7. Notes issued against commercial paper.—In some countries, banks are allowed to issue their notes in exchange for good commercial paper. In this case, ultimate redemption is secured by all the assets of the issuing bank, no particular class of assets being set aside for that purpose. It is evident that good, short term commercial paper also serves as a kind of se curity for current redemption, since some of the paper in a bank's folio is constantly coming due, and the paper which is not due can usually be sold in the market. When times are dull or panicky, however, these sales cannot be made, and even the paper that is due may be uncollectible. At such times, a cash reserve is absolutely necessary if a bank is to continue to redeem its notes.
This plan has the great adyantage of permitting a bank to issue notes as long as there is a real need for them, provided it can get enough lawful money for reserve purposes. An increase in the real demand for bank notes is always evidenced by an increase in the supply of commercial paper. There is, however, one danger to guard against. When times are good, every business is promising, and men are eager to borrow in order to extend their operations. Business men are likely to become too optimistic and to seek loans which are unwarranted by actual prospects. Everithe bankers may be deceived. As a result, they will exchange their notes for commercial paper that is not so good as it looks, and the day of reckoning must come. The danger of over-expansion will be greatly minimized if all the bankers are strictly limiting their note issues to an amount against which they are able to maintain adequate cash reserves. Additional re serves become harder to get as over-expansion in creases. When times are good and prices are rising above the level in other countries, the balance of trade goes against us, and gold begins to flow out of the country, thus reducing the supply of money available for bank reserves.
This plan of issuing notes against commercial paper, if intelligently carried out, is the best system of note issue.
8. Notes a preferred further security is usually provided for note-holders by giving them a prior claim over depositors on the assets of a liqui dating bank. If the assets of a failed bank are insuf ficient to pay both the note-holders and the depositors, even after the stockholders have contributed the extra amount for which they are liable under the double liability provision, note-holders are paid before de positors. For various reasons the law gives note
holders better protection than depositors. In the first place, measures for protecting them are more ob vious and more easily applied. Legislatures, more over, have a way of thinking that notes form a kind of liability different from that of deposits, altho they are similar in many respects. It is, however, undoubt edly true that depositors, as a class, are better in formed of the bank's condition. They can protect themselves more easily, and so they have less claim on the protection of the law. Notes circulate among the poor as, well as among the rich, and also among people who live at a distance from the issuing bank. The poor are often not in a position to judge the worth of a particular bank's notes; and if they were able to do so, in many cases they could not refuse to accept them, for fear of losing their jobs. For these reasons it is right that note-holders should be given a preferred claim to all or some part of the assets of a liquidating bank.
9. Government guarantee of furnish a final security for bank notes, the government some times steps in and guarantees their ultimate redemp tion. If the credit of the government is good, this feature immediately gives the notes a wide range of ,acceptability, which is desirable. The objection to this plan is that it places too great a burden on the government. If the banking system breaks down, the credit of the government is affected. The bank ing system should be made so sound that govern ment support will be unnecessary. If the system is in this condition, its notes will be accepted quickly enough. It may be argued that the government will not be hurt if the system is a sound one. This is true, but in such a case government guarantee is unneces sary and, after all, the possibility of failure, like the sword of Damocles, is always suspended over the government's head. Moreover, if the credit of the government should decline, as was the case with the United States during the Civil War, the loss of con fidence in the government might be reflected in the credit of the banks, and the whole situation would be rendered infinitely more embarrassing.
These are the principal means that have been de vised for directly securing the ultimate redemption of bank notes. Their security is made better indirectly thru certain regulations which the government some times imposes upon issue.