B. Regulated Credit Issues. Under this head are included all those systems of note issue which, while undertaking to do something for the security of the notes, do not attempt to accomplish the object directly, as, for example, by requiring the pledging of bonds to cover them. Instead, these systems content themselves with defining in one way or another the circumstances and conditions of issue, with the intention of thereby increasing the probability that the notes will be secure. Schemes of this sort are very numerous, and some grouping of them is almost necessary. Perhaps as convenient a classification as any is one which makes five groups: viz., (a) those which try to gain security by a proper placing of the power of issue, (b) those . which seek the end by restricting the amount of issue, (c) those which restrict the circulation of the notes, (d) those which dictate with respect to the assets kept by the bank, and (e) those which impose some degree of government supervision. Obviously, these different methods of regulation may be combined, one with another, as also with Secured Issue systems, or Guaranteed Issue systems.

The method of procedure which aims to furnish security by a proper placing of the right of issue gives us two cases: (1) restricting the right of issue to some particular bank or class of banks, and (2) restricting the right to a special department within the bank. Restricting the right of issue to special banks has taken a variety of forms. Sometimes the exercise of this function has been permitted only to banks having special charters from the legislature. Further, the legislature has granted such charters very sparingly, in France to one bank only, in England and Germany to one principal one, together with a few others which are permitted to play a subordinate rôle. In other cases the right of issue has been limited to companies incorporated in a certain way and acting under certain well-defined conditions. In the United States the right is by indirection restricted to banks organized under Federal Law.

That this plan of exercising great care in placing the right of issue tends to increase the security of the notes cannot be doubted. Manifestly it diminishes the chances that this important function shall pass into the hands of banks which are too loosely organized, too weak, too badly managed, or too dishonest to furnish a really safe

note.

Restricting the right of issue to a special department is illustrated by the Bank of England. It contributes to the ultimate security of the notes in at least two ways. First, it in some measure frees the

note from control of those persons in the bank management who are under most temptation to be imprudent in extending unduly the issue, since these persons will belong to the loan, rather than to the the issue, department. In the second place any evasion of legal restrictions with respect to the amount or conditions of issue is more difficult when the issuing of notes is under the control of a separate department, since such evasion would in this case require guilty collusion between the responsible managers of the two departments.

The efficiency of the plan for promoting security which limits the amount of issue is manifestly derived from the fact that restricting the quantity diminishes the danger that an imprudent management will extend its issues until bankruptcy is inevitable, or that, in case of bankruptcy, the bank will find the amount of its outstanding notes too great to be paid. In our day substantially every banking system of importance puts limits of one or more kinds on the amount of notes issued. Such limits may be direct or indirect; that is, a maximum may be definitely specified, or conditions of issue may be imposed which by indirection limit issues.

The direct limitations are: (a) absolute, in terms of dollars, pounds, or francs; (b) relative, or proportional, to capital or other factor; (c) fixed, where maximum may never be exceeded; (d) elastic, where maximum may be passed under penalty of a tax.

The indirect limitations are: (a) to notes of high denominations; (b) frequent redemption; (c) restricting territory in which notes may circulate.

C. Secured Issue Systems.-Here are included all which attempt to safeguard the note-holder by giving him a special claim on all, or some, of the property owned by the issuing bank. Of such systems the simplest is that which gives the note-holder a first lien on the general assets of the bank. That is, should the bank fail, the noteholder must be paid in full before other creditors get anything. The fitness of this device to contribute to the security of the notes is plain.

Different forms of property are used for security. The general choice lies between (1) special securities, such as bonds and mortgages, and (2) ordinary banking assets, such as notes and bills of merchants and manufacturers. If the former are decided upon, choice has again to be made among bonds, stocks, and mortgages.

D. Guaranteed Issue Systems.-The essence of this system is to be found in the fact that some institution, or group of institutions,

outside the issuing banks becomes sponsor for that bank, guaranteeing that its notes shall be paid in any and all cases.

One of the most notable examples of the Guaranteed Issue system is to be found in the National Bank system of the United States. Here the guarantor is the Federal Treasury. That is, the Federal Treasury promises to redeem on sight all notes of insolvent national banks, thus giving to those notes all the security which the credit of a great and rich government can furnish. At the same time the Treasury is fully secured against loss by several simple provisions. First, it has in its possession, in lawful money, a fund belonging to the bank equal to 5 per cent of the bank's circulation. Secondly, it is custodian for Federal bonds belonging to the bank equal in value to the total circulation. Thirdly, it has a first lien on all the other assets of the bank.

III.

THE ELASTICITY OF BANK NOTE CURRENCIES

In considering what are the best means for securing that the notes shall possess this property of elasticity it is convenient to distinguish ordinary elasticity and emergency elasticity. By the former is meant the capacity to expand or contract, according to the changes in need which characterize an ordinary year. By emergency elasticity is meant the power to expand or contract according to the changes in need which characterize a commercial crisis and the depression which follows it. Each sort of elasticity needs to be studied in the two phases essential to both, viz., expansibility and contractility.

118. THE "CURRENCY" VERSUS THE "BANKING" PRINCIPLE' By N. G. PIERSON

"If," asks Lord Overstone who was the first to proclaim the currency theory-"there be no bank notes in a country, can there ever be scarcity of metallic money in that country?" Would it be possible, for instance, for the balance of payments of such a country to become so unfavorable as to cause all the metallic money and bullion to be exported. The answer is, that it would not be possible, for when money is scarce its value rises and prices fall. And when prices fall exports increase and imports diminish until there is sufficient money and bullion in the country once more. A nation which

' Adapted from The English Banking System, pp. 243-52. (National Monetary Commission, 1911.)

does not use bank notes can never, in the long run, have too little metallic money in relation to other things. It may be a poor nation, certainly, but its capital will always include such a proportion of coined money as shall be needful.

It is different with a country which uses bank notes as well as coined money, for in such a country exportation of the latter does not necessarily cause a scarcity of money. The balance of payments becomes unfavorable; considerable exports of gold take place; but at the same time, by granting credit, the banks greatly increase their uncovered circulation. Will prices fall in this case too? Will the balance of payments change and cause the exported gold to return to the country? There is no reason to expect that it will, because no deficiency will have arisen in the monetary circulation. In the first of the two cases described the evil cures itself; in the second it grows more acute. With a mixed circulation, that is, with a circulation consisting partly of paper, the whole of the metal may disappear without causing any reduction in prices.

What, then, are the means which a country using bank notes should adopt in order to prevent the whole of its gold from being exported? The law should prevent the banks from substituting paper for the exported metal; or, better still, it should compel them to reduce their uncovered circulation in proportion to the exports of the metal. Suppose the stock of money required in a country to be represented by the figure 100 and to consist entirely of gold; if a quantity of this money corresponding to the figure 10 were to leave the country, there would remain 90, consequently not enough to meet the demand, and this of itself would cause prices to fall. But suppose the needful stock of 100 to consist of 50 parts gold and 50 parts paper. In this case, if, while 10 parts of the metallic money left the country, the paper circulation were increased to 60, the total stock of money would still remain at 100, and therefore suffice to meet the demand. And if a second 10 parts of the metallic money were to leave the country and to be followed by a third and fourth 10 parts, while the paper circulation was increased, at first from 60 to 70, then from 70 to 80, and then from 80 to 90, there would always be a sufficient stock of money in the country, and the exported gold would not return. This must be prevented. A deficiency in the monetary circulation must not be met with paper. Measures must be adopted to prevent the possibility of the whole of the specie and bullion being drained from a country and the bank notes of that country thus becoming inconvertible.

Such is the currency theory; now let us examine its defects. First of all it is not true that a bank invariably does wrong when it supplies a deficiency in the monetary supply by issuing notes. We forfeit one of the greatest advantages of a well-regulated banking system when we conform strictly to the currency theory. Suppose, for instance, that a crisis has occurred, and that the demand for money has greatly increased in consequence. Will it not have a salutary effect if the bank of issue is able to meet this demand, and would it not be the height of folly to interfere with such action on the part of the bank? Or suppose that the corn crop has failed, so that it has become necessary to import large quantities of grain for home consumption. Is it not an advantage in such a case not to have to part at a given moment with large quantities of interest-bearing bonds, or cattle, or machinery, or other necessaries, in order to pay for the imports of grain and to be able to pay for them in the meantime by exporting precious metals, for which paper can be temporarily substituted? Steps must be taken to ensure the return of the exported metal; but this need not be done immediately. A well-managed bank always has a larger metallic reserve than it needs in ordinary times, and of which it will therefore be able to spare a part in times of emergency. When the time of stress has passed, the bank will gradually restrict its credits, thus enabling its metallic reserve to accumulate once more. In the meantime it will have rendered a great service to the community, for it will have mitigated the adverse effects of the crop failure by enabling them to be spread over a more extended period of time.

There is a second mistake in the currency theory. It is not true that in a country where no bank notes are in circulation exportation of specie results in an immediate fall in prices, and consequently in an alteration in the balance of payments. It would be so if the bank notes were the only possible substitutes for specie, but bank deposits also serve as substitutes for specie. Bank notes and bank deposits differ only in form, since both take the place of specie when they are not covered by a metallic reserve. Let the needful stock of media of payment be represented by the figure 100, and suppose it to be made up of specie and bank deposits each to the extent of 50. If specie be now exported to the value of 10, but the banks at the same time grant credits to their depositors to the same amount, how is the fall in prices to take place which the supporters of the currency theory declare to be the inevitable result of the exportation of precious metal from a country