Government inspection.—The principal support of universal credit through banking is the assurance that uniform methods, honest in principle and accurate in execution, are followed. To secure these results a system of government inspection and guaranty seems absolutely necessary. If the public faith is to be maintained, the ground of that faith must be publicly established. The more complete the examination by trusted officials and the more frequent the publication of official reports, the better the public credit. It seems possible that even individual trustworthiness may become a matter of government record as it is now of private consideration in [pg 152] all business circles. One chief guaranty of credit through the banks is the strict inquiry made by the banks themselves into the business standing of their customers. If the record were perfect, the chief weakness of the credit system would be largely removed.
The balance of trade.—The bulk of trade between countries, that is of dealers in different countries, is settled in the usual routine of banking as has been indicated; but since under present systems the standards of value are given in different terms in different countries, somewhat more of friction remains in such trade. A greater attention is given to the fact of final settlement in coin or bullion. The price of exchange from a country whose dealers owe more than is due them, under the law of supply and demand, soon arises to an amount sufficient to cover the cost of transporting gold or silver. When these metals are used in payment by transportation from one country to another they are said to indicate the balance of trade; that is, they show that more of other property comes into the country than goes out. This balance of trade is supposed to show the relative prosperity of a nation, and is said to be against it when the nation buys more than it sells.
It is usually sought in the difference between the value of coin or bullion exported and of that imported. In two sets of circumstances a large correction is necessary to show the actual condition of trade. One is where a nation is buying on long credit, as in case of great enterprises like railroads or factories, constructed by sale of bonds in foreign countries or by sale of any other securities, government or individual, in a foreign land. The [pg 153] other is where a country like our own is a large producer of gold and silver by mining. In this case the products of the mines are as proper an article of export as the products of the farms or of the factories, and should be estimated as a part of the natural exports. For these reasons the balance of trade must be carefully scrutinized before being accepted as proof of a nation's progress in poverty or wealth.
Bank loans.—So far, in dealing with the subject of banking, no mention has been made of the function of extending individual credit by time loans. One of the original purposes of banking was to make a convenient office for the meeting of borrowers and lenders. The banks are still the go-betweens of those who have money to lend and those who have to borrow. In fact, every banking association is assumed to be a corporation of money lenders. Under ordinary circumstances this corporation is able to loan to individuals whose credit is good all of its capital not otherwise employed in the machinery of the bank, a considerable portion of deposits from its customers, and to a certain extent its own credit in the commercial world. In the case of a national bank a portion of capital is loaned to the government in the purchase of bonds, which are the basis of its circulating notes. The circulating notes, from 60 per cent to 90 per cent of the value of the bonds, are an extension of credit; that is, the capital already loaned on time to the government is partially loaned again to individuals. Again, the deposits of the customers, to be drawn as needed, in ordinary circumstances are not needed the same day. The bank soon learns by experience what portion it is [pg 154] safe to lend from day to day to individuals who are sure to make payments when promised. Double signatures, or endorsements, double the surety of prompt payment.
Thus the banks are enabled to provide safe keeping for money without charge, and even to pay a low rate of interest upon considerable deposits when times are good. In this way legitimate borrowers and legitimate lenders find a close connection in the bank. A legitimate lender is one who has property not needed at present for his own use. A legitimate borrower is one who can use capital to advantage in production. Any producer may at one part of a year be a lender and afterward a borrower to advantage of everybody. If the banks are thoroughly satisfactory the proceeds of the fall crops may serve the busy manufacturers as circulating capital during the winter. Again, the proceeds of the spring sales of goods and machinery may tide the farmers over the season of growth.
In this way labor of every kind is sustained by labor of every other kind. In all these ways the banking power of a country is extended to several times the coin money in circulation, and that with perfect safety. But it is possible for banks to be tempted through the very perfection of their own credit. The note of an individual has no established market value. A deposit in the bank is valued as cash. It is possible to secure the credit of having a bank deposit by discounting an individual note. If that note is a time note the bank has increased its immediate liabilities by the amount of a nominal deposit, with only a promise to pay in the future to rest upon. To lend to an individual is practically [pg 155] to enter into partnership with his fortune. The fortunes of the group of individuals representing the bank is less doubtful than that of any one person. The borrower in this instance pays in the discount of his note the difference in risk between his fortune and that of the combination. Such deposits purchased upon credit must be distinguished from deposits of cash, lest the bank should nominally increase its power to lend while in fact it has already lent up to its ability. Sometimes such nominal deposits are maintained by persons deeply in debt for the sake of paying a larger rate of interest than is allowed by law.
Safety of banking.—In times of business prosperity a bank with usual business caution as to customers, is safe for all concerned. And yet, in the very nature of extended credit, it has promised to pay on any particular day, if demanded, far more than it has cash in hand. Its liabilities embrace the whole of its deposits except a small portion made for a definite time, and all its issues of currency subject to redemption. To meet these engagements its immediate resources are whatever currency in any form of coin or bills it may have at hand. This amount, since its profits are made from lending, not from holding, must be small in proportion to its liabilities. The bulk of its means of payment is in notes not yet due, and to be collected when due. Of other property it is likely to have bonds of municipalities or of great corporations, and these are supposed to be a more available form of resources than individual notes, because they usually have a definite market value and can be sold or used as security for loans in any [pg 156] money market. If real estate forms a part of the capital, it can never be made available for immediate use. Hence any bank dealing in mortgages on real estate invests its funds where they cannot be had when wanted. All banking schemes based upon security in land have necessarily failed, because land has no current use in trade.
Under the pressure of panic, from whatever source, each depositor is sure to demand every cent due him from the bank, and just as certainly the bank's own resources are insufficient to meet those dues without the sale of bonds and notes in other markets. For these reasons in any great period of distrust the banks are obliged to suspend payments. Since all the banks of the community are in similar circumstances they cannot help each other, and time must be given for the collection of loans, according to agreement, that the gradual accumulation of ready cash may return to the vault, and so to the depositors, all that has been loaned. Because of this necessary instability bankers watch most carefully the tendencies of the money market, and necessarily reduce their loans for safety when any anxious pressure begins. For the same reason legitimate banking is limited to short time loans—on demand, thirty, sixty, ninety days—the shorter being the safer. Laws sometimes prohibit a bank from dealing in any other business, where a stock of goods must tie up funds, or from speculation in real estate, which confines capital more certainly.
In most banks the amount to be loaned to a single individual or firm is limited to a small portion, one-tenth [pg 157] to one-fifth, of the total capital. The principal causes of failure in banking are defalcation of officers, misuse of funds in speculative enterprises, dealing in speculative securities or on boards of trade, careless loaning to poor paymasters, investment in long time securities not readily marketable, or sacrifice in hurried sale of stocks and bonds under the pressure of panic.
The better the customers of a bank understand its condition and management, the less is its danger, for the basis of banking, as of the credit of the world, is the public confidence. Farmers who acquaint themselves with the workings of neighboring banks by making use of their aid in business benefit both themselves and their neighbors. The progress of the world demands of every farmer a closer contact with business and, therefore, a greater familiarity with business methods. Even the burden of debts will be lessened when farmers understand and appreciate the advantage of systematic credit. The dangers from over expansion of credit are lessened when all the people clearly understand the essential conditions for maintaining credit. The final perfection of a banking system depends upon the interest of the whole people, with a fair knowledge of the growth already made.