Part 38

MR. BANKER: My position was just the reverse of that of Mr. Lawyer, for while I had studied it from an economic point of view and that of a practical banker, and had become so convinced of its utter unsoundness on the one hand, and unfitness for use to ninety-nine out of every hundred of American banks, I never dug into the soul of its management, until the past week. So we compared notes, and found the situation particularly interesting.

MR. MERCHANT: Before you go any further, I want to read something from a speech, delivered in Congress March 29, 1910, two years before the Aldrich plan was born. You are all doubtless aware that the Aldrich scheme was nothing more nor less than an attempt to transfer to this country the German scheme of note issue and banking generally.

MR. LABORINGMAN: I heard the other day, that the Aldrich bill was deader than a door-nail. Why do we want to spend any time on that? Or, are you fellows like the Irishman, who said that he was kicking a dead dog to teach him that there was such a thing as punishment after death?

MR. MERCHANT: You must remember, Mr. Laboringman, that error is always repeating itself, and that sin and iniquity never die; so, the economic blunders of the Aldrich Bill and its administrative purposes should be exposed and held up as a lesson and an illustration to guide us in the future.

What I wanted to read, was a part of Congressman Fowler's speech, delivered in the House of Representatives. Referring to the German banking situation, he said:

"The position of both England and France, under present conditions, would seem sound and impregnable from a governmental as well as a banking point of view. Each has planted itself upon the gold standard, with certain precautions peculiar to its circumstances. Germany, on the other hand, has not pursued the course of England, with its limited gold reserve, forcing the public into the deposit and check system to meet the current demands of trade. This would have been impossible without a long-continued ruinous revolution, considering that there is a quarterly settlement in Germany that calls for an expansion in currency amounting to $125,000,000. Nor has Germany pursued the course of France, which has a gold reserve large enough to meet any test or burden that either the Government or the commerce of Germany might have imposed upon it, but has adopted a middle course which has not the strength of the position of either England or France, nor the credit facility of France.

"Its gold reserve is of the halfway sort, and its bank note issue is also of the halfway sort. The result is that the financial and banking situation of Germany must necessarily prove weak upon the first great test when the bank notes of the Imperial Bank of Germany must be made a legal tender.

"Indeed, upon the declaration of war by Germany or against Germany, the first step taken in a financial way would be for her to declare her bank notes a legal tender. It is hardly problematical what would soon happen, with the wide divergence between her gold fund and the amount of her note issue."

Gentlemen, within eighteen months after he made that statement, when war seemed probable with France, Germany made her bank notes a legal tender.

Further along in the same speech, commenting upon the unsoundness of the German plan, he said:

"Imagine for a moment a central bank in the United States, like the Imperial Bank of Germany, issuing all our bank note currency and these notes going into the reserves of our myriad of banks as the basis of loans which, under our system, in turn become our deposits.

"The natural, first, and immediate effect would be an expansion of credit, an inflation to just the extent to which the notes were used for reserves.

"As soon as the situation became obviously dangerous, a halt would be called and a contraction in loans would follow. But a contraction of loans calls for liquidation, and liquidation produces an exigent demand for currency. We all learned that lesson only so short a time ago as 1907.

"But in the very face of the increased demand for more currency the currency would be contracting, because the loans would be reduced by calling in bank notes which were being used for reserves; or, in other words, the loans called would be paid in bank notes.

"For every $100,000 of notes so called in the loans might be reduced to an average of $500,000, and yet this very process of liquidation would be concurrently destroying the only instruments of credit that would adequately meet the demand created by forced contraction. It would clearly lead to self-destruction, to commercial suicide.

"The best thought of England recognizes this subtle but obviously destructive contradiction in the use of credit, and therefore opposes the use of credit notes by the Bank of England."

_Gentlemen, the fact that we can force our banks to carry a specified amount of reserves and of a specified quality, by the power of taxation, will preclude the use of bank notes as reserves in the United States._

Mr. Fowler then concludes as follows:

"There are then, in addition to all of the objections to the Bank of France, three other unanswerable objections to the establishment in this country of any central organization approaching in character the Imperial Bank of Germany:

"_First_: It would give us a financial and banking structure so weak that it could not stand any great strain such as necessarily comes with a great war, if, indeed, it were not so weak as to lead to a suspension of gold payments even in time of peace.

"_Second_: No thought whatever should be given to any suggestion that makes it possible for one bank credit to be used in the reserves of another bank and so substitute any form of credit for gold in our bank reserves.

"Unless gold alone is ultimately recognized as fit for bank reserves, we shall continue to pay dearly for our mistake until it is corrected.

"_Third_: No proposal whatever should be entertained by us that involves the possibility of the suspension of gold payments, for no country can become the clearing house of the world that is not a free market for gold. The United States and not England ought to be the clearing house of the world."

These words, as I have said, were spoken about two years before Mr. Aldrich attempted to import the German Bank into this country.

MR. BANKER: That is very interesting and prophetic, but not more so than his speech at the Republican Club of New York, January 20, 1912. Let me read that to you, gentlemen, by way of an exposition of the economic faults of the so-called Aldrich scheme. He said:

"I wish to speak purely from an economic point of view and to cover only one single phase of the proposal; its dangerous expansion, unbounded inflation and certain expulsion of gold from the country.

"'_First_: Nothing should ever go into the reserves of the banks of a country except what is coined out of its standard of value.

"'_Second_: The poorer money always drives out the better.'

"Every single note of the so-called Reserve Association used in the reserves of our banks will displace just that much gold and drive it out of the country.

"Judged, therefore, from a purely economic point of view, I assert that the Reserve Association plan is the most unsound, the most dangerous; indeed, it is absolutely the worst proposal that has been brought forward for serious consideration by any respectable body of men since the adoption of the Constitution, with the two following exceptions: First, the issue of legal tender money by the Government such as greenbacks; second, the free and unlimited coinage of silver at the ratio of 16 to 1.

"An officer of one of the largest banks of the United States recently used this language: 'Mr. Fowler, it is incredible that we should be called upon to consider such a proposition.'

"If this is really true, how does it happen, that so many business men and so many bankers approve it, is a most natural inquiry. The cause is not difficult to perceive.

"There is not a business man nor hardly a banker who is not even now still living in a state of fright from the terror of 1907. One thought alone seems to have taken possession of the country to the exclusion of everything else, and that thought is this: That we must hereafter be able to convert our commercial credits into bank or current credits. There seems to be something approaching madness; indeed, there seems to be an insane haste lest they be caught again, possibly tomorrow, certainly next fall. But they need not worry, for danger is not imminent; 1907 will not come again right away.

"During the past two years up to the present time the entire thought of the country has been directed to a mere mechanism to achieve this result, without any reference to or consideration whatever of those fundamental, eternal principles of banking economics that demand recognition and obedience if we are to escape the frightful penalties which their violation always inflicts.

"In the outset I want to lay down two fundamental laws that I wish were burned into the minds of every banker and every business man within the borders of this republic. They are these:

"One--Nothing should ever be counted as a reserve which is not coined out of the standard of value. Our standard of value is gold, therefore nothing should go into the reserves of our banks except gold.

"Two--The poorer money always drives out the better.

"I hope that whoever hears these words will commit these two laws to memory, for they are as fundamental and eternal in their operation as the law of gravitation.

"I assert that the plan of the so-called reserve association is in direct violation of the first of these laws, and will put the second law into operation to a dangerous and destructive degree.

"Every intelligent student knows that the plan proposes to transport to this country the German system of banking, which I assert has completely broken down at home during the past six months. Now, if this system has broken down in Germany, where there are a few great banks with hundreds of millions of assets and not more than 500 banks all told, what can you expect it to do here with more than 25,000 individual, independent banks, directly responsible to their depositors?

"The following letter was given to me by an officer of one of our largest banks, accompanied with these words:

"'I realize that in giving you this letter I am, in a way, betraying a business confidence, but I regard it as my patriotic duty to give it to you, to use in any way you may see fit. For what would happen to this bank if we should send out such a letter to our depositors? Our doors would be closed inside of twenty-four hours.'"

The letter referred to was written by the Deutsche Bank of Berlin, which has assets approximating $500,000,000, and is as follows:

"'In consequence of the restrictions recently made by the Imperial Bank, with regard to the supply of money at the end of every quarter of the year, we are, to our regret, compelled to ask you, when drawing against your account with us upon our head office and our branches by mail, kindly to advise us by cable of such drafts on them as are likely to come forward for payment during the last three working days of the quarter and the following two working days, so as to enable us to provide from here especially the necessary funds at the office drawn upon.

"'As to cable transfers which, during the five days in question, you may have to order on our head office or branches, to the debit of your account with us, we shall feel obliged by your ordering them only if you can advise us by cable one day before, the amounts to be placed by us to your debit on receipt of such advice, or ordering upon us for mail transfer from here.

"'The foregoing, of course, does not apply to small amounts.'

"As a further proof that the system has broken down at home, let us see what has been going on in Germany during the past six months to further demonstrate the weakness of their system.

"The great banks of Germany have been scouring the markets of the world, going into every nook and corner, hunting for gold. At what price? Was it at 5 per cent, 6 per cent, 7 per cent, 8 per cent, 9 per cent, 10 per cent? No. The New York _Evening Post_, in its annual review, says it was from 12 per cent to 20 per cent. I have been credibly informed that the great banks of Germany, with hundreds of millions of assets, were borrowing money in our own markets at 7-1/2 per cent and 1-1/2 per cent for three months, or upwards of 13 per cent.

"I was told of one loan to one of the largest banks in Berlin, running for a whole year at 7 per cent.

"Think of it! What would the condition in our country have to be before The National City, The Bank of Commerce and the First National of New York, and the First National and Continental Commercial of Chicago, were scouring all quarters of the globe for gold and paying from 15 to 20 per cent for the loans?

"The Imperial Bank of Germany could not save the few great banks of Germany. What would the same kind of an institution in the United States do for 25,000 independent banks under the same circumstances, all pulling at the skirts of this proposed financial balloon? The Imperial Bank could not make real money out of paper credit when the crisis came.

"Let me ask the 25,000 individual independent banks of America, what they would do when the day of contraction and refusal came? Where would you go for gold with your comparatively small capital and limited credit?

"The financial situation in Germany is by far the weakest of all the great nations of Europe and the cause is not far to find nor difficult to detect.

"Their notes, which are based upon only 33 per cent of gold and 66 per cent of commercial credits, are used as reserves and made the basis of additional credits. Economically speaking, whenever a bank puts anything into its reserves it makes that thing a legal tender and exactly to that extent displaces that much gold, if gold is the standard of value.

"During the ten years from 1900 to 1910 the gold accumulated by Russia amounted to upward of $200,000,000; that accumulated by France, upward of $300,000,000; that accumulated by England, where nothing but gold is treated as reserves and where there has been comparatively little growth in business, $32,000,000. The United States accumulated $1,100,000,000, while Germany, with all her development of trade during the last ten years, accumulated only $40,000,000 of gold when it ought to have been ten times as much, all things considered, or $400,000,000. If she had done this she would not have been compelled to send her great financial institutions all over the globe in search of gold and been compelled to pay 15 per cent and 20 per cent for it."

Gentlemen, within sixty days after those words were uttered, this conversation was reported to have taken place. The German Emperor asked Herr Havenstein, the President of the Imperial Bank of Germany, whether Germany was prepared, financially, to carry on a war with a first-class power. Herr Havenstein said: "No." To this the German Emperor replied, "I do not want that answer to that question when I ask it again."

Herr Havenstein immediately called the managers of the thirty great banks together, and told them that they must collect at least a 15 per cent reserve. To this they protested, saying that it meant the accumulation of at least $250,000,000 in gold; but Havenstein persisted and insisted upon his demand. Now, gentlemen, if you add the $40,000,000 they had accumulated, to what Havenstein insisted that they should accumulate, or $250,000,000, you have $300,000,000 as a minimum. It is altogether probable that $400,000,000 was nearer what they should have accumulated.

It should be noted in this very connection, that Germany recently appointed a commission to investigate her banking system, and that this commission reported that the individual banks of Germany should carry their own reserves, precisely as Congressman Fowler has always contended, declaring that it is especially important in the case of our individual, independent banking system. From what has been said, it has been demonstrated that every criticism that he has made of the German system, has been confirmed by their own subsequent action.

The rest of his speech was as follows:

"Mark this: If we did not have the $346,000,000 United States notes or greenbacks, the $650,000,000 of legal tender silver and a part of the $750,000,000 national bank notes in the reserves of our banks, we would now have in the United States $2,500,000,000 of gold instead of only $1,850,000,000. Does all this prove nothing to us?

"Every intelligent student of economics knows that after Alexander Hamilton, with the acquiescence and approval of Jefferson, had fixed the ratio of the gold and silver dollar in 1792, a differential of only one-half to one per cent drove all the gold out of the country by 1832, and that from 1834 to 1860 the changed ratio drove every dollar of silver out of circulation. Who does not know that from 1861 to 1865 the issue of fiat Government paper drove every dollar of gold out of the country; that for seventeen years we were off the gold standard, resuming specie payments in 1879?

"Has any banker over fifty years of age forgotten the silver struggle from 1879 to 1894, when, because of the silver purchase act by which we only added $50,000,000 a year to our reserve money, we came to the very precipice of repudiation and national dishonor?

"These four great and significant lessons have been taught us--since the establishment of this Government--the poorer money invariably drives out the better, and yet we are confronted by such stuff as the following falling from the lips of the reputed author of the so-called Reserve Association:

"'The banks will be able to replenish their reserves indefinitely.' The counterpart of this proposition is that the banks will be able to make loans indefinitely. Think of such a proposition! And again, he says it was deemed necessary 'to provide such effective regulation of discounts and note issues as would enable the organization to respond promptly at all times to normal or unusual demands for credit or currency without danger of undue expansion or inflation.' If this proposition survives at all it will be as the curiosity of the century. I submit that neither of these propositions could have emanated from a mind capable of thinking in the terms of economics.

"I assert that if we adopt a sound financial system in the near future we shall have in the course of ten years upward of $3,000,000,000, possibly $3,500,000,000, of gold in the United States. I assert further that if we adopt the proposed so-called reserve association scheme we shall have at the end of five years thereafter in the neighborhood of only $1,250,000,000, allowing for a differential of $250,000,000 either way as a possibility. In other words, we would have as a result not more than 40 per cent and possibly not more than 30 per cent of the gold that we shall have if we pursue a wise economic policy.

"The scheme provides that any deposits with the association may count as reserves; also that any of its notes may be held as reserves.

"Since the average reserve of all national banks is and has been for many years about 20 per cent, let us assume, first, that a national bank called 'X' has $5,000,000 of deposits and holds a 20 per cent reserve, or $1,000,000 of gold; second, that X National Bank deposits this million of gold with the reserve association; third, that a national bank called the 'Y National Bank' exchanges $1,000,000 of commercial paper for $1,000,000 of the notes of the reserve association, which it puts into its reserves.

"In the course of time it will have a million of deposits, largely in the shape of loans based upon this million of notes; so that the original $1,000,000 which stood guard over $5,000,000 of debts now is called upon to protect $12,000,000 of debts, or only about an 8 per cent reserve as against 20.

"The X National Bank owes $5,000,000 of deposits against $1,000,000 deposited with the association. The association owes the X National Bank the $1,000,000 deposited with it and $1,000,000 of notes outstanding which it issued to the Y National Bank. The Y National Bank has liabilities outstanding of $5,000,000 with the notes as reserves, or a net expansion and inflation of $7,000,000.

"It has been assumed or claimed by some advocates of the scheme that probably $1,000,000,000 of gold would be deposited with the association, in which event there would be an expansion and inflation of $7,000,000,000, or a total liability of $12,000,000,000 where now there are only $5,000,000,000.

"While this expansion and this inflation have been going on the notes have been going into the banks as reserves, and a corresponding amount of gold has been driven out of the banks and out of the country.

"Now, mark you, I have not pursued this expansion, this inflation, beyond the 50 per cent gold reserve for all the liabilities of the reserve association. When you turn your imagination to all the possibilities remaining in rediscounts, borrowing direct, acceptances and falling in your reserves, and the credits which grow out of credits directly and indirectly, the prospect becomes bewildering. The expansion and inflation becomes a matter of planetary distances and astronomical figures. The proposal leads into the nebulous somewhere, into the bottomless nowhere.

"Every student recognizes that the weakest point in our national bank system is the superimposed credit resulting from the deposits with our reserve cities and then with our central reserve cities. But in the very face of that fact here is a proposal that accentuates that fault one hundred fold.

"The strangest thing about this whole proposal is that it is based upon the fact that we have not sufficient capacity for expansion and inflation of credit. Will any one say that what we wanted during the years of 1913-4-5-6-7 was more inflation? Does not every intelligent student of banking economics know that what we should have had was some way of checking the delirium instead of increasing the mad speculation?

"To determine now what we want we must first ascertain with some degree of accuracy just what happened.

"Until we come to realize that there are two distinct kinds of capital involved in our banking business, and learn to treat them according to their peculiarities, we shall continue to have the same kind of trouble, to a greater or less degree, that we have had in the past.

"There is the trust fund or the savings of the people and money belonging to estates or the investment fund. Then there is the commercial fund or that capital engaged in production and trade. The law should compel the segregation or separation of these two funds, so that we know with some degree of certainty whether the investment fund has all been exhausted and our commercial funds or capital are being encroached upon and absorbed in fixed investments. This is precisely what happened by 1907.

"To illustrate this thought, let us assume that a railroad needs one hundred flatcars to carry its peculiar freight and needs one hundred passenger cars for the accommodation of the people. It is self-evident that if the road uses all the flatcars and half the passenger cars to carry its freight, the balance of the passengers will have to make some other provision for transportation or walk. This is just what occurred in 1907, and a great many people are still walking as a result of that misadventure. Liquidation is still going on, with a probability that we shall be well into 1913 before normal or really good business conditions will prevail all round.