19th century financial (?) idiom - "shaving" short paper? - and banknotes on the frontier

Factual Questions
1

I’m reading some letters from a businessman to his brother-in-law about opportunities in Muscatine, Iowa in the 1850s. He’s extolling the low cost of living, the game so plentiful you can shoot it without getting out of the buggy, etc. He ends with:

A man with $3000 or $4000 can live easy here by “shaving” short paper at 20 and 30% (quote marks in original)

I gather that this refers to making short-term loans at high interest rates, but does the “shaving” indicate anything? Something unscrupulous, perhaps? It makes me think of points-shaving, or embezzlement, but the 1850s version of “shaving” may not have that connotation. Also, the interest rate seems high. Is he inviting his brother to be a loan shark, or would these rates have been reasonable in what was almost a frontier town?

In another letter he complains that

…money matters have been very much deranged for the last three months. We take no Indiana bank bills excepting State Bank. No Ohio money excepting State Bank. No Kentucky excepting Northern Bank, and none from banks south of that. How long this situation will last I can’t tell, but not long, I think.

A fun reminder that we didn’t have Federal banknotes until 1863. Presumably he’d be worried about the solvency of other note-issuing banks that weren’t backed up by a state, but how would he be privy to such information, and what would change such that he would be willing to take notes from, say, banks in southern Kentucky again? I get the impression that most banknotes were only good for a short radius around the issuing bank in the best of times, while gold and silver coins were always good.

2

Yes, it indicates a certain illegality. Not sure of the etymology, but I’d guess it harks back to the days of literal coin clipping.

3

It might be technically illegal in not paying the face value of an issued bank note but was also standard and necessary commercial practice before central currency regulation.

For banknotes that were from dodgy sources, cheques and promissory notes [essentially IOUs where you to trust the payer and the piece of paper as both being legit], a merchant would typically accept them at a discount [‘shaving’] off face value.

I mosey up to some hick town and pull out a fresh $10 from the Bank of Monopoly and start buying at a store, they would assess the risk and give me say $8 worth of value, while a $10 note from State Bank of Ohio might get me $10 worth of goods and credit.

Promissory notes were only as good to the distance the ultimate payee was known. One critical role of saloons and merchants was to maintain up to date intelligence of all the main employers in a region, who were the most likely people to be issuing cheques or promissory notes. If you didn’t know that Black Bob had had a bad crop you stood to lose money if you didn’t discount to cover your exposure. And saloons were a key place to exchange cheques and notes into cash, so they had to get it right.

4

Not necessarily illegal, unless loan interest rates are controlled by law. Basically it refers to lending money at exorbitant rates of interest.

As other references in the letter make clear, banking services were - ahem - somewhat underdevoped and most banks were more or less perpetually beset by concern about their solvency, which discouraged people from depositing money in them or accepting their banknotes. They tried to address these concerns by developing a reputation for only lending to people of impeccable solvency, or on very good security. Which mean that, for people who weren’t already very wealthy, access to credit was a problem.

The gap was filled by private credit. I’m a small trader who needs, let’s say, $100 to buy supplies and pay my workers. The workers will process the supplies in a way that adds value and then I’ll sell the finished product for more than $100. But I have to lay out before I can get in, so I need $100, and the bank won’t look at me. So I go to Rich Guy In Town who knows me better than the bank does, and who may also have ways of incentivising me to repay loans that a bank would baulk at.

The particular mechanism used here was a promissory note. On, say, 1 March I sign a note promising to pay Rich Guy $110 dollars on 1 July. In return for this, he give me $100 cash. I’m effectively paying $10 to borrow $100 for 3 months, which works out at a swingeing annual interest rate, but because the bank won’t look at me I don’t have a lot of options. The promissory note is a legal security; it can be enforced through the courts if necessary. Promissory notes collectively are sometimes referred to as “commercial paper” or simply “paper”

The difference between the amount I promise to pay in the future (in this example, $110) and the amount I am given now ($100) is the “discount”. To “shave paper” was slang for issuing promissory notes at exorbitant, but not necessarily illegal, discounts.

It could be a steady line of business because, of course, in three months’ time, when the note falls due, assuming my business is still going I still need working capital so, instead of repaying the note, I may ask Rich Guy to renew it for a further 3 months, at a further discount. And so on and so on, until my business grows to the point where enough profits can be reserved to fund working capital and repay the notes, or to the point where I am unable to renew and bankruptcy looms.

5

According to this paper (which is behind a paywall), “shaving” was a 19th century term for charging very high rates of discount when buying bills of exchange or commercial paper. Discounting was a common 19th century way of extending credit: A banker would purchase a paper that was due at some point in the future and pay the face value minus a deduction that accounts for the interest rate until maturity. Apparently, “shaving” is when you apply particularly high discount rates in doing so. So yes, essentially loan sharping, albeit cloaked in a form that was common in banking at the time.

6

Thanks to all for the quick and helpful responses! I gather that my writer was a sharp operator:

I have been here two days only and of course can give no very distinct ideas of business matters, but can give impressions gathered from my limited observation, and from conversation with others.

This is followed by four pages describing the production capacity of the local sawmills and flour mills and barrel factory, with wholesale prices for goods; prices for commercial and agricultural real estate with the note that prices drop 4 miles out of town; “you can let any quantity of money here at 25%, with ample security”; a précis of the geography and biomes around town out to twenty miles; a critical comparison to the nearest competing town, Davenport, which does less business but is building a railroad and which will not require as much civil engineering as Muscatine; and an estimate of total recent immigration to Iowa based on ferry traffic.

He arrived October 16th, and by November 10th he was a contractor for the Lyons Iowa Central Railroad, with a $30,000 contract to grade two miles of rail bed near Tipton by June 1854. Based on wages he was paying to laborers, he expected that half of this would be profit! Unfortunately for him the railroad went bankrupt about seven months later, but he pivoted to the hotel business catering to the streams of immigrants passing through town:

We have 85 regular family and sometimes as high as 125 arrivals per day. We pack them away like bales of goods and charge them big storage.