VII. THE SILVER QUESTION IN THE UNITED STATES…

VII. THE SILVER QUESTION IN THE UNITED STATES

[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, 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 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 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 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 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 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.

SILVER CERTIFICATES

[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, 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 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 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.

AMOUNT OF MONTHLY ISSUES

[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, 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

THE BIMETALLIST ARGUMENTS

[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 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; 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 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 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 EFFECT OF IMPROVEMENTS IN PRODUCTION

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 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 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 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 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 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.

THE CASE OF THE FARMER

Nevertheless, there is something more to be said, in explanation and justification of the discontent with falling prices, and 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 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. 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 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:

Date Net gold reserve

June 30, 1890 $190,232,405 June 30, 1891 117,667,723 June 30, 1892 114,342,367 June 30, 1893 95,485,413 June 30, 1894 64,873,025

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 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:

1890 $229,668,000 1891 219,522,000 1892 177,452,000 1893 203,355,000 1894 131,818,000

... 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 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 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 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.

SALE OF BONDS FOR GOLD

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 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 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:

Date Gold in Treasury January 31, 1894 $65,650,000 February 10, " 104,119,000 Bond issue. November 20, " 59,054,000 November 30, " 105,424,000 Bond issue. February 9, 1895 41,393,000

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.

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 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.

FOOTNOTES:

[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.

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VIII. INDEX NUMBERS

[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 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 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 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 L60,000,000, and on meat L100,000,000: 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 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, 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."

FOOTNOTES:

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

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IX. BANKING OPERATIONS AND ACCOUNTS

[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 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 paid in, in specie, on the morning when it opens its doors for business, we shall have the following:

Liabilities Resources Capital $100,000 Specie $100,000

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:

Liabilities Resources Capital $100,000 Real estate, furniture, fixtures, etc. $ 5,000 Specie 95,000 -------- -------- $100,000 $100,000

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, 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 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:

Liabilities Resources

Capital $100,000 Loans $90,000 Undivided profits 1,350 Real estate, furniture, fixtures, etc. 5,000 Deposit 88,650 Specie 95,000 -------- -------- $190,000 $190,000

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:

Liabilities

Capital $100,000 Undivided profits 1,350 Deposits 73,650 ------ $175,000

Resources

Loans $90,000 Real estate, etc 5,000 Specie 80,000 ------ $175,000

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:

Liabilities

Capital $100,000 Surplus 29,000 Undivided profits 10,000 Deposits 305,000 -------- $444,000

Resources

Loans $305,000 Bonds and stocks 23,000 Real estate 15,000 Other assets 20,000 Expenses 1,000 Legal-tender notes } Cash items } 80,000 Specie } -------- $444,000

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, 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 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, 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" 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:

Liabilities

Capital $100,000 Surplus 29,000 Undivided profits 10,300 Deposits 319,775 -------- $459,075

Resources

Loans $325,000 Bonds and stocks 23,000 Real estate 15,000 Other assets 20,000 Expenses 1,000 Reserve 75,075 -------- $459,075

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:

Liabilities

Capital $100,000 Surplus 29,000 Undivided profits 10,300 Deposits 279,775 -------- $419,075

Resources Loans $275,000 Bonds and stocks 13,000 Real estate 15,000 Other assets 20,000 Expenses 2,250 Reserve 93,825 -------- $419,075

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:

Liabilities

Capital $100,000 Surplus 30,000 Undivided profits 3,150 Deposits 281,775 -------- $414,925

Resources

Loans $275,000 Bonds and stocks 9,000 Real estate 15,000 Other assets 18,000 Reserve 97,925 -------- $414,925

STATEMENT OF A REPRESENTATIVE NATIONAL BANK

Resources

Loans and discounts $739,743.27 Overdrafts, secured 973.08 U. S. bonds deposited to secure circulation 100,000.00 U. S. bonds pledged to secure U. S. deposits 1,000.00 Bonds other than U. S. bonds pledged to secure postal savings deposits 7,000.00 Other Securities 191,098.05 Stock of Federal Reserve bank 4,800.00 Banking House 30,000.00 Furniture and Fixtures 5,000.00 Due from Federal Reserve Bank 20,000.00 Due from approved reserve agents 89,919.25 Due from other banks 12,074.23 Checks on banks in same city 6,051.46 Outside checks and other cash items 13,171.83 Fractional currency, nickels, and cents 283.14 Notes of other national banks 1,295.00 Coin and certificates 38,604.05 Legal-tender notes 25,000.00 Redemption fund 3,500.00 ------------- $1,289,513.36

Liabilities

Capital stock paid in $100,000.00 Surplus fund 60,000.00 Undivided profits 40,877.46 Less current expenses, interest, and taxes paid 17,110.28 23,767.18 Circulating 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 ------------- $1,289,513.36

[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:

Resources

Cash $100,000 Notes 100,000 -------- $200,000

Liabilities

Capital Stock $100,000 Deposits 100,000 -------- $200,000

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

Resources

Cash $100,000 Notes (Loans and Discounts) 666,666 -------- $766,666

Liabilities

Capital Stock $100,000 Deposits 666,666 -------- $766,666

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.

Resources

Cash (original) $100,000 Loans and Discounts 666,666 Cash (new) (85,000 (15,000 L & D (new) 566,666 ---------- $1,433,333

Liabilities

Capital Stock $100,000 Deposits 666,666 Deposits (new) (100,000 (566,666 ---------- $1,433,333

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 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 x (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 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 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 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 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 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 L Capital paid up 16 Reserve Fund 11 Current and deposit accounts 249 Acceptance on behalf of customers 16-1/2 Profit and Loss account 1-1/2 ------- 294

Millions of L Cash in hand and at the Bank of England 43 Loans at call and short notice 27-1/2 Bills discounted and advances 153 Investments 48 Liability of customers on acceptances 16-1/2 Premises 6 ------- 294

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.

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 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 L. Millions of L. Due to shareholders 28-1/2 Cash in hand and at Bank Due to customers 249 of England 43 -------- Investments 48 277-1/2 Premises 6 Due from customers 180-1/2 -------- 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 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 L1,050, 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 L1,050. 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 L1,050 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 would be that Parr's would have L1,050 more "advances to customers" and L1,050 less cash at the Bank of England among its assets, while Lloyd's would have L1,050 more deposits and L1,050 more cash at the Bank of England. And the L1,050 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 L1,050 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 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 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....

THE ROLE OF A SPECIE RESERVE ILLUSTRATED BY THE INCONVERTIBLE NOTES OF THE BANK OF ENGLAND ISSUED DURING THE OPERATION OF THE RESTRICTION ACT[37]

[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 L3 17_s._ 10-1/2_d._ per ounce of standard fineness, was, during the years 1806, 1807, and 1808, as high as L4 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 L4 9_s._ to L4 12_s._ per ounce. The market price at L4 10_s._ 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 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 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 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....

FOOTNOTES:

[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.

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Chapter X

THE USE OF CREDIT INSTRUMENTS IN PAYMENTS IN THE UNITED STATES

[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.

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 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 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 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 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 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....

... 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 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....

FOOTNOTES:

[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.]

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