The Challenge of Credit Supply: American Problems and Solutions, 1650-1950 by Michael Anthony Kirsch

Author:Michael Anthony Kirsch [Kirsch, Michael Anthony]
Language: eng
Format: epub
Publisher: Vernon Art & Science, Inc.
Published: 2016-06-21T21:00:00+00:00

Chapter 16

Speculation and the Crisis of 1873

A growing issue for the Grant Administration was speculation using bank reserves along with the increasing cost of obtaining a reliable means of payment. The National Banking Act of 1864 designated seventeen cities as financial centers. In these locations national bank associations were required to hold 25% lawful money reserves against their total notes and deposits. National banks in these cities could deposit up to half of these reserves in national banks located in New York City. National banks outside of these seventeen cities had reserve requirements of 15% and were permitted to deposit three-fifths of those in a national bank located in one of the financial centers.

As depositories of the reserves of country banks, the financial center banks accumulated more reserves than they could employ in their normal business. They often lent the excess reserves out for speculative investment purposes. This money was more often than not demanded when money became tight, commonly at harvest time or when prices fell and credit was in high demand. During these periods competition for these deposits also rose. Banks in the financial centers began offering interest on deposits to induce country banks to select them. The bidding up of interest necessitated reinvestment with riskier investments in order to make sufficient profit to pay the higher deposit rates. Anticipation of tight money periods led many banks in the country to lend their excess reserves temporarily rather than invest their excess reserves in capital. When business was dull they would lend their money to eastern city banks as a way of making interim profits. Since few had use for short-term money of this kind, the New York banks would in turn lend it to investors or stockbrokers at low rates of interest. The deposits lent out for speculation were then unavailable in times of stress, and when country banks made simultaneous demands for their deposits panic would break out at city banks.1

During this period fluctuations in business activity often generated financial difficulty for the banks due to their inability to supply their debtors and communities with sufficient cash when required. Without the ability to create notes or a central institution devoted to the purpose, banks were unable to turn their liquid assets into a means of payment when most needed. The result was an unstable basis for the banking system, which could easily be pushed to a breaking point when unanticipated factors intervened.

To address these problems, Comptroller Hulburd proposed in 1868 that a clearinghouse agency should be established that would ensure redemptions of excess notes and centralize reserves. The central redeeming agency would prevent the reserves from being lent out to speculators and stockbrokers. It was to be a reservoir that would distribute reserves wherever they were needed for domestic exchange, facilitating debt settlements between cities. This agency would redeem national bank notes in gold. These measures would make the currency better able to contract and expand in response to supply and demand. However, only the redemption component of this agency would be established and not till much later.

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