Prices of the necessities of life increased; merchants were obliged to increase them, not only to cover depreciation of their merchandise, but also to cover their risk of loss from fluctuation; while the prices of products thus rose, wages, which had gone up at first under the general stimulus, fell. Under the univer sal doubt and discouragement commerce or manufactures were checked or destroyed. As a consequence, the demand for labor was stopped; laboring men were thrown out of employment, and under the operation of the simplest law of supply and demand, the price of labor - the daily wages of the laboring class-went down until, at a time when prices of food, clothing, and various articles of consumption were enormous, wages were nearly as low as at the time preceding the first issue of irredeemable currency. The mercantile classes at first thought themselves exempt from the general misfortune. They were delighted at the apparent advance in the value of the goods on their shelves. But they soon found that, as they increased prices to cover the inflation of currency and the risk from fluctuation and uncertainty, purchasers were fewer, purchases less, and payments less sure; a feeling of insecurity spread throughout the country; enterprise was deadened and general stagnation followed. New issues of paper were clamored for as a new dram is called for by a drunkard. The new issues only increased the evil; capitalists were all the more reluctant to embark their money on such a sea of doubt. Workmen of all sorts were more and more thrown out of employment. Issue after issue of currency came; but no relief save a momentary stimulus, which aggravated the disease. The most ingenious evasions of natural laws in finance which the most subtle theorists could contrive were tried,- all in vain; the most brilliant substitutes for those laws were tried; self-regulating schemes, "interconverting" schemes, — all equally vain. All thoughtful men had lost confidence. All men were waiting; stagnation became worse and worse. At last came the collapse, and then a return by a fearful shock to a state of things which presented something like certainty of remuneration to capital and labor. Then, and not until then, came the beginning of a new era of prosperity. CHAPTER XVI 1 THE REGULATION OF A BANK-NOTE CURRENCY 1 1. Circulation secured by Bonds Whatever impedes the ability of a bank to furnish its currency, whether this currency take the form of notes or of deposits, must necessarily hinder it in the performance of its legitimate functions. As will be seen later the assessment of a tax upon the currency of a bank will increase the cost to the bank of furnishing its loans to the community. That is to say, so far as it results in a rise in the rate of interest, it means that the tax has been shifted by the bank to the borrower. From the side of the borrower it is clear that anything which interferes with the ability of the bank to make him a loan, and thus raises the rate of discount, is injurious to him. It is clear, then, that in the interest of the whole community the issue of bank currency should be as unrestricted as is consistent with safety. In the United States the choice at present is supposed to lie between a bond-secured issue bonds or securities of some sort being pledged for the redemption of the circulation) and a system in which the notes, like the deposits, are secured only by the general assets of the bank. Before considering, however, the bond-secured type of circulation as such, one point having special application to the banking system of the United States must be considered. The bonds at present required as security for circulation are national bonds. The people of the United States have become accustomed to the security of bank notes based upon the deposit with the government of national bonds. For thirty-five years this has furnished an absolutely safe bank 1 By J. Laurence Laughlin. Reprinted, by permission of the author and of H. H. Hanna, from the Report of the Monetary Commission of the Indianapolis Convention [Indianapolis, 1900]. circulation. There is good reason why the people should have come to regard this system as highly satisfactory, and why there should be a strong belief that no other kind of security would be acceptable. It is well understood, however, to be the traditional policy of the United States to pay off its bonded indebtedness. Since the close of the Civil War the reduction of the debt had gone on in a way to surprise the debt-burdened countries of Europe. Two thirds of the debt existing in 1865 has been paid off, and the amount of bonds now available for national bank circulation is not large. If we should return to the policy of the past and begin the payment of our national debt again, it is evident that United States bonds could not be used to provide a permanent and increasing bank circulation. Certainly, we may not seriously discuss the possibility that a debt of the United States would be purposely contracted or maintained merely in order that bonds might be provided with which to secure the notes of national banks. Even if sufficient amounts of United States bonds were provided in the future, or if other kinds of bonds were deemed satisfactory, there would still be serious objections to the plan of a circulation secured by bonds./ First, any provision which obstructs the easy flow of loans from banks to customers in the particular form in which they wish to take their loans is a burden to the community. It works in much the same way as an increased cost of agricultural implements to farmers, who can accomplish results only at an increased cost, whether their tools cost them more, or whether their loans cost them more. Any means by which the notes are less obstructed will facilitate loans, and better serve the community which is dependent on notes. To communities where the supply of loanable capital is inadequate to the demands, and where the rate of interest is correspondingly high, the system of bond security as a basis for note issue is especially disadvantageous for another reason. It deprives that community of a large amount of capital which it would otherwise have, in that it requires the banks in that community to loan elsewhere at a low rate of interest (in the form of investments in bonds) large amounts which would otherwise be loaned to borrowers in the community in question. An illustration may make this clearer. The present capital of the national banks of Nebraska, Kansas, Alabama, and Texas is about $45,000,000; the deposits in those states are, roughly, $75,000,000. If the banks of these states were to issue notes under the present system to the amount of $36,000,000 (80 per cent of their capital) their accounts would stand somewhat as follows: If, however, the banks were not required to invest in bonds, they could loan to local borrowers not only the $81,200,000 possible under the present law, but also the $46,800,000 now required to be invested in bonds, leaving the account standing as follows: Circulation based on Commercial Assets This of itself would be objection enough to the system from the standpoint of our Western and Southern States; but when 1 $20,000,000 4's of 1907 at 110; and $20,000,000 4's of 1925 at 124. 2 The sum of the loans and the cost of the bonds under the bond-deposit requirement. - to this hardship that capital is taken away from their local borrowers and invested elsewhere in bonds is added the further disability which has been mentioned that this outside investment must be at an exceedingly low rate of interest — it seems inexplicable that the system should have been permitted to exist as long as it has. It needs no argument to show that if one condition precedent to the establishment of a bank of issue in such a locality is that a greater or less amount of capital shall be loaned elsewhere at a rate of interest much lower than the local rate, the loss thus incurred will necessarily be made up by a higher rate of interest upon the capital which remains to be loaned at home. A system of bond-deposit security will be a rigid system. It cannot respond to sudden needs. The relation of the price of bonds to the market rate of interest produces great difficulties in regard to the probable issue of bank-note circulation when it is needed. It is well understood that changes may take place in the value of bonds due to changes in the credit of the government or to changes in the normal rate of interest, entirely outside of the control of the banks. As elsewhere shown, the profit of a bank on its circulation is diminished as the price of the deposited bonds increases, that is to say, as the rate of interest received on the bonds fall's below the commercial rate. For this reason changes in the price of bonds may have a direct bearing upon the profit of circulation, and hence upon the volume of the notes which the banks will thereby keep outstanding. It may, therefore, be laid down as an undisputed fact that a system of bond-secured circulation is practically inconsistent with the automatic adjustment of the quantity of notes to the demands of borrowers and the needs of trade. When the demand for loans is great, there is little profit to be maden putting out notes; that is, when the demand is urgent, the supply is not forthcoming. Also, an increase in the commercial rate of interest will lessen ` the relative profitableness of issuing notes secured by bonds. paying a low and fixed rate of interest. At any given time, with |