James A[lexander] Hamilton to MVB, [January? 1829]
My Dear Sir:
By conversation with intelligent and well-informed persons on this particular subject, and by extensive reading, I have become so imbued with some of the leading principles which I believe ought to govern the Legislature in deciding upon the serious question as to the renewal of the charters of the banks of the State, that I cannot forbear writing to you on the subject, even in a hasty and negligent manner, owing, in some measure, to my want of leisure. The two great points to be considered are, first, a due regard to the stability of the currency of the country; and, second, the security of the depositors and holders of the notes of the banks. Contrary to first, and most usual impressions, I consider the first, really the most important question of the two, and therefore give it the first rank. The evils to the community, great as they are, resulting from the failure of banks, are immeasurably less than the semi-annual panics to which we are exposed by what is called a pressure for money, and which always results from over issues, consequently, over trading and endless individual bankruptcy.
It is as erroneous as it is common, to say that the commercial difficulties in England in 1825 and in this country in 1829 and 1826, and the approaching commercial difficulties, are the legitimate results of speculation. This is certainly not so. The truth is, that such a spirit is the consequence of a too great facility of borrowing money, induced on the part of the banks by a desire to make large profits; and this results in an excessive issue of their notes and credits. The mischief of this error is not confined to lenders only, but it embraces all classes of the community. It makes the consumer buy at high prices; it leads to extravagance, and it depreciates the value of the means of all who live upon fixed incomes, while the failures must necessarily produce great and extended individual distress; it also diminishes the ability of the banks (as they cannot escape amid the extended ruin unharmed) to pay their public creditors, and thus, in a great measure, to impair the security of depositors and note holders. If I am correct in these views, the first question on the subject of the banks is—Can the Legislature, by special enactments, prevent these excessive issues, and thus aid in maintaining the stability of the local currency? I believe they cannot; but I do believe that if incorporations are granted upon correct principles, that it will produce this effect. You might as well endeavor to restrain the exportation of the precious metals of the country, as, by special provisions, endeavor to prevent the banks from issuing more notes than the fair commerce of the country requires. No! The only way to arrive at that great desideratum is, first, to compel the banks to do what it was originally intended they should do, as Mr. Bronson expresses it—“Furnish a medium of trade, and not capital,” that is, discount paper which originates in business transactions, and not paper in order to originate business; which may be called accommodation paper. The former is intended to be, and would, under a proper system, be paid when it became due. The latter is, on the contrary, intended to be a long or permanent loan, and is used as capital; whereas the other facilitates the repayment of capital already acquired and invested in purchases. And, second, to require them so to place their capital that it cannot be loaned, and consequently having nothing but credit to bank upon, they will be subjected to some of those never varying laws of currency, and thus be unable, without certain ruin, to go beyond a proper limit. I have before stated that I was in favor of a State Bank, by which I mean, granting new, in preference to re-incorporated banks, because the latter have run into habits that are vicious, and wholly foreign to true principles; and that it would be easier to commence a new system correctly, than to amend an old one, as it is easier, (I may be permitted, in writing to my Commander-in-Chief, to make a military reference,) to make a soldier of a raw recruit because he has only to learn his new duty, than it is to make one out of a militia-man, who has not only to learn what is correct, but to unlearn what is erroneous in his duty. But this is by no means an important question—whether new banks are formed or old ones renewed. The two great points to which I have referred must be guarded: and I think this will be done effectually by a plan Bronson has submitted to me, together with the plan you have referred to.
The capital ought, before the Bank can commence its operations, to be invested in the United States or State Stocks—and these securities ought to be placed beyond the control of the bank; that they may be a fund in reserve, and never to be used or to be available for any banking operation; and the amount of the notes to be issued never to exceed the amount of this fund: and, as a mean of preventing any excess, let it be provided that after the bank shall have given security for its notes, they shall be countersigned and stamped by the proper officer or commissioner within whose control the stock is placed. (If it is objected that these securities ought not to be entrusted to any individual, the answer is, that there can be no difficulty in transferring and assigning them in such a special manner to the Register and Assistant Register, if you please, of the Court of Chancery, as would make the cooperation or the order of the bank necessary to the assignment.) By this provision the capital of the bank would be secured to the public as a fund to be applied in payment of the notes in circulation, and these could not at any time exceed the amount thereof. It would also be incapable of being loaned to dealers, and consequently not liable to be lost; but above all the bank would thus be compelled to loan its credits, resulting from its deposits, and bills receivable, and these sources only—the necessary consequence of which is that the loans must be for short periods, in order that the stream which flows out, may be regularly and equally supplied by that which flows in; if this is not so, the efflux would soon cease—consequently, if the operations of the banks are confined to business paper as it is called, which is made up of these notes at short periods that have been taken for goods sold, and which are expected to be paid out of the re-sale of the same goods to other dealers or consumers; there will be no greater amount of notes offered, than is required for permanent and successful commercial purposes. Or if the banks, being unable to loan their capital, should stretch their credit too far, or in other words make it too cheap, they would necessarily impair it; and by the invariable course of raising the price of goods, every tyro in the business well knows that the reaction would be ruinous: whereas, if in addition to their credit as is now the case, they could loan their capital, they can encourage over trading not without some, but certainly with less risk than the plan proposed. If instead of confining their issues to the paper which had originated in business transactions, they should then, as they now do, stimulate speculation by lending capital—an inevitable consequence would be that the notes would be depreciated, and consequently (without going through the whole process) specie would be called for which they could not pay, inasmuch as their capital does not consist in any part of it. It is unnecessary for me to go further into the reasoning on the subject. It is as demonstrable that excessive issues would be thus checked at least, as it is clear that while the stock remained invested, the notes of the bank could all be paid.
In addition to this provision, which would tend to preserve the stability of the currency and to secure the payment of the notes of the bank, I would superadd a Provision—
2dly. That a commissioner should be appointed by electors chosen by the banks, an elector to every $400,000 of stock, and one to each bank whose capital should be less than that amount; whose duty it should be to require for each bank 1/4 of one per cent. on its capital to form a fund to be invested as before, in order to make good any deficiency, should any arise, after applying all the credits of the bank and all its stock to the amount of its deposits and notes; and further to require from each bank a monthly return of all its notes in circulation. Such commissioner or supervisor to keep a vigilant eye to the state of the exchanges; of the exports, and imports of the country: and to the general ranges of the prices of commodities, and to notify to the banks any indication of an over-issue of paper—such commissioner or supervisor not to have any interest or concern directly or indirectly in trade or commerce of any kind—to hold his office during the pleasure of the banks, and to be paid his salary out of the income arising from the contributed fund, and the residue of such income to be paid over punctually to the fund, and the residue of such income to be paid over punctually to the contributors in proportion to their respective interests therein.
Principles deemed insdispensable in a reformed system of banking.
1st. The aggregate amount of bank credit which can be sustained in circulation without depreciation, whether issued from one bank or one thousand banks, can never exceed the amount of the circulating medium which the laws of commerce assign to the county; or more than there would be in gold and silver if there were no banks; although that amount will be different at different times, since it must be regulated by the exigencies of the country, and the state of its exchange with other countries.
2d. A banker who employs capital, will be enabled to lend more money than one who employs none; but not more credit, therefore he derives no profit on his capital, for in this, as in all other concerns, the interest on the capital is to be charged in the profit and loss account, and as the banker can receive no greater interest where he loans it than he charges for its use, it is evident he must be a loser on that operation, as the expenses and losses attending the loan of capital, must be deducted from the profit he makes on the use of his credit; and that credit he can circulate as extensively if his capital is vested in stock or bonds and mortgages, as he could do if he employed his capital in the same manner as he does his credit. Besides, if the capital is kept in a condition to be at all times available in the current business of the banker, large portions of it must be occasionally unemployed, and of course unproductive, and when that is the case, he is tempted to lend it on doubtful security, rather than let it remain idle.
3d. There need be no other funds employed in banking operations than those created by bank credit, the aggregate amount of which, as before stated, ought never to exceed the amount required for a circulating medium; and this supply should be steady and uniform, that is, always in proportion to the natural requirements of commerce, and that amount will be indicated by those immutable laws, which alike regulate both commerce and currency; and which so limit the quantity independently of legislative injunctions, that banks conducted on this principle, can never force any considerable excess into circulation, without producing a reaction which would soon exhaust their specie and check their issues, before that excess could materially enhance the exchangeable value of commodities.
4th. The legitimate business of bankers, strictly speaking, is the employment of the funds produced by their credit in discounting notes and bills of exchange which have been created in the course of business, and which have but a short time to run. It requires no capital to discount all paper of this description, as the payment of every note furnishes funds to discount others of equal amount.
5th. The fluctuations in the price of commodities, when excessive, are generally owing, not to a demand for consumption, but to the effect produced by one speculator bidding upon another which creates an artificial price, and its deviation from that which is natural (depending on supply and demand for consumption) is in proportion to the amount of capital which banks can furnish for such objects, and when a reaction ensues, as it always does when loans are excessive, those who were bidding upon each other when the banks were extending, are now compelled, by underbidding each other, to reconvert their commodities into money at such reduced prices as to cause innumerable failures, which, if banks were restricted to credit only, would seldom happen.
6th. No loans of capital are so injurious in their consequences, as those temporary accommodation loans made by banks; their first effect is, by creating a competition amongst buyers, to raise the exchangeable value of commodities too high for the foreign markets, and a consequent demand on the banks is produced, for specie to export in their place. The next is such a retrenchment of loans, and reduction of price, as will send commodities abroad and bring back money; and those who supposed themselves enriched by the rise of property, now find that they are impoverished or ruined by its fail; and all the property obtained from individuals, on the private credit of those who fail, passes into the hands of their endorsers, to secure the banks against any participation in the losses sustained by their debtors, and which losses their own operations have rendered inevitable. The possession of capital, and the necessity of employing it to make a dividend, sets all the banks simultaneously striving to see who can lend the most money and make the greatest dividend; until the drafts for the coin for exportation create an alarm, the strife in curtailing becomes as great as it had been before in extending their loans; those fluctuations, though not so regular, become quite as certain as the rise and fall of the tides, and are obviously the effect of banking capital employed in loads of this pernicious character.
7th. The monied capital of the country would be better employed to aid production, than in creating artificial prices of the commodities produced. Loans of bank capital are easily obtained when they are not wanted, but not easily repaid when they are,—as those who have ventured into deep speculations so uncertain, both in their amount and duration, have too often experienced.
8th. It is the medium of trade, and not the capital necessary for carrying it on, which it is the proper functions of the banks to furnish. When the requisite amount of bank notes have been issued from such medium, the diminution or increase of discounts can have but little influence upon its quantity, except for short periods. If the discounts increase, there must be a correspondent increase of payments, and vice versa, and both may happen without having any sensible effect upon prices or upon the amount of money in circulation. Yet such an effect on both may be produced to any desirable extent by withholding loans and requiring payments, or by lending more and requiring less. When, and to what extent the exercise of this power becomes necessary, every experienced banker will know by attending to the state of the foreign exchanges, and the operations of commerce; and the perfection of his skill consists in so conducting his business, as never to have occasion to exercise the power to correct an evil of his own creating.
If the foregoing propositions are true,—and it is believed that they are,—then it must be admitted that the employment of capital in banking operations adds nothing to the profit of the banker, while it has such an influence in raising and depressing the value of commodities so much above and below their natural or exchangeable value, (by which is meant that value which the relation between the supply and the demand for consumption always imparts) as to occasion most of the failures which occur amongst men in trade; and which would seldom happen if the banking capital was safely and permanently vested in some productive funds, and the credit of the banks only employed in advancing in anticipation and in receiving at maturity the money for all goods made payable at short periods which may be offered at discount. Hence it follows that perfect security may be provided against the failure of monied corporations, without lessening their profits or their utility, by requiring their capital to be paid in full, and to be permanently loaned on mortgaged security or vested in stock, prohibiting by proper penalties the employment of any part of it in banking operations, and limiting the issue of credit to the amount of capital; by which simple process the object of all these complicated restrictions and penalties now provided by law, will be fully attained; everything else may be safely left to the discretion of the directors,—the condition of their being will necessarily prescribe the nature and limits of their operations, secure dividends to the stockholders, and perfect security to the public, while any operations, if attempted, incompatible with the interest of the stockholders or the public good, will be rendered powerless.