Chapter XIX (2)

A check is drawn by a subsidiary corporation to its dividend account, and deposited; a check on this dividend account[425] is then deposited in the general account of the parent corporation; a third deposit, of the same funds, is then made in the dividend account of the parent corporation; a fourth deposit of the same funds is made in a trust fund which holds stock in the parent corporation; a fifth deposit in the personal account of the beneficiary of the trust fund; a sixth deposit may be made of a check on this fund in the personal account of the beneficiary's wife. The first three of these deposits, at least, will be made of the total dividend of the subsidiary corporation. _Not one_ of these six deposits represents _trade_. Payments of wages and rents should count as trade, but payments of interest and dividends stand on a separate footing. When a man has bought a stock or a bond, he has already bought all the income which is to come from them, and to count the interest and dividends as separate items is double counting. They are _payments_, but not _trade_. Even if the dividend payment be counted as trade, however, it is counted _six_ times.

There is enormous overcounting as a consequence of the combinations of corporations, each of which retains its own numerous bank accounts. The Interstate Commerce Commission calls attention to great duplications from this cause in connection with railway income accounts.[426] Even within single corporations the duplications[427] are very great. Thus, the local agent of a railroad deposits his receipts in a local bank. His check, or, more usually, the draft of the bank, is subsequently deposited in a bank at headquarters. Subsequent disbursements, in places away from headquarters, particularly of wages, will frequently be preceded by deposits in other local banks. This duplication will be true of telegraph, telephone, insurance and other companies which have scattered agencies, including the wholesale trade. Advertising agencies will illustrate it. _All_ checks between agent and principal, customer and broker, etc., will illustrate it. There is a great deal of double counting in stock transactions from this source. Thus, a Boston broker takes orders, with a check for margin, for execution in New York. The order is executed by a New York broker, who deals with another New York broker, who represents a Louisville broker, who represents a Louisville client. Now to the extent that any checks at all pass between the Boston broker and his client, the Boston broker and the New York broker, the other New York broker and the Louisville broker, or the Louisville broker and his client, we have overcounting. Only the check between the two New York brokers is properly counted. It is, of course, well known that a small percentage of the dealings of a customer of a brokerage house is represented by checks between broker and customer. Professor Fisher states this to be about 5%.[428] It is, however, 5% of overcounting! Moreover, through keeping "open accounts," with irregular settlements of "margins" only, the Boston broker and the New York broker reduce markedly the checks passing between them. There is a back and forth flow of items which in large degree cancel one another, since the Boston broker sells in New York as well as buys there, and the New York broker, to a less degree, both buys and sells Boston securities, through his Boston correspondent. But not all by any means is canceled, and _all_ the checks that pass in this way represent double counting. The total is large.

_Public funds_ are included in the deposits reported to Kinley. Taxes are not _trade_. Double, triple and multiple counting comes as revenues are received by local authorities, transferred to State accounts, subsequently redistributed to local accounts, or to the treasurers of State institutions, transferred from one bank to another, etc. The State of Massachusetts scatters its deposits in banks all over the State, and makes transfers from one account to another. The City of Boston has many bank accounts. The Federal Treasury deals largely with banks over the country.

Whenever a retail store has branches, duplications are likely to occur. "Chain stores" make great overcounting. "Kiting" swells bank deposits.

Replying to these contentions, Professor Fisher has urged that there is large _undercounting_, also, and that the undercounting balances the overcounting. I have myself called attention to a good deal of undercounting in the chapter on "Barter." A substantial amount of ordinary trade is carried on by means of partially offsetting book-credit, time bills of exchange, simple barter, etc. The amount might even run high, as compared with ordinary trade, when the clearing arrangements in the stock and produce exchanges are taken into account. But it is impossible to figure out anything at all in this line which is to be compared with the great gap between the 141 billions of trade we were able to find,[429] and the 387 billions Professor Fisher assigns to trade. The gap of over 245 billions is much too great. Besides, in our 141 billions, we have counted barter items, book-credit items, time-bill of exchange items, etc., already.

The main item of undercounting must be in connection with the clearing arrangements in the speculative exchanges. This would seem to be Professor Fisher's view, as well.[430] Data are at hand for the two great exchanges of the country which enable us to measure, with some precision, the amount of the undercounting--_i. e._, to tell the extent to which checks are dispensed with in the trading of these two great exchanges. The two exchanges are the Chicago Board of Trade and the New York Stock Exchange.

For the New York Stock Exchange, figures are taken from Pratt's _Work of Wall Street_, 1912 ed., pp. 166-167, 180, 273. The figures are for the big year, 1901, when 266 million shares were sold, more than in 1909 by 51 millions of shares, and when the Stock Exchange Clearing House should have done better, in the magnitude of the undercounting, than it did in 1909. Figures since 1901 are, Pratt states,[431] not available. Pratt also gives figures for 1893, but does not give data as to the percentage of stocks handled by the Clearing House, so that comparison with the 1901 figures cannot be made.

In 1901, 265,944,659 shares were sold. Of these, 15% were "X-Clearing House," _i. e._, not on the list of stocks handled through the Stock Exchange Clearing House. This 15% was paid for in full by check. The bond sales are not cleared, and so another billion dollars of checks is required for this item.[432] If we assume (on the basis of the estimates given to the writer by DeCoppet & Doremus, and Mr. Byron W. Holt, for recent years) that 25% of the 100 share sales would be added if "odd lots" were counted, we have another large item that does not go to the Clearing House. "Private clearings" reduce the number of checks in connection with odd lots, but not so effectively as is the case with hundred share sales put through the Clearing House. So far the Clearing House has done nothing. What did it do with the 85% of the stocks in hundred share lots offered for clearing?

The figures are perfectly definite. The 85% of the 266 million shares sold was 226 million shares. The "share balance" remaining after the Clearing House had done its best was 134 million shares.[433] The number of shares sold, then, for which checks did not have to pass as a result of the clearing process was 93 millions. In terms of dollars, we may put the same figures. The estimated money-value of the 266 million shares sold was 20.5 billions;[434] 85% of this is 17,425 millions. The certifications required to pay for the 134 million share balance was 10,930 millions. The saving in checks was, thus, 6,495 millions of dollars. This is the full extent to which the Stock Exchange Clearing House undercounts recorded share sales. This is less than 1.7% of Professor Fisher's 387 billions! To offset this, however, we have _over_counting in the 5% of checks for all dealings on the Exchange which pass between brokers and customers, as shown, and all the checks between brokers and out-of-town brokers. We shall also find items of _over_counting which vastly more than offset this undercounting, in _loan_ transactions between brokers, and between banks and brokers, to which we shall shortly give attention.

This six and a half billions in checks saved on account of sales of stocks is no small matter, absolutely. But this, though measuring the extent of undercounted _sales_, by no means measures the services of the Clearing House to the Stock Exchange. Not merely stocks _sold_ have to be cleared. Stocks _borrowed_ are also cleared. Borrowing of stocks is not _trade_, but borrowing of stocks requires the passage of money and checks. When stocks are borrowed, money is _loaned_. A bear sells short. He has to deliver next day. He accomplishes this by having his broker "borrow" the stock he needs from a broker representing a bull, who is long on the stocks, and who needs money to "carry" them. The bull, who lends the stock, receives dividends from the bear, as they accrue, and pays the bear interest on the money lent. An enormous lot of this takes place. Moreover, to some extent, these transactions are increased artificially, in order that the broker may make his "clearing sheet" misleading, and avoid revealing his position with reference to the market.[435] Loans of stock and sales of stock appear alike in the transactions of the Clearing House. Moreover, apart from the necessities of the bears for stocks to deliver, we have the necessities of the bulls for money to carry their stocks. If a broker who has borrowed largely from the banks finds his customers turning to the bear side of the market, he has an excess of funds. He may repay his loans, but they may be, in part, time loans, and in any case, he may find it just as well, if he can make a small fraction of 1% in interest, to lend to another broker, among whose customers the bulls are increasing. A vast deal of money is thus transferred, on collateral security, by means of "loaning stocks." Brokers prefer to borrow money from one another in this manner, since no margins are required, in general, whereas banks would require margins. These various reasons make a vast deal of "borrowing and carrying" transactions, and a regular place is set aside for them on the Floor--Post 4, commonly called the "Money Post." At this post, also, the banks, through brokers, lend on call, and the published call rates are established there. Of this, however, we shall have more to say later.

The extent to which this loaning of stocks takes place at the "Money Post," as compared with the loaning done privately, varies. It makes no difference, however, from the standpoint of the volume of these transactions that go to the Clearing House whether they are put through at the "Money Post" or outside. The loans made by the _banks_ at the "Money Post" do not affect the Stock Exchange Clearing House totals.[436] Formerly the "Money Post" was a place where the position of the bears could be gauged in a given stock. If the demand for a stock was great, the bulls could take heart, and increase the pressure. To avoid giving away this information, however, borrowing is done on a large scale privately, at present.[437] Of course, if the pressure gets too strong, it will manifest itself at the money post anyhow, since bears borrowing particular stocks will forego all or part of the interest, or even pay a premium for the stock.[438]

Now it is possible, from the figures given for the total clearings of the Stock Exchange Clearing House, in conjunction with the figures of recorded sales, and the percentage of "X-Clearing House" sales, to get a fairly accurate idea of the magnitude of these stock borrowing operations between brokers. The total number of shares offered for clearing by "both sides" in 1901 was 926,347,300! This is double the actual amount, since both buyer and seller report the same transaction to the Clearing House, the former with a "receive from" sheet, and the latter with a "deliver to" sheet. Half this amount, or 463,173,650 shares, represents the actual number of shares to be handled. As we have seen, 226 millions of this (85% of the recorded sales of 266 millions) represents sales. The rest, or 237,173,650, represents borrowing of stocks.[439] Borrowing exceeds actual sales, if the figures for 1901--a year of enormous sales--are representative. We have, now, an explanation of the prevailing opinion among brokers that the Stock Exchange Clearing House dispenses with the major part of the checks that would otherwise be required. _For their purposes_, it does make a vast difference. Pratt's figures[440] show that, without the Clearing House, certifications of $27,995,896,400 would have been required; that certifications of $17,065,042,800 were obviated[441] by the Clearing House, leaving the balance of $10,930,853,600 of certifications which had to be used. This balance, as we have seen, is the major portion of what would have had to be paid anyhow for the stocks actually sold and offered for clearing. The saving on the actual sales is only 6.5 billions. But the saving to the brokers was, of course, much greater. Even six and a half billions is no slight matter for any purpose except the explanation of our 245 surplus billions! Pratt gives an estimate at another place of the certifications required by the Stock Exchange sales, reaching virtually the same conclusion that we have reached by a somewhat different combination of his figures. He indicates that 14 billions of certifications were required, counting in the bonds, in 1901.[442] This compares with the 20.5 billions estimated value of stocks sold, and approximately one billion of bonds. This leaves 7.5 billions of certifications obviated on sales. This takes no account of the "odd lots." If they run to an additional 25%, we have five billions more which are not put through the Clearing House. My information is, however, that "private clearings" reduce the checks in connection with these, though not so efficiently as is the case with the big Clearing House.

Do the figures that get into the "all other" deposits from those connected with the Stock Exchange undercount sales made there? Not yet have we taken account of an item which swamps all that we have considered. I refer to loan transactions by the banks, particularly call loans. The volume of these is enormous. At the "Money Post" alone, the figures average between 20 millions and 25 millions a day.[443] The range is from 10 to 50 millions. The major part of these loans are not made on the Floor of the Exchange, however, but privately, between banks and brokers. Even on the Floor, no records of the loans are kept, and only estimates are available. For the loans made privately, no figures are attainable at all. The total must be enormous. One authority writes, in a letter, "The total amount of money loaned at the post varies considerably, depending upon the rate. For instance, when money is under 3%, loans are largely made directly between the banks and the brokers, but when it gets over 3% and gets strong, more loans are made at the post. Some national banks make all their loans there right along, so I understand." My information from an officer of the National City Bank is that it lends the major part of its demand money on the floor of the Exchange. The other chief lenders, according to the Pujo Report,[444] are the National Bank of Commerce, The Chase National, the Hanover National, J. P. Morgan and Co., and Kuhn-Loeb. The same report states that the bulk of such loans are made directly between banks and brokers, and not at the "Money Post."

How do these transactions affect Kinley's figures for deposits, and so Fisher's total of 387 billions? The small dealer deals, usually, with one bank. When he borrows, he gets a "credit" on his deposit account, but makes no "deposit" that would get into Kinley's figures. But stockbrokers deal with many banks. They have one bank which "certifies" for them, and with which they regularly keep a "balance." But for their loans, they deal with whatever bank gives them the best rate, or has the funds to spare. In time of tight money, they shift their loans with great frequency. They borrow also from one another. "Money" is "worth money" in New York, and idle funds will be lent by whomever has them for whatever the market will pay, on collateral security on call. When a broker deposits money in his bank borrowed from another bank or another broker, he gets a deposit credit which does get into Kinley's figures--he deposits a certified check, or a bank draft. The following has been described as a typical transaction by the bond expert of a Boston banking house, and has been amplified by several Wall Street men with whom I have discussed it. A, whose home bank is Bank W, has borrowed, on call, $500,000 from Bank X. Bank X calls the loan. A finds Bank Y willing to lend him enough to pay it off. Before he can get the new loan from Bank Y, however, he must get his collateral released by Bank X. Before he can do that, he must pay off the loan at Bank X. His recourse, then, is to Bank W, his regular bank, which certifies for him, and with which he keeps his balance. Bank W gives him a certified check (either an overcertification, or a "morning loan" transaction), for $500,000, with which he pays off the loan at Bank X. He then takes the collateral from Bank X to Bank Y, and makes a new loan. He gets a draft from Bank Y, which he deposits with Bank W, and then draws another check against his deposit with Bank W to pay off the "morning loan," in case the transaction took that form. Here are three checks for this loan transaction, two of which get into clearings, and one of which gets into "all other deposits." But the checks may be multiplied. A, instead of getting a new loan at Bank Y, may call a loan from broker B, who may then call a loan from broker C, who may go to Bank Y to get the funds he needs to pay B. Here are two new checks in the series, both of which get into the "all other" deposits. Checks fly about recklessly in Wall Street, and men will turn over money many times, if an eighth of 1%, or less, can stick by the way, on a good sum, for a few days! This is strikingly illustrated by a fact which caught my attention in the monthly bank statement of a brokerage house which I was allowed to examine. The deposits made during the month, and the checks drawn during the month, balanced to within five hundred and fifty dollars out of several millions. The broker said of this: "It would be true even for a single day, and it would be true for a year. The bank requires us to keep a minimum balance; it is to our interest not to keep more than that. If we have more at the end of the day, we lend it out; if we have less, we borrow to make up the deficiency. We try to have just that balance, and no more, to our credit at the bank at the end of every day." The handling of funds by a brokerage house is a fine art, involving both technical skill and a philosophic grasp of the factors of the "money market." Are rates going up? Then it is well to reduce call loans, and borrow more on time. If lower rates are anticipated, more call money will be employed--with the possibility of a "squeeze" if too much is taken that way. Hidden dangers must be foreseen. The sums borrowed are enormous, and brokers' profits depend in very substantial degree on their skill in borrowing as cheaply as possible, and in utilizing their funds to the utmost.

It is here, I think, in loan transactions between banks and brokers and between brokers, that we have a major part of the explanation of the huge deposit figures for New York City, and for the tremendous influence of stock sales on clearings, which Mr. Silberling's[445] figures show. This is the opinion of Professor O. M. W. Sprague, who first called my attention to the volume of call loans, and rapid shifting of call loans, in New York, and it is the opinion of every Wall Street man with whom I have discussed the matter. The actual pecuniary magnitude of the share sales and bond sales is not enough to do it. The mass of connected loan transactions, however, substantially greater in volume than the actual sales of securities, is, with the security sales, enough to do it.

When the call rate is high, which will particularly happen when bank reserves are low, the shifting in loans will be much increased. One bank will have money to lend one day, but the next day will have to call it, to meet heavy demands at the Clearing House, while some other bank will have the surplus funds to lend. The brokers, by bidding up the rate, will tempt the temporary lending even of small surpluses, if their necessities are great. The volume of "all other deposits" and of bank clearings will be swelled by this much beyond ordinary. That this should not be revealed to ordinary statistical tests is due to the fact that speculation tends to fall off at such a time, so that the other factors in the stock exchange operations tend to reduce daily deposits and bank clearings. Mr. Silberling has applied to this problem the technique of a refinement of the correlation method, the method of partial correlation, with the result of confirming this view.[446]

I conclude, therefore, that stock exchange transactions, instead of being undercounted in bank deposits, are very greatly overcounted.[447] The big item that does it is loan transactions between brokers and brokers and between brokers and banks.

The evidence from the Chicago Board of Trade, with reference to the extent of clearings within the exchange there, comes in a letter from the Secretary of the Board of Trade to Professor Taussig. The only clearing house transactions are in connection with "futures." All "spot" transactions are paid in full by check. All futures other than those offset by clearing are paid in full by check. The total amount put through the Clearing House in 1915 was 118 millions, of which the balances paid were 41 millions (saving checks to the extent of 77 millions). This 77 millions is a trifle indeed as compared with the gap of 245 billions we are trying to fill! It is a trifle also as compared with the business done on the Board of Trade. The Secretary estimates that commodities to the value of $375,000,000 actually arrived on the exchange in 1915. On the average, the figure would be $350,000,000. For the Stock Yards "it is approximately the same--last year was $375,000,000. Of fruits, vegetables, poultry, butter, eggs, etc., sold in South Water Street, it is claimed by their statisticians, the value is $350,000,000, or a total of about eleven hundred millions _arriving_ [Italics mine] yearly at this great market place, all of which is paid for by checks, and when the ownership changes, the change of ownership is always paid by check." How many times the goods change hands, cannot be stated on the basis of records of the Board of Trade. The Secretary contents himself with saying that they are "sold and resold many times." We have discussed this, on the basis of reputed figures of the Federal tax on grain futures in 1915, in our chapter on "Volume of Money and Volume of Trade." In any case, it is clear that the 77 millions of checks economized, though absolutely great, is relatively a bagatelle. It is, moreover, more than compensated for by loan transactions. The Secretary estimates that for a sixty-day period, when grain is coming in, from two to four millions will be lent by the banks daily on _arriving_ grain. How great the loan transactions on subsequent sales will be we can only conjecture.

While able to find, then, important cases of trade and speculation which dispense with the use of checks, I cannot find anything of magnitude sufficient to aid Professor Fisher's case, and I find, on the other hand, enormous overcounting in every field where business and banks meet, as well as in the relations of banks to non-commercial depositors.

I conclude, therefore, with reference to the figures of Fisher and Kemmerer[448] for volume of trade, that they are much exaggerated for the base year, and that for every other year they are wholly wrong, both because of their excessive magnitude, and because the index of variation has been wrongly chosen.

The discussion of P, the price-level, in the statistics of Kemmerer and Fisher need not be extended. P, for the equation of exchange, and for the quantity theory, is a _weighted_ average, each price that goes into it being weighted by the number of exchanges involving the commodity of which it is the price. The weighting of P should correspond to the elements in T, the volume of trade, and should vary from year to year, as the elements in T change.[449] Now Kemmerer's P is weighted as follows: wages, 3, security prices, 8, wholesale prices, 89.[450] If our conclusions with reference to the composition of the volume of trade, as developed in the chapter on "Volume of Money and Volume of Trade," are valid, this weighting gives us a P which has no relevance to the equation of exchange. The wholesale items should have a weight of not more than one-sixth of the total for 1909. Certain commodities, as wheat and cotton, in which there is heavy speculation, should be given great weight, and securities should have, probably, the greatest weight of all. If "trade" is to be extended to cover transactions in bills of exchange and loan transactions (as it is by Kemmerer),[451] then P should contain these things, weighted more than all else put together, particularly if call loans are included. The weights should be radically altered from year to year. We should then get a P which would fit the "equation of exchange"--though what else it would be good for is hard to say! The same criticism applies to Fisher's P. It is dominated by wholesale prices.[452] It therefore has no relevance to an equation of exchange in which only one-sixth at the very most of the items are wholesale items. Neither Fisher nor Kemmerer alter their weights in P at all, to correspond to yearly alterations in the composition of T.

As _indicia_ of changes in the _absolute value_ of money, Kemmerer's and Fisher's index numbers, or other index numbers of numerous wholesale prices, with a substantial weighting of wages, are probably better than an index dominated by stocks. Stocks fluctuate more widely than wholesale prices and wages, their values are more affected by variations in business confidence, and by variations in the rate of interest. For measuring _the value of money_, the index numbers here criticised are very good. But for the purpose for which they are chosen, namely, to fill the equation of exchange, and to measure variations in a _price-level_ of the sort the quantity theory and the equation of exchange are concerned with, they are simply irrelevant. If it were really true that such an index number varied with the quantity of money, then the quantity theory would be effectively disproved!

Now, in general summary of our criticisms of the figures of Kemmerer and Fisher: they have systematically buried New York City, and systematically covered up speculation. All the errors converge in this direction. The _indicia_ of trade cover up speculation and the other things that go on in New York, and other financial centers. The _indicia_ of prices do likewise. Fisher weights New York clearings only 1, while weighting country clearings 5, in his index of variation of check transactions. He also counts New York returns for March 16, 1909, as complete, and gives all of his estimate for non-reporting banks to the country. Kemmerer does not do this, but he does exaggerate the importance of money, as compared with checks, and does not allow the velocity of money to vary at all in his figures, thus getting a much greater constancy in the figure for total circulation of money and checks than is proper, and covering up the flexibility and variability which New York gives to our system.[453] In general, our task in this chapter has been an archaeological excavation--we have rediscovered a buried city.