rate of interest is low because there are few opportunities of profitably employing capital, then it would not be impossible to expect the banks to use superabundant funds in buying bonds of a low rate of interest. Therefore, at a time when the demand for loans is slight and the rate of discount low, it would be easy for the banks to invest in bonds and thereby obtain notes. In short, when there is no demand the supply is easily obtained. It needs no further comment, consequently, to see that such a system of note issues works at crosspurposes with the needs of the public. With a deposit of bonds for security of notes, there is no supply of notes at a time when most needed and an abundant supply of notes when least needed.

To give concrete examples, the financial panic of 1890 caused a fall in the prices of government bonds, and thereby increased the chances of profit on the circulation of national bank notes. As a result there was a net increase of $13,000,000 in their circulation in 1891 and of $8,000,000 in 1892. Now, in these two years, there was absolutely no demand for an increase in the circulating medium of this country; on the contrary, the Treasury Department in these years was injecting arbitrarily between $25,000,000 and $50,000,000 of silver paper money into the currency of the country, as a result of the Silver Purchase Act of 1890, and gold, in consequence, was being exported at a rate which alarmed business men and finally precipitated the panic of 1893.

"During 1893 the 4's of 1907 sold down to 113, and the banks added to their circulation $37,000,000. During the months of June, July, and August of that year there was a most urgent need for an expansion of the currency; but during these months the new national bank notes did not appear. Not until after the panic was over and money was piling up in all the financial centers a drug on the market—did the increase in the national bank note circulation take place. As a result of the panic, business being depressed, the interest rate on prime commercial paper during 1894, 1895, and 1896 was between 3 per cent and 4 per cent. The money supply of the country was in excess of its needs and gold was exported in large amounts. The Treasury, embarrassed by the withdrawals of gold, was forced to issue bonds in order to maintain the gold reserve. These bond issues forced down the prices of bonds, and thus increased the profit which banks could make upon new circulation. Therefore, considerable idle banking capital, which could be loaned barely at 3 per cent in business, was exchanged for government bonds and made the

basis for bank notes, so that in 1895 and 1896 there was a net addition to the bank note circulation of $32,000,000. Thus, the national bank note helped to embarrass the government by inflating the currency at a time when the government was doing its utmost to hinder inflation and prevent the exportation of gold to Europe."

Secondly, it should be noted that when the necessities of business urgently demand additional notes, even if the price of bonds should be such as to make the issue profitable, the delays incident to the purchase of bonds, the taking out of circulation upon them, etc., would make it impossible to obtain the currency until all need for it was practically past. Under such a system, therefore, banks must refuse to customers additional supplies of notes upon sudden demand even though the community in such circumstances has enlarged its currency need and an additional supply may, therefore, without additional strain on the bank, be kept in circulation. Under such circumstances, if notes are an essential to the borrower, rates for loans rise abnormally and crisis conditions are vastly intensified. Probably the best illustration of this delay in responding to demand was seen in the difficulty of obtaining currency during the summer of 1893, when it was practically impossible to secure a sufficient supply of a circulating medium of any sort. The New York banks held on June 1, 1893, a surplus of $21,000,000 in excess of their legal reserve. At that time the volume of national bank notes outstanding was about $177,000,000. By the first of August extraordinary demands for currency had drawn down the reserves $14,000,000 below the legal minimum and yet the outstanding notes were only about $5,000,000 more than on June 1. By September 1, however, when the reserves were but $1,500,000 below the minimum, and the urgency was past and currency once more comparatively abundant, the notes. had begun to expand and had already reached $199,800,000, subsequently rising to $209,300,000 on November 1, notwithstanding the continued decrease in the demand for them.

93. INTEREST ON DEPOSITS AND BANK-NOTE INELASTICITY' By O. M. W. SPRAGUE

During periods of inactive trade the amount of bank notes sent to Washington for redemption invariably reaches large proportions. The city banks are chiefly responsible for this movement. Something like half the notes are sent in by the New York banks alone,

• Adapted from "Proposals for Strengthening the National Banking System," Quarterly Journal of Economics, XXIV (1909-10), pp. 639–40.

which, when rates for call loans are persistently below 2 per cent, are naturally desirous of reducing bankers' balances swollen by the receipt of idle funds from all quarters. But the redemption of the notes does not secure contraction. All the banks, more particularly the country banks and those of the smaller cities, make haste to reissue notes, thus' setting free an equivalent amount of money, which in the absence of local demand is shipped to the money centres for the sake of the interest to be had from the city banks. There is a sort of endless chain, the working of which can be interrupted only by the discontinuance of the present practice of paying interest on bankers' deposits. Were that inducement removed, our bondsecured notes would prove to be susceptible of a considerable measure of contraction. Even if the banks continued to reissue their notes as regularly as at present, contraction would still take place. An equivalent amount of money would be locked up in the banks, since they would reap no advantage from sending it to the money centres. Moreover, even if it were sent thither the pressure on city banks to force a demand for loans by the offer of low rates would be removed and they would doubtless maintain a higher reserve level.

94. CLEARING-HOUSE LOAN CERTIFICATES AND EQUALIZATION OF RESERVES

By O. M. W. SPRAGUE

In 1893 and in 1907 the clearing-house loan certificate was the only device resorted to in order to secure the adoption of a common policy by the banks. In 1873, as on earlier occasions when its use was authorized, provision was also made for the equalization of the reserves of the banks. Thus in 1873 the Clearing-House Association, in addition to the customary arrangements for the issue of loan certificates, adopted the following resolution:

That in order to accomplish the purposes set forth in this agreement the legal tenders belonging to the associated banks shall be considered and treated as a common fund, held for mutual aid and protection, and the committee appointed shall have power to equalize the same by assessment or otherwise at their discretion. For this purpose a statement shall be made to the committee of the condition of such bank on the morning of every day, before the opening of business, which shall be sent with the exchanges to the manager of the Clearing-House, specifying the following

1 Adapted from "Proposals for Strengthening the National Banking System," Quarterly Journal of Economics, XXIV (1909-10), pp. 232-39.

items:

(1) Loans and discounts.

(2) Amount of loan certificates. (3) Amount of United States certificates of deposit and legal-tender notes. (4) Amount of deposits, deducting therefrom the amount of special gold deposits.

Two fairly distinct powers were given the clearing-house committee: the right to issue clearing-house certificates, and control over the currency portion of the reserves of the banks. This machinery was devised (according to tradition) after the crisis of 1857 by George S. Coe, who for more than thirty years was president of the American Exchange National Bank. The purpose of the certificate was to remove certain serious difficulties which had become generally recognized during that crisis. The banks had pursued a policy of loan contraction which ultimately led to general suspension, because it had proved impossible to secure an agreement among them. The banks which were prepared to assist the business community with loans could not do so because they would be certain to be found with unfavorable clearing-house balances in favor of the banks which followed a more selfish course. The loan certificate provided a means of payment other than cash. What was more important, it took away the temptation from any single bank to seek to strengthen itself at the expense of its fellows and rendered each bank more willing to assist the community with loans to the extent of its power.

But in addition to the arrangement for the use of loan certificates provision was also made for what was called the equalization of reserves. The individual banks were not, of course, equally strong in reserves at the times when loan certificates were authorized. From that moment they would be unable to strengthen themselves, aside from the receipt of money from depositors, except in so far as the other banks should choose to meet unfavorable balances in cash. Moreover, withdrawals of cash by depositors would not fall evenly upon the banks. Some would find their reserves falling away rapidly with no adequate means of replenishing them. The enforced suspension of individual banks would pretty certainly involve the other banks in its train. Finally, it would not be impossible for a bank to induce friendly depositors to present checks on other banks directly for cash payment, instead of depositing them for collection and probable payment in loan certificates, through the clearing-house. The arrangement for equalizing reserves therefore diminished the likelihood of the banks working at cross-purposes-a danger which the use of clearing-house certificates alone cannot entirely remove.

These arrangements had enabled the banks to pass through periods of severe strain in 1860 and in 1861 without suspension. In both instances the use of the loan certificate was followed immediately by an increase in the loans of the banks, and in a short time by an increase in their reserves. The stipulation in 1873 was more serious, and, as events proved, the reserve strength of the banks, while sufficient to carry them through the worst of the storm, was not enough to enable them to avoid the resort to suspension.

In 1884, the next occasion when clearing-house loan certificates were issued, the opposition to the provision for the equalization of reserves was so widespread that it does not appear that it was even formally considered. The ground for this opposition can be readily understood. In 1873 the practice of paying interest upon bankers' deposits was generally regarded with disfavor. Only twelve of the clearing-house banks offered this inducement to attract deposits; but by this means they had secured the bulk of the balances of outside banks. It was in meeting the requirements of these banks that the reserves of all the banks were exhausted at that time. The noninterest-paying banks entered into the arrangement by the equalization of reserves in expectation of securing a clearing-house rule against the practice of paying interest on deposits. But their efforts had resulted in failure. Some of them had employed their reserves for the common good most reluctantly in 1873, and the feeling against a similar arrangement in 1884 was naturally far stronger and more general. Moreover, the working of the pooling agreement in 1873 had occasioned heartburnings which had not entirely disappeared with the lapse of time. It was believed, and doubtless with reason, that some of the banks had evaded the obligations of the pooling agreement. It was said that some of the banks had encouraged special currency deposits so as not to be obliged to turn money into the common fund. Further, as the arrangement had not included bank notes, banks exchanged greenbacks for notes in order either to increase their holdings of cash or to secure money for payment over the counter. Here we come upon an objection to the pooling arrangement which doubtless had much weight with the specially strong banks, although it is more apparent than real. In order to supply the pressing requirements of some banks, others who believed that they would have been able to meet all the demands of their depositors were obliged to restrict payments. That such an expectation would have proved illusory later experience affords ample proof. When