A Short History of Paper Money and Banking

CHAPTER XX. Summary View of the Advantages which the System gives to some men over others.

If two individuals should trade with one another, on the same principle that the Banks trade with the community, it would soon be seen on which side the advantage lay. If A should-pay interest on all the notes he gave, and finally pay the notes themselves with his own wealth, and if B should receive interest on all the notes he issued, and finally pay the notes themselves with A’s wealth, A’s loss and B’s gain would be in proportion to the amount of transactions between them.

This is the exact principle of American Banking operations; but, owing to the multitude of persons concerned, the nature of the transaction is not discovered by the public. Regard the whole Banking interest as one body corporate, and the whole of the rest of the community as one body politic, and it will be seen that the body politic pays interest to the body corporate for the whole amount of notes received, while the body corporate finally satisfies the demands of the body politic by transferring the body politic’s own property to its credit.

In private credit, there is a reciprocity of burdens and of benefits. Substantial wealth is given when goods are sold, and substantial wealth is received when payment is made, and an equivalent is allowed for the time during which payment is deferred. If A took a note from B, endorsed by the richest man in the country, he would require interest for the time for which payment was postponed. But the Banking system reverses this natural order. The interest which is due to the productive classes that receive the Bank notes, is paid to the Banks that issue them.

If the superior credit the Banks enjoy, grew out of the natural order of things, it would not be a subject of complaint. But the Banks owe their credit to their charters—to special acts of legislation in their favor, and to their notes being made receivable in payment of dues to Government. The kind of credit which is created for them by law, being equipollent with cash in the market, enables them to transfer an equal amount of substantial wealth from the productive classes to themselves, giving the productive classes only representatives of credit, or evidences of debt, in return for the substantial wealth which they part with.

To test the Banking principle fairly, let us bring down our minds from a country to a county, and, to give definiteness to our ideas, let us, in all instances, make round numbers the basis of our calculation.

Suppose a county to contain a thousand families of ten persons each, and each family to be worth 5,000 dollars. The wealth of the community is, then, 5,000,000 dollars. One-tenth of this wealth, or 500 dollars for each family, we will suppose to be in silver money. The rest is in land, houses, and various commodities. The state of credit in this county is as sound as the state of the currency. The distribution of wealth is left to natural laws. The production and acquisition of riches are never separated. Every man enjoys what he produces, and what he saves; and no man enjoys what is produced or what is saved by another. We will suppose the income of this community to be 1,000,000, dollars, or 1,000 dollars a year for each family, and that 700,000 dollars of this aggregate income is derived from industry, and the rest from capital, profits being at the rate of six per cent.

In this county are ten men of a speculative turn of mind, who grow tired of working and saving, and wish to grow rich in some more easy way. They apply to the Legislature for a charter for a Bank, with a nominal capital of 100,000 dollars, divided into a thousand shares of 100 dollars each: and their prayer is granted. It is provided in the charter that, as soon as five dollars shall be paid on each share, the Bank shall commence operations. The payment of the other instalments is, according to the custom of Pennsylvania, left to the discretion of the Directors.

The business of Banking is new in this county, and as none clearly understand its operation but the ten speculators, they subscribe for the whole of the stock, or for one hundred shares each. Each of them pays down 500 dollars, making the whole capital paid in, 5,000 dollars.

The Bank then commences business, and issues notes to the amount of 25,000 dollars. By the contrivance of “convertibility,” and by another contrivance by which they are made receivable in payment of dues to Government, the notes become current. The notes are borrowed by the speculators. Each speculator has then 2,500 dollars at command, instead of 500. It is true, he pays interest to the Bank as a borrower: but he receives the same interest back as a stockholder. It is evident that the equality of wealth is destroyed. The possession of a monied capital so much greater than that of his neighbors, will give him advantages in trade equal to double the amount of interest. But, estimating his advantages as equal to only six per cent., his annual income is increased from 1000 dollars to 1120, his 500 dollars formerly yielding him but 30 dollars a year, and now, by their conversion into Bank-stock, yielding him 150 dollars; for, each metallic dollar is, by this contrivance, made to produce to him as much as five did formerly.

But this is only the first operation of the Bank. Some of the families in the county deposit their silver in the vaults of the Bank, for safe-keeping. Other families, finding that Bank notes serve all the purposes of domestic trade, export their silver. This creates a new demand for Bank notes as a circulating medium. In time, the Bank finds that its permanent deposits of silver are not liable to be reduced beyond a certain amount: and to increase its profits, it lends a great part of the silver to those who export it.

It may require some years to bring the machine into complete operation. The “prejudices”f some men against paper, and in favor of metallic money, are not easily subdued. But even those with whom the “prejudices” remain, are brought at length, through the force of example, through necessity, or through some other cause, to make deposits in Bank, and to pay and receive Bank paper. Bank medium then becomes the money of the county: and as soon as this is accomplished, the regular receipts of the Bank may be estimated as follows:

On 100,000 of Bank notes lent, at 6 40,		-	$6,400
On 100,000 of active Bank credit lent,		-	6,400
On 100,000 of silver deposited by some, and lent by the Bank to others who export it,		-	6,400
			$19,200

On this supposition, 200,000 of metallic money will be left in the county, half of which may be in the vaults of the Bank, and the other half circulate as the medium of retail trade.

In our haste we passed over the payment of the second, third, and subsequent instalments of the stock. It was not of much moment. The payments were merely nominal. The speculators could easily have paid all the instalments, after the first, by the profits derived from the operations of the Bank itself. But where would have been the use of this? The money, if paid in, would have been lent and exported. It would have added something to the income of the Bank. But each speculator can make as much by keeping it in his own hands. The original sum of 5,000 dollars, and so much of the silver of depositors as is retained, are sufficient to support the credit of the Bank. Each of the speculators, therefore, throws in a note for 500 dollars, when the second instalment becomes due. The Bank discounts it: pays out its own paper at one counter, and receives it hack at another, or, perhaps, only makes a new credit entry in its books. It is true, that the speculators are made debtors to the Bank for a certain amount as borrowers: but they are credited with an equal amount as stockholders: and in this way the whole of the remaining instalments may be arranged. By this contrivance the sum of 95,000 dollars will be added to the debts due to the Bank, but nothing to its circulation or responsibilities.

The time has now come, in which the speculators may sell a part or the whole of the stock. They may with safety dispose of seven hundred and fifty shares, to widows, orphans, and literary and charitable institutions, for these will never interfere with Bank management.

We will deduct 9,200 dollars from the gross income of the Bank, for expenses, losses, and reservations for a contingent fund. It will then be able to divide ten per cent. on its nominal capital: and at the rate at which permanent annuities are calculated, stock yielding ten per cent. will be estimated as worth in the market 150 dollars a share. Each of our speculators sells seventy-five shares of his stock at this rate, or for 11,255 dollars, and invests the proceeds in land, houses, or merchandise. The risk of payment to the Bank of the notes discounted, he transfers to the purchaser of the stock.

Thus we see that our ten speculators have, by the “judicious” use of 5,000 dollars of metalic money, got transferred to them 112,550 dollars’ worth of real and personal estate. Retaining two hundred and fifty shares of stock, they keep the control of the institution in their own hands.

Now, we pretend not to say that the accounts of any one of our American Banks would, if faithfully exhibited, accord in every particular with this supposed case. Their profits do not appear to be usually as great: but extreme cases serve best to illustrate principles; and these are the fundamental principles of the American Banking System. A small amount of metalic money is paid in: the other instalments are arranged by the discounting of stock notes. The Bank extends its operations by discounts on deposits, and by substituting a paper for a metalic medium: and, at a suitable time, the founders of the Bank sell a portion of the stock, and invest the proceeds in lands, houses, and merchandise.

The Bank of Chester had, on the 3d of November, 1829, a capital of 90,000 dollars, notes in circulation to the amount of 209,064 dollars, and deposits to the amount of 166,374 dollars. The specie in its vaults amounted to 61,462 dollars, and the investments on which it was drawing interest amounted apparently to 451,663 dollars. The circulation and deposits of the Bank of Chester, were altogether 375,438. Those of the Bank in the case supposed, for the sake of illustrating the principle, were only 300,000 dollars. The investments of the Bank of Chester, yielding interest, amounted to 451,663. Those of the supposed Bank, to only 395,000, including the stock notes of the ten founders of the Bank.

It may be, that the whole 90,000 of the capital of the Bank of Chester was paid in, without any resort to discounting of stock notes, or any similar contrivances. But if it was, there was nothing in the principles of the system to prevent the stock of the Bank of Chester from being filled up in the way which is usual in establishing new Banks in America. The Bank of Chester County having gone into operation in the year in which specie payments were suspended, the filling up of its stock must have been an easy process, whatever method was adopted.

As it is public credit that supports the Banks, and not the Banks that support public credit—as the deposits of the Banks are the property of the community generally, and as the profits derived from circulation come from the community generally, they ought to go to the community generally, and be used (if used at all) to lighten the burdens of taxation. “If,” says Ricardo, “a charter were about to expire, the public might question the policy of permitting a company to enjoy all the advantages which attend the supplying of a great country with paper money. Paper money may be considered as affording a seignorage equal to its whole exchangeable value—but seignorage in all countries belongs to the State.”

If, after the manner of the Scotch Banks, the American Banks paid four per cent. interest on deposits, and granted discounts at the rate of five per cent. there would be something like equity in this department of their operations, for one per cent. would not be more than a fair commission. But they allow no interest on deposits, except in Boston, and perhaps in Baltimore, though it is, in point of fact, through the means of the deposits, that they support the credit of the notes they have in circulation.

But the reader will have a very imperfect idea of the advantages the present Banking system gives to some men, if he extends his view no further than the profits derived from trading on deposits, from substituting a credit medium of commerce for a metallic medium, from the formation of Bank stock secundum artem, and the subsequent exchange of that Bank stock for lands, houses and merchandise.

In addition to this, he must take into consideration—

What some have gained and others have lost, by the various kinds of stock-jobbing and usury, to which Banking has given rise:

What some have gained and others lost, by that fluctuation of prices which is produced by “contractions” and “expansions” of Bank medium, and which has made most kinds of business more uncertain than a lottery:

What some have gained and others lost, through that super-extended system of commercial credit, which has its origin and support in Banking:

What some have gained and others lost, by the breaking of upwards of one hundred and sixty Banks between the years 1811 and 1830:

What some have gained and others lost, through the circulation of counterfeit notes:

What some have gained and others lost, by receiving genuine notes at one rate, and passing them at another:

Let him add all these accounts together, and he will have a pretty correct idea of what some have gained and others have lost by the direct operations of the system.