For one thing, the profits to the national banks from the bank note privilege are so small and the operations of issue, withdrawal, and redemption so troublesome, that many national banks make no use of their privilege in this respect or only a partial use.

Again, the volume of circulating notes is made dependent upon the price of bonds, that is, upon the speculative and investment market, which may or may not coincide with the needs of the commercial money market. If the financial market is strong and bonds rise to premium standard, the profit from the circulation privilege declines; and if the commercial money rate is also high at such times, the profit is still lower. There would seem, therefore, to be a sort of perverse elasticity to the circulation. It is difficult to show this statistically because the number of banks and the capitalization of banks are varying at the same time that the prices of the bonds and the amount of bonds deposited to secure circulation are varying.

A further disadvantage is the fact that the volume of national bank notes is made dependent upon the government debt. The expansion of the debt may cause undesirable expansions of the circulation, though the government has lately prevented this by denying new bond issues the circulation privilege. On the other hand, if the government pays its debt, the volume of bank notes must contract; if, as between 1880 and 1891, the Treasury goes on the open market and buys bonds, the price is driven to a point of high premium, eliminating the profits on the circulation. Between the dates mentioned the volume of bank notes declined

51 per cent (see Table Showing Effect of Debt Payment on Circulation) and this despite the fact that that was a decade of unparalleled growth in population and wealth and business activity, and when the need for an increasing currency was peculiarly felt because gold production was not keeping up with the world's needs. This decrease was due to the payment of more than half the government debt within those years. During this period, however, the number of national banks was fast increasing, so that each bank was shorn to its minimum amount of required circulation.

Table Showing Effect Of Debt Payment On Volume Of Circulation

One other bad feature of this dependence on government debt is that there is no physical limit to the inflation of notes. If the notes were made dependent on a reserve of gold they could be increased only by some multiple of that reserve, and the reserve could not be increased largely or suddenly since the gold must first be dug from the earth. On the other hand, if the notes were made dependent upon commercial paper they would vary with business need. But the inflation of notes based on debt may come at the very times when the currency is being inflated by gold, and may therefore accelerate the rise of the price level unduly. Such was the case after 1900.

Another disadvantage of national bank notes is that the volume of circulation is at the caprice of the legislature. By permitting banks to organize at smaller capitalization and requiring them to buy fewer bonds, and by lowering the tax on circulation, Congress caused a sudden and tremendous expansion in the bank note circulation between 1900 and 1914. National banks of small size were organized in great numbers, particularly in the South and West, and generally in rural districts. It is true that these were the proper regions for the circulation of bank notes, and the increase occurred during a period of rapid industrial expansion; but the increase was a factor in unduly accelerating the rise of prices at the time. (See the table, page 234, for the periods of rapid increase and decrease of our bank note currency.)

The fact that national bank notes have a 5 per cent redemption fund but no strictly reserve fund held against them, is an additional disadvantage. Since they remain in circulation indefinitely, the issuing bank usually minimizes or disregards the liability of their presentation for redemption and keeps on hand little, if any, gold for this purpose. But the state banks, trust companies, savings and private banks regard the notes as reserve, in accordance with the law, and base extensions of deposit credit upon them. As a result there is a pyramiding of credit, which extends the weaknesses of the bank notes to the deposits. It was still more dangerous when national banks sometimes, contrary to law, counted the bank notes in their tills as part of their reserve. At present the legal reserve of all member banks of the federal reserve system consists wholly of credits with the federal reserve bank.