A Treatise on Currency & Banking

BOOK THE SECOND.

OF THE LAWS WHICH REGULATE A MIXED CURRENCY COMPOSED OF THE PRECIOUS METALS, AND OF PAPER CONVERTIBLE INTO COIN ON DEMAND.

IN the former part of this work I pointed out the principles by which a currency composed entirely of the precious metals is regulated. I come now to speak of the laws which regulate a currency composed of coin and convertible paper, and here I wish it to be distinctly understood, that by convertible paper, I mean notes issued by banks, payable to bearer in coin on demand. Paper money issued by governments, like the paper of the North American colonies before the revolution, or like the continental money of a subsequent period, or like the assignats of France, or the actual paper money of some of the nations of Europe, not being payable in coin by the issuers at the pleasure of the holder, belongs to another category, and is governed by laws peculiar to itself.

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CHAPTER I.

OF BANKS OF DEPOSITE, OF BANKS OF DISCOUNT AND OF BANKS OF CIRCULATION.

OF banks there are three distinct kinds, wholly different from each other, in their constitution, their uses, their operations, and their influence upon the public prosperity, viz. banks of deposite, banks of discount, and banks of circulation, or, as some express it, banks of issue, of each of which I will speak in its turn.

A bank of deposite is an institution established solely for the safe keeping of the coin and bullion of individuals, which would otherwise have to be kept in iron chests or less secure receptacles, and for facilitating mercantile payments by the transfer upon its books by checks or drafts of the various amounts standing to the credit of the depositors, thus saving the labor of repeated countings, and the expense of repeated transportations of the precious metals from house to house, accompanied at the same time by a diminished risk from fire or pillage, and a diminished wear and tear of the coins by friction. Such a bank, it is manifest, is more appropriate for a community using a currency of coin alone, than for one employing a mixed currency; and accordingly, we find such a bank as having formerly existed at Amsterdam, and at the present day at Hamburgh, in which latter city, a deposite of standard silver of the weight of a marc, entitles the depositor to the credit of an amount denominated a marc banco, which is the unit of the currency of Hamburgh, in which all bills of exchange and mercantile debts are payable, and which the party who holds the credit may draw out at his pleasure in marcs weight, or transfer to others. As regards the operations of this particular species of banks, the reader will perceive that they add nothing to the existing amount of the currency, and that they take nothing from it. The credits on their books represent certain quantities of bullion ascertained by weight, placed there for safe keeping, without any authority on the part of the administrators of the bank to lend it, or to apply it to any purpose whatever, until called for by its owners, or transferred by them to other persons; and hence it is clear, that such banks exercise no influence whatever over the currency, by contracting or expanding its amount.

A bank of discount is an institution possessing a capital in money, which the proprietors, for there are usually several, associated in part for the sake of maintaining a survivorship, lend to merchants and others by discounting acceptances and promissory notes, originating in the sale of merchandise and other property, having short periods to run. It also receives on deposite, either by allowing interest or not, as the agreement may be, the money of other people, repayable at fixed periods or on demand, which it also lends with its own capital in discounting commercial securities. Of this description of banks, are all the establishments in London, (except the Bank of England,) and many of those of the principal cities on the continent of Europe known as private bankers. Several bankers of the same description, but better known as extensive brokers, have also at different periods in New York and Philadelphia, carried on the business of lending their own capitals and the capitals of others deposited with them, and it is probable that in every commercial community there are establishments of the kind upon a larger or a smaller scale. As such banks do nothing more than lend the money which actually exists in the community, it is evident, that they, like banks of deposite, exert no influence whatever over the currency, in expanding or contracting its amount, and that consequently they produce no effects different from those which would result if the same money had been loaned out by its individual proprietors, through the agency of brokers.

Some persons indeed suppose that where the money of depositors is repayable on demand, an expansion of the currency takes place to the whole extent of such deposited sums, in case they have been loaned to others, inasmuch as the depositor as well as the person to whom his money has been loaned, has each the power to make purchases in the market for the same amount, the right possessed by the former to draw money out of the bank, giving him the same command of funds as the actual possession of money by the latter confers upon him. But this is an error, for, if the depositor’s money has been loaned out, it can in no possible way be paid back to him, but by the bank’s requiring the borrower or some other of its debtors to refund an equal amount, by which process the aggregate mass of the currency is preserved the same as before. Banks well administered, do not, however, place themselves in the condition of being obliged in order to meet the sudden demands of depositors, to call unexpectedly on their debtors. They keep on hand an amount of money unemployed, sufficient to meet any probable calls that may be made upon them, before the bills receivable held by them fall due, and like the mill pond which is supplied with water from the stream above, just as fast as it is discharged through the mill race below, they preserve a uniform level in the currency. Nor is the matter at all changed by the fact that bank credits or deposites are transferable by means of checks, from the account of one person to that of another, for it is clear, that if by such transfers, one person becomes possessed of the command of funds, another parts with it to the same amount, and consequently, there is but one power of purchase in the market at any one time, with the same money.

A bank of circulation is an institution established solely for the purpose of lending credit, which is performed by exchanging its promissory notes payable to bearer on demand in coin, or giving transferable credits on its books, also payable on demand in coin, for the promissory notes of individuals, payable at a future fixed day, the latter paying a per centage per annum equal to the interest on a loan of capital, for the advantages they consider themselves as enjoying by dealing in the market with the credit of the bank instead of their own. The operations of such a bank, it will be perceived, are different from those of the two preceding ones, inasmuch as the currency by the introduction into it of paper money and paper credits, createable at will, in addition to the coin which before constituted the entire currency of the country, admits of expansion and contraction, and consesequently of fluctuations such as are unknown under a metallic currency.

In the nine hundred banks and branches which now exist in the United States,1 all the operations of these three distinct institutions are combined; and it is owing to this combination, by which dissimilar things are confusedly mixed together, that the public mind has been led into so much error upon the subject of banking. An analytical examination can alone enable any one to understand the true merits of this important subject.

From the foregoing definitions it will be seen that banks of deposit and banks of discount are of positive advantage to every country in which they are established. The former protects the gold and silver of the community from the danger of robbery and fire, as well as from loss by abrasion, as has already been remarked, and at the same time greatly facilitates the operations of commerce by the convenience of payments in checks instead of payments in coin. The latter keeps the money of the community in constant employment by lending it to one borrower, as fast as it is paid back by another. But it will be readily seen, that such institutions do not hold out sufficient temptations for their frequent establishment, as corporations. To maintain a bank of deposite, a fund must be provided by government or individuals to defray its expenses, inasmuch as no number of persons would assume the responsibility of taking care of other people’s money, and of keeping their cash accounts, without compensation, and in regard to a bank of discount, it would scarcely be worth while for a company to become incorporated or to pay the rent of a banking house, and the salaries of a number of officers, to do that which the individuals could do themselves or by the employment of brokers at a much less expense, or, indeed, at no expense at all, as the brokerage is usually paid by the borrowers, unless a comparatively large amount of deposites could be relied on, at a low interest or at no interest at all. Banks of circulation have, therefore, been resorted to, as presenting the only certain, or apparently certain, prospects of emolument; and as the credit requisite to give confidence to the paper could not be established without having for its basis a capital, more or less extensive, they have in every case been consolidated with a bank of discount. To secure the popular favor too, as well as to derive a profit from the lending of the money of others, they have also taken upon themselves, without charge to the public, that part of the duties of banks of deposite which relates to the keeping of cash accounts with individuals, and transfers of credits on their books, but not that part which guarantees the safe keeping of the coin and bullion of depositors, except in the few cases where an agreement for special deposites is made.

But banks of circulation are themselves, when properly conducted, and when their operations are confined to the legitimate objects of banking, and when their liability to comply with their contracts is strictly enforced by the public, capable of conferring benefits upon a country. By the creation of paper money they enable the merchants to export a part of the metallic money which was previously required to circulate its commodities, and thereby convert it into active capital, yielding an annual income equal to the average profits of trade. The mode in which this is effected, I will endeavor to illustrate in detail in the succeeding chapter.

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CHAPTER II.

OF THE OPERATIONS OF BANKS OF CIRCULATION.

IN a former part of this treatise2 it was shown, that under a metallic currency, it is not possible to retain in any country, for any length of time together, a larger amount of coin than that which is requisite to place its currency upon a level with the currencies of other countries; and it was also shown, that if by any extraordinary cause a greater amount should at any time be brought into any country, it would continue but for a short time, and would gradually disappear by exportation, in the manner there described, until the equilibrium should be restored.

What is true of a metallic currency, is equally true of a mixed currency, consisting of coin and paper exchangeable for coin on demand. The aggregate amount of the two component parts cannot exceed for any great length of time, the amount of coin which would circulate if there was no paper, as I shall now proceed to show.3

Let us suppose that, in a particular country, enjoying a metallic currency, the quantity of coin requisite to circulate its products and commodities, and to maintain its currency upon a level with the currencies of other countries, is ten millions of dollars, and that the balance of trade and payments is such at the time of our supposition, that the exchange is at par. A bank of deposit, discount and circulation is established upon the corporate or joint-stock principle, with a capital of one million of dollars in coin, which amount is of course to be taken from the ten millions in circulation. We will suppose this capital all to be paid in before the bank commences its operations. The effect of this would be a temporary pressure for money, by withdrawing one million of dollars from circulation. This pressure, however, would be gradually relieved, as the bank commenced discounting, and would wholly disappear after it had loaned out a million of dollars.4 Now it is manifest, that up to the period at which the loans of the bank do not exceed one million of dollars, its operations have been simply those of a bank of discount, for it has only loaned the amount of its capital, that is, of money previously existing. It may indeed, have issued notes, or given credits on its books for loans made, instead of paying out the identical gold and silver received from the stockholders; or, it may have given notes, or credits, on a deposit of coin for the convenience of the public; but such notes and credits in such cases would be mere certificates that corresponding amounts of gold and silver were lying in the vaults of the bank, belonging to the owners of such notes or credits, held subject to their order, precisely as in the case of special deposites. It might even happen, that millions of dollars in the form of notes and credits might be issued by the bank in exchange for specie, without thus far exercising one single prerogative of a bank of circulation, or influencing in the slightest degree the state of the currency, any more than the Bank of Hamburgh, already described, influences the currency of that city.

From this view of the subject, how clear is to be seen that what the bank has thus far performed, is nothing more than what the individuals who own the capital of the bank, could themselves have performed more cheaply, quite as securely, and perhaps more advantageously to the public, seeing that loans to unskilful and imprudent borrowers, of which individuals are not so apt to be guilty as corporations, lead to a diminution of the wealth of a country, whether it result from injudicious voyages, or from any species of enterprise which converts productive capital into properly which is not equally productive, or, from improvident sales of merchandise to persons not entitled to credit. Incorporated or joint stock banks, it is thought, owing to their directors not having a deep personal interest at stake, and owing to their liability to be influenced as a board, by considerations which do not operate upon individuals, and especially owing to the absolute impossibility of their devoting any large share of their time to the investigation of the characters of all applicants for loans, cannot, in the nature of things, exercise the same discrimination in the choice of its borrowers, as individual capitalists do.5

The circulating principle is now put into operation by our supposed bank, by lending its credit in addition to its capital. In other words, without having any more money to lend, it undertakes to discount notes at short periods, by giving to the borrowers not coin, or notes or credits absolutely representing coin in its vaults, as in the case of its original loans, but notes or credits promising to pay gold or silver on demand, founded upon a presumption that no such demand will be made, until the notes, in the discount of which they were issued, or some of the other notes discounted by the bank, will be paid, and thus bring into its coffers an equal amount of specie. In other words, the bank lends its credit, and as this credit is just as valuable to any of the parties who are indebted to the bank for the first million, or for any subsequent sum loaned, as gold or silver, any of them will be willing to receive it in payment of debts or for merchandise sold, as readily as coin, and the notoriety of this fact, added to the right of conversion on demand, gives the notes and transferable credits of the bank a circulation with the public equivalent to coin. Every emission, however, of these bank notes and credits is an augmentation of the currency, and depreciates it below the general level.6 Let us, for the sake of argument, suppose the amount of this augmentation to be extended in a given time to one million of dollars, that being the sum requisite, we will further suppose, to occasion the degree of depreciation that must exist before it is profitable to export coin. The amount of the currency will then be eleven millions of dollars, that is to say, ten millions of coin, and one million of paper. The effect of this would inevitably be what is called a plenty of money. The prices of all commodities would rise, because there would be eleven purchasers in the market, where before there were but ten, or, what amounts to the same thing, because the former purchasers would possess one tenth more means to purchase with, than they possessed before. This rise of prices, operating upon foreign as well as domestic commodities, would lead to the importation of additional quantities of foreign merchandise. But no corresponding export of domestic products would take place, on account of their artificially high price, upon which bills could be drawn to pay for the foreign imports; and the consequence would be, that money would be sent abroad in their stead, as presenting the most profitable species of export. But of the money in circulation, it is evident that nobody would think of exporting the paper, which would have no value abroad, and consequently, all the exports that would take place, would be of coin.

The effect just described would as certainly take place as that water would find its level, and would continue until the export of coin was equal to the amount of the paper issued, that is, to one million of dollars, when the level would be again restored, owing to the fact of the aggregate of the coin and paper united being only ten millions of dollars, that is, nine millions of coin and one million of paper.7 Further emissions of bank notes or credits might then take place with precisely the same results, and provided that the extent to which the issues are carried is not so great as to drive out of the country too great a portion of the metallic currency, by which the convertibility of the paper into coin in case of a sudden panic occasioned by foreign war or domestic disturbance, or by fear of insolvency, might be endangered, the operations of the bank are decidedly beneficial to the country. It has disengaged from a comparatively unproductive employment, a capital capable of producing an annual profit to the nation equal to the average profits of capital, or, in other words, has substituted an expensive instrument of commerce by one costing less. And yet, by this operation, no permanent depreciation of the currency takes place, because the total quantity of coin and paper united is only equal to the quantity of coin that would have circulated had there been no bank.

From these positions two conclusions are self-evident: first, that banks of circulation are only beneficial to a country when they occasion the exportation of coin; and secondly, that paper is only beneficial when its quantity does not exceed the quantity of coin which has been removed from the currency by exportation. The actual extent to which this substitution may take place with safety to a banking system is a matter which cannot be determined by any fixed proportions. Some persons fancy that the extent to which a bank may loan without danger of reaction depends entirely upon the extent of its capital, and reason thus: if a bank with one million of dollars capital can with safety loan a million and a half, which is fifty per cent. increase, one with a capital of ten millions of dollars can loan to the extent of fifteen millions. Others imagine that the power of expansion in a bank always bears a fixed proportion to the average amount of its deposites and circulation; whilst others again entertain the idea that it depends upon the amount of coin it has in its vaults, and that if this be large, the amount of its issues may be proportionally large. All these hypotheses, however, are fallacious. The real truth is, as has been shown, that the channels of circulation will only hold, without depreciation, a certain quantity of paper in addition to the quantity of coin that must needs exist as the basis of the mixed currency, and this is equally the case whether the paper be issued by one bank or by one thousand. All attempts to increase that quantity permanently beyond the quantity requisite to preserve an equivalency with the general level, must, in the nature of things, be futile. If the channels are made to overflow, depreciation of the whole mass (for where convertibility exists the coin is involved in the depreciation in common with the paper) will necessarily take place, followed by an exportation of coin as a necessary effect from a cause, and all redundant issues of notes will return upon the issuers for payment, with the same unerring certainty as the fabled stone of Sysiphus rolled back upon the wretched struggler. It may, however, be here remarked, that the possible case might occur of a favorable balance of trade existing at the same time that an expansion of the currency has taken place, the consequence of which would be, that the former, by occasioning a low rate of exchange, would arrest the tendency of the depreciated currency to relieve itself by exportation. But such a state of things could not long continue, and it is merely referred to as presenting one of the phenomena which we occasionally witness, and which sometimes puzzle the heads of superficial reasoners so much that they deny the existence of all fixed principles in political economy.

There is, however, one circumstance connected with the corrective power of exportation, which is of vast importance, and which renders the paper currency of the United States more liable to excessive depreciation than that of any European country. I allude to the effect produced by a war with any powerful maritime nation, which by augmenting the rates of freight and insurance on specie, prevents the application of the remedy against over issues by the banks, at as early a stage of depreciation as would take place in time of peace. Thus in a time of peace, one per cent. would cover those charges between North America and Europe, whereas in a time of war, five or ten per cent. might be required, the inevitable result of which would be, that the paper currency, although convertible on demand into coin, might be depreciated to the extent of five or ten per cent. below the general level, and foreign bills of exchange might rise to that extent above the real par, before the merchants, having remittances to make, would find it advantageous to ship specie, and consequently before any reaction would be felt by the banks. This fact ought to have weight with our public men, as being one of the most fatal of the elements which make up the aggregate of national suffering, arising from a state of war, as may be well remembered by those who witnessed the suspension of specie payments in 1814 during our war with England, and its disastrous consequences.

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CHAPTER III.

OF THE PRINCIPLES BY WHICH THE PROFITS OF BANKS OF CIRCULATION ARE DETERMINED.

FROM what has been said in the preceding chapter, how clearly is it to be perceived, that the profit to be derived from supplying the paper currency of a country, is a limited amount, and that if it be divided amongst a great number of banks, and distributed over the surfaces of many large capitals, its proportionate rate must be very small. To make this matter, however, more plain, for I consider a correct view of this branch of the subject as all-important in overthrowing the present errors of our banking system I will illustrate it by reference to the case of the same country, which was above supposed to require a circulating medium of ten millions of dollars.

Without pretending to determine the precise extent to which its coin might be safely substituted by paper, I will suppose, for the sake of argument, that one half of the former shall be exported, and that consequently the currency consists of five millions of coin and five millions of paper. Under this state of things, the bank would be drawing interest on a sum five times as large as its capital, even allowing that it retained a sum equal to its whole capital of a million in its vaults in coin, to meet occasional demands. The profits of its business would therefore be very great on account of the small capital of which it was the income, and the consequence would no doubt be, as soon as the secret should become known to others, that a second bank would be established.

Few of the projectors, however, of this new bank would probably believe that the great profits made by the original bank were the result of a monopoly, and that they would not have been any greater in absolute amount, if its capital had been five millions instead of one; but under delusive notions that the same per centage of profit, or something near it, would attach to a large capital as to a small one, they would probably establish their new bank with a capital, let it be supposed, of two millions of dollars. Now to make a proportionate profit equal to that enjoyed by the original bank, paper must be issued to the amount of ten millions, and the bank accordingly commences its operations by a profusion of loans. But the channels of circulation are already full of the paper of the old bank, and there is no room for any more. Issues, however, go on until money becomes plenty, and the currency becomes depreciated below the general level, as in the case of the original bank. Prices of all commodities rise; foreign merchandise, by its high price, holds out inducements for importation; domestic products become too dear for exportation; bills of exchange rise, because the demand for them to pay for foreign commodities increases faster than the supply; and as soon as their price in the market exceeds the amount of the expense of transmitting gold and silver abroad, a portion of the remaining five millions of coin will be exported. Then is the new bank first reminded of its mistaken views. Its notes return upon it for payment in coin, to be sent out of the country, and its neighbor, too, the old bank, which has five millions of paper in circulation, feels the effects of this reaction, and both are obliged to call in a part of their loans, in order to avoid a worse state of things. The consequences would be, a general scarcity of money, and a temporary commercial embarrassment. The result, however, would be found to be, that as five millions of dollars was the total amount of paper that could be kept in circulation without depreciation, the profits of furnishing this amount are now to be divided between two banks instead of being monopolised by one, and in such proportions as the particular influence or management of each may be able to establish.

A similar effect precisely would follow the creation of every additional bank: and should the number increase to five or ten, the aggregate profit would still be the same; for although the paper currency of five millions would be occasionally augmented in quantity as each bank commenced its operations, as has been shown, yet in the long run it would settle down at the old amount. But, notwithstanding the certainty of this fact, there would still be a perpetual endeavor on the part of some of these banks to get the largest share of the profits of this supply of the paper currency by extraordinary issues. This, however, it could not accomplish, if the public would always insist upon strict convertibility, and if other banks were true to their interests by making a daily demand upon each other for the payment of balances occurring in their mutual transactions, not in paper, but in coin.

And here I will remark, that precisely as each bank of a city thus checks the issues of its neighbors, the united banks of a city check the issues of other neighboring cities. If the currency of a particular city, Philadelphia, for example, were to become depreciated below that of New York, the effect would immediately be shown by a rise in the former city in the prices of stocks, bills of exchange, and other securities of easy transmission, of which the consequence would be, that amounts of these would be sent to Philadelphia for sale, and by that means the banks of that city would be brought into debt to the banks of New York, which would call for payment of the balance in coin, and that would lead to a contraction of the currency, until the equilibrium would be again restored. It is precisely upon the same principle that the general currency of the country is corrected by the influence of those of foreign countries, and therefore, if any obstruction to the free exportation of coin should at any time exist, either by the timidity of the holders of bank notes to demand their rights, or by the laws of a country, or by the exciting of public odium against the exporters, either by banks, politicians, or otherwise, so as to deter them from exporting when it is profitable for them to export, the currency must inevitably sustain depreciation, and mischief must be the result.

In connection with this subject, it may here be also remarked, that should the time ever arrive, when all the principal commercial countries of the world should adopt the circulating banking system, the whole of the benefits resulting from the substitution of paper money for coin will vanish. The only reason why this substitution is now productive of profit to any country where banks of circulation exist, is, that there are other countries in which there is no paper money, and which are willing to give other commodities for gold and silver. But only let them all adopt the policy of issuing bank notes in an equal proportion, so as to preserve their respective currencies upon the same level, and it will at once be seen that the precious metals will not flow out from either, and that the inevitable consequence will be, that the prices of commodities and property will be increased all over the world, whilst not a dollar will be added to their value. Every movement made in Europe towards the establishment of banks of circulation, is a step towards that terrible consummation, when no domestic or foreign checks will longer exist to prevent those unlimited expansions, which cannot possibly exist without alternate contractions, subversive of the industry and prosperity of the whole civilised world.

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CHAPTER IV.

OF THE SAFEST AND MOST PROFITABLE MODE OF INVESTING THE CAPITALS OF BANKS OF CIRCULATION.

IT has been shown that banks of discount upon the corporate or joint-stock principle could not generally he conducted to a profit, seeing that the income they derive from the loan of capital would not be as great as the income which the individual proprietors could have derived from lending their money without the agency of salaried officers and the rent and other expenses of a banking house. It has also been shown, that for the same reason, banks which perform the double function of banks of discount and banks of circulation, can make no banking profit by the mere lending of their capitals. All their profits are derived from lending their credit; for, although where the rate of interest is six per cent. per annum, the practice of taking the interest beforehand, and charging sixty-four days discount for the use of the money for sixty-three days, as in Philadelphia and other places, the actual rate received is 6 per cent., yet the additional four-tenths of one per cent, do not pay the proportion of the whole expenses of the bank, which the amount of its capital bears to the whole amount of its loans. Indeed, a little reflection will enable any one to perceive, that not only do all the profits beyond legal interest of a bank of discount and circulation, where it is successful, arise from the loan of its credit, but those profits must besides furnish a fund for making up the loss incident to the lending of its capital. Thus, if we suppose a bank of discount and circulation with a capital of one million of dollars, having loans out to the amount of one million and a half, and the whole annual expenses of the bank to be fifteen thousand dollars, or one per cent, upon the amount of the loans, it will be seen that two thirds of this expense attaches to the lending of the capital, and only one third to the lending of the credit of the bank, so that if separate accounts were kept of the expenses of each department of the institution, they would show a gain upon the lending of credit and a loss upon the lending of capital. If, therefore, the whole operation be profitable, the profit must arise from the lending of credit, and must consist’ of what remains after defraying the loss incident to the lending of the capital, which is precisely equal to the excess of the expenses of bank agency in loans over those of private agency, deducting the four-tenths of one per cent, which a bank charges, more than individuals would have a right to charge by law on loans.8 At all events, no one will pretend that banks make more by the loan of their capitals than individuals could make, and even on this admission it is apparent that all the peculiar profits of what is usually called banking arise from the loan of credit.9

Now, if these positions be true, it follows as a necessary consequence, that the true policy of banks of discount and circulation is, to adopt the most economical and safe mode of lending their capitals, so as to lose as little as possible by the operation. Long loans, it is manifest, are attended with less expense than short ones, and the security of real estate or public funds is safer than the promissory notes of individuals. One officer can superintend loans on mortgage or investment in public securities, collect the interest, and keep all the accounts, as easily as four could attend to the discounting of an equal amount of notes at ninety days; and as to the difference between the security of mortgages and public stocks, and private paper, no one can fail to see the superiority of the former.

From these views, it is evident that banks of circulation derive no benefit whatever, but rather injury, from having capitals to lend. Why then, it may be asked, should they be connected with banks of discount? For no other reason than to give credit to their notes, which would not be allowed to get into circulation as money unless the public was assured of a responsible endorser. The bank of discount thus becomes the guarantee of the bank of circulation, and as the solidity of the guarantee is what the public most look after, how plain is it to be seen that a capital loaned upon real estate or state stocks would be a better security against insolvency than any promissory notes or bills of exchange could possibly be. In other words, a bank with a capital of one million of dollars loaned upon well secured mortgages and state stocks of undoubted solidity would offer a better security for the payment of its notes, than one with an equal capital loaned upon discounted notes and bills.

And not only is this true; not only would the credit of its notes be more perfectly secured as far as the public is concerned, but the interests of the stockholders themselves would be very greatly promoted by such a mode of lending the capital, first by a diminution in the expenses of management, and secondly by a diminution of the risk of lending.

But this is not all. The individual borrowers themselves, of the capitals of banks, would be greatly benefitted by such a system. They would obtain money at six per cent, per annum, instead of six per cent, and four-tenths; they would be able to borrow for such long periods at once, by giving the requisite security, as would give time for the winding up of the voyage or operation for the conducting of which the loan was required, instead of asking for renewals every sixty or ninety days, always accompanied with a degree of uncertainty, and generally attended with the additional tax of a loss of interest upon a balance in bank, tacitly, if not expressly required as the price of a continued accommodation; amounting, probably, to as much as with the four-tenths of one per cent, above referred to, may be equal to one per cent.

To this it may, perhaps, be objected, that all borrowers have not real estate or state stocks to pledge for loans of money. Farmers and manufacturers may have lands, houses, and factories, but merchants may not; and, at all events, it would deprive of the power of borrowing capital of banks all those persons who have no real estate or state stocks to offer as security. This is perfectly true, and it is precisely what ought to be, for banks are bound to obtain as good security on the loan of their capitals as their individual proprietors would demand; and we all know that individuals rarely lend their capitals for long periods at simple interest, as permanent investments, upon the mere personal security of persons engaged in trade, or hazardous enterprises. If they do occasionally depart from this rule, it is because they have such a knowledge of the affairs of the borrower as to render his personal promise equivalent, in their estimation, to a mortgage; and at all events they have a right to risk their own property if they choose, but as banks of discount stand towards the public in the position of guarantees to the banks of circulation, with which they are united, they act unwisely if they accept of any but the most perfect security, such as that afforded by mortgage on real estate, or by an investment in undoubted public securities.

What has been said, let it be remembered, relates only to the loans of its capital by a bank, and I trust that the reader will not fail to perceive the justice of the remarks. He will at least perceive, that as far as the lending of the capital of a bank goes, whether the loans be made for sixty days or twelve months, whether they be made on mortgage or to the government, or upon promissory notes and bills of exchange, the effect upon the currency is precisely the same. Neither mode makes money more or less abundant than the other; inasmuch as that which has been loaned is precisely the amount which previously existed in the community, and is, indeed, the precise amount which the individual stockholders of the bank would have had to loan, had they not associated together as a bank. The question, then, is a simple question as to the borrowers, and whilst those who could not give landed security for loans might think themselves deprived of a right to which they are entitled; yet it is evident, that the holders of bank notes and bank credits, and the owners of the capital, and all the rest of the community, who are to a man interested in the safe employment of the capital which belongs to the whole society, are manifestly benefitted. In truth, however, borrowers have no rights as regards the capital of a bank which they do not possess as regards the capital of an individual; and any one would see how preposterous it would be for a borrower of money to insist with an individual upon his right to borrow his capital upon a promissory note, when the individual should refuse to lend in any other way than upon mortgage.

I am aware that a plausible objection to this reasoning might be raised with reference to the banking system as carried on in the United States, by asserting the fact, that were it not for the demand of borrowers who have no real estate to offer as security, there would probably not be employment for one half the banking capital now existing in the United States. This, however, proves nothing more than that there is in existence double the amount of banking capital required to sustain the credit of the paper currency, which I have shown to be the only advantage derived from bank capitals, seeing that as far as the capitals go, nobody gains by their amount being loaned through corporate agencies, rather than by their individual proprietors. If the fact be that nearly all the capitals of all our banks are loaned out upon personal security in the discounting of promissory notes and bills of exchange, it is quite clear that the stockholders are not as secure from loss, and that their profits are not as great, as they would be if one half their capitals were returned to them, and loaned out by themselves individually upon landed security. There can be no doubt that in the United States great mischief results from so large a portion of the debts of the community being in the form of promissory notes discounted by the banks, instead of permanent loans, owing to the temptation of banks to expand, arising from the broad field upon which they suppose they can contract in case of need, which is much larger than it would be if all their capitals were loaned out upon permanent securities. I say, “suppose they can contract,” because the fact of their being able to contract at all times, may be considered as fully disproved by the stoppages of payment in 1837 by all the banks, and in 1839 by all the banks to the south of New York.

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CHAPTER V.

OF THE LEGITIMATE OPERATIONS OF BANKS OF CIRCULATION.

HAVING disposed of the question of the safest mode of employing the capitals of banks, I now come to the question, what is the legitimate function of a bank of circulation, considered in its distinctive character as a bank without any capital to lend?

The manifest answer to this question is, to lend its credit in such a way as to produce the greatest possible benefit to itself without injuring the public.

The mode in which a bank lends its credit is to exchange its own promissory notes payable on demand, for the promissory notes or acceptances of individuals payable at a future period, deducting the interest for the time which the latter have to run before they become due, and allowing no interest on its own notes for the time that may elapse before their payment is demanded. In making this exchange, the profits of the bank depend entirely upon the length of time that its notes remain abroad, and its ability to meet them depends of course upon the length of time which the notes have to run in exchange for which they were issued. If bank notes be issued only upon the principles laid down in a former chapter as mere substitutes for coin exported, and without augmenting in any degree the amount of the currency, they will remain in permanent circulation, unless in case of a panic, or discredit, which occasions a run upon the bank, and will constitute a source of permanent profit; for although some of them may be constantly returning in payment of debts, yet they are sent out again as fast as they come in, in the discount of other bills or acceptances. As to the length of time which the discounted paper should have to run, experience must decide, the bank having regard to the possibility of a panic, as well as to the action of other neighboring banks, seeing that an over-issue by anyone of them, by depreciating the currency, may occasion a temporary reaction upon other hanks as well as itself, and disturb even those that are the most prudently conducted. The practice of the banks in the United States prior to the war of 1812, was generally to limit their loans to paper not having more than sixty-three days to run. Since that time, loans have been made at longer periods, extending sometimes even to four and six months, and to this circumstance is no doubt to be ascribed, in a great degree, the frequent revulsions that have since taken place in our currency, and especially that which eventuated in a general stoppage of specie payments in May, 1837.10 It must be manifest, that the power of a bank to meet any extraordinary emergency must depend upon the command it has over its loans, and if the experience of other countries can be considered as any guide, that of England and France may both be referred to, where discounts of paper having more than sixty or a hundred days to run, are wholly discountenanced. A similar practice in the United States could not fail to be productive of much benefit to the community, as a means of correcting with promptness any accidental expansion of the currency.

But in order to render legitimate the operations of a bank of circulation, its loans should not only be for short periods, but should be confined solely to the discounting of what is called business paper, that is, promissory notes and acceptances received by the holders for merchandise and property sold. If none others were discounted, the expansion of the paper system would only be in proportion to the expansion of business. When this was extended, so as to call for more currency, as at particular seasons of the year, more currency would be created; and when business was diminished, as at other seasons, so as to require less currency, the excess would be absorbed by the payments made back to the banks. In these operations, the level of the currency would not be disturbed, so as to produce a depreciation; for although there would at times be a greater quantity of bank notes in existence than at other times, yet this quantity would be in exact proportion to the increased demand, arising from an increase of transactions. Thus would the elasticity of the banking principle accommodate itself to the state of commercial wants. Money would always be procurable, when it was really wanted, and it would never be so plenty as to depreciate the currency. The holders of real paper could always get it discounted, and even those, whose sales of merchandise to the country should not put them in possession of notes or acceptances payable by resident debtors, could also, without any violation of the legitimate principles of banking, get discounts for short periods on the hypothecation of such foreign paper.

But it is absolutely necessary upon sound banking principles, that no paper except that received for property sold should be discounted. Fictitious or accommodation notes are not as safe investments for a bank as real notes. A real note given by A to B., for five thousand dollars, for a hundred hogsheads of sugar sold and delivered, endorsed by the latter, and discounted by a bank, is guaranteed by B., who has five thousand dollars in cash, the proceeds of the note, less the discount, and by A. who has five thousand dollars worth of sugar. Of this there is no doubt. An accommodation note drawn by C. to D. may have upon it two names apparently as solvent, but there is no certainty that the two together possess any thing more than the sum loaned by the bank. And this is not all. The discounting of a real note is merely anticipating a capital previously existing, whereas the discounting of an accommodation note is lending capital to one who did not possess it before. The borrower of money on an accommodation note must require it to pay an old debt, in which case his control over it is parted with, or, for some new operation, agricultural, commercial, manufacturing, or speculative, which in the nature of things may not be terminated in a short time, and in neither case is he the sort of borrower that a bank can rely upon to enable it to meet, under all circumstances, its notes payable on demand. Nor is this yet all. The discounting of notes given for property sold, does not encourage over-trading, like the discounting of accommodation notes. The latter, if the proceeds be not applied to pay old debts, places at the disposal of borrowers the means of speculating which they did not before possess. Speculation raises prices, and stimulates speculative sales and transfers, by which the regular business of the community is disturbed, only to be followed by a reaction.

From this view of the subject it may easily be seen, how absolutely essential it is for the interest of the public, that banks of circulation should retain unimpaired their control over their loans. So soon, therefore, as they exchange their promissory notes payable on demand in gold and silver, not for the promissory notes of individuals given for property sold, and payable at short periods, but for notes payable at distant periods, or for notes understood expressly or impliedly, to be renewable in whole or in part, they annihilate their power, and place themselves at the mercy of the public. They are liable to be called upon for the payment of their notes faster than their debtors are bound or are able to pay them; and instead of fulfilling their engagements promptly and in good faith, they are obliged to resort to discreditable expedients, to deter the holders of their notes from demanding payment.

In the preceding remarks, I have only spoken of bank notes as being the form in which banks of circulation lend their credit, but this was done to simplify the subject. All that has been said in relation to bank notes, applies equally to that other species of obligation which is expressed by the term bank credit or deposit when it arises from the discounting of a note, for it must be manifest that the same profit results to a bank, where such a credit or deposit remains undrawn for, as where an equal amount remains in circulation in the form of bank notes, and that the ability to pay such a liability depends, as in the case of notes, upon the length of time for which discounts are made.

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CHAPTER VI.

EXAMINATION OF THE COMMON OPINION THAT BANKS CREATE CAPITAL.

A VERY general error prevails with the public, arising from a want of analytical examination of the subject, which is, that banks have the power to create capital. As this error lies at the bottom of the whole system of false reasoning with which the speeches in legislative bodies, and the columns of newspapers are filled, and as its eradication is of vital importance to the country, and must precede any real reform in the banking system, I shall enter in detail into its investigation, and solicit the reader’s particular attention.

What is capital? The capital of a community is that aggregate mass of things possessing exchangeable value, which are destined to supply the necessaries, the comforts, and the luxuries of life, or, which are intended to be employed in the production of other things with such ultimate view. Hence lands, houses, workshops, factories, rail-roads, canals, provisions, clothing, fuel, merchandise, raw materials of every kind, ships, utensils, machinery, and other such articles, including gold and silver, are capital. If the farmer wishes to cultivate more fields, or to cultivate his present fields more highly, or to make improvements on his farm, or extend his operations in any way, the capital he stands in need of, is land, cattle, horses, sheep, implements, seed, food and clothing. If a manufacturer desires to enlarge his operations, he requires buildings, machinery, raw materials, and subsistence for his workmen. If a merchant proposes to extend his commerce, he wants ships, cargoes of agricultural produce, or merchandise, and provisions for his crew. The money which is wanted by each of these operators to deal with, as well as to pay the wages of those whom he employs, is only the instrument by which he and his laborers are enabled to procure some of the articles above enumerated, so that it is manifest that the power of any given population to set additional industry in motion, is limited by the amount of its capital as above described. Now it is very evident, that the mere emission of bank notes adds nothing to the mass of capital previously existing. It creates neither lands, houses, machinery, ships, raw materials, provisions, raiment, gold, silver, or any other conceivable thing that comes under the denomination of capital. In fact, a bank note is nothing but a promise to deliver on demand a certain quantity of gold or silver which is capital, and it is easily to he seen, that a promise to deliver capital is not capital itself, and that no conceivable number of such promises can ever constitute one atom of the thing promised. As well might it be asserted to a hungry man, that a baker’s promise to deliver a loaf of bread, was bread itself, or to a shivering man on a cold day, that a tailor’s promise to deliver a suit of clothes would protect him from the weather as well as the suit itself. The matter is so plain, that no one can fail to perceive the truth of these positions.

How then, it may be asked, do the issues of paper credits by banks of circulation operate upon the community, and produce that appearance of increasing wealth in places where they have been established? This is an important question, and if closely examined, will be found to lead to an answer, calculated to dispel much of the delusion under which the public labors, as to a supposed magic power of production conferred upon a number of individuals by an act of incorporation. It is this. These issues facilitate the transfer of the existing capital, that is, of things possessing exchangeable value, by creating an additional set of dealers with bank notes in their hands, and who are thereby enabled to purchase with the credit of the bank, what they could not purchase so conveniently with their own credit. A bank note indeed may be considered as a draft in favor of the borrower, given by a bank upon the public at large, to deliver him a certain amount of capital of any description he may want; the bank promising any one who may honor its draft, to pay on demand an equal value in gold and silver. Or, the bank may be imagined as borrowing upon its promissory note, a certain amount of capital from A, and handing it over to B, taking in payment the promissory note of the latter, and charging a commission for its agency. That this is the case, will be made plain from the following statement.

Let us suppose a bank with a capital of one million of dollars. After this is all loaned out, it is very evident that the bank has no more capital to lend. A offers a note for discount, having sixty days to run, for one thousand dollars, and the bank discounts it, by giving one thousand dollars of its own notes payable on demand.11 These notes, as I have shown, are not capital, but a promise to deliver capital, and it is only because the bank supposes that no demand will be made upon it before the expiration of sixty days, when A’s note will become due, that it considers itself safe in exchanging notes with A for that length of time. If the notes come back for payment before A’s note is paid, it is evident that the bank cannot fulfil its promises to deliver capital, without borrowing from same one else, or without compelling some of its other debtors to pay, and what is true of A’s note is true of all the other notes which the bank may discount in exchange for its own notes.

A then, it is clear, has not borrowed capital of the bank, as all the other borrowers did who preceded him. He has merely borrowed the credit of the bank. And the question may now be very naturally asked, why should he be willing to borrow the credit of the bank at the rate of six per cent, per annum, when he has found his own credit so good that the bank would take it, as is proved by their trusting him for sixty days with one thousand dollars of their notes? The answer to this question is, that the credit of the bank is of greater notoriety than the credit of A. Every body will trust the bank because its capital is known, or assumed to exist, and because every body has heard of the bank, and has not heard of A, and consequently there are persons who will trust the bank, who would not trust A; or, because a confidence exists, that a bank note will, for an indefinite period, continue to pass from hand to hand, as equivalent to the metal, which, upon its face, it promises to pay on demand. This universal confidence in the credit of the bank it is, in connection with the known fact, that these notes will pay the debts due to the bank for the million of dollars first loaned as readily as gold and silver, which renders them universally receivable; and as every body who holds them knows that he can at any time procure whatever he wishes to buy with them, no one is in a hurry to send them in for payment, and on that account they remain out in circulation for a long or short time, by which the bank gains interest, whilst the holders of its notes lose no more than they would lose upon an equal balance kept on hand in gold or silver. But there is another reason why the credit of the bank is worth at least a part of the price which A pays for it. It is susceptible like coins, of divisions and sub-divisions into very small fractions, whilst security is afforded for punctual payment by the perpetual succession incident to a charter, or by the survivorship of one or more of several copartners, and facilities are granted by having certain hours on each day at which payment may be demanded, so that no time is lost in making a second or third call, which would be very apt to happen with the notes of individuals not acting as bankers. Perhaps the certain knowledge of the fact that banks during certain hours are to be found open and ready to meet demands without a moment’s delay, does as much to keep their notes out in circulation as any thing else; for any one can see, if there were no banking hours, and if a call might have to be repeated, people at a distance would receive notes with reluctance, and would send them in for payment before they actually needed the money, for fear of disappointment on the day it was wanted.

But it may be said that A, when he got his note discounted, did not want to purchase goods by retail, but by wholesale, and that therefore, he gained nothing by the privilege he possessed of taking small bank notes. Why did he not then purchase the goods he wanted of the holder directly by using his own credit and giving his own note, instead of giving the bank one per cent., the discount of his note for sixty days, for the use of their notes? I answer for the very simple reason, that he found that he could purchase goods with the credit of the bank upon better terms than he could upon his own credit. Upon no other principle would he have gone to the bank for a discount; for surely no man would give one per cent, to a bank for swapping notes for one thousand dollars if the bank’s notes would not buy more than his own individual note at sixty days for a thousand dollars would buy. If it should be said that the object of A in getting the discount was to pay an old debt, the case would not be altered. The credit of the bank is worth to him in this case as much as in the former, the creditor being willing to receive it as money, for the same reason that the sellers of goods above referred to were willing to receive it, because its notoriety rendered it universally receivable by others.

In no case then can the issues of a bank of circulation constitute capital; and we think the reader will now be ready to acknowledge, that all that a bank of circulation does effect, is the mere lending of its credit to individuals, to enable them to procure upon better terms, and in a more expeditious and convenient mode, the capital of others, than they could with their own credit Whether this facility be beneficial or otherwise will appear hereafter.

CHAPTER VII.

ON THE STRICT CONVERTIBILITY OF BANK NOTES AND CREDITS.

BUT it may be asked, how are banks to ascertain the precise limits beyond which they cannot extend their issues without endangering their solvency and depreciating the currency, and of course injuring the public? And what guarantee has the public, who, from the nature of things, can know nothing of the state of their issues at all times, that their confidence will not be misplaced?

The answer to this question is not easily to be arrived at. In the various investigations before the British House of Commons in reference to the Bank of England, rules for prudent issues have been laid down by different directors, with a variety which showed that all did not possess a scientific acquaintance with the principles of banking. In the management of the numerous banks of the United States, an inexcusable ignorance of first principles has been repeatedly manifested, and hence, we have seen repeated expansions and contractions of a highly prejudicial nature. These expansions and contractions, however, with the fluctuations in prices necessarily accompanying them, would exist only to a limited extent, if there were a real bona fide convertibility; and I wish it to be distinctly understood that all my remarks favoring banks of circulation, are founded, upon the supposition of such convertibility.

How then is absolute convertibility to be attained? I answer, by the joint co-operation of the banks, of the public, and of the legislatures.

The duties which the banks have to perform are, first, to deal honestly with their creditors, by keeping themselves in a condition at all times to meet their liabilities, and by promptly paying on demand, in acceptable coin, their notes or deposites for any amount that may be called for, without the slightest intimation by the looks, words, or deeds of their officers, that they would rather not pay, and consequently, by despising those miserable and discreditable expedients so frequently resorted to by banks on the eve of insolvency, of gaining time by a useless delay in counting out small coins, or in weighing gold pieces; secondly, by scrupulously avoiding to throw obstructions in the way of a free exportation of coin, either by refusing facilities for the packing up at the bank of sums however large, or by disqualifying the exporters from their equal rights with others when applying for discounts; thirdly, by calling upon each other for the payment of daily balances in coin, in order that each bank may be restricted within its proper sphere; and, fourthly, by confining themselves to the legitimate pursuits of banking, and by carefully watching the political horizon, to see that no event like war, civil commotion, or governmental interference with the currency, is likely to find them unprepared.

An honest observance of these rules would of itself establish true convertibility, but unfortunately experience has given too much reason to fear, that the moral sense of corporations cannot be relied upon for the protection of the public. The ignorance of some, the speculative avarice of others, the favoritism incident to most, and the desire common to all, to amass large profits, are constantly operating to effect an expansion of the currency to the utmost limits of tension; and however prudently and wisely conducted may be many of these institutions, their influence and example are lost upon the rest, and when a calamity befalls the country by a general stoppage of payments, they are made to share in the common catastrophe.

The duties which the public have to perform, as a check upon this perpetual tendency to over-issue, are incumbent on every citizen; and he who withholds his co-operation, when he has a motive to act, becomes a participator in the wrong. They are, simply, for every man who wishes to convert bank notes or deposites into coin, either for the purpose of convenience or exportation, and whether the amount be large or small, to make his demand without being influenced by fear, favor, or affection, or through any false or mistaken delicacy towards the directors of banks, or their debtors who might in consequence thereof be called upon for an earlier reimbursement. Here, again, unfortunately, experience demonstrates, that the independence and moral firmness of most merchants is not proof against the influences which may be brought to bear against them. On the one hand, they find their discounts interfered with, and their commercial operations crippled; whilst on the other, they discover that a clamor is raised against them by those debtors to the banks who purchase commodities from them, as soon as they feel the pressure occasioned by a diminution of discounts, consequent upon a heavy demand for specie.12

The only true resort, therefore, that can be appealed to for absolute convertibility is legislation. But how is this legislation to be expressed? By forfeiting the charters of banks that do not pay their notes. The legislature of New York in May, 1837, absolved its bank’s from this penalty for one year. By imposing a penalty of twelve or twenty-four per cent, per annum, upon notes and deposites not paid in coin. Such provisions were wholly inoperative in those states where they prevailed, during the late general suspension, by the evasion of the banks, and by popular clamor raised against individuals who demanded their rights, and cannot be relied upon, either to prevent a general stoppage, or to enforce a resumption with promptness. The true and only answer is, by establishing individual liability, such as that which exists with all the joint-stock banks of England, and all the private banks of that country as well as of Europe.13

With such a convertibility as this would accomplish, we should run comparatively very little risk of expansions and their consequent contractions, or of an alternate plenty and scarcity of money. The overtrading of each particular bank would be checked by the prudent regard to self-interest which would operate upon its managers; and if recklessness should characterise the conduct of one, or a dozen, or a hundred banks, it or they would simply fail, like individual traders, and make an assignment of their property, without producing the catastrophe of a general suspension of specie payments. To prevent the failure of banks altogether is impossible. The most that can be done, is to prevent a general stoppage.

But in laying down this proposition, I am far from imagining the present possibility of its adoption in the United States. The principle of limited liability by acts of incorporation, and by laws authorising limited partnerships, is too deeply rooted in our system to be now eradicated ; and as I believe the most practicable scheme of reform to which legislation can be applied at this day, is to be found in the policy of the New York general banking law, I will in a future chapter give my reasons for believing that plan to be better calculated, if made general throughout the Union, to give stability to the currency, than any other that would be likely to meet a general acceptance.

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CHAPTER VIII.

OF THE VARIOUS MODES RESORTED TO BY SOME BANKS TO AUGMENT THEIR DIVIDENDS.

EVERY sound thinker who has taken notice of the high rates of dividends that were declared by many of the banks throughout the United States, during the years 1836, 1837, and 1838, whilst their number was increasing, and when, upon every known principle, their dividends ought to have decreased, must be satisfied in his own mind, that these extraordinary dividends did not result from the legitimate operations of banking, that is, from the lending of money or credit at the rate of interest authorised by law. The charters of most of our banks restrict their operation to the lending of money and to trading and dealing in bills of exchange, gold and silver bullion, and certain specified public securities; and hence, all other transactions are in violation of the laws. I have stated in a former chapter, that the charge of one half per cent, interest taken beforehand, in connection with the practice of charging interest for sixty-four days upon a note payable in sixty days with three days grace, is equal to 6 per cent, per annum, and this it is evident is all that a bank has a right to claim for the use of its money or credit. Modern competition, however, has operated upon some, and led them to adopt numerous modes of getting more than this rate. Amongst these are the following:

1. The practice of giving a preference in their discounts to those customers, who by agreement, express or implied, stipulate to leave in the bank, never to be drawn for, a certain proportion of the amount borrowed; by which virtually the bank receives interest for money or credit which it does not lend. Examples have been known wherein a sum equal to twenty, thirty, or forty per cent, has been expected to remain as a permanent undrawn balance, thus adding to the profits of the bank, by a sheer evasion of the laws against usury. Borrowers upon such terms are seldom to be found amongst the most responsible traders, but can always be had in abundance amongst that class of needy men, who, without such a facility, would be obliged to borrow in the open market at a higher rate of interest. If this principle had been extended to the loans of all the banks of the United States, amounting in 1838 to upwards of $500,000,000 as far as five per cent, upon an average, the banks would have derived from it a profit equal to the interest on twenty-five millions of dollars, that is, upwards of a million and a half of dollars.

2. The practice of discounting notes, and instead of giving cash for the net proceeds, giving post notes payable at thirty or sixty days date, by which means the bank gains a profit equal to the interest for the time the note has to run. In other words, if a bank discounts a note having ninety days to run, and gives in exchange for it a post note payable in thirty days, it receives interest for ninety days for the loan of money for sixty days, inasmuch as the post note is not money until it becomes due, as will hereafter be shown. The extent to which this practice has been carried throughout the United States is very great, and it is defended upon the ground that the emission of post notes enables merchants who have remittances to make to distant points, to effect that object more securely and conveniently than by the transmission of bank notes payable to bearer, on account of the security afforded by the former’s being only transferable by endorsement. This is true, but it is manifest that this end would be as completely attained by a post note payable in three days after date, as by one payable in sixty days. But this is not all. Post notes at long dates, not only enable banks to profit by evading the laws against usury, but they enable banks to raise money for their own use when they are embarrassed, without appearing to borrow, a facility which renders them less careful of expansions of the currency than they otherwise would be.14

3. The practice of lending the notes of a bank with an express understanding that the borrower is not to put them into circulation within a certain distance of the place where the bank is located, or within a certain time from their coming into his possession, by which means the bank would receive interest for the time that would thus intervene, without having made any loan. An example of this species of contract was exposed in the examination of the affairs of the Chelsea bank near Boston, in 1837, two of the directors of which borrowed the notes of the bank which they were not to put in circulation, but which they were to pledge for money borrowed, elsewhere, and it was probably with the view of preventing a resort to such expedients, that the legislature of Massachusetts in that year prohibited banks from issuing notes that are not to go into immediate circulation.

4. The practice of discounting notes, and instead of paying the net proceeds in money, stipulating with the borrower that he is to take the notes of distant banks, known to be in the market at a discount. This expedient has been extensively resorted to all over the United States, and in some cases in such flagrant violation of the laws aginst usury, as to be accompanied by a regular bargain to purchase back by the bank, at the market rate of discount, the very paper just handed to the borrower. Nay, transactions have been even conducted in so barefaced a manner, that discounts have been made payable in distant paper which the bank did not possess, and which she purchased back at a discount, thus substituting a constructive sale and purchase of what possessed no existence, for the sake of avoiding a direct usurious transaction. Many flagrant examples of the expedients here described, extending to nearly all the banks of Providence, were exposed by a committee of the legislature of Rhode Island in June, 1836, in a report, a copy of which accompanied the secretary of the treasury’s report on the condition of certain banks, of January 4, 1837.

5. The practice of discounting domestic or inland bills of exchange, by which advantage has been taken under the color of exchange, to charge, besides the legal interest, and a fair charge for collecting, the most extortionate rates of profit, having no real relation to the actual expense of collecting, but only to the necessities of borrowers.15 In the examination, by a committee of the legislature of New York, in 1838, of the affairs of one of the city banks, some gross malpractices of that institution were developed. It was proved to have charged from five to ten per cent, exchange on the collection of drafts, when the market rate of exchange on similar drafts was not more than from three to six; had discounted paper with the express understanding that the party accommodated was not to receive cash for the net proceeds, but a draft at par upon some distant place, worth in the market one to three per cent, less than the rate at which it was taken; and had even purchased back their own drafts at such a rate of discount. What this bank did, has been done, more or less, by a large portion of the banks in the United States, and the evil has become so extensive that funds which should be devoted to the discounting of real paper payable on the spot, have been diverted to the purchase of fictitious bills, created for the very purpose of raising money, and not in the ordinary course of trade.

6. The practice resorted to by some banks, of discounting notes in the market, through the instrumentality of brokers, at usurious interest, instead of discounting them at lawful interest, in the regular way. The New York bank above referred to, was proved to have discounted at usurious interest out of doors, the very notes that had been offered to the bank and been rejected by the board of directors.

7. The practice of speculating in stocks, and, in the case of some of the Mississippi banks and others, transacting the business of cotton factors, and cotton exporters.

8. The practice of buying up the depreciated paper of other banks, under a suspension of specie payments, and holding it until redeemed in coin. Large sums were invested, in 183S, by some of the Philadelphia and New York banks, in purchases of the notes of the Mississippi banks from ten to twenty-five per cent, discount, and loaned to the latter at par for their bonds payable at a subsequent period.

9. The practice adopted by many of the banks of New England, and perhaps of other places, of lending to brokers on interest, repayable on demand, a large proportion of the amount which banks in other places consider themselves bound to keep on hand, in coin, to meet possible demands.

10. If to these items be added the amount of profit made by the banks during the late suspension, by drawing interest on money that belonged to their creditors and not to themselves, we shall have the true sources from which the large dividends were derived. What proportion of the whole interest received is to be ascribed to this source, is not precisely ascertainable; but this much may be known with certainty, that it was equal to the income arising from that proportion of the aggregate mass of loans made by all the banks, that exceeded the amount that could have been sustained under a convertible currency.

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CHAPTER IX.

OF THE CREATION OF BANKS WITHOUT CAPITALS, OR OF FRAUDULENT BANKS.

THE term fraudulent bank is intended to be applied to a bank commenced without capital, or what is the same thing, a bank, the stock of which is held by persons who have not the means of paying for it, and who have consequently been obliged to hypothecate it to the bank as collateral security for stock notes discounted to meet the instalments as severally called for. The mode by which such a bank may be established without capital is this:—

Books are opened to receive subscriptions to the capital stock, each share of which is to be $100, of which $5 per share is to be paid at the time of subscribing. The capital is to consist of 1000 shares, equal to $100,000. The stock is taken, not by capitalists, as a mode of investment, but by persons who subscribe as a matter of speculation, with the view of selling out at a profit. The first instalment, amounting to $5000 being paid in, the directors are chosen from amongst these very speculators, who are expected to make the payment of the ensuing instalments come easy to themselves and their constituents. A second instalment of $10 is called for, but as the holders of the stock have no more money to pay in, they offer notes for discount, and pledge their stock to the bank as collateral security. The third, fourth, fifth, and all subsequent instalments are paid in a similar manner by stock notes; and, finally, the stock-holders obtain an additional discount for the original $5 per share paid in, which may have been originally borrowed, and thus we have a bank with a nominal capital of $100,000, but possessing not one dollar of real capital.

Such a bank, however, in its operations thus far, must be a losing concern. The expenses of management would compel the stockholders to pay in discounts more than they would receive in dividends, and the next step of the directors would of course be, to issue bank notes in exchange for the promissory notes of individuals. In the first instance they would probably discount their own notes or the notes of other stockholders, in which case, if the notes of the bank could be got into circulation, which experience shows they could be, if the directors were adroit and active, the borrowers of them would be enabled to command the capital of other people, to carry on business with. It is, perhaps, not probable that many of the banks of the United States have been entirely established upon this principle, but no small number of them have been partially so, and it must be evident that so far as any part of the capital of a bank has been loaned to a stockholder upon the hypothecation of his stock, he not being entitled to credit upon his mere personal security, so far the capital of the bank is diminished, and so far the public are deprived of the security which the nominal amount of the capital promises to afford.

The same deficiency of security might exist in case there were two banks established upon similar principles, and the stock of each was pledged with the other by two speculating sets of holders who changed position.

The following account of banks established in part upon this fraudulent principle is extracted from a report made to the legislature of North Carolina, during the session of 1828–29:—

“The legislature having laid down, in the charters of the several banks, certain fundamental articles for the government thereof, the committee assumed these articles as the basis of their investigations, and proceeded accordingly to inquire, in the first place, whether the stock of the several banks had been raised in the manner required by their charters. The evidence received by the committee on this point, shows that the charters of the banks were disregarded and violated in the very creation of their capital.

“The charter of the Bank of Cape Fear, enacted in 1804, authorised that corporation to raise a capital stock of $250,000; and the charter of the Newbern Bank, enacted in the same year, authorised that bank to raise a capital stock of $200,000; both charters directing the capital to be paid by the stockholders in gold or silver. The undersigned have received no evidence as to the mode in which these banks got into operation. It would seem, however, that they contemplated, at the outset, an evasion of the provisions of their charters. It is in evidence to the undersigned, that soon after they went into operation, they contrived to get possession of nearly all the paper money which had been issued on the faith of the state, which being at the time a legal tender, enabled them to evade demands for specie, which they did, by thrusting this ragged paper at those who presented their notes for specie. In 1807, $25,000 was added to the capital stock of each of these banks; in 1814, their charters were extended, and they were authorised to increase their respective capitals to $800,000 each, viz., the Newbern Bank was authorised to raise an addition to its stock of $575,000, and the Bank of Cape Fear, an addition of $525,000. It is in evidence to the undersigned, that the whole of this additional stock was manufactured by the banks themselves, and that, in many instances, favored individuals were permitted to acquire stock by subscribing their names, and putting their notes into bank, without advancing a single dollar of actual capital. It follows, that the whole amount of the interest drawn from the people, on the loans made on this fictitious capital, was a foul and illegal extortion. The effect of the transaction was the same as if the pretended stockholders had individually executed their notes of hand, without interest, to the amount of the notes which they issued from the bank, and exchanged them with the people for their notes, bearing interest and renewable every ninety days. Taking the issues made on this fabricated capital to be in proportion with those made on the former capital, they must have put into circulation, on the faith of the assumed stock, between three and four millions of notes; and thus, a parcel of individuals, under the name of stockholders, but who, in fact, held no stock, contrived to exchange their notes, without interest, to the amount of three or four millions, for the notes of the people, bearing an interest of more than six per cent.; and while the property of the people was pledged for the payment of the notes they had given to the stockholders, there was not. a dollar or an atom of property pledged to them for the payment of the notes they had received from the stockholders; so that for the use of their notes, which, intrinsically, were of no value at all, the stockholders of these two banks have drawn from the people, by way of interest, something like $200,000 annually.”

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CHAPTER X.

ON THE EFFECTS OF BANKS DEALING IN EXCHANGE.

THE proper business of a bank of discount is to lend money. That of a bank of circulation is to lend credit, and the technical idea of banking excludes all transactions other than that of lending. This was formerly so well understood in the United States, that the discounting of notes or acceptances payable on the spot was the sole mode in which the capital and credit of the banks were employed; and if, by way of accommodating their customers they occasionally discounted a note or acceptance payable at a distant place, it was always done upon the same terms as if it were payable on the spot, the banks not calculating upon any profit in the way of exchange, but relying upon getting their money back again by supplying another customer with a check or draft at par. The ordinary exchange transactions between different cities and states were left to individual competition which established the market rate, as it does in all other countries of the world, and as it must invariably do wherever it is not interfered with by artificial causes.

Such was the state of things that existed prior to the establishment of the late bank of the United States. That institution, at some period subsequent to the commencement of its operations in February, 1817, entered upon the business of a dealer in inland bills of exchange by buying and selling bills upon all points where its branches were located, upon terms that gave it a profit on the transaction. This practice probably gave rise to the general custom now prevailing amongst banks of buying and selling bills of exchange; and as the custom appears to be one which facilitates the operations of trade, the public has overlooked the mischief which results from its exercise. It is of this mischief I now propose to speak, and I beg the reader’s attention to the remarks I am about to offer.

It has been shown, in the chapter on exchange, that the competition of the market will always settle the rate of premium or discount on bills, according as the proportion may vary between the supply and the demand. Nobody need ever be apprehensive that the rate can ever be forced unreasonably high by the combination of sellers, or forced unreasonably low by the combination of buyers. Each party has his remedy, as we have shown, against undue exactions, by the right that can never be taken from him, of transmitting coin instead of a bill. Under this free competition of the market, it must be manifest that the profit on bills, where there is one, goes into the pockets of the right people, that is, of those who are fairly entitled to it; and that the loss on bills, where there is one, also falls upon the right people, that is, upon those who ought to bear it; and in this manner equal justice is done to every individual, and the commercial wealth is consequently distributed through the natural and legitimate channels. If, at one season of the year, for instance, bills at Natchez on New York sell for two per cent, premium, this advantage fairly belongs to the seller. If at another season they sell at two per cent, discount, this loss goes into the pocket of the buyer of the bill as a profit, and fairly belongs to him. Any one, however, can perceive that this question of profit and loss on exchange is a private affair between one set of dealers and another, and as far as the public is concerned, it is a matter in which, as a body, they have no interest. It is of no sort of consequence to the community at large, whether the rate of exchange on inland bills is at the maximum or minimum price, or whether A or B puts a profit into his pocket, but it is of great consequence to the community that the profit should go into the right pockets, and that the inland exchanges should be carried on at the least possible expense to the country.

Let us now see how far the interference of banks in the operations of exchange disturbs the natural course of things.

And here I will remark, in the first place, that the competition of banks operates upon the bill market in a manner wholly different from that of individuals, owing to the power they possess of contracting the currency when they want to buy, and of expanding it when they want to sell. By the exercise of this power they can accomplish what individuals cannot accomplish, for these latter, having but a given amount of money to purchase with, cannot augment its quantity at pleasure, and their influence in the general competition, therefore, can only be proportioned to their actual cash. Can any one doubt the operation of this principle who has noticed the effect upon the price of cotton, universally admitted to have existed throughout the cotton growing states, during the years 1837 and 1838, by the dealings of banks in the purchase of cotton? Does not every body know that the price of cotton was kept a cent or more per pound, by the issues of banks, higher than individual competition could have kept it? And if so great a rise as ten or fifteen per cent, could be created in cotton, is it not easy to be seen how readily a rise in the rate of inland bills of exchange, of a quarter or half per cent., could be effected?

The mischievous tendency, however, of banks dealing in exchange, is greatly augmented where banks have branches, or enter into extensive combinations for a united system of action. Let us, for instance, suppose a large bank in a northern citiy with branches, or agencies at the principal southern ports, of sufficient extent of capital to operate upon the value of the currency at those ports. Let us suppose, the mother bank, at the seasons for shipments of cotton to the north, to give orders to its branches to buy the bills drawn upon those shipments at the cheapest rates that they can be obtained at. Any one can perceive at a glance, that the withholding of discounts for a few days, will make money scarce, and thereby depress the price of bills below the previous rate. At this new price the branches may buy, and transmit these bills to the mother bank, which in a short time after is drawn upon by the branches at a higher rate of exchange, which they were enabled to obtain by making money plenty, whilst in the case of the purchase of foreign bills drawn upon shipments of cotton to Europe, the mother bank by adopting the same expedient, or, what amounts to the same thing, by selling those bills on a credit at a higher price than the current cash rate with interest added, makes an additional profit. That such expedients as are here brought into view, may be, if they have not already been, practised by some of our banks can hardly be questioned, and the mischief thence resulting, far more than counterbalances all the benefit to individuals which an equalising of the exchanges can possibly accomplish.

But it may be said, that, without the agency of banks, there would not be the same facility in negotiating bills. This objection is not borne out by the experience of Europe, where bills of exchange can at all times and at all places be negotiated upon the most favorable terms, through individual capitalists, who have no control over the currency in augmenting or diminishing its quantity; and there is not the slightest reason for supposing that equal facilities would not exist in this country through private competition, if the ground were not already occupied by banks possessing by their very power of expansion and contraction, the ability to annihilate all private competition. It may also, perhaps, be said, that the agency of banks between buyers and sellers is afforded at a cheaper rate than that of individual capitalists would be. This assertion may very well be doubted, when we reflect upon the monopoly the banks at present enjoy, and the facility that exists for their combining to fix prices; and even if it were true, the small advantage gained by this circumstance would be greatly overbalanced by the mischievous power to which 1 have alluded, of depressing or raising the market price of bills, by contractions and expansions of the currency.

It is, however, in the interference with the foreign exchanges of a country that the power of banks is most to be deprecated. Upon this subject, the author advanced some views in an essay published by him in the year 1828, which so entirely correspond with those which he at present entertains, that he has concluded to transcribe them, rather than to adopt any new phraseology. The essay was in answer to one written a short time before, by a friend of the Bank of the United States, with the design, amongst other things, of showing the importance to the country of the power exercised by the bank of dealing in exchange.16 The following are extracts:

“This is the course that matters take under a currency composed entirely of coin, or a sound mixed currency composed of coin and paper exchangeable for coin, but it must be kept in mind, that under such a currency, actual shipments of specie from one country to another, do not take place to any very great extent. A very slight comparative diminution of the quantity of coin circulating in a country, creates a scarcity of money, and this operates very soon upon the prices of all commodities, by reducing them in the market.”

“This partial export, however, and tendency of the coin to go abroad, is the only check upon overtrading. It indicates that more commodities have been imported than exported, and warns the importer of an approaching fall in the prices of the articles in which he deals, which induces him to countermand or diminish his orders, and in the next year to import less; and this operation brings back the small quantity of coin, which, by its removal, had diminished the currency below the quantity which was requisite to maintain it upon a level with the currencies of other countries. From this view of the subject, it is apparent, that exchange may be looked upon as the beam of a pair of scales, very nicely balanced, and employed in ascertaining the value from day to day of the imports and exports of a country. The slightest departure from the equilibrium shows itself in the fall and rise in the price of bills, and the assayer of the mint does not keep his eyes more steadily fixed upon the balances in which he weighs his gold, than should the merchants keep theirs fixed upon the rate of exchange.”

“If these things be true, it would seem to follow, that the most free and unrestricted competition possible in the bill market, would be the best calculated to prevent over-trading in the banks as well as individuals, for from such free competition the earliest indications of an excess of imports, or of a depreciating currency, would show themselves. That the operation of the Bank of the United States is to interfere with, and to a certain extent to destroy this competition, and consequently the check which ought to be suffered to operate monthly, weekly, and even daily with its warning voice, is admitted in the following sentence. ‘ Its principal advantage, and that which makes the bank pursue it, is, that this stock of exchange operates like a lever to keep the exchange market easy, to prevent the excessive price of bills, and to enable the merchants to calculate with reasonable probability the habitual cost of their remittances’ By this language, we understand, not only that the bank is desirous of effecting something like a steady price in exchange throughout the year, but that it does actually possess the power so to do. That this power is not, however, always exercised in such a way, as to prevent ‘the excessive price of bills,’ is evident from the admitted fact, that bills on London have been so high, that a merchant could afford to ship dollars at a less expense than the premium on bills, and indeed so much less, that it was an object of speculation to ship coin for the sole purpose of drawing bills upon it.

“We cannot therefore but conclude, that the dealing in bills of exchange by the bank, upon the principles professed, removes the great check upon over-trading and over-issues of paper, created by the free competition of the exchange market. To this it may be replied, how can a dealer who only purchases five millions of dollars value of bills in a year, disturb the competition, when the probable amount negotiated may be six or eight times that amount? We answer, by that power of purchasing, possessed, but not of necessity fully exercised by the bank, which is known to every drawer of a bill, and also by that moral influence, which silently operates, and compels the drawers of bills to keep up the price very near that fixed by the bank, through fear that mercantile discredit would accompany any offer to draw at a price much below it. The fact, however, of a control over the rate of exchange is admitted in the above quotation, and therefore needs no further evidence of its existence.

“But let us examine and see whether the benefits flowing from this dealing in exchange by the bank, be in reality such, as they are described to be, by the essay in question. ‘In the south it furnishes capital for facilitating trade.’ Does this mean, that because the bank is a buyer of bills in that quarter of the Union, it therefore issues more bank notes than are called for in the ordinary course of discounts? If so, the tendency of such over issues is to depreciate the currency, and whatever may be the favor done thereby to the southern planters, factors or merchants, there is certainly a positive injury inflicted upon all the rest of the community. If, however, the tendency be not to enlarge the issues of bank notes, how is any capital afforded to facilitate trade, in addition to that which would be procurable by the same planters, factors or merchants, by offering for discount the promissory notes or acceptances of individuals, to whom their bills would have been sold, if the bank were not a dealer in exchange? ‘To the north it supplies a safe and undoubted remittance.’ This is unquestionably true, inasmuch as it affords to all those who are willing to pay for increased security, an opportunity of fulfilling their engagements in Europe, without danger of defalcation. This benefit, which by the way, we humbly conceive to be the only real one of a general nature, which results from the power of the bank to deal in exchange, could, however, be conferred by the bank in a way far less injurious to the public, than the one now pursued, and that would be, by the simple operation of guaranteeing bills for a stipulated commission.

“To the southern merchants it affords another buyer of bills, to the northern another seller, widening in both cases the field of competition.” This to be sure appears plausible, but we apprehend will not stand the test of analysis. The bank it would seem goes into the market at Richmond, Charleston, Savannah, and New Orleans, to purchase the bills upon Europe, drawn upon the shipments of produce made from those ports. The immediate buyers of those bills, if the bank was not a dealer in exchange, would be, either the importing merchants on the spot, or the importing merchants in the northern cities. The bank, we will allow, by its competition, raises the price of bills above what it would otherwise be, because it is a speculator with a large capital, which buys, not because it stands in need of bills, but because it is sure it can make money by the purchase, owing to its power of controlling the market price. This, too, we will admit, benefits the drawer of the bill, and perhaps in a very trifling degree the planter, who gets a better price for his crops on account of the increased premium on bills. But is not the importing merchant of the south, as well as the importing merchant of the north, injured by this operation precisely in the degree that the others are benefitted? Are they not compelled to give more for their bills, than they would otherwise have given? And why should then an institution, general in its nature, take merit to itself, for taxing one portion of the community for the benefit of another? And how is the bank a ‘new seller to the north?’ Does she offer any more bills in the northern cities, than would be offered there for sale, without her intervention? We apprehend not to the value of a dollar. She occupies the mere place, which, without her, would be occupied by a number of individuals; and it is self-evident that her agency in the matter, so far from widening the field of competition, actually restricts it, and raises the price of exchange as much above what it would be, if she were not a dealer in bills, as the profit she obtains by her operations.

“But after all, why should the bank undertake to be the arbiter of exchange? Why should she be particularly careful that exchange should not be too high, rather than that it should not be too low? As far as some of our own citizens are the drawers, and others the purchasers of bills, it is of no sort of consequence to the public, what is their precise rate. To the parties themselves it is indeed of moment, inasmuch as what comes out of the pocket of one goes into that of the other; but the country is neither richer nor poorer for the operation, and the parties themselves are quite as able to adjust the rate as the bank. As far, however, as bills are wanted for the account of foreigners, for goods sold in the country, it is of advantage to the country, that exchange should be high, inasmuch as thereby the balances due them would be paid by a less amount of bills. But, notwithstanding this, the bank should not attempt to interfere with the natural course of exchange, any more than a government should interfere with the natural course of trade.

“Upon every view of the subject which we have been able to take, we consider all profits made by the bank upon its foreign exchange transactions, beyond the amount of a fair charge for guarantee, and brokerage for bringing buyers and sellers together, as a tax upon the consumption of the country, for which no equivalent service is rendered. We also consider that its dealing in exchange, and accumulating large stocks in Europe, which can only be done, we apprehend, by extra issues of paper, prejudicial to the currency, and consequently to the nation, is destructive of the only imaginable check upon over-trading and over-banking, inasmuch as it conceals for long periods together, the real state of the competition of the market, the only guide by which merchants and banks can regulate their transactions, with advantage to the country. If it should be asked, whether there is any difference in the effect produced by the operations of the bank, from that which would be produced by the operations of private speculators, we would reply, that there is a most essential one. Indpendent of the powerful force of a huge capital, which gives a weight in the market, that no moderate number of our citizens could bring to bear, the bank after it buys bills, has power to make an addition to the currency, the immediate effect of which is to raise the price of those bills, and thus afford a profit by their sale. Individual speculators, on the contrary, add nothing to the mass of the currency, and their operations must, in the nature of things, have but a very slight effect upon the market price of exchange.”

CHAPTER XI.

EXAMINATION OF THE COMMON OPINION THAT THE ESTABLISHMENT OF BANKS IN THE WESTERN STATES, UPON EASTERN CAPITAL, IS BENEFICIAL TO THOSE STATES.

IT is an opinion very frequently expressed, that the establishment of banks in the western and southwestern country, has been a great source of prosperity to the cities and towns where they have been located as evinced by the improvements to which they have given rise, and by the commercial and manufacturing activity that has been displayed. Cincinnati, Louisville, Nashville, Natchez, Vicksburg, and numerous other places, it is said, owe a large share of their prosperity to the establishment of banks; and as these have all been banks of circulation, it is concluded that therefore banks of circulation must have powers to create national wealth, which I have denied to them. Let us examine this doctrine.

It has been shown in a former chapter, that nothing but capital, that is, something possessing an intrinsic value, can possibly be the means of setting industry in motion, and that banks have not the power of creating such capital by a mere issue of promissory notes. It may, then, fairly be concluded, that as far as any real prosperity has been ascribed to the circulating principle of the banks established in the places that have been mentioned, the position is fallacious, and without a shadow of foundation. But, at the same time, I am prepared to admit, that as far as the capitals of the banks referred to have been subscribed by capitalists residing in the Atlantic cities, those cities and towns have reaped all the benefits resulting from the borrowing of a foreign capital, whatever they may be. The simple fact of that capital’s being nominally what is called “a money capital,” is of no sort of consequence in the estimate of the benefits; for, in truth, although subscribed in money, it was never in the form of coin in the actual possession of the western banks, but a fund in the Atlantic cities, drawn upon and sold to the western merchants as a remittance to pay up their existing debts, or to purchase new supplies of goods. It was thus a capital subscribed, nominally in money, but really paid up in dry-goods, hardware, and groceries; and the effect, therefore, upon the prosperity of the western towns, was precisely the same as that of obtaining from individual merchants, or in any other way upon credit, an equal amount of merchandise, with this difference, that the credit might not cost as much through the process of a bank, as if obtained through a purchase of goods in the ordinary way.

This difference in the cost of the credit, however, is all the benefit that the western cities and towns can have reaped from borrowing foreign capital through bank charters, rather than through the ordinary channels of purchasing goods on credit. What it may have amounted to, it is not easy to ascertain; but as a set off to it, it may very fairly be assumed, that in the scramble for discounts made on the first opening of the banks, the loans of capital and credit were not as judiciously made for the general interests of the country, as sales of merchandise would have been by the eastern merchants, as is shown by the fact that immense sums were loaned to planters who embarked in speculations in lands and slaves, and to merchants who embarked in shipments of cotton, and who ultimately became embarrassed or ruined by these operations. Every one remembers that the southwestern banks were the last to resume specie payments after the late suspension; and it is well known to many, that they were only enabled to do it when they did, by borrowing large sums from the eastern cities, or by the emission of post notes payable at distant periods with which they absorbed a part of their immediate liabilities. If any stronger proof were wanted of injudicious and improvident loans on the part of many of those banks, it may perhaps be found in the second failure that has taken place with all of them since their resumption in January, 1839, and in the expression of public opinion manifested on the stock exchanges of New York and Philadelphia at a recent period, which places the stocks of all of them below par, and of some of them very considerably below it.17 If these facts be conclusive as to indiscreet and improvident loans, all the mischief which I have in other parts of this work traced to the same cause in other places, must be equally predicated of the western and southwestern banks; and it will not perhaps be difficult for the reader to admit, that all the benefit which the western and southwestern states have derived from the establishment amongst them of banks constructed upon foreign capital over and above the benefits which those states would have derived from their merchants buying and selling an equal amount of foreign goods on credit, has been more than counterbalanced by the evils resulting from incautious loans of capital and credit.

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CHAPTER XII.

ON THE CIRCULATION OF SMALL BANK NOTES.

IT must be manifest to all who will reflect upon the subject, that the currency of the United States is exposed to dangers from over-expansions to which that of Great Britain is not in the same degree liable. The distance from the American to the European continent is so great, that even after the general establishment of steam packets, a month would be requisite for obtaining a supply of the precious metals under a panic, which could be obtained in England from the adjacent parts of the continent in four or five days, and it would therefore seem to be sound policy for the state legislatures of our Union to authorise no measures to be pursued by our banks which can have a tendency to diminish the metallic basis of our paper currency so greatly, as to endanger its convertibility. It is self-evident, that just in proportion to the diminutive size of bank notes authorised in a country, will be the supply and consequent circulation of gold and silver. In France, where no bank note is allowed to be issued of a less denomination than five hundred francs, (equal to about ninety-four dollars of our money,) the whole of the retail transactions of a community of thirty millions of people, nearly double our population, are carried on by the precious metals.18 In England, no note of a less denomination than five pounds sterling (equal to twenty-four dollars and upwards,) can be issued by the Bank of England, or by any joint-stock or private bank; so that in that country too, the minor channels of circulation are kept well filled with gold, so that on any emergency, a large fund can be made available to meet any reaction of the banking system, before the necessity occurs of ordering bullion from abroad.

In the United States, unfortunately, the blindness of the legislatures and the public, and the avarice of the bankers, has at all times, since the existence of banks, led to the emission of notes of a much less denomination. With the exception of the Bank of the United States, incorporated by congress in 1816, and the Pennsylvania Bank of the United States, chartered in 1836, which were not allowed to issue notes of a less denomination than ten dollars, and of the new bank of Missouri, which can issue none of a less denomination than twenty dollars, there has probably been no bank chartered by any of the states which has not been authorised to issue five dollar notes. The consequence of this policy has been, that the stock of the precious metals in the country has at all times been much less than it would have been, had the policy intended by congress in 1816 been preserved by the state. I say “intended” because the prohibition was evaded by the issue by the bank, of checks for five dollars drawn by the branches upon each other, which answered all the purposes of five dollar notes.

But although, by the exclusion of all notes of a less denomination than ten dollars, the security of our paper currency would be greatly strengthened in case of an unexpected panic, yet the design of this chapter is more particularly to inveigh against the growing propensities in some of our legislative bodies to authorise the emission of notes of a denomination less even than five dollars, a policy which, if adopted by all the states, will fill not only all the arteries of circulation, but even the very smallest veins, with paper, and drive from the country the few coins which the five dollar notes have spared.

A short sketch of the history of small bank notes may not be without interest.

Prior to the suspension of specie payments in August, 1814, I am not aware that any notes of a less denomination than five dollars were any where issued, although there may have been in a few of the states. By that event, specie disappeared wholly from circulation in all the states except those of New England, where the banks, coerced by efficient laws and public opinion combined, continued to fulfil their engagements, and its place was supplied by emissions of notes by banks from three dollars down to twenty-five cents, some with the sanction of law, granted for the especial occasion, and some without it; and by other emissions from all sorts of corporations, public officers, private institutions, and even by individuals, who generously accommodated the public with their credit for sums as small as five cents, in the hope that the notes would be worn out. or lost, and that they should never be troubled with a demand for their payment. This wretched state of things continued for some time after the restoration of specie payments in February, 1817. An incubus appeared to be fastened upon the community, which no combination of individuals could shake off, and which continued for a longer or shorter time, according as legislative interference was delayed. In Pennsylvania, where, from the multiplicity of banks, this evil was of great magnitude, an act was passed on the 22d of March, 1817, prohibiting, under a penalty, the emission or circulation of any notes or tickets in the nature of bank notes, of a less denomination than five dollars, excepting by banks duly authorised; and also prohibiting, after the first day of October following, any bank from issuing such notes: a privilege which had been granted by act of 28th December, 1814. This law, being partially carried into effect, expelled from circulation the principal part of the miserable trash against which it was directed, and the silver fractions of a dollar began to make their appearance from the pockets and strong boxes of the public, where they had been concealed for near three years. Still the cure was not complete, owing to evasions of the law, and to the introduction of small notes and tickets of neighboring states. The banks of Pennsylvania, having ceased after the first of October to issue notes of a less denomination than five dollars, the neighboring states of Delaware, New Jersey, and New York, sent us an abundant supply and the chief effect of the law appeared to be, not to give us a circulation of specie in the place of small notes, but to fasten upon us a set of notes not known to the public, for another set that was known. And yet, with this fact staring them in the face, the Senate of Pennsylvania rejected, by a vote of 16 to 15, on the 9th of March, 1820, a bill introduced into that body by the author, who was then a member, prohibiting the circulation of all notes of a less denomination than five dollars, wheresoever or by whomsoever issued.

After the defeat of this measure, which was opposed most strenuously on the ground that if the small notes were expelled, the people in the interior where they chiefly circulated, would be wholly destitute of change; and advocated on the ground, that so far from this being the effect, the immediate and necessary consequence would be, that every man who had in his pocket a dollar in paper would find it instantly converted into a dollar in silver, the subject was permitted to sleep for a number of years; and it was not until the 12th of April, 1828, that Pennsylvania was convinced of the impolicy of a measure which prevented specie from flowing in upon her citizens. The act of that date fixed upon the 1st of January, 1829, as the period for enforcing the prohibition, and it was not without great apprehensions of a repeal before the appointed day, that the friends of a wholesome currency saw numerous petitions with that object presented to the legislature in the preceding month of December. Happily, however, these evidences of ignorance and folly were disregarded by the legislature. The law went into operation, the flood of foreign paper was forced back upon its issuers, and, as if by magic, silver was immediately seen to circulate in abundance in those counties where before there was nothing but paper.

The successful issue of this experiment in Pennsylvania was followed in subsequent years by a number of other states, which in turn proscribed notes under five dollars; and their total expulsion from all the states of the Union might reasonably have been expected in the course of a few years, had it not been for the unfortunate suspension of specie payments in May, 1837, which again deluged the country from one end to the other with a flood of small notes and tickets, from three dollars down to five cents, and extinguished in some of our legislatures the lights of science which so much pains had been for so many years taken, by the intelligent few, to kindle into a flame. New York has backslided by authorising, by a recent act, the emission by her own banks of notes of a less denomination than five dollars, and as far as she is concerned, has proclaimed her unwillingness to assist in retaining in the country a proper specie basis for the huge mass of paper money which her banks fabricate. The state of Maine, too, has fallen off by a similar recreant step, and indications have also elsewhere appeared of a similar delinquency. Still it is to be hoped that this retrograde movement will be of limited extent, and that the example of those states which entertain sounder views of a currency will ultimately operate upon the rest, and convince them that the profit of private corporations should never be made to outweigh the substantial interests of the community, by placing the stability of the currency in a constant state of jeopardy.19

 

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20 According to the report of the secretary of the treasury of April, 1840, the number was 901, with a paid up capital of near $360,000,000. See Appendix C.

21 Book I. Chap. 4.

22 This expression must be qualified thus. Every emission of a paper currency in any country drives out a portion of its coin, and augments the total amount of the currency of the world, in the same manner that an additional quantity of gold and silver from the mines would do it; and hence an emission of paper money any where must augment the currency every where, after time has been afforded for the distribution.

23 I am aware that the usual practice of banks is to call in their capitals by instalments, and to lend out those instalments as fast as received, which is undoubtedly the best mode, if the loans were not so apt to be made to needy or speculating stockholders, to enable them to pay up the subsequent instalments.

24 If it be objected to this proposition, that the losses of the banks in the United States are comparatively few, I would reply, that this result is to be ascribed to the absence of a general bankrupt law, which would prevent those partial assignments for the benefit of endorsers at bank, by which banks become preferred creditors in most cases of insolvency, and thereby get a larger share of the assets of their debtors, than other creditors.

25 The depreciation of a currenny when it takes place must necessarily show itself in reference to every species of property and commodity, although it takes longer to reach some things than others, so as to occasion a change in their price. A depreciation of the currency, in reference to particular things only, cannot be supposed, any more than a rise of the tides in reference to some particular objects on the margin of a river, and not to all others.

26 Strictly speaking, the export would not be quite equal to the amount of the paper issued, for the reason assigned in the second note to this chapter, page 73.

27 The banks of Pennsylvania, and perhaps most other states, are authorised to charge one per cent, interest for sixty days, and to receive it in advance. Individuals can only charge six per cent. per annum, without the right to receive it before hand, but the law in this case is seldom observed.

28 Except in those cases where deposites constitute a large portion of the amount loaned by the bank.

29 To this circumstance may also be mainly ascribed the practice which of late years has generally prevailed of long credits on merchandise sold. Eight months are now given, where formerly only four were required, the effect of which is to double the stocks of dealers who buy on credit, and to double the amount of outstanding debts. When long notes are discounted by banks, long credits will be given by the merchants.

30 The discount will of course be deducted.

31 Whenever gold and silver legal tenders are both saleable at a premium, it is proof of the absence of true convertibility.

32 Mr. McCulloch in his Commercial Dictionary, edition of 1834, pages 109 and 110, has the following remarks. “Bad as our system of country banking undoubtedly is, we should be exceedingly sorry to see any attempt made to improve it, by the adoption of even the best parts of the American system!” * * * * * * “That part of the American system which limits the responsibility of the partners in a bank to the amount of their shares, seems to us to be in the last degree objectionable. It affords a strong temptation to the commission of fraud, and we have yet to learn, that it possesses a single countervailing advantage. We have been assured by those well acquainted with the facts, that it has been productive of the most mischievous consequences.”

For an able exposition of the principles of individual liability, see the article G, in the Appendix, by James Cox Esq., of Philadelphia, now first published.

33 The banks of New York are prohibited from issuing post notes. Some of those of Philadelphia entered very deeply into this branch of business in the years 1838 and 1839, abroad as well as at home, and became greatly embarrassed by it.

34 The following article which appeared in a newspaper in December, 1839, is important as regards this practice.

Important Legal Decision.—The Cincinnati Gazette contains a notice of the decision of a case at Columbus, Ohio, which attracted much attention on account of the principles involved. The facts were briefly these:

Paddleford wrote to the cashier of the bank, inquiring if they would discount a note with his and other names mentioned, payable east 6 or 8 months. The cashier replied, that the bank was not discounting, but his bill with the names mentioned for $5000, at 6 months payable in New York, Philadelphia, or Baltimore, would be purchased at their usual rates, and the procceeds paid in their own bills, if intended for circulation or in a check east at the usual premium: and he endorsed a printed blank form of a bill, Paddleford and the other person signed the blank paper filled up only with the sum, and he sent it to the cashier in a letter requesting him to remit the proceeds to him in an eastern check, less the premium. The paper was received at the bank, and filled up with the name of their own correspondent in New York, the cashier of a bank as a drawee, in their own favor. The drawer never had funds in his hands. Deducting the interest for six months and four days, and one per cent, they remitted him the net proceeds in a check on New York less 1½ per cent, premium, and ordered a notice to be furnished to him of the name of the drawee, and of the time and place of payment, which notice was duly received.

The charter of the bank prohibits them from taking more than at the rate of 6 per cent, per annum on their loans or discounts. The defendants, the securities, (Paddleford not having been served with process) set up as a defence, that this bill was discounted at a higher rate than 6 per cent. per annum, and therefore was against the charter, unlawful and void. The bank claimed that the bill was fairly purchased in the market, and that one per cent, was retained as exchange. The court instructed the jury that the bank could buy and sell exchange at any fair Tate agreed upon, without violating its charter; and if the transaction before them was a real purchase of a bill at 1 per cent, exchange and interest off, the bank could recover, but if the intention was to get a greater compensation for the use of the money than at the rate of 6 per cent, per annum, and the form of the bill was resorted to, to cover up that design, then the contract was unlawful, and the defendants must have a verdict; that the jury should be governed by the real transaction, no matter what form it assumed.

This decision seems to cut up by the roots, the business of discounting fictitious bills of exchange by banks similarly restricted, merely for the purpose of exacting high interest under the name of exchange.

35 The essay last mentioned, appeared in the National Gazette, of 10th April, 1828, under the title of “The Currency.” The reply was published in the Philadelphia Gazette, of 17th April, 1828, under the title of “On Exchange.” Both essays were republished in the Free Trade Advocate in 1829.

36 The following western and southwestern bank stocks were sold at New York and Philadelphia, where a large amount of them are owned, between the 1st of September, 1839, and the 1st of January, 1840, as low as the prices specified in the first column. The sales at Philadelphia were made prior to the suspension of specie payments on the 9th of October, so that in both cases the specie price is given.

The second column gives the lowest and highest prices between the 1st of January and the 1st of May, 1840.

37 These sales were made at Philadelphia, in paper currency, depreciated from 8 to 5 per cent, the range between January and May.

It is supposed that at least fifteen millions of dollars of Philadelphia and New York capital have been invested in the stocks of the western and south-western banks and internal improvement companies, but chiefly in banks, which accounts in some degree for the present embarrassment of those two cities.

38 Silver is virtually the currency of France. Gold being undervalued at the mint in relation to silver, commands a small premium in the market, when wanted for travellers or exportation.

39 During the suspension of specie payments which commenced on 9th October, 1839, and which still continues in all the States south and west of New York, small notes as low as $1, issued by the banks of Delaware and New Jersey, have been current in Pennsylvania. No notes under five dollars having been issued by bank corporations or individuals in Pennsylvania.

• 1* According to the report of the secretary of the treasury of April, 1840, the number was 901, with a paid up capital of near $360,000,000. See Appendix C.
• 2* Book I. Chap. 4.
• 3† This expression must be qualified thus. Every emission of a paper currency in any country drives out a portion of its coin, and augments the total amount of the currency of the world, in the same manner that an additional quantity of gold and silver from the mines would do it; and hence an emission of paper money any where must augment the currency every where, after time has been afforded for the distribution.
• 4* I am aware that the usual practice of banks is to call in their capitals by instalments, and to lend out those instalments as fast as received, which is undoubtedly the best mode, if the loans were not so apt to be made to needy or speculating stockholders, to enable them to pay up the subsequent instalments.
• 5* If it be objected to this proposition, that the losses of the banks in the United States are comparatively few, I would reply, that this result is to be ascribed to the absence of a general bankrupt law, which would prevent those partial assignments for the benefit of endorsers at bank, by which banks become preferred creditors in most cases of insolvency, and thereby get a larger share of the assets of their debtors, than other creditors.
• 6* The depreciation of a currenny when it takes place must necessarily show itself in reference to every species of property and commodity, although it takes longer to reach some things than others, so as to occasion a change in their price. A depreciation of the currency, in reference to particular things only, cannot be supposed, any more than a rise of the tides in reference to some particular objects on the margin of a river, and not to all others.
• 7* Strictly speaking, the export would not be quite equal to the amount of the paper issued, for the reason assigned in the second note to this chapter, page 73.
• 8* The banks of Pennsylvania, and perhaps most other states, are authorised to charge one per cent, interest for sixty days, and to receive it in advance. Individuals can only charge six per cent. per annum, without the right to receive it before hand, but the law in this case is seldom observed.
• 9* Except in those cases where deposites constitute a large portion of the amount loaned by the bank.
• 10* To this circumstance may also be mainly ascribed the practice which of late years has generally prevailed of long credits on merchandise sold. Eight months are now given, where formerly only four were required, the effect of which is to double the stocks of dealers who buy on credit, and to double the amount of outstanding debts. When long notes are discounted by banks, long credits will be given by the merchants.
• 11* The discount will of course be deducted.
• 12* Whenever gold and silver legal tenders are both saleable at a premium, it is proof of the absence of true convertibility.
• 13* Mr. McCulloch in his Commercial Dictionary, edition of 1834, pages 109 and 110, has the following remarks. “Bad as our system of country banking undoubtedly is, we should be exceedingly sorry to see any attempt made to improve it, by the adoption of even the best parts of the American system!” * * * * * * “That part of the American system which limits the responsibility of the partners in a bank to the amount of their shares, seems to us to be in the last degree objectionable. It affords a strong temptation to the commission of fraud, and we have yet to learn, that it possesses a single countervailing advantage. We have been assured by those well acquainted with the facts, that it has been productive of the most mischievous consequences.”
• 14* The banks of New York are prohibited from issuing post notes. Some of those of Philadelphia entered very deeply into this branch of business in the years 1838 and 1839, abroad as well as at home, and became greatly embarrassed by it.
• 15* The following article which appeared in a newspaper in December, 1839, is important as regards this practice.
• 16* The essay last mentioned, appeared in the National Gazette, of 10th April, 1828, under the title of “The Currency.” The reply was published in the Philadelphia Gazette, of 17th April, 1828, under the title of “On Exchange.” Both essays were republished in the Free Trade Advocate in 1829.
• 17* The following western and southwestern bank stocks were sold at New York and Philadelphia, where a large amount of them are owned, between the 1st of September, 1839, and the 1st of January, 1840, as low as the prices specified in the first column. The sales at Philadelphia were made prior to the suspension of specie payments on the 9th of October, so that in both cases the specie price is given.
• 18* Silver is virtually the currency of France. Gold being undervalued at the mint in relation to silver, commands a small premium in the market, when wanted for travellers or exportation.
• 19* During the suspension of specie payments which commenced on 9th October, 1839, and which still continues in all the States south and west of New York, small notes as low as $1, issued by the banks of Delaware and New Jersey, have been current in Pennsylvania. No notes under five dollars having been issued by bank corporations or individuals in Pennsylvania.
• 20In the nine hundred banks and branches which now exist in the United States,* all the operations of these three distinct institutions are combined; and it is owing to this combination, by which dissimilar things are confusedly mixed together, that the public mind has been led into so much error upon the subject of banking. An analytical examination can alone enable any one to understand the true merits of this important subject.
• 21IN a former part of this treatise* it was shown, that under a metallic currency, it is not possible to retain in any country, for any length of time together, a larger amount of coin than that which is requisite to place its currency upon a level with the currencies of other countries; and it was also shown, that if by any extraordinary cause a greater amount should at any time be brought into any country, it would continue but for a short time, and would gradually disappear by exportation, in the manner there described, until the equilibrium should be restored.
• 22What is true of a metallic currency, is equally true of a mixed currency, consisting of coin and paper exchangeable for coin on demand. The aggregate amount of the two component parts cannot exceed for any great length of time, the amount of coin which would circulate if there was no paper, as I shall now proceed to show.†
• 23Let us suppose that, in a particular country, enjoying a metallic currency, the quantity of coin requisite to circulate its products and commodities, and to maintain its currency upon a level with the currencies of other countries, is ten millions of dollars, and that the balance of trade and payments is such at the time of our supposition, that the exchange is at par. A bank of deposit, discount and circulation is established upon the corporate or joint-stock principle, with a capital of one million of dollars in coin, which amount is of course to be taken from the ten millions in circulation. We will suppose this capital all to be paid in before the bank commences its operations. The effect of this would be a temporary pressure for money, by withdrawing one million of dollars from circulation. This pressure, however, would be gradually relieved, as the bank commenced discounting, and would wholly disappear after it had loaned out a million of dollars.* Now it is manifest, that up to the period at which the loans of the bank do not exceed one million of dollars, its operations have been simply those of a bank of discount, for it has only loaned the amount of its capital, that is, of money previously existing. It may indeed, have issued notes, or given credits on its books for loans made, instead of paying out the identical gold and silver received from the stockholders; or, it may have given notes, or credits, on a deposit of coin for the convenience of the public; but such notes and credits in such cases would be mere certificates that corresponding amounts of gold and silver were lying in the vaults of the bank, belonging to the owners of such notes or credits, held subject to their order, precisely as in the case of special deposites. It might even happen, that millions of dollars in the form of notes and credits might be issued by the bank in exchange for specie, without thus far exercising one single prerogative of a bank of circulation, or influencing in the slightest degree the state of the currency, any more than the Bank of Hamburgh, already described, influences the currency of that city.
• 24From this view of the subject, how clear is to be seen that what the bank has thus far performed, is nothing more than what the individuals who own the capital of the bank, could themselves have performed more cheaply, quite as securely, and perhaps more advantageously to the public, seeing that loans to unskilful and imprudent borrowers, of which individuals are not so apt to be guilty as corporations, lead to a diminution of the wealth of a country, whether it result from injudicious voyages, or from any species of enterprise which converts productive capital into properly which is not equally productive, or, from improvident sales of merchandise to persons not entitled to credit. Incorporated or joint stock banks, it is thought, owing to their directors not having a deep personal interest at stake, and owing to their liability to be influenced as a board, by considerations which do not operate upon individuals, and especially owing to the absolute impossibility of their devoting any large share of their time to the investigation of the characters of all applicants for loans, cannot, in the nature of things, exercise the same discrimination in the choice of its borrowers, as individual capitalists do.*
• 25The circulating principle is now put into operation by our supposed bank, by lending its credit in addition to its capital. In other words, without having any more money to lend, it undertakes to discount notes at short periods, by giving to the borrowers not coin, or notes or credits absolutely representing coin in its vaults, as in the case of its original loans, but notes or credits promising to pay gold or silver on demand, founded upon a presumption that no such demand will be made, until the notes, in the discount of which they were issued, or some of the other notes discounted by the bank, will be paid, and thus bring into its coffers an equal amount of specie. In other words, the bank lends its credit, and as this credit is just as valuable to any of the parties who are indebted to the bank for the first million, or for any subsequent sum loaned, as gold or silver, any of them will be willing to receive it in payment of debts or for merchandise sold, as readily as coin, and the notoriety of this fact, added to the right of conversion on demand, gives the notes and transferable credits of the bank a circulation with the public equivalent to coin. Every emission, however, of these bank notes and credits is an augmentation of the currency, and depreciates it below the general level.* Let us, for the sake of argument, suppose the amount of this augmentation to be extended in a given time to one million of dollars, that being the sum requisite, we will further suppose, to occasion the degree of depreciation that must exist before it is profitable to export coin. The amount of the currency will then be eleven millions of dollars, that is to say, ten millions of coin, and one million of paper. The effect of this would inevitably be what is called a plenty of money. The prices of all commodities would rise, because there would be eleven purchasers in the market, where before there were but ten, or, what amounts to the same thing, because the former purchasers would possess one tenth more means to purchase with, than they possessed before. This rise of prices, operating upon foreign as well as domestic commodities, would lead to the importation of additional quantities of foreign merchandise. But no corresponding export of domestic products would take place, on account of their artificially high price, upon which bills could be drawn to pay for the foreign imports; and the consequence would be, that money would be sent abroad in their stead, as presenting the most profitable species of export. But of the money in circulation, it is evident that nobody would think of exporting the paper, which would have no value abroad, and consequently, all the exports that would take place, would be of coin.
• 26The effect just described would as certainly take place as that water would find its level, and would continue until the export of coin was equal to the amount of the paper issued, that is, to one million of dollars, when the level would be again restored, owing to the fact of the aggregate of the coin and paper united being only ten millions of dollars, that is, nine millions of coin and one million of paper.* Further emissions of bank notes or credits might then take place with precisely the same results, and provided that the extent to which the issues are carried is not so great as to drive out of the country too great a portion of the metallic currency, by which the convertibility of the paper into coin in case of a sudden panic occasioned by foreign war or domestic disturbance, or by fear of insolvency, might be endangered, the operations of the bank are decidedly beneficial to the country. It has disengaged from a comparatively unproductive employment, a capital capable of producing an annual profit to the nation equal to the average profits of capital, or, in other words, has substituted an expensive instrument of commerce by one costing less. And yet, by this operation, no permanent depreciation of the currency takes place, because the total quantity of coin and paper united is only equal to the quantity of coin that would have circulated had there been no bank.
• 27IT has been shown that banks of discount upon the corporate or joint-stock principle could not generally he conducted to a profit, seeing that the income they derive from the loan of capital would not be as great as the income which the individual proprietors could have derived from lending their money without the agency of salaried officers and the rent and other expenses of a banking house. It has also been shown, that for the same reason, banks which perform the double function of banks of discount and banks of circulation, can make no banking profit by the mere lending of their capitals. All their profits are derived from lending their credit; for, although where the rate of interest is six per cent. per annum, the practice of taking the interest beforehand, and charging sixty-four days discount for the use of the money for sixty-three days, as in Philadelphia and other places, the actual rate received is 6 per cent., yet the additional four-tenths of one per cent, do not pay the proportion of the whole expenses of the bank, which the amount of its capital bears to the whole amount of its loans. Indeed, a little reflection will enable any one to perceive, that not only do all the profits beyond legal interest of a bank of discount and circulation, where it is successful, arise from the loan of its credit, but those profits must besides furnish a fund for making up the loss incident to the lending of its capital. Thus, if we suppose a bank of discount and circulation with a capital of one million of dollars, having loans out to the amount of one million and a half, and the whole annual expenses of the bank to be fifteen thousand dollars, or one per cent, upon the amount of the loans, it will be seen that two thirds of this expense attaches to the lending of the capital, and only one third to the lending of the credit of the bank, so that if separate accounts were kept of the expenses of each department of the institution, they would show a gain upon the lending of credit and a loss upon the lending of capital. If, therefore, the whole operation be profitable, the profit must arise from the lending of credit, and must consist’ of what remains after defraying the loss incident to the lending of the capital, which is precisely equal to the excess of the expenses of bank agency in loans over those of private agency, deducting the four-tenths of one per cent, which a bank charges, more than individuals would have a right to charge by law on loans.* At all events, no one will pretend that banks make more by the loan of their capitals than individuals could make, and even on this admission it is apparent that all the peculiar profits of what is usually called banking arise from the loan of credit.*
• 28IT has been shown that banks of discount upon the corporate or joint-stock principle could not generally he conducted to a profit, seeing that the income they derive from the loan of capital would not be as great as the income which the individual proprietors could have derived from lending their money without the agency of salaried officers and the rent and other expenses of a banking house. It has also been shown, that for the same reason, banks which perform the double function of banks of discount and banks of circulation, can make no banking profit by the mere lending of their capitals. All their profits are derived from lending their credit; for, although where the rate of interest is six per cent. per annum, the practice of taking the interest beforehand, and charging sixty-four days discount for the use of the money for sixty-three days, as in Philadelphia and other places, the actual rate received is 6 per cent., yet the additional four-tenths of one per cent, do not pay the proportion of the whole expenses of the bank, which the amount of its capital bears to the whole amount of its loans. Indeed, a little reflection will enable any one to perceive, that not only do all the profits beyond legal interest of a bank of discount and circulation, where it is successful, arise from the loan of its credit, but those profits must besides furnish a fund for making up the loss incident to the lending of its capital. Thus, if we suppose a bank of discount and circulation with a capital of one million of dollars, having loans out to the amount of one million and a half, and the whole annual expenses of the bank to be fifteen thousand dollars, or one per cent, upon the amount of the loans, it will be seen that two thirds of this expense attaches to the lending of the capital, and only one third to the lending of the credit of the bank, so that if separate accounts were kept of the expenses of each department of the institution, they would show a gain upon the lending of credit and a loss upon the lending of capital. If, therefore, the whole operation be profitable, the profit must arise from the lending of credit, and must consist’ of what remains after defraying the loss incident to the lending of the capital, which is precisely equal to the excess of the expenses of bank agency in loans over those of private agency, deducting the four-tenths of one per cent, which a bank charges, more than individuals would have a right to charge by law on loans.* At all events, no one will pretend that banks make more by the loan of their capitals than individuals could make, and even on this admission it is apparent that all the peculiar profits of what is usually called banking arise from the loan of credit.*
• 29The mode in which a bank lends its credit is to exchange its own promissory notes payable on demand, for the promissory notes or acceptances of individuals payable at a future period, deducting the interest for the time which the latter have to run before they become due, and allowing no interest on its own notes for the time that may elapse before their payment is demanded. In making this exchange, the profits of the bank depend entirely upon the length of time that its notes remain abroad, and its ability to meet them depends of course upon the length of time which the notes have to run in exchange for which they were issued. If bank notes be issued only upon the principles laid down in a former chapter as mere substitutes for coin exported, and without augmenting in any degree the amount of the currency, they will remain in permanent circulation, unless in case of a panic, or discredit, which occasions a run upon the bank, and will constitute a source of permanent profit; for although some of them may be constantly returning in payment of debts, yet they are sent out again as fast as they come in, in the discount of other bills or acceptances. As to the length of time which the discounted paper should have to run, experience must decide, the bank having regard to the possibility of a panic, as well as to the action of other neighboring banks, seeing that an over-issue by anyone of them, by depreciating the currency, may occasion a temporary reaction upon other hanks as well as itself, and disturb even those that are the most prudently conducted. The practice of the banks in the United States prior to the war of 1812, was generally to limit their loans to paper not having more than sixty-three days to run. Since that time, loans have been made at longer periods, extending sometimes even to four and six months, and to this circumstance is no doubt to be ascribed, in a great degree, the frequent revulsions that have since taken place in our currency, and especially that which eventuated in a general stoppage of specie payments in May, 1837.* It must be manifest, that the power of a bank to meet any extraordinary emergency must depend upon the command it has over its loans, and if the experience of other countries can be considered as any guide, that of England and France may both be referred to, where discounts of paper having more than sixty or a hundred days to run, are wholly discountenanced. A similar practice in the United States could not fail to be productive of much benefit to the community, as a means of correcting with promptness any accidental expansion of the currency.
• 30Let us suppose a bank with a capital of one million of dollars. After this is all loaned out, it is very evident that the bank has no more capital to lend. A offers a note for discount, having sixty days to run, for one thousand dollars, and the bank discounts it, by giving one thousand dollars of its own notes payable on demand.* These notes, as I have shown, are not capital, but a promise to deliver capital, and it is only because the bank supposes that no demand will be made upon it before the expiration of sixty days, when A’s note will become due, that it considers itself safe in exchanging notes with A for that length of time. If the notes come back for payment before A’s note is paid, it is evident that the bank cannot fulfil its promises to deliver capital, without borrowing from same one else, or without compelling some of its other debtors to pay, and what is true of A’s note is true of all the other notes which the bank may discount in exchange for its own notes.
• 31The duties which the public have to perform, as a check upon this perpetual tendency to over-issue, are incumbent on every citizen; and he who withholds his co-operation, when he has a motive to act, becomes a participator in the wrong. They are, simply, for every man who wishes to convert bank notes or deposites into coin, either for the purpose of convenience or exportation, and whether the amount be large or small, to make his demand without being influenced by fear, favor, or affection, or through any false or mistaken delicacy towards the directors of banks, or their debtors who might in consequence thereof be called upon for an earlier reimbursement. Here, again, unfortunately, experience demonstrates, that the independence and moral firmness of most merchants is not proof against the influences which may be brought to bear against them. On the one hand, they find their discounts interfered with, and their commercial operations crippled; whilst on the other, they discover that a clamor is raised against them by those debtors to the banks who purchase commodities from them, as soon as they feel the pressure occasioned by a diminution of discounts, consequent upon a heavy demand for specie.*
• 32The only true resort, therefore, that can be appealed to for absolute convertibility is legislation. But how is this legislation to be expressed? By forfeiting the charters of banks that do not pay their notes. The legislature of New York in May, 1837, absolved its bank’s from this penalty for one year. By imposing a penalty of twelve or twenty-four per cent, per annum, upon notes and deposites not paid in coin. Such provisions were wholly inoperative in those states where they prevailed, during the late general suspension, by the evasion of the banks, and by popular clamor raised against individuals who demanded their rights, and cannot be relied upon, either to prevent a general stoppage, or to enforce a resumption with promptness. The true and only answer is, by establishing individual liability, such as that which exists with all the joint-stock banks of England, and all the private banks of that country as well as of Europe.*
• 33The practice of discounting notes, and instead of giving cash for the net proceeds, giving post notes payable at thirty or sixty days date, by which means the bank gains a profit equal to the interest for the time the note has to run. In other words, if a bank discounts a note having ninety days to run, and gives in exchange for it a post note payable in thirty days, it receives interest for ninety days for the loan of money for sixty days, inasmuch as the post note is not money until it becomes due, as will hereafter be shown. The extent to which this practice has been carried throughout the United States is very great, and it is defended upon the ground that the emission of post notes enables merchants who have remittances to make to distant points, to effect that object more securely and conveniently than by the transmission of bank notes payable to bearer, on account of the security afforded by the former’s being only transferable by endorsement. This is true, but it is manifest that this end would be as completely attained by a post note payable in three days after date, as by one payable in sixty days. But this is not all. Post notes at long dates, not only enable banks to profit by evading the laws against usury, but they enable banks to raise money for their own use when they are embarrassed, without appearing to borrow, a facility which renders them less careful of expansions of the currency than they otherwise would be.*
• 34The practice of discounting domestic or inland bills of exchange, by which advantage has been taken under the color of exchange, to charge, besides the legal interest, and a fair charge for collecting, the most extortionate rates of profit, having no real relation to the actual expense of collecting, but only to the necessities of borrowers.* In the examination, by a committee of the legislature of New York, in 1838, of the affairs of one of the city banks, some gross malpractices of that institution were developed. It was proved to have charged from five to ten per cent, exchange on the collection of drafts, when the market rate of exchange on similar drafts was not more than from three to six; had discounted paper with the express understanding that the party accommodated was not to receive cash for the net proceeds, but a draft at par upon some distant place, worth in the market one to three per cent, less than the rate at which it was taken; and had even purchased back their own drafts at such a rate of discount. What this bank did, has been done, more or less, by a large portion of the banks in the United States, and the evil has become so extensive that funds which should be devoted to the discounting of real paper payable on the spot, have been diverted to the purchase of fictitious bills, created for the very purpose of raising money, and not in the ordinary course of trade.
• 35It is, however, in the interference with the foreign exchanges of a country that the power of banks is most to be deprecated. Upon this subject, the author advanced some views in an essay published by him in the year 1828, which so entirely correspond with those which he at present entertains, that he has concluded to transcribe them, rather than to adopt any new phraseology. The essay was in answer to one written a short time before, by a friend of the Bank of the United States, with the design, amongst other things, of showing the importance to the country of the power exercised by the bank of dealing in exchange.* The following are extracts:
• 36This difference in the cost of the credit, however, is all the benefit that the western cities and towns can have reaped from borrowing foreign capital through bank charters, rather than through the ordinary channels of purchasing goods on credit. What it may have amounted to, it is not easy to ascertain; but as a set off to it, it may very fairly be assumed, that in the scramble for discounts made on the first opening of the banks, the loans of capital and credit were not as judiciously made for the general interests of the country, as sales of merchandise would have been by the eastern merchants, as is shown by the fact that immense sums were loaned to planters who embarked in speculations in lands and slaves, and to merchants who embarked in shipments of cotton, and who ultimately became embarrassed or ruined by these operations. Every one remembers that the southwestern banks were the last to resume specie payments after the late suspension; and it is well known to many, that they were only enabled to do it when they did, by borrowing large sums from the eastern cities, or by the emission of post notes payable at distant periods with which they absorbed a part of their immediate liabilities. If any stronger proof were wanted of injudicious and improvident loans on the part of many of those banks, it may perhaps be found in the second failure that has taken place with all of them since their resumption in January, 1839, and in the expression of public opinion manifested on the stock exchanges of New York and Philadelphia at a recent period, which places the stocks of all of them below par, and of some of them very considerably below it.* If these facts be conclusive as to indiscreet and improvident loans, all the mischief which I have in other parts of this work traced to the same cause in other places, must be equally predicated of the western and southwestern banks; and it will not perhaps be difficult for the reader to admit, that all the benefit which the western and southwestern states have derived from the establishment amongst them of banks constructed upon foreign capital over and above the benefits which those states would have derived from their merchants buying and selling an equal amount of foreign goods on credit, has been more than counterbalanced by the evils resulting from incautious loans of capital and credit.
• 37
• 38IT must be manifest to all who will reflect upon the subject, that the currency of the United States is exposed to dangers from over-expansions to which that of Great Britain is not in the same degree liable. The distance from the American to the European continent is so great, that even after the general establishment of steam packets, a month would be requisite for obtaining a supply of the precious metals under a panic, which could be obtained in England from the adjacent parts of the continent in four or five days, and it would therefore seem to be sound policy for the state legislatures of our Union to authorise no measures to be pursued by our banks which can have a tendency to diminish the metallic basis of our paper currency so greatly, as to endanger its convertibility. It is self-evident, that just in proportion to the diminutive size of bank notes authorised in a country, will be the supply and consequent circulation of gold and silver. In France, where no bank note is allowed to be issued of a less denomination than five hundred francs, (equal to about ninety-four dollars of our money,) the whole of the retail transactions of a community of thirty millions of people, nearly double our population, are carried on by the precious metals.* In England, no note of a less denomination than five pounds sterling (equal to twenty-four dollars and upwards,) can be issued by the Bank of England, or by any joint-stock or private bank; so that in that country too, the minor channels of circulation are kept well filled with gold, so that on any emergency, a large fund can be made available to meet any reaction of the banking system, before the necessity occurs of ordering bullion from abroad.
• 39The successful issue of this experiment in Pennsylvania was followed in subsequent years by a number of other states, which in turn proscribed notes under five dollars; and their total expulsion from all the states of the Union might reasonably have been expected in the course of a few years, had it not been for the unfortunate suspension of specie payments in May, 1837, which again deluged the country from one end to the other with a flood of small notes and tickets, from three dollars down to five cents, and extinguished in some of our legislatures the lights of science which so much pains had been for so many years taken, by the intelligent few, to kindle into a flame. New York has backslided by authorising, by a recent act, the emission by her own banks of notes of a less denomination than five dollars, and as far as she is concerned, has proclaimed her unwillingness to assist in retaining in the country a proper specie basis for the huge mass of paper money which her banks fabricate. The state of Maine, too, has fallen off by a similar recreant step, and indications have also elsewhere appeared of a similar delinquency. Still it is to be hoped that this retrograde movement will be of limited extent, and that the example of those states which entertain sounder views of a currency will ultimately operate upon the rest, and convince them that the profit of private corporations should never be made to outweigh the substantial interests of the community, by placing the stability of the currency in a constant state of jeopardy.*