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140 INTRODUCTION TO THE STUDY OF COMMERCE

of business men, or in the circumstances of whatever
sort that make them hopeful. Believing that business
is going to be good, that prices will be higher,
merchants and manufacturers lay in supplies for future
use in order to be ready for the coming demand and
to have these very supplies before their prices go up.
Now this very conduct of theirs tends to make busi-
ness better and make prices higher ; it would have
this result even if the original reason for their belief
that better times were near at hand had been entirely
unfounded. In other words, the mere belief that
prices are going to be higher will of itself tend to
make them higher.

The rise of prices once started tends to grow of
itself, to extend from one line of goods to another,
from one section of the country to another, and from
a high level of prices to a still higher one ; the more
confident do speculators become that they can buy
up almost anything, hold it a time, then sell at
a large advance in price. This progressive rise of
prices is aided by the expansion of credit which will
be described briefly in the next section. For the
present we merely wish to note that good times may
develop into such a feverish condition of business,
with prices soaring at a giddy height, as to be appro-
priately termed times of speculation.

But all things come to an end, and so does this
progressive rise of prices. Something happens : it
may be the failure of a bank or of a prominent mer-
chant ; it may be the rumor of a war, of a lower
tariff, or of a change in the money system of the
country ; something alarms the business men of the



PKICES 141

country, they fear that prices will rise no higher and
may fall lower, and everybody makes haste to sell
what he has before the drop comes. When every-
body wants to sell, and nobody wants to buy, prices
go down even if there be no other reason for it.
And they go down with a rush ; a few hours or a
few days may see a fall as great as the rise had been
for the five years preceding. Banks fail, business
men fail, rates of interest rise to hundreds per cent,
and all sorts of shocking things happen. This is the
panic or commercial crisis.

The panic does not last long, but for several years
after it business is dull and prices are low. The
country experiences hard times. In time there is a
gradual recovery ; young men come to the front who
had no real experience of the panic and think it
mostly a bogey anyway, business picks up slowly,
and at last prices move upward a little. Then every-
thing starts up to go around the cycle again.

Commercial crises have sometimes come at inter-
vals of ten or eleven years, but the United States has
had only three great ones ; they occurred in 1837,
1873, and 1893.

Optional Work

2. Present to the class incidents learned from business
men about the last panic.

3. Read in some of the larger histories of the United
States about the panic of 1873. Of 1837.

4. References : B., 282-96 ; W., 150-60 ; K, 168-72 ;
L. M., 325-43; M. II., 64-70, 77-9; H., 295-9; Nich.
II., 131-7, 206-14.

5. Compare the bank clearings in New York for the
year before a panic with the year after. See S. A., 70.



CHAPTER VIII.
PAYMENTS
36. Banks

1. Name some banks that you know. What kinds of
business are carried on there? Describe each kind of
business as precisely as possible.

2. What is a bank check ? Trace its course from the
person who drew it until it returns to him again.

Some banks issue notes, but not all. Issuing notes
is not a necessary function of banking.

A bank will usually change money for any one,
and will always do it for its customers. A bank
will sell to any one a draft payable in any part of the
country, or perhaps even in some foreign country.
A bank will cash a draft drawn by a bank in another
part of the country or a check drawn on such a
bank. This is called exchange business.

Banks lend money ; they may lend their own capi-
tal and also the money that is deposited with them
for safe keeping. The interest received for these
loans is the main source of a bank's income. Much
lending by banks is done in a form called discount.

Banks receive deposits. Deposits made for a stated
time, like six months, bear interest and are known
as time-deposits. Most deposits can be drawn out

142



PAYMENTS 143

at any time ; such do not bear interest except by
special agreement in the case of large deposits.

Deposits that can be drawn out at any time (and
these only will receive any further attention in this
book) are usually drawn by means of checks. A
check is an order drawn by a depositor on his bank
directing that a sum named be paid to a person
named. The person named receives this check from
the one who drew it and can get the money on it at
a bank or he can sign the check over to some one
else who can then get the money. Most people who
receive checks do not draw the money on them, but
deposit them at whatever banks they do business
with exactly as if they were money* That is the
chief reason why banks do not ordinarily need to be
in readiness to pay out more than five per cent of
their deposits in actual cash. Even persons who
borrow of banks may prefer to have their loans
deposited to their credit instead of given them in
money.

When a bank cashes a check (and this includes
receiving a check on deposit) which was drawn by
one of its own depositors, it subtracts the amount of
the check from his deposit. Checks received which
were drawn on another bank in the same city are
sent to the other bank at a given time each day.
When there are a number of banks in a city, this
interchange of checks is all done at the same time
at a place called the clearing house. Each bank
settles with the clearing house instead of with each
of the other banks ; only the balances are paid in
cash.



144 INTRODUCTION TO THE STUDY OF COMMERCE

A bank carries on its exchange with other parts
of the country by means of a list of banks called
correspondents. Thus a bank in Oshkosh will have
one correspondent in St. Paul, another in Milwau-
kee, another in Chicago, and another in New York,
besides numerous smaller banks in towns that are
tributary to Oshkosh. Nearly every bank in the
country has a correspondent bank in New York, and
most banks in the West have correspondents in Chi-
cago. When a bank receives a check drawn on a
bank in another city, it sends the check to its corre-
spondent in that city, if it has one there, otherwise
to that correspondent which has most convenient
access to that city.

In 7 it was noticed that the general level of
prices in a country is affected by the amount of
money in the country. But it is now evident, and
the next two sections will make it still more evident,
that more payments are made in checks or drafts
and other credit instruments than in money. The
quantity of these representatives of money can ex-
pand or contract while the amount of money remains
stationary, and their quantity affects prices the same
as the quantity of money itself. One element in the
credit cycle discussed in the preceding section is
the great increase of checks and drafts in time of
speculation, and their decrease in time of depression.
If there were no banks, a general increase in pur-
chases could scarcely take place, because the money
to pay with could not be obtained. It is credit as
organized by the banks that makes possible the
increased purchases in time of speculation.



PAYMENTS 145

Required Work

3. Who are the three parties named on a check ? ,0n
a bank draft ? What is the difference between a check
and a draft ?

4. Prepare to explain the operations of the clearing
house.

5. A bank has a capital of $10,000 and deposits
amounting to $50,000. On half of these deposits it
pays two and one-half per cent interest, on the other
half it pays no interest. It keeps on hand an average of
$4000 in cash ; the remainder of its money is loaned to
persons or corporations or is deposited in other banks,
and brings in an average yearly interest of six per cent.
It makes $765 a year out of its exchange business. It
loses $400 on bad loans and pays $2500 for expenses.
How much can be divided as dividends ? What per
cent will the dividends be ? If this is an average year's
business, what would the stock of the bank be worth,
assuming that it must yield five per cent on the invest-
ment?

Optional Work

6. Explain the difference between loans and discounts.
Consult a banker.

7. Trace the course of a draft or check that goes through
banks in two or more cities.

8. Put a bank statement on the blackboard and
explain it.

9. References: B., 273-17; W., 313-9; L., 328-38;
N., 158-67, 179-86; Dunbar, 1-81 ; E., 162-3; L., 149-53;
Nich. II., 164-7 ; H., 235-7 ; Eaton, 9-32 ; Nelson, 76-84.

37. The Use of Credit

1. What examples have you known of goods not being
paid for at the time they are bought? What are the
reasons for it ?



146 INTRODUCTION TO THE STUDY OF COMMERCE

If retail customers were always required to pay
cash for what they bought, they would have to keep
money on hand all the time, and often have to keep
considerable sums for which they had no immediate
need ; occasionally they would suffer great incon-
venience. Those who had regular incomes would
not wholly escape these disadvantages, and those
whose incomes were uncertain or irregular would
feel their full force. All would be trying to steer
between the two opposite undesirables the empty
purse and the large sum of idle money.

If the dealer were always required to pay cash for
all that he bought, it would necessitate his having a
capital at least as large as the largest stock of goods
that he would ever need to have on hand at one time.
Then there would be times when he would not need
such a large stock and some of his capital would be
idle. Furthermore, men with proved ability to carry
on business and make it pay, but who lacked capital,
would be excluded from it, to the loss of the com-
munity as well as of themselves ; and new communi-
ties with little capital, but certain of being able to
pay in the near future, would be unable to buy.

These disadvantages are all met by the system of
credit. In nearly every business which has many
buyers and few sellers, the sellers take on themselves
the burden of adjusting these inequalities by permit-
ting regular customers to buy on credit, provided
only the means of ultimate payment are certain.
For the sake of simplicity, the length of credit given
is generally uniform in each line of trade ; but the
intention is not to require the purchaser to pay for



PAYMENTS 147

his goods until the ordinary course of business brings
him means of paying for them. Thus in retail
trade, credit is given until the customers get their
wages or salaries, which means until the end of the
month in most cases ; stores whose customers are
laborers getting their pay weekly require that goods
sold be paid for weekly. In the wholesale trade,
the term of credit depends on how long the buyer
will have to carry the goods before he can sell them
and get his pay, at least in part ; each line of goods,
therefore, has its own term of credit, and each bill
of goods sold is allowed to run this length of time
before payment is demanded. The grocer's sugar
sells quickly, and so he must pay his wholesaler for
it at the end of a month from the date of sale ; on
most of his other goods the time is two months ; on
tea, which sells most slowly of all, the time is three
or four months.

When the sellers are many and the buyers are
few, the general rule is to give no credit. In a few
businesses, however, the buyer gives the credit, i.e.
he pays for the goods before he gets them. Thus
the wholesaler of lumber contracts with a saw-mill
for a certain amount of lumber ; he pays part of the
price when the mill gets the logs on hand, and addi-
tional installments as the lumber is sawed and piled
on the premises of the mill. The wholesaler pre-
sumably has more capital and can carry the goods
easier than the mill owner.

Prices are always fixed with the expectation that
the usual credit will be given. If the purchaser at
wholesale has sufficient capital to pay cash for his



148 INTRODUCTION TO THE STUDY OF COMMERCE

goods, a discount will always be given ; sometimes
the same thing is done in retail trade.

It remains to see how the banks furnish much of
the capital for doing business on credit. Instead of
buying his goods on time, the buyer may borrow the
money at a bank in his own city and pay cash for
them so as to get the discount; or the seller may
sell on time and then immediately borrow of the
bank in his city an amount nearly equal to the sum
due him and for a similar length of time. There
are two ways of doing this : he may require his
customer to sign a note or a time draft which he
will sell to his bank, thus turning over to the bank
the collection of the money when the note or draft
falls due ; or he may make to his banker a statement
of the condition of his business, showing how much
will come to him from his customers in a few weeks
or months for goods already sold, and then borrow
on his own note up to the amount the banker thinks
safe to lend him. Between wholesalers and small
retailers the latter method is nearly always followed
when the purchaser does not borrow and pay cash.
Between jobbers, wholesalers, importers and export-
ers, and large manufacturers the former method pre-
vails, especially in the older portions of the country ;
the essential condition is that the customer whose
note or draft is offered for discount shall be known
to the banker.

Required Work

2. Give one example of the use of credit. State all
of the conditions carefully, and show how credit is a
convenience.



PAYMENTS 149



Optional Work

3. Describe fully the credit system in use with some
line of goods.

4. Modify the example of the grocer on page 124 by
assuming that his wholesaler lets him have an additional
$2000 worth of goods on two months' credit. The
grocer sells half of his goods for spot cash and the other
half on monthly bills. In case of the latter, two weeks
is the average length of credit before the end of the
month, but it takes an additional week to make out the
bills, present them, and collect the money.

5. Make an example similar to the above for some
other kind of business.



38. How Payments are Made

1. Name as many ways as you know of by which pay-
ments can be made in distant places.

2. What are the three parties whose names appear
on a bank check ? On a bank draft ? Which one is a
debtor ? Which one is a creditor ?

3. Explain the post-office money order. The com-
mercial draft or bill of exchange.

The numerous ways by which a debtor may make
payment to a distant creditor may be divided into
two classes : he may send to the creditor either the
money or some document that will enable him to get
the money ; he may wait for the creditor to draw on
him by sending him a document which requires him
to pay the money to a third party.

Merchants rarely send money itself. Only bankers
make a business of shipping money. The substitute



150 INTRODUCTION TO THE STUDY OF COMMERCE

for money most familiar to the public is the postal
money order. The principle of the postal order is
also the basis of the express order and the sending
of money by telegraph. Among business men the
bank check is more extensively used than all other
means of payment combined. The bank draft comes
next in importance.

The commercial draft which the creditor draws on
the debtor is like the bank draft or the check, in that
it is an order of the creditor addressed to the debtor ;
but the bank draft and the check are drawn on de-
posits of money, the debtor being the bank holding
the deposit, while the commercial draft is drawn on
a debt which originated in a sale of goods. The com-
mercial draft on a debtor in a foreign country is often
called a bill of exchange. The draft which demands
immediate payment is called a sight draft. But many
drafts are made payable thirty, sixty, or ninety days
after sight ; these are called time drafts. By "sight"
is meant the date when the draft is presented to the
drawee ; he then accepts it by writing his name across
the face ; when the required number of days have
elapsed, it is presented to him again for payment.

As was stated in the preceding section, commercial
drafts are most used in the older portions of the
United States where business is most highly devel-
oped. They prevail in international trade the world
over, and in England, the world's trade center.

The drawer of a commercial draft either sells it to
his banker or places it in the hands of his banker for
collection. This bank sends the draft to its corre-
spondent bank in the place where the drawee does



PAYMENTS 151

business; the latter bank gets the draft accepted,
collects the money at maturity, and remits or depos-
its to the credit of the former bank. The exporter
as soon as he has shipped his goods, draws a draft on
the person to whom they are sent, pins to it the bill
of lading of the transportation company and the
receipt of the marine insurance company, and sells it
to a banker. The banker sends the draft to his cor-
respondent nearest the destination of the goods, who
will collect the money and hold it to his credit. Now
an importer who wishes to make a payment abroad
will come to this same banker and buy a bank draft,
which the banker may perhaps draw on the same cor-
respondent to whom he sent the commercial draft ;
the two payments will thus tend to offset each other.
Merchants in England have long been accustomed
to wait for their creditors in foreign countries to
draw on them ; at the same time they require that
debtors in foreign countries shall make payment in
drafts drawn on England. The result of this is that
the greater part of the commercial drafts that arise
in foreign trade are drawn on England by those who
export goods to England from other parts of the
world, but few of them are drawn in England. The
banker's drafts are also mostly drawn on England
in the various other countries and are sent to Eng-
land, but their purpose is to pay for the goods the
various countries have bought from England. This
means that most foreign drafts, both those drawn by
merchants and those drawn by bankers, are payable
by merchants or bankers in England in pounds
sterling.



152 INTRODUCTION TO THE STUDY OF COMMERCE



Required Work

4. Explain drawer, drawee, and payee. Which one is
probably a creditor ? A debtor ?

5. Be prepared to write on the blackboard sample
bank checks, bank drafts, and commercial drafts.

6. Trace the course of a commercial draft from the
drawer until it returns to him again. Compare this with
the course of a bank check.

Optional Work

7. Give an account of the way payments are made in
some line of trade.

8. Exhibit samples of the various documents mentioned
in this section.

9. References: Eaton, 39-41 ; N., 183-6; Nelson, 84-
95.

39. Exchange

1. Give the various definitions of the word exchange.

2. A banker in Milwaukee speaks of selling New York
exchange. Another banker says he has plenty of New
York exchange. What does each mean ?

Domestic exchange is handled by ordinary banks
as a part of their regular business, but not so foreign
exchange ; that is more often a business by itself in
the hands of the foreign exchange brokers or bank-
ers. Many ordinary banks buy and sell foreign
drafts, but they usually do it through the foreign
bankers at New York.

An illustration will best show how the exchange
business is carried on. During a given week mer-
chants and manufacturers doing business in New York



PAYMENTS 153

City may have sold to others in Chicago to the
amount of $20,000,000. The Chicago people will pay
for these in some one of the ways treated in the pre-
ceding section.

These modes of payment all alike result in the
Chicago banks owing the New York banks the full
amount involved, or at least they would owe that
amount if there were nothing to offset against it.
But during the same week Chicago may have sold
to New York to the amount of $22,000,000, which
will be paid for in the same way except that the
checks and drafts will travel in the opposite direc-
tion. The New York banks will now owe the Chi-
cago banks only a balance of $2,000,000. The
Chicago banks will have plenty of New York ex-
change to sett, that is, they would be glad to sell
more drafts to persons having payments to make in
New York, and so transfer to their own vaults some
of the money standing to their credit in New York.
The next week the balance may be on the other side,
and New York exchange will be scarce in Chicago.
If the net balances should be in favor of Chicago for
a long time, the New York banks would have to ship
the amount of them to Chicago in money.

Such would be the situation if Chicago and New
York did business only with each other; but each
also does business with practically the entire United
States. In reality, therefore, it is the payments from
the rest of the country to Chicago that are offset
against the payments from Chicago to the rest of the
country. The clearing house through which their
payments are all unified is New York. Banks



154 INTRODUCTION TO THE STUDY OF COMMERCE

throughout the United States keep deposits in New
York banks all the time so that they are always able
to draw drafts on New York. Balances between
the banks of the different cities are usually paid in
New York exchange. For example, if business be-
tween Chicago and St. Louis is giving a balance of
payments to Chicago, the St. Louis banks will pay
this by sending to the Chicago bankers drafts on
New York. So when a city adjusts its balance with
New York, receiving or paying as the case may be,
it in reality adjusts at the same time its balance with
the countless other places that have had money trans-
actions with it. And it is possible to speak of the
exchange market of a city as a unit in this way,
because the banks in a city cooperate so freely ; the
bank that has plenty of New York exchange will sell
to the bank that needs some, and no bank in a city
need have money shipped to or from New York un-
less all the other banks in the same city are in about
the same condition as regards New York exchange.

International payments are arbitrated in the same
way, with London as their center. For example, a
Minneapolis miller exports flour to Europe and draws
bills of exchange on the dealers to whom he ships.
The bills are payable in the money of the country on
which they are drawn : if drawn on England, they
call for pounds sterling ; if on France, they call for
francs ; if on Germany, they call for marks. The
miller sells his bills to Minneapolis bankers, who in
turn sell them to brokers in New York. The brok-
ers then send them, in most cases, to their corre-
spondents in London, and are credited there with



PAYMENTS 155

pounds sterling. Then when the merchant who has
imported coffee from Brazil comes to the broker for
a draft with which he can make payment in Brazil,
the broker draws a draft on his London correspond-
ent, and thus uses his sterling exchange. This
example is typical of the foreign exchange business
of the United States. There is a large balance due
us from Europe ; this is used to pay the balance
against us in our trade with the tropics. The
commercial drafts of our exporters give us London
exchange ; the banker's drafts drawn for the use of
our importers exhaust it.

It should now be clear that exchange with any
distant point is bought and sold like goods. And
like goods, its price varies according to supply and
demand ; 10,000 in St. Paul may not be worth the
same as 110,000 in New York. If New York ex-
change is scarce in St. Paul, a merchant there who
has a sight draft on New York to sell can get 110,006
for it ; if it is plenty, he would have to sell his draft
at a discount of $6.

The amount to which the discount or premium can
rise depends on the cost to the banker of shipping
money between the two points. This cost consists
of several items. First comes the expressage or the
postage and registry fee on the package of money ;
and if the package is not carried by a company that
guarantees delivery, it must be insured, and that costs
something. Then there is the loss the banker will
suffer in not being able to use the money while it is
in transit ; this depends on two factors the length


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