Creature From Jekyll Island by G. Edward

fifty-four per cent of the country's total banking deposits. By 1913, when the Federal Reserve Act was passed, those numbers were seventy-one per cent non-national banks holding fifty-seven per cent of the deposits.1 In the eyes of those duck hunters from New York, this was a trend that simply had to be reversed.

Competition also was coming from a new trend in industry to finance future growth out of profits rather than from borrowed capital. This was the outgrowth of free-market interest rates which set a realistic balance between debt and thrift. Rates were low enough to attract serious borrowers who were confident of the success of their business ventures and of their ability to repay, but they were high enough to discourage loans for frivolous ventures or those for which there were alternative sources of funding—for example, one's own capital. That balance between debt and thrift was the result of a limited money supply. Banks could create loans in excess of their actual deposits, as we shall see, but there was a limit to that process. And that limit was ultimately determined by the supply of gold they held. Consequently, between 1900 and 1910, seventy per cent of the funding for American corporate 1. See Gabriel Kolko, The Triumph of Conservatism (New York: The Free Press of Glencoe, a division of the Macmillan Co., 1963), p. 140.

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growth was generated internally, making industry increasingly independent of the banks.1 Even the federal government was becoming thrifty. It had a growing stockpile of gold, was systemati-cally redeeming the Greenbacks—which had been issued during the Civil War—and was rapidly reducing the national debt.

Here was another trend that had to be halted. What the bankers wanted—and what many businessmen wanted also—was to intervene in the free market and tip the balance of interest rates downward, to favor debt over thrift. To accomplish this, the money supply simply had to be disconnected from gold and made more plentiful or, as they described it, more elastic.

THE SPECTER OF BANK FAILURE

The greatest threat, however, came, not from rivals or private capital formation, but from the public at large in the form of what bankers call a run on the bank. This is because, when banks accept a customer's deposit, they give in return a 'balance' in his account.

This is the equivalent of a promise to pay back the deposit anytime he wants. Likewise, when another customer borroivs money from the bank, he also is given an account balance which usually is withdrawn immediately to satisfy the purpose of the loan. This creates a ticking time bomb because, at that point, the bank has issued more promises to 'pay-on-demand' than it has money in the vault. Even though the depositing customer thinks he can get his money any time he wants, in reality it has been given to the borrowing customer and no longer is available at the bank.

The problem is compounded further by the fact that banks are allowed to loan even more money than they have received in deposit. The mechanism for accomplishing this seemingly impossible feat will be described in a later chapter, but it is a fact of modern banking that promises-to-pay often exceed savings deposits by a factor of ten-to-one. And, because only about three per cent of these accounts are actually retained in the vault in the form of cash—the rest having been put into even more loans and investments—the bank's promises exceed its ability to keep those promises by a factor of over three hundred-to-one.2 As long as only a small percentage 1. William Greider, Secrets of the Temple (New York: Simon and Schuster, 1987), p.

274, 275. Also Kolko, p. 145.

2. Another way of putting it is that their reserves are underfunded by over 33,333% (10-to-l divided by .03 = 333.333-tol. That divided by .01 = 33,333%.) 14

THE CREATURE FROM JEKYLL ISLAND

of depositors request their money at one time, no one is the wiser.

But if public confidence is shaken, and if more than a few per cent attempt to withdraw their funds, the scheme is finally exposed. The bank cannot keep all its promises and is forced to close its doors.

Bankruptcy usually follows in due course.

CURRENCY DRAINS

The same result could happen—and, prior to the Federal

Reserve System, often did happen—even without depositors making a run on the bank. Instead of withdrawing their funds at the teller's window, they simply wrote checks to purchase goods or services. People receiving those checks took them to a bank for deposit. If that bank happened to be the same one from which the check was drawn, then all was well, because it was not necessary to remove any real money from the vault. But if the holder of the check took it to another bank, it was quickly passed back to the issuing bank and settlement was demanded between banks.

This is not a one-way street, however. While the Downtown Bank is demanding payment from the Uptown Bank, the Uptown Bank is also clearing checks and demanding payment from the Downtown bank. As long as the money flow in both directions is equal, then everything can be handled with simple bookkeeping.

But if the flow is not equal, then one of the banks will have to actually send money to the other to make up the difference. If the amount of money required exceeds a few percentage points of the bank's total deposits, the result is the same as a run on the bank by depositors. This demand of money by other banks rather than by depositors is called a currency drain.

In 1910, the most common cause of a bank having to declare bankruptcy due to a currency drain was that it followed a loan policy that was more reckless than that of its competitors. More money was demanded from it because more money was loaned by it. It was dangerous enough to loan ninety per cent of their customers' savings (keeping only one dollar in reserve out of every ten), but that had proven to be adequate most of the time. Some banks, however, were tempted to walk even closer to the precipice.

They pushed the ratio to ninety-too per cent, ninety -five per cent, ninety -nine per cent. After all, the way a bank makes money is to collect interest, and the only way to do that is to make loans. The more loans, the better. And, so, there was a practice among some of THE JOURNEY TO JEKYLL ISLAND

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