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The Pamphlet Collection of Sir Robert Stout: Volume 76

Federal and State Banks and Currency Reform

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Federal and State Banks and Currency Reform.

Melbourne: J. Haase, Printer. 17 Swanston St.

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This pamphlet is a re-print of an article which was published in the Age newspaper of Saturday, March 23rd. It had to appear in a condensed form owing to the pressure on space at a time when the contests for seats in the Federal Parliament were at their height. To have appeared in the columns of a leading newspaper at such a time was, in itself, a recognation of the great importance of the question, and of the necessity that it should be made the subject of early legislation. The deplorable sufferings caused by the financial crash of 1893, which deprived so many thousands of people of all ranks of their life-long savings and means of livelihood, has taught this lesson. Great as these sufferings have been, it is, probably, all the better for our future prosperity that the disaster should have been so thorough as to have impressed bankers, investors, and all business men with the dangerous nature of the foundation upon which our financial and commercial systems are reared—a huge volume of credit resting upon an insignificant volume or legal-tender metallic coin. It is now recognized in influential quarters that the State must come to the rescue, and remedy this by the creation of a Federal Bank of Issue, from which private commercial banks can draw their supply of notes under conditions that will give elasticity to the note circulation commensurate with industrial requirements. It is not, however, so clearly apprehended that the Federal Bank of Issue should be so constituted as to leave it open for each State to create a State Bank of of its own in touch with the Federal Bank of Issue so as to obtain from this source an elastic note currency with which to conduct and develops State trading operations.

Every attempt to better social conditions will have but little real or permanent value without this complete monetary reform. No stability can be given to trade, nor safe expansion to commerce, nor certainty and regularity to employment, nor just compensation to labor, without a monetary system that will keep even pace with industrial and commercial progress, and that will afford instant and unhesitating support to every sound business at times when temporary suspensions of credit might otherwise develop into panics.

It is understood, from remarks made by Sir George Turner in a speech recently delivered at St. Kilda, that he is in touch with representative bankers with the view of early legislation on the subject in the Federal Parliament. I would beg leave to suggest that a Federal Banking Scheme be formulated in consultation with State Governments as well as with bankers, so that ample provision may be made for supplying States with federal notes in a direct manner, and not give private banks a monopoly of the circulation. To fail in this would be a serious mistake, limiting the elasticity of the currency, and depriving States of monetary facilities for economically developing their resources and promoting social improvements.

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Federal and State Banks and Currency Reform.

No. I.

The need for a State bank is perfectly plain as a means for regulating the currency, to give all possible stability to credit and commerce, and prevent the enormous sacrifices of values occasioned by ever-recurrent monetary panics. The uniformity of the monetary circulation is the object to be aimed at, and an instrument whereby to accomplish this, so as to reduce to a minimum the fluctuation between inflations and contractions of credit, is the thing desired. The keeping of this main object steadily in view will provide a guiding principle in the framing of a constitution for a State Bank, and in directing its operations. The quantitative theory of money, as stated by Mill, is "that the value of money, other things being equal, varies inversely as to its quantity; every increase of quantity lowering its value, and every diminution raising it, in ratio exactly equivalent." The supreme importance of this law will be more evident when expressed in its alternative form, namely, the values of commodities rise or fall, other things being equal, in direct ratio to the rise or fall in the volume of money. For instance, if, by any means, the volume the world's money were reduced to one-half, that half would come to command as much of the world's goods as the entire volume could have done before its reduction, to the great injury of industry and commerce. An inflation of the currency would work in an exactly opposite direction; both are evils, but a currency contraction is by far the greater of the two. An increasing commerce will soon overtake a redundant currency and reduce inflated values to normal levels, but if trade expands without a corresponding expansion of money volume prices must keep on falling in proportion, and no manufacturer would continue to produce, nor merchant to purchase, goods which had to be disposed of in a continuously falling market. The consequences would be that commerce would have to limit itself to articles of more absolute necessity, and that the effective demand for articles of minor necessity would become continuously lower with increase of population—a reversion towards barbarism. "If money depreciates," says Hume, "and prices rise, everything takes a new face. Labor and industry gain life, the merchant becomes more enterprising, the manufacturer more diligent and skilful, and even the farmer ploughs with greater alacrity and attention. If it appreciates and prices fall, then poverty, beggary and sloth are easily foreseen." But the desideratum is to find a scientific monetary system capable of expanding in exact ratio to the natural expansion of commerce, and not liable to the sudden contractions to which a monetary system formed of credit based upon gold only is constantly exposed. A period of prosperity may have no speculative "boom" in it such as naturally leads to financial failures; it may be a perfectly legitimate and necessary expansion of commerce, tested by uniformity and steadiness of values. Yet hundreds of circumstances, such as the sudden cessation of a large public expenditure, a bad harvest, shortage in the supply of the staple of some leading industry, and so on, may interfere with the smooth course of commercial exchanges, and bring about a period of unrest, which may easily develop into a crisis, when credit may become suspended and a demand for gold set in. "At no time," says Ricardo, "can there be in a bank or in a country so much specie or bullion as the moneyed individuals of such country have a right to demand." Bankers themselves, therefore, in sensitive apprehension of danger, are influential factors in the precipita- page 4 tion of panics. In preparing for possible contingencies, solvent customers are more likely to suffer, in order to replenish a bank's treasury, than those from whose assets it would be hopeless to realise the amount of their indebtedness, with the not infrequently anomalous results that good estates are forced into liquidation, whilst bad and doubtful ones may be permitted to weather the storm.

Fortunately, leading bankers seem to recognise the gravity of the situation, and to realise that in State aid only can safety be found. This was clearly manifested at a conference of bankers held in Sydney in June, 1895, a report of whose transactions forms part of the appendix to the report issued in the same year by the Victorian Royal Commission on State Banking.

In the number of "United Australia" for April last year, Mr. H. G. Turner, general manager of the Commercial Bank, Melbourne, advocates uniform legislation, applicable to all banks carrying on business throughout the Commonwealth, and to the July number of the same quarterly Mr. J. Russell-French, general manager of the Bank of New South Wales, Sydney, contributes a paper on Federal Currency, of very great value to the State Bank discussion, but with a banker's bias respecting the control under which the Federal Bank notes ought to be distributed. "Some scheme," says Mr. French, "is earnestly to be desired of a Federal character to place our paper currency on a satisfactory basis as regards its usefulness, and to lift it out of the comparatively subordinate position it now occupies. The bankers recognise that this can be accomplished more successfully if the management is brought more closely in touch with the State; but at the same time they believe that the banks are the most convenient and suitable medium of distribution."

Mr. French clearly depends upon a State Bank of Issue as the instrument, under bankers' control, by which the currency can be endowed with the qualities of elasticity and stability so necessary for the expansion and steady maintenance of commerce. He says:—"As time goes on and our population increases and internal trade expands, the currency arrangements must be made to keep pace with them; and if, in addition to the ordinary requirements, some elastic properties can be imparted to it of a sound but simple character, so that it may prove a weapon of defence in times of crisis, then it will become a real benefit to the community, instead of a very partial one, as it is at present." This is really admirable. In this way the elasticity of the currency, which comes from the expansion of a credit which is timorously ready to collapse as soon as it receives a slight check and a demand sets in for a little of the ridiculously insufficient volume of legal tender money upon which it is based, would be substituted by an elasticity derived from a credit based upon State notes, available to supply all solvent banking demands, and which all creditors would be ready to accept without doubt or hesitation. This would supply an elastic and stable currency, involving a complete departure from the theory that every bank note must represent so much actual gold in reserve. Yet, nothwithstanding this, the monetary value of a bank note would still be measured by a gold standard. "So long," says M'Leod, "as the market or paper price of gold bullion coincides with the mint price it is an infallible proof that the currency is not depreciated, that the paper is at its par value. We have little hesitation in saying that the maxim that the issues of paper must be rigidly restricted to the gold which they displace is an unnecessary and cruel hardship to commerce and agriculture." It is necessary that all this should be understood as the keynote to the situation. The form of State aid to banking which Mr. French recommends is that which was adopted by the Sydney conference of bankers in June, 1895, of which Mr. French was unanimously elected chairman, and the main features of which he presents in his recent paper, as follows:—

The present separate issues of the banks in the Australian colonies to be given up, and their place taken by an uniform issue for each colony, managed and regulated by commissioners, under appropriate acts of Parliament, the banks to act as agents or medium of distribution, and to share with the Government in the appointment of representatives on the commission, and also in the profits derivable from the working of the issue.

The banks on application to have rights to receive notes from the commissioners in exchange for coin; the supply of notes to each being regulated by their existing note issues and their total assets and liabilities in each colony; that is to say, in proportion to their business.

These notes to be used:—First, to retire from circulation existing notes of the banks of issue; secondly, to provide till money in lieu of the existing rights to issue notes from these tills.

The coin so provided, save 25 to 30 per cent kept as a reserve in coin, to be invested in local Government stock.

Notes thus issued to be legal tender, save at the office of the commissioners, where they would be converted into gold.

The Expansion Clause provided for the issue of further quantities of notes to any bank requiring them on special deposit of 20 per cent, of coin, in addition to lodgment of approved Government securities, on such terms of interest and repayment as might be arranged. Discretionary emergency powers were provided, so that the commissioners could issue notes on other classes of securities in very special cases.

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"The foregoing scheme," Mr. French remarks, "would be as applicable under federation as in the case of separate colonies. The issue would, of course, need to be uniform to in character throughout, and it would gain additional strength by resting on the much wider and more solid basis of Federal instead of State security. It is probable that the bankers who formulated that scheme wild not see any necessity to modify their lesions very materially at the present day, and that is the reason why I have given it fine prominence."

The proposed legislation suggests a real and practical currency and banking reform, based upon scientific conceptions of currency principles, infinitely superior to the flaky, haphazard system it is intended to supersede. If, however, the scheme were to be adopted without modifications of its proposed management, it might be found to favor restrictions which would prevent its marking out for the public benefit to the full extent of which it is capable. It seem evident, and, indeed, inevitable, that State Governments will have to create State Banks in touch with a Federal Bank of Issue the better to enable each to fulfil its obligations within its own territory as universal landlord and if private banking interests were to dominate in the administration of a Federal Bank of Issue, it might found an obstacle to the due performance of the duties which a State Govern it might find itself obliged to undertake the interests of country settlements [unclear: and] industries, and in rendering financial aid to municipalities, shire councls, [unclear: credit] societies for the better housing of people and other projects. It [unclear: would] far more advisable to preserve the management of the Federal Bank of Issue from the influence of bankers and politicians, and to have its affairs administered it board of commissioners chosen from picturing, mercantile, pastoral and [unclear: ltural] circles; men of known caution and business capacity, such as banking and company directorates are supposed to be supposed of, and likely to give more satisfaction than boards formed of banking [unclear: exp] only.

It is not only necessary that a Federal Bank if Issue should have the power to apply private banks with sufficient [unclear: liber-] enable them to afford steady support to an expanding trade, but also [unclear: to] notes to State Banks for the purpose developing the country's resources. As already observed, bank notes are not to be prepared as representing so much [unclear: actual] in reserve, but as paper money regulated value by a gold standard. M'Leod follows up remarks upon this principle of elasticity in currency by saying:—

While, therefore, we utterly dissent from the doctrine that paper should be limited by the actual quantity of gold it displaces, we think the preceding considerations suggest the following as the only limit:—That the quantity of paper which the industry of the country can absorb at its par value . . . is the quantity of paper it legitimately requires for a due development of its resources, and that is the quantity it ought to have. . . . The more paper the better, so long as it is exactly equivalent to its nominal value in gold, because it proves that the industry of the country is prosperous.

He then proceeds to show how this currency expansion could, and ought to, take place, so as to develop sources of wealth otherwise neglected.

Let us suppose, he says, that there is a tract of uncultivated or unreclaimed land which is, however, capable of being cultivated; let us suppose that there are a number of people living in its neighborhood sunk in poverty and misery from having no one to employ them. Suppose that a bank, seeing this state of things, plants a branch in this district of country, and a number of poor but skilful and industrious farmers settle there, and take leases of this uncultivated land. The bank agrees to advance them a number of its notes. With the advances so made the farmers engage the poor people as laborers, and in a very short time that which was a moor and a waste is covered with fields of waving corn and turnips and potatoes, affording sustenance to a large population; and cattle, and the excess of its produce over what is required for their support is exported abroad, and brings all sorts of commodities in exchange.

The history of land reclamation and farming in Scotland presents not a few practical instances of this kind, owing to the freedom with which Scottish banks could issue notes without slavish adherence to actual gold reserves.

A perfect and often quoted example of the benefits to be derived from a judicious issue of paper money is afforded by a scheme under which a meat market was built in the Island of Guernsey in 1822, as narrated by John Jacob, in his "Annals of the British Norman Isles":—

The estimated cost of the new market being about £4000, how to raise the amount became the immediate question with the promoters of the scheme. Numerous consultations were held, the upshot of which was that, instead of borrowing gold at interest payable in gold, the promoters determined to issue "market house scrip," or legal tender notes of their own, founded on the credit of the island. The politicians of the day called them a set of innovators for adopting a course so opposed to ancient custom: but, notwithstanding all opposition, market house scrip to the requisite amount was ultimately issued by the authority of the House of Assembly, when Daniel de Lisle Brock was Governor of the island. The materials were found, the men put to work, the market erected, and the stalls rented. Every month's rent reduced the total of the scrip, and in less than ten years all the scrip was paid back into the public treasury, stamped "cancelled"; and thus ended the life of the Guernsey market house scrip. But the rents have to this day continued, and are applied to local improvements.

The value of a monetary issue of this description cannot be doubted. Although page 6 the notes were not made convertible, their issue did not disturb the uniformity of the currency owing to the confidence with which the public accepted them at par value with gold, to the reproductive character of the work upon which the money was expended, and to the gradual extinction of the notes as the returns from the investment came in. Before the American Revolution the State of Pennsylvania was made prosperous by an issue of paper money under similar guarded conditions. Hume says of it:—

A planter, immediately he purchases any land, can go to a public office and receive notes to the amount of half the value of his land, which notes he employs in payments, and they circulate through the colony by convention. To prevent the colony being overwhelmed by this representative money, there are two means employed—first, the notes issued to any one planter must not exceed a certain sum, whatever may be the value of the land; secondly, every planter is obliged to pay back into the public office every year one-tenth of his notes.

The prosperity of Pennsylvania under this monetary system was phenomenal. The limitation of the notes issued to any one individual land owner discouraged land monopoly, and the loans were repaid and the notes canceled in periodic instalments, whilst the gold in the State was left free for use as international money. These two instances supply examples of a perfect circulating medium of exchange. Paper money was issued to effect certain reproductive purposes, and from the new sources of profit thus created the notes were repaid with periodic regularity, leaving behind them results which permanently enriched the communities—in the one case, a revenue-producing public market; in the other, land settlements and improvements, and the trade expansion which naturally accompanies them.

No. II.

The Credit Foncier System of Loan Repayments.

The valuable principle set out in my previous article is embodied in the Credit Foncier method of loan repayments, and is applied by Credit Foncier associations to their borrowings as well as to their lendings; a practice which ought to be followed as closely as may be found possible by Governments, municipalities and money lending societies, as one of the best safeguards against bad business, and a most efficient regulator of the currency. The periods of repayments must vary from we month to twelve months or more, according to circumstances. New loans for the planting of orchards, vineyards and land improvements may have to stand unreduced for a fixed term of years, until the investments begin to yield profitable returns, bat after that the periodic repayment should commence forthwith. Under the practice of "fixed loans" the tendency of interest is to rise and swallow up the whole of the profits made by a large proportion of borrowers, depriving them of ability to make provision for repayment of principal, or any part of it, as loans mature. This is a taxi upon industry to which the adoption of the Credit Foncier system would be a whole-some check. The compulsory character of periodic repayments of loans, both principal and interest, would prevent reckless borrowings and usurious lendings, whilst testing the ability of borrowers to meet their obligations right through the course from beginning to end.

Building societies have adopted the gradual repayment system, but very imperfectly. They apply the principle to the repayment of advances made by themselves to borrowers, but not to the repayment of their own borrowings from the public who supply them with loan funds. It is not easy to see how they could have done otherwise without Government assistance, even if they tried, in a community where the system is so unknown and its economic value so little understood. Where Credit Foncier societies are in vogue, and their operations familiar, their credit—which can never be assailed as ours can be under the cruder methods we employ—is such that their bonds are saleable with but slight variations in value, notwithstanding minor temporary fluctuations in the market rate of interest for no purchaser would give much more than par for stock that was liable to be balloted for at any time at face value, and no seller, for the same reason, would accept much less. The essential part of the system must be that the bonds should carry interest comparing favorably with that carried by other sound stocks, with a slight increase to compensate for any inconvenience a bond holder might suffer in having to surrender his scrip and accept payment at short notice. All this goes to give a steadiness to the value of Credit Foncier bonds, which makes them favorite stock for temporary investments, and, when made of small denominations, form an addition to the currency, being as easily changed as a ten pound note.

This enables the directors of Credit Foncier societies to effect another important economy, which forms a special feature of the system when carried out in its integrity, and that is, to make their advances in bonds instead of in cash. Borrowers have to accept the responsibility of selling page 7 the bonds, the issuing society, probably, acting as broker, charging a small commission. The advantage of this is that the society has no idle money on hand the proceeds of a premature sale of bonds for the purpose of providing loan funds, as would have to be the case if advances were to be made in cash, and as soon as a bond is issued the account becomes at once active. Some of the societies have their bonds guaranteed by the State, for which consideration is given, making them marketable at a rate of interest a little more favorable to the societies and their borrowers.

If our Government, at the commencement of lending money to farmers on the Credit Foncier system, had issued its bonds a rate of interest liberal enough to take them at once attractive to investors, the public would by this time have become familiarised with this description of stock, and interest, if at first a little too would have come to adjust itself to a fair market rate, after which every other economy belonging to the system, other things being equal, could come into practical with natural facility. But under the monetary system which prevails other things might not remain equal, for it has to be constantly kept in view in this discussion that every extended use made of a volume of money not elastic enough to expand "pari passu" with the demand for it is like the distribution of an insufficient quantity of water to supply the wants of a increasing population, "losing in depth what it gains in diffusion," as Dr. Chalmers said of the literature of his day. For want if new money to support trade expansion, new demands must either remain unsatisfied, or must be met by an extended use of the volume of money already in existence—amounting to a practical shrinking of the currency, with a proportionate tendency to the lowering of prices. A State bank in touch with a Federal Bank of Issue would meet this case on exactly the same principle as that on which it has been argued that Bute banks in touch with a Federal Bank of Issue could be provided with an elastic currency to support commercial expansion at level prices. In granting loans to farmers, for instance, the Government could make its advances in bonds instead of cash, and enter into arrangements with the State and Federal Banks under which the State Bank could at once purchase the bonds from the borrower, and pay for them in Federal notes, issued on the security of the new business and the guaranty of the State, the state Bank immediately placing the bonds on Change to be taken up by private is restors Savings Bank commissioners as they might feel disposed.

This mode of working the Credit Foncier system in association with the State, in making loans to farmers and to societies formed for the better housing of the people, or in any direction in which the State may have to accept responsibility, would be in complete harmony with the proposed banking and currency reform—indeed, a very necessary part of it—and, whilst promoting public interests of the most important character, would have the following economic effects, proving it to be based on true currency principles:—
(a)Making advances in bonds, instead of in cash, would relieve the Government from having to pay interest on idle money.
(b)The prompt purchase of the bonds by the j State bank would protect borrowers against loss; of time and money in getting their bonds disposed of.
(c)By paying for the bonds in federal notes, the new money necessary to promote the new trade expansion would be found; and
(d)By offering the bonds at once to the public at a studiously fair rate of interest the question would at once be tested whether the new money for the new business was required or not. If the bonds were neglected, it would be evidence that the new money was necessary, as it would be plain that some of the money in existence could only be obtained by competing for it at a high rate of interest. If, on the contrary, the bonds were taken up, it would show that some of the money already in existence was available at a fair late of interest, and that no new money was required.

This would be a sound and perfect currency, which is well tested in other lands where many millions of pounds of people's money are invested in societies which adopt it. If the Labor party here understood but a little of its great value as the most economical of all means for providing the workers with better homes, it would not cease to agitate for it until Government gave it being, not as a Government department, like the Brunswick experiment, but by chartering and assisting a Credit Foncier society to give it effect, and to prevent its administration falling into the hands of politicians.

Where the Constitution of the Bank of England is Defective.

The institution of a Federal Bank of Issue and of a State Bank on the lines suggested, and in touch with each other, would bear analogy to the two departments into which the Bank of England was divided by the Act of 1844. viz.. an issue department and a banking department, but without the limitations and provisions which make the administration of the Bank of England as much a danger as an aid to commercial security. The Bank of England has power to issue notes against Government and other securities to the extent of £15,750,000, but any further issue must be represented by coin or bullion. As a great deal more page 8 than the amount represented by securities is always in circulation, it follows that the market supply has to be regulated by notes issued against gold only. Instead of this being instrumental in preserving currency uniformity, it is a constant cause of embarrassment and anxiety, accentuated by the provision which compels the bank to publish reports of the notes in circulation and its reserves from week to week. As this "barometer" falls, apprehensions are created lest discounts may be refused and exchanges thrown into disorder. Of the crisis of 1847 Macleod tells us that "as the whole commercial world knew that the resources of the banking department were being rapaidly exhausted, a complete panic seized them. A complete cessation of private discounts followed. No one would part with money or notes in his possession." Deputation after deputation waited upon the Government to obtain relaxation of the Bank Act, and permit an issue of notes beyond the statutory limitation, but not until the situation became utterly desperate was "a letter of licence" to the bank granted by the Government, and as soon as this was made known, "the panic vanished like a dream." "Not only," Macleod continues, "did no infringement of the act take place, but the whole issue of notes was only £400,000, so that, while at one moment the whole credit of Great Britain was in imminent danger of total destruction, within one hour it was saved by the issue of £400,000." The notes were not really required. What was required was confidence that notes could be had if necessary. For want of this a most disastrous financial panic was produced, which could have been entirely avoided had the Bank of England been constituted on the lines advocated by the Sydney conference of bankers. The notes were not refused for want of plenty good securities, but for want of the necessary elasticity in the bank's constitution.


The situation may be summarised as follows:—Our currency is formed of a maximum of credit based upon a minimum of legal tender metallic money. The expansion of commerce which follows increase of population is mainly supported by an extension of this credit, manipulated through an ingenious and highly developed system of banking. (See "Lombard-street," by W. Bagehot.) New credits are formed of people's savings, representing the unconsumed portion of the profits of industry, which is periodically added to the public wealth as new capital; and so long as exchanges are effected at level prices and obligations are met with fair regularity, commerce is sound and healthy. Yet a nation's trade is apt to be thrown into disorder at any moment for want of a monetary system which can be successfully used to support credit when something happens to disturb the even course of commercial exchanged and legal tender money is called for. At such times financiers and bankers, who art the first to perceive signs of approaching danger, look to the Bank of England d affording great possibilities, for a comparatively small issue of notes in excess of the legal quantity would save many serious situations if done promptly before creditors had time to become alarmed, But this is never done, and many millions' worth of the people's savings are lost, and incradicable despair seizes hold of many thousands of human hearts before the Government decides to take the only course which can put an end to a financial panic, and sanction the further issue of as many notes as will effect the purpose. Instead of making this action exceptional and dilatory, and under the taint of failure, surely frequent and bitted experiences must have amply proved that it would be much wiser to make this power leading feature of the bank's constitution, to be exercised at the discretion of the directors, not tardily and spasmodically, but continuously and judiciously, as occasion might demand. There would be no danger then to public credit from allowing any business concern to go into prompt liquidation, however large the amount involved, if proved to be hopelessly insolvent, because it would be well understood that all sound businesses would receive ample support, and rotten branches could be cut off without creation serious public alarm.

It therefore seems an absolute necessity that the creation of a Federal Bank of Issue, on the lines wisely laid down by the Sydney Conference of Bankers, with some such modifications as are herein suggested, should, next to the settlement of the till be amongst the very first measures to engage the attention of the Federal Parliament; and that each State should take steps to establish a State Bank in touch with the Federal Bank of Issue, in order to enable it economically to carry out its land purchase and land settlement operations; to aid municipalities, county councils and Credit Foncier societies for the better housing suburban and rural populations. The rapid and solid progress of the nation and the expansion and permanent safety of our commerce depend upon the elastic and stable currency which such institutions would provide.