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Professor of Political Economy in the University of Chicago; Author
of "The Principles of Money"; "The History of Bimetallism
in the United States"The
Abridgment of J. S.
Mill's Political Economy"; "Reciprocity"; etc.








Copyright, 1912,
By The National Citizens' Leagtte
For the Promotion of a
Sound Banking System




H I S volume is intended to furnish a plain, untechnical exposition of the defects of our present banking and currency
system, together with a discussion of the remedies. Not
since the Civil War has the country been confronted with a monetary and banking question of greater importance to business prosperity. The adequacy of the banking system affects the everyday
existence of the laborer, farmer and merchant. The unnecessary
expense of obtaining credit under a bad banking system is borne by
the borrower; the impossibility of getting loans in a time of panic
shuts up factory and shop and falls most severely upon the wageearner who loses his employment.
Unemployment is largely
increased by financial panics.
The reason for the existence of the National Citizens' League,
which is made up of business men, is found in the fact that the
reform affects the borrowing business man more than the lending
bank; the bank can always protect itself by sacrificing the borrower. There is practically no class in the community not directly
concerned in the outcome of this campaign of education. This
book explains the effects of our banking system and of its reform
on every class.
It has long been seen that our currency is needlessly inelastic;
that our credit system is even more dangerously inelastic; that our
large gold supply is ineffectively used; that the scattering of reserves forbids co-operative action by the banks in times of stress;
that our rigid reserve system even breeds panics; that state banks
and trust companies are doing commercial banking but without
cooperation with national banks; that our Independent Sub-Treasury often attacks the reserves of banks at times of danger and
works without business-like economy and efficiency; that idle funds
of banks drift to New York and on call loans feed stock speculation; and that our trade is greatly hampered by lack of American
banking facilities in foreign countries. For these reasons the people are calling loudly for legislation which shall be non-partisan
and formed on seasoned experience, without breaking with our




democratic system of independent banks.

It should also be a mat-

ter of care that elasticity should be obtained without the dangers
of over-expansion.
The reform should not take the shape of a dominant central
bank, nor should it be the creature» of politics. For this reason
the Government of the United States should not enter the discount
and deposit business of banking; but, on the other hand, it should
supervise and regulate a cooperative means of assistance, like an
enlarged clearing-house association, in the common interest, and
require the banks to pay all the cost of providing capital, supplying
gold reserves, and issuing notes under its close supervision. Thus
the surplus profits of note-issues and of discounts would go to the
people of the United States. Moreover, in any legislation, care
should be taken that control of our credit system should not pass
into the hands of any sinister political or financial interests.
For these good and sufficient reasons, the National Citizens'
League, organized in most of the States of the Union, is now carrying on a campaign of education so that the worth of every measure proposed to Congress may be rightly judged. For this reason
the plan of the National Monetary Commission—the elaborate and
most discussed plan before the public—has been given extended
study. The League, however, is not committed to any specific measure. If discussion shows that any other plan is superior to that
now before Congress, it will support that plan. I t will favor any
measure which incorporates its fundamental principles without regard to its origin. It realizes, however, that the remedy for the
defects of our present credit system lies in some form of a cooperative institution, evolved from our clearing-house experience, by
whatever name it may be called, which will remove the defects of
to-day. The evil of separate sections, working at odds, can no
longer be tolerated. The cooperation desired should be countrywide, providing for the importation of gold, in the interest of all
banks, big and little, giving assistance to all in times of stress, and
supplying uniformity in the rate of discount. Such advantages
could not be gained by dividing the country into independent detached sections, leaving the situation much as it is to-day. But this
cooperative agency should furnish the indispensable economy of
united reserves and common places for the rediscount of commercial paper impossible under a system of separate organizations.
In the preparation of this volume, especial acknowledgment is



made to Professor H. Parker Willis of George Washington University. The question of constitutionality has been treated by Dean
James P. Hall, of the Law School of the University of Chicago;
and in the legal question regarding acceptances, valuable aid was
given by Professor F. R. Mechem of the same school. Indebtedness
for assistance, advice and care-taking industry is due to Professor
W. A. Scott, of the University of Wisconsin; Mr. A. D. Welton,
Mr. Frank H. Fayant; and Professor M. S. Wildman, of Northwestern University.
Chairman of the Executive Committee,
National Citizens' League.

Chicago, April 15, 1912.






§ 1. The National Banking System
§ 2. Scope of the National Banking System and Capital Invested
§ 3. Chartering National Banks
§ 4. National Bank Note Issues, Their Restriction
and Regulation
§ 5. How Banks Are Classed Under the Reserve
§ 6. Relations of Banks to Each Other
§ 7. Duties of the Comptroller of the Currency
§ 8. National Banks the Mainstay of the Whole
Banking System
§ 9. Relation of the National Banks to the Government
§10. Defects of the National Banking System
§11. Remedy for the Defects
§ 1. Defects of Banking System Diagnosed
§ 2. Means of Cooperation
§ 3. Why Cooperation Is Necessary
§ 4. Protection to Deposits
§ 5. Final Extinction of National Bank Notes
§ 6. Control Over Expansion
§ 7. Uniform Rate of Discount
§ 8. Discount Market for Acceptances
§ 9. Protection from Wall Street
§10. Political Pressure to Secure Government Deposits
§11. Our International Position
§ 1. Rigidity of the System
§ 2. Our Reserve System Makes Credit Inelastic..
§ 3. Foreign Practice in Contrast with Ours
§ 4. Stringencies Bring Out Fundamental Defects..
§ 5. Redepositing Reserves Encourages Speculation
§ 6. Our Reserve System Implies High Cost of Loans
§ 7. Country Paper at a Disadvantage
§ 8. Lack of Discount Market Limits Loans
§ 9. Remedy

1. Panic Conditions
2. Dangerous Grasping for Reserves
3. Ways of Converting Assets into Immediate
Means of Payment
§ 4. Bank Notes Not a Desirable Remedy for Panics
§ 5. Remedy Must Touch Lending Power of Banks..
§ 6. Restoration of Confidence if Assets Good







§ 7.
§ 8.
§ 9.

S 1. Classification of Loans
§ 2. Nature and Origin of Commercial Paper
§ 3. Types of Commercial Paper
§ 4. Characteristics of Commercial Paper
§ 5. Reserve Association Restricted to Commercial
§ 6.
§ 7.





Experience of Other Countries
Remedies for Panics Not in Temporary Measures
Importation of Gold for Reserves

American Practice With Promissory Notes
Commercial Paper a Protection Against OverExpansion




§ 1. European Accepted Bills of Exchange
§ 2. American Promissory Notes
§ 3. National Banks Cannot Accept Bills of Exchange
§ 4. A Discount Market
I 5. Danger of Over-Expansion
§ 6. The Rate of Discount
§ 7. Uniform Rate of Discount in United States
§ 1. Analysis of Bank Credit
§ 2. Origin of Call Loans
§ 3. Real Security for Commercial Loans
§ 4. Extent of Call Loans
§ 5. Development of Margin Trading from Call
§ 6. Banks "Would Prefer Not to Lend for Speculative Purposes
§ 7. How Discount Market Would Work
§ 8. Reserve Association Would Be an Intermediary
Between Banks
§ 9. Possibilities of Evading Charter Requirements
as to Commercial Loans
§10. Banks Would Protect Themselves
§ 1. Why National Bank Notes Were First Issued..
§ 2. Foreign Systems of Note Issue
§ 3. Motives for Note Issues
§ 4. Working of National System
§ 5. An Inelastic Currency System and Its Effects..
§ 6. Panic Conditions and "Emergency Currency"..
§ 7. Actual Note Issues
§ 8. Relation of Notes to Bonds
§ 9. Notes Limited by Cost of Bonds
§10. Notes Not Quickly Obtained
§11. Criticism of Conditions
§ 1. Fear of Inflation
§ 2. How Inflation Is Revealed and Produced





§ 3.


§ 8.




Safeguards Regarding Investments and Redemption
Regarding Adequate Reserves
Limitation of Note Issues
The National Reserve Association and Inflation
Fear That the National Reserve Association
Will Stimulate Inflation
Inflation, Theoretically Imaginable, but Not

§ 1. Retiring the National Banl: Notes
§ 2. Refunding the Bonds
| 3. Other Plans for Using the Bonds
§ 4. An Alternative Method and Objections to It
§ 5. The Monetary Commission's Plan
§ 6. Disposition of the Bonds
§ 7. The Question of Monopoly
§ 8. Use of Profits from Note Issues
§ 9. Access to Notes
§10. Security of the Notes



§ 1. Clearing-House Associations the Only Form of
§ 2. Development of Clearing-House Functions
§ 3. Methods of Clearing-House Examiners
§ 4. Government Recognition of Clearing-House Examinations
§ 5. Issue of Clearing-House Certificates
§ 6. Nature of the Issue Function
§ 7. Action by Congress Following 1907 Panic
§ 8. National Currency Associations and Why Few
Have Been Organized
§ 9. Associations, Both Clearing-House and "National Currency," Have Been Incomplete
§10. The Question of Inflation
§11. Avoidance of Inflation
§12. Advantage of Regularity
§13. Need of Extending Clearing-House Functions..




Three General Types of Banking
Banking Systems in the United States
European Banks
Canadian System
Defects of the Competitive System in the United
§ 6. Statistics as to Distribution of Reserves and
§ 7. Tendency to Concentration of Control
§ 8. Development of Joint Control—Holding Companies
§ 9. Effect of Government Deposits
§10. Cooperation Under Present System Limited
§11. Organized Legal Cooperation
§12. Economy of Reserves
§13. Kinds of Paper Rediscounted




§ 1.
§ 2
§ 3.
§ 4!
§ 5.
§ 6.
§ 7.
§ 8.
§ 9.


Gains of Legal Cooperation

The Fear of Making Present Bad Conditions
A National Reserve Association—Possibility of
Keeping It Free from Speculative Influences 224
How to Prevent Concentration of Funds
Directors of National Reserve Association and
22 &
How Chosen
What Is Meant by "Control"
Possibility of Control of Reserve Association
The Idea of Control Through a Holding Com2 35
Publicity and a Free Banking System as Safe2 37
The Question of Share Influence
Possible Control Through Favor
Geographical Control and Sectional Opposition 243
Unity of Banking Interests
Political Control and the Evil It Would Work 245
To What Use Could Control of the Reserve
Association Be Put?
Control of Other Banks Would Not Interest
Safety Through Establishment of a Market for
Commercial Paper
Why Large Banks Do Not Oppose Reserve

§ 1.

Small Banks as Members of National Reserve
§ 2. New Duties and Privileges
§ 3. No Rediscount Facilities Under Present System
§ 4. Economies
§ 5. Small Banks to Control National Reserve Association
§ 6. The Chief Danger Now Confronting the Small
§ 7. Many Problems of the Small Bank Would Be
§ 8. Commercial Paper and How It is Regarded..
§ 9. Commercial and Investment Loans
§10. Small Banks Will Become Really Independent
§11. Divorced from Reserve City Banks


§ 1. A Large Number of State Banks and Trust
§ 2. The Problem of State Banks
§ 3. Control of State and National Banks by Each
§ 4. Reserve Plan Puts State and National Banks on
Same Footing
§ 5. Trust Companies and Mutual Savings Banks..



§ 6.
§ 7.
§ 8.



§ 2.


§ 2.
§ 3.
§ 4.
§ 5.
§ 6.

Small Merchants Form a Large Group of Bank
The Small Merchant and His Customers—Business on a Cash Basis
How the Bank Comes in
Bank Competition Prevents Discrimination
Benefit of an Institution for Rediscounting
Small Merchant as a Depositor
Handicaps of the Present Banking System and
Advantages of the One Proposed


Seasonal Character of Agriculture and Crop
Farmers' Loans Under Present Banking System
Difficulty Due to Inelastic Note and Credit System
The Remedy in Cooperation
Experience of Canada
Idle Funds and a Discount Market




§ 5.
§ 6.
§ 7.


§ 1.


Interest in Banking Is General
Relations of People to Banks
Interest of the Depositors
Safeguards for Interests of the Wage-Earner..
How Bank Credit Reacts on the Laborer
Stability of Industry
Influence of the Supply of Money

§ 1.


Uniformity of Examination
A Single Discount Market
Benefit, of a Reserve Association to Institutions
Outside It




Financing Import and Export Business
New York Supplies Cash to Move the Cotton..
How Cotton Is Bought from the Producer
Defects of Present Banking System in Relation
to the Cotton Movement
Cotton Movement and a Discount Market
The Bill of Lading




Relation of the Depositor to the Bank
Guarantee of Deposits
Shortcomings of Examination
Bank Failures
The Question of Rediscounts
Segregation of Commercial and Other Banks..






§ 1. Banks as Government Depositories and Establishment of the Independent Treasury System 355
§ 2. Workings of the System
§ 3. Exchange Functions of the Treasury
§ 4. Foreign Experience
§ 5. Plan of National Reserve Association
§ 6. Contrast with Present System
§ 7. The Question of Safety of the Government
§ 8. Public Function of National Reserve Association
§ 1. Readjustment of the Banking System to Meet
Foreign Trade Conditions
§ 2. Uniform Discount Rate and the Flow of Specie
§ 3. United States Not Considered as a Center of
§ 4. Purchase and Sale of Exchange
§ 5. Reserve Association to Do Banking Business
§ 6. International Flow of Gold
§ 7. Foreign Exchange Banks



APPENDIX—The National Citizens' League







§1. The National Banking System—Revising Banking Systems to Fit
Changing Conditions—§2. Scope of the National Banking System
and Capital Invested—§3. Chartering National Banks—Safeguards
Against Banking Monopoly—§4. National Bank Note Issues, Their
Restriction and Regulation—Inelasticity of Note System—§5. How
Banks Are Classed Under the Reserve System—Regulations for
the Independence of National Banks—§6. Relations of Banks to
Each Other—§7. Duties of the Comptroller of the Currency—Cooperation Among National Banks Practically Impossible—§8. National Banks Only an Element in the Banking System—National
Banks the Mainstay of the Whole Banking System—§9. Relation
of the National Banks to the Government—§10.
Defects of the
National Banking System—§11. R e m e d y for the Defects.


Organized in 1863, the national banking system has had

a life of nearly fifty years.

Within that period little has been done

to alter its scope or constitution.

The first enactment was modi-

fied in important particulars June 24, 1804, but the two measures
may be considered substantially one.

Subsequent innovations have

been such as were necessitated by extraneous features of national
policy—the redemption of the greenbacks, the refunding of the public debt from time to time, and others.

Fundamentally, the plan of

banking for which the system itself stands is what it was at the
Pew systems of banking can last for half a century without requiring substantial modification. The Canadian banking system is
remodeled every decade, in pursuance of a requirement embodied in
the fundamental law which governs it. The legislation of European
countries is frequently revised and adjusted to current necessities,
This is an unavoidable outgrowth of changing commercial conditions
which call for changes in the legislative adjustments that control
them. Today the national banking system presents serious problems to the commercial world. These call loudly for study and solu-





tion. Bill after bill has been presented to Congress within the past
ten years, but of all this multitude of measures not one has received
more than cursory study and none has ever been seriously considered as a practical question. It is for the commercial community
to decide whether the present system shall be continued, or whether
one better adapted to current needs and designed to furnish suitable
protection to the business interests, to the farmers, and to the salaried and consuming classes of the country, shall be enacted.
Scope of
System 9

§2* According to the latest figures of the Comptroller of the
Currency, the national banking system now includes 7 , 3 0 1 active
institutions. Many have been formed only to fail or go out of business, but the system has steadily grown in the number of active
banks until it has reached its present proportions.
In reviewing the condition of the system and in tracing its internal problems, it is essential to bear in mind the principal features
relating to the distribution of capital among banks of different
classes and among different states and localities throughout the
country. The following table, compiled by the Comptroller of the
Currency, furnishes the chief data with regard to this subject:
1. 1911.

States, etc.

Capital $25,000

Capital over
$25,000 and Capital $50,000 Total organiless than
and over

No. Capital No. Capital
New England
New Hampshire..
Rhode Island...,











Sutern States
New York
97 2,425,000 9
New Jersey
51 1,275,000 7
219 5,475,500 24
150,000 3
31 775,000 5
District of Columbia





National banks
reporting Sept. 1,
No. Capital paid in-

7 $385,000
2 200,000
19 4,450,000
1 500,000

11 $485,000 70
7 330,000 56
T 275,000 51
20 4,475,000 188
1 500,000 22
300,000 79


35 5,885,000

54 6,365,000 466


287,500 97 17,970,000 203 20,682,500 462
210,000 41 3,510,000 99 4,995,000 196
807,000 223 24,080,000 466 30,362,000 832
245,000 28
172,000 13 1,480,000
2,427.000 107
4 1,250,000
1,250,000 11
404 10,100,000 48 1,571,500 378 48,290,000 830 59,961,500 1,636)




States, etc.

Capital $25,000

Southern States
West Virginia
North Carolina...
South Carolina...
Middle Western
Western States
North Dakota...
South Dakota...,
New Mexico
Pacific States
Hawaii... . „
Porto Rico


Capital over
$25,000 and Capital $50,000 Total organiless than
and over

Capital No. Capital No. Capital

49 $1,225,000
35 875,000
21 525,000
12 300,000
25 625,000
7 175,000
33 825,000
6 150,000
12 300.000
219 5,475,000
20 500,000
52 1,300,000
32 800,000

10 $356,000
11 395,000
20 675, Ò Ó
4 125,000
10 304,500
1 3 0,000
84 2,680,000
7 230,000
6 180,000


National banks
reporting Sept. 1*

No. Capital No. Capital paid in

42 $4,565,000 101 $6,146,000 129 $16,668,500.00
39 3,265,000 85 4,535,000 107
28 2,710,000 53 3,365,000 74
20 2,135,000 32 2,435,000 43
49 4,650,000 94 5,950,000 114 13,944,500.00
25 4,125,000 36 4,425,000 45
33 2.775,000 76 3,904,500 83
19 1,815,000 28 2,055,000 30
19 3,410,000 32 3,740,000 32
136 14,160,000 439 22,321,000 513 45,026,000.00
25 2,020,000 46 2,550,000 47 ' 4,460,000.00
35 5,270,000 94 6,800,000 144 17.450,900.00
31 3,385,000 69 4,365,000 100 12,435,000.00

523 13,075,000 161 6,231,500 501 54,285,000 1,185 72,591,500 1,461 159,927,430.00




86 12,725,000
67 9,150,000
86 13,750,000
26 4,790,000
28 3,350.000
29 4,500,000
60 3,645,000
40 12,885,000

213 16,078,000
172 11,883.000
263 18,353,500
44 6,270,000
67 4,350,000
220 9,371,000
190 7,050,000
88 14,185,000



728 18,200,000 107 3,545,500 422 64,795,000 1,257 86,540,500 2,038 276,673,100.00121

3,025,000 7
1,700,000 3
2,575,000 20
2,300,000 10
575,000 4
1,275,000 " i i
600,000 4
7,650,000 26







799 19,975,000 85 2,856,000 225 17,240,000 1,109 40,071,000 1,240


34 850,000
32 800,000
90 2,250,000
27 675,000
6 150,000
196 4,900,000







30 3,495,000 66 4,415,000 80
23 1,595,000 57 2,451,000 78
97 24,562,800 192 26,972,800 204
13 910,000 43 1,680,000 46
5 1,625,000 12 1,205,000 21
9 1,225,000 12 1,300,000 11
5 250,000 10 380,000 13


14 441,000 183 33,112,800 393 38,453^800 455


















Grand Total.. 2,670 66,750,000 41C 13,675,500 1,747 224,257,800 4.833 304,683,300 7,301 1,025,441,384.50



§3. The most striking and characteristic feature of the national banking system is that access to it is freely granted. Under
the national banking act, any five persons possessing the necessary
capital may apply to the "Comptroller of the Currency for a charter
incorporating them to do business as a national bank. The charters
thus granted run for twenty years and give to the institutions receiving them the usual corporate powers. Their capital is required
to be paid up in money within six months after opening the doors
for business, 30 per cent in specie being on hand in the vaults at
the outset.
Theoretically, there is therefore no reason why any number of
groups of men should not gain access to the national banking system as they desire. The only restriction comes from the policy of
the Comptroller of the Currency. It is not mandatory upon the
Comptroller that he grant national bank charters. In practice,
therefore, he limits his extension of such charters to those cases in
which he finds, after special examination, that there is a genuine
demand for a bank, and that such an institution can be created without imperiling the business of any existing institution.
Under these conditions, and on the supposition that the men
who apply for incorporation are solvent and are known business
factors of proper standing in the community where they propose to
organize the bank, the Comptroller of the Currency will usually
grant them a'charter. Of late, there has been a strenuous effort to
discourage the granting of charters to promoters or persons whose
object in effecting organization was not that of conducting the
business of banking along sober and conservative lines. These
restrictions, however, are purely a minimum. They are the necessary and fundamental requirements which must be enforced in order
that the system may be kept free of injurious influences and maintained upon a basis of essential soundness and legitimacy.
The importance of the free banking principle thus provided for

of National


can hardly be over-estimated.

It guarantees that the business of

banking shall not, as in some countries, become a monopoly, and that
it shall be freely open to all those who desire to enter it in good
faith and with genuine capital.

This idea of free access to the

occupation is with justice regarded as fundamental in the American
system of banking, and nothing could be more improbable than that
any change will ever be made tending to limit or destroy this feature
of it. The banks themselves properly desire that, so far as possible.,



they shall be guaranteed against outside interference and shall be
enabled to continue their business upon their own lines and without
the domination of, or subservience to, larger institutions under the
control of others.
Every proposal for a change in the existing system must, therefore, necessarily maintain these two ideas—freedom of access and
freedom from control. This, however, does not necessarily mean
that the banks are not to be limited and restrained at proper points,
in order that they may be subjected to those methods of supervision
which experience has shown to be necessary in all banking systems.
They are, in fact, thus subject to oversight at the present time, for
the law prescribes how their capital shall be paid and how their business shall be done.
The question of further legislation is not that of limiting or
destroying freedom of access or competition, but is merely that of
prescribing proper regulations designed to protect the banks themselves and the public against the development of evils at points
requiring epecial safeguard. What are these points ?
§4. À peculiar feature of the national banking system, growing out of the circumstances of its origin, is seen in the present
method of issuing and securing bank notes. The bank note is
theoretically different in no respect from any other form of banking
credit, yet for reasons which will later be reviewed, it has been
deemed specially worthy of restriction and limitation by legislative
In the national banking system, it was from the first provided
that the total issue of notes by all the banks of the system should
not exceed a specified sum, set at $300,000,000. It was further
required that in no case should the total amount of notes obtained
by any bank exceed the capital of that bank. Third, it was provided
that the notes should be protected by national" bonds which the banks
were required to buy and deposit with the Treasurer of the United
States, receiving back notes not to exceed 90 per cent of the face
value of the bonds. Fourth, it was required that at least a specified
percentage of its capital should be put by each bank into the form
of bonds, such bonds to be used at its discretion as a basis for
demanding issues of notes from the Treasury. Today all of these
requirements and restrictions are in operation, except that which
limits the total amount of notes issued by all banks.


of Note


The limitation of outstanding issues to 90 per cent of the face
value of the bonds has been displaced by one which permits the
taking out of notes up to the par value of the bonds deposited, supposing these bonds to be selling at par or better. Under these conditions, it is evident that the total note issue cannot exceed the total
amount of national bonds in existence, and in the case of any given
bank, cannot exceed the amount of its capital. It is, moreover,
obvious that the policy of the banks in taking out notes, above the
minimum amount of bonds which they are required to buy in any
event, would depend in no small degree upon the price of the bonds.
In fact, the issues of bank notes actually taken out have varied and
fluctuated largely in accordance with the price of bonds. Today
the total note issue of all the banks is about $700,000,000. It is
one of the most severe criticisms upon the national banking system
at the present time that these notes displace gold, are expensive,
fail to respond to the needs of the community, and are inelastic,
often contracting when they are needed and expanding when they
are not needed. The note system has been one of the points at
which the National Bank Act has been most severely criticised, and
in respect to which there has been the most strenuous demand for a
rectification of existing conditions.

§5. More fundamentally significant to the national banking
system, and equally as characteristic as the note issue plan, is the peUnderaSSCd culiar reserve system established under the act as modified in 1864.
s y s ^ e m three classes of banks are established. Three cities,
New York, Chicago, and St. Louis, are designated as "central reserve
cities," while some forty-seven others are designated as "reserve
cities." All other banks are classed as "country banks." The reserve cities are Boston, Albany, Brooklyn, Philadelphia, Pittsburgh,
Baltimore, Washington, Savannah, New Orleans, Dallas, Fort
Worth, Galveston, Houston, San Antonio, Waco, Louisville, Cincinnati, Cleveland, Columbus, Indianapolis, Detroit, Milwaukee,
Minneapolis, St. Paul, Cedar Eapids, Des Moines, Dubuque, Sioux
City, Kansas City (Mo.), St. Joseph, Lincoln, Omaha, South
Omaha, Kansas City (Kans.), Topeka. Wichita, Denver, Pueblo,
Muskogee, Oklahoma City, Seattle, Spokane, Tacoma, Portland;
Los Angeles, San Francisco, and Salt Lake City. The country
banks are all those not situated in either of the groups of cities
already referred to,




Under the terms of the National Banking Act, no bank is permitted to establish branches. Every bank is presumably an independent institution. According to the same law, country banks are
required to hold a reserve equal to 15 per cent of their outstand- Regulations
ing liabilities, and may re-deposit 9 per cent of it with reserve city dependence
banks. They thus retain in their own vaults, at the minimum, cash of National
equal to only 6 per cent of their outstanding liabilities. The reserve B a n k s
city banks, which are required to hold a reserve equal to 25 per cent
of their outstanding liabilities, may re-deposit one-half of this
amount, or 12}A per cent, with banks in central reserve cities. They
may thus do business with cash in the vaults equal to only 12l/ 2
per cent of their liabilities, provided they have on hand with banks
in reserve cities a deposit credit equal to 1 2 % per cent more of
their outstanding liabilities.
As a matter of fact the banks have availed themselves of this
reserve provision very extensively, and much of the present so-called
reserves consists not of cash in their own vaults but of deposits in
other banks in reserve cities. At a recent date of report to the
Comptroller of the Currency, about 551 millions of dollars represented the total reserve held by country banks, while of this sum
only 246 millions was actually in the possession of these banks in
the form of lawful money. All the national banks of the country
had reserves of 1,404 millions, of which only 862 millions was
actual lawful money in hand.
§6. It is evident that as a result of this reserve system, very Relations
intimate relations between different classes of banks must exist.
On the other hand, banks in the country and in reserve cities which Other
have deposited their reserves with other banks are necessarily profoundly interested in the condition of these other institutions. T o
them they look for the resources which will enable them to fill up
their own reserves in times of sudden demand for payment. T o them
they must look for accommodation through direct loans, or through
the discounting of paper, or through some one of the various methods which are employed for granting relief to the smaller institutions when the stronger and larger banks are in position to afford
such aid.
Conversely, the city banks look with interest to the outside institutions as the source of deposits which they expect to use in
times of financial ease and slack business in the country, for the



purpose of facilitating transactions in the cities and general financial operations. It is thus not true that our national banking system, though theoretically made up of more than 7,300 individual
units, is actually composed of that number of independent organizations. On the contrary, the tie between the institutions, resulting
from the present use of reserves, is an extremely close and intimate
one. It is a tie which sometimes furthers the good of all who are
connected by it, but perhaps as often is injurious or dangerous in its
eifeets upon the welfare of tlie banks whose business is thus intertwined. Certain it is that in studying the development of the national banking system and in considering proposed changes with reference thereto, it is not possible to consider the different institutions
as if they were independent. They must rather be regarded as
already connected with one another, and changes must be spoken of
simply as substituting a different kind of relationship for one which
already exists.
of the
of the

§7. By the terms of the national bank act, the general oversight and control of the system is committed to an officer known as
the Comptroller of the Currency, under the general jurisdiction of
the Secretary of the Treasury. It is the Comptroller who has to do
with the chartering of banks, regular examinations of them by bank
examiners, the study of the returns made by the banks through
these examiners, the writing of letters designed to call the attention
of banks to cases in which they have failed to live up to the requirements of the system, and in general to take charge of the enforcement of the national banking act.
The Comptroller is an officer whose office is largely ministerial
and who cannot be expected to use a large amount of personal discretion or judgment. The bank act indicates his duties, on the
whole, quite precisely, and he can use a latitude of action only in
those cases where there is doubt about the actual arrival of some
event which has been provide^ for in the law. For example, it may
be a question of judgment with him when to declare a bank insolvent
and when to pursue the course mapped out in the act for the purpose of closing the institution. Upon the Comptroller depends
much of the effective working of the banking system, since to him is
committed the duty of seeing that the functions of the organization
are adequately and properly fulfilled, and that there are no viola-



tions of charter. In proportion as he is able effectively to carry out
this duty the system is likely to be effectively carried on.
It is justly said that the banks have a much more vital interest
in the proper conduct of their affairs than the Comptroller himself National
can have, and that they may be relied upon to accomplish the results p^ciJcaTly
that are sought. This might be true if banks were perfectly inde- Impossible
pendent factors operating in accord with considerations of general
well-being. But this is far from the reality. The larger banks have
scanty means of knowing the details of one another's affairs and no
means at all of enforcing their own ideas upon one another in any
case. The smaller banks, while to an extent overseen and influenced
by the larger, are not in touch with one another or able to judge of
the movement of credit in the operations of the other institutions.
This condition means that there is strong need for some agency
which will tend to unite the competing institutions in a certain degree and will in some measure afford a common bond between the
banks. It is this which the Comptroller of the Currency is called
upon to supply, and in so far as he is able under the law to furnish
it he is an effective officer. The question whether he can effectively
perform such a function is, however, largely dependent upon many
conditions in the system itself. Of late years the great development
of the class of small banks, the increasing difficulty of judging the
value and quality of the paper held by the banks, and a variety of
other factors have tended to diminish the efficiency of the Comptroller as a link between the widely scattered and separated banks
of the system.
§8. The national banking system has come more and more National
within recent years to be merely one element in a great scheme of Q ^ s 0 n e
banking. As the most recent reports of the government show, the Element
national banks number only about 7,300 out of an aggregate of per- g a
haps 25,000 institutions, including in that total, state banks, private s y s t e m
banks, and loan and trust companies. These other institutions are
organized under the laws of the several states, and their position will
call for special discussion at a later point.
It should be noted here merely that the national banking system stands in a peculiar position with respect to the banks of the
states, for more than one reason. Not only is it the largest single
set of institutions under one jurisdiction, but the terms of the
national bank act, in limiting the kinds of business which the banks


Banks the
of the





may do, have marked them out in a peculiar sense as what are known
as commercial banks. They are the institutions to which are committed the keeping of the funds of the country and the maintenance of a proper protection against outstanding liabilities. This
is true for two reasons. The national banks, if they conform to the
law, cannot invest their funds in anything except live, short-time
commercial paper so that their resources are kept in a fluid condition. The national banks, moreover, have tended in an increasing
degree to become the reserve holders of the country, the state banks
and trust companies re-depositing their funds with the national
banks, which are permitted to dispose of them as they see fit.
In some states, requirements have been made as to the amount
of reserve to be held by such state banks and trust companies that
place them nearly or wholly on a par with the national banks. But
in many states this is not true ; and in most, the national institutions are subject to stricter regulation than the competing banks
organized under state law. National banks are therefore subject to
much more severe judgment than the state institutions, and they
have thus far occupied a more responsible position. By reason of
the act of Congress imposing on state bank notes a prohibitive tax,
the power of note issue has practically been made a monopoly of the
national banks, and thus they have again been differentiated from
the institutions organized under state law. For these reasons the
national banks are in reality the core of the credit and financial
system of the country, and a change in their organization implies a
change in the whole system of which they are a part.

§9. The relation of the national banks to the government is
now clear, in so far as matters of organization and oversight are
concerned. But in another sense, the national banks have a relation
g ° v e r m n e n t thatis possessed by no other class of institutions.
They are not the holders of government resources, these being held,
under the independent treasury system, in the Treasury and subtreasuries of the United States. But, since it frequently happens
that the withdrawal of funds from circulation and their segregation
in the Treasury is injurious to the community, the government ia
obliged to employ a banking mechanism for the purpose of again
placing them in circulation. It must, moreover, at times make use
of banking methods, in order that its operations may conform, ^ven
if only remotely, to the requirements of modern business.

of the
to the



national banking system is the agency through which this connection between the government and the community is effected.
When government funds are to be deposited in banks, they are Government
placed solely with national institutions. Even then they are re- National
quired to be protected by the deposit of bonds of specified classes, Qn?y 3
to an equal amount, with the Treasury Department. When banking
machinery has to be used for the purpose of making payments, it is
the national institutions that are invariably utilized. Large quantities of funds are constantly held in national banks by the Treasurer
of the United States and by government disbursing officers, while
other officials, such as collectors of internal revenue, are permitted,
upon their own authority, and at their own risk, to keep their fund3
in national banks and to receive payments in the form of checks
and drafts upon other banks. Such arrangements are uniformly
made with national banks. National bank notes are received by the
government in many classes of payments and are regularly redeemed at the Treasury out of a fund provided for that purpose.
It is thus clear that, despite the limitations of the independent M e t h o d o f
treasury system, the national banks have an immediate and im- Handling
portant relationship to the government and its funds. A change p unc |s
in the status of the national institutions must profoundly affect the Antiquated
methods of handling government funds; conversely, a change in the
latter will have an important influence upon the national banks.
It is probable, however, that the national institutions would feel
the effect of such a change far less than would the Treasury itself,
since the present method of dealing with public funds has proved
antiquated, inadequate and ineffectual.
One of the most serious difficulties encountered in dealing with
the banking problem today is found in the method of disposing of
and caring for public moneys. It is evident that the day cannot
long be deferred when the Treasury will have to abandon the present plan of withdrawing its funds from circulation and piling them
up in the government vaults. The circumstances of modern business require that the government modernize its methods. The government is a huge business institution, but it has not learned to
use banks in a business way.
§10. The defects of the national banking system are naturally found at those points where its characteristic features are

of the

Gives No


most distinctly seen. In other particulars the system has not been
different from any other. It is at the special points where it was
formerly adjusted, with a view to meeting the particular requirements of the community, that it has tended to bcconie obsolete or
unsatisfactory, and it is consequently at these points that the system is necessarily calling for improvement and strengthening. No
one desires to minimize the importance of the characteristic features
of the national banking system. It is necessary to recognize the
desirability of preserving its chief and essential merits. What is
desired is to extend, elaborate and refine these merits, and to add
such new methods of organization as will enable the banks to perform more perfectly, for their own service and that of the public, the
functions entrusted to them at the time when the system was first
set on foot.
The fundamental defect of the national banking system is
to be sought in the fact that it is not in any proper sense a "system" of banking at all, but a series of banks artificially grouped.
Because of the lack of cooperative or fundamental relationships
between the institutions, it is not possible for them to exercise
any general policy with reference to the control of reserves, the fixing of rates of discount, or the granting of loans. They can only
«ct independently of one another, and the well-conducted institutions must, therefore, suffer from the mistakes of others whoso
conduct tends to arouse suspicion or alarm in the mind of the
public. Because of this situation, it will be seen, the national
banking system as at present conducted is in a sense a breeder
of panics, while it fails entirely to grant any adequate relief
from these commercial convulsions. It entirely fails to supply
a note circulation, elastic, sound, adequate, and well adjusted to
local necessities. It furnishes no general market for commercial
paper, no matter how high the quality of such paper may be.
It fails to meet the legitimate demands of the fanner, the depositor, the small merchant, and of other customer classes, just
as it imposes upon the banks themselves severe hardship, due to
their inability to protect themselves adequately against loss of confidence. In conjunction with the independent Treasury system,
it furnishes only an inadequate and disturbing method of disposing of public funds, and is thereby an incalculable and uncertain
factor in the money market Its unavoidable lack of a discount
policy prevents it from controlling the international flow of specie




as is done by the other banking systems of the world, or of supplying facilities for the transaction of foreign trade. The defects will
be treated of at greater length in following chapters.
From the foregoing brief discussion, it is seen that the aspects The Great
of the national banking system which are deemed most worthy of fh^Day j°8f
study, and which have furnished thus far most cause for dissatisfac- Cooperation
tion and for the feeling that improvements are feasible and desirable, grow out of the note issue function, the present reserve organization, the method of overseeing and inspecting the operations of
the banks, and the conditions in the system which permit unduly
independent action at times when such action may injure both
those banks which resort to it and those who are indirectly affected
by such action. In general, it may be said that the great problem
of the national banking system to-day is cooperation—cooperation
among the banks themselves, cooperation between them and the
government, and cooperation between them and the business public.
Nearly all of the difficulties which have arisen in the history
of the system have grown out of the lack of cooperative effort,
implying as it does a failure to mass the full strength of the banks
behind the business community in times of special demand for
funds, whether these demands fell at particular seasons of the year
or at periods of panic and difficulty.
§11. In the belief that the existing difficulties of the national Remedy
banking system are those which follow from a lack of coopera- Q ^ ^ S
tion, it is designed herewith to discuss plans for a cooperative
organization of a kind which would unite the banks into a single,
coherent whole and would thereby not only place the strength
of all at the service of any one, whenever aid could be legitimately
demanded, but would economize the funds of the country and reduce
the charge for banking accommodation, while equalizing such
charges throughout the different portions of the United States. This
plan is not intended to remove any of the essential features of the
national banking system, or to increase the power of any element
in it. It is intended as a labor-saving device for the common good
of the community and for the perfecting of the system by adjusting its different parts to one another and enabling them to work
harmoniously. In the following pages, the effort is made to explain
the nature of this mechanism and to indicate what its effect would
be upon certain aspects of the national banking system. Particular




effort has been made to explain how it would provide for the difficulties which now exist, and how far it could be depended upon to
rectify evils in the system, which to-day constitute a serious menace
to banking integrity and commercial soundness. In carrying out
this design, a general survey of the proposed plan is first offered, and
then its detailed operation is dealt with.



Defects of Banking System Diagnosed—2.
Means of Cooperation—3.
W h y Cooperation Is Necessary—4.
Protection to Deposits—5. Pinal Extinction of National Bank Notes—6.
over Expansion—7.
Uniform Hate of Discount—8.
Market for Acceptances—9.
Protection from W a l l Street—10.
Political Pressure to Secure Government Deposits—11.
International Position.

§1. The panics of 1893 and 1907 taught the weaknesses of
the monetary and banking system of the United States with convincing thoroughness. It was demonstrated even more convinc- Defects
ingly in 1907, that when the system is subjected to any strain beyond the ordinary it collapses/ From the resultant injury no class Diagnosed
of society is exempt. The experiences mentioned and the study
that followed advanced the question to the point where remedies
for known defects should be given legislative attention, discussion and action. We have, in fact, reached the point where we are
ready to profit by our own experiences and disasters, and to take
account of the results of carefully devised European methods.
Although European conditions differ so much from ours that
their institutions cannot be bodily transferred to our country, we
have much to learn from them. Direct copying would be folly;
we must take only that which aids us in a natural evolution out of
our own past. The central bank of Europe is not suited to our conditions ; it is contrary to the spirit of our institutions; and, in any
event, it would be politically impossible. Nor do we need a bank centra!
of the type of the Second United States Bank (1816-1836), which Bank
excited the opposition of Andrew Jackson. We do not need a
dominating, powerful Central Bank; what we need is not centralization, but cooperation—entered into by all our institutions of
credit—to the end that we may avoid selfish isolation and create a
federation in the interest of all the banks, small as well as great.
We do not need an institution which discounts for the general pub-




lie and competes for business; but we do need a cooperative union
of all the banks in the common interest whenever danger appears.
This cooperation, moreover, is more in the interest of the borrower than of the banker.
§2. Means of cooperation devised by a National Reserve
Association should be aimed at a decentralization, rather than at a
centralization, of credit—as opposed to a dependence of local
banks upon centralized institutions, as now. Under the plan
evolved by the National Monetary Commission all the banks in
a locality would be grouped into a local Association, composed
of not less than ten banks, whose combined capital and surplus
should not be less than $5,000,000. Each separate Association
would have local self-government; but yet, as we shall see, it
would be a part of a cooperative plan. Three-fifths of the governing directors of the Association would be chosen on the basis
of votes of banks without regard to size, each bank having one
vote; and two-fifths of the directors would be chosen on the basis
of votes in proportion to shares held in the National Reserve Assoof a 8
Cooperation ciation (i. e., in proportion to capital). It is also proposed, as a
check against centralized control of local associations, that if a single shareholder had a forty per cent ownership in a chain of banks,
the whole chain would have but one vote—and this rule would apply
whether the shareholder were a bank, individual, corporation or
Then, while locally self-governed, these Associations would be
grouped in fifteen districts, into which the whole country would be
divided. All the local Associations in a district would federate
themselves—as in a republic—to form a branch of the National
Reserve Association. The governing board of each district branch
would consist of not less than twelve directors in addition to the
manager; one-half the directors would be elected by the member
banks, each bank having one vote; one-third would be elected by
the member banks on the basis of the shares held in the National
Reserve Association; the remaining one-sixth would be chosen bv
the directors already elected from the agricultural, commercial and
industrial ranks.
The district branches would be federated in the National Reserve Association. The national directors would be chosen as follows : Each of the branches would elect two directors, one of whom
must be neither a bank officer nor a bank director, but must rep-



resent the agricultural, commercial, industrial and other interests
of his district; nine additional directors would be elected by voting
representatives from the branches, each to cast a number of votes
equal to the number of shares held in the National Reserve Association by the banks in his district; there would be seven ex officio
members of the board—the governor and two deputy governors, together with the Secretary of the Treasury, the Secretary of Commerce and Labor, the Secretary of Agriculture and the Comptroller
of the Currency. The executive officers would be appointed by the
board of directors. Not more than three directors would be elected
from any one district. The executive committee would be composed of nine members, including the three executive officers and
the Comptroller of the Currency,
§3. Cooperation of our credit institutions, state and national,
is desired, in order that the business public, producer and merchant,
having legitimate demands for loans, should not be cut oil from
them by unnecessary and accidental conditions of panic. When Why
collections are slow, or when an unexpected emergency arises, the f g 0 ^essar>
borrower, holding staple goods or unquestioned collateral, ought
not to be forced into bankruptcy by the inability to get the means
of paying his maturing obligations. Moreover, seasonal demands
arise which cause a stringency in the loan market and put an undue
strain on our system of credit. The financing of the cotton or
grain movement in the autumn has always been a cause of apprehension in the money market.
Demands of this character have given rise to a desire for a
greater elasticity in our monetary and banking system. Such elasticity is thought of in connection with two different possibilities:
( 1 ) normal seasonal demands, such as the recurring needs of cropmoving; and (2) abnormal demands at the time of a financial
panic. A common idea is that these demands can be met only by Eiaaticity
the issue of notes, or by some medium of exchange to be circulated of the
in the hands of the public. This is the ground for some crude plans C u r r e n c y
aiming at the issue of paper by the Government. In truth, while
there is always a need for some change money in the pockets of
everyone, some till and counter money in the hands of business
houses and banks, and lawful money for settling clearing-house
balance^, the fundamental need is not solely for a medium of exchange (sufficiently provided by checks drawn on deposit accounts),



but for loan power. If a borrower can get a loan, lie will never have
any difficulty in transferring his credit because of any lack of a
medium of exchange.
In financing the movement of cotton and grain in the autumn,
demands for cash from the country districts fall directly on the
r e s e r v e g 0 f banks, because there are no means of providing tempoMovement rary needs for cash except by drawing down reserves, and thus constricting the lending power of the banks, to the serious detriment
of the borrower.
Likewise, but to a more acute degree of danger, in a time of
panic the real need is not so much the issue of notes for circulation in the hands of the public (except to protect reserves), as for a
loan to meet a maturing obligation. That is, the question is more
truly one of the organization of credit than of the injection of additional money into the circulation.
For these reasons, it would be the purpose of a National Reserve Association, or whatever the cooperative agency may be
called, to provide an elastic currency whenever it was needed by
the public; to make this possible without drawing down bank
reserves; to give credits based on cotton, grain and the like, without expensive shipments of cash to and f r o ; and, finally, in time
of panic, to provide the possibility of getting loans—which is more
important than an increase of the circulation.
These ends would be accomplished by the individual bank—
Rediscounts national bank, state bank, or trust company receiving deposits—
by Branches presenting picked assets to be rediscounted by the branch offices of
the National Reserve Association. This opportunity would be exAssociation tended equitably to every subscribing bank, big or little, without discrimination. The credit given the borrowing bank could be used
as a part of its legal reserve, which would thus enable it to meet the
demands of its customers, or it could get National Reserve Association notes to the same amount, and place these in its reserves. This
would be merely an evolution out of our experience with ClearingHouse Associations, and an improvement upon, and legalization of,
the idea of Clearing-House Loan Certificates well known to banking history.
The individual banks would be able to obtain such rediscounts in four different ways:
(1) Any bank might, without any guaranty, have
twenty-eight-day paper discounted upon its own endorsement.



(2) If the paper should run for more than twenty-eight
days, but not longer than four months, it would have to be
guaranteed by the local Association.
(3) In times of stress, the subscribing bank might bor- R°^[ s c o u n t
row under careful restrictions directly on its own obligation, if System
the loan were protected by satisfactory collateral and guaran- work*
teed by the local Association.
(4) Time bills of exchange, running not over ninety
days and accepted by houses or banks in good standing» might
be purchased by the National Reserve Association from subscribing banks to a limited amount.
If any banks were at first not disposed to take any interest in
the plan, thinking they could earn more on their capital than by
subscribing to a National Reserve Association, they would find
themselves "outside of the breastworks" when a stringency came,
and would learn the advantage of membership by stern experience.
§4. The safety to depositors is also to be kept in mind. If,
for instance, a country national bank had $100,000 deposits, it
would be obliged under the present law to keep $6,000 on hand in
lawful money. In times of doubt, depositors would measure the ^ ¿ ^ p * ^
ability of the bank to meet a run by this amount of cash; and in a
short time this reserve would be easily exhausted and the bank
obliged to close its doors. The depositors owning the claims to
the remaining $i)4,000 would then be forced to await the process of
liquidation before they could get cash for their deposits. In case,
however, the bank were a member of a National Reserve Association, the public would know that the ability of the bank to pay off
depositors would not depend upon the amount of actual cash held at
any moment, but upon the amount and character of its assets which
could be used as a basis of discount at the National Reserve Association. That is, an institution like a National Reserve Association would most effectually enable a bank with sound assets to convert them into cash, and serve as the best method yet known of
guaranteeing cash payments to the individual depositor.
§5. The inelasticity of our national bank circulation, or of
any notes based on the security of bonds, has long been admitted.
It is not desirable, however, to make any sudden or drastic changes
which might cause possible disturbance or losses. There has been



more or less antagonism to the issue of notes by banks, on the
ground that the profit of issuing notes should go to the United
States by the issue of its own notes. In our own experience, however, the issue of greenbacks has, in fact, been costly to the Treasury because of the expense of maintaining reserves. But since the
profit to a bank in discounting can be obtained as truly when it
grants the borrower a demand deposit account as when it issues to
him its demand notes, the note-issues cannot be regarded as a special source of profit. This explains why state banks, issuing no
notes, can accumulate large profits as well as national banks. But
if there is any value in the idea of withdrawing the notes of naFinal
tional banks, it appears in the plan of the National Eeserve Associaof*National
proposes the eventual extinction of national bank notes
Bank Notes and their replacement by notes of an office which would be closely
under the supervision of the Treasury. Thus all the dangers and
disadvantages of Government notes would be escaped, while all surplus profits from discounts, above four or five per cent to shareholders, would go to the Association's surplus or to the United
States Treasury. In this way, the people would get whatever profits
arose from the issue of notes by the National Eeserve Association;
and the national bank notes would ultimately disappear.
The bonds now owned by the banks for the security of national bank circulation would be taken over by the National Eeserve Association, which would assume the redemption of the national bank notes. These bonds are largely two per cents, which
have a fictitious value due to the circulation privilege. Therefore,
if the circulation privilege were withdrawn, to prevent injustice
the Treasury should be empowered to refund them at a rate (say
three per cent) based on investment conditions and the credit of
the Treasury. If the losses had to be borne by the banks, they
would properly decline to enter the cooperative union.
The banks, state and national, would be required to provide
Not a
the capital of the National Reserve Association. Banks would

P e r c e n ^ o n ^íeir s^ock
tional Reserve Association, and it should be provided that earnings
beyond that dividend should partly go to surplus, or to a contingent fund, but mainly to the Treasury of the United States. Thus
a National Reserve Association would by no means be a profitmaking institution to its shareholders, and there would be no inducement to the management to overrexpand for the sake of larger






§6. Elasticity of the currency properly implies, not only expansion under legitimate need, but contraction when the need has
passed. The expansion of credit, however, may take place by an
undue expansion of loans, which shows itself in an enlargement
of the deposit accounts credited to borrowing banks—in case note«
are not needed by them. The obvious protection from over-expansion of loans, in normal times, and the avoidance of support to
speculation, would be found in requiring a National Reserve Association to keep a large gold and cash reserve for its demand liabilities, both notes and deposits. Should the reserve fall below a
legally-fixed limit, the deficiency should be progressively taxed, so
that for the protection of its diminishing reserves the National Reserve Association would raise the discount rate, thus making the
borrowing banks pay the tax imposed. This would stop any loan
demand for speculative purposes. Thus the National Reserve Association notes would be quickly available in time of stress, but
could not profitably be kept out when not needed. They would
be redeemable on demand, in gold, or lawful money, and the total
demand liabilities would be protected by a substratum of bonds (as
in the case of the note issues of the Bank of England), a stratum
of lawful money, a stratum of gold, and a stratum of short-time
commercial paper (as in the case of the Reichsbank of Germany).
The relative amounts of the stratum of short-time paper and the
stratum of cash would be controlled by the tax on loans. There can
be no over-expansion where there is immediate redemption in cash
of all demand liabilities.
The fall of reserves is always a signal of danger under the
present system. Indeed, when reserves fall to the legal limit
(twenty-five per cent in central reserve cities), we have no reserves
in the proper sense of the term. The surplus reserve is the only
one which can really be made use of. Consequently, our rigid legal
percentage of reserves causes a sudden stoppage of loans, and often
failure and ruin to needy borrowers. Hence, at present, all attention is centered on the quantity of a bank's cash reserves. If trouble threatens, each separate bank clutches at reserve money in selfish
isolation. Herein is our great danger. At such a time, the large
banking institutions have exceptional power to aid, or refuse help to,
smaller institutions. Under present conditions, when small banks
must go for assistance to the large banks, we have a system of practical centralization, based on special favors to desirable correspondents.






Supply of
Gold Is
Useless in


Under any plan for a cooperative banking agency, the reserves should be so mobilized that aid can be given at the point of
danger in amounts sufficient to prevent failures. The present
scattering of reserves and the grasping of legal money would be
stopped, because any bank having good assets arising from loans
could get rediscounts at the National Reserve Association ari3
thereby replenish its reserves. As things are now, because of scattered reserves, a local bank, even though having good paper, would
not be sure of assistance in time of need from its correspondent in
a large central city. It would be otherwise with a National Reserve
Association. Of course, no bank could secure rediscounts on unsatisfactory paper; but in case of stress and strain the banks, large
or small, having good discountable paper would know of a certainty that the National Reserve Association would be in a position
to make a loan. This kind of cooperation means a decentralization of banking credit. The safety of a bank would be judged by
the character of its assets rather than, as now, by the amount of its
cash reserves. The advantage of combining reserves has been
likened to having a large reservoir of water, available as a protection against fire by any one householder, as compared with a system in which each would have only its single pail of water. If water
reserves are scattered, then when a fire comes, each would try to
steal the other's water.
In order to stop this unnecessary grasping for legal reserve
money—to hold the reserves (as in a reservoir) for the common
good in a place where they can be directed as a whole against
threatened danger—it is proposed that the banks should keep the
legal reserves now required to be kept in their own vaults (6 per
cent for country banks, 12y 2 per cent for reserve city banks, and
2 5




ccntral reserve


b a n k s ) , i n the N a t i o n a l Reserve

Association vaults. Today we have a quantity of gold in this country so large as to meet all possible dangers, but it is so scattered,
or so disposed, as to be practically useless in a serious emergency.
In such a situation, the United States Treasury is subject to private
demands for deposits of government money. This should not be.
By creating a proper efficiency and economy of reserves and by protecting them with the note-issuing power of a National Reserve
Association, thus applying business sense to public finance, the
exchanges of the country could be carried on at a less cost, and
vital dangers to our credit could be avoided or lessened.

§7. In Europe, the ability to raise or lower the rate of discount affords an effective means of controlling undue expansion of
loans, and yet to give legitimate aid in time of pressure. In this
country, the requirement of a fixed percentage of reserves is often
a source of danger, for it is unlawful to increase loans just when
reserves are running down below the legal limit and when loans are
imperatively needed. The long and successful experience of Europe
teaches us that a sliding scale of rates for loans, falling as reserves
fill up and rising as reserves decline, is the best device to prevent
over-expansion of credit, and yet to afford aid in time of danger. Uniform
To accomplish this end, there should be some means by which the Discount
National Reserve Association could from time to time indicate to
its borrowers—the banks—the current rate of discount which
would rise as reserves fell, and vice versa. Obviously, a National
Reserve Association must treat all borrowers, big and little, alike;
and hence the rate of discount must be uniform to all applicants.
This, of course, is primarily in the interest of the borrowing public. The banks in some districts where capital is scarce and rates
high would not enjoy this provision; and in old districts where
rates are now very low, it might possibly raise them a little—
equalizing rates more or less throughout the country, much like
the effect of branch banking in Canada. On the other hand, it
is to be remembered that the dealings of a National Reserve
Association would be only with banks, and not with the public.
Hence, as in such central money markets as London, Paris and
Berlin, there would be the reserve agency's rate of discount; and
alongside that an unofficial rate (on the street) of individual banks
with their customers depending, as now, upon the conditions of
demand and supply of loanable funds and upon the quality of the
paper offered. Thus, in practice, there would remain a desirable
elasticity of rates, together with a governing force regulating the
general level.
§8. In this country, promissory notes make up the bulk of Discount
our banking paper, and their security varies as widely as does the ^ c c p t - *
standing of the borrowers. In Europe, on the contrary, the bill ances
of exchange is the usual form of paper.
An American merchant, who has a bill for goods he has purchased, borrows money on his own promissory note at the bank,
pays the bill with it and gets the cash discount. His obligation




is thus transferred from the concern he bought of to the bank
where he made the loan. Ordinarily, the bank does not know for
what purpose he borrowed the money, and he may or may not
use the proceeds of the loan to pay his bill for merchandise. A deposit credit is given him at the bank and he draws checks against it.
In Europe the seller of the merchandise draws a time bill on
the buyer; or, what is of especial interest in the financing of foreign trade, the buyer (importer) enters into an arrangement with
his bank by which the seller (exporter) draws directly on the bank,
and the bank accepts the bill. (See Chapter V I . )
The bank
has its protection from the buyer of the merchandise, the seller
is insured by the credit of the bank and the accepted bill goes on
the market. The paper so created explains on its face the nature
of the transaction out of which it grew.
Such acceptances can be bought and sold in any discount market where the bank has standing. They form an asset immediately
convertible into cash, being even superior to a government bond.
In the United States, the right to accept a time bill of exchange
is now forbidden by the courts to national banks. It is proposed
that acceptances of time bills of exchange should be made possible
to subscribing banks. Should acceptances of this kind be allowed
to all subscribing banks, however, without restraint, there might
be dangerous over-expansion of credit. Therefore, the use of acceptances should be hedged in by such restrictions as will prevent
all possibilities of abuse and over-expansion. .
Moreover, it must be kept in mind that in the United States
the development of credit to the manufacturer, jobber and retailer
has been so carefully worked out that those in good standing can
borrow on one-name promissory notes, enabling them to pay cash
for materials and goods, and thus gaining the highest trade discounts. This is one reason why so little strictly commercial paper
exists in this country, as compared with bills of exchange created on
the sale of goods in Europe. This fabric of credit in the United
States—probably more advanced here than in Europe—should be
carefully protected, and in no case should the system of acceptances be introduced at the expense of stability and safety to our
existing structure of credit.
§9. The right of subscribing banks to accept time bills of
exchange and the creation of a discount market would help to free
our money market from the influences that aim to use bank funds



for speculation in Wall Street. To accomplish this end still further, the election of directors of the allied associations and of the
final governing body of the reserve agency should be so contrived protection
that any group of special interests, financial or political, could
not control its policy, or use the organization for their selfish street
advantage. The local self-government of each Association, and
the federation of the Associations, should be so built up from
independent units that domination by a few, no matter how powerful, would be humanly impossible. The existence of directors
drawn from trade, industry and agriculture, would bring to bear
the vigilance of the borrowing, as distinct from the lending, public.
Moreover, the plan of a National Reserve Association, following the long-established policy of European banking, aims to encourage commercial loans arising from an exchange of goods, and
to discourage loans arising from stock exchange transactions. In
the Monetary Commission's plan rediscounts (not guaranteed) for
subscribing banks by the National Reserve Association are especially forbidden, if known to be used for carrying stocks, bonds,
or other investment securities. Only in case of great stress, and
only with the approval of the Executive Committee of the National Reserve Association and the Secretary of the Treasury, would
discounts be allowed directly to a subscribing bank, when protected by securities—and even then, only when endorsed by the
local Association. This rule follows European experience, by which
a higher rate of discount is usually charged for loans based on
stock exchange securities than for bills arising from the purchase
and sale of staple goods.
The one end to be sought is the protection of the commercial The One
interests of the country. Under the present system of recog- pJ^J®^®
nizing speculative securities as equal or superior to commercial qf
paper as the basis for bank loans, legitimate business and stock
speculation are too closely connected. The one suffers when the
other is unduly extended. There have been notable instances in
recent years of the inability of the country to finance a speculative
and a business boom at the same time. And yet so closely are
the two connected under our centralizing system that the collapse
or partial collapse of either reacts on the other. Wherever the trouble starts, the result is the same and business inevitably suffers.
Legitimate business is in need of protection and is to be divorced
from its relation to speculation.



Likewise, a National Reserve Association, acting as the cooperative organization of all the banks in the country, should be
able to import gold for the protection of the reserves, for the common good, instead of leaving this operation, as now, to the leadership of large private institutions in close connection with the
securities market. Such action would be public, and every subscribing bank, large or small, would be a participant in the resulting stability of the combined reserves.
Also, when a National Reserve Association became the
custodian of the funds of the Treasury, it would end all possible
pressure upon the Treasury to come to the aid of the money market
in stringencies caused by the movement of the crops, or an acute
financial crisis. If Wall Street operators needed assistance, they
would be obliged to get it through their own banks, which would
have to assume all the responsibility, knowing they could get little
or no help from rediscounts with the National Reserve Association.

to Secure

§10. In times past, the Treasury of the United States with
a surplus has caused unnecessary difficulties in the market, because
sums due the Treasury were drawn from the lawful reserves of the
banks, without any regard to the conditions of business or the needs
borrowersThis mechanical operation has long been seen to
^e °bsolete; and the obvious remedy has been the deposit of govf u n d s i n t h e n a t i o n a l banks designated as depositories.
But this has resulted in political pressure to obtain government
deposits for this or that district. Moreover, the Treasury has
necessarily been called on, in times of panic, to help privatelyowned national banks by deposits which filled up their reserves
and rescued the borrowers from ruin. All these methods are undesirable, clumsy and contrary to the seasoned experience of older
If a National Reserve Association were established, the force
of a panic and the. pressure for lawful money reserves would be
met by the combined reserves of a cooperative, decentralized institution. Should the funds of the United States Treasury also be
kept with a National Reserve Association, there would be no more



IJent oi 31

r e X P e ° t e d ' i e r k y C d l S h 0 m t h e T r e a s u l T ^ r cash; the payments
b y a n d t o the Treasury would be adjusted by credits on the books
of the m e m association in a businesslike way, after the fashion
of any other large commercial operation, without the present ex-




pensive and disturbing movement of cash. No other country of
importance maintains such an antiquated system as ours, which
dates back to 1846, when government payments were small and
business conditions were very different from what they are now.
Not only would our system of credit be thus relieved from unnecessary shocks coming from tin Treasury, but the power of the
Treasury to interfere with the money market would cease, and with
it all political connection with our banking situation. Moreover,
the expense of handling the funds of the United States Treasury
would be transferred to the National Reserve Association, while
its operations would come directly under the eye of Treasury officials. For all these reasons, the proposed reserve agency should
be made the fiscal agent of the Treasury.
§11. Great as is our wealth as a nation (about $125,000,000,000), and vast as is our foreign trade (some $3,500*000,000 a year), our banking and credit system is not what it
ought to be in view of our real merits as a trading nation. To
gain prestige due us in international finance, much depends on
our organization of credit. Certain steps in the right direction
are obvious:
( 1 ) Foreign capital will flow into our money markets Our^
if we are wise enough to create an international discount nati0"nal
market through the use of acceptances. This kind of paper Position
would be useful in creating credits in Europe, on which we
could draw for gold in the day of need. In other words,
acceptances would open to us the door to the abundant capital
of older nations, instead of our being obliged to make intense demands at certain seasons upon our own capital at
Our ill-regulated credit system, with its spasmodic
and violent reactions, causes us to make special demands on
Europe for gold which are regarded as unreasonable and unnecessary. We are looked upon as a nuisance and as a creator
of financial disturbance.
Our detached and unorganized
mass of banks prevents us from acting unitedly in the common interest with foreign countries.
Therefore, a cooperative institution, acting as the representative of all our
banks—instead of private institutions acting for their own
correspondents, and for only a small number of the banks—

should be established, which would have the standing, capital
and power to borrow gold abroad upon the deposit of government bonds, to deal in foreign exchange, and, in general, to
protect our banking and credit position in international trade.
(3) Our trade, especially in the East and in South
America, is handicapped by the absence of American banking
facilities. This has been long recognized by the merchants
in our export trade. Other countries, like Great Britain,
Germany, and even Italy, Belgium and France, have been
quite active in this important matter. It should, therefore,
be permitted to a National Reserve Association to establish
under its supervision branches in foreign countries which
might worthily represent the wealth and banking power of
the United States and assist our own merchants who wish
to sell their goods in other lands.



Rigidity of the System—2. Our Reserve System Makes Credit Inelastic—3. Foreign Practice in Contrast With Ours—4. Stringencies
Bring Out Fundamental Defects—5.
Redepositing Reserves Encourages Speculation—6. Our Reserve System Implies High Cost
of Loans—7. Country Paper at a Disadvantage—8. Lack of Discount Market Limits Loans—9. Remedy.

§1. The outline of the present reserve requirements under
the national banking system has already been sketched.
It undoubtedly constitutes the foremost problem in the present system of banking, inasmuch as the control of his reserves, and the
general condition of the reserves of the country, as a whole, is always the chief anxiety of the careful and far-seeing banker. We
are aware that the national banking system fails to perform its
functions adequately at the present time. In seeking for a remedy which shall not only insure a greater soundness than at present, but shall further supply the desired elements of economy and
flexibility, attention is therefore given, first of all, to the question
of reserves under our national system and the methods by which
they may be better dealt with.
What chiefly strikes the student of reserve conditions under
the national system is the fact that the banks of the country are
required to maintain a rigid amount of reserve money. In the
country banks are required to hold reserves of 15 per cent of their
outstanding liabilities. Reserve city and central reserve city banks
must hold 25 per cent; the country banks are required to keep
6 out of their 15, and the reserve city banks 12*/2 out of their 25
per cent of reserve in their own vaults; but the country banks may
deposit 9 per cent with reserve agents, and reserve city banks
per cent in central reserve banks. As the banks of the country are
called upon to maintain their reserves in this rigid way it is obvious
that they must stop lending whenever the line of safety drawn by
the law is reached. They have then in practice as a flexible resource
only what are known as "surplus reserves"—the amount of cash re-





sources held over and above the sum specified by the law as their
minimum or "legal" reserve. Just how much margin this actually
leaves the banks in the several parts of the country may be understood from a recent analysis (1910-1911) of reports to the Comptroller of the Currency in which are shown the various reserves and
surplus reserves This analysis is as follows:
Date of

H e l d by

Nov. 10
Jan. 7
Mar. 7
June 7
Sept. 1



Per Cent
Reserve Held
Reserve Held
Reserve City Banks
Central Reserve Cities
Other Reserve Cities

of Excess

? 6,102,5S5

Nov. 10
Jan. 7
Mar. 7
June 7
Sept. 1

Total Reserve Cities





Country Banks
New England States





Eastern States



Southern States



Middle Western States



7 .







Western States





Pacific States





liESKli V K S

It is thus clear that the? rigidity of reserve requirements on
the part of the banks subjects them to the necessity of prompt!)
ceasing to loan when their reserve line is approached, or else of
building up their reserves in some other way. They can do the
latter only by applying to other banks for accommodation; that
is, by selling to the other banks certain of their assets, or borrowing from them some of the latter's funds. Of course, this
process is resorted to in a degree by all banks, but, for reasons
which will later be examined more in detail, present conditions
do not admit of its being carried very far when the need is most,
§2. The chief reason why larger banks are not able to
assist smaller institutions to a greater extent than they now do,
and why smaller banks need this larger accommodation, is the
attempt to maintain many small reserves at different points
throughout the country. Since every bank recognizes that it must
keep up its reserve funds to the figure indicated by law, unless Many
it is willing to subject itself to the danger of being closed by the Reserves
Comptroller, it feels the necessity of drawing upon other banks?
for funds whenever it finds the required minimum in danger of
being trespassed upon. No bank, therefore, which holds the deposits of other banks, can ever feel sure that it may not be hastily
called upon to supply them with actual cash; and since e v e n bank has outstanding liabilities several times greater than thv
amount of its reserves, a sudden demand for cash from all parts
of the country results in depleting the funds in reserve cities and
central reserve cities to a point where they are in danger of falling below the legal requirement. The larger banks of the country thus live in a condition of doubt whether they may not sud- D cma ndt
denly be required to part with the whole of their surplus reserves
and thereby to be deprived of the power to make further loans to
their customers.
Whenever there is a sudden call for large loans in the interior, the necessities of the public cannot be satisfied by the simple
process of testing the paper offered to the banks and then reselling it to the larger institutions which hold the reserves of tin?
country; nor can the whole transaction be settled on a basis of
bank credit. Under our system, actual currency must move. Tho
rigid reserve system requires that a given proportion of liabilities
be maintained in the vaults. Moreover, with notes practically in-




of Credit


elastic, many loans in country districts must take the form of
actual currency or money. This means a very large movement of
currency from bank to bank at certain seasons of the year. A
like movement takes jilace at those periods when the business of
a particular community is rising to a higher level and when there
is a call for steadily increasing volumes of bank loans. Under
such conditions, the scattering of reserves is marked. Cash is
accumulated for local use when it ought not to be drawn off from
other portions of the country, but left at their service.
Both periodically and regularly, therefore, there is an ebbing
and flowing of currency which keeps a large quantity of circulating medium in transit and demands the services of another largo
quantity as a support for bank loans. This greatly reduces the
volume of outstanding bank credits which can be maintained
upon a given quantity of reserve money. It is probable that no
country in the world has so small a volume of bank credits outstanding as the United States, in proportion to the amount of
money retained in the country. Thus is created a condition which
implies the holding in idleness of large quantities of coin that
might otherwise be dispensed with. It shows why the great
"per capita" circulation of the United States is not beneficial,
but, on the contrary, is an expensive luxury which the community
cannot afford to maintain. This is quite in opposition to the
usual view of the relation between money and bank credit in the
community, but a reference to foreign experience corroborates it*
The national banking system has been able to expand its
deposit-credits satisfactorily in response to the calls of the commercial community for loans, whenever there was no doubt about
its general solvency and ability to redeem. This has been due
to the fact that the granting of the deposit-credits was not hampered and crippled by anything corresponding to the bond-depositrequirement which has so limited the elasticity and flexibility of
the notes. But times arrive in every commercial country when
there is doubt concerning the value of goods and paper. On such
occasions it is the function of good banking to discriminate between the good and the bad paper, and to continue unhesitatingly
to advance capital upon that which is of unquestionable soundness. When that is done, the effect of lack of confidence, or
stringency, is simply to sift good assets from bad. The men who
own the sound commercial paper do not seriously suffer.

If, however, the system is such that banks are unable to continue their advances, no matter whether the paper offered to them
is good or bad, because they fear for their own existence,
it cannot be regarded as being a sound system, or as having met
the commercial requirements of the community. That is, in Reserve
truth, the unfortunate situation under the present national bank-


ing system, owing to its peculiar use of reserves. With reserves
widely scattered and with no definite assurance on the part of the
banks that they can dispose of commercial paper, no matter how
sound such paper may be, every institution must necessarily protect its own interests from a selfish standpoint by refusing to continue accommodations to the public whenever it appears likely to
be subjected to serious strain. This strain usually takes effect in a
drawing down of reserves.


§3. How the national banking system fails to perform its
part during such a period of special strain can be clearly illustrated by comparing the accommodation extended to the public
by the national banks with that extended to the public by some
of the principal foreign banks in the same periods. A contrast of
this kind can be instituted to good advantage between the banks
of the national system and the large central banks of France,
England, and Germany. In the following tables are represented
the loans and discounts, reserves, and the individual deposits of the
banks in the system for the five dates during 1892 and 1893, upon
which regular reports were made to the Comptroller, while the
first report in 1894 is also added. Reviewing these figures, it is
seen that the high-water mark of loans and discounts and, at the
same time, of deposits was reached during the latter part of
1892. When a stringency came on, both fell off, and a low point
was reached in 1893, whereupon recovery started. The five dates
for 1907 and the first date in 1908 have likewise been compiled.
During 1907 there was an increase in loans and discounts and
deposits up to August, when stringency set in and a serious decline was brought about, this decline continuing into the following year.



R"g e r v e s

The figures given for reserves or stocks of money in Europe QU|te
show that there was a shrinkage of these stocks in the hands of the
the foreign banks practically at the same time that they were ¡^Europe
enlarging their accommodations, while the specie stocks of the



national banks enlarged as they curtailed their accommodations.
The foreign banks helped their customers and let go their cash
for that purpose. Our banks refused aid to their customers and
insisted upon accumulating larger stocks of money than they would
have sought, even in normal times.
(000,000 omitted.)
Loans and
Mar. 1
S i y 17 .
Julv 12
Sept. 30
Mar. 6
May 4
July 12
Dec. 19
Feb. 23
Jan. 26
Mar. 22
May 20
Aug. 22
Dec. 3
Feb. 14


2 108,















The next table exhibits still further the distribution of loans
and discounts, individual deposits, and reserves among the central
reserve cities, other reserve cities, and country banks of the National Banks in the United States, during the critical periods of
the panics of 1893 and 1907. The figures in this table show the
difference in attitude towards their customers which was adopted
In Panic
by the banks in the United States as compared with those in
Europe; and inferences may also be drawn as to the attitude of the
large city banks as compared with that of the country banks. The
reader should note the change in the loans, and also in the deposit
item, which is often the result of loans. If the loans fell off, it
would show that the banks were liquidating their loans to the public, in order to reduce their immediate liabilities; on the other hand,
an addition to the reserves would show that the banks were protecting themselves. If the reserves were increased at the same
time that loans to the public fell off, it would show that under our
system the banks were driven to the policy of refusing loans just at
the time when they were most needed by the public.



(000,000 omitted)
Central Res. Cities
Other Res. Cities
$ 534
$ 452

Mar. 6, 1S93
4, 1893
July 12, 1893
3, 1S93
Dec. 19, 1S93
28, 1894

Dec. 3,
Feb. 14,

3908, ..


Country I3anks





Central Res. Cities
$ 3S0
9, 1892....
Mar. 6, 1893
May 4, 1S93
July 12, 1893...
3, 1893
19, 1893
28, 1894
Dec. 3,



Other Res.
$ 423

$ 95 G




Central Reserve
9, 1892.,,
Mar. 6, 1S93..
May 4, 1S93..
July 12, 1893..
3, 1S93..
Dec. 19, 1S93..
Feb. 28, 1894..





Per Ct.

Other Reserve
Per Ct.


Per Ct.


26. S


IS. 75


Taking the country banks first (in the table on the preceding
page) it is observable that there was a very sharp constriction of
loans and discounts (representing the amount of accommodation
extended to the public) in the period between March 6, 1893, and

Increase of
In Time of





October 3, 1893. The loans and discounts fell from $1,867,000,000
to $970,000,000; and in the same period the individual deposits
fell from $970,000,000 to $764,000,000. At the same time that
the country banks as a whole were reducing their loans to the public, they were simultaneously increasing the percentage of their
reserves to deposits from 25 to 30 per cent.
Likewise for the central reserve cities in the same period there
was a decline of loans from $522,000,000 to $442,000,000; there
was a corresponding decline in individual deposits from $404,000,000 to $352,000,000; and an increase in the percentage of reserves from 29 to 35 per cent. This again shows that in a time
of crisis, when loans were most needed, the reserve city banks (other
than central reserve cities) withdrew their assistance to the public
and increased the percentage of their reserves; that is, in order
to protect themselves, the banks sacrificed their customers.

Action of
City Banks

It is to be observed that the banks of the central reserve cities
acted more nearly after the fashion of the European banks. They
were the holders of reserves for other banks, and when called upon
for cash, they sent shipments out into the country and maintained
their position by importing gold from abroad or by obtaining lawful money from the Treasury. In justice to these banks, it should
be observed that loans on March 6, 1893, were $350,000,000; July
12, 1893, they had risen to the amount of $571,000,000; and
October 3, 1893, they were $377,000,000. However, individual deposits fell from $374,000,000 March 0, 1893, to $330,000,000 October 3, 1893; and reserves increased in the same period from 26 to
37 per cent. Here again we see, even in the case of the central
reserve cities, a tendency to the liquidation of deposits accompanied
by an increase of percentage of reserves to deposits.
Similar lessons are to be drawn from experience during the
panic of 1907. The loans of country banks as a whole fell from
$2,272,000,000 March 22, 1907, to $2,198,000,000 February 14,
1908. In the same time, individual deposits fell from $2,502,000,000 to $2.411,000,000; and the percentage of reserves rose from
16 to more than 18 per cent. Eor the reserve cities (other than
central reserve cities) the loans fell from $1,224,000,000 to $1,153,000,000; the deposits fell from $996,000,000 to $932,000,000; and
reserves increased from 24 to 27 per cent. The banks in central
reserve cities increased their loans from $1,039,000,000 to $1,070,000,000, while individual deposits changed from $770,000,000 to



$701,000,000, showing practically no change; while reserves increased from 25 to 28 per cent. Here again it will be observed that
under our rigid reserve system, the country and the reserve city
banks believed their only protection was to be found in an increase
of actual cash reserves at the expense of the borrowing public.
However, it is to the credit of the central reserve city banks that
they met the demands for loans more nearly after the experience of
foreign countries than did the banks depending upon them. The
system as thus explained in the United States, however, standi
out in striking contrast to the working of credit in times of panic
in European countries.

0 f the

In studying the Bank of France, the items chosen are circulation, private deposits, commercial discounts and reserves. Circulation is here combined with private deposits because of the fact
that during the periods of stringency in France circulation is
more likely to be the form in which loans are completed than are
deposits, while at all times the note issues constitute a far more
important medium for the making of loans than do the deposits.
Reviewing these figures, it is seen that the circulation of the Bank ^ f a n k
of France, which had been 3,114 million francs early in 1892, France
continued to rise steadily, reaching its maximum for the dates
given on March 1, 1894, when it was 3,527 million francs. Meanwhile, the commercial discounts had risen from 672 million francs
to 715 million francs. In 11)07-08 the course of development was
very similar. The bank had brought about a shrinkage in its note
issues just before the stringency came on, so that at the end of
May there were 1,686 million francs outstanding. As stringency
developed, the notes expanded to 4,006 in December, and then to
4,832 million francs in February of the following year. The
commercial discounts went through somewhat the same course of
development, reaching a maximum of 1,255 million francs in
December, when the stringency wus at its height.
In the case of the Bank of France the figures for reserves
show a substantially stable condition during the latter part of
1892 and practically the whole of 1893. Very little fluctuation
occurred during those months. Although there was a material
increase in commercial discounts during the middle of 1893, and
a large increase in private deposits at the same time, both followed by a shrinkage, there was no effect on the reserves. The
growth in circulation, which reached a maximum in July, 1893,
not equaled during the preceding eighteen months or the follow-




ing nine months, was not paralleled by any corresponding movement in the stock of cash on hand. Reviewing the conditions during 1907 and the early part of 1908, it is seen that, although circulation reached its high point in December, 1907, and private
deposits were larger on that date than they had been for many
months, the same being true of commercial discounts, the reserve
was decidedly smaller than it had been at the last preceding date
(August, 1907), and was practically at the same level it had held
for several months before that time. This again illustrates the
fact already referred to that there was no disposition on the part
of the Bank of France to increase its holdings of specie during a
period of stringency, but that it was rather inclined to let the stock
run down, notwithstanding the increase of accommodations to the

Mar. 3
Mav 19
Ju.v 15
Sept. 29
Mar. 2
May 4
July 13
Des. 21
Mar. 1
Jan. 24
Mar. 21
May 23
Aug. 22
Feb. 13



(In Francs; 000,000 omitted)


3,HO I,
















In the case of the German lteichsbank, the figures chosen for
tabulation are bills discounted, notes, other demand liabilities and
coin. The notes and other demand liabilities represent the forms
in which credit was extended to the commercial public, while the
bills discounted represent the assets in the form of commercial paper
received by the banks. In 1892 the bills discounted by the bank
were about 544 million marks. This figure rose steadily during
the period of stringency, reaching its maximum in October, 1S93,
with 638 million marks, after which shrinkage occurred as the
stringency abated. The course of development in the note issues
was very similar. Demand liabilities other than notes shrank



during 1S92, then increased again as the business public began to
demand more accommodation in the form of deposit accounts.
Vet the bank was willing to pay reserves, while increasing loans
in order to aid the public. The coin held by the bank shrank a
liood deal more than 100,000,000 murks during 3 8!)-\ recovered P a i d 0 u t
only moderately at the opening of 1 8 9 3 ; but fell nearly 2 0 0 , 0 0 0 , 0 0 0 and
marks in 1893. and reached a low point in the latter part of the Increased

year. Yet while the coin on hand was thus falling off, notes were
increasing to their maximum (October, 1 8 9 3 ) , while the same was
true of bills discounted.
In 1907. the bills discounted gradually increased as the
stringency grew more intense, while the notes went through the
same course of expansion, reaching a maximum in Pecomher, 1907.
Other demand liabilities had reached a maximum early in the year,
and shrank during the panic period, when loans were taken largely
in the form of notes. Then, as business men began to demand
accommodation in the deposit form more and more, the other demand liabilities expanded at the time when they were shrinking in the United States. A condition similar to that in 1893 existed during 1907 in regard to reserves. The low point in coin
holdings was reached in Pecember simultaneously with the high
point in bills discounted and in notes issued. That is, as contrasted with our contraction of loans and increase of reserves in a
time of real need by borrowers, the Reichsbank increased its loans,
as shown by the increase of its immediate liabilities, at the very
time when it was meeting demands for cash by paying out its

Fob. 29
May 15
July 15
Sept. ,10
Dec. ir>
Feb. 2S
Jan. 31
Mar. 23
Aug. 23
Dec. 31

(In Marks; 000 omit tod)
Othor Demand
S3 6,445


(565, m

920,13 i
9 iS,S17








1,001, SI?i







Bank of


In representing the course of business at the Banking Department of the Bank of England there are tabulated the figures
showing total deposits, seven-day bills, and reserves. For the period
1 8 9 2 - 9 3 , it will be observed that there was a shrinkage during
the period before the breaking out of the panic, the low point being reached early in December, 1892, when the figures show
This figure steadily increased until it readied £ 4 0 , 1 3 5
^ ^
isd3. Subsequently, there was another shrinkage and then
an upward trend. The specie holdings of the Bank of England
during the panic period, 1 8 9 2 - 9 4 , reached their maximum in July,
1893, but promptly fell off during the latter part of the year. There
was no corresponding shrinkage in deposits and seven-day bills,
and an inspection of the figures shows that at times when the
amount of these accommodations was growing rapidly as was the
case early in 1893, reserve funds were falling heavily. The smallest sum of reserve held was in May, 1893, at a time when the deposits and seven-day bills stood at a figure nearly as high as any
that was reached during the whole period.
Mar. 2
May 18
July 13
Sept. 28
Mar. 1
July 12
Dec. 20
Feb. 28
Jan. 23
Mar. 20
May 22
Aug. 21
Feb. 12

Total Deposits and
Seven-Day Bills

Reserve Notes
and Specie









During the year 1907 there was a high point of deposits at
£60,271 in March, which was reduced in May and August. The
figure remained about stationary from that time until about the
end of the year, then expanded, while accommodations in the
United States were shrinking. During 1907-08, the low period in
holdings of reserve funds was reached in December, that being
practically the most severe moment of strain, while at the same



time accommodations in the form of deposits and seven-day bills,
although not at a maximum, stood at a figure fully up to the general average. The way in which the bank extended accommodation can be seen from the fact that when the strain of the panic
was relaxed early in 1908, specie was increased by about one-third,
while only a moderate increase in accommodations took place.
In all of this discussion it should be borne in mind, of course,
that the periods of most severe stringency do not exactly coincide
in the several countries. The dates chosen, however, have been
selected as nearly as possible to correspond. Jf more dates were
given, the course of the expansion of banking accommodation
could be more closely followed in each of the countries.
But £? t ™ p a r , s o n
enough has been said to explain the essential difference between United
foreign countries and those of the United States in the matter of S t a t e s
banking accommodation. This may be summed up in the statement that whereas foreign banking systems are able to increase
their accommodation in times of special need for it, American banks
must curtail. Coincident with this situation is the condition
which leads to the piling up of reserve funds in American banks
at the same time that their accommodations are being shortened,
whereas in foreign banks, although there is a natural disposition
to strengthen the reserve as opportunity favors, particularly by importations of specie from abroad, there is no hesitation about
letting the reserve stock run down if by so doing the commercial
community can be materially helped. It naturally appears that
this relaxation of the effort to maintain a large .specie stock occurs
coincidently with the increasing of current accommodation.
§4. In the foregoing comparison, and generally throughout
the discussion in this chapter thus far, reference has been made
to periods of special stringency or panic as if they were the chief
or only occasions upon which difficulty of the kind referred to
was encountered. This is far from being the case. The periods
referred to have been mentioned simply because they afford a clearer
illustration of the essential defect in the reserve requirements of
the national system than could be had from an analysis of conditions at other times. The fact remains that periods of special
strain are in no respect peculiar, or different in their nature from
others. They are simply times at which essential weaknesses show
themselves more obviously than at others. This means that the
traits which are developed at those moments are seen at all times,




although less intelligibly and certainly at some than at others.
The national banking system, under present circumstances, contracts its loans and raises their price at the very moment, important
or unimportant, when there is a special call for funds.


there is no such call it relaxes its grasp upon business, money becomes easy and borrowing is stimulated.
If we had such an organization of business that the demand
for loans was about as great at one period of the year as another,
this peculiarity of the system would not be noticeable.

The fact

is, however, that demands for loans differ greatly, not only between
years of stringency and years of easy money, but also between
different seasons in the same year.

There are many occasions when

an exceptional demand for loans makes itself felt and when the
loans are correspondingly hard to get.

The best known example

of this sort is seen in the case of the crop-moving period.


peculiarities of crop moving are dealt with later in the present

At this point it is enough to say that the crop-moving

period is, for reasons to be noted later, a period of special demand
for funds with certain classes of banks.

These banks are so

widely diffused that the crop-moving season may be said to be an
occasion of special demand for loans throughout the whole country.
Under the present organization it is, however, a period when loans
are exceptionally hard to get and their price is exceptionally high.
The situation is aggravated, as we shall later see, by the fact
that at those seasons of the year and in those parts of the country

where crop moving is active, the demand for bank credit in the
form of note issues is unusually strong.

This tends to accentuate

the high cost of loans when the latter are taken in the form of
notes, and may at times so shift the balance of demand from those
forms of bank credit which take shape as deposit accounts as to
leave the latter form of credit available in some parts of the coun-r
try at exceptionally low figures. This, however, is merely an accidental feature of the problem.

The fundamental fact is that at

those seasons credit becomes high in price, loans are reluctantly
granted by many banks, and an effort is made to keep control of
specie, notwithstanding that this is the very time when reserves
should be allowed to run down in response to legitimate demands,
and when every effort should be made to cheapen the crop-moving
process by reducing the cost of accommodation on perfectly sound
'Chapter XVIII.



paper growing out of business requirements. The difficulty is
inherent in the reserve system of the national banking law.
§5. In Chapter 1 the outlines of the present system of redepositing reserves were made familiar. What has just been said
suggests that as the system of scattering reserves tends to create an
undue anxiety on the part of banks to build up reserves just when
loans are wanted and when the reverse policy should be pursued, Rede*
so the system of rcdepositing reserves has an opposite and, in some r^J."®,
respects, an equally bad effect. Under the scattered reserve system, Has a
when money is "easy," isolated banks arc desirous of finding some
way to employ their funds. The reserve system tends to draw
these funds to the commercial centers, and particularly to New
York, whenever business throughout the country is slack. Under
those conditions, the prospect of earning a rate of interest, or
some similar reason, attracts the funds of the country banks to the
reserve cities.
Occasionally the funds are not redeposited with banks in these
centers under the reserve system, but are simply sent to brokers
and others who offer them on loan at the highest rate of interest
that is attainable. The effect of this system is to create a feverish Funds
market for loan capital under certain well-marked conditions.
The drifting of the funds to New York and other centers of speculation necessarily enables much speculation to flourish which would
not exist if it were not for the offering of low rates of interest on
deposits. These low rates, however, open the possibility of doing
some profitable business, even when the fluctuations in stocks are
not very wide.
The question is often asked why the drifting of the bank funds
to the centers does not make the use of the funds to commercial
interests as free and as cheap as to speculative interests. The reason is that these funds constitute a part of the reserve of the banks
when they are deposited with other banks in the centers. Even w h y
when peddled out by banks to borrowers through private bank- These
srs, loan offices and brokers, they constitute a part of the avail- D^Not
able liquid funds of the banks. They have therefore to be within Go to
at least moderately easy reach. They could not be loaned on Borrowers''
time, since that would imply the creation of time paper, which
would be of no service unless it could be rediscounted. The
banks naturally feel that they can lend their funds in this way







only upon demand or call. No regular merchant feels that he
can afford to borrow funds upon call. The risk of being asked
to make payments at times when he can least afford to do so
is far too great. Ordinarily, he would rather not borrow at all
—and correspondingly limit his operations—than borrow on cali,
unless the case is one of extreme necessity. Speculators, on the
other hand, usually prefer the call loan type of borrowing. They
want to make quick "turns," and the condition of the stock market, or produce exchanges, frequently permits them to do so. If
they can get the use of cash, even for a few days at a time, provided it does not cost them too much, they are willing to take it.
The opportunity for lending such funds as have been spoken of
therefore is practically limited to the call loan field.
There is another aspect of this same matter which seems opposed to the views already expressed, although it really is not so.
In what has been said, the suggestion has been offered that the
loans most frequently made are made at low rates and on call,
due to the fact that speculators are encouraged to take the funds
because of their cheapness. This is usually the case. There are
some occasions, however, when precisely the converse of this situation exists. In the case of a severe stringency or panic it may
be absolutely imperative for speculators who have committed
themselves very heavily to get the use of funds for a short time.
Under those conditions the speculators stand ready to pay abnormally high rates in order to get the command of funds for a short
Very quickly the banks of New York City, or any other
similarly situated place, find themselves heavily burdened with
loans. Many of the loans which they will be found to be carrying under such conditions are necessarily loans based on collateral,
either directly or indirectly. The banks do not feel like enlarging
their liabilities of this kind. Consequently, a limit is very easily
reached to what the banks can do, and speculators find themselves
obliged to turn to banks in other places. The question is then
opened whether such other banks will be willing to furnish the
funds needed, if by so doing they endanger the welfare of their
own customers. Occasionally such a danger may be consciously
incurred because the banks want to profit by the high rates of interest at a distance. If a national bank thus wilfully puts out of
its hands the funds which have been entrusted to it by the community, and which should be used in that eommunity"so long as


there is a need for them, it places its local customers at an undeserved disadvantage, and it does this for the sake of furthering
the enterprises of remote speculators.
More frequently, however, the local national banks do not
intend anything of this sort. They know that they have a small
sum to spare and are tempted by offers of high rates of interest
to let it go. When they have thus weakened themselves, unexpected calls are made by local customers. It becomes impossible
to provide lor the local business men; and thus, without any wrong
intention 011 the part of the banks, the regular customers are Fubjected to the same bad conditions as if the bank had voluntarily
separated the community from the loanable funds which it should
have kept within reach. This necessarily means cither that the
community must go without the banking accommodation it needs
or else that it must appeal to other communities and pay high
rates of interest in order to get its loans. In other words, business and industrial interests are obliged to bid for accommodation
on a parity with speculators who have been pinched in stock or
produce exchange operations.
Where these conditions exist in most aggravated form, the
effect is to deprive regular borrowers of the advantage of very low
rates, but to impose upon them the disadvantage of the highest
rates that prevailed from time to time. That is, commercial rates
of interest are made to depend upon speculative rates. Of course,
this necessarily means that the expense of speculation is in considerable measure added to the expense of obtaining regular and
legitimate loans. Even when that has been said, no account is
taken of the burden and, perhaps, destructive influence, that has
resulted from the withholding of reliable loans at moderate rates
when the community had a right to expect that they would be
made, but when, in fact, they had been rendered impossible. The
difficulty with the national system in this respect is twofold. It
grows out of the entire lack of any cooperative reserve system
which might serve to control the movement of funds between different parts of the country. It also results in large measure from
the great diffusion of reserves among different communities which
prevents any adequate estimate or adjustment of regular demands
for accommodation.
The defects of the system of redepositing reserves and
the tendency of this system to promote speculation need not be




Cost of

Amount of



regarded as the only factors tending to increase the cost of loans
to the community and to render them irregular and disproportionate
between different communities. It must be concedcd that the
system of diffused reserves implies a high cost of loans, even under
the most favorable conditions. That is, a system which requires
an unnecessarily large amount of reserves, unproductive in the
form of cash, is an expense to the banking community, inevitably
falling in the end upon the borrower in a higher rate of discount.
Bearing in mind that the diffused reserve system is necessarily closely associated with the peculiar characteristics of the
discount market in the United States, it can be understood that
the maintenance of reserves is very closely dependent upon the
existence of a satisfactory and active market for paper. Great
economies in bank operation could be effected if banks could be
certain of a prompt and reliable market for their paper, so that
they could feel sure of always being able to replenish their reserves whenever circumstances demanded. Under such conditions,
reserves could safely be allowed to run down to a much lower
figure than would otherwise be prudent. At present the maintenance of a considerable cash reserve by any bank which is doing
an active business is practically unavoidable, since it cannot have
the assurance of being able to rediscount or market its paper at
favorable rates without delay whenever it may desire more funds.
It is therefore obliged to keep on hand, and in an idle condition,
considerable quantities of reserve money.
This reserve is necessary in any system of isolated and independent banks. The framers of the national bank act tried to
reduce the cost of carrying reserves as much as possible by permitting the redepositing of reserves with banks in reserve cities
and central reserve cities. But these banks themselves can pay
only a low rate of interest upon such reserves when left with them
subject to call. The payment of this interest is frequently an
unfortunate thing, both for the bank which gives it and the
bank which receives it, for more reasons than one; but, whether
it be paid or not, the fact remains that the redeposit system, as
applied to reserves, does not materially lower the cost of carrying
on the banks. This is where the branch bank system has its
greatest advantage in the matter of expense—it does not require
the payment of a large reserve fund into distant vaults, where it may
remain idle almost indefinitely. On the other hand, a plan which
would avoid the present necessity of keeping unnecessary reserves,



by providing some cooperative system for their mobilization, would
largely eliminate this element of cost.
Meantime, the high cost of independent banking continues to
be one of the serious defects of the national system, both by depriving small communities of credit facilities and by raising the cost
of loans at country banks. The fact that the country hanks' customers are obliged to pay a higher raie of interest for their accommodation than customers in cities is often explained on the ground
that the paper presented to the country banks contains a larger
element of risk than does that presented to the city banks. This
may or may not be true; but even if the paper were of the same
grade the differences in the rates of discount would exist for the
reasons already stated. That it is not nece??ary to have such a
difference is seen from the experience of Canada, whose system of
business and agricultural organization is very similar to that of
the United States. A comparison of interest rates at various points
in the United States, compiled from the reports of about (».000
country banks, makes the following showing:
DeTimo maiiil
Loans. Ijoans.

DeTim o in a ml
Loans. Loans.
New England States
New Hampshire
5. IS
Rhode Island




Eastern States
New York
5. S3
New Jersey
5. S0
Dist. of Columbia

f>. 67









5. S
6. O



Western States
North Dakota
South Dakota
New Mexico


Average for the United States.

6.1 G


Southern States
West Virginia
North Carolina
South Carolina


Middle States



S. 51
S. 09




S. 70


S. 55

Pacific States



. 7.S3






Need of



A feature of the national banking system to which comparatively little attention has been given by those who have compared it with foreign countries is found in the lack of credit
facilities afforded to small places. The national banking system,
organized as it has been upon a basis of entire independence in
banking, has naturally limited the size of the institutions that
could be established. The framers of the national act did not feel
that a bank could be safely organized with a capital of less than
$50,000. This continued to be the lower limit of capitalization
until the year 1900, when the limit was placed at $25,000. National banks may therefore be organized today with capital not
exceeding $25,000, if they are located in towns having a population of not over 3,000 persons. Of course, the practice of limiting
banks with reference to capitalization means that the very smallest
places cannot be taken care of, but must look to others to supply
them with credit facilities. This, in fact, is the method which
they have followed. State and private banks of very much smaller
capitals, running as low as $5,000, have been organized in the most
minute units of population.

The reason why even these small banks cannot be maintained
in some places is that the expense of carrying them on is too great
in proportion to the amount of business offering in those places.
tfnles3 a bank can make a fair return upon its capital it necessarily
seeks some other field. Yet in foreign countries banking facilities
are provided in places which are deprived of them in the United
by a
Cooperative States where the business is unprofitable. It is possible to extend
the facilities there by the use of the branch bank system. No
such system exists in the United States, and no one now proposes
to introduce it. Yet it would be highly desirable if the advantages
offered by the branch bank system could be furnished here through
adjustments of the cost of carrying on banks by economies in reserves and otherwise.

Cost of

§7. The hoarding of cash in the manner described, and the
failure to afford commercial loans when they are needed, have
many indirect effects that are not so obvious as those immediately
related to the banking system itself. One of these is the influence
produced by the credit system of the national banks upon prices
of goods. Bank credit—the cost of borrowed capital—is a regular
element in the expenses of production of every large business. H

credit is high in price, the expenses of carrying on the business

arc correspondingly raised; ii it is low, they arc correspondingly
reduced. Bank credit is costly when the expenses to the bank
involved in supplying it are high. This occurs whenever too little
facility exists for the extension of loans at the times when they
are most needed. Instead of expanding these loans to meet larger
volumes of business, the banker under the present system almost
necessarily shortens his loans, usually raising his rate at the same
time. The result, in the long run, is to necessitate1 higher prices for
commodities in couscqucnce of the expensivene^s of bank credit.
This condition is not so marked in commercial centers, or
oven in manufacturing towns, a- it is in the rural districts, li
is seen in aggravated form in some agricultural regions when»
rates of discount are extravagantly high, due partly to the inability to obtain rediscounts from other hanks on the paper which
originates in these communities, and partly to the relatively large
volume of money which is required in order to provide a basis for
the loans in the community. This situation arises wherever the
custom of the community calls for actual currency, and where the
only kind of currency that can be had is that which the bank
borrows from some other institution at a high rate of interest.
The liigh prices which are so frequently referred to by superficial thinkers on money as growing out of the presence of a large
volume of money in the community, are really due to an entirely
different circumstance. They are the result of costly bank credit
resulting from u clumsy banking mechanism, which necessarily
calls a large volume of cash to its aid, as an inexperienced swimmer
requires an unnecessarily large amount of supporting power to
keep him from sinking. The large quantity of money held in the
circulation is the concomitant of the high prices which have been
partly due to the use of primitive banking methods.
This failure of the banks to cooperate successfully and
economically with the business community is aggravated by the
difficulty of selling local paper in other parts of the country. The
paper in the hands of the small bank in a remote spot may be excellent, yet may be entirely unsalable at a distance, owing to a
lack of knowledge in other banking institutions concerning the
character of the paper of the given locality. Inasmuch as this
general ignorance could only be repaired through some agency like
the bank itself, and inasmuch as the bank is itself interested to
sell the paper to the institution from which it is seeking accommodation, the latter has no impartial way of testing the paper.


Not Due
to Large
of Money

at a



This is one of the most serious defects of the national hanking
system, and is very nearly peculiar to it. In foreign countries local
paper is tested through branches representing larger institutions,
or through cooperative effort on the part of several banks, or otherwise. Nothing of the kind exists here. Paper offered for rediscount to distant financial institutions must rest entirely upon
the credit of the bank itself and of the maker of the paper.
It is this local character in our paper which renders it hard for
banks to aid other banks with the conviction that in so doing they
are not inflicting an injustice upon their own stockholders and

to Go

to Widely

§8. Conversely, the conditions which have just been described
operate to obstruct the getting of loans by large concerns which
need them and are entitled to them. It frequently happens that
a large business house of unquestioned solvency and ability finds
that it cannot float its paper with the local banks in the place where
it is situated. This is not because of untrustworthines3 on its
part, but-it may bo simply that the concern does not feel like
paying the high rate of interest that is demanded by the local
banks in consequence of the general condition of credit prevailing
there at that time. Either the banks are not willing to take the
paper at all, simply because they are overloaded, or else they are
willing to take it, but at so high a rate of interest that it would
not be worth while for the concern to use more capital in that
Under such conditions the business may place its paper in
the hands of note-brokers, who dispose of it in communities where
the banking system is able to provide further loans, and where
therefore it is not difficult to float the paper at a reasonable rate
of interest. This operation has two serious objections: I t requires time; and the cost involved in paying the note-broker is
large when compared with the total cost of the loan. Added to
these is the fact that where paper is thus distributed very widely the
buying banks cannot judge of its character, while the door is opened
for irregularity and deception on the part of unscrupulous persons.
But it should be clearly understood that however the paper
may be floated and wherever banks may be induced to take it up,
the whole question is merely that of the supply of bank funds as
compared with the demand for them. The bank in the large city
which is visited by a known and tried customer would be glad to



extend accommodation to him if it could feel any assurance of being able to convert the unquestionably sound paper thus furnished
him into immediate funds in the event of necessity. It does not
dare to go beyond a certain point, because it knows that there may
be danger. The reason for danger is that the possibility is recognized that customers or depositors may suddenly converge upon
the bank with a demand for cash. So, in seeking accommodation,
the borrower finds it necessary, simply because there is no general
discount market in the United States, to hunt up the banks which
still have a surplus of lending power within their control—that is, L a c k o f
which are not "loaned up" to their limit or to the limit of safety. Discount
Whether a demand converges on the large bank in a city, or whether Limits
it appears at the small bank in the country, the effect is the same. Loan®
There is no difference in the character of the problem. The large
bank, if anything, is in a proportionately less stable position and
has to protect itself more carefully, because many of its customers
arc small banks, and their demand, when exerted, is a demand for
actual cash with which to supply their own reserves.
§9. It is clear that the evil which most urgently demands
correction in Die present reserve system is its rigidity. But it is
equally clear that this evil cannot be corrected by merely allowing
banks under existing conditions to regulate their reserves at
pleasure. To permit them to do so would, no doubt, be beneficial
in many instances, since it would result in permitting the banks
to use their own judgment more freely about letting cash run down
when circumstances seemed to require such action. Probably, in
other cases, such a change would not be beneficial, and in some
would be injurious. The real evil can be corrected only by the Cooperation
establishment of a means of getting rediscounts, or of obtaining
accommodation, from a source which can be relied upon to supply
the banks with current funds for the replenishment of their reserves, so long as they can present live commercial paper, running
for short periods, and growing out of legitimate commercial
transaction. This can be accomplished only through the establishment of a cooperative system which will permit the joint control
of reserves so as to practically place the spare funds of all parts
of the country at the service of each when circumstances may require it. An improved system of joint control of reserves created
by the harmonious action of the banks themselves acting together,



and working through the medium of an open discount market,
would substitute for the present system of scattered and competitive
reserves a plan which would afford tlio strength of unity and cooperation.



Panic Conditions—2. Dangerous Grasping for Reserves—3.
of Converting Assets Into Immediate Means of Payment—4. Bank
Notes Not a Desirable Remedy for Panics—5. R e m e d y Must Touch
Lending Power of Banks—G. Restoration of Confidence if Assets
Good—7. Experience of Other Countries—8. Remedies for Panics
Not in Temporary Measures—9.
Importation of Gold for Reserves.

§1. In preceding chapters reference has been made to the
fact that at periods of panic or stringency the national banks
under existing conditions shorten their loans and restrict accommodation. This was noted as merely one example of the way in
which the present reserve system tends to limit accommodation
when it is much needed, while granting it when it is not so much
needed. Although the general rigidity of the system, existing as it
does at all times and in all places, is the really serious element in
the banking problem of today, attention has rightly been given to
the tendency of the system to fail just at the most critical
period and thereby to prevent the attainment of relief at times
when such relief is absolutely necessary. The relation of the banking system to panics and crises has therefore received an exceptional amount of study and has sometimes been spoken of as
if it were a special problem. It, however, is not that; but it is, as
already noted, a special case of a general problem. It is worthy of
independent discussion, however, because at periods of stringency
the effects of various measures of relief upon the commercial community can be clearly traced. Lessons are thus indicated for the
conduct of affairs in normal times.
The course of a commercial disturbance of the sort referred
to is somewhat as follows. Difficulty at the banks is indicated by
the fact that they are unable to extend accommodation as it is
wanted to regular customers. Probably for some time preceding,
bank liabilities have been increasing, while eash has either barely
held its own, or has fallen off. The bank endeavors to secure means


of Our
System In
Part of

Leading to
a Panic



to make further loans by appealing to other banks for accommodation.

But on such occasions these other banks are themselves

crippled in somewhat the same way; or they are appealed to by
so many institutions that they cannot furnish the aid that is called
for, at least not in the amount that is needed.

The banks then

find themselves in danger of a decline of their reserves below the
legal minimum or, perhaps, even below the line which experience
has marked out as the margin of safety.

In such cases the only

resource is to refuse loans to the business public.

This means

that extensions cannot be had in some cases, while in others men
who had confidently expected to receive more accommodation are
cut off.

Consequently, they do not find it possible to pay others

and a so-called lack of confidence is developed.
If a time arrives when it is generally realized by the business
community that the activity of the operations in a particular line,
or perhaps in all lines, has gone too far, and that the upward trend
of prices has reached its limit, the result is likely to be a sudden
falling off in demand, or an inability to make sales of goods or
Lack of

P r o P e r t y> which must be disposed of in order to liquidate the obliga-


* i o n s that haTe been incurred by owners, who have taken it over




check to business tends to restrict sales, and makes it necessary


at a valuation


is n o w

g cen

to be too high.


for those who have obtained accommodation at banks to secure extensions of time in order that they may be given a greater opportunity to collect what is due them from others, or to dispose of
the goods they have on hand in a manner sufficiently profitable
to enable them to clear themselves and liquidate their indebtedness.
The banks must then decide whether they can afford to make
this extension.

T o do so will deprive them of immediate resources

either in cash or in claims on other banks which they had expected.
It may be a serious matter to the banks to grant an extension of
the accommodation, because they may be called on to do so at a
time when their resources are running so low as to put them in

If at this particular juncture, the banks being unable, to

collect what is due them, depositors holding demand liabilities of
some bank or banks begin" to demand the actual liquidation of
these liabilities in cash, the bank or banks thus affected may be
placed in a very embarrassing position.

They may find themselves

face to face with an empty vault, while demand liabilities are still
being presented at the counter for liquidation.

§2. Meanwhile, if the smaller banks have had funds on deposit with other banks, they have probably drawn them down to
some extent. True, they are allowed to count these funds as part
oi their reserves, but the reserve city and central reserve city banks
which require large stocks of lawful money in their vaults have
usually had to call in all items due from other banks. The first
result of this situation is a general tightening of credit, a shortening of the balances on hand in banks due to other banks, and GraiplnQ
presently a reduction of individual bank balances or deposits a:- ^
these are gradually used to liquidate outstanding obligations. As
the deposits are drawn upon, those to whom they are paid away
may either redeposit them or draw them out by asking the banks
for cash. Before the stringency is far advanced, a good many persons are choosing the cash alternative, and are thereby putting
the banks in an embarrassing position. The more cash the bank? pay
out, the less able they are to extend credit, and since they cannot
get further accommodation or rediscounts at other banks, their difficulty is likely to be very serious.
Of course, all this would be remedied if there were some general means for expanding loans just at the time when they are
most needed, or if it had been possible, in anticipation, to penalize
the banks by taxation or otherwise for their action in allowing
themselves to become so short of funds. But the national banking system makes no provision for such relief. Its regulations are
rigid and require the maintenance of a given amount of reserve,
Even when these regulations are stretched to the utmost and the
banks let their reserves run down, in order to continue extending
accommodations, the fact that there is no fixed relationship between
the banks makes it possible for selfish institutions, so to speak, to
help themselves to the country's stock of cash. They play the part
of dogs in the manger, accumulating cash in their vaults often to
guard against a fancied threat rather than any real harm. Although they are precisely the institutions which ought to be helpful
and inclined to place their funds at the disposal of the community,
those banks which are in most liquid condition are able to practice
this kind of selfishness to the greatest extent.
Very often this process of hoarding is carricd to an extreme.
During the panic of 1907, there was a mad rush for actual money,
and many local banks grasped all that they could get, piling the
coin and currency in their vaults and advertising the fact to the

co-operation Exists
seifjgh Vent




public. In some cases this unnecessary reserve was raised as high
as 50, or even 75 per cent of outstanding liabilities. The cash,
if left in the hands of other banks, would have enabled many
which got into difficulties, to keep afloat, and at the same time to
supply the needs of borrowers who were looking to them for aid.
n o t r e ( l u i r e c o n < l u c t of this kind on the part of a very large
number of banks to make the existing stock of cash inadequate.
The visible supply was speedily shortened below the danger line,
and then the only resource lay in some extraordinary methods, such
as suspension of payments, issue of clearing-house certificates, or
some other equally drastic measure.

§3. All that lifls been said thus far is based upon the assumption that the operations of the banks have been essentiall) conservative and sound, and that the paper they hold is absolutely valid
and can be collected. There is supposed to be no bad paper, U T
losses due to favoritism or dishonesty. If such losses occur, they,
of course, aggravate the situation, and when they become known
Aggravathey still further stimulate public alarm. It is not necessary that
tion of
Alarm by
such losses should go to the extent of exhausting the bank's surLosses
plus, or even its capital, for them to be a very serious factor
affecting its status. Knowledge that such losses have occurred
arouses suspicion and fear, and within a very short time the desire
of creditors to secure liquidation from the banks is heightened to
an abnormal extent. This, however, is more usually due to the
conduct of individual banks than to the banking system as a whole.
Panic conditions and lack of confidence, on the other hand, can
be developed without any imprudence or over-extension on the part
of banks, simply as a result of undue speculation or expansion on
the part of the business community. However it originates, the
problem by which banks are confronted at a time of panic or crisis
Need of
—supposing their assets to be perfectly good and well protected—
Assets into is that of converting their resources into immediate funds. They
Means of
must find some way of satisfying the demands that are made upon
them by individuals for means of payment that are available without any delay and can be used in the satisfaction of debts.
The current supposition is that the "immediate funds" which
are thus wanted must take the form of "money/'
This idea
probably grows out of the belief that in times of panic or stringency
the banks which have money in their vaults are deemed safe, and




find it easy to allay fears concerning their ability to redeem.
Hence, the conviction in many quarters that what is wanted on
such occasions is a means of issuing money in the form of "notes."
Out of this belief have grown the many futile schemes for providing an issue of "emergency currency." The truth is that such
an emergency currency can be of use only in case the recipient
of it confidingly believes that the bank has actually liquidated its
debt to him by issuing a debt in a different form. When a panic
comes on, many people find themselves the holders of claims against
the banks. These claims may be in the form of deposit credits or
they may be in the form of notes. If they are already in the latter
shape, the presentation of note« at the banks for redemption cannot
be met by the issue of other notes—in that case, the trouble would
be that the bank was already finding it hard to .sustain its outstanding note issue by redemption in lawful money. If the outstanding
claims are in the form of deposit credits, depositors will not he satisfied in a period of distrust by the exchange of these credits for the
bank's own notes, since these are merely another form of its obligation. The power to issue more notes of its own, therefore, is not,
as a general principle, a satisfactory way of providing it with what
we have called available funds.
Only under one condition can notes supply this need. If they
are protected in some special way, as for example by a joint guaranty on the part of other banks (as in the Canadian system), creditors of the bank may feel better satisfied if they have in their possession an obligation guaranteed by all of the banks, than they
would be ii they simply had the note of one bank. Their fears may,
therefore, be allayed by giving them notes thus guaranteed, in exchange for the deposit credits, which are valid only against the bank
which granted them. In this case the situation may be relieved by
the issue of notes of the kind indicated. But it should be noted
that what has been done here has been to grant relief by substituting the obligation of a group of banks for the obligation of a single
In the same way, relief may be obtained if, under a bond security system, certain portions of bank assets known as bonds which
are of unquestionable soundness, can be segregated, and notes issued
against them, preferably under governmental regulation.
may be willing to accept these notes in liquidation of the claims
they hold against the bank even though they may not be a legal

One Liability for

of Bank
Notes by a


by Segregation of
Assets In
Form of

Means of

Notes of
by Rediscount



tender. In this case, the situation lias been met, as before, by substituting a claim upon a certain kind of acceptable assets for a claim
upon other assets which were distrusted. In one instance, there
was substituted an obligation guaranteed by all of the banks and
perhaps protected by a special redemption fund; in the other
there was substituted a'lien upon certain particular portions of the
banks' assets, so that the recipient of the notes occupied the position of a preferred creditor protected by a special and unquestionable form of security. Neither transaction has anything whatever
to do with a supposed "shortage of currency" or "amount of money"
in the country The transaction has been simply the exchange of
a better or more valid claim for one which was believed to be less
As we have expressed it above, the demand in a time of panic
or stringency is for immediate funds, and, as just explained, the
meaning of this term is simply a means of payment. Evidently any
other means of payment which would grant the same feeling of security would attain the same result. Available, or immediate, funds
might be obtained by having the directors of the bank—if men of
known solvency or wealth—personally endorse, or obligate themselves to pay, the claims of the creditors of the bank. This expedient has been tried in some instances with decided success where the
credit of the directors was well known and above reproach.
But immediate funds might be obtained in any one of several
other ways. If it were possible for an institution, A, hard pressed
by its depositors, to take some of its paper to another institution,
B, and secure a discount there, A would be relieved just as satisfactorily as if an issue of its own new notes (secured as above indicated) had been obtained. Moreover, if the rediscount brought
forth from B lawful money, or a deposit-account which could be
counted in its reserves, the lending power of A would be increased
far more than by any issue of notes. True, the turning over of
this money to the bank, A, would withdraw that amount of cash
from use elsewhere. But if B, the institution which rediscounted
the paper, were itself authorized to issue notes, the relief to the
•bank, A, obtaining the rediscount would be the same as before, provided these notes were acceptable to the community (even if not
lawful reserve money). That is to say, the bank would now be able
to substitute the obligations of a larger, stronger, and better-known
institution for its own, and the community would be satisfied be-



cause it would feel more assurance of the solvency of these notes.
The institution would in reality have guaranteed certain assets of
the bank and segregated them for the protection of certain creditors. Thus precisely the same object would have been obtained as in
the other case considered.
But this same end could be arrived at equally as well in still
another way. The demands made upon banks in times of panic do Runs on
not all come from the outside world. The effort of depositors to only* 6an
draw out currency by presenting themselves at the wickets of the indication
banks is merely a surface indication of a much deeper-seated trou- o f T r o u b , °
ble. Probably a good while before any such condition arrives,
long before the general public becomes aware of a bank's weakness,
or fears that an institution is unsound (though it really may not be
so), larger depositors have begun to withdraw their funds. As a
rule, they will simply have allowed their accounts with the bank to
run down, checking them out in payment of obligations and not increasing them. Or, they may have directly transferred their accounts to other banks by drawing checks upon the bank in which
they originally kept their accounts.
In either case, other banks have become the creditors of the
bank which is under suspicion to a much greater amount than it
can claim from them. That is to say, there is a heavy balance
against the bank which it must liquidate in some way. It cannot
liquidate this balance by simply paying in its own notes, for theso
will promptly be sent home for redemption, in which case it will be
in exactly the same position as before. All it can do is to secure a
rediscount with some other bank which has claims upon the banks
that are demanding payment from the first institution. It may thus
get the rediscounting bank to relieve it of a part of the claims
against it. The bank does this for a consideration and accepts part
of the assets of the bank that asks for the discount as a protection.
Or, if all banks are united, they may agree to accept in payment
of balances between themselves notes or credits which are obtained ,

from a committee representing the joint institutions and formed for protected
that express purpose. In this case, they merely agree to defer the
liquidation'of their claims against one another until a future date, tion of
being in the meantime protected by portions of bank assets which
are segregated and turned over to the representatives of the combined institutions as security.
In all these cases, available funds have been obtained simply by


of Ways
Means of




securing the recognition of certain assets as being undeniably and
unmistakably good so that they, or what represents them, are accepted by the community, whether directly or indirectly, in liquidation of the claims held by the community against the particular
bank that has been trader suspicion. Available funds, in other
words, are representatives of value which are so clearly worth their
face and are so plainly and immediately collectible that they readily pass current. They may take the form of notes secured by
bonds of known character; or they may be the obligations of the
bank itself protected by special endorsements; or they may be notes
issued by some stronger bank whose credit is above reproach; or
they may be simple claims (deposit credits) upon such a bank; or
they may be notes or claims which have been recognizcd and validated by,the general group of banks of the community for use
among themselves. Whatever they may be, they perform the same
function—they serve to show creditors that the bank or banks under
suspicion have assets which they are able to dispose of in exchange
for evidences of value that are undoubted.
§4. In the past, much emphasis has been placed on the inelasticity of our note-issues; but to-day it is coming to be understood that the underlying trouble in a time of stringency is the inelasticity of our credit system. Already it has been shown how
our rigid percentage of reserves to liabilities creates a dangerous
Some persons have a belief that monetary and credit emergencies can be met by the issue of banknotes. Others express the belief that the problem is not so much one of circulation as it is one
of the organization of credit. The problems, therefore, seem to
center about banknotes on the one hand, and the power of a bank
to lend on the other: (1) The needs of the public for currency, and
(2) the needs of a bank when under pressure in meeting demands
for loans.
The needs of the public for currency to act as a medium of
exchange in buying and selling goods, in paying wage-rolls, in
travel, etc., are obvious. In certain sorts of transactions, mainly
in retail trade and in districts unused to banking methods,
some form of money must be passed from buyer to seller. In
total amounts, however, these transactions are insignificant in comparison with those transactions on a large scale which are carried



on by checks, drafts or bills of exchange—without the use of any
forms of ordinary money. With an increasing population, but
chiefly with the increasing products bought and sold at retail, the
demand for currency, such as it is, must normally increase absolutely in greater or less sums. For such needs an elastic banknote
circulation, slowly rising, but expanding and contracting sharply
with seasonal demands, is imperative. Our present national bank
circulation does not provide for this elasticity. It expands and con-


tracts without any direct relation to the demands of the coinmu- EJajUcity
of Notes
mty. To this point of elasticity much emphasis has been directed. Imperative
Its importance is not to be minimized; but it is to he doubted
if it is as vital as some suppose. If we used only banknotes (or
other paper money) as a medium of exchange, the insistence upon
an elastic banknote circulation would be of first importance; and in
the limited field in which actual money is imperative, the need of
an elastic banknote issue to the general public remains highly important. Although we have the deposit currency as a medium of
exchange which is perfectly elastic, elasticity of note issues should
receive attention in the due proportion of the importance of hanknotes to other media of exchange, under normal conditions of business.
Still keeping in mind, however, the needs of the public for a
medium of exchange and not the needs of the bank itself, it will
probably appear to many that the demand of the public for expanding issues of currency is of vital importance in a time of financial ^ ^
distress, such as that in the autumn of 1907. To those who set most From 1907
store by the virtues of an elastic banknote issue this seems the crux
of the whole matter. It is supposed that in a time of stringency
the public will demand more circulation; and to support this view
the events of the panic of 1907 have been drawn upon as proof. It
is true, of course, that government or bank notes could not be had in
most cities during the height of the panic in 1907, even in small
sums; and as a consequence the clearing-house associations issued
clearing-house notes (as distinct from clearing-house loan certificates) for circulation among the public. Without doubt this inability to get cash for a small check on a bank or at a paying office
made a deeper impression on the minds of the people than any
other event during the panic. It was this popular belief in the
need of more money to which Congress evidently catered when it
passed the Aldrich-Vreeland Act, as a provisional measure before a


Idea of
Need of
Notes In

Banknotes not



coming election in 3908. It was, as everyone must admit, a striking commentary on the inadequacy of our banking and monetary
system that it was impossible for the banks to supply to employers
of labor and for the small needs of every day a relatively small
amount of currency having a general circulation. Yet, on the other
hand, it is a fact that the total amounts of the clearing-house notes
for the use of the public were not large, nor wrere they long outstanding. Moreover, as affecting the ability of the producing and
trading firms to weather the stress of the panic, they had practically no influence whatever. The banks were more frightened than the
public. The demands of the small local banks for additional precautionary reserves drew down the cash reserves of city banks more
than did the demands of business men. This was the reason for the
scarcity of circulation. The holding on to their cash by the city
banks was primarily in the interest of reserves and, therefore, in the
interest of those who wished loans or who had to be carried for a
The power to expand their note issues (which are liabilities)
could not have added to the cash reserves of the banks and thus
have enlarged their power to aid needy borrowers. It is true, however, that an expansion of note issues would have aided the banks
indirectly; it would have allowed them to satisfy the urgent demand
of the public for a medium of exchange by passing out their notes
and thus would have enabled them to retain lawful money which
could be used as reserves to support their loans and deposits. But,
primarily, the issue of banknotes is for circulation in the hands of
the public and not for any serious advantage which they render in
increasing the power of the banks to lend and to stave off a panic.
Accordingly, the prevailing idea that we must provide against future panics and avoid a repetition of what happened in the panic of
1907 by arranging for the rapid issue of banknotes in a -time of
emergency is quite aside from the real point, for it is based on the
wrong assumption that it is the lack of currency in the hands of
the public, and not the difficulty of the banks in lending, which is
the critical thing at such a time.
This popular insistence on the view that we can prevent the
occurrence of panics and meet all the dangers of a financial panic,
once it is upon us, by the device of an expansion of banknotes is
based on an erroneous analysis of banking operations in times of
stress. Very respectable authorities have asserted that our mone-



tary system is radically at fault so long as it will not prevent the occurrence of panics. And the belief that the Bank of England and
the Bank of France—as central institutions—have been able to head
off speculation and avert the evils of expanded credit is referred to
as an instance of what can be done by a central institution in this
country. We have been led to think that the issue of notes is the
means by which the effects of the crisis are met and its inconveniences reduced; in the case of England by the suspension of the
Bank Act bringing out more notes from the Issue Department; and
in the case of France directly by the increase of notes of the Bank
of France. As we shall see later, this appeal to the banks of England and France is wholly unfounded in fact.
The reserve city bank which can quickly increase its own notes
can supply the demands made upon it by country national bank?
and correspondents—provided the country bank wishes only currency for circulation in its neighborhood and not for its own reserves. Here, again, the new bank issues do not give the pivotal aid
which some suppose always comes from additional circulation. Not
being lawful money, they could not be used in reserves and, therefore, would not—and could not—improve the lending power of the
local country national bank. They would, however, supply currency
to the country bank which could be paid out, if urgently demanded,
and thus indirectly protect reserves, and they could be used as reserves by other than national banks.
Another advantage in emergency banknotes, of course, is the
opportunity they present to national banks having relations with
state banks and trust companies. By issuing their own notes they
may exchange them for lawful money held by banks outside the national system. In this way they can indirectly increase their lawful money and consequently their power to lend.
All the above advantages are patent and are arguments in favor
of a margin of elastic note issues. But while these issues have a
great importance, they would not cure the fundamental difficulties
existing in times of panic. The principal reason for this statement
exists in the fact that, obviously, the national bank cannot replenish its reserves—which are an asset—by an addition to its own
notes, which are a liability. Apart from its illegality, it is a banking lie.
Too much may be made of the need of an elastic bank circulation in a time of panic in view of the fact that we already have a

not Prevented
Merely by
in Europe

Help to

Banknotes not
an Asset


as Medium
of Exchange in


perfectly elastic medium of exchange in our deposit currency, especially for all large transactions. The term "money" is loosely used.
We use gold as a standard, but we do not use it to any appreciable
extent as a medium of exchange. More than 95 per cent of our
large transactions are performed by a chock and deposit currency
which rises and falls exactly in proportion to the exchanges of good^
which call forth loans and bank deposits. Under existing familiar
methods of payment by checks and drafts, the borrower who is able
to get a loan in a time of stress has no difficulty whatever in meeting his maturing obligation by a check on a solvent bank. To get
the loan is the important thing—not the particular form of liability
which the bank gives him on making the discount. In fact, on getting the loan the borrowing merchant would not wish to take out
notes and then be obliged to find a place in which to deposit tliern
again. It is clear, therefore, that the mere power to issue banknotes in itself is not the only nor the most important way of meeting an emergency brought on bv a disturbance of credit.

We have heard much in this country about the need of an clastic bank currency. About a marginal elasticity to a large total
circulation in normal conditions for seasonal demands, something
has already been said. There is no difference of opinion concerning that important need. But most persons who advocate an elastic
currency have in mind a need of a very different kind—the need
of help to borrowers in a time of panic. Eor a need of this kind
careful examination will disclose that the issue of banknotes is of
SankNotes of
minor importance and does not touch the real cause of difficulty.
n ™ o r i m P 01 'tarico, for the ability to pay off depositors
in banknotes would undoubtedly give to customers of a bank the
means of meeting maturing indebtedness. But the serious pressure comes from those whose deposit accounts are insufficient to
meet heavy panic demands. The real question is: Will the power
to issue more notes (a liability) enable a bank to enlarge its loans
greatly without having thereby received anything which will increase its cash reserves?
It is a crude thought that an increase of banknotes is needed
by the general public as a medium of exchange because of the inability of business men to exchange goods due to a scarcity of currency. The real difficulty resides not with the general public and
the media of exchange—for checks are as good as ever as a medium
of exchange if there are deposit accounts on which they can be



drawn—but it resides with the banks, with the power of the banks to
expand their loans in a time of stress. This is the pivotal thing in
any plan to relieve the distress of a financial panic (even with those
who are urging an elastic currency as a cure-all).
§5. So much for the relation of bank issues to the situation
created by a financial crisis; but, as has been already pointed out,
there are other elements in the situation of far greater impor- Lending
tance. When we look back to the panic of 1907 we find three important happenings, connected in purpose and need, which alto- Most
gether transcend the minor question of the issue of clearing-house I m P o r t a n t
currency for public use. These three points of central importance
have to do with the lending power of the banks and are as follows:
(1) The importation of gold; ( 2 ) The deposit of lawful money
with the banks by the Treasury; ( 3 ) The issue of clearing-house
loan certificates.
Every banker, every borrower, who was concerned with the
work of preventing disaster from spreading in 1907 knows how
dominating were these three matters. Why? Because they directly touched the power of the banks to lend. There was a crisis, not
because of a scarcity of a medium of exchange in the hands of the
public, but because large banks had had excessive demands
made upon them for loans and because they held paper which had
become more or less unsound. A crisis comes because credit has
been unduly expanded in a period of prolonged prosperity; in an Why a
optimistic spirit men have entered into transactions beyond their Arise«
actual means, as is shown when the test of actual payment is exacted, and in a time of fright, collateral, as well as goods, falls in
price. In such a situation liquidation needs time if disaster is to be
prevented. Houses doing a legitimate business are in trouble, and
the banks are called upon to carry them. Just when timid persons or
country banks are drawing down cash reserves, the banks are forced
by the situation to increase their loans. In the one week ending
November 2, 1907, the reserves of the New York banks fell $37,000,000, while loans were increased $60,000,000. That showed that
the New York banks met a difficult situation with courage and good
judgment. At their own risk they came to the rescue of a hardpressed business public. Eveiything centered in those things which
would aid the lending power of the banks. It is needless to say that
the issue by the bank of its own liabilities in the form of notes


of Note




would be an insignificant palliative and would not touch (except as
mentioned above) the cash reserves and the power to lend. The
one central thing to be done was to increase reserves. Here is the
crux of the whole matter, whether it is a time of an impending
stringency or the storm-center of a crushing panic. The bank's
own notes (its own liability) cannot legally or morally be used to
fill up its reserves (the bank's active asset). Here is the fatal deficiency of banknote issues as a means of curing a panic. The one
thing needed was lawful money which could be used as reserves.
The most important of the devices resorted to in 1907, however, as well as in former panics as far back as 1861, was the issue
of clearing-house loan certificates. What WJIS the point of their
issue ? It was not that the country needed more money for general
circulation or more media of exchange, but that the banks whose reserves had run down needed aid for the purpose of lending to hardpressed borrowers. In a crisis what is wanted—and wanted above
all other things—is the loan. Once given the loan, the borrower
has no difficulty in finding a medium of exchange, by which he can
transfer his credit in a way to satisfy his maturing obligation.
The loan is the primary thing. All that the creditor demands is a
P a y m o n t acceptable in his community. It is just at this
point that we find the most confusion of thinking and the greatest amount of loose talking. It is carelessly assumed that the
great need is an issue of banknotes, when in reality the great
need is some means—whatever it may be—which will enable a
bank to make loans to a client, who can thereby be saved from
failure and from hasty and ruinous liquidation. The whole object of clearing-house certificates, then, is—not to provide currency
—but to make loans possible to solvent, though needy, borrowers. After loans are made, checks provide all the means of payment
anyone needs. The increase of a bank's liabilities does not increase
its reserves or its power to lend, so that the issue of banknotes—except as above indicated—is wholly aside from the point.
means of

§6. The real remedy for panic conditions is thus seen to be
not currency but the creation of a means of payment in which all
have confidence. The "confidence" may be supplied through the
issue of properly secured currency, but it is the former and not the
latter which ameliorates the situation. And it is not desirable that
the issue of currency should be the only way of restoring confidence.



On the contrary, it is very much better that means of payment
should be supplied in that form which is most convenient to the
bank that is drawn upon.
For example, if a bank finds itself
.hard pressed by creditors so that its stock of cash is running very Confidence
low, and, if nine-tenths of the total demand upon it comes from
other banks, while one-tenth comes from outsiders, how shall it be
strengthened ? Anything that will enable it to satisfy its two classes
of creditors will do the work.
But it is very much better that the obligations it owes to other
banks should be liquidated as simply and conveniently as possible.
If it can bring about such a liquidation by giving these banks checks
upon some larger and stronger institution, the needs of the case arc
met quite as well as if it handed them bundles of "emergency currency." It could get the credit with the large institution which
would enable it to draw in this way only by satisfying that institution that it had good assets and by leaving a part of such assets with
the institution as security. If the bank were able to do this, it
would need fear nothing, so long as its portfolio contained abundant
paper of an assured kind. In this case, then, the banks which got
into difficulties with the public could be relieved up to the point that
was fixed by their own possession of good assets and by the capacity
of the institution to grant them relief by giving them credits on
Die security of their assets when presented for rediscount.
But suppose that the lack of confidence felt by the public extended to not one, nor to a few, but to many institutions in various
parts of the country—could relief be obtained in this same way?
Would there not be a limit to what could be done by the institution R^IS.* 0
engaged in the rediscount business? Would not the coming in of counts of
much paper practically subject the institution to so severe a strain as Assets
lo compel it to cease rediscounting, inasmuch as it must see to the
security and convertibility of its own outstanding obligations?
Of course the answer to such a question must be found only under
hypothetical conditions.
If there were so general a condition of lack of confidence in the
banking system that every creditor at every bank insisted upon having his whole obligation liquidated in cash, no banking system could
stand the strain. In such a case, if there were an institution which
was engaged in rediscounting paper for any bank that found its
resources running low, a time would come when such an institution
could no longer extend accommodations because it could not con-


Case of




vert all of the obligations of all of the banks into available funds
' ^ ^lose
conversion did so because of
doubt in the solvency of the banking system as a whole, a point
^e r e a c ^ e ( l beyond which no further relief could be given, and
banknotes, if issued by such a large institution, wotild for the reasons already indicated be as troublesome as other forms of liability.
They would be presented to the institution in liquidation of its own
maturing claims on others so that it would be prevented from getting any cash with which to maintain the redeemability of the outstanding claims against it.
But such a condition could come about only under one or two
suppositions: (1) that practically the whole business structure was
breaking down, or (2) that the institution which carried on the
discounting process was itself crippled by having accepted in the
past unsound assets as the basis for its loans. If its assets were all
thoroughly sound and it habitually accepted none but unquestionably sound assets, no such point could ever be reached. As for the
complete breaking down of the business mechanism—that of course
would be a catastrophe that could not be guarded against. The
banking mechanism cannot be made stronger than the general body
of the business which it is created to facilitate.
§7. The best answer to questions concerning the limit that
is likely to be met in providing means to protect the community
against demands for liquidation is afforded by a consideration of
foreign systems. Examination of these shows that in the principal
European countries where there exists a strong institution representing the various banks and largely engaged in rediscounting their
paper, disturbances of the kind referred to do not occur. It is customary to say that European banking does not suffer from panics or
° f i s e s : T h i s > h o w e v e r > would be inaccurate. Investors and financiers in European countries are as likely to make serious errors as
those elsewhere. When they do so, the chances that they may involve bankers with them are entirely governed by the prudence and
experience of the bankers. Many European private banks are engaged in more or less hazardous enterprises which occasionally break
down. European business has its epochs of inflation and contraction
due to errors of judgment, miscalculation of securities, etc.
But in those countries where an ample means of converting
sound assets into immediate funds has been provided, the banking
system does not become generally and completely involved. In such



countries it is always possible to convert sound business assets into
means of payment. This is practicable simply because institutions
exist equipped with sufficient capital to meet all legitimate demands
and so rigidly governed by law or custom, or both, as to have been
entirely debarred from speculative operations. As their business
has consisted entirely or largely in the testing of paper which had
already been tested by bankers, rejecting all paper which was based Assets
upon or grew out of non-commercial operations, and accepting only [j,°£ v c r t c d
that which was the product of the actual buying and selling of goods Means of
and the movement of genuinely existing values, these institutions P a y m e n t
are constantly in position to convert good assets into immediate resources, retaining meanwhile the power to hold the confidence of
the commuity by reason of their conservatism and large means.
Under such conditions the banking system as a whole is not likely
to be troubled by panics or crises except in so far as its members
may have accepted paper which was not good, or which was lowered
in value by the shrinkage due to the loss of confidence and consequent reduction of prices which accompanies the panic.
These phenomena have nothing to do with the process of
facilitating the exchange of goods by regular business transactions;
but in the United States the regular and steady business house is involved with the speculator and the undertaker of hazardous enterprises. lie suffers from the shrinkage of credit and the suspension
of payments in times of panic notwithstanding that he was no fac- ^^"JjJJ
tor in bringing them on and that the security he has to offer is as with
good as it ever was. But because banks have allowed themselves to
loan their capital to those who are more venturesome or because loss
of public confidence due to the misconduct of a few banks has weakened all, the proprietor of perfectly good paper cannot secure the
accommodation he must have, nor can the bank which holds such
paper convert it into resources at will.
§8. It is thus seen that the essential attribute of soundness
which suffices to carry a system through a commercial panic or
crisis without disaster is simply that of conservatism and adherence
to known values. If all national banks would practice such conservatism in methods of discounting there might be no difficulty,
in spite of the possible danger in the fact that many of them are of
small capital and may be forced to the wall by a sudden demand,
which leaves them no time or opportunity to convert their assets.




But the national banking act does not restrict national banks rigidly to loans upon commercial paper and other absolutely live security. If it did do so, many national banks would be unable to
get the business they need in order to continue in existence. They
would have to close their doors.

tlons upon

Moreover, such a limitation would prevent many perfectly
legitimate enterprises from getting accommodation. As things
stand, too, the national banks must compete with state banks; and
even with the present limitation upon the kinds of business in which
they may engage they find it a decidedly difficult task in many places
to sustain themselves. Under these conditions, it is not possible to
limit the national banks much more closely in the kinds of business
they do than is attempted by the national banking act.
Some few restrictions in certain directions would be helpful, but
in the main it is not feasible to go very much further. The country
therefore has to run its chance and when periods of stringency come
on, it must rely upon the possibility that a sufficient number of
banks have been so conservative in their methods as to possess the
means of granting relief to others, or failing in this, that some extraordinary device like the suspension of payments, or the issue of
clearing-house loan certificates, will be adopted by common consent
as a means of getting time to retreat from the too advanced position assumed by the banks in granting their discount. The remedy for the difficulties of a threatened panic or crisis does not lie
in such temporary and sporadic measures, but is to be found in the
provision of a regular source of accommodation.


Every economic expedient which is resorted to sporadically and
semi-occasionally is expensive. This is true of the methods employed under the national banking system for the relief of panic.
When clearing-house certificates have been issued heretofore they
have usually borne an interest of six per cent or more. But this was
only a small part of the cost of issuing them. Much greater was the
cost involved in the withdrawal of deposits and in the general .weakening of the institutions which preceded and forced the issue of the
In the Aldrich-Vreeland Act of 1908, provision was made
for the issue of emergency currency through national currency
associations. But these emergency notes were TequiTed to pay a tax
rising from 5 per cent during the first month of their life to 10 per
cent at the end of six months. The cost was so enormous that no



such notes have ever been issued, the expense of issue being one
of the prime factors militating against their being taken out.
This idea of a very high rate of charge or tax to be imposed
upon the notes that are used for the purpose of relieving a panic or
crisis is fundamentally fallacious. As we have already seen, there is
little distinction between the notes or certificates, or whatever they
may be called, and the granting of accommodation in any other
form. And there is no occasion for making the getting of credits in
times of commercial difficulty any more expensive than necessary.
The argument is all the other way. This extreme costliness of relief
in times of panic or pressure has been one of the most serious criticisms upon the national banking system and the burden of it has
been keenly felt by borrowers on all such occasions. They have noted
that they could get accommodation to any extent when money was
easy and business was flourishing—that is to say, when they did not
need it. But they have found that, when the relief was actually
needed, not only for the sake of given individuals, but for that of the
community, and when they themselves stood ready to offer their
best assets as security, the aid was not forthcoming, or, if obtained
at all, must be paid for at an exorbitant rate. A period of panic or
crisis is a period when accommodation should be granted as liberally and as cheaply as possible, and when no artificial and unnecessary obstacles should be put in the way of extending it.
It remains true nevertheless that increased demand for a given
article or service invariably and properly results in a higher price,
supply remaining the same. The great European banks raise their
rates as the demand for loans stiffens or as supply of specie falls
off owing to adverse balances of trade or the hoarding of cash. They
do this as a matter of routine business for the purpose of equalizing the supply of loans with the demand for them. They recognize
that many applications for loans at banks are not necessary but are
matters of convenience or profit. If the bank rate is, say, 4 per cent,
many persons will see a profit in the use of borrowed money obtained on that basis. At 5 per cent, a certain number of operations
are excluded, because the additional 1 per cent cuts the margin of
advantage. As the rate rises, the number of applications decreases
and the institution is more fully able to meet the claims for accommodation which are presented to it.
But this is a phenomenon which is not characteristic of periods of panic or stringency; it is seen on every occasion when a
readjustment of supply and demand for bank accommodation is

Notes too

^ n Ifl L 0 J„*
| n panlc



fupply" 8
and De¡¡¡^^ for


of Rate as
a Preventive to

Need of a
Agency In
States to
Fix Rate


needed. If, in a crisis, this demand for accommodation becomes
exceptionally great, while reserves fall off, an unusual increase in the
rate of discount may be desirable for the purpose of warning all
those who do not absolutely require accommodation that they
had better not apply for it and that, if they do, they will be charged
a rate which they cannot afford. This very process of raising the
rate and thus regulating the supply of, and demand for, bank accommodation is one of the most important factors in preventing the
commercial world from drifting into a panic or crisis. In the
United States, we have had no means of securing such an advance in
rates of discount by general agreement or consent among the banks.
The banks have been competing sharply with one another, and, in
their effort to get business, have allowed rates to become and remain unduly low until the community was so far advanced toward
a stringency that it was too late to apply the precautionary method
of raising the rate of discount, and have it serve any useful purpose.
If there were some mechanism, like a National Reserve Association, to which resort was currently had for rediscounts, and
which would act as the principal reserve-holding agency of the country, it would be possible to compare the reserve more accurately than
now with the total demands likely to fall upon it, while it would be
possible to protect this reserve as is done in Europe by regulation
of the "bank rate." The function which is performed in thus
shifting the rate is merely that of equalizing demand and supply.
It is not the purpose to penalize the man who needs loans, nor is
it that of "driving in" the notes or other forms of accommodation
that are received by the borrower. These forms of bank credit will
take care of themselves if their issue is made dependent solely upon
commercial demand and sufficient opportunities are provided for
their immediate redemption.
§9. Thus far the assumption in what has been said has been
that a given country at any time was practically dependent upon its
own stock of specie and currency for the redemption of its bank liabilities into current funds. The discussion has proceeded from the
assumption that the service of the bank was that of economizing
and equalizing such funds, preventing them from being dissipated,
and using them in such a way as to take off all of those demands
for specie and notes that were simply due to a lack of confidence
in the ability to pay. This is the normal duty of the bank.



But conditions may supervene in which it is desirable to
strengthen the stock of specie by getting more from abroad. In
ordinary times, the international distribution of the precious metals
is self-regulating and adjusts itself in accordance with the supply
of, and demand for, metal in the different countries of the world.
This is brought about by international payments for goods and Internaservices. In time of panic or crisis, there may arise a sudden sharp Movement
demand for money which has no relation to the necessities of exPrecious
change and is simply due to a disturbance of the level of business Metals
confidence such as we have already sketched. In such instances, it is
not possible to wait for the international distribution of the
precious metals to adjust itself by the sure but slow forces which
ordinarily govern it. It may then be desirable or necessary to import specie or gold from abroad. The object of such importation is
of course that of building up bank reserves and thereby rendering it
possible to extend more credit if desired.
In foreign countries where the rate of discount is controlled
by some large institution which acts as the reserve-holder of all
the banks, this matter of importation is attended to by that institution. Gold is engaged abroad when it is needed in order to build up
a specie reserve in this country. In such cases it will be borrowed,
usually from those who have it. That is to say, foreign bankers will
be asked to ship a part of their reserve money to this country. The
loan or advance may be protected, just as in the case of a loan to
an individual, by collateral security of some kind. Or, where a
great staple crop like cotton is soon to move abroad, the shipment
of gold may be obtained as an advance payment on cotton bills.
In such instances, however, the real nature of the transaction is
merely that of a loan. The relief obtained from it is again merely
that of convincing the home public that there are resources in actual
cash that are amply able to take care of all outstanding demand
liabilities. Such operations are expensive. In the United States
they are not usually undertaken until the decline of bank reserves Gold
has reached a decidedly alarming point; but it is very desirable that Expensive
this method of restoring a reserve, if it is to be resorted to at all.
should be employed early enough to get its full benefit. The best
banking theory, therefore, tends to penalize banks for permitting
their reserves to become too low by taxing them in proportion as
their reserves fall below a given point. Of course this means that
the bank shifts the cost of the tax to the borrower who insists upon


Tax Banks


further accommodation after the reserve has gone down to the point
specified. But it also means that the bank will as promptly as posr e s o r ^ to'the importation of
gold whenever that becomes
cheaper than the payment of the tax. This will be done both in its
own interest and in that of the borrower.



1. Classification of Loans—2. Nature and Origin of Commercial
Paper—3. Types of Commercial Paper—4. Characteristics of
Commercial Paper—5. Reserve Association Restricted to Commercial Paper—6. American Practice With Promissory Notes—
7. Commercial Paper a Protection Against Over-Expansion.

§ 1. The character of the bank in its relation to the community,,
like that of every other institution, is determined by the kind of
business that it does. However, it is not ordinarily recognized
by the public that there is great diversity in kinds of business done
with banks, and that there is no uniform character common to
all of them. Some banks do a certain kind of business based
on given classes of transactions almost exclusively. Others confine themselves largely to a particular kind of paper, and still
others do several different classes of business, carrying them along
side by side. In general, the character of the institution and the
kind of work that it does are necessarily determined by its clientèle
and the demands that are made upon it. This clientèle may be
fairly uniform or homogeneous, or it may consist of persons engaged in many very different classes of trade who ask the bank's
assistance in financing the operations they are engaged in, and
who, therefore, lead it into varying lines of enterprise in so far
as it undertakes to sustain these different persons, by supplying
them with funds.
The general business done by banks of whatever kind is that
of lending. They may, therefore, be classified upon the basis of
the kinds of loans they make. This classification may take a twofold form:
It may be founded (a) upon the character of the
security offered to protect the loan; or (b) the time for which
the loan is obtained and the form in which the obligation of
the borrower to the bank is recognized.
From the viewpoint of security, three general groupings may be
noted. Loans may be protected ( 1 ) by collateral security, in which
case a claim is given the bank upon stocks, bonds, mortgages, or some


^p| h e s B a n k s

Jg® urit y
for Loans



other evidence of tangible invested values; or (2) they may be
"unsecured," in which case the bank simply receives a note from
an individual, promising to pay a specified sum at a specified
time, protection being found in high standing and in the possession of general property by the borrower; or ( 3 ) they may be
based upon evidence of a commercial transaction which is to be
liquidated at some time in the future. In this latter case, the
ultimate protection to the bank is found in the fact that borrowers
are possessed of property, while the prospect of immediate payment is improved by the fact that, by the nature of the security
he has offered, the borrower is shown to have had dealings which
will result in giving him liquid funds at a date in the early

tlnotions 8 "


From the viewpoint of time, the chief lines of classification should be drawn between those loans which are made on
demand, or on call, and those which are made on time, the latter
being grouped as short-time and long-time loans. The loans made
on call correspond roughly to those of the first classification by
security—the collateral loans—while those made on time correspond to the other two classes of loans under the first grouping—
those protected by personal credit and those by evidences of the
transactions. Long-time loans are usually protected by a mortgage
or other claim upon property, and are not to be considered as banking loans in the proper sense of the term.
The bulk of banking business growing out of commerce and
industry is confined to loans on personal credit, or loans based oil
evidences of transactions; the paper which develops in the
course of this business and is held by the banks is known as commercial paper. It consists of instruments evidencing claims upon
in<3 ividuals, s t a ted in terms of money, and resulting from operations requiring a comparatively short period for their consummation. When a man desires funds for a long period, he should
get them, not frQin the bank, but from those who have spare
capital to invest for some considerable period of time. The
business of the bank, then, consists of dealing in the commercial
paper which grows out of current transactions.
§ 2. We have already classified commercial paper on a Tough
general basis. It is now necessary to consider more carefully the
nature of this paper and the way in which it comes into exist-



ence, as well as the relation of the bank to it. Suppose that A,
who is doing a large business, has sold goods on credit (open
accounts) to many customers. A may find himself short of current funds, in consequence of the absorption of his capital in carrying these customers. If he goes to the bank for accommodation,
he may request a loan simply on the strength of his own personal,
unsecured note. In this case, the wisdom of the bank in granting
the loan will depend entirely upon what it knows of the customer.
If the total amount which he desires is moderate as compared with
his total assets, and particularly as compared with his current
cash receipts over a specified period, the loan is "safe." If it
complies wholly with these requirements, it is, perhaps, the safest
purchase the bank can make, since the individual has total assets Single
largely in excess of the loan, while he has current incomes that p*™®
supply the means for prompt payment. The bank can assure itself
that these conditions are complied with only by a thorough knowledge of the business condition of the concern or person obtaining
the loan. It may get this either through a statement of the business
itself, if entire confidence is entertained concerning the honesty and
accuracy of its accounting system, or it may get it through the work
of an outside iirm of accountants who are called in to examine
the books and certify to the truthfulness of the showing made
and to its correctness from an economic standpoint. Thus assured,
the bank is warranted in advancing the funds that are needed.
If it does so, accepting in exchange the unsecured note of the
borrower, the paper thus obtained is termed single-name paper.
According to the Comptroller of the Currency, there was held
by national banks the country over (7,301 in all in 1911) the following amounts of various classes of paper during the past three
years r
% Amt.
7o Arnt.
On demand, paper with one or more
individual or firm names
$ 411
S.6 $ 524
9.6 $ 529
On demand, secured by stocks, bonds
and other personal securities
957 18.7
939 17.2
953 17.0
On time, paper with two or more
individual or firm names
1,698 33.2 1,842 33.7 lfS53 33.6
On time, single-name paper (one person or firm), without other security 971 18.9 1,068 19.5 1,124 20.0
On time, secured by stocks, bonds
and other personal securities, or on
mortgages or other real estate
1.060 20.6
1,092 20.0 1,117 20.0



100.0 $5,467 100.0 $5,610 100.0

Report of Comptroller of the Currency, 1911, p. 9.

®f*p® p ®
Held by



It will be observed that about one-third of the total paper
held by the banks was two-name paper on time, and about onefifth was single-name paper on time. These made a totalof a little
more than one-half for the two kinds of loans taken together.
Demand paper with one or more names furnished about 9 per
cent more.
§ 3. Suppose, however, that A , instead of selling his goods
on credit (open accounts), has required his customers to give him
their notes payable at 30 days. He may take these notes to his
bank and ask for a discount, in which case the bank will desire to
know substantially the same things as before. It may or may not
make a close inquiry into the condition of the persons who gave
Creation of
the notes to the merchant that originally sold the goods. It asTwo-Name
sumes, of course, that A has investigated them with care. But its
real security is found in the fact that it knows the man who presents the notes for discount, is familiar with his business, and
requires him to endorse the noies before getting accommodation
based on them. This is called two-name paper, and while collection at maturity will first be sought from the person who made
the notes—that is, the person who bought the goods from the
original merchant and gave the latter the notes in exchange—
the bank will, if payment is not promptly made, require the person who secured the discount to make good the sum.
The value of two-name paper as compared with single-name
paper is entirely relative and dependent upon circumstances. If
the individual who presents the notes for discount is stronger and
better known financially than the makers of the notes, it is
T e s t of
probable that his own unsecured note would be quite as satisfactory
as the two-name paper. If the maker of the notes and the man
who presents them for discount are both persons of small resources
and questionable credit, the combination of liability furnished by
the two-name paper is not important and does not of itself make
the paper good. The ultimate test is invariably found in the
responsibility of those whose names appear, and if one of these
names represents unquestioned commercial solvency, it is far better
as a protection to the bank than several names whose credit is
doubtful or limited.
The amount of various classes of paper carried by national
b ^nks in New York City is thus stated by the Comptroller: 1
"JWA, p. 10.

Aug. 22,

Loans and Dis1907
38 Banks
On demand, paper with
one or more individual or firm names...$ 16
On demand, secured by
other personal securities
On time, paper with
two or more individual or firm names... 161
On time, single-name
paper (one person or
firm), without other
On time, securcd by
other personal securities, or on real estate
mortgages or other
liens on realty


Sept. 23,

37 Banks

$ 6

Sept. 1,
38 Banks



Sept. 1,
39 Banks













June 7,
40 Banks

Held by
New York









It will be observed from the figures for the last report that in
all about $375,000,000 of single and double name paper was carried by the New York banks, and that this was fairly evenly divided
between the two classes, the preference being slightly for the singlename paper. The amount of either class of security is usually very
much less than the volume of the loans made on demand and secured
by stocks, bonds, etc.
That is, loans protected by stocks, etc., on demand amounted
to about 36 per cent of the whole; and collateral loans, on time
and on demand, amounted to about 56 per cent. This furnishes
a striking contrast with the showing for the national banks as
a whole and indicates that the larger bulk of the commercial paper
of the country originates in the producing districts and in the
commercial centers; while financial operations, which predominate
in New York, are financed very largely on the call-loan basis.
(See Chapter Y I I on Call Loans.) The commercial paper of the
country, whether single-name or two-name, whether on time or on
demand (usually the former), constitutes the staple bankable security of the country and represents the demands of the business
interests proper upon the banks.

New York
and Count r y as

The kind of two-name paper which has just been described
is not the only one. In many parts of the country, it is not even
the most important. A, who sold the goods to B, may instead of
requiring B to give him a "note" payable after 30 days, stipulate
at the time when his sale is made, that he will simply "draw" on Drafts
B "at 30 days' sight." That is to say, simultaneously with his Drawn on
shipment of goods to B, he hands to his bank a draft on B which



is payable 30 clays after being presented to the latter. The bank
then sends this draft to a bank in the place where B is situated,
and this bank presents it to B, who, if the transaction is carried
out, "accepts" the draft by writing his name, with the date, upon
it under the word "accepted." This makes the draft an obligation
on the part of B to pay a specified sum at the end of a specified
time. It is primarily an obligation of B's, but in case he should
not pay it, any person who had acquired A's claim on B in the
meantime, would look to A for payment.
Now, if A merely passed the draft to his bank for collection,
he must wait 30 days in order to get his payment, which is then
reported to him and placed to his credit by the bank that originally
took the draft. Probably, however, A wants funds at once. If so,
he has told his bank at the outset that he wishes to have the draft
discounted. In that case, the bank has allowed him an immediate
of Goods
credit on its books equal to the face of the draft less discount. It
then looks to B for payment, thereby standing in the place of A.
But in the event that B defaults and does not liquidate at the
specified time, A's bank will look to A, the merchant, for reimbursement of the amount which it originally advanced him on the
strength of his application for a discount accompanied by the
draft on B. It is, in short, protected by two names. Paper of
this kind is regarded with peculiar favor by banks, because it
grows out of a live commercial transaction; and, where the operation is legitimate, there is every reason to suppose that B will
liquidate at maturity, while in case he does not, the bank can fall
back upon an individual in its own city about whom it has full
information. It may make the discount with confidence, if it is
absolutely assured' of the solvency and honesty of either A or B,
the transaction itself being good evidence that there is real value
in existence to back up the transaction.
If the bank wishes to be exceedingly well protected, it may
demand that A, who discounts the draft with it, shall turn over
to it, along with the draft itself, the documents which give control
of the property which has been sold, so long as the same is in
transit. These documents may be of several kinds and more or
com pan led" ! e s s ™ ™ e r o u s - The commonest is the ordinary "bill of lading,"
by Bills of issued by the common carrier who has accepted the goods. It
indicates that the ultimate power of demanding the goods from
the carrier has been surrendered by the shipper, and is now in



the hands of the hank which has discounted the draft. The hank
may send this bill of lading, along with the draft, to its correspondent bank in the place where B lives, and may decline to give
up the title to the property until such time as B liquidates the
draft. Or, it may assent to the surrender of the property under
conditions which are satisfactory to itself. In this case, the use
of the documents serves to locate the responsibility for releasing
the ultimate property on which the transaction is based—the
goods that passed from A to B in the original transaction.
Besides the bill of lading thus referred to, there may be certificates of insurance, and in the case of foreign shipments, master's
receipts, the proper consular invoices, health certificates in the case
of foodstuffs, etc., etc. The aim in transferring these documents other
is to show that all the requirements of a bona fide sale have been
complied with, and that the way has been completely cleared for R|Sk
putting the goods en route to the consumer via the ultimate dealer,
while all risks in connection with the process have been transferred
to others who are prepared to assume such risks. This is a way
of giving the bank additional assurance that everything is right,
and that it has nothing to apprehend from legal or other obstacles.
It then assumes only the legitimate risks which it was organized
to incur—those connected with the transfer of property from man
to man, and the collection of the proceeds of sales, either at sight
or after the lapse of a specified period.
§ 4 . We have thus sketched some of the principal types of
commercial paper, and are now prepared to understand the characteristics of such paper. It is called "commercial" because it has
to do with the operations of trade and commerce and arises out
of bona fide transactions. The real and ultimate basis of the
operation in such cases is found in the fact that there was a commercial or industrial operation which gave rise to the demand for
a loan or accommodation at the bank. This security, taken in
the aggregate, is in reality simply the security afforded by the buying power of the population and the general condition of trade
and industry as a whole. It is not a kind of security which is
dependent upon investment values or earning power in the last
analysis, but is a security which is dependent upon consuming
power. It is thus directly based upon the capacity of the population to absorb, and pay for, a definite amount of goods which are
the products of past operations that have resulted in producing

Based on
Power to


W i t h Call
Loans on

them. This shows clearly how paper of the class referred to is
differentiated from other kinds of security, such as collateral of
various descriptions.
When call loans are made there is no assurance that the person who makes the loan will be in better position to liquidate his
obligation at the end of the time for which it was made than he
was at the beginning of the loan period. If he has borrowed for
the purpose of carrying on speculative operations, and if his means
are quite fully "tied up" in such operations, success in his speculation is necessary, for otherwise the bank will have to look to a sale
of the collateral for its payment. While this may be safe enough
in any one case, a general attempt to realize on collateral means
that the collateral cannot be sold; in other words, that there is no
immediate means of payment available. This is the most important distinction between loans based on commercial paper and
others which are not so based. The commercial paper represents
the quick type of loan easily realizable, practically certain to be
paid, taking large masses and not individual pieces ot paper, and
therefore entirely different from the investment securities which
are longer in duration and which depend upon future earning
power for their value.

Restricted n



It is with these facts in mind that the proposed plan for

^ e s e r v e Association ^ould limit that association largely to trans-

to Commer- actions based on commercial paper. The Monetary Commission's
clal Paper \ i \ ^vhich presents a Reserve Association plan, defines the kind
y\ 9
of operations which the concern may undertake as follows:
SEC. 26. The National Reserve Association may, through a
branch rediscount, for and with the indorsement of any bank having a deposit with it, notes and bills of exchange arising out of
commercial transactions; that is, notes and bills of exchange issued
or drawn for agricultural, industrial or commercial purposes, and
not including notes or bills issued or drawn for the purpose of
carrying stocks, bonds, or other investment securities.
Such notes and hills must have a maturity of not more than
twenty-eight days, and must have been made at least thirty days
prior to the date of rediscount. The amount so rediscounted shall
at no time exceed the capital of the bank for which the rediscounts are made. The aggregate of such notes and bills bearing
the signature or indorsement of any one person, company, firm or
corporation, rediscounted for any one bank, shall at no time excecd
ten per centum of the unimpaired capital and surplus of said hank.
SEC. 27. The National Reserve Association may, through a



branch, also rediscount, for and with the indorsement of any hank
having a deposit with it, notes and hills of exchange arising out of
commercial transactions as hereinbefore defined, having more than
twenty-eight days, hut not exceeding four months, to run, hut in
such cases the paper must be guaranteed by the local association
of which the bank asking for the rediscount is a member.

An interpretation of these permitted types of transaction, in
the light of what has already been said, shows that the functions
of the Association would be chiefly confined to operations based
on such commercial paper as has been described here. In what
we have said, however, no reference has been made to bank acceptances. Because dealings in such acceptances constitute a new type
of business, not heretofore practiced in the United States upon
the European basis, a special treatment has been given to them.
(See Chapter V I on Acceptances.) It will be noted that the rediscounts of the Reserve Association are to be primarily "notes
and bills of exchange arising out of commercial transactions," running 28 days or less. Such notes and bills are those issued or drawn
for agricultural, industrial or commercial purposes. An exception is made in favor of similar notes and bills of exchange running
more than 28 days, but not over four months, provided that such
paper is guaranteed by the local association of banks to which any
bank asking for the accommodation may belong. This merely
means that the Reserve Association, while seeking to limit itself
to the very shortest kinds of commercial paper, will stand ready
to accept those which run somewhat longer, provided they are of
absolutely known goodness—so much so that a group of banks
representing a distinct section of the country is willing to guarantee
It will have been noted that the Reserve Association in rediscounting paper is authorized to deal only with banks which
are stockholders in it. This means that the commercial paper
which comes to it must be that which has already been tested and
approved by the local banks that present it for rediscount. The Must Have
local banks, of course, are far more familiar with the character of y^sted b y
the paper in their own districts or places than any outside institu- Banks
tion, however well officered and managed, could be. This means
that the transactions that give rise to the paper will have been
scrutinized with care by persons technically familiar with local
conditions before such paper comes to the Reserve Association to
be rediscounted.

In the case of the two-name paper already described, which
constitutes the bulk of the security of a commercial sort offered
to banks, there will thus be, not only the protection afforded by
the signatures of the drawer and acceptor of the paper, but also
Commercial that furnished by the fact that the bank itself has indorsed the
paper when applying for a rediscount. Of course, in many places
there will be prime commercial paper of the best description, which
the bank itself will have recognized as absolutely unquestionable,
even though protected by only a single name, but which it has
taken up on account of the undoubted solvency and ability of its
maker. Such paper will go to the Reserve Association for discount,
protected by the maker's name and the indorsement of the bank
that originally extended the accommodation to the borrower. II
will thus be two-name paper in so far as the Reserve Association
itself is concerned. The only condition will be that the loan must
have been originally intended for agricultural, industrial or commercial purposes—a group of objects which in this discussion we
have classed together under the single head, "Commercial."
§ 6. As is well known, promissory notes make up the bankable paper of this country, as contrasted with the accepted bill
of exchange drawn by the seller on the buyer of goods in Europe.
Transactlon The promissory note, however, does not always show the nature
In Goods
of the transaction which gave rise to it. Much reliance, therefore,
Often not
Shown by
must be placed on the honor and character of the borrower. OneGood Paper
name paper, not disclosing the exact nature of the use to which
it is put, demands strict surveillance and discrimination on the
part of the bank. Consequently, it is now not so easy in this
country to say what is commercial paper; that is, to affirm that
it is the outcome of a direct exchange of goods.
In the Aldrich-Vreeland Act of May 30, 1908, commercial
paper was defined as follows:
"The term 'commercial paper' shall be held to include only
notes representing actual commercial transactions, which, when
accepted by the Association, shall bear the names of at least two
responsible parties and have not exceeding four months to run."

Practically the only way in which two-name paper, based on
actual transactions, is presented for discount in this country, is
that in which so-called "trade-paper" is created. When a merchant
buys goods in the United States on time, he receives a greater or
less discount for paying cash before the account is due. This dis-



count varies in different trades. In groceries, food products, etc.,
the sales are usually on 10 days' time, and the discounts play no
real part. In the sale of luxuries, such as fine millinery, or
jewelry, the period allowed for payment of goods may be six months.
But in trades like hardware, the time runs from 30 to 00 days.
Hence, if a discount of 3 per cent is allowed by the seller, if cash
is paid in 10 days on goods sold at 90 days' credit, that is equivalent
to 3 per cent for 80 days, or at a rate of 13V2 per cent per annum.
Likewise, a discount of 2 per cent for cash paid in 30 days is equal
to 12 per cent per annum. Now, if the buyer has good standing,
he can borrow* at 4 or 5 per cent, and pay off his account, thereby
saving the difference between 4 or 5 and 12 or 13% per cent. The
longer the time on which goods are sold, the larger the discounts
and the greater the inducement to borrow and to anticipate payment of the account. Consequently, the merchants having the best
credit never wait until their accounts mature; some of poorer
credit meet payment at maturity; and others, not able to pay when
the accounts fall due, must borrow and meet one indebtedness by
creating a new one. Now, this last class, the poorest of all, creates
two-name paper, based on actual transactions, on less than four
months' time usually, and would be technically acceptable under
existing law (May 30, 1908) as "commercial paper" security for
note-issues; while the paper of the men of higher credit, who can
always borrow and save on the trade discounts, would not be acceptable. It is obvious that this requirement would rule out some of
the best paper now held by banks.




Consequently, the best paper brought to the banks is one-name
paper, in the form of a promissory note, which does not show on
its face that it is "commercial paper," or paper arising out of a s t r l c t I y
purchase or sale of goods. On the other hand, the buyer of goods Commercial
whose credit is less good, and who cannot borrow so easily, is the Q^ e n r n o t
one whose paper may be strictly "commercial," but it is not re- the Best
garded by the banks nearly as highly as one-name promissory
notes of a firm of high standing. Such a buyer cannot pay cash
for his goods, because his credit is not high. Therefore, in our
practice, it must be remembered that often paper'directly based on
the exchange of goods may be less desirable because of the standing of the borrower. Thus, in the United States, under existing
customs, we have the paradox of one-name paper not technically
"commercial," rating higher than some strictly commercial paper.
The ultimate reason for this, of course, is that the high credit of


Test not



some one-name paper is the conviction of the bank that the borrower's business is legitimate and really of a character to allow of
quick liquidation when required. The exception proves the rule.
The test of commercial paper may not always lie on the face of the
paper. In case of accepted bills of exchange the test is almost
always openly to be seen.
In truth, the paper of a firm of high standing readily taken
by the bank may not be always "commercial," and hence not always
safestI n c a s e s u c l 1 a firm
borrowed on its one-name paper
$500,000, and used it to enlarge its plant, the transaction does
not provide for its certain and quick liquidation; the paper then
tends to belong to the class based on long-term investment securities,
and loses its characteristic as commercial paper. Consequently,
while arising out of "industrial purposes," and not used for the
"carrying of stocks, bonds, or other investment securities," such
paper could not be strictly called "commercial paper" available for
rediscount at the National Reserve Association. In a time of crisis,
such paper would not liquidate itself by the sale of the goods. In
fact, much must in the last analysis depend on the management
of the bank.
As everyone knows, the banks dealing mainly in loans of a
mercantile character are large buyers of paper sold by note brokers.
Such notes are rarely secured by collateral, and usually bear one
name. In the case of large corporations, the indorsement of
more than one officer of the company could not make two-name
paper. In spite of some faults in such loans—doubtless remediable
—the extent of the dependence on note brokers is widespread. The
situation is well expressed by a prominent banker, as follows:
"The ease with which loans are obtainable in normal times by
responsible houses on their own direct, unsecured obligations,
through the agency of note brokers, has nearly done away with
trade paper (i. e., two-name commercial paper) of the highest
grade. All good concerns and many even in second and third
grade credit are enabled to borrow all the funds required to take
advantage of trado discounts, and enough more to meet all other
bills at maturity, so there is little or no reason to settle trade
accounts by notes. . . .
No house can habitually do so without
ultimate damage to its credit. The business of the note broker in
directly supplying capital when needed by solvent borrowers for
production use in trade is comparatively a modern occupation, and
it is highly beneficial if confined within legitimate and prudent
limits. In this country the business has developed enormously
within two or three decades and along lines that were unthought



of a few years ago, and which then would have been deemed impossible and extremely hazardous. The system, as we know it, it>
not in common practice anywhere else in the world."

All such paper obviously would be excluded by the legal definition of "commercial paper."
The New York Clearing House Association in the live months
beginning October 27, 1007, accepted securities to the amount of
$453,000,000, against which clearing-house certificates were issued.
Of these securities, 73 per cent ($330,000,000) were commercial
paper; but not a dollar was lost in that whole time of crisis through
this use of commercial paper as security for certificates.
§ 7. The fact that the Reserve Association would be so closely
restricted to business based upon commercial paper offered to it is
an important consideration in connection with the question how
far there is ground for fear of over-expansion of its discounts.
This matter can be dealt with clearly and conclusively by a refer- protection
ence to the nature of commercial paper and the character of the Against
operations out of which it grows, as contrasted with other kinds of
bank loans. The danger of inflation or over-extension of credit is
one which grows out of the action of banks in converting too many
obligations or forms of property into immediate means of payment.
A borrower or group of borrowers presents to the banks collateral
of some kind which is considered undoubted security by the institutions to which it is offered. Then a loan is made on the strength
of it. This loan may or may not be liquidated at maturity, or it
may be met by making another loan of equal amount. When loans
are paid only by contracting new ones, so that the fluid funds
originally advanced have become tied up in fixed forms, inflation or
overlending has occurred.
As already pointed out, the essential characteristic of commercial paper, which distinguishes it from other classes of bank
security, is that it grows out of an actual transaction. It therefore provides its own means of liquidation under ordinary conditions. A does not sell to B because he thinks that at some time
in the future B may be able to make a profit on some investments,
but because he knows that B intends to dispose of his goods either
by working them up into another form or by selling them direct
to the consumer, and that in either case, the goods themselves are
wanted for consumption purposes, so that the current labor and
productive power of the community, on the basis of already exist-




ing investments, will provide the means of liquidation. Dishonesty
may exist in a given case, and thus there may be loss, but the
aggregate of the commercial paper of the country must be s o u n d as sound as the general business of the community itself. The business of discounting this paper is nothing more than the business
of supplying liquid funds for a short time to those who need them
in order to continue the productive process. It is not the taking
of a chance upon the possible, or even probable, results of investment, but is merely a part of a process of division of labor, whereby
the fluid resources of the community are placed at the disposal of
those who need them, in return for a fair consideration.
This characteristic of commercial paper has enabled the community to develop a mode of testing its goodness which does not
exist in the case of any other kind of bank security. By means
c r e f ^ organizations and institutions, it is possible to ascertain,
as accurately as human knowledge can ever ascertain anything
relating to the future, exactly what pieces of commercial paper
are likely to be unsound. Credit agencies, collection institutions,
credit departments in banks, corporation reports, the special reports of accountants, and many similar devices, are.all available
for the purpose of weeding out such commercial paper as is not
trustworthy or reliable. Usually, banks which make loans on
commercial paper prefer to obtain their own information as to the
solvency of the makers of the paper, rather than to get it secondhand from others. The larger they are, the wider their clientèle,
the better organized they are for the purpose of tracing the operations of the makers of commercial paper, the less cause there is for
reliance upon outside agencies. Such institutions as the banks of
England, France and Germany are thoroughly familiar with the
character of the paper which comes to them for rediscount or for
direct discount. They seldom lose.
The same situation would exist under a Reserve Association
plan, such as has been suggested. The Reserve Association would
be able to obtain knowledge as to the commercial paper of different
sections of the country through its various branches and the associations of banks which were subsidiary to them. There would be
no reason why it should ever be misled regarding the goodness of
the paper presented to it. If, for the reasons already stated, it be
true that commercial paper, being the outgrowth of actual transactions, practically provides its own means of liquidation where
•all is bona fide and honest; and if it be further true, as just shown,



that a large institution, enlisting the cooperation of banks and
credit institutions everywhere, can practically eliminate every element of dishonesty or unsoundness in such paper, it will evidently
be true that the loans made on this basis by such an institution
will be absolutely sound. They cannot become "inflated," since
they will be merely coterminous with the business to which they
relate, and will involve no element of hazard or of future uncertainty. By limiting the operations of the institution to this class
of security, and by eliminating every other class except under
unusual conditions specially provided for, the funds of the Reserve
Association are, not only absolutely safeguarded from speculative
uses, but are protected by the only system of guarantee which is
possible in banking—the placing of the combined banking and
business judgment of the community behind the assets of the institution.





European Accepted Bills of Exchange—2. American Promissory
Notes—3. National Banks Cannot Accept Bills of Exchange—4.
A Discount Market—5. Danger of Over-Expansion—6. The Rate oI
Discount—7. Uniform Rate of Discount in United States.

§1. In getting a loan, different forms are used in different
countries, due to different business customs. In the United States
borrowing at a bank is accomplished by the borrower giving the
bank his promissory note for the term of the loan. I t is quite otlierwise in EuroPeThere, the bill of exchange is the common instrument of credit. A bill of exchange is an order drawn by the
seller of goods, A, upon the buyer, B, asking B to pay (on demand,
or at a given time) to C, a sum of money. The actual form of a
sight bill of exchange is as follows:

New York, January 1, 1912.
At sight of this first bill of exchange (second and third unpaid), pay to the order of C, £10,000, value received, and charge the
sum to the account of
A (exporter from U. S.).
To B (buyer from A ) , London.

If B accepts the bill by writing the word "accepted" across
its face, with his signature and the date, it becomes an obligation
of B, who on presentation assumes the payment at maturity to C.
Accepted bills of exchange are thus the common form of paper
at European banks.


A particular class of accepted bills of exchange, known as
"bankers' bills," forms a considerable part of the assets of European banks in their item of loans. That is, a borrower may secure
a loan (for say, 90 days) from a bank, by drawing a bill on the
bank, which accepts the bill because of an arrangement previously
made between the bank and the drawer. Such a bill is immediately




salable wherever the accepting bank is known, and the drawer is
thus able to obtain funds without delay. There are various ways
of making the bills, but the essential clement as above, is contained
in them all. For instance, the debtor, B, may draw a bill on the
bank, instructing it to pay A, the seller of the goods, and if accepted, the payment to A is secured by the credit of the bank. The relation of the accepting bank to the drawer, B, is a matter solely
affecting the bank and B, the borrower. That relation is, in essence,
the usual one existing between a borrower and the lending bank—
no matter what may be the peculiar legal forms entered into by
which the borrower secures the bank for the loan. The credit
essence is the same—even though the legal forms for repayment
differ—whether a promissory note is given as in the United States,
or a bill of exchange with assurances of payment at maturity, as in
When a European bank makes a loan to a customer by accepting his bill drawn on the bank, it may be based on the borrower's
general standing—just, as when, in the United States, a discount
is granted on the one-name promissory paper of a person, or firm, of
high standing. In either case the risk to the bank is much the same.
But, in Europe, as well as here, the bank may exact security in
addition to the signature of the borrower. For instance, an im- Security
porter may wish a loan to pay for goods in warehouse, or in transit,
the bank may agree to accept the bill as soon as the drawer has deposited with the bank the bills of lading, or other documents, covering the shipment of the goods; and the bank may next give the
borrower an opportunity to dispose of the goods upon receiving a
trust receipt. Still the relation between the borrower and the accepting bank is a primary matter. In Europe the practice is for
the borrower to give the bank an agreement, duly signed, to hold
the bank harmless for accepting the bill, to provide for tbe bank
funds sufficient to meet the bill three days prior to the date of
maturity, and to pay the bank the market rate of discount and a
commission (varying1 according to the standing of the borrower
and the time the bill is to run).
§2. As has been said, the direct promissory note of a borrower to the lender is the usual form of credit in the United States.
As previously shown (see Chapter V ) , prime commercial paper
inay be one-name paper; while two-name trade paper may not be so



desirable. That is, the form of credit likely to show the nature of
the transaction—which appears also in the bill of exchange—is not
necessarily the best paper offered to the banks. On the other hand,
the paper of the firms in highest standing does not on its face disPromissory
Note Usual close the nature of the transaction. However this may be, the best
Form of
managed banks by experience and judgment have worked out a
system under which they know definitely what paper is good, and
what is bad. Since the paper itself does not convey information
as to the trade transaction, the bank will carry in its dossier complete details of the extent and character of the customer's business
and borrowings. To be sure, the bank—except through Clearingnouse Committees, or by some such central credit bureau as that
proposed by the Comptroller of the Currency—may not know how
extensively the borrower has extended his credit with other banks.

of NoteBrokers

In the last few decades, banking operations have been influenced by the same conditions which have led to the formation of
large industrial combinations. Formerly, producers and merchants
obtained loans from the local banks by getting their promissory
notes discounted at home. But as the operations of many firms
developed extensively, their borrowing needs soon increased beyond the small resources of the local banks. Those which entered
into large combinations had their discounts necessarily taken care of
through the management located in the largest financial centers.
But the vast number of independent producers of all kinds, not
only in small towns, but in the large cities, as their need of loans
increased with increasing business, broke up a large loan into
small pieces which were placed in the hands of note-brokers to
be sold to banks in all parts of the country. This business of the
note-brokers has increased amazingly; the broker can parade the
good qualities of a firm's paper to a bank in a way not permissible
to the drawer himself. Thus in lieu of a discount market for paper
in the United States, a great amount of promissory notes has been
widely distributed and sold by note-brokers.
The safety of the usual form of credit used in this country—
the promissory note—depends upon the standing of the maker,
varying as widely as the standing of men and industrial concerns
all over the country. Obviously, then, our commercial paper has
no uniform quality or security, and consequently the rate of discount varies as much as the standing of the borrower. We have
no discount market—such as that known in Europe for accepted



bills of exchange—beyond that provided by the note-brokers, who
peddle out the paper wherever it can be sold.
In the absence of a discount market, the banks themselves,
when in need of cash resources, have no open way of disposing
of their paper. Rediscounting their paper is regarded as an evidence of weakness and that the condition of their reserves is unsatisfactory. Hence the banks fear to have it known that they are
rediscounting their paper. Nevertheless, the same thing in another form is constantly and necessarily going on. Perhaps a director of the bank is used personally as a means of getting a redis- Rediscountcount upon assets of the bank. In one way or another, rediscount- Ing Not
ing of promissory notes is going on, and is probably ine\itable under
existing conditions. Single-name promissory notes have no universality of credit, and hence could not feed a discount market.
Such paper can not be instantly turned into cash in an open market.
The objection of banks to rediscounting their paper is due to
the fact that it offers a note whose security depends solely on the
standing of its maker. If the bank endorses it for rediscount, the
lending bank which rediscounts it makes the loan wholly on the
strength of the endorsing bank; it is, in effect, a loan directly to
that bank; and it practically creates accommodation paper in favor
of the borrowing bank. This is doubtless the reason why rediscounting is supposed to injure the credit of a bank. If, however, a coun- counting
try bank had invested its idle funds in bills accepted by a well- , s Now
known bank, and wished to realize on them instantly, the redis- S u * P e c t c d
count would not be a loan to the country bank, and would not affect
the bank's credit. It would indicate only that the country bank
had found a more profitable employment of its funds, or that it
wished to increase its reserves. That is, acceptances would serve
as a desirable "secondary reserve," which could be instantly turned
into cash in the open market ; while promissory notes, rediscounted,
mean an appeal to a single correspondent bank for accommodation.
§3. By the decisions of the courts under the national bank act,
national basks are apparently not permitted to accept time bills of
exchange. The act authorizes banks organized under it to earnon the business of banking "by discounting and negotiating
promissory notes, drafts, bills of exchange, and other evidences
of debt; by receiving deposits; by buying and selling exchange,
coin and bullion; by loaning money on personal security." " I t



is settled," says the Supreme Court1, "that the United States
statutes relative to national banks constitute the measure of the
authority of such corporations, and that they cannot rightfully exercise any powers except those expressly granted, or which are inDeflnition
cidental to carrying on the business for which they are established."
Under these powers a national bank may certify checks ; 2 it may,
of National j n selling or rediscounting paper held by it, bind itself by indorsing
or guaranteeing the payment of the paper; 3 it may, for the purpose
of securing payment of a debt due it, guarantee the payment of notes
delivered to it (but not payable to it) by the debtor in order that
the bank should then negotiate them to another ; 4 a bank may permit an over-draft because this may be merely one method of loaning money; but, on the other hand, it is held in many cases decided
by State and the lower Federal courts (though the question seems
not to have been directly passed upon by the United States Supreme Court) that a national bank can not lend its credit,5 and
particularly can not make accommodation acceptances and guarantees for the benefit of third persons,6 even though it received a
compensation for doing so.7
California Bank v. Kennedy, 167 U. S. 362.
'Merchants' Bank v. State Bank, 10 Wall. (77 U. S.) 604.
•Peoples* Bank v. National Bank, 101 U. S. 181; United States
National Bank v. First National Bank, 24 C. C. A. 597, 79 Fed. 296.
'Peoples' Bank v. National Bank, supra.
'Thus in Seligman v. Charlottesville Nat Bank, 3 Hughes 647, 21
Fed. Cas., p. 1036, it is said by Judge Bond in the circuit court: "The
bank is allowed [by the statute] to lend money upon personal security;
but it must be jnoney that it loans, not its credit." This language has
been repeated in many cases. In this case a national bank had undertaken, upon receiving a deposit of collaterals, to guarantee to another
bank a letter of credit issued by the latter to a customer of the former;
Held to be ultra vires.
"See Seligman v. Bank, supra; National Bank u. Atkinson, 55 Fed.
465, affirmed, 10 C. C. A. 87, 61 Fed. 809; Commercial Nat. Bank v.
Pirie, 27 C. C. A. 171, 82 Fed. 799; Merchants' Bank v. Bairdt 90 C. C.
A. 338, 160 Fed. 642; Norton v. Berry Nat Bank, 61 N. H. 589; National
Bank v. Sixth Nat. Bank, 212 Pa. 238; Thilmany v. Iowa Nat Bank.
108 Iowa 333; First Nat Bank v. American Nat Bank, 173 Mo. 153;
First Nat Bank v. Monroe, 135 Ga. 614; Fidelity Co. v. National Bank
(Tex. Civ. App.) f 106 S. W . 782.
Contra: Hutchins v. Planters1 Nat Bank, 128 N. Car. 72; Farmers'
Nat. Bank v. Illinois Nat Bank, 146 111. App. 136.
No one of the cases cited involved the precise question herein
'It might, however, be liable, not on the guaranty, but quasi contractually to the extent of any consideration actually received by it
in the course of its business. See Appleton v. Citizens' Nat Bank, 116
N. Y. App. Div. 404, reversed, 190 N. Y. 417, affirmed, 216 U. S. 196.
See also Rankin v. Emigh, 218 U. S. 27.



If a bank were to give an acceptance which was to be paid soon,
independently of the question whether the customer had then provided funds to meet it, it would not differ in substance from a loan
of the money, and might not be deemed to differ in legal effect. But
if the acceptance were of a time bill and it was the agreement and "lances
expectation that the customer should provide funds to meet it be- and
fore maturity, so that the bank would not expect to advance its own Between*8
money at all, it would seem to be nothing else than a loan of credit Acceptances
- I . - .


and not a loan oi money m any sense.
It may be concedcd that there is little apparent difference in
result between the case in which a man gives his note to the bank
seen red by collateral, has the proceeds placed to his credit, and
then draws his own check upon the deposit; and the case where
he agrees to indemnify the bank, deposits the same collateral, and
is permitted to draw a bill upon the bank, which it accepts, and lie
then uses the acceptance instead of his own check, as in the case first
supposed. In both cases the bank relies upon his responsibility
and the value of the collateral. It may be that the bank would be
just as safe in the latter case as in the former. It would not, however be in an equally convenient situation, if it should desire to
transfer or realize upon these securities, since the customer's note
secured by collateral would be negotiable and readily rediscountcd,
while his agreement to indemnify secured by the same collateral
would not be negotiable or readily used in the market.8 From the
standpoint of the statute, however, there would be quite a distinct
difference in form and some difference in effect. In one case the
bank would lend money on personal security, which is within the
language of the Act, and in the other case it would lend credit on
personal security, which seems to be outside the language of the Act.
'This, of course, proceeds upon the assumption that what the
customer gives the hank is, as suggested in an earlier section, an
agreement to indemnify the bank against liability upon the acceptance and to provide funds in ample time to meet it. The customer
might, indeed, give the bank his note for the amount of the acceptance, payable before the latter was to mature; and in that event the
distinction in the form of the security held by the bank would disappear.
Where the customer gives an ordinary agreement to indemnify
the bank, as at first supposed, there would usually, in addition to the
disadvantage of non-negotiability mentioned in the text, be some
differences in procedure and evidence in enforcing an agreement to
indemnify as compared with the more liquidated and flexible negotiable note.

and Loans


It is also possible that the Supreme Court of the United States

might, in view of the practical and economic similarity of the two
transactions, hold that the differences in form were immaterial.
It is also, of course, true that the difficulty is merely one of
charter or statutory power, which may be removed by appropriate

In Europe

§4. In Europe, the general use of bills of exchange, and their
acceptance by banks, has led to the creation of a discount market
in London, Paris, Amsterdam, Berlin, and other centers. When the
bill is accepted, the risk of payment is assumed by the bank. The
security of the paper is no longer dependent upon the varying standing of the drawer, but upon the standing of! the bank; consequently
it possesses uniform security in any market where the bank is
known. The case for creating a discount market in this country
is stated as follows by Mr. Lawrence M. Jacobs i1
" T h e weakness of our banking system as compared with the
systems of Europe may very certainly be attributed in part to the
omission of the hank act to permit bank acceptances.

It is a weak-

ness, furthermore, which involves the country in serious economic

Without a national discount market, the great majority of

our merchants and manufacturers are compelled to confine their
borrowings to American capital;

either through the discounting

of their paper with their local banks or through its sale to note

All hut the strongest and largest are practically excluded

from the benefits of foreign competition for their paper.


from the great concerns with international ramifications, which
are able to arrange their own credits abroad, our merchants and
manufacturers are not benefited by low foreign discount


except in
so far as note brokers, who make it a practice to borrow
in Europe with commercial paper as collateral, are better able to
finance their purchases.

W h a t is more, they receive


little advantage from an accumulation of funds in New York banks.
Low call loan rates have an indirect rather than a direct effect on
the rate which the mercantile community has to pay for money.
Low call rates, in other words, are an indication more especially
of stagnation in the stock market than of a lack of demand for
accommodation from merchants and manufacturers.

Such rates

do not act as a stimulus to trade in general any more than high
call rates act as an immediate check to overexpansion.
" I t is not only in our domestic trade that the country suffers
through the want of a discount market.

Without bank acceptances

we are at a distinct disadvantage in connection with our foreign
»National Monetary Commission, " B a n k Acceptances."



trade. Our importers, unable to open credits with their banks, as
Is done abroad, are not in a position to finance their purchases
upon as favorable a basis as the importers in other countries, as
English cotton-spinners, for example. The English spinner about
to purchase cotton in America arranges for his bank to accept
sixty or ninety days' sight bills drawn on it by the American
shipper. The latter draws his bills on the English bank and
attaches the documents covering the shipment, such as the bills of
lading, insurance certificates, invoices, etc. He then sells them to
a New York bank, thereby receiving immediate payment for his
cotton. The New York bank forwards the bills to its London correspondent, which presents them for acceptance to the bank upon
which they are drawn. Upon the acceptance of the bills the documents are delivered to the accepting bank, which then turns them
over to the spinner upon whatever arrangement has previously
been made. The accepted bills are discounted by the New York
bank in London and the proceeds placed to its credit there. The
New York bank can afford to pay a high rate for such bills, as they
are drawn on prime bankers, rendering certain their ultimate payment. The purchase of the bills does not, moreover, necessitate
any outlay of money, as, against the credit to be received through
the discount of the bills, the New York bank can immediately sell
its checks on London.
"Without such banking facilities—that is, the ability to
arrange with his bank to accept time bills drawn on it by a foreign
shipper, the American importer is compelled to finance his purchases in either one of two ways. He may pay for the goods at
once by remitting funds direct to the shipper. This, however,
ordinarily necessitates the negotiation by the importer of a loan
on his promissory note. If he is not in a position to secure such
an advance he must shift the burden of providing funds to finance
the shipment, from the time it is forwarded until it is to be paid
for, upon the foreign shipper, who is then in a position to exact
terms more favorable to himself through an adjustment of prices.
The practice in connection with this method of making payment
for foreign purchases is for the shipper to draw his draft on the
American importer and turn it over to his banker to forward for
collection. Such drafts, drawn as they are on individual importers
and not on banks whose standing is well known abroad, must be
sent for collection since there is no general market for them.
Practically the only way in which a foreign shipper can realize
immediately on bills of this character is to dispose of them to hia
own banker or get him to make an advance on them.
"Either of these two methods of financing our imports is expensive even when the time between the shipment and the receipt
of the goods is short. When the time is much longer, as in the
case of imports from South America and the Far East, the cost is
almost prohibitive—that is, so great that we cannot compete on
an even basis with foreign buyers. In fact, we might be practl-

cally excluded from these markets if a makeshift were not possible. Our importer gets around our lack of banking facilities by
haviug his bank arrange a credit with its London correspondent.
He receives an undertaking, called a commercial letter of credit,
giving the terms of the credit—that is, the name of the London
bank upon which the bills are to be drawn, the amount which may
be drawn, the character of the goods which are to be purchased,
the tenor of the bills, and the documents which must accompany
them. On the strength of such a letter of credit, the shipper in
South America, for example, is able to dispose of his bills on London and thus receive immediate payment for his goods. The local
bank which buys the bills sends them with the documents to its
London correspondent, which presents the bills to the bank on
which they are drawn—that is, the bank with which the credit was
opened. Upon the acceptance o£ the bills the documents are delivered. They are then sent by the London accepting bank to the
New York bank which opened the credit and the latter delivers
them to the importer against his trust receipt Twelve days prior
to the maturity of the bills in London the New York bank presents
a statement to the importer indicating the amount of pounds sterling which must bo remitted to London to provide for their payment at maturity or rather a bill stated in dollars for the amount
of pounds sterling drawn under the credit. In this purchase of
exchange the importer makes payment for his goods. This method
while workable is obviously cumbersome, yet it is practically the
only one which the American importer can follow in connection
with such imports. It is expensive for the importer, for not only
must he pay his bank a commission for arranging the credit,
but there is included in this commission a charge made by the
London bank for its acceptance. Further than that, the importer
must take a material risk in exchange. A t the time a credit is
opened the cost of remitting, say £10,000, to take up the bills in
London, might be only $48,600, or at the rate of $4.86, whereas by
the time the bills actually mature exchange may have risen and
cost him $4.87, or $48,700.
" A s a result of the inability of our banks to finance imports,
through the acceptance of time bills, American importers are then
made dependent to a large extent upon London, and are required
to pay London a considerable annual tribute in the way of acceptance commissions. This practice not only adds to the importance
of London and militates against the development of New York as
a financial center, but it at the same time works serious injury to
our export trade. Since time bills cannot be drawn on our banks
from foreign points against shipments of goods to the United
States, there are consequently in such foreign countries very few
bills which can be purchased for remittance to the United States
in payment for goods which have been bought here. In other
words, under our present banking system our imports do not create
a supply of exchange on New York, for example, which can be sold



in foreign countries to those who have payments to make in New
York. This means that our exporters are also, to their great dls
advantage, made dependent upon London. It means that when
they are shipping goods to South America and to the Orient they
cannot, when they are subject to competition, advantageously bill
them in United States dollars. They naturally do not care to value
their goods in local currency—that is, in the money of the country
to which the goods are going—so their only alternative is to value
them in francs or marks or sterling, preferably the latter, owing
to the distribution and extent of British trade, creating throughout the world, as it does under the English banking system, a
fairly constant supply of and demand for exchange on London.
When we come to bill our goods in sterling, however, it is at once
seen that our exporters are obliged to take a risk of exchange,
which is a serious handicap when competing with British exporters. Our exporters who are to receive payment for their goods in
sterling must previously decide on what rate of exchange will
make the transaction profitable.
If, in an effort to safeguard
themselves against a loss in exchange, they calculate on too low a
rate for the ultimate conversion of their sterling into dollars,
their prices become unfavorable compared to those made by British exporters and they lose the business. If they do not calculate
on a sufficiently low rate, they get the business, but lose money on
the transaction through a loss in exchange.
" T h e prohibition of bank acceptances not only acts as a hamper
upon our domestic and foreign trade, but is detrimental to our
banks as well.
It is the small country bank which is chiefly
affected. The business of the country bank, so far as the employment of Its funds is concerned, may be divided into two classes—
that which relates to advances to local customers and that connected with the investment of its surplus. It is in respect to the
latter that the matter of acceptances is important. Under the
present limitations of the national bank act, there are three principal ways in which a country bank may render its surplus funds
productive. It may deposit them with its reserve agent. This means
a low interest return, too low in fact to permit of more than a
relatively small amount being thus employed. It may invest in
bonds. In this way an increased interest return can be secured,
providing a wise selection of securities is made, but it partakes of
the nature of speculation. The third way is to buy commercial
paper. Such purchases give an ample interest return and there is
no savor of speculation. Even this method of employing a bank's
funds, however, is far from satisfactory. It means the investment
in a security for the strength of which the bank must depend on
the word of note-brokers, the rating of the mercantile agencies, or
the opinion of some correspondent bank. It means, furthermore,
the tying up of the bank's funds for a fixed period. If national
banks were permitted to accept time bills, the country bank could
then invest its funds In paper bearing the guaranty of some great

bank with whose standing it is perfectly familiar. Risk such as
now has to be taken would be eliminated. What is vital, however,
is that with a national discount market an investment in a bankaccepted bill is one which could be realized upon immediately.
"Since the reserves of interior banks are so largely concentrated with them and it is essential that they keep their assets in
an especially liquid condition, the prohibition of bank acceptances
works Injury to the banks at the country's financial center, New
York, in a different way. It deprives them of what London banks,
for example, have—that is, a mass of the soundest securities
against which to loan their money on call or in which they may
invest their funds for very brief periods—bills of exchange, covering genuine commercial transactions, bearing the acceptance of
prime bankers. Unquestionably such securities as a basis for loans
are preferable to stocks and bonds, but without them New York
banks must have recourse to day-to-day loans on the Stock Ex
change. Moreover, when the demand for such loans is limited,
New York banks are forced into the keenest kind of competition, a
competition which; as has been pointed out, is not only of little
benefit to trade but which, through the lowering of the money rate,
actually stimulates speculation. Furthermore, without a steady
money rate such as exists in countries possessing discount markets,
New York banks are left with no reasonable or satisfactory basis
upon which to fix a rate of interest to pay for the deposits of
country banks. In London interest on bank deposits is fixed at a
certain percentage below the Bank of England discount rate,
usually 1 % per cent—that is, a rate which fluctuates with the value
of money and normally leaves a certain margin of profit to the
London bank. The same practice is followed in all the great
financial centers of Europe. With us, country banks receive a fixed
rate of interest for their deposits, usually 2 per cent the year
round, regardless of fluctuations in the value of money.
unscientific nature of such a rate is obvious. When the call loan
rate is high, country banks do not receive interest in proportion
to the value of their deposits. When it is'low the New York banks
pay more interest than the deposits are worth.
In the latter
instance the New York banks are forced into injurious competition
with one another. They are in much the same position as competing railroads were earlier in our history, with results similarly
baneful. With the railroads it was worth while to secure traffic
even at a losing rate, as no matter what the return, it helped, if
only a little, toward meeting fixed charges. Oftentimes with the
New York banks today any rate which they can secure for their
money, whether losing or not, is acceptable as helping to meet
this fixed interest charge on bank deposits. To pay 2 per cent for
deposits and to keep a 25 per cent reserve a bank must loan its
money at 2 % per cent to come out even, taking into consideration
the actual expense of making and recording the transaction. It is
better to loan at 1 % per cent, however, than to let the money lie



It Is better to lose 1 per cent than to lose the entire 2 %

per cent, as would be done in case no loans at all were made,
clerk-hire being just as much a fixed charge as Interest.

With tho

amendment of the national bank act, to permit the acceptance of
time bills, such ruinous competition would cease.

The funds of the

banks would come to be principally invested in trade paper and
stock-exchange loans would be relegated to a position of secondary
importance, as in London and on the Continent.

The field for the

investment of their deposits would be greatly broadened, to tho
benefit both of the banks and trade in general.
" T o remedy this primary defect in our banking system, to
trade along the lines which have proved so advantageous in other
countries, to provide negotiable paper of a character suitable to the
investment of foreign funds, paper which can not only be discounted but rediscounted, to give trade the advantage of bank
surpluses accumulated both In the country at large and in New
York, to lessen the evils of speculation, to afford a reasonable basis
for the calculation of interest rates on bank deposits in central
reserve cities, to bring New York into the circle of those financial
centers between which funds move naturally as discount rates rise
or decline, to secure the advantage of the competition of foreign
capital for our trade paper—can be put in the way of accomplishment by the Insertion of a paragraph

or two in the national

bank act.
" T o permit bank acceptances would not require the revision of
the entire bank act.

To remove the barrier to scientific banking, as

it is known abroad, no complicated piece of legislation would be

Time only would be required for the development of a

great national discount market."

§5. The permission to all subscribing national banks to accept time bills of exchange, is a part of the banking reform measure
before the country. It is obvious that acceptances are a form of
loan, differing from promissory notes only in the legal forms adopt- R * s t r , c t , o n B
ed for protecting the bank against the borrower. There should, Acceptances
therefore, be the same precautions taken against over-expansion in
the case of acceptances as in the case of other paper.
The first essential restriction, of course, is that they should
arise out of commercial transactions; indeed for bills of exchange
drawn by sellers on buyers this test is more easily made than for
promissory notes. If drawn on real transactions, there can be little danger of over-expansion. In addition, it is provided that they
should not have more than four months to run, and be properly
secured by the usual documentary evidences, such as bills of lading,
etc. Besides these restrictions, the total amount allowed should not




exceed one-half the capital and surplus of the accepting bank.
Moreover, when the paper is presented to the National Reserve
Association for sale, the acceptor must be a bank or firm of unquestioned financial responsibility; the paper must have not over
90 days to run; be known as prime bills; and bear the endorsement
of the selling bank, which must be other than the accepting bank.
Of course, the market for acceptances would not b'j confined to
the National Reserve Association. While only well-known banks
will probably resort to acceptances, yet it is a resort permissible to
any small bank. A buyer of cotton or grain could arrange to draw
on a country bank and have the bill accepted, under the plan proposed. Such an acceptance could be sold in the open market for
paper wherever that bank is known; but, as already noted, no
subscribing bank, large or small, could create acceptances to exceed one-half its capital and surplus. That is, a bank with a capital of $25,000 and a surplus of $5,000 would be limited to $15,000
of acceptances.
Having thus reached its limit of acceptances, when good cotton or grain paper was offered it, a bank could still discount promissory notes, provided its reserves allowed; but if its reserves began
to fall below the legal limit, it could then take its cotton or grain
paper to the branch of the National Reserve Association for rediscount, and with the proceeds add to its reserves. But, in no case
could such bank, country or city, obtain rediscounts in excess of its
capital. As a result, over-expansion seems to be well guarded
against, apart from the requirement that the paper should be commercial, and not used for carrying stock exchange securities.

of Foreign

Regarding rates, Mr. Jacobs says:

"In European centers the discount rate is the rate upon
which the cye3 of the financial community are fixed. In New
York it is the rate for day-to-day loans on the stock exchange. The
advantage in character of the one rate over the other clearly indicates an important advantage of European banking systems over
our own. In the first place, the European discount rate bears a
very direct relation to trade conditions. Its fluctuations depend
primarily on the demand for and supply of bills which owe their
origin to trade transactions, as balanced against the demand for
and supply of money. If trade is active, the supply of bills
becomes large, rapidly absorbing the loanable funds of the banks.
As these surplus funds become less and less, banks are unwilling to
discount except at advanced rates. If trade is slack, less accommodation from bankers in the way of acceptances is required, bills



become fewer in number, the competition for them in the discount,
market more lceen, and the rate of discount declines. Low rates
are an incentive to business and advancing rates act as a natural
check. The New York call-loan rate, on the other hand, bears
only an indirect relation to trade conditions. Its day-to-day fluctuations register mainly the speculative and investment demand for
stocks. Low rates, instead of being an incentive to the revival of
trade, are rather made the basis for speculative operations in
"The striking difference, however, between European discount
rates and the New York call-loan rates is that the former are comparatively stable and the latter subject to most violent oscillations.
Foreign discount rates, as bank reserves become depleted, advance
by fractions of 1 per cent. In New York the money rate advances
on occasion 10 per cent at a time, mounting by leaps and bounds
from 20 per cent to 100 per cent in times of stress.
"There are two principal reasons for the stability of foreign
discount rates.
In the first place, trade expands and contracts
gradually, so trade bills multiply or diminish in number little by
little, producing a gradual increase or decrease in the demand for
money. In the second place, discount rates are steady because
there is a free movement of funds between the countries possessing
great discount markets. Between London and Paris money flows
as the balance of indebtedness changes, modified by the discount
rates at the respective centers. If France owes England more than
England owes France, money will tend to flow from Paris 1o London in settlement of this balance of indebtedness. If the London
discount rate is higher than that of Paris, the movement will bo
accentuated by the movement of French funds to London for
investment in sterling bills of exchange—that is, in bills drawn on
and accepted by prime English banks and bankers. If the Paris
discount rate is higher than that of London, there will be a natural offset to the tendency of funds to move to London in settlement of this balance of indebtedness. Briefly, money seeks investment in those centers where the discount rates are highest. If the
discount rate is l 1 ^ per cent in Paris and 2*4 per cent in London,
Paris bankers remit funds to London for investment in sterling
bills. This increases the supply of money competing for bills in
London and forces the discount rate downward. At the same time
the drain of funds from Paris results in lessening the competition
for bills in that center and the Paris discount rate rises. Thus
it is that funds freely move to and fro between- London, Paris,
Berlin and Amsterdam, an exact equality in rates being prevented
largely by the fact that the discount markets in these cities differ
in size and that there is not in each an equally free market for
gold. For example, the Paris discount market is broader than
that of Amsterdam, and there is consequently less risk in exchange
in forwarding funds to Paris for investment than to Amsterdam.
That the Paris discount rate should rule somewhat lower than that


of Amsterdam

Is accordingly natural.


Sterling bills, moreover,

are favored above German bills because London possesses a freer
market for gold than does Berlin—that is, a holder of credit in
London can count on being able not only to convert it into gold,
but to withdraw the gold, whereas artificial restrictions are sometimes placed on the withdrawal of gold from Germany.

In conse-

quence, apart from any consideration as to relative size of the two
money markets, there is a tendency for funds to remain in or to
move to London even when the Berlin discount rate is slightly
"There are likewise two principal reasons for the instability
of the money rate in New York. The first is that the demand for
loans for the purpose of speculative operations in stocks does not
increase gradually. A few weeks at most are sufficient for a large
speculative movement to develop. A t the same time the profits
in successful stock speculation are so great compared with those
in trade that the matter of whether the call rate is 6 per cent or
10 per cent is relatively unimportant.
So it Is that only very
sharp and very considerable advances in the call rate are effective
in checking the demand for money. The second reason is that an
advance in the call rate above the level of foreign discount rates
does not serve directly to attract funds from Europe. The continuance of high rates can not be depended upon, and furthermore,
while London bankers, for example, may be willing to loan money
to finance speculative movements at home, to make advances for
similar purposes abroad is quite another matter.
In fact, the
higher the call rate is the less the European banker is inclined to
lend his money in the new York market. N e w Y o r k is in a class
by itself. Without bank-accepted bills it can have no discount
market. Without a discount market, funds can not move to it as
they do between the financial centers of Europe, because there are
no bank-accepted bills in which foreign banks can invest.
commercial paper is not suitable. Foreign banks will not purchase
it because they are not acquainted with, or sure of the rating of,
miscellaneous mercantile establishments, and because such paper
could not be readily disposed of in case it became necessary or
profitable to withdraw funds from New York for remittance elsewhere."


The creation of a discount market in the United States

would introduce here the phenomena of so-called market and bank


The former are the rates established


r a t e S E0 c o m m o n


on the open market by the competition of all banks and other in-


vestors in this class of securities and the latter is the rate fixed by
the central banks.

The market rates on different classes of bills

are different and, as has been indicated, they fluctuatp in accordance with the demand and supply of bills on the one hand and of



funds on the other. The bank rate is much more stable. In France
it has at times remained stationary for two or more years, and
a stationary rate for several months is common in all countries
which have well organized central banks. Jt is also a uniform
rate throughout the entire country, the central bank offering its
services on the same terms to all sections, banks and persons.
In the determination of its rate of discount the National Reserve Association would be influenced by considerations similar to
those which actuate the banking institutions of Europe, namely, the
state of its reserves, the foreign exchanges and the general conditions of credit. In the open market here, as in Europe, there would
be different rates on different classes of bills and these rates would
fluctuate with the varying conditions of supply and demand.

gank Rate?

In Europe the market rates are usually below the bank rate.
Only occasionally and for short periods do they rise above it. On
this account ordinarily most of the discounting is done in the open
market, the central banks rediscounting for other banks as their
needs for cash and notes dictate. When for any reason the market rates soar above the bank rate, the latter is apt also to be raised
in order to prevent too great an increase of the Central Bank's discounts, and, if it does not rise, the transfer of customers from the
market to the Central Bank is certain to diminish the demand
there and thus to bring the market rates back to their normal state.
In the United States a peculiar situation exists on account of
the wide differences between the rates in different sections of the
country and on account of the relatively high rates everywhere. Could the
The query arises whether it would be practicable fox the National Association
Reserve Association to maintain a uniform rate throughout the
country under these conditions. Would not its rate be continually Rate?
below the market rates in many sections of the country and would
not the banks in those sections find it profitable to borrow heavily
from the Reserve Association in order to loan at higher rates at
home and thus to make too heavy drafts upon the Association's resources and to over-expand credit in those regions?
Before the effect of a uniform rate of discount by a National
Reserve Association can be appreciated, notice must be taken of the
fact that the chief cause for the differences now prevailing between
loan rates in different sections is the absence at the present time
of suitable machinery for the distribution of the funds of the coun-


Causes of
Rates in
by Reserve

Tending to


try, and that the rates under consideration pertain only to commercial paper of short maturities.
Barring the risks involved in loans to new enterprises managed by more or less inexperienced men in undeveloped regions, the
only reason for abnormally high rates in portions of the West and
South is the lack of adequate banking capital and the absence of
such cooperation between the banks of the entire country as make
it practicable and safe for banks in the older and richer sections
to send a portion of their resources for investment to the less developed and under-supplied sections.
The organization of a National Reserve Association would
remedy this latter difficulty. It would standardize those forms of
commercial paper which it is permitted to discount und create a
national market for them. All banks could and would enter this
market when they had surplus funds to invest, and these standard
forms of paper, originating in the regions in which rates are now
abnormally high, would enter the market on the same terms as
similar paper originating in other sections. The organization of
a National Reserve Association would result in drawing a sharp line
of distinction for the first time in this country between commercial
and investment paper. It would create a national market for the
former; and, for those classes which the Association is permitted,,
to discount (namely, paper with twenty-eight days of maturity,
four-months paper and bank acceptances) it would establish standard rates which, with the exception of minor variations due to
differences in the domestic rates of exchange at different points
and the varying degrees of credit of the individuals, firms and
corporations whose paper would be presented for discount, would
be. uniform throughout the United States.
The influences which would tend to enforce this uniformity
would be the uniform rate of discount of the National Reserve Association for paper of the same quality without reference to the
place of origin, and the competition of banks in the now relatively
low-interest-rate sections. When the business men of any locality
learn that their bankers are able to borrow from the Reserve Association on their paper at certain rates by merely adding the bank's
endorsement, they will not long tolerate a charge to them in excess
of the rate the banks pay the Association, plus a reasonable profit
on the transaction; and they will not be obliged to tolerate it, because the fact that the National Reserve Association is freely dis-



counting the paper of these individuals, firms or corporations will
give them credit on the open market and enable them to command
the surplus resources of banks in other sections.
The uniformity of rates here under consideration should be
understood to apply only to paper identical in quality and character. The National Reserve Association should be permitted to
make different rates for the different classes of paper it is permitted to discount, and in making such differences it should be
guided by the condition of the market and by its own needs; but
whatever rate it establishes on a specified grade and class of paper
should be uniform throughout the country. The alternative to such
uniformity would be some kind of a sliding scale based on the rates
charged in each locality, and this would have the disadvantage of
keeping intact existing differences. The influence of the Association should be in the direction of a more equitable distribution
of the country's banking resources and a greater uniformity in
the price of banking accommodation to business men, farmers and
others in every part of the country.



The establishment of substantial uniformity of rates on paper
of the classes available for discount by the Reserve Association
would tend toward the establishment of uniformity on commercial
paper of the other classes, such as paper of longer maturities. Once
the short-time paper of an individual, firm or corporation becomes
accredited on the discount market, other paper of the same individual, firm or corporation would share in the benefits.
Paper which belongs to the investment rather than to the commercial class would doubtless still continue to command different
rates in different sections of the country, since such rates depend
in the last analysis primarily upon the dividend-paying character
and prospects of the enterprises which issue it rather than upon
the money market. The rates on such paper would continue as at
present to be a matter of negotiation between the local banks and
their customers. The facilities for the better distribution of the Rates on
banking resources of the country supplied by the Reserve Associa- pa^/p™*"*
tion would also help better to distribute the country's investment
capital and thus exert some influence in the direction of uniformity, even upon the rates of this kind of paper, but it probably would
not be sufficient to overcome the influences tending in the opposite
Canada may serve as an excellent illustration of the fact that


ufulrtra **


adequate machinery for the distribution of a nation's loanable funds
tends towards uniformity of rates. That country resembles our own
territory, great differences in the development of different sections, character and density of population, and nature of the
business transacted, and yet the differences between the rates
charged for loans in the different sections, of that country are very
much less than in our own. The explanation of this is to be found
in the Canadian banking system in which a few large banks with
widely scattered branches enable the funds of the country and
those imported from Europe and the United States to be easily
and cheaply distributed to all sections according to their needs.
A National Reserve Association would render this same service to the people of this country without interfering in any way
with our system of independent banks and without introducing
among us any of the difficulties involved in the branch bank system. It would render even more efficient service than the Canadian
system in the direction of equalizing rates between the different
sections of the country, because its own rates would be uniform and
its influence would be everywhere felt, while the Canadian banks
are under no compulsion to charge uniform rates and no single
bank is represented in every section. The tendency towards uniformity in Canada is a result of the branch bank system and of
competition between different institutions. There is wanting the
influence of a single national institution with a uniform rate.



Analysis of Bank Credit—2. Origin of Call Loans—3. Real Security for Commercial Loans—4. Extent of Call Loans—5. Development of Margin Trading From Call Loans—6. Banks Would
Prefer Not to Lend for Speculative Purposes—7. How Discount
Market Would Work—8. Reserve Association Would Be an Intermediary between Banks—9. Possibilities of Evading Charter
Requirements as to Commercial Loans—10. Banks Would Protect

§1. In studying the use that is made of bank credit the
subject must be analyzed from two standpoints—(1) the effect
of certain classes of credit upon the banks themselves, and (2) the
conditions under which such credit is employed by those who get
the loans. In this connection, probably the most fundamental
question to be asked relates to the period for which the ordinary Restrictions of
bank loan is made. This period is of interest because it has a National
Bank Act
direct relation to the fluidity of the bank's funds, because it has
an important bearing upon the terms and conditions of commercial credit, and because the period of the loan shows to a certain
extent the nature of the purposes for which the loan has been obtained.
Recognizing these facts, the national bank act has been very
specific with reference to the character of security which may be accepted behind a bank loan. It is not that banks needed to be
safeguarded and kept from making loans on weak security. That
is a matter which can be entrusted to the selfish interest of the
bank with entire safety, while if corrupt managers are in charge
of the bank there is very little use in attempting to protect stockholders and creditors by law. The reason why the law specifies
with such care the kind of security that may be accepted, is that it
is desired to keep the funds of banks in a fluid condition so as
to insure as far as possible the constant liquidation of loans and to
avoid the tying up of the funds in long period securities which
might be hard to liquidate. Because of this, the bank act has


purpose to
Make Bank



No Limit


prohibited loans upon real estate security and has thrown other
safeguards about certain classes of undertakings. But it has placed
no restriction upon the amount of loans that banks might make on
demand. Theoretically such loans are the most fluid type of bank
assets. Since they are supposed to be collectible whenever the bank
desires, they are, if good, the next thing to actual cash in hand, since
they can presumably be gathered in at a day's notice. This is undoubtedly the assumption of the bank act. Had it been supposed
t i m t SUcl1 l o a n s w e r e ° p e n t 0 ^
d a n g e r , there would
have been an effort to protect them against that danger. But it can
be seen that such absence of restriction was entirely based upon the
assumption already suggested. If that assumption is baseless, such
loans are no longer to be regarded as a fluid type of assets. Should
it appear that they cannot be actually collected on demand, they
at once pass into the class of doubtful or questionable accommodations. This is frequently the case, as can be seen from a study of
that particular type of loan and an analysis of the security by which
it is usually protected.

Cal? Loans

§2. As has already been noted, the essential character of a
loan depends upon the kind of operation that gave rise to it. Of
course the goodness of all loans is ultimately dependent upon the
solvency of the persons who obtain the accommodation and that
is tested by the extent of their ownership of wealth. But among a
group of persons, all perfectly solvent in the long run, there is a
great variety of borrowing power and an equally great variety of
capacity to pay promptly. I t will be found in every case that this
variation depends upon the kind of business done and undertakings
engaged in. As a rule, the length of time for which the borrower
at a bank seeks to obtain accommodation is the average length of
time required for turning over capital in the business in which
he is engaged. Ordinary mercantile credits will run f o r 30, 60, or
90 days. During that period, goods have been placed on the market, disposed of, and the proceeds collected, thus furnishing a fund
for use in settling with the bank.
Where a demand loan is made, there is no such term of credit,
but the assumption is that the business can yield a given amount
of cash at any time. Evidently this could be true only if the business were in position to dispose, at satisfactory prices, of such asBets as might be necessary at any given time, and to obtain in exchange cash .or immediate funds that could be used in payment.



This is not the case in any commercial or industrial operation. Call
loans are seldom found among mercantile or industrial paper, because the men engaged in retailing or manufacturing cannot afford
to put themselves in a position where they are likely to be called
upon suddenly for cash. They feel that they must know exactly
when iheir obligations are going to mature, so that they can provide against them. The call loan may be regarded as synonymous
for practical purposes with the loan for speculative ends. This is
not invariably the case; as, for reasons of convenience on the part
of either side in the transaction, an ordinary loan may be made in
the demand form. But for the most part, that is not the case.
The loans in question are granted with the distinct recognition
that they are to be used for the purchasing and carrying of stocks.

on Which
Loans Are

§3. In the ordinary commercial loan, the security which protects the paper may be simply the signatures of the maker and
acceptor or endorser. The real security in this case is the whole
property and credit of the persons who are concerned in the transaction. The bank knows that the transaction grows out of a real
piece of commercial business so that it i3 protected not only by the
credit of the persons engaged, but also has in view a means of
liquidation which will be supplied when the operation is finally
closed. The call loan, if made from the speculative standpoint, has
no such commercial basis, but is founded usually upon the opinion
that the purchase which is undertaken is wise because of a probable
increase in the price of the security purchased. This may or may
not be warranted by facts, and the security may 01 may not be salable at a higher price in the future. In order to protect itself,
therefore, the bank must refuse to make the loan as large as the
transaction involved, and must limit itself to a specified percentage of the price of the security. This ia presumably the valuation at which the security could he sold at practically any time. C a | | L o a n
were it found necessary to get rid of it at a f orced sale in order Collateral
to provide means of satisfying the loan. On the assumption p ^ , ® 0
that the security is thus actually salable at practically any moment Salable
for some price, the bank makes a call or demand loan. This implies that if the bank wants to be paid, the person who has received
the loan can dispose of his security which he has hypothecated with
the bank as collateral and can with the funds pay off the institution which advanced them to him.

These assumptions are found to be erroneous under certain well


Met In
Call Loan

Tying Up



marked conditions. It is clear that the "securities" which are supposed to be used for the basis of speculation are simply investments;
that is to say, they are capitalized incomes which are estimated on
the basis of the past yield of given industries. The amount that
will be given for them at any moment is regulated entirely by the
supply of and demand for fluid funds seeking investment. If this is
small, there is no reason why the price of the securities should not
drop heavily as compared with the point they had reached when
there was active demand. Moreover, the amount of fluid funds
which can be used for such purposes may be greatly limited at certain times. If the banks all have extended considerable accommodation to persons desirous of buying the securities in question,
and if those who sold the securities in the first place have taken
the funds resulting from the sale and have wasted them or put
them into fixed forms of capital, it may be very difficult for the
holders of these securities to liquidate them at any given time should
very many endeavor to do so. In such a case, a large flood of
securities thrown upon the investment market wTould fail to find
any immediate demand of similar amount. The result would be
that prices would collapse, and holders of the securities would not
be able to pay their obligations to the bank if they depended upon
the proceeds of the sales of such collateral for means with which
to do so. In that case, if the men to whom credit had been granted
by the bank had no other property or resources, upon which the bank
could fall back in its effort to collect, than the securities in question,
the result would be that the bank must take over the securities itself
and carry them on its books at a value equal to the amount of the
loan, or else must write off a certain percentage of the amount lent
as a loss on the transaction.
Of course what would have happened in this case would have
been the practical tying up of bank assets in a long-term investment. The bank which is obliged to take over stocks or bonds of
a corporation is in exactly the same position as a bank which has
lent funds upon real estate mortgage. The latter institution is
likely to be the better off of the two, as the mortgage probably will
not run for more than three years, while the bonds taken over may
run for a much longer period, many of the issues on the market having a maturity of fifty years. As for stocks thus taken over, there
ia no definite date of maturity for them, so that in practice the bank
can get its funds out of these forms of investment only by finding
someone else who is willing to buy them. Thus a decidedly non-




banking transaction has been necessitated. The bank has purchased
the long period securities and can relieve itself only by finding
someone to accept the responsibility of purchasing them in its
place. If it finds the investment market poor for a long period,
this may prove to be out of the question, meanwhile. Under such
circumstances, the call loan instead of being the most fluid type
of banking accommodation, is the least so. In fact, its fluidity depends entirely upon the limited extent to which it has been made,
and the attitude of the community toward speculation and investment. Neither of these conditions can be always exactly estimated Dangers of
by any bank. In a period of overspc-culation and rising prices,
there is grave danger that too large a proportion of bank loans
may be on speculative securities. Then, when a reaction ^ets in,
the funds of the-community are found to have passed out of the
control of the banks and into that of persons who arc exploiting
commercial and industrial opportunities.
§4. It is not possible to ascertain with accuracy how exten Extent of
eive the call loans of the banks are at any given moment as com - Call Loans
pared with other types of loan. The following national bank re
turns furnish some information on the subject:


Sept. 30, 190Ï
Sept. 15, 1902
9, 1903
Sept. 6, 1901
Aug. 25, 1905
4, 1906
Aug. 22, 1907
Sept. 23, 11/08
1, 1909
l ( 1910
Juno 7. 1911

$ >1

706 .





$ 468

Millions. Millions.
$ 586

A study of these figures shows that, on the average, about threequarters of the loans of the national banks of the whole country are
time loans, while one-quarter are call loans. Of the call loans, about
two-thirds are on collateral security. But the call loan market must
be studied in those cities where there are speculative markets, or



where the banks make a practice of making loans to borrowers engaged in stock-market operations in the financial centers. The largest call loan market is naturally in New York. The reports of the
national banks in that city show that more than two-fifths of their
loans are call loans, while less than three-fifths are time loans.
Only a very small fraction of the New York call loans are not secured by collateral.
Approximately about one-sixth of the loans of all national
banks are made by associations located in the city of New York,
and the following statement shows the amount and character of
such loans on comparable dates from 1905 to 1910, inclusive:
New York




On demand, paper with one or
individual or firm names
On demand, secured b y stocks,
and other personal securities
On time, paper with two or
individual or firm names


Aug. 25, ID05.
42 Banks.

On time, single-name paper (one
person or firm), without other securities
On time, secured b y stocks, bonds
and other personal securities or
on real estate mortgages or other
liens on realty


Loans and Discounts.

Sep. 23,1908.
37 Banks.
On demand, paper with one or more
individual or firm names
? 6,800,529
On demand, secured by stocks, bonds
and other personal securities
On time, paper with two or more
individual or firm names
On time, single-name paper (one
person or firm), without other securities
On time, secured b y stocks, bonds
ar.d other personal securities, or
on real estate mortgages or other
liens on realty


Sep. 4, 1906.
40 Banks.

Aug. 22, 1907.
38 Banks.

$ 10,676,198

$ 16,254,018.22











Sep. 1, 1 9 0 9 .
38 Banks.

Sep. 1, 1910
39 Banks.

















It is probable that no such considerable supply of call loans
could be furnished by the banks of the localities in which they are
made if it were not for the cooperation of other banks. The call
loans are rendered possible by the existence of quantities of idle
funds and they therefore tend to be enlarged and developed at those
points where idle funds are most abundant. This usually hap-



pens to be New York City because of the provisions of the national
bank act which permit the redepositing of reserves and which
thereby tend to consolidate the reserve money of the country in
central reserve cities. There are three such cities, New York, Chicago, and St. Louis, and there is no apparent reason why the call
loan business should not be highly developed in all of them, since
all are subject to much the same conditions.
In the division of banking business, New York has tended
more and more to become the headquarters for financial operations
and the loans which are connected witli them, while the other cities,
particularly Chicago, have tended more largely to become the headquarters for industrial and commercial operations involving the
necessity of aid on the part of banks. That being the case, the call
loan market has its headquarters in New York City and much the
larger proportion of this kind of business is done there. New York
has become a speculative center. It has drawn the resources upon
which it relies for abundant loanable funds of this kind from the
smaller banks of the country which have redeposited with the New
York institutions, while it has found these institutions looking more
and more directly to it as a place where they could put their funds
at interest during the periods when there was no demand for them
at home. Depending as it does both upon the presence of large
quantities of idle funds, and the existence of an opportunity for
using these funds to profitable advantage in speculation, an ideal
opportunity has been furnished by the speculative markets of New
York, and banks have been able to take advantage of them while
still keeping within the terms of the national banking act. At
times it has become necessary for the government to attempt to
check the tendency of the small banks to invest their spare funds
in this way. This was notably the case before the panic of 1907
when the Treasury Department found that the deposits made by
the government in small banks in the interior were being promptly
transferred to New York banks, or were being placed with agents
of one kind or another in New York that they might be lent on
call at very high rates of interest.
§5. The effect of this call loan market has been important in
a number of ways. It has undoubtedly rendered possible the development of an extensive system of margin trading in stocks which
would otherwise have found itself a good deal more hampered for
funds. At those seasons of the year when interest has fallen to a



£^J° s n sapy
| n 1907 to
| n New



low level in New York owing to the inflow of funds from the count y bank loans have been abnormally cheap and available for the
use of speculators. The speculators have under these conditions
Develophastened to avail themselves of the opportunities
held out
ment of
to them by extending their transactions in stocks on marTrading
gin. Brokers have obtained accommodation at the banks, putting
up the securities themselves as collateral to protect the loans. Thus
bank funds have become closely intertwined with the stock market,
and bank condition has been made dependent in a certain way
upon the level of prices on the exchanges. Conversely, stock exchange values have been made to depend upon the willingness of
the banking and commercial public to supply the funds that could
be used for speculation. All this has brought about a closeness
of relationship between speculation and commercial banking which
does not exist in foreign countries.
The situation is a peculiar outgrowth of the national bankSpeculative ing system and its defective methods of controlling and regulating
Use of
the extension of bank credit. This makes it important to conBank Funds
eider both the attitude of foreign systems toward this peculiar type
Due to
Defects In
of loan and the question what should be done in the United States
to eliminate the evils resulting from undue extension of such loans.
So much attention has been focused upon the use of bank funds
for speculative purposes and serious bank failures have so often
been brought about by the participation of banks in speculative operations that there is a general, if ill-founded, fear on the
part of many that any new legislation on banking is the outcome
of efforts to obtain even more control over the fluid funds of the
country that they may be used in speculation.

So far is this assumption from being correct, that it is an

unquestionable fact that the banks of the country, and especially
those in New York, would greatly prefer not to loan their funds
on call.
Not to
Lend on

We have seen how the call loan system comes into
If, in place of thus lending their funds, banks could

be assured of a regular and steady market in which they could
both dispose of such paper as they may need to realize upon,
and at other times invest such funds as they may have to spare,
they would seldom, if ever, make loans for purely speculative

The reason why they now make such loans in so large

a volume is, as indicated, that they are obliged under the national banking act to keep their so-called reserves within reach.



This they cannot be sure of doing if the funds are tied up in time
paper, because, in that event, they are dependent upon the other
banks of the country for accommodation, and these other banka
may or may not be willing to liquidate the paper in which the
bank funds have been thus invested. If the other banks were always willing to convert paper held by banks which needed fluid
funds into such funds, the banks would as soon have their resources
invested in time paper as in call loans, provided that the rate of interest was as good in the one case as in the other.
In the majority of cases the banks would find the rate of interest earned on commercial paper of the short period variety as
good as or better than that earned on call loans. It would be only L°an®




Paper as

m moments of stress in the discount market that the speculator
would stand ready to pay the exorbitant rates of interest that are
occasionally offered for short periods in order to get the bank ac- Loans
oommodation that is wanted. In other words, a discount market
would cause a distinct shift in the use of bank funds.
Of course this does not mean that the establishment of a discount market would abolish the call loan. There is no reason why it
should do that, and it would not be desirable to have such an end
accomplished. There are many cases in which call loans are not
made for speculative purposes. Frequently a man may have securities which he does not care to dispose of, but needing to realize
a small portion of their value, he may go to a bank and ask for accommodation, offering the securities as collateral. In such a case,
the bank may prefer to lend the money on demand both in order
that it may not be troubled by the necessity of renewing the loan
in case the borrower is not ready to pay back at the end of a stated
period, and in order to call for more security at any moment in
the event of a reduction in the market price of the collateral. This'
is a familiar type of trust company operation and will be likely to
continue indefinitely. Moreover, there will always be banks and
trust companies which devote themselves to financing trust company
operations. Within proper limits, this kind of business is entirely Harm
legitimate and is open to no criticism whatever. The harm coine3 p r o m i s e
when the commercial funds of the country are used in speculation of Bank
or in sustaining speculators' operations in the market. That simply sustain0
means that under those conditions it is not possible for the commer- Speculative
cial world to get back its reserves when it wants them and that con- M a r , < c t a
sequently business has to wait upon speculation. It is this part of
the call loan business now done that would be cut off, if the mar-




ket for call loans were displaced and a discount market substituted
in its stead as a field for its employment of commercial funds.


for Commercial
Loans Is

§7. The discount market to which reference has been made
has been fully described and explained in the preceding chapter.
At this point it is worth while to consider how the market would
work in relation to speculation. Evidently two things would
be required of such a market if it were to overcome the conditions
that are complained of under the present system of call loans:
( 1 ) It would have to afford a satisfactory and adequate field of employment for the funds which now go into call loans, providing an
equally available kind of resource; and ( 2 ) it would have to be of
a character that would prevent the employment of its own funds in
connection with speculation. That is to. say, it would have to supply the banks on the one hand with the advantage they now realize
from the call loan market, and on the other hand, it would have
to transact its own business without falling back upon call loans.
How far would these objects be accomplished? As for the
absorption of the bank funds which are now thrown on the market
at certain seasons and which afford the basis for call loans in speculative centers, it is clear that the whole question would be whether
there was a demand for these funds in other parts of the country
in connection with regular commercial operations there. If there
were not this demand, there would not be any paper originating in
commercial transactions into which the fluid funds could go. Now
such a demand does exist. The operation of moving the crops does
not occur simultaneously in all parts of the country, but the cropmoving seasons are seasons in the strict sense of the word and succeed one another at different dates. Moreover, it is a fact that
manufacturing is active at periods that do not correspond to the
growing seasons, while the same is true of importation in many
lines of goods.
While it is not possible to afford accurate statistics on such a
subject, it is an undoubtedly safe generalization from experience,
supported by the opinion of the most competent contemporary
business men and experts, that the country's industrial efforts
are so diversified as to furnish a very steady and constant supply
of commercial paper.

Assuming that to

be true, what


happen would be that when banks had met the needs of their own
customers fully during the growing season, they would transmit
their funds to be used in the purchase of commercial paper origin-



ating elsewhere, in the assurance that they would be able to get
their funds out of this paper on short notice if they desired. When
a season that called for abundant fluid funds again presented
itself, they would be able to dispose of the paper in the discount
market to other banks which found themselves with a plethora of
resources. Meanwhile, the banks which supplied the paper thus
purchased would be banks which were feeling the full pressure of
demand from local borrowers and which consequently had to get
their resources from a distance, doing so in the case supposed, by
selling their commercial paper and getting the proceeds.
§8. The discount market which has been described elsewhere
was to be furnished by the creation of a reserve association representing the combined banks of the country as stockholders. The
operation which we have just described might conceivably bo performed without the aid of such an association but practically would
be very much facilitated thereby. The Reserve Association would £ o w
simply act as an intermediary between the banks in different parts
of the country, receiving spare funds from some of them on deposit and accommodating others by rediscounting their paper. If
credits with the Reserve Association were to be counted as reserves of the individual banks, as is proposed, the result would be
still further to aid in making easy the movement of funds from
one part of the country to another. Outside of and around the
Reserve Association, however, there would ebb and flow a large
volume of business based upon acceptances by the several banks.
Such acceptances would be current all over the country, and inasmuch as they would bo always rediscountable at the Reserve Association offices, they would be a very desirable form of investment
for bank funds. Thus the Reserve Association would simply be the
core of a large body of business done between the banks for the purpose of taking up the spare funds of some and supplying the others
with these funds at times when they were hard pressed for the
means of making loans.
This same function is performed to some extent at the present time by the system of selling commercial paper through note
brokers and otherwise all over the country. But this system works
only in a partial and incomplete way, and does not supply the vital
element that is needed—a medium of unquestionably salable paper
in which the banks can invest with assurance that they can get
their funds out again. To supply this assurance in positive terms



S ale of




Views as
to Loans
on Stocks
and Bonds


there is necessary the presence of an institution dealing specifically
in such paper and obligated to take it upon request provided it conforms to definite requirements laid down by statute.
This brings us to the other side of the question—whether the
resources of the Reserve Association, and through it of the banks
of the country, could be kept out of the speculative market. On
tliis point, it ought to be sufficient to note that those who advocate the plan of a Reserve Association recognize the necessity of
thus safeguarding the funds of the Association and to insist upon
the necessity of keeping the resources of the Reserve Association
out of the stock market.
There may be question as to the stringency of such a provision.
Obviously the essential end of a Reserve Association like the one
which has been proposed is to promote the solvency and security of
the banks of the country. There may be times when such solvency
and security would be furthered by granting relief to the possessors
of sound collateral who were in need of loans. Others think that
even if this necessity be recognized, the desirability of keeping the
Reserve Association absolutely free from even the most remote
connection with the stock market is such as to make it worth while
to forbid in absolute terms the lending of funds upon collateral at
any time. This is a question of judgment. It is, at all events,
entirely possible by a rigid and exclusive limitation to put it out
of the question that any funds whatever should be loaned by the
Reserve Association on collateral security. This would mean that
the institution would not deal in call loans at all. It would, in
short, confine itself absolutely and wholly to the doing of a commercial business in the narrowest sense of the term, and its purchases of paper would be confined exclusively to the descriptions
of paper and the kinds of business laid down in its charter. The
question of seeing to it that the limitations of the charter were
lived up to would be nothing more than a simple problem in bank
inspection, the requirements of the law being easily enforced.
§9. What seems to be feared by some is that even though the
requirements of the law creating the Reserve Association and of
its charter, were technically lived up to, it might nevertheless be
possible to get the use of the funds of the Association for speculative purposes by some other means. The statement is continually
made that the "financial interests" of the country would seek to
control the policy of the institution in their own favor. Granting

that there was no dishonesty and that infractions of the law and
charter were not winked at, this could be done only by the presentation of paper of the kind specified to the institution. Only in that
way could it be induced to make loans, since in no other way could
it extend accommodation without doing violence to the terms on
which it was allowed to exist.
This raises the question:
Could speculators throw their
transactions into such a form as to get the use of funds of the Reserve Association without asking for call loans? It is to be noted,
first, that all business would have to be done with the Association
through the agency of an existing bank. The question therefore
is: Could a bank manage to get the funds of the Reserve Association by some transaction which did not involve a collateral loan Possibllland thus place them at the disposal of speculators?
It is, of course, clear that a bank might have in its portfolio
a certain amount of live commercial paper and a certain number
of loans made on collateral security. Now suppose that it desired to
enlarge or extend its loans on collateral. It could take its live paper
to the Reserve Association, get it rediscounted, and then use the
proceeds in making more call loans on stocks. In that case all that
would have happened would have been that the Reserve Association, representing the banks of the system, had taken the live part
of the assets of this bank and had paid for them. There would
be no result except that the bank thus disposing of its live commercial paper would speedily put itself into a position where it would
have to go out of business. Customers of the commercial and mercantile kind would probably steer clear of it, while it would be unable to get further accommodation from the Reserve Association,
inasmuch as it would thus be deprived of the kind of paper upon
the strength of which it could provide itself with material for demanding rediscounts. In this case the result of the operations of
the bank which sought to extend further accommodation to speculators would promptly be to cut it off from the commercial banking
community, and thereby to eliminate the danger that the funds of
the community would become more and more involved in supporting the stock market as they now are. The Reserve Association under these conditions would directly act as an agency for
limiting the stock market phases of present-day banking.
§10. The banks, however, would be their own protectors. It
is not their interest to allow themselves to become involved in the





stock market, and at present it is only a very small percentage of
banks that do actually become thus involved. When they do, it is
necessary under our system to take care of them and prevent them
from dragging down other banks into disaster. Under the proposed
system a sharp line would be drawn between banks engaged in stock
market operations and others. The former could not expect any
assistance from the latter on the strength of the danger they offered
to the commercial community. They would have to take the risk
of their own operations themselves. In the event of danger, they
Themselves could expect aid only from one another and from those banks
which, although not directly involved, deemed it wise for reasons
of their own to come to the aid of the institutions or corporations
which had become entangled in stock market transactions. That
there would always be some such banks there is no reason to doubt.
The operations of the Reserve Association would tend simply toward the segregation of the strictly commercial banks of the community which would be federated together for their own protection
through the working of the Reserve Association.
Even if there were 110 restriction upon the operation of the
Reserve Association, so that it could lend on stock market security
if it desired, it is far from probable that the banks controlling it
would permit any such use of its funds. United by a common interest, and looking to the Reserve Association as the source of relief
for themselves, in case of necessity, they would recognize that every
such loan made on stock market collateral would constitute a reWhy Banks
duction of the loaning power of the Association upon other securWould
Guard Asity ; that is to say that it would constitute a direct reduction in the
amount of accommodation they themselves could get. The only
possible case in which it could be assumed that such transactions
were likely to occur would be seen in an event where enough banks
had become involved in stock market operations to influence the
Reserve Association, against the judgment of its other members, to
assist them out of their difficulties. No such case would ever occur for the reason that the vast majority of the banks of the country would not have funds tied up in the stock market or loaned
on collateral. Self interest would prevent them from assenting to
any such proposal. It may be said that in the past self-interest has
worked in exactly the opposite direction. In periods of difficulty,
clearing-house banks have united, sometimes, for the sake of
supporting the very institutions which had fallen into difficulty
by financing speculative transactions. That is true; but the case



would be quite different with a Reserve Association. In times
past, the banks have aided those of their number which had become involved in speculation, because the failure of these banks
would involve an attack upon their own solvency which they would
have no means of resisting. An entirely different situation would
exist if they could go to a strong central association for all the rediscounts they needed, provided they were equipped with the right
kind of paper.
There is no fear with reference to the working of a Reserve
Association that may be more readily or certainly dismissed than
the dread that the funds of the banks would, through such an association, be devoted to stock market speculation, or financial promo- Fears Not
tion schemes. Not onlv is the danger one that is perfectly easy W* 11 .
to guard against by law, but, as has been shown, the whole purpose
and working of the association would be to destroy the conditions
which now operate to produce the danger contemplated.



Vere First3

W h y National Bank Notes Were First Issued—2. Foreign Systems
of Note Issue—3. Motives for Note Issues—4.
Working of National System—*5. An Inelastic Currency System and Its Effects—
6. Panic Conditions and "Emergency Currency"—7. Actual Note
Issues—8. Relation of Notes to Bonds—9. Notes Limited by Cost
of Bonds—10. Notes Not Quickly Obtained—11. Criticism of Conditions.

§1. One of the features of the national banking system which
has been most widely subject to criticism is the method it provides for the issue of bank notes. A review of the history of the
national banking system shows that the present method of securtiie n ° t e s WaS adoPtecI a s a

direct outgrowth of civil war conditions which had demanded the use of some method for assisting
the sale of national bonds, and at the same time of furnishing a uniform national currency to take the place of the widely divergent,
and often unsound, state bank notes. In consequence, the national
banking act provided, as one of its salient features, for the issue of
notes to be protected by deposits of United States bonds. These
notes were to be supplied by the government Treasury as soon as
the banks had handed over to the Treasury in trust a sum in bonds
equal at least to a specified percentage of the capital of the bank
itself. The turning over of the bonds was thus compulsory up to
the specified percentage of capital (which differed as the size of
the banks varied), while it was voluntary beyond that point and up
to an amount equal to the face of the bank's capital. The banks,
however, could not obtain an amount of notes more than equal
to 90 per cent of the sum of bonds which they deposited. This
therefore implied that they could not issue notes in excess of 90
per cent of their capitalization. The latter provision was subsequently altered (Act of March 14, 1900), and to-day national banks
can take out notes equal in amount to the face of the bonds they




deposit, such bonds not exceeding in par value the capitalization of
the depositing bank. This therefore makes a rigid limitation upon
the issues of notes, but at the same time, presumably protects the
note holder against loss through the failure of banks.
§2. A glance over the systems of note issue in vogue in foreign countries shows none where the plan followed in the United
States is pursued. Japan, when preparing to introduce western Foreign
civilization, adopted our note-issue method, but discarded it at about ^ { J q ™
the same time that she gave up the obsolete type of battleship, issue
Other countries have never seriously considered anything of the
sort. Their systems are cither those in which the notes are issued
on the same basis as that on which bank credits are created, being
subject to no restriction, or else they are protected by some special
requirements as to the character of the assets behind the notes, or
occasionally through the establishment of a guaranty fund contributed by all the banks, or in some similar manner.
The national banking system stands entirely alone in respect
to its methods of providing for note issue. Inasmuch as it does
thus stand alone, conclusions with respect to the working of the
system of note issue provided by it cannot be compared with parallel
inferences based upon the experience of foreign countries, but must
rest upon their own foundation. In the main the situation under
the national banking system has, however, been clear and easy to
trace, and there need be no doubt about the principal defects and
merits of its note issue system.
The chief field of discussion is opened when the question is
raised whether such defects as there are in the system of note
issue are responsible for the shortcomings of the national banking
system as a whole, or whether they are to be regarded as merely an
element in a general problem. It is the present view that the latter
is the case. Fundamentally, there is no theoretical distinction be- N o t f i |gflu
tween the bank note and the credit deposit. A borrower at a bank One
secures a loan or discount. Then the question in what form the l='re£ture


funds are to be supplied must be met He may arrange to get them
either in the shape of an issue of notes or in that of a book account.
Which he will ask for depends entirely upon the character of the
means of payment which he desires to use, and there is no reason
to suppose that the effect upon the bank due to the issue of bank
notes will be different from that arising from the granting of a
deposit credit. In either case the action of the bank creates a de-

or Genera

Notes and

For Note


mand liability against which it must keep a reserve, and for which
it must provide in other ways.
While this is the case in theory, there are practical differences
of detail between the working of loans made through the issue of
notes and those made through the granting of credit deposits. These
differences are due primarily to the greater or less length of time
for which the notes or deposits are kept outstanding without being
cancelled. They are also due to the differences, so far as any exist,
between the habits and practiccs of those who prefer notes and of
those who prefer deposit accounts. It has come about that the
bank note is more largely used in the rural districts, while the deposit account is more largely used in the cities. The note-holder
in ordinary times is inclined to hold his note longer without asking
for redemption or requiring any transfer on the books of the bank
than is the depositor. These differences in practice give rise to a
necessity for different classes of safeguards and different methods
of protecting the various kinds of liability.
§3. It is clear that the motive governing note issues is the same
as the motive governing deposit credits. This motive in either case
is simply the desire to make a profit. The banker wishes to grant
accommodation upon such security as may be offered to him, provided he considers this security sufficiently liquid and adequately
protective, so that he can afford to make the loan. On the other
hand, the borrower wishes to get his loan in order that he may
use it in meeting his obligations and presumably in earning a
profit. Anything that is done, therefore, to diminish the motive
which leads to the issue of notes will alter the conditions of their
In considering the bond deposit system, the important question
is whether this system has tended to alter the circumstances under
which the notes get out into circulation and are returned to the
banks for redemption. It is evident that unless the purchase of
the bonds results in bringing to the bank as great a profit as that
which it could get without them, it will prefer not to issue the notes
but to employ its funds in sustaining loans that take the form of
deposit credits. Likewise if the use of the bonds results in bringing to the bank a greater profit than it could otherwise get, it will
seek to force notes out into circulation as long as it can, since it
will prefer to make its loans in that form rather than that of deposit credit. Conversely if the note-holder finds that notes are

more expensive for his use than other forms of bank accommodation, he will, where possible, take his loans in the cheaper form.
Moreover, wherever he is assured, through bond deposit requirements, that the notes are guaranteed by the government, practically speaking, he will be much less desirous of demanding their
redemption than he otherwise would be.
§4. In the national system all these factors have been seen
in operation. Practically, it is not true that banks are in the habit
of making a distinction to borrowers between loans that are granted
through the issue of notes, and those that are granted through thè
establishment of credit deposits. The straightforward banker will
treat his customers alike. But in those parts of the country where
notes are predominantly called for, banks charge a higher rate of Working of
interest, while in those where the credit deposit is used, they are s y * ^ 1
able to grant accommodations more cheaply. Again under the
national system the tendency has been at times to curtail note
issues to an unreasonable degree because the bonds were very costly.
During the later years before the bonds issued to meet the cost of
the civil war were refunded, and while the securities were still
yielding five and six per cent, a very high premium was paid in the
market for bonds. Inasmuch as the banks could not get any notes
corresponding to the amount of the premium, the difference between a sum equal to i)0 per cent of the face value of the bonds
and the actual market price represented funds tied up and unproductive. By spending, say, $140 for a six per cent bond of face
value of $100, the banks could get only $00 of notes. There was
therefore a strong tendency toward contraction. In some recent
years when money has been abnormally "easy," and when, therefore, there was little or no inducement to the use of bank resources
in a thorough way for the purpose of maintaining as large a volume
of commercial discounts as was possible, there has been a tendency for banks to make little or no effort to draw in their out- | n f l u e n c c
standing issues. They have always been able to curtail when thev o f t h c
chose under the provision of law which allowed them to deposit Price of
lawful money with the Treasury to an amount equal to the sum B o n d s
they desired to withdraw, thus placing upon the Treasury the
burden of redemption to that extent and relieving themselves of an
equal amount of future responsibility. When they had no urgent
need for their funds in other directions, they have not practiced
this method of curtailing circulation but have allowed notes to re-



main outstanding as long as holders chose to keep them out. The
latter, on the other hand, have not been eager to secure redemptions, but have left it to the banks themselves to present one another's notes for that purpose. There has been very little real
activity of redemption, the banks seldom presenting notes direct
to one another, and only occasionally sending them to the Treasury for conversion into legal tender money. By this roundabout
method of redemption, it has been brought to pass that the average
life of the bank note under the national system is on the average
some two years, as against the 30 days which is the average life
of the Scotch bank note under the active system of redemption
applied to their issues.



§5. This is what is called an inelastic currency—that is to
say, one which neither expands nor contracts with direct refere n c e t o t l i e i n c r easing and decreasing needs of business. The national bank currency has been enlarged in those years and at those
t i m e s w h e n t , i e r e w a s a sudden urgent demand for notes.
been expanded on those occasions, it has been hard to force the notes
in again. They have tended to remain in circulation, often in excessive amounts. Being thus a semi-permanent part of the currency
system, they have tended to displace gold and have undoubtedly
occupied a place which would otherwise have been filled by gold
or its representatives. In this way, the bank notes have practically
operated to prevent the banks from realizing any advantage through
the exercise of the note-issue function. They have remained outstanding, in amounts which fluctuated but little and which were
frequently near the upper permitted limit of the volume of notes
that any given bank could issue.
When times of very urgent stress have come, the banks have
not been able to meet their customers' wishes by taking out more
notes, since in many instances they already had outstanding all
that they could successfully care for. The result has been that they
could get notes under such conditions only by borrowing them from
other banks which had not fully exercised the note-issuing power.
Frequently the Treasury Department has found its general fund
clogged with bank notes to such an extent as to render its available
gold resources dangerously small, pending the time that it could
send the notes home for redemption. In those cases where the
notes in the general fund were issues against which lawful money
had already been deposited but which had not actually been re-



deemed, the case was even worse. Altogether the bond deposit system, by making the currency inelastic, has tended to prevent the
extension of credits in this form when they were wanted.
§6. Much has been made of the failure of the national bank
notes to expand in times of panic and of the fact that under such P a n , c
conditions the lack of an "emergency currency" rendered it neces- and
° 8
eary to resort to the issue of clearing-house certificates in order to currency"C>
supply the place which should have been taken by bank notes under
a properly organized system. As will be seen at a later point, this
is a misconception of the problem which offers itself at a time of
bank panic, and the difficulties of such a period cannot be met by
merely issuing notes, because the notes are liabilities with banks
just as are their deposits.
It is true that at times of panic the defects of the system have
been more obvious than at other times, because on such occasions
there has frequently been a tendency to hoard money and thereby
a shortage of currency has been produced which led to a demand
for bank notes to fill the gap. This is a condition which has no
necessary connection with the issue of notes as a means of relief
from panic. It does, however, present a condition in which very
useful service can be done by the banks, if they are in position to
supply the convenience of the public by furnishing a form of currency to fill the void occasioned by the withdrawal of lawful money
through unreasonable hoarding. A serious criticism has therefore p an | Cg
legitimately been made upon the national banking system because Emphasize
of its incapacity to perform the primary purpose of a note-issue
system—that of aiding the public in the transaction of its neces- system
sary daily business.
It is probable that the evils experienced from this unsatisfactory bank currency in periods of panic are not nearly as great aa
those which result from the unsatisfactory working of the system
year in and year out. Nor would the evils of panic periods have
been B serious, had the gold stock not been partially displaced by
the presence of a body of unredeemed and inelastic bank notes in
the currency system of the country. With this outline of the conditions generally produced in the national system by the retention
of a method of note issue which was the product of civil war financiering, we may now pass to a discussion of the details which have
surrounded the national bank currency in actual practice.




The actual note issues that have been taken out and re-

deemed by the combined banks of the United States during the years
Note Issues
Lack of

since 1900 are reviewed in the following table :
•Since the beginning of the system.



The figures indicate primarily the extreme slowness of redemptions under the national system. Although there has been a steady
upward tendency in the amount of notes, resulting sometimes in
inflation, the conditions of note issue have not been such as to produce^ any genuine elasticity in the currency. By elasticity, as has
already been seen, is meant the changing of the amount of notes in
circulation from time to time to correspond with the changing demands of business. If the currency of the United States were
elastic, there would be what is called a seasonal variation in its
amount. It would increase with the growth of demand in the spring
and autumn and would decrease as this demand fell off.
How a truly elastic currency expands and contracts may be
seen by comparing the figures showing changes in the note issues
Comparison 0 f the United States with corresponding figures for the banking
system of Canada. In the following table is reviewed the note issue
situation in the Dominion during some recent years:
TS?, 11
QU; 1

47 421977



Ke c M b * r
em e

e«» 1QS * 777




August . . . . .

5 £'2?I'i$3



A prii


With this should be contrasted the note issues of the national
banks by months during the same period:


March ..

Bank Notes






















Bank Notes
3.1 S.984,1 S3



Bank Notes



Bank Notes









From the showing thus made it is clear that a very important
distinction is to be recognize'd between the course followed by
national banks of the United States and those of Canada. Thid
difference is found in what is called the seasonal variation.
countries whose agricultural and industrial systems are organized
Do Not
Follow the
as are those of the United States and Canada, the demand for note
Demands of
currency varies a good deal with the season of the year. In the
spring and autumn, there are ordinarily periods of largely increased
demand for currency which should be met by enlarged note issues
followed by corresponding shrinkage when the demand for the
notes is past. In every country with an elastic bank currency, this
kind of seasonal variation or fluctuation occurs, the notes moving



in regular waves with high and low periods at corresponding seasons of the year. This is not the case in the United States, nor
can it be so where bonds arc used as a basis for the notes. Where
they are so used, the conditions which control note issue and the
amount kept outstanding are different from those which depend
purely upon the current condition of business and upon its demands for accommodation. This lack of relation will be universally
found wherever bank loans are taken in the form of notes.
§8. We have already noted the legal requirements which direct
that no bank shall take out notes without having bonds of the national government to an equal amount for deposit at Washington as security. This, in itself, at once limits the gross amount of note? Re I at lor.
of Notes
that can be issued to a sum equal to the gross total of bonds in to Bonos
existence. In practice, the amount which can be issued is much
more limited, since not all national bonds that have been sold by
the government are available for use by the banks in securing their
currency. Considerable quantities of tliein arc held by private individuals, or fiduciary concerns, as a means of investment. It has
been an increasing practice in providing for the investment of certain classes of trust funds to require that they be used in the purchase of government bonds. Thus the amount of bonds available
for use in protecting circulation is shrinking, and at times this
reduction in the available amount has proved serious.
Moreover, it has been the practice of the government under
the act of June 3, 18G-1, to require that government bonds to an
equal amount be deposited by the banks with the Treasury Department, whenever that department makes deposits of funds with
the national banks (as it is permitted to by the law).* In times
when a large Treasury surplus exists, the demand for bonds for this
purpose is often ffreat, and, in proportion as the bonds are thus
j •
.i t i•i
j. •
* n
taken up, the quantity available for use behind note-issues falls
off. The Treasury is likely to be the custodian of large surplus
revenues in periods of business prosperity when there is a strong
demand for accommodation at the banks and incidentally for currency. These are precisely the occasions when national bank note3
would probably increase if they were allowed to do so without artificial restriction. Yet these are also the occasions when the supply of bonds is limited by reason of their use as a protection for
public deposits.
• 15153 R. S.




Limited by
Supply of


After the panic of 1907, it was found that nearly all government bonds were deposited with the Treasury either behind notes
or to secure deposits of public funds, and Congress then relaxed
the requirements as to the kind of bonds to be held behind public
deposits so as to permit the substitution of other securities in place
of them. This, however, had already been done without express
warrant by Secretaries of the Treasury from time to time, in order
to release government bonds from behind public deposits that they
might be used as a basis for the issue of bank notes. The fact remains that an effective limitation upon the amount of notes issued
exists, and fhat this limitation has been important in the past and
might become so at any time in the future.
In February, 1911, Congress passed an act permitting, for
reasons which we shall consider elsewhere, the sale of new issues
of United States bonds without the circulation privilege. Thus
again the absolute limitation upon the amount of notes which can
be issued on the strength of bonds is emphasized.

Limited by
Cost of

§9. The maximum limitation upon the quantity of the notes
which could be issued in case of necessity is, however, unimportant
as compared with the limitation which is afforded by the cost of
the bonds and the other obstacles to their use as a basis f o r notes.
United States two per cent bonds which are now outstanding to the
extent of more than $730,000,000 constitute the principal class of
security used to protect bank notes.1 At present these bonds are
Belling at but little more than par, but there have been times (during 1902) when their value has risen as high as 108 or 109. In
the event of a severe shortage of currency they would probably rise
again to a considerable premium. 2
as folIow? 0nd8 ° n

deposit on

November 1, 1911» to secure circulation were

^ _
On Deposit
. „
- ^ ^
On Deposit to
to SeNational Bank Notes
Kinds of Bonds
Per Secure Nat'l cure Public of Each DenominaT I ^ . I ' i o o T
^I 1 *- ? a n k N o t c s - Deposits.
tion Outstanding.
343 ' 6 1S
U. S. Loan of 192o...
$ 22,854,300 $ 3,743,000 $
U . ^ L o a n of 1908-1918
18 199 380
4 199 300
T f p S
°i iS3S
593,006,600 15 478 900
ii* e l £ S a n i a °£ J22S
2,132 500
T I" SilXiSS' °5
'712 000
of 1961
12 5*6 000
Philippine Loans
.. .
4 717 000
35 996 000
Porto Rico Loans....
754 00ft
District ofofColumbia.
g^'ooo Fraction1 000
23 000
Philippine Railway...


State, City and Railr'd.Various
. t


14« 000 **


»«4.170,320 ,48.583,700
'Report of Secretary of the Treasury, 1911, p. 5.





Total... .5744,195,898



The three per cent bonds, even without the circulation privilege, command a premium of 2*4 per cent today, and such of the
issues bearing a higher rate of interest as are still in circulation
of course sell at an even higher rate. Whenever banks are obliged
to purchase bonds in order to secure issues of currency thereon,
they find the price of the bonds an important consideration. Under
existing law the maximum amount of notes which can be issued on
a bond of the par value of $1,000 is $1,000. Upon the sum which
has to be invested in a bond bearing a premium, there is therefore a
loss caused by locking up the premium. Thus, if the bond sells at
105, the bank which purchases it for deposit behind notes must
pay $105 in lawful money of some kind, and will get in return only
$100 of notes after it has deposited the bond with the Treasury.
Moreover, such a transaction involves the bank in the necessity of
investing at least $100 of its funds in a security which will yield
it but 2 per cent on par, and even less on the real investment.
The practice in many cases is, of course, that of borrowing the
bonds from those who own them, the owners in such cases being
willing to lend them for use in this way in return for a consideration. The point is interesting as a matter of technical practice, but
does not alter the real facts in the case. The amount which must
be paid for the use of the bonds by the banks which borrow them
is enough to put the institutions in as unfavorable a position as if
they had purchased the securities at the outset.
Supposing that the bank is able to lend the notes thus taken
out immediately, it will secure a return of but 2 per cent on $100
plus the going rate of interest—say 6 per cent—on the $100 of
notes. From this earning it will have to deduct the cost of maintaining an adequate reserve of suitable amount behind the notes
for their current redemption, the cost of depositing a 5 per cent
redemption fund with the Treasury (keeping it idle and unproductive so long as the money is there held), and the cost of engraving and printing the notes, as well as the pro rata share of the
expenses of operating the bank. Due to these conditions, banks
find little profit in note issue at the present time. An estimate
of the cost of note issue, ignoring the cost' of reserve, ia given as
follows by the Comptroller:



Profit on National Bank Circulation» Rated on a Deposit of $100,000 United States Consols of 1930, Loan of 1925 and Panama Canal
Loan, at the Average Net Price, Monthly, During the Year Ended October 31. 1910.Fanama Canal Loan of 1916-1936.*


Cost of

Interest on Circulatlon
Receipts. Tax.
Obtainable. Bonds.
6 Per Ct.

January $100,620
February 100,656
March . . 100,182
April . . . 100,687
June . . . . 100,687
August .. 100,905
September 101,000
October . 100,920






Expenses. Fund.







Profit on Circulation In Excess of
6 Per Cent
Interest on
on the
Cost of
Bonds at
6 Per Ct.
Amount. Per.Ct.



•Here treated sL maturing August 1, 1936.
1 The

act cutting off the circulation privilege from the 3 per cent Panama bonds was approved March 2, 1911, and was as follows:
• M Bo it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, That the
secretary of the treasury be, and he is hereby, authorized to insert In the bonds to be Issued by him under section thirty-nine of an
Act entitled 'An A c t to provide revenue, equalize duties and encourage the industries of the United States, and for other purposes/
approved August 5, 1909, a provision that such bonds shall not be receivable by the treasurer of the United States as security for the
issue of circulating noteB to national banks; and the bonds containing such provision shall not be receivable f o r that purpose."





i i





It should be understood, however, that in thus computing tho
cost of getting out the notes only a very narrow method has been
employed. Although the mode of computation of the profit on
notes followed is that adopted by the Comptroller of the Currency,
it remains true that this is not the way in which a banker should
compute the cost of the bond deposit system as determining the
amount of notes he could issue. The real cost to him of using his
funds for the purchase of bonds, and thus for the getting out of
the notes, is the amount of bank credit which he is obliged to forego by reason of the necessity he is under of getting out his notes
in this way. As is well known, a bank is obliged to hold a given
sum of reserve money as the basis for perhaps four or five times
that amount of bank credit. That is to say, an institution which
has $1,000 of gold can, if there is a demand for the funds, and if
borrowers draw nothing from their accounts, make loans at the
outside, to the extent of $1,000 or $5,000, giving the borrowers
credit for that amount on its books. If the $1,000 must be used
for the purpose of buying bonds upon which to base an issue of
notes, its reserve is weakened to that extent. Even though it be
released from the necessity of maintaining a reserve in the ordinary sense behind the notes, because of the fact that they are
so fully protected by bonds, it still has to forego the genuine
banking profit, which comes from the use of the money as a reserve basis to support loans of credit to customers. It is this which
must be regarded as the true test, therefore, of the cost of note

Power of
a Bank

§10. One further phase of the inadequacy of the national
bank circulation is seen in the extreme delay which is necessary in
order to get out bank notes. Under the old system of bank-note
issue, which prevailed prior to the passage of the Aldrich-Vrccs
land act (and which prevails to-day except in so far as special issue3
of notes have been provided for by that law), much time was re- Notes Not
quired to secure an issue of bank currency. It was necessary to
have an application for currency filed with the Comptroller, and
then to have the currency printed, dried, and sent back to the bank,
which in the meantime was obliged to get the bonds to deposit behind the new notes as security. This process requires at the narrowest computation 21 days, and where currency has to be shipped
to distant points a much longer period is requisite. It is clear,
then, that no speedy issue of notes can be hoped for even under


of Bank


the supposition that the banks which desire to take out the notes
have in their possession the bonds which are required for their
protection. On the contrary, it is certain that under the most favorable circumstances three or four weeks must elapse before the
notes can be issued.
The Aldrich-Vreeland law provided for the printing of $ 5 0 0 , 0 0 0 , 0 0 0 of emergency currency which is kept stored in Washington and could be issued without delay in the event of a call for it
by banks. Banks, however, are not willing to pay the tax which the
issue of this emergency currency necessitates and therefore they are
still condemned to the long delay involved in getting out notes under
the original note-issue provisions. Moreover, in most instances, the
bonds are not in possession of the banks at the time when they
want to take out the currency. They must buy them or, as is usually the case, must borrow them from others. If there is a shortage of bonds in the market this may cause a still longer delay.
The unfortunate eifects of the inelasticity of the national bank
currency are seen at their worst in times of panic and were probably never better exemplified than during the stringency of 1907
and the months succeeding it. Every effort was made during the
latter part of 1907 to secure an expansion of the currency. The
' i e ight
the c r ^ s c a m e
October. In November, the increase was more than $ 4 6 , 0 0 0 , 0 0 0 , while in December it was
more than $ 3 3 , 0 0 0 , 0 0 0 . This enlargement was brought about by
very severe effort, and while some of it was obtained in time to
grant a certain amount of relief from currency stringency, the bulk
of it did not get out into circulation until too late to do much
good. It would have been natural to expect that, because of this
condition of affairs, there would have been a rapid retirement of
such currency when the stringency wTas over. A t such times, there
is always a large shrinkage in commercial credits and the period
after the panic of 1907 was no exception. This is seen by the fact
that there was a decrease of 33 per cent in clearing-house exchanges
for March, 1908, as compared with March, 1907; while for the
first quarter of 1908 the clearing-house shrinkage was 28 per cent
as compared with the preceding year. But at this time, when commercial credits were shrinking, national bank notes continued very
redundant, actually growing by more than $8,000,000 during the
first months of 1908.
The increase in notes was largely due to the organization of
new banks and the issue of currency to institutions which had

applied for it, but had not obtained what tliey wanted during the
actual stringency. These tendencies to increase should have been
vastly more than offset by shrinkages due to the retirement of old
bank notes or notes issued during the panic; but there was no such
contraction. The currency continued upon an abnormal level for
a great while. The difficulty with the national bank currency has
been summed up by Mr. A. D. Noyes in the following manner:1
"The sum of the whole matter Is that under the existing system of
bank notes based upon government bonds, normal and authentic expansion and contraction of the currency, in response to needs of trade, ia
flatly impossible. The currcncy supply may be greatly enlarged in the
dull midsummer months and suddenly contracted when the active
autumn business season begins. It may increase rapidly at a time
when trade reaction has reduced to a minimum the necessities for even
the existing bank note supply, or it may be as rapidly rcduced when
large harvests, full employment of labor, and active hand-to-hand use
of currency, most need a larger circulating medium. That there Is no
remedy for this abnormal situation, except the substitution of some
other system for that which prescribes the United States Government
bond as a basis for bank note issues, every economist at all familiar
with the question agrees."

§11. The unsatisfactory character of the national bank-note
currency has been one of the few things about the system that have
been universally recognized and agreed to. There is hardly any Criticism
support for the present system of issuing the currency. Even those of
who look upon it as having been heretofore a measurably success- 0
ful experiment in note issue recognize that it is not possible to continue a system which would imply the existence of a national debt.
While of course there is no positive assurance as to the future history of the debt of the United States, it is a fact that very large
debt reductions have been made since the civil war, and that they
may be hoped for in the future. It is also true that on not a few occasions when the debt might have been curtailed, Treasury authorities have stayed their hands because of a desire not to limit the
basis of national bank currency in an undue degree. They have
therefore opposed the purchase of bonds at times when funds were
available for that purpose and might readily have been devoted to it.
Even if it were sure that the bonds would continue to exist in
substantial amount, it would also be true that the problems connected with note issue have been found to be decidedly more eeri1 History of
the National

Bank Currency, p. 20, National



R E T E N T I O N OF L O N G - S E C U R E I) I S S U E S

ous because of the operations on bonds growing out of the use of
such securities as trust investments and the like.

The problem of

government deposits in banks has further tended to enhance th*
difficulty since it has appeared that the depositing of public funds
upon a pledge of bonds exerted a strong constricting influence upon
the currency at precisely the periods when expansion was wanted
and vice versa.

For these reasons even those who have been willing

to accept theoretically the idea of bond security behind bank notes
have not been willing to accept a basis which implied dependence
upon government bonds under existing conditions.
This has raised the question whether it is not possible to retain a bond secured circulation by employing other classes of bonds
Use of
as security behind the notes. The question was answered by ConOther
gress tentatively in the Aldrich-Vreeland law, which, besides a proviGovernment
sion that notes might be issued under specified conditions by naBonds

tional currency associations, also contained a provision that notes
might be issued direct to banks by the Treasury Department, provided that the banks would deposit with the Treasury other bonds
of specified classes.

Of course it was seen that this greatly increased

the danger of issues of notes based upon bonds of an "outside"

These issues would necessarily tend to displace gold,

because they are not issued in response to business demand, but in
order to earn profits from the investment in bonds which backed
them, combined with the interest on the loans through which they
were forced into circulation.

Consequently the Aldrich-Vreeland

law provided for a heavy tax on such note issues and a like provision has been carried in nearly every suggestion for banking reform
that has been put forward within recent years.
It has beeu seen that the question of redemption—rapid and
Redemption of
to Safety

thorough—or of some other means of insuring the retirement of
the notes was a fundamental prerequisite if safety was to be in any
way ensured.

Consequently the proposal to retain the bond-secured

basis for the currency by allowing the substitution of other bonds
has received only a very qualified approval from those who were
friendly to the general ideas of the national banking system.
The question has been greatly broadened by the dedease in
the stress that competent students have been disposed to place upon
the note question, owing to the more extensive study of banking
problems that has been undertaken within recent years.

There has

been a tendency to consider the note-issue question as identical with



the question of other forms of bank credit and to endeavor to ascertain how such credit forms should be treated in order to secure
proper assurance of safety, as well as proper redemption, contraction and expansion of notes along with other means of extending
accommodation. Altogether the subject has lost the special character which it possessed as long as the national banking system was
regarded as satisfactory in other particulars.
The note issue problem has now become a part of the general
banking discussion. In popular talk about questions of currency
and banking in general, however, there continues to be a good deal
of over-emphasis upon the note question, and the fear is repeatedly
expressed that if the exercise of the note issue function is not restricted in some exceptional way, what is called "inflation" will
result. The problem of inflation is as serious in connection with
other forms of bank credit as it is with notes. It is worthy, therefore, to be considered in a separate chapter.



and Overexpansion
Used Synonymously

by the
of Banks

Fear of Inflation—2. How Inflation is Revealed and Produced—
3. Safeguards Regarding Investments and Redemption—4. Regarding Adequate Reserves—5. Limitation of Note Issues—6.
Tho National Reserve Association and Inflation—7. Fear That
the National Reserve Association Will Stimulate Inflation—8.
Inflation, Theoretically Imaginable, But Not Possible.

§1. In current discussions of banking, there is an almost
invariable expression of fear lest any particular plan that is proposed may lead to what is called "over-expansion." This term
is sometimes used interchangeably with the expression, "inflation."
The two are practically synonymous as employed in current argument on the subject of banking, and there is general agreement
that they constitute a serious menace to soundness in the management of any system which offers a field for them. I t is, therefore, considered a test of any system of banking to ascertain
whether it affords an undue opportunity for this expansion or
inflation. In former chapters reference has been made to inflation
in connection with note-currency, and it has been pointed out that
the proper protection of the credit-granting operation avoids the
danger of this over-expansion or inflation. I t is now, however,
necessary to explain in greater detail the methods by which such
inflation is to be guarded against.
§2. Inflation or over-expansion is ordinarily revealed in the
condition of banks. It exists in the case of an individual bank
when, through loans, discounts or other investments, it has created
against itself demand obligations in the form of book credits or
notes which it is unable easily and readily to liquidate as the need
for such liquidation appears. When such conditions are common
to the banks of an entire community or country, there exists local
or national inflation or over-expansion, a condition which is quite




certain to end in a crisis, or, at any rate, in prolonged business
In order clearly to reveal the manner in which such conditions may be, and usually are, brought about, we must distinguish two functions of commercial banks and note the means
available for performing them.
The most fundamental of these is their service as local, national and international bookkeepers in the current exchange of
all kinds of goods and products. For such exchanges time is required and credit is often wanted to bridge over these time gaps.
Thus, the farmer needs goods of various kinds during the period Commerof the growth of the crops, by the sale of which he must pay for
the goods; the manufacturer must buy raw materials, pay his workmen and meet various other expenses during the time required
for the manufacture of the goods, by the sale of which he must
ultimately pay these bills; the wholesaler must buy goods considerably in advance of the date of selling and receiving payment
for them; and the same may be said of the retailer and of every
link in our complicated chain of cooperative production.
In the last analysis this function of commercial banks resolves
itself into a process of bookkeeping by which the purchases and
sales between the people of a given community, between those of
different communities and between nations, are offset against each
other in the form of debits and credits. Promissory notes, time
bills of exchange, checks, drafts and bank notes, represent simply
different steps in this process of bookkeeping.
Another function of banks is their service as intermediaries
in the investment of capital. In this capacity they receivc people's
savings, which they credit as time deposits, and invest them directly
or indirectly in the farms, factories, railroads and other industrial
enterprises of the world, or in its homes, public buildings, wharves,
It should be carefully noted that these two functions differ
essentially and that a bank's means for performing them come
from different sources. In the one case it is balancing on its books
the current purchases and sales of its constituents; in the other,
it is balancing their savings against permanent investments. Difficulty arises in the form of inflation or over-expansion when the
latter business is confused with the former in such a manner that
the banks overlook the fact that they cannot safely put into per-

cist Banks



|^ u 0 c n ® d
fusion of


of Perfect
Arrangements and


manent investments more than the savings entrusted to them.
If they exchange their own demand obligations against investment
securities, there will be forthcoming no offsets, except the annual
profits from the enterprises in which the investments were made,
and it will take several years for such offsets to become complete.
Meantime, they will be called upon to liquidate the credits they
have granted and they will lack the necessary means.
In the performance of the function of balancing purchases
against sales, inflation can only arise when the exchange machinery
is not complete, or when it is out of order, or when the banks have
miscalculated, or failed to note the proportion established by the
habits of the community between the volume of transactions effected
by means of cash and those effected by means of bank devices.
In order that this balancing of purchases against sales may be
complete, clearing arrangements must be established between the
banks in all parts of the commercial world, which will work continuously and perfectly. T o the extent that these arrangements arc
incomplete, or fail to work, banks are certain to be called upon to
liquidate their demand obligations in money. The fact that not
all purchases and sales are represented on the books of the banks,
some being effected by means of money and credit supplied by
other agencies, also renders this process of bookkeeping incomplete
and subjects banks to demands for cash. It is at this point that the
necessty for cash reserves becomes apparent; and then it becomes
evident that a failure to maintain such reserves in proper volume
results in inflation.
§3. In order to protect the community against inflation or
over-expansion, therefore, safeguards must be devised to ( 1 ) prevent
banks from tying up more than their savings deposits and their
capital and surplus in investment securities and ( 2 ) to prevent their
maintenance of inadequate reserves. Some of the means to these
ends are direct and others are indirect in their operation.

of Loans
as Investment

The chief of the direct means is legislative regulation of the
proportion of a bank's resources that may be loaned on investment
securities and the enforcement of such laws by rigid systems of
inspection and supervision. In the past, such legislation has been
faulty and incomplete, partly because of the difficulty of setting
up a practicable standard for distinguishing between commercial
and investment securities, and partly, probably chiefly, because the
importance of this distinction has not been understood.


11 f
* >

As samples of the kind of legislation here under consideration
may be cited the provisions of our national bank act and of many
of our state banking acts prohibiting investments in real-estate and
prohibiting, or limiting, investments on real-estate security as collateral. In France and Germany the statutes regulative of the Illustration
Bank of France and the Imperial Bank, respectively, limit the imitations
bills which these banks may purchase to those which mature in
not more than ninety days and which are secured by at least two
names of solvent persons, and, in the ense of the former bank, by
an additional endorsement or by high-grade collateral. In the
case of the Imperial Bank, the requirement is also made that the
bank must hold enough of such bills to cover, together with its
cash, the entire amount of its note issue? and that the proportion
of cash must not be less than 3 3 % per cent.
In our legislation no direct attempt has been made to draw a
line between commercial and investment- paper; but the French and
German legislation aims to accomplish this end, the theory being
that the great bulk of short-time paper is commercial. The only A Possible
step beyond that taken bv the German and French legislators ^ f ^ ^
that could probably effectively be taken by legislative bodies is the
careful definition by statute of the two categories of paper and
the fixing of the proportion of eacli kind that a bank might accept
in accordance with the proportion between commercial and savings
deposits, adding to the latter the bank's capital and surplus funds.
The enforcement of such laws by inspection and supervision
is difficult and can only be successful when backed by sound judgment, good will and good business methods on the part of bank Enforceofficials. The organization of efficient credit departments in large
banks and personal investigation by loaning officers of the use to
be made of borrowed funds, backed by frequent consultation of upto-date balance sheets in «mailer banks, are essential.
Another direct means is the provision of as complete clearing
arrangements as possible. Check?, drafts and hank notes are documents essential to the complete posting of the books by which these
exchange processes are accomplished, and machinery must exist
for securing the speedy recording on the books of banks of the
debit and credit operations they represent.
For the clearing of checks and drafts elaborate machinery has
been developed all over the world, mostly by the voluntary action
of banks themselves. In this country clearing houses do the work


of Checks
and Drafts


for the banks of the cities in which they are located, and, where
clearing houses do not exist, daily clearings are effected by the
direct exchange of checks between the banks themselves. Between
different localities and between this and other countries, the work
of clearing is accomplished by the correspondence system. In
Europe the central banks with their branches play an important
role, especially in inter-municipal and international clearing.

The clearing of bank notes is a more difficult problem. Being in form suitable for use as hand-to-hand currency, the public
Clearing of does not have the same motive for returning them to the banks
Bank Notes as they do in the case of checks and drafts, and, when they are
presented at any other than the bank of issue, the receiving bank
does not always have a strong motive for presenting them for redemption to the issuing bank. Especially is this the case where
the issue privilege is monopolized by a single bank and where
other banks are permitted to count such notes as a part of theii
Regarding this matter of the motive back of the presentation
of notes for redemption, it should not be forgotten, however, that,
so far as the public is concerned, in the United States at least,
all forms of currency are constantly passing in and out of the
banks. It is not the custom in this country for people to hoard
Motives for
money or to carry large amounts of it around on their persons.
the Presentation of The desire of most people to avoid the danger of loss and theft, or
Notes for
Redemption to receive the interest evervwhere paid on savings deposits, is
sufficient in most cases to bring the money back to the banks in a
comparatively short period of time.
The case is somewhat different as regards the motive of a
receiving bank in presenting for redemption the notes of
another bank. Here the question is one primarily of the profitableness and the limitations on issues. If a bank has power to
issue notes freely and finds it profitable and easy so to do, it will
return for redemption the notes of other institutions and use its
own in their place. The sluggishness of redemption under our
national banking system is due chiefly to the very small profits
that are obtainable through the issue of notes, to the difficulty of
procuring bonds to deposit as security, and to the time and expense involved in our machinery of redemption. In the early
history of New England, when her banks were issuing notes against
commercial assets and the Suffolk system supplied easily accessible



and inexpensive machinery for redemption, bank notes were redeemed on the average about ten times a year.
"When all note issues proceed from a single institution the redemption of notes is primarily a problem of reserves and of the
exchange of one form of money for another. If the non-issuing Redemption
banks are obliged to keep currencv locked up in their vaults be- sues Arc
cause they are compelled so to do by law, or because of the difficulty Centralized
of obtaining it in time of need, bank notes are as likely to be kept
under lock and key as any other form of currency, and so redemption will be sluggish. If, on the other hand, banks can easily and
quickly secure currency by rediscounts, they will find it profitable
to hold as "secondary" reserves interest-bearing rodiscoimtable
paper rather than currency, and the latter, including bank notes,
will flow into the vaults of the reserve-holding institution or institutions.
Another motive for redemption under a system of issue by a
single institution is the desire to exchange one kind of currency or
money for another. In Europe gold is commonly obtained for ex- Desire to
port or other purposes by the presentation of bank notes for redemption. This is an almost universal practice in England and of Currency
it is common in Germany and France. It is sometimes interfered f o r A n o t h e r
with in Germany by the inauguration of a restrictive policy by the
Imperial Bank, and in France by the legal privilege enjoyed by the
Bank of France of redeeming its notes in silver five franc pieces.
The desire to exchange bank notes for other forms of currency
is promoted by the issue of the notes in denominations too large
for convenient use by the general public. In that case banks cannot use them as till money except in small quantities, and speedily
send them in to the reserve-holding institution for credit or for
exchange for currency of lower denominations.
§4. Other direct methods of guarding against inflation pertain
to the maintenance of adequate reserves. In most countries this
matter is left to the voluntary action of the banks themselves, the Reserves as
theory apparently being that their self-interest is a sufficiently a Check
strong motive to this end and that they alone have the knowl- j^fa'tlon
edge and means necessary for a proper solution of the problem.
In the United States wo have attempted to secure this end by laws
which fix a minimum below which banks are not permitted to
allow their reserves to fall and proscribe the elements of which
they must consist.



In other portions of this book the evils and disadvantages
of our system have been portrayed. Suffice it here to note what
constitutes adequate reserves and what are the means available for
their maintenance.


of Reserve

Reserves are adequate when they enable banks to meet all the
demands for cash normally made upon them and likely to be made
upon them on extraordinary occasions. The demands for cash
normally and regularly made upon them are determined by the
habits of their communities relative to the use of hand-to-hand
money as distinguished from checks; and these habits are the result partly of tradition and long continued use and partly of the
fact that for many purposes hand-to-hand money is more convenient than checks. These cash demands come from banks' regulai
customers in the form of the presentation of checks for encashment,
and in the form of demands from other banks for the settlement ol
balances either through clearing-houses or by the direct presentation of claims. Their magnitude and fluctuations are made known
to the banks by experience. There are, of course, irregularities
which cannot be foreseen and which cannot be exactly calculated,
but these usually form but a small percentage of the total.
Extraordinary demands usually arise from the shattering of
credit, from unforeseen changes in the volume of business transacted, from unusual events, such as wars, the payment of indemnities, etc., and in the United States also from the operations of our
independent treasury system.
Demands for cash, whether ordinary or extraordinary, must
be met by the gold and silver coin already in circulation, by the
new supplies resulting from the output of gold and silver mines and
brought to or purchased by mints, by notes supplied by governments, and by bank notes. In the ease of the Uniied States, some
of these elements, especially government notes and silver coin, are
limited in various ways by legislation, and losses or gains of specie
may result from fluctuations in the balance between the imports
and the exports of gold or other forms of money. These funds
pass into the banks by the ordinary process of deposit, and, as has
already been noted, the greater part of the supply is in an almost
constant state of circulation through them.
There is no inherent difficulty in the banks securing an
adequate supply of hand-to-hand money, provided the bank note
element is based on commercial assets. In that case, if the re-



demption system hereinbefore discussed is complete and works
perfectly, it will expand and contract automatically so as to render
the entire volume of currency just sufficient to meet the needs.
Difficulties in the maintenance of adequate reserves arise when Maintaining
such an elastic element is lacking, or when the clearing and re-


demption systems are inadequaie, or when a country curtails its
gold supply by a system of fiduciary currency which is purely local
in its character and which is so large in volume as to leave too
small a place for the local circulation of gold coin.

In this hitter

event the banks may find difficulty in meeting their foreign balances,
which, as a rule, are payable only in the yellow metal.
§5. As indirect methods of preventing inflation, may be mentioned various plans for the limitation of note issues.

In the

earl}' history of state banking in this country previous to the Civil
War, especially in New England, laws were enacted limiting the
amount of notes that might be issued to some percentage of the Limitation
capital, as, for example,





The English Bank

of Note

Act of 1344, usually known as the Peel Act, fixed an absolute limit
beyond which the bank note element in the currency might not be
expanded, by prescribing that after a date mentioned in the act
private and joint stock bunks might not under any circumstances
increase their issues? and the "Rank nf England might not increase
its issues? beyond £1-1,000,OnO, except in exchange for gold, pound
for pound, or in substitution for the lapsed issues of other banks.
In this latter case it could increase its issues by two-thirds of
the amount lapsed, provided the Government, by resolution, should
give it permission so to do.

French law sets a limit beyond which

the issues of the Bank of France may not go, but in the past it has
raised the limit several times to meet the growing needs of the
country for this kind of currency.

Our National Banking Act

limits the issues of national banks to the amount of the paid-up
This kind of legislation has usually been inspired by the hope
and the expectation that the limitation of note issues would correspondingly limit the activities of banks and thus keep them
within safe bounds.

Sometimes also, especially in the case of the

Peel Act, other theories and motives have been back of the legislation.

I t should be noted, however, that the mere limitation of the


D f



ofC Note ° R



amount of business a bank may do does not necessarily prevent
inflation, because it does not insure its choice of the right kind
of securities as investments, adequate redemption and clearing
arrangements, or adequate reserves. Furthermore, the limitation
of note issues only leaves the doors wide open for expansion through
checking accounts and does not, therefore, nowadays seriously restrict a bank's operations. When the earliest of this kind of legislation was passed, however, deposit banking was in its infancy and
limitations on note issues were much more effective than they are
Another method of restriction which has been favored by some •
reasoners and has found a place in certain banking systems is the
imposition of a tax upon note issues beyond a certain point. Occasionally this tax is made progressive, rising as the amount of the
notes increases and falling as it decreases, until at a designated
is c u t oii
entirely. The purpose of such a tax is to check
the issue of notes and the corresponding granting of credits by
making it unprofitable, or, in case the rate of interest is high
enough to yield a profit in spite of the tax, to insure the speedy
retirement of the notes and the contraction of the credits granted
when the rate of interest falls.
The tax idea has been adopted in the German banking system, which is probably its best known exemplification. In that
country notes form the usual medium of exchange. It has, however, frequently been urged elsewhere and has been a favorite and
staple recommendation in the United States as a means of limiting
the over-issues of bank notes, even though checks drawn on deposits form the usual medium of exchange. In the Aldrich-VreeJand law, whose provisions have elsewhere been described, the tax
plan is applied for the purpose of restricting the issue of "emergency currency" therein provided for. The terms of the original
plan were so extreme in this regard that they provided for a tax
running as high as 10 per cent per annum if the notes remained
outstanding long enough. This, it is supposed, would tend to reduce the volume of the currency in circulation. By using the tax
m conjunction with a reserve requirement, as is done in the German system, it is assumed that an even stronger safeguard is obtained. Thus, if the notes exceed a certain multiple of the amount
of reserve on hand, they are to be subjected to a tax which increases as the relation to the reserve increases. In this event, the
bank could cut of! the tax in either of two ways—by retiring its



circulation or by building up its reserve so as to make it a larger
percentage of the outstanding notes. The Aldrich-Vrceland law
adopts the cruder plan of simply applying the tax in proportion
to the time the notes stay out, without any reference to the question whether they are backed by an increasing amount of coin or
§6. In the plans for a National Reserve Association, suggested by the Monetary Commission, several provisions have a bearing on this matter of inflation or over-expansion. In the first place,
it restricts the discounts of the proposed Association to commercial
paper and thus strikes at the very heart of the problem. Its book
credits are not to be protected by any kind of investment paper,
and only that portion of its notes are to be so secured which
are to be substituted for the present circulation of our national
banks; and this condition will last only so long as the Government
bonds, acquired in the process, are retained by the Association. As
fast as it disposes of these bonds to the investing public, it will
to some extent substitute commercial paper for them as a basis for
its issues.
Other provisions bearing upon this matter are those which constitute this Association the reserve-holding institution for the entire country. If the banks of the country generally take advantage
of the privileges granted in these provisions, they will cease to
hold more currency in their vaults than current demands upon
them necessitate; and the currency of the country, including its
bank notes, will circulate through the Reserve Association in the
manner above indicated. Redemption of notes will thus be automatic and as regular and frequent as it is in France or Germany.
The only danger here lies in the possibility of hoarding by the
people or by the banks. In that case, bank notes are as likely to be
hoarded as any other form of currency, unless their denominations
are so large as to render their use unlikely by people who are
apt to hoard and so large as to supply to banks a motive for sending them in for exchange for other forms of money or for credit.
Experience, therefore, may suggest the advisability of issuing most
of the notes of the Association in relatively large denominations.
Regarding the matter of hoarding, it may be said that there
is nothing in the plan of the Association, or in its realization, to
encourage such a practice. On the contrary, it offers many inducements of the opposite kind. It will increase the safety of banking



centra I izatlon of


Po6S |.
bility of



operations generally and thus the willingness of people to entrust
their funds to banks, and it will -remove from the latter the necessity of keeping currency locked up in their vaults as reserves and
furnish them inducements to turn over to the Association their
surplus supplies. If experience should show that these inducements need to be made stronger, the Association might agree to
pay the expenses of return shipments of its notes.

for Withdrawing

The Tax
on Circulation


It should be noted that the proposed National Reserve Association will not have the same motive for keeping its notes out>
standing that a bank would have which is managed primarily for
the earning of dividends for its stockholders. Restricted as it would
be in the amount of dividends it can declare, its primary motive
would be to keep the banking system of the country safe and strong
and our currency in proper relation to our needs. In the matter
of the return of its notes for redemption after the need for them
had passed, its interests would be identical with those of the public.
The plan of the Monetary Commission, however, does not rely
upon the self-interest of the Association as an inducement to seek
the return of its notes. It provides an additional motive in the
form of a progressive tax on the notes when they exceed $900,000,000, a sum less than $200,000,000 in excess of the amount of
National bank notes now outstanding and probably no larger, if it
is as large, as the country will need in the . crop-moving season.
A further check against excessive issues is provided in the
requirement that a reserve of 50 per cent of the amount of deposits and notes must be carried in legal tender money, or in lieu
of such reserves, a heavy tax paid. Moreover, no more notes can
be issued when the gold in the reserves falls below 3 3 % per cent of
the note-issues. Hence, at that point, borrowing banks demanding
notes would be refused loans.
A further check against inflation is provided in the increased
facilities for clearing offered by the Reserve Association. The local
associations are to be permitted to assume clearing functions, and,
to the extent "that they do, the time required for the collection of
checks will be shortened and their return to the banks upon which
they are drawn correspondingly hastened. Furthermore, the central office and the* branches of the Reserve Association will constitute additional links in the national bookkeeping process, and
will offset against each other on their books many of the mutual
claims of banks which now remain unsettled for longer or shorter



periods of time, and, when they are settled, occasion a considerable
demand for cash.
In this connection should be considered other provisions which
supply the Association with the means of replenishing its reserves,
if the streams of money flowing into its vaults from regular
sources should at any time be inadequate. These are the provisions
which authorize the Association to deal in foreign bills of exchange
purchased from other bankers or on foreign markets and to regulate
its rate of discount according to its needs.
Both these provisions will enable the Association to bring gold
into its vaults from foreign sources. When its reserves are large,
it can purchase foreign bills, and it can sell them for gold when
its supply oi money is short. It will probably also be able to
attract gold by raising its rate of discount. This will certainly
be possible when the volume of bank acceptances becomes large and
a regular market for them is established. European bankers will
then invest in them, when the rates are higher than they are at
home, just as they now do in London bills.
Still another feature of the proposed plan for a National Reserve Association deserves mention in connection with this subject
of inflation, and that is the provision that it shall hold the deposits of the federal government. The operation of our independent
treasury system at the present time is a source of embarrassment
to banks because of the uncertainty of its drafts upon, and its contribution to, their reserves. By unexpectedly withdrawing reservefrom the banks, it leaves them less able to meet their demand liabilities in cash. It is thus a cause of inflation, and its abolition,
so far as concerns the holding of the treasury balances, will be a
safeguard against this evil.

Mean» of

Abolition of

Finally, and most important of all checks on over-expansion,
there is the increasing rate of discount which the National Reserve
Association would charge as its reserves decline. That is, any general tendency to apply to the National Reserve Association for loans
would directly increase its immediate liabilities in its deposit or
note items, and thus lower the percentage of cash reserves to these
liabilities. Automatically the rate of discount to borrowing banks Raising
should rise, thus making it more expensive to carry the loan. ^ . * c o u n t
Hence, there would be created a self-interest on the part of the Rate
borrower to pay off the loan. Moreover, no speculative accounts
created for carrying goods which show a tendency to rising prices
could endure the increasing rates of interest. The experience of


Brake on




Europe shows the influence of the rate of discount. In England,
where conditions of banking more nearly resemble our own, the increase in the rate at the Bank of England at once drives away applications for loans, except where absolutely needed. Then, when
the pressure for loans ceases, the rate of discount falls as a matter
of course. Here, then, is the one most effective brake which the
National Reserve Association would apply to prevent over-expansion. Taken in connection with the other preventives above mentioned there need be no fear of over-expansion, with ordinary intelligent management and courage. In recent proposals now before
Congress it is not left to the will of the management to decide when
the time has arrived to raise the rate. As soon as the reserves fall
below 50 per cent of the notes and deposits a progressive tax is imposed, which is intended to force the National Reserve Association
to reimburse itself by raising the rate to the borrower.
In addition to this provision, the loans to any one subscribing
bank should not exceed its capital; and none should make acceptances to exceed one-half its capital and surplus.

of Those

§7. In spite of those safeguards the fear has been expressed
that the National Reserve Association will promote or stimulate
inflation. Critics of the plan (of allowing the banks to count as
reserves notes or credits obtained from the Association by rediscounting their commercial paper) argue that this easy way of increasing reserves would lead to an enormous inflation of loan3.
National bank loans are now about six times as large as the reserves, and it is argued that any increase in the reserves would result in an increase in loans in the same ratio. Banks, when loaned
up to the limit, could rediscount commercial paper to the amount
of their capital, and could then pyramid more loans on the basis
of the notes or credits thus obtained from the Association. The
operation would be accelerated, it is argued, because the proposed
transfer to the Association of the greater part of the reserves now
held by the banks would enable the Association to expand its liabilities to from two to three times the amount of the cash so received.
The fear resulting from this argument is based upon the
failure to distinguish, on the one hand, between the possible and
the practicable expansion of loans; and, on the other, between the
kind of loan expansion which results in inflation and that which
does not so result. The above calculation measures the extent to

which the National Beserve Association might possibly increase
accommodations to the commerce of the country, but it is no measure of the extent to which it would be practicable to increase loans
under given conditions.
If the crops of the country and the output of our mines and
factories and the incomes and corresponding consumption power of
our people should increase in proper proportions to each other to
such an extent that the increased volume of exchanges would require for their execution the degree of expansion of loans and deposits indicated in the above calculations, .such expansion would
take place; and it would carry with it no inflation and be in no
sense dangerous, because in this increased volume of exchanges the
purchases and sales would offset each other on the hooks of the
banks just as readily and easily as would be the case in a smaller
volume of exchanges. It is not the magnitude of the number of
items in the debit and credit accounts of banks that is significant in
this connection, but the balance between the two, and that balance
may be just as readily struck when the number is large as when it
is small. For instance, loans based on cotton evidenced by warehouse receipts could be increased in the autumn to a sum equal to
the amount of the crop without resulting in expansion.
As has been shown in previous paragraphs, the striking of the
balance is the important thing, and to this end the primary consideration from the banking standpoint is the differentiation between
commercial and savings deposits and the fixing of the relation between the amount of commercial and investment paper purchased
in accordance with the proportion between their magnitudes, modified by the capital and surplus funds of the banks themselves.
But it may be asked, how can the banks be induced or compelled to observe such distinctions and to shape their practices
So far as supplying inducements is concerned,
the National Beserve Association will be a mighty force. Since
it will take commercial paper only and will create a national and
international market for it, the banks will be obliged to make the
distinction above mentioned and will have the strongest possible
motive for shaping the practices of their customers accordingly.
As an aid to this end they will be able to offer them the inducement of lower rates on such paper.
So far as compulsion is concerned, the necessity of constantly
liquidating the book credits banks create will be quite adequate.
If a bank makes the mistake of creating too great a volume of

and Commercial


That the
Notes Will


credits against investment securities, it will find itself speedily
checked up by adverse clearing-house balances and the presentation of checks for encashment, which demands it will find difficulty
in meeting, even through acccss to the National lteserve Association, because of the very shortage of commercial paper which lies
at the basis of the trouble.
The effective restraint of banks under such conditions will
be accomplished by the clearing and redemption facilities before
described. So long as the checks and sight drafts issued in these
credit operations are speedily returned to the banks against which
they arc drawn and the notes issued by the National Reserve Association are constantly and regularly returned to it for redemption,
there can be 110 inflation or over-expansion of loans. It is, therefore, with the perfection or imperfection of these features of the
plan that the question of inflation is primarily connected.
Another phase of the inflation fear is presented in the charge
that the notes of the National Reserve Association would displace
large quantities of gold in our circulation and thus endanger the
maintenance of our standard of value. This, like the other, may
be shown to be groundless.
To the extent that the National Reserve Association assumes
the issue privileges of the national banks, and as long as it retains the bonds purchased in the process, its notes will fill the place
now occupied by the national bank notes, and will not in any
respect change the existing relation between the gold and the
fiduciary elements in our currency. The additional untaxed issues
to be allowed will bo no more than adequate to meet the increased currency demands of the crop-moving and spring-opening seasons and will be speedily retired by the process of redemption previously described when the need for them has passed.
There is, therefore, no ground whatever for fear that they will
displace gold. Indeed, they may occasion an increase in the gold
supply, since the Association may find it necessary to secure the
increased reserves required by the importation of gold. The reason why, under existing law, it may be charged that undesirable
increases of national bank notes are driving out gold, is that there
is no effective means of contracting these notes when once issued.
An elastic note circulation which contracts when not needed would
not drive out gold.
Conditions will not differ essentially if the Association should
make use of its right further to extend its issues by the payment



of the tax prescribed. Such an issue would represent a greater or
less degree of emergency, would be absorbed by the increased currency demand thus occasioned, and would be speedily retired when
this demand disappears. Meantime, as in the previous case, the
Association may have found it necessary to import gold as a means
of increasing its reserves.
This fear is doubtless responsible for the suggestion that the
National Reserve Association should not be permitted to count as
reserves any form of money except gold.
If, as above indicated, should
there is no danger of the displacement of gold by notes of the
Association, there seems to be no good reason for placing this Reserve
limitation upon it. There may be good grounds for the desire to
increase our supply of gold, but there is no reason for shifting the of Gold
responsibility for any shortage we may have from the Congress
of the United States where it belongs. Indeed, if it is desirable
to retain our greenbacks and to preserve, without change in the
conditions of redemption, our silver coin and silver certificates, it
is equally desirable that the National Reserve Association should
be allowed to consider them as reserves. Any other arrangement
would amount to a discrimination between the different elements
of our currency, the exact parity between which the Secretary of
the Treasury is obliged by law to maintain. If Congress is ready
to acknowledge that such a discrimination should be made, it should
proceed at once to the retirement of the greenbacks and to the reduction of our silver currency to a subsidiary basis. Under such
conditions the reserves of the Association would consist exclusively
of gold.
§8. The question may be raised whether a borrowing bank
should be permitted to count the notes of the National Reserve
Association in its lawful reserve. It has been generally agreed that
it should so count its crédits on the books of the National Reserve
Association. Then, why discriminate against the notes? The notes
of the Issue Department of the Bank of England, as is well known,
are counted in the reserve of the Banking Department. But the
conditions there are not the same as here. Moreover, it may be
urged that the borrowing bank, if allowed to hold the notes of the
National Reserve Association in its reserve, would have no motive
for sending them in for redemption, since they would be as good
as gold; that the proceeds of one loan in the form of National Reserve Association notes could as reserves form the basis of addi-


Case of


tional loans by the subscribing bank from four to sixteen times
as much more; and that in a period of 28 days a first loan might
be made the occasion of a very dangerous pyramid of credit.
For instance, a bank with a capital of $100,000 might get
a rediscount of $30,000 for 28 days, and place $30,000 of National
Reserve Association notes in its reserves. I f obliged to keep 25 per
cent reserves, the bank might, it is said, make new loans for $120,000. With the commercial paper thus obtained, the subscribing
bank might get another rediscount for $70,000 more from the National Reserve Association, and add $70,000 more notes to its lawful reserves; and then be enabled to again increase its loans; to its
customers by perhaps $280,000. Thus, on an initial loan of $30,000, the subscribing bank might increase its loans by a total of
$400,000. If its percentage of reserves were only 15, then the
total would be much larger.
In such an instance as this, it should be noted that expansion
is as possible with credit accounts on the books of the National Reserve Association, when the outcome of a loan, as it is with National Reserve Association notes. But, it is assumed that the credits
would not be so expansible, since they must soon be liquidated by
extinguishing a credit at the National Reserve Association when
the loan is repaid. But we may take the case of the notes as the
most extreme case.

Case as the

What would be the restrictions on such pyramiding as is described above? ( 1 ) If a rediscount is made directly to the bank (and
not guaranteed by the local association) the loan must be paid
back within 28 days. ( 2 ) The subscribing bank, when expanding
loans to its own customers must count upon these customers drawing down the amounts loaned them, perhaps by 75 per cent. If so,
then customers to whom were loaned $400,000 would call for
$300,000 of cash from the reserves (or checks from other banks
would be presented to that "amount at the clearing-house). But
the bank would have had only $100,000 (equal to its capital) of
National Reserve Association notes in its reserve. That is, the requirement of reserves (which would remain as now) would at
once hobble the bank from any such pyramiding.
In short, its
lending power would be obviously limited, as explained earlier in
this chapter. In the example given, the bank having received notes
to the amount of its capital ($100,000) would probably not dare
to grant loans on the basis of reserve (which it must give up in 28
days) of more than once or twice the amount of this reserve. If ft




made loans of $200,000, and drafts were made by customers on
their accounts to oven 50 per cent, then all the National Reserve
Association notes would be exhausted. To say nothing of strict
surveillance by bank examinations, ordinary banking self-preservation would prevent such attempts at expansion. And what is true
of National Reserve Association notes would also be true of credits
on the books of the National Reserve Association. On the other
hand, if the public already had circulation enough for its business
habits, additional notes would not be drawn from the banks taken
as a whole; and the new reserves would in truth carry a larger
amount of loans than indicated.
If such operations were really to be feared, it might be possible entirely to prevent them by a provision forbidding any subscribing bank to hold more than (say) 10 per cent of its lawful
reserves in notes of the National Reserve Association on an average during any one calendar month; but this provision is doubtless unnecessary.
In the whole matter of over-expansion, the crux of the question is due provision for elasticity of notes and credit. Elasticity
in extending notes and credit in time of need must be always accompanied by proper regulations for their contraction when the
need has passed by. The rising rate of discount is the practiced
and proved instrument for bringing about contraction of credit
when not needed. In the case of notes, provided immediate redemption by the National Reserve Association is secured, any surplus not needed by the public would be sent in for deposit or redemption; and the banks would have no reason for holding on to
them, because if returned to the National Reserve Association, they
would still form a credit on the books of that institution as reserves. The banks would retain them only to satisfy the calls of
customers for cash when receipts of cash fell below demands.
More than that, a situation would be created by the National
Reserve Association in which there is a premium on getting rid
of notes of the Association and of any other forms of money. That
is, the motive for earning dead cash, which earns nothing, is taken
away by the knowledge that liquid assets in the form of good commercial paper can at anv moment be converted into bank reserves,
If so, a bank will have a positive inducement to change dead cash
in its assets to interest-bearing assets to the fullest possible extent.
Thus, more of the bank's assets will be earning a return than ever
before, and the reserves of the country will be economized with


a L 've



safety. Under such conditions, there will exist a strong incentive
to each subscribing bank to send in the notes of the National Reserve Association, and thus secure the quick redemption which is
so necessai'y a part of elasticity of the circulation.
In addition, the banks in cities having a foreign trade and
which inay be called upon for gold for exports or other purposes
Redemption would be led to present the notes of the National Reserve Associato^iasticity
gold- There would thus be another reason
for driving in the notes for redemption. Obviously it would be
well, for this reason, to issue a considerable portion of the notes
of the Association in large denominations.



Retiring the National Bank Notes—2.
Refunding the Bonds—
3. Other Plans for Using the Bonds—4. An Alternative Method and
Objections to It—5. The Monetary Commission's Plan—6. Disposition of the Bonds—7. The Question of Monopoly—8. Use of Profits
from Note Issues—9. Access to Notes—10. Security of the Notes.

§1. It may be agreed that the substitution of bank notes not
based upon government bonds for the present bond-secured currency would be a very desirable change in present banking methods
in the United States, and yet there may be very sharp disagreement as to what should take the place of such notes and how Retiring
the various conditions connected with the problem of retirement ^ a t j o n a j
should be dealt with. Naturally, a system of note issue which Bank
has been in operation for half a century, mid around which N o t C i
many interests have been developed, cannot be easily broken off
in favor of another. Numerous problems of detail require attention, equities must be recognized, and the operation, however
beneficial in its main purpose, must be carried out in such a way
as to cause as little friction during the transition as may be.
Many plans for making the actual change from a bond-secured
bank currency to one not so secured have been offered during the
past two decades. In all of them, of course, there is fundamentally
present the question, What would be the effect of such a change upon Changing
government bonds and their owners? As we have seen, the bond- ghQend
secured currency was first resorted to in order to create a market Basts
for bonds. It ultimately succeeded in accomplishing this end. The
chief effect of the artificial requirement that banks should invest
in government bonds as a condition of their existence has been
greatly to raise the price of the bonds themselves. The old G per
cent and 4 per cent bonds commanded a very high premium,
running as high as 40 per cent above par.
In the act of March 14, 1900, the national debt was consolidated into a general 2 per cent loan, of which about $730,000,000



in the


to Banks


is now outstanding. Most of the other bonds, as they ran out,
were converted into two per cents, and it was supposed that the
twos would sell at about par. In fact, they sold at a premium of as
high as 8 per cent within a year after the first issue was put out.
In recent years prices of all bonds have tended to decline and the
twos have gone down as others have, reaching a general level of
about 101. Of the $730,000,000 outstanding, not- less than $690,000,000 are held by banks for the purpose of protecting government
deposits or issues of currency. This means that the loss due to
the depreciation of the bonds has fallen in very large measure upon
the banks. The total amount of such loss is estimated by the Comptroller of the Currency at probably about $30,000,000—a loss which
has been simply "written off" by the banks on their books.
In spite of this reduction in price, it remains true that the
bonds are very far above their natural value. This is shown in
several ways. Sales of short time bonds bearing 3 per cent interest
and not available for circulation purposes brought only about par
in 1907. The postal savings bonds recently placed on the market, which bore 2y 2 per cent interest and could not be used to protect circulation, have sold at 92l/j- Comparisons of our borrowing
power with that of foreign countries confirm the belief that O T
bonds are not entitled to anything like their present price on an
investment basis. This idea is fully borne out by the table lately
compiled in the Treasury Department. (See next page.)
The influence which has maintained the value of the 2 per
cent bonds has been the fact that they could be used behind circulation. If that were removed, they would undoubtedly fall to a
point somewhere between 80 and 85. The banks which hold them
would thus lose l o or 20 per cent of the par value of the bonds.
It would be an impossible and unfair suggestion to secure the
alteration of present methods of issuing currency by any plan which
would impose on the banks so heavy a loss as would thus be necessitated. The banks took the bonds in good faitli and with the circulation privilege as one element in their value. To strip the
bonds of this privilege would be equivalent to taking away one of the
favorable terms and conditions upon which they were disposed of
at the time when the banks took them over. This would be practically equivalent to the repudiation of a part of the value of the
bonds, that is to say, a part of the debt of the government. As
such it is not to be thought of. Neither from the standpoint of
equity, nor from that of political expediency and possibility, nor

The quotations for English consols, French rentes and German Imperial loans from 1878 to 1907 are taken from the "Materialien
zur Beurteilung der Zusammenhänge zwischen dem öffentlichen .Schuldenwesen und dem Kapitalmarkte," Berlin, 1908.
The quotations for United Stales bonds were compiled by the United States Treasury Department.
German Imperial Loans.
Rente. 3
4 Per Ct.
3 Per Ct. 2% P e r C t . 2% Per Ct. Ter Ct.
1878... . .
97. S9
1879... . .
83. IG
1880... . .
S3. SO
1881... . .
1882... . .
1S83... . . 100.44
1S84... . . 100.25
18S5... . .
1SS6... . . 100.05
18S7... . . 101.05
97. C
95. S
89.27 '
*. . . . . . .
•Compiled from weekly statements In London Economist.
tComplled from Ftnanzherald.
Special Docket No. 570, 61st Congress, Second Session, p. 279.

English Consols.

.. ...

.. ......

.. ......

.. ...*••
.. ......
.. ......



4 Per Ct.
of 1907.

United States Bonds.
4 Per Ct.
2 Per Ct.
of 1925.
of 1930.


115. (i4




3 Per
Ct. of



from that of public credit, can such an idea be entertained. Even
if it could be carried through Congress, it would put into hopeless
jeopardy the relations of the government with the investing public
for the future.
§2. If it be accepted as axiomatic that the government must,
in the event of a change in circulation methods, in some way take
a course that will maintain the value of the bonds so that the banks R e f u n d i n g
shall not be obliged to carry them at a heavy depreciation or be the
obliged to lose the amount of their shrinkage below par, the ques- B o n d s
tion remains how'it would be possible to protect the banks against
loss at the same time that the note issue basis was changed.
The simplest and most obvious method of effecting the transition would be to refund the bonds directly at a higher rate of interest. The government would say to the banks: You may bring
your bonds to us and receive in exchange other bonds of similar par
value bearing a higher rate of interest. Or it could say: We will
redeem 3-our bonds at par at any time that they are turned in, and
you will get the money by a new flotation of bonds, although we
know that in order to get par for the new bonds we shall have to
pay a higher rate of interest.
What would this operation cost? Light on that question is
thrown by the recent sales of government bonds under the terms
of the act passed by Congress in February, 1911, which authorized
the sale of Panama Canal securities without the circulation privilege, bearing 3 per cent interest. At this rate, the securities brought
in rather more than 2 per cent premium. This, however, was 011
the relatively small sale of $50,000,000. If all of the $730,000,000
of twos now outstanding were to be refunded by the issue of 3
per cents, it is safe to say"that not more than par could be realized
for them. This would imply an increase of 1 per cent annually
on the whole $730,000,000 of debt, a charge which would amount to
about $7,300,000 in addition to present charges.
The amount which would thus have to be paid by the government for the purpose of relieving the existing bonds of the circulation privilege would be large, but it should be borne in mind that
this is nothing more than a just indebtedness which must be liquidated in order that the creditors of the government may be equitably dealt with.


of the
po^g^ 1 " 9


for Using
the Bonds



§3. While, the refunding of the bonds at a higher rate of
interest is the simple, natural and direct plan for meeting the
need» of the case, the question has frequently been raised whether
there is not some substitute wherby the cost thus to be incurred
would be avoided. The question is specifically asked whether existing bonds could not be allowed to retain the circulation privilege,
the banks themselves being permitted, as at present, to buy bonds
and secure notes from the government by depositing such bonds
with the Treasury.
Various plans have come before Congress in which it is provided that, before issuing any notes not secured by bonds, national
banks shall be required to have outstanding a specified amount of
their capitalization in the form of notes secured by national bonds.
This, it is assumed, would leave the banks the privilege of issuing
currency, and would keep the bonds on their present basis without
the necessity of stripping them of the circulation privilege and
thereby incurring a large expense of the kind already indicated.
Such plans of course are dependent for success upon the assumption that such a scheme would meet the requirements of bank-note
reform sufficiently well. How far would they probably attain that
object ?
Too much emphasis can hardly be laid upon the statement that
such a hybrid proposal as this would not reach the desired end. As
we have seen in former chapters, the currency of the United States
is now redundant. The national bank notes have displaced gold
and gold representatives to an amount equal to their own volume.
Consequently, they have taken for themselves a place which ought to
be filled, so far as it is filled at all, by gold representatives. The
notes do not expand and contract in proportion to changes in credit
needs, and consequently there is on their part neither the power to
supply a solid legal tender currency nor to furnish the credit element needed at times when demands for loans in the form of notes
become urgent. Therefore, a plan which practically retained the
existing bond-secured notes would not meet the requirements of
the case at all.
If the present notes were kept outstanding in practically their
total volume, it is questionable how effective a new note-currency
which was superadded to them would be. Perhaps it would be only
an "emergency currency/' subject to all the defects and criticisms
which apply in the case of such currency and not fulfilling the
ordinary requirements of the situation at all. More probably, the



new currency would at least partially displace the bond-secured
notes. ' If it should do that, the loss on the bonds, although not
likely to be as great as would ensue from a complete deprivation of
their power to act as security, would be more or less severe, and
the banks would therefore suffer correspondingly from the sacrifice
involved in the change. However this might be, the combination
of a new plan of note issue with the remnants of the old plan would
condemn the currency system of the United States to the retention of a foreign and purely artificial body of notes—the bondsecured currency—with all of its well-known evils, for a period of
years. This period would continue at least until the maturity of
the bonds, or nearly 20 years. Then the country would have an
opportunity of deciding whether or not to continue to maintain the
circulation power now possessed by the bonds, and might or might
not answer in the affirmative. If it did so answer, the result would
by the retention of this foreign element of bond-secured currency
for an indefinite time.
§4. Alternative with the two methods of dealing with the
bond question, in the event of a change in methods of issuing currency, is the proposal that in some way the cost of making the
transition shall be laid upon those who are to get the benefit of the
greater convenience, and perhaps larger opportunities for profit,
which arise from the introduction of a new method of note issue.
In connection with the National Reserve Association plan, it
has been proposed that the new institution should be vested with the
exclusive privilege of note issue, and in return should take over
from the banks at par the total volume of the bonds tlicy now possess. A scheme suggested by some in the same connection has been
that the national banks be allowed to continue their present method
of issuing notes, and that the new institution be permitted to issue
its own notes in addition. This latter variant of the proposal would
be open to the objection already sketched, in that it would retain the
bond-secured currency in existence. Yet there arc legal and other
difficulties connected with any plan which would directly deprive
the banks, which now own the bonds, of their circulation rights.

f0p n 3



Banks to

Discussion has therefore settled down upon the suggestion that, and Their
while the existing banks shall be recognized in the enjoyment of Surrender
their present privileges and be permitted to retain them if they
wish, it shall be made to their interest to cede these privileges to



the proposed new institution and in exchange to receive the assurance of direct redemption of their bonds. The effect of this plan
will be to enable a bank to choose between retaining its bonds and
its circulation rights and transferring them to the new institution.
It is probable that the present national system contains not a few
banks which for reasons of sentiment, or on some other ground,
would probably retain their circulation privileges if they could be
assured of having always the power to transfer their bonds to the
Reserve Association at par, so that they would lose nothing.
This plan is considered undesirable for the reason that it
would tend to maintain a proportion at least of existing national
bank notes in circulation by the side of the new system, and therefore it has been suggested that any forthcoming plan should limit
the time during which the transfer to the Reserve Association could
be made to a brief period, perhaps a year. If that were done, it is
probable that most of the bonds would be transferred to the Reserve
Association and would be paid for by it at par, while it would, of
course, receive the right to issue an equal amount of circulation,
although this circulation would not be directly based on the bonds,
as it is at present.

The detailed scheme by which the -Monetary Commission bill
proposes to work out this change may be outlined as follows, from
the actual measure which has been introduced in Congress to embody the suggestions of the Commission:
SEC. 48. There shall be no further issue of circulating notes
by any national bank beyond the amount now outstanding. National banks may maintain their present note issue, but whenever
a bank retires the whole or any part of its existing issue, its right
to reissue the notes so retired shall thereupon cease.
SEC. 49. The National Reserve Association shall, for a period
of one year from the date of its organization, offer to purchase at a
price not less than par and accrued interest the two per centum
bonds held by subscribing national banks and deposited to secure
their circulating notes. The National Reserve Association shall
take over the bonds so purchased and assume responsibility for the
redemption upon presentation of outstanding notes secured thereby.
The National Reserve Association shall issue, on the terms herein
provided, its own notes as the outstanding notes secured by such
bonds so held shall be presented for redemption, and may issue
further notes from time to time to meet business requirements, It
being the policy of the United States to retire as rapidly as possible, consistent with the public interests, bond-secured circulation
and to substitute therefor notes of the National Reserve Associa-



tlon of a character and secured and redeemed in the manner provided for in this Act.
SEC. 55. Upon application of the National Reserve Association
the Secretary of the Treasury shall exchange the two per centum
bonds of the United States bearing the circulation privilege purchased from subscribing banks for three per centum bonds of the
United States without the circulation privilege, payable after fifty
years from the date of issue. The National Reserve Association
shall hold the three per centum bonds so issued during the period
of its corporate existence: Provided, That after five years from
the date of its organization the Secretary of the Treasury may, at
his option, permit the National Reserve Association to sell not
more than fifty million dollars of such bonds annually: And provided -further, That the United States reserves the right at any
time to pay any of such bonds before maturity, or to purchase any
of them at par for the trustees of the postal savings, or otherwise.
Si:c. 56. The National Reserve Association shall pay to the
government a special franchise tax of one and one-half per centum
annually during the period, of its charter upon an amount equal to
the par value of such United States bonds transferred to it by the
subscribing banks.

§6. It is evident that the effect of this plan would be to enable the banks at once to turn their bonds into current funds,
while they would simultaneously lose the power of issuing any
notes. An equal amount of notes would, however, be issued (if they
were wanted) by the National Reserve Association, so that the
"shortage of currency" so often dreaded would not make its appearance. From that time on, those who wished to got notes would
have to look exclusively to the National Reserve Association. Few,
if any, banks would be willing to take the cliancc of holding their
bonds and keeping their notes outstanding.
By the terms of the plan outlined, the government would turn
these 2 per cent bonds into 3 per cents, thereby involving
itself in an additional charge of 1 per cent interest on the total
volume taken over. Simultaneously, it would lose the tax of
of 1 per cent on national bank notes which is now collected. It
would thus, theoretically, be a loser to the extent of
per cent
on the total volume of bonds taken over. The Monetary Cominission's plan would refund this amount to the government by paying out of the profits of the Reserve Association a franchise tax annually to the extent of V/ 2 per cent on the total volume of bonds
thus transferred. The effect would be to leave the government
exactly where it is at present, so far as expense is concerned, ex-

of ff xhj s

Be a
Loser 6 *' 03 '



cept that it would save the various items oi! outlay which are now
involved in caring for national hank currency and which are paid
for out of the y> per cent tax now collected on notes.
The criticism has been made on the plan that it is merely a
way of concealing the real fact that the government has to pay
the cost of the operation. This is because the Monetary Commission's plan, and every other plan of the same sort thus far proposed,
has provided for giving the government all of the profits of a National Reserve Association or other cooperative institution over and
above a fair minimum interest on the capital invested. If l 1 /^
per cent on the total volume of the bonds is first deducted as a
franchise tax, the volume of profits available for division is theoretically reduced to that extent. Of course this is not quite fair,
because in all of the plans that have been suggested, the payment
of a fair-going rate of interest on the capitalization of the concern is
to be provided for first, and the balance is to be transferred to the
government. Under the proposed plan, the franchise tax would
be a kind of first mortgage upon the gross income of the institution. It would be one of those expenses that must be provided for
in any case, no matter what happened. It would come out of the
receipts of the Association before any division of profits was made,
whether to stockholders or to the government.
One of the good features of this plan would be that the future of the bonds would be provided for. The government does
not desire to see its bonds sold at a discount. Yet 2 per cent
Disposition bonds cannot be sold on any other basis. At 3 per cent they could
investors at par, judging from the prices at present ruling in the bond market. It would be possible, therefore, for the
National Reserve Association gradually to sell them out to investors. This would be desirable also from the standpoint of the National Reserve Association itself. It is not well that a large volume
of long-time securities should be retained in the portfolio of a
great institution which is to deal primarily in commercial paper.
As soon, therefore, as the National Reserve Association could relieve itself of the bonds without injuring their standing in the
market, it would be well to do so. The Monetary Commission's
plan provides for the sale of these bonds at the discretion of the
National Reserve Association at a specified rate of $50,000,000 per
annum. This would not be a sufficiently rapid rate either to interfere with the floating of new government loans or to clog the bond
market. The object would be to have the securities absorbed by



the sound, gilt-edged investment demand of the country, thereby
providing a permanent place for the bonds and putting them where
they need cause no worry either to the government or to the Reserve Association. They would be taken by persons who want a
perfectly safe investment and are willing to accept a very moderate rate of interest. In that way, an equal amount of the fluid capi- Clogging




the Bond

tal of the country would be drawn into the Reserve Association in Market
exchange for the bonds, and would be by it used as a basis for
In the long run, the bonds would thus be entirely eliminated
from the commercial banking system of the country and a corresponding amount of bank funds now tied up in these bonds would
be released for use in meeting the current demands of the commercial public. That would be a consummation devoutly to be

§?. It would remain true that the power of bank note issue j h e
under this plan would be vested in a single great institution and Question
might be referred to as a "note monopoly." This is often men- Monopoly
tioned as an objection to the proposal. Just what basis has this
objection ?
It should be admitted at the outset that the proposed plan
would, exactly as alleged, make the note issue power a monopoly
in the sense that it would vest it solely in a single institution. This
institution, however, would he controlled by the banks of the country that held stock in it, and any bank that chose to become a stockholder could do so. The "monopoly" existing, therefore, would be
a monopoly in the same sense that the power of note issue is a
monopoly in the hands of banks generally. Indeed, from some
points of view the degree of monopoly of the power of note issue
would be less than that which exists at present.
Under current conditions, only national banks can take out
notes, and state banks are practically cut off from issuing their
own notes, although theoretically permitted io do so, by reason
of the 10 per cent tax on issues which is levied in consequence of
the act of Congress passed in I860. Under the proposed plan,
state banks would be stockholders in the Reserve Association and
could secure the use of its notes on exactly the same terms as national banks. A much more immediate and direct access to bank
note issues, and such benefit as may lie derivable from them, would



be guaranteed to them.


In this way, then, the monopoly element

in the control of note issues would be less than it is at the present
In no country arc bank notes permitted to issue without any
restriction whatever, and in many they are issued only by a single
institution, or in the main by such an institution, with a very
limited power of note issue surviving in the hands of a few other
smaller banks.

The chief institution is the residual legatee of

this power as it is given up by the other banks. The proposed situation in the United States would provide far less monopoly control than exists in France, England or Germany.



§8. The real question in connection with the problem of
monopoly of note issue is not, however, one of theoretical monopoly,
but is whether the profits obtained from the use of the notes are
properly employed. Where would they go under the proposed system? Presumably they would go to the government in the form
of dividends or bonus, after the limited rate of return on capital
invested, provided for in the bill, had actually been liquidated.
That is to say, the government would get all of the pecuniary benefit
accruing to the National Reserve Association through its exercise
of the note monopoly. In that case, it would appear that no complaint could reasonably be made, because of the fact that the sole
power of note issue had been vested in the National Reserve Association.
While in some ways this would be a satisfactory assurance, it
would not be a complete reply to the charge of monopoly. It might
very well happen that all of the proceeds obtained by the use of the
note-issue power would actually be turned over to the public by
provisions requiring the payment of all excess profits to the government, and yet harm might be inflicted upon the community as a
whole through the exacting of excessive charges for the use of the
notes. This would be a very serious evil if it existed, and one whose
effects could not be waved aside by the mere statement that the
profits were all returned to the public. In this connection it should
first be noted, however, that if the profits obtained from the use
of the note3, like those obtained from other branches of the institution's business, were to go to the government, there would be
no inducement from the standpoint of profit for the charging



of an exorbitant rate on those loans to customers which took the
form of notes.
This reduces the question to the real problem involved, which
is: Would the charge made by the Reserve Association for the
use of its notes be reasonable, and would it be such as to place the
facilities of the institution under the new note plan fully at the
disposal of those who needed them? In answering this question,
there are several points to be observed. First of all, the plan of
the Reserve Association, as already fully shown, would be such
as to draw no line of distinction between loans made through the
crediting of funds on the books, and loans made through the issue
of notes. The reserve requirements would be the same with respect
to notes as with respect to deposits, and in every other particular
there would be the same general basis of equality. It is evident,
therefore, that there would he no reason on the face of ihings to
suppose that the institution would charge an unfair rate for loans
which it was desired to take in the note form.
Next should be considered the question, What will regulate its
rate of discount, whether for loans made in the form of notes or
those in the form of deposits ? Certainly not the profit to be earned
by the institution, for reasons already fully set forth. The institution would be guided in Iking its rate of discount partly, of
course, by the general rates current in the community as a whole,
and partly by the policy of its directors with reference to the extension or restriction of commercial credit and the controlling of
exportation and importation of specie. Whatever their policy on
these points might be, there would probably be no time when the
rate which they would charge for the issue of bank notes would
even remotely approach the high rates which are now charged in
those parts of the country where bank notes are chiefly used. In
few, if any, countries is there so great a discrepancy between different regions as regards rates of discount, as exists in the United
The main function of the Reserve Association would be to
equalize rates of discount charged for paper of similar classes in
different parts of the country. It is, therefore, an absolute certainty
that, in equalizing this rate, a very great reduction would be effected, as compared with the rates now charged in the more distant
and more thinly settled portions of the United States, which are
those where the present demand for note currency is greatest. Altogether it is impossible to escape the positive conclusion that the

Is the
for Notes

Guides In
Rate of

Cost of
Loans in
Form of



effect of the proposed plan would be greatly to reduce the cost of
loans taken in the form of bank notes as compared with the present
rates of charge.


Easier for
to Get
New Plan

Ways of

§9. It may be feared by some that, while the rates of charge
would be low, the proposed institution would in some way render
access to the notes more difficult than at present. That is to say,
it might be true that favored institutions under the new regime
would be able to get the notes they wanted, and to lend them to
their customers, a good deal more cheaply than they now can, yet
there might be circumstances and conditions which would interpose
to prevent their getting them at all. This is merely another form
of the statement that the Reserve Association would tend to be
influenced by motives of favoritism.
Xo basis for such a charge exists. On the contrary, the proposed plan makes extremely stringent provision for guaranteeing
to every bank absolute equality of opportunity and of treatment
at the offices of the Reserve Association. Nothing more need be
said on that point.
It is worth while, however, to observe that, assuming such
equality of treatment, the access of the banks generally to the
notes would be vastly easier than it now is. At the present time,
those institutions which have large issues of notes outstanding
for the convenience of their customers, find, in times of stress, that
it is very hard for them to get any further currency. This is
due, in the first placc, to the fact that bonds arc at times exceedingly difficult to obtain under any conditions. A notable instance
of this kind was observed during the panic of 1007, when the
bonds were practically out of reach so far as related to new note
issues. Moreover, banks which are in the habit of issuing notes
to meet the needs of their customers are likely to be close to the
upper limit of what they can issue, even with an unlimited amount
of bonds at their disposal. When they have outstanding a sum
of notes equal to their capitalization, they can issue no more.
Under those conditions, banks arc obliged to obtain the notes
by getting other banks to issue and lend such notes, for use by
the institutions which stand in need of them. This is a familiar
situation at crop-moving times. The notes may be obtained from
the larger banks in any one of a variety of ways, cither by loans
made to officers or directors, or by any of the other roundabout



methods that are familiar. The fact remains that this is the way
in which notes are now obtained by those banks that find themselves pretty well up to the limit of note issue. They are, in *
word, obliged to depend upon the willingness of other banks to
accommodate them. The other banks are sometimes ready to extend
this aid and sometimes not.
This merely amounts to a statement that on no conceivable
basis could the situation under the proposed plan be worse than
that which exists under present methods of banking. Such is, in

fact, the case. The methods of the Reserve Association in regard
io the issue of notes would, even under the worst conditions, be
better than those which have prevailed under the National Bank
System at its best. A review of the provisions of the National Reserve plan will confirm this belief in every particular, since it will
show that at every point the interests of the several banks have
been thoroughly safeguarded as against the Reserve Association,
while the motives of self-interest which might conceivably prompt
the managers of the Reserve Association to take action in the interest of certain banks or groups of banks, have been carefully
With every reason to accommodate the public in the matter of
note issue, and with the possibility of selfish motives destroyed,
the Reserve Association would be found at the service of every
part of the country that needed accommodation in the note form.
the only question being the presentation of sound commercial paper
of the kind specified, in sufficient quantity to get the notes that
were asked for. Here, as in every other branch of the business,
the question which banks would have to face would be merely the
kinds of transactions on the part of their customers which they
were engaged in financing. This, however, would be a general
question applicable to the whole problem of reorganizing the banking system and not exceptionally prominent in connection with
the note issues.
There remains the question whether the interest of the public
would be sufficiently safeguarded under the plan which has been
proposed for retiring the national bank notes and for putting in
their place issues of the National Reserve Association. This is a
problem of security. '
At the present time, the notes of the national banks are protected by government bonds to an equal amount deposited with
the Treasury. They may be redeemed out of a fund equal to 5


^ Povec j










per cent of their face, which is kept with the Treasury, or out
of any funds the banks which issued them may have on hand.
The notes would be backed by gold and other lawful money to
the extent of 50 per cent of their value, while they would be payable
to the government and could be deposited with the banks, thereby
at any time substituting the obligation of a local bank for that of
the Reserve Association. This makes it plain that the new notes
of U Such C3S
he thrice protected; first, by an enormously large reserve kept
a Currency in the fundamental money of the country, gold: second, by the obligation of the government to receive these notes in payment to it at
any time and in any amount; third, by the obligation of every bank
in the system to substitute its own promise to pay for the notes of
the Reserve Association. The notes would be as sound as the government, and as sound as the whole banking system of the country,
which is the same as saying that they would be as sound as the
whole structure of the business of the country. More than this
could not be required.



Clearing-House Associations the Only Form of Cooperation—2.
Development of Clearing-House Functions—3. Methods of ClearingHouse Examiners—4. Government Recognition of Clearing-House
Examinations—5. Issue of Clearing-House Certificates—G. Nature of
the Issue Function—7. Action by Congress Following 1907
Panic—S. National Currency Associations and Why Few Have
Been Organized—9. Associations, both Clearing-House and "National Currency," Have Been Incomplete—10. The Question of Inflation—11. Avoidance of Inflation—12. Advantage of Regularity—13. Need of Extending Clearing-House Functions.

§1. Only one real effort at genuine cooperation has been
made by the banks of the national system. This has been seen in
the establishment of clearing-houses which, thus far, have been
simply informal, unincorporated associations, organized for the
purpose of mutual aid, but having in ordinary times only mechanical functions conrieclcd with the clearing-process itself. In the
following pages it is intended to describe briefly the clearinghouse function and to set it in its relation to the general banking
problem. It is not designed to discuss the details of the clearing
process. These have been made frequently and thoroughly familiar. The intention is to show the position assumed by the clearinghouse as an organization in its relation to the banks of the country.
The original cause of clearing-house organization was undoubtedly the plain need of cooperation among the banks. Institutions located here and there within the same city or region saw
the necessity of mutual cooperation and assistance in exchanging
their checks and drafts. This was simply a labor-saving device
intended to avoid the necessity of going from bank to bank for
the purpose of presenting items for cashing. The constitution
of the New York Clearing-house adopted in 1853 provided that
the manager, under control of the clearing-house committee, should
have full charge of all business and should superintend the operation of clearing, the adjustment and settlement of balances, the


Clearlngtions Only

The^ Qf



keeping of the records of transactions as they take place from day
to day, and the preparation and publication of detail bank statements. The clearing-house committee was to have charge of the
general business affairs of the institution and if necessary to exThe First
amine any member of the association. A "conference commitClearingtee" was to be annually elected and its function was, in concurHouse
Association rence with the clearing-house committee, to suspend any bank
from the privileges of the clearing-house in case of necessity, until
the pleasure of the association was ascertained thereon. No suspension, however, was to take place except under very carefully
restricted conditions. Other provisions were intended to govern
the membership and the methods of doing business.
Throughout the whole list of provisions ran the idea of establishing such rules and regulations as might be considered necessary to control the management of a large business concern chiefly
organized with a view to the offsetting of claims and the adjustment of balances. There was no idea at the outset of carrying
the notion of cooperation to the extent of protecting the banks which
might be members of the clearing-house against one another's operations, should the latter become objectionable. Neither was there
any apparent intention of providing for the relief of members of
the clearing-house in the event that they should become hardpressed by creditors or financially embarrassed.
Other clearing-houses were organized on similar lines and
those which have been subsequently created have imitated the
earlier institutions. The confessed purpose of the clearing-houses
is therefore the useful one of effecting a division of labor.

Development of

§2. Gradually other functions have been added by the clearing-houses to their original duties. The most natural function to
be joined to those originally fixed was that of mutual supervision
and inspection on the part of the banks. This early came into existence in a more or less distinct form. Mr. James G. Cannon in
his work on "Clearing-Houses" says on that subject:
It is significant of the ever widening scope of clearing-house
supervision and usefulness that several associations have in the
past few years, after giving careful consideration to the subjcct,
appointed special bank examiners, assisted, where necessary, by
trained experts under rigid regulation and ready to go to work at
a moment's notice. This departure has been deemed of sufficient
importance to warrant a complete explanation of the conditions
under which these examiners operate.



The mere establishment of associations and the requirement
that statements be formulated as thus indicated was only the first
step forward. As time has gone on, the general supervision of the
clearing-house over its members has been extended to a broad, if
vague, requirement that they shall conduct their business in accordance with professional principles and shall scrupulously observe the known and recognized obligations of banking. Thus has
come into existence a decidedly important function whose futility
has been recognized on many occasions.
In all those places where clearing-houses have been organized, an important factor in their work is the establishment of a
kind of joint oversight, which enables banks to repress any irregular practices and to maintain a high standard of management
among the group of participating institutions taken as a whole.
This is rendered possible through regular bank statements prepared by the different institutions, and through the work of a
clearing-house examiner, who regularly goes through the different
institutions and makes a thorough inspection of their accounts and
assets in behalf of the association. Until recentlv such examiners
have worked in only a few cities. During the summer of 1911,
however, Comptroller of the Currency Murray induced several cities to appoint regular clearing-house examiners, and, in order to
make such action worth while, he indicated a willingness to relieve banks which supported a clearing-house examiner who made
regular inspections of a certain number of the examinations usually made by government examiners. Tho offer was accepted
with satisfaction in several places, and the system has thus far
worked so well that it is likely to be considerably extended. Thus
an informal relationship between the government and a co-operating group of banks has been brought about in so far as inspection
and examination of paper is concerned. Even where there is no
regular examiner, the banks of a clearing-house, more or less, keep
watch on one another's transactions, thus taking, in a loose way,
joint action intended to insure soundness in the commercial paper
of the community.
§3. This most recent extension of clearing-house duties and
recognition of the establishments by the government through the
order that where clearing-house examiners are appointed the number of government examinations through regular national bank
examiners will be substantially decreased, is worthy of further etudy.

^'Q^" 9 "




In these cities the clearing-house examiner is appointed by the
banks and is jointly paid by them. The aid of a staff of assistants
is given him, and together these clearing-house examiners inspect
the banks, keeping the results of their inquiries strictly to themMethoda of selves, so far as details are concerned. If they detect irregularities,
it is their duty to call them to the attention of the bank or, in case
Examiners 0 f necessity, to the clearing-house managers. In a report on the
method of conducting clearing-house examinations in Chicago and
St. Louis, a report subsequently used as a basis for the introduction
of the clearing-house examiner system at Pittsburgh, the following description of the methods employed is given:

St. Louis

The duties of the Clearing-House Bank Examiner, of what his
force consists and the manner in which he performs his duties, as
adopted by the St. Louis Clearing-House Association, are as follows: The Department includes the Examiner and three assistants.
Before entering upon his duties, the Examiner signs a written
contract that in case of his resignation or dismissal, he will not
connect himself with any bank or trust company within three
hundred miles of St. Louis, for a period of three years, and each
of his assistants enters into a similar obligation for the same
period. The object of this stipulation is apparent. They have in
St. Louis seventeen members of the Clearing-House, and thirtyeight associate members, the associate members being Banks and
Trust companies clearing through members. This gives a total of
fifty-five banks and trust companies under the control of the Clearing-House, and subject to its rules and examinations.
Without notice, the examiner, of his own volition, and with his
assistants, enters any bank or trust company and commences his
examination. All information he asks for must be given him, and
all books and papers placed before him as in the case of a national
or state bank examination. When the examination is completed, he
makes duplicate reports, stating all the essential facts obtained in
his investigation—whether the institution has the required amount
of cash on hand, the amounts of its past due paper, the amount of
its bad debts, if any, the amount due by the directors as payers,
endorsers or as guarantors, and the amount due by corporations in
which they are interested, the value of bonds carried and whether
they are carried at a sum in excess of the market value, whether
the amount shown as capital, surplus and undivided profits is
represented not by bad, but by good assets; in other words, whether
the published statements are true, and finally, a complete state*
ment of the bank's condition is set out, with any suggestion
which, in his judgment, sound banking requires him to make.
One copy of the report is delivered by the examiner to the
president of the institution examined, and each director of that
Institution is notified by mail of such delivery, accompanied hy a



written request that the director notify the examiner in writing of
the receipt of the notice. If, at the end of two weeks, the examiner
has not received from the director the acknowledgment desired,
he sends a second notice, or a third, if necessary, it being the
purpose of the committee to establish the fact that every director
of every institution which is a member of, or connected with, the Bank
St. Louis Clearing-House, is informed of the condition of his Directors
institution as ascertained by the Clearing-IIouse bank examiner. of ExamiIf the examination discloses nothing indicating bad manage- nation
ment or unsafe condition, the examiner places the duplicate in
his files and writes to the Chairman of the Committee of Management. If, on the other hand, the examiner finds conditions different
from the case above stated, he sends a letter addressed to the
Chairman of the Committee of Management. A meeting of tho
Committee of Management, which Committee consists of five members and the President of the Association, who is a member e.roflicio, is callcd, and the examiner makes his report, the manager
of the Clearing-House acting as secretary of the Committee and
keeping full minutes of its proceedings. The Examiner's report
is read and considered in detail. He is then directed to notify the
President of the institution that the Committee requests that certain steps be taken which, in its opinion, are advisable and necessary.
If this request is not complied with, the Chairman of the Committee requests the President and the cashier of the bank in
question to appear before the Committee, when they are notified
of the matters complained of and informed that unless they are
corrected, their institution will be suspended from the Clearing- First
House until a meeting of the Clearing-House has been called, and Action of
the whole matter in all its details placed before it. The President Report Discloses Bad
and cashier are informed at once that no member of the Clearing- Practices
House, or any other than those in the room, knows, or will ever
know, of the Comirfittee's action or the fact that their institution
has been under criticism, provided the required action be taken.
In no case yet has the Committee been compelled to suspend a
bank or trust company, and in no case has any institution made
any complaint that it had become known that its affairs were under
discussion. In either city if the examiner finds unwarranted conditions in a bank after having completed his examination, he calls
the matter to the attention of the officers of the bank, and if
proper adjustment is made, makes no mention of it in his report.

In speaking of the clearing-house examination system, Mr.
James G. Cannon says:
The clearing-house association of Chicago was the pioneer in
the establishment of an independent system of clearing-house bank
examinations in this country, its system having been inaugurated
on June 1, 1906, with results that have to ths present time more
than fulfilled the expectations of the bankers of that community.


Success In

of ClearingHouse

The chairman of the clearing-house committee, speaking in this
connection only recently, said: "The result of our experience in
Chicago is most satisfactory and gratifying. The banks have
almost unanimously adopted every suggestion made by the clearing-house committee for their betterment and strength. In several
instances, the committee, from its wider knowledge of the financial
situation, has been able to save some of the smaller institutions
from loss by enabling them to take hold of conditions in time.
I cannot properly go into such details as would illustrate the effectiveness of clearing-house examinations as we have experienced it,
and can only say in a general way that it has been even more satisfactory than I anticipated it would be before it was undertaken."

§4. Comptroller Murray's order, in which he directs a substitution of the clearing-house examination for the regular national
bank examinations up to a certain point, was first suggested in a
letter written by him and reading as follows:
My Dear Mr.


The greatest force in this country to-day for safe and conservative banking is a well-organized clearing-house association, having
its own clearing-house examiner, and it is my earnest wish that at
least every reserve city shall have its own clearing-house examiner.
The three central reserve cities, New York, Chicago and St.
Louis, have adopted the plan, and in addition a number of reserve
cities, including Kansas City, Minneapolis, St. Paul, St. Joseph, Los
Angeles, San Francisco, Milwaukee, Philadelphia, Oklahoma City,
Nashville and Cleveland.
Every one of the objections always urged against a clearinghouse examiner was used before these clearing-house associations
adopted the plan, and every single one of the objections, by actual
experience, has fallen to the ground. The f a d is that no real argument from any angle can be made against the wisdom and
efficiency of such a plan of supervision. Give to the state supervisors of banks all the power they ask; give to the Comptroller of
the Currency all the power he may want, and then let each select
the very best examiners available, and, even with these ideal
conditions, an effective clearing-house association, with an efficient
clearing-house examiner, will be by far a more potent factor for
sound banking in the community than either or both combined.
The total assets held by all the banks in the United States will
approximate $22,500,000,000, making the banking power (capital,
surplus, circulation and deposits) of the country $21,000,000,000, a
sum greater than the combined banking power of the United Kingdom, France and Germany. Of this vast total, more than one-half
is in the central reserve and reserve city bank3 and represents a
power exceeding that of the United Kingdom, and also exceeding
the combined banking power of France and Germany.



Nearly one-fourth of the banking power of the country, as a
whole, is lodged in the central reserve cities alone, New York,
Chicago and St. Louis, and more than another one-fourth is
represented by the banking strength of the forty-seven reserve
No stone ought to be left unturned to securely safeguard the
handling of this great wealth. If we are to have supervision of
banks at all, let us have the best that can be had. And by all
means let us have it in our reserve cities. That supervision Is not
the state examination and control; it is not the national examination and control; but it is the control of an efficient clearing-house
association, and an efficient clearing-house examiner, under the
authority and with the advice of a clearing-house committee composed without exception of the ablest and most experienced
There are clearing-house examiners in fourteen of the reserve
cities and the plan in each city is in some respects different. I ask
you to communicate at once with these different clearing-house
associations, and ask them to give you in detail the plan under
which they are working.
I also invite your attention to an address delivered by Mr.
James B. Forgan, president of the First National Eank of Chicago,
on the subject of clearing-house examinations by clearing-house
examiners, at a meeting of the clearing-house section of the American Bankers' Association at their convention held in Los Angeles
in October last; also, to an article on clearing-house examinations
by Mr. Joseph T. Talbert, now vice-president of the National City
Bank of New York, which can be found in the Journal of the
American Bankers' Association for January, 1909.
So far as argument is concerned, based on actual experience,
it seems to me that these addresses of Mr. Forgan and Mr. Talbert contain all that need be said on the subject.
The plan suggested is as follows:
First: In cities where the charge would not be a great burden
on the banks they should have their own examiner, selected and
paid by the banks of the clearing-house association.
Second: Where this would be such a burden on the banks as
to make it impracticable, an arrangement may be made with the
national bank examiner to furnish the clearing-house committee
with a copy of his report to the Comptroller; and in case there
happened to be—as is likely—state banks and trust companies,
the bank examiner should make an independent examination of
them and report directly to the clearing-house. For this service
he would be entitled to a reasonable compensation, but the expense to the banks would be so light as not to make it a burden.
In case the second plan is adopted, of having the national
bank examiner or the state bank examiner act as a clearing-house
examiner, the details can be easily worked out at a conference
between the clearing-house association and the examiner and state



supervisor, if a state examiner is selected, or between the clearing
house association and the comptroller, if a national bank examiner
is selected.
I earnestly ask that this letter be read at a full meeting of your
clearing-house association; that you at once enter into correspondence with the cities having their own clearing-house examiners, that you adopt some one of the plans now wording so
admirably in those cities, or a modified plan. If you take this
up in the spirit which I think you should, and which it is hoped
that you will, we will have, in at least all the reserve cities, what
we should have had as soon as they were made such—a clearinghouse examiner. Yours very respectfully,


The functions of the examination system have been described
by another authority as follows:
of the
cf Examinations.

The idea of having a clearing-house bank examiner Is not to
hamper the banks in any way, but to prevent them from taking
undue risks in order to secure high rates of interest, or go into
underwriting schemes of a questionable character, or allow directors or officers of an institution loaning the banks' funds to corporations in which they are interested, provided they are not well
secured; also to prevent firms and corporations securing larger
lines of credit than they should be entitled to, based on their
assets, and to enable the banks to check up firms, individuals or
corporations that make false statements.

§5. It is thus plain that so far as oversight is concerned the
clearing-house association has demonstrated its cfficicncy so clearly
as to be recognized by government authority. But by the side of
this function has been developed another which has been exercised
issue of
only in exceptional instances. This is the so-called clearing-house
House Cercertificate or currency function which in substance has been the
providing of a certain kind of reserve resource through the concerted action of the banks, in order that they may be relieved of
the pressure and danger growing out of severe strain upon their
resources in times of panic or stringency.

First Used
In 1860.

The earliest issue of clearing-house loan certificates occurred
in 18G0. There had been a serious decline in bank business toward
the close of 1860. In consequence the clearing-house banks of
New York adopted a resolution whereby it was proposed that any
bank in the association might, at its option, deposit with a committee of five persons to be appointed for that purpose an amount
of its bills receivable, United States stocks, Treasury notes, or stocks
of the State of New York, to be approved by the Committee, which



should bo authorized to issue thereon to the bank depositing them
certificates of deposit, bearing interest at 7 per cent per annum,
in denominations of $5,000 and $10,000 each, to an amount equal
to 75 per cent of the deposit. These certificates might be used
in the settlement of balances at the clearing-house for a period of
30 days from the date thereof, and were to be received by the
creditor banks during that period daily in certain proportions.
The association also agreed that the specie belonging to the associated banks should be considered and treated as a common fund
for mutual aid and protection, and a committee of the clearinghouse was given authority to "equalize" the fund by assessment or
otherwise as occasion might seem to demand.
This expedient was again resorted to in 1861, and again in
1863 and 1864, but after that date no further loan certificates were
issued until 1873, when a very much larger issue was made. In
that year also the loan certificate expedient was adopted by the other
Boston clearing-house association and by those of Philadelphia, o f sUCh
Baltimore, St. Louis, New Orleans and Cincinnati. Again in 1879, Certificates
a small issue was put out by the New Orleans association, and
again in 1884, New York resorted to the certificates. In 1890
there were issues in New York, Boston, and Philadelphia. In 1893,
the use of the certificates was again undertaken, and issues were
made at New York, Boston, Baltimore, New Orleans and Cincinnati. Small issues were put out at Buffalo, Pittsburgh, Detroit,
Atlanta, Birmingham, Richmond, Chattanooga, and other places.
Again in 1896, there was a small issue at New Orleans, and a small
issue in 1895-1896 was used at Boston and at Philadelphia.
Probably the most extensive issue of clearing-house certificates
ever made was in 1907 when New York and practically all of the
other principal cities of the country issued clearing-house loan
certificates. In many smaller manufacturing towns there were
issued so-called clearing-house checks or cashier's checks in small
denominations to supply the need of cash. These were simply
checks printed from steel plates in small denominations and issued
to the various clearing-house banks, which then signed them,
through their cashiers, and paid them out to persons who desired
funds. In some places, the clearing-house loan certificates were
made the basis for issues, dollar for dollar, of clearing-house checks
running as low as one dollar in denomination.


Nature of

A R E D I S C 0 U N T 1 N G OF


§6. It is obvious from this outline that the essential function
performed by the clearing-houses in connection with the issue of
loan certificates and checks has been the rediscounting of paper.
Such rediscount was in the form of a credit which was practically
as good as legal tender money inasmuch as, by common agreement,
the banks of the clearing-house associations undertook to receive
it in payment of all obligations, and thereby converted it into a
means of cash payment available to any reasonable amount. They
substantially entered into an agreement not to attempt to drain
away one another's cash, but to treat the cash as a common fund.

The purpose of the clearing-house certificate system has been
to afford the banks the means of liquidating paper at a time when
they are peculiarly in want of cash owing to panic demands upon
them. The banks which feel the need of cash hypothecate» with a
Purpose of
Certificates committee of the clearing-house, paper of satisfactory quality which
Was to
Meet Panic they happen to have, and get in return clearing-house loan certifiDemands
cates to (say) 75 per cent of the amount of the paper thus pledged.
for Cash
By making the clearing-house certificates payable in liquidation
of all sums due from one bank to another, the clearing-houses have
practically relieved their members for the time being of the necessity of directly settling in cash such obligations as are presented
to them by other banks. Since a rate of interest is charged on the
certificates, the banks desire to retire them as soon as they can.
The use of these certificates practically throws the whole body
of clearing-house banks into the form of a commercial unit during the period of stringency. This is probably the highest and
closest form of cooperation established among the banks.
Form of
The success of the plan is evident from the repeated employment of this expedient over a period lasting half a century, and
by the continuous extension of the system to the smaller clearinghouses which have taken it up in recent years as necessity seemed
to demand.
The success of the clearing-house loan certificate plan has
often raised the question in the minds of observers why this plan
was not made a permanent feature of clearing-house organization
and Perma- so that it could be resorted to at any time, and the very great power
nence of
of expansion in accommodation resulting from it be realized. So
the Plan
acceptable has this notion been to many persons, that for years past
there have been bills regularly presented to Congress for the pur-



pose of legalizing issues of loan certificates by recognizing the right
of the clearing-houses to get them out—a right which is, to say
the least, very doubtful under the conditions of existing law. Very
little support has been accorded to these efforts by the clearinghouse banks themselves. Apparently, their view has been that the A r g u m e n t s
legalization of the scheme, and the adoption of an act making it Against
permanent, would destroy its basis of success. It has been con- ¿/tjjJj23*1011
tended that, if the scheme were to be regularly resorted to, the Plan
effect of it would be to encourage banks to expand their operations
because they would know that they could get relief at any time by
applying to the clearing-house committee and obtaining loan certificates. What is good medicine for a sharp attack of disease, it has
been picturesquely stated, is not desirable as a regular diet. This
aphorism hardly meets the real facts in the case, but at all events
it explains the grounds upon which there has been a hesitation
on the part of bankers to see the clearing-houses regularly endowed
with the function of issuing these certificates.
§7. Without the support of bankers and almost against their
wishes, Congress, however, has practically legalized something
analogous to the clearing-house certificates. After the panic of
1907, there was a strong demand for legislation which would render
the recurrence of such an event improbable or impossible. Under
the stimulus of popular demand, Congress, which had previously Action by
been indifferent to the wishes of the community in regard to bank- Following
ing reform, attempted to adopt legislation designed to avoid future Panic
of 1907
panics. • Two plans were placed before it, the one simply providing
that banks might, if they desired, present bonds of specified kinds,
other than national, to the Treasury Department and receive back
circulating notes in a specified proportion of the face of the bonds.
Such notes, however, were to be quite heavily taxed on the ground
that they were an "emergency currency" and as such to be "driven
in" as soon as possible.
The other plan provided for the issue of notes by associations
of banks to be organized in various districts into which the country
was to be divided. Notes of this kind were not to be based upon
any specified securities expressly segregated for that purpose, but
were to be in the nature of so-called "asset currency" protected by
the joint action of the banks in the district associations. Finally,




after several months of struggle, a new plan was evolved whereby
so-called "clearing-house associations" were to be formed for the
express purpose of getting out notes when desired. Ultimately this
again was changed to a plan for the formation of "National Currency Associations" which were to have nothing to do with clearinghouses, but were apparently intended to be the inheritors of that
part of the clearing-house function which had been previously represented by loan certificate issues.
This plan was at last consolidated with the bill which provided for the issue of notes direct from the Treasury to banks
which might deposit approved securities (other than national
bonds) with it, the resulting legislation being known as the "Aldrich-Vreeland" law.
In this law it was provided that in addition to the issues of
b e obtained direct from the Treasury, other isHave°Been D ° t e S w l l i c h
Takcn Out fiUes c o u l < i b e h a d ^ r o m t i l e National Currency Associations. Such
Under This associations would consist of not less than ten banks having a combined capitalization of at least $5,000,000, situated in contiguous
territory. The issue of the notes was to follow lines that had already
been made.familiar by the clearing-houses. Securities of a specified
kind were to be receivable by the National Currency Associations
and, when thus received, issues of notes up to 75 per cent of the
value of the securities might be obtained from the Treasury by the
Association and distributed to the banks which had deposited the
collateral with the National Currency Associations. The banks in
any association were, however, to be jointly responsible for the
notes thus obtained and issued. Under this plan no notes have
ever been taken out and only a few such associations—seventeen in
ali—have been organized.


§8. It is clear that, with the National Currency Associations
as with the clearing-house associations, what has been done has
been to provide a means for rediscounting commercial paper, the
form of the rediscount being the issue of notes jointly guaranteed
b y t h e b a n k s w h i c h w e r e t h e members of the organization apply-

for the notes. It would be easy to say that the failure to organi z e m o r e o f t h e s e associations and the entire failure to get out any
Been N O t
notes is due to the fact that no commercial crisis or stringency has
supervened since the legislation was adopted that would render such
a force necessary. Of course, this neglects the fact fully c o m m e n t e d
upon elsewhere in this discussion, that the clearing-house associa-



tion or National Currency Association merely fills a need which
constantly exists, and that in the past issues of notes by such associations have occurred when it was impossible to get along without
them on account of the extreme necessities of the case. The reason
why no notes have been issued by the National Currency Associations is not altogether that there.has been no occasion to demand
them. ' Nor can any similar explanation be accepted for the failure
to get out clearing-house certificates except during certain specified
years when panic or stringency had driven the banks to a resort to
that expedient.
In the case of the clearing-houses, the notes were not issued
except upon extraordinary occasion and were then driven in as
early as circumstances would permit, because the strong banks did
not care to be responsible for them any longer than was necessary,
and because tho whole thing was looked upon as an extra-legal, if
not an illegal, expedient.
In this case of the National Currency Associations, the inactivity may be attributed to the fact that the getting out of such
notes is severely penalized by the imposition of a very heavy tax
upon them and by the fact that the notes constitute an unlimited
liability upon all of the banks which are parties to the National
Currency Association. Moreover, through defects in the law, the
character of the commercial paper which may be received by such
associations as a backing for issues of notes is very far from being
clearly described, so that in many places it would appear that
very little paper would be available as security behind the notes if
the law were rigidly adhered to. But, entirely apart from all
these questions of technique is the fact that the issue of notes or
loan certificates is manifestly a temporary expedient upon a temporary basis and is vitiated by this "emergency" quality. The
banks do not care to arouse alarm, by employing an expedient
which is regarded by the community as a danger signal, while
no individual bank is willing, except in case of extremity, to ask
other institutions to consider the getting out of notes, since this
step would necessitate an exposure of its own affairs, and an explanation of the reasons which had led it to so unusual a step.


§9. It is clear that the associations, whether clearing-house
or national currency, have been incomplete in their operations and
that what they lacked was (a) legal sanction and recognition as HavV'Seen"
permanent institutions, and (b) legal oversight and restraint.



The harm that came from issues of certificates was due to the
fact that they were regarded as the result of danger, if not of disaster. The good that came from them lay in the fact that they
converted sound and unquestionably valid assets into immediate
means of payment. The danger seen in them resided in the fact
that it was feared that they would give to weak institutions a
power to expand accommodation to which they were not entitled
and which might work hardship to sounder and better managed
The cooperative idea implied in the associations was their
distinguishing beneficial factor, and it is this that should now be
carried a step further by placing the clearing-houses or national
currency associations upon a permanent working basis—or what is
j>y borrowing the idea of cooperation from them and
organizing an institution to apply it regularly and systematically.
Such an institution would maintain and accept the germ idea of
the clearing-house or National Currency Association—that of the
rediscounting of paper and the conversion of it into resources
which might be used as reserve funds. It would, however, carry
this notion further by keeping the institution always open for
business and thereby rendering it possible for its operations to
go on without shock or alarm to the community. Involved in this
thought would also be the abolition of everything that could be
considered to penalize the use of the resources of the institution.
Proper restraint and oversight would be obtained by the application
of professional knowledge and skill to the business of testing paper
presented for rediscounting.

0 n a ion

§10. With such professional skill and oversight applied to
the operations of a cooperative association, how far would there
be a warrant for the belief of inflation? The belief is frequently
expressed that the clearing-house principle, so-called (meaning
thereby the principle of converting assets into immediate resources), would be carried to an extreme, and inflation would

I t i s w e l 1 t o n o t e t l l e e x a c t effect produced by the clearingj 0 £ m c e r tifi c a tes when they were issued, and to consider the
probable result of producing this same effect under usual
The action of the clearing-houses in issuing loan certificates
(and the action proposed for the national currency associations)



was to be that of accepting given securities and issuing notes in
exchange therefor. In ordinary discussion, it is assumed that these
issues gave relief because they "increased the quantity of money"
in the community. A shortage in money had been brought about
as a result of public clamor and uncertainty, and this shortage had
to be relieved in some way. The relief was obtained, it was supposed, by issuing notes which took the place of some money that
had been withdrawn from the banks and had disappeared through
hoarding or otherwise. This was a complete misapprehension of the
situation and was not only erroneous in its statement of facts, but
in its view of the theory upon which the action of the clearinghouse was founded.

Misapprehensions of

The conditions by which clearing-house banks have found
themselves confronted in times of difficulty have been that, although
assets of known value were available, they could not be quickly
tested and converted into resources, thus making them available
for the purpose of liquidating obligations whose settlement was
called for.
The issue of the loan certificates grew out of two distinct
propositions: (1) the joint guaranty bjT the banks of the paper offered to them, since they issued notes based thereon to the extent
of 75 per cent of the paper accepted; (2) the creation of a readily
available and recognizable form of resource. It should be perfectly Real
plain that preciselv as much <;ood would have been done, had the ii. at " re



„ the Trans-

clearing-house, instead of issuing these ''certificates"' or "notes, action
granted to the banks presenting paper and asking for the certificates a right to draw upon the clearing-house a check which should
have been valid simply in payments to other banks. Confusion
has arisen; from the use of paper certificates, or notes of the kind
referred to, which have effectually masked the real nature of the
transaction. This real nature lay in the examination and testing
of credit paper and in the joint agreement to accept such paper
when once it had been tested and certified.
Now, what is inflation? It is currently stated that, if clearinghouses were to continue the operation just described, the result
would be inflation. So eager have clearing-house associations been
to avoid this danger, that they have usually penalized the use of What Is
the certificates by charging a very high rate of interest on them. l n f I a t , o n ?
This has been intended to "drive the certificates i n a n d , as the certificates have usually eome in very rapidly when the need for



them was over, it has been supposed that they had been driven in
by this rate of interest or tax. Inflation, however, is not to be
feared if every loan is based upon sound values which are promptly
The avoidance of inflation is found in redemption. Constant
redeemability of obligations means that these obligations cannot
become inflated—that is, cannot become too numerous. If, for
example, an issue of bank notes is thoroughly and fully protected
by cash reserves, yet the notes on the average remain in circulation for some time, the meaning is that the notes are needed in
the Remedy circulation and that the community is more benefited by having
them kept outstanding than by having them redeemed and reInflation
tired. If there is no method of prompt! redemption, or if there is
an artificial stimulus to the issue of notes which has no relation
to commercial necessities—as in a bond-secured currency—then
there may be inflation. That is to say, the notes may get
into circulation and stay there without reference to the exchange
function they perform.
This inflation may occur just as easily in the granting of
bank credits. The danger is there seen when banks accept paper
and allow deposit credits on the strength of it, notwithstanding
that the paper cannot be promptly met or is of doubtful value. In
this case, banks are practically putting their resources behind
property which does not grow out of actual commercial exchanges
and which, therefore, however good it may be in the long run, is
not a quick asset. Persons who know that they can go to banks and
obtain abnormal credit in this way, whether it be in the form
of notes or deposit accounts, recognize that they are able to use
as purchasing power values which under other conditions they
would have great difficulty in disposing of.
This is inflation, and it is a process which has nothing whatever to do with the amount of currency in existence or in circulation. From this, then, it is clear that inflation is to be feared
only when the extension of credit is made upon an unwise basis
and when, therefore, there is doubt about the immediate conExchange
vertibility of the credit that is granted and, perhaps, some doubt
the Test
of Soundeven about its ultimate convertibility. By convertibility is not
necessarily meant convertibility into "money" or "currency," as
many persons loosely assume. It means convertibility either into
money or into bank credits that have more recently been created.



Activity and prompt exchange are the tests of soundness. When
there is this kind of activity, there is nothing to be feared from the
extension of credit in the way described.
§11. Inflation is avoided, therefore, when paper is carefully
tested before being guaranteed, and is found acceptable as a basis for
immediate funds. If this testing is carried out with sufficient
care, and if it applies only to the live assets of the community,
there is nothing to be feared from a constant resort to it. More- Avoidance
over, there is no occasion for penalizing those who make use of of inflation
it. The charge properly made by thern is the regular commercial
charge for the use of capital in a given form for the period the
paper has to run. By making this charge, an institution, or a
cooperative group of institutions, is relieved of the necessity of
"carrying" any paper, and merely extends a business service for
which it is properly compensated. Those who thus convert their
assets into immediate resources do so because such resources are
more valuable to them than the cost of making the exchange. They
convert their paper into resources in this way because other* persons are calling upon them. to liquidate demand obligations or o f converbecause they see a possibility of using these resources as a means 8 i o n
of extending their business still further. For either of these reasons, they are willing to pay the price of conversion. When they
have done so, there is no hazard or risk unless they are unable
to meet their maturing obligation when it falls due, or, what is
the same thing, unless the person or firm who made the paper
, originally is unable to meet it when it falls due. In either of these
cases there has simply been a miscarriage of the conversion operation—that is, something has been mistaken for quick assets which
was not so. The remedy in this case is not to make it more expensive for all future borrowers to get their accommodation, but
is to employ more capable men or to install a more effective system for the purpose of testing the paper that is offered as a basis
for credit.
§12. In this matter of converting commercial obligations Advantage
into means of payment, just as in all other banking operations, of Reguthere is an immense advantage on the side of regularity. The ,arity *
operations of the clearing-house were unsatisfactory as regards the
issue of loan certificates because the function was an irregular one.


of the

Need of


There was no regular machinery for carrying it on, nor was there
any specified capital set apart. The loan certificates consequently
came into existence sporadically, and by means of hastily organized processes. The same thing would necessarily be true of the
currency now permitted to be taken out by National Currency Associations, although the hasty and unorganized character of the
transaction would not be so conspicuous with them as it was with
the clearing-houses.
Neither institution can aiFord the steady responsible type of
accommodation that is wanted. That can be obtained only by setting aside a definite capital and creating a definite organization
to do the work of converting heterogeneous commercial credits,
varying in origin and in type and resembling one another only in
their activity and short term, into immediate means of payment.
Such an institution, operating in the way indicated, has all the
advantage which come from economy and regularity in its operation. It represents simply the further carrying out of the cooperative principle embodied in the clearing-house and the subjecting of this principle to stated and recognized methods of application for the benefit of all who may need to invoke its assistance.
§13. From what has been said, it must be plain that an organization of banks which undertook to carry further the principles
involved in the joint testing of credits would find that the other
functions allied to this testing of credit which had heretofore been
performed by clearing-houses would be much more easily performed
by such an organization. It has been seen how clearing-house
banks cooperated for the purpose of bringing pressure to bear upon
every member in order to compel them all to avoid questionable
practices and to live up to the best professional methods in vogue.
It was noted that this result is accomplished by ordering either
periodic and sporadic, or (where a elecaring-house examiner is employed), regular examinations or tests of the condition of the banks.
There will always be a field for the exercise of this function of
joint examination no matter whether the ultimate process of testing paper and converting it into immediate resources be confided
to some special institution or not.
It is plain that the ivork of such an institution, if properly
carried out, would render immensely more simple the problem of
exercising the proper mutual control over bank operations. It



would place a heavy premium upon those methods of banking
which resulted in the creation of the right kinds of paper and
would penalize those methods of banking which resulted in granting accommodation to persons who were not entitled to it as estimated by the immediate character of their resources. While. Would

therefore, an institution of the kind described would be able to do Better
vastly more effective work than the clearing-houses by simply Banking,
carrying the principles employed by them to a higher point of perfection, it would in no wise usurp their functions. They would
still have an abundant field for the performance of the work which
they were fundamentally authorized to undertake—that of clearing checks and items that were deposited with the various banks.
They would, moreover, exercise an oversight over one another which
could not be exerted by any other institution of more general
Unless such an institution were organized with branches, which
has been proposed by nobody under existing conditions, it would
be necessary for the work of testing credit and making loans to be
complemented by the efforts of the clearing-houses. But this work
of testing credit and making loans must be carried on with a fixed
capital and upon a definite basis of business enterprise. Without
that, it inevitably assumes the temporary or sporadic character it
has heretofore had under the clearing-house system, and which it
would necessarily retain under'the plan provided for in the AldrichVreeland Act.
A cooperative institution would introduce no new principle
beyond that which has been pursued by the clearing-houses and
which it wa3 sought to legalize in the Aldrich-Vreeland Act. All
that would be done would be to carry this principle further, sys- Element of
tematize its working, and subject it to the safeguards and checks Novelty,
which are necessary in order to prevent undesirable conditions from
growing up. The only element of novelty in the system would be
that of organization and stability of method coupled with the extension of the plan harmoniously throughout the country.




A Central
Bank In

Three General Types of Banking.—2.
Banking Systems in the
United States—3. European Banks—4. Canadian System—5. Defects of the Competitive System in the United States—6. Statistics
as to Distribution of Reserves and Deposits—7. Tendency to Concentration of Control.—8. Development of Joint Control—Holding
Companies—9. Effect of Government Deposits—10. Cooperation
under Present System Limited—11. Organized Legal Cooperation—
12. Economy of Reserves—13. Kinds of Paper Rediscounted—14.
Gains of Legal Cooperation—15. Summary.

§1. A review of the banking systems in vogue throughout the
world at the present time shows that they may be classified as belonging to three general groups or types: ( 1 ) Those depending
on a central bank as their principal feature; (2) those based on
independent competitive banks; and (3) those involving a cooperative principle. The question as to which plan is best adapted to the
needs of a commercial country has been actively discussed for a long
time. Probably no final answer can be given to it. The decision
in every case must depend upon the conditions existing at the
time in any given country. In general, the tendency of modern
commercial countries has been away from the purely competitive
and independent type of banking system. There has been a strong
drift toward either centralization or cooperation. In some cases,
this drift has been guided by legislation; in others, it has gone on
without any official or legal recognition, simply by virtue of the
demands of business and economy of resources.
§2. Early in the history of the United States, the idea of
centralization in banking was advocated. Hamilton urged the
establishment of a large central bank in his famous report on that
subject in 1791. Later in the same year such a bank was actually
established and lasted for twenty years. Meanwhile, many banks




had been chartered by the several states and had come into operalion on a competitive basis.
After the close of the charter granted the first bank of the
United States, a renewal was refused by Congress, and there ensued
a period of about five years during which full opportunity was given
state banks for development. In that period, the United States
government had no single financial institution upon which to rely,
but called upon the state banks for such loans, and other banking
facilities, as it stood in need of. This proved unsatisfactory, and
in 1816 the Second Bank of the United States received a twentyyear charter. This bank, like its predecessor, acted as fiscal agent of
the government, furnished such loans as the Treasury needed, and
generally exerted a steadying and controlling influence over the state
banks, which continued to be chartered upon a competitive basis.
A renewal of its charter was also refused after a long and bitter
political struggle, lasting from 1S29 until the close of the existence
of the institution.
From 1837 down to the Civil War, the system of banking in
the United States was entirely under state control and rested on a
purely competitive basis. No federal legislation relating to banking was adopted, and the only serious innovation upon previous conditions was found in the establishment of the independent Treasury, which was to act as the custodian of public funds. Under this
state banking system, as many different kinds of currency as there State
were banks in the country were issued, while the government, could B a n k 3
not in case of necessity obtain the support of any very strong single
After the opening of the Civil War, the national bank act
was passed (1863) for the purpose of supplying a uniform currency and aiding the government, through the purchase of bonds
which were to be used as security behind bank notes. Later (1866),
state bank notes were driven out of circulation by a ten per cent National
tax levied upon them. Access to the banking system was free, those B a n k a
who would organize a bank being permitted to do so without restriction, provided they were able to furnish the necessary capital
and comply with moderate requirements concerning the conduct of
Since 1863, the national banking system has been continually
in existence and nearly 10,000 institutions have been chartered at
the date of the last Comptroller's Report, 1911, of which 7,301 are



still ill existence. States and territories have in the meantime gono
on incorporating banks under their own laws. Thus there has
been perfectly free competition in banking throughout the United
States, save in so far as related to the issue of notes. This function
has been reserved to a single class of banks—those in the national
system—but within the national system there has been absolute
freedom of action in issuing notes subject to the requirements of the
national bank act. These restrictions have been the same for all
banks of similar size.

Bank of

Bank of

Reichsbank of

§3. The course of development in the United States has been
very different from that which has existed abroad. In England,
the Bank of England was chartered in 1694 and has continued from
that day to this, standing in a peculiar relation to the government
as its fiscal agent, and ultimately taking to itself the function of
note issue in a practically exclusive manner.
By long-developed
custom, the Bank of England has become the reserve holder of the
country and has grown into what is practically a banker's bank,
although it does an extensive business with individuals. In this
peculiar position, the Bank of England is able to act largely as the
financial dictator of the English credit system—a power which it
has exercised with judgment, non-partisanship and discretion.
In France, the Bank of France was developed in 1S00-1803 and
has continued in operation since that time. It enjoys a monopoly
of note-issue, practically holds the reserves of the country, and,
while doing an extensive business with individuals, also serves as
the great market for rediscounting paper presented by other banks
and financial institutions. With its system of branches throughout France, it operates as a controlling agency, regulating in the
main the banking customs, and determining the flow of specie into
and out of the country, subject to the general conditions of international trade.
Similar functions are exercised by the Imperial Bank of Germany, organized in 1875. Most of the continental countries of
Europe have followed this same system of establishing central institutions, standing in close relation to the governments of these
states and exercising a general oversight over banking. Most of
them, however, are privately owned. A recognition of the public
quality of the service with which they are entrusted is obtained by
subjecting them to constant and watchful government oversight,




while in the case of most, there is direct governmental participation in the management of their affairs. The effort is made in every
case to give the commercial public a voice in the management of tbe J^r^ae,an
institutions, and to ensure that they shall be carried on in such a Banks
way as to serve the commercial interests of the countries where
they are situated.
The pressure of public opinion in the highly organized and
closely centralized countries of Europe also has an important influence in keeping the banks true to their public quality and preventing them from neglecting the duties which fall upon them in consequence thereof. Thus, in most of the European states, the basis of
the banking system is found in a strong central bank which constitutes the connecting link between the government and the public.
This bank holds the reserves of the other banks to a very large extent, and furnishes credit to the community, besides regulating the
importation and exportation of specie.
§4. Canada has developed her banking system in a different
way, and may be regarded as the best example of the cooperative type
of banking to which reference was made above. The peculiarity of
Canada's system lies in the fact that, although there is no single institution possessing an exclusive monopoly of note-issue, or of any
other function, and although there is no government bank holding Canadian
public funds and possessing the power to dictate the use that shall gy^em9
be made of the cash resources of the country, practically all of
Canada's banks are of large size. At present only twenty-seven different institutions are in operation, and the requirement of the law
is that no new institution shall receive a charter if it has a capital
below $500,000. Every bank is permitted to establish as many
branches as it sees fit, and some institutions operate hundreds of
such branch offices, there being in all nearly 2,000 branch offices. Branches
Notes are issued by all of the banks, but they are guaranteed by
a fund which is contributed by the various institutions, and which
is used for the purpose of redeeming the outstanding notes of failed
banks, being reimbursed, so far as possible, from the assets of such
banks when their affairs are settled.
Thus Canada, without having a centralized banking system,
enjoys many of the advantages of such a system. The number of
responsible managers of the banks is small and consultations can
easily be had. The banks—as said—are all substantial in size, and



the degree cf cooperation among them is high, even in those particulars that are not subject to legal regulation. Under the law,
they are required to cooperate absolutely in safeguarding their
notes, and they have always succeeded in protecting them fully.
On the other hand, a measure of competition is assured by the possibility of chartering new banks, each with the issue function, at
any time when applicants with sufficient capital in their possession
present themselves. Moreover, the keenest of competition in serving the public is secured through the operation of the branch system.
Thus, although access to the Canadian banking system is not a
mere routine matter, as it practically is in the United States, there
is an approach to free banking at the same time that there is preserved a very substantial part of the advantages of central banking.


§5. The United States affords probably the best example of
a competitive or free banking system. In the effort to assure perfectly unhampered access to the system, admission has been mado
general, the law providing for the granting of charters through a

merely routine or administrative act on the part of the Comptroller
of the Currency in Washington. In order to prevent the pressure
ompe ive o f com p e tItion from being applied by large institutions to small
ones, the law has practically prohibited the establishment of
branches, while interpretations of the act by the Supreme Court
have rendered it illegal for one bank to control the stock of another.5 Altogether the idea of individualism and separation in
banking has been developed here as far as law could bring it about.
The good features of this system have been so fully realized that
it is probable that its fundamental features may be regarded as
firmly fixed. There is no probability that free access to the business
of banking will be denied under any legislation. At present there
seems to be little chance that the establishment of branches will be
permitted. This means that there will be a permanent retention of
conditions in which many very email banks must exist in order
to meet the needs of the communities they serve, and in which there
will be no direct control by one institution, or group of institutions,
over another.
The maintenance of such conditions necessarily involves some
rather serious suffering. Among the difficulties which have been
JSee, California National Bank vs. Kennedy, 167 U. S. 362; also First
National Bank of Concord vs. Hawkins, 124 " U. S. 364.



found to be characteristic of the national system, are those of wide
diffusion of reserves, extravagance in the use of banking resources,
lack of cooperation, inability to finance large operations with ease,
lack of control over the exportation and importation of specie and Defects
numerous others. Yet it is probable that all of these defects would
be endured if it were true that competition and independence had
been maintained contemporaneously with them, or that it could
not be had without them. Neither of these suppositions holds good;
for today a high degree of banking centralization has, unknown to
the community, been produced; while an easy means of escape from
it and from the evils incident to the present system is undoubtedly
available. The truth about existing conditions in the banking system of the United States and the actual degree of centralization that
has been attained can be best understood from a survey of the present relations between banks. How this system operates to put the
funds out of the control of their owners is seen by a survey of the
actual distribution of reserves at the present moment.
§6. The following figures show the reserves of country national
banks (1883-1910) classified as lawful money held, due from reserve
agents (held by other banks on deposit), redemption fund (held by
the Treasury).
Number of


2, 1883..
7, 1886..
5, 1887..
2, 1890..
25, 1891..
2, 1894.28,1895..
6, 1896..
5, 1897..

. .2,417
. .2,467
. .2,590
. .2,847
. .2,992
. .3,430



Classification of Reserve
Due from Redemption Total





$157.5 of Reserves



Number of


20, 1898. ...3,259
7, 1899. ...3,274
5, 1900. ...3,540
30,1901. ...3,885
15, 1902. ..,4,268
9,1903. ...4,691
6,1904. . . .5,065

Aug. 25, 1905. ...5,412
Sept. 1, 1906. ...5,781
Aug. 22, 1907. ...6,178
Sept. 23,1908. ...6,482
Sept. 1,1909. ...6,595
Sept. 1,1910. ...6,791
Dec. 5,1911.....6,949

In Other

In State


Classification of Reserve
Due from Redemption









The showing indicates the extent to which the country banks
have placed their resources at the disposal of others. In 1911 much
less than one-half (§2-16.3 millions) the total reserve ($551.7 millions) was in the actual possession of the country banks.
But the practice of redepositing bank funds has been carried
much beyond the limits of the reserve system. In the following
table is reviewed the growth of the items "due to national banks,"
and "due to state and private banks" during the years since 18?5.
The figures are given by five-year periods down to the year 1900 and
once a year thereafter, the date chosen being the earliest report date
in each year. From this compilation it can be seen that, while the
growth in the items has been irregular, the tendency has been
strongly upward. For the report of January 31, 1910, the figures
show $962,000,000 against $137,000,000 in 1875. For 1900 (February 13), the figure was $536,000,000. The item "due to state
and private banks" does not show the same steady growth, but
fluctuates considerably, though it is now largely in advance of the
figures for 1900. One reason why this latter item has not grown
more rapidly may be the large development of the trust company
system and the increase of deposits in national banks carried in
favor of these institutions. Taken in the aggregate, the items "due
to banks" have grown much faster than the capitalization of the national system.






Bank Deposits In National Banks
Due to
National Banks


Due to State and
private Hunks

$ 55

The effect of the redeposit system has been to give to the city
banks actual control over the fluid funds of the country in very
large measure. Naturally this control has centered in New York
City. The outcome has been that, without the necessitv of con- CentrallzaJ
tion of

trolling the stock of country institutions, large city banks have Reserves In
through the redeposit system been able to exert the practical con- New York
trol of which so much is now heard.
The following tabulation shows the growth of the system in New
York City, since 1890:





Bank Deposits In New York
Due to
National Banks



Due to State and
Private Banks

$ 48


Deposit fn
Banks of
New York


Exceptional significance should be given to the growth of these
items, which show in part the development of relationships between
state and national banks. In many places it has come about that
the national banks are practically the "bankers' banks" of the region ; the state and private banks, trust companies and other institutions depositing largely with them and relying on them for loan9
and rediscounts when necessary. In truth, the New York banks
jointly have come to stand in a relation to the other banks of the
country very much like that of the Bank of England to the other
banks in London and the country. This, of course, means that
the national banks have tended to assume the function of holding
the reserve money of the country which is left with them, not only
by trust companies and similar institutions, but in many cases by
state banks. It is not to be assumed that this is always the case,
but in a large number of instances it is so. Moreover, it has been
seen, from the statements already made, that the national banks in
reserve cities are practically assuming a position in which they hold
the surplus reserve of the other national banks of the country, such
reserve being more and more closely controlled by city banks. This:
has been the natural evolution of our banking system in the effort;
so far as possible, to economize reserves.

§7. The practice of doing a banking business with other
banks has grown extensively within the past few years. At present, small banks the country over, when purchasing paper, keep in
mind the possibility of obtaining accommodation from other banks
from time to time as they find it desirable to do so. This again
is another result of the tendency to economize resources. The
small banks buy paper when times are dull at home, in order that
they may keep their resources active and earn a fair rate of return
for their stockholders from year to year. It is, however, necessary
for them to take care of their own customers. Many of these customers arc intermittent, or periodic, in the demands they make
upon the banks for loans. At times, therefore, it becomes necessary
for the banks which serve them to relieve themselves of some of
Dependence the paper, and thereby secure fluid funds for use as a basis of loans
of Small
to customers who need such accommodation in their regular busiBanks for
Redisness transactions. In order to be sure of a rediscount market for
their paper in this way, it is necessary for banks to establish a
more or less close affiliation with banks in reserve cities. This re-



lationship permits the reserve c-ity banks to exert a very distinct
control over the operations of the smaller institutions. Such control is none the less effective for being indirect and based on no provision of law. The small bank recognizes the necessity of shaping
its operations in such a way as to be sure of accommodation from
the larger institution. Thus, in another way, a strong tendency
towárds outside control of the bank's business is set at work.
Another indication of the concentration of control of banking
capital is afforded by a study of the changes that have taken place
within recent years in the relative numbers of banks of different
capitalization organized under the national system. Comparisons Tendency
cannot be made with absolute fullness and exactness, owing to the


introduction of a new class of banks of $25,000 capital by virtue of tion
the law of March 14, 1900. Some interesting inferences may, however, be drawn from the following table :
Capital of National Banks Classified by Size of Banks, 1870, 1880, 1890,
1900, and 1909
x rc c
- , C ri
Od Cw,a í


ç2 o __
d c chS
c •
. . . . 457
. . . . 650
. . . . 630 $6
. . . . 944 57





i- m GO
« do
m o
¿ ^ d g r t ^ g d
.¿¿ o $
o— « c o o—
o— « c - . C
— ~- - o
^ o^c ^
_ a a
.ü d i : «
< •=—„ o
C Ü S « Ci
$14 3.4
29 6.4
72 11.2
1.0 83 13.2
6.1 117 12.5
6.2 121 12.1
6.1 123 12.0

„ ri


cUü ^c ^
_ d
n.'Z^ o
cí — — °
cirn o tí C^ «m o
$150 34.9 $123 2S.7
169 37.1 107 23.5
218 33.5 150 23.2
179 28.4 130 20.8
193 20.5 221 23.4
195 19.5 225 22.5
197 19.7 232 22.7


cí!T>^ «
$20 -1.6
10 2.1
10 1.5
35 5.5
112 11.9
152 15.2
160 15.5


This showing indicates that, while there has been a remarkable
increase in the relative proportions of banks of the largest capitalization, there has been a relative decline in the numbers of those
of medium capitalization. The small banks of less than $100,000
capital have increased largely, while the same is true of the very
large banks, possessing $5,000,000 of capital or over. This points
to a growing tendency of banks to drift into two classes, the one
with very small capital depending upon the other, possessed of immense capital, for general accommodation.



Through a


Under the existing banking system, therefore, it is evident that
centralization of control is already on the way to being effected.
The situation is one which thus calls for some corrective, if bank
independence is to be maintained. Consolidation of banks has
gone on rapidly in reccnt years in nearly all of the large cities of
the country, the assets of one institution being taken over by others,
institution thus sold immediately going out of business, or the
stock of both institutions being retired and replaced by new issues
in specified proportions. The growth in the number of banks of
large size cannot, therefore, be regarded as simply the result of the
advance in wealth, or of the increasing demand for the services of
large institutions, able to make immense single loans to institutions
and corporations, but it is also indicative of a disposition to construct these large institutions by using smaller ones as component
parts. It is thus more or less an indication of the development of
control by large private financial interests over the banking resources of the country.
§8. If there were any doubt as to the progress in centralization of control in American banking, it would be entirely dispelled
by the results of an inquiry which was ordered by Secretary McVeagh, of the Treasury Department, in July, 1911, in connection
with what was known as the National City Bank case. AttorneyGeneral Wickersham, of the Department of Justice, investigated
a recently organized New York concern, chartered under state
law and known as the "National City Company" of New York.
This organization had attracted the attention of the AttorneyGeneral, partly because of its announced intention to own bank
stock, and partly because of the fact that it was owned and controlled by a body of stockholders who were nearly identical with
the stockholders of the National City Bank, the largest national
bank in New York and in the country.
Mr. Wickersham found that the company was, as reported,
established partly with a view to holding stocks in other concerns,
some of them the shares of national banks. He reached the conclusion that a joint control of this kind on the part of a body of
stockholders in a national bank who also owned shares in a state
concern, the one ¡not to be transferable except as the other
was transferred, was inharmonious with the purpose and spirit


20 5

of the national bank act itself.* One reason for the adoption of
this point of view was found in the circumstance that the National City Company, or any concern organized in a similar way,
could be used as an instrument designed to defeat the intent of The
the framers of the national bank act. The Supreme Court, Mr. Q^y 0 ^ 1
Wickersham noted, has invariably taken the view that such joint
control is not permissible, and that national banks may not own
the stock of other national banks. Attention has been called to
this matter elsewhere. If now, he reasoned, they accomplish the
same object by reason of an instrumentality created under state
law, for the purpose, in whole or in part, of holding the stocks
of other national banks, is this not a violation of the plain intent
of the national bank act? Reaching the conclusion that it was
so, the Attorney-General submitted his opinion to the Secretary of
the Treasury, who referred it to the President of the United States.
The investigation ordered was intended to show how far a
similar type of control exists throughout the national system. It
resulted in listing the names of about 300 institutions which possessed the same or similar relationship to other banks that existed in
the case of the National City Company and its parent institution,
the National City Bank of New York.1
In this direct and simple manner, there has sprung up in the
national banking system a method by which banks may control
other banks as far as they desire or have the means, since there is
no reason why state institutions, jointly controlled with national J^t'of"
banks, may not purchase and hold the stock of any number of other Joint
national banks, thereby permitting the stockholders in the original
institution to control as many others as they wish or as their means
will permit. It is not true that in every, or nearly every, case where
this plan has been resorted to by national banks, the affiliation with
•The original announcement of the purposes of the National City Company said:
The board of directors of the National City Bank have decided to form
a security company, with a capital of 510,000,000, in which stockholders
of the bank mav acquire a beneficial Interest according to their holdings
in the stock of the bank.
This plan has already been approved by stockholders representing considerably more than two-thirds of the stock of the bank. As part of this
plan, directors have declared a cash dividend of 40 per cent on the capital
stock of the bank, payable Julv 10 to stock of record July 5. This dividend
is declared to facilitate stockholders in acquiring beneficial interest in the
security company. Evidence of this beneficial interest will be stamped on
the shares of th'e Crty Bank stock.
»The National City Company has since declared Its intent to dispose
of Its bank stocks.


of Banks


the state bank or trust company has been brought about for the
purpose of owning and controlling bank stocks.3 This has doubtless been done in some cases. But the fact that there are three
hundred instances in which machinery has been devised and set
in motion, which would permit such control, is another evidence
of centralization of banking authority which should frankly be
inet. It constitutes a criticism upon the existing situation, and
unless provided against, in whatever plan might be adopted for
the future, it would constitute a means through which any institution managed by banks as stockholders might be dominated.
Nor is the system of joint control the only indication of centralization effected in this same general way. The investigation»
of the Comptroller of the Currency during the past year or twe
have shown that in numerous instances, series, or "chains," of
banks are organized and owned by the same group of persons.
Sometimes, when banks have been independently organized, a majority of their stock is purchased by persons who already hold the
majority of the shares in one or more other national banks. Thus,
a community of interest within the national system is established,
whereby large banks control and direct the policy of others. Where
the subordinate or controlled banks are themselves influential factors in a local banking group, as, for example, in a clearing-house
association, the actual and real control exerted may be very much
more extensive and powerful than the purely nominal control
obtained through direct ownership of stock. In such cases, a
nucleus is formed for the extension of banking influence over a
considerable area, or over a considerable group of financial institutions.
No figures are available in published form to show precisely
how extensive this type of control is, but it is an undoubted fact
that it has already gained a .substantial foothold. This is attested
by the inquiries of the Comptroller of the Currency, and by commonly know n and observed facts concerning inter-bank control in
well-known instances.

Extent of
Control By
Chains of

A New York bank, for example, gains control of smaller banks
in Washington and at various southern points, through the purchase of stock in such institutions by directors or controlling
stockholders of the New York concern. It is then in position to
*v, i n , ? ? m e
example, in Illinois, the statutes expressly forbid
the holding of bank stocks by other banks.




direct country deposits toward itself and to exert a general control, not only over the institutions whose stock is owned, but also
over those which are tributary to the owned or controlled banks.
In this way, networks of banking influences have been allowed
to develop and spread over the country, to what precise extent
cannot be stated, although their scope is unmistakably large.
There is nothing in existing law to interfere directly with the
growth of this kind of control, and should a new system of cooperation between banks be established for the purpose of economizing
reserves and supplying discounts, it must be done in EUCII a way
as to avoid the danger of undue influence which could make itself
felt through the extensive voting control obtained by national banks
in the way already indicated. Moreover, this system of control is A Remedy
by no means limited to the national system, although it has been N c c d e d
more carefully studied there. Extensive inter-bank relationships
of a like kind are known to obtain in many of the states, small
trust companies and state banks being, in practical effect, branches
of other and larger institutions.
§9. There is another way in which centralization of control
under present conditions has been greatly forwarded, and in which
outside financial influence over liquid funds has been strengthened.
This is found in the relation of the government to the banks. Under existing law, government revenues are paid in to the Independent Treasury, which holds them in actual cash. The Treasury,
however, cannot hold these funds long in any great quantity, without doing serious harm. It, therefore, will wish to put them back
into circulation as soon as may be, in order that there may be no
shortage of reserve money due to its withdrawal of funds through
the receipt of revenues and through the failure to pay out an equal
amount in current disbursements.
Such a return of the funds to commercial channels is usually
effected under existing law by making government deposits in national banks. These deposits are protected by requiring the banks
to leave with the Treasury, bonds of specified kinds, which might be
sold in the event that the failure of the depository bank should
expose the government to the risk of loss. The bonds may be
owned by the banks which deposit them, or may be borrowed from
others, but in any case, they are turned over to the Treasury, and
title is transferred, in order to protect the government.

by Government

Bond ®



of Deposits

to Relieve
the Market


There is no criticism upon the system of protection, but very
severe criticism must be made upon the way in which these deposits
have been made in the past. In ordinary times, such deposits have
been distributed largely upon a political basis, the attempt being
made to apportion them somewhat according to population, geographical distribution, or bank capitalization. Not infrequently the
distribution has been made, also, by political pressure. In this
way harm was done, because banks received control of funds which
did not normally arise in their own communities and which were
drawn from some other community that had acquired control of
them as the natural result of its commercial operations, often in
places and under conditions where trade was the greatest.
In times of panic or stringency, however, the situation has
been even less satisfactory. On such occasions, the government
has often been driven to placing its funds in large blocks with the
banks in the principal cities. It has sometimes appeared that the
reason why some of these institutions were in such great want a3
to require relief was that they had been making excessive loans
for speculative purposes. When speculation threatened to break
down, relief could be had only by getting more government funds.
In such cases, it would often be unwise to withdraw or curtail the
speculative loans, inasmuch as such action would result in commercial depression and disaster. On these occasions, therefore,
the action of the government in depositing largely with banks
in the larger cities, "in order to relieve the market/' has been
equivalent to the placing of government funds at the disposal of
speculators who were permitted to use them for their own purposes. This course of action could not be justified upon any
grounds save those of necessity—a necessity growing out of the
peculiar organization ci our banking and credit system at the
present moment.
§10. It has thus been evident for a good while that the system of nominal competition establish.::1 under the national bonking system was not real, and that actual centralization had developed
because of the weakness of the smaller banks and their necessary
recourse to others in times of special strain. Only the defect?
of the competitive system in banking have been retained—the weakness of reserves, the inability to accommodate borrowers, and the
susceptibility to panic. The facts in the situation have been long

perceived, even if only subconsciously, by the banks, and it has Failure of
been recognized that the evils of the system could be corrected by ?0° Present"
the use of some plan of cooperation, without a resort to legal cen- Centraiizatralization in banking. It was seen that the most expedient and ° n
easy way to introduce into the United States the superior safeguards and more advantageous methods found in foreign systems
of banking was not the mechanical adoption of some legislation
of doubtful utility and dangerous suggestion, but rather that of
effecting a closer cooperation among the banks themselves. Efforts to get such cooperation have taken very definite form.
The best and most natural step was the organization of associations of banks called clearing-houses. As we have elsewhere
seen, the first of these was established in New York in the year
1853, but this did not long remain an isolated example. Informal
conferences and associations of banks early came into existence
in many places, and at present there exist formally organized clearing houses in about 13? localities.
So successful were these clearing-houses in their work of cooperation at periods of stringency, that they were later able to aiiord
a lesson in practical legislation. The Aldrich-Yreeland Act, passed
in liJOS, sought to apply, through the organization of "national
currency associations," the same methods of mutual aid which
had been developed by the clearing-houses. But the AidrichYreeland Act has been thus far practically a dead letter, and
the clearing-houses in their exercise of credit functions have continued to be merely temporary expedients. Whenever the period
of worst danger has passed by and the community has reached
a calmer mood, they have been disposed to "stand from under/4
and at times this has resulted in forcing a number of weak banks
to the wall. It would have been well if the cooperation had begun
early enough to prevent such banks from becoming weak, or had
continued long enough to enable them to recover their solvency;
but under a purely voluntary system of cooperation, neither of
these desirable objects could be gained.
Moreover, the banks hitherto have never been able to obtain
by joint action any satisfactory method of controlling reserves or
economizing the use of funds, and of course they have never had
any means of regulating the flow of gold and silver into and out
of the country. That could be accomplished only by cooperative
action of a very close and well-defined type, or else by the action





of some central institution acting as a reserve-holder for the country

and recognized as the leader of the financial community. There
is nothing to indicate that any of these objects can, or will, be
obtained under the present system.

A Central
In the

Cooperation or joint action on the part of the banks has evidently gone about as far as it is likely to go. There are few or
no particulars in which it seems possible to draw the relationship
between the institutions closer than at present. This implies that,
if anything is to be done in securing better joint action from the
banks, it will have to be accomplished by some plan of federation
in which, while preserving their own freedom and individuality,
they will join under legal forms, for the purpose of promoting the
interests of the banking system of the country as distinct from that
of each individual bank. The experience of other countries, as
already noted, shows that these results may be obtained, either
through the establishment of a central institution or through cooperation. Our own experience points to cooperation as not only the
line along which voluntary development has been proceeding, but
also that which holds out the easiest and most promising avenue
to the attainment of the safeguards and convenience realized by
foreign banks.
The universal testimony of those who have studied political
and economic conditions in the United States is that a central
bank, in the sense in which such institutions exist in Europe, is
not only impossible but undesirable. Such an institution, privately
owned, would be regarded with suspicion by the public. Our own
experience during the first fifty years of American history with
such an institution was unfavorable from the political standpoint.
It is seriously to be doubted whether such an institution could, as
a matter of practical legislation, be obtained again. And there
is the best of reasons for questioning whether a bank of this type
would be desirable, even if it could be chartered. The large institutions of Europe are successful, partly because they have a recognized
place in the community, which has been gradually developed
through long years of custom and tradition. They stand in a
peculiar relation to the governments of their countries, which is
feasible because of the types of administrative control which exist
there, but which would not be feasible with the types of administrative control which exist here. European countries are much
smaller than our own and their commercial systems are organized



about a few well-recognized financial centers. They do not present
the same widely divergent types of climate, industry, population
and competition that are included within the United States. This
means that a central bank, if established here, would have a do- European
cidedly different problem to deal with from that which is presented
in any of the European countries. Nothing would be more unwise than simply to copy the external features of a European banking system without having the basis for it which makes it successful. It has been said with justice by some critics of the so-called
"central bank" plan, that if we were to adopt that system in the
United States, we should need not one, but several "central*' banks.
It is at all events quite clear that a single central institution,
privately owned, and similar in its nature to the groat government
institutions of the present day, or similar to the two great banks
which were chartered by the United States during its first fifty
years, could not be created to advantage.
It has been suggested that the government itself should perform banking functions, accepting the duties which are met by the
large central banks of Europe, and in some way holding the reserve of the country and extending accommodation to bankers who
might desire it. This scheme has never assumed any distinct form,
and is too nebulous to warrant very serious discussion. This point,
however, will be given more complete treatment elsewhere. It
should be said, however, that no government bank is likely to bo A Governsatisfactory or efficient in the United States, and that such a Treasuryscheme is too hazardous, under our political conditions, to be con- Bank
sidered for a moment. Practically, then, there remains merely
the question whether some reorganization of American banking
that will meet existing difficulties and permit cooperation is possible. The natural way in which to work out this sole method
of reform is through the application and development of the methods
already resorted to in a rudimentary way by the banks. The problems involved in bringing about such a result may now be briefly
§11. The fundamental necessity in introducing a regime of
cooperation among the banks is that of regular and organized legal
cooperation. As has been seen, all forms of cooperation thus far
have been informal. True, to national currency associations has been
given a legal existence, but their operation is sporadic and purely

voluntary. These two things condemn the National Currency Associations and limit their usefulness to exceptional periods of crisis
or stringency. We do not want a "panic currency/' or any means
of "relief/' What is wanted is steady support that will render
relief unnecessary, and will prevent the recurrence of stringency
calling for such relief.
In order to get this sort of continuous and sustained cooperation among the hanks, it is evidently necessary to establish some
institution with a definite capital which will be in continuous existence, applying itself regularly to the duty of supplying bank credit
as needed. By whom should such an institution be owned ? There
is, as noted, abundant reason in political conditions why it will
not be feasible to place the ownership of such a concern in the
hands of private individual stockholders, even if it be rigidly supervised, and perhaps in part owned by the government itself. We
have also indicated briefly why the stock cannot all be owned by
the government itself. This leaves only the banks themselves as
possible stockholders. If they were to be called upon to organize an
institution in which all banks could share, they would be entirely
freed of any fears of undue outside competition. They would know
that a minimum of profit would be redistributed among them
equally; and, more important still, they would know that such
Should Be
an institution could be conducted in a way that would give>due
by the
consideration to every stockholding bank. The public would thus
be assured of receiving ultimately the benefits from the operation
of silch an institution, inasmuch as free banking would continue
and competition between banks would be as keen as it now is. This
would imply that every bank, whenever organized, should be permitted to become a stockholder in the new institution. The organization could, therefore, never become a monopoly.
If every bank, whenever organized, were permitted to take
out a specified amount of capital stock in the concern and, whenever it went into liquidation, were to be compelled to surrender
its stock, the organization would have an outstanding capital corresponding, in a fixed proportion, to the total capital of the bank9
of the country, and increasing as that increased and diminishing
Cooperation as it diminished. The advantages of such an organization would
be, while preserving their individuality, to give a definite and fixe3
relationship to the banks that were members of the organization,
with reference to their cooperative functions, and to place them in
and Continuous Cooperation



position to get the direct benefit of joint action. The creation of
such an institution would imply that a sufficiently large capital
had been contributed by the banks and had been made available
as a basis of business operations. That such capital could be made
to earn a fair rate of return for those who supplied it, there is
no reason to doubt, while the gain in permanence and stability
for the cooperative organization would be far superior to any mere
earnings that the institution might produce.
If such an institution were to be genuinely cooperative in its
functions, it should necessarily be so restricted in the elapses of
business it could do as not to compete in any undue way with the
banks that had become stockholders. The first limitation upon its
business, then, would be that it should not deal with individuals at
all, or only under very carefully described circumstances. Its business should be limited in the main to dealings with the banks that
had established it. This would signify that all testing of paper
presented for discount, and all determination of the amount and
character of loans, would be effected in the first instance directly
by the several banks that held stock. After such banks had acquired
commercial paper or made loans on securities, they would be in
position to do business with the cooperative association. This business would consist primarily in rediscounting the paper which had
been created in the way already described. A few other classes
of business would probably also be undertaken, as will be seen
In performing this rediscount business, the cooperative institution would afford a permanent and constant market for commercial paper. If the banks could secure better accommodation
from one another, there would be no reason why they should not
do so. The cooperative institution would make no effort to compete with banks which were disposed to discount the paper of others.
But, in those cases where banks preferred not to sell their paper
to others, or where rediscounts were refused, or where the transactions proposed were so large as to be beyond the reach of the banks
which were asked to buy or rediscount paper, the new institution
would afford a stable, regular market. In so doing, it would provide a means of escape from all danger of bank favoritism, and
from any discrimination that might otherwise exist among institutions as under the present system. Its operations would be carried
on upon a basis of equal opportunity for all and upon equal term*




Also Create



to all Not competition, but the rendering of assistance and the
promotion of convenience, would be the duty of the new institution.


§12. It is probable that, with such an organization as has
been described, there would be developed a very strong tendency
toward economizing and conserving the stock of reserve money in
the country. Thi6 would mean that the stockholding banks, by depositing their funds with the association, would not only provide
resources upon which to draw in normal times
upon the principal financial centers, but also, they could feel assured,
under the rigid restrictions by which the concern would be controlled, that their funds would be available whenever they might
wish to use them. This would be rendered possible by the grant
of much more liberal powers of note-issue than are now conceded
to the national banks, and by much greater economy in the distribution of the reserve funds. It is proposed that the various banks
should be subject to much the same reserve requirements as at
present, but that in counting their reserves, they should be allowed
to include such credits as they had secured with the National Reserve Association, or cooperative institution, as described. This
would mean that in practice, banks would keep in their vaults only
those amounts of actual currency which were required to meet current calls for cash.
As will be seen elsewhere, the proposed plan calls for the
ultimate absorption of the power cf note-issue by the National
Reserve Association. That being the case, a bank which found

AskNotehei° i t s e ! f r u n n i n g l o w i n reserve funds, would supply itself, not by
Banks fop calling upon some other bank in another city for actual lawful
m 0 D e ^ n o r by borrowing bonds and securing, after considerable
difficulty, an issue of notes through the Treasury Department, but
by simply taking such live commercial paper as it might have to a
local association of banks, or direct to the local branch of the National Reserve Association, and obtaining a rediscount. Under
such conditions, the banks would not care to keep on hand very
large quantities of coin or government notes in their vaults. InHoardlng
6 t e a d 0 f hoarding these resources as they now do, they would place
them where they would be most convenient, that is to say, with
the National Reserve Association.
The Reserve Association would be required to keep on hand
an ample supply of coin and government notes for the purpose



of meeting actual calls for money and currency. Probably the
amount of reserve the institution should thus be required to keep,
under normal conditions, should not be less .than 50 per cent in
lawful money. In order to insure that this reserve requirement C h e c k o n
-hould not be a rigid limitation which would prevent the Associa- Reserves
tion from granting the discounts that were needed, it should be
provided that the Association might let its reserve run down, provided that for each unit of decline there should be a tax increasing
proportionately as the reserve fell. This would mean that while
the Reserve Association would probably be willing to discount
first-class paper, even if its reserve were at or below the 50 per
cent line, it would not be willing to do so without charging an
extra rate of interest. If it charged such a rate of interest, in
addition to the commercial or going rate, banks would hesitate
about demanding rediscounts. They would call for them only
when they felt a genuine necessity for an increase of credits with
the Reserve Association; that is to say, for an increase of what
would to them be reserve money.
It can be seen that the effect of this system would be (a) to
reduce the actual lawful money held by the banks in their own
vaults and to transfer this lawful money to the Reserve Association; (b) to make it possible for banks to obtain all needed additional credit (which to them would be reserve) by paying suf- Gains from
ficiently high rates of interest at the National Reserve Associa- %°%c0™tlon
tion offices; (c) to induce the National Reserve Association to omizlng
keep its reserve at a safe point by compelling it to bear the bur- R ® l c r v c «
den of heavy taxation upon all shrinkage below 50 per cent.
Thus the stock of money of the country would be economized.
More than this, the stock of money would be shifted to those
points where it was wanted. When banks did not need large
reserves, they would not call upon the Reserve Association for
rediscounts; they would keep the cash reserves in their own vaults,
or deposit them with the Reserve Association, but without asking for accommodation. Other banks in other parts of the country might at the same time be suffering from some stress. If the
Reserve Association were well supplied with funds left with it by
banks in regions which did not need accommodation, it would, by
reason of this abundance of resources, be able to extend credit
cheaply to the outlying banks whose resources had run down.*
•This institution would then, in Its own way. provide for remote parts
of the United States all the advantages that accruo to Canada by their
system of branch banking.



Only in case of a pretty general stringency, resulting in a call for
accommodation everywhere, would the reserves of the National
Reserve Association run down to the line mentioned, and result
in the levying of a tax of an amount proportioned to the reduction
below 50 per cent.

Serve the
Banks as
the Banks
Serve the

§13. In what has been said thus far, constant reference has
been made to "rediscounts" as being the kind of business that would
be done by a cooperative institution or a National Reserve Association. It is now time to indicate more precisely exactly what classes
of business could properly be undertaken by such a cooperative institution, with the design of supplementing the work , of the banks,
while at the same time avoiding undue competition with them.
Evidently such transactions would necessarily exclude the idea of
dealing direct with the commercial public which makes the paper
that is offered to the banks—certainly in all except a very restricted
number of cases. This must mean, then, that kinds of business
offered to the cooperative association would be those which had
already been offered to, and accepted by, the banks which were
authorized to deal with it.
In essence, then, the cooperative
function of the association would consist in purchasing from the
banks the paper which they had already acquired—that is to say,
the Reserve Association, acting as the representative of all the
banks in the country, stands ready at any time to relieve any bank
of paper in its possession, provided such paper is of approved
kinds, thereby turning its resources back into a liquid form, and
performing for it exactly the same service which it performed for
its original customer. Theoretically then, the Reserve Association
would be a bankers' institution, and its relation to banks would
be like the relation of the banks to the public.
But just here it should be -asked whether the Reserve Association ought to do all the kinds of business that are done by the
constituent banks; that is, should it stand ready to purchase all
the classes of paper which are purchased by the several institutions? If not, then what limitations should be placed upon the
business of this cooperative institution ? The kinds of paper which
the Association may properly deal in can be made clear by remembering that the function of the institution is to serve the commercial public. This implies the use of certain standards in the
selection of commercial paper. Such paper must be (1) abso-

lutely sound; (2) running for short periods only, and therefore
liquid; (3) the product of commercial transactions strictly—in

Tests of

other words, the outcome of transactions undertaken for agri- sound
cultural, industrial or commercial purposes. Following such t e s t e .
the institution would ordinarily he absolutely assured of the soundness of the paper presented to it. The prime paper of firms
recognized as of high standing, if of short maturity, could be
directly rediseounted for a bank at a branch of the Association.
Moreover, it ought not even to run the risks that are naturally
and properly incurred by a single bank in the course of business.
Such assurance might be obtained through the guarantee of paper if Guaranpresented to it by a group of banks formed in a local association lVmI^
in any given section of the country. Supposing that such a Na- Banks
tional Reserve Association as is here described were to be organized
with branch offices, these offices would act as the agencies for rediscount, and could be assured of the goodness of the paper presented by any bank, provided that it was backed by the guarantee
of other banks in the neighborhood and having knowledge of the
local conditions. Here would be one type of paper of unquestionable soundness.
P a

Or, the Reserve Association might purchase the acceptances of
banks or acceptors of unquestioned financial responsibility, arising
out of commercial transactions. Thus, by an arrangement entered
into between a bank and its customer, a buyer of gonds, a bank
might be drawn upon by the seller of goods for. say, sixty days.
The bank would accept this draft. The seller could then discount
this bill at his bank. The second bank could olfer it for rediscount
at the Reserve Association. This paper—a prime acceptance—
would be of exceptional soundness, because it would bear the acceptance of one bank and the endorsement of a second. Hero would be
a second class of business in which the Association might engage.
It- would be a class of business in which national banks cannot now
engage, because of legal restrictions.
Evidently similar transactions in foreign exchange, guaranteed
in the same way, should fall within the scope of the Association,
and likewise transactions in gold coin and bullion, and, under
proper restrictions, in public debt. In order to keep all these
transactions and the resources of the institution constantly liquid,
the period for which any of this paper could run should necessarily
be short. How short it would be must necessarily depend upon the

c r





commercial practice giving rise to that particular class of paper.
From 30 to 120 days would he the scopc of time covered in the
various kinds of transactions of the institution.
Nothing has been said thus far of excluded transactions except
by implication. It is clear, however, that two chief kinds of operaStock
tions would fall without the scope of the Reserve Association:
(1) those involving long-time loans, and (2) those involving a
speculative element. This restriction would necessarily shut out
loans upon stocks and bonds and collateral security of the same
kind. By limiting the business of the institution solely to commercial paper, and shutting out absolutely paper based upon doubtful or speculative transactions, the institution could be made a
cooperative agency in the highest sense of the term. It would
deal only in those kinds of paper that are clearly and unquestionably common to all banks, and it would refuse those classes
of .paper that are rejected by any class of legitimate banks. Under rigorous conditions only, would it rediscount loans made even
on high-class bonds and collateral as security. It would, in short,
confine itself to those operations that were unmistakably and
obviously legitimate banking transactions. This would mean that
Confined to
no operation could be undertaken which would be regarded by
outside bankers or merchants with doubt or question. Only those
to Both
transactions could be undertaken which were clearly for the benefit
Banks and
of all the banks to have carried on, and at the same time for the
benefit of the business public. Thus, all responsibility of using
the consolidated power of the Association for the purpose of promoting the interests of any given institution or of any group of
clients of such institutions, would be rendered impossible. The
cooperative function would be seen in the use of the funds of all
the banks to facilitate and promote the performance of those
transactions in which every commercial bank is engaged.

n ary

§14. In such a plan as has thus been set forth, there would
be no compulsory element. No bank need avail itself of the
facilities held out to it unless it felt so disposed. It would not
be obli ed t o
business with the Reserve Association if it could
g e t l , e t t e r t e r m S a n 3 c o n d i t i o n s elsewhere.
If, in ordinary times,
the methods that have been employed in the past sufficed, banks
could avail themselves of these methods in the future exactly as
they do now. But the Association would afford an additional



means of relief and protection, not previously offered, at the same
time that it would furnish entire protection to the banks against
any additional competition in doing business with the public.
It would probably be found that much business in the way of
rediscount, not acceptable to the Reserve Association, would continue to be handled by the individual banks which transact such
business at the present time. If that were done, there would
merely be a differentiation of function between the Reserve Association and the banks which now do a large discount business. There
would probably be a great growth in business, and the resources More
of the banks, economized and strengthened by mutual support, q ^ ^ " 8 ©
would be called into use in many directions where they cannot Safely
now be successfully employed at all. In that case, the business D o n o
done by the Reserve Association would be simply so much clear
gain, since it would represent additional transactions that could
be financed by the banking system of the country with safety.
By thus enabling existing banks to take care of a larger volume
of business successfully and at lower rates, the actual expenses
of banking would be greatly reduced. The banks would find
that they could lower their rates of interest very materially to
borrowers for commercial paper of the best class, and by so doing
they would stimulate the development of such paper. Cooperation, by producing division of labor in banking, would increase
earnings. There is probably no institution that would not profit increased
continuously and regularly from the establishment of the proposed
Reserve Association. They would, moreover, be saved the serious
losses which are entailed as a result of periodical crises, or
stringencies, in which the institutions are obliged to reject business because they cannot safely provide for or take care of it. This,
then, would be the chief agency in assuring cooperation—that such
cooperation was profitable and resulted in greater success than
could be obtained without it. Competition would in no way be
impaired or interfered with; on the contrary, it would tend to be
increased, since the expenses of bank operation would be reduced
to a lower and far more systematic basis than under the present
Simultaneously with this beneficial result of cooperation
among the banks themselves, there would be produced a most desirable effect upon the commercial public of the country. The



public would find that, through the ability of the banks to rediscount with the Reserve Association, the opportunities for obtaining accommodation were greatly increased, provided that the paper
Credit on
Good Paper
ottered was of first-class character. This would mean that the
man having such paper could always be assured of a satisfactory
supply of capital and could get this capital at the lowest rate. It
would not be necessary to employ middlemen to float commercial
paper to anything like the extent that is now practiced.
In another way, the operation of the proposed institution
would produce nothing but benefit. At present, there are too
many banks that accept the paper of commercial houses somewhat
independent of its liquidity. The result is that in some cases bank
funds are "tied up," and the institutions are not able to extend
to Commerthe credit that they otherwise would be able to grant to business
concerns which do not stand in close personal relations with the
bank managers, but which, nevertheless; have first-class paper to
oifer. This is an injury to the legitimate business of the country,
and necessarily impairs the development of those business concerns of high standing that depend largely upon bank credit to
finance their operations. As no business doing a large volume
of trade can get along without extensive bank accommodation, the
effect of such conditions is to limit the scope of commercial transactions. With this difficulty removed, and with a broad national
market for paper growing out of actual commercial operations, the
resources at the disposal of legitimate and active firms would be far
greater than now.

§15- The characteristics of the present banking system are
division of energy, lack of concentration of banking power, and
scattering of resources.
These evils can be overcome only by joint action or through
the powerful control of some large central bank.
The latter is
undesirable and impossible so far as the United States is concerned. The establishment of some cooperative association designed to .consolidate and economize banking resources would overcome the evils now suffered.
Such an association could be obtained by federating the banks
in an incorporated organization, endowed with sufficient capital,
and authorized to perform operations that are for the good of all.



The operations which the institution should thus perforin are
those connected with the rediscounting of certain classes of paper.
These classes arc those which grow out of actual commercial transactions.
The performance of such a service for the banks would not
subject them to outside competition, but would enable them to
compete more successfully and regularly with one another for the
benefit of the commercial public.
By properly limiting the activities of such an institution, its
funds could be kept entirely out of the hands of those persons
who might wish to use them for speculative enterprises.
Such an institution would be found in a National Keserve
Association possessing functions of the kind described.



The Fear of Making Present Bad Conditions Permanent—2. .
National Reserve Association—Possibility of Keeping it Free from
Speculative Influences—3. How to Prevent Concentration of Funth
—Active Business at the Branches—The Local Association the
Unit of Control—Control of Branches—4. Directors of National
Reserve Association and How Chosen—5. What is Meant by "Control"—6. Possibility of Control of Reserve Association Discussed—
7. The Idea of Control Through a Holding Company—8. Publicity
and a Free Banking System as Safeguards—9. The Question of
Share Influence—10. Possible Control Through Favor—11. Geographical Control and Sectional Opposition—12. Unity of Banking
interests—13. Political Control and the Evil It Would Work—14.
To What Use Could Control of the Reserve Association Be Put?
—15. Control of Other Banks Would Not Interest Bankers—16.
Safety Through Establishment of a Market for Commercial Paper
—17. Why Large Banks do Not Oppose Peserve Plan.

§1. At the present time a method of centralized control has
The Fear of
a more or less secure foothold in the banking system. If left
undisturbed, the tendency to centralization will be likely to go
Conditions on increasing and may lead to unfortunate results. There is nothing
to check this tendency under existing conditions, and it is doubtful whether merely prohibitory legislation could be enacted that
would eradicate it. The evils of the existing system of inter-bank
control have been very keenly felt in many quarters. Nowhere has
this been more truly the case than among the small banks and
their customers, who have suffered from its effects.
As a result of this critical attitude there has sprung up a natural feeling of hostility to what is called "centralization," because
it is supposed that with such centralization there would be a mucR
higher degree of control on the part of large banks over small banks
than is exercised at the present time. It is feared that proposed legislation would consolidate or petrify existing conditions and add
6ome further elements of the same sort which would aggravate the
troubles now complained of. This fear is founded upon the distinct
recognition of existing evils. But it should be understood that
legislation on banking in the United States ought to be adopted




for the purpose of ending these conditions. Knowing as the}' do
that the conditions from which they are suffering today are the
result of extra-legal arrangements between banks, the smaller institutions feel that it is still possible to remedy such harm as may
exist at the present time, by the introduction of legislation designed
to terminate it. or by the gradual growth of belter methods of banking practice. The question is not merely negative; it docs not imply
simply the demand that nothing shall be done to aggravate unfortunate conditions. It is rather a positive issue and its significance
is the demand for legislation which shall actually improve the present banking mechanism and remove the possibility of any coming
The Federal government could not pass legislation which would
be applicable to the banking systems of the several states, even if it
desired to do so. It is, however, possible for the Federal government to correct existing conditions in two ways: (1) by providing fjitent^of
inducements to banks to abandon or refrain from such alliances; New Legand (2) by the removal of those conditions in the banking sys- i , , a t , o n
tem which have tended to establish and confirm the drift toward
inter-bank control. The new legislation should be of a kind that
would end the system of dependence which exists among the banks
and should at the same time render inter-bank control absolutely
out of the question. That is the object which is sought by those
who believe in a cooperative banking institution, or National Reserve Association. It should be a primary object of this institution
to bring about a condition of entire independence on the part of
the banks by supplying them from the Association with such aid
and support as they may need in the conduct of their legitimate
business. It should seek to put an end to any conditions that would
permit the further development of present day tendencies toward
banking" combination. The plan for new banking legislation must
be absolutely tested by its success in providing effectually (a) Tests of
against inter-bank control through stock ownership or stork ^ggtelatlor
manipulation; (b) «against inter-bank control through the granting
or withholding of favors or through any subterranean influence;
and (c) against the control of banks by ambitious politician? who
wish to use them, or such new banking mechanism as may be established, for their own purposes.
If these objects can be gained by legislation, the banks of the
country would be freed from the necessity of depending upon, or
asking favors of, other banks, and their customers would be relieved



of the cost and inconvenience entailed by the present system. Th«
advantages of cooperation as sketched in an earlier part of our discussion would be theirs and they would be protected against any
control or monopolization of these advantages by large banks, by
speculators, or by any outsiders whatever. This plan aims to avoid
the further development of the danger of ambitious financial control by eliminating the conditions which tend to produce it and by
offering every inducement to banks to join, upon a strictly and entirely independent basis, in a system of cooperation which will leave
them in position to cany on their own business, in their own way,
without being subject to the influence of other institutions.
§2. The plan of a national reserve association is so framed
as expressly to avoid influences originating in speculative markets
and tending to divert bank resources from commercial, into financial or speculative, channels. The plan is to create a cooperative
institution called for convenience the National Reserve AssociaA National t i o n ' i t s s t o c k ' i c l ( 1
banks, its customers to be solely or almost
solely banks seeking accommodation, and its control to be so localAssociation i z e d that in every part of the country bankers will feel that a
direct power in the management of its affairs vests in themselves.
The plan as elsewhere outlined (Chapter I I ) would provide for an
institution with, say, $200,000,000 of capital to be taken up by national and state institutions in proportion to their own capitalization.
Would it be possible to keep such an organization free from
speculative influence and to insure that the banks' funds should
be used for their own benefit and that of the communities in which
they were situated? To suppose that the attainment of such a
purpose is impossible would be merely to assume that correct organPossibility ization for the accomplishment of a very simple end woul3 be im?t Free**
P o s s i W e - It it could be demonstrated that, whatever plan might be
ado ted
s°«ul I
P > i t s "Itimato purpose would be to facilitate local business,
PflueUnclsVe a n d t h a t i t s method of control would safeguard the individual banks
and the community against exploitation, then there would be perfect assurance of freedom from such speculative influence. The
only problem would be that of working out the details.
Such details of management might possibly be developed in
any one of a number of different ways designed to attain the eaine
" '
In the plan for a National Reserve Association1 now before the



country the effort is to provide a regular and legitimate means of
cooperation among the banks whereby they may obtain the strength
which comes from united effort, and may be relieved of the burden
which falls upon isolated institutions when they can get no aid in
times of special stress or anxiety. At the same time the plan of the
National Reserve Association is to secure, if possible, the general
public benefits arising from the combined use of bank funds in the
most efficient and economical way under restrictions and limitations
which will absolutely prevent any group of persons from taking the
advantage to be had from the employment of bank funds for the
promotion of their own special enterprises. In other words, it
wishes to secure all the benefits of strength and easy distribution of
credit which are to be derived from a cooperative plan, while assuring the distribution of these benefits to the public generally by
means of rigid control over bank operations. Cooperation, not centralization, is the object aimed at and the results are to be those of
joint effort and responsibility, not those of individual or central
control and responsibility.
§3. In carrying out this enterprise two classes of difficulties
must be met—those relating to the too great concentration of
funds, and those relating to the too great personal influence of
strong men in the financial world. To guard against the first class
of dangers, the National Reserve Association plan provides for the
operation of a series of branches and of local bank associations.
The branches of the institution "will be the scene of its principal
operations. The head office, located in Washington, a non-commercial city, will be chiefly a central place of record and oversight.
The active centers of operation will be in the branch offices, which
aro to be located at fifteen different points distributed fairly
throughout the country. Not centralization, then, in the ordinary
sense of the word, but cooperative action at fifteen principal business centers, these joined together for the purposes of mutual aid,
is the plan in mind. Under the proposed scheme, each of these
branches would do simply a rediscount business. Paper of restricted
kind3 could be presented to them by local associations of banks
and by individual banks under certain specified conditions. Tilia
paper would then be rediscounted, and every bank applying for
rediscount accommodation would thus be able to get advances
which now it is obliged to solicit from the correspondent bank«

Is for tho

How to
Concentration of

at the




with which it does business. Under the proposed system it could
demand the desired accommodation as a right, if the paper offered
were unexceptionable.
In order to provide for full control by local banks over their
own affairs in relation to the National Reserve Association, all
subscribing banks would be grouped into associations to be designated as "local associations." Each such local association would
have corporate powers and would be composed of not less than ten
banks, while the combined capital and surplus of the members of
each local association would aggregate not less than $5,000,000.
Such local associations would be generally grouped within one of
the fifteen divisions, to be called districts. Within each district
the territory would be so apportioned that each bank would be
located within the boundaries assigned to a local association, and
every bank which was a stockholder in the National Reserve Association would be expected to become a member of the local association comprising the banks in the locality in which it is situated.
Thus, in every one of the fifteen districts covering the whole country, there would be a number of local associations arranged according to convenience. The number which could exist in any one
district would depend upon the amount of the total capitalization
of the banks in that district and their number, as compared with
The Local
a capitalization of $5,000,000 and the number ten, these constitutAssociation
the Unit
ing the minimum size of a local association. The local associaof Control
tion would thus be the nnit for the control of national reserve
affairs within the district in question. Its management would,
therefore, be the really important and significant feature in the
whole organization of the National Reserve Association.
There might be various methods of choosing a board of control to manage a local association, but the one which would pTobably be of greatest advantage would be as follows: Each local
association would determine upon a number of directors to manage
its affairs, which should be either five or some multiple of five.
Of this number, three-fifths could be chosen by ballot cast by the
representatives of the banks that are members of the local associations. Each bank would have one representative and each repreGovernment of
sentative one vote, without reference to the size of the bank. TwoLocal
Association fifths of the whole number of directors would be chosen by these
same representatives of the several banks that were members of
the association, but in voting for the additional directors (the twofifths), each representative would be entitled to as many votes as



the bank which he represented held shares in the National Reserve
Association. Here would be a method of choosing a Board of Directors in which each bank would be assigned due weight, independent of its capitalization, since, in making the choice of men,
each bank would be allowed a vote for three-fifths of the directors
upon a perfectly equal basis with other institutions.
The plan would also allow some influence to banks in proportion to their ownership of shares in the National Reserve Association- but it is to be noted that this influence of banks in the
choice of directors on a basis of share ownership would be limited
to two-fifths of the directors in all. The fact that a bank was an
independent institution would thus count for more than its share
ownership in determining the composition of the Board of Directors.
These directors when thus elected would annually choose the usual
officers, a president, a vice-president and an executive committee,
whose powers and duties and terms of office should be determined
by the by-laws of the local association. In these by-laws would be
provided a method of filling vacancies on the boards of directors.
The main restriction imposed upon the directors would be that
no director should at the same time be a director of a branch of
the National Reserve Association.
Of course, the method of controlling the branches of the National Reserve Association, one of which would be located in each
district, would be equally as important as that of the local association itself. Let there be at least twelve directors. Probably the
best plan would be that each local association should select by ballot a voting representative. One-half of these directors might be
elected by representatives of the banks, each representative being
entitled to one vote without reference to the number of shares his
association holds in the National Reserve Association. One-third
of the directors might be chosen by the same representatives, each
representative having a number of votes equal to the number of
shares in the National Reserve Association held by all the banks in
his association. In order to bring the directorate of the branch into
close connection with the business life of the community, it is supposed that in addition to these directors there should be added a
number equal to one-sixth of the total number of directors, such
additional directors to be chosen by the already appointed directors
and to be selected in such a way as to represent fairly the industrial,
commercial and agricultural interests of the district, none of them
being officers of banks, or financial institutions.

One Bank,








If this plan were carried out, the Boardt of Directors of every
branch of the National Reserve Association would contain the following elements:
(1) A group of directors not less than six in number, chosen
by the directors of the local association, each association having
one vote.
(2) A group of directors equal in number to one-third of
the whole number of directors and elected by stock representation.
(3) A group of directors equal in number to one-sixth of
the whole, representing the industrial, commercial, agricultural
and other interests of the district, and elected by the votes of the
first two groups, each director thus voting having one vote.
(4) If the manager of the branch were added, as he necessarily would be, he would be ex-officio a member of the Board of
Directors of the branch, and should be chairman of the Board;
The members of the Board thus chosen, except the chairman,
should be classified at the first meeting and should hold office
according to classes, for one, two and three years, respectively, all
succeeding directors being chosen for periods of three years in each
§4. What has been said thus far relates entirely to the question of local control—that is, the control of the local associations
of banks and of the branches of the National Reserve Association.
Nothing has been said of the methods by which the central board
of directors controlling the Reserve Association as a whole is to be
chosen and managed. The Board of the National Reserve Association would consist of forty-six directors, and would be composed
in the following manner under the Monetary Commission's plan:
First. Fifteen directors shall be elected, one by the board
of directors of each branch of the National Reserve Association.
In case the number of districts shall be increased hereafter,
each additional district shall he entitled to elect an additional
director of this class.

of National

Second. Fifteen additional directors shall be elected, one
by the board of directors of each branch of the National Reserve Association, ^ho shall fairly represent the agricultural,
commercial, industrial, and other interests of the district, and
who shall not be officers, nor, while serving, directors of hanks,
trust companies, insurance companies, or other financial institutions. In case the number of districts shall be increased hereafter, each additional district shall be entitled to elect an additional director of this class.



Third. Nine additional directors shall be elected by voting
representatives chosen by the boards of directors of the various
branches, each of whom shall cast a number of votes equal to
the number of shares in the National Reserve Association held
by banks in the branch which he represents. Not more than
one of the directors of this class shall be chosen from one district. Directors of each of the three classes named above shall
be residents of the district from which they arc elected.
Fourth. There shall be seven cx-oificio members of the
board of directors, namely: The governor of the National Reserve Association, who shall be chairman of the board, two
deputy governors of the National Reserve Association, the Secretary of the Treasury, the Secretary of Agriculture, the Secretary of Commerce and Labor, and the Comptroller of the Currency.
No member of any national or State legislative body shall
be a director of the National Reserve Association, nor of any
of its branches, nor of any local association.

Under the provisions of the plan the New York district, with
29 per cent of the banking resources of the country, would have 8
per cent of the representation on the board; New England, with 12
per cent of the resources, would have 8 per cent of the representation; the Eastern States, as defined in the bill, with 11 per cent
of resources, would have lf> per cent of representation; the Middle
West, with 24 per cent of resources, would have 31 per cent of
representation; the Southern States, with 11 per cent of resources,
would have 23 per cent of representation; and the Western and
Pacific States, with 12 per cent of resources, would have 23 per
cent of representation. The New England, Eastern, and Middle
West States, taken together, witli 77 per cent of the resource?, could
elect only 21 out of the 46 directors in the Reserve Association,
while the Southern, Western and Pacific States, with 23 per cent
of the resources, might- have 4G per cent of the representation.
These percentages of representation have been based upon the theory
that the New England, Eastern and Middle Western States, by
reason of their preponderance of capital, would be entitled to elect
the maximum number of three directors for each district.
At the first meeting of the board all of its members, except
the ez-officio members, would be classified into three classes, an«l Hcm^on
the terms of office of these three classes would be respectively, ono. Board
two, and three years. Thereafter, members of the board would ^Ip1*3*^
be elected for a term* of three years.
No member of any national or state legislative body would



be a director of the National Reserve Association, nor of any of
the branches, nor of any local association.
The directors of the National Reserve Association would annually elect from their number an executive committee and such
other committees as the by-laws of the National Reserve Association might provide. The executive committee would consist of
nine members, of whom the Governor of the National Reserve Association would be ex-officio chairman and the Secretary of the Treasury and the Comptroller of the Currency, ex-officio members; but
not more than one of the elected members would be chosen from
any one district.
The power of the Executive Committee would be limited to
the execution of the general policy of action determined by the
whole board of directors.
There would be a board of examination elected by the board
of directors, from persons outside the banking profession, of which
the Secretary of the Treasury would be ex-officio chairman.
This selection, it should be clear, places the institution ^„"j-j
in the hands of men chosen by the several branch offices and eai n
l to
of representatives of the Federal Government. The real control,
therefore, goes back in the last analysis to the local associations of
banks since these are the agencies for choosing the directorates of the
branch offices. If the operations of the local associations have been
sufficiently safeguarded, the general management of the Reserve
Association, as a whole, is adequately protected. For the reasons
which were stated in connection with the discussion of these local
associations of banks, therefore, it is believed that provision has
been made in this tentative plan for keeping the fundamental units
in the scheme of federated management—the local association of
banks—free of any possible influence originating with selfish or
ambitious financiers who might seek to divert bank funds to their
own purposes.
The question how the Reserve Association would be managed
and directed, is, of course, fundamental. If it were to be managed
in such a way as to allow special influence or recognition to certain
banks, or groups of banks, the situation would be dangerous. But
it is possible to throw safeguards around the enterprise by methods
that will not only prevent the development of undue control or
influence by large banks a n d speculative interests, but will largely
destroy the influence exerted by such institutions upon the financial
system of the country at the present time. As has been seen,



the tendency to cei.tralization of control which exists today among
the banks is partly a product of united ownership of stock, either
in whole or in part, by the same controlling interests. It 1»
feared by some that under such a system as ha9 been proposed. Manafl©the National Reserve Association could be dominated by groups £fC"he
of financiers who already have or would acquire large holdings Reserve
in existing national banks. If, for example, a group of financial m " " be
interests had a dominating influence in a chain of banks stretch- S a f c "
ing through the various districts into which the country would
be divided under the National Reserve Association plan, might
not the interests in question bring about a concert of action in
their favor throughout the various districts and at the various
branch offices of the National Reserve Association ? Or if the
principal banks of a given city, such as New York, were in large:
measure controlled by a common financial interest, might not
there be a development of practical control over that particular
branch office? If such were to be the case, the conditions which
already exist in some measure under present methods of banking,
would be produced, and perhaps exaggerated. If there were no
suitable safeguards upon the methods of voting stock, such a
growth of control might reasonably be feared, although it would
be far from being the most serious danger to be met.
§5. It is fitting thfct the question how this proposed system
would be controlled should be carefully considered. For the reasonalready stated, many bankers and borrowers are fearful lest a new W h a t |g
system of legislation should throw them still more into the hands Meant by
of outsiders, who might use their power for selfish ends. In con- , < C o n t r ° r
sidering the extent to which the proposed new plan would be subject to danger of this kind, it is well to understand clearly what
is meant by "controlling'*' an institution.
The most obvious form of such control would be seen in arrangements that might lead to domination in the choice of directors
or other governing factors in the new National Reserve Association. If the new institution were so shaped that certain very limited financial interests might exert an undue influence in the selection of a majority of the directors, the result would be to enable
them to dictate to the new institution. They could put their own
men in charge of its affairs, and these men would presumably be
guided by the welfare of the persons who had placed them in control.



A type of control which might exist, aoart from the direct
personal influence already sketched, would bo seen in the possibility of geographical or sectional control. Directors might be
chosen in such a way as to permit them to form groups among
themselves, whereby one part of the country would be more powerControl
Also a
ful than other parts, and would thus be able to direct the policy
of the new institution into channels that would forward its own
to be
Considered interest as opposed to those of the country as a whole, or of other
communities which were competing with those that were most
strongly placed in the Board of Directors. More subtle than either
of these types of control over the directorate would be a condition,
or situation, in wThich the new institution practically dominated
the banks by refusing them discounts or accommodation at its
pleasure. If such a condition should be established that certain
large banks, even though not very strongly represented in the
directorate, were able to get better treatment from the Reserve Association than others, or in any way to influence or direct its policy,
the influential character of their position would speedily have its
effect in coercing smaller institutions. The smaller banks would
see that by deferring to the wishes of the larger institutions they
might secure for themselves a friend whose good offices with the
National Reserve Association would be very valuable, or who could
be used as an intermediary for the purpose of getting rediscounts
and doing business which might be rejected, if application were
made to the National Reserve Association simply on the merits of
the paper as such.
Apart from these types of control, it is worth while also to
mention the possibility of political control due to the development
of a considerable body of directors chosen under political influences
or amenable to political considerations. All of these types of conof
trol over banking institutions may either be observed at the present
time in the United States, or are found exemplified in its banking
history. The question how far any new institution would be affected by considerations of the same sort is, therefore, a thoroughly
practical and reasonable one. The different types of control thus
possibly to be eserted may be taken up in their order, beginning
with the most elementary form—that of direct intervention in the
choice of the personnel of the new institution.
§6. As has been seen at an earlier point, the small banks pre-.
ponderate in the United States. This is true of ever}7 part of the



country. More than G per cent of tlie banks have capitals below
$100,000, and more than 1)0 per cent below $250,000. On the surface, then, the power of electing directors, both fo the local association of banks, to the branches of the National Reserve Astoria- |™na"8
tion, and ultimately to the Reserve Association itself, would un- Are in the
deniably and conspicuously rest in the hands of the smaller instilu- M a J o r , t y
tions. The unit system of voting already described, and the comparatively small number of directors in local associations who
would be chosen on a voting basis proportioned to stock ownership
in the National Reserve Association, would give a very great preponderance to the small banks. But this condition would hold
true only if the small banks were absolutely independent of one another and of the large banks. How far, then, would it be possible
for large banks to control the smaller institutions, and through
them the National Reserve Association? How far could outside
capitalists do the same thing? Assuming that there were no legal
restrictions upon the holdings of bank stocks by another bank, so
that it was in this respect upon the same footing as a corporation
or individual, it is clear that in order to be nble to dictate the
action of small banks under the system of unit voting already
described, it would be neccssary for the bank, corporation or capitalist, aiming at such control to obtain a majority of bank vote*.
Let it be supposed that a syndicate should undertake to get
control of the N. R. A. It is proper to inquire how easy or diflicult the undertaking would be from the point of view of cost alone,
It will be readily seen that such control could only be had through
the vote of eight of the fifteen branch directories:. To secure this
it must be necessary to control the majority votes of one more than
half of the local associations in each of these eight districts. This
could be done either by securing the unit votes of over half ihe banks
in a local association, that is, by controlling a large number of small
banks, or by securing the stock vote1—amounting to two-fifths the
whole—plus enough unit votes to carry fifty-one per cent of the
votes cast in electing a branch board. The presumption is that
any such syndicate would choose the former course as requiring the
less outlay of capital.
At least three solutions of this problem have been attempted,
each writer using different conditions and assumptions. The first of
these calculations starts with the syndicate as an outside party compelled to buy in at every point. Assuming that the necessary bank

t 0 t,e



stocks could be had at $200 per share—average book value is a little more than that—the cost would be $856,485,174.
Another calculation supposes a syndicate to be formed among
banks already existing and controlling at the outset all banks in all
the forty-two cities of 100,000 population. Assuming no expenditure necessary for control of the banks in these 42 cities, it would
still be necessary to buy or to organize anew 7,000 banks, properly
$175,000,000 distributed; and at $25,000 each this could be done by the outlay
as an Initial Outlay of $175,000,000. But, of course, the final sum required would be
larger than this.
A third calculation is based on the distribution of branches as
proposed by the bill of the Monetary Commission, as follows:
New England—1
Eastern States—2
Far West—4

Middle West—4

Granting the extreme case that the three branches in New
England and the Eastern States were already in combination, it
would be necessary to secure control of five branches in the South,
Middle West, or Far West. From the best information available,
it appears that the four branches in the South would involve 4,6S9
banks with capital and surplus of $372,700,000; four in Middle
West, 5,655 banks with capital and surplus of $314,800,000; four
in the Far West, 5,334 banks, with a capital and surplus of $314,-


A Theoretical and

Assuming no opposition from public opinion, the most economical course would be to purchase the four districts of the South
and one in the Far West. Supposing the stock of the banks could
be had for its book value, the purchase of one-half the southern
banks outright would cost $186,000,000; but a controlling interest
(51 per cent) could be had for $95,000,000, because it would be
necessary to have only 51 per cent of the stock of one-half the banks
to be controlled. Add to this the cost of control in one branch from
the Far West computed in the same manner and we get a total of
But the book value of Southern banks averages approximately
$80,000 per bank.

By purchasing one of these and dividing its

capital for the purpose of increasing the number of unit votes to he
controlled by the syndicate, three new banks could be established
with a capital of $25,000 each with a balance of $5,000 to spare. By
buying 1,125 banks, 3,580 new ones could be created out of them.
When the original number of 4,689 is reduced

by the




bought, 3,580 would constitute a majority and give a controlling
voice in the four branches. This operation on the basis of a 51
per cent stock control would cost but $J 0,000,000. T o secure tho
fifth branch by a similar method in the Far West, where the book
value is $00,000, would require the control of only «100 banks and
51 per cent would cost $12,210,000; or a grand total for the five
districts of $58,240,000.
Supposing that the old banks could not be bought economically,
control might be secured by the institution of new ones with tho
minimum capital of $25,000 each. To control four branches in tho
South, 4,690 banks would be required, costing $117,250,000. On f j ® ^ 1 ' ,
the basis of 51 per cent control, the cost would be $59,797,500. Favorable
Adding the cost of one branch in the Far West computed on the ®.sb£0G"
same basis, the entire cost of control would he $7(5." 97.000. Thi«
computation is as favorable as it can be made to the possibility of
control; although, as will be shown, there could be no motive for
acquiring control.
Such a computation is wholly theoretical, and takes no account
of public opinion, the unwillingness of banks to give up their independence, and the great improbability that directors and local business men would allow the banks to put their borrowers in a position where loans could be dictated by a controlling syndicate. The
improbability is so great that this computation—making it as extreme as the case would allow—cannnt bo taken seriously. Moreover, it assumes that bankers as a class have no honor, no independence, no regard for the business conditions of the country, and
are responsive only to the desire for gain; when, in truth, they
have the same average qualities as other large classes of the community.
§7. One method of controlling the stock of a large number
of banks which has been considered by some of those who are afraid
of ambitious financial influence in the National Reserve Association is the formation of a holding company probably in connection with some large national bank. The idea of such a company, it T h e | d c a
is supposed, would be that of acquiring the stocks of various banks of Control
in order to exert a direct influence in their affairs. In those cases Hoidin9gha
where such stocks were owned to the extent of a majority of the Company
shares of the banks to which they relate, the holding company
would naturally be able to dictate the policy of the controlled institutions in harmony with that of the larger banks and, of course,



could dictate the names, or, at all events, the action of the directors

Where there was no majority, but merely a consider-

able holding, large influence could be exerted.

This would be en-

tirely feasible, provided that substantial purchase and holding of
stock could be brought about.

The fear has a basis since, in some

instances, companies of the kind indicated have already been organized and have confessedly put forward as one of their objects
the ownership and control of national bank stock.
As already seen, at least 300 national banks have at the present
time formed affiliations with trust companies or state banks.
of Banks


these instances the stock of the national bank is held by the same
persons who hold the stock of the state bank or trust company.
As the stock of the two institutions thus allied is controlled by
an identical body of stockholders, the actions of both will be harmonious. The state institutions can usually be employed, if desired,
to purchase bank stocks which are then practically under control
of the national bank.

But whether the plan pursued be the estab-

lishment of a holding company of the kind indicated, or a joint
ownership of shares in a state and national institution, uniformity
of action and policy is insured.

In such cases, it is evident that

to the extent of their stock holdings such concerns might be able
to exert a more than proportionate influence in the affairs of the
National Reserve Association.
The question whether relationships of this kind are legal or
not is still under adjudication and an adverse opinion has been
rendered by Attorney-General Wickersham.

Even supposing that

such relationships shall be upheld, however, the difficulties of extending the control to any extent that would make the operation
worth while would be impossible for the same reason which has
been sketched in speaking of the possibility of direct ownership of
the small banks by an individual or concern which might attempt
this method of obtaining enough votes to place itself in a commanding position.
Why a
Scheme of
Control is

No holding company could, as a practical mat-

ter of fact, acquire enough bank stock to give it a direct majority
of votes in the Reserve Association.

As f o r gaining control ol

one of the branches of the Reserve Association and thereby directing the operations of that particular branch, the undertaking would
be more reasonable, but still out of the question, for reasons that
will be stated presently.

The mere question of obtaining control

of the majority of the stock of enough banks to give a majority,
either in the directorate of the Association itself, or any one of



its branches, would require so great an expenditure that it may
fairly be considered impossible, simply as a problem in financial
organization and in the acquirement of fimds sufficient to obtain
the necessary bank stocks by direct purchase- It has. moreover,
been suggested that corporations be forbidden to own national bank
stock—a plan favored by Deputy Comptroller T . P. Kane. This
would render holding company control of national banks impossible.1
§8. Discussions of such forms of control are largely academic,
although it has been thought well to review them here for the purpose of citing every possibility of domination, no matter how remote. The fact remains that in practice an individual or a concern, even witfi unlimited capital, will be unable to get a majority
of the stock in any such number of institutions as would enable
him, or it, to carry out such a plan. Long before a majority of
the stock in all of the banks of a small community can be acquired,
the operations of one engaged in such a transaction would have at'Of the possibility of a voting trust or trusteeship Mr. M. S. Wlldman
Let It be supposed that the stock of the subsidiary banks be Individually
owned, but placed In trust, with power In the trustee to vote it In determining the policies and directories of the particular hanks. There Is no wellgrounded objection to this. In
far as It concerns the Inside working of tho
banks In question. However, there Is serious objection to allowing a bank,
whose stock Is bo held, to exercise full voting-power In the Reserve Association. The law should provide, therefore, that the voting-powrr of a bank
shall be curtailed In the proportion in which Its stock may be held Jn trust,
whether the trustee be an Individual, a committee or a corporation. Trusteeships for bank stocks are very common and desirable; cases of Individual
Insolvency, tho settlement of estate?, and the protection of wards, are among
the circumstances which give rise to thcin. The question arise» whether
any substantial hardship would result from limiting the power of a bank
whose stock Is so held, In voting for directors of the local association.
The vote cast by a trustee Is substantially a vote by proxy. Voting of
proxies may not be objectionable In determining the policies of separate
banks, but there Is precedent for Its prohibition when tho public Interest Is
supposed to be Involved. Of the twenty-ilve thousand shares of the First
Bank of the United States, at one time no less than eighteen thousand were
held by others than citizens of this country. According to law, none of these
owners of shares could vote, either In person or by proxy, and the control
of the institution actually rested with
small minority, holding less than a
third of the stock. To this situation no serious objection was raised; and
that there was no substantial hardship was proved by the fact that Europeans were anxious to buy the stock at prices far above par. Moreover, tho
principle of proxy-voting la condemned In the plan now proposed. In the
provision that each bank may vote only through its properly-designated officers; and this provision Is followed by the words, "There shall bo no proxies."
No objection has been raised to this restriction. If the prohibition of
proxies be no hardship, the restriction of the voting-power of any bank to
the extent that Its stock Is not held by the equitable owner could certainly
Involve no hardship of practical Importance.

A Simple
£, c p m e d y



of Banks
Not Purchasable

and a


tracted the attention of the community. Usually, the attention of
the local business public would be riveted upon the operation a long
time before such control could be obtained of the shares of even one
banking institution. It would be impossible in practice to obtain this
kind of stock ownership in very many institutions. Even if it could
be obtained by some manipulation or sleight of hand, the fact
would remain that the influence thus acquired was largely an empty
shell. One who buys a bank under a free banking system gets nothing but the bank's assets; he does not purchase the good will of
the banks unless the customers are willing to continue it. Other
banks can be organized without difficulty and would be thus organized. The persons who acquired control of the stocks of the
different banks would be obliged to pay for them and they would
thus provide the old shareholders with the means of reopening competing institutions. Such a bank "trust" as has been described
might find itself met at every point by as many new institutions
as it got control of. Local communities would not be willing to sec
their credit entirely in the hands of outside interests any more than
they are at the present time. They would transfer their business
to other institutions. The only condition under which such a possibility could be seriously considered would be one in which
the number of banks in a community or in the country was limited, or in which the organization of the banks was
made dependent upon the granting of a special charter. Neither
of these conditions can or does exist in the United States today nor
is it likely ever to exist. At present, both the Federal Government
and all- of the states grant bank charters under special laws which
allow perfectly free organization of institutions. The National
Reserve plan provides that banks organized under state laws shall
be allowed to participate in the National Reserve Association upon
equal terms with the members of the national system. Nothing is
more wildly improbable than that the national and all of the state
governments should jointly abolish the free banking system and
limit the number of institutions to those which now exist, or even
render access to the systems more difficult than it is at the present
Considering, then, the difficulty of acquiring the control of
even one institution and the infinitely increased difficulty of obtaining control of all those in a given community or of a large
number scattered through different communities, and taking this
in conjunction with the fact that the purchase of bank stock would



supply the means for competitive banking, it must fairly be conceded that the fears expressed on this score are entirely chimerical.
There is no possibility of the development of any such type of control of the directorates of the different institutions. Neither the
unit control of different banks nor the acquirement of sufficient
shares by a holding company with or without a national bank affiliation would attain the object sought.
The difficulties in the way of the purchases of such bank stock
as are here referred to have been set forth by a banker of international prominence, who has discussed the estimate of cost of controi
already given above from a critical standpoint. He says that "if one
succeeded in acquiring one bank in a city without creating comment, y j ^ n k f c r ' s
one would be doing well, but to try to do this with more than half such a
of the banks of that city would create such a stir that it could not Possibility,
possibly be done secretly. If, in addition, a bank of the city having
a capital of $50,000 should see that sum reduced for no plausible
reason whatever—it being presumed that the capital would not have
been raised to $50,000 unless the bank required that amount for its
standing and its business—and if the only excuse for such action
which could be given to the astonished directors would be that it was
being done wholesale all over the country, so that the 'ring* might
control the situation, it is easy to perceive the indignation that
would be aroused and how very welcome a means of advertising
would be given to those banks that had remained independent.
T o acquire a bank against the will of its management and its
directors is buying nothing but an empty shell. It is the easiest
thing for the directors and the -management to take out a new
charter and to raise the new capital of $25,000 and to take with
them all of the business and all the good will that the old bank
commanded. Moreover, the ring would find it a pretty hard proposition to feed 50 per cent of all the banks of a given community and
make them valuable. It would be for this reason a very unprofitable investment."
§9. It is fair to ask whether, even if absolute control of the
type described could not be attained, it would not be possible by a
judicious acquisition of the stock of influential banks scattered
here and there throughout the country to exert- a strong general influence in favor of a special "ticket" to be put up for election to
the directorate of the National Reserve Association. This suggestion in its more general form must be put aside when it is ob-




served that the country is to be divided into 15 districts, in each
of which a separate organization is to be maintained.
of directors as there are districts must be elected.

AB many sets
Suppose, how-

ever, that a bank limited its operations to the affairs of its own disThe
trict—how far could it g o ? It would find in sucli a case that It
Question of
must secure the election of directorates under its control in all of
the local associations existing throughout the district since these
would be the ultimate source from which





branches (one branch to a district) of the National Eeserve Association would be drawn.

This would necessitate its scattering its

efforts throughout the various local associations in a way that would
be found impracticable for the same reasons that would obtain in
the case of the institution as a whole.
I t may also be asked whether an institution might not secure
the control of the directorate of its own local association by obtaining the majority of the stock in enough of the institutions which
were members of the Association to enable it to control a majority
of the directorate.

I t should be frankly stated that such a situa-

tion would be possible, even if not very probable.

I t could, how-

ever, very readily be met by making the acquirement of stock of
of the
Local Associations
and a

no service in electing directors.

I f it were provided that no institu-

tion should vote in elections of the National Reserve Association
and its branches to an extent greater than was represented by the
independent holders of shares by stockholders the whole difficulty of
which so much is now made would be obviated.

All possibilities of

danger could be overcome by the adoption of a provision in the
act allowing a person (or corporation) to select the bank in which
lie own3 shares and wishes his shares to be counted, but reducing
the voting power of any other bank in such proportion as the same
person owns shares in such other bank. 1

Such a provision would

be very drastic, and should be resorted to only as an extreme measure to Temove the motive to the acquirement of control over stock
b i n o f t h © Monetary Commission contains the following provision:
Tnat In case forty per centum of the capital stock in any subscribing bank
is owned directly or indirectly by any other subscribing bank, or in case
x l i P l r , c e n t u m o f the capital stock in each of two or more subscribing
m e m b e r s 0 1 the same local association, is owned directly or
y t h e S a t n e p e r s o n ' Persons, copartnership, voluntary association,
E X T « ¿ V k 1 P ° r a t I o n ' t h e n a n d I n e i t h e r of such cases, neither of sucn
1 be entitled to vote separately, as a unit, or upon its stock,
8 U ? h b a n k s a c t l n * together, as one unit, shall be entitled to one
I T ' I
^ U e l * ? t l o n o f t h e b °ard of directors of such local association. In
no case shall voting by proxy be allowed. The authorized representative of a
bank, as herein provided, shall be its president vice-president, or cashier.



in a number of institutions, inasmuch as it would debar the holdo n from obtaining any increase in their voting power at meeting»
of the National Reserve Association. It would not debar anyone
from owning filiares in more than one bank for profit, but it would
debar such ownership from being used to control the association.
There would be no reason for fearing, with such a provision of law,
that any particular institution would succeed in exerting an undue
power or influence over the operations of a branch of the Reserve
In the last analysis the question would be whether the banks
themselves were able to maintain their own autonomy and thereby
retain the management of the association» and of the branches of
the National Reserve Association in their own hands. It would
be easy to require the names of all stockholders in every bank owning shares in the National Reserve Association to be filed with the
National Reserve Association head office or possibly with the Comptroller of the Currency. By prohibiting any bank from casting a
full vote in elections for directors of the local associations or of the
branches, provided any of their stock were controlled by other banks
or b%y stockholders in other banks, it would be practicable to eliminate this kind of joint influence. Inasmuch as. in that case, only
those banks would be full voting units whose stock control was
dissociated from that of other banks, the exercise of any central influence over the National Reserve Association would be
practically precluded and it would be impossible for any individual,
or corporation, 110 matter how much bank stock ho or it might buy,
to acquire more than a voting power based upon its maximum share
ownership in a single institution. The fear of control of the local
associations or of the brandies of the National Reserve Association
would thus be absolutely removed. There would be far less danger
of such control than there is today of the joint control of groups
of banks. The possibility that the local units would be used in the
interest of some financial power would be out of the question.
§10. There are other methods than those of stock ownership p 0 8 9 ibi e
by which banks are today controlled by other banks. One of these Control
is the distribution of special favors. A large institution, for ex- Favoi^and
ample, has planned to underwrite certain bonds. It apportion* Hope^of
these bonds among a certain number of other institutions, and
when the securities are sold and expenses paid the profits are distributed in accordance with the original assignments of securities.




Thus a clear gain accrucs to the banks which have originally been
designated as recipients of these favors. The knowledge that a large
bank has it in its power to distribute profitable opportunities in this
way is of course a strong inducement in every case to the small bank
to observe the wishes of the larger institution so far as it can. Influence of this kind rarely extends to the country banks, but it is exerted by the institutions of high capitalization situated in financial
centers over banks in the same city or in other reserve cities.


return it is of course expected that the banks thus given consideration will exert themselves to serve the interest of the larger bank.
If they do so by directing deposits toward it, and otherwise facilitating its operations, the obligation is cancelled.

Why might not a

similar kind of influence be exerted by such large institutions over
other banks in order to induce them to cast their votes in the National Reserve Association for some indicated candidate or candidates who are acceptable to the larger institution?
There is under existing conditions nothing to prevent such
influence from being exercised nor is there anything in the proposed plan that would do so.

Whether such influences would ex-

tend very far must, however, be considered seriously open to ques-


I f Safety?


Ifc.is hiShly

improbable that many banks could be brought

to terms in this way.

In every business organization, as in all po-

S o v e r nmental organizations, there will usually be a pos-

sibility of irregular work.

No system can be devised which will

make every citizen upright, and in the same way, no system can be
devised that will compel every bank to be disinterested or to maintain its own individuality if it does not so choose.

The fact re-

mains that the great majority of banks neither could be thus controlled nor would they allow themselves to fall under influence of
this kind.

Public opinion would be too strongly against it in those

few places where such possibilities were open, and in others, the
danger, as already noted, would be practically non-existent.

In the

aggregate the smaller banks, not subject to such control and voting
as units, would be able to direct matters.
But all this would be of no service i f there remained conditions that would continue the present system of inter-bank control
m full force and would compel the smaller institutions to rely or
depend upon the larger.

If there were such conditions under the

new system, the introduction of elaborately devised machinery would
not correct the evils complained of.

I t would be impossible to con-

trol directorates in such a way as to eliminate the chance of undue



influence hv large banks if it remained true that rediscounts were
to be granted as a matter of favor. In order to abolish the existing tendency toward undue control and to provide an adequate safeguard against the extension or renewal of it under the new sy.-tcm,
it is necessary to make such provision as will guarantee the hanks
against any necessity of depending upon others and will assure
them absolute equality of treatment at the hands of the National
lieservo Association or its branches when they apply for it. This is
what the plan provides for.
§11. While it is an easy matter to prevent the domination of
the Beserve Association by any control of capital stock by any institution or group of institutions, the question is frequently asked
whether a certain geographical control over a National Reserve
Association might not be exerted. Not a few persons have fcare'd
that the distribution of capitalization among the banks of the
country would be such as to ensure a controlling power to the
"east" or to some other section. This, of course, assumes that one
section of the country has banking interests that are opposed to
those of other sections. Nothing of the kind is true save in so far
as there may be speculative centers which afford a greater demand
for funds than would come from ordinary commercial sources. It
should be borne in mind in this connection that "speculation" is not
local or confined to any part of the country. Active real estate
speculation exists nearly everywhere. It has been particularly noteworthy in the middle western and western states of late years and
has at times imposed a very serious strain on the banks which were
called upon to provide the resources with which to carry it on. On
the other hand, speculation on the exchanges is not confined to New
York or the Eastern states. There is as active speculation on the
Chicago Board of Trade as there is on the Eastern stock exchanges.
The problem of keeping the funds of the public out of the
hands of speculators is one that must be Eettled by the bankers in
their capacity as such, and not by the establishment of governmental machinery for the purpose. But the National Reserve Association would at all event« afford no special or peculiar facilities
whereby banks in any one section of the country would be able to
control or outvote those representing any other section.
As has been stated, the real operations of the proposed reserve association would be transacted at the branch offices, each of
which would work in close conjunction with local associations of

leal Control

is a
Not One cf


No Section



banks. There need be nothing to warrant the belief that such local
associations would be influenced by anything except the interests
of. those who composed them. I t would be of far more importance,
then, to see that the local associations of banks were kept free of
any improper influence than to attempt to safeguard the geographical control of the National Reserve Association. Figures for the
capitalization of banks do not warrant the belief that there is any
given section of the country which is superior in its hanking power
to any other. The traditional classification of states as New Eng] a n ( ^ Eastern, Middle, Western, Pacific, etc., shows the following
arrangement of bank capitalization for the national system :
New England States
Eastern States
Southern States
Middle Western States
Western States
Pacific States




For all banks the arrangement is as follows:
New England States
Eastern States
Southern States
Middle Western States
Western States
Pacific States

581,370,131 33
297,137,727 16
509,622,221 28

Then, if New England, which has 8 per cent of the banking
capital of the country, had one branch; the Eastern States, with 33
per cent, had two branches; the Southern States, with 16 per cent,
had four branches; the Middle Western States, with 27 per cent,
had four branches; and the Western and Pacific States, with 15 per
cent, had four branches, certainly the West and South would easily
outvote the East—especially the New Y o r k district.
be assumed that






Even if it


interests of a banking kind different from those east



line, and that in meetings of the National Heserve Association, or
some similar institution where voting power was based on bank
capital, there would be a direct voting opposition between them, it
is clear that there would still be enough voting power, even in the
western states, to make any action that might be deemed obnoxious
to the interests of the west practically impossible.

The National

Reserve Association plan would provide f o r a strong representation of the government on the controlling board of the organization.

This in itself would make possible the turning of any given




decision one way or the oilier according as the equities of the caso
might demand. No administration could afford to take obviously
inequitable action, distasteful to any large portion of the country
since it would speedily be rebuked ai the polls and it* successor
would feel the necessity of rectifying the mistakes that had been
made by forcing an undesired policy upon the country. Sectional
action would work in the same way to safeguard the National lieserve Association. Finally, it is entirely possible to provide that
not more than a given number of directors in the National reserve
board shall be drawn from any given an?« or section.
§12. It cannot be too strongly emphasized that there is no U n | t y o f
such opposition of banking interests as is suggested by the point <»f Banking
view of sectional jealousy or opposition. Every part of the coun- , n l e r c s t B
try is interested in the banking success of every other part. A complete identity of interest exists. New York banks and foreign institutions join in furnishing the capital needed to move the cotton
crop and they perfonn the same service so far as necessary in bringing the western cereal and other crops to market and in assisting
to finance the movement of manufactured goods generally. There
is no ground for supposing that they have any interest opposed to
the welfare of bankers in other parts of the country. I t is, of
course, a constant matter of competition between different groups
of bankers to secure as much of the good paper offering in the community as they themselves can carry. They do not care to see this
paper, when profitable, taken up by outside institutions. Yet the
interests of such banks are entirely identical from the banking
standpoint. From the standpoint of profitmaking they are opposed,
as are the interests of any competitors. The question of equality of
opportunity among such competitors, and not an imaginary conflict of interest between sections of the country, is the real problem to be met in connection with the control of the National Reserve Association. This is the issue which is dealt with in those
portions of the plan relating to the organization of local associations. How these associations will he organized and how thev
would operate in conjunction with the branch offices of the Reserve
Association is the real and fundamental problem of the whole
question of organization of banking under the new plan.

It is as important to keep the business of banking free

from political control as it is from that of ambitious financial in-




fluences which might use the funds of the institution for their own
ends. Political control or undue influence in any banking institution implies two distinct evils: ( 1 ) the appointment of directors
or officers xinder conditions such as make their tenure of office deControl
pendent upon changes in party supremacy and ( 2 ) the extensions
and the
Evil It
of loans to persons belonging to or affiliated with the dominant poWould
litical party and hence likely to exert some influence in the aifairs
of the government as aftecting the bank granting the favors. In
some cases this political influence in the making of loans may go B
far as to bring about the extension of accommodation for the direct
purpose of assuring the retention of given persons in office. Of
course it is obvious that neither of these conditions ought to be
allowed to exist. The choice of directors in a manner that makes
their tenure dependent upon political changes implies a shifting
control of the institution which is undesirable from every standpoint. Nothing is more important in the management of any commercial institution than strength and continuity of policy. Neither
of these qualities can be expected from persons who are subject to
removal or appointment not on the strength of merit but upon
that of party affiliation or prejudice. On the other hand, the making of loan3 in such a way as to placate politicians necessarily
means rottenness in banking management and is, if anything, more
to be feared than the making of loans in a way that would placate
financial interests. The latter are likely to give security for the
loans, in which case the thing chiefly to be feared is the diversion
of funds from more important to the less desirable objects; while
the ordinary type of political loan is likely to be made on inadequate security, the "influence" of the person who seeks the accommodation serving to insure the acceptance of security that would
not otherwise be considered as bankable.
These evils of political control are not imaginary, but were more
or less exemplified in the history of the first and second banks of
the United States, particularly in that of the second bank. They
are likely to appear in any institution which is largely controlled
by a board of directors whose majority consists of government apDanger
of Political pointees. For this reason the National Reserve Association plan
Control Is
seeks to guard against the introduction of a political type of conGuarded
trol of the institution by providing for the appointment of four
directors only out of 46 in all at the instance of the President. Even
these would not be directly named by him inasmuch as they would
be the regular officers of the government—the Secretary of the

G O V E R X M E X T ' S 11 E PII E ¡S E X T A T I O X


Treasury, Comptroller of the Currency, etc. With this .small number of representatives standing for the government it could never
be feared that they would exert a controlling voice in the management of the affairs of the institution, since they would he so largely
outnumbered by the directors chosen in the several districts into
which the country would be divided for specified terms of years.
The question may be asked why there should he any political
or governmental appointees whatever upon the hoard of directors.
Several reasons exist for giving the government this kind of representation. The proposed institution is to be the holder of the fund.-«
of the government and would perform important functions growing out of this holding of funds. There is therefore the same rea- £ e a s o n s fo»*
, 1 1 1 ,
son why the government should he represented upon the directo- Representarate as there is for the representation of any other interest. The
Reserve Association is to be a great public institution, not organ- Directors,
ized primarily f o r profit, and exerting a powerful influence in the
banking system of the country. Thus every reason exists for governmental oversight and examination, and for that more intimate
knowledge of policy which could be obtained only by having direct
representation in the directorate. This would be attained by the
choice of the officials already indicated as members of the board
of directors and by the free use of a policy of publicity.
Some public men who have recently discussed the question of
control of the Reserve Association have taken the view that it ought
to be almost entirely managed by directors appointed by the President and subject to confirmation by the Senate. This would be the
extreme type of political control tested in the past and found wanting for the reasons already stated. Others have gone to the opposite extreme by complaining of the presence of any representatives
of the government upon the board. The proper course lies intermediate between these two radical views. I t consists in giving to the
representatives of the people a due voice and oversight of the affairs
of the institution that they may be conducted with an eye to the
general good, while refusing a dominating influence to such govemmental officers. This is in order that there may be sufficient con«
tinuity of policy, and that the controlling spirits in the organization may be chosen for their success and skill in banking rather than
for the possession of those qualities which lead to political success.
§14. What has thus far been said is entirely based upon the
assumption that the control of the Reserve Association when oh-



tained would be of such value as to induce banks to go to the most
I t has been assumed


Control of

that the holding of a position of leadership or authority in the

es Put?


their.effort to secure it.


^ e s e r v e Association would be of decided value and significance to the banks that succeeded in acquiring it.

Is this the case?

Obviously, mere "control" is not wanted for its own sake.


ists will not go to the trouble of manipulating votes, much less will
they expend large sums of money, in order merely to obtain the
prestige involved in the management of a Reserve Association representing the combined banks of the country. I f they were willing
to undertake the work on a basis of mere public spirit or ambition
and without any ulterior object, there might be no harm in allowing them to direct the management of the institution. But of coursc
the supposition of those who are concerned about the control of the
Reserve Association is that those who are seeking it are doing so
because they want to use the funds for some purpose of their own.
This can only be ( 1 ) the making of loans upon security of a special type that would be in their possession more largely than in that
of other banks, or else ( 2 ) the making of loans to them to the exclusion of loans to other persons.

If either of these ends could

be attained there would be a motive in attempting to acquire control of the Reserve Association.

I f neither of them could be at-

tained, there would be no reason why any one should wish to obtain
such control even though the attainment of it might be a comparatively Bimple matter.
What is feared by most persons who express a dread of ambitious financial control is that the funds of the Reserve Association
Securities'6 w o u l d b e
the purpose of making loans on stocks or
Not Recofl- other speculative securities. The fundamental intention of the ReCollate"».

? A s f i 0 c i a t i 0 n i s t o Promote commercial banking. Only in
specially guarded cases would the making of loans on collateral
be permitted at all. On this point the provisions of the Reserve
Association plan would afford full protection by requiring that loans
on collateral security could be made only when


tíle g o v e r n o r o f

the National Reserve Assoshould so require, such opinion to
committee of the National
a n d t 0 h a v e to® definite approval of the
t h e £ r i a s u r yIn such cases the National Reserve
b e a l l o w e d through a branch to discount
depositing bank, indorsed by Its local
ticEriEEfr T ^ n 6 * t h a t t b e indorsement of the local associatlon should be fully secured by the pledge and deposit with it
SL o«««,™J U , bli v


the executIve



of satisfactory securities, which should be held by the local
association for account of the National Reserve Association.
In DO such case should the amount loaned by the National
Reserve Association exceed three-fourths of the actual value
of the securities so pledged.

In another way an institution such as has been described would
render the idea of central control more than ever remote from facts.
At present small local banks, as has "been explained, are subject to H o w Large
control by reason of the fact that in iimes of stress or special de- Favor Small
mand for funds they have to look to citv banks for accommodation. Ones, and
the Result»
This accommodation is not usually extended in the form of a rediscount in this country. A strong prejudice exists among the banks
against making application to another bank for a rediscount. But
the same object is attained in other ways. Ofl'icers of the small bank
secure personal loans from the larger institution and turn them
over to their own bank for its use, the nature of the operation being
perfect!}' well understood by the institution which grant? the loan.
Or the small bank may secure from the larger institution permission to draw on it in excess of its credit. This practice gives rise
frequently to large amounts of overdrafts upon which the small institutions pay interest just as they would oil a straight loan properly secured. It does not matter whether the extension of accommodation in this way is technically called a "rediscount" or not.
The fact that the small institutions have to come to the larger
banks for aid remains and is the fundamental consideration. Under
the present system by refusing to grant such accommodation the
larger institutions can practically direct the policy of the small ones
under certain conditions, if they feel so disposed, while by favoring
them under other conditions they are able to promote the development of certain kinds of business. This is obviously bad policy.
Banks should feel assurance that if they extend accommodation to
customers on live commercial paper growing out of legitimate
transactions they will be able to dispose of it. They are not able
to do so to-day.
The only means of getting relief from this kind of control is
found in the establishment of some system which will render it
possible for banks to know with great definitenees what they can
expect in the way of rediscount and how far they can safely go in
extending credit to potential borrowers upon certain classes of security. The advantage of a federation, or cooperative association,
of banks of the kind referred to is that under it there would be this
possibility of exact knowledge regarding the kind of credit that



could bo obtained and tlie extent to which it could be had. Elsewhere, the methods by which discounts would be granted at the
branches of the National Reserve Association have been fully described. At this point it is enough to say that under the proposed
Limitations p] a n a n y subscribing bank would be allowed to apply to its local
other 0 °
association for a guaranty of the commercial paper which it desired
to rediscount at the branch of the National Reserve Association in
Commercial its district, while it would be unlikely the officers of an assoPaper.
dation would refuse a rediscount to any bank when the collateral
was beyond question, on the ground that the business of the subscribing bank was not important or for any similar reason. By
limiting the total amount of the guarantees which a local association could make to the total aggregate surplus and capital of the
banks forming the association, and by requiring that every bank
should have on deposit with the National Reserve Association a
specified and adequate percentage of the total credit granted to
such bank by the association, the danger of over-loans would bo
met. It would be provided that loans might be granted direct to any
shareholding bank in given classes of cases intended to cover all
regular and non-speculative commercial operations.
The plan of the Reserve Association in short contemplates that
loans shall be made only under conditions that will give all institutions a perfectly equal opportunity. That is to say, the Reserve Association is to be called upon to discount all paper of a particularly
described kind, no matter where it may originate or what bank
may hold it. Its operations are to be absolutely dispassionate and
non-partisan, as nearly automatic as the nature of the case will
All of the privileges and advantages of the National Reserve
Association should be equitably and proportionately extended to
«very subscribing bank. Any such bank may obtain loans from the
National Reserve Association in any of the four following ways:
^ 1. Rediscounts not guaranteed. The National Reserve Association may through a branch rediscount for and with the endorsement of any depositing bank, such notes as the bank may have
discounted for its customers, rediscounted for other banks, or purchased through commercial paper brokers, the proceeds of which
have been used for commercial industrial, or agricultural purposes,
and not for carrying stocks, bonds, or other investment securities.
Such notes and bills should have a maturity of not more than
twenty-eight days, and should have been made at least thirty days

prior to the date of rediscount. The amount so rediscounled should
in no case exceed the capital of the bank applying for the redis- Functions
count. The aggregate of such notes and bills bearing the signa- Reserve
ture or endorsement of any one person, company, corporation, or Association
firm, rcdiscounted for any one bank, should at no time exceed teu
per cent of the capital and surplus of said bank.
2. Rediscounts guaranteed. The National Reserve Association should also rediscount for any depositing bank similar notes and
bills of exchange arising out of commercial transactions having
more than twenty-eight clays to run, but not. exceeding four months,
provided the paper has been guaranteed by the local association of
which the bank asking for the rediscount is a member.
3. Direct loans to a bank. Whenever the public interests so
require, the National Reserve Association may, with the approval
of the governor, the executive connnittce and the Secretary of the
Treasury, discount the direct obligation of a depositing bank, indorsed by its local association, provided that the endorsement of the
local association should be fully secured by the pledge and deposit
with it of satisfactory securities, which should be held by the local
association for the account of the National Reserve Association;
but in no such case should the amount loaned bv the National Reserve Association exceed three-fourths of the actual value of the
securities so pledged.
4. Acccptances.
The National Reserve Association
whenever its own condition and the general financial conditions
warrant such investment, purchase to a limited amount from a
depositing bank acceptances of banks or houses of unquestioned
financial responsibility. Such acceptances should arise from commercial transactions and have a maturity not exceeding ninety days,
and should be of a character generally known in the market as
prime bills. Such acceptances should also bear the endorsement
of the depositing bank selling the same, which endorsement should
be other than that of the acceptor.
§15. If every bank, entitled by virtue of the fact that it is a
stockholder to receive accommodation at the offices of the National
Reserve Association, shall he assured of such accommodation, and
if every bank shall recognize that its only claim to such accommodation is to be the ownership of specified classes of paper presented
for rediscounting, it mil direct its efforts toward the acquirement
of this hind of paper rather than toward the control of the Reserve



Association. That is to say, its objects will be served by complying with the rules which are enjoined upon all those who ought to
Control of receive accommodation rather than by attempting to exercise authorOther
ity of a merely administrative kind. This means, in short, that
Would Not the institution is to be placed upon a basis where the directors
shall have absolutely no power to favor one bank or to engage in
the Icinds of business that are feared.
There remains only the question whether it might be worth
while to be in control of the Reserve Association in order to make
sure that in the event of inability to rediscount beyond a certain sum
those who were most influential should be able to get first chance
at the accommodations. If it were true that the Reserve Association
could rediscount only a very moderate amount of paper such as is
the case with many of the larger banks at the present day so that
certain applicants for accommodation would necessarily be unsatisfied there might still be a sufficient reason for securing a decisive
influence in the management in the institution. There is, however, no basis for any such assumption. Careful restrictions are
imposed upon the classes of paper that are to be acceptable at tne
No Need of offices of the Reserve Association; there are provisions for large
Striving for
Control to note issues to be made by the institution; and with the arInsure the rangement regarding reserves which permits of their continuous
Gaining of
reduction in order to meet necessities (provided that borrowers are
willing to pay the additional cost entailed by an increased rate of
discount, largely based upon the amount of the lowering of the
reserve beyond a specified point), there would be no reason whatever to fear that the Association would ever be unable to comply
with all legitimate demands made upon it for the rediscounting of

Experience with clearing-house certificates in the past, as well
as the experience of foreign banks, furnishes abundant evidence
to s o that there is small prospect of exhausting the credit-granthw
ing powers of the Association, or of pressing it close to the limit
beyond which it cannot safely go in extending accommodation. If?
therefore, the operations of the institution were restricted to certain
classes of paper, if the discounting of such paper were made invariable so that no favoritism could be allowed to creep in ; so that, in
short, every bank would be assured of the same treatment as every
other; and if,finally,the credit-affording powers of the institution
within the limits set for it were practically limitless, the consequence
would be that no object whatever could be served by obtaining the



upper hand in its management. Violation o í the statutes of the
institution would be a heavily-penalized offense and ofliocrs would
be under the same supervisoiv authority that is today exerted by
the government over the doings of the banking institutions through- Governout the national system.
I t has been suggested that a motive for trying to gain enntrol over the National Reserve Association might exist in a desire «ociation
to favor concerns allied with dominant financial interests as against Officers
other concerns who were their rivals probably in the same kind of
business. Inasmuch as their paper would be commercial, and
not secured by stock exchange collateral, here might be a situation in which good commercial paper might be refuse«! by Branch
officials at the behest of the great "interests," if thev could gain
control; thus, oven if stock exchange collateral were unavailable,
there might be a motive for gaining control.
A s to this suggestion there are several points to be considered :
( 1 ) The customer retains all his present relations with his bank
unchanged. Ilis bank, which wishes his account, retains its present relations with its correspondent bank, from which it can get
rediscounts. If a customer is discriminated against, that implies
that no bank wishes his account. ( 2 ) The real point at issue is,
will the National Reserve Association discriminate against any one
subscribing bank which presents good commercial paper? Will it
be possible to refuse such good paper for the real purpose of driving a rival out of business? This is a difficulty to some minds.
The bank, of course, has the alternative of going either to it? correspondent bank, as now, or to the Branch of the National Reserve
Association. The paper is passed upon by the executive officers of
the Branch. These officers arc governed by by-laws made by the
Directors of the Branch, who are in turn the creature? of the local
associations. The action of the branches in rcdiscounting must,
therefore, be amenable to the opinion of the locality. ( 3 ) Questions of general policy for the whole country, such as the total
magnitude of loans made, reserves to be carried, the uniform rato
of discount, and the like must be determined, of course, by the
Board at Washington; hut the question as to what paper shall he
accepted must be determined by the Branch, which is representative if its region. There can obviously be no compulsory discounting ordained by law, any more than good weather can be required
by law for the Fourth of July. In the main, rcliance must bo
placed on the character of the management, as in all banking sys-

25-t B E N E F I T S OF A X I N D E P E N D E N T A S S O C I A T I O N

This character of the management can lie obtained by the

kind of directors chosen by local associations.
§16. I n studying the steps which must be taken in order to
remove the conditions that give rise to present-day centralization
of control in banking, the conclusion is inevitably reached that the
most effective method of avoiding this type of control is that of
furnishing an ample and satisfactory market for commercial paper.
By this means banks would be assured full consideration of their
necessities and could feel confident that they would be supplied ds
occasion might demand. If assured of a permanent and reliable institution ai which to present their paper for rediscount, and with
which to redeposit such reserve funds as they did not immediately
Establishment of an need, they would cease to feel dependent upon the good will of large
city institutions which must be placated in order to insure their
Market for
Commercial aid in an emergency or financial stringency. On the other hand,
if banks were supplied with an assured method of obtaining exchange, they would be relieved of the necessity of relying upon a
correspondent bank for that service. These and other necessities
of similar character could be fully met by the establishment of a
strong institution dealing only or primarily with banks, and intended to supply them with an absolutely fair and unbiased agency
with which to transact their outside business, f r o m which to get
loans, and through which to transfer funds to other banks. They
would not, with such an institution at hand, need to trouble themselves about anything except the careful testing of the commercial
paper presented to them, in the effort to make sure that the security
was safe. All this is based upon the assumption that such an institution, when established, would, as stated, be absolutely independent, free of partisan control, and under no subtle financial influence which would lead it to prefer one bank or group of banks to

Why Large
Do Not

§17. The question may arise—if the plan of the National
Keserve Association would tend to divert idle funds from the central
reserve cities, especially from New Y o r k ; reduce the amount which
can be loaned at call on the stock exchange; direct capital more or
less away from speculative loans to the discount markets f o r legitimate commercial paper; and break up the present feudal dependence of smaller banks upon very large ones: W h y do not the large
banks in the central reserve cities oppose the plan with all their



No doubt on this question has ever arisen in the minds of any
managers of large banks who have passed through crises like those
of 1893 and 1907. In an emergency, or crisis, the large hanking
institution finds itself confronted with exactly the same sort of difficulty, the same restrictions on its power to make now loans, the
same inability to provide loans to old customers, as those which
confront the small institution ; only, it may be said that the difficulties, although of the same kind, are greater, harder to meet, and
carry with them larger possibilities of disaster. For instance, a
local bank in Missouri, or Kansas, may find itself "loaned u p " to
its limit, and yet in an emergency additional demands for loans
from merchants and farmers are pressing hard. It.- duty is to serve
the local community; but under the present inelasticity of credit the
bank is bound hand and foot. If it fails to use good judgment,
or to render aid to legitimate customers, it would cause failures
throughout its constituency. Its only help is from its large correspondent bank, probably in St. Louis, Chicago, or New York.
So far the facts are clear.
Now, how is it with the large bank having hundreds or thousands of smali correspondent banks looking to it for favors, or
funds, in time of stress? As these arc scattered over n wide territory, the accumulated demands from correspondent banks, when
trouble comes, are something tremendous. The failure to respond
to aid would, when trouble comes, break down a local hank and carrv L a r g e
with it all its customers. The same thing is true of a cen- Banks Have
tral reserve city hank.
That is, the large hank has exactly the T [ m c s 0 f
same kind of thing to meet as the small bank, only on a larger scale, Stress,
with immensely greater responsibilities. If the small bank, therefore, would get relief out of a National Reserve Association, how
much more would it be to the interest of the large bank to seek the
establishment of such an agency. The common sense of the matter
ip, of course, that advantages from such a plan would inure to all
banks, small or large. In a storm on a rocky coast, when two
boats, one small and one large, are using all their seamanship to
protect themselves from disaster, a shipwreck of the larger would
carry distress to more families throughout the land than that of
the smaller ship. The suffering of any one of ten persons on the
small boat is, of course, as poignant as that of any one of a thousand on the big boat; but the full extent of the ruin caused by the
latter is very much greater. That is, aids to safe navigation—
lighthouses, buoys and charts—are quite as much to the interest of



the large, as of the small, ship. But suppose that the smaller boat
was in tow of the large boat; then, when the larger ship went ashore,
in fog or darkness, it would carry the small one with it. Similarly, the system which enables banks to aid their customers with
loans in storm and stress is needed even more by the largest than
by the smallest banks; and the preservation of a large bank protects the smaller correspondent banks.
Injurious financial control, then, should be made impossible;
but preventive measures should be based on a real and expert knowledge of the organization of credit. As it now is we have practical
centralization; as it ought to be we would have actual cooperation
among all banks in the common interest.



Small Banks as Members of National Reserve Association—2. New
Duties and Privileges—3. No Rediscount Facilities Under Present
System—4. Economies—5. Small Banks to Control National Reservo Association—6. The Chief Danger Now Confronting the
Small Bank—7. Many Problems of the Small Bank Would Bo
Solved—8. Commercial Paper and llow It Is Regarded—9. Commercial and Investment Loans—10. Small Banks Will Becomo
Really Independent—11. Divorced From Reserve City Banks.

§1. The National Reserve Association is proposed as a means
of completing and perfecting the process of organization of our
banking institutions which has been in progress at least since the
establishment of our national banking system. It is designed to
serve these institutions, not to compeic with them ; to add something
to what they already have, to increase their usefulness, not to take Small
something away from them or to supplant them. Constituting as vf t "^ 8 y a r o
they do probably seventy-five per cent of the total number, small Concerned
banks are vitally concerned in this project.
The plan at present under consideration places before such a
bank first of all the alternative of becoming a member of a National
Reserve Association or of remaining outside. Assuming that it decides to become a part of the organization, it would be required to
subscribe for stock in the Association to the amount of twenty per
cent of its capital and to pay half that amount in cash, the other
half remaining subject to call. It would also be required to join
with the other banks in its vicinity, which had also become members Member, n t . ho
of the Association, in the formation of a local Association. It would
. . .
, .
not be required to sever any of its existing relations with other Reserve
banks. I t could retain its correspondents, its membership in the A s 8 0 C | a t , 0 n
clearing house, if it had one, and its bank customers. It could
form any new relations of this kind that might he desired. Its relations to the national or the state system to which it belongs would




not be in any respect disturbed. National banks would continue as
at present to be inspected and supervised by the Comptroller of the
Currency and his assistants, and state banks and trust companies by
the state officers at present entrusted with that duty.
§2. These simple additions to the connections of the small
bank would impose upon it new duties and give it privileges not
now enjoyed. Chief among the former are the choice of one of its
officers as its representative in the election of directors of the local
Association and his equipment with any desired instructions, and,
New Dutle« in conjunction with fellow members of the Association, the choice of
and New
representatives to vote for directors of the district Association and
to vote the stock of the xlssociation in the election of directors of
the district branch and of the National Association. Another is the
assumption, in conjunction with fellow members of the local Association, of the obligation to make good any losses involved in the
non-payment by any member, of the paper bearing the endorsement
of the local Association, which the bank had rediscounted at any
branch or at the central office; the amount of its obligation in such
a case being determined by the proportion its capital and surplus
bear to the aggregate capital and surplus of all the banks of the
local Association. A third is the obligation to report to the National Reserve Association monthly or oftener, if required, the principal items in its balance sheet and to submit to examination by
representatives of the local Association.
The new privileges to be made available pertain to its reserves, rediscounts and loans, clearings and transfers, note issues
and holdings of government bonds. I t would be permitted to count
as part of its legal reserve its balances in any of the offices of the
Association in addition to those with its present reserve agents
Locked Up
which it is now permitted to count. This would relieve the small
bank of the obligation now imposed of keeping locked up in its
vaults cash to the amount of at least six per cent of its deposits. It
would also be relieved of the necessity of keeping reserves against
time deposits payable more than thirty days ahead.

No Rediscount

§3. In the matter of rediscounts small banks at the present
time have very limited, if any, facilities. Occasionally as a special
favor their correspondents will take some of their customers' paper,
but ordinarily they are obliged to hold such paper until maturity
and frequently to renew it. The plan f o r a National Reserve Asso-

ciation proposes materially to change this condition of affairs by
furnishing adequate rediscount facilities. Genuine commercial bills
maturing in not more than twenty-eight days, which have been
made at least thirty days previously, are to be rediscountable
directly; that is, when presented by the bank itself without the mediation of its local Association. Bills of the same churacter maturing in not to exceed four months are to be acceptable for rediscount when endorsed by the local Association. In cases of special
need loans arc also to he made directly to banks on the security of
their own paper endorsed by the local Association and secured by
collateral. Such loans, however, must have the approval of the Secretary of the Treasury, and are intended to meet special exigencies
only and would not probably, therefore, be often available for
small banks.
It should be noted that the extension of these rediscount and
loan facilities to all banks will benefit the small ones not only directly but also indirectly by making it possible for their large correspondents to grant them facilities in this line not now possible,
Being able themselves to secure ample accommodations from the Reserve Association, these correspondents will he able without danger
to rediscount for their small-bank customers and to loan to them.
The latter would thus doubtless be able to rediscount other paper
than that acceptable to the Reserve Association and would be able
to avoid application to the local Association, if for any reason that
should not seem desirable. Small banks which do not belong to
the Association would in this way also be able to enjoy some of its

p*^® 1 1

Another very valuable privilege is that of the transfer

without charge of the whole or any part of a bank's balance with
the Reserve Association to any other bank having an account with
the Association. This would practically eliminate exchange charges
and greatly diminish the time now required for the making of exchanges between distant places.

Another saving would be effected


by the privilege of securing without cost shipments of the circulat- ™ c e
ing notes of the Association.


Since these would serve all the pur- shipping

poses of cash and could be counted as a part of the legal reserve, Currency
banks would be saved the greater part of the expense now involved
in currency shipments to replenish depleted supplies.
Another feature of the plan of great importance to small bank?



is the privilege to be accorded local Associations of exercising the
powers and functions of clearing houses.

I f these Associations

should generally avail themselves of this privilege, the collections
of the small banks would be greatly facilitated and the greater part
of the expense now involved in them eliminated.

Since these local

Associations would embrace the entire country and would be connected with each other through the branches and the central office
of the general Association, banks would have no difficulty in disposing at par of any check or draft, no matter in what part of the
country drawn or payable.

Since clearing balances would be made

payable in checks against balances in the Reserve Association's
offices, no shipment of currency would be required in their settlement.

This privilege would remove one of the chief causes of fric-

tion now existing between small banks and their correspondents, a
considerable amount of irritation now being caused by the refusal
of the latter from time to time to accept certain checks or to collect
them without a heavy charge for exchange.
All the privileges thus far described would be available to state
and national banks alike.

The latter would enjoy the additional

one of being able, if they so desire, to dispose of their government
bonds at par without forfeiting their national charters.

The plan

does not contemplate the application to national banks of any pressure to give up their present issues, but it oilers them the opportunity on terms that are fair and that involve little, if any, loss.


extension of their note issues beyond the amount outstanding at the
date of the organization of the Association is not to be permitted.
The plan further proposes to permit national banks to lend a
portion of their savings deposits on real estate security, thus removing one of the handicaps under which they now operate in competiNational
Could Make
Loans on
Real Estate

tion with state institutions.

This privilege concerns principally the

small banks of this group, especially those located in small towns
and country districts.

I t would greatly enlarge their capacity to

serve their present constituents and to add to their number.
Another privilege is offered national banks by this plan, namely, that of accepting bills for their customers.

This concerns small

institutions as well as large, although the latter will doubtless make
most use of it, at any rate at first. T o the small bank, however, it
offers a form of two-name paper which in many cases it will be
able to substitute f o r the one-name paper it is now obliged to accept



§5. The assumption of the obligations and the enjoyment of
the privileges which have been mentioned are calculated to
strengthen the small banks of the country, improve their business
methods and remove from thern the chief obstacles in the way of
their proper development and the chief dangers which now threaten
them. In substantiation of this claim it should be noted first of
all that the plan now under consideration proposes to put the control of the National Reserve Association in their hands on the assumption that an institution which is designed for the service of
banks ought to be controlled and managed by them; otherwise there
is danger of its becoming a master instead of a servant. The assumption of such an obligation is a great responsibility, and like all
great responsibilities it promises the development of strength as
well as power.
One of the penalties which our small banks have been obliged
to pay for their independence of ownership, their close connection
with local interests and their circumscribed field of operations is
relative isolation. They arc at a distance from the larger currents
of affairs and in ordinary times out of touch with them. As a rule
only when crises threaten or actually occur does the fact that they
are but parts of a great mechanism of exchange, international in the
6cope of its operation and influence, strike their attention and impress them in a vivid manner. Among the consequences of thiB
isolation are inaccessibility to sources of information essential to
the proper training of their officers and to the safest and most successful conduct of their business, and a species of provincialism
which stands in the way of progress.
A National Reserve Association controlled by them would
bring small banks into close touch with each other, with larger
banks in the commercial centers, and with itself, the balance wheel
of the entire system. As members of a local Association and financially responsible for losses resulting from defaulted paper rediscounted by fellow members, they would be forced to interest themselves in each otlier's affairs and in the economic activities of the region embraced in the Association. Having the duty to vote for directors of the branches and of the central Association at Washington and being vitally interested in the discount, reserve and issue
policies practiced by them, they would be obliged to 6tudy these
matters, and through them the financial and commercial facts and
movements on which they are based. N o bank could properly per-

lank« to

JJJJ^q^^ 1
f U l and




form its function in the proposed organization without strengthening its officers and directors along lines which tend to develop length
and breadth of vision, broad-mindedness, wider and deeper knowledge of banking and commercial affairs, and the spirit of cooperation
and patriotism.

The Chief
Now Con*
the Small

§6. Among the more obvious services a National Reserve Association will render the small banks, are the removal of the chief
danger which now menaces them, the increase of their capacity to
serve their constituents, and the power it will place in their hands
for the inducement of the cooperation of their constituents in the
development of sounder business methods.
The chief danger which now menaces the small bank which
honestly and faithfully serves its constituents is the locking up of
its resources in unmarketable securities. Its chief business is the receipt of deposits which it agrees to pay on demand and their loan
for considerable periods of time on personal security, usually onename paper. Its borrowers consist chiefly of local business men who
are little known outside of their home town and whose paper in
consequence is unmarketable except at the local bank. The quality
of this paper varies widely, but, all things considered, is high. It is
not revealed by the face of the instrument itself, however; can be
tested as a rule only by the banker of the man who makes i t ; and
his method of putting it to a test would frequently not pass muster in a court of credit men. I n fact it is the essential conservatism
and soundness of the methods of the average American business man
upon which dependence is placed rather than upon balance sheets,
careful investigation, or collateral.
Moreover, the small banker's relation to his constituents is personal and private. In this respect it resembles that of a physician
to his patient.

The business man expects his banker to afford him

such accommodations as he needs in the f o r m of loans, and the
Its Relation to Its
Constituents Personal and

banker is obliged practically to assume this obligation.

H i s cash

resources, however, which are even further beyond his power of regulation and control, bear no necessary relation to the magnitude of
these loans. They depend primarily upon the amount of money in
circulation in the community, the number of his depositors who are
not borrowers and the relative proportion of time to demand deposits.

I f it were not f o r the fact that most of his borrowers re-

ceive the proceeds of their loans in the f o r m of balances against
which they check, and his ability consequently to pay off one cus-



tomer by borrowing from another, he could not do business at nil.
But in spite of the high development of the check system in this
country, the danger of being called upon for more cash than he re*
ceives from his customers in the normal course of events constantly
menaces him. At the present time he is able to provide against this
only in a very imperfect and haphazard manner. There is no regular and normal way of so doing. He must always resort to such
expedients as his ingenuity and conditions at the time suggest.
§7. The National Reserve Association will completely change
all this. It will provide an easy, normal and always available
method of adjusting cash resources to needs, and that, too, without
compelling the small banker to change in any essential particular
his present business methods or without in any way curtailing his
activities. In case he is threatened by a shortage of cash, lie will
simply need to select those notes from his portfolio which mature
in the near future and which he knows from experience or from prearrangement with the customers whose names are upon them, will
be paid at maturity instead of renewed, and turn them over to the
nearest branch of the National Reserve Association for rediscount.
A favorable credit balance will thus be created against which he
can draw to the extent of his need. Upon demand the Association
will even ship him currency free of charge.

of the Small

This privilege of rediscount will not only relieve the small
banker of his chief anxiety and his chief danger, but will enlarge his
capacity to serve his constituents. Safety now compels him either
to keep on hand funds in excess of his real needs and in excess of
the legal reserve, which he is forbidden to use, or else to invest in
such securities as he can readily turn into cash, and these are rarely
the kind that his customers can supply. In either case his constituents are deprived of the use of funds which the National Reserve Association will enable him to place at their disposal.
Furthermore, the National Reserve Association will enable the
small banker to place at the disposal of his customers foreign capital to a degree which is now impossible. He will not be obliged to Outside
reject a good loan simply because he is "loaned up." l i e can always Capital Will
turn such a loan over to the Reserve Association, provided only the ** JJabll
proceeds are to be used for strictly commercial purposes. This
limitation will prevent him from lending assistance to such of his
customers as are interested in over-expansion and inflation, but in
110 way interfere with his aiding them in the prosecution of legitimate commerce.




The fear has been expressed that danger lurks in the scheme
at this point, that the National Reserve Association will make it so
easy for the small banker to get capital for his customers that
they will be encouraged to embark in all kinds of inflation schemes.
This fear is based upon a misconception of the nature of the commercial paper to which it is proposed to limit the investments of the
Association, and upon a failure to note the effects of variations in
the rate of discount. .
§8. The term "commercial paper" is commonly used in this
country to mean paper that is sold about the country by brokers, and
small bankers, having frequently suffered loss from investments in
it, do not rank it highly. Indeed many of them will have nothing to
do with it. Emphasis should be placed on the fact that as the term
is used in connection with the National Reserve Association it means
something very different, namely, paper which represents moveThe Term
ments of goods from producers to consumers, the transformation of
"Commercial Paper" raw materials into finished products, of the seed, fertilizers, maand How It chinery, labor and tools of the fanner into crops, and of lean into
Is Usually fat cattle, etc., etc. It should be contrasted with investment paper,
which represents the capitalization of new enterprises and the enlargement of old ones, the purchase of land, water powers, irrigation
projects, the construction of buildings, the opening up of mines, and
the building of railroads, lighting and heating plants, etc. Commercial paper in this sense is to be found in every community.
I t is presented to the banker by his own customers and is more
abundant than any other form of loan.
Inflation results when investment loans exceed current savings,
because when this happens, banks assume demand obligations, that
is, issue currency against obligations which will not be paid for
years, and the currency consequently piles up, accumulates, instead
of being returned and redeemed.

When, however, they invest in

commercial paper, they simply act as intermediaries in an exchange
of goods against goods, the currency which they create being returned to them for cancellation by the completion of the processes
of exchange in which it originates, and this normally happens,
sometimes in a few hours, usually in a few days or weeks, and at
the longest in a few months.

Against the possibility of even temporary inflation caused b
over-investment in commercial paper of the longest maturities or b
a temporary stoppage of the ordinary processes of commerce, the



power of the Reserve Association to regulate the rate of discount i9
a safeguard. When that rate is raised, it will check the rapidity of safeguard
exchange operations all along the line and diminish their magni- Against
tude. When it is lowered the opposite will happen. The Reserve
Association will thus be able to maintain a proper adjustment between the country's commerce and its credit operations.

The emphasis which the Reserve Association will


forced to place on commercial paper and the fact that it will supply
for the first time in this country an open market for such paper will
tend to influence in a wholesome fashion the business habits of
small banks and their constituents.

Few of these now observe in

their practice, and perhaps many of them are unconscious of, the J ° j i m c r c , a ®
distinction which has just been drawn between commercial and in- investment
vestment loans.

In consequence they contribute, without doubt un-


consciously in most cases, to the inflation of credit which characterizes every period of prosperity.

The National Reserve


ciation will force this distinction upon their attention and will
furnish them a strong motive for its observance in practice.


our experience proves to be different from that of other countries,
once a market for commercial paper is created, it will be placed at
the top of the list of bank investments, and the rate on it will be the
lowest in the market.

Small bankers will, therefore, be able to offer

customers decidedly better terms for paper of this kind than for
any other, thus furnishing them the strongest kind of a motive for
giving this character to as large a proportion of their obligations as
This will also materially aid such bankers in the very difficult task of inducing their customers to disclose the uses to which
they propose to put borrowed funds and to supply financial statements of their business operations. A t the present time small bankers are able to get this information only to a limited extent, especially in regard to paper furnished by note-brokers. When they are
able to offer a customer a one or two per cent reduction in the rate of
interest on all paper which bears on its face or in the form of attached documents the evidence of its commercial character, he will
no longer hesitate to furnish what is wanted. If he does, he will
force his banker to the conclusion that he cannot furnish it and
thus injure his own credit.

It is at this point that the significance of the proposal to allow


Will be
Superior to

banks to accept drafts for their customers appears. Such acceptances will be useful and superior to promissory notes only in the
financing of purchases of goods at distant points, the buyer in such
cases being able to discount a bank acceptance, but not that of an
unknown merchant. The name and location of the drawer will in
most cases reveal to the accepting bank the nature of the transaction on which the bill is based, and the customer will derive the advantage of getting credit for the period in question at a lower rate
than would otherwise be possible.

Not so obvious, perhaps, but quite as important hi the

long run are the scrutiny and supervision of his fellow bankers
and the increase in real independence which the National Reserve
Association will bring to the small banker.

In order that the offi-

cers of the local Associations may be in a position to pass intelligently upon the quality of the paper submitted to them for rediscount, they must carefully study the business methods of the bankSmall
Bank Will
Really Independent

ers with whom they deal, and this study will not be spasmodic but

Their fund of knowledge will constantly increase and

become the common property of the entire banking community.
Every bank will have a pecuniary interest in keeping its fellows up
to a high grade of soundness and will be obliged to conduct its own
affairs in the open.

The knowledge of this fact and the conscious-

ness of this scrutiny will be the most efficient check on bad banking
yet devised in this country.

It will do for small banks everywhere

what clearing-house inspection in some of our large cities has done
f o r banks thus associated.
This mutual scrutiny and supervision will furnish the best possible guarantee to depositors.

Deposits can never be in danger so

long as loans are properly made and safeguarded and are


transmutable into cash, and it is primarily on loans that this scruBest

tiny will be concentrated.

The borrowers of a bank will gradually

be revealed by the paper sent up f o r rediscount and their character
will be put to the test of outside, disinterested investigation.


this investigation the banker will ultimately find his strongest
weapon against the undue pressure of unscrupulous and plunging

I t is a widespread belief at the present time that the

much boasted independence of the small American bank has been
partially, if not wholly, lost. Without attempting to examine the



validity of the grounds usually assigned for this belief, it is pertinent to note the fact that a degree of dependence upon reserve city
banks and the stock market is unavoidable under present conditions.
The small banker must have liquid assets and his only method of
getting them now is by the favor of his reserve agent in granting
him rediscounts, or loans 011 collateral, or by investments in stock
exchange securities. Whichever horn of the dilemma he chooses, lie
delivers his fortunes in part into the hands of ether people. His
reserve agent is not obliged to rediscount for him or to grant him
loans. Neither obligation is necessarily involved in the reserve
agent function. The small banker must ask these privileges as q
favor and in consequence must be prepared to grant favors in return, and these return favors at times may seriously interfere with
his independence. When he invests in stock exchange securities with
the expectation of turning these into cash in case of need, he throw*
hjs fortunes to that extent into the hands of the people who have
most influence in the marketing of such securities, and, in order
to be on the right side of the market, he is tempted to seek their
favor and to follow their advice.

wm° De-' 0 '
liver the

The National Reserve Association will deliver him from both
kinds of thralldom. It will give him an institution of his own in
which he has property rights and over which he has control, to
which he can always turn for cash as a right instead of a favor,
which in fact exists primarily for the purpose of rendering him this
service. He will then be truly independent, an equal among equals,
the arbiter of his own fortunes.
§ 12. Recently the fear has been expressed that some small
banks would be unable to derive much benefit from rediscounts
through the proposed Reserve Association because the greater part
of the paper they hold is of longer maturities than four months,
the maximum the Association is to be allowed to accept. This fear
is based upon a misconception of the clause in the proposed act
which permits rediscounts of paper maturing in not less than
twenty-eight days. Such paper must have been in the possession Small
of the bank for at least thirty days, but it may have been there for p^lscoun
a much longer period. Every bank always has on hand paper ma- Privileges
turing during the coming month. So far as this regulation is con- A m P , e
cerned it matters not how long it may have been in the bank's
possession. Provided it is actually payable within twenty-eight
days it falls within the category of directly rediscountable paper.




It should furthermore be remembered that nothing in the proposed plan prevents correspondents from rediscounting for their
bank customers paper of longer maturities than four months, and
their ability to rediscount with the Eeserve Association will give
them facilities for so doing which they do not now possess and a
motive for so doing which docs not now exist. Such banks will
ordinarily have plenty of paper which falls within the rediscountable categories and, in order to prevent the removal of their bank
customers' balances to the Reserve Association, they will find it in
their interest to accommodate them in every possible way.


1. A Largo Number of State Banks and Trust Companies—2. The
Problem of State Banks—3. Control of State and National Banks
by Each Other—4. Reserve Plan Puts State and National lianks on
Same Footing—5. Trust Companies and Mutual Savings Banks—
6. Uniformity of Examination—7. A Single Discount Market—8.
Benefit of a Reserve Association to Institutions Outside It.

§1. The national banking system is merely the core of the
present system of banking in the United States. The national
institutions number over 7,300, while beside them there exist institutions organized under state laws to the number of at least 17,000 or 18,000. Some of the state banks have small capital; others
large capital and resources. Some of the strongest banks in the
country are private partnerships organized under state laws and
engaged in foreign trade and operations for which other banks have
no facilities.


Congress has paid little attention to these various classes of
institutions, except that in 1866 it taxed the notes of state banks
at the rate of 10 per cent so as to make the further issue and
circulation of such notes impracticable. I t was then desired to
reserve the function of note-issue entirely to national banks, but
beyond this early and exceptional action, the federal government
has not sought to interfere with the activities of the state institutions.
While it is true that there is great variation in the laws of
the several states, it is also true that in the main the banking systerns of the states have been copied from the national banking
system. T h e trust company laws of the several states have been a
later evolution designed to permit the growth of a class of institution8 equipped to do special kinds of business allied to banking.
These trust companies originally engaged chiefly in the operations
which their name implies; then having large funds of their own,






Development of

where not prevented by law, they understook to do their own
banking, and rapidly developed into concerns possessing large
banking departments receiving funds and making loans in very
much the same way as regular banks. While many of them aTe
strong, highly-organized institutions with large reserves, they have
in general been disposed to do a much broader type of business
than the banks, to accept much less convertible security, and to
be much less stringently managed in respect to the maintenance
of reserves and the liquidity of assets. But, in the aggregate,
both the trust companies and the state banks are performing a
very substantial share of the regular banking business of the country—so much in fact that their welfare has a direct and immediate
relationship to that of the national banks. Their position, therefore, in relation to any new legislation is fundamental.

The essential problems which have come to the front with

respect to the relations of state and national banks may be summarized as follows:

( 1 ) The equalization of conditions of business

and competition between state and national institutions; ( 2 ) the
equalization of methods of banking and government oversight between the two classes of banks; ( 3 ) the harmonizing of the interThe

ests of the two group? of banks so as to strengthen and unify the


discount market of the country f o r the future.


New legislation,

whatever it may be, must consider these three important phases of
the situation.

I f such legislation should relate only to national

banks, it might operate to give these institutions a decided advantage over their competitors.
In this connection must also be borne in mind the fact that
by a process of joint ownership and stock control a very close relationship has been established between state and national banks
in many cases and that this inter-relationship must be so regulated

a C


b y I a w as t o

P r e v e n t the use of state laws by national institutions

f o r the purpose of controlling others and vice versa.
( uestion


This raises the

w i t h e r so close a relationship should be permitted to

continue, and if not what substitute can be found f o r it or how the
difficulty which it was intended to remedy can be overcome.
It is generally conceded that the continued maintenance of
banks in a different position before the law, controlled in decidedly different ways, and subject to entirely different requirements, must necessarily cause serious interference with the har-



luouious and uniform organization of any system of general banking control. In brief, the question presented is: What shall be the
future relations between national banks and institutions organized
under state laws, in order to promote the best interests of both ?
Further explanation of the difficulties which arise out of differences in competitive conditions shows that the national banks are
subjected to very decided restrictions with reference to the classes
of business they can do. For example, tliev may not lend more
than an amount equal to 10 per cent of their capitalization to any
individual or corporation, capitalization being interpreted to mean National
capitalization plus surplus when the latter does not exceed 30 per B a n k t
cent of nominal capital. They may not incur obligations of certain specified kinds or make loans on security of given classes such
as real estate. Moreover, they arc obliged to submit to examination
at times and under conditions which are quite different from those
that govern in the case of the slate banks.
The trust companies are in a particularly favored condition.
In many states they are subject to negligible reserve requirements,
whereas the national banks, as we have elsewhere noted, are very
closely bound down in the matter of reserves. The same thinp
is true with reference to the classes of operations in which they Advantages
can engage.
0 0
by Trust
A great deal of business offered to a national bank in the companies
ordinary course of events must be refused.

When thus refused,

it naturally goes to some other institution, frequently a rival bank
organized under state laws or to a trust company which is affiliated
with a state bank.
its rivals.

The national bank is thus sending business to

It is not only debarred from earning the profits which

might be obtained from the rejected business, but it also loses the
valuable financial connections which might be established through
the acceptance of this business.

On many accounts, therefore, it

finds the sacrifice of the operations which are closed to it under
the national banking law a great source of weakness.

Although in

the main the restrictions of the bank act arc wise, when taken in
the aggregate as they apply to the banks as a complete group, it
remains true that there are many instances in which they work a
decided hardship and in which, therefore, the bank affected by
them is naturally restive under these restraints.
Urged on by the pressure of competition offered by state institutions not subject to restrictions as stringent as those of the



Ways of

fht Law

national act, many national banks have devoted themselves to devising ways of competing successfully with the state institutions,
while at the s m time technically observing the requirements of
a e
the national bank act. The method most favored in that connection has been the organization of institutions under state law, closely
affiliated with the national banks themselves and at the same time
able to do all those classes of business which are within the r a h
of the state institutions, although beyond the scope of the national
bank's powers.
This system of organizing affiliated state institutions has been
greatly developed.

It discloses many elements of



vestigations made by the Comptroller of the Currency at the request of the Secretary of the Treasury have shown that in not less

than 300 cases national banks are thus affiliated with state institu-

In Affiliation


tanks or trust companies.

Sometimes they are united

of National

by the common ownership of stock by bodies of stockholders prac-


tically identical

f o r tlie

two institutions, and sometimes by an ar-

rangement wherein the stock of each institution is made non-transferable except upon condition that the stock of the other is simultaneously transferred along with it, share for share.
The dangers inhering in this relationship have been seen partly
in the possibility of the establishment of an inter-bank control
which might conceivably become dangerous.

Particularly would

this danger exist from certain standpoints in the event that a Beserve Association were to be organized whose stock should be owped
by the banks of the country, in proportion to their own capital

Under existing law, national banks are forbidden to own

the stock of other banks, for although the law does not contain
any such prohibition in express terms, the Supreme Court has decided that this is its intent.

But by close affiliation with a state

institution in the way just referred to, it is entirely possible for
the national bank to reach the same end as if it actually owned
or controlled the stock of other banks.

Through the intermediation of the trust company or state
bank, the national bank can frequently hold and direct the use of
such stock in other institutions. It is true that there are states
which forbid this kind of control by prohibiting banks organized
under their laws from owning the stock of other banks. This prohibition is found in a number of states. But there are m n
others w e e it does not exist.



Even if the question of control be left out of account., it remains a fact that the association of a national and stale institution
in the way referred to is likely to be always a matter of criticism.
I t evidently gives to the bank which is organized under the more
stringent set of laws a means of taking advantage of the laws of
the less stringent jurisdiction. This raises in a serious way the
question how to rectify the relationships between national and state
banks, and bring them to a proper basis.
§ 3 . So strongly have the national authorities felt on this
subject of bank control that President Tnft and Secretary Mc- Control
af Stata
Veagh in recent communications to Congress have demanded loci's- a n d
lation prohibiting national banks from directly or indirectly con- National
trolling the stock of other banks. Legal difficulties have been raised by "Each
in conuection with the adoption of such legislation. Hut in spite of other
these difficulties the fact remains that the spirit of the enactment
is the most important matter and that a plain prohibition incorporated into existing law would go a long way in correcting the
conditions complained of.
The National Monetary Commission in the hanking plan lately
presented by it to Congress has recognized the necessity of guarding
against the possibility of such control us has been referred to and
has therefore incorporated in its proposed bill the following provision:
That in case forty per centum of the capital stock in any subscribing bank is owned directly or indirectly by any other sub*
scribing bank, or in case forty per centum of the capital stock
in each of two or more subscribing banks, being members of the
same local association, is owned directly or indirectly by the same
person, persons, co-partnership, voluntary absociation, trustee, or
corporation, then and In either of such eases, neither of such banks
shall be entitled to vote separately, as a unit, or upon its stock,
except that such banks acting together, as one unit, shall be entitled to one vote, for the election of the board of directors of
such local association. In no case shall voting by proxy be allowed. The authorized representative of a bank, as herein provided» shall be its president, vice-president, or cashier.

There may lie difference of opinion as to the question whether
this provision is sufficiently stringent or not, but it is clear that
the amount of stock which could be permitted to he controlled by
another bank may bo decreased to any extent that is desired. The
extreme penalty available to the government is simply the loss of
-voting power in the National Reserve Association, and for any

sion's Bill

274 P R O V I S I O N S A G A I N S T



further legislation designed to prevent the junction of banks in
this way it would be necessary to go to the state legislature. The
adoption of a provision like that just referred to would, however,
entirely prevent the possibility of action by any one bank designed
to increase its influence in the National Reserve Association or any
similar institution whose stock was held by banks, through the
ownership of stock in other banks that enjoyed the privilege of
voting in such a concern.

as to
of Banks

Powers of

In Behalf
of State

Probably a more important means of checking the growing
tendency toward joint control of national and state banks is seen
in the effort to place these institutions upon a basis of equality, in
respect to the business they can do. We have already noted that
one important reason why national banks have sought to affiliate
themselves in this way with the state banks is that the latter usually have broader powers, while trust companies organized under
state laws almost invariably have. If the national banks had the
same kind of powers that are possessed by state banks and trust
companies, they would not seek to establish this sort of inter-bank
The plan of a reserve association proposed by the National
Monetary Commission gives to national banks the power of lending
a certain portion of their resources upon real estate security, enable«
them to do a savings business upon more satisfactory terms than
at present, and broadens their authority in other directions. With
these concessions made to the competitive demands of business, it i*
likely that the national banks would be largely relieved of any
necessity or strong desire for establishing close affiliations with
state institutions. In fact, some of those who have made a close
comparison of national and state banks f r o m the standpoint ot
actual business competition are disposed to think that the national
banks would have the advantage of the state organized concerns, in
which case there would be no motive for affiliation.
In speaking on this point before the American Bankers' Association at the 1911 meeting in New Orleans, President F. H.
Goff of the Cleveland Trust Company, of Cleveland, Ohio, expressed the opinion that state banks would be at a disadvantage
in a number of respects under the proposed plan. These he enumerates as follows:


State banks could not accept oarer drawn on them
In many states they could not establish branches.





(3) They could not own stock in banks doing business is
foreign countries.
(4) In most Jurisdictions they would be compelled to main*
tain greater reserves against their demand deposits than Is re*
quired by the law of the state where they aro located.
(5) While national banks would not be required to keep any
reserve for time deposits not payable within 30 days, state banks
in most jurisdictions would be compelled to do so.
(6) While national banks would be required to keep a reserve for savings deposits equal to only 40 per cent of that required for demand deposits, which in reserve cities would be ten
per cent and in non-reserve cities C per cent, state banks in many
cities would be compelled to maintain a 15 per cent reserve
against savings liabilities.
(7) Funds deposited with the Reserve Association could not
be counted as reserve.
(8) Notes of the Reserve Association held by state banks
could not bo couuted as reserve.
(9) State banks must agree to submit to such examinations
and to make such reports as may be required by federal law or
by the local association.
§ 4.

These supposed difficulties grow out of the fact that the

National Monetary Commission plan (»alls f o r the establishment of
u n i f o r m reserve requirements in conncction with state banks which
become members of the National Reserve Association.

Such re-

quirement would, it is supposed, subject the state banks t o the
onerous features of the new legislation, while they would not he


relieved, as the national banks would lie. of those onerous features of

p|- n

existing legislation which were no longer necessary because of tli«j I" Regard
organization o f the National

Reserve Association.

T h e require-

ments of the National Monetary Commission's plan on this subject have met with general approval and are as follows:
The subscriptions of a bank or trust company incorporated
under the laws of any state or of the District of Columbia to the
capital stock of the National Reserve Association shall be made
subject to the following conditions:
First. That (a) If a bank, it shall have a paid-in and unimpaired capital of not less than that required for a national bank
In the same locality; and that (b) if a trust company, it shall
have an unimpaired surplus of not less than twenty por centum
of its capital, and if located in a place having a population of six
thousand inhabitants or less shall have a paid-in and unimpaired
capital of not less than fifty thousand dollars; it located in a city
having a population of more than six thousand inhabitants and
not more than fifty thousand inhabitants shall have a paid-in and





unimpaired capital of not less than one hundred thousand dollars;
if located in a city having a population of more than fifty thousand
inhabitants and not more than two hundred thousand inhabitants
shall have a paid-in and unimpaired capital of not less than two
hundred thousand dollars; if located in a city having a population
of more than two hundred thousand inhabitants and not more
than three hundred thousand inhabitants shall have a paid-in
and unimpaired capital of not less than three hundred thousand
dollars; if located in a city having a population of more than
three hundred thousand inhabitants and not more than four hundred thousand inhabitants shall have a paid-in and unimpaired
capital of not less than four hundred thousand dollars; and if located in a city having a population of more than four hundred
thousand inhabitants shall have a paid-in and unimpaired capital
of not less than five hundred thousand dollars.
Second« That it shall have and agree to maintain against
its demand deposits a reserve of like character and proportion to
that required by law of a national bank in the same locality;
provided, however, that deposits which it may have with any
subscribing national bank, state hank, or trust company in a city
designated in the national banking laws as a reserve city or a
central reserve city shall count as reserve in like manner and
to the same extent as similar deposits of a national bank with
national banks in such cities.
Third. That it shall have and agree to maintain against other
classes of deposits the percentages of reserve required by this act.
Fourth. That it shall agree to submit to such examinations
and ta make such reports as are required by law and to comply
with the requirements and conditions imposed by this act and
regulations made in conformity therewith.
W h i l e it m a y be conceded that u n d e r this c o n d i t i o n o f affairs
the state banks w o u l d be at a relative disadvantage, i t is n o t likely
they w o u l d l o n g continue in that c o n d i t i o n .

M r . G o f f , w h o m we

have already quoted, s a y s : " W h i l e the disadvantages a t the outset
w o u l d be m a n y and burdensome, I a m c o n f i d e n t t h e legislatures in
the several states can be relied u p o n t o p r o m p t l y e n a c t legislation
correcting these inequalities."
i o n is well f o u n d e d .

T h e r e is n o d o u b t that this opin-

I n f a c t , it is one o f the best features o f the N a t i o n a l Reserve


p k n





w o u l d

t e n d

t o u n i f y the state a n d national banking

W i t h a definite pattern afforded b v federal legislation,




b a n k s

w e r c

w i l l i n g t o c o m p l y i n order that

they m i g h t be placed u p o n terms o f equality i n c o m p e t i n g with
national banks, it m a y be expected that p r o g r e s s t o w a r d u n i f o r m i t y
m b a n k i n g legislation t h r o u g h o u t the c o u n t r y w o u l d b e m u c h more




rapid than ever before. This uniformity would be exceedingly desirable, since it would take away the possibility of evading legal
provisions. At the same time it would prevent the transaction of
undesirable forms of business that are sometimes undertaken by
banks as a result of their being "played off* against one another
by designing borrowers.
The tendency would be to segregate and harmonize into one
general group all the commercial banks of the country whether
organized under state or national laws. Those that did not choose
to conform to the requirements laid down in the legislation, with
respect to reserves, kinds of business (lone, etc., would remain out
of the National Reserve Association and would at once be recognized as belonging to quite a different class of banking institutions.
They would exercise in their way as good and effective a function
as that performed by the banks, whether slate or national, that had
brought themselves into conformity with the provision? of the pro-

posed reform, but their position in the community and the rules Association
of their action would be quite different. They would be set apart,
not as being state institutions, the line of distinction drawn at
present, but as being institutions properly classed as not strictly
banks in the proper sense of the term.
§ 5. The question has been raised whether under these circumstances it is desirable or necessary to admit such institutions
as trust companies and mutual savings banks to membership in Trust
the National Reserve Association. It must be admitted that in and
manv instances these institutions are not now commercial banks M ut t ual
and that, if they were to accept the requirements of the National Banks
Reserve Association, they would have to transform their character
quite materially.
This whole question, however, really settles itself. I t does so
because the National Reserve Association plan necessarily limits
the kind of paper that can be rediscounted by the National Reserve Association to certain specified classes. It is permitted to
rediscount short-time commercial paper, it can purchase bank acceptances running not over 90 davs? under certain conditions it can
discount paper arising out of commercial transaction? not exceeding four months' duration, and under condition? specified it can
discount the direct obligation of a depositing member. Most of
these classes of business could not be offered to the Reserve Association by savings banks and trust companies. Probably only the



direct discounting of their own obligations would be possible. In
other words, the Reserve Association would not be of only indirect
value to savings banks and trust companies that did a genuine
savings bank and trust company business.
Intended to

This is as it should be. The new institution is intended solely
for the strengthening of the commercial banks of the country. The
savings banks and trust companies would get their aid, if they did
not choose to throw off their own character and become something
else, from the same source from which they now get aid, the other
regular institutions of the country.
Any plan whereby the Reserve Association would be allowed to
make loans to such institutions upon the collateral security which
constitutes in many instances the basis for the bulk of their present
loans would open too large a possibility of danger. Such a course
would present the risk of involving the funds of the Reserve
Association in stock exchange securities. In many cases, the ability
to grant aid to savings banks and trust companies by rediscounting
their notes secured in the way already indicated would be very desirable, but the possibilities growing out of it would be too serious
to permit of its consideration.
§ 6.

The second point noted as offering a fundamental prob-

lem in connection with the establishment of state and national
banks on a uniform footing was the equalization of conditions of

i e g a l regulation and government oversight between the two groups

Some of the discussion already offered with reference

to the equalization of business and competition has necessarily referred to this subject.

The plan suggested in the National Reserve

Association proposal calls directly for the assent of state institutions to conditions of examination similar to those imposed upon
national banks. This would be an exceedingly desirable consummation.

It has long been sought by the Comptroller of the Currencv

through conferences with state bank examiners and superintendents of banking to reach this very end.

H e has found in his experi-

ence that serious harm results from the discrepancies in the dates
of examination of state and national institutions, while still more
serious harm results from differences in method of examination.
Considerable progress has been made by the Comptroller toward the development of a greater measure of uniformity in re- ^
gard to this matter.

He has received encouraging responses to his '

overtures, from state superintendents of banking and from state



bank examiners. In the organization of a clearing-house system
of examination the Comptroller has succeeded in securing an agency
which will be important in its influence upon the uniformity of Clearing
state and national bank examinations in the cities. State bank ex- coSperation
aminers in the clearing house cities undoubtedly will cooperate to
a very material extent with national bank examiners and the rep- In Examresentatives of the clearing houses. Such relation?, however, are , n a t , o n *
entirely voluntary and cannot be made effective, except so far and
so long as the banks are willing to abide by them.
It is not possible to curry the requirements of examination to
the extent that is actually demanded by the circumstances of the
case. Moreover, such relations have no basis in the country districts or in the smaller places where the banks arc not organized
among themselves. It is therefore almost necessarily true that
under existing conditions there will continue t > he large discrep<
ancies in examination methods, just as there will be similar discrepancies between legal requirements governing the administration of
banks and the kind of business they can perform. As things now
stand, conditions will not be much improved through the changing
of legislation by the several states with a view to establishing a
uniformity of practice which does not now exist. That can he
attained only in some other way.
It would be possible to reach it by the national reserve plan.
In the requirements imposed in the suggested plan with reference
to membership on the part of banks in the Reserve Association, it
is specified that each member bank, holding stock in the concern,
shall agree to submit to the same examinations and to make the
same reports that are required by federal law. This will practically
impose uniformity of banking control upon the state banks which
choose to become stockholders in the National Reserve association
and thereby to get the advantage of ite provisions. It would be a
practical exchange of uniformity of examination and control as
part of the price exacted of the state banks for their membership
in the Reserve Association. This will go much farther than anything that can be accomplished by the Comptroller of the Currency under the plan which he is now endeavoring to enforce with
respect to the banks.
§ 7. AH that has been said with reference to the effect of
the proposed Reserve Association in equalizing conditions of husi-



A Single

Effect on
of State


ness and competition, and in equalizing methods of banking and
government oversight b t e n national and state banks, is merely
ew e
contributory to, and explanatory of, the third principal problem.
This third problem w s that of "the harmonizing of the ina
terests of the two groups of banks so as to strengthen and unify
the discount market of the country for the future/' This is the
essential purpose to be gained by the admission of state institutions
to stock-holding membership in the Reserve Association. If the
association w r to be organized without reference to the state
banks, it would leave out of account many of the strongest institutions in the country and would be obliged to depend entirely u o
the national banks which h d taken stock in it for the organization
and conduct of the n w institution. Doubtless the institution could
be conducted on that basis. The effect of such an attempt, however, would be to put the commercial state banks which are in competition with the national institutions at a disadvantage.
It may be that under the proposed plan trust companies will
still b at something of a disadvantage as compared with the nae
tional banks. But certainly the conditions will be far more nearly
equal and far more nearly adequate under the proposed plan. The
state banks, although organized under state law, will in fact b
brought to a c m o and harmonious basis of practice with the
o mn
national institutions, while a strong influence will be furnished
tending to influence state legislatures toward the adoption of uniform banking laws based on those of the federal government. The
general outcome will be to m k the banking system of the country
more uniform, the rates of interest more level, and the general position of the business community with respect to the banks more
The immediate and direct outworking of this change will be
seen in the development of a uniform system of discounting. State
banks will apply the same standards in judging paper as do the
national banks which are associated with them in the Reserve
Association. They will endeavor to extend credit on the s m
a e
terms to their customers. They will be inclined to send stockexchange business and operations involving classes of paper w i h
are not recognized by the Reserve Association to the noncommercial banks outside of the association. They, as well as the national
banks, will conduct their business in all essential particulars along
similar lines. The test of a bank's suitability for membership in



the Reserve Association will be found not in the question whether
it has a state or federal charter but whether it is willing to accept
the most rigid standards of commercial banking and to limit itself
largely to specified classes of business.
This will do away not only with the discrimination which
might otherwise exist against state banks, but with the lack of
harmony of practice among the commercial banks which would
otherwise result from the establishment of an elaborate rediscount
system open only to national institutions or to institutions which
might seek to gain access to it through the intermediation of the
national institutions.


The eifect upon the customers of the state banks will be
beneficial in the same way and for the same reasons a? with the
customers of the national banks, and there will be no reason why
any shift in the clientele of the banks should occur as between national and state institutions. At the same time, the trust companies, mutual savings banks, and others which distinctly carry on
a peculiar type of business and which do not carc to accept the restrictions proper to commercial banking will be permitted to continue their own kind of business, not only without disturbance but
with an additional element of strength.
§ 8. Benefit to the outside institutions will be genuine. In
the first place they will lie relieved of the competition which in
some cases they have experienced from rational and state institutions. These institutions will be inclined more and more to restrict themselves to a purely commercial banking business. It will
not be possible for them to comply with the requirements of the
Reserve Association fully and completely and at the same time to
compete along outside lines as unrestrictedly as they can at present.
Whether the ownership of the stock of national banks and state institutions, including trust companies, by identical persons is to be
continued or not is a matter for subsequent legislation, but whether
it be terminated or not,, the tendency of the new system will be to
restrict and limit such combinations.
More important than this is the fact that the outside institutions will be able to get accommodation for themselves from the
national and state banks which are members of the Reserve Association in a way and to an extent that has not heretofore been
possible. The various banks, feeling sure that their own shorttime commercial paper can be converted readily into reserve funds,

B e n e fi t to


Amount of
Will Be


will be far more able to afford accommodations to state banks and
trust companies which come to them with collateral of undoubted
validity on the strength of which temporary accommodation is solicited. This is practically the situation which exists in foreign
countries, where precisely the relations just described are maintained between the commercial institutions and the savings and
private banks which are less limited than the former in respect
to the kind of business they can do. "With the bank acceptance
system fully established as provided by the terms of the Reserve
Association plan, the amount of inter-bank accommodation which
can be granted will be greatly increased without any corresponding
increase in the difficulty of maintaining convertibility. The benefits of the Reserve Association will accrue not merely to its members or even to its own customers, but in an almost equal degree
to outside institutions and their customers. What strengthens the
banking system as a whole will strengthen every element in i t



Interest in Banking is General—2. Relations of People to Bank6—
3. Interest of the Depositors—4. Safeguards for Interests of the
Wage-Earner—5. IIow Bank Credit Reacts on the L a b o r e r — r » . Stability of Industry—7. Influence of the Supply of Money.

§1. Much of the discussion about banking is apparently based
upon the assumption that the issue has to do only with direct customers at banks or at least with those who apply for loans. This
is not the case. Every economic institution has its dircct relationship to, and bearing upon, the well-being of every class in the
community. This statement is conspicuously true of the banking
sj'stem which supplies the machinery of exchange and production interest in
to so large an extent. A good banking system is of as great iin- ®2nera? |S
portancc to the consumer and the recipient of wages as it is to the
man engaged in distributive business or in manufacturing. When
the banking system suffers, the injury i s reflected with cumulative
force through various economic groups until its limit is reached in
the wage-earning and consuming classes in the community.
The bank stands in a two-fold relation to the community as a
whole—meaning by that term those who are not nccessarilv customers of the bank or depositors with it, as well as those who, while
using the bank as a means of convenience for the safe-keeping of
funds, do not transact any business with it in which credit is bought
or guaranteed. This two-fold relation consists: ( 1 ) in the supply- B a n k » s
ing of a satisfactory means of exchange and in the safe-keeping of Relation
funds; and (2) in the maintenance of such credit conditions that ^ 0 f ^ u n | t y
economic opportunities, including the field of employment, the
chances for investment, and other conditions of the same sort, are
permitted to develop gradually and steadily without shock and in
such a way as to preserve the welfare of every member of society.
Much is said about the "safety" of banks, and the national
banking system has been highly praised because of the fact that its
notes have always been redeemable at face value, while the losses to




Safe Banks
May Be



depositors have been small when compared with the total liabilities.
I t remains true that a bank may be a very " s a f e " institution and
yet a very unsatisfactory agency. Even from the narrowest standpoint, the mere maintenance of an ability to redeem its obligations is only the bare minimum of what should and must be required of an institution of crcdit. Little or nothing is heard of the
bearing of bank credit upon the general steadiness of employment,
the payment of wages, and the support of prosperous conditions.
Yet all of these factors have a direct and intimate connection with
banking. It is a severe criticism upon the national banking system that it has not done well when judged by the test thus indicated, and it is a strong argument for the introduction of a new
system that it could do for the community in the directions just
indicated, great service which is not now rendered by existing banks.
§ 2 . The simplest form in which the bank is brought into
contact with the individual is seen in the actual safe-keeping of
money. The individual may have coin or currency which he does
not immediately need to use and which he therefore deposits in a
bank for safe-keeping. The bank is said to be sound OT solvent if
it is able at all times to return to individuals an amount of money
equivalent to that which they have left with it.
A somewhat more complex form of relationship is seen in those
cases where the individual has not left actual money with the bank
but has deposited with it checks or drafts upon other banks (or
upon the bank itself). In such cases, he has transferred to the
bank a right which he might have exercised of calling for such
money or currency as his checks and drafts entitled him to. The
solvency or safety of the bank is tested in this case, as in the former
one, by the ability of the bank to liquidate this title to dTaw which
the depositor has received from it at the time when he gave up bis
checks or drafts to the bank.
Now the total amount of outstanding claims upon banks is
always far in excess of the money which they carry in their vaults.
Under the national banking system, the largest amount of re-

and Their

serve which any bank is compelled to hold is 25 per cent of its outstanding liabilities.

This means that, even if every deposit with

the bank had been directly made in coin, it might have used this
money as a basis for loans to four times the amount of the deposit
in question; in other words, it might have increased its liabilities
to four times the amount of the money and currency on hand.


is evident that in such a case a solvent bank is so only in proportion




as claims are not presented to it for cashing, since it could at no
time meet the combined claims outstanding. If any considerable
part of them were presented and a demand for liquidation into
money were made, the bank would have to close its doors.
Plainly then the safety of tlie bank does not consist in its keeping on hand a large sum in money, since it never can expect to have
in its vaults enough money to meet all possible claims. The safety
or solvency of the bank is found in two conditions: ( 1 ) the possession of assets which can unquestionably be turned into cash, in
sufficient amount to equal the liabilities of the bank, and ( 2 ) the What
possession of opportunities or facilities for converting these assets g^ivVncy"
into cash so steadily and regularly that it will at no time be compelled, even temporarily, to suspend specie payments—that is to
say, to ask its depositors to wait.
§ 3. For many reasons, the depositor places great stress upon
this ability to convert his deposit promptly into liquid resources,
n i s credit at the bank may be all that he has to protect himself and
those dependent on him and supply them with necessities. If the
bank fails, his funds are "tied u p " indefinitely, and perhaps arc
partially or even wholly lost. If the bank suspends, he is unable to
get the current funds he needs to pay his ordinary "bills." In the
first case, his savings arc swent awav and his interests are de*
stroyed correspondingly. In the second case, he is obliged to ask o f t h e
others for credit or for leniency during the time that the bank has Depositor
suspended. He is thus put to a very considerable inconvenience.
During the period of suspension, demands may come upon him for
cash which he is absolutely unable to satisfy. Opportunities for
investment or for other uses of his funds must be sacrificed, simply
because he cannot draw upon his own resources, which arc now in a
non-liquid form.
Invariably therefore, he considers the maintenance of liquidity at his bank as essential and this requirement
is so strongly entertained by him that in the event of suspicion concerning his bank's immediate capacity to meet its liabilities he
may make matters worse by insisting that the bank pay him in full
at once. If enough depositors adopt this course, the result is to
make the situation much more serious and perhaps to drive the
bank to close its doors. Ability on the part of the bank to meet a
condition of this kind is therefore essential.
Judged by this test of safety and solvency, our banking system has been found wanting from the standpoint of the consumer
and earner of wages. While the number of national banks that


Found" |S


have failed lias not been disgracefully large, it 1ms been large enough
to cause fear in {he minds of depositors. The record of the state
banking system has been even less satisfactory than that of the
national. But individual failures cannot be prevented and some
always occur. No system of banking is so safe or can be so

protected as to avoid the necessity of care and judgment on the part
of customers at banks. They must select their institutions with
reference to the record and capacity that the institutions have
Under our banking system, however, we have from time to
time suspended specie payments completely, owing to the fact that
a large number of banks feared their ability to meet their obligations and therefore found refuge in refusing to pay out cash until
more normal conditions had been restored. This phenomenon has
Refusedto° b e e n o l ) S e r v e d a t nearly every period of crisis or panic in the liisPay Out
tory of the United States. The effect of it has been to tie up funds
for an indefinite period often lasting several weeks. Corresponding
hardship has been inflicted during this period upon the small depositor.
The hardship has fallen with exceptional severity upon the
laboring class in the community, because that class was more limited in its resources and its members were not usually able to get
the extensions of credit from tradesmen that were accorded to others
of larger means. As the average laborer conducts his affairs much
more largely 011 a cash basis than the man of larger resources,
WageThe man
h e is correspondingly dependent upon cash at all times.
who has no savings in bank has in such periods of stringency sufMost
fered worse than the man who had something on deposit, even
though the latter might not be able to get money from the institution with which he had left his funds. The laborer who was absolutely dependent upon money wages from week to week or from
day to day has usually found his immediate earning capacity annihilated, whenever funds were not in circulation, owing to the
inability of banks to supply contractors and factory superintendents
with the sums they needed for the payment of daily wages. Thus
it lias occasionally been necessary to suspend industrial operations at
a time when conditions were otherwise fairly prosperous—merely
because of a suspension of bank payments.
Besides the phenomena of suspension of specie payments, our
system of scattered reserves and absence of general cooperation
among banking institutions is responsible for the widespread
havoc in the form of failures of banks and business firms which







accompanies every commercial crisis in this country. Only a 6ma11
percentage of such failures is due to a lack of adequate and sound
resources. Most of the failing banks and firms have been found
to be ultimately entirely solvent, that is, able to pay a hundred
cents on the dollar, and their failure due simply to temporary inability to convert their assets into means of payment.
The effect upon the laboring population of these widespread
and long continued disasters is effectively presented in a recent
article by Mr. John V. Farwell of Chicago, printed in "The Indepe n d e n t " of February 1, 1918. In the following chart Mr. Farwell graphically indicates the effects of the crises of 181W and 1907
on poverty in Chicago:


Representing Relative
Numbers Helped by ths
Chicago Relief and
Aid Society
19 Consecutive Years
Note Years of
industrial Depression
'93 to '97 and 1908
1894 Represents
Abnormal Conditions
Following World's Fair




Mr. Farwell also quotes the following letter from Mr. Sherman C. Kingsley, formerly secretary of the Chicago Relief and Aid
Society, and the author of the chart, relative to their effects in other
"The chart not only illustrated the situation in Chicago, but
was fairly typical of the conditions in the largo cities of the country. In 1894 I began this work, and I happened to be with the
Brooklyn Bureau of Charities. The work there more than doubled.
W e resorted to all kinds of methods in an effort to give employment to people who were self-respecting, who had never before
been obliged to ask for aid. The same kind of conditions prevailed in Boston, in New York, Philadelphia and other cities.
Here are the figures from the Association for Improving the
Condition of the Poor in New York: In 1892, $47,957, with 8,589
families; in 1893, $61,000; in 1894, $120,506; in 1895, $87,000.
In Philadelphia, $20,962 in 1890, $19,875 in 1891, $19,320 in 1892,
but $42,331 in 1894. In Baltimore, $7,320 with 7,769 applications
in 1892, $9,278 in 1894 with 18,845 applications. In Boston, 8,020
cases in 1890, but 11,710 cases in 1894, with a similar increase in
the amount expended.
"In Chicago, in 1906 and 1907, the Relief and Aid Society
was giving about the same amounts that it had given back in
1890, and dealing with about the same number of families. In
1908, after the sharp panic arrived, applications doubled; the
amount spent on relief more than doubled. A citizens' committee was appointed to canvass the town in an effort more adequately
to meet the demands. Again we resorted to all kinds of expedients to create work for people who were thrown out of employment, and who, as in 1893, had never before sought help—strong,
willing, able-bodied men begging for a chance to do something, and
accepting makeshift work, cleaning streets, shoveling snow, sawing wood, doing anything that we could get to do and accepting
a wage of about $1 or $1.25 a day, just enough to meet emergent
demands. The municipal lodging house in 1908 became inadequate to take care of the men out of employment and annexes
had to be created. Men lodged on police station floors—men who
were self-respecting and anxious to work but for whom work
could not be found. This all because something went wrong in
the financial world. There are certain effects resulting from these
paroxysms in industry which are lasting. Men go from day to
day seeking employment and finding none. They come home at
night and see the wretchedness of their families. They feel
themselves a burden. They go elsewhere looking for employment.
They become demoralized. They' drink, they fall into evil habits,
they desert their families. There is an undue amount of sickness incident to unusual kinds of exposure—standing on street
corners, waiting in line for jobs—hundreds of them when only a




few are taken—all kinds of demoralization both of morals And
"The normal balance has been struck quicker after the panic
of 1908 than after that of 1894. If one should draw a line through
this chart, striking about a medium line of average causes of
poverty, one would throw into bold relief a big section of dis*
tress due to panics."

§ 4. The real safety of the bank and consequently the safeguarding of the interests of the laborer and of every mail who feels
a direct reliance upon cash is to be found not in the maintenance of
large supplies of money but in the ability to get accommodation,
that is to say, to dispose of assets promptly as occasion demands.
Banks that suspend and many of those that fail could be prevented interests of
from getting into difficulties if they were able to take their live
assets to some institution which would convert them into immediate May Be
cash or its equivalent. Ranks are frequently able to do just this S a f e r
through the assistance of other banks. But when the stringency
spreads over the country, banks are not willing to let go their own
funds for the sake of assisting others. Aid can then conic only
from cooperative effort which unites the resources of the banks and
enables them jointly to cope with the difficulties that arc presented
to any one.
This is exactly what has been done by the banks when they have
united through clcaring-house associations to extend accommodations to each other. The clearing-house associations have maintained solvency and sometimes liquidity and have thereby prevented
institutions from going to the wall. But no permanent safeguard
can be obtained whereby the small depositor will be enabled to as- {£"® p c r a "
sure himself of the immediate liquidation of his demands, unless Through
there is a constant and permanent market for assets of a particular Houses9
kind. Where such a market exists, the depositor secures absolute
protection by dealing only with institutions which are known to
invest their funds primarily in assets of this marketable description. I f . through the organization of a cooperative National Reserve Association, such a market could be created, the interests of
the small customer and particularly of the laborer who needs cash
would be safeguarded as is possible in no other way. The interest
of no class in the community is more intimately dependent upon a
safe and steady market for rediscounts than is that of the person
who wishes to be able to liquidate his claims on demand.
The average man, however, no matter whether or not he is





able to get cash from his bank upon demand to the full extent of his
deposit, is not materially aided thereby unless he is able to continue remunerative èmployment. Few wage workers^ and perhaps
comparatively few members óf the coriimunity, have liquid funds
on deposit with banks to an amount that is equal to their consumpEffect of
tion for six months in advance. The total number of depositors in
on Field of the national banks of the country was 7,690,468 in 1910 and their
Employtotal deposits $5,287,200,000, an average of less than $700 per dement
positor. Assuming that the average annual wages of those who
work for day wages are $600, it is clear that a very large number
of persons are only a little ahead of ordinary requirements. Many
even of those who possess bank accounts are "hard up the last 30
days in every month."
This calls attention to the second requirement of the wageworker in connection with banking. T h e system must be such as
to assure him, so far as it can, the steady flow òf funds that will
enable him to restore his deposits when they have been drawn down
by the withdrawal of cash for current needs. This reconstruction
Free Flow
of Funds
of deposit accounts comes only through a free flow of funds throughNecessary
out the community, that is to say, through the steady payment of
for Small
wages and salaries. This process is rendered possible only by the
continuous activity of industry. But continuous activity can be
obtained only in those cases where the business world is able to
obtain freely and at reasonable rates thè capital which is necessary
to enable it to offer employment and thereby to secure thè means
of operating its plants continuously. When employes ate able to
do this, there is a free flow of funds throughout the community, and
the laborer is àblè to get wages in cash in exchange f o r his services.
I f the flow of funds in this way is checked through inability on the
part of banks to liquidate, thé employer may desire earnestly to set
men at work and laborers ni ay bè eagerly iii search of employment
but they will not be able to comperate. I n modern society, where
labor is highly specialized and a 'machiné type of industry prevails,
wages are not paid in the products of labor but are paid from the
previously stored capital which is kèpt ih a fluid ór liquid condition through the action of banks.
§ 5. H o w a bad condition óf bànk crédit reacts upon thè laborer may easily be undèrstood by considering the course òf evénts
at a period when bank credit is reduced. Let us supposé that émployers are not unduly expanding their operations, biit that they are




receiving a normal amount of credit from hanks. Under those conditions, loans to them at the hanks will he simply what is necesBary to make their commercial paper liquid by giving them the
advances they need, thus enabling them to anticipate payments
which would come in to them from persons who have bought goods
in the natural course of trade. It may be supposed that the paper
which they are in the habit of presenting to banks is perfectly sound
and that no exception is to be taken to it.
Now there occurs some event which tends to place a strain
upon bankers. If these bankers are unable to dispose, in their
turn, of the paper which has been discounted bv them for customers, they will necessarily see their reserves declining as a result of
the unusual demand to which they are supposed to have been subjected. The result will be that, in order to meet obligations which
they have already incurred, they will he obliged to cease extending
any further accommodations. The employer who ha? been looking
to the bank to provide him with the fluid capital which he needs in
carrying on his business will thus find himself cut off. Deprived
of bank credit, he necessarily reduces those outlays which call for
ready funds. In most mercantile or industrial establishments, the
most important outlay is for labor, and the curtailment of resources invariably results in the discharge of men and consequently
the cessation of their wages pending the time when business can
get bank credit again.
The difficulty which is thus caused may be only temporär}*. But
on the other hand, it may become so widely extended as to give a
serious check to business. In this case, what is known as a depression may set in, its chief feature being the slowing down or
even suspension of industry in a great number of quarters. Such
depression means reduction of employment and more or less permanent restriction of the opportunities for earning wages.
The effects of such a period of depression are far from falling
evenly upon all classes in the community. T o the large retail merchant or manufacturer, the depression may not mean more than a
restriction or abolition of his opportunities for profit. If obliged
to curtail his personal enjoyments or expenses, such curtailment
will not be of a kind that entails much hardship. He may be somewhat less prodigal and may endeavor to cut off some unnecessary
outlays of large amount. Beyond this he docs not go, since his accumulated resources continue to provide him with ample funds.
The serious effects of the reduction in business activity are

How Bank

Not Evenly





felt by the employe in far greater measure. Precisely in proportion
as he has been depending upon his regular earnings to provide for
his necessities and those of persons who are dependent upon him, he
will be affected by the reduction of employment. If he has accumulated no savings, he immediately becomes dependent upon
credit for his support or is obliged to look to others to furnish him
means pending the revival of business and the re-establishment of
a demand for his services. If he has accumulated some savings,
he is obliged to fall back upon these. Where banks remain able to
meet all of their demand liabilities, the savings may be drawn out
in cash and gradually consumed. Where they are forced by excessive strain on their resources and inability on their part to convert
assets into immediate funds, they may be obliged to close, in which
case the small depositor is placed in the same position for the time
being at least, as if he had made no accumulation. Thus the weight
of the shortage necessarily falls upon the employe either in his
capacity of wage-earner or in that of savings-depositor or in both.
§ 6. The essential need of the wage-earner is stability in industry. Such stability can be secured only when industrial managers are supplied with all the elements of production. Of these
stability of elements, bank credit forms an increasingly important part.
The claim may be made that such credit is not needed by all
Great Need

concerns and that only in an "inflated" condition of industry would
it be needed or called for. It is assumed by some persons that
the business man who borrows at the banks is an exceptional person. This is far from being the fact. Practically every business
that is conducted upon any considerable scale requires accommodation. The accommodation in question is not "loans" as a general
rule, but "discounts," in other words, funds which anticipate the
payment of claims which the business has obtained against others
in return for the services or goods which it supplies. In proportion as goods are sold upon credit, is it necessary that banks should
intervene between the purchaser and the seller of the goods. The
purchaser does not pay cash because he looks to the sale of the
goods to provide the means for liquidating their cost. But the
seller needs cash because he has to pay his employes in cash. He
places his prices at such a point that he can afford to extend credit
for a reasonable period. Then he draws upon his customer, and
through the aid of the bank the draft is recognized and the funds
are placed at his disposal for immediate use.

These transactions become more numerous and necessary in
proportion as industry becomes highly specialized, and in proportion as more and more processes intervene between the original producer of raw materials and the person who consumes the product
that has been developed out of them.
The intervening stages
through which the product goes represent repeated turnovers of
capital and require time. The element of time thus becomes an important feature in productive enterprise,, and this it is the function
of the bank to allow. When the banking mechanism breaks down,
there is a gap between the producer and the consumer which cannot
be bridged.
§ 7. In proportion as credit plays a part in the process of producing goods it constitutes a corresponding element in the cost at
which goods are turned out. The cost at which goods are turned T h c
out determines their price to the consumer upon any competitive Question of
market. The wage-worker spends the principal part of his in- P r l c e t
come in purchasing commodities for consumption. He has to pay
a correspondingly larger part of his income when the prices of
commodities are high and is correspondingly relieved when they
are low. Any element that can reduce cost is likely to reduce the
price to the consumer. AVherever capital is an important element
of cost, therefore, it is an important factor in determining how
much the worker shall get in return for his money wages.
But borrowed capital is an important clement in all modern
operations. Whatever then results in high interest rates on loans
at banks ultimately tends to produce higher prices for goods to the
consumer. The consumer who is predominantly a worker for wages
receives a larger amount in real wages—the things that money will
buy, wherever industry is stable and bank accommodation is reasonable. It is a familiar fact in all countries where rates of interest are very high, that prices are correspondingly exorbitant and
the result is that in those countries all goods that are produced with
the use of borrowed capital are raised in price to an equivalent extent. While, therefore, the well-being of the general mass of the
consuming and laboring population in thc maintenance of a stable
currency and a steady condition of business, free of panics and depressions, is very great, the interests of these groups in the community in the regular and systematic conduct of industry upon an
economical basis is even greater.

Precisely for the same reasons that have already b e sketched,





it is highly important that the community should, from the standpoint of the average man, he freed from fluctuations of prices.
FluctuaSuch fluctuations may he due to many causes, but one large group
tlons in
of causes is found in connection with the banking system. Prices
may rise ewing to a natural shortage in supply or from some similar reason. This has nothing to do with the question of banking.
But it frequently happens that artificial increase of prices is produced through the partial cornering of the supply of a given article.
Such corners cannot be brought about, as a rule, without extensive
banking accommodations. When such accommodation is afforded,
the banks practically employ the funds of the community for the
purpose of enabling given persons to raise prices to the members
of the community.
There is no satisfactory way of preventing such artificial movements of prices by legislation or similar precautions. The best
safeguard against them is to prevent the speculative part of the
community from securing accommodation at banks, certainly until
an n Ald r to a,t a f t e r a U t h e o t h e r elements have been disposed of. This can be
Speculation done by a system which shall guarantee that the preference shall
always be given by the banking system as a whole to paper originating in legitimate commercial transactions and in no way connected
with speculative operations. I f speculators wish to monopolize the
6upply of wheat, corn or cotton, they can do so ordinarily only by
securing extensive accommodation at banks. But this accommodation necessarily deprives legitimate business men of the support
they need or at all events makes the price higher to them. In proportion as the speculation succeeds, the consumer is injured, because he not only has to pay higher for the article which has been
monopolized by the use of bank funds, but he also has to bear the
burden involved in the higher cost of credit to the producer who is
turning out the articles he wants to purchase f o r his own needs.
In the National Reserve Association banking plan, it is expressly provided that there shall be no loaning of the funds of the
association upon speculative security. This is important in two
ways—it places a premium upon the production of sound commercial paper and upon operations that give rise to i t ; and it discourages operations which are speculative in character or are based upon
speculative securities. The excesses of speculation and the fluctuations of price which result f r o m them are found in a far less aggravated form in those countries which possess sound banking systems than in those which permit the use of bank funds f o r specula-




tive purposes, either through lack of restraint upon hank operations
or by reason of excessive competition among the banks and consequent desire to get business even to the disadvantage of the community.
§ 7. Closely allied with the considerations already indicated
is that of the supply of money. A great quantity of money in a
country is often referred to as an indication of prosperity or success. It is usually the reverse of this, in so far as it indicates anything, since it shows that the community has to maintain a large
supply of a costly factor in exchange in order to got its work done,
Those countries which are most carefully organized from the banking standpoint, have as a rule the smallest supply of actual money.
Thus in 1910, Great Britain had §15.14 per capita of gold and
silver in and out of her banks. The United States during the same
year had $26.18. This signifies that in the United States we maintained in use a much larger amount of medium of exchange in order
to effect our transactions than did Great Britain. In other words,
we were obliged to keep that amount of money idle, thereby losing
the interest upon it. The country with the smaller amount of
money was at a correspondingly less expense in performing its operations for the same reason that a workman who has a given task
to perform does not care to purchase more than enough tools to
enable him to get through his work expeditiously and effectively.
In those countries where banking is organized upon a basis
that economizes specie, this object is attained and the needs of the
community for actual currency are supplied by currency issued
through the banks and costing nothing except the expense of putting it into circulation and of maintaining a reserve for its redemption. Even where no bank notes are used, it is clear that the same
purpose is served if there is an active circulation of coin and if the
quantity of it needed is economized by making every piece as active
as possible.
Examples of the latter condition are seen in those countries
where cooperation in banking has tended to reduce the necessary
amount of reserve carried and by massing reserves in a small number of institutions to keep them constantly ready for the relief of
difficulty whenever such difficulty may manifest itself. Here the
economy in the use of specie is obtained by avoiding the necessity
of keeping a large number of small or isolated reserves while in
the case first cited (that where actual currency is needed in many

Influence of

the Supply
o f Mon «y

N c e d i of


Economy In
the Use of



transactions) the saving is effected by supplying cheap and abundant bank currency. In either case, the effect is the same—that of
reducing the expense involved in the exchange of goods. This saving manifests itself in the form of lower commodity prices, just as
cheap accommodations at banks tend to reduce the cost of an important element in production. Such savings are directly in
the interest of the man who uses currency in the actual transaction
of his business or in the actual purchase of commodities and necessities.



Small Merchants Form a Large Group of Dank Customers—2. Tho
Small Merchant and His Customers—Business on a Cash Basis—
3. How the Bank Comes In—4. Bank Competition Prevents Discrimination—6. Benefit of an Institution for Redlscountlng—6.
Small Merchant as a Depositor—7. Handicaps of the Present
Banking System and Advantages of the One Proposed.

§1. The small business man is particularly and peculiarly
interested in banking facilities. He has demands for credit and
bank accommodation as acute as any large merchant's without the
letter's resources or power to force compliance with his needs. He
is infrequently interested in, as a stockholder, or connected as a
director with, any bank institution. His paper is not known beyond the locality in which he operates. No bank is specially eager
to secure his business and he cannot send his paper abroad for
disposal if he has urgent demands which, for any reason, his particular bank will not consider.
The merchant with small capital is, however, a decidedly important factor in every community, large or small. In the aggregate he is a great power in the nation. He supplies the needs of the
ultimate consumer and it is through him the banks are brought
into touch with the consuming masses and are thus made parties to
the final process in the transition of goods from producer to con*
In the end it is this consumer who supplies the cash to discharge a credit obligation which may have originated in a loan to
the producer of the commodity. At every stage in the various
forms of transferring a thing from producer to final distributor
borrowed capital may have been used and credit for it extended on
the strength of the continued existence of the commodity. The
ultimate consumer has no such security to offer. Once a thing is
passed to him, it is destroyed or its value impaired by use. He
must pay for it.


, n Relation

The Small
to the



Broadly viewed, the banks must be keenly interested in the final
process of the series which marks the progress of goods toward
the goal. They must be particularly alive to the important position held by this small merchant. To a large degree it is on the
ability to discharge his final duty that the success of the whole
complicated scheme of production and distribution depends. His
financial position and his means of using his capital and securing
credit to carry en his operations are therefore of vital importance
in any plan of tanking or banking reform. His paper has its own
characteristics. It is essentially local. The extension of credit to
him is determined largely by the banker's knowledge of his personal dependableness and the character of the business in which he
is engaged.
These characteristics distinguish the paper of the small merchant without regard to his location. His case is the same in the
large city or small town. If he is in the latter, the field in which
he may apply for loans is geographically restricted. If he is in the
former his difficulties are not less because he must necessarily attach himself to one bank and look to that one for his accommodation. In every case his demand for loans is direct, personal and
largely dependent for its satisfaction upon the judgment of the
bankey and his appreciation of the needs of this small client.

the Small
Has to

§2. Behind the small merchant are always the customers he
serves. The extent of the credit to which he is entitled is measured somewhat by their willingness to buy and their power to pay.
He may begin business with a small capital and make a rule that
his customers shall pay him in cash or its equivalent. In such a
case he will have few accounts outstanding at any time and his
relations with the bank will depend on the adequacy of the funds
with which he is operating. If his trade is good, he can turn his
capital oyer quickly and transact a large business as compared with
the amount qf his original investment.
But even if this merchant sells only for cash, before his original
stock is gone, it will be necessary for him to place orders with factories or jobbers for new supplies of goods.
Much of his capital is still locked up in the stock on hand and
to convert it into cash with which to pay for the new supplies is
impossible. He must either get credit from the supply men or
borrow from the bank to carry the transaction to a conclusion. The



supply houses may be willing to give a term of credit of thirty,
sixty or ninety days. This may be sufficient to meet his immediate
requirements. If it is not, the bank must be appealed to.
In any event the bank comes into the transaction. If the supply house extends credit it has either borrowed against the merchants obligation indirectly or discounted his direct obligation at
its own bank. In the latter case the claim comes to the merchant's
bank for collection when due. If the merchant can pay it, the
particular transaction comes to an end. But if he cannot, and at
some time payment will be impossible or inconvenient, he must
secure an extension of credit. If he asks this from the supply house
it will be at the risk of impairing his standing there. If he asks
it from his bank, he must give satisfactory evidence that his business is in good condition. He must convince the banker that he
has in stock goods of a value sufficient to protect the bank, that
the stock is in favor with the public and is moving out into consumption. This is what he does and the bank gives him the necessary accommodation. The credit is, of course, extended on the
merchant's obligation, which is practically unsecured. What the
banker has is only the assurance that the state of the merchant's
business warrants the credit.
In such a case the bank is obviously supplying part of the
capital needed to carry on the merchant's operations. As a result
he may carry a larger and more diversified stock than if he were
dependent on his own resources. He can do more business than
if he paid cash for everything he bought, or had to liquidate
promptly at the end of the credit period whether he had sold the
goods or not. It is true he is paying interest on this borrowed
amount but he is gaining profits otherwise impossible.
In due course, as business grows, this merchant finds it more
convenient and profitable to confine his credit business to the bank.
Instead of buying on thirty or sixty days and paying at the termination of the period, he finds he can gain a profit by taking
advantage of the customary cash discount. To do this he gets accommodation at the bank, not when his bill comes due, but practically at the time he makes the purchase. No bank transaction
is commoner than this. In illustration: A is in business. His
capital is $10,000, He buys a bill of goods amounting to $10,000.
The terms of the sale are sixty days, subject to a discount of three
per cent for cash. If he can borrow $10,000 from his bank at six

Comes into


p r o fj t



per cent, or one per cent for the sixty days, he can get the cash discount and so gain two per cent by the transaction, or $200.
In this case the bank practically pays for the goods. Morally,
if not legally, it owns the goods and allows the merchant to dispose of them, holding them in his control in the meantime. One
theory is that the goods, during the time of their passage from
producer to consumer, are a proper basis for credit operations, the
credit obligation being discharged by the payment of the ultimate
consumer under whose possession they pass out of existence as
merchantable commodities.
Banks which supply the credit which makes such enterprise
possible are engaged in financing the business operations of the
community. Their service is complete or incomplete according to
their capacity to accommodate those who have legitimate demands
and who need fluid funds. The extension of such accommodation
by banks is one of their chief functions and of much importance to
of Their
the public. It makes it possible for the merchant to sell his goods
at closer figures and his customers share in his advantage under
the compelling force of competition with rival merchants.

When the
Does a

Tied Up
in Book

§3. The merchant does not always do a cash business.
Frequently when his capital is sufficient to permit him to do business on this basis it will not permit him to carry on an enterprise
in which credit is granted to his customers. The kind of business
he does is largely controlled by the habits of the community he
serves. If this community is made up of persons whose incomes
are received at long intervals, he must furnish supplies and wait
for his pay until his customers secure money from their own operations. This is bound to be the case if his customers are farmers
who are paid for their crops and receive very little cash during the
remainder of the year. The situation is not greatly different if the
community is made up of wage-earners who get paid once a month.
In such cases the merchant finds that to hold his trade he must
open "book accounts" with his customers. These accounts may
not be paid oftener than once a month and perhaps once in three
months. The time of liquidation of these accounts may be weekly,
but in any event a large amount of business is done under this
system and a considerable proportion of the merchant's capital is
tied up in the form of personal credits. For these he has no security. If the bank did not stand ready to supply him with fundshis




operations would bo hampered, Ins business would be restricted
and his profits materially reduced.
In such eases the bank is practically granting accommodation
to the community. It is extending loans to the customers of the
merchant. Legally, of course, the obligation is the merchant's, to the
He is responsible and the bank must have satisfied itself as to his C o m m u n , t x
capacity to make good any loss that might occur in the business
owing to inability to collect accounts. Economically, however, the
funds which are advanced to the merchant arc really advanced to
his customers, and the security which hacks them is the general
capacity of the clientele of the merchant to pay its hills when due.
If the bank knows that the customers arc steady, reliable men,
receiving regular wages, and that employment in the community is
abundant, it will not hesitate to grant the merchant, that is to say,
the community, the accommodation that is wanted. In its essence,
the transaction thus carried out is simply an anticipation of wage
payments, the goods being advanced to the consumers during the
period when they are engaged in the occupations which will produce the funds necessary to pay for the supplies that have been
furnished to them.
The service of the bank is thus that of facilitating the flow p a y f o r
of goods into the consumers' hands at the time when they arc
wanted. The consumers have to pay for this service in the priccs Renders
charged by the merchant, because he naturally is obliged to
compensate the bank for its advances of funds, and his operating
expenses are thereby increased. The longer the period of credit is,
the higher the prices will be, and the larger the accommodation
which has to be granted by the bank, and the rate of remuneration that will have to be charged for it. Presumably, the consumer
gets more than a corresponding return in the shape of convenience,
or he would not submit to this condition but would pay cash for
his goods.
In the case of such transactions loans are made by the bank credit
upon the merchant's own personal note. Evidence of his solvency determined
and ability to pay is secured from inspection of his stock, his books 0 f His Y
and accounts, from his statements or otherwise. If he has prop- Customers
erty outside his business which is within reach, the bank will fed t 0 P a y
the more confidence, but whether he ha3 such property or not, the
immediate test of the loan will be the character of the customers he
is supplying and the nature of their own personal credit—the ex«
tent of their capacity to pay.




It is now clear why accommodation of this kind cannot be
granted save in a "local" way. The fundamental basis of the whole
transaction is the personal relationship which exists between the
banker and the merchant, and the essential test of the sècurity is found in the banker's estimate of the capacity and integrity
of the merchant in his déalings with his customers. This is based
upon general knowlèdge of the conditions in the community. No
such knowledge, however, could be obtained except through careful personal study of local conditions, and this is the task of the
banker whose clientèle is largely made up of merchants and business men who demand his aid in their operations.
Thé banker's judgment as to which members of the community arè entitled to the use of the fluid funds of thé community
is therefore vital, because it results in entrusting the funds to the
successful or unsuccessful individuals as the case may be. It places
them in trustworthy or untrustworthy hands. It puts them where
they will be wiséìy used or will be wasted. In the long run, the
judgment óf thé banker on this subject is always right. If he
makes many mistakés in judging the character of his customers and
their title to accommodation, he himself is the loser and éventually must go out of business. He will then be succeeded by some
one élse whosé judgment is sounder and better than his own. Probably there are few linës of business in which closer and more accurate scrutiny and knowledge of the details of transactions are
needed and are actually obtainéd than in country banking or in
city banking where the clientele consists of retailers.

§4. I t is often asserted that the character of the accommodation needed by the merchant makes him peculiarly liable
Discrimina- to discrimination. The local bank is able to limit or ruin his busition by
ness if it will, and at the same time to advance the business of
Banks Is
competitors. This is a real danger where there is a monopoly in
by Com*
banking. In the United States with absolutely free organization of
banks under both state and national laws, this danger is not great.
The banking business, particularly in small communities, is
highly competitive. If a local bank is known to be making good
profits, another is certain to be organized. Indeed, within recent
years, there has been a decided tendency towards o v e r - b a n k i n g in
many parts of the country. Where competition is keen, the tendency on the part of the banker is to extend credit too freely. He
is disposed to accommodate a customer as long as there is & fair




chance of repayment. The temptation to allow the bank to become
involved in unsuccessful business is strong because the banker
recognizes that a refusal to supply the means desired may drive his
customer to the institution across the way. Only careful bank inspection and examination can wholly chcck this evil. This must
be supplemented by watchfulness on the part of the directors and
officers of the bank.
The paper of the merchant, as has been shown, is distinctly
local in character. The whole banking operation connected with it
must, therefore, be carried on by persons familiar with conditions in
the community where it originates. It is plain, also, that, under
such circumstances, the limit to the loans which can be extended
is marked by the banking capital available in the community. This
banking capital is supplied by those who first organized the local
banks and those who have subsequently made actual deposits of
fluid resources.
If the capital of the community is adequate to the business
going on, this is a satisfactory source of accommodation. If it is
not, the bank must seek accommodation elsewhere. When it is
necessary for the bank to take such a step the character of its business places it at a disadvantage.
As an illustration the position of a bank in a small community
with a clientèle composed largely of retail merchants may be
contrasted with that of a bank in a manufacturing town. The
latter carries a considerable amount of paper for the local factories. If it wishes to get a rediscount from a large institution in
a neighboring city, it probably has no difficulty. Offering as the
basis for such accommodation the paper of the manufacturers, it
finds they are well known and their credit is established. But the
bank whose customers are local merchants is likely to encounter
difficulties when it asks for a rediscount. Its customers may be
solvent and trustworthy men but they are not widely known. The
city bank has no means of testing their credit. It must rely entirely upon the judgment of the local bank.
The situation is the same, even if the rediscount spoken of
be not technically asked for, but if, instead, the officers of the small
bank undertake to get accommodation from the larger on their
own personal notes or in some similar way. The question in the
end is always whether the large bank is willing to put its resources at the disposal of the small community in order to enable
it to continue the expansion of its business. Frequently it is not

Limit to
Loan« Bank





willing. Thus a very distinct limit to the amount of accommodar
tion that can be obtained by local merchants is found to exist.
They must, under present conditions, enlarge their banking capital if they want loans beyond a certain point; they cannot easily
get them elsewhere.
§5. This condition of affairs would be very much helped by
the establishment of a definite rediscount market such as would be
furnished by the creation of a Reserve Association of the kind
previously discussed. Such an association would be able to supply
loans to banks that were in position to offer it prime short time
commercial paper. Where the paper ran for four months it could
be rediscounted under the proposed plan if guaranteed by the banks
comprised within a local association. The plan would thus be in
of an
practice that of cooperation among local banks in order to get
Rediscount aid from the great source of banking capital representing the combined banking interests of the country. By thus organizing for
mutual protection, they would secure the opportunity to get rediscounts to almost any reasonable amount for which they could
offer bona fide commercial paper arising out of the actual mercantile transactions existing in their own towns. At the same time
they would be able to avoid the danger of over-extension of loans,
since they would be able to assure themselves of the character of
the paper by the usual methods which are open to those who study
credit. The knowledge that paper was to be tested in this way
would exercise a strong restraining influence.
With good bank examination and with a general knowledge on
the part of all banks similarly circumstanced concerning the type
of transactions in which each was engaged, it would hot be difficult to devise a system of guaranteeing one another's paper in the
way suggested in section 27 of the National Monetary Commission's bill, which is intended to cover precisely this class of cases. It
reads as follows:
Section 27. The National Reserve Association may through
a branch also rediscount, for and with the Indorsement of any
bank having a deposit with it, notes and bills of exchange arising
out of commercial transactions as hereinbefore defined, having
more than twenty-eight days, but not exceeding four months, to
run, but in such cases the paper must be guaranteed by the local
association of which the bank asking for the rediscount is a


An important effect of the scheme proposed would undoubtedly be that of reducing and rendering much more stable the rate
of discount which now varies so widely throughout the country.
The merchant, who borrows from a bank in a town of 10,000 in- D l g c o u n t
habitants in Texas, is likely to pay a much higher rate than is Rate
charged to the merchant in a similar town in the interior of New
York, though it is highly probably that the obligation of the Texas Stable
merchant will be considerably more liquid than that of the borrower in New York. This is because of the peculiar conditions
surrounding the distribution of bank capital and the methods of
handling local loans in the United States.
The situation may be compared with that which exists under
the Bank of France. The latter institution, through its branches,
makes an immense number of direct loans to small merchants,
many of them for extremely insignificant sums. It is able to do
this at a very moderate rate of interest and to charge the same
rate of interest throughout the country. This is due to the fact H o w t h e
that it can turn its great capital in any direction, and can supply Bank of
loans where they are needed at any time, withdrawing its loaning operates
power from those regions where, for the moment, there is no active
demand. A similar situation exists in other countries where a system of cooperative management of bank capital has been applied.
In the United States, the same results would be obtained under the
Reserve Association plan, although by a different method. The
branches of the Reserve Association would be established only in a
few places. The direct relationship with the merchant, the
testing of his paper, and the extension of his loans would be carried on by his local banker, just as heretofore. But the Reserve
Association, through its brandies, would deal with the small local
bank, would become acquainted with its paper as that of one of its
regular customers, would rediscount it; or, when occasion demanded,
would ask for a guarantee on the part of the association of banks to
which the given institution belongs. The machinery would be different, but the result would be similar to that which is seen in
France and other countries where banking is similarly organized.
There would be an equalization and reduction of rates of interest,
and at the same time there would be afforded an unlimited supply of bank capital so long as the community deserved it and
could profitably employ it.



§6. There is another aspect of this relationship between the
local merchant and the bank. The merchant is invariably also a
depositor at his bank, as well as a borrower. He is a depositor
in a sense somewhat different from that which has been considered
in another chapter dealing specifically with the depositor as such
(Chapter X X ) . The merchant who borrows from the bank almost
invariably takes his loan in the form of a book credit. He draws
on this book credit in order to meet his obligations. He seldom
asks the bank for actual money. Frequently, his customers pay
as a
him in checks and he deposits them with the bank. When they
pay in actual cash, he promptly takes the money thus received to
the bank. His deposits with the bank, whatever they may be, are
frequently less than the amount that he owes the bank for the
accommodation which has been extended to him. It is therefore
vital to his success that he should be enabled to continue doing
business with the institution without interruption.
A panic or stringency which compels the bank to call in its
loans to him wipes out his deposit with the bank or compels him
to get funds from some other source, perhaps at a very serious sacrifice. On the other hand, a check to business or to general solvency throughout the community means that his customers can not
•freely liquidate their obligations to him. In that event, he may
have to ask for extensions of credit, or his deposits at the bank
may be cut down below the figure which the institution considers
necessary. In any case, he cannot go to the bank and demand
liquidation of its obligations to him with the same assurance that
exists in the case of a depositor who owes the bank nothing on his
paper. It is, if anything, more important to him that the bank
should be sustained in times of panic and stringency than it is to
the man who has no dealings with the institution except to deposit
his funds there and draw them as they are needed.
For such reasons the mercantile part of the community is
usually the strongest support of the banks simply because its interest is so closely bound up with that of the banks. The security
behind the commercial paper of the community is thus not merely
Bound Up
the actual property of the merchants who compose it but is also
With Bank
their commercial future and their general prospects of success in
a business way. The paper which they supply to the bank is therefore one of the best bases for rediscount that can be offered. The
assurance that it will be paid without default is as great as can
be obtained.



§7. The local merchant shares with his community the penalties an inadequate banking system imposes, and he lias some particular grievances in addition. Like everyone who has direct dealings
with the banks he is the victim of the rigid reserve system. Under
our banking customs and laws, emphasis is placcd on the quantity of
cash reserves. These are commonly held to be the test of banking solidity. Every banker, and especially the isolated country
banker, is solicitous about his reserves. lie sacrifices everything
that they may not be impaired. At the first sign of trouble in
the business world he grasps for lawful money to fill up his reserves. He stops lending. The only law he knows is that of selfpreservation. He knows there is no place he can go with the assurance that he will get help.
The country merchant, dependent on local bank resources, or
the small city merchant, dependent on one bank, is the first to feel
this suspension or curtailment of loaning power.
With a reserve agency would come cooperation among the
banks. Under this system the power of a bank to lend would not
depend on the condition of its cash reserves, but on the quality of
the paper it had on hand. Instead of garnering cash and stopping
discounts, it could pay out cash and make loans in the certainty that,
with good paper on hand, it could get cash. Instead of increasing
and intensifying a stringency by eiTorts to protect itself, it would
contribute to end the stringency and restore confidence. No local
merchant would ever be driven to failure by lack of banking accommodation and no bank would be forced into liquidation because
of inability to convert sound assets into cash.
Such a reserve agency is more in the interest of the local
merchant than of his bank. With a rediscount market established,
the rate of interest would be the same to every bank, in any part
of the country. In sparsely settled communities the small merchant may be forced by scarcity of capital to pay ten, twelve or
even fifteen per cent interest per annum. A Reserve Association
would bring capital to the points where it was most needed, that
is, wherever good commercial paper was offered. This would be
bound to lower interest rates. The local merchant, instead of being
cut off from sources of credit, would have new ones opened to liim.
The only condition would be the quality of the paper he had to
Under present conditions it is startling to discover that in the
autumn, when bountiful nature is pouring her products into the

How the


would" Do
for the

JlJ"^er t h e





warehouses, that is the time—of all times in the year—when it is
most difficult to get credit. And yet paper based on the exchange of
these products is the best in the world. With a Reserve Association abundance of products would provide abundant means of payment for them. The country merchant, dependent on the movement
and sale of crops, is the one person who should be most interested
in improved banking methods through the establishment of a cooperative reserve association.



Seasonal Character of Agriculture and Crop-Moving—2. Farmer«'
Loans Under Present Banking System—Cycle of Money Movement
—3. Difficulty Due to Inelastic Note and Credit System—4. The
Remedy in Cooperation—5. Experience of Canada—6. Idle Funds
and a Discount Market.

§1. It has been pointed out that more than half of our
millions of people live in the rural districts and cultivate nearly
one billion acres of land. The valuation of agricultural land? and
buildings is more than 34 billions of dollars. What is most striking Farmers
of all is that the annual product of our farms is nine billions of dol- as Pro.
lars, or about as much as the entire resources of all our national wealth ° f
banks; in other words, 10 per cent of one year's product of our
farms would pay off the national debt. The capital invested in
agriculture exceeds that invested in cither manufacturing or railroad enterprises. The men who till the soil are creating wealth in
the United States at the rate of about 25 million dollars daily. It
may well be said, therefore, that the importance of the relation of
the farmer to our credit and banking system is equaled by that of
no other class in the country.
The obvious peculiarity of agriculture is that, owing to the
character of our climate, in most cases but one crop per annum of
a given kind is harvested. The significant relation of the famer to
our banking system arises out of the fact that the harvesting of
the regular staple crops of the country, such as wheat, corn, oats,
cotton, and others, is a seasonal operation. This is the one important fact which distinguishes the financing of agricultural operations from those of industry and manufactures in relation to banking. In regions which are mainly agricultural, the seasons of the
year when the products of the soil are being marketed are the seasons when large calls are made upon the banks for loans.
There are few lines of industry in which anything like the same
seasonal character is found. Some classes of manufactures, to be



on the

From the
Banks to
Move the


sure, are to some extent dependent upon climatic conditions—upon
the spring or the fall trade. For instance, the general retail trade
feels an upward movement at times when the seasons are changing,
and a corresponding depression at the height of the season. But
beneath this ebb and flow of trade there is invariably a steady current of exchanges which continues at nearly the same volume
throughout the year and represents the normal consumption needs
of the community.
The needs of the fanner, however, are peculiar. A t the time
of the year when the ground is being prepared and seeded, there is
more or less demand for loans, but none of these are at all comparable to the demand for funds in the harvest season. After the
crop has been harvested, the strain upon the banks is removed.
Moreover, since the characteristic of agriculture means a seasonal
income for the fanner, it gives likewise a seasonal character to
other branches of business which are allied with agriculture. The
business of the small merchant is a good deal more brisk after a
large crop has been sold and paid for than it is at any other time.
The milling of wheat is similarly affected. Likewise, there is some
movement of the laboring population into the agricultural regions
at the harvest time, and a movement from the farms into the villages after the harvest is over. All these conditions therefore create
a peculiar seasonal problem for the banks to deal with.
During the planting and growing season of late spring and
early summer the farmer of the Middle West has need for only a
moderate amount of ready cash, even though a crop of considerable size is coming forward. Some money had to be spent at seeding time, and a certain amount was paid in wages during the growth
of the crop. But the chief expense is that of harvesting, gathering
the product in the barns or warehouses, preparing it for shipment,
and actually taking it to the transportation line. When the wheat
crop ripens, the farmer usually has not the ready money to pay
out for labor and more machinery; in fact, he may have invested
any surplus in extending his acreage or making permanent improvements. To pay his harvest hands and the consequent bills for
additional food and farm supplies, he is likely to go to his local
bank and obtain a small amount in cash. He requests a loan which
may run for a comparatively short period. He may ask for it simply on the strength of his known credit in the community, or he
may even secure it by a mortgage on his crops and farm



Perhaps the farmer has disposed of the crop as it stands to a
middleman or agent, as is frequently done in the case of apple
and other fruit crops. The middleman in that case may seek ac- Bank«
commodation cither at the local bank or elsewhere. If lie has no provide
collateral to offer as credit, he may furnish the bank with bills of Credit
lading covering the produce in transit to some purchaser who has
bought the goods from him. Such a transaction would be possible
only after a portion of the products had been gathered and delivered to the transportation company. Whether the demand for the
loan comes from the farmer, or from some local purchaser of his
products, the demands upon the banks are the saine. The funds arc
needed for the purpose of setting the products in motion towards
the consumer. The term of credit is the average time required to
complete this movement; and the security is usually the products
§2. The local national bank of Wheatville, we may suppose,
has deposits of $200,000; the law requires that $30,000 of this
must be kept as a "legal reserve"; $12,000 of this $30,000 must be
kept in its vaults in lawful money (greenbacks, gold and silver).
If paid out the banking law is violated and the bank may be
closed by the Comptroller. To do the ordinary business of the bank
perhaps $5,000 in cash is needed, since the money deposited day by Country
day about offsets the amount paid out. But in order to have funds |feric«Re"
in the big cities, on which drafts may be drawn to accommodate
customers and to lessen the risk of keeping large sums in its vaults,
the bank keeps part of its reserves in nearby reserve city banks, and
smaller accounts at Chicago, St. Louis and New York.
The form in which the borrower wishes to get his accommodation from the bank is that which will be most acceptable as a means
of payment to the persons he owes. In a city the borrower will
generally make his payments by drawing checks upon the deposit
account which the bank gives him as the result of the loan. In a
sparsely settled country community where the number of banks
is small and where the use of checks is not customary, the borrower will generally ask from the bank some forms of cash. The
farm hands and others who are to receive the payments involved in
gathering the crops prefer to have a medium of exchange which will
pass current among them more easily than the bank check. This is
usually satisfied by any form of cash. In short, during the cropmoving period, the banker must bear in mind that he must meet an


Crop Demand for

Need of


urgent request for various forms of lawful money or bank notes.
Some of this currency does not come back to the bank; the hired
men may keep it until the end of their jobs, then travel on, and
finally carry the money back to their homes. Hence, while the local
bank may have paid out $10,000 a week in cash, only a portion of
this amount will have returned to the bank in the deposits of merchants. Finding its supply of money running low, it sends to
its reserve center—perhaps Kansas City, Omaha, or Minneapolis—
for a shipment of currency. Hundreds of other banks are doing
the same thing, and the city banks soon find their own supply of
reserves decreasing. Thus they make requests on Chicago or St.
Louis. There a demand is felt from thousands of banks over a wide
area, and they consequently send to New York, where they keep a
portion of their reserve funds, asking for large shipments to be
sent from the East to the West. Thus the same pressure which
is felt by the local bank is inevitably transferred with constantly increasing intensity to the banks of the central reserve cities of St.
Louis, Chicago and New York.
The seasonal characteristic in the agricultural regions is, as we
have seen, not confined to the farm; in such a community, the mill
or the local buyer of grain also needs loans. During a period of
about three months the mill must secure wheat and corn enough to
insure a supply throughout the entire year. It is, of course, impossible for it to carry through the other months of the year actual
cash for that tremendous expenditure. The management therefore
borrows from the bank thé funds for buying grain. A small country mill may need as much as $20,000 to $40,000. Since the mill
will be purchasing the farmers' grain, the mill must have the cash
to complete the purchase; consequently the demand of the mill on
the bank is likewise a demand which must be met in cash. The
loan to the mill may have a maturity of several months—that is,
for a period covering the grinding of the wheat, the shipping to a
distant customer, and the return of the payment. A car sent to
New York from the Prairie States may be eight weeks on the way.
The mill is paying interest on the loan, and the amount of this
loan, whether high or low, correspondingly affects the working expenses of the mill, and it must be met by a charge on the wheat
producer or on the consumer—either in a lower price to the farmer
for his grain, or in a higher price on the flour to the consumer.
That is, a dlumsy and expensive banking system inevitably lays its
tribute upon the farmer or the consumer.



The farmer, moreover, often appears as a business borrower.
He may have harvested 40,000 bushels of corn; lie may have had
a large hay crop. If he could buy 200 head of range cattle to
fatten he could make a fine profit on both his grain and stock. He
may ask the bank to give him a loan on a note properly secured, and
with the credit buy the stock. Or, it may be that the fanner has a
fine lot of young cattle, but has no feed for them. In that case
he would wish to borrow the money with which to purchase hay
and corn. Thus the bank must carry that loan until the cattle arc
fattened and sold—a period of perhaps three or four months.
The seasonal characteristic of agriculture also influences thu
business of the local merchant. The small merchant who keeps a
supply of farmers' necessities may carry a stock of goods worth
perhaps $20,000; but a part of that is bought upon credit. He
must, to hold his trade, frequently buy new supplies from the
city. To obtain this added capital he needs a loan until he can
sell the goods. This can be obtained either by a loan from the bank,
or the wholesale house must give him G or 90 days' time. In the
latter case, the wholesale house is itself probably the borrower from
a city bank. In one way or another the banks collectively must
meet this seasonal demand.
It will be observed that the cash obtained by the farmer from
his bank is soon paid out for supplies or labor. The money .sent
from reserve cities into country districts requires some period of
time before it comes again into the local banks. In the autumn \ho
farmer may not sell his wheat at oncc; he may haul in one or two
loads at a time, for, perhaps, $45 a load of 50 bushels. He takes a
check for the money from the elevator or mill, and cashes it at the
bank. The farmer's family may go to a county seat or a larger
town at some distance where there are more pretentious stores and
distribute some of this cash away from home. In this case the small
country bank feels the prolonged demand for currency, and may bo
obliged to ship in considerable sums, even late in the autumn. Taking the banks collectively, however, the expenditure by the farmers
for goods will inevitably result in the return of the cash by the
merchants to the banks. The farmer begins to prepare for winter;
tax-paying time arrives; the holiday trade opens; the farmer goes to
town oftener and spends more freely. The local bank finds each
day that it closes its business with more cash on hand than the day
before; it ship3 a few thousand dollars to its nearest reserve center; thence it is shipped to St. Louis or Chicago; and in turn those

g*^*™ 3 1


FI0W of




cities send more or less on to New York, until the tide of currency
is running back to the financial centers of the country from which
it was drawn early in the autumn. Thus there is an ebb and flow of
actual currency from the financial centers to the agricultural centers for several months. Then there follows a stationary period
stretching on until the call of the harvest is repeated. Although
more than 95 per cent of the wholesale transactions of the country
is done with checks, actual money is demanded because of the seasonal characteristic of agriculture.

In SupplyNotesani<

§3. From what has been said, it is clear that banks in the
agricultural parts of the country are expected to be able to provide
notes, while the customers of banks in other parts of the country
y do their business largely with checks. When the country banks
a r e called on for loans, they should be able to provide notes of their
° W D *SSUe* ^ n c * e r o u r P r e s e n t system, however, they find themselves obstructed by the limitations upon national bank currency,
that is, the rigidity and inelasticity of our system works a direct
injury to the country bank and to the borrowing farmers. They
must first provide themselves with government bonds, then go
through with the formalities attendant upon the issue of the notes.
In very few cases where a bank in an agricultural region has
a good trade, is it able to satisfy the wants of its customers by simply lending them its own notes. This means that it must supply
itself with funds from some other source. The only source from
which it can obtain what it needs is the other banks of the country. Hence, in order to have a resource upon which it can draw at
crop-moving periods, it must build up a credit account with some
bank elsewhere. This it endeavors to do. It is allowed by the national banking law to place a part of its reserve with the banks in
reserve cities and central reserve cities, and to the sum thus fixed
it seeks to add by remitting such exchange on the cities as comes
into its possession in the course of the year. When the crop-moving period arrives, it draws on its correspondent bank in the city
for actual funds. The correspondent b a n t ships the money, usually
. in the form of paper currency, to it by express, and thus it is able
to supply the wants of borrowers. If the point is reached where
it cannot further draw down its account with the city bank without danger or without violation of legal requirements, it must either
stop lending or else ask the city bank for accommodation. The
latter can be had by obtaining a straight loan or a rediscount from



the bank—the result being in either case to increase its crcdit with
the correspondent bank and hence enable it to draw on that bank
for the resources it actually needs.
Of course the process just sketched is not an isolated one. It
is going on simultaneously in many parts of the country, and although the height of the crop season is not the fp.me in all parts
of the Union, owing to the difference in the dates at which given
products mature and owing to climatic variation;?, there is enough
of simultaneous demand to subject many banks t(, strain at about the
same time. Therefore, all over the country there is likely to be a general call for funds which will take cash out of the vaults of the banks
and keep it out for a certain period. This is a situation against
which the city banks endeavor to provide by furnishing themselves
with note issues, in many instances, which they would not otherwise take out. But, even when they have thus protected themselves, the demand for loans is likely to be so irregular and subject to such variation that the protection is inadequate. Even if
it is sufficient, the cost of issuing the notes, as outlined in an
earlier chapter of this volume, is so great that the expense of furnishing loanable funds for crop-moving is invariably high. Whether
the city banks be called upon, therefore, to extend accommodation
in the form of reserve money or in that of their own notes, they
must charge a tolerably high price for such accommodation.
Consequently the borrower must pay a more than equally high
price. If the city bank has to part with reserve money (or, what
is the same thing, is called upon to extend a loan to a bank, knowing that that bank will promptly call upon it for cash), it recognizes that the making of this loan will be a decidedly serious thing
for it, since its credit-extending power in its own community will
be cut down in proportion to the amount of loans that could have
been supported by the reserve money with which it parts. If it has
to get out notes expressly for the purpose of satisfying a borrower,
it ties up a part of its fluid resources in the form of bonds, or else
it borrows the bonds and pays their owners for the use of them. In
any case, therefore, the operation is expensive. This expense is
thrown upon the borrower in the form of a higher rate of interest.
The home bank charges him whatever it has had to pay to the
city bank, and in addition such a rate as will compensate it for its
own services in acting as an intermediary and practically guaranteeing the loan made by the city bank. Such action is inevitable,
and of course involves no criticism upon the banks which thus

Call for
Fundi Cuts
Down Reserves

Jo ^or?*1**





charge a double rate for the accommodation they extend. But it
makes the cost of supplying credit with which to move the crops
abnormal. Inasmuch as the credit obtained is a part of the expenses
of production in any economic operation, it is a part of the cost of
placing agricultural products on the market. As the price of such
products, in so far as they are staples, is a world price, they are
necessarily less profitable to the producer than they otherwise would
be. This means that there is an unnecessary burden upon the
farmer as a result of our present system of agricultural loans.
The method in which a stringency or panic affects the agricultural section may be shown by what happened in the autumn of
A s h a s b e e n e x P l a i n e d , farmers, crop-buyers and banks were
drawing on the large reserve centers for currency. Suddenly, because of financial disturbances, there came runs on certain New
York banks which compelled caution on the part of all other banking institutions of that city. This local situation, together with
heavy demands for currency from the agricultural belt, made it
impossible for the New York banks to satisfy all demands and also
keep their currency reserve up to the point required by the banking law. They were compelled to refuse currency shipments to
Chicago, St. Louis, Memphis, New Orleans and other points; consequently, the banks of those cities could not assist Minneapolis,
Omaha, Kansas City and the cotton belt without illegally lowering
their own cash reserves. In a day the entire country was alarmed;
everybody wanted his deposits in cash, and there was not enough
to go around and no possibility of getting more. This account
explains fully why the New York banks are equally interested in
obtaining a measure of banking reform by which the cooperation
of all the banks would relieve the pressure upon themselves as well
as upon the small local bank.
The local banks had the notes of merchants and farmers—all
good commercial paper—but they had no cash to pay out and
yet retain their lawful reserves. In such a case the hank of
Wheatville, for instance, has $12,000 lying in its vaults, but it
can not use it. It may have $200,000 of deposits and $25,000 of
capital, but it may not be able to loan more than $160,000 to
$170,000; it must keep as legal reserve $30,000, that cannot be
used and, for safety, or in a moment of slightest alarm, it tries to
keep its reserve in excess of the actual legal requirements. Likewise, every other of the national banks in the United States has



a portion of its reserve ¡11 gold or other cash, but und*r the present
banking law it cannot be used. Depositors, therefore, are compelled to wait. Loans become expensive to the farmer.
The essential need of the farmer or producer is a cheap source
of credit that will enable him to send his product to market at a
reasonable cost. This source must be one that can provide him with
note currency, since, for the reasons already noted, that is a
form in which he prefers to take his loans. lie gets his accommodsit|
tion in the best shape when it is in the form that is most acceptable Need of
to the people whom he has to pay and, as we have seen, that is the
bank note, or actual reserve money of some kind. This kind of
accommodation must be supplied him at as low a cost as is con*
sistent with a fair return on bank capital and with the character
of the paper the farmer has to offer. In the majority of cases the
security offered by such farm product loans intended for cropmoving is of the best. The cotton bills of the South arc well
known for their reliability, and the same is true of similar paper
based upon any staple crop, such as corn, wheat, oats, etc., in transit.
As stated before, it is not a matter of much importance whether
these bills originate with the farmer himself or not. Whether
they originate with him, or with some factor or middleman, the
cost of getting the accommodation from banks to cover the period
while the goods are in transit or while they arc being held to await
a higher price is reflected back upon the farmer, in the form of a
lower return. In so far as lie can offer, therefore, paper of the
very best description either directly or indirectly, there should be
no reason why he should not get credit at the lowest going rates.
His necessities call for a large, well-recognized market for paper
of the kind lie has to offer and an expansible or elastic medium into
which his bank credit may be transformed.
§4. Our antiquated banking system, which has remained practically unchanged since the Civil War, is obviously working in a
destmctive fashion upon the farming community.
When the
Bank of Wheatville has loaned to the farmers, elevator men and
merchants all that its resources warrant, it must stop lending;
under our present banking laws, it has no method of expanding
either its credit or its currency. The farmer may offer his note
secured by wheat or stock and the bank cannot accommodate him;
the mill may have 50,000 bushels of wheat in store, but it cannot

by Banking



use that as security to borrow from the bank. The bank's only
resource is to send the paper elsewhere, trying to find, if possible,
some other bank not loaned to its full capacity.
It is not creditable to the intelligence of our country, more
than half of whose 95 millions live in the rural districts, that
there should be a perpetual and unnecessary struggle between the
lending institutions and the borrowers. There ought to be some
method by which the farmer, merchant and dealer in grain or
stock can obtain credit when he needs actual currency. It has been
made clear that any complication of the machinery by which it is
made difficult to get credit means a lessened business opportunity
for both the farmer and the merchant, and directly or indirectly
results either in lower prices for the producer or higher prices
for the consumer.
The obvious remedy would be a cooperative agency by which
all the banks of the country would be united in a national reserve
association. Thereby the banks in any section where pressure arose
would be able to bring the combined capital and credit of all the
banks of the country to the assistance of the region at the time when
it was most in need. As a consequence, no bank would be obliged to
CoSperatlon refuse accommodation to its customer, if it possessed good cornRemedy
mercial paper; because the local bank could take that paper to a
branch of the national reserve association—free from dependence
upon any city correspondent bank—and, with the proceeds of the
loan, immediately increase its lawful reserves and its ability to
lend to its constituents. When the Bank of Wheatville needed
more currency at any time, it would change its credits with the
national reserve association to notes, which would be sent to it
without charge from the branch. Thus the notes of the national
reserve association would automatically expand and contract, in
accordance with the ebb and flow of the seasonal demands. Instead
of each bank working out its salvation alone, all the banks would
work together under a general policy.
§5. The experience of other countries shows that it is not
necessary to have a stringency, great or small, at periods of cropmoving, but that the seasons when agricultural products are being sent to market can be financed as easily as any other productive period. This can be done by supplying the two fundamental necessities already referred to. In Canada, where the system



of production is very similar to our own, results arc obtained by
means of an elastic note issue which expands as the demand for
agricultural loans expands. This note currency is supplied through
a large number of branch banks which are thrown out into the
agricultural districts by strong, highly capitalized institutions. The
branch banks gets the notes from the head offices as fast as they
are wanted, and lend them to farmers on the strength of the
staple agricultural security which the latter have to ofTer. This
system is often referred to as a flexible note currency system Jj^Heips"
for moving the crops. It is, in reality, a flexible system of bank the
credit which happens to take the form of note currency. It ful- F a r m c r i
fills the two requirements already mentioned in a preceding section. The large banks which establish the branches constitute
the market for the paper of the agricultural communities. With
their head offices situated in commercial centers, and with branches
located in manufacturing regions, they are in position to draw
idle funds from all sources and mass them where they are wanted
at crucial moments. They thus afford a genuine market for agricultural paper. On the other hand, owing to their ability to issue
large volumes of notes, they can supply the accommodation in that
form and do actually do so.
But while the branch system is desirable in many ways, it
is not necessary, provided there be established such a system of
cooperation among banks as to give to every institution which B r a n c h
is called on for accommodation beyond its immediate means to Banks
grant, a certain and assured opportunity of marketing the paper
which is offered to it and thus of getting the backing of a strong
institution which will supply the support that is needed. Where
this is done the result is to furnish exactly the same means of
accommodation which are supplied under the Canadian banking
system. If a cooperative institution were created, with power to
issue notes as they were wanted, it could rediscount the paper
presented by small banks. Having meanwhile obtained from other
banks the surplus funds of other communities, it is able to use
these as a basis for other loans and thus to afford genuine accommodation to the banks that are in need of it. This accommodation would naturally take the form of bank notes in the agricultural regions of the country. It would not matter whether the
loans were made in the form of notes or in the form of credit deposits, so far as the maker of the loan was concerned, but it would


Low Interest Rates


be a matter of great importance to the individual borrower. The
6ervice of the note-issuer would be merely that of converting into
immediate means of payment assets which would be almost immediately wanted by the community and which had a certain market
at a definite figure. There would be no reason why any higher
charge should be made for this kind of accommodation than for
any other; and as a matter of fact, there would not be.
A comparison of the rates of interest charged in the United
States with those charged in Canada shows a very decided difference. In the United States (see table of interest rates of national banks given in Chapter I I I ) the rates are uniformly high
in outlying sections. In Canada they are little, if at all, higher
commercial centers. Differences in paper, the
length of the loan required, and other factors of the Bame sort, lead
s o m e differences in rates of interest, but otherwise rates are
uniform. In the United States the charge for accommodation at
farming points in Texas may be 10, 12, or 1 5 per cent at the same
time that in New York there is a plethora of idle funds which
are being loaned at Sy 2 and 4 per cent. Probably the rate on
the loans in our country districts would never fall as low as this,
for it often happens that the inability, under our system, to shift
banking capital to different parts of the country as it is wanted
causes a rate of interest which is as abnormally low in the cities
as it is abnormally high in the country. With fluidity in banking
capital and equality of adjustment between the two forms of bank
credit, it would be found that a medium rate of interest somewhat higher than the abnormally low rate of the present day and
much lower than the abnormally high rates which prevail in the
country at present would be established. There would, in short, be
a general adjustment of supply to demand in the matter of bank
loans and accommodations.
oriJaHnJt ' f

Market for


? * °f

a re^ular

8gnCUltUraI c o

market for paper
™ * i e s , and the Pn,vision of

war 1 T h " Î J T W ° U l d b e o f
V a n t a g e in another
i i i e Problem of the hanlr in
. ,,
a ^ c u I t u r a l community is
two-fold—how to set » ^ i «
cron mnw' Z
, a c t i o n a l means of accommodation at the
u Z r Z S I ™ ! ' T d h ° W t 0 d i 8 P° s * of « s surplus fundsat other
Z r J , aDk during 8 ]arSe P«rt of the year now has d i f ®
P T g
w h i c h we left with it.
f Z Î
°f the
iarmers are p a i d for their crops and have liquidated their loans



at the bank from which tliey borrowed, there is a surplus which
represents their remuneration for their own labor and the use
of their land during the producing season. This surplus is deposited, while at the same time the demand for loans falls off
heavily. The local bank tries to keep its funds active by buying
commercial paper elsewhere, or by redepositing with other banks
which pay it interest. When the funds are thus employed, the
bank can afford not to seek loans of the less secure or less fluid
character which may be offered in its own community—in other
words, it can adhere closely to the actual business of banking from
the commercial standpoint.
The purchase of the outside commercial paper may thus be
a good thing; and the redepositing of its funds with other institutions, or the lending of such funds in distant markets, may
be a good thing. Unfortunately, it frequently happens that the
funds which are thus lent at a distance are lent upon speculative
security. Sometimes, although not so often, the commercial paper
which is bought by the bank is bought unwisely and results in a
loss to the institution. Under the most favorable circumstances,
there is probably a larger chance of loss, or of unwisdom in such
use of the funds, than would exist if the bank could use them
in buying paper which had been tested by a large cooperative institution or by an existing bank that afforded a market for such paper.
Thus, a discount market would be of great servicc to the bank,
not only in marketing its own paper in times of special pressure,
but also in keeping its funds active. At the same time it would
be relieving the necessities of other communities which had a
surplus of paper at times when the first institution had a surplus
of funds.
The effect of this discount market would be most obvious
in the aid it would afford to banks in keeping their funds active
and thereby enabling them to earn a good profit. But it would
also have a favorable effect upon the borrower at the local bank.
As we have seen, the local institution has to chargc an exceptionally
high rate because of the irregularity of business, which is abundant
at some times and deficient at others. If it could be relieved of
this irregularity, and enabled to employ its funds at about the
same rate, and on about the same terms, throughout the year, it
would be able to supply accommodation at a charge that was
practically uniform throughout the year and that varied only as

p urc h a 6e
of Outside



the general supply of, and demand for, loans varied throughout
the country. In this way, a discount market would work in the
interest not only, and not even primarily, of the banks, but to the
distinct advantage of the borrowers at those banks. The local
institution would be much better able to invest its idle funds as
well as to get the use of idle funds from other places. In working
of Interest Rates
out such a system, therefore, the business community would be promoting the interest not merely of the banks, but of everyone who
was in the least dependent upon bank credit to facilitate his operations.
The plan suggested would really amount to a means of economizing the use of capital throughout the whole agricultural community. At present there is very great waste in the use of capital,
owing to the necessity of holding it idle for long periods. The
tendency of banks in some places has been to employ their surplus
funds in long-period loans on real estate and similar security. This
kind of business the national banks have technically been cut off
from doing. Much of such business has, therefore, been taken over
by state banks. This creates competition between different classes of
banks. In not a few sections of the country, the effect of this competition has been to lead banks to undertake real estate loans by
roundabout methods which violated the spirit of the national bank
act, notwithstanding that they observed the letter of the law. Where
this has been done, the effect may be to enable the banks to get
better returns on their capital, but it is more than proportionately
Causes Bad
injurious to the community when the time comes for active shortperiod loans to be used in moving the crops. At such times, it is
found that, in so far as the bank's capital has become involved
in long-period security, it is unavailable for current uses. It is
then so placed as to work a reduction in the active loaning power
of the bank. This simply means that, in the attempt to get a
full return on their investments and keep their capital actively
employed, the banks have really reduced that portion of capital
which is in a shape to furnish the basis for commercial loans.
Under such circumstances, the banking capital of the community
is narrowed by that amount. The community is then driven more
and more to rely upon distant banks in time of stress. To the
extent that it is thus obliged to look elsewhere for its short-period
accommodations, it is without real banking capital. The function
of banks as such in an agricultural community is not that of fur-



nishing farm loans, which are to be employed in the making of
permanent improvements or the extension of farmer's equipment.
That is a kind of business which should be performed by savings
institutions, or by companies specially organized to do a mortgage
business. The function should be kept quite separate from that of
banking, as the type of organization which can be relied upon to
furnish loans of the one class cannot be relied upon for the other.
The adoption of a plan for rendering the crop-moving proccss
efficient would aid the banking system as a whole, and through
it would cheapen accommodations to borrowers in urban centers. Broader
The discount market would be materially aided by the offering of ^¡I^om.
agricultural funds at slack seasons for the purchase of paper merclal
originating in manufacturing regions or in retailing and jobbing P a P c r
centers. It would thus greatly tend to broaden the regular market
for paper originating in either of these quarters. But it would also
tend to create a new field for the exploitation of city bank capital.
It has been noted how and why agricultural communities call for
note credits rather than book credits. Conversely, we have seen,
city communities demand book crcdits and do not care for many
notes. At the present time, city banks take advantage of this condition of affairs, so far as the cramped conditions of note issue
under the national system will permit them, to issue their own
notes and to place these in the country when there is a demand
for crop-moving "money." Very much more could be done in this
way by an institution which was vested with a genuine noteissuing power. Inasmuch as the demand for the two kinds of
bank accommodation is not interchangeable, it is usually true that
a bank can maintain a considerably larger volume of outstanding
credits where it has the power to make use of both classes of
accommodation instead of employing only one.
If a cooperative institution representing all the banks were
thus vested with a large note-issue power, it would practically call
into operation a large resource of credit which is now not employed
at all. This kind of credit may be considered to have the same
relation to the deposit form of bank accommodation as does the B c n c f i t s
by-product in an industrial operation. If a manufacturing con- toother
cern is throwing away, or not utilizing, the material for the pro- ^„„J"* o f
duction of an important by-product, it is not in position to sell its
chief output as cheaply as it could were it realizing something
for its waste material. In a similar manner, the fact that the



banks of the country were employing their power of sustaining
a note issue would call into effect a source of revenue which would
enable them to supply credit by the other means at a lower rate.
The steady call for note currency from the agricultural districts
would, in other words, imply a possibility of keeping the rate on
ordinary loans in the cities and manufacturing regions considerably
lower. This is the interest of the ordinary business man and manufacturer in establishing a system of good agricultural credit. The
desire for such a system of credit is not a purely altruistic one with
him. It is coupled with the effort to make his own credit more
secure by freeing the banks with which he deals of undue demand
at periods of exceptional stringency. This makes it possible to reduce the regular charge to him for the credit he needs, at all
periods. Agricultural in a country like the United States is one of
the basic industries of the nation. Whatever tends to render that
industry more stable and regular in its methods, and at the same
time to lower its cost of production, necessarily produces a beneficial
reflex effect upon the rest of the community.



Financing Import and Export Business.—2. New York Supplies
Cash to Move the Cotton—3. How Cotton Is Bought From the Producer—4. Defects of Present Banking System in Relation to the
Cotton Movement—5. Cotton Movement and a Discount Market—
6. The Bill of Lading—7. Acceptances.

§1. The South, through its ports—New Orleans, Galveston,
Mobile, Savannah, and Charleston—is engaged in the importation
of such products as coffee, or bananas, from South and Central
America; or in the exportation of such a main staple as cotton to
Europe. In both cases, the transactions give rise to credit instruments by which shipments of actual cash are saved. That is, bills
of exchange (or drafts) from different countries are offset against {f^*™**
each other in international bookkeeping with much the same gen- Bookkeeperal effect as are checks on different banks within our country offset against each other at our clearing houses. To show the working f ^ a n d
of a National Reserve Association upon Southern business and Business
banking, it will be well to discuss: (a) The matter of exports;
and later (b) that of imports. Under (a), the points taken up
will be:
(1) A description of the present movement of cotton, and
the bills of lading arising therefrom
(2) The present financing of this movement by the banks
(3) The evils of the present system
(4) The remedies offered by a National Reserve Association
and acceptances
(5) The bills of lading question
§2. The total value of unmanufactured cotton exported from N e w Y o r J (
the Southern States in 1910 was $450,447,213.00 (or 6,263,293 Finances
bales). Under present conditions, the main part of this move Movement1
ment of cotton is financed through New York, and the profits thereby gained are variously estimated at several millions of dollars.



Fi r 8 t
Steps In


The question has been raised whether the Southern banks might not
be able to do more of this business at home. Of course, it is a
question, also, of the use of capital during the crop-moving season;
and the South itself does not possess the available capital to meet
the need when it comes.
In the technique of the cotton movement, it may be well to
distinguish between (1) "domestic bills" and (2) "foreign bills/'
the former based on the operations within the country up to the
arrival of the cotton at the port of shipment, the latter arising
from the over-sea movement by ship. It is to be remembered that
about one-half of the cotton produced is consumed at home. Hence
domestic cotton bills between different parts of the United States
are many; and they are also related to questions of warehousing,
bills of lading, and the demand for credit. But times requires that
this study should be confined to the cotton intended for exportation.
A cotton factor, or merchant, at some place like New Orleans,
or Mobile, has cotton from various parts of the South sent him
consignment, or under some agreement as to price, to be sold.
Or, a buyer sets out to purchase cotton in any part of the producing area. In such cases, the cotton conies in on a railroad bill of
lading, running only to the domestic port, or place of shipment;
and if this cotton is sold to an American mill, or to another shipper, only domestic bills of exchange arise. In case the factor sells
any of this staple for export, he delivers it from the warehouse to
the purchaser, who loads it on the ship and then obtains an ocean
bill of lading. It may also happen that the foreign buyer himself
may purchase cotton in the interior, and, wishing to see the actual
goods, or collecting small shipments together at the seaboard, he
may have the cotton sent to him on domestic railroad bills of lading; then, afterwards, when he loads it on a steamer, he obtains
a separate ocean bill. Thus, two sets of bills of exchange and bills
of lading arise, a "domestic" and a "foreign;" but each covers an
entirely separate transaction. If this distinction is kept in mind,
much confusion may be avoided in understanding the financing of
the crop.
The method of handling cotton for export varies, of course,
according to the conditions prevailing at the moment. At times
the foreign buyer may find it advantageous to buy the cotton from
the supply which is always accumulating at the seaboard. But,
as is well known, there are throughout the producing area what



might be called inland cotton centers, such as Memphis, Dallas and
the like, where the commodity is accumulated from the surrounding country. Consequently, the purchaser for foreign account may
buy cotton at these interior points and ship it direcly abroad on
what is known as a Through Bill of Lading. This bill of lading T h e
is issued by the railroad, and designates that the cotton is to bo Buiof9*1
carried to the seaboard and thence by steamer to a specified for- Lading
eign port. At the seaboard, such cotton is transferred without being
touched by the shipper; but, when the cotton is placcd on shipboard, the shipper obtains a document known as the Master's
Receipt. This document, however, does not control the shipment
nor enter into the negotiation of drafts. The bill of exchange on
Europe is negotiated on the through bill of lading, which controls
the delivery abroad in the same manner as a simple ocean bill of
lading. In this case, one set of bills covers the entire transaction.
§3. Such being the usual course of the cotton movement, it
will be the next step to indicate the present method of financing
these operations during the months from September to January.
In regard to the local cotton business, it is to be mentioned
that the transactions are always in cash; hence a buyer, A, if of
good standing, will arrange with his local bank to obtain funds if
he wishes to purchase cotton. As is usual in this country, A will
give his demand note, and secure it by warehouse, or compress,
receipts, or by railroad bills of lading, covering a certain number
of bales of cotton. Conservative banks will not advance on this FiOWof
form of security more than their capital stock and surplus; but Currency
this amount of credit is not adequate, and it makes the movement c o t t o n f s
of cotton difficult. Moreover, if done, it is expensive. Payments Moving
for cotton are demanded in cash. Consequently, when A buys
1,000 bales of cotton and gets the loan for, say $(50,000, the bank
knows without any doubt that within three or four days it will be
called on for $60,000 in currency, which must come out of its reserves, or must be shipped to the bank from the central reserve
cities. When the cotton movement is over by January, this currency comes in, and must be returned again, chiefly to New York.
It is estimated that approximately $200,000,000 of currency is
thus sent into the South, and again shipped back, during these four
months, at a cost to country banks of possibly $40,000.
In the thirteen cotton-growing states, including Kentucky and
excluding Missouri, there are 1,461 national banks with a combined



capital stock of $159,927,430. When this capitalization is considered in connection with the value of the cotton crop it becomes immediately obvious why the South has to call on the North and on
Europe for aid when the crop is to be moved. And, since the whole
crop-moving period makes patent the insufficiency of American capital for all the demands—grain- as well as cotton-moving—put upon
it, the inevitable resort is to Europe. And the ninety-day bill of
exchange is the usual form by which this borrowing is carried out.
In regard to financing exports of cotton and foreign buying,
the operations are as follows: A cotton buyer, A, in the SouthFinancing
ern States, having borrowed as above described from his local bank,
Shipments will now make a contract with a spinner abroad, or with a foreign
cotton buyer (one who sells cotton to mills abroad), to sell him,
say, 1,000 bales of cotton of a particular grade and staple, for
shipment at a stipulated time and at a certain price. This price
is usually what is known as "C. I. P. & 6%," i. e., cost, insurance
and freight, and 6% tare deducted. Having assembled the requisite number of bales, A takes out an ocean bill of lading for them,
drawn to his own order, and stipulating that the steamship line
shall notify the person abroad to whom he has sold them. He
then makes up his invoice for the net amount which the foreign
buyer should pay him and draws a draft (or bill of exchange),
payable ninety days after sight to the order of himself, and endorsed in blank, which is called a documentary bill, because A attaches to it the ship's bill-of lading, or the through inland bill of
lading (as previously described, covering both railroad and steamship transportation), and a policy of insurance covering the shipment. This draft, or bill, is drawn either upon the cotton firm to
whom he has sold the cotton, or upon a mill which purchased the
cotton, or upon some bank whose name has been given by the purchaser as one that will accept the bill by arrangement with him
(the foreign purchaser). The Southern cotton buyer, A, then presents these documents to a bank, which offers him (for a commission) the equivalent in dollars for whatever foreign money the bill
may call for. By the proceeds of this sale of cotton to Europe, A
has funds with which to take up his loan from a local bank, if he
Of course, foreign cotton bills may not be sold to a local bank
in the South. A may sell through a broker in New York to some
bank. Then the local bank, from which A first borrowed on his
demand note, may draw a domestic bill of exchange, with the or-



iginal documents (warehouse receipt) attached, on the New York
bank. Thus, in another way, the local bank will gain the sum ncccssary to liquidate A's obligation to it. Of course, the broker in New
York gets a commission for selling the bill of exchange; and the
New York bank makes a profit on the bill of exchange.
Next, the bank forwards this bill, or draft, to its correspondent abroad, who presents it to the person upon whom it is drawn,
and has it accepted—this acceptance being made by writing across
the face of the bill the word "accepted;99 with the name of the
firm, mill, or bank, and the date.
The bill of lading and the insurance policy arc thereupon
delivered to the accepting institution, and the acceptance is held
for the account of the American bank which forwarded it; and it
may be carried until its maturity, or it may be discounted in the
foreign discount market and the proceeds placed to the credit of
the bank in this country. Finally, the American bank can sell
a demand bill against the proceeds of the discounted ninety-day
bill, and thus obtain the funds to meet the bill on maturity, or,
in the meantime, to continue similar operations.
§4. Having described the existing methods of shipping and
financing the cotton crop, the defects of the present system may
be here briefly mentioned.
1. There is a lack of actual currency during the cropmoving period, and a plethora at other times. This lack
arises from the inelasticity of our currency: greenbacks and
silver are issued in fixed amounts; and the bond-secured
national-bank notes increase (they do not decrease) according to the prices of bonds, irrespective of the demands of the
South or of any other community. To the extent that transactions are increasingly settled by checks rather than by actual
cash, the conditions are changing for the better; for, as more
banks are established in the interior of the Southern States,
there is a greater use of checks; but at present, and, as this
condition may not soon be changed, the movement of the
crop calls for many millions in circulating notes.
2. Even when it is possible for Northern banks to increase
their note-issue, the annual requirement for currency to be
sent in from outside during the movement of the crop brings
with it certain expenses and difficulties. Since there is but
one agency, and that at Washington, there is great delay and

Bills of

Money Is




expense attached to the forwarding of national-bank notes.
Moreover, the banks find it impossible at any time to change
large notes for small ones, and vice versa, and, in consequence their customers are seriously inconvenienced. In
addition, there is a high charge—seventy-five cents per thousand—for telegraphic transfers of currency from the New
York Subtreasury to New Orleans.
3. The necessity of shipping actual cash into the South
in the autumn months, and the expenses involved in this
operation, are, in themselves, only signs of causes lying deeper
down. In the main, these are two in kind:
(a) One is the retention of really primitive conditions of exchange. Cash is required where credit-offsets might be more generally used. Because of the rigidity of our bank-issues, the inelasticity of our note system
is painfully apparent. This is especially true in regions
where checks are not generally used. No part of the
country suffers more from the inelasticity of our noteissues than the South.
(b) But the inelasticity of the notes is really traceable
to a more fundamental cause. That cause is the patent
insufficiency of Southern capital to meet the exceptional
demands of moving a crop valued at from $700,000,000
to $900,000,000.
It is absolutely necessary to obtain
credit from centers where the capital of the world can
be drawn upon; that is, Southern banks are obliged to
call upon their large city correspondents for credit. In
ordinary times, such credit is freely obtained; but, in any
serious emergency—such as a real stress or panic—credit
is actually unobtainable. If credit were easily obtainable, then the transfer by check, as a medium of exchange, would be possible, even if notes were scarce.
Hence, apart from the inelasticity of notes (which entails difficulties and expense), the fundamental difficulty
is the inelasticity of credit. Even though cotton in
bales is as good a basis of credit as anything in the world,
the banks of the South are restricted in their operations
by an existing system, which, the moment a strain is put
upon it, cuts them off from accommodation when it is
most needed. As soon as a Southern bank's loans rise
to a point where its immediate liabilities (in its deposit



account) are no longer in the legal ratio to its lawful reserves, it must cease to lend for the moving of cotton.
And, if large city banks are also restricted in the same
way, they cannot lend to their country correspondents.
And it is unfortunately true that when the country banks
are "loaned up/' the city banks arc likely to be in the
same condition and for the same reason. The absence of
any cooperative organization of credit, by which the reserves of all are put to the common service, hits the
South in the cotton-moving period harder than any other
part of the United States. That is, in any part of the
country where capital is as yet insufficient for its needs,
the lack is not so much a lack of currency as it is a lack
of credit; if the credit can be had, then a medium of
exchange can be got, either in the form of chccks or
(with some delay and expense) in the form of notes.
The remedy, therefore, must be suited to the need.

Than Any

§5. The plan of a National Reserve Association, in the form
of a cooperative agency for all the banks—which is not a central
bank—would enable any bank having cotton paper, accompanied by
warehouse receipts or bills of lading, to obtain a rediscount at any
branch of the Association. The proceeds of this loan might be
had either in a credit on the books of the Association, or in the
note-issues of the Association; and in either form (under proper Cotton
restrictions) the borrowing bank would be able to use them in its
reserves. The point of this operation would be that good cotton Finance
bills would carry with them the power to finance themselves, with- , t M , f
out resort to the aid of banks in the Central reserve cities. That
is, cotton could be immediately transmuted into currcnt funds
during the period between its purchase and its sale. Such an institution could not be used for the promotion of syndicates, nor
for carrying stocks and bonds, nor for providing funds to be used
in speculation; because the only paper (in normal times) accepted
for rediscount would be short-time commercial paper (such as
ninety-day cotton bills). Such a plan, moreover, would be open to
all banks, state or national, and the rates of discount to subscribing
banks would be uniform throughout the Union.
This National Reserve Association would do no discounting
with the general public, and hence would not compete for deposits
with existing national and state banks and trust companies. Con-



6tituted in the common interest of all the banks, it would make the
credit of the whole Association available to the banks in that part of
the country where the special need might arise.
It is not always realized that the amount of business a bank
can do is related, not to the volume of its capital and surplus, but
to the quality of the paper it discounts. There is no possibility of
of Business
undue expansion by a bank if its discounts are confined to credits
a Bank
Can Do
based on cotton, in warehouse or in transit. Loans on such goods,
by early sale for cash, carry within themselves the means of quick
liquidation. Such paper is far and away safer than long-time bonds,
which do not fall due for a considerable period, and do not possess
any advantage over other property in being convertible into cash
Such a cooperative agency as a National Reserve Association, therefore, is, by its very nature and operation, adapted to meet the peculiar difficulties which confront the South during the movement
of the cotton crop.
1. It has been seen that cotton dealings are uniformly
settled in cash; that the enormous burden of moving cotton
causes the shipment of hundreds of millions of dollars of currency to and from the South in the autumn; and that the inelasticity of our note-issues makes currency scarce and high.
Any demand for cash draws down the reserves of banks.
When the surplus reserves are gone, the legal reserves cannot
be paid out. In consequence, the banks cannot lend, even
when good cotton bills are presented. This intolerable, humiliating, and rigid inelasticity of our currency would be
entirely removed by a National Reserve Association. If a
bank in Atlanta, Mobile, or New Orleans, during the cropmoving period, found its reserves down to the legal ratio, it
could take cotton bills to the Branch (not to New York
banks) and obtain notes of the Reserve Association which it
could hold or put into circulation. That is, notes would come
into existence just in proportion to the need for them as the
cotton was moved. Instead of a big crop-movement creating a
money stringency, it would bring a corresponding supply of
From the
notes. Instead of a production of vast new wealth from the
Soil Would
soil causing a stoppage of credit, it would, as it ought to, enProsperity
large it, and bring prosperity with it. Then, since the notes of
the Association would be redeemable on demand in gold or
lawful money, their Teturn for redemption should be forced
by some provision which would make them costly to the banki



to hold in reserves. Consequently, there would be the necessary contraction, after the demand for them had passed, which
is as essential to elasticity as a ready expansion in time of need.
By such a cooperative association the South would be
enabled to coin its own cotton into notes through its
own local associations; and there would be no reason
for the expensive shipment of cash to and from New York.
Moreover, by making the South dependent only on itself, it Getting
would be freed from its present dependence for credit on C a i h From
New York, or on other central reserve cities. More than that,
under the present dependence, it is often not able to get the
funds, even if it has the cotton paper to be rediscounted; but,
under a National Beserve Association, it would be safely provided with currency, if it so desired, just in proportion to the
amount of cotton bought and sold.
2. Not only would the cooperative organization of banks
in a National Beserve Association provide elasticity of notes,
but, more than that, it would provide an elasticity of credit.
The one essential fact forced home on the South in the
autumn is the inability to get credit. The value of the cotton crop is too great for her banking system to handle. But
credit must be had. The bill of exchange for ocean shipments is the instrument used to get funds. How can the
South get these funds, instead of feeling annually this aggravated constriction?
Under a National Reserve Association, aid would be given
in a striking and effective way. Even if notes were not required, a bank, when threatened by a shortage of cash, would
need only to present cotton bills having a short maturity to
the nearest branch for rediscount. A credit would thus be
created on which the bank could draw; or, the Association
would even ship to it notes free of charge. AH the items of
present expense, as above enumerated, would disappear. The
main point of this result should not be regarded as the convenience, or gain, to the local bank; the real substance of the
new order would be the ability of the bank to accommodate
its customers. Here is the crux of .the whole matter: The
persons to be benefited most are the borrowers, L c., the cotton factors, the cotton growers, and the whole public dependent upon the industry—the farmer, the laborer, and the storekeeper. If they are enabled to realize on their crop, their

New York


Would Be

purchasing power becomes evident at once.
Now why could a National Reserve Association work this
miracle with the insufficient capital of the South? Simply
because, as a cooperative agency, it would be enabled to call
to its aid the mobilized reserves of the whole country to support an intense temporary demand; and because, by discounting bills for the banks, it could draw upon the capital
of the North and of Europe. This capital would be available
to the South whenever necessary, without begging for it, without asking for it, but as a natural outcome of the operation of
the system. Why the South has not demanded some such institution long before is passing strange. Certainly there is no
reason why it should remain content with dependence on New
York, especially when, in times of emergency, that center reeponds to requests for aid only with the greatest difficulty.
It will be of interest to give here the opinion of a French
banker, expressed to a friend in Atlanta, who is here quoted:
"He is manager of the second largest bank in France, and
the fourth largest bank in the world. He said that he was in the
South for the purpose of studying its banking methods, and, if
possible, to obtain accounts for his bank; that, to his great surprise, he found that the banks in the South commenced to advance money to make the cotton crop as early as January, by
supplying the farmers with funds to purchase mules and fertilizer, and that such security as we took from farmers would
not be considered good in his country; that we advanced a large
amount of funds for labor in planting the cotton crop, which
might never materialize, or be injured to a great extent, thereby making our collateral subject to weather conditions; that
later on we advanced further large sums for the purpose of
picking the cotton and preparing it for the market, and this he
did not consider good security. After the cotton is picked and
ready for market, the Southern banks advanced more funds,
taking as security inadequate warehouse receipts. In fact, our
entire system of banking was based upon the problematical security of a growing crop, which is not always certain. He stated,
further, that, to his great surprise, he found that when the cotton is shipped and the security put in the form of a sixty- or
ninety-day bill on bankers in Europe (which is in every respect
equivalent to a demand on the Bank of England or the Bank of
France), that we Southern bankers will not advance a dollar on
the security, and the only explanation he could get was that we
did not know how to do it; and this is a simple truth. We take
all the risk of growing the crop, and the poor warehouse system,
and when we get a document on which there is absolutely no
risk, we refuse to handle it, and let this gilt-edged security go
to New York, where it is handled at a good profit."

Further, by the instrumentality of a National Reserve
Association, the financing of the cotton crop could be accomplished at home; the cotton bills could be drawn and sold by



Southern banks; and all the profit on handling the export of
cotton could go to them, rather than to New York.
3. It is to be remembered, also, that the National Reserve Association should be empowered to deal in foreign
bills of exchange, provided they arise from commercial transactions (as opposed to dealings in investment securities), and
bear at least two responsible names. In such a case, with an
agency in London, the gain from the transactions would accrue almost entirely to home institutions. A bank in the
South having bought a cotton bill on a firm in England could
forward it to the London Branch, which would present the
bill to the acceptor. The accepted bills then in the hands of
the Branch could be discounted in the open market in London,
or in New York or Chicago. Thus the profit would be gained
by the National Reserve Association, rather than by a foreign bank. Yet in this case, as elsewhere, the bill of exchange would enable foreign credit to be used in and for the
4. In the proposals for banking reform, it is also intended
to allow all banks, under proper restrictions, to create accept- N c w
ances. That is, instead of borrowing in the form of a de- Instrument«
mand note, the borrower, A, would make an arrangement with o f C r e d , t
his bank to buy a bill drawn on A by B (the planter), or accept one drawn by A on his bank. Thereby, when accepted,
the bank would assume the risk of repayment, and give the
paper uniform security wherever the bank was known. The
quality of the paper would no longer vary with the standing
of the individual borrowers, but would be as good as the bank
that accepted it. Consequently, such acceptances could be
sold to investors in any discount market, at home or abroad,
where the bank was known.
For instance, a cotton merchant at Greenwood, Mississippi,
might arrange with his home bank, or with a bank in New
Orleans, or in some other city, to grant him credit for $60,000. He would draw a bill of exchange, or draft, on the
given bank at sixty or ninety days, to which would be attached the warehouse receipts. When this bill had been accepted, the paper could then be sold in any open market; and
the bank could obtain at any time funds for such bills. So
long as the credits were based on actual warehouse receipts,
there could be no over-expansion. Over-expansion could


No Danger
of OverExpansion

of Uniform
Rate of

arise only if acceptances were granted without the actual
Obviously, the introduction of acceptances, which would also
be handled by the Branch of the National Reserve Association, would enable a bank to provide for a customer a credit
instead of currency (or notes of the National Reserve Association, if so desired). Hence, a Southern bank could with
safety extend loans based on actual cotton receipts to
two and a half or three times the amount of its capital and
surplus. Consequently, the lending power of the Southern
banks in the crop-moving period would be doubled or trebled,
not only to their own profit, but to the advantage of their
customers, and the whole people.
5. Since these acceptances could be sold in the open discount market for prime bills, they would command a low rate
of discount; and, if negotiating in Europe, the South would
obtain its capital for crop-moving purposes at the low European rate, rather than at the higher New York rate (as at
present). If the Southern banks could thus borrow at low
rates on acceptances, they could grant lower rates than now
to the merchants and farmers who form their constituency.
For a small bank could borrow at the National Reserve Association at exactly the same rate as the large central reserve
city bank. That brings out the democratic character of the
proposed National Reserve Association.
The importance to the South of this uniform rate of discount by the National Reserve Association cannot easily be
exaggerated. As things go now, the idle funds of local banks
go to New York banks, are there loaned on call, and used
for stock speculation.
If acceptances were made possible, under proper restriction, and idle funds were directed
to buying them in the open discount market at, say, 4 or 4 ^
per cent, instead of the 2 per cent obtained on New York
deposits, the banks, as well as the borrower, would gain; the
former getting a higher rate, and the latter a lower rate, than
now. More than that, the flow of funds into call loans, as at
present, makes the rate which the mercantile borrower pays
depend upon the rates current on the stock exchange. But.

with a National Reserve Association rediscounting only commercial paper, and with acceptances to be had in the open
market, the mercantile borrower would be protected against



aberrations due to the excitements of stock exchange speculation. Not infrequently, in times of emergency—when a borrower is most in need—the rates in New York have advanced
as high as 100 or 150 per cent. Likewise, the variation in the
rates throughout the United States is wide, even in normal
times :
New York,
per cent
Chicago, 3i/»-4 per cent
Atlanta, 5-G per cent
Macon, 6-7 per cent
Greensboro, 8-10 per cent
Smaller towns, 12-15 per cent
Under a system by which mobilization of reserves was made sma||
possible, the rates to banks in the smaller towns, on the same Bank«
kind of security, would be as low as to the large bank in New ^ave**
York or Chicago.


6. The effect of the National Reserve Association would
be far reaching in many ways. At present, the central reserve
city banks value the accounts of their correspondents according to the amount of their deposit accounts with them. The
rules of the New York banks as to balances and discounts
regulate the amount of credits to the Southern banks. And
at some times in the year their funds in New York are available to them only at a discount.
But if bills and acceptances were made in the South and Cut« Off
forwarded direct to London by the Southern banks, the South q J ^ J ^
would have credits in London for sale. This practice would 8|0nt
eliminate the commission of the New York broker, and the
Southern banks would retain for themselves the profit of the
New York banker. Having cable advices as to rates of discount with their European correspondents, the Southern
banks could make a price for exchange to the local cotton exporter. Having accounts in London, Paris, Berlin, or Bremen,
the Southern bank could buy bills on Europe, forward them
to its European correspondent, where the rate charged would
be the European (not the American) rate; on this account it
could draw its clear demand bills, or cable transfers. That
is, it could sell its European credits wherever in the world
(New York, Chicago, Rio Janeiro, Buenos Ayres, Montreal,
or Havana) credits on Europe were desired. For example, if
Brazil were buying manufactured goods from London, and ex-




porting coffee to New York; and if the South were exporting
cotton to London; then the Southern bank could sell a London credit (in sterling) to Rio; and the Rio bank could cablc
New York to place the sum (in dollars) to the credit of the
Southern bank. This whole arbitrage transaction could be
completed in twelve hours.
As compared with a New York account, the London account is more satisfactory to the Southern bank. It is not
so much a question with the London banker what the amount
of the balance with him is; he is not rediscounting, as is the
New York banker; he permits the Southern bank to draw
on him, and he simply accepts the bills, charging for the
period it is carried a rate of preferably V/2 to 3 per cent—a
rate much lower than that of New York. The London banker
values the account according to the amount of acceptances he
gets; the greater the number and amount of bills, the greater
his commissions. The credit is forthcoming in exact proportion to the need; while in New York it is dependent largely
on the amount of balances held, or on the rigid system of reserves.
§6. Finally, we come out upon the bill-of-lading question,
which has recently occupied so much attention since fraudulent bills
were disclosed and efforts were made by foreign bankers to force a
guaranty of the genuineness of the bills of lading before discounts
were granted.
The risk attendant upon such transactions to the American
banker is primarily whether or not the cotton was actually sold
by the buyer in this country to the buyer abroad; and secondly,
whether or not the firm upon which the draft is drawn really
authorized its acceptance. I t is therefore incumbent upon the
American banker to be thoroughly acquainted with the person
from whom he buys, and to be satisfied of his integrity and
that he would not offer for sale a bill of exchange drawn against
cotton which had not been actually sold, nor draw upon a firm
or bank which had not agreed to accept it. The American banker
operates upon the theory that his responsibility as to the validity
of all the documents ceases when the bill has been accepted; and
the only responsibility he runs thereunder is by reason of his endorsement on the bill, in the event of the failure of the accepting
bank or firm.



The risk to the foreign cotton merchant lies in whether or
not the American cotton buyer from whom he has purchased the
cotton is honest and responsible. He may he defrauded in various Wayiof

(1) The foreigner may have purchased the cotton at a
stipulated price and the American buyer may never deliver it
to him, if the market advances sharply and the transaction
would show a serious loss;
(2) The American may deliver him cotton of a lower
grade than that which he purchased, and draw for the value
of the higher grade;
(3) He may ship him cotton of less weight than that
for which lie draws;
(4) He may make out a fraudulent bill of lading by
signing the name of an interior agent, and draw against the
cotton without ever having shipped it.
It is therefore incumbent upon the foreigner to be thoroughly
informed as to the firm or person from whom he buys, t. c.f in the
same manner in which it is necessary for anyone extending credit to
be conversant with the affairs of the person with whom he is dealingThe risk to the foreign banker who has agreed to accept such
documents lies in whether or not the foreign spinner or cotton
merchant for whom he has agreed to accept is financially responsible and able to pay the draft, even though the cotton may never
have been shipped. He is, therefore, required to exercise his judgment in the same manner as when extending credit upon any
other piece of negotiable paper. In the main, the risk arising
from the possibility of fraudulent bills of lading is no greater than
the risks which the banks assume every day in the chance of paying forged checks.
If the European methods, by which the buyer of cotton arranges with his bank to accept bills drawn at thirty, sixty or
ninety days against shipments of cotton, were generally introduced
into the South, much of the fear as to fraudulent bills of lading
would disappear. The local Southern bank would be over-careful
to see that the bills of lading were genuine, if it accepted the bill
and assumed the risk; and its facilities for insuring genuineness
are apparent. The main source of difficulty has arisen from
the fact that the cotton bills now usually pass through New York
banks, which obviously do not have the means of verifying the



Fear of
gj , jjj|^ ,cnt



bills of lading, as do the banks in the cotton district. The attempt
of the English bankers to force the responsibility home upon the
New York bankers has its origin in the same general cause. Were
cotton bills generally accepted by Southern banks, the risk would
be placed where there is the least chance of deceit, i. eon the
acceptng banks. If desired, the American banker could insist
upon holding the bill of lading until the cotton arrived at destination, and requiring that it should be placed in the warehouse,
insured for his benefit, and paid for only when withdrawn from
the warehouse by the mill. Such a procedure is usual in handling
imports, such as coffee. Such a method could be successfully carried out by Southern banks, and they could transact a very much
larger business than now, were there established a National Reserve Association at which an accepting bank could rediscount its
own acceptances; or if there existed a general discount market
for acceptances.



§7. Lastly, we may briefly discuss (b) the relation of the
financing of imports to the National Beserve Association.
A in New Orleans purchases coffee ($10,000) from B in Rio
j a n e j r o # ^ wishes a time loan on this coffee in order to be able
in due course to pay for it out of the proceeds of its sale. A applies to Bank X in New Orleans for a credit in London, which
he can transfer to B's order; because, as Brazil buys its goods in
Europe rather than in the United States, it wishes to use its proceeds from exports of coffee to the United States in payment of
its debts to Europe. Bank X grants this loan to A by instructing
its correspondent bank, Y, in London to accept drafts (or bills
of exchange), usually running ninety days ahead, drawn by B in
Rio Janeiro on London to the amount of $10,000. Bank X guarantees to Y the payment at maturity of this draft. The charge
for this credit to A is made in the form of a commission of %
of 1 % ($50), of which % of 1 % ($25) goes to the London
bank, Y .

The London bank, Y , receives the draft from B in Rio accompanied by the Bills of Lading and the Insurance Certificates
of the coffee sent to A in New Orleans. Bank Y accepts the draft,
but sends the bills of lading, etc., to its correspondent, X, in New
Orleans. Then A must pay Bank X for the coffee: either (1) &
cash, less the discount at the London rate to date of maturity; or
(2) A may leave the documents with Bank X until the coffee ar-



rives; or (3) A may take the coffee out on a Trust Receipt, place
the coffee in a warehouse, and give Bank X the warehouse receipts
as security; or (4) A may be given the coffee on Trust Receipt,
and allowed to sell it, the bank arranging to be paid by A fifteen
days before maturity of the bill in London. Thus A expects to
get the means of payment for the loan by a credit based on the
sale of the coffee.
If acceptances by national banks were legalized under the
National Reserve Association act, a national bank, X. could itself
accept these drafts from Rio directly, without asking London
to do it. This paper would have on it the name of the Brazilian ticneWith
exporting house, and of Bank X which accepted it, and it would Foreign
be guaranteed, also, by the importer, A, in New Orleans. If
Bank X accepted the Rio draft, Bank X could provide A with a
bill of exchange on London which A could transmit to Rio in payment of the coffee. Then from the proceeds of the sale of the
coffee A could pay off his obligation to Bank X. As is well known,
such a use of credit instruments would prevent the needless shipment of actual cash. By this method the profits of accepting bills
would be transferred from London to New Orleans. Of course,
any state bank or trust company, not being under the jurisdiction
of the National Banking Act, could do this business to-day; and it
is coming to be understood by some enterprising state bankers in the
The outcome of the whole matter is that the National Reserve Association would by evolution carry to a wider field of operation the principles of the clearing house associations, and save
the needless movement of actual cash, not merely between banks
in the same city, but between different portions of the country.
Thus the crop-moving period would no longer be a time of a great
shifting of money reserves, and a time of stringency, but a season
of prosperity and increased purchasing power.


1. Relation of the Depositor to the Bank—2. Guarantee of Deposits—
3. Shortcomings of Examination—4. Bank Failures—5. The
Question of Rediscounts—6. Segregation of Commercial and Other

and Noteholders
Must Be

View of the

§1. The relation of the depositor to the bank is often spoken
of as if it were the principal problem to be dealt with from the
side of the public in relation to banking. In former chapters, we
have seen that the same point of view is also taken with respect to
the note-holder. Neither view, in this exclusive form, is well founded. Both the note-holder and the depositor must be considered
since both are holders of demand liabilities of the bank. But, while
both are theoretically to be regarded as equal, the fact remains
that in modern banking in commercial countries, the depositor
has gradually assumed a much more important place than the noteholder because of the fact that the deposits which the bank has
obligated itself to pay are so much larger than the notes which it
has issued and which it has undertaken to redeem.
A completely erroneous view of the depositor and his status
is often taken and until this is eliminated, nothing can be accomplished in analyzing his relation to the bank from a correct standpoint. The ordinary discussion of the depositor assumes that he
has left something with the bank for safekeeping. This the bank
is assumed to have received, and to be protecting, using it in the
meanwhile for its own purposes as it is permitted to do. What the
depositor is thus supposed to have "left" is "money." The bank
is conceived of as . the guardian of the depositor's money and he is
thought of as having placed money in the bank. This is practically
the reverse of the case.
It is true that a few depositors bring actual money to the bank
and leave it there, receiving in exchange a credit on the books of the
bank, which is evidenced by a memorandum or by figures in a socalled "bank book." But this is not the way in which the bulk of




the deposits are made. Usually the deposit is made by asking the
bank for a loan. A borrower goes to the bank and ofTcrs his note,
with or without some additional protection. The bank agrees to
grant him the desired accommodation and he gets a credit of,
say, $1,000 on the books. Against this he is allowed to draw; and,
if he wishes, he may call for cash to that amount. The depositor
who has actually left cash with the bank could not do more.
Both are depositors upon an equal basis and are treated alike by the
bank. In fact, neither of them usually wishes to draw any money
except, perhaps, in relatively small sums for current use. If they
did so desire, they would not have become depositors at the bank in
the first instance. The man who actually left cash there wrtuld not
have done so but would have kept the cash in his possession. The
man who got the loan would have taken it in the form of notes instead of that of a book credit.
This gives us a new point of view as to the depositor. If he
is not, in the majority of cases, one who has left money with the
bank, but is one who has obtained a loan from the bank, what is Depositor
the relation of the bank to him, and what ought to be the tilings g ^ ' ^ J a
or conditions which he should be in position to exact from the
bank? What ought the institution to be expected to do for him?
These questions can be tentatively answered by considering
what it is that the bank agrees to do when it either accepts his
money on deposit or grants him a credit on its books. The thing
it undertakes to do is to liquidate, in current funds, all claims that
may be presented to it up to the amount thus credited, redeeming
them in cash over the counter if actually called upon to do so. Of
course, as everybody knows, no bank could redeem its outstanding
deposits in cash if all depositors were to call upon it at once to make
good their claims in that way. It is assumed that they will not do
so, but that only a normal amount of them will come in. If the
bank keeps itself in such condition that it can meet the normal
claims of depositors that are regularly presented to it, and maintains its assets in such condition that with a reasonable and average notice it can convert them into cash and thus ultimately liquidate the whole of its depositors' claims upon it, it has done all that
can properly be expected. Discussion of the relation of the depositor to the bank must therefore be an analysis of the way in
which the bank has to proceed in order to get these results, and the
nature of the precautions that must be observed in order that all



banks may have an equally favorable chance of success in thus protecting themselves and their creditors.

of Deposits

Based on
of Deposits


§2. It is to be noted that in the foregoing analysis nothing
has been said of "guarantee of bank deposits." In recent years
there has been an outcry for legislation that would guarantee the
depositor against loss through the failure of banks and would also
guarantee him an immediate payment in the case of suspension.
This notion was based upon the idea that the deposits in banks were
actual deposits of money and as such that their "return" could be
"guaranteed." It was supposed that by establishing a "guaranty
fund" contributed to by all banks in a certain percentage of their
outstanding deposits, a resource would be created upon which all
claims payable by failed or suspended banks could be made to draw.
The trouble with this supposition was that (as we have seen)
the deposits were credits in the proper sense of the term and the
guarantee of bank deposits was therefore a guaranty of bank credits
or, in other words, a guaranty on the part of banks that the loans
they had all made would be liquidated at once if desired. Inasmuch as bank deposits are several times the amount of cash in existence at any given moment, and inasmuch as values depend entirely upon the continued existence of business as a going operation,
the guaranty thus offered was impossible and imaginary. There
was no assurance that the claims could be liquidated at any given
moment and could not have been, since no one could know how
many would be presented at any given time. Wherever the bank
deposit guaranty system has been tried, it has been found ineffective.
The real nature of the guaranty which can and should be given
to the depositors of the bank is not found in the furnishing of an
assurance that the deposit accounts will certainly be paid. That
merely prevents depositors from discriminating between banks and
selecting their institutions wisely and carefully. It is found in the
establishment of regulations which will give all the assurance that
is humanly possible that banks are being carried on efficiently and
safely, that their funds are being invested in properly secured
loans, and that they are maintaining a due degree of liquidity to
their assets.
Part of this kind of assurance can be had from thorough and
careful inspection of banks and the rigid enforcement of restrictions
upon bank business which will prevent the institutions from en-



gaging in hazardous or doubtful operations. If bank,« can be prevented from using their funds in directions which would not be
approved by stockholders and creditors, all has been done that the
government is in position to do, and there is no ground for demanding that other banks stand behind the credits granted by the
institution to depositors. If to this be added such arrangements
as will insure the banks a means of liquidating their paper at those
times when they desire to convert their assets into immediate funds,
there is little more that can be done.
It has been supposed that, under existing conditions in the
national banking system, the government was performing the first
of these duties, that of thoroughly inspecting and examining the
banks, although it was not performing the second. Even if it were
true that the duty of inspection and examination were being fully
performed by the government with respect to the national banks,
the question of the state institutions would still remain. It is a
notorious fact that, although there are some states whose bank
examinations are as good as or better than those of the national
government, there are numerous others in which the examinations
are unsatisfactory. Since the state institutions outnumber the national more than two to one, and since difficulty with banks in one
system may communicate itself to the banks in the other, it would
not be true that depositors were getting the proper protection today even if the national system of inspection and examination were
sound or even if most of the systems of the states were also sound.
But there is grave doubt as to whether even the national system of
inspection is satisfactory.
§3. Within recent years a very serious defect in the national
banking system has been found in the difficulty of examining the
different institutions. During the earlier years of the system when
the banks were few in number the problem of examination was not
very serious. It was then possible to send satisfactory and capable
examiners with sufficient frequency to the different banks, and to
ascertain with substantial accuracy what they were doing. Many
conditions intervened to change this situation. The very growth
of the system has thrown serious obstacles in the way of examination. Obliged to follow reports from more than 7,300 national
banks, the officers of the Currency Bureau in Washington find it
far from easy to keep in mind the doings of each of the banks. But
the growth of large systems of state banking and the development



of State


of trust companies organized under state laws by the side of the national banking system has greatly complicated the problem.
Many of these state institutions are affiliated more o less
closely with national banks, while many more depend on the national banks to hold their reserves and supply them with loans.
The state institutions are subject to the oversight and control o
the state superintendents or supervisors of banking. Although
genuine efforts have been made by the Comptroller of the Currency to improve the examining methods of the national b n s
and to bring about cooperation and uniformity between the national and state systems, his efforts have been only partially successful. Until very recently, a bank which was driven out of the
national system for loose or bad banking promptly took out a
state charter; and vice versa. This meant that it was impossible
to get rid of the undesirable banking institutions of the country
since they could alwaysfinda refuge, even though they had b e
obliged to give up their original charters on account of bad or
doubtful practices, or the making of unwise loans.
Under existing conditions, it is also very difficult to keep track
of the paper w h i c h is outstanding and to make sure that it shall
not be distributed by borrowers, w o want more a c c o m m o d a t i o n
t h a n they are entitled to, throughout a large group of banks n n
of w o e m m e s k o s what the others are doing. The Comphs
e br nw
troller of the Currency haB done what he could to bring about a
greater diffusion of knowledge of this kind a m o n g the national
bank examiners, and through them among the banks themselves,
but his efforts are, of course, confined to the system under his jurisdiction. He cannot k o of the conditions existing in the state
systems, except by the courtesy or aid of state bank examiners,
which they are not obliged to extend. It is, therefore, entirely possible tofloatpaper in the ways indicated, and thereby to secure extensions of credit that ought not to be granted. Secretiveness and
hostility among many of the banks greatly promote this condition
of affairs, and it could be remedied only by some measure that w ud
unite the banks more truly than now into a system, in the proper
sense of the word. Until that shall be done, it will unavoidably
be true that, owing to lack of knowledge and inadequate facilities
for testing paper, the banks will suffer to a certain extent, a d
the soundness of the situation will be correspondingly impaired.
This condition is seen at its worst during a period of credit inflation. In such a period, banks, perhaps throughout a given sec-



tion of the country, become over-confident and extend loans on certain classes of security either directly or indirectly beyond the limit
to which they ought to confine themselves. Having thus exceeded
the bounds of caution, there is nothing to check them such as would
be supplied by a cooperative association to which paper would be
carried for rediscount. Banks at a distance rediscount freely for
the institutions which have been doing business with them in the
speculative region, while other banks rediscount in the same way
for still other institutions in this same area. That is, as things
stand today, the capital of conservative districts is used to facilitate loans in speculative districts.
In consequence, credit is extended for certain purposes in a
way that would not be followed if there were any general method
of checking up what has been done. With the existence of such a
method, there would be furnished a means of accurately estimating Difficulties
the total amount of the available funds of the country which were { „ ^ " c of
being employed in certain classes of undertakings. Both the banks Inflation
which originally made the paper, and those to whom it might be
presented for rediscount, would thus get a far clearer knowledge
than is possible at the present time. Present bank examinations
cannot thoroughly reveal a condition of this sort because they afford no comparative test, or attempt such a test only in a remote
and approximate manner. It is entirely possible that the assets of
a bank at any given time may be quite sound, considered by themselves, yet be far from sound when considered comparatively with
those of other institutions. Such a comparison reveals the fact that
there has been undue emphasis upon certain classes of loans so that
the liquidity of the paper is seriously impaired. This merely presents one phase of the danger that exists in an incompletely organized banking system, of diverting capital too largely into given
channels and occasionally of making too largely extended loans
upon given kinds of security. It is not a situation that can be corrected by any examination plan per se, however thorough.
§4. It is a natural consequence of our incomplete and inadequate system of examination that there should be a good many
bank failures from time to time. The statement is frequently pa|jUPes of
made that such failures are not very numerous and that there is National
no particular reason for fearing failures under the national system unless there has been dishonesty on the part of officers. The



facts hardly hear out this assertion. According to the report of
the Comptroller of the Currency, for 1910, such failures have
caused a loss of $150,000,000 and have been as follows:
Summary of Reports of Receivers of Insolvent National Banks, 1865 to
October 31, 1910.
Closed receiverships,

Total assets taken charge of b y
Disposition of assets:
Offsets allowed and settled
Loss on assets, compounded or
sold under order of court
Nominal value of assets returned
to stockholders
Nominal value of remaining- assets . . . .
Collected from assets
Collected from assets as above
Collected f r o m assessments
Total collections

Failures in

Active recelverships.

Total, 514









• 3,714,802
















While it is true that the number of failures thus reported
does not appear to be very great when considered in the aggregate, it is much greater than the failures reported from other countries. The total number of banks failing in Canada during the
past twenty-two years was only six, with a total amount of capital
° f l e S S t h a n $2>000>0°0'
Their liabilities were about $12,571,000,
most of which were paid. This was the experience under a cornpetitive banking system, which numbered in 1909 some thirty-three
banks, with a joint capital of $143,466,000. The losses in other
countries have been even smaller, depending upon the degree of
oversight and closeness of supervision accorded to the banks. Nowhere has a system of banks directly overseen and controlled by
the governments of European countries proved itself liable to
It is thus evident that while the national banking system has
not been peculiarly subject to insolvency, considering the great
number of small units of which it is composed, it has,
nevertheless, been far from affording complete protection to
its creditors. The losses to stockholders have, of course, been
severe in those institutions where a receivership continued for some
time or where assets were bad or doubtful to begin with. The
fact often alluded to that no note-holder of any national bank
has ever lost, owing to the fact that his notes are protected by



government bonds, which the bank is compelled to buy in a specified
percentage upon organization, is not a very important point.
Clearly the benefit or gain to the note-holder thus secured is offset
by a corresponding decrease in the assets which might have been
distributed among the other creditors.
On account of the necessity of going through the legislation
and regulations of so many different commonwealths, it would require a much more elaborate treatment to show how inspection
and examination work in the several states and what are the defects of these local systems, but it may be stated with truth that
the evils present in the national system exist throughout the state
systems, and in a magnified form. The state systems have IKCU
thoroughly unsatisfactory in the matter of failures, while in so
far as concerns examinations, most states leave a great deal to
be desired. All this urgently raises the question, What can be
done to improve the situation regarding the safety and solvency
of the banks of the country and thereby to put the depositor in
the proper position with rcspect to the bank, the position to which
his claims indisputably entitle him ?
Evidently the first step to be taken in this direction will be
that of making all banks engaged in regular commercial operations as nearly subject to one general kind of oversight or control
as may be. This could hardly be done by any direct legislation
under our constitutional system. But it can be reached by some
action that will unite the banks into a cooperative association for
the purpose of supplying one another with funds through a rediscount process whenever that may be found necessary. If a reserve association, such as has been suggested in preceding chapters
of this volume, were to be created, the effect would be to cause many
banks to resort to it for accommodation as their needs might
dictate. Probably every bank that owns stock in the association
would at some time or other obtain loans from it, while those that
did not do so would undoubtedly keep their spare funds with it
on deposit.
The result of establishing such an association, with its various
branch offices, would be to create a general standard as to banking operations and to enforce this standard in a way that is not
now possible. Banks would seek, in the first place, to confine themselves to such business as was recognized by the association as
legitimate, and would attempt to have on hand at all times a fair
amount of paper of the kinds that could be rediscounted with the


tion of



association. The effect of this would be to exert the same kind
of wholesome influence that is now exerted by clearing-houses in
the large cities. Such influence, however, would be extended to
the smaller towns and villages, and there would be a general
toning up of the banking system throughout the country. Bank
paper would be standardized and bank operations subjected to a
uniform mode of control.
In these ways, depositors would be very greatly protected.
They would run no such risk as they now run through the resort
by banks to irregular methods of doing business, since it would
be far easier to detect such methods under the proposed system.
A genuine "guaranty" of bank deposits in the best sense of the
term would thus be afforded, because the depositor would get
the kind of protection he required, and the institution with which
he dealt would be likely to fail only as the result of direct dishonesty on the part of officers or directors.
§5. While what has been said holds good of the banking
system and of banking operations generally, there remains the
question of the relation of the bank to the depositor in times of
panic. It is this, and not the relation of the bank to the depositor in ordinary times, that has received most attention, notwithstanding the latter is probably the more important problem of
the two.
What happens in periods of panic, as we have previously
.fort.h> i s a s u d d e n call on the part of depositors for the
for Cash In liquidation of the bank's obligation to them in spot cash.
A s w e h a v e s e e n also > t h i s
Panic ° f
is not a demand that is likely
to be made by depositors everywhere, or even at very many
places. If it were, no means of meeting the demand could be
devised. The demand occurs only at certain banks and in certain
places, and the sole question in such cases is whether these banks
have good assets. If they have, depositors should not be obliged
to go without their funds, but should be enabled to get cash if
they wanted it.

S . et

This can be accomplished by means of a rediscount institution which would enable such banks to convert their assets into
immediate means of payment.
Such an institution would
be provided in the proposed Beserve Association; and, if it
were, the change in the present situation would simply amount
to an assurance to all depositors that whenever the banks with



which they dealt had good assets, they need feel no doubt whatever
about their own capacity to secure cash at any time they desired
it. The bank which held their accounts would be able to go to M c t
the Reserve Association, ask for a credit there, presenting its com- Tmaitution
inercial paper of specified kinds for rediscount, and then either
to use this credit as a reserve (thereby releasing the actual funds
held in its vaults), or take it in notes of the Reserve Association
which could be paid out over the counter, thereby substituting
the note liability of all of the banks of the country (as federated
together in the Reserve Association), for the obligation of the
local bank itself, which for some reason had incurred the distrust
of the depositors. The operation would be exactly the same that
is performed by our clearing-house associations when they issue
clearing-house certificates, except that it would be managed
smoothly and efficiently, without any of the shocks to business
confidence which are inevitably given under present methods.
It can safely be asserted that, with such a system in working
order, funds would seldom be called for. They would never be
asked for by depositors of banks which were recognized as undoubtedly keeping their funds in an available form through the Association
maintenance of a volume of paper that was eligible for rediscount Would
at the National Reserve Association. Doubtless, many small de- Ca( | f 0 P
positors would know nothing of the practices of the banks in this Fund»
regard. Large depositors would have this knowledge, however,
and would act accordingly. If small depositors, owing to some
false rumor or market flurry, should lose confidence in a given
bank and begin to draw out cash, it would be easy to check them
promptly by obtaining abundant rediscounts from the National
Reserve Association, and allowing the fact, if necessary, to be
known. The consequence would be that large withdrawals of cash
by depositors at times of panic or doubt would not take place,
and the whole system would be put upon a much more satisfactory
and normal basis than it is at present.
As we have seen, this would save an immense amount
of waste in the use of reserve money by avoiding the
maintenance of great sums of cash in the vaults of banks. It T * ^ 1 0
would also avoid the current necessity of obtaining actual cash Effected
and paying it out over the counter in those instances where a
run occurred. An issue of notes by the Reserve Association would
avoid this necessity, while the notes would be equally acceptable
to the depositors as cash, since they could use them for practically



every purpose for which cash could he used. The conveniences of
the banks and of the depositors, economy of the country's money
supply, and avoidance of unnecessary strain on bank reserves would
result from this method of meeting the calls of depositors and the
latter would be correspondingly aided.
While this condition of affairs is sometimes spoken of as being
of great advantage to the banks, inasmuch as they would be protected against disturbance to business, loss of reserves, etc., the
protection and advantage to the depositor would be vastly greater
than to the banks themselves. Depositors who call for cash in
Rediscount times of loss of confidence do so, not because they want the cash,
but because they have come to fear that the institution which is
holding their deposits is not capable of maintaining payment.
They recognize the serious loss to which they will be subject, if,
as a result of the bank's suspension, they aTe prevented from
drawing their funds as they need them. This loss is not merely
the ultimate sacrifice of the value represented by the depositor.
On the contrary, an analysis of bank failures shows that, in the
long run, a very large percentage of bank obligations is fully
liquidated, when the banks have had the time they need to convert
their assets into cash and call in the proceeds of stockholders5 liability, etc. Meantime, however, the immediate need of the depositor has not been met. His funds being tied up, he has been
unable to meet claims upon him, or to take advantage of business
opportunities, or perhaps to liquidate pressing indebtedness, failure
to meet which means loss of business credit and possibly, in extreme cases, bankruptcy. The return of his funds at some period
far in the future is not a sufficient recompense to him.
Guaranty of bank deposits, even if it succeeded ultimately in
making good to every bank depositor the total amount that was
due him from banks, would not suffice to meet the real needs of
the situation, since the most important requirement is not ultimate
but immediate payment ; and the latter, as we have seen, none of
of Deposits the familiar deposit guaranty systems can provide for. They would
Does Not
break down as soon as the immediate liability became large, and
Meet Real
at best could merely succeed in subtracting some cash from the
other banks, thereby weakening them to a corresponding extent
without, as a rule, doing any good to the depositors. But by giving
to every bank the power to convert its reliable assets into cash by
rediscounting them as may be desired, the requirements of the depositor for immediate payment are fully protected up to the point



that the bank with which he deals is in possession of good bankable assets which it can with assurance present to the Reserve
Association for rediscount.
Besides aiding the bank, the establishment of a discount market furnishes an accurate measure of the depositor's responsibility.
Such responsibility is destroyed under a bank deposit guarantee
system. As against that system, the proposed plan requires the
depositor practically to keep his funds with those banks that confine themselves to strictly commercial banking, if his own business
is such that his prime need is constant ability to draw. If a depositor found that his bank, in a time of stress, was not able to
meet his needs and could not liquidate the deposit accounts it
had become liable for, he could only conclude that the kinds of
loans it had made were predominantly those which gave rise to
paper which the Reserve Association could not recognize. It would
then be for him to choose whether he would continue to do business with an institution that acceptcd such business as thus referred to. He might conclude that it was preferable to keep his
account with a bank that loaned only on commercial paper of
the highest type. Probably this would be his conclusion if that
were the type of paper that was produced by his own operations. Of
course, if the loans he himself had obtained were based upon
security, which, although perhaps perfectly unimpeachable, was of
a kind not recognized by the Reserve Association as furnishing
a proper basis for loans, he might prefer to continue transacting
business with an institution which engaged in operations not of
the strictly commercial banking class.
In this way a fairly sharp segregation of banks doing a commercial business, and of banks engaging in other operations, would
be brought about. There is a strong tendency toward such segregation today, as we have seen elsewhere, but this tendency would
be very greatly strengthened and increased by the sharp distinction that would be drawn (under a discount system which was
ready to grant accommodation to banks presenting short-time live
commercial paper) between banks which could and those which
could not offer security of this kind.
§6. It should not be understood that such segregation would
imply an inability on the part of banks doing a non-commercial
business to get accommodation in case they were hard pressed.
The savings bank which was being drawn upon by its depositors,

ey, l l "" u n t

ff 0¿orn-t,On


Would Not
Banks of
Aid In Need



the trust company which found its deposits leaking away, and
other institutions in difficulties, owing to the urgent nature of
the demands made upon them, would always be able to request
other banks to grant them assistance with as good a prospect of
being listened to as their securities warranted, and their depositors
would benefit accordingly. The extension of such accommodation
would, of course, depend upon the condition of the other banks
of whom the request was made, and the arrangements that had
been made with them beforehand, but their capacity to aid would
be greatly strengthened by the creation of a discount market.
It is a fact that in European countries today there are many
such banks which succeed in getting abundant accommodation
from other institutions when they need it. They very seldom
suspend or fail as compared with banks in the United States.
But the distinct recognition of two classes of banks, one dealing predominantly in live commercial paper and confidently looking to a cooperative association comprising the banking power of
the country for aid when needed, the other making loans of a
less stereotyped character and getting assistance only in proportion
as that might be granted by other banks of the community, places
the depositors in a very much stronger position. They are able
to select the banks with which they are to do business, with far
greater discrimination and intelligence. A savings depositor, for
example, who does not need his funds currently, but who merely
wishes to be certain of their ultimate return, is safe in leaving
his funds with a savings bank, although he knows that this bank
may, if hard pressed for funds, require a notice of sixty days
before he draws any cash. On the other hand, the holder of a trust
fund may prefer to deposit this fund with a perfectly solvent trust
company which will pay him a rate of interest, even though it
would not be possible for him to draw the cash at any moment in
case of stringency. This may be due to the fact that he would
rather get the interest than be able to draw his money certainly
on demand. At the present time, these functions are far too
greatly confused, many banks having both savings and trust deposits as well as their regular commercial deposits growing out
of loan and discount operations. The distinct segregation of the
banks by classes aids materially, not only in rendering possible
an effective system for keeping commercial discounts liquid, but
in enabling depositors to make definite choice of an institution
whose business practices are suited to their special or peculiar needs,
and then to exact from it thé proper methods of operation.



Banks as Government Depositories and Establishment of the Independent Treasury System—2. Workings of the System—3. Exchange Functions of the Treasury—4. Foreign Experience—5. Plan
of National Reserve Association—0. Contrast With Present System—7. The Question of Safety of the Government Funds—8. Public Function of National Reserve Association.

§1. An integral part of the proposed plan of banking reform
is found in the transfer of government funds from the Treasury
of the United States to the banks of the country. The depositing
of public funds in banks was the policy of the United States government from the adoption of the Constitution down to 184G when Depos"'
the present independent Treasury system was created. Shortly tories
after the adoption of the Constitution, Alexander Hamilton, c
then Secretary of the Treasury, recommended the establishment
of a large institution to be known as the Bank of the United
States. This was finally chartered in 1701 with a twenty-year
franchise. From 1811 to 1817 public funds were deposited in
private banks. Then the second Bank of the United States was
chartered and it continued in operation until 1837, when it went out
of existence, and public funds were again deposited in the state
banks. This plan continued to be followed until 184G, as already
While the first and second United States Banks were, in the
main, ably conducted, and were at all times sound financial institutions, handling the funds of the government with economy and
despatch, there was much complaint of their operations on the
ground that they were influenced by political considérations. On
the other hand, the placing of public funds in state banks was not
satisfactory, because these institutions were small and often inefficient. Frequently they suspended payment or failed, and as a
result the government was either kept from the use of its funds
for a long time or unable to get them back at all.



The Independent


The consequence was the adoption of a plan whereby payments
and disbursements were to be made in actual money, and whereby
the government was to keep its funds in its own vaults. To this
end so-called sub-treasuries were established at convenient points
in which the receiving officers of the Government were directed to
deposit the funds coming into their hands and for which disbursing
officers were supplied with funds through properly drawn warrants.

§2. A rigid adherence to the notion of having all payments
and disbursements made in money has not been possible, and today various modifications of it are in effect. Perhaps the most important is that which permits the Government to deposit Treasury
funds with national banks on condition that these banks shall turn
over to the Government approved bonds to an amount equal to the
Modifications of
sum of deposits left with them. In this way it has sometimes octhe System
curred in recent years that all of the available funds of the Government except a small working balance were parcelled out among
banks. There have been times when the amount thus distributed
was as much as $250,000,000 and the number of depositary banks
nearly 1,400.


Moreover, it has not been found possible to keep the Government entirely separate from the machinery of modern banking.
Today the independent Treasury System consists of the Treasury
itself, and nine independent or sub-treasuries located at as many
different places. These sub-treasuries are members of the local clearinghouses in the places where they are situated and clear their
claims with the banks through this means. When it has debts to
pay, the Treasury pays them by means of a Government warrant
(the equivalent of a check, which it resembles in form), upon a convenient sub-treasury. Such warrants are deposited with the banks
by the persons who receive them and thus the banks come into possession of claims against the sub-treasury. On the other hand, the
Government at times finds it desirable to draw on the depositary
banks, and thus the banks and the sub-treasuries have occasion
to interchange their claims by the usual clearing process.
But in spite of these modifications in the system, its essential
features remain. It is substantially a plan for drawing the funds
of the community by-taxation out of the pockets of the people,
keeping them locked up for an indefinite period in government



vaults, and finally paying them out in whole or in part to other

This set of operations has a serious and important cfTect

upon the business of the community.

On account of its possession of largo quantities of cash

funds and its refusal to let these funds go back into circulation,
the Treasury Department has been forccd to acccpt still other banking functions.

It now supplies exchange at current rates by al-

lowing sub-treasuries in the various places to pay out cash upon
telegraphic order when an equal amount of funds plus exchange has
been deposited elsewhere.

Tims payments at New York may be

offset by disbursements at San Francisco, if New York banks desire to supply currency to others in the latter city.
The function of providing exchange in this way is not properly
a governmental duty but should be exercised in conjunction with
the function of discounting and of buying commercial paper. When
divorced from the latter function, it tends to disturb the exchange
market, although it may serve a useful purpose at the time it is per- Domeitlc
formed by obviating the necessity for shipments of currency back N o ^ a " 8 *
and forth. The same end would be gained, and gained much bet- Government
ter, if the funds upon which the Treasury bases its operations were
in actual commercial use the country over. Yet how can this end
be attained, and the exchange function be entirely relegated to the
banks, so long as the government is the holder of so large a percentage of the country's circulating medium ? It is not possible to
turn this work over to the banks while the funds of the country
are partly in the Treasury; nor would it bo practicable to entrust
them with the work of supplying exchange in this way without
giving the profits to a relatively small number of them.
The problem raised by the independent Treasury system is
therefore not only that of meeting the demand for a better disposition of the actual funds of the country, but is tbat of affording
6ome means whereby the public may get the benefit of the banking
mechanism, operating upon the.ce funds in connection with its com- Independen«
mercial transactions. This merely amounts to the statement that withdraw«
the essention evil in the independent Treasury system today is its Funds from
withdrawal of current funds from banking uses and its consequent
infringement of the functions which arc, and can be, successfully
performed only by the banks. This may be re-stated by saying that
the United States Treasury is not a bank and cannot successfully



perform the services which banks render, yet that it takes to itself
the funds of the community without giving any return in the form
of aid to exchange and business.

The facts which have thus been briefly stated are so well

understood throughout the world that the independent Treasury
system is today almost if not wholly unique.

No important coun-

try today hoards money or currency or declines to accept the
properly authenticated checks and notes of solvent banks in liquidation of claims due to it. Nor is there any which fails to employ the
solvent banks of the country and their credit mechanism in making
its payments to individuals, corporations, and other countries.
In most European countries today, there is a close official relationship between the financial department of the government and
some great banking institution. Familiar examples of this kind
are seen in the case of the Banks of England and Prance, and of
the Eeichsbank of Germany. These great banks hold the funds
belonging to the public and in return are closely supervised, inspected and controlled by the governments with which they are

The fact that government funds constitute everywhere so
large a s m and could be used for the purpose of earning an enorm u profit w r they freely entrusted to the banks in which they
are deposited, has led to the adoption of methods for assuring to the
Distribution Y^1™. Powers their due
of Profits " i n t h i s w a y Various


bGSt m e t h ° d

share of the profits which may be obtained
ideas have existed with reference to the

government its proper share of
of the banking business under such conditions. In the
first and second United States Banks, the government of the United
States, which had chartered the institutions, was a large stockholder, and received the dividends upon its stock as did other owners of shares. In Germany at the present time the government
obtains its share of the proceeds partly by means of taxation and
partly by a division of profits. In Prance a similar system though
with different details is adopted. The general opinion in the advanced commercial countries of the world is that, while it is absolutely essential that some institution shall act as a connecting link
between the government and the financial system of the country,
it is necessary that the profits derived incidentally in this way shall
go in large measure to the government. Probably the best opinion


f ° r reservin& t o t h e



at present supports a plan whereby nil income above a mere commercial rate of interest on the capital invested is taken by the government in return for its grant of a franchise to the institution
which holds its cash, as well as for the advantage given by the use of
the immense deposits of current funds made by the government
§5. This is the arrangement which is aimed at in the
National Reserve Association proposal. It recognizes the essential necessity of leaving the funds of the country in the hands of Excess
the community and of reserving to the government the profit which J^r0Qt8t
would come from their use by a private agency. It contemplates Governplacing in the hands of the Reserve Association, as that institution m o n t
has been described, all of the current funds of the Treasury. It is
intended that the government shall regularly place its receipts on
deposit with the Association except in those cases where it may
be desired to put funds into national banks in cities where no
branch of the Reserve Association exists. Disbursements, however,
would be made entirely through the National Reserve Association.
It would be the duty of that association to make payments without
charge at those points where the government had obligations to
meet. The notes of the Reserve Association would be received at
par in payment of all dues to the United States and would be payable by the United States to all of its creditors except those who
held obligations specifically payable in gold.
In return for this relationship to the government and the possible profit which might be made out of it, the Reserve Association
would turn over to the government all earnings at the start in excess of 4 per cent. Of these earnings a division would be made,
one-half going to surplus of the Reserve Association until that
surplus amounted to 20 per cent of the paid-in capital, and onefourth to stockholders, while one-fourth would go to the government.
When the stockholders' dividends reached 5 per cent and when
the surplus of the Reserve Association had reached 20 per cent
of its capital, the whole balance would be given to the government.
This would mean that, however large the earnings made by the
use of the government's funds might be, they would revert to the
government after the stockholders had received a moderate interest
of 5 per cent on their investment. At the present time the average earning upon all capital invested in national banks is very


on Bank

on Our

by Case of
New York


nearly 10 per cent. Besides getting whatever profits were thus
earned from the use of its funds, the government would make a
large saving in running expenses. It would no longer have to manage exchanges, see to the transfor of funds hither and thither, and
pay the charges arising out of these duties. The Beserve Association would do this work and would do it without charge.
In our earlier discussion we saw that the fundamental question to be considered in connection with national banking was the
effect of any change that might be introduced upon the reserve
system of the national banks. This was because the reserves are the
fundamental element in the banking system and upon them depend the solvency, economy and efficiency of the whole. It is important, therefore, to consider first of all what would be the change
in our reserve system arising from the designation of the proposed
National Beserve Association as the fiscal agent of the government.
The effect of the change can be briefly stated. I t would abolish
all of the artificial disturbances which arise from the present
Treasury system, and would leave business conditions and relationships practically the same as they would be, from the banking
standpoint, if the government never exacted any taxation. When
taxes were payable, when customs duties were collectible, they
would be paid to the government either in notes of the National
Beserve Association or in checks upon it, or, of course, if the payer
wished, in actual money.
Suppose the case of an importer at New York who had a large
consignment of goods which he wished released from the custom
house. If his customs payment was $20,000 and if he did not wish
(as he would not) to make payment in actual money, he would go
to his own bank and would obtain from it a draft on the National
Beserve Association, or, if he desired, notes of the National
Beserve Association. He might pay for this draft or the notes in
a check drawn upon a previously established credit in the bank
itself, just as today, if he wished to buy a draft on Chicago or
San Francisco, he would get it from his bank and pay that bank
with a check on itself. If his account with the bank was not large
enough, he would have to obtain from it a discount, the bank placing to his credit such a sum as he desired and thus enabling him to
buy from it a draft on the National Beserve Association. Of course
the effect of issuing such drafts would be to reduce the bankVbal-



ance with the Reserve Association. This would he built up again
either by the depositing of claims on the Reserve Association transferred to it by other banks or by rediscounting, perhaps, the very
paper left with the bank by the importer. In any case—and this is
the important point—there would be no displacement of currcnt
funds. No money would have had to be drawn from bank vaults in
making the payment.
§6. This transaction should be studied in comparison with
the management of a similar transaction under the present system. Suppose that this importer today wishes to pay $20,000
in duties. Knowing that the payment is to be made, he has usually
spoken to his bank in advance and the bank has sent to the subtreasury gold or legal tender money to the amount of $20,000.
Then when the importer appears, he is allowed to pay the government in a check on his own bank, because that bank has the
actual cash in the vaults of the government. Or the importer may
draw actual money from his bank and physically carry it to tho
sub-treasury, depositing it there at the time when he liquidates his
customs duties.
"What is the effect of either of these transactions? In the first
place, the withdrawal of the money from the reserve of the bank
means that so long as the funds are taken out, that particular bankfinds its reserve weakened to a corresponding extent. If these
funds went promptly into some other bank, little harm perbaph Reserves
would be done, although even in that case, the effect of the transaction would be to withdraw the funds temporarily from the banks
while the transfer was being made. It would be better even in
such a case to have the payment made in the form of a check or
draft which would stand a chance of being offset against other
checks or drafts, so that only a small balance in money would
have to pass in order to settle the transaction in the last analysis.
But the sum withdrawn does not go into the vaults of other banks
at the time. It goes into the Treasury, and must therefore be considered lost to the banks of the country so long as it is tied up
Will not the Treasury let the cash out almost immediately and T r c a s u p y
will not the withdrawal therefore be only temporary? This de- Hoards
pends upon the state of government revenues. Evidently, in order C a s h
to have such an adjustment as would thus be produced, it is neces-



sary that ( 1 ) disbursements shall be made by the Treasury about
as fast as incomes accrue, and ( 2 ) they shall be made at about the
same places as those at which incomes are received. Neither of
these conditions exists.
At present there is a very great difference between the rate at
which funds come in and that at which they go out. Often for a
series of years there is a regular Treasury surplus of incomes over
expenditures. Funds come in much faster than they are spent.
Even in years when the total outgo is about the same as the total
income, that is not true throughout the year. Funds will be received largely at certain seasons and will lie idle for some months,
when they will rapidly go out again.

Distribution not
to Needs

Consequences of

Moreover, the points where cash is disbursed are quite different from those where it is received. The government now gets its
income chiefly at a few large ports through which goods pass into
the country, and at a few points in the interior where whisky and
tobacco taxes are paid. The corporation tax and a few other kinds
of payment are more widely diffused, but they are minor items.
The payments of the government are made largely at Washington, at those points where bodies of troops and ships of war are
stationed, at the post offices and other government offices throughout the country, and at points where supplies have been purchased. In making payments, as we have already seen, the Treasury may either pay cash or issue warrants on the sub-treasuries.
Whichever it does, the effect of its disbursements is to draw cash
from the points of collection to the points of disbursement. If the
payment were made in a claim upon such an institution as the National Reserve Association, this would not be the case, but the claim
would go through the ordinary mechanism of banking, would be
offset against other claims, and would in the long run give rise only
to such a movement of cash as might be necessary to settle balances between different places.
The present consequences of the Treasury system of hoarding
are very serious. It is an unfortunate fact that the payments to
the government under the present system of taxation are likely to
be heaviest at those seasons when funds are most needed in reserve.
We have seen in earlier chapters that the crop-moving season in the
autumn is a period of special demand for accommodation. But
that is also a time when payments for customs are likely to be heaviest. Throughout the late summer and early fall merchants are



receiving goods from abroad, releasing them from the custom
house and paying duties. T o do this they are withdrawing funds
from banks and transferring them to the Treasury. Just at this
same juncture, the banks are feeling the demand for large accommodations in the interior.
Of course the effect of thus diminishing reserves is to make
it more expensive for producers to get accommodation, while the
banks are embarrassed by the necessity of having to let go of the
funds they need to sustain their credit. If it should happen that
the surplus reserve of the country is very low at any time, the
effect is to curtail the banks* power of lending very materially.
There is no reason why government payments should be exceptionally large contemporaneously with these large receipts. In
fact, they are not, for the greatest disbursements are made on
the first of January and of July, when interest is paid, during
the early months of the fiscal year, July and August, when new
appropriations go into effect, and at other times of exceptional demand, due to payments for labor or supplies as determined by
conditions of construction on public works and the like. The situation is therefore exceptionally embarrassing and difficult.
The Treasury has, as briefly noted heretofore, attempted to
apply a crude means of relieving this situation. Whenever funds
have tended to accumulate too rapidly, by virtue of its power M e a n §
under congressional enactment, it has redepositcd with the banks. 0 f Relief
In so doing, it has, however, had to select the banks with which C r u d o
it would place its funds. Wisdom would have dictated the placing
of the funds as near to the points from which they were drawn
as possible. That would have been difficult at the best, but
political exigencies have rendered it impossible.
Congress has made it mandatory upon the Treasury in making deposits to distribute them as nearly as possible in proportion to population throughout the states and territories. Unfortunately, the amount of business and credit performed and
needed by different communities is not proportionate to population, and therefore the distribution has, in most cases, been productive of much incidental harm. It was much better to get the
money out of the Treasury than to have it accumulate there, but
it has never been distributed in such a way as to facilitate the
needs of the country. Very often a large government deposit in


of Taxes



a t w has resulted in the unwise extension of credit to entero n
prises w i h could not otherwise have obtained it. In other cases,
w e there w s no local use for the funds, they have been shipped
direct to N w York, and have there been reloaned on call to
speculators. It has b e felt that, since the government might deen
m n the deposits at an early date and since there was no profitad
able use for t e at home, the bank might as well make the
most out of them by lending them as a basis for speculation.
Consequently, such deposits have not infrequently b c m a
eo e
stimulus to speculation in securities.
The payment of taxes ought not to be an unnecessary disturbing influence to commerce. It should, in its essential nature,
b nothing more than the transfer of a portion of private wealth
to the public authorities. It should therefore cause no more disturbance than a similar transfer from one private individual to another. The transaction should be effected in the same w y in
such transactions are effected in the commercial world.
Whatever the ultimate economic result of taxation may be, there
w ud then b no incidental effects. The operation of paying
taxes would be merely that of establishing a suitable balance with
the b n and then transferring the title to that balance to the
government in the same w y that the individual would pay any
other claim upon him. At present this is not the case with federal
taxation which, as w have seen, exerts a seriously annoying ine
fluence upon the mechanism of credit practically throughout the
With a proper banking system in close harmony with the
public treasury, no such danger would.exist, but the transfer w ud
take place mechanically and the government would simply c m
o e
into possession of a certain share of the wealth of the country
as the result of its laws. So far as the banking mechanism is
concerned, it would not matter whether this exaction were m d
at one time of the year or at another. Since no movement of
m n y or currency would be necessary, no change would take place
in the volume of reserve funds held by the institutions of the
country, and no local readjustments in the supply of funds available at one point as contrasted with those available at another
would be requisite.
While the effect of the substitution of the banks for the
Treasury as a,fiscalagent, through the medium of the Reserve



Association, would thus be desirable from the standpoint of taxation and of its effect upon the producing and exchanging mechanism of the country, the change would be equally as desirable from
another standpoint. At present the Treasury Department exerts
a disturbing influence upon the reserve supply of the country, ^ t h e 1 " 8
not only through its receipts and disbursements of the proceeds
of taxation, but through its handling of the public debt. The
floating of bonds at the present time is effected by advertising
for bids, which are subsequently opened in the Treasury Department, the bonds being then awarded to the highest bidder. Such
bidders are usually banks and other financial institutions. With
their bids they submit, as a rule, a certified check covering the
percentage of their offering which is required by the department.
Then, on getting an award, they pay in a certain percentage of
the amount of bonds assigned them. Later they complete their
payment by a specified date.
The Treasury may either take the proceeds of its sales in
cash or it may leave the funds on deposit with the banks, in which
case it merely accepts a claim on the banks in liquidation of the
loan. There have been occasions within the past ten years when
the Secretary of the Treasury let it be known that he would leave
the funds on deposit for a time with the same banks which received
the awards of bonds, so that these banks would make payment
to the Treasury merely by crediting the government with a certain sum on its books. This, however, is a rare case. Ordinarily,
cash must be taken out of the vaults and turned over to the department, or else, even where funds are left on deposit, they
must be shifted from the banks which get the bonds to the banks
which are to receive the deposits. In either case there is a tendency to tie up the cash of the country and to place it in institutions remote from the points at which it originated. The harm
is similar to that which was found to exist in the present method
of paying taxes.
It would be far better if the government obtained its payment
for bonds in the form of a transfer to it of a credit on the books of
a National Reserve Association representing the banks of the coun- Managed
try acting as a unit. Then, if bank A, an institution of, say, ^y R « ^ ®
$25,000 capital, at some point in the interior should bid for and
secure a block of, say, $5,000 in government bonds, it could pay
for these bonds by giving the government a check on the Na-



tional Reserve Association. This association would have granted
to the bank the right to draw on it either in return for a deposit
of cash, or a deposit of its own notes, or as the proceeds of a discount of commercial paper offered to it by the bank in question.
Usually the interior bank would have built up its credit with the
Reserve Association by offering such paper for rediscount. This
would mean that there had been no disturbance of the reserve
money of the country or of its distribution, but merely that the
government had obtained a title to a certain amount of the fluid
wealth of the country in exchange for its own long-time obligation. If it then paid out this wealth by giving to its creditors
claims on the National Reserve Association, the whole transaction
would have been settled by means of a mere transfer of title.
Suppose, for example, that the proceeds of the bonds were
to be used in the irrigation of arid lands and that the government had a payment of $5,000 to make in the same general region,
perhaps in the same county where the bank which got the bonds
was located. In that case, the wealth would be expended in the
same place where it originated. Not a dollar would have moved
out of the community necessarily. The bank would have paid
the government in a claim on the Reserve Association and the
government would have paid the contractor in the same way. Very
probably the contractor would have deposited the claim he received from the government in the bank which had bid for the
bonds. Thus, in the last analysis, the bank would have obtained
the bonds and turned over the payment for them to persons in
the same community. If it had bought the bonds as agent of
certain investors in the community, the investors would pay it
by drawing checks in its favor on their bank accounts. The
wealth of the country would have been invested to the extent of
$5,000 in the irrigation system, and the local investors would have
received bonds backed by the government to an equal amount.
The task imposed on the government at the present time of
furnishing exchange would be entirely eliminated by the use, as
Governrnent a fiscal agency, of a banking institution of the kind described.
No Longer T h i s i n s t i t u t i o n , having close connections with banks in all parts
Exchai e
XC a n 9 e


t h e country> w o u l d serve as a m e a n s f o r

equalizing the supply of
throughout the whole country, and would find the successful
performance of this duty one of the chief tests of its efficiency and





Probably very much less demand for the movement of funds
from one part of the country to another would be felt with such
an institution at work than without it. It would tend to act as
a great clearing-house for claims offered by one part of the country
against another, and vice versa. When there was a demand for
funds in one region, it would be met by the Reserve Association,
which would create credits available there. These crcdits would
later be canceled by others resulting from the sale of goods, and
business would be financed without the movement of money. This
alone would be a great saving to the community. It would also
be a great saving to the government, which is not now able to take
advantage, save in a minor degree, of the banking mechanism of
the country, in facilitating its payments.
The Treasury would not only cease to furnish exchange for
commercial applicants, but it would also cease to need exchange
on its own account. Not only disturbance to business, but actual
expense would thus be economized. It is impossible to say how
large a saving in the routine operations of the Treasury could be
made by the transfer of its funds to a fiscal agent in the way
described, until details had been more fully worked out, but it is
certain that the saving would be very substantial and that much
work now done in the Department would be rendered entirely
§7. An objection which is frequently heard with reference
to the adoption of this fiscal agency idea. is that under it the
government "would not be able to get its funds when it wanted
them." This appears to mean either that the banks would be unable to pay on demand and would have to ask for time before meeting the request of the government, or else that there would be
danger of failure. The latter question may be considered first.
Certainly it would be an unfortunate situation if the proposed
Reserve Association were to fail or suspend payment and thereby
prevent the government from getting the use of its resources. In
this connection, the real question is the strength of the Reserve
Association. Constituted as it would be, as already explained, it
would be practically equivalent to an agency representing the
united banks of the country. It would therefore have the same
strength that is possessed by the combined banks of the country.
The government cannot expect to be stronger in its resources than






the commercial community. If all the banks of the country were
to fail, it would not be remarkable if the government should fail
also. In fact, it could not collect taxation and might as well
suspend efforts at making payment. This is merely a reductio ad
absurdum, inasmuch as it shows the impossibility of the assumption that the reserve association organized as already suggested
would differ in its strength from that of the combined banks, and
inasmuch as it emphasizes the fact that a financial strength greater
than that of the combined banks is neither attainable nor perhaps
desirable. There is no case on record where a large European
institution acting as the fiscal agency of the government under
which it is organized has failed. Such a failure would imply
careless, if not criminal, oversight on the part of the officials entrusted with the supervision of banking, and would besides be
evidence of the complete instability and decay of the general business conditions and institutions of the country.
The question of a suspension or temporary inability to pay
on the part of such a reserve association is a matter which involves somewhat different considerations. It might be sufficient
to say on this .point that under no conceivable system, reserve
a s s o c * a ^ o n o r other, could conditions be worse than they have
Jon S T
Suspension been under the national banking system. It can be stated with
absolute certainty that at all times when the government has had
large and widely diffused deposits in national banks it has had
the very greatest difficulty in getting them back, even in times of
prosperity and public confidence. During the past ten years it
has been customary when the Treasury wanted to draw in some
of its deposits to issue what was termed " a call" for deposits.
This was habitually given out from 15 to 30 days in advance of
the time when the deposits were wanted, and amounted to a notice
to the banks that they would have to pay at a certain date. Very
often banks sent representatives to the Treasury to beg for more
time. It was a difficult matter to get them to liquidate under any
In times of panic and stringency, the Treasury, instead of
calling for deposits, has habitually placed more funds with the
banks, if it could command them. Thus, during the panic of
1907, Secretary Cortelyou went so far in the pursuit of this policy
as to deposit with the banks practically everything that the
Treasury owned in the way of cash, outside of its trust funds, so



that probably there was hardly a week's supply of actual cash in
the Treasury at the time when it was in greatest straits. Other
instances of the same kind could be citcd.
The whole trouble comes from the fact that when the Treasury
calls for deposit, it asks for actual money. To give this the banks
must cut down their reserve by a corresponding amount, and that
usually implies a curtailment of commercial credit. If the funds
of the government were regularly on deposit with a reserve association and if the government never "called" for its deposits ex- Due to
cept in so far as it needed cash for immediate disbursement, just j ! ^ ® 8 ^
as would be done by any large business house, there would be no Cash
occasion for difficulty, but the institution would always be able to
meet its obligations so long as it was in a solvent condition. It
would never have to contemplate the problem of turning a portion
of its reserve over to the Treasury Department. The government
would build up its account with the Reserve Association by depositing there the proceeds of taxation and of bond sales as they
came in, and it would transfer these claims to its creditors. The
.capacity of the Reserve Association to meet the demands would
be merely a question of its solvency, a question already sufficiently
Of course, the whole fallacy in the views of those who speak
of the danger of turning over government funds to a private institution lies in the attempt to draw a distinction between the government and the community which it represents. The government
cannot be stronger than its subjects. If the latter are represented
by an institution which acts as the joint agency of the banks of
the country and in that way practically stands for the whole of Government
the business community, the government cannot hope to put itself No Stronger
in a more powerful or solvent condition than the institution which p e o p i e
thus has at its disposal the fluid resources of the nation. Its sole
anxiety must be that of seeing that the institution in question
is properly conducted, and that it does not fall into the hands of
selfish persons who may pervert its purpose for their own object.
That is a question which is met by the provisions governing organization and management. These have already been discussed,
and it has been shown how such an institution can properly be
managed in the public interest. If the government has done its
share in directing the policy of the institution by appointing able
directors to present its views on the controlling board, and if it



has properly performed its function of inspection and oversight
there is no more to be said. The safety of the institution is
equivalent to that of the nation as a whole, and the government
could not do better than to trust the public funds to the institution which thus represented the public in its financial aspect.
§8. The proposed Reserve Association is to be, in fact, a
public institution in the highest sense of the word. It would be
conducted in the interest of the public, for the good of the public,
and its profits above the moderate rate of 5 per cent on capital
Association invested would go to the public authorities. Under those condia Public
tions the employment of the Reserve Association as the fiscal agent
Institution of the government would in no sense be the turning over of the
funds of the government to private individuals. It would be simply
the substitution of an effective public institution possessing banking
functions and working in close harmony with the banking institutions of the country for another public institution, the Treasury,
possessing no equipment for this service, having no necessary relation to the banking mechanism of the country and in every way
lacking the equipment that would render it a satisfactory means
to the accomplishment of the fiscal purposes of the government.



1. Readjustment of the Banking System to Meet Foreign Trade Conditions—2. Unitorm Discount Rate and tho Flow of Specie—3.
United States Not Considered as a Center of Finance—4. Purchase and Sale of Exchange—5. Reserve Association to I)o Dunking
Business Abroad—6. International Flow of Gold—7. Foreign Exchange Banks.
§1. An important element in the plan of banking reform,
proposed by the National Monetary Commission, is found in the
provision it contains for a new adjustment of our banking system
to foreign trade conditions. Such readjustment has long been considered a necessary feature of any plan of reform in banking.
The national banking system was established at a time when foreign trade was small and when little or no heed had been given to
the peculiar credit requirements of export houses. Since that
time, the export business of the United States has greatly expanded.
Simultaneously, competition with foreign countries has become
much more severe. In this competition, we have found ourselves
exceptionally handicapped, owing to the circumstance that foreign
banking systems were so much better equipped to furnish the credit
needed in financing these international operations.
I t has been found that our peculiarly subdivided and independent system of banks ( 1 ) entirely lacks the power to control
international gold movements by changes in the rate of discount;
( 2 ) is unable under the terms of the national act to establish
branches in foreign countries capable of supplying American exporters with the funds they require in order to meet the peculiar
credit conditions there obtaining; ( 3 ) could not with entire success
develop the mechanism needed for dealing in international exchange; and ( 4 ) lacks the unity of policy required to properly
finance export movements of commodities.


Readjustment to




These defects in the national system have at times been exemplified in a striking way. This has been true at critical periods
of stringency and panic. Less conspicuous, but perhaps more important, has however been the fact that the national system has
suffered continuously from these evils and weaknesses, and was
unable to supply the necessities of the trade of the country in such
a way as to support and encourage its business. The most noticeable feature of the situation has been seen when the gold reserves
have been reduced below normal necessities, without any serious
action on the part of the banks intended to check the outflow or
restore the depleted supply.

It has occasionally happened that the gold resources of the
country fell far below normal requirements, reserves were allowed
to run down, and danger to solvency and liquidity was encountered.
This was the case during the three years just after the Sherman Silver Purchase Act of 1890, when it appeared that foreign
countries were sending back to the United States the securities of
American enterprises which failed to command confidence because
of the threat then current in" American politics that the country
would pass to a silver standard. It would not have been possible
a Silver
on that occasion for the banks to prevent the withdrawal of cash
funds in payment for the securities, since the real cause of the outWas
Threatened flow was entirely beyond their control. A suitably organized system of banking would, however, have managed the operation with
far less suffering and stress, would have been able to give earlier
and more effective notice to the country of what was occurring
and of its causes, and would have been able to rectify arid restore
the normal supply of gold, after proper legislative action had been
taken. In this way the crisis of 1893 might have been prevented,
or greatly mitigated.
During the panic of 1907, when reserves were being drawn
down by depositors and by small banks which feared that they
would become unable to pay cash, a suitably-organized banking system would have succeeded in drawing gold from abroad much more
readily than was actually done. There were many banking houses
during the panic of 1907 which imported large quantities of gold
In 1907
and placed it at the disposal of their correspondents. The same was
true on previous occasions when similar, although less urgent, needs
made themselves felt. But there was no general or concerted attempt to rectify the situation by raising rates of discount, or bv



offering foreign countries the inducements necessary in order to
get them to part with their specie in favor of the United States.
Throughout the whole period of our foreign trade development during the past 20 years, it has been necessary for exporters
to rely upon accommodations at foreign banks or at private banking houses, which, although efficient so far as their operations extended, necessarily worked upon a limited scale and without refer- Broader
cnce to the broader needs of the country. There has been constant N e «ds
of the

complaint, therefore, of the difficulties connected with the obtain- country
ing of credit in the proper form and amount for the conduct of Not^ ^
foreign trade operations. For these reasons, the question is always, and properly, asked, in connection with any proposed system
of banking legislation, how far and in what way it will meet the
evils which have developed in the ways already described.
§2. The most important change in our relation to foreign
countries in regard to the international flow of specie would be
found in the introduction of some element of cooperative or combined control over such movements, exerting itself by the establishment of a uniform rate of discount which would be raised or lowered as circumstances might demand. One of the most important Discount
of these circumstances would be the condition of our foreign trade Rate and
the Flow

and the state of our international balance. If conditions had de- 0 f Specie
veloped in such a way as to create tendencies toward the outflow
of specie, a properly-organized banking system would do what was
needed in order to moderate and control this tendency. In foreign
countries, such work is performed by the great banking institutions
which act as representatives of the combined banks of the nation.
Thus the banks of France, England, Germany, etc., find a large
part of their activity directed toward the regulation of rates of discount in such a way as to prevent the gold stock of their clientele
from being unduly depleted, or to build it up when circumstances
call for such steps.
No such policy is possible in a country where there is no
cooperative agency to regulate the rate of discount. It is impossible to expect banks, acting on their own initiative, in competition
with others, and controlled primarily by a desire for profit, to pursue a policy which would merely reduce their own earnings and
would not result in conserving the gold supply of the country. If
they could act as a unit, there would be many cases in which they



No Force
in this
Country to
the Gold

would agree to raise the rate of discount to customers in order to
check borrowing, reduce exportation of gold, and put a brake upou
lines of business which were going too far for the general good of
the country. Acting alone, they cannot be expected to sacrifice
themselves for such a purpose, particularly as such self-sacrifice
would be of little or no use where it was not practiced by others.
Fundamentally a great service to our foreign trade which
would be performed through a cooperative reserve institution would
be that of controlling the specie movement. The knowledge that a
banking mechanism of such a kind, comparable in strength and vitality to those existing elsewhere, had been established here would
greatly strengthen the financial position of American borrowers and
American enterprises abroad, and would immensely improve our
general position in the world community of finance.

At present, the United States does not receive the con-

sideration as a center of finance and industry to which its rank in
wealth entitles it.
of the
in the
of Finance

International enterprises prefer to establish

their headquarters in countries whose banking systems are upon
a more stable basis.

They do not care to run the risk of such oc-

currences as the panic of 1907, suspensions of payment, shortages
of accommodation, and general financial disturbance.

They find

it more advantageous to operate where they are free from such unnecessary dangers, and where at the same time they can be assured
of any amount of accommodation for which they can show good
and sufficient security of the proper kind.

All these considerations

make against our status in the international financial market and
tend to drive enterprises away from our shores when the high character of the management is such that it can select the place of principal operation at will.

The effect is to cut us off from much de-

sirable .business and in a measure to isolate the American market.
The lack of cooperation among our banks prevents the estabIsolation
of the

lishment of any uniform system or standard for financial transactions, such as exists in the principal countries abroad, and it is
partly due to this fact that American securities are looked upon
with doubt by many foreign investors and are listed only with hesitation by foreign exchanges.

The establishment of a cooperative

institution would bring about a great change in these conditions.

would establish here a mechanism which is not a





but which would be comparable in power and prestige with the
great banks of Europe, would ensure suitable supplies of crcdit
when they were needed, and would thereby prevent the rccurrcnce
of bank suspensions and difficulties similar to those of 1907 and
preceding panic years.1
Precisely how the proposed plan would work and by what
mechanism it would bring about the results indicated may now
be pointed out. At present, banks of the United States arc for the
most part too small in capital to engage in large international
transactions. This is true both of national and state institutions.
Partly as a result of law, partly in consequence of the dictates of
sound business policy, it is not wise for them to tie up their funds
in the long-term operations needed in international trade. They
arc not able under existing conditions to be sure of rediscount accominodations that would suffice to give them the assurance they
need in dealing with applicants for loans on international paper.

The Bank


Such new mechanism as may be established must therefore
have large capital. It must further be able either to "carry" enterprises for such periods of time as they may require in international
operations, or to secure through foreign banking institutions the
aid necessary to do so. Further it must have power to operate in
foreign countries and to adjust its methods to those of the credit Large
systems which there prevail. None of these things is now practic- Capital
able. The problem is how to supply them. From another point of N c c e 8 s a r y
view, the proposition assumes a twofold f o r m — ( 1 ) that of changing our banking organization so as to supply the amount of capital
and the type of credit needed; and ( 2 ) that of standardizing local
paper so as to make it pass current in world markets.

•§4. The fundamental operation in financing foreign trade
transactions is the purchase and sale of exchange. This amounts
practically to the making of loans by the general methods already
described (see Chapter V on "Commercial Paper"), but in such
' T h e
the plan:
T h e
Reserve Association
is given a m p l e
p o w e r to protect
Its o w n
o r d e r t h a t it m a y b e a b l e a t all t i m e s t o e x e r c i s e its m o s t i m p o r t a n t
function—that of sustaining the commercial
crcdit of
countryF o r t h e p u r p o s e o f s t r e n g t h e n i n g i t s o w n r e s e r v e s It m a y ,
f r o m other countries b y a n a d v a n c e in
its discount rate: second,
a n d b o r r o w gold and give security for its loans, including the
of government
b u y
m o s t
m e a n s of replenishing a gold supply, a n d of preventing the exportation
gold a t critical


of Bills


How a


a way as to finance transactions involving exportation and importation. An exporter sells a bill of goods to a buyer in Rio Janeiro.
He wishes to have the returns for the goods immediately, and so
draws at a specified number of days upon his correspondent in that
city. This draft, accompanied by the necessary documents, is taken
by him to a bank and is there presented for discount. The bank
examines the draft and the attached documents. Finding all satisfactory, and being certain of the solvency of the customer who asks
for the discount, it grants the accommodation desired. Thereupon,
it stands possessed of the claim upon the buyer in Rio Janeiro, the
exporter who discounted the draft being meanwhile under obligation for the amount of the loan only in case there should be a
default at the .other end.
Such loans are necessarily longer in their period than ordinary
commercial paper, and the business probably could not be done in
many instances upon the narrow margin of time which is usual in
domestic trade. This has prevented national banks from engaging
actively in this kind of operation notwithstanding that such loans
are among the best and safest that can be found. Banks do not
care to have too great a proportion of their funds tied up in loans
that can be realized upon only with possible difficulty. A large
proportion of this business has, therefore, gone in the past to private institutions, and has been dealt with by them only sporadically
and in many instances unsatisfactorily.
One fundamental necessity in the case is that of providing
some method that will permit a rediscount of such paper. This
function would be performed to best advantage by a Reserve Association such as has been spoken of.
If such an institution stood ready to advance funds upon
paper arising out of foreign trade operations, several desirable
effects would be brought about. The trade itself would be greatly
facilitated, because of the increased possibility of getting current
accommodations at the reasonable rates needed in the business. The
plan would, render material aid also, because of the encouragement
afforded by it to ordinary banks to take up such paper when offered
to them. This would tend to keep the rate of discount at a low figure since it would ensure the banks' power to hypothecate the bills
of exchange upon terms as favorable as those accorded to any
kind of paper originating elsewhere. I t would undoubtedly bring



about a more friendly attitude on the part of the banking public
toward export enterprises in general. On this point the National
Monetary Commission says:
A wider domestic market for the commercial paper we have
described will be found in the changes which are likely to tako
place under the provisions of the bill submitted, in the investment
of the surplus funds of the banks, and by surplus funds in this
connection we do not refer to moneys deposited with reserve
agents, but to funds for which there may be no legitimate local
demand. The surplus funds referred to are now deposited perhaps
through correspondents in New York at 2 per cent interest. Tho
New York banks are usually obliged to loan them on call on stock
exchange collaterals, inducing at times dangerous speculative
conditions, with the probability that when the money is withdrawn the necessary calling of loans may cause disturbances in
reserves and in the market and sometimes lead to panics.
We propose by the provision of the bill submitted to enable
the banks to invest their surplus funds of the character we have
described in notes or bills of exchange representing the industries or the products of the United States. It may be that they
will not be able in making these loans to obtain the full rate current for discounts of commercial paper, as they will have to compete with foreign banks for a portion of the business, but thoy
will certainly receive more than 2 per cent for their money, and
they will have in their portfolio commercial paper created for
legitimate purposes which they can take to the district branch
and have transformed into cash or a cash credit at any hour of
any business day of the year.

In order to facilitate this foreign business, the proposed

plan of the National Reserve Association, one form of which has
been presented by the National Monetary Commission, proposes to
To Have

give power to the association to open banking accounts in foreign Banking
countries and to do business there along lines that arc appropriate Accounts

in Foreign

or necessary to the carrying out of this branch of its operations. Countries
The Monetary Commission's bill says:
The National Reserve Association shall have power to open
and maintain banking accounts in foreign countries and to establish agencies in foreign countries for the purpose of purchasing,
selling, and collecting foreign bills of exchange, and it shall have
authority to buy and sell, with or without its indorsement, through
such correspondents or agencies, checks or prime foreign bills of
exchange arising out of commercial transactions, which have not
exceeding ninety days to run, and which bear the signatures of
two or more responsible parties.


An International

Authorization as to


It is evident that this provision would furnish the association
with the power needed to establish close business connections with
foreign countries. The limitation by which the paper is to run
not more than 90 days and to bear the signatures of two responsible
parties is intended to prevent the use of the funds of the association in financing very long period loans, and has the same object
as the limitation of domestic loans to 28-day transactions under all
except very carefully safeguarded conditions. The provisions just
quoted would merely furnish the basis for the extension of the
business of the National Reserve Association beyond the confines of
the United States. It would thus be fundamental because it would
permit the creation of an .international banking mechanism with
headquarters in the United States. This is now entirely lacking
in our present national banking system.
The National Reserve Association is intended to do business
only with banks and is not to be permitted to undertake any independent operations, in domestic trade. Communication with the
public of the United States, therefore, is to be had solely through
the constituent banks which have taken stock in the Reserve Association.2 We have already seen how carefully it is intended to limit
the operations of these banks in order that they may not succeed
in securing the use of funds of the association for purposes that
might be dangerous or that might result in inflation. A special
C o n s i d e r a b l e difference of opinion o n the question w h e t h e r bills
be bought only
the banks
still e x i s t s a m o n g
reference to this subject, Mr. F r a n k
of the
of California of San
" T h e p o w e r to m a k e its rate effective w o u l d b e the Association's
greatest weapon of offense and
d e f e n s e . It will, if efficient
give the
to our banking s y s t e m w h i c h is so desirable—elasticity
expansion, not expansion alone, in normal
times the Influence of
A s s o c i a t i o n ' s r a t e w o u l d b e p r a c t i c a l l y n i l . U n d e r t h e p l a n t h e Association
would be a beggar at the doors of its depositors, dependent upon t h e m
the Investment of
its f u n d s ;
failing there, all of its f u n d s w o u l d
go abroad for investment. O n the other hand, w h e n the banks were
up and actual stringency existed, the banks would
to g o to
Assoc i a t i o n a n d a c c e p t s u c h t e r m s a s it i m p o s e d ; - t h a t is, t h e A s s o c i a t i o n
will be effective only w h e n the b a n k s h a v e to b o r r o w . In other words,
A s s o c i a t i o n c a n o n l y a c t o n t h e d e f e n s i v e a n d its i n f l u e n c e will n o t b e felt
until inflation h a s got u n d e r pretty full h e a d w a y .
W o r l d
b e so settled that the Association felt that the business public w a s
to lower rates, and that there w a s
n o d a n g e r in a l l o w i n g business to
it certainly would
the Association's m o n e y at such a time.
O n
t h e o t h e r h a n d , it w o u l d
conservative for the Association to let s o m e of its m o n e y out b y
purchasi n g bills in t h e o p e n m a r k e t , b e c a u s e it w o u l d b e in a p o s i t i o n t o
the situation w h e n
T h e purchases
the Association
only of the highest grades of short-time paper, and
the competition
the b a n k s w o u l d b e practically negligible; t h e A s s o c i a t i o n
be able to serve the nation and the b a n k s m o r e intelligently and with
s a f e t y if it c o u l d p u r c h a s e a n d sell in t h e o p e n m a r k e t . I f t h e
is to b e c h a r g e d w i t h
the reserves of
b a n k s and the gold supply of the country, it should b e given the
m a k e its rate effective. If the lessons of h i s t o r y a r e w o r t h a n y t h i n g ,
A s s o c i a t i o n will n o t b e fully s u c c e s s f u l u n l e s s it c a n
m a k e Its r a t e
e l e c tive."



provision would, therefore, be needed to expand the scope of the
National Reserve Association's work in connection with international trade. Were this not done, the purchase of paper growing
out of foreign trade transactions would be forbidden to the Reserve
Association. The following section of the plan proposed by the
National Monetary Commission shows what authority it is intended
to give to the National Reserve Association in this connection:
The National Reserve Association shall have power to purchase from its subscribing banks and to sell, with or without its
indorsement, checks or bills of exchange arising out of commercial transactions as hereinbefore defined, payable in such foreign
countries as the board of directors of the National Reserve Association may determine. These bills of exchange must have not
exceeding ninety days to run, and must bear the signatures of two
or more responsible parties, of which the last one shall be that of
a subscribing bank.
While this provision would give a large degree of discretion
to the Board of Directors of the Reserve Association in limiting
the classes of paper in which they were willing to trade in international business, it would not permit any discrimination between
different institutions. The different banks would be guaranteed
the same access to the Reserve Association as any other of their
number and the association would be able to limit itself only in
regard to certain specified classes of transactions.
By requiring that each bank offering paper for rediscount shall
place its signature upon the paper offered to the Rescn » Associa.
tion for rediscount, the plan makes it certain that each piece of Tests
paper will have been tested by the bank to which application is 0 P a f
originally made, and that nothing will have been done except upon
the request and with the approval of some bank which so strongly
backs its judgment in the matter as to make itself liable by placing
its signature upon the paper.
§6. A power incidental to, and correlative with, the authority already granted in the provision referred to is that of attracting
gold coin and bullion from foreign countries whenever necessary
to rectify the balance of trade and to supply needed reserve resources
in the United States. On that point the plan of the National
Monetary Commission provides as follows :
Sec. 34. The Notional Reserve Association shall have power,
both at home and abroad, to deal in gold coin or bullion, to make
loanB thereon, and to contract for loans of gold coin or bullion,

of Gold


giving therefor, when necessary, acceptable security, including
the hypothecation of any of its holdings of United States bonds.

Not Be

In Bonds
of Other

The effect of this provision would be to permit the association
at times when the currents of international trade had gone against
thé United States, thereby depleting our gold supply, to obtain
gold abroad, practically by purchase, and to arrange for its importation into the United States. This at times is a necessary
function in order to avert stringency and supply actual gold to
meet demands for reserves. In times past, when stringency has
occurred, there were no means of obtaining gold by united action on
the part of the banks, but it was necessary to rely entirely upon the
sporadic activities of large banks in order to secure the import of
gold. The new plan would place the power, and therewith the
responsibility, for such work upon the National Reserve Association. The banks themselves would thereby be relieved of the necessity of concerning themselves further about the general question
of gold supply as compared with that of foreign countries, and
would be enabled to look directly to the National Reserve Association for such accommodation as they might deem necessary.
By the side of this provision may be set another, which,
although not absolutely required, is likely to be of distinct service
in the management of foreign trade relations. This is the power
to deal in the national bonds not only of the United States but of
foreign countries.
The Monetary Commission plan makes the following provision
on that score :
The National Reserve Association may invest in United States
bonds; also in obligations, having not more than one year to run,
of the United States or its dependencies, or of any state, or of
foreign governments.
§7. Thus far, what has been said has had reference entirely
to the operations of a National Reserve Association. It has been
assumed that the transactions involved in the financing of foreign


C O u l d b e a t t e n d e d t o b y the banks, provided they were
afforded a means of obtaining rediscounts. It is not certain, however, that such would be the case.. The operations of national banks
are primarily domestic in character, and bankers hesitate to allow
their funds to become involved in business requiring so long a term
of credit as is implied in international operations. It is therefore





thought necessary by some that a new set of institutions should
be authorized for the purpose of providing more adequately for the
needs of our foreign trade. They would be institutions which would
specialize in foreign business. On this point, the National Monetary Commission has put forward the following plan as Section 57"
of its bill:
Sec. 57. That banking corporations for carrying on the business of banking in foreign countries and in aid of tlio commerce
of the United States with foreign countries and to act when required as fiscal agents of the United States in such countries may
be formed by any number of persons, not less in any case than
five, who shall enter into articles of association which shall specify
in general terms the object, for which the banking corporation is
formed and may contain any other provisions not inconsistent
with the provisions of this section which the banking corporation
may see fit to adopt for the regulation and conduct of its business and affairs, which said regulations shall be signed, in duplicate, by the persons uniting to form the banking corporation, and
one copy thereof shall be forwarded to the Comptroller of the
Currency and the other to the Secretary of State, to be filed and
preserved in their offices.
That the persons uniting to form such banking corporation
shall under their hands make an organization certificate which
shall specify, first, the name assumed by such banking corporation, which name shall be subject to approval by the Comptroller;
second, the foreign country or countries or the dependencies or
colonies of foreign countries or the dependencies of the United
States where its banking operations are to be carried on; third,
the place in the United States where its home office shall bo
located; fourth, the amount of its capital stock and the number
of shares into which the same shall be divided; fifth, the names
and places of residence of the shareholders and the number of
shares held by each of them, and, sixth, a declaration that said
certificate is made to enable such persons to avail themselves of
the advantages of this section.
That no banking corporation shall be organized under the
provisions of this section with a less capital than two million
dollars, which shall be fully paid in before the banking corporation shall be authorized to commence business, and the fact of
said payment shall be certified by the Comptroller of the Currency and a copy of his certificate to this effect shall be filed
with the Secretary of State; provided, that the capital stock of
any such bank may be increased at any time by a vote of twothirds of its shareholders with the approval of the Comptroller
of the Currency and that the capital stock of any such bank which
exceeds two million dollars may be reduced at any time to the
sum of two million dollars by the vote of shareholders owning
two-thirds of the capital.


That every banking corporation formed pursuant to the provisions of this section shall for a period of twenty years from
the date of the execution of its organization certificate be a body
corporate, but shall not be authorized to receive deposits in the
United States nor transact any domestic business not necessarily
related to the business being done in foreign countries or in the
dependencies of the United States. Such banking corporations
shall have authority to make acceptances, buy and sell bills of
exchange, or other commercial paper relating to foreign business,
and to purchase and sell securities, including securities of the
United States or of any state in the Union. Each banking corporation organized under the provisions of this section shall have
power to establish and maintain for the transaction of its business a branch or branches in foreign countries, their dependencies or the dependencies of the United States at such places
and under such regulations as its board of directors may deem
A majority of the shares of the capital stock of such banking
corporation shall be held and owned by citizens of the United
States or corporations chartered under the laws of the United
States or of any state of the Union, and a majority of the members of the board of directors of such banking corporations shall
be citizens of the United States. Each director shall own in his
own right at least one hundred shares of the capital stock of the
banking corporation of which he is a director.
Whenever the Comptroller shall become satisfied of the insolvency of any such banking corporation he may appoint a
receiver who shall proceed to close up such corporation in the
same manner in which he would close a national bank, the disposition of the assets of the branches to be subject to any special
provisions of the laws of the country under whose jurisdiction
such assets are located.
The annual meeting of every such banking corporation shall
be held at its home office in the United States, and every such
banking corporation shall keep at its home oflice books containing the names of all stockholders of such banking corporation and
members of its board of directors, together with copies of the reports furnished by it to the Comptroller of the Currency exhibiting in detail and under appropriate heads the resources and liabilities of the banking corporation. Every such banking corporation
shall make reports to the Comptroller of the Currency at such
times as he may require, and shall be subject to examinations
when deemed necessary by the Comptroller of the Currency
through examiners appointed by him; the compensation of such
examiners to be fixed by the Comptroller of the Currency.
Any such banking corporation may go into liquidation and
be closed by the vote of its shareholders owning two-thirds of its
Any bank doing business in the United States and being the



owner of stock in the National Reserve Association may subfceribo
to the stock of any banking corporation organized under the provisions of this section, but the aggregate of such stock held by
any one bank shall not excecd ten per centum of the capital stock
of the subscribing bank.
Of this provision, the Commission itself says:
Section 57 of the bill submitted provides for tho incorporation of banks to do business in foreign countries. We assume
that it is not necessary to call attention to the desirability of
making every reasonable effort to promote our foreign trade and
to establish closer commercial and financial relations with foreign countries. The impediments in the way of the development
of our international trade are numerous. Perhaps none of these
is more important than the absence of American banking facilities in other countries and the lack of knowledge abroad of our
financial resources and of the strength and character of our
banking institutions. The status of the United States ns one of tho
great powers in the political world is now universally recognized,
but we have yet to securc recognition as an important factor in
the financial world. This condition of affairs is likely to remain
unchanged as long as practically all our purchases and sales
abroad are financed by foreign bankers. We anticipate that tho
changes in the currents of trade which will follow the opening of
the Panama Canal will tend to the enlargement of our international commerce.
If this or some similar plan were to he adopted, provision
would practically be made for highly-specialized institutions authorized to do business with particular parts of the world and to
maintain in the United States simply a head office without branches
on our soil. While branches could be organized abroad and would
be so organized in order to carry out the purposes for which the
enterprise was inaugurated in the first place, they would not be
located in the United States and hence would not infringe at all
upon the existing system of free banking.
The effect of the new class of banks would be merely that of
supplying special and expert banking skill in connection with our
foreign trade. The new system would result in establishing institutions in those countries in which we transact business closely
connected with the National Reserve Association and its foreign
agencies, in the same way that domestic banks would be connected
with, and would look to, the proposed National Reserve Association
itself and its fifteen branches in the United States.
The functions of these banks organized to engage in foreign
trade would be very similar to those of the chartered banks in







of British

Be as
for as


Great Britain which are intended to carry on banking operations
in the Orient and in the British foreign possessions generally. It
is the function of these institutions to facilitate, so far as possible,
transactions between English exporters and importers on the one
hand and merchants and producers in the countries with which they
are trading on the other. The credit situation in this trade has a
special character in that differences in terms and periods of lending conditions, of purchase and sale of goods, and the like, exist
in various countries depending upon the varying customs of the
people. These call for direct study by bankers and for the adjustment of credit institutions thereto. The result is that such banks
are able to accomplish a distinct service which could not be had
from other institutions. They get their ultimate support from the
Bank of England, which rediscounts their paper, just as the proposed new class of institutions for the United States would get
support through the rediscounts granted it by a National Reserve Association.
The change in the present situation which would Tesult from
the proposed plan would really be twofold: ( 1 ) The recognition
of a new set of institutions properly organized and authorized to
supply capital for use in foreign trade; and ( 2 ) the linking of these
institutions and of the financial and banking system of the country
as a whole to the National Reserve Association by authorizing it
to do a rediscount business in foreign trade. The effect of these
changes would simply be to give to those who wished to engage in
foreign trade somewhat the same facilities that now exist in con*
nection with domestic business. Foreign business would in no way
be preferred to domestic, but the exporter would be assured of the
same access to loanable capital as the local manufacturer.
The effect of such changes would be that of giving the United
States a decidedly different status in the commercial world as compared with that which it occupies today. Not only would it share
in many international financial operations from which it is today
practically excluded, but it would extend to American merchants the
accommodation which they now have to seek from foreign banks,
sometimes with indifferent success, when they were engaged in selling their products in foreign countries.
One of the chief obstacles to our successfully entering foreign
markets has been the fact that our exporters were not in position
to accommodate themselves to the longer terms of credit and special



conditions there prevailing. They were often obliged to insist
upon immediate or short-period payment, while their European
competitors, having rediscount facilities at hand, could grant a
much longer period to the purchaser who expected to retail the
goods to consumers. Important as the establishment of a cooperative institution is in domestic trade, it is probable that the
proper conduct of foreign trade is even more directly dependent
upon the introduction of suitable facilities for making loans and
securing rediscounts than is true of domestic borrowers.



Dean of the Law School of the University of Chicago

Preliminary Statement
Upon the supposition that Congress may undertake the reorganization of our present national currency system, I understand
that an opinion is asked regarding the constitutionality of a plan
of reorganization proposed by the National Citizens' League involving substantially the following features:
The United States shall charter, for a term of years, a corporation to be known as the National Reserve Association, with an
authorized capital equal to twenty per cent of the capital of the
subscribing banks, and a head office in Washington, D. C. All national banks, and incorporated state banks, savings banks, and trust
companies, receiving deposits, may (under certain prescribed conditions as to capital, reserves, examinations, reports, and so forth)
subscribe to the capital stock of the National Reserve Association
up to a certain percentage of their own stock. Stock in the National
Association shall be non-transferable and if a subscriber reduces
its capital or ceases business its stock shall be surrendered proportionately in return for its par value in cash. The country is to be
divided into fifteen "districts;" with a branch of the Association
in each, and the Association and its branches are to be exempt from
state and local taxation except upon real estate. Net earnings are
to be divided between stockholders in the Association, the United
States, and the creation of a surplus reserve for the Association.
Subscribing banks in contiguous territory are to be formed into
"local associations," with corporate powers, a minimum membership of ten banks, and a combined capital of at least $5,000,000.
Every bank will belong to some local association, and all of the latter are grouped into fifteen divisions corresponding to the abovementioned "districts." Detailed provision is made for the choice of




directors and governors of local associations and of the National
The privileges of the local association and of the National Association are to be equitably extended to every subscribing bank.
The National Association may rediscount for any subscribing bank
notes based upon actual commercial transactions (not for carrying
investment securities) to an amount not exceeding the capital of the
subscriber. If the paper rcdiscounlcd has over twenty-eight days
to run, it must be guaranteed by the subscriber's local association for
a commission, and must mature in not over four months. Subject
to the approval of certain officials, direct loans may be made to
subscribing banks by the Association when the public interests so
require, up to three-fourths of the value of satisfactory securities
pledged therefor. The borrowing subscriber must keep on deposit
with the Association a certain percentage of its loan item. The
Association may also purchase from subscribers prime bills maturing in not over ninety days.
The Association shall be the principal fiscal agent of the
United States, receiving on deposit the cash receipts of the latter,
and making its disbursements. The United States and the subscribing banks are to be the sole depositors, and have the sole domestic transactions with the Association ; but the Association may
invest in obligations of the United States, the states, or of certain
foreign governments, it may deal in gold coin or bullion, or foreign
exchange, and may establish agencies abroad.
National banks shall issue no more circulating notes, and any
retired shall not be reissued. The Association shall for one year
offer to buy at par the two per cent bonds now deposited with the
United States to secure bank circulation, and shall assume responsibility for the notes secured thereby. Its own notes shall
be issued in place of bank circulation thus retired, with the object
of wholly replacing the present bond-secured circulation as soon as
convenient. It shall hold United States bonds thus purchased
for not less than ten years, except that with the government's consent it may, after two years, sell not over $50,000,000 of them annually. The Association may also issue additional circulating notes,
provided it secure all of its note or deposit demand liabilities by a
thirty three per cent gold reserve and the remainder by bankable
commercial paper, United States bonds, or other kinds of lawful
money. The Association's notes shall be a first lien upon all of

its assets, shall be redeemable in gold, and shall be receivable for
all demands due to or from the United States (unless specifically
payable in gold), and for all due to or between subscribing banks.
The Association shall make weekly public reports to the comptroller
of the currency, and full reports five times a year.

The power of Congress to charter a corporation authorized
to receive deposits, make discounts, and to issue bills designed to
circulate as money (though not necessarily legal tender) became
the subject of vigorous discussion immediately after the adoption
of the Constitution. The third session of the First Congress passed
an act (1 St. L. 191) incorporating the first Bank of the United
States for twenty years, with such powers, which was approved by
President Washington on February 25, 1791. One-fifth of its
capital stock of $10,000,000 was to be subscribed by the United
States, and three-fourths of the amount of private subscriptions
was to be paid in the interest-bearing public debt of the United
States. Its demand notes were made receivable in all payments to
the government. Washington sought the advice of various members
of his cabinet upon the constitutionality of the act, before signing
it, and opinions adverse to it were given by Secretary of State
Thomas Jefferson and Attorney-General Edmund Randolph, and
in its favor by Secretary of the Treasury Alexander Hamilton.
The arguments of the latter carried conviction to the President
Though Hamilton's opinion is without force as a judicial precedent,
great weight has always justly attached to it, not only on account
of its author's high reputation as a lawyer and his relation as a
statesman to the measure in question, but also because of the
breadth and cogency of its reasoning, which has been largely
adopted by the courts.
In brief outline, Hamilton's argument was as follows:
In addition to various enumerated powers expressly conferred
npon Congress by the Constitution, Congress is authorized "to make
all laws which shall be necessary and proper for carrying into
execution the foregoing powers, and all other powers vested by
this Constitution in the government of the United States, or in any
department or officer thereof." Cons., Art. I , sec. 8, clause 18.
"Necessary" here does not mean absolutely and indispensably necessary, but no more than "needful, requisite, incidental, useful, or



conducive to," and so gives Congress a fair choice of means in carrying out the authorized ends of the federal government If a
national bank, then, is an incidental or useful means of exercising
any power vested in the United States government, it may constitutionally be chartered by Congress. "Accordingly it is affirmed
that it has a relation, more or less direct, to the power of collecting
taxes, to that of borrowing money, to that of regulating trade between the States, and to those of raising and maintaining fleets
and armies. To the two former the relation may be said to be
immediate; and in the last place it will be argued, that it is clearly
within the provision which authorizes the making of all needful
rules and regulations concerning the property of the United States,
as the same has been practiced upon by the government
" A bank relates to the collection of taxes in two ways—indirectly, by increasing the quantity of circulating medium and quickening circulation, which facilitates the means of paying directly,
by creating a convenient species of medium in which they are to
be paid." It also provides a safe and ready means of transferring
collections from one part of the country to another, and it prevents
the evils to trade that result from locking up in the government
vaults large sums of money not needed for current disbursements
which are thus withdrawn from circulation.
"A bank has a direct relation to the power of borrowing money,
because it is a usual, and in sudden emergencies an essential,
instrument in the obtaining of loans to government." Taxes and
loans from individuals are often too slow in an exigency, and a
bank enables the ready accumulation of a fund to be loaned.
"The institution of a bank has also a natural relation
to the regulation of trade between the States, in so far as
it is conducive to the creation of a convenient medium of
exchange between them, and to the keeping up a full circulation, by preventing the frequent displacement of the
metals In reciprocal remittances. Money is the very hingo
on which commerce turns. And this does not merely mean
gold and silver; many other things have served the purpose, with different degrees of utility. Paper has been
extensively employed."

The government may use its property, produced by taxation,
for the general welfare, and may thus become a joint proprietor
in a national bank like the one contemplated, in which the United
States was to subscribe one-fifth of the $10,000,000 capital.


Finally, "there is a sort of evidence on this point, arising from an aggregate view of the Constitution, which is
of no inconsiderable weight: the very general power of laying and collecting taxes, and appropriating their proceeds—
that of borrowing money indefinitely—that of coining
money, and regulating foreign coins—that oi making all
needful rules and regulations respecting the property of
the United States. These powers combined, as well as
the reason and nature of the thing, speak strongly this
language: that it is the manifest design and scope of the
Constitution to vest in Congress all the powers requisite
to the effectual administration of the finances of the
United States. As far as concerns this object, there appears to be no parsimony of power."

The legality of the first Bank of the United States seems never
to have been questioned in the federal courts. Its charter expired
in 1811.
In 1816 the second Bank of the United States was chartered
by Congress (2 St. L. 266) for twenty years with a capital of $35,000,000, one-fifth of which was subscribed by the United States.
Three-fourths of the amount of private subscriptions was payable
either in coin or in the public debt of the United States contracted
at the time. The bank's notes were made receivable in all payments to he government, the bank was made a depository of the
public money, and was required to transfer the public funds from
place to place, to pay public creditors, and to perform the duties
of loan commissioners in the states.
The validity of this institution was judicially challenged in
the case of McCulloch v. Maryland, 4 Wheat. 316, in 1819. Maryland attempted to tax the issue of notes by a local branch of the
bank, and in defense of this urged, among other reasons, the invalidity of its charter. The cause of the bank was advocated before the United States Supreme Court by Webster, Pinkney, and
Attorney-General Wirt, all great lawyers, who used substantially
Hamilton's arguments. Webster said:
"A bank is a proper and suitable instrument to assist
the operations of the government, in the collection and
disbursement of. the revenue; in the occasional anticipations of taxes and imposts; and in the regulation of the
actual currency, as being a part of the trade, and exchange between the States. It is not for this court to
decide whether a tank, or such a lank as this, be the
best possible means to aid these purposes of government.

Such topics must be left to that discussion which belongs
to them in the two houses of Congress. Here, the only
question is, whether a bank, in its known and ordinary
operations, is capable of being so connected with tho
finances and revenues of the government, as to be fairly
within the discretion of Congress, when selecting means
and instruments to execute its powers and perform Its
duties." 4 Wheat., 325.
The Attorney-General said:
"If, therefore, the act of Congress establishing tho
bank was necessary and proper to carry into execution any
one or more of the enumerated powers, the authority to
pass it is expressly delegated to Congress by the Constitution. We contend that it was necessary and proper to
carry into execution several of the enumerated powers,
such as, the power of levying and collecting taxes throughout this widely extended empire; of paying the public
debts, both in the United States and in foreign countries; of borrowing money, at home and abroad; of regulating commerce with foreign nations, and among the several States; of raising and supporting armies and a navy;
and of carrying on war. That banks dispersed throughout the country are appropriate means of carrying into
execution all these powers, cannot be denied." 4 Wheat,
Pinkney said :
"If, then, all the powers of the national government
are sovereign and supreme; if the power of incorporation
is incidental, and involved in the others; if the degree of
political necessity which will justify a resort to a particular means, to carry into execution the other powers of
the government, can never be a criterion of judicial
determination, but must be left to legislative discrétion;
it only remains to inquire, whether a bank has a natural
and obvious connection with other express or Implied powers, so as to become a necessary and proper means of carrying them into execution. A bank might be established as
a branch of the public administration without incorporation. The government might issue paper upon the credit
of the public faith, pledged for its redemption, or upon
the credit of its property and funds. Let the office where
this paper is issued be made a place of deposit for the
money of individuals, and authorize its officers to discount, and a bank is created. It only wants the forms of
incorporation. But, surely, it will not be pretended that
clothing it with these forms would make such an establishment unconstitutional. In the bank which is actually
established and Incorporated, the United States are joint


stockholders, and appoint joint directors; the secretary of
the treasury has a supervising authority over its affairs;
it is hound, upon his requisition, to transfer the funds of
the government wherever they may be wanted; it performs all the duties of commissioners of the loan office;
it is bound to loan the government a certain amount of
money on demand; its notes are receivable in payment for
public debts and duties; it is Intimately connected, according to the usage of the whole world, with the power of
borrowing money, and with all the financial operations
of the government. It has, also, a close connection with
the power of regulating foreign commerce, and that between the different States. - It provides a circulating
medium, by which that commerce can be more conveniently carried on, and exchanges may be facilitated. It is
true, there are state banks by which a circulating medium
to a certain extent is provided. But that only diminishes
the quantum of necessity, which is no criterion by which
to test the constitutionality of a measure. It is also connected with the power of making all needful regulations
for the government of the territory, 'and other property
of the United States/ If they may establish a corporation
to regulate their territory, they may establish one to regulate their property. Their treasure is their property, and
may be invested in this mode. It is put in partnership;
but not for the purpose of carrying on the trade of banking, as one of the ends for which the government was
established; but only as an instrument or means for executing its sovereign powers. This instrument could not be
rendered effectual for this purpose but by mixing the
property of individuals with that of the public. The bank
could not otherwise acquire a credit for its notes. Universal experience shows that, if altogether a government
bank, it could not acquire, or would soon lose, the confidence of the community." 4 Wheat., 388-90.

The decision of the court unanimously sustained the hank.
Mr, Chief Justice Marshall, in the course of the opinion concurred
in by all the judges, said:
"Although, among the enumerated powers of government, we do not find the word 'bank9 or 'incorporation,9
we find the great powers to lay and collect taxes; to borrow money; to regulate commerce; to declare and conduct
a war; and to raise and support armies and navies. The
sword and the purse, all the external relations, and no
inconsiderable portion of the industry of the nation, are
entrusted to its government. It can never be pretended
that these vast powers draw after them others of inferior

importance, merely because they arc inferior. Such an
idea can never be advanced. But it may with great reason be contended that a government entrusted with such
ample powers, on the due execution of which the happiness
and prosperity of the nation so vitally depends, must also
be entrusted with ample means for their execution. The
power being given, it is the interest of the nation to facilitate Its execution. It can never be their interest, and
cannot be presumed to have been their intention, to clog
and embarrass its execution by withholding the most appropriate means. Throughout this vast republic, from the St.
Croix to the Gulf of Mexico, from the Atlantic to the
Pacific, revenue is to be collected and expended, armies
are to be marched and supported. The exigencies of the
nation may require that the treasure raised in the north
should be transported to the south, that raised in the
east conveyed to the west, or that this order should be
reversed. Is that construction of the Constitution to be
preferred which would render these operations difficult,
hazardous, and expensive? Can we adopt that construction (unless the words imperiously require it), which
would impute to the framers of that instrument, when
granting these powers for the public good, the intention
of impeding their exercise by withholding a choice of
means? If, indeed, such be the mandate of the Constitution, we have only to obey; but that instrument does not
profess to enumerate the means by which the powers it
confers may be executed; nor does it prohibit the creation of a corporation, if the existence of such a being be
essential to the beneficial exercise of those powers. It
is, then, the subject of fair inquiry, how far such means
may be employed.
"It is not denied, that the powers given to the government imply the ordinary means of execution. That,
for example, of raising revenue, and applying it to national
purposes, is admitted to imply the power of conveying
money from place to place, as the exigencies of the nation
may require, and of employing the usual means of conveyance. But it is denied that the government has Its
choice of means; or, that it may employ the most convenient means, if, to employ them, it be necessary to erect
a corporation.
"On what foundation does this argument rest? On this
alone: The power of creating a corporation, is one appertaining to sovereignty, and is not expressly conferred on
Congress. This is true. But all legislative powers appertain to sovereignty. The original power of giving the law
on any subject whatever, is a sovereign power; and if the


government of the Union is restrained from creating a corporation, as a means for performing its functions, on the
single reason that the creation of a corporation is an act
of sovereignty; if the sufficiency of this reason be acknowledged, there would be some difficulty in sustaining the
authority of Congress to pass other laws for the accomplishment of the same objects.
"The government which has a right to do an act, and
has imposed on it the duty of performing that act, must,
according to the dictates of reason, be allowed to select the
means; and those who contend that it may not select any
appropriate means, that one particular mode of effecting
the object is excepted, take upon themselves the burden
of establishing that exception.





''The power of creating a corporation, though appertaining to sovereignty, is not, like the power of making
war, or levying taxes, or of regulating commerce, a great
substantive and independent power, which cannot be implied as incidental to other powers, or used as a means
of executing them. It is never the end for which other
powers are exercised, but a means by which other objects
are accomplished. No contributions are made to charity
for the sake of an incorporation, but a corporation is
created to administer the charity; no seminary of learning is instituted in order to be incorporated, but the corporate character is conferred to subserve the purposes of
education. No city was ever built with the sole object of
being Incorporated, but is incorporated as affording the best
means of being well governed. The power of creating a
corporation is never used for its own sake, but for the
purpose of effecting something else. No sufficient reason
Is, therefore, perceived, why it may not pass as incidental to those powers which are expressly given, if it be a
direct mode of executing them.
"But the Constitution of the United States has not
left the right of Congress to employ the necessary means,
for the execution of the powers conferred on the government, to general reasoning. To its enumeration of powers
is added that of making 'all laws which shall be necessary
and proper, for carrying into execution the foregoing powers, and all other powers vested by this Constitution, in
the government of the United States, or in any department thereof.1
• • • * •
"But the argument on which most reliance is placed,
Is drawn from the peculiar language of this clause. Congress is not empowered by it to make all laws, which may

have relation to the powers conferred on the government,
but. such only as may be •ticccssary and proper* for carrying them into execution. The word 'ncccssary* Is considered as controlling the whole sentence, and as limiting
the right to pass laws for the execution of the granted
powers, to such as are indispensable, and without which
the power would be nugatory. That It excludes the choice
of means, and leaves to Congress, in each case, that only
which is most direct and simple.
"Is it true, that this is the sense in which the word
'necessary' is always used? Docs it always import an
absoluto physical necessity, so strong, that one thing, to
which another may be termed necessary, cannot exist without that other? We think it docs not. If reference be had
to its use, in the common affairs of the world, or in approved authors, we find that it frequently imports no more
than that one thing is convenient, or useful, or essential to
another. To employ the means neccssary to an end, is
generally understood as employing any means calculated to
produce the end, and not as being confined to those single
means, without which the end would be entirely unattainable. * * * A thing may be necessary, very necessary,
absolutely or indispensably necessary. To no mind would
the same idea be conveyed, by these several phrases. This
comment on the word is well illustrated by the passage
cited at the bar from the 10th section of the 1st article of
the Constitution. It is, we think, impossible to compare
the sentence which prohibits a State from laying 'imposts, or duties on imports or exports, except what may be
absolutely necessary for executing its inspection laws/
with that which authorizes Congress 'to make all laws
which shall be necessary and proper for carrying into
execution' the powers of the general government, without
feeling a conviction that the convention understood itself
to change materially the meaning of the word 'necessary/
by prefixing the word 'absolutely/ This word, then, like
others, Is used in various senses; and, in its construction,
the subject, the context, the intention of the person using
them, are all to be taken into view.
"Let this be done in the case under consideration. The
subject is the execution of those great powers on which
the welfare of a nation essentially depends. It must have
been the intention of those who gave these powers, to
Insure, as far as human prudence could insure, their beneficial execution. This could not be done by confiding the
choice of means to such narrow limits as not to leave it
in the power of Congress to adopt any which might be
appropriate, and which were conducive to the end. This

provision is made in a Constitution intended to endure for
ages to come, and, consequently, to be adapted to the
various crises of human affairs. To have prescribed the
means by which government should, in all future time,
execute its powers, would have been to change, entirely,
the character of the instrument, and give it the properties of a legal code. It would have been an unwise attempt
to provide, by immutable rules, for exigencies which, if
foreseen at all, must have been seen dimly, and which can
be best provided for as they occur. To have declared that
the best means shall not be used, but those alone without
which the power given would be nugatory, would have
been to deprive the legislature of the capacity to avail
Itself of experience, to exercise its reason, and to accommodate its legislation to circumstances. If we apply this
principle of construction to any of the powers of the government, we shall find it so pernicious in its operation that
we shall be compelled to discard i t
• * • • •
"So, with respect to the whole penal code of the United
States: whence arises the power to punish in cases not
prescribed by the Constitution? All admit that the government may, legitimately, punish any violation of its
laws; and yet, this is not among the enumerated powers of
Congress. The right to enforce the observance of law,
by punishing its infraction, might be denied with the more
plausibility, because it is expressly given in some cases.
Congress is empowered 'to provide for the punishment of
counterfeiting the securities and current coin of the
United States/ and 'to define and punish piracies and felonies committed on the high seas, and offenses against the
law of nations.' The several powers of Congress may exist,
in a very imperfect state to be sure, but they may exist
and be carried into execution, although no punishment
should be inflicted in cases where the right to punish is not
expressly given.
"Take, for example, the power 'to establish post-offices
and post roads/ This power is executed by the single act
of making the establishment. But, from this has been
Inferred the power and duty of carrying the mail along the
post road, from one post-office to another. And, from this
implied power, has again been inferred the right to punish
those who steal letters from the post-office, or rob the mail.
It may be said, with some plausibility, that the right to
carry the mail, and to punish those who rob it, is not indispensably necessary to the establishment of a post-office and
post road. This right is indeed essential to the beneficial
exercise of the power, but not indispensably necessary to

Its existence. So, of the punishment of the crimes of
stealing or falsifying a record or proccss of a court of the
United States, or of perjury in such court. To punish
these offenses is certainly conducive to the due administration of justice. But courts may exist, and may dccide
the causes brought before them, though such crimes escape
"The baneful influence of this narrow construction on
all the operations of the government, and the absolute
impracticability of maintaining it without rendering the
government incompetent to its great objects, might be illustrated by numerous examples drawn from the Constitution,
and from our laws. The good sense of the public has pronounced, without hesitation, that the power of punishment
appertains to sovereignty, and may be exercieed whenever
the sovereign has a right to act, as incidental to his con*
etitutional powers. It is a means of carrying into execution all sovereign powers, and may be used, although not
Indispensably necessary. It is a right incidental to tho
power, and conducive to its beneficial exercise.
"If this limited construction of the word 'necessary4
must be abandoned in order to punish, whence is derived
the rule which would reinstate it, when the government
would carry its powers into execution by means not vin*
dictive in their nature? If the word 'necessary' means
'needful/ 'requisite/ 'essential/ 'conducive to/ in order to
let in the power of punishment for the infraction of law;
why is It not equally comprehensive when required to
authorize the use of means which facilitate the execution
of the powers of government without the Infliction of punishment?
• • 9 • •
"We admit, as all must admit, that the powers of the
government are limited, and that its limits are not to be
transcended. But we think the sound construction of the
constitution must allow to the national legislature that
discretion, with respect to the means by which the powers
it confers are to be carried into execution, which will
enable that body to perform the high duties assigned to It,
In the manner most beneficial to the people. Let the end
be legitimate, let it be within the scope of the Constitution, and all means which are appropriate, which are
plainly adapted to that end, which are not prohibited, but
consist with the letter and spirit of the Constitution, are
• » • • +
"If a corporation may be employed indiscriminately
with other means to carry into execution the powers of



the government, no particular reason can he assigned for
excluding the use of a bank, if required for its fiscal
operations. To use one must be within the discretion of
Congress, if it be an appropriate mode of executing the
powers of government. That it is a convenient, a useful,
and essential instrument in the prosecution of its fiscal
operations, is not now a subject of controversy. All those
who have been concerned in the administration of our
finances have concurred in representing its Importance and
necessity; and so strongly have they been felt, that statesmen of the first class, whose previous opinions against it
had been confirmed by every circumstance which can fix
the human judgment, have yielded those opinions to the
exigencies of the nation. Under the confederation, Congress» justifying the measure by its necessity, transcended
perhaps its powers to obtain the advantage of a bank;
and our own legislation attests the universal conviction of
the utility of this measure. The time has passed away
when it can be necessary to enter into any discussion in
order to prove the importance of this instrument, as a
means to effect the legitimate objects of the government."
4 Wheat., 407-23, passim.
In Fleckner v. U. S. Bank, 8 Wheat. 338 (1823), the power of
the bank to discount promissory notes in the course of its banking
operations was upheld, and in Osborn v. U. S. Bank, 9 Wheat. 738
(1824), the decision in McCulloch v. Maryland was elaborately
reviewed and affirmed. The following extracts from the opinion,
also by Marshall, deal particularly with the constitutionality of the
private aspects of national banking.
"The whole opinion of the court, in the case of McCulloch v. The State of Maryland, is founded on, and sustained by, the idea that the bank is an instrument which
Is 'necessary and proper for carrying into effect the powers vested in the government of the United States.9 It is
not an instrument which the government found ready
made, and has supposed to be adapted to its purpose; but
one which was created in the form in which it now appears,
for national purposes only. It is, undoubtedly, capable of
transacting private as well as public business. While it
is the great instrument by which the fiscal operations of
the government are effected, it is also trading with individuals for its own advantage. The appellants endeavor
to distinguish between this trade and its agency for the
public, between its banking operations and those qualities
which it possesses in common with every corporation,
such as individuality, immortality, etc. While they seem

to admit the right to preserve this corporate existence, they
deny the right to protect it in its trade and business.
» • • • •
"Let this distinction be considered.
"Why is it that Congress can Incorporate or create a
bank? This question was answered in the case of AfcCulloch v. The State of Maryland. It is an instrument
which is 'necessary and proper' for carrying on the fiscal
operations of government. Can this instrument, on any
rational calculation, effect its objcct, unless it be endowed
with that faculty of lending and dealing in money which
is conferred by its charter? If it can, if it be as competent to the purposes of government without as with this
faculty, there will be much difficulty in sustaining that
essential part of the charter. If it cannot, then this faculty
is necessary to the legitimate operations of government,
and was constitutionally and rightfully engrafted on tho
Institution. It is, in that view of the subject, the vital
part of the corporation; it is its soul; and the right to pre*
serve it originates in the same principle, with the right to
preserve the skeleton or body which it animates. The distinction between destroying what is dominated the corporate franchise, and destroying its vivifying principle, is
precisely as Incapable of being maintained, as a distinction
between the right to sentence a human being to death,
and a right to sentence him to a total privation of sustenance during life. Deprive a bank of its trade and business, which is its sustenance, and its immortality, if it
have that property, will be a very useless attribute.
"This distinction, then, has no real existence. To tax
its faculties, its trade, and occupation, is to tax the bank
itself. To destroy or preserve the one, is to destroy or pre
serve the other.
"It is urged, that Congress has not, by this act of Incorporation, created the faculty of trading in money; that it
had anterior existence, and may be carried on by a private individual, or company, as well as by a corporation.
As this profession or business may be taxed, regulated,
or restrained, when conducted by an individual, it may,
likewise, be taxed, regulated, or restrained, when conducted
by a corporation.
"The general correctness of these propositions need not
be controverted. Their particular application to the question before the court is alone to be considered. We do not
maintain that the corporate character of the bank exempts its operations from the action of state authority.
If an individual were to be endowed with the same faculties, for the same purposes, he would be equally protected


in the exercise of those faculties. The operations of the
bank are believed not only to yield the compensation for
Its services to the government, but to be essential to the
performance of those services. Those operations give its
value to the currency in which all the transactions of the
government are conducted. They are, therefore, inseparably connected with those transactions. They enable
the bank to render those services to the nation for which
it was created, and are, therefore, of the very essence of
Its character, as national instruments. The business of
the bank constitutes its capacity to perform its functions,
as a machine for the money transactions of the government Its corporate character is merely an Incident,
which enables It to transact that business more beneficially.
"Congress was of opinion that these faculties were
necessary, to enable the bank to perform the services
which are exacted from it, and for which it was created.
This was certainly a question proper for the considerar
tion of the national legislature. But, were it now to undergo revision, who would have the hardihood to say,
that, without the employment of a banking capital, those
services could be performed? That the exercise of these
faculties greatly facilitates the fiscal operations of the government, is too obvious for controversy; and who will
venture to affirm, that the suppression of them would not
materially affect those operations, and essentially impair,
if not totally destroy, the utility of the machine to the
government? The currency which it circulates, by means
of its trade with individuals, is believed to make it a more
-fit instrument for the purposes of government, than it
could otherwise be; and, if this be true, the capacity to
carry on this trade is a faculty indispensable to the character and objects of the institution.
"The appellants admit that, if this faculty be necessary to make the bank a fit instrument for the purposes
of the government, Congress possesses the same power to
protect the machine in this, as in its direct fiscal operations; but they deny that it is necessary to those purposes, and insist that it is granted solely for the benefit
of the members of the corporation. Were this proposition
to be admitted, all the consequences >rhich are drawn from
It might follow. But it is not admitted. The court has
already stated its conviction, that without this capacity to
trade with individuals, the bank would be a very defective
instrument, when considered with a single view to its fitness for the purposes of government. On this point the
whole argument rests." 9 Wheat., 860-65, passim.



The charter of the Second Bank of the United States was not
renewed upon its expiration in 1836, and there was no further
federal legislation upon the subject until it was called forth by the
exigencies of the Civil War. The principal acts concerning currency
and banking passed at this period were those authorizing the issue
of circulating notes directly by the government (12 St. L. 259, 313,
338), later issues of which were made a legal tender for debts
(12 St. L. 345, 370, 532, 7 1 0 ) ; those authorizing the formation
of national banks with the power to issue notes based upon the
deposit of United States bonds (12 St. L. 665; 13 lb. 9 9 ) ; and
the prohibitive tax of ten per cent upon the circulation of all notes
other than those of the United States and of national banks (13
St. L. 484; 14 lb. 146). Fractional currency was also issued (12
St. L. 711). All of these acts were finally upheld, upon grounds
attributing to the United States a complete control over the currency of the country. Even the first legal tender case (Hepburn
v. Griswold, 8 Wall. 603), which by a divided court denied that
Congress could make its notes a legal tender for prior debts, contained affirmations by all*the judges of the validity of government
or national bank notes not a legal tender.
In Veazie Bank v. Fenno, 8 Wall. 533 (1869), the court upheld
the federal tax of ten per cent upon non-federal circulating notes
by the following reasoning:
"It cannot be doubted that under the Constitution the
power to provide a circulation of coin is given to Congress.
And it is settled by the uniform practice of the govern*
ment and by repeated decisions, that Congress may constitutionally authorize the emission of bills of credit. It Is
not important here to decide whether the quality of legal
tender, in payment of debts, can be constitutionally imparted to these bills; it is enough to say that there can be
no question of the power of the government to emit them;
to make them receivable in payment of debts to itself; to
fit them for use by those who see fit to use them in all the
transactions of commerce; to provide for their redemption;
to make them a currency, uniform in value and description,
and convenient and useful for circulation. These powers,
until recently, were only partially and occasionally exercised. Lately, however, they have been called into full
activity, and Congress has undertaken to supply a currency
for the entire country.
"The methods adopted for the supply of this currency were briefly explained in the first part of this opinion. It now consists of coin, of United States notes, and


of the notes of the national banks. Both descriptions
of notes may be properly described as bills of credit, for
both .are furnished by the government; both are issued
on the credit of the government; and the government is
responsible for the redemption of both; primarily as to the
first description, and immediately upon default of the bank,
as to the second. When these bills shall be made convertible into coin, at the will of the holder, this currency
will, perhaps, satisfy the wants of the community, In
respect to a circulating medium, as perfectly as any
mixed currency that can be devised.
"Having thus, in the exercise of undisputed constitutional powers, undertaken to provide a currency for the
whole country, it cannot be questioned that Congress may,
constitutionally, secure the benefit of it to the people by
appropriate legislation. To this end, Congress has denied
the quality of legal tender to foreign coins, and has provided by law against the imposition of counterfeit and base
coin on the community. To the same end. Congress may
restrain, by suitable enactments, the circulation as money
of any notes not issued under its own authority. Without
this power, indeed, its attempts to secure a sound and uniform currency for the country must be futile/9 8 Wall,

In Hepburn v. Griswold, 8 Wall. 603 (1870), the majority of
the court said:
"Let It be considered what has actually been done in
the provision of a national currency. In July and August,
1861, and February, 1862, the issue of sixty millions of dollars in United States notes, payable on demand, was authorized. (12 Stat at Large, 259. 818, and 838.) They
were made receivable in payments, but were not declared
a legal tender until March, 1862 (12 Stat at Large, 370),
when the amount in circulation had been greatly reduced
by receipt and cancellation. In 1862 and 1863 (12 Stat
at Large, 345, 532 and 709) the issue of four hundred and
fifty millions in the United States notes, payable not on
demand, but, in effect, at the convenience of the government, was authorized, subject to certain restrictions as
to fifty millions. These notes were made receivable for the
bonds of the national loans, for all debts due to or from
the United States, except duties on Imports and interest
on the public debt, and were also declared a legal tender.
In March, 1863 (12 Stat at Large, Til), the issue of notes
for parts of a dollar was authorized to an amount not exceeding fifty millions of dollars. These notes were not
declared a legal tender, but were made redeemable under
regulations to be prescribed by the secretary of the treaa-



ury. In February, 1863 (12 Stat, at Large, 669), the Issue
of three hundred millions of dollars in notes of the national banking associations was authorized. These notes
were made receivable to the same extent as United States
notes, and provision was made to secure their redemption,
but they were not made a legal tender.
"The several descriptions of notes have since constt*
tuted, under the various acts of Congress, the common
currency of the United States.





"No one questions the general constitutionality, and
not very many, perhaps, the general expediency of the legislation by which a note currency haB been authorized In
recent years. The doubt is as to the power to declare a
particular class of these notes to be a legal tender In payment of pre-existing debts." 8 Wall, 618-19.

This doubt the majority decided against the existence of the
power, and were overruled a year later in the Legal Tender Cases,
12 Wall. 457 (1871). Mr. Justice Strong, giving the opinion of
the court in this case, said:
"It may be conceded that Congress is not authorized
to enact laws in furtherance even of a legitimate end,
merely because they are useful, or because they make the
government stronger. There must be some relation between the means and the end; some adaptedness or appropriateness of the laws to carry into execution the powers
created by the Constitution. But when a statute