The Project Gutenberg eBook, Readings in Money and Banking, by Chester Arthur Phillips

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Title: Readings in Money and Banking

Selected and Adapted

Author: Chester Arthur Phillips

Release Date: January 30, 2011 [eBook #35120]

Language: English

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Assistant Professor of Economics in Dartmouth College
and Assistant Professor of Banking in the Amos
Tuck School of Administration and Finance

New York



All rights reserved


Copyright 1916


Set up and electrotyped. Published September, 1916.





Designed mainly for class room use in connection with one of the introductory manuals on the subject of Money and Banking or of Money and Currency, this volume, in itself, lays no claim to completeness. Where its use is contemplated the problems of emphasis and proportion are, accordingly, to be solved by the selection of one or another of the available texts, or by the choice of supplementary lecture topics and materials. The contents of the introductory manuals are so divergent in character as to render possible combinations of text and readings that will include, it is hoped, matter of such range and variety as may be desired.

Fullness of treatment has been attempted, however, in the chapters dealing with the important recent developments in the "mechanism of exchange," and my aim has been throughout to select and, in many instances, to adapt with a view to meeting the wants of those who are interested chiefly in the modern phases of the subject.

For valuable suggestions in the preparation of the volume I am greatly indebted to Professors F. H. Dixon and G. R. Wicker and Mr. J. M. Shortliffe of Dartmouth, Professor Hastings Lyon of Columbia, Professor E. E. Day of Harvard, and to my former teacher, Professor F. R. Fairchild of Yale. I desire also to mention my great obligation to authors and publishers who alike have generously permitted the reproduction of copyrighted material.

Chester Arthur Phillips.

Dartmouth College,
Hanover, N. H., July, 1916.



I The Origin and Functions of Money 1

II The Early History of Money 10

III Qualities of the Material of Money 18

IV Legal Tender 26

V The Greenback Issues 33

VI International Bimetallism 71

VII The Silver Question in the United States 82

VIII Index Numbers 115

IX Banking Operations and Accounts 121

X The Use of Credit Instruments in Payments in the United States 150

XI A Symposium on the Relation Between Money and General Prices 159

XII The Gold Exchange Standard 213

XIII A Plan for a Compensated Dollar 229

XIV Monetary Systems of Foreign Countries 246

XV The Nature and Functions of Trust Companies 256

XVI Savings Banks 270

XVII Domestic Exchange 290

XVIII Foreign Exchange 305

XIX Clearing Houses 355

XX State Banks and Trust Companies Since the Passage of the National Bank Act 381

XXI The Canadian Banking System 406

XXII The English Banking System 435

XXIII The Scotch Banks 474

XXIV The French Banking System 488

XXV The German Banking System 526

XXVI Banking in South America 559

XXVII Agricultural Credit in the United States 575

XXVIII The Concentration of Control of Money and Credit 606

XXIX Crises 627

XXX The Weaknesses of Our Banking System Prior to
the Establishment of the Federal Reserve System

XXXI The Federal Reserve System 723

XXXII The European War in Relation to Money, Banking and Finance 797

Appendices 830

[Pg 1]




[1]In order to understand the manifold functions of a Circulating Medium, there is no better way than to consider what are the principal inconveniences which we should experience if we had not such a medium. The first and most obvious would be the want of a common measure for values of different sorts. If a tailor had only coats, and wanted to buy bread or a horse, it would be very troublesome to ascertain how much bread he ought to obtain for a coat, or how many coats he should give for a horse. The calculation must be recommenced on different data, every time he bartered his coats for a different kind of article; and there could be no current price, or regular quotations of value. Whereas now each thing has a current price in money, and he gets over all difficulties by reckoning his coat at £4 or £5, and a four-pound loaf at 6d. or 7d. As it is much easier to compare different lengths by expressing them in a common language of feet and inches, so it is much easier to compare values by means of a common language of pounds, shillings, and pence. In no other way can values be arranged one above another in a scale: in no other can a person conveniently calculate the sum of his possessions; and it is easier to ascertain and remember the relations of many things to one thing, than their innumerable cross relations with one another. This advantage of having a common language in which values may be expressed, is, even by itself, so important, that some such mode of expressing and computing them would probably[Pg 2] be used even if a pound or a shilling did not express any real thing, but a mere unit of calculation. It is said that there are African tribes in which this somewhat artificial contrivance actually prevails. They calculate the value of things in a sort of money of account, called macutes. They say, one thing is worth ten macutes, another fifteen, another twenty. There is no real thing called a macute: it is a conventional unit, for the more convenient comparison of things with one another.

This advantage, however, forms but an inconsiderable part of the economical benefits derived from the use of money. The inconveniences of barter are so great, that without some more commodious means of effecting exchanges, the division of employments could hardly have been carried to any considerable extent. A tailor, who had nothing but coats, might starve before he could find any person having bread to sell who wanted a coat: besides, he would not want as much bread at a time as would be worth a coat, and the coat could not be divided. Every person, therefore, would at all times hasten to dispose of his commodity in exchange for anything which, though it might not be fitted to his own immediate wants, was in great and general demand, and easily divisible, so that he might be sure of being able to purchase with it, whatever was offered for sale. The primary necessaries of life possess these properties in a high degree. Bread is extremely divisible, and an object of universal desire. Still, this is not the sort of thing required: for, of food, unless in expectation of a scarcity, no one wishes to possess more at once than is wanted for immediate consumption; so that a person is never sure of finding an immediate purchaser for articles of food; and unless soon disposed of, most of them perish. The thing which people would select to keep by them for making purchases, must be one which, besides being divisible, and generally desired, does not deteriorate by keeping. This reduces the choice to a small number of articles.

By a tacit concurrence, almost all nations, at a very early period, fixed upon certain metals, and especially gold and silver, to serve this purpose. No other substances unite the necessary qualities in so great a degree, with so many subordinate advantages. Next to food and clothing, and in some climates[Pg 3] even before clothing, the strongest inclination in a rude state of society is for personal ornament, and for the kind of distinction which is obtained by rarity or costliness in such ornaments. After the immediate necessities of life were satisfied, every one was eager to accumulate as great a store as possible of things at once costly and ornamental; which were chiefly gold, silver, and jewels. These were the things which it most pleased every one to possess, and which there was most certainty of finding others willing to receive in exchange for any kind of produce. They were among the most imperishable of all substances. They were also portable, and containing great value in small bulk, were easily hid; a consideration of much importance in an age of insecurity. Jewels are inferior to gold and silver in the quality of divisibility; and are of very various qualities, not to be accurately discriminated without great trouble. Gold and silver are eminently divisible, and when pure, always of the same quality; and their purity may be ascertained and certified by a public authority.

Accordingly, though furs have been employed as money in some countries, cattle in others, in Chinese Tartary cubes of tea closely pressed together, the shells called cowries on the coast of Western Africa, and in Abyssinia at this day blocks of rock salt; though even of metals, the less costly have sometimes been chosen, as iron in Lacedæmon from ascetic policy, copper in the early Roman republic from the poverty of the people; gold and silver have been generally preferred by nations which were able to obtain them, either by industry, commerce, or conquest. To the qualities which originally recommended them, another came to be added, the importance of which only unfolded itself by degrees. Of all commodities, they are among the least influenced by any of the causes which produce fluctuations of value. They fluctuate less than almost any other things in their cost of production. And from their durability, the total quantity in existence is at all times so great in proportion to the annual supply, that the effect on value even of a change in the cost of production is not sudden: a very long time being required to diminish materially the quantity in existence, and even to increase it very greatly not being a rapid process. Gold and silver, therefore, are more[Pg 4] fit than any other commodity to be the subject of engagements for receiving or paying a given quantity at some distant period. If the engagement were made in corn, a failure of crops might increase the burthen of the payment in one year to fourfold what was intended, or an exuberant harvest sink it in another to one-fourth. If stipulated in cloth, some manufacturing invention might permanently reduce the payment to a tenth of its original value. Such things have occurred even in the case of payments stipulated in gold and silver; but the great fall of their value after the discovery of America, is, as yet, the only authenticated instance; and in this case the change was extremely gradual, being spread over a period of many years.

When gold and silver had become virtually a medium of exchange, by becoming the things for which people generally sold, and with which they generally bought, whatever they had to sell or to buy; the contrivance of coining obviously suggested itself. By this process the metal was divided into convenient portions, of any degree of smallness, and bearing a recognized proportion to one another; and the trouble was saved of weighing and assaying at every change of possessors, an inconvenience which on the occasion of small purchases would soon have become insupportable. Governments found it their interest to take the operation into their own hands, and to interdict all coining by private persons; indeed, their guarantee was often the only one which would have been relied on, a reliance however which very often it ill deserved; profligate governments having until a very modern period seldom scrupled, for the sake of robbing their creditors, to confer on all other debtors a licence to rob theirs, by the shallow and impudent artifice of lowering the standard; that least covert of all modes of knavery, which consists in calling a shilling a pound, that a debt of a hundred pounds may be cancelled by the payment of a hundred shillings. It would have been as simple a plan, and would have answered the purpose as well, to have enacted that "a hundred" should always be interpreted to mean five, which would have effected the same reduction in all pecuniary contracts, and would not have been at all more shameless. Such strokes of policy have not wholly ceased to be recommended, but they have ceased to be practised;[Pg 5] except occasionally through the medium of paper money, in which case the character of the transaction, from the greater obscurity of the subject, is a little less barefaced.

Money, when its use has grown habitual, is the medium through which the incomes of the different members of the community are distributed to them, and the measure by which they estimate their possessions. As it is always by means of money that people provide for their different necessities, there grows up in their minds a powerful association leading them to regard money as wealth in a more peculiar sense than any other article; and even those who pass their lives in the production of the most useful objects, acquire the habit of regarding those objects as chiefly important by their capacity of being exchanged for money. A person who parts with money to obtain commodities, unless he intends to sell them, appears to the imagination to be making a worse bargain than a person who parts with commodities to get money; the one seems to be spending his means, the other adding to them. Illusions which, though now in some measure dispelled, were long powerful enough to overmaster the mind of every politician, both speculative and practical, in Europe.

It must be evident, however, that the mere introduction of a particular mode of exchanging things for one another, by first exchanging a thing for money, and then exchanging the money for something else, makes no difference in the essential character of transactions. It is not with money that things are really purchased. Nobody's income (except that of the gold or silver miner) is derived from the precious metals. The pounds or shillings which a person receives weekly or yearly, are not what constitutes his income; they are a sort of tickets or orders which he can present for payment at any shop he pleases, and which entitle him to receive a certain value of any commodity that he makes choice of. The farmer pays his laborers and his landlord in these tickets, as the most convenient plan for himself and them; but their real income is their share of his corn, cattle, and hay, and it makes no essential difference whether he distributes it to them directly or sells it for them and gives them the price; but as they would have to sell it for money if he did not, and he is[Pg 6] a seller at any rate, it best suits the purposes of all, that he should sell their share along with his own, and leave the laborers more leisure for work and the landlord for being idle. The capitalists, except those who are producers of the precious metals, derive no part of their income from those metals, since they only get them by buying them with their own produce: while all other persons have their incomes paid to them by the capitalists, or by those who have received payment from the capitalists, and as the capitalists have nothing, from the first, except their produce, it is that and nothing else which supplies all incomes furnished by them. There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labor. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order.

The introduction of money does not interfere with the operation of any of the Laws of Value.... The reasons which make the temporary or market value of things depend on the demand and supply, and their average and permanent values upon their cost of production, are as applicable to a money system as to a system of barter. Things which by barter would exchange for one another, will, if sold for money, sell for an equal amount of it, and so will exchange for one another still, though the process of exchanging them will consist of two operations instead of only one. The relations of commodities to one another remain unaltered by money: the only new relation introduced, is their relation to money itself; how much or how little money they will exchange for; in other words, how the Exchange Value of money itself is determined. And this is not a question of any difficulty, when the illusion is dispelled, which caused money to be looked upon as a peculiar thing, not governed by the same laws as other things. Money is a commodity, and its value is determined like that of other commodities, temporarily by demand and supply, permanently and on the average by cost of production.[Pg 7]

In the foregoing,[2] attention has been directed mainly to the two functions of money known (1) as the Standard or Common Denominator of Value, and (2) as the Medium of Exchange. Concerning transactions begun and ended on the spot nothing more need be said; but the fact of contracts over a period of time introduces an important element—the time element. Whenever a contract is made covering a period of time, within which serious changes in the economic world may take place, then difficulties may arise as to what is a just standard of payments. Various articles might serve equally well as a standard for exchanges performed on the spot, but it is not so when any one article is chosen as a standard for deferred payments. Without much regard to theory, the world has in fact used the same standard for transactions whether settled on the spot, or whether extending over a period of time.

In order to work with perfection as a standard for deferred payments, the article chosen as that standard should place both debtors and creditors in exactly the same absolute, and the same relative, position to each other at the end of a contract that they occupied at its beginning; this implies that the chosen article should maintain the same exchange value in relation to goods, rents, and the wages of labour at the end as at the beginning of the contract, and it implies that the borrower and lender should preserve the same relative position as regards their fellow producers and consumers at the later as at the earlier point of time, and that they have not changed this relation, one at the loss of the other. This makes demands which any article that can be suggested as a standard cannot satisfy. And yet it is a practical necessity of society that some one article should in fact be selected as the standard. The business world has thus been forced to find some commodity which—while admittedly never capable of perfection—provides more nearly than anything else all the essentials of a desirable standard.

The causes which may bring about changes in the relations between goods and labor, on the one side, and the standard, on[Pg 8] the other, are various. We may, for instance, compare wheat with the existing gold standard. The quantity of gold for which the wheat will exchange is its price. As wheat falls in value relatively to gold, it exchanges for less gold, that is, its price falls; or, vice versa, gold exchanges for more wheat, and relatively to wheat gold has risen. As one goes up, the other term in the ratio necessarily goes down; just as certainly as a rise in one end of a plank balanced on a log necessitates a fall in the other end of the plank. Therefore, changes in prices can be caused by forces affecting either the gold side or the wheat side of the ratio; by forces affecting either the money standard or the goods compared with that standard. Consequences of importance follow from this explanation. First suppose that commodities and labor remain unchanged in their production and reward, respectively; then, anything affecting the supply of and demand for gold will affect in general the value of gold in comparison with goods and labor. Or, second, if we suppose an equilibrium between the demand for and supply of gold, then, prices and wages can be affected also by anything affecting the cost of obtaining goods or labor. It is one-sided to look for changes in prices solely from causes touching gold, or one term of the price ratio. If, however, it should be desired that prices should remain stationary, then this can be brought about only by finding for the standard an article that would automatically move in extent, and in the proper compensating direction, so as to meet any changes in value arising not only from causes affecting itself, but also from causes affecting labor and the vast number of goods that may be quoted in price. No commodity ever existed which could thus move in value.

During long periods of time—within which gains in mechanical skill and invention, revolutions in political and social habits, changes in taste or fashion, settlement of new countries, opening of new markets, may take place—great alterations in the value of the standard may occur wholly from natural causes affecting the commodity side of the price ratio. And yet, in default of a perfect standard, persons who borrow and lend create debts and obligations expressed in terms of that article which has been adopted as the standard[Pg 9] by the concurring habits of the commercial community of which they form a part. It should be understood, whenever men enter into obligations reaching over a period of time, that a necessary part of the risks involved in this undertaking is the possibility of an alteration in the exchange values of goods, on the one hand, and in the standard metal on the other, due to industrial changes and natural causes. This is one of the risks which belong to individual enterprise, differing in no way from other possibilities of gain and loss. For instance, prices rose, as indicated by an index number of 100 in 1860 to an index number of 216 in 1865. Therefore, in the United States, in this period of rising prices the creditor lost and the debtor gained. On the other hand, from 1865 to 1878, prices fell from 216 to 101, and in this period of falling prices the creditor gained and the debtor lost. It is to be observed, however, that these figures refer to actual quotations of prices during the fluctuations of our paper money. But it is evident in such movements as these, that parties to a time-contract must take their own chances of changes; and indeed it is much more wholesome that they should do so.

It should be kept well in mind that it is not a proper function of government to step in and save men from the ordinary risks of trade and industry. It goes without saying that if changes in the value of the standard due to natural causes take place during the continuance of a contract, it is not the business of government to indemnify either party to the contract. This is a matter on which every individual who enters into time obligations must bear his own responsibility.


[1] John Stuart Mill, Principles of Political Economy, Vol. II, pp. 17-23.

[2] Adapted from The Report of the Commission of the Indianapolis Convention, pp. 92, 93, 103, 104. The University of Chicago Press, 1898.

[Pg 10]



[3]Living in civilized communities, and accustomed to the use of coined metallic money, we learn to identify money with gold and silver; hence spring hurtful and insidious fallacies. It is always useful, therefore, to be reminded of the truth, so well stated by Turgot, that every kind of merchandise has the two properties of measuring value and transferring value. It is entirely a question of degree what commodities will in any given state of society form the most convenient currency, and this truth will be best impressed upon us by a brief consideration of the very numerous things which have at one time or other been employed as money. Though there are many numismatists and many political economists, the natural history of money is almost a virgin subject, upon which I should like to dilate; but the narrow limits of my space forbid me from attempting more than a brief sketch of the many interesting facts which may be collected.

Currency in the Hunting State

Perhaps the most rudimentary state of industry is that in which subsistence is gained by hunting wild animals. The proceeds of the chase would, in such a state, be the property of most generally recognized value. The meat of the animals captured would, indeed, be too perishable in nature to be hoarded or often exchanged; but it is otherwise with the skins, which, being preserved and valued for clothing, became one of the earliest materials of currency. Accordingly, there is abundant evidence that furs or skins were employed as money in many ancient nations. They serve this purpose to the present day in some parts of the world.[Pg 11]

In the book of Job (ii, 4) we read, "Skin for skin, yea, all that a man hath will he give for his life"; a statement clearly implying that skins were taken as the representative of value among the ancient Oriental nations. Etymological research shows that the same may be said of the northern nations from the earliest times. In the Esthonian language the word râha generally signifies money, but its equivalent in the kindred Lappish tongue has not yet altogether lost the original meaning of skin or fur. Leather money is said to have circulated in Russia as late as the reign of Peter the Great, and it is worthy of notice, that classical writers have recorded traditions to the effect that the earliest currency used at Rome, Lacedæmon, and Carthage, was formed of leather.

We need not go back, however, to such early times to study the use of rude currencies. In the traffic of the Hudson's Bay Company with the North American Indians, furs, in spite of their differences of quality and size, long formed the medium of exchange. It is very instructive, and corroborative of the previous evidence to find that even after the use of coin had become common among the Indians the skin was still commonly used as the money of account. Thus Whymper says, "a gun, nominally worth about forty shillings, bought twenty 'skins.' This term is the old one employed by the company. One skin (beaver) is supposed to be worth two shillings, and it represents two marten, and so on. You heard a great deal about 'skins' at Fort Yukon, as the workmen were also charged for clothing, etc., in this way."

Currency in the Pastoral State

In the next higher stage of civilization, the pastoral state, sheep and cattle naturally form the most valuable and negotiable kind of property. They are easily transferable, convey themselves about, and can be kept for many years, so that they readily perform some of the functions of money.

We have abundance of evidence, traditional, written, and etymological, to show this. In the Homeric poems oxen are distinctly and repeatedly mentioned as the commodity in terms of which other objects are valued. The arms of Diomed are stated to be worth nine oxen, and are compared with those of[Pg 12] Glaucos, worth one hundred. The tripod, the first prize for wrestlers in the 23rd Iliad, was valued at twelve oxen, and a woman captive, skilled in industry, at four. It is peculiarly interesting to find oxen thus used as the common measure of value, because from other passages it is probable, as already mentioned, that the precious metals, though as yet uncoined, were used as a store of value, and occasionally as a medium of exchange. The several functions of money were thus clearly performed by different commodities at this early period.

In several languages the name for money is identical with that of some kind of cattle or domesticated animal. It is generally allowed that pecunia, the Latin word for money, is derived from pecus, cattle. From the Agamemnon of Æschylus we learn that the figure of an ox was the sign first impressed upon coins, and the same is said to have been the case with the earliest issues of the Roman As. Numismatic researches fail to bear out these traditions, which were probably invented to explain the connection between the name of the coin and the animal. A corresponding connection between these notions may be detected in much more modern languages. Our common expression for the payment of a sum of money is fee, which is nothing but the Anglo-Saxon feoh, meaning alike money and cattle, a word cognate with the German vieh, which still bears only the original meaning of cattle.

In the ancient German codes of law, fines and penalties are actually defined in terms of live-stock. In the Zend Avesta, as Professor Theodores ... informs me, the scale of rewards to be paid to physicians is carefully stated, and in every case the fee consists in some sort of cattle. The fifth and sixth lectures in Sir H. S. Maine's most interesting work on The Early History of Institutions, which has just been published, are full of curious information showing the importance of live-stock in a primitive state of society. Being counted by the head, the kine was called capitale, whence the economical term capital, the law term chattel, and our common name cattle.

In countries where slaves form one of the most common and valuable possessions, it is quite natural that they should[Pg 13] serve as the medium of exchange like cattle. Pausanias mentions their use in this way, and in Central Africa and some other places where slavery still flourishes, they are the medium of exchange along with cattle and ivory tusks. According to Earl's account of New Guinea, there is in that island a large traffic in slaves, and a slave forms the unit of value. Even in England slaves are believed to have been exchanged at one time in the manner of money.

Articles of Ornament as Currency

A passion for personal adornment is one of the most primitive and powerful instincts of the human race, and as articles used for such purposes would be durable, universally esteemed, and easily transferable, it is natural that they should be circulated as money. The wampumpeag of the North American Indians is a case in point, as it certainly served as jewellery. It consisted of beads made of the ends of black and white shells, rubbed down and polished, and then strung into belts or necklaces, which were valued according to their length, and also according to their color and luster, a foot of black peag being worth two feet of white peag. It was so well established as currency among the natives that the Court of Massachusetts ordered in 1649, that it should be received in the payment of debts among settlers to the amount of forty shillings. It is curious to learn, too, that just as European misers hoard up gold and silver coins, the richer Indian chiefs secrete piles of wampum beads, having no better means of investing their superfluous wealth.

Exactly analogous to this North American currency, is that of the cowry shells, which, under one name or another—chamgos, zimbis, bouges, porcelanes, etc.—have long been used in the East Indies as small money. In British India, Siam, the West Coast of Africa, and elsewhere on the tropical coasts, they are still used as small change, being collected on the shores of the Maldive and Laccadive Islands, and exported for the purpose. Their value varies somewhat, according to the abundance of the yield, but in India the current rate used to be about five thousand shells for one rupee, at which rate each shell is worth about the two-hundredth part of a penny.[Pg 14] Among our interesting fellow-subjects, the Fijians, whale's teeth served in the place of cowries, and white teeth were exchanged for red teeth somewhat in the ratio of shillings to sovereigns.

Among other articles of ornament or of special value used as currency, may be mentioned yellow amber, engraved stones, such as the Egyptian scarabæi, and tusks of ivory.

Currency in the Agricultural State

Many vegetable productions are at least as well suited for circulation as some of the articles which have been mentioned. It is not surprising to find, then, that among a people supporting themselves by agriculture, the more durable products were thus used. Corn has been the medium of exchange in remote parts of Europe from the time of the ancient Greeks to the present day. In Norway corn is even deposited in banks, and lent and borrowed. What wheat, barley, and oats are to Europe, such is maize in parts of Central America, especially Mexico, where it formerly circulated. In many of the countries surrounding the Mediterranean, olive oil is one of the commonest articles of produce and consumption; being, moreover, pretty uniform in quality, durable, and easily divisible, it has long served as currency in the Ionian Islands, Mytilene, some towns of Asia Minor, and elsewhere in the Levant.

Just as cowries circulate in the East Indies, so cacao nuts, in Central America and Yucatan, form a perfectly recognized and probably an ancient fractional money. Travellers have published many distinct statements as to their value, but it is impossible to reconcile these statements without supposing great changes of value either in the nuts or in the coins with which they are compared. In 1521, at Caracas, about thirty cacao nuts were worth one penny English, whereas recently ten beans would go to a penny, according to Squier's statements. In the European countries, where almonds are commonly grown, they have circulated to some extent like the cacao nuts, but are variable in value, according to the success of the harvest.

It is not only, however, as a minor currency that vegetable[Pg 15] products have been used in modern times. In the American settlements and the West India Islands, in former days, specie used to become inconveniently scarce, and the legislators fell back upon the device of obliging creditors to receive payment in produce at stated rates. In 1618, the Governor of the Plantations of Virginia ordered that tobacco should be received at the rate of three shillings for the pound weight, under the penalty of three years' hard labor. We are told that, when the Virginia Company imported young women as wives for the settlers, the price per head was one hundred pounds of tobacco, subsequently raised to one hundred and fifty. As late as 1732, the legislature of Maryland made tobacco and Indian corn legal tenders; and in 1641 there were similar laws concerning corn in Massachusetts. The governments of some of the West India Islands seem to have made attempts to imitate these peculiar currency laws, and it was provided that the successful plaintiff in a lawsuit should be obliged to accept various kinds of raw produce, such as sugar, rum, molasses, ginger, indigo, or tobacco....

The perishable nature of most kinds of animal food prevents them from being much used as money; but eggs are said to have circulated in the Alpine villages of Switzerland, and dried codfish have certainly acted as currency in the colony of Newfoundland.

Manufactured and Miscellaneous Articles as Currency

The enumeration of articles which have served as money may already seem long enough for the purposes in view. I will, therefore, only add briefly that a great number of manufactured commodities have been used as a medium of exchange in various times and places. Such are the pieces of cotton cloth, called Guinea pieces, used for traffic upon the banks of the Senegal, or the somewhat similar pieces circulated in Abyssinia, the Soulou Archipelago, Sumatra, Mexico, Peru, Siberia, and among the Veddahs. It is less easy to understand the origin of the curious straw money which circulated until 1694 in the Portuguese possessions in Angola, and which consisted of small mats, called libongos, woven out[Pg 16] of rice straw, and worth about 1-1/2d. each. These mats must have had, at least originally, some purpose apart from their use as currency, and were perhaps analogous to the fine woven mats so much valued by the Samoans, and also treated by them as a medium of exchange.

Salt has been circulated not only in Abyssinia, but in Sumatra, Mexico, and elsewhere. Cubes of benzoin gum or beeswax in Sumatra, red feathers in the Islands of the Pacific Ocean, cubes of tea in Tartary, iron shovels or hoes among the Malagasy, are other peculiar forms of currency. The remarks of Adam Smith concerning the use of hand-made nails as money in some Scotch villages will be remembered by many readers, and need not be repeated. M. Chevalier has adduced an exactly corresponding case from one of the French coalfields.

Were space available it would be interesting to discuss the not improbable suggestion of Boucher de Perthes, that, perhaps, after all, the finely worked stone implements now so frequently discovered were among the earliest mediums of exchange. Some of them are certainly made of jade, nephrite, or other hard stones, only found in distant countries, so that an active traffic in such implements must have existed in times of which we have no records whatever.

There are some obscure allusions in classical authors to a wooden money circulating among the Byzantines, and to a wooden talent used at Antioch and Alexandria, but in the absence of fuller information as to their nature, it is impossible to do more than mention them....

The Invention of Coining

The date of the invention of coining can be assigned with some degree of probability. Coined money was clearly unknown in the Homeric times, and it was known in the time of Lycurgus. We might therefore assume, with various authorities, that it was invented in the mean time, or about 900 b. c. There is tradition, moreover, that Pheidon, King of Argos, first struck silver money in the island of Ægina about 895 b. c., and the tradition is supported by the existence of small stamped ingots of silver, which have been found[Pg 17] in Ægina. Later inquiries, however, lead to the conclusion that Pheidon lived in the middle of the eighth century b. c., and Grote has shown good reasons for believing that what he did accomplish was done in Argos, and not in Ægina.

The mode in which the invention happened is sufficiently evident. Seals were familiarly employed in very early times, as we learn from the Egyptian paintings or the stamped bricks of Nineveh. Being employed to signify possession, or to ratify contracts, they came to indicate authority. When a ruler first undertook to certify the weights of pieces of metal, he naturally employed his seal to make the fact known, just as, at Goldsmiths' Hall, a small punch is used to certify the fineness of plate. In the earliest forms of coinage there were no attempts at so fashioning the metal that its weight could not be altered without destroying the stamp or design. The earliest coins struck, both in Lydia and in the Peloponnesus, were stamped on one side only....


[3] W. Stanley Jevons, Money and the Mechanism of Exchange, D. Appleton and Company, New York, 1902, pp. 19-28, 54, 55.

[Pg 18]



[4]Many recent writers, such as Huskisson, MacCulloch, James Mill, Garnier, Chevalier, and Walras, have satisfactorily described the qualities which should be possessed by the material of money. Earlier writers seem, however, to have understood the subject almost as well.... Of all writers, M. Chevalier ... probably gives the most accurate and full account of the properties which money should possess, and I shall in many points follow his views.

The prevailing defect in the treatment of the subject is the failure to observe that money requires different properties as regards different functions. To decide upon the best material for money is thus a problem of great complexity, because we must take into account at once the relative importance of the several functions of money, the degree in which money is employed for each function, and the importance of each of the physical qualities of the substance with respect to each function. In a simple state of industry money is chiefly required to pass about between buyers and sellers. It should, then, be conveniently portable, divisible into pieces of various size, so that any sum may readily be made up, and easily distinguishable by its appearance, or by the design impressed upon it. When money, however, comes to serve, as it will at some future time, almost exclusively as a measure and standard of value, the system of exchange, being one of perfected barter, such properties become a matter of comparative indifference, and stability of value, joined perhaps to portability, is the most important quality. Before venturing, however, to discuss such complex questions, we must proceed to a preliminary discussion of the properties in question, which[Pg 19] may thus perhaps be enumerated in the order of their importance:

1. Utility and value.
2. Portability.
3. Indestructibility.
4. Homogeneity.
5. Divisibility.
6. Stability of value.
7. Cognisability.

1. Utility and Value

Since money has to be exchanged for valuable goods, it should itself possess value and it must therefore have utility as the basis of value. Money, when once in full currency, is only received in order to be passed on, so that if all people could be induced to take worthless bits of material at a fixed rate of valuation, it might seem that money does not really require to have substantial value. Something like this does frequently happen in the history of currencies, and apparently valueless shells, bits of leather, or scraps of paper are actually received in exchange for costly commodities. This strange phenomenon is, however, in most cases capable of easy explanation, and if we were acquainted with the history of every kind of money the like explanation would no doubt be possible in other cases. The essential point is that people should be induced to receive money, and pass it on freely at steady ratios of exchange for other objects; but there must always be some sufficient reason first inducing people to accept the money. The force of habit, convention, or legal enactment may do much to maintain money in circulation when once it is afloat, but it is doubtful whether the most powerful government could oblige its subjects to accept and circulate as money a worthless substance which they had no other motive for receiving.

Certainly, in the early stages of society, the use of money was not based on legal regulations, so that the utility of the substance for other purposes must have been the prior condition of its employment as money. Thus the singular peag currency, or wampumpeag, which was found in circulation among the North American Indians by the early explorers, was esteemed for the purpose of adornment, as already mentioned.... The cowry shells, so widely used as a small[Pg 20] currency in the East, are valued for ornamental purposes on the West Coast of Africa, and were in all probability employed as ornaments before they were employed as money. All the other articles [previously] mentioned ... such as oxen, corn, skins, tobacco, salt, cacao nuts, tea, olive oil, etc., which have performed the functions of money in one place or another, possessed independent utility and value. If there are any apparent exceptions at all to this rule, they would doubtless admit of explanation by fuller knowledge. We may, therefore, agree with Storch when he says: "It is impossible that a substance which has no direct value should be introduced as money, however suitable it may be in other respects for this use."

When once a substance is widely employed as money, it is conceivable that its utility will come to depend mainly upon the services which it thus confers upon the community. Gold, for instance, is far more important as the material of money than in the production of plate, jewellery, watches, gold-leaf, etc. A substance originally used for many purposes may eventually serve only as money, and yet, by the demand for currency and the force of habit, may maintain its value. The cowry circulation of the Indian coasts is probably a case in point. The importance of habit, personal or hereditary, is at least as great in monetary science as it is, according to Mr. Herbert Spencer, in morals and sociological phenomena generally.

There is, however, no reason to suppose that the value of gold and silver is at present due solely to their conventional use as money. These metals are endowed with such singularly useful properties that, if we could only get them in sufficient abundance, they would supplant all the other metals in the manufacture of household utensils, ornaments, fittings of all kinds, and an infinite multitude of small articles, which are now made of brass, copper, bronze, pewter, German silver, or other inferior metals and alloys.

In order that money may perform some of its functions efficiently, especially those of a medium of exchange and a store of value, to be carried about, it is important that it should be made of a substance valued highly in all parts of[Pg 21] the world, and, if possible, almost equally esteemed by all peoples. There is reason to think that gold and silver have been admired and valued by all tribes which have been lucky enough to procure them. The beautiful lustre of these metals must have drawn attention and excited admiration as much in the earliest as in the present times.

2. Portability

The material of money must not only be valuable, but the value must be so related to the weight and bulk of the material, that the money shall not be inconveniently heavy on the one hand, nor inconveniently minute on the other. There was a tradition in Greece that Lycurgus obliged the Lacedæmonians to use iron money, in order that its weight might deter them from overmuch trading. However this may be, it is certain that iron money could not be used in cash payments at the present day, since a penny would weigh about a pound, and instead of a five-pound note, we should have to deliver a ton of iron. During the last century copper was actually used as the chief medium of exchange in Sweden; and merchants had to take a wheelbarrow with them when they went to receive payments in copper dalers. Many of the substances used as currency in former times must have been sadly wanting in portability. Oxen and sheep, indeed, would transport themselves on their own legs; but corn, skins, oil, nuts, almonds, etc., though in several respects forming fair currency, would be intolerably bulky and troublesome to transfer.

The portability of money is an important quality not merely because it enables the owner to carry small sums in the pocket without trouble, but because large sums can be transferred from place to place, or from continent to continent, at little cost. The result is to secure an approximate uniformity in the value of money in all parts of the world. A substance which is very heavy and bulky in proportion to value, like corn or coal, may be very scarce in one place and over-abundant in another; yet the supply and demand cannot be equalised without great expense in carriage. The cost of conveying gold or silver from London to Paris, including insurance, is only about four-tenths of one per cent.; and[Pg 22] between the most distant parts of the world it does not exceed from 2 to 3 per cent.

Substances may be too valuable as well as too cheap, so that for ordinary transactions it would be necessary to call in the aid of the microscope and the chemical balance. Diamonds, apart from other objections, would be far too valuable for small transactions. The value of such stones is said to vary as the square of the weight, so that we cannot institute any exact comparison with metals of which the value is simply proportional to the weight. But taking a one-carat diamond (four grains) as worth £15, we find it is, weight for weight, 460 times as valuable as gold. There are several rare metals, such as iridium and osmium, which would likewise be far too valuable to circulate. Even gold and silver are too costly for small currency. A silver penny now weighs 7-1/4 grains, and a gold penny would weigh only half a grain. The pretty octagonal quarter-dollar tokens circulated in California are the smallest gold coins I have seen, weighing less than four grains each, and are so thin that they can almost be blown away.

3. Indestructibility

If it is to be passed about in trade, and kept in reserve, money must not be subject to easy deterioration or loss. It must not evaporate like alcohol, nor putrefy like animal substances, nor decay like wood, nor rust like iron. Destructible articles, such as eggs, dried codfish, cattle, or oil, have certainly been used as currency; but what is treated as money one day must soon afterwards be eaten up. Thus a large stock of such perishable commodities cannot be kept on hand, and their value must be very variable. The several kinds of corn are less subject to this objection, since, when well dried at first, they suffer no appreciable deterioration for several years.

4. Homogeneity

All portions of specimens of the substance used as money should be homogeneous, that is, of the same quality, so that equal weights will have exactly the same value. In order that we may correctly count in terms of any unit, the units must[Pg 23] be equal and similar, so that twice two will always make four. If we were to count in precious stones, it would seldom happen that four stones would be just twice as valuable as two stones. Even the precious metals, as found in the native state, are not perfectly homogeneous, being mixed together in almost all proportions; but this produces little inconvenience, because the assayer readily determines the quantity of each pure metal present in any ingot. In the processes of refining and coining, the metals are afterwards reduced to almost exactly uniform degrees of fineness, so that equal weights are then of exactly equal value.

5. Divisibility

Closely connected with the last property is that of divisibility. Every material is, indeed, mechanically divisible, almost without limit. The hardest gems can be broken, and steel can be cut by harder steel. But the material of money should be not merely capable of division, but the aggregate value of the mass after division should be almost exactly the same as before division. If we cut up a skin or fur the pieces will, as a general rule, be far less valuable than the whole skin or fur, except for a special intended purpose; and the same is the case with timber, stone, and most other materials in which reunion is impossible. But portions of metal can be melted together again whenever it is desirable, and the cost of doing this, including the metal lost, is in the case of precious metals very inconsiderable, varying from 1/4d. to 1/2d. per ounce. Thus, approximately speaking, the value of any piece of gold or silver is simply proportional to the weight of fine metal which it contains.

6. Stability of Value

It is evidently desirable that the currency should not be subject to fluctuations of value. The ratios in which money exchanges for other commodities should be maintained as nearly as possible invariable on the average. This would be a matter of comparatively minor importance were money used only as a measure of values at any one moment, and as a medium of exchange. If all prices were altered in like proportion[Pg 24] as soon as money varied in value, no one would lose or gain, except as regards the coin which he happened to have in his pocket, safe, or bank balance. But, practically speaking, as we have seen, people do employ money as a standard of value for long contracts, and they often maintain payments at the same variable rate, by custom or law, even when the real value of the payment is much altered. Hence every change in the value of money does some injury to society.

It might be plausibly said, indeed, that the debtor gains as much as the creditor loses, or vice versa, so that on the whole the community is as rich as before; but this is not really true. A mathematical analysis of the subject shows that to take any sum of money from one and give it to another will, on the average of cases, injure the loser more than it benefits the receiver. A person with an income of one hundred pounds a year would suffer more by losing ten pounds than he would gain by an addition of ten pounds, because the degree of utility of money to him is considerably higher at ninety pounds than it is at one hundred and ten. On the same principle, all gaming, betting, pure speculation, or other accidental modes of transferring property involve, on the average, a dead loss of utility. The whole incitement to industry and commerce and the accumulation of capital depends upon the expectation of enjoyment thence arising, and every variation of the currency tends in some degree to frustrate such expectation and to lessen the motives for exertion.

7. Cognisability

By this name we may denote the capability of a substance for being easily recognised and distinguished from all other substances. As a medium of exchange, money has to be continually handed about, and it will occasion great trouble if every person receiving currency has to scrutinize, weigh, and test it. If it requires any skill to discriminate good money from bad, poor ignorant people are sure to be imposed upon. Hence the medium of exchange should have certain distinct marks which nobody can mistake. Precious stones, even if in other respects good as money, could not be so used, because[Pg 25] only a skilled lapidary can surely distinguish between true and imitation gems.

Under cognisability we may properly include what has been aptly called impressibility, namely, the capability of a substance to receive such an impression, seal, or design, as shall establish its character as current money of certain value. We might more simply say, that the material of money should be coinable, so that a portion, being once issued according to proper regulations with the impress of the state, may be known to all as good and legal currency, equal in weight, size, and value to all similarly marked currency....


[4] W. Stanley Jevons, Money and the Mechanism of Exchange, pp. 29-39. D. Appleton & Company, New York, 1902.

[Pg 26]



The essential idea of "legal tender" is that quality given to money by law which obliges the creditor to receive it in full satisfaction of a past debt when expressed in general terms of the money of a country. A debt is a sum of money due by contract, express or implied. When our laws, for instance, declare that United States notes are legal tender—and this is the only complete designation of a legal-tender money—for "all debts public and private," it must be understood that this provision does not cover any operations not arising from contract. Current buying and selling do not make a situation calling for legal tender; a purchaser cannot compel the delivery of goods over a counter by offering legal-tender money for them, because, as yet, no debt has been created.[6]

Contracts made in general terms of the money units of the country must necessarily often be interpreted by the courts. The existence of contracts calling for a given sum of dollars and the necessity of adjudicating and enforcing such contracts, require that there should be an accurate legal interpretation of what a dollar is. As every one knows, the name, or unit of account, is affixed to a given number of grains of a specified fineness of a certain metal. This being the standard, and this having been chosen by the concurring habits of the business world, it is fit that the law should designate that, when only[Pg 27] dollars are mentioned in a contract, it should be satisfied only by the payment of that which is the standard money of the community.

Since prices and contracts are expressed in terms of the standard article, it is clear that the legal-tender quality should not be equally affixed to different articles having different values, but called by the same name. This method would be sure to bring confusion, uncertainty, and injustice into trade and industry. No one who had made a contract would know in what he was to be paid. The legal-tender quality, then, should be confined to that which is the sole standard. And it is also obvious that when a standard is satisfactorily determined upon, and when various effective media of exchange, like bank notes, checks, or bills of exchange, have sprung up, the legal-tender quality should not be given to these instruments of convenience. They are themselves expressed in, and are resolvable into, the standard metal; so the power to satisfy debts should be given not to the shadow, but to the substance, not to the devices drawn in terms of the standard, but only to the standard itself, even though, as a matter of fact, nine-tenths of the debts and contracts are actually settled by means of these devices. So long as these instruments are convertible into, and thus made fully equal to, the standard in terms of which they are drawn, they will be used by the business community for the settlement of debts without being made a legal tender. And whenever they are worth less than the standard they certainly should not be made a legal tender, because of the injustice which in such a case they would work.

Having shown that the legal-tender quality is only a necessary legal complement of the choice of a standard, it will not be difficult to see that the state properly chooses an article fit to have the legal-tender attribute for exactly the reasons that governed the selection of the same article as a standard. The whole history of money shows that the standard article was the one which had utility to the community using it. As the evolution of the money commodity went on from cattle to silver and gold, so the legal-tender provisions naturally followed this course.

A state may select a valueless commodity as a standard,[Pg 28] but that will not make it of value to those who would already give nothing for it; and so, it may give the legal-tender quality to a thing which has become valueless, but that will not of itself insure the maintenance of its former value. This proposition may, at first, appear to be opposed to a widely-spread belief; but its soundness can be fully supported. It should be learned that a commodity, or a standard, holds its value for reasons quite independent of the fact that it is given legal recognition. It has happened that legal recognition has been given to it because it possessed qualities that gave it value to the commercial world, and not that it came to have these qualities and this value because it was made a legal tender.

A good illustration of this truth is to be found in international trade. Money which is not dependent on artificial influences for its value, and which is not redeemable in something else, is good the world over at its actual commercial value, not at its value as fixed by any legal-tender laws. It is not the legal-tender stamp that gives a coin its value in international payments. A sovereign, an eagle, a napoleon, is constantly given and received in international trade not because of the stamp it bears, but because of the number of grains of a given fineness of gold which it contains—the value of which is determined in the markets of the world. And an enormous trade among the great commercial countries goes on easily and effectively without regard to the legal-tender laws of the particular country whose coins are used.

By imposing the attribute of legal tender, however, upon a given metal or money, it may be believed that thereby a new demand is created for that metal, and that its value is thus controlled. And in theory there is some basis for this belief. It is, of course, true that, in so far as giving to money a legal-tender power creates a new demand for it (which without that power would not have existed) an effect upon its value can be produced. But this effect is undoubtedly much less than is usually supposed. It must be remembered that the value of gold, for instance, is affected by world influences; that its value is determined by the demand of the whole world as compared with the whole existing supply in the world. In order to affect the value of gold in any one country, a demand created[Pg 29] by a legal-tender enactment must be sufficient to affect the world-value of gold. Evidently the effect will be only in the proportion that the new demand bears to the whole stock in the world. It is like the addition of a barrel of water to a pond; theoretically the surface level is raised, but not to any appreciable extent.

It may now be permissible to examine into the extent to which a demand is created by legal-tender laws. If the article endowed with a legal-tender power is already used as the standard and as a medium of exchange, it is given no value which it did not have before. The customs and business habits of a country alone determine how much of the standard coin will be carried about and used in hand-to-hand purchases, and how much of the business will be performed by other media of exchange, such as checks or drafts. The decision of a country to adopt gold—when it had only paper before, as was the case in Italy—would create a demand for gold to an extent determined by the monetary habits of that country; and this demand has an effect, as was said, only in the proportion of this amount to the total supply in the world. This operation arises from choosing gold as the standard of prices and as the medium of exchange. To give this standard a legal-tender power in addition does not increase the demand for it, because the stamp on the coin does not in any way alter the existing habits of the community as to the quantity of money it will use.

But in case an equal power to pay debts is given to fixed quantities of two metals, while each quantity so fixed has a different metallic value but the same denomination in the coinage, Gresham's law is set in operation with the result that the cheaper metal becomes the standard. After this change has been accomplished, the legal tender has no value-giving force. When the cheaper metal has become the standard, its legal-tender quality does not raise the value of the coin beyond the value of its content. This cheaper standard, in international trade, would be worth no more in the purchase of goods because it bore the stamp of any one country. Prices must necessarily be adjusted between the relative values of goods and the standard with which they are compared. If the[Pg 30] standard is cheaper, prices will be higher, irrespective of legal-tender acts. Where two metals are concerned, then, the only effect of a legal-tender clause is an injurious one, in that the metal which is overvalued drives out that which is under-valued.

The example of an inconvertible paper, such as our United States notes (greenbacks) in 1862-1879, is still more conclusive. Although a full legal tender for all debts public and private, their value steadily sank until they were at one time worth only 35 cents in gold. In California, moreover, these notes, although legal-tender, were even kept out of circulation by public opinion. In short, the value of inconvertible paper can be but little affected by legal-tender powers. Its value is more directly governed, as in the case of token coins, by the probabilities of redemption.[7] As bearing on the point that the value of the paper was more influenced by the chances of redemption than by legal-tender laws, we may cite the sudden fluctuations in the value of our United States notes during the Civil War. With no change in the legal-tender quality and no change in the indebtedness which might be paid with such notes, their value frequently rose or fell many per cent. in a single day owing to reports of Federal successes or defeats in battle, which had a tendency to affect one way or the other the public estimate of the probabilities of an early resumption of specie payments. The fact that they were legal tender evidently had no effect whatever in maintaining their value.

In view of the evident fact that legal-tender acts do not preserve the value of money, it is clear that the demand created by such legislation must be insignificant. And this must be so in principle as well as in fact.

There is but one thing which the legal-tender quality enables money to do which it could not equally well do without being a legal tender; that is, to pay past debts. An examination, however, shows that this use of money is very small compared with its other uses. The amount of past debts coming due and which might be paid in any year, month or day is insignificant when compared with the total transactions of that[Pg 31] year, month or day—so very small as to lose all measurable value-giving power. In other words, the one thing which legal-tender money can surely do in spite of the habits, wishes or prejudices of the business community in which it exists, namely, cancel past debt, is infinitesimally small when compared with those other things which man wishes money to do for him. It is for this reason that it ceases to give value, and this is why history has shown so many instances where money endowed with legal-tender power has become utterly valueless. The legal-tender money is no longer money if it will not secure for man the things which are most important for his welfare, if it will not buy food, clothes and shelter; for it performs none of the functions of money except the subsidiary one of cancelling past debts.

Moreover, the obligatory uses of legal-tender money are in fact very inconsiderable. A law requiring a past debt to be satisfied with money of a certain kind has for its essence only the payment of something of a definite value, or its equivalent; in practice, it does not even bring about the actual use of a legal money, since the monetary habits of the community will not necessarily require the debt to be paid in such money. Take the extreme case of a judgment by a court against a defendant for fulfilment of a contract; in such an example, of all others, it would be supposed that legal money would be exacted. But even here, the judgment would most probably be satisfied by the attorney's check, or at most by a certified check. If such media of exchange are of common usage in the community they will be resorted to in practice even for legal-tender payments.

The necessity of paying that which would be mutually satisfactory to payer and payee also makes clear why the existence of a legal-tender money does not necessarily cause its actual use in payments. The business habits of the community are stronger than legislative powers. Business men will not as a rule take advantage of a legal-tender act to pay debts in a cheaper money, if they look forward to remaining in business. For, if, by taking advantage of legal devices they defraud the creditor, they cannot expect credit again from the same source; and since loans are a necessity of legitimate[Pg 32] modern trade, such action would ruin their credit and cut them off from business activity in the future. Gold was not driven out of circulation by paper money during the years 1862-1879 in California, because the sentiment of the business public was against the use of our depreciated greenback currency; and a discrimination was made against merchants who resorted to the use of paper.

Explanation has been given of the principles according to which legal-tender laws should be applied, if at all. It is not wholly clear that there is any reason for their existence. It may now be well to indicate briefly the origin of legal-tender provisions. It can scarcely be doubted that their use arose from the desire of defaulting monarchs to ease their indebtedness by forcing upon creditors a debased coinage. Having possession of the mints, the right of coinage vesting in the lord, the rulers of previous centuries have covered the pages of history with the records of successive debasements of the money of account. The legal-tender enactment was the instrument by which the full payment of debts was evaded. There would have been no reason for debasing coins, if they could not be forced upon unwilling creditors. It is, therefore, strange indeed that, in imitation of monarchical morals of a past day, republican countries should have thought it a wise policy to clothe depreciated money with a nominal value for paying debts. Although the people are now sovereign, they should not embrace the vices of mediæval sovereignty for their own dishonest gain in scaling debts.


[5] Report of the Monetary Commission of the Indianapolis Convention, pp. 131-7. The Hollenbeck Press, Indianapolis, 1900.

[6] "A contract payable in money generally is, undoubtedly, payable in any kind of money made by law legal tender, at the option of the debtor at the time of payment. He contracts simply to pay so much money, and creates a debt pure and simple; and by paying what the law says is money his contract is performed. But, if he agrees to pay in gold coin, it is not an agreement to pay money simply, but to pay or deliver a specific kind of money and nothing else; and the payment in any other is not a fulfilment of the contract according to its terms or the intention of the parties." 25 California 564, Carpenter vs. Atherton.

[7] For a contrary view, see Joseph French Johnson, Money and Currency, Chapter 13.—Editor.

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The Greenback Issues

[8]The greenbacks were an outgrowth of the Civil War. Soon after the opening of the struggle the Secretary of the Treasury negotiated a loan of $150,000,000 with Eastern banks. Partly because of Confederate successes and partly because of the failure of Secretary Chase to adopt a firm policy of loans supported by taxation, public credit greatly declined, and Government bonds became almost unsaleable. The outlook became alarming and depositors withdrew gold from the New York banks in such large amounts that specie payments were suspended, December 30, 1861. In February, 1862, Congress provided for the issue of $150,000,000 in United States notes or greenbacks. Bond sales proceeded slowly and a second issue of $150,000,000 of notes was authorised in July of the same year. As a result of "military necessity" a third issue of $100,000,000 was authorised January 17, 1863, and temporarily increased March 3 to $150,000,000. Provision was made for the reissue of the greenbacks and $400,000,000 were outstanding at the close of the war.

The Fluctuating Premium on Gold

Depreciation of the greenbacks occurred at once and the value of gold as expressed in greenbacks was subject to almost constant change. During the year 1862 the premium varied from 2 to 32; in 1863 from 25 to 60; and in 1864 from 55 to 185. Among the most important political and economic factors which caused these fluctuations may be mentioned:

[Pg 34]

(1) The increase in the amount of the greenbacks. Each new issue was reflected in a rise in the premium.

(2) The condition of the treasury. The annual reports of the Secretary of the Treasury were anxiously awaited and their appearance caused a rise or fall of the premium according as the condition of the finances seemed gloomy or hopeful.

(3) Ability of the Government to borrow. The fate of a loan indicated public confidence or distrust.

(4) Changes in the officials of the treasury department. Secretary Chase's resignation, July 1, 1864, depressed the currency decidedly.

(5) War news. Every victory raised the price of currency and every defeat depressed it.

From 1862 to 1865 the premium on gold and the median of relative prices correspond so well that one cannot resist the conclusion that these changes were mainly due to a common cause, which can hardly be other than the varying esteem in which the notes of the Government that constituted the standard money of the country were held. If this conclusion be accepted, it follows that the suspension of specie payments and the legal-tender acts must be held almost entirely responsible for all the far-reaching economic disturbances following from the price upheaval which it is our task now to trace in detail.

The Effects of Greenbacks upon Wages

Statistical evidence supports unequivocally the common theory that persons whose incomes are derived from wages suffer seriously from a depreciation of the currency. The confirmation seems particularly striking when the conditions other than monetary affecting the labour market are taken into consideration. American workingmen are intelligent and keenly alive to their interests. There are probably few districts where custom plays a smaller and competition a larger rôle in determining wages than in the Northern States. While labor organisations had not yet attained their present power, manual laborers did not fail to avail themselves of the help of concerted action in the attempt to secure more pay. Strikes were frequent. All these facts favored a speedy readjustment of money wages to correspond with changed prices.[Pg 35] But more than all else, a very considerable part of the labor supply was withdrawn from the market into the army and navy. In 1864 and 1865 about one million of men seem to have been enrolled. About one-seventh of the labor supply withdrew from the market. But despite all these favoring circumstances, the men who stayed at home did not succeed in obtaining an advance in pay at all commensurate with the increase in living expenses. Women on the whole succeeded less well than men in the struggle to readjust money wages to the increased cost of living.

It is sometimes argued that the withdrawal of laborers from industrial life was the chief cause of the price disturbances of the war period. This withdrawal, it is said, caused the advance of wages, and greater cost of labor led to the rise of prices. The baselessness of this view is shown by two well established facts—first, that the advance of wages was later than the advance of prices, and second, that wages continued to rise in 1866 after the volunteer armies had been disbanded and the men gone back to work.

Wage-earners, however, seem to have been more fully employed during the war than in common times of prosperity. Of course, the enlistment of so many thousands of the most efficient workers made places for many who might otherwise have found it difficult to secure work. Moreover, the paper currency itself tended to obtain full employment for the laborer, for the very reason that it diminished his real income. In the distribution of what Marshall has termed the "national dividend" a diminution of the proportion received by the laborer must have been accompanied by an increase in the share of some one else. Nor is it difficult to determine who this person was. The beneficiary was the active employer, who found that the money wages, interest, and rent he had to pay increased less rapidly than the money prices of his products. The difference between the increase of receipts and the increase of expenses swelled his profits. Of course, the possibility of making high profits provided an incentive for employing as many hands as possible.

After an examination of the change in the condition of the great mass of wage-earners, it may seem surprising that few[Pg 36] complaints were heard from them of unusual privations. This silence may be due in part to the fact that a considerable increase of money income produces in the minds of many a fatuous feeling of prosperity, even though it be more than offset by an increase of prices. But doubtless the chief reason is to be found in the absorption of public interest in the events of the war. The people both of the South and North were so vitally concerned with the struggle that they bore without murmuring the hardships it entailed of whatever kind. Government taxation that under other circumstances might have been felt to be intolerable was submitted to with cheerfulness. The paper currency imposed upon wage-earners a heavier tax—amounting to confiscation of perhaps a fifth or a sixth of real incomes. But the workingmen of the North were receiving considerably more than a bare subsistence minimum before the war, and reduction of consumption was possible without producing serious want. Accordingly the currency tax, like the tariff and the internal revenue duties, was accepted as a necessary sacrifice to the common cause and paid without protest by severe retrenchment.



In studying the influence of depreciation upon rent, it is necessary to use that term in its popular rather than in its scientific sense. This fact is less to be lamented, because the theorist himself admits that the distinction becomes sadly blurred when he attempts to deal with short intervals of time. Capital once invested in improvements can seldom be withdrawn rapidly. In "the short run," therefore, it is practically a part of the land, and the return to it follows the analogy of rent rather than of interest.

The renting landlord found that the degree in which he was affected by the fluctuations in the value of the paper money depended largely upon the terms of the contract into which he had entered. It is clear from a careful examination that the landlord who before suspension had leased his property for a considerable period without opportunity for revaluation[Pg 37] must have suffered severely if paid in greenbacks. The number of "dollars" received as rental might be the same in 1865 as in 1860, but their purchasing power was less than one-half as great. Somewhat less hard was the situation of the landlord who had let his property for but one or two years. At the expiration of the leases he had opportunities to make new contracts with the tenants.

In his capacity as special commissioner of the revenue, Mr. David A. Wells devoted some attention to the rise of rent. His report for December, 1866, says:

The average advance in the rents of houses occupied by mechanics and laborers in the great manufacturing centres of the country is estimated to have been about 90 per cent.; in some sections, however, a much greater advance has been experienced, as for example, at Pittsburgh, where 200 per cent. and upward is reported. In many of the rural districts, on the other hand, the advance has been much less. Mr. Wells later modified this estimate somewhat.

The advance in rents was greater in cities than in minor towns. In some cities—e. g., Cincinnati and Louisville—owners of workingmen's tenements appear to have been able to increase their money incomes rather more rapidly than prices advanced, but in Boston, Philadelphia, St. Louis, and in smaller towns, their money incomes appear to have increased more slowly than living expenses. These conclusions rest, however, on a narrow statistical basis.


The rural landowner suffered serious injury from the paper currency when he let his land for a money rent. But renting farms for a fixed sum of money has always been less common in the United States than renting for a definite share of the products. It is probable that at the time of the Civil War more than three-quarters of the rented farms were let "on shares." Inasmuch as no money payments entered into such arrangements, the pecuniary relations of landlord and tenant were not directly affected by the change in the monetary standard. Farm owners who had let their places on these conditions escaped the direct losses that weighed so heavily on the recipients of money rents. But even they did not avoid all[Pg 38] loss. For the price of agricultural products for the greater part of the war period lagged considerably behind the price of other goods. This difference, of course, meant loss to men whose incomes were paid in bushels of grain.

Interest and Loan Capital


The task of ascertaining the effect of the greenback issues upon the situation of lenders and borrowers of capital is in one respect more simple and in another respect more complex than the task of dealing with wage-earners. It is simpler in that there are not different grades of capital to be considered like the different grades of labor. But it is more complex in that the capitalist must be considered not only as the recipient of a money income, as is the laborer, but also as the possessor of certain property that may be affected by changes in the standard money.

The problem is further complicated by the fact that the relative importance of these two items—rate of interest and value of principal—is not the same in all cases. Whether a lender is affected more by the one item or the other depends upon what he intends to do with his property at the expiration of existing contracts. A widow left in 1860 with an estate of say $10,000, who expected to keep this sum constantly at interest and to find new borrowers as soon as the old loans were paid, could neglect everything but the net rate of interest received. On the other hand, if this estate had been left to a youth of twenty who intended to invest his property in some business after a few years, the rate of interest would be of relatively less importance to him than the purchasing power of the principal when the time came to set up for himself.

Of course, the same difference exists in the case of different borrowers. Those borrowers who expected to renew old loans on maturity would have to consider little beyond the interest demanded by lenders, while borrowers who expected to pay off the loans out of the proceeds of their ventures would be interested primarily in the amount of goods that would sell for sufficient money to make up the principal.[Pg 39]

Although these two classes of cases are by no means independent of each other, the following discussion will be rendered clearer by observing the broad difference between them. Accordingly, attention will first be directed to the effect of the price fluctuations upon the purchasing power of the principal of loans, and afterward to changes in the rate of interest.


Most persons who made loans in the earlier part of the Civil War and were repaid in greenbacks must have suffered heavy losses from the smaller purchasing power of the principal when it was returned to them. But while this general fact is clear, it is difficult to make a quantitative statement of the degree of the loss that will be even tolerably satisfactory.

In the case of almost all loans made before the middle of 1864 and repaid prior to 1866, the creditor found that the sum returned to him had a purchasing power much less than the purchasing power that had been transferred to the borrower when the loan was made. This decline varied from 1 to more than 50 per cent. On loans made in the middle of 1864 or later, on the contrary, the creditor gained as a rule. In the case of loans made in January, 1865, and repaid six months later, the increase in purchasing power was over 40 per cent.


In turning to study the fortunes of men who have no thought of employing their capital for themselves, but expect to seek new borrowers as rapidly as old loans are repaid, one finds it necessary to distinguish between cases where loans have been made for short and for long terms; between the cases, that is, where there is and where there is not an opportunity to make a new contract regarding the rate of interest. The latter cases may be dismissed with a word. The capitalist who lent $10,000 for five years in April, 1862, at 6 per cent. interest, would be in relatively the same position as the workingman who received no advance in money wages; while his money income remained the same, the rise of prices would decrease his real income in 1864 and 1865 by about one-half. Of course, this loss to the creditor is a gain to the debtor; for to[Pg 40] the business man using borrowed capital the advance of prices means that he can raise his interest money by selling a smaller proportion of his output.

More interesting is the case of loans maturing and made afresh during the period under examination. The important question is: How far did the lender secure compensation for the diminished purchasing power of the money in which he was paid by contracting for a higher rate of interest?

The advance in the rate of interest was comparatively small—much too small to compensate for the increased cost of living. While prices rose approximately 85 per cent. and money wages somewhat less than 60 per cent. during the years 1860-65, rates of interest on call and time loans increased less than 15 per cent. during the same period.

The conclusion is not only that persons who derived their income from capital lent at interest for short terms were injured by the issues of the greenbacks, but also that their injuries were more serious than those suffered by wage-earners.

To explain this state of affairs is not easy. The first reason that suggests itself to the mind considering the problem is that both lenders and borrowers failed to foresee the changes that would take place in the purchasing power of money between the dates when loans were made and repaid. No doubt there is much force in this explanation. If, for instance, men arranging for loans in April, 1862, to be repaid a year later, had known that in the meantime the purchasing power of money would decline 30 per cent., they would have agreed upon a very high rate of interest. Men able to discern the future course of prices would not have lent money at the ordinary rates, and if the rates prevailing in the New York market throughout all 1862 and 1863 were less than 7 per cent., it must have been because the extraordinary rise of prices was not foreseen by borrowers and lenders.

Nor is it surprising that business men failed to see what was coming; for the course of prices depended chiefly upon the valuation set upon the greenbacks, and this valuation, in turn, depended chiefly upon the state of the finances and the fortunes of war—matters that no one could foresee with certainty. Indeed, there was much of the time a very general[Pg 41] disposition to take an unwarrantedly optimistic view of the military situation and the chances of an early peace. Many members of the business community seem to have felt that the premium on gold was artificial and must soon drop, that prices were inflated and must collapse. To the extent that such views prevailed borrowers would be cautious about making engagements to repay money in a future that might well present a lower range of prices, and lenders would expect a gain instead of a loss from the changes in the purchasing power of money.

But the full explanation of the slight advance in interest cannot be found in this inability to foresee the future—at least not without further analysis of what consequences such inability entailed. Workingmen are commonly credited with less foresight than capitalists, and nevertheless they seem, according to the figures, to have succeeded better in making bargains with employers of labour than did lenders with employers of capital. The explanation of this less success seems to be found in the difference between the way in which depreciation affected what the capitalist and the laborer had to offer in return for interest and wages. There is no reason for assuming that an artisan who changed employers during the war would render less efficient service in his new than in his old position, or that a landlord who changed tenants had less advantages to put at the disposal of the incoming lessee. In both these cases the good offered to the active business man remained substantially the same, and it may safely be assumed that, other things being equal, this business man could afford to give quite as much for the labor and the land after as before suspension. From the business man's point of view, therefore, there seems to have been room for a doubling of money wages and rent when the purchasing power of money had fallen one-half. But in the case of the borrower of capital the like was not true. The thousand dollars which Mr. A offered him in 1865 was not, like the labour of John Smith or the farm of Mr. B, as efficient for his purposes as it would have been five years before. For, with the thousand dollars he could not purchase anything like the same amount of machinery, material, or labor. And since the same nominal[Pg 42] amount of capital was of less efficiency in the hands of the borrower, he could not without loss to himself increase the interest which he paid for new loans in proportion to the decline in the purchasing power of money, as he could increase the wages of laborers or the rent for land.

It should also be pointed out that on one important class of loans capitalists suffered comparatively little even during the war. Interest on many forms of Government bonds was paid in gold. Capitalists who invested their means in these securities consequently received an income of almost unvarying specie value. If the person who made these investments were an American, he would be able to sell his gold-interest money at a high premium, but he would also have to pay correspondingly high prices for commodities, so that upon the whole his position would not be greatly different from that of the foreign investor. That such opportunities for investment as these securities offered should exist when men were most of the time loaning money for short terms at 7 per cent. or less, is perhaps the most emphatic proof that could be offered of the inability of the public to foresee what the future had in store.


Laborers, landlords, and lending capitalists are all alike in that the amount of remuneration received by them for the aid which they render to production is commonly fixed in advance by agreement, and is not immediately affected by the profitableness or unprofitableness of the undertaking. It remains to examine the economic fortunes of those men whose money incomes are made up by the sums left over in any business after all the stipulated expenses have been met.

A very important part of the solution of the problem of profits has already been contributed by the preceding studies of wages, rent, and interest. The evidence has been found to support the conclusion that in almost all cases the sums of money wages, rent, and interest received by laborers, landlords, and capitalists increased much less rapidly than did the general price level. If the wording of this conclusion be reversed—the prices of products rose more rapidly than wages, rent, or interest—we come at once to the proposition that as a[Pg 43] rule profits must have increased more rapidly than prices. For, if the sums paid to all the other co-operating parties were increased in just the same ratio as the prices of the articles sold, it would follow that, other things remaining the same, money profits also would increase in the same ratio. But if, while prices doubled, the payments to labourers, landlords, and capitalists increased in any ratio less than 100 per cent., the sums of money left for the residual claimants must have more than doubled. In other words, the effect of the depreciation of the paper currency upon the distribution of wealth may be summed up in the proposition: The shares of wage-earners, landowners, and lenders in the national dividend were diminished and the share of residual claimants was increased.

Two other general propositions respecting profits are suggested. First, other things being equal, profits varied inversely as the average wage per day paid to employees. This conclusion follows directly from the fact that the money wages of men earning $1-$1.49 per day before the perturbation of prices increased in higher ratio than those of men earning $1.50-$1.99; that the wages of the latter class increased more than the wages of men in the next higher wage class, etc. Second, other things being equal, profits varied directly as the complexity of the business organization. By this proposition is meant, for example, that a farmer who paid money rent, used borrowed capital, and employed hired labourers, made a higher percentage of profits than a farmer of whom any one of these suppositions did not hold true. If, as has been argued, the increase of profits was made at the expense of laborers, landlords, and capitalists, it follows that that entrepreneur fared best whose contracts enabled him to exploit the largest number of these other persons.


The farmers of the loyal states were among the unfortunate producers whose products rose in price less than the majority of other articles, and from this standpoint they were losers rather than gainers by the paper currency. Of course, it is possible that the farmer's loss from this inequality of price fluctuations might be more than offset by his gains at the[Pg 44] expense of labourers, landlord, and lending capitalist. But there is good reason for believing that the increase of the entrepreneur's profits in the latter fashion was less in farming than in any other important industry. This conclusion seems to follow from the proposition that, other things being equal, profits varied directly as the complexity of business organization. The American farmers of the Civil War were in a large proportion of cases their own landlords, capitalists, and laborers. So far as this was true, they had few important pecuniary contracts with other persons of which they could take advantage by paying in depreciated dollars. Of those farmers who hired labor very many paid wages partly in board and lodging—an arrangement which threw a considerable part of the increased cost of living upon them instead of upon their employees. Finally, the renting farmer probably gained less on the average from the contract with his landlord than tenants of any other class, because in a majority of cases the rent was not a sum of money, but a share of the produce. While, then, the general effect of the paper standard was in the direction of increasing profits, it seems very doubtful whether farmers as a whole did not lose more than they gained because of the price disturbances.


It would be highly desirable to test our general conclusions by means of direct information regarding profits made in various branches of trade, but the data available for such a purpose are very meager. What scraps of information are available, however, support the view that profits were uncommonly large. Mr. David A. Wells, for example, in his reports as special commissioner of the revenue, has stories of "most anomalous and extraordinary" profits that were realized in the paper, woolen, pig-iron, and salt industries. A more general indication of the profitableness of business is afforded by the remark in the annual circular of Dun's Mercantile Agency for 1864, that "it is generally conceded that the average profits on trade range from 12 to 15 per cent."

But the most important piece of evidence is found in the statistics of failures compiled by the same agency. The following[Pg 45] table shows Dun's report of the number of bankruptcies and the amount of liabilities in the loyal States from the panic year 1857 to the end of the war:


The very great decrease both in the number and the liabilities of firms that failed is the best proof that almost all business enterprises were "making money."

From one point of view the small number of failures is surprising. An unstable currency is generally held to make business unsafe, and seldom has the standard money of a mercantile community proven so unstable, undergone such violent fluctuations in so short a time, as in the United States during the Civil War. Yet, instead of being extremely hazardous, business seems from the statistics of failures to have been more than usually safe.

The explanation of the anomaly seems to be that the very extremity of the danger proved a safeguard. Business men realized that the inflation of prices was due to the depreciation of the currency, and that when the war was over gold would fall and prices follow. They realized very clearly the necessity of taking precautions against being caught in a position where a sudden decline of prices would ruin them. They did this by curtailing credits. So long as prices continued to rise such precautions were really not needed by the man in active business except, in so far as he was a creditor of other men; but when prices commenced to fall prudence had its reward. Such a sudden and violent drop of prices as occurred between January and July, 1865, would have brought a financial revulsion of a most serious character upon a business community under ordinary circumstances. But so well had the change been prepared for, that the number of failures was actually less than it had been in the preceding year of rapidly rising prices.

The whole situation can hardly be explained better than it was by a New York business man writing in[Pg 46] Harper's Monthl Magazine: "When the war ended," he said, "we all knew we should have a panic. Some of us, like Mr. Hoar, expected that greenbacks and volunteers would be disbanded together. Others expected gold to fall to 101 or 102 in a few days. Others saw a collapse of manufacturing industry, owing to the cessation of Government purchases. But we all knew a 'crisis' was coming, and having set our houses in order accordingly, the 'crisis' of course never came."

The Production and Consumption of Wealth


What influence did the greenback currency have as one of the many factors that affected the production of wealth? In the first place, the paper standard was responsible in large measure for the feeling of "prosperity" that seems from all the evidence to have characterized the public's frame of mind. Almost every owner of property found that the price of his possessions had increased, and almost every wage-earner found that his pay was advanced. Strive as people may to emancipate themselves from the feeling that a dollar represents a fixed quantity of desirable things, it is very difficult for them to resist a pleasurable sensation when the money value of their property rises or their incomes increase. They are almost certain to feel cheerful over the larger sums that they can spend, even though the amount of commodities the larger sums will buy is decreased. Habit is too strong for arithmetic.

But, more than this, "business" in the common meaning of the word was unusually profitable during the war. The "residual claimant" is in most enterprises the active business man, and, as has been shown, his money income did as a rule rise more rapidly than the cost of living. In other words, "business" was, in reality as well as in appearance, rendered more profitable by the greenbacks. There is therefore no error in saying that the business of the country enjoyed unwonted prosperity during the war. And it may be added that the active business man is probably a more potent factor in determining the community's feeling about "good times" and[Pg 47] "bad times" than is the workingman, the landlord, or the lending capitalist.

The effect of high profits, however, is not limited to producing a cheerful frame of mind among business men. Under ordinary circumstances one would say that when the great majority of men already in business are "making money" with more than usual rapidity they will be inclined to enlarge their operations, that others will be inclined to enter the field, and that thus the production of wealth will be stimulated. But the circumstances of the war period were not ordinary and this conclusion cannot be accepted without serious modifications.

1. It has been shown that business men realised the precariousness of all operations that depended for their success upon the future course of prices—and nearly all operations that involved any considerable time for their consummation were thus dependent. So far did this disposition prevail that it produced a marked curtailment in the use of credit. The prudent man might be willing to push his business as far as possible with the means at his own disposal, but he showed a disinclination to borrow for the purpose. Thus the uncertainty which all men felt about the future in a large measure counteracted the influence of high profits in increasing production.

2. The foregoing consideration of course weighed most heavily in the minds of cautious men. But not all business men are cautious. Among many the chance of winning large profits in case of success is sufficient to induce them to undertake heavy risks of loss. On the whole, Americans seem to display a decided propensity toward speculative ventures and are not easily deterred by having to take chances. To men of this type it seems that the business opportunities offered by the fluctuating currency would make a strong appeal. But, while the force of this observation may be admitted, it does not necessitate a reconsideration of the conclusion that the instability of prices tended to diminish the production of wealth. For in a time of great price fluctuations the possibilities of making fortunes rapidly are much greater in trade than in agriculture, mining, or manufactures. Every rise and fall in[Pg 48] quotations holds out an alluring promise of quick gain to the man who believes in his shrewdness and good fortune, and who does not hesitate to take chances. The probable profits of productive industry in the narrower sense might be larger than common, but this would not attract investors in large numbers if the probable profits of trading were larger yet; and such seems clearly to have been the case during the war when the paper currency offered such brilliant possibilities to fortunate speculators in gold, in stocks, or in commodities. Instead, then, of the greenbacks being credited with stimulating the production of wealth, they must be charged with offering inducements to abandon agriculture and manufactures for the more speculative forms of trade.

This tendency of the times did not escape observation. On the contrary, it was often remarked and lamented in terms that seem exaggerated. Hugh McCulloch, for instance, in his report as Secretary of the Treasury for 1865, said:

There are no indications of real and permanent prosperity ... in the splendid fortunes reported to be made by skilful manipulations at the gold room or the stock board; no evidences of increasing wealth in the facts that railroads and steamboats are crowded with passengers, and hotels with guests; that cities are full to overflowing, and rents and the necessities of life, as well as luxuries, are daily advancing. All these things prove rather ... that the number of non-producers is increasing, and that productive industry is being diminished.

In one of his reports as special commissioner of the revenue, Mr. Wells said:

During the last few years large numbers of our population, under the influence and example of high profits realized in trading during the period of monetary expansion, have abandoned employments directly productive of national wealth, and sought employments connected with commerce, trading, or speculation. As a consequence we everywhere find large additions to the population of our commercial cities, an increase in the number and cost of the buildings devoted to banking, brokerage, insurance, commission business, and agencies of all kinds, the spirit of trading and speculating pervading the whole community, as distinguished from the spirit of production.

Within the period under review, then, it seems very doubtful whether the high profits had their usual effect of leading to a[Pg 49] larger production of raw materials or to an increase in manufactures. The prudent man hesitated to expand his undertakings because of the instability of the inflated level of prices; the man with a turn for speculative ventures found more alluring opportunities in trade.


No one can read contemporary comments on American social life of the later years of the war without being impressed by the charges of extravagance made against the people of the North. Newspapers and pulpits were at one in denouncing the sinful waste that, they declared, was increasing at a most alarming rate. The "shoddy aristocracy" with its ostentatious display of wealth became a stock subject for cartoonists at home, and earned a well-merited reputation for vulgarity abroad.

In trying to account for this unpleasant phase of social development, men usually laid the blame upon the paper standard. High prices were said to make every one feel suddenly richer and so to tempt every one to adopt a more lavish style of living than his former wont. Thus the view gained general credence that the greenbacks were ultimately responsible for a great increase in the consumption of wealth.

However, such a view regarding the consumption of wealth can be but partially true. The enormous profits of entrepreneurs made possible the rapid accumulation of an unusual number of fortunes, and the families thus lifted into sudden affluence enjoyed spending their money in the ostentatious fashion characteristic of the newly rich. It is therefore true that the monetary situation was largely responsible for the appearance of a considerable class of persons—of whom the fortunate speculator and the army contractor are typical—who plunged into the recklessly extravagant habits that called down upon their heads the condemnation of the popular moralist.

But if the greenbacks were in the last resort a chief cause of the increased consumption of articles of luxury by families whom they had aided in enriching, they were not less truly a cause of restricted consumption by a much larger class of[Pg 50] humbler folk. The laboring man whose money wages increased but one-half, while the cost of living doubled, could not continue to provide for his family's wants so fully as before. He was forced to practise economies—to wear his old clothing longer, to use less coffee and less sugar, to substitute cheaper for better qualities in every line of expenditure where possible. Similar retrenchment of living expenses must have been practised by the families of many owners of land and lenders of capital. In other words, the war time fortunes resulted in a very large measure from the mere transfer of wealth from a wide circle of persons to the relatively small number of residual claimants to the proceeds of business enterprises. The enlarged consumption of wealth which the paper currency made possible for the fortunate few was therefore contrasted with a diminished consumption on the part of the unfortunate many on whose slender means the greenbacks levied contributions for the benefit of their employers.

That the diminished consumption of wealth by large numbers of poor people escaped general notice, while the extravagance of the newly rich attracted so much attention, need not shake one's confidence in the validity of these conclusions. The purchase of a fast trotting-horse by a Government contractor, and the elaborateness of his wife's gowns and jewelry, are much more conspicuous facts than the petty economies practised by his employees. The same trait that leads fortunate people to flaunt their material prosperity in the eyes of the world leads the unfortunate to conceal their small privations. Even an attentive observer may fail to notice that the wives of workingmen are still wearing their last year's dresses and that the children are running barefoot longer than usual.

But though the newspapers were not full of comments on the enforced economies of the mass of the population, wholesale dealers in staple articles of food and clothing noticed a decrease in sales. In reviewing the trade situation in September, 1864. when real wages were near their lowest ebb, Hunt's Merchants' Magazine remarked that "the rise in the prices of commodities has ... outrun the power of consumption and the fall trade has been almost at a stand. Those[Pg 51] articles such as coffee, sugar, low grade goods, which form the staple products of the great mass of the people in moderate circumstances, have reached such high rates that the decline in consumption is very marked, amounting almost to a stagnation of the fall trade." The consumption of many articles of luxury increased very greatly, while the consumption of many staple articles declined.

The Greenbacks and the Cost of the Civil War

The reader who goes back to the debates upon the legal-tender bills will find that most of the unfortunate consequences that followed their enactment were foretold in Congress—the decline of real wages, the injury done creditors, the uncertainty of prices that hampered legitimate business and fostered speculation. But a majority of this Congress were ready to subject the community to such ills because they believed that the relief of the treasury from its embarrassments was of more importance than the maintenance of a relatively stable monetary standard.


What effect had the greenbacks upon the amount of expenditures incurred? Few questions raised by the legal-tender acts have attracted more attention than this. Even while the first legal-tender bill was being considered its critics declared that if made a law it would increase the cost of waging the war by causing an advance in the prices of articles that the Government had to buy. As the war went on the soundness of this view became apparent.

When the war was over and the divers reasons that had deterred many men from criticizing the financial policy of the government were removed, competent writers began to express similar views with freedom. For example, Mr. C. P. Williams put the increase of debt at one-third to two-fifths; S. T. Spear, at a billion dollars; L. H. Courtney, an English critic, at nearly $900,000,000. Of later discussions that of H. C. Adams has attracted the most attention. He estimated that of the gross receipts from debts created between January 1,[Pg 52] 1862, and September 30, 1865, amounting to $2,565,000,000 the gold value was but $1,695,000,000—a difference of $870,000,000 between value received and obligations incurred.

A detailed consideration of the elements that enter the problem would seem to warrant a reduction of the estimates given to $791,000,000. It is hardly necessary to insist strenuously that this is but a very rough estimate.


The total increase of receipts was approximately $174,000,000, as shown in the following table:

(In millions of dollars)

1862Fiscal Year1866
(Six Months)186318641865(Two Months)
Current receipts:
From customs33.569.1102.384.931.3
From sales of public lands.
From direct tax1.
From miscellaneous sources.53.047.533.012.3
From internal revenue...37.6109.7209.564.4
Estimated actual increase0  10  39  106  19  

The caution is hardly necessary that the above results are to be accepted subject also to a wide margin of error.

There were other financial consequences of the shift from the specie to the paper standard, however, that were not unimportant, though they were indirect and difficult to gauge. Two of the most prominent must be indicated.

1. It is probable that not a little of the lavishness with which public funds were appropriated by Congress during the war can be traced to the paper-money policy.

2. If the paper currency tempted the Government to reckless expenditures, it also predisposed the people to submit more willingly to heavy taxation. It has been remarked several times that the advance of money wages and of money prices made most people feel wealthier, and, feeling wealthier, they were less inclined to grumble over the taxes.

While these indirect effects of the paper currency on expenditures and receipts could not by any system of bookkeeping[Pg 53] be brought to definite quantitative statement, it is probable that their net result was unfavorable to the treasury.

Contraction and Inflation of the Legal Tenders[9]

The policy of a permanent currency of government legal-tender paper at the close of the Civil War was unknown. Upwards of four hundred million notes of the United States were, it is true, in circulation at the return of peace. There were doubtless many individuals who approved the continuance of exactly this form of currency. But no such proposition had been advanced by any public man of influence or by any political organization. That the resort to legal-tender powers was an evil justified only by extreme emergency, and that the circulation of government notes in any form was a purely temporary measure, were the unanimous convictions of the statesmen who contrived the system. The logical inference that these Government notes would be paid off and cancelled, as soon as the war deficiency had ended, was publicly accepted.

Such was the theory and purpose of the public men through whom the Legal-Tender Act was constructed and applied. Nor is the general position of our statesmen, at the close of the Civil War, any more obscure than their original position. The first financial resolution adopted by Congress, in December, 1865, was an explicit promise to retire the legal tenders. The first legislation of that Congress gave discretionary powers to the Secretary of the Treasury for continuous contraction. Very few legislative victories are won without at least a temporary popular endorsement, and the votes of December, 1865, and of March, 1866, were no exceptions. But the popular approval of contraction in that year, exception as it was to all our subsequent legislation, is readily enough explained. Public opinion, when the war ended, was governed by impatience with inflated prices; inflation far beyond the European level, and properly ascribed to the condition of the currency. The cost of living reached during 1865 the highest point recorded in this country's history. From 1860 to 1865, inclusive, the average of European prices rose only 4 to 6 per cent.; average[Pg 54] prices in the United States advanced, in the same period, no less than 116 per cent. With flour at $16 a barrel, butter at 55 cents a pound, coal at $10 a ton, and wages and salaries advanced since 1860 hardly one-third as far as prices, the demand for currency reform obtained ready endorsement from the people.

This popular sentiment was further strengthened by the Administration's attitude at the opening of Lincoln's second term. Mr. McCulloch's first official Treasury report, dated December 4, 1865, took positive ground for the reduction of the legal-tender debt. He asked authority to issue bonds in his discretion, at 6 per cent. or less, "for the purpose of retiring not only the compound interest notes, but the United States notes."

Two weeks after the publication of this report, on December 18, 1865, the House of Representatives resolved, by a vote of 144 to 6,

that this house cordially concurs in the view of the Secretary of the Treasury in relation to the necessity of a contraction of the currency, with a view to as early a resumption of specie payments as the business interests of this country will permit; and we hereby pledge co-operative action to this end as speedily as practicable.

This resolution of 1865, however, marked the climax of the movement. Never thereafter did the policy of retiring the legal-tender notes even approach success. The truth is, that the inflated prices had begun already, during the three months after the resolution of December, to recede. This was inevitable, from the very nature of the previous expansion; and it was a welcome movement to consumers. But it necessarily caused some derangement in the plans of trade, and politicians began to ask, when they had to face the fulfilment of their pledge through a formal act of Congress, how the contraction policy would be greeted by producers. The bill, as originally introduced, granted full powers to the Secretary of the Treasury to issue new bonds for the retirement both of interest-bearing and of noninterest-bearing debt. In the spring of 1866 this measure was defeated in the House of Representatives by a vote of 70 to 64. Reconsidered and amended so as to restrict contraction of the legal tenders to $10,000,000 in[Pg 55] the first six months and to $4,000,000 per month thereafter, the compromise measure did indeed pass the House by 83 to 53, and the Senate by 32 to 7. But a victory thus won was ominous. Mr. McCulloch himself declared the amended act to be awkward and ineffective. Still more significant was the character of opposition developed in the course of the debate. It had a dozen varying grounds of argument, most of them pretty certain to appeal to popular prejudice later on. Some Congressmen objected to the discretionary powers as revolutionary, and, while conceding Mr. McCulloch's ability and conservatism, pointed out that a very different Treasury Secretary might succeed him. Others pronounced the notion of immediate resumption of specie payments to be "Utopian in the extreme." Much was heard of the comfortable theory that if Congress would "allow things to go on without active interference," the "natural development of events" would automatically bring about resumption. More than one legislator could not understand, "when we have $450,000,000 [debt] bearing no interest, and which need bear no interest, why it is to be taken up and put into bonds." The excellence of a circulating medium "that rests on the property of the whole country, and has for its security the faith and patriotism of the greatest and freest country on the face of the globe," played its usual part in the discussion; so did the argument that "the amount of legal tenders now outstanding is not too much for the present condition of the country." In short, all the arguments which have been made familiar by the twenty subsequent years of controversy, cut a figure in this opening discussion.

As a matter of fact, even the restricted powers of note retirement granted under the law of March, 1866, were revoked within two years. Little or no progress had meantime been made towards resumption of specie payments. The Secretary himself had officially pointed out that two commercial influences must be removed before resumption would be possible; the excessively high prices in the United States and the heavy balance of foreign trade against us. But prices continued above the European level, and, as a consequence, export of merchandise was checked and imports greatly stimulated. The[Pg 56] entire gold product of each year in the United States was sent abroad.

Contraction of the inflated currency, even if pursued under the limitations of the Act of 1866, would in time have brought about conditions under which resumption might have been planned. But events outside of the United States now moved in such a way as to turn the entire financial community against the Secretary's policy. Hardly two months after the vote of March came a wholly unexpected crisis in the foreign money markets. The London collapse, precipitated by the Overend-Gurney failure of May, 1866, was in some respects as complete as any in the history of England. It affected every nation with which Great Britain had commercial dealings; not least of all the United States, of whose securities it was estimated that European investors even then held $600,000,000. During three months the Bank of England kept its minimum discount rate at the panic figure of 10 per cent.; the consequent sudden recall of foreign capital put a heavy strain on the American markets.

With the familiar disposition of the trade community to lay the blame for disordered markets on some move of public policy, the Treasury's operations to reduce outstanding notes were made the scapegoat. Politicians with an eye to popularity were quick to catch this drift of public sentiment. Some of them honestly believed that McCulloch's action in the currency was the cause of the trade distress; others, better informed but equally politic, avoided personal declaration of opinion, but characteristically announced that whether the theory was correct or not, the public believed it, and that in deference to the public, currency contraction ought to cease. The usual result ensued. Under the previous question, and without debate, a measure revoking absolutely the Secretary's power of contraction passed the House of Representatives in December, 1867, by a vote of 127 to 32. In the Senate there was an able show of opposition, but it was plainly put on the defensive, and on January 22, 1868, the resolution passed both chambers in its original and final shape.

This was the end of the McCulloch plan. It was the end of all serious debate upon resumption, for at least six years.[Pg 57] It was also, and very logically, the beginning of the fiat-money party. The Republicans were forced into open defence of sound financial principles by the very recklessness of their opponents. Helped by the great personal prestige of its candidate, General Grant, the Republican party won a sweeping victory. President Johnson, who was then at open odds with his party, had produced in his Annual Message of December 7, 1868, the extraordinary suggestion that "the 6 per cent. interest now paid by the Government" on its debt "should be applied to the reduction of the principal in semi-annual instalments"; in other words, that the plan of repudiating interest obligations—since adopted, with no agreeable results, by Turkey and Greece—should be formally approved by the United States. This remarkable utterance was first condemned by an overwhelming vote in both House and Senate; next, by an almost equally decisive vote, on March 3, 1869, Congress adopted the Public Credit Act, promising coin redemption of both notes and bonds, solemnly pledging its faith "to make provision, at the earliest practicable period, for the redemption of the United States notes in coin."

The promise was as easily made as the similar pledge of December, 1865; was still more easily broken. No such arrangement was made, nor any serious attempt in that direction, until the matter was forced on the party by the exigency of politics. Not only was no effort made to reduce outstanding legal tenders, but the supply in circulation was heavily increased; rising from $314,704,000 in the middle of 1869 to $346,168,000 in 1872, and two years later, as a result of the Treasury's weak experiments in the panic, to $371,421,000.

This period was congenial to such juggling with public credit and legislative pledges. Socially, financially, and politically, it stands out quite apart from any other decade of the century. Moral sense for a time seemed to have deteriorated in the whole community; it was a sorry audience, at Washington or elsewhere, to which to address appeals for economy, retrenchment, and rigid preservation of the public faith. The Government's financial recklessness was readily imitated by the community at large; debt was the order of the day in the affairs of both. As the period approached its culmination,[Pg 58] foreign trade reflected the nature of the situation. Merchandise imports in the fiscal year 1871 rose $84,000,000 over 1870; in 1872 they increased $106,000,000 over 1871. This movement was the familiar warning of an approaching crash; but the warning fell on deaf ears, as it usually does. In 1873 the house of cards collapsed.

The panic of 1873 left the country's financial and commercial structure almost a ruin. It had, however, several ulterior results so valuable that it is not wholly unreasonable to describe the wreck of credit as a blessing in disguise. American prices, long out of joint with the markets of the world, and thoroughly artificial in themselves, were certain to be eventually brought down. This very liquidating process served a useful double purpose; it disclosed the nation's true resources, and it placed the United States on equal footing with the commercial world at large. With the bursting of the bubble of inflated debt and inflated prices, the excessive importations ceased. Simultaneously the export trade, which had halted during 1872, in spite of the continued agricultural expansion, rose to proportions never before approached in our commercial history. In 1874, the balance of foreign trade turned permanently in our favor. By 1876, even the continuous outflow of gold was checked. In short, the two conditions fixed by Hugh McCulloch, ten years before, as indispensable to resumption of specie payments, had now been realized.

Congress was not by any means disposed, however, to seize the opportunity. The first result of the money market crisis in 1873, as in all similar years, was urgent public clamor for more currency. The Supreme Court had decided finally, in 1871, for the constitutionality of the legal tenders; the Secretary of the Treasury, in 1873, had so far yielded to the prevalent excitement as to reissue legal-tender notes already formally retired. The first response of Congress, therefore, was an inflation measure. By a vote of 140 to 102 in the House of Representatives, and of 29 to 24 in the Senate, a law was passed for the permanent increase of the legal-tender currency, by $18,000,000. The Republican party controlled Congress by unusually large majorities; but 60 per cent. of the party's vote in each chamber was cast in favor of the bill. Only the[Pg 59] interposition of Grant's Presidential veto prevented this first positive backward step in the direction of fiat money.

It is reasonable to suppose that this curious vote of the Administration party, which occurred in April, 1874, measured the party's political desperation. They were about to receive, in the Congressional elections, the usual chastisement experienced by a dominant party when the people vote in a period of hard times; the inflation act was an anchor thrown desperately to windward. The experiment was in all respects a failure. Even the party's own State conventions failed to say a good word for the inflation bill, and it gained no mitigation of sentence in the November vote.

Passage of the Resumption Act[10]

The Forty-third Congress had three months of existence left to it after the vote of November, 1874. Already defeated overwhelmingly at the polls, it had nothing to risk by a move in sound-money legislation, and possibly much to gain. It used this three-months' period to enact a law of the first importance, not only to the nation, but to the Republican party's future history—a law which must fairly be described, however, under the circumstances of the time, as an expression of death-bed repentance. This was the Specie-Resumption Act, drawn up by a party committee, and submitted to Congress, in December, 1874, by Senator John Sherman. It fixed the date for resumption of specie payments at January 1, 1879, provided for the reduction of legal-tender notes from $382,000,000 to $300,000,000, but made no provision for any further retirement of the notes. It went through Congress on January 7, 1875. It was contended by some that under the Resumption Act of 1875 there could be no reissue of the greenbacks once received into the Treasury. Inflationist successes of 1877-1878 settled this uncertainty, as Congress, May 31, 1878, ordered that there be no further destruction of greenbacks. The amount then outstanding was $346,681,000—the volume of legal tenders still current.

[Pg 60]

The Struggle for Resumption[11]

The Resumption Act is one of the most curious laws in financial history. It was plain in its requirement that on and after January 1, 1879, the Treasury should "redeem in coin the United States legal-tender notes then outstanding, on their presentation for redemption"; but it left the Treasury to make whatever arrangements it might choose. The law, it is true, conferred ample powers. In order "to prepare and provide for the redemption in this Act authorized or required," it empowered the Secretary of the Treasury "to use any surplus revenues, from time to time, in the Treasury not otherwise appropriated, and to issue, sell, and dispose of bonds of the United States at not less than par in coin." This power was perpetual.

The Law of 1875 involved the double problem of providing for resumption at the stipulated date, and of maintaining it afterward. It is the first of these undertakings, which we shall now sketch. There were, as we have already seen, two influences at work in 1875, which made possible the achievement as it would not have been in 1866. These influences—the shifting of the foreign trade balance in favor of the United States and the subsequent check to gold exports—were factors on which no finance minister could have reckoned. Both in fact developed after the passage of the Resumption Law. But even after allowing for these accidental commercial advantages, the credit for the return to specie payments on January 1, 1879, belongs individually and without dispute to John Sherman.

As one of the authors of the Resumption Act, Mr. Sherman was responsible both for its virtues and its vices. His appointment to the Treasury, therefore, in the Administration under which resumption must by law be carried out, was entirely logical. Yet the practical efficiency of Mr. Sherman, in an administrative office, could not then have been foretold. The Secretary's previous career, though useful and industrious, had been marred by weaknesses which did not promise well. As a legislator, he belonged to the school of compromisers who have indirectly been responsible, in a score of critical emergencies, for the gravest mischief in our history.[Pg 61]

But Mr. Sherman was not the first of public men to show that the faults or weakness of a legislator, whose purpose is to obtain enactment of a policy, will sometimes disappear in the administrator, who presses settled policies into execution. As Secretary he was unwavering in pursuit of the resumption goal; practical, resolute, and adroit in the means employed. It was in the face of the repudiation clamor that he declared officially for payment of the Government bonds in gold. Equally distinct was the Secretary's public declaration that the Act of 1875 conferred the power to issue bonds after, as well as before, resumption; another precedent which did invaluable service sixteen years afterward.

To say that Secretary Sherman's management of the Treasury achieved during his time precisely the results proposed, and achieved them promptly, is to concede his administration's practical success. Nor were these results attained through extravagance or waste. In his refunding and resumption operations, Mr. Sherman placed the bonds of the United States on better terms than any of his predecessors.

Arrangements for Resumption[12]

The Secretary of the Treasury now put the final touches on his arrangements for resumption. Partly by accident and partly through stress of circumstances, the Treasury gold reserve was defined, in later years, at a fixed and arbitrary minimum. The theory adopted by Mr. Sherman, however, in his early operations, was different and undoubtedly better. Following probably the practice of the Bank of England, he fixed his reserve at 40 per cent. of outstanding notes—"the smallest reserve," he wrote to Congress, "upon which resumption could be prudently commenced and successfully maintained." On this basis he held in the Treasury, on December 31, 1878, $114,193,000 gold in excess of outstanding gold certificates, which was a trifle over 40 per cent. of the Government notes then circulating outside the Treasury. Of this gold reserve, $95,500,000 had been obtained through sale of bonds, part of the coin being procured in Europe.

[Pg 62]

There remained now to be settled only the formal machinery of exchange between the Treasury and outside institutions. If the Treasury had left the banks to pursue unchanged their policy of keeping special gold deposits, the Government reserve would have been at once imperilled. If the banks had continued to present their individual drafts for redemption across the counter of the Sub-Treasury, any timid or blundering banker might have started a general drain of gold. Against these possibilities Mr. Sherman now took measures. He secured the admission of the New York Sub-Treasury as a member of the clearing-house. At New York and Boston the clearing-houses modified their rules, agreed to abolish "gold deposits" after January 1st, and to accept the legal tenders freely in discharge of balances against one another and against the Government. At the same time, the requirement of coin payment of customs duties was revoked, and public officers were directed to receive coin or legal tenders at the payer's option—a move of obvious propriety, since refusal to take notes in payment would merely send the importer to the Treasury's redemption office to convert them into coin. All these preliminaries had been formally and positively settled before the close of 1878. On December 17th, the premium on gold disappeared, for the first time since 1861; on January 1st, specie payments were quietly resumed.

Should the Greenbacks Be Retired?

[13]Let us now consider for a moment an issue which twenty years ago was urgently pertinent, was in fact the very crux of so-called "currency reform," and which still persists as a live issue in the minds of some of the veteran "reformers" of those days, although the conditions which then gave it point have long since disappeared.

In the middle nineties, when it was estimated that the total gold stock of the entire country was only about 600 million dollars and less than 200 millions of this was in the vaults of[Pg 63] the treasury, the Government's fiduciary currency, consisting of 346 millions of greenbacks and 400 millions or more of overvalued silver, presented beyond question a serious menace to the country's monetary standard. It meant that the treasury had outstanding currency obligations payable in gold to the extent of three or four times its own gold holdings, and amounting to far more than all of the gold in the country, including the holdings of the treasury, the banks, and the general public. At that time fluctuations in the trade balance of a single year sometimes almost equalled the treasury's gold holdings in amount, and it was quite conceivable, in fact not improbable, that a sudden unfavorable change in that balance might drain the treasury of all of its gold, and leave the country with a currency standard of depreciated silver or paper. This was the situation which continually menaced Mr. Cleveland's second administration, causing great financial anxiety and forcing the treasury during those years of peace and normal expenditures to borrow 262 million dollars in gold in order to replenish its continually dwindling reserve. Such a situation inevitably led the advocates of monetary legislation in the nineties to place first and foremost among their proposals the necessity of getting rid of the precarious greenback, and most of the plans proposed by bankers' associations, chambers of commerce, and financial experts generally at that time emphasized the urgency of this measure.


It sometimes happens that, with the lapse of time and with changed conditions, infirmities, long left untreated, cure themselves, and so it has been with the one-time bothersome greenback. Twenty years ago, when the outstanding greenbacks amounted to twice the gold holdings of the treasury and to much more than half of the country's entire gold stock, there was abundant reason for anxiety on account of their continued circulation. The situation is utterly different to-day. Gold has accumulated in the treasury beyond the wildest "dreams of avarice" of the nineties. From less than 200 millions in the middle nineties the treasury's gold holdings have grown to approximately 1,250 millions to-day, and the estimated gold[Pg 64] stock of the country has increased from 600 to more than 1,800 millions, despite the fact that the Director of the Mint in 1907 reduced the estimate for gold in circulation by 135 millions as compared with the basis of previous years.

The greenback has thus become each year a relatively less important element in our currency system, an element of ever less and less potency for harm. Doubtless the absolute amount of outstanding greenbacks has diminished considerably through loss and destruction during fifty years, and is to-day far less than the $346,000,000 issued during the Civil War, which are still carried as an obligation on the Government books....

The greenbacks are less menacing to-day for the further reason that they are being rapidly transformed into small denominations which are absorbed in the general circulation, and which could only with great difficulty be collected in sufficiently large amounts to cause a serious drain upon the treasury through presentation for redemption.... So great and continuous is the demand for notes of small denominations that one may safely predict that in another decade practically all of the greenbacks still in existence will be in small denominations in the pockets of the people.

The "endless chain" with its ineffectual bond issues, the imminence of specie suspension, and the fear of treasury bankruptcy will never again result from the outstanding greenbacks. Their dangers, lurid and nerve-racking though they were twenty years ago, are now only memories.

The Confederate Currency[14]

The financial system adopted by the Confederate Government was singularly simple and free from technicalities. It consisted chiefly in the issue of treasury notes enough to meet all the expenses of the Government, and in the present advanced state of the art of printing there was but one difficulty incident to this process; namely, the impossibility of having the notes signed in the Treasury Department, as fast as they were needed. There happened, however, to be several thousand young ladies in Richmond willing to accept light and remunerative employment[Pg 65] at their homes, and as it was really a matter of small moment whose name the notes bore, they were given out in sheets to these young ladies, who signed and returned them for a consideration. I shall not undertake to guess how many Confederate treasury notes were issued. Indeed, I am credibly informed by a gentleman who was high in office in the Treasury Department, that even the Secretary himself did not certainly know. It was clearly out of the power of the Government ever to redeem the notes, and whatever may have been the state of affairs within the treasury, nobody outside its precincts ever cared to muddle his head in an attempt to get at exact figures.

We knew only that money was astonishingly abundant. Provisions fell short sometimes, and the supply of clothing was not always as large as we should have liked, but nobody found it difficult to get money enough. It was to be had almost for the asking. And to some extent the abundance of the currency really seemed to atone for its extreme badness. Money was so easily got, and its value was so utterly uncertain, that we were never able to determine what was a fair price for anything. We fell into the habit of paying whatever was asked, knowing that to-morrow we should have to pay more.

Speculation became the easiest and surest thing imaginable. The speculator saw no risks of loss. Every article of merchandise rose in value every day, and to buy anything this week and sell it next was to make an enormous profit quite as a matter of course. So uncertain were prices, or rather so constantly did they tend upward, that when a cargo of cadet gray cloths was brought into Charleston once, an officer in my battery, attending the sale, was able to secure enough of the cloth to make two suits of clothes, without any expense whatever, merely by speculating upon an immediate advance. Naturally enough, speculation soon fell into very bad repute, and the epithet "speculator" came to be considered the most opprobrious in the whole vocabulary of invective. The feeling was universal that the speculators were fattening upon the necessities of the country and the sufferings of the people. Nearly all mercantile business was regarded at least with suspicion, and much of it fell into the hands of people with no[Pg 66] reputations to lose, a fact which certainly did not tend to relieve the community in the matter of high prices.

The prices which obtained were almost fabulous, and singularly enough there seemed to be no sort of ratio existing between the values of different articles. I bought coffee at forty dollars and tea at thirty dollars a pound on the same day. My dinner at a hotel cost me twenty dollars, while five dollars gained me a seat in the dress circle of the theatre. I paid one dollar the next morning for a copy of the Examiner, but I might have got the Whig, Dispatch, Enquirer, or Sentinel, for half that sum. For some wretched tallow candles I paid ten dollars a pound. The utter absence of proportion between these several prices is apparent, and I know of no way of explaining it except upon the theory that the unstable character of the money had superinduced a reckless disregard of all value on the part of both buyers and sellers. A facetious friend used to say prices were so high that nobody could see them, and that they "got mixed for want of supervision." He held, however, that the difference between the old and the new order of things was a trifling one. "Before the war," he said, "I went to market with the money in my pocket, and brought back my purchases in a basket; now I take the money in the basket, and bring the things home in my pocket."

As I was returning to my home after the surrender at Appomattox Court House, a party of us stopped at the residence of a planter for supper, and as the country was full of marauders and horse thieves, deserters from both armies, bent upon indiscriminate plunder, our host set a little black boy to watch our horses while we ate, with instructions to give the alarm if anybody should approach. After supper we dealt liberally with little Sam. Silver and gold we had none, of course, but Confederate money was ours in great abundance, and we bestowed the crisp notes upon the guardian of our horses, to the extent of several hundreds of dollars. A richer person than that little negro I have never seen. Money, even at par, never carried more of happiness with it than did those promises of a dead government to pay. We frankly told Sam that he could buy nothing with the notes, but the information brought no sadness to his simple heart.[Pg 67]

"I don' want to buy nothin', master," he replied. "I's gwine to keep dis always."

I fancy his regard for the worthless paper, merely because it was called money, was closely akin to the feeling which had made it circulate among better-informed people than he. Everybody knew, long before the surrender, that these notes never could be redeemed. There was little reason to hope, during the last two years of the war, that the "ratification of a treaty of peace between the Confederate States and the United States," on which the payment was conditioned, would ever come. We knew the paper was worthless, and yet it continued to circulate. It professed to be money, and on the strength of that profession people continued to take it in payment for goods. The amount of it for which the owner of any article would part with his possession was always uncertain. Prices were regulated largely by accident, and were therefore wholly incongruous.

In the winter of 1863-64 Congress became aware of the fact that prices were higher than they should be under a sound currency. If Congress suspected this at any earlier date, there is nothing in the proceedings of that body to indicate it. Now, however, the newspapers were calling attention to an uncommonly ugly phase of the matter, and reminding Congress that what the Government bought with a currency depreciated to less than one per cent. of its face, the Government must some day pay for in gold at par. The lawgivers took the alarm and sat themselves down to devise a remedy for the evil condition of affairs. With that infantile simplicity which characterized nearly all the doings and quite all the financial legislation of the Richmond Congress, it was decided that the very best way to enhance the value of the currency was to depreciate it still further by a declaratory statute, and then to issue a good deal more of it. The act set a day, after which the currency already in circulation should be worth only two-thirds of its face, at which rate it was made convertible into notes of the new issue, which some, at least, of the members of Congress were innocent enough to believe would be worth very nearly their par value. This measure was intended, of course, to compel the funding of the currency, and it had that[Pg 68] effect to some extent, without doubt. Much of the old currency remained in circulation, however, even after the new notes were issued. For a time people calculated the discount, in passing and receiving the old paper, but as the new notes showed an undiminished tendency to still further depreciation, there were people, not a few, who spared themselves the trouble of making the distinction.

I am sometimes asked at what time prices attained their highest point in the Confederacy, and I find that memory fails to answer the question satisfactorily. They were about as high as they could be in the fall of 1863, and I should be disposed to fix upon that as the time when the climax was reached, but for my consciousness that the law of constant depreciation was a fixed one throughout the war. The financial condition got steadily worse to the end.

The Government's course in levying a tax in kind, as the only possible way of making the taxation amount to anything, led speedily to the adoption of a similar plan, as far as possible, by the people. A physician would order from his planter friend ten or twenty visits' worth of corn, and the transaction was a perfectly intelligible one to both. The visits would be counted at ante-war rates, and the corn estimated by the same standard. In the early spring of 1865 I wanted a horse, and a friend having one to spare, I sent for the animal, offering to pay whatever the owner should ask for it. He could not fix a price, having literally no standard of value to which he could appeal, but he sent me the horse, writing, in reply to my note:

"Take the horse, and when the war shall be over, if we are both alive and you are able, give me as good a one in return. Don't send any note or due-bill. It might complicate matters if either should die."

A few months later I paid my debt by returning the very horse I had bought. I give this incident merely to show how utterly without financial compass or rudder we were.

How did people manage to live during such a time? I am often asked; and as I look back at the history of those years, I can hardly persuade myself that the problem was solved at all. A large part of the people, however, was in the army, and drew rations from the Government. The country people raised upon[Pg 69] their plantations all the necessaries of life, and were generally allowed to keep enough of them to live on, the remainder being taken by the subsistence officers for army use.

In the cities, living was not by any means so easy as in the country. Business was paralyzed, and abundant as money was, it seems almost incredible that city people got enough of it to live on. Very many of them were employed, however, in various capacities, in the arsenals, departments, bureaus, etc., and these were allowed to buy rations at fixed rates, after the post-office clerks in Richmond had brought matters to a crisis by resigning their clerkships to go into the army, because they could not support life on their salaries of nine thousand dollars a year. For the rest, if people had anything to sell, they got enormous prices for it, and could live a while on the proceeds. Above all, a kindly, helpful spirit was developed by the common suffering, and this, without doubt, kept many thousands of people from starvation. Nobody formed any plans or laid by any money for to-morrow or next week or next year, and indeed to most of us there really seemed to be no future. We were not used to think of ourselves as possible survivors of a struggle which was every day perceptibly thinning our ranks. The coming of ultimate failure we saw clearly enough, but the future beyond was a blank.

The reader may find it difficult to believe that with gold at a hundred and twenty-five for one, or 12,400 per cent. premium; when every day made the hopelessness of the struggle more apparent; when our last man was in the field; when the resources of the country were visibly at an end, there were financial theorists who honestly believed that by a mere trick of legislation the currency could be brought back to par. I heard some of these people explain their plan during a two days' stay in Richmond. Gold, they said, is an inconvenient currency always, and nobody wants it, except as a basis. The Government has some gold—several millions in fact—and if Congress will only be bold enough to declare the treasury notes redeemable at par in coin, we shall have no further difficulty with our finances. So long as notes are redeemable in gold at the option of the holder, nobody wants them redeemed.... The gold which the Government holds will[Pg 70] suffice to satisfy a few timid ones, and there will be an end of high prices and depreciated currency. I am not jesting. This is, as nearly as I can repeat it, the utterance of a member of the Confederate Congress.

The matter of prices was frequently made a subject for jesting in private, but for the most part it was carefully avoided in the newspapers. As with the accounts of battles in which our arms were not successful, necessary references to the condition of the finances were crowded into a corner, as far out of sight as possible. The Examiner, however, on one occasion denounced with some fierceness the charges prevailing in the schools; and I quote a passage from Prof. Sidney H. Owens's reply, which is interesting as a summary of the condition of things in the South at that time:

"The charges made for tuition are about five or six times as high as in 1860. Now, sir, your shoemaker, carpenter, butcher, market man, etc., demand from twenty, to thirty, to forty times as much as in 1860. Will you show me a civilian who is charging only six times the prices charged in 1860, except the teacher only? As to the amassing of fortunes by teachers, spoken of in your article, make your calculations, sir, and you will find that to be almost an absurdity, since they pay from twenty to forty prices for everything used, and are denounced exorbitant and unreasonable in demanding five or six prices for their own labor and skill!"

There were compensations, however. When gold was at 12,000 per cent. premium with us, we had the consolation of knowing that it was in the neighborhood of one hundred above par in New York, and a Richmond paper of September 22, 1864, now before me, fairly chuckles over the high prices prevailing at the North, in a two-line paragraph which says, "Tar is selling in New York at two dollars a pound. It used to cost eighty cents a barrel." That paragraph doubtless made many a five-dollar beefsteak palatable.


[8] Adapted from Wesley Clair Mitchell, A History of the Greenbacks, Part II, The University of Chicago Press, 1903.

[9] Adapted from A. D. Noyes, Forty Years of American Finance, pp. 7-20. G. P. Putnam's Sons, New York and London, 1909.

[10] Ibid., pp. 21-22.

[11] Ibid., pp. 23-31.

[12] Ibid., pp. 44-47.

[13] A. Piatt Andrew, The Essential and the Unessential in Currency Legislation, in Questions of Public Policy, Addresses delivered in the Page Lecture Series, 1913, before the Senior Class of the Sheffield Scientific School, Yale University, pp. 55-59. Yale University Press, New Haven, Connecticut. 1913.

[14] Adapted from George Gary Eggleston, A Rebel's Recollections, pp. 78-107. Hurd and Houghton. Boston, 1875.

[Pg 71]



[15]... There are natural and commercial causes which may operate to produce either an incessant fluctuation in the relative value of silver and gold, or a wide and increasing divergence, from year to year, through a long period, from the ratio of exchange existing between the two metals at the commencement of the period. So far are the sources and conditions of supply of the one different from those of the other that, notwithstanding the influence of the durableness of the metals in giving steadiness of value to either by turns, and hence to the two in their relation to each other, it would be in the highest degree unreasonable to assume that the ratio of exchange between gold and silver would remain unaltered through any considerable term of years. The annual or monthly variations may take the form of oscillations, now on one side and now on the other of any historical ratio, or they may be cumulative on one side of that ratio, producing a divergence increasing from month to month, and year to year; but variations in some degree, in some direction, are to be expected under the unrestrained operation of causes influencing the demand for, or the supply of, each metal.

The conditions, natural and commercial, which determine the ratio of exchange of the two metals being such, we have seen that government may enter, and, by making the two indifferently legal tender for debts at a ratio fixed by law, may, for the time, counteract the operation of any and all forces tending to produce divergence. So long as any country establishing such a principle holds a considerable amount of that metal which, under the natural and commercial conditions of supply and demand prevailing at the time, tends to[Pg 72] become the dearer of the two, it is impossible that the cheapened metal should there, or in any market, fall far below that ratio. By the force of the bimetallic law, the substitution of the cheapened for the dearer metal will at once begin; and so long as that continues, the divergence of the market ratio from the mint ratio can never be wide. Why should any one in London or New York pay much more than fifteen and a half ounces of silver for an ounce of gold, when gold can, at any time and in any amount, be obtained for silver at the rate of fifteen and a half in Paris?

This operation of the bimetallic system can not be denied; but there is ground for dispute as to the degree of the advantages to result, and as to the cost at which those advantages are to be obtained. The monometallist, or advocate of the so-called single standard, is disposed to disparage the benefits to be expected, and to magnify the expense of this system. He points to the fact that the two metals do not actually circulate in the same country, at the same time, in any considerable degree; that it is always the one metal or the other which is used as money, according as the market ratio diverges to the one side or the other of the mint ratio, while the coin made from the dearer metal acquires a premium, and is exported or hoarded. Hence it is said bimetallism really means the use of but one metal in a country at a time. It is not a double standard, but an alternate standard.

To this the bimetallist replies that the concurrent use of the two money metals, side by side, in the same markets, is a matter wholly of indifference. The merit of the bimetallic scheme does not depend on this at all.

The object of bimetallism is, by joining the two metals together in the coinage, at a fixed ratio, to diminish the extent of the fluctuations to which the value of each would be separately liable, by generating a compensatory action between the two, by which the cheapening metal shall receive a larger use, while the appreciating metal drops partially out of its former demand, thus making the two fall together, if there must be a fall, or rise together, in the opposite case: or, conceivably, making the tendency of one to fall precisely counteract the tendency of the other to rise.[Pg 73]

Thus we may suppose four successive cases to illustrate the working of this principle.

The first is, where the demand for the use of either metal in trade remaining the same, a large increase in the supply of one metal, A, takes place, the supply of the other, B, remaining unchanged. In this case, without the bimetallic system, the value of A would tend to fall rapidly through a considerable space, while the value of B would stand fast. With the bimetallic system, the joint supply of the two metals would be applicable to meet the joint demand for the two. Now, as the joint supply has been increased without any change in the joint demand, there must be a fall in value; but the fall will be in the two indistinguishably, except for a slight degree of delay and friction in exchange. Both will fall, but the depth of the fall will be diminished as the surface over which it is to take place has been enlarged.

The second is where, the demands of trade for both metals remaining the same, a diminution occurs in the supply of A, while the supply of B remains unchanged. Here, by the operation of the same principle, a rise in the value of money will take place, since the joint supply has been reduced without any corresponding change in the joint demand. The rise will be a rise of the two metals indistinguishably, the height of the rise being diminished as the surface over which it is to take place has been enlarged.

The third case is where, demand remaining the same, the supply of both metals undergoes a change in the same direction, either of increase or of diminution, at the same time. In this event, the fall or rise will again be of the two indistinguishably, the point reached being a mean between the points which would have been reached by the two severally.

The fourth case is where, demand remaining the same, the supply of the two metals undergoes a change at the same time, but in opposite directions, A through diminution, B through increase. In this case, the opposite tendencies will counteract each other. If of equal force, the value of money will be stable; if of unequal force, there will be movement in the direction of the stronger to the extent of the difference between the two. Instead of one falling and the other rising[Pg 74] in value, the change will be wrought in the two indistinguishably.

It will appear from the foregoing statements that, under the bimetallic system, the value of money will be liable to vary more frequently than under the monometallic system. That is, a change in respect to either constituent of the money mass will produce a change of value; and it is apparent that the chances of change are greater with two constituents than with one. On the other hand, the variations under the bimetallic system are likely to be less extensive. Indeed, it is a matter of practical certainty that they will be far less extensive than they would be under the monometallic system, whichever metal were adopted as the standard of deferred payments.

But, again, the monometallist interposes the objection that the bimetallic system is only to be supported at great expense to the States maintaining it; that they lose by the exchange of the dearer for the cheapened metal, even though they acquire a certain premium in doing so, and that sooner or later the stock of the dearer metal in the bimetallic countries will become exhausted, and the system will collapse, the price of the two metals no longer being held closely or nearly at the former ratio by the possibility of exchanging them at that ratio, freely, in any amount.

How far a bimetallic country loses by the alternation of the metals in circulation, as now one and now the other becomes the cheaper at the coinage ratio, is a nice question.

That the service rendered to the commerce of the world by establishing a normal price for each metal in terms of the other, and thus creating and maintaining a par-of-exchange between gold countries and silver countries, is worth far more than its cost, seems to me beyond a rational doubt. It would, in my view, be as reasonable to doubt whether London Bridge repays the expense of its erection and repair. Were the cost of this bimetallic service, whatever it is, properly assessed upon and collected from each commercial nation of the world by turns, according to the proportion in which it derives advantage therefrom, I think it might safely be said that no one of these nations would sustain a single other charge which so fully justified itself in the return it made, whether[Pg 75] that other charge were for works of construction, for the administration of justice, or for any other strictly necessary purpose.

But there is no assurance that the cost of the bimetallic system will be thus equitably assessed. If the whole charge of erecting and repairing London Bridge were thrown upon the merchants of the two or three streets nearest thereto, while yet the whole population were allowed to use the bridge, free of toll, there would not unnaturally arise a strong sense of injustice on the part of those who bore this burden for the public benefit; it might even become a question whether the undoubted advantages derived by them from the use of the bridge repaid the disproportionate expense which it caused them. If the maintenance of the bimetallic system involves a certain burden on the nations which sustain it, as I am disposed to think is the case, it fairly becomes a question whether those individual nations are compensated for bearing the whole expense of the service by their share of the advantages resulting therefrom to the trade and industry of the world.

That England could well have afforded, throughout the present century, to maintain this system for her own benefit, whatever it cost, even though other nations profited by it in greater or less degree, is clear as the light. That France, a country of far less extended international trade, has been compensated for bearing so large a part as she has done of the burden of maintaining a par-of-exchange for the commerce of the world, by her share of the resulting advantages, I make no question; but it must be admitted to be fairly a matter of dispute.

On such a point it is evidence of no small value that the French people themselves and the French statesmen, though singularly acute and sagacious in matters of finance, have apparently not doubted that the bimetallic system was for the interest of their country. Certain of the French political economists—MM. Chevalier, Levasseur, Bonnet, Mannequin, Leroy Beaulieu—from their theory of the subject have held that France lost by her policy in this respect; but the financiers of that remarkable nation held firmly to the "double standard"[Pg 76] from 1785 to 1874. And though France at the latter date restricted her silver coinage, and two years later stopped it altogether, it was not done as the result of any change of views. Partly it was from deference to her monetary allies, Belgium and Switzerland, but chiefly because the demonetization of silver by Germany and the sale of the discarded metal of that empire brought a sudden strain upon the bimetallic system which threatened to break it violently down. Hence France closed her mints to silver, but not with any confession that her policy had been erroneous under the conditions previously existing; not from any desire to abandon that policy should the future offer conditions which would admit the resumption of bimetallism. It was the declaration of M. Léon Say, the French Minister of Finance, the President of the International Monetary Conference of 1878, that France, in suspending the coinage of silver, had taken no step towards the single gold standard, but had placed herself in a position to await events, a position which she would not leave till good reasons for action should appear, and then most probably to re-enter on the system of the double standard....

The objection that the stock of the dearer metal in the bimetallic States must, if the drain be indefinitely continued, become after a while exhausted, and that the system will then lose all its efficiency in holding the two metals together, is unquestionably valid; but an altogether unreasonable weight has been assigned to it in the discussion of bimetallism as a scheme of practical statesmanship.

If we look at almost any treatise written from the monometallic point of view, we shall find that it is taken as conclusive against that scheme, that conditions of supply and demand can be assumed for the two metals separately which would result in the complete exhaustion of the dearer metal, and the consequent loss of all virtue in the bimetallic scheme. The bimetallist is confronted with a series of adverse conditions, taken each at its maximum and piled one above the other without the least regard to the modesty of nature, or the experience of the past; and is then challenged to say whether the system he proposes could be maintained under such circumstances. If he is candid enough to admit that[Pg 77] bimetallism would fail there, it is taken for granted that the whole question is disposed of.

Now, human institutions are not to be judged of, and approved or disapproved, by such methods. The folly of reasoning like this would be seen at once were it applied to ordinary political matters. No government on earth could stand against one-fourth or one-tenth of the elements of hostility which might conceivably be arrayed against it. Mankind do not, therefore, refuse to form governments.

Bimetallism is a political institution for practical ends, and is entitled to be judged with reference to reasonable probabilities. It may claim the benefit of the chance that adverse conditions will be offset by conditions favourable, and that the adverse conditions will not prove so severe at the start as they may be conceived, and that their force will be more quickly spent than might be feared.

It would be perfectly legitimate ground on which to establish European bimetallism, that the French system, with so little of support from other States, passed within a quarter of a century through the three successive shocks of the gold discoveries of Siberia, the gold discoveries of California, and the gold discoveries of Australia, and yet was not brought to the ground.

With Germany, France, and England joined in a monetary union, no changes reasonably to be anticipated in the conditions of supply of the one metal or the other would succeed in moving the market ratio far apart from the mint ratio thus supported by maintaining over so wide a surface a legal equivalence between the two metals in payment of debts.

And, moreover, while bimetallism is entitled to be judged like any other political institution, with reference to the reasonable probabilities of the future, the allowance which requires to be made for error and extraneous force is less than in most political institutions, inasmuch as the failure of bimetallism involves no disaster to industry or society.

When an engineer designs a bridge which is intended to sustain a weight of eighty tons, he introduces a "factor of safety," say three or five, and makes the bridge strong enough to bear two hundred and forty or four hundred tons. The[Pg 78] greater the calamity which would result from the breaking down of the bridge—the deeper the chasm which it spans, the swifter the torrent below—the larger the factor of safety. With many political institutions, likewise, the consequences of failure would be so disastrous that the statesman seeks to introduce a high factor of safety; but in the case of bimetallism no catastrophe whatever is to be anticipated, even in the event of failure. At the worst, after the drain of the dearer metal, in consequence of changes in the conditions of supply, is completed, the bimetallic country is simply in the same position with the countries of the single standard using the cheapened metal. While the process of substitution is going on, it sells the dearer metal at a premium; when the process is over, it is no worse off than it would have been had it originally selected as its sole money of full legal-tender power the metal which it has bought at a discount, and which other countries, perhaps its immediate neighbours, are still using. It is not the case of a country seeking to reject the cheapening metal, and to supply its place with the metal which is continually becoming scarcer and dearer.... There is all the difference, in the two cases, between going down hill and going up hill.

Not only is no catastrophe involved in the failure of bimetallism through the exhaustion of the dearer metal, but it is always in the power of the Government to arrest the drain at any point without shock.

Thus, in 1874, France and her monetary allies, seeing the prospect of a considerable drain of gold through the importation of the discarded and cheapened silver of Germany, and having decided, whether wisely or unwisely, not to prevent that drain, restricted the coinage of silver without repealing or suspending the law which made gold and silver legal tender indifferently at a fixed ratio. Two years later, finding that the forces operating to lower the value of silver were powerful and persistent, the coinage of silver was peremptorily stopped.

Can one point to any sign that France has suffered any special injury to her trade and production from this act?...

We now have to note ... that every additional State which joins the bimetallic group, having the same mint ratio[Pg 79] between gold and silver, does not only share the cost or the burden with those already in the system, but diminishes the aggregate cost or burden to be borne, and this, not in a slight, but in an important degree, so that should the monetary league become general, the total cost or burden to be divided among the many allies would be inappreciable; while, should the system come to embrace all commercial States, there would, in theory, be no burden at all to be borne by any one.

Thus let us suppose the commercial world to be divided into sixteen States, A to P, inclusive, the first six having the single gold standard, four, G to J, the so-called double standard of gold and silver, say at 15-1/2:1; the remaining six States having the single standard of silver, thus:

A, B, C, D, E, F (G, H, I, J), K, L, M, N, O, P.

It is evident that in the case of a change in the conditions of supply tending to cheapen silver relatively to gold, the new silver would pass into the countries of the double standard, G to J, be there exchanged for gold at the rate of 15-1/2: 1, with some small premium as the profit of the transaction, and the gold would go to the gold countries, A to F, in settlement of trade balances.

The rapidity with which this substitution of silver for gold will go forward will depend, first, on the force of the natural causes operating to cheapen silver, and, secondly, on the force of the commercial causes operating to maintain or advance the value of gold. The length of time during which the drain of the dearer metal can be sustained without exhaustion will (given the rate of movement) depend solely on the stock of that metal existing in the bimetallic States jointly when the drain begins.

But chief among the commercial causes operating to maintain or advance the value of gold is the exclusive power with which gold is invested by law to pay debts within States A to F; while the stock of the dearer metal available to sustain the drain described is made up, not of all the gold in the sixteen States A to P, or in the ten States A to J, but only of the gold in the four bimetallic States, G to J.

Hence we see that for every gold State which adopts the "double standard" the amount of gold available, in the case[Pg 80] of a cheapening of silver, to meet the drain of the dearer metal (on which the virtue of the bimetallic system depends) is increased; while the demand for gold in preference to silver at 15-1/2:1 (the only cause which threatens the stability of the bimetallic system) is, in just so far, diminished. On the other hand, every silver State that adopts the "double standard" strengthens the bimetallic system in the case of a cheapening of gold.

Let us suppose the sixteen commercial States to be divided as four gold States, eight gold and silver States, and four silver States, as follows:

A, B, C, D (E, F, G, H, I, J, K, L), M, N, O, F.

We see that the bimetallic system is now not twice as strong merely as in the case first assumed, but many times as strong, since not only is the amount of the dearer metal (whichever that may at the time be) subject to drain greatly increased, but the demand for that metal, in preference to silver at 15-1/2:1, now comes from four countries only, instead of six, as formerly. The transfer of still another State from each of the two single-standard groups would vastly increase the stability of the bimetallic system, A, B, C (D, E, F, G, H, I, J, K, L, M), N, O, P. Not only would the base of the system be broadened by bringing the dearer metal of ten States, D to M, under tribute in the event of changes operating on the supply of either to affect its value; but the force of the causes threatening the equilibrium of the system would be reduced, since the demand for the dearer metal would now come from only three States: A, B, C, in the case of a cheapening of silver relatively to gold; N, O, P, in the case of a cheapening of gold relatively to silver.

Bring still another State from each group into the monetary union, and the danger of a breaking down of the system, under any change in the conditions of supply which it would be reasonable to anticipate, almost disappears.

A, B (C, D, E, F, G, H, I, J, K, L, M, N), O, P. Twelve States now supply the dearer metal; only two States will take it in preference to the other at the ratio of the mint. Those two States—whether A, B, or O, P—can not take the dearer metal indefinitely. They will soon be surfeited. A[Pg 81] further increase of money in them would only be followed by a fall in its value, which would soon proceed so far as to bring the metals together again. What the one metal would tend to lose in value through increase of supply, the other would tend to lose through diminution of demand.

This is the Modern Bimetallic Scheme advocated by Wolowski and Cernuschi in France, Malou and de Laveleye in Belgium, Mees and Vrolik in Holland, Schneider in Germany, Haupt in Austria, Seyd and the Liverpool writers in England, Horton, Nourse, and George Walker in the United States.

It differs widely from the plan of the so-called "double standard," which was pronounced impracticable by Locke, Adam Smith, and Ricardo. Not the smallest presumption against the reasonableness of this scheme is created by the fact that eminent economists of the past century, and of the first half of the present, declared in favour of the single standard, whether of gold or of silver. Those writers contemplated a condition of international relations in which anything like general and permanent concert of action, in establishing and maintaining a ratio between the metals in the coinage, would have been wholly beyond reasonable expectation....

A general or universal system of bimetallism would involve no machinery, no international accounts, no detail whatever. The simple agreement of governments to coin at a certain ratio would be sufficient for all the objects that have been discussed. If unification of coinage, identity of moneypieces, and mutual acceptance of coins by the several nations forming such a monetary league, were to be added, some machinery for the redemption of worn pieces might require to be brought into existence; but this is not a necessary feature of successful bimetallism, which would be entirely compatible with the retention by each State of its own devices and denominations, and with the exchange of moneys as at present effected....


[15] Francis A. Walker. Money in Its Relations to Trade and Industry, pp. 164-176; 178-182. Henry Holt & Company. New York. 1889.

[Pg 82]



[16]Such was the singular combination of events after the peace of 1865 that almost at the moment when a million citizens were turned from organised destruction to pursuit of peaceful industry, the avenues of American employment and production were widened in a degree unprecedented in the history of trade. Within eight years after Lee's surrender, the railway mileage of the United States was literally doubled. Only a fraction of this increase belonged to the transcontinental lines which linked the two oceans in 1869. Quite aside from the 1,800 miles of the Pacific railways, upwards of 30,000 miles of track were laid in the United States between 1865 and 1873. Four noteworthy economic developments accompanied this extension of the transportation system. A fertile interior domain, hitherto untouched, was opened up to industry. With the rush of population to these Western districts, not only did the disbanded army resume production without industrial overcrowding such as followed the Napoleonic wars, but provision was made for three or four hundred thousand immigrants annually. European capital in enormous volume was drawn upon to provide the means for this development. Finally, the United States rose from the position of a second- or third-class commercial State to the first rank among agricultural producers and exporters. Each of these several phenomena had its special influence on the period.

Not less immediately connected with this opening up and settlement of our agricultural West was still another phenomenon, of peculiar interest to the study of the ensuing period. The average price of grain had advanced with great rapidity during the Civil War. In 1867, the price of wheat,[Pg 83] even on the Chicago market, reached the remarkable level of $2.85 per bushel; nor was this price very greatly above the annual maximum of the period. In a large degree, this advance resulted from inflation of the American currency. But the upward movement was world-wide; in 1867 and 1868 the average price, even in England, was close to the equivalent of two dollars a bushel. That any such abnormal market could be maintained in the face of the new American supplies was at least improbable. The increase in cereal production was twice as rapid as the country's increase in population; the United States became therefore the leading figure in the world's export markets; and this was certain to have important influence on prices.

As in America, so in Europe, production received immediate stimulus. While American capital was opening up the Mississippi Valley, European capital was similarly busy along the fertile river basins of the Dnieper and the Danube. The Russian railway system grew during this period from something like 2,000 miles to upwards of 13,000. In Austria-Hungary the percentage of increase was almost equally large. All of these new transportation lines, like our own new Granger railways, were at once engaged in carrying to the seaboard supplies of grain which never before had reached an export market. The problem of an earlier generation had been how to feed the constantly increasing population; a wholly new problem was presently to arise, based on the question how to find a ready and profitable market for the year's output of breadstuffs. Prices, in short, which rose almost continuously throughout the world during the period of slack production from 1858 to 1873, receded almost as continuously in the ensuing generation. Nowhere was this phenomenon destined to have more immediate importance, economically, socially, and politically, than in the United States.

The opinion is more or less widely held that the decline in prices, notably of grain, has resulted from legislation on the currency. Without for the present arguing that proposition, it may be affirmed with entire safety that a good share of the period's currency legislation has resulted from the decline in the price of grain. The fall in wheat has been the typical[Pg 84] argument for arbitrary increase of the silver or paper currency in almost every Congressional debate since 1872. What is perhaps even more significant, the division in almost every Congressional vote upon these subjects has been, not political but geographical—the commercial East against the agricultural West.

Agitation for Silver and the Passage of the Bland Bill

[17]In the summer session of 1876, several bills had been introduced, providing for increased silver coinage and for remonetization of the silver dollar. None of these propositions came to anything; they were chiefly remarkable from the fact that they first gave vogue to the theory of the "crime of 1873"—a theory which assumed that the dropping of the silver dollar from the list of coins in the statutes of that year was the outcome of a conspiracy which carried its legislation through in secret. The entire baselessness of this assertion has been demonstrated often enough and in convincing detail; this very provision regarding the silver dollar was a subject of public discussion in the House, and met with no serious opposition. The assertion in itself is so patently absurd that I shall not pause to discuss it. The truth is that silver in 1873, and during a generation before that date, was worth more to its owner in the form of bullion than in the form of coin. In 1872 the silver requisite to coin a dollar at the established ratio was worth $1.02. For years, therefore, nobody thought of bringing his silver to the mint for coinage; he sold it in the commercial markets. The total silver-dollar coinage of the United States, between 1789 and 1873, was barely eight million dollars, and when, in 1873, the law provided that except for the so-called trade dollar coined for export, "no deposit of silver for other coinage shall be received," no one had interest enough in the matter to offer criticism.

But in 1874 and 1875 came one of those curious coincidences which render possible for all time conflicting theories of an economic event. Germany, having adopted the gold[Pg 85] standard of currency in July, 1873, began to sell its old silver coin as bullion. At exactly the same time, Mackay and Fair, in the heart of the Nevada Mountains, were opening up the Great Bonanza. The Pacific Coast was in fact going wild over the rise in mining shares while the East was financially and industrially paralysed.

The statute dropping the silver dollar from this country's coinage list was enacted February 12, 1873; the German law for retirement of silver coinage was adopted July 9, 1873; and a year later the news of the rich Nevada "ore-finds" became public property. Between the German sales and the sales at Nevada City, the price of silver yielded. In 1874, for the first time in a generation, 412-1/2 grains of standard silver would have been worth more when coined into a legal-tender dollar than when sold in the bullion market. The motive of the mining interest in the free-silver coinage agitation of 1876 and 1877 was not mysterious.

The motive of the anti-Administration party in Congress was somewhat different. There is not the slightest question that the silver-coinage movement, in the agricultural West particularly, had the same origin and the same following as the paper inflation movement of a few years before. Mr. Bland himself, the author of the silver bill, declared that the question was presented as between what he called "honest resumption" with silver coinage, "or on the other hand a forced unlimited inflation of paper money." In the heat of debate on the silver bill, the same statesman declared in Congress that if his coinage plan could not be passed, he was "in favour of issuing paper money enough to stuff down the bondholders until they are sick." The point of these remarks lies in their frank assumption that the free-silver sentiment and the fiat-money sentiment were interchangeable.

So much, then, for the origin and nature of the silver movement. The Bland Bill passed the House on November 5, 1877, under the previous question and without debate, by a vote of 164 to 34, and the resumption operations of the Government came to an instant halt. The market price of silver then was such that the legal-tender dollar of the Act would have been worth intrinsically less than ninety cents. Foreign[Pg 86] subscribers to our resumption bonds suspected instantly that payment of the Government debt in a depreciated coin was planned by Congress; their suspicions were confirmed by a resolution introduced December 6th by Stanley Matthews, Mr. Sherman's own successor in the Senate, and passed by both houses. The resolution explicitly declared that in the opinion of Congress, all the bonds of the United States, "issued or authorized to be issued," were payable in the silver dollars of the Bland Law. The extraordinary character of this resolution may be judged from the fact that it was proposed and passed in both houses while the Coinage Act was still pending, and while, therefore, there was not in existence the coin which was duly declared a legal tender for settlement with public creditors. To the conservative portion of the public, the resolution seemed a piece of financial lunacy; to the Treasury, it was not only embarrassing but humiliating. Hardly a month before, in his annual report to Congress, the Secretary had repeated his official statement, previously made to bond subscribers, that payment of the bonds in gold might safely be anticipated. The publication of this statement in New York and London had been followed by greatly increased subscriptions to the bonds, in payment of which gold was required by the Government. The Matthews resolution amounted, so far as Congress was concerned, to repudiation of a formal bargain of which the Government had already obtained the fruits. The debate was such as might have been expected on a measure of the sort. It centred repeatedly on denunciation of Government bond investors. Foreign subscribers were treated with especial scorn; indeed, our foreign customers in general were not spared. It was this debate which drew forth Senator Matthews's somewhat celebrated query: "What have we got to do with abroad?"—a remark which was perhaps as typical of the session's deliberations as any utterance made from the floor of Congress.

The situation, during the early months of 1878, was extremely critical. For the time the three direct assaults on the public credit were warded off. The Matthews resolution was "concurrent," and hence a mere expression of opinion without binding force. The bill repealing the Resumption Act of 1875[Pg 87] was killed by disagreement in the Senate. Meantime the Silver-Coinage Act was modified by the Senate into a compromise requiring purchase and coinage by the Government of two to four millions' worth of silver monthly. Even thus modified, it encountered the veto of the President, but was passed over his veto, without a day's delay, by the requisite two-thirds majority. Executive conservatism seemed to be fruitless; nevertheless, there is no doubt whatever that the steadfast policy of Mr. Hayes did much to stem the current of reaction.

Congress adjourned on June 19th. Even before Congressional adjournment, the canvass for the November State elections had begun. The State Convention platforms in the summer of 1878, were not in all respects such as the session's work in Congress would have suggested.

The opposition had gone too far in Congress, and popular opinion to that effect was expressed with sufficient emphasis in November, 1878. The Administration party gained what amounted to a decided victory. There were but four States, East or West, where opposition majorities were increased in 1878 or Administration majorities diminished, and these were agricultural States, where the season's sharp decline in wheat had stirred up discontent. There was not much danger from the closing session of a Congress whose earlier ventures had received this response from the people.

Provisions of the Act of 1878

[18]Although the silver dollar of which the coinage was resumed in 1878, dates back as a coin to the earlier days of the Republic, its reissue in that year marks a policy so radically new that the experience of previous years throws practically no light on its working. The act of 1878 provided for the purchase by the Government, each month, of not less than two million dollars' worth, and not more than four million dollars' worth of silver bullion, for coinage into silver dollars at the rate of 412-1/2 grains of standard silver (or 371-1/4 grains of fine silver) for each dollar. The amount of the purchases, within the specified limits, was left to the discretion of the Secretary[Pg 88] of the Treasury. As every Secretary of the Treasury, throughout the period in which the act was in force, kept to the minimum amount, the practical result was a monthly purchase of two million dollars' worth of silver bullion.

The act is sometimes described as having called for a monthly issue of two million silver dollars; but this was not the exact situation. The amount of silver obtainable with two million dollars obviously varies according to the price of the metal in terms of the dollars with which the purchases are made. In February, 1878, when the first purchases were made, those dollars were the inconvertible United States notes, or greenbacks, worth something less than their face in gold. The amount of silver bullion obtainable with two million such dollars depended, on the one hand, on the price of silver bullion in terms of gold, and on the other hand on the value of the dollars themselves in terms of gold. When specie payments were resumed, on the first of January, 1879, and the greenbacks became redeemable in gold, the measure of value in the United States became gold, and the extent of the coinage of silver dollars under the act of 1878 became simply a question of how much silver bullion could be bought with two million dollars of gold. The price of silver in 1878 was, in terms of gold, not far from a dollar for an ounce of standard silver. Since 1878 it has gone down almost steadily, and ... in 1889 was barely above 80 cents an ounce.[19] The silver dollar of 412-1/2 grains contains less than an ounce (480 grains) of standard silver. The monthly purchase of two million dollars' worth of silver has therefore always yielded more than two million silver dollars, the amount being obviously greater as the price of silver went lower. On the average, the monthly yield [was] not far from two million and a half of silver dollars.... Thirty millions of silver dollars a year was roughly the addition to the currency of the community from the act of 1878.

[Pg 89]


[20]An important provision of the act of 1878 was that authorising the issue of silver certificates against the deposit of silver dollars. This authority was limited at the time to certificates in denominations only of ten dollars and upward: a restriction which ... proved to be of great importance. At the time it does not seem to have been expected that the silver certificates would enter directly into the circulating medium; we may infer from the restriction to large denominations that no such expectation was entertained. But in fact, it has been chiefly in the form of certificates that the silver has entered into circulation. These certificates, it is true, are not, like the dollars themselves, a legal tender; but they are receivable for all public dues, customs included, and they pass from hand to hand at least as readily as the bulky pieces which they represent.

Causes of the Act

[21]The passage of that act was due to causes easily described. It was part of the opposition to the contraction of the currency and the resumption of specie payments which forms the most important episode in our financial history between 1867 and 1879. The resumption of specie payments had been provided for by the act of 1875, and was to take place on January 1, 1879. In the meanwhile, the long-continued depression which followed the crisis of 1873 intensified the demand for more money and higher prices. That demand led to the inflation bill passed by both Houses of Congress in 1878, and killed by the veto of President Grant. The same feeling led to the silver act. The great fall in the price of silver, beginning in 1873, and showing itself markedly in 1876, made silver, at the old ratio, a cheaper currency than gold, and so caused the opponents of the return to specie payments to prefer silver to gold, as they preferred paper to either. No doubt some additional force was given to the movement in favor of the use of silver from the desire of the silver-mining States and their representatives,[Pg 90] that the price of the metal should be kept up through a larger use of it for coinage....

Wherein Peculiar

[22]Although the specific measure passed in 1878 thus rested on a long train of historical causes, it contained details that were essentially new, not only in our own experience, but in that of the world at large.... It ... provided for a regular mechanical addition of large amount to the general circulating medium. No precise experiment of this kind had ever been tried. It is true that Germany and the countries of the Latin Union possess, in their circulating medium, large quantities of overvalued thalers and five-franc pieces which are exactly like our silver dollars. They also are legal tender without limit; their total quantity is limited; and it is only by this limitation of the quantity that their value is kept above that of the bullion contained in them. But the thalers and francs in these countries are not new additions to the currency. They are remnants from an earlier period, when Germany had a silver standard, and the Latin Union a complete bimetallic standard. No addition whatever to the thalers is made in Germany; and if some coinage of five-franc pieces takes place in France and in other countries of the Latin Union, the additions are meant merely to fill the place of abraded coins, to provide for the ordinary losses from daily use, and to make any additions to the supply which may be needed for convenience in making small change. No other country has ever entered on an addition of overvalued coin to its circulating medium having the object and extent of that made by our silver act of 1878. This characteristic of the measure, it need hardly be said, was the result not of any deliberate intention to try a new experiment, but of the spirit of compromise which explains so many anomalies in the legislation of democratic communities. The silver act, as passed by the House of Representatives, provided for complete bimetallism—for the free and unlimited coinage of the silver dollar at the old ratio of 16 to 1. In the Senate, it was amended by the substitution of[Pg 91] the provisions for a limited coinage, which were finally enacted. The compromise was meant to satisfy both those who objected to the cheaper standard and those who wanted more money; and it afforded a welcome escape to the legislators who were trying to satisfy all parties. At the time, no one probably expected that the measure would remain in force for any great length of time. The conservative element hoped that it would be repealed after a short trial; the inflationists (for by that name they might, then at least, fairly be called) believed that it would soon be superseded by the free and unlimited coinage of silver. As it happened, the act remained in force, unamended, and indeed without very serious attempt at amendment, for over twelve years; and the measure which succeeded it in 1890, though different in many details, followed the same method of forcing a large regular injection into the circulating medium of money based on silver purchases by the Government.

Limited Circulation of the Silver Dollars

[23]The Government has made every effort to get the dollar coins out of its hands.... But the great bulk of the coins thus got out of the treasury return to it almost at once. The degree of favor which they meet with of course ... varies in different parts of the country, apparently reflecting in a curious way the popular feeling as to the desirability of having silver currency at all. They circulate very little east of the Alleghanies, but are used more freely and permanently in the Mississippi Valley. Among the negroes of the South the big pieces are said to be favorites, and to find a permanent lodgment. Their greatest circulation ... was reached in 1886; after that time the change in the denominations of silver certificates caused a decline in the amount used.

Provisions of the Act of 1890

[24]The act of July 14, 1890, is[25] more remarkable than that of 1878. It is unique in monetary history. It provides that[Pg 92] the Secretary of the Treasury shall purchase each month at the market price four and a half million ounces of silver bullion. In payment he shall issue Treasury notes of the United States, in denominations of between one dollar and one thousand dollars. These Treasury notes, unlike the old silver certificates, are a direct legal tender for all debts, public or private, unless a different medium is expressly stipulated in the contract. They differ from the silver certificates in another respect; they are redeemable either in gold or silver coin, at the discretion of the Secretary of the Treasury. The indirect process of redemption which,... was applied to the silver certificates, is replaced for the new notes by direct redemption. The avowed object is to keep the silver money equal to gold, for it is declared to be "the established policy of the United States to maintain the two metals at a parity with each other on the present legal ratio, or such ratio as may be provided by law." The act of 1878 is repealed; but the coinage of two million ounces of silver into dollars is to be continued for a year (until July 1, 1891). Thereafter it is directed that only so many silver dollars shall be coined as may be needed for redeeming any Treasury notes presented for redemption. Practically this means that the coinage shall cease; redemption in silver dollars will not be called for under present conditions. The coinage of silver dollars accordingly was suspended by the Treasury on July 1, 1891; a change which was the occasion of some vociferous abuse and equally vociferous praise, but which in reality was of no consequence whatever.


[26]The monthly issues of the new Treasury notes vary, like those of the old silver certificates, with the price of silver. But the new issues vary directly with the price of silver, while as we have seen, the old issues varied inversely with the price. The volume of Treasury notes issued is equal to the market price of four and one-half million ounces of silver. For a month or two after the passage of the act, the price of silver advanced rapidly, and at its highest, on August 19, 1890,[Pg 93] touched $1.20. After September a steady decline set in....

The Policy of the Banks

[27]Shortly after the passage of the act [of 1890], some sort of understanding seems to have been reached between the Treasury Department and the banks of New York. The banks came to an agreement that the new notes were to be treated as "current funds," receivable in all payments, clearing-house settlements included....

The fact that the new notes were received by the banks from the Sub-Treasury in settlement of clearings, was of sensible advantage to the Government. The success of the Government in maintaining its nominal willingness to pay gold to all comers was due to the forbearance of the banks. Gold was called for by them only when needed for export.

The Argument for Silver


[28]... Is it desirable that we should have more money? Does the maintenance of the gold standard involve injustice or hardship to debtors, or to any class in the community? Does it have any ill effects in hampering industry or checking the advance of production? Is the free coinage of silver, or any measure leading ultimately to a silver basis, fairly open to the objections commonly urged against it on the grounds of dishonesty and injustice?...

In considering these questions, we must look to the ultimate and permanent results of the silver standard. The details ... as to the mode in which the silver issues circulate and the degree of promptness with which they will affect prices, are here of no great importance. Under a silver standard the rise in prices will take place in the end; and we are concerned with the social consequences of such an eventual result....

I propose here to take up chiefly one set of serious arguments—those[Pg 94] which rest on the changes in general prices which have taken place throughout the civilised world in the last twenty years. The conclusions in favor of a wider use of silver, drawn from such changes, have been maintained by distinguished economists. It is true that the particular plans for the use of silver which are now in vogue in the United States have generally been opposed by these economists. They have urged international agreements for the wider use of silver, and have deprecated independent action by any one nation. But the more thoroughgoing advocates of free silver in the United States say, certainly with much force, that an international agreement has proved to be simply impracticable, and that if the wider use of silver is to be deferred until there is concerted action by the great nations, it will never come. If anything in this direction is to be done, some one country must be courageous enough to take the lead, trusting that others will follow in due time. And certainly it is true that the scheme for international bimetallism has practically no prospect of adoption; while, on the other hand, the serious arguments urged by its advocates tell, in some degree, in favor of any scheme for enlarging the use of silver as money. These arguments, moreover, are of weight, and deserve a more painstaking consideration than is often admitted by those who oppose the silver legislation of the United States.

The serious and important arguments, then, among those who, both in this country and in Europe, advocate a greater use of silver as money, are derived from the general fall in prices which has been so conspicuous among the economic phenomena of the last twenty years. To that fall they ascribe two evils: first, an unjust increase in the burdens of debtors; and, second, a check to enterprise and to the efficient working of the productive machinery of the community. The increase in the burdens of debtors is one which all economists have pointed to as the result of a general fall in prices, or rise in the value of the circulating medium. The debtor who borrows a hundred dollars now, and repays them five years hence, when all prices have fallen, gives back more than he received. On debts running for short periods of time, changes in general prices are not likely to be great enough to cause serious hardship;[Pg 95] but on debts running over long periods the loss to debtors and the gain to creditors will be great and continuing. But such a steady and continuous fall, it is urged, has taken place since 1873; and the fall is likely to continue further, and to renew its hardships on each new act of borrowing, because its cause is a permanent one. That cause is found in the growing scarcity of gold, which has been selected as the sole standard of value among civilised countries. The production of gold, after having increased with great rapidity in the twenty years following the Californian and Australian discoveries in 1850, has gone on but slowly since 1870. Meanwhile, the population of the civilized countries, their wealth, their production of commodities to be exchanged, have increased with extraordinary rapidity; while the adoption of the gold standard by Germany in 1873, and the resumption of specie payments by the United States in 1879 and by Italy in 1883, have added to the demands for which the scanty annual supply of gold must suffice. Hence the general fall in prices; in other words, the appreciation of gold.

The second effect of the appreciation of gold, in checking industrial progress and promoting industrial depression, has been less insisted on in the United States than in European countries. The classic economists had generally reasoned that a general rise or fall in prices was indifferent, except in regard to the relations of debtor and creditor. If money became scarce, if its value rose and all prices fell, every producer, to be sure, would receive a smaller money income than before, and would have a smaller money capital. But he would be able to buy as many commodities and as much labor as before, and would be in reality just as rich and prosperous. In the middle of the eighteenth century, when economic thought was just beginning to assume its modern form, David Hume had argued that though a fall in prices is at bottom indifferent to everybody (except as debtor or creditor), it would yet, in its effects on men's spirits and expectations, which are all connected with money and with terms of money, exert a depressing influence on industry, and would so be harmful; while rising prices, though also really indifferent to all, would stimulate hope and confidence, and so arouse to more active[Pg 96] exertion and more plentiful production. The younger Mill, in his Political Economy, thought it worth while to enter on a careful refutation of Hume's reasoning. But the bimetallists of our time are disposed to agree with the shrewd Scotchman. They say that the active manager of industry, the business man or entrepreneur, in the first place is always more or less in debt; in the second place, is always buying labor, or materials, or goods, with the intention of selling a product at a later date at an advance in price. He habitually measures his gains in terms of money, and not in terms of the commodities he can buy with the money. In times when prices are falling, he finds it harder to meet his debts, and to dispose of his goods in hand at a money advance over what they cost him. But the business man, or entrepreneur, in our day is the director and initiator of industry. He employs labor, borrows capital, sets the wheels of industry in motion; it is his expectations and fears and hopes which determine primarily whether the investment of capital shall take place in large or small amount, and whether the machinery of production shall move smoothly and effectively, or slowly, hesitatingly, inefficiently. The argument certainly does not lack plausibility; nor can it be said to have often been squarely met. No doubt it takes the form, in the United States, more frequently of confused encomiums on the inspiriting effects of plentiful money, than of direct reasoning as to the ill effects of too little money, such as I have endeavored to state with fairness in the preceding sentences. Yet it does not lack weighty backing. So eminent an economist as President Francis A. Walker has ... insisted on the evils of a deficient supply of money as strangling the arteries of industrial life.

On the whole, however, the other argument, bearing on the increase in the burdens of debtors under falling prices, has been more often heard in the United States, and certainly has been of more effect. Prosperity, activity, general industrial advance, have been in this country so great and so obvious that the argument as to any check to industry could take serious hold only in occasional periods of depression or slackened advance. The burden on American debtors from falling prices has therefore been much more steadily complained of, chiefly in[Pg 97] regard to the debts of the farmers and other borrowers on a comparatively small scale. No doubt there are other debtors whose burdens are affected at least as much, notably the railways, among whom the practice of borrowing heavily on long time has sometimes had its serious effects. But it is the farmer whose case has received most attention, and in some ways doubtless has deserved it most.

The discussion of the relations of debtors and creditors under the gold standard has led to some further conclusions as to the "honesty" of the gold and silver standards. Those who oppose a silver basis speak of the silver dollar as a "dishonest" coin. But those who attack the gold standard retort that the really dishonest dollar is that of gold. It is pointed out by them that the fall in the price of silver which has taken place since 1873 has not been greater than that in the prices of commodities generally. As compared with commodities, therefore, silver has been more steady in value than gold. The fall in the gold price of silver, which is adduced by the mono-metallists to show that silver is not a good standard of value, is said to be the very thing which proves it to be a good standard of value; for a given amount of silver will buy the same amount of commodities, roughly, as it would twenty years ago, while a given amount of gold will buy more. If debts had been expressed in terms of silver, the debtor would have had to repay the creditor the same amount of commodities that he received—not more commodities, as he has had to do, with debts measured and repaid in terms of gold. So far as the attainment of the closest possible approach to ideal justice is concerned, a silver standard would have served the purpose better than a gold one.


The bimetallist agitation for a return to the wider use of silver concurrently with gold first became prominent in the years of depression which followed the crisis of 1873. For some time those who opposed it took the ground that the alleged evils did not exist—that in fact there had been no permanent fall in general prices. The decline in the years after 1873 was supposed to be simply the usual reaction from the rise in[Pg 98] prices which marks a period of speculative activity. It was expected that the upward movement of the next period of activity would bring the average range of prices as high as it had been before. The general revival which set in after 1879 in all civilized countries did indeed check the downward tendency, and in some countries brought about an appreciable rise. But this counter-movement by no means offset the marked fall which had preceded it; and in any case it soon came to an end, and was followed by a new fall, which has continued with no considerable interruption to the present time (1891). It is true that some part of the fall is no more than a recoil from the abnormally high prices of the years 1871-73. It is true, also, that some commodities have shown a tendency to rise, and that in one very important respect—in money incomes and the money rate of wages—there has been a striking exception to the general movement. Further, it must be borne in mind that even the lowered level which has now been reached cannot be described as abnormally low, being still as high as that which obtained at the middle of the present century. But on the whole, the fact of a general fall in the prices of commodities during the last fifteen or twenty years cannot be denied. The fall has not been uninterrupted; it has not been so rapid or general as to bear on the face of it proof of harmful results; but it has been steady, and, in the opinion of the present writer at least, is likely to continue slowly and steadily for some time to come.

Recently, therefore, those who combat the bimetallist reasoning have taken a different position. They have reasoned that while prices may in fact have gone down, the fall is not due, as the bimetallists allege, to an appreciation of gold. It is to be accounted for, they say, by other causes, notably by the extraordinary improvements in the production of commodities. New inventions and the perfecting of old ones have cheapened almost all manufactured articles. Raw materials and food products have been cheapened partly by the discovery of new sources of supply, and partly by that improvement which has been transforming the industrial situation more radically than any other—the wonderful cheapening of transportation by railways and steamships, which has made the[Pg 99] resources of the plains of our West and of the sheep-runs of Australia available for the supply of the markets of London and New York.

So far as this train of reasoning undertakes to explain the mode in which the fall in prices has been brought about, it seems to me impregnable. But in so far as it endeavors to disprove the appreciation of gold, or to show that the general fall is not due to this appreciation, I have never been able to see its force. In truth, both the bimetallists and their opponents seem to confuse the question when they speak of the appreciation of gold as causing lower prices. The appreciation of gold is the general fall in prices. The two are not related as cause and effect; they are simply two names for one and the same thing—namely, a different rate of exchange between gold on the one hand and commodities in general on the other, by which the same amount of gold buys more commodities than before. When the general fall in prices is admitted, the case of the bimetallists as to the appreciation of gold is established once for all. Improvements in the production of commodities may explain how it happens that they are more abundant, and exchange on less favorable terms with gold, of which the quantity has not been increased by new rich mines or great improvements in production; but the fact of the depreciation of commodities, or of the appreciation of gold, is not thereby explained away.

Nevertheless, the improvements in production do seem to me to have an important bearing on the question in hand: a bearing not on the simple fact of the appreciation of gold, but on the social consequences which are said to flow from it, and therefore on the questions of policy which are here under consideration. A moment's thought will show, for example, that a general increase in the efficiency of labor affects very materially the mode in which a fall in prices acts on the relations of debtor and creditor. If A borrows from B a hundred dollars, repayable in five years, and if at the end of the five years prices in general have fallen to one-half of the previous rates, B, in paying back to A the one hundred dollars, clearly returns twice as many commodities as he got. But if, at the same time, the efficiency of labor has been doubled by improvements[Pg 100] in production, B can produce with the same labor twice as many commodities as before; and he returns to A the product of the same quantity of labor as he received. The classic economists and the socialists (at least some schools of socialists) have maintained alike that the ideally perfect standard of justice in the exchange of commodities and services is equality of sacrifice or labor; that if things so exchanged for each other that equal sacrifice got the same reward, complete justice would be attained. Applying this test to the relations of debtor and creditor in the case supposed, we find it not one of hardship to the debtor, but apparently one of justice to both parties. It is true the creditor gets more commodities than he gave; but he gets the product of the same amount of labor as he devoted to the commodities originally lent; and why should he not share with the rest of the community the benefits of a general increase in the productiveness of labor?

This line of reasoning will become simpler and more concrete if we approach it from another point of view. Reference has already been made to the most striking and important exception to the general tendency of prices to fall, namely, that money wages and incomes in all civilized countries have shown a tendency not to fall, but to rise. Whether the incomes of the rich have increased faster than those of the poor, or whether the movement has shown itself with rough uniformity for all classes, is immaterial for the present discussion. The admitted fact of a general upward movement alike among rich, middle class, and poor is the significant thing. In other words, there has been an inverse movement of money wages and of the prices of commodities, the one going up while the other went down. Now, such an inverse movement is what must take place in case of any real improvement in material welfare. The only concrete way in which civilized people can become better off, is by being able to buy more—by their money incomes going further in the purchase of commodities. The improvement may take the form either of higher money incomes, with stationary prices; or that of stationary incomes, with lower prices; or the intermediate form which in fact seems to have occurred, of money incomes rising somewhat and prices at the same time falling somewhat. If we assume a[Pg 101] monetary supply that is limited, or does not increase as fast as improved means of production cause the quantities of commodities to increase, one or the other of the two forms last mentioned must be found.

In such a state of things there can hardly be said to be any real hardship for the debtor. It is true that prices have fallen, and that the money he repays the creditor will buy more goods than it did when the loan was contracted; but his own money income has risen, or at least has not fallen, and the repayment of the loan can cause him no special hardship—none greater than he must have expected. The case clearly differs fundamentally from that of a simple rise in the value of money, or general fall in both prices and wages.... The fall in prices in the United States since 1879, and that in European countries in the period since 1873, are the result, on the whole and in the long run, of ... the general improvements in production; they have not been accompanied by a fall in money incomes, and they cannot be said to have caused an increase in the burden of debtors.

The reasoning of the preceding paragraphs bears also on the second part of the bimetallist indictment—that, namely, as to the depressing effects of falling prices on industrial enterprise. Whether a simple rise in the value of money, unaccompanied by any other circumstance, would have the depressing effects which the bimetallists predict and the classic economists deny, is a question radically different from that which in fact presents itself. It may be that in this simple case the bimetallists might prove to be, in some degree at least, in the right, and that the classic reasoning, here as on many other subjects, while sound in the long run, would need some qualifications and correction. In the long run, no doubt, it is immaterial whether prices are high or low, whether money returns fall or rise; and yet it might turn out that the habitual association of gain or loss with "making money" would cause a period of simple falling prices to be one of hesitating investment of capital and unenterprising conduct of business. But what the world in fact has seen has been the complex case of a fall in prices accompanied by great improvements in production. The business man and capitalist has had, to be sure, to[Pg 102] deal with falling prices; but the same amount of capital and labor has turned out more commodities than before; and his total money returns, so far from declining, have generally increased. The money incomes of the managers of industry have shown the same upward movement as the money incomes of the other classes in society. So long as this is the case, it is idle to talk of a depressing effect on enterprise from the fall in prices, or of a strangling of the industrial organism from insufficiency of the circulating medium. In fact, the immediate cause of the fall in prices has been the pushing on the market for sale of larger and larger quantities of commodities, produced with profit at lower and lower cost: a state of things fortunate for the community, and surely not depressing for the business man....

This effect on the entrepreneur of improvements and of falling prices combined, doubtless accounts for the failure of the bimetallist agitation to secure any appreciable hold in the business world. The bimetallists, both in England and on the Continent, have labored zealously to engage support among the business men, but never with a degree of success at all proportionate to the energy displayed. The simple reason is that the business world has not been in any state of chronic depression. In the ups and downs of industrial activity there have been periods which seemed to confirm the pessimistic accounts of the bimetallist and of other persons malcontent with the present order of things; but in due time the tide has always turned....

On the whole, then, the fall in prices, when considered in connection with the other great changes which have accompanied it, does not afford so much countenance to the bimetallist proposal as at first sight it seems to. The rise in money incomes and the improvements in production disprove any intolerable burden on debtors, and make it highly improbable that the change has had any general depressing effect on industry.


Nevertheless, there is something more to be said, in explanation and justification of the discontent with falling prices, and[Pg 103] of the silver agitation which rests on that discontent. While the effects of the fall in prices on debtors as a class and on producers as a whole have not given real grounds for complaint, certain particular debtors and producers have undoubtedly been injured. The case of these latter have given plausibility to the general arguments of the bimetallists, and, what is more important at the present juncture, has given strength to the movement in the United States for more money and more silver.

The situation will be best understood if we contrast for a moment the different modes in which the improvements in production have been brought about in manufacturing industries on the one hand, in agriculture on the other hand. In manufactures the improvements have been better machinery, new processes, labor-saving inventions, the conduct of business on a larger scale, and so the greater and more effective division of labor. In agriculture the main cause of cheaper production has been different: it has been the opening up of new lands and new sources of supply. No doubt there are important exceptions to these general statements. In agriculture there have been advances in the arts—new plants, better fertilizers, improved implements, more effective ways of cultivating the soil. In manufactures, on the other hand, there have been important changes due to the discovery of new and rich mines of materials, such as coal, iron, copper. But on the whole, the difference holds good. In agriculture undoubtedly the opening of new lands through the improvements in transportation has been the most important single cause at work. The cheapening of agricultural products has been due not so much to the more effective use of the soil already under cultivation, as to the development of soil not formerly available for the supply of the market.

The changes in production and prices have consequently affected the producers in these two branches of production in very different ways. In manufactures all alike have felt them, and have been able to accommodate themselves to the effects. No doubt the shrewder producers adopt improvements and new inventions first, and, so long as they keep in the lead, have the advantage of their competitors. They gain by doing a[Pg 104] large business at lower prices, while for the time being their slower competitors lose. But new processes and new inventions spread over the whole field in no long time. The opening of a new source of supply, on the other hand, cheapens production through a process which the holders of the old source of supply cannot avail themselves of. If wheat is raised in large quantities in Dakota, the price goes down as effectively as if the wheat fields of England and New York had suddenly become more fertile; but as those wheat fields produce no more than before, the farmer or land owner on the old soil has nothing to offset the lower price. This is the explanation of the agricultural distress of which so much has been heard in Europe in recent years, and which has been the main occasion of the revival of protectionist feeling in France, Germany, and other countries of the Continent. The farmer on the old lands does not find in improvements in production any compensation for lower prices. If he owns the land, he must pocket the loss, and perhaps in the end abandon his land and turn to something else; such has been a common case in New England. If he is a tenant on the land, he will probably, after a period of struggle and hardship, get lower rents, leaving the landlord as the permanent sufferer; such has been the outcome in old England. If he was in debt before the change took place, he will find his debts growing more burdensome as his money income goes down; such has been the result with many a Western farmer.

It is in causes of this sort that we find the explanation, in part at least, of the restlessness among the Western farmers of which the silver agitation is one sign. The fall in the prices of wheat, corn, and other staples has been due to enormously increased production in regions which were formerly out of reach of the market: in India, Australia, Russia, as well as in California, Dakota, Washington, Oregon, and the Far West generally....

It is probable that some of the complaints in regard to the burden of debt on the farmers are simply a legacy from the old days of inflated paper money. Not a few of the debts of the present [1891] go back to the years before 1870, when we had prices high in terms of over-issued paper money.[Pg 105] These debts have been renewed and continued, in whole or in part; and the fall in prices has made them heavier and heavier to bear. The evil here again is real, and a remedy is now hard to find. The only conclusion which can be laid down with perfect conviction is that we should make sure of preventing the recurrence of a new era of excessive paper money.

... Another important circumstance is the general transition in agricultural methods inevitable in those western states which have been settled for a generation or more. When new land is first taken into cultivation the most effective use of it is found in the continuous production of some staple crop like wheat and corn, which can be grown, so long as the cream of the soil is not exhausted, year after year with large returns. After a while, however, the land begins to show signs of exhaustion. The staple crops do not yield as largely as before, and less crude methods of using the soil must be resorted to. Manures have to be applied, and the rotation and selection of crops practised. Meat and dairy products, vegetables, fruits, and the miscellaneous agricultural articles, must take their place in rural economy. This change has been carried through very largely in states like New York, Pennsylvania, and Ohio. In the heart of the Mississippi Valley it is now under way; but the transition is trying, and to some of the farmers it is impossible. A good share of the American agricultural population has been so steadily bred to the easy and careless use of virgin soil that it cannot accommodate itself to more intensive methods. It is constantly moving westward; settling for a generation in one spot, and then, as the land shows signs of exhaustion, moving farther west. The more intelligent and versatile stay behind, adapt themselves to new conditions, and in time prosper under them. The least active also stay behind, and flounder hopelessly in the old ways. But a large number are always moving west. In every state between the Alleghanies and the Missouri river there are large tracts formerly cultivated by native settlers, who have sold their lands, as they showed signs of giving out, to German or Swedish immigrants. These latter have not infrequently paid good prices for the lands: but they have been bred to intensive farming, to careful and varied use of the soil, and they have[Pg 106] prospered where their native predecessors have been unwilling or unable to adapt themselves to the new conditions. The period of transition is a hard one for all of the native farmers, whether they stay behind or move on, and the lesson of using the soil with more skill and care is learned only under the pressure of necessity. In such periods all sorts of remedies for hard times make their appearance and have their run.

The Repeal of the Sherman Silver Purchase Act and the Financial and Economic Consequences of Silver Legislation

[29]For fourteen years, 1878-1892, only an insignificant amount of gold was paid out of the Treasury in the redemption of legal-tender notes; the total amount of gold in the Treasury increased almost steadily and continuously from $140,000,000 on January 1, 1879, to $300,000,000 in 1891. In 1890 the new issue of Treasury notes, together with a change in commercial conditions, placed heavy burdens upon the reserve, the rapid diminution of which is shown in the following figures:

DateNet gold reserve
June 30, 1890$190,232,405
June 30, 1891117,667,723
June 30, 1892114,342,367
June 30, 189395,485,413
June 30, 189464,873,025

The reasons for the fall in the gold reserve are too various and complicated to be treated here: the failure of the great English banking-house of Baring Brothers in 1890 brought about a considerable withdrawal of English capital invested in the United States; and an unhealthy and inflated industrial development in this country was stimulated by the new tariff. To outward appearances the country was very prosperous; expenditures were large, imports increased, and a failure of the crops in Europe in 1891 enlarged our grain exports. For a brief season only, were the natural effects of the Sherman law delayed: Europe soon recovered, American exports fell, and in the six months ending June 30, 1893, the balance of[Pg 107] trade against the United States was $68,800,000. The tariff of 1890 was followed by diminished customs receipts. The revenue from customs was as follows:


... Fortunately the internal revenue receipts maintained their customary level with something to spare; but increased appropriations, due largely to the passage of a dependent pension bill in 1890, cut deep into the funds of the Treasury. In 1890 the surplus was $105,344,000; in 1891, $37,239,000; in 1892, $9,914,000; in 1893, $2,341,000; but in 1894 appeared a deficit amounting to $69,803,000. The Treasury had been weakened by the reluctance of Secretary Windom to deposit government funds in national bank depositories, and by his preference to rely entirely upon the purchase of bonds for getting money back into circulation. In the earlier years of Harrison's administration, bonds were purchased freely—too generously in view of the impending strain upon the resources of the Treasury.

Another element of concern was due to the change in the kind of money received by the Government in the payment of revenue. Before the passage of the Sherman Act nine-tenths or more of the customs receipts at the New York custom-house were paid in gold and gold certificates; in the summer of 1891 the proportion of gold and gold certificates fell as low as 12 per cent., and in September, 1892, to less than 4 per cent. The use of United States notes and Treasury notes of 1890 correspondingly increased....

The reason for this substitution of notes for gold was partly due to a reversal in Treasury practice. For many years it had been the custom of the Sub-Treasury in New York to settle its clearing-house balances almost exclusively in gold or gold certificates. For example, in the fiscal year 1889-1890 the Sub-Treasury paid gold balances to the banks of nearly $230,000,000, and in the next year $212,000,000. The banks were thus daily supplied with gold which they in turn could furnish[Pg 108] to their customers either for customs purposes or export deliveries. In August, 1890, the Treasury began the policy of using ... the new Treasury notes in the settlement of New York balances, and in the year ending June, 1891, Secretary Foster, apparently convinced of the need of a larger gold reserve to support the credit of the Treasury notes, increased the use of the older United States notes and held on to the gold reserve. The unexpected result was that the banks, deprived of their usual supply of gold for trade purposes, sought for it at the Treasury by the presentation of government notes....

In March, 1893, Cleveland for a second time entered upon the presidency. He demanded as the first condition of relief the suspension of silver purchases. The silver advocates, however, were still powerful in both parties, and President Cleveland was at a disadvantage in not having the undivided support of his own party. Even the position of Secretary Carlisle was ... doubted: it was publicly declared that he stood ready, if expediency demanded it, to redeem the Treasury notes of 1890 in silver instead of gold, and, while standing upon the letter of the law which demanded their redemption in coin, practically to cut asunder the parity of gold and silver which had thus far been maintained. Although the President attempted by a specific declaration to make clear the harmonious purpose of the administration that redemption would continue in gold, public apprehension would not be allayed. Whatever might be the wishes of the administration, it was feared that it would not have power to carry them out; particularly when it was announced in April, 1893, that the gold reserve had been drawn down to $96,000,000 by redeeming the Treasury notes of 1890.

At this juncture of financial and commercial difficulties, in June, 1893, the British Government closed the mints in India to the free coinage of silver. The price of silver bullion fell promptly and rapidly, and, while such a decline might on another occasion have produced no immediately serious consequences to the Treasury, it came at a moment when public opinion, at least in the Eastern States, was aroused to a belief that the entire financial problem was associated with the coinage of silver; and it thus furnished one of the contributory[Pg 109] forces which drove the commercial community into a state of panic.

It was not until June 30, 1893, when the panic was well under way, that a special session of Congress was called for August 7; only by the most strenuous efforts could an adequate support, composed of elements in both political parties, be rallied to uphold the President's insistence that purchases of silver by the Government should cease. The House quickly acquiesced, and on August 21, by a vote of 239 to 108, passed a bill for the repeal of the purchasing clause; but the Senate was stubborn, and not until October 30 could a favorable vote, 43 to 32, be secured. So far as the Treasury was concerned, the mischief had been done; although the Government was relieved from further purchase of silver which increased the volume of the obligations to be supported by gold, the old burdens still were sufficiently heavy, in connection with the low state of commerce and industry, to exhaust its immediate revenues. Thus on December 1, 1893, the actual net balance in the Treasury above the gold reserve, pledged funds, and agency accounts was only $11,038,448. Trade and industry had been disorganized; the panic of 1893 extended into every department of industrial life. In December, 1893, the Comptroller of the Currency announced the failure during the year of 158 national banks, 172 state banks, 177 private banks, 47 savings banks, 13 loan and trust companies, and 6 mortgage companies. Some of these institutions afterwards resumed business, but the permanent damage was great. The fright of depositors was general and the shrinkage in deposits enormous; bank clearings were the lowest since 1885; clearing-house loan certificates were once more resorted to, this time on a much larger scale than ever before, and extended to cities throughout the country.

The production of coal, both anthracite and bituminous, fell off; the output of pig-iron, which had been about 9,157,000 tons in 1892, fell to 6,657,000 tons in 1894; new railway construction almost ceased; in 1894 there were 156 railways, operating a mileage of nearly 39,000 miles, in the hands of receivers; among these were three great railway systems,—the Erie, Northern Pacific, and Union Pacific. The total[Pg 110] capitalization in the hands of receivers was about $2,500,000,000, or one-fourth of the railway capital of the country. The earnings of railroads and the dividends paid to stockholders were seriously affected; securities fell to one-half and even one-quarter their former value; commercial failures increased from 10,344 in 1892, with liabilities of $114,000,000, to 15,242 in 1893, with liabilities of $346,000,000. The problem of the unemployed became general; special committees were organized in nearly all of the large cities to provide food, and in many places relief work by public bodies was instituted. In the spring of 1894 general want and distress led to labor strikes and riots, as in Chicago, and even to more abnormal outbreaks, as seen by the march of Coxey's army of unemployed from Ohio to Washington. The distress was increased by the failure of the corn crop in 1894; the demand for wheat in Europe fell off and wheat was sold on the Western farm for less than fifty cents a bushel.


Under these adverse conditions it was inevitable that the revenues of the Government should continue to decline. In the six months, January to June, 1893, the excess of expenditures over receipts was $4,198,000, and during the fiscal year ending June 30, 1894, this excess increased to $69,803,000. It was even necessary to encroach upon the gold reserve for current expenses, and for months this fund was far less than caution and prudence demanded. When the integrity of the gold reserve was first assailed, both Secretary Foster, in the closing months of Harrison's administration, and Secretary Carlisle, at the beginning of Cleveland's term, endeavored, with some success, to tide over emergencies by appealing to the banks to exchange gold for legal tenders. The banks recognized that the instability of Government credit seriously affected the value of all securities in which they were interested; and in February, 1893, they handed over to the Treasury about $6,000,000 in gold, and in March and April about $25,000,000 more. The expedient was not enough to stop the continued drain upon the Treasury. At the very moment that the Government was relieved of notes through the exchange of[Pg 111] gold by the banks, other notes were presented to the Treasury for redemption, largely to draw gold for exportation in the settlement of trade balances....

The only way to protect the fund of gold reserve under the circumstances was borrowing—that is, the sale of bonds for gold—yet some people who were opposed to the overthrow of the gold standard consistently urged that borrowing be postponed until the last moment, so as to add as little as possible to the resources available for purchases of silver. Some of the gold party would even have permitted the drain to go on to the end, notwithstanding the inevitable evils, in the belief that the country could be convinced of its errors in no other way.

Eventually, to prevent a suspension of specie payments in gold, the Treasury Department made successive issues of bonds for the purchase of gold. These issues are very interesting to the student of finance. No administration wishes to add to public indebtedness in times of peace; and Secretary Carlisle had scruples against selling bonds, except with the authority of the Congress then sitting; hence the issue of bonds was put off to the last possible moment. The only existing authority for selling bonds was the resumption act of 1875; this provided only for ten-year 5 per cent., fifteen-year 4-1/2, and thirty-year 4 per cent. bonds, all of which would command a premium so high as to diminish their attractiveness as an investment, and, taken in connection with the length of time which they ran, to hamper the Treasury in purchasing or refunding the debt when the crisis was over. The administration asked for the issue of low-rate bonds, but Congress, inspired in part by free silver arguments, and in part by political intrigues to discredit the administration, paid no attention to the recommendation of the Secretary. Finally, in January, 1894, without special legislation, but under the ancient authority of the resumption act, $50,000,000 of 5 per cent. ten-year bonds were sold, yielding $58,660,917; and again in November an equal amount of bonds with like conditions were marketed, yielding $58,538,500. The sale of the first issue was on the whole creditable, considering that at about the same time the President was obliged to veto a bill providing for[Pg 112] coining the silver seigniorage, and that an effort had been made in the courts to enjoin the Secretary of the Treasury from selling bonds under the law of 1875.

In each case the sale of bonds called for subscriptions in gold, but the new supplies were quickly exhausted by fresh redemption of notes. The fluctuations in the volume of gold in the Treasury as a consequence of the bond sales is seen in the following figures:

DateGold in Treasury
January 31, 1894$65,650,000
February 10, "104,119,000Bond issue.
November 20, "59,054,000
November 30, "105,424,000Bond issue.
February 9, 189541,393,000

The endless chain appeared to be in full and unceasing operation; not only was gold being withdrawn for export but also for individual hoarding, in fear of an impending suspension of gold payments. The Treasury finally recognized the futility of selling bonds for gold, most of which was drawn out of the Treasury itself, by the presentation of legal-tender notes for redemption. A new device was tried: in February, 1895, the Secretary of the Treasury entered into a contract with certain bankers for the purchase of 3,500,000 ounces of standard gold at the price of $17.80441 per ounce, to be paid for by the delivery of United States bonds having thirty years to run and bearing 4 per cent. interest; not less than one-half of this gold was to be procured abroad, and the parties with whom the contract was made stipulated that they would "as far as lies in their power exert all financial influence and make all legitimate efforts to protect the Treasury of the United States against the withdrawals of gold, pending the complete performance of this contract." An ounce of standard gold was worth $18.60465, and the difference between that sum and the contract price represented the premium received by the Government on the bonds, making the price at which the bonds were accepted $104.4946. A condition was affixed to the contract, by which, in case Congressional authority could be secured, a 3 per cent. gold bond might be substituted, and for this the syndicate agreed to pay a higher price.[Pg 113]

In view of the unfavorable terms of the bargain imposed by this contract, the administration hoped that Congress would promptly act and authorize the issue of the lower and more remunerative bond. Faithful in its adherence to silver, Congress could not be swerved; it defeated the bill authorizing the sale of a low-rate gold bond, and then engaged in an angry debate denouncing the Executive for his subserviency to the gold standard banking interests in entering into a contract not only disgraceful but illegal. In reply it could be shown that the New York Sub-Treasury was within forty-eight hours of gold exhaustion....

At first the syndicate was successful, because of some slight improvement in trade, but later it practically failed to control the price of exchange. It once more became cheaper for merchants to ship gold than to purchase bills, and gold continued to be withdrawn from the Treasury. On December 3, 1895, the gold reserve stood at $79,333,000, and after the commercial apprehension caused by President Cleveland's Venezuelan message a fortnight later, the reserve was still further reduced. Once more the administration resorted to a bond sale, and again the action was preceded by a special message from the President to Congress asking for a grant of authority to issue gold bonds instead of coin bonds, and also for the retirement of the legal-tender notes which continued in an endless chain their journey to the Treasury, and drove off gold to the commercial market. As Congress still refused to act, the Treasury resorted to a fourth issue of $100,000,000 4 per cent. bonds. The Treasury now carefully avoided any appearance of dealing through a syndicate and publicly advertised for offers, with the encouraging result of 4,640 bids, amounting to $684,262,850. Seven hundred and eighty-one bids were accepted and the premium yielded about $11,000,000. The relief obtained by the Treasury, however, was meagre, for it is estimated that $40,000,000 of the bonds were purchased with gold withdrawn from the Treasury by the redemption of notes. This was the Government's penalty for its endeavor to separate itself from all dealings with a banking syndicate.

In spite of this sale of bonds the reserve remained near the traditional danger line. In July, 1896, it fell to $90,000,000[Pg 114] because of hoarding due to popular apprehension as to the success of the silver movement in the November presidential election. Fearful that a new bond issue might strengthen the claims of the silver advocates, bankers and dealers in foreign exchange voluntarily combined to support the Treasury by exchanging gold for notes. The effort succeeded, and the reserve was placed in safety. After the elections in November gold came out from its hiding-places, and was turned into the Treasury in large amounts. Business and revenue improved and the difficulties of the Treasury Department were tided over.

Many Republicans held the earnest conviction that the issue of bonds would not have been necessary if the revenue had been sufficient. Not only had industry and commerce been unsettled by the tariff act of 1894, but the operations of the endless chain must certainly continue, it was held, until there was a generous income in excess of expenditures, whereby a considerable part of the credit currency might be covered into the Treasury and thus lessen the possible claims for redemption. The administration emphatically replied that at no time when bonds were issued was there intention of paying the expenses of the Government with their proceeds, and that the Treasury Department had no authority whatever to issue bonds for such purposes. President Cleveland was insistent that on each occasion of a bond issue there were sufficient funds in the Treasury to meet the ordinary expenditures of the Government. The proceeds of the bonds sold for the maintenance of the national credit were, however, turned into the general fund of the Treasury, and consequently, though not originally designed for that purpose, employed to meet indiscriminately all demands made upon the Government, whether for redemption of notes or the payment of debts.... There was a series of deficits beginning with 1894, but the deficit by no means equalled the amounts of bonds sold.


[16] Adapted from A. D. Noyes, Forty Years of American Finance, pp. 2-6 G. P. Putnam's Sons, New York and London. 1909.

[17] Ibid., pp. 35-44.

[18] F. W. Taussig, The Silver Situation in the United States, pp. 8, 9. G. P. Putnam's Sons. New York. 1893.

[19] I have stated the price here, for simplicity, in terms of so much per ounce of standard silver, i. e., silver containing 10 per cent. of alloy. The usual quotation in the United States is per ounce of fine silver. [Thus, the New York price, March 10, 1916, was 56-3/4 cents per ounce of fine silver.]

[20] Ibid., pp. 9, 10.

[21] Ibid., pp. 10, 11.

[22] Ibid., pp. 11-13.

[23] Ibid., pp. 19, 20.

[24] Ibid., pp. 50, 51.

[25] [Present tense because written while the act was still in force.]

[26] Ibid., pp. 51, 52.

[27] Ibid., pp. 52, 59.

[28] Ibid., pp. 84-106.

[29] Davis R. Dewey, Financial History of the United States, pp. 442-455. Longmans, Green and Company, New York, 1915.

[Pg 115]



[30]Index numbers are used to indicate changes in the value of money. The objects for which this measurement is undertaken are thus well stated by Sir R. Giffen (Second Report of the committee appointed for the purpose of investigating the best method of ascertaining and measuring variations in the value of the monetary standard. Report of the British Association, 1888): (1) The fixation of rents or other deferred payments extending over long periods of time, for which it has been desired to obtain a currency of a more stable sort than money is supposed to be. (2) To enable comparisons to be made between the value of money incomes in different places, which is often an object of great practical interest; not only individuals contemplating residential changes, but also governments and other large spending bodies, spending money in widely distant places, having to consider this question. (3) To enable historians and other students making comparisons between past and present to give an approximate meaning to the money expressions which they deal with, and say roughly what a given fine, or payment, or amount of national revenue or expenditure in a past age would mean in modern language. To which some would add: (4) To afford a measure of the extent to which trade and industry have been injuriously affected by a variation in prices; and of the correction which it would be desirable to apply to the currency.

An index number is constructed by combining several items, each of which is a ratio between the price of a certain article at a particular date under consideration (e. g., last year or month) and the price of the same article at a period taken as base or standard (e. g., 1867-77, in the index number constructed[Pg 116] by Mr. Sauerbeck, Journal of the Statistical Society, 1886 and 1893). These ratios are generally expressed as percentages. E. g., the percentage for flour in 1885, as given by Mr. Sauerbeck, is 63; meaning that the price of flour in 1885 is to the average price of the same article in 1867-77 as 63:100. The term index number is sometimes applied (e. g., by Mr. Sauerbeck, op. cit.) to each of these items, as well as to their combination.

The percentages are usually compounded by taking an average of them. But a result of equal generality may be obtained by taking their sum. One of the best-known index numbers, that of the Economist, is thus constructed. Twenty-two articles having been selected, the price of each article at the current date compared with its price at the standard period (1845-50) is expressed as a percentage; and the sum of these percentages is put as the index number. Thus the Economist index number for the year 1873 is 2947; such a sum is easily reduced to the form of an average by simple division (e. g., 2947 ÷ 22 = 134). Accordingly in what follows it will be sufficient to consider the latter form only.

The construction of an index number presents the following problems: (a) What are the commodities of which the prices are to be taken? (b) How are the prices to be ascertained? (c) How are the ratios between the prices of each article at the current and the standard dates to be combined?

The answers to these questions vary according to the purpose in hand.... As appropriate to the first purpose, a standard of deferred payments, two methods present themselves, viz., to arrange that the debtor should pay, the creditor receive, either (1) the same quantity of goods and services, the same amount of utility, so to speak; or (2) the product of the same quantity of labour—or more exactly effort and sacrifice.

Of these methods the former has been more generally accepted. It is adopted for instance by the British Association Committee already referred to, as par excellence the measure of the change in the value of the monetary standard. The former method is indeed more intelligible. However, in favour of the latter there are some weighty considerations and authorities. It seems to be the nearest possible approach to[Pg 117] Ricardo's conception of a commodity invariable in value, "which at all times requires the same sacrifice of toil and labour to produce it." (Principles, iii. ch. xx., "On Value and Riches," cp. Mill, bk. iii. ch. xv., "On a Measure of Value.") "A standard," says Mr. Leonard Courtney, "should be something which as far as possible involves the same labour and the same sacrifice in obtaining it" (Nineteenth Century, March, 1893). Prof. Marshall, in his evidence before the royal commission on gold and silver, says, speaking of appreciation of gold: "When it is used as denoting a rise in the real value of gold, I then regard it as measured by the diminution in the power which gold has of purchasing labour of all kinds—that is, not only manual labour, but the labour of business men and all others engaged in industry of any kind" (Question 9625).

If the first method is adopted, the answers to the questions above set are as follows: (a) The commodities of which the prices are to be taken should be articles of consumption rather than materials and implements. Payments for personal services should be included, but not wages in general. (b) Retail prices should be used. (c) The proper combination of the ratios is an average of the kind technically called weighted.... The general principle according to which the weights are to be assigned is that they should represent the importance of each commodity to the consumer. But this idea may be embodied in different plans.

1. One plan is to assign as the weight of each percentage, or ratio between prices, the value of the corresponding commodity at the initial or standard period. According to this plan the index number is the ratio between these two values: the quantities initially consumed at the prices of the current date, and the same quantities at the standard prices. This method is exemplified by Sir R. Giffen's estimate of the change in the value of money between 1873 (and 1883) and earlier years, in his report on prices of exports and imports, 1885, table v.

2. Another plan is to assign, as the relative importance of each percentage, its value at the particular epoch, the current year. This plan is adopted by Mr. Palgrave in his memorandum[Pg 118] on Currency and Standard of Value ... in the third report of the royal commission on depression of trade and industry, table xxvii.

3. According to another plan, the index number is the ratio between the following two values: the quantities consumed at the current date at the current prices, and the same quantities at standard prices. This plan is adopted by Mr. Sauerbeck (Journ. Stat. Soc., 1886, p. 595).

4. Or, instead of taking either the initial quantities or those of the current date, a mean between the two may be taken. This is the plan adopted by the British Association Committee. They estimate "the average national expenditure on each class of article at present and for the last few years"; and put for the relative importance of each commodity a round number corresponding to that estimate. Thus the estimated expenditure per annum on wheat is £60,000,000, and on meat £100,000,000: that is respectively 6.5 per cent., and 11 per cent. of the sum of the corresponding estimates for all the commodities utilized by the committee. As convenient approximations, the weights five and ten are recommended by the committee.

If the index number based on labour ... rather than on consumption, is adopted as the standard for deferred payments, it would be proper by analogy to take as the measure of appreciation or depreciation the change in the pecuniary remuneration of a certain set of services, namely all, or the principal, which are rendered in the course of production throughout the community during a year, either at the initial or the current epoch; or some expression intermediate between the two specified. But it may be doubted whether the statistics requisite for this method are available.

With regard to the second and third of the purposes above enumerated, the determination of the comparative value of money at distant places and remote times—one or other of the two methods indicated would seem to be theoretically proper.

For the fourth purpose, the regulation of currency, the proper construction of the index number would seem to be as follows: (a) The "articles" of which the prices are taken[Pg 119] into account should be both commodities and services; (b) both wholesale and retail prices should be used; (c) the relative importance of each article should be proportioned to the demand upon the currency which it makes. But here as in other parts of the subject theory halts a little, and statistics lag far behind theory.

Considering the theoretical doubts and statistical difficulties which attend the determination of weights proper to each purpose, there is much to be said in favour of assigning equal relative importance to all the items; especially if care is taken to include many articles such as corn, cotton, etc., which for any of the purposes which may be contemplated must be of first-rate importance. Such is the character of some of the principal index numbers which have been constructed—those of the Economist, of Jevons, of Soetbeer, and of Mr. Sauerbeck.

In the construction of such an index number the use of the arithmetic mean is not imperative. Jevons employs the geometric mean. His reasons for preferring it are not very clear (the "Variation of Prices," Currency and Finance, p. 120).... The geometric mean has also the advantage of being less liable than the ordinary average to be unduly affected by extremely high prices (Report of the British Association, 1887, p. 283). The great objection to the geometric mean is its cumbrousness.

There is another kind of mean which has some of the advantages of the geometric, and is free from its essential disadvantage; namely, the median ... which is formed by arranging the items in the order of magnitude, and taking as the mean that figure which has as many of the items above as below it. For instance the median of the forty-five percentages on which Mr. Sauerbeck's index number is based was, for 1892, 66; while the arithmetic mean was 68. It is difficult to see why the latter result is preferable to the former; if what is required is an index of the change in general prices, not specially referred to any particular purpose, such as of securing a constant benefit to a legatee.

The perplexity of a choice between such a variety of methods is much reduced by the two following considerations. First,[Pg 120] beggars cannot be choosers. The paucity of statistical data (see the report drawn up by Sir R. Giffen in the Report of the British Association for 1888, p. 183) restricts the operation. Thus for the purpose of index numbers based on consumption ... retail prices are theoretically appropriate; but "practically it is found that only the prices of leading commodities, capable of being dealt with in large wholesale markets, can be made use of" (Giffen, loc. cit.). Second, the difference between the results of different methods is likely to be less than at first sight appears. For instance, the probable difference between the index number constructed by the British Association committee, and six others which have been proposed by high authorities—supposing the different methods to be applied to the same data, viz., the prices of twenty-one articles specified by the Committee may thus be expressed. The discrepancy which is as likely as not to occur between the committee's and other results is from 2 to 2.5 per cent. The discrepancy which is very unlikely to occur is from 8 to 11 per cent. (Report of the British Association for 1888, p. 217). In fact, the index number for the year 1885, as determined from the same data by seven different methods, proved to be 70, 70.6, 73, 69, 72, 72, 69.5 (ibid., p. 211).

The practical outcome of these two considerations is thus well expressed by Giffen (loc. cit. p. 184), "The articles as to which records of prices are obtainable being themselves only a portion of the whole, nearly as good a final result may apparently be arrived at by a selection without bias, according to no better principle than accessibility of record, as by a careful attention to weighting.... Practically the committee would recommend the use of a weighted index number of some kind, as, on the whole, commanding more confidence.... A weighted index number, in one aspect, is almost an unnecessary precaution to secure accuracy, though, on the whole, the committee recommend it."


[30] Dictionary of Political Economy, edited by R. H. T. Palgrave. Vol. II, pp. 384-7. Macmillan and Company, Limited. London. 1912.

[Pg 121]



[31]The intermediate employed in actual transactions is, in increasing degree, that form of currency called credit, the lowest order of currency, rather than money itself. Checks and drafts make up a progressively larger share of the circulating medium. The net deposit credits in the national banks in the United States—to say nothing of the other banks—are double the volume of the actual money in the country. And a large share of this actual money is really employed as reserves to support the credit circulation. More than 90 per cent. of the larger sorts of transactions are mediated through the use of deposit credit, and probably more than one-half of the remaining transactions are similarly effected. Thus the study of banking is essential to any understanding of monetary problems....

[32]For a bank, as well as for any other considerable establishment, it is requisite that a capital should be provided at the outset. There can be no constant proportion between the amount of this capital and the extent of the business which may be built up by its means. We can only say that, other things being equal, the larger the business that can be carried on with safety with a given capital, the larger will be the field from which profits can be earned, and the higher the proportion which the profits will bear to the original investment; but the point at which the extension of the business passes the line of safety, must be determined by the circumstances of the particular bank, by the kind of business carried on by those dealing with it, and by the condition of the community in which it is[Pg 122] established. The attempt has sometimes been made to limit by law for incorporated banks the proportion of transactions for a given amount of capital, but no such provision has any foundation except a conjectured average, too rough to be of service in any individual case. In this respect, as in so many others, the judgment of the persons most interested, acting under the law of self-preservation, is far more trustworthy than any legislative decision.

The capital thus to be provided at the outset is, of course, in the case of a private bank, the contribution of the partners, as in any other undertaking. In the case of an incorporated bank the capital is divided by law into equal shares or units of fixed amount; as e. g., under the law of the United States, a capital of $100,000 is divided into 1,000 shares of $100 each; and these shares are contributed by the individual shareholders, in such proportion as they please. The law may as a matter of public policy limit the proportion of capital stock to be owned by any one individual or firm, and it may also limit the liability of shareholders for debts due by the bank, in case of its failure; but in general, in the absence of special provisions to the contrary, the powers, rights, and liabilities of every shareholder are now usually determined by the number of shares of the stock contributed or owned by him. In the election of directors and of other officers for the immediate management of the business, every share entitles its owner to cast one vote; the dividend of profit is divided in the ratio of shares owned, and contributions to meet losses, if required by law, are called for in the same ratio.

The capital subscribed by the intending shareholders must necessarily be paid in in money or in the legal tender of the country. It is not necessary that the whole should be paid in at the outset, but the payment of the whole usually precedes the full establishment of the business; and, in the case of incorporated banks, the law often requires that some definite proportion, as e. g., one-half, shall be paid in before the opening of business, in order to insure good faith and a solid basis for the business undertaken.

If, now, we undertake to represent by a brief statement of account the condition of a bank having a capital of $100,000[Pg 123] paid in, in specie, on the morning when it opens its doors for business, we shall have the following:


It may at first sight appear to be a contradiction in terms, that the capital should be set down as a liability and not as a resource. But we must here distinguish between the financial liability for what has been received from the shareholders and the right of property in the thing received. The bank has become accountable to its shareholders for the amounts paid in by them respectively, but the money actually paid in has become the property of the bank; or, in the language of accountants, the bank has become liable for its capital, and the money in hand is for the present its resource for meeting this liability, or for explaining the disposition made of what has been received.

As the bank requires banking-rooms and a certain supply of furniture and fixtures for the convenient transaction of its business, we may suppose it to expend $5,000 of its cash in providing this "plant." The property thus procured, with the remaining $95,000 in cash, will then be the aggregate resources by means of which the capital is to be accounted for, and the account will stand as follows:

Capital$100,000Real estate, furniture, fixtures, etc.$ 5,000
———— ————

The bank, however, cannot answer the purposes of its existence, or earn a profit for its shareholders, until its idle cash is converted into some kind of interest-bearing security. Nor is it enough that a permanent investment of the ordinary kind should be made, as by the simple exchange of the cash for government bonds or railway securities. It is the chief business of the bank to afford to purchasers and dealers the means of using, by anticipation, funds which are receivable by them in the future, and this implies both the purchase of private securities or "business paper" to a considerable extent,[Pg 124] and also frequent change and renewal of purchases. Moreover, while the private capitalist finds it advantageous to make simple investments of a permanent sort, this would plainly be insufficient for the shareholders of a bank, who have to pay from its profits some serious expenses of management, and need, therefore, a larger field for earnings than the ordinary returns on their capital alone. The bank being obliged then to extend its operations beyond the amount of its capital, is compelled for this purpose to make use of its credit. In fact, it is only by such a use of its credit that the establishment becomes in reality a bank.

Most of the conditions of the case are best answered by the "discount" of commercial paper as above described. The time for which such obligations have to run varies with the custom of the trade which gives rise to them, but is in most cases short enough to imply early repayment to the bank. And even where custom gives the paper longer time, if the paper itself is used only as a collateral security, the note which is the actual object of negotiation with the bank is by preference usually made not to exceed four months. It is easy then to arrange the purchases of paper with reference to the times of maturity, so as to provide for a steady succession of payments to the bank, and thus facilitate the reduction of the business, if necessary, or its direction into new channels, as prudence or good policy may require. The certainty of prompt payment at maturity, needed for this end, is presented in a high degree by the paper created in the ordinary course of business. Independently of the collateral security which the bank may hold, the written promise of a merchant or manufacturer to pay on a fixed day is an engagement which involves the credit of the promisor so far that failure is an act both of legal insolvency and of commercial dishonor. Selected with judgment, then, such paper is not only the investment which most completely answers the purposes of the bank's existence, but is probably as safe as any investment which could be found.

It may easily happen, however, that the bank may find it desirable to invest a part of its resources in some other form, either because good commercial paper cannot be procured in sufficient amount, or as a matter of policy. In this case it will[Pg 125] purchase such other securities as offer not only complete safety of investment, but the possibility of easy conversion into cash in case of need. In this country United States bonds, and many descriptions of State, municipal, and corporation bonds might answer this purpose. Stocks would more rarely answer it, being more liable to the fluctuations in price caused by misfortune or the ordinary vicissitudes of business. Mortgages on real estate, however, would not be admissible, except when held as a security, collateral to some other which is more easily convertible, for even when the mortgaged property is so ample and stable as to insure the goodness of the mortgage, the conversion of the mortgage into cash by sale is not always easy, and is especially difficult at those times when the bank most needs to have all its resources at command. Indeed, the danger to be apprehended from the locking up of resources, in securities which may be solid but are not easily realized, is so great, that it has been said to be the first duty of the banker to learn to distinguish between a note and a mortgage, his business lying with the former. Real estate, of course, cannot be regarded as a banking security, however desirable it may be as an investment for individuals, for it is not only subject to great fluctuations in value, but is at times unsaleable....

The results of the process of investment in commercial paper and in other securities are best understood when we trace the effect in the account of the bank. Taking then the account as it stood after the purchase of fixtures, let us suppose that the bank buys paper or securities from those dealing with it, or, in the common phrase, makes "loans to its customers," to the amount of $90,000, the paper being in many pieces and having various lengths of time to run, but averaging about three months. Supposing the interest to be computed at 6 per cent., we should have the account changed by the operation as follows:

Undivided profits1,350Real estate, furniture, fixtures, etc.5,000
———— ————

[Pg 126]

Here we have the securities which certify the right of the bank to demand and receive $90,000 at a future date placed among the resources; the net proceeds of the securities, or the aggregate of the sums which the bank holds itself liable to pay for them on demand, stand among the liabilities as deposits; and the interest deducted in advance, or the profit on the operation, which the bank must at the proper time account for to the stockholders, also stands as a liability. This, however, is the condition of the account at the moment of making the investment, when the bank has made its purchase of securities by merely creating a liability. As this liability is real and must be met, so far as the depositors at any time see fit to press it, let us suppose that depositors call for cash to the amount of $15,000, and we shall have a further change in the account as follows:

Undivided profits1,350
Real estate, etc5,000

It is clear that, unless the enforcement of the liability for deposits and consequent withdrawal of specie goes much farther than this, the bank can safely increase its loans or its purchase of securities, although its method of doing so is by the increase of its liabilities. We will suppose it, therefore, to have expanded its affairs until it has reached something like the average condition of those banks in the United States, which, being incorporated under the laws of the several States, are not authorized to issue notes. It will then stand thus:

Undivided profits10,000
Bonds and stocks23,000
Real estate15,000
Other assets20,000
Legal-tender notes}
Cash items}   80,000

[Pg 127]

Postponing for the present the consideration of some terms which here occur for the first time, it appears from the above account that purchases of securities have been made to more than three times the amount of the capital, and that this has been effected chiefly by the creation of liabilities in the form of deposits. What determines the limit to which this process can be carried?

If depositors seldom demanded the payment to which they are entitled, but were contented with the mere transfer of their rights among themselves as a conventional currency, the bank might dispense with holding any large amount of specie or cash in any form and keep most of its resources employed in its productive securities. The expansion of the deposits would then resemble in its effects the expansion of any other currency and might go on until a check should be interposed by the consequent rise of prices and demand for specie for exportation. And it is true, as we shall see, that in communities where banking is largely practised, the use of deposits as currency by transfer from hand to hand is so extensive, that a bank in good credit can rely upon their being withdrawn so slowly, or rather to so small an extent, as to make it unnecessary to have cash in readiness for the payment of more than a small proportion at any given moment. But in a period of financial disorder or alarm, withdrawals may be made earlier or more frequently, and a larger provision of cash may be needed for safety, than at other times; the kind of business carried on by depositors may expose one bank, or the banks in one place, to heavier occasional demands, or may on the other hand make demands steadier, than is the case elsewhere; and a city bank may be more subject to heavy calls from depositors than a country bank. In general, then, for every bank, in its place and under the circumstances of the time, there is some line below which its provision of cash cannot safely fall. This provision of cash, which in the account last given includes the cash items, specie, and legal-tender notes, is called the reserve, and the necessity of maintaining a certain minimum reserve fixes a limit to the ability of the bank to increase its securities. For obviously any increase of securities, that is, of loans or bonds, must ordinarily be effected,[Pg 128] either by an increase of deposits, or by an actual expenditure of cash. If, then, the reserve were already as low as prudence would allow, or were threatened by approaching heavy demands from depositors, no increase of securities could be made without serious risk.

What proportion the reserve should bear to the liabilities which it is to protect is a question which the law has sometimes attempted to settle, by requiring a certain minimum, leaving it to every individual bank to determine for itself how much may be required in addition to this minimum. And this is no doubt as far as any general rule can go. As has already been suggested, the requirements for safety of different banks and in different places must vary, and so must the requirements of the same bank at different times. In fact, the question as to the proper amount of reserve never depends simply on the absolute ratio of the reserve to the liabilities, but always involves further questions as to the probable receipts of cash by the bank and probable demands upon it, in the near future. It can only be said that the reserve should be large enough, not only to insure the immediate payment of any probable demand from depositors, but also to secure the bank from being brought down to the "danger line" by any such demand. If 25 per cent. is the minimum consistent with safety, the reserve should be far enough above this to be secure from reduction to a point where any further demand or accident may make the situation hazardous.

In the management of its reserve the bank itself necessarily feels a strong conflict of interests. On the one hand, it is impelled to increase its securities as far as possible, for it is from them that it derives its profits, and the retention of a large amount of idle cash is felt as a loss. On the other hand, the maintenance of a reserve sufficient, not only to enable the bank to continue its payments but to inspire the public with confidence in its ability to continue them, is a necessity of its existence, even though a part of its resources do thus appear to be kept permanently idle. As a natural consequence, the actual settlement of the question in favor of a large or of a small reserve in any particular case will depend in good measure[Pg 129] on the temperament of the managers. In every banking community may be found "conservative" banks, the caution of whose managers forbids them to take risks by extending their business at the expense of an ample reserve; and by their side may be seen the more "active" banks, whose managers habitually spread all possible sail, and provide for the storm only when it comes.

It is to be observed that the necessity of providing a cash reserve is not met by the excellence of the securities held by the bank. Although their certainty of payment at maturity be absolute, still the demands upon the banks are demands for cash, and cannot be answered by the offer of even the best securities. If the depositor or creditor does not receive cash in full for his demand when it is made, the bank has failed, and any satisfaction of his claim by the delivery of a security is, as it were, only the beginning of a division of the property of the bank among its creditors. Specie, therefore, or the paper which is a substitute for it as a legal tender for debt, forms the real banking reserve. The reserve of the bank may, however, be greatly strengthened by the judicious selection of securities. For example, if, in the account above given, the "bonds and stocks" are, as they should be, of descriptions which are readily saleable, they afford the means of replenishing the reserve in case of need, without foregoing the enjoyment of an income from this amount of resources for the present. In extreme cases of general financial panic, it is true, even the strongest government securities may find but few purchasers; still such a provision is the best support which can be had in the absence of, or as an auxiliary to, a sufficient reserve of actual cash.

The natural method of securing the proper apportionment of resources between securities and reserve, under ordinary circumstances, is by increasing or diminishing the loans, or, in other words, the purchases of securities made from day to day in the regular course of business. That part of the securities which consists of the promises of individuals or firms to pay to the bank at fixed dates, is made up of many such pieces of commercial paper, maturing, if properly marshalled,[Pg 130] in tolerably steady succession. The payment of one of these engagements when it becomes due may be made either in money, or by the surrender to the bank of an equal amount of its own liabilities ... [in the form of deposits]. In the former case, the payment of the maturing paper to the bank is in fact the conversion of a security into cash, and increases the reserve without change in the liabilities; in the latter, the reduction of securities is balanced by a reduction of liabilities which raises the proportion of reserve. If, then, the bank stops its "discounts" or the investments in new securities, or if it even slackens its usual activity in making such investments, the regular succession of maturing paper will gradually strengthen its reserve; if it increases its activity in investment, it will weaken or lower its reserve; and if it adjusts the amount of its new investments to the regular stream of payments made by its debtors, it may keep the strength of its reserve unaltered, until some change in the condition of affairs brings cash to it or takes cash away by some other process.

This natural dependence of the reserve upon the more or less rapid re-investment of its resources by the bank is distinctly recognized by the law of the United States, which provides that when the reserve of any national bank falls below the legal minimum, such bank "shall not increase its liabilities by making any new loans or discounts," until its reserve has been restored to its required proportion. By a less harsh application of the same principle, the Bank of England operates upon its reserve by lowering or raising its rate of discount, and thus encouraging or discouraging applications for loans. And it was with a view of facilitating the replenishment of the reserve by the curtailment of loans, that the law of Louisiana formerly provided that the banks of New Orleans should hold what were called "short bills," or paper maturing within ninety days, to the amount of two-thirds of their cash liabilities, so that the constant stream of payments of such paper might always insure to every bank the early command of a large part of its resources.

To return, in conclusion, to the account last given; we have there among the liabilities certain sums classified as "surplus"[Pg 131] and as "undivided profits." Taken together these sums represent the profits which have been made, but not divided among the stockholders, and which are therefore to be accounted for by the bank. The surplus is that portion of these profits which as a matter of policy it has been determined not to divide and pay over to the stockholders, but to retain in the business, as in fact, although not in name, an addition to the capital. The remaining portion, the undivided profits, is the fund from which, after payment of current expenses and of any losses which may occur, the next dividend to the stockholders will be made. The current expenses are for the present entered on the other side of the account, as they represent a certain amount of cash which has disappeared; but at the periodical settlement of accounts they must be deducted from the undivided profits, and will thus drop out from the statement. "Other assets," here set down as an investment, may be supposed to cover any form of property held by the bank and not otherwise classified, but especially the doubtful securities, or such property, not properly dealt in by a bank, as it may have been necessary to take and to hold temporarily, for the purpose of securing some debt not otherwise recoverable. For example, although the bank could not properly invest in a mortgage, it might be wise for it to accept a mortgage in settlement with an embarrassed debtor, and in this case the mortgage would stand among the "other assets." And, finally, "cash items" include such demands on individuals or other banks as are collectible in cash and can therefore fairly be deemed the equivalent of cash in hand. In the absence of any legal provision limiting the classification of such demands as reserve, they may be regarded as virtually a part of the reserve, which in the case before us may therefore be treated as made up of cash items, specie, and legal-tender notes.

To illustrate what has been said in this chapter we will now suppose the bank to make the following operations:

a. To add to its securities $20,000, by discount of three-months paper at 6 per cent., three-fourths being purchased by the creation of liabilities, and one-fourth by the expenditure of cash. The account would then stand as follows:[Pg 132]

Undivided profits10,300
Bonds and stocks23,000
Real estate15,000
Other assets20,000

b. To retrace its steps by diminishing its "discounts" or holding of securities to the extent of $50,000, of which four-fifths are paid to it by the surrender of demands for deposits to a like amount and one-fifth in cash; to pay $1,250 for current expenses; and further to increase its reserve by the sale of bonds and stocks to the amount of $10,000. The following would then be the state of the account:

Undivided profits10,300
Bonds and stocks13,000
Real estate15,000
Other assets20,000

c. To sell $2,000 of its other assets for cash with a loss of $500; to make a semi-annual dividend of 4 per cent., of which one-half is credited to stockholders who happen to be depositors also, and one-half is paid in cash; to sell $4,000 of bonds at a profit of 15 per cent., and to carry $1,000 of its undivided profits to surplus. The account would then stand at the beginning of the new half year, as follows:

Undivided profits3,150
Bonds and stocks9,000
Real estate15,000
Other assets18,000

[Pg 133]

Statement of A Representative National Bank

Loans and discounts$739,743.27
Overdrafts, secured973.08
U. S. bonds deposited to secure circulation100,000.00
U. S. bonds pledged to secure U. S. deposits1,000.00
Bonds other than U. S. bonds pledged to secure postal savings deposits7,000.00
Other Securities191,098.05
Stock of Federal Reserve bank4,800.00
Banking House30,000.00
Furniture and Fixtures5,000.00
Due from Federal Reserve Bank20,000.00
Due from approved reserve agents89,919.25
Due from other banks12,074.23
Checks on banks in same city6,051.46
Outside checks and other cash items13,171.83
Fractional currency, nickels, and cents283.14
Notes of other national banks1,295.00
Coin and certificates38,604.05
Legal-tender notes25,000.00
Redemption fund3,500.00
Capital stock paid in $100,000.00
Surplus fund 60,000.00
Undivided profits40,877.46
Less current expenses, interest, and taxes paid17,110.2823,767.18
Notes Out-standing 98,500.00
Individual deposits subject to check 404,871.37
Certificates of deposit due in less than 30 days 596,335.82
Certified Checks 125.00
United States deposits 1,000.00
Postal savings deposits 4,913.99

[33]The Method and Extent of Credit Issue.—Assume that a bank with a cash capital of $100,000 is opening for business in an isolated town and is the only bank in that town. How much can it lend? Ordinarily a bank lends by discounting a customer's note and by giving the customer a deposit credit upon its books for the proceeds of the note.... If, now, our bank in question lends $100,000, giving deposit credit for this sum, it has $100,000 of cash on hand against $100,000 of cash liability. Its statement will stand as follows:

Capital Stock$100,000

Now let it lend another $100,000. With its loans and deposits each standing at $200,000 its reserves are 50 per cent.[Pg 134] of its demand liability. Only with $666,666 of loans will its reserves have reached ... [a] 15 per cent. limit:

Notes (Loans and Discounts)666,666
Capital Stock$100,000

Further: Suppose that $100,000 of cash is deposited with the bank from the channels of business; how much more can it lend? Fifteen thousand dollars must be retained as reserve against the new liability; $85,000 is available as reserves against further lending. Based upon these further reserves loans may be granted to the extent of nearly $600,000 more. In fact, only with an expansion of $1,233,333 in loans and in derived deposits—a total deposit of $1,333,333—has its reserve fallen to the ratio of 15 per cent. of its liability.

Cash (original)$100,000
Loans and Discounts 666,666
Cash (new)(85,000
L & D (new)566,666
Capital Stock$100,000
Deposits (new)(100,000

The situation summarizes as follows: On its asset side the bank has $200,000 of cash and $1,233,333 of securities (Bills and Notes). Its deposit liabilities amount to $1,333,333.

Its cash is 2/13.3+ of its liability—15 per cent.

The Function of Reserves.—If this is what actual banking means, is banking safe? What would happen if all these deposits were immediately called for in cash? True, not all are likely to be called for, but some cash will be demanded. In fact, the borrowers, instead of accepting all of the proceeds of these notes in deposit credit, will in some measure require and receive cash. Precisely so; and so the bank must keep on hand a cash reserve to meet this possibility. For the most part, however, the customers of the bank make payments through checks upon the bank, and these credits are deposited[Pg 135] in turn to the credit of other customers. No cash, but only bookkeeping, is required. And if some customers draw out cash, other customers will probably receive it and return it to the bank. A reserve of 15 per cent. is enough for the case. There, would, indeed, be small gain in banking if against every deposit an equal sum in cash must be held in store by the bank.

Economy of Redemption Money.—It is thus evident that the employment of $200,000 cash as a banking reserve has made possible the existence of a more than sixfold volume of circulating medium—currency. Against each $1,000 of deposit liability there need be only $150 of actual cash. The bank customer, however, thinks of his deposit claim as money, and it really serves him all the purposes of money. The right to have the money when desired is as good as the actual money, is more convenient, and is as readily and as serviceably transferred.

The economy of money through the use of credit substitutes for money extends really further than the foregoing analysis indicates. Under the [now superseded] law, three-fifths of the reserves of a rural bank may be on deposit with banks in reserve cities. Thus against $100,000 of deposit liability the rural bank needs hold only $6,000 of reserve money. Against the deposit of the remaining $9,000, the reserve city bank is required in turn to hold a reserve of only 25 per cent.—$2,250. And of this required $2,250, one-half may be represented by deposits in central reserve cities, e. g., New York, Chicago, and St. Louis. Against the $1,125 deposited with it the central reserve bank is required to hold only 25 per cent. of reserves—$281.25. Thus at the outside limit of credit extension, $100,000 of deposit currency may be supported by only $7,406.25 of reserves in money,

(6000 + 1/2 × (9000/4) + (1125/4)).

one dollar of reserves upholding $13 of currency.[34]

It is, of course, not true that the banks ordinarily allow their reserves to run as low as the legal limit, or make the utmost possible use of the privilege of counting claims against[Pg 136] one another as legal reserves. Nor is it accurately true that all forms of money are of equal efficiency in the support of credit. Not all forms of money, but only those of the higher levels in the money scale, are allowed to be counted as legal reserves.... Some forms of money make demands upon other forms for redemption, or are limited in exchange power to the exchange power of the form in which redemption is to be made. The total exchange efficiency of the money of a country is, then, not accurately to be computed on the assumption that all moneys are equally efficient for all purposes—that some are not in varying degree burdens upon the money functions of the others.

Banking Viewed in Detail and in the Aggregate.—And one further modification is called for. The analysis so far made, while valid for any isolated bank, or for the banking system regarded as an aggregate, is not precisely accurate for the affairs of any one competing bank among other banks. When the check drawn by the borrowing depositor may be deposited in other banks and collected by them against the lending bank, its granting of credits rapidly draws down its reserves to swell the reserves of its competitors. One hundred thousand dollars of new reserves may not mean to it an increase of lending power of more than, say, $125,000. For banks in the aggregate, however, this increase of reserves brings its full several-fold increase of lending power, provided that all the reserve efficiency is utilized in whatever bank it rests. As the lending by each bank is depleting its reserves, the lending which other banks are doing is reinforcing these reserves. The aggregate possible extension of credit is not changed.

What Banks Actually Do and Lend.—It follows from the foregoing analysis that, in the main, banks do not lend their deposits, but rather, by their own extensions of credit, create the deposits; that these deposits are funds which the deposit-creditors of the bank can lend if they will, and that many men into whose hands these deposits fall through transfer are certain to use them as funds to be lent. In fact, also, even when the deposits in the bank are not derived from the lending activity of the bank, but are really funds deposited from outside[Pg 137] sources, these funds are commonly used by the bank as a reserve basis on which loans are extended rather than as funds which are themselves loaned out by the bank. Banks are, in truth, mostly intermediaries between debtors and creditors—but not in the sense of borrowing funds from one class of customers in order to lend them to another class, but rather in the sense of creating for their borrowing customers funds which may be used by these borrowers as present purchasing power. The borrower becomes indebted to the bank in order that for his own purposes he may use the promise of the bank as the equivalent of cash to himself. In the form of a deposit liability the bank becomes a debtor to whomever the borrower shall nominate. The fact that the borrower pays interest while the bank undertakes a noninterest-bearing obligation, or pays relatively low interest, explains in the main the gains attending the business of commercial banking.

Deposits and Solvency.—It is, therefore, a sheer blunder to infer that a bank is rich or strong because of its great total of deposits, or to regard deposits in banking institutions as making part of the aggregate wealth of the community. Instead, the deposits indicate for a bank the extent of its operations, and indicate for a community the extent to which the banks, under the guise of noninterest-bearing obligations, have assumed the debts of business men, on terms of these business men becoming debtors—and interest-paying debtors—to the banks. The solvency of the bank is in its portfolio of securities. Its deposits are not its assets, but its liabilities. These liabilities it has mostly created for the use of its borrowers. The further it may safely go in assuming liabilities, the larger its holdings of borrowers' notes may be, and the more interest or discount charges it may collect. Essentially, therefore, the business of a bank is a form of suretyship—the guaranteeing of its borrowers' solvency—an underwriting of the credit of its customers. The bank transfers its customers' prospective future paying power into present funds. It is for this reason that the contract takes the form of a money loan and the premium the guise of an interest payment.

Bank Loans Related to Currency and Loan Funds.—And note now that it is precisely because the business of a bank[Pg 138] is to furnish to its borrower a present purchasing power for his own use that the business of banking becomes the source of the larger part of the circulating medium of society. In their service to their customers the banks create currency; and in creating currency they create loan funds which, in the hands of the holders of them, are available like other currency for any purpose, either lending or other.

The Sources of Currency Supply.—It is, then, clear that the larger part of the circulating medium of society is not money; that not all of the money that there is is bullion money; and that not even all of the bullion money need be ultimate money—redemption money of the highest rank. The sources of currency in society are various—some of it bullion, with a cost of production limit upon its supply, some of it government paper, substantially free of cost, some of it banking credit with certain peculiar and appropriate costs attending its issue.

Currency and Its Cost of Production.—It is obvious that the actual limitations upon the supply of exchange media must be made clear if we are to understand the influences which are fundamental to the exchange values of the currency unit. Only, indeed, by this investigation of the sources of the supply, and of the terms on which each different factor of the supply is available, are we in position to understand the influences which impose upon bidders for money a certain level of sacrifice in obtaining it.

What, then, are the limitations upon the supply of credit currency supplied by the banks? In other words, what are the banking costs in the granting of demand deposit rights to customers? Evidently limitations there must be, and limitations in the nature of costs, else the competitive activity of the banks would indefinitely increase the supply of currency, and any would-be purchaser of goods or payor of debts or projector of an enterprise could have the time use of purchasing power gratis; no limit would exist to the rise in prices which must attend this increase in the circulating medium.

What are these limitations? (1) Each bank must conform the volume of its lending, and therewith its issue of circulating credit, to the fundamental requirement that it be always able[Pg 139] to make good its agreement to discharge its deposit liabilities on demand. To maintain reserves involves expense. Especially may it be expensive if they have been allowed to get low; securities may have to be marketed at a sacrifice, or good customers pressed for payment at inconvenient times. In periods of general pressure or panic, other banks are not likely to be in a position to lend their own reserve funds or to consent to create deposit credit in aid of still other suffering banks. Not rarely the Bank of England, in the attempt to attract reserve funds, advances bank notes or deposit credit to importers of gold, without imposing the customary interest charge for the covering of the delays of the mint. In at least one case, in 1890, it borrowed reserves from the Bank of France. In 1907 the United States Treasury made especially large money deposits with the national banks of New York to help eke out the needed reserves. Meantime the interior banks were compelled to pay to exporting merchants generous premiums for exchange bills upon Europe, through which, despite the high interest rates ruling in European markets, these banks were able to import 107 millions of gold for their own reserve requirements. In fact, the banking business involves the hazard not merely that some of the debtors of the bank may become insolvent, but also the general and overhead hazard attaching to its underwriting service that it may itself in time of stress become unable to meet its obligations. Its liabilities must not be allowed to get seriously out of ratio to its cash resources.

The Protection of Reserves.—In point of fact also the efforts of the various different banks to maintain each its own reserve place a limit on the extent to which any one bank can extend its activity in the expansion of loans and of the derivative liabilities. Just as a relatively liberal granting of credit by one bank must tend to transfer its reserves to other banks, so a relatively great extension of credit in one center or in one country must tend to transfer the reserves, e. g., gold, to other centers or countries. Even were it true that a local credit expansion has no effect upon local prices and thereby upon the currents of trade, some transfers of reserves would still take place, and would impose a policy of restriction in[Pg 140] credit accommodations.... The influence is actually exerted by both methods.

(2) Another Cost in Bank-Made Currency.—The loan rates of the bank must also provide a fund to cover its costs of administration—salaries, clerk hire, rents, and the like. Where transactions run in large units the ratio of expense to the volume of business may be low. This is in part the explanation for the low rates of discount in the great financial centers compared with the rates outside. Credit currency has its cost of production rate as truly as any other service upon the market....

The Relation Between Loans and Deposits

[35]The money of modern English commerce and finance is the cheque, and the credit dealt in in the London money market is the right to draw a cheque....

Now that we have come to the point at which the manufacture of the right to draw cheques has to be made as clear as may be, it will be well to come into close touch with the facts of the case and look at a bank balance-sheet of to-day. In order to get a fair average specimen I have taken the latest available balance-sheets of half a dozen of the biggest London banks, and put their figures together.... Let us examine the aggregated specimen that I have drawn up.

Millions of £
Capital paid up16
Reserve Fund11
Current and deposit accounts249
Acceptance on behalf of customers16-1/2
Profit and Loss account1-1/2
Millions of £
Cash in hand and at the Bank of England43
Loans at call and short notice27-1/2
Bills discounted and advances153
Liability of customers on acceptances16-1/2

The above statement does not include the figures of the Bank of England, but is an agglomeration of the balance-sheets of six of the biggest of the ordinary joint-stock banks.

[Pg 141]

The first feature that strikes the casual observer is the smallness of the paid-up capital of the banks when compared with the vastness of the figures that they handle. We see that only 16 millions out of the 294 that they have to account for have been actually paid up by shareholders, though 11 millions have been retained out of past profits and accumulated in reserve funds ["surplus," in United States], and 1-1/2 millions are due to shareholders, for distribution as dividend or addition to reserve, in the shape of the profit and loss account balance for the period covered by the balance-sheet. A profit of 1-1/2 millions on 16 is handsome enough, especially when it is considered that most of these balance-sheets covered a half-year's work, but 1-1/2 millions out of 294 is a trifle, and it thus appears that a narrow margin of profit on their total turnover enables the banks to pay good dividends, and that the business of credit manufacture earns its reward, as might be expected, out of the credit that it makes.

Proceeding in our examination, we see that the item of acceptances on behalf of customers on one side is balanced by the liability of customers on the other. This means that the banks have accepted bills for their customers (so making them first-class paper and easily negotiable), and are so technically liable to meet them on maturity; but since the customers are expected to meet them, and have presumably given due security, this liability of the customer to the bank is an offsetting asset against the acceptance. And since the acceptance business is a comparatively small item, and a bank's liability under its acceptances is not a liability in quite the same sense as its deposits, and does not immediately affect the present question of the manufacture of currency, it may be omitted for the present. We can thus simplify the balance-sheet by taking out this contra entry on both sides.

Further analysis of the liabilities shows that the capital, reserves, or surplus, and profit and loss balance may be regarded as due from the banks to their shareholders, and that the remaining big item, current and deposit accounts, is due to their customers. This is the item which is usually spoken of as the deposits, according to the tiresome habit of monetary nomenclature which seems to delight in applying the same[Pg 142] name to a genus and one of the species into which it is divided. Just as the bill of exchange is divided into cheques and bills of exchange, so the English banks' deposit accounts are divided into current and deposit accounts. But most people who have a banking account know the meaning of this distinction. Your current account is the amount at your credit which you can draw out, or against which you can draw cheques, at any moment; your deposit account is the amount that you have placed on deposit with the bank and can only withdraw on a week's or longer notice, and it earns a rate of interest, usually 1-1/2 per cent. below the Bank of England's official rate. The essential point to be grasped is the fact that the banks' deposits, as usually spoken of, include both the current and deposit accounts, and are due by the banks to their customers.

Now let us see how this huge debt from the banks to the public has been created. An examination of the assets side of the balance-sheet proves that most of it has been created by money lent to their customers by the banks, and that the cheque currency of to-day is, like the note currency of a former day, based on mutual indebtedness between the banks and their customers. For the assets side shows that the banks hold 43 millions in cash and at the Bank of England, 48 millions in investments, and 6 millions invested in their premises—the buildings in which they conduct their business—and that 180-1/2 millions have been lent by them to their customers, either by the discounting of bills or by advances to borrowers, or by loans at call or short notice. We can now reconstruct our balance-sheet, leaving out the acceptances on both sides, as follows:

Millions of £. Millions of £.
Due to shareholders28-1/2Cash in hand and at Bank of England43
Due to customers249Investments48
  Due from customers180-1/2
———— ————
277-1/2 277-1/2

And it thus appears that nearly three-quarters of the amount due from the banks to their customers are due from their customers to the banks, having been borrowed from them in[Pg 143] one form or another. And this proportion would perhaps be exceeded if we could take the figures of English banking as a whole. But that cannot be done at present, because some of the smaller banks do not separate their cash from their loans at call in their published statements. The greater part of the banks' deposits is thus seen to consist, not of cash paid in, but of credits borrowed. For every loan makes a deposit, and since our balance-sheet shows 180-1/2 millions of loans, 180-1/2 out of the 249 millions of deposits have been created by loans.

To show how a loan makes a deposit, let us suppose that you want to buy a thousand-guinea motor-car and raise the wherewithal from your banker, pledging with him marketable securities, and receiving from him an advance, which is added to your current account. Being a prudent person you make this arrangement several days before you have to pay for the car, and so for this period the bank's deposits are swollen by your £1,050, and on the other side of its balance-sheet the entry "advances to customers" is also increased by this amount, and the loan has clearly created a deposit.

But you raised your loan for a definite purpose, and not to leave with your bank, and it might be thought that when you use it to pay for your car the deposit would be cancelled. But not so. If the seller of your car banks at your bank, which we will suppose to be Parr's, he will pay your cheque into his own account, and Parr's bank's position with regard to its deposits will be unchanged, still showing the increase due to your loan. But if, as is obviously more probable, he banks elsewhere—perhaps at Lloyd's—he will pay your cheque into his account at Lloyd's bank, and it will be the creditor of Parr's for the amount of £1,050. In actual fact, of course, so small a transaction would be swallowed up in the vast mass of the cross-entries which each of the banks every day makes against all the others, and would be a mere needle in a bottle of hay. But for the sake of clearness we will suppose that this little cheque is the only transaction between Parr's and Lloyd's on the day on which it is presented; the result would be that Parr's would transfer to Lloyd's £1,050 of its balance at the Bank of England, where all the banks keep an account for clearing purposes. And the final outcome of the operation[Pg 144] would be that Parr's would have £1,050 more "advances to customers" and £1,050 less cash at the Bank of England among its assets, while Lloyd's would have £1,050 more deposits and £1,050 more cash at the Bank of England. And the £1,050 increase in Lloyd's deposits would have been created by your loan, and though it will be drawn against by the man who sold you the car, it will only be transferred perhaps in smaller fragments to the deposits of other banks; and as long as your loan is outstanding there will be a deposit against it in the books of one bank or another, unless, as is most unlikely, it is used for the withdrawal of coin or notes; and even then the coin and notes are probably paid into some other bank, and become a deposit again; and so we come back to our original conclusion that your borrowing of £1,050 has increased the sum of banking deposits, as a whole, by that amount.

The same reasoning applies whenever a bank makes a loan, whatever be the collateral, or pledge deposited by the borrower, whether Stock Exchange securities, as in the case cited, or bales of cotton or tons of copper; or, again, whenever it discounts a bill. In each case it gives the borrower or the seller of the bill a credit in its books—in other words, a deposit; and though this deposit is probably—almost certainly—transferred to another bank, the sum of banking deposits is thereby increased, and remains so, as long as the loans are in existence. And so it appears that the loans of one bank make the deposits of others, and its deposits consist largely of other banks' loans....

Relation Between Reserves and Demand Liabilities Again

[36]... a bank must so regulate its loans and note issues as to keep on hand a sufficient cash reserve, and thus prevent insufficiency of cash from ... threatening. It can regulate the reserve by alternately selling securities for cash and loaning cash on securities. The more the loans in proportion to the cash on hand, the greater the profits, but the greater the danger also. In the long run a bank maintains its necessary[Pg 145] reserve by means of adjusting the interest rate charged for loans. If it has few loans and a reserve large enough to support loans of much greater volume, it will endeavor to extend its loans by lowering the rate of interest. If its loans are large and it fears too great demands on the reserve, it will restrict the loans by a high interest charge. Thus, by alternately raising and lowering interest, a bank keeps its loans within the sum which the reserve can support, but endeavors to keep them (for the sake of profit) as high as the reserve will support.

If the sums owed to individual depositors are large, relatively to the total liabilities, the reserve should be proportionately large, since the action of a small number of depositors can deplete it rapidly. Similarly, the reserves should be larger against fluctuating deposits (as of stock brokers) or those known to be temporary. The reserve in a large city of great bank activity needs to be greater in proportion to its demand liabilities than in a small town with infrequent banking transactions.

Experience dictates differently the average size of deposit accounts for different banks according to the general character and amount of their business. For every bank there is a normal ratio and hence for a whole community there is also a normal ratio—an average of the ratios for the different banks. No absolute numerical rule can be given. Arbitrary rules are often imposed by law. National banks in the United States, for instance, are required to keep a reserve for their deposits, varying according as they are or are not situated in certain cities designated by law as "reserve" cities, i. e., cities where national banks hold deposits of banks elsewhere. These reserves are all in defense of deposits. In defense of notes, on the other hand, no cash reserve is required—that is, of national banks. True, the same economic principles apply to both bank notes and deposits, but the law treats them differently. The Government itself chooses to undertake to redeem the national bank notes on demand.

The state banks are subject to varying restrictions. Thus the requirement as to the ratio of reserve to deposits varies from 12-1/2 per cent. to 22-1/2 per cent., being usually between[Pg 146] 15 per cent. and 20 per cent. Of the reserve, the part which must be cash varies from 10 per cent. (of the reserve) to 50 per cent., usually 40 per cent.

Such legal regulation of banking reserves, however, is not a necessary development of banking....


[38]... Your Committee proceeded, in the first instance, to ascertain what the price of gold bullion [in terms of Bank of England notes] had been, as well as the rates of the foreign exchanges, for some time past; particularly during the last year.

Your Committee have found that the price of gold bullion, which, by the regulations of his Majesty's Mint, is £3 17s. 10-1/2d. per ounce of standard fineness, was, during the years 1806, 1807, and 1808, as high as £4 in the market. Towards the end of 1808 it began to advance very rapidly, and continued very high during the whole year 1809; the market price of standard gold in bars fluctuating from £4 9s. to £4 12s. per ounce. The market price at £4 10s. is about 15-1/2 per cent. above the Mint price....

It is due,... in justice to the present Directors of the Bank of England, to remind the House that the suspension of their cash payments, though it appears in some degree to have originated in a mistaken view taken by the Bank of the peculiar difficulties of that time, was not a measure sought for by the Bank, but imposed upon it by the Legislature for what were held to be urgent reasons of state policy and public expediency. And it ought not to be urged as matter of charge against the Directors, if in this novel situation in which their commercial company was placed by the law, and entrusted with the regulation and control of the whole circulating[Pg 147] medium of the country, they were not fully aware of the principles by which so delicate a trust should be executed, but continued to conduct their business of discounts and advances according to their former routine.

It is important at the same time to observe that under the former system, when the Bank was bound to answer its notes in specie upon demand, the state of the foreign exchanges and the price of gold did most materially influence its conduct in the issue of those notes, though it was not the practice of the Directors systematically to watch either the one or the other. So long as gold was demandable for their paper, they were speedily apprised of a depression of the exchange, and a rise in the price of gold, by a run upon them for that article. If at any time they incautiously exceeded the proper limit of their advances and issues, the paper was quickly brought back to them, by those who were tempted to profit by the market price of gold or by the rate of exchange. In this manner the evil soon cured itself. The Directors of the Bank having their apprehensions excited by the reduction of their stock of gold, and being able to replace their loss only by reiterated purchases of bullion at a very losing price, naturally contracted their issues of paper, and thus gave to the remaining paper, as well as to the coin for which it was interchangeable, an increased value, while the clandestine exportation either of the coin, or the gold produced from it, combined in improving the state of the exchange and in producing a corresponding diminution of the difference between the market price and Mint price of gold, or of paper convertible into gold.

Your Committee do not mean to represent that the manner in which this effect resulted from the conduct which they have described, was distinctly perceived by the Bank Directors. The fact of limiting their paper as often as they experienced any great drain of gold, is, however, unquestionable....

It was a necessary consequence of the suspension of cash payments, to exempt the Bank from that drain of gold, which, in former times, was sure to result from an unfavourable exchange and a high price of bullion. And the Directors, released from all fears of such a drain, and no longer feeling any inconvenience from such a state of things, have not been[Pg 148] prompted to restore the exchanges and the price of gold to their proper level by a reduction of their advances and issues. The Directors, in former times, did not perhaps perceive and acknowledge the principle more distinctly than those of the present day, but they felt the inconvenience, and obeyed its impulse; which practically established a check and limitation to the issue of paper. In the present times the inconvenience is not felt; and the check, accordingly, is no longer in force....

By far the most important ... consequence ... [of the Restriction Act] is, that while the convertibility into specie no longer exists as a check to an over-issue of paper, the Bank Directors have not perceived that the removal of that check rendered it possible that such an excess might be issued by the discount of perfectly good bills. So far from perceiving this ... they maintain the contrary doctrine with the utmost confidence.... That this doctrine is a very fallacious one, your Committee cannot entertain a doubt. The fallacy, upon which it is founded, lies in not distinguishing between an advance of capital to merchants, and an addition of supply of currency to the general mass of circulating medium. If the advance of capital only is considered, as made to those who are ready to employ it in judicious and productive undertakings, it is evident there need be no other limit to the total amount of advances than what the means of the lender, and his prudence in the selection of borrowers, may impose. But in the present situation of the Bank, intrusted as it is with the function of supplying the public with that paper currency which forms the basis of our circulation, and at the same time not subjected to the liability of converting the paper into specie, every advance which it makes of capital to the merchants in the shape of discount, becomes an addition also to the mass of circulating medium. In the first instance, when the advance is made by notes paid in discount of a bill, it is undoubtedly so much capital, so much power of making purchases, placed in the hands of the merchant who receives the notes; and if those hands are safe, the operation is so far, and in this its first step, useful and productive to the public. But as soon as the portion of circulating medium in which the[Pg 149] advance was thus made performs in the hands of him to whom it was advanced this its first operation as capital, as soon as the notes are exchanged by him for some other article which is capital, they fall into the channel of circulation as so much circulating medium, and form an addition to the mass of currency. The necessary effect of every such addition to the mass is to diminish the relative value of any given portion of that mass in exchange for commodities. If the addition were made by notes convertible into specie, this diminution of the relative value of any given portion of the whole mass would speedily bring back upon the Bank which issued the notes as much as was excessive. But if by law they are not so convertible, of course this excess will not be brought back, but will remain in the channel of circulation, until paid in again to the Bank itself in discharge of the bills which were originally discounted. During the whole time they remain out, they perform all the functions of circulating medium; and before they come to be paid in discharge of those bills, they have already been followed by a new issue of notes in a similar operation of discounting. Each successive advance repeats the same process. If the whole sum of discounts continues outstanding at a given amount, there will remain permanently out in circulation a corresponding amount of paper; and if the amount of discounts is progressively increasing, the amount of paper, which remains out in circulation over and above what is otherwise wanted for the occasions of the public, will progressively increase also, and the money prices of commodities will progressively rise. This progress may be as indefinite as the range of speculation and adventure in a great commercial country....


[31] Herbert Joseph Davenport, The Economics of Enterprise, pp. 259, 60. The Macmillan Company, New York. 1913.

[32] Charles F. Dunbar, Chapters on the Theory and History of Banking, pp. 20-38, G. P. Putnam's Sons, New York and London. 1902.

[33] Herbert Joseph Davenport, The Economics of Enterprise, pp. 260-6. The Macmillan Company. New York. 1913.

[34] It should not be overlooked, furthermore, that the velocity of the circulation of deposits is approximately two and one-half times that of money.—Editor.

[35] Hartley Withers, The Meaning of Money, pp. 57-73. E. P. Dutton and Company. New York. 1914.

[36] Irving Fisher, The Purchasing Power of Money, pp. 45-47. The Macmillan Company. New York. 1911.

[37] This act, passed in 1797 in order to prevent a drain of gold to the continent during the Napoleonic War, forbade the Bank of England to redeem its notes. It remained in force until 1821, when specie payment was resumed.—Editor.

[38] Report from the Select Committee on the High Price of Gold Bullion. Ordered by the House of Commons, to be printed, 8 June, 1810.

[Pg 150]



[39]Discussions concerning the issue of notes by banking institutions, which largely occupied the attention of students of finance and business men in the eighteenth and the first three quarters of the nineteenth centuries, have been succeeded by equally intense discussions of the amount and influence of credit deposits on the books of the banks, when drawn on by their customers with checks. The fact that the use of checks against deposits renders unnecessary a large amount of money, or currency, attracted attention early in the history of deposit banking, and efforts have been made from time to time to determine the proportion of money, or currency, replaced with checks and credit documents of similar character.[40]

We may summarize the results of our inquiry and inferences therefrom briefly as follows:

1. In the first place, it is very clear that a large proportion of the business of the country, even the retail trade, is done by means of credit instruments. While it is probably true that wage-earners, as a class, do not commonly use checks, it is also true that a great many of them do. Moreover, the use of checks is common among people who derive their income from other sources, even though it be not larger than the well-paid day laborer. We are justified ... in concluding that 50 or 60 per cent. of the retail trade of the country is settled in this way.

2.... Over 90 per cent. of the wholesale trade of the country is done with checks and other credit documents.

[Pg 151]

3. The very general use of checks is shown in the deposits of "all other" depositors. The average is close up to that of the wholesale trade, and while many corporations, public and private, are doubtless represented here, and many speculative transactions are included, there is no reason for excluding any one of those in determining the proportion of business done, whatever we may think of its legitimacy from the point of view of public morals or public utility.

4. The use of checks is promoted in a measure by the payment of wages by check. It appears from our investigation that of weekly pay rolls reported by the banks, aggregating $134,800,000 for the week ending March 13 last, 70 per cent. was in checks....

5. The great use of checks is shown also by the large number of accounts under $500....

6. We may therefore safely accept an average of 80 to 85 per cent. as the probable percentage of business of this country done by check.

7. The fact that so large a proportion of business is done with credit paper may or may not be a good thing. Whether it is or not depends on circumstances. If any part of the country is compelled to use checks because of the lack of currency, when it would prefer the latter, the situation is an evil.

8. The transaction of so large a volume of our business by checks is an element of danger in times of stringency and crisis. In such times the uncalled balance of credit transactions creates a larger demand for money, but the habit of settling by check has meantime kept the available amount of money at a minimum.

9. Consequently there ought to be some means of supplying additional currency when credit as a means of payment diminishes. This currency ought to be as safe and as uniform as the ordinary currency, and it should be capable of being quickly emitted and recalled. That is, it should possess elasticity.

10. The large money circulation of the country is explained by the facts that our prices and wages range high, that our people probably carry a larger average amount of money on[Pg 152] their persons than do foreigners, that some portion of our currency has been destroyed or lost or hoarded.... As our business grows, the amount of money needed as reserve to perform this vast volume of business transactions increases, too....

13. The volume of credit transactions very likely tends to increase as population and business grow. It does not increase uniformly, however, but by periodic movements. That is to say, the rate of increase of credit transactions, as compared with the whole volume of business, grows, as it were, by jerks and at a decreasing rate.

Several important questions are closely related to the inquiry which has been [made and summarized]. Among them are these:

1. What is the amount of money rendered unnecessary by the use of credit paper?

2. What is the influence of the vast volume of credit transactions on the value of money or the level of prices?[41]

3. Why is it that our per capita circulation is so large and where is the money in active circulation?...

1. We will take these questions up in order.... No one can say ... with definiteness what is the amount of money released if 75 or 80 per cent. of our business transactions are settled by means of credit paper. This is a matter in which the long experience of practical bankers is the only safe guide, because the amount in question is changing from day to day as the conditions change. No simple rule about it can be laid down....

One point needs to be carefully borne in mind. However great the volume of credit exchanges, however extensive the use of credit may become in a community, they can never fully displace sales for direct money payment. The extensive use of credit is not of itself a sign that a community is well off. Credit is used in poor as well as in rich communities. Its extensive use in a poor and undeveloped country is likely to indicate a lack of capital rather than an abundance of[Pg 153] wealth. Every community tends to use the cheapest medium of exchange accessible to it. If its capital is of very high value for producing goods for direct consumption, a community will be averse to investing much of it in a medium of exchange.

This is the reason why undeveloped countries, as our own was a century ago, try to effect their exchanges by means of credit paper to a larger extent than wealthier communities. Under such conditions paper money is commonly thought to be the cheapest medium of exchange. If, now, part of the money exchanges are replaced with credit exchanges, the amount of money released, or the amount without which the community could now get on, would be the whole amount formerly used in money payments ... minus the reserve necessary to do this credit business. The important point, however, is that less money is necessary. How much less we can not be sure. We can get some light on the subject, however, by noting the volume of business done by credit paper and the balances which from time to time are carried as a basis of settlement.

It is important to note also that an increase in the volume of credit transactions does not necessarily mean that we must get a proportionate increase in our reserve of money. Every refinement of the credit mechanism makes it possible to do a larger volume of business on the same reserve....

The volume of business that can be done by credit paper depends on several circumstances. Obviously, in the first place, it depends upon the banking facilities of the country. If the banks are widely distributed, if they are willing to deal in transactions small enough to be within the reach of large numbers of people, many more transactions will be settled through them than would otherwise be the case. This fact undoubtedly explains in large measure the development of what may be called the "banking habit" among the people of the United States. Undoubtedly our people pay by check much more commonly and much more largely than people of any other country. We settle smaller transactions by check; our banks are willing to carry smaller accounts. Indeed, the rapid industrial development of our country is probably due[Pg 154] in no small degree to our system of independent banks and the facility with which we have permitted banks to be established. The small independent bank in the country community has felt that its interests and success were bound up with the interests and success of the community, and, therefore, has undoubtedly been willing to do more for the general interests than a branch of a large bank in some remote commercial center would have felt like doing, even if it had been justified in doing so. The small capital with which we have permitted banks to be established also has undoubtedly been a contributing factor to our rapid economic development, as well as to the promotion of the banking habit among our people.

In the next place, the density of population is, of course, an important factor for the growth of credit exchanges. A larger volume of business is settled by bank paper in a commercial center than in an agricultural community, even though the proportion of total business thus settled may not be larger. However, it is necessary that there should be a certain number of people within reach of a common center in order to have a bank established there. Of course the smaller the bank the fewer the people thus required. Thus again our inclination in the past to favor the establishment of the small independent banks has facilitated the spread of banking and promoted the volume of business settled in the country districts by credit payment and stimulated the banking habit among our people.

Finally, the general education and intelligence of the mass of the people is an important factor. Men do not use banks unless they have confidence in them, and they have come to be regarded as a settled part of the ordinary commercial mechanism of the community. Our people are people of a wide general education and high order of intelligence. They understand the place and work of the bank in a community much better than the same number of people, for example, in a European country. This fact is strikingly brought out by a study of the proportion of retail business settled by means of checks, in what are called the "foreign" districts of our large cities, on the one hand, and in an agricultural community on the other. The European immigrant is not a man who[Pg 155] has had banking connections in his home country, and he does not use them here, even though the facilities are more numerous.

Such evidence as there is seems to indicate that payment by check has shown an increase during the past few years:

(a) In the first place, the returns of our reports show a larger percentage in retail trade....

(b) The prosperity of the farmers in the Central West has enabled many to have bank accounts who fifteen years ago could not carry balances. The writer's information from central Illinois is strongly in this direction.

(c) The third evidence is found in the growth of the number of small banks, especially in the country districts....

(d) The appearance of a considerable proportion of checks in the deposits of mutual savings banks is also, to some degree, significant....

On the other hand, the increase of that part of the population which consists of the wage-earning class, by whom the use of checks is small, is undoubtedly greater than that of our other classes of population. However, the wealthy classes, though fewer in number, have more to spend and their use of checks raises the proportion of credit paper in payments.

We can not expect any social movement to continue steadily in one direction for an indefinite time. Such evidence as inquiries of this character furnish seems to show that there is a certain ebb and flow in the proportion of checks used in business payments. With a given amount of money a certain proportion of it can be used for bank reserves on which to build credit transactions. For a time the volume of business will increase more rapidly than the money supplies, so that the proportion of credit business to the whole will increase, the improvement of the credit machinery in the meantime facilitating the movement. But the perfection of the facilities for utilizing to the utmost a given reserve, or a slowly increasing one, will come to a stop after a time, and it will be necessary to increase the money supply for any further expansion of credit. In the language of business, another unit of capital must be added to plant. The unit added to the social capital[Pg 156] devoted to exchange—that is, the additional amount of money—will be larger than is necessary for most profitable immediate use, consequently the proportion of money exchanges will for a time show an increase. We may conclude, therefore, that the volume of business done on credit gradually increases as the population and total amount of business are enlarged, but at a decreasing rate and with occasional or periodic retardations.

2. Relation of credit exchanges to the volume of money and prices.—It is pertinent to inquire, now, what effect, if any, this great settlement of indebtedness by means of credit paper has upon the value of money. Evidently, it can influence this value, or the general price level, only as it changes the amount of demand for money. We have seen reason, now, to think that 80 per cent. of our business transactions are settled by means of credit paper. Credit paper cancellation enables a larger amount of business to be done with the same amount of money and has an effect in determining the value of money by increasing the demand for reserves....

... The use of credit paper in effecting credit exchanges makes possible a far larger volume of business than could otherwise be done, and that this increased volume of business must in some way influence prices seem[s] undeniable....

... We are told by many that there is a vast amount of credit transactions embodied in banking and clearing-house statistics which may be termed "fictitious." That is to say, they are not a part of the necessary work of exchange in a community. For example, the cotton and wheat crops are sold several times over on the exchanges of the country, but not all these purchases and sales are a necessary part of the process of getting the cotton from the planter to the manufacturer. These sales, we are told, are purely speculative and born out of the credit organization, which, it is urged, merely makes the transactions possible.... However,... these exchanges actually exist. All the purchases involved constitute a part of the demand for means of settlement. Therefore they are to be regarded as a proper part of the exchange business of the country, and in some degree they must influence the need for money....[Pg 157]

... The demand for money to effect exchanges includes, first, demand for money for direct exchanges; second, demand for reserves for credit exchanges. Some goods exchange by direct barter and still more probably by indirect barter. If these last exchanges just cancelled one another, the credit paper that grows out of them would also cancel, and no balances would remain to be settled with money. Usually, however, they do not cancel, and the balance must be settled with cash; hence a reserve is necessary.... This demand for reserve is certainly one of the influences that go to determine the value of money. In short, the demand for money includes a demand for direct payment and a demand for reserve....

3. Our monetary circulation.—Our per capita circulation, as estimated by the Comptroller of the Currency, has increased from $21.10 in 1906 to $34.72 in 1908.[42] This is larger than the per capita circulation of other great industrial and commercial countries with the exception of France. Why is it necessary and where is it? It is necessary, perhaps, for the following reasons:

(a) A larger amount of money is needed in this country because, in the first place, our prices range higher. If the prices of articles commonly consumed range 20 per cent. higher than they do abroad, the people who buy them and pay for them with money need a larger amount to make their purchases. The same cause makes a larger reserve necessary to exchange a given volume of goods by credit. The demand for money, therefore, both for reserve and direct money transactions, is greater on account of the higher scale of prices.

(b) The same kind of reasoning applies to our wage scale. Whether the wage scale be the cause of the higher cost of living or the higher cost of living be the cause of the higher wage scale, more money will be needed in proportion to the trade. If wages are paid with checks, more money will be needed by the amount that the reserve must be increased to furnish a basis for the checks.

(c) Our country is more sparsely settled than England, France, or Germany. In spite of the large increase in the banking facilities of the country, it still remains true that very[Pg 158] many places are remote from banks, so that business, so far as it is not barter, will probably be carried on with money. It is necessary, therefore, to have a larger amount of money than if population were denser....

(d) It may be that our spirit of individualism plays some part. So large a proportion of our wage-earning population have come from conditions where they had opportunity to handle very little money, that they like to carry money on their persons. It makes them feel, as one man said to the writer, "more independent." To quote the same informant, they would "rather pay higher prices and have more money to pay with."

(e) Doubtless there is a good deal of hoarding by people who distrust banks or are not near enough to use them. It might be urged that no larger proportion of people here hoard than is the case in Europe. Without disputing this, it is true, however, that if only the same proportion hoard and in the same relative amounts as is done by corresponding classes of the population, the absolute amount thus withdrawn would be larger because of our higher scale of wages and prices....


[39] David Kinley, The Use of Credit Instruments in Payments in the United States, pp. 1, 2; 199-216. Senate Document No. 399. 61st Congress, 2d Session.

[40] In this discussion the phrase "credit documents" or "credit instruments" does not include bank notes.

[41] [The effect of credit exchanges on the value of money, treated at length in the next chapter, is only briefly discussed in the extracts here reproduced.]

[42] [Approximately $40 in 1916.]

[Pg 159]



The form of this chapter was suggested by the proceedings of a session of the 1910 Meeting of the American Economic Association, devoted to a consideration of the causes of the rise in prices between 1896 and 1909. Selections from papers there presented, and from the relative discussion, make up a considerable part of the chapter, and it is suggested that all of the selections, except the last, may well be considered for purposes of study as having come from the papers and discussion of the session referred to, although numerous additions and substitutions have been made in order to render the treatment one of principles involved in the determination of general prices without special reference to any particular period of years.

Irving Fisher[43]: Overlooking the influence of deposit currency, or checks, the price level may be said to depend on only three sets of causes: (1) the quantity of money in circulation; (2) its "efficiency" or velocity of circulation (or the average number of times a year money is exchanged for goods); and (3) the volume of trade (or amount of goods bought by money). The so-called "quantity theory,"[44] i.e., that prices vary proportionately to money, has often been incorrectly formulated, but (overlooking checks) the theory is correct in the sense that the level of prices varies directly with the quantity of money in circulation, provided the velocity of circulation of that money and the volume of trade which it is obliged to perform are not changed.

The quantity theory has been one of the most bitterly contested theories in economics, largely because the recognition[Pg 160] of its truth or falsity affected powerful interests in commerce and politics. It has been maintained—and the assertion is scarcely an exaggeration—that the theorems of Euclid would be bitterly controverted if financial or political interests were involved.

The quantity theory has, unfortunately, been made the basis of arguments for unsound currency schemes. It has been invoked in behalf of irredeemable paper money and of national free coinage of silver at the ratio of 16 to 1. As a consequence, not a few "sound money men," believing that a theory used to support such vagaries must be wrong, and fearing the political effects of its propagation, have drifted into the position of opposing, not only the unsound propaganda, but also the sound principles by which its advocates sought to bolster it up.[45] These attacks upon the quantity theory have been rendered easy by the imperfect comprehension of it on the part of those who have thus invoked it in a bad cause.

Personally, I believe that few mental attitudes are more pernicious, and in the end more disastrous, than those which would uphold sound practice by denying sound principles because some thinkers make unsound application of those principles. At any rate, in scientific study there is no choice but to find and state the unvarnished truth.

The quantity theory will be made more clear by the equation of exchange, which is now to be explained.

The equation of exchange is a statement, in mathematical form, of the total transactions effected in a certain period in a given community. It is obtained simply by adding together the equations of exchange for all individual transactions. Suppose, for instance, that a person buys 10 pounds of sugar at 7 cents per pound. This is an exchange transaction, in which 10 pounds of sugar have been regarded as equal to 70 cents, and this fact may be expressed thus: 70 cents = 10 pounds of sugar multiplied by 7 cents a pound. Every other sale and purchase may be expressed similarly, and by adding them all together we get the equation of exchange [Pg 161]for a certain period in a given community. During this same period, however, the same money may serve, and usually does serve, for several transactions. For that reason the money side of the equation is of course greater than the total amount of money in circulation.

The equation of exchange relates to all the purchases made by money in a certain community during a certain time. We shall continue to ignore checks or any circulating medium not money. We shall also ignore foreign trade and thus restrict ourselves to trade within a hypothetical community. Later we shall reinclude these factors, proceeding by a series of approximations through successive hypothetical conditions to the actual conditions which prevail to-day. We must, of course, not forget that the conclusions expressed in each successive approximation are true solely on the particular hypothesis assumed.

The equation of exchange is simply the sum of the equations involved in all individual exchanges in a year. In each sale and purchase, the money and goods exchanged are ipso facto equivalent; for instance, the money paid for sugar is equivalent to the sugar bought. And in the grand total of all exchanges for a year, the total money paid is equal in value to the total value of the goods bought. The equation thus has a money side and a goods side. The money side is the total money paid, and may be considered as the product of the quantity of money multiplied by its rapidity of circulation. The goods side is made up of the products of quantities of goods exchanged multiplied by their respective prices.

The important magnitude, called the velocity of circulation, or rapidity of turnover, is simply the quotient obtained by dividing the total money payments for goods in the course of a year by the average amount of money in circulation by which those payments are effected. This velocity of circulation for an entire community is a sort of average of the rates of turnover of money for different persons. Each person has his own rate of turnover which he can readily calculate by dividing the amount of money he expends per year by the average amount he carries.

Let us begin with the money side. If the number of dollars[Pg 162] in a country is 5,000,000, and their velocity of circulation is twenty times per year, then the total amount of money changing hands (for goods) per year is 5,000,000 times twenty, or $100,000,000. This is the money side of the equation of exchange.

Since the money side of the equation is $100,000,000, the goods side must be the same. For if $100,000,000 has been spent for goods in the course of the year, then $100,000,000 worth of goods must have been sold in that year. In order to avoid the necessity of writing out the quantities and prices of the innumerable varieties of goods which are actually exchanged, let us assume for the present that there are only three kinds of goods,—bread, coal, and cloth; and that the sales are:

200,000,000 loaves of bread at$ .10 a loaf,
 10,000,000 tons of coal at5.00 a ton, and
 30,000,000 yards of cloth at1.00 a yard.

The value of these transactions is evidently $100,000,000, i. e., $20,000,000 worth of bread plus $50,000,000 worth of coal plus $30,000,000 worth of cloth. The equation of exchange therefore (remember that the money side consisted of $5,000,000 exchanged 20 times) is as follows:

$5,000,000 × 20 times a year
=200,000,000 loaves×$ .10 a loaf
+10,000,000 tons×5.00 a ton
+30,000,000 yards×1.00 a yard

This equation contains on the money side two magnitudes, viz. (1) the quantity of money and (2) its velocity of circulation; and on the goods side two groups of magnitudes in two columns, viz. (1) the quantities of goods exchanged (loaves, tons, yards), and (2) the prices of these goods. The equation shows that these four sets of magnitudes are mutually related. Because this equation must be fulfilled, the prices must bear a relation to the three other sets of magnitudes—quantity of money, rapidity of circulation, and quantities of goods exchanged. Consequently, these prices must, as a whole, vary proportionally with the quantity of money and with its velocity of circulation, and inversely with the quantities of goods exchanged.[Pg 163]

Suppose, for instance, that the quantity of money were doubled, while its velocity of circulation and the quantities of goods exchanged remained the same. Then it would be quite impossible for prices to remain unchanged. The money side would now be $10,000,000 × 20 times a year or $200,000,000; whereas, if prices should not change, the goods would remain $100,000,000, and the equation would be violated. Since exchanges, individually and collectively, always involve an equivalent quid pro quo, the two sides must be equal. Not only must purchases and sales be equal in amount—since every article bought by one person is necessarily sold by another—but the total value of goods sold must equal the total amount of money exchanged. Therefore, under the given conditions, prices must change in such a way as to raise the goods side from $100,000,000 to $200,000,000. This doubling may be accomplished by an even or uneven rise in prices but some sort of a rise of prices there must be. If the prices rise evenly, they will evidently all be exactly doubled.... If the prices rise unevenly, the doubling must evidently be brought about by compensation; if some prices rise by less than double, others must rise by enough more than double to exactly compensate.

But whether all prices increase uniformly, each being exactly doubled, or some prices increase more and some less (so as still to double the total money value of the goods purchased), the prices are doubled on the average.... From the mere fact, therefore, that the money spent for goods must equal the quantities of those goods multiplied by their prices, it follows that the level of prices must rise or fall according to changes in the quantity of money, unless there are changes in its velocity of circulation or in the quantities of goods exchanged.

If changes in the quantity of money affect prices, so will changes in the other factors—quantities of goods and velocity of circulation—affect prices, and in a very similar manner. Thus a doubling in the velocity of circulation of money will double the level of prices, provided the quantity of money in circulation and the quantities of goods exchanged for money remain as before....[Pg 164]

Again, a doubling in the quantities of goods exchanged will not double, but halve, the height of the price level, provided the quantity of money and its velocity of circulation remain the same....

Finally, if there is a simultaneous change in two or all of the three influences, i. e., quantity of money, velocity of circulation, and quantities of goods exchanged, the price level will be a compound or resultant of these various influences. If, for example, the quantity of money is doubled, and its velocity of circulation is halved, while the quantity of goods exchanged remains constant, the price level will be undisturbed. Likewise, it will be undisturbed if the quantity of money is doubled and the quantity of goods is doubled, while the velocity of circulation remains the same. To double the quantity of money, therefore, is not always to double prices. We must distinctly recognize that the quantity of money is only one of three factors, all equally important in determining the price level....

We now come to the strict algebraic statement of the equation of exchange.... Let us denote the total circulation of money, i. e., the amount of money expended for goods in a given community during a given year, by E (expenditure); and the average amount of money in circulation in the community during the year by M (money). M will be the simple arithmetical average of the amounts of money existing at successive instants separated from each other by equal intervals of time indefinitely small. If we divide the year's expenditures, E, by the average amount of money, M, we shall obtain what is called the average rate of turnover of money in its exchange for goods, E/M that is, the velocity of circulation of money. This velocity may be denoted by V, so that E/M = V; then E may be expressed as MV. In words: the total circulation of money in the sense of money expended is equal to the total money in circulation multiplied by its velocity of circulation or turnover. E or MV, therefore, expresses the money side of the equation of exchange. Turning to the goods side of the equation, we have to deal with the prices of goods exchanged and quantities of goods exchanged. The[Pg 165] average price of sale of any particular good, such as bread, purchased in the given community during the given year, may be represented by p (price); and the total quantity of it purchased, by Q (quantity); likewise the average price of another good (say coal) may be represented by and the total quantity of it exchanged, by ; the average price and the total quantity of a third good (say cloth) may be represented by p´´ and Q´´ respectively; and so on, for all other goods exchanged, however numerous. The equation of exchange may evidently be expressed as follows:

MV = pQ
+ p´Q´
+ p´´Q´´
+ etc.

The right-hand side of this equation is the sum of terms of the form pQ—a price multiplied by a quantity bought. It is customary in mathematics to abbreviate such a sum of terms (all of which are of the same form) by using "Σ" as a symbol of summation. This symbol does not signify a magnitude as do the symbols M, V, p, Q, etc. It signifies merely the operation of addition and should be read "the sum of terms of the following type." The equation of exchange may therefore be written:

MV = ΣpQ.

That is, the magnitudes E, M, V, the p's and the Q's relate to the entire community and an entire year; but they are based on and related to corresponding magnitudes for the individual persons of which the community is composed and for the individual moments of time of which the year is composed.

The algebraic derivation of this equation is, of course, essentially the same as the arithmetical derivation previously given. It consists simply in adding together the equations for all individual purchases within the community during the year....

[We are now] ... prepared for the inclusion of bank deposits or circulating credit in the equation of exchange. We[Pg 166] shall still use M to express the quantity of actual money, and V to express the velocity of its circulation.[46] Similarly, we shall now use to express the total deposits subject to transfer by check; and to express the average velocity of circulation. The total value of purchases in a year is therefore no longer to be measured by MV, but by MV + M´V´´. The equation of exchange, therefore, becomes:

MV + M´V´ = ΣpQ = PT[47]....

With the extension of the equation of monetary circulation to include deposit circulation, the influence exerted by the quantity of money on general prices becomes less direct; and the process of tracing this influence becomes more difficult and complicated. It has even been argued that this interposition of circulating credit breaks whatever connection there may be between prices and the quantity of money.[48] This would be true if circulating credit were independent of money. But the fact is that the quantity of circulating credit, , tends to hold a definite relation to M, the quantity of money in circulation; that is, deposits are normally a more or less definite multiple of money.

Two facts normally give deposits a more or less definite ratio to money. The first ... [is] that bank reserves are kept in a more or less definite ratio to bank deposits. The second is that individuals, firms, and corporations preserve more or less definite ratios between their cash transactions and their check transactions, and also between their money and deposit balances.[49] These ratios are determined by motives of individual convenience and habit. In general, business firms[Pg 167] use money for wage payments, and for small miscellaneous transactions included under the term "petty cash"; while for settlements with each other they usually prefer checks. These preferences are so strong that we could not imagine them overridden except temporarily and to a small degree. A business firm would hardly pay car fares with checks and liquidate its large liabilities with cash. Each person strikes an equilibrium between his use of the two methods of payment, and does not greatly disturb it except for short periods of time. He keeps his stock of money or his bank balance in constant adjustment to the payments he makes in money or by check. Whenever his stock of money becomes relatively small and his bank balance relatively large, he cashes a check. In the opposite event, he deposits cash. In this way he is constantly converting one of the two media of exchange into the other. A private individual usually feeds his purse from his bank account; a retail commercial firm usually feeds its bank account from its till. The bank acts as intermediary for both.

In a given community the quantitative relation of deposit currency to money is determined by several considerations of convenience. In the first place, the more highly developed the business of a community, the more prevalent the use of checks. Where business is conducted on a large scale, merchants habitually transact their larger operations with each other by means of checks, and their smaller ones by means of cash. Again, the more concentrated the population, the more prevalent the use of checks. In cities it is more convenient both for the payer and the payee to make large payments by check; whereas, in the country, trips to a bank are too expensive in time and effort to be convenient, and therefore more money is used in proportion to the amount of business done. Again, the wealthier the members of the community, the more largely will they use checks. Laborers seldom use them; but capitalists, professional and salaried men use them habitually, for personal as well as business transactions.

There is, then, a relation of convenience and custom between check and cash circulation, and a more or less stable ratio between the deposit balance of the average man or corporation and the stock of money kept in pocket or till. This[Pg 168] fact, as applied to the country as a whole, means that by convenience a rough ratio is fixed between M and . If that ratio is disturbed temporarily, there will come into play a tendency to restore it. Individuals will deposit surplus cash, or they will cash surplus deposits.

Hence, both money in circulation ... and money in reserve ... tend to keep in a fixed ratio to deposits. It follows that the two must be in a fixed ratio to each other.

It further follows that any change in M, the quantity of money in circulation, requiring as it normally does a proportional change in , the volume of bank deposits subject to check, will result in an exactly proportional change in the general level of prices except, of course, so far as this effect be interfered with by concomitant changes in the V's or the Q's. The truth of this proposition is evident from the equation MV + M´V´ = ΣpQ; for if, say, M and are doubled, while V and remain the same, the left side of the equation is doubled and therefore the right side must be doubled also. But if the Q's remain unchanged, then evidently all the p's must be doubled, or else if some are less than doubled, others must be enough more than doubled to compensate....

The factors in the equation of exchange are ... continually seeking normal adjustment. A ship in a calm sea will "pitch" only a few times before coming to rest, but in a high sea, the pitching never ceases. While continually seeking equilibrium, the ship continually encounters causes which accentuate the oscillation. The factors seeking mutual adjustment are money in circulation, deposits, their velocities, the Q's and the p's. These magnitudes must always be linked together by the equation MV + M´V´ = ΣpQ. This represents the mechanism of exchange. But in order to conform to such a relation the displacement of any one part of the mechanism spreads its effects during the transition periods [i.e., periods of rising or falling prices] over all parts. Since periods of transition are the rule and those of equilibrium the exception, the mechanism of exchange is almost always in a dynamic rather than a static condition....[50]

[Pg 169]

[Pg 170]

[51]It is interesting to make a quantitative comparison of the various magnitudes with the increase in the quantity of money as the most important factor in raising the price level. While it is true, as shown by the diagram, that the volume of deposits subject to check has increased greatly, the major part of the increase has to be ascribed to the increase in the quantity of money. Only so far as the volume of deposits subject to check has increased relatively to the money in circulation, can the increase of deposits be regarded as an independent cause of the rise in prices. We have thus to consider the relative importance of the five causes affecting prices:

1. The quantity of money in circulation (M).

2. The volume of bank deposits subject to check considered relatively to money (M´/M).

3. The velocity of the former (V´).

4. The velocity of the latter (V).

5. The volume of trade (T).

We may best compare the relative importance of these five magnitudes by answering the question: What would the result have been had any one of these magnitudes remained unchanged, assuming that the other four changed in the same manner that they actually did change. We find (1) that if the money in circulation, M, had not changed, between the years 1896 and 1909, for example, the price level of 1909 would have been 45 per cent. lower than it actually was; (2) that if M´/M, the relative deposits, had not changed, during the same period the price level in 1909 would have been 23 per cent. lower than it actually was; (3) if the velocity of circulation of money, V, had not changed, the price level for 1909 would have been 1 per cent. lower; (4) if the velocity of circulation of deposits, V´, had not changed, the price level in 1909 would have been 28 per cent. lower; (5) if T had not[Pg 171] changed, the price level in 1909 would have been 106 per cent. higher.

Thus the changes in the first four factors have tended to raise prices, while the change in T has tended to lower prices. The relative importance of the four price-raising causes may be stated in terms of the per cent. already given which represents how much lower prices would have been except for each of these causes separately considered. According to this test we find the relative importance of the four price-raising factors to be as follows:

The importance of V is represented by 1,

The importance of M´/M is represented by 23,

The importance of V is represented by 28,

The importance of M is represented by 45.

That is, the increase in the quantity of money had an importance nearly double that of any other one price-raising factor, during the period mentioned.

Indirect Influences on Purchasing Power[52]

Thus far we have considered the level of prices as affected by the volume of trade, by the velocities of circulation of money and of deposits, and by the quantities of money and of deposits. These are the only influences which can directly affect the level of prices. Any other influences on prices must act through these five. There are myriads of such influences (outside of the equation of exchange) that affect prices through these five. It is our purpose ... to note the chief among them....

We shall first consider the outside influences that affect the volume of trade and, through it, the price level. The conditions which determine the extent of trade are numerous and technical. The most important may be classified as follows:

1. Conditions affecting producers.

(a) Geographical differences in natural resources.

(b) The division of labor.

[Pg 172]

(c) Knowledge of the technique of production.

(d) The accumulation of capital.

2. Conditions affecting consumers.

(a) The extent and variety of human wants.

3. Conditions connecting producers and consumers.

(a) Facilities for transportation.

(b) Relative freedom of trade.

(c) Character of monetary and banking systems.

(d) Business confidence.

1 (a). It is evident that if all localities were exactly alike in their natural resources, in other words, in their comparative costs of production, no trade would be set up between them.... Cattle raising in Texas, the production of coal in Pennsylvania, of oranges in Florida, and of apples in Oregon have increased the volume of trade for these communities respectively.

1 (b). Equally obvious is the influence of the division of labor....

1 (c).... The state of knowledge of production will affect trade. Vast coal fields in China await development, largely for lack of knowledge of how to extract and market the coal. Egypt awaits the advent of scientific agriculture, to usher in trade expansion. Nowadays, trade schools in Germany, England, and the United States are increasing and diffusing knowledge of productive technique.

1 (d). But knowledge, to be of use, must be applied; and its application usually requires the aid of capital. The greater and the more productive the stock or capital in any community, the more goods it can put into the currents of trade....

Since increase in trade tends to decrease the general level of prices, anything which tends to increase trade likewise tends to decrease the general level of prices. We conclude, therefore, that among the causes tending to decrease prices are increasing geographical or personal specialization, improved productive technique, and the accumulation of capital. The history of commerce shows that all these causes have been increasingly[Pg 173] operative during a long period including the last century. Consequently, there has been a constant tendency, from these sources at least, for prices to fall.

2 (a).... An increase of wants, by leading to an increase in trade, tends to lower the price level. Historically, during recent times through invention, education, and the emulation coming from increased contact in centers of population, there has been a great intensification and diversification of human wants and therefore increased trade. Consequently, there has been from these causes a tendency of prices to fall.

3 (a). Anything which facilitates intercourse tends to increase trade. Anything that interferes with intercourse tends to decrease trade. First of all, there are the mechanical facilities for transport. As Macaulay said, with the exception of the alphabet and the printing press, no set of inventions has tended to alter civilization so much as those which abridge distance,—such as the railway, the steamship, the telephone, the telegraph, and that conveyer of information and advertisements, the newspaper. These all tend, therefore, to decrease prices.

3 (b). Trade barriers are not only physical but legal. A tariff between countries has the same influence in decreasing trade as a chain of mountains. The freer the trade, the more of it there will be....

3 (c). The development of efficient monetary and banking systems tends to increase trade. There have been times in the history of the world when money was in so uncertain a state that people hesitated to make many trade contracts because of the lack of knowledge of what would be required of them when the contract should be fulfilled. In the same way, when people cannot depend on the good faith or stability of banks, they will hesitate to use deposits and checks.

3 (d). Confidence, not only in banks in particular, but in business in general, is truly said to be "the soul of trade." Without this confidence there cannot be a great volume of contracts. Anything that tends to increase this confidence tends to increase trade....

We see, then, that prices will tend to fall through increase in trade, which may in turn be brought about by improved[Pg 174] transportation, by increased freedom of trade, by improved monetary and banking systems, and by business confidence. Historically, during recent years, all of these causes have tended to grow in power, except freedom of trade....

Having examined those causes outside the equation which affect the volume of trade, our next task is to consider the outside causes that affect the velocities of circulation of money and of deposits. For the most part, the causes affecting one of these velocities affect the other also. These causes may be classified as follows:

1. Habits of the individual.

(a) As to thrift and hoarding.

(b) As to book credit.

(c) As to the use of checks.

2. Systems of payments in the community.

(a) As to frequency of receipts and of disbursements.

(b) As to regularity of receipts and disbursements.

(c) As to correspondence between times and amounts of receipts and disbursements.

3. General causes.

(a) Density of population.

(b) Rapidity of transportation.

1 (a). Taking these up in order, we may first consider what influence thrift has on the velocity of circulation. Velocity of circulation of money is the same thing as its rate of turnover. It is found by dividing the total payments effected by money in a year by the amount of money in circulation in a year. It depends upon the rates of turnover of the individuals who compose the society. This velocity of circulation or rapidity of turnover of money is the greater for each individual the more he spends, with a given average amount of cash on hand; or the less average cash he keeps, with a given yearly expenditure....

1 (b). The habit of "charging," i.e., using book credit, tends to increase the velocity of circulation of money, because the man who gets things "charged" does not need to keep[Pg 175] on hand as much money as he would if he made all payments in cash. A man who pays cash daily needs to keep cash for daily contingencies. The system of cash payments, unlike the system of book credit, requires that money shall be kept on hand in advance of purchases. Evidently, if money must be provided in advance, it must be provided in larger quantities than when merely required to liquidate past debts....

But we have seen that to increase the rate of turnover will tend to increase the price level. Therefore, book credit tends to increase the price level....

1 (c). The habit of using checks rather than money will also affect the velocity of circulation; because a depositor's surplus money will immediately be put into the bank in return for a right to draw by check....

We see, then, that three habits—spendthrift habits, the habit of charging, and the habit of using checks—all tend to raise the level of prices....

2 (a). The more frequently money or checks are received and disbursed, the shorter is the average interval between the receipt and the expenditure of money or checks and the more rapid is the velocity of circulation.

This may best be seen from an example. A change from monthly to weekly wage payments tends to increase the velocity of circulation of money. If a laborer is paid weekly $7 and reduces this evenly each day, ending each week empty-handed, his average cash ... would be a little over half of $7, or about $4. This makes his turnover nearly twice a week. Under monthly payments the laborer who receives and spends an average of $1 a day will have to spread the $30 more or less evenly over the following 30 days. If, at the next pay day, he comes out empty-handed, his average money during the month has been about $15. This makes his turnover about twice a month. Thus the rate of turnover is more rapid under weekly than under monthly payments....

Frequency of disbursements evidently has an effect similar to the effect of frequency of receipts; i.e., it tends to accelerate the velocity of turnover, or circulation.

2 (b). Regularity of payments also facilitates the turnover. When the workingman can be fairly certain of both his receipts[Pg 176] and expenditures, he can, by close calculation, adjust them so precisely as safely to end each payment cycle with an empty pocket. This habit is extremely common among certain classes of city laborers. On the other hand, if the receipts and expenditures are irregular, either in amount or in time, prudence requires the worker to keep a larger sum on hand, to insure against mishaps.... We may, therefore, conclude that regularity, both of receipts and of payments, tends to increase velocity of circulation.

2 (c). Next, consider the synchronizing of receipts and disbursements, i. e., making payments at the same intervals as obtaining receipts.... This arrangement obviates the necessity of keeping much money or deposits on hand, and therefore increases their velocity of circulation....

3 (a). The more densely populated a locality, the more rapid will be the velocity of circulation.

There is definite evidence that this is true of bank deposits. The following figures give the velocities of circulation of deposits in ten cities, arranged in order of size:

New Haven16
Santa Barbara1

Madrid is the only city seriously out of its order in respect to velocity of circulation.

3 (b). Again the more extensive and the speedier the transportation in general, the more rapid the circulation of money. Anything which makes it easier to pass money from one person to another will tend to increase the velocity of circulation. Railways have this effect.... Mail and express, by facilitating the transmission of bank deposits and money, have likewise tended to increase their velocity of circulation.

We conclude, then, that density of population and rapidity of transportation have tended to increase prices by increasing velocities. Historically this concentration of population in cities has been an important factor in raising prices in the United States....[Pg 177]


[53]The purchasing power ... of money has been studied as the effect of five, and only five, groups of causes. The five groups are money, deposits, their velocities of circulation, and the volume of trade. These and their effects, prices, we saw to be connected by an equation called the equation of exchange, MV + M'V' = ΣpQ. The five causes, in turn,... are themselves effects of antecedent causes lying entirely outside of the equation of exchange, as follows: the volume of trade will be increased, and therefore the price level correspondingly decreased by the differentiation of human wants; by diversification of industry; and by facilitation of transportation. The velocities of circulation will be increased, and therefore also the price level increased by improvident habits; by the use of book credit; and by rapid transportation. The quantity of money will be increased and therefore the price level increased correspondingly by the import and minting of money, and, antecedently, by the mining of the money metal; by the introduction of another and initially cheaper money metal through bimetallism; and by the issue of bank notes and other paper money. The quantity of deposits will be increased, and therefore the price level increased by extension of the banking system and by the use of book credit. The reverse causes produce, of course, reverse effects.

Thus, behind the five sets of causes which alone affect the purchasing power of money, we find over a dozen antecedent causes. If we chose to pursue the inquiry to still remoter stages, the number of causes would be found to increase at each stage in much the same way as the number of one's ancestors increases with each generation into the past. In the last analysis myriads of factors play upon the purchasing power of money; but it would be neither feasible nor profitable to catalogue them. The value of our analysis consists rather in simplifying the problem by setting forth clearly the five proximate causes through which all others whatsoever must operate. At the close of our study, as at the beginning, stands forth the equation of exchange as the great determinant of the purchasing power of money.

[Pg 178]

J. Laurence Laughlin[54]: To my mind, the following propositions contain the essence of the theory of prices.... As every one will appreciate, only general statements, without any limiting qualifications to speak of, can be given in so small a compass.

1. The price of a commodity is measured by the quantity of a given standard for which it will exchange.

2. A change of prices may be due to changes in the conditions affecting the supply (thus including expenses of production) of goods, as well as to changes in the demand for and supply of gold. A statistical statement of a change of price is not a statement of the cause of the change.

3. Probably there is not so much difference of opinion regarding the theory of prices as is sometimes supposed. Other causes being supposed constant, an increased supply of gold would tend to raise prices. No one can fail to see that, if by "money" is meant gold, a change in its quantity would, other things being equal, be a factor affecting prices. An increasing demand for gold, however, would work against the effect of an increasing supply. If the new demand offset the new supply, then, if changes of prices occurred, their cause must be sought in the influences touching the producing and marketing of goods.

4. The effective demand for goods (granting their utility) is limited by the buyer's purchasing power. This purchasing power is not identical with the quantity of the media of exchange in circulation, any more than the value of the total exchangeable wealth of the community is identical with the value of the total money in circulation.

5. The general level of prices is not independent of particular prices; since there can be no such thing as a general level, or average, of prices which is not the resultant of a number of particular prices each arrived at by individual buyers and sellers. The causes of price changes must be sought in the forces settling particular prices. This does not exclude the[Pg 179] consideration of any causes affecting the value of the standard in which the prices of goods are expressed, because the standard is itself a particular commodity.

6. In particular cases, competitive prices in this country are arrived at by the higgling of the market, which depends on buyers' and sellers' judgment of the demand and supply of the commodity (e. g., wheat); and, when the price is fixed, the credit medium by which the commodity is passed from seller to buyer comes easily and naturally into existence and, of course, for a sum exactly equaling the price agreed upon, multiplied by the number of units of goods. Price-making generally precedes the demand upon the media of exchange, and does not at all imply any necessary demand at the moment upon the standard in which the prices are expressed (cf. 10).

7. The offer of "money" for goods is only a resultant of price-making forces previously at work, and does not measure the demand for goods (cf. 6). That is, the quantity of the actual media of exchange thus brought into use is a result and not a cause of the price-making process. The supposed offer of money has no money as its basis, but is only the offer of a purchasing power, previously existing, based on saleable goods, which at the moment of payment appears expressed in terms of the standard. By credit devices the actual transfer of the standard is reduced to an inconsiderable minimum. In reality (as in foreign trade) goods are exchanged against goods.

8. The effect of credit on prices is to be found mainly in banking facilities by which goods are coined into means of payment, so that, expressed in terms of the standard gold, they may be exchanged against each other. Thus credit devices relieve the standard to an incredibly great degree from the demand for the use of gold as a medium of exchange, and thus remove a demand, as trade increases, which would otherwise have enormously affected the value of gold. Thus the effect of credit on the general level of prices in considerable periods of time is shown by a tendency to reduce the demand on the standard gold, and hence to prevent the tendency toward falling prices.[Pg 180]

9. A general proposition is that banks are limited in making loans by the possession of capital, a bank of large capital and deposits being able to make large loans, a bank of small capital and deposits, small loans. A second proposition is that the demand for legitimate loans varies with the exchanges of goods and collateral and the opportunities for investment. With an increasing activity in business, however—either sound or speculative—the expansion of loans is limited by the resources of the bank. Next, a bank trying to carry a certain amount of loans, must hold a specified proportion of reserves to demand liabilities under the rule of banking experience or law. The amount of its capital and the funds left with it determine the relative size of its loan item; and the sum of its loans and resultant deposits determine the amount of its reserves. The reserves of a bank are thus a consequence of the loan operations. This conclusion, however, as it affects the practical problem of the present day, is not, in my opinion, invalidated by the conceivable cases arising, when business tends to outrun banking facilities, in which anything that makes increasing reserves possible would increase the power of the banks to lend. When gold becomes increasingly abundant, the banks having large resources more easily get the gold reserves needed for their operations. It still remains true that the fact of an increased supply of gold does not of itself increase loans, unless conditions of business demand an increase in loans. Therefore, the expansion of business is not a necessary consequence of an increasing supply of gold, any more than an expansion of railway traffic is the necessary consequence of an increasing supply of cars. If increasing goods are in existence to be transported, then, of course, there is an increasing demand for cars. Likewise, if there are more bank resources and loans, there is an increasing demand for that which is lawful reserve; from which it is claimed that the use of new gold in bank reserves, under present conditions, is not the significant causal force which expands business and raises prices (although it may be contemporary with it).

10. The problem of explaining the general level of prices is one of arriving at the adjustment between two terms of a ratio (the standard on the one side, and goods on the other),[Pg 181] each of which is influenced by supply and demand. Gold being one, and goods being many, a cause working on gold alone, and important enough to show an appreciable effect, might explain a general movement of prices. In practical operation, however, because of the large existing stock of gold, very considerable additions may take place in the supply of gold without materially changing the world value of gold as related to goods in general. Rapid changes of prices are hence more likely to be due to influences in the market for goods, to speculative changes of demand for goods, or to psychological forces working independently of facts....

In the problem of discovering the causes of changes in the level of prices, it is necessary first to reach a conclusion as to those causes which operate on the gold standard in which our prices are expressed. By so doing we may locate the general level—so far as the standard is concerned—or the one thing which might work as a cause common to all goods. The relation between gold and goods might be illustrated by the familiar mechanical illustration: a rod balanced on a fulcrum, on one end of which works the forces affecting the value of gold, and on the other end the forces affecting the value of particular goods. The relation between goods and gold being a ratio, as one end of the rod goes up, the other necessarily goes down.

There are, as we all know, various forces at work to produce the resultant price level. We may here start from a proposition on which we can all agree. An increase in the quantity of the monetary standard in the world—such as gold—would tend, other things being equal, to lower its value and thus raise prices. In trying to find the causes in the price level at any given time (as in 1896-1909) it is necessary, therefore, after stating the facts as to the increase of gold, to examine into the influence of "the other things."

To begin, we may take up the demand for gold, which, of course, is both monetary and non-monetary. First as to the non-monetary uses, such as abrasion, shipwreck, and disappearance in the arts: The statistics of consumption in the arts are unsatisfactory; at the best they are only estimates. Although the total production of the world, 1493-1850, was $3,158,000,000, there is no evidence as to the available stock in 1850.[Pg 182] My belief is that there was not more than $2,000,000,000.[55] In the period of 1851-1895, the production was $5,641,000,000, and the consumption in the arts, at the average rate of $50,000,000 a year requires a deduction of $2,250,000,000, which leaves $3,391,000,000. The arts in recent years are estimated to use more than $100,000,000.[56] In the period, 1896-1905, if $1,000,000,000 be deducted from the production of $2,899,000,000 we have $1,899,000,000. Thus the total available stock in 1905 would be about $7,690,000,000. The production of the last four years, 1906-1910, is about $1,600,000,000, or, less the consumption in the arts, about $1,200,000,000.

The monetary demand for gold, on the other hand, has shown certain definite characteristics. Whether it be prejudice, or enlightened business judgment, the commercial nations of the world have shown a persistent and continuing disposition to adopt a gold monetary system as soon as their own means, or the forthcoming supply of gold, has made it possible. The United States led in 1853, when we declined to change the ratio in order to bring silver into circulation when only gold was in use. From 1871-3, Germany, the countries of the Latin Union, Austria-Hungary, the United States (with the resumption in gold in 1879), and India (in 1893), in response to the preferences of the commercial world, placed themselves on the gold standard by legal enactments. The demand for gold all through this period was based upon considerations independent of the movement of prices. For this was a time of falling prices when much was heard of the appreciation of gold and the need of silver. In spite of this tendency toward falling prices, the movement toward the adoption of gold went on.... It was precisely this large new supply of gold which enabled the commercial nations to gratify their desire for what they believed was a more stable standard.

As we enter the present period (1896-1909) we find this momentum towards the gold standard still in force: and other countries in emulation planned to put themselves on an equally[Pg 183] stable standard with those whose means had permitted an earlier action—quite irrespective of the fact that this last was a period of rising prices, while the former was one of falling prices. In this period, Russia, Japan, various states in South America, such as Peru, Argentina, and Brazil, and recently Mexico, have emphasized the movement away from silver to gold. Moreover, as backward lands, like Turkey, parts of Asia, Egypt, and various districts of Africa, have developed their resources and increased their trade, they have taken on gold in their monetary systems. With increasing trade also there are more exchanges of goods; hence, even in countries (like Great Britain and the United States) that do not use gold to speak of, except in reserves, there are increasing loans and deposits and thus a demand for more gold reserves. Consequently, in countries long ago established on the gold standard there will be a steadily increasing demand for gold as exchanges expand. We find thus a special characteristic of the demand for gold (certainly not existing in the demand for silver). The power of developing countries to soak up new gold is as marked a part of present conditions as is the power of a porous and sandy soil to soak up a heavy rainfall. We must, therefore, take full account of the noticeable fact that the recent demand for gold seems about to keep pace with the new supply; that a shipment of gold from the mines to London is to-day eagerly competed for, not only by European countries, but by Egypt, India, Turkey, Argentina, and Brazil.

Consequently it may be of interest to see which countries have taken the largest amounts of gold into their stocks since 1895:

United States$994,000,000
South American States213,000,000
British Empire194,000,000

Besides the demand for gold in the arts, and the apparent monetary demand, as thus already presented, we must not omit to take into account also the large stocks of gold held by banks and institutions which publish no statements. In the[Pg 184] hands of large private institutions like those of the Rothschilds, Bleichroders, and others, great amounts of gold are carried. It is from such stores that the needs of states, such as Austria-Hungary, France, Italy, and even the United States (in Cleveland's administration), have been supplied without drawing down visible reserves.

Thus far, then, we have examined the one factor of demand for gold, among the "other things" (which were supposed to remain equal). There is abundant evidence to show that the demand for gold, in this recent period of rising prices (1896-1909) has been as strong as, or even stronger than, the demand for gold in the previous period (1873-1896) of falling prices.

It looks very much as if we must seek for the causes of rising prices since 1896 in some of the "other things" not yet examined. There is no time, however, for extended discussion on these points....

The effects of Tariffs and Taxation, Unionism and higher Wages, and changing Agricultural Conditions in increasing expenses of production in all industries are so patent as to require no enlargement. Immediately after the passage of the Dingley Act in 1897, a large list of articles rose in price precipitously. Moreover, just so far as higher money wages for the same work, or the same money wages for a reduced number of hours, have been granted without a corresponding increase in the efficiency of the labor, the expenses of producing goods in general—and consequently prices—have risen. But, without doubt, one of the most important factors in raising prices—directly and indirectly—has been the increased price of food due to the changing conditions of agriculture. This most influential cause of higher prices is one of the "other things" which has been at work quite independent of the quantity of new gold. Moreover, the indirect effect of high prices of food produces the most serious practical problem. It wipes out all the gain of previous increases of wages, and drives laborers to repeat their demands for higher pay, thus working again to increase expenses of production. It is not too much to say that the gains of industry, shown by the fall in prices, as they stood about 1890 have been lost to us by the[Pg 185] high tariffs of 1897 and the wastes of bad farming and the recent high costs of agriculture.

Our analysis would be inadequate, however, if we stopped here with our examination of expenses of production. The really practical problem is still before us in trying to analyze the forces at work fixing prices in that vague and dangerous margin between actual expenses of production and the prices in fact paid by the consumer....

The whole raison d'être of monopolistic combinations is to control prices, and prevent active competition. As every economist knows, in the conditions under which many industries are to-day organized, expenses of production have no direct relation to prices. In such conditions, there is a field in which the policy of charging "what the traffic will bear" prevails; and this includes industries that are not public utilities.

Furthermore, we must face the fact of increasing riches not only in this country, but all over the world. New wealth makes a liberal spender. The retail dealer finding his expenses increasing and—even when they are not—tries the experiment of charging his richer customers an increasing price. The newly rich pay and do not feel it. But what can the poorer unorganized buyer do when retail prices are raised? What can he do if his meat bill, or his plumbing-repairs bill, rises enormously? The extravagance of the rich has increased the cost of traveling, the rates at hotels, the fees, the luxury of steamships and automobiles, the consumption of fruits and vegetables out of season once never thought of, and has generally raised the standard of expenditure. Those of smaller income find they also must pay the higher prices. Thus we have reached a point where we have to pay almost whatever any one asks. Organized buyers are the only offset to organized sellers.

Moreover, rising prices due to high expenses of production, or to combinations of sellers, present a paradise for speculation. A movement upward based on facts can be easily converted into a further rise based only on speculative manipulation. A rise of prices which brings large profits to a combination, thus directly affects earnings and gives especial opportunity to speculation in the securities of industrials. Hence, the field of speculation spreads from commodities to securities.[Pg 186] The facts as to the movement of prices of securities are well shown in Brookmire's Economic Charts since 1885; and, while the presence of gold serves as a fund of lawful money in reserves, the spread of speculation has gone on seemingly unaffected by the new supplies of gold. That is, speculative conditions may arise and disappear antecedent to and seemingly independent of the gold supplies.

D. F. Houston[57]: The discussion of money and prices to-day reminds one very strongly of the discussion forty years ago. Now, as then, the opinion is that prices have risen; but now, as then, there is wide difference as to the explanation. Now, as then, a highly respectable body of economists attribute the rise mainly to the new gold; and now, as then, a number of economists attribute the rise to influences immediately affecting the cost of production of commodities in general, instancing such things as labor unions, monopolies, extravagance, the tariff, general prosperity, etc....

That the tariff has played a part in the situation, I should of course not deny. By preventing us from securing supplies where they can be more economically produced, and by making it possible for domestic manufacturers to monopolize the market, and by tending to compel the payment for exports in gold, it has unquestionably played a part and is a notable factor.... In considering the tariff as a factor, however, we must not forget that we have had the tariff since the beginning, and that the rates have been nearly as high since the Civil War as they are to-day; and we must remember, further, that in one of the great countries which has no protective tariff the tendency of price has been upward; furthermore, we must not overlook the fact that many of the tariff rates, which are very high now, are not effective or not nearly so effective as they were in the earlier period, and also that its influence is probably greater in things in which the rise of price has been less marked.

I should not deny that labor unions and monopolies have had an influence in increasing price. The evidence seems to justify the conclusion that monopolies have had some effect[Pg 187] in increasing price. I am not sure that there is sufficient evidence in regard to labor unions to enable us to form a conclusion....

Much has been said in discussion about the influence of extravagance. This has played a part in similar discussions at all times; every era has its cry of extravagance, and it is not clear that it has been more marked in our time than in former times. And one thing is quite clear, that the extravagance, or economic waste, resulting from the prosecution of war and its after effects, has been conspicuously absent during the last fifteen years....

The stock of gold in the leading western commercial nations, with which we are concerned in discussing prices, probably did not exceed $5,000,000,000 at the end of 1895. During the next fourteen years there was added to the stock of gold of these countries an amount nearly equal to the existing stock. In addition, a number of these countries enormously developed their credit devices. According to all economic law, these facts create a strong presumption that gold has been the main factor affecting price. No sufficient evidence has been presented to overthrow this presumption.

E. W. Kemmerer[58]: An adequate discussion of the papers presented by Professors Fisher and Laughlin would require much more time than the few minutes at my disposal. I shall accordingly limit myself to a few points and support my conclusions principally by footnote references. This procedure is perhaps the more justifiable in view of the fact that my own philosophy of the relationship between money and prices is given in detail in the book[59] on money and prices to which Professor Fisher has so generously referred.[60]

I have had the opportunity of reading in manuscript Professor Fisher's forthcoming book on Price Levels, of which his paper to-day represents one chapter, and find myself in substantial agreement with his main contentions. His discussion is a permanent contribution to monetary science of very[Pg 188] great value. To a number of minor points, however, it seems to me, exception must be taken....

Professor Fisher's formula expressing the relationship between the circulating media and prices is essentially the same as my own,[61] but he pays little attention to the factor of business confidence, which is a most important consideration in the interpretation of the formula. The ratio of deposit currency to bank reserves is a function of business confidence.[62]

The distinction Professor Fisher draws between the prices of individual commodities and the general price level appears to me, as to Professor Laughlin, to be untenable. It is, moreover, contradictory to his general philosophy of money. His index numbers recognize no general price level distinct from individual prices. He illustrates the point that the price of any individual commodity presupposes a general price level by saying that "the position of a particular wave in the ocean depends on the general level of the ocean." I can conceive of no such distinction between the general price level and individual prices as his statements seem to imply. General prices "are but a combination, or composite photograph, as it were, of individual prices."...[63]

Passing to Professor Laughlin's paper, which has been presented to me merely in the form of an abstract, we find ten propositions, which to a considerable extent are repetitious. His first five propositions are rather commonplace generalizations and few economists will be disposed to dissent from their essential soundness. They place him much closer to the quantity theory of money than most of us, judging him from his previous writings, were disposed to think he would go; and in his third proposition he says, "Probably there is not so much difference of mind regarding the theory of prices as is sometimes supposed."

With reference to Professor Laughlin's fourth proposition it may be said that no economist of standing claims that purchasing power is "identical with the quantity of the media of exchange in circulation." Effective purchasing power, however,[Pg 189] in our modern business communities, does depend upon the possession of money or of the right to demand money. The amount of deposit currency which can be used at any time in purchasing goods is limited by bank reserves because commercial deposits are payable in money on demand at the order of the depositor. Other assets, no matter how good, cannot be used for the purpose of meeting deposit obligations, except when the entire credit machinery breaks down and suspension is resorted to under the euphemistic name of clearing house loan certificates.

Professor Laughlin's sixth and seventh points are essentially the same and may be considered together. He says:

... Price-making generally precedes the demand upon the media of exchange, and does not at all imply any necessary demand at the moment upon the standard in which the prices are expressed.... The offer of money for goods is only a resultant of price-making forces previously at work, and does not measure the demand for goods.... That is, the quantity of the actual media of exchange thus brought into use is a result and not a cause of the price-making process....

This contention appears to me to result from a superficial view of the price-making process. The offer of money for goods and the offer of goods for money are of course not the first steps. Each person has his own individual or subjective prices on all sorts of commodities; these subjective prices represent the valuations which he places upon the respective commodities in terms of the valuation which he places upon the money unit. The more of a particular commodity he has the lower his subjective valuation of a unit of that commodity; the more money he owns the lower his estimation of a dollar and the higher his subjective prices; and vice versa. Through a process of competition, selection, and adaptation, some of these subjective prices develop into market prices, that is, prices at which both buyer and seller benefit, and at which therefore an exchange takes place. To paraphrase an old adage, the proof of the market price is in the exchange. It is a common observation that stock quotations to be of much value must show the number of sales effected at the prices quoted. A stock for which the maximum bids were 100 and the minimum offers were 110,[Pg 190] would not possess a market price in the strict sense of the word. The fact that sales have recently been made at a certain price, or are now being so made, is of course presumptive evidence that intending purchasers can buy at about that price. A market price, however, is the amount of money paid for a commodity, not the amount asked, offered, or promised.

Professor Laughlin's ninth proposition I find very difficult to follow. His premise that reserves are "a consequence of the loan operations" is a dangerous half truth; they are also a consequence of most other kinds of banking operations, cash deposits, cash withdrawals and clearing house balances, foreign and domestic exchange operations, etc. His other premise, that "the fact of an increased supply of gold does not of itself [the italics are mine] increase loans, unless the bank possesses the control of the capital which is a condition precedent to the loans," contains an element of truth, but is misleading. While an increased supply of gold does not of itself increase loans it normally has that result; and the bank's discount rate and the condition of its reserve are powerful factors in influencing its loan account. His premises, I believe, are not sound, and his conclusion, namely, that "the expansion of business is not a direct consequence of an increasing supply of gold, any more than an expansion of railway traffic is the direct consequence of an increasing supply of cars," would not follow from his premises, even if they were sound. The normal causal chain is more nearly this: increased gold production results in greatly increased amounts of gold coming into the monetary uses.[64] This gold comes into the hands of individuals and is to a large extent deposited in banks; increased money incomes on the part of individuals lower their estimations of the value of the money unit, raise subjective prices, and as a consequence market prices; larger money deposits in banks result in larger reserves, banks do not make interest on money held in reserves, and accordingly take measures to invest such surplus money, keeping these reserves as low as is consistent with law and their ideas of safety;[65] inducements to borrowers are made in the[Pg 191] form of more favorable discount rates; collateral is not scrutinized so carefully; the speculative market is stimulated by increasing supplies of call money; confidence everywhere increases; new enterprises spring up and old ones are expanded; and in a short time the new gold is absorbed by a higher price level and an overstimulated business activity. This was the situation after the Californian and Australian gold discoveries of the last century and it has been the result of the greatly increased gold production of the last few years.

Professor Laughlin's final point is that since 1895 the new demand for gold has roughly equalled the new supply, and that the changes in prices since 1896 must be sought mainly in the "other things," which have not remained equal. In support of this conclusion he offers two principal arguments. The first is as follows:

... Because of the large existing stock of gold, very considerable changes may take place in the supply of gold without materially changing the world value of gold as related to goods in general. Rapid changes of price are hence more likely to be due to influences in the market for goods, to speculative changes of demand for goods, or to psychological forces working independently of facts....

In reply it may be said that the production of gold since 1895 represents a very large percentage of the total supply. The Soetbeer figures as supplemented by those of the Director of the Mint show that the world's gold production for the 405 years 1492-1896 inclusive was in round numbers $8,982,000,000,[66] and that for the eleven years 1897-1907, was $3,513,000,000; in other words, for these eleven years it was over 39 per cent. of the total for the preceding 405 years. Probably the effective supply represents a much larger proportion of recent gold because of (1) the large amount of loss chiefly by abrasion of the gold produced in the earlier years, and of (2) the greater degree to which this early gold has assumed specialized forms, such as jewelry, plate, etc.

Satisfactory index numbers of prices for recent years are[Pg 192] not available for all the principal countries of the world. Such as we have, however, point to a decided rise of prices in all gold standard countries since about 1897. Comparing standard price index numbers in six of the chief countries of the world for the years 1897 and 1907, we find the general price level to have risen as follows:[67]

United States—Bureau of Labor figures44.4%
Canada—Coats figures, (weighted)43.7%
England—Sauerbeck figures29.0%
France—de Foville, figures for export prices[68]13.3%
Germany—Hamburg figures30.8%
Italy—Necco figures for export prices23.4%

If we average these figures together, assigning the same importance to the figures of each country, in order to get a rough idea of the movement of world prices in gold standard countries during the eleven years in question, we find that the average increase was 30.8 per cent. If we follow Professor Laughlin and compare the years 1895 and 1907, we find the average increase in prices to have been 25.8 per cent., and the world's gold production for the 13 years 1895 to 1907 to have been about 42 per cent. of that for the preceding 404 years. When to this is added the fact that the evidence points to a smaller percentage of the world's annual gold production going into the industrial uses than formerly, and the further fact that during the period in question the increase and improvements in the world's banking facilities have greatly economized the uses of money, we see that a very substantial increase in general prices would be expected, despite a great expansion of business. World prices in fact have not increased nearly as rapidly as the flow of gold into monetary uses since 1897, not to mention the enormous development of deposit currency. The Director of the Mint estimates each year the amount of the world's new gold used in the industrial arts. Computations I have made based upon these figures show a tendency for a decreasing percentage of the annual production to be used in the arts, although there is considerable irregularity.[Pg 193] For the seven years 1895-1901 the average percentage was 27.1, and for the seven years 1902-1908 it was 25.3.[69]

Professor Laughlin's second argument in favor of the proposition that the recent rise in prices has not been due primarily to the increased gold production is one of the most beautiful examples of begging the question that I have seen in economic literature. He says:

"In recent discussions one of the 'other' factors which has been slighted is the demand for gold since 1895. The examination shows that the new demand in countries turning to the gold standard, and in those already using gold and extending their demand, amounts in round numbers to about $3,000,000,000. Hence the new demand has roughly equalled the new supply, since 1895—a fact which jumps with the known conditions in the great financial markets like London, where new arrivals of gold are eagerly competed for by European banks."

Of course the demand for gold equals the supply, as does the demand for wheat or any other commodity, when one interprets demand and supply as one should, in terms of market prices. The general price level is the very thing which equilibrates the demand for gold and the supply. The higher price level about which we are talking is an expression of the absorption of most of this new gold into the world's circulation. Banks and merchants eagerly compete for it, because higher prices require more money to do a given amount of exchange work, and rising prices stimulate business.

Joseph French Johnson[70]: I am glad to observe that there appears to be a tendency toward agreement with regard to the fact that the value of money depends upon the demand for it and supply of it. Professor Laughlin likes the word standard better than I do. It suggests something permanent and fixed, whereas money is a very changeable thing. While I am in agreement with Professor Laughlin in the conclusion that the general level of prices depends upon the demand for and supply of money, I am unable to give assent to many of[Pg 194] the propositions which he puts forward as links in the chain of reasoning leading to that conclusion.

For example, Professor Laughlin says, "A change of prices may be due to changes in the demand for and supply of (thus including the expenses of production) goods as well as to changes in the demand for and supply of gold." This proposition is true with regard to changes in the prices of particular commodities. The price of wheat may rise or fall as a result of a change in the demand for or in the supply of wheat. The proposition, however, is not true with regard to a change in the general level of prices. An increase in the supply of goods will lower the level of prices for the simple reason that it will increase the demand for gold. I am not certain that I have understood Professor Laughlin's exposition of his theory, but he certainly seemed to me to argue that there could be a change in the general level of prices without any change whatever in the demand for or supply of gold. Such a position, it seems to me, is absolutely untenable.

That Professor Laughlin seeks to hold this untenable position, it seems to me, is made evident by the qualification with which he accepts the statement that a change in the quantity of money, other things being equal, would be a factor affecting prices. He says, "An increasing demand for gold, however, would work against the effect of an increasing supply. If the new demand offset the new supply, then, if changes of price occurred, their cause must be sought in the influences touching the producing and marketing of goods." The second conditional clause in that last sentence introduces an impossible supposition, for if a new supply of gold is offset by a new demand for it, there could be no change in the general level of prices, so that no cause for any change would have to be sought in the "influences touching the producing and marketing of goods." Professor Laughlin appears to have in mind forces affecting the general level of prices which are entirely hidden from my sight. A change in the level of prices means a change in the value of gold, and how can there be a change in that if the new demand for gold just offsets the new supply?

Professor Laughlin's analysis of the price-making process is incomplete and misleading. He is correct when he says that[Pg 195] the causes of price changes must be sought in the forces settling particular prices, but he is manifestly wrong when he states that the price of wheat is "arrived at by the higgling of the market, which depends on the buyers' and sellers' judgment of the demand for and supply of wheat." Such higgling would determine only the value of wheat. The price of wheat is not fixed until buyer and seller have reached an agreement in their estimates as to the value not only of wheat, but also of money. If wheat is comparatively easy to get, the price falls. If money is easier to get, the price rises. The demand for and supply of money is evidently just as important in the determination of the price of wheat as is the demand for and supply of wheat itself. When Professor Laughlin says that the offer of money for goods is only a resultant of price-making forces previously at work, he must have in mind some price-making process and price-making forces of which I have never heard. I know of no market in which goods are lowered in price except for the reason that at the higher price not enough money is offered to absorb the supply; nor of any market in which goods are raised in price except for the reason that buyers are willing to offer more money for the goods.

In his analysis of credit and its relation to the value of money, Professor Laughlin seems to me to have in mind a hypothetical financial world, the like of which does not and could not exist on earth. He strives to show that a bank's ability to make loans depends upon the amount of its capital and deposits, and that therefore any increase in the supply of gold would not in itself lead to an increase of loans. "Expansion of business," he remarks, "is not a direct consequence of an increasing supply of gold any more than an expansion of railway traffic is the direct consequence of an increasing supply of cars." He is quite right if he means that an increase in the amount of gold will not necessarily cause the exchange of more goods. But this does not appear to be his meaning. He holds that the use of new gold in bank reserves cannot be a causal force raising prices, for the bankers cannot increase their loans, in his opinion, unless the condition of business demands such an increase. In his hypothetical financial world bankers are willing to carry idle stocks of gold and to wait[Pg 196] until business conditions make necessary an increase in their loans. In the real financial world, of course, bankers do nothing of the sort. Bankers with surplus gold immediately tempt borrowers by lowering the rate of discount and thus increasing the money demand for goods in the markets. As a result there is an irregular and general rise of prices. More goods may not be bought and sold and there may be no expansion of business, but expressed in terms of money the totals are bigger. There is no analogy between dollars and freight cars. The carrying capacity of a car is fixed and unchangeable, but the carrying capacity of a dollar is elastic—so elastic, in fact, that dollars are always fully loaded no matter how small the supply of goods. As Professor Laughlin points out, although he apparently does not see its significance, the new demand for gold since 1895 has "roughly equalled the new supply." Surely it could not have been otherwise, and no statistics are necessary to prove the fact.

Murray S. Wildman[71]: My comments on these interesting papers will be directed upon the methods employed, and certain assumptions involved, in the arguments of both. Granting that Professor Fisher's analysis shows a perfect correspondence between the course of prices on the one hand and the quantity of money and credit instruments on the other hand, I am still unable to see which magnitudes are properly to be regarded as causes and which as effects. That variations in the value of gold and in the price level must be reciprocal, all will admit. If we regard M as denoting the gold supply for the present, a causal relation between M and P cannot be denied. But may it not be possible that variations in M´, or credit, and V and V´, the velocity of circulation of both money and credit, be simply in consequence of the variation in M and P? Why is P the only passive term or why is it passive at all?

Suppose that the problem set was to discover the cause of credit expansion from 1896 to 1910. Would we not seek at once to explain it by reference to rising prices and greater volume of goods, making a broader basis for credit, while[Pg 197] along with that is a greater gold supply which promotes the convertibility of an extended credit? Then might we not invoke Professor Fisher's algebraic formula, with terms rearranged, and show by this method of reasoning, supported by statistical verification, that the high prices afford an adequate cause for the present expansion of credit?

But we are seeking the cause or causes of rise in the price level. This is equivalent to seeking the cause of decline in the value of gold. Does the "quantity theory" as newly expounded give us the solution? I think not. Rather it shows us that as gold has grown in supply, and fallen in value, credit has grown in magnitude and in rapidity of circulation, and that these changes in values and volumes have gone hand in hand with proportional changes in the price level and in the magnitude of commodity exchanges.

This view of the case brings me to substantial approval of Professor Laughlin's method of analysis and argument. That is, we must seek the facts regarding supply and demand as applied to gold, and those which bear upon supply and demand as touching goods, in so far as the demand for goods is expressed in offers of gold and gold representatives. Here the algebraic formula would be invoked to support his reasoning since M´ and V and V´ may be regarded as factors in the demand for gold.

To accept Professor Laughlin's method does not involve the necessity of his conclusions. The terms, by this method, do not lend themselves to exact mathematical statement and statistical proof, so conclusions cannot be exact and definite. This may be illustrated in a consideration of demand for gold. Some say that demand has grown step by step with supply and therefore gold has not been cheapened. Others say that supply has grown more rapidly than demand, and so gold has been cheapened and to that extent prices are raised.

Either statement may be wrong. I do not believe we have yet any reliable data regarding the demand for gold in the sense of a value-making factor. Most efforts to measure demand are based on statistics of gold in use. If one can show that consumption of gold in the arts, in the circulation, and in greater bank reserves, has increased pari passu with production,[Pg 198] we are told that the value of gold has not been lowered by the greater supply.

But statistics of consumption give no clue to demand in the value-determining sense. We have many staple commodities, such as wheat and cotton, whose price drops sharply when the supply exceeds a certain normal volume, even though the whole crop is consumed. Statistically speaking, the demand for a cotton crop always rises as supply rises, and falls as supply falls, but that is because demand and supply become equated through a variation in price. Demand, in this sense of quantity demanded, is in part a result rather than a cause of value.

When we can properly speak of demand as potent for the determination of value, we are thinking of demand from the point of view of intensity rather than the point of view of magnitude. But the demand which makes for value—demand intensively considered—is only measured by the purchasing power offered. Applied to gold, I know of no measure of demand except in the goods and services offered in exchange. To say that goods and services offered for an ounce of gold in 1910 are less than are offered for an ounce of gold in 1896, is simply to say that prices are higher. But it is these prices that we are trying to explain by giving the effect for the cause, when we say that demand has risen with supply.

Those staple commodities whose value falls off abruptly with any increase of supply beyond a customary stock are said to be subject to an inelastic demand, and those whose value declines uniformly with excessive supplies are said to have an elastic demand. Is the demand for gold elastic, or is it inelastic? And is it possible by independent analysis to construct the curve of elasticity which properly belongs to gold, and so avoid circular reasoning from the very prices we are trying to explain?

If the demand for gold is inelastic and the demand curve drops off abruptly after a certain supply is in evidence, the presumption is that in the conditions of gold production, rather than in the conditions of commodity production, lies the cause of our high prices. Moreover, if this be the case, we can readily see the cause of cheapening of gold, even though the[Pg 199] product of a single year bears a small proportion to the existing stock.

If on the other hand the demand for gold be very elastic, so that it expands with growing supplies with no substantial alterations in value, then we are driven to seek the cause of high prices in influences directly touching the goods and services rather than in those directly affecting gold.

It would seem therefore that both methods of treatment have left something to be desired. The algebraic analysis, even as verified, presents the relations between magnitudes without showing the cause of high prices. The argument directed immediately at the value of gold of necessity involves consideration of the demand for gold, which, as a price-making factor, remains an unknown quantity.

T. N. Carver[72]: Professor Fisher ... has demonstrated beyond all question the accuracy of his formula. The question remains, however, whether his formula supports his own conclusion or Professor Laughlin's. If, for example, it should be found that P is the cause of M, the formula would to that extent support Professor Laughlin's position. I believe that to a certain extent P is actually the cause of M. If the growing scarcity of agricultural land, or the increase in population and the increased demand for agricultural products without an increase in land, should increase the marginal cost of producing agricultural products to supply this larger demand, that would tend to increase the exchange value of these products, even according to the formula of Cairnes as quoted by President Houston.[73] Even without any increase in the gold supply, this would cause each unit of product to exchange for a little more gold; then, in order that a given number of exchanges in agricultural products could be carried on, it would be necessary to have a larger number of ounces of gold, or a larger number of gold coins, or some other form of money of given denominations to do the money work. This, in other words, would necessitate a larger supply of money: and, if other forms than gold were not forthcoming, it would necessitate that a larger[Pg 200] proportion of the stock of gold should be coined into money in order to do the work. Thus, without any increase whatever in the world's total gold supply, there would come to be an increase in the proportion of that supply used as money, or in the amount of gold coin actually used in circulation. I believe that this has taken place, and that it is one of the factors in the problem, although there has also been a very large increase in the gold supply to still further accentuate the tendency.

F. W. Taussig[74]: I congratulate Professor Fisher on his admirable paper. I am in accord with him in his method of reasoning and in all his essential results. His investigation of this subject adds another to the brilliant studies with which he has enriched economic science.

It deserves to be said, perhaps, that the term M´ (deposits) in his equation is not entirely independent, but is in some degree a function of T. I say to some degree; it is dependent on T in part only, and not for very long periods. Professor Fisher has here treated it as dependent simply on M.... He has indicated the qualifications which must be attached to this dependence of deposits on bank reserves. He has pointed out that though a general dependence appears over long periods of time, it is affected by changes in banking ways, and by the tendency to build up a higher superstructure of deposits in times of active business. But there is also a connection between T, volume of trade, and M´. That is, for short periods—nay, for periods of some years—an increasing volume of trade tends of itself to bring about an increasing volume of deposits. (I may say, parenthetically, that "volume of trade" does not seem to me an apt expression; "units of commodities," the other phrase used by Professor Fisher, is better.) Though I would by no means go the length of Professor Laughlin's reasoning, which seems to imply that every act of exchange supplies automatically its own medium of exchange, it does seem to me that our modern mechanism of deposit banking supplies an elastic source of deposits, which, for considerable periods, enables them to run pari passu with the transactions[Pg 201] and loans resting on them. In the end, an increase of deposits finds its limit in the volume of cash held by the banks. But there is some elasticity of adjustment, by which loans and deposits increase as fast as transactions or faster; and this accounts in no small degree for the rise in prices during periods of activity. The phenomenon shows itself most strikingly in stock exchange loans, especially in a center like New York. There the business creates for itself quasi-automatically its own medium of exchange. I suspect it is undue generalization from operations of this sort that has led Professor Laughlin to take his extreme position—a position which I can not but think untenable. Some allowance for the temporary interaction between M´ and T is necessary for the completeness of Professor Fisher's reasoning.

Ralph H. Hess[75]: Professor Fisher's formula (MV + M´V´ = PT) approximately expresses the mathematical equality of purchase and payment which cannot be questioned. I say approximately because M´ (defined by Professor Fisher as "bank deposits subject to check"), if it be made to express an accurate measure of circulating credit, should include not only open bank accounts, but certain other values which constitute current means of payment, such as bankers' bills, trade bills, cashiers' checks, and certified checks....

The relation which Professor Taussig has pointed out between M´ and T (the value of negotiable credit and the contemporary volume of trade) is not only possible, but, in any community of modernized commerce, is actual. Moreover, a knowledge of the process by which commerce is financed by the existing mechanism of discount, loan, deposit, and draft justifies the conclusion that, if the volume of trade (T) be resolved into its factors, namely, materials of trade and their frequency of exchange, the latter factor of T is quite commensurate with the velocity of credit (V´).

To me it seems incontestable that the volume and velocity of credit currency, as represented by bank deposits and other circulating media, vary directly as the volume and value of the materials of trade in the process of exchange, and are,[Pg 202] mathematically speaking, dependent functions thereof. Granting this relation, an analysis of the equation of exchange establishes PT as the major determinant of M´V´, and, in so far as paper money may be authorized and issued upon the security of commercial assets, of M. That part of the money in circulation which does not derive its circulating powers from actual and potential commercial values is itself material of barter incorporating so-called intrinsic values.

The conclusion is clear that P (price) is independent of all other terms and factors of Professor Fisher's equation, that V and V´ are determined by the mechanical circumstances and organization of exchange, and that the value of M and M´, taken collectively, is a spontaneous derivative of PT. The fundamental determinants of prices and of "price levels," therefore, are to be found outside of monetary and credit agencies per se.

As to the nature and order of the price-making process and the actual forces behind price movements, I am in substantial accord with Professor Laughlin. That prices, individually and collectively considered, express the value-proportion of demand for and supply of goods on the market to demand for and "visible supply" of the standard commodity is fundamentally logical. Nor is there occasion to quibble over the paradox of disturbed equilibrium of demand and supply. Physically considered, the goods which objectify these terms are, of course, identical; but, in the valuation process, demand and supply denominate, respectively, desire and utility—the generally acknowledged antecedents of value. Price is the equalizing factor between the effective demand for gold and the effective demand for other goods, each taken in conventional units; and price changes are resultants of, and commensurate with, net variations in the value-factors of the standard and of the objects of exchange.

Referring to the nature of credit and the economic qualities of credit instruments, the somewhat figurative expression "goods coined into a means of payment" is a striking and accurate characterization. It is possible that all legitimate market values, under normal trade conditions, may be liquidized through credit agencies, and the goods in which they are[Pg 203] incorporated be thus rendered immediately and conveniently exchangeable. This process may be consummated independently of prices and with slight regard to the actual supply of money. The truth of this assertion is, in fact, demonstrated daily in the marts of trade.

J. Laurence Laughlin[76]: There is time to answer briefly only a few of the points raised by several speakers. First, Professor Fisher's equation of MV + M´V´ = PT is to my mind not a solution, but only a statement, of the problem of price levels. It can be read backward as well as forward. For instance, it does not follow that the level of prices (P) will rise with an increase of M´, since—as Professor Taussig has pointed out already—an active development of trade and industry (T) would itself be a reason for an increase of banking loans and deposits subject to check (M´), thus equalizing effects on both sides of the equation without necessarily increasing P. This result is, in fact, one of the points on which I have steadily insisted in my own exposition of the theory of prices and credit; and Professor Fisher's equation allows it to appear distinctly. His equation does not show causes; it states a static situation, into which various causes may be read. The facts between 1876 and 1896 disclose an increase of bank deposits of 500 or 600 per cent., and yet that period was distinguished as one of falling prices. Therefore M´ cannot be regarded as having been proved to be a cause of higher prices.

Second, Professor Fisher ... seeks to establish a causal relation between the amount of money in circulation (M) and the amount of deposits (M´) which, in my judgment, is wholly unfounded. He has developed this in his paper in the Royal Statistical Journal. The error consists in supposing that a man's deposit account at any time varies with the amount of money in his possession. Rather, the deposit account varies with a man's wealth. The rich man does not carry much more money to pass from hand to hand than the man of moderate means. Monetary habits in the community require a certain level of circulation for all persons, but the deposits of an individual may soar above the common level without regard[Pg 204] to the money he keeps in circulation. His bank deposits are rather a measure of the saleable goods he has sold, "coined into means of payment."

Third, I well recognize the high position Professor Fisher occupies in the mathematical school of Walras and others; but has he not made an error in stating the essence of the price relation in his mathematical symbols? So far as I understand him, he seems to deny the fundamental value-concept (on which there has hitherto been general agreement) that price is a ratio between goods and gold. In furtherance of that idea, he thinks that, before individual prices can be arrived at, the general price level must be ascertained. Now, in my exposition using the ratio-concept, I explained in detail how the general level of prices might be affected by causes affecting the gold side of the ratio. Therefore, I did not neglect to account for the general level and that too without doing violence to the accepted value-concept. But the ratio-concept (which Professor Fisher seems to deny) allows the forces acting on goods also to affect the general level of prices as I have shown. In my opinion, he wrongly works from a general level of prices to particular prices; while I hold that particular prices, or actual quotations, are the bases from which all averages, or price levels, are always and inevitably computed. Moreover, in his diagrams, the level of prices he used was the one computed from individual quotations. Hence his whole reasoning on the conformity of the statistics to the terms of his equation is vitiated. Indeed the better agreement he finds—after elaborate statistical computations—between the elements and their result on prices ...—is due, I think, to relying on an equation which is nothing more than a statement that the whole is equal to the sum of its parts....

Finally, when Professor Johnson suggests that I am wrong in stating that forces affecting the goods side of the price ratio have an influence on prices, he certainly cannot mean that conditions affecting the producing, marketing, and financing of goods have no effect on prices. How else, for instance, can we explain the rise of the prices of agricultural products? The special causes affecting them have little to do with the quantity of "money." Moreover, the term "money" itself[Pg 205] is used so loosely and vaguely that we can come to agreement on price theories only by first agreeing upon what we mean by "money." In my paper, I have discussed the relations of goods, and their prices, to gold. But, in this country, we use gold little as a medium by which goods are exchanged. Thus the relation of the prices of goods to our media of exchange has been practically omitted. And yet the price-making process generally precedes the creation of the usual banking media of exchange by which most goods are exchanged.

Irving Fisher[77]: In connection with the statement and explanation of the equation of exchange it was shown (1) that prices vary directly as the quantity of money, provided the volume of trade and the velocities of circulation remain unchanged; (2) that prices vary directly as the velocities of circulation (if these velocities vary together), provided the quantity of money and the volume of trade remain unchanged, and (3) that prices vary inversely as the volume of trade, provided the quantity of money—and therefore deposits—and their velocities remain unchanged.

Let us now inquire how far these propositions are really causal propositions. An examination of the influence of each of the six magnitudes on each of the other five will afford answers to the objections which have been raised to the quantity theory of money.

To set forth all the facts and possibilities as to causation we need to study the effects of varying, one at a time, the various magnitudes in the equation of exchange.

Our first question is: given (say) a doubling of the quantity of money in circulation (M) what are the normal or ultimate effects on the other magnitudes in the equation of exchange, viz.: , V, , the p's and the Q's?

We have seen that normally the effect of doubling money in circulation (M) is to double deposits () because under any given conditions of industry and civilization deposits tend to hold a fixed or normal ratio to money in circulation. Hence[Pg 206] the ultimate effect of a doubling in M is the same as that of doubling both M and . We propose next to show that this doubling of M and does not normally change V, or the Q's, but only the p's. The equation of exchange of itself does not affirm or deny these propositions.

For aught the equation of exchange itself tells us, the quantities of money and deposits might even vary inversely as their respective velocities of circulation. Were this true, an increase in the quantity of money would exhaust all its effects in reducing the velocity of circulation, and could not produce any effect on prices. If the opponents of the "quantity theory" could establish such a relationship, they would have proven their case despite the equation of exchange. But they have not even attempted to prove such a proposition. As a matter of fact, the velocities of circulation of money and of deposits depend, as will be seen, on technical conditions and bear no discoverable relation to the quantity of money in circulation. Velocity of circulation is the average rate of "turnover", and depends on countless individual rates of turnover. These depend on individual habits. Each person regulates his turnover to suit his convenience. A given rate of turnover for any person implies a given time of turnover—that is, an average length of time a dollar remains in his hands. He adjusts this time of turnover by adjusting his average quantity of pocket money, or till money, to suit his expenditures. He will try to avoid carrying too little lest, on occasion, he be unduly embarrassed; and on the other hand to avoid encumbrance, waste of interest, and risk of robbery, he will avoid carrying too much. Each man's adjustment is, of course, somewhat rough, and dependent largely on the accident of the moment; but, in the long run and for a large number of people, the average rate of turnover, or what amounts to the same thing, the average time money remains in the same hands, will be very closely determined. It will depend on density of population, commercial customs, rapidity of transport, and other technical conditions, but not on the quantity of money and deposits nor on the price level. These may change without any effect on velocity. If the quantities of money and deposits are doubled, there is nothing, so far as velocity of circulation is concerned,[Pg 207] to prevent the price level from doubling. On the contrary, doubling money, deposits, and prices would necessarily leave velocity quite unchanged. Each individual would need to spend more money for the same goods, and to keep more on hand. The ratio of money expended to money on hand would not vary. If the number of dollars in circulation and in deposit should be doubled and a dollar should come to have only half its former purchasing power, the change would imply merely that twice as many dollars as before were expended by each person and twice as many kept on hand. The ratio of expenditure to stock on hand would be unaffected.

If it be objected that this assumes that with the doubling in M and there would be also a doubling of prices, we may meet the objection by putting the argument in a slightly different form. Suppose, for a moment, that a doubling in the currency in circulation should not at once raise prices, but should halve the velocities instead; such a result would evidently upset for each individual the adjustment which he had made of cash on hand. Prices being unchanged, he now has double the amount of money and deposits which his convenience had taught him to keep on hand. He will then try to get rid of the surplus money and deposits by buying goods. But as somebody else must be found to take the money off his hands, its mere transfer will not diminish the amount in the community. It will simply increase somebody else's surplus. Everybody has money on his hands beyond what experience and convenience have shown to be necessary. Everybody will want to exchange this relatively useless extra money for goods, and the desire so to do must surely drive up the price of goods. No one can deny that the effect of every one's desiring to spend more money will be to raise prices. Obviously this tendency will continue until there is found another adjustment of quantities to expenditures, and the V's are the same as originally. That is, if there is no change in the quantities sold (the Q's), the only possible effect of doubling M and will be a doubling of the p's; for we have just seen that the V's cannot be permanently reduced without causing people to have surplus money and deposits, and there cannot be surplus money and deposits without a desire to spend[Pg 208] it, and there cannot be a desire to spend it without a rise in prices. In short, the only way to get rid of a plethora of money is to raise prices to correspond.

So far as the surplus deposits are concerned, there might seem to be a way of getting rid of them by cancelling bank loans, but this would reduce the normal ratio which bears to M, which we have seen tends to be maintained.

We come back to the conclusion that the velocity of circulation either of money or deposits is independent of the quantity of money or of deposits. No reason has been, or, so far as is apparent, can be assigned, to show why the velocity of circulation of money, or deposits, should be different, when the quantity of money, or deposits, is great, from what it is when the quantity is small.

There still remains one seeming way of escape from the conclusion that the sole effect of an increase in the quantity of money in circulation will be to increase prices. It may be claimed—in fact it has been claimed—that such an increase results in an increased volume of trade. We now proceed to show that (except during transition periods) the volume of trade, like the velocity of circulation of money, is independent of the quantity of money. An inflation of the currency cannot increase the product of farms and factories, nor the speed of freight trains or ships. The stream of business depends on natural resources and technical conditions, not on the quantity of money. The whole machinery of production, transportation, and sale is a matter of physical capacities and technique, none of which depend on the quantity of money. The only way in which the quantities of trade appear to be affected by the quantity of money is by influencing trades accessory to the creation of money and to the money metal. An increase of gold money will, as has been noted, bring with it an increase in the trade in gold objects. It will also bring about an increase in the sales of gold mining machinery, in gold miners' services, in assaying apparatus and labor. These changes may entail changes in associated trades. Thus if more gold ornaments are sold, fewer silver ornaments and diamonds may be sold. Again the issue of paper money may affect the paper and printing trades, the employment of bank and government[Pg 209] clerks, etc. In fact, there is no end to the minute changes in the Q's which the changes mentioned, and others, might bring about. But from a practical or statistical point of view they amount to nothing, for they could not add to nor subtract one-tenth of 1 per cent. from the general aggregate of trade. Only a very few Q's would be appreciably affected, and those few very insignificant.

We conclude, therefore, that a change in the quantity of money will not appreciably affect the quantities of goods sold for money.

Since, then, a doubling in the quantity of money: (1) will normally double deposits subject to check in the same ratio, and (2) will not appreciably affect either the velocity of circulation of money or of deposits or the volume of trade, it follows necessarily and mathematically that the level of prices must double. While, therefore, the equation of exchange, of itself, asserts no causal relations between quantity of money and price level, any more than it asserts a causal relation between any other two factors, yet, when we take into account conditions known quite apart from that equation, viz., that a change in M produces a proportional change in , and no changes in V, , or the Q's, there is no possible escape from the conclusion that a change in the quantity of money (M) must normally cause a proportional change in the price level (the p's).

While the equation of exchange is, if we choose, a mere "truism," based on the equivalence, in all purchases, of the money or checks expended, on the one hand, and what they buy, on the other, yet in view of supplementary knowledge as to the relation of M to , and the non-relation of M to V, , and the Q's, this equation is the means of demonstrating the fact that normally the p's vary directly as M, that is, demonstrating the quantity theory. To throw away contemptuously the equation of exchange because it is so obviously true is to neglect the chance to formulate for economic science some of the most important and exact laws of which it is capable.

We may now restate, then, in what causal sense the quantity theory is true. It is true in the sense that one of the[Pg 210] normal effects of an increase in the quantity of money is an exactly proportional increase in the general level of prices.

I have no desire, as some one has humorously suggested, to hide behind an equation, but I do find it necessary to take refuge behind my book on the Purchasing Power of Money. So many new questions have been asked that, in the few moments at my disposal, I could not answer them all satisfactorily. I believe they have all been answered in the book referred to. For instance, a chapter has been devoted to transition periods in which it has been shown, as Professor Taussig has suggested, that during transition periods an increase in T may cause an increase in .

The Testimony of Ricardo

[78]Let us suppose that the circulation of all countries were carried on by the precious metals only, and that the proportion which England possessed were one million; let us further suppose, that, at once, half of the currencies of all countries, excepting that of England, were suddenly annihilated, would it be possible for England to continue to retain the million which she before possessed? Would not her currency become relatively excessive compared with that of other countries? If a quarter of wheat, for example, had been both in France and England of the same value as an ounce of coined gold, would not half an ounce now purchase it in France, whilst in England it continued of the same value as one ounce? Could we by any laws, under such circumstances, prevent wheat or some other commodity (for all would be equally affected) from being imported into England, and gold coin from being exported? If ... the exportation of bullion were free, gold might rise 100 per cent.; and for the same reason, if 35 Flemish schillings in Hamburgh had before been of equal value with a pound sterling, 17-1/2 schillings would now attain that value. If the currency of England only had been doubled, the effects would have been precisely the same.

Suppose, again, the case reversed, and that all other currencies[Pg 211] remained as before, while half that of England was retrenched. If the coinage of money at the mint was on the present footing, would not the prices of commodities be so reduced here that cheapness would invite foreign purchasers, and would not this continue till the relative proportions in the different currencies were restored?

If such would be the effects of a diminution of money below its natural level, and that such would be the consequences the most celebrated writers on political economy are agreed, how can it be justly contended that the increase or diminution of money has nothing to do either with the foreign exchanges, or with the price of bullion?

Now, a paper circulation, not convertible into specie, differs in its effects in no respect from a metallic currency, with the law against exportation strictly executed.

Supposing, then, the first case to occur whilst our circulation consisted wholly of paper, would not the exchanges fall, and the price of bullion rise in the manner which I have been representing; and would not our currency be depreciated, because it was no longer of the same value in the markets of the world as the bullion which it professed to represent? The fact of depreciation could not be denied, however the Bank Directors might assure the public that they never discounted but good bills for bona fide transactions; however they might assert that they never forced a note into circulation; that the quantity of money was no more than it had always been, and was only adequate to the wants of commerce, which had increased and not diminished;[79] that the price of gold, which was here at twice its mint value, was equally high, or higher, abroad, as might be proved by sending an ounce of bullion to Hamburgh, and having the produce remitted by bill payable in[Pg 212] London bank notes; and that the increase or diminution of their notes could not possibly either affect the exchange or the price of bullion. All this, except the last, might be true, and yet would any man refuse his assent to the fact of the currency being depreciated?

Could the symptoms which I have been enumerating proceed from any other cause but a relative excess in our currency? Could our currency be restored to its bullion value by any other means than by a reduction in its quantity, which should raise it to the value of the currencies of other countries; or by the increase of the precious metals, which lower the value of theirs to the level of ours?


[43] The Purchasing Power of Money, pp. 14-71. The Macmillan Company. New York. 1911.

[44] This theory, though often crudely formulated, has been accepted by Locke, Hume, Adam Smith, Ricardo Mill, Walker, Marshall, Hadley, Fetter, Kemmerer and most writers on the subject. The Roman Julius Paulus, about 200 a. d., stated his belief that the value of money depends on its quantity. See Zuckerkandl, Theorie des Preises: Kemmerer, Money and Credit Instruments in their Relation to General Prices, New York (Holt), 1909. It is true that many writers still oppose the quantity theory. See especially, Laughlin, Principles of Money, New York (Scribner). 1903.

[45] See Scott, "It has been a most fruitful source of false doctrines regarding monetary matters, and is constantly and successfully employed in defense of harmful legislation and as a means of preventing needed monetary reforms." Money and Banking. New York, 1903, p. 68.

[46] [For a method of determining the velocity of the circulation of money, see Appendix A.]

[47] It is important to bear in mind that wherever P is used in this chapter it represents the index number, or scale of prices, at which the trade, T, is conducted.—Editor.

[48] An almost opposite view is that of Laughlin that normal credit cannot affect prices because it is not an offer of standard money and cannot affect the value of the standard which alone determines general prices. See the Principles of Money, New York (Scribner), 1903, p. 97. Both views are inconsistent with that upheld ... [here].

[49] This fact is apparently overlooked by Laughlin when he argues that there is not "any reason for limiting the amount of the deposit currency, or the assumption of an absolute scarcity of specie reserves." See Principles of Money, p. 127.

[50] Interesting changes in the magnitudes of the equation of exchange between 1896 and 1914 are given in the appended diagram, which is taken from a reprint of Professor Fisher's article, The Equation of Exchange for 1914, and the War, the American Economic Review, Vol. V, No. 2, June, 1915.—Editor.

[51] Adapted from Irving Fisher. Recent Changes in Price Levels and Their Causes, Bulletin of the American Economic Association. Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp. 43-44.

[52] Irving Fisher, The Purchasing Power of Money, pp. 74-88.

[53] Ibid., pp. 149, 150.

[54] Causes of the Changes in Prices since 1896. Bulletin of the American Economic Association, Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp. 27-36.

[55] There is a possible error here of perhaps $500,000,000.

[56] The estimate for 1908 is $113,996,000. Cf. U. S. Report of Director of Mint, 1909, p. 80.

[57] Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 46-52.

[58] Ibid., pp. 52-61.

[59] Money and Credit Instruments in their Relation to General Prices, 2d edition, 1909. New York: Henry Holt & Company.

[60] The passages referred to are omitted.—Editor.

[61] Kemmerer, Money and Credit Instruments, pp. 9-18, 74-82.

[62] Ibid., pp. 82-8, 121-6, 145-8.

[63] Ibid., p. 9. [See Fisher: Purchasing Power of Money, pp. 175-180.]

[64] The value of gold bullion deposited at the United States mints and assay offices increased from $87,924,000 for 1897 to $205,036,000 for 1907. Figures furnished by the Director of the Mint.

[65] It is noteworthy that the reserves of the New York associated banks for example are usually kept very close to the legal reserve requirements. Cf. Sprague, Crises under the National Banking System, p. 222.

[66] Gold produced before 1492 represents an insignificant part of the existing supply.

[67] Useful tables summarizing all of these index numbers, except those of Canada, are given by Achille Necco, in his article on La curva dei prezzi delle merci in Italia negli anni 1881-1909, in La Riforma Sociale, Sept.-Oct., 1910.

[68] Comparison is for 1897 and 1906, figures for 1907 not being available.

[69] De Launay thinks that the industrial consumption averages somewhere between 40 and 50 per cent. of the annual output, but believes that for several years past the industrial uses have been absorbing a decreasing proportion, though an increasing amount. (The World's Gold, pp. 176-7.)

[70] Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 59-61.

[71] Ibid., pp. 61-63.

[72] Ibid., p. 64.

[73] The quotation here referred to is omitted.—Editor.

[74] Ibid., pp. 64-65.

[75] Ibid., pp. 65-67.

[76] Ibid., pp. 67-69.

[77] Adapted from The Purchasing Power of Money, pp. 150-157; and Bulletin of the American Economic Association, Fourth Series, No. 2. Papers and Discussions of the Twenty-third Annual Meeting, December, 1910. p. 70.

[78] David Ricardo, Reply to Mr. Bosanquet's Practical Observations on the Report of the Bullion Committee, Works, pp. 326-328. John Murray. London. 1888.

[79] The Bank could not on their own principles, then urge that most erroneous opinion, that the rate of interest would be affected in the money market if their issues were excessive, and would therefore cause their notes to return to them, because, in the case here supposed, the actual amount of the money of the world being greatly diminished, they must contend that the rate of interest would generally rise, and they might therefore increase their issues. If, after the able exposition of Dr. Smith, any further argument were necessary to prove that the rate of interest is governed wholly by the relation of the amount of capital with the means of employing it, and is entirely independent of the abundance or scarcity of the circulating medium, this illustration would I think afford it.

[Pg 213]



It is an essential feature of the gold exchange standard as it exists in the Philippines, for example, that premiums charged by the Government in Manila for exchange on New York, and in New York for exchange on Manila are fixed at a point somewhat below the gold export points in each case. Thus the would-be exporter of gold in the Philippines never finds it profitable to ship gold to New York. On the other hand, international bankers in New York never find it profitable to ship gold or currency to the Philippines, because the authorised agent of the Philippine government in New York always stands ready to sell in exchange for United States currency, drafts drawn upon Manila at a premium less than the cost of shipping gold or currency. Through a regulation of the supply of silver pesos in actual circulation in the Philippines they are maintained at a definite ratio to—not gold in the Philippines, but—gold, or its equivalent, in New York. The way in which the supply of local currency in the gold-exchange country is regulated will be made clear in what follows.

The gold exchange standard has not entirely escaped criticism. Professor J. Shield Nicholson has recently attacked this standard in India. (Economic Journal, June, 1914.) It is his contention that inflation may occur in India, if it has not already occurred, on account of the "impeded convertibility of rupees into gold." After a certain point is reached in the inflation the decline in the general purchasing power of the rupee must be followed, he affirms, by a specific depreciation as regards gold; and then the main object of the plan would be defeated. He offers no evidence, however, that prices have risen faster in India than in gold standard countries. With the exception of Mexico, where currency conditions have become extremely chaotic, the historical material here reprinted is in accord with the recent monetary history of the countries under discussion.

[80]When the Government of British India sought, in 1893, to give a fixed gold value to about £120,000,000 in rupee silver, it undertook an experiment of great importance to the financial world, and one which was naturally viewed in many quarters with grave misgivings. The experience of fifteen years which have followed that experiment has taught many lessons in monetary science. It may, indeed, be said to have blazed a new path in the principles of money—at least, in their practical application. The effort to raise the coins to a fixed gold value by scarcity alone was not successful, but it led to other[Pg 214] devices, which, imitated or improved upon in Mexico, the Philippines, and the Straits Settlements, as well as in India, have created a new type of monetary system which has come to bear the title of the gold exchange standard.

The gold exchange standard differs in several respects from the limping standard. It has been the product of definite purpose and plan in the Philippines and in Mexico and to a certain extent in India. While in British India it has been, like the limping standard, a compromise with existing conditions, it has there, as elsewhere, received a definite form and substance which separated it from the limping standard as evolved in France and in other countries which found themselves with a large amount of legal-tender silver on their hands when the metal had fallen below the official parity. There are two other essential differences between the limping standard and the gold exchange standard. One is that the gold exchange standard contemplates a circulation of token coins of silver without any necessary concurrent circulation of gold or paper. The other is that the gold exchange standard contemplates definite and comprehensive measures to maintain the value of token coins at par with gold instead of relying purely upon custom and scarcity to give them value.

The essential principle upon which the exchange standard has been established is that the value of money is governed by the law of supply and demand. So long as supply was indefinite and excessive, as under the system of the free coinage of silver, there was no way of preventing safely and effectively the decline in the gold value of the coins to the bullion value of their silver contents. The moment, however, that Government undertook to limit the supply of coins to the demand for them, it took an important step to separate their value from that of their bullion contents and to give them a value based upon the demand for them as money signs required for carrying on exchanges. Strangely enough, while this principle had been in operation for many years in the case of subsidiary coins, its bearing upon the use of silver in countries where the standard had been depreciating was not clearly comprehended until within recent years. Those who understood the principle doubted its sufficiency to give a fixed value to silver coins as[Pg 215] the sole medium of exchange, or they distrusted the ability of any government to judge accurately the number of coins required.

Upon the latter point they would have been correct if dependence had been placed upon guesswork or any empirical method of determining the amount needed. It remained to find the true solution of the problem by so regulating the quantity of the coins that it would respond automatically to the demands of trade. The correct method of doing this is through the system of exchange funds. As this system is operated in the Philippines, it is not possible to obtain gold coin for silver certificates in small quantities; but it is possible always to obtain drafts upon New York at par, plus the usual charges for exchange between gold standard countries. These drafts have to be purchased with actual silver coin or coin certificates. In either case the coins and certificates are, by the requirements of the coinage law, held in the Philippine Treasury. The law does not permit their deposit by the Treasury in current account at a bank, which would turn them back into the general circulation.

For practical purposes the volume of currency in circulation is contracted to the same extent as if a corresponding amount of gold were taken from the circulation for export. When the current turns and rates for money become high in the Philippines, Philippine currency can be released for local circulation by the purchase in New York from the gold standard fund of bills upon the Philippine Treasury. This rule of locking up the proceeds of the sale of bills is not rigidly applied to the funds in New York, because the influence of the Philippine purchases upon the local circulation there would be insignificant. On the contrary, the Government obtains a generous interest rate, which has at times been as high as 4 per cent., upon the deposit of Philippine funds with New York bankers. During the stress of the autumn of 1907 considerable transfers of capital were made from Manila to New York by means of the purchase of New York drafts from the Philippine Treasury. The process, often repeated even under less serious pressure, clearly shows that the monetary system of the Philippines is linked to gold, and that capital can be freely transferred[Pg 216] upon a gold basis between Manila and other markets.

The experience of fifteen years since the free coinage of rupees was first suspended in British India, of five years since the new system was established in the Philippines, and of nearly four years since it was in operation in Mexico, have settled most of the doubts which were felt when the experiment was undertaken in India. In the first place, it has been made clear that the value of the coins in exchange, as fixed by law, has not been influenced by variations in the price of silver bullion. This statement, of course, applies only to one side of the problem—the fall of the gold value of the silver in the coin below its face value. It would not be possible under any system yet discovered, except such uneconomic devices as prohibiting exportation, to prevent the disappearance of silver coins when the [bullion] value of their contents rises above the legal value in exchange. Both the Philippines and Mexico have faced this menace to their monetary circulation since their systems were inaugurated, but both have succeeded in removing it. In the Philippines the contents of the silver unit—the peso—was reduced in 1906 from about 371 grains to 247 grains in pure silver. The amount fixed by the law of 1903 was practically the same as the contents of the old Mexican dollar. The adoption of a coin of this weight was caused partly by the desire to avoid the distrust which some feared might arise from reducing the weight. At the time of the passage of the law, moreover, the price of silver was nearly at the lowest point in its history, having touched the minimum of 21-11/16 pence in January, 1903, and being at an average price of 22-1/2 pence in March. The adoption of so heavy a coin, however, was not in accordance with the original recommendation made by the present writer to the War Department in November, 1901. The weight then recommended was 385 grains, nine-tenths fine, or about 347 grains of pure silver.

In Mexico the rise of the silver coins above the legal gold value proved a blessing in disguise. It enabled Mexico to go almost to an absolute gold standard by selling her silver at a premium. From May 1st, 1905, to October 22nd, 1907, the old silver piasters were exported to the amount of $85,956,202,[Pg 217] while gold coinage was executed to the amount of $71,646,500 (about £7,200,000).[81] The gold has gone chiefly into the reserves of the banks, which have in circulation about $95,000,000 in notes. Gold holdings of the banks, which were only $15,832,840 in January, 1906, were $54,165,483 in October, 1907, while silver holdings declined over the same period from $49,781,155 to $14,399,924.[82] This influx of gold came about because silver at 33 pence was above the Mexican coinage ratio of about 32 to 1, and much of it was sold by the Commission on Money and Exchange at a direct profit to the Mexican Treasury. In view of the subsequent fall in silver below 23 pence, at which rate Mexico is in a position to replenish her supply of subsidiary coinage, her statesmen may claim the credit of following the great rule of profit in the commercial world as well as on the stock exchange—to sell when things are dear and to buy when things are cheap.

The coincidence in the rise of silver and the adoption of the Mexican monetary reform in 1905 was in some degree accidental. It facilitated the reform, not only by introducing gold, but by removing the objections which would otherwise have been heard from the miners of silver to the rise in gold wages which would have accompanied a fixing of the exchange at a point above the value of silver bullion. It was the intention of the Mexican Government, however, to proceed resolutely, though deliberately, to a fixed exchange, and they would undoubtedly have accomplished this result, even if they had not been aided by the rise in the value of silver. Its subsequent fall has in no wise impaired the stability of the gold standard.

Some fears were expressed in the Philippines as to the willingness of the natives and of Chinese traders to accept a silver coin at a gold value fixed by law which was obviously above its value as bullion. This difficulty has proved almost negligible. Silver within less than three years has been above 33 pence per ounce and below 23 pence. It is doubtful if the Government officials in India or the Philippines have so much as taken note of the daily fluctuations since the price dropped[Pg 218] below the legal parity of the coins, and it is certain that the exchange value of the coins has been in no wise impaired by their fall in bullion value. When the last reduction was made in the weight and fineness of the Philippine coins, lowering by almost 30 per cent. their silver contents, the precaution was taken of advising the public by means of an official circular, translated into the various languages and dialects of the Islands, why the change had been made, and that it would not affect the exchange value of the coins. Provincial and municipal treasurers were also directed to carry on a campaign of education among the people by way of explaining the character and effect of the change. The greatest menace to the value of the new coins lay with the Chinese, for in China for many hundreds of years local bankers and merchants have adhered to the rule that a coin derived no value from the stamp, but was worth just what it would fetch on the scales. The Chinese traders at first undertook to discriminate in this manner against the new coins of the Philippines. In some cases they refused to receive them except at a discount varying from 20 to 40 per cent. They also offered 105 in the new coins for 100 in the old, evidently in the hope of exporting the old at a profit while they continued to be worth as bullion more than their legal gold value. The success of this discrimination was local and extremely short-lived. The first consignment of the new coins reached Manila on May 4, 1907, and when the Treasurer of the Islands prepared his annual report on October 15th, 1907, he was able to make the following statement of conditions:

At this time, October 15, the new coin is accepted without question in every part of the Islands, and no reports or complaints have been received for the past two months as to discounting it, and, so far as can be ascertained, no premium is now paid for the old coin. In fact, the demand for the new coin for exchange purposes has so far exceeded the supply that it became necessary to withdraw nearly half a million of the new pesos from the banks to meet the requisitions therefor from the provinces.

The hesitation which prevailed, therefore, in many quarters in regard to the ability of a government to overcome the conservatism of the East in its preference for coins of full bullion value has not been warranted by events. This demonstration[Pg 219] is of importance if the exchange standard is to be considered for China. At present the Government of China is not perhaps strong enough and sufficiently centralised to assure its subjects that it can give a definite gold value to a token coin and maintain it honestly and efficiently. The trial of the system, however, in the Philippines, in British India, and in the Straits Settlements, in all of which there are many Chinese, has probably so far cleared the air upon this point that the Chinese Imperial Government would be able to establish the gold exchange system if it did so under sufficient guarantees to the financial world that it would be honestly and intelligently maintained.

Next in importance to the settlement of this question of native willingness to accept the new system may be considered the degree of difficulty in maintaining it. It is not surprising, perhaps, that when it was proposed in an incomplete form for British India, it should have been denounced as a "fair weather" device—"a leap in the dark," which would not stand the test of business depression, deficient crops, and an unfavourable balance of trade.[83]

The most serious difficulty which has been foreseen by critics of the gold exchange system relates to the sufficiency of the exchange funds. Up to the period of the general panic of 1907 and the crop failure in India in the spring of 1908, it might fairly be said, perhaps, that the system had not been subjected to any but "fair weather" conditions. The experience of India, however, has thrown striking light upon the possibilities and limitations of the system in time of stress. The test in India has been of such magnitude, moreover, that its results are much more conclusive than any test which might have been afforded in a smaller country dealing with a less enormous mass of token coins. If the test had come before the exchange funds had acquired a respectable size, the system might have been allowed to break down, through timidity and delay in taking proper measures of protection, and discredit have thus been cast upon it before it had been fairly tried.

What happened in India was that the failure of the crops[Pg 220] deprived the country of the usual means of compensating by exports the heavy imports of foreign goods which had been contracted for. It became necessary, under the settled principles of exchange, to find gold to fill the gap. Usually the exchange account substantially balanced itself by the sale in London of Council drafts upon the Indian Government to obtain gold to pay the interest on the debt held in England. These drafts were purchased by importers in London, and used to pay for the Indian crops; but all through the spring of 1908 purchasers for drafts failed to appear, because there had been no considerable exports of Indian crops to be paid for. Hence Council drafts were without a market, and for a moment it seemed that the link which bound the Indian monetary system to the gold market of London had been severed, and that the silver rupee might drop as disastrously as the Mexican dollar before its free coinage was suspended. This would have added the influence of an appalling disaster to the burden already imposed upon Indian finance by the failure of the crops, for it would have compelled the Indian importer of English goods to find a greatly increased number of rupees to meet his gold obligations in London. Obviously, it was a disaster which, if it had occurred, would have invited the bankruptcy of the country, reflected lasting disgrace upon English financial foresight, and perhaps even have led to organised revolt.

The Indian Government had available for meeting the crisis about £18,500,000, principally invested in securities in London. This fund, known as the gold standard reserve, was distinct from the currency reserve, consisting of gold received for currency notes, which amounted in the spring of 1908 to about £12,000,000. It was against the former fund that the Indian Government felt compelled to offer to sell exchange in India. Such offers were made for a time in limited amounts of £500,000 each, but they proved substantially adequate for meeting the demand, and by early summer the demand fell below the supply. The offer of exchange in this form for rupees maintained the value of the rupee coinage, contracted the amount of rupees in circulation in India, and enabled the Indian merchants to meet their obligations without the loss which they must have suffered if the currency had been allowed to depreciate[Pg 221] in gold value. The actual sales of bills upon the exchange funds in London reached, between March 26th and August 13th, 1908, the considerable total of £8,058,000. Of this amount about £2,000,000 was taken from the currency reserve in gold, which was "earmarked" at the Bank of England, incidentally affording relief to the London money market which was keenly appreciated. Most of the remainder was obtained by the sale of securities to an amount which reduced such holdings from £14,019,676 on March 31st to £9,415,708 on July 31st.

The test to which the Indian system, as the most important example of the gold exchange standard, was thus subjected was perhaps of a higher importance than was realised by those in the thick of the conflict. It was plainly intimated, however, in the annual report on financial conditions for 1908 that, if necessary, the Indian Government would have issued short-dated securities in order to still further replenish the exchange funds in London. This would have been the true means of meeting the situation if the existing fund had been unduly impaired. The argument against it would have been that the demand was indefinite, and might become so large as to be unmanageable. The fact that the demand for exchange was met without the issue of new securities and without trenching upon the reserve funds beyond the amount of £8,000,000 out of £18,500,000 affords pretty strong evidence that there is a natural limit to such demands.

It is in this principle, that there is a natural limit to the possible drain upon the exchange funds, that the security of the new system lies.... It is only the supply of local currency on the margin of possible export demands which needs to be safeguarded. The substratum, which can never leave the country unless under the influence of an almost inconceivable economic cataclysm, is analogous in some respects to the "authorised" circulation of the Bank of England. It represents the irreducible minimum below which the local need for currency can never fall. If the supply on the margin of the international exchange movement is adequately guarded, then the whole system is secure. If it were conceivable that the demand for exchange would equal the whole amount of the local currency,[Pg 222] or even the half of it, then it would be necessary to maintain exchange funds equal to the whole amount of token coins or the half of them in order to insure safety. But obviously this could never be the case.

This argument against the exchange standard is only a repetition of the dilemma sometimes presented by untrained minds in regard to bank-notes: what would happen if all the notes should be presented at one time for redemption? That question has been answered by banking experience; the question in regard to the gold exchange system has been and must be answered by experience in substantially the same manner. No country can be subjected to such stress as to consent to part with its entire monetary circulation, or even the half of it. On the contrary, every influence which tends to contract the circulation tends to create a condition which makes further contraction more difficult. Rates for the loan of money are affected, prices of imported goods are influenced, imports fall off and exports increase, and inevitably in the modern money market local equilibrium is restored, often with considerable strain, but none the less without pulling down the pillars of the financial temple.

The experience of last spring in India proves the adequacy of a reserve of 15 or 20 per cent. of the circulation to maintain the steady parity of a token coinage. There is apparently no evidence that serious distrust of the rupee arose, even when the Government was hesitating as to just what steps should be taken to meet the demand for exchange. Even if such distrust had arisen, however, it could have expressed itself through financial channels only by the demand for drafts on London. These would not have been very valuable to the average local tradesman except as he was able to sell them back again to the banks for the very rupees which had aroused his distrust. In this respect the gold exchange standard may be said to put a brake upon the disposition to export currency from fear alone, when the exportation is not demanded by the balance of trade.

If any mistake was made in the management of the Indian currency, it was in the investment of too large a proportion of the gold standard reserve in securities. While investment in[Pg 223] securities is naturally attractive because of the income earned, and while it is not subject to just criticism while kept within certain limits, the possession of actual gold to a considerable amount is highly desirable. It would not be necessary, perhaps, that such gold should be "earmarked." If the Indian Government had a large deposit account in such an institution as the Union of London and Smith's Bank, or the London City and Midland, it would possess for the purposes of the Indian Government the character of gold. Drafts against such a deposit could be sold without the discount or delay which might be required in disposing of securities. It seems highly desirable, therefore, in spite of the prudence with which the recent pressure was met, that at least 30 or 40 per cent. of the gold standard reserve should in the future be kept either in "earmarked" gold or in the form of demand deposits.

In the case of the Philippine Islands the reserve is not "earmarked," but is at present entirely in the form of deposits with New York bankers. The problem in the Philippines is really child's play compared to that in British India. The entire circulation of the Philippine Islands is about 40,000,000 pesos (£4,000,000), against which a large reserve has accumulated as the result of the recoinage at a reduced rate as well as by the profits on the original coinage. It is hardly conceivable that an emergency would arise which would impair this reserve; but if this should occur, the scratch of a pen in Washington would remedy the situation. This would be accomplished by depositing gold or its equivalent in the exchange fund in New York to the credit of the war and navy, and placing an equivalent amount of local currency at the command of the military forces in the Philippines. Such a deposit would operate to increase the resources at the command of military disbursing officers in the Islands without increasing the amount actually in circulation until the occasion arose to disburse it. The Panama currency has been steadily maintained at par by friendly interchanges of this sort, even with a very insignificant official exchange fund. No Governor of the Philippines, therefore, need have any fear of his ability to maintain the parity of the Philippine coinage.

Whether the exchange standard would stand the strain of a[Pg 224] great war is yet to be subjected to practical test.[84] It may be said, however, that its capacity to meet such a test would run upon all fours with the capacity of any monetary system which does not consist exclusively of gold coin. The experience of France in the war with Prussia seemed to justify the suspension of specie payments for the purpose of husbanding the national stock of gold. The history of the Spanish exchange, where the coins have followed the value of the bank-notes instead of that of silver bullion, is another case in point. Both Russia and Japan, however, in the war of 1904-5, succeeded in maintaining complete convertibility of their bank-notes. There is no reason why the gold exchange standard should not be successfully maintained so long as the country where it was established retained its national independence and pursued a sound financial policy. The issue of large amounts of debt would not in itself impair the stability of the standard, unless the Government, in order to obtain gold, ravished the exchange funds in financial centres. The questions involved would be substantially the same as those involved in maintaining the parity of bank-notes or paper money: first, the disposition of the Government to maintain its credit; secondly, the resources which the Government was able to command. Without either good intentions or monetary resources, the monetary system, along with the fiscal system, would break down. It is not apparent, however, that a country operating upon the gold exchange system would find any greater difficulty in maintaining the system than the Bank of Japan had in maintaining the convertibility of its notes during the war with Russia.

If there were a disposition in time of war to transfer capital abroad by excessive demands upon the exchange funds, it could be counteracted in three ways. One would be the automatic influence of the deficiency of currency which would arise at home. Another would be the issue of loans abroad, from which exchange demands could be met. A third would be the deliberate elevation by a small percentage of the charge for exchange. This would amount to a slight depreciation in the[Pg 225] currency, but if kept within prudent bounds, it would probably permit the maintenance of an adequate circulation without disturbance to local prices and without even a theoretical depression below the 2 or 2-1/2 per cent. which affected the notes of the Bank of France in the war of 1870.

The gold exchange system may indeed be said to be an extension of the bank-note system to token coins. The token coin is, in effect, a metallic bank-note, whose maintenance at gold par is subject to the rules of sound banking. Its advantages over the bank-note in undeveloped countries are that it conforms to a strong prejudice in favour of "hard money," not subject to the vicissitudes of tropical climes, and that the output can be more safely regulated, where new coins are issued only for gold, than where a bank may increase its note issues to take over assets of speculative or doubtful character. In the advanced countries, with a highly organised credit system, gold, and gold alone, is the proper form of full legal-tender coin; but in the less advanced countries of the Orient silver token coins have the advantage that they conform in size and denominations to the small scale of local transactions, that they are not so rapidly absorbed by hoarding, and that their very non-exportability enables the Government to keep in circulation a quantity of currency which might under a different system be drained away to richer countries, and leave the community denuded of an adequate medium for carrying on exchanges.

Objections To The Gold-Exchange Standard For The Straits Settlements Answered

[85]... the establishment of the gold standard in the Straits Settlements ... in the spring of 1903 ... provided for the recoinage of the British and Mexican dollars then circulating in the Malay Peninsula into new Straits Settlements dollars ... of the same weight and fineness as the British dollar, and for the subsequent raising of the value of these new dollars to an unannounced gold par by means of limiting the supply,[Pg 226] in accordance with the principle by which India raised the gold value of the rupee....

The objections urged to the adoption of the gold-exchange standard are [were]: (1) That it would unduly interfere with the [foreign exchange] business of the banks. (2) That it would encourage banks to work on dangerously low cash balances, knowing as they would that they could obtain dollars of the Government on a moment's notice by the purchase of cable transfers on Singapore from the crown agents for the colonies in London. (3) That there would be danger of the Government's notes [a part of the circulating medium] depreciating unless they were redeemable in gold in the country itself. (4) That the monetary circulation of the Straits Settlements was too small to make the plan feasible there. (5) That the plan would require a larger reserve fund than would otherwise be necessary, because the Government would be compelled to keep a reserve both in London and Singapore; and that in each place the reserve would have to be large, because drafts on the fund through the sale of telegraphic transfers would not give the Government any such warning in advance of the demands liable to be made as would enable it to replenish the reserve.

The above arguments, all of which were urged upon the writer either by officials or business men in the Straits Settlements, do not appear to be conclusive for the following reasons, which may conveniently be stated in the same order as the objections.[86] (1) If the rates for the sale of government drafts were fixed at the "gold points," as they presumably would be under the gold-exchange standard, and if only drafts of large amounts were to be sold by the Government, redemption by the sale of drafts would not interfere appreciably more with the business of the banks than would redemption in coin. Under these circumstances the banks themselves would be the principal purchasers of government drafts, and such drafts would be purchased and forwarded merely in lieu of the shipment of sovereigns. (2) The sale of telegraphic transfers,[Pg 227] while desirable in the interest of currency elasticity, is by no means a necessary feature of the gold-exchange standard. If the Government were opposed to making a minimum legal reserve requirement of banks, it could limit its sales of drafts to demand drafts or even, if need be, to short-time drafts. (3) If government notes were redeemable in silver dollars on demand, and if the silver dollars were redeemable in gold exchange on demand, depreciation would be impossible in a country where the people have the confidence in the Government which they have in the Straits Settlements. (4) The system of the gold-exchange standard is better suited to a country with a small circulation than to one with a large circulation. It is evidently easier to maintain a small reserve abroad than a large one and the operations with a small reserve are less disturbing to the money market of the financial center in which the reserve is located. (5) It is not probable that the Straits Settlements would require so large a reserve under the gold-exchange standard as it will under the system to be adopted. Under either system it would need a sovereign reserve and a dollar reserve. Under the system to be adopted both reserves will be located in Singapore; under the gold-exchange standard the dollar reserve would be located in Singapore and the sovereign reserve in London. The sale of cable transfers is not a necessary part of the system, as above pointed out; and, even if it were, the movement of market rates of exchange would ordinarily give ample warning of a demand for dollar drafts or sovereign drafts. Emergency cases, if such should arise, could be met through the temporary transfer of funds to the gold reserve from the security portion of the note guarantee fund, or through the transfer of dollars to the credit of the home government in Singapore in exchange for an equivalent amount of sovereigns placed to the credit of the Straits government in London.... A prolonged and severe drain upon the reserve fund, which in a country like the Straits Settlements would be an extremely improbable contingency if the Government withdrew from circulation dollars presented in the purchase of government drafts, could of course always be met by the forward sale on the London silver market of the redundant dollars piling up in the Government's dollar reserve in Singapore.[Pg 228] The gold-exchange standard would probably enable the country to get along with a smaller gold reserve than will the system to be adopted, inasmuch as it would keep gold coins out of circulation and the demands upon it would be limited to the requirements of meeting foreign trade balances—the only monetary use to which the dollars could not be applied. The Straits Settlements, inasmuch as it is a country for whose trade requirements silver coins are better adapted than gold, and a country which is anxious to maintain its reserve at as small an expense as possible, would in fact seem to be a place peculiarly adapted to the gold-exchange standard. The premiums which the Government would realize on its sale of exchange, together with the interest it would obtain on that part of its reserve deposited abroad, would doubtless yield sufficient profit, as in the Philippines, to pay the expenses of administering the currency system and to provide in addition a substantial annual increment to the gold reserve.


[80] Charles A. Conant, The Gold Exchange Standard in the Light of Experience, The Economic Journal, Vol. 19, June, 1909, pp. 190-200.

[81] Le Marché Financier en 1907-8, p. 711.

[82] These figures are from the annual budget statements of the Minister of Finance.

[83] For some of these doubts see London Bankers' Magazine, October, 1908, LXXXVI, p. 435.

[84] Throughout August, 1914, while sterling rates in other countries rose to unprecedented heights, India succeeded in maintaining rates on London in the neighborhood of the gold export point—a striking testimony to the soundness of the Indian arrangements.—Editor.

[85] E. W. Kemmerer, A Gold Standard for the Straits Settlements II., Political Science Quarterly, Vol. XXI, No. 4, p. 663, 678-680.

[86] The answers given to the objections just stated have been confirmed and strengthened by the actual operation of the gold-exchange standard as later adopted by the Straits Settlements.—Editor.

[Pg 229]



[87]In the Purchasing Power of Money (1911) I sketched a plan for controlling the price level, i. e., standardizing the purchasing power of monetary units. This plan was presented more briefly, but in more popular language, before the International Congress of Chambers of Commerce, at Boston, September, 1912. The details were most fully elaborated in the Quarterly Journal of Economics, February, 1913. Following these and various other presentations of the subject, especially the discussion at the meeting of the American Economic Association in December, 1912, the plan was widely criticized by economists, both favorably and unfavorably, as well as by the general public.

On the whole the plan has been received with far more favor than I had dared to hope and even the adverse criticism has usually been tempered by a certain degree of approval.

The object of the present paper is briefly to state the plan and to answer the more important and technical objections which have been raised. Answers to the more popular objections, omitted from this article through lack of space, will appear in a book, Standardising the Dollar, which I hope to publish in 1915.

I shall begin with a skeleton statement of the plan; space is lacking for more. In brief, the plan is virtually to vary each month the weight of the gold dollar, or other unit, and to vary it in such a way as to enable it always to have substantially the same general purchasing power. The word "virtually" is emphasized, lest, as has frequently happened, any one should imagine that the actual gold coins were to be recoined at a new[Pg 230] weight each month. The simplest disposition of existing gold coins would be to call them in and issue paper certificates therefor. The virtual gold dollar would then be that varying quantum of gold bullion in which each dollar of these certificates could be redeemed. The situation would be only slightly different from that at present, since very little actual gold now circulates; instead, the public uses gold certificates, obtained on the deposit of gold bullion at the Treasury, and redeemable in gold bullion at the Treasury at the rate of 25.8 grains, nine-tenths fine, per dollar. The only important change which would be introduced by the plan is in the redemption bullion; we would substitute for 25.8 a new figure each month. The gold miner, or other owners of bullion, would, just as now, deposit gold at the United States Mint or Treasury and receive paper representatives, while the jeweler, exporter, and other holders of these certificates would, just as now, present them to the Treasury when gold bullion was desired.

There would also be a small fee or "brassage," of, say, 1 per cent. for "coinage," i. e., for depositing the bullion and obtaining its paper circulating representative. In other words, the Government would buy gold bullion at 1 per cent less than it sold it. This pair of prices, for buying and selling, would be shifted in unison, both up or both down, from month to month, it being provided, however, that no single shift should exceed 1 per cent., a figure equal to the amount by which the two differ. The object of this proviso is to prevent speculation in gold.

To determine each month what the pair of prices should be, or, what is practically the same thing, to determine what amount of gold bullion should be received and paid out in exchange for paper, recourse would be had to an official index number of prices. If, in any month, the index number is found to deviate from the initial par, the weight of bullion in which it shall be redeemable the next month is to be corrected in proportion to this deviation. Thus, the depreciation of gold would lead to a heavier virtual dollar; and an appreciation, to a lighter virtual dollar.

There are, of course, other details and possible variants of the plan, some of which will be referred to later when necessary.[Pg 231] The objections to the plan are classified under the following heads:

1. "The plan assumes the truth of the quantity theory of money." There is nothing whatever in the plan itself which could not be accepted by those who reject the quantity theory altogether. On the contrary, the plan will seem simpler, I think, to those who believe a direct relationship exists between the purchasing power of the dollar and the bullion from which it is made—without any intermediation of the quantity of money—than it will seem to quantity theorists.

2. "It contradicts the quantity theory." This objection, the opposite of that above, is raised by some, who, like Professor Boissevain, believe in the quantity theory, but imagine that the operation of the plan could not affect the quantity of money at all (or would not affect it to the degree needed). But evidently an increase in the weight of the virtual dollar, i. e., a reduction in the price of gold bullion, would tend to contract the currency, by diverting gold from the mint into the arts; because its reduced price would cause an increased demand and consumption. A decrease, of course, would have the opposite effect.

3. "It might aggravate the evils it seeks to remedy." This objection, raised by Professor Taussig and a few others, is based on the preceding. It is claimed that an increase in coined money may take place for years "without visible effect on prices; then comes a flare-up, so to speak." I doubt if Professor Taussig meant the first half of this statement to be quite so strong. The evidence only justifies the statement that the rise is slow at first and rapid later while similarly the effect of a scarcity of money is slow at first and rapid later. Professor Taussig then proceeds to apply the same idea to my plan:

The cumulative consequence would be like the cumulative consequence of a long continued decline in gold production. After a season or two of declining bank reserves, tight money, and so on, a sudden collapse might be occasioned, and apparently caused, by the announcement of some particular seigniorage adjustment. Then there might be a decline in prices much greater than in proportion to the bullion change.

[Pg 232]

But the working of the compensated dollar would not be in the least analogous to the operation of gold inflation or contraction, even as Professor Taussig supposes it. The plan always works cumulatively toward par, never cumulatively away from par. One often sees a wagon with its wheels on a street-railway track having some difficulty getting off; the front wheels have to be turned at a large angle before they are forced out of their grooves; then of a sudden they jump away. This is analogous to the delayed "flare-up" of prices which Professor Taussig supposes under the influence of a long continued decline or increase in the gold supply. But if the driver instead of trying to turn out is trying to keep the wagon on the track he will pull the horse back at every tendency to turn to the right or left. The more the horse turns to the right the harder will the driver endeavor to turn him to the left. Clearly the effect of the driver's efforts will be to avert or delay, not to aggravate or hasten, any jumping out of the grooves which other causes may tend to produce.

In other words, if it takes as much time as Professor Taussig fears for a pressure on prices to move them, then so much the more certain is it that, under the plan, deviations from par, though they may be persistent, cannot be either rapid or wide. A long continued small deviation gives plenty of time for the counter pressure exerted by the compensating device to accumulate and head off any wide deviation.

Suppose that, following Professor Taussig's ideas, some cause such as an increase of gold production would, in the absence of the compensated dollar plan, gradually lift the price level as follows: during the first year, not at all; during the second year, 1 per cent.; during the third year, 2 per cent.; after which would come a "flare-up" of 10 per cent. We may suppose then that, if the plan were in operation during the first year, there being no deviation visible, there would be no change in the weight of the dollar. After the first month of the second year when prices were 1 per cent. above par, the weight of the dollar would according to the plan be raised 1 per cent. If this were unavailing, so that in the second month the deviation were still 1 per cent., the weight of the dollar would be again increased 1 per cent. Every month, as long[Pg 233] as the deviation of 1 per cent. lasts, the weight of the dollar would receive an additional 1 per cent. Unless some effect were produced on the supposed original schedule of deviations, the weight of the dollar of the second year would be increased 12 per cent., and by the end of the third year by 24 per cent. more, or 36 per cent. in all. But it is clear that by this time, with so swollen a dollar, the "flare-up" scheduled for the fourth year could not occur, but that a counter movement would set in—in fact, would have set in long before the dollar became so heavily counterpoised. Nor could the result of the counterpoise, even if so heavy, be to swing suddenly prices far below par. Prices would, by hypothesis, yield slowly and again give time for taking the counterpoise off. If the price level sank, say to 1 per cent. below par for six months, then to 2 per cent. for another six months and to 3 per cent. in the next six months, evidently the entire 36 per cent. would be taken off in eighteen months (since 1 × 6 + 2 × 6 + 3 × 6 = 36). The compensating device is thus similar to the governor on a steam engine. It is the balance wheel that is largest and hardest to move which is the most easily controlled by the governor. So if the "flare-up" theory is true, the system will work more perfectly than if it were not true.

4. "It would not work unless every single mint in the world employed it." This is an error. Although it could be easily shown to be politically inadvisable for one nation alone to operate the plan, this would not be economically impossible. Those who hold the contrary are deceived by the term "mint price." They reason that our mint price ($18.60 an ounce of gold, 9/10 fine) and England's mint price (£3 17s. 10-1/2d. for gold 11/12 fine) are now "the same," and that, consequently, if our price were lowered 1 per cent., i. e., to $18.41, while the English price remained unchanged, all our gold would be taken to England to take advantage of the "higher" price there. But these comparisons between English and American prices are based on the present "par of exchange" ($4.866 of American money for the English sovereign): which par of exchange is in turn based on the relative weights of the dollar and the sovereign. As soon as our dollar were made 1 per cent. heavier, not only would the new American mint price[Pg 234] go down 1 per cent., but the par of exchange would also go down 1 per cent., to $4.82. Consequently, the new mint price of $18.41, although in figures it is lower than the old, yet, being in heavier dollars, would still be "the same" as the English mint price of £3 17s. 10-1/2d. This sameness of mint price as between the two countries means at bottom merely that an ounce of gold in America is equivalent to an ounce of gold in England.

It is true that each increase in the weight of the virtual dollar in America—in other words, each fall in the official American price of gold—would at first discourage the minting of gold in America. The miner would at first send his gold to London, where the mint price was the same as formerly, and realize by selling exchange on the London credit thus obtained. But the rate of exchange would soon be affected through these very operations, by which he attempted to profit, and his profit would soon be reduced to zero; the export of gold to England would increase the supply of bills of exchange in America drawn on London and lower the rate of exchange until there would be no longer any profit in sending gold from the United States to England and selling exchange against it. When this happened it would be as profitable to sell gold to American mints at $18.41 per ounce as to ship it abroad; and $18.41 in America would be the exact equivalent at the new par of exchange ($4.82) of the English mint price of £3 17s. 10-1/2d.

5. "The system would be destroyed by war." Professor Taussig fears that if money were stabilized, the system would itself be upset by war. "Any war would put an end to it." To this I would reply: first, that if war did put an end to it the system would do good so long as it lasted and its discontinuance would do no more harm than the existence of our present unscientific system is doing at all times; secondly I do not see any reason for thinking that war would put an end to it.

Possibly Professor Taussig has in mind the first form in which I explained the plan, viz., in my book, The Purchasing Power of Money. In that form one country was to serve as a centre and all other countries were to have the gold exchange[Pg 235] standard in terms of gold reserves in the central country, just as now the Philippines have a gold exchange standard with reference to the United States and India with reference to England. Professor Taussig's objection would undoubtedly apply, to some extent, in cases where the plan was carried out through the gold exchange mechanism. But where the system was independently established in each country simply parallel to the systems in other countries, there would be no more need for its abandonment in case of war than for the abandonment now by Germany of the gold standard because England, its enemy, has the gold standard also. We know, of course, that in time of war, the gold standard is often temporarily abandoned in favor of a paper standard; and the new proposal would not escape such a difficulty. This, however, would not be due to the international character of the plan, but to the exigencies of war.

6. "The multiple standard is not ideal. Especially is it faulty when the cause of price movements is entirely a matter of the abundance or scarcity of goods in general." Those who hold this objection point out that an ideal standard would not be one which always smooths out the price level but one which discriminates and leaves unchanged such rises and falls as are due to general scarcity and abundance of goods. There is much to be said in favor of such discrimination as an ideal. It must be admitted that the compensated dollar plan would not discriminate between changes in the price level due to the scarcity or abundance of goods in general and those due to changes in money and credit. It must be further admitted that a theoretically ideal standard would take some account of this distinction. But the compensated dollar plan does not claim to be ideal. The plan would simply correct the gold standard to make it conform to a multiple commodity standard. It does not pretend to correct the multiple commodity standard to make it conform to some "absolute" standard of value.

Such an ideal standard is as unattainable as is absolute space. Changes in relative value indicate change in absolute value, either of goods or of money; but it is not possible for us to know, except in a general way, how much of the absolute[Pg 236] change is in goods and how much in the dollar. On general principles we may be assured that the absolute change is wholly or mostly in the dollar. We economists in our measurements of value are in much the same predicament as the astronomers. Our economical "fixed stars" are fixed only in a relative sense. We cannot measure the empty spaces of absolute value, but can only express values in terms of visible goods, the general average of which is the nearest approach to absolute invariability we can, in practice, reach.

But if it were possible to measure absolute values to our universal satisfaction, in terms, say, of "marginal utility," or of "disutility of labor," or of anything else, there are no statistics by which we can realize such a standard in practice. The only readily available statistics by which we can correct our present standard are price statistics from the great markets. We can, by index numbers based on these price statistics, translate from gold into commodities, but as yet we cannot translate from commodities into any ideal or absolute standard.

If I were treating of the problem of an ideal standard of value, I think I should be inclined to agree with Professor Marshall that a standard that represents a gradually descending scale of prices to keep pace with the "real" cheapening improvements in industrial processes is better than one which represents an absolute constancy of prices. But it would be quite impracticable to discover the exact rate of fall of prices which would correctly register the improvement going on in industry, and, moreover, it would, I believe, be so small as not to depart much from the mutiple standard. This I infer is also the opinion of Professor Marshall.

Professor Kinley makes the very interesting suggestion that we can suppose a more ideal standard than the tabular by making our unit a definite percentage of the national annual dividend. This appeals to me as a rough and ready way of fixing a unit more nearly ideal than that fixed by the tabular standard. But it would certainly not be practicable. It would not even be quite ideal. But if Professor Kinley will measure his standard, the compensated dollar plan will be able to take care of it.

In fact, if we could find a more absolute standard than the[Pg 237] tabular standard and could accurately measure it in statistics, precisely the same method of compensating the dollar could be employed to keep the dollar in tune with that standard as with the tabular standard. The only difference would be that the guiding index would be different. The plan for compensating the dollar does not in essence consist in selecting the multiple or any other standard. It consists in a method of making the monetary unit conform to any standard chosen. But there is convincing evidence that the multiple standard is usually near enough to the ideal for all practical purposes and infinitely nearer than the gold standard. While individual goods may vary greatly in absolute value, the general mass of goods will vary comparatively little and seldom. There may be some absolute change in the general mass of commodities, but it must usually be extremely small in comparison with changes in any one commodity like gold. It is clear from the theory of chances that this must be the case. The odds are hundreds to one that the variations in absolute value in several hundred commodities will offset each other to a large degree. We very seldom have world feasts or world famines. If the corn crop is short in some places it is abundant in others. If it is short everywhere the crop of wheat or barley or something else is practically certain not to be. We cannot expect that everything will usually move in one and the same direction. If there is a war in Japan, it is not likely that there will also be a war in India. A world war or even anything as near to a world war as the present conflict in Europe is a most unusual thing.

A standard composed of several hundred commodities must therefore be, in all human probability, more stable than a standard based, as is our present gold standard, on one commodity. Bimetallists made much of this point when claiming that two metals joined together were steadier than one, just as two tipsy men walk more steadily arm in arm than separately. Still more steady is the average of a hundred commodities just as a line of a hundred tipsy men abreast and holding each other's arms will march even more steadily than two. This is because it is wholly unlikely that every man in the line will lurch in the same direction at the same instant.[Pg 238] The lurching of some in one direction can always be depended on to offset almost entirely the lurching of others in the other direction. This theory of probabilities in its application to the present rise of prices is, I believe, borne out by the facts.

After a careful study of all available evidence, I am convinced that the present general rise in prices beginning in 1896, cannot be traced to any simultaneous scarcity of goods. I refer the reader to Why Is the Dollar Shrinking? where I have given the summary of the evidence. I think the facts are equally clear that the great fall in prices from 1873 to 1896 can not be laid, wholly at least, to the increasing plentifulness of goods.

Finally, even if we could measure and apply an absolute standard, it is doubtful if, in practice, it would be of any more service in regulating contracts, than a multiple standard. For after all, as I have tried to show in Appreciation and Interest what we want in a contract is something that is dependable rather than something that is absolutely constant; and the multiple standard gives dependability in terms of the ordinary staple necessities of life. If we could know that the dollar always means a definite collection of goods, we could know that the bondholder or the salaried man who gets a stated income of $100 a month, would have the same command over actual goods, and such knowledge would be of great service. This whole subject I have discussed in Chapter X of my Purchasing Power of Money.

7. "It would be inadequate to check rapid and large changes of the price level." Owing to the narrow limits, e. g., 1 per cent. as stated, imposed on the monthly adjustments, it is quite true that a sudden and strong tendency of prices to rise or fall could not be completely checked. If prices were to rise 8 per cent. per annum and the plan permitted no more rapid shift than 6 per cent. per annum, this would leave only 2 per cent. per annum uncorrected, or only one-fourth the rate at which prices would rise if wholly uncorrected. But half (or in this illustration three-quarters of) a loaf is better than no bread. Moreover, such extreme cases are rare and when they occur there is all the keener need for mitigation even if it be somewhat inadequate. Ultimately, of course, after the rapid spurt[Pg 239] has abated, the counterpoise, in its relentless pursuit, would overtake the escaped price level and bring it back to par.

8. "The correction always comes too late." It is objected that the plan does not make any correction until actual deviation has occurred, and so the remedy always lags behind the disease. It is true that the corrections follow the deviations. They could not precede them unless we foreknew what the deviations were to be; and we could not afford to entrust the work of guessing to government officials. In this respect, as in others, the plan does not attain perfection; yet it is infinitely better than the present plan, which leaves the standard haphazard. It is also pointed out that after the correction is applied it may happen that prices will take the opposite turn, in which case the remedy actually aggravates the disease. But, taking the extremely fitful course of prices since 1896 and correcting it according to the plan, month by month, as shown in the Quarterly Journal of Economics diagram, we find that in nine cases out of ten the opposite is true. Even in the few remaining cases the deflections were very slight and were, of course, soon corrected immediately after the following adjustments. If the corrections are sufficiently frequent, it is impossible not to maintain, in general, an extremely steady adjustment.

When steering an automobile the chauffeur can only correct the deviation from its intended course after the deviation has occurred; yet, by making these corrections sufficiently frequent, he can keep his course so steady that the aberrations are scarcely perceptible. There seems no reason why the monetary automobile cannot be driven almost equally straight.

9. "The plan assumes that a 1 per cent. fluctuation can be exactly corrected by a 1 per cent. adjustment of the dollar's weight." Owing, I fear, to my own fault of phrasing, I have found that several people have acquired the mistaken impression that the plan requires, to be made at each adjustment, an increase of 1 per cent. in the weight of the dollar for every 1 per cent. increase of the index number since the last adjustment; whereas actually the plan requires, to be made at each adjustment, an increase of 1 per cent. in the weight of the[Pg 240] dollar for every 1 per cent. excess of the index above par then outstanding.

From this mistaken premise it has naturally been inferred that, in order that the plan should work correctly, a 1 per cent. loading of the dollar would always have to exactly correct a 1 per cent. change in the index number, and, very properly, the critics doubted the truth of this. But since the premise was mistaken the objection based on it disappears.

10. "The plan would be sure to create dissatisfaction and quarrelling." This fear is, I believe, wholly imaginary. There would be some ground for it if the proposal were to adopt the old "tabular standard" by correcting money payments through the addition to or subtraction from the debt of a certain number of dollars. Under these circumstances the extra dollars paid or the dollars from which the debtors were excused would stand out definitely and would be a subject for debate and dispute, but if the tabular standard were merged in the actual money of the country the ordinary debtor and creditor would be as unaware of how his interests had been affected as he is now unaware of how his interests are affected by gold appreciation. It would still be true that to the ordinary man "a dollar is a dollar."

If we cannot get the ordinary man to-day really excited over the fact that his monetary standard has affected him to the tune of some 50 per cent. of his principal of fifteen years ago, it does not seem likely that he could get excited because some one tells him that the index number used in the "compensated dollar" plan robbed him of 1 or 5 per cent. as compared with some other possible system.

The debtor class favored in large measure bimetallism, or free silver, as a means of helping them pay debts, while the creditor class opposed it. But this was a question of changing the standard, not of keeping it unchanged. If it were proposed to shorten the yardstick, undoubtedly many who would profit in the outstanding contracts would and ought to oppose it. But there is and can be no contest over efforts to keep the yardstick from changing.

11. "It has never been tried." True; but the proposal is, in mechanism, almost identical with the gold exchange device[Pg 241] introduced by Great Britain to maintain the Indian currency at par with gold. The system here proposed would really be to-day less of an innovation in principle than was the Indian system when introduced and developed between 1893 and 1900, while the evils it would correct are similar to, but vastly greater than, the evils for which the Indian system was devised.

The truth is, unless I am greatly mistaken, that the last named is the only strong objection to the plan in the minds of most of its critics; it is the constitutional objection to any change of the status quo. It is simply the temperamental opposition to anything new. As Bunty well says in the play, "anything new is scandalous." The conservative temperament dislikes experiment because it is experiment. Accordingly it is not surprising that we find many of the objectors saying, "let well enough alone," "let us 'rather bear those ills we have than fly to others that we know not of.'" These people seldom give assent to untried experiments; yet after the new plan has been tried and established they invariably turn about and become its most staunch supporters. This fact has been often illustrated in our monetary and banking system. Nothing short of the shock of civil war was required to divert us from a state system of banking to a national one. In spite of the intolerable evils of the former, it was easy to find many arguments in its favor. After the change these arguments never reappeared. The same was true of slavery.

But conservatism always yields gradually to pressure. Its resistance is strong but has no resiliency. It is not like the resistance of a steel spring (which, when pushed in one direction, will bend back), but a mass of dough or putty which, though it resists impact strongly, yet when it is moved stays inert and does not return. Under these circumstances, even if progress is made an inch at a time, it seems to me worth while to try to make it. The two steps first necessary have been taken, namely, the perfecting of the plan and the running the gauntlet of criticism.

It is not impossible, judging from the many and authoritative endorsements of the plan, that it may be pushed rapidly toward realization. All depends on the opening up of opportunities.[Pg 242] After the present war, for instance, it may be that "internationalism" will come into a new vogue and that some special opportunity will be afforded to bring the plan with its endorsements to the serious attention of the world's administrative officials.

[88]It must be admitted at the outset that the plan, if carried out with iron consistency for a considerable stretch of time, would achieve the result mainly had in view—the prevention of a long-continued and considerable rise in prices. It might not achieve that result as smoothly and evenly as its proposer expects; and the qualifications just stated—that it must be carried out unflinchingly for a long period—should be borne in mind. No one who holds to the doctrine that the general range of prices is determined by the relation between the quantity of commodities and the volume of the circulating medium, and that the volume of the circulating medium in the end depends, ceteris paribus, on the amount of coined money, can do otherwise than admit the logical soundness of the scheme. He who maintains that the rise in prices during the last fifteen years is due to the greater gold supply must admit that a restriction of the monetary supply of gold will check the rise. The plan proposed is in essence one for a regulation in the monetary supply of gold. Its effects must be the same in kind as those of a cessation of free coinage, with an apportioned limited coinage....

The question arises whether it would be feasible for one country alone to adopt the plan. It would be feasible, in the same sense that it would be feasible for all countries together to adopt it. One country alone, carrying it out with unflinching consistency, might secure the desired result, subject to the qualifications which have already been indicated. But that any one country would in fact adopt it alone seems to me in the highest degree improbable.

Consider for a moment the mode in which the scheme would work in detail if adopted by a single country. Though the immediate effect upon general prices within the country would[Pg 243] be unpredictable, the effect upon certain kinds of prices would be certain, predictable, almost instantaneous. Exported commodities would feel the effect at once. Their prices are determined, to use the current expression, by the foreign market. It would be more accurate to say that their prices are determined by the total market, domestic as well as foreign. But it is clear that their prices must be the same (due allowance being made for transportation charges and the like) within the country as without. Now the immediate effect of a seigniorage would be, as Professor Fisher points out, a readjustment of the par of foreign exchange. The exporter would find the par of exchange lessened, and in terms of domestic money (compensated dollars) he would receive less than he got before. All commodities of export would fall in price at once, or fail to rise, to the extent of the seigniorage. Other commodities probably would be unaffected for the moment. In the long run, no doubt, these other commodities (we may call them domestic commodities) would also be affected. But, to repeat, the rapidity and extent of the change in general prices is impossible of prediction. The exporters, none the less, would feel an immediate and unmistakable effect. Beyond question they would be as hotly indignant with the plan as if an excise tax had been imposed on their commodities without any possibility of their raising the price of their products. Consider for a moment what would be the state of mind in our cotton-exporting South. Is it to be supposed that any set of legislators could resist the political pressure from the various exporting sections, and carry out the scheme unflinchingly? Can we imagine a Congressman telling his constituents that they need only wait a while, until all money incomes and all prices had adjusted themselves to the new conditions? that then nobody would be worse off or better off than before? To ask this sort of question is to answer it. The very proposal of the scheme in the halls of Congress would invite the hot opposition of the exporting sections and industries. Its immediate consequences for them would be seen quickly enough, and no promise of ultimate adjustment would lessen their hostility....

Professor Fisher has predicted that prices will rise further.[Pg 244] He is disposed to believe that there will be not only a rise, but that there will be a considerable rise. I hesitate very greatly to enter the domain of prediction. I am inclined to believe that the rise in prices will not cease for the next decade; but whether it will be considerable or moderate or negligible in extent, I should not venture to say. Predictions concerning the output from the mines are to be taken with the greatest caution. We all recall the predictions which Suess made in 1892. The distinguished geologist believed that the prospects of an increased production of gold were of the slightest, and that the world must fall back on the use of both metals. How different the course of events has been from that which he predicted! There are those who believe that the output of gold, so far from continuing to increase, has reached, or is approaching, its maximum. For myself, I should not be surprised if there were a cessation in growth, and should certainly be surprised if there were not a relaxation in the rate of growth.

Further: it deserves to be borne in mind that the total supply of the precious metals is now so much greater than it was twenty years ago that the same annual increment will have much less effect on prices. This is the familiar consequence of the durability of the precious metals....

Finally, a circumstance should be borne in mind which bears not only upon the intrinsic desirability of a regulative plan, but also upon the attitude of the general public and the consequent political and industrial possibilities. Economists are familiar with the difference between the phrase which they use in describing the new conditions, and that which is current in popular discussion. The economists speak of the "rise in prices"; the general public speaks of the "high cost of living." The difference in phraseology is not due simply to variation of the point of view. It results from the fact that very different phenomena are had in mind by the two sets of persons. The economist is thinking and reasoning about the change which has been of special interest for him—the general rise in prices. The man on the street is thinking about the exceptional rise in the prices of one important set of commodities. Any one who will examine with care the index[Pg 245] numbers of our Bureau of Labor will see what a marked rise, much beyond that of the general index number, has appeared in the prices of farm products, and especially in the prices of meat. That special advance has taken place within the last three or four years. It is precisely within this period that general attention has been turned to rising prices. What the public has had chiefly in mind has been the commodities of wide consumption. This, I believe, is the main cause of labor unrest....

Whatever be the particular causes that have led to the high prices of food, economists agree that these causes will operate irrespective of any compensated dollar plan. This would simply serve, at its best, to keep general prices where they are, leaving each particular group of commodities subject to its own particular set of causes. If the compensated dollar plan were to be adopted, and if the prices of food should continue to mount, there would be disappointment for the general public, but nothing to surprise the economist. And conversely, it is entirely possible that the rise in the cost of living, that is, the special rise in the prices of foodstuffs, will reach its end irrespective of any monetary change whatever. The general rise in prices and money incomes ... is not unwelcome to the great majority of people. Its incidental consequences are perceived and debated chiefly by the economists; such as the effects on the creditor class and the slowness of so-called fixed incomes to rise correspondingly. The general public is concerned chiefly with the conspicuous rise in the prices of foodstuffs, which is ascribable to causes very different from those that bring the general rise, and can be reached only by remedies very different....


[87] Adapted from Irving Fisher, Objections to a Compensated Dollar Answered, reprint from The American Economic Review, Vol. IV, No. 4, December, 1914.

[88] F. W. Taussig, The Plan for a Compensated Dollar, The Quarterly Journal of Economics, Vol. 27, May, 1913, pp. 401-416.

[Pg 246]




[90]The monetary unit is the pound, or sovereign, equal to $4.8665, divided into 20 shillings of 12 pence each, each penny equal to 4 farthings. Originally the pound was a Troy pound of silver, .925 fine. Under the law of 1816 gold was made the standard and silver subsidiary. The coinage of gold is free, and to avoid delay the Bank of England is required to buy all gold and pay for the same at once at the [minimum] rate of £3 17s. 9d. per ounce, a [maximum] charge of 1-1/2d. being imposed for the accommodation. Silver is only coined on government account and the coinage ratio is 14.29 to one.

They have the gold sovereign (containing 113.001 grains pure gold), the unit of their currency, also half-sovereigns, crowns (5s.), double florins, (4s.), half-crowns, florins, shillings,[Pg 247] six and three pence pieces, four pence (groat), two pence and penny, all in silver, also penny, half-penny, and farthing in bronze. A few English banks, operating under old charters, issue notes to a limited extent, which circulate as money. Otherwise the paper currency of England and Wales consists wholly of notes of the Bank of England....

Extraordinary measures were resorted to by the British government in the early stages of the European war of 1914; with the close of the war currency conditions will doubtless go back to normal, as described above.

The Government, also, under date of August 6, authorized an issue of currency notes, in denominations of £1 and 10 shillings....

These notes, which were first issued to the public August 7, were deposited with the Bank of England for account of the British government, as the practical way of getting them into use; they were used for various purposes, including advances to banks at 5 per cent. per annum, up to 20 per cent. of their deposits; the volume outstanding December 30, 1914, was £38,478,164; the amount outstanding on June 23, 1915, was £46,199,705. These notes were protected in part by securities and by an increasingly large gold reserve, exceeding 75 per cent. in March, 1915.

Postal orders were made legal tender and so remained until February 4, 1915....


In 1857 the legislature of Upper and Lower Canada formally adopted dollars and cents as the money in which public accounts should be kept. The Confederation in 1867 adopted the same for the Dominion, retaining, however, the sovereign.

In 1871 the Currency Act prescribed the same for all accounts, providing also that the gold coins of the United States of America should be legal tender along with British sovereigns, the latter at a rating of $4.86 2/3.

The silver and bronze tokens (including pieces of 50, 25, 20, 10, 5, and 1 cents) had been supplied from the London Mint, or from Birmingham on its behalf, from 1856 to 1907. After the Confederation no more coins were issued for the[Pg 248] separate Provinces. The twenty-cent piece (though still retained by Newfoundland) has not been struck for Canada since 1864.

From January 2, 1908, the whole supply of British and Canadian coins was undertaken by the Ottawa Mint. By the Ottawa Mint Act the Dominion Parliament undertook the support of a branch of the Royal Mint in Ottawa, the administration to be in the hands of the British Treasury. This system (the same as that of the Australian Branch Mints, Sydney, Melbourne, Perth) was preferred to the plan of an independent Dominion Mint because that was the only way of procuring the privilege of coining British sovereigns.

A royal proclamation published on November 2, 1907, duly established a branch of the Royal Mint at Ottawa, and authorized the coinage of British sterling gold coins from dies prepared in England, such coins to rank with those struck in London. The depositor of gold bullion has the right to demand British sovereigns in exchange....

The British sovereign (or pound) is legal tender in Canada at $4.8666. The American gold coins are also legal tender. Canadian silver coins are 925 parts fine, and have a slightly less amount of fine silver than United States of America silver coins of similar circulating values. The dollar, though sanctioned, has not yet been struck.

Paper currency consists of legal-tender Dominion notes and bank-notes issued against the credit of the banks; there were at the end of 1914, 22 banks, with 3,130 branches in the Dominion, 20 in Newfoundland and 72 in the United States and other foreign countries....

On July 31, 1914, just before the war, Dominion notes were issuable without limit, providing the amount over $30,000,000 was covered by gold. The volume at that time was $112,821,618.53 and the gold held amounted to $90,292,833.28. As a consequence of the war the limit beyond which Dominion notes may not ordinarily be issued without being entirely covered by gold was by an Act passed in August increased from $30,000,000 to $50,000,000....[Pg 249]

British Colonies

The British West Indies, as also Guiana, make British gold legal tender. United States gold also circulates freely. There are a few banks with limited note-issuing power, and minor coins are similar to those of England. There is a growing use of United States currency.

British Honduras has a dollar unit, identical with that of the United States.

British India has ... adopted the gold [-exchange] standard and India has for some years been largely absorbing gold; the pound is the unit—the metallic currency, mainly silver, is maintained at parity with gold by an arbitrary valuation or rate of exchange. The principal coin is the rupee, equal to $0.3244; by a fixed government rating 15 rupees equal £1. There is a gold [-exchange] standard reserve for India, amounting, March 13, 1915, to £25,627,393, about one-half held in India and one-half in London; it consists of gold and investments.... Paper money is issued only by the Government and is covered by gold, silver largely, and securities to some extent.

The Straits Settlements have a dollar currency, divided into 100 cents; the value of the dollar was fixed by the Government at 2s. 4d., on January 29, 1909, and has since been maintained at approximately that rate, a gold [-exchange] standard reserve being accumulated for that purpose. The system is copied after that of India.

Hong Kong, silver standard, is the exchange point between gold and silver countries, and hence important. The British dollar of 416 grains is the principal coin. It fluctuates in value with the value of silver bullion.

Australia and New Zealand have the British system of banking. There are many banks, some with British charters, and many branches; they issue notes covered by gold. Gold in large quantities has been produced in these states since 1851.

British Africa and other minor Eastern possessions have the British system, modified in various respects.

Egypt having recently been formally annexed by Great Britain, her monetary system will naturally be closely identified[Pg 250] with that of England in the future. The English sovereign has been for many years the gold coin of common use.

Latin Union

The Latin Union consists of France, Italy, Belgium, Switzerland and Greece; they are bimetallic, both gold and silver being full legal tender, and the coinage ratio being 15-1/2 to 1; they have identical systems, and formed a union to maintain the parity of silver and gold, at the above ratio, by accepting each other's silver coins; while their systems are bimetallic in law, silver is now coined only in small denominations and on government account. The general adoption of the gold standard by other countries has embarrassed the efforts of the Union to preserve the parity and also the interchangeability of silver coins between these nations.


France has the franc, equal to $0.193, as the monetary unit; the principal gold coin is the louis, equal to 20 francs. The paper currency of France is issued wholly by the Bank of France, a private corporation, privately owned, but whose chief officers are appointed by the Government, which thereby obtains a general control of policy and administration; the maximum amount of note-issue is fixed by law, arbitrarily, and by occasional increase is kept well ahead of the country's necessities; no fixed legal reserve is required, but the total note-issue must be covered by gold, silver, securities, and commercial paper; as a matter of fact it carries very large metallic reserves, and since it may lawfully pay its obligations in either gold or silver, it can always conserve its gold holdings by requiring a premium for the same, or withhold gold payment altogether.

It has over 400 branches and the same rate of discount obtains in all branches on the same day; it thus regulates and controls the interest rate throughout France, in the interest of uniformity and fairness; it may do business with banks or individuals and has many very small loans; its notes are a legal tender; the power to issue currency is one of its chief elements of banking power....[Pg 251]


Belgium is bimetallic and its coins are the same as those of France and have unlimited lawful currency; bank-notes are issued only by one bank, privately owned; the Government receives a share of the dividends in excess of 6 per cent., and imposes a tax upon the note-issues; demand liabilities, including notes, must be protected by a coin reserve of 33-1/3 per cent. and the notes must be covered by cash, commercial paper and securities.


Italy has the lira, equal to $0.193, and divided into 100 centesimi; her coins correspond to those of France; the Bank of Italy largely, and two other banks to a lesser extent, issue notes against their credit, limited, however, to three times their capital, unless covered by gold; the issue may be increased, but comes in for a tax of 1 per cent. per annum and must be protected by a 33-1/3 per cent. reserve in coin and foreign exchange....


Switzerland's coinage system duplicates that of France, and her Federal Bank is very similar to the Bank of France....


Greece ... has for its monetary unit the drachma, equal to $0.193. Her coinage follows the Latin Union agreement. Paper currency is issued both by the Government and by banks, and both are depreciated. Greece had to resort to emergency measures during the Balkan War, which may have an influence upon her currency for some time.


Spain ... has the peseta, equal to $0.193 United States, as her unit. The Bank of Spain has the sole right to issue notes, which may equal five times its capital and must be protected by a 25 per cent. coin reserve. Gold commands a premium. Silver is coined only on Government account....[Pg 252]


Germany, gold standard, has for her currency unit the mark, of 100 pfennig, equal to $0.238; the 5-mark piece contains the same amount of pure silver as the 5-franc piece and two United States half-dollars.... Silver is legal tender to the amount of 20 marks. The coins for her colonies are varied to suit local needs.


Austria-Hungary, gold standard, has as its unit the krone, equal to $0.2026; 20-krone and 10-krone pieces are coined in gold, also gold ducats, worth $2.288; silver coins are of various fineness....


The Portuguese Government, by decree of May 22, 1911, adopted a new monetary system and the coins will be placed in circulation as soon as possible. The unit of the system, excepting for her possessions in India, is the gold escudo,... equal to $1.08 American gold. The escudo is divided into 100 equal parts called centavos.... Multiples are 2, 5, and 10 escudos. Divisions of the escudo are of silver, with values of 50, 20, and 10 centavos; subsidiary coins consist of bronze and nickel pieces. Her currency is not maintained at a parity with gold.


... The unit is the florin or guilder of 100 cents, equal to $0.402. The 10-florin piece is the principal gold coin; the ryksdaalder (2-1/2 florins), the florin and half-florin in silver are legal tender, as well as all gold coins; silver is maintained at parity with gold by law; coinage of silver is only on Government account; paper money is issued by a central bank and 40 per cent. metallic (gold and silver) reserve is required against deposits as well as notes; the balance of the notes are covered by negotiable instruments. The central bank was organized in 1814. Banking in the Netherlands is excellently managed.[Pg 253]

Sweden—Norway—Denmark (Scandinavian Union)

These have the gold standard and have for their unit the krone, equal to $0.268 United States currency; their subsidiary silver has various fineness; paper currency of Sweden is issued by the Royal Bank, owned by the Government; notes are legal tender and may be issued to a fixed amount in excess of gold on hand or in foreign banks, but must at all times have gold to the extent of at least 10,000,000 kroner.

Norway has a single bank of issue, controlled by the State, which owns a majority of the stock; notes are legal tender and may be issued to twice the amount of gold on hand and in foreign banks.

Denmark's paper money is issued by a privately owned bank, but under strict control by the Government; the notes are legal tender and may be issued to a sum 30,000,000 kroner in excess of the gold on hand.


Russia is on a gold basis and has for its unit the ruble, of 100 kopecks, equal to $0.51456 in United States currency; the silver coins in common use are the ruble, one-half and one-fourth ruble; paper money is issued by the Imperial Bank, which is owned by the Government and managed as part of its finance department; the law requires the coin reserve to equal two-thirds of the note issue....


Japan maintains the gold standard and its unit is the yen, equal to $0.498; the yen is divided into 100 sen, the sen into 10 rin. The yen equals 11.574 grains of pure gold.

The Bank of Japan may issue notes to the extent of $120,000,000 upon securities, any amount upon specie, and also may issue further sums in excess of specie, subject to a tax of 5 per cent. The stock of the bank is all privately owned. Japan first copied the national banking system of the United States and after trial abandoned the same for a central bank. She has managed her finances and her banking with wonderful ability and great success. Besides the Bank of Japan, there[Pg 254] are many strong private banks, notably the Yokohama Specie Bank.


China, silver basis, had for its unit the tael, divided into 1000 cash; there are said to be sixteen different kinds of tael in the different states of China; the most valuable is the "Haikwan," or "customs tael," the one in which customs dues are reckoned, and this equalled $0.664 United States currency, October 1, 1914. The cash is of base metal, with a square hole punched in the centre and is worth less than a mill in our currency.

In the last years of the Empire a new system of coinage was established and since continued by the Republic. The unit is the yuan of silver, worth $0.477, but varies with the price of silver; one-half, one-fifth, and one-tenth yuan are also coined in silver and smaller coins in copper and brass....


The unit of value is the peso, equal to $0.50 in United States currency. The fiscal affairs are administered by the United States and the currency is safe and maintained on [essentially] a gold basis.


At a time when the cultivation and development of trade relations with South America seem most alluring, we find a principal embarrassment in the currency and credit conditions which obtain in most South American States, but Argentina, one of the most favored of South American States, has a stable and sound currency system. Her unit is the peso, of 100 centavos. The gold peso is equal to $0.9647 in United States money. In 1889 the Government took measures to acquire gold and fixed the relation of paper to gold at 227.27 per cent., and it has since been maintained at that level without fluctuation. This made the paper peso equal to about $0.44 gold. They have a very large gold reserve in their caja de conversion, 262,000,000 pesos gold, which protects the paper money and gives it stability. Gold payments were suspended[Pg 255] temporarily at the commencement of the European war (1914), but paper money seems to have remained at par....


Brazil was formerly a colony of Portugal, and naturally copies the parent country in her currency system. Her unit is the milreis, of 1000 reis. Nominally the gold standard prevails, but depreciated paper is the currency of her commerce. The milreis contains 12.686 grains of pure gold and is worth in United States currency $0.546.

In 1898 the Government assumed the sole power to issue paper money, and strove to bring the same to a parity with gold; the arbitrary valuation put upon the milreis by the Government was 15d. or $0.30.

On December 20, 1910, the value of a milreis was raised to 16d. The Government accumulated a conversion fund, understood to be $60,000,000 to $70,000,000, but owing to crises at home and abroad it has not yet been able to make gold and paper notes interconvertible.

Brazil possesses an enormous area, and is wonderfully rich in undeveloped resources. Her coffee and rubber are especially valuable and should take care of her international trade balances. In the near future her currency should become stable and free from fluctuation. Brazilians receive important service from foreign banks and bankers.


Chili has the gold standard, but her paper currency is not maintained at a parity with gold; her unit is the peso, of 100 centavos, of the value of 18d....


[89] The following table, from The Monetary Systems of the Principal Countries of the World, compiled in the office of the Director of the Mint, Washington, 1912, gives the weight, fineness, etc., of the coins of Great Britain:

Denominations.Weight.Fineness.Fine weight.Weight.Pure gold or silver.Value in United States money.
5 pounds39.9410916-2/336.6125616.3720565.0080$24.3325
2 pounds15.9764916-2/314.6450246.5488226.00329.7330
Half sovereign3.9941916-2/33.661261.637256.50082.4332
Half crown14.137992513.0775218.1760201.8119$0.6083
Fourpence (groat)1.88509251.743629.089326.9071.0811

[90] A. Barton Hepburn, A History of Currency in the United States, pp. 450-473. The Macmillan Company. New York. 1915.

[Pg 256]



[91]The trust company supplements the bank. Through a long process of evolution the bank has developed as a means of facilitating the exchange of commodities. The trust company is a still further step in the same process, and, in a highly organized society, it meets needs which the bank is not able to supply.

In a new community the general store forms the centre of the business life of the place. With growth and increasing trade, the private banker sees room for the profitable employment of his funds. The state or national bank meets the needs of further growth. Success and the accumulation of wealth pave the way for the trust company. The bank is organized primarily to serve the needs of active commercial life; the trust company handles funds in less active circulation.

It is customary for the courts to designate or approve certain trust companies as depositories for funds paid into court, and the effect of such designation or approval would be to relieve executors, trustees, or others acting in a fiduciary capacity and depositing with these companies from liability for loss through their failure. A person charged with due care in the selection of a depository could not be held to have been wanting in such care in choosing as a depository a trust company which the court has itself approved.

The powers of trust companies vary in different states, and when they are created by special legislation, local companies are found with different charter privileges. The capital and surplus of these institutions are liable for their acts in fiduciary[Pg 257] capacities, and in some states they are required to deposit with one of the state departments a fund as a special guarantee. The liability assumed is generally accepted by the courts in lieu of the bonds which individuals acting in similar capacities are required to give.

The development of trust companies in the United States has been remarkably rapid. Since 1882, when the first legal authority was given for the exercise by corporations of fiduciary powers, they have steadily grown in number until there are now more than fifteen hundred, distributed as follows:

District of Columbia5
New Hampshire4
New Jersey86
New Mexico10
New York78
North Carolina38
North Dakota5
Rhode Island11
South Carolina17
South Dakota12
West Virginia22

Their business in all departments has shown a steady increase, and the trust companies of the United States to-day carry deposits amounting to over $3,858,300,000. Net deposits in the 7397 national banks aggregate $5,891,670,000.

In some states commercial banking and trust powers are exercised by the same companies. In such cases, separate departments are maintained for the various classes of business. Another method is for the same individuals to organize a national bank and a trust company, the former under national and the latter under state laws.

The securities company or trust company organized under state laws and controlled by a national bank with the stock interest in the former distributed among the owners of the stock of the bank and evidenced by indorsement on its certificates is still another expedient which has been resorted to in order to enable a closely affiliated and controlled organization[Pg 258] to exercise legitimate functions which are, however, outside the province of a national bank.

The earning power of trust companies has equalled and even exceeded that of the banks, and the stock of those companies which are well established and doing a flourishing business sells at such a premium that investment in it at its market value gives a very low return.

Trust company failures have been few and far between, and where they have occurred they can be traced to a disregard of sound banking principles and to the assumption of unwarranted risks. Even in the case of companies which have failed there is no record of any impairment of trust funds, whatever loss there was having been borne by the stockholders and, to a less degree, by the depositors. This fact, the result of the absolute separation of trust assets from assets belonging to the company, is the strongest argument for the employment of trust companies in fiduciary capacities, and explains their rapid growth in popular favor.

The literature put out by these institutions invariably recites the advantages to be gained by dealing with them instead of with individuals. The following is a good example of such reasoning:

The Advantages of a Trust Company as Trustee

A trust company is preferable to individual trustees, because it possesses every quality of desirability which the individual lacks, to wit:—

(1) Its permanency: it does not die.

(2) It does not go abroad.

(3) It does not become insane.

(4) It does not imperil the trust by failure or dishonesty.

(5) Its experience and judgment in trust matters are beyond dispute.

(6) It never neglects its work or hands it over to untrustworthy people.

(7) It does not refuse to act from caprice or on the ground of inexperience.

(8) It is invariably on hand during business hours and can be consulted at all times.

(9) Its wide experience of trust business and trust securities is invaluable to the estate.[Pg 259]

(10) It is absolutely confidential.

(11) It has no sympathies or antipathies and no politics.

(12) It can be relied upon to act up to its instructions.

(13) It does not resign.

(14) All new investments of value suitable for trust estates are offered in the first instance to trust companies, and in that way it has a choice of valuable security; and as its purchases are on a scale of magnitude, it can usually buy at a rate which is lower than that at which the individual trustee can purchase.

The most common objection to the appointment of corporate trustees is thus stated by Augustus Peabody Loring, Esq.:

The trust companies, which have of late years become so numerous, to a considerable extent do away with the element of personal risk attaching to an individual trustee; but they lack the advantages of personal management. These companies sometimes fail from improper management as utterly as individuals do, and as a rule the lack of personal management results in securing the minimum return only on the amount invested, and lacks the great advantages often secured by the able personal oversight of individual trustees.

The question, after all, comes back to the personal qualifications of corporate officers and individuals. If the former are less capable than the latter, the fault is with the particular company—not the system, and if interest returns are sometimes less under corporate management, this fact is more than equalized by the added safety to the corpus of the estate.

A "Trustee Company" has been suggested as a proper title for the company doing a legitimate trust business, and is the name used in Australia and in New Zealand. In some states the use of the word "trust" in corporate titles is now regulated by law. Confusion has arisen in the popular mind between the trust company and the trusts or industrial combinations.

The usual functions of a trust company are: banking in a more or less limited form, execution of corporate trusts, execution of individual trusts, care of securities and valuables. In addition, other functions are sometimes exercised, such as life, title, and fidelity insurance, and the business of becoming surety. The earlier companies in the United States were chartered to manage individual estates only and to act in certain[Pg 260] fiduciary capacities; the recent development of the trust company has been in the direction of banking functions and corporate trust business.

It is worthy to note that the life insurance companies which originally secured trust powers have, with but few exceptions, given up their life insurance business, and that most of the fidelity insurance and surety business is given over to companies which now make a specialty of such risks. The fact is being recognized that the assumption of vast risks contingent on future occurrences is not compatible with the absolute security which is essential in the transaction of legitimate trust business.


The banking functions of trust companies may include any or all of the following:

The receipt of money deposits payable on demand and subject to check, or payable at a fixed date, or according to special agreement. Interest is usually allowed on all deposits above a fixed maximum amount or on the total sum.

Money advances secured by the hypothecation of stocks, bonds, life insurance policies, bonds and mortgages, or other personal property.

Real estate loans, secured by bond and mortgage. It is customary to loan not over two-thirds of the value of improved property; when the property is unimproved, not more than half.

Discounting paper is engaged in principally by companies transacting a commercial banking business. The purchase of unsecured paper is permitted in some states where discounting is not allowed.

The purchase and sale of securities.

Trust companies sometimes guarantee issues of bonds, or at least set their stamp of approval upon them.

The issue or guarantee of letters of credit, and the transaction of a foreign exchange business.

The care of savings deposits. For this purpose a separate department is usually maintained.[Pg 261]

Corporate Trusts

Among the most important functions of a trust company are those relative to the business of other corporations:

Of late years the trust companies in the Eastern cities have been selected as trustees instead of individuals whenever the law of the State where the property was situated allowed such selection. Trust companies have manifold advantages over individuals in such a relationship; they do not die; the large amount of financial business which they daily transact provides them with the machinery for such purposes; while their well-known names stand as evidence to the purchasing public that at least the necessary formalities have been complied with. Beyond that responsibility the trustees of corporation mortgages usually assume none.

In recent years the trust companies have shown a tendency, when acting as mortgage trustees, to recognize a greater moral responsibility than they at first were willing to bear. Trust companies did not, of course, intend to appear as in any way guaranteeing the bonds to which they certified, though that seems often to have been the erroneous opinion of the unthinking; but trustees now acknowledge themselves bound within the limits of the mortgage to use their influence to protect the interest of the bondholders. A trust company which should now allow the issue of unsecured bonds because of some glaring defect in the language of the mortgage, would not longer be morally excused by financial opinion, though perhaps held technically innocent.[92]

As trustee under corporate mortgages and trust deeds, the trust company acts for the bondholders. It is customary for it to authenticate each bond issued subject to the provisions of the mortgage, to represent the bondholders in case of default, and to exercise such other functions as may be provided in the mortgage.

A generation ago it was customary for a railroad to name one or more individuals as trustees of the mortgages executed to secure bond issues. The development of trust companies and their manifest advantages over individuals in such a capacity has resulted in their absorbing almost all this business. Trust companies are now generally appointed as trustees in corporation mortgages, and are also often named to succeed individuals who have died or resigned. The appointment[Pg 262] is one of the most important and far reaching which the trust company can accept. Its name and reputation serve as an assurance that the transaction is a regular one, and entered into in good faith. Although the modern corporation mortgage is usually explicit in its terms to the effect that the trustee in no way guarantees the value of the security and assumes no liability except for its own negligence, yet the intimate connection between the trustee and the borrowing corporation in the minds of investors makes it necessary that care be taken not to assume trusteeships which may lead to a wrong use of the name and credit of the trust company.

As trustee under mortgages securing bond issues, the title to the mortgaged property is vested in the trust company for the benefit of the security holders. The corporation owning the mortgaged property retains physical possession of it so long as the terms of the obligation are complied with, except in the case of securities pledged, which are usually lodged with the trustee. In case of default, however, it devolves upon the trustee to protect the interests of the bondholders, and this may necessitate the foreclosure of the mortgage and sale of the property.

As fiscal agent it dispenses coupon and interest payments on bond issues, and dividends on stock. It receives sums set aside as sinking funds to provide for the retirement of obligations at maturity, or when bonds are subject to redemption, draws the specified amount by lot and pays the principal.

As registrar the trust company authenticates certificates of stock and bonds in order to prevent an over-issue, and to reduce the chance of loss or theft. As transfer agent, the company attends to perfecting transfers of ownership for stock and bond issues or parts thereof.

The New York Stock Exchange, like most other stock exchanges, in its constitution requires that all active listed stocks must be registered. This Exchange also requires that a trust company or other agency shall not at the same time act as registrar and transfer agent of the same corporation. In the popular mind, and even in the minds of some trust company officers, the difference between the duties of the two positions has been more or less confused. Both have been created to[Pg 263] safeguard and facilitate the passing of title to shares of stock, but the duties of a transfer agent and a registrar are not synonymous; they are distinctive. One is called upon to examine and give clear titles to property transfers, and the other is merely to record such transfers.

As manager of underwriting syndicates, the trust company issues the prospectus and markets the securities of corporations which are being launched, or of established companies which are putting out new securities.

In railroad and other reorganizations, the trust company takes a prominent part, acting both as a depositary for, and as a representative of, the committees which formulate and execute the plans of reorganization. Its officers often have a large share in the preparation of such plans.

As assignee and receiver, the trust company acts in the same capacity for corporations as for individuals and firms or partnerships, assisting in winding up insolvent businesses and in conducting embarrassed ones.

Individual Trusts

The execution of individual trusts is the function originally assumed by trust companies. The various other forms of business which are now engaged in, have, with the exception of life insurance, been later developments of the trust company idea. The earliest power granted these companies was to receive moneys or other property, real or personal, in trust. The trust company now also acts as executor and administrator of the estates of decedents.

As executor appointed by the will of a decedent, it takes out letters testamentary upon probate of the will, advertises, files inventory and appraisement, pays debts, collects claims, makes the requisite accounting to the probate or orphans' court, and makes distribution of the estate in accordance with the terms of the will and the court's decree.

As administrator acting under appointment of the register of wills or probate court, it performs similar duties, distributing the estate in accordance with decedent's will if there is one, or if there is none, in accordance with the intestate laws of[Pg 264] the state, which specify the order of succession and distributive shares in the case of estates of decedents leaving no wills. There are different kinds of administrators, in any of which capacities a trust company may be called upon to act.

As trustee under will, the trust company carries out the provisions of the will, investing and managing the estate or particular fund in accordance with the directions of the testator. As such it may hold real and personal property.

As trustee under deed or private agreement, a contract is entered into between the company and the owner of the property, by which the title to the property is vested in the corporation subject to the terms recited in the instrument. Such deeds of trust may be revocable or irrevocable. Marriage settlements are frequently made in this way.

The trustee's duty in investing the funds is a double one; namely, to invest them securely so that the principal shall be preserved intact, and to invest them as productively as possible under his powers, so that they shall yield the best rate of interest obtainable for the benefit of the person or persons entitled to the income. He must hold the scales evenly, regarding scrupulously his duties to all beneficiaries. The popular idea that security is the only consideration is erroneous, as the trustee is equally bound to invest the funds as profitably as possible and cannot neglect one duty more than the other. The mistaken impression that the corporate trustee, even more than the individual, is mindful only of the safety of the principal and entirely loses sight of the question of income, has arisen from the restrictions as to investments imposed by law, and frequently also by the will or trust deed, and from the fact that the individual executor or trustee, rightly or wrongly, sometimes assumes risks and personal liability which the proper rules of a trust company would not permit it to assume.

The executor or trustee is governed, as to the kinds of investments, by the directions of the will or deed of trust. This may require the purchase of "legal investments" only, or state that the trustee is not to be confined to securities prescribed by law, or give specific directions as to the classes of securities which are to be bought. The terms of such documents[Pg 265] are always strictly construed by the courts; if no directions are given, the trustee is expected to buy only "legal" securities, and when he exceeds his powers he is held responsible for any loss. Administrators and guardians without broader powers given by will are obliged to invest, except at their personal risk, in such securities as are sanctioned by law or directed by the court.

Some states prescribe by statute the securities in which a trustee may invest. "Where there is no statute or decision of the highest court fixing the class of securities in which a trustee may invest, he can safely follow the rule prescribed for the investment of the funds of savings banks." In general, city, State, and United States bonds, first mortgages secured on improved real estate with ample margin, are among the investments sanctioned by law. As to real estate, stocks, and first mortgage bonds of railroad, manufacturing, and other corporations, the practice varies in the different states. Loans on personal property, second mortgages, and other investments subject to prior liens or of a speculative character are excluded. All investments must possess "intrinsic" value; the courts hold trustees liable for any losses from speculative risks—but any gains accrue to the trust estate.

Other Functions

The trust company acts as guardian, curator, or committee of the estates, and in some states, of the persons of minors, those who are insane or mentally incompetent, spendthrifts, drunkards, and any other persons not legally qualified to take charge of their own affairs. In the case of a minor, the trust terminates on the ward's becoming of age; in other cases, when the disability is removed, or in accordance with a decree of court. These appointments are frequently made by order of court, and to it accounting must be made. In some states the company is styled "conservator" when caring for the estates of persons of unsound mind.

When acting as attorney in fact, the company obtains its authority by virtue of a letter of attorney which usually is or can be recorded, conveying certain definitely specified powers.[Pg 266] This may be either to perform a single act—such as to satisfy a mortgage—or may be broader and continuing, granting authority to sell and transfer securities and collect income. A general power of attorney, as the term indicates, is a delegation to another of the general powers of the person appointing—as to payments, collections, transfers of property, and all transactions of a business nature.

As agent merely, the company takes charge of property, real or personal, for its owner, but such agency does not imply nor ordinarily include authority to sell or convey title. Moreover, trust companies as agent often take up lines of business which they either cannot or would not engage in on their own account. Thus, a trust company can act as agent for fire or life insurance companies, for water, gas, and other public service corporations. In new communities and where it is difficult to find responsible representatives, the trust company can often render efficient service and secure a steady income without risk by assuming agencies of various sorts.

As assignee the trust company takes possession of the property assigned for the purpose of carrying out the terms of the deed of assignment in the interest both of the assignor and the creditors of the assignor. The deed of assignment is an acknowledgment of an embarrassed or insolvent condition, and the efforts of the assignee are directed to realizing as much as possible from the assets intrusted to its management.

As receiver, the duties may be very similar to those of assignee, although they are usually broader in scope. The business may not be insolvent, and the application for the appointment of a receiver may be due to temporary difficulties only. By such an appointment the property is preserved intact and equal treatment is afforded creditors. An able receivership often results in the adjustment of difficulties and the return of the property to its owners on a paying basis. While in the case of assignee the appointment is by the individual, partnership, or corporation executing the deed of assignment which specifies the powers and duties of the assignee, in the case of receiver the appointment is by a court and the company so appointed acts as an appointee or ministerial officer of the court, and as such is directly subject to the court's orders.[Pg 267]

A trust company acting as receiver is better able than an individual to furnish additional capital, if amply secured, and thus successfully to meet the difficulties which withdrawal of credit and restricted capital have temporarily brought upon an otherwise prosperous business. The courts authorize the issue of receivers' certificates to provide funds for purchase of equipment and the proper maintenance of the property and conduct of the business when the creditors are benefited by such expenditures. Such certificates may be made a first lien on all assets, taking precedence even of mortgages and other secured obligations. The receiver thus secures the capital necessary to make the property more productive and to secure the largest return from the business.

As custodian or depositary, the trust company sometimes holds property the title to which is in dispute, delivering the same when the ownership is legally determined.

In taking charge of escrows or conditional instruments or deeds delivered to a third party until the condition is performed, the trust company acts in a similar capacity, as the joint representative of both parties.

The trust company acts as the representative of both the living and the dead in practically every legal relation in which an individual is qualified to act. Its function is not only to keep intact the estate of which it has charge, but to look to and safeguard the interest of every beneficiary.

Care of Securities and Valuables

The functions already recited have resulted in the assumption of the duty of caring for property other than that of the estates held in the trust department. In the safe deposit department, individual safes are rented, bulky packages—not containing stocks or bonds—are received on storage, certificates of deposit covering securities are issued, and provision is made for access to, and examination of, the property so deposited. For personal property received on storage, the charges are either according to bulk or value. Wills are usually receipted for and kept without charge.[Pg 268]


The examination and insurance of real estate titles is a later development often found in connection with the usual trust functions.

Fidelity insurance and suretyship providing against loss by reason of the dishonesty of individuals and the non-performance of obligations, contracts, etc., have often been combined with the various forms of trust company activity. They are, however, largely passing into the hands of corporations especially organized for the transaction of such business.


When acting as trustee under corporation mortgages, a definite charge may be made for accepting the trust, and a fixed amount per annum thereafter for paying coupons and performing other duties. For the certification of bonds it is usual to charge fifty cents per bond in the case of large issues, and one dollar for small issues. The figures, however, vary in different places. The charge for certifying the bonds may be the only one, although an additional charge is usually made for counsel fees. In case of default and consequent foreclosure of the mortgage, extra payment is made to the trustee covering all services incident to the foreclosure.

For the disbursement of sinking funds, interest, or coupons, the temporary use of the money may be considered adequate compensation, if the amount involved is large. A commission on the sum distributed or a fixed amount is charged when acting as fiscal agent, apart from duties in other capacities. For acting as registrar or as transfer agent it is usual to make a fixed charge per annum, based on the amount of labor involved. The transfer agent is usually paid about twice as much as the registrar. Compensation for acting as manager of an underwriting syndicate may be a fixed sum or a commission, according to the provisions of the underwriting agreement. For acting as depositary under plans of reorganization, assignee, or receiver, a lump sum is usually paid covering all services. Agency work of various sorts is paid for in accordance[Pg 269] with the usual practice in the business which is undertaken; a fixed sum, or a fixed sum and a commission, or a commission only, may be received.

The trust company is in a position to render valuable, and often indispensable, aid to its corporate clients. Large amounts being involved, the great railroad and industrial corporations are willing to pay well for such services. Corporate trust business has, consequently, been a profitable field for the trust companies.

Government Regulation

An examination of the laws of the various states is interesting as showing the attempts which are being made at regulation. Most of these laws have been enacted within recent years and to-day there are but few States which do not have such statutes on their books.

The step which Massachusetts first took in requiring a legal reserve to secure deposits has been followed by similar action in other states. In general, the wisdom of prohibiting companies which engage in the care of estates from assuming excessive risks is becoming better recognized. The promotion and underwriting of commercial ventures and the assumption of unknown risks are functions not compatible with the proper exercise of the duties of trustee or executor.

The supervision of trust companies by the separate states provides an elastic system to supplement the rigidly guarded powers of the national banks, and can adapt itself to changing conditions and enlarging needs, leaving for solution according to the requirements of each section of the country such questions as proper functions, reserves, and the authority to establish branch offices.


[91] Adapted from Kirkbride and Sterrett, The Modern Trust Company, pp. 1-13, 113, 114, 127, 143-146, 204, 205, 208. The Macmillan Company. 1913.

[92] Thomas L. Greene, Corporation Finance, p. 59.

[Pg 270]



[93]The savings bank works with those unacquainted with the ways of business and who could not single handed take good care of their money, or invest it safely or profitably. The bank of discount is generally managed by business men versed in the ways of business, acquainted with monetary affairs, and able to conduct financial operations with intelligence. They combine their capital in order to make it effective; the savings bank combines savings in order to make them capital, and as such to acquire a power impossible to the scattered savings.

The savings bank is for the saver; its funds are invested permanently, while the business bank opens its doors to business men and loans rather than invests its funds, and for a short time only. The latter deals with borrowers rather than savers, and serves for hire. The one serves best by keeping—the other by lending. One aims at profit, while the other never makes (or should make) profit an end. The savings bank is the receiving reservoir for the little springs, the bank of discount is the distributing reservoir for accumulated capital.

We must get the last idea clearly in mind or we get a misconception of the savings bank. However much the element of interest may figure in the management, and whether we pay depositors 4 per cent. or 3 per cent., or no interest at all, the accumulation of interest is not to be compared in importance with the accumulation of principal.

No man ever acquired riches at 4 per cent. In fact, 4 per cent. upon small deposits is so trifling a matter that it may be ignored in considering the greater value of the increase of capital. However desirable the accumulation of interest may[Pg 271] be (and this in the course of years is considerable), the chief end and aim of the savings bank should be the accumulation of principal.

Classification of Savings Banks

We may roughly classify savings institutions into: First, mutual (trustee), or philanthropic; second, stock (including "savings and trust companies"); third, co-operative, or democratic, as exemplified in the co-operative banks of Europe. The first are usually managed by a self-perpetuating body of trustees, who do not share the earnings; the second are managed by the directors elected by the stockholders; the third are managed by officials elected by the members.

A second classification may be made into public and private institutions; the first includes the postal and municipal banks; the private embraces the mutual, stock, and co-operative. A third classification may still be made into the "unit" and the chain system. In the unit system the bank is an independent entity and has no connection (aside from a managerial standpoint) with any other bank. The banks of the United States are all, excepting the Postal Savings Banks and a few branch savings banks, of this character. In the second, the bank is but a part of a chain, as in the postal system, the municipal banks of Germany, and the co-operative credit banks of Europe. We shall briefly review each system.

Trustee Savings Banks

The original savings bank is the trustee bank. As Hamilton says, "It stands for the attempt on the part of the well-to-do to improve the condition of the poorer classes, and involves a self-sacrificing service on the part of a few in the interest of the many." While many of the early savings banks partook of this character, others were organised from purely selfish motives and were characterised by bad management and bad faith from the start. A study of savings bank frauds will amply bear out this statement.

The "spirit of commercialism" hereafter spoken of has[Pg 272] invaded the domain of the mutual savings bank and it cannot in truth be said that some of the newer banks were organised from any spirit of philanthropy, although the management as a whole may be above suspicion and honorable in the highest degree.

But, however this may be, the mutual savings bank is a product of the East and promises to remain so in spite of the fact that some of the Western states have very good, if not excellent, savings bank laws.

The distinguishing characteristic of the trustee savings bank is mutuality. All the earnings of the bank, less reasonable administrative expenses and the apportionment to surplus or guaranty fund, are divided among the depositors in the form of interest.

One or two features of the mutual bank may be mentioned. First, the investments of such institutions are usually carefully restricted, looking primarily to the element of safety; and as long as the trustees keep their funds so invested they cannot be held, either in law or morals, responsible for losses. Second, the predominancy of the mortgage loan. The nature of the deposits being more or less permanent, investments of a permanent character may be made without fear of a sudden demand for their return on the part of depositors; and to safeguard the banks from such unexpected calls, quite generally trustee banks are permitted by law to require notice, the usual time being either sixty or ninety days. The third distinguishing feature is the self-perpetuation of the board of managers. No amount of money can buy a man's way into a mutual savings bank. He cannot, as in stock concerns, buy enough stock to vote himself into office—he can only gain office as the other men advocate his cause. And, on the contrary, he cannot be voted out of office. Only an act, such as bankruptcy (which voids his office), can affect him, and, like a Supreme Court judge, he is appointed during good behavior.

The greatest weakness of the trustee bank is this: Lacking the "essential element" that prompts men to undertake such ventures (profit), it does not appeal to the average man of means unless he is sentimentally inclined; and not being indispensable to trade and commerce, like a bank of discount,[Pg 273] it does not come to be a commercial necessity. Even in a great State like New York we find twenty-eight counties with no savings banks. And in many of these counties there are large and thriving towns and cities. Thus the city of Jamestown, with over 30,000 population, has no savings banks; while Elmira, with over 35,000 population, has but one, and that with but half a million assets.

From the viewpoint of intensive results, as tested by the volume of patronage accorded these institutions, a perusal of the statistics will demonstrate that in some places the trustee bank has had a remarkable record. For instance, in Maine, a sparsely-settled State, and largely of a rural nature, we find one savings account to every 3 of the population. More remarkable is Vermont, the "Green Mountain State," where natural conditions would seem to be much more hostile to such development, we find 30 per cent. of the population having savings bank accounts. New Hampshire has an account for every 2-1/2 of the population, while Massachusetts heads the list, with seventy-five out of every hundred. New York has one to every three.

"In seeking an explanation of this remarkable success of the trustee system," says Hamilton, "we are reminded that New England is singularly separate and distinct in its customs, habits and ideals from the rest of the country. Notwithstanding the large foreign population, the dominant type is more homogeneous and more Anglo-Saxon than it is in any other section, and therefore fixed customs have been more rigid and controlling. Among the ideals behind the customs and institutions must be noted a stern, Puritanical sense of simple living, industry and providence, and this spirit is so strong as to be well calculated to give color and direction to the philanthropic impulse. There is also an unusual amount of public spirit, of collective rather than a neighborly character, as seen in the institution of the town meeting."

Stock Savings Banks

The stock savings bank, where it is a savings bank, and not a bank of discount under a savings title, differs in no essential[Pg 274] degree from the mutual institution. The mutual bank belongs to the depositors; the stock bank to the stockholders. The mutual bank pays dividends to depositors only; the stock bank pays dividends to both stockholders and depositors. The stock bank does not pretend to be philanthropic in its management. It is purely a business proposition, and where the investments are of the accepted savings bank type, it can justly claim to be on a par with its mutual friends, provided, of course, that it measures up to the standard in its management.

As is implied in the term "stock," it issues capital shares and pays dividends thereon. It has, therefore, the added protection of the stockholder's liability, which, together with the accumulated surplus, affords the element of strength so necessary in all financial concerns. It usually pays the depositors a stipulated rate of interest, and the profits beyond this belong to and are distributed to the stockholders as dividends. The partnership idea is entirely lacking, and the depositors get what they bargain for, while the surplus goes to those who invest, not necessarily their savings, but their capital, and assume all risks of the business. It could not in law or equity "scale down" its deposits to make good any losses—a feature peculiar to the mutual institution.

In this respect one thing is certain: In so far as safety is concerned, especially in a young bank, the stock bank with the stockholders' liability is surely superior to the mutual, unless the trustees of the latter are of such high order and of such financial worth as to be able and willing to assume the burden of any losses that may accrue until the surplus or guaranty fund affords ample protection. This was the trouble in the early days of the mutual savings banks in England.

Guaranty Savings Banks

New Hampshire is the only state in which "guaranty savings banks" are found. These are a combination of mutual and stock—a cross between the two. They do not transact a commercial business, being strictly savings banks in their functions, yet having "special deposits," which to all intents and purposes are capital stock. "The guaranty savings bank[Pg 275] differs from the ordinary mutual savings bank in that it has capital stock or special deposits, as they are called. It pays a certain stipulated rate of interest to its general depositors and any surplus of earnings above this dividend is available for dividends on the capital stock or special deposits. These special deposits constitute a guaranty fund for the general depositors, and the charter ordinarily stipulates that the special deposits shall always equal 10 per cent. of the deposits."

Such institutions are savings banks in every sense of the word, but the strictly mutual feature is lacking in the specialising of part of the deposits and paying a higher rate of interest on these deposits. In New York State savings banks cannot take a "special deposit," but in New Hampshire, in return for the higher interest rate, the special depositors assume all the risk of loss or depreciation, and, as in the case of stock concerns, they would be the first to suffer in the event of insolvency.

Municipal Savings Banks

This form of savings banks properly belongs to a strong class of municipalities. They can only thrive in places where the local spirit is strong, the local government pure, and where the local officials are accustomed to wield a large measure of authority. Accordingly, they have come into being and met with success in those countries where the early history of the town made a large measure of local autonomy a necessity. Towns of this class possess the public spirit and the intelligent administration required for the success of such a public venture. They also possess a fund of gratuitous public service among the citizens which may be drawn upon when occasion requires.

Such banks are found in Austria, France, Italy, Denmark, Sweden, and Japan. The best examples are to be found in Germany, where they have been in operation for a long period of years. Savings institutions exist here at present in great variety and number, including State or Province Savings Banks, City Savings Banks, Township Savings Banks, County Savings Banks, Bezirk (District) Savings Banks, Private Savings Banks, and Co-operative Savings Banks.[Pg 276]

These banks have some 19,000,000 pass books out and their deposits amount to 13,500,000,000 marks ($3,213,000,000). These deposits are practically all guaranteed by the various municipalities of the Empire, which condition forms a bulwark of confidence in the security of private wealth and earnings that cannot be shaken by hard times, panics, bank failures, etc.

People's Banks

The co-operative banks of Europe, otherwise called "People's Banks," are essentially savings banks, in that they depend for their working capital upon the accumulated savings of their members. The aims of these banks are first economic, to enable the economically weak to make themselves financially strong by the power of combination; second, moral, to bring the members together in a unity of interests and to develop character by making thrift and good habits the groundwork of their operations; third, educational, to train in business methods and in the handling of money those whose scope has been narrow and whose experiences have been few in this regard.

In the establishment of these banks, the cardinal rules have been: Maximum of responsibility, minimum of risk, maximum of publicity. To secure the maximum of responsibility, unlimited liability has been accepted by the members in many cases; that is, each one pledging his all for the good of all; and, second, to secure the minimum of risk, character is made the basis of membership and good habits the prime requisite for membership. No investments are made in speculative enterprises, and the purposes for which the money is borrowed are closely inquired into and due care taken that the funds shall be applied for such purposes only. To secure the maximum of publicity the action of the bank in all matters is given the widest publicity possible in order that the work may have public inspection.

The result of these simple rules has been that the poor have proven as good, if not better, creditors than the rich; for once losing credit they can never regain it except by the slow process of years of good behavior.[Pg 277]

The great pioneers in the "People's Banks" were Raiffeisen and Schulze-Delitzsch. They fully appreciated that any system that would succeed must descend to the level of its beneficiaries and they have admirably adapted the co-operative idea of banking.

The Localization of Savings Banks in the United States

The home of the mutual savings bank is in the East, where it began operations in 1816, and may even be said to be in the Eastern States; for west of Buffalo and south of Baltimore, we find only 21 savings banks of the mutual character. Out of 647 savings banks of the mutual type found in the United States, 593 are found in New England, New York, and New Jersey; and over one-half, or 334, are found in the two States of New York and Massachusetts. Maine, Vermont, Connecticut and New Hampshire have 215, the total of which accounts for all but 100 of the mutual savings banks in this country.

The dearth of savings banks in Pennsylvania is notable. It would seem strange that in a state of such character, where the mutual savings bank had its first test, and where in individual instances it has been extremely popular and successful, the failure of such an institution has been so pronounced; but Pennsylvania is the home of the building and loan association (there are over 1,400 in operation), which seems in a measure at least, to fulfill the same purpose. From a pamphlet issued by the Dollar Savings Bank of Pittsburgh in 1905, the striking sentence is gathered, that to-day at the end of half a century the Dollar Savings Bank stands as the only institution of its kind in Western Pennsylvania.

As we go south and west the banks take on a more commercial aspect, and the savings bank as we know it in the East is a rarity, and the word "savings" in their title is a misnomer. This is particularly true of Iowa, where we find practically all state banks using this word, and yet very few of them are other than banks of discount. The reason for the large number may be in the economic conditions of that State, and also the fact that banks may organise with as low as $10,000 in[Pg 278] capital, making it possible to establish a bank in even the smallest place.

In Illinois, for instance, we find no distinctively savings banks, and in a city like Chicago, where if the same success had attended the savings banks as it has in New York, upwards of a billion dollars would be on deposit, we find no strictly savings institution other than banks of discount and trust companies operating savings departments.

The reasons for the absence of mutual savings banks in the West and South lie, no doubt, as Hamilton suggests, in the fact that these sections were not settled from religious, but commercial motives; and the "spirit of New England" being lacking, the savings bank which requires a peculiar spirit of philanthropy, and age, as well, has not become a factor in the development of the country. In fact, the eleemosynary institution, such as the college, the hospital, or the savings bank, the former requiring endowments of money to become successful, and the latter the endowment of gratuitous management to become possible, is last to follow in the economic development of a community. Another reason may be in the pre-ponderance of agriculture among the employments, which does not, until the country becomes highly prosperous, afford much in the way of idle funds which would go into the savings banks. The mutual savings bank is a product of the East and promises to remain so in spite of the fact that some of the Western states have very good, if not excellent, savings banks laws.

The dearth of savings banks in the South is, no doubt, due to the prostration following the Civil War, which left the country drained of its resources; the general ignorance of banking functions, and the improvidence of the Negro.

Postal Savings Banks

The postal savings bank is not a bank, or a banking system, so much as it is an adjunct of the Government; for the fundamental idea is that through the post office the Government holds itself out as willing to accept the savings deposits of the people, invest them in its own securities and become absolutely[Pg 279] responsible for the safe return of the funds when called for, with a nominal rate of interest. All the leading countries of the world except Germany and Switzerland now operate the postal savings banks. While the rules may differ in the details, the general scheme is the same, and a review in brief of the system of Great Britain will serve to illustrate the methods of operation of such an institution.

The present system was established in England in 1861. The deposits, at whatever office they may be made, can be withdrawn from any other office which transacts a savings bank business. The accounts are kept in London and all moneys are remitted to the headquarters, where it is handed over to the Commissioners for the Reduction of the National Debt, who invest the funds in public securities.

Deposits may be made as low as one shilling or multiples thereof, and the limit of deposits for an individual is $150 during one year or $650 in all. Charitable societies may deposit without limit. For the benefit of youthful depositors, who have not a shilling to deposit, cards are issued upon which stamps are placed as purchased, and when filled represent one shilling, and may be turned in as cash. School managers are urged to bring this plan to the attention of the pupils, and it has been productive of good results, over 5,000 schools having adopted this system. The interest rate is fixed at 2-1/2 per cent. and never varies.

American Postal Savings Banks


[94]In spite of the numerous differences in the postal savings bank system of the forty-odd countries possessing them, there are certain fundamental features common to all. Whatever else a postal savings bank may be, it is without exception an institution working principally through the post offices, and its primary object is the encouragement of thrift among the poorer classes by providing safe and convenient places for the deposit of savings at a comparatively low rate of interest. In[Pg 280] the discussion of the postal savings bank proposition in this country, no one questioned the desirability of encouraging habits of economy and thrift on the part of the public, nor was there any question that adequate savings bank facilities should be provided for this purpose; the debate hinged very largely upon the question whether adequate facilities of this character were not already provided by private initiative.

The advocates of a postal savings bank claimed that adequate savings facilities were not and could not be provided by private enterprise, because of the expense of conducting savings banks in small communities, and also in larger communities where the people were not yet educated to the saving habit; and they pointed particularly to the lack of savings facilities in the southern and western states....

... The country is not nearly so well provided with banks receiving savings accounts as with post offices. In the United States there are 270 square miles of territory to each bank carrying savings accounts and 50 square miles to each post office; there is a population of 8,370 to each such bank and of 1,542 to each post office; and there are 5.4 post offices to each bank carrying savings accounts. A comparison of the figures for the different sections and states shows that it is in the southern, western, and Pacific states that savings bank facilities are most lacking.... The New England, eastern, and middle western states are much better provided with banking facilities than are the other sections; but even in these states post office facilities are much more ample than savings bank facilities....

An objection repeatedly urged against the establishment of a postal savings bank was that it would prove a competitor to existing banks. The fear of such competition appears to have been the chief cause of the opposition of most members of the banking fraternity to all postal savings banks proposals. Senator Cummins of Iowa said in the Senate:

The banks of the United States are opposed unanimously to the institution of a postal savings system.... I venture the assertion that during the nearly two years that I have been a member of this body ... I have received the protests of nearly every bank in my state against any such scheme, and those protests have usually been[Pg 281] accompanied by a very large number of petitions, secured, I have no doubt, through the industry and energy of the bank officers.

It was argued that postal savings banks would have an undue advantage over private institutions because of the great confidence in the Government entertained by working people; and it was asserted that funds would be withdrawn from existing banks and deposited in the postal savings banks.... In reply, the advocates of postal savings banks claimed that existing banks had nothing to fear from governmental competition; that they had the advantages of an established clientele, higher interest rates, higher limits, if any, in the amounts that could be kept on deposit, and of the close personal and advisory relation which so often exists between a bank and its customers. They further argued that postal savings banks would be a help rather than a hindrance to other banks. They would educate the people to habits of thrift and would draw money out of hoards; and the deposits which they received would for the most part be transferred to other banks as soon as the limit fixed for postal savings banks deposits should be reached, or even before, as the depositor began to appreciate the safety of other banks and the advantage of their higher rate of interest....

The immediate occasion of the last active movement for a postal savings bank system in the United States was ... the losses and inconveniences arising from bank failures and from the suspension of cash payments in the panic of 1907. Naturally, therefore, the demand for great safety of savings deposits played an important part in the discussion.

The advocates of postal savings banks cited figures showing the number of national bank failures and the losses involved, and similar figures for savings bank failures in certain states. They made much of the large amounts involved and of the hardships in individual cases. On the other hand, the opponents of the postal savings bank scheme quite generally dealt with percentage figures rather than with absolute amounts and showed that for recent years the average losses, in terms of percentage of the amounts on deposit, were almost infinitesimal.

The figures cited for bank failures, so far as they relate to[Pg 282] savings deposits, are so incomplete as to be of doubtful value in measuring the extent of the losses....

After all, such figures give us no adequate measure for losses of this kind. "Among the experiences of working people none is more demoralizing and few are more cruel than loss of savings through failure of banks or absconding of individuals intrusted with funds." To such people there is cold comfort in the assurance that the average loss of savings bank depositors over a long period of years is but a fraction of a mill on a dollar. The loss is theirs: it is not distributed among all depositors.

In urging that a postal savings bank would draw money from hoards into circulation, the advocates of the scheme claimed also that such a bank would keep in the United States money that would otherwise be sent abroad by foreigners.... Much was made of the fact that every year many millions of dollars in money orders payable to self are bought for savings purposes.... In such cases the purchaser not only failed to receive any interest on his savings but was required to pay the money order fee. Many immigrants, moreover, distrust American banks, and, being familiar with postal savings banks in their home countries and having great confidence in government institutions, remit their savings to these home banks. How extensively this is done we have no figures to show....


[95]The Postal Savings Bank System of the United States, which began operations January 3, 1911, by the opening of a postal savings bank in each state, is under the control of a board of trustees, consisting of the Postmaster-General, the Secretary of the Treasury, and the Attorney-General.

Depositories for the receipt of such moneys are designated by the Board. An initial appropriation of $100,000 was made to cover the cost of putting the law in operation, which was supplemented by another appropriation of $500,000 in the session of 1911.

Any person over ten years of age may deposit, but no person[Pg 283] shall have more than one postal savings bank account in his or her own right. Upon making the first deposit, a certificate of deposit is issued, which is to be surrendered when paid, and cancelled; or in the event of making a subsequent deposit is to be surrendered for one calling for a higher amount. The lowest deposit permitted is one dollar, the limit being $100 in a calendar month; but to provide for small deposits, a postal savings card is issued for ten cents, to which may be attached postal savings stamps, which when filled will be accepted in lieu of one dollar.

The interest rate allowed is 2 per cent., credited once a year, and the highest balance permitted is $500 to one person. Withdrawals may be made on demand.

The funds so received are to be deposited in national and state banks at 2-1/4 per cent. interest. Five per cent. of these deposits may be withdrawn and kept in the Treasury of the United States as reserve. Before becoming a depository, the bank must furnish as security government, state, or municipal bonds, the limit of deposits being an amount equal to the paid-up capital and one-half the surplus.... Not over 30 per cent. of the amount of such funds may be withdrawn by the trustees for investment in United States bonds, and it is the intent of the act that the residue of such funds amounting to 65 per cent., shall remain on deposit in the banks in each state and territory willing to receive the same under the terms of the act, but may be withdrawn for investment in bonds under the direction of the President, "when in his judgment, the general welfare and interests of the United States so require." Provision is also made for the conversion of savings bank deposits into United States bonds, at the request of depositors.

"Postal Savings Behind the Scenes"

Speech of Hon. Carter B. Keene, Director of the United States Postal Savings System at the Banquet of the Investment Bankers Association of America at Denver, Colorado, Tuesday evening, September 21, 1915.

Mr. Toastmaster and Gentlemen:

I appreciate very highly your invitation to speak here to-night, also the words of commendation from your presiding[Pg 284] officer. I have often wondered whether the fact that I am the only director of a big savings institution has anything to do with the ability of that institution to pay every depositor his money on demand. (Laughter and applause.)...

The toastmaster was wrong when he said that postal savings has nothing to do with investment bankers. We have a great deal to do with them. Indirectly, we are one of their best customers. More than ninety-four million dollars in bonds are now with the Treasurer of the United States as security for postal savings funds, and you gentlemen have largely supplied the banks with these bonds. Sixteen million dollars are in State and Territory bonds; city, town, and village bonds amount to forty-six millions; county bonds nine; miscellaneous bonds ten; and bonds of the United States Government and its dependencies thirteen....

Since I have been here this week I have heard billions and billions talked about.... I can hardly comprehend what a million is. But I want to tell you that in four and a half years the postal savings system of the United States has become custodian of sixty-eight million dollars, in cash, of the people's savings. Let me lay emphasis on the cash, because big figures do not always mean cash. Sixty-five million dollars of this money is on deposit in six thousand banks scattered throughout the country. In other words, practically all of the money we have collected has been released through the banks to channels of trade in the very localities where it originated. I am sure you will agree with me that this is a very creditable showing so far as dollars and cents are concerned.

The Federal Reserve Act, which went into effect on the 16th of November last, provided that postal savings funds should not be deposited in non-member banks. The Attorney General for the United States has held that the prohibition relates to funds received on and after November 16th. Therefore, postal savings on deposit in state institutions when the act became effective have been allowed to remain, except as it has been necessary to withdraw it to pay depositors.

The Post Office Department has made frequent investigations to determine where postal savings deposits come from; with the invariable result that they are found to come from[Pg 285] chimney corners, mattresses, bootlegs, etc., but until very recently no effort has been made to ascertain where postal savings go when withdrawn. And this recent inquiry has been both gratifying and entertaining. It was found that in a vast majority of cases savings were withdrawn for very substantial reasons, prominent among them being payments on homes and the launching of small business enterprises. Occasionally a hospital bill was paid. Some depositors sent money to the old country to bring over a parent or a brother; a wedding trousseau here and there; and in Colorado we have record of a withdrawal to buy an automobile. (Laughter.)

I am glad to say that there has been a very great change in the attitude of the banks toward postal savings in the last few years. At the outset, many bankers thought that postal savings was an unwarranted invasion of the domain of private enterprise and that the service would prove a severe drain on their established business. The opposite has been the result. The tarnished coins and soiled currency that come into our postal depositories represent hidden savings—money that is beyond the reach of any corporate banking institution no matter how sound it may be or how conservatively managed. This newly discovered money has been made available for commercial purposes in the very cities and localities from which it was withdrawn, so instead of being a drain on corporate banking institutions postal savings has added to the deposits of some six thousand banks more than sixty-five millions. The bankers now freely admit that postal savings has been a help to them, and it is no uncommon thing for banks, especially in the mining regions of the West, to urge the Post Office Department to extend postal savings facilities in order that more money may be made available for local uses.

Among our 540,000 depositors every nation on the face of the earth is represented, also every conceivable occupation. The fisherman, the miner, the shoemaker, the preacher, the bank teller, the butcher, the baker, the candle-stick maker, all have accounts, but the great bulk of our deposits come from the men and women who work with their hands for a daily wage.

The foreign born are our most numerous and liberal patrons.[Pg 286] An interesting poll of depositors has just been made by the Post Office Department and it was found that 59 per cent. of all postal savings depositors were born outside the United States, while the American born comprise 41 per cent. A still more surprising fact is that the foreign born own 72 per cent. of all the deposits. The Russians lead with $14,000,000 to their credit, or 20.7 per cent. Then follow the Italians with $9,650,000, or 14.2 per cent.; natives of Great Britain and her colonies with $6,000,000, or 8.8 per cent.; the Austrians with $5,900,000, or 8.7 per cent.; Hungarians, $2,900,000, or 4.3 per cent.; Germans, $2,800,000, or 4.1 per cent.; Swedes, $1,500,000, or 2.2 per cent.; and Greeks, $1,200,000, or 1.8 per cent.

What a splendid vote of confidence on the part of our foreign-born citizens in the good faith of the United States. And in these figures also is a high testimonial to the industry and frugality of our newly acquired citizens. That they should take most kindly to postal savings is not remarkable when we consider that they were accustomed to a similar service in their native countries....

Another thing that has induced foreigners to become postal savings depositors is the disastrous experiences many of them have had with so-called "private banks," usually operated by people of their own tongue. It is difficult to conceive of a more heinous crime than some of these so-called "bankers"—slick and persuasive—have committed in alluring credulous, hard-working men and women, to entrust their humble savings with them for the deliberate purpose of theft. I am glad to see that prosecuting officers have recently been aroused to the "private bank swindle" and that their promoters are getting the punishment they deserve.

When Europe got on fire last year, our postal savings receipts began to increase by leaps and bounds. During the fiscal year 1915, the deposits jumped from $43,440,000 to $65,680,000 and more than 140,000 new accounts were opened. The war still has an influence upon postal savings deposits, but the more immediate cause of large deposits at this time is the remarkable revival of commercial activities. Seven cities now have more than a million dollars on deposit, namely. New[Pg 287] York, Brooklyn, Chicago, Boston, Detroit, San Francisco, and Portland, Oregon. Greater New York, including Brooklyn and several other offices in the municipality, now have over one-fourth of all the money in the Postal Savings System. During the past fiscal year New York City gained 200 per cent.; Bridgeport, Connecticut, 188 per cent.; Brooklyn, New York, 167 per cent.; Paterson, New Jersey, 162 per cent.; Jersey City, New Jersey, 122 per cent.; Detroit, Michigan, 112 per cent.; Newark, New Jersey, 100 per cent.; Akron, Ohio, 77 per cent.; Gary, Indiana, 66 per cent.; Pueblo, Colorado, 52 per cent.

Now, my friends, I come to a point that I hope will make an impression on your minds—a lasting impression—and that point is that the Postal Savings System from the first has been seriously handicapped by statutory restrictions on the amount that may be accepted. The law permits the acceptance of only one hundred dollars a month and five hundred dollars in all from a depositor. It has been shown that the foreign born are the largest patrons of our savings service and if this service is to reach its full measure of success we must recognize and respect the habits of the foreigner, and one of his habits is to save his money until he gets several hundred dollars together and then take the entire amount to the post office, just as he did in the old country. Because the postmaster cannot accept all that is offered, the intending depositor very frequently goes away in resentment and disappointment without depositing a dollar....

It is the testimony of postmasters from all over the country that they are rejecting about as much money as they are taking in. The Postmaster General last year recommended to Congress that one thousand dollars be accepted with interest and that another thousand dollars be accepted without interest, but for safekeeping. That was a practical and reasonable recommendation—one which would meet all requirements in ninety-five per cent. of the cases. Unfortunately the recommendation failed.... The Postmaster General has indicated that he will repeat the recommendation in his forthcoming annual report and I sincerely hope that Congress will promptly recognize the urgent need of the legislation. Millions of dollars,[Pg 288] my friends, are spent every year by uplift societies for the betterment of the foreigners. These foreigners, these begrimed, hard-working foreigners, come to our post offices and ask us to take their humble savings. How unfortunate that we cannot accept what they offer, within reasonable bounds. What an effective agency this would be in bettering in a most practical and permanent way the conditions of the very people we want to Americanize as speedily as possible.

... We have five hundred and forty thousand depositors in the United States to-day and postal savings has a new and different story for each of them. It is not always the big things in life that change or fix our course. Can't you remember when a few dollars or the want of a few dollars tipped you one way or the other in some important matter. Who can estimate the happiness and prosperity that the starting of a postal savings account may lead to. It is a step, and an important one, in the right direction. Some one has well said that the immigrant who opens a postal savings account steps unconsciously on a moving platform; one thing leads to another, and his deposit might lead him into local investment and investment into business and into citizenship.

There is a very interesting human-interest side to postal savings in which every phase of good fortune and disaster is reflected. An aged couple at Norfolk without the knowledge of each other had been carrying $100 on their persons as a guaranty of respectable burial. They are now postal savings depositors. Two sisters died in each other's arms in the Eastland disaster in Chicago a few weeks ago—two working girls—and they had postal savings accounts for like amounts. Their savings went to pay for their burial. One of Uncle Sam's bluejackets who went down on the ill-fated submarine F-4 was the owner of a substantial postal savings account. Gentlemen, the Postal Savings System means something more than a cold array of assets and liabilities, a balance sheet. Way off in an isolated spot in Russia a money order went not long ago to the home of a humble peasant. That money order represented the savings of a son who was drowned in the Susquehanna River. A few weeks back, a thrifty Mexican girl withdrew her savings from the post office at San Diego, California,[Pg 289] to buy a trousseau. After the honeymoon she returned to the office with her new husband and both opened postal savings accounts.

Last year Leadville, Colorado, struck a thrift note that was new in this country, so far as I know, and reference to it is particularly timely as Christmas is approaching. A mining company in that city struck the note and I hope it will be heard from one end of this country to the other. It was this: Last December an officer of the company went to the post office and opened a postal savings account for every employee—ninety in all—as a Christmas present. He placed to the credit of each 2 per cent. of what he had earned during the year. These Christmas remembrances amounted to over fifteen hundred dollars. Out of the ninety employees only five had previously opened postal savings accounts. Now, I count that substantial charity; I call that well-directed charity. We have kept track of these particular deposits and the workmen who get their start through that Christmas bounty are adding to their savings weekly by their own personal efforts. (Applause.)

Gentlemen, as a rule, we in official life swing back and forth in a measured arc, and the little one can do is so small when compared with the mass of Government activity that we feel insignificant and lost. But I feel, my friends, that in the Postal Savings System my associates and I are doing a positive good for humanity. I believe that we are making people better and happier because postal savings points the way from the sweat shop to the school—it stands for clean homes and empty alleys. Each of you is a stockholder in the Postal Savings System and its success is your success. Your dividends are in the better and happier American citizenship which it encourages and promotes. (Applause.)


[93] Adapted from W. H. Kniffin, The Savings Bank and Its Practical Work, pp. 54-75. The Bankers Publishing Company. New York, 1912.

[94] E. W. Kemmerer, The United States Postal Savings Bank, Political Science Quarterly, Vol. XXVI, No. 3, September, 1911, pp. 465-77.

[95] W. H. Kniffin, The Savings Bank and Its Practical Work, pp. 75, 76. The Bankers Publishing Company, New York. 1912.

[Pg 290]



[96]The banker has become the bookkeeper and settling agent of the business world. The products of a locality, let us say the State of Georgia, move out to the markets of the world and create credits in favor of that locality on the books of banking institutions in the commercial centers, while at the same time a counter movement of commodities is under way from other localities into Georgia, in like manner creating credits for those localities which are debits against Georgia. The practical effect is that the commodities moving between these communities are exchanged and pay for themselves, the running accounts being kept and settlements effected in the banks.

To illustrate the details: A dealer in cotton in Atlanta makes a sale to a mill in Fall River and receives in payment a check or draft drawn on a New York bank, which he deposits for the credit of his account in an Atlanta bank, and which the latter forwards for the credit of its bank account in New York. Meanwhile an Atlanta merchant has bought goods in New York and in order to pay for them buys from the Atlanta bank an order for the New York credit, and this when forwarded completes the circle of payments for cotton and goods.

If we would extend the investigation to include the bank accounts of the Fall River mill and the Atlanta dealer we would find, first, that the mill account was built up constantly by deposits of checks and drafts received in payment for goods sold in all parts of the country and perhaps all over the world, with almost no deposits of cash, and that it was drawn down by checks for raw cotton, and supplies and large amounts of cash for the pay-rolls; second, that the cotton dealer's[Pg 291] account was built up entirely by deposits of checks or drafts received for cotton shipments and drawn down by checks and cash payments to farmers for cotton.

For payments at a distance bank credit in the form of a check or draft is [commonly] used....

The foregoing illustrates the movement of the exchanges constantly proceeding ... between ... different communities.... There is a network of relationship between banks through which each local community and market is connected with all other communities and markets.... No locality is so remote as to be outside of the circle and no community's sales and purchases are so scattered but that they can be brought together in the settlements. Each bank is the center of a circle of which it is the clearing agent; all payments between its own customers may be made by a transfer of credit upon its books. If there are two banks or more banks in a town, all payments between their customers are resolved into offsets between these banks, and in like manner all payments between localities are resolved into offsets between banks, and if not settled in local centers are passed up to larger and larger clearing centers....

But while the cross-payments of trade may be depended upon in the long run to balance and settle themselves, it does not follow that they will do so from day to day, or that they coincide so closely that payments in money are never required. An individual's sales and purchases are seldom made at the same time, and the sales and purchases of communities are not constantly balanced. The trade of a one-crop farming district will not be so evenly balanced as one of a district in which mixed farming prevails, and in every industry there are periods, usually recurring every year, when the payments exceed the current income, and corresponding periods when income exceeds outgo....

A region like the cotton states, whose products move quickly to market, may have large credit balances at one season and at another be wanting to borrow....

The banker is an equalizing agency in the situation. He stands in the breach: he must either supply the missing offsets of credit, or, as a last resort, make the payments in money....[Pg 292]

The entire system of settlements, with transfers and offsets and advances and interchange of capital and credit, is exceedingly interesting and wonderfully simple and effective, but depends for its effectiveness upon a scrupulous observance of the principle upon which it is based. That principle is the natural reciprocity of trade....

While there are balances from time to time in the exchanges ... between different localities ... which cannot be settled without shipments of money, they are usually met without inconvenience unless there is a disturbance of credit.

Exchange Relations Between Chicago and New York

[97]... It should always be borne in mind that the fact that New York City is the country's dominating financial market results in making New York funds acceptable everywhere as a means of payment, and in making a ready market for New York exchange throughout the country for a large part of the year.

Throughout January money in Chicago relative to that in New York City is cheap. Exchange rates on New York are high and there is a considerable movement of cash from Chicago to the Eastern States—particularly to New York City....

Just prior to January 1 there is normally a large demand in Chicago for New York exchange with which to meet dividend and interest payments due in New York, and the high rates thus created continue somewhat into the new year. The crop-moving and holiday demand, however, being over, money becomes relatively cheap in Chicago and flows to New York City, where it can at least earn the 2 per cent. paid by banks on bankers' balances, and where it is absorbed somewhat in speculative activity and in the higher security prices, which normally rule the latter part of January and the fore part of February.

[Pg 293]

From the last of January to the fore part of March the demand for money in Chicago relative to that in New York rapidly rises. Exchange rates on New York fall to a low point, and shipments of cash to the Eastern States are very small....

... There is, however, no evidence of a movement of cash from the East to Chicago in February, although there is something of a westward movement in March.

During this period the relative demand for money in Chicago is increased by the anticipated opening of navigation on the Great Lakes, for the opening of navigation gives rise to a large amount of New York exchange received in payment of grain bills. There is also a demand on the part of western bankers for currency to meet the spring needs of the western farmers. The first of March in many sections of the Middle West is the commonest time for making settlements of interest and principal on farm mortgages. It is also a common date for paying farm rents.

This spring advance in the value of money in Chicago as compared with New York reaches its maximum early in March. The demand then falls off rapidly and with only temporary interruptions (the most noteworthy being about the first of May) until it reaches the low level of the early summer, the latter part of May. It continues at a low level until early in July, when the crop-moving advance begins....

About the first of July the relative demand for money in Chicago and vicinity begins to increase, advancing rapidly, with minor interruptions, until early in September, and then maintaining a high level until the fore part of November. During this period exchange rates rule low and money moves in large quantities from the Eastern States to Chicago....

The primary cause for this increasing and large demand for money in Chicago is of course the anticipated and actual crop-moving demand, there being no sufficiently strong Eastern demand for money at the time to hold it back....

It has been found ... that during the last six to eight weeks of the year, after the crop-moving demand has to a large extent subsided, the relative demand for moneyed capital in both New York City and Chicago is maintained until the time[Pg 294] of January settlements at nearly the high level of the crop-moving period. A study of domestic exchange rates and of currency shipments shows that the relative demand for money is stronger during this period in New York City than in Chicago, that exchange rates in Chicago on New York rise, and that cash moves eastward....

Money becomes relatively cheap in Chicago and vicinity during these last six to eight weeks of the year, principally because of the return flow of currency previously shipped to the country districts for crop-moving purposes. There is also considerable demand at this time for New York exchange to meet payments in certain lines of goods, such as hardware and dry goods, that are due New York and New England houses by Western establishments, and to make purchases for the holiday trade.... Comparatively high exchange rates... [near] the end of the year are largely due to preparations for the January disbursements, which Western concerns are called upon to make in New York City....[98]

Exchange Relations Between St. Louis and New York

[99]... General seasonal movements in the relative demand for money in St. Louis (as compared with New York City), ... are fairly regular in their occurrence.

From the beginning of the year until the fore part of May the demand appears to be moderate, exchange rates rule near par, and there is a moderate tendency for cash to move from St. Louis to the Eastern States, with almost no tendency to move in the opposite direction....

The first eighteen weeks of the year, St. Louis bankers say, are a period of comparative inactivity in the local money market.[Pg 295] Concerning this period, a prominent St. Louis banker writes: "For the first eighteen weeks in the year... there is comparatively no New York exchange making and also a nominal demand for it, and likewise an easy, quiet money market."...

The second noticeable movement in the St. Louis money market is the sharp decline in the relative demand for money from the fore part of May to about the first of June. Exchange on New York rises rapidly at this time, and May is the month of heaviest shipments of cash to the East....

The high exchange rates in May, and the resulting eastward movement of money, are due largely to the fact that at about this time in St. Louis the bills of boot, shoe, hardware, and dry goods merchants mature, and as their paper is held largely in the East, exchange is required in large amounts. The result is large payments to St. Louis banks, the building up of their reserves, and resulting reduction of their credit balances in New York City.

From the first of June to the first of November the demand for money in St. Louis relative to that in New York City increases rapidly, advancing from the cheapest money in the year (twenty-first week) to the dearest money (forty-fourth week)....

This greatly increasing relative demand for money in St. Louis is, of course, attributable to the crop-moving requirements.... The cashier of a St. Louis bank writes: "New York exchange... always goes to a discount here in the fall of the year, and this is caused by the large cotton drafts drawn in payment of cotton shipped out from the Southwest. The banks down there either send us drafts drawn on New England points or New York, or else they send drafts drawn on the two large cotton buyers here, who, in turn, draw their drafts on Eastern points. The result is a great deal of exchange comes in, for which there is a demand for currency." The resulting low rates of exchange continue as long as the cotton season lasts. During this crop-moving season there are heavy shipments of cash from St. Louis to the Southern States....

After about the first week in November the relative demand[Pg 296] for money in St. Louis falls off rapidly until about the first of December, and then fluctuates at a moderate level until the end of the year....

The rise in exchange and easing up of the St. Louis money market in the latter part of November and in December is due to the decline in the crop-moving demand for cash, particularly in the South, and the return movement of cash from that section,... which begins the latter part of November. Southern banks in settling their St. Louis bills first use their eastern exchange and then ship currency. The upward movement of exchange is hastened shortly after the first of November by heavy purchases, for about four weeks, of New York exchange by dry goods, hardware, and boot-and-shoe houses for the purpose of settling their eastern accounts....

Domestic Exchange in San Francisco on New York City

[100]... Before taking up the subject of seasonal variations in San Francisco domestic exchange rates on New York City, it may be well to observe that in a number of respects the San Francisco domestic exchange market is a peculiar one.

In the first place the principal kind of money in circulation is gold coin and this fact materially influences the range of domestic exchange fluctuations, i. e., the shipping points. Concerning this matter I can do no better than quote from letters of Mr. F. L. Lipman of the Wells Fargo Nevada National Bank. Mr. Lipman writes (under date of February 7, 1908): "In the East the medium of exchange is paper or new gold by weight. In California it is current gold coin by tale, with a mingling of paper and new gold. The first effect of an upward movement of exchange, there, is that at about 40 cents per $1,000 the currency shipping point is reached, which in due course, drains off our paper money. At approximately $1.10 per $1,000 the gold shipping point is reached. Of course the only gold that can be economically shipped is new gold. Now it not infrequently happens that the demand for remittance will be so great as to exhaust[Pg 297] (1st) the currency and (2d) the new gold, leaving only our current gold, for which there is practically no shipping point, the discount on worn coin being practically prohibitory."

A second peculiarity of the San Francisco exchange market arises from the fact that San Francisco, being the chief port city of the Pacific coast and the seat of one of the United States mints and subtreasury offices, is the recipient of large quantities of gold from gold-producing regions, i. e., California, Alaska, and Australia. The United States mint will issue without any charge its transfer drafts on the subtreasury in New York in return for deposits of gold, the new product of mines, or for deposits of imported gold. "Frequently," writes Mr. Lipman, "this usage is without influence on our local market, as when large importations of Australian gold are received for New York on London account. At other times this practice of the Treasury has a decided effect on our exchange market as, for instance, when the early gold shipments come down from Alaska. These shipments command the service of the Treasury Department to the full amount thereof, while a portion at least of the proceeds is used in payment of local bills for supplies to Alaska from this city. This throws on the market an additional supply of exchange when such exchange is desired. The owners of the gold, however, have the privilege of taking gold coin instead of eastern exchange from the Treasury, and this alternative tends to bring exchange to about par. The Government also influences exchange from the other side, by its willingness to transmit money by telegraph from New York and Chicago to this city."...

Professor Carl C. Plehn of the University of California, suggests three other characteristics of the San Francisco domestic exchange market, i. e., (1) the close exchange relations with the Orient, (2) the fact that in San Francisco, New York bills very frequently represent merely steps in a general arbitrage transaction, and (3) the appreciable interest element involved in demand transactions because of the distance between San Francisco and New York....

From the beginning of January to about the first of March there is a rapid decline in the relative demand for money in[Pg 298] San Francisco, resulting in the lowest level of the year during February.

The average rate of exchange rose from 30 cents discount in the first week to $1.05 premium in the seventh....

... Among the principal factors cheapening money in San Francisco at this time and forcing up exchange may be mentioned: (1) the fact that advances which have been made for the movement of general crops up and down the Pacific coast are being repaid very rapidly; (2) the demand for eastern exchange with which to pay bills incurred for holiday purchases; and, finally (3), the latter part of February, the desire of taxpayers to discharge eastern obligations and get movable funds out of the State before the tax returns of the first Monday in March are made to the assessor.

From the fore part of March to the fore part of June the demand for money in San Francisco relative to New York City tends to increase....

Among the causes at work in reducing exchange rates at this time may be mentioned: (1) the readjustment after the heavy demands for exchange which were made anticipatory of assessment day: (2) preparation for the second installment of taxes which become delinquent the last Monday in April; (3) demand for funds by the large fruit canneries with which to buy sugar and tin in preparation for the annual fruit pack which begins in May; (4) by May the shipping trade in green fruits has begun, giving rise to many eastern bills; (5) demand for funds for equipping fishing companies going on long trips....

From about the 1st of July to the fore part of September there is an almost continuous increase in the relative demand for money in San Francisco....

... During August and September, particularly the latter month, substantial transfers of cash [are made] to San Francisco by the United States subtreasury at New York.

This decline in exchange is principally due to the large amount of eastern credits available locally at this time from the shipment of California products, especially green fruits, to eastern points; the returns for such shipments being usually available in either Chicago or New York exchange.... The[Pg 299] California hay and grain harvests cause considerable demand for funds by the middle of July, while the ships returning from the fisheries in August and September require large sums with which to pay their crews.

From about the middle of September (thirty-fourth week) to the latter part of October (thirty-ninth week) New York exchange tends to rule at near par....

During these weeks the outward movements of grain, green fruit, and fish tend to force exchange down, while the fact that this is the quarter of large receipts of gold ... from Alaska, making it a period of large receipts of gold bullion at the Mint, and that the San Francisco Mint makes returns for this gold in gold coin or New York exchange, at the option of the owner of the bullion, tends to keep New York exchange at par.

The demand for money in San Francisco relative to New York City increases rapidly from the latter part of October to about the 1st of December when it reaches its highest point in the year.... November and December are the months of largest transfers of cash to San Francisco by the United States subtreasury in New York. The fall in exchange during this period appears to be due primarily to the outward movement of dried fruits, such as raisins, prunes, and apricots. The banks pay out large amounts of actual coin which goes to the country, and receive in return drafts on eastern points which build up their eastern balances. This also represents the most active part of the northern grain season. The low point of the year for exchange is about the last week in November when the tax collector for the city and county of San Francisco withdraws large sums of actual coin from circulation and locks much of it up in the vaults of the city hall.

December is a month in which the relative demand for money in San Francisco lightens considerably as the result of the rapid falling off of the crop-moving demand.... The demand for remittances to the East for January 1st settlements tends to force up exchange rates at the end of the year....[Pg 300]

Currency Movements Between New England and the Eastern States

[101]... The distance between New York City and the principal New England cities is very small, and there is a great community of financial interest among these cities and New York. Between New York City and Boston the currency shipping points are only about 25 cents premium and 25 cents discount. Single financial deals between New York City and Boston are frequently of sufficient moment to lead to considerable shipments of currency, although exchange rates previously were only moderate. The relations among the clearing-house banks of Boston and among those of other New England cities are close, so that when one bank is in need of New York funds it is liable to obtain them from another which may have more than it needs. For this reason, it is said, much less money is now received from New York City and shipped there than was the case a few years ago....

The Domestic Exchanges During the Crisis of 1907[102]

There is no part of our banking machinery which has received so little elucidation as that of the domestic exchanges. Even for normal times the subject is obscure, and the writer therefore ventures upon an explanation of its course during a period of crisis with hesitation, and he is by no means confident that important considerations may not have been overlooked.

As in the case of foreign exchange, domestic exchange rates fluctuate within limits fixed by the cost of shipping money, and also, in the case of cities distant from New York, by the loss of interest while currency is in transit. The quoted rates apply principally to business between banks, the rates being determined by demand and supply. A Boston bank, for example, receives from its customers New York drafts and also checks drawn on banks in New York and its vicinity. All[Pg 301] these items will serve to build up its balances in that city. On the other hand, its depositors have been sending out checks, many of which will in the course of time reach New York and reduce its balances there. The Boston bank will also have received from banks of New York and from banks elsewhere items for collection in its vicinity, and remittance in ordinary course will be made by it in New York funds. Similarly it has sent away items for collection to banks in other cities upon which it expects a like remittance. As a result of all these various influences the balances of the Boston bank may either increase or decrease. If they increase it may be ready to sell exchange to other Boston banks whose balances are running low. It may also happen that the bank is desirous of reducing its New York balances, and in that case it will also appear as a seller of exchange in the market.

Now, if in the course of a crisis clearing-house loan certificates become the principal or sole medium of payment between banks, it may well happen that a bank will be unwilling to sell exchange unless it is unusually well supplied with New York funds. By the sale of exchange it can at best only secure a favorable clearing-house balance, which will be settled in loan certificates, and if this balance should be unfavorable it can meet it by taking out certificates on its own account. Each bank, therefore, to a greater extent than in normal times, is obliged to rely upon itself for means of payment in New York. The loan certificate does indeed yield a return or involve an expense of 6 or 7 per cent., while the return on New York balances is only 2 per cent. This advantage does not, however, seem to have induced the banks to sell exchange as freely as in normal times.

This is, however, not the only disturbing influence. The Boston bank may have remitted to New York upon items collected by it for other banks—let us say those of Philadelphia—but it may happen that the Philadelphia banks delay or even discontinue remitting to New York upon items sent to them for collection by banks of Boston and other cities. The Boston bank can then no longer rely upon what would normally serve to build up its own New York balances. It will be simply acquiring a mass of unavailable[Pg 302] credits at scattered points throughout the country. The supply of New York exchange which it might have been willing to sell is consequently diminished, and the premium on exchange must rise to a point at which it will tempt some of the banks to sell exchange, even though it intrenches upon their balances with agents which are available for reserve.

The premium would naturally be especially high in those cities where the banks were most unwilling to reduce their New York balances. Philadelphia seems a case in point, as its deposits with reserve agents, which were $30,995,000 on August 22, were reduced to only $29,389,000 on December 3. At that time the premium on currency in Philadelphia ranged from $1.50 to $3 per $1,000. It is, therefore, a reasonable conclusion that the banks were strongly disinclined to make use of their New York balances. In a few cities it is probable that the premium reached a high level because the banks had exhausted their New York balances. St. Louis may be mentioned as a probable example. Being a central reserve city, its banks would naturally have only such balances in New York as normal business requirements made necessary. The dislocation of exchange elsewhere or the course of payments between New York and St. Louis may have combined to produce such a balance of payments as would have required currency shipments if the St. Louis banks had remitted promptly to New York.

The extent to which banks in different cities delayed or refused to remit to New York on items collected by them for other banks cannot be determined. Banks in one city, very naturally and honestly, were inclined to lay the blame upon banks elsewhere. The banks in other places, however, may not have been able to secure payment of the items sent to them for collection from other banks in their locality with the usual promptness. When every allowance has been made, however, there can be no question that banks in certain cities, in these as well as in other matters, adopted a policy wholly designed to strengthen themselves regardless of consequences.

The general prevalence of the premium on New York exchange is, as we have seen, accounted for in part by the use of clearing-house loan certificates in settling balances between[Pg 303] banks and by the delay in remitting in New York funds upon items collected for other banks. It seems probable, however, that, taking the country as a whole, the course of payments was favorable to the New York banks. At the beginning of November withdrawals for crop-moving purposes have in recent years begun to diminish, except to the South, and movements of money from eastern centers are distinctly in favor of New York at that season of the year. If this were indeed the case in 1907, it affords still another reason for thinking that the New York banks might have met the crisis successfully without restricting payments. They would probably have been obliged to meet only withdrawals arising from lack of confidence and not real needs for crop-moving purposes, such as would have increased the difficulties of the situation had the crisis begun at the beginning of September.

Finally, it should be noted that the restriction of cash payments to depositors and the currency premium seem to have increased the demand for New York exchange. Only in that city was it possible to buy any considerable quantity of money. Many banks in various parts of the country purchased gold and currency at a premium in New York and, instead of drawing on their own balances, then entered their home market as purchasers of exchange which was remitted in payment.

In the few instances where exchange was below par the currency premium was a more direct influence; but exchange could not have dropped to the low figures recorded in 1893 in the case of Chicago [$30 discount per $1,000], because the Chicago banks in 1907 did not maintain payments among themselves as they had done on previous occasions. Exchange was at a discount only in those cities where the course of payments was so strongly against New York that practically all the banks found their balances in that city increasing. Chicago might have been expected to belong to this group, but its banks made extensive use of bills derived from grain exports to secure gold which was shipped directly to them. In general, exchange was at a discount, or at par only, in the Southern States, the banks of which, by means of cotton sales, are normally in position to draw money from the northeastern part of the country during the late autumn.[Pg 304]

In conclusion, it should perhaps be pointed out that the quoted rates of exchange were often without much significance. The ordinary course of dealings was so completely disorganized in many places that the rates were purely nominal, representing little or no actual transactions.


[96] Frank A. Vanderlip, Modern Banking, Three Addresses delivered at Chautauqua, New York, August, 1911, pp. 17-29. The National City Bank. New York. 1911 [?].

[97] E. W. Kemmerer, Seasonal Variations in the Relative Demand for Money and Capital in the United States. Publication of the National Monetary Commission, Senate Document No. 588, 61st Congress, 2d Session, pp. 96-100.

[98] [Owing to the growth of deposit banking among the farming classes, the increasing diversification of industry in the agricultural States, Sub-treasury operations, and the offer of remunerative rates of interest on loans in New York during the fall, the net autumnal currency movement since 1907 has frequently been to New York. See E. M. Patterson, Certain Changes in New York's Position as a Financial Center, Journal of Political Economy. Vol. XXI, June, 1913, pp. 523-539.]

[99] E. W. Kemmerer, op. cit., pp. 101-105.

[100] Ibid., pp. 118-121.

[101] Ibid., 54. 55.

[102] O. M. W. Sprague, History of Crises under the National Banking System, Publications of the National Monetary Commission, Senate Document No. 538, 61st Congress, 2d Session, pp. 293-297.

[Pg 305]



The Nature of Foreign Exchange

[103]The bill, or order to pay money in a foreign centre, is the commodity that is actually bought and sold by dealers in foreign exchange, but it is better for the moment to leave bills out of consideration. They are only the tangible expression of the claim for money in another centre, and at this early stage of our inquiry it is better to keep our minds fixed on what is at the back of the bill, namely, the money in a foreign centre to which it gives its holder a claim. The French buyer of a bill on London buys it, as a rule, because by sending it to his English correspondent he can discharge a debt to him in English money. What he really buys with his francs is so many English pounds, and the labyrinth of the foreign exchanges is much easier to thread if, before we complicate the question by talking about bills, we keep our eye on the comparatively simple problem which is the key to the puzzle, namely, the exchange of one country's money for another's.

Thus stripped to its naked simplicity, the problem begins to look as if it were not a problem at all, and a critical inquirer may be excused for thinking that at least in the case of countries that use currencies based on the same metal, there ought to be no need for daily quotations of rates of exchange, because the relative value of their moneys ought to be constant. It is a natural question to ask, why should there be these daily fluctuations, and, since they are evidently there, what is the sense or purport of them? The answer is, that money in France and money in England are two different things, and the relative value of two different things is almost[Pg 306] certain to fluctuate. Quite apart from any differences in the fineness of gold coined by two different countries, or the ease or difficulty with which a credit instrument can be turned into gold, mere distance is quite enough to make the difference that will create fluctuation in price. New York and Chicago use exactly the same currencies, but money in New York differs from money in Chicago by being nearly a thousand miles away, and consequently there are frequent variations in their relative value. The English and Australian sovereigns are identical in weight and fineness, but there is constant fluctuation in the buying power of the English sovereign as expressed in its brother that is circulating in the Antipodes.

These fluctuations are based on the same influence that sways the movements in the prices of all goods and services that are bought and sold, that is, the influence of supply and demand. Just as the price of boots, Consols, medical advice, football professionals, or anything else that can be the subject of a bargain, will depend in the end upon the number of people who want to buy them compared with that of those who want to sell them, at or near a certain figure, so the price of English pounds, when expressed in francs, guilders, milreis, or Australian sovereigns, depends on the number of people abroad who have to buy money in England as compared with the number of those who have money in England to sell. People abroad have to buy money in England when they owe money to Englishmen and want to pay it; and they have money in England to sell when Englishmen owe them money.

Jacques Bonhomme in Paris has been selling shiploads of Christmas kickshaws to John Robinson in London, and so has thousands of English pounds due to him by the said Robinson. But English pounds, as such, are not wanted by M. Bonhomme. He wants to sell them, to turn them into francs, the currency of his own country, with which he makes his daily payments at home. On the other hand, there are always plenty of Frenchmen who have imported English goods or have had services rendered by English bankers, or shipowners, or insurance companies, and so want to buy English money wherewith to pay their English creditors. So it follows that the price that M. Bonhomme will get for his English pounds[Pg 307] will depend on the value of goods and services that other Frenchmen have been selling to England, so producing English pounds to be sold in Paris, as compared with the value of the claims that have to be met in London, for the satisfaction of which English pounds have to be bought. If the amount of English money on offer is bigger than the amount wanted, down will go the price of the English pound as expressed in francs, and the seller in francs will get less in francs for his pound. If the amount of English money wanted is the bigger, the price will go up, and the seller will get more for his pound. When the price goes down, the exchange is said to move against London, because there is a depreciation in the value of the sovereign as expressed in francs. When it goes up the exchange moves in favour of London, because the buying power of the sovereign is enhanced.

The process is exactly the same, and is even more simple and easy to understand when we take away the complication of the exchange of the moneys of two different nations, and look at it at work between two distant towns of the same country. If in the course of trade New York has large payments to make in Chicago, money in Chicago will be wanted in New York, and competition there will send up the price of it, so that a dollar in Chicago will be worth more for the time being to New Yorkers than a dollar in New York, and any New York bank or firm that has a balance or a credit in Chicago will be able to dispose of it at a premium. The extent of this premium, however, will obviously be limited by the expense involved in sending lawful money, as the Americans call it, from New York to Chicago. If we suppose, for the sake of simplicity, that the cost of sending a dollar and insuring it is covered by a cent, no one in New York will pay much more than one dollar and a cent for a dollar in Chicago. Rather than do so he will send his dollar. He will probably pay a small fraction more to save himself the trouble and time involved by sending and insuring money, and this minute fraction that he will sacrifice is the opportunity of the exchange dealer, who will send money to Chicago, and put himself in funds there, and so be able to supply money in Chicago to any one in New York who will pay for it at the rate of one dollar[Pg 308] and one cent plus any profit that the exchange dealer can squeeze out of him.

Viewed in this simple example the problem of exchange has few terrors. It is merely a question of the price of money in one place, as expressed in the same money in another, with fluctuations governed by supply and demand and limited by the cost of sending money from place to place. This limitation does not mean that supply and demand cease to govern the market, but merely that at a point supply can be increased to meet any demand by the despatch of currency.

"Favourable" and "Unfavourable" Exchanges

[104]The general feeling with regard to the function of the exchanges, as giving evidence of the mercantile (or rather monetary) situation of any country, is indicated by the usual phrase of a "favourable or unfavourable state of the exchanges." A phrase which occurs so frequently in all banking discussions that it cannot be passed over without remark. It may originally have implied the erroneous theory that the object of commerce is to attract gold, and that that country towards which the tide of bullion sets with the greatest force is ipso facto the most prosperous. Political economists, from their point of view, are correct in their statement that, as regards the country at large and the interchange of commodities, exports and imports are always balanced, and that both the words "unfavourable balance of trade" and "unfavourable exchanges" involve fallacy. But merchants and bankers are influenced by the feeling, that at any given moment they may be under greater liabilities for imports than they can temporarily meet, owing to the system of credit which disturbs the coincidence of payments for exports and imports, though their value may actually be equal; and further, by the anxiety as to the possibility of meeting these liabilities in that specific mode of payment to which they are pledged, namely, in gold or convertible notes. When, therefore, in banking treatises, it is said that the exchanges are favourable to any particular[Pg 309] country, it should be understood that the intention is simply to state the fact that bills of that country upon foreign cities are difficult of sale, whilst bills drawn upon it from abroad are at a premium, indicating an eventual influx of specie. So, when it is said that the exchanges are unfavorable, a situation is described in which foreign bills are in great demand, and when, consequently, their value seems likely to be so enhanced as to render the export of bullion an unavoidable alternative.

The Origin and Supply of Foreign Exchange

[105]Underlying the whole business of foreign exchange is the way in which obligations between creditors in one country and debtors in another have come to be settled—by having the creditor draw a draft directly upon the debtor or upon some bank designated by him. John Smith in London owes me money. I draw on him for 100 pounds, take the draft around to my bank and sell it at, say, 4.86, getting for it a check for $486.00. I have my money, and I am out of the transaction.

The fact that the gold in a new British sovereign (or pound sterling) is worth $4.8665 in our money by no means proves, however, that drafts payable in pounds in London can always be bought or sold for $4.8665 per pound. To reduce the case to a unit basis, suppose that you owed one pound in London, and that, finding it difficult to buy a draft to send in payment, you elected to send actual gold. The amount of gold necessary to settle your debt would cost $4.8665, in addition to which you would have to pay all the expenses of remitting. It would be cheaper, therefore, to pay considerably more than $4.8665 for a one-pound draft, and you would probably bid up until somebody consented to sell you the draft you wanted.

Which goes to show that the mint par is not what governs the price at which drafts in pounds sterling can be bought, but that demand and supply are the controlling factors. There are exporters who have been shipping merchandise and selling foreign exchange against the shipments all their lives[Pg 310] who have never even heard of a mint par of exchange. All they know is, that when exports are running large and bills in great quantity are being offered, bankers are willing to pay them only low rates—$4.83 or $4.84, perhaps, for the commercial bills they want to sell for dollars. Conversely, when exports are running light and bills drawn against shipments are scarce, bankers may be willing to pay 4.87 or 4.88 for them.

For a clear understanding of the mechanics of the exchange market there is necessary a clear understanding of what the various forms of obligations are which bring foreign exchange into existence. Practically all bills originate from one of the following causes:

1. Merchandise has been shipped and the shipper draws his draft on the buyer or on a bank abroad designated by him.

2. Securities have been sold abroad and the seller is drawing on the buyer for the purchase price.

3. Foreign money is being loaned in this market, the operation necessitating the drawing of drafts on the lender.

4. Finance-bills are being drawn, i. e., a banker abroad is allowing a banker here to draw on him in pounds sterling at 60 or 90 days' sight in order that the drawer of the drafts may sell them (for dollars) and use the proceeds until the drafts come due and have to be paid.

1. Looking at these sources of supply in the order in which they are given, it is apparent, first, that a vast amount of foreign exchange originates from the direct export of merchandise from this country.

Not all merchandise is drawn against; in some cases the buyer abroad chooses rather to secure a dollar draft on some American bank and to send that in payment. But in the vast majority of cases the regular course is followed and the seller here draws on the buyer there.

2. The second source of supply is in the sale abroad of stocks and bonds.

Origin of bills from this source is apt to exert an important influence on rates, in that it is often sudden and often concentrated on a comparatively short period of time. The announcement of a single big bond issue, often, where it is an assured fact that a large part of it will be placed abroad, is[Pg 311] enough to seriously depress the exchange market. Bankers know that when the shipping abroad of the bonds begins, large amounts of bills drawn against them will be offered and that rates will in all probability be driven down.

3. The third great source of supply is in the draft which bankers in one country draw upon bankers in another in the operation of making international loans. The mechanism of such transactions will be treated in greater detail later on, but without any knowledge of the subject whatever, it is plain that the transfer of banking capital, say from England to the United States, can best be effected by having the American house draw upon the English bank which wants to lend the money. The arranging of these loans means the continuous creation of very large amounts of foreign exchange.

4. Drawing of so-called "finance-bills," is the fourth source whence foreign exchange originates. Whenever money rates become decidedly higher in one of the great markets than in the others, bankers at that point who have the requisite facilities and credit, arrange with bankers in other markets to allow them (the bankers at the point where money is high) to draw 60 or 90 days' sight bills. These bills can then be disposed of in the exchange market, dollars being realized on them, which can then be loaned out during the whole life of the bills.

These are the principal sources from which foreign exchange originates—shipments of merchandise, sales abroad of securities, transfer of foreign banking capital to this side, sale of finance-bills. Other causes of less importance—interest and profits on American capital invested in Europe, for instance—are responsible for the existence of some quantity of exchange, but the great bulk of it originates from one of the four sources above set forth.

The Sources of the Demand for Foreign Exchange[106]

Turning now to consideration of the various sources from which spring the demand for foreign exchange, it appears that they can be divided about as follows:

[Pg 312]

1. The need for exchange with which to pay for imports of merchandise.

2. The need for exchange with which to pay for securities (American or foreign) purchased by us in Europe.

3. The necessity of remitting abroad the interest and dividends on the huge sums of foreign capital invested here, and the money which foreigners domiciled in this country are continually sending home.

4. The necessity of remitting abroad freight and insurance money earned here by foreign companies.

5. Money to cover American tourists' disbursements and expenses of wealthy Americans living abroad.

6. The need of exchange with which to pay off maturing foreign short-loans and finance-bills.

1. Payment for merchandise imported constitutes probably the most important source of demand for foreign exchange. Practically the whole amount of our huge importations has had to be paid for with bills of exchange. Whether the merchandise in question is cutlery manufactured in England or coffee grown in Brazil, the chances are it will be paid for by a bill of exchange drawn on London or some other great European financial centre.

2. The second great source of demand originates out of the necessity of making payment for securities purchased abroad. So far as the American participation in foreign bond issues is concerned, the past few years have seen very great developments.

Security operations involving a demand for foreign exchange are, however, by no means confined to American participation in foreign bond issues. Accumulated during the course of the past half century, there is a perfectly immense amount of American securities held all over Europe. The greater part of this investment is in bonds and remains untouched for years at a stretch. But then there come times when, for one reason or another, waves of selling pass over the European holdings of "Americans," and we are required to take back millions of dollars' worth of our stock and bonds. Such selling movements do not really get very far below the surface—they do not, for instance, disturb the great blocks of American bonds in which so large a proportion of many of the big foreign fortunes are invested. The same thing is true[Pg 313] with stocks, though in that case the selling movements are more frequent and less important.

3. So great is the foreign investment of capital in this country that the necessity of remitting the interest and dividends alone means another continuous demand for very large amounts of foreign exchange. Estimates of how much European money is invested here are little better than guesses. The only sure thing about it is that the figures run well up into the billions and that several hundred millions of dollars' worth of interest and dividends must be sent across the water each year. At the interest periods at the beginning and middle of each year it becomes apparent how large a proportion of our bonds are held in Europe and how great is the demand for exchange with which to make the remittances of accrued interest. At such times the incoming mails of the international banking houses bulge with great quantities of coupons sent over here for collection. For several weeks on either side of the two important interest periods, the exchange market feels the stimulus of the demand for exchange with which the proceeds of these masses of coupons are to be sent abroad.

4. Freights and insurance are responsible for a fourth important source of demand for foreign exchange. A walk along William Street in New York is all that is necessary to give a good idea of the number and importance of the foreign companies doing business in the United States. In some form or other all the premiums paid have to be sent to the other side. Times come, of course, like the year of the Baltimore fire, when losses by these foreign companies greatly outbalance premiums received, the business they do thus resulting in the actual creation of great amounts of foreign exchange, but in the long run—year in, year out—the remitting abroad of the premiums earned means a steady demand for exchange.

With freights it is the same proposition, except that the proportion of American shipping business done by foreign companies is much greater than the proportion of insurance business done by foreign companies. An estimate that the yearly freight bill amounts to $150,000,000 is probably not too high. That means that in the course of every year there is[Pg 314] a demand for that amount of exchange with which to remit back what has been earned from us.

5. Tourists' expenditures abroad are responsible for a further heavy demand for exchange. The sums spent by American tourists in foreign lands annually aggregate a very large amount—possibly as much as $175,000,000—all of which has eventually to be covered by remittances of exchange from this side.

Then again there must be considered the expenditures of wealthy Americans who either live abroad entirely or else spend a large part of their time on the other side. By these expatriates money is spent extremely freely, their drafts on London and Paris requiring the frequent replenishment, by remittances of exchange from this side, of their bank balances at those points. Furthermore, there must be considered the great amounts of American capital transferred abroad by the marriage of wealthy American women with titled foreigners. Such alliances mean not only the transfer of large amounts of capital en bloc, but mean as well, usually, an annual remittance of a very large sum of money. No account of the money drained out of the country in this way is kept, of course, but it is an item which certainly runs up into the tens of millions.

6. Lastly, there is the demand for exchange originating from the paying off of the short-term loans which European bankers so continuously make in the American market.

These loaning operations, it must be understood, both originate exchange and create a demand for it. They were mentioned as one of the sources from which exchange originates, and now as one of the sources from which, during the course of every year, springs a demand for a very great quantity of exchange.

In a general way, it may be pointed out, the sources of demand for exchange conform with influences which cause exchange to go up, and the sources of supply of exchange constitute causes which make for low rates.

It is to be noted, however, that money rates are a great factor influencing foreign exchange. Whenever money is cheap at any given centre, and borrowers are bidding only[Pg 315] low rates for its use, lenders seek a more profitable field for the employment of their capital.

Money rates in the New York market are not often less attractive than those in London, so that American floating capital is not generally employed in the English market, but it does occasionally come about that rates become abnormally low here and that bankers send away their balances to be loaned out at other points. Such a time was the long period of stagnant money conditions following the 1907 panic. Trust companies and banks who were paying interest on large deposits at that time sent very large amounts of money to the other side and kept big balances running with their correspondents at such points as Amsterdam, Copenhagen, St. Petersburg, etc.—anywhere, in fact, where some little demand for money actually existed. Demand for exchange with which to send this money abroad was a big factor in keeping exchange rates at their high level during all that long period.

High money rates at some given foreign point as a factor in elevating exchange rates on that point might almost be considered as a corollary of low money here, but special considerations often govern such a condition and make it worth while to note its effect. Suppose, for instance, that at a time when money market conditions all over the world are about normal, rates, for any given reason, begin to rise at some point, say London. Instantly a flow of capital begins in that direction. In New York, Paris, Berlin, and other centres it is realized that London is bidding better rates for money than are obtainable locally, and bankers forthwith make preparations to increase the sterling balances they are employing in London. Exchange on that particular point being in such demand, rates begin to rise, and continue to rise, according to the urgency of the demand.

The international money markets are a most decidedly complex proposition, and there is literally never a time when several influences tending to put exchange rates up are not conflicting with several influences tending to put rates down. The actual movement of the rate represents the relative strength of the two sets of influences. To be able to "size up" the influences present and to gauge what movement of[Pg 316] rates they will result in, is an operation requiring, first, knowledge, then judgment. The former qualification can perhaps be derived, in small degree, from study of the foregoing pages. The latter is a matter of mental calibre and experience.

Methods of Financing Imports and Exports[107]

The foreign trade of the United States has increased during the last forty years about 370 per cent.... This increase ... reflected not alone our own marvellous development, but as well the wonderful growth of trade throughout the world. The United States stands third among the countries of the world, its foreign trade being exceeded only by that of the United Kingdom ... and Germany....

Our imports and exports[108] are being financed more and more by means of what are known as commercial letters of credit.... An explanation of the operation of the commercial letter of credit will ... disclose the methods and conditions under which our imports are financed.

The commercial letter of credit is an authorization, say of an American bank to its London correspondent, to honor drafts for its account drawn at various tenors by foreign shippers or others against shipments of merchandise to this country. These credits are of two kinds, documentary and clean. Under the documentary credit the London bank is authorized to accept drafts for the account of the American bank only when the bill of exchange is accompanied by certain documents described in the letter of credit. These documents may be the bills of lading for the goods, consular invoices, insurance certificates and possibly other papers. Probably a large proportion of such credits requires that drafts be drawn at sixty or ninety days' sight. So many elements of danger are involved in financing commodities under commercial[Pg 317] letters of credit, even where the control of the goods is given to the bank issuing the credit or its agents, that the financial standing of those asking for credits must be the first consideration in their issuance. Dishonesty on the part of the shipper, resulting in a drawing under the credit against forged documents or against shipments of inferior merchandise, is always possible, and the financial responsibility of the buyer of the credit is all that stands between the banker issuing the credit and a loss in such cases.

In order to obtain a clear understanding of the working of a commercial letter of credit, we will take a concrete example and follow its every transaction. An importer of coffee (A) in New York purchases a certain number of bags of coffee from an exporter (B) in Brazil. A agrees to furnish B with a commercial letter of credit. B is not in position, we will say, to await the arrival of the coffee in New York and the return of a remittance before receiving his pay. A on the other hand is unable to remit B for the coffee before its receipt and sale to his customers. A goes to his banker in New York and requests him to authorize B to draw upon the New York banker's London correspondent at ninety days' sight with bills of lading for coffee to the amount of the purchase attached to the draft, consular invoice and insurance certificate, if B is to furnish insurance. If A's banker is willing to extend the credit he writes a letter (or uses a printed form), requesting his London banker to accept B's drafts upon presentation under the conditions already mentioned and others of minor importance. This letter is issued in duplicate, one copy going to the London banker, the other being delivered to A. A then mails the copy received by him to B. B thereupon arranges to ship the coffee, obtains the bill of lading, invoice, etc., and takes them with the copy of the credit to his banker in Brazil. A draft is then drawn on the London bank under the terms of the credit at ninety days' sight and is discounted by the Brazilian banker, the proceeds being placed to the credit of B's account or given to him in the form of a check or cash. The Brazilian banker then forwards the draft and documents, except such documents as the instructions may require to be forwarded direct to New York, to his London[Pg 318] banker. He may secure discount of the bill at once by cable or await its arrival in London before doing so, or he may request his London banker to have the bill accepted and hold it for maturity. If the bill is discounted the Brazilian banker may draw against it immediately and thus put himself in funds to purchase other coffee bills. Upon receipt of the bill by the London correspondent it is presented to the London banker on whom it is drawn for acceptance. The acceptor bank examines the documents and if they are drawn according to the terms of the credit accepts the draft and returns it to the correspondent of the Brazilian bank, retaining the documents, which it then forwards to the New York bank which opened the credit. In accepting the draft the London bank has in effect agreed to pay it at the end of ninety days, or, figuring grace, ninety-three days. Upon maturity payment is made and the amount is charged to the account of the issuing New York bank. Upon receipt of the documents the New York bank delivers them to its customer under a trust receipt or against collateral, and the latter is then in position to obtain the goods. Ten days before the bill of exchange is due in London the New York bank collects the amount from A, together with the commission agreed upon when the credit was opened, and remits the amount to its London banker to meet the draft. On all such transactions the London banker, while not himself advancing any money, is extending a credit for which he charges the New York bank a commission. The result is that we are paying tribute to European bankers amounting to an immense sum annually for the purpose of financing our imports.

The fact that London exchange is more marketable generally throughout the world than New York exchange is one of the principal reasons why it is necessary for us to issue credits upon London instead of upon New York.

Our imports are distributed generally throughout the United States. The importers, however, are mostly situated at the ports of entry. A very large proportion of them obtain their credits through New York institutions, although some of them deal direct with foreign bankers.

Probably a smaller proportion of our exports is financed by[Pg 319] means of commercial letters of credit than of our imports. Different commodities are handled in accordance with special customs which have grown up around them, due partly to trade conditions and partly to the nature of the products. Sellers of grain usually draw at sixty days' sight upon the foreign buyer instead of under a bank credit. These bills, under the customs prevailing in most foreign countries, may be rebated by the foreign buyer whenever he desires to obtain the goods at the "bank rate" or 1 per cent. under the bank rate, or such other rate as custom in the country on which the drafts are drawn requires. Such drafts, with bills of lading and such other documents as are necessary, are purchased by American banks and are forwarded by them to their European correspondents. The American banker is obliged to advance the money on such paper, unless he draws his own time bills against them, until such time as they are rebated. In the case of grain bills the average time rebated is probably around fifty-six days, which places the American bank in possession of demand foreign exchange, against which it can draw in order to reimburse itself with the loss of a very few days' interest.

Flour bills, which are financed in the same manner as grain bills, usually run nearly to maturity before they are rebated, although the condition of the discount market sometimes influences the purchaser, and causes him to take the bills up more promptly. Many foreign shipments are made under three-day sight bills, which uses the money of the American banks making the advance from four to seven days or more, depending upon whether the laws of the country on which the bills are drawn allow grace or not and whether the bills are purchased with intervening days before the sailing of steamers. Other classes of bills are drawn at sight. This includes a portion of our lumber shipments and miscellaneous articles. Where shipments are made on sailing vessels, drafts are frequently drawn at four or six months' sight, and many other transactions go through against cable payments.

As nearly 40 per cent. of our exports consist of cotton, the method under which it is financed is worthy of special consideration. Cotton bills are ordinarily of two kinds: documentary[Pg 320] payment bills and bills drawn upon bankers. Documentary payment bills, which are drawn upon cotton merchants or spinners at sixty or ninety days' sight or other tenors, are handled in the same manner as flour bills. The cotton merchant accepts the draft upon presentation and rebates it when the goods arrive, or when he desires to obtain the cotton. A small percentage of cotton is handled in this way. Most of the commodity is financed by means of credits opened by the foreign buyer through his banker. Various abuses have developed under this system, which have caused losses running into millions of dollars to all of the various parties engaged in carrying the transactions to their close. These losses have only been possible because of the turning over of credits by the foreign buyers to irresponsible concerns in America in their endeavor to obtain cotton at lower prices than their competitors. A foreign buyer makes arrangements with certain American concerns to cable him offers of cotton. The American firms whose offers are accepted receive cablegrams from the buyer advising them of the acceptance of their offers and giving them the names of the foreign bankers on whom the drafts in payment of the cotton are to be drawn. The American sellers thereupon ship the cotton to the buyer under bills of lading drawn to the shipper's order and endorsed in blank. The bills of lading are then attached to drafts drawn upon the bankers designated by the buyer at the given tenor, which is usually sixty or ninety days. This exchange is then sold in the market to the highest bidder or it is forwarded to New York to be sold in the same manner upon arrival. The American exchange buyers have no means whatever of designating whose bills shall be upon the market, as the sellers are all agents of the European buyers. The American exchange houses in their need for exchange to meet the demands of their importers have accepted the bills offered in the market, each exchange man endeavoring to keep his "water line" on weak names as low as possible. If the European buyers only dealt with first-class houses only first-class bills would be offered, but when they deal with second- or third-rate houses, or houses with no standing whatever, such[Pg 321] bills drawn upon prime European banks come upon the market.

The American exchange buyers having the cotton as collateral while the drafts are on the water, and then having the acceptance of a prime European bank for the sixty or ninety days following before maturity of the draft, have accepted these risks, although unwillingly, for want of better bills. They endeavor to protect themselves as far as possible by trying to buy bills only of those in whose honesty they have reason to believe, whether they have any capital back of them or not. If the cotton were actually shipped under a bona fide order, any fluctuation in the value of the cotton which they accepted as collateral, although taken entirely without margin, would probably cause them neither loss nor friction. They have run the risk, however, of having forged documents forced upon them which did not represent goods, or exchange that was drawn without authority. Lines which exchange buyers are willing to take from each cotton shipper before acceptance, and before the name of a prime European banker is added to the paper, have to be based upon this consideration.

The old form of the cotton bill of lading which has been signed by freight agents or their assistants or others has been an instrument not possible to authenticate. This was particularly dangerous, due to the manner in which bills of lading were issued. They were formerly given out to the shippers, who filled them in and returned them to the railroad agent, who in turn often signed them without having any knowledge as to whether the goods called for by the bill of lading were in his possession or not. Under a new system bills of lading are not to be given up until the goods are actually in possession of the railroads. This system, which calls for validation certificates, numbered and printed upon a specially protected water-mark paper, to be attached to the bills of lading in such manner as to make it practically impossible to remove them without detection, went into effect September 1, 1910, and it is confidently hoped that it will give sufficient added safety to the bills of lading of American railroads to satisfy the foreign bankers.[Pg 322]

The very act of guaranteeing such bills is recognized by foreign bankers as being wrong in principle, and while they are requesting that American exchange buyers guarantee bills of lading for exports yet on the other hand they particularly call attention to the fact that no bills of lading which pass through their hands for imports to the United States are guaranteed by them in any way, shape, or manner.

Credit Risks of Drafts Drawn on Buyers Abroad

[109]Many American manufacturers do not realize the essential "credit" element of transactions on the basis of drafts drawn on foreign customers.... The exporter has received an order; he purchases the goods covered by this order from the manufacturer, and should the customer change his mind the exporter may suffer a loss. Or the customer refuses to accept the goods, and the exporter may again suffer a loss. Or the customer may accept the goods and the draft, but fail to pay, and the exporter once more is the loser....

... The turning over of the bill of lading vests the property right to the goods in the customer. The customer either pays the value of the draft in cash ("documents against payment," abbreviated d/p) or accepts the draft for payment at some future date, which is the more customary course ("documents against acceptance," d/a). Even in the case of d/p drafts, payment by the customer may be postponed; instead of paying cash he accepts the draft at one to three months, but neither the documents nor the goods are turned over to him. He may want to wait until he has sold the goods, on the basis of samples, perhaps, and the goods are warehoused until he can pay the amount of the draft into the bank or to the forwarding agency. This is frequently done in the Far East. Here the banks maintain so-called "godowns" for this purpose. The goods are occasionally turned over to the customer for warehousing purposes against the so-called "trust receipt." One important feature of "acceptance" of the draft by the customer is the fact that it forms an acknowledgment of indebtedness,[Pg 323] which it is then unnecessary to prove item by item in case of litigation. In most countries acceptances are far simpler to collect judicially than open accounts. When an accepted draft is unpaid it is "protested," and the debtors may be proceeded against without further trouble.

Frequently open accounts may be neglected by a customer who may find himself for some reason short of immediately available funds, but to neglect the payment of an accepted draft is regarded in the trade and by banks as so serious a matter that the drawee would lose caste with the banks; oversea buyers endeavor in most cases to honor accepted drafts....

England Draws Few Bills, But Accepts Many—The Reason and the Result

[110]It has been shown that, if two countries buy of each other to the same amount, their transactions need not give rise to two separate sets of bills, but that on the contrary, if the foreigner draws on us to the full value of his exports, the bills so created will be sent as remittances to the exporter on this side and will pay him for his sales. Conversely, if the British exporter draws, there is no necessity for the other side to do so.

What, then, are the facts? Does the United Kingdom, generally speaking, draw on abroad, or does the foreigner take the initiative by drawing on London?

As a matter of fact, both sides draw; but, as all who are acquainted with the customs of trade are well aware, the bills drawn by Great Britain on abroad are vastly outnumbered by those drawn from abroad on London.

Owing chiefly to the magnitude of our trade, but also to several contributory causes—such as the stability of our currency; the certainty that a bill on London means gold and nothing but gold; the facility with which those who deserve credit can obtain it here; our freedom from invasion, etc.—London has become to a great extent the settling-place of[Pg 324] Europe and the world, and the seller, wherever he may be, of a good bill on London can always be sure of finding a buyer and of realizing a fair price. As the sale of a bill, moreover, carries the valuable advantage of ready money and a speedy turnover of capital, it is invariably preferred by the foreign exporter, who has consigned or sold produce to us, to the alternative plan of awaiting remittances from this side. The foreign importer, too, who has to pay for the goods he has bought, would rather do so by remitting to London than by allowing us to draw upon him. In the former case, the rate he has to pay depends upon his own success in higgling; in the latter, it is fixed by a London bill-broker, who has not the same interest in the matter.

If the same considerations held good on this side also, our merchants and manufacturers might perhaps object to letting the foreigner have it all his own way; but, on the contrary, it appears to suit both buyers and sellers very well—the former, because in the majority of cases they would scarcely know how or where to buy suitable bills, and the latter, because the drawing and negotiation of a foreign bill requires a certain amount of knowledge of the exchanges, which they do not always possess, and entails a certain amount of trouble, which they would gladly be spared. There is also more risk of loss in drawing. In the latter case they have only their correspondent to look to, while on a London remittance they have the additional security of the other parties to the bill.

Practically speaking, therefore, the settlement of our foreign trade is effected by means of bills of exchange which are drawn and negotiated abroad, and are accepted and paid in London.

To the student of the exchanges this fact is of considerable importance, for, as the rate of exchange between two countries—the price at which bills on the one are sold in the other—must be fixed by the one that draws and negotiates the bill, it follows that the exchanges between England and most other countries are controlled from the other side, and that we in London have scarcely part or say in the matter. The rate of exchange, for example, between England and the United States is fixed in New York; between England and Brazil,[Pg 325] in Rio; between England and Turkey, in Constantinople; and so on. There may be exceptions, of which the Indian exchange is the most notable, but that is the general rule, and it is one that should be carefully borne in mind.

The same fact also supplies a reason for the solicitude with which the foreign trader watches the fluctuations of the exchange, and for the utter indifference with which they are regarded by the British trader. To the former, who intends maybe to draw a few hundred pounds on London in a day or two against the shipment he is preparing, the difference between selling his draft next week instead of this may mean, if the rate should move in his favor, the gain of an additional half per cent.; but to our home manufacturers, who sell their wares in sterling and stipulate for payment in bills on London, the see-saw of rates is but of academic interest. They pay attention to the course of discount, because they may have to melt some of their paper before pay-day comes round; but the course of the exchange—the question of the rate rising or falling—hardly concerns them at all.

It is not sought to detract from the influence of the English-drawn foreign bill, or, as might be imagined, to explain it away altogether. On the contrary, paper to a considerable amount is, and will continue to be, negotiated on the Royal Exchange (though the total, if compared with that of the paper on London negotiated abroad, would appear quite insignificant).[111] The object in view is merely to bring into prominence, and to impress on the reader, the essential principle that, while the position of every rate of exchange is the outcome of the market conditions in the two countries combined, the predominant mass of the dealings take place on the other side, so that, as a consequence, the real significance of the fluctuations can only be grasped by viewing them from the foreign [e. g., American] standpoint.

[Pg 326]

The Recent Rise of the American Acceptance Market

[112]Probably the most important effect at this time [1915] of the Federal Reserve Act is the establishment of the American acceptance market. It may well be said that heretofore America has had no real money market. The only semblance of a money market previously existing in this country was the call loan market of New York City. That, however, did not truly reflect money conditions in this country, as it has more often reflected the secondary effect of some movement of the stock market.

The development of a real money market in this country was greatly hampered by the lack of a standardized credit instrument. In every other country the bank acceptance in which the element of credit risk has been practically eliminated is the standard instrument of credit, and the discount rate of such paper marks the level of the money market.

Bank acceptances were not known in this country prior to the operation of the Federal Reserve Act. For the benefit of those who may not be familiar with bank acceptances, I will briefly describe an operation giving rise to such acceptances. Jones, an importer of coffee in New York, desires to purchase a cargo of coffee in Rio de Janeiro. He goes to his bank in New York and arranges with them to finance the deal. Smith, the grower of the coffee in Brazil, makes the shipment to New York and draws a ninety days' sight draft on the New York bank for the amount of his invoice. This draft he then sells to some Brazilian bank.... The Brazilian bank then sends the draft to New York. It is there presented to the New York bank for acceptance. The New York bank accepts the draft by writing the word "accepted" across the face of the draft and affixing its official signature thereto. The draft now becomes the primary obligation of the New York bank. Of course, Jones, for whose account the New York bank accepted the draft, has obligated himself to provide[Pg 327] the New York bank with funds to meet the draft, but if he should fail to do so the New York bank must pay the acceptance nevertheless. It is, therefore, the direct obligation of the New York bank, and as such it commands the best discount rates current. This briefly is what is known as a bank acceptance, i. e., a draft drawn on and accepted by a prime bank or banker.

Although this business is still in its infancy, it has reached important proportions and there is an active market for them in New York City. A number of brokers have taken up the business of buying and selling acceptances. Every morning they make the rounds of the various banks with the list of the acceptances they have for sale and the rates at which they are willing to sell them. Incidentally, they also learn whether the banks have any acceptances for sale and at what rates. As the credit risk is practically eliminated, acceptances are a very attractive form of secondary reserve; they are, as a London banker once expressed it, a means of enabling the banker to eat his cake and have it too—the banker by investing his money in acceptances earns the discount and at the same time he knows that his money is instantly available in case of need, so that they are almost as available as cash. This explains why the discount rate on acceptances ranges so low. Ninety days' sight acceptances sold in New York City at one time as low as 2 per cent. per annum and to-day prime acceptances command the excellent rate of 2-3/8 per cent.

The Economies and Advantages of "Dollar Credits"[113]

Many radical changes in the mechanism of international finance have occurred during the past fifteen months, since the beginning of the European war. Not the least important among these changes, viewed from the standpoint of the American importer, is the evolution in the methods of financing our importations.

Our imports in the way of commodities such as hides, coffee,[Pg 328] rubber, wool, etc., etc., run into hundreds of millions of dollars annually, and these are financed generally through the medium of commercial credits established by the purchaser in favor of the vendor of the merchandise. Commercial credits, so called, are in effect a bank guarantee to the seller that his drafts covering certain merchandise, when drawn in accordance with the conditions prescribed in the credit, will meet with due honor on presentation to the accepting bank named in the credit instrument.

In order merely to gain an idea as to the importance and volume of such transactions, it is only necessary to glance at the totals of a few of our principal imports. In the year 1914 we imported, among other commodities, the following:

Hides and skins$120,289,781.00
Wool (unmanufactured)53,190,767.00

Prior to the outbreak of the war in Europe, it is safe to assume that fully 95 per cent. of the credits issued to cover these importations were passed through London in the form of sterling credits; that is to say, credits available by drafts drawn in pounds sterling on London. Requests for the issuance of credits available by drafts drawn in United States dollars on New York were extremely rare, and they were issued only in exceptional cases.

Conditions have changed materially in this respect. The Federal Reserve Act grants to national banks the privilege of accepting drafts or bills of exchange growing out of transactions involving the importation or exportation of goods. This acceptance privilege was accorded to national banks only a short time before the commencement of hostilities abroad, and this fact in conjunction with the resulting dislocation in the delicate machinery of international credit brought about by the war, together with the coincidental establishment of American branch banks in South America, has contributed in a large measure to bring about the use of what is known now as "Dollar Credits."

As a factor in creating the existing demand for Dollar Credits, the establishment of American branch banks abroad[Pg 329] cannot be emphasized too strongly. Through these branch banks, a new and adequate medium for the liquidation of transactions as between the United States and certain South American countries, especially the Argentine, Brazil, and Uruguay, has been placed at the disposal of our merchants. A direct channel is now open to the ebb and flow of credit transfer between the United States and the countries mentioned, and, as a natural sequence, the former disparity existing against the dollar, as compared with pounds sterling and the principal continental exchanges, has disappeared. The resulting equalization in the rates of exchange benefits the American merchant to the extent of relieving him of the tribute formerly paid to the indirect channels of liquidation, or, in other words, to the foreign banker.

The Dollar Credit is of capital importance to every American merchant who is interested either directly or indirectly in the importation of commodities of any character. A study of the advantages accruing from this form of credit will demonstrate the desirability of its general employment as the vehicle for financing not only our own imports but also those of other countries. Primarily, it is more economical than the Sterling or Continental Credit, for the initial commission cost of issuance is lower. Secondly, it is based on a known quantity, the dollar, a factor of supreme importance in these days of extreme and violent fluctuations in the exchange rates, and therefore all exchange risk is eliminated from the operation as far as the importer is concerned. Maturities drawn under Dollar Credits are due and payable in dollars on a given date, and no question arises as to what the exchange rate on London may be ninety days after acceptance of the bill.

Under existing conditions in the New York money market, and considering the present low rates of interest actually in effect, the use of Dollar Credits is proving to be particularly attractive to the American importer as the medium for financing his importations. The rate of discount in New York for prime bank acceptances is 2-1/8@2-1/4 per cent. per annum, and a broad, well-developed discount market now exists, with an ever-increasing demand in evidence for this class of paper. On the other hand, the rate of discount in London for prime[Pg 330] ninety-day bills is 4-3/4 per cent. per annum, with operations restricted in a far from normal market. A comparison of these two discount rates will show a difference in favor of New York of 2-1/2@2-5/8 per cent. per annum. In addition to this difference in interest, there is also a difference in the initial cost in the form of commission for issuance, as between credits available by ninety-day drafts drawn on New York in dollars and those available by ninety-day drafts drawn on London in pounds sterling. This difference in commission in favor of New York will average 1/2 per cent. per annum, and when added to the saving in discount or interest already noted, will show a net saving on the Dollar Credit of 3@3-1/8 per cent. per annum, which accrues to the importer through the use of Dollar Credits in his operations.

Quite apart from the direct economy to the individual resulting from the use of Dollar Credits, is the broader question of the economic value accruing to the nation as a whole through the designation of the dollar as the basis of value in our credit transactions with the rest of the world. Since 1903, when the total of our imports amounted to $1,025,719,237, the volume of our imports has increased rapidly, and in 1914, the total imports reached the enormous sum of $1,893,925,657. These figures cover products from all parts of the world shipped direct to our own shores, and while no nation enjoys higher international credit than the United States, yet it is a fact that in order to finance the movement of our imports we have been compelled to have recourse to indirect channels and call on foreign money centers to furnish us with the necessary credit facilities to take care of a large part of our importations. Naturally, we have been obliged to pay for this accommodation, and the service has cost us millions of dollars annually in interest, commissions, etc.

These charges can be saved and an important economy effected, thus benefiting our commerce as a whole by the general designation of dollars in our foreign credit transactions. The purchasing power of the dollar in foreign markets is much greater to-day than it is in normal times because of the varying premium which the dollar commands at present practically throughout the world. The time is unquestionably opportune[Pg 331] to increase the prestige of the dollar and to standardize its use in the liquidation of our direct purchases abroad. Co-operation and concerted action on the part of our merchants to the end of generalizing the use of Dollar Credits is therefore a duty, which will bring about lasting benefit to the economic fabric of our commerce.

The New York Foreign Exchange Market[114]

A market may be defined as the coming together of buyers and sellers. It therefore involves all the mechanism necessary to facilitate their intercourse. One may speak of a general market or of a local market, of a market in one or in another place. Thus, there is the New York market for the buying and selling of exchange on London. A bank in New Haven, Connecticut, may be a part of that market if it buys from and sells to it. That market includes, besides the commercial and industrial organizations which buy or sell drafts, all middlemen of whatever class who engage in the trade.

The middlemen may be divided roughly into three classes. First may be mentioned banks which do a regular foreign exchange business, buying bills from those who have them to sell and selling their own drafts on foreign correspondents to persons desiring to remit. Much of this business is done by foreign exchange banks which carry on little or no other business. Some of it is done by ordinary commercial banks, such as United States National Banks, in addition to their other banking business. Second, we may call attention to those exchange dealers whose principal business is to buy commercial and bankers' bills, and to resell them, chiefly to banks. Third are the independent brokers who make small commissions by bringing buyers and sellers together. These do not invest their own capital, do not, that is, buy bills of exchange in the market, but assist those desiring to sell bills to find buyers, and vice versa....

[Pg 332]

New York City Practically Absorbs by Purchase All American Foreign Exchange

[115]There is, perhaps, no feature pertaining to banking throughout the country so dependent upon New York financiers, as foreign exchange. The very foundation of this branch of banking is constructed by the New York bankers, and from their banking houses emanate the basic prices and quotations upon which foreign bills are bought and sold throughout the United States.

It is the custom of New York foreign exchange brokers to furnish their Western clients, direct, or through their local representatives, daily market quotations, and to promptly advise them of fluctuations throughout the day. So closely is the West allied to the East, in this respect, that any interruption caused by delayed or suspended telegraphic service, immediately superinduces a practical standstill of exchange transactions, and operations thereafter must necessarily be made in the "dark" until free communication is again renewed between the cities....

The absorptive power of the New York market, to digest not only the surplus foreign exchange of the Chicago market, but that of the entire United States as well, has been demonstrated for many years. The reason for this can be attributed to the fact that international trade balances are at the present day, and always will be, adjusted by the financiers of New York City.

How Money Is Made in Foreign Exchange—The Operations of the Foreign Department

[116]Complete description of the various forms of activity of the foreign exchange department of an important firm would fill a large volume, but there are certain stock operations in foreign exchange which are the basis of most of the transactions carried out and the understanding of which ought to go a long[Pg 333] way toward making clear what the nature of the foreign exchange department's business really is.


The first and most elementary form of activity is, of course, the buying of demand bills at a certain price and the selling of the banker's own demand drafts against them at a higher price. A banker finds, for instance, that he can buy John Smith & Co.'s sight draft for £1,000, on London, at the rate of 4.86, and that he can sell his own draft for £1,000 on his London banking correspondent at 4.87. All he has to do, therefore, is to buy John Smith's draft for $4,860, send it to London for credit of his account there, and then draw his own draft for £1,000 on the newly created balance, selling it for $4,870. It cost him $4,860 to buy the commercial draft, and he has sold his own draft against it for $4,870. His gross profit on the transaction, therefore, is $10.

As may be imagined, not very much money is made in transactions exactly of this kind—the one cited is taken only because it illustrates the principle. For whether the banker sends over in every mail a bewildering assortment of every conceivable form of foreign exchange to be credited to his account abroad, or whether he confines himself to remittances of the simplest kind of bills, the idea remains exactly the same—he is depositing money to the credit of his account in order that he may have a balance on which he can draw. That is, indeed, the sum and substance of the exchange business of the foreign department of most banking houses—the maintaining of deposit accounts in banks at foreign centres on which deposit account the bank here is in a position to draw according to the wants and needs of its customers.


A "cable," so-called, differs from a sight draft only in that the banker abroad who is to pay out the money is advised to do so by means of a telegraphic message instead of by a bit of paper instructing him to "pay to the order of so and so."

Under ordinary circumstances foreign exchange dealers who engage in the business of selling cables carry adequate balances[Pg 334] on the other side, balances which they keep replenishing by continuous remittances of demand exchange.


If there is a stock operation in the conduct of a foreign exchange business it is the selling by bankers of their demand bills of exchange against remittances of commercial and bankers' long paper. Bills of the latter class make up the bulk of foreign exchange traded in, and its disposal naturally is the most important phase of foreign exchange business. What the foreign exchange business really is grounded on is the existence of commercial bills called into existence by exports of merchandise.

Buying and remitting commercial long bills is no pastime for an inexperienced man. Entirely aside from the question of rate, and profit on the exchange end of the transaction, there must be taken into consideration the matter of the credit of the drawer and the drawee, the salability of the merchandise specified in the bill of lading, and a number of other important points.

Where documents accompany the draft and the merchandise is formally hypothecated to the buyer of the draft, it might not be thought that the standing of the drawer would be of such great importance. Possession of the merchandise, it is true, gives the banker a certain form of security in case acceptance of the bill is refused by the parties on whom it is drawn or in case they refuse to pay it when it comes due, but the disposal of such collateral is a burdensome and often expensive operation. The banker in New York who buys a sixty-day draft drawn against a shipment of butter is presumably not an expert on the butter market and if he should be forced to sell the butter, might not be able to do so to the fullest possible advantage. Employment of an expert agent is an expensive operation, and, moreover, there is always the danger of legal complication arising out of the banker's having sold the collateral. It is desirable in every way that if there is to be any trouble about the acceptance or payment of a draft, the banker should keep himself out of it.[Pg 335]

The successive steps in an actual transaction are as follows:

The banker in New York having ascertained by cable the rate at which bills "to arrive" in London by a certain steamer will be discounted, buys the bills here and sends them over, with instructions that they be immediately discounted and the proceeds placed to his credit. On this resulting balance he will at once draw his demand draft and sell it in the open market. If, from selling this demand draft, he can realize more dollars than it cost him in dollars to put the balance over there, he has made a gross profit of the difference.

To illustrate more specifically: A banker has bought, say, a £1,000 ninety days' sight prime draft, on London, documents deliverable on acceptance. This he has remitted to his foreign correspondent, and his foreign correspondent has had it stamped with the required "bill-stamp," has had it discounted, and after having taken his commission out of the proceeds, has had them placed to the credit of the American bank. In all this process the bill has lost weight. It arrived in London as £1,000, but after commissions, bill-stamps, and ninety-three days' discount have been taken out of it, the amount is reduced well below £1,000. The net proceeds going to make up the balance on which the American banker can draw his draft are, perhaps, not over £990. He paid so-and-so many dollars for the £1,000 ninety-day bill, originally. If he can realize that many dollars by selling a demand draft for £990 he is even on the transaction.


In its influence upon the other markets, there is perhaps no more important phase of foreign exchange than the making of foreign loans in the American market. The mechanics of these foreign loaning operations, the way in which the money is transferred to this side, etc., will now be taken up.

To begin at the very beginning, consider how favorable a field is the American market for the employment of Europe's spare banking capital. Almost invariably loaning rates in New York are higher than they are in London or Paris. This is due, perhaps, to the fact that industry here runs on at a[Pg 336] much faster pace than in England or France, or it may be due to the fact that we are a newer country, that there is no such accumulated fund of capital here as there is abroad. Such a hypothesis for our own higher interest rates would seem to be supported by the fact that in Germany, too, interest is consistently on a higher level than in London or Paris, Germany, like ourselves, being a vigorous industrial nation without any very great accumulated fund of capital saved by the people. But whatever the reason, the fact remains that in New York money rates are generally on so much more attractive a basis than they are abroad that there is practically never a time when there are not hundreds of millions of dollars of English and French money loaned out in this market. All through the past ten years London has at various times opened her reservoirs of capital and literally poured money into the American market.

To take up the actual operation of loaning foreign money in the American market, suppose conditions to be such that an English bank's managers have made up their minds to loan out £100,000 in New York—not on joint account with the American correspondent, as is often done, but entirely independently. Included in the arrangements for the transaction will be a stipulation as to whether the foreign bank loaning the money wants to loan it on the basis of receiving a commission and letting the borrower take the risk of how demand exchange may fluctuate during the life of the loan, or whether the lender prefers to lend at a fixed rate of interest, say 6 per cent., and himself accept the risk of exchange.

What the foregoing means will perhaps become more clear if it is realized that in the first case the American agent of the foreign lender draws a ninety days' sight sterling bill for, say, £100,000 on the lender, and hands the actual bill over to the parties here who want the money. Upon the latter falls the task of selling the bill, and, ninety days later, when the time of repayment comes, the duty of returning a demand bill for £100,000, plus the stipulated commission. In the second kind of a loan the borrower has nothing to do with the exchange part of the transaction, the American banking agent of the foreign lender turning over to the borrower not a sterling[Pg 337] draft but the dollar proceeds of a sterling draft. How the exchange market fluctuates in the meantime—what rate may have to be paid at the end of ninety days for the necessary demand draft—concerns the borrower not at all. He received dollars in the first place, and when the loan comes due he pays back dollars, plus 4, 5, or 6 per cent., as the case may be. What rate has to be paid for the demand exchange affects the banker only, not the borrower.

Loans made under the first conditions are known as sterling, mark, or franc loans; the other kind are usually called "currency loans." At the risk of repetition, it is to be said that in the case of sterling loans the borrower pays a flat commission and takes the risk of what rate he may have to pay for demand exchange when the loan comes due. In the case of a currency loan the borrower knows nothing about the foreign exchange transaction. He receives dollars, and pays them back with a fixed rate of interest, leaving the whole question and risk of exchange to the lending banker.

To illustrate the mechanism of one of these sterling loans. Suppose the London Bank, Ltd., to have arranged with the New York Bank to have the latter loan out £100,000 in the New York market. The New York Bank draws £100,000 of ninety days' sight bills, and, satisfactory collateral having been deposited, turns them over to the brokerage house of Smith & Jones, the borrowers. Smith & Jones at once sell the £100,000, receiving therefor, say, $484,000.

The bills sold by Smith & Jones find their way to London by the first steamer, are accepted and discounted. Ninety days later they will come due and have to be paid, and ten days prior to their maturity the New York Bank will be expecting Smith & Jones to send in a demand draft for £100,000, plus 3/8 per cent. commission, making £375 additional. This £100,375 less its commission for having handled the loan, the New York Bank will send to London, where it will arrive a couple of days before the £100,000 of ninety days' sight bills originally drawn on the London Bank, Ltd., mature.

What each of the bankers concerned makes out of the transaction is plain enough. As to what Smith & Jones' ninety-day loan cost them, in addition to the flat 3/8 per cent.[Pg 338] they had to pay, that depends upon what they realize from the sale of the ninety days' sight bills in the first place and secondly on what rate they had to pay for the demand bill for £100,000. Exchange may have gone up during the life of the loan, making the loan expensive, or it may have gone down, making the cost very little. Plainly stated, unless they secured themselves by buying a "future" for the delivery of a £100,000 demand bill in ninety days at a fixed rate, Messrs. Smith & Jones have been making a mild speculation in foreign exchange.

If the same loan had been made on the other basis, the New York Bank would have turned over to Smith & Jones not a sterling bill for £100,000, but the dollar proceeds of such a bill, say a check for $484,000. At the end of ninety days Smith & Jones would have had to pay back $484,000, plus ninety days' interest at 6 per cent., $7,260, all of which cash, less commission, the New York Bank would have invested in a demand bill of exchange and sent over to the London Bank, Ltd. Whatever more than the £100,000 needed to pay off the maturing nineties such a demand draft amounted to, would be the London Bank, Ltd.'s profit.

From all of which it is plainly to be seen that when the London bankers are willing to lend money here and figure that the exchange market is on the down track, they will insist upon doing their lending on the "currency loan" basis—taking the risk of exchange themselves. Conversely, when loaning operations seem profitable but rates seem to be on the upturn, lenders will do their best to put their money out in the form of "sterling loans." Bankers are not always right in their views, by any means, but as a general principle it can be said that when big amounts of foreign money offered in this market are all offered on the "sterling loan" basis, a rising exchange market is to be expected.

From what has been said about the mechanism of making these foreign loans, it is evident that no transfer of cash actually takes place, and that what really happens is that the foreign banking institution lends out its credit instead of its cash. For in no case is the lender required to put up any money. The foreign lender is at no stage out of any actual capital,[Pg 339] although it is true, of course, that he has obligated himself to pay the drafts on maturity, by "accepting" them.

Where, then, is the limit of what the foreign bankers can lend in the New York market? On one consideration only does that depend—the amount of accepted long bills which the London discount market will stand. For all the ninety days' sight bills drawn in the course of these transfers of credit must eventually be discounted in the London discount market, and when the London discount market refuses to absorb bills of this kind a material check is naturally administered to their creation.


Approaching the subject of finance-bills, the author is well aware that concerning this phase of the foreign exchange business there is a wide difference of opinion. Finance-bills make money, but they make trouble, too. Their existence is one of the chief points of contact between the foreign exchange and the other markets, and one of the principal reasons why a knowledge of foreign exchange is necessary to any well-rounded understanding of banking conditions.

Strictly speaking, a finance-bill is a long draft drawn by a banker of one country on a banker in another, sometimes secured by collateral, but more often not, and issued by the drawing banker for the purpose of raising money. Such bills are not always distinguishable from the bills a banker in New York may draw on a banker in London in the operation of lending money for him, but in nature they are essentially different. Whether or not any collateral is put up, the whole purpose of the drawing of finance-bills is to provide an easy way of raising money without the banker here having to go to some other bank to do it.

The origin of the ordinary finance-bill is about as follows: A bank here in New York carries a good balance in London and works a substantial foreign exchange business in connection with the London bank where this balance is carried. A time comes when the New York banking house could advantageously use more money. Arrangements are therefore made with the London bank whereby the London bank agrees[Pg 340] to "accept" a certain amount of the American banker's long bills, for a commission. In the course of his regular business, then, the American banker simply draws that many more pounds sterling in long bills, sells them, and for the time being has the use of the money. In the great majority of cases no extra collateral is put up, nor is the London bank especially secured in any way. The American banker's credit is good enough to make the English banker willing, for a commission, to "accept" his drafts and obligate himself that the drafts will be paid at maturity. Naturally, a house has to be in good standing and enjoy high credit not only here but on the other side before any reputable London bank can be induced to "accept" its finance paper.

The ability to draw finance-bills of this kind often puts a house disposed to take chances with the movement of the exchange market into line for very considerable profit possibilities. Suppose, for instance, that the manager of a house here figures that there is going to be a sharp break in foreign exchange. He, therefore, sells a line of ninety-day bills, putting himself technically short of the exchange market and banking on the chance of being able to buy in his "cover" cheaply when it comes time for him to cover. In the meantime he has the use of the money he derived from the sale of the "nineties" to do with as he pleases, and if he has figured the market aright, it may not cost him any more per pound to buy his "cover" than he realized from the sale of the long bills. In which case he would have had the use of the money for the whole three months practically free of interest.

It is plain speculating in exchange—there is no getting away from it, and yet this practice of selling finance-bills gives such an opportunity to the exchange manager shrewd enough to read the situation aright to make money, that many of the big houses go in for it to a large extent. During the summer, for instance, if the outlook is for big crops, the situation is apt to commend itself to this kind of operation. Money in the summer months is apt to be low and exchange high, affording a good basis on which to sell exchange. Then, if the expected crops materialize, large amounts of exchange drawn against exports will come into the market, forcing down rates and giving[Pg 341] the operator who has previously sold his long bills an excellent chance to cover them profitably as they come due.


Arbitraging in exchange—the buying by a New York banker, for instance, through the medium of the London market, of exchange drawn on Paris—is another broad and profitable field for the operations of the expert foreign exchange manager. Take, for example, a time when exchange on Paris is more plentiful in London than in New York—a shrewd New York exchange manager needing a draft on Paris might well secure it in London rather than in his home city.

Between such cities rates are not apt to be wide enough apart to afford a wide margin of profit, but the chance for arbitraging does exist and is being continuously taken advantage of. So keenly, indeed, are the various rates in their possible relation to one another watched by the exchange men that it is next to impossible for them to "open up" to any appreciable extent. The chance to make even a slight profit by shifting balances is so quickly availed of that in the constant demand for exchange wherever any relative weakness is shown, there exists a force which keeps the whole structure at parity. The ability to buy drafts on Paris relatively much cheaper at London than at New York, for instance, would be so quickly taken advantage of by half a dozen watchful exchange men that the London rate on Paris would quickly enough be driven up to its right relative position. If a chance exists to sell a draft on London and then to put the requisite balance there through an arbitration involving Paris, Brussels, and Amsterdam, the chances are that there will be some shrewd manager who will find it out and put through the transaction. Some of the larger banking houses employ men who do little but look for just such opportunities.

The foregoing are the main forms of activity of the average foreign department, though there are, of course, many other ways of making money out of foreign exchange.[Pg 342]

Gold Movements

[117]When there is a heavy demand for exchange and little supply, the price of exchange gradually advances. The banker, called on by his customers to draw exchange for them, finding few bills in the market that he can remit to cover his drafts, sends gold and directs its equivalent in foreign coin to be placed to his credit, and against this credit he draws. There may be no market abroad for our crops or manufactures; but gold need not be sold in order to produce money; it need only be coined. As this process can be carried on indefinitely, the cost of sending gold is obviously the limit beyond which the price of demand bills cannot advance. Let us follow this transaction in detail. The pure gold contained in one English sovereign is exactly equal to the pure gold contained in $4.8665 of our gold coins; so that, apart from charges and expenses, $4.8665 of our gold will, when sent abroad, produce a credit of £1; to this cost must be added freight, insurance, and other expenses, amounting to about one-fourth of 1 per cent. This brings the cost of £1 through shipment of gold to about $4.88, which is, roughly, the gold export point for full weight coin. The exporting banker obtains his gold either by drawing gold coin from his bank or else by drawing suitable currency from his bank, and obtaining gold coin for it at the subtreasury. In either case, he obtains coin that has suffered more or less abrasion by handling, and this loss of weight by abrasion, amounting to perhaps one-tenth of 1 per cent., increases the cost of his remittance. Generally, however, the banker can obtain gold bars from the United States Assay Office at the nominal charge of one twenty-fifth of 1 per cent., although at times a larger charge is made. The banker prefers bars, because on these there is no loss by abrasion; the Government can afford to give bars, because their export prevents the export of coin, and so saves the cost of coining new money to replace that shipped.

Now for gold import. When there is a large volume of[Pg 343] bills offered to bankers, perhaps by grain and cotton exporters, and but little demand from buyers of exchange, the market gradually declines in price, while New York bankers, sending abroad the bills they buy, with little occasion to draw against them, accumulate large sums to their credit in London, with no way of getting the money back to New York through operations in the exchange market. They are not, however, helpless; they can order gold sovereigns sent here, and, once here, can have them melted down at the United States Assay Office and coined into eagles and double eagles, which they can deposit with their banks. Obviously, the amount received in dollars for each melted sovereign will mark the price the banker can afford to pay for sterling bills, and competition among bankers will prevent the rate of exchange from declining below this point by more than a fair margin of profit. The British sovereign, if full weight, will, when sent here and melted down, yield gold for which the United States Assay Office will pay $4.8665; the expense of sending the sovereign, freight, insurance, cartage, and kegs, will amount to about one quarter of 1 per cent., so that the net yield of the full weight sovereign in dollars will be $4.85-3/8. But between the day on which the banker buys the bill of exchange in New York and the day on which he receives in New York the gold which the bill entitled him to collect in London, there must elapse the time needed to send the bill to London, plus the time needed to send the gold back (roughly fifteen days), during which period the banker loses the use of the money. This loss of interest must be deducted from the net yield of the imported sovereign, and thus, if money is worth 6 per cent. per annum, the net yield of full weight sovereigns is brought down to about $4.84-1/4, which is the gold import point for demand exchange, when money is worth 6 per cent. per annum. Losses by abrasion will bring down this point by perhaps one-tenth of 1 per cent., to about $4.83-3/4. When money is higher, the import point will be lower, and vice versa. There is therefore a margin of profit in buying demand bills and importing gold sovereigns against the purchase, whenever the rate for demand bills falls below the gold import point. Active exchange bankers take advantage of this profit whenever[Pg 344] exchange prices decline to the proper point, and their competition in buying bills to cover their gold importations stops further decline in exchange rates. It is interesting to note that during the recent crisis, when gold and currency were at a premium, bankers could sell the imported gold at a premium, and this constituted an additional and very large profit; gold importers could therefore pay higher prices than ordinarily for exchange bought to cover the importations, and the stress of competition so drove up the rate of exchange that gold was being imported at a profit, though exchange rates stood at what, under ordinary circumstances, would have been the gold export point.

Gold is, however, not always imported from England in the form of sovereigns. The Bank of England has in its vaults large quantities of American eagles and double eagles exported to England in the past and held without melting. The bank also holds foreign coin and bar gold. Any holder of Bank of England notes can get sovereigns on demand—other gold he can get only as the result of a special bargain. When gold is wanted for export, the bank is often glad to sell bar gold or double eagles at rates somewhat more advantageous to the exporter than would be the export of sovereigns; this the bank can afford to do, for the expense of coining sovereigns to replace those exported is thus saved, while the exporter, if he can get bar gold on the same basis as sovereigns, avoids the losses of abrasion. Eagles are even more advantageous to the exporter, for they are bought in England by weight and used in America by count; the banker therefore gets an advantage if they are light, so long as that lightness is not so great as to make them uncurrent—practically he buys them as light and uses them as full weight....

The mechanism of gold import to, and export from, Germany is practically the same as with England, the Reichsbank being required to give gold coin in exchange for its circulating notes. At times, however, German exchange has fallen below the theoretical gold import point, owing, not to the refusal of the Reichsbank to give gold, but to the practical obstacles that at times are somehow placed in the way of free export of gold.[Pg 345] The Reichsbank does not refuse gold for its bank-notes, but German bankers say to their correspondents: "Don't ask us to get gold for you, or we shall lose caste," and on such occasions German exchange rates drop to a point that is theoretically impossible. I do not mean to criticise them: German banks, when they refuse to demand gold of the Reichsbank, do no more than our own banks and bankers did recently, when asked by foreign correspondents to collect in gold the maturing obligations of railroads and other corporations. As will be remembered, clearing-house funds rather than cash were at that time current here, and New York banks and bankers sent to their foreign correspondents the same answer as the Germans have at times sent us. I cite the German instance in partial mitigation of censure of our own course rather than as a reproach to them.

The Bank of France is not compelled to give gold in exchange for its circulating notes; it may at its option give silver. Thus, when it is inconvenient to give gold, the bank can refuse, or, if it prefers, it can exact a premium. This power has been very moderately and very wisely used by the bank to modify foreign demands on the one hand, and, on the other, to keep interest rates low for the requirements of internal trade. Of course, when a premium is exacted, the French gold import point drops accordingly.

Between the gold export point and the gold import point, exchange fluctuates under the sway of conflicting currents and tendencies—I had almost said emotions, for these currents and tendencies have their rise in emotions, needs, and passions as varied as life itself, whether they be hunger as expressed in the grain bill, or love of elegance in the importation of silk, or forethought in the profitable investment of capital.

This brief review will have made clear what is meant by a free gold market—a market in which current money can at all times be exchanged for gold without delay and without premium. Such a market has great commercial advantages; its stability draws business to it. London is such a market, and its commercial and financial pre-eminence is in great measure due to that fact. Paris is not such a market and does not[Pg 346] pretend to be; Berlin pretends to be, but cannot always be counted on; New York was believed to be before our recent panic.

I have spoken of the exchange market as an economical mechanism, automatically making delicate international adjustments. In justification of that observation, let me direct attention to the manner in which gold, in moving from financial centre to financial centre, always travels by the most direct route, and that, too, not because some public official is charged with the duty of preventing waste, but because a private trader is trying to make a profit, and is incidentally serving the community; serving it perhaps better than if he had consciously determined to serve it.

Useful acts springing from self-interest have one very comforting aspect—we need have no misgivings as to their continuance. Charity may grow weary or disgusted, but self-interest, once enlisted, may be counted on to continue in operation, whether it be the business man's self-interest in a profit or the professional man's self-interest in advancement and fame. Of course, both the business man and the professional man, in addition to seeking the direct rewards of their labor, take an interest in their work as work and make it yield them pleasure.

It is therefore satisfactory to know that, so long as the banker looks after his profits, gold will move by the most direct route. Let us suppose the United States to be exporting a large quantity of cotton to England at a time when little merchandise is being imported here from England, but when much is being imported from France. If the volume of exports to England and of imports from France were large enough, we might conceivably be importing gold from England in payment of our produce, and exporting it to France in payment for her luxuries; but, in practice, gold does not move that way. Every morning, the New York exchange banker learns by cable the Paris market rate for demand bills on London. When, therefore, he finds a large volume of bills on London offered for sale, and little demand for such bills, while there is large demand for bills on Paris and little supply, he determines, instead of drawing from New York against his[Pg 347] purchases of London bills, to let his Paris agent draw against these purchases, placing the proceeds to his credit in Paris; against this credit in Paris, the New York banker draws his bill in francs, having thus supplied via London the New York demand for bills on Paris. He knows how many dollars each pound sterling costs him in New York, and the Paris rate for bills on London tells him how many francs each pound sterling will net him in Paris, and so he can calculate how many cents each franc will cost him. Moreover, he is not the only banker in New York that receives cable quotations; and so with a large volume of London bills offered and little direct demand for such bills, and large demand for Paris bills with little direct supply, we get a situation where New York bankers, competing with each other to buy the London bills for use via Paris, prevent the price of sterling from falling to the gold import point; and then, as a result, these same bankers, competing with each other to supply the demand for Paris bills, by their competition prevent the Paris rate from rising to gold export point. Lastly, they compete with each other in Paris, where all are sellers of bills on London against their New York purchases of London bills, and by that competition they reduce the rate for London bills in Paris to the point, at which, other things being equal, gold will go from London to Paris. What has happened, therefore, is that instead of our importing gold from London, and then exporting it to Paris, it has gone direct from London to Paris.


[118]It is safe to assert that when the exchanges go down to the point at which it pays better to ship gold from London than to buy a bill, gold will go. But in the first place, experts always differ as to where that point begins; and in the second, gold often leaves London long before there is any question of its being the more profitable form of remittance. In fact, it may be asserted that the foreign exchanges very seldom go down to the export gold point, because gold begins to go before they can get there.

[Pg 348]

It has often happened to me, when I was a financial journalist and had to try to find out the how and why of gold movements, to ask several of the most experienced and well-informed cambists in the city whether a gold shipment which had taken place had been made as a genuine exchange transaction or was done for some other reason, and to hear from one that there was a reasonable exchange profit on it, from another that there might be just a shade of a turn to be got out of it if you scraped it very hard with a knife, and from another that you could not find a particle of profit in it if you put it under a microscope for a week. So many complications have to be considered that the most eminent doctors may be pardoned for disagreeing.

It may be objected that dealers in exchange, and the comparatively few firms that make a special study of gold shipping, are not in the business for their health, and that shipments would not happen if there were not some profit in them. This is perfectly true, but the profit need not be got from the exchange. As an exchange transaction it only pays to ship gold to America when bills on London can only be sold in New York at a lower price than gold would fetch if brought from London and exchanged into dollars in New York. If bills on London are selling at 4.83-3/4, and gold can be bought and shipped and turned into dollars at the rate of 4.83-7/8, after allowing for all charges and commissions and the loss of interest during transit, then the operation pays as an exchange transaction. If the dollars realized by the gold were at the rate of only 4.83-3/4 the importer would be no better off than if he had sold a bill; if they were at the rate of 4.83-5/8 he would be out of pocket on the business, viewed strictly as an exchange transaction. But this is by no means the only consideration. Gold has such a magical fascination for moneyed mankind, and its movements are so eagerly discussed in their markets and newspapers, that it is often handled and shipped at a loss, especially in America, for the sake of the advertisement that the importing firm thereby gains for itself.

Moreover, imports of gold have a very stimulating effect on speculative stock markets, because an increase in the amount of gold available means a roughly corresponding increase in the[Pg 349] amount of credit that bankers can give, so that when gold is known to be coming speculators know that credit will be cheaper for carrying their commitments, and will come in and buy, with a light heart, stock that they could not possibly pay for, but hope to pawn with their bankers until they can sell it at a higher price. And so unless the loss on the exchange side of the business is too great, it often pays the leaders of a bull campaign to import gold, having first laid in a line of stock, and make their profit by unloading during the fit of exhilaration produced by the news that the gold is on the way.

Or, again, quite apart from any speculative and spectacular motives behind gold shipments, it may pay bankers, in a country where rates for money are ruling high, to import gold at an apparent loss, because of the high rates that they get for the credit that they are thereby enabled to give. They thus, in effect, borrow gold, and recoup themselves by being able to lend, on profitable terms, larger amounts than they borrow, since they can always create credit to larger amounts than that of the gold in their vaults. Sometimes, in fact, in times of pressure banks find themselves obliged to import gold so as to strengthen their position, whatever the loss on exchange may be.

For instance, last September, when the Berlin exchange was at the point at which, if theory ruled in these matters, Berlin ought to have been thinking of packing up some gold to send to London, Berlin was buying gold in London and shipping it to the Fatherland, because there is always great pressure for currency in Germany at the end of September when the interest on mortgages falls due and has to be paid in cash, with the result that the Reichsbank's note circulation expands very rapidly and the backing of gold behind it has to be increased. Sometimes, again, in order to attract gold, a central bank will give importers credit for gold that is on the way, so that they may be saved from loss of interest while the metal is afloat. Thus the actual importer may make a profit on the shipment, not as a genuine exchange transaction, but at the expense of the central bank.

In these cases two of the many functions performed by gold have to be considered. As a means of international remittance,[Pg 350] it may not be as cheap as a bill, but it may have to be sent, not as a means of remittance, but because it is urgently wanted in the importing country as a make-weight for the balloon of credit.

So we see that the grumbling bill broker who ... [said] that these confounded exchanges only work one way, was actually understating his case. Not only do we [Englishmen] always lose gold when the exchanges go against us, and often get none when they go in our favour, but we also often lose gold long before the exchanges are sufficiently against us to justify its going, and sometimes even when they are strongly in our favour.

The effect on the exchange of an import or export of gold is, of course, just the same as that of the import or export of any other commodity—an import turns the exchange against us and an export turns it in our favour. If we send gold, for example, to Germany we thereby meet a German claim on us or create a claim for ourselves on Germany; in the former case the bills drawn on us will be less by the amount of the gold shipped, and the supply in Berlin of bills on London will be less in relation to the demand, so that the tendency will be for the price of sovereigns, as expressed in marks, to rise. In the latter case some one in Berlin will have a claim to meet in London and will have to bid there for a bill on London, and his bidding will have the same beneficent effect on the exchange. When we import gold, whether brought out of bankers' vaults, or dug out of the bowels of the earth, the country that sends it to us meets claims of ours on it or establishes claims on us. In either case the tendency is for the exchange to move against us.


[119]Whether in coined pieces or bars (bullion), the gold is packed in strong kegs or boxes, securely strapped with hoop iron, and carefully sealed with private seals; the latter to discover[Pg 351] if tampered with en route. Space is chartered from the steamship company, as in the case of merchandise, although nearly all large fast steamers have rooms especially constructed for such valuable cargo.... As an extra safeguard in case of large shipments, the steamship company details special armed men to guard the room day and night, and sometimes the shipper employs special detectives in citizens' clothes to watch the passengers on the trip, since it is generally known several days in advance when large shipments of gold are to be made.

The Silver Exchanges

[120]... It is acknowledged that commerce between gold standard countries is satisfactory to all classes of traders, for both importers and exporters know exactly the return they may expect, but in trade between a silver-using country and one on a gold basis, a large measure of uncertainty invariably exists. Whenever there is a fall in the gold value of silver, either the exporter in the gold standard country or the importer in the silver country must suffer.

Let us take the case of the exporter. We will suppose that A. Blank & Company, of Manchester, calico printers, send goods to Shanghai, which they hope to sell there for a total sum of, say, £1,000. The price of silver when the shipment was despatched was, we will say, 25d. per standard ounce, and on this basis A. Blank & Company have calculated the selling price which is to yield them £1,000. By the time the calico arrives in Shanghai, the gold price of silver has dropped, we will suppose, to 20d. per standard ounce, and this obviously indicates that the manufacturers will receive one-fifth less for their wares, since they are paid in the currency of the province (taels in this instance), and when Blank & Company's money comes to be converted back into British gold pieces, they are face to face with the fact that the outturn is £200 less than they had calculated: they have lost one-fifth, and receive £800 only. This is, of course, an extreme case, as in the ordinary course silver would be unlikely to drop 5d. in the period between[Pg 352] shipment and arrival of the goods in Shanghai; but whatever the fall, the principle is the same, and the illustration serves to show exactly what happens.

It is not only the British exporters who stand to lose in the lottery of trade with countries which have an unstable silver exchange; the capitalist also, and every class of investor, is liable to be adversely affected in operations with silver standard countries. The rate of exchange between such countries and gold standard countries is plainly the exchange between gold and silver; therefore, if a person has invested in undertakings in the silver country, when he receives his dividends in the currency of that country, he will obtain less for his dividend warrant on the London market in proportion to the fall in the price of silver—assuming that it does fall. Conversely, he may reap a higher return on his investment if silver has gone up before the encashment of his dividend.

Finally, the principal is affected in the same way, whenever it is desired to convert it back into gold. A further example will show how this works out in practice.

We may assume that an investor, encouraged by the chance of earning 6 per cent. on his money, remits to China £1,000. The price of silver on the 1st January, 1914, was 26-7/16d. per ounce standard; on the 31st December, 1914, 22-11/16d. For the sake of argument, we will imagine our investor sent the money out to the Eastern country on the 1st January, 1914, but circumstances made it advisable for him to recall his money at the end of December in the same year, when the metal had depreciated to 22-11/16d.; in converting his principal back to British currency he will find himself faced with a sharp loss. Silver, in which the investment stood, has dropped 3-3/4d. of its gold equivalent, roughly, one-seventh; consequently on conversion the gold value of his original £1,000 has fallen to about £857....

... The exchanges of these silver standard countries ... [are] quoted in shillings and pence to the dollar, tael, or rupee, as the case may be, that is, the gold value of the respective silver coins. Hong-Kong, for instance, is quoted 1s. 10-3/8d. to the dollar, and Shanghai, 2s. 5-5/8d. to the tael. The rates from these centres ... indicate the price for telegraphic[Pg 353] transfers on London: the unit of exchange in the centres named being by general consent the rate for telegraphic transfers on London.

Let us take the Shanghai rate as an example: 2s. 5-5/8d. per tael, means that for every silver tael the remitter hands over to the exchange bank in Shanghai, 2s. 5-5/8d., or, to give it its real significance, a little less than one-eighth of a sovereign in gold, will be paid to the person in whose favour the remittance is made, as soon as a telegram can reach the bank's London branch....

... Besides the T. T. rate, as it is called for the sake of brevity, we have the four months' sight and six months' sight rates, which are the quotations for first-class bank bills. Both quotations are higher than for the telegraphic transfers, that is to say, for every silver tael paid in Shanghai the bank will allow more shillings and pence where it is a question of paying the gold value in London four or six months hence, than it would if the payment is to be made on demand or by wire. The reason is, that if a bill drawn on London, payable four months after sight, is sent, the remitter is bound to place the receiver in such a position that if the latter chooses to turn the bill into cash after it has been "sighted" and accepted, he will not be worse off than if the money had been sent by cable....

As may be gathered, therefore, the discount rates ruling on the London market are of great importance to the Eastern bankers and exchange dealers: so important are they in fact, that it is necessary for each side to keep in direct telegraphic communication regarding the existing discount quotations and the probable trend of the markets....

... The rate at which they are able to cover their drawing operations ... governs the price at which they will sell bills. If a banker has funds deposited with his correspondent upon which he can draw, well and good: if he has no balance with the agent, he must either provide the wherewithal to meet the bills which he has drawn, or, alternatively, he can instruct the agent to draw on him in reimbursement. Finally, there comes a time,... when, as all other means of placing his correspondent in funds have been exhausted, the banker will be[Pg 354] obliged to ship ... silver to be sold for what it will fetch....

It is fairly clear that the real trouble in Eastern exchange lies in the fact that we have three main factors to deal with instead of two. In the gold exchanges we have simply the demand for and supply of bills and telegraphic transfers; in the silver exchanges the matter is complicated by the way in which we also have to depend upon the fluctuations in the price of silver on the London market....

Shanghai draws on London for the cost of her exports and remits to London for the value of her imports, and the principal reason for this procedure is that the manufacturer in Great Britain does not wish to be bothered with the variations in exchange, although as the reader has seen, he may be pretty severely affected if silver has depreciated before his goods are sold. Leaving that out of the question, however, we may take it that as all his expenses are payable in gold, he naturally prefers to deal in terms of that metal. Consequently, goods shipped to China are nearly always paid for by remittances, or drawn for in sterling, which comes to the same thing. The Chinese producer is on rather a different footing. His expenses are in silver, and in silver he wishes to be paid. His produce, however, he has sold to Great Britain for a gold price, and either he cannot afford to, or does not want to wait until a remittance can be sent by mail from London. The one way open to him is to draw in sterling and settle the rate of exchange on the spot, which he does and so makes an end of the matter....


[103] Hartley Withers, Money Changing, pp. 30-35. E. P. Dutton and Company. New York. 1914.

[104] Adapted from the Rt. Hon. Viscount Goschen, The Theory of the Foreign Exchanges, pp. 85-88. Effingham Wilson. London. 1913.

[105] Adapted from Franklin Escher, The Elements of Foreign Exchange, pp. 3-14. Bankers Publishing Company. New York. 1913.

[106] Ibid., pp. 15-24, 26, 31-33, 44.

[107] Adapted from Frederick I. Kent, Financing Our Foreign Trade, The Annals of the American Academy of Political and Social Science, Vol. XXXVI, No. 3, November, 1910, pp. 492-500.

[108] [The method explained would apply without qualification to our imports generally prior to 1914, whether coffee from Brazil, hides from the Levant or textiles from France. The recent and growing practice of drawing on New York rather than on London is discussed later in this chapter.]

[109] Adapted from Archibald J. Wolfe, Foreign Credits, pp. 22, 23, Special Agents Series—No. 62. Department of Commerce and Labor. Washington. 1913.

[110] George Clare, The A B C of the Foreign Exchanges, pp. 11-15. Macmillan and Company. London. 1911.

[111] [English bills drawn on our banks have increased in volume since 1914, through the operation of the Federal Reserve Act and the amended New York State Bank Law which make provision for the acceptance of time drafts by National and New York State banks, respectively.]

[112] John E. Rovensky, How the War Affects Practical Operations in International Exchange, Journal of the American Bankers Association, Vol. 7, No. 12, June, 1915, pp. 1008, 1009.

[113] Joseph T. Cosby, The Economies and Advantages of "Dollar Credits." The National City Bank. New York. 1915.

[114] Harry G. Brown, International Trade and Exchange, pp. 65-66. The Macmillan Company. New York. 1914.

[115] Anthony W. Margraff, International Exchange, pp. 104-105. Fergus Printing Company. Chicago. 1903.

[116] Adapted from Franklin Escher, Elements of Foreign Exchange, pp. 68-101. Bankers Publishing Company. 1910.

[117] Albert Strauss, Gold Movements and the Foreign Exchanges, The Currency Problem and the Present Financial Situation. A Series of Addresses Delivered at Columbia University, 1907-1908, pp. 65-72. The Columbia University Press. 1908.

[118] Hartley Withers, Money Changing, pp. 159-164. E. P. Dutton and Company. New York. 1914.

[119] Address by H. K. Brooks. Lectures on Commerce, Edited by Henry Rand Hatfield, University of Chicago Publications of the College of Commerce and Administration, Vol. I., pp. 283-4. The University of Chicago Press. Chicago. 1904.

[120] William F. Spalding, Foreign Exchange and Foreign Bills in Theory and in Practice, pp. 133-140. Sir Isaac Pitman & Sons, Ltd., Bath, New York and Melbourne. 1915.

[Pg 355]



The following discussion of clearing houses is confined mainly to the United States and England. References to the clearing houses of France and Germany, where the introduction of the use of checks and the consequent development of clearing facilities have been tardy, are contained in the chapters devoted to the banking systems of those countries.

I. In the United States


[121]What is a clearing house? The Supreme Court of the State of Pennsylvania has defined it thus:

It is an ingenious device to simplify and facilitate the work of the banks in reaching an adjustment and payment of the daily balances due to and from each other at one time and in one place on each day. In practical operation it is a place where all the representatives of the banks in a given city meet, and, under the supervision of a competent committee or officer selected by the associated banks, settle their accounts with each other and make or receive payment of balances and so "clear" the transactions of the day for which the settlement is made.

But we must go farther than this, for though originally designed as a labor-saving device, the clearing house has expanded far beyond those limits, until it has become a medium for united action among the banks in ways that did not exist even in the imagination of those who were instrumental in its inception. A clearing house, therefore, may be defined as a device to simplify and facilitate the daily exchanges of items and settlements of balances among the banks and a medium for united action upon all questions affecting their mutual welfare.

[Pg 356]


[122]During a comparatively short period immediately following 1849 the number of banks in New York increased from 24 to 60. In the daily course of business each bank received checks and other items on each of the other banks, which had to be presented for collection. All such items on hand were assorted and listed on separate slips at the close of the day, and items coming in through the mail on the following morning were added at that time. To make the daily exchanges each bank sent out a porter with a book of entry, or pass book, together with the items to be exchanged.

The receiving teller of the first bank visited entered the exchanges brought by the porter on the credit side of his book and the return exchanges on the debit side, who then hurried away to deliver and receive in like manner at the other banks. It often happened that five or six porters would meet at the same bank, thereby retarding one another's progress and causing much delay. Considerable time was consumed in making the circuit. Hence, the entry of the return items in the books of the several banks was delayed until the afternoon, at an hour when the other work of the bank was becoming urgent.

A daily settlement of the balances was not attempted by the banks, owing to the time it would have required, but they informally agreed upon a weekly adjustment, the same to take place after the exchanges on Friday morning. At that time the cashier of each bank drew a check for each of the several balances due it, and sent a porter out to collect them. At the same time the porter carried coin with which to pay balances due by his bank. After the settlement had been made, there was a meeting to adjust differences and bring order out of chaos.

An old bank officer (J. S. Gibbons), in describing the inconveniences and defects of this system, says that some of the more speculative banks took advantage of the weekly method of settlements by carrying a line of discounts to an amount greater than their legitimate resources would allow. Thus, a bank would manage to carry a small debit balance of $2,000[Pg 357] or $3,000 with thirty or more institutions, making a total debit balance of, say, $100,000 on which it discounted paper. It was the practice to borrow enough on Thursday to make the settlements on Friday, and the return of the loan on Saturday threw it again into the debtor column. Virtually, therefore, the weekly settlements were nominal only, and to show that there was no attempt at economy of time and labor in making them, it is only necessary to say that the cashier drew a check for every balance due him, whereas a draft on one bank in favor of another might have settled two accounts at once.

The banks were at liberty to draw on each other for their credit balances without waiting for the settlements on Friday, and hence, when specie was needed, this was not infrequently done. But so far did many of the banks extend their loans and discounts that a single small draft by one bank on another would induce a general drawing and involve them all in confusion and virtual war on each other. Three o'clock would arrive, with the line of drafts incomplete, thus enabling debtor banks ofttimes to add $50,000 to their specie, whereas creditor banks would find themselves at the close of the day depleted in perhaps twice that sum.


[123]The desirability of a substitute for such a system had long been realized, but as yet no plausible scheme had been proposed. As early as 1831 a plan had been suggested by Albert Gallatin, which, to a very remarkable degree, coincided with the one ultimately adopted.

But the times were not ripe for the scheme thus proposed. Mr. Gallatin was thinking in advance of the age. In time, however, the question began to be more generally discussed. For nearly a year it was under consideration, and finally it was deemed advisable to call a meeting to take decisive action upon it.

On August 23, 1853, 16 presidents, 1 vice-president, and 21 cashiers, representing 38 banks, assembled in the directors' room of the Merchants' Bank, and at this meeting a resolution was passed providing that "a committee be appointed to[Pg 358] procure or hire a suitable room in or near Wall Street, for the purpose of holding meetings of the officers of the city banks; that the said committee be requested to submit a plan, at an adjourned meeting of this body, to simplify the system of making exchanges and settling the daily balances; and that when a room is procured or hired for the above purpose, the presidents or cashiers be requested to meet weekly until a plan is agreed upon." In compliance with this request, the committee presented a plan for the daily settlement of balances, at a meeting held on August 31, 1853, which plan was amended so as to provide "that a room be procured for that purpose, sufficiently large to afford suitable accommodations."

On September 13, 1853, the scheme was adopted and the committee was "clothed with full power to hire a room, appoint a manager and clerks, and make all the necessary arrangements to carry the plan for a clearing house into effect." The date for beginning operations was fixed for October 11. Accordingly, on the appointed day, the representatives of the banks, members of the association, met in a room which had been procured in the basement at No. 14 Wall Street, and made the first exchanges. The total clearings on that day were $22,648,109.87, and the balances were $1,290,572.38. These clearings have since been eclipsed by over $30,000,000 in the totals of a single bank.

The clearing system in America was thus fairly launched, and from that time forth its success exceeded the expectations of even its most ardent projectors. The association consisted at that time of 52 banks, banded together for their common good, which, as they then conceived, consisted solely in the exchange of items and settlement of balances at a uniform time and place. For nearly a year the operations were conducted without a constitution. The adoption of such an instrument was opposed, on the ground that it was not needed and might lead to a dangerous concentration of power in the hands of a few managers, who might use it for personal aggrandizement, or for the exercise of an arbitrary supervision.[Pg 359]


[124]The association at present (1909) consists of 50 members[125] (32 National Banks and 18 State Banks) and the United States subtreasury located at New York. The latter makes its exchanges only at the clearing house, its balances being settled at its own counter. It has no voice in the government of the association, and pays a nominal sum for actual expenses. The privilege which the subtreasury enjoys of making its exchanges through the clearing house is a matter of great accommodation both to the subtreasury and to the banks. The New York post-office clears through one of the members, but renders no compensation to the association for the privilege.

The membership of the association since its organization has been constantly changing, owing to the admission and expulsion of members and voluntary withdrawals, as provided by the constitution.

The association began with 51 members, but by 1858 the list had declined to 46, the lowest number in the history of the clearing house. A membership of 67 was attained in 1895.

On February 28, 1854, the Bank of the Union was expelled and the clearing-house association was authorized to return to it whatever amount was necessary to offset its advances toward the expenses of the clearing house. In the following December the Empire City Bank was expelled and a similar resolution was passed but in no case thereafter were any such refunds made....

The constitution is very explicit in its terms governing the admission and conduct of members. Applicants are first considered by the clearing-house committee and referred hence to the committee on admissions. The latter committee, if, in its opinion, after a careful examination, the applicants are qualified for membership, refers them to the association for final action, a three-fourths vote of those present being necessary for admission. Banks may be elected to membership at any meeting of the association, but before being considered by the clearing-house committee each applicant must be shown[Pg 360] to have an unimpaired capital or an unimpaired capital and surplus of at least $500,000. Each new member is required to signify its assent to the constitution, in the same manner as the original members, and pay an admission fee, according to capital, as follows: A bank the capital of which does not exceed $5,000,000 must pay $5,000; a bank the capital of which exceeds $5,000,000 must pay $7,500. Any member increasing its capital is required to pay in accordance with those rates.


There are no less than five different methods of settling balances, in whole or in part, without the use of money at the clearing house. They are (1) by manager's check on debtor banks given to creditor banks; (2) by borrowing and loaning balances without interest; (3) by borrowing and loaning balances with interest; (4) by the use of one or more of four forms of certificates, viz., gold and currency depository certificates, United States assistant treasurer certificates, and clearing-house loan certificates; and (5) by draft on another city.

When money is not used in the adjustment of balances at the clearing house, one of the most common methods of settlement is by manager's check on debtor banks in favor of creditor banks. In such cases the creditor banks send clerks to the clearing house to receive the manager's checks, which may be cashed by the debtor banks, exchanged for cashier's checks or exchange on another city, or sent through the clearings on another day.

There is one important advantage of the manager's check over settlements in cash at the clearing house: By its use only one transfer of cash is necessary in making settlements, and thus the risk is greatly diminished.

The second mode of settlement, other than on a cash basis, is by borrowing and loaning balances without interest. At Chicago and Pittsburg this method is practised as a matter of convenience to the several members. After the exchanges[Pg 361] have been made and the balances determined, a certain length of time is devoted to this transfer.

The third method is that of borrowing and loaning balances upon interest, as practised in Boston.

The fourth method is that of employing some form of certificate. Many of the large clearing houses provide for a depository to receive in special trust such United States gold coin as any of the banks belonging to the association may voluntarily deposit with it for safekeeping, upon which certificates may be issued, to be used in the settlement of clearing-house balances. Such certificates are usually issued in denominations of $5,000 and $10,000, and are negotiable only among the associated banks. Many of the clearing houses impose a fine for their transfer to any other party than a member of the association.

Coin certificates were devised by F. W. Edmunds of New York, and came into use about 1857. The Bank of America first acted as a depository, but after the beginning of the greenback epoch the associated banks chose the United States subtreasury as such depository for both gold and currency. When the new clearing house in Cedar Street was occupied, the gold deposits were transferred to the magnificent vaults with which it is provided, and these at the present time hold a very heavy deposit of gold, as well as a very large amount of currency, against which have been issued clearing-house certificates as before mentioned. The associations in practically all of the large cities of the United States now use these gold depository certificates in the settlement of clearing-house balances.

Clearing-house loan certificates are issued only in emergencies. The period during which balances are settled by such instruments lasts usually only three or four months, or until the financial disturbance which called them forth has subsided.

The fifth method is by draft on some other city. In some places the option is given of settling in cash or by draft, as at Austin, Tex.; Charleston, S. C.; Frederick, Md.; Jacksonville, Fla.; Kansas City, Mo.; New Orleans, La.; Rochester, N. Y.; and Saginaw, Mich. In others settlements are made exclusively by drafts on another city. Among these are Syracuse, N. Y.; Worcester, Mass.; Fall River, Mass.; Fremont, Ohio;[Pg 362] Hartford, Conn.; Holyoke and Lowell, Mass.; and Binghamton, N. Y. Sometimes foreign drafts are used in payments of equal thousands only, as at Wilmington, Del., and Chester, Pa.

Generally speaking, about 40 per cent. of the clearing houses of the United States use drafts on other cities in paying their balances. About 30 per cent. settle by manager's check, and about 25 per cent. settle by cash alone, the remaining 5 per cent. settling by a combination of two or more of the foregoing methods.

Clearing houses located in New England settle, as a rule, with drafts on Boston or New York, or both. Clearing houses in the vicinity of Philadelphia usually settle with drafts on that city or on New York, and those located in that part of the country lying east of the Mississippi River settle more or less by draft on New York or Chicago. Settlement is also sometimes made by draft on some of the larger cities, such as Baltimore, Washington, Savannah, Kansas City, Detroit, Omaha, and San Francisco.


The ratio of balances to clearings depends partly upon the number of banks, but much more upon the amount and character of their business and upon their relations one to another. This is illustrated by figures which have just been collected, covering the transactions for the year 1908. At Pittsburg, with 20 members and 128 non-members clearing through members, the balances were 16.5 per cent. of the clearings; at Buffalo, with 11 members and 7 non-members, 12 per cent.; at Chicago, with 20 members and 40 non-members clearing through members, 7.5 per cent.; at Philadelphia, with 31 members and 1 non-member, 11.5 per cent.; at St. Louis, with 17 members and 35 non-members, 9.3 per cent.; while in New York, during the fifty-four years of its existence, the percentage of balances to clearings has been only 4.64 per cent., notwithstanding the operation of the United States assistant treasurer, who almost always has a heavy debit balance.

The more nearly the banks stand on an equality with one another, the more nearly will their transactions approach a[Pg 363] complete offset, which, of course, would leave no balance to settle.


Clearing-house certificates are of two kinds—those issued upon the deposit of gold coin (and in New York City and Boston on gold and silver certificates and legal-tender notes) and those issued upon the deposit of collateral securities. The former are employed in ordinary times solely as a method of economizing time and labor and reducing risk in handling large sums of money. The latter are employed in times of financial disturbance or panic, and although both are intended for use solely in the settlement of balances at the clearing house, the circumstances that call them forth, the results effected by their use, and the part they play in banking economy have little or nothing in common. The certificates issued upon the deposit of gold, etc., are termed "Clearing-house certificates," and those issued upon the deposit of collateral security are very properly termed "Clearing-house loan certificates," with which latter only are we here concerned.

Clearing-house loan certificates may be defined as temporary loans made by the banks associated together as a clearing-house association, to the members thereof, for the purpose of settling clearing-house balances. Such certificates are negotiable, as a rule, only among the members of the association, and are not in any sense to be regarded as currency. They are not even seen by the business community, and do not pass from bank to bank except in payment of clearing-house balances.

To obtain an intelligent understanding of the real character and purpose of such certificates it will be well to treat somewhat of the circumstances under which they are issued. In the course of the present century the United States has undergone periodical derangements of business affairs, when confidence was displaced by mistrust, when the payment of debts became difficult, when property values declined, and business houses failed; when industry and trade were paralyzed,[Pg 364] and general stagnation ensued in all lines of enterprise. In such times depositors in banks, stricken with fear and sometimes pressed by need, draw out their deposits, in many cases to such an extent as to render it difficult or even impossible for the banks to contract their loans sufficiently to meet the demands thus made upon them. Under our currency system no adequate method is [was] provided for expanding the money volume as occasion demands, whereby the banks can continue their usual loans and discounts, and thus prevent a panic with all its evil consequences. Hence it is left in a large measure to the financiers of each community to work out their own remedy, supplemented by such mutual assistance as a courteous regard for each other may dictate or as business relations may demand.

Quick to see the defects in our currency system, and the desirability of in some way supplying it, the bankers of New York, nearly fifty years ago, devised the scheme of issuing clearing-house loan certificates as a method of relief from temporary stringencies. Subsequently, nearly all the clearing houses in the great centres adopted the same device, and by their heroic resort to the measure they have at different times relieved the business community of untold disaster, for which invaluable service they have justly received the grateful recognition of the entire country.

The great value of clearing-house loan certificates lies in the fact that they take the place of money in settlements at the clearing house, and hence save the use of so much actual cash, leaving the amount to be used by the banks in making loans and discounts, and in meeting other obligations. The volume of currency, to all intents and purposes, is expanded by this means to the full amount of the certificates issued.

The loan certificates are taken out by the clearing-house members through loan committees, specially appointed, and are used, as a rule, only in the payment of balances among the associated banks. Thus, when the stringency in the money market seems sufficient to demand it, the clearing-house association meets and appoints a committee called the "loan committee," consisting usually of five bank officers, to act in concurrence[Pg 365] with the president of the clearing-house association, who serves ex officio as a member. It is the duty of such committee to meet each morning at the clearing house and examine the collateral offered as security by the banks and issue loan certificates thereon, in such denominations and proportions to collaterals deposited as may be agreed upon. In the past the denominations have varied from 25 cents to $100,000 in the different associations and in proportions varying from $50 to $100 of certificates to $100 of collateral deposited.

These loan certificates bear interest at rates varying from 5 to 10 per cent. per annum, payable by the banks to which they are issued to the banks receiving such certificates in settlement of daily balances. Hence the interest charged against certain banks must exactly equal and offset that credited to certain other banks. The aim is to fix the rates sufficiently high to insure the retirement of the certificates as soon as the emergency which called them forth has passed by. As a rule they are retired by the banks, which take them out as soon as they have obtained sufficient cash to meet their daily obligations. Notice is given by the debtor banks to the committee, calling for such certificates as they wish to retire, and the committee gives notice to the banks holding the same, stating that the interest will cease after a specified date. In due course the holders send the certificates to the clearing house for redemption. Upon the retirement of the certificates the collateral deposited as security is surrendered by the committee in the same proportion to certificates turned in as was required for deposit at the time of issue.

It is by no means the general practice for all the members to take out loan certificates when issues are arranged by the association. Some banks are in such condition as to be able to weather the storm without them, while others are weak and in great need of relief. Some banks regard their use of clearing-house loan certificates as a reflection upon their standing, and hence refuse to apply for them unless driven to it by sheer necessity. Others regard it as in no way prejudicial to their interests, but rather as a patriotic movement in[Pg 366] which all the banks should engage, both for the purpose of assisting their fellow-members and for the welfare of the community as a whole.


Comparison of the course of events during the crisis of 1873 with that in subsequent crises shows a progressively increasing unwillingness or inability among the New York banks to make use of their cash reserves. In 1873 the New York banks at the outset of the crisis held an available reserve of $34,300,000. In the course of four weeks this was reduced to $5,800,000, and the ratio to deposit liabilities was then less than 4.5 per cent.[130] Suspension was not escaped in 1873 but it was of shorter duration than in later crises. The banks at that time were unable to increase their cash resources by any of the means which have been available in later crises. The Government had no surplus of greenbacks, aside from about $12,000,000 which was almost entirely secured and retained by the savings banks. Banknotes could not be issued because the total circulation was at that time limited by law. Finally, additional supplies of gold, secured through imports, were useless for ordinary banking purposes because the business of the country was then carried on by means of an inconvertible and depreciated paper currency. Notwithstanding all these special difficulties, the New York banks, by continuing to use their reserves freely even after payments had been restricted, were able to restore confidence in a comparatively short time, and money began to flow back to them within three weeks after the outbreak of the crisis.

In 1893 the New York banks were in what was for them an unusually strong condition at the beginning of the disturbance, having early in June a cash reserve exceeding 30 per cent. of their net deposits. A succession of banking failures[Pg 367] in the West and South led to heavy withdrawals from New York during the latter part of June and the beginning of July. Then followed a lull and money began to be returned to New York. During the third week of July banking failures were renewed in the West and South and the drain was resumed. The positively unfavorable aspects of the situation were altogether similar to those of the previous month with the one further circumstance of a reduced cash reserve in New York. On the other hand, additional means with which to meet the situation were becoming available. At the end of July gold imports in large amount had been arranged. Foreign purchases of our securities were heavy, reflecting increasing confidence in the repeal of the silver purchase law. Arrangements had also been made which would certainly lead to a considerable increase in the issues of bank-notes during August and September. Notwithstanding all these favorable circumstances the New York banks suspended, during the first week of August, when they still held a cash reserve of $79,000,000, more than 20 per cent. of their deposit liabilities.

In 1907 the New York banks restricted payments when they still held a cash reserve of more than $220,000,000 and when the reserve ratio was also above 20 per cent. Both in 1893 and in 1907 suspension was not a measure of last resort taken after the banks had entirely exhausted their reserves and when there was no means of securing additional cash resources. Moreover, after cash payments were restricted the policy of the banks was unlike that adopted in 1873, in that the banks did not make further use of their reserves; they hoarded them and added to their amount, thus unduly prolonging the period of suspension.

Explanation of the failure of the banks in 1893 and 1907 to use their cash resources as completely as in 1873 is simple; but it is of the very greatest significance because it will bring to light the most serious element of weakness in our credit structure. [Written before our banking reform of 1913.]

In 1893 and in 1907 the clearing-house loan certificate was the only device resorted to in order to secure the adoption of a common policy by the banks. In 1873, as on earlier occasions[Pg 368] when its use was authorized, provision was also made for the equalization of the reserves of the banks. Thus in 1873 the Clearing House Association in addition to the customary arrangements for the issue of loan certificates adopted the following resolution:

That in order to accomplish the purposes set forth in this agreement the legal tenders belonging to the associated banks shall be considered and treated as a common fund, held for mutual aid and protection, and the committee appointed shall have power to equalize the same by assessment or otherwise at their discretion. For this purpose a statement shall be made to the committee of the condition of such bank on the morning of every day, before the opening of business, which shall be sent with the exchanges to the manager of the Clearing House, specifying the following items:

(1) Loans and discounts. (2) Amount of loan certificates. (3) Amount of United States certificates of deposit and legal tender notes. (4) Amount of deposits deducting therefrom the amount of special gold deposits.

Two fairly distinct powers were given the clearing-house committee: the right to issue clearing-house certificates, and control over the currency portion of the reserves of the banks. This machinery was devised (according to tradition) after the crisis of 1857 by George S. Coe, who for more than thirty years was president of the American Exchange National Bank. The purpose of the certificate was to remove certain serious difficulties which had become generally recognized during that crisis. The banks had pursued a policy of loan contraction which ultimately led to general suspension, because it had proved impossible to secure any agreement among them.[131] The banks which were prepared to assist the business community with loans could not do so because they would be certain to be found with unfavorable clearing-house balances in favor of the banks which followed a more selfish course. The loan certificate provided a means of payment other than cash. What was more important, it took away the temptation from any single bank to seek to strengthen itself at the expense of its fellows, and rendered each bank more willing to assist the community with loans to the extent of its power.

[Pg 369]

But in addition to the arrangement for the use of loan certificates provision was also made for what was called the equalization of reserves. The individual banks were not, of course, equally strong in reserves at the times when loan certificates were authorized. From that moment they would be unable to strengthen themselves, aside from the receipt of money from depositors, except in so far as the other banks should choose to meet unfavorable balances in cash. Moreover, withdrawals of cash by depositors would not fall evenly upon the banks. Some would find their reserves falling away rapidly with no adequate means of replenishing them. The enforced suspension of individual banks would pretty certainly involve the other banks in its train. Finally, it would not be impossible for a bank to induce friendly depositors to present checks on other banks directly for cash payment, instead of depositing them for collection and probable payment in loan certificates, through the clearing house. The arrangement for equalizing reserves therefore diminished the likelihood of the banks working at cross purposes—a danger which the use of clearing-house certificates alone cannot entirely remove.

These arrangements had enabled the banks to pass through periods of severe strain in 1860 and in 1861 without suspension. In both instances the use of the loan certificate was followed immediately by an increase in the loans of the banks, and in no short time by an increase in their reserves. The situation in 1873 was more serious, and as events proved, the reserve strength of the banks, while sufficient to carry them through the worst of the storm, was not enough to enable them to avoid the resort to suspension.

In 1884, the next occasion when clearing-house loan certificates were issued, the opposition to the provision for the equalization of reserves was so widespread that it does not appear that it was even formally considered. The ground for this opposition can be readily understood. In 1873 the practice of paying interest upon bankers' deposits was generally regarded with disfavor. Only twelve of the clearing-house banks offered this inducement to attract deposits; but by this means they had secured the bulk of the balances of outside[Pg 370] banks. It was in meeting the requirements of these banks that the reserves of all the banks were exhausted at that time. The noninterest paying banks entered into the arrangement for the equalization of reserves in expectation of securing a clearing-house rule against the practice of paying interest on deposits. But their efforts had resulted in failure. Some of them had employed their reserves for the common good most reluctantly in 1873, and the feeling against a similar arrangement in 1884 was naturally far stronger and more general. Moreover, the working of the pooling agreement in 1873 had occasioned heart-burnings which had not entirely disappeared with the lapse of time. It was believed, and doubtless with reason, that some of the banks had evaded the obligations of the pooling agreement. It was said that some of the banks had encouraged special currency deposits so as not to be obliged to turn money into the common fund. Further, as the arrangement had not included bank-notes, banks exchanged greenbacks for notes in order either to increase their holdings of cash or to secure money for payment over the counter. Here we come upon an objection to the pooling arrangement which doubtless had much weight with the specially strong banks, although it is more apparent than real. In order to supply the pressing requirements of some banks, others who believed that they would have been able to meet all demands of their depositors were obliged to restrict payments. That such an expectation would have proved illusory later experience affords ample proof. When a large number of the banks in any locality suspend, the others cannot escape adopting the same course. But in 1884 the erroneousness of the belief had not been made clear by recent experience.

The New York banks weathered the moderate storms of 1884 and 1890 without suspension, by means of the clearing-house loan certificate alone, and in the course of time all recollection of the arrangement for the equalization of reserves seems to have faded from the memory of the banking community. There was, however, in those years another potent influence which tended to lessen the likelihood of suspension following the issue of loan certificates. Many banks were unwilling to take them out, fearing that such action[Pg 371] would be regarded as a confession of weakness. The prejudice against them was indeed so strong that needed loan expansion did not follow the authorization of their issue. In 1890 the directors of the Bank of Commerce, then, as now, one of the most important banks of the city, passed a resolution urging other banks to relieve the situation by increasing loans and by taking out loan certificates.

In 1893 only a small part of the balances between the banks was settled in certificates at first; but by the end of July practically all balances were settled in that way and suspension followed at once. In 1907 all the banks having unfavorable balances, with but one important exception, took out certificates on the first day that their issue was authorized, and suspension was then for the first time simultaneous with their issue.

The connection between suspension and the use of clearing-house loan certificates as the sole medium of payment between the banks is simple and direct. The bank which receives a relatively large amount of drafts and checks on other banks from its customers cannot pay out cash indefinitely if it is unable to secure any money from the banks on which they are drawn. So long as only a few banks are taking out certificates and the bulk of payments are made in money, no difficulty is experienced; but as soon as all the banks make use of that medium, the suspension of the banks which have large numbers of correspondents soon becomes inevitable. The contention of bankers both in 1893 and in 1907 that they had not suspended since they had only refused to honor drafts on other banks was untenable. The clearing-house loan certificate was a device which the banks themselves had adopted and they had failed to provide any means for preventing partial suspension as the result of its use. The further contention of some bankers that they had suspended because they had no money to pay out was doubtless true of a few banks, but for that very reason other banks must have been all the stronger, probably well above their required reserve.

That the arrangement for equalizing the reserves, adopted in 1873, would have availed to prevent suspension on subsequent occasions, is highly probable, indeed a practical certainty.[Pg 372] In 1893 events proved that the banks had maintained payments up to the very last of the succession of disasters with the results of which they had been contending. During August the number of bank failures was not large and none of them was of great importance. We cannot, of course, know how soon money would have begun to flow back to New York, but certainly the suspension of payments could hardly have hastened the movement. From the beginning of September the reported movements of currency showed a gain for the New York banks, and for the week ending September 16 the gain was no less than $8,000,000. One month more of drain, therefore, was the most that the banks would have been obliged to endure, and for the needs of that month the banks would not, as in 1873, have been confined to the single resource of the $79,000,000 of the cash in their vaults.[132]

Similarly, the enormous increase in the money supply of the country in November and December, 1907, would have offset much of the loss of reserve which the banks would have incurred, if they had continued to meet all the demands of their customers for cash. And, finally, it may be observed that in the unlikely event that alarm had not been allayed and suspension in the end had become unavoidable, it would not have made any practical difference to depositors whether the reserves of the banks had been but 10 per cent. rather than 20 per cent. of their demand liabilities.


Most bank failures are due to the gradual acquirement of undesirable assets over a period of years, and if some authority exists with power to make recommendations of a remedial character, with the further power to enforce such recommendations, if necessary, there is little doubt that many bank failures would be averted.

The panic of 1907 presented many striking examples of just what is intended to be here emphasized, viz., that under[Pg 373] the careful supervision of a competent and reliable examiner many of the assets of the failed banks, upon which it was impossible for them to realize at a time when they needed their funds, would probably have been liquidated upon his recommendation and advice long before the necessity for such liquidation had arisen.

Mr. J. B. Forgan of Chicago, has recently said on this subject:

A competent examiner—and there are many such now in the government employ—while he can not pass judgment on all the loans in a bank, can, after a careful examination, or a series of examinations, form a wonderfully correct judgment as to the general character of its assets and as to whether its management is good or bad, conservative or reckless, honest or dishonest. Examinations, as they are now conducted, have a most beneficial influence on bank management, especially by way of restraint. The correspondence carried on by the Comptroller, based on the examiners' reports, does an inestimable lot of good in the way of forcing bank officers to comply with the law and in compelling them to face and provide for known losses as they occur. Supervision by examination does not, however, carry with it control of management and can not, therefore, be held responsible for either errors of judgment or lapses of integrity. Examination is always an event after the act, having no control over a bank's initiative, which rests exclusively with the executive officers and directors, and depends entirely on their business ability, judgment, and honesty of purpose.

The clearing-house association of Chicago was the pioneer in the establishment of an independent system of clearing-house bank examinations in this country, its system having been inaugurated on June 1, 1906, with results that have, to the present time, more than fulfilled the expectations of the bankers of that community[134]....

In substantially his own words the Chicago examiner operates under the following conditions: The examinations extend to all the associated banks of Chicago and to all non-member institutions. The work is conducted with the aid of five regular assistants, each fitted by experience to thoroughly do that part of the work assigned to him. The examinations include, besides a verification of the assets and liabilities of[Pg 374] each bank, so far as is possible, an investigation into the workings of every department and are made as thorough as is practicable. After each examination the examiner prepares a detailed report in duplicate, describing the bank's loans, bonds, investments, and other assets, mentioning specially all loans, either direct or indirect, to officers, directors, or employees, or to corporations in which they may be interested. The report also contains a description of conditions found in every department. One of these reports is filed in the vaults of the clearing house, in the custody of the examiner, and the other is handed to the examined bank's president for the use of its directors. The individual directors are then notified that the examination has been made and that a copy of the examiner's report has been handed to the president for their use. In this way every director is given an opportunity to see the report, and the examiner, in every instance, insists upon receiving acknowledgment of the receipt of these notices.

The detailed report retained by the examiner is not submitted to the clearing-house committee, under whose direct supervision he operates, unless the discovery of unusual conditions makes it necessary. A special report in brief form is prepared in every case and read to the clearing-house committee at meetings called for that purpose. The report is made in letter form, and describes in general terms the character of the examined bank's assets, points out all loans, direct or indirect, to officers, directors, or employees, or to corporations in which they may have an interest. It further describes all excessive and important loans, calls attention to any unwarranted conditions, gross irregularities, or dangerous tendencies, should any such exist, and expresses, in a general way, the examiner's opinion of each bank as he finds it.

Less than a year after the Chicago Clearing House Association appointed its special examiner the associated banks of Minneapolis took similar action. The conditions under which the Minneapolis examiner operates are substantially the same as those governing the examiner at Chicago, the principal difference being that instead of the examiner sending a copy of his report to the president of the examined bank and notifying each of the directors of such bank that he has made[Pg 375] such examination and that the report is in the hands of the president of the institution, as is the rule of procedure at Chicago, and which, in a measure, leaves it to the discretion of the directors whether they examine the report carefully and in detail, the original report is delivered by the examiner at Minneapolis in person to the board of directors of each bank which he examines, at a meeting convened for that purpose. The report is read and the criticisms, if any, are fully discussed, and the recommendations considered. In this way no director can complain that he had not sufficient opportunity to become fully conversant with all the details of his bank.

II. Clearing Houses in England


[135]The exact origin of the London Bankers' Clearing House will probably never be determined, for, like other institutions whose purpose has been to save time and trouble, its system appears to have been gradually evolved.[136]

With the growth of the check system, each banker would daily find himself in possession of a number of drafts for the credit of his customers that needed collection at the offices of other bankers. This would necessitate each bank sending out one or more clerks on what became known as "walks" to obtain cash or notes for these drafts from the houses on which they were drawn.

As in London alone there were some fifty or more private firms carrying on a banking business this necessitated a considerable amount of work and was attended with grave risk of robbery.

It is probable, therefore, that arrangements were made by some of the bankers, as it is still done in some country towns, to meet at one bank one week and at another the next for the purpose of exchanging checks.

[Pg 376]

But in consequence of the number of the London bankers this method would prove awkward, and about the year 1770 we find that the walk clerks from the city and West End banks had made a practice of meeting at lunch time at a public house called the Five Bells in Dove Court, Lombard Street, close to St. Mary Woolnoth Church, and not so very far from the site of the Bankers' Clearing House of to-day. Here in the public room, or according to tradition on the posts in the court outside, each day after lunch a rough system of exchange of checks was carried on between the clerks from each bank, the balances being settled in notes and cash. From this rough system has developed the efficient organization of to-day.

In May, 1854, the clearing house was closed for alterations and enlargement, and the business was temporarily carried on at the Hall of Commerce. Here, on June 6, 1854, applications for admission to the clearing house were received from the following joint-stock banks: The London and Westminster, the London Joint Stock, the Union Bank of London, the Commercial Bank of London, and the London and County Bank; and it was resolved "that the secretary be authorized to comply with such applications, subject to the payment of an annual sum to be fixed by the committee to reimburse them for the outlay that has been found necessary to afford accommodation for their admission." There were at this time 25 private banks in the clearing house.

Following on the admission of the five premier joint-stock banks in 1854 there were frequent applications from other joint-stock banks—many from the moment of their foundation. But the wise reply of the committee was invariably that they did not "deem it expedient to take into consideration such applications from any banking establishment that has not been in operation at least for a period of twelve months."

Though the joint-stock banks had been admitted to the clearing house yet they were only allowed to rent seats there and had no share in the management, so for the support of their mutual interests they had a committee of their own which settled the rate to be given by the joint-stock banks in the London district for deposit money at seven days' notice.[Pg 377]

In 1858 the country bankers submitted a plan for establishing a country bankers' clearing house in London and proposed that the clearing house committee should appoint two or three of their number to unite with them as a working committee.

The establishment of a separate country bankers' clearing house would have led to many inconveniences, and Mr. John Lubbock, now Lord Avebury, submitted a plan for carrying out a separate country clearing at the clearing house. The committee approved the plan and submitted it to the country bankers' committee, who also gave their approval.

Thus was instituted at the Bankers' Clearing House the country clearing, which more than all else has brought about the almost universal use of checks in England, to the exclusion of notes and coin.

Mr. Lubbock's scheme was so well thought out that from its initiation to the present time the rules have had to be only very slightly modified.

In 1864 the Bank of England entered the clearing house to clear on one side only, the outside, for though the bank presents to the clearing bankers at the clearing house all checks payable by them, all checks and bills drawn on the bank are presented by the clearing bankers at the bank itself, and the proceeds placed to the credit of each bank's account. At the same time the governor of the Bank of England was made ex officio a member of the committee of clearing bankers. After 1864 few changes were made in the working of the clearing house, the volume of the country and town clearings increased greatly, but the house proved capable of meeting any increase.

Friction between the old private bankers and the joint-stock banks grew less as amalgamations and absorptions increased, and before many years the committee of London clearing bankers and joint-stock banks committee amalgamated, it being agreed, as a condition of the joint-stock banks committee ceasing to exist, that all the banks would abide by the ruling of the committee as to the rate of deposit at seven days' notice. Henceforth, every bank in the clearing house was entitled to have one representative on the committee. Such[Pg 378] representatives have hitherto been chosen solely from the board or the partners and are nominated by their banks and formally elected by the committee. The committee elects its own chairman, vice-chairman, and honorary secretary. This committee meets regularly on the first Thursday in each month, Thursday being the day on which the Bank of England in normal times makes any alteration in the bank rate of discount, but it may be summoned by requisition at any time and meets automatically should the bank rate be altered, since this governs the rate of deposit allowed by the bankers.

The committee has full power over all clearing house matters, and from the importance of the banks who compose the clearing house its opinion carries very great weight on all matters in the banking world. It is, however, controlled only by the mutual agreement of its members: and the decision of the majority of its members, though followed loyally, is never used with any ultimate power of compulsion in matters affecting banking in general.

In 1907 a third clearing, the Metropolitan, was established. Hitherto, with the exception of one or two city offices which were included in the town clearing, the collection of drafts on London branches of the clearing banks had been effected by the post and by the sending out of walk clerks by each bank; but in 1907 it was determined to do away with such means of collection as far as possible and to collect the branch checks through the clearing house. This proved so successful that the West End banks were approached the following year, and with one exception readily consented to come into the new plan by which their clearing agents had delivered to them at the Metropolitan clearing all checks drawn upon them. This clearing is the first clearing made each morning and is handled so expeditiously that even the most distant London branches get their checks almost earlier than under the old system. They have, therefore, plenty of time to go through them and to make returns of any checks that cannot be paid in time for such return checks to reach the clearing house early in the afternoon. There are now over 330 banks and branches using this clearing.

For the better defining of the three clearing areas—town,[Pg 379] metropolitan, and country—the letters T M C have been placed in the corner of all bank checks. From February 19, 1907, the date of the initiation of the Metropolitan Clearing, up to December 31 of that year, £482,227,000 was paid in this clearing, while for the year 1908 the total was £647,842,000, as compared with the town clearing total for that year of £10,408,254,000 and the country total of £1,064,266,000, making in all a grand total of £12,120,362,000, which figures, vast as they are, were a decrease of £610,031,000 on the total £12,730,393,000 for the previous year, 1907.[137] The work entailed by such vast figures as these could scarcely have been dealt with by hand alone, but by the installation of adding machines the work is easily and quickly done.

It must not be thought that all checks on London are presented through the clearing house, for checks on the London branches of the Scotch banks and of the colonial and foreign banks are still presented over the counter.

Moreover, though it is mutually understood between the clearing banks that checks on each other will only be presented through the clearing house, this agreement has no legal binding.

Two exceptions are continually made; documents or goods have to be taken up against cash, and the owner before parting wishes to be certain of his money. In this case the presenting banker either presents his check for marking—that is to say, the paying banker having ascertained from his customer's account that there is sufficient money thereon, marks the check for payment, which has the same effect as if the banker had accepted it; or, as is becoming more usual, the paying banker gives one of his own drafts on the Bank of England in exchange for the check.


Besides the London clearing house, which is an irregular building of no architectural features whatever, there are eight provincial clearing houses in England—Birmingham, Bristol,[Pg 380] Leeds, Leicester, Liverpool, Manchester, Newcastle and Sheffield.[138]

Two only of these clear over £100,000,000 in the year. Manchester cleared £320,296,332 in 1907, with an average weekly total of £6,159,545 and an average daily total of £1,039,923, and Liverpool £196,325,829. The others cleared in the same year from £12,000,000 to £61,000,000. Small figures, indeed, compared with London, where the highest total paid on any one day was, in 1907, £106,703,000. In 1908 the highest total paid in one day in the London clearing was £85,833,000 and the lowest £24,903,000.

In London, as in the provincial places, the object of the clearing house is primarily the convenience of exchange of checks, not the regulation of banking, and little is regulated save, perhaps, the rate of interest to be paid on deposits at seven days' notice.

In these days, too, when the tendency is strong for amalgamation, the local banks are dwarfed by their gigantic competitors, with their branches in many counties and head offices in London, with the result that London each year controls more of the banking in England and the provincial clearings cease more and more to be under local control, but are controlled by their London head offices.

This may, if the present tendency of amalgamation continues,[139] result in the committee of London clearing bankers becoming an important controlling body, but that time is not yet at hand, and though, as we have said, an expression of opinion on the part of the committee carries very great weight, yet anything like dictation would very properly be resented by the important and old-established banks in both London and the provinces that are outside the clearing house.


[121] James G. Cannon, Clearing Houses, Publications of the National Monetary Commission, Senate Document, No. 491, 61st Congress, 2nd Session, p. 1.

[122] Ibid., pp. 148-150.

[123] Ibid., pp. 150-154.

[124] Ibid., pp. 163-165.

[125] 62 members in 1914.

[126] Ibid., pp. 41, 43, 44-46.

[127] Ibid., p. 37.

[128] Ibid., pp. 75-79.

[129] O. M. W. Sprague, Banking Reform in the United States, pp. 104-113. Harvard University. 1911.

[130] The figures in the text refer to the legal tender holdings of the banks. The banks also held a considerable amount of specie but it was not a free asset as most of it had been received on special accounts payable in gold. Including the specie holdings the reserve ratio was 12.8 per cent.

[131] C. F. Dunbar, Economic Essays, chap. XVI.

[132] The increase in the amount of money in circulation for August, 1893, was estimated at $70,000,000.

[133] James G. Cannon, Clearing Houses. Publications of the National Monetary Commission, Senate Document No. 491, 61st Congress, 2d Session, pp. 137-141.

[134] [A number of the more important cities such as St. Paul, St. Louis, and Philadelphia, following the example of Chicago and Minneapolis, have instituted clearing house bank examinations since 1907.]

[135] Adapted from Robert Martin Holland, The London Bankers Clearing House. Publications of the National Monetary Commission, Senate Document No. 492, 61st Congress. 2nd Session.

[136] The date of the establishment of the Clearing House is not known. The Clearing has, however, been in existence about 150 years.—Editor.

[137] [For the five years 1910-14, the total clearings of the London Clearing House were in the neighborhood of £15,000,000,000 per annum of which the Town, Metropolitan, and Country Clearings were about 86, 5.5, and 8.5 per cent., respectively.]

[138] [The approximate number of clearing houses outside of London, in England, in 1915 is twelve, but these are used only for local clearings. In addition, most of the towns in England and Wales have a local exchange which is a clearing on a small scale.]

[139] This tendency has continued as to both the joint-stock and private banks.—Editor.

[Pg 381]



[140]The banking institutions of the United States other than national banks are ordinarily classified into (a) state banks, (b) trust companies, (c) stock savings banks, (d) mutual savings banks, and (e) private banks. The following pages deal with two of these classes, viz., state banks and trust companies. It will be desirable at the outset to distinguish them from the other classes, and to outline the history of legislation concerning them since 1865.

The term "state bank" has been used in the United States in several different senses; but whatever the variance in meaning, such banks have always had one common characteristic—incorporation under state authority. In the bank reports of some of the States, private banks are not distinguished from state banks. This is due to the fact that in these States incorporated and unincorporated banks are subject to the same regulation. A private bank, however, is an unincorporated bank.

Not all banking institutions incorporated by the States are state banks. Mutual savings banks, stock savings banks, and trust companies are also corporations organized under state laws or charters granted by state legislatures. The distinction between mutual savings banks and state banks is clear. Mutual savings banks do not have a capital stock and do not carry on a discount and deposit business—i. e., they do not discount commercial paper, and do not receive demand deposits payable on check. State banks, on the other hand, have a capital stock and carry on a discount and deposit business.[Pg 382] Many state banks, however, receive also savings deposits. The line of demarcation between state banks and stock savings banks is much less definitely marked. Both state banks and stock savings banks have a capital stock. Stock savings banks are primarily savings banks, and many of them do not do a discount and deposit business, but confine themselves to the savings bank business. But in several States the distinction between state banks and stock savings banks is of the most unsubstantial character, since the stock savings banks carry on the business of a commercial bank, receiving demand deposits payable on check, and discounting commercial paper. Finally, the distinction between state banks and trust companies is not exactly the same in any two of the States.

"State banks" then, as the term is used in the following pages, are banks of discount and deposit (as distinguished from savings banks, mutual and stock) incorporated by one of the States or Territories (in contrast with private banks, which are unincorporated, and with national banks, which are organized under the national-bank act).[141]

In 1860 there were in the United States 1,562 state banks. Owing to the repressive influence of the national-bank act, hastened in its effect by the 10 per cent. tax on state-bank notes, the number of state banks had by 1868 fallen to 247. One result of this decline in the number and importance of state banks was the cessation of state banking legislation. The old laws regulating state banks of issue were swept away by code revisions, or remained obsolete and unchanged on the statute books.

The number of state banks began to increase about 1870. In a few States old banking laws intended for the regulation of banks of issue hampered their development, but in the remaining States they were left for a considerable period almost entirely without regulation. As late as 1892, in his digest of the state statute law, Mr. Stimson said:

It seems unnecessary to incorporate the state banking laws in this edition. Nearly all the States, except the newer States and Territories, have special chapters in their corporation acts concerning[Pg 383] banks and moneyed institutions, but these chapters are usually of old date, and have practically been superseded for so long a time by the national banking laws that they have become obsolete in use and form.

The increasing attention paid in recent years by the state legislatures to the regulation of the state banks has been partly due to the rapid growth of the banks in numbers and in financial importance; but it is to be accounted for primarily by a change of view as to the purpose of banking regulation. The antebellum state-bank regulations were intended to secure the safety of the bank note. Although the depositor was protected by many of the regulations, this protection was purely incidental. The view that note-issuing banks alone required governmental regulation persisted for a considerable time after the passage of the national-bank act. Since the national banks had a monopoly of the issue of bank notes, the regulation of state banks was considered needless. As the importance of note issue as a banking function decreased, banking regulation, as seen in the national-bank act, began to be considered desirable as a protection to depositors.

The Evolution of the Trust Company

With the exception of the power to issue notes, which would be unavailable because of the tax on note issue, the powers of the state banks of to-day are essentially the same as the powers of the state banks which were in operation before the Civil War. On the other hand, the trust company is a new type of banking institution, the functions of which are even yet not clearly defined. A great part of the legislation with reference to trust companies, therefore, has had to do with defining the powers of these corporations.

The early laws for the incorporation of trust companies show the widest differences of opinion with regard to their field of operation. The one point of agreement appears to have been the idea that a corporation could administer trusts more advantageously and safely than an individual. But the companies in all the States were given additional powers more or less closely connected with their trust powers. Some of[Pg 384] the companies, chiefly the very early ones, were empowered to insure lives and to grant annuities. In a considerable number of States the companies were authorized to insure the fidelity of persons in positions of trust and in some States to insure titles to land. Almost all the companies were empowered to do a safe-deposit business. Among these powers there was a certain apparent connection. The power to insure the fidelity of trustees, administrators, and executors seemed a natural addition to the powers of a company which might act in such capacities. Similarly, it appeared that the business of insuring titles to land was one which could be most economically conducted by a corporation which, in its capacity of trustee, would be a large owner of real estate.

One other power was given to practically all the companies—the power to receive deposits of money in trust. The following quotation from the Report of the Massachusetts Commissioners of Savings Banks for 1871 shows the use which it was expected would be made of this power:

The trust company in Worcester and the New England Trust Company in Boston, both in successful operation, are the first of such corporations established in this State. They were incorporated after a very careful investigation by the legislature, with power to hold money in trust, and so restricted in making loans and investments as to afford the safety which the character of their business requires. A similar institution will soon be organized in Northampton, and others are contemplated. They are well calculated to promote public interests by affording to the owners of capital not engaged in business many of the advantages secured by our savings-bank system for the savings of labor.

The development of the trust company as reflected in the legislation with reference to its powers shows two main tendencies: (1) The companies have to a very large extent given up the insuring of the fidelity of persons in positions of trust and the guaranteeing of land titles. (2) They have largely increased their banking activities.

1. In some States which formerly authorised trust companies to insure the fidelity of persons in positions of trust, or to guarantee titles to real estate, the more recent laws do not permit the combination of such business with the business of a trust company.[Pg 385]

The fidelity insurance business during the past twenty years has been largely concentrated in the hands of a comparatively small number of companies which have agencies in all parts of the country and which do not undertake a trust or banking business. The elimination of fidelity insurance from the functions of the trust company has not been chiefly or even largely due to adverse legislation, but to the nature of the fidelity insurance business. The most successful conduct of that business appears to require, like other kinds of insurance, that the risks shall be numerous and widely distributed. These conditions are best met by companies which carry on business in many different places.

For the most economical conduct of the title insurance business an expensive plant is necessary. The business in each city tends therefore to fall into the hands of a single company, which ordinarily finds it profitable to devote itself entirely to the one kind of business. At the present time, only a very small part of the trust companies in the United States insure titles to land.

2. The second great tendency in the development of the powers of the trust company—the enlargement of its banking powers—has also been primarily an economic development and not one due to legislative design. As has already been noted, the early trust companies ordinarily had power to receive trust deposits and to loan money. Some such powers were necessary for the exercise of their trust functions. The opportunity to enlarge the banking powers of the companies lay in the difficulty of distinguishing clearly between the powers which it was intended to confer upon the trust companies and the banking powers possessed by state and national banks.

In the greater number of the States the wording of the sections conferring powers to do a trust business was such that the trust companies were either held by the courts to be empowered to do a banking business, or, if the power to do such business seemed not to be granted, were able by some change in the method of doing the kind of banking business in question to bring it within the powers actually conferred. In Missouri, for instance, since 1885 trust companies have[Pg 386] been empowered to "receive money in trust and to accumulate the same at such rate as may be obtained or agreed upon or to allow such interest thereon as may be agreed." The supreme court of Missouri in construing the power thereby conferred has held that a trust company can take only interest-bearing deposits, but that such deposits may be demand deposits payable on check. The rate of interest may, however, be nominal.

In other States the trust companies have attained legal recognition of their banking powers by slow steps. The history of the Pennsylvania trust companies affords an illustration. In the Pennsylvania general corporation act of 1874 no provision was made for the formation of trust companies, but provision was made for the incorporation of title-insurance companies. By an amendment to the corporation act in 1881 title-insurance companies with a capital of at least $250,000 were given trust and fidelity-insurance powers; but it was expressly provided that such companies were not authorized thereby to do a banking business. In 1885 the trust companies were given the power to receive upon deposit for safekeeping valuable property of every description, and in 1895 trust companies were given power to "receive deposits of money and other personal property and to issue their obligations therefor ... and to loan money on real and personal securities." In 1900 the United States circuit court of Pennsylvania decided that Pennsylvania trust companies might legally receive demand as well as time deposits. Pennsylvania trust companies apparently even now cannot discount commercial paper, but they may loan on it as collateral and may purchase it from the holder.

The States in which the banking powers of the trust companies have been most narrowly restricted are Iowa, Michigan, Nebraska, and Wisconsin. In Nebraska a trust company cannot do a banking business. In Iowa trust companies cannot do a banking business except that they may receive time deposits and issue drafts on their depositories. In Michigan trust companies are expressly forbidden to do "a general banking business." The Michigan commissioner of banking in his report for 1906 complained, however, that the law was[Pg 387] not clear as to the banking powers of the companies. In Minnesota the trust companies may receive trust deposits, but may not "engage in any banking business except such as is expressly authorized for such a corporation." In Wisconsin the extent of the power of trust companies to receive deposits was much debated until 1909, when the legislature provided for the incorporation of "trust-company banks," which have power to receive time and savings deposits, but do not have power to receive deposits subject to check.

The result of the two tendencies described above—the elimination of the insurance powers of the trust company and the addition of banking powers—has gradually standardized the powers of the trust company, until at the present time the trust company, as it appears in the corporation laws of most of the States, may be fairly well defined as a bank which has power to act in the capacity of trustee, administrator, guardian, or executor.

In a number of States the legislation concerning trust companies deals with them explicitly from this standpoint. The Illinois bank act of 1887 provided that any bank might have power to execute trusts by complying with the trust-company law. In Alabama and Tennessee any state bank may be appointed and may act as an executor, administrator, receiver, or guardian. In Mississippi any bank with a paid-up capital of $100,000 may do a trust-company business. In Georgia any trust company may acquire banking powers by complying with the laws regulating banks. In Texas banks may acquire trust-company powers. The same tendency is shown in the important banking laws enacted in Ohio in 1905 and California in 1909.

The gradual change from the view that the trust company is an institution of markedly different character from the ordinary bank of discount and deposit to the view that the trust company is merely a bank exercising functions additional to those exercised by the majority of banks has been the chief influence in determining the form of the legal regulations imposed upon trust companies. As long as the older view obtained, the regulations concerning trust companies were widely different from those imposed upon banks; but as the trust company[Pg 388] has increased both the scope and amount of its banking business, the regulation of the banking business of the trust company has tended to become assimilated to the regulations imposed upon state banks.


Since 1865 state banks and trust companies have been incorporated by the use of one of three methods: (1) By special charter; (2) under the "business incorporation law"; (3) under the general banking law. Not very many of the States have used consecutively all three methods, for the special charter and the "business incorporation law" were used contemporaneously in different sections of the country. Both have given place, in the great mass of States, to the general banking law. From 1865 to 1875 probably the greater number of the banks formed were incorporated under special acts; from 1875 to 1887 incorporation under the "business incorporation law" was the prevailing method, and since then the general banking law has become the almost universal method of incorporating banks and trust companies.

Capital and Surplus Requirements

When the States began to give attention to the regulation of the banking business the question of capital received immediate attention. The national-bank act and the banking laws in New York and the Middle West which had survived from the antebellum period contained provisions concerning the amount and payment of capital. A requirement with regard to capital was recognized as the central point in any system of bank regulation. The capital stock is a buffer interposed between the bank's creditors and losses which the bank may suffer. If there is no capital, losses may fall directly on the creditor, and the larger the capital stock, other things being equal, the less the likelihood of loss to the depositor.

The States and Territories may be divided roughly into two groups according to the amount of the smallest permissible capital for state banks:[Pg 389]

1. In the Eastern States and the more easterly of the Middle Western States, the banking laws, with one exception, require that banks shall have a capital of at least $25,000.

2. In the other sections of the United States banks in most of the States are incorporated with a capital as small as $10,000, although in a few of these States the smallest permissible capital is $15,000, $20,000, $25,000, and $30,000, and in one, North Carolina, it is $5,000.

The amount of capital required, except in a few States, is not a uniform amount, but is graded, usually according to the size of the city in which the bank is located. In 29 of the 37 States and Territories which require under a general law a specified amount of capital for the incorporation of state banks the amount of capital is thus graded. The grading of the amount of capital required according to the population of the place in which a bank is located has been chiefly due to the desire to bring about some adjustment between the capital of each bank and the volume of its business. It is assumed that the larger the business of the bank the greater the chance of its suffering large losses and the larger the capital necessary to protect its depositors against loss. It is also assumed that the size of the city in which it is located is a rough index of the volume of business done by a bank. Under many of the state banking laws the grades are very numerous. The minute gradation of the capital requirements found in many of the state banking laws is due to the desire to encourage the formation of banks in the smaller cities and towns, for it is to be noted that in the greater part of the state laws the grades are not numerous for the larger places.

Obviously, if any law requiring a minimum capital for banks is to be effective, it must provide specifically for the payment either of all the capital or of a specified sum; otherwise the directors of the bank may require the payment of only a small part of the capital. The provision in the national-bank act concerning the payment of capital has been the model for similar provisions in the banking laws of a large number of the States. Many of the state banking laws likewise contain the same provision as the national-bank act with reference to surplus.[Pg 390]

In several States the laws make no provision with reference to the amount of capital required for a trust company. In Connecticut, Delaware, New Hampshire, and Vermont, trust companies are incorporated only under special acts and the amount of their capital is determined in each particular case by the legislature. In Rhode Island trust companies are incorporated by a board which has power to fix the terms of incorporation, including the amount of capital.

The first general laws for the incorporation of trust companies in the United States required such companies to have a much larger capital than that required for banks, but the later legislation shows a distinct tendency in the direction of lowering the requirements in regard to capital. In nearly all of the States, however, the requirement for trust companies is still substantially different from that for state banks. The smallest permissible capital for a trust company ranges from $5,000 in North Carolina to $1,000,000 in the District of Columbia. The majority of the States, which provide that trust companies must have a specified minimum capital, do not permit the organization of trust companies with a smaller capital than $100,000.

In only one State, Iowa, is the smallest permissible capital less for trust companies than for state banks; in six States it is the same; in all the others it is larger. The accumulation of a surplus is not required in so many States for trust companies as for banks.

Liability of Stockholders

With the practical prohibition of the issue of state bank notes in 1866 and the consequent decrease in the number of state banks, the liability of stockholders in state banks became in nearly all of the States, except where an additional liability was imposed by the constitution, the same as that of stockholders in ordinary business corporations. Since 1880, however, provisions imposing an additional liability on the stockholders of banking corporations have been placed in the banking and trust-company laws of nearly all the States in which state banks or trust companies have assumed any great importance.[Pg 391] In the larger number of the States and Territories the liability is a proportionate one, and the stockholders are responsible "equally and ratably and not one for another."

The imposition of the statutory liability on the stockholders of state banks and trust companies has not proved of great service as a protection to bank creditors against loss. As yet little has been accomplished in the way of making the enforcement of the liability effective.

Restrictions on Loans and Discounts

The desirability of some legal limitation on the extent of the liability to a banking institution which any one person, firm, or corporation may incur is largely due to the fact, that, since the American banking system is a system of independent banks, the resources of many of the banks are necessarily small in comparison with the needs of some of their customers for loans. A large manufacturing concern located in a small town may very well be able to use all the assets of the local bank. If the local bank were the branch of a larger bank, the mere fact that a large loan was wanted by a manufacturer in a small town would be of no significance, since the amount of the loan would be small compared with the total assets of the bank.

Moreover, in many banks a controlling interest is held by a person, firm, or corporation that is actively engaged in other business enterprises. Such control is far more likely to be found in small banks than in large, and in a system of independent banks than in one of branch banks. One consequence of the close identification of interest thus brought about between banking and other business enterprises is the probability that loans will be made directly or indirectly to some one borrower to an amount larger than a proper distribution of risks would justify.

The national-bank act in its original form provided that the total liabilities to any national bank of any person, company, corporation, or firm for money borrowed should not exceed one-tenth of the amount of the paid-in capital stock of the bank. The liabilities of the members of the firm or company[Pg 392] were to be included in the liabilities of the firm or company. It was provided, however, that "the discount of bills of exchange in good faith against actually existing values and the discount of commercial or business paper actually owned by the person negotiating the same" should not be considered as money borrowed. This section of the national-bank act remained unchanged until 1906, when it was amended so as to permit a single liability to be contracted equal to one-tenth of the capital and surplus, instead of one-tenth of capital only, but it was also provided that the liability should not, in any case, exceed 30 per cent. of the capital stock.

In the banking laws of seven States the limit on the amount of single liability is the same as under the national-bank act. The banking laws of almost all the other States permit a larger amount to be loaned on a single liability than is permitted by the national-bank act.

In nearly all of those States in which trust companies have acquired full banking powers the provision limiting the amount of any single liability applies to both banks and trust companies. In only one State or Territory—New Mexico—is there such a provision for trust companies and none for state banks. In a few States—Kansas, Michigan, Minnesota, Missouri, Montana, Oklahoma, New Jersey, Nebraska, and Wisconsin—there are limitations on the amount of a single liability for banks, but none for trust companies.


In almost all the banking institutions of the United States the directors or a part of them are actively engaged also in other business enterprises; and in many cases they borrow from the banks or trust companies in which they are directors. Moreover, in some banks one or two of the directors own a controlling interest, and are at the same time large borrowers. The possibility, in such cases, that larger loans may be made than the credit of those directors warrant is very considerable. The national-bank act contains no provisions regarding loans to directors, but in the laws of about one-half of the States attempts have been made to devise rules which would prevent[Pg 393] the making of loans to directors in excess of the amount to which their credit entitles them. The requirement that loans to directors shall be formally approved by the board of directors is the one most frequently found. It has been thought that directors would be reluctant to vote for excessive loans to other directors if their vote is to be recorded.


There is no more characteristic difference between state banking laws and the national-bank act than the fact that, in almost all the States, state banks and trust companies may make loans on the security of real estate, whereas national banks are [were] prohibited from doing so [before the passage of the Federal Reserve Act]. In some States, where the influence of the example of the national-bank act was strong enough at the beginning of state-bank regulation to secure the insertion in the state banking laws of the prohibition of real estate loans, it has later been found desirable to amend the laws in this respect. The Pennsylvania general banking law of 1878, for instance, did not permit banks to loan on real estate, but was amended in 1901, so as to permit such loans to be made. In North Dakota and South Dakota, also, similar changes have been made in the banking laws. In 1910 trust companies in all the States and Territories where incorporated under general laws were allowed to loan on the security of real estate. State banks so incorporated may also loan on real estate in all the States and Territories except New Mexico and Rhode Island. In Rhode Island, however, banks may loan on real estate part of their savings deposits.

A few of the state banking and trust-company laws contain provisions limiting the amount which may be invested in real estate loans.

Not withstanding the disadvantages of real estate as a convertible asset, the power to loan on the security of real estate is a valuable one to many of the state banks.[142] Many banks, particularly those in the smaller towns and cities, if restricted[Pg 394] to loans on personal security, find it difficult to fully employ their funds. There are not sufficient local loans of this kind to employ all the funds of the bank; and the amount not so employed, if it is to yield a revenue, must either be invested in outside commercial paper or deposited with banks in the great commercial cities.


In most of the antebellum state banking laws reserves were required only against note issue. In Ohio, for example, the general banking law required a reserve of 30 per cent., against circulation, but none whatever against deposits. Several of the state banking laws which survived the destruction of the state bank-note issue contained, however, provisions requiring banks to hold a reserve against deposits; but in none of these States was the increase in the number of state banks important. In those States in which the state banks were organized under the "business incorporation laws" there were, of course, no reserve requirements. Until 1887 a reserve was required for state banks in only three States, Ohio, Minnesota, Connecticut, and in these the required reserves were small. Even since the revival of state bank regulation, which began in 1887, the requirement of a reserve has not been regarded in many of the States as an important part of the state banking law.

The most striking and important difference between the reserve required by the national-bank act and the reserves required by the state banking laws is that under the national-bank act the reserve is a percentage of "deposits"—i. e., of all deposits—while under the banking laws of a majority of the States either no reserve is required against time or savings deposits, or a smaller amount of reserve is required than against demand deposits.

None of the state banking laws require that the reserve of any class of banks shall consist wholly of cash in bank. All the laws permit balances in other banks to be counted at least[Pg 395] as a part of the reserve. There are great differences among the laws, however, with respect to the amount which may be so counted.

The laws in all the States leave the banks almost entirely free to deposit their funds in banks in the great commercial centres. The strong economic pressure toward concentration is thus left free to act toward drawing reserves into banks located in the reserve and central reserve cities.

In the greater number of States which incorporate both state banks and trust companies the reserve requirement is the same for both classes of credit institutions. Slight differences between the requirements for trust-company reserves and those for state-bank reserves are chiefly of two kinds. In the first place, the provisions for trust-company reserves more frequently permit the counting of bonds as a part of reserve; secondly, the provisions for differing amounts of reserve against time and demand deposits.

In recent years there has been much complaint in some States that the reserves required for trust companies are inadequate.

Branch Banks

The most characteristic feature of American banking is the extent to which the banks and trust companies are independent institutions. The national-bank act makes no provision for the establishment of branch banks except in cases of the conversion of state banks which already have branches. Such banks are allowed to retain their branches on condition that the capital is assigned to the mother bank and the branches in definite proportions, but only a few national banks have branches. Under none of the state banking laws has there been built up an important system of branch banks. This has been partly due to the very general desire of each American community, no matter how small, to have its bank managed by its own citizens, and partly to the fact that in most of the States the establishment of branch banks is either explicitly forbidden or in no way provided for by law. In eight States—Colorado, Connecticut, Mississippi, Missouri, Nevada, Pennsylvania, Texas, and Wisconsin—the opening of branch[Pg 396] offices is forbidden by specific enactment. In a large number of other States the banking laws make no provision for the establishment of branches, and it has been held in most of these States that the opening of branch offices is unlawful.

The States in which state banks and trust companies are definitely permitted to have branches are California, Delaware, Florida, Georgia, New York, Oregon, Rhode Island, Virginia, and Washington. In Louisiana, Maine, and Massachusetts trust companies may have branches. In Maryland and North Carolina branches are operated by some banks and trust companies which were chartered by special act. There are in several of these States, however, restrictions on the opening of branch offices. In New York and Massachusetts branches may be established only in the city in which the principal office of the bank or trust company is located. In New York, moreover, only banks located in a city of 1,000,000 inhabitants or over may have branches; but any trust company may have branches. In Maine a trust company may establish branches only in the county in which it is located or in an adjoining county.

In nearly all the States which permit banks or trust companies to establish branches one or both of two conditions are imposed. In the first place, additional capital is required for each branch bank over and above the amount of the parent bank. Secondly, the establishment of a branch bank must be specifically authorized by some state official or officials.

The number of branches of banks and trust companies cannot exceed a few hundred in the entire United States. Compared with the total number of banks and trust companies this is a small development. Moreover, the most important affiliations among banking institutions are among those located in the same city. The "chains" of country banks possess, for the most part, little vitality, and in the total banking business of the country they play an insignificant rôle. The great mass of state banks and trust companies are independent institutions. The most enduring affiliations at present existing among the banking institutions are those between a national bank and a trust company or a state bank and a trust company. The comparatively limited powers of the national[Pg 397] banks and in some States of the state banks have made it desirable for many of these institutions to affiliate trust companies with themselves in order that desirable business may not be lost.

Further Reason for the Lack of Branch Banks in the United States

[143]It would seem that there must be a reason for this peculiarity [the small number of branches] in the banking system of the United States. In searching for this reason, the first fact of importance seems to be that, although the organization of branches has been permitted to the non-note-issuing banks in some of the States, they have not been organized, while in other countries they have been established in nearly every case. by note-issuing banks. This seems at once to indicate that in places where notes are the most important medium of exchange a connection of some sort exists between the issue of notes and the establishment of branches.

The inducement to the establishment of branches by banks is, of course, the possibility of profit. But as has already been frequently pointed out, profit can be obtained only by making loans. These when greater than the amount of the capital, as it is necessary that they should be, can be made by the loan of funds left with banks by others or by the issue of circulating notes. It is also clear that, were the possibilities of loaning beyond the amount of the capital wholly or chiefly confined to one of these forms of liability—the other being unavailable, as in the case of the state bank notes whose issue is prohibited by the 10 per cent. tax—and were this other form distasteful or impossible of introduction among the community where the branch was to be established, the motive for the creation of the branch would be absent. This motive has been wanting in many parts of the United States. By the laws of the United States, the issue of notes has been made impossible to all save national banks, and the capital of these banks has been limited to $50,000 as a minimum. Banks other than national must,[Pg 398] therefore, be established under state laws, some of which have permitted the organization of such institutions with capitals as low as $5,000 or $10,000. They can, however, make use only of deposits as a means of loaning beyond the amount of their capital. But deposits do not provide a desirable form of currency for use in country districts. It follows, therefore, that the state-bank systems supply the deficiencies of the national system only in so far as they furnish independent banks of smaller capital than $50,000 ($25,000 since 1900).

Nor would it have been of material assistance had the organization of national banks of capitals smaller than $50,000 been allowed. As the system has worked out, the issue function has been a useless one. The compulsory deposit of bonds to secure circulation has hampered the banks in exercising this function, since the requirement to deposit bonds now cuts off all profit arising from the issue of notes. Moreover, the rural communities are those where interest is highest, and hence where notes can least advantageously be issued under the present system of bond-deposit, owing to the high price of the bonds. These difficulties probably cannot be overcome by the establishment of banks of lower capitals than now exist.

[144]At the 1910 convention of the Alabama Bankers' Association, held in Birmingham in May, one of the speakers, whose topic was "State Banks and Their Branches," closed a condemnatory address with the words: "We believe the days of the branch bank are numbered." Two months later, at Cooperstown, Hon. E. B. Vreeland told the bankers of New York State, at their convention: "No one will ever live to see the day when the branch banking system which prevails in Canada and in Germany and in England and in France will be tolerated by the people of the United States."... "The economies of the branch banking system are such that no other system can live beside it. It is just as sure as the sun will rise to-morrow that the branch banking system, if taken up in the United States, would in the end drive out of existence all the banks in every city and town in the country outside of the[Pg 399] great financial centres. That is the experience of the world."

If this statement means anything it is a confession that the system of local single-office banks is wasteful in operation, and it seems to me that it sets forth one reason why branch banks are inevitable. When a banking system is wasteful it is the stockholders, borrowers, and depositors who suffer from the circumstance, and as soon as they realize the fact its doom is sealed.

It should be said here that it is not their economical operation alone that has enabled the branch banks to displace the small local banks in England, Germany, and France. The branch institutions are cleaner, more efficient, and they provide better opportunities for the clerks and officers; they give a better and more complete service to the localities in which they work.... Another reason is found in their stability during crises....

The New York State Bank Act of 1914[145]

In June, 1913, George C. Van Tuyl, Jr., superintendent of banks of the State of New York, appointed a commission to look into the banking conditions of the State and to make a thorough revision of the law relating to banks. This commission conducted many public hearings; sought information from banking experts in this State and in other States; made a careful study of private banking conditions, rural credits, and other special banking problems of the State; and, finally, on February 25, 1914, they presented their report in the form of a bill of some 500 pages. After a good many amendments had been made to appease conflicting interests, the bill was passed and became law April 16, 1914.

In general, the new law marks a decided improvement and shows a commendable spirit of progressiveness. Its framers believe that it is a law which may well become the model for other States, and there are some who say that it is without question the best balanced and most comprehensive state banking legislation which has ever been enacted.

[Pg 400]

The new law was the outgrowth of the general agitation for banking reform which had swept over this country following the panic of 1907. The inciting cause, however, was the passage of the Federal Reserve Act which made it necessary to revise the state law so that the state banks either might join the federal system or be in a position to compete successfully against the national banks of the State, whose powers had been considerably enlarged by this act. In part, the law is modelled after the federal act, and, in part, European experience has been drawn upon.

Under the new law the state banks will have even more importance in the competition for banking business than in the past. From the point of view of banking power, the 278 banks of deposit and discount and trust companies have aggregate deposits in excess of those of the 479 national banks in the sum of $281,786,000.[146] Furthermore, it has been estimated that the total resources of the New York state banks are equivalent to 17 per cent. of the aggregate resources of all banks in the United States, both state and national. Superiority in banking power is one element in the strong competitive position of the state banks, and another element is the privileges granted to these banks under the new law which, in some respects, are superior to those granted the national banks under the federal law. In view of the fact that the state banks can enjoy either directly or indirectly most of the advantages of the federal system and also that in some particulars the state law gives them more liberal powers, it seems probable that these banks will continue to see an advantage in their state charters; and thus the amount of defection from the state system will be negligible.

More real power has been given to the banking department in the provisions of the law. Through investigation, authorization certificates, and regular uniform reports, the superintendent of banks has more direct control over the banks than ever before. Besides the extension of the supervisory powers, the penal provisions of the act have been strengthened and made more exacting.

[Pg 401]

1. Features of the act relating to banks of deposit and discount and trust companies. The reserves required against deposits were reduced substantially, and made nearly uniform with those required for national banks. The following table gives the percentage of reserve required and the percentage of reserve on hand which the new law specifies for these banks.

Banks of deposit and discount Trust companies
Per cent. of deposits Per cent. of deposits
PopulationRequired reserveReserve on handRequired reserveReserve on hand
2,000,000 or over18121510
Elsewhere in the state124104 or 3

The reserve requirements are made still more definite by the fact that the law compels the banks to keep one-half at least of the reserve on hand in "gold, gold bullion, gold coin, United States gold certificates, or United States notes: and the remainder in any form of currency authorized by the law of the United States other than federal reserve notes."

Among the powers granted to these banks is the power "to accept for payment at a future date, drafts drawn upon its customers and to issue letters of credit authorizing the holders thereof to draw drafts upon it or its correspondents at sight or on time not exceeding one year." This clause gives a much wider power to the state banks in the important matter of acceptances than its counterpart in the Federal Reserve Act. In the one case both domestic and foreign acceptances may be made and handled without stipulation as to aggregate amount and bearing maturities of one year or less, while in the other case the acceptances are limited to those arising out of the importation or exportation of goods with maturities not exceeding six months. Seemingly, the state banks have the advantage, and to this extent the state law is superior to the federal act.

One other important forward step was taken in relation to this group of banks. They are given the privilege of establishing[Pg 402] branches outside the State of New York, either in the United States or in foreign countries. This privilege is qualified, however, by the provision that no bank can establish such branches unless it has a combined capital and surplus of $1,000,000 or over and the written approval of the superintendent of banks. Although the old law permitted trust companies to establish branches in the place where they were incorporated, the practical effect was to limit branch banking to the city of New York. In this particular also the state banks have the advantage over the banks in the federal reserve system which are allowed to establish branches only in foreign countries.

2. Features relating to private banks and bankers. The regulation of private banks and bankers is an entirely new departure in the law of this State. In the past the banking department had no authority to supervise that relatively large number of private bankers who receive deposits in small amounts from the wage-earning classes while conducting in connection therewith a mercantile or some other kind of business.

Mercantile firms like the Siegel Company, by paying a higher rate of interest upon deposits than savings banks, were able to obtain the savings of many small depositors. This money was invested in the business and secured only by the capital stock of the mercantile establishments. In case the firm failed there was no security back of these deposits but these same shares of stock, and so depositors were fortunate if they received in settlement even 40 per cent. of their claims. Such firms were not doing a legitimate banking business inasmuch as they did not keep their assets in liquid form and carried no reserve against deposits.

The new act corrects this situation by giving the banking department authority to conduct independent investigations into any violation of the banking law by a corporation or individual. In the future a corporation which is in any way engaged in the business of banking cannot hide under the wing of the general corporation law when the banking department sees fit to make an investigation of its affairs.

Some of the specifications of this part of the law are all[Pg 403] securities, property, and the evidences of title thereto in which the permanent capital and the deposits are invested are to be segregated and kept separate from all other property and assets of the private banker; depositors have a prior lien on the assets of the private banker, in case of insolvency or suspension of business; and, in addition, every private banker must maintain a reserve of 15 per cent. against deposits in cities of the first class and a reserve of 10 per cent. in any other city, one-tenth of which shall consist of reserve on hand and the remainder may be kept on deposit subject to call with banks approved by the superintendent of banks. These requirements will go far toward preventing the recurrence of such disasters as the Siegel failure.

3. Features relating to co-operative credit. Within the last thirty years the agricultural methods of the State, in harmony with the agricultural methods throughout the United States, have undergone great changes. Scientific farming, improved machinery, and changed market conditions have brought new problems in the field of agricultural credit. To-day agriculture has come to be in a real sense capitalistic and has in consequence laid new requirements on the credit structure of the nation. Moreover, the period of large returns or satisfactory returns from an extensive and rather careless cultivation of the soil, which made possible an ignoring of unit cost, or, at least, brought the farmer to minimize the importance of such cost, has given way, so far as the successful farmer is concerned, to the careful estimates of cost and close calculations of profits on a narrow margin between unit cost and unit selling price.

In the field of cost, the rate at which capital or money may be borrowed is no small factor; and with the high rates prevailing in the United States in comparison with those current in Europe, the borrower in this country who pledges his land or agricultural products as security for a loan finds himself at a disadvantage. To meet this condition cheaper agricultural credit has been strongly urged. Europe furnishes the example in her well-organized land banks and co-operative credit unions. Already Massachusetts has a law authorizing co-operative organizations for furnishing cheaper credit facilities[Pg 404] to the agriculturalist, and in Illinois there is a "crédit foncier" which has been in successful operation a number of years. New York State has put itself in line with this growing movement to furnish ample and cheaper credit to the farmer and the purchasers of real estate by putting into the new law provisions for the establishment of a land bank and co-operative credit unions.

Sections 421-438 authorize ten or more savings and loan associations, the aggregate resources of which shall not be less than $5,000,000, to form a Land Bank of the State of New York. This bank can "issue, sell and redeem debenture bonds secured by bonds and first mortgages made to or held by member associations" and "invest its capital and other funds in bonds secured by first mortgages on real estate situated within the territory in which its members are authorized to make loans." The bank is not permitted to do a general deposit business or incur any indebtedness upon notes and bonds in excess of twenty times the amount of its capital. The debenture bonds authorized by the act are to be issued in series of not less than $50,000, and may be called on any interest day at 102-1/2 provided a sixty-day notice is given. Amortization payments upon mortgages which are given as collateral security for the debentures of the land bank shall be sufficient to liquidate the debt in a period not exceeding forty years.

In Article XI the law provides for the establishment of credit unions. A credit union may be organized by any seven or more persons with a share capital the par value of which shall not exceed $25. The objects of the credit union are: (1) to loan money in small amounts on personal security or in larger amounts on endorsed notes at rates not exceeding 1 per cent. per month, inclusive of all charges incident to the making of such loans; (2) to receive the savings of its members in payment of shares on deposit; (3) to borrow money to an amount not to exceed 40 per cent. of its capital; (4) to pay dividends on its share capital. As to the method of making loans, the law prescribes that a credit committee shall pass upon all applications for loans which must be made in writing and must state the purpose for which the loan is desired and the security offered. No loan will be made unless it receives[Pg 405] the unanimous approval of the members of the committee present at the meeting, provided always a majority of the committee is present.

With the land bank acting as a central clearing agency for the local savings and loan associations and the organization of many rural credit unions the problem of agricultural credit will be largely solved for New York State. This, however, all hinges on the proper functioning of the land bank and the co-operation of the farmers in the establishment of local credit unions. Agriculturists as a class are slow to adopt new methods and it may be only after prolonged education that all the possibilities of this new legislation will be realized.


[140] Adapted from George E. Barnett, State Banks and Trust Companies since the Passage of the National Bank-Act, Publications of the National Monetary Commission. Senate Document No. 659, 61st Congress, Second Session.

[141] [At least one savings bank has gained admittance to the Federal Reserve System as a "state" bank.]

[142] According to reports to the National Monetary Commission on April 28, 1909, the loans of all the state banks in the United States on the security of real estate were 20.6 per cent. of their total loans and discounts.

[143] The Report of the Monetary Commission of the Indianapolis Convention, pp. 377-8. The University of Chicago Press. 1898.

[144] Adapted from H. M. P. Eckardt, Branch Banking Among the State Banks, The Annals of the American Academy of Political and Social Science, Vol. 36, No. 3, November, 1910 pp. 626-630.

[145] Adapted from Everett W. Goodhue, The Revision of the New York State Banking Law, The American Economic Review, Vol. V, No. 2, pp. 413-421.

[146] Annual Report of the Superintendent of Banks of the State of New York, Jan. 6, 1915, p. 33.

[Pg 406]



[147]Financially, Canada is part of the United States. Fully half the gold reserve upon which its credit system is based is lodged in the vaults of the New York Clearing House. In any emergency requiring additional capital Montreal, Toronto, and Winnipeg call on New York for funds just as do St. Paul, Kansas City, and New Orleans. New York exchange is a current and universal medium in Canada and is in constant demand among the banks. A Canadian wishing to invest in securities that may be quickly marketed commonly turns to the New York market for stocks and bonds. Yet the American banker visiting in Canada, if he is unacquainted with the history of banking in his own country, finds himself in a land of financial novelties, for Canada has a banking system unlike any in operation in the United States at the present time. Twenty-nine banks, known as the "chartered banks," transact all the banking business of the Dominion. They have 2,200 branches, and each may establish new branches without increase of its capital stock. [At the close of the year 1915 there were twenty-two banks with approximately 3,200 branches.] They issue notes without depositing security with the Government and in such abundance that no other form of currency in denominations of $5 and above is in circulation. Notwithstanding the fact that the notes are "unsecured," their "goodness" is unquestioned among the Canadian people.

The System Not New

But to the student of the history of banking in the United States there is little that is radically new in the Canadian system. He finds in it many of the practices and expedients that[Pg 407] were found excellent in the United States in the first half of the nineteenth century, and is almost persuaded that but for the Civil War what is now known as the Canadian banking system would everywhere be called the American system.

The fiscal exigencies of war, which have caused changes in the banking systems of most countries, have had no influence upon the development of banking in Canada. During the first half of the nineteenth century the commercial and financial interests of Canada and the United States were comparatively intimate and the financial institutions of both countries developed on similar lines. The safety-fund system, first introduced in the State of New York in 1829, found favor also in Canada and is still an integral part of the Canadian banking system. Branch banking, which was most successfully illustrated in this country by the State Bank of Indiana, and which now exists in some form or other in almost all countries except the United States, has always prevailed in Canada. The importance of a prompt redemption of bank notes as exemplified in the old Suffolk banking system in New England before the war, was fully realized in Canada and is probably better illustrated in the present Canadian system than in any other country. There bank notes and bank checks are treated as identical in nature, both being cleared with the same regularity and promptness. The so-called free banking system, which was first adopted in the State of New York in 1839 and thereafter adopted by eighteen other States of the Union, was tried in Canada in the fifties, but not on a large scale. This system, requiring that issues of bank notes should be secured by a segregated deposit of certain classes of stocks and bonds, has never met with approval among the leading bankers of Canada.

The Canadian system is a product of evolution. It has taken its present form because of the commercial and financial needs of the Canadian people. It was not created by lawyers or statesmen to meet a fiscal need of the Government, but has grown up gradually under the fostering care of experienced bankers, no changes having been made until experience proved them necessary or advisable.

The chartered banks transact the business which in the United States is divided among national banks, trust companies,[Pg 408] private banks, and savings banks. They buy and sell commercial paper, discount the notes of their customers, lend money on stocks and bonds, make advances to farmers, and sometimes aid in the financing of railroads and industrial enterprises. To a Canadian the word "bank" means one of the twenty-odd "chartered banks," for the law prohibits the use of the word "bank" by any other institution.

Other Financial Institutions

The only other financial institutions in Canada which possess much importance are the mortgage and loan companies. These usually operate under charters granted by the provincial legislatures and do a business similar to that of the farm and mortgage companies which once flourished in the United States, making loans to farmers for a term of years and taking farm mortgage for security. They also make loans upon urban and suburban real estate and thus aid in the upbuilding of the cities and their suburbs. The business of these institutions is made possible by the fact that the bank act does not permit the chartered banks to accept loans secured by real estate.

The Dominion Government maintains a double system of savings banks. One set is managed by the post-office department, every post-office receiving deposits. The other set is managed by the finance department. The post-office department also sells annuities and old-age pensions. The money received through the savings banks is regarded as a loan from the people and is used, like money obtained by taxation, in the payment of the Government's general expenses. The Government is required to carry a gold reserve of 10 per cent. against the savings deposits, but no assets are set aside for their security. The chartered banks pay the same rate of interest and get most of the business, for they offer facilities with which the Government does not attempt to compete. Most of the Government's deposits come from the poorest and most ignorant classes, people who in all countries are suspicious of banks. Some of the Canadian cities maintain municipal savings banks, but they are of relatively small importance.

Trust companies in Canada are not financial institutions.[Pg 409] They are trust companies in fact as well as in name, their business being to act as trustee and administrator. A few of them accept deposits, although it is not certain that they have a right to do so. The bulk of the money they handle comes to them through the administration of estates and trust funds.

Private banking firms are almost unknown in Canada, there being only two or three in the entire Dominion, and these do a mortgage and loan business rather than a strictly commercial banking business.

Hence, if any one seeks to understand the financial or banking situation in Canada, he must devote his attention in the main to the chartered banks. These through their branches furnish the loanable capital necessary for the support of the Dominion's trade and industry and for much of its agricultural enterprise. To them the Government turns when funds are needed for internal improvements or when the exchequer faces a deficit. The promoters of street railways, steam railways, steam railroads, and other permanent improvements take counsel with the managers of these chartered banks before they issue their securities. The banks as a rule do not invest their funds in the stocks or bonds of new enterprises, yet their managers are the men most familiar with the world's money markets and their approval, therefore, of any financial undertaking is highly esteemed.

The Essentials of the System

A chartered bank in Canada is a bank of branches, not a bank with branches. The parent bank, technically known as the "head office," neither takes deposits nor lends money. All the banking business is done by the branches, each enjoying considerable independence, but all subject to the supervision and control of the head office. The law places no restrictions upon the number or location of branches. Canadian banks, therefore, have branches in foreign countries as well as in Canada.


The provisions of the bank act with respect to the organization of new banks are intended to guard against the entry of[Pg 410] unfit or inexperienced persons into the banking business. The minimum required capital of a bank is $500,000, of which all must be subscribed and one-half paid in before a new bank can open. At least five men of integrity and good financial standing must agree to act as provisional directors and secure a favorable report on their project from the parliamentary committee on banking and commerce. These men must agree to subscribe for fairly large blocks of stock, otherwise the committee will be inclined to reject their application. They must convince the committee that their project is a well considered one, that there is need for the new bank. If they satisfy the parliamentary committee it will be granted. The bank, however, cannot yet begin business. Provisional directors now have merely the right to advertise and cause stock books to be opened. If inside of one year capital stock to the amount of $500,000 has been subscribed and $250,000 thereof paid in, the provisional directors may call a meeting of the shareholders, at which a board of regular directors shall be chosen. Before this meeting is held at least $250,000 in cash must be paid over to the Minister of Finance. The regular directors must then apply to a body known as the treasury board for a certificate permitting the bank to issue notes and begin business and the treasury board may refuse this certificate unless it is entirely satisfied that all the requirements of the law have been met. Delay on the part of the treasury board might prove fatal to the new enterprise, for if a new bank does not obtain a certificate within one year from the date of its incorporation, all the rights, powers, and privileges conferred by the act of incorporation cease. These requirements make it impossible to organize a new bank in Canada with any degree of secrecy.


Having obtained its charter, a new bank must open its head office in the place designated, and may then proceed to establish branches or agencies, upon the number and location of which the law places no restriction. Under its charter it has authority to issue circulating notes up to the amount of its unimpaired paid-up capital in denominations of $5 and multiples[Pg 411] thereof. An amendment of the bank act passed July 20, 1908, gives the bank the right to issue what may be called an emergency circulation during the crop-moving season (October 1 to January 31). During this period the legal maximum of the circulation of a bank is its paid-up capital plus 15 per cent. of its combined paid-up capital and surplus or rest fund. This emergency circulation, which consists of notes in form and in other respects exactly like the regular issues, is subject to a tax at a rate not to exceed 5 per cent. per annum, the rate being fixed by the governor in council. If a bank's circulation does not exceed its paid-up capital, it pays no tax.


The law is silent on several subjects that seem of great importance to most bankers in the United States. For instance, it does not require that the banks shall deposit with a government official, or in any way set aside any kind of security for the protection of the note holder. It does not even require that the banks shall carry a cash reserve against either notes or deposits, nor does the law make the notes a legal tender for any payment. A bank need not accept the notes of other banks. The Government does not guarantee the redemption of the notes. Neither does it bind itself to receive them in payment of dues to itself.

Nevertheless the notes of the Canadian banks are everywhere acceptable at par, the people apparently not being at all concerned about their "goodness." And their confidence in the note has been well justified, for nobody since 1890 has lost a dollar through the failure of a bank to redeem its notes. Following are the legal requirements, which for twenty years have proved adequate protection for the note holder:

1. Every bank must redeem its notes at its head office and in such commercial centres as are designated by the treasury board. The redemption cities are the same for all the banks. They are Toronto, Montreal, Halifax, Winnipeg, Victoria, St. John, and Charlottetown.

2. Each bank must keep on deposit with the Minister of Finance a sum of lawful money (gold or Dominion notes) equal to 5 per cent. of its average circulation; the total so deposited[Pg 412] is called the "circulation redemption fund." It is a guaranty or insurance fund for use, if need be, in the redemption of the notes of failed banks.

3. Bank notes possess first lien upon the assets of a bank.

4. Bank stockholders are liable to an assessment equal to the par value of their stock.

5. A bank must make to the Minister of Finance on or before the fifteenth of each month a detailed statement of its assets and liabilities on the last business day of the preceding month. This monthly return, the form for which is set forth in the act, must be signed by three general officers.

6. The Canadian Bankers' Association, an incorporated body of which each bank is a member, is given supervision by the bank act of the issue and cancellation of notes and of the affairs of a failed bank.

7. The notes of a failed bank draw interest at 5 per cent. from the date fixed for their redemption by the Minister of Finance, who may redeem them out of the assets of the bank or out of the "circulation redemption fund."


Each of these provisions of the law has its value and significance, but only the first is absolutely essential to the successful operation of the system. All the other provisions might be changed or abolished without impairment of the efficiency of the banking system. But the abolishment of this redemption system would at once give Canada a new banking system. The bank note is almost the sole circulating medium in Canada, and the people have confidence in it because it is tested every day at the clearing houses and proves itself as good as gold. This daily test would probably not take place with the same regularity as now if the banks did not have branches or if they were obliged to deposit security against their issues. Canadian banks are national, not local institutions. All but a few of them have branches in every part of the Dominion, and these branches, as fast as they receive the notes of other banks, either send them in to the nearest redemption centre or convert them into lawful money—or its equivalent, a bill of exchange—through branches of the issuing[Pg 413] banks located in the same towns. Each bank is seeking, through its branches, to satisfy all the legitimate needs of the people for a circulating medium. When the note of a bank is in circulation it is earning money for the bank, but when it is in the vault or on the counter of the bank it is an idle and useless piece of paper. Hence every bank always pays out its own notes through its branches and sends the notes of other banks in for redemption, thus increasing its own circulation and strengthening its own reserve.

Furthermore, if the banks were not allowed complete freedom of issue within the prescribed limit, but were required to deposit some form of security, as is required of the national banks in the United States, an investment or speculative risk would arise that would inevitably cause friction. If bonds were designated as security, bankers might often be tempted by high prices to sell their bonds and forego the profit on circulation for the sake of making a larger profit by the sale of the security. Thus the volume of bank notes might contract even at a time when the people needed more currency. In such case, of course, Canada would be obliged to import gold in order to fill the gap in the circulating medium.


The 5 per cent. insurance fund for the redemption of the notes of failed banks is theoretically an important and prominent part of the system, yet practically it would seem to be of little consequence, for not once since 1890 has it been necessary to use a dollar of the fund. Banks have failed, to be sure, but the notes of these banks have always been redeemed either out of the assets or by recourse to the double liability of the shareholders. It is a mistake to suppose that the people of Canada have confidence in bank notes because of the existence of this redemption fund. The average business man knows nothing about the fund and if his attention were called to it as being a source of security for the bank notes, he would probably think a 5 per cent. reserve altogether too small. The real reason why the people have faith in bank notes is because the notes are always honored by the banks and never fail to stand the test of the clearing house. In other words, they believe that[Pg 414] bank notes are good for about the same reason that they believe the sun will rise in the east every twenty-four hours, and do not bother themselves about reasons.

Nevertheless this redemption fund does contribute to the strength of the banking system. It makes each bank to a certain extent liable for the mistakes of other banks, and as a result gives rise to a spirit of mutual watchfulness and helpfulness. Other features of the system contribute to the same result, especially the fact that a Canadian bank accepts from a depositor without indorsement the notes of other banks. Since the banks have branches in agricultural and mining communities, often distant from the railroad by several days' journey, and these branches are accepting the notes of other banks and giving credit for them as if they were gold itself, it is evidently important that each banker should have all possible information with regard to the status and business of his competitors. As a result one finds among the bankers of Canada a surprisingly intimate knowledge of each other's affairs.


The two negative qualities of the Canadian bank note—its lack of a legal-tender quality and of a government guaranty—at first sight may seem to readers in the United States a source of weakness. Yet Canadian bankers would doubtless all agree that nothing would be gained by making bank notes legal tender for any kind of payment or by making the Government in any measure liable for their ultimate redemption. Such measures would probably be rejected as likely to prove harmful. It would be like hampering a flying machine with unnecessary bars of steel. Bank notes, like bank checks, are mere promises to pay money and are more convenient than money because they can be created as need for a medium of exchange arises. When either has done the work that called it into existence, it should disappear from circulation and be redeemed. If it is made a legal tender like money itself, or if its redemption is guaranteed by a strong government, there is always the danger that ignorant classes of people will regard it as money itself and withdraw it from circulation.

The Canadian Government has nothing to do with the daily[Pg 415] redemption of bank notes and does not guarantee that they shall be redeemed. It is custodian of the 5 per cent. redemption fund and is under obligation to redeem the notes of failed banks out of this fund, but if a series of bank failures should exhaust it the note holder has no guaranty that government funds will be used for his relief.

The possession by the note holder of a first lien upon the assets of a bank, including the funds that may be collected from shareholders on account of their double liability, gives rise to such general confidence in the ultimate convertibility of a bank note that the notes of a failed bank, on account of the interest they bear, sometimes command a premium. As a rule, the notes of such a bank are collected by the other banks and held until the date of redemption has been named by the Minister of Finance.


The Canadian Bankers' Association is an incorporated body with powers and duties prescribed in an amendment to the Bank Act passed in 1900. Each chartered bank is represented in the membership and has one vote. The association is required by law to supervise the issue of bank notes and to report to the Government all over-issues, to look after the destruction of worn and mutilated notes, and to take charge of suspended banks. Its headquarters are in Ottawa. The expenses of the association are apportioned among the banks and do not apparently constitute a very heavy burden, for the secretary has an exceedingly small staff. All expenses incurred by the association on account of a suspended bank are, of course, a charge against the assets of the bank.

When the notes of a bank are so worn or mutilated that it wishes to replace them with new notes, notice is sent to the secretary of the association, a date is fixed, and in the presence of the secretary the old notes are duly counted and taken to a furnace, where they are consumed in the presence of the secretary and other witnesses. After this solemn operation has been performed and the signatures of all parties observing it have been duly attested, new notes are issued by the association to replace those that have been destroyed.[Pg 416]

The clearing houses in the Dominion are subject to regulation by the association. It also has the power to establish sub-sections and to do educational work by providing for lectures, competitive papers, examinations, etc. The Journal of the Canadian Bankers' Association, a quarterly publication of excellent quality, is edited by the secretary and is at present the only educational force at work among bank employees.


While the amount of notes that the chartered banks may issue is limited by the Bank Act to the amount of their paid-up capital, experience has proved that this legal limitation is only nominal and that the real and effective limit is imposed unconsciously and automatically by their customers and themselves. Each constantly seeks to increase its issue of notes to the legal limit, yet the combined efforts of all are never able to force into circulation more notes than the people need.

The reason why an excessive issue of bank notes in Canada is impossible is found in the two following facts:

1. Every bank must redeem its notes on demand in seven commercial centres in different parts of the Dominion.

2. The monetary circulation of Canada, exclusive of $1 and $2 bills, and "change" consists entirely of bank notes.

The redemption system is an automatic and effectual check against inflation. It is easier to get notes redeemed in Canada than it is to secure payment of checks in the United States, for the notes are redeemable at different points throughout the Dominion and no exchange is ever charged. If a country merchant accumulates more currency than he desires to keep on hand, he deposits it, together with his checks and drafts, in the local branch of his bank. This branch immediately sorts out the notes of other banks and treats them as it does checks and drafts upon other banks, either sending them to the nearest redemption agency or using them as an offset in the local clearing house if the issuing banks have branches in the locality. The branches of a bank are not obliged to redeem the notes of the parent bank, but must accept them at par in the payment of all dues. Thus each bank is doing its utmost to bring about the redemption of the notes of other banks. At[Pg 417] the same time it is paying out its own notes to all customers who ask for cash, seeking to bring its circulation up to the limit. As a result of these operations, two powerful forces are constantly at work, one putting notes into circulation, the other retiring them, and the people of Canada always have on hand just the amount of currency they need and no more. It is the people, not the banks, who determine how much the circulation of the banks shall be.


The fact that the bank note has exclusive possession of the monetary field in Canada is most important. His ignorance of this fact is one reason why the average banker or business man in the United States has been unable to get a practical understanding of the Canadian system. Its significance is easily seen. If Canada, like the United States, had in circulation a lot of government notes in denominations of $5, $10, $20, the Canadian banks would be able to increase their issues of bank notes almost without limit, for their new notes would simply take the place of the government notes, the latter going into bank reserves. The people of Canada in making deposits would not discriminate against bank notes, but would deposit the government paper quite as freely as the bank paper. As a result, the amount of the government paper in circulation would gradually decrease and the amount of bank notes would increase. The volume of Dominion notes in the vaults of the banks would expand, and as these notes are redeemable in gold the banks would feel justified in larger extension of their credit, so that an increase in deposits and current loans would ensue. Under such circumstances such freedom of issue as is enjoyed by the Canadian banks would doubtless result in inflation.

But such conditions do not exist in Canada. All the paper currency in the hands of the people, excepting $1 and $2 bills, is in the form of bank notes. There is no chance to substitute bank notes for government notes. Hence, if at any time business relaxes and the need for money among the people grows less, an increasing tide of bank notes flows into the banks. The people who bring these notes do not ask for money in exchange, for to them the notes are money. They take bank[Pg 418] notes to the banks just as people in the United States take greenbacks and silver certificates—to be exchanged for a deposit credit or account.


Theoretically there is no reason why any limit should be fixed upon the amount of notes which a bank may issue. Even though a bank has a monopoly of issue in a country—like the Bank of France—it nevertheless is unable to expand its circulation beyond the people's needs. Such a bank, unless it should adopt a reckless policy of lending which would bring ruin quickly upon itself, can exercise very little influence upon the amount of currency in circulation. In a country like Canada, where several banks are issuing currency, no single institution can enlarge its issue of notes beyond the needs of its own customers. If it should endeavor to do this by lending freely to customers who promised to use its notes in different parts of the country, the effort would be futile. The notes would quickly find their way into the branches of other banks and be sent in for redemption.

Like most other countries, however, Canada has placed a limit on the note-issuing privilege, fixing it at the amount of a bank's paid-up capital. While there is no scientific necessity that such a limit be fixed in order to prevent the over-issue of notes, nevertheless there are other considerations which justify it. It is an indirect method of compelling banks to increase their capitalization pari passu with the growth of their business. Inasmuch as the capital of a bank is the stockholder's contribution toward its assets, it is exceedingly desirable that this contribution be made as large as possible, for, other things being equal, the strength of a bank varies with the amount of its capital. It is not unreasonable, therefore, to require that banks in return for the useful note-issuing privilege should be required to keep their capital resources large.

When a Canadian bank has reached the limit of its note issue—which has rarely happened—it begins at once to treat the notes of other banks very much as if they were its own. Instead of going to the expense of sending them in for redemption, it uses them as counter money, paying them out to depositors[Pg 419] in response to their calls for cash. If all the banks in Canada should issue notes up to the limit, as some of them did during the exciting months of 1907, and if the current rate of interest did not warrant the issue of the taxed notes provided for by the amendment of 1908, the note circulation would immediately lose its elasticity. As further expansion would be impossible, the banks would have to meet any increasing demand for currency by paying out gold and Dominion notes, thus depleting their reserves. Such a situation would doubtless lead to a sharp advance in the discount rate and to the importation of gold.


It should be noted that the practical limit of note issue is about 10 per cent. below the legal limit. The manager of a bank having a paid-up capital of $1,000,000 begins to get nervous when his circulation equals $900,000. His office may be in Montreal and his bank may have branches in the far East and in the far West and in the mining wilderness of the North. Some of these branches he can not reach by telegraph and some are distant a week by mail. He immediately sends warning to all the branches and cautions them against any large out-giving of notes and against entering into transactions which will be likely to lead to unusual demands for currency. On account of this situation, even in times of greatest pressure, the total issue of the banks is usually 10 per cent. below the authorized limit.


The liabilities of Canadian banks, like those of commercial banks in Great Britain and the United States, furnish a fairly correct index to the expansion of the country's credit. Since the Canadians, like other Anglo-Saxons, make free use of the check book in the settlement of both business and private accounts, any increase of bank loans and discounts is usually attended by a corresponding increase in deposits. When a Canadian business man discounts his note at his bank he almost invariably leaves the proceeds on deposit with the bank.[Pg 420] As he makes his payments by check his own deposit account declines, but the bank accounts of his creditors increase, so that the net result of borrowing in Canada is an increase in the total of bank deposits. Consequently, in good times, when the banks are freely extending credit, the deposits grow, and in periods of dullness and liquidation they decline. A growth of deposits, therefore, is commonly accepted as an indication of business and industrial activity.

If a business man in Canada has temporarily a large balance in his bank and realizes that he will not need the money for several months, he will either arrange for its entry as a time or savings bank account, or for the payment of interest on his balance as a current account. Of course, the bankers do not encourage this practice, nor can it be indulged in by a depositor who is also a borrower. Depositors of the class who are paid a small rate of interest—usually 2 per cent.—by national and state banks in the United States, usually have savings department accounts in Canada and get 3 per cent.


On account of the fact that the time or savings bank deposits contain such a large proportion of money likely to be needed in business at any time, the banks regard both classes of deposit as being essentially the same form of liability. Practically all the deposit liabilities of a Canadian bank are payable on demand, although payment on two-thirds of them at the present time can not legally be demanded until after notice. Custom has made it imperative that a Canadian bank shall pay any and all of its depositors on demand. For any bank to refuse to let a depositor have his money when he calls for it would be regarded by the public as an acknowledgment of weakness. Certainly no Canadian bank would take the risk of making the experiment.

Canadian bankers feel that 3 per cent. is too high a rate of interest to pay depositors. This rate is a matter of tacit agreement among the banks and no single bank can afford to lower it, for such action would cause it a loss of business. On the other hand, if any bank, hoping to increase its deposits, should offer to pay 3-1/2 per cent. or 4 per cent., its conduct[Pg 421] would be looked upon with grave disapproval by its competitors. Some of the new banks in recent y