through the holding of coin was frequently referred to by the bank commissioners and legislative committees. Not, however, until 1860 was there any specific requirement as to specie holdings by banks in Pennsylvania, and in the law then passed only 8 per cent in specie or its equivalent was demanded. Virginia passed an act in 1837 providing that banks should have one-fifth of their notes in specie and forbade a bank to make any loan when the reserve fell below this limit. This ratio was observed in subsequent legislation.

In 1838 the bank commissioners of Mississippi advised that the banks should have $1 in specie for every $3 in circulation and deposits. Louisiana had the credit of taking the most advanced position of all the States in her reserve requirements for banks; for many years the Louisiana State Bank maintained a specie holding of one-third its total responsibilities. In 1838 the associated banks of New Orleans agreed to carry, in 1839, specie holdings of one-third their aggregate circulations and deposits in specie, while a sum equal to the remaining two-thirds must be invested in short-time paper payable absolutely at maturity. Discounting by a bank which had been ten days below the specie line was made an act of insolvency, requiring liquidation, and directors or managers who assented to the violation of the law on this point were made individually liable for all debts. This legislation was approved by its results; banks of New Orleans passed successfully through the crisis of 1837, and in March, 1861, at the beginning of the Civil War, they held sixteen millions of specie to a capital of twenty millions.

Ohio, in 1839, enacted that the volume of bills issued should not exceed three times the amount of specie on hand, exclusive of deposits. By the free banking act of 1851 banks were required to have on hand in gold or silver, or their equivalent, 30 per cent of their outstanding notes. The State Bank of Iowa, 1858, required a reserve of coin of one-fourth the circulation and a similar reserve in current notes for the deposits.

121. NOTE ISSUES UNDER THE FREE-BANKING SYSTEM1

BY JOHN JAY KNOX

The free-banking system of New York was authorized on April 13, 1838. Under its provisions any number of persons were authorized to form banking associations upon the terms and conditions and

I

1 Adapted from Report of Comptroller of the Currency, 1876, pp. xxiii-xxxvi.

subject to the liabilities of the act. The law originally provided that such associations, on depositing stocks of the State of New York or of the United States, or any State stock which should be, or be made, equal to a 5 per cent stock, or bonds and mortgages on improved and productive real estate worth, exclusive of the buildings thereon, double the amount secured by the mortgage, and bearing interest at not less than 6 per cent per annum, should receive from the Comptroller of the State an equal amount of circulating notes. Previous to the year 1843 twenty-nine of these banks, with an aggregate circulation of $1,233,374, had failed; and their securities, consisting of stocks and bonds and mortgages amounting to $1,555,338, were sold for $953,371, entailing a loss of $601,966. The avails of the securities were sufficient to pay but 74 per cent of the circulation alone. The losses to the bill-holders occurred only in the case of those banks which had deposited State stocks other than those of New York. The law was thereupon so amended as to exclude all stocks except those issued by the State of New York, and to require these to be made equal to a 5 per cent stock. An amendment in 1848 required that the stocks deposited should bear 6 per cent interest instead of 5, and that the bonds and mortgages should bear interest at 7 per cent, and should be on productive property and for an amount not exceeding two-fifths of the value of the land covered by them. Subsequently, on April 10, 1849, the law was again so amended as to require that at least onehalf of the securities so deposited should consist of New York State stocks, and that not more than one-half should be in the stocks of the United States, the securities in all cases to be, or to be made, equal to a stock producing an interest of 6 per cent per annum, and to be taken at a rate not above their par value and at not more than their market value. In 1840 a law was passed requiring the banks of New York to redeem their notes at an agency of the bank, either in New York City, Albany, or Troy, at one-half of 1 per cent discount.

The constitution of 1846 also provided that, after the year 1850, stockholders of banks issuing circulating notes should be individually responsible to the amount of their shares for all debts and liabilities of every kind, and that, in case of the insolvency of any bank or banking association, the bill-holders should be entitled to preference in payment over all other creditors; and the constitution, as amended in 1874, still contains substantially the same provisions.

After the New York free-banking law had been perfected by various amendments, and subsequent to 1850, a number of the States,

among which were Massachusetts, Vermont, Connecticut, New Jersey, Ohio, Indiana, Illinois, Wisconsin, Tennessee, Virginia, and Louisiana, adopted the system which had proved so satisfactory in New York. The Massachusetts and Louisiana acts, in addition to the many excellent features of the New York act, required an ample reserve to be kept on hand, and also contained other restrictions, which were subsequently embodied in the national bank act. In nearly all the States which adopted the free-banking system charters for banks were still granted which authorized the issue of circulating notes without security and in excess of capital. These were more profitable, and therefore in most of the States but few banks were organized under general laws. In other States the best features of the New York law were omitted. The shareholders were not made personally liable; the security required was not sufficient; the notes were issued in proportion to the stock and bonds deposited and not in proportion to the cash capital; no provision was made for the prompt redemption of the notes at any commercial center, and a majority of the directors and shareholders were frequently non-residents. Many of the organizations were not banks, in any true sense of the word, but were associations without capital, located at places not easily accessible, and owned by non-residents, who availed themselves of ill-considered legislation to convert their bonds into currency at rates higher than the market value drawing the interest on their bonds, but transacting little or no business at the place of issue. When the bonds depreciated in value, and any considerable amount of notes were presented at their counters for redemption, the banks failed, the securities were sold by the authority of the States, and the avails were distributed among the note-holders.

The governor of Indiana, referring to such banks, says in his message for 1853: "The speculator comes to Indianapolis with a bundle of bank notes in one hand and the stock in the other; in twenty-four hours he is on the way to some distant point of the Union to circulate what he denominates a legal currency authorized by the legislature of Indiana. He has nominally located his bank in some remote part of the State, difficult of access, where he knows no banking facilities are required, and intends that his notes shall go into the hands of persons who will have no means of demanding their redemption."

The New York Journal of Commerce in June, 1853, referring to the same subject, says: "The operators in these schemes have turned

to the West, and, under the free-banking laws of Indiana, Illinois, and Wisconsin, are prepared to flood the channels of circulation with their notes. It is not western capital that is seeking profitable employment, nor is it eastern capital invested at the West. Not a dollar of the new currency will be issued where it is likely to be presented for redemption."

I22. THE SAFETY-FUND BANKS1

BY JOHN JAY KNOX

The safety-fund system was recommendeed by Mr. Van Buren in his message as governor of New York in 1829, and the act establishing it passed the legislature and became a law on April 2 of that year. Forty banks were then in operation, and their charters were about to expire. It is said to have been suggested by a system which originated with the Hong merchants in China, by which each member contributed to uphold and cherish the weak members of the Hong. The act authorized the issue of circulating notes not exceeding twice the amount of capital paid in and limited the loans to twice and onehalf the amount of the capital. The feature of most importance in the act was the establishment of a common fund, by a provision requiring every banking corporation thereafter organized, or whose charter should be renewed or extended, to pay annually to the treasurer of the State a sum equal to one-half of 1 per cent of its capital stock paid in, the payments to be continued until every such corporation had paid into the treasury 3 per cent upon its capital stock. The fund thus created was made applicable to the payment of the circulation and other debts of any insolvent bank contributing to the same. If the fund became at any time diminished by payments from it, each bank was required to renew its annual contribution until the deficiency was restored.

Contributions to the fund were first made in 1831. In 1841-42 eleven of the safety-fund banks failed, with an aggregate capital of $3,150,000. The sum which had been paid into the fund by these banks was but $86,274, while the amount required for the redemption of their circulation was $1,548,588, and for the payment of claims of their other creditors $1,010,375, making a total of $2,558,933. According to the report of the State Comptroller, made in 1849, the whole amount contributed to the fund down to September 30, 1848,

I

Adapted from Report of the Comptroller of the Currency, 1876, pp. xxi-xxii.

was but $1,876,063; and even if full payments, as required by law, had been made by all the banks organized under the system, the fund would still have been insufficient to pay the deficiency occasioned by the insolvency of these eleven banks. This deficiency was subsequently provided for by the issue of a 6 per cent stock by the State, to be reimbursed largely by new contributions from the banks. During the year 1842 the act was so amended that the safety-fund became a security only for the notes in circulation and not for the other debts of the banks.

(3) ASSET CURRENCY

123. THE ARGUMENT FOR ASSET CURRENCY1

While a bond-secured circulation cannot furnish an elastic medium, expanding and contracting automatically, it is quite otherwise with a currency that is based upon the general assets of the issuing banks. The volume of notes put forth under such circumstances will, like deposits, automatically expand in volume by being issued upon demand from legitimate borrowers and automatically contract by being returned to the bank when the need for the currency is past. Under such a system any increase in the demand for money, and consequent higher rate of interest, adds to the inducement to issue notes instead of making it less profitable, as in the case of bond-secured currency.

There is, moreover, no delay or inconvenience such as exists where bonds must be purchased and deposited with the Treasurer before the notes can be issued. The assets on which the notes are based are the ordinary commercial paper acquired by the bank in the course of its regular business. The bank is thus always ready to increase its circulation if the public will use more notes, and all considerations of profit lead it to do so, as its power to loan will be increased in proportion as it is able to keep more notes in circulation. The same motives acting on all the banks lead to active competition, which results in the prompt redemption of all notes deposited or paid into any bank.

Another result of a system of bank currency based on general assets-indeed a corollary of what has just been stated-is that each community is thereby enabled to furnish for itself most easily and

I

Adapted from Report of the Monetary Commission of the Indianapolis Convention, 1898, pp. 231-34.