But with bank notes it is far different. These are in many cases as freely accepted and passed on as are the coins of the realm. Once they acquire the sanction of custom, people do not inquire whether the bank which issues them is in a position to redeem all its obligations; they are freely accepted until without warning the bank may suspend payment and the holders of the notes find them worthless.

The history of banking in England during the eighteenth century affords countless instances of bank notes, issued by entirely irresponsible individuals, which circulated freely for a time until the inevitable crash came. The Charter of the Bank of England rendered the establishment of powerful banks of issue an impossibility, and it was left to small tradesmen and others to issue as many notes as the public would accept, with the result that periodic convulsions of credit occurred, in which hundreds of these small bankers came to grief.

There is, or rather has been, a school of economists, called the Free Banking School, who insist that the issue of notes should be left unrestrained, except by the legal obligation of being payable in coin on demand, but these opinions are now generally discredited and we find a universal tendency over the civilised world to place restrictions of some kind upon their issue.

Before examining the chief methods of regulating a note issue, a few words are necessary on the important distinction between a convertible and an inconvertible note issue. Speaking briefly, any system of inconvertible notes is bad, and should only be resorted to in the direst national extremity. The weakness of a paper issue lies in the possibility of over issue, which lessens the value of the currency and destroys the stability of the standard of value; and the most powerful preventive of excessive issue is convertibility. An issue of inconvertible paper may retain its value and perform all the functions of money so long as its amount is restricted, but experience shows that the power of issuing an inconvertible currency can rarely be used in moderation for any length of time and that the temptation to abuse the power of issue is so great as to be almost irresistible.

The chief qualification therefore of a note issue is that it should be legally payable on demand in coin of the realm. Then the problem arises, how to ensure this convertibility? We have to consider not only the ultimate solvency of the issuing bank, but the immediate convertibility of the note. A note is a promise to pay coin on demand, and it is not sufficient if the issuing bank, though unable to provide gold, yet has plenty of landed or other securities to cover its debt. There have been attempts in plenty to solve the monetary problem by issuing notes against the security of land or other forms of wealth, but all have failed when the impossibility of paying the notes in coin became apparent.

The most certain method of ensuring convertibility is, of course, to compel the deposit of gold in the strong room of the bank to an equal amount with the total of the notes issued - what is known as the "simple deposit method." The disadvantages are, however, obvious. In early times, when credit was in an embryo stage, such a method was pursued with success, as in the early days of the Bank of Amsterdam. But now-a-days the paper circulation is not only a substitute for the coinage, designed merely to save the cost of wear and tear - it is an addition to the currency. Gold so deposited is gold lying idle. As we shall see, some gold must be kept idle in the shape of a reserve; but to withdraw from circulation an amount of gold equal to the total note issue and to lock it up so that it cannot be touched, except by withdrawing those notes from circulation, is too wasteful for modern methods. The method which is usually adopted is some modification of the partial deposit system, which consists in allowing the banks concerned to issue only a limited amount of notes without the deposit of gold. This is the English system as governed by the Bank Charter Act of 1844, which is discussed in a separate chapter.

The Germans have copied us in this respect, but with an important modification. The English Act fixes a strict limit, beyond which all notes must have gold deposited to secure their convertibility, but the Germans have adopted provisions which enable the limit to be exceeded under certain conditions; the limit is an "elastic" one. The Imperial Bank of Germany can issue notes to the value of £22,500,000 sterling against the deposit of securities, but beyond this amount all notes must be secured by the deposit of an equal amount of gold. But in order to give the bank the power of increasing the currency in an emergency, this limit can be exceeded on payment of a tax of 5 per cent. on the excess issue, provided there shall, at all times, be a gold reserve of at least one-third of the total note circulation.

The American system is based upon what is called a "proportional reserve" of coin or bullion. The United States note issues are divided into three classes. First of all there are the "Gold Certificates," against the issue of which gold is deposited to the full nominal amount in the United States Treasury. These notes are not intended for general circulation, and are chiefly held by bankers in large amounts. Secondly, there are the Government legal tender notes or "greenbacks," originally issued to pay for the American Civil War; and, thirdly, there are the notes of the National Banks. The National Banks are required to keep a cash reserve, equal at all times to at least one-fourth of their total liabilities to the public, if they are situated in one of certain large towns, or 15 per cent. if outside these towns. In return they obtain the practical monopoly of issuing bank notes; the State Banks, which are not governed by these conditions, can only issue notes on payment of a tax of 10 per cent., which is practically prohibitive.

The proportional reserve system acts well in ordinary circumstances, but directly the reserve is allowed to reach the minimum (and a legal minimum reserve always tends to be a practical maximum reserve) it results in an exceptional contraction of credit.

Another method of ensuring convertibility is the "maximum issue ' method. . This is the system under which the circulation of the English country banks is governed by the Act of 1844. A maximum amount is fixed by the Act for each bank possessing the privilege, and beyond this amount the banks cannot issue except under heavy penalties.

The French system is also regulated by a legal maximum of issue, which is fixed at a high amount, being now 5,000,000,000 francs. The position of France is, however, somewhat exceptional. The metallic circulation of the country is a very large one, and an enormous cash reserve is held by the Bank of France, which takes all possible precautions against undue depletion, precautions which entail the relinquishment of the claim of Paris to be a free gold market.