the result that the speculative movement for the rise is reversed and a repressive influence cast upon general business.

It is certain that a measure of stock-exchange speculation would persist even if the resources of the New York banks were alone available for financing it, but the extent of such accommodation, even when supplemented by the demand loans made available by individual capitalists, would be limited and the cost of securing it would be greater. Individual speculation would be less in amount and narrower in distribution. Most of all, the periods of speculation, in so far as determined by the cheapness of money, would vary logically with the movement of general business, instead of, as at present, running in vicious opposition thereto.

217. INVESTMENT LOANS OF COMMERCIAL BANKS1

By C. W. BARRON

The best estimates that we can get privately of bankers is that the real commercial loans in the national banks do not exceed three billions, or one-half the loan account.

While the paper appears in the form of commercial loans, a considerable part is for fixed forms of property and for as distinctively industrial expansion as are stocks and bonds. And why should it not be?

A merchant with sufficient capital to do his own banking may have several hundred thousand dollars cash in the bank, owe no money, and have a million dollars in accounts on his books, or notes in his box representing commercial loans due him. His business expands and he desires to put a half-million or a million into a new factory. Will he issue stocks or bonds or make any permanent borrowing for this? Certainly not. He notifies the bank he will want a half-million or more money covering certain months. The bank's response is, of course, that he can have all the money he wants and give any kind of a note on time or demand. His cash balance is worthy of his credit. His borrowing is, therefore, not necessary commercial borrowing, but commercial borrowing is forced by his construction.

The state banks and trust companies carry far less commercial paper than the national banks. On page 51 of the Report of the Comptroller of the Currency for 1913 will be found a record of not only the 'Adapted from The Federal Reserve Act, pp. 68-73. (Boston News Publishing Co., 1914.)

7,473 national banks but of 18,520 state banks, trust companies, private bankers, and savings banks in respect to the character of their loans. Out of a total of $14,600,000,000 loans based largely on demand deposits, $3,500,000,000 are secured by real estate and mortgages, and $4,500,000,000 by other collateral, and $8,000,000,000 on fixed forms of property. The "other loans" are $6,500,000,000, including, of course, the so-called $3,000,000,000 commercial loans in the national banks as noted above. Of these the real commercial loans are somewhere between three billions and six billions. Private estimates of bankers with far better knowledge of the real situation than is possessed by the government officials vary all the way between these two figures.

We have for some time estimated that the real commercial loans for the transactions of commerce in this country do not exceed five billions and that between nine and ten millions of bank loans are on fixed forms of property.

This represents property in process of digestion by investors. When the amount is large, or the investment fund is light, it is termed overinvestment or indigestion of securities. Nearly two-thirds of our bank loans represent constructive industry, stocks, bonds, and fixed forms of property in process of digestion, and only one-third represent commercial transactions.'

218. THE MISUSE OF COMMERCIAL BANK FUNDS

By H. M. GEIGER

We have all been too busy to keep books accurately on a big scale. Consequently no one can tell us exactly what proportion of our assets represents permanent investment; what percentage we use for development and construction, or what sum is absolutely necessary to carry on the rapid-fire exchanges of industry and commerce.

Roughly, we know that certain sums are deposited in savings banks, trust companies, and in the savings departments or time certificates of deposit of national banks. With some degree of approximation we can guess that these funds are available for more or less permanent investment in stocks, bonds, investment notes, or other securities which will not be paid in full until a long period of time has

2

See selections Nos. 32 and 37.-EDITOR.

Adapted from a pamphlet entitled Financial Readjustments (1915), pp. 2–5. (Copyright by the author.)

elapsed. But we have no exact account of our "commercial" and our "investment" funds in general.

Even without this information, however, the daily practice of business constitutes sufficient proof in itself that the combined total of all "investment funds" as represented by the resources of savings, trust, and insurance companies, private investors and investment banks, are not sufficient to meet the demands created by our industrial expansion. The extraordinary expansion of civilization in America during the past century has made use of every penny of available capital, has borrowed five or six billions from Europe, and has still been driven to make merciless inroads on what we should have been taught to respect as our "commercial" fund. This is not a cause for sorrow or of worry. The money has been well used. Our fathers found a wilderness. Since then the wilderness has not only been reduced to a fairly well cultivated area of farms, cities, mines, and factories, but the nation as a whole has kept pace with the unprecedented commercial and industrial progress of the older civilizations of Europe, which had all the fundamentals of their culture built and paid for when we were surveying roads through forests and following Indian trails across the Western plains.

Our one error was in mistaking the proper functions of our commercial banks.

Stated bluntly, a majority of the resources of national banks are tied up in loans of a more or less permanent character. Truly, the notes are usually made for periods of four or six months, but it is the understanding between the banker and the borrower in many instances that these notes shall be renewed indefinitely, provided certain periodical reductions are made and the interest discounted in advance. Moreover, the country is filled with manufacturers who expect bankers not only to finance their temporary needs, but who have also built their plants on capital borrowed and reborrowed, again and again, from banks.

This practice has been one of the most prolific causes of industrial failures in the United States. Dun's and Bradstreet's reports for many years show that 90 per cent of all failures are due to lack of capital. In very many instances excellent enterprises were undertaken at periods when it was easy to secure loans from banks, only to fail in the midst of their development because some contingency forced the bank to withdraw its support and demand the payment of its loans.

So, while the practice of loaning "demand" deposits to borrowers who are not prepared to pay except at the end of a long period has caused many sleepless nights for bankers, it has also produced innumerable tragic failures for enterprising men who have seen their plans shrivel up and disappear under the sheriff's hammer to satisfy a note that had been "called."

219. THE ADVANTAGE OF THE DRAFT OVER THE PROMISSORY NOTE IN COMMERCIAL BANKING1

BY EARLE P. CARMAN

The usual method of obtaining credit for commercial purposes is by borrowing on the promissory note, and the usual method of extending commercial credit is on open book account. Let us examine both methods.

The promissory note is not a distinctive commercial instrument. It bears nothing on its face to indicate the purpose for which the funds it represents have been used or are to be used. Very often it is simply an accommodation credit instrument and has nothing behind it except the general resources of the borrower. Quite frequently it is an investment credit instrument, representing nonconvertible property. A prominent banker of western Pennsylvania recently issued promissory notes for the purpose of obtaining investment funds, to the extent of several million dollars, and with the usual disastrous result.

When used for commercial purposes, the promissory note usually represents a combination of commercial credit and investment credit. In other words, the proceeds of the note are usually used partly to pay for commodities of trade which will be resold and partly to pay for permanent fixtures or improvements which will never be resold while the business of the borrower continues.

But the aggregate amount of commercial credit tied up and made inconvertible by the use of promissory notes representing mixed commercial and investment credits is probably small in comparison to the aggregate amount of commercial credit represented by book accounts, which are both immobile and nonconvertible. This vicious system of extending commercial credit is quite unknown in any of

Adapted from "The Change of Credit Methods Made Necessary by the Federal Reserve Act," Commercial and Financial Chronicle, April 24, 1915, pp. 1396-98.

the other leading countries. It has everything against it and nothing in its favor, either as regards the seller, the buyer, or the general credit situation.

As regards the seller, it compels him to limit his sales on credit by the capital employed in his business, and his profits are restricted accordingly. If he extended credit only in such form that it could be converted into cash, he could sell all the goods that the trade would consume, and his profits would be limited only by the laws of supply and demand and his maximum capacity.

As regards the buyer, it is obvious that commercial credit extended to him in convertible form would be limited only by his legitimate needs and ultimate ability to pay, while credit extended to him through the nonconvertible book account is limited by the capital of the seller and many other extraneous considerations.

As regards the general credit situation, the book account has the same effect as the non-convertible promissory note, which has already been described.

Need any more be said to show that the mixed promissory note and the open book account are unsound and impracticable mediums of commercial credit, and that their general use is a serious handicap to commercial progress?

The European method of extending commercial credit is free from any of the evils mentioned and is simple and uniform. It consists merely of the use of the draft or bill of exchange in all cases where we use the book account and promissory note. The period of credit to be extended is agreed upon by the parties, and when the seller ships his goods he draws a draft against the buyer, payable in thirty, sixty, or ninety days, as the case may be, for the amount of the invoice, which is usually attached with the bill of lading to the draft. The draft and shipping papers may be forwarded to the purchaser either directly or through the banks, as may be deemed advisable. When they are received, the purchaser detaches and retains the shipping papers, affixes his signature to the draft under the word "Accepted," and returns it to the seller or the bank presenting it, as the case may be. It thus becomes a bill of exchange which can be discounted and thereby converted into cash at any time.