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Obviously a country's reserve money must to a large extent be concentrated in one reserve or, at most, in a few large reserves, if it is to be effective. It must be marshalled in armies, not scattered in small squads. But these armies must be mobile so that they can be quickly moved singly or in combinations to places of threatened attack. An army's mobility is a big factor in its efficiency—a truth which the great mobility of the armies of the Central Powers in the recent war has emphasized. Our American bank reserves were not only scattered, they were also immobile. There was no effective way of quickly gathering them together and massing them at the points of financial danger.
These then were the three most serious phases of our banking decentralization: (1) Absence of a responsible national conservator of our money market, like the Bank of France or the Bank of England. (2) Scattered bank reserves. (3) Immobile bank reserves.
INELASTICITY OF AMERICAN BANK CREDIT PRIOR TO FEDERAL RESERVE SYSTEM
The second group of defects of the old banking system, defects closely related to those of decentralization, were those of credit inelasticity. A very large part of the country's current business is carried on by means of funds borrowed from commercial banks. These borrowed funds are left on deposit with the banks, and the deposits are circulated by means of checks, the debits and credits of individual accounts being offset in such a way that the total commercial deposits of the country do not normally vary greatly in short periods of time.
Extent to which Bank Credit is Used as a
Medium of Exchange
The point may be illustrated by a few figures, and, inasmuch as conditions have been very abnormal since the outbreak of the European War, the figures used will be those for the year 1913. Reports made to the Comptroller of the Cur
rency show that on June 4, 1913, the loans and discounts of commercial banks which reported to the Comptroller (exclusive of loans classified as real-estate loans) amounted to approximately 8 billion dollars. Estimates made by Professor Irving Fisher give a rate of deposit turnover for the United States in 1913 of approximately 54, which means that for each checkdeposit balance, maintained in a commercial bank, averaging throughout the year $1,000, approximately $54,000 in checks were drawn and paid. The average deposit balance of 8 billions dollars would mean therefore check transactions to the extent of 54 times 82 billions dollars or 472 billions dollars in 1913. Investigations made for the National Monetary Commission in 1909 by Professor David Kinley showed that between 80 and 85 per cent of the country's total business was transacted by means of checks. If we accept the latter figure as the more representative one for 1913, we arrive at 83 billions dollars (namely, 15/85 of the amount of business done by means of checks), as the amount of business in that year performed by means of cash. In June, 1913, of the total amount of money in circulation in the United States, 21 per cent, or $716 millions consisted of bank notes. Although from the public's point of view bank notes are money, from
the issuing bank's point of view they are a form of bank credit. If we treat them as a form of bank credit, and add to the $472 billions of check business 21 per cent of the $83 billions of money business we arrive at approximately 490 billion dollars worth of business in 1913, representing 88 per cent of the country's total business transactions, as the amount performed by means of bank credit-checks and bank notes.
The amount of money and of deposit currency which a country needs to carry on its business, at a price level in equilibrium with the price levels of other countries, depends largely upon the amount of business or of money work to be done. In years of active business a larger supply of circulating media is needed than in years of business depression. Furthermore, in a country like the United States, in which agriculture is a particularly important industry, there are very pronounced seasonal fluctuations in the amount of business to be done, and consequently in the demand for cash and for deposit currency. One important postulate of a good banking system is its capacity to adjust the supply of deposit and bank-note currency to variations in trade demands, increasing it, for example, at the time of the heavy crop-moving demands in the fall and reducing it at the time of the period of inactive
business, which normally sets in shortly after the opening of the new year. Capacity to contract the circulating media when business demands decline is as important as capacity to expand them when these demands increase.
Under the old régime our American bank credit, both note and deposit, was peculiarly inelastic, although the seasonal character of much of the country's business is such as to make credit elasticity a desideratum of unusual importance in the United States.
Our national bank notes, which should have furnished the elastic element in the country's hand to hand money, were notoriously inelastic. National banks were authorized to issue these notes by depositing with the Government United States bonds equal in par value to the notes issued. The banks were supposed to realize a "double profit" on the bank notes, namely, interest on the bonds, and interest on the notes when they were loaned out as money. After 1900 the bonds used, however, were mostly two per cent bonds of 1930, and as the issue of bank notes
1 If the market value were below the par value, additional bonds were to be deposited so as to make the market value at least equal to the notes issued. In recent years the market value of these bonds has been usually above the par value.