One of the principal defects of the banking system was the absolute rigidity of the currency. A national bank could issue notes only by depositing government bonds with the Treasury. As bonds usually sold considerably above par a bank was disinclined to buy them since it had to pay out more money for the bonds than it was permitted to issue in currency. Instead of rising and falling with the needs of trade and commerce, as deposit currency does, the volume of national bank notes fluctuated with the price of government bonds. The price of these bonds, notably the two per cents which are held almost exclusively by the banks, is determined not by their general investment value, but by the profit possible to banks in using them as security for circulating notes. The people of the United States have become accustomed to bank notes secured by the deposit of government bonds. For fifty years this has furnished an absolutely safe bank note currency, and many people have come to believe that no other kind of bank note would be safe and acceptable. But in the past it has been the policy of the Government to pay off its bonded indebtedness and, doubtless, that policy will be continued. The reduction of the national debt will leave a constantly decreasing volume of bonds as a basis for the note issues of a steadily increasing number of banks. It is inconceivable that the United States would contract new debts or maintain old ones in order to provide a supply of bonds with which to secure bank notes. Even if sufficient amounts of bonds were available in the future, the plan of a circulation secured by bonds stands condemned as inelastic and unresponsive to business needs.
The particular service rendered by bank note currency is substantially the same as that supplied by deposit currency. Both originate from private business operations of discount and deposit. The proportion of notes needed varies with the season, the business habits of the locality, and the rise and fall in the volume of goods exchanged. Though bank notes do far less work than deposit currency, it is essential that they shall be free, as deposit currency is free, to expand and contract with the changing needs of business.
We have about 7,500 national banks issuing notes. In other countries the note-issuing function has been turned over almost entirely to single central institutions under government supervision. An elastic currency which will automatically expand to meet the normal increase in business and contract when the demands of business lessen, can best be secured by giving to a central reserve association or to a small number of strong banks the power to issue circulating notes based upon sound commercial assets and protected by an adequate gold reserve. To guard against inflation or over-expansion it may be desirable to impose a tax upon notes issued to meet unusual conditions or emergencies as in the German or Canadian systems. Such a tax, however, falls upon the user of the notes imposing upon him an unnecessary burden. It is believed that under the system of regional reserve banks, which provides that no association shall pay out any notes except its own, prompt redemption will be assured and over-expansion prevented.