CHAPTER IV

DEFECTIVE EXCHANGE AND TRANSFER SYSTEM

A third group of defects in our old banking system consisted in certain cumbersome features -unnecessary wheels and bolts as it were-in our domestic and foreign exchange mechanism. These features greatly interfered with the efficient operation of the machine and at the same time added to the expense. This subject is a large and complicated one and can only be touched upon here. It may be divided into two parts, that relating to domestic exchange, and that relating to foreign exchange.

Domestic Exchange

Of the hundreds of billions of dollars in checks drawn every year, a very large proportion are for local payments, and, being settled promptly through local clearing houses or directly between the banks concerned, offer no difficulties. Our American clearing house machinery is a marvel of perfection for the settlement of local checks. In addition to the checks drawn for purely local

payments, however, checks whose span of life is but one day and which are born, live and die within the narrow limits of one town or city, there are millions of checks drawn daily for out-oftown payments, checks whose span of life often covers many days and which in the range and speed of their movements excel the proverbial American tourist party in Europe. The supply of these checks that is continually in transit, recently estimated to amount at any one time to about $300 millions, is what is known among bankers as the "float." The problem of efficiently and cheaply handling this float and of equitably apportioning the expense was for years a perplexing one. Some clearing houses, as for example that of New York, imposed certain definite charges for the collection of checks on points beyond a certain radius from New York City. Other clearing houses imposed no charges. The Boston clearing house developed a system for the parring of checks throughout New England, thereby eliminating all collection charges on items drawn on banks entering the system. Similar devices were adopted in a number of other sections of the country, notably in the middle west. Some cities, like Albany for example, became known as free cities and others were notorious for their high collection charges. Many banks

imposed exchange charges—some high and some low-for the collection of out-of-town checks received over their counters, and some made a charge for the collection of checks drawn upon themselves when presented from out-of-town sources. These practices led among other evils to the practice of routing checks, which means that checks in the process of collection would often be sent by roundabout and devious routes in order to avoid or reduce collection charges. In this way the length of time in which checks were in transit was increased and the economic cost to the community for the collection of checks was made heavier.>

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One serious phase of the practice of routing checks was the manner in which it padded legal reserves. Competition among large-city banks for the accounts of country banks led the city banks to give an immediate credit to the country banks for out-of-town checks, checks which sometimes took the city bank a week or more to collect. The country bank counted as legal reserve out-of-town checks sent to the reserve city bank for collection as soon as they were mailed. The reserve city bank in turn would send some of these same checks to the central reserve city bank and count them as reserve money as soon as they were put in the mail. In this way one check in

transit frequently counted as legal reserve for both a country bank and a reserve city bank. Occasionally such a check, after performing a yeoman service in being counted as legal reserve money by two banks for several days, would be returned as worthless marked "no funds."

Another defect of the domestic exchange system was the expense and trouble, for which it was largely responsible, of requiring heavy shipments of currency back and forth over the country. As previously noted, American money markets are subject to pronounced seasonal swings. At one season of the year the relative demand for bank funds is heaviest in the cotton belt of the south; at another time it is heaviest in the great cereal producing sections of the west and middle west; and at another season it is heaviest in the leading financial centers of the east. This heaviest demand often shifts from one section to another within a very brief period of time. Under our old banking system these shifts carried with them large shipments of currency -shipments amounting in the course of a year to hundreds of millions of dollars-and frequently a shipment would hardly be received and unpacked before a shift in the monetary demand would require it to be sent to another section or perhaps to be returned to the place whence it

came. All this involved expense, including packing, shipping, abrasion, insurance and interest items.

A second phase of the exchange difficulties under the old banking system was that relating to the foreign exchanges.

Foreign Exchange Difficulties

Our foreign trade was financed largely through London, and those parts of the trade which were with the Orient and with South America were financed almost entirely through London. London is the world's financial center and it is but natural that we should utilize to a substantial extent her unrivalled facilities for financing oversea trade. The trouble was not that we utilized them, but that we utilized them too much and were unduly dependent upon them. This involved several difficulties, only two of which need be mentioned here. In the first place, payments through London gave rise to an additional foreign exchange operation, which normally added to both the expense and the risk of financing a shipment of goods. In the second place, the fact that invoices, bills of lading and other documents passed through the hands of foreign banks and of South American or oriental branches of foreign banks gave to our foreign competitors "in