The explanation of the devotion of the redeposited portion of the reserves to the operations of the New York Stock Exchange is to be found in the fact that that exchange furnishes a regular market for call loans on a large scale. Since these funds are held subject to the call of the banks which deposited them, and interest at the rate of at least two per cent is paid upon them, the depository banks are bound to seek investment for them, and call loans on collateral listed on the exchange under ordinary circumstances are best suited to their purposes.
Another disadvantage of this reserve system is the dangerous situation in which it places banks from time to time, and the tendency to panic which it fosters. The demands made upon banks for both cash and credit vary with the seasons. In the fall and spring they are much greater than in the winter and summer. They also vary regularly through periods of years, increasing during the up-grade of a credit cycle and decreasing for a longer or shorter period after a crisis. Irregular and unexpected events also cause variations. On account of the rigidity of this reserve system and the lack of elasticity in our currency, the means available to banks for meeting increased demands, especially those of an irregular and unexpected character, are inadequate, and their employment is often dangerous. These means are: keeping in the vaults in slack times a large amount of unused cash, a practice too expensive to be employed; keeping surplus balances with correspondents at two or three per cent interest, not a sufficiently remunerative practice to be employed on a sufficiently extensive scale; rediscount with correspondents of some of their customers' paper, or loans from them on the security of their own signatures or on such security supplemented by collateral; and sale of bonds at such prices as they will bring.
None of these expedients is certain at all times and under all conditions, and some of them are precarious at all times. Surplus balances with correspondents are most reliable, but they occasionally fail on account of the inability of correspondents to realize upon their call loans. When calls for the payment of balances are large and general, it is impossible for brokers whose loans are called by one bank to transfer them to another. The collateral deposited as security must, therefore, be offered for sale on the stock exchange, and the very stringency which resulted in their being so offered renders their sale, even at slaughter prices, difficult and sometimes impossible. The result at the best is a heavy fall in the prices of stock-market securities, and at the worst a stock-market panic and a suspension of payments by the banks.
Rediscounts and loans from correspondent banks cannot be depended on. Correspondents are under no obligation to make them. They will usually do so as a favor, if their condition warrants, otherwise not. Sales of bonds on the stock exchange are difficult and sometimes impossible in times of emergency, and are usually attended with loss.
On account of this uncertainty and the danger attending it, when new and unusual conditions likely to result in increased demands upon them arise, banks are likely to act "panicky"; to call in their balances from correspondents; to sell bonds; to call loans; and greatly to curtail or absolutely to cut off new discounts. This action spreads the panicky feeling among their customers, and creates such pressure at the reserve centers as to cause curtailment of accommodations and panic there.
At the very best, this reserve system is accompanied by high discount and loan rates and by speculation on the stock market. High rates result inevitably from the hoarding of currency which it involves, the supply of loan funds being abnormally diminished, and speculation follows from the concentration in slack times of funds in New York City, which can only be employed in call loans on stock-exchange collateral. Stock brokers regularly take advantage of this situation, speculate themselves and inspire speculation among their customers. The mutual dependence of the stock and money markets thus produced by this reserve system is disadvantageous to both, fluctuations in values, uncertainty, and irregularity on both being the result.
(e) Lack of Elasticity in the Currency.—The money of the United States consists of four main elements, gold and silver coin, United States notes, and national bank notes, and none of these fluctuate in volume in accord with the needs of commerce.
The gold element depends primarily upon the output of our gold mines and upon the international movement of gold, increasing when that output increases and when our imports of gold exceed our exports, and decreasing under opposite conditions. These fluctuations, however, are quite independent of our commercial needs. Silver dollars, which constitute the major part of our silver currency, for several years have been unchanged in quantity, and the volume of United States notes has remained at $346,681,016 since the resumption of specie payments, January 1, 1879.
National bank notes fluctuate in volume as a result of changes in the number of national banks and in the prices of government bonds. Whenever a new national bank is organized, a specified portion of its capital must be invested in government bonds, which bonds are usually deposited with the Comptroller of the Currency in exchange for notes; and, when the price of government bonds rises, banks holding more than the minimum required by law frequently retire a portion of their circulation in order to recover their bonds for sale at the enhanced price. When the price of government bonds falls, many banks purchase additional quantities and increase their circulation.
Changes in the price of government bonds and in the number of national banks, however, have no connection whatever with changes in our currency needs, and no more do the fluctuations in the volume of the currency as a whole, made up of these various elements combined. As a result of this condition, rates on loans and discounts fluctuate greatly on account of wide variations between the demand and the supply of loan funds, and commerce is hampered at certain seasons and overstimulated at others. As was indicated above, this lack of elasticity in our currency aggravates the defects of our reserve system and also aids in the production of financial panics.