Periodic
Financial
Panics
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DISEROW
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Periodic Financial
Panics
THE CAUSE and
THE REMEDY
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CHAS. W. DISBROW
SAINT LOUIS :
Finance Publishing Company
Pierce Building
1913
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COPYRIGHT, 1013
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Chas. w. disbrow
BANK DEPOSITS
A former speaker of the House of Representa¬
tives, in a recent address before a convention of
bankers, said that the business of banking was
"only one of the spokes of the business wheel".
This seems to be the idea of many substantial
people, yet nothing could be more erroneous. The
modern banking system is not a mere spoke in the
business wheel—it is the hub of the wheel, and all
business revolves about and is dependent upon it.
Theoretical writers on finance usually begin by
telling us that originally business was a mere ex¬
change of article for article—a barter and sale—and
they then carry us down through the ages to when
money—cash—became a medium of exchange, and
the prices of all goods were expressed in terms of
the value of this money, and all payments were
made with this money. Here they stop. None
of them seem to have grasped the fact that we have
gone far beyond the point where the money itself—
cash—is the sole medium of exchange, and that
modem business is now conducted by means of an
exchange of bank credit, commonly called bank
"deposit", assignable from hand to hand by the bank
check.
1
PERIODIC FINANCUL PANICS
It is true that this credit is spoken of in terms
of money. We speak of a credit balance at the bank
as "cash in bank", but it is not cash. The credit
balances of depositors in the banks of the United
States, the so-called bank "deposits", amount to
over sixteen billion dollars, while the total cash in
bank is but one and one-half billion dollars, hence
it is a physical impossibility that such "deposits"
be cash.
These bank "deposits"—these amounts due
depositors—these credit balances at the bank
assignable by bank check—are something entirely
separate and distinct from cash. They are a new
medium of exchange; and the wonderful expansion
of business of the past century began with, and is
entirely due to, the creation of this new medium of
exchange; and all business today is dependent upon
the smooth working of the banking machinery
which creates and maintains this new medium of
exchange.
AD financial writers agree that the character and
volume of business that can be carried on in any
community depends upon the amount of exchange
medium in such community. They speak of early
communities where banks were unknown, and money
(the only known medium), was scarce, and they
2
BANK DEPOSITS
show how business quickened as soon as more
money got into circulation.
I desire to make clear that the creation of the
modern bank created a new medium of exchange,
which multiplied the power of a dollar a dozen fold
and made possible modern business.
What we term bank "deposits^', are mere entries
on the books of the banks showing the amount of
credit to which each individual "depositor" is
entitled; and this credit is assignable from one
party to another by a written order, termed a bank
check, or draft. It is by means of these assignments
of credit—bank checks—this new medium of
exchange, that modern business is transacted.
If modern banks were mere depositories of coin,
as the first banks were, always keeping on hand a
dollar in coin for every dollar of deposit, that is to
say a 100% reserve, then the total bank deposits
could not exceed four billion dollars, as that is all
the cash there is in the nation; and a bank check
then would in fact be a mere substitute for the cash
itself. But the banks do not keep on hand 100%
reserve; they average less than 10%. With about
one and one-half billions of cash in bank they
support "deposits" of over sixteen billions. The
bank checks issued in a single week against these
sixteen billions of "deposits" amount to twice the
3
PERIODIC FINANCIAL PANICS
amount of all the cash in all the banks, the clearings
for the week ending December 14, 1912, being
$3,786,606,814.00. These "deposits" are handled by
the banks by the mere making of entries in books,
yet the check is the only "medium of exchange" used.
Call it a substitute for money and theorize as we
will, the cold practical fact is that by the use of
bank "deposits" and assignments of same, we have
sixteen billions of exchange medium, whereas, if
only the coin itself was used, we would have but one
and one-half billions.
Gold has been described as the "life blood of
trade flowing through the arteries of commerce,
quickening into greater life all it touches." I want
to bring out the fact that the modern banking
machine has taken one and one-half billion dollars
of this gold and multiplied it into sixteen billion
dollars of "deposits", and that the checks drawn
against these sixteen billions of deposits are what
really flow through the arteries of commerce and
are the real life blood of trade. I want to explain
the actual working of this modern banking machine
and show what a vital personal interest every man,
woman and child has in it, and point out how
necessary it is to perfect this machine.
4
bank deposits
Liquid Capital
If one has no cash or credit balance at the
bank—a "deposit"—he can do little business. He is
without medium of exchange, or "liquid capital", as
it is sometimes called. He cannot meet his bills.
If he has other assets, he must first convert them
into cash or "deposit", as cash or bank check
is the only recognized medium of payment. It
necessarily follows that the more of this medium of
exchange—this liquid capital—one possesses, the
more business one can do; and what is true of the
individual is true of the mass. The more liquid
capital—^bank "deposits"—^possessed by a nation,
the more business that nation can do.
How Bank "Deposits" are Created
How are these bank "deposits" created? The
average man seems to think that because he has
obtained a check on one bank and with it opens
a deposit account with another bank, that he has
thereby created a bank deposit. The fact is that
he has merely transferred a bank credit from one
bank account to another. A check is a mere assign¬
ment of credit; it transfers from one place to another,
but it does not create anything. Individual bank
checks might be issued to eternity, and the sum
total of bank deposits would not be increased
thereby.
5
PERIODIC FINANCIAL PANICS
Again, a man may think that by putting actual
cash into bank, he has created a deposit. This is
true if the money was newly created; not true if it
merely came out of some other bank. If all the
money in the nation was deposited in bank, it
would create less than four billions of deposits,
while there are actually sixteen billions of "deposits".
How then are these "deposits" created?
The first bank was merely a depository for safe
keeping of money—a safety deposit box. The
depositor got back the same coin he put in and
paid a fee for its safe keeping. Hence the name
bank "deposit". This name is no longer des¬
criptive. The credit balances on the books of a
modern bank showing how much the bank owes its
customers are in no sense deposits.
Later on in history we find the banks paying
out, not the same coin, but any coin of the same
value, but still keeping on hand a dollar of coin for
a dollar of deposit—a 100% reserve. Then slowly
the bankers realized that all of the depositors did
not want to withdraw all of their deposits at the
same time, and that it was safe to use some of the
money deposited with them, keeping on hand enough
to meet any demand that was likely to arise; in
other words, to operate on less than 100% reserve.
6
BANK DEPOSITS
Here began the modern bank, and here began
modern business. The power of a gold dollar was
doubled. The banker put the gold dollar back into
circulation by lending it to some merchant to use
in his business, while the original depositor drew
his check and on that check did a dollar's worth of
business; hence the dollar was doing double work.
Theoretically it was the same dollar, practically
it was two dollars. Theoretically the banker had
to pay out that dollar in coin upon the presentation
of the check; practically he did nothing of the kind.
With one and one-half billions of cash in bank, the
banks now support sixteen billions of "deposits".
The bank checks drawn against these deposits for
the year 1910, passing through the clearing houses,
aggregated 168 billion dollars. The business trans¬
actions represented by this enormous aggregate of
bank checks was transacted by mere assignments
of credit—bank "deposits"—and the amount of
actual cash used was, comparatively, infinitesimal.
There was not at any time in all the banks together
more than about one and one-half billion dollars.
This one and one-half billions of cash expanded
into sixteen billions of medium of exchange; and
with better banking machinery can be made to
expand still farther.
7
periodic financial panics
The original bank deposit was created by
depositing in bank the actual coin. The modern
"bank deposit" is created when the banker uses
this coin as he sees fit, without consulting his
"depositor", so that the money flows back through
the channels of trade as a new deposit.
Let us follow the actual bookkeeping of the trans¬
action. It will simplify matters if we consider all
banks as one banking machine. The first depositor,
"a", places in bank in coin $100,000.00. The
banker loans $50,000.00 in coin to "x". "x" pays
out the money to laborers for work done for him,
who in turn pay it to merchants, "b", "c", "d"
and "e" who, in turn, deposit it back into bank to
their individual credit. The money is now all
back in bank, and we find the books of the bank
reading as follows :—
Assets.
Cash on hand $100,000
Loan to "x" 50,000
Total $150,000
Liabilities.
Owe to depositor "a" $100,000
Owe to depositor "b," "c," "d" and "e"|„ 50,000
Total deposits. $150,000
Thus the bank "deposits", that is, the amount
due depositors,—the credit balances at the bank
8
BANK DEPOSITS
against which the "depositors" may draw checks,—
the liquid capital of the nation—^has been increased
from $100,000.00 to $150,000,00 through the action
of the bank in making the loan to "x".
The same transaction is effected more quickly
in modern practice. The loan to "x" is a mere
order to the cashier to credit "x" on the bank's
books with $50,000.00, leaving it to "x" to issue
his checks against same as he sees fit, so that no
coin is handled at all; yet this new credit balance
of "x" is a bank "deposit".
Instead of making a loan to "x" the bank may
buy some security outright from "x", paying him
with "depositors'" money. As soon as "x" re-
deposits this money, a new bank "deposit" is created,
because the bank still owes its old depositors and
now owes "x" the amount of the new "deposit".
It will be noted that the merchants "b", "c",
"d" and "e" have "deposits" at the bank,
although they have not procured any bank loan nor
sold anything to the bank, nor do they know any¬
thing about the original deposit by "a" or the
loan to "x". Yet it is apparent that had the bank
not made the loan to "x", no money could have
been paid to the laborers, such laborers could not
have paid the merchants, and the merchants could
9
PERIODIC FINANCIAL PANICS
have no "deposits". Hence the merchants "b",
"c", "d" and "e" and the laborers were just as
vitally interested in the loan as was "x".
The way that bank "deposits" in American
banks are created therefore is:—
1. By depositing in bank actual money. The
total deposits from this source cannot exceed
the actual coin in the nation—about
three and one-half billion dollars.
2. By borrowing from the bank (loans and
discounts).
3. By selling something to the bank (in¬
vestments).
Theorists may complain that the coin loaned
or paid to "x", as above described, may not flow
back into bank. The fact is that it does, all theories
to the contrary notwithstanding. The United States
Comptroller of the Currency gives a table showing
amount of money in the hands of the people and the
amount in the hands of the bankers at different times
during the past twenty years, and this table shows
that there is steadily more cash going back into
bank than there is going out of the bank. See
table, page 29.
Theorists may complain that in the above
example the bank laid itself open to disaster be-
10
BANK DEPOSITS
cause, by loaning to "x", $50,000.00, and depleting
its cash on hand below $100,000.00, it would not
have been able to honor the check of the depositor
"a", had he demanded all his "deposit", as he had
a right to do. This would be true if "a" was the
only depositor of the bank. It is unsafe for a bank
to keep on hand less than any one depositor can
draw out. A bank with only one depositor would
be unsafe in keeping less than 100% reserve. But
a bank has a great number of depositors, some
putting in as others draw out, and in actual practice
the banking machine keeps on hand less than
ten cents in cash on each dollar of "deposits".
It is thus seen that bank "deposits" (beyond
the actual cash in bank) are created by the action
of the banks in using their depositors' money for
loans, discounts and investments. A glance at
the statistics will show how closely related are
these ßgures. The report of the United States
Comptroller for 1908, page 31, gives a table showing
the principle items of resources and liabilities of
all reporting banks other than- National banks—
unfortunately the figures of the National banks
for the same dates are not available—^but these
figures are sufiBciently complete to show the re¬
lation between loans, discounts and investments
11
periodic financial panics
and cash on hand on the one side and "deposits"
on the other.
Consolidated Returns from State, Savings,
Private Banks, and Loan and Trust Com¬
panies.—From Report U. S. Comptroller, 1908,
page 31.
{In Millions)
Items
1900
1904
1906
1907
1908
Loans
. 3013.4
4360.2
5656.8
6099.8
5797.6
Bonds
.. 1723.8
2522.8
2790.1
2931.5
2873.2
Cash
.. 220.6
301.5
334.9
391.8
479.1
Total
Deposits...
.. 4957.8
7184.5
8781.8
9424.1
9149.9
..4780.8
6688.1
8159.8
8776.7
8409.3
How Bank "Deposits" are Limited
Is there any limit to the amount of bank "de¬
posits" that may be created? The bank "deposits"
are created, as just explained, by the loans, discounts
and investments of the banks. Whatever limits
the amount of such bank loans, discounts and
investments, therefore, limits the amount of bank
"deposits."
The foundation theory upon which our entire
banking system rests is that all the "depositors"
will not call for all their "deposits" at the same
time, and therefore, it is safe for the bank to use
a portion of same, keeping on hand a sufficient
reserve of cash to meet all current demands. The
question as to just how much reserve shall be kept
on hand is the great question for each banker to
12
BANK DEPOSITS
answer for himself, and the amount deemed nec¬
essary for each bank will fluctuate with the season
of the year and the condition of the money market.
In a farming community the withdrawals during
harvest and the moving of the crops will be the
heaviest. The rest of the year the movements
will be slight, hence the banker loans deeply after
harvesting season, letting his cash reserve run low,
but towards next harvest season, he calls in his
loans and increases his cash reserve.
If a bank operates on a 50% cash reserve, it
means that for every dollar of "deposit "it must have
fifty cents of cash. Hence, if a bank has deposits
of a million dollars and cash on hand of a million
dollars, it could loan out five hundred thousand
dollars, leaving $500,000.00 cash, or 50% of the
deposits.
If the same bank operated on a 20% cash re¬
serve, then it could loan eight hundred thousand
dollars, leaving $200,000.00 cash in bank, or 20%
reserve. Hence, the amount of loans that a bank
can make depends upon what percentage of cash
reserve it operates and how much cash it has in
bank.
In the early days when a depositor issued a
check, the holder would probably demand the cash
from the bank, and it would be some time perhaps
13
PERIODIC FINANCIAL PANICS
before that particular cash was put back into the
channels of trade and flowed back to the bank as
a new " deposit." Hence, in those days conservative
bankers probably kept on hand cash equal to per¬
haps 75% of their "deposits," that is to say, they
operated on a 75% cash reserve. Later on, when
banks came into more intimate touch with all
classes of the people, the holder of the check was
less likely to demand cash, but instead simply
deposited the check to his own credit at bank, so
that the banker merely made an entry on his books
crediting the new depositor and debiting the old
one. Hence, the check became a mere assignment
of credit, and the business transaction which gave
rise to the issuance of the check was thus completed
without the use of cash, but merely by an assign¬
ment of credit.
The more universal this practice became, the
more perfect became the bank machine; the less
reserve the banker found it necessary to keep,
the more loans he could make, and more bank
"deposits" were created.
But every bank must keep some reserve of cash
for every dollar of "deposit", and it must stop
making loans when it has no more cash outside of
the reserve chest. So that the amoimt of bank
14
BANK DEPOSITS
"deposits " depends upon the amount of bank loans,
discounts and investments, and the amount of
these in turn depends upon the amount of cash on
hand over and above what the banker is holding
for reserve.
The banks of America now maintain check¬
ing "deposits" of $8,125,000,000.00, with cash
in bank of $1,503,000.00, or about 5 for 1. (See
tables 87, 88 and 91,Report U.S.Comptroller, 1911).
In England and on the Continent of Europe the
banking machinery is still more perfect, and there
they maintain a much larger credit structure upon
less actual cash. If our bank machineiy was as
perfect, our "deposits" could and would vastly
expand, thereby giving to the business man the
"liquid capital" of which he is in such crying need.
15
THE BANKING MACHINE
Deposits
There are 24,000 banks in America, each a
separate, independent unit of the great banking
machine. This machine draws to itself all the
cash it can get, and upon this cash as a foundation
rears a great credit structure of loans, discounts
and "deposits".
It takes a dollar of gold and multiplies it into
many dollars of loans, discounts and investments,
the proceeds of which flow out into the channels
of trade and come back to the banking machine as
new "deposits", and these "deposits" constitute
the great bulk of the exchange medium—the liquid
capital—of the nation;—^but the machine must
have the dollar first.
Let us see just how the machine operates :—
Suppose that all banks operated on a 25%
reserve, that is, that they loaned out all moneys
in excess of 25% of their deposit liabilities. Let
us say a deposit of $100,000.00 gold is made in any
bank. The bank must set aside as reserve 25%
or $25,000.00, and may loan the remainder, or
17
PERIODIC FINANCIAL PANICS
$75,000.00. This $75,000.00 when loaned flows
back as a second deposit to some bank. The
deposits are now $175,000.00, and the cash is back
in bank. The bank sets aside for reserve 25%
of this second deposit or $18,750.00, and loans
out the remainder, $56,250.00. This $56,250.00
again flows back as a third deposit, and the bank
sets aside for reserve 25% of it, $14,062.50, and
loans out the remainder, $42,187,50, which flows
back as a fourth deposit, and so until the total of
all the deposits amount to $400,000.00, when the
banks can loan no more because the whole of the
$100,000.00 of gold will be in the reserve chest, as
a 25% reserve. Hence, if the banking machine of
America operated on a 25% reserve, it could create
bank deposits through loans, discounts and in¬
vestments of four times the cash in bank.
Let us suppose that the entire banking machine
operated on a 10% cash reserve basis. The first
deposit would be $100,000.00, of which $10,000.00
would go into reserve and $90,000.00 out into
loans. When this $90,000.00 flowed back, $9,000.00
would go into reserve and $81,000.00 out into
loans. Carry out the process to the end and it
will be found that the "deposits"will amount to one
million dollars when the loans stop on account of
18
THE BANKING MACHINE
all of the original $100,000.00 of gold being in the
reserve chest as a 10% reserve. Hence, if the
banking machine operated on a 10% cash reserve, it
could multiply every reserve dollar into ten dollars
of bank "deposit". The difference between a
banking machine that creates four dollars of liquid
capital, and a machine that creates ten dollars of
liquid capital out of the same dollar means to the
working people and business men of America the
difference between having a bank "deposit" of four
dollars or having one of ten dollars.
The point to be clearly noted and understood
is that the amount of loans, discounts and invest¬
ments that can be made by the banking machine
of America depends upon (1) the amount of cash
on hand, {2) the percentage of cash reserve on
which the banking machine operates, (S) the
amount of "deposits." These are the fundamental
working parts of the banking machine. Whatever
affects one of the parts affects all.
Put new money into the banking machine
and new loans are made. The effect of the loans
is to increase the "deposits". The "deposits"
are mere entries on the bank's books, but against
every entry a cash reserve must be set aside, hence
the increased "deposits" require more reserve. All
19
PERIODIC FINANCIAL PANICS
the new money goes into the reserve to support
the new "deposits", and the loaning stops. Con¬
versely, if the banking machine finds that its "de¬
posits" have expanded and that it has not enough
reserve money on hand, it must reduce its "deposits".
It therefore calls its loans, that is, demands that
they be paid. To pay a loan a check is drawn
against some "deposit", thus reducing that "deposit".
The check goes to the bank itself and is credited
to "Loans and Discounts" and not to "Deposits",
hence the sum total of bank "deposits" is reduced.
The "deposits" being thus reduced, the amount of
cash necessary to be kept in reserve is decreased.
Hence the banking machine now finds itself with
enough reserve money, though it has not a dollar
more than it had before and not a dollar of actual
coin has been handled in the transaction.
To go back to our first example. "X" may
have gilt edged bonds and offer them as collateral
for a bank loan, and he may intend to use the pro¬
ceeds of the loan to build a factory. If the bank
caimot make the loan because all its money is in
the reserve chest, the factory cannot be built, the
laborers cannot be employed, and they cannot buy
of merchants, and there is nothing for the merchants
to deposit in bank. Hence, it is of the most vital
20
the banking machine
importance to the laborers and to the merchants
that the bank make the loan to " x The laborers
and the merchants do not know "x". He may
get his loan in New York City, and with the proceeds
of the loan purchase some securities from a party
who uses such proceeds to build a factory in Seattle.
The laborers in Seattle pay the retail merchants
there, who in turn pay their wholesale houses in
St. Louis. The bank "deposit" of the St. Louis
wholesaler is increased. It would not have been
had not the loan been made, as there would have
been no factory built and no goods used. Hence,
the pocket of every one in the business world is
affected by the operation of the banking machine.
The more loans, discounts and investments the
banking machine can safely make on a given amount
of cash, the more business will be done and the
more bank "deposits" will the people have.
Currency
Certain American banks have been granted
power to issue a limited amount of promissory
notes, payable on demand, which notes pass from
hand to hand as money and are termed currency.
These credit instruments are kept afloat on the
same theory that keeps afloat bank "deposits",
to-vdt, that all the holders will not demand payment
21
PERIODIC FINANCIAL PANICS
of all the notes at the same time. The same gold
reserve that supports the "deposits" also, in fact,
supports such outstanding notes.
Such American bank notes actually serve the pur¬
pose of money, for, if they are presented to the
bank for payment, they are paid and reissued. As
a matter of fact, they are not presented for payment
at all, they pass in and out of the banks the same
as any other kind of money. There are seven
hundred million dollars of United States bank
notes outstanding that for all practical purposes are
the same as gold.
There is no specific gold reserve required to be
held, but if there was not in fact a large mass of
gold in the bank out of which such notes, if pre¬
sented, could be paid, the people would lose con¬
fidence in them and would demand immediate
payment in gold. As a matter of fact, there has
never been the slightest doubt of the ability of the
banks to pay these notes on demand, and such
notes are accepted as money by the people, and are
also used by state banks as part of Ihe cash reserve
held against "deposits." To withdraw these notes
from circulation would be a national calamity;
not only would it reduce the circulating medium
by seven hundred million dollars, but it would
22
THE BANKING MACHINE
draw out from the state banks the reserve founda¬
tion upon whieh a great mass of loans, discounts
and "deposits" depend.
Hence the banking machine not only takes a
dollar of gold and upon it as a reserve rears a great
structure of loans, "deposits," etc., but on the same
dollar, issues credit instruments which are called
money and do in fact perform all the work of money
and become the foundation upon which a new
credit structure is reared.
The Bank of England not only issues a certain
limited fixed quantity of uncovered paper very
similar to our national bank notes, but also issues
daily currency to meet daily demands. As soon
as this daily currency fiows back to the bank, it
is cancelled, so that in effect such currency is nothing
more than a bank check, drawn by the bank itself
instead of by an individual depositor. The Amer¬
ican National Bank notes cannot be cancelled
instantly upon their fiowing into a bank, and hence
become an addition to our permanent stock of
money, and credit structures are reared upon such
money. These notes perform a great service and
should be let alone, but they do not perform the
service of the daily currency issues of the Bank of
England. We have nothing similar.
23
PERIODIC FINANCIAL PANICS
The American farmer usually pays all his bills
in bank checks the same as any one else, but at
harvest time he employs a great number of strangers
who demand payment of wages, etc,, in cash, as
they have no facilities for using checks. The
farmer therefore every Fall draws from the banking
machine actual cash to the amoimt of several
hundred million dollars. The banks have no such
amount of available money on hand—it is all in
the reserve chests. To get it out of the reserve
chests it is first necessary to remove the credit
structure of loans, discounts, investments and
" deposits " reared upon it. [That means the calling
of loans and discounts, the sale of securities, the
reduction of "deposits" and the violent disturbance
of the entire credit structure. The Bank of England
would simply issue its own checks in small de¬
nominations and give them to the farmer in return
for the farmer's check against his "deposit". Such
checks would be called "currency" or "money",
but in fact, it would be simply taking the bank
check of the farmer against his own "deposit"
and splitting it up into a number of smaller checks
bearing the signature of the bank. When such
checks came back, they would be cancelled exactly
the same as an ordinary bank check. Thus in
England the crop movement could be financed on
24
the banking machine
the farmer's own bank "deposit" converted into
another form of bank credit, and without disturbing
the money market.
In America we cannot do that, simple as it is.
Our banks must draw these hundreds of millions of
dollars of actual cash out of their reserve chests,
and to get them out must first destroy the credit
structure of loans, discounts and "deposits" that are
reared upon same. Hence every Fall we hear of
"tight money", high interest rates, called loans,
stock market disturbances; and all for want of
common sense credit machinery.
Commercial Paper
The banking machine of England is permitted
by law to endorse commercial paper, thereby
guaranteeing its payment. A merchant "a" sells
goods to another merchant "b" on sixty days'
time, "a" at once draws a draft on "b" payable
in sixty days, "b" writes the word "accepted"
across the face of the draft and returns to "a."
"a" now endorses the draft and takes it to a bank.
The bank for a small fee also endorses the draft.
The draft now bears three names of going concerns.
All three have got to fail within sixty days to make
the paper worthless. As this is extremely unlikely,
25
PERIODIC FINANCIAL PANICS
such paper bears the highest possible credit and is
very readily sold in the market at par. While
the banks make very small fees out of these trans¬
actions, the merchants reap tremendous advantages.
An American merchant in the place of "a" would
have his capital tied up in the goods sold "b". He
would have a mere book account against "b", and
book accounts cannot be sold very readily and only
at a sacrifice; but the English merchant can sell
without loss the draft of "b" and get back his
capital. Hence the American merchant is working
at a tremendous disadvantage, but he cannot seem
to see it.
A credit balance at the bank is liquid capital,
the same as money in pocket. If this liquid capital
lies idle, it is not good for trade. Merchant "a"
may have a credit balance at the bank of $100,000.00
which he will need in sixty days, but not before.
Merchant "b" may want to borrow $100,000.00,
but is without collateral other than his book accounts
showing that amount of money owing to him,
usually termed "accounts receivable". Under our
present system "b" would not meet "a", and even
if he did, the "accounts receivable" would not
interest "a", and "a's" credit balance would lie
idle.
26
THE BANKING MACHINE
Under the English system "b" would have the
notes or accepted drafts of his customers for $100,-
000.00, payable in thirty to sixty days instead of
mere book accounts. He would endorse this paper,
get the bank to endorse it, and offer it for sale at
3% to 4j% discount per annum. Merchant
"a" having a credit balance lying idle, not wanted
for sixty days, would be looking for just such an
investment, knowing that even if he wanted his
money back before the paper became due, he could
sell it instantly without loss or expense. Hence
he would issue a check transferring his credit balance
to "b", who would put it to use. The banking
machine would have the same amount of deposits,
would have earned a fee for endorsing the paper,
and would not have been called upon unnecessarily
to extend a credit to "b", thus conserving its reserves.
London is the financial center of the world
simply because of the perfection of its credit ma¬
chinery. If the American banks had as perfect a
machine, we would instantly become the greatest
financial nation on the globe, because of our great
stock of gold. All that is needed is a very few
changes in our present banking laws.
27
MONEY
The following table from the report of United
States Comptroller, 1911, page 61, shows the total
money in America and how it is distributed :—
Coin and other
Coin and other
Coin and other money
Coin and
money in Treas¬
money in report¬
not in Treasury or
Year
other
ury as aiisets.'
ing banks."
banks.
ended
money
June
in the
30—
United
States
Amount
Per
cent
Amount
Per
cent
Amount
Per
cent
Per
capita
Millions
Millions
Millions
Millions
1892
Sl.752,2
S150.9
8.60
$ 586.4
33.48
$1,014.9
57.92
$15.50
1893
1,738.8
142.1
8.17
515.9
29.68
1,080.8
62.15
16.14
1894
1,805.5
144.2
7.99
688.9
38.17
972.4
53.84
14.21
1895
1,819.3
217.4
11.95
631.1
34.96
970.8
53.36
13.89
1896
1,799.9
293.5
16.31
531.8
29.55
974.6
54.14
13.65
1897
1,906.7
26.5.7
13.93
628.2
32.94
1,012.8
53.13
13.87
1898
2,073.5
235.7
11.37
687.7
33.17
1,150.1
55.46
15.43
1899
2,190.0
286.0
13.06
723.2
33.02
1,180.8
53.92
15.51
1900
2,339.7
284.6
12.16
749.9
32.05
1,305.2
55.79
17.11
1901
2,483.1
307.8
12.39
794.9
32.02
1,380.4
55.59
17.75
1902
2.563.2
313.9
12.24
837.9
32.69
1,411.4
55.07
17.90
1903
2,684.7
317.0
11.80
848.0
31.59
1,519.7
56.61
18.88
1904
2,803.5
284.3
10.14
982.9
35.06
1,536.3
54.80
18.77
1905
2,883.1
295.2
10.24
987.8
34.27
1,600.1
55.49
19.22
1906
3,069.9
333.3
10.86
1,010.7
.32.92
1,725.9
56.22
20.39
1907
3,115.6
342.6
11.00
1,106.5
35.51
1,666.5
53.49
19.36
1908
3,378.8
340.8
10.08
1,362.9
40..34
1,675.1
49.58
19.15
1909
3,406.3
300.1
8.81
"1,444.3
42.40
1,661.9
48.78
18.68
1910
3,419.5
317.2
9.27
1,414.6
41.37
1,687.7
49.36
18.68
1911
3,555.9
341.9
9.61
1,545.5
43.46
1,668.5
46.93
17.75
^Public money in national-bank depositaries to the credit of the Treas¬
urer of the United States not included.
^Money in banks of island possessions not included.
^Compiled from special reports, April 28, 1909.
Note—^This table has been revised and shows slight changes from
previous figures in a number of the items for the years 1892 to 1900, in¬
clusive.
Of a total of three and one-half billion dollars,
therefore, about one and one-half billion is in the
29
PERIODIC FINANCIAL PANICS
pockets of the people, one and one-half billion in
the banks, and one-third of a billion in the United
States Treasury.
The money in the pockets of the people is,
generally speaking, the money that they get in
their pay envelopes Saturday and spend during
the week. The merchants get it and deposit it
back in bank ready for next pay-day. This part
of the money is used as actual medium of exchange.
It passes from hand to hand in payment of the
smaller business transactions.
The money in the banks is kept there, securely
locked in vaults, seldom touched or seen, but that
money is the foundation for the great structure of
credit—loans, discounts and deposits—reared upon
it.
The money in the United States Treasury is
not used for any purpose whatever while it stays
there; it is dead money; if this three hundred forty-
one million dollars was in the banks, it would be
multiplied into from one thousand to three thousand
million dollars of "liquid capital"—bank "deposits"
with which the American people might finance
their affairs—(the state banks with only two hundred
thirty-six millions on hand maintain over two and
one-half billions of deposits with it).
30
money
It is thus seen that money serves two great
purposes. In the hands of the people it is a medium
of exchange passing from hand to hand as payment
and settlement of business transactions. In the
vaults of the banks it is the raw product out of
which the bank manufactures loans, discounts,
investments, deposits and credit instruments. It
is the foundation of the great credit structure which
reaches out and touches every citizen, and upon
the safety and security of which depends the business
fabric of the nation.
Cash in Hands of People
The people require a certain amount of cash in
hand. The foregoing table shows the amount to
be a very steady, non-fluctuating quantity. The
amount per capita in 1911 was identically the same
as the amount per capita in 1901, to-wit, $17.75.
There is much loose talk of vast amounts of cash
being hidden away in "the old stocking", in safety
deposit boxes, etc., but there is little or no evidence
of any very great amount being so hidden. The
Postal Savings Banks were designed to bring out
into the channels of trade this hidden hoard, but
so far the total - deposits of such banks are under
thirty millions, and it will be interesting to see from
the next table of the Comptroller showing the
31
periodic financial panics
distribution of cash whether this was in fact
"hoarded" cash, or merely came out of the regular
banks.
The point to be noted is that the one and one-
half billion dollars of cash in the hands of the people
is cash that cannot be reached in any known way,
and therefore cannot be considered in figuring the
amount of cash available for bank reserves.
Cash in United States Treasury
The amount of money in the vaults of the
United States Treasury fluctuates with the times.
The more prosperous the times, the more taxes,
and hence the more cash is paid to the govern¬
ment. Every dollar so put away to sleep is
taken from the bank reserves and takes away
the foundation for many dollars of loans, dis¬
counts and deposits. The United States Treasurer
can re-deposit this money back in bank, but
does so only to a limited extent. By draining out
from the banks the gold upon which they have
reared a great structure of credit, the United States
Treasury does incalculable harm to the business of
the nation—even to the extent of helping on a
financial panic. No other country in the world
could stand such a drain. There is one very good
point about it, however; when the panic does come,
32
money
this mass of gold in the United States Treasury
needs but be put back into the market to instantly
restore the bank reserves and stay the panic. Until
the banking machine is so perfected that bank
panics are as unknown with us as they are with
other countries, it is very necessary that we main¬
tain the independent treasury system as a panic
breaker.
There is no way that the banking machine can
prevent either the people or the United States
Treasury from taking all the cash they want. The
banks must be content with what is left.
Kinds of Money
Money in use today is of two kinds (1) gold,
and (2) substitutes for gold. As the people have
repudiated silver as a reserve money, the only
fundamental money is gold. All other forms and
kinds of money and all credit instruments of what¬
ever kind or nature are founded upon the stock
of gold. Theoretically, every credit instrument
is a promise to pay in gold. In practice, however,
we have created certain credit instruments which
we call currency, and which actually do serve all
the purposes of money. The most important of
these instruments are the notes issued by the National
33
PERIODIC FINANCIAL PANICS
Banks, some seven hundred million dollars of
promises to pay. These instruments are backed
by a deposit qf United States bonds, and are re¬
deemable in gold on demand. It is just as feasible
for a bank to keep afloat this kind of credit as it is
to maintain bank deposits. It is simply a question
of how much gold reserve is kept on hand with
which to redeem such notes as are presented for
payment.
The Government also keeps a large quantity of
silver in circulation by its promise to redeem all
of it in gold on demand. It is a substitute for gold,
redeemable in gold, and passes at par only so long
as the Government is able to redeem in gold on
demand.
Practically every dollar in circulation, gold,
silver, or paper, is money and serves the same
purpose either as a medium of exchange or as a
bank reserve. Certain kinds of money cannot be
used as reserve in National banks, but same can
and are used as such in State Banks. Theoretically,
all kinds of money other than gold are merely
substitutes for gold and maintain their values
because they can be exchanged for gold upon
demand. Practically, it all stands upon its own
bottom, never will be exchanged for gold and ncA er
can be without destroying the banking machine
34
money
and with it the entire business fabric of America.
Suppose the National banks of America were
called upon to pay gold for the 700 million dollars
of outstanding National bank notes. Theoretically,
they will do this on demand. Practically, where
would the gold come from? They haven't got it
except in the reserve chests, and if it is taken from
there, the four billions of bank "deposits" in such
banks will be without support.
The underlying fact upon which the entire bank¬
ing and currency system is based is that a large
mass of gold, held as a reserve, will support and
maintain floating credit instruments many times
the value of the gold, because all such instruments
will not be presented for payment at the same
time, and any gold paid out at one time will flow
back into the bank and be ready to be paid out
the next time demand is made. Just how much
credit can be supported on a given quantity of gold
depends upon how perfect is the banking machinery.
Elastic Currency
Money may also be classified as (1) Permanent
money and (2) Temporary money. Permanent
money is that which, when put into circulation,
stays in circulation and forms part of the reserve
upon which the credit structure of the nation is
35
PERIODIC FINANCIAL PANICS
built. Temporary money is that which is issued
as a substitute for the bank check of an individual,
to be used for a particular purpose, like a bank
check, and when that purpose is accomplished, to
be redeemed and cancelled like a bank check.
Temporary money is what is really meant by
the term "elastic currency". We have no Tempo¬
rary money in America; it is all Permanent money.
Theoretically, the seven himdred million dollars
of National bank notes are Temporary money,
redeemable on presentation; practically, they are'
not redeemed, but continue indefinitely to circulate
as money. The notes can be cancelled only by a
cumbersome process. As a matter of fact, the
amount in circulation fluctuates very little. The
statistics show that such amount is gradually
increasing, there being seven hundred thirty-seven
millions October 1, 1911, against seven hundred
twenty-four millions November 1, 1910.
The idea is that Temporary money shall be
printed to look like Permanent money, so that it
will be accepted without question as money by the
people, but that it shall be issued only to meet a
temporary demand such as for moving the crops,
and when that demand is over, shall return to the
bank issuing same and be marked paid and can-
36
money
celled on its books by crediting the depositor of
same and debiting the account of "outstanding
currency", just as a bank check is cancelled by
crediting the "depositor" of same and debiting the
accoimt of the "depositor" issuing same.
It is easy enough to issue Temporary money,
it is easy enough to keep it afloat with the gold in
stock, but to get it back again when it has served
its purpose and to prevent its becoming part of
the permanent stock of money upon which new
credit structures will be reared, is not at all easy.
How to get this temporary money back again has
been the unsolved riddle of this nation, and it will
continue to be an unsolved riddle until we perfect
our banking machine. There is nothing mysterious
about the matter, however; other nations find no
difficulty.
Quantity of Reserve Money
It is very apparent, notwithstanding all the
talk of over-production, that there is not enough
gold to supply the demand of the banks for reserve
money, and it is not being mined fast enough to
meet the demand for cash reserves to be set aside
against the deposits created by the daily increase
in loans, discounts and bank investments.
37
PERIODIC FINANCIAL PANICS
The gold coming from the mines of South Africa
is sold at a premium on the London market before
the gold arrives there. The New York Journal of
Commerce in its issue of December 13, 1912, records
the fact that American bankers have been warned
not to bid for gold in the London market on threat
of a six per cent, bank discount rate by the Bank
of England. The same paper in its various issues
for several weeks preceding that date records the
severe competition that the banks of the world
have been engaged in to obtain more gold. The
withdrawal of even five million dollars of gold from
Berlin is a matter of world wide comment and
affects the exchanges of the world.
The banks of New York City during the last
week in November, 1912, were obhged to and did
reduce loans by fifty million dollars because their
reserves of cash had become impaired and it was
necessary either to reduce deposits or get more gold,
and they could not find the gold.
All the commercial nations are issuing great
quantities of uncovered paper money, that is,
credit instruments, redeemable in gold, to pass
as money and in fact remain in circulation as a
substitute for gold. If there is an over-production
of gold, as one class of theorists are constantly
38
MONEY
proclaiming, why are these substitutes for gold
kept in circulation? Why go. tofsücfe iróable aijd
expense to keep afloat substitutes for gold if there
is already too much of the gold itself? If there is
an over-production of gold why not immediately
cancel the seven hundred million dollars of National
bank notes, and in place thereof deposit seven
hundred million dollars of gold in the United States
Treasury and issue warehouse receipts for same,
the same as our present "y^ffow backs"? That
would be real, fundamental money. But every
banker knows that it is an impossibility to
get the fifth part of that amount of gold without
tearing it out from underneath the credit structure
of the world, and in doing so destroy that structure.
The "credit structure" means "bank deposits". It
is "bank deposits" against which a gold reserve is
held. If we have too great an amount of bank
"deposits", then we have an over-production of
gold, otherwise not. The existing gold and the
existing substitutes for gold that pass as money
cannot be reduced in quantity without reducing
bank deposits in the proportion of more than ten
dollars of bank deposit to one dollar of money.
Every man in this nation seems to have his own pet
theory about our banking and currency system,
3d
"FÍRIOÓIC FINANCIAL PANICS
but* i-hav^ yet .'+ö £nd one who desires the bank
dtij>i)^its-dec/eá^d. Yet a "deposit" cannot exist
without a foundation of reserve money, and re¬
serve money means gold.
All theories aside, the fact is very apparent
that the banking machine of America cannot look
for any substantial increase in its cash holdings,
and the amount of the liquid capital that such
banking machine can create and maintain for
the use of the American business men out of the one
and one-half billion dollars of cash it now has,
depends upon the perfection of its machinery. If
the machine cannot safely operate upon less than
20% average cash reserve, the commercial deposits
cannot exceed seven and one-half billions. If the
machine is so perfected that it will be safe to operate
on an average of 10% cash reserve, such commercial
"deposits" may increase to fifteen billion dollars.
There are now but eight billions. Such increase
in "deposits" would supply the liquid capital which
one of our most prominent railroad presidents and
financiers says is absolutely necessary if prosperity
is to continue.
40
THE BANK-CHAIN-RESERVE
SYSTEM OF THE UNITED STATES
Foreign Reserve Ststem
In other nations individual banks operate on
such percentage of cash reserve as they see fit
without any regulation by law, but in such nations
the banking and credit machinery is such that the
cash of the nation naturally flows to one central
bank, so that this bank becomes a great reservoir
of cash. The individual banks draw cash from this
central bank as they need it and redeposit it when
the need is over. The taxes and revenue collected
by the Government are also deposited there. The
individual banks keep credit balances—"deposits"—
with the central bank, against which they issue
checks as they desire. They also obtain cash from
such central bank by re-discounting with it the
promissory notes and accepted drafts of their
customers on which they had granted loans and
discounts.
Thus merchant "a" borrows from banker "b"
one hundred dollars upon his promissory note at
4% payable in sixty days. Banker "b", finding
41
PERIODIC FINANCIAL PANICS
at the end of thirty days that he desires cash,
endorses this note, takes it to the central bank and
obtains one hundred dollars, less interest for the
balance of the term at such rate as the central bank
is charging on the day of the discount. If this
rate is less than 4%, the banker makes a profit; if
over 4%, he has a loss. Hence if the rate of interest
charged by the central bank—the discount rate,
as it is termed—is low, the banker is apt to borrow
heavily and reloan to his customers, but if it is high,
he is apt to pay off all loans at maturity and wait
for a lower rate. It is by raising and lowering its
discount rate that the central bank keeps absolute
control over bank loans, discoimts, investments
and deposits. It can stimulate bank loans, dis¬
counts and investments, and thereby increase
deposits, by lowering the discount rate. It can
check the expansion of loans or force their payment,
thus checking the expansion of deposits or de¬
creasing the volume of same, by raising its rate.
Every banker in England knows just how much
cash there is in the central bank and how much
it will cost him to get any of it at any minute. He
knows positively the exact condition of the money
market and whether to loan freely at low interest
or to charge a high interest rate and retrench.
42
the bank-chain-reserve system of the u. s.
Many a man can make a profit on handling 3%
money that he cannot use at 5%. He borrows
when the discount rate is low, pays off when it
is high.
There is a limit to the amount of liquid capital
that can be created in England, but that limit is
positively known, and before the limit is reached,
further expansion is checked by raising the discount
rate until only those that absolutely must have
money continue to borrow, while others pay off
their loans and thus reduce deposits. The lack of
liquid capital checks business and brings on hard
times, but bank panics are unknown under such
system.
United States Reserve System
In the United States conditions are very different.
We have no central bank, no consolidated cash
reserves, no daily statement of the available and
loanable funds of the nation, no established interest
rate, no re-discount market, no control over loans,
discounts and investments, no way to prevent an
over-expansion of deposits, no way to protect our
reserves. When the Government collects taxes
and revenue, the cash goes out of the banks instead
of coming into the banks.
43
PERIODIC FINANCIAL PANICS
When the farmer wants to use cash instead of
bank checks to pay his help in the crop moving
season, the cash must come out of the reserve
chest and disturb the entire credit structure. The
banks have no power to substitute their own sig¬
natures on credit instruments in place of the farmers'
signatures.
Our reserve system is a curious chain-of-banks
system, each bank relying upon some other bank to
supply it with cash when cash is needed, and such
other bank relying upon some third bank, each
bank loaning out all its available cash outside of
its reserve funds, and no bank in the entire 24,000
actually maintaining an adequate fund to supply
even the banks that have credit balances with it.
Our Federal Government authorizes the in¬
corporation of banks under what is known as the
National Bank Act. Banks organized under this
act are known as National Banks. Such banks
now number about 7,000.
Each State authorizes the incorporation of banks
under general laws relating to banking, known as
State banks. Private banks and Savings banks.
They now number about 18,000. The State laws
do not generally require any specific cash reserve
against deposits, hence state, private and savings
44
THE BANK-CHAIN-BESERVE SYSTEM OF THE U. S.
banks are left free to operate on such percentage of
cash reserve as each individual bank may see fit.
Such banks in fact keep very little cash on hand,
but carry large credit balances in other banks and
rely upon such other banks to supply cash on call.
National banks are bound by very strict pro¬
visions relating to reserve. The banks are divided
into three classes. Those in New York City,
Chicago and St. Louis are termed Central Reserve
banks. They must keep on hand at all times in
lawful money 25% of their deposits, hence they
operate on a 25%, or more, cash reserve. Banks
in certain other designated cities, about fifty, are
termed Reserve banks, and must maintain a reserve
of 25%, but only half of it need be kept on hand in
lawful money. The balance may be a mere credit
balance at a Central Reserve bank, hence these
banks must operate on a 12|%, or more, cash
reserve. All other National banks are termed
Country banks, and must maintain a 15% reserve,
but only 6% need be kept on hand in cash, and 9%
may be a credit balance at a Reserve or Central
Reserve bank, hence these banks must operate on
a 6%, or more, cash reserve.
Whenever a National bank has on hand less
lawful money than is required for reserve computed
on the foregoing percentages, it must cease loaning.
45
PERIODIC FINANCIAL PANICS
Under this fixed percentage of cash reserve
system, the amount of "deposits" that can be
created by the National banks can be very de¬
finitely determined.
Let us suppose that one hundred dollars in gold
is deposited in a Country National bank and that
each bank in the chain loans to the limit of the law.
Of this one hundred dollars, therefore, the Country
bank would retain six dollars in its reserve chest,
send nine dollars to its Reserve bank, and loan out
eighty-five dollars. The Reserve bank receiving
the $9.00 as a deposit would retain 12|%, or $1.12|,
in its reserve chest, and send 12^%, or $1.12§, to
its Central Reserve bank, and loan the balance,
$6.75. The Central Reserve bank receiving the
$1;125 as a deposit would retain 25%, or 28| cents
as a reserve, and loan out the balance of 83f cents.
Hence the total cash reserve held by all the banks
together would be $7.40f.
If now the Country Bank should decide to
draw back in cash the nine dollars it had sent to
the Reserve Bank, such Reserve Bank would have
to (1) demand payment of its loan of $6.75, and (2)
draw back in cash from the Central Reserve Bank
the $1.12^. To get the $1.12| the Central Reserve
bank would have to demand payment of its loan
46
THE BANK-CHAIN-RESBRVE SYSTEM OF THE Ü. S.
of 83f cents. Hence, to reassemble in cash the nine
dollars which the Country bank calls "cash in
bank" compels the calling of loans in the Reserve
cities and in the Central Reserve cities.
The Report of United States Comptroller, 1911,
page 35, shows that on June 7, 1911, the banks of
the United States counted as part of their resources
credit balances at other banks (that is, with each
other) of $2,788,772,572.47, over two and one-half
billions of dollars, almost twice as much as aU the
cash of all kinds in all the banks at that time.
Each bank figured upon its credit balance with
some other bank as part of its working reserve,
considered it "ready money", "cash on call"; yet
it is apparent that such credit balances were not
cash on call, because one and one-half billions of
cash cannot pay two and one-half billions of calls
even if all the one and one-half billions is available,
but—and this is the great glaring defect in the
chain-of-banks-reserve-system—very little of this
money was available. With this same money these
same banks were maintaining individual "deposits",
savings "deposits" and other credit liabilities of over
fifteen billion dollars, all of this gigantic credit
structure resting upon this same one and one-half
billions of cash.
47
PERIODIC FINANCIAL PANICS
The report of the United States Comptroller,
1908, page 212, shows that on November 12, 1906,
which was near the top of a great business boom
and just before the beginning of the panic which
culminated in 1907, the National banks had loaned
to the utmost practical limit of their capacity, and
the Reserve and Central Reserve banks actually
did not have enough cash for legal reserve, the figures
being as follows:—
(Report U. S. Comptroller, 1908, P. 212.)
November 12, 1906.
Percent Percent
Deiwsits Lawful Cash Required
in Millions Money Reserve by Law
Central Reserve Cities. 1128.9 281.8 24.9 25
Other Reserve Cities.... 1372.5 167.4 12^ 12^
All Other Cities. 2468.5 185.3 7i 6
Total 4969.9 634.5
From this table it will be noted that the Reserve
and Central Reserve banks did not have a single
available dollar to pay to any one for any purpose,
and the Country banks had but very Kttle. The
legal reserve required of the Country banks was 6%
of $2,468,500,000.00, or $148,110,000.00. They
actually had $183,300,000.00, just thirty-seven
million over the legal requirement, so that the only
available cash in all the national banks in the nation
was thirty-seven million dollars. Yet at this very
48
THE BANK-CHAIN-RESERVE SYSTEM OF THE U. S.
time, the amount of credit balances held by these
banks with each other and counted as "cash at call",
was about one billion dollars. When the Western
bankers checked against their Eastern balances,
demanding cash, they of course could not get it,
because it was all in the reserve chests, but many
of them do not yet know why they could not get their
own "cash at call".
The only foundation for the credit structure of
any nation is the cash, the ultimate money, in that
nation. In other countries they take that money,
put it in one place where it can be seen, place it in
charge of responsible men and give those men proper
power to rjegulate the entire credit machinery of
the nation. In this country we scatter our reserve
money all over the nation, no one knows how much
is availablé at any time, and we fool our bankers
into counting as available reserve their credit
balances with other banks, which, however, cannot
possibly be converted into cash in time of stringency,
the only time it is wanted.
Our reserve system has failed every time it has
been tested, and it necessarily must fail whenever
a strain is put upon it. Each and every bank of
the banking machine cannot loan all its available
cash, (that is, expand its deposits, until all the cash
it has—the whole one and one-half billions—is in
49
PERIODIC FINANCIAL PANICS
the reserve chest), and then expect to convert into
cash the credit balances held by each bank with
some other bank. When all of the cash of the banking
machine is in the reserve chest, that is the end of
the game, no matter how much one bank may have
of "cash at call" on "deposit" with any other bank.
If there is no cash, it cannot get any, whether it is
entitled to it or not.
50
PERIODIC FINANCIAL PANICS
Financial panics always come as the culmination
of "boom" times; they never occur during hard times.
The direct cause of the panic is always the same—
an undue expansion of bank credits followed by a
disturbance of the cash reserves of the banking
machine.
The banking machine can take a gold dollar and
by loaning and reloaning it create a credit structure
of loans and deposits of a certain definite size and
can maintain this credit structure as long as it has
the gold dollar for a foimdation. But take away
that dollar and the whole credit structure neces¬
sarily falls. If the bank is given time, it can take
down the credit structure piece by piece, as a
building is wrecked to make place for another. It
can compel payment of maturing loans, refuse to
make more loans and thus reduce deposits until the
gold dollar is released from the reserve chest, but
this takes time. If the gold dollar is taken out
suddenly, the effect upon the credit structure is the
same as an explosion of dynamite in the foundation
of a building.
51
PERIODIC FINANCIAL PANICS
In " boom" times there is an enormous demand
upon the banks to make loans and discounts or
to invest in securities. Every business man feels
the rapid beating of the pulse of trade and desires
to extend his own lines. To do so he must have
liquid capital—a bank "deposit". He borrows
at the bank, spends the proceeds, which are re-
deposited and become another "deposit". Thus in
"boom" times the bank "deposits" expand and swell.
The "deposit" is a mere bookkeeping entry, but
against each entry there must be a reserve in
cash. The higher the "deposits" go, the more cash
must go into the reserve chest. At the top
of the boom all the cash possessed by the entire
banking machine goes into the reserve chest and
there is none left for loans or any other purpose.
Thatiswhyit is thetopof the "boom." If there was
any more available cash in bank so that more liquid
capital could be created, the "boom" would continue
until such cash was absorbed by the reserve. This
was the actual condition of the banks November 1'2,
1906, at the beginning of the panic that culminated
the next year, as appears from the table appearing
on page 48. The legal reserves of the National
banks in all the reserve and central reserve cities
were impaired. Their "deposits" were so large
52
PERIODIC FINANCIAL PANICS
that all the cash they had was in the reserve chests,
and even then they did not have as large a per¬
centage of reserve as the law demands that they
shall have. It is a very serious thing for a single
bank to find itself with less cash on hand than is
required by law. Such bank immediately attempts
to get a supply of cash. There are only three
methods by which it can get cash: (1) draw cash
from some other bank, in which bank it holds a
credit balance of its own—a "deposit"—or (2)
sell for cash its securities and investments, or (3)
demand that its customers pay off their loans and
discounts. When one bank tries any one or all
three of these methods, it is of little consequence
to the world at large. But when the entire banking
machine finds its reserves too low and every unit
in the machine starts at the same time to strengthen
\
its reserve, there is at once a nation wide disturb¬
ance. All the banks try the first method of drawing
on the other banks wherein they have "deposits".
The effect of this is simply to transfer the cash
from one bank to another. One bank may be
strengthened and another weakened, but the entire
machine gets no more cash by the transaction, and
the reserves are as much impaired as ever. The
banks then try the second plan of selling their
53
PERIODIC FINANCIAL PANICS
securities. Securities cannot be sold unless there
are buyers. If the entire banking machine cannot
buy the securities, and cannot lend money to men
who want to buy, it takes out of the market the
bulk of the buyers. Hence the effect of the entire
banking machine trying to sell securities on a market
from which the bulk of the buyers have been re¬
moved is to depress the price of such securities.
This is what happened in 1906-1907. There had
been a wonderful business expansion, "deposits" had
vastly increased. The banks had on hand more
cash money than ever before in their history—
1,010.7 million dollars—^but it was all in the re¬
serve chests. We all remember the cry of "currency
shortage". It was not the people that wanted
currency, it was not the United States Treasury,
it was the banks that wanted it, although they
had more of it than ever before, but their "deposits"
were expanding, and against the "deposits" they
were required to hold a cash reserve—they did
not have enough cash and had to get it somewhere.
General business conditions in America were
never so prosperous as in the winter of 1906-1907,
yet the effect of the attempt of the banks to in¬
crease their cash holdings by the sale of securities
and the call of loans caused a great decline in the
54
PERIODIC FINANCUL PANICS
quoted values of stocks and bonds on the New
York Stock Exchange. The decline began early
in January, 1907, and from then on until Fall
values simply melted away.
A vast number of the loans of the banks are
secured by stocks and bonds as collateral, and the
loans are made entirely upon the value of such
stocks and bonds, as determined by 'the daily
quotations of the New York Stock Exchange.
When the quoted values of stocks began to go
lower and lower, from January on, the banks found
the collateral on which they were loaning con¬
stantly shrinking in value, and hence were con¬
stantly demanding of their customers more collat¬
eral, and upon failing to get it, called the loan,
which meant in most instances the immediate sale
of the stocks and bonds, which of course further
demoralized the market.
The general business conditions in 1906-1907
were so splendidly prosperous that the bulk of the
business men, and in fact, most of the bankers
whose loans were not based on stocks and bonds,
refused to be frightened by 50% call money and
what they termed "a rich man's panic on the
Stock Exchange". In the late summer of 1907,
however, the farmers made their usual demands
55
PERIODIC FINANCUL PANICS
for cash to move the crops, and the Western banks
drew as usual upon their own credit balances in
the reserve centers, but the banks in reserve centers
could not honor the drafts of the Western banks.
They had no cash outside of the reserve chests.
There never was a more surprised body of men
than the Western and Southern bankers when they
found in August and September, 1907, that they not
only could not draw any cash from the great Eastern
banks that actually owed it to them, but that they
could not even sell for cash the gilt edged commercial
paper and other securities they were holding.
With the entire banking machine without a
dollar of available cash, with the farmers demanding
cash, with the quoted values of stocks shrinking
daily, it was only a question of time when some
weak link had to go. The panic broke when a
bank in New York closed its doors. A run started
on every bank in America, and if the people had
been permitted to draw out gold or other money,
thus tearing out the foundation from the credit
structure, the banks must necessarily have failed,
as it is impossible to pay sixteen dollars of deposit
with one dollar of money and impossible to maintain
a credit structure without a foundation of cash.
The effect of the failure of the banks is to destroy
56
periodic financial panics
the bank "deposits" and leave the nation with a
greatly reduced volume of liquid capital or ex¬
change medium. This is what happened in 1893,
and that is why it took the nation so long to get
over the panic. The supply of liquid capital was
greatly reduced, and it took years to create more.
Nobody had any "money" on which to do business
for several years. In 1907, however, the banks
were better organized, and they simultaneously
suspended specie payment, but permitted checks to
be used the same as before. Thus the exchange
medium was not destroyed, and the business man
collected his credits in the form of checks just as
before and liquidated his own bills with checks,
and business went on as usual; hence we had little
of the hard times following 1907 that we had in
1893, because the liquid capital of the people was
not destroyed.
The Panics of the Past
The panic of 1837 was directly due to the action
of the Government in establishing its Independent
Treasury System and withdrawing from the in¬
dividual banks large amounts of cash, thus dis-
tiu-bing the cash reserves of the entire banking
machine.
57
PERIODIC FINANCIAL PANICS
"Black Friday" was caused by speculators who
systematically withdrew gold from the banks at a
time when bank "deposits" had expanded to a point
where the greater portion of the cash in bank was
in the reserve chests, thus producing what was
then termed a "gold corner". The panic was in¬
stantly stayed when the Government deposited
with the banks a large quantity of gold from the
vaults of the United States Treasury.
The panic of 1893 was due to the sudden loss
of confidence in silver as a reserve money and the
attempt to shift the entire credit structure to a gold
foundation.
Cause of Periodic Financial Panics
It has been repeatedly stated that panics are
caused by "an over expansion of credits", but I
have failed to find any explanation of how this
over expansion operates to produce a panic. From
such a statement one would naturally suppose that
creditors were unable to collect from debtors, thus
causing commercial failures; but it is a matter of
common knowledge that the failure, in large numbers,
of commercial houses usually follows a panic in¬
stead of preceding it, and that a panic usually
starts in the banking machine.
58
PERIODIC FINANCIAL PANICS
The statement is also frequently made that in
"boom" times vast quantities of liquid capital are
"converted" into fixed capital, through the pur¬
chase of great quantities of securities, the con¬
struction of railroads, factories, etc., thereby pro¬
ducing a liquid capital famine. It is apparent,
however, that liquid capital is not, and cannot be,
"converted" into fixed capital in any such way—it
is merely transferred, or assigned, from one set of
people, the purchasers, to another set, the sellers,
and in the hands of this second set of people is just
as much liquid capital as it was before.
It is true that an over expansion of credits is
the first step in the cause of panics, but it is bank
credits, loans and discounts, and not commercial
credits that are over expanded. These bank credits
are not over expanded in the sense that individuals
have been permitted to borrow more than they are
able to pay, but in the sense that the banks have
created a larger credit structure than they can
support with the cash on hand.
The withdrawal of large amounts of cash from
the banks so that the reserves are pulled from
under the credit structure, is bound to cause a
panic, but under the fixed percentage of cash-
chain-of-banks reserve system of our nation, we
59
PERIODIC FINANCIAL PANICS
are bound to have a panic whenever we have
"boom" times.
The cause of our periodic financial panics there¬
fore is :—
(1) Boom times, causing a great expansion of
bank loans, discounts and investments;
Which causes
(2) An expansion of "deposits";
Which causes
(3) The exhaustion of all the cash in bank to
meet the requirements of our fixed cash reserve laws;
Which causes
(4) All of the individual banks to attempt to
get cash by drawing from each other, each bank
under our chain-of-banks reserve system having the
right to demand cash, but no bank having any to
give;
Which causes
(5) The Central Reserve banks upon whom the
greatest demands for cash are made by the other
banks to try to sell securities when there is no one
to buy, and to try to force payment of loans on a
boom market;
Which causes
(6) A reduction in the amount of liquid capital
at the very time that the booming market needs it
most, creating a capital famine;
60
PERIODIC FINANCIAL PANICS
Which causes
(7) High interest rates for call loans, a falling
stock market, forced liquidation, a cry of "cur¬
rency shortage" and a feeling of uncertainty in the
business world;
Which causes
(8) A wild rush to sell everything and to draw
all money out of banks;
Which causes
(9) Panic.
Any withdrawal of cash from the banks at such
time, whether by the farmers, the United States
Treasury, or by speculators, helps along the panic,
but "boom" times will eventually eat up all the cash
for reserves without any outside help.
The panic of 1907 was an absolutely natural
panic, the kind of a panic that we shall have again
as soon as we have a business boom and the bank
loans increase and cause the "bank deposits" to
expand until all the cash in bank is in the reserve
chest.
This nation is constantly growing greater and
there is a constant and ever increasing demand for
liquid capital. Liquid capital is created by the
banking machine, but the amount that can be so
created is absolutely limited by (1) the amount of
61
PERIODIC FINANCIAL PANICS
reserve money in the vaults of the banks and (2)
the percentage of cash reserve upon whicb the
machine can safely operate. The banking machine
reached the extreme limit of its loaning capacity
in 1906 and had to stop making loans, which meant
it had to stop creating liquid capital. The "boom"
was still in full force and the demands for liquid
capital enormous. The cry of "currency shortage"
was heard everywhere, but the real trouble was a
capital famine.
We cannot have a new business boom unless
there is enough liquid capital to finance it, no matter
how wonderful may be our crops nor how impatient
our business men to expand their fines. A boom
cannot get far on 6% money and little of it. 12%
call money in Wall Street does not mean "currency
shortage"; it does not mean stock gambling; it
means a nation wide "capital famine".
62
REMEDY
The fundamental defects in our banking
machine are :—
(1) Inability to create as much liquid capital
from a given quantity of gold as is done by the
banking machine of other nations—due largely to
the fixed percentage of cash reserve law and the
uncertainty of the cash supply.
(2) Inability to check the over expansion of
bank "deposits" beyond the ability of the cash on
hand to support same, and utter lack of control
over such expansion of credits—due to the scattering
of the cash reserves through the chain-of-banks
system, and the lack of a re-discount market with
a national daily discount rate.
(3) Inability to issue Temporary money to meet
temporary demands instead of using Permanent
money which should be left in the reserve chests
to support the credit structure—due to the in¬
ability of the machine to get such temporary money
back again when the purpose for which it was
issued has been accomplished.
63
PERIODIC FINANCIAL PANICS
(4) Inability to give circulation and a ready
market to commercial paper by endorsing same so
that our merchants might have the use of their
liquid capital instead of having it tied up in "ac¬
counts receivable".
(5) Inability to prevent its reserve of gold
from being drained from under its credit structure
by the United States Treasury—due to the main¬
tenance of a separate banking machine by the
United States Government.
Therç is only one possible way in which these
defects can be remedied, and that is by abolishing
our present reserve system, changing the Indepen¬
dent United States Treasury system, and creat¬
ing a Central bank to hold the consolidated
cash reserves of the entire nation, with power to
re-discount (for banks only),issue Temporary money
in limited quantities, and have all the incidental
powers of the central banks of other nations.
This Central bank should be prohibited from
receiving deposits except from banks, prohibited
from advancing money except to banks, and be
prohibited from purchasing securities.
We do not want a new bank to compete with
old ones; what we want is a quasi-public insti¬
tution of great strength (1) to hold the consolidated
64
REMEDY
cash reserves of the Government and of all the
banks, (2) to loan back to the banks on re-discounts
as much of such cash reserve as is safe, in order
that the banks may re-loan it to the people, thus
creating the utmost possible amount of liquid
capital, (3) to regulate and control the credits of
the nation through its discount rate—discouraging
speculation by refusing to re-discount paper backed
by speculative stocks held for speculative purposes,
but accepting the paper of merchants originating
in actual business transactions or paper backed by
legitimate holders of stocks and bonds; (4) to issue
Temporary money and draw that money back
when its purpose has been accomplished, as it
could do through its control over the credit ma¬
chinery of the nation.
In order to get such a bank started, it would be
necessary to abolish the present Reserve system,
and in its place provide that every national bank
shall keep with such Central bank a credit balance
equal to say 10% of its deposits, and that all com¬
mercial state banks, private banks and trust
companies may keep such credit balances, and if
they fail to avail themselves of such privilege, be
prevented from enjoying any of the rights of re¬
discount. National banks should also be pro-
65
PERIODIC FINANCIAL PANICS
hibited from clearing for, holding a deposit of or
re-discounting for any other bank, thus breaking
up entirely the chain-of-banks system and making
every bank an independent unit dealing directly
with the Central bank.
The individual deposits of commercial banks
(other than savings accounts) on June 7, 1911,
amounted to 8,126 million dollars, and the cash in
such banks 1,503 million dollars. (See tables 81,
84, Report U. S. Comptroller, 1911.) Under this
proposed plan 10% of deposits, or 812 million
dollars, would be deposited in cash with the Central
bank, leaving 691 million dollars cash in the hands of
the banks, or 8^% of deposits, all of which would
be available for use and none of it dead money.
The Central bank would start in with the 812
million dollars deposited by the individual banks.
If the United States Treasury cash of 341 millions
was also deposited, it would increase the deposits
of the Central bank to 1,153 million dollars in cash.
If such Central bank operated on a 40% to 50%
cash reserve, the same as other similar institutions
do,'it could loan back to the banks from 575 to 690
million dollars in cash, such loans to the banks
being made by re-discounting the paper held by
such banks.
66
REMEDY
The amount of cash that an individual commer¬
cial bank must keep on hand to meet the daily
demands of its customers depends largely upon
how smoothly the credit machinery operates.
Savings banks keep on hand less than 1%, because
the depositors in such banks seldom draw out
their deposits, but if they should get frightened and
start a run, the banks have authority under the
law to refuse to pay for thirty days, thus gaining
time to obtain cash. By the time the thirty days
are up, the run is usually over. The reserve of the
Mutual Savings Banks was but 78-100 of 1%, or
78 cents for each one hundred dollars of deposit.
The Country National banks, over six thousand
in number, usually maintain cash on hand equal
to about 8% of deposits. With a perfectly working
Central bank system from which cash could be
obtained instantly, and which could issue Tem¬
porary money for crop moving and other temporary
purposes, so as to leave the Permanent money to
the permanent work of maintaining the credit
structure, how much cash on hand would the banks
require?
It is to be remembered that the more perfect
the banking machine, the less cash the people will
use and the more reliance will be placed on credit
67
PERIODIC FINANXIAL PANICS
instruments. The amount of cash in the pockets
of the people in the year 1901 was $17.75 for each
person, and that is exactly what it was in 1911,
ten years later. The highest amount of cash the
people ever drew out of bank was $20.39 per capita,
in 1906. In the five years ending with 1911, the
fluctuation in the amount of money in the hands
of the people was less than 25 million dollars, the
lowest amount being 1,661 million dollars in 1909,
and the highest 1,687 million dollars in 1910. In
1911 it dropped to 1,668 million. (See Table, page
29). These figures prove conclusively that it is
not necessary for the banks to keep on hand an
enormous fund of cash against the possibility of
the people suddenly drawing it out. The people
will not draw it out unless there be a panic, and
then the banks will not let them have it.
If, through the creation of a Central bank,
the individual commercial banks could safely
operate on a 5% cash working balance and a 10%
credit balance at the Central bank; and the Central
bank operated on a 50% cash reserve, then in¬
dividual "deposits" in such commercial banks
could expand to ten times the cash in the banking
machine, because there would be but 5% cash with
the banks, and the cash in the Central bank would
68
REMEDY
be 50% of 10%, or 5%, making a total of 10% cash
reserve against individual deposits; hence the
"deposits" could expand until they amounted to
ten times the cash in the banking machine. With
the present 1,503 million dollars and the 341 million
dollars from the United States Treasury, the banking
machine would have 1,844 million dollars in cash
and could grant loans and discounts and purchase
commercial paper, securities, etc., until the "de¬
posits" had expanded to ten times that amount, or
over 18 billion dollars, an increase in the supply
of liquid capital of over 7 billion dollars.
The figures would be as follows:—
INDIVIDUAL BANKS
(Excluding Savings and other accounts not
requiring much cash reserve.)
Deposits $18,440,000,000
Cash on hand, 5%. 922,000,000
Credit balances at Central Bank, 10% 1,844,000,000
Loans, discounts, commercial paper and
securities. 15,678,000,000
Total. $18,440,000,000
CENTRAL BANK
Due Banks $ 1,844,000,000
Cash on hand 922,000,000
Re-discounts to banks 922,000,000
Total - $ 1,844,000,000
Cash in Individual banks 922,000,000
Cash in Central bank 922,000,000
Total cash in banking machine....$ 1,844,000,000
69
periodic financial panics
Control op Credits
To create and make available within a limited
time anything like five to seven biUion dollars of
liquid capital would bring about a new "boom" such
as began in the year 1900 and culminated in the
panic of 1907. During those years the banks in¬
creased their loans, discounts and investments until
the "deposits" expanded from 7,686 million dollars
in 1900 to 13,654 million dollars in 1907, an in¬
crease of 5,966 million dollars, nearly six billions
in seven years. There is only one known way to
control such expansion of credit and prevent its
running wild, and that is by and through the
Central bank.
According to the proposed plan the Central
bank would start business with 1,153 million
dollars cash. Not a dollar of this cash would go
back into circulation unless the banks came and
borrowed it and paid the interest demanded.
Suppose the Central bank offered to re-discount
commercial paper held by the banks to the extent
of 100 million dollars at 2% interest—how long
would it take to get that amoimt of money out?
It would probably be over-subscribed five fold in
as many hours. Suppose it offered it at 6%, how
much would go out, bearing in mind that none
70
REMEDY
of it is for stock speculation? Possibly very little.
We are today again suffering from a capital famine.
Call money has recently been at 12%. Conditions
are very similar to those of 1906-1907, the only
difference being the absence of a stock market
boom. Let the Central bank be created and let
it loan carefully to the banks on re-discounts a little
at a time, and the capital famine will disappear,
and legitimate business will have the capital it
needs at a low rate of interest. If credits extend
too fast, they can be checked instantly by increasing
the discount rate of the Central bank because the
individual banks cannot expand credits very far
on the limited amount of cash they would hold
and the necessity of remitting in actual cash to
the Central bank an amount equal to 10% of the
new deposits. To expand credits the individual
banks would have to borrow from the Central
bank, and the rate of interest that bank charged
would regulate the amount borrowed.
Mr. Harriman constructed a railroad empire on
4% money. He could not have gotten very far
on 6% money, and he could not have built even a
street car line on 12% money. The disount rate,
once a central discount market is established, is
71
periodic financial panics
the key to the whole credit situation. There can
be no over-expansion of credits if the rate is applied
properly.
Temporary Money
The only objection to the issuance of Temporary
money is the diflîculty of getting it back again.
The Central bank would have no diflSculty in
regulating this. When the farmers wanted to
move the crops, the local banks would go to the
Central bank with their holdings of thirty to sixty
day commercial paper and re-discount same, borrow¬
ing say 250 million dollars. The Central bank
would issue Temporary money, that is to say, its
own notes payable on demand. The local banks
would pay same to the farmers, who in turn would
spend them for the purposes for which they were
borrowed, and in due course they would float back
to the banks. It is a very inactive dollar that
does not see the inside of a bank in sixty days.
The commercial paper would mature in thirty to
sixty days, and all the Central bank needs do is
to await payment of same, which payment must be
in cash if such bank so wills. As the cash is so
paid in, part of it will be the identical Temporary
notes issued, and these must be instantly cancelled
72
remedy
just as a bank check is cancelled. The rest of the
cash so paid in will be Permanent money. This
can be at once placed in a separate vault and held
as a redemption fund awaiting the return of the
Temporary money. Thus, if the Temporary money
never comes back, it will be of no consequence,
because it will merely stand for a similar amount
of Permanent money held for its redemption and
kept out of circulation.
There is a vast difference between Permanent
money and Temporary money. Permanent money
should be gold, or, if there is not enough gold, then
paper well secured by ample collateral deposited
against it and backed by a large supply of gold,
and the amount issued should be strictly limited.
Temporary money, on the other hand, is nothing
more than another form of bank check issued
against a credit balance at the bank, to be treated
exactly like a bank check. This is the only kind
of currency imaginable that will be "elastic".
Commercial Paper
The manufacturer sells goods to the wholesaler
on thirty to sixty days time. The wholesaler sells
the same goods to the retailer on sixty to ninety
days time. The retailer sells to the consumer for
cash and tries to get the cash in time to pay the
73
PERIODIC FINANCIAL PANICS
bills of the wholesaler. From the time the manu¬
facturer parts with the goods to the time the con¬
sumer pays, and the money flows back, either the
manufacturer or the wholesaler has his capital tied
up. There is no good reason for this. If the whole¬
saler gave the manufacturer his note at sixty days,
(or an accepted draft) and the manufacturer en¬
dorsed the paper, such paper would represent a
business transaction between two going concerns,
both of which would have to fail within sixty days
to make the paper worthless. If now a local bank,
knowing the standing and financial condition of
the manufacturer and in position to investigate
the condition and standing of the wholesaler,
should endorse such paper, it would become as
readily salable in the local market as a Govern¬
ment Bond. The manufacturer could sell same to
one who had a credit balance at the bank for which
he had no immediate use, and the manufacturer
would have back his capital.
Once create a Central bank and establish a
discount market for commercial paper, and this
kind of transaction will be as common here as it
is abroad. Its beneficial effect to our business men
is almost beyond calculation.
74
remedy
We are trying to open up South American
markets where the merchants demand credits of
six months to a year. Foreign merchants can
grant these credits because of their re-discount
market—our merchants cannot. South America
will remain a sealed book to our merchants until
we get a Central bank.
The Independent United States
Treasury System
When Mr. Jackson, President of the United
States, fearing the political power of the United
States National Bank, determined to destroy
that bank, he drew out from this bank and
from all other banks, in cash, all the credit bal¬
ances of the Government and placed same in
the vaults of the United States Treasury. Such
disturbance of the cash reserves of the banks brought
on the terrific panic of 1837. Since that day the
Government has refused to deal with the banks in
its fiscal affairs. It requires its custom duties to
be paid in specie and puts that specie away in its
own vaults where it lies dead. The table on page 29
shows just how much of the people's money has
thus been taken out of the channels of trade and
kept out. The last report, 1911, showed 341
million dollars.
75
PERIODIC FINANCIAL PANICS
The more prosperous are the times the more
custom duties and other taxes are paid into the
United States Treasury and the cash taken out of
the banks, but the more prosperous are the times,
the more liquid capital the people need in their
expanding business. How can the banks create
such liquid capital if the gold upon which the entire
credit structure of the nation rests is being taken
from them and hoarded away in the United States
Treasury Vaults.'' The banks do not need this
money one-ten-thousandth part as badly as the
people need the liquid capital that it would create.
How much longer will the American business man
permit this utterly useless and senseless inter¬
ference with the rights of business?
The Government should put its money in the
banks. If the people can trust their billions of
liquid capital to the banks, the people's Govern¬
ment can trust its third of a billion. Until it does
so, it is useless to attempt any reform of the banking
machine.
It is not necessary that the entire Treasury
system shall be changed. All that is necessary is
that all Government cash shall be kept in the
banks just as is the people's money.
76
remedy
Details of Formation of Central Bank
_ Up to this point the facts and figures have spoken
for themselves, and it has been necessary only to
properly assemble such facts and figures to show
as a logical and inevitable sequence the absolute
necessity for the creation of a Central bank with
the powers described.
There are many matters of detail relating to
the creation and control of such bank about which
there is room for many different opinions.
Shall such bank have a capital stock, and if
so, who shall own it? To whom will the profits
go? Who will control it?
In my opinion, the National Government
should have a substantial interst in the bank,
should appoint a number of its governors for life,
and such executive officers of the National Gov¬
ernment as the President and Secretary of the
Treasury should be ex-officio members of the
Governing Board. The individual banks should
have the remaining interest and appoint or elect
the remaining governors either for life or for sub¬
stantial terms. The entire power and authority
should be centered in this Board of Governors,
so that the individual responsibility of each be
fixed.
77
PERIODIC FINANCIAL PANICS
I suggest that each bank, national or state,
including Trust Companies, be permitted to sub¬
scribe for $1,000.00 of the capital stock, neither
more nor less. That would create a capital of
24 million dollars. Let the Government subscribe
25 million dollars of the stock, thus making the
capital 49 million dollars, and let new banks come
in as they desire, each taking the same amount,
to-wit, $1,000.00. The profits could be distributed
as dividends. The amount of such dividends to
each bank would be small, which is proper, as such
institution should not be created for individual
profits, but as a credit regulator and liquid capital
creator.
This proposed remedy would not create any
disturbance in our existing banking and currency
system, nor with the United States Treasury system.
The people would hardly know that anything had
happened until they felt the business boom that
the creation of the new liquid capital would produce.
The Central bank would be created by a simple
act of Congress; the oflBcers would be selected and
at a given time it would open its doors. The cash
of the United States Treasury would be transferred
to it, 341 million dollars. It would be necessary
for the individual banks within a reasonable time
78
REMEDY
to obtain a credit balance in such bank equal to
10% of their individual deposits, which would call
for 812 million dollars. But the banking machine
has in its vaults 1,554 million dollars in cash, and
by the repeal of the present law requiring a fixed
percentage of cash reserve, all of this cash would
be available for use. In order to facilitate the banks
in obtaining such credit balance, the Central bank
could grant re-discounts immediately. Thus, in¬
stead of calling for the transference of 812 million
dollars in cash, but half of such sum or even less
would be needed. Thus, the Central bank would
start out with perhaps three to five hundred million
dollars of re-discounted paper, which with a discount
rate even as low as 2%, would produce an income
for it of six to ten million dollars per annum.
Such Central bank would enable the banking
machine (1) to create a vast deal more liquid capital
than now exists, (2) would absolutely control the
expansion of credits and stop forever our periodic
financial panics, (3) would create "elastic" currency,
leaving the Permanent money to the work of sup¬
porting the credit structure, (4) would create a
market for commercial paper, thus enabling our
merchants to sell their goods on time without
thereby tying up their working capital, (5) would
bring to life the dead money of the United States
Treasury.
79