A Short History of Paper Money and Banking

CHAPTER XIII. Of the “Convertibility” of Bank Medium.

Many who are inimical to paper money in every other form, are friendly to the use of Bank paper, because it is, they say, equal to specie, inasmuch as specie can be obtained for, it at the will of the holder.

But what does this “convertibility” amount to? Though we have between three and four hundred Banks, we have not yet one at every man’s door; and, if we had, every man would, in the course of business, be compelled to receive the paper of distant Banks. A man may prefer silver, and yet not choose to walk even half a mile, to have his note changed.

Those whose money dealings are most extensive, like not to offend the Banks by too frequent calls on them for specie. It might lead to a curtailment of their accommodation. They have as deep an interest as the stockholders and the directors in keeping the notes in circulation.1

In addition to this, it must be remembered, that Bank paper is “convertible” into only one of those species which should, according to law and constitution, be the money of the United States. An incorrect valuation of gold at the Mint, and paper money together, have driven this precious metal from the country. Bank paper is “convertible” into silver only, which is inconvenient for large payments, and for transportation to distant places in large amounts.

From this combination of causes, not more than one-twentieth of the paper is actually “convertible” at any one time, and herein consists the safety of the Banks. An attempt to convert but one half of the Bank medium, into specie, would, though several months were allowed for the operation, break all the Banks in the country.

Now, can such a “convertibility” make Bank notes “equal” to specie? We mean equal to specie as money, in its three functions of a circulating medium, and of a standard and measure of value. We know the two articles are equal in the market, but the question is, if they ought to be so.

“Convertibility,” so far from being an assurance of the soundness of Bank notes as money, is not even an assurance, for three days together, of their soundness as bills of credit. This is verified in the case of Banks whose paper is in one week at par, and in the next at a discount of fifty per cent.

When the contingencies on which convertibility depend, are taken into consideration, the risk appears so great as of itself to outweigh all the arguments usually adduced in favor of Bank medium.

The practice of the Banks is to make provision for those demands only which it is probable will be made upon them, which provision is seldom for more than one-fifth of the amount of their actual engagements to pay on demand. It is very easy for the Directors to make a mistake in their estimate of probabilities. Events which they could not foresee may occur, and circumstances they cannot control. It is not always easy to say where the line of safety should be drawn; and the Directors are at all times tempted to transcend it, from the desire of making large dividends, and raising the price of their stock in the market. Sudden changes in the political and commercial world, may render the best conducted Banks unable to comply with their engagements, though they may have in store double the amount of specie, which would, in other times, be necessary to support their credit.

On a certain day in 1819, there were but $80,000 between us and universal bankruptcy. This was the whole amount of specie in the United States Bank at Philadelphia; and if that had been exhausted, a shock would have been given to Bank credit, which would have caused a general suspension of specie payments. In 1825, the condition of both England and the United States was hardly less critical. The failure of two or three of our principal Banks would cause a run upon all the others. They could then comply with but a part of their engagements, and their inability to satisfy the claims of the holders of their notes and of depositors, would render the fulfilment of other money contracts impossible. The credit which Bank notes enjoy, has been called “suspicion lulled to sleep.” Events may awaken that suspicion.

Attempts are sometimes made to show the perfect security of the Banks, by contrasting the amount due by them for notes in circulation and for deposites, with the amount falling due to them every sixty or ninety days on account of mercantile paper discounted by them. But such calculations, even when they rest on indisputable data, prove only the ultimate solvency of a Bank. The amount due by the Bank, on account of deposites and on account of notes in circulation, may all be legally demanded in one day; nay, in one hour. A greater amount may be owing to the Bank, but it is payable at different times, and the extremes of the term are sixty or ninety days apart. The individuals who owe this money to the Bank may be rich men: but their ability to pay, within the time agreed upon, depends on the credit of Bank paper being maintained. Let the depositors suddenly withdraw but one-half the amount of specie ordinarily retained by the Banks, and the credit of Bank notes necessarily falls. A portion of the debts due to the Banks may be paid in this depreciated paper; but the Banks will not have the means of satisfying all their creditors. There being little specie in the country, the collection of debts due by individuals to individuals, would be suspended, (if Bank paper should suddenly lose its credit.)  *  *  *  *  *  *

The danger of such an event may not be very imminent; but it is sufficient to show that the stability of Bank medium depends on contingencies which, as they cannot always be foreseen, cannot always be guarded against. What was called “a panic” in England, in 1825, broke up a number of private Bankers who were perfectly solvent, and was near proving destructive to the whole system. If a suspension of specie payments should again occur in this country, we should be left for a time without a sufficient medium of exchanges. Too many men are now aware of the nature of “inconvertible” Bank paper for it to have general circulation. It would soon run the course of the Continental money, and of the French assignats.

So long as Bank paper is “convertible,” more than a certain amount cannot be kept in circulation for a long time without undergoing a sensible depreciation. Hence “convertibility” fixes a limit which Bank issues cannot pass. By carefully watching one another, by attending to the course of foreign exchanges, and by guarding against a drain of specie, the Banks may, in ordinary times, maintain the “convertibility” of their paper; but the history of Banking, both in England and the United States, since the resumption of specie payments, shows that this “convertibility” cannot give to Bank medium that stability which is essential to a sound money system.

In the means by which “convertibility” is maintained, we have an abundant source of evils. It is by one Bank pressing on another, and thereby forcing the debtor Bank to press on its customers. When there is a foreign demand for specie, the “convertibility” of Bank medium is maintained by a general pressure on the community.

Lord Liverpool, in a debate in the British House of Peers, in Feb. 1826, placed the doctrine of convertibility in its true light. “The doctrine,” he said, “maintained by some noble lords, that nothing was better than a paper circulation convertible into gold, is true to this extent—that if convertible into coin, the evil would cure itself, whilst one not convertible would lead to nothing but ruin. But how is the cure to be operated? By the downfall of thousands and hundreds of thousands, and the convulsion of all kinds of property. It is true that the evil carries its own cure, but with such terrible consequences that the cure is worse than the evil.”

 

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2 In a debate in Parliament in July 1828, Lord King said, that “as for payment in gold, he knew there was an esprit de corps among the Bankers, and people who wished to get accommodations from them would find it no easy thing to obtain gold. The Banker would inquire if the individual was in the habit of asking for gold, aud if so, accommodations would be withheld. Paying in gold was not, therefore, that check to over-issues which some people imagined.”

• 1* Letter to Mr. Gallatin, by Publicola, New York, 1815.
• 2“In most disquisitions upon the noxious tendency of Banks,” says another writer* “much stress has been laid upon the injuries they have a power to inflict, by excessive loans and consequent bankruptcy, and by creating and circulating a permanent excess of currency. Could these two evils be avoided, many believe that Banks would be innoxious. I regret to differ. I am not of those who imagine that Banks incorporated with a liberal capital, will ever endanger their solvency by extending their loans; nor of those who believe that Banks controlled by specie payment, can circulate a permanent excess of paper. And yet, I think I can perceive a portentous power that they exercise over commercial enterprize. I am of opinion that they can circulate a temporary excess of paper, which, from time to time, finds a corrective, in a run upon the Banks for specie; that this temporary excess is succeeded by a temporary deficiency, one extreme invariably tending to another; that the consequences of this alternate excess and deficiency are, in the former case to impart an undue excitement, and in the latter an undue depression to commercial enterprize; that the effect of the former is to create an unnatural facility in procuring money, and to enhance unnaturally the price of commodities; while that of the latter is to produce an artificial scarcity, and to cheapen prices artificially; that the victims of these vibrations are the great body of merchants, whose capital and average deposits cannot always command discounts; that the gainers are a few intelligent and shrewd capitalists, the magnitude of whose deposits commands enormous discounts at all times, and who, being behind the curtain, know when to buy and when to sell. I am of opinion that these vibrations inflict evils which close not with mercantile speculation; that they tend to unhinge and disorder the regular routine of commerce, and introduce at one moment a spirit of wild and daring speculation, and at another, a prostration of confidence, and stagnation of business: that these feelings are transferred from the counting-house to the fire-side; that the visionary profits of one day stimulate extravagance, and the positive losses of another engender spleen, irritation, restlessness, a spirit of gambling and domestic inquietude.