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Bank Currency (bank notes)

Bank currency, or bank notes, may be issued by privately owned commercial banks or by central banks that are either privately or governmentally owned. When currency has been issued by privately owned banks, various devices have been used in attempts to safeguard its quality.

The devices have included special safety funds in cash or securities; first lien on all the assets of the bank; or the requirement that they be backed by deposit of government bonds or other high-grade obligations. Security through the deposit of government bonds with an independent agency was one of the most popular methods of protecting the noteholder. Unfortunately, such a bond-secured currency, because of its inelasticity, frequently operated to protect the noteholder at the expense of the total economy.

The panic of 1907 in the United States, with its widespread bank failures, its suspension of specie payment, and its shortage of currency, offers a particularly striking demonstration of the economic dangers of an inelastic currency. As a result of the 1907 experience, a relief bill, the Aldrich-Vreeland Act, was passed by Congress in 1908. It authorized the issuance of emergency currency by groups of banks organized as "national currency associations." None of this emergency currency was issued until the financial disorganization flowing from World War I necessitated the issuance of $1,121,000,000 of such notes in 1914. These were later replaced by currency issued by the Federal Reserve System, which began to function in November 1914.

The national bank notes in the United States offer a lesson in the shortcomings of a bond-secured currency. These notes were inversely elastic because it was to the interest of the banks to sell bonds and retire their notes in anticipation of increased business activity, which would cause bond prices to decline. Thus banks would sell bonds and retire notes at the very time when business needed more currency. Conversely, it was to the interest of the banks to buy bonds and force notes into circulation when business had no need for additional currency.

Because all of the government bonds carrying the currency-issue privilege have been retired, it is no longer possible to issue national bank notes in the United States. The few that remain in circulation are the liability of the government, as the banks deposited other currency with the redemption office when the currency-issue bonds were retired.

Currency in the United States

The currency system of the United States was simplified greatly by steps taken in the 1930's and 1940's, resulting in great progress toward making Federal Reserve notes the sole currency medium. The gold certificates were withdrawn from circulation in 1933; national bank notes were eliminated in 1935 by redeeming the government bonds bearing the circulation privilege; and the power of the Reserve banks to issue Federal Reserve Bank notes was repealed in 1945. In 1963 the U. S. Treasury stopped issuing silver certificates—the paper money that was backed by silver. In 1968 the United States removed the last gold backing for its currency; up to that time, the law did not allow the currency to expand to more than four times the amount of gold held by the government.

Federal Reserve notes are obligations of the United States and a first lien on all the assets of the issuing Federal Reserve bank. They make up most of the nation's currency.

Wartime Shortages. The higher prices, higher taxes, black markets, and other effects of war place strains on currency. In World War II, for instance, the United States experienced a great increase in circulation, particularly in the larger denominations. From 1941 to 1946, $1 notes in circulation increased by 48%—but, in contrast, $20 notes increased 266% and $100 notes by 233%. Total circulation, about 5% of which was in coin, increased from about $11 billion in 1941 to about $27 billion just 10 years later. Although higher prices and increased business activity were responsible for a large part of this total, analysis of the increase by denominations of bills that were issued clearly indicated that substantial hoarding had occurred.

Currency in Canada

Prior to the organization of the Bank of Canada in 1934. Canadian currency was issued by the chartered banks and the treasury. The banks could issue up to $120 million against a reserve of 25% in gold plus $26 million against the security of specified railway securities guaranteed by the Canadian government.

Under the Finance Act of 1914, Dominion notes could be issued in an unlimited amount by the Treasury to the chartered banks and the savings banks in the Province of Quebec, as advances against the deposit of securities specified in the act. In addition, the issuance of an unlimited amount of currency was permitted against a reserve of 100% in gold. Although the bank notes were not legal tender, they were redeemable in Dominion notes on demand and thus circulated at par throughout Canada.

The Bank of Canada Act in 1934 rescinded the power of the Treasury to issue notes and progressively limited the power of the chartered banks to issue them. Later, the Bank Act of 1944 provided that beginning in 1945 the chartered banks could not issue or reissue their own notes for circulation in Canada, and that beginning in 1950 all liability for outstanding notes would be transferred to the Bank of Canada by payment of a like amount by the chartered banks. As the responsibility for the Dominion notes had been transferred to the Bank of Canada upon its opening, it thus became the sole source of Canadian currency issue.