CHAPTER IV.

COMMERCIAL CREDITS.

Political Economy is the Science of Sales; and because it _is_ the

science of sales, its definitions and principles must cover equally

all cases of sales actually occurring or possible to occur. We have

seen repeatedly, that only three kinds of things are ever bought and

sold, or ever will be, and these are Commodities and Services and

Claims. The first two kinds have been fully elucidated already in the

two preceding chapters, and it belongs to the present chapter to

explain and illustrate clearly the peculiarities of the third kind of

things salable. Ours is the only science that has to do with the

motives and facts and economic results of all sales as such.

The discussions of the present chapter will proceed orderly through

the following topics:--

_The Nature of Credit._

_The Forms of Credit._

_The Advantages of Credit._

_The Disadvantages of Credit._

1. Certain things are essential in every sale of anything, and of

course are common to all sales of everything, such as two persons and

two desires and two estimates and two renderings; while there are

certain _peculiarities_ in the sale of things belonging to each of the

three special classes of things salable; for example, in the sale of a

commodity there is a rendering of a tangible object that has been

prepared for sale in past time, and in the sale of a service a

rendering of an intangible something wholly in the present time; while

in the sale of a credit there are likewise two peculiarities, one of

them relating to future time and the other to a special trust felt in

a person by some other person. We must now study these two

peculiarities with care; and, mastering these, we shall be master of

the Nature of Credit.

a. Some sales are consummated at once, the things exchanged and the

ownership in them are mutually passed over then and there, the

reciprocal satisfactions are entered upon immediately, and there is at

once an economical end.

For example, one neighbor sells another a peck of green peas and takes

in pay a peck of new potatoes, both vegetables may be cooked for

dinner in the respective families the same day, and the commercial

transaction is all over. But there are other exchanges, an immense

class of them, different from these in this respect, that though the

transaction considered as a mere case of value created and measured is

then and there ended, yet considered as to the nature of that

preliminary exchange which implies and requires another future

exchange to consummate it, it is not then and there ultimately closed,

but one (or both) of the parties then exchanging relies on the good

faith of some one else to fulfil in the future a pledge expressly or

impliedly made in the prior exchange. Commonly some external evidence

of the pledge is created and passed at the time, but this is not

essential to the validity of the pledge itself. For example, A buys 50

bushels of wheat of B, and B takes in pay for it A's note of hand at

six months for $75. The note is not the pledge, but it is a legal and

convenient proof of it. As a case in Value, the wheat is sold for the

pledge and the pledge is the equivalent of the wheat. Each party

rendered the other then and there satisfactory equivalents. All our

definitions apply here perfectly.

Still a further and future exchange was contemplated by both parties

at the time of making this exchange, and as a silent part of it. A

takes what is now his own wheat, and B takes as an equivalent for what

was his wheat a right to demand of A in six months an equivalent for

the present equivalent (the pledge) for the sake of which B rendered

the wheat. The note of hand is the evidence of this pledge, and it

belongs absolutely to B. It is his property. He may keep it till

maturity and then sell it to A for its face, or he may sell it at once

to a bank for its face less the discount for six months. Discount is

the difference between the face and the present price of a note of

hand. The first peculiarity, then, of Credit is, that it always

involves the element of future time. But it involves this secondarily,

and not primarily. In other words, a present equivalent is always

rendered by both parties in every commercial transaction; but the

present equivalent in the case of a credit transaction is the right to

demand something of somebody sometime in the future. This distinction

is very important, as we shall see clearly when we come to treat of

Banking, though it is generally ill-understood at present. Valuables,

when they exchange at all, exchange once for all. But there is one

kind of valuables, namely, claims, which, when subject to exchange,

imply and require another and a future exchange, not necessarily

between the parties to the first exchange, but between _some_ two

parties; and not, speaking strictly, to _consummate_ the first

exchange, because that took and gave its own satisfactory equivalents;

but, as involving both time and trust, the credit sale must in the

nature of things be followed by another sale of one of the three

kinds.

We see, accordingly, that in Credit our science of Economics takes

partial possession of future time for certain purposes of its own.

Exchange sets its throne and reigns pre-eminently in present time; but

its sceptre extends also over past time, so far as all capital is

concerned, and so far as all material commodities (the result of past

work) are exposed for sale in the present; and its right hand of rule

goes forth also to grasp the future, under limitations indeed both as

to the stretch of time covered and as to the character of the persons

concerned, but still there is there a fair domain and a broad domain,

and a realm on the whole winning a wider and wider circuit. It is one

of the proud boasts of Political Economy as a science, as it is too

one of the exalted traits of human nature, that the lordly impulse to

buy and sell does not confine itself to what the Past offers in all

its accumulated valuables, nor to what the Present unfolds in the

unlimited desires and efforts of congregated men, but reaches out also

into the Future, and makes that pay tribute more and more into the

vast treasury of its Gains. And this too is legitimate. Man is at once

and all the time actor and historian and prophet. The future is not

wholly unknown. Given the one assumption, that Earth and Men go on as

heretofore, Exchange knows well enough, and better and better, whom of

the coming men to trust and for how long a time. The doctrine of

averages and of probabilities comes along to guide and to enhearten

the investor. Any thoroughly established government of to-day can

borrow all the money that it wants on its public pledge to repay the

principal fifty years hence. England has borrowed millions of pounds

sterling, giving no day certain in the future for its repayment. These

funds are called "Consolidated Annuities": the interest on them is

paid on a day nominated in the bond: the principal is to be paid when

the borrower chooses, or never.

b. The other and final peculiarity of Credit is, that it always

involves on the part of one person a commercial confidence in some

person _as such_. The term, Credit, is derived from the Latin CREDO,

_I believe_, and the corresponding term, Debt, from DEBEO, _I owe_.

Thus the personal element and the future element are wrapt up in the

very origin of the words. There is no credit without debt, and no debt

without credit. The very words imply a _belief_ of one of the two

parties in a commercial promise made by the other, and also an

_obligation_ acknowledged by this party as due to the first. There is

a basis for credit in human nature. Faith in each other to a certain

extent is natural to men. Whatever enlarges the intellectual

foresight, and especially the moral character of men, opens a broader

and surer field for Credits. Civilization, so-called, and Christianity

certainly, deepens and broadens the natural trust of man in man.

Despite all the instances of broken faith, and they are too many;

despite the shocks and cautions that come every now and then to every

man who trusts much in his fellow-men; experience itself justifies and

rewards an ever-growing commercial trust. It is one of the noble

things in international commerce, as we shall see, that men trust each

other across the oceans, and lay millions of value upon the faith of a

single firm. As the core of the Christian religion is confidence in a

_Person_, so the very substance of credits is a natural and in general

well-grounded faith in _persons as such_.

A Credit, then, may be defined to be _a Right to demand something of

somebody_; and a Debt to be _an Obligation to pay something to

somebody_. What always lies, accordingly, between creditors and

debtors, are Rights coupled with Obligations; and these are

_Property_, just as much as anything is and for the same reason, since

they always may be, and usually are, bought and sold by other parties

as well as the original parties. In these Rights or Claims,

therefore, arises a commerce, domestic and foreign, immense in extent

and amount, and the Rights themselves take their undisputed place on

an equality with tangible Commodities and personal Services.

Having thus reached an ultimate and satisfactory definition of Credit,

we must still pursue a little further our present object, namely, to

obtain a clear conception of the _nature_ of this great class of

Valuables, by drawing two or three distinctions between Credit-Rights

and some other rights very apt to be confounded with them.

(1) The distinction between credit-rights and other rights is well

rooted in the Latin language and in the Roman law, while the

corresponding English terms are quite ambiguous and need to be used

with great caution. In Latin, a true debt is called a _Mutuum_,

because it lies between two persons, a creditor, and a debtor, and is

a credit-right independent of the question of fact whether the debtor

has now the thing rendered to him or not, indeed whether he has

anything at all to pay with or not; on the other hand, a thing merely

lent, when the very thing lent is to be returned to its owner, who has

not in the meantime parted with his property to the other, is called

in Latin a _Commodatum_. The English tongue has but the one word,

_Loan_, for the two very distinct operations: for the loan of a book,

for instance, which is to be returned after use, and which may be

legally reclaimed by the owner if he chance to find it anywhere, that

is, the Latin _commodatum_; and for the loan of money, or other such

measurable thing, which is to be returned _in kind_ only, and which

may _not_ legally be reclaimed except through some action of the

borrower, since the ownership of that thing rendered has passed over

to him completely, that is, the Latin _mutuum_. The same ambiguity of

course inheres in the corresponding English word, _Borrow_. The

English language is relatively poor in words expressing nice legal

distinctions.

Now, as a true debt is a claim on a _person_ and never on a _thing_,

the Roman Law is true to the nature of things and to the vital

distinctions of our science, when it names the right to which a

_mutuum_ gives birth as a _jus in personam_, that is to say, a right

against the person; while it names the legal obligation arising out of

a _commodatum_ as a _jus in re_, that is to say, a right to the very

thing. So strongly is this doctrine, namely, that the security of a

true debt lies against persons and not against things, intrenched in

the Roman Law, that debts or credits are even termed "_nomina_,"

_names_, in that law, as when Ulpian says, "_Nomina eorum qui sub

conditione vel in diem debent et emere et vendere solemus_": We are

accustomed to buy and sell DEBTS payable on a certain day and at a

certain event. The fundamental law of the present national banks of

the United States explicitly recognizes this old and good distinction

by requiring the banks to loan money on _personal_ security only, that

is to say, no tangible things, not even real estate, may be taken as

_original_ security for any loan.

(2) Henry Dunning Macleod, who has cast fresh light on the nature of

Credit, draws another distinction that lies on the threshold of the

subject, namely, that between paper documents conveying titles to

_specific things_, such as a bill of lading, for example, and those

conveying _credit-rights_, such as a bank-note, for example. Bills of

lading describe the goods, go out with the goods, are a title to the

goods, and have no value separate from the goods; bank-notes have

nothing to do with any specific pieces of property anywhere, are in no

proper sense a title to anything whatever, but a general _claim_ for

something upon some person somewhere that awaits his action for its

validity and realization. For instance, a grain-dealer in Chicago

sells 1,000 bushels of No. 2 wheat to a party in New York, and ships

the grain to that point by rail: two kinds of paper documents arise in

connection with this transaction, which are quite diverse in their

nature and course of operation: one is a _bill of lading_, that goes

along with the wheat, and gives the person named in the bill a

complete title to 1,000 bushels of wheat of a certain description, and

the holder of the bill takes the wheat and asks no favors of anybody;

and the other is a _bill of exchange_, drawn by the grain-dealer in

Chicago on the consignee of the wheat in New York, which bill of

exchange is sold at once by the creditor in Chicago to a banker there,

provided the banker has commercial confidence in the two names on the

bill and a sufficient motive in the shape of a discount for buying it:

thus the bill of lading has in it neither element of Credit, neither

Time nor Trust, while the bill of exchange has both of these elements

in it.

(3) Attention should be called to a third distinction of the same

general nature, as between relations very different in themselves and

yet extremely liable to be confounded with each other. Let us take a

common instance: a customer of a bank takes a package of valuables of

any kind to his banker, such as bonds and bills payable and jewels and

plate, and asks him to take care of it for the present in his vault,

subject of course to a return to him or any one else to his order at

any time: no property in these valuables passes over to the banker, it

is not a deposit in the ordinary banking sense, the relation of debtor

and creditor does not arise as between banker and depositor, the

banker becomes Trustee or Bailee of the package, and is bound to

exercise common vigilance in the care of it, but if it be burned or

stolen extraordinarily the loss is the customer's and not the

banker's. But now, on the other hand, when a customer deposits in the

banking sense money or bills payable with his banker, the property in

the money and bills passes over to the banker instantly, the relation

of debtor and creditor arises, the depositor receives a credit on the

banker's books in return for the money and bills rendered, the

exchange as a mere case of value is consummated to the profit of both

parties, but the return-service to the depositor is _the right to

demand equivalents of the banker at some future time_. In other words,

it is a case in Credit.

(4) As this general distinction is vital, we shall lose nothing in the

end if we make even a fourth exemplification of it. The United States

Treasury receives silver dollars of its own minting from any person

who chooses to place them there, and gives out in token what are

called "Silver certificates" to the same amount, entitling the bearer

to take out the dollars again at will, and thus the certificates being

more convenient than the dollars and just as valuable become a part of

the money of the country. The Treasury is bound to exercise due care

in the keeping of these silver coins, and to return them to the

holders of certificates on demand, just as the elevator and railroad

companies are under legal obligations to show diligence in keeping and

transporting the wheat of our former example; but the United States is

not _debtor_ to the holders of these certificates any more than the

elevator company is _debtor_ to the wheat shipper, and consequently

there is no element of Credit in these certificates. Just so of the

later gold certificate. On the other hand, the so-called greenbacks

issued by the United States are also a part of the money of the

country, but they are _credit_-money, inasmuch as they are a _promise_

to pay to the bearer some time in the future so many dollars. The

Treasury has never kept up any special fund of gold and silver, with

which to redeem the greenbacks. They rest back for their value on the

good faith of the country. The United States is _debtor_ to the

bearers, and these in turn are _creditors_, and the legal-tender

quality of the greenbacks does not alter their character as a form of

pure credit. Both the elements of good faith and future time inhere in

the greenbacks, as they do also in the bonds of the United States,

while in the certificates neither of these elements appears.

However, circumstances easily conceivable and which were actually

realized in the case of the famous Bank of Amsterdam, founded in 1609,

might make the United States a debtor and the holders of the silver

certificates creditors in the commercial sense of those terms. The

Directors of the Bank of Amsterdam, towards the close of the second

century of its beneficent existence, loaned out to the Dutch East

India Company and to the City of Amsterdam large parts of the bullion,

on which its certificates ("bank money") were based, unknown to the

public, which felt unlimited confidence in the bank, and the result

was in 1795, when the French invaded Holland and the facts became

known, that bank money which had previously borne a premium of 5% fell

at once to a discount of 16%, although the bullion that remained and

the debts due the Bank were fully equal to redeem the certificates and

were used for that purpose. So, if the United States should use,

clandestinely or otherwise, the silver dollars for other purposes than

to redeem the certificates on demand, the latter would undoubtedly

both in law and fact be transformed from mere token-money (as now)

into credit-money valid as against the United States as debtor, like

the greenbacks at present.

Have we now compassed our first object? Do we fully understand, from

the foregoing descriptions and distinctions, the _Nature_ of Credit?

If so, we are prepared to look narrowly into its _Forms_.

2. Credit-rights are commonly, but not always, recorded upon paper;

but it is important to observe, that the paper-document is the mere

evidence of the right, and not the right itself, which lies back of

the paper as substance to shadow, and persists intact even were the

paper lost or destroyed. These paper instruments of Credit are

commonly contemplated as of two kinds, Promises to pay and Orders to

pay, but there is not at bottom any radical difference between these,

the Right as between two persons is not affected by this superficial

difference, as we shall see, and the present enumeration of

credit-forms will proceed independently of it.

_a._ Book Accounts. A charge in a trader's books is both a current and

a legal evidence that the person charged has received a certain

service, and has virtually promised to render the sum charged as a

return-service. Book accounts are the most common of the forms of

credit; and if the person charged fails of his own accord to complete

the exchange thus commenced, the law, in the absence of any proof to

make the charge suspicious, collects it, if possible, and forcibly

completes the exchange. The convenience of this form of credit is so

great, that it is not likely ever to be disused; and as between people

who deal much with each other is very useful, inasmuch as their

respective book accounts are set against each other in settlement, and

only balances are required to be cancelled in money. It is for the

benefit of both creditors and debtors, however, even when the same

parties are both creditor and debtor, that such credits should be

short in time and such settlements frequent, since in book accounts

there is no interest on charges however long they run, and since in

this way only can the creditor realize the full gain of the exchange,

and the debtor keep fair his mercantile name. If it be difficult or

impossible to follow strictly the excellent financial maxim, "Pay as

you go," the next best thing to that is, "Go and pay." The gains of an

exchange are lessened, or its terms become more onerous, just in

proportion as delay in its completion is experienced or expected. Book

accounts are subject also to this disadvantage as compared with other

forms of credit, that their number and amount as against any person

are less likely to become publicly known, and therefore he is more

likely to be trusted in this form by others beyond the point of his

solvency and their safety.

_b._ Promissory Notes. These differ from Book accounts in that they

are always either expressly or virtually on interest, and are

consequently negotiable. They are issued by individuals, corporations,

and Nations. If the principal be deemed secure, that is, if there be a

thorough trust on the part of the holder in the maker of the note, the

time of the payment of the principal becomes a matter of comparative

indifference, because the interest is compensation for delay, and is

often the motive on the part of the holder for rendering that service

of which the note is evidence. Indeed a long obligation, other things

being equal, is commonly preferred to a short one, and bears a higher

price. When a note is sold (negotiated) by the original holder it

becomes payable to the purchaser, or to each subsequent purchaser in

turn, and thus may run a devious round, may play a part in many

commercial transactions, may be set off by the transient holder

against a debt owed by him and thus cancel that, and when itself is

cancelled by ultimate set-off or by any other mode of payment the last

holder takes the return for the service originally rendered by the

first holder. The promissory notes of individuals are frequently

discounted by Banks in a manner to be presently explained. These are

always for short times, and are debts bought by banks on the personal

security of the names upon the notes. The notes are founded on the

relation of debtor and creditor, which is always a personal relation,

and so differ in their nature from a _mortgage_, which is a qualified

_title_ to a specific piece of property, usually real estate. A note

secured by a mortgage is, as it were, absorbed into the mortgage, and

becomes another thing from a common promissory note, or _commercial

paper_, as it is called. A mortgage rests therefore on other grounds

than a commercial trust in the good faith of a _person_.

Corporations also issue promissory notes, and as such issuers become

in a sense _moral persons_ entitled to confidence according to the

character and purposes of the individual corporators and the financial

means and methods of the corporation itself. It is an old saying, that

"corporations have no souls"; economists as such have no need to

pronounce on that proposition; the fact is enough for them, that the

short notes of corporations are often discounted by bankers on the

same ground as the notes of individuals are discounted; and that their

long-time obligations, commonly called _Bonds_, are all the time

bought and sold in the market like commodities. Many of the Railroad

bonds, of which immense quantities are in the markets of the world,

rest back also for their security upon _Mortgages_ of the real estate

of the corporations made over to Trustees to hold for the assurance of

the holders of the bonds. The personal obligation of the corporators

is thus reinforced, much as a common mortgage reinforces the note or

bond, to secure which the mortgage is executed. Whenever _all_ the

real estate of a railroad company becomes subject to a mortgage, when

there are previous partial mortgages or liens, these latter take

precedence in due order of any subsequent pledges or bonds secured by

what is properly called the _consolidated mortgage_. Such a mortgage

has recently been executed by the Northern Pacific Railroad Company

for $160,000,000. Railroad Bonds so fortified in proper and legal

terms possess the highest possible credit-security to their holders.

When no such consolidated or "blanket" mortgage has been put on the

property, first and second and third mortgages sometimes support bonds

of primary and secondary and tertiary validity; and sometimes

so-called _Income-bonds_ are issued, with or without mortgages behind

them, for the payment of the interest on which bonds the net earnings

of the corporations are specifically pledged. Frequently also simple

long-time bonds resting on corporation security only are negotiated

without difficulty.

It must be constantly borne in mind, that certificates of Stock in

railroad and all other similar corporations are not credit-documents

at all, but are mere evidences of so much proportional _ownership_ in

the corporate property. They are not interest-bearing documents at

all, although they may draw interest or rather dividends, if the

property be prosperous. They are somewhat like deeds to land, in which

no element of credit inheres.

Nations too are moral persons in the same loose though binding sense

as corporations, and as such often issue promissory notes on interest,

commonly called in this country Bonds, in Great Britain Funds, and in

some countries Stocks. These are always pure credit. Nations give no

mortgages. Yet they often borrow at a less rate of interest than the

most solvent individuals or corporations can, as is seen by the fact,

that British consols carry but 3%, and yet bear a premium in the

present market. The term, "consols," is a popular contraction of

"consolidated annuities," the Act to create which at 3%, out of a then

confused mass of public debts at various rates of interest passed

Parliament in 1757. The maximum of the British debt was

$4,500,000,000 in 1815, and has now decreased to $3,467,787,960.

The United States also sold its bonds at 3% for a small premium in

1882. It had borrowed of its own citizens in 1862-65, both inclusive,

about $2,500,000,000 on its bonds at different rates of interest and

at different times of repayment: some of these bore gold interest at

6% annually, Government reserving the right to pay the principal in

five years and pledging itself to pay it twenty years from date, and

so these bonds were called "Five-twenties"; others bore gold interest

at 5%, becoming payable at ten and demandable at forty years, and so

were called "Ten-forties"; and still others bore greenback interest at

7-30/100%, the principal payable in greenbacks at three years, or

fundable in gold sixes, at the option of the holders, and these were

named "Seven-thirties." Over $90,000,000 of this last kind of bonds

were subscribed for by the American people in the course of a single

week in the spring of 1865. The whole of our national debt issued

prior to 1865 was made payable on a day certain; the so-called

"consols" of 1865 and 1867 and 1868 were payable _not more_ than forty

years from date; while all the bonds authorized from 1870 to 1882 were

Consols proper, whose peculiarity is, that they never fall due so as

to become a claim for the principal against the Government, but after

a day fixed or on a condition fixed are payable "at the pleasure of

the United States."[7]

The separate States of our Union, as sovereign in their own sphere

quite as much as the national Government is sovereign in its sphere,

have unlimited power to contract debts for State purposes through

their regularly constituted authorities; and consequently to issue

promissory notes or bonds to liquidate such debts. New York commenced

in this way in 1817 the magnificent enterprise of the Erie Canal, to

connect the great Lakes with the city of New York by an inland

water-way for commerce, and the completion of this in 1825 made the

State the "Empire State," and the city the undisputed commercial

metropolis of the Union. In a similar way Massachusetts undertook in

1862 the completion of the Hoosac Tunnel for a railway lengthwise of

the State; and although the process became unduly expensive, and great

abuses sprang up in connection with it, no one now questions that the

pecuniary and moral resources of the State have been augmented, on the

whole, by contracting the debt and providing by taxation for the

liquidation of both interest and principal. The credit of

Massachusetts, that is, the ability to borrow money at low rates of

interest, has been at times greater than that of the United States;

mainly because the State in 1862 and onwards refused to avail itself

of a depreciated national paper-money (greenbacks) made legal tender

for all debts, with which to pay the interest on its then existing

State debt, but persisted throughout (alone of the States) to pay that

interest so soon as due in gold coin. On the other hand, several of

the States of the Union at different times, and under more or less of

provocation and justification, have made a partial or entire

repudiation of certain portions of their public debts, justly damaging

to their individual credit, and even to the good name abroad of the

whole people of the United States.

Counties and cities and towns may also issue interest-bearing bonds

for public improvements, which have a _quasi_ governmental character,

but only under conditions and to a maximum amount prescribed by a law

of the State.

_c._ Bank Bills. These are a form of promissory notes not on interest,

and thus differ from the notes of ordinary corporations, and from the

bonds of nations and states and municipalities; but the issuing Bank

offers, as a sort of compensation for the privilege of circulating

notes not on interest, to convert them into coin, that is, to pay them

instantly on the demand of any holder. It is this proffered and

immediate convertibility into coin that enables the promissory notes

of a bank to circulate as money, while the notes of other corporations

and individuals equally solid and solvent do not circulate as money.

It must be borne in mind, however, that this offer to convert them

into the legal and ultimate coin-money does not essentially alter the

nature of Bank Bills; they are a form of commercial credit; and

although they are commonly issued against another form of such credit,

namely, against the interest-bearing promissory notes of individuals

and corporations who resort to the bank for discount, this only

complicates the exchange without changing its nature. It is a common

instance of exchanging one form of credit for another form which

happens to have a greater currency or validity than the first, and for

this superiority of the bank credit the individual credit pays an

interest, in other words, is discounted; and such exchanges of one

form of paper credit for another, with or without a premium, may go on

indefinitely; especially as _credit-money_ in the form of bank bills,

such paper may serve as a medium in many exchanges; but ultimately,

and before the entire series of transactions is closed, such bank

bills are to be redeemed in coin, or taken in by the banker in payment

of some debt due to him, in both which cases they are extinguished as

an instrument of Credit.

The Bank of England keeps out in circulation on the average

£25,000,000 in bank bills. It has been computed, that the average

length of life of a Bank of England bill between its issue and

redemption is about three days; and no bill once redeemed or received

back over the counters of the Bank is ever issued again. It is then

placed on file for record only. The joint-stock and private banks of

England and Wales circulate on the average rather more than £4,000,000

of bank bills of their own; and no bank bill of any kind is legal in

England and Wales of a less denomination than £5. The ten Scotch banks

and their branches keep out in bills about £5,000,000; six out of the

nine Irish banks and their branches issue on the average not far from

£10,000,000; but both the Scotch and Irish banks are allowed to put

out £1 bills.

Bank bills, as a form of paper credit not on interest, but ostensibly

redeemable in coin on demand of the holder, have been issued in the

United States by more parties and to a larger extent and with more

recklessness as to redemption than in any other country. Omitting all

reference to Colonial issues, and confining the outlook to the first

century under the Constitution, let us note, that when the present

national government went into operation in 1789, the "Bank of North

America" in Philadelphia and the "Bank of New York" in New York and

the "Bank of Massachusetts" in Boston had been opened for business,

and all three were State banks issuing bills convertible into coin,

though each confined its business mostly to the city in which it was

located. Two years later under the auspices of Alexander Hamilton,

then Secretary of the Treasury, the first "United States Bank" went

into operation at Philadelphia under a charter from Congress that was

to run twenty years with a capital stock of $10,000,000. At first no

bills were issued by this bank of a less denomination than $10; the

money was popular and was converted on demand; the Bank was

prosperous, and paid dividends to stockholders never falling below 8%

and frequently rising to 10% annually; as the time approached for the

charter to expire, the stockholders were anxious for a renewal of

their privileges; but the opposition to them in Congress was now

strong, owing mainly to the increase in the number of State banks from

3 to 88; and accordingly the recharter was defeated in the House by

one vote, and in the Senate also, by the casting vote of the

Vice-President, and the Bank was obliged to wind up its affairs in

1811.

Then came in a sort of mania for the creation of new State banks,

under the hope that these, now there was no National Bank, might

obtain the Custody and temporary use of the national funds, and

especially might furnish the country with paper money in the shape of

State bank bills. The number of banks went up to 246 in 1816. So many

bank bills were put out, and became so much distrusted, and so many

were presented for redemption, that the banks could not respond in

coin, and in the fall of 1814, there was a general stoppage of specie

payment in all the banks of the Country excepting those in New

England. General resumption of specie payment by the banks did not

take place till 1819. New York bank bills went down to 90%, those of

Philadelphia to 82%, those of Baltimore to 80%, and those of Pittsburg

to 75%.

Under these circumstances the Second Bank of the United States went

into operation in January, 1817, also with a charter to run twenty

years, with a capital stock of $35,000,000, of which the national

Government subscribed one-fifth. The new Bank helped indeed the State

banks to resume specie payments, as was a part of the purpose, but it

pushed its own bills into circulation with such eagerness, that it is

thought $100,000,000 of them were in the hands of the people, before

the first year was out. In this way the Bank fell into difficulties.

Its bills were distrusted. Coin came to bear a premium over them of

10%. President Jackson began his famous contest with the Bank seven

years before its charter was to expire, and took care that it went out

of being the same year that he went out of office, in 1837, namely.

The next year the State banks increased in number to 675, and

continued to increase till 1862, when there were over 1500 of them,

and when the issue of the "Greenbacks" by the national Government

interfered with what had been their exclusive issuing of the paper

money after 1837. In 1857, before the commercial panic of that year,

the aggregate of their bills stood at $214,000,000, the largest it

ever reached. These bills were nominally convertible into coin at the

will of the holders, but they were never actually so convertible for

any great length of time. The ratio of their volume to the specie

reserved to redeem it was always a very high ratio. For instance, the

average for the whole country in January, 1863, was 4:1; in Rhode

Island 12:1; and in Vermont 28:1. Such a paper money can be called

convertible only by a stretch of courtesy.

It was wisely determined by the People to abandon this loose form of

paper money, and in 1863 went into operation the present national

banking system, under which originally $300,000,000 of bank bills were

authorized to be issued in the aggregate, but this limit was extended

in 1870 to $354,000,000, and the Act of 1875 removed all restrictions

on the total amount, while there have always been restrictions on the

amount that can be issued by any _one_ bank in the system. By the law

of 1882, national banks may withdraw their bills by depositing lawful

money in the Treasury to take them up, and then take back the

proportionate amount of the bonds held for the security of the bills.

There were outstanding Dec. 26, 1883, $341,320,256 of these national

bank bills, but their volume declined under the law of 1882 to

$151,702,809 on Oct. 4, 1888. These bills were from the first

redeemable in greenbacks, which were themselves, however,

irredeemable in gold and silver till New Year's, 1879, since which

time till the present all the paper money of the United States of both

kinds has been convertible into coin at the will of the holder.

_d._ Bank Deposits. We are studying in order the forms of commercial

Credits, and we have now come to that one which is central in the

operations of Banking, and accordingly this is the place for us to

understand clearly what a Bank is, who a Banker is, and what are the

motives actuating at once the Banker and his Customers. A BANK IS AN

INSTITUTION FOR THE CREATION, MANAGEMENT, AND EXTINCTION OF CREDITS.

Money of any kind plays a very subordinate part in the general

operations of banks, which live and move and have their being in the

sphere of pure Credits. _Bankers are buyers and sellers of credits._

As merchants are dealers in commodities, so bankers are dealers in

credits, buying (1) some credits with other credits, (2) some credits

with money, and (3) money also with credits. Before unfolding these

three operations of bankers in their motives and profits, a glance

backward to the origin of banks would be a help to us in grasping

their nature and benefits.

The word "bank" meant originally a mass or pile or ridge of earth, as

we still say, a _sand-bank_, and the _banks_ of a river. When first

applied to commercial transactions, the word had a different meaning

from what it has at present, although the idea of _credit_ has inhered

in it from the first: in 1171, the Republic of Venice, being at war,

ordered a forced loan from its citizens, and promised to pay interest

on it at 5%; and certificates were issued for the sums paid in, and

public commissioners were appointed to manage the payment of the

interest and the transfers of the certificates, which were made

negotiable. The Italian word applied to such a public loan is _monte_,

but as the Germans were then strong in Italy, the German equivalent

word, _bank_, came to be used alongside of it and instead of it. It

meant this common contribution of the citizens to the wants of the

State, represented by the mass of the certificates, and came to be

applied also to the _place_ where the commissioners paid the interest

and transferred the shares. Two other such loans were contracted there

afterwards, and an English writer, in 1646, quoted by Macleod, speaks

of the "_three bankes of Venice_," meaning these three public debts,

including the evidences of them and the place where they were managed.

The Bank of England also was in its origin in 1694 an incorporation of

those persons willing to subscribe to a public loan in time of stress,

as "The Governer and Company of the Bank of England." The subscribers

to a loan of £1,200,000 became an association, or bank, on the

condition that the Government should pay interest to the lenders at 8%

annually, and also £4000 a year in addition for the management of the

bank, that is, of this debt of £1,200,000 which was the sole capital

stock of the new Company, which was authorized to issue an equivalent

amount of bank bills to circulate as money. The capital stock was of

no use, so far as redeeming these bills was concerned, the

stockholders must furnish other money for that purpose besides what

they have loaned to the State, but the ownership of so much of the

public debt divided among the shareholders, made the Bank respectable,

and tended to give public credit to its bills, which at first were

paid promptly in coin on demand, and thus the Bank, by increasing the

volume of money and by showing confidence in the stability of the

State, strengthened the revolutionary position of William and Mary,

and consequently the Whigs were the friends and the Jacobites the

enemies of the Bank. This function of issuing bills or promissory

notes designed to circulate as money, thus begun and still continued

by the Bank of England, is much less important in modern banking than

the other two functions of receiving Deposits and making Discounts,

but it was the function on which the turn began to be made from the

older to the newer modes of Banking. All that is needful to be said on

this tertiary or money-issuing function of Banks has been already

urged under the last head.

The two Banks of the United States in succession, as they were more or

less modelled after the Bank of England, gave the same prominence to

the function of issuing paper money, under the belief that government

bonds afford the best security for the redemption of bank bills, an

idea that underlies our present system of National Banks also; and,

moreover, those two great banks began to teach the people of the

United States something of the mysteries of _Deposit-banking_, the

point that we have now in hand. One-fifth of the capital stock of the

first Bank, $2,000,000 out of $10,000,000, was subscribed by the

national Government; and besides, the proceeds of the national taxes

as they were paid in were passed over to the Bank as _Deposits_, that

is to say, the Bank bought this money of the Government, paying for it

with a Credit; and then properly used the money as its own in paying

expenses and in discounting paper. Bank deposits do not belong to the

depositors, but to the bank; which has thus bought money with credit;

and when Andrew Jackson suddenly removed from the second Bank of the

United States the national moneys deposited there, and placed them "in

the custody," as he expressed it, of certain selected State banks,

these amounted at the moment to $10,000,000, and the discount line

resting in part on these deposits was at the time over $60,000,000, he

removed them under a strong misapprehension _of the nature of such

deposits_; and their _removal_ affected credit, and disarranged

business to a remarkable degree, and caused intense excitement all

over the Union. Depositing those national moneys with the Bank was a

_trade_ between the Government and the Bank for the time being. The

Government took in return for the moneys a Right to demand of the Bank

in future by cheque or otherwise sums at its convenience to the

aggregate of the sums deposited; the moneys became the property of the

Bank to be used at its discretion in its ordinary business; the

Government took its return-service for the moneys in a Credit, that

is, a right to draw out at its convenience in the future corresponding

sums; there was a commercial understanding in that case between the

Government and the Bank underlying the buying and selling involved in

the Deposit, as there always is between depositors and their banks;

the banks are always bound to order their business in such a way as to

be able to respond to every depositor's call for money, when it comes;

but banks in general find practically that a cash reserve of one-third

of their Deposits is ample to answer the current demands of their

depositors, and the remaining two-thirds may be safely used in

discounting short-time commercial paper to their own profit; Deposits,

accordingly, are not placed "in the custody" of the banks receiving

them; they are really bought by the banks of their customers, who

receive in return certain privileges and credits that they prefer to

the "custody" of their own moneys; and under these general motives on

both sides, there has grown up in all commercial countries an immense

line of Bank Deposits so-called, and perhaps we may say that the

principal function of banks at present is to buy these deposits with

their Credit, and then to handle them in further operations to the

convenience of their customers and to their own gain.

Under our present national banking system the Government is still a

depositor of public moneys in some of the banks designated as

"depositaries." At the close of the fiscal year, 1888, there were 290

of such depositary national banks, and the Treasurer held United

States bonds of the face value of $56,128,000 and the market value of

$68,668,182 in trust for these banks to secure public moneys lodged

with them. This system of national deposit with the banks began in

1864. The total held by the banks June 30, 1888, was $58,712,511, an

increase during the year of $35,395,633.

But our concern is especially with the Bank Deposits of individuals,

with their motives in making these, and with the motives and the

methods of the bankers in handling them. In order to draw the

confidence of the people in its locality, a bank must not only be, but

also _seem_ to be, well-to-do and prosperous. Most bankers find it to

their account to become known owners of public stocks; and in many

cases, as in the present national banks of this country, are required

by law to own such stocks, and this gives them a kind of credit and

public standing scarcely to be reached by the ownership of ordinary

property. Thus the Bank of England held at the outset £1,200,000, and

now holds £15,000,000 of securities, mostly of the public debt of

England. As merchants begin by laying in stocks of goods of the kinds

they purpose to deal in and offering them for sale, so bankers begin

by bringing together money and credits of their own in order to

attract to themselves in the way of buying and selling the money and

credits of other people. In order to deal successfully in credits the

banker must have _credit_, that is, he must have the reputation of

having property of his own, and of being an honest and careful manager

of his own affairs and of the affairs of others so far as they are

intrusted to him. Each of our present national banks, now (1890) 3150

in number, must have by law a paid-up capital of not less than

$100,000, and in cities of 50,000 people their capital must not be

less than $200,000 each, except that in places having less than 6000

inhabitants banks with not less than $50,000 capital _may be_

organized at the discretion of the Secretary of the Treasury. The main

purpose of all this is to secure strong financial organizations fitted

to draw the confidence of the communities in which they are placed,

and in this manner and by means also of constant national supervision

to attract the Deposits of the people to the banks.

Now, as was said a little while ago, perhaps the central function in

banking is for the banker to receive his customer's money and also his

credits falling due, and to render to him in return for these _a

credit_, that is, a right to demand from himself an equal sum at a

future time or times. The evidence of this right is entered on the

banker's books, and usually too on the customer's passbook, and thus

becomes what is called a DEPOSIT. The ownership of the money and of

the credits deposited passes over completely from the customer to the

banker. It is a complete case of buying and selling to the mutual

profit of the parties. The banker has the right to do just what he

pleases with his deposits, and the customer has a right to draw

cheques on his credit as and when he pleases; only the banker's entry

of the transaction on his books is a virtual and a legal _promise_ to

pay that amount to his customer, and therefore he must be ready to

respond to his customer's call, whenever the latter demands, not his

own money, but so much of his banker's money. _A deposit, accordingly,

is not the very thing deposited, but a credit._ It is the banker's

promise and the depositor's property. It is in this way that a banker

buys ready money with a credit.

The motive, then, that leads the depositor to intrust his money to the

banker is the desire, not to have that specific money kept safely for

him, for he lost possession of it absolutely when it passed the

counter, he _sold_ it and took his pay in something else, but rather

to have the unquestioned right to call on the banker for such sums

(not to exceed the deposit in the aggregate) and at such times as may

suit his own convenience. He has such confidence in the integrity and

solvency of the banker, finds it so practically convenient to have

dealings with him, and comes to have certain minor privileges at the

bank in other relations over non-depositors, that he quite prefers a

credit on the banker to the possession of the money itself.

The corresponding motive of the banker to receive his customer's funds

on these terms is that he finds by experience (his own and others'),

that he can safely use a large portion of these moneys deposited in

other operations in credit profitable to himself, and at the same time

be practically sure of meeting all his customer's calls for money as

they are made. Every good banker finds out, that many of his customers

wish always to leave a balance in his hands; that while some of them

are constantly drawing cheques on him for cash, others of them are as

constantly depositing with him in cash; and that consequently he can

properly and safely use a large part of the money he has purchased

with his credit to purchase other credits with. Deposit-banking,

therefore, is not only convenient and profitable for the depositor,

but also excellent and profitable for the banker.

Besides these two parties benefited, there is a gain, too, for the

community at large in deposit-banking; inasmuch as a new capital as

such has been thereby created, a series of new values, which would not

otherwise have existed at all. Were there no deposit-bank in that

locality, every man now a customer of it would of course keep his own

reserves for himself for prospective contingencies: now, all these

little reserves are aggregated in the bank, the convenience of them

for each customer's contingencies is just as great as if he kept his

own in his own safe or wallet, but the banker finds that he can use,

say two-thirds of the whole, and still answer each customer's call.

Here is a new capital. Here are scattered valuables brought together

to be loaned out to a profit, which were otherwise barren and useless

for the time being. Industry is quickened in a wide circle, products

are created and brought to market, wages are paid and profits are

gained, in direct consequence of bringing together under favorable

auspices for safe loaning the little hoards and driblets of many

individuals, which were practically useless in isolated hands.

It may easily be objected at this point, that it is entirely possible

that any banker might be called upon to pay off all his

deposit-liabilities at once in money, which, if it happened, would

break him of course; so it is abstractly possible that all the lives

insured in a Life Insurance Company might terminate in one day, in

which case no Company in the world could meet its obligations; and so

it is abstractly possible that all the houses insured in a Fire

Insurance Company might be burned up in a single night, which, if it

happened, would cause the collapse of the soundest company; but in all

these cases of possibility there is a _certainty_ that the possibility

will not become a fact. _Ex nihilo nihil fit._ A supposition

practically impossible to become a fact can yield no logical inference

whatever. The Greek language has a special grammatical form for a

hypothesis impossible to be realized in fact: would that the English

had also such a form of speech! It would save us a mess of bad

reasoning. If, however, any banker may have misjudged for his locality

at any time the proper ratio of reserves kept to deposits received,

and be crowded in consequence, he must sell some of the securities

bought with the excess, or borrow money on them.

Surprisingly large is the amount of bank deposits in all the leading

commercial nations of the world. The average public and private

deposits of the Bank of England, on which no current interest is paid

by the Bank, amounts to about £40,000,000 all the time. The ten

joint-stock banks of London carry about £80,000,000 in private

deposits, of which those to remain some time _draw_ an interest, but

those lodged on current accounts and on call _draw_ none. Scotland has

carried deposit-banking further and to greater advantage than any

other country in the world. There are now no private banks in

Scotland, but the ten joint-stock banks with their numerous branches

scattered to every village in the land hold constantly about

£70,000,000 as individual deposits, on which current interest is

allowed, and so the habit of keeping one's account with a banker has

become universal with the people. No one thinks of keeping money to

any amount in his house or about his person, and consequently

house-breaking and highway robbery have almost ceased. Bankers even

attend all the great fairs in the country to receive deposits and to

pay off cheques. Credit in this form and in another form soon to be

described treads its utmost verge in Scotland. Although in the United

States the custom of keeping deposits with bankers and drawing cheques

against them has not gone nearly so far as in Scotland, and not nearly

so far as it will go in the immediate future, yet the aggregate of

individual deposits in the national banks alone, Oct. 4, 1888, was

$1,350,320,861, an increase in just seven years of 26%.

_e._ Bank Discounts. The credits that are discounted by bankers may be

either the promissory notes of individuals and corporations already

characterized, or the Bills of Exchange soon to be characterized, but

the entire function of discount is so peculiar, that the paper

subjected to it ought to be enumerated in a classification of the

instruments of Credit. The discounting of commercial paper is the

second essential function of banking, as the buying and handling of

deposits is the first; and it is more in accordance with genuine

_banking_ to pass the price of the paper discounted to the seller's

credit in the form of a deposit, that is, to buy one credit by

creating another, than to pay the money over the counter at once, and

thus to buy credits with money. Those who do the latter are called

_bill-discounters_ rather than bankers, but most of our bankers do

both, though there is a tendency towards the separation of the two in

this country also.

Manufacturers and wholesale merchants usually sell their goods _on

time_, as it is called, say three or six months. Debts are thus

created, or to say the same thing in other words, Credits are thus

given. The manufacturer or wholesaler is creditor and the jobber or

retailer is debtor. But a debt is property; and the creditor in this

case wishes to avail himself of his property at once for further

production; so he either takes a Promissory Note from his debtor, or

draws a Bill of Exchange upon him, and this piece of property is ready

for sale. Neither piece mentions _interest_ expressly, but the face

sum virtually covers it as contemplating discount. Banks have been

organized for the express purpose of buying for their own profit and

for the convenience of business such pieces of property; some banker,

accordingly, buys this particular piece, that is to say, this creditor

passes over to this banker the commercial right to demand payment from

this debtor at the end of three months, and receives in return from

the banker either money direct or so much of the banker's credit, that

is, a deposit in favor of the creditor on the banker's books. For

furnishing this creditor either with ready money or a more available

credit in lieu of his mercantile paper, the banker charges of course

_a percentage_. This is _Discount_. _Discount is the difference

between the face and the price of the paper._ This percentage called

discount is the chief source of profit in ordinary banking. It is

virtually compound interest on the sum advanced till the maturity of

the paper, when the banker realizes from the debtor its full face.

The following is a common form of a bankable note:--

$1,000 WILLIAMSTOWN, Mass., Nov. 10, 1889.

Three months after date I promise to pay to the order of

JOSHUA SWAN, one thousand dollars, payable at the

Williamstown National Bank, value received.

Due Feb. 10/13. LEANDER ALLEN.

When Swan has put his name on the back of this note, that is in bank

phrase, has _indorsed_ it, in token that he thereby at once sells and

guarantees it to the bank, it is then discounted on the strength of

the two _names_, Allen and Swan. As Allen technically takes the

advance from the bank for his own benefit, he is technically expected

to take up the note when it matures, and if he do not, the bank falls

back on Swan, who is equally bound with Allen to see that it is paid

at the proper time. Two names are nearly always, not always, requisite

to a note acceptable for discount at a bank; and more names merely

strengthen the note, since it is discounted on the combined validity

of all the names upon it.

One obvious advantage of discount is, that it tends to make all

capital active and thus productive. It enables the banks to sell their

credit and make a gain, to use a part of their money deposits to buy

mercantile paper with, and so get a bank interest on them; it enables

dealers in commodities to realize in cash _minus_ the discount the

sum of what they have sold _on time_; and by means of _accommodation_

notes or bills, which only differ from the others in that there is no

_actual_ debt between the parties, business men may swell the volume

of their business temporarily, and non-business people may borrow

small sums for convenience or emergencies. Bankers have not always

credit enough or money enough from their depositors to buy in either

mode all the good paper that is offered to them, in which case, they

raise the rate of discount unless the law forbids, or by easy evasions

even when the law forbids; or else accommodate regular customers and

large depositors first, or buy of all that are "good" a certain

proportion only.

The discount line of 3140 national banks reporting Oct. 4, 1888, was

$1,674,886,285.29.

It is thus through the purchase of discountable notes for money, that

banks derive their partial character as money-lenders. Also, such

reserve sums as they do not wish to invest in negotiable paper, on

account of the time involved before such paper matures, banks

frequently loan _on call_ to those customers who have good collateral

securities to pledge for the repayment of such loans. The terms of

such a contract give the bank full authority to sell such collateral

"_at the Brokers' Board or at public or private sale, or otherwise at

said bank's option, on the non-performance of this promise, and

without notice_." So far forth banks become direct money-lenders. It

ought also to be added, that promissory notes with a single name (or

more) are often discounted by banks partly on the strength of

collateral securities deposited to fortify the names upon the notes.

_f._ Bills of Exchange. A Bill of Exchange is a written instrument

designed to secure the payment of a distant debt without the

transmission of money, being in effect a setting-off or exchange of

one debt against another. It is in form and in several technicalities

different from a promissory note, inasmuch as it is an _order to pay_

instead of a _promise to pay_, and inasmuch as the maker of a note is

always _debtor_ and the drawer of a bill of exchange is always

_creditor_; but all this makes practically very little difference

between the two as instruments of Credit, since nearly all bills of

exchange come into banks in the way of ordinary business, either for

discount or collection, and as the banks care nothing except for

_names_, the _form_ of the purchasable paper is a matter of

indifference to them. The following is the essential form of an inland

bill of exchange:--

$3,000 PITTSFIELD, Mass., Oct. 16, 1889.

Four months after date pay to the order of JOHN KENT three

thousand dollars, value received, and charge the same to

account of

To ELI TRIPP, Boston, Mass. DAN STORRS.

In the case of this bill, which may serve as a sample of thousands,

Storrs is the _drawer_, who is creditor in relation to Tripp, and

Tripp is _drawee_, but Storrs is debtor in relation to Kent, who is

the _payee_. A bill of exchange is the sale of a debt, in such a way

that two debts are so far forth set off against each other, and both

transactions are closed without sending any money at all. Tripp owes

Storrs, and Storrs owes Kent, and so Storrs pays Kent by an order on

Tripp. As this is a bill at four months, Kent will doubtless send it

to Tripp for his _acceptance_, as it is called, that is, his

acknowledgment that he owes Storrs to that amount, and that he will

pay the sum to the holder of the bill when it becomes due. An

acceptance is written on the _face_ of a bill, and an indorsement upon

the _back_ of the note: the initials are sufficient for the name of

an acceptor, but the full business name is usual for an indorser.

Thus a bill of exchange is the formal sale of a debt, in order to

liquidate thereby another debt, when the parties to the transaction

live in different and distant places. Storrs does business in

Pittsfield, and Tripp in Boston, and it is a matter of comparative

indifference where Kent lives, unless there is trouble at the time of

collection, for he will perhaps negotiate this bill again, that is,

make use of it to pay some debt that he himself owes. It is not often

that the same person, as Tripp, happens to owe another person in a

distant town, as Storrs, the same amount as Storrs owes another person

somewhere, as Kent; but by two bills of exchange, one drawn by each

creditor on his own debtor, and then each set off against the other,

through the simple and beautiful expedient of bank balances,

substantially the same advantages are reached as if it always happened

so. Many bills of exchange are drawn _at sight_, as it is called, in

which case the payee presents it for payment to the drawee, there is

no acceptance and no discount, and a bill of this kind becomes the

same as a cheque.

Time bills, however, are usually discounted: the payee indorses his

claim over to a fourth party by name, or, by what is called an

indorsement _in blank_, that is, by merely writing his own name on the

back of the bill, makes it payable to bearer: when banks buy these

bills for discount, it is on the joint credit of acceptor and drawer

and payee, and in that order of validity and precedence: a promissory

note may be protested by a bank without notice to the maker, but a

bill of exchange cannot be without notice to the drawer: a promissory

note has two parties to it, a debtor and a creditor; while a bill of

exchange has three parties to it, two creditors and a debtor.

Inland bills of exchange, both time bills and sight bills, are very

convenient in settling debts between distant places without the

costly, and more or less hazardous, transmission of money back and

forth; besides this, time bills possess the very useful function of

enabling a debt due from one person to avail the creditor as a means

of obtaining credit from a third party in discount; and in addition to

these two points of benefit, it is plain, that the common use of bills

of exchange in all their forms releases from use large amounts of

money that would else be needful in trade. The less money in use in

any country beyond a certain point, the better, because, if coin, it

costs much to mint and maintain it, and if paper, it is difficult to

make and sustain it of full value.

Bankers sometimes change what they call "exchange" for settling debts

between distant places in the same country; in some cases there may be

a sound reason for this, in other cases there is none, but in all

cases it adds a little to the profits of the banks for handling the

bills of exchange; the principle of charging an "exchange" is

this,--when one place as Chicago draws more bills on another place as

New York than suffice to cancel the bills drawn at that time by New

York on Chicago, the point _at_ which the larger indebtedness lies is

the point for sending drafts _to_ which banks naturally charge a

percentage; perhaps the idea, which is actually realized in foreign

exchange, that money may have to be sent to liquidate such a balance,

may have brought in the custom of charging "exchange" in such cases;

and there are instances aside from such a supposed balance, in which

there may be an extra cost of collection in some form to the bank,

that may justify an "exchange" charge; but there is another principle

counterworking and often neutralizing entirely this alleged doctrine

of a "balance" of debt as between two distant places, namely, that the

chief settling place and commercial centre of a country, such as New

York is, draws towards itself from the whole circuit with such force,

everybody wanting a balance there and having occasion to send funds

thither, that drafts on such a place are apt to bear a premium without

any reference to its comparative indebtedness at the time.

Very similar to these inland bills in their nature and course and

usefulness are Foreign Bills of Exchange, which, as a vastly important

topic, especially in its relations with Foreign Trade, we must now

study minutely and completely. Commercial relations between two

countries, let us say, for instance, France and England, always give

rise to a mutual indebtedness of their merchants; if these reciprocal

debts were all to be paid by the actual sending of money to and from,

there would have to be a constant and expensive and more or less

hazardous outward and inward flow of the precious metals in respect to

each country; all which necessity is neatly obviated by the use of

reciprocal bills of exchange, and coin is only transmitted to settle

the balances on whichever side there may happen an excess of debt at

the time. French dealers are always sending goods to England, and

English dealers goods to France; and for what they send to England the

French merchants draw bills of exchange on the parties to whom the

goods are consigned, and the English merchants draw similar bills on

their debtors in France; then these bills are bought up by bankers or

brokers in either country, and virtually exposed again for sale

through new bills drawn against them to any parties who may have debts

to pay in the other country. Thus bills on London, in other words, on

English debtors, are always for sale in France; and bills on France,

that is, on French debtors, are always for sale in London; the

reciprocal debtors of the two countries, therefore, instead of sending

coin to cancel their debts, buy and transmit these bills.

Let us take a sample instance. Pierre & Co. of Paris send a cargo of

wine worth £1000 in English money to John Barclay of London. Barclay

thus becomes indebted to the Paris firm to that amount, and Pierre &

Co. draw at once, so soon as the cargo is despatched, a bill in francs

to the equivalent of £1000. If they themselves have no debt to pay in

London, they will sell this bill immediately to a Paris banker or

broker (if the exchange be then at par) for its full face _minus_

interest for the time it has to run, say two months; this broker is

now ready to sell this bill again, or what is the same, his own bill

drawn on the strength of it, to anybody in Paris who may have a debt

to pay in London; and the party in London who receives it in

liquidation of a French debt to him, presents it at maturity to John

Barclay for payment. Thus one bill of exchange serves the ends of two

creditors and one debtor: Pierre & Co. get their pay for the wine, the

London party gets his pay for goods, and Barclay pays his debt, by

means of it. A bill drawn in London for a cargo of hardware sent to

Paris is similarly negotiated with a London broker or banker, and

finds its way similarly to France in payment of some English debt owed

there, and ends its course when it reaches the French firm on which it

was originally drawn.

We are now in position to understand clearly what is meant by the _par

of Exchange_ in its commercial (not coinage) import. The merchants in

Paris, who have debts due to them from London, draw bills of exchange

for the amount of these debts; and, through the agency of middlemen,

go into the market to sell these bills to other Paris dealers who have

debts to pay in London. If the former class have a larger amount to

sell than the latter have occasion to buy, in other words, if there be

a larger amount of debts due from London to Paris than from Paris to

London, then the natural competition of the sellers in Paris of the

bills on London will lower their price somewhat in that market

(Paris), in order, as usual, that the Supply and Demand may be

equalized there. In this case the par of exchange is disturbed, a bill

on London for £100 in francs may not sell for over £99, and the

exchange is then said to be 1% _against_ London, or, which is the same

thing, 1% _in favor_ of Paris.

The _par of Exchange_, accordingly, between two countries, depends on

the substantial equality of their commercial debts. In the above

example, if the exchange as against London in favor of Paris continue

long, and especially if the premium of 1% on bills drawn in London on

Paris be sufficient to cover the expense of the transmission of specie

from London to Paris, gold will begin to flow from London to Paris,

because the debtors there may find it cheaper for themselves to buy

and send gold than to pay the high premium on bills; and thus the

equilibrium of payments and the commercial par may be restored. Also,

this par tends to restore itself, without any sending of specie, in

this other perfectly natural and effectual way: if bills on Paris are

at a premium in London, for the same reason that they are so will

bills on London be at a discount in Paris; therefore, there will be a

direct encouragement to the extent of the premium for _exportation_ of

goods from England to France, because on every cargo thus sent bills

can be drawn and sold in London for a premium; while the more bills on

Paris thus offered in London, the more the premium disappears of

course, and the par will be restored so soon as the bills on Paris

substantially equal the bills on London offered in Paris; and at the

same time, so long as the discount on London bills continues in Paris,

there is a direct _discouragement_ to further exportations from France

to England, because the bills drawn in virtue of such cargoes can

only be sold below par, and this too tends to _restore_ the par in the

commercial sense of the term.

Here is another instance of a magnificently comprehensive law, by

which Nature vindicates her right to reign in the domain of Exchange.

It is through this natural and beneficent law of automatic

compensations, stimulating exportations on the one side and slackening

them on the other, that most of the casual disturbances of the

commercial par as between two countries are easily and perfectly

rectified.

While this great law is in full possession of our minds, let us note

in passing how artificial restrictions by one country on the

importation of goods from another, commonly called "Protectionism,"

affects this commercial par as between those two countries. Besides

stopping absolutely a mass of otherwise profitable exportations and

importations for both countries, it makes less profitable to the

country imposing the restrictions whatever foreign trade _does take

place_ between them in spite of the restrictions. Suppose England, as

is the fact, opens her ports freely to the commodities of France,

while France puts restrictions in the shape of heavy taxes upon

importations from England; more French goods are likely under these

circumstances to seek English ports than English goods to seek French

ports, because they are more welcome; consequently, more bills of

exchange drawn on London will naturally be offered in Paris than bills

on Paris in London, and will so far forth be sold at a discount, while

the London bills drawn on Paris will be sold at a premium; in other

words, the comparatively few goods that do get out of a "protected"

country, realize less to their owners than the natural value, because

the bills drawn on them are extremely apt to be sold below par! With

this course of things all known facts agree. Since the United States

became conspicuously a "protected" country a quarter of a century ago,

it has been at rare intervals and for short periods that bills drawn

here on London have been at par. They have been usually much below

par. The equivalent of £1 sterling in United States money is $4.8665;

and when bills on London sell for less per pound sterling than $4.86,

they are at a discount in New York or Boston; and exporters here are

direct losers to the extent of the discount.

If, however, notwithstanding the beautiful action of this great law of

commerce, the disturbance in the commercial par as between two

countries continues obstinate, it indicates one of several things as

true of the country, whose bills of exchange drawn on another persist

in a considerable discount; (1) it has come to be a pretty steady

debtor country as towards the other, by sending thither its national

or State or corporation bonds, whose interest and ultimately principal

also must sooner or later be remitted in exports _extra_ to the

exports needed to pay for the current imports of goods; (2) it has

either naturally or by persistence in a bad public policy little or no

shipping of its own, so that freights both ways have to be paid to

foreigners in the form of exported goods _extra_ to those exported to

pay for those imported in transient trade, which of course increases

the number and face of the bills drawn _in_ the luckless country _on_

the lucky country or countries; (3) it has made the vast and fatal

mistake of excluding by legal barriers of taxes put on for that

purpose the goods of foreigners, whose only motive in coming is to

take off corresponding goods of the deluded country's own to the

profit of both, and so these last-mentioned goods must seek a foreign

market (if at all) at reduced rates, their natural market having been

destroyed by national law; and (4) it may have made the national money

in which the bills drawn on it are liable to be paid an inferior

money, either transiently by mere abundance or permanently by worsened

quality, which is well illustrated in the instance of Amsterdam as

cited in a preceding chapter, and which can only be remedied by

raising the standard of the money to the level of the best.

Very little, if anything, can be inferred as to the prosperity of a

country or even as to the real condition of its "exchanges" in this

technical sense of the term, by the transient movements of gold to and

from the commercial countries, in their present complex relations as

gold-producing and non-gold-producing countries and as debt-settling

and non-debt-settling centres. Gold moves back and forth in obedience

to several other impulses than to settle the balances in an

international trade of Commodities. Gold-producing countries of course

export gold just as they would any other native product. If for any

reason gold becomes relatively more abundant in one country than in

other commercial countries around it, general prices will rise in that

country in consequence; which means, that gold is then and there the

cheapest article that the people of that country can export to pay

their commercial debts with. Also, the imports which a nation pays for

in gold, or in bills of exchange bought above par, are often bought

with a high profit. Creditor nations, nations that have managed to

make themselves settling-places for the world's commercial debts, and

nations that welcome imports without impediment from every quarter of

the earth (and England may serve as a sample for all these three),

will largely pay for imports in gold or in bills bearing a premium.

It is a thousand pities, that technical terms which are quite

misleading unless one remembers their origin and exact significance,

have come to be intrenched in commercial language too strongly to be

dislodged at this late day, as the common terms to express the state

of the "exchanges" as between two countries. These terms are

"_against_" and "_in favor of_." The old Mercantile system, which has

left other unsavory progeny behind it besides this, in order to keep

and heap gold and silver in a country, encouraged exports in every way

and discouraged imports, in order that the "_balance of trade_," as

the phrase ran, that is, the difference in volume between exports and

imports, might come back to the country in gold and silver; and this

foolish and now thoroughly exploded notion gave rise to the terms in

question; exchanges were then said to be "against" a country when the

record seemed to show more imports than exports, as if that implied

that the imports were too great for a "balance" in gold and silver;

and were said to be "in favor of" a country when its export-line was

greater than the line of imports, as implying a favorable balance to

be met by a specie-import in future. The false "System" is gone

forever, but the "terms" still abide in commercial language, and

confuse the minds more or less (more rather than less) of everybody

who tries to make these terms a vehicle of thought. We have now

described the causes and courses of international bills of exchange

without resorting to these technicalities, which imply movements of

gold and silver which do not actually take place under the conditions

supposed; for example, the exchanges were "in favor" of the United

States in 1874-77, there being an apparent trade balance of

$164,000,000 in 1877 and a still larger in 1876 and a larger one in

the two years preceding, but the import of specie was small in all

those years, averaging about $25,000,000 a year, and the rest of the

excess of exports went to pay interest due to foreigners, freights on

the cargoes both ways, and so on. It is difficult to use without

abusing the terms "against" and "in favor of" in this connection, and

the reader is cautioned not to employ them; although "discount" and

"premium" on international bills of exchange are matters extremely

important to observe and to know the grounds of. Were there no

counterworking principle, bills of exchange drawn _on_ capitalist and

creditor countries, like Great Britain, whose imports are apt to be

strongly in excess of the exports, and whose public policy is wise

enough to put no obstacles in the way of the free receipt of imports,

would be at a _discount_ in countries sending exports thither.

This counterworking principle, already illustrated as to inland

exchange in the case of New York, is best seen internationally in

connection with London, which is the settling-place of the world's

commerce. When the Romans dredged the Thames and made "the pool" just

below London Bridge, they took the first steps towards making that

town a commercial centre; since a market for products is products in

market, the busy exchange of commodities there has quickened in every

age the accumulation of capital and the increase of population;

previous to the Dock Laborers' Strike in 1889, about 100 vessels

entered the port of London every day, which received about one-half of

the total customs revenue of the United Kingdom, and sent out about

one-fourth of its exports; the business of out-of-the-way and

semi-civilized countries has somehow (and it would not be hard to tell

why) centered in London, as well as the business of originally British

Colonies everywhere and of all other commercial countries;

accordingly, debtors and creditors abound there, bills of exchange

concentre there, and debts due from everywhere are payable _there_;

and therefore, because bills on London are good all over the world,

the Demand for them counterworks the natural cheapness of the bills

drawn on exports _thither_ as compared with the natural dearness of

the bills drawn there on exports _thence_.

Another thing must be borne in mind in comparing the merchandise

accounts of any country, namely, that whenever the "exchange" is

sufficient to cover the cost and risk of the transmission of gold,

gold itself is likely to go freely from the country, in which bills

drawn on exports are at a premium, or to use for once the old

hazardous phrase, "_against_" which the exchanges have turned, and

bills will be drawn on that gold, as upon common merchandise, and sold

of course for the sake of the premium; or, if a decidedly higher rate

of discount prevail in a neighboring country, gold will naturally go

thither from the lower-rate lands, because lenders in the latter will

desire to realize the higher rate of current interest on money, and

bills will be drawn on this gold as well, which will tend to lower the

premium on bills there; unless, then, the premium _and_ the difference

in interest abroad will justify the speculation, the gold will not

stir; although, if the difference in interest abroad were very

considerable and promised to continue for some time, the bills on the

gold might sell at a discount and still leave a profit to the senders;

but the home bankers can always stop a drain of gold of this kind by

raising their own rates of discount.

This casual mention of bankers leads on to the weighty point, that the

whole business of foreign exchange is falling more and more into the

hands of the bankers, because bills drawn _by_ and _upon_ well-known

bankers naturally have a better credit than ordinary commercial bills,

the names upon which are less widely and favorably known. Accordingly,

persons sending cargoes of cotton, say, or of any other valuables,

from New York to Liverpool, arrange with their bankers in New York to

have the proceeds of the cargoes put to the _bankers'_ credit in

London, and then these bankers draw bills on the London bankers, which

will bring a higher price in New York than a common commercial bill,

because many remitters and most travellers prefer bankers' bills,

which, though they cost more, pay better and buy better abroad.

Commercial bills are still bought and sold in every commercial town,

but bankers' bills are more and more taking their place; and the

quotations usually give the current price of each.

London is so prominent as the settling-place of the world's

transactions by means of bills drawn on and by London bankers, partly

on account of the commercial predominance of England, partly from

excellent banking customs there, and mainly because an immense mass of

cheap loanable capital exists there, which even foreigners may borrow

at London rates, provided only that they can get credit there, that

is, leave to draw on a London banker, to whom of course remittances

must be made as fast as he accepts their bills. Besides, the Bank of

England, as the principal bank in Great Britain, and as closely

connected with the Government, acts as a bank of support to the public

and private Credit of that country. It does a regular business as a

bank of deposits and discounts, but it means to keep its rate of

discount somewhat above the rate demanded by the other bankers in

London, so as not to come into competition with them much in their

ordinary business, and be able to act as a bank of support to them and

all others in times of pressure. All banks have about so much credit

to sell, _and no more_; most banks sell in ordinary times about all

the credit they have, because their profits depend on that; but if the

Bank of England did this, it would become useless in periods of panic.

In point of fact, that Bank just begins to sell its reserve credit,

when the credit of the bankers below is exhausted. When they are at

the _end_ of their rope, there is generally an abundance of slack rope

still in the great Institution above.