loan account so as to keep just above the 25 per cent requirement against deposits. They did no more than maintain the reserve position which previous experience had clearly shown to be inadequate, although the burden resting upon them through the relatively greater expansion elsewhere tended to increase. New York still maintained its commanding position as a debtor of national banks. There had been no marked change in the proportion of deposits due to national banks compared with the total deposits of the New York banks. They were 30 per cent of the total in 1897, nearly as much in 1906, and 27 per cent in 1907. The New York banks were comparatively as strong as in the past and under no greater relative obligations to other national banks. They might, however, reasonably have expected somewhat greater withdrawals in an emergency, because of the smaller cash reserve ratio of all the other banks in, the system, though the probable difference on this account was not remarkably great.

During this period there was a startling increase in the number of state banks and trust companies, in consequence of which the banking situation as a whole is greatly complicated. On October 2, 1897, the net amount due from national banks to state banks of all kinds was only $185,600,000; on August 22, 1907, it was $646,000,000. In particular, the increase in the deposits of state banks and trust companies held by the New York banks was most striking, and might well have been considered alarming.

From a little more than one-third the aggregate of bankers' deposits in 1897 the deposits due state institutions had become in 1907 almost equal to those due the national banks. The aggregate of bankers' deposits had also become a slightly larger part of the total deposits of the New York banks, but the real importance of this growth is due to the fact that the cash reserves of the state banks and trust companies were notoriously inadequate.

79. BANKING POLICY IMMEDIATELY PRECEDING A CRISIS1 By O. M. W. SPRAGUE

After the San Francisco earthquake on April 18, 1906, eighteen months before the crisis, there were indications in plenty that the pace was too rapid and that the equilibrium of economic forces was becoming increasingly unstable. That catastrophe destroyed an immense

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Adapted from Crises under the National Banking System, pp. 237-45. (National Monetary Commission, 1910.)

amount of capital, a loss which, through insurance, was widely distributed; but even if it had not occurred it is certain that demand for additional capital was outstripping current savings seeking investment. Increasing difficulty was experienced in marketing securities of the very highest class. The strain upon capital was world-wide, and in the United States municipal bonds whose sale would have been stimulated by distrust of business corporations could only be marketed when offered at lower prices or a higher rate of interest.

The inability to secure capital by the sale of securities in a period of active business should have been enough in itself to inspire unusual caution in the management of banking institutions. When corporations of the highest standing are obliged to resort to short-term notes it may be assumed without question that other corporations are expanding upon an insufficient foundation of working capital, that current obligations are increasing, and that bank credits are being used to their utmost extent. This probability might well have been recognized as a certainty when it appeared that during the latter half of 1906 and the first eight months of 1907 the loans of the national banks had increased more rapidly than at any time in the history of the system.

Increasing tension in New York, whenever comparatively slight contraction in loans took place, was another indication pointing to the same condition of affairs. It suggested that there were few persons in the community with idle funds available to take over either the loans or the collateral of borrowers, and that, consequently, any considerable liquidation of loans would be difficult, and, if carried through rapidly, disastrous.

Another indication of the approach of a period of declining activity in trade was the increasing ratio of costs reported in many industries. This is probably one of the most fundamental causes of industrial reaction and the necessity for an occasional period of recuperation. During the ten years before 1907 production in many branches had more than doubled; as, for example, coal, iron, and also railroad traffic. A far more rapid increase in the number employed in such occupations was made than was compatible with the maintenance of industrial efficiency. The incompetent could hold places because there were none to fill their positions, and there was no time to acquire skill by those capable of acquiring it.

As a result of these and other causes which might be mentioned there could be no doubt that the United States, like other countries, was about to pass through a period of reaction, though the exact

moment of its beginning could not be foreseen and might largely be determined by fortuitous circumstances. It was so probable that with each month of 1906 and 1907 the exercise of increasing caution might well have been expected in all responsible circles.

Little heed seems to have been given to these warning signs, but much was made of every straw which suggested a possible further advance. On July 31, 1906, dividends were resumed on the common stock of the United States Steel Corporation, and on August 18 the Union Pacific dividend was advanced from 6 to 10 per cent, and dividends were begun at the rate of 5 per cent on the shares of the Southern Pacific Railroad. Events seem to have proved conclusively the ability of these companies to earn the dividends which were then declared, but nevertheless, coming when it did, this action exercised an unfortunate general influence. It gave encouragement to the unbridled optimism which was already too much in evidence. It was preceded and followed by a speculative movement on the stock exchange, which was made possible through credits granted by the banks upon the foundation of the usual summer inflow of funds from the interior.

Despite the numerous evidences of danger during the early autumn of 1906 and the "rich men's panic" of March, 1907, when the severest declines occurred that have been known to the New York Stock Exchange, the banks of New York made no real preparation for the crisis that was obviously due. They were in slightly better shape in August, however, than they were a year earlier. The following table shows the situation:

Until very recently no one admitted that his judgment dictated any policy of retrenchment. Gentlemen, we cannot hold the

Adapted from an address before the New York State Bankers' Association, June 27, 1907. Quoted in Bankers' Magazine, LXXV, No. I (1907), 1–3.

present pace. We should not hold it, even if we could. Though our depositors do not realize this, our unpleasant but perfectly plain duty is to curtail their accommodation lines and force retrenchment. We are in an era of extravagance, both corporate and individual, of extravagance in enterprise and of extravagance in expenditure; extravagance as much beyond precedent as is our feverish business activity. No matter what this country's book-profits are, it cannot accumulate capital without thrift, and today thrift appears to be forgotten. At least a moderate amount of what is popularly known as "hard times" is the only cure.

Expansion is not confined to the industrial and commercial world. For years banking facilities have been expanding out of all proportion to the growth of cash reserves. For several years there has not been a week in which all the New York Clearing-House banks have held full reserves, and frequently half, or nearly half, have been short. The same tendency prevails throughout the country. Is it not time for bankers to check this undue expansion, to prune this tree too luxuriant for its roots, this fabric of credit built on an inadequate foundation of reserve? Consider that our reserves consist largely of balances due from other banks. The system of reserve agents, both in our state and national banking systems, with which you are all familiar, the abolition of which would be opposed by most if not by all the bankers in this room, contains possibilities of serious trouble; nay more, invites serious trouble.

For instance, a state bank near Buffalo receives a deposit of $10,000, which it redeposits with a trust company in Buffalo. The latter redeposits the amount with its reserve agent, a state bank in Buffalo; the state bank redeposits the amount with its reserve agent, a correspondent in Albany, and the Albany bank redeposits the amount with its reserve agent, a correspondent in New York City. Here is one $10,000 deposit, multiplied by five swelling discounts in this state by $50,000, and swelling so-called reserve by $42,500, against which the only cash reserve held is that of the New York bank, amounting to $2,500.

Of course,

Is not this inflation? This is no imaginary case. each bank is supposed to keep a very small part of each deposit in reserve, in cash, but it frequently happens that each bank in the chain has a little surplus cash reserve, and that the operation is exactly as stated.

Now, what happens? The country depositor draws on his bank for $10,000, the country bank on the trust company, the trust com

pany on the Buffalo bank, the Buffalo bank on the Albany bank, and the Albany bank on the New York bank. Deposits shrink $50,000; $42,500 of reserve vanishes.

Thousands of such operations occur daily, the countless ramifications of which are so interlaced that their effects are widely felt. In ordinary times these operations pass without notice. When our next financial disaster comes they will cause widespread disturbance and promote panic. We should remember that most of the reserve cities in the national system have sprung up in recent years, and were not in existence during the panic of 1893. The system has not stood the test of a financial crisis. I know that country bankers desire interest on their reserve accounts, and that banks in reserve cities desire such accounts. Nevertheless, I advocate that whatever reserve may be required by law, that reserve shall be in cash in each bank's own vaults, and that the present system of reserve depositaries, both state and national, be abolished as most unsound and dangerous.

81. INDEPENDENT BANKING THE CAUSE OF INFLATION'

BY VICTOR MORAWETZ

The managers of each bank have the power to regulate the amount of its loans and discounts and the expansion of its deposit liabilities in relation to reserves, having regard to the condition of the particular bank which they control; but in the United States bank managers have no power to regulate the expansion of credits of all the banks with a view to the security of the general credit situation, and have no power, through the issue and redemption of bank notes, to prevent sudden and wide fluctuations in the credit power of the banks resulting from the fluctuations of the volume of currency used as a circulating medium. Though the managers of fifty, or of a hundred, out of the seven thousand national banks may be of the opinion that, having regard to existing or prospective conditions, the expansion of credits has gone too far, they have no power to accomplish any substantial result. They could restrict the grant of credits by their own banks, and so lose profitable business that would go to other banks, but they could not materialy improve the general situation. This was the case prior to the recent panic. For months before the panic many intelligent managers of banks and trust companies knew that the

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Adapted from The Banking and Currency Problem in the United States, pp. 36-42. (North American Review Publishing Co., 1909.)