The Functions of Banks Chapter

§ 8. Bills of exchange, domestic.

Foreign and domestic exchange is the sale of orders for the payment of specified sums of money at distant points. But for this, payments at distant points would ordinarily have to be made by send ing the money in some way. It must often occur, for ex ample, that hundreds of payments, aggregating millions of dollars, must be made by persons in and near Chicago to those in and near New York, while, at the same time, equally large sums are due from New York to Chicago. The waste ful process of shipping these sums back and forth is avoided by the cancellation of indebtedness between the two localities. It has been the practice for each small bank to keep a part of its funds in correspondent banks in one or more of the larger cities on which it draws bills of exchange for its cus tomers and to which in turn it remits for collection drafts and checks which it has received. Before 1914 such deposits might, up to a certain percentage, be colinted as part of the depositing bank's legal reserves. From time to time, as balances of accounts increase on the one side or the other, shipments of actual money become necessary; but these are only a small fraction of the total amount of the bills of exchange mutually cancelled. Similarly, the settlement of ac counts between any two localities can be made by the ship ment of comparatively small sums of money. Under the Federal Reserve Act the reserve banks have in various ways 8 The Federal Reserve Act of 1913 has given encouragement to this practice by reducing to 3 per cent the reserve required to be kept against time deposits. See ch. 9, 6 7.

assumed the functions of the correspondent banks, aiming to bring about parity of checks issued in any part of the country.

The wider use and acceptance of individual checks at long distances from the banks upon which they are drawn limit by so much the proportion of special bills of exchange drawn by the banks themselves. Domestic exchange involves just the same principles as foreign exchange of funds, except that in the latter, usually, two different units of standard money are used. In connection with the discussion of foreign trade below, foreign exchanges will be explained and further light will be thrown upon the adjustment of the money supplies and levels of prices of the various sections of a single country, as well as between different countries.

§ 9. Issues of notes. The issue of bank-notes as a mode of lending a bank's credit calls for consideration here. Yet it must be observed at once that comparatively few banks in the world have now the legal right to issue their own notes. The function of bank-note issue has come to be looked upon as so closely connected with that of the coinage and regulation of the standard money that it has been increasingly limited in each country to a central national bank, or group of banks, which is in many respects practically an organ of the govern ment. To such banks the right of note issue is granted as

a monopoly in return for specified payments and services. In normal times the issues of bank-notes are regulated by the banks themselves; but in times such as those following the outbreak of the World War the bank-note issues become es sentially political money (irredeemable) issued by command, and to meet the urgent financial needs, of the sovereign state.

No two countries have quite the same kind and system of bank-notes. Typical bank money( or "credit currency") consists of notes issued by banks on the credit of their gen eral assets, without special regulation by law. Many of the bank-notes issued by the banks chartered by either the federal or the state governments before the Civil War of this 45100A kind; but after 1837 the notes of the Second Bank of the United States, which had been prudently controlled, were retired. The experience with many (not all) of the state bank-notes issues thereafter, until the Civil War, was less fortunate. As it was to the interest of the banks to keep in circulation as many notes as possible, many banks yielded to the temptation to abuse the power of note issue. The period is known as that of "wild-eat" banking. In 1866 a federal tax of 10 per cent on state bank-notes made their issue unprofitable.

Since the passage of the Federal Reserve Act we have temporarily two kinds of bank-notes, the old bond-secured notes, in use since 1863 (very different from the typical and the new kind of Federal Reserve notes very nearly typical in character but issued only by the Federal Reserve banks, not by individual banks.

A bank, by the issue of notes, puts into circulation as money its own promises to pay. The customer, in borrowing money or in withdrawing deposits or cashing checks and drafts from other banks, is paid with the bank's notes instead of with standard money. These notes may be returned to the issuing bank, either to be redeemed in specie or to be paid in some other form of credit, such as deposits or exchange. The limit of the issue of such notes is the need of the community for that form of money, and if they are promptly redeemed in standard money on demand, they never can exceed that amount. A holder of a note (in the absence of special regula tions) has the same claim on the bank that a depositor has.

§ 10. Divergent views of typical bank-notes. Some per sons, seeing in bank-notes but a form of ordinary commercial credit (like the promissory note or an individual's cheek), have contended that their issue should be entirely unlimited 9 Including, now, two varieties: the "national bank-notes," issued, as before, through local banks, and some "Federal Reserve bank-notes," which are national bank-notes that have been taken over by the Federal Reserve banks.