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Monetary reform and the redemption of national bank notes.

41 Commercial and Financial Chronicle, 2 June 1866, 674-75.

42 Comptroller of the Currency, Annual Report (1866), vi. (Clarke had resigned in mid-1866 in the wake of policy disputes with both McCulloch and Hulburd.)

43 Margaret G. Myers, The New York Money Market, vol. 1: Origins and Development (New York, 1931), 404.

44 Ibid.; Commercial and Financial Chronicle, 22 Jan. 1870, 102-3.

45 Comptroller of the Currency, Annual Report (1866), vi.

The fifty years during which the National Banking System operated are among the most eventful in U.S. financial and monetary history: they span the period of Populist demands for free silver, the debate over returning to the gold standard, and the struggles over restrictions on bank-note issue and branch banking. During this period, the country was rocked by a series of banking panics and associated sharp depressions - particularly in 1873, 1884, 1893, and 1907 - that sent policymakers and theorists alike in search of reforms that would overcome the banking system's defects.

A much-discussed shortcoming of the national banking regime was its upwardly inelastic supply of bank-note currency.(1) The stock of national bank notes failed to expand to meet the peak demands for currency that arose seasonally with "crop moving" and cyclically with financial crisis; it also failed to grow secularly with national income. That the system also suffered from downward inelasticity of the currency is nowadays seldom mentioned, though contemporaries complained forcefully that the stock of notes failed to contract in conjunction with seasonal troughs in currency demand.(2) Critics attributed this problem to the lack of an effective redemption mechanism for removing excess notes from circulation. In this article, we examine those complaints and the associated efforts to reform the redemption system.

Introduction

Since the expiration of the charter of the Second Bank of the United States in 1836, the nation's banking functions had been carried out entirely by state-chartered banks. Incorporated state banks issued their own notes, in many cases secured by state or federal bonds and ordinarily redeemable in specie on demand. These notes moved around the country and were usually exchanged at par near home and at a discount as distance (and redemption costs) increased. There was no "national" currency save specie.

The National Banking System, born during the Civil War, operated in the United States from the passage of the National Currency Act in early 1863 until the signing of the Federal Reserve Act in 1913. Shortages of reserves had caused banks to suspend specie payments in 1861. In early 1862 the Legal Tender Act authorized the federal government issue of "greenbacks" - non-interest-bearing U.S. notes not redeemable in specie but to be accepted throughout the United States as legal tender. This provided an alternative circulating currency and bank reserve medium, but it did not deal with another problem: the inability of the U.S. government to place its bonds for further war financing.

The new banking legislation, which established a series of federally chartered banks whose notes had to be backed by U.S. government bonds, was therefore most immediately motivated by the Union government's need to finance its war effort. But the movement toward national banking was given impetus by the secession of the Southern states and by the advocacy of Secretary of the Treasury Salmon P. Chase (1861-64). Secession removed the heavily Democratic (and anti-central bank) Southern members from Congress and gave the Republicans enough votes to pass the Currency Act of 25 February 1863, soon revised by the act of 3 June 1864. These measures established the office of the comptroller of the currency to administer the granting of charters to national banks and to enforce the rules under which notes could be issued and redeemed: the amount of paid-in capital required; the percentage of capital and bond valuation against which notes could be issued; the aggregate allowed volume of notes; the methods of apportioning distribution of note issue allowances; and the methods of redeeming notes for specie or greenbacks. It is on efforts to change the workings of the redemption system that we focus here.

Although the redemption reform movement has been largely overlooked in the secondary literature, it is crucial to understanding the course of reforms aimed at securing an "elastic" currency and leading up to the Federal Reserve Act.(3) Legal restrictions were clearly responsible for the problem of upward inelasticity: note issue was restricted by a 10 percent tax on state banks and by an aggregate ceiling on national bank notes before 1875, and thereafter by the costly requirement that a national bank over-collateralize its notes with (low-yield) federal bonds. Why then was simple deregulation of note issue not a more popular proposal among those who complained about inelasticity? We find that the leading advocates of monetary reform, particularly those who proposed some form of deregulation to allow notes backed by ordinary banking assets ("asset currency"), understandably feared that freed-up banks might over-issue notes unless the system were equipped with an adequate redemption mechanism. Attempts to solve the redemption problem were therefore a key ingredient of the period's monetary reform proposals.

We first explain briefly why note redemption was inadequate under national banking and why that mattered. We then survey contemporary criticisms of sluggish redemption, and trace the reformers' efforts to achieve more active note redemption, both privately through banking industry cooperation and publicly through legislation. Many of these reformers correctly blamed inadequate note redemption on legal restrictions and emphasized the self-adjusting properties of a deregulated bank-note currency. Their proposals ultimately failed to be adopted because the reformers endorsed branch banking as a means toward active redemption, arousing the opposition of unit banking forces. We conclude by considering whether the Federal Reserve Act appropriately addressed the problem.

Causes and Consequences of Sluggish Redemption

In an unregulated banking system with plural note issue, banks naturally come to accept one another's notes. The banks promptly return collected notes to their issuers directly or through an interbank clearing system.(4) The prompt redemption of its excess notes confronts an individual bank with rising marginal liquidity costs of note issue. Issuing an additional note undesired by the public means losing an equivalent amount of reserves, and thereby increases the bank's chances of running out of reserves. The liquidity costs accompanying efficient note redemption are therefore crucial to limiting a bank's desired volume of note issues. The same costs limit a bank's desired volume of non-interest-bearing demand deposits in the standard analysis of a system lacking statutory reserve requirements.(5)

Several features of the National Banking System discouraged the active redemption of notes. In particular, by requiring that national banks purchase $100 in face value of eligible government bonds for every $90 of their circulation, the regime 1) homogenized the notes of all national banks, eliminating the usual incentive for a member of the public to hold only certain preferred brands of notes while redeeming or depositing others, and 2) removed the usual profit to a bank from putting more of its own notes in circulation in place of the notes of other banks. The system thus suppressed the active interbank clearing and redemption of notes. With active redemption absent, national bank notes attained a "quasi-high-powered" status: although not a legal reserve medium, the notes circulated and were held by banks almost interchangeably with legal tender (greenbacks and gold), thus forming part of the base supporting broader monetary aggregates.(6) In the aggregate, an increase in the stock of national bank notes would allow a multiple expansion of loans and deposits, much as if an equal amount of greenbacks had been issued.(7)

One especially visible symptom of the sluggish redemption of national bank notes was the notoriously poor physical condition of the notes in hand-to-hand circulation. Under ordinary conditions of plural issue, as the clearing system repeatedly sends notes home to their issuing banks, the banks can replace older notes before they become too worn. The national bank notes' lack of homing power sentenced them to remain in circulation long after becoming tattered and filthy, to the point where one observer (apparently not in jest) suggested that bank tellers faced a health risk in handling the currency.(5)

An important consequence of the quasi-high-powered status of national bank notes was the absence of any reliable market-based restraint on the volume of notes. An individual bank issuing additional notes faced near-zero marginal liquidity costs. The notes could be expected to circulate indefinitely, as other banks that happened to receive them in deposits or loan payments would routinely reissue them instead of returning them to the issuer for redemption. As has been noted for the case of fiat currency, a plurality of unconstrained issuers of a homogenous high-powered money is inconsistent with monetary stability.(9) Recognizing this problem, contemporary banking experts sharply criticized the weak homing power of national bank notes. Charles Dunbar, a Boston financial editor and the first chairman of Harvard's economics department, found it "singularly at variance with the principle of having a wholesome restraint upon the operations of each bank by itself, which governs our treatment of other demand liabilities." Oliver M. W. Sprague, another Harvard economist, assailed the "inelasticity on the side of contraction," which "removes from the banks individually and as a whole some of the consequences of their operations for which they should be immediately responsible."(10)

Before 1875, the ceiling on aggregate national bank circulation ruled out any possibility of secular inflation while also creating a problem of rationing note issue among banks in different regions. Representatives of the South and West complained that their share was too small, frustrating efforts to establish new banks.(11) Proposals to remove the ceiling (a policy called "free banking" at the time) were met with the understandable objection that removal would lead to over-expansion and inflation unless it were accompanied by measures to ensure active redemption of notes. Fear of inflation was accompanied by concern that resumption of the gold standard (not accomplished until 1879) would be delayed. "Free banking" finally prevailed in 1875, but only following a major (though incomplete) reform of note-redemption arrangements in the previous year.

The return to the gold, standard in 1879 meant that secular inflation was no longer a danger from excess note issue, but seasonal and cyclical disturbances remained a serious problem. Rather than being redeemed locally, notes unwanted in the interior during periods of slack currency demand traveled via payments or interbank deposits to the Northeast and ultimately to New York City, where they appear to have contributed to the seasonality of interest rates by spilling over into loanable funds markets. New York banks, finding an accumulation of country notes in their vaults, were hard-pressed to convert them into useful assets. Before 1874 they sometimes resorted to selling notes at a discount for greenbacks or to lending country notes at zero interest to borrowers who were expected to repay their loans in greenbacks.(12) Much of this lending took the form of call loans for stock market speculation. In the late summer and fall, as interior banks drew cash from their correspondents to meet the peak demand for currency associated with the fall harvest, the currency movement reversed itself. The drain of cash into the interior confronted the Northeast with credit stringency, and occasionally with currency shortage, as reserve losses forced banks to contract their balance sheets. On several occasions - including 1884, 1893, and 1907 - financial stringency gave way to full-blown banking panics.

After the 1874 reform (detailed in a later section), New York banks could redeem unwanted notes and receive immediate payment from the subtreasury for them, but issuers were not called on to replenish the redemption fund immediately.(13) The reform therefore did not discourage seasonal shipments of currency to the city. Redemptions at the subtreasury merely gave the New York banks excess reserves, rather than excess country notes, to lend at call and did not immediately reduce the excess reserves of country banks - thus allowing the seasonal influence on interest rates to persist. Between 1890 and 1908 increases in the excess reserves of New York banks, which largely followed interbank shipments of excess currency to New York, were associated with decreases in interest rates on call loans and on 60-to-90-day paper in the New York money market.(14) Edwin W. Kemmerer provided evidence of such a linkage in his National Monetary Commission study of seasonal variations in money and financial markets under national banking. The seasonality of currency demand thus helps to account for the marked seasonality of interest rates between 1890 and 1919, which reinforced the effects of the seasonal credit demand emphasized by several analysts as a contributing factor in nineteenth-century financial crises.(15)

Had there been regular active redemption of national bank notes, interior banks would not have exported local credit expansion and contraction to the Northeast. Most excess country notes would have been intercepted by rival banks, redeemed, and removed from circulation before leaving the interior. Notes that did make their way to the Northeast would have been returned to their issuers promptly for redemption instead of swelling the quantity of high-powered money in the system as a whole. The original issuing banks would not have found it profitable to issue more notes until the demand to hold their currency rose. The seasonal movements of funds to and from the Northeast would consequently have been far less pronounced, reducing the likelihood of panics. The periodic excess of high-powered money would have been halted at the source, rather than spilling over into the bend market and causing a temporary distortion in interest rates and associated distortions of savings and investment.

The contrast between variations in the currency stock and interest rates in the United States and corresponding figures from Canada serves to illustrate this point. Seasonality in the demand for currency was common to beth agricultural countries. The actual circulation of bank notes showed substantial seasonal variation in Canada during 1890-1908, when there was virtually no seasonal variation in the United States. During the same years, interest rates on Montreal call loans showed much less seasonal variation than New York or Boston rates.(16) The seasonal pattern in New York call loan rates was in fact roughly similar to the seasonal pattern in the circulation of Canadian bank notes: low in the spring and summer, high in the fall. The greater interest-rate seasonality of the United States thus appears to have reflected in part the seasonal inelasticity of the national currency stock. Had national bank notes been actively redeemed rather than reissued, seasonality in the public's demand for currency would have led to a seasonal pattern in the quantity of notes (as it did in Canada), rather then generating spillover effects in the credit market. Such spillover effects were undesirable, because they presumably interfered with the normal function of the credit market in coordinating intertemporal allocation plans.

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Early Fears of Overissue

The inadequate provision for active note redemption under the Currency Act was criticized even before the act became law in 1863. Representative Stephen Baker of New York, in the principal speech opposing the act, warned that the lack of central redemption facilities would cause national bank notes to be discounted by banks or brokers seeking to cover high redemption costs.(17) Massachusetts Representative and economist Amasa Walker predicted that national bank notes would "continue to circulate as long as the material of which they are made will permit them to last." Walker argued that the act's provision making the notes receivable at par anywhere in payments to the federal government would remove any incentive for note-holders to return unneeded notes to their issuers; the notes would instead be held for government payments. Walker feared that "wildcat" national banks would spring up in remote places, issuing notes that would circulate indefinitely.(18)

A report issued by the New York Clearing House Association also doubted that adequate redemption would occur, given that a national bank note was redeemable only at its issuer's counter:

But how are the people to make such a presentation [at the issuing bank's counter]? Or how can even any institution, if it were disposed, afford to do it? Suppose eight or ten millions, belonging nominally in as many different states, be put afloat in New York, how can the city get rid of them? By what process procure a redemption of this uncurrent money? Whose business will it be to save a hundred dollars of this bank, and a thousand of that, and send them to Wisconsin and Dakota, only to be protested, returned to New York, then sent to Washington, and after thirty days redeemed there at par?

The report predicted, as Walker had, that holders of bank notes would keep them for payments to the government rather than "submit to a discount of from one to five per cent" in trading the notes for local money. The report illustrated the threat of a new kind of wildcat banking through a hypothetical example of a bank "originally of $50,000 capital" that could swell its circulation and assets to $500,000 "without perhaps even having redeemed, even with legal tender, $10,000 at its remote head office."(19)

Other critics envisioned that wildcat banks in the remote West would issue notes and have them "sealed up and sent to New York, where there are always debtors to the United States that could use them without trouble." Once received by the federal government, the notes would be forced on the government's creditors, whereupon the "great centers of trade [would] be flooded with a depreciated currency." One contemporary commentator insisted that "not even the Congress of the United States [can] make a bank-bill, redeemable in New Mexico or Utah, of as much value to a merchant of Boston as one for the same amount payable in State Street."(20)

Events bore out several of these predictions. National bank notes from other parts of the country appear to have initially traded at a discount in New York City. As early as February 1864, the banks of the New York Clearing House Association resolved to accept at par only those national bank notes redeemed at par by a member bank. Other notes were to be traded as "uncurrent money," accepted only at a discount, if at all.(21) Notes from all parts of the country accumulated in New York, particularly when demand to hold notes in the interior was below the spring and fall peaks. The existence of a less costly alternative to selling notes at a discount - namely, retaining them for use in payments to the government - led as predicted to few notes being sent home for redemption. The absence of a redemption constraint encouraged banks to issue all the notes for which they could get authorization. Hunt's Merchants Magazine reported that two national banks in New Haven, Connecticut (hardly the remote West) had $300,000 in notes outstanding for half a year or more without being asked to redeem a single dollar.(22) According to economist Francis Bowen, the New Haven situation was typical. Any national bank could "pay out its bills on the morning after it receives them from the Comptroller, with a comfortable assurance of not seeing more than a stray one or two of them again for a twelve-month." Rather than returning to their sources, national bank notes, once issued, became a "part of the permanent money stock."(23)

Congress was at first untroubled by the lack of note redemption. According to Charles Dunbar, many authorities assumed that arrangements for note redemption would be superfluous under the greenback standard then in place, because they would merely permit the exchange of one paper money for another.(24) Johns Hopkins astronomer and economist Simon Newcomb observed that "the law which provides for redemption provides for a mere farce. The paper in which the [national bank] bills are to be redeemed will answer no end which the bill itself will not equally answer."(25) Senator John Sherman of Ohio, younger brother of the Civil War general, even praised the long circulation period of national bank notes as a point of economy in the notes' favor.(26) Both Newcomb and Sherman neglected to consider that interbank redemption of notes for reserve money would have helped to limit the volume of bank-issued money even under a greenback standard.

Reform Efforts before 1874

The earliest reform effort - embodied in the 1864 revision of the National Currency Act - was motivated not by the low volume of redemptions, but in part by Congress's surprise at discovering that notes were not trading everywhere at par. Congress had expected that national bank notes would be a "uniform national currency," circulating at par throughout the country by virtue of their common collateral backing and their public receivability.

One revision proposed to the House Banking Committee in spring 1864 would have required each national bank to redeem its notes through agents in numerous specified cities as well as at its home office. Redemption agents' reserves would have been counted as part of a bank's lawful reserves. As the plan moved forward, congressmen scrambled to have cities and towns in their home districts included on the list of redemption centers.(27) In the end, seventeen cities were selected, including eight of the nine original reserve cities from the act of 1863.(28) To soften the impact on country banks, however, the proposal was modified to allow each national bank to choose just one city from the list as a par redemption site, subject to the approval of the comptroller of the currency. National banks in reserve-redemption cities other than New York were to be required to redeem at par through a national bank in New York.

Committee members feared that allowing banks to choose a single redemption city from among the seventeen would not be enough to eliminate all discounts on itinerant notes. They observed that redemption agents could be located well away from the main centers of trade where a note might be found. As New York City banker James Gallatin argued, a "'uniform national currency,' issued and redeemable at different places, is a chimera. To be 'uniform' it is indispensable that it should be redeemed at some central points - say, New York, Boston, and Philadelphia."(29) In response to this criticism, Representative James Wilson of Iowa recommended that all banks be required to redeem their notes at par in New York City, where most notes ended up.(30) Although the committee was convinced of the need for some further measure to keep notes from falling below par outside their limited redemption points, it nonetheless rejected Wilson's suggestion on the Populist grounds that it would make the rest of the country "pay tribute" to New York.

The committee's blunt solution, included in the revised National Currency Act of 3 June 1864 (renamed the National Bank Act in 1874), was to require all national banks to receive all national bank notes at par. This measure - which banned any national bank from discounting or refusing any national bank note - secured the uniformity of the national currency, but with unfortunate consequences for redemption. Discount charges had been instrumental in financing what little volume of note redemption there was. Once out-of-town notes could no longer be acquired at a discount, no spread remained to cover the transportation and transaction costs of redeeming them. The abolition of discounts also allowed a national bank's notes to circulate well beyond the area within which they could be returned to their issuer at relatively low cost.

The par-acceptance requirement burdened the banks of Philadelphia, Boston, and especially New York. Notes were brought to New York by the "channels of trade" and - more importantly - by shipments from correspondent banks who thereby acquired deposits in the "reserve city" banks that they could count as legal reserves.(31) The banks in all three cities had to accept large quantities of national bank notes from all over the country, without a discount to cover the costs of sorting and returning the notes to their issuers for redemption in lawful reserves. In May 1865 a committee of officers from sixteen major banks in the three cities endeavored to solve this problem. The committee's preliminary plan called for all national bank notes redeemable north of Cairo, Illinois, and east of the Mississippi River, but not redeemable in Philadelphia, Boston, or New York, to be sent daily to a central "Assorting House." Notes redeemable in Philadelphia or Boston would be sent directly to assorting houses to be established in those cities, and notes redeemable in New York would be exchanged through the New York Clearing House. Banks that remitted notes would be paid immediately in negotiable interest-bearing certificates equal to 90 percent of their remittances. The certificates would be redeemable (with accumulated interest) in legal tender and canceled when the issuers or their agents redeemed the returned notes. Assorting house expenses would be assessed monthly against participating banks in proportion to their remittances.(32)

By the time a meeting was held at the New York Clearing House in September 1865 to consider the plan, the interior banks had already "conceived a not unnatural dislike" of it. The plan threatened to erode their profits from note issue, and several refused even to send delegates. Disagreements among the bankers present led to a "spirited and prolonged discussion."(33) Some country bankers regarded the plan as a scheme to make them keep non-interest-bearing deposits at New York, as the Suffolk Bank had required New England country banks to keep deposits at Boston earlier in the century.(34) The meeting ended without agreement on the plan.

Following that gathering, the Commercial and Financial Chronicle pleaded with country bankers to "rise above the sordid views of private advantage" and to "promote rather than hinder" arrangements for active note redemption.(35) The newspaper argued that the plan would ultimately work in the country banks' own interest by countering popular hostility toward national bank currency and the "double profit" (interest on collateral bonds plus interest on loans) it supposedly allowed. The committee solicited endorsements for its assorting house plan from Secretary of the Treasury Hugh McCulloch (1865-69; 1884-85) and from Comptroller of the Currency Freeman Clarke (1865-66). Clarke's statement indicated that the federal authorities were becoming concerned about the danger of monetary expansion stemming from inadequate note redemption:

Banks have received and paid [national bank currency] out, and have had no further concern about it; consequently all have found it profitable, as they received the interest on the government bonds, pledged for its security, and lend the notes upon interest. Nearly all, therefore, are anxious to increase their circulation and, I greatly fear, will be able ... to bring such influence to bear as will induce Congress to authorize a large increase of the national bank currency. This may be prevented if immediate action is taken to provide for the redemption and return to the place of issue the notes of existing banks.(36) As noted earlier, active redemption would confront a note issuer with rising marginal liquidity costs, limiting its profit-maximizing note circulation to the quantity of its notes the public desired to hold.

The committee of city bankers reconvened in closed session on 19 September, and the members voted twenty-nine to twelve in favor of carrying its proposal forward.(37) A new seven-member committee, chaired by James Gallatin, was elected to write a constitution for a National Bank Note Redemption Association. This constitution, embodying all the important features of the draft plan, was adopted on 12 October.(38)

This victory for the proponents of active note redemption proved hollow, however. Many interior banks would not voluntarily cooperate with the Redemption Association or help to defray its expenses, which therefore had to be borne by the banks in the three organizing cities of New York, Boston, and Philadelphia. Although the assorting house plan promised substantial savings compared to decentralized redemption, it was costly nonetheless, and the law prohibited participating banks from discounting out-of-town notes to cover expenses. Unable to spread the costs of the assorting house scheme broadly, or to pass them on to the public, the city banks abandoned the plan. As the editors of Bankers' Magazine had predicted, central redemption would require "more thought, more experience, more labor, and more capital" than the city banks could muster.(39) In the next several years two further attempts to establish a New York assorting house also failed.

After the failure of these private remedies, the movement for active note redemption focused on legislative reform. In Washington, Comptroller of the Currency Clarke advocated "compulsory redemption in the great financial and commercial centers of the country" to check monetary expansion, achieve a fairer distribution of currency across the country, and discourage the establishment of national banks purely for "the advantage arising from the issue of their own promises, without the expectation of being called upon to redeem them." Conditional on compulsory redemption "at the central and accessible points mentioned," which would eliminate the "danger of bank issues exceeding the limits prescribed by the demands of legitimate business," Clarke was willing to recommend an increase in the aggregate limit on national bank notes from $300 to $400 million.(40) A bill (H.R. 771) reflecting these recommendations was reported to Congress in 1866. The bill required national banks in reserve-redemption cities other than Philadelphia, Boston, or New York to maintain note-redemption agents in one of those three cities; Philadelphia and Boston banks would be required to redeem their notes at par through agents in New York. Interior banks objected to the redemption provisions of the bill, while those wishing for a rapid return to specie payments opposed the expansion of national bank notes.(41) The bill, minus its original provision for a raised ceiling on national bank notes, became law in 1867.

The new law had little effect on the frequency of note redemption. Clarke's successor as comptroller of the currency, Hiland R. Hulburd (1867-72), observed that, under the old law, notes of 1,320 of the 1,647 national banks had already been redeemable in Philadelphia, Boston, or New York.(42) The new concentration of redemption points did little to reduce the costs of sorting and transporting notes, except perhaps to allow minor economies of scale where several banks happened to share the same redemption agent. Even after 1867, redemption-agent banks in the Northeast that received notes issued by their own interior correspondents (possibly shipped by the correspondents themselves for credit to their reserve accounts) were apparently reluctant to request redemption in legal tender, for fear that they would "offend" (impose expenses on) the correspondents and drive their reserve account business elsewhere.(43) The redemption-agent banks could instead dispose of the notes in "hot-potato" fashion by passing them back into circulation.

The summertime accumulation of unwanted country notes in the Northeast therefore continued unabated. Individual New York banks tried to dispose of the country notes by lending them free of interest for up to two weeks on the condition that the loan be repaid in greenbacks. They also sold notes to brokers, at a loss of one-tenth to one-quarter of one percent.(44) Many observers concluded that only compulsory centralized redemption of all notes in New York would prevent accumulation of the notes there. Prior to the passage of the 1867 law, Hulburd had remarked that the arguments urged in its favor "would, if carried to their logical conclusion, establish the expediency of requiring redemptions at one central point" - namely, New York.(45)

Hulburd continued this theme in his subsequent annual reports. He argued that centralized redemption at New York would be "a healthy reminder to the banks that their circulation is a liability payable on demand." It would also be a "first step towards specie payments," an opinion echoed by the New York Clearing House Association. As long as remote banks did not have to redeem their notes at New York, Hulburd warned, they would "be tempted to undue expansion by the difficulty of returning their notes for redemption."(46) The consequence, reflecting the operation of Gresham's Law under compulsory par acceptance, would be a currency dominated by "inferior" notes. Hulburd proposed that Congress establish a special non-issuing bank in New York, owned and managed by ordinary national banks, to be "the redeeming agency of the whole country, and the clearing-house of all national bank notes." He suggested, rather unconvincingly, that the bank could cover the expenses of note redemption and still return a profit to its shareholders by having a separate department devoted to "regular banking business."(47)

The financial press in the Northeast also campaigned for compulsory note redemption in New York. Bankers' Magazine stated that it would prove "a valuable tonic for preventing [the] succession of excitement and depression, of fever and chill" in New York financial markets.(48) The Commercial and Financial Chronicle declared that existing redemption arrangements were "notoriously imperfect and unsatisfactory" and were responsible for the growing public outcry to replace bank notes with greenbacks. It was up to the banks themselves to protect their interests by renewing the effort to achieve redemption for all notes in New York:

[T]he only way to make sure that the volume of bank notes shall increase when they are needed for business and shall diminish when the want has passed away, is to make it impossible for the banks to keep out their notes in excess. This is easily to be done. Banking experience has supplied an effective safe-guard. It is the safe-guard of metropolitan redemption. Let the banks be compelled to redeem their notes at the metropolis, where in time of plethora the notes are sure to accumulate, and we have the best remedy for the elasticity of the currency, which the nature of the case seems to admit.

Elsewhere the editors of the Chronicle observed that centralized note redemption would "impose a natural . . . check upon inflation" by forcing interior banks "to keep their affairs in a much more conservative condition."(49)

Interior banks fought all proposals for centralized note redemption.(50) In doing so, they inadvertently lent credibility to the argument that active redemption would restrain their issues. The Chronicle attributed the opposition to the interior banks' desire to maximize short-term profits, to their constant fear of becoming "tributary" to New York, and to the "demoralization of opinion upon banking regulations which grew out of the financial expedients of the [Civil War]."(51)

The Reform of 1874

By the early 1870s Congress was under considerable pressure to secure active redemption of national bank notes for three reasons: to relieve New York City banks of their accumulations of excess notes; to alleviate the filthy and worn condition of the currency; and to hasten the resumption of specie payments by reining in the stock of currency. An equally powerful movement demanded that greater circulation privileges be granted to banks in the West and South. The law of 20 June 1874, enacted after a long series of conferences and amendments, reflected these pressures. It combined a plan for centralized note redemption with re-apportionment of circulation privileges toward banks in the South and West in accordance with the census of 1870.(52)

The act of 1874 replaced the old system of redemption agents with a single National Bank Redemption Agency under U.S. Treasury auspices in Washington, D.C., making national bank notes redeemable through the Treasury as well as at their issuers' counters. Redemption at other locations was now prohibited.(53) The reserve requirement against notes was altered so that each bank now had to contribute legal tender equal to 5 percent of its outstanding circulation to a redemption fund held at the Treasury. When a bank's notes were redeemed, the senders would be paid immediately out of the fund, which the issuing banks would then have to replenish. Significantly, the costs of note redemption, including those for sorting and transportation, were assessed against issuing banks in proportion to the number of their notes received.

It appeared that centralized note redemption had at last been achieved, albeit with redemption centered in Washington rather than in New York. The choice of Washington, contravening the plan favored by the banks in the Northeast, was inefficient insofar as it meant additional costs of transporting notes and legal tender between the Northeast, where most notes accumulated, and Washington.(54) The choice, according to John Jay Knox (who served as comptroller of the currency from 1872 to 1884), was designed to appease forces at the Treasury who hoped to use their new powers to encourage a greater substitution of greenbacks for national bank notes.(55) The choice may also have defused the Populist suspicion that centralized redemption was a scheme to make interior banks "pay tribute" to New York.

The new law nonetheless won the approval of the northeastern banking community. The Commercial and Financial Chronicle, overlooking its previously expressed opinion that the Treasury's involvement in note redemption would be "bad in principle," expressed the hope that the reform would finally "rid [the] banking system of one of its worst defects."(56) Bankers' Magazine was even more confident:

The work of redemption seems at last to be provided for; and if carried out in good faith it will be worth more to the country than any of the other measures recently proposed to Congress. The practical difficulty of assorting the notes and presenting them for redemption is at once obviated, and the work will be greatly facilitated by the [bank charter] numbers to be hereafter stamped on all bills when issued.(57)

The new arrangement did improve note redemption. From 1864 to 1873, the only significant redemptions had consisted of returns to the Treasury of notes unfit for further use. The annual amount of such redemptions was at most about 10 percent of the total outstanding stock of notes.(58) Following the reform, the volume of currency received rose dramatically. National banks for the first time experienced significant note returns. Shipments of worn notes surged, and the Treasury was also asked to redeem many notes still fit for circulation. During the fiscal year ending 31 October 1876, the volume of national bank notes shipped to Washington (over $209 million) exceeded 60 percent of the outstanding circulation. A year later the figure was over 75 percent.

The new law, according to Bankers' Magazine, "worked more efficiently than its friends had ventured to expect."(59) Southern and western bankers who had anticipated improved opportunities for note issue were now worried that note expansion would involve marginal liquidity costs. One Arkansas banker complained that the new arrangement imposed "an unjust hardship" and "an onerous and outrageous burden" on him and his colleagues.(60)

Such worries and complaints turned out to be overblown. The Redemption Agency fell far short of achieving the ideal of comprehensive active note redemption experienced in other banking systems. Even the 75 percent redemption flow during the peak year of 1877 was a trickle compared to the estimated 1,200 percent reflow in Canada, where nationwide branch banking sponsored active note redemption. The volume of U.S. national redemptions in 1877, $214 million, was not much greater than the average annual value of New England redemptions by the Suffolk Bank during the 1840s and 1850s.(61) University of Chicago economist J. Laurence Laughlin estimated that in 1890, when approximately $130 million of national bank notes were in circulation, national banks received about $4 million of one another's notes daily.(62) Had all been redeemed, annual shipments to the Treasury would have been nearly $1 billion, about 800 percent of the stock. Allowing for notes received by state banks, which accounted for about one-third of the nation's banking-industry capital at this time, that figure represents a turnover comparable to Canada's. In contrast, the actual Redemption Agency volume in 1890 was $36 million, less than 28 percent. Even at the 1877 peak, if Laughlin's estimate roughly captures the ratio between the total circulation and the volume of notes that banks received, banks redeemed less than 10 percent of the notes received.

Most notes went unredeemed because of state banks' continued inability to issue their own notes and of some interior national banks' inability to accumulate notes rapidly enough (that is, without undue loss of interest) to meet the $1,000 minimum remittance accepted by the Redemption Agency. Most interior banks continued to reissue other banks' notes or to ship them to their city correspondents, extending the notes' circulation.(63) The majority of notes received by the Treasury were sent by New York banks, with shipments from Philadelphia and Boston next in size.

Sherman's Order of 1878

Despite the relative paucity of note returns, the treasurer's office was quickly overwhelmed by the "great amount of work suddenly thrown upon" it. The treasurer wrote in a circular of 4 September 1874 that "with the greatest exertions, it has been found impossible to assort enough of the redeemed national bank notes."(64) It was therefore impossible to requisition replenishment funds from issuers sufficient to avoid exhausting the 5 percent fund. Nearly $12 million of the fund's original $17.5 million was paid out before the sorting of notes even began.(65) In vain the treasurer requested voluntary contributions to the redemption fund equal to an additional 5 percent of circulation. He finally suspended payments for several weeks, beginning 19 September, so that the Redemption Agency could catch up. An act of 3 March 1875 later moved the agency from the treasurer's office to larger quarters employing ninety-eight full-time clerks under the secretary of the treasury's direct supervision.(66)

The Treasury regretted having taken on the burden of note redemption and soon acted to reduce it. Secretary of the Treasury John Sherman (1877-81), who as a senator in 1864 had praised the long circulation period of national bank notes for economizing on the use of paper, announced in September 1878 that, effective 1 October, parties transmitting notes to Washington for redemption would have to pay their own express charges, which the Treasury had previously assessed against the issuers of redeemed notes.(67) The new regulation, together with the standing prohibition against charging a discount for receiving other national banks' notes, meant that recipient banks would suffer losses in redeeming those notes.

The New York Clearing House Association protested to Sherman that the new rule amounted "to a penalty for forwarding National bank notes for redemption, [impeding] the practical operation of the law" of 1874 and renewing the interior banks' incentives to overissue.(68) Sherman replied disingenuously that the law "did not contemplate the establishment of a grand clearing house," but aimed merely at removing worn-out notes from circulation. He declared it a "manifest injustice" to compel issuers to pay the costs of redeeming their notes, since the issuers "have no-interest whatever" in having their notes returned. He regretted that some interior banks had been temporarily deprived "of the advantages of the repeal of the original act [of 1864], which required them to redeem their circulation in the large cities."(69) Sherman evidently wished to view the act of 1874 not as a remedy for the accumulation of currency in the Northeast, but solely as an expansionary measure.

Following Sherman's decision, the volume of notes sent to the Treasury fell dramatically. The volume had been $243 million in fiscal 1877 and $213 million in 1878; it dropped to $158 million in 1879 and to $62 million in 1880 (see Fig. 3). As Sherman intended, most of the decline came in shipments of notes still fit for use, which fell from $151 million in 1877 to $25 million in 1880. Redemptions of worn notes also declined, from $62 million in fiscal 1877 to $30 million in 1880. Fearing renewed deterioration of the currency, the Treasury modified Sherman's order on 1 December 1879 to allow transportation costs for worn notes to be paid out of the 5 percent fund. This measure did not make much difference, because many banks were unwilling to undertake the costs of separating worn from fit notes and accumulating amounts sufficient for forwarding to the treasurer.(70) On 13 January 1881, just before Sherman left his Treasury post, his order was revoked entirely. The original arrangements of 1874 were restored, except that assorting expenses were now assessed on banks in proportion to the value rather than to the number of their returned notes.(71)

Redemption of worn notes rebounded to over $53 million by fiscal 1882. Returns of fit notes continued to decline, however, reaching a low mark of $3.8 million in fiscal 1882 and not recovering their 1878 level until 1912. The principal causes of the continued low levels of fit-note redemptions were the rising price (and falling yield) of the bonds required as collateral for note issue, which made it less profitable than ever for banks to issue more notes, and the growth in the relative importance of non-note-issuing state banks.(72)

The lack of active note redemption after 1882 was both a consequence of and something of a compensation for the restrictive effects of the bond-collateral requirement. Had note redemption somehow been as active as in Canada and elsewhere despite regulatory restrictions on note issuance, high liquidity costs would have been added to the high cost of securing collateral. The secular shrinkage in the stock of national bank notes would have been even more severe. The Commercial and Financial Chronicle pointed out the incongruity of a restriction that taxed note issue in one respect while subsidizing it in others and pleaded for reforms that would allow the stock of notes to attain a natural elasticity:

Ought we not then to make the law so that it will be reasonably profitable for a bank to obtain and issue notes? - at the same time be sure and add to it a plan of redemption which will be prompt and effective, taking the place of the miserable make-shift, which now exists for redemption, through a Washington Bureau? In this way can be produced a perfect automatic currency machine, as obedient to the laws of trade as the circulation of blood is to the beat of the heart.(73)

Active Redemption and the Asset Currency Movement

The banking reform movement intensified following the panic of 1893. The House Committee on Banking and Currency considered dozens of bills, all aimed at providing a more "elastic" currency whose volume would respond appropriately to secular and especially to seasonal changes in the public's currency-holding demands.(74) The typical proposal for improving elasticity was to let banks issue an "asset" currency - that is, to allow bank notes to be matched on the balance sheet by general bank assets instead of requiring them to be (over)-matched by specific government bonds. This step was meant to enable banks to accommodate increases in currency demand. Improved redemption facilities, sometimes supplemented by a tax on circulation, were to guarantee appropriate contraction of the currency when demand subsided.

Freer note issue and active redemption were viewed as complementary reforms that together would give rise to an automatically adjusting currency. J. Laurence Laughlin, writing for the Indianapolis Commission on Monetary Reform, argued that "to secure real elasticity it is not enough that the circulation should expand when the necessities of commerce require more currency; it is just as essential that it should promptly contract when those necessities have gone by." To ensure prompt contraction, "daily and immediate redemption of notes" was a necessary counterpart to enhanced freedom of issue. A naturally developed redemption system, which the United States lacked, would regulate the currency appropriately: "All [the] anxiety for something to force retirement of a redundant bank-currency has arisen from a failure to appreciate the important function of redemption and the way in which, when freely developed, it serves as a constant regulator of the volume of currency."(75)

Banker William C. Cornwall similarly insisted that an asset currency system with active note redemption would provide automatic elasticity:

[W]ith every bank crowding for redemption and retirement of all the notes of every other bank, and pressing out all it possibly can of its own, it is readily seen that only the actual amount needed by commerce will stay out. . . . This is the principle of elasticity scientifically carried out, suppressing inflation, fostering enterprise and working out its own fine end under the test of daily redemption.(76)

It was widely believed that, in the absence of provisions for active note redemption, greater freedom of note issue might lead to "an excessive supply of circulation and an illegitimate expansion of bank credits."(77)

Almost all of the reform plans considered by Congress attempted to provide for active note redemption.(78) Many plans even emphasized redemption over freer note issue, reflecting the understandable belief that getting more currency out would be easier than getting it back in again, as well as the belief that seasonal shortages of currency were largely due to maldistributions or prior overexpansions that active redemption would prevent. Proponents of reform disagreed, however, on how to implement active redemption. A minority, including the authors of the "Baltimore Plan" endorsed by the American Bankers' Association (ABA) at its 1894 Baltimore convention, argued or implied that greater freedom of note issue would itself bring about sufficiently active redemption by raising the opportunity costs to banks of reissuing rivals' notes, as experience in other nations showed. The majority, however, though recognizing "a very close connection between the ease or difficulty of issuing notes and the activity and efficiency of the redemption system," believed that legislation redesigning the redemption system was needed to prevent overissue of asset currency.(79)

Congress quickly abandoned the Baltimore Plan after critics pointed out that it relied on the "usual, slow process" of note redemption.(80) The majority view was bolstered by the observation that redemption under the National Banking System had been hindered not only by banks' inability to issue more of their own notes, but also by the expense of sorting and transporting the notes issued by thousands of other banks. The minority view appeared to overlook the fact that banks in the United States were much more numerous and dispersed than banks in other nations.

Legislative Proposals for Active Redemption

An obvious but unpopular route to active note redemption was to repeal the requirement that national banks receive one another's notes at par. This idea, proposed by Comptroller Knox in 1873, was revived in the late 1890s by Virginia banker William L. Royall. In testimony before the House Banking Committee, Royall blamed par acceptance for the seasonal glut of notes in New York: "[I]f you put out notes in a backwoods community that are good at par in New York, those notes will leave the backwoods community and go to New York."(81) Non-par acceptance would make sorting and returning notes profitable and would prevent notes from circulating far from their places of issue and redemption. He cited the case of antebellum Virginia notes, which traded at a discount in New York and consequently were seldom taken there.

The same sort of localness characterized Canadian bank notes before 1890.(82) Non-par valuation eventually disappeared, as discounts paved the way for improved redemption facilities. A non-par currency was nevertheless viewed in the United States as decidedly retrograde. T. G. Bush of the Indianapolis Monetary Commission told the House Banking Committee that proponents of such a solution "in coming to Washington ought to have taken the stagecoach instead of the railroad train," as outdated means were "more in keeping with their views."(83)

A second proposal for encouraging active note redemption was to make it illegal for national banks to pay out one another's notes, as Massachusetts had done for state banks in 1843. This proposal, recommended by Charles Dunbar, was considered but ultimately abandoned by the authors of the bill (H.R. 3333) submitted to the 55th Congress by Joseph Walker of Massachusetts, chair of the House Banking and Currency Committee.(84) The proposal failed to reckon with country banks' option of sending unwanted notes to their reserve-city correspondents. Instead of helping to spread the redemption process more widely, it would have increased the burden on city banks struggling to dispose of excess notes.

A third and more popular proposal was to increase the number of common locations at which banks were obliged to redeem their notes. Various subtreasuries could officially be required to serve as redemption bureaus along with the Redemption Agency in Washington, as some already were doing unofficially.(85) Alternatively, national banks could be officially required to redeem their notes at par at private clearinghouses approved by the comptroller of the currency. The bill supported by New York banker R. B. Ferris (H.R. 2699) read before the 54th Congress and the bills submitted by Secretary of the Treasury Lyman Gage (1897-1902) (H.R. 5181) and the Indianapolis Monetary Commission (H.R. 5855) to the 55th Congress embodied the subtreasury approach. The Treasury Department proved unwilling, however, to take on any additional burden. The clearinghouse approach found its way into a large number of proposals, including an early Walker bill and at least four others.(86) The banking community opposed these bills because they would have imposed high costs on banks.

A fourth and still more popular approach, following the Canadian and Scottish models, was to allow interstate branch banking by national banks while requiring each branch to redeem at par the notes issued by its head office. Branching would permit banks to expand profitably into new areas where their notes might circulate. The branch-redemption requirement would make them devote some share of the resulting earnings to maintaining more widespread redemption facilities. The inclusion of branching privileges in asset currency plans was seen by some as essential for getting any part of the banking industry to support legislated redemption provisions. Others, particularly Representative Charles N. Fowler - a member (and later chairman) of the House Banking and Currency Committee, a member of the Indianapolis Monetary Commission, and an uncompromising promoter of asset currency - viewed branch banking as a means to active note redemption and thereby as a key to the success of an asset currency.(87)

Branch banking, however, had politically influential opponents. The smaller interior banks feared the consolidation of the banking industry that interstate branching would bring. The unit banking lobby was able to prevent the passage of any measure that even hinted at banking across state lines throughout the 1890s and beyond.(88) The path of least resistance, evident in the Gold Standard Act of 1900, was therefore to relax bond-collateral requirements without making any improvements in note redemption to provide an offsetting restraint. As one commentator observed, "[T]he plans of the theorists contemplated that the bank issues should be at the same time expansible and contractible. But legislation has adopted only one-half of the project, for it has seized upon the idea of expanding the bank issues but made no provision for their contraction."(89)

The Ultimate Failure of the Asset Currency Movement

By obstructing potential improvements in note redemption, the defenders of unit banking helped to undermine the asset currency movement. They did so knowingly. Andrew J. Frame, a Wisconsin banker who was one of branch banking's more outspoken opponents, made his position clear in a 1907 address: "Enforced quick redemption . . . will work under a branch banking system, but it is impracticable under ours. For one, I do not propose to be accessory to my own hanging by aiding in bringing about any branch banking system, which I confidently believe is the ultimate end in view of many of the asset currency advocates."(90)

By 1907 the asset currency movement had abandoned "its moorings in branch banking."(91) It instead attempted to devise second-best means for achieving an elastic currency with active note redemption. The clearest example of a second-best proposal, and the last important effort to establish an actively redeemed asset currency, was a joint product of the ABA's Currency Commission and the Committee on Finance and Currency of the New York State Chamber of Commerce. Their proposal, put before Congress in 1907 as H. R. 23017, recommended that national banks be allowed to issue unsecured "credit" notes to supplement their bond-secured notes. The comptroller of the currency would "designate certain cities conveniently located in the various sections of the United States for the current daily redemption" of the credit notes.

Both the New York committee and the ABA Currency Commission stressed the importance of note redemption. Economists Charles Conant and Joseph French Johnson, writing for the New York committee, held that active redemption was a matter "of the first importance," and that multiple redemption points were necessary to secure it: "If the volume of bank notes is to vary sensitively with the need for them, there must be incessant daily redemption, and this can be had only when the redemption points are so numerous that no bank will be more than 24 hours distant from one."(92) James B. Forgan, president of the First National Bank of Chicago and a member of the ABA Currency Commission, argued that creating an asset currency "without providing means for its contraction . . . would only enhance the evils of our present system." He elaborated:

It is, therefore, no expansion of the currency that we are advocating, but the adjustment of it to fluctuating demands of commerce with an adequate power to contract as these demands are reduced. . . . There is only one possible way by which this attribute of elasticity can be given to it; that is, by active redemption and practical cancellation of bank notes which are not kept in circulation by the requirements of commerce.

Drawing on his experience as a former employee of both Scottish and Canadian banks, Forgan claimed that, with adequate redemption facilities, national bank notes would circulate "on exactly the same basis as checks, bank drafts, and other similar obligations," being "presented along with these through the Clearing House for redemption" instead of being treated like gold or greenbacks.(93)

Others were skeptical that multiple redemption points alone, unaccompanied by branch banking, could achieve active note redemption. Frame dismissed the proposal as "an expensive luxury" that would make "a picnic for the express companies" at great expense to the national banks.(94) But skepticism was not confined to the unit banking interests. Frank Vanderlip, a former assistant secretary of the treasury and a member of the New York currency committee, also came to doubt "whether the creation of numerous redemption points would be sufficient to drive in the redundant circulation."(95) The New York committee and the ABA Currency Commission responded by proposing a tax on credit notes in circulation. Taxing circulation, however, penalizes notes generally, not only excess notes, and does nothing by itself to drive redundant notes to their issuers.(96) Forgan admitted that once a note has been issued, it may, tax or no tax, remain "entirely beyond the reach of the bank that wants to redeem it" if no mechanism exists for returning it promptly.(97)

By endorsing a circulation tax, the sponsors of H. R. 23017 played into the hands of the opponents of asset currency, led by Senator Nelson Aldrich of Rhode Island. Aldrich favored allowing a supplemental currency, to be issued only during "emergencies" and subject to a heavy tax aimed at achieving its prompt withdrawal. The Aldrich-Vreeland Act of 30 May 1908 embodied a compromise between Aldrich and the supporters of H. R. 23017, authorizing an emergency asset currency under a heavy tax but denying an ordinary asset currency with active redemption. The act was, moreover, adopted only as a temporary expedient (expiring 30 June 1914) while the National Monetary Commission, which it authorized, looked into permanent reform solutions. Ultimately it gave way, not to any asset currency, but to the Federal Reserve Act (1913).

The Federal Reserve System provided even less adequately than the National Banking System had for active note redemption. Each of the twelve regional Federal Reserve Banks was required to receive and prohibited from re-issuing (except at a 10 percent penalty) the notes of any other reserve bank, but the banks seldom had the opportunity to redeem one another's notes. The public, as before, did not seek to redeem unwanted notes directly, but found it easier to deposit them in their accounts at commercial banks. State and national banks preferred to hold and re-issue Federal Reserve notes rather than to redeem them for gold, even though the banks could not yet count the notes as part of their legal reserves. The Federal Reserve notes were the favored currency medium of the public, and the national banks' own profits from note issue were dwindling. The holding and re-issue of Federal Reserve notes was also encouraged by a rule preventing a bank from directly receiving reserve-balance credit from its district reserve bank for a deposit of notes issued in other districts. Member banks were thus encouraged to return their own reserve bank's notes, but not to send in the notes issued by other district reserve banks.(98)

Federal Reserve notes were therefore as lacking in "homing power" as national bank notes had been before. Economist F. M. Taylor concluded that "the new law does not promise to give to the note issue the degree of contractibility which has hitherto been considered desirable."(99) The Commercial and Financial Chronicle noted the irony of this outcome in light of the original aim of providing a downwardly elastic currency:

What is now being done . . . is just the reverse of what was intended. . . . Instead of notes being retired, when their mission as a medium for carrying mercantile paper has been fulfilled, they are being forced into circulation and a determination exists to keep them afloat indefinitely. Mr. [Benjamin] Strong [Governor of the Federal Reserve Bank of New York] argues that this does no harm and that if the notes become redundant they will quickly come in and be presented for redemption. As a matter of fact unless some crisis intervenes they will stay out just as long as the banks and the trust companies continue to pay them out.(100)

The Federal Reserve Act had introduced a currency whose volume was "elastic" only in the sense that it could be increased or reduced at the Federal Reserve's discretion. Although this sort of discretionary elasticity did succeed in smoothing interest rates and (for a time) in avoiding financial crises by eliminating seasonal accumulations of currency in New York City, it was far from providing the automatic elasticity that reformers throughout the national banking era had tried to achieve.(101)

Conclusion

The inadequacy of note redemption under the National Banking System in the late nineteenth and early twentieth centuries was appreciated by many reformers, who sought improved opportunities for redemption as a complement to greater freedom of issue. According to their diagnosis of the banking system's problems, the interventions of the federal government prevented the stock of bank notes from adjusting, in an automatic and desirable way, in response to changes in the demand to hold notes. The reformers' goal of an elastic currency was co-opted, and their deregulatory program ultimately discarded, in the fashioning of the Aldrich-Vreeland and Federal Reserve acts. Recent work on the self-adjusting properties of the note supply under deregulated conditions suggests, however, that the reformers' diagnosis was essentially correct.(102) Their program deserved a better hearing.

1 See Vera C. Smith, The Rationale of Central Banking (1936; Indianapolis, Ind., 1990); Philip Cagan, "The First Fifty Years of the National Banking System - An Historical Appraisal," in Banking and Monetary Studies, ed. Deane Carson (Homewood, Ill., 1963); Richard H. Timberlake, The Origins of Central Banking in the United States (Cambridge, Mass., 1978); and Bruce A. Champ, "The Underissuance of National Banknotes during the Period 1875-1913" (Ph.D. diss., University of Minnesota, 1990).

2 See, for example, O. M. W. Sprague, "The Distribution of Money between People since 1893," Quarterly Journal of Economics 18 (Aug. 1904): 527-28.

3 One of the few authors to notice the reformers' emphasis, Fritz Redlich, in The Molding of American Banking, part 2 (New York, 1951), 114-16, dismisses redemption reform as an "infatuation." Lloyd W. Mints, A History of Banking Theory (Chicago, Ill., 1945), 230-31, observes that "the paramount importance of 'contractility' of note issues, as well as of expansionability, was repeatedly emphasized" by reformers, and that "adequate redemption facilities ... were generally insisted upon" as a means of providing contractability, but he does not discuss redemption reform in any further detail.

4 George A. Selgin and Lawrence H. White, "The Evolution of a Free Banking System," Economic Inquiry 25 (July 1987): 439-57.

5 Ernst Baltensperger, "Alternative Approaches to the Theory of the Banking Firm," Journal of Monetary Economics 6 (Jan. 1980): 1-37.

6 Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960 (Princeton, N.J., 1963), 50, 781-82.

7 George A. Selgin and Lawrence H. White, "National Bank Notes as a Quasi-High-Powered Money," unpub. MS, University of Georgia (1992), discuss in more detail the "quasi-high-powered" status of national bank notes and its consequences. The remainder of this section draws heavily on that work.

8 F. Cyril James, The Growth of Chicago Banks (New York, 1938), 399-400.

9 Benjamin Klein, "The Competitive Supply of Money," Journal of Money, Credit, and Banking 6 (Nov. 1974): 423-53.

10 Charles Francis Dunbar, Economic Essays (1897; New York, 1904), 241; Sprague, "The Distribution of Money," 527-28.

11 George L. Anderson, "The National Banking System, 1865-1875: A Sectional Institution" (Ph.D. diss., University of Illinois, Urbana, 1933), 353. The original ceiling was $300 million.

12 Friedman and Schwartz, Monetary History of the United States, 21n8; Commercial and Financial Chronicle (New York), 22 Jan. 1870, 102-3.

13 Philip Cagan and Anna J. Schwartz, "The National Bank Note Puzzle Reinterpreted," Journal of Money, Credit, and Banking 23 (Aug. 1991): 300-301. The second Independent Treasury Act (1846) had established subtreasuries at New York, Boston, Charleston, St. Louis, New Orleans, and Philadelphia; subsequent legislation during the National Banking period removed Charleston and added Baltimore, Cincinnati, San Francisco, and Chicago.

14 Other determinants of New York banks' excess reserves were, in order of significance: 1) movements of gold and greenbacks between banks and the public; 2) movements between the banks and the New York subtreasury; and 3) international gold flows (William A. Scott, "Rates on the New York Money Market, 1896-1906," Journal of Political Economy 12 [May 1908]: 273-98). From 1902 to 1907, Treasury Secretary Leslie Shaw actively intervened in the New York market by shifting funds from the subtreasury to the banks in the fall and back in spring, in an effort to reduce the seasonal fluctuations in banks' reserves and loan rates. See Timberlake, Origins of Central Banking, chap. 12; Andrew T. Allen, "Private Sector Response to Stabilization Policy: A Case Study," Explorations in Economic History 23 (July 1986): 253-68.

15 Edwin W. Kemmerer, Seasonal Variations in the Relative Demand for Money and Capital in the United States (Washington, D.C., 1910); Allen, "Private Sector Response"; R. Glen Donaldson, "The Sources of Panics: Evidence from Weekly Data," Journal of Monetary Economics 30 (Nov. 1992): 277-305; and Gregory Mankiw, Jeffrey Miron, and David Weil, "The Adjustment of Expectations to a Ch0ange in Regime: A Study of the Founding of the Federal Reserve," American Economic Review 77 (June 1987): 358-74.

16 Taking the differences between averages of end-of-quarter interest rates reported by Georg Rich, The Cross of Gold: Money and the Canadian Business Cycle, 1867-1913 (Ottawa, Ont., 1988), 49-50, for the period 1902-13, Montreal call loan rates varied only 30 basis points between mid-year and year-end (5.3 vs. 5.6 percent), whereas New York rates varied 470 basis points (2.5 vs. 7.5 percent), and Boston rates varied 260 basis points (3.3 vs. 5.9 percent). Consistent with the international arbitrage opportunities seemingly available, Rich observes that "in the fourth quarter.... Canada typically acted as a lender to the New York money market" (178). But he notes that before 1914 risks and information costs apparently prevented arbitrage from equalizing Canadian and U.S. interest rates, or even rates within the two countries (151). Citing the variations in Montreal call loan rates, both over time and across banks, Rich argues against the view that the Canadian loan rates were fixed by collusive agreements (though deposit rates may have been thus fixed) (48-51).

17 Albert S. Bolles, The Financial History of the United States from 1861 to 1885 (New York, 1886), 215.

18 Amasa Walker, "The New Currency of the United States," Bankers' Magazine 12 (May 1863): 833-43, quotation at 836.

19 John Earl Williams and J. L. Everitt, Report of a Committee on the National Bank Currency Act, Its Defects and Effects (New York, 1863), 8-9.

20 In order, the three quotations are from Waldo Flint, Some Strictures on an Act to Provide a National Currency (Boston, Mass., 1863), 14-15; George L. Stearns, A Few Facts Pertaining to Currency and Banking (Boston, Mass., 1864), 6; and Flint, Some Strictures, 15.

21 Hunt's Merchants Magazine, April 1864, 307. Redlich, Molding of American Banking, 114, dismisses "the fact that National Bank notes were not at par in New York" as the result of an arbitrary clearinghouse policy. In fact, the policy reflected the costliness to the banks of redeeming or otherwise discharging unwanted notes. In Chicago, where by contrast national bank notes appear not to have accumulated, the national banks agreed in April 1864 to accept all national bank notes at par (James, Growth of Chicago Banks, 357-61).

22 Hunt's Merchants Magazine, Sept. 1864, 248.

23 Frances Bowen, "The National Banking System," Bankers' Magazine, April 1866, 773.

24 Dunbar, Economic Essays, 238-39.

25 Simon Newcomb, A Critical Examination of Our Financial Policy during the Southern Rebellion (New York, 1865), 209-11.

26 Dunbar, Economic Essays, 289.

27 Congressional Globe, 2 April 1864, 1377.

25 The seventeen cities were: New York, Boston, Philadelphia, St. Louis, Chicago, New Orleans, Cincinnati, Baltimore, Louisville, Detroit, Cleveland, Pittsburgh, Milwaukee, Albany, Leavenworth, San Francisco, and Washington. The first eight cities listed continued from the 1863 act; Providence, in the 1863 list, was omitted in 1864.

29 James Gallatin, The National Debt, Taxation, Currency, and Banking System of the United States (New York, 1864), 15.

30 Congressional Globe, 2 April 1864, 1378.

31 In 1837 New York city banks had resisted a similar state proposal to compel their par acceptance of upstate notes on the grounds that it would allow the country notes to "engross the circulation in New York"; see Davis Rich Dewey, State Banking before the Civil War (Washington, D.C., 1910), 97. It is not clear why New York should have been expected to run a persistent balance of trade surplus with the rest of the state or country.

32 The plan is reproduced in Bankers' Magazine, Sept. 1865, 198-200.

33 Commercial and Financial Chronicle, 16 Sept. 1865, 354; Bankers' Magazine, Nov. 1865, 401.

34 The views of one country banker are set forth in a letter appearing in the Bankers' Magazine, Dec. 1865, 460-65.

35 Commercial and Financial Chronicle, 16 Sept. 1865, 354.

36 Freeman Clarke, quoted in ibid., 363-64.

37 Bankers' Magazine, Nov. 1865, 402.

38 It is reprinted in the Commercial and Financial Chronicle, 14 Oct. 1865, 489.

39 Bankers' Magazine, Sept. 1865, 194.

40 Comptroller of the Currency, Annual Report (1865), 6-8.
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