America's Money Machine

An Interlude for Debate 51
With a central bank such as he proposed, the "inelasticity" of the
prevailing system would have been remedied. The prevailing system, as
Warburg rightly pointed out, depended primarily upon stock exchange
loans, while the most legitimate business, that of the purchase of commercial
paper, caused a dangerous locking up of capital in single name
promissory notes, which under normal conditions were unsalable. By
creating a central bank, after the European pattern, such commercial
paper would be converted from a non-liquid asset into the quickest asset
of the banks.
What Warburg neglected to point out, however, was that such commercial
paper, while gaining increased liquidity-that is, wider acceptability
and marketability-was not thereby rendered more substantial as a base
for money, particularly ifthe endorsing banks were careless oftheir credit
and endorsed more notes than their own assets could possibly cover.
Warburg's proposal was, undoubtedly, an improvement over the existing
system which permitted the unlimited issue of circulating notes
against government bonds, though as we will notice later, the system
eventually adopted did not remove this evil.
Warburg's ideas, cogently phrased as they were, were profoundly influential,
perhaps because they seemed to offer such an easy solution to the
problems besetting the country.*
Because of the influence exercised by the German system in the ultimate
framing of the Federal Reserve System, a brief description of its
features is appropriate.
The defeat of France by Prussia in the War of 1870 and the collection
ofa war indemnity of5 billion francs in gold made possible the formation
of the German Empire and with it the establishment of a new currency
system and standard. The condition of the currency had been one of
near-chaos. Six different systems were legally in force, and in addition an
uncounted number and variety ofcoins were in circulation. Both gold and
silver were legal standards. Currency reform began with the Acts of
December 4, 1871, and]uly 9, 1873, which established the standard as
the gold mark equivalent to 1/1395 ofa pound weight offine gold (5.531
English grains) and proclaimed the formal acceptance of the gold -stan-
*The National Monetary Commission spent a great deal oftime in examining the workings
of European banking systems, particularly the German, to the exclusion of a study of
monetary history, the question of coinage, or the standard, or the qualities and requisites
of legal tender. Of the twenty-four volumes of reports produced by the Commission, five
dealt exclusively with the German banking system.