This section is from the book "Banking And Business", by H. Parker Willis, George W. Edwards. Also available from Amazon: Banking and Business .
The power to control note issues, and the prestige resulting from federal supervision, however, gave the national banks the lead, and from 1866 onward they were rapidly organized, extending into the South as soon as the Civil War had closed. Great difficulty was experienced in consequence of the limitation of the note issues to $300,000,000 in the aggregate. In 1866 the national-bank circulation amounted to about $280,000,000. This sum was very badly distributed. The wealthier and older parts of the North had secured a large share of the notes. In New England much more than the due proportion belonging to them had been acquired by the banks, while the South was unable to get much currency, notwithstanding that it was sorely in need of some notes to take the place of the Confederate currency which had driven out specie. The maximum limitation had been set partly because Congress feared that in a time of suspension of specie payments such as then existed throughout the country, permission to issue notes up to any amount of bonds that the banks might deposit (not exceeding then-capital) might lead to an overissue of bank notes, which would operate still further to postpone the date of redemption.
The national government was, therefore, not willing to relieve the shortage of currency by removing the limitation, but finally sought to help matters somewhat by enlarging the maximum limitation to $354,000,000, while it was further provided that $25,000,000 should be withdrawn from those states that had more notes than their share and issued to banks and states which had less than their share. The provision was so complex, and the rate of interest was so high in the South and West as compared with the comparatively low interest earned on the bonds which had to be deposited in order to get the notes, that there was relatively little disposition on the part of the Southern and Western banks to act under the law of 1870. In fact, this demand was so slack that it did not prove necessary to withdraw the $25,000,000 in notes from banks that had more than their proportionate share.
When Congress finally got to the point, in 1875, where it felt able to provide for the resumption of specie payments, it also dealt with the bank-note question by repealing all limitations upon the issue of bank notes to any amount, subject to the general limitations and requirements of the law with reference to bonds and capital. This change helped the situation considerably. There was a decided increase in the development and prosperity of the national system, and, on the other hand, a decided growth of opposition sprang up. The system was, however, by this time thoroughly well established, and, after the resumption of specie payments in 1879, the notes of the banks were equivalent in value to gold, and provided an unques-tionably stable and satisfactory currency so far as questions of safety and security were concerned. Changes, however, had occurred in the fundamental basis upon which the national banking system was founded, and the result was a tendency to decrease the amount of circulation outstanding.
As has been seen, the banks were required to deposit $100 in bonds for every $90 which they received in notes. Supposing the bonds employed for this purpose bore 6 per cent, it is plain that a bank that had $100 in gold coin or other legal-tender money could (if the bonds were at par) buy $100 in bonds, thus getting 6 per cent interest thereon, deposit the amount with the Secretary of the Treasury, receive back $90 in notes, and then lend these notes to borrowers at such a rate of interest as they were willing to pay. The following of this plan led in some quarters to the bringing forward of an argument now very familiar - that banks, by reason of the bond deposit system, were able to make a "double profit," inasmuch as they got the interest on the bonds and the interest on the notes.
As a matter of fact, there was no foundation for this complaint. A "double" profit is what every banker has to make in order to pay the special expenses of banking, otherwise he might as well use his capital in loans on real estate or other security. If the banker had $100 in gold to start with, he would do very much better for himself were he to use the cash as a reserve and simply make his loans by granting credits on his books than he would were he to follow the plan of buying bonds and getting notes to be loaned. In practice, if the banker were able to lend four times the amount of his reserve he would get the interest on $400 of loans and maintain a reserve of $100 in coin, while in the national system, if he took out notes he would get the interest on $100 in bonds and $90 in notes, even if he did not have to supply a reserve behind these notes - which, of course, he would be obliged to do, either in the form of a redemption fund with the Treasury or as a cash reserve in his vaults.
It is obvious that the higher the price of the bonds went, the less would be the profit to be derived from notes, since, under the original National Act, the banks could get only 90 per cent of the par value. Thus, if bonds stood at 125 it is clear that the banker would have to spend $125 in order to get a bond whose par value was $100 and on the strength of which he could get only $90 in notes. This would mean that there was a margin of $35 between the amount paid for the bond and the amount of notes obtained, on which there was no return. During the years after 1870, the price of bonds steadily rose, and this process was accelerated after 1875, when resumption was decided on.
A further influence tending to stimulate the price of bonds came from the redemption of portions of the debt out of surplus revenues. Not only did the issue of circulation become less profitable to the banks, but they also saw opportunities for making a substantial profit by selling their bonds at the higher prices that had become the rule. Under the influence of these conditions, the national circulation, which had risen to about $350,000,000 at the end of 1873, fell off nearly $50,000,000 during the succeeding three years. Subsequently there was a slight expansion, and then the reactionary movement set in once more. In 1879 - the resumption year - the circulation was only $323,000,000.
Congress was now under the influence of the anti-banking sentiment which had developed throughout the country, and in 1881 passed a bill requiring 3-percent bonds which were to be issued for the purpose of refunding the national debt to be used by the banks as security for circulation. Other provisions in the Act would have made it difficult or impossible to reduce circulation any further, and the result was a sharp retirement of notes in anticipation of the passage of the law. The measure was vetoed, but, while a good many bonds that had been withdrawn were redeposited, the movement toward the curtailment of circulation had now definitely begun.
 
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