The amount of notes outstanding varied not at all with the business needs of the country, but rather with made out of circulation depended upon this and upon the current commercial rate of interest. When bonds were low there was a tendency to purchase them and increase circulation. When they were high, the tendency was in the opposite direction. The National City Bank of New York stated in one of its monthly circular letters: Owing to the fact that the bank must part with more money to buy bonds which it will require as a basis for cir culation than it will receive back in circulating notes (be cause of the premium on government bonds) its profits in circulation increase as the average rate of interest in the money market declines ; and as average money market rates the profits on circulation decline. This is caused from the fact that it could loan the entire sum which it in vests in bonds at the average money market rate, but if it takes out circulation it can only loan an amount equal to the par value of the bonds and loses the interest on the premium.
The higher the market rate of interest the greater was the loss on this premium; hence, a smaller profit on circulation. Inasmuch as the rate of interest, in creases with increased demand for loans, the profit on circulation declined when an increase of notes was needed most.
The dependence of the aggregate amount of cir culation upon these two influences was never proved more completely than during 1908. The price of government bonds and the rate of interest were very low and, in response, circulation increased many mil lion dollars.
It is obvious that comprehensive reform was neces sary if the nation was to have a currency which would finance its business needs economically and enable it to pass from periods of great activity to those of quietude without complete paralysis of its economic machinery. The chief defects of the system were decentralization and inelasticity.
12. Lack of unity in the addition to the seven thousand national banks there were a great many more state banks and trust companies, which were not only direct competitors of the national banks but which were governed by different laws and regu lations. The result was a mechanism with over twenty-five thousand managers, each interested in the welfare of his own institution. A system was needed which would enable the banks to work in unison instead of at cross purposes with one another, and which would render possible the issue and re demption of notes as the need for notes might arise and pass away.
13. Banks and the Federal the Second Bank of the United States ceased operation the government had no option but to deposit funds in the state banks, as it had no vaults of its own. Dur ing the panic of 1837, the government was much em barrassed thru the suspension of specie payments by some of the depositories. Consequently, in 1840 an act was passed which provided for the establish ment of an independent treasury. The law was re pealed in 1841 but reenacted in substantially the same form in 1846. All the funds of the government were to be kept in the Federal Treasury and none deposited in the banks. An objection to this plan was raised at the time, that this would result in a contraction of the country's currency supply when the receipts of the government were outrunning the expenditures and money was piling up in the Treasury vaults, and vice versa. But the people were more concerned then with safety than with elasticity.
The Treasury was again put in touch with the banks by the passage of the National Banking Act, which authorized the Secretary of the Treasury to use na tional banks as depositories of public money except receipts from customs. These receipts have been so large, however, and so variable in amount that they have often caused stringencies. A certain amount of money is in the pockets of the people, a certain amount in the bank reserves, serving as a basis for credit, and a certain amount lies in the Treasury. It has frequently happened in the autumnal season that both the amount demanded in circulation and the amount lodged in the Treasury have increased sud denly at the expense of the bank reserves, especially those in New York City. This has often necessi tated a contraction of credit and, at times, has caused an acute financial stringency.
The condition outlined in the foregoing paragraphs was evidently caused by bad laws. However, the bankers of the country, particularly those of New York, were often loudly blamed for allowing such conditions to arise. But, among so many, who was to assume the responsibility of maintaining such re serves as would be necessary, or who would have had the power? The banker is conducting a private business for private gain and there is no reason why he should be expected to assume a public function of such magnitude. The thing needed was a banking system which would make the interest of the bank ers coincident with the interest of the whole com munity.