The Literature Collection reports on The American Crisis Of 1907.
(emphasis mine) [my comment]
1 A second lecture to the Institute of Secretaries, delivered on March 7 31st, 1909.
[This is an interesting look at the flaws of the pre-Fed US monetary system]
The American Crisis Of 1907
THE theme I have taken as my text this evening is perhaps too large for the limits of a single lecture. It will hardly be possible within these limits to deal adequately with such a colossal disturbance as the American crisis of 1907. An American professor has described this crisis as "the most extensive and prolonged breakdown of the country's credit mechanism which has occurred since the establishment of the National banking system [in 1863]"; and another writer styles it "the biggest slump in the history of the human race." The effects have resounded throughout the whole financial and commercial world, which is still suffering serious depression nearly eighteen months after the collapse, and is likely, I fear, to suffer for many months yet.
A BANKING CRISIS.
But there is one aspect from which this crisis seems specially interesting and instructive. It is a notable illustration of the importance of the question of banking reserve, upon which I had the pleasure of addressing you last month. I propose tonight to deal with it mainly from this point of view. Speaking broadly, the crisis of 1907 stands out unique among modern crises, and especially in contrast with European crises, as mainly due, not so much to over-trading, or to general over-speculation, as to defective banking. I maintain that this crisis was emphatically a banking crisis; and I entirely agree with Professor Sprague, who, in concluding an admirable account in the Economic Journal for September, 1908, sums up the moral of the disaster in the words, "Above all, a more intelligent understanding of the purpose of banking reserves is required." This view has been traversed by high authorities in the City; but the objectors would probably admit that if the American system of banking had been as well organised as the ordinary European system, the crisis need not have taken place, and the liquidation required by the somewhat unsound conditions which prevailed in the eighteen months preceding October 1907, need not have involved the complete paralysis of general credit. This is my case.
To make the point more clear, we must distinguish between financial crisis and trade depression. I am afraid that periods of trade depression are at present inevitable. It used to be supposed that these periods must necessarily be connected with a collapse of credit. Jevons, as most of you know, tried to make out that a crisis must be expected every ten years; and lie attempted to find a physical connection (through the tropical harvests) between financial crises and sunspots, which recur at about the same interval. Right or wrong, it was a brilliant example of scientific imagination; and Mr. Jevons's son maintains that his father's theory is strengthened by recent physical research.
Now, though that theory may possibly be true with regard to trade depression, it is certainly not true with regard to financial collapse. In England we still have our periods of excitement and depression in trade; but we have had no crisis, properly so-called (though we have had sufficiently narrow escapes), since 1866. Improved banking has enabled us to pass from our booms to our slumps without any general collapse of credit, in which the sound and the unsound are all necessarily involved. This has not been the case in the United States. The financial crisis proper is a regular institution there, and I am afraid it becomes more acute as time goes on. This points to the inadequacy of their banking system.
No doubt a certain strain was put upon the banking system by the abnormal activity of business and the speculative inflation of 1906-7; but there was no reason why the banks, if properly organized, should not have easily met the strain. I do not think it can be said that the general condition of business was unsound. There had been remarkable developments of production, but they were in the main justified by the demand. Nowhere had this activity been more marked than in the railway world. But the development of the railways can hardly be called speculative. They were unable to carry the traffic that was coming forward. Hundreds of miles of sidings were blocked with cars that could not be got through. "To this day," says Mr. Leppington, "by far the greater portion of railroad mileage in the States is single track. Not long ago complaints were loud of a dearth of freight cars. The companies were devising ambitious schemes for bringing up their equipment to a level capable of coping with the requirements of an era of unprecedented prosperity. Lines were to be doubled and regraded, bridges rebuilt, rolling stock renewed." In the general markets there was no pronounced accumulation of unsold goods, except in the case of coffee; and the small number of business failures arising out of the crisis shows that there was no special commercial weakness. Professor Sprague says, "It would be difficult to find an equally long period of business activity, at the close of which the relative development of different industries would seem to have been similarly satisfactory."
1 Even in the height of the panic, November, 1907, traffic receipts were 3 per cent, above those of the previous year.
The financial position was much weaker. This very activity of business, however genuine we may consider it, had made great demands upon the loan markets of the world. Flotations had been overdone, and it was difficult to raise capital by normal methods. Even New York City had to borrow at 4 per cent., as against London's 3 per cent; and the railways had resorted to an excessive extent to the doubtful resource of borrowing on short-term bonds. The weakness was most pronounced in regard to Stock Exchange operations. Certain stocks and certain shares, notably copper shares, had been carried to extreme points by means of bank loans; and those loans had been very largely financed from this and other European markets by the agency of the Finance Bill. I admit all that, and I admit the danger of it. Stock Exchange loans are specially liable to give way when banks find it necessary to contract their advances. They can be more easily called in than commercial and international loans, because they are secured by collateral that can be easily realized within the margins imposed on borrowers. If, then, there is a very large amount of Stock Exchange advances out, it is in the power of the banks to bring about a very awkw ard contraction. The contraction goes on increasing, too, because the first effect is that securities are thrown on the market, and prices are brought down; and then, margins running off, further blocks must be sold, and the position grows steadily worse. But these Stock Exchange advances had been considerably reduced long before September 1907, and the prices of stocks were in many cases lower at the time when the panic set in than they are today. Messrs. Henry Clews & Co., in their circular for August 1907, while pointing out that the bank reserves needed strengthening in view of autumnal demands, observe that the security market had already had a severe shrinkage, and that, "beyond question, many good securities are selling below intrinsic values." The Stock Exchange position, if still artificial, ought not to have been unmanageable.
In short, I entirely accept the judgment of Professor Sprague, who writes that, "nothing in the general economic conditions of the country has been disclosed, either during the crisis or in the subsequent months of depression, which can be regarded as so hopelessly unsound as to have rendered the explosion of last autumn (1907) clearly unavoidable."
It has sometimes happened that where the conditions were otherwise satisfactory, a crisis has been caused by a sudden and unexpected withdrawal of gold from a country. This was certainly not the case with this particular crisis. There was no scarcity either of monetary or purely metallic resources. Credits had grown apace, but the monetary basis of the credit was not unduly small. In the eleven years, 1895-1906, the American banks and Treasury combined are estimated to have increased their gold holding by about two hundred millions, and just before the panic of October 1907, the stock of gold was estimated at 305,000,000. Their position, both in legal tender money and gold, was much stronger than ours [in the UK]. In December 1907, the National banks held legal tender to the extent of 16.7 per cent, of their deposits; the State banks, 8.28 per cent.; the Loan and Trust Companies, 5 per cent. an average for the whole of about 11 "3 per cent., of course excluding Savings Banks. On the same basis, our best showing would not be over 6 per cent; or, if we are to exclude the Bank of England, as corresponding in some degree with the United States Treasury, not more than 5 per cent. If we take the monetary stock per head of population, the United States banks held 7 of legal tender per head, as against our 4. Passing to the pure gold holding, the position is still better than our own. The United States banks held 6 per cent, of their deposit liabilities in gold, including certificates represented by bar gold, excluding the Treasury holding, against our 3 per cent, excluding the Bank of England, or 4 per cent, including it. Moreover, it must be remembered that there is no demand for gold as circulation in the United States, the currency being almost exclusively paper. I have only been in the United States once; but during the two months I was on that side of the Atlantic, I only once saw a United States gold coin. It was shown me as a curiosity. Such gold as they have is, therefore, all available for banking purposes. Further, the panic and the drain being entirely for internal purposes, any form of legal tender would be as serviceable as gold. In this respect our own case is more difficult. Our difficulties are likely to arise from a foreign drain, and could only be met by gold. Then we must not pass over the holdings of the United States Treasury, though the extent to which they will be available is always uncertain. In the August preceding the crisis, the Treasury held something like 354,000,000 of gold; and, although that was largely trust money, money held against various forms of legal tender, and earmarked in fact for currency purposes, yet much of this was not absolutely necessary to be held, and might have been used in case of necessity as our own issue reserve has been drawn upon at such times. But quite apart from this, there was a free reserve in the Treasury of over sixty-six millions sterling, not trust money or earmarked in any way (except that thirty millions is held to guarantee currency parity), which the Treasury might, if it thought proper, have used to assist the banks.
It seems clear, then, that the weakness did not lie in the monetary position. Their case was the reverse of our own. We make the utmost of our little monetary store, except in so far as we are obstructed by the Act of 1844. But it is quite inadequate in amount. They had ample monetary resources, but could not make effective use of them. The fault lay partly in their banking system, and partly in the banking habits generated by that system. These faults were matter of notoriety. They had often been pointed out, both at home and abroad; and the breakdown of the system had been predicted. For over twenty years I have been accustomed to use the American reserve law as the classical example of mistaken banking legislation. The Special Currency Committee of the New York Chamber, in October 1906, pointed out the want of elasticity in the currency, and recommended a central bank of issue, dealing exclusively with banks, and controlled by the Government. But Americans are like Englishmen. As long as they can make money, they have no time for anything else. Reforms have to wait till times are bad. Mr. Secretary Shaw, in proposing his emergency issue, September 28th, 1905, said: " He was convinced that there would be no further currency legislation until there was a panic occasioned by the want of elasticity. The country did not appreciate the danger, and until the danger was fully understood no remedy would be applied." Mr. Shaw was right. The panic came, and, immediately after the panic, you had the Aldrich-Vreeland Act of 1908. In March 1907, Mr. Rozenraad, noticing the introduction of a forerunner of this Act, the Aldrich Currency Bill, remarked that "the measure, good as it seemed to be, would only temporarily ease the New York money market. In the long run it would be found that a complete reorganisation of the existing Banking system would be necessary." Mr. Hermann Schmidt put the case more strongly. After criticising our own Bank Act, he said, "After all, England is scientific compared to the United States. There everything is topsy-turvydom, at least according to European ideas. They have no national bank, no central reserve fund, only the 15 to 25 per cent, of the deposits legally prescribed. The result is periodical crisis, when they have to go to the Treasury for assistance the trade of the whole country dependent upon the decision of a single individual about the worst situation possible."
But I must describe this American system, and you may form your own judgment as to the extent to which it was responsible for the crisis. Some account of it is all the more necessary, because it di ffers so much from our own and from most European systems.
As a basis for a contrast between the United States banking system and our own, let me take the Report of the Comptroller of the Currency, December 1907, which gives the position up to the June preceding the Taking round figures, there are (including savings banks) nearly 20,000 different and independent banks in the United States, with, say, 225 millions sterling of currency, and 2,620 millions sterling of deposits. Omitting savings banks, you get 18^ thousand banks, with nearly 200 millions sterling of currency, and 1,920 millions sterling of deposits. The deposits in the English banks are almost exactly half this amount. But the United States population is just double our own; hence the deposits per head are the same. Against these deposits the United States banks hold 12 per cent, reserve, as against our 5 per cent, or 6 per cent, (including till-money in each, and allowing for redeposited reserves). The total resources of these banks are put at 1,600,000,000 for the National banks, 800,000,000 for the State banks, and 800,000,000 for the Trust companies a total of 3,200,000,000, against about 1,150,000,000 for the banks of the United Kingdom. Allowing for the difference in population, the assets are about 50 per cent, larger per head in the United States than in the United Kingdom.
The contrast in the number of banks is very remarkable. Mr. Palgrave puts the total for the United Kingdom at 182; one hundred of these have no branches, and only the eighty-nine which publish accounts can be regarded as important. Even in this number are included army agents, and some institutions which are mainly discount houses. Mr. Boissevain puts the number of effective banks at seventy-four. But the total number of bank offices, including head offices, is 7,753. This works out at about fifty per cent, fewer offices per head of population than in the United States, where, of course, the population is more scattered. [The 108 foreign and colonial banks are excluded from this calculation.] The banks of the United Kingdom are now nearly all of them organised upon the Scottish or branch bank type. "There are four banks in England and Wales which alone direct more offices than all the banks in the whole of the United Kingdom possessed among them half a century since " (Mr. Palgrave). Lloyds, the London City and Midland, Barclays, and Capital and Counties control 2,070 offices. The whole United Kingdom only had 2,008 bank offices in 1858. Now, speaking broadly, American banks have no branches. They are forbidden in a great many States, and forbidden under the National Bank Act. I need hardly add that some of the separate banks in the United States are extremely small.
But there are many different kinds of United States banks, and I must say a word on the different types. You have, in the first place, some 6,500 National Banks. These all come under the National Bank Act, passed in 1863-4, and frequently amended. By conforming to the provisions of this Act they obtain the right of note issue, and certain other privileges. Then you have nearly ten thousand State banks, coming under the laws of the respective States, not always the same. These banks are not allowed to issue notes, and they are smaller, as a rule, than the National Banks. Then you have the important group called loan and trust companies, intimately connected, as we shall find, with the origin of the crisis of 1907. These must not be confused with the great commercial trusts we are so familiar with, such as the Standard Oil Company, the Steel Corporation, and the like. They are rather trustee companies; but they have added to their trustee business the functions of banking, just as our English banks are beginning to add the work of trustee companies to their banking business. They have been happily described by M. Arthur Raffalovitch as "financial maids-of-all- work," generals, in the civilian sense of that word. Their primary function was to take charge of securities, and to receive deposits as savings banks; then they undertook the execution of trusts of all kinds, much as our Official Trustee does; and to this they added the examination of titles, the care of real estate, fidelity insurance, and lastly, the practice of limited banking. They are not subject to the regulations imposed upon the National Banks.
As to the savings banks, I need only say that they are entitled to demand from thirty to sixty days' notice of withdrawal of deposits. That is a most valuable right at a time of panic, and not an unreasonable one when it is remembered that American panics are constantly accompanied by a premium on currency, so that it becomes a mere matter of interest for depositors, whether alarmed or not, to withdraw all the deposits they can control.
Over all these institutions, and at times in very vital relation to them, stands the Treasury of the United States. It is rather difficult to explain this in terms of European institutions. There is nothing exactly like it in Europe. But it is in the main a currency, rather than a banking institution; it is more like the Issue Department of our Bank of England than like its Banking Department, except, of course, that it holds the Government account. In this respect it exercises banking functions, and it is this side of its operations which is most disturbing to the money market, and most open to criticism. Its funds necessarily vary with the Government balances. At times it becomes possessed of large sums of money, drawn off the market by the collection of taxes, and, unless it can get rid of these surplus reserves, its operations cause a monetary stringency. But it has no regular and normal means of getting rid of this money, because it is not part of the general banking system. It can only be redistributed if the Secretary of the Treasury thinks fit to deposit moneys in the National banks on Government account. In doing this, the Secretary of the Treasury acts in something like the way in which our Chancellors of Exchequer have acted in times of crisis, when they have authorised the Bank to have access to the Issue Reserve. There is something arbitrary and artificial about this procedure which unfits it for normal use, and has made some persons object to resort to it in any case. No charges, so far as I know, have ever been brought against the absolute impartiality of the Secretaries of the Treasury in this action; but still it is not easy to defend a system which puts into the hands of a single individual the power of making money dear or cheap, of throwing twenty millions on the market or withholding it, as seems to him fit.
The primary business of the Treasury is to guarantee the parity of all the various forms of money in the United States. It is a first principle with the United States, in which all parties, whatever their monetary policies, have always agreed, that a dollar shall always be a dollar. That is to say, whether payment is made in silver dollars, gold coin, gold certificates, greenbacks, or National bank notes, all are agreed that there shall be no discount or premium as between the different forms of legal payment [how far have we fallen?] . Even their subsidiary money can be exchanged for full legal tender money. I am bound to say that they have been most successful in carrying this out. I have never heard of any premium or discount on any special form of their money. We have not been so successful with our silver, which is often sold at a discount. This business of keeping all the moneys of the United States at parity is the duty of the Treasury. Its huge reserves are maintained chiefly for this purpose, and the redemption fund by which it is able to guarantee payment of National bank notes in case of the failure of any bank may be ranked under the same head.
CHARACTER OF THE BANKS: THE RESERVE LAW.
After this sketch of the United States banking system, I come to consider the character of the banks and the reserve law. Here is an account from our Bankers' Magazine, February, 1903: "Each of the American banks is self-centred, with its own system of administration, its own reserve of specie and legal tender notes, and, in the case of the National banks, with its own note issue. These banks are established sometimes in very small towns, it may be said, almost in villages. It is a marvellous proof of the natural business ability of the citizens of the United States that such a number of banks can be successfully carried on." The National Bank Act of 1900, which somewhat relaxed the limits imposed by the original Act of 1864, permitted the establishment of banks in places of less than three thousand inhabitants, with a capital as small as 5,000. The Act greatly stimulated the formation of National banks; but it is clear that many of them must be very small, not large enough to be the principal business interest of those who own and manage them. Of late years there seems to have been an increasing tendency to obtain control of banks, in order to further private interests. Except as regards this latter point, the system of banking in the country districts of the United States strongly resembles the condition of English banking before the rise of the joint-stock banks, that is to say, in what we consider our worst period of banking. Of course, the large National banks in New York and the other central reserve cities are more like our great joint-stock banks in the magnitude of their operations, but they have no branches, and no connecting link in a central bank. To a European it seems obvious that it would be better if the whole system were organised, consolidated, and unified, and if the system of branch banking was adopted. But American public opinion appears to be opposed to such a change.
My reaction: This article does a good job of showing the problems the Federal Reserve was created to solve.