank Acts: Canadian, see Cana- dian Bank Acts; English, see English Bank Acts ; French, see French Bank Acts. Bank Correspondents: 118, 119; as suppliers of cash to other banks, 140. Bank Currency: advantages of, iii-iiS; elasticity of, 112-115; how issued, 112, 113; how re- tired, 113, 114. Bankers: private, see Private Bankers. Bankers' Balances: how deter- mined, 120, 121 ; as an item of the international balance sheet, 130. Bank filr Handel und Industrie: 267. , . Banking: literature on regulation of, 151; free in New York State, 170-172; free in western states, 173-175; national, see National Banking System ; state since the war, 186- 188; concentration of in the United States, 189; in Canada, see Can- ada ; free banking experiment in Canada, 200-202; steps toward the uniform regulation of in Can- ada, 202-204; relation to of British North American act of 1867, 205-209 ; literature on Can- adian, 219; country in England, 221-223 ; literature on English, 237; present organization of the business in Germany, 270, 271 ; literature on in Germany, 272; provincial in France, 242, 243; literature on in France, 256; stages in the history of Ger- man, 257; in Prussia, 258-260. Bank Inspection and Supervision: in United States, 145-146; in Europe, 146. Bank Investments: considerations governing, 134, 135; notes and bills as, 135, 136; no fixed rules regarding, 136 ; bonds and stocks as, 136, 137; difficulty of regu- lation by law, 137; how restrict- ed in case of national banks, 137, 138. Banking Instttuitons: origin of, 105-108. Bank-notes: form of, 96; as currency, no; compared to deposits as currency and as obligation of banks in ; reserves for special pro- tection of holders of, 142; methods of safeguarding, 142- 144; relative advantages and dis- advantages of different methods of safeguarding, 144, 145; as rivals of government notes, 182; how secured in Canada, 216; limitation on issues of Bank of 371 372 Index France, 246; in Prussia, 260; and the money market, 281, 282. Bank of England: origin of, 220; terms of original charter, 220, 221 ; branches of, 223 ; modified by Peel's act, 226; uncovered note issues of, 226, 228; govern- ment of, 230; departments of, 231 ; special customers of, 231, 232; its business with other banks, 232, 233; capital and sur- plus of, 233; average percent- age of reserves to deposits in, 233- Bank of France: origin and origi- nal constitution of, 238, 239; modifications effected by acts of 1803, 1806 and 1808, 239-241; experiences of during Napole- onic regime, 241, 242; branches of, 241, 243, 248, 249 ; since 1848, 245-249; capital of, 245; surplus of, 245-246; limit on note issues of, 246; statutes regarding in- vestments of, 246, 247; relations to the French Government, 247, 248; present position of, 253- 256; operation of issues of on money market, 290, 291 ; use of five-franc pieces in protection of gold reserve by, 290, 291. Bank of Germany: see Imperial Bank of Germany. Bank of the United States: First, see First Bank of the United States ;i«Second, see Second Bank of the United States. Bank Rate: definition of, 276; its influence on the reserves, 280, 281 ; effect of manipulation of that of London, 288. Banks: origin of, 105-108; devel- opment of functions of, 106, 107; as agents in the conduct of foreign exchanges, 107; rela- tive importance of functions of, 107, 108; literature on, 115; earliest in United States, 153- 15s; state in period 1791 to 1811, IS7. 158 ; nature of the business of early state, 157, 158; in Massa- chusetts before the war, 164- 169; in state of New York be- fore the war, 169-174; state owned, 175-176: state since the war, 186-188; Joint Stock, see Joint Stock Banks; of deposit in England, 223, 224; local in France, 242, 243; Prussian, 257- 259; mortgage in Germany, 267, 268; cooperative in Germany, 268-270. Banks of Discount: in Germany, 261. Banks of Issue: in Prussia, 260; German, see German Banks of Issue. Barter: difficulties of, 2, 3, 7-9. Berlin: the financial center of Germany, 267 ; as a central mon- ey market, 273. Berlin Money Market: compared to those of London and Paris, 292; as a free market for gold, 293; how affected by great pri- vate banks, 293. Bills of Exchange: definition of, 97; sight, short, long, bankers, cotton, grain, etc., 97; checks and drafts as, 97, 98; as invest- ments for banks, 135, 136. Bimetallism: definition of, 296; essentials of, 297, 298; weak points in the theory of, 303-307; national and international, 308; literature on, 309, 345 ; in middle ages, 311-315; in France, 318- 323. 334-336; in the United States, 326-330, 336-338; inter- national conferences concerning, 338-342; present status of, 342- 344- Bimetallists : objections to mono- metallic system, 299, 300. Bland Act: 337. Bonds: as_ instruments of credit, 97; as investments for banks, 136, 137. Book Accounts: as a form of credit, 95. Borrowing: need for means of borrowing and lending, 8 and 9. Brassage: definition of, 76. Canada: epochs in history of, 191, 192; early economic and social conditions in, 192-194; the first banks in, 194-197; influences re- straining banking excesses in. Index 373 197-199; charter provisions of early banks of, 19S-196; bank acts of 1870 and 1871, 209-211; of 1880, 213; of i8go, 214-217; bank failures in, 212; crisis of 1873 in, 212. Canadian Bank Acts: of 1870 and 1871, 209-211; of 1880, 213: of 1890, 214-217; of 1900, 218, 219. Canadian Bankers' Association: 219. Capital: as a means of safeguard- ing commercial banking, 132 ; requirements of our national banks, 132, 133; investment of, 133, 134- Cash: need of a bank for, 140; function of correspondents in furnishing, 140. Centesimo: 70. Centime: 70. Central Reserves: 274, 275; rela- tion to bank rates, 276, 277. Certificates: gold and silver, 81, 82; of deposits, 96, 97. Chevalier, M: 76. Clearing House: functions of, 117; literature on, 130; London, 224. Coins: definition of, 66; manu- facture of, see Coinage; influ- ences determining those which shall be minted, 71, 72; size, weight and fineness of, 72, 73; gold, 72, 73; silver, 72, 73; cop- per, 72, 73; nickel, 72, 73; "sweating," 74; clipping, 74; naming and stamping of, 74, 75 ; need for various denominations of, 19 and 20; disappearance from circulation of undervalued, see Gresham's law ; standard and subsidiary, 28-30 ; means of mak- ing subsidiary, 29, 30. Coinage: purpose and importance of, 66-69; definition of, 66; im- portance of honesty and accu- racy in manufacture of, 67, 68; in middle ages, 68; monopoly of by government, 69. Comptoir d'Escompte de Paris: origin of, 245; history of, 249, 250. Comptoirs d'Escompte: 242, 244. 245- Conferences, International Mone- tary: 338-342. Cooperative Banks: in Germany, 268-270. Cotton Bills: 97. Credit: definition of, 92, 93; in- struments of, see Instruments of Credit; foundations of, 99- 102 ; relation to prices, 102, 103 ; literature on, 104; its relation to exchange, 92; advantages of to the individual, 93, 94; ad- vantages of to the nation, 94, 95 ; book, 95 ; peculiarities in the use of the various instru- ments of, 98, 99; relation of good condition of trade and character of debtor to saleabil- ity of, 100, loi ; its relation to money, loi, 102; as a substitute for money, 103; relations be- tween communities, 122; use as a medium of exchange, 11, 12. Credit Fancier: 252, 253. Credit Lyonnais: origin of, 249; history of, 250, 252. Credit Industriel et Commercial: origin of, 249; history of, 250- 252. Crises: in France, 241. Currency: importance of an ac- curate, convenient and safe, 14- 16; characteristics of a good, 16-18; composition of modern, 18, 19; classification of metallic, 19; paper, see Paper Currency; cost of shipments of, 124, 125; literature on movements of, 130 ; United States act of 1792, 326; United States act of 1834, 328; United States act of 1853, 329. Currency Reform: in England, 31S-318; in Germany, 331, 332. Decimal System: of reckoning, 70. Demand for standard of value: importance of distinction be- tween demand for primary and secondary standards, 50; peculi- arity of monetary, 51; how af- fected by substitution of other forms of currency for, 52, 53; magnitude of, how determined, S3, S4; relation of prices to, 54, 374 Index 55 ; arbitrary modification of, 55, S6- . Deposits: certificates of deposit, 96, 97; nature and classification of bank, 108; as currency, 109, no. Depreciation: of secondary stand- ards, 35, 36, 41, 58-61. Deutsche Bank: 266. Discontogesellschaft: 267. Discount Brokerage: as a special branch of banking in England, 224, 225 ; business of in England, 236, 237- Dollar: United States, 70. Domestic Exchange: literature on, 130. Double Standard: compensatory action of, 300-303. Dresdner Bank, 266. English Bank Acts: of 1826, 222; of 1833, 224; of 1844, 225-227. Exchange: meaning of in political economy, 92; bills of, 97, 98; technical meaning of in bank- ing parlance, 116; rate of, 123- 125; foreign, 125-130; par of, 125; sterling, 126; importance of London, 127, 128 ; medium of, see Medium of Exchange. Exchanges: local, 116, 117; out- of-town, 1 17-120. Finance Bills: 97. First Bank of the United States: origin of, 155 ; details of charter, 156, 157; branches of, 157. Florin: Austrian, 70. Foreign Exchange: literature on, 130; principles of, 125-130. Franc: French, 70. Frederick The Great: and the Bank of Prussia, 258; and the Seehandlungs-Sozietat, 258, 259; and Prussian land banks, 259. French Bank Acts: of 1800, 238, 239 ; of 1803, 1806 and 1808, 239- 241 ; since 1848, 245-249. Friedrich d'ors: Prussian, 74. George d'ors: English, 74. German Banks of Issue: early, 258, 260 ; relation to Imperial System, 264, 265. Gold: coins for which it is suit- able, 20, 72, 73; explanation of its importance as a money metal, 20, 21 ; as standard of value, 40, 41 ; certificates, 81, 82 ; points, 126; import and export points, 126; imports and ex- ports in France, 321 ; produc- tion of after 1850, 324, 325; in- creased use of in Europe, 333, 334. Gold Points: 126. Government Notes: depreciation of French, 41 ; inconvertible, 79-81; convertible, 81-90; dis- advantages of depreciated, 79, 80: Greenbacks and Sherman notes, 83; their use during co- lonial period of history^ of United States, 152, 153 ; as rivals of bank notes, 182; in provinces of Canada and Nova Scotia, 207. Greenbacks: 83. Gresham's Law: explanation of, 24-26 ; disadvantages of its oper- ation, 26, 27; its relation to prices, 27, 28 ; antiquity of, 27 note; illustrations of operation of, 26; literature on, 31. Gresham, Sir Thomas: 27. Heller: Austrian, 70. Imperial Bank of Germany: origin of, 262 ; definition of business of, 263, 264 ; its relation to the Empire, 264; growth of, 265, 266 ; untaxed note-issues of, 265, 266. Incorporation: as a means of safeguarding commercial bank- ing, 131, 132. Independent Treasury System: 162, 163. India: as an absorber of silver, 332. Instruments of Credit: importance of security back of, 99 ; peculiari- ties in the use of the different varieties of, 98, 99. Interest: charges allowed to banks by laws of Canada, 218. Investments: for banks, see Bank Investments. Joint Stock Banks: provincial in England, 223; of deposit, 223, 224 ; of issue, 227, 228 ; and con- centration, 229, 230; classifica- Index 375 tion of, 229 ; functions and busi- ness of, 234, 23s ; in France, 238. Joint Stock Companies: in Ger- many, 260. Kopeck: Russian, 70. Kreutzer: Austrian, 70. Krone: Austrian, 70. Latin Union: 334-336. Law: Gresham's, see Gresham's Law. Lending: need for means of bor- rowing and lending, 8, g. Lira: Italian, 70. Loans and Discounts: the making of as a function of banking, 108, log. Lombards: as bankers in England, 220. London and Westminster Bank: 224. London: as clearing house for international commerce, 287 ; bank rate of, 280, 281, 288; in- fluence of stock exchange on money market of, 289. London Money Market: how af- fected by internatioHal com- merce of London, 287; effect of manipulation of bank rate on, 288; its command over gold resources of the world, 289; how affected by stock exchange, 289. London Stock Exchange: and the money market, 289. Mark: German, 70. Market Rates: definition of, 276; classification of in New York, 277, 278 ; charts showing fluctua- tions of in New York, 277, 278; classification of in London, 279; maximum and minimum in New York, 284. Medium of Exchange: definition of, 6; needs which it satisfies, 7-9; how it satisfies commercial wants, 9-1 1 ; importance of ac- curacy, convenience and safety in, 14-16; characteristics of a good, 16-18; composition of modern, 18, 19; relation to standard of value, 13; litera- ture on, I3- Methods of Reckoning: English, 69, 70; decimal, 70. Monetary Conference: Paris, 338, 339; Brussels, 341, 342. Money Markets: central, 273, 274; New York, see New York Money Market; London, see London Money Market; Paris, see Paris Money Market; Berlin, see Berlin Money Mar- ket. Money: two functions of, i; in- definite meaning of term, i ; con- current circulation of paper and metallic, 30-31; See also Cur- rency, Medium of Exchange, and Standard of Value. Monometallism: definition of, 296; arraignment of by bimetallists, 299, 300. Mortgage Banks: in Germany, 267, 268. Napoleons: French, 74. National Bank fiir Deutschland: 266. National Banking System: origin of, 176, 177; act of 1863 con- cerning, 177-179; slow progress of in early years, 179, 180; act of 1864 concerning, 179, 180; act of 1870, 1874 and 1875 con- cerning, 181 ; defect of bond se- curity feature, 183; its merits, 183, 184; relation of deposit banking to success of, 185. National Banks: decline in circu- lation of in period 1875 to 1879, 183. National Discount Company: 225. New York City: as a central money market, 273. New York Money Market: effect on of inelastic note issues, 283, 284; how affected by Independ- ent Treasury System, 283; fluc- tuations of rates on, 284; neglect of public interests on, 285; ef- fect of greenbacks on, 285, 286; effect on of mass of silver dollars, 286. Notes: Government, see Govern- ment Notes; Treasury, see Treasury Notes ; bank, see Bank Notes; promissory, as invest- 376 Index ments for banks, 96, 135, 136; provincial in Canada, 204, 205. Paper Currency: classification of, ig; utility of, 21-23; secret of its circulation, 11, 12; inexpen- siveness of, 22; superiority of in respect to convenience and safety, 23, 24; elasticity of, 23, 24. Paris: as a central money market, 273- Paris Money Market: how affected by- issues of Bank of France, 290; protection of gold supply on, 290, 291 ; stability of rates on, 292. Par of Exchange: 125. Pfennig: German, 70. Prices: definition of, 32; relation of standard of value to, 33, 34; interpretation of, 46-49; statis- tics of, 47-49 ; interpretation of average, 47, 48; how related to demand for standard com- modity, 54, 55 ; relative as in- fluenced by currency movements, 123. Private Bankers: in England, 221, 222, 224 ; diminution in number of English, 227, 228 ; functions of English, 23s, 236. Quantity Theory: explanation of, 61-63; criticism of, 63-65; litera- ture on, 65. Rate of Exchange: domestic, 123- 125; foreign, 125-130; relation to of costs of shipments of cur- rency, 124 ; differences between on different classes of bills, 126, 127. Rates: Bank, see Bank Rates; market, see Market Rates. Ratio between Gold and Silver: in 1803-1893, 319; causes of fluc- tuations in, 323, 324. Redemption Fund: for bank circu- lation in Canada, 216. Reserves: regulation of, 138-141 ; seasonal variation in, 139; how related to demand for hand-to- hand money, 139, 140; regula- tions concerning imposed by national banking act, 140, 141 ; objections to legal regulation of, 141 ; central, see Central Re- serves. Resumption of Specie Payments: act of 187s concerning, 180. Revolution: of 1830 in France, 242; of 1848 in France, 243-245. Ruble: Russian, 70. Safety-Fund: as a method of pro- tecting holders of bank notes, 142, 143 ; experience with in New York State, 169-171 ; Cana- dian, 216. Saving: means for promoting, 8. Second United States Bank: its charter compared to that of First, 160 ; branches, 161 ; de- feat of bill for recharter of, 161, 162. Seehandlungs Sosietdt, 258, 259. Seniorage: definition of, 75; argu- ments for and against, jy, 78. Sherman Act: 338. Sherman Notes: 83. Shortt, Adam: 192, 196. Silver: coins for which it is suit- able, 20; explanation of its im- portance as a money-metal, 20, 21 ; certificates, 81, 82 ; imports and exports of in France, 320; fall in value of after 1875, 330- 334; production of after 1865, 331 ; sale of by Germany, 331, 332; limitation of monetary use of, 332, 333- Societe Generale: origin of, 249; history of, 250-252. Specie Payments: resumption of in United States, 180; suspen- sion of in 1814, 159; resumption of aided by United States Bank, 169. Standard of Value: definition of, 2; functions of, 2-6; capacity to serve as, 6; relation to medi- um of exchange, 13 ; literature on, 13, 49 ; relation to prices, 33, 34; distinction between primary and secondary, 34-37; character- istic features of, 37-40; history of, 40-43 ; importance of stabil- ity of value of, 43-46; difficulty of securing stable standard of value, 46; serviceability as medi- um of exchange, 38, 39; impor- Index zn tance of high degree of utility for purposes of ordinary con- sumption, 37, 38; depreciation of secondary, 35, 36, 41, 58-61 ; relation to debts, 45-46; value of, 50-.65 ; demand for, see De- mand for Standard of Value; supply of, see Supply of Standard of Value; secondary, 58-61. Stockholders: double liability of, 134, 197, 210. Stocks: as investments for banks, 136, 137- Sub-treasury : New York, 274. Suffolk Bank System: 167-169. Supply 0^ Standard of Value: definition of, 56, 57; effect of durability of the precious metals on, 57, S8. Surplus: accumulation of as a means of safeguarding com- mercial banking, 133 ; require- ment of national banks, 133 ; investment of, 133, 134; of Bank of France, 245, 246. Thaler s: German, 299 note. Treasury Notes: convertible, 82- 90; Greenbacks and Sherman Notes, 83; their defects as cur- rency, 83-90; contrasted with gold and silver certificates, 83 ; their lack of elasticity, 84; pos- sible expensiveness, 85-87 ; United States experience with, 87, 88; comparison with sub- sidiary coin, 89; literature on, 90, 91. Trust Companies: functions of, 188; their development in the United States, 188, 189; litera- ture on, 190. Unit of Value: definition of, 32; its relation to prices, 32, 33 ; weight of in United States, 32; history of, 42, 43; need not be tance of certainty of in the medi- ferent countries, 70-72; deter- mination of size of, 70, 71. Value: language of, 2-6; impor- tance of certainty of in the medi- um of exchange, 18; standard of, see Standard of Value; unit of, see Unit of Value ; stability of in the standard, 43-46; quan- tity theory of, see Quantity Theory. Wealth: need for means of ac- cumulating, 8; saleability of in its relation to credit, 100. »3ii!JW0fafflppspi