Part 18

MR. BANKER: That is precisely what we ought to be permitted to do.

MR. LAWYER: Then, Mr. Banker, instead of sending as you now do, 9 per cent of your deposits, or $175,000, to a reserve city, and that city in turn sending a part of it to some central reserve city, your balance with your reserve city should be sufficient to carry your exchange account, and the balance go to a great central gold reserve, upon which you and your fellow bankers throughout the country could rely absolutely when the emergency came.

MR. MANUFACTURER: I have been listening to you gentlemen with intense interest, and must say that you have worked this plan out completely and practically.

I see what an enormous advantage it would be to a bank to use its reserve as a reserve should be used, and what an absolute guarantee of protection it would be to have all the reserves of all the banks centralized, and ready to help anyone of them in need of gold, because the gold was actually on hand, and had not been loaned out as the banks now do; but I have been wondering where the State Banks and Trust Companies were going to get 10 per cent more reserves of their demand deposits to put up in this central gold reserve. You must remember that they have five billion of deposits.

MR. BANKER: I can tell you how to do that; that is very easy.

When the State Banks come into the National system as they certainly will, if you have the right kind of a system, they will exchange their notes for the gold or gold certificates that are now in circulation, as they come in over their counters. You see that all the gold and gold certificates that are now held by the banks only amount to $879,000,000, although there is in the country $1,850,000,000 of gold, practically one billion of gold, or $10 of gold for every man, woman and child out in the corn, cotton and wheat fields; in the mining camps, when as a matter of fact, this gold should be in the reserves of our banks, protecting our bank credits; and bank notes should be in the corn, cotton and wheat fields, in the mining camps filling the true function of currency, and where gold, or gold certificates are not at all needed.

MR. LAWYER: Now, wait a moment, Mr. Banker, and let me see if I grasp that. It is very important that we should all understand this. I am exceedingly anxious to, and it strikes me that we are at a mighty interesting juncture of this subject. If a State Bank with a reserve of $70,000 came into your National system and had to increase its present reserve, which is only 7 per cent, by as much as 10 per cent, it could do so by simply retaining the gold and gold certificates as they were deposited from day to day, and pay out its bank notes to the extent of one hundred thousand dollars. The result would be that the bank would increase its liabilities by $100,000, but it would also increase its reserves by $100,000. That is certainly a perfectly sound proposition. Before the bank came into the system, its reserves were only 7 per cent, or $70,000, since its deposits were $1,000,000. After it goes into the National system, it has changed $100,000 of its notes for $100,000 of gold, or gold certificates, as they came in over the counter; it now owes $1,100,000, of which $100,000 is of notes, but it now has $187,000 of reserves of all of its demand liabilities, or 17 per cent, instead of $70,000, or 7 per cent, as before.

MR. MERCHANT: Isn't that a simple and very easy thing to do? And what tremendous strength it would give to the whole banking situation immediately.

MR. MANUFACTURER: Then when you think of it, what a stupendous piece of folly it is, to have all this gold floating around the country, doing no possible good, when a piece of credit paper, or bank note, would do the work just as well.

MR. LABORINGMAN: Anybody can see that. A man that can't ought to be arrested for want of brains. He'd have to plead guilty. Putting that gold that you need in your bank reserves at the rate of one dollar of gold for five or six dollars of credit into the streets, cotton fields, corn fields and in the mines, is no greater piece of folly than it would be to send a six-horse team to haul Mr. Farmer home, when one horse would do just as well.

UNCLE SAM: Mr. Laboringman has got this thing dead right. In fact, in my judgment, he has the horse sense of this crowd. Give him a show, I'll bet on him every time, he always takes a short cut, and hits the nail square on the head.

MR. MERCHANT: Suppose, Mr. Banker, that all the banks of the country should come into the National system, and put up, say 10 per cent, as you suggested a while ago, of their demand or individual deposits, and 5 per cent of their savings deposits, what would your central gold reserve amount to?

MR. BANKER: On June 14, 1912, the Comptroller of the Currency reported that the individual deposits amounted to ten billion five hundred million ($10,500,000,000), and that the savings deposits, outside of the mutual savings bank, amounted to two billion eight hundred and seventy-two million ($2,872,000,000).

If the State Banks and Trust Companies should become National Banks, and bring their reserves up to the National standard, by exchanging their notes for gold; that is, exchanging $468,000,000 of their notes for that much gold, the result would be as follows:

Individual Deposits $10,500,000,000 @10% $1,050,000,000 Savings Deposits 2,872,000,000 @ 5% 143,600,000 Bank Notes 1,219,000,000 @10% 121,900,000 -------------- Making a total central gold reserve of $1,315,500,000

This is just double what the gold reserve of France is, the largest gold reserve in the world today, but when you consider the fact that our banking resources are 45 per cent of the total banking resources of the world, it should be even more than that. It is interesting to note that in making this readjustment for a central gold reserve it would be just $100,000,000 larger than our bank note circulation.

With this central reserve of gold created, the United States could then control the inflow and outflow of gold to and from the United States, precisely as England controls the movements of gold today by fixing the rate of discount or a price for the use of gold.

UNCLE SAM: Well, boys, if there is one phase of this question that you have treated with a greater thoroughness and more satisfactory results than any other, to my mind, it is your plan for protecting our bank credits with ample gold reserves. They are so disposed of as to keep at all times all bank credits in touch with gold, and therefore as good as gold; at the same time have developed a great central gold reserve in harmony with the practice of the great commercial nations of the world, and commensurate with my importance as a banking power in the world. You have made this subject so clear and conclusive that I need not restate the points you have made.

I hope our next night will be as satisfactory as this has been.

Good Night.

ELEVENTH NIGHT

THE BANK

UNCLE SAM: At our last meeting you considered the very important element in banking, of reserves, and seemingly the final factor that enters into the structure of a bank. You have run the whole schedule off, I think. Standard of value, money, currency, exchange, capital, credit, government credit as money and as currency, land credit as money and as currency and reserves. What else can there be?

MR. BANKER: I do not think there is any particular topic for us to tackle now, but the bank itself, and I want to be permitted in the outset to describe just what a bank is, and what it does. I do not think there is any single thing in business life that is so misunderstood. People think of a bank as a kind of mystery.

The banker is a merchant in money and credit, and precisely as you can say that a man is a hardware merchant, cotton goods merchant, grain and flour merchant, so you can say that the banker is a money and credit merchant. He deals in these two things.

Let me illustrate this in a simple way. If Mr. Farmer should come to me to borrow a thousand dollars for three months, and I should make him the loan, as we say, I, as a banker, would buy his note, due in three months. That is just what happens every time a bank makes a loan; it simply buys the note. Now, in all probability I would not give Mr. Farmer any actual money, but would simply give him credit for one thousand dollars on the books of the bank, so that he could draw his check against it. In other words, I would owe him one thousand dollars. I have created a debt to him of one thousand dollars; in short, I have traded debts with him. He has given me his note, which is a debt for one thousand dollars due in three months, and I have given him credit on the books of the bank, a debt due to him on demand. The transaction does not differ in the slightest degree from the trade of horses for cattle. Let me demonstrate this. Suppose that Mr. Farmer came to me and offered me two of his Jersey cows for my horse and buggy, because he does not want the cows, but does want the horse and buggy to do a lot of running around. I want the cows to milk, and so make the exchange with him. He gets something that meets his pressing needs in the horse and buggy, and I get something from which I receive an income, the cows from which I get milk. This corresponds to the interest on his note, and by the way, the cream would be my profit.

MR. LABORINGMAN: That's it; you bankers are always milking the public, and the interest you get is all cream; all profit.

MR. BANKER: Oh, no! it is not as bad as that. Don't make such a mistake. The average cost to the bankers of the country, outside of any losses, is about 4 per cent upon their deposits for interest paid on deposits, rent for building, clerk hire and other general expenses. So you see that it is not all profit by any means.

But let me get right back to what I was saying. The banker is nothing but a trader who keeps an open shop for the purpose of trading his debts for the debts of his depositors; or to put it in another way, for the purpose of exchanging his credit for actual money which is deposited with him, or for checks and drafts that are deposited with him, or for promissory notes which he buys when he loans money to his customers, and gives them credit on his books for the amount of the loans. All these different things, money, checks, drafts and promissory notes are bought by the banker with his credit, and the greater the amount he buys with his credit the greater will be his debt. But, you will probably say these are his deposits. Very true, but his deposits are his debts. Don't forget that.

MR. LAWYER: Mr. Banker, you have accurately described the situation, just as it exists today, and that, of course, is what we are interested in; but it seems to me as though it would be a great help to us to follow the development of banking, as we have it now.

MacLeod, the highest authority upon banking credit, and the theory of banking, used this language: "The first business of a banker is not to lend money to others, but to collect money from others."

Bagehot used this language, in describing the business of the bank: "Thus, a banker's business--his proper business--does not begin while he is using his own money; it commences when he begins to use the capital of others."

Many writers have maintained that a bank should only be allowed to create exactly as much credit as the specie paid in, and that its sole function should be to exchange its credit for coin, and coin for credit; and that the quantity of the bank's credit should always be exactly the same as the coin it displaces. This principle is called the currency principle.

Many banks in the world's history have been constructed on this principle, especially those famous banks at Venice, Hamburg, Amsterdam and several others.

These cities, small in themselves, were the centers of great foreign commerce; and as a natural consequence, an immense quantity of coin and denominations of all sorts of different countries was brought by the foreigner who resorted to them. These coins were, moreover, greatly clipped, worn and diminished. The degraded state of the current coin produced intolerable inconvenience, disorder and confusion among merchants, who, when they had to make or receive payment of their bills, had to offer or receive a bag full of all sorts of different coins. The settlement of these bills, therefore, involved perpetual dispute--which coins were to be received, and which were not, and how much each was to count for. In order to remedy this, it finally became absolutely necessary that some fixed uniform standard of payment should be devised, to insure regularity and a just discharge of debts. In order to do this, the magistrates of those cities instituted a Bank of Deposit, in which every merchant placed all his coins of different kinds and nations. These were all weighed, and the bank gave him credit, either in the form of notes, or a credit on their books, exactly corresponding to the real amount of the bullion deposited. The owner of this credit was entitled to have it paid in full weighted coin on demand. These capital credits, therefore, always insured a uniform standard of payment; and it was enacted that all bills upon these respective cities, above a certain amount, should be paid in these Bank Credits, which were called _Bank Money_. The consequence was evident, as this Bank Credit, or Bank Money, was always exchangeable for money of full weight on demand; it was always at a premium.

These banks professed to keep all the coin and bullion deposited with them in their vaults. They made no use of it in the way of business, as by discounting bills. Thus the credit created was exactly equal to the specie deposited and their sole function was to exchange specie for credit and credit for specie.

These banks were examples of the currency principle; they were of no further use to commerce than this, that they served as a safe place to keep money in--and they insured a uniform standard of payment for debts. They made no profit by their business, but those who kept their accounts with them paid certain fees to defray the expenses of the establishment.

Later and during the civil war in Great Britain the goldsmiths of London began to receive the cash of the merchants on deposit. They not only agreed to repay it on demand, but to pay 6 per cent per annum for the use of it. Consequently, in order to enable them to do that, the deposits necessarily became their property to trade with as they thought best.

When, therefore, these goldsmiths received this money on deposit, they gave in exchange for it, or issued to their customers a credit, or right to demand back an equal amount of money at will. And it must be noted that it is this banker's credit which in banking language is termed a deposit. The money itself is called an asset, or resource.

MacLeod says that in practice it will be found that in ordinary times a banker's balance in cash will seldom differ by more than one thirty-sixth part from day to day. So that if he retains one-tenth part of his cash to meet any demands for payment that may be made, that is ample and sufficient in ordinary times.

The banker, therefore, can see that if an amount of cash was sufficient to support ten times the amount of his liabilities, he might safely buy debts to several times the amount of cash in his hands.

From this you see clearly by evolution a banker is a trader, just as Mr. Banker said a few moments ago, whose business consists in buying money and debts by creating other debts. If he has taken actual money on deposit, he has bought it, and if he has received checks and drafts on deposit, he has bought them likewise with his credit.

Thus, it is seen that the essential and distinctive feature of a bank and a banker is to issue credit payable on demand, and that this credit may be put into circulation and serve as money.

_First_: They might demand payment in cash; if they did so, the banker canceled his debt.

_Second_: The banker, if his customer wished it, gave him his promissory note to pay him or the bearer on demand such sum as he might wish; this neither created nor extinguished a deposit, it merely recorded it on paper for the convenience of transferring it to someone else. This promise to pay was at first called a "Goldsmith's Note," and is now called "A Bank Note."

_Third_: If the customer wished to make a payment he might write a note to his banker desiring him to pay the money to some particular person, or to his order, or to bearer. These notes were then called "Cash Notes," but are now called "Checks."

Now, it is perfectly clear that neither a bank note, nor a check creates any new right; it merely records on paper a right to have money which already exists, and it is used for the purpose of transferring that right to have money to someone else.

It will be noted now, and I want you to keep this observation clearly in mind, that all banks are banks of issue, that is issues of credit. MacLeod says that the very meaning of the words "To Bank" is to issue a right of action or a credit, in exchange for money or other debts; and when once the banker has issued this right of action, or right to have money, to his customer by writing it down to his credit, it makes not the slightest difference as to his liability whether he delivers his own promissory note, that is a bank note, to his customer, or whether he merely creates the credit, and gives him the right to transfer it to someone else by means of a check.

When a person deposits money at the bank, it is not his intention to deprive himself of the use of it; on the contrary, he means to have as free use of it as if it were in his own purse. The depositor, therefore, lends his money to his banker, but yet at the same time has the free use of it, as the bank employs that same money in promoting trade; upon the strength of the money being deposited with the bank, it buys debts with its promises to pay, either in the form of "Bank Notes," or of credit on its books, several times exceeding the amount of the cash placed with it; and the depositors who sell the bank their debts, have the free use of the very same coin which the depositor has the right to demand; thus the lender that is, the depositor, and the borrower that is, the banker, have the same right at the same time to the free use of the same money. All banking depends on the calculation that only a certain small portion of each set of depositors will demand the actual cash, but that the majority will be satisfied with the mere promise, the "Bank Notes" or the credit on the books of the bank.

Banking is a species of insurance; it is theoretically possible that a banker may be called upon to pay all his deposits at once, just as it is theoretically possible that all the lives insured in an office may end at the same instant; or it is theoretically possible that all the houses insured may be burned at the same hour. The depositors and noteholders of the Bank of England could demand payment the same day. All the depositors and noteholders of the Bank of France could demand payment the same day. All the depositors of any bank could demand payment the same day. But all banking, as well as all insurance, is based upon the expectation that these contingencies will not happen, and the average experience of life proves that they do not happen. A banker multiplies his debts to be paid on demand and keeps buying a sufficient amount of cash to insure the immediate payment of all claims which are _likely_ to be demanded at one time. If a pressure comes upon him he must sell some of the securities he has bought, or borrow money on them.

When the customer discounts a note at his bank he parts with the property in it, just as when he sells any other article. The note becomes the absolute property of the banker and he may sell it again, or pledge it, or deal with it in any way that suits his own interests best.

The notes in the safe of a banker are exactly similar to the goods in the shop of a retail dealer. The retail dealer buys the goods from the wholesale dealer and sells them at a higher price to his customers; and, as he makes a profit by doing so, the goods are _capital_ to him. Notes likewise are goods, or merchandise, which the bank buys from its own depositors at a discount, or bearing interest for a time, and as the bank makes a profit by so doing, the notes are _capital_ to the bank precisely in the same way that the goods in the shop of the retail dealer are _capital_.

Now, lest we shall be misled, I want to call your attention to an error which is very common. Many persons not being aware that the word "_Deposit_" in banking language means the credit created in exchange for money, checks, drafts or notes bought, when they hear or read that a bank has such an amount of deposits conceive or suppose that the bank has that amount of cash on hand to trade with.

When it is said that a bank has $10,000,000, $50,000,000 or $100,000,000 or $200,000,000 of deposits, they are not deposits in cash at all; they are almost entirely pure credit, and are exactly equivalent to just as many "Bank Notes." They are nothing but an enormous superstructure of _Credit_ built up on a comparatively small basis of reserves exactly like the note circulation. These figures do not show the quantity of cash at the command of the bank that can be traded with; but they show the quantity of business the bank has done, and the debts or liabilities it has created. These deposits, then, which so many think are cash, are in fact nothing but the credits the banks have created in exchange for the cash and notes which figure on the other side of the balance sheet as assets or resources.

This play of bank credit has been graphically described by Joseph T. Talbot, the Vice-President of one of our largest National Banks; he says: "A customer holding a bank note may present it for deposit and credit, instead of demanding redemption in cash. In this case, there is a conversion from the circulating form of credit, payable to bearer, back to a 'Book Credit,' payable to order, as was ordinarily the case. Thus it will be seen that all these forms of 'Bank Credits' are interchangeable, one for another, at the pleasure of the holder of the credit. The difference between these several forms of credit involves no changes whatever in the bank's liabilities. They amount to about the same difference which exists, let us say, between a coupon bond and a registered bond. The one is payable to bearer, the other is not. At one time a bank note may best serve a customer's needs; at another time he might prefer a deposit in the bank; or again he might prefer 'exchange.' All these interchangeable uses of credit actually and continuously take place. It will now be clear that a circulating 'Bank Note' in the hands of the public does not differ essentially from a 'Deposit Credit' on the bank's books.