Banking in the United States Before 1914 1

The maintenance of the government's independent treasury contributed to the difficulties by causing the irregular with drawal of money from circulation and thus depleting bank 3 The expressions within quotation marks in the following sections are taken from this report.

4

See further on this in 7 on periodical congestion of funds.

reserves in periods of excessive government revenues and by returning these funds into circulation only in periods of deficient revenues. Efforts to modify this system by a partial distribution of the public moneys among national banks, had resulted, it was charged, in discrimination and favoritism in the treatment of different banks and of different sections of the country.

§ 6. Inelasticity of credit.

Our banks, considered both separately and collectively, were unable to increase their lend ing powers quickly and easily to respond to business needs. The need of greater elasticity of credit was felt in the more or less regular seasonal variations within the year, and in the more irregular variations in cycles of years from periods of prosperity to those of panic and depression in business. The inelasticity was necessitated by illogical federal and state laws restricting absolutely the further extension of credit when the reserves fell below the percentage of deposits (15 or 25 per cent) fixed by law. Reserves thus could not legally be used to meet demands for cash payments at the very time when most needed. This feature has been likened to the rule of the prudent liveryman who always refused to allow the last horse to leave his stable so that he would never be without a horse when a customer called for one. The refusal of credit by the banks at such times when they still had large amounts of cash in their vaults increased the need and eagerness of the public to draw from the bank all the cash they could, and often precipitated the insolvency of the banks. Clearly, some means were needed to enable the lending power of the indi vidual banks to be increased at such times, so that no customer with good commercial paper need fear to be refused a loan even though the rate of interest might have to be somewhat higher for a few days or weeks than the normal rate.

Our bond-secured bank-notes lacked almost entirely the quality of elasticity needed to meet these changing business needs.' Their value being dependent primarily upon the

I See above, 1 3.

amount and price of United States bonds, they might be most numerous just when least needed as a part of our circulating medium.

§ 7. Periodical local congestion of funds. In times of general confidence each bank finds it profitable, and is tempted, to extend its credit to the extreme limit permitted by the law governing the proportion of reserves to deposits. Of the 15 per cent reserves that were required in the so-called "country" banks, three fifths (9 per cent) might be kept in banks in reserve cities; and of the 25 per cent in reserve city banks, per cent might be kept in central reserve cities. There it counted as part of the depositing banks' legal reserves, was a fund upon which domestic exchanges could be drawn, and earned a small rate of interest (usually 2 per cent) paid by banks in reserve and central reserve cities to their "country" correspondents. By this process of pyramiding, reserves in very large part came to be kept in New York city, where they could be lent "on call," and the largest use for call loans was in stock-exchange specula tion. Thus every period of prosperity encouraged an un healthy distribution of reserves, gave an unhealthy stim ulus to rising prices, and "promoted dangerous specula tion." § 8. Unequal territorial distribution of banking facilities. Another aspect of this concentration of surplus money and available funds in the larger cities was the comparatively ample provision of banking facilities in the cities and in the manufacturng sections, and imperfect provision in the agri cultural districts. The whole financial system seemed de signed to induce the poorer country districts to lend tempo rarily available funds at low rates of interest to be used speculatively in cities, instead of enabling the richer districts, the cities, to lend to the rural districts for productive enter prise. The rates of bank discount in different sections of our country have long been most unequal—lowest in the largest cities and highest in the rural South and West—whereas in Canada, with a different system of banking, the rates have long been much more approximately uniform in urban and agricultural districts.