The Principles of Economics Part 44

[Sidenote: Rising prices the temporary solution]

Though no change seems likely or possible at the present time, the free-silver advocate has been justified by events against those gold advocates who said that the amount of money has nothing to do with prices. Prices have gone up as gold has increased. The free-silver advocates have gotten what they wanted through a change for which neither party can claim the credit. Yet the present situation is unsatisfactory and undeveloped. A standard better than a single metal, more stable than a single commodity, is desirable if it can be found.

The money question must arise again and in a new form before many years.

The difficulty has not been finally settled; it is but postponed.

CHAPTER 48

BANKING AND CREDIT

-- I. FUNCTIONS OF A BANK

[Sidenote: The essential banking function]

1. _A bank is a business whose income is derived chiefly from lending its promises to pay._ Banks have pa.s.sed through many changes in the past three centuries. Originating on the street corner for exchange of money, they have evolved into great inst.i.tutions of many forms, and performing many functions. The definition seems paradoxical, but it expresses what in modern thought is the essential feature of a bank: the lending of its credit. A reserve of money is needed by the man of business. But for the banks each man would have to keep his reserve in his own till. Except the small sum needed for current uses, a bank can keep this reserve more economically than individuals can. It has the advantages of large production similar to those of a large factory. The process of lending credit is called deposit and discount. It grew out of the deposit of actual money for safe keeping and the loaning to borrowers by the method of discounting their notes. The term now has a somewhat different meaning, for a merchant may obtain a deposit to-day without putting any money in the bank. He gets the bank to discount his notes or collateral security, and to enter the sum to his credit as a deposit. He becomes a depositor by borrowing, not by lending to the bank. The sum is under the borrower's control; he can check it out when he wishes; but he usually keeps a certain balance to his credit. The bank's gain is larger than ordinary interest, because it gets a discount on the large sums left in its possession. The bank increases its funds also by attracting deposits from those who do not care to borrow.

[Sidenote: Other functions usually performed]

2. _Functions not essential to banking are ordinary money-lending, money-changing, exchange to distant points, safe deposit, and issue of bank-notes._ Banks often lend in the ordinary way, allowing borrowers to draw the money out at once, but this is not the business they prefer.

Many individuals and corporations, such as endowed charities, colleges, insurance companies, lend great sums of their own money without thereby partaking in any degree of the peculiar character of banking.

Money-changing (the exchange of coins of different countries) is done by banks, but likewise by many other agencies not sharing the essential banking character. Foreign and domestic exchange is the issue and cashing of "drafts" for money payments between distant places. Most banks are well fitted to perform this function, but some banks do not undertake it, and it is performed also by some business houses that are not banks. Safe deposit is the keeping of things to be returned in identical form, as silverware, notes, and papers. By banks in small towns this is sometimes done freely, sometimes for a slight charge; but in large cities safe-deposit vaults are generally quite unconnected with banks. Even bank-note issue is not essential to banking; most banks in the United States issue no notes, others issue very few. All these functions may be united under one management, but the essential banking function is deposit and discount.

[Sidenote: Sources of the income of banks]

3. _The income of banks is derived from discounts, interest on their own capital, charges for exchange and collection, rents on investments, and profit from the loan of their bank-notes._ The income of banks is drawn from different sources, according to the size of the community, and the nature of the banks. While in the villages and smaller cities they perform a number of functions, in the larger cities they usually specialize in a far greater degree. Like every other enterprise, a bank must start in business with some paid-up capital as a guarantee of credit. Further security is afforded by the limited liability of shareholders for losses, in proportion to their capital stock. The same amount of money could be loaned with less trouble and more cheaply without starting a bank, but used as a banking capital a part of it can be loaned while still serving to attract money deposits. Charges to smaller customers for exchange are a source of income to some banks, but in many cases this service is freely performed for regular customers and becomes a considerable expense. Banks make few investments in real estate or other physical property; it is, in fact, their duty to keep out of ordinary enterprises, but they are forced sometimes to take for unpaid debts things that have been held as security. Profits on bank-notes have at times been the main, possibly the sole, motive for starting banks; but that is not the case to-day when the right of issue is so strictly limited.

[Sidenote: Productive services of banks]

4. _Banks are productive economic agents performing important industrial services._ False ideas have long been entertained about the magic power of banks to produce wealth from nothing. To many, banks are a mystery much like paper money. Their opponents sometimes have pictured them as vampires fattening on the blood of industry. That they have shown abuses at times is undeniable, but, like other economic agents, they are to be judged by their net efficiency. The bank is a tool performing services similar to those of money. For some purposes money is an awkward and costly agent in comparison with banks. For remitting payments from New York to San Francisco or Hong Kong, money is a medieval device. Money can more safely be entrusted to a bank than to a strong chest in one's own house. The man who refused to make use of banks in this day would isolate himself economically, and would soon find himself out of any but the smallest business. He could no more get along without the banks than without the post, the telegraph, or the telephone.

[Sidenote: The bank as a labor-saving device]

The gathering of loanable funds by the banks, making them available at once, reduces h.o.a.rding, makes money move more rapidly, and creates a central market between borrowers and lenders for the sale of credit.

While not creating more physical wealth directly, it adds to the efficiency of wealth; it oils the bearings of the industrial machine. To abolish banks would be to destroy labor-saving machinery. Banks perform incidentally a further service in developing better business methods in the community. In supplying credit to active business, banks are constantly pa.s.sing judgment on the collateral security presented to them and on the solidity of the enterprises that are seeking support. They enforce promptness and exact.i.tude in business dealings.

Because in their public nature banks are very a.n.a.logous to money, they have always been looked upon as properly subject to more supervision than most private business, and government has always exercised a considerable measure of control over them, sometimes for good, sometimes for evil.

-- II. TYPICAL BANK MONEY

[Sidenote: Nature of typical bank money]

1. _Typical bank money consists of notes issued by banks on the credit of their general a.s.sets, without special regulation by law._ As no two leading countries have quite the same system of bank-notes, the subject is a difficult one. It is well to begin, therefore, with a clear conception of typical bank money, unregulated by government. Such a form of note is one with which few now living in the United States have had any experience, as the present national bank-notes differ in essential ways from the typical form. Typical bank-notes are notes issued by banks as a means of loaning their credit. The borrower, instead of receiving a credit balance at the bank subject to check, gets notes which he hands on to other men. These notes are returned for redemption to the issuing bank as soon as any one wishes specie in their stead. The limit of the issue of such notes is the need of the community for that form of money, and if they are promptly redeemed in gold on demand, they never can exceed that amount. A holder of a note (in the absence of special regulations) has the same claim on the bank that a depositor has. As it is to the interest of the bank to keep in circulation as many notes as possible, there is a temptation to abuse the power of note-issue, to which many banks yielded in the period of so-called "wild-cat banking"

before the Civil War.

[Sidenote: Bank-notes viewed as commercial paper]

2. _Bank-notes are viewed by some as a form of commercial credit._ Typical bank-notes are not legal tender, and every one has the legal right to take or refuse them as he pleases. It is therefore said by some that bank-note issue is of no special concern to the state, that it can safely be left to individual self-interest. It is said that if one has little faith in a note, he may refuse to accept it. But in reality every one is compelled to take the money that is current. The average citizen cannot know the credit of distant banks, and thus has not the same power of judging wisely in taking bank-notes that he has in making deposits in the bank of his own neighborhood. Between bank-notes and ordinary promissory notes, there are other differences of a nature pretty generally recognized. Bank-notes pa.s.s without endors.e.m.e.nt and thus depend on the credit of the bank alone, not like checks, on the credit of the person from whom received. They yield no interest to the holder.

They are intended to be used as money and are so used. Thus they come near to paper money in their nature, and the banks are near to exercising the right of coinage.

[Sidenote: Bank-notes viewed as a form of political money]

3. _By others, bank-notes are considered to be almost identical with government paper money._ Some opponents of bank-note issue declare that it is a usurpation of the prerogatives of government, and that no power but the sovereign state should issue money. While many in America to-day hold this view, the comparison probably is false and strained. Typical bank-notes, unlike inconvertible paper money, depend for their value on the credit of the bank, not on their legal-tender quality and on political power. They must be redeemed on penalty of insolvency; government notes need not be, and yet will circulate at par if properly limited.

While these differences mark off government paper money pretty sharply from typical bank-notes, it must be noted that in many cases actual bank-note issues have been far from this typical form. In the days of "wild-cat" banking, bank-notes were issued in excess and fell below par, yet the man in a Western community who dared to ask the bank to redeem the notes in specie was not only frowned on by the bank, but condemned by the public, which felt that business was endangered by such a demand.

Redemption on demand would have required a reduction of the amount of money in circulation and would have caused a fall in prices. Inflation of the bank currency went on with results almost identical with those following an excessive issue of government paper money. Not formal law but public opinion made such bank-notes essentially political money.

[Sidenote: Policy of public regulation of bank-notes]

4. _The public nature of bank money has led to many forms of public regulation of their issues._ Bank-notes thus stand midway in their economic nature between political money and private notes, sharing something of the character of each. An extreme a.n.a.logy in either direction is misleading. It is of great social importance that the circulating medium should be reliable. The least possible amount of the citizen's energy and thought should be required to decide whether the money is good or bad. Nevertheless, those opposed to state interference in industry declare that if the citizen is not left to look out for himself, the growth of stupidity will be encouraged; and they say that it is no more essential for the state to guarantee the quality of bank-notes than the quality of woolen cloth or of sugar. Few, however, take so extreme a view, and it is generally held that it is a function of the state to insure in a greater or less degree the quality of the money in circulation. The actual bank-notes of the leading countries are thus of many varieties. The Canadian notes are the most nearly typical bank-notes issued to-day; those of Germany come next, while those of the United States have little of the typical character.

-- III. BANKS OF THE UNITED STATES TO-DAY

[Sidenote: Forms of banks in the United States]

1. _The three forms of banks in the United States are private, state, and national._ Any one with a little capital may become a private banker. There are "curbstone brokers" in almost every town, and some of the great financial houses are private banks. But the law will not allow this to go very far. Some states will not allow a man to put up a sign announcing himself as a banker unless he complies with certain banking laws. In some states even private banks are subjected to the same inspection as the state banks and are required to make the same reports to the state officials. State banks are those organized under special state banking laws. They are usually subject to inspection by state-bank commissioners, must make regular reports, and are required to comply with certain rules as to their reserves, rates, and investments. In any case they do not issue bank-notes, because the national laws now tax the notes of state banks so heavily that they are unprofitable. National banks, the largest and most important portion of our banking system, were authorized by law in 1863, during the Civil War. They are subject to stricter regulation and inspection than are other banks, and that regulation is perhaps an advantage to them, as it strengthens public confidence in their stability. Yet this regulation does not insure the depositors against loss, as some national banks fail every year. They may be organized with twenty-five thousand dollars capital in towns of less than three thousand population, with fifty thousand dollars in towns of less than six thousand, with one hundred thousand dollars in cities of less than fifty thousand, and with two hundred thousand dollars in larger cities.

[Sidenote: Nature of our national bank-notes]

2. _Our national bank-notes have no essential mark of typical bank money._ The one marked peculiarity of the national banks of the United States as compared with those of other countries, is their mode of note-issue. They perform all the other functions of banks, essential and unessential, and perform them well, but the issue of bank-notes is optional with them, and some of them do not issue any bank-notes. The legal condition to their issue is that bonds of the United States shall be purchased in the open market and deposited with the treasurer of the United States. Until 1900, notes might be issued only to ninety per cent. of the value of the bonds deposited; but now they may be issued up to the par value of the bonds. The notes, being secured by the value of the bonds, rest on the credit of the government, not on the credit of the bank. These notes are not promptly sent back for redemption to the banks issuing them, as is done with typical bank-notes. They may circulate thousands of miles away from the bank that issued them, and for years after that bank has gone out of business. They are not an "elastic currency" increasing or diminishing with the needs of business.

The changes in their amount depend upon the chance of the banks to make more or less in this way than by any other use of their capital, and this in turn depends largely on the price of bonds and on the rate of interest they bear. From 1864 to 1870, fortunes were made from this source, but in recent years there has been little opportunity of gain from note-issues. Our present bank-note issues are not on a logical basis, and satisfy no one entirely. They are of importance neither to the bank, to which they afford little or no profit, nor to the public, for which they do a service equally well done by silver certificates, greenbacks, or coins.

[Sidenote: Suggested reforms of the bank-note system]

Along with the discussion of the currency has gone, since 1896, a vigorous discussion of the banking system. The two problems are so closely related that a change in the one suggests readjustment of the other. One extreme plan is to abolish bank-notes entirely and to replace them with additional issues of greenbacks; the other extreme plan is to authorize the issue of almost typical bank-notes. A modification of the Canadian banking system, which has great merits, is held up for imitation. Bills have been repeatedly before Congress authorizing the maintenance of a general guarantee fund with which the notes of failed banks could be redeemed, and at the same time authorizing branch banks such as those in Canada. Public sentiment has never strongly favored this plan, however, and there is more likelihood of the pa.s.sage of a bill providing for emergency notes in time of financial stress, after the plan followed in Germany.

[Sidenote: Bank regulation a protective measure]

That the control of banking is an important duty of government is the conclusion of the practical world. The various banking systems of the leading countries embody different plans for the one purpose of the adequate control of banking in the public interest. Government control of bank-notes is felt to be of the same nature as factory inspection, that is, to be a protective measure. When public interests are at stake and private interests conflict with them, government acts to forbid one citizen from doing harm, and to protect other citizens from injury.

CHAPTER 49

TAXATION IN ITS RELATION TO VALUE

-- I. PURPOSES OF TAXATION

[Sidenote: Taxation defined]

1. _Provision for the expense of organized government is the fundamental purpose of taxation._ Taxation may be defined as the taking by the government of private property for public uses. This implies a certain degree of compulsion. When the national government accepts ten million dollars in trust for the Carnegie Inst.i.tution, it is not taxation, though wealth is given for public uses. The effects of taxation pervade all industrial affairs, but they will be discussed here only in relation to the value of goods and to the distribution of incomes. By taxation the government interferes with the individual's free choice and with the impersonal economic forces. It expends income in different ways from those which would be chosen by the individual.