While in ordinary times an individual bank may find commercial paper, call and time loans, and stocks and bonds readily convertible forms of earning assets, it is usually true that this seeming liquidity is rather the effect of their movement among banks than of an actual reduction of the earning assets of the bank system as a whole. If bank A converts securities by selling them to bank B, there is an interchange of cash assets for securities assets; if they are sold to an individual X, who borrows funds from bank B to make the purchase, there is then a secured promissory note in B's assets instead of cash, and cash in A's assets instead of securities. Only to the degree (and it is usually small) that the cash is derived from other than banks, is there any genuine liquidity for the banking system as a whole. In proportion as all banks rely upon one form of secondary reserve, whether securities or call loans or purchased paper, it becomes increasingly difficult for them to procure cash funds by selling assets.

It appears, therefore, that the ability of the banks of the entire system to pass through a panic without suspension of specie payments cannot be attained by the possession of securities, purchased paper, or other earning assets which may in theory but cannot in fact be sold to other institutions, nor by the contraction of loans, whether call or time loans, secured or unsecured. When a violent panic breaks, every banking system, particularly the decentralized, has experienced the utter impossibility of defense against suspension by such means of liquidation, though local or moderate panics may be averted or assuaged.

In the time of boom immediately preceding a panic the business world resists any extensive contraction of loans. Even bankers, moved by the desire for profits as well as the desire to promote the business enterprises in which their customers are interested, are often blind to the impending crisis or fearful lest a contraction might itself precipitate a panic. For these reasons they are hesitant and reluctant to call or refuse loans. Therefore the "expansion generally proceeds in the absence of fortuitous events to the acute stage, when financial disruption may be avoided only by a rapid expansion of accommodations, leaving the liquidation to be automatically achieved in the period of depression which follows."2 In other words, contraction usually follows rather than precedes a panic, and the process after the panic is to liquidate first the financial (speculative) loans and then the commercial loans. The increased discount rate discourages all but necessitous borrowers and attracts hoarded or foreign funds and may alleviate the situation, but too often such relief does not come until after the panic has broken.

2 Journal Of Political Economy, Vol. 36, P. 727.

A central bank, moved by its sense of public responsibility rather than by a desire for profits, and clothed with a legal or generally acknowledged control over loans and discount rates, may stifle undue expansion at its inception by raising the discount rate or otherwise discouraging loans; when the panic stage is reached, the central bank can succor solvent needy banks with accommodation based upon its unused reserves and stop the panic, not by a sudden contraction or liquidation but by an expansion of loans to be slowly contracted after the panic stage is passed.