William Gouge
An Inquiry

Of the "Convertibility" of Bank Medium.

Many who are inimical to paper money in every other form, are friendly to the use of Bank paper, because it is, they say, equal to specie, inasmuch as specie can be obtained for it at the will of the holder.

But what does this "convertibility" amount to ?  Though we have between three and four hundred Banks, we have not yet one at every man's door;  and, if we had, every man would, in the course of business, be compelled to receive the paper of distant Banks.  A man may prefer silver, and yet not choose to walk even half a mile, to have his note changed.

Those whose money dealings are most extensive, like not to offend the Banks by too frequent calls on them for specie.  It might lead to a curtailment of their accommodation.  They have as deep an interest as the stockholders and the directors in keeping the notes in circulation.[7]

In addition to this, it must be remembered, that Bank paper is "convertible" into only one of those species which should, according to law and constitution, be the money of the United States.  An incorrect valuation of gold at the Mint, and paper money together, have driven this precious metal from the country.  Bank paper is "convertible" in to silver only, which is inconvenient for large payments, and for transportation to distant places in large amounts.

From this combination of causes, not more than one twentieth of the paper is actually "convertible" at any one time, and herein consists the safety of the Banks.  An attempt to convert but one half of the Bank medium, into specie, would, though several months were allowed for the operation, break all the Banks in the country.

Now, can such a "convertibility" make Bank notes "equal" to specie ?  We mean equal to specie as money, in its three functions of a circulating medium, and of a standard and measure of value.  We know the two articles are equal in the market, but the question is, if they ought to be so.

"Convertibility," so far from being an assurance of the soundness of Bank notes as money, is not even an assurance, for three days together, of their soundness as bills of credit.  This is verified in the case of Banks whose paper is in one week at par, and in the next at a discount of fifty per cent.

When the contingencies on which convertibility depend, are taken into consideration, the risk appears so great as of itself to outweigh all the arguments usually adduced in favor of Bank medium.

The practice of the Banks is to make provision for those demands only which it is probable will be made upon them, which provision is seldom for more than one-fifth of the amount of their actual engagements to pay on demand.  It is very easy for the Directors to make a mistake in their estimate of probabilities.  Events which they could not foresee may occur, and circumstances they cannot control.  It is not always easy to say where the line of safety should be drawn;  and the Directors are at all times tempted to transcend it, from the desire of making large dividends, and raising the price of their stock in the market.  Sudden changes in the political and commercial world, may render the best conducted Banks unable to comply with their engagements, though they may have in store double the amount of specie, which would, in other times, be necessary to support their credit.

On a certain day in 1819, there were but $80,000 between us and universal bankruptcy.  This was the whole amount of specie in the United States Bank at Philadelphia;  and if that had been exhausted, a shock would have been given to Bank credit, which would have caused a general suspension of specie payments.  In 1825, the condition of both England and the United States was hardly less critical.  The failure of two or three of our principal Banks would cause a run upon all the others.  They could then comply with but a part of their engagements, and their inability to satisfy the claims of the holders of their notes and of depositors, would render the fulfilment of other money contracts impossible.  The credit which Bank notes enjoy, has been called "suspicion lulled to sleep."  Events may awaken that suspicion.

Attempts are sometimes made to show the perfect security of the Banks, by contrasting the amount due by them for notes in circulation and for deposites, with the amount falling due to them every sixty or ninety days on account of mercantile paper discounted by them.  But such calculations, even when they rest on indisputable data, prove only the ultimate solvency of a Bank.  The amount due by the Bank, on account of deposites and on account of notes in circulation, may all be legally demanded in one day;  nay, in one hour.  A greater amount may be owing to the Bank, but it is payable at different times, and the extremes of the term are sixty or ninety days apart.  The individuals who owe this money to the Bank may be rich men: but their ability to pay, within the time agreed upon, depends on the credit of Bank paper being maintained.  Let the depositors suddenly withdraw but one-half the amount of specie ordinarily retained by the Banks, and the credit of Bank notes necessarily falls.  A portion of the debts due to the Banks may be paid in this depreciated paper;  but the Banks will not have the means of satisfying all their creditors.  There being little specie in the country, the collection of debts due by individuals to individuals, would be suspended, (if Bank paper should suddenly lose its credit.)

The danger of such an event may not be very imminent;  but it is sufficient to show that the stability of Bank medium depends on contingencies which, as they cannot always be foreseen, cannot always be guarded against.  What was called "a panic" in England, in 1825, broke up a number of private Bankers who were perfectly solvent, and was near proving destructive to the whole system.  If a suspension of specie payments should again occur in this country, we should be left for a time without a sufficient medium of exchanges.  Too many men are now aware of the nature of "inconvertible" Bank paper for it to have general circulation.  It would soon run the course of the Continental money, and of the French assignats.

So long as Bank paper is "convertible," more than a certain amount cannot be kept in circulation for a long time without undergoing a sensible depreciation.  Hence "convertibility" fixes a limit which Bank issues cannot pass.  By carefully watching one another, by attending to the course of foreign exchanges, and by guarding against a drain of specie, the Banks may, in ordinary times, main tain the "convertibility" of their paper;  but the history of Banking, both in England and the United States, since the resumption of specie payments, shows that this "convertibility" cannot give to Bank medium that stability which is essential to a sound money system.

In the means by which "convertibility" is maintained, we have an abundant source of evils.  It is by one Bank pressing on another, and thereby forcing the debtor Bank to press on its customers.  When there is a foreign demand for specie, the "convertibility" of Bank medium is maintained by a general pressure on the community.

Lord Liverpool, in a debate in the British House of Peers, in February 1826, placed the doctrine of convertibility in its true light.  "The doctrine," he said, "maintained by some noble lords, that nothing was better than a paper circulation convertible into gold, is true to this extent– that if convertible into coin, the evil would cure itself, whilst one not convertible would lead to nothing but ruin.  But how is the cure to be operated ?  By the downfall of thousands and hundreds of thousands, and the convulsion of all kinds of property.  It is true that the evil carries its own cure, but with such terrible consequences that the cure is worse than the evil."


7   In a debate in Parliament in July 1828, Lord King said, that "as for payment in gold, he knew there was an esprit de corps among the Bankers, and people who wished to get accommodations from them would find it no easy thing to obtain gold.  The Banker would inquire if the individual was in the habit of asking for gold, and if so, accommodations would be withheld.  Paying in gold was not, therefore, that check to over-issues which some people imagined."

Of the "Elasticity" of Bank Medium.

The value of Bank medium," says a writer on this subject, "consists in its elasticity – in its power of alternate expansion and contraction to suit the wants of the community.  In truth, the merit of a Bank is nearly in proportion to the flexibility of its means."

Most unfortunately for this argument, when the demand for money is greatest, the Banks are compelled to contract their issues.  When the natural demand is least, they are able to expand most.  These "alternate contractions and expansions" do not, therefore, "suit the wants of the community."

It is not a regard to "the wants of the community" that regulates these "alternate expansions and contractions."  It is a simple regard to their own profits that induces the Banks to expand their issues.  In contractions, the Banks have regard only to their own safety.

Every thing is not, indeed, left to the arbitrary discretion of the Directors.  The natural and political causes that affect trade, affect also their operations.

If wars, or other political operations, cause a flow of specie to a particular point, the Banks are immediately compelled to reduce their issues of paper.  As a demand on the Banks for a million of specie usually causes them to reduce their accommodations to the amount of four millions, the pressure on the community is four times as great as it would be if the foreign demand operated singly.

A rise in the price of our staples in foreign markets enables the Banks immediately to expand their issues.  The spirit of speculation is then excited, and the Banks supply it with aliment.  Hence, immediately after news of a rise in the price of flour and cotton, in foreign markets, these articles rise so high at home that they cannot be exported and sold at a profit abroad.  The original holders gain something by selling their stock to the speculators.  The price is raised on the domestic consumer;  but very little is added to the wealth of the nation, for the rise of price at home causes little to be exported.

To enumerate all the causes that affect expansions and contractions of Bank issues, would be to enumerate all the causes, immediate or remote, that affect trade, or affect the confidence man has in man.  Any thing that excites the spirit of enterprize, has a tendency to increase the amount of Bank issues.  Whatever damps the spirit of enterprize or of speculation, has a tendency to reduce the amount of Bank issues.  As the wild spirit of speculation has in most cases its origin, and in all its aliment, in Banking transactions, these various causes operate in a circle.  The Banks, by expanding their issues, give aliment to the wild spirit of speculation when it begins;  and by their contractions, they aggravate the evils of the natural reaction.

One of the principal inducements for preferring the precious metals as the material for money, is their want of this very "elasticity" or "flexibility" which the writer above quoted, declares is the principal excellence of Bank medium.  The mere desire of one man to have money, and of another to gratify that desire that he may make a profit by it himself, will not increase the supply of the precious metals.  The spirit of wild speculation, therefore, in solid money countries, wants that aliment which is so readily afforded to it in our own.  The production of gold and silver requires an expenditure of labor equal to that which must be expended in the production of those articles which gold and silver can procure.  The supply is regulated by natural causes which are as powerful as those which regulate the demand.

When an addition is made to the stock of gold and silver in a solid money country, it does not immediately affect prices.  It usually comes in the shape of bullion or foreign coin.  The importer considers whether a profit may not be acquired by shipping it to some foreign country.  If he decides on retaining it, part of it is probably wrought up into plate or jewellery.  If he sends it to the mint, some time must elapse before it can be converted into coin.  After it is converted into coin, he may not choose to put it immediately into circulation.  He may make it part of his reserved stock, and wait for months, perhaps, for an opportunity for making advantageous purchases.  If he can make no advantageous purchases at home, he sends the money abroad.  Thus while there are powerful causes in operation throughout the commercial world, which make the demand and supply of silver and gold to vary in only an imperceptible degree, from year to year, there are particular causes operating, which make the supply in all solid money countries, just equal to the effective demand, and thereby truly "to suit the wants of the community."

In such countries, when the spirit of enterprize is awakened by fair prospects of a profitable trade, no sudden plentifulness of money follows to convert the spirit of enterprize into a spirit of wild speculation.

If the enterprizes prove unsuccessful, the evil is not aggravated by an artificial scarcity of money.

If wars, or other political operations, create a demand for specie, the pressure is only equal to the foreign demand –not fourfold, as with us.

If there is a rise abroad in the prices of the staples of exports of a solid money country, no sudden increase of currency raises prices so high as to make the exportation a losing business.

Such are the advantages of an "inflexible" and "non elastic" money.