Banks, Workmen, And Retailers
( Originally Published 1918 )
During the movement conducted by The National Citizens' League for the Promotion of a Sound Banking System, which led up to and largely assisted in establishing the present Re-serve Bank System, that league issued (1912) a book under the title "Banking Reform." Prof. J. Laurence Laughlin, an authority in the science of finance and a member of the faculty of the University of Chicago, edited the book, and contributed considerable original matter.
Leading up to its object, the book gave an out-line of the course of American banking from the passage of the National Bank Act to the time of writing. One section was given to an untechnical account of those functions and traits of banking which are fundamental to all modern systems. Among these was the following consideration of the direct relations between banks, wage earners and small merchants:
The bank stands in a two-fold relation to the community as a whole—meaning by that term those who are not necessarily customers of the bank or depositors with it, as well as those who, while using the bank as a means of convenience for the safe-keeping of funds, do not transact any business with it in which credit is bought or guaranteed. This two-fold relation consists : (1) in supplying a satisfactory means of exchange and in the safe-keeping of funds; and (2) in the maintenance of such credit conditions that economic opportunities, including the field of employment, the chances for investment, and other conditions of the same sort, are permitted to develop gradually and steadily without shock and in such a way as to preserve the welfare of every member of society.
Much is said about the "safety" of banks, and the national banking system has been highly praised because of the fact that its notes have al-ways been redeemable at face value, while the losses to depositors have been small when compared with the total liabilities. It remains true that a bank may be a very safe institution and yet a very unsatisfactory agency.
Even from the narrowest standpoint, the mere maintenance of an ability to redeem its obligations is only the bare minimum of what should and must be required of an institution of credit. Little or nothing is heard of the bearing of bank credit upon the general steadiness of employment, the payment of wages, and the support of prosperous conditions. Yet all of these factors have a direct and intimate connection with banking.
The simplest form in which the bank is brought into contact with the individual is seen in the actual safe-keeping of money. The individual may have coin or currency which he does not immediately need to use and which he therefore deposits in a bank for safe keeping. The bank is said to be sound or solvent if it is able at all times to return to individuals an amount of money equivalent to that which they have left with it.
A somewhat more complex form of relation-ship is seen in those cases where the individual has not left actual money with the bank, but has deposited with it checks or drafts upon other banks (or upon the bank itself). In such cases, he has transferred to the bank a right which he might have exercised of calling for such money or currency as his checks and drafts entitled him to. The solvency or safety of the bank is tested in this case, as in the former one, by the ability of the bank to liquidate this title to draw which the depositor has received from it at the time when he gave up his checks or drafts to the bank.
The total amount of outstanding claims upon banks is always far in excess of the money which they carry in their vaults. Under the national banking system, the largest amount of reserve which any bank is compelled to hold is 25 per cent of its outstanding liabilities. This means that even if every deposit with the bank had been directly made in coin, it might have used this money as a basis for loans to four times the amount of the deposit in question; in other words, it might have increased its liabilities to four tinies the amount of the money and currency in hand. It is evident that in such cases a solvent bank is so only in proportion as claims are not presented to it for cashing, since it could at no time meet the combined claims outstanding. If any considerable part of them were presented and a demand for liquidation into money were made, the bank would have to close its doors. Plainly then, the safety of the bank does not consist in its keeping on hand a large sum in money, since it never can expect to have in its vaults enough money to meet all possible claims.
The safety or solvency of the bank is found in two conditions: (1) the possession of assets which can unquestionably be turned into cash, in sufficient amount to equal the liabilities of the bank, and (2) the possession of opportunities or facilities for converting these assets into cash so steadily and regularly that it will at no time be compelled, even temporarily, to suspend specie payments—that is to say, to ask its depositors to wait.
For many reasons, the depositor places great stress upon this ability to convert his deposit promptly into liquid resources. His credit at the bank may be all that he has to protect himself and those dependent .on him and supply them with necessaries. If the bank fails, his funds are tied up indefinitely, and perhaps are partially or even wholly lost. If the bank suspends, he is un-able to get the current funds he needs to pay his ordinary bills. In the first case, his savings are swept away and his interests are destroyed correspondingly. In the second case, he is obliged to ask others for credit or for leniency during the time that the bank has suspended. He is thus put to a very considerable inconvenience.
During the period of suspension, demands may come upon him for cash which he is absolutely unable to satisfy. Opportunities for investment or for other uses of his funds must be sacrificed simply because he cannot draw upon his own resources, which are now in a non-liquid form. Invariably therefore, he considers the maintenance of liquidity at his bank as essential; and this requirement is so strongly entertained by him that in the event of suspicion concerning his bank's immediate capacity to meet its liabilities he may make matters worse by insisting that the bank pay him in full at once. If enough depositors adopt this course, the result is to make the situation much more serious and perhaps to drive the bank to close its doors. Ability on the part of the bank to meet a condition of this kind is therefore essential.
How Workmen Are Affected.—This calls attention to the requirements of the wage worker in connection with banking. The system must be such as to assure him, so far as it can, the steady flow of funds that will enable him to re-store his deposits when they have been drawn down by the withdrawal of cash for current needs. This reconstruction of deposit accounts comes only through a free flow of funds through-out the community; that is to say, through the steady payment of wages and salaries. This process is rendered possible only by the continuous activity of industry. But continuous activity can be obtained only in those cases where the business world is able to obtain freely and at reasonable rates the capital which is necessary to enable it to offer employment, and thereby secure the means of operating its plants continuously. When employers are able to do this, there is a free flow of funds throughout the community, and the laborer is able to get wages in cash in exchange for his services. If the flow of funds in this way is checked through inability on the part of banks to liquidate, the employer may desire earnestly to set men at work, and laborers may be eagerly in search of employ-ment, but they will not be able to cooperate. In modern society where labor is highly specialized and a machine type of industry prevails, wages are not paid in the products of labor, but are paid from the previously stored capital which is kept in a fluid or liquid condition through the action of banks.
The essential need of the wage earner is stability in industry. Such stability can be secured only when industrial managers are supplied with all the elements of production. Of these elements, bank credit forms an increasingly important part.
The claim may be made that such credit is not needed by all concerns and that only in an inflated condition of industry would it be called for. It is assumed by some that the business man who borrows at the banks is an exceptional person. This is far from being the fact. Practically every business that is conducted upon any considerable scale requires accommodation. The accommodation in question is not loans as a general rule, but discounts; in other words, funds which anticipate the payment of claims which the business has obtained against others in re-turn for the services or goods which it supplies. In proportion as goods are sold upon credit, it is necessary that banks should intervene between the purchaser and the seller of the goods. The purchaser does not pay cash, because he looks to the sale of the goods to provide the means for liquidating their cost. But the seller needs cash because he has to pay his employes in cash. He places his price at such a point that he can afford to extend credit for a reasonable period. Then he draws upon his customer, and through the aid of the bank the draft is recognized and the funds are placed at his disposal for immediate use.
These transactions become more numerous and necessary in proportion as industry becomes highly specialized, and in proportion as more and more processes intervene between the original producer of raw materials and .the person who consumes the product that has been developed out of them. The intervening stages through which the product goes represent repeated turnovers of capital, and require time.
The element of time thus becomes an important feature in productive enterprise, and this it is the function of the bank to allow. Should the banking mechanism break down, a gap would open between the producer and the consumer which could not be bridged.
In proportion as credit plays a part in the process of producing goods, it constitutes a corresponding element in the cost at which goods are turned out. The cost at which goods are turned out determines their price to the consumer upon any competitive market. The wage-worker spends the principal part of his income in purchasing commodities for consumption. He has to pay a correspondingly larger part of his income when the prices of commodities are high, and is correspondingly relieved when they are low. Any element that can reduce cost is likely to reduce the price to the consumer. Wherever capital is an important element of cost, therefore, it is an important factor in determining how much the worker shall get in return for his money wages.
Borrowed capital is an important element in all modern operations. Whatever then results in high interest rates on loans at banks, ultimately tends to produce higher prices for goods to the consumer. The consumer, who is predominantly a worker for wages, receives a larger amount in real wages—the things that money will buy whenever industry is stable and bank accommodation is reasonable. It is a familiar fact in all countries where rates of interest are very high, that prices are correspondingly exhorbitant and the result is that in those countries all goods that are produced with the use of borrowed capital are raised in price to an equivalent extent.
While, therefore, the well-being of the general mass of the consuming and laboring population in the maintenance of a stable currency and a steady condition of business, free of panics and depression, is very great, the interests of these groups in the community in the regular and systematic conduct of the industry upon an economical basis is even greater.
The small business man is particularly and peculiarly interested in banking facilities. He has demands for credit and bank accommodation as acute as any large merchants, without the latter's resources of power to force compliance with his needs. He is infrequently interested as stockholder in, or connected as a director with, any bank institution. His paper is not known beyond the locality in which he operates. No bank is specially eager to secure his business, and he cannot send his paper abroad for disposal if he has urgent demands which, for any reason, his particular bank will not consider.
The merchant with small capital is, however, a decidedly important factor in every community, large or small. In the aggregate he is a great power in the nation. He supplies the needs of the ultimate consumer, and it is through him that the banks are brought into touch with the consuming masses and are thus made parties to the final process in the transition of goods from producer to consumer.
In the end it is this consumer who supplies the cash to discharge a credit obligation which may have originated in a loan to the producer of the commodity. At every stage in the various forms of transferring a thing from producer to final distributor, borrowed capital may have been used and credit for it extended on the strength of the continued existence of the commodity. The ultimate consumer has no such security to offer. Once a thing is passed to him, it is destroyed or its value impaired by use. He must pay for it.
Broadly viewed, the banks must be keenly interested in the final process of the series which marks the progress of goods toward the goal. They must be particularly alive to the important position held by this small merchant. To a large degree it is on the ability to discharge his final duty that the success of the whole complicated scheme of production and distribution depends. His financial position and his means of using his capital and securing credit to carry on his operations are therefore of vital importance in any plan of banking or banking reform. His paper has its own characteristics. It is essentially local. The extension of credit to him is determined largely by the banker's knowledge of his personal dependableness and the character of the business in which he is engaged.
These characteristics distinguish the paper of the small merchant without regard to his location. His case is the same in the large city or the small town. If he is in the latter, the field in which he may apply for loans is geographically restricted. If he is in the former, his difficulties are not less, because he must necessarily attach himself to one bank and look to that one for his accommodation. In every case his demand for loans is direct, personal, and largely dependent for its satisfaction upon the judgment of the banker and his appreciation of the needs of this small client.
The service of the bank is thus that of facilitating the flow of goods into the consumer's hands at the time when they are wanted. The consumers have to pay for this service in the prices charged by the merchant, because he naturally is obliged to compénsate the bank for its advances of funds, and his operating expenses are thereby increased. The longer the period of credit is, the higher the prices will be, and the larger the accommodation which has to be granted by the bank, and the rate of remuneration that will have to be charged for it. Presumably, the consumer gets more than a corresponding return in the shape of convenience or he would not submit to this condition but would pay cash for his goods.
In such transactions loans are made by the bank upon the merchant's own personal note. Evidence of his solvency and ability to pay is se-cured from inspection of his stock, his books and accounts, from his statements or otherwise. If he has property outside his business which is within reach, the bank will feel the more confidence, but whether he has such property or not, the immediate test of the loan will be the character of the customers he is supplying and the nature of their own personal credit—the extent of their capacity to pay.
The banker's judgment as to which members of the community are entitled to the use of the fluid funds of the community is therefore vital, because it results in entrusting the funds to successful or unsuccessful individuals, as the case may be. It places them in trustworthy or un-trustworthy hands. It puts them where they will be wisely used or will be wasted. In the long run, the judgment of the banker on this subject is always right.
If he makes many mistakes in judging the character of his customers and their title to accommodation, he himself is the loser and eventually must go out of business. He will then be succeeded by some one else whose judgment is sounder and better than his own. Probably there are few lines of business in which closer and more accurate scrutiny and knowledge of the details of transactions are needed and are actually obtained than in the country banking or in city banking where the clientele consists of retailers.
The paper of the merchant, as has been shown, is distinctly local in character. The whole banking operation connected with it must, therefore, be carried on by persons familiar with conditions in the community where it originates. It is plain, also that in such circumstances, the limit to the loans which can be extended is marked by the banking capital available in the community. This banking capital is supplied by those who first organized the local banks and those who have subsequently made actual deposits of fluid resources.
There is another aspect of this relationship between the local merchant and the bank. The merchant is invariably also a depositor at his bank, as well as a borrower. He is a depositor in a sense somewhat different from that which attaches to a depositor specifically as such. When he borrows from the bank he almost in-variably takes his loan in the form of a book credit. He draws on this book credit in order to meet his obligations. He seldom asks the bank for actual money. Frequently, his customers pay him in checks and he deposits them with the bank. When they pay in actual cash, he promptly takes the money thus received to the bank. His deposits with the bank, whatever they may be, are frequently less than the amount that he owes the bank for the accommodation which has been extended to him. It is therefore vital to his success that he should be enabled to continue doing business with the institution without interruption.
For such reasons the mercantile part of the community is usually the strongest support of the banks simply because its interest is so closely bound up with that of the banks. The security behind the commercial paper of the community is thus not merely the actual property of the merchants who compose it, but is also their commercial future and their general prospects of success in a business way. The paper which they supply the bank is therefore one of the best bases for rediscount that can be offered. The assurance that it will be paid without default is as great as can be obtained.