An instance such as this serves to show the difference between gambling and speculating, terms that are often misapplied by critics of stock markets. A gambler seeks and makes risks which it is not necessary to assume, and which, in their assumption, contribute nothing to the general uplift. But the speculator—in the instance just cited, a bear who sells short—volunteers to assume those risks of business which must inevitably fall somewhere, and without which the mine, or the factory, or the railroad could not be undertaken. His profession, and the daily risks he assumes, call for special knowledge and superior foresight, so that the probability of loss is less than it would be to others. If he did not do it—if there were no bear speculators—the same risks would have to be borne by others less fitted to assume them or the useful projects in question would not be undertaken at all.
So general is the employment of these hedging or insurance operations that in the case of cotton—to cite but one instance—the business is regarded by practically all cotton merchants as an absolute necessity under modern methods of conducting business. “An idea of the value of the hedging function may be obtained,” says Herbert Knox Smith, Commissioner of Corporations, “when it is stated that in Great Britain banks very generally refuse to loan money on cotton that is not hedged. Moreover, it is almost universally conceded that, since the introduction of hedging, failures in the cotton trade, which had previously been frequent, have been materially reduced as a direct result of the greater stability with which transactions in spot cotton can be conducted.”39
In conclusion it may be noted that as early as 1732 an attempt was made in England to prevent short sales by law, that the law was recognized a mistake and subsequently repealed. To-day there is no law on the English Statute books restricting speculation in any form. In America the New York State Legislature enacted a law in 1812 and the Federal Government in 1864, both designed to prevent short selling. These laws have also been repealed and they will not be revived. The bear has come to stay. As a spectre to frighten amateurs, he may continue for a time to stalk abroad o’ nights; as a necessary and useful part of all business he is a substantial reality. And he is not “immoral.”40
CHAPTER IV
THE RELATIONSHIP BETWEEN THE BANKS AND THE STOCK EXCHANGE
“A million in the hands of a single banker is a great power,” said Walter Bagehot; “he can at once lend it where he will, and borrowers can come to him because they know or believe that he has it. But the same sum scattered in tens and fifties through a whole nation is no power at all; no one knows where to find it or whom to ask for it.” This explains the power of Wall Street. Money flows there for the same reason that water flows downhill. The great agricultural districts of the West, for example, will gather from their crops this year several hundred millions of dollars. They have no real economic use for all this money in the farming districts; the large commercial and industrial undertakings that help to make America rich and powerful are not in that neighborhood.
Particular trades settle in particular districts, and the money they require must be sent to them from other districts. “Commerce is curiously conservative in its homes;” the steel trade concentrates in and around Pittsburg, the grain trade at Chicago, wholesale merchants in special lines are always to be found huddled together in our big cities in neighborly intimacy; and once a trade has settled in one spot it remains there. The millions that go West to pay the farmer must therefore go elsewhere to pay others as fast as a demand for money arises, because the price that will be paid for it elsewhere is greater than the price it will bring in the farmer’s pockets. This is doubly true because, as we have said, there are no imperious demands for money for commercial undertakings in the farmer’s neighborhood, and, even if there were, home enterprises are seldom attractive; curiously enough there is a familiarity about them and their local promoters that breeds contempt. Besides, these millions are scattered in small sums all over the agricultural States; there is no cohesion, no concentration.
What then becomes of these vast sums? They are deposited in the local banks, and the local bankers, who are wisely permitted by law to deposit three fifths of their legal reserves in a city bank, promptly transfer the funds that are not required at home to the bank that will pay interest on them. In this way large capital accumulates, and when we say this is a wise provision of the law we mean that scattered reserves in local country banks are of no more avail in emergencies than the five-dollar bills in the people’s pockets; but, gathered into one great central fund that will aggregate a sum large enough to provide every solvent bank and business house with ample support in times of distress, they accomplish a purpose worth talking about.
This is the way they do in Europe, but say “Central Bank” in America, and people are frightened out of their wits. They say politics would dominate it; “the interests” would control it. The bigness of things seems to paralyze them. But to attack a thing merely because it is big and powerful is no argument. In a country full of big things it does not ring true; it is un-American, and, as for the bogy of a centralized banking control, there is infinitely more of it in New York to-day, under the existing system, than there could possibly be under the plan proposed by the original Aldrich measure. However, the idea of a great Central Bank is not the subject under discussion.
When money flows into the New York banks the popular notion seems to be that it is used to facilitate speculation on the Stock Exchange. But this is only one of its many sources of employment. It will supply the payroll at Pittsburg, it will ship grain to Europe, it will discount the bills of merchants, it will return to the West and South when they call for it to move the next crop. If Canada or Europe wants it, and bids high enough for it, they will get a share of it. Wherever capital is most profitable, there it will turn; it will rapidly leave any country that cannot pay for it. It is the old simile of water finding its own level. The first step consists in gathering the idle hoards of individuals into banks; the next consists in centralizing these deposits where they will be available for other sections of the country that have use for them.
In order to attract these funds and so facilitate the business of the country smoothly and economically, the New York banks are accustomed to paying 2 per cent. interest on such deposits. Critics who seem to feel that there is something objectionable in the laws of gravitation, would prevent country banks from depositing in the cities by forbidding the payment of interest on deposits by national banks. But the laws that govern national banks, as Mr. Horace White suggests, are not the laws that govern State banks and trust companies, and, as these would gladly pay the 2 per cent. interest on deposits, they would be given an unfair advantage.41 Critics also say that country banks should not be allowed to keep three fifths of their reserves in city banks, but then they would be at a disadvantage with the State banks in their neighborhood, since the prohibition would not apply to them. Moreover, if country banks were not thus permitted to deposit three fifths of their reserves, what would they do with their funds? For long periods the money would remain idle, and idle funds are as unhealthy for the community as they are for the banks.
There is no other way but for the country banker to take care of his customers first, and then send as much of his surplus as the law permits to the centre that will pay him the best return and the safest return. This is good business; it makes money; it is sound economics. And before the critic goes into a paroxysm over the fear that speculation in stocks will absorb all this wealth once it finds its way to New York, let me remind him, to cite but one instance, that short-time commercial paper, representing actual commodities moving to market, has the first call. The Minneapolis miller’s ninety-day bill, accepted by a reliable merchant and based on an actual carload of flour, has in all normal times a preferred claim on the banker’s funds.
This discounting of commercial paper is the ideal function of banking, to quote Mr. White, and if there were always