Economics and The Public Welfare
17: Money, Bank Credit, and Capital
Chapter 17
Money, Bank Credit, and Capital
Capital is created when men produce machinery instead of hats and shoes and ice cream, when men build bridges and railroads instead of making phonograph records. Capital consists of producers’ goods, of instruments to be used in further production, instead of commodities destined for immediate consumption. The growth of capital is a factor of first importance in the progress of civilization. Capital increases when the community produces more than it consumes. Capital decreases when the community consumes more than it produces.
The Five Main Sources of Capital. In the world of money and money transactions—the world of buying, selling, lending and borrowing in terms of money—the formation of capital usually involves monetary transactions and generally involves monetary calculations. Even in such a world, however, there remains an important amount of capital creation without any intermediation of money.
1. Direct Capitalization. There are five main sources of capital. The first is direct capitalization, particularly important in agriculture today. This takes place when the farmer uses his spare time in building barns and fences and putting in subsoil drainage, in damming up gullies and making ponds. It takes place when the farmer lets his flocks and herds increase instead of selling off the whole of the annual increase. It takes place when the farmer turns his wheat land into orchard, and must wait eight years to get his return. A similar direct production of capital takes place often in a mechanic’s shop when he makes or improves a tool or a workbench. It is especially important in European agriculture. Senator Luigi Einaudi, the distinguished Italian economist, in conversation has emphasized its importance. He remarked in 1937, for example, that he thought that the Italian peasant was creating enough new capital with his hands to offset the deficit in the national government’s budget.
2. Consumer Thrift. The second main source of capital, and the one to which the older economists gave their chief attention, is consumer thrift. The consumer has an income of $5,000. He and his family spend $4,500 in living. He saves $500. He may use this to buy machinery or tools or livestock to aid himself in his own work. He may, on the other hand, lend it to a neighbor who will use it in buying tools and equipment. Or he may put it in the savings bank and the savings bank may use it in buying the bond of a great industrial corporation which is erecting a new factory or which wishes more working capital to put into raw materials and work in process. In any of these cases, however, more capital is created and less consumers’ goods are created as a result of the thrift of the consumer, than would have been the case if he and his family had spent the whole five thousand dollars in current living. Consumer thrift is, of course, of tremendous importance to the growth of capital.
3. Business Thrift, and Especially Corporate Thrift. When a business house retains part of its profits to add to surplus, capital is created. The corporation which refrains from paying out all of its profits as dividends, retaining part to add to surplus, is creating capital. The importance of this and the extent of it was first forcibly brought to the attention of economists in David Friday’s pioneer study, Profits, Wages and Prices, New York, 1920. From 1909 to 1929 additions to corporate surplus ran as follows:
| Corporate Savings * (Millions of dollars) | |
|---|---|
| Year | Additions to corporate surplus |
| 1909 | 1,296 |
| 1910 | 1,151 |
| 1911 | 690 |
| 1912 | 1,246 |
| 1913 | 1,400 |
| 1914 | 585 |
| 1915 | 2,117 |
| 1916 | 4,939 |
| 1917 | 4,732 |
| 1918 | 1,986 |
| 1919 | 4,330 |
| 1920 | 1,397 |
| 1921 | -2,685 |
| 1922 | 1,676 |
| 1923 | 2,432 |
| 1924 | 1,463 |
| 1925 | 2,851 |
| 1926 | 2,223 |
| 1927 | 996 |
| 1928 | 2,388 |
| 1929 | 2,238 |
* From America’s Capacity to Consume, published by the Brookings Institution, p. 109
4. Taxation for Capital Purposes. When government taxes inheritances at very high rates and uses the proceeds for current expenditures it is dissipating capital. When, however, government taxes income and uses the proceeds to pay down public debt it is creating new capital, returning capital to the investment market. In Boone County, Missouri, a generation ago, there was need for a new court house. The farmers of the county had had the unpleasant experience of paying off a bond issue, shortly after the Civil War, for a railroad that was never built, and in three elections they voted down the proposal to borrow money to build a court house. Then an able local editor, William Hirth, proposed a special tax levy for three years, which would raise the $100,000 needed while the work of building the court house was going on. The county would then own the court house free and clear of debt. The farmers liked this proposal and it was carried by a very large majority. The bankers paid the county interest on the money instead of the county’s paying interest to bondholders on the money. This was taxation for capital purposes. It created new capital. During the period of the 1920’s a great deal of capital was created by taxation. The Federal Government steadily collected more revenues than its ordinary expenses amounted to, steadily paid public debt and returned a great many billions of dollars to the capital market. Unfortunately, this tendency in Federal finance was offset by a counter tendency in State and municipal finance.
First Four Sources of Capital Never Carried to Excess. These four sources of capital: direct capitalization, consumers’ thrift, business thrift (and especially corporate thrift), and finally, taxation for capital purposes, are all wholesome, sound, and safe. They have never been overdone; no country has ever gone wrong in creating capital in these ways.1 The great troubles of the 1920’s grew out of a fifth source of capital, namely, new bank credit for capital purposes.
5. New Bank Credit as Source of Capital. Certain of the older economists would have denied that an expansion of bank credit could create capital. Bank credit expands when the customer gives the bank his note, which the bank takes in as an asset, and the bank in exchange gives a customer a deposit credit, a liability of the bank against which the customer may draw checks. In this transaction there is simply the interchange of two liabilities, the liability of the customer to the bank and the liability of the bank to the customer. The bank’s balance sheet is increased on both sides by this transaction. Loans and discounts are increased on the asset side and deposits are increased on the liability side. How can the interchange of two liabilities create new capital? How can it serve as a substitute for direct capitalization, or for consumer thrift, or for business and corporate thrift, or for taxation for capital purposes? How can it create a new machine instead of new hats and shoes?
Obviously, at the instant, there are no more hats or shoes or machines. There is simply more paper. And yet for the customer of the bank who wants machines the new bank credit is enough. He can use it to get the machines, and more machines will be produced than would otherwise have been produced, as a result of his demand based on the credit which the bank is giving him.
If at the time he orders a new machine, industry is fully employed, the new machine can be produced only by withdrawing labor and supplies from other employments, and his purchase of the machine will force upon the consumers a reduced consumption of hats or shoes or ice cream. There is involuntary “abstinence.” If, on the other hand, there is a state of industrial slack with idle labor, the new machine can be added to the capital equipment of the country without any diminution in the flow of consumers’ goods. In either case, however, new capital comes into existence which would not have existed if the bank had not extended credit.
Sound if Held Within Limits. It must be recognized that, held within limits, the expansion of bank credit is a wholesome and legitimate source of new capital. The nature of these limits involves the general theory of bank credit. To Adam Smith it would have seemed impossible that a bank should do much of this. The bank might properly lend to a merchant for quick turnover. The bank might lend to a manufacturer part of his working capital for the purchase of raw materials and the payment of the labor which worked up the raw materials in anticipation of a prompt sale. But the bank must lend to the manufacturer no part of his “forge” or “smelting house.” The banker’s liabilities are quick liabilities, and the banker must keep his assets quick also in order that he may meet his quick liabilities. The forge and the smelting house are not quick, are not liquid; they are fixed, and loans against them may safely be made only by those who can afford to wait a long time to get their money back—retired investors and the like.
Less rigid banking standards could recognize that a bank may put a substantial part of it resources into slow loans, provided it keeps a sufficient per cent of cash and highly liquid paper to meet the variations in depositors’ calls for cash. German banks have always gone much further in making capital loans to industries than banks in England or the United States. A regular practice of the German banks, both before and after World War I, was to make advances, usually in the form of overdrafts, to industries and to increase these with the growth of the industry year by year. Frequently, or even usually, in connection with such advances the bank would place its own officers on the board of directors of the borrowing industry. When the advance had reached a great enough magnitude, the bank would often have the industry give it bonds or even shares in cancellation of the advance; and then at a time when the stock market was rising and the affairs of the corporation looked favorable, the bank would make a public issue of the shares and the bonds.
British banks do not like to own shares and prefer that the long-time financing of an industry should be conducted through the capital market. Nonetheless, in the advances of the British banks there is usually a great deal of slow paper which in effect represents capital loans. American banks in the great cities try hard to adhere to the practice of having their borrowers “clean up once a year.” But this is not always insisted upon in the case of the one-bank borrower, and even in the case of the borrower with several banks it is often accomplished only by an increase of loans at one bank as another bank is paid off. But American banks do expect, in any case, that the total borrowings of a concern shall have a seasonal peak, and that a substantial liquidation from this peak shall take place in total borrowings. Banks in smaller cities and country banks often do carry a substantial volume of paper for their customers, periodically renewed, which represents capital advances.2
Stock Market and Bank Credit for Capital Purposes. The main way, however, in which bank credit has gone into industrial equipment and other capital uses in the United States has been via the stock market, rather than by direct capital loans. The bank cannot safely lend a railroad funds for its roadbed or its terminals. But when the roadbed and the terminals are represented by $1000 bonds or by $100 shares for which a broad and active market exists, then the banks may safely make collateral loans secured by such bonds and shares, knowing that it can get the money back promptly by calling upon the borrower to pay, and by selling his shares and bonds in the stock market if the borrower does not pay. The bank may even buy the bonds and own them itself, knowing that it can sell them promptly if it needs to. Through the stock market, therefore, bank credit has come to finance industry, as well as commerce, on a great scale.
There is no need whatever to be doctrinaire in objecting to the employment of bank credit for capital purposes, so long as the growth of this is kept proportionate to the growth of the industry of the country, so long as the prices and quality of the shares and bonds are closely scrutinized by the lending officials of the banks, and so long as adequate margins and proper diversification of collateral are maintained. But when in the period 1924-1929 there came an extraordinary spurt of this kind of employment of bank funds, and when commercial loans began going down in the banks at the same time that the stock market loans and bank holdings of bonds were mounting rapidly, the careful observer grew alarmed. And when in addition there came a startling increase of several hundred per cent in bank holdings of real estate mortgages, the thing seemed extremely ominous. Adam Smith’s reasons against bank holding of mortgages were very nearly as valid in the 1922-1933 period as they were in his day. The first lesson of a young banker should be to learn the difference between a mortgage and a bill of exchange.
Growth of Capital and Growth of Debt. With respect to the five sources of capital it must be observed that when capital is created by direct capitalization, or by corporate and other business thrift, or by taxation for capital purposes, the capital of the country increases without a corresponding growth of debt. When capital is increased by consumer thrift, there need not be a growth in debt. If the thrifty consumer invests his savings in corporate shares, or if he uses them in his own business, there is no growth of debt. If he puts them in the savings bank there is a growth of debt, in that the savings bank now owes him money. If he lends to a neighbor there in an increase of debt. But the growth of capital from consumer thrift moves more rapidly than the related growth of debt. Direct capitalization and corporate thrift involve no increase of debt at all. Governmental thrift usually involves an actual decrease of debt.
When, however, new bank credit is employed to create new capital, there is a dollar-for-dollar concomitant growth of capital and debt. Credit and debt are merely different names for the same thing. There is no creditor without a debtor and no debtor without a creditor. One of the obvious and ominous aspects of rapid expansion of bank credit is the growth of debt—the debt of the people to the banks and the debt of the banks to the people. For this reason alone, if for no other, the employment of bank credit as a substitute for the first four sources of capital should be used cautiously and discreetly, and the growth of it should be held in proper relation to the growth of the industrial activity of the country.3
The Process of Bank Expansion, 1922-1928, on the Basis of Excess Reserves. When the cash reserves of the banks are not excessive, bank credit does not easily expand. Banks will increase loans under these conditions to customers, but they will usually sell investments as they increase loans and they will increase the loans at rising rates of interest. A bank must always be prepared to pay its depositors on demand. It must protect its cash. The minimum ratio of reserves to deposits has long been fixed by law in the United States, but even when there are no legal reserve requirements, banks know very well that they must protect their reserves in order to protect their solvency.
Multiple Expansion Impossible for a Single Bank. There is an old theory that when a bank receives an unaccustomed amount of cash above its reserve requirements, it may forthwith proceed to increase its loans and its deposits in some multiple ratio. An old New Jersey banker, repudiating this theory, once said that he had been trying for forty years to make one dollar do the work of four, but in the warfare of checks at the clearing house the other banks wouldn’t let him. The practical banker knows that under ordinary circumstances an increase in loans promptly reflects itself in withdrawals of cash. Having an excess of $100,000 in reserves over his required reserves, the banker will ordinarily lend or invest $100,000, increasing his loans and investments by $100,000, and increasing his deposits by $100,000—the proceeds of the loan are ordinarily taken by the borrower in the form of a deposit credit. If the borrower promptly checks against his deposit balance to make payment to a depositor in another bank, the banker who has made the new loan will find his deposits reduced and his cash reserves reduced by $100,000 very speedily. His total assets and his total liabilities will be what they were before the loan was made, but the composition of his assets will be changed. His cash reserve will be reduced by $100,000 and his loans increased by $100,000.
This is the normal expectation of the banker, and represents the situation when the total volume of bank reserves is changing little and when, in the banking community generally, there is no excess of reserves over reserve requirements—some banks being a little over and others a little under the required reserves.
Takes Place When Banks in Aggregate Have Excess Reserves—The Process. But obviously the situation is different if on the same day many banks find themselves with excess reserves and all of them simultaneously try to lend out the excess. Assume a clearing house with three bank members, all approximately equal in size, and assume that each finds itself with $100,000 excess reserves, and that each is trying to put its money to profitable use, increasing its loans by $100,000 and its deposits by $100,000. Assume that the borrowers promptly use the proceeds of the loans in making payments, so that checks for $100,000 are drawn on Bank A and deposited in Bank B, checks for the same amount are drawn on Bank B and deposited in Bank C, and checks for $100,000 are drawn on Bank C and deposited in Bank A.
Next day at the clearing house each bank has to meet, as a consequence of its loan operations of the preceding day, checks drawn against it for $100,000. But, on the other hand, each bank has checks on one of the other banks to present for $100,000. They merely swap checks at the clearing house and none of them loses any cash. Deposits are up $100,000 in each bank; loans are up $100,000 in each bank; and reserves are still in excess in each bank. Next day they try again, each trying to get rid of its excess reserve, but again they merely swap checks at the clearing house and lose no cash.
The process will go on, on the assumptions laid down, until new bank credit is created in an amount such that the $100,000 original excess reserve in each bank is now needed as required reserve for the expanded deposits. There will be a multiple expansion based on the excess reserves. How great the multiple will be will depend upon the legal reserve requirement or the minimum reserve ratio that banking practices have dictated in the absence of legal reserve requirements. In New York City in the period of the 1920’s the legal reserve requirement was 13% for demand deposits. On this basis the $100,000 excess reserve in each bank would permit new deposits of $769,230 to be created, growing out of new loans of the same amount. Then there would no longer be excess reserves, and the process would stop. For banks in reserve cities outside New York and Chicago, the rule was 10% for demand deposits, and for country banks 7% for demand deposits, while for all three classes of banks the legally required reserve for time deposits was 3%.
Limits on Bank Expansion—Largely Inoperative, 1922-1928. The foregoing illustration is artificially simple. It ignores many complications, but it does illustrate the essential causation in the American money market in the period of the 1920’s.
Among the complications ignored are the existence of outside markets which would pull away reserves, not merely from Bank A, but from the whole system of Banks A, B, and C. The expansion we will assume to take place in New York, but part of the proceeds of the expansion would be spent in Chicago or New Orleans or San Francisco. During the 1920’s, however, the excess bank reserves were widely diffused over the country and the country as a whole expanded.
The illustration ignores the further fact that when increased loans are made for commercial purposes in connection with increasing commercial activities, there is usually an increased demand for hand-to-hand cash which pulls down banking reserves, checking the expansion. But the years 1924 to 1929, inclusive, showed an amazing constancy in the volume of money in circulation, despite the immense growth in bank deposits that took place.
The illustration ignores the probability that bank expansion in the United States would cause foreign money markets to pull away gold from the United States, which would cut under the volume of bank reserves in the United States and check the expansion before it could go far. But from 1920 into 1927 the United States gained gold instead of losing it.
Excess Reserves Do Not Generate Expansion When Confidence Is Low. The illustration given above assumes, moreover, that the only factor governing the volume of loans that banks will make is the volume of reserves available. Now there have been times in the history of the country, notably in the 1870’s and in the middle 1890’s and in the 1930’s, when reserves piled up without being used, either because the banks could not find satisfactory credits, or because good borrowers would not take loans even at low rates, or because many banks felt obliged to carry reserves high above the legal requirements in view of uncertainties and dangers. For the New York Clearing House banks, the average reserves for the year stood in 1894 at 37.59% of deposits, though the legal requirement was only 25%. The figure stood at 45.2% in February of 1894. The average for the whole of the United States was 26% in 1894, although the legal requirement was far below this. The same average for the year was 15% in 1906.
Excess reserves rose to fantastic levels in the period of the 1930’s, and interest rates literally dragged the ground without encouraging any great expansion of bank credit except as the government borrowed—noting the exception of a strong growth in commercial loans from early 1936 to the crash of 1937.
Federal Reserve Credit and Multiple Expansion—Rediscounts vs. Open Market Purchases. The proposition given above that, on the basis of excess reserves, a multiple expansion of bank credit can take place is very different from the proposition sometimes made that, on the basis of every dollar of Federal Reserve bank credit, a multiple expansion can take place. If Federal Reserve bank credit expands only in response to increased needs for money in circulation, or for the replenishment of member bank reserves in a period of active business, or in the normal seasonal crop moving time—and if the Federal Reserve bank expansion takes place only in response to rediscounting by the member banks, and if the member banks, as they normally do, pay off the rediscounts when the need is over—then the expansion and contraction of Federal Reserve bank credit need occasion no general expansion or contraction of commercial bank credit at all. The Federal Reserve banks in these cases will merely prevent tension and take in slack.
It is only when the Federal Reserve banks take the initiative, through their purchases of government securities, in creating Federal Reserve bank credit that surplus reserves of the member banks are created thereby, and that multiple expansion based on Federal Reserve credit takes place. This did happen on a colossal scale in the period of the 1920’s, the two major episodes being in the years 1924 and 1927. Government security purchases by the Federal Reserve banks of several hundred million dollars in each of these years were promptly followed by multiple expansion of billions of dollars in general bank credit.
How Surplus Reserves and Bank Expansion Generate Time Deposits More Than Demand Deposits. The great bank credit expansion in the 1920’s took the form of time deposits to a greater extent than of demand deposits. Why was this? It would not have happened if, accompanying the immense bank expansion, there had been a corresponding increase in the demands of trade, and if the bank expansion had been called forth by trade needs instead of being pushed out by excess reserves. But there was no such growth in trade needs for money, and businessmen and most other people tend to be economical in the use of money. When banks pay interest on deposits and encourage deposits, people are glad to deposit unneeded pocket cash in the banks, and when banks pay more interest on time deposits than they pay on demand deposits, businessmen and others tend to put their excess funds into the form of time deposits rather than demand deposits.
This expansion of time deposits, it may be observed, tended to reduce the reserve ratio required for a given volume of deposits and thus permitted the expansion to go much further than would otherwise have been the case.
Time Deposits and Savings. There were those who looked with great complacency upon our immense expansion of bank deposits in the 1920’s on the theory that it took the form chiefly of time deposits and that time deposits represented savings. The view was largely fallacious. Time deposits expanded most rapidly when bank reserves were most excessive, and time deposits ceased to expand when the money market tightened. They showed none of the steady growth of ordinary savings deposits. Moreover, they outran ordinary savings deposits by an appalling percentage. The following table shows the comparative growth of savings deposits and time deposits in the commercial banks.
| Comparative Growth of Savings Deposits and Time Deposits (In millions of dollars) | ||||
|---|---|---|---|---|
| Date | Deposits of all mutual savings banks | Time deposits of National Banks | Time deposits of Reporting Member Banks in N.Y. District * | Time deposits of all Reporting Member Banks * |
| June 30, 1922 | 5,780 | 4,112 | 666 | 3,380 |
| June 30, 1923 | 6,289 | 4,755 | 901 | 4,000 |
| June 30, 1924 | 6,693 | 5,260 | 972 | 4,418 |
| June 30, 1925 | 7,147 | 5,925 | 1,174 | 5,172 |
| June 30, 1926 | 7,578 | 6,314 | 1,263 | 5,650 |
| June 30, 1927 | 8,077 | 7,316 | 1,472 | 6,212 |
| Jan. 1, 1928 | 8,315† | 7,808‡ | 1,622 | 6,611 |
| % increase over 1922 | 43.9 | 89.9 | 143-5 | 95.6 |
* Figures for Reporting Member Banks are for dates nearest June 30.
† Estimated.
‡ Dec. 31, 1927.
Time deposits in the great New York banks could be identified as consisting of temporarily idle money of large investors who had sold out in a rising stock market and were waiting to reinvest; as deposits of foreign banks subject to prompt recall; and as temporarily idle money of great industrial corporations. The great New York banks knew that they must keep just as liquid against these time deposits as against demand deposits. This was true in most of the major cities of the country, notable exceptions being Cleveland, Ohio, and Los Angeles, California, where the time deposits of the great banks represented in large degree true savings accounts.4 Time deposits in country banks represented real savings far more than they did in city banks. But the most rapid growth of time deposits in this period was in the city banks, as is strikingly illustrated by the following table for the National Banks:
| National Bank Deposits (In millions of dollars) | ||||||
|---|---|---|---|---|---|---|
| Banks in central Reserve cities | Banks in other Reserve cities | Banks outside Reserve Cities | ||||
| Date | Net demand deposits | Time deposits | Net demand deposits | Time deposits | Net demand deposits | Time deposits |
| May 5, 1922 | 3,112 | 227 | 3,014 | 736 | 3,805 | 2,955 |
| Feb. 28, 1928 | 3,394 | 636 | 4,210 | 2,398 | 4,574 | 4,959 |
Time deposits in the country banks increased only 68%, but in the central reserve cities increased 180%, and in the other reserve cities more than 225%. For approximately the same period time deposits in the New York Federal Reserve District increased 207%, in the Atlanta Federal Reserve District 65%, and in the Kansas City Reserve District 68%. Time deposits even in country banks were swollen by the temporarily idle funds of business corporations which went to them, attracted by the fact that country banks paid higher rates of interest on bank deposits than great city banks did. If the country banker were misled into thinking that he had here a true savings account, not subject to sudden withdrawal, which he could safely invest in slow local loans, including mortgages, he had a rude awakening. Repeatedly in the period of the 1920’s the New York banks got frantic telegrams from country correspondent banks calling for help when one great automobile company suddenly withdrew its time deposit. These calls for help were honored, but usually with a spanking and with a warning not to do it again.
Even the deposits of the mutual savings banks were swollen by the rapid expansion of commercial bank credit which was taking place. This was particularly true in New York City, where the mutual savings banks would take deposits up to $7500. There were many cases where investors, selling their securities at the rapidly rising prices of the period, put their funds into savings banks, placing $7500 blocks in each of several such banks. These deposits did not represent new savings. They represented in part old savings displaced and in part capital gains based on expanded commercial bank credit. In 1928 and 1929 there was also a counterinfluence on savings banks deposits. Some savings bank depositors took funds out of the savings banks to put into stocks at rising prices.
In general, however, savings bank deposits moved steadily without showing great influence of contemporary expansion of commercial bank deposits. Time deposits of the commercial banks, however, moved by jerks. They moved rapidly when the Federal Reserve banks increased their open market purchases, and they expanded slowly or not at all when the Federal Reserve banks were selling Government securities.
The year 1922 was a year of rapid expansion. The Federal Reserve banks increased their open market purchases, gold came in, and deposits moved rapidly. From January 4, 1922, to January 3, 1923, the time deposits of the reporting member banks increased from $3,011,000,000 to $3,748,000,000, or 24.5%. The year 1923 was one in which the Federal Reserve banks reversed their policy and offset the incoming gold by reducing their open market purchases and raising their rates of rediscount. The time deposits of the reporting member banks in this year rose from the $3,748,000,000 of January 3, 1923, to $4,104,000,000 by January 2 of 1924, or 9.5%. The year 1924 was one of very great Federal Reserve bank expansion, great ease of money, and very rapid bank expansion. Time deposits moved up in this year from $4,104,000,000 on January 2 to $4,849,000,000 on January 7 of 1925, or 18.2%.
The case is even more striking when we observe the behavior of time deposits in certain of the major cities. From April 12, 1922, to April 11, 1923, time deposits in New York City moved up from $353,000,000 to $627,000,000, or 77.6%. In the following year, the period of restricted credit, the same time deposits moved up only from $627,000,000 to $649,000,000, or 3.5% (by April 16, 1924). In the following year (to April 15, 1925), a period of great monetary ease, time deposits moved up to $816,000,000, or 25.7%, whereas in the next year (to April 14, 1926), there was an actual decrease of $2,000,000, the 1926 figure being $814,000,000.
A similar story can be told for Chicago. From April 5, 1922, to April 11, 1923, time deposits increased from $311,000,000 to $372,000,000; but from April 11, 1923, to April 16, 1924, they increased only $1,000,000 to $373,000,000. This high variability in the growth of time deposits is very different from the steady growth which characterizes the figures of the savings banks.
Investors’ Money vs. Bank Expansion. It was not easy to convince investment bankers and bond dealers in the period 1925-1929 that it was commercial bank expansion which was generating the demand for the securities which they were selling. They insisted, and correctly, that real investors’ money was coming in, and that a great many securities were being bought outright. They were impressed by the statistics showing the growth of stock and bond collateral loans in the banks, the growth of bank ownership of bonds, and the growth of bank deposits, but they still insisted that they were selling to investors. But here is a typical case where one could trace every step of the process. An old lady in Missouri held a mortgage which she had inherited from her father. A Missouri Joint Stock Land Bank floated a bond issue in New York, receiving cash for it, part of which came out of a syndicate loan which the underwriters placed with New York banks, and for which they got a deposit credit. The deposit was transferred to a great Missouri city, and from there to the smaller place where the old lady lived, and the mortgage which she held was refunded at a lower rate of interest by the Joint Stock Land Bank, and she was paid off. She first placed the money on deposit with the local bank, and then wrote a kinsman in a New York bank, sending a check which she asked to have placed in good bonds for her. Here was true investor’s cash coming out of an interior town to New York to buy bonds, but it represented no new savings. The old lady’s father had saved that money sixty years before. It was a displaced old investment. Newly created money sweeping out of New York had displaced her investment, and her investment funds came back to New York for reinvestment.
- 1This point will be discussed at length in Chap. 34.
- 2I have not been able to find that this article was ever published. However, the reader will find much of it in two books by Veblen: Imperial Germany and the Industrial Revolution, New York, 1915; and The Nature of Peace and the Terms of Its Perpetuation, New York, 1917.
- 3See my book The Effects of the War on Money, Credit and Banking in France and the United States, published by the Carnegie Endowment for International Peace, Oxford University Press, New York, 1919. For London, see the interesting articles by Mr. J. M. Keynes in the British Economic Journal in late 1914.
- 4O. M. W. Sprague: “Crisis of 1914 in the United States,” American Economic Review, September, 1915; H. G. S. Noble: “The New York Stock Exchange in the Crisis of 1914,” Garden City, N. Y., Country Life Press, 1915. These two papers are classics of permanent value.
