A history of modern banks of issue; with an account of the economic crises of the present century

Front matter

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SItbrarg

A fjistory of modern banks of issue; with

Preface To The Second Edition

THE exhaustion of the first edition of the " History of Modern Banks of Issue, ' ' less than six months after its pubHcation, is one among many proofs of the interest taken by the people of the United States in financial subjects. The banking problem was not directly involved in the contest, which has just closed, regarding the metallic basis of the monetary circulation. The relations of the metallic standard and the paper currency are, however, so linked with each other that the consideration of the one almost necessarily involves the other. The decision which has been made bj^ the majority of the voters in favor of the gold standard is, in some senses, only a negative decision, and merely clears the ground for the radical reforms which are needed, in order to place our currency system upon a scientific basis and make it responsive to the legitimate needs of business. The financial ills from which the United States have suffered in recent years cannot be permanently cured by a political victory over the forces of discontent. A defective currency system has undoubtedly been one among .several causes which have contributed to recent agitation, and the political party which has the judgment and the courage to reform the system will do much to commend itself to the intelligent support of the American people.

The changes made in the present edition of this book are unimportant, because of the short time which has elapsed since the appearance of the first edition. There have been few changes in the banking laws of important states within the past six months, and even statistics are not yet available

VI PREFACE TO THE SECOND EDITION.

for a later year than 1895. The more serious criticisms of the book made in leading newspapers and reviews have been directed rather to the brevity of the discussion of banking principles than to the actual contents of the work. These criticisms would have force, if the author had proposed to develop an}' new theories of banking. It was his more modest purpose to record the simple facts regarding existing banking systems, and in this record no serious errors have thus far been pointed out.

CHARLES A. CONANT.

Washington, Nov. 12, 1896.

Preface

THK reason for being of this work is the growing interest in the United States in financial and economic subjects and the fact that they promise to be the paramount issues of American politics for many years to come. My purpose has been to bring together, in compact form, the leading facts regarding the banks of the world authorized to issue circulating notes and the history of the financial and economic crises through which they have passed. There is no work in English covering exactlj'- the ground covered by the History of Modem Banks of Issue. The materials for such a history are accessible in public records as well as special works, but they have never -before been brought together in a form easily accessible to the American and English reading public.

The functions and character of history have changed with the changes in the character of national development. The historical development of the human race has passed through two essential stages and has entered upon a third. The first was the struggle for the existence of civilization and national life ; the second was the struggle for the legal and politiqal freedom of the individual within the state ; the third is the struggle for the complete development, according to sound economic laws, of the producing capacity of the community. The Muse of History has followed no unreasoning whim in turning her pen to the story of each successive stage of the world' s progress. In the first stage of her work, her theme was the history of nations and the acts of their sovereign powers. In the second stage, the history of

VUl PREFACE.

value to the community became the history of the people and the contest for popular rights. The historians of each age have been logical in looking to the dominant spirit of that age.

The issue of the present and of the immediate future, — and the subject with which the Historic Muse must most concern herself, — is the best means of developing the possibilities of individual and national life. This issue is essentially an economic one and the histor}' of economic development must, in the ver}- nature of events, be in future the principal study of practical thinkers and workers. The Alassachusetts Senator who declared that of late j'ears the American people had given " too much attention, perhaps, to economic questions, and too little attention to those great and far-reaching questions on which the future of the republic depends," ' spoke out of the education and out of the political theories of the past and with his face to the past rather than to the future. The pursuit of the best means of increasing wealth, not for its own sake, but for the wider opportunities of intellectual and moral development which it places in the hands of the community, is the mission of the student of public affairs for the future, and the public man \^ho seeks different political ends subjects himself to the judgment pronounced upon himself by Lord Stanley a generation ago, that he was brought up in the pre-scientific period.^

Political economj' is still in a large measure an experimental and a disputed field, but this is less true of financial administration than of the questions of taxation and the distribution of wealth, which still perplex economic students. The modern banking community have already learned, during the past hundred years of the history of banking, the leading lessons of the failures and experiments of that period. There is doubtless much jet to be learned, but the system of a banking currency and of the management of banking operations is now a practicable and workable system. The

' Congressional Record, Fifty-third Congress, Third Session, March 2, 1895, p. 3108. 2 McCarthy, I., 31.

PREFACE. IX

results of the experiments of the century can be summed up and their lessons indicated in a clear and certain manner, subject to little dispute by those who have given unprejudiced study to the subjects It is these experiments which I have endeavored to describe in the following chapters, leaving their lessons for the most part to be derived from a comparison of their results with the rules of sound banking policy.

The purpose of this work is historical rather than controversial and I have even refrained from discussing the problem of the single or double standard, because the rules which govern a banking currency apply with equal force, whatever metal constitutes the standard mone}' of redemption. I have thought it proper to state, as simply and as clearly as possible, the theory of a banking currencj^, but I have endeavored to avoid all digressions which were not essential to an understanding of the history of banks of issue and of recent events in the financial world. Systems of coinage, the historj' of public loans and political events, the many forms of mortgage, deposit and popular banks, and the new problems relating to the uses of speculation and the part played by negotiable securities in modern economic life, are such important subjects of discussion that each is worthy of separate treatment, and they are only referred to here where they seem to form a necessary part of the history of one of the great banks of the world. It has been necessary to refer in several cases to the history of government paper money, because it is related to the origin and growth of banks of issue, but my plan excludes the S3'stematic treatment of paper money, which would of itself fill a volume. My chief object, beyond that of a narrator, will be accomplished if the study of the dismal record of government interference with monetary laws shall convince thinking Americans of the axiomatic truth that —

The currency of a co-nimercial country should be regulated by commercial conditions and not by the whims of politicians .

CHARIvES A. CONANT.

Washington, D. C, April i, 1896.

I beg to acknowledge my obligations to tlie Hon. William E. Curtis, Assistant Secretary of the Treasury ; to the Hon. James H. Eckels, the Comptroller of the Currency ; and to the Hon. Robert E. Preston, the Director of the Mint, for the use of many valuable public documents of foreign countries as well as of the United States ; to them, and many other oflScers of the Treasury, to the fion. l,ewis Sperry of Hartford, Conn., and to Mr. I,. Carroll Root of New York, for many helpful suggestions ; and to my Secretarj', Miss Florence Johnson, for her intelligent assistance.

Amounts expressed in foreign currency in the following pages are reduced only to round sums in United States money, with sufficient frequency to afford a general idea of the sums dealt with, but the exact equivalent of the foreign monetary unit is usually stated early in the chapter in which it appears.

The full titles of the leading authorities cited will be found at the back of the book.

C. A. C.

Chapter I. The Theory Of A Banking Currency

The Distinction between Bank-notes and Money— The Functions of Currency as a Standard of Value and Medium of Exchange — The Mechanism of a Bank of Issue — Do Note Issues Create Capital? — Importance of Redemption in Coin on Demand — The Necessity for Quick Assets — The Operation of the Rate of Interest and the Foreign Exchanges on the Volume of Circulation — DifiSculty of " Cornering " Money under Free Banking.

IT is the purpose of this work to give the outlines of the history of the leading banks of issue in the world and their methods of doing business, and incidentally to set forth the principles and uses of a banking currency. Banking can be done without the issue of bank-notes, but they are an important factor in the devolopment of the use of capital and afford the best currency for general uses. In their capacity as a circulating medium, bank-notes have come to be confused with money and have attained in the minds of many a special and olficial character different from that of other commercial paper. The examination of the history of banks of issue, as well as of the theory of a banking currency, will serve to show the gradual development of the use of bank-notes as a means of transferring credit and the part they play in commercial transactions alongside of other forms of credit which differ from them only in degree of negotiability.

The creation and regulation of a banking currency are based upon the theory that bank-notes are a convenient means of giving mobility to capital. There are two important truths which should be clearly understood at the outset of the discussion of banking and paper currency. They are :

1. That bank-notes are not money.

2. That bank-notes are a form of credit and are of substantially the same nature as bills of exchange, promissory notes, and checks.

The distinction between bank-notes and money is of prime importance for the purposes of economic study and from the standpoint of legislation, if not always important in daily transactions. It will be convenient, however, first to point out what bank-notes are, before considering what they are not. It will be convenient also to state broadly, in the beginning, the theory of a banking currency and of free banking, as a theory, before dealing with certain limitations, for the purpose of promoting uniformity and security, which experience and sound judgment may suggest in practice.

Bank-notes are the proper instruments of commercial transactions because they are the creatures of commercial needs and are adapted in volume and use to commercial necessities. In this respect they differ' from government paper money, which is regulated wholly by the necessities of governments and not by the convenience of trade. Bank-notes are substantially similar to checks and bills of exchange, because they are simply the paper representatives of credit. In the language of Prof Bonamy Price :

A seller by taking tbe bank-note makes himself the creditor of the government or bank, and is willing to part with his property, substantially, on credit to the state or bank. He finds in this debt, now due to him, of the issuer of the bank-note a sufficient guarantee for being able to buy with it other goods. . . . Every buyer with a note virtually says, "I have no money ; give me the goods and I will tell a good man who owes me money to pay you for me." '

> Currency and Banking, 42-43. The character of a bank-note is clearly and simply defined by Prof. Charles F. Dunbar, professor of

Those who insist that gold and silver constitute the only proper medium of financial transactions do not clearly distinguish the two essential functions of currency. These functions are the creation of a standard of value and the provision of a means of exchange. It is only in the fulfilment of the first function that exchange value is required in the material of which the currency is made. The fulfilment of the second function requires only that the currency shall represent value, rather than that it shall contain value in itself.' A bank-note currency represents the value bound up in commodities which are in process of production and exchange. The essential function of business operations is the production and exchange of commodities for each other, — not the exchange of barren heaps of metal for each other nor of commodities for metal. The intervention of gold and silver in such exchanges adds nothing to the sum of production and is not necessary to carry them on, except as the metals afford, with paper, a convenient tool of exchange

political economy in Harvard University, as follows : " The bank-note is the duly certified promise of, the bank to pay on demand, adapted for circulation as a convenient substitute for the money ■which it promises. It is issued by the bank, and can be issued only to such persons as are willing to receive the engagement of the bank in this form instead of receiving money, or instead of being credited with a deposit." — Theory and History of Banking, 16.

' It is difficult to get away from the term " intrinsic value," in the terms of ordinary discussion, in spite of the ■well-reasoned demonstration of Prof. MacLeod that value is a relation based upon exchange rather than an inherent quality. — Elements of Banking, 12. Gold and silver, strictly speaking, are not only limited to an exchange value, but they perform to a large extent, by the convention of civilized nations, the same functions in monetary uses, as representatives of value, as bank-notes and other commercial instruments. Roscher illustrates the fact that even the currency of gold as money rests in a measure upon credit. "The person who takes money as such must always harbor the hope of being able to dispose of it again as money. . . . The savage Goahiros, between Rio de la Hacha and Maracaibo, are too ' distrustful ' to take anything in trade but commodities fit for the most immediate use." — Political Economy, I., 351. The refinement in the use of credit is a pretty accurate measure of national economic progress.

4 HISTORY OF MODERl^ BANKS OF ISSUE.

and, by themselves, a standard and common denominator by which exchanges are measured. Bank-notes are not, as government paper money usually is, pieces of paper created out of nothing to represent value. They are simply the paper representatives of a great mass of mercantile transactions. They are the convenient counters by which men carry on exchanges. The presence of gold and silver is a necessary element in these exchanges only for the purpose of applj'ing the test of a common and fixed standard, and this is secured for bank-notes by the condition that they shall be redeemable in standard coin on demand.

The entire fabric of a bank of issue constitutes a harmonious whole. The capital subscribed by the stock-holders at once becomes a liability and provides the bank with cash for making loans and keeping a coin reserve. The issue of notes enables the bank to furnish accommodation to the holders of good commercial paper by covering the paper into its assets and treating the notes as demand liabilities. A bank of issue, therefore, has on one side its liability to its stock-holders for their invested capital and its liability to its note-holders to pay coin on demand. It has on the other side, as its resources, the cash derived from subscriptions to the capital and the commercial paper payable in cash by its makers at maturity. When deposits are received in cash or paper convertible into cash, the proceeds can be employed to enlarge the scope of the discounts. The obligation to pay the deposit becomes a liability, but the cash deposited furnishes assets of equal volume as an offset. Most of the great banking institutions of the world have begun business, and many of them continue it to-day, upon their capital and their loans and with but a small proportion of cash deposits.

The volume of notes which a bank may issue, when not directly limited by law, is determined by a prudent relation between the issues and the coin reserve. The greater part of the cash received in capital and deposits, over and above the coin reserve, is available for loans and discounts. Loans as distinguished from discounts are actual advances of money

Upon negotiable securities. They usually constitute a smaller proportion of the transactions of a bank in a commercial city than the commercial discounts. These are simply purchases by the bank of commercial paper, carrying the right to collect money at some future time. The wholesale merchant, for instance, receives from his retail customer a promissory note or bill of exchange, covering the cost of goods he has sold, payable sixty or ninety days from date. By taking this note or bill to the bank the wholesaler obtains currency at once for the amount contracted to be paid, less an interest charge which is known as discount. The business of a bank of issue is simply to transform the bill of exchange, which is itself a negotiable security, into another sort of negotiable security. For this purpose it issues bank-notes. In the concise language of an eminent French financial writer :

The bank bill is a promise to pay a fixed sum at sight or to bearer. In promising to pay at sight, the difficulty is avoided of maturity at a fixed term and the bearer is relieved of the limitations which result from it. By the promise to pay to bearer, one gets rid of the embarrassment of endorsements, protests, recourse, etc. One obtains by this means a security always negotiable, to which suffices a signature generally known and in some degree public to make it equally accepted and demanded, even in preference to metallic money.'

The bank by the issue of notes gives mobility to capital in several ways. It enables the holder of a bill of exchange to put it to active use instead of locking it up against the time of its maturity. The wholesaler or manufacturer, by paying a small commission to the bank upon such a bill, is able to obtain in advance the use of capital in negotiable form to which he would otherwise not become entitled for several months. He is enabled to obtain it not only in advance of the time it would otherwise be due, but in such form that he can split it into small amounts and pay a part for his raw materials, a part for his labor, and a part for his personal expenditures. The issue of bank-notes also enables small depositors to combine their capital in the hands of the bank,

' Courcelle-Seneuil, 102.

SO that it becomes available for constant use. This is one of the great advantages of modern banking, that it brings out into the light and into the current of the processes of production the capital which would otherwise be locked up in idle hoards. The bank-note is a loan from the holder, but a loan which costs him nothing and, on the contrary, affords him the benefit of security, convenience, and negotiability for his capital. In the sense in which government paper money, made by law a legal tender for the payment of debt, is a forced loan, for non-commercial uses, upon the productive forces of the community, the bank-note, which is not forced legal tender, is a voluntary loan, for commercial uses, which tends to bring into play, for the mutual benefit of borrowers and lenders, the full efiiciency of those productive forces. '

The simple statement of the theory of a banking currency shows how absurd it is to imprison the volume of circulating notes within fixed limits, or to condition their issue, w^hen they are kept in circulation at par with coin, upon any other specific thing than the amount of loanable capital. The Bank of England is limited in its note issues, beyond a fixed amount, by the Bank Act of 1844, to deposits of gold coin or bullion, with the result that there is an annual autumnal stringency in the money market.' There have been repeated periods of business paralysis when every possible substitute has been employed to make up for the deficiency of circulating notes, and the limitation itself has been finally suspended in every acute crisis as the only means of averting universal bankruptcy. The banks of issue of the United States are required to purchase evidences of the national debt and are allowed in circulation only ninety per cent, of

' Exactly the opposite view was urged by some of the early opponents of the Bank of England. Davenant declared that the effort to attract deposits by the offer of four per-cent. interest -was a hindrance to energy and enterprise. Rogers, 18. This view overlooked the fact that the money would be loaned by the bank for active use.

^ V. Jevons, Investigations in Currency and Finance, Ch. v., 160-93, — " The Frequent Autumnal Pressure in the Money Market."

THE THEORY OF A BANKING CURRENCY. J

ulie face value of these securities, with the result that as the debt has been reduced, the bank-note circulation has declined. The securities have reached an enormous premium as they have become scarce, and the bank-note circulation has fallen from $354,408,008 on June 30, 1875, to $211,600,- 698 on June 30, 1895, while loans and discounts, which indicate the volume of business, have more than doubled. The public, under these circumstances, have looked to other sources than the banks for a circulating medium and found it, until the repeal of the purchasing clause of the Sherman law, in purchases of silver bullion, by the Treasury, and the issue of government paper money in paj'ment for the bullion. This circulation proved absolutely irresponsive to the demands of business and resulted, after periods of great stringency in the autumn of 1890 and the summer of 1893, i^i a long period of redundancy and gold exports during 1894 and 1895. The experience of both England and the United States in this respect -justifies the judgment of those who believe that the circulating medium should be based upon the general assets of the banks and governed by business conditions rather than based upon extraneous securities and governed by their fluctuations in quantity or value.

The theory of a banking currency, as here defined, is in accordance with the " banking principle," which is approved by most bankers and writers upon political economy. There is another theory of bank-note issues, described in England under the name of " the currency principle," upon which the law governing the circulation of the Bank of England is based. The essential difference between the two theories is, that " the banking principle " regards bank-notes as similar to other commercial paper and their volume as properly subject to business requirements, while " the currency principle ' ' regards bank-notes as performing the functions and possessing substantially the character of actual money and their volume as properly subject to regulations which will cause it to change in the same manner as a circulation entirely of coin. The failure of this principle to operate as expected by its supporters in the case of the Bank of England -will be set forth in the chapter relating to the later history of that bank. The theory is not applicable where credit exists in any form, and its advocates have never succeeded in advancing any substantial reason for assimilating bank-notes to coined money, except the fact that they enter, like money, into general circulation. This fact justifies certain regulations to secure uniformity and safety, but the regulations should be the same in kind as those which govern other commercial paper and evidences of indebtedness.

There is no reason why the number of bank-notes should be limited any more than other commercial paper, except by the requirement of redemption in coin on demand which serves as a test of their value and the solvency of their issuers. A bank authorized to issue circulating notes occupies, substantially, the position of a corporation or business firm, — the circulation of its notes depends upon its reputation for solvency and honestJ^ Government regulations requiring a mutual guarantee or the formation of a common safety fund may enable the notes to pass from hand to hand without inspection as to the particular institution putting them in circulation, but, even in such a case, the validity of the notes depends upon the solvency and resources of the united body of issuers, if not upon that of the individual issuer.

Prof. H. Dunning MacL,eod, an acute and brilliant writer upon the laws of banking, undertakes to show that the issue of instruments of credit is in itself the creation of capital. He brings many arguments to the support of his position, but his strongest argument is a legal rather than an economic one. He shows plainly enough that there is an essential distinction in law between the personal deposit {deposihcm) secured by a warehouse receipt, entitling the holder to the return of the specific goods deposited, and the creation of a debt (mutuum), by which the lender is simply entitled to the return of some equivalent, but not the specific thing entrusted to the borrower. The claim in the first case is specific, and possession of the article may be recovered by a writ of replevin, but it constitutes in the other case only a general claim against the entire assets of the borrower. Professor MacI,eod is doubtless right, as a proposition of mathematics or of law, in his demonstration that the new obligations created by evidences of debt are not properlyset off against specific property in the hands of the debtor. The holder of a bank-note for ten dollars has no claim against any specific ten dollars in the cash drawer of the bank ; he simply has a legal claim for an equivalent for the amount."

But Professor MacLeod, in his subtle argument upon this subject, confuses the domains of law and mathematics with the domain of economics. Political economy looks deeper than legal distinctions and looks to the substance behind algebraic formulae. The creation of paper credit from this point of view is not an addition to existing capital. It greatly assists in the movement of capital and, in individual cases, the creator of paper credit may obtain the use of more capital than he possesses, but in every such case he simply obtains the use of the capital of some other person or body of persons. Barring the question of the incorporeal wealth arising from mental culture, economics deal with tangible property. Negotiable securities represent tangible property, either in the possession of the issuers or in the possession of the holders of the securities who are willing to advance their capital for the promotion of some enterprise. The individual who borrows beyond the limits of his tangible capital simply obtains the use of some other person's capital. In the words of Professor Emile de Laveleye :

' The legal distinction is important enough to a correct compreliension of the lawsof banking to justify giving it in Prof. MacLeod's own words : "The essential feature of a ' Banker' is, that when his customers pay in money to their accounts, Ihey cede the property in the money to the Banker. The money placed with him is not a Depositum, or Bailment ; but it is a Mutuum : it is a I,oan, or Sale, directly to himself. The ' Banker ' buys the money from his customer ; and in exchange for it, he gives his customer a Credit, or Right of action to demand back an equivalent amount of money at any time he pleases ; which Right of action he is also at liberty to transfer to any one else he pleases." — Theory and Practice of Banking, I., 319.

lO HISTORY OF MODERN BANKS OF ISSUE.

Credit seems to multiply capital because by the side of the thing due appears the promise which gives a right to its possession ; but in fact there are not two things, — one is only the shadow of the other. Burn every evidence of credit ; nothing real would cease to exist. Juridicial relations only are changed. The creditors lose exactly what the debtors gain.'

A bank of issue, therefore, creates no new capital when it issues its notes to the amount of its assets available beyond its coin reserve. It simply takes the titles to capital which have been transferred to its custodj' and loans them to its customers in the form of negotiable paper. This paper, under a system of free banking, differs in no respect, except its greater degree of transferability, from personal promissory notes and bills of exchange. The bank, whether by its intrinsic reputation or by the requirements of certain uniform laws, simply affords a definite and well-known security and a uniform style of note paper which add to the convenience of the business community.