The great danger of the system, however, lay in the reserve requirements and customs. All country banks were permitted to keep a portion of their re serve on deposit in reserve city banks. This permis sion was incorporated into the law with the idea of en abling the country banker to keep a city account without expense as a basis for exchange. A further reason was to increase the mobility of loanable funds by enabling the city banker to lend the deposits of the country bank in the large centers. These needs continued to exist as they did in the beginning, but the lending of the country banker's deposits by the city banker was so greatly abused that its dangers be came as great as its benefits.
9. Seasonal abuse grew out of the custom of the country banks of depositing in financial centers not only a portion of their reserve during cer tain seasons of the year but also a large amount of additional cash. Since competition between the city banks resulted in the payment of interest on country balances these deposits had to be loaned, and since they were demand deposits they had to be loaned on demand or call. As the chief field for this sort of loan was in the stock market, the promotion of specu lation was the principal function of these country balances.
When the demand for loans as well as for actual money increased in the country, as it invariably does in the late summer, these deposits were withdrawn and shipments of currency were requested. Loans in the financial centers had to be sharply contracted. The deposit currency would not meet the need, be cause the demand was for a circulating medium of general acceptability. Here was a demand, there fore, which could have been met under a system of elastic note issue without shipment of gold, the con sequent depletion of reserves and the calling of loans.
Perhaps it is well that under our system of reserve deposits we had this check upon speculation, but the desideratum is a system which will lessen the neces sity of keeping cash balances in the cities by enabling the country banker to increase his own currency sup ply. This would increase his purchases of commer cial paper with funds diverted from the stock mar ket.
10. Depletion of danger of deplet ing reserves was most acute in times of panic. At such times a general demand for the liquidation of all credits arose, including these deposit credits. Bank runs are deplored by an bankers, yet the country banks themselves were the first to withdraw deposits.
Each bank was anxious to increase the cash reserve in its own vaults, and this could be done only at the ex pense of some other bank. As reserves were de pleted, loans had to be called, and the lending power of the banks was sadly crippled at a time when it was greatly needed. With the calling of loans came fall ing prices, and if those in need of funds could not borrow they had to sell their property at great sacri fice. It would not be the function of bank notes to prevent failures of concerns which are over-extended and unhealthy, but the issue of true bank notes at such times would save many solvent firms tem porarily in need of funds.
This withdrawal of deposits became so general, both on the part of the individual and of the country bank, that during a panic the city banks were forced to refuse the payment of deposits in currency. This was done illegally, of course, but at such times ex pediency rather than legality is the paramount influ ence. It was only in. this way that bank reserves could be maintained.
A very certain method of obtaining money to in crease reserves is the purchase of gold abroad. Gold may always be obtained, provided a sufficiently high price is bid for it. The large banks, particularly those in New .York, can exchange their interest-earn ing resources, a large amount of which are standard securities, for gold in the markets of the world. Ob viously, however, this method is extremely slow and very likely to be expensive, as it involves the sale of good collateral at sacrifice prices.
11. Inelasticity.—Altho the aggregate amount of notes outstanding increased four times in the course of forty-five years, the increase had nothing to do with the expansion and contraction of business. A perfect currency must have the attribute of elasticity. This means not only the ability to expand when neces sary but the power to contract automatically when the necessity for expansion is removed. In neither respect did our national bank notes meet this need. The requirement that bonds must be purchased and deposited in advance made the procedure so slow that oftentimes the notes could not be issued until the demand for them had disappeared. Contraction was even slower because of the provision that only $9,000,000 in the aggregate might be retired in any one month.