Cyclopædia of Political Science, Political Economy, and the Political History of the United States

Edited by: Lalor, John J.
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New York: Maynard, Merrill, and Co.
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Includes articles by Frédéric Bastiat, Gustave de Molinari, Henry George, J. B. Say, Francis A. Walker, and more.
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BANKS OF ISSUE are those banks engaged in the transfer of credit by means of the issue of bank notes, i.e., by means of promissory notes of the bank which are payable at sight to the bearer. No questions connected with the money economy of modern times have been more hotly discussed than those in reference to banks of issue. The most extravagant charges have been made against them, and equally extravagant claims made in their behalf. One party sees in them the agency which, above all others, excites and promotes over-speculation, causes commercial crises and aggravates all the ills of our modern industrial economy. Another party regards them as the magicians under whose wands trade and industry are called into life, the healthy growth of credit is favored, palaces and ware-houses are made to appear, and national prosperity is created and sustained. Without taking sides with either party, for the present, we propose to introduce our discussion by an investigation into the origin and historical development of banks of issue; for only in this way can we hope to arrive at clear and distinct views of the nature and function of such banks, and to put ourselves in a position to answer satisfactorily the various questions which will come up concerning them.


—I. HISTORICAL DEVELOPMENT OF THE BANKS OF ISSUE. Modern banks may be divided into two general classes: those which are occupied mainly with dealing in money—money banks, and those which are occupied mainly with dealing in credit—credit banks The money bank was the original form of a bank, and that from which the credit bank was gradually developed. It is worth while to trace out this development for it throws a flood of light upon the nature of the bank of issue and its relation to other credit institutions.


—We must distinguish between active and passive accounts in the history of banking. Active accounts are those in which the bank is a creditor; passive, those in which it is a debtor. During the middle ages, owing to the imperfect coinage, to counterfeiting, to clipping, and to the inability of the public to test the purity of the coins, it was absolutely necessary that there should be some opportunity to exchange the coins and test their value. This opportunity the professional money changers gave. Their profits consisted in a deduction when they took the coins and a charge when they were taken away. It was a fee or commission for changing money. The business was carried on in the first place with their own capital which for this purpose was invested in coins or the precious metals. This circumstance, and the natural desire of making their capital as lucrative as possible, led them to lend out, on short time, whatever part of their money supply they were not using in their business. Thus arose the first kind of credit transactions as an active transaction of the old money bank, i.e., a transaction in which the bank was creditor. These operations, on account of the necessities of their money changing business, had to be conducted according to the same principles which modern banks have had to observe in all their active operations, on account of their rapidly increasing passive transactions. These principles were, security of the loans and constant and immediate control of all advances. These have remained down to the present day a controlling administrative principle of all banks of deposit and of issue. The very first loans of the money changers had to comply with the requisites. The first line of business was pawnbroking, i.e., short loans on pledges of various sorts, such as jewels, coins, precious metals in bars, etc., etc., which persons did not wish to sell. The insecurity of law led to a second branch of business, dealing in bills, which from the very first at times took the form of discounting. Pawnbroking and bill-broking were, then, the original forms of the active transactions of all banks.


—The course of industry favored simultaneously the gradual decline of the mere money changing business, and the growth of the loan business. For the improvement in coinage, and the adoption of a proper coinage policy, gradually lessened the necessity for the money changer, while the development of productive credit, the growing security of law, the increasing division of labor, rendered more and more necessary the money lender. In this circumstance we find the explanation of the transition from the old money banks to the credit operations of modern banks.


—This loan business could and can be carried on with the capital stock of the bank. And yet, with the low rate of interest prevailing in the discount business, a rate of profit equaling that in other lines of business could hardly be expected. As soon, therefore, as the capital no longer yielded a suitable rate of profit in the money changing business, this very circumstance paved the way for a new development toward which other influences were also working. The bank began to take up money with the intention of loaning it again, i.e., to the active transactions of the bank are now added passive transactions, whose enormous development has made possible the equally enormous development in modern times of the active transactions. The first and simplest passive operations, (i.e., those in which the bank was debtor), arose independently, but were soon connected with the money changing and money loaning business. In the earliest period of this development the term passive transaction could only be applied according to the usage of double entry, in which, by the fiction of a business personality distinct from the head of the house, not only the debts but also the capital stock of the bank, and, further, not only these two but also the property deposited for safekeeping, are entered among the liabilities. The beginning of this passive business was, namely, the acceptance of precious metals in coins or bars as a real deposit, (in legal language depositum), or in bank language as a deposit for safekeeping. The bank was merely a depositary with the ordinary obligations, not a creditor; it had no right, therefore, to loan out the sum intrusted to it.


—In course of time it became customary among these brokers and banks not to allow the deposits to lie dead at the depositories until the depositors withdrew them, but to make the payments of the depositors in the same bank to each other by a simple transfer in the accounts. In this way the actual movement of money was saved in many cases, and a simple, safe and convenient mode of payment found in the transfer of accounts. The profit of the bank (to which in the case of public institutions the term giro-bank, or circulation-bank, was applied, i.e., one in which deposits circulated from account to account,) consisted of commissions, which were charged partly for the safekeeping and partly for making payments for transferring accounts. This profit corresponded exactly to the profit in money changing, and was not interest, as in real credit transactions.


—From this time the subsequent development was very different in the case of the money brokers and the giro-banks. The real giro-bank holds fast to the actual deposit and the transfer of the actual deposits, loans no part of the money received, has consequently the total amount of all deposits on hand, and, in addition, generally a capital stock as guarantee. It is, therefore, in a condition, as long as embezzlement or robbery does not occur, to pay out at any time all its deposits at once. This absolute security of the deposits forms in the eyes of the friends of the giro-bank the great advantage of such banks over credit banks, and particularly over the modern bank of deposit and bank of issue. The giro-bank is the model to which many persons would like to see all banks reduced.


—Among the money brokers and goldsmiths, who took deposits for safekeeping and also for transferring accounts, the banking business developed in a different way. Those deposits became "deposits for use," the real deposits (deposita) became loans regularly for short, definite periods, sometimes to be repaid on demand. With this step the old money bank became the modern credit bank. When the deposits had once become loans, then the modern banks of deposit, check banks and banks of issue were inevitably evolved from the old banking system. The change of the deposit to a loan constituted an epoch in the history of banking. With the justification of this step is granted the justification of the whole modern system of banking. The subsequent phases of the development of the latter, the various influences which have been at work from the earliest period until the present, the ceasing to charge a fee for safekeeping, the payment of the services of the bank by letting it have capital without interest, the ever-increasing participation of the depositors in the profits of the bank, for example in the form of free collections on the part of the bank for its customers, and, later, in the form of interest on deposits; these and other points we need not pursue for our present purpose. These points explain the history of the growth of the banking system, and the peculiar forms which various kinds of banks and various branches of banking business have assumed at various times, and, in this connection, are full of interest. But for the main question as to the justification of the credit banking system, and of the particular form which we have under discussion, viz., the bank of issue, they are not important. The whole question here turns on the justification of that first decisive step, the change of the depositaries to debtors. Let us see whether there were any circumstances which justified this change.


—The deposits for safekeeping were all expected to be held in reserve at the money changer's or at the giro-bank. Experience soon showed that a balance constantly remained although the depositors could draw out all their deposits at any time. For even if each drew out all his money in the course of the year, as some did many times over, yet all did not do it at once. One drew out while another was just paying in. In the giro business many payments were made between the customers of the bank without affecting the total deposits. The average amount, the movement, the times of drain and influx, the lowest point to which the balance sank, could all be easily ascertained by experience. Now, the part which was never used lay fallow, was unproductive for the individual as well as for the whole. It could, therefore, be dispensed with in the real deposit business, and was consequently available for other purposes. It could, therefore, be loaned out in the same way and for the same reasons as that portion of the capital stock of the money changer which from time to time was not needed in the broking business. Only, in one case as the other, there had to be an assurance that the sum could be easily and quickly made available in case of unusual demands on the part of depositors The investment of the superfluous capital in short loans and advances on pledges afforded this security, and thus the change of the deposit to a loan was justified. This transformation could of course take place only under legal forms and with the full consent of both parties. The mutual advantage of both parties and the development of industry produced this understanding in one place at an early period, in another at a later. And thus the money-depository or giro-bank became the modern bank of deposit, and this last is the type of all other modern banks, and particularly of the banks of issue. Any objection against the bank of issue on account of its essential nature (and many such objections have been made even in the last few years), is also an objection to the bank of deposit.


—Now, of course, no one can deny the possibility of a temporary suspension of payments on the part of such a bank, inasmuch as the money which may be demanded is not all at once in the coffers of the bank. But it is a sufficient security if the probability of such a necessity can be reduced to a minimum by a proper conduct of the bank business, by a proper investment of the superfluous capital, and by a capital stock large enough to guarantee against ultimate losses. Experience shows that such a security can be assured. Modern banks promise to pay the debt which they incur when they accept a deposit. Experience shows that they can do this and still loan out a large part of their deposits; and thus their business is justified independently of the enormous advantages which accrue to trade and industry from rendering available a large amount of capital, which would otherwise lie dead and useless. But the justification of the deposit business carries with it the justification of the exactly similar business of issuing bank notes. The polemic against the bank note, which is not based dollar for dollar upon a cash reserve, applies just as forcibly to the deposit not so based.


—The business of issuing bank notes is nothing but a variety of the modern deposit business, and has been evolved in the same way from the old depositum. It makes no difference in the nature of the depositum or in the nature of the giro-bank, so far as the last is a place for the safekeeping of deposits, whether for the money deposited a certificate for the whole amount of every individual deposit or for portions of the same in round sums be given. Nor can it change the character of the old deposit banks, even if these certificates, given to individuals, can be further indorsed or furnished with blank indorsement, or even issued to the bearer. The so called recepisse of the Amsterdam giro bank were such deposit certificates These certificates were the bank notes of the old money banks. And the demand that bank notes shall be secured by a full cash reserve, dollar for dollar, is nothing else than a demand that the modern bank note shall be reduced to the old deposit certificate. For what is the difference between these two forms of bank notes? Exactly the same as between the modern deposit and the old deposit, i.e, as between a loan and a deposit for safekeeping. The deposit certificates are receipts of the bank for money deposited and kept in its coffers. The bank notes are bonds of the bank in which the bank acknowledges itself debtor for the given sum, and promises to pay it on demand to the presenter of the note. In our present system of bank notes, as little as in the modern deposit business, does the bank promise to keep cash on hand for the amount of its notes, but by a proper conduct of business it is able to keep its promise to redeem on demand. That is sufficient. Why talk in this connection of deception, of fictitious money, of the creation of imaginary capital, as do the opponents of the banks of issue? We might make the same objection to the deposit system of modern times, indeed to every use of credit, and with just as little reason.


—The subsequent development of the banks of issue and deposit banks upon the new basis has led to no essential change, but to a mere expansion of their business. The banks gradually began to borrow more and more for the purpose of loaning again, until their principal business consisted in the handling of others capital, and the capital stock of the bank lost all significance except as a guarantee for the proper conduct of the business of the bank. Wherever the banking system has been allowed by the government to develop itself naturally, the deposit business, as the original and simplest, has been the most important branch; the issuing of notes has been simply a complement of the former. They are but two forms of essentially the same business, that of contracting debts, and the one or the other has been employed according to the varying demands of trade and industry. The conduct of the passive transactions of the bank in both forms must be regulated by essentially the same principles The oft repeated demand for a separation of these two branches of business is inconsistent with the organic development of the whole credit banking system, and, where complied with, leads to the abandonment of the peculiar advantages which grow out of a proper combination of both systems of operations.


—II. THE BANK NOTE AND ITS ECONOMICAL FUNCTION The bank note must be clearly distinguished from both metallic and paper money. Money is a standard of value and a medium of exchange. But the pure bank note is only a medium of exchange, not a standard of value, and does not therefore discharge the money function. Paper money is inconvertible, and a legal tender, bank notes are convertible, and not a legal tender. But aside from the convertibility, bank notes are distinguished from paper money in their mode of issue, and consequently in their mode of reflux. Bank notes are regularly issued as loans, paper money as payment; the former, therefore, temporarily, the latter, permanently. In place of the bank note there remains a claim, by whose conversion the corresponding debt of the bank can be called in or protected by a cash reserve; in place of the paper money the state has merely a receipt; it can get rid of its money only by special transactions. The notes flow back to the place of issue gradually and regularly in the ordinary course of trade in the payment of the advances made by the bank, provided the bank capital has been properly invested in short loans. The different manner in which notes and paper money get into the channels of trade reveals further advantages for the former and disposes of a whole series of objections which in the case of the latter might seem well founded. An issue of notes is necessarily preceded by a demand for loans, and even if a bank has partly created this demand by carelessly advancing loans upon insufficient security, yet the danger is not great, particularly under a system of free banking. For the notes which exceed the momentary demand for such means of payment immediately flow back to the coffers of the bank for redemption, particularly under a system of competing banks The excessive issue of bank notes is, therefore, except in certain rare cases, impossible. The banks can not increase their issues at pleasure. The course of bank circulation under a well-developed system of banks of issue depends upon the changing wants of trade, and the latter upon the variations in price of commodities. These variations in price, according to Tooke's detailed investigations, precede the corresponding variations in bank circulation, and can not, therefore, have been caused by them. It is, consequently, wrong to attribute to banks of issue the fault of causing over-speculation and commercial crises. With this view of the subject a whole series of objections is effectually disposed of, which grew out of a false identification of paper money and bank notes, and out of attributing to the latter the qualities of the former.


—Bank notes are not only not money, but they are essentially like all other substitutes for money which fulfill the function of money as a medium of exchange. The bank note is only one member in the organism of credit institutions together with checks, drafts, notes, book credits, clearing houses, etc., a number whose relative importance with the development of the credit economy grows on the whole less and less, although at certain times, viz., at the turning point in commercial crises, it acquires again a greater importance. The consequence of this conception of the bank note is a corrector view of public legislation in reference to banks of issue. The unfair favoritism toward these banks on the one hand, or the limitation of them on the other, the artificial regulation, so often characterized as a natural necessity, thus appears erroneous and often enough injurious. The whole development of the credit economy suffers under it. So far are bank notes from being the most important form of credit, that the whole development of the modern credit system shows a constantly increasing tendency to substitute for bank notes some other form of credit. This tendency shows itself either in an absolute decrease in the quantity of bank notes in circulation, or more often by a relatively more rapid increase in the quantity of other substitutes for money.


—III. SYSTEM OF SECURING THE NOTES. From the history of the origin and growth of the bank of issue, and from a proper conception of the function of the bank note in industrial economy, may easily be deduced the proper system of securing bank notes. By this last term we understand that regulation of the resources of the bank or that investment of the bank capital (i.e., of both the capital stock and the capital which has been collected by the issue of notes), which will insure the constant and immediate redeemability of the notes in coin. What are the principles, then, which underlie a proper system of security?


—Three systems of securing the notes have been proposed and defended: 1, the basing of the note circulation, dollar for dollar, on a cash reserve; 2, the investment of the capital in securities not easily convertible, particularly in real estate or mortgages on the same, and in stocks or bonds; 3, the so-called banking security. Practically a compromise between one or more of these systems has been generally adopted as the basis for legislation, proceeding on the assumption that one portion of the notes might be secured by the second system, while another portion might be based on the third system.


—As to the first system, we refer the reader to what has been said above. Such a demand simply means the rejection of all that is peculiar in modern banking. For, if the bank note is to be nothing but that ancient deposit certificate, the deposit which has become a loan (at least the deposits payable on demand, i.e., the great mass of the deposits), must again become deposita, that is, real deposits for safekeeping. Those who demand a complete cash security confuse possibility and actual reality. All the notes can, of course, flow in at once for redemption, but, as a matter of fact, they do not. And under the banking system of security they find their economically proper and practically more important redemption, in their regular reflux, as payment of credit given them in a cash redemption.


—Basing the notes on real estate and mortgage security, as in the second system, has been warmly recommended, especially from financial considerations and in the interest of agriculture. But this proposition must be rejected for the same reasons as the similar one of basing the notes on stocks and bonds, viz., that resources in such form are not readily convertible into cash. We must grant, however, that that portion of the notes which, according to one of the compromises mentioned above, need not necessarily be secured by the banking system, might be made available for mortgage loans, if it were not that it is financial necessity which ordinarily leads to such compromises, and which, therefore, requires that the sum mentioned shall be secured by government bonds. The payment for the monopoly of circulation which occurs here and there (as in Austria) through such a loan to the government, might be better arranged by allowing the state a share in bank profits.


—The third system of securing the notes, the banking security, we consider the only rational, scientific and satisfactory one. It consists of a proper combination (changing according to circumstances) of a cash reserve and of securities which are easily and readily convertible into cash. Such securities are found most readily in the discount and Lombard business, particularly in the former. The discount business insures, further, the regular reflux of the notes to the bank, and in this way offers an opportunity for the most thorough control of the issue of notes. The discounted bills and the claims on pledges form, therefore, the chief security of the notes, compared with which the cash reserve is of secondary importance. A great heresy in the face of popular sentiment, which is fond of calling all notes "unsecured" which are not based on a cash reserve—an exceedingly materialistic view in the age of that most spiritual of all economical elements, credit.


—The cash reserve acquires its importance in view of the irregular reflux of notes to the bank for the purposes of redemption. This reflux can be controlled even in exceptional periods by properly regulating the loans of the banks, provided the banks of issue have developed under normal conditions. Its approximate amount can be told beforehand by observations in the banking business, because the question turns here on periodical movements. For critical times the strength of the reflux may also be estimated, with a little attention, by observing the transactions in the money market, in commerce, and in general production. Of course, such observations must be made by experts, conscientiously undertaken and thoroughly carried out by every banking institution. The relative and absolute amount of the cash reserve must be determined by these observations, and the necessary increase or allowable decrease be effected by the regulation of the discount and lombard business. After what we have said, we need lose no words over the attempt to fix, once for all, in an arithmetical ratio, the relation of the cash reserve to the note circulation. (See VI)


—The chief point in the banking security lies in the element of the easy convertibility of all resources of the bank which do not consist of cash on hand. This is demanded by the nature of the notes as obligations payable on demand. In this way the objection of those who demand a full cash reserve for notes payable at sight is met, so far as it corresponds to actual relations the irregular reflux can assume unusual dimensions, but under these circumstances can not be out of proportion to the time and place. The easy convertibility of the loans forms the real assurance against the dangers which do undeniably lie in note circulation.


—For these reasons, real estate, mortgages, direct claims on the state, great quantities of public securities, on long time, form no proper security for the notes. For even if they afford a safe security, which is often enough questionable, (particularly in the case of the first two in critical periods), yet they are difficult to convert into cash, even individually, not to say in large quantities. Mortgage credit must be taken on long time, owing to the nature of agriculture and of investments in building. In this consideration, and not in an arbitrary monopoly of banking for the advantage of commercial credit, (as the agricultural interests maintain), is to be found the reason of preferring discounts to mortgages on real estate. Other securities, such as running accounts, book credits, ordinary obligations, good bonds, i.e., such as vary but little in value in exchange, preference bonds, etc., may be accepted in limited quantities, but ought to be considered inferior to discounts and lombard claims. Shares in industrial undertakings, and speculations of all sorts on change ought to be excluded. (See VI)


—IV. FUNCTION OF THE BANK NOTE IN COMMERCIAL CRISES. The discount business is a necessary presupposition of the modern development of trade and industry. A commodity, in the process of its manufacture, must pass through many different hands before it finally reaches the consumer. As the commodity is ultimately paid for by the consumer, the various intermediate agents find difficulty in paying for the commodity as they receive it. Under these circumstance one of two things is necessary. Each of these agents must carry on the business with a greater amount of capital, (in other words, a portion of the capital becomes unproductive), or they must run the risk of letting trade and production come to a standstill at times for want of payment. A help for this condition of affairs is found in the draft of the seller upon the buyer for the selling price and for the time that will probably elapse until payment can be made, and in the acceptance of the draft by the buyer. The seller now has this discounted and thus receives his necessary capital in the form of money or of a substitute for money, such as book credit or bank notes. The modern credit bank has evidently a very important relation to this discount business. Individual merchants could not carry on this business in the regular way and on a large scale necessary for the demands of trade and industry. Particular institutions appear which make it their function to collect the surplus capital in the community and apply it in this discount business. These institutions are called banks of deposit. The whole credit economy has become a highly organized and yet, because constructed on rational principles, a very accurate mechanism. But at times some of the wheels in this mechanism give out. In critical periods we see that, after all, we have not a material mechanism but an organism, whose vital principle is credit, confidence, the spiritual element par excellence in the credit economy. Let confidence disappear, the soul departs, the organism is dead. At such times the bank note shows its importance as a "primary" means of credit.


—The whole credit economy is based on confidence. The confidence of one man conditions that of another. Let mistrust appear, and it spreads rapidly in all directions, destroys the credit of those who deserve confidence, and together with many guilty parties who have abused credit it overthrows many more innocent parties who have only used it. In this lies the danger of all commercial and credit crises. The crisis generally begins, however, in some one branch of industry. The mistrust extends to all the business relations, and particularly to all forms of credit payment usual in that branch. Now, the kind of credit payment which can command most confidence at such a period acquires an unusual importance in the failure of all other ordinary means of credit payment. The bank note commands this confidence because it circulates in other quarters, and because the security of the notes need not be affected even by a great industrial crisis, if the bank has been properly conducted. We may, therefore, designate the bank note as a suitable and important substitute to fill up the temporary chasm made in the credit economy by too great mistrust. Where it is lacking, or confidence is not felt in it, the only resource is specie. Historically the crises have been most severe where the bank note did not exist. Of course, great care must be taken at such a time in issuing notes that credit be given only to solvent houses after the turn in the crisis and not for the sake of keeping up the prices and furthering speculation. At such times the advantages of large banks appear most clearly, as the notes of such banks possess most confidence.


—The banks must exercise unusual vigilance in their discounts during crises; for a proper regulation of the discounts affords the best security for the notes. A proper policy in reference to discounts is of most importance in times when the rate of interest is rising, and a scarcity of money begins to be felt; toward the end of speculative periods, when speculation feels the ground giving way beneath it, and uses its short respite for all sorts of extravagances; when exchanges become unfavorable; when specie ceases to come in and begins to be exported; in a word, when all the signs indicate the approaching storm. The discount capital of the banks forms, then, a large part of all the funds in trade and industry available for short loans in mercantile business. The operations with it, therefore, are of wide-reaching influence at the time when the pressure upon the banks for discounts is increasing. In three ways can the bank counteract this pressure and thus favor the necessary reaction in the money market, and revolution in the rate of exchange, while it secures at the same time its own position. It may refuse to make certain loans, to accept certain notes, may limit the maximum credit of certain houses—not a very desirable means, and never thoroughly impartial and safe. Or, it may shorten the maturity of all notes and loans, which is more equal in its effects. Or, it may raise the rate of discount, either on all loans, or somewhat differently for notes and lombards, and for the shorter or longer maturity of the notes. The last method deserves the preference; it best secures the bank, affects merchants more equally, and furthers in the most efficient way, the necessary reaction in the money market, in the rate of exchange, in the prices of commodities and the course of securities. This method, which is a logical necessity of the nature of the credit bank, is condemned only by the short-sightedness of practical business men. For the condition of extensive active transactions on the part of the bank is an extensive passive business; but the latter is diminished by the withdrawal of the deposits and the reflux of the notes, or, at least, the bank has such a change in its passive business to fear, and must regulate its active business accordingly, i.e., lessen the loans by making them more difficult.


—V. RELATION OF THE STATE TO THE BANK NOTE. In what precedes we have presented the natural development of the system of banks of issue, or rather, the tendency of its natural development; for, as a matter of fact, this tendency has never been fully realized, because the state has interfered with it everywhere. It is probable, that if there had been no interference, and no artificial regulation, the system of banking would have been changed from the old money banks to the modern credit banks, at the same time with the general change in industry and commerce characteristic of modern times, and that the deposits would have remained the chief branch of the banking business, and that the bank note would have come into use as an incidental means of assisting the deposit business. But it would have been wonderful if the banking business, in its early history, had escaped regulation on the part of the government at a time when all other branches of business were subjected to a most minute supervision. And, indeed, we find that the paternal care of the government was extended to banks in general, and banks of issue in particular, to an unusual extent. Every civilized government undertook in some way the direct control of the issue of notes; England, France, Austria, Russia, Prussia, all the small German states, Norway and Sweden, Italy and Switzerland, committed themselves to a distinct policy in reference to banks of issue. After the interference was an actual fact, the attempt was made to justify it on various grounds. On the one hand, the right to control the issue of notes was deduced from the coinage prerogative. On the other, the necessity of controlling such issue was based on the essential difference between bank notes and other credit circulating media.


—Let us examine how far theoretical considerations can justify such interference. As we have already said, according to our view, the bank note is not money, not even paper money, and is not essentially different from other credit circulating media. All the reasons advanced, therefore, in favor of interference on the part of the state, based upon the false identification of bank notes and money, and upon the essential difference between bank notes and other credit means of payment, are of no force. But there are certain inferences from our views of the nature and function of the bank note, which justify a proper positive relation of the state to the bank note and its organs of issue.


—In order that the bank note shall remain a bank note, no conjunction of circumstances should be allowed to assimilate it to money or paper money. Everything depends upon this one thing: the acceptance of the bank note must remain completely voluntary. Only under such circumstances is the bank note like other credit means of payment. All the objections which have not been answered by the foregoing discussion are concentrated in this one point. All the peculiarities of the bank note which call for a positive interference of the state, turn upon this one feature. The state, consequently, must see to it that the acceptance of the note is really voluntary, and should limit its interference to the performance of this function.


—Now the acceptance of the note may become to a certain degree compulsory, although the note may not be made a legal tender or irredeemable. Thus the bank note may have passed into such widespread circulation that it must be accepted for want of any other circulating medium. Or, it may exist in small denominations which can hardly be refused by the poorer and more uneducated classes, particularly as payment for wages. Or, it may be that the individual can not easily present it for redemption on account of his distance from the place of redemption. Now, under such circumstances the state should hold fast to three points: 1, It must not make the notes a legal tender, or by its own action artificially favor the note circulation; 2, it must forbid the issuing of notes below a certain denomination; 3, it must see to it that the convertibility of the note is a reality, and is not made illusory by certain unfair practices.


—Tried by the first principle, the legal tender quality of the bank of England note and of similar notes is to be condemned. Nor will it do to answer this objection by saying that the legal tender quality enables a bank note to perform more easily the peculiar function in commercial crises, which we have ascribed to it above; for English experience before 1844, and continental experience before and after, show clearly, that it is not the legal tender quality that adapts a bank note for that function. And theoretical considerations lead to the same result. Any other possible advantages are outweighed by the inconsistency of the policy with the general principles of banking, or, if this be a too doctrinaire objection, by the very practical consideration that the transition from the legal tender bank note to the legal tender paper money is easier and more alluring.


—In other cases the state favors the bank note as a means of payment by receiving it, for instance, in payment of taxes. This favor is generally accorded to the large centralized banks, and affords what might be called a tax security of the notes. This must also be condemned. For the public, knowing it can pay the notes as taxes, receives them more readily and thus give them a wider circulation, while at the same time neglecting to examine as closely as it otherwise would, the condition of the banks. The banks, relying on the ready acceptance of their notes, and their more irregular reflux for redemption, are less careful of their banking security. The government in critical periods, when it must have the specie, can get it only by endangering the existence of the banks whose condition it has made insecure by its mistaken policy of favoritism; and the state, in case of ultimate failure of the banks, can hardly escape the fair charge of being accessory with the banks to the distress in trade and industry which must ensue. Giving the holders of the notes a priority over the other creditors of the bank has also a tendency to unduly favor the issue of notes. And, negatively, the government must not favor the note circulation by allowing the banks to conceal their condition, but must insist on periodical publications of the exact state of the banks' resources and liabilities.


—It is necessary to insist upon the second point mentioned above, because there is a difference not only of kind but of degree between bank notes of large and small denominations. The latter are very similar to paper money in their qualities. They supplant money to a greater degree than large bank notes. They circulate in spheres where other substitutes for money do not come at all. They pass into the hands of laborers and artisans who never have any great amount of money on hand at once. It hardly pays to present them for redemption, and thus they stray away from their place of issue so far that they can not be presented for redemption without sacrificing a large per cent. of their value. The fundamental conditions, then, of their remaining true bank notes are wanting, and they become to all intents and purposes paper money.


—By the third point we do not mean that the state is to undertake to insure that every bank shall be constantly in a condition to redeem its notes, but simply to see to it that a bank does not practically escape its obligations of redemption under various pretexts. If a bank is no longer able to redeem its notes, let it pass into bankruptcy at once. But banks often manage to keep from redeeming their notes while they are perfectly solvent. The banking history of the United States affords very good examples of such conduct. The banks often made it so tedious to get money for the notes (as, for instance, by appointing a certain inconvenient hour of the day, by slowly counting out the coins one after another, etc.), that the note holders were deterred from presenting them for redemption. In this connection abuses of four kinds may arise, in reference, namely: to place, time, coins, and manner of redemption. In a system of local banks, the banks ought to be compelled to redeem their notes wherever they are likely to circulate in large quantities at convenient times and in proper coins, i.e., the coin money of the realm, and in a manner convenient for the note holders. All these points ought to be features of every general banking law, and are not inconsistent with a system of free banking.


—VI. RELATION OF THE STATE TO THE CONTROL OF THE BUSINESS OF BANKS OF ISSUE. Our investigations so far lead us to the conclusion that there are no economical reasons why the state should take any different relation toward the establishment of the banks of issue than that which it occupies toward the establishment of other credit banks. The so-called free banking system may prevail in the case of banks of issue as in the case of other banks. From this point of view any regulative interference of the state in the business of the banks is to be condemned. But the case is very different if the state claims the monopoly of issuing notes, or insists that every bank before issuing notes must secure special permission for that purpose. For the logical consequence of such a claim is further interference, leading ultimately to more or less direct control of the banking business. The contrast here lies between a free banking system with a formal bank law not at all inconsistent with such a system, and governmental control of banking with regulative legislation. In the last the system of securing the notes, the amount of circulation, and the amount and mode of investment of the capital stock of the banks, are all prescribed. As typical forms of such laws with manifold but unimportant modifications in detail, we select the German or continental, the English system of Peel's law, and the North American system.


—The first system rests upon the principle of the banking security, i.e., the notes are based upon a cash reserve, and loans of various sorts easily convertible, and a capital stock as a guarantee fund. The government has in many cases made further provisions fixing the absolute and relative amount of note circulation in relation to the capital stock, nearly always determining the minimum cash reserve, and often regulating the loan and discount business. These all have the defect of attempting to fix mathematically the ratio between the capital stock and the various active transactions of the bank, which is naturally impossible and frequently very injurious. The bank itself is often led to depend upon the law instead of its own careful conduct of business. The idea that fixing the maximum of note circulation is a wise step depends upon the false view that banks can expand their circulation at pleasure. The provisions requiring that the circulation shall bear a constant relation to the capital stock has but little in its favor, while the fact that it hampers the healthy development of banking constitutes a serious objection. Still more arbitrary is the provision occurring in most laws that the cash reserve shall be equal to one-third the note circulation. The only excuse to be made for such a provision, is that it is intended to fix the minimum. But even in this sense it may be injurious under some circumstances. In any case there ought to be a similar provision in reference to deposits, or else the banks will make the one-third reserve for the notes serve as reserve for both notes and deposits. The capital stock of the bank, according to most of the laws, must be invested, like the deposits and loans, through notes, in securities which are easily convertible. It is decidedly best that the capital stock be restricted to this banking investment. The bank should not invest its capital in stocks and bonds which are exposed to great variations in value. Still more questionable is the policy of immobilizing the capital, i.e., investing it in a loan to the state on long time, (as in the case of the Austrian bank) or in untransferable bonds (as in the case of the French bank). Of course such an investment need not endanger the convertibility of the notes, as this depends immediately upon the investment of the note capital, i.e., the capital received in return for notes. But in such a case the capital stock loses all significance as a subsidiary means of securing this convertibility, and is of no more assistance for such a purpose than if it did not exist. It is of importance only in the case of ultimate insolvency of the bank. Of course such a provision grew out of the monopoly policy and financial necessity. But it would be better, as has been said above, to have the bank allow the state a portion of its profits and invest its capital in the proper banking method.


—The bank of England is historically a realization of the so called "currency theory" of Lord Overstone. This currency theory rested upon the false views of the nature of the bank note which we have discussed above. It identifies bank notes and money and posits an essential difference between bank notes and other credit substitutes for money, and demands that a bank note circulation shall vary exactly as a specie circulation would in its place Peel's act does not aim to secure the convertibility of the note, nor even to limit the amount of the note circulation, but to regulate the latter artificially so that it shall increase and decrease in exact keeping with the increase and decrease in the cash reserve of the bank of England. This attempt sprung from false theoretical views, from a complete mistaking of the importance of deposit business and its functions in the influx and efflux of the precious metals, as well as from a misunderstanding of the causes, effects and phenomena accompanying an exportation or importation of specie. Peel's act did not succeed in its attempt, nor was the practical object attained of avoiding commercial crises in the future. On the contrary, the act has repeatedly aggravated the crises, injured the efficiency of the bank, and has been several times suspended by the English ministry.


—Its system of securing the notes is as follows. A minimum amount was taken below which, according to experience, the note circulation of the country had never fallen. Such an amount of notes, it was assumed, was secure even without a cash reserve, on account of which it was chosen as the maximum amount of unsecured notes. Every further note had to be secured by a full cash reserve, pound for pound.


—As a matter of fact, the bank of England holds in general to the banking system of security. The only point is that the provisions as to the cash reserve are different in the case of the English system from those of the continental. And all points of difference are, in our opinion, to the disadvantage of the English system.


—The North American system secures the notes by fixing their amount at a high percentage of the capital stock of the bank, immobilizing this capital, and giving the note holders a priority right to it. The security of the notes as such is left to the banks, with the exception of prescribing a minimum cash reserve, and is ordinarily the usual banking security. The state does not aim to secure the instant convertibility of the note, but in case of bankruptcy its ultimate redemption. In this feature, and in the immobility of the capital stock, lie two great defects of the American system. The fiscal tendency of the whole system is apparent in its every feature.


—It will thus be seen that the continental system, although hampered by many arbitrary restrictions, is, on the whole, the most natural, because it adheres, in principle, at least, to the banking security. A vigorous bank administration would undoubtedly feel itself cramped in many respects by its provisions. And yet, it keeps in view, on the whole, the points which under a free banking system every bank would have to observe. It adapts itself more easily to the wants of trade than the English or American systems; and experience certainly does not condemn it in comparison with the others. And if we assign to the state the office of controlling the banking business there is no reason why a different basis should be sought than that which underlies the continental system. As a matter of fact, both the English and American systems approach the continental more nearly in practice than in theory, for both maintain in practice the banking security which they reject in theory. The continental system, we must conclude, is best for all kinds of banks of issue, as well for a great monopoly bank like that of England, as for a system of local banks like that of America or Germany.


—VII. RELATION OF THE STATE TO THE ESTABLISHMENT OF BANKS OF ISSUE. Although a system of free banking may be demanded on theoretical grounds for banks of issue as well as for others, yet there may be practical considerations which justify an interference on the part of the state, for instance, if one kind of banks of issue possesses advantages for trade and industry over other kinds and needs governmental aid in establishing itself. The question here turns on the respective advantages of a centralized and of a local system of banks of issue. The contest over this point has been as warm and as one-sided as over any other point connected with this whole subject. The abuse of credit has often been noticed, and then in theory and practice some one kind of credit institution made the scapegoat of all such abuses. But experience has by this time pretty well demonstrated that an abuse of credit is possible everywhere and under every form, that no kind of banks can hinder it, no credit banks and no particular form of banks of issue necessarily favors or prevents it more than any other, and that the respective advantages of the various systems have been greatly over-estimated by their supporters. In fact, the arguments in favor of a centralized system can be nearly all matched by arguments equally as strong in favor of local banks, while all the defects of the latter have their counterparts in the former. The question is pre-eminently a practical one, and can hardly be decided upon theoretical grounds. The objection to local banks, that in competing with each other they will succeed in issuing an excessive quantity of bank notes, has been answered already. The position of a great monopoly bank is connected with some dangers because its great resources enable it to persist in a false policy for a longer period, and thus it may favor the feverish speculation preceding a crisis to too great an extent. But in return for that, after the crisis has come, such a bank can do much more toward alleviating its effect than local banks could.


—One great advantage of local banks is, that by these the business of issue is developed in more intimate connection with the other banking business, and can become, as it ought to be, a mere complement of the deposit business. The reflux of the notes is more regular and powerful, and, in so far, the notes are better secured; while, on the other hand, as they must secure both deposits and notes, the latter are ordinarily based on a relatively smaller cash reserve than those of a great central bank.


—The comparison between a system of local banks and a great central bank with many branch banks, must end similarly. Each has its advantages and disadvantages, and other influences than banking considerations must finally give the decision. The local banks, besides the advantage mentioned above, can adapt themselves better to local demands. But the central bank with branches can afford a greater extension of the remittance business. If there is less self-dependence in the great bank, there is a more effectual control through the publicity which all its acts possess. If there is greater danger of its becoming involved in the financial difficulties of the government, of its bank notes becoming paper money, there is less danger of the government's going over to a pure paper money system. Which is generally far worse. Besides that, American history shows clearly enough that a system of local banks affords no security against abuse for financial purposes. If in the great bank the reflux of notes is weaker, there is a greater cash reserve. If there is occasional partiality in discounting, there is in general greater safety in the loans, less danger of being ruined by local swindles, etc., etc. One point, however, must be kept in mind, which, in general, will give the decision in favor of free local banks of issue. Modern trade and industry by their own natural development tend to give us all the advantages of these great central banks, without any of the disadvantages which come from monopoly banks. And it is probable that great banks would have appeared in London, Paris, Berlin and Vienna able to confer all the advantages afforded by the state banks in those places, with almost none of their defects.


—VIII PRINCIPLES OF LEGISLATION IN REFERENCE TO BANKS OF ISSUE. It follows from the previous considerations that the relation of the state to banks of issue need not consist in a regulative interference. The application of general legal principles to the system of banks of issue, and a general banking law in which there need be only a few particular provisions for banks of issue, are sufficient. We enumerate here some of the principles which should underlie general bank legislation.


—1. The establishment of banks of issue may be free as well as that of other credit banks.


—2. The provisions as to the capital stock of banks of issue and the amount of liability of the stockholders may be the same as in other banks.


—3. A regulative control of the business of the bank ought not to be attempted by the state, as it can never be really carried out. The amount of the capital stock and its investment, the amount of the cash reserve, its yearly increase, the distribution of the profits, the establishment of branches, the extension of the business, the conditions as to the acceptance and amount of deposits, the kinds of bank notes and their total amount, the security of its liabilities, etc., etc., ought to be left entirely to the bank.


—4. The care of the state must extend, however, to two, possibly three, points. It must insist on the strictest publicity of the transactions of the bank, so that the public can judge at any time of the bank's solvency; it must fix the lowest denomination of note and provide proper means to force every bank either to convert its notes on demand or go into bankruptcy; and it may exercise a formal control so long as it does not interfere with the principles of free banking.


—5. The principle of publicity demands the preparation and publication of regular reports as to the condition of the bank, and the law ought to be framed with the utmost care so that the banks may not be able to evade its provisions.


—6. The strictest personal responsibility, on the part of directors, etc., for the full execution of the law, ought to be part of all banking legislation. Provision ought to be made for a compulsory examination of the books by the proper authorities and the publication of the results from time to time.


—In a word, the action of the state is in general to limit itself to making possible a strict and immediate control of the banks by public opinion. The state guarantees the publicity of all bank affairs; the public must really watch the banks and hold them to their duty.


—LITERATURE. The literature of the question is simply enormous. All the ordinary text books on political economy discuss the subject in one or more of its phases. The various encyclopædias contain articles of more or less value. Worthy of particular mention in this connection is the article on Zettelbankwesen, in Bluntschli and Brater's Staatsworterbuch; by Adolph Wagner, of which the present article is essentially an abridgment, and the discussions under various heads in Macleod's dictionary of political economy, and M'Culloch's commercial dictionary. The periodical literature of the last 80 years, in French, German and English, is full of the discussion. The various reports of the English and French governments and banks are also full of valuable matter. The writings of Gilbert, Wilson and lord Overstone, Wolowski and Horn, Schaffle, Rau, Wirth, Wagner, Carey, Walker (Amasa and Francis), Gibbon, and Price, contain many interesting discussions of the topic. Of formal works on the subject we mention the following, in which the reader will find references to all that is valuable on the question in any language: Tooke and Newmarch, History of Prices, London, 1838-1857; Fullerton's Regulation of the Currencies, London, 1845; Walker's Money, New York, 1878; Walker's Money, Trade, and Industry, New York, 1879; Macleod's Theory and Practice of Banking, London, 1875; Gibbons' Banks of New York, New York, 1859; Wolowski's Quest. des Banques, Paris, 1864; Horn's Liberté des Banques, Paris 1867; Geyer's Theorie and Praxis d. Zettelbankwesens, 1867; Tellkampf's Princip. d. Geld and Bankwesens, Berlin, 1867; A. Wagner's Zettelbankpolitik, Freiburg, 1873. The last contains a very full account of banks of issue and an exhaustive discussion of all points, theoretical and practical, relating to them.


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