The Value of Money Part 21

What is the significance of this? We have seen that for national banks, the great bulk (over 66%) of the collateral loans were secured by stocks and bonds in June, 1915. We saw reasons for supposing that a higher percentage of stock exchange collateral would be found when State banks and trust companies are included. Suppose we a.s.sume that 75% of the collateral loans of all three cla.s.ses of inst.i.tutions here in question are based on stock exchange collateral.[528] This would mean 16-1/2% of the total resources of these inst.i.tutions in stock exchange loans--still well above the 13-1/2% we have a.s.signed to "commercial paper." In any case, it is at least justifiable to contend that loans on stock exchange collateral are as great in volume as commercial loans. I think that they very substantially exceed them. But further, we have another large percentage of bank resources invested in stock exchange securities outright--chiefly in bonds. The aggregate for those investments in the inst.i.tutions under consideration is 3,250 millions. This is something over 19% of the total a.s.sets of these inst.i.tutions. Combining this with the loans on stock exchange collateral, we get nearly 36% of bank and trust company a.s.sets invested, directly or indirectly, in stock exchange securities, as against an a.s.sumed 13-1/2% in commercial paper. Conceding that all the "all other loans" are commercial loans, the stock exchange a.s.sets still exceed them in the ratio of 36 to 27-1/2.

In our second table, we have listed items which aggregate only 12,456 millions of the total resources for these inst.i.tutions of 16,774 millions. The items listed, however, represent virtually all the credit extended by banks to industry, commerce, agriculture, the stock market, other speculation, and the State. The excluded items of main importance are: Due from other banks and bankers, 2,302 millions; checks and other cash items, 432 millions; and cash on hand, 1,411 millions--the three items aggregating 4,146 millions, which virtually closes the gap. These three items are of immense importance as making for liquidity in banking a.s.sets, and as making possible extensions of credit to the business world, but it is not proper to count them when an estimate of the extent of bank-credits is in question. Our second table contains, for the three cla.s.ses of inst.i.tutions, all the items properly counted there, except overdrafts (small in amount) and one other big item which does not get into bank statements at all, namely, _overcertifications_ and "_morning loans_." Of this last item, more later. We may, then, recalculate our percentages on the basis of the credit extended by the three cla.s.ses of inst.i.tutions, instead of on the basis of total resources. On this basis, the percentages are:

Real estate loans, 7.4%;

Collateral loans, 30%, of which we a.s.sign to stock exchange collateral, 22-1/2%, and to other collateral, 7-1/2%;

All other loans, 36.4%, of which we a.s.sign to "Commercial paper" 18.2%;

Total stocks and bonds, 26%.

Adding the percentages for stock exchange collateral loans and for stocks and bonds owned, we get 48-1/2% of all extensions of bank-credit for these three cla.s.ses of inst.i.tutions in the form of credits extended to the security market. If everything else except the real estate loans should be counted as "commercial loans" the stock exchange credit would still exceed the commercial credit. If my estimate of 18.2% of bank-credit based on commercial paper is high enough,[529] the banks and trust companies have extended over two and a half times as much credit, at a given time, to the security market as they have to commerce. This on the face of the record. But there is, as above indicated, a further item which does not get into the record, namely, overcertifications and "morning loans." Every day in the great speculative centres, and very especially in Wall Street, enormous advances are made to brokers, which are canceled during the day, but which, during their short life, are a real addition to bank-credit. To attempt to estimate this with any accuracy is hopeless, but the total on any ordinary day is enormous, and most of it is extended in connection with stock market transactions.

A final comparison,[530] which will conclude this perhaps too wearisome a.n.a.lysis of these figures, will consider the loans alone, neglecting the securities owned:

Of total loans:

Real estate loans, 9.3%;

Collateral loans, 40.8%, of which we a.s.sign to stock exchange collateral, 30.6%, and to other collateral, 10.2%;

All other loans, 49.6%, of which we a.s.sign to "Commercial paper," 24.8%.

The development of bank loans on stock exchange collateral is a remarkable feature of the three or four decades preceding 1909. The following figures, of national bank loans in New York City,[531]

ill.u.s.trate the tendency:

(000,000 omitted)

_Loans on _Advances on _Date_ Commercial Paper_[532] Securities_

1886 146 107 1890 151 145 1892 160 183 1894 168 192 1896 151 162 1898 181 260 1900 185 384 1902 210 396 1903 239 391 1904 268 538

The tendency is not peculiar to America, however. The following table gives a cla.s.sification of the loans and discounts of all the great European banks[533] in selected years from 1875 to 1903:

(Figures in francs, 000,000 omitted)

_Note _Commercial _Advances on _Date_ Circulation_ Loans_ Securities_ 1875 9,699 4,027 828 1880 10,482 3,384 1,112 1885 11,662 4,050 1,231 1890 13,194 5,192 1,549 1895 15,896 5,328 3,669 1899 14,992 8,352 4,037 1900 15,906 8,514 4,171 1902 16,215 6,939 4,178 1903 16,539 6,147 4,129

We conclude, therefore, that the great bulk of banking credit in the United States, even of "commercial banks," is not commercial credit.

Much of it, in the smaller places, especially, represents in fact, whatever the form, long time advances to agriculture and industry. Most of it, in the great cities, and to a large extent in even the smaller places, represents advances to the permanent financing of corporate industry. Excluding real estate loans, more than half of bank-credit represents either owners.h.i.+p of bonds (with some stocks) or else advances on stocks and bonds. Another important part of bank-credit, which I shall not even attempt to measure, is employed in financing commodity speculation.

It is worth while to compare our figures concerning bank loans with Kinley's figures, which we have previously considered, for deposits made on March 16 of 1909, the year we have chosen for the bank loans figures.

It is important to remember that "deposits," as used by Kinley in this investigation, does not mean what the term means in a bank balance sheet. Kinley's figures relate to the actual items deposited on the day in question, and not to the net balance after deposits and withdrawals have been compared when the bank has closed for the day. A large deposit in the balance sheet sense might show no "deposits" in Kinley's sense, in a given day; while enormous "deposits" in Kinley's sense might be so offset by incoming checks that virtually nothing is left on the balance sheet at the end of the day, for a given depositor. Kinley's figures thus give us a means of getting at the degree of _activity_ of different cla.s.ses of deposits in the balance sheet sense, and so, indirectly, of different cla.s.ses of _loans_.

Loans and deposits (in the balance sheet sense) are, as we know, closely correlated. This is true for banks in the aggregate, and for banks individually at a moment of time. It is not generally true of a given individual deposit account at a moment of time, but through a period of time, for business deposits, it tends to be true that the items deposited offset the amounts borrowed.[534] If the items deposited are numerous, if the depositor has an "active" deposit account, receiving a large flow of banking funds, as compared with his net deposit balances, we may infer that his loans are also active, that he pays off loans frequently, that his paper, in the a.s.sets of the bank, is "liquid."

I need not give the details of Kinley's figures again, as they have been elaborately a.n.a.lyzed in connection with the estimate of the "volume of trade."[535] The figures show that retail and wholesale deposits between them make up about 25% of the total deposits. This would serve to show that "commercial paper," which we have allowed to be about 24.8 of total loans, is slightly more active (and hence "liquid") than the average of loans.[536] It will also suggest, however, that our figure for "commercial paper," truly liquid, is too high, since we should expect this kind of paper to be more active than the average--unless, indeed, stock exchange collateral loans are so exceedingly active as to make a tremendously high average. I refrain from trying to get a definite answer on this point, since there are many indeterminate elements: among others, uncertainty as to the extent to which wholesale deposits and retail deposits _include_ all commercial deposits, and uncertainty as to the extent to which they _exclude_ manufacturer's deposits. The great bulk of Kinley's deposits, however, fall into the "all other" cla.s.s, and the great bulk of the "all other deposits" are located in the great financial and speculative centres, particularly New York. We have concluded that they represent chiefly (a) transactions in securities; (b) other speculation; (c) loan and other financial transactions, particularly the s.h.i.+fting of call loans on stock exchange collateral. It is, then, the deposits of those connected with the great financial and speculative markets, particularly the stock market, whose deposits are most active, and whose loans are most liquid. Stock market collateral loans thus const.i.tute the most perfectly satisfactory sort of bank loan, from the standpoint of liquidity. Though such loans do not make up the bulk of bank loans (we have concluded that they const.i.tute 30.6% of the loans of State and national banks and trust companies in 1909), they do account for the bulk of banking activity, and supply the greatest part of the liquidity of total bank loans.

When we consider further the item of securities (chiefly bonds) in banking a.s.sets, we find another highly important source of liquidity.

The sales of bonds in the great banking centres are enormous. The figures of bond sales on the exchanges do not begin to tell the story.

One big bank in New York in 1911 sold more than half as many bonds as were sold in that year on the floor of the Stock Exchange.[537] It has been frequently stated that ten bonds, of those listed on the Exchange are sold over the counter for one on the floor. This is truer of Boston than New York. The "outside market" for unlisted bonds is a very important matter. Dealings among banks in these items and in foreign exchange are exceedingly important. This is especially true of the business of the great private bankers, as Morgan, Kuhn-Loeb and others.

Much of this does not appear in Kinley's figures, since neither the deposits of the great private banks in other banks, nor the deposits made in the private banks themselves (so far as New York City is concerned) figure in his totals.[538] Had they been included, the percentage of the "all other deposits" would have grown, and we should have had still more impressive evidence of the fact that modern banking in the United States is largely bound up with the security market, and that modern bank-credit gets its liquidity chiefly from that source.

The story is even more impressively told by the figures for bank clearings, which include the transactions between banks, and the transactions of the private bankers. In New York, in 1909, total clearings for the year were 104 billions, as against 62 billions for the whole country outside New York.[539] That bank clearings are closely correlated with stock exchange transactions, has been demonstrated fully by N. J. Silberling, who has shown the following correlations: New York Stock Exchange share sales with New York clearings, r = .718; total clearings for the country with New York share sales, r = .607; total clearings for the country with railway gross receipts (as representative of ordinary trade), r = .356.[540] The active deposits and the liquid loans are chiefly connected with activities in finance and speculation.

Now two important practical conclusions are suggested by this a.n.a.lysis.

The first is that the complaint of many farmers, merchants, politicians, and even scientific writers that too much money and bank-credit are at the disposal of Wall Street and other speculators rests on a misunderstanding of causal relations. Wall Street does not, by using a large amount of bank-credit, take just that much away from ordinary business. Rather, it increases the amount available for ordinary business! Wall Street, and the other financial and speculative centres, supply the _liquidity_ for bank a.s.sets, and so make possible loans on non-liquid paper. Banks do not need to have all their a.s.sets liquid. If they did, American banks would have long since gone under! The foregoing discussion of loans to farmers, and manufacturers and even merchants should have made that clear. But banks do need a substantial margin of liquidity, to protect the rest. They get it from stock exchange collateral loans, and from owners.h.i.+p of listed and easily marketable bonds, primarily. They get part of it from true commercial paper. Thus, the director of a country bank in Iowa told the writer that banks in his section--where banks owned in large measure by farmers, and dealing largely with farmers, are very numerous and important--make a regular practice of buying, through brokers, a considerable amount of notes of outside merchants. They do this to protect themselves. Their other loans, to farmers, while good, are slow. If pressed themselves, they cannot press their depositors. These notes bought through note-brokers, however, are impersonal. They can refuse to renew them. They can sell them again. They thus b.u.t.tress the rest of their a.s.sets. They can thus lend more, rather than less, to local customers. They can safely get along with much smaller cash reserves. Similarly with the practice of country banks of sending a large part of their cash to Wall Street banks to be lent on call, for which the country banks get, say, 2% from the Wall Street banks. Their country customers would pay 6% or more for that money in some cases, but the banks dare not tie up more of their a.s.sets in non-liquid local paper. They lend more, rather than less, at home, because they send part away. Wall Street is not "draining our commerce of its life blood"![541] Wall Street is rather preventing that life blood from coagulating!

A second important practical conclusion relates to the provision in the Federal Reserve Act which forbids Federal Reserve Banks to rediscount stock exchange paper. This provision was intended to keep funds from being diverted from commerce to stock speculation, and doubtless met the approval of many very good students of the subject. If the foregoing be true, however, that provision is a mistake. It is a mistake, first, because it will lessen, rather than increase, the power of the Reserve Banks to provide relief to commerce through aiding in making bank a.s.sets liquid _via_ the stock market. It will limit the liquid a.s.sets of the Federal Reserve Banks in too great a degree to gold. It is a mistake, in the second place, because it prevents the Reserve Banks, particularly in New York and Boston, from making satisfactory profits--which is one important purpose of a bank! Even more important, however, is the third objection: it prevents, in large degree, the Federal Reserve Banks from being effective weapons against the "Money Trust." How far we have a "Money Trust" need not be here argued. The Pujo Committee, relying in considerable degree on admissions of prominent financiers that "concentration had gone far enough," and on the inability of Mr. Baker to find more than one issue of securities of over $10,000,000 within ten years, without the cooperation or partic.i.p.ation of one of the members of a small group, concluded that we have a "Money Trust" in the sense that there is "an established and well-defined ident.i.ty and community of interests between a few leaders of finance ... which has resulted in a vast and growing concentration of control of money and credit in the hands of a comparatively few men."[542] How far this conclusion is justified is, of course, a matter that would require elaborate discussion. There seems to be evidence that there is, since the death of the elder Morgan, a decided loosening of ties. One feels the need, moreover, of discounting very considerably many of the conclusions of the Pujo Committee. The present writer feels that the case has been made, however, that there has been, and probably continues, a much greater concentration of such control than is desirable. Whether or not there is at present such a "Money Trust," it seems pretty clear that temporary, if not permanent, alignments, may give effective monopoly control when the issue of very big blocks of securities is involved. For present purposes, however, it is enough to note that _if_ there is, or should come to be, a "Money Trust," it is a trust concerned with _financing industry, through handling security issues_, and not a trust _in the granting of ordinary commercial credit._[543] If, therefore, the Federal Reserve Banks are to compete with it, and break its monopoly, they must do it by entering the market with funds for the financing of corporate industry. Power to rediscount commercial paper seems a feeble and hardly relevant weapon against a combination concerned with purchasing securities, and making collateral loans! No doubt, this power is worth something. If an independent investment banker wishes to compete with a "Money Trust" in financing a new enterprise, he can go to his commercial banker, and offer collateral security for a loan; if the commercial banker wishes to aid him, but is short of lending power, he may, if he has plenty of commercial paper available for rediscount, rediscount it with the Federal Reserve Bank, and so get the additional funds. But a New York bank, or trust company, with the bulk of its a.s.sets in stock exchange investments, may well not have enough commercial paper eligible for rediscount, and the Federal Reserve Bank could help very much more effectively if it could take collateral loans directly. A fourth, and even more important objection to the restriction on stock exchange collateral loans for Federal Reserve Banks relates to the power of these banks to aid in a crisis. Crises first hit the stock market. Financial panics are most acute there. The need for immediate and drastic relief is greatest there. If stock exchange loans lose their liquidity, what of the rest of bank loans? Power to lend on stock exchange collateral, in the hands of the Federal Reserve Banks, may well prove, in crises, an essential, if we wish to make our system definitely "panic proof."[544]

And now for a vital theoretical conclusion from this lengthy a.n.a.lysis of bank loans. For the quant.i.ty theory, and the "equation of exchange," all exchanges stand on a par. If one exchange takes place, that lessens the money and credit available for another exchange. The more exchanges there are, the less money and credit there are per exchange, and the lower prices must be, as a consequence. Nothing could be more false.

Exchanges are not on a par.[545] Some cla.s.ses of exchanges increase, rather than decrease the funds available for handling others. The activity of the speculative markets, making loans fluid, enormously increases the lending power of the banks for all purposes. Exchanges of securities, especially, instead of lowering prices, make it easier for prices to rise.[546] The years of extraordinary stock sales have always been "bull" years. There have been big "bear" days,[547] but never big bear years, in the record of New York Stock Exchange share sales. The selling and reselling of speculative goods of securities, and of notes and bills are especially important as making it easier for banks to expand loans. To list all manner of items, as Professor Fisher does,[548] "real estate, commodities, stocks, bonds, mortgages, private notes, time bills of exchange, rented real estate, rented commodities, hired workers," and count them all as "actual sales," all part of the "goods"[549] which make up the "volume of trade," is to put the theory utterly beyond the pale. Seasonal calls on an inelastic money supply for actual cash to move crops and pay agricultural wages may make a real difference in the value of money; scarcity of money of the right denominations for retail trade may give an agio to such money,[550] but the money and credit used by speculators, bill brokers, dealers in foreign exchange, investment bankers, etc., increases, rather than decreases, the funds available for ordinary industry and commerce.

I have made clear the distinction between the direct and indirect financing of industry by banks. Great banks in Continental Europe often _buy_ the stocks of new corporations, hold them permanently, put bank officers on the boards of directors, and supervise closely the operations of the companies. In America, while officers of commercial[551] banks often are members of boards of directors of the companies which borrow heavily from the banks, the practice is to make short-time loans to such companies (in form, if not in fact), and to lend on their securities, rather than to buy them. Our banks own securities in enormous amount, but they are chiefly seasoned bonds, rather than stocks of new or even well-proved, enterprises.

It is commonly supposed, too, that collateral loans are chiefly or almost wholly made to speculators, who buy securities in the expectation of holding them only till investors take them off their hands, and that investors buy them, not with bank-credit derived from loans, but with money or bank-credit which they acc.u.mulate by saving out of current income. It is particularly true of the higher grade securities, which savings banks and insurance companies can buy, that this is the case.

The bank-credit thus serves for temporary, rather than for permanent financing, to the extent that this is true. I think, however, that the extent to which bank-credit serves for permanently financing industry is underrated. A good many investors have learned that the short-time money-rates are, on the long time average, lower than the yield on long-time securities.[552] They have learned, too, that high-yield securities--securities high in yield as compared with the long-time average of money-rates--can be obtained which can safely be carried on margins of thirty, forty and fifty points, without danger that even such catastrophes as the slump in security prices at the outbreak of the War will wipe the margins out. The old distinction between investors and speculators, the former those who buy for the yield, and the latter those who buy for an antic.i.p.ated rise in capital value, no longer corresponds to the distinction between those who buy outright and those who buy on a margin. The investor, buying a 6 or 7% preferred stock, carrying it on a forty point margin, with money from his bank or broker at 4 or 5%, is making 6 or 7% on his own forty dollars, and is making the difference between 6 or 7% and 4 or 5% on the sixty dollars lent him by his banker or broker. He substantially increases his yield thereby, and his risks, if he chooses his stocks carefully, and scatters them among a number of issues, are not great. For the banker or broker, such a loan is perfectly satisfactory. The margin of security is wider than that demanded on more speculative securities. Such a borrower will receive consideration when more speculative loans are being called, or not renewed. The investor of this type is, in effect, engaging in a form of banking business. He is lending to the corporation funds which he has borrowed from others; he has put up his own capital for the same purpose that the bank uses its capital--to supply a margin of safety to those who have taken his short-term promises to pay. Like the bank, too, he converts rights to payments at a later date into rights to payment at an earlier date. He is one of the links in the chain whereby the wealth of low saleability employed in industry becomes distilled and refined till it enters the money market. His profits come in the difference in the yield as between more saleable and less saleable forms of rights.

The extent of this practice cannot be stated, so far as any data to which the present writer has access are concerned. The writer has met the practice in a good many cases. One brokerage house, with whose operations the writer has considerable acquaintance, makes a practice of advising its more conservative customers to do this. A good many brokerage houses sell investment securities on the "instalment plan,"

which often means, in practice, that the initial margin put up by the investor is his only payment, and that the security is gradually paid for by letting the yield increase the margin. During the extremely easy money of the present War period, occasional reference has been made in the financial papers to the practice of buying even the highest grade bonds on this basis--the yield of the bonds being very substantially higher than the money-rates, giving a comfortable profit to those who hold the bonds on a margin.

That the practice is not wider spread is due primarily, probably, to the temperamental qualities required. The investor, proper, is commonly a very conservative person, who has an unreasoning distrust of speculation, and to whom the word, "margin," necessarily suggests speculation. That buying a stock on a margin is the same sort of thing as buying the equity in a mortgaged farm, does not occur to him. On the other hand, the man who knows the market well enough to be willing to deal on margins, frequently is not content with the slow process of acc.u.mulation which comes from annual yields, and prefers to take larger chances in speculation on capital values. But there is an intermediate cla.s.s, who buy investment securities, with narrow range of fluctuation in capital values, for the sake of the yield, and who buy them on margins, margins ample to enable them to sleep at night, and to neglect the daily market reports. I think that there are indications that this cla.s.s is growing larger, and more important. Doubtless much more important than individual "bankers" of this sort, however, is the enormous number of houses dealing in securities, "wholesalers" and "retailers," who find profit on their "wares" even while on their "shelves," through the differential between the yield and the charge made by commercial banks on collateral loans. A very large percentage of collateral loans is made to inst.i.tutions of this type. As this practice becomes more important, the result must be to widen the money market, to increase the proportion of banking capital that goes permanently into financing industry, and to reduce the difference in yield between short-time paper and long-time securities--in other words, to bring the "money-rates" closer and closer to the long-time interest rates.

This would have seemed very strange and weird to Adam Smith. It means, in effect, that the bulk of our banking credit is, directly or indirectly, financing our industry rather than our commerce. Adam Smith thought that a bank could safely lend to its customers only so much as they would otherwise keep by them in the form of money. Perhaps this notion, as growing out of some speculations regarding the general theory of money, should not be taken as the statement of Smith's practical att.i.tude on the matter, but that practical att.i.tude, as clearly expressed in the paragraph[553] following, is that a bank can afford to lend only for mercantile operations that are carried through in a very moderate time, that the bank can afford to supply only the minor part of the circulating capital, and no part of the fixed capital, of a merchant, or manufacturer, no part of his forge and smelting house, etc.

Such loans lack the liquidity which the bank must insist upon. Only those persons who have withdrawn from active business, and are content with the income upon their capital, can afford to lend for such purposes. The theory is sound, on the basis of the facts as Smith knew them. But modern corporate organization and modern stock markets have changed all that. Anything that is highly saleable can come into the money market, and the modern corporation organization of business, coupled with organized stock exchanges and a large and active body of speculators, has made the forge and the smelting house as saleable as the finished product.

This is not to accept Schumpeter's doctrine,[554] so far as the United States are concerned, that it is primarily the bankers, the manufacturers of bank-credit, who make the decisions that turn industry from old to new lines. They do not, on the whole. In Continental Europe, particularly Germany, they do to a much greater extent. Criticism has been made of our American commercial bankers, as contrasted with German bankers, that the former are parasites, who insist on sure things, and refuse to take chances with other business men in the development of industry. To the present writer, our banking system seems to be rather a more developed system than that of Germany, in that the "division of labor" has gone further with us, and risk-bearing and the manufacturing of bank-credit have been more sharply differentiated. We have bankers enough who are "risk-bearers." But they are, on the whole, "private bankers," "investment bankers," and the like, who do not manufacture a great deal of deposit credit, but rather borrow heavily from the commercial banks, which are the great manufacturers of bank-credit.

Under our system, the decisions which divert industry from old to new lines are more democratically made, by speculators and investors under the leaders.h.i.+p of private bankers, and sometimes without that leaders.h.i.+p. These const.i.tute the important intermediary which transforms stock exchange securities into the basis of bank-loans. The commercial banker buys, in general, not the stocks, but the note of the private banker, broker, speculator, or investor, with the stocks as collateral.

If investment bankers, speculators and investors decide to support old ways of doing things, the banks lend on the securities of the old kinds of businesses; if investment bankers, speculators and investors turn to new things, the commercial banks follow suit. Commercial banks can and do discourage certain types of enterprises by refusing loans with their securities as collateral, or by requiring very heavy margins with such loans, but even these may be developed, and are with us on a large scale developed, on banking credit, advanced by the speculators and private bankers who borrowed it from the commercial banks with other securities as collateral. The commercial banks of the United States may to a very considerable degree check dynamic tendencies, but in general, they do not lead and direct them. Bank-credit, directed by others than commercial bankers, does, however, enormously facilitate both the starting of new enterprises and social readjustment to them.

How far can the total wealth of the country, agricultural as well as industrial, be brought into the circle of the money market? The full answer to the question would go far beyond the limits of this book. If agriculture can be brought under the control of large corporations, there is little reason for supposing that it, too, might not come in.

There are some peculiarities of agriculture, special dangers of drought and flood, dangers of over-production and low prices, wide seasonal fluctuations in conditions, which make it hard to standardize in any case. But mining and even the manufacturing of such things as primary steel products have wide variations in prosperity too. So long, however, as agriculture remains a matter of families on a homestead--and for social and political reasons, we may hope that this will always be the case--it is difficult to bring it in. Bonds of agricultural a.s.sociations or of agricultural banks have had limited sale on the bourses of Europe.

The present writer, for example, found it impossible to find in four great libraries in New York and Boston any quotation of the bonds of the _Bayerische Landwirtschaftsbank_. Apparently, in general, such securities have not high saleability. While this remains true, agriculture may expect to remain under a handicap of higher interest rates than industry and commerce.

If, however, all forms of wealth could be made equally saleable, we should find interest rates rising for those loans and securities which now have the highest saleability. They would lose the peculiarity which now enables them to perform a service as bearer of options. Money-rates and long-time rates of interest would tend to come together. Long-time rates on formerly unsaleable loans would fall, and rates on highly saleable loans would rise. The present low rates in the "money market"

grow out of _differential_ advantages.

We turn now to the third important aspect of the technique of banking, namely, the matter of cash reserves. First I would point out that this is merely a part of the more general problem of liquid a.s.sets. The difference between cash and liquid paper is a matter of degree. There is large possibility of subst.i.tution of the one for the other, as it becomes more profitable to use one or the other. When money-rates are low, it may well be worth while to carry large reserves; when money-rates are higher, the gains to be made by subst.i.tuting paper for cash in the bank's a.s.sets are much greater. I have pointed out the use which great European banks, notably the Austro-Hungarian Bank, make of foreign bills of exchange as "reserve," selling bills when money is "easy," and the yield on bills is small, buying bills when money is "tight," and the yield on bills is large.[555] The great Joint Stock Banks of England, the chief sources of bank-credit in the great banking country of the world, also make use chiefly of deposits with the Bank of England as their "reserves." Some cash they keep, but it is "till money," rather than reserve. They carry, also, "secondary reserves" in highly liquid paper, stock exchange loans and commercial bills. The differences are differences in degree. The Bank of England does keep a large reserve in cash (including notes of the Issue Department and gold bullion) but it denies that it has any definite ratio in mind,[556] and it protects its reserves, when they are low, not by ceasing to loan, but by raising its discount-rate. The whole thing is highly flexible.

This is, in general, true throughout the world,[557] where banking is highly developed. A country which has expanding business, based on rising values of goods and rising capital values of antic.i.p.ated incomes, which in turn grow out of increasing business confidence, etc., and out of the development of new enterprises which make readjustment necessary, expands its bank-credit to meet the situation. Expanding bank-credits in time grow so large that bankers feel larger cash reserves to be desirable. Their reserves may be also, in some measure, drawn upon by the growing retail trade and wage-payments, which call for more money in circulation. They meet the situation by raising money-rates. This tends to prevent the exportation of gold, and tends to encourage the importation of gold, which finds its way into bank reserves. Banks may even borrow directly from banks in other countries, to get the gold they need, or to prevent the exportation of the gold they have. The higher money-rates, also, tend to check marginal borrowing--the borrowing by those who see only very small profits to be made by the use of the bank-credit they borrow. If the rising values of goods, however, and the profits to be made by effecting exchanges, speculative and other, are large, the volume of bank-credit will, none the less, grow. If the tide of rising business confidence is strong, the banks will be disposed to accept securities and rights as collateral which they would distrust at other times. A very big difference indeed may appear between bank reserves in active times and bank reserves in dull times. The banks need less reserves in proportion to deposits in active times, because the very activity itself increases the liquidity, the saleability, of their paper a.s.sets, and so makes actual cash less necessary. Even in this country, the practice of counting deposits in other banks as reserve is well developed. This is not only true of country banks, or banks outside the reserve cities. It has been, in considerable degree, the practice of the big trust companies in New York City. It is the practice of private bankers connected with the stock exchanges, and the practice of brokers, who are, for many purposes, bankers, especially those who allow their customers to check on their accounts. Such houses may carry no cash at all. One, with whose workings the writer is somewhat familiar, makes the rule--"We pay by check and receive only checks." None the less, this house allows its customers to check upon it, and checks drawn on it perform all the functions of checks drawn on banks which keep a cash reserve. Of course, our new Federal Reserve system is built, in part, on the principle of collecting reserves in central reservoirs, and our banks will doubtless increase the practice of counting deposits with other banks as reserve.[558] They will feel the need for less reserves, also, with a wider rediscount market.

_Within a given country_, I think that we may safely generalize the doctrine that the causal relation between reserves and deposits is exactly the reverse of that a.s.serted by the quant.i.ty theory, within very wide limits indeed. That is to say, increasing reserves are a _result_, and not a _cause_, of increasing loans and deposits. We shall further hold that the relation between them instead of being definite, is highly flexible. This is not to a.s.sert that reserves may not increase without a prior increase in loans and deposits. That has happened in the United States during the present War. It does mean, however, that increasing loans and deposits will pull gold into a country, and that increasing reserves do not force increasing deposits and loans.[559] If a country's business is growing, if that business is soundly based, so that expectations are being met, obligations being paid out of the income which arrives, on schedule time, to meet antic.i.p.ations, there need be no effective check to the amount of gold that will come into the country to serve as reserves, within limits that are rarely reached. It is miscalculation, maladjustment of costs and prices in particular enterprises, failure of "interst.i.tial adjustments," especially failure of particular crucial links in the business chain, as the businesses engaged in producing iron and steel, to respond to the needs of other expanding businesses, that check movements of expansion in business, not inadequacies of bank reserves.[560] As long as only wise plans are made, as long as they meet no mishaps, as long as the carrying out of the new plans does not itself so change the facts on which the calculations of business men have been based as to cut under antic.i.p.ated profits, so long may business, within a given country, expand without danger from inadequate reserves. Of course, if the whole world is simultaneously expanding, the compet.i.tion for gold in the international money markets may be so severe that all may be hampered.

That reserves will increase, as expanding credit, due to increasing business or rising prices, requires increased reserves, can hardly be disputed, I think, if we look at a country of small size, or (what is the same thing from the angle of economic a.n.a.lysis, so far as the present problem is concerned) if we take a particular part of a country.

Seasonal movements of cash for reserves in this country have been obviously determined by the movements of credit, rather than the reverse. Expanding business at crop moving seasons, requiring advances of credit by country banks, and an unusual drain on the cash resources of the country banks, has regularly meant that the country banks draw cash from the New York banks. When the need for such cash in the country banks pa.s.ses, when they can no longer employ it to advantage at home, they send it back to New York. New York, to meet the emergency caused by the withdrawal of cash, draws to a considerable extent on Europe for gold. It is not as easy for New York to get gold quickly from Europe as it is for France to get gold in an emergency from England. More time is required. Inelasticity, too, in the forms of currency most needed for small transactions, has made very real difficulties for us. But that, within the country, the sections whose business and credit were expanding take cash reserves from those sections where credit is less urgently demanded, needs no debating. This is seasonal. But the same thing is true in the long run. As business and bank-credit have expanded, year by year, in Oklahoma, Oklahoma's cash reserves have grown. Bank-credit in a country cannot go on indefinitely mounting, if bankers are making unsound loans, if the values on which the loans rest are based on vain imaginings, if antic.i.p.ated profits are not realized.

But if a country have rich resources and intelligent entrepreneurs, with sagacious bankers who can discriminate between sound and unsound business, it may, within very wide limits indeed, expand its bank-credit without check from inadequate reserves, as its business expands, and as prices, particularly prices of lands and securities, rise.[561]

If the country in question be a very large country, however,--large in the sense that its business and volume of bank-credit are very large, and particularly in the sense that bankers' a.s.sets are of such character that a large volume of reserves is desirable--restraints on the process of expansion may come. Reserves will come in, but the resistance in stiffer money-rates will be felt. Bankers in other countries will compete with the bankers in the country in question for reserves. Rising money-rates will put an end to many marginal exchanges. They will lessen the saleability of many rights which might otherwise be available as banking collateral. The extension of bank-credit will feel a drag. There is large flexibility here. But, in a long run period of many years, the volume of gold in the world will impose a maximum limit upon the possibility of expansion of bank-credit in the world as a whole. This limit is doubtless never reached. Within the limit, the variations in the volume of the world's credit are primarily determined by the other concrete factors we have been discussing. Proportionality between the world's gold and the world's volume of credit does not at all obtain.

Under certain conditions, much higher proportions of reserves to bank-credit will be found in a given country than at other times, and the same will be true in the world at large.