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Cryptography and Network Security: Principles and Practice, 6th Edition, by William
Stallings

CHAPTER 6: BLOCK CIPHER OPERATION

TRUE OR FALSE

T F 1. Once the plaintext is converted to ciphertext using the

encryption algorithm the plaintext is then used as input and the
algorithm is applied again.

T F 2. There are no practical cryptanalytic attacks on 3DES.

T F 3. A mode of operation is a technique for enhancing the effect of a

cryptographic algorithm or adapting the algorithm for an
application.

T F 4. The XTS-AES standard describes a method of decryption for data

stored in sector-based devices where the threat model includes
possible access to stored data by the adversary.

T F 5. S-AES is the most widely used multiple encryption scheme.

T F 6. Given the potential vulnerability of DES to a brute-force attack, an

alternative has been found.

T F 7. A number of Internet based applications have adopted two-key

3DES, including PGP and S/MIME.

T F 8. The sender is the only one who needs to know an initialization

vector.

T F 9. A typical application of Output Feedback mode is stream oriented

transmission over noisy channel, such as satellite communication.

T F 10. Cipher Feedback (CFB) is used for the secure transmission of

single values.

T F 11. Cipher Block Chaining is a simple way to satisfy the security

deficiencies of ECB.

T F 12. It is possible to convert a block cipher into a stream cipher using

cipher feedback, output feedback and counter modes.

T F 13. Cipher Feedback Mode conforms to the typical construction of a

stream cipher.
Cryptography and Network Security: Principles and Practice, 6th Edition, by William
Stallings

T F 14. OFB mode requires an initialization vector that must be unique to

each execution of the encryption operation.

T F 15. The XTS-AES mode is based on the concept of a tweakable block

cipher.

MULTIPLE CHOICE

1. In the first instance of multiple encryption plaintext is converted to __________

using the encryption algorithm.

A. block cipher B. ciphertext

C. S-AES mode D. Triple DES

2. Triple DES makes use of __________ stages of the DES algorithm, using a total of
two or three distinct keys.

A. nine B. six

C. twelve D. three

3. Another important mode, XTS-AES, has been standardized by the __________

Security in Storage Working Group.

A. IEEE B. ISO

C. NIST D. ITIL

4. The _________ and _________ block cipher modes of operation are used for
authentication.

A. OFB, CTR B. ECB, CBC

C. CFB, OFB D. CBC, CFB

Cryptography and Network Security: Principles and Practice, 6th Edition, by William
Stallings

5. __________ modes of operation have been standardized by NIST for use with
symmetric block ciphers such as DES and AES.

A. Three B. Five

C. Nine D. Seven

6. The output of the encryption function is fed back to the shift register in
Output Feedback mode, whereas in ___________ the ciphertext unit is fed back
to the shift register.

A. Cipher Block Chaining mode B. Electronic Codebook mode

C. Cipher Feedback mode D. Counter mode

7. The simplest form of multiple encryption has __________ encryption stages and
__________ keys.

A. four, two B. two, three

C. two, two D. three, two

8. The __________ algorithm will work against any block encryption cipher and
does not depend on any particular property of DES.

A. cipher block chaining B. meet-in-the-middle attack

C. counter mode attack D. ciphertext stealing

9. The __________ method is ideal for a short amount of data and is the
appropriate mode to use if you want to transmit a DES or AES key securely.

A. cipher feedback mode B. counter mode

C. output feedback mode D. electronic codebook mode

Cryptography and Network Security: Principles and Practice, 6th Edition, by William
Stallings
10. _________ mode is similar to Cipher Feedback, except that the input to the
encryption algorithm is the preceding DES output.

A. Cipher Feedback B. Counter

C. Output Feedback D. Cipher Block Chaining

11. “Each block of plaintext is XORed with an encrypted counter. The counter is
incremented for each subsequent block", is a description of ___________ mode.

A. Cipher Block Chaining B. Counter

C. Cipher Feedback D. Electronic Codebook

12. The __________ mode operates on full blocks of plaintext and ciphertext, as
opposed to an s-bit subset.

A. CBC B. ECB

C. OFB D. CFB

13. Because of the opportunities for parallel execution in __________ mode,

processors that support parallel features, such as aggressive pipelining,
multiple instruction dispatch per clock cycle, a large number of registers, and
SIMD instructions can be effectively utilized.

A. CBC B. CTR

C. ECB D. CFB

14. __________ mode is suitable for parallel operation. Because there is no

chaining, multiple blocks can be encrypted or decrypted simultaneously.
Unlike CTR mode, this mode includes a nonce as well as a counter.

A. OFB B. S-AES

C. 3DES D. XTS-AES

15. Both __________ produce output that is independent of both the plaintext and
the ciphertext. This makes them natural candidates for stream ciphers that
encrypt plaintext by XOR one full block at a time.

A. CBC and ECB B. OFB and CTR

C. ECB and OFB D. CTR and CBC

Cryptography and Network Security: Principles and Practice, 6th Edition, by William
Stallings

SHORT ANSWER

1. The__________ is a technique in which an encryption algorithm is used multiple

times.

2. The most significant characteristic of __________ is that if the same b-bit block
of plaintext appears more than once in the message, it always produces the
same ciphertext.

3. A __________ is a technique for enhancing the effect of a cryptographic

algorithm or adapting the algorithm for an application, such as applying a
block cipher to a sequence of data blocks or a data stream.

4. Five modes of operation have been standardized by NIST for use with
symmetric block ciphers such as DES and AES: electronic codebook mode,
cipher block chaining mode, cipher feedback mode, __________, and counter
mode.

5. One of the most widely used multiple-encryption scheme is __________ .

6. "The input to the encryption algorithm is the XOR of the next 64 bits of
plaintext and the preceding 64 bits of ciphertext" is a description of __________
mode.

7. The simplest mode of operation is the ___________ mode, in which plaintext is

handled one block at a time and each block of plaintext is encrypted using the
same key.

8. The requirements for encrypting stored data, also referred to as ___________ ,

differ somewhat from those for transmitted data.

9. The __________ block cipher mode of operation is a general purpose block

oriented transmission useful for high speed requirements.

10. "Input is processed s bits at a time. Preceding ciphertext is used as input to

the encryption algorithm to produce pseudorandom output, which is XORed
with plaintext to produce next unit of ciphertext", is a description of the
_________ mode of operation.

11. The _________ must be a data block that is unique to each execution of the
encryption operation and may be a counter, a timestamp, or a message
number.
Cryptography and Network Security: Principles and Practice, 6th Edition, by William
Stallings

12. A __________ cipher can operate in real time and eliminates the need to pad a
message to be an integral number of blocks.

13. Hardware efficiency, software efficiency, preprocessing, random access,

provable security, and simplicity are all advantages of __________ mode.

14. The plaintext of a sector or data unit is organized in to blocks of 128 bits. For
encryption and decryption, each block is treated independently. The only
exception occurs when the last block has less than 128 bits. In that case the
last two blocks are encrypted/decrypted using a ___________ technique instead
of padding.

15. The __________ standard describes a method of encryption for data stored in
sector-based devices where the threat model includes possible access to
stored data by the adversary. Some characteristics of this standard include:
the ciphertext is freely available for an attacker, the data layout is not
changed on the storage medium and in transit, and the same plaintext is
encrypted to different ciphertexts at different locations.
Other documents randomly have
different content
without a premium, may go on indefinitely; especially as credit-money in the form
of bank bills, such paper may serve as a medium in many exchanges; but
ultimately, and before the entire series of transactions is closed, such bank bills are
to be redeemed in coin, or taken in by the banker in payment of some debt due to
him, in both which cases they are extinguished as an instrument of Credit.
The Bank of England keeps out in circulation on the average £25,000,000 in bank
bills. It has been computed, that the average length of life of a Bank of England
bill between its issue and redemption is about three days; and no bill once
redeemed or received back over the counters of the Bank is ever issued again. It
is then placed on file for record only. The joint-stock and private banks of England
and Wales circulate on the average rather more than £4,000,000 of bank bills of
their own; and no bank bill of any kind is legal in England and Wales of a less
denomination than £5. The ten Scotch banks and their branches keep out in bills
about £5,000,000; six out of the nine Irish banks and their branches issue on the
average not far from £10,000,000; but both the Scotch and Irish banks are
allowed to put out £1 bills.
Bank bills, as a form of paper credit not on interest, but ostensibly redeemable in
coin on demand of the holder, have been issued in the United States by more
parties and to a larger extent and with more recklessness as to redemption than in
any other country. Omitting all reference to Colonial issues, and confining the
outlook to the first century under the Constitution, let us note, that when the
present national government went into operation in 1789, the "Bank of North
America" in Philadelphia and the "Bank of New York" in New York and the "Bank of
Massachusetts" in Boston had been opened for business, and all three were State
banks issuing bills convertible into coin, though each confined its business mostly
to the city in which it was located. Two years later under the auspices of Alexander
Hamilton, then Secretary of the Treasury, the first "United States Bank" went into
operation at Philadelphia under a charter from Congress that was to run twenty
years with a capital stock of $10,000,000. At first no bills were issued by this bank
of a less denomination than $10; the money was popular and was converted on
demand; the Bank was prosperous, and paid dividends to stockholders never
falling below 8% and frequently rising to 10% annually; as the time approached
for the charter to expire, the stockholders were anxious for a renewal of their
privileges; but the opposition to them in Congress was now strong, owing mainly
to the increase in the number of State banks from 3 to 88; and accordingly the
recharter was defeated in the House by one vote, and in the Senate also, by the
casting vote of the Vice-President, and the Bank was obliged to wind up its affairs
in 1811.
Then came in a sort of mania for the creation of new State banks, under the hope
that these, now there was no National Bank, might obtain the Custody and
temporary use of the national funds, and especially might furnish the country with
paper money in the shape of State bank bills. The number of banks went up to
246 in 1816. So many bank bills were put out, and became so much distrusted,
and so many were presented for redemption, that the banks could not respond in
coin, and in the fall of 1814, there was a general stoppage of specie payment in all
the banks of the Country excepting those in New England. General resumption of
specie payment by the banks did not take place till 1819. New York bank bills went
down to 90%, those of Philadelphia to 82%, those of Baltimore to 80%, and those
of Pittsburg to 75%.
Under these circumstances the Second Bank of the United States went into
operation in January, 1817, also with a charter to run twenty years, with a capital
stock of $35,000,000, of which the national Government subscribed one-fifth. The
new Bank helped indeed the State banks to resume specie payments, as was a
part of the purpose, but it pushed its own bills into circulation with such
eagerness, that it is thought $100,000,000 of them were in the hands of the
people, before the first year was out. In this way the Bank fell into difficulties. Its
bills were distrusted. Coin came to bear a premium over them of 10%. President
Jackson began his famous contest with the Bank seven years before its charter
was to expire, and took care that it went out of being the same year that he went
out of office, in 1837, namely.
The next year the State banks increased in number to 675, and continued to
increase till 1862, when there were over 1500 of them, and when the issue of the
"Greenbacks" by the national Government interfered with what had been their
exclusive issuing of the paper money after 1837. In 1857, before the commercial
panic of that year, the aggregate of their bills stood at $214,000,000, the largest it
ever reached. These bills were nominally convertible into coin at the will of the
holders, but they were never actually so convertible for any great length of time.
The ratio of their volume to the specie reserved to redeem it was always a very
high ratio. For instance, the average for the whole country in January, 1863, was
4:1; in Rhode Island 12:1; and in Vermont 28:1. Such a paper money can be
called convertible only by a stretch of courtesy.
It was wisely determined by the People to abandon this loose form of paper
money, and in 1863 went into operation the present national banking system,
under which originally $300,000,000 of bank bills were authorized to be issued in
the aggregate, but this limit was extended in 1870 to $354,000,000, and the Act
of 1875 removed all restrictions on the total amount, while there have always been
restrictions on the amount that can be issued by any one bank in the system. By
the law of 1882, national banks may withdraw their bills by depositing lawful
money in the Treasury to take them up, and then take back the proportionate
amount of the bonds held for the security of the bills. There were outstanding
Dec. 26, 1883, $341,320,256 of these national bank bills, but their volume
declined under the law of 1882 to $151,702,809 on Oct. 4, 1888. These bills were
from the first redeemable in greenbacks, which were themselves, however,
irredeemable in gold and silver till New Year's, 1879, since which time till the
present all the paper money of the United States of both kinds has been
convertible into coin at the will of the holder.
d. Bank Deposits. We are studying in order the forms of commercial Credits, and
we have now come to that one which is central in the operations of Banking, and
accordingly this is the place for us to understand clearly what a Bank is, who a
Banker is, and what are the motives actuating at once the Banker and his
Customers. A Bank is an institution for the Creation, Management, and Extinction of
Credits. Money of any kind plays a very subordinate part in the general operations
of banks, which live and move and have their being in the sphere of pure Credits.
Bankers are buyers and sellers of credits. As merchants are dealers in
commodities, so bankers are dealers in credits, buying (1) some credits with other
credits, (2) some credits with money, and (3) money also with credits. Before
unfolding these three operations of bankers in their motives and profits, a glance
backward to the origin of banks would be a help to us in grasping their nature and
benefits.
The word "bank" meant originally a mass or pile or ridge of earth, as we still say, a
sand-bank, and the banks of a river. When first applied to commercial transactions,
the word had a different meaning from what it has at present, although the idea
of credit has inhered in it from the first: in 1171, the Republic of Venice, being at
war, ordered a forced loan from its citizens, and promised to pay interest on it at
5%; and certificates were issued for the sums paid in, and public commissioners
were appointed to manage the payment of the interest and the transfers of the
certificates, which were made negotiable. The Italian word applied to such a public
loan is monte, but as the Germans were then strong in Italy, the German
equivalent word, bank, came to be used alongside of it and instead of it. It meant
this common contribution of the citizens to the wants of the State, represented by
the mass of the certificates, and came to be applied also to the place where the
commissioners paid the interest and transferred the shares. Two other such loans
were contracted there afterwards, and an English writer, in 1646, quoted by
Macleod, speaks of the "three bankes of Venice," meaning these three public
debts, including the evidences of them and the place where they were managed.
The Bank of England also was in its origin in 1694 an incorporation of those
persons willing to subscribe to a public loan in time of stress, as "The Governer
and Company of the Bank of England." The subscribers to a loan of £1,200,000
became an association, or bank, on the condition that the Government should pay
interest to the lenders at 8% annually, and also £4000 a year in addition for the
management of the bank, that is, of this debt of £1,200,000 which was the sole
capital stock of the new Company, which was authorized to issue an equivalent
amount of bank bills to circulate as money. The capital stock was of no use, so far
as redeeming these bills was concerned, the stockholders must furnish other
money for that purpose besides what they have loaned to the State, but the
ownership of so much of the public debt divided among the shareholders, made
the Bank respectable, and tended to give public credit to its bills, which at first
were paid promptly in coin on demand, and thus the Bank, by increasing the
volume of money and by showing confidence in the stability of the State,
strengthened the revolutionary position of William and Mary, and consequently the
Whigs were the friends and the Jacobites the enemies of the Bank. This function
of issuing bills or promissory notes designed to circulate as money, thus begun and
still continued by the Bank of England, is much less important in modern banking
than the other two functions of receiving Deposits and making Discounts, but it
was the function on which the turn began to be made from the older to the newer
modes of Banking. All that is needful to be said on this tertiary or money-issuing
function of Banks has been already urged under the last head.
The two Banks of the United States in succession, as they were more or less
modelled after the Bank of England, gave the same prominence to the function of
issuing paper money, under the belief that government bonds afford the best
security for the redemption of bank bills, an idea that underlies our present system
of National Banks also; and, moreover, those two great banks began to teach the
people of the United States something of the mysteries of Deposit-banking, the
point that we have now in hand. One-fifth of the capital stock of the first Bank,
$2,000,000 out of $10,000,000, was subscribed by the national Government; and
besides, the proceeds of the national taxes as they were paid in were passed over
to the Bank as Deposits, that is to say, the Bank bought this money of the
Government, paying for it with a Credit; and then properly used the money as its
own in paying expenses and in discounting paper. Bank deposits do not belong to
the depositors, but to the bank; which has thus bought money with credit; and
when Andrew Jackson suddenly removed from the second Bank of the United
States the national moneys deposited there, and placed them "in the custody," as
he expressed it, of certain selected State banks, these amounted at the moment to
$10,000,000, and the discount line resting in part on these deposits was at the
time over $60,000,000, he removed them under a strong misapprehension of the
nature of such deposits; and their removal affected credit, and disarranged
business to a remarkable degree, and caused intense excitement all over the
Union. Depositing those national moneys with the Bank was a trade between the
Government and the Bank for the time being. The Government took in return for
the moneys a Right to demand of the Bank in future by cheque or otherwise sums
at its convenience to the aggregate of the sums deposited; the moneys became
the property of the Bank to be used at its discretion in its ordinary business; the
Government took its return-service for the moneys in a Credit, that is, a right to
draw out at its convenience in the future corresponding sums; there was a
commercial understanding in that case between the Government and the Bank
underlying the buying and selling involved in the Deposit, as there always is
between depositors and their banks; the banks are always bound to order their
business in such a way as to be able to respond to every depositor's call for
money, when it comes; but banks in general find practically that a cash reserve of
one-third of their Deposits is ample to answer the current demands of their
depositors, and the remaining two-thirds may be safely used in discounting short-
time commercial paper to their own profit; Deposits, accordingly, are not placed
"in the custody" of the banks receiving them; they are really bought by the banks
of their customers, who receive in return certain privileges and credits that they
prefer to the "custody" of their own moneys; and under these general motives on
both sides, there has grown up in all commercial countries an immense line of
Bank Deposits so-called, and perhaps we may say that the principal function of
banks at present is to buy these deposits with their Credit, and then to handle
them in further operations to the convenience of their customers and to their own
gain.
Under our present national banking system the Government is still a depositor of
public moneys in some of the banks designated as "depositaries." At the close of
the fiscal year, 1888, there were 290 of such depositary national banks, and the
Treasurer held United States bonds of the face value of $56,128,000 and the
market value of $68,668,182 in trust for these banks to secure public moneys
lodged with them. This system of national deposit with the banks began in 1864.
The total held by the banks June 30, 1888, was $58,712,511, an increase during
the year of $35,395,633.
But our concern is especially with the Bank Deposits of individuals, with their
motives in making these, and with the motives and the methods of the bankers in
handling them. In order to draw the confidence of the people in its locality, a bank
must not only be, but also seem to be, well-to-do and prosperous. Most bankers
find it to their account to become known owners of public stocks; and in many
cases, as in the present national banks of this country, are required by law to own
such stocks, and this gives them a kind of credit and public standing scarcely to be
reached by the ownership of ordinary property. Thus the Bank of England held at
the outset £1,200,000, and now holds £15,000,000 of securities, mostly of the
public debt of England. As merchants begin by laying in stocks of goods of the
kinds they purpose to deal in and offering them for sale, so bankers begin by
bringing together money and credits of their own in order to attract to themselves
in the way of buying and selling the money and credits of other people. In order to
deal successfully in credits the banker must have credit, that is, he must have the
reputation of having property of his own, and of being an honest and careful
manager of his own affairs and of the affairs of others so far as they are intrusted
to him. Each of our present national banks, now (1890) 3150 in number, must
have by law a paid-up capital of not less than $100,000, and in cities of 50,000
people their capital must not be less than $200,000 each, except that in places
having less than 6000 inhabitants banks with not less than $50,000 capital may be
organized at the discretion of the Secretary of the Treasury. The main purpose of
all this is to secure strong financial organizations fitted to draw the confidence of
the communities in which they are placed, and in this manner and by means also
of constant national supervision to attract the Deposits of the people to the banks.
Now, as was said a little while ago, perhaps the central function in banking is for
the banker to receive his customer's money and also his credits falling due, and to
render to him in return for these a credit, that is, a right to demand from himself
an equal sum at a future time or times. The evidence of this right is entered on
the banker's books, and usually too on the customer's passbook, and thus
becomes what is called a Deposit. The ownership of the money and of the credits
deposited passes over completely from the customer to the banker. It is a
complete case of buying and selling to the mutual profit of the parties. The banker
has the right to do just what he pleases with his deposits, and the customer has a
right to draw cheques on his credit as and when he pleases; only the banker's
entry of the transaction on his books is a virtual and a legal promise to pay that
amount to his customer, and therefore he must be ready to respond to his
customer's call, whenever the latter demands, not his own money, but so much of
his banker's money. A deposit, accordingly, is not the very thing deposited, but a
credit. It is the banker's promise and the depositor's property. It is in this way that
a banker buys ready money with a credit.
The motive, then, that leads the depositor to intrust his money to the banker is
the desire, not to have that specific money kept safely for him, for he lost
possession of it absolutely when it passed the counter, he sold it and took his pay
in something else, but rather to have the unquestioned right to call on the banker
for such sums (not to exceed the deposit in the aggregate) and at such times as
may suit his own convenience. He has such confidence in the integrity and
solvency of the banker, finds it so practically convenient to have dealings with him,
and comes to have certain minor privileges at the bank in other relations over non-
depositors, that he quite prefers a credit on the banker to the possession of the
money itself.
The corresponding motive of the banker to receive his customer's funds on these
terms is that he finds by experience (his own and others'), that he can safely use a
large portion of these moneys deposited in other operations in credit profitable to
himself, and at the same time be practically sure of meeting all his customer's calls
for money as they are made. Every good banker finds out, that many of his
customers wish always to leave a balance in his hands; that while some of them
are constantly drawing cheques on him for cash, others of them are as constantly
depositing with him in cash; and that consequently he can properly and safely use
a large part of the money he has purchased with his credit to purchase other
credits with. Deposit-banking, therefore, is not only convenient and profitable for
the depositor, but also excellent and profitable for the banker.
Besides these two parties benefited, there is a gain, too, for the community at
large in deposit-banking; inasmuch as a new capital as such has been thereby
created, a series of new values, which would not otherwise have existed at all.
Were there no deposit-bank in that locality, every man now a customer of it would
of course keep his own reserves for himself for prospective contingencies: now, all
these little reserves are aggregated in the bank, the convenience of them for each
customer's contingencies is just as great as if he kept his own in his own safe or
wallet, but the banker finds that he can use, say two-thirds of the whole, and still
answer each customer's call. Here is a new capital. Here are scattered valuables
brought together to be loaned out to a profit, which were otherwise barren and
useless for the time being. Industry is quickened in a wide circle, products are
created and brought to market, wages are paid and profits are gained, in direct
consequence of bringing together under favorable auspices for safe loaning the
little hoards and driblets of many individuals, which were practically useless in
isolated hands.
It may easily be objected at this point, that it is entirely possible that any banker
might be called upon to pay off all his deposit-liabilities at once in money, which, if
it happened, would break him of course; so it is abstractly possible that all the
lives insured in a Life Insurance Company might terminate in one day, in which
case no Company in the world could meet its obligations; and so it is abstractly
possible that all the houses insured in a Fire Insurance Company might be burned
up in a single night, which, if it happened, would cause the collapse of the
soundest company; but in all these cases of possibility there is a certainty that the
possibility will not become a fact. Ex nihilo nihil fit. A supposition practically
impossible to become a fact can yield no logical inference whatever. The Greek
language has a special grammatical form for a hypothesis impossible to be realized
in fact: would that the English had also such a form of speech! It would save us a
mess of bad reasoning. If, however, any banker may have misjudged for his
locality at any time the proper ratio of reserves kept to deposits received, and be
crowded in consequence, he must sell some of the securities bought with the
excess, or borrow money on them.
Surprisingly large is the amount of bank deposits in all the leading commercial
nations of the world. The average public and private deposits of the Bank of
England, on which no current interest is paid by the Bank, amounts to about
£40,000,000 all the time. The ten joint-stock banks of London carry about
£80,000,000 in private deposits, of which those to remain some time draw an
interest, but those lodged on current accounts and on call draw none. Scotland
has carried deposit-banking further and to greater advantage than any other
country in the world. There are now no private banks in Scotland, but the ten
joint-stock banks with their numerous branches scattered to every village in the
land hold constantly about £70,000,000 as individual deposits, on which current
interest is allowed, and so the habit of keeping one's account with a banker has
become universal with the people. No one thinks of keeping money to any amount
in his house or about his person, and consequently house-breaking and highway
robbery have almost ceased. Bankers even attend all the great fairs in the country
to receive deposits and to pay off cheques. Credit in this form and in another form
soon to be described treads its utmost verge in Scotland. Although in the United
States the custom of keeping deposits with bankers and drawing cheques against
them has not gone nearly so far as in Scotland, and not nearly so far as it will go
in the immediate future, yet the aggregate of individual deposits in the national
banks alone, Oct. 4, 1888, was $1,350,320,861, an increase in just seven years of
26%.
e. Bank Discounts. The credits that are discounted by bankers may be either the
promissory notes of individuals and corporations already characterized, or the Bills
of Exchange soon to be characterized, but the entire function of discount is so
peculiar, that the paper subjected to it ought to be enumerated in a classification
of the instruments of Credit. The discounting of commercial paper is the second
essential function of banking, as the buying and handling of deposits is the first;
and it is more in accordance with genuine banking to pass the price of the paper
discounted to the seller's credit in the form of a deposit, that is, to buy one credit
by creating another, than to pay the money over the counter at once, and thus to
buy credits with money. Those who do the latter are called bill-discounters rather
than bankers, but most of our bankers do both, though there is a tendency
towards the separation of the two in this country also.
Manufacturers and wholesale merchants usually sell their goods on time, as it is
called, say three or six months. Debts are thus created, or to say the same thing
in other words, Credits are thus given. The manufacturer or wholesaler is creditor
and the jobber or retailer is debtor. But a debt is property; and the creditor in this
case wishes to avail himself of his property at once for further production; so he
either takes a Promissory Note from his debtor, or draws a Bill of Exchange upon
him, and this piece of property is ready for sale. Neither piece mentions interest
expressly, but the face sum virtually covers it as contemplating discount. Banks
have been organized for the express purpose of buying for their own profit and for
the convenience of business such pieces of property; some banker, accordingly,
buys this particular piece, that is to say, this creditor passes over to this banker the
commercial right to demand payment from this debtor at the end of three months,
and receives in return from the banker either money direct or so much of the
banker's credit, that is, a deposit in favor of the creditor on the banker's books. For
furnishing this creditor either with ready money or a more available credit in lieu of
his mercantile paper, the banker charges of course a percentage. This is Discount.
Discount is the difference between the face and the price of the paper. This
percentage called discount is the chief source of profit in ordinary banking. It is
virtually compound interest on the sum advanced till the maturity of the paper,
when the banker realizes from the debtor its full face.
The following is a common form of a bankable note:—

$1,000 Williamstown, Mass., Nov. 10, 1889.

Three months after date I promise to pay to the order of Joshua Swan, one
thousand dollars, payable at the Williamstown National Bank, value received.

Due Feb. 10⁄13. Leander Allen.

When Swan has put his name on the back of this note, that is in bank phrase, has
indorsed it, in token that he thereby at once sells and guarantees it to the bank, it
is then discounted on the strength of the two names, Allen and Swan. As Allen
technically takes the advance from the bank for his own benefit, he is technically
expected to take up the note when it matures, and if he do not, the bank falls
back on Swan, who is equally bound with Allen to see that it is paid at the proper
time. Two names are nearly always, not always, requisite to a note acceptable for
discount at a bank; and more names merely strengthen the note, since it is
discounted on the combined validity of all the names upon it.
One obvious advantage of discount is, that it tends to make all capital active and
thus productive. It enables the banks to sell their credit and make a gain, to use a
part of their money deposits to buy mercantile paper with, and so get a bank
interest on them; it enables dealers in commodities to realize in cash minus the
discount the sum of what they have sold on time; and by means of
accommodation notes or bills, which only differ from the others in that there is no
actual debt between the parties, business men may swell the volume of their
business temporarily, and non-business people may borrow small sums for
convenience or emergencies. Bankers have not always credit enough or money
enough from their depositors to buy in either mode all the good paper that is
offered to them, in which case, they raise the rate of discount unless the law
forbids, or by easy evasions even when the law forbids; or else accommodate
regular customers and large depositors first, or buy of all that are "good" a certain
proportion only.
The discount line of 3140 national banks reporting Oct. 4, 1888, was
$1,674,886,285.29.
It is thus through the purchase of discountable notes for money, that banks derive
their partial character as money-lenders. Also, such reserve sums as they do not
wish to invest in negotiable paper, on account of the time involved before such
paper matures, banks frequently loan on call to those customers who have good
collateral securities to pledge for the repayment of such loans. The terms of such a
contract give the bank full authority to sell such collateral "at the Brokers' Board or
at public or private sale, or otherwise at said bank's option, on the non-
performance of this promise, and without notice." So far forth banks become
direct money-lenders. It ought also to be added, that promissory notes with a
single name (or more) are often discounted by banks partly on the strength of
collateral securities deposited to fortify the names upon the notes.
f. Bills of Exchange. A Bill of Exchange is a written instrument designed to secure
the payment of a distant debt without the transmission of money, being in effect a
setting-off or exchange of one debt against another. It is in form and in several
technicalities different from a promissory note, inasmuch as it is an order to pay
instead of a promise to pay, and inasmuch as the maker of a note is always debtor
and the drawer of a bill of exchange is always creditor; but all this makes
practically very little difference between the two as instruments of Credit, since
nearly all bills of exchange come into banks in the way of ordinary business, either
for discount or collection, and as the banks care nothing except for names, the
form of the purchasable paper is a matter of indifference to them. The following is
the essential form of an inland bill of exchange:—

$3,000 Pittsfield, Mass., Oct. 16, 1889.

Four months after date pay to the order of John Kent three thousand dollars,
value received, and charge the same to account of
To Eli Tripp, Boston, Mass. Dan Storrs.

In the case of this bill, which may serve as a sample of thousands, Storrs is the
drawer, who is creditor in relation to Tripp, and Tripp is drawee, but Storrs is
debtor in relation to Kent, who is the payee. A bill of exchange is the sale of a
debt, in such a way that two debts are so far forth set off against each other, and
both transactions are closed without sending any money at all. Tripp owes Storrs,
and Storrs owes Kent, and so Storrs pays Kent by an order on Tripp. As this is a
bill at four months, Kent will doubtless send it to Tripp for his acceptance, as it is
called, that is, his acknowledgment that he owes Storrs to that amount, and that
he will pay the sum to the holder of the bill when it becomes due. An acceptance
is written on the face of a bill, and an indorsement upon the back of the note: the
initials are sufficient for the name of an acceptor, but the full business name is
usual for an indorser.
Thus a bill of exchange is the formal sale of a debt, in order to liquidate thereby
another debt, when the parties to the transaction live in different and distant
places. Storrs does business in Pittsfield, and Tripp in Boston, and it is a matter of
comparative indifference where Kent lives, unless there is trouble at the time of
collection, for he will perhaps negotiate this bill again, that is, make use of it to
pay some debt that he himself owes. It is not often that the same person, as
Tripp, happens to owe another person in a distant town, as Storrs, the same
amount as Storrs owes another person somewhere, as Kent; but by two bills of
exchange, one drawn by each creditor on his own debtor, and then each set off
against the other, through the simple and beautiful expedient of bank balances,
substantially the same advantages are reached as if it always happened so. Many
bills of exchange are drawn at sight, as it is called, in which case the payee
presents it for payment to the drawee, there is no acceptance and no discount,
and a bill of this kind becomes the same as a cheque.
Time bills, however, are usually discounted: the payee indorses his claim over to a
fourth party by name, or, by what is called an indorsement in blank, that is, by
merely writing his own name on the back of the bill, makes it payable to bearer:
when banks buy these bills for discount, it is on the joint credit of acceptor and
drawer and payee, and in that order of validity and precedence: a promissory note
may be protested by a bank without notice to the maker, but a bill of exchange
cannot be without notice to the drawer: a promissory note has two parties to it, a
debtor and a creditor; while a bill of exchange has three parties to it, two creditors
and a debtor.
Inland bills of exchange, both time bills and sight bills, are very convenient in
settling debts between distant places without the costly, and more or less
hazardous, transmission of money back and forth; besides this, time bills possess
the very useful function of enabling a debt due from one person to avail the
creditor as a means of obtaining credit from a third party in discount; and in
addition to these two points of benefit, it is plain, that the common use of bills of
exchange in all their forms releases from use large amounts of money that would
else be needful in trade. The less money in use in any country beyond a certain
point, the better, because, if coin, it costs much to mint and maintain it, and if
paper, it is difficult to make and sustain it of full value.
Bankers sometimes change what they call "exchange" for settling debts between
distant places in the same country; in some cases there may be a sound reason
for this, in other cases there is none, but in all cases it adds a little to the profits of
the banks for handling the bills of exchange; the principle of charging an
"exchange" is this,—when one place as Chicago draws more bills on another place
as New York than suffice to cancel the bills drawn at that time by New York on
Chicago, the point at which the larger indebtedness lies is the point for sending
drafts to which banks naturally charge a percentage; perhaps the idea, which is
actually realized in foreign exchange, that money may have to be sent to liquidate
such a balance, may have brought in the custom of charging "exchange" in such
cases; and there are instances aside from such a supposed balance, in which there
may be an extra cost of collection in some form to the bank, that may justify an
"exchange" charge; but there is another principle counterworking and often
neutralizing entirely this alleged doctrine of a "balance" of debt as between two
distant places, namely, that the chief settling place and commercial centre of a
country, such as New York is, draws towards itself from the whole circuit with such
force, everybody wanting a balance there and having occasion to send funds
thither, that drafts on such a place are apt to bear a premium without any
reference to its comparative indebtedness at the time.
Very similar to these inland bills in their nature and course and usefulness are
Foreign Bills of Exchange, which, as a vastly important topic, especially in its
relations with Foreign Trade, we must now study minutely and completely.
Commercial relations between two countries, let us say, for instance, France and
England, always give rise to a mutual indebtedness of their merchants; if these
reciprocal debts were all to be paid by the actual sending of money to and from,
there would have to be a constant and expensive and more or less hazardous
outward and inward flow of the precious metals in respect to each country; all
which necessity is neatly obviated by the use of reciprocal bills of exchange, and
coin is only transmitted to settle the balances on whichever side there may happen
an excess of debt at the time. French dealers are always sending goods to
England, and English dealers goods to France; and for what they send to England
the French merchants draw bills of exchange on the parties to whom the goods
are consigned, and the English merchants draw similar bills on their debtors in
France; then these bills are bought up by bankers or brokers in either country, and
virtually exposed again for sale through new bills drawn against them to any
parties who may have debts to pay in the other country. Thus bills on London, in
other words, on English debtors, are always for sale in France; and bills on France,
that is, on French debtors, are always for sale in London; the reciprocal debtors of
the two countries, therefore, instead of sending coin to cancel their debts, buy and
transmit these bills.
Let us take a sample instance. Pierre & Co. of Paris send a cargo of wine worth
£1000 in English money to John Barclay of London. Barclay thus becomes
indebted to the Paris firm to that amount, and Pierre & Co. draw at once, so soon
as the cargo is despatched, a bill in francs to the equivalent of £1000. If they
themselves have no debt to pay in London, they will sell this bill immediately to a
Paris banker or broker (if the exchange be then at par) for its full face minus
interest for the time it has to run, say two months; this broker is now ready to sell
this bill again, or what is the same, his own bill drawn on the strength of it, to
anybody in Paris who may have a debt to pay in London; and the party in London
who receives it in liquidation of a French debt to him, presents it at maturity to
John Barclay for payment. Thus one bill of exchange serves the ends of two
creditors and one debtor: Pierre & Co. get their pay for the wine, the London party
gets his pay for goods, and Barclay pays his debt, by means of it. A bill drawn in
London for a cargo of hardware sent to Paris is similarly negotiated with a London
broker or banker, and finds its way similarly to France in payment of some English
debt owed there, and ends its course when it reaches the French firm on which it
was originally drawn.
We are now in position to understand clearly what is meant by the par of
Exchange in its commercial (not coinage) import. The merchants in Paris, who
have debts due to them from London, draw bills of exchange for the amount of
these debts; and, through the agency of middlemen, go into the market to sell
these bills to other Paris dealers who have debts to pay in London. If the former
class have a larger amount to sell than the latter have occasion to buy, in other
words, if there be a larger amount of debts due from London to Paris than from
Paris to London, then the natural competition of the sellers in Paris of the bills on
London will lower their price somewhat in that market (Paris), in order, as usual,
that the Supply and Demand may be equalized there. In this case the par of
exchange is disturbed, a bill on London for £100 in francs may not sell for over
£99, and the exchange is then said to be 1% against London, or, which is the
same thing, 1% in favor of Paris.
The par of Exchange, accordingly, between two countries, depends on the
substantial equality of their commercial debts. In the above example, if the
exchange as against London in favor of Paris continue long, and especially if the
premium of 1% on bills drawn in London on Paris be sufficient to cover the
expense of the transmission of specie from London to Paris, gold will begin to flow
from London to Paris, because the debtors there may find it cheaper for
themselves to buy and send gold than to pay the high premium on bills; and thus
the equilibrium of payments and the commercial par may be restored. Also, this
par tends to restore itself, without any sending of specie, in this other perfectly
natural and effectual way: if bills on Paris are at a premium in London, for the
same reason that they are so will bills on London be at a discount in Paris;
therefore, there will be a direct encouragement to the extent of the premium for
exportation of goods from England to France, because on every cargo thus sent
bills can be drawn and sold in London for a premium; while the more bills on Paris
thus offered in London, the more the premium disappears of course, and the par
will be restored so soon as the bills on Paris substantially equal the bills on London
offered in Paris; and at the same time, so long as the discount on London bills
continues in Paris, there is a direct discouragement to further exportations from
France to England, because the bills drawn in virtue of such cargoes can only be
sold below par, and this too tends to restore the par in the commercial sense of
the term.
Here is another instance of a magnificently comprehensive law, by which Nature
vindicates her right to reign in the domain of Exchange. It is through this natural
and beneficent law of automatic compensations, stimulating exportations on the
one side and slackening them on the other, that most of the casual disturbances of
the commercial par as between two countries are easily and perfectly rectified.
While this great law is in full possession of our minds, let us note in passing how
artificial restrictions by one country on the importation of goods from another,
commonly called "Protectionism," affects this commercial par as between those
two countries. Besides stopping absolutely a mass of otherwise profitable
exportations and importations for both countries, it makes less profitable to the
country imposing the restrictions whatever foreign trade does take place between
them in spite of the restrictions. Suppose England, as is the fact, opens her ports
freely to the commodities of France, while France puts restrictions in the shape of
heavy taxes upon importations from England; more French goods are likely under
these circumstances to seek English ports than English goods to seek French
ports, because they are more welcome; consequently, more bills of exchange
drawn on London will naturally be offered in Paris than bills on Paris in London,
and will so far forth be sold at a discount, while the London bills drawn on Paris
will be sold at a premium; in other words, the comparatively few goods that do get
out of a "protected" country, realize less to their owners than the natural value,
because the bills drawn on them are extremely apt to be sold below par! With this
course of things all known facts agree. Since the United States became
conspicuously a "protected" country a quarter of a century ago, it has been at rare
intervals and for short periods that bills drawn here on London have been at par.
They have been usually much below par. The equivalent of £1 sterling in United
States money is $4.8665; and when bills on London sell for less per pound sterling
than $4.86, they are at a discount in New York or Boston; and exporters here are
direct losers to the extent of the discount.
If, however, notwithstanding the beautiful action of this great law of commerce,
the disturbance in the commercial par as between two countries continues
obstinate, it indicates one of several things as true of the country, whose bills of
exchange drawn on another persist in a considerable discount; (1) it has come to
be a pretty steady debtor country as towards the other, by sending thither its
national or State or corporation bonds, whose interest and ultimately principal also
must sooner or later be remitted in exports extra to the exports needed to pay for
the current imports of goods; (2) it has either naturally or by persistence in a bad
public policy little or no shipping of its own, so that freights both ways have to be
paid to foreigners in the form of exported goods extra to those exported to pay for
those imported in transient trade, which of course increases the number and face
of the bills drawn in the luckless country on the lucky country or countries; (3) it
has made the vast and fatal mistake of excluding by legal barriers of taxes put on
for that purpose the goods of foreigners, whose only motive in coming is to take
off corresponding goods of the deluded country's own to the profit of both, and so
these last-mentioned goods must seek a foreign market (if at all) at reduced rates,
their natural market having been destroyed by national law; and (4) it may have
made the national money in which the bills drawn on it are liable to be paid an
inferior money, either transiently by mere abundance or permanently by worsened
quality, which is well illustrated in the instance of Amsterdam as cited in a
preceding chapter, and which can only be remedied by raising the standard of the
money to the level of the best.
Very little, if anything, can be inferred as to the prosperity of a country or even as
to the real condition of its "exchanges" in this technical sense of the term, by the
transient movements of gold to and from the commercial countries, in their
present complex relations as gold-producing and non-gold-producing countries and
as debt-settling and non-debt-settling centres. Gold moves back and forth in
obedience to several other impulses than to settle the balances in an international
trade of Commodities. Gold-producing countries of course export gold just as they
would any other native product. If for any reason gold becomes relatively more
abundant in one country than in other commercial countries around it, general
prices will rise in that country in consequence; which means, that gold is then and
there the cheapest article that the people of that country can export to pay their
commercial debts with. Also, the imports which a nation pays for in gold, or in bills
of exchange bought above par, are often bought with a high profit. Creditor
nations, nations that have managed to make themselves settling-places for the
world's commercial debts, and nations that welcome imports without impediment
from every quarter of the earth (and England may serve as a sample for all these
three), will largely pay for imports in gold or in bills bearing a premium.
It is a thousand pities, that technical terms which are quite misleading unless one
remembers their origin and exact significance, have come to be intrenched in
commercial language too strongly to be dislodged at this late day, as the common
terms to express the state of the "exchanges" as between two countries. These
terms are "against" and "in favor of." The old Mercantile system, which has left
other unsavory progeny behind it besides this, in order to keep and heap gold and
silver in a country, encouraged exports in every way and discouraged imports, in
order that the "balance of trade," as the phrase ran, that is, the difference in
volume between exports and imports, might come back to the country in gold and
silver; and this foolish and now thoroughly exploded notion gave rise to the terms
in question; exchanges were then said to be "against" a country when the record
seemed to show more imports than exports, as if that implied that the imports
were too great for a "balance" in gold and silver; and were said to be "in favor of"
a country when its export-line was greater than the line of imports, as implying a
favorable balance to be met by a specie-import in future. The false "System" is
gone forever, but the "terms" still abide in commercial language, and confuse the
minds more or less (more rather than less) of everybody who tries to make these
terms a vehicle of thought. We have now described the causes and courses of
international bills of exchange without resorting to these technicalities, which
imply movements of gold and silver which do not actually take place under the
conditions supposed; for example, the exchanges were "in favor" of the United
States in 1874-77, there being an apparent trade balance of $164,000,000 in 1877
and a still larger in 1876 and a larger one in the two years preceding, but the
import of specie was small in all those years, averaging about $25,000,000 a year,
and the rest of the excess of exports went to pay interest due to foreigners,
freights on the cargoes both ways, and so on. It is difficult to use without abusing
the terms "against" and "in favor of" in this connection, and the reader is
cautioned not to employ them; although "discount" and "premium" on
international bills of exchange are matters extremely important to observe and to
know the grounds of. Were there no counterworking principle, bills of exchange
drawn on capitalist and creditor countries, like Great Britain, whose imports are
apt to be strongly in excess of the exports, and whose public policy is wise enough
to put no obstacles in the way of the free receipt of imports, would be at a
discount in countries sending exports thither.
This counterworking principle, already illustrated as to inland exchange in the case
of New York, is best seen internationally in connection with London, which is the
settling-place of the world's commerce. When the Romans dredged the Thames
and made "the pool" just below London Bridge, they took the first steps towards
making that town a commercial centre; since a market for products is products in
market, the busy exchange of commodities there has quickened in every age the
accumulation of capital and the increase of population; previous to the Dock
Laborers' Strike in 1889, about 100 vessels entered the port of London every day,
which received about one-half of the total customs revenue of the United
Kingdom, and sent out about one-fourth of its exports; the business of out-of-the-
way and semi-civilized countries has somehow (and it would not be hard to tell
why) centered in London, as well as the business of originally British Colonies
everywhere and of all other commercial countries; accordingly, debtors and
creditors abound there, bills of exchange concentre there, and debts due from
everywhere are payable there; and therefore, because bills on London are good all
over the world, the Demand for them counterworks the natural cheapness of the
bills drawn on exports thither as compared with the natural dearness of the bills
drawn there on exports thence.
Another thing must be borne in mind in comparing the merchandise accounts of
any country, namely, that whenever the "exchange" is sufficient to cover the cost
and risk of the transmission of gold, gold itself is likely to go freely from the
country, in which bills drawn on exports are at a premium, or to use for once the
old hazardous phrase, "against" which the exchanges have turned, and bills will be
drawn on that gold, as upon common merchandise, and sold of course for the
sake of the premium; or, if a decidedly higher rate of discount prevail in a
neighboring country, gold will naturally go thither from the lower-rate lands,
because lenders in the latter will desire to realize the higher rate of current
interest on money, and bills will be drawn on this gold as well, which will tend to
lower the premium on bills there; unless, then, the premium and the difference in
interest abroad will justify the speculation, the gold will not stir; although, if the
difference in interest abroad were very considerable and promised to continue for
some time, the bills on the gold might sell at a discount and still leave a profit to
the senders; but the home bankers can always stop a drain of gold of this kind by
raising their own rates of discount.
This casual mention of bankers leads on to the weighty point, that the whole
business of foreign exchange is falling more and more into the hands of the
bankers, because bills drawn by and upon well-known bankers naturally have a
better credit than ordinary commercial bills, the names upon which are less widely
and favorably known. Accordingly, persons sending cargoes of cotton, say, or of
any other valuables, from New York to Liverpool, arrange with their bankers in
New York to have the proceeds of the cargoes put to the bankers' credit in
London, and then these bankers draw bills on the London bankers, which will bring
a higher price in New York than a common commercial bill, because many
remitters and most travellers prefer bankers' bills, which, though they cost more,
pay better and buy better abroad. Commercial bills are still bought and sold in
every commercial town, but bankers' bills are more and more taking their place;
and the quotations usually give the current price of each.
London is so prominent as the settling-place of the world's transactions by means
of bills drawn on and by London bankers, partly on account of the commercial
predominance of England, partly from excellent banking customs there, and
mainly because an immense mass of cheap loanable capital exists there, which
even foreigners may borrow at London rates, provided only that they can get
credit there, that is, leave to draw on a London banker, to whom of course
remittances must be made as fast as he accepts their bills. Besides, the Bank of
England, as the principal bank in Great Britain, and as closely connected with the
Government, acts as a bank of support to the public and private Credit of that
country. It does a regular business as a bank of deposits and discounts, but it
means to keep its rate of discount somewhat above the rate demanded by the
other bankers in London, so as not to come into competition with them much in
their ordinary business, and be able to act as a bank of support to them and all
others in times of pressure. All banks have about so much credit to sell, and no
more; most banks sell in ordinary times about all the credit they have, because
their profits depend on that; but if the Bank of England did this, it would become
useless in periods of panic. In point of fact, that Bank just begins to sell its reserve
credit, when the credit of the bankers below is exhausted. When they are at the
end of their rope, there is generally an abundance of slack rope still in the great
Institution above.
Now, as gold can be drawn out of the Bank of England by the cheques of
depositors as well as by the presentation of its own notes for redemption, the Rate
of Discount becomes a matter of prime importance in the management of the
Bank. The whole line of deposits is a line of liabilities to pay out gold, if the
depositors demand it; and, as deposits come largely through discounts, whenever
there is a strong tendency to draw out gold so as to weaken the reserves of the
Bank, the directors have an effectual remedy by raising the rate of discount. The
higher the price the Bank charges for its credit, the fewer, so far forth, will be its
customers, and the smaller its line of deposits, and the less likely a continuous
drain of gold from its vaults. The Bank of England is managed throughout by so
simple a manner as the turning back and forth of this magic screw of Discount.
Besides the use of the term "Par of Exchange" in the broad commercial sense in
which we have now been examining it, as indicating the substantial equality of
international debts as between two countries by the current prices of bills of
exchange, there is another and subordinate sense in which the phrase is
employed, namely, as denoting the relative value of the coins of one nation in the
coins of another. Thus, our present gold dollar contains 23.22 grains of pure gold;
the English pound sterling contains 113.001 grains; consequently, there are
$4.8665 to the English pound; and this is the "par of exchange" (in the secondary
sense) between the United States and Great Britain. Between the United States
and France the "par" is $1 to 5.18 francs, since the franc is 19.29 of our cents. An
English shilling equals 24.33 of our cents, the new German "mark" is 23.82 cents,
and the new Scandinavian "crown" equals 26.78 cents.
g. Bank Cheques. In substance indeed and even in form, Cheques are Bills of
Exchange, but the two have such differing legal incidents, and run so different a
course towards extinguishment, that for our purposes in this treatise they should
be put under a separate discussion. Bills of exchange are expressly drawn "at
sight" or for a day certain, when they become payable by the drawee: cheques say
nothing about "sight" or any future date, though they are really drawn at sight,
and are payable to bearer on demand: they must, therefore, be presented for
payment within the shortest reasonable time (all things considered), in order that
the holder may legally claim against the drawer should the banker fail meantime: a
cheque is held as the payment of a debt until it be dishonored on presentation:
the banker bears the risk of the forgery of the drawer's name, unless his mistake
be made easier by the drawer's carelessness in drawing: a cheque is not payable
after the drawer's death. The parties to cheques are the Drawer, who is a
depositor with some banker; that banker thus becomes the Drawee; and the
person named in the cheque is the Payee, who can indorse his own right over to
another person by name or in blank to bearer. When a cheque is drawn in this way
by one banker upon another, it is usually called in this country a Draft.
Formerly in England, and in other countries as well, each considerable dealer kept
his own strong box, and when he had occasion to make payments, told down the
solid cash upon his own counter. Afterwards, the goldsmiths of London solicited
the honor of keeping in their vaults the spare cash of the merchants, and these in
their payments among each other came to employ orders or cheques drawn on
the goldsmiths, and at the shops of the latter the principal payments in coin were
effected. The later introduction of Banks brought along with it the custom, now
continually widening in commercial countries among all classes of the people, of
keeping one's funds with some banker, and making payments by written orders or
cheques upon him. When the person making the payment and the person
receiving it keep their money with the same banker, there is no need of any
money at all passing in the premises, the sum being merely transferred in the
banker's books from the credit of the payer to the credit of the receiver. The
banker is quite willing usually to do this business for nothing, and even sometimes
to allow the depositors a low rate of interest on all balances remaining in his
hands, in consideration of the privilege involved of loaning such proportion of the
aggregate of these sums as he deems safe to other parties at a higher rate of
interest.
In the larger cities, by an arrangement called the "Clearing-house," substantially
the same benefits are secured as if all the depositors of the city kept their cash at
the same bank; inasmuch as all the cheques drawn on each of the different banks,
and passing in the course of the business day into other banks, are assorted
before evening at all the banks, and adjusted the next morning through the
clearing-house, and the credits and debits of each bank are set off as far as
possible against each other, leaving only small balances to be settled in money.
The London Bankers' Clearing-house was established in 1775; in 1864, the Bank of
England was admitted to it; and since then, the Clearing-house itself, and all the
bankers and firms using it, keep accounts with the Bank of England, and the
balances, formerly settled by money, are now adjusted by simple transfers of
account on the books of that great Bank. This carries out the grand principle of
the Clearing further than it has yet been carried in this Country, although the
United States Sub-Treasury not very long ago joined the New York Clearing-house,
while the practical details of the Clearing are simpler and better in New York than
in London. The average clearings in the London house (and there are besides
many other clearing-houses in the United Kingdom) were £5,218,000,000 a year
for 1875-80, and the amounts cleared frequently rose to £20,000,000 a day;
which, if paid in gold coin, would weigh about 157 tons and require about 80
horses to carry it; and if paid in silver coin would weigh more than 2500 tons and
require 1275 horses. This is stated on the excellent authority of the late Professor
Jevons.
The total business of the 23 clearing-houses of the United States in 1880 was over
$50,000,000,000; the New York Clearing-house did 65% of that business for that
year; and the average daily clearings there for the fiscal year 1879 were
$76,167,983.
We will now describe mainly from personal observation the New York Clearing-
house, which was established in 1853, premising that the principle is the same,
though the details may be different, in all other clearing-houses wherever located.
Business men in New York, as elsewhere, usually pass in to their bankers as a
deposit all the cheques and current credits received in the course of a business
day. It is the custom for everybody to draw his own cheque on his banker to make
payments with, and to pass in to his banker the cheques he receives from others.
Say there are sixty clearing-banks in New York City. Each of these banks sorts out
after business hours every day all the cheques it has received that day drawn on
each of the other banks into separate parcels ready for the clearing the next
morning. Each bank has, then, fifty-nine parcels to deliver, which represent the
property of that bank, and are a claim upon the other banks; and also to receive
fifty-nine parcels, which represent the property of the other banks, and are a claim
upon itself.
Before ten o'clock in the morning sixty messengers, each having fifty-nine parcels
to deliver, appear at the clearing-house, each reporting to the manager at once for
record the amount of "exchange" he has brought, which is entered of course as
credit to his bank; and then all take their positions in order in front of the sixty
desks, which occupy the floor of the house, behind which sit sixty clerks, each
representing one of the banks. Each messenger stands opposite the desk of his
own bank, with his fifty-nine parcels already arranged in the exact order of the
bank-desks before him. Of course no messenger has anything to deliver to the
clerk of his own bank. Each clerk inside his desk has a sheet of paper containing
the names of all the other banks arranged in the same order as the desks, with
the amounts carried out upon it which his messenger has just brought to each. All
these are entered in his credit column. Each messenger carries also a slip of paper
ready to be delivered with each parcel to each clerk, on which is entered the
amount of the cheques he now brings to each bank. Of course the amount
delivered to each bank is debit to that bank, just as the amount brought by each is
credit to that bank.
A signal from the manager, who stands on a raised platform at one end of the
room with his two or more clerks before him, and each messenger steps forward
to the next desk in front of him, delivers his parcel and also the slip that goes with
it, which latter the clerk signs with his initials and hands back to the messenger as
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