Chapter X.—Of the Effects of Banks Dealing in Exchange

CHAPTER X.

ON THE EFFECTS OF BANKS DEALING IN EXCHANGE.

THE proper business of a bank of discount is to lend money. That of a bank of circulation is to lend credit, and the technical idea of banking excludes all transactions other than that of lending. This was formerly so well understood in the United States, that the discounting of notes or acceptances payable on the spot was the sole mode in which the capital and credit of the banks were employed; and if, by way of accommodating their customers they occasionally discounted a note or acceptance payable at a distant place, it was always done upon the same terms as if it were payable on the spot, the banks not calculating upon any profit in the way of exchange, but relying upon getting their money back again by supplying another customer with a check or draft at par. The ordinary exchange transactions between different cities and states were left to individual competition which established the market rate, as it does in all other countries of the world, and as it must invariably do wherever it is not interfered with by artificial causes.

Such was the state of things that existed prior to the establishment of the late bank of the United States. That institution, at some period subsequent to the commencement of its operations in February, 1817, entered upon the business of a dealer in inland bills of exchange by buying and selling bills upon all points where its branches were located, upon terms that gave it a profit on the transaction. This practice probably gave rise to the general custom now prevailing amongst banks of buying and selling bills of exchange; and as the custom appears to be one which facilitates the operations of trade, the public has overlooked the mischief which results from its exercise. It is of this mischief I now propose to speak, and I beg the reader’s attention to the remarks I am about to offer.

It has been shown, in the chapter on exchange, that the competition of the market will always settle the rate of premium or discount on bills, according as the proportion may vary between the supply and the demand. Nobody need ever be apprehensive that the rate can ever be forced unreasonably high by the combination of sellers, or forced unreasonably low by the combination of buyers. Each party has his remedy, as we have shown, against undue exactions, by the right that can never be taken from him, of transmitting coin instead of a bill. Under this free competition of the market, it must be manifest that the profit on bills, where there is one, goes into the pockets of the right people, that is, of those who are fairly entitled to it; and that the loss on bills, where there is one, also falls upon the right people, that is, upon those who ought to bear it; and in this manner equal justice is done to every individual, and the commercial wealth is consequently distributed through the natural and legitimate channels. If, at one season of the year, for instance, bills at Natchez on New York sell for two per cent, premium, this advantage fairly belongs to the seller. If at another season they sell at two per cent, discount, this loss goes into the pocket of the buyer of the bill as a profit, and fairly belongs to him. Any one, however, can perceive that this question of profit and loss on exchange is a private affair between one set of dealers and another, and as far as the public is concerned, it is a matter in which, as a body, they have no interest. It is of no sort of consequence to the community at large, whether the rate of exchange on inland bills is at the maximum or minimum price, or whether A or B puts a profit into his pocket, but it is of great consequence to the community that the profit should go into the right pockets, and that the inland exchanges should be carried on at the least possible expense to the country.

Let us now see how far the interference of banks in the operations of exchange disturbs the natural course of things.

And here I will remark, in the first place, that the competition of banks operates upon the bill market in a manner wholly different from that of individuals, owing to the power they possess of contracting the currency when they want to buy, and of expanding it when they want to sell. By the exercise of this power they can accomplish what individuals cannot accomplish, for these latter, having but a given amount of money to purchase with, cannot augment its quantity at pleasure, and their influence in the general competition, therefore, can only be proportioned to their actual cash. Can any one doubt the operation of this principle who has noticed the effect upon the price of cotton, universally admitted to have existed throughout the cotton growing states, during the years 1837 and 1838, by the dealings of banks in the purchase of cotton? Does not every body know that the price of cotton was kept a cent or more per pound, by the issues of banks, higher than individual competition could have kept it? And if so great a rise as ten or fifteen per cent, could be created in cotton, is it not easy to be seen how readily a rise in the rate of inland bills of exchange, of a quarter or half per cent., could be effected?

The mischievous tendency, however, of banks dealing in exchange, is greatly augmented where banks have branches, or enter into extensive combinations for a united system of action. Let us, for instance, suppose a large bank in a northern citiy with branches, or agencies at the principal southern ports, of sufficient extent of capital to operate upon the value of the currency at those ports. Let us suppose, the mother bank, at the seasons for shipments of cotton to the north, to give orders to its branches to buy the bills drawn upon those shipments at the cheapest rates that they can be obtained at. Any one can perceive at a glance, that the withholding of discounts for a few days, will make money scarce, and thereby depress the price of bills below the previous rate. At this new price the branches may buy, and transmit these bills to the mother bank, which in a short time after is drawn upon by the branches at a higher rate of exchange, which they were enabled to obtain by making money plenty, whilst in the case of the purchase of foreign bills drawn upon shipments of cotton to Europe, the mother bank by adopting the same expedient, or, what amounts to the same thing, by selling those bills on a credit at a higher price than the current cash rate with interest added, makes an additional profit. That such expedients as are here brought into view, may be, if they have not already been, practised by some of our banks can hardly be questioned, and the mischief thence resulting, far more than counterbalances all the benefit to individuals which an equalising of the exchanges can possibly accomplish.

But it may be said, that, without the agency of banks, there would not be the same facility in negotiating bills. This objection is not borne out by the experience of Europe, where bills of exchange can at all times and at all places be negotiated upon the most favorable terms, through individual capitalists, who have no control over the currency in augmenting or diminishing its quantity; and there is not the slightest reason for supposing that equal facilities would not exist in this country through private competition, if the ground were not already occupied by banks possessing by their very power of expansion and contraction, the ability to annihilate all private competition. It may also, perhaps, be said, that the agency of banks between buyers and sellers is afforded at a cheaper rate than that of individual capitalists would be. This assertion may very well be doubted, when we reflect upon the monopoly the banks at present enjoy, and the facility that exists for their combining to fix prices; and even if it were true, the small advantage gained by this circumstance would be greatly overbalanced by the mischievous power to which 1 have alluded, of depressing or raising the market price of bills, by contractions and expansions of the currency.

It is, however, in the interference with the foreign exchanges of a country that the power of banks is most to be deprecated. Upon this subject, the author advanced some views in an essay published by him in the year 1828, which so entirely correspond with those which he at present entertains, that he has concluded to transcribe them, rather than to adopt any new phraseology. The essay was in answer to one written a short time before, by a friend of the Bank of the United States, with the design, amongst other things, of showing the importance to the country of the power exercised by the bank of dealing in exchange.* The following are extracts:

“This is the course that matters take under a currency composed entirely of coin, or a sound mixed currency composed of coin and paper exchangeable for coin, but it must be kept in mind, that under such a currency, actual shipments of specie from one country to another, do not take place to any very great extent. A very slight comparative diminution of the quantity of coin circulating in a country, creates a scarcity of money, and this operates very soon upon the prices of all commodities, by reducing them in the market.”

“This partial export, however, and tendency of the coin to go abroad, is the only check upon overtrading. It indicates that more commodities have been imported than exported, and warns the importer of an approaching fall in the prices of the articles in which he deals, which induces him to countermand or diminish his orders, and in the next year to import less; and this operation brings back the small quantity of coin, which, by its removal, had diminished the currency below the quantity which was requisite to maintain it upon a level with the currencies of other countries. From this view of the subject, it is apparent, that exchange may be looked upon as the beam of a pair of scales, very nicely balanced, and employed in ascertaining the value from day to day of the imports and exports of a country. The slightest departure from the equilibrium shows itself in the fall and rise in the price of bills, and the assayer of the mint does not keep his eyes more steadily fixed upon the balances in which he weighs his gold, than should the merchants keep theirs fixed upon the rate of exchange.”

“If these things be true, it would seem to follow, that the most free and unrestricted competition possible in the bill market, would be the best calculated to prevent over-trading in the banks as well as individuals, for from such free competition the earliest indications of an excess of imports, or of a depreciating currency, would show themselves. That the operation of the Bank of the United States is to interfere with, and to a certain extent to destroy this competition, and consequently the check which ought to be suffered to operate monthly, weekly, and even daily with its warning voice, is admitted in the following sentence. ‘ Its principal advantage, and that which makes the bank pursue it, is, that this stock of exchange operates like a lever to keep the exchange market easy, to prevent the excessive price of bills, and to enable the merchants to calculate with reasonable probability the habitual cost of their remittances’ By this language, we understand, not only that the bank is desirous of effecting something like a steady price in exchange throughout the year, but that it does actually possess the power so to do. That this power is not, however, always exercised in such a way, as to prevent ‘the excessive price of bills,’ is evident from the admitted fact, that bills on London have been so high, that a merchant could afford to ship dollars at a less expense than the premium on bills, and indeed so much less, that it was an object of speculation to ship coin for the sole purpose of drawing bills upon it.

“We cannot therefore but conclude, that the dealing in bills of exchange by the bank, upon the principles professed, removes the great check upon over-trading and over-issues of paper, created by the free competition of the exchange market. To this it may be replied, how can a dealer who only purchases five millions of dollars value of bills in a year, disturb the competition, when the probable amount negotiated may be six or eight times that amount? We answer, by that power of purchasing, possessed, but not of necessity fully exercised by the bank, which is known to every drawer of a bill, and also by that moral influence, which silently operates, and compels the drawers of bills to keep up the price very near that fixed by the bank, through fear that mercantile discredit would accompany any offer to draw at a price much below it. The fact, however, of a control over the rate of exchange is admitted in the above quotation, and therefore needs no further evidence of its existence.

“But let us examine and see whether the benefits flowing from this dealing in exchange by the bank, be in reality such, as they are described to be, by the essay in question. ‘In the south it furnishes capital for facilitating trade.’ Does this mean, that because the bank is a buyer of bills in that quarter of the Union, it therefore issues more bank notes than are called for in the ordinary course of discounts? If so, the tendency of such over issues is to depreciate the currency, and whatever may be the favor done thereby to the southern planters, factors or merchants, there is certainly a positive injury inflicted upon all the rest of the community. If, however, the tendency be not to enlarge the issues of bank notes, how is any capital afforded to facilitate trade, in addition to that which would be procurable by the same planters, factors or merchants, by offering for discount the promissory notes or acceptances of individuals, to whom their bills would have been sold, if the bank were not a dealer in exchange? ‘To the north it supplies a safe and undoubted remittance.’ This is unquestionably true, inasmuch as it affords to all those who are willing to pay for increased security, an opportunity of fulfilling their engagements in Europe, without danger of defalcation. This benefit, which by the way, we humbly conceive to be the only real one of a general nature, which results from the power of the bank to deal in exchange, could, however, be conferred by the bank in a way far less injurious to the public, than the one now pursued, and that would be, by the simple operation of guaranteeing bills for a stipulated commission.

“To the southern merchants it affords another buyer of bills, to the northern another seller, widening in both cases the field of competition.” This to be sure appears plausible, but we apprehend will not stand the test of analysis. The bank it would seem goes into the market at Richmond, Charleston, Savannah, and New Orleans, to purchase the bills upon Europe, drawn upon the shipments of produce made from those ports. The immediate buyers of those bills, if the bank was not a dealer in exchange, would be, either the importing merchants on the spot, or the importing merchants in the northern cities. The bank, we will allow, by its competition, raises the price of bills above what it would otherwise be, because it is a speculator with a large capital, which buys, not because it stands in need of bills, but because it is sure it can make money by the purchase, owing to its power of controlling the market price. This, too, we will admit, benefits the drawer of the bill, and perhaps in a very trifling degree the planter, who gets a better price for his crops on account of the increased premium on bills. But is not the importing merchant of the south, as well as the importing merchant of the north, injured by this operation precisely in the degree that the others are benefitted? Are they not compelled to give more for their bills, than they would otherwise have given? And why should then an institution, general in its nature, take merit to itself, for taxing one portion of the community for the benefit of another? And how is the bank a ‘new seller to the north?’ Does she offer any more bills in the northern cities, than would be offered there for sale, without her intervention? We apprehend not to the value of a dollar. She occupies the mere place, which, without her, would be occupied by a number of individuals; and it is self-evident that her agency in the matter, so far from widening the field of competition, actually restricts it, and raises the price of exchange as much above what it would be, if she were not a dealer in bills, as the profit she obtains by her operations.

“But after all, why should the bank undertake to be the arbiter of exchange? Why should she be particularly careful that exchange should not be too high, rather than that it should not be too low? As far as some of our own citizens are the drawers, and others the purchasers of bills, it is of no sort of consequence to the public, what is their precise rate. To the parties themselves it is indeed of moment, inasmuch as what comes out of the pocket of one goes into that of the other; but the country is neither richer nor poorer for the operation, and the parties themselves are quite as able to adjust the rate as the bank. As far, however, as bills are wanted for the account of foreigners, for goods sold in the country, it is of advantage to the country, that exchange should be high, inasmuch as thereby the balances due them would be paid by a less amount of bills. But, notwithstanding this, the bank should not attempt to interfere with the natural course of exchange, any more than a government should interfere with the natural course of trade.

“Upon every view of the subject which we have been able to take, we consider all profits made by the bank upon its foreign exchange transactions, beyond the amount of a fair charge for guarantee, and brokerage for bringing buyers and sellers together, as a tax upon the consumption of the country, for which no equivalent service is rendered. We also consider that its dealing in exchange, and accumulating large stocks in Europe, which can only be done, we apprehend, by extra issues of paper, prejudicial to the currency, and consequently to the nation, is destructive of the only imaginable check upon over-trading and over-banking, inasmuch as it conceals for long periods together, the real state of the competition of the market, the only guide by which merchants and banks can regulate their transactions, with advantage to the country. If it should be asked, whether there is any difference in the effect produced by the operations of the bank, from that which would be produced by the operations of private speculators, we would reply, that there is a most essential one. Indpendent of the powerful force of a huge capital, which gives a weight in the market, that no moderate number of our citizens could bring to bear, the bank after it buys bills, has power to make an addition to the currency, the immediate effect of which is to raise the price of those bills, and thus afford a profit by their sale. Individual speculators, on the contrary, add nothing to the mass of the currency, and their operations must, in the nature of things, have but a very slight effect upon the market price of exchange.”