Where it is desired to give more protection to notes than to deposits, the notes may be given a prior lien on the general assets, that is, after the notes have been liquidated at par the depositors are entitled to the remaining assets. It is evident that by the prior lien noteholders are protected at the expense of depositors. The bank note systems of France and Canada illus trate these two schemes respectively.
In general, however, the issuance of bank notes is regulated in the interest of the holders, and these regulations are supposed to provide indirectly for security. The plans for such regulation are numerous.
One method is to restrict the issue to certain banks. The central banks of England, Germany, and France enjoy practical monopolies of issue in their respective countries; these banks are exceptionally strong and are moved by a public interest which does not generally characterize local banks. In England this restriction allocates the issues still more by placing that activity entirely in the hands of the Issue Department, a plan which results in a clear-cut separation of loans and issue, mak ing baneful collusion of bank officers, as well as trespasses on the law, less easy and secret.
A second method is to restrict the amount of the aggregate issue. The limit may be absolutely fixed at so many milliards, as in France or Germany, or be limited according to the gov ernment debt or the issuing bank's capital, as in the United States. The limit fixed may or may not be elastic—the 5 per cent tax on the excess as used in Germany, or the Aldrich Vreeland Currency Associations formerly used in the United States, illustrates the elastic limit. Indirect limitations may be imposed in various ways, such as by: r. Allowing only large denominations which will not circu late freely—for instance, the Bank of England note and the national bank note are relatively large denomina tions.
2. Requiring immediate clearance and redemption, as in Canada.
3. Limiting the area of circulation.
4. Guarding the nature of loans and assets and supervising the banks' practices through legal restraints, regula tions, examinations, and reports. These methods of indirect limitation are combined in varying degrees and ways.
A third group of methods of protecting noteholders with ulti mate security is to pledge special assets. The segregation of these assets, usually those of better quality than the rest, for the special security of bank notes is made to the detriment of the security for deposits. This partiality is shown to notes because legislatures,
for previously mentioned reasons, regard the noteholder as a more immediate ward of the state.
The particular assets set aside for the protection of the note holders are usually high-quality assets, such as mortgages or government bonds, and are pledged with the government, which is authorized to sell the bonds and redeem the outstanding notes. Commercial papers, such as notes and acceptances of tradesmen and manufacturers, are very serviceable assets for use as a pledge against notes, because they open a way to procure elasticity.
Another system of affording security is to have a government or other large institution or group of institutions stand guarantor of the notes issued. The security of the notes is then that of both the commercial world and the government or guaranteeing institution. The best example of this system is our national bank system, for the notes of which our federal Treasury stands prac tical guarantor.
3. Elasticity of Note Issues The great danger in any system of protection of note issues is that the restrictions may be so rigid as to destroy or unduly cir cumscribe elasticity of issue. A note issue should be capable of expanding suddenly and greatly in case of emergency, and of contracting as readily when the emergency subsides. It should also be able to increase and decrease with the seasonal demands for money. The term "elasticity" is strictly applicable to the latter case only. Elasticity of the currency is desirable so that: 1. Accommodation, particularly to deserving and efficient borrowers, can be extended freely and the continuity of business maintained.
2. The market rate of interest may be stabilized and fluctua tions of credit reduced.
3. The quantity of money rather than the price level may fluctuate seasonally.
It is highly desirable that an expansion or contraction of the volume of bank notes should be unmistakably in response, re spectively, to an increased or lessened demand of the legitimate business world—a demand not based, except to a relatively small degree, on speculative operations but on actual indusixiat and, commercial operations. This correlation may be most surely achieved by issuing bank notes only to borrowers who use the funds only for such legitimate purposes. In practice the persons who decide whether the purpose alleged is legitimate, and who watch to see that the loans are used for the alleged purpose, are the loaning bankers.