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Modern Economic Problems by Frank Albert Fetter

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of credit by the banks at such times when they still had large amounts
of cash in their vaults increased the need and eagerness of the public
to draw from the bank all the cash they could, and often precipitated
the insolvency of the banks. Clearly some means were needed to enable
the loaning power of the individual banks to be increased at such
times, so that no customer with good commercial paper need fear to
be refused a loan, even tho the rate of interest might have to be
somewhat higher for a few days or weeks than the normal rate.

Our bond-secured bank notes lacked almost entirely the quality of
elasticity needed to meet these changing business needs.[6] Their
value being dependent primarily upon the amount and price of United
States bonds, they might be most numerous just when least needed as a
part of our circulating medium.

Sec. 7. #Periodical local congestion of funds#. In times of general
confidence each bank finds it profitable, and is tempted, to extend
its credit to the extreme limit permitted by the law governing the
proportion of reserves to deposits. Of the 15 per cent reserves
required in most banks, three-fifths (9 per cent) might be kept in
banks in reserve cities, and of the 25 per cent in reserve city banks,
12-1/2 per cent might be kept in central reserve cities, where it
counted as part of the depositing banks' legal reserves, was a fund
upon which domestic exchanges could be drawn, and usually earned a
small rate of interest (usually 2 per cent). Very large reserves were
kept in New York city where they could be loaned "on call," and the
largest use for call loans was in stock-exchange speculation. Thus
every period of prosperity encouraged an unhealthy distribution of
reserves, gave an unhealthy stimulus to rising prices, and "promoted
dangerous speculation."

Sec. 8. #Unequal territorial distribution of banking facilities.# Another
aspect of this concentration of surplus money and available funds in
the larger cities was the comparatively ample provision of banking
facilities in the cities and in the manufacturing sections, and
imperfect provision in the agricultural districts. The whole financial
system seemed designed to induce the poorer country districts to lend
funds at low rates of interest to be used speculatively in cities,
instead of enabling the richer districts, the cities, to lend to the
rural districts for productive enterprise. The rates of bank
discount in different sections of our country have long been most
unequal--lowest in the largest cities, and highest in the rural South
and West--whereas in all parts of Canada, with a different system of
banking, the rates have long been much more approximately uniform.

Indeed, our national banking development has been predominantly urban
and commercial to the neglect of rural and agricultural interests.
National banks were (until 1913) forbidden to make loans on real
estate, and this greatly "restricted their power to serve farmers and
other borrowers in rural communities." There was "no effective
agency to meet the ordinary or unusual demands for credit or currency
necessary for moving crops or for other legitimate purposes." The lack
of uniform standards of regulation, examination, and publication of
reports in the different sections prevented the free extension of
credit where most needed. Finally, the methods and agencies for
making domestic exchange of funds were, compared with other countries,
imperfect and uneconomical even in normal times and could not "prevent
disastrous disruption of all such exchanges in times of serious

Sec. 9. #Lack of provision for foreign financial operations.# Not without
its influence on public opinion was the consideration that we had "no
American banking institutions in foreign countries." Many bankers and
business men felt, as did the commission, that the time had come when
the organization of such banks was "necessary for the development of
our foreign trade." Foreign banks in South America and the Orient,
handling American trade, were believed to favor their own countrymen
rather than the interests of American merchants. In contrast with the
European nations with their centralized control of banking, we had "no
instrumentality that" could "deal effectively with the broad questions
which, from an international standpoint, affect the credit and status
of the United States as one of the great financial powers of the
world. In times of threatened trouble or of actual panic these
questions, which involve the course of foreign exchange and the
international movements of gold, are even more important to us from a
national than from an international standpoint."

Sec. 10. #The "Aldrich plan."# The National Monetary Commission submitted
with its report a plan which was known by the name of the commission's
chairman, Senator Aldrich. This plan was embodied in a bill for
a National Reserve Association, a bank for banks which bore some
likeness to the great central banks of Europe. In the many details
of the plan an effort has been made to remedy every one of the
difficulties above described and to supply all the needs indicated.
The plan was favored pretty generally by bankers, but called forth
many adverse opinions. In the year of a presidential election,
however, Congress took no action in the matter. All parties were
pledged to some kind of banking reform, but particular proposals were
not discussed in the campaign.

[Footnote 1: Whichever was the smaller. In 1900 this was changed so
that notes could be issued to the full amount of the denomination of
the bonds.]

[Footnote 2: In recent years this has been one half of 1 per cent when
2 per cent bonds, and 1 per cent when bonds bearing a higher interest,
were deposited.]

[Footnote 3: In reserve cities 25 per cent and in other cities 15 per
cent. The details of the regulations in the old law (given in part
below, sec. 7) were ll altered by the legislation of 1913.]

[Footnote 4: The expressions within quotation marks in the following
sections are taken from this report.]

[Footnote 5: See further on this in sec. 7 on periodical congestion of

[Footnote 6: See above, sec. 3.]

Chapter 9


Sec. 1. General banking organization. Sec. 2. The Federal Reserve Board.
Sec. 3. Federal reserve banks. Sec. 4. Federal reserve notes. Sec. 5. Reserves
against Federal reserve notes. Sec. 6. Reserves against Federal reserve
bank deposits. Sec. 7. Reserves in member banks. Sec. 8. Rediscount by
Federal reserve banks. Sec. 9. Changes in national banks.
Sec. 10. Operation of the Act.

Sec. 1. #General banking organization#. President Wilson and the newly
elected Congress with its Democratic majority made banking reform one
of the main objects on the program for the special session beginning
March 5, 1913. The result was the Glass-Owen bill, which became law
as the Federal Reserve Act December 23 of that year. The bill was
actively discussed within and without the halls of Congress, and
many of its features were attacked by bankers individually and acting
through the bankers' associations, at various stages of its progress.
As a result it underwent numerous amendments in details, and tho it
remained in most essentials as it was first proposed, it was at last
accepted even by its critics as on the whole a beneficent act of
legislation. Indeed, its strongest critics had been the friends of
the Aldrich plan, and the Federal Reserve Act embodies, in a greater
degree than its authors were ready to admit, the main features of the
Aldrich plan. In one important respect, however, it is different; it
provides for more decentralization of control and of reserves than did
the Aldrich plan. It created not one central banking reserve, but, in
the end, twelve regional, or district, banks each to keep the reserves
of its district. The Jacksonian tradition of opposition to a central
bank[1] in part helps to explain this; in part the contemporary
congressional investigation and discussion of the so-called
"money-trust" and the consequent desire to decrease the importance of
"Wall Street" and of New York city banking power.

On the accompanying map are given the outlines of the districts as
constituted and altered down to 1916.[2]


Sec. 2. #The Federal Reserve Board#. At the head of the banking system
stands the Federal Reserve Board of seven members, five of them
appointed by the President and Senate of the United States for this
purpose, and two serving _ex-officio_--the Secretary of the Treasury
and the Comptroller of the Currency. One of the five shall be
designated by the President as Governor and one as Vice-Governor of
the Board, but the Secretary of the Treasury is _ex-officio_ chairman.
The term of the appointive members is ten years and the salary is
$12,000 a year.

The powers of the board are numerous and important. The board is made
the head of a real _system_ of banking, the twelve parts of which can,
in times of emergency, and at the board's discretion, be compelled
to combine their reserves by means of lending to each other
(rediscounting), to the very limit of their resources, at rates fixed
by the board. By this means the reserves of the several district banks
may be "piped together" and thus be practically made into one central
bank under governmental control, altho centralization was in outward
form avoided by the bill. Alongside of the Reserve Board, is placed a
Federal Advisory Council, consisting of one member from the board of
directors of each of the twelve district banks. This council has only
the power to confer with, make representations and recommendations to,
and call for information from, the Federal Reserve Board.

Sec. 3. #Federal reserve banks#. The twelve Federal reserve banks which
opened for business November 16, 1914, are of a type of institution
new in our financial history. They are "banks for banks" belonging to
the system in their respective districts. Every national bank must,
and any state bank or trust company may,[3] subscribe for stock to
the amount of 6 per cent of its capital and surplus, and thus become
a "member bank." The capital of each Federal reserve bank was to be
at least $4,000,000; in fact only two of those organized (Atlanta and
Minneapolis) had at their opening less than $5,000,000 capital; the
largest (New York) had $21,000,000, and the average was $9,000,000.
The member banks are to receive dividends of 6 per cent, cumulative,
on this stock, and net earnings above that amount are to be paid to
the Government as a franchise tax.[4]

Each reserve bank has nine directors, consisting of three classes of
three men each. Classes A and B are elected by the member banks by a
system of group and preferential voting designed to prevent the large
banks from outvoting the smaller ones. Directors of class A are chosen
by the banks to represent them, and are expected to be bankers; those
of class B, tho chosen by the banks and tho they may be stockholders,
shall not be officers of any bank, and shall at the time of their
election be actively engaged within the district in commerce,
agriculture, or some other industrial pursuit. Directors in class
C are appointed by the Federal Reserve Board, one of them being
designated as chairman of the board of directors and as Federal
reserve agent. They represent the public particularly, and may not be
stockholders of any bank.

Any Federal reserve bank may:

a. Receive deposits from member banks and from the United States.

b. Discount upon the indorsement of any of its member banks negotiable
papers, with maturity not more than ninety days, that have arisen
out of actual business transactions, but not drawn for the purpose of
trading in stock and other investment securities.

c. Purchase in the open market anywhere various kinds of negotiable

d. Deal anywhere in gold coin and bullion.

e. Buy and sell anywhere bills, notes, revenue bonds, and warrants of
the states and subdivisions in the continental United States.

f. Fix the rate of discount it shall charge on each class of paper
(subject to review by the Federal Reserve Board).

g. Establish accounts with other Federal reserve banks and with banks
in foreign countries or establish foreign branches.

h. Apply to the Federal Reserve Board for Federal reserve notes to be
issued in the manner below indicated.

Sec. 4. #Federal reserve notes#. In 1914 there were outstanding about
$750,000,000 of what we may now call the old-style bank notes
(bond-secured). These were by the new act not forcibly retired at
once; but, as the law is shaped, they probably will be retired at
the rate of about $25,000,000 a year, and will all disappear from
circulation in thirty years.[5]

Whenever the banks having old-style bank notes outstanding desire to
retire any of their circulating notes, the Federal reserve banks
are required[6] to purchase the bonds in due quota (not to exceed
$25,000,000 in any one year). On the deposit of these bonds with the
Treasurer of the United States, the Federal reserve banks may receive
other circulating notes (essentially of the old style) called Federal
reserve bank notes, or may receive 3 per cent bonds not bearing the
circulating privilege.

The new kind of notes provided by the act are called Federal reserve
notes. They are not secured by the deposit of government bonds, but
they are secured beyond all question in other ways. First, they are
obligations of the United States receivable for all taxes, customs,
and other public dues, and are redeemable in gold on demand at the
Treasury of the United States. Secondly they are receivable by all
member banks in the twelve districts and by all Federal reserve banks,
and redeemable by the latter in gold or lawful money (which includes
greenbacks and gold and silver certificates). Thirdly, their credit
and prompt redemption is insured by certain elastic rules as to
reserves in gold which must be kept for the redemption of outstanding
notes. Fourthly, they are secured by collateral, consisting of notes
and bills accepted for rediscount from member banks, which must be
deposited by a Federal reserve bank with the Federal reserve agent of
its district, dollar for dollar for every note it receives. Fifthly,
the notes become "a first and paramount lien on all the assets of the
bank." This is what gives the notes their character of asset currency.
It is evident that the notes unite in a manner without example
the characteristic of asset bank notes with the characteristics of
political paper money.[7]

No notes, it will be observed, are issued by or on request of the
member banks, but only on request of a Federal reserve bank. After the
notes have been issued, the bank may reduce its liability any day by
depositing lawful money with the Federal reserve agent who is right
there in the bank. The Federal reserve banks and the United States
Treasury must promptly return to the banks through which they were
issued all notes as fast as they are received, and "no Federal reserve
bank shall pay out notes issued through another on penalty of a tax of
ten per centum." The regulations do not apply to the member banks,
but their effect must be to keep notes from circulating long in any
district except that for which they were issued.

Sec. 5. #Reserves against Federal reserve notes.# The rule applying in
normal times to reserves against note issues is that each bank must
provide a reserve in gold equal to 40 per cent "against the Federal
reserve notes in actual circulation, and not offset by gold or lawful
money deposited with the Federal reserve agent." At least 5 per
cent is to be on deposit in the Treasury of the United States. The
proportion of reserves to the liability for note issues by any bank,
however, may be allowed to fall below 40 per cent, on condition that
the Federal Reserve Board shall establish a graduated tax of not more
than 1 per cent per annum (it evidently might be made less if the
board chose) upon such deficiency, until the reserves fall to 32-1/2
per cent and thereafter a graduated tax of not less than 1-1/2
per cent on each additional 2-1/2 per cent deficiency or fraction

This tax must be paid by the reserve bank, but it must add an amount
equal to the tax to the rates of interest and discount charged to
member banks. The effect of these rules is to give a power of note
issue in time of emergency without compelling the reserve banks to
lock up their reserves held against notes. Suppose for example that
the circulating notes were in normal times $1,000,000,000 and the
reserves, therefore, were $400,000,000 and the rate of discount 5 per
cent. Then the circulation might be doubled with the same reserves,
the proportion thus falling to 20 per cent of outstanding notes, and
the rate of discount to customers rising to 13.5 per cent (5 plus
8.5). Or, to take a most extreme supposition, suppose that the
withdrawal of gold had been so great as to reduce the reserves against
notes to $50,000,000; yet outstanding notes might be doubled (becoming
$2,000,000,000,) the proportion falling to 2.5 per cent, the rate of
discount rising to 24 (5 plus 19).

Sec. 6. #Reserves against Federal reserve bank deposits.# Every Federal
reserve bank shall, under normal conditions, maintain reserves in
lawful money of not less than 35 per cent against its deposits. But
the Federal Reserve Board may suspend any reserve requirement in the
Act for a period not exceeding 30 days and from time to time renew the
suspension for periods not exceeding 15 days; but in that case it
must establish a graduated tax upon the amounts by which the reserve
requirements may be permitted to fall below the levels specified as to
note issues. Altho the amount of the tax on the deficiency of reserves
against deposits is not indicated in the act (as it is in respect to
excess note issues) it is plainly the thought that the Board, to which
discretion is left, will follow somewhat the same rule in both cases.
The great discretionary power as to reserve requirements thus lodged
in the hands of the Board makes possible at times of emergency the
use of the reserves both of the reserve banks and of the member banks,
down to the last dollar, if need be, without violation of law. This
gives practically unlimited opportunity to expand credit both by
the issue of bank notes and by discount and deposit in periods of
financial crises.

Sec. 7. #Reserves in member banks.# A fundamental change is made in the
rules as to the reserves against deposits that must be maintained by
the member banks. A new distinction is made between time and demand
deposits. Time deposits are defined as those payable after thirty days
or subject to not less than thirty days' notice; and demand deposits
as those payable within thirty days. In every case the reserve
requirement against time deposits is only 5 per cent. This gives
encouragement to banks to maintain savings departments.

The requirements as to reserves against demand deposits are not
uniform, being the lowest for banks in smaller cities (the great
majority), larger for banks in the reserve cities, and largest for
banks in the three central reserve cities (New York, Chicago, St.
Louis). The act substitutes the new Federal reserve banks for the
banks in reserve and central reserve cities as the depositories of
funds that may[9] be counted as a part of the reserves of member
banks. The new rule requires that one-third must be in the bank's own
possession, a fraction slightly over a third must be in the Federal
reserve bank, and the remainder may be kept in either place. This may
be tabulated as follows:

_Not in In reserve In central
reserve cities cities reserve cities_

Total reserves, per cent 12 15 18
Must be in its own vaults 4/12 5/15 6/18
May be either place 3/12 4/15 5/18
Must be in a Federal reserve bank 5/12 6/15 7/18

These requirements as to total reserves are, as compared with
requirements of national banks under the old law, a reduction
respectively of 20 per cent, 40 per cent, and 28 per cent. The total
decrease in the amount of reserves required for all three classes of
national banks was about $400,000,000 on the amount of deposits held
in September, 1914.

Sec. 8. #Rediscounts by Federal reserve banks.# More important than
any other single feature of the act is, however, that by which each
Federal reserve bank is to rediscount notes, drafts, and bills of
exchange arising out of actual commercial transactions, when indorsed
and presented by any of its member banks. This, quite apart from
the note issues, gives a power to the banks collectively, under
the general supervision and control of the board, to expand credits
indefinitely at any time for real business purposes. Any business man
able to offer any commercial paper of sound quality should now be able
to borrow on it at some rate of discount, even in the most stringent
times. And, in turn, every member bank will now be able at such times
to rediscount such paper and thus secure credit toward its reserve
requirement on the books of its Federal reserve bank. Suppose, for
example, that a member bank (in a central reserve city) saw its
reserve in the Federal bank fall below 7 per cent of its deposits. It
could by rediscounting $7000 worth of notes increase by $38,888 the
amount to which it might legally extend credit to its customers (i.e.,
$7000 is 18 per cent of that sum). The deposits of the Federal reserve
bank would then be increased $7000, against which it must have a
reserve of 35 per cent, or $2450. If the reserves of any Federal
reserve bank fall too low, it can in turn rediscount its paper with
the other Federal reserve banks.[10] If the time comes when no one of
the twelve banks can longer maintain a 35 per cent reserve, the
board may reduce or suspend the requirement, levying a tax graduated
according to the deficiency. The provision here for elasticity of
credit combined with union and solidarity of all the central banking
reserves of the country to meet unusual demands in emergencies,
exceeds any needs which can be expected to arise.

Sec. 9. #Changes in national banks.# There is here created a national
system of reserves, but it will be observed that membership in the new
system of the Federal reserve banks is not limited to national banks,
but is open on equal terms to banks organized under state laws. While
in most respects the general banking law remains as it was, certain
changes are of importance. The percentage of reserves henceforth
required of all member banks (as above indicated) is a substantial
reduction of the former requirement for national banks. In some other
respects the powers of national banks are enlarged. One with a capital
and surplus of $1,000,000 may with the approval of the Board establish
foreign branches, and one not situated in a central reserve city may
loan on farm lands for a term not longer than five years, but not to
exceed one third of its time deposits or 25 per cent of its capital
and surplus. National banks may now be granted permission by the board
to act as trustee, executor, administrator, or registrar of stocks and
bonds, thus having the rights that have proved in many cases to be of
advantage to trust companies organized under state laws.

Sec. 10. #Operation of the Act#. It was fortunate that this act was
nearly ready to be put into operation when, August 1, 1914, the great
European war broke out. The able appointees to the Federal Reserve
Board commanded the confidence of the bankers and of the public. The
knowledge that the reserve banks would early begin operations was
reassuring during the grave financial stress of the next three months,
and the opening of the district banks in November, 1914, at once made
possible the release for commercial uses of cash reserves and
credits to meet the needs of reviving business.[11] Only an extended
experience can show how this enormous new banking organization will
operate as a whole and in its details.

Because of the very wide discretionary powers given to the board
in the administration of the act much depends on the character and
ability of the members of the board as well as on a sound public
opinion that will keep this great power from use in partisan and
selfish ways. No doubt amendments of the act will appear necessary,
but there can be no question that the Federal Reserve Act has
inaugurated a new epoch in the banking and financial history of our

[Footnote 1: See ch. 8, sec. 1.]

[Footnote 2: The law provided that an organization committee should
designate not less than eight nor more than twelve cities as Federal
reserve cities and should divide the continental United States,
excluding Alaska, into districts each containing one such city. Twelve
districts were designated. Wherever, therefore, the act speaks of "not
less than eight nor more than twelve," or of "as many as there are
Federal reserve districts," we may, for convenience, speak of twelve.]

[Footnote 3: On agreeing to comply with reserve and capital
requirements of national banks and to submit to Federal examination.]

[Footnote 4: Except that until the surplus of any reserve bank amounts
to 40 per cent of its paid-in capital stock, one half of its net
earnings shall be paid into a surplus fund.]

[Footnote 5: These notes are all secured by the deposit of bonds of
the United States, a large share of them bearing interest at the very
low rate of 2 per cent. Two per cent is less than the market rate for
government loans, for 3 per cent bonds without this privilege
sell above par. Therefore these 2 per cent bonds were held almost
exclusively by banks, and would have lost a good share of their value
had the note-deposit privilege been withdrawn.]

[Footnote 6: Through the Federal Reserve Board or they may do it
voluntarily, sec. 4.]

[Footnote 7: The Act does not explicitly say by whom the notes are
issued: it says that they are "to be issued at the discretion of the
Federal Reserve Board"; that "the said notes shall be obligations of
the United States." Further on the notes are spoken of as "issued
to" a Federal reserve bank, and again as "issued through" a Federal
reserve bank, but not _by_ it. But the phrase occurs (sec. 16) "its
[i.e., the Federal reserve bank's] Federal reserve notes." The notes
thus are technically issued by the United States, but not as ordinary
political (fiat) money, for they are not given a forced circulation
by the Government in paying its indebtedness. But the banks "shall pay
such rate of interest on" the amounts of notes outstanding as may be
established by the Federal Reserve Board (i.e., to the Government of
the United States). Practically the notes (as respects choice of time
of issue, amounts, profits from them, commercial assets to secure them
and to redeem them) are asset currency issued by the several Federal
reserve banks.]

[Footnote 8: This may be shown in the following table:

When reserves against notes are the tax rate upon the total
are-- deficiency shall be--

Below 40.0 to 32.5 per cent 1.0 per cent
" 35.5 to 30.0 " " 2.5 " "
" 30.0 to 27.5 " " 4.0 " "
" 27.5 to 25.0 " " 5.5 " "
" 25.0 to 22.5 " " 7.0 " "
" 22.5 to 20.0 " " 8.5 " "
" 20.0 to 17.5 " " 10.0 " "
" 17.5 to 15.0 " " 11.5 " "
" 15.0 to 12.5 " " 13.0 " "
" 12.5 to 10.0 " " 14.5 " "
" 10.0 to 7.5 " " 16.0 " "
" 7.5 to 5.0 " " 17.5 " "
" 5.0 to 2.5 " " 19.0 " "
" 2.5 to 0.0 " " 20.5 " "

[Footnote 9: The complete application of the new rule is deferred for
a period of three years from the passage of the act.]

[Footnote 10: See on "piping" provision, sec. 2, above.]

[Footnote 11: See sec. 7 above.]

[Footnote 12: Several other features of the law well merit
description. Among these features are measures for developing bankers'
acceptances, open market operations, the gold clearing system of
the Federal Reserve Board, and the clearing of checks and parring of



Sec. 1. Mischance, special and general, in business. Sec. 2. Definitions.
Sec. 3. A feature of a money economy. Sec. 4. European crises. Sec. 5. American
crises. Sec. 6. A business cycle. Sec. 7. General features of a crisis.
Sec. 8. "Glut" theories of crises. Sec. 9. Monetary theories of crises. Sec. 10.
Capitalization theory of crises. Sec. 11. The use of credit. Sec. 12. Interest
rates in a crisis. Sec. 13. Dynamic conditions and price readjustments.
Sec. 14. Tariff changes and business uncertainty. Sec. 15. Rhythmic changes
in weather and in crops. Sec. 16. Remedies for crises.

Sec. 1. #Mischance, special and general, in business.# Every separate
business enterprise is subject to chances which suddenly decrease
its profits and the prosperity of its owners; such are fire, flood,
illness of its owners, unfavorable changes in prices of materials
or of the products.[1] The interests of many other persons in the
neighborhood may be so bound up with an enterprise that its losses may
mean unemployment, lower wages to workingmen, and bankruptcy to local
merchants and to banks. Sometimes misfortune and disaster affect whole
communities. The lack of cotton while the Civil War was in progress
compelled the factories of Manchester to close in 1864, and the
earthquake and fire in San Francisco in 1906 left a quarter of a
million people homeless.

But a change of business conditions is constantly occurring that is of
wider extent, that is of less accidental and of more rhythmic nature,
and that appears to be the effect of slowly working and more general
causes. The enterprise of a modern community, as a whole, "general
business," moves along, in a wavelike manner, going through a somewhat
regular series of changes that is called a business cycle. We are now
to study the nature of these cycles.

Sec. 2. #Definitions.# Crisis means, generally, a decisive moment or
turning point. The word crisis suggests a brief period, a moment,
something that is sudden, severe, and soon over. In medical usage
it is the period when the disease must take a turn for better or
for worse. As used in economics, the term, however, implies a sudden
change of business conditions for the worse, a collapse of prosperity.
What precedes has not the appearance of disease, but rather that
of exuberant health. Crises in economics may be distinguished as
industrial, speculative, and financial, according as one or another
influence seems to be more potent, but all are essentially financial.
The change that occurs always is connected in some way with the use of
money and credit.

A financial _crisis_ is the culmination of a period of rising prices,
and a sudden fall which shatters the credit of some banks, brokers,
merchants, and manufacturers. Every crisis is marked by much confusion
and loss and by hasty efforts of individuals and institutions to meet
their pressing obligations. Sometimes this process of liquidation goes
on quietly and in other cases it becomes a wild scramble, each one
trying to save himself, in which case it is a financial _panic_.
An _industrial depression_ is the period of hard times that usually
follows a financial crisis.

Sec. 3. #A feature of a money economy.# Financial crises, by their
very nature, are confined to communities in which the money economy
prevails and where there is a developed state of industry. The periods
of industrial hardship in the Middle Ages were connected usually not
with the collapse of prices, but with political oppression, famine,
wars, pestilence, and scourges of nature. Throughout the lands money
was little used and there was no development of credit and of credit
prices. The money economy began, as has been noted, in the cities.
As the use of money spread, as larger commercial enterprises were
undertaken, as borrowing and the payment of interest became common,
there began to appear in city trading circles, on a small scale, the
phenomena of the modern crisis.[2]

Sec. 4. #European crises.# In Europe financial crises date from 1763
and have occurred at more or less regular intervals since. The common
statement that the cycle of a crisis is run in a period of ten
years, finds only partial support in history. The chief crises of the
eighteenth century occurred in 1763, 1783, 1793, these dates marking
the close of wars of some magnitude. The crises were not widespread
or general, but were more marked in England, which was at that time
farther developed industrially and in its money economy than other
countries. Likewise, in the nineteenth century, the crises were of
unequal force in various countries, usually being severer in England.
They may be dated 1803, 1825, 1838, 1847, 1857, 1864-66, 1875, 1890,
1900, 1907, and 1914. These were attributed to various causes; that of
1825 to over-trading abroad; that of 1847 to railroad-building; while
that of 1866 followed the severe disturbance of trade in 1864 caused
by the interruption of the cotton trade and commerce by the Civil
War in America. While in many parts of England the crisis of 1864 was
unusually severe, in other countries it was of little moment. Germany,
after several years of great speculative prosperity, had a most
severe crisis in 1875; while France, although prostrated by the war
of 1870-71, losing a large amount of wealth, and paying a thousand
millions of dollars to Germany as a war indemnity, escaped a
commercial crisis almost entirely at that time.

Sec. 5. #American crises.# Since the beginning of the nineteenth century,
the financial connections of the United States with London, the
leading loan market of Europe, have been such that every crisis
in either England or America has extended its effects to the other
country. But the disturbances are so modified by the particular
conditions (of crops, politics, and speculation) that the phenomena
never correspond exactly in time of occurrence, in duration, or in
intensity. The first notable crisis in America occurred about 1817
in the very violent readjustment of trade after the resumption of
commerce with Europe in 1816.[3] In 1837-39 came in quick succession
two crises, not quite distinct from each other, the second similar
to the relapse of a fever patient. The conditions were rapid westward
expansion, over-speculation in lands, reckless state internal
improvements, great issues of state bank notes, and the financial
measures of Andrew Jackson, which included the dissolution of the
Second Bank of the United States in 1836.[4] The crisis of 1857
followed a period of great prosperity marked by rising gold production
and prices and a great increase in foreign trade. The crisis of 1873,
possibly the severest in our history, followed great speculation,
especially in the direction of railroad building on an unexampled
scale after the war. The blow, when it fell, was intensified by the
relative contraction of currency then in progress, leading to the
return to a specie basis and lower prices.[5] The crisis of 1884,
a comparatively slight one, occasioned (rather than caused) by the
discussion of the money question, was followed by some years of
noticeable depression. The years 1889 to 1892 witnessed prosperity,
only slightly interrupted in 1890, that culminated in a crisis in May,
1893 (likewise generally explained as due to the unsettled state of
our monetary system), followed by a period of great depression lasting
until 1897. A rapid growth of business was checked but little in 1900
when a crisis occurred in Europe, especially severe in Germany. In
November, 1902, began in America what has been called "the rich
man's panic" of 1903 in which for a year many securities were sold
by holders because European creditors were recalling their loans.
American business, however, slackened but little, altho building
operations were somewhat checked. General prices, which had been
moving upward since 1897, remained almost unchanged in 1903 and
1904, and then continued going upward until 1907. In the period from
September to November of that year occurred a severe crisis both in
Europe and in America. The industrial depression following this was
marked in 1908, slowly growing less. The crisis at the outbreak of the
war in August, 1914, was quite exceptional, being due to the sudden
demand of Europe upon New York for funds. Within a couple of months
it was over and soon prices were again rising as the result of large
exports of merchandise followed by gold imports.

Sec. 6. #A business cycle#. Let us now sketch in broad outline a business
cycle, bearing in mind that this series of changes does not repeat
itself with unvarying regularity, but that it is fairly typical in
the modern business world. The period leading up to a crisis is one
of relative prosperity; then occurs a crisis in which prices fall,
at first rapidly, and afterward for a while going slowly lower. When
prices are at the lowest point many factories are closed, and much
labor is unemployed. Let us start at that point. Conditions are worse
in some industries than in others. General economy and great caution
prevail; few new enterprises are undertaken. For those persons having
available funds this is a good time to buy, and property begins to
change hands. Then hoarded money begins to come out of its hiding
places. Money and credit flow in from other countries, particularly if
business conditions are better abroad than here, for when prices are
lower than they have been, relative to those of other countries, a
country is a good place in which to buy. At the same time that the
money in circulation thus increases, there is a general return of
confidence that increases credit. Not only are there more dollars, but
each does more work. Then old enterprises are resumed and new ones are
undertaken. The purchase of materials in larger quantities causes a
rapid rise in the prices of many raw materials and of all kinds of
industrial equipment. The less efficient laborers and others that have
been out of work, begin to find employment, and then, more tardily,
wages begin to rise. As a result, the costs of many products begin to
rise rapidly. The only classes not sharing in this improvement are the
receivers of fixed incomes. As prices rise, the purchasing power of
their incomes correspondingly falls.

At length prices begin to go up less rapidly, and the question arises
in many minds whether the movement can continue, and if not, when it
will cease. Men wish to hold on for the last profits, and are willing
to risk something to gain them. When prices rise not only as compared
with former domestic prices, but as compared with current foreign
prices, foreign imports are stimulated and exports fall. This calls
for a new equilibrium of money and requires at length large and
continued exportation of specie. This checks prices, and, reducing the
specie reserves of the banks, compels them to be more cautious. At the
same time the increase of costs in many industries begins to reduce
profits. The fall in the value of many stocks and securities held
by the banks forces many brokers and speculators to convert their
resources into ready money. This is the moment of danger; weak
enterprises find their foundations crumbling, and there are many
failures.[6] The falling prices, the shattered credit, and the
financial losses force many factories to close, and many workmen
are thrown out of employment. This moment of widespread loss is the
crisis, It is followed by another period of low prices and of small
output, and therefore of profits small or negative in many industries.
Business must again enter upon a period of retrenchment, for it has
completed another cycle.

Sec. 7. #General features of a crisis.# Altho irregular in time of
occurrence and unlike in their immediate occasions, financial crises
show certain general features. They are a part of the larger movement
here outlined as the business cycle. Some have thought this cycle to
be normally a period of ten years, divided into one year of crisis,
three years of depression, three years of recovery, and three years of
unusual prosperity. This succession of events occurs pretty regularly,
though not in the regular intervals of time. Crises are more severe in
countries with more extensive use of money and credit, but still more
severe where the credit system is more loosely administered and less
efficiently cooerdinated. They are harder in the United States and
England than in Germany, harder in Germany than in France, harder in
western Europe than in eastern Europe, harder in Christendom than in
heathendom. They are less severe in rural districts, where prosperity
depends more on crop conditions, and business has in it less of
financial speculation. Their effects are least felt in the staple
industries, for when hard times come people economize on the
less essential things. The glove-factory, the silk-factory, the
golf-club-factory are more likely to close than the flour-mill. In
a crisis wages and salaries are less affected than are profits, but
wageworkers suffer in the loss of employment. Those money lenders who
have eliminated chance as far as possible and have taken a low rate
of interest lose little; the risk-takers who draw their incomes from
dividends on stock or from bonds of a less stable kind, often lose

Sec. 8. #"Glut" theories of crises#. Many explanations of the causes of
financial crises have been offered.[7] Nearly all of these belong to
the general group of "glut" theories, of which genus there are two
species, under-consumption and over-production theories. These are, in
truth, but two aspects of the same idea.[8] The one view is that too
many goods are produced, the other that too few are consumed. The
over-production theorist seeing that in a crisis warehouses are filled
with goods that cannot be disposed of for what they cost (or at best,
not so as to give a profit), and that factories are shut down and men
are out of employment for lack of demand, declares that productive
power has grown too great. The under-consumption theorist, seeing
the same facts, says that the trouble is lack of purchasing power. He
observes that there are some people who would like to buy more of some
of these things, but that such people lack income with which to buy.
Usually he asserts that this is because production grows faster
than wages, wages being fixed, as he believes, by the minimum
of subsistence--a theory akin to the iron law of wages. In both
over-production and under-consumption theories, the inequality of
demand and supply is looked upon as a general one. There is supposed
to be not merely an unequal and mistaken distribution of production,
but a general excess of productive power.

The wide vogue held by these views would justify a fuller discussion
and disproof of them here, did space permit. It must suffice to
indicate merely that they have the same taint of illogicalness as the
"fallacy of waste," and the "fallacy of luxury."[9] They overlook the
fact that an income, either of money or of other goods, coming even
to the wealthiest, will be used in some way. It may be used either
for immediate consumption or for further indirect use in durable
form. Through miscalculation there may be, at a given moment, too many
consumption goods of a particular kind, but the durable applications
can find no limit until the inconceivable day when the material world
is no longer capable of improvement. At the time of a crisis, there is
unquestionably a bad apportionment of productive agents, and a still
worse adjustment of their valuations, but these facts should not be
taken as proving that there is an excess of all kinds of economic

Sec. 9. #Monetary theories of crises.# Another group of theories explains
the crises as being due to money, either too much or too little. The
unregulated issue of bank notes has been assigned as the cause of
crises, especially under the circumstances accompanying such crises
as those of 1837 and 1857 in America, when bank note issues greatly
contributed to the unsound expansion of credit. The issue of
government paper money years before, leading to inflation and
speculation, was by many believed to be the cause of the crisis
of 1873. The reverse view is taken by the advocates of a cheap and
plentiful money. They say that these crises were caused, not by the
expansion, but by the contraction of the money stock; for example, not
by the inflation of prices through the issue of greenbacks in 1862 to
1865, but by the contraction of the currency from 1866 to 1873.

There is only a fragment of truth in these various views. It is always
lack of "money" at the moment of the crisis that causes any particular
failure, and in that sense it is always lack of "money" that causes
a crisis. The question is, whether in any reasonable sense it can be
said that it was lack of a circulating medium before the crisis that
brought it on. There is no support for this view, except in the rare
case when the money standard is undergoing a rapid change, as in the
United States from 1866 to 1873, and the statement then needs much
modification and explanation. The monetary theories of crises are a
bit nearer to the truth than are those of the over-production type,
for the crisis is always connected with prices and credit. But it
is clear that these rhythmic price changes occurring in the business
cycle are not due to the same causes as are the general movements of
the price level, due to an increasing or decreasing output of gold or
again to a paper money inflation. Statistics show that while a general
price level is slowly changing like a tidal movement, the effect
of the rhythmic business cycle appears now in hastening, now in
retarding, the changes in the price level.

Sec. 10. #Capitalization theory of crises#. Here we verge upon a
different type of explanation of the financial crisis--one of a
psychological nature. The quantity of money, we have seen, affects
prices more or less according as credit is more or less used in
connection with it. Money plus confidence has a larger power of
sustaining prices, than money without, or with less, confidence. And
throughout the business cycle the amount of confidence, expressed in
such ways as the readiness to grant credits and in the easy extension
of the time of collection, is constantly changing. Over-confidence at
one time is suddenly followed by widespread lack of confidence. This
has led some to say that lack of confidence is the cause of crises.
This is a truism, but it does not explain what is the real cause of
this lack of confidence, which, when the crisis comes, is not mere
unreasoning fear that needs only to ignore the danger to banish it.
Might it not just as truly, if not more truly, be said that the cause
is _over-confidence_ in the period preceding the crisis?

The essential characteristic of a crisis is the forcible and sudden
movement of readjustment in the mistaken capitalization of productive
agents. Capitalization runs through all industry. The value of
everything that lasts for more than a moment is built in part upon
incomes that are not actual, but expectative, whose amount, therefore,
is a matter of guesswork, or "speculation."[10] Many unknown factors
enter into the estimate of future incomes. The universal tendency
to rhythm in motion (material or psychic) manifests itself in an
overestimate or underestimate of incomes and of every other factor in
value. This is emphasized by a psychological factor called sometimes
the "hypnotism of the crowd," and sometimes, the "mob mind." Most
men follow a leader in investment as in other things. The spirit of
speculation grows till often it becomes almost a frenzy, and people
rush toward this or that investment, throwing capitalization in some
industries far out of equilibrium with that in others.

The cause of crises immediately back of the maladjusted capitalization
thus is seen to be a psychological factor; it is the rhythmic
miscalculation of incomes and of capital value, occurring to some
degree throughout industry, but particularly in certain lines. This
subjective cause in men is given an opportunity for action only when
certain favoring objective conditions are present.

Sec. 11. #The use of credit.# Most noteworthy of these objective
conditions is the general use of credit. The credit system greatly
enhances the rhythm of price. If the value of a thing that is fully
paid for falls, the owner alone loses; but if the value of a thing
only partly paid for falls so much that the owner is forced to default
in his payment, the loss may be transmitted along the line of credit
to every one in a long series of transactions. A credit system, highly
developed, is a house of cards at a time of financial stress. Demand
liabilities are at such a time the greatest danger, so that the banks,
ordinarily the pillars of financial strength, become at such a time
the points of greatest weakness in the financial situation. If many
of the customers were not restrained by their sense of personal
obligation to the banks, by the strong pressure which the banks can
bring to bear upon them, or by the force of public opinion among
business men, from withdrawing the balances to their credit in a time
of crisis, all commercial banks would become insolvent at once in a
crisis by the very nature of their business; for all their ordinary
deposits are nominally payable on demand.

Sec. 12. #Interest rates in a crisis.# In normal times there is always
outstanding a great mass of short-time, commercial loans.[11] The
motive of the borrower, in most cases has been to hire more labor and
to buy more materials for use in his business. Ordinarily these loans
can and are renewed without difficulty or are replaced by others,
based on the security of new business transactions in unbroken
succession. Now at the time of a crisis a general contraction of
credit occurs, and all borrowers with maturing obligations are faced
with bankruptcy. The effort of the business man at such a time is not
to make a positive profit, but to save what he can from the threatened
wreck. The demand for short-time loans, therefore, in such times
of stress, fluctuates rapidly, and exceedingly high interest rates
prevail in these loan markets for a few days or a few weeks, rates
which have only a remote relationship with the usual capitalization of
most agents.

The distress of the business man is magnified by the fact that it
is just at such times that both the equipment he has bought and the
products he has made become temporarily almost unsaleable at prices as
high as he paid for them when he bought them with the borrowed money.
He may know that prices will soon be higher, but he cannot wait.
Various courses are open to him in this emergency; he may borrow the
money at a very high rate of interest, holding the goods for better
prices; or he may sell the goods under the unfavorable conditions; or
he may sell other capital such as stocks and bonds. The end sought
is the same--to get ready money; and the methods are not essentially
unlike--the exchange of greater future values for smaller present
values. The sacrifice sale thus reveals the merchant's high estimate
of present goods in the form of money. The purchaser of some kinds
of property in times of depression is securing them at a lower
capitalization than they will later have. The rise in value may be
foreseen as well by seller as by buyer, but the low capitalization
reflects the high interest rate temporarily obtaining. A.T. Stewart,
once the most famous New York merchant, is said to have laid the
foundation of his fortune when, being out of debt himself, he bought
up the bankrupt stocks of his competitors in a great financial panic.
The high interest at such times is but the reflection of the high
premium on present purchasing power.

The worst of the evils of crises are confined to the markets where the
greatest numbers of short-time loans are made. Most of the long-time
loans do not fall due in such seasons of stress, and the great mass of
slowly exchanging wealth alters little and slowly in price. Such loans
as fall due can generally be renewed for long periods at rates little
higher than usual, the market for long-time and short-time loans being
in large measure independent of each other. But they are not quite
independent, and some lenders take whatever sums they can collect on
maturing long-time obligations and loan them on short terms at high
rates of interest, or buy goods, whole enterprises, bonds, and stocks,
at the unusually low prices temporarily prevailing. The effect of this
is to raise somewhat the interest rate on long-time paper to accord
with the new conditions.

Sec. 13. #Dynamic conditions and price readjustments.# Another condition
favorable to the rhythmic movement of capitalization is a dynamic
economic society. The past century has opened up new fields for
investment on an unexampled scale. Investment has advanced both
intensively and extensively in a series of great waves. New machinery
and processes have given undreamt of opportunities for enterprise in
the older countries, and the physical frontier of investment has moved
outward with the march of millions of immigrants to people the fertile
wilderness. Such factors disturb the equilibrium of prices both in
time and space, give a powerful impulse toward higher values in
the older lands, and stimulate the hopes of all investors. When the
balance between the capitalizations of various industries and between
the incomes of the various periods proves to be false, the inevitable
readjustment causes suffering and loss to many, but particularly in
the inflated industries. But, because of the mutual relations of men
in business, few even of those who have kept freest from speculation
can quite escape the evils.

Among the dynamic conditions in industry are changes in the general
price level whether due to changes in the production of the standard
money commodity (relative to population) or to changing methods of
doing business. If the price level is falling (i.e., the standard unit
is appreciating), the burden of the great mass of outstanding debts
is growing heavier upon the debtors.[12] Sooner or later some of them
break down under its weight. At such times many attempt to shift their
capital from active investments such as stocks, to passive investments
such as bonds. When the price level is rising, the opposite conditions
prevail. But such adjustments proceed uncertainly and unevenly in
different industries, with much speculation in shifting from one type
of business to another, and with much accompanying miscalculation.

Sec. 14. #Tariff changes and business uncertainty.# Another variable
influence in American business has been the tariff. Every tariff
revision, whether the rates go upward or downward, shifts somewhat
the relative opportunities and profitableness of different industries.
Some of these call for far-reaching readjustments of investments and
of productive forces. Some persons gain and some lose by every such
change. It is observed that a reduction of tariff rates seems to have
a more disturbing effect upon business than does an increase. This
probably is because the industries favored by protective tariffs in
America are those most fully within the circle affected by crises;
whereas most of the consumers adversely affected by a rise of tariff
rates are outside the commercial circles where short-time credit
is common and where the rapid readjustment of investment leads to a
financial crisis. It never has been convincingly shown, however,
that there is any large measure of correspondence in time (not to say
causal relation) between tariff revisions and crises.[13]

Sec. 15. #Rhythmic changes in weather and in crops#. A psychological
movement, once started, accumulates force and momentum up to a certain
point where a reaction begins. This rhythmic movement as it appears
in the capitalization of enterprises is favored and magnified, we
have seen, by the wide use of credit and by the constantly changing
technical and physical conditions of industry. These call for constant
revaluations of the sources of incomes, thus destroying customary
and habitual valuations. But why should the cycle begin or end at one
point of time rather than at another; and what determines the length
of the cycle? Some of the new dynamic forces such as inventions and
growth of population are distributed pretty regularly along the line,
so that their influences are nearly equalized. But occasionally
some large impulse may serve to start a swing and if this impulse
is somewhat regularly repeated, it may serve to keep up the rhythmic
motion. True, the lack of coincidence in the impact of various
influences which occur accidentally, such as political changes, wars,
and the rapid opening of new routes of transportation, would serve
to hasten or to retard, perhaps for a time quite to alter, what would
otherwise be the rhythm of the cycle. That there is nevertheless, a
noticeable degree of regularity in the recurrence of crises may be due
to the presence of one dominating factor.

Alternation of good and poor harvests has always seemed to be
favorable to business prosperity. In America since about 1865, farm
products have constituted the larger part of our exports, so that a
succession of large harvests has usually acted to stimulate exports
(one of the features of a period of prosperity), to give us a larger
credit balance in international trade, and to reduce the rate of
exchange. Large harvests of the staple agricultural crops in America
have been known to be closely related to the amount of rainfall in the
three most important growing months. Recently, it has been shown that
the rainfall of the Ohio Valley occurs in cycles of about eight years,
and in a larger cycle of thirty-three years. The cycle of yield per
acre of the nine principal crops is shown to correspond closely with
the cycle of pig iron production (one of the best single indices of
growing business) dated one to two years later.[14] As the cycles of
rainfall and of harvests are not coincident in different countries, it
will require further study to adjust to these observations the fact
of the world-wide extent of the great financial crises. But a better
understanding of objective conditions of this kind will give fuller
meaning to the psychological interpretation of crises.

Sec. 16. #Remedies for crises#. The financial crisis must be looked upon
as an economic disease which brings many evils in its train. The need
is not merely to mitigate the severity of the brief period of crisis,
but also to smooth out the curve of the business cycle so as to reduce
periodic unemployment, the lottery element in profits, and the number
of unmerited failures in business. Several measures may aid toward
this end. In the past the crisis has been more severe in America than
in Europe because of certain well-recognized defects which now have
been largely remedied in the Federal Reserve Act.[15] The provisions
whereby any one may get credit on good commercial assets should
make it impossible for a crisis to degenerate into a panic. This
legislation has provided springs to reduce the jolt of the change from
a higher to a lower level of prices.

Probably other improvements may be made in our banking laws. Competent
students of the subject have urged that the payment of interest
on deposits not subject to notice before withdrawal should be made
unlawful, because demand deposits constitute the greatest danger at
critical times. In principle this objection is sound, tho experience
may show that this evil has been practically remedied by other
features of the Federal Reserve Act. Moreover, bankers could, by
pursuing a more conservative policy, discourage speculative methods of
enterprise. The strong public disapproval of stock-market speculation
on margins may some day be able to express itself effectively in ways
that will not injure healthy business. Greater stability in our tariff
policy would remove a constantly disturbing factor in prices, as would
likewise the stabilizing of the standard of deferred payments. In
the attempt to remedy the great evil of unemployment, public works of
every kind might be planned and distributed in time so as to better
equalize the demand for labor and materials. Finally, much better
commercial statistics are needed, and for collecting them and
reporting the outlook, government organization is required comparable
in range and methods to the weather bureau.

It cannot be expected, however, that financial crises, in the sense of
general readjustments of prices downward from time to time, ever
can be completely abolished. There will always be changes in general
industrial conditions calling for reevaluation of the existing sources
of income; and in this process there will always be a tendency to
rhythmic swing like that of a river, which carries the stream
of prices now on this side of the valley, now on that. But this
fluctuation of general prices surely can be so greatly moderated in
magnitude and in evil results as to make the word "crisis" almost a
misnomer. It is toward the attainment of this irreducible minimum of
uncertainty and disaster in business that efforts should be directed.

[Footnote 1: On the way these affect private profits see Vol. I, pp.
340, 341 (and references there given in note), 348 ff. and 361 ff.
There are thus good reasons for discussing crises in connection with
profits, as well as with money and banking.]

[Footnote 2: See Vol. I, pp. 51, 154, 300-302.]

[Footnote 3: See below, ch. 15, sec. 5, on the tariff legislation at
this time.]

[Footnote 4: See ch. 8, sec. 1.]

[Footnote 5: See ch. 6, sec 5.]

[Footnote 6: See diagram of business failures 1890-1914, in Vol. I p.

[Footnote 7: In the first annual report of the United States
Commissioner of Labor is given a long catalog of theories that have
been suggested, many of them quite fantastic.]

[Footnote 8: See Vol. I, ch. 38, on Abstinence and Production.
Believers in the glut theory usually condemn efforts to encourage
frugality among the masses, calling it the "fallacy of saving."]

[Footnote 9: See Vol. I, ch. 37, secs, 6 and 9.]

[Footnote 10: See e.g., Vol. I, pp. 271. 335, 365 367.]

[Footnote 11: See Vol. I, p. 304.]

[Footnote 12: See above, ch. 6, on the standard of deferred payments.]

[Footnote 13: See note on tariff legislation and business crises, end
of ch. 15.]

[Footnote 14: In both cases there is what is called in statistics
a high degree of correlation (viz., .719 and .800), indicating that
there is that percentage of probability that there is some causal
relation between the two sets of figures.]

[Footnote 15: See above, ch. 9, secs. 5, 6, 8.]



Sec. 1. The nature of saving. Sec. 2. Economic limit of saving. Sec. 3. Commercial
bank deposits of an investment nature. Sec. 4. Investment banking.
Sec. 5. Savings banks in the United States. Sec. 6. Typical mutual
savings banks. Sec. 7. Postal savings plan. Sec. 8. Advantages of the postal
savings plan. Sec. 9. Collection of savings and education in thrift. Sec. 10.
Building and loan associations. Sec. 11. The main features. Sec. 12. The
continuous plan. Sec. 13. The distribution of earnings. Sec. 14. Possible
developments of savings institutions.

Sec. 1. #The nature of saving.# The motives actuating the different
classes of lenders may, for our present purpose, be reduced to two:
to postpone the consumption of income, and to obtain a net income
from wealth (or investment). Saving always is relative to a particular
period and is for more or less distant ends. The child saves its
pennies to go to the circus next week, the working girl saves her
dimes for a new hat next spring, the earnest high school pupil saves
to go to college next year, and the provident man saves for his
family's future needs and for his own old age. But always, to
constitute saving, there must be for the time a net result: the
excess of income over consumptive outgo in that period. This is easily
distinguishable from various forms of pseudo-saving of which many
persons that are really spending all their incomes are very proud.
Such forms are: planning to buy a particular thing and then deciding
not to do so, but buying something else; finding the price less than
was expected, and thereupon using this so-called saving for another
purpose; spending less than some one else for a particular purpose,
such as food, but off-setting this by larger outlay for another
purpose, such as clothing; spending all one's own income but less
than some one else with a larger income. We may define saving as the
conversion, into expenditure for consumptive use, of less than one's
net income within a given income period.

Saving goes on in a natural economy both by accumulation of indirect
agents and by elaboration so as to improve their quality.[1] It goes
on to-day by the replacement of perishable by durative agents, as in
replacing a wooden house by one of stone or concrete, and by producing
wealth without consuming it, as in increasing the number of cattle on
one's farm. But saving has come to be increasingly made in the form
of money (or of monetary funds), and in this chapter we shall consider
some of the ways in which this can now be done.

Sec. 2. #Economic limit of saving#. There is an economic limit to saving,
as judged from the standpoint of each individual.[2] The ultimate
purpose of every act of saving is the provision of future incomes,
either as total sums to be used later or as new (net) incomes to be
received at successive periods. The economic limit of saving in each
case is dependent upon the person's present needs in relation to
present income and conditions, as compared with the prospect of his
future needs in relation to his future income and conditions. Each
free economic subject must form a judgment and make his choice as
best he can and in the light of experience. There is no absolute and
infallible standard of judgment that can be applied by outsiders to
each case. Yet there is occasion to deplore the improvidence that is
fostered and that prevails, especially among those receiving their
incomes in the form of wage or salary. Considered with reference to
the possible maximum of welfare of the individuals themselves, the
apportionment of their incomes in time is frequently woful. It is
uneconomic for families of small income to save through buying
less food than is needed to keep them in health; but it is likewise
uneconomic to spend the income, when work is plentiful and wages good,
for expensive foods having little nutriment and then, for lack of
savings, to go badly underfed when work is slack and wages are small.
There is for each class of circumstances a golden mean of saving. The
saving habit may develop to irrational excess and become miserliness,
but this happens rarely compared with the many cases where men in the
period of their largest earnings spend up to the limit on a gay life
and make no provision for any of the mischances of life--business
reverses, loss of employment, accidents, temporary sickness, permanent
invalidity, or unprovided old age. Despite the development of late of
new agencies and opportunities for saving there is need of doing more
toward popular education in thrift.[3]

Sec. 3. #Commercial bank deposits of an investment nature.# If a
commercial bank pays no interest on demand deposits there is no motive
for the depositor to keep a balance larger than he needs as current
purchasing power. When his bank account increases beyond that point,
it becomes available for a more or less lasting investment to yield
financial income. If the sum is small or if the owner is at all
uncertain as to his plans or if he is not in a position to find
another attractive form of investment, the offer by the bank of a
small rate of interest on special time deposits (2 to 3 per cent is
not an unusual rate in such cases) will suffice to cause him to leave
such funds in the bank. Since about 1900 the practice has been greatly
extended of paying interest even on "current balances" of regular
checking accounts (demand deposits). If the new 5 per cent rule[4] as
to reserves against time deposits operates to cause commercial banks
generally to pay a rate ranging from 2-1/2 to 3-1/2 per cent on time
deposits, their amount will doubtless increase greatly. But still, in
the future as in the past, those depositors having funds that can be
invested for considerable periods will seek a higher rate of interest
than can be obtained from commercial banks.

In their loaning function the "commercial" banks (as the adjective
indicates) serve mainly the special needs of the _commercial_ elements
of the community--business men borrowing for short terms to carry out
particular transactions. Loans made on short-time commercial paper
(quick assets) are very suitable to the needs of a bank that has its
liabilities largely in the form of demand deposits. Time deposits can
be more safely loaned on the security of real estate and for longer

Despite their limitations in this respect, the commercial banks must
be recognized as of growing importance in the work of encouraging and
collecting small savings, which in many cases are better invested in
other ways. In 1916, the centenary of the beginning of savings banks
in this country, a nation-wide propaganda was undertaken by the
American Bankers' Association for the encouragement of savings.

Sec. 4. #Investment banking#. Enormous amounts of securities issued by
governments or by corporations (railroad or industrial) are now on
the market and to be bought conveniently by private investors. Through
special bond houses some bonds are to be had in denominations as small
as $100 and $500. The regular brokers on the stock exchanges buy and
sell, for a small commission, the regular bonds and investment stocks.
Several large statistical and financial expert agencies[5] in return
for an annual subscription, offer advice to investors regarding
general market conditions and special securities.

For a large number of investors the personal examination and selection
of sound securities is too difficult a task. To serve their needs many
bonds and trust companies have of late developed special departments
for investment banking. Through these agencies the banks are
constantly placing as relatively permanent investments securities
which they have bought or have aided "to float" or which they handle
only as commission agents. In any case the real investment banker
is bringing to his task special training and a high sense of
his professional obligations, and is employing the services of
statisticians, financial experts, and of practical engineers to
determine exactly the fundamental conditions of each investment.
Investment banking promises to increase steadily in amount and

Sec. 5. #Savings banks in the United States.# For the increasing
number of wage-earners, salaried employees, and persons following
professions, investment as active capitalists is impossible.[6] Their
savings must take the form of passive investments. But there are few
good opportunities for lending money in small amounts, without great
risk, and the requirement of skill, time, and labor to look after the
loans and to collect the interest is prohibitive to a small lender. To
provide a place where small sums could be kept with safety and so as
to yield a moderate rate of income, the first modern savings bank
in the United States was instituted in New York in 1816 after a plan
already developed in England.

In form these banks are mutual, having no capital stock on which
dividends are to be paid. The boards of trustees are self-perpetuating
and receive only fees for attending meetings. In their legal aspect
these banks have a philanthropic character. Their investments are
limited by law to specified, conservative classes of securities and
loans on real estate. The total increase from investments is,
after paying the expenses of operation and setting aside a surplus,
distributable to the depositors at regular periods. In the United
States the number of such institutions reported in 1914 was 2100.[7]
They have over 11,000,000 depositors, deposits to the amount of
$5,000,000,000, an average deposit of $444 per depositor, or of $50
per capita of the whole population. These figures are very unequally
distributed geographically, the divisions ranking as to total deposits
in the following order: the Eastern Middle, New England, Middle
Western, Pacific, Southern, and Western divisions. The first two of
these groups of states have about 75 per cent of all the deposits, the
Southern states hardly 2 per cent, and the Western (North Dakota to
Oklahoma) only 1/4 of 1 per cent.

Sec. 6. #Typical mutual savings banks#. About one third of these banks
are on the mutual plan, having no capital stock (most of them in the
East) and these contain about four fifths of all the deposits.
The stock savings banks have individual deposits of over a billion
dollars, and have outstanding capital stock to the amount of about
$90,000,000 (about 9 per cent of their deposits). These stock savings
banks to a much greater extent than do the mutual banks transact also
a commercial business.

The banks on the mutual plan are therefore the most important, the
typical savings banks. The average rate of interest they paid
to depositors in 1914 was 3.86 per cent. About one half of their
resources are invested in loans, mostly to small borrowers on the
security of real estate, and most of the remainder consists of bonds
and other securities of the safer kinds.

Savings banks are subject to the supervision and inspection of the
banking departments in the several states, a fact that exerts a
salutary effect though not insuring absolutely against either mistaken
judgment or dishonesty on the part of the bank officials.[8]

Savings banks seek to keep invested as large a part as possible of
their assets, keeping only in ready cash enough to meet a possible
temporary excess of withdrawals over deposits. In contrast with the
policy of commercial banks with their demand deposits, the sound
policy for savings banks is to reserve the right to require notice of
intention to withdraw. The period of such notice varies from a
minimum of ten days to a maximum of about sixty days. In ordinary
circumstances it is not needful or usual for a bank to exercise this
right, but it is a needful safeguard in times of commercial crises.
This requirement of notice is greatly to the advantage of depositors
collectively and thus of the community as a whole. It is not an undue
limitation of the rights of the individual depositor. It is unfair
for the individual, in a period of financial stress, to seek his own
safety in a manner which is impossible for all, and thus to endanger
the interests of all.[9]

The mutual savings banks in 1914 had (on the average) but six tenths
of a cent of actual cash (and "checks and cash items") in their tills
for every dollar of deposits, but in addition they had for every
dollar of deposits four cents due on demand from state and national
(commercial) banks. In the aggregate these demand deposits amounted to
the large sum of $172,000,000, a large part of which bore a low rate
of interest.

The depositors in savings banks have a direct legal claim on the bank
as a corporation. The bank's only means of payment are its assets,
consisting of claims upon the owners of such wealth as houses,
factories, railroads, electric light plants, good roads, and school
buildings. Thus virtually the depositors have by their savings made
possible the building and equipping of these actual forms of wealth,
and have an equitable claim upon the usance of them, which claim is
met by the payment of interest and dividends to the savings banks.
Viewed in this way the great social importance of the savings function
appears, and the importance of developing the savings institutions.

Sec. 7. #Postal savings plan.# In many countries of the world the
governments have not only authorized private, corporate, and trustee
savings banks, but have provided public agencies where it is possible
for the citizens to deposit small amounts. Thus municipal, and what
are called communal, savings banks are operated by many European
cities; but the most effective and widely used agencies for the
purpose are the national post-offices. Postal savings banks, or postal
savings systems as divisions of the postal service, are now found in
all the larger countries of the world, and in many smaller ones. The
United States of America was almost the last civilized country to
establish such a system, which was authorized by act of Congress in
1910, and went into operation in a few designated cities in January,
1911. The number of offices at which it was in operation was rapidly
increased, and the number in 1914 was about 10,000.

Any one ten years of age may become a depositor. Deposit must be made
always in multiples of one dollar. Not more than $100 will be accepted
for deposit in any one calendar month, and nothing after the total
balance to the depositor's credit is as much as $1000, exclusive of
accumulated interest. However, amounts less than one dollar may be
saved for deposit by purchasing a ten-cent postal savings card and
affixing ten-cent postal savings stamps until the nine blank spaces
are filled. Such a filled card will be accepted as a deposit of
one dollar either in opening an account or in adding to an existing

Deposits are not entered in a depositor's book, as is the usual
practice of savings banks, but are evidenced by certificates issued in
fixed denominations of $1, $2, $5, $10, $20, $50, and $100. These bear
interest, from the first day of the month next following that in which
the deposit is made, at the rate of 2 per cent per annum for a whole
year (interest is not paid for any fraction of a year). Interest
is not compounded, unless the depositor withdraws the interest and
redeposits it, but simple interest continues to accrue annually on
a certificate so long as it is outstanding, without limitation as to

By the end of the first year (1911) of operation the savings system
held a balance to the credit of depositors of nearly $11,000,000; in
the next year (1912) there was added to this about $17,000,000; in
the next year (1913) about $12,000,000; and this average rate of one
million dollars a month net addition to deposits has continued to the
present (1916). These funds are deposited in banks belonging to the
federal reserve system, which must deposit with the Treasurer of
the United States designated kinds of bonds (national, state, and
municipal) as security and pay interest at the rate of 2-1/2 per
cent on the amount of the deposits. The one-half per cent difference
between this rate and that paid to individuals goes far toward paying
the expense of operating the system.

Provision is made for the issue of postal savings bonds in exchange
for certificates issued in sums of $20 or multiples thereof up to
$500. These bonds bear interest at the rate of 2-1/2 per cent payable
in semi-annual instalments, January 1 and July 1. These bonds are
not counted as a part of the $500 maximum of deposits allowed to one
person, and there is no limit to the amount of bonds which may be
acquired by one depositor. Postal savings bonds are exempt from all
kinds of taxes, federal and local. These bonds are issued only on the
surrender of postal savings deposits, but may be sold by the owner
at any time. Three years after the law went into effect, there were
$4,635,820 of postal savings bonds outstanding.

Sec. 8. #Advantages of the postal savings plan.# As compared with
corporate savings banks the postal savings system has certain

(a) It protects the small depositors from the danger of dishonest
private bankers who have preyed upon the immigrants in the larger
cities. To foreigners, accustomed to the postal savings plan in their
home countries, it is especially useful.

(b) It gives to every depositor the greatest safety possible, as "the
faith of the United States is solemnly pledged" for the repayment of

(c) It brings a savings institution to many a small town and rural
place formerly entirely lacking in facilities for small depositors.
The benefit of this has not immediately appeared to be great, but may
in time prove to be.

(d) It pays interest from the first of the month following the date of
deposit whereas the usual practice of savings and commercial banks is
to pay only from the beginning of the quarter year or half year.

(e) It provides for the exchange of deposits for bonds bearing a
higher rate of interest--a unique feature greatly simplifying for the
small saver the process of buying bonds for more lasting investment.

In some respects, however, the postal savings system falls short of
the advantages of the regular savings banks. These usually accept
for deposit as small an amount as ten cents; they pay interest either
quarterly or semi-annually; they pay on the average (at present)
almost double the rate of interest, and the interest is credited
to the depositor's account at stated intervals and automatically
compounded. The postal savings system, as the law now stands, may be
looked upon, therefore, as supplementing the regular savings banks
rather than competing with them.

Sec. 9. #Collection of savings and education in thrift.# Small savings
have been encouraged in many places by penny provident funds, dime
savings banks, and school savings funds, which have been conducted at
public schools, social settlements, and factories, by school officers
and by charitable and educational societies acting through canvassers.
These plans all call for much personal effort and cost, which must be
provided by volunteer services and private gifts. These plans being
undertaken mainly as a means of education in thrift and in the
related moralities, their results are not to be measured merely by the
magnitude of the sums collected. They are not rivals of the ordinary
savings banks, but rather auxiliary methods of encouraging their use.
The funds collected by these agencies are usually deposited in local
savings banks, and depositors are encouraged to open individual
accounts there, whenever they have considerable sums saved.

In Germany the public schools have been furnished with automatic stamp
vending machines, from which savings stamps in as small denominations
as ten pfennigs (2-1/2 cents) may be had by dropping a coin into a
slot.[10] This method could be used very effectively in connection
either with the postal savings system or with a local savings bank. It
ought to be made easy to deposit funds at every school house, at every
post-office, at every factory counter on pay day, and wherever people
pass in numbers. Allurements to foolish expenditures meet old and
young at every turn; to spend the dime is made all too easy, whereas
to save it and deposit it in a safe place too often calls for wasteful
and discouraging efforts from the person of small means.

Sec. 10. #Building and loan associations.# Building and loan association
is the name applied to a cooeperative organization of persons with
the purpose of collecting regularly from members small sums which
are loaned to some members for the purpose of building or paying
for homes.[11] The first association of this type was organized in
Frankford, Pennsylvania, in 1831. It and others of its kind have
made Philadelphia notable among all the larger cities as "the city of
homes." The number of such associations has almost steadily increased
in the United States. Pennsylvania continues to rank first in respect
to amount of total assets, with Ohio a close second, and New Jersey
third (the ranking first in proportion to population). Associations
of this type have been hardly second in importance in America to the
savings banks as institutions for savings for persons of moderate
means. The number of their members (nearly 3,000,000) is about
one-fourth of that of savings bank depositors, and the amount of
their assets (1-1/4 billion dollars) is about one-fourth that of the
reported savings banks. But their relative influence in educating and
encouraging to thrift is doubtless much greater than these figures
indicate. There are more than three times as many of them as of
reported savings banks, their management is much more democratic than
is that of the banks, and many of their members attend and participate
in the meetings and understand how they are conducted. Moreover, the
savings made through these associations are constantly passing on into
the houses that are fully paid for, and which continue to yield their
incomes to their owners. Each year these associations collect from
their members as dues and in repayment of loans (made to build houses)
the sum of over half a billion dollars, which is twice as much as the
annual increase in the deposits of the reported savings banks.[12]

Sec. 11. #The main features.# A building and loan association is
organized by a group of persons in a neighborhood, uniting to form a
corporation under the laws of the state, every member to subscribe
for one or more shares. The officers elected all serve without pay
excepting the secretary-treasurer, who receives a small fee for his
services. All official meetings are open to all members. The shares
vary in denomination from $25 to $200; the larger figure being common
under the serial plan and $100 being usual under the continuous (or
permanent) plan, described below. Whenever there is a sufficient
sum it is loaned to one of the members for the purpose of building a
house. The borrower must subscribe for shares to the par value of his

The receipts of the association are of several kinds.

(a) Interest is received from members, usually at the rate of 6
per cent, and from banks at a lower rate on the small working cash
balances kept on deposit. Usually the loans made are large enough to
cover a large proportion of the cost of the house, but the land on
which the house stands must be free from all incumbrance, and its
value gives a margin of safety to the association. Then by the method
of payment of dues the debt is, from the first month, steadily reduced
and the security for the loan therefore grows constantly better.

(b) Premiums are collected in addition, sometimes in the form of a
higher rate of interest, but the practice of charging premiums has
been mostly abandoned and the total amount of premiums now constitutes
less than 1 per cent of all payments from members.

(c) Fines for delinquency also are less commonly imposed now and
constitute a small fraction of 1 per cent of total payments.

(d) Deductions are made on account of withdrawal before the maturity
of the shares; under these circumstances it is usual to pay a portion
but not all of the accumulated profits, sometimes a proportion
increasing as the shares approach maturity.

Different plans have been and still are followed in respect to the
method of issuing the shares. Under the _terminating plan_ all
the shares begin and mature at the same time (for all members that
continue to the end). Whereupon the association dissolves or starts
anew. The chief difficulty in this plan is that the association has
too few funds to loan at the beginning of its career, and a surplus
of unloanable funds as it nears the maturity of the series. It is
therefore necessary to encourage or to compel the withdrawal of
non-borrowing members on the payment of estimated profits to date.

The better to remedy this difficulty the _serial plan_ was devised,
by which new series of stock are issued at intervals--yearly,
half-yearly, quarterly, and even oftener.

Sec. 12. #The continuous plan.# A further development is the continuous
plan (usually called the _permanent_ or the Dayton plan), by which
much greater flexibility is attained in the organization. Shares
of stock may be subscribed for at any time, each man's separate
subscription of shares being treated as a separate series, and
maturing each at its own time. There is thus, after an association has
been for some time in operation, a continuous stream of new members
(or new subscriptions) flowing into the association, and a continuous
outflow of shareholders whose shares have matured. The maturing shares
of borrowing members discharge their indebtedness to the association;
the maturing shares of non-borrowing members are paid in money, or
may (if the association has use for the funds) be left as an
interest-bearing loan.

Additional funds are obtained when needed by issuing paid-up stock to
non-borrowers. This is convenient at the beginning of an association
and when the movement in building is more active than usual. But if an
association has funds that cannot be loaned, outstanding paid-up stock
may be called in. In practice a large part of the paid-up stock as
well as of the running stock is subscribed for and held not by large
capitalists but by persons of small means, especially "the more frugal
element in the working classes." Non-borrowing members desiring
to withdraw may do so at any time under certain conditions; but to
safeguard the association, the laws usually require that thirty days'
notice of intention to withdraw shall be given, that not more than
one half of the funds received in any one month shall be paid on
withdrawals, and that withdrawing shareholders shall be paid in the
order of the notices of intention to withdraw.

The most intelligent and prudent workers were formerly deterred from
subscribing by the fear that sickness, unemployment, or other mishap
might make it impossible to keep up regular payments. Now, however,
fines for late payment have been almost entirely done away with. On
the other hand, extra payments may be made at any time by borrowing
members, to hasten the date when their shares mature and their debt
be discharged. These privileges are possible because of the method of
distributing earnings which will now be described.

Sec. 13. #The distribution of earnings.# Every six months is ascertained
the amount of the gross earnings which, under this plan, consist
almost entirely of interest paid on loans. From this amount are
deducted expenses (and in some states 5 per cent of the total is
placed in a "loss fund" to meet possible losses) and the rest is
divided in proportion to the amount standing to the credit of each
member, being credited to the account of running stock and paid in
cash to holders of paid-up stock.

The payment of dues is correspondingly simple. The dues at twenty-five
cents a week amount to $13 a year per share of $100. This is the whole
bill; there are no extras. The interest at 6 per cent (the usual rate)
is $6, and the rest, $7, is credited upon the stock. Thus at the end
of the first six months the member has $3.50 to his credit, and is
entitled to his share of the net earnings on that amount. Thus his
share of the earnings is steadily increased by compound interest, and
if he keeps up his regular payments the shares mature in about sixteen
years. This means in most cases that a prudent tenant can become the
owner of a house in sixteen years while paying no more than the rent
would be. As the active investor he becomes his own rent collector
and uses the house with less need of repairs, thus dispensing with
services and costs which are included in contractual rents.[13]

These associations are properly made subject to supervision and
examination by state officials, in the manner of that exercised over
banks. They have been favored by exempting the shares of members and
the mortgages held by the associations from all state and municipal
taxation. As the houses built or paid for are taxed, this is of course
but just, but it is an exception to the rule of the illogical general
property tax.[14]

Sec. 14. #Possible developments of savings institutions.# The social
importance of increasing and improving the agencies of savings for the
masses is being more fully recognized, but much more might be done in
these directions. Some possible changes have been suggested above, and
a few words more may be added.

Probably the greatest developments in the near future will be through
the savings departments of commercial banks (favored by the reserve
rules of the Federal Reserve Act) rather than by the increase in the
number of special banks for savings. The initial expense and risk of
starting a savings bank is considerable, and outside of cities of some
size this is prohibitive. Whereas a savings department, with its
funds and reserves separated, can be easily and cheaply operated in
connection with a general bank. It is much to be desired, however,
that a larger measure of popular cooeperation might be made possible to
the depositors, both for its educational value and to reduce the real
evil of the autocratic or the plutocratic centralization of the money
power in the small communities.

Savings banks usually limit the amount of an account to $3000. It
is desirable that depositors should be able easily to convert their
savings-bank deposits over certain amounts into good bonds, bearing
a higher rate of interest (after the method of the issue of postal
savings bonds). There is need of a central market in each community
where such bonds can be bought and sold at any time; and the savings
banks might easily serve to buy and sell for their customers in this
way in the larger bond market. This would be of benefit also to the
states and municipalities which issue bonds for such purposes as
schools, roads, and public utilities, by creating a more open and
regular market to small investors than now is provided for such
securities. This might somewhat reduce the rate of interest and there
would be a gain divided between taxpayers and lenders.

The general plan and principles of local building and loan
associations might well be extended to groups of rural cooeperators,
enabling them to make loans to their members; and to groups of small
investors, permitting them to hold real estate mortgages and bonds and
stocks of corporations, free from taxation other than that paid on the
wealth itself. Members of such organizations could get a higher income
on their investments than a savings bank could pay, and with greater
security than if each attempted to save and invest by himself.[15]

Savings institutions are necessarily also lending institutions. In
this chapter they have been looked at mainly from the saver's (the
lender's) standpoint, though their service to the borrower is of
cooerdinate importance. In the case of building and loan associations
this feature is most apparent. Later, the problem of the agricultural
borrower will receive further consideration.

[Footnote 1: See Vol. I, chs. 9 and 10.]

[Footnote 2: See Vol. I, pp. 285-290 for the analysis of saving from
the individual standpoint; and pp. 482-499 for its relation to general
economic conditions.]

[Footnote 3: See Vol. I, p. 484.]

[Footnote 4: See above, ch. 9, sec. 7.]

[Footnote 5: E.g., Babson Statistical Organization, Brookmire Economic
Service, Moody Manual Co., Moody Corporation Service.]

[Footnote 6: See Vol. I, p. 318.]

[Footnote 7: Report of the Comptroller of the Currency. Not all of
these are mutual. Statistics, moreover, include in some cases (e.g.,
California) the savings deposits of commercial banks but not the
number of such banks, and in other cases (Michigan) some banks that do
chiefly a commercial business. The line of demarcation between savings
banks and savings departments of commercial banks cannot be sharply
drawn. The Comptroller of the Currency reported in 1914 in a different
form the amount of savings deposits and of time certificates
of deposits in _all_ kinds of banks as the enormous sum of

[Footnote 8: In the last twenty-three years, on the average, seven
savings banks a year have failed, the annual excess of liabilities
over assets being about $200,000, or about $30,000 for each failing
bank. The total loss has been about 1/5 of 1 per cent of total

[Footnote 9: The Federal Reserve Act, by making it possible for loans
to be had at any time (through member banks) on good security, should
reduce the danger of runs on savings banks.]

[Footnote 10: The author saw in operation a new machine of this kind
which had been installed in a German public school as early as 1910.]

[Footnote 11: See Vol. I, pp. 290, 297-298, 484, and 486.]

[Footnote 12: The figures here given and the description of methods
apply to the "local" building and loan associations. The success of
this kind led to the organization of other associations which took the
name "National" building and loan associations, to carry on a business
in a larger field. The number of these has always been comparatively
small, and their operation is less simple, democratic, and economical
than the local associations. They have borne more of the nature of
ordinary profit-making enterprises. They should not be confused with
the local associations.]

[Footnote 13: On these economies, see Vol. I, p. 298.]

[Footnote 14: See ch. 17, sec. 4.]

[Footnote 15: Since this was written the Federal Rural Credits Act has
been passed, embodying the main idea here described.]



Sec. 1. Chance, unavoidable and average. Sec. 2. Uneconomic character of
gambling. Sec. 3. Borderland of gambling. Sec. 4. Insurance: definition and
kinds. Sec. 5. Insurance viewed as a wager. Sec. 6. Insurance as mutual
protection. Sec. 7. Conditions of sound insurance. Sec. 8. Purpose of life
insurance. Sec. 9. Assessment plan. Sec. 10. The reserve plan. Sec. 11. The
mortality table. Sec. 12. The single premium for any term. Sec. 13. Level
annual premiums and reserves. Sec. 14. Different features of policies.
Sec. 15. Insurance assets and investments as savings. Sec. 16. Excessive
costs of insurance operation.

Sec. 1. #Chance, unavoidable and average.# Every action and every
movement in life has in it some element of chance. There are what
may be called natural chances, arising from the uncertainties of the
seasons, or from rainfall, heat, hail, storm, flood, lightning, or
land-slides. Such chances must be taken both by the small enterpriser
and by the large. In earlier conditions of society natural chance
dominated industry, and it still remains and must always remain
important. There is the chance of unexpected political events, such
as war, riot, and legislation on money, tariffs, credit, and business
relations. These things are caused, it is true, by the action of men,
but it is a collective action out of the control of the individual.
There is the chance of human carelessness causing fire, explosions,
and wrecks on misplaced switches. There is the chance of physical or
mental collapse, as the sudden insanity or the sudden death of one
performing responsible duties. There is the chance of sickness that
often wrecks the plans and the fortunes of a whole family. There is
the chance of economic alterations in methods of production and of
transportation, in fashions and demand in this direction or for those

Some of these chances are more connected with money-lending, others
with manufacturing, some with agriculture, others with commerce; but
all are present in some degree in every industry. Some events are
unique in nature and seem unlikely ever to occur again; others are of
a kind occurring so irregularly that no reasonable prediction can be
made as to the time and frequency of their occurrences. Still others
occur frequently and to many different persons; but no individual can
tell when and how they will occur to him. A general average of chances
in different lines of business causes some to be called safe, others
extra-hazardous. Chance has its favorable as well as its unfavorable
aspects. Chances are averaged and added algebraically to the profit or
loss in an industry, for an extra-hazardous enterprise must in general
afford a higher average of profit in order to induce men to engage in
it. It is folly to take a risk without ascertaining its degree so far
as general experience enables one to choose. But inasmuch and in so
far as the gains and losses fall unequally upon different individuals,
income depends upon chance.

Sec. 2. #Uneconomic character of gambling.# This prevalence of chance
sometimes tempts men to say that business is "a gamble." But a
distinction in principle must be made between gambling and legitimate
risk-taking. The chances enumerated above are not sought, but avoided
as far as possible; yet they must be borne by some one if productive
enterprise is to continue, and the burden must somehow be distributed
throughout the community. Gambling is, however, a kind of risk-taking
which has a very different economic and moral quality. Gambling
creates the hazard, making the gain or loss of income depend on an
event that is not a necessary part of productive enterprise. Typical
gambling is the transfer of wealth on the outcome of events absolutely
unpredictable, so far as the two gamblers are concerned. Examples are
the shaking of unloaded dice or the honest dealing of a pack of cards,
and the betting on prices in so-called "bucket-shops" by persons
having no connection with the market of real things, and seeking to
get something for nothing as a result of mere chance.

Cheating is not a necessary mark of gambling, altho the cruder
forms of dishonesty, such as the loading of dice or the collusion of
horse-owners or of horse-jockeys to deceive the betting public, are
so common that they seem often to be an essential feature. Gamblers
recognize fair as opposed to unfair methods. Fair gambling is a kind
of minor morality within the immoral field of gambling, like the
honor found among thieves. The chance-taking in gambling has no useful
purpose or result outside itself. Betting and gambling do not produce
wealth, but merely shift the ownership of existing wealth. The
gamblers constitute themselves a little fictitious economic circle,
and they transfer gains and losses on the turn of events that have no
practical objective result within their circle except to determine the
direction of the transfer. Even when fairest, gambling must, in its
average results, be uneconomic. In any economic trade each trader
gains by getting goods that are, on the marginal principle, to him
more valuable than the other kinds of goods he gives up.[1] But in
gambling the winner gets all, the loser gets nothing. If two men of
like incomes gamble the additional desires that the winner is able
to gratify are (by the principle of decreasing gratification) less in
amount than the desires which the loser must forego. As a result the
loser is often depressed and seriously injured by the loss of his
income, the winner makes reckless and extravagant use of his winnings.
Easy come, easy go, is the rule of gamblers.

Moreover, gambling reduces the amount of wealth by relaxing the
motives of economic activity, diverting energy from productive
enterprise, tempting men into dishonesty to offset their losses, and
leading them into speculation and embezzlement.

Sec. 3. #Borderland of gambling.# Ranging between the extremes of
unavoidable risk-taking and of gambling are a number of cases of a
mixed nature. In nearly all wagers, judgment in some degree influences
the choice of sides. One man bets on a horse whose pedigree and
performances he knows thoroly; another judges by the horse's
appearance as it comes upon the track. The professional bookmakers
have the latest possible and most exact information on which to base
their bids.

In the bets made on one's own prowess, as on speed in running, the
chance-taking is still on the uneconomic side of the borderland,
certainly if the running is for the sake of the wager, not for
pleasure or for a useful purpose. A premium won by a runner for speed
in delivering a message of economic importance presents an essential
contrast to the winnings in a wager.

Finally, the very borderland of difficulty is reached in the purchase
and sale of goods in the market with a view of profiting by chance
changes in price. The purchasing and holding of land, lumber, grain,
cattle, and other tangible and useful things, that need to be stored,
held for buyers, or taken to market, must be judged liberally. The
quality of gambling depends somewhat on the motive as well as on the
ability of the trader. The enterpriser dealing with real wealth, and
fitted to take the risks both because of his resources and of his
exceptional knowledge, needs the motive of gain in such cases, and in
a sense can be said to earn socially what he gets. The motive of the
uninformed must be a blind trust in luck, and a hope to gain from a
rise in prices which they are quite unable to foresee or to explain.

Sec. 4. #Insurance: definition and kinds.# The large element of luck in
industry due to unavoidable chances has something of the same evil
character as gambling. It brings unearned prizes to some and to others
unmerited losses. It must therefore be a benefit to the community, if
this element of unavoidable chance cannot be reduced as a whole,
at least to regularize it and make it exactly calculable for any
individual. In this way each may be encouraged by the more certain
prospect of receiving a reward proportionate to his efforts and
abilities. This desirable condition has in many respects been
accomplished by means of insurance.

_Insurance_ is the act of providing a guarantee of indemnity against
a financial loss that will result if an event of a specified kind
occurs. The person seeking some surety against the possible loss is
the _insured_; the person contracting to indemnify against the loss is
the _insurer_; the written contract of insurance is the _policy_;
and the price paid by the insured in fulfillment of his part of
the contract is the _premium_; the amount paid when a loss has been
incurred is the _indemnity_; and the person to whom the indemnity is
paid is the _beneficiary_ (who may or may not be the insured).

The insurance with which we are here concerned is that which gives
financial indemnity. This is given for loss of expected net income,
when by chance either receipts are less or costs are more than
average. The two main classes as regards kinds of loss are property
insurance and personal insurance. _Property insurance_ is that which
indemnifies for loss of one's possession in specified ways, such as by
fire, by the elements at sea (marine), by hail, lightning, or cyclone,
by death (of valuable animals), by robbery, and by breakage (of window
glass). _Personal insurance_ is that which indemnifies the beneficiary
for loss of income as the result of various happenings to persons,
the chief being death, accident, sickness, invalidity, old age, and
unemployment. The principle of insurance is being constantly extended
to new subjects[2] and it is capable of further development in a
variety of directions.

Sec. 5. #Insurance viewed as a wager.# Insurance, without question a
highly useful thing, appears, paradoxically, to be in its outer form
a bet. The large merchant with many vessels used in many kinds of
business had in the days before marine insurance an advantage in
distributing his losses over a number of voyages. Antonio, the wealthy
merchant, is made thus to express his security:

"My ventures are not in one bottom trusted
Nor to one place; nor is my whole estate
Upon the fortune of the present year.
Therefore my merchandise makes me not sad."

In its early form marine insurance was the attempt of smaller
ship-owners to distribute their losses (as could the wealthy merchant)
over a number of undertakings, lucky and unlucky. It became customary
for a ship-owner to bet with a wealthy man that the ship would not
return. If it did come back, the owner could afford to pay the bet;
if it did not, he won his bet and thus recovered a part of his loss.
Gradually there came about a specialization of risk-taking by the men
most able to bear it. They could tell by experience about what was the
degree of uncertainty, and could lay their wagers accordingly. When
several insurers were in the same business, competition forced them to
insure the vessel and cargo of the ordinary trader for something near
the percentage of risk involved. The insurance thus tended to become a
mutual protection to the ship-owners; what had to be paid in premiums
to cover risk came to be counted as part of the cost of carrying on
that business.

Every legitimate form of insurance exhibits substantially the same
characteristics; it reduces loss at the margin where it is felt most
keenly. The difference between insurance and gambling, thus, lies
primarily in the purpose of insurance, which is not to increase
artificially the risk that any individual runs, but to neutralize or
offset an already existing chance. The insurance bet is what is called
a "hedge." The difference lies further in the collective method of
insurance, which combines the chances scattered among a number of
persons. Insurance does not increase the total of risks and of losses,
but merely combines, averages, and distributes them equally among all
the insured. This eliminates the chance element to the individual by
converting it into a regular cost.

Sec. 6. #Insurance as mutual protection.# Modern insurance is conducted
either by enterprisers for profit, or by mutual companies; but in any
case in large measure the losses in insurance are mutually shared,
as the premiums (plus interest earned) equal the total losses plus
operating expenses and profit, if any is made. Each insured gets a
contract of indemnity for the payment of a sum that will help cover
the losses of others. Such an exchange is mutually beneficial. The
premium comes from marginal income; the loss if it occurs would fall
upon the parts of income having higher value to the insured. The less
urgent needs of the present are sacrificed in order to protect
the income that gratifies the more urgent needs of the future. In
insurance each party gives a smaller value for a greater; each makes a
gain. The greater security in business stimulates effort. This effect
is quite the opposite of that of gambling.

Sec. 7. #Conditions of sound insurance.# To be economically sound,
insurance must have to do with real productive agents, and with
a group of occurrences which, as a whole, are approximately
ascertainable in advance--however irregularly they may fall upon
individuals. The beneficiary must have an _incurable interest_ in the
property or person insured; that is, the beneficiary must actually
suffer a loss by the occurrence insured against. Finally, the amount
of the indemnity must not be greater than the loss incurred. Some of
the greatest difficulties in insurance arise from the absence of these
essential conditions. When there is no insurable interest or when
the indemnity is greater than the loss that may be incurred, the
beneficiary may and sometimes does find it to his interest to bring
about the socially injurious event insured against. He artificially
increases the loss against which insurance was taken. When the insured
sets fire to his own buildings, he makes an illegitimate use of
insurance. Constant efforts are made by insurance companies to guard
against these "moral risks," the least calculable of any. Merchants
whose stocks have been mysteriously burned two or three times find
difficulty in getting further insurance. Formerly insurance was not
paid in case of death by suicide; but now usually no such limitation
is contained in a policy after a period of one or more years. As men
rarely plan suicide years in advance, death by one's own hand some
years after taking life insurance is regarded as coming under the
ordinary rules of chance. Yet it is to be feared that this
liberal policy serves as a temptation at times to crime and to

Sec. 8. #Purpose of life insurance.# Property insurance is mainly an
aspect of enterpriser's cost, whereas personal insurance is more
closely connected with the object of saving.[3] We shall in the rest
of this chapter limit the discussion to the one most important form
of personal insurance, that called life insurance (sometimes called
survivors' insurance).

Life insurance is that form of insurance in which partial indemnity
is provided for survivors against the financial loss incurred by the
death of the insured. Usually the insured is the breadwinner of
the family and the beneficiary is a member of his family, but in an
increasing number of cases the beneficiary is the surviving business
partner, a creditor, or a business corporation with an insurable
interest in the life of one of its employees.

Life insurance has been much used by persons mainly dependent on labor
incomes[4] rather than on incomes from capital, by those receiving
salaries, professional fees, and by active business men. It has of
late been extended rapidly, as "industrial insurance" to wage earners,
in policies never exceeding $1000, but averaging very much less,
and often being for no more than enough to pay funeral expenses. The
premiums on such policies are usually collected weekly and by agents
making personal visits. The cost to the insured is, therefore,
necessarily very high in proportion to the amount of insurance.

Sec. 9. #Assessment plan.# Life insurance plans may be distinguished,
with reference to the time and method of collecting the premiums, as
assessment and reserve insurance.

In the simple form of assessment insurance originally the losses were
paid by contributions taken after the losses occurred, each member
paying an equal share without regard to age. In a slightly improved
plan the assessments are made at the beginning of the year, based upon
the expected mortality for the year. The sum just sufficient for this
purpose (omitting expenses) is called the _natural premium_. The
cost of such insurance is closely related to the average age of
the members. The rates are very low in a new organization with a
membership of young men; but each year the average age, and therefore
the mortality of the membership, rises and the annual assessments must

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