The bank pays no interest on this sum, but receives interest for it; for it is able to let out the whole, only taking care to let it for short periods, so that it may be within reach, as it were, if suddenly called for. Thus far, then, the bank, with only $100,000 of capital, receives interest on $125,000, and is thus in a fair way to pay its expenses, and still yield six per cent to its stockholders. It should be observed, that the whole amount of its deposits cannot be suddenly called for, nor even a considerable portion of them. These deposits consist in great part of the funds which the various customers of the bank are constantly transferring from one to another, in the settlement of their accounts with each other; and these transfers are made upon the bank-books, as already explained, without any necessity of ever withdrawing the sum from the custody of the institution.

The usual mode in which banks lend their capital and other funds to their customers is, by discounting promissory notes. We shall, therefore, gain a clearer view of their second function, as banks of discount, by looking closely into the origin and character of such notes. It is usual in every trade to give a certain length of credit for goods bought, six or eight months, or even a year, according to the custom in the particular trade. This length of credit is virtually offered to the purchaser as an inducement to him to pay a higher price for the goods bought; he is offered either six months' credit, or a discount of five per cent from the price demanded, though the usual rate of interest for six months is but three per cent; and in nine cases out of ten, the purchaser decides to take the credit rather than the diminished price. The seller offers this credit, though he is in truth not able to offer it, but needs his capital returned immediately. He offers it, however, because he knows he can sell this note to the bank, or transfer the debt to it, receiving the amount minus the interest for the time it has still to run. It might seem to be a less circuitous and less costly mode of transacting the business, if the purchaser of the goods, instead of paying five per cent for six months' credit, should himself obtain a loan from the bank of the necessary sum at only three per cent, and thus be enabled to pay for his goods with ready money. But then the bank, for its own security, requires two persons to become responsible for the

repayment of the loan, these two usually being the signer and an indorser of the note. The buyer can only offer his own personal security, which is not enough; the seller can offer a note signed by the buyer, and indorsed by himself, so as to complete the requisite guaranty. The real nature of the transaction, then, is as follows: the seller, in order to enable a customer to buy his goods, obtains for him from the bank a six months' loan of the purchase-money, charging him two per cent for this service and for guaranteeing the repayment to the bank.

It is the chief function of the banks to discount or buy such notes, which are called real or business paper, to distinguish them from another class of notes, which are denominated ficlitious or accommodation paper, because they are not grounded on any debt previously due from the promisor to the indorser. "Real notes (it is sometimes said) represent actual property. There are actual goods in existence, which are the counterpart to every real note. Notes which are not drawn in consequence of a sale of goods, are a species of false wealth, by which a nation is deceived. These supply only an imaginary capital; the others indicate one that is real."

But there are no good grounds for this distinction and preference. A loan obtained by a purchaser, on a note indorsed by a friend, may be applied to the purchase of goods, just as much as if the note were indorsed by the person who sold those goods. Then there may be actual commodities or values corresponding to the accommodation or fictitious paper, as well as to real notes; the wealth is no more fictitious, nor are the pretences on which the loan is obtained more unfounded or fraudulent, in the one case than in the other. Again, though all the notes should be given as the results of actual sales of commodities, it is by no means certain that these commodities are equal in value to the whole (aggregate) amount for which the notes are given; for the same goods may be sold over and over again by successive purchasers, so that there may be many notes, each representing the whole value of one and the same parcel of goods. For instance, A may sell $1,000 worth of merchandise to B, and receive therefor B's note at six months;

* H. Thornton's Inquiry into the Nature and Effects of Paper Credit.

within a week, B may sell the same goods to C, and receive his note for the same sum; C may soon dispose of them in like manner, and receive a third note. Before six months have elapsed, there may be a dozen such notes in being, all of which may possibly be discounted at the same bank; yet only one of them represents any actual property.

Up to this point, be it observed, there has been no mention of bank-notes, or of the issue of a substitute for specie currency. The bank might exist, might exercise the two functions now explained of deposit and discount, and pay dividends of a reasonable amount to its stockholders, though the currency of a country should consist exclusively of gold and silver. The establishment of the bank would lessen the amount of these two metals required for making exchanges, would limit them in great part to the retail trade, or to transactions between dealers and consumers, the business of dealers with each other being adjusted almost exclusively by checks transferring deposits. But it now becomes a question whether the precious metals may not be dispensed with, even for this service. They are used only to be passed from hand to hand; their material and specific qualities - their hardness, weight, &c.— are not needed to fit them for such transfer. A scrap of paper would answer just as well to be passed about, provided only that the receiver of it felt secure that it would not diminish in value while in his keeping, or that his neighbor would always be willing to receive it on the same valuation upon which it had come into his own hands. Instead of effecting a purchase with five hard and weighty silver dollars, it would be even more convenient to effect it with a scrap of paper, which the holder is sure of being able to exchange at any moment, and without difficulty, for that sum in specie. The bank, having relieved the large dealers from the necessity of using specie through its system of checks and deposits, may now relieve the smaller ones, and the community generally, from such necessity, by issuing its own notes for small sums, payable on demand in gold or silver at its own counter. In its immediate vicinity, such notes would evidently be preferred to coin, on account of their superior convenience; beyond that vicinity, they would not circulate, because the distance would oppose an obstacle to their immediate conversion into cash, and be

cause the circumstances and solvency of the bank could not be so well known at a distance.

To return to the bank with $100,000 of capital, which was taken as an example to illustrate the theory of these institutions; we have seen that its capital and deposits combined would enable it to make loans on interest to the amount of $125,000. If we suppose that it can raise its circulation to $50,000 by keeping only 10,000 specie dollars in reserve, it is evident that $ 40,000 will be added to its productive means; or that it will now be able to lend on interest $165,000. It can then easily pay its banking expenses, pay 6 or 7 per cent. on its capital to the stockholders, and still have a small surplus to meet the contingency of some loans made by it not being repaid, or, in other words, to make up for bad debts. How this excess of circulation over the specie held in reserve is so much added to its productive means, appears very easily on a little reflection. After it has lent out all its capital and all its deposits, it can still lend its own notes, or its own promises to pay specie on demand, which will circulate as readily as hard money, and for which, therefore, the borrower will pay as much interest as for hard money.

Under ordinary circumstances, it is certain that one dollar in specie held by the banks is a safe basis for the circulation of three or four dollars in paper; for paper being equally available with specie for all domestic purposes, and far more convenient, it would be strange indeed, if the inhabitants of any town or the people of any country should suddenly have occasion to send abroad, or out of their own precincts, a sum in specie equal to one third or one fourth of their whole paper circulation. Such an export from the United States would amount perhaps to sixty or seventy millions in specie, a drain upon the currency quite sufficient to so far raise the value of what money remained behind, that the prices of all commodities would inevitably fall much below the average, and there would consequently be an irresistible temptation to export merchandise and import bullion.

But the great danger to the circulation of the banks arises, not from the possibility of a sudden demand for a great amount of specie to be sent abroad, but from the occurrence of one of those panics among the people, which are not infrequently

caused by commercial crises, or by the failure of one or more large banks through the gross mismanagement or fraud of their directors, a failure which, among the ill-informed, of course excites suspicions as to the soundness of all the other banks. Against such panics, in truth, there is no adequate protection, except the diffusion among the people of a knowledge of the theory and practice of banking, a knowledge which would teach them that, by yielding to the excitement, and joining in the run upon the banks, they are acting directly against their own interests, which are not otherwise in jeopardy. An anecdote is told of an eccentric banker, who, when a great crowd had collected about his doors, in consequence of one of these unreasoning excitements, came out and pushed them away with great violence of gesticulation, exclaiming, "Go away, you foolish people! or I will break, and ruin every man among you." He was quite right; in every bank that is managed, I will not say, with common ability and discretion, but with common honesty, the capital and other resources so largely exceed the circulation, that it is impossible for the notes to fail of being ultimately redeemed in specie. In the case of the bank which has been taken as an example, the assets are, the notes and bills of individuals, which it has bought or discounted to the amount of $165,000, and $10,000 in specie, making an aggregate of $175,000, as a fund for the redemption of only $50,000 in its own paper. If less than one fourth of these notes of individuals are duly paid at maturity, the bank-notes cannot fail to be redeemed in full; and without a breach of honesty, it is certainly impossible that the directors of any institution should let out their own money and that of others in such a manner as to lose more than four fifths of it. But a great panic may bring home upon the bank more than one fourth of its circulation in one day, each holder of its notes being anxious to secure himself, and careless of the effect upon others. In this case, the bank would be obliged to suspend specie payments, its notes would be dishonored and consequently depreciated, merchants would be deprived of their deposits and customary facilities at the banks, in consequence of which they also would fail to redeem their own notes due to the bank, and a general sacrifice or destruction of property would ensue.