The chief advantage to the banks is sometimes presumed to be the gaining of profits from the note issue privilege. It is com monly alleged that banks make a "double profit "—the interest on the pledged bonds, and the interest on the loans of notes. The extra profit from the interest on the bonds is not large, how ever, since the rate of interest on most of the bonds bearing the circulation privilege is now only 2 per cent, and this percentage is reduced by several factors. If the bonds sell at a premium, more is paid for a bond than the sum of the notes which may be issued on it, since the notes may not exceed the par value of the bond. Moreover, the bank must maintain a 5 per cent redemp tion fund with the Treasurer and this may not be regarded as reserve and does not earn interest. In addition, the circulating notes are taxed r or 34 per cent per year, and the expense of preparing plates, transporting, issuing and redeeming notes, ex amining the bonds and plates annually, and witnessing the de struction of worn-out notes, must be deducted from the gross profit. Furthermore, if the bonds are bought above par and will be redeemed at par, a sinking fund must be maintained. And, finally, the full volume of notes issued to the bank cannot be kept continuously outstanding by means of loans. After mak ing these many deductions, the net profit from the circulation privilege is small.
The profit is further affected by money rates. In the case of a purchase of bonds at par, the average rate for money does not affect the additional profit derived from taking out circulation, as the amount of notes received is exactly the same as the money invested in the bonds. With bonds purchased at a premium, it is more profitable to take out circulation in a low money market than in a high, since the notes received are less in amount than the price paid for the bonds, and the bank will therefore be able to loan an amount only equal to the par value of the bonds. In a low money market this loss of interest is less than in a high market. Hence, in case of bonds bought at a premium the profits are less in a high money market than in a low money market.
Method of Calculating Profit on Note Circulation Profit on a national bank's circulation may be thus calculated: Date of calculation, March 1, 'gm.
Issue of bonds purchased, United States registered 2% bonds of 193o. Price of bonds (Ior and interest), $toi,000.
Par value of bonds, $ioo,000.
Money worth on the market, 6%.
Income from bonds per year $2,000 Income from circulation (Szoo,000 less $3,000 redemption fund) loaned at 6% Total gross income Deductions: Tax on circulation $3oo Sinking fund to retire premium, set aside each year 26 Expenses for plates, expressage, etc 63 Net income from circulation $7,111 Net income from loaning $ror,000 (net cost of bonds purchased) at 6% 6,o6o Increased income from circulation over loaning cost of bonds direct 1,051 Percentage of increased profit on investment 1.04% C. F. Childs and Company, specialists in government bonds, publish the following table of the profits from the note issue privilege under varying conditions of bonds, money rates, and purchase price: It thus appears that the profit is lowest when the premium is highest; that at any market price it is higher when the market rate of interest is lowest; that the profits on the 2's may be as great as on the 4's, since the purchase price of the bonds may equalize the earnings. Roughly speaking, in the light of the
prevailing prices of these bonds, the circulation privilege adds x.5 per cent to the earnings of the bond and therefore gives the bond an exceptional value in the hands of the national banks; any other buyer, capitalizing the earnings which he would receive alone as interest, could afford to pay less than par. The bonds have an artificial value, part of it being the capitalized value of the monopoly note issue privilege; the recent popular notion that the government could borrow freely at 2 per cent is beside the point.
Disadvantages of National Bank Notes National bank notes have several disadvantages.
For one thing, the profits to the national banks from the bank note privilege are so small and the operations of issue, with drawal, and redemption so troublesome, that many national banks make no use of their privilege in this respect or only a partial use.
Again, the volume of circulating notes is made dependent upon the price of bonds, that is, upon the speculative and investment market, which may or may not coincide with the needs of the com mercial money market. If the financial market is strong and bonds rise to premium standard, the profit from the circulation privilege declines; and if the commercial money rate is also high at such times, the profit is still lower. There would seem, therefore, to be a sort of perverse elasticity to the circulation. It is difficult to show this statistically because the number of banks and the capitalization of banks are varying at the same time that the prices of the bonds and the amount of bonds deposited to secure circulation are varying.
A further disadvantage is the fact that the volume of national bank notes is made dependent upon the government debt. The expansion of the debt may cause undesirable expansions of the circulation, though the government has lately prevented this by denying new bond issues the circulation privilege. On the other hand, if the government pays its debt, the volume of bank notes must contract; if, as between 188o and 1891, the Treasury goes on the open market and buys bonds, the price is driven to a point of high premium, eliminating the profits on the circulation. Between the dates mentioned the volume of bank notes declined 51 per cent (see Table Showing Effect of Debt Payment on Circulation) and this despite the fact that that was a decade of unparalleled growth in population and wealth and business ac tivity, and when the need for an increasing currency was peculiarly felt because gold production was not keeping up with the world's needs. This decrease was due to the payment of more than half the government debt within those years. During this period, however, the number of national banks was fast increasing, so that each bank was shorn to its minimum amount of required circulation.