a deposit liability into a note liability and finding itself in exactly the same position after the transaction as before.

VII. Reserves against Notes.

Most modern banking systems have found, however, that the note liability was likely to be much more widely diffused than the deposit liability where smaller amounts were involved. In other words, they have found that note-holders were more numerous and less able to protect themselves than deposit-holders. The conclusion has been widely drawn that the government owed a special obligation to noteholders to protect them against loss by limiting very strictly the issue of notes. Such limitation has been brought about in many countries by the establishment of a maximum figure beyond which issues should not expand; or by providing that no notes be issued except as the result of discounting paper of particular kinds-that is to say, representing particular kinds of transactions.

Practically all banking systems have, of late yearseither independently or in conjunction with some of the safeguards mentioned above-required the holding of large reserves of coin against outstanding currency or notes. The amounts of reserves so held vary a good deal. Federal Reserve Banks are required to hold 40 per cent of the amount of their notes in gold; and in some European systems, before the World War, the proportion of gold behind notes ran as high as 60 to 70 per cent. As a result of the policy, inaugurated in England in 1844, of allowing no issues of notes to take place without an equal amount of gold behind them (except for a small initial issue of about £18,000,000 Sterling protected by Government bonds), the pre-war percentage of reserves was quite close to 100 per cent. Experience shows that in normal times a very high cash reserve against notes is not likely to be needed, since the quantity of them that come in for conversion into cash is small. Nevertheless, sound banking dictates the maintenance of a high cash-holding in order that there may be no question of the ability of the bank to redeem upon request.

VIII. Profit in Notes.

A great deal is often said about the profitableness of the note currency privilege. It is pointed out that if a customer A comes to a bank, hands in his obligation for $1,000 which is discounted and placed to his credit, and goes away with $1,000 in bank notes which he then pays out to his creditors (who in turn pay them out to others) so that they remain in circulation and do not return to the bank-that institution is getting what is called a double profit. That is to say, it is receiving (we may suppose) 6 per cent on the $1,000 obligation while at the same time it has lost no "money" since it has given nothing in exchange for the obligation except its own notes which have been retained in circulation. It can, if it chooses, sell the $1,000 obligation at a profit and thus "make money" by the simple expedient of being allowed to keep notes out in circulation.

However, it takes only a slightly different analysis to show that what the bank is allowed to do here is little else than what it is allowed to do when it takes funds on deposit. The bank earns profits by reason of the fact that it receives interest but does not pay it, at least not in the same proportion. It may fairly be said, therefore, that there is no special field of profit in bank note issue except to the extent that, by reason of its power to issue notes, the bank may be able to keep its credit obligations outstanding longer (not being called upon to redeem them) than it otherwise could. Where the notes are allowed to go out in very small denominations, so that they actually take the place of currency or money and remain in circulation indefinitely, they do attain a longer life than any other kind of credit, and hence are proportionately profitable to the issuer.

IX. Notes in the United States.

The United States has had a long and checkered experience with note issues. Before the Civil War the federal government and the several states allowed great freedom in

the issue of notes by small independent banks that were locally chartered. Then came the national banking system, established during the years just prior to 1865, which introduced uniform currency secured by a deposit of government bonds with the Treasurer of the United States, and by a supplementary act (1866) made it practically impossible for any state-chartered bank to issue notes because of the imposition of a tax upon transfers in which such state banks figured. Eventually the national currency became the only paper medium, but it was soon obliged to share its place with gold and silver certificates which were practically warehouse receipts issued to represent gold and silver in the Treasury Department. The greenbacks or legal-tender Treasury notes of the Civil War -issued by the Government to raise war funds—had antedated the national-bank notes by a year or more and survived with it. Still later, as the result of the government's silver-purchase experiment in 1890, the so-called Treasury notes of 1890 (issued by the government in payment for silver purchased by it) came into existence.

In 1913 the Federal Reserve System was established and one of its principal functions was to be that of supplying an elastic and uniform currency. This currency was to be based only upon liquid discounted paper which had been rediscounted by Federal Reserve Banks for their members. The Act, however, granted permission for the issuance of notes secured by government bonds which had been purchased by reserve banks from their members, and to these notes was given the name "Federal Reserve Bank Notes." Against the Federal Reserve notes themselves a reserve of 40 per cent was to be carried, but against the Reserve Bank notes only 5 per cent was required, there being special security to the extent of 100 per cent in the form of government bonds as already explained in the case of national bank notes. Although it had not been expected that these notes would be issued to any considerable extent, they made their appearance largely during our participation in the World War but after it were pretty generally withdrawn.

The present note-currency system of the United States may be briefly summarized as follows:

1. Greenbacks or legal tender Treasury notes, protected by $150,000,000 in the Treasury and by the general taxing powers of the government.

2. Federal Reserve notes issued by Federal Reserve Banks and protected by discounted paper and gold-the latter to the extent of 40 per cent of the notes, deliverable in settlement of all dues to the government but not an absolute legal tender, and secured the resources of the banks and guaranteed by the government.

3. Federal Reserve Bank notes issued by Federal Reserve Banks and protected by 100 per cent government bonds and 5 per cent reserve money held with the United States Treasury, besides being a lien upon the resources of all Reserve Banks.

4. National bank notes issued by any national bank so desiring, and protected by 100 per cent government bonds and 5 per cent reserve money placed with the Treasurer of the United States, besides being a lien upon the assets of the issuing bank.

5. Gold and silver certificates representing gold and silver coin to the amount of 100 per cent in the Treasury of the United States and now legal tender.

6. Treasury notes of 1890, few in number but theoretically protected only by the general credit of the government.

CHAPTER IX

FINANCING THE BUSINESS MAN

I. PROBLEMS IN FINANCING BUSINESS ENTERPRISES.

As already seen, the relationships between the public and the banker may be merely those of depositor and safe keeper, or of purchaser and furnisher of remittance or exchange, or of user and supplier of currency. In addition to these there is, as already mentioned, another relationship, which is that of lender and borrower. It is this relationship which gives opportunity for the exercise of the real service of the bank, since it gives opportunity for the institution to perform the function known as extension of credit. This function results in the creation of what are called loans and discounts on the part of the bank and these loans and discounts are paralleled or represented on the ledger by deposit liabilities. The loans and discounts assume any one of a number of different forms, according to the type of paper which the bank has bought or discounted.

It must not be supposed, however, that the bank can purchase any kind of paper it chooses or can select the constituent elements in its portfolio according to its own disposition. The bank is surrounded by a community which has specified habits and customs of doing business. These cannot be immediately altered as a result of request or dictation, and if modified must be changed slowly and conservatively. Even within a given community the individual bank finds it a difficult problem of business competition to select exactly the clientele that it wants. There are many kinds of borrowers and many classes of business in every community. In every trade, occupation, or profession there are many individuals who vary in their solvency and the degree of their reliability, so that the bank must always