THE FEDERAL RESERVE SYSTEM—ITS PURPOSE AND WORK

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V o lu m e XCIX J a n u a ry , 1922

Editor: CLYDE L. KING Assistant Editor: J. H. WILLITS Editorial Council: THOMAS CONWAY, Jr., C. H. CRENNAN, A. A. GIESECKE, A. R. HATTON, AMOS S. HERSHEY, E. M. HOPKINS, S. S. HUEBNER, CARL KELSEY, J. P. LICH- TENBERGER, ROSWELL C. McCREA, E . M. PATTERSON, L. S. ROWE, HENRY SUZZALO, T. W. VAN METRE, F. D. WATSON

Editors in Charge of this Volume A. D. WELTON C. H. CRENNAN

T h e American A cademy o f P olitical and S ocial Science 1 39th Street and W oodland Avenue P hiladelphia 1922

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Copyright, 1922, by T h e Am erican A cademy of P olitical an d Social S cience All rights reserved

EUROPEAN AGENTS ENGLAND: P. S. King & Son, Ltd., 2 Great Smith Street, Westminster, London, S. W. FRANCE: L. Larose, Rue Soufflot, 22, Paris. GERMANY: Mayer & Muller, 2 Prinz Louis Ferdinandstrasse, Berlin, N. W. ITALY: Giornale Degli Economisti, via Monte Savello, Palazzo Orsini, Rome. SPAIN: E. Dossat, 9 Plaza de Santa Ana, Madrid

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CONTENTS PAGE CONTRIBUTORS TO THIS VOLUME...... v FOREWORD—THE INTEGRITY OP THE FEDERAL RESERVE SYSTEM...... ix A. D. Welton and C. H. Crennan, Editors-in-Charge PART 1—BEFORE THE RESERVE ACT OUTLINE OF BANKING HISTORY FROM THE FIRST BANK OF THE UNITED STATES THROUGH THE PANIC OF 1907...... 1 B. H. Beckhart, Columbia University THE STUDIES OF THE NATIONAL MONETARY COMMISSION...... 17 N. A. Weston, University of Illinois THE NATIONAL CITIZENS’ LEAGUE: A MOVEMENT FOR A SOUND BANKING SYSTEM...... 26 Harry A. Wheeler, Vice-President, Union Trust Company of Chicago THE EDUCATIONAL CAMPAIGN FOR BANKING REFORM...... 29 A. D. Welton, Continental and Commercial National Bank of Chicago THE FEDERAL RESERVE ACT IN CONGRESS...... 36 H. Parker Willis, Columbia University THE ALDRICH-VREELAND EMERGENCY CURRENCY...... 49 Homer Joseph Dodge, Editor, The Federal Trade Information Service PART II—THE PURPOSES OF THE FEDERAL RESERVE ACT THE RESERVE ACT IN ITS IMPLICIT MEANING...... 56 A. D. Welton, Continental and Commercial National Bank of Chicago THE PURPOSES OF THE FEDERAL RESERVE ACT AS SHOWN BY ITS EXPLICIT PROVISIONS...... 62 E. W. Kemmerer, Princeton University PART III—OPERATION OF THE SYSTEM POLITICAL PRESSURE AND THE FUTURE OF THE FEDERAL RESERVE SYSTEM 70 Paul M. Warburg, Member of the Federal Reserve Board, 1914-1918 EARLY FUNCTIONING OF THE FEDERAL RESERVE SYSTEM...... 74 Arthur Reynolds, President, Continental and Commercial National Bank of Chicago THE FEDERAL RESERVE SYSTEM, STATE BANKS AND PAR COLLECTIONS.. 79 Pierre Jay, Chairman and Federal Reserve Agent, Federal Reserve Bank of New York RELATIONS OF RESERVE BANKS TO MEMBER BANKS AND INTER-RELATIONS OF FEDERAL RESERVE BANKS...... 87 R. M. Gidney, Controller at Large, Federal Reserve Bank of New York THE EVOLUTION AND PRACTICAL OPERATION OF THE GOLD SETTLEMENT FUND...... 95 George J. Seay, Governor of the Federal Reserve Bank of Richmond ELIGIBILITY FOR DISCOUNT...... 105 Charles L. Powell, Counsel for Federal Reserve Bank of Chicago AMENDMENTS TO THE FEDERAL RESERVE ACT...... 114 Walter S. Logan, General Counsel, Federal Reserve Board PREPARATION FOR WAR AND THE LIBERTY LOANS...... 121 J. H. Case, Deputy Governor, Federal Reserve Bank of New York THE ASSUMPTION OF TREASURY FUNCTIONS BY THE FEDERAL RESERVE BANKS...... 129 Murray S. Wildman, Stanford University THE ESTABLISHMENT AND SCOPE OF BRANCHES OF FEDERAL RESERVE BANKS...... 135 E. R. Fancher, Governor, Federal Reserve Bank of Cleveland iii

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis iv Contents CURVES OF EXPANSION AND CONTRACTION 1919-1921...... 142 A. C. Miller, Federal Reserve Board, Washington, D. C. EXPANSION AND CONTRACTION UNDER THE FEDERAL RESERVE SYSTEM 151 Ernest Minor Patterson, University of Pennsylvania EXPANSION AND CONTRACTION AS SEEN BY A BUSINESS MAN...... 163 J. V. Farwell, President, John V. Farwell Company CURRENCY EXPANSION AND CONTRACTION...... 167 James B. Forgan, Chairman of the Board, the First National Bank of Chicago EXPANSION AND CONTRACTION FROM THE FEDERAL RESERVE STAND­ POINT...... *...... \ ...... 174 John H. Rich, Chairman and Federal Reserve Agent, Federal Reserve Bank of Minneapolis PRINCIPLES GOVERNING THE DISCOUNT RATE...... 183 W. P. G. Harding, Governor of the Federal Reserve Board REDISCOUNT RATES, BANK RATES AND BUSINESS ACTIVITY...... 190 George M. Reynolds, Chairman of the Board, Continental and Commercial National Bank of Chicago THEORETICAL CONSIDERATIONS BEARING ON THE CONTROL OF BANK CREDIT UNDER THE OPERATION OF THE FEDERAL RESERVE SYSTEM 195 Chester A. Phillips, University of Iowa AGRICULTURAL AND COMMERCIAL LOANS...... 199 J. B. McDougal, Governor, Federal Reserve Bank of Chicago POPULAR AND UNPOPULAR ACTIVITIES OF THE FEDERAL RESERVE BOARD AND THE FEDERAL RESERVE BANKS...... 203 William A. Scott, University of Wisconsin THE DEVELOPMENT OF AN OPEN MARKET FOR COMMERCIAL PAPER...... 209 E. E. Agger, Columbia University THE EFFICIENCY OF CREDIT...... 218 O. M. W. Sprague, Harvard University BOOK DEPARTMENT...... 222 INDEX...... 225

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CONTRIBUTORS TO THIS VOLUME A gger, E. E.—Associate Professor of tional Bank of the Republic, Chicago, Economics, Columbia University. and Harris Safety Deposit Co., Chicago; Contributing editor to the Standard Director, Liverpool & London & Globe Daily Trade Service. Insurance Co.; President, First State For some time Assistant to President Pawners Society of Chicago. of the National City Bank, N. Y. Was President of the National Citizens Editor, American Edition of Clay’s League for the Promotion of a Sound Economics for the General Reader and Banking System. author of articles on banking subjects. F org an, J. B.—Chairman of the Board, B eckhart, B. H.—Lecturer in Banking, First National Bank of Chicago. School of Business, Columbia University, Was with Royal Bank of Scotland for 1921; Instructor in Economics and Social three years; later with Bank of British Institutions, Princeton University, 1920- North America, with assignments to 1921; employed at Federal Reserve Bank Montreal, New York and Halifax; In­ of New York, 1919-1920. spector of Agencies, Bank of Nova Scotia; C a se , J. H.—Deputy Governor, Federal Cashier and Manager, ^ Northwestern Reserve Bank of New York, 1917 to National Bank, Minneapolis 1888; Vice- date. President, First National Bank, Chicago, Was Vice-President, Farmers Loan 1892, President, 1900, Chairman of and Trust Co., New York City, Board since 1916. Member Board of also Secretary-Treasurer-Vice-President, Directors, Federal Reserve Bank, Chi­ Plainfield Trust Co., Plainfield, N. J. cago, 1914-1919; President, Advisory C r e n n a n , C. H.—Economist, Continental Council, Federal Reserve Board, 1914- and Commercial National Bank, Chicago; 1920; Vice-Chairman, Currency Commis­ formerly member of faculty, University sion, American Bankers Association, of Pennsylvania, Director, Research Bu­ 1907 to date. reau, Pennsylvania State Chamber of G id n e y , R. M.—Controller at Large, Fed­ Commerce, and Assistant Editor of The eral Reserve Bank of New York. Annals of the American Academy of Po­ For eight years engaged in banking at litical and Social Science. Santa Barbara and Bakersfield, Cali­ Editor-in-charge of several volumes fornia. August 1914, appointed secre­ of The Annals. tary to A. C. Miller, member of the D odge, H om er J.—Editor, Federal Trade Federal Reserve Board; later, Federal Information Service; President, The Treas­ Reserve examiner; 1917, Assistant Federal ury Correspondents Association. During Reserve Agent at the Federal Reserve the War reported financial and eco­ Bank of New York. Manager of the nomic news for the international News Buffalo Branch of the Federal Reserve Service, covering Treasury, Federal Bank of New York, 1919-1921. Reserve Board and other business depart­ H a r d in g , W. P . G.—Governor, Federal ments. Reserve Board, Washington, since 1916. Author of numerous articles on eco­ Vice-President, Bemey National Bank, nomic topics. Compiled speakers’ hand­ Birmingham, 1896, President 1902. Mem­ book for Four Minute Men which con­ ber Federal Reserve Board, Washington tained information about war financing. 1914. President, Alabama State Bank­ F a nc h er, E. R.—Governor, Federal Re­ ers’ Association 1908 and Birmingham serve Bank of Cleveland, 1914 to Chamber of Commerce, 1913. date. J a y , P ie r r e —Federal Reserve Agent and Formerly President, Union National Chairman of Board, Federal Reserve Bank, Cleveland. Bank of New York since 1914. F a rw ell, J. V.—President, John V. Far- Vice-President, Manhattan Company, well Company, Chicago; Director, Na­ New York, 1909-1914; Bank Commis­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis vi C ontributors to T his V olume sioner of Massachusetts, 1906- 1909; Cornell, 1891-2; Professor of Finance, Vice-President, Old Colony Trust Com­ University of Chicago, 1892-1902; Pro­ pany, Boston, 1903- 1906. fessor History and Politics, University K em m erer , E. W.—Professor of Econom­ of California, 1890-1; Instructor Eco­ ics and Finance, Princeton University. nomics, Harvard, 1889-90. Professor of Economics and Finance, Author of papers on finance, banking, 1909-1912 Cornell University; Assistant etc. in economic and financial journals. Professor Political Economy, 1906-1909. P h il l ips, C. A.—Dean, College of Com­ Financial adviser to United States merce, University of Iowa. Member of Philippine Commission, 1903; Chief, the Dartmouth faculty, 1911-1920. Division of Currency, P. I., 1904-06; Member, The Inter-American High Special Commissioner Philippine Govern­ Commission. ment to Egypt, 1906; Financial adviser Editor, Readings in Money and Bank­ to Government of Mexico 1917 and ing and author of Bank Credit. to Government of Guatemala, 1919. P a tter so n , E. M.—Professor of Econom­ Managing editor of the Economic Bul­ ics, University of Pennsylvania, 1919 to letin, 1907-1910; Associate editor, Ameri­ date. Formerly Assistant Professor of can Economic Review 1911-1914. Economics, University of Pennsylvania, Author numerous reports on banking 1915-1919. and currency questions; Money and Joint author, Conway and Patterson, Credit Instruments in their Relation to The Operation of the New Bank Act. General Prices, 1907, revised 1909; Author, numerous articles on money and Seasonal Variations in the Relative De­ banking questions. Editor-in-charge of mands for Money and Capital in the ,several issues of The Annals. United States (in report of National P ow ell, C h a s. L.—Member of law firm of Monetary Commission) 1910; Modem Mayer, Meyer, Austrian & Platt, Chi­ Currency Reforms 1916; The United cago; counsel of the Federal Reserve Bank States Postal Savings System, 1917; of Chicago, 1914 to date. Practiced law Monetary System of Mexico, 1917; The for twenty years in Iowa. Student of A.B.C. of the Federal Reserve System, banking, especially the legal aspects of 1918. banking questions. L og an, W alter S.—General Counsel to R ey n o ld s, A rth ur—President, Conti­ the Federal Reserve Board. Practiced nental and Commercial National Bank' law in New York City in the office of of Chicago, President, Continental and Winter & Winter and also in the office Commercial Trust and Savings Bank and of Cadwalader, Wickersham & Taft. Be­ President, Continental and Commercial came Assistant Counsel to the Federal Securities Company. Reserve Board July 1, 1919, and Gen­ Cashier, Guthrie County National eral Counsel July 1, 1920. Bank, 1893; Cashier, Des Moines M cD o ug al, J. B.—Governor, Federal National Bank, 1895-97, President, Reserve Bank of Chicago since 1914. 1897- 1915; First Vice-President, Conti­ National Bank examiner, 1901- 1906; nental and Commercial National Bank became official examiner of associated 1915- 1921. Chairman, Federal Legisla­ banks of Chicago, 1906; organized and tive Committee, A.B.A. 1905; Member conducted department of examination Currency Commission A.B.A., Treas­ of the Chicago Clearing House and was urer, A.B.A. 1910; President, A.B.A. its official head until 1914. 1913. M il l e r , A. C.—Member Federal Reserve R ey n o ld s, G. M.—Chairman of the Board of Washington, D. C. since 1914. Board, Continental and Commercial Assistant to the Secretary of the interior, National Bank of Chicago, Chairman of Washington, 1913-1914. Flood Pro­ the Board, Continental and Commercial fessor Economics and Commerce, Uni­ Trust and Savings Bank, Chairman of versity of California, 1902-13; Associate the Board, Continental and Commercial Professor Political Economy and Finance, Securities Company. President, Con­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis C ontributors to T h is V olume vii tinental and Commercial National Bank, Imperial University of Tokyo, 1905-08; 1910-1921. President, American Bank­ Assistant Professor, 1904-5, Harvard. ers Association, 1908; Adviser, National Author History of Crises under the Monetary Commission, 1908; Director, Notional Banking System, 1910; Banking Federal Reserve Bank of Chicago, New Reform in the United States, 1911; Theory York Life Insurance Company, Com­ and History of Banking, 1917, and many mercial Insurance Company. economic articles. R ic h , J o h n H.—Chairman of Board and W a r b u r g , P a u l M.—Chairman of the Federal Reserve Agent, Federal Reserve Board, International Acceptance Bank, Bank of Minneapolis, 1914 to date. Inc. Member Federal Reserve Board For many years president of a country for term 1914-1918. bank and a manufacturer. President of Was Director National Bank of Com­ the Citizens League of Minnesota, and merce, United States Mortgage and active in the movement to secure the Trust Co., B. and O. R. R. Co., National adoption of the Federal Reserve Act. Railways of Mexico, Wells Fargo & Co., Author of numerous monographs on Westinghouse Electric and Manufactur­ Federal Reserve banking, the operations ing Company. Resigned all director­ of Federal Reserve Banks and agricul­ ships and trusteeships when appointed to tural credit. Federal Reserve Board. Author many S e a y , G eo r g e J.—Governor, Federal Re­ pamphlets on banking and currency, serve Bank of Richmond. For twenty particularly in relation to the Reserve years connected with a bank in Peters­ System both before and after its or­ burg, Va. Later, a partner in the ganization. banking firm of Scott & Stringfellow W e l t o n , A. D.—Director of Publicity, of* Richmond. In 1909 withdrew to Continental and Commercial Banks, carry on studies, following with close Chicago. General Secretary, National attention agitation for banking reform Citizens League; practiced law in De­ which resulted in the Reserve Act. troit; Editor, Detroit Free Press, 1905- Prepared case for selecting Richmond 1906, St. Louis Post-Dispatch, 1911 and as Reserve Bank. Upon organization, Journal of the American Bankers Associa­ elected Class B director. Elected Gov­ tion, 1914-1918. ernor at first meeting of Board. Served W e s t o n , N. A.—Professor of Economics, as member of Federal Advisory Council. University of Illinois; Formerly Dean of Writer on banking and railroad the College of Commerce and Business finance. Administration, University of Illinois. S cott, W m . A.—Director of the Course W h e e l e r , H. A.—Vice-President, Union in Commerce and Professor of Political Trust Company of Chicago since 1910; Economy, University of Wisconsin, Vice-President, 1899- 1901, President, Chairman of the Board of Directors of 1901-1910, Credit Clearing House, Chi­ the Commercial National Bank, Madison, cago; General Secretary, Chicago Asso­ Wisconsin. Professor of History and ciation of Commerce, 1906- 1907, Chair­ Political Science, University of South man, Ways and Means Committee 1908, Dakota, 1887-90; Instructor in Johns Vice-President, 1909, Chairman, Execu­ Hopkins University, 1890-92. tive Committee, 1910, President 1911. Author, Repudiation of State Debts, President, Chamber of Commerce,1 U.S.A. 1893; Money and Banking, 1903; revised 1912- 1913, 1918-1919. Director and edit. 1910; Money, 1913; Banking, 1913; member Executive Committee, National “Austrian School and Recent Develop­ Citizens League. ments,” ch. VII revised edit, of Ingram’s W il d m a n , M u r r a y —Professor of Eco­ History of Political Economy, 1915. nomics, Leland Stanford, Jr., University, S p r a g u e , O. M. W.—Professor Banking 1912 to date. and Finance, Harvard, 1913 to date. Founder, Cashier and Vice-President, Assistant Professor, Banking and Fi­ Henry County Bank, Spiceland, Cal. nance, 1908- 1913; Professor Economics, Assistant Professor Economics, Univer-

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis viii C ontributors to T h is V olume sit/ pi Missouri; Professor Economics Secretary, Federal Reserve Board, and Commerce, Northwestern Univer­ 1914-1918; Assistant to Monetary Com­ sity; Organization Secretary, National mission, 1897-8; Expert, Ways and Citizens League, 1911- 1912; Bureau Means Committee, House of Represen­ of Research, War Trade Board, and tatives, Washington 1911-13; Banking division planning and statistics War and Currency Committee, 1912- 13; Industries Board, 1918-1919. President, Philippine National Bank Author Money Inflation in the United 1916-7; Special Commissioner in Aus­ States, 1905 and economic articles. tralasia for Chase National Bank & W il l is , H. P a r k e r —Professor of Eco­ Central Trust Company, 1919. nomics, Columbia University, Editor, Author, History of the Latin Monetary New York Journal of Commerce and Union; Principles and Problems of Modern Director, Division of Analysis and Re­ Banking; The Federal Reserve; American search, Federal Reserve Board. Banking and many articles on banking.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis The Integrity of the Federal Reserve System By A. D. W elton a nd C. H. Cr en n a n Editors-in-Charge HE Federal Reserve System has Banks give them all the business they to do only with commercial bank­ have, except the government, which ing.1 Commercial banking has only tois their only other customer. The doT with getting goods from producer country has then a banking system to consumer. It operates on the composed of banks of various kinds, assumption, ordinarily valid, that the some chartered by the nation and sale of goods to the consumer produces some by the states, brought into a funds to discharge whatever obligation cooperating organization with the Fed­ has been created. eral Reserve Banks as the operating Investment banking, on the other mechanism. hand, operates on the assumption that Over this operating mechanism of the capital loaned will be repaid out of the cooperating organization of banks, the earnings its use permits in a speci­ the government exercises a general fied number of years. supervision. There are many people The essence of commercial banking who thought the supervising authority is liquidity of the credit on which it should be different, but it isn’t and it functions. Its credit instruments must doesn’t matter so long as it is com­ be of short maturity. The banks petent and impartial. which invest in them undertake to pay The purpose of the Federal Reserve on demand and they must have a System was to provide for business constant inflow of funds or a means of just what has been provided. There quickly realizing on their credit in­ was no purpose and no intention to struments. It is necessary, therefore, establish government banks, and none that the goods against which such credit was established. There was no pur­ is granted should be always in process pose to help or favor operating banks of sale. because they needed neither help nor Primarily and fundamentally the favors. There was a purpose and Reserve System was designed to pro­ intention to put the operating, com­ vide for the credit instruments of mercial banks in a better position to commerce an instant sale. It was discharge their duties to business so an attempt to organize not a new lot of that business might go on under any banks, but a new banking machine and all circumstances, if this could supported by the resources of all its be achieved through an economic member banks.2 use of credit and competent credit The Reserve System is then an machinery. organization of banks. The Reserve In relation to business, therefore, Banks draw their capital from banks. the Federal Reserve System is more than a banking system. It is a code 1 Permission to national banks to receive for business behavior. It is more than savings deposits and to exercise trust company powers does not affect the commercial nature of a machine for expanding and con­ the Reserve System. tracting credit and currency. It is a 2 Cf. Article by Professor Kemmerer in this means for the orderly and systematic volume. functioning of business credit and,

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis X T h e A n na ls of the A m erican A cademy through reapportionment of this credit, mits the application of principles of for the stabilization of business. demonstrated soundness. Its funda­ No comprehensive grasp of the ments are vital, not only because they System can be had if, among its attest that old fallacies have been dis­ attributes, is included that of a missed, but also because they have remedy for all business and financial been proved under the test of prac­ ills. It is not. It can never save the tice. day for the insolvent. It is man-made Probably, in any organization ap­ and man-operated. It has and must plying rules of conduct, there is a have limitations. It must not be degree of fluidity. Some measure of concluded because it financed the War, change is always possible even when that it can go on indefinitely producing not always desirable. But change for rabbits of credit and currency out of an the sake of change is not progress or empty hat. It didn’t do that even in improvement. On the other hand, war. It did give life and credit form to there is advantage in holding to fixed latent and dormant resources. It did practice. It is not difficult to test make the unliquid at least temporarily the quality of any amendment proposed liquid. But war demands such per­ to the Federal Reserve Act. It is formances. necessary only to get the fundamental It might have been better if the purposes in mind. Anything out of Reserve System had been called on to accord with them may instantly be do less, and more had been done dismissed. through other means, the Treasury, But a great banking system cannot for instance. It would have been as grow and develop out of itself. Deal­ well for the country and better for the ing with such an intangible as credit System. Had this course been followed and so nebulous a quality as confidence, the Reserve Banks would have avoided the attitude of the public must be much harsh criticism for displaying reckoned with. So susceptible are their limitations, once war pressure banks generally to public opinion that was removed. Many suggestions for the banker subconsciously, almost, con­ changing the System would never have siders that as a factor to be used in all been made. It would not have been his calculations. In any event the expected to bring to realization so public is a factor in the future develop­ many fatuous dreams. ment of the Reserve System, as Paul M. As an operating banking mechanism Warburg points out elsewhere in this the System need not, however, be volume. If the public is dismissed be­ taken for what it is. Changes in the cause even a meager popular under­ machinery may be made if the funda­ standing of the intricacies of banking is mental structure is not impaired. Any beyond hope, the business man, from banking system is a thing of growth. whom more may be expected, stands If, in its final form, it shows that forth as a grim spectre. wisdom has been gained from experi­ The public, most assuredly, feels and ence and skill from practice, it begins does not analyze. The business man to approximate general needs. The may be controlled by emotion rather Reserve System is an evolution out of than reason. The more certain the more than a century of hard and bitter, operations of the Reserve Banks, experience made harder and more bitter therefore, the better they will come to by experiments. Its mechanism is, be understood. Eventually, although therefore, of moment only as it per­ it may be only a hope, the public will

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Integrity of the F ederal R eserve System xi come to understand up to the point of will indicate the influence that old having confidence. experiments and controversies exerted Thus the public is an important on the makers of the Reserve Act and factor in the development of the the form and content of the law. In Federal Reserve System. There must the struggle over note issues and be a growth without the banks as well redemption of bank notes will be as within them. The public mind found the causes for the demand that must become attuned to them. Federal Reserve notes be made “ obli­ For the people the Reserve System is gations of the United States.” The a precious thing. If it is to fulfill its workings of the national bank system work and its mission, they must view will explain the development of re­ it with confidence. Its integrity is to serve banking and the need for be guarded with as much jealousy as elasticity of both credit and currency, the .Constitution itself. The jealousy and so on. must be inculcated into the popular In his article on “The Studies of the mind. The attainment of such a state National Monetary Commission,” Pro­ is taken to be desirable. If it is, the fessor Weston illuminates the defects prospect of its realization will be in of the old banking system and shows constant jeopardy unless members of how they were studied in relation to Congress can be induced to abandon other systems and the probable needs the idea that the Reserve Act is of modem business for adequate bank­ subject to tinkering at the behest of any ing service. amateur banker. These needs found expression in the organization of the National Citizens’ K now ledge of B ank ing H istory League for the Promotion of a Sound H elps to P ublic U nderstanding Banking System. The story of the Under the interpretation of the Fed­ organization of that movement is eral Reserve System given above, its told by Mr. Harry A. Wheeler, who growth, improvement and develop­ participated in it and who was also one ment to the maximum of satisfaction of the organizers and the first President and efficiency can be attained only if of the Chamber of Commerce of the its fundamental purposes are under­ United States. stood. The forces without the System Through the workings of the Na­ must contribute a share in this growth tional Citizens’ League, later supple­ and development. These outside forces mented by work of the Chamber of are the business men and the public Commerce, the business men and the generally. business organizations of the country There can be no adequate under­ were bound together. A community of standing or appreciation of the System thought on banking methods and unless there is a general familiarity services was thus brought about and with what preceded it. To this end translated into definite purpose. the first section of this volume is To get this result—a first step given over to an historical review. The toward legislation—demanded an elab­ first article sketches the history of orate educational campaign. Success banking from 1791, when the First in this venture was made more difficult Bank of the United States was organ­ because of the many schemes for ized, down through the panic of 1907.3 monetary and banking reform con­ Even cursory reading of these events ceived and promoted by modern John 3 By B. H. Beckhart. Laws. These enthusiasts, often seeing

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e A nna ls of the A m erican A cademy in banking the means of attaining under pressure because of their rela­ universal happiness, found no other tion to control in execution. Thus weapon than legislative compulsion or elasticity of note issue was confused government operation of banks. Dis­ with distribution of credit and would missing the exploded theories, it need have been sacrificed or impaired if only be said that the guaranty of help for the farmer could have been bank deposits was the measure of secured thereby. One illustration of reform being pressed with vigor at that the confusion of economics and politics time. It had many advocates in will suffice. Congress. However, the educational In an economic sense, rediscount­ campaign was persistently prosecuted ing for profit was at that time unthink­ and was successful to the extent nec­ able. The maturity of paper offered essary in bringing attention to sound for rediscount at the proposed banks economics in banking reform as against was of incidental importance. Com­ the pursuit of emotional rainbows. mercial banks could not consider paper In his article on “The Federal Re­ of anything but short maturity and it serve Act in Congress,” Dr. H. Parker was equally clear that paper for re­ Willis gives an intimate recital of facts, discount would not be offered to the many of which have not previously Reserve Bank by the discounting bank been published. As expert for the on the day of discount. But dozens of House Committee on Banking and congressmen could not or would not Currency, Dr. Willis was familiar understand that the farmer could have with every step in the development of no direct dealing with the Reserve the bill before it was in the Committee Bank. Hours of discussion in the for discussion and subsequently. The Senate were given over to the maturity political factor is here disclosed as it of agricultural paper. Senators who came forward to influence what was saw in the Reserve Act only a new way an economic product. The degree of of settling the farmer’s eternal credit interest of the Administration in the problem, would have willingly de­ measure, the pressure placed on Con­ stroyed the commercial character of gress and the suggestions from the the Reserve Banks on the chance of Treasury and other departments are settling that question. The time made clear. agricultural paper for rediscount may In this phase of the development, run was increased to ninety days. distinction must be made between the This maturity would have been of no administrative and the economic pro­ importance if the rediscount rates had visions. Control of the System was ever been scientifically adjusted and always a subject of contention. The is of little importance anyway. In decentralizing of credit and curbing August, 1921, the average maturity of of the supposed power of Wall Street rediscounted paper was 15.76 days. and the “Money Trust” were always In September it was 1 7 .2 2 days. In matters of political concern. The the Minneapolis Bank it was 42.06 days tendency toward government control and in Boston 7 .7 4 days. If maturities of the operating banks themselves had had not been mentioned in the Act, to be guarded against. Over the the result would probably have been economic provisions, there was less the same. trouble. There was no disagreement The House bill as recommended by of moment in this respect, but pro­ Chairman Glass’ Committee was the visions strictly economic were often real bill, as Dr. Willis points out.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Integrity of the F ederal R eserve System xiii Senator Owen had a different bill Aside from the useful service of which he was induced, eventually, to providing currency and thereby sus­ abandon. There was also a bill taining confidence, the operation of fathered by the Treasury providing this law was effective to prove its in­ for a central government bank with capacity to meet anything more than a the Treasury's gold as the capital. passing strain. There were many men The fact that the gold belonged to —bankers included—who thought that the holders of the certificates issued the demand for banking reform would against it, was thought to be insig­ be completely met by this law or any nificant. The advocates of this plan law which would permit the turning of floundered about in it for some time bank assets into currency. It was a bit until the President himself summarily of good fortune that there was a dem­ suppressed it. onstration to show that banking effi­ Dr. Willis shows clearly that the ciency was a reserve and not a currency Glass bill was the Administration’s problem. It eliminated forever from bill. After all other proposals had been consideration a half-hearted remedy. discussed, and mechanical changes were made—notably that providing E arly P roblems a nd O perations of for retirement of the bond-secured the F ederal R eserv e B oard currency—the Act as passed was sub­ and B a nk s stantially the bill as it came from the The Federal Reserve Board and House Committee. the Banks were organized without The true purposes of the Federal much difficulty. The Organization Reserve Act will be found in the dis­ Committee toured the country to cussions and reports of the Banking gather information and hear the argu­ and Currency Committee of the House, ments of the various civic and banking of which Carter Glass was chairman. committees selected to advance the The beginning of the European War claims of the many cities which thought brought an almost instant business themselves entitled to selection as the dislocation. Fear of panic was allayed homes of the Reserve Banks. There by the summary closing of the stock were many contenders for these honors exchanges. A currency famine was and there was some bitterness. Fixing supposed to be imminent. The mem­ the boundary lines of the districts also bers of the Federal Reserve Board had caused contention. Political “pull” been appointed about this time— was exerted to influence the committee August 9, 1914—but the time for from without and political prejudice opening the new Reserve Banks could was working within. But these mat­ not even be predicted. ters were of minor importance com­ In September the dormant National pared to the Organization Committee’s Currency Associations were awakened. interpretation of the provision as to the These had been formed in many dis­ number of Banks. They decided that tricts under the provisions of the twelve should be immediately estab­ Aldrich-Vreeland Act, passed after the lished, and not eight, to be increased panic of 1907. Emergency currency to twelve later if experience showed was issued to these Associations and twelve to be necessary. met whatever stress there was, as Undoubtedly the Committee felt the told in Mr. Dodge’s article.4 pressure keenly. Southern cities were 4 “The Aldrich-Vreeland Emergency Cur­ very ambitious and very influential. rency/* But, so far as politics was concerned,

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis xiv T h e A n na ls of the A m erican A cademy its full force was not manifested until the Board had no power to review the matter of organizing the Reserve the determination of the Organization districts came before the Reserve Committee in a manner that might Board for review in 1915. affect the existence of any of the twelve The Federal Reserve Act (Section 2) Reserve Banks already established. says, “The determination of said or­ The point to be made is that the ganization committee shall not be sub­ integrity of the Reserve System is of ject to review except by the Federal indifferent consequence in the face of Reserve Board when organized” and political exigency. Perhaps just such “the districts thus created may be ad­ a thing will not happen again but this justed and new districts may from is the second instance in which appeal time to time be created by the Federal was made to the Attorney-General to Reserve Board, not to exceed twelve in give legal support to a plan politically all.” desired. The Board seemed to think that pro­ The fear of future political assaults vision mandatory. It was, therefore, on the integrity of the Reserve System in the performance of what they con­ is so well founded in experience that sidered a duty that they turned to a Mr. Warburg is wholly justified in his study of district boundaries and the conclusion that the people must de­ location of Reserve Banks. In several velop a jealous regard for their banking instances changes in boundaries were machinery if they wish it to endure. made, but when a discussion of the Mr. Warburg, in his article, is appar­ possible strengthening of the System ently less concerned with the past than by combining some of the districts with the future. Recent experiences (without closing any offices already es­ indicate the correctness of his views tablished) was begun, political power and the basis for his fear of political began immediately to work. encroachment. He worked so faith­ The then Governor of the Board and fully and effectively to gain and hold the two ex-officio members combined for the Reserve Banks what they have to prevent any change of the kind un­ that anything he says has particular der discussion. The ex-officio members and peculiar significance. —the Secretary of the Treasury and Once the Reserve Board was in ac­ Comptroller of the Currency whose tion, there was the usual clamor for action as members of the Organization jobs from eager politicians but it was Committee was to be reviewed—and mostly clamor. The positions to be the Governor were a minority of the filled were hedged about by qualifica­ Reserve Board. But, over the signa­ tions that could not be met by those ture of the Governor and without the without banking experience. The po­ authority or knowledge of the majority sition of Reserve agent attracted the of the Board, they asked the President avid attention of the politically faithful. to transmit to the Attorney-General a The duties of this position were not request for an opinion defining the clearly defined. At first sight it seemed Reserve Board’s powers of review. to offer attractions of ease and afford a The opinion was turned out over quiet resting place for an agreeable ex­ Saturday and Sunday, which may be something classed in political slang as considered unusual dispatch. When a “lame-duck.” There were, of course, the Board met again it was faced with hundreds of applications for these places the Administrations’ interpretation of and every applicant was supported by the law and the interpretation was that heavy political indorsements.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Integrity of the F ederal R eserve System xv However, the Reserve Board itself In nearly every district leading banks was wisely chosen. Efforts to diversify rediscounted paper for the sake of its membership both in equipment and example.5 The Reserve Board had to representative character were success­ study the law, which settled all ful. The Board, charged with the difficult problems by saying “under duty of organizing a new banking such regulations as the Board may system at the time the world was be­ prescribe.” It must also be re­ ginning the greatest of wars, did not membered that Aldrich-Vreeland emer­ view the task lightly or politically. gency currency was in circulation and Bankers were drafted into the service was to be retired or supplanted by of the Reserve Banks and accepted, Federal Reserve notes. often at large sacrifice. Bankers and Rules were to be made, precedents business men chosen to the directo­ set and the gathering of traditions rates of the Reserve Banks were as begun. Eligible paper had to be much in earnest as the Reserve Board. defined; at least, a beginning had to be The political pressure was strong made.6 Not only banking customs enough to bring a lapse here and there, but business habits would have to be but the general character and business remolded and remodelled, if the Re­ complexion of the official staffs stood serve Banks were to have anything on up under close inspection. This early which to function. Acceptances were proceeding is to be judged only in the authorized by the Act. They were light of results obtained and not by the new to the banking world. The efforts that were made to impose upon lessons of war were beginning to say Board or Banks the wishes of those who that gold would have to be gathered were politically moved. It is a fair and impounded.7 The state chartered inference that, so far as jobs were banks were hostile or, at best, only concerned, political officialdom passed neutral. It grew rapidly plainer that recommendations along in the serene they would have to be wooed and won. confidence that the banking minds The law made it mandatory that the would accept the responsibility of the clearing and collection of checks and refusal to concur. drafts be undertaken. A first step in In any event the Banks came into this direction threw the country banks existence as banks and were opened on that were members of the System into November 16, 1914. Having buildings, spasms of anger and fear. It made equipment, officers and staffs, they the state banks glad that they were were naturally curious as to what they beyond such meddling. might do. Could they advertise and The GoldSettlement Fund came as an go out after business? No provision ingenious means to economy and con­ had been made for such a course. They venience for member banks. It was a would get business when their member first notable step in what the Reserve banks were hard pressed for funds. Banks could do—something that would Humiliation attached to rediscounting. be helpful, speedy and cheap. The plan It was regarded as a sign of weakness. was worked out by the Reserve Board Moreover, while the Reserve Banks were open for business, reserve funds 8 “Early Functioning of the Federal Reserve System.” were to be turned over to them in 8 “Eligibility for Discount” by Charles L. installments. The banking system Powell. was otherwise running along as before. 7 See “Preparation for War and the Liberty There was, however, much to do. Loans” by J. H. Case.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis xvi T h e A n na ls of the A m erican A cademy in conjunction with experts called The development of the relations of from member banks. It was simple Reserve Banks to their members and and easy and established itself so with one another immediately became quickly in favor that it was almost as a serious problem once the Reserve quickly forgotten as a service. It has Banks were in operation. How this always worked perfectly and stands was done and what was and is being nowas a real achievement.8 It isaserv- done, is told by Mr. Gidney. The ice no less to business than to banks. Reserve Banks can never supplant The story of the winning of the “correspondent” banks. There are state banks and of par collections is too many services the latter render, told in the paper by Mr. Pierre Jay, too many personal and long-standing Chairman of the Board of the Federal connections, but the Reserve Banks Reserve Bank of New York. Mr. Jay have made great progress and have was called to that position from the brought their depositors to a realiza­ presidency of a state bank. It is tion that they are customers and will needless to say that his sympathetic be treated as such. The development understanding of state bank problems, of close relationships among the Re­ his patience and persistence found serve Banks and their officials has opportunity for display in dealing also been as important as it is in­ with those institutions. But the teresting. Unity demanded it, but national banks within the System systematic effort was essential to its were more rebellious than the state achievement. banks without it. They would not be There will always be non-member mollified and they were impervious to banks because banking is often special­ argument. They nearly disrupted the ized and men have notions of inde­ American Bankers Association. They pendence. The mutual savings banks forced Congress to consider amend­ of the East are not eligible to member­ ment of the Act and missed winning ship. They have no capital stock. completely by a narrow margin. They The laws have been changed in one or went to law about it. It is possible two states to permit them to invest a still to make exchange charges and part of their funds in “commercial they are made, but the “par collec­ paper” and acceptances, but their tion” competition is too strong. In investments are not supposed to be the face of all the obstacles the Reserve liquid, and they are far removed from Banks are now the great instruments commercial banking. for check collections and they will Probably there will always be pri­ have competition in this field only vate bankers with freedom to operate from banks of great reach, capable of within that borderland where invest­ maintaining the necessary connections ment and commercial banking meet and facilities. and divide, or on both sides of it. But However, the War, not the wooing, the Reserve System, as now formed of brought the state banks into the Reserve Banks, national banks, state System—not all of them, of course, banks and foreign trade banks, is but a number in point of resources sufficiently inclusive and strong to quite great enough to give the Reserve permit the statement that it is as System the necessary universality—if nearly universal as necessary. There there is any such thing as a degree. is nothing on the horizon, or nearer, 8“ The Evolution of the Gold Settlement to indicate that it will diminish in­ Fund” by George J. Seay. stead of grow.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis I ntegrity of the F ederal R eserve System xvii Amendments to the Reserve Act banks have proved the necessity for have been fairly numerous, but gen­ their existence. Governor Fancher, erally they have been made to meet of the Cleveland Reserve Bank tells conditions that could not be foreseen the story.9 There are, however, varia­ or to make operating conditions easier tions in the operation of branches. In or simpler. It is good fortune as well the far West the geographical extent as good judgment that there has yet of the San Francisco district demanded been no success in perverting the a larger independence in management provisions of the Act. Congress has for the branches than in the East, but so far yielded to the guidance of the telegraphic communication is always Reserve Board and, when there was close. threat of unsound doctrine, Carter The assumption of the functions of Glass, as representative and senator, the Independent Treasury—see Pro­ has been found on guard. The first fessor Wildman’s article—came be­ thrust at the integrity of the System latedly. It was probably as well that by the War Finance Corporation has it was deferred by politics and war. been parried. Even the admission When it did come, the banks were that that Corporation is now doing experienced and ready. So far as the commendable work and meeting an public was aware the subtreasuries urgent need, does not justify dismissal slipped their moorings and drifted into of the hope that its life and the the sea of oblivion with no one’s emergency which revived it, will both knowing or caring. end as scheduled on July 1, 1922. Amendments to the Act are dis­ E x pa n sio n , C ontraction a nd the cussed in Mr. Walter S. Logan’s D iscount R ate—V ital paper where their bearing and trend P roblems may be learned. In this connection It was thought advisable by the it is not amiss to say that bankers have editors of this volume to have as wide contributed loyally to the effectiveness a discussion as possible of “Expansion of the Reserve Banks’ operations. If and Contraction.” Involved with they fought lustily, through one or this question is the influence of the two groups, against par collections, rediscount rate on business activity they cooperated zealously by sur­ and, therefore, the relation of the rendering their gold to the Reserve rediscount rate to business and to the Banks. Without the War the im­ expansion and contraction of money pounding of gold would have been and credit. exceedingly difficult; as it was, it The Reserve Board is charged with required effort. But good teaching many duties. The Reserve Banks and good leadership carried through, function in many ways. But no in the closing months of 1917, a plan question goes more to the vitals of the whose success stood as a milestone in entire scheme than the adjustment of the progress of the Reserve System. the discount rate of the Reserve Banks. Branches of the Federal Reserve Whatever else they may do and how­ Banks were established and opened in ever successful they may be in the dis­ the interest of service to business. charge of collateral and subsidiary The jealousies engendered by the duties, around the discount rate and its selection of Reserve Bank cities and making cluster the factors that bear the making of reserve districts were 9 “ The Establishment and Scope of Branches wiped out in this way, but the branch of Federal Reserve Banks.”

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis xviii T h e A nnals of the A m erican A cademy directly on the success or failure of the charges, proposals and remedies were Reserve Banks as aids to commercial made. In the end the rate was business or to the member banks which popularly charged with undoing busi­ act in response to business and react to ness—for lack of a better reason. its advantage. All this was a new experience with The relation of the Reserve Banks’ the discount rate. It was a valuable discount rate to and influence on experience because it was a first lesson business has by no means been deter­ in the time relationship between busi­ mined. The factors to be considered ness activity and the Reserve Bank’s in determining the rate are pretty well discount rate which, to whatever extent settled, but their relation to one it affects business activity, can do it another and the relative importance of only through the influence it exerts on each is still an open question. In the rates charged by member banks. seven years of operation the deter­ In the articles on these questions, a mining of the discount rate has been wide range of experience, supplemented influenced by extraneous or distract­ by opinion and study, was sought. ing conditions. At first when the Bankers, Reserve Bank officials, mer­ Banks were new, it was of no im­ chants, economists were all invited to portance. When war pressed, other express themselves. Governor Hard­ factors received scant attention. After ing, of the Reserve Board, has stated the Armistice the belief that the the problem as it is before the Board. unexampled prosperity would endure, Mr. John H. Rich, Chairman of the supported the Treasury’s needs for Board of the Minneapolis Reserve more financing. When, finally, some­ Bank, has furthered the discussion with thing had to be done to avert a views and experiences in that extensive crash, it was found that no genuine and interesting Reserve district. Dr. experience in adjusting the discount A. C. Miller of the Reserve Board, has rate to influence business had been brought to bear on it a mind singularly had. The first increase of the rate free from prejudice and admirably to “slow up” business came as an equipped to ferret out and interpret arbitrary decree based on a conception facts. Mr. John V. Farwell, from the drawn from British experience. That merchant’s interested and detached was in January, 1920. Business did position, gives helpful suggestions and not slow up. It went on, undoubtedly clear exposition. Mr. J. B. Forgan, despite the higher rate, despite the dean of bankers, and tried in experience warning, but, because of what? Pos­ by long service on the Federal Advisory sibly because of its own momentum. Council, and Mr. George M. Reynolds, Expansion increased. It was many from a terraced height of banking gloomy months after the rate was first leadership fairly won, make contribu­ increased before the peak of either tions which are supplemented by those credit or currency expansion was of Professor E. M. Patterson of the reached. In the meantime business University of Pennsylvania and Dean generally declined to believe that the Chester A. Phillips, of the University end of war prosperity had come or that of Iowa, theorists in the field of eco­ the revival and continuation of it was nomics but with practical bents and not around the corner. The Reserve adept in the use of scientific method. Board and the rates of the Reserve Needless to say, these men are not Banks were mentioned only to be entirely in agreement. But close read­ damned. All kinds of allegations, ing of their contributions will disclose

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis I ntegrity of the F ederal R eserve System xix that they are far from hopelessly apart. The condition outlined shows the Any divergence of statement is not strength of the position of those who over what the discount policy has say the rediscount rate should always been, but rather in emphasis as to be higher than, say, the rate for stand­ what it should be in the future. ard commercial paper charged by The problem of the time relation­ member banks. However, there are ship between the rediscount rate and strong arguments why the rediscount business activity seems vital in the dis­ rate should sometimes be lower. At cussion. Of the efficacy of the redis­ present the lower rate is giving many count rate to influence business there hard pressed banks in the farming is little room for question. Recent sections a needed breathing spell. experience, however, indicates a con­ A lower rate’s influence in stimulating siderable lapse between the time of business may also be problematical fixing the rate and the time when busi­ unless the member banks adjust their ness feels and responds to it. On rates to it as quickly as possible and January 21, 1920, the first increase in with considerable speed in any event. discount rate to six per cent was made. It is not that these statements create This rate was maintained until the a dilemma but they seem to justify no following June when the rate for other conclusion than that further Chicago and New York was increased experience in influencing the rates of to seven per cent. This rate was main­ member banks, if not further experi­ tained for a year. In June, 1921, the ment, is necessary before it may be lowering began. said that wisdom is justified of her The point made by Mr. Reynolds is children. that business is not immediately affec­ ted by the rates charged by commercial Importance of the “ Ope n banks. The rediscount rate can affect M a r k e t ” business activity only through its effect If operation of the Federal Reserve on the rates of commercial banks. But Banks, under stable conditions of busi­ banking, as a result rather than a cause ness, is to be seasonal and cyclical, as of business activity, can react only many of the contributors to this volume after business has made commitments seem to believe, the further develop­ which it is bound to carry through ment of open-market operations. will if it can. If, under the present rela­ be in order. It so happens that the tionship between the rediscount rate Reserve Banks, early in their careers, and business activity, the rate is to be found war a wonderful accelerator. adjusted effectively, adjustment must War made them busy and prosperous. be made in anticipation of a business Henceforth they will operate under activity which may need restraint or of changed conditions. Not that there an inactivity which may need stimula­ will not be continuous business for the tion. Such an adjustment might be Reserve Banks, but they will not be precarious and it would likely be un­ carrying peak loads twelve months in certain. It is venturesome to say that the year. Their operations in the the rates charged for loans by member open market will be more important banks would be a better guide in seek­ under the new conditions than in the ing a basis for the rediscount rate, for past. In this field they may find it those rates have variations, as do the possible to exert an influence which rates charged for standard “commercial will make for the stabilization of paper.” money rates.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis XX T h e A n nals o r the A m erican A cademy Mr. Agger tells of the development among bankers, that the Federal and position of the open market. Reserve Banks are government banks. From what has been achieved we may They are bankers’ banks. This fact get an idea that here is a field for is written into the Federal Reserve cultivation, with success reacting to Act.10 demonstrate another and large service It is implied in the provisions of that the Reserve Banks may render busi­ instrument.11 It is not only recognized ness. The law made provision for by economists,12 but also indorsed by such conduct by the Reserve Banks and operating officers of Reserve Banks.13 its importance must be kept in mind. No Federal Reserve Bank stock is held by the Federal government. The M isconceptions of the System government possesses its regulatory Under the stress of financial diffi­ power because the System is freighted culties incident to war and its after- with a public interest. The govern­ math the Reserve Banks came in for ment has an interest in Reserve Bank a full measure of criticism. It was to profits only through a franchise tax. be expected, and it is not surprising, The Federal Reserve Banks are sub­ that a portion of the criticism was ject to taxation like other private hostile as well as adverse. Professor corporations. To be sure, a minority Patterson, in his discussion of contrac­ of the directors of Reserve Banks are tion and expansion, gives a very clear appointed by the Federal Reserve Board elucidation of Reserve Bank operations and members of that Board are gov­ in their relation to government financ­ ernment appointees exercising super­ ing, foreign business and conditions visory powers in the public interest. and commercial banking. In these Moreover, Federal Reserve Banks do operations will be found such basis as act as fiscal agents, and in other ways, exists for real criticism. The article for the government’s convenience. might well be read with that also in Nevertheless, Federal Reserve Banks mind. are not government banks. They are In his review of the “Popular and bankers’ banks designed to aid busi­ Unpopular Activities of the Federal ness by facilitating commercial trans­ Reserve Board and the Federal Reserve actions. The fact that the Reserve Banks/5 Dr. Scott goes more partic­ Banks are not government banks de­ ularly into these criticisms, the rea­ stroys the groundwork for assumptions: sons for them and the shallowness of (1) That the System can produce most of them, while Governor McDou- general “prosperity,” and (2) that gal of the Reserve Bank of Chicago, it should be dominated by govern­ gives a striking illustration of the lean ment. foundation on which rest the allega­ Under the stimulation of war the fa­ tions of discrimination against the cilities of the Reserve Act for expansion agricultural districts. became an engine of inflation. They It is not enough to state what the cannot be made an engine of “pros- Federal Reserve System is designed to 10 See the Act and Professor Kemmerer’s paper do, if the fundaments of that System in this volume. are to be understood. Current mis­ 11 Cf. “The Reserve Act in its Implicit Mean- mg.♦ _ » conceptions must be cleared away. 12 See Professor Phillips’ article, for example. The prevalence of erroneous ideas 13 Cf. “Relations of Reserve Banks to Member compels such procedure. Banks and Inter-Relations of Federal Reserve A wide-spread notion prevails, even Banks.”

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis I ntegrity of the F ederal R eserve S ystem xxi perity.” Neither deft nor awkward ment bonds.14 This control was no political manipulation can turn the doubt bred of war’s necessities. The Reserve System from its strictly eco­ War is over. But no end has come to nomic purpose. It was not designed political pressure on the Reserve to salvage insolvents. It cannot create System. That pressure seems now to credit out of nothing. While com­ come through Congress, or a section mercial banks can control the flow of thereof, rather than through the Ad­ commercial credit and thus affect the ministration. It is suggestive, if not currents of the productive processes, legally accurate, to say that the business creates that credit which Federal Reserve Board can exercise banks, even the Reserve Banks, ap­ those powers expressly granted or portion. Business impels; banking con­ necessarily and fairly resulting there­ trols the drives,—after a time. If from, while the Reserve Banks hold there must be a causal relationship residual powers. “Less government between business and banking, busi­ in business” can find a starting point ness causes banking. There is actually in the Reserve System. Government a functional relationship. Business supervision is very different from po­ gives rise to banking and banking litical manipulation. These bankers’ reacts on business. Neither commer­ banks should be unhampered by cial banks nor Reserve Banks can politics. create credit and thus create “pros­ A current misconception that is perity.” giving way is the notion of dead-level One of the facts that doubtless has uniformity of policy and practice obscured thinking about the funda­ among the Reserve Banks. The Fed­ mental play of commercial banking is eral Reserve System meets the neces­ this one, that the Reserve Banks have sities of American geography and his­ handled government issues, redis­ tory in providing regional banks with counted paper secured by government a centralized supervision. This fact is obligations and otherwise performed attested by many of the contributors war functions for the Federal govern­ to this volume.15 Presumably each ment. They have been functioning, in Reserve Bank will adapt its policy and no small measure, on other than com­ practice to the hard and particular facts mercial credits. This was not their of the business situation in its district.16 original purpose. Government promises Where differences in procedure are to pay should not be the chief grist necessary, they must and will be allowed taken to the Reserve Bank mill. But by the Federal Reserve Board, just as as a result of war operations, the differentials in discount rates are assumption that Reserve Banks can “permitted” between districts that are “manufacture” credit out of nothing dissimilar. The Reserve Board will seems to find justification with those play its part of leadership by function­ who have not seen the underlying ing on common matters of policy and sources of the promises to pay on which practice without constraining the direc­ the Reserve Banks have been function­ tors of the various banks in matters of ing. Business, not banking, creates 14 See Governor Harding’s statement in the what is called “prosperity.” article, “Rediscount Rates, Bank Rates and Business Activity.” An instance of government domina­ 15 See, for instance, the articles by B. H. Beck- tion of the Federal Reserve System hart and John H. Rich. can be found in the control of the 16 See the paper by H. Parker Willis in this rediscount rates by the rate on govern­ volume.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis xxii T he A nnals of the A m erican A cademy justifiable difference. Thus will the proceeds of this year’s crop. Some of System best perform its service in these banks are themselves having dif­ facilitating commerce. Arbitrary con­ ficulty in meeting their bills payable. trol, political interference and dead- This situation is too well known to level uniformity will destroy, not main­ need elaboration. The War Finance tain, the integrity of the Federal Corporation Act expressly permits Reserve System. banks with “frozen” agricultural cred­ its to apply for advances from the Cor­ T h e A voidance of I nvestm ent Oper ­ poration for six months or a year, with atio ns by R eserv e B ank s a renewal privilege which may give Investment banking should have no the obligation a total life of three years. place in the operations of Federal By getting time in which to retire its Reserve Banks. Their reason for be­ bills payable, the bank is in a position ing is to aid commercial banking. In­ to give farmer borrowers time in which vestment operations can be avoided to make a new crop, or two if necessary, by confining the paper eligible for and thus clean up their obligations. discount at the Reserve Banks to The Bank’s obligation must be secured commercial paper.17 by collateral which will insure ultimate Should the Federal Reserve Banks payment, but time is given for pay­ perform such agricultural credit func­ ment. In short, the Corporation is tions as are now being developed by functioning in the way of carrying the the War Finance Corporation and burden of agricultural loans that are should they be “adapted” to such slow but should ultimately be paid. functions? The answer to this ques­ To the extent that the Corporation tion will not only emphasize the gets funds into the agricultural sections distinction between commercial and where frozen agricultural credits still investment banking—in what may be prevail, the operations of the Corpora­ urged as a border-line case—but will tion will no doubt be helpful to banks also illustrate the need of confining in those districts and indirectly to the eligible paper to that which evidences farmer borrowers and the country a movement of goods from producer to in general. Whether Section 2 4 of the consumer and is self-liquidating. War Finance Corporation Act is a The original purpose of the War sound politico-economic measure need Finance Corporation is of no present not now be debated. It is a fact. moment. The essential purpose of Bankers and economists have few illu­ Section 2 4 of the War Finance Cor­ sions as to the probable extent or nature' poration Act, under which the Corpora­ of its operations, but about one point tion is now operating, is to give bankers there can be no doubt, namely, that and farmers time in which to pay their this giving of time to bankers and obligations. Banks in various agri­ indirectly to farmers puts the opera­ cultural communities have made loans tions of the Corporation in the class of for “agricultural purposes” which can­ investment rather than commercial not be repaid at maturity out of the banking. If the Federal Reserve Banks 17 The term commercial paper, unless in quotes were to carry loans for three years, in this article, means commercial paper as defined they would be doing an investment in the Federal Reserve Act and rulings of the banking business. It is the purpose of Federal Reserve Board, and expressly includes agricultural paper. In the case of agricultural the Federal Reserve Act to deal in self- paper, however, the maturity of the paper is the liquidating paper. The Reserve Act essential point in giving it eligibility. might conceivably be amended to

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis I ntegrity of the F ederal R eserve S ystem xxiii permit the Reserve Banks to perform of the Federal Reserve Act anticipated such long time banking operations as the World War, the proviso clause in are now entrusted to the War Finance Section 13 of the Reserve Act, which Corporation, but such amendment permits rediscounts to be secured by would be a blow to the integrity of the government obligations, would prob­ Federal Reserve System as a commer­ ably not have been passed.19 And cial banking mechanism. certainly there was sufficient experience Should the War Finance Corpora­ with this proviso clause of Section 13, tion so extend its operations in granting as to its potency for inflation, to have agricultural credits that its capital is warned against the amendment of the exhausted, the Corporation may issue Reserve Act so as to permit the War debentures to secure additional funds. Finance Corporation’s debentures to The Corporation is empowered by the be used to secure rediscounts. Section Act to have advances to banks out­ 24 of the War Finance Corporation Act standing at any one time to the amount was not approved until August 24, of a billion dollars. The capital stock 1921. of the Corporation, which is owned by While government obligations are so the Federal government, is five hun­ extensively held by individuals and dred million dollars. Should the Cor­ business concerns, it is perhaps im­ poration issue its debentures, these practicable to amend Section 13 of the promises to pay must be considered Federal Reserve Act so as to prevent investment paper. They may be used the use of government obligations to to secure rediscounts with the Federal secure rediscounts and the issuance of Reserve Banks. Should they be so Federal Reserve notes on the security used, they will be in the same position of those obligations. Until the war as government obligations which are bonds of the government find a final used to secure rediscounts. The pro­ resting place with investors—which priety of making loans and issuing may mean until refunding plans are Federal Reserve notes on the basis put into operation—it would probably of paper “collateraled” by investment be impracticable to prevent a member securities is a question that may well be bank’s offering the note of a business raised in considering the integrity of man for rediscount which is secured by the Reserve System as a commercial government bonds. Until that time banking institution. it may be impossible to have Federal Government bonds and debentures Reserve notes issued only in response of the War Finance Corporation are to commercial needs, evidenced by the promises to pay. They are not in offering of commercial paper for redis­ themselves evidences of a movement count. In the perfecting of the Reserve of goods from producer to consumer. Act, Section 13 might well be changed, They are not self-liquidating as is on the chance of a recurrence of very commercial paper. The legal permis­ large government demands. There sion to secure rediscounts with invest­ will be no valid excuse for permitting ment paper is a deviation from the the rediscounting of notes secured by original purpose of the Federal Reserve the debentures of the War Finance Act. It is true that the Reserve Act Corporation should that Corporation makes express provision for rediscounts function extensively enough to issue secured by government obligations.18 its debentures. Of course, it might be But it is also true that had the framers 19 See paper entitled, “The Reserve Act in its 18 See Section 13 of the Federal Reserve Act. Implicit Meaning.”

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis xxiv T h e A nna ls of the A m erican A cademy difficult to sell such debentures without between commercial and long-time this feature. banking, that was not easily estab­ The avoidance of investment opera­ lished, is to permit just such a situation tions by Reserve Banks will be difficult as now obtains in many country banks. so long as Congress, or any group of They have slow assets with which to congressmen, can force amendment of meet quick liabilities. It is as impos­ the Federal Reserve Act to take from sible to add investment banking to the Federal Reserve Board its power commercial banking and get security to define eligible paper under the Act as it is to add apples to oranges and as it now stands. In the spirit of the get peaches. And it must not be Act the resources of the Reserve Banks forgot that the slow obligations of are not to be used for withholding farmer borrowers and agricultural crops from the market to secure higher banks can be traced in part to land prices. Commercial paper involves speculation and inflated land values. the moving of goods to the market, not withholding therefrom in order to insert R elation of the R eserv e System a price peg or even to secure “more to International F in an ce orderly marketing.” Measures to ad­ The Federal Reserve Act permitted mit irrigation and development bonds the extension of banking operations as paper for the Reserve Banks to into the foreign field. Under this au­ function on might conceivably be thorization American banks branched passed by Congress. But no matter out in foreign territory extensively and how great the need of particular not always profitably. However costly agricultural districts, or how desirable the experience with foreign banking, it various measures of relief, it seems clear is probably safe to say that banks man­ that the definition of eligible paper aged by those who are experienced in should be restricted to commercial foreign trade and foreign banking will paper unless there is a general and well in the future find sufficient latitude for considered intent to depart from the profitable operation under the Reserve commercial character of the Federal Act. Reserve System. The Federal Reserve Act was amend­ There may or may not be need of ed by the Edge law to permit an exten­ specialized banking machinery to take sion of foreign banking facilities through care of the long time financial require­ the establishment of new foreign bank­ ments of farmers, due to recurrent crop ing corporations in which commercial failures or price slumps, as well as their banks were expressly permitted to own need for long time funds in bringing stock. This fact that commercial cattle to market. But in any event banks could hold the stock of Edge law that need would have to be determined corporations is sufficient reason for the on the basis of experience that is more Reserve Board’s being given supervi­ than transitory or that arises from a sory control. Moreover, Edge law world-wide emergency, caused by the corporations were designed to finance distortions of war. But the fact that imports and exports, but especially these needs exist is not a sufficient to aid the movement of goods from reason to destroy the integrity of the American producers to foreign con­ commercial banking system that has sumers. They were designed to do a been established. They rather point foreign commercial banking business. the way to the provision of other facili­ The Edge law merely extended the ties, if necessary. To destroy the line provisions of the Reserve Act that had

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis I ntegrity of the F ederal R eserve System xxv previously permitted foreign banking. sponsible legislative positions and it is Since the banking business of Edge not improbable that somehow, if a law law corporations is largely commercial were passed to establish such an inter­ in character, the Edge law is not an national bank, that bank would get attempt to graft onto the Federal itself tied up with the Federal Reserve Reserve System investment features System. It is against such projects that would have destroyed its integrity that the Federal Reserve System must as a commercial banking system. be safeguarded by an alert and vigilant Whether Edge law corporations were public opinion which allows no devia­ or are desirable from the standpoint of tion from its commercial character. practicality is really beside the point. Though the condition of business in The Reserve Act was extended by the the United States is affected by the Edge law to put the Federal Reserve play of world-wide economic and System into more intimate touch with political forces and the Federal Reserve international finance. It is merely a System is affected by the condition of matter of record that “rest in peace,” business, that System touches the in proper Latin phraseology, has been international financial structure im­ written over the mammoth corporation mediately at one point, through its proposed to be operated under the control of gold. How the Federal Edge law. Reserve Board impounded gold is told Dreamer’s dreams of international in Mr. Case’s article. The Reserve banks, which would restore mint pars Board’s control of the gold of the of exchange and otherwise work out United States is now complete. Cer­ the difficulties of international finance, tain it is, also, that the flow of gold can be dismissed with scant considera­ into the United States shortly after tion. They do, however, contain a the outbreak of the War, but particu­ warning. The capital of one such larly since September, 1920, has result­ bank was to be composed largely of ed in such redistribution of the world’s the promises to pay of “solvent foreign stock of monetary gold as to give the governments.” The test of solvency United States—the Federal Reserve was prompt payment of external Board—control of some 40 per cent of obligations and the taking of steps that stock. towards disarmament. Foreign bonds, In this connection the article of Dr. even of such “solvent governments,” Sprague may be read with profit. are scarcely to be considered banking There is within the Reserve System, as capital. It is difficult, also, to see how operated, an inherent power for expan­ the operations of such a bank would sion. The manner in which gold is rectify foreign exchange when any handled is of the greatest importance adjustment depends so largely on and Dr. Sprague has indicated the dan­ measures taken by European nations gers to be guarded against in the future themselves—such as deflation of their as well as those which have not been currencies and balancing of their budg­ met effectively in the past. ets—to bring the purchasing power of their moneys more nearly into align­ P urpose of the V olume ment with the purchasing power of The purpose of this volume is natu­ American money. Exchange rates to­ rally to be ascertained from the read­ day are on a purchasing power parity. ing of the various articles contributed. However fatuous such projects, they Books have been written on the Reserve are conceived by those holding re­ System. Some of them have given its

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis xxvi T h e A n na ls of the A m erican A cademy purposes and some have been devoted It is pertinent to add that sight was to its operations and operating mecha­ never lost of the fact that the Federal nism. The editors .assumed, however, Reserve System is not generally under­ that heretofore no opportunity has stood. It is unfortunate that it is been offered to bring together in one distinctly misunderstood. If this vol­ volume the authoritative statements ume is of any assistance in clearing up from those who were directly interested the misunderstandings and giving a in framing and formulating the Act and better conception of the work and the were, therefore, familiar with its pur­ mission of the Reserve Banks, the poses; from those who were and are editors will feel fully rewarded. They actively connected with the operation owe everything to the contributors who of the Reserve Banks and therefore have responded so capably and gen­ competent to interpret their conduct, erously to their requests, often, it may and from those who directly and be said, despite of engagements and indirectly make use of the Banks or are the pressing demands of their own keenly interested to study the progress businesses. No editors were ever more of the System. fortunate in securing cooperation from Thus we have in this volume of The contributors. Annals the Reserve System as contem­ It is only an editorial hope that the plated by its framers, as operated by volume may meet approval. It was those in charge, and as observed by fairly intended to produce a useful and those in a position to interpret the practical work. Whether it does or operations in relation to the purpose. does not perform a useful service, we In any event these three forces were feel justified in appending the message sought and have responded. The for the book suggested by the governor relationship between purpose and oper­ of a Reserve Bank: “It will not be easy ation is set forth and the limitations as reading; it may not be agreeable read­ well as the scope of the System have ing, but I think it mighty important that been shown. every business man should read it.”

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Outline of Banking History From the First Bank of the United States Through the Panic of 1907 By B. H. Beckhart Columbia University] HE United States was particularly The entire capital was subscribed fortunate in having as its first within two hours on the day6 the sub­ Secretary of the Treasury a veritablescription books were thrown open, and Tgenius, whose program of fiscal reformthe Bank was ready to begin business quickly placed the new republic on a on December 12, 1791, with Thomas sound financial basis. As an essential Willing as president.6 From the very part of his program, Hamilton urged outset, the Bank proved to be a great the establishment of a National Bank success, in providing the country with in a report to Congress, dated Decem­ a sound and elastic currency, in supply­ ber 13,1790. Since the economic signif­ ing the needed banking facilities, and icance of banks was then but crudely in preventing any excess issue of state understood, Hamilton, in this now fa­ bank notes by having such state notes mous document, first indicated the as were in its possession redeemed. In numerous advantages resulting from the performance of its fiscal functions, banking in general and from a National it transferred government funds and Bank in particular, taking occasion to provided a safe depositary for them; it dispel some of the current erroneous also helped to collect the revenues and ideas on the subject.1 After showing provided the bullion needed by the that no one of the three banking insti­ mint in coinage. Further, by 1795 it tutions2 then in existence could be suit­ had loaned the government $6,200,000. ably employed as a National Bank, In order to procure funds to repay the he laid down in great detail the plan loan, the government by 1802 had sold for the new institution.8 The act all of its stock at a profit of $671,860, chartering the bank modelled upon this and while a shareholder had received plan was signed by the President on $1,101,720 in dividends of 8f per cent. February 25, 1791.4 On April 20, 1808, the stockhold­ 1 Hamilton's report may be found printed in ers memorialized Congress for a re­ full in the American State Papers—Finance I., newal of the charter which expired in pp. 67-76. 1811. A month later, Albert Gallatin, 2 The Bank of North America founded in then Secretary of the Treasury, in a 1781, the Bank of Massachusetts in 1784, and the Bank of New York in 1784. report to Congress enumerated the 3 Hamilton's plan closely followed the charter fiscal services of the Bank and advised of the Bank of England as it existed at that time. that the charter be renewed with a few 4 The act provided for a capital of $10,000,000, changes. Nevertheless, the bill to con­ of which one-fifth was to be subscribed by the tinue the charter was defeated, the government. The administration was placed in the hands of twenty-five directors elected an­ oftener than once a week by the Treasury nually by the shareholders. Branches were to Department. be established where the directors saw fit. The 6 July 4th, 1791, at Philadelphia. circulation was not to exceed the capital. State­ •Formerly, president of the Bank of North ments of condition might be called for but not America.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 2 T h e A n na ls of the A m erican A cademy opponents charging that the Bank was to 1817. Further, without the assist­ a “ money trust ” controlled by foreign­ ance of the Bank, the government had ers,7 a tool in the hands of the Federal­ difficulty in selling its bonds (even ists, and that the act chartering the when offered below par), and was bank was unconstitutional—so the forced to borrow sums from the state First United States Bank went out of banks and to issue some 37 million existence on March 3, 1811.8 dollars of “Treasury notes” which “ultimately degenerated into a kind of Financial Chaos, 1811-1816 currency.”11 Writing in 1831, Gallatin It was a most unfortunate time for stated that had the Bank been rechar­ the country, on the verge of a war with tered, the suspension might have been England, to be deprived of the services prevented and the state banks would of the Bank. State banks sprang up on have been restrained within proper every hand to take its place. Their bounds. number increased from 88 in 1811 to T h e S econd B a nk of the U n ited 246 in 1816 and their circulation grew S tates from 22.7 million dollars in 1811 to 100 millions six years later.9 Such a rapid As early as October 14, 1814, Secre­ inflation of the currency resulted nat­ tary Dallas,12 in a report submitted to urally in the depreciation of bank notes Congress, called attention to the need in terms of gold, amounting at the for a National Bank, emphasizing the maximum to 23 per cent in Baltimore, fact that such a bank could restore the and 16 per cent in Philadelphia and depreciated currency to a gold parity New York.10 and that in its fiscal relations with the The revenues of the government, Treasury would be of incalculable consisting largely of tariff duties, were assistance. After seven unsuccessful for the most part collected in this attempts within two years, the charter depreciated currency, while it was of the Second Bank, closely resembling necessary for the nation to make large that of the First, was passed by Con­ disbursements of funds in New Eng­ gress and became law on April 10, land where specie payments had been 1816.18 Through an agreement with maintained. By reason of this con­ 11 Willis, H.P., American Banking. 1918, p. 209. dition, it has been estimated that the 12 Alexander J. Dallas from Pennsylvania, government lost $5,000,000 from 1814 appointed Secretary of the Treasury, October 6, 1812. 7 Though three-fourths of the stock was held 13 The act provided for a capital of $35,000,000, abroad, the foreign shareholders exerted little of which the government subscribed one-fifth. control, as they were not allowed to vote through There were to be twenty-five directors, twenty of proxies. whom were to be elected annually by the share­ 8 By 1834 the process of liquidating the assets holders and five appointed by the government. had been completed, the shareholders receiving Branches were to be established wherever the in all $434 for each *$400 share. The assets of Bank thought necessary, managed by from seven the parent bank in Philadelphia were purchased to thirteen directors appointed by the parent by Stephen A. Girard, which was reopened on bank. The circulation was not to exceed the May 12, 1812, as “Girard’s Bank.” capital. Deposits of public funds were to be •This increase was due to two factors: (1) made in the Bank unless the Secretary of the the suspension of specie payments everywhere Treasury should otherwise direct. The Bank during August of 1814 excepting in New Eng­ was required to pay the government a bonus of land; and (2) to the withdrawal of the restraining $1,500,000 and to transfer public funds without influence of the Bank. charge. Weekly statements of condition might 10 The specie was either driven abroad or into be called for and Congress was given the right to the New England States. inspect the books of the Bank.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Ou tline of B ank ing H istory 3 the state banks in the larger towns, the bursing government funds, in furnish­ resumption of specie payments was ing domestic exchange, in paying the brought about (nominally at least) by pensioners of the government, and in February 20, 1817, thus realizing the acting until 1833 as the sole depositary first purpose of the Bank. Due partly of public moneys, the Bank was of great to governmental pressure and partly to service to the whole people. a lack of banking training, the direc­ In his first message to Congress, on tors, at first, extended loans and rapidly December 8, 1829, President Jackson increased the circulation, a policy expressed doubts as to the constitu­ which resulted in a heavy loss to the tionality of the Bank and the sound­ Bank and in the retirement of William ness of its notes. The President’s Jones as president in January of 1819. hostility subsequently cooled, but Langdon Cheves, chosen as his succes­ when the Whig party at Baltimore in sor, immediately inaugurated a policy 1831 took the side of the Bank, there of retrenchment and deflation. Under ensued a long and bitter struggle which his management and later under that ended in the defeat of the attempt to of Nicholas Biddle, the Bank became recharter it. The reasons as given by “the most powerful and best managed Professor Catterall for this opposition financial institution the country had were the “widespread belief that the ever seen.”14 Its notes, circulating from Bank was unconstitutional, the hostil­ Montreal to Mexico City, were safe ity of the states, the opposition of the and elastic, In transferring and dis­ state banks, the rise of democracy, Chart I

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 4 T h e A nnals of the A m erican A cademy and the envy and hatred which the and the government, whereby they poor always feel for the rich.”15 were required to give security for the Upon the failure to recharter the funds deposited “ whenever the deposits Second Bank, the era of central banks, should exceed one-half the bank modelled after those existing in Europe, capital paid in,”17 or whenever the passed. Banking in America entered government deemed it necessary. The upon entirely different lines of devel­ banks agreed to perform for the govern­ opment. In the years that followed, ment all of the fiscal services formerly the government was to miss keenly rendered by the Bank of the United the fiscal services of the Bank, and States, to render weekly reports, and the people, no longer protected ljy to submit to examinations when the its restraining influence on the note Secretary thought necessary. On June issues of the state banks, suffered 28, 1836, an act was passed “to regu­ severely from the resulting financial late the deposites of the public money” chaos. following closely the provisions of Taney’s contracts.18 In his annual T h e I n d epen d en t T reasury message, September, 1837, Van Buren From 1791 to 1811, the First Bank showed that the custody of the public was utilized to a large extent as a funds by state banks had proved very depositary of government funds. After unsatisfactory and urged that the its charter had expired the government government take care of its funds itself was forced to use the services of state and require that all dues be paid in banks, from whom no security was specie. While this suggestion was required for the moneys deposited, but being considered, the public funds were by whom in accordance with an agree­ left in the hands of the collecting offi­ ment entered into, weekly and monthly cers and a few banks. statements of condition were to be The bill creating the Independent submitted to the Secretary of the Treasury, finally passed on July 4, Treasury. The use of state banks as 1840, was repealed on August 13, depositaries proved so unsuccessful 1841, and was repassed on August 6, that it wa£ provided, in the charter of the Second Bank, that it was to be the 17 Kinley, David, Independent Treasury. 1910, pp. 26, 27. sole depositary except in such places 18 This act provided that the banks selected as where the Bank had no branches, or depositaries must furnish the Secretary with a when the Secretary of the Treasury statement of their condition, a list of their direc­ deemed it unwise to employ it as such. tors, the current price of their stock and a copy of their charter. Further, the Secretary might This latter provision of the act was examine the general accounts. Such banks must taken advantage of in September of redeem their notes upon demand, and no bank 1833 by Secretary Taney, who “or­ issuing notes of a denomination of less than $5 dered the collectors of revenue to cease was to be chosen. Collateral against the funds depositing in the Bank of the United so deposited could be called for whenever the Secretary deemed this necessary, and must be States and to employ designated called for if the deposits exceeded one-half state banks for that purpose.”16 the Bank’s capital. In return for such deposits, A contract was entered into between the banks must render the government all the these banks (the so-called “pet banks”) services and duties heretofore required of the Second Bank. It was further provided that if 15 Catterall, Ralph C. H., The Second Bank of the government’s deposits exceeded a fourth the United States, p. 164. part of the Bank’s capital for at least three 16 Kinley, David, Independent Treasury. 1910, months, interest at the rate of 2 per cent per pp. 26, 27. annum must be paid on this excess.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Ou tl in e of B ank ing H istory 5 C h a r t II Statistics of State Banks, 1836-1863 M illions niitioA* «# goiter* pollan

1840 1050 1360 1846.19 The act provided that all safely without loaning, using or de­ receivers of public moneys must keep positing them in banks. Further, on such funds as were received by them and after June 1, 1847, all payments 19 The repeal of the act in 1840 necessitated a of taxes, duties, etc., to the United return to the use of state banks as depositaries, States must be made in gold or silver until the act was repassed. or Treasury notes. New York, Phila­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 6 T h e A nna ls of the A m erican A cademy delphia, Washington, Charleston, New to the want of any uniform system— Orleans and St. Louis were made the and to the significant fact that public principal centers of deposit. opinion was both torpid and unintelli­ gent,”21 the losses to the people from State Banks, 1836-1863 poorly and dishonestly managed banks In the course of these years, “almost were enormous. Some of these banks every type of banking system was were established by special charters, attempted, and the result was the some, under the Free Banking Laws; accumulation of a great fund of experi­ few seemed to have been prudently or ence”20 mostly as to the best way in wisely managed. Some, called “wild­ which not to conduct banking. In cat” or “red-dog” banks, were located New England and in New York the in remote sections, in order to keep efforts to regulate banking through their notes in circulation longer and state and private means were much render redemption more difficult. The more successful than in the rest of the lack of any uniformity in the bank country. Thus, by an act passed in notes, the failure adequately to protect 1829, New York State endeavored to them, and the absence of governmental „ protect both the depositor and note control were among the motivating holder by means of a safety fund which factors leading to the passage of the was built up by contributions from National Bank Act. • the banks and which was to be used to meet the obligations (excluding capital) T h e N ational B ank ing System of the failed banks. This scheme was The national banking system, re­ not very successful until, beginning sembling somewhat the free banking with 1842, the use of the fund was system of New York State, was recom­ limited strictly to the redemption of mended by Secretary Chase as early the notes of failed banks. The notes as December, 1861. After two de­ of the banks organized under the Free feats, due largely to the opposition of Banking Law of 1838 in New York the state banks, the bill establishing State were protected, not by the safety the system became a law February 25, fund, but by deposits of certain speci­ 1863; but in accordance with the rec­ fied bonds or mortgages with the state ommendations of Mr. Hugh McCul­ comptroller. loch, the first Comptroller of the Cur­ The success of the First and Second rency, it was completely revised and United States Banks led many states passed again on June 3, 1864.22 to charter banks modelled upon these. The predominating motive in Secre- Among the more successful were the 21 White, Horace, Money and Banking. 1914, State Banks of Indiana, Louisiana and p. 331. Ohio, but the Bank of the Common­ 22 The chief differences in these two bills were wealth of Kentucky, the Banks of as follows: Alabama, of Mississippi, of Arkansas, 1. The Act of 1863 required a smaller mini­ mum of capital for a new bank than did the Act of Illinois and the Union Bank of of 1864, and required that a smaller proportion Florida ended in dismal failures, leav­ be paid in before beginning business, and allowed ing the citizens with millions of dollars a longer time for the payment of the remainder. of unredeemed notes and worthless 2. The Act of 1863 permitted loans on real as well as personal security. deposit accounts. 3. The prohibition of issuing notes of a denom­ In the western and southern states, ination less than $5 took place at once in the “due to the lack of public regulation, former act. 20 Willis, H. P., American Banking, 1918, p. 212. 4. By the former act all national banks were

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Outline of B anking H istory 7 tary Chase’s mind for the passage of of which 50 per cent was to be paid in the act was the establishment of a cashbefore commencingbusiness and the uniform currency. On, January 1, remainder within five months at a rate 1862, there were in the United States, not less than 10 per cent per month.26 1,496 banks issuing some 7,000 different Each national bank was required to kinds of circulating notes, “based on a buy government registered bonds to great variety of securities, of different an amount not less than $30,000 or qualities and quantities,”23 and some less than one-third of the capital stock based on no security at all. The fram­ paid in. When such bonds had been ers of the Act not only wished to rid the deposited with the Treasurer of the country of such conditions as these, United States, the national bank would but it was felt by many also that the be entitled to receive notes up to 90 issues of state bank notes were fre­ per cent of the par or market value of quently redundant, were subjected to the bonds whichever was the lower, but violent expansions and contractions, no bank was permitted to issue an and were unequally distributed among amount of notes greater than its paid- the various states.24 in capital. Thus the circulation could The increased demand for bonds, at no time exceed the paid-in capital which such a system would create, of all the banks, and in addition an was to Secretary Chase a motive of absolute maximum of $300,000,000 was secondary importance.25 Additional placed on the note issues. The notes advantages of the system, of course, were to be receivable at par in pay­ were that such banks could act as ment of all dues to the United States depositaries of government funds, float except for duties on imports, and to be loans, stimulate patriotism, and, be­ paid out at par for all the debts of the cause of being a national system, pre­ United States except interest on the vent future rebellions. public debt, and in redemption of the By the Act of 1864 the capital of the national currency.27 national banks was proportioned to It was further provided that na­ the population as follows: tional banks in the reserve cities must Capital make arrangements to redeem their Cities with a population of 6,000 currency in New York City, and, simi- or less...... $50,000 26 The Act made an error in not proportioning Cities with a population of from capital to the bank’s liabilities instead of to the 6,000 to 50,000...... 100,000 population of the town in which the bank hap­ Cities with a population of 50,000 pened to be located. The requirement that the and above...... 200,000 capital be paid in cash was an effort to stop the vicious practice begun at the time the First required to maintain a reserve of 25 per cent Bank was chartered of allowing the shareholders against notes and deposits. to contribute their part of the capital in their 5. The Act of 1864 makes more complete own discounted notes. provision for the conversion of state banks into 27 Inasmuch as the Loan Acts of March 3, national associations. 1863 and March 3, 1864, provided that both 23 Dewey, D. R., Financial History of the United principal and interest be paid in coin, and the States. 1918, p. 321. Loan Acts of February 25, 1862, June 30, 1864 24 Chart II, brings out the first two points in and March 3, 1865, provided for the payment a striking fashion. of the interest in coin, in order to help sustain 25 As a matter of fact, at the time of Lee’s sur­ the public credit, it was necessary, therefore, as render, the bonds bought by the national banks specie payments were suspended from 1862 to to secure their circulation were less than 4 per 1879, that the government collect its import cent of the total bonds floated by the govern­ duties in gold in order to obtain a supply which ment during the war. could be used as required by the above acts.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 8 T h e A n nals of the A m erican A cademy larly, national banks in country towns June 20,1874, did away with the lawful must redeem their notes at some bank money reserve which was formerly located in a reserve city.28 required to be held against the circu­ By an act passed on March 3, 1865, lation, provided for the 5 per cent $150,000,000 of the national bank redemption fund, provided that here­ notes were to be apportioned among after banks would have to redeem the national banks in the several states their notes only at their own counters according to the respective populations, or at the Treasury Department, and while the remainder was to be propor­ also provided that a bank which wished tioned by the Secretary of the Treas­ to retire its circulation might with­ ury “having due regard to the existing draw the bonds deposited with the banking capital, resources, and busi­ Treasurer of the United States, pro­ ness of such States, Districts, and vided that lawful money to an equal Territories.” amount be deposited to redeem the State bank notes were forced out of circulation still outstanding; but in no circulation by a provision in the case should the amount of bonds on Revenue Act of March 3,1865, levying deposit for circulation be reduced a 10 per cent annual tax on the notes below $50,OOO.30 By the Resumption paid out after July 1, 1866.29 Act of January 14, 1875, the provi­ That the entrance of state banks sions in the former acts regarding the into the system was slow at first, was aggregate amount of national bank due, according to Mr. McCulloch, to notes in circulation and their distribu­ the fear on their part that the national tion were repealed. banking system might be a repetition From 1882, when the national bank of the free banking system in its worst notes in circulation touched the highest aspects. Up to November 25, 1864, figure up to that time, 361 million dol­ only 168 state banks had entered the lars, the amount outstanding declined system, but with the retirement of the rapidly until in 1891 there were only state bank notes in sight, only 244 re­ 172 million dollars in circulation, and mained out by the end of 1868, and of this amount more than 50 millions 1,643 were members of the national were secured by lawful money. Nat­ banking system. An amendment to urally one would expect a bank’s cir­ the National Bank Act passed on culation to increase as the population 28 New York was the only central reserve grew and the nation’s resources were city, whereas the reserve cities were St. Louis, developed, but it must be remembered Louisville, Chicago, Detroit, Milwaukee, New that these bank notes based on govern­ Orleans, Cincinnati, Cleveland, Pittsburg, Balti­ more, Philadelphia, Boston, Albany, Leaven­ ment bonds were alone of their kind in worth, San Francisco, Washington City, and the world, and as the yield on later, Charleston and Richmond. government bonds31 was decreasing Banks in New York City were to keep on hand 80 By the Act of July 12, 1882, banks with a a 25 per cent lawful money reserve against both capital of $150,000 or less were permitted to notes and deposits, while banks in the reserve withdraw bonds, which they had deposited cities were to keep a 25 per cent reserve but one- against their circulation, down to one-fourth of half of this might be deposited with a New York their capital, provided that they deposit enough City bank. Banks in other towns must keep lawful money to retire the notes not covered by a reserve equal to 15 per cent, three-fifths of bonds, but not more than $3,000,000 of National which could be kept on deposit with a bank in a Bank notes were to be so retired in any one New York or in any reserve city. month. All bond requirements were repealed 29 State bank notes made their last appearance by the act of June 21, 1917. in the Treasury reports on July 1, 1876, when 81 By reason of the steadily rising prices of the the circulation was $1,047,335. bonds.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Outline of B ank ing H istory 9 throughout this period, it was no longer this measure was to provide a basis for as profitable for the banks to take out the bond-secured national bank notes notes, as the so-called double-profit by postponing the maturity of a large had declined. From 1891 to 1899, the part of the public debt.84 The tax on amount of national bank notes in­ the notes issued remained at 1 per creased, due to the increased yield on cent per annum if the bonds bore more government bonds, and to special than 2 per cent interest, but if they demands .for money during the panic bore 2 per cent interest or less, this of 1893. tax was reduced to one-half of 1 per cent. The Gold Standard Act of 1900 Under the stimulus of the Act, This act derives its name from the especially by reason of allowing na­ fact that it provided that the dollar, tional banks to issue notes up to the par consisting of twenty-five and eight- value of the bonds, and by reason of tenths grains of gold, nine-tenths fine, the increased yield of government should be the standard unit of value, bonds, the amount of notes in circula­ and all other forms of money should tion increased rapidly from 332 mil­ be maintained at a parity of value lion dollars in 1900 to 609 millions in with the standard.32 1907. The Act also allowed national banks The Gold Standard Act of 1900 was with as small a capitalization as $25,000 not a constructive piece of legislation, to be formed in towns of 3,000 inhab­ as it did little else than modify slightly itants or less.83 This led to a rapid the technical details in the organiza­ increase in the number of national tion and operation of the national banks from 3,583 in 1899 to 4,165 in banks, and made no attempt to remedy 1901. any of the basic defects of our banking Though the notes to be issued by a system. national bank were at no time to The Panic of 1907 exceed its paid-in capital, it was pro­ Beginning with 1896, prices in the vided that they could be issued here­ various gold standard nations, which after up to the full market or par value had been falling for nearly a genera­ of the bonds deposited, whichever was tion, began to turn upward. This the lower, instead of only up to 90 per change was due to an increase in the cent of such value. The refunding of production of gold and use of money the 5 per cent bonds maturing in 1904, substitutes, and to the wasteful ex­ the 4 per cent maturing in 1907, and ploitation of the world’s natural re­ the 3 per cent maturing in 1908, repre­ sources. The rise in the price level senting a total amount of 839 million led to such a stimulation of industry dollars, into 2 per cent bonds maturing that until 1907, aside from a local in 1930, was provided. One purpose of crisis in Germany in 1900 and the 82 This act simply affirmed the gold standard “rich man’s panic” of 1903 in America, which had really been established in the act of 1873 which demonetized the silver dollar. the period was one of general prosper- w As established by the Act, the capital re­ 84 Horace White has estimated that the loss to quirements were: the government on additional interest paid by Capital extending the maturity of these bonds amounted In towns of less than 3,000...... $25,000 to $244 millions — a tremendous price to pay for In towns of 3,000 to 6,000...... 50,000 an increase in circulation up to 1907 of only 277 In towns of 6,000 to 50,000...... 100,000 millions of dollars. Money and Banking, Horace In towns with more than 50,000 people 200,000 White. 1914, p. 406.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 10 T he A nna ls of the A m erican A cademy ity. This expansion in business and Toward the end of that year it was the resulting increase in speculation apparent that the demand for capital intensified the demand for capital. was such that borrowers had difficulty As the demand could not be met from in being accommodated even though the current savings of the people, com­ bank credits were strained to the limit. mercial banks began to make larger In January and February of 1907 large and larger extensions of credit, a policy blocks of securities had to be sold to which resulted in progressively lower repay the loans previously procured reserves and forced the banks to raise from the London market through the discount rates and curtail extensions of drawing of finance bills. Prices of credit. This retrenchment was accom­ stocks fell steadily and crashed in panied by a diminishing purchasing March. After a slight recovery the power on the part of the great mass of market began to fall again in August consumers, for wages lagged behind and was still falling when the panic prices in the upward movement, forc­ occurred. ing the sale of products at sacrifice In addition to the general causes of prices. This condition checked the the world crisis of 1907, there were ele­ rise in the price level and brought on a ments of weakness in the American period of depression throughout the banking system, reflected chiefly in world. the New York money market, which In America, as in the nations of caused the crisis here to degenerate Europe, prices, wages and interest into a panic. One of the most signifi­ rates rose one after the other. While cant facts in the development of Amer­ this differential between prices and the ican banking from 1896 to 1907 was the cost of production lasted, the specula­ rapid growth of state banks and trust tor optimistically capitalized the future companies. State banks increased earnings of industry, and the prices of particularly throughout the West and stocks soared, reaching a peak in 1906. South as the requirements of the state

T a b le A—Growth of State Banks and Trust Companies, 1896, 1902, 1907 S tate B a n e s Individual Cash Proportion of Year Number Capital Deposits Holdings Cash (Millions) (Millions) (Millions) to Deposits 1896...... 3,978 310.8 695.7 101.0 14.5% 1902...... 5,433 388:3 1,698.2 178.6 10.5 1907...... 10,352 664.2 3,068.6 254.0 8.3

T rust C o m panies Proportion of Capital Individual Cash Cash to Deposits Year Number (Millions) Deposits Holdings (National Bank (Millions) (Millions) Notes Included) 1896...... 257 173.5 586.5 26.8 4.6% 1902...... 636 329.6 1,525.9 31.9 2.1 1907...... 1,485 645.4 2,061.6 101.7 4.9

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Ou tline of B ank ing H istory 11 banking laws were less strict there than drawals during a crisis, a time when those of the National Bank Act. banks ought to increase their loans to The greatest growth in trust companies save the solvent but temporarily occurred in the East, as there they embarrassed borrower, is obvious. were not subject to the same strict Moreover, the Secretary of Treasury, requirements as were state and na­ Leslie M. Shaw, encouraged other tional banks. The growth of these two unsound banking practices by a series types of banking institutions is shown of innovations which he introduced in Table A on the preceding page. from 1902 to 1907. Among the more As the proportion of cash to the radical of his changes, was the exemp­ individual deposits of state banks and tion of national banks from the main­ trust companies, amounting to 8.3 per tenance of a cash reserve against gov­ cent and 4.9 per cent respectively, in ernment deposits, the acceptance of 1907, was woefully inadequate to meet other than United States bonds as a heavy drain, they carried balances securities for government deposits, the with national banks which they depositing of government funds where planned to withdraw in time of an money seemed tight, and the artificial emergency. On August 22, 1907, they stimulation of gold imports. had 196.3 million dollars on deposit The cause directly leading to the with the national banks in New York panic was the announcement, on City. Though these deposits would October 21, 1907, by the NationalBank surely be withdrawn during a crisis, the of Commerce of New York that it national banks in the performance of would no longer clear for the Knicker­ their functions as reserve agents, “did bocker Trust Company, whose man­ not build up reserves any larger than agement was under suspicion. This they would have carried had they been action precipitated a run on the Trust received from that class of conservative Company, which was forced to sus­ individuals who habitually maintain pend the following day after paying large balances with their banks.”35 out eight million dollars. Immedi­ Furthermore the national banks in ately, the alarm spread throughout the New York City held a considerable land, a wild scramble for money ensued, porportion of the deposited reserves of banks and individuals hastened to the national banks located in the withdraw their funds from the New interior, amounting on August 22 to York City banks, and the panic was 213.8 million dollars.36 Against the on. The New York City banks being certainty of having the bankers’ bal­ ill prepared to meet these heavy with­ ances withdrawn during a crisis, the drawals were forced to suspend cash New York banks maintained the payments on October 26. The rest of ridiculously low cash reserve of 224 the country immediately followed their million dollars in 1906 (though this was example. slightly above the legal minimum) against total deposits (including those T h e D e f e c t s i n t h e A m e r ic a n made by the government) of 1,162 B a n k in g S y s t e m a s R e v e a l e d i n millions, of which at least a half con­ t h e P a n ic o f 1907 sisted of bankers’ balances. That they One of the most serious of these would be unable to meet heavy with- defects was the rigidity and immobility 88 Sprague, O. M. W., History of Crises Under of the reserves. The proportion of the National Banking System. 1910, p. 226. reserves to be held by national banks 18 See footnote 37. against their deposits were definitely

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 12 T h e A n na ls of th e Am erican A cademy fixed by statute.37 In compliance with brokers, as call loans, which they felt the provisions of the Act, on August were the most liquid form, in the ab­ 2 2 , 1907, national banks held cash sence of a general discount market. and deposited reserves as shown in The capacity of the interior banks to Table B. meet their depositors’ demands during The provision allowing a certain pro­ a panic depended in part upon their portion of the reserves to consist of ability to withdraw the funds which balances with other banks was intended they had deposited with their New to provide the interior banks with ex­ York reserve agent. But the New change to sell on New York and other York banks were unable to meet heavy important commercial centers. How­ drains of cash, due to the insufficiency ever. praiseworthy this intention might of their reserves, and the unliquid

T able B—Cash and D eposited R eserves op N ational Banks, August 22, 1907

Deposits Cash Reserves Deposited Reserves Number of Banks (millions) (millions) (millions)

Central Reserve Cities 60 $1,205.5 $315.5 Reserve Cities...... 306 1,423.4 196.6 $165.7 Others...... 6,178 2,627.2 216.8 226.7

Total...... 6,544 $5,256.1 $728.9 $392.4

Percentage of cash reserves against deposits = 13.87%. be, the provision led to a pyramiding character of call loans, secured by of reserves, so that our credit structure stocks and bonds, during a panic when represented an inverted pyramid with the prices of securities were tumbling. a relatively small cash apex in New Far from being able to repay his loans, York City. In fact, of the reserves the broker needed additional help from deposited with national banks in bankers at such a time.38 central reserve cities, more than two- Realizing that it might be impossible, thirds were held by the banks in New during a panic, to withdraw their York City. In August of 1907 they deposited funds, national banks placed held cash reserves against these bank­ great dependence upon their cash ers’ balances amounting to 2 6 .5 per reserves to meet the emergency. But cent, and, as was customary, had these, scattered as they were in 1907 loaned a large part of the remainder to among 6,429 banks, were ineffective in allaying the panic. When the finan­ 87 The provisions were, that national banks in New York City, St. Louis and Chicago (known cial storm broke each little bank as the central reserve cities) must keep a lawful endeavored to strengthen and to guard money reserve of 25 per cent against their its own reserve against withdrawals, deposits; that national banks in some forty- as there was no established agency seven other large towns (reserve cities) must maintain a 25 per cent reserve but one-half of 88 Prof. Sprague finds that out of a total loan this might be deposited with a national bank in increase by the national banks in New York a central reserve city; all other national banks City between August 22 and December 3, 1907 were to maintain a 15 per cent reserve but three- of sixty-three million dollars, call loans account fifths of this might be deposited with national for fifty-four million dollars.— History of Crises banks in reserve or central reserve cities. Under the National Banking System, p. 801.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Outline of B ank ing H istory 13 which would grant it aid through the money, rather than credit instruments, extension of loans or the discounting of is demanded as a medium of exchange. its paper. Once the reserve had fallen The suspension of specie payments, to the legal minimum, the bank was following the failure of the Knicker­ not expected to extend any further bocker Trust Company resulted in a accommodation to its customers. The premium on currency ranging as high cash reserves of national banks, though as 4 per cent. The Honorable A. Piatt large in the aggregate, were so scat­ Andrew has estimated that to meet tered, hoarded and immobile as to be the demands for money, 334 million ineffective during a time of financial dollars of currency substitutes were difficulty. issued, including clearing house loan Another defect in our banking sys­ certificates and checks, cashiers’ tem revealed in 1907, as in every other checks and manufacturers’ pay panic, was the inelasticity of the na­ checks.39 Our bank notes did not tional bank notes. An elastic currency begin to increase until the first part of should expand to meet seasonal and November and by the first of the year cyclical demands for money, and when had increased by only fifty-four million these demands have been satisfied, dollars. The reason is found in the should contract. Cyclical demands time it took to buy the necessary bonds occur at the time of a crisis, for then and to comply with the governmental business confidence is at a low ebb and red tape.

Chart III

39 Andrew, A. Piatt, "Substitutes for Cash in the Panic of 1907.” The Quarterly Journal of Economics, August, 1908.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 14 T he A n na ls of the A merican A cademy Seasonal demands for money arise section to another, and had this cur­ from periodically recurring needs, such rency contracted, once the need was as the demands of the farmers for satisfied, interest rates could have been money each fall to harvest and market fairly stabilized. Furthermore, due their crops. As the national bank to the immobility of reserves, and the notes failed to expand, the interior concentration of banking capital in the banks secured much of the money East, there were considerable sectional needed by withdrawing their deposits disparities in interest rates which from the New York banks. To the could not be eliminated without central extent that the New York banks met reserve banks. this demand with lawful money, their From time to time, the government reserves were lowered, necessitating a endeavored to extend relief to the contraction of loans and forcing up banks in order to counteract the evils interest rates. Chart III showing the in our banking system. The innova­ seasonal variations (with secular and tions of Secretary Shaw have been cyclical tendencies removed) in the noted. Mr. George B. Cortelyou, his national bank notes and the notes successor, continued this policy. After issued by the Reichsbank, illustrates the panic had begun, he transferred to in a striking fashion the inelasticity the national banks in New York City of the former. (from October 21 to October 31) nearly Such powers of expansion and con­ thirty-eight million dollars to help traction as the national bank notes them meet their withdrawals. Later possessed, depended upon the yield of he offered for sale 150 million dollars government bonds, for should this of bonds to stimulate the issue of increase, the double profit would rise national bank notes. The government and it would become profitable for had to choose between interfering in banks to force the notes into circula­ the money market in this way or keep­ tion.40 ing its funds locked up in the sub­ The seasonal movements of cur­ treasuries. This latter policy would rency into and out of the New York have had the effect of making the cur­ City banks, producing a dearth of rency redundant at the time the gov­ money at one time and a plethora at ernment made disbursements and another, caused interest rates to vary scarce when its taxes were collected.42 from artificially low levels to abnor­ mally high. Thus the average weekly 42 The Act passed in February 25, 1863 estab­ low call money rate from 1890 to 1908 lishing the national banking system amended was 2.31 per cent, occurring in the the Independent Treasury Act so as to allow national banks designated by the Secretary of second week of June, while the average the Treasury to be depositaries of public funds, high, was 7.38 per cent,41 occurring in except receipts from customs. These banks the fourth week of December. Had were required to give security by the “ deposit the seasonal demands been met, as was of United States bonds and otherwise.” By an act passed on March 3,1901 the Secretary of the true on the Continent, by an actual Treasury was expected to “ distribute the depos­ increase in the amount of currency, its herein— so far as practicable equitably be­ instead of by shifting funds from one tween different States and sections.” Secretary Shaw, in 1903, began to accept other than United 40 See pages 8 and 9 for a further illustra­ States bonds from the banks against government tion of this point. deposits, interpreting the words “ and otherwise” 41 Kemmerer, E. W., Seasonal Variations in the to mean “ or otherwise.” By the Act of March Relative Demand for Money and Capital in the 4, 1907 it was provided that receipts from cus­ United States.— 1910, p. 15. toms might be placed in designated depositaries.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Outline of B ank ing H istory 15 Of course such policies as introduced tain a reserve against deposits be by Secretary Shaw were but palliatives repealed.44 for the situation and could not by On November 18, 1896, a resolution themselves remedy the defects of our was adopted by the Board of Gover­ banking system. nors of the Indianapolis Board of Trade inviting representatives from E f f o r t s a t R e f o r m the boards of trade of sixteen middle It was imperative that the defects western cities to assemble at Indian­ in our currency and banking systems apolis in December of 1896 “for the should be remedied, if the nation were purpose of considering the advisability to escape the disaster, humiliation and of calling a larger conference,—to ruin of recurring panics. The members consider the propriety of creating a of the American Bankers Association non-partisan commission, to which were among the first to realize the shall be assigned the duty of formulat­ necessity for reformation, and endorsed, ing a plan for the reform of our cur­ at a meeting held in Baltimore in rency system.”45 1894, a plan of reform known there­ Representatives from the boards of after as the “Baltimore Plan.” This trade and similar commercial bodies plan proposed that government bonds of eleven of the cities invited attended be eliminated as security for national this preliminary conference and issued bank notes, and provided for their a call for a non-partisan monetary issue on much the same conditions convention of business men to con­ that govern the issue of the Canadian vene at Indianapolis on January 12, bank notes.43 1897. Delegates from twenty-six About the same time in a report to states and the District of Columbia Congress, Mr. John G. Carlisle, Secre­ attended the convention, at which it tary of the Treasury from 1893 to was unanimously agreed that an 1897, proposed a plan of reform re­ executive committee of fifteen be sembling in its main outlines the appointed which would endeavor to Baltimore Plan, but with the addition procure at the next session of Congress that the provisions in the National legislation for the appointment of a Bank Act requiring banks to main­ Monetary Commission by the Presi­ dent, to consider the entire question 43 The “ Baltimore plan” proposed that gov­ of currency and banking reform. In ernment bonds be eliminated as security for case this effort failed it was provided bank notes and provided that each National that the executive committee should Bank be allowed to issue notes up to 50 per cent of its paid-up, unimpaired capital subject to a ^Carlisle’s plan closely followed the Balti­ tax of one-half of one per cent per annum on the more plan, but differed in this respect that in average amount of notes outstanding, and further addition to the 5 per cent guaranty fund, he that an additional circulation, known as emer­ would require each national bank issuing notes gency currency, equal to 25 per cent of the bank’s to maintain 30 per cent lawful money reserve, paid-up unimpaired capital be allowed subject consisting of United States notes including the to a heavier tax. Each bank issuing notes was Treasury notes of 1890, against the notes issued. to contribute an amount to a central guarantee State banks were to be allowed to issue notes in fund equal to 5 per cent of its notes in circula­ accordance with these provisions. He also pro­ tion, from which the notes of failed banks were posed that the provisions in the National Bank­ to be paid. If the fund were not sufficiently ing Act requiring a bank to maintain reserves large for this, the remainder of the notes were against deposits be repealed. to be redeemed from the assets of the failed 45 Report of the Monetary Commission of the bank. A 5 per cent redemption fund was to be Indianapolis Convention, Chicago.— The Uni­ maintained as at present, versity of Chicago Press, 1898. p. 5.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 16 T he A n n a ls of the A m erican A cademy select eleven men to make a thorough protect the noteholders from loss, each investigation of the monetary needs of bank was to contribute to a guaranty the country. The Commission of fund an amount in gold equal to 5 per Eleven was appointed and held their cent of its circulation, from which the first meeting on September 22, 1897, in notes of failed banks were to be paid. Washington. After a series of con­ In case that the fund became impaired, ferences lasting through the fall, a by reason of payments made to redeem preliminary report was adopted on the notes, the Comptroller of the Cur­ December 17, while the preparation of rency was authorized to make an the final report was entrusted to J. assessment upon all banks in propor­ Laurence Laughlin, a member of the tion to their circulation. The present Commission. This report was com­ 5 per cent gold redemption fund was to pleted by April of 1898. The prelim­ continue. inary report simply states the Com­ The plan for banking reform in­ mission’s plan of reform, while the cluded the proposals that the present final report deals in an exhaustive way reserve requirements be maintained with the subject of money and banking against deposits with the exception that from a theoretical, historical and sta­ one-fourth of the reserves required tistical standpoint, and is a note­ should be held in coin in the vaults of worthy contribution to economics. the bank. The establishment of branch After advising that the existing gold banks was provided for in case the standard be maintained the Commis­ Comptroller of the Currency approved. sion proposed that national banks be It was further recommended that the allowed to issue notes up to the organization of national banks in amount of their paid-up unimpaired towns of 4,000 or less with a m inim um capital, exclusive of so much as is capital of $25,000 be permitted. invested in real estate. For the first The Commission’s proposals would five years after the passage of the pro­ have provided America with a safe and posed measure, the notes issued up to elastic currency, but would not have 25 per cent of a bank’s capital were to remedied any of the other defects of be secured by government bonds, 'but our banking system. These could not thereafter the amount of bonds re­ be removed by a modification of the quired to be deposited, before notes then existing system, but required the might be issued, was to be reduced by introduction of central reserve banks. one-fifth each year. The notes issued The work of the Commission is valu­ in excess of 60 per cent of the capital able, not because of its immediate and not in excess of 80 per cent were to effect upon legislation, but for the be taxed at the rate of 2 per cent per reason that it awakened the public annum, while those issued in excess of conscience to the necessity of banking 80 per cent were to be taxed at the rate and monetary reform, and paved the of 6 per cent per annum. In order to way for the final reformatory measures.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e Studies of the M onetary C ommission 17

The Studies of the National Monetary Commission By N. A. W e s t o n University of Illinois HE National Monetary Commis­ what was needed to correct the evils of sion had its origin in the financial the existing situation, conflicting busi­ and banking panic of 1907. Thatness interests and partisan political astonishingT disturbance and collapse aims, would prevent the enactment of of credit was one of the most un­ any thorough-going measure of re­ becoming, if not disgraceful, episodes in form. The leaders of the dominant our financial history. Popular clamor party in Congress adopted, therefore, followed. When the air had cleared a temporizing policy and secured the it was seen that the trouble was due to passage of a law, commonly known as the banking system, which, ill-adapted the Aldrich-Vreeland Act, approved to supply the needs of a progressive May 30, 1908, providing for the issu­ industrial nation under normal con­ ance of emergency currency under ditions, was utterly inadequate for the certain conditions. This act was a preservation of business equilibrium makeshift measure and must be re­ and the allaying of distrust in times garded as a political rather than a of business accident and unexpected financial expedient. It was passed strain. with but little debate and without Dissatisfaction with our banking previous consideration by the reg­ system began, however, long before ularly constituted committee of either the panic of 1907. The banks received house of Congress. It was intended to a share of the blame for the crises of satisfy the urgent public demand for 1873 and 1893, while during the ten action by Congress and to enable the years of intense business activity party in power to say that provision preceding the panic of 1907, banking had been made against a recurrence of reform was a question of almost con­ the troubles that had afflicted the stant public agitation. This was a country in the preceding autumn. period of rapid, indeed almost revolu­ tionary, changes in industrial and T h e M o n e t a r y C o m m is s io n a n d commercial organization, but the de­ I t s D u t ie s velopment of banking seemed to lag But the Aldrich-Vreeland Act also behind, owing, it was believed, to the created the National Monetary Com­ rigid character of the banking laws. mission, to be composed of nine mem­ The panic of 1907 brought the criti­ bers from the Senate and nine from cism of the banking system to a climax the House of Representatives, pre­ and the Congress which assembled in scribed its authority and duties and December of that year, some weeks made an appropriation to cover the after the outbreak of the panic, was necessary expenses of its work. The flooded with bills designed to reform work of the Commission is clearly the monetary and banking systems of defined in Section 18 of the Act which the country. provides: In this aroused state of public That it shall be the duty of this com­ opinion some action by Congress was mission to inquire into and report to inevitable, but it was soon realized Congress at the earliest date practicable, that widely divergent views as to what changes are necessary or desirable in 3

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 18 T h e A n na ls of the A m erican A cademy the monetary system of the United States tries of Europe whose economic con­ or in the laws relating to banking and ditions were most nearly like our own, currency. The commission shall have the power, through subcommittee or otherwise, and appointed representatives to visit to examine witnesses and to make such other countries for the purpose of investigations and examinations, in this or holding personal interviews with the other countries, of the subjects committed officials of leading institutions con­ to their charge as they shall deem neces­ cerning their banking organization and sary. their arrangements for dealing with reserves, note issues, commercial paper Within a short time after the passage and other banking problems. The of the law, the National Monetary Commission also conducted hearings Commission was organized with Sena­ and made inquiries in different parts of tor Nelson W. Aldrich, of Rhode the United States and particularly in a Island, as chairman and Congressman dozen or more of the leading com­ E. B. Vreeland, of New York, as mercial centers of the country for the vice-chairman. The Commission was a purpose of getting the opinions of purely political body. The law re­ people in different localities and occu­ stricted membership to senators and pations on desirable changes in our representatives in Congress. All sec­ banking laws. The discussion of cur­ tions of the country, including sixteen rency and banking problems in the different states, were represented in its meetings of various learned societies original composition. The members and associations of business men and could hardly be regarded as experts or bankers were also utilized by the even students of banking and currency Commission as a means of securing problems and only a few of them had expert opinions. had any legislative experience with such questions. The Commission was, P ublications o f t h e M o n e t a r y therefore, forced to depend in large C o m m is s io n measure on outside help in making its The results of the studies and in­ inquiry and preparing its recommenda­ vestigations carried on by people tions. Almost from the beginning, the enlisted in the service of the Commis­ work of the Commission was person­ sion, and of its own interviews, public ally directed by Senator Aldrich and hearings and inquiries, together with was continued for a period of more the report and bill submitted to than three years with some consider­ Congress by the Commission at the able intervals of inactivity. conclusion of its work, have been In order to make the inquiry re­ issued as public documents in a series quired by the law and bring together of twenty-three volumes under the the information that would be needed general title of Publications of the in formulating legislative proposals, National Monetary Commission. The the Commission employed a number of material in these volumes covers about prominent economists, financial edi­ 14,000 octavo pages and about 1,200 tors, bankers and government officials quarto pages, the latter containing in the United States and foreign coun­ chiefly statistical matter. Of the total tries to prepare monographs, papers of over 15,000 pages, about two-thirds, and reports on the actual operations or more than 9,000 pages, deals with of banks and on their separate functions banking and related problems in and mutual relations. Members of the foreign countries. Of the whole mass Commission visited the leading coun­ of information brought together in the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e Stud ies of the M onetary C ommission 19 publications only a relatively small fined to the New York money market part is entirely new. Some of the alone, but included also the markets of material included is simply a reprint Chicago, St. Louis, New Orleans and of previous publications, and a large San Francisco, to the extent that in­ part of the matter dealing with formation was available. While Pro­ American conditions consists of books, fessor Kemmerer’s investigation was monographs and reports previously the most complete of any ever made in published but revised and brought up this field, it did not result in any to date and republished for the uses of modification of accepted theories of the Commission. seasonal and other periodic market Some of these revisions were, how­ movements but served rather to con­ ever, of vital importance to the firm them. completion of the investigation which Professor Sprague’s volume of 484 the commission had undertaken. This pages on “The History of Crises under was especially true of the two mono­ the National Banking System” is an graphs by Dr. David Kinley on “The important contribution to our financial Independent Treasury of the United literature and the most valuable of the States and its Relations to the Banks original studies made for the Monetary of the Country” and “The Use of Commission. It is a careful, critical Credit Instruments in Payments in examination of the results of banking the United States.” The study of policy and management as developed Treasury operations left no doubt con­ under the National Bank Act in all the cerning the need of some new and periods of crisis from 1873 to 1907. efficient machinery for handling the Professor Sprague describes the nature government’s financial business, while of the problems that presented them­ the investigation of the use of credit selves from time to time and compares instruments fixed attention on the the success of the methods that were tremendously important function of evolved to meet them. His final judg­ the deposit currency as a means of ment is that “it is impossible to escape employing bank credit in the trans­ the depressing conclusion that the action of the business of the country. banking situation in 1907 was handled less skilfully and boldly than in 1893, V a l u a b l e C ontributions and far less so than in 1873. No new Among the most notable of the new elements of weakness were disclosed, contributions to the study of American but no real effort was made to over­ conditions were the “Seasonal Vari­ come difficulties which had been met, ations in the Relative Demand for with partial success at least, on former Money and Capital in the United occasions.” The most important lesson States” by Professor E. W. Kemmerer to be drawn from Professor Sprague’s and the “History of Crises under the study is that banking reform would National Banking System” by Pro­ prove most certain and successful if fessor O. M. W. Sprague. The volume pursued along the line of the means by Professor Kemmerer is an elaborate naturally evolved by our bankers for statistical study based on a mass of meeting their problems. financial data, such as statements of Such an inference is in accordance condition of banks, clearing house with our best experience. Probably returns, movements of money, rates of the most successful banking system we exchange, monetary circulation, bond have had in this country was the prices, etc. The study was not con­ Suffolk system of the New England

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 20 T h e A n na ls of the A m erican A cademy states in the period before the Civil “The German Great Banks and their War. This was a plan of banking Concentration in Connection with the developed by bankers, slightly aided Economic Development of Germany,” from time to time in their efforts by almost the entire report and proceed­ the law, to insure efficiency and safety ings of the “German Bank Inquiry in the employment of bank credit on a Commission of 1908,” a series of articles basis of circulating notes. If bankers from the Frankfurter Zeitung relating since the Civil War had been free to to “The Renewal of the Reichsbank act in accordance with their experi­ Charter” and a series of “Miscel­ ence, and had been reasonably sup­ laneous Articles on German Banking” ported by the law, there is no reason extracted mainly from the proceedings to suppose that they could not have of the Third German Bankers’ Conven­ developed for the whole country equally tion. But in spite of the large amount efficient and successful methods of of space given to German material, insuring safety in the use of bank the publications of the Commission credit based on deposit currency. contain no general review of German banking as a whole, an omission which I nvestigation o f F o r e ig n B a n k in g can only be regarded as a defect in the S y s t e m s work of the Commission since so much In the investigation of foreign bank­ importance was attached to German ing and currency conditions, much conditions and experience. more attention was given to England, The information relating to English France and Germany because it was and French conditions is much briefer believed that business conditions in but also more useful in making a these countries were more nearly like comparative study of American ex­ our own. Of the 9,000 pages in the perience. The monographs by Hartley publications devoted to material re­ Withers on “The English Banking lating to foreign countries, over 6,500 System” and by R. H. I. Palgrave on deal with conditions in these three the “History of the Separation of the countries alone, and of these pages Departments of the Bank of England” about 4,500 relate exclusively to Ger­ are the best of the publications re­ many. It was the opinion of Senator lating to England. Mr. Withers’ Aldrich, as well as of some other mem­ statement is an illuminating account bers of the Commission, that the bank­ of the complicated relations of the ing system of Germany was of more Bank of England, the joint-stock and interest than any other to the people of private banks, and the accepting the United States because the indus­ houses and discount houses, and the trial and commercial interests of the position of all of them in the market. German Empire were very largely of The most valuable of the publi­ the same character as our own. This cations dealing with French conditions German material, like that relating to are the “Evolution of Credit and the United States, consists largely of Banks in France from the Founding reprints in English translation of books, of the Bank of France to the Present reports and papers previously pub­ Time” by Andre Liesse and “The lished in German. These reprints Bank of France in its Relation to include the memorial history of “The National and International Credit.” Reichsbank, 1876- 1900,” the “German Some of the best information con­ Imperial Banking Laws,” the third cerning the operation of the foreign German edition of Dr. Jacob Riesser’s banking systems, and particularly those

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e S tudies of the M onetary C ommission 21 of England, France and Germany, Monetary Commission had in shaping is to be found in the reports of the its conclusions concerning the defects interviews held in the summer of 1908, of our banking system and in devising The replies to questions put to bank the necessary measures of reform officials in these interviews, with re­ which were finally submitted to Con­ spect both to what they said and gress in the form of a report and a bill what they left unsaid, often throw at the beginning of 1912, three and more light on some aspects of the one-half years after the initiation of the actual working of the foreign systems Commission’s work. A large portion than anything else published by the of the publications of the Commission Commission. But the information were issued in 1910 before anything contained in these reports is not so definite was known of the plan of accessible because no attempt was reform to be recommended. In Janu­ made to analyze and digest it in a ary, 1911, Senator Aldrich personally systematic manner. gave out what he described as a “suggested plan of monetary legisla­ D is c l o s u r e s a s t h e R e s u l t o f tion.” C o n t r a s t in g B a n k in g S y s t e m s In substance this plan was an The things which this extended elaborate central bank scheme to be study of foreign banking conditions owned and controlled by the banks of emphasizes in contrast with American the country with due representation of conditions are: the government on its official board. 1. The existence in each country of a This suggested plan does not seem to central institution, more or less closely have been the product of any delibera­ related to the government of the tions of the National Monetary Com­ country, which serves not only as a mission itself, based on the results of government bank but also as a bank­ the scientific inquiry it had been er’s bank and as a bank for the public. conducting. No formal meetings of 2. The centralization and control the Commission as an official body were of note issue by means of these insti­ held before the fall of 1911 when a tutions. resolution calling for a report from the 3. The high degree of centralization National Monetary Commission on in general administration and manage­ January 8, following, was introduced in ment of reserves in all countries. Congress by Senator Cummins of The publication of this mass of Iowa and adopted. material relating to foreign banking Although due allowance must ]be was one of the most useful services made for the influence of American that the National Monetary Com­ opinion and European experience, the mission performed. It made avail­ suggested plan was probably the work able for our political leaders, banking of Senator Aldrich, aided by the advice and financial journalists and the gen­ of a few experienced men, ajnong eral public, a vast fund of information whom Mr. Paul M. Warburg, the on banking organization and operation New York banker, is commonly re­ in foreign countries which was formerly puted to have played an influential known only to expert students of the part. The proposals made in this plan, subject. which soon came to be spoken of as the It is not easy to estimate the in­ Aldrich Plan, were fully discussed for fluence which the studies carried on several months in meetings of bankers under the direction of the National and business men and in economic,

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis m T he A n na ls op the A m erican A cademy banking and financial periodicals and To rectify these evils, the bill recom­ newspapers. In October, 1911, the mended by the Commission proposed plan was revised and redrafted in the to incorporate the National Reserve form of a bill and included in the Association of the United States, with report submitted to Congress on Jan­ a capital of $100,000,000 to be sub­ uary 8, 1912, as the recommendation scribed voluntarily by national banks, of the National Monetary Commission. and also by state banks and trust companies under certain conditions. D e f e c t s i n t h e U n it e d S t a t e s Subscribing banks in contiguous ter­ B a n k in g S y s t e m ritory were to be grouped in local The defects in our banking system associations, while these local associa­ which are elaborately summarized in tions were to be combined into fifteen the report of the Commission may, for district associations covering the en­ the purposes of this paper, be briefly tire territory of the United States and recapitulated as follows: serving as branches of the National 1. The existing banking system pro­ Association. The central association vides no effective means for coopera­ thus organized was to have authority: tion by banks in crises. 1. To take over the note issuing 2. It admits of no concentration of function of the national banks, basing the banking reserves of the country for such note issues ultimately on legal use in times of stringency or unusual money and first class commercial strain. paper instead of bonds, and further, to 3. The banknote circulation fails to have the privilege of issuing additional respond, through automatic expansion notes, having the same security, on and contraction, to changing needs of payment of a graduated tax thereon. business. 2. To rediscount for national banks 4. The existing system provides no first class commercial paper maturing effective agency for facilitating ex­ in short periods of time. changes and transfers of funds between 3. To transfer funds for national different localities and sections of the banks between the central association country. and the branches, and between the 5. It affords no means of properly branches. regulating the foreign exchanges and 4. To receive and hold deposits of controlling the international flow of subscribing banks and the government, gold. but no private deposits. 6. Interior communities do not have To insure safety in reserve manage­ the benefits of ready access to the ment the National Association was central money markets. required to hold a cash reserve equal to 7. Existing arrangements lead to fifty per cent of its demand liabilities. the congestion of banking resources in It was also provided that the associa­ large financial centers stimulating spec­ tion should serve as a depository for ulation when they are accumulating public funds and as the fiscal agent of and unsettling the market when they the Federal government. No changes are withdrawn. were made in the reserve requirements 8. The accumulation of government of national banks except that they funds in other institutions than the could count the notes of the central banks results in constant disturbance association as well as their deposits of bank reserves and further unsettling with it as reserves. of the market. Probably no economic measure ever

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e S tudies of the M onetary C ommission 23 brought before the Congress of the United States received at the hands of T h e R e s e r v e A ct a n d t h e political leaders, students of banking M o n e t a r y C o m m iss io n ’s W o r k and currency problems, and the general The extent to which the framers of public, such comprehensive study and the Federal Reserve Act drew upon the thorough discussion as this one, but in work of the National Monetary Com­ spite of the great amount of time and mission has been a matter of some labor spent on it and the heavy ex­ interest. At the time the Act was pense incurred, it had no direct under discussion many people regarded consequences whatever in the way of it as nothing but a copy in large part of constructive legislation. the Aldrich Plan, but there were no substantial grounds for such a claim, P o l it ic a l C h a n g e a n d t h e A l d r ic h although the two projects were similar P l a n in many of their fundamental provi­ By the beginning of 1912 the politi­ sions. In describing the legislative cal situation had completely changed history of the Federal Reserve Act and the recommendations of the Mone­ some months after its passage, Dr. H. tary Commission were never brought Parker Willis, who was the expert of up in Congress for consideration. the House Banking Currency Com­ Many of the men who had been mem­ mittee while the bill was being drafted, bers of the Commission when it was makes the following statement con­ organized had either retired from cerning its origin:1 public life or had been retired in the The Federal Reserve Act is the product elections of 1910. During the dis­ of a lengthy course of development and has cussion of Senator Aldrich’s suggested grown gradually out of the discussion and plan, which preceded the formal sub­ analysis of the past twenty years. It is not mission of the Commission’s findings drawn, even largely, from any single and recommendations, much oppo­ source, but is the product of comparisons, selection and refinement upon the various sition of a general character developed materials, ideas and data, rendered avail­ against it, not apparently because of able throughout a long course of study and any lack of confidence in the soundness agitation. Many bills embodying the same of the measures proposed, but because general line of thought that now finds of a general distrust of the men who expression in the new act have been were primarily responsible for it, offered in Congress. particularly of Senator Aldrich who, as chairman, had controlled and directed All of this might be said also, with all the activities of the Commission. equal truth, of the Aldrich Plan itself. Whether or not it was warranted, there Certain it is, that the fundamental was a widespread belief in the country principles underlying the essential pro­ that Senator Aldrich was too close to visions of both measures were well some of the great business interests established in European and American whose purposes, it was believed, were banking theory. not always in harmony with the The investigations of the National highest public welfare. In view of this Monetary Commission were limited to attitude of the public it was not un­ the field of banking and bank currency natural that the new party leaders in although the scope of the instructions Congress should decline to look for given the Commission by the law guidance in the work and findings of would have permitted a wider range the National Monetary Commission. 1 American Economic Review, Vol. IV, p. 18.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis u T h e A n na ls of the A m erican A cademy of activities. Many students thought would be effected thereby were very at the time that it was a good oppor­ common. But it is a strange economy tunity to amend some of the other of money that results in inflation! serious defects in our monetary sys­ When the history of some of the pro­ tem. Since the beginning of the Civil visions of the Federal Reserve Act and War, our money had become the most its amendments comes to be written, heterogeneous and complex of any in the judgment will be that they were use by the great nations of the world. inflationist legislation and that their Besides the gold basis, it included enactment added still others to a long several different types of fiduciary list of monetary errors into which the money in large amounts with compli­ country has fallen. cated machinery for maintaining them at a parity with the standard. A S o m e U n l e a r n e d L e s s o n s general reform of our banking system While the National Monetary Com­ and bank currency was regarded by mission devoted a large amount of many as furnishing the best oppor­ attention to the organization and tunity to secure a final solution of the working of the foreign banking sys­ greenback and silver questions, but tems, it neglected some aspects of those the National Monetary Commission systems, a better understanding of avoided these issues as did also the which might have led to a clearer framers of the Federal Reserve Act. conception of the true defects of our own systems and of the best means of C u r r e n c y C omplexities P e r s is t correcting them. Perhaps the most Today, it is a serious question significant feature of the great foreign whether or not the addition of the systems, according to the studies of Federal Reserve notes to our monetary the Commission, is the high degree of circulation, without any material centralization that exists in control change in the amount of national bank and management. But while the in­ notes or the other forms of fiduciary fluence of the great central institutions money in use, has not increased the in securing this centralization is complexity and difficulties of our mone­ strongly emphasized, no emphasis is tary system without improving its laid on the effect of extreme con­ efficiency as an instrument of economic centration in foreign banking due to the welfare. widely extended system of branches. Between 1913 and 1920 the United A relatively few great companies or States passed through a period of in­ corporations, including the central flation that exceeded in its extent banks, control the business of banking anything in our previous history. in England, France and Germany. Some of this was due to our large This control is exercised from central acquisitions of new gold, but far more offices, usually located in the financial of it was due to the release of gold center of the country. This is an from bank reserves, made possible by important, distinguishing feature of the issue of Federal Reserve notes European banking as compared with when the reserve requirements under our own. the Federal Reserve Act were changed In the United States much praise to their present form by the amend­ has been conferred on the Canadian ment of June, 1917. After this change banking system, but the chief differ­ in the law, expressions of gratification ence between it and our own lies in the over the great economy of money that fact that Canada has relatively few

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e Studies of the M onetary C ommission 25 banking corporations with many explanation of the true nature of this branches widely scattered. Between control and how it is exercised. The 1900 and 1912 about 15,000 new banks impression is often gained that the were organized in the Unites States. bank rate determines the market rate, This meant 15,000 new boards of but it would probably be just as true to directors and probably as many new say that the market rate determines conceptions of what constitutes sound the bank rate. When Lord Avebury, bank policy and management. The partner of Robarts, Lubbock and existence of our vast number of in­ Company, was asked concerning the dependent institutions needs only to be extent to which the bank rate governed mentioned to make it clear that no their loan and discount transactions, scheme of cooperation among banks he replied, “The bank rate generally is yet devised in this country will give an expression of the market rate.” the degree of centralization in control The truth is that the market rate is a and management that has been at­ competitive rate in the determination tained under the foreign branch sys­ of which the competition, actual or tems. potential, of the Bank of England with the other banks is always a factor. S u c c e s s f u l B a n k in g P r im a r il y a Q u e s t io n o f A dministration I n f l u e n c e o f B a n k in g C o m p e t it io n Another aspect of this subject is also of vital importance. If there is any The influence of competition is more one lesson that the study of European clearly seen in the operation of the experience enforces, it is that success­ French system than in that of England. ful banking is more a question of In replying to a direct question con­ administration than of law. As Hart­ cerning the competition of the Bank ley Withers says, “Good banking is of France with the other banks, M. produced, not by good laws, b b y Pallain, the governor of the Bank of good bankers.” An important con­ France, said, “On certain points there sequence of the extreme concentration may be competition, and it is on in foreign banking is that it brings the account of this salutary competition best banking talent into positions of that wherever a branch of the Bank responsibility and control. No doubt has been established the rate of dis­ our best bankers are the equals of the count has been perceptibly reduced, in best European bankers but our type the interest of commerce.” of banking does not bring them into The fact is that the control of the flow positions where they can exercise of credit in these countries is a competi­ complete control over the banking tive one. The central banks are not business of the country. only bankers’ banks and government The apparent control of the flow of banks; they are also public banks and credit in the leading European coun­ compete with the other great central­ tries through the manipulation of the ized institutions for a share of the discount rates of the central banks, is banking business of the country. Their another feature of foreign banking relations to their governments, their which has always been in sharp con­ prestige, and the fact that their trast with our own practice and which managers think not only of profits but we have tried to imitate in our banking of the national economic welfare, reform. The studies of the Monetary places them in a strong competitive Commission furnish no satisfactory position and enables them to exercise

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 26 T h e A n na ls of the A m erican A cademy an influence much out of proportion to explanation is that the Federal Re­ the amount of business they do. serve Banks are banks for banks and There has been much discussion banks for government and not, at recently of the discount policy of the the same time, public banks in the Federal Reserve Board and the control true sense of the word. They cannot of the flow of credit under the Federal exert the competitive influence against Reserve System. The charges of the other banks that the foreign cen­ banks to their customers have not been tral banks exert. They are not in fact materially affected by the manipula­ in the market and cannot, in conse­ tion of the rediscount rates. The quence, share in market control.

The National Citizens’ League A Movement for a Sound Banking System By Harry A. W heeler Vice-President, Union Trust Company of Chicago S a result of the panic of 1907 the and other legitimate interests of the business men of the country be­ country; Fourth—Said system to be absolutely Acame greatly concerned for the com­free from domination or control by political mercial safety of the future. At the or any other favored interests; annual meeting of the National Board Resolved, That the National Board of of Trade, held in Washington on Jan­ Trade calls upon all its constituent bodies uary 25,26 and 27, 1910, the subject of to carefully study the fundamental princi­ monetary reform was discussed and the ples of banking and currency, in order to following resolutions were unanimously intelligently aid the enactment of such adopted: legislation as will best conserve the in­ Whereas, We assume that a plan for the terests of the entire country. revision of our currency system will be The National Board of Trade deter­ formulated after the National Monetary mined to devote one day in connection Commission has made its final report; and Whereas, A revision of our currency with its annual meeting in 1911 a system upon a permanently sound and Business Men’s Monetary Conference. scientific basis is of vital importance to all January 18 was set aside as “Monetary interests and should be accomplished as Day.” Two hundred selected com­ soon as practicable; mercial bodies were to appoint special Resolved, That the National Board of committees to make a careful study of Trade favors the adoption of a currency the banking question. Each organiza­ system which will be based upon the fol­ tion was requested to submit its lowing fundamental principles and insure conclusions and recommendations to the following results: First—Be absolutely fair to all interests the National Board of Trade at least and to all localities; one month before the meeting and to Second—Insure at all times an adequate send a representative to the meeting, supply of properly safeguarded currency; to be held in Washington beginning Third—The volume of said currency to January 17, 1911. The invitation met automatically expand and contract in with a hearty response on the part of response to the normal demands of the the commercial organizations through­ manufacturing, commercial, agricultural, out the country and a large number

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he N ational C itizen s’ L eague 27 of delegates participated in the con­ The new movement was initiated by ference. the Chicago Association of Commerce. The Business Men’s Monetary Con­ A joint meeting of the Board of Direc­ ference, under the chairmanship of tors and the Executive Committee of C. Stuart Patterson of Philadelphia, the Association was held on May 2 9 , adopted resolutions which ultimately and took action by passing the follow­ led to the creation of the National ing resolution: Citizens’ League. By these resolutions, Resolved, That the Chicago Association of the chairman of the Conference was Commerce recognizing the distressing ef­ authorized to appoint a committee of fects of panics on trade, capital, and labor, seven to organize a “Business Men’s the consequent need of a sound banking Monetary Reform League,” with head­ system in the interest of all the people in quarters in Chicago and branches in the country, and the suggestion made for the principal centers of the country, the creation of a National Reserve Associa­ tion, hereby requests John G. Shedd, whose object should be to conduct a Marvin Hughitt, Graham Taylor, Harry A. comprehensive compaign of education Wheeler, B. E. Sunny, Cyrus H. McCor­ in behalf of some kind of national mick, Julius Rosenwald, Charles H. Wacker, reserve association. It was agreed Frederic A. Delano, John Barton Payne, that the delegates to the Conference A. C. Bartlett, A. A. Sprague, J. Laurence should endeavor to enlist the active Laughlin, John V. Farwell, Clyde M. Carr, aid of the commercial bodies they Fred W. Upham, F. H. Armstrong, and represented. Joseph Basch to form a National Citizens’ Acting on the authority of these League, the object of which shall be to give resolutions, a committee was appointed organized expression to the growing public composed of: C. Stuart Patterson, of sentiment in favor of, and to aid in, securing Philadelphia, James J. Storrow, of legislation necessary to insure an improved Boston, Paul M. Warburg, of New banking system for the United States of York, Irving T. Bush, of New York, America. George D. Markham, of St. Louis, Acting under this authority, “The Fred W. Upham, of Chicago and National Citizens’ League for the Pro­ Harry A. Wheeler, of Chicago. This motion of a Sound Banking System” committee was called into conference was organized and a certificate of in­ in Chicago on April 2 4 , 1911. The corporation was granted by the Secre­ committee was unanimous in its opin­ tary of State under date of June 6, ion that the responsibility of creating a 1911. Article 2 of the certificate of national organization should be left incorporation is as follows: “The with the business men of Chicago, who object for which it is formed is to give should conduct a nation-wide cam­ organized expression to the growing paign from their city. public sentiment in favor of, and to On April 2 7 , 1911, a conference was carry on a campaign of education for called by the committee at which were an improved banking system for the present about fifty of Chicago’s fore­ United States of America.” In organ­ most business men, representing both ization and in operation the Citizens’ the commercial and the financial field. League was at once made national. This conference, after careful delibera­ The Chicago Association of Com­ tion, agreed to accept as a duty and merce only accepted a responsibility privilege the responsibility of conduct­ imposed upon it by the other com­ ing the campaign from Chicago as a mercial bodies of the nation to take the center. initiative in the conduct of a campaign

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 28 T h e A n n a ls of the A m erican A cademy to which their support had been of the United States of America, acting pledged. The only part taken by the under instructions unanimously voted by Chicago Association, as such, was to the convention of January twenty-first to twenty-third, 1913, urge upon the Banking launch the new League. This done, and Currency Committee of the House of it surrendered all control into the Representatives the early submission to hands of the Board of Directors of the Congress in extra session of a measure League. which will overcome the difficulties from In April, 1913, pursuant to a call which we are suffering; upon the Senate, from the President of the United its prompt consideration of such measure States and his Secretary of Commerce, at the extra session; and upon President­ the Chamber of Commerce of the elect Wilson, his cordial and earnest United States was organized. It support in favor of early and complete legislation. became the sucessor to the National And be it further Resolved, That a copy of Board of Trade and, recognizing its this memorial be sent to President-elect relation to the subject of monetary Wilson and to Honorable Carter Glass, of reform, established a close contact the Banking and Currency Committee of with the Citizens’ League. the House of Representatives. The first Annual Meeting of the Chamber of Commerce of the United A standing Committee on Currency States, in January, 1913, dealt with and Banking was also appointed to the problem as of first importance to press upon the Administration the the new incoming administration and necessity for early action, to follow instructed its Board of Directors to legislative development, and to prepare present the matter to the President­ a report for subsequent submission to elect. In February, 1913, the direc­ the membership through referendum, tors carried into effect the mandate of as provided in the rules. the Annual Meeting by the following This committee was composed of resolution: Wallace D. Simmons, St. Louis, Chair­ man, John W. Craddock, Lynchburg, The Chamber of Commerce of the Virginia, Irving T. Bush, New York United States of America believes the City, Edmund D. Fisher, New York present moment to be one of grave import to banking and currency legislation. The City, Edward D. Page, Oakland, New country has been profoundly stirred by the Jersey, Joseph French Johnson, New discussions of the past two years. The York City, J. Laurence Laughlin, defects of our present system are generally Chicago, George A. Mahan, Hannibal, understood to constitute a menace, both to Missouri, William A. Scott, Madison, our domestic and to our international Wisconsin, William George Bruce, trade. The business men of the country Milwaukee, Wisconsin, J. M. Miller, should not again be exposed to the rigors of Jr., Richmond, Virginia, Allen Cucullu, another such stringency as followed the Lynchburg, Virginia, John V. Farwell, large crop of 1912. The expected changes Chicago, Edmund D. Hulbert, Chicago. in our tariffs and the financing of another crop in 1913 make imperative immediate It completed its preliminary work in action by Congress. Moreover, it is ap­ August, 1913, and sent to referendum parent that the presentation of a sound a report on pending legislation with measure to Congress would crystallize recommendations for amendment in behind it the support of the business and keeping with the principles put for­ banking interests of the country. ward by the National Citizens’ Therefore be it Resolved, That the Board League. of Directors of the Chamber of Commerce The League, having completed the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E ducational Campaign for B ank ing R eform 29 work for which it was organized, lative stages and disbanded; the formally requested the Chamber of Chamber, through its Committee, fol­ Commerce of the United States to lowed the matter closely until its pursue the subject through its legis­ “Federal Reserve Act” became a law.

The Educational Campaign for Banking Reform By A. D. W e l t o n Continental and Commercial National Bank, Chicago RGANIZING the National Citi­ time a central bank or the central­ zens League in 1911 was no less ization of banking power was men­ a task than organizing the country.tioned. The traditions of the Demo­ ItO was the final step, outside of cratic party stood as strongly in this political declaration and legislative respect as when Andrew Jackson and action, to bring about a demand for Nicholas Biddle fought over the Sec­ the reform of the nation’s banking ond Bank of the United States eighty laws. The havoc of the last panic years before. The mention of asset had been wrought. Emergency legis­ currency roused the smoldering fires lation in the form of the Aldrich- of greenbackism and free silverism. Vreeland Act was on the Statute It was plain that many people cher­ Books. The Monetary Commission ished the belief that issuing currency had junketed, experted and ruminated was a sovereign power of the govern­ and Senator Aldrich was working on a ment, and Mr. Bryan was present to reform proposal. insist that such was the case. From these statements it might be Every time the question of currency gathered that public sentiment had had come up for popular considera­ at least begun to crystallize; that the tion in the three preceding decades, subject of all this discussion and effort the believers in soundness as wrought was nearing the point of issue and by a single gold standard had been on action. Nothing was farther from the defensive. They merely prevented the truth. There was no popular their enemy from doing something comprehension of what it was all about. vicious. The one constructive bit of Panic meant only a lack of currency. legislation was the Gold Standard Newspaper writers were miles at sea. Act of 1898. That followed the affair Politicians were floundering in dark­ of 1896 as the Aldrich-Vreeland Act ness. Practical bankers were looking and the appointment of the Monetary to their few leaders for guidance. Commission followed the panic of The economists, however clear their 1907. theories, were blinded by traditions, and precedents of long standing. E d u c a t io n a F o r m id a b l e There was a dominant desire for a U n d e r t a k in g change but any suggestion of a All the studies of the Commission practical plan raised a clamor of pointed to the necessity of a plan for hostility to centralization, the great banking cooperation, for mobilizing political bugaboo. reserves, for making both currency The persistence of political rancor and credit elastic, and for creating a found a new demonstration every discount market. It was a formidable

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 30 T h e A n na ls of the A m erican A cademy enough undertaking to make any charged with all kinds of crimes and considerable portion of the people would plead to no indictment. There understand these things. It was a were two “money trusts” in fact—one much larger one to make a consider­ that the politicians created out of able portion of them unlearn the their vivid imaginations for their financial follies they had been taught. own private uses, and another, de­ For this undertaking the teachers fined as a “community of interest” were not many. It was necessary to among powerful bankers, created by a train teachers. The bankers were of defective and inadequate banking sys­ little assistance in this way. Very tem. The imagined “Money Trust,” few of them understood the science linked with a plan to reform the of banking, however versed they banking and monetary system, became might be in the art of it; fewer much more imposing as a political still were competent to teach the spectre. Such a “Money Trust” must economics of money. Moreover, the necessarily have impious designs, and bankers were under suspicion. Had what more natural than it should seek they not defeated Mr. Bryan in 1896 to have the banking laws remodeled and subsequently and also subse­ to fit its own purposes! quently? Mr. Bryan had frequently Here was another barrier the League testified to that fact. had to take. Finally, Senator Nelson W. Al­ drich was Chairman of the Monetary P o l it ic a l a n d P a r t is a n Commission. For years he had been C omplexities in a conspicuous position of leader­ Another circumstance lets in light ship. His name was synonymous with on the difficulties that lay before this everything abhorrent to progressive economic missionary. Republicans had thought. In the public mind he was passed the Aldrich-Vreeland law and first friend of the trusts, advocate of planned the work of the Monetary Com­ special privilege, the defender of Wall mission. Republicans had planned Street and ally of the money devil. to drive through a new banking act. Politically, it made no difference that But a new Congress had been elected the Senator from Rhode Island had with a Democratic House. There worked hard for years to equip himself were even predictions that the next for the task now on hand. It was of no president would be a Democrat. Wis­ moment that his great ambition was dom forbade that the League have to give the United States a sound even a remote appearance of parti­ banking system or that his devotion sanship. As a matter of fact the was complete and unselfish. He was manner of its organization made a popular target for editorial anath­ partisanship impossible but it was emas and anything emanating from frequently charged in the first months him must be bad because of its origin. that this was “the million dollar or­ In June, 1911, approval of a plan ganization formed to put over the for a new banking system meant Aldrich banking scheme.” approval of Aldrich. The National It is unnecessary to go farther into Citizens’ League came into existence the conditions of the day to show under a handicap. that the League had a large task and The “Money Trust” was an active that it would have to justify itself by monster of that day also. It was an performance if it was to survive and indefinite something which could be succeed.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E ducational Cam paign for B ank ing R eform S i

E a r l y I n v e n t o r y o f t h e L e a g u e ’s particular scheme of reform. It deals in concrete plans only by way of illustrat­ W o r k ing the great general problems of efficiency It succeeded so well that in March, of bank reserves, a discount market, in­ 1912, it took account of itself as dependent banking, an elastic currency and follows:1 credit system and adequate banking facili­ The campaign for banking reform has ties. Its belief is that when the people come been carried into 44 states. The National to have an understanding of the fundamen­ Citizens’ League has now 46 organizations— tal requisites of an efficient monetary and one in each of 43 states, two in California, banking system the legislation will take and the German section with headquarters care of itself. With the fundaments in New York City. The extension of this understood, as they will be, the working out organization work reflects the progress of of the details may be left to Congress. the sentiment for an improved monetary How the application is made, or what the and credit system. system is called are matters of.no impor­ The League came into corporate ex­ tance. Who frames the measure finally istence in June, 1911. It is a non-partisan adopted or after whom it is named, are organization. It has no affiliations with equally inconsequential. any class or any interest. Among the 1,500 officers of its branches and its R e c r u it in g t h e F o r c e o f increasing thousands of members, men E d u c a t o r s engaged in manufacturing, merchandising and agricultural business are in the great It is not surprising that an organi­ majority. The business element is pre­ zation so elaborately born should ponderant. The League and its campaign have a name as elaborate. Almost have been indorsed by resolutions adopted the first error was in this selection. by 68 boards of trade and associations of The National Citizens’ League for the commerce and similar organizations. Promotion of a Sound Banking System There is reason for this preponderance of business men. The League had its was the cumbersome heritage of the origin at a meeting of the National Board men who later assumed the work of of Trade in Washington. The business giving the scheme publicity. As the organizations represented there felt that economists—the professors of political they should have a voice in the question economy—were about the only ones of improving anything of such vital who could write on questions of interest to them as the monetary system. banking, they were drafted early. C. Stuart Patterson, of Philadelphia, The work of creating organizations in was made chairman of a committee the various states was speedily got appointed at that meeting which later under way. Pamphlets on pertinent conferred with the Chicago Business Men’s Monetary Reform League. subjects were produced and printed. The Chicago Association of Commerce Speakers—mostly economists—were volunteered to launch the new organization recruited. A declaration of the prin­ and requested the present Chicago Execu­ ciples the League indorsed was made. tive Committee to undertake the work. Large sums of money were spent. Thus the National Citizens’ League came Later, and not much later, the diffi­ into existence. culty that always confronts such The astonihisng feature of the progress organizations, was encountered. It was of the League is that it has met prac­ necessary to expend time and energy tically no opposition. This is undoubt­ in raising funds to support the work. edly due to the fact that its work has been The publicity work was conven­ wholly educative. It has indorsed no tionally organized. Pamphlets, whose 1 Banking Reform Magazine, March 16, 1912. distribution called for mailing lists,

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 32 T he A n na ls of the A m erican A cademy were a matter of course. Member­ were carefully met and countered. ship in the League at $1 a year carried Some of these were temporarily seri­ with it all published matter and an obli­ ous but usually they were ludicrous. gation to spread the gospel. All were treated alike. If the op­ The state and local organizations, ponent of banking reform or the in some cases self-supporting but always advocate of something unsound found with a paid secretary, supplied names space for his outpouring in a newspaper, for the mailing lists and often did the the same newspaper was supplied distributing. |The entire list of League with other material, often through a officers and directors would make a local League representative. If the business blue book. Local secretaries first newspaper refused publicity, the were chosen, so far as possible, be­ rival paper was tried. If both , were cause of some familiarity with pub­ recalcitrant a local mailing list was licity methods. There was no rule. compiled and used. In some states publicity was the only medium used. In others, dependence M o n t h l y M a g a z in e s t h e G r e a t e s t was placed on meetings and speakers. P u b l ic it y M e d iu m In still others, local business organi­ The League’s monthly publication, zations were enlisted. This was all Banking Reform, was used in most ordered by expediency or the desires cases. It was the uninvited visitor or peculiarities of the local officials. to every newspaper office in the The undertaking of the central country. It could be, and frequently office in Chicago was to guide the was, used to meet some special thought of every member of the opposition, % When a weekly paper League, every officer of each state in an obscure county of California organization. As loosely joined as assaulted the Monetary Commission, the organization was, a single policy the League, banking reform and every­ and harmony of purpose were indis­ one interested in it, a special edition pensable. of Banking Reform was printed and The marvelous and general lack of sent to everyone in the county. It was familiarity of the general run of effective. bankers and business men with mone­ When a venerable, retired county tary problems was of great assistance. judge in Texas unlimbered a page of They had to take what was given heavy artillery in the county seat them because they had practically no paper on the sacred and sovereign other sources of information. The right of the government to issue money, old sources of monetary information the case could not be ignored. The were dried up. Previous demands rhetorical flood was broken up, the for monetary reform were directed at facts extracted and a reply written the currency and the quantity of it. and sent to the paper. It was pub­ Financial progress in terms of elastic lished—two-thirds of a column. The credit and bank reserves was unprec­ venerable judge countered with an­ edented and, considered by itself, other solid page. The reply was strikingly logical. short and pointed. The judge was This is not to say that the old unwittingly doing well for the League, “isms” did not outcrop at frequent He became interested in the new intervals and in unexpected places. proposition. He wrote to headquarters The local secretaries watched care­ for pamphlets. A month later he fully for such outbursts and they graciously acknowledged his conver­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E ducational Campaign for B ank ing R eform 33 sion, sent in a dollar and joined the vision of our antiquated banking laws” League. This incident had no repe­ and demanded the creation of an tition. The devotees of greenbacks, “elastic note and credit system,” the free silver and the “sovereign right turn came. The politicians were be­ of the government” were, and are, coming familiar with the terminology. irreconcilable but they were not trouble­ In the platforms of state conventions some for long. Their attack lacked of both parties—and they followed versatility and mere continuity made rapidly—there were phrases and it tiresome. terms which bespoke familiarity with From the viewpoint of real publicity the League’s literature. Naturally the monthly, Banking Reform, was the these platform utterances were com­ mainstay of the publicity campaign. mented on by newspapers everywhere. It was the messenger to the press. It The comments were almost univer­ permitted repetition and reiteration, sally favorable. The terminology in which were necessary to give editors this field began clearly to indicate familiarity with what was to them a familiarity with banking reform. new terminology. It was slow and In June, 1912, came the great disheartening work for many months. national conventions. Both Demo­ Once the fervor of early political contro­ crat and Republican platforms had versy had cooled and political economy planks on the monetary question. was the order, publicity results were Neither one of them meant anything scant. In the central office clippings in particular. The Republicans called were garnered with care and treasured in attention to the party’s historic stand the files. One of the first months of for a sound currency, and the Demo­ effort brought only seven. The next crats smashed away at Wall Street month there were none, which was and the “ Money Trust.” The League’s interpreted to mean that the seven publication said that banking re­ were accidents or incidents of edi­ form “is a political question only torial good nature. so far as its solution requires political attention in the highest sense of the A T im e W h e n P o l it ic s H e l p e d term. There is no chance that a Politics again intervened to give a Democratic scheme of reform will be stimulus. The other side of the League’s better than a Republican scheme organization was at work. State con­ because it is offered by Democrats, ventions of the political parties were or that a Republican scheme will ahead. The League’s text book, be superior because it is offered by Banking Reform, came from the press. Republicans. In banking methods The book was distributed widely to neither party is at an advantage members, whose number it was in­ over the other because banking is not strumental in increasing greatly, and a matter related to their differing was extensively reviewed. The book conceptions of popular government.” stimulated interest in the magazine Committed to banking reform and for which the demand also increased. not to politics or party, the League’s The clipping agency employed began purpose was to keep, so far as possible, to send in bulkier packages. These the question from assuming a partisan could now be read but they were no aspect. longer filed. When the Alabama Dem­ With the political phase formally ocratic convention had declared for entered, however, the publicity cam­ “a democratic and non-partisan re­ paign became more difficult in one

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 34 T h e A n na ls of the A m erican A cademy aspect and much easier in another. go to the national treasury. This as­ There was no longer difficulty in sociation should: having matter accepted and printed Hold the final banking reserves. by all kinds of publications. It was Act as fiscal agent of the government. in constant demand. The problem Rediscount standardized commercial paper for banks at published rates of discount uniform was to hold discussion to the essentials. over the country. Clippings now came in huge bundles Issue circulating notes secured by gold and and were dumped summarily into commercial paper. waste baskets. No one had time to Deal in gold and foreign exchange. look at them. The venerable judge Establish foreign agencies. from Texas might have flashed his It must be remembered that this message in fire on the sky and no statement was made two months League official would have heeded, before Woodrow Wilson was elected for banking reform had passed from president and eight months before the stage of a vague request to & Congress began to debate the Glass demand for speedy political action. bill. It was no longer a question of a new The League’s principles were care­ banking law, but what kind of new law. fully drawn very early in the cam­ paign. They took no account of E n u n c ia t io n o f F u n d a m e n t a l partisanship, except to guard against P r in c ip l e s it, as generally befitted an organization In September, 1912, the League of business men bent on securing an stated the principles it believed should economic reform. The principles were: underlie a banking bill. The statement gave as the reasons for banking 1. Cooperation, not dominant central­ ization, of all banks by an evolution out reform: of our clearing-house experiences. To prevent the recurrence of money 2. Protection of the credit system of the panics* country from the domination of any group To provide for seasonal and special of financial or political interests. demands for currency and credit. 3. Independence of the individual banks, - To insure more uniform and steady national or state, and uniform treatment interest rates throughout the country. in discounts and rates to ail banks, large or To divorce commercial from invest­ small. ment banking. 4. Provisions for making liquid the To strengthen our international credit. sound commercial paper of all the banks, To establish higher standards of banking. either in the form of credits or bank notes redeemable in gold or lawful money. It is remarkable, perhaps, in the Legalization of acceptances and time bills light of current discussions that in of exchange in order to create a discount 1912, Banking Reform said: market at home and abroad. The National Citizens’ League believes 5. Elasticity of currency and credit in that these reforms in our banking and times of seasonal demands and stringencies, currency system can be best brought with full protection against over-expansion. about by the formation of a cooperative 6. The organization of better banking association of all classes of commercial facilities with other countries to aid in the banks, with restricted powers, managed extension of our foreign trade. by a board of bankers, Federal officials and other citizens. The Association In the beginning, these six prin­ should not be a money-making institution ciples were the guide in all publicity. and all earnings beyond a fixed rate should Their amplification came when the %

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E ducational Cam paign for B ank ing R eform 35 final political stage was reached as crats in the important positions in noted above. House, Senate and elsewhere. The so-called “Money Trust” in­ The new President’s message on vestigation was an incident which banking reform preceded action in received only incidental attention. Congress. That is another story. In an educational way it had no During this period of many hearings significance. What is known as Wall by the banking and currency com­ Street never showed hostility to the mittees the publicity was continued as League; it gave much financial as­ actively as ever. As the League sistance and seemed quite uncon­ was concerned only with principles, cerned over the prospect of decen­ and not with administrative forms, tralized bank reserves. its printed matter gave no heed to the latter except for informative purposes. A t t it u d e o f B a n k e r s a n d O t h e r The magazine had naturally become the O rganizations dependence of many thousands of Bankers and bankers’ organizations persons for such information. Many were always helpful and friendly. newspapers looked to it for an inter­ They were never keen for the League’s pretation of the news developments. principles and, as a rule, they were Its influence was wide. Reading of collectively and individually more the news and comment on the pro­ interested in the probable effects of ceedings in Congress made the extent any change in laws on their estab­ of this influence clear and certainly lished method of operation. In this the members of Congress were not respect they often clashed with the immune to it. business men whom the League rep­ When the Glass bill had passed the resented but they always admitted House, it became apparent that the the need of change in the banking League’s work was nearly done. It scheme. had undertaken only to lay a founda­ As the campaign progressed other tion for legislative action. It is true forces came in to give assistance and its organization work had been carried often to interfere. Usually these or­ into practically every congressional ganizations made plans. Of plans district. The gospel of banking re­ for a new banking system there was a form was carried most effectively to myriad. They came up from all every congressman from his home. sides. Everyone seemed to have a But when the Glass bill had become plan. The League never had one. the Glass-Owen bill and the Senate In that lay its strength. ? had it under consideration, the League In September, 1921, Woodrow Wil­ began to wind up its affairs. son spoke of the need for a new bank­ ing law in his address accepting the C l o s e o f t h e C a m p a ig n Democratic nomination for the pres­ In the last issue of Banking Reform, idency. Soon after his election, and October, 1913, it was said: that of a Democratic House and The League never undertook to partici­ Senate, it became obvious that bank­ pate in the actual work of legislation. ing reform legislation would be a Article 2 of the certificate of incorporation Democratic action. This political reads: shift made it advisable to give un­ The object for which it is formed is to usual attention to the South because give organized expression to the growing seniority would place southern Demo­ public sentiment in favor of, and to carry

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 36 T h e A n na ls of the A m erican A cademy on a campaign of education for, an im­ to failure on the League’s part. It has been proved banking system for the United stated many times in these columns that States of America. the machinery by whose operation the Of the success of the League’s campaign principles enunciated were to be given there is no doubt. It is evidenced by the operation might assume any one of many fact that for more than two years the forms. The Monetary Commission evolved question of monetary reform has been one form, the Glass Committee evolved growing in the public mind until today it is another. Neither is perfect in anticipated the question of paramount political as well operation. It is doubtful if any ma­ as economic importance. It has occupied chinery will be perfect until made over the latter position for many years, but it after practical test. But either plan has was not until the League’s work was well obvious merits and forms a basis on which under way that it was lifted out of classifi­ can be built up an operating success. cation with the impenetrable mysteries to The Executive Committee of the League that of a great, and finally the paramount, feels, therefore, that the work of the organ­ public issue. One Congressman reduced ization has been practically completed and the situation to terse form when he said, success has been achieved. It will retain “No League, no bill.” its corporate entity and maintain its organ­ The League has distributed literally ization intact against possible contingen­ millions of pamphlets. It has been the cies until results are written in the statute means of supplying literally millions of books. But unless the unexpected hap­ columns of matter to newspapers. It has pens, the League will rest content that the supplied speakers for thousands of meet­ question of banking reform and its satis­ ings. But the indirect results of its efforts factory solution is in the hands of the have been more momentous. It brought national legislature. Over this body it has interest in the question of monetary science no control, and seeks none, as it has had to an acute stage. It challenged every none anywhere save what was based on argument founded on a false conception logic and built up on adherence to proved of monetary economics. It supplied ma­ principles of monetary economics. terial which made editorial work easier. It translated technicalities into simple As a final testimony of the efficiency language. It stimulated thought and dis­ of the League’s campaign, it may be cussion. It freed thousands from the pertinent to record that the terse thraldom of half a century of false teaching. statement, “No League, no bill,” The fact that the Glass bill is not per­ was made by the Honorable Carter fectly satisfying is in nowise attributable Glass.

The Federal Reserve Act in. Congress By H. P a r k e r W il l is Columbia University UCH has been vaguely or errone­ tory of the measure would be a task of M ously written of the early history lengthy detail. The following article of the Federal Reserve Act and there is is not intended to enter into any such already a widespread misunderstanding elaborate review but to set forth in regarding it. Some part of this mis­ compact form the chief facts, without understanding is due to the fact that controversial discussion. What it offers much of the work on the Act was done is merely a consecutive outline of the in committee or in caucus or in private history of the Federal Reserve Act conference. To review the whole his­ during its formation and subsequent

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e F ederal R eserve A ct in C ongress 37 discussion in Congress. It will afford, experience of the banks of the country however, as definite an historical ac­ in organizing clearing house associa­ count as is possible within a very brief tions. The conclusion was definitely space, of the various stages through reached that a central bank of issue which this measure passed. and deposit was not desirable but that, instead of this, a district type of organ­ I n c e p t io n o f M e a s u r e ization, in which the banks of the The inception of what afterward be­ country should participate, was to be came the Federal Reserve Act grew out preferred. It was further agreed that of the action of the Banking and Cur­ such district organizations ought to be rency Committee of the House of Rep­ vested with the function of issuing note resentatives in authorizing, during the currency upon what had come to be spring of the year 1912, an investiga­ known as the elastic, or “ asset secured” tion into currency and banking con­ plan. It was further thought that the ditions. This authorization led to the reserves of the country should clearly organization of the Banking and Cur­ be transferred to such organizations rency Committee in two parts, or and that large functions of examination sections—the one entrusted with an and oversight of the rank and file of inquiry into what was at the time the banks should be provided for. known as the “Money Trust” and the other assigned the duty of studying W o r k o f S ubcommittee and recommending legislation designed With these very general principles to promote banking and currency re­ definitely laid down as a basis, a bill form. This second subcommittee was was drafted during the summer and organized under the chairmanship of early autumn of 1912, and the sub­ the Honorable Carter Glass, who had stance of this bill was informally dis­ been for several years a member of the cussed at meetings of the subcommittee Banking and Currency Committee, which occurred during November, and its first active work was under­ 1912. At that time agreement was taken at about the opening of April, reached that further progress in the 1912. At that time this subcommittee development of the proposed bill would retained technical assistance, and in­ not be possible unless the attitude of structions were given to make a general the incoming administration (the Hon­ survey of pending banking and cur­ orable Woodrow Wilson having been rency legislation, including especially elected President early in November, the proposals of the National Mone­ 1912) could be known. Mr. Glass tary Commission which were embodied accordingly addressed a letter to in what had come to be known as the President-elect Wilson informing him Aldrich bill. generally of what had been done and Such a survey of pending and pro­ asking for his views in the matter. posed legislation, both recent and An early reply was received from the earlier, was completed and placed in President-elect in which he expressed the hands of the subcommittee during agreement in the thought that a suit­ June of 1912. An informal discussion able banking measure should be devel­ of the question of what lines should be oped at an early date, and a time was followed, ensued. As a result of this set for consultation with representa­ informal-discussion, it was agreed to tives of the subcommittee of the prepare a tentative bill which should Banking and Currency Committee. be based essentially upon the past This date was December 26, 1912, at

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 38 T h e A n na ls of the A m erican A cademy which time Mr. Glass visited Princeton present and views to express and where President-elect Wilson was then whether it was or was not wise to allow living. the contents of the proposed bill to During the conference on the 26th of become known. On both these points December there was laid before Mr. a definite policy was developed as Wilson the substance of the tentative follows: bill already drafted and question was 1. The question of holding hearings asked as to his opinion regarding the had been discussed with President­ extent to which the bill should go. elect Wilson at Princeton at the meet­ Particularly was the question raised ing already referred to, and he had with him whether the new bill should favored the holding of hearings. It provide for an emergency or permanent was now determined to make the type of banking organization; whether hearings very inclusive and to send out it should provide for local organization letters to representatives of labor, to or for a central control of some kind; manufacturers* associations, to bank­ whether reserves should be transferred ers, to economists and to business men. to the new banking organization and 2. It was further determined to whether new note issues should be pro­ make public no draft of the proposed vided for. Most of these points had bill but to mature it slowly and care­ not been considered by the President­ fully, especially in view of the fact that elect except in a very general way. He action on it could not be expected until expressed himself, however, as desirous after the incoming of the new admin­ of making the measure a thorough­ istration on March 4, 1913. It was, going, complete banking and currency however, determined to make known bill, and was positive in his thought to persons who had a legitimate inter­ that there should be a central control est in the pending measure the prin­ organization—although he accepted cipal lines of thought on which the the view already developed in the committee was working. Statements subcommittee—and that actual bank­ on this subject were made from time to ing should be carried on in districts time to a variety of inquirers, some of and by local organizations acting more them bankers, some, business men or or less independently of one another. representatives of their organizations, He was ready to support the transfer of some, legislators. As a result there reserves from existing banks to the new was a crop of bills—some published, organizations and, in general, granted others never printed but filed with the his support to the idea of complete committee—whose authors sought to transformation of the existing banking put down in writing what they be­ system. lieved to be a plan similar to that favored by the subcommittee and P u b l ic D is c u s s io n o f L e g is l a t io n hence presumably likely to become the By this time the fact that a bill was official plan of the administration. seriously under consideration in the There was thus a large crop of subcommittee on legislation had be­ so-called “original bank bills” in Con­ come widely known throughout the gress. The Aldrich bill was remodeled country among those who were inter­ by advocates for possible use, free of ested in securing action from Congress. many objectionable features, and was It became necessary to consider the issued as a revised plan by western stu­ question whether hearings should be dents of banking. Other plans were given to those who had arguments to developed in the same way and in

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e F ederal R eserve A ct in C ongress 39 sundry cases the authors of such plans completed about the beginning of continued to take an interest in the March, 1913. This third main draft matter after the Federal Reserve Act contained principally improvements in became public and as it passed from language and in technique but dis­ stage to stage, eventually correcting carded the plan of guaranteeing bank them and bringing them up to date as liabilities and also greatly simplified the Reserve Act itself was perfected in the method of electing directors. the course of its passage through the dif­ With the preparation of this plan ferent legislative processes. Thus there and the expiration of the old Congress was at all times during the year 1913 a on March 4, the work of the subcom­ considerable array of measures whose mittee was completed and the final general thought was the same that had draft was once more submitted to already been developed by the Sub­ President-elect Wilson at Trenton, committee on Banking and Currency, N. J., where he was visited by Mr. although until such time as the Federal Glass, and the finished work sub­ Reserve Act itself became public the mitted to him. The President-elect terms of the various bills were, of course, again gave to the bill in its revised form widely different both from one another a general preliminary approval. and from those of the Act itself. During the months of January and W o r k o p t h e S e c r e t a r y o f t h e February, 1913, the Banking and Cur­ T r e a s u r y rency subcommittee held many hear­ Little work was done on the Federal ings upon the plan already laid out and Reserve Act during the month of an entirely new redraft of the Federal March, 1913, but at the beginning of Reserve Act was made. This redraft April, President Wilson entrusted to had been practically completed at the Secretary of the Treasury McAdoo the close of the hearings in February. It duty of reviewing the measure for the differed from the original act chiefly in purpose of reporting to him on the detail, embodying in one consistent subject. The measure was canvassed statute the various elements of the plan section by section by the Secretary of which had been submitted to President­ the Treasury and a variety of minor elect Wilson in the preceding Decem­ changes were,fumade in it. These ber. It included provision for the changes related principally to details of transfer of reserves and the issue of language. Two important changes notes, for the refunding of government were, however, introduced during this bonds as well as a provision for govern­ process. The first was the acceptance ment supervision and control of the of the idea that the notes to be issued Reserve Banks, although such super­ by the new banks should in some way vision and control was shared between be passed upon or approved or guar­ the government itself and the bankers anteed by the government, while of the country. This bill also included modifications in the plan for the re­ aprovisionfor the guaranteeing of bank funding of government bonds were also deposits, insofar as the assets of the introduced. It was the thought of member banks would permit, and it Secretary McAdoo that the original also contained an elaborate plan for the funding provision had been unduly election of directors in Reserve Banks unfavorable to the government. with the aid of commercial bodies. Many of the changes in language After the close of the hearings an­ proposed in the first instance by repre­ other redraft was undertaken and was sentatives of the Treasury were after­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 40 T h e A n na ls of the A m erican A cademy ward cancelled and the original lan­ dom of the measure, and he, therefore, guage restored when further study of proposed and brought to the attention the draft had convinced the Treasury of representative bankers a plan of his representatives that the changes which own under the terms of which the they were at first inclined to introduce Treasury would have gone, more or had not been well warranted. less extensively, into a banking busi­ One further change of great impor­ ness, with the various subtreasuries as tance was introduced during this period branches. The appearance of this plan, of the bill’s history, although not at fathered by the Secretary of the Treas­ the instance of the Secretary of the ury, naturally tended to throw grave Treasury. This was the provision doubts upon the prospects of the Fed­ calling for par clearance of member eral Reserve Act. About the end of bank obligations. There had been a May the whole situation was forcefully doubt in the minds of the subcom­ brought once more before the atten­ mittee whether the introduction of this tion of the President for his decision. provision, in addition to the other Meantime a separate and independ­ extensive elements of the measure, ent bill had been developed by Senator would be desirable or not, and it was Robert L. Owen of Oklahoma, who had eventually determined to present the become Chairman of the Banking and matter to Secretary of the Treasury Currency Committee of the Senate. McAdoo in order to get his thought on President Wilson thus had before him the subject. the McAdoo plan, Senator Owen’s The “Money Trust” section of the tentative plan and the draft of the Banking and Currency Committee had Federal Reserve Act—as well as, of in the meantime carried on a lengthy course, a multitude of other bills, “probe” into banking conditions in drafts and suggestions which had been New York and had reported that, in filed with him by many citizens. After no small measure, unsatisfactory con­ very considerable attention the Presi­ ditions there were due to faulty clearing dent determined to hold to his original house organization. It had, therefore, decision in favor of the Federal Re­ recommended certain legislation de­ serve Act and accordingly announced signed to control clearing houses. his determination to discard all of the Secretary McAdoo was of the opinion other suggestions which were then that some provision relating to clearing before him. In so doing, however, he and intended to give the clearance found it necessary to consult with the power to Federal Reserve Banks would so-called Bryan element in the Cabinet be desirable as showing that due atten­ which had already been generally tion had been paid to the work of the advised of the intended scope of the “Money Trust” subcommittee. He Federal Reserve Act. accordingly assented in general terms As a result of this consultation two to the plan which was placed before further definite changes were made in him and which was therefore incor­ the bill: the notes to be issued by the porated into the bill. several banks were now definitely made liabilities of the United States, while A t t e m p t t o S u b s t it u t e a n A d m in ­ it was determined that the Federal is t r a t io n B il l Reserve Board should be exclusively Careful study of the Federal Reserve composed of government appointees Act as thus drafted, however, led to be named by the President and con­ Secretary McAdoo to doubt the wis­ firmed by the Senate. These changes

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e F ederal R eserve A ct in C ongress 41 having been agreed upon, the bill was (4) Provision of machinery for doing introduced into Congress in its existing foreign banking business. In order to accomplish these purposes form and thus finally worked out. fully it is necessary to (a) repeal certain Shortly afterward a new House bank­ portions of existing law; (b) rectify various ing and currency committee was ap­ conditions in the present national banking pointed with Mr. Glass as chairman. system which are in some cases only indi­ The Glass bill—the completed draft of rectly connected with the objects sought; the Federal Reserve Act—was promptly (c) furnish a new class of institutions for referred to the Banking and Currency the performance of some functions which Committee as thus organized and the cannot well be entrusted to existing banks, actual work upon the measure was be­ or at all events can better be performed by gun. This work was vigorously under­ others and (d) alter the present reserve system to a very material degree. taken toward the end of June, 1913. The scope of the bill can best be under­ stood by an analytical review of its con­ C h a r a c t e r o f M e a s u r e tents, with reference to sections and para­ It will be observed that the first graphs. This is herewith subjoined. innovation in the terms of the original measure had come at the instance of B a sis of P r e se n t Sit u a tio n The present banking situation in the Secretary Bryan during late May, United States rests upon the National Bank 1913. It is interesting, therefore, to Act proper as slightly, modified from time know just what the plan was which had to time and upon the so-called Aldrich- been completed for introduction into Vreeland Act (Act of May 30, 1908). Of Congress. Space unfortunately for­ these acts the latter is completely repealed bids a detailed description. At that (Section 1) on the ground that it has never time, however, there was prepared for become operative, probably will not be­ the use, and at the request, of the Pres­ come operative except under extreme stress, ident, a digest stating the chief content and was never satisfactory. The National and purpose of the bill. This digest, Bank Act itself is modified in numerous heretofore never published, is an essential particulars which will be pointed authentic description of the conclu­ out from time to time in this memorandum. sions tentatively reached up to that In a separate measure a general revision of time and shows fairly clearly the nature the administrative provisions of the Na­ of the original measure. It is accord­ tional Bank Act is also provided. ingly subjoined verbatim: N e w C lass of B a n k s Fundamental to the idea of the bill is the M e m o r a n d u m o n S c o p e a n d E f f e c t creation of a new class of banks (Section 2), o f H. R.------, t o R e o r g a n iz e t h e to be known as National Reserve Banks. P r e s e n t B a n k in g a n d C u r r e n c y The chief points about these banks are as S y s t e m . follows: In H. R .-----prepared for introduction (1) Number to be twenty with possible by Representative Glass of Virginia it is increase later as provided. (Section 2.) intended to furnish a comprehensive meas­ (2) Ownership to be in the hands of the ure for the attainment of four objects: national banks of the twenty districts in (1) Provision of a place for rediscounting which the banks are situated. (Section 2.) commercial paper of specified types. (3) Capitalization to be 20 per cent of (2) Provision of a basis for elastic note the capital of the stockholding banks, one issues properly safeguarded. half paid in and one half subject to call. (3) Refunding of outstanding 2 per cent (Section 2.) bonds so as not to inflict loss upon present (4) Business to be as follows: holders. (a) Rediscounting of paper presented by

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 42 T he A n nals of the A m erican A cademy stockholding banks and by other banks that therefore the government is morally under specified conditions, provided such bound to maintain their value in a corre­ paper grows out of actual agricultural, sponding degree; (b) and that it is desirable commercial or industrial transactions and to retire the bonds now held behind bank does not run more than a specified number notes and put in their place bonds whose of days. (Section 14.) value is sustained solely by their income- (b) Buying and selling government secu­ paying power, it is provided that: rities, gold and silver bullion and foreign coin, (1) Banks now holding the bonds may foreign exchange. (Sections 16 and 17.) offer these bonds for redemption or con­ (c) Government fiscal operations. (Sec­ version into 3 per cent bonds at a rate not tion £1.) to exceed one tenth of their holdings each I s su e o f N o tes year. (Section 2 6 .) This would mean that The bill provides for the maintenance of a maximum of about $65,000,000 a year existing bank notes outstanding so long as could theoretically be converted, and the their present issuers want to keep them evidence is that that sum would be ab­ out, and also calls for the establishment of sorbed without difficulty by investors each a note issue on a new basis to be put out by year. the National Reserve Banks. Provision (2) At the end of ten years other holders is, however, made for retiring the present of bonds would be allowed to convert them National Bank notes at the discretion of into 3 per cents. (Section 26.) their issuers. This plan comprises the (3) As a result of these changes the gov­ following points: ernment would be obliged to increase its (1) Every national bank would be interest charge the first year of the new allowed to continue its note issue exactly arrangement by an amount not greater as at present. (Section 26.) than one per cent on $65,000,000, or (2) It would not, however, be allowed $650,000, while the second year a like addi­ to increase the issue beyond the point at tion would be made and so on, until at the which it stood when the law was passed. end of ten years a possible maximum addi­ (Section 26.) tion of $7,300,000 in interest charges would (3) No newly organized bank would be probably have been assumed. required to purchase government bonds; P rotection o f N otes hence no new bank would have any note Fully admitting the necessity of an issues. (Section 26.) absolute protection of note issues, the bill (4) Whenever an existing bank retired seeks to safeguard those for which it pro­ any of its notes and withdrew its bonds it vides as follows: would lose the right to put out further (1) National bank notes are safeguarded issues of notes above the amount to which at every point by exactly the same elements its issue was thus reduced. (Section 26.) of protection which exist to-day, none of (5) National Reserve Banks would be these being diminished in the slightest allowed to issue notes secured in the same degree. way as their other obligations to an amount (2) Notes issued by National Reserve equal to twice the par value of their capital Banks are protected by a large gold reserve, stock. They would also be allowed to by constant close government supervision, issue additional notes if they desired, equal and by immediate and prompt redemption. to the amount of notes withdrawn by the Stringent provisions are made against individual banks which might from time to counting any of these notes as a part of time surrender their note issue privilege in bank reserves, thus insuring their speedy part or in whole. (Sections 23 and 2 6 .) return to the point of origin. (Sections Disposal of U. S. B o n d s 30, 31, etc.) , Recognizing (a) that the present 2 per (3) All notes are made receivable by the cent bonds were sold to the banks on the government and are to be received by every basis of a pledge that they might continue bank in the system on deposit at par, with­ to be used as a basis for circulation, and out exchange. (Section 23.)

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e F ederal R eserve A ct in Congress 43 (4) Uniformity in the currency is ob­ tional banks except as to the election of tained by making the National Reserve directors which is provided for as follows: notes identical in appearance and wording (a) Banks in every district are divided with the National bank notes. (Section into five classes according to capitalization. 23.) In each class the directors of the banks (5) Power to oversee and control the nominate a candidate for the directorship issue of notes is placed in the hands of a of the Reserve Bank. These are then supervisory board. (Sections 13, etc.) voted on (one bank one vote) and a director is chosen for each of the five classes—five G o vernm ent C ontrol in all. (Section 4.) Overseeing the whole system is created (b) In the five classes aforesaid bank through a so-called Federal Reserve Board, stockholders vote for and elect a director (Section 13) with the following organization for each class by a process prescribed in and functions: each case making five in all, or with the (1) Board to consist of representatives of preceding five, ten. (Section 4.) (a) National Reserve Banks (b) bank (c) The ten men thus named select four stockholders (c) the government itself. others after a prescribed process, eight (Section 10.) votes required to elect, and the nominees (2) Actual working body to be an exe­ subject to rejection by the Federal Reserve cutive committee of this Board consisting Board. (Section 4.) of Secretary of the Treasury, Comptroller (d) A fifteenth member, to be Chairman of the Currency, and Attorney-General, of the Board of Directors is chosen by the with four members of the Federal Reserve Federal Reserve Board itself. (Section 4.) Board chosen by the latter. (Section 11.) (3) The Federal Reserve Board consists (3) Board and Executive Committee, as of two members from each district and the thus made up, to have power to deposit three government officials already specified. Government funds in National Reserve (Section 10.) It is not an incorporated Banks, to fix rates of rediscount in such body, has no banking functions but is banks, to compel any National Reserve supervisory. Bank to rediscount the paper of any other, (a) One member of the Federal Reserve and to examine the banks of the system. Board in each district is chosen directly by (Section 13.) the directors of the National Reserve Bank of the district. (Section 10.) Structure o p System (b) A second member of the Board from The effort has been made to “popular­ each district is chosen by the bank stock­ ize” the control' “of* the whole system of holders of the district, voting by a pre­ banking thus built up while at the same scribed method. (Section 10.) time preserving a sufficient amount of (c) These members of the two classes centralization, controlled by governmental referred to choose by ballot four of their agency, to insure that the whole system own number to join with the government shall be responsive to legitimate public officers already mentioned as the Executive demands. The bill is based on the belief Committee of the Board. These four are that no one should participate in the control designated by the Secretary of the Treas­ of the system unless he is either financially ury to hold the offices of President, first interested himself or chosen by those who and second Vice-Presidents and Secretary are, save insofar as the government steps in to exert the authority of the whole com­ of the Federal Reserve Board. (Section munity. With this in mind the system 11.) has been developed as follows: R e ser v es (1) Organization, powers and functions In the belief that the present reserve of national banks are left as at present. system is antiquated and unsatisfactory, (2) National Reserve Banks are incor­ that the massing of funds in New York and porated institutions holding Federal char­ other financial centers of which so much has ters and in all respects managed like na­ been said in recent years, is largely due to

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 44 T he A nnals of the American A cademy the present reserve requirements of na­ industrial transactions evidenced by very tional banks, and that in order to get the short term paper and on rare occasions real benefit from the system of rediscount under carefully prescribed conditions to which has been proposed as a remedy for financial operations protected by collateral. many existing evils, it is necessary to base They will also be able to engage in foreign such system upon an actual control of exchange operations, sales of government reserves, provision has been made for securities, etc., as already explained. recasting the present bank reserve system.1 (2) National banks will be subjected to The plan includes: precisely the same restrictions as at pres­ (1) Transfer of reserves from existing ent with a relaxation in favor of a moderate national banks in reserve and central re­ amount of real estate loans by country serve cities, to National Reserve Banks. banks under carefully guarded conditions. (Section 27.) (Section 39.) (2) Spreading out of this process of trans­ (3) By a revision of the administrative fer over a period of fourteen months in features of the National Banking Act, order to give as little shock as possible to provision will be made for close oversight market conditions. (Section 27.) of National institutions with a view to (3) Ultimately the establishment of a holding them strictly up to the require­ Reserve System, at the end of the transi­ ments of a legitimate banking business. tion period in which so-called country (Text of bill still to be submitted.) banks will have 15 per cent of reserve (i. e. (4) In order to possess themselves of the 15 per cent of total demand liabilities) such kind of paper entitling them to rediscounts, 15 per cent to be held, 5 per cent in the x national banks will find themselves obliged bank’s vaults, 5 per cent with the National to keep a reasonable proportion of their Reserve Banks and 5 per cent either at assets in the form of paper eligible for home or with the Reserve Bank; while rediscounting, and this will mean very con­ reserve and central reserve city banks will siderable emphasis upon the strictly com­ have reserves of 20 per cent of demand mercial aspects of the business done by liabilities, of which 5 per cent will be at national institutions. home, 5 per cent with the Reserve Bank of the district and 10 per cent either at home P ositio n o f S tate B a n k s or with the Reserve Bank. (Section 27.) It has not been thought wise to permit (4) The presumed effect of this plan will State banks to own stock in the National be to end the placing of reserves with Reserve Banks for two reasons: central reserve city banks for use in stock (1) State banks by the terms of their market operations, to keep reserves in organization are differently managed ^ and some measure at home, and to require controlled from national. speculators to get the funds they need in (2) The laws of the United States differ their operations either by directly borrow­ with respect to liabilities, the collection of ing them from persons who hold them and debts, and other matters. want to lend the cash for that purpose, or Hence the bill has attempted only to else by borrowing from the banks in the provide for giving these banks equal facil­ places where the operations are to be car­ ities for doing business by establishing the following conditions: ried on. (1) State banks may affiliate themselves D iv isio n o f B u sin e s s with National Reserve Banks by maintain­ The object of the bill is to effect a mod­ ing the same deposits with the National erate division and classification of banking Reserve Banks that are kept by national business along indicated lines, the net banks under the proposed act. (Section result, presumably, being summed up as 29.) follows: (2) State banks shall in these circum­ (1) National Reserve Banks will be stances be entitled to do business with and strictly limited to actual commercial and get rediscounts from National Reserve 1 Including collections and clearances. Banks. (Section 29.)

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he F ederal R eserve A ct in Congress 45 (3) State banks shall be subject to in­the placing of Treasury funds in the hands spection and examination by National of National Reserve Banks. Reserve Banks. (Section 29.) C o m m it t e e S u s t a in s B il l R ela tio n s w ith T r ea su r y It is believed that the present sub­ The work of the Banking and Cur­ treasury system is unsatisfactory, clumsy, rency Committee covered a period of injurious to business and difficult to man­ several weeks and was largely devoted age in times of stress. The bill therefore to the improvement of details in the provides for: pending bill. A list of these changes (1) The placing of all current funds of the Treasury in National Reserve Banks would not be of special interest, even and the payment of government creditors were it possible in a brief treatment of by check thereon. (Section 21.) the history of the Federal Reserve Act. (2) The equalization of the public funds It is enough to say that the Commit­ between the different reserve banks subject tee speedily developed a difference of to a rate of interest to be fixed by the opinion with respect to the measure, a Federal Reserve Board. (Section 13.) substantial section of it desiring to (3) The trust funds of the Treasury are broaden the bill in the direction of to be held as at present in the vaults of the action which would give to agricultural Treasury. interests a larger borrowing power. F o reig n B a n k s Accordingly, the maturity of paper Recognizing that present banking legis­ based upon farming operations was lation under the national system is inade­ quate in its relation to foreign trade, increased to 180 days although all because it furnishes far too little recogni­ other paper was prohibited from dis­ tion of the necessities of the case, and count for a period of over 90 days. believing that the development of foreign Some other concessions were made to banking ought to be aided and promoted so-called farming interests. Public and at the same time regulated by the control over the Reserve Banks was national government, it has been sought in strengthened and a provision creating drafting the bill to provide: a so-called Federal Advisory Council, (1) A new type of institutions created a body of bankers drawn from the for foreign trade purposes and organized by various districts and directed to meet individuals or existing national banks or at intervals for consultation with the both. (Section 41.) (2) Permission to establish branches in Federal Reserve Board, was estab­ foreign countries and whenever necessary lished. under specified conditions to establish such Outside these and a relatively small additional branches in the United States number of other amendments the as may seem requisite. changes in the Banking and Currency (3) Authority on the part of the Na­ Committee of the House of Representa­ tional Reserve Banks to deal in foreign tives amounted to little more than exchange and otherwise to facilitate oper­ textual change effected for the purpose ations involving international trade. (Sec­ of improving or clarifying the language tion 18 and Section 19.) (4) Permission to national banks to do employed. When the bill, on Septem­ an acceptance business in all matters ber 9, was ready for introduction in relating to foreign trade, the importation the House of Representatives, with, a and exportation of goods, the furnishing of committee report, but little alteration travellers’ funds on letters of credit, etc. in it had been made in any essential (5) The more efficient and successful particular. First, however, it was handling of financial relations between the necessary that the bill should pass United States and foreign countries through through the House of Representatives

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 46 T he A nnals of the American A cademy caucus of the Democratic party. Al­ sure on the part of the Administration though severely attacked in the delib­ that it proved possible to obtain a erations of this body, which were held favorable report to bring the bill before behind closed doors, no material change the Senate for debate and eventually was introduced and the bill accordingly to pass it. went to the House on September 18. Analysis of the Senate debate would After a short debate, it was finally be out of the question in any brief adopted and sent to the Senate in a space and may therefore be passed over form not very different from that with the remark that, although the already given to it by the Committee. discussion resulted in changes in the Federal Reserve bill, which, when S e n a t e H o s t il it y combined with those already made by In the Senate the Federal Reserve the Senate Banking and Currency Bill, for as such it was now coming to Committee, produced a measure very be known, encountered much more different from that adopted by the serious opposition than it had been House, nearly all of the changes made obliged to meet and overcome in the by the Senate, as will presently be lower chamber. The Banking and seen, were ultimately surrendered in Currency Committee as then organized Conference Committee, the bill being was not friendly to it. The Chairman thus shifted back in substance to the of that Committee, Senator R. L. original House form. During the Con­ Owen, had prepared a bill of his own ference Committee sessions, it is which had not succeeded in making worthy of remark, one important headway. Its place was taken by the innovation was introduced; a substi­ Federal Reserve bill which he had tute section relating to the refunding finally consented to introduce as drafted of government % per cent bonds was in the House. transmitted to the Committee by In the Banking and Currency Com­ Secretary McAdoo and adopted prac­ mittee at least two Democratic groups, tically as it stood in lieu of the pro­ neither of them friendly to the meas­ visions which had been made on that ure, were formed, while among Repub­ subject by the two houses. licans practically two other groups existed, one inclined to favor the bill, C h a n g e s b y t h e S e n a t e the other, to oppose or remodel it. In It is now worth while to sketch hearings before the Senate Committee, briefly and succinctly the changes lengthy opportunity was given to the made by the Senate in the House draft advocates of a central bank to present of the Federal Reserve Act insofar as argument. Eventually the discussion, they were ultimately retained in the although taking a wide range, settled final law. The work thus done may down about the question as to whether be surveyed as follows:2 there should be fewer or a larger Turning first to the alterations in number of Reserve Banks, whether the House bill that secured acceptance, the Reserve Banks themselves should the principal features may be enu­ have full power over reserves and col­ merated as follows: lections, and whether the type of note (1) Introduction of provision for sale of issue which had been favored in the stock in Federal Reserve Banks to the House bill should be retained. It was public in the event that not enough banks with great difficulty and, probably, 2 From article by the author in American only as a result of the strongest pres­ Economic Review, March 1914.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he F ederal R eserve A ct in Congress 47 subscribe for the stock to furnish an ade­ stituted a reduction below the House quate capital in any given district. provision. (2) Provision for alternative voting in (7) Reduction of period of maturity for the choice of directors of Federal Reserve which discountable paper might run from Banks so as to insure prompt election. 180 days to 90 days. (3) Reduction of number of Federal Reserve Banks.to not more than 12, as While various other points of modi­ against the “at least 12” of the House bill. fication and concession on either side (4) Elimination of requirement that all might, of course, be enumerated, it is national banks recharter. believed that the foregoing presenta­ (5) Broadening of powers of Federal tion is representative and shows suf­ Reserve Board and modification of lan­ ficiently well the nature of the con­ guage relating to rediscounts between Fed­ ference work and the character of the eral Reserve Banks, so as to render such points conceded on either side. As­ rediscounts easier than was intended by the suming that such a fair or representa­ House bill. (6) Provision that the Secretary of the tive selection has been made, it is Treasury might, not must, deposit public evident that the work of the confer­ funds in reserve banks. ence resulted in the establishment of (7) Reduction of reserve requirements the House contentions at nearly every placed upon member banks under House essential point, the exceptions to such bill. a remark being found in two main On the other hand, the following particulars: (1) the reduction in the important points were yielded by the number of Reserve Banks and their Senate in the conference: limitation to not more than twelve at (1) Omission of provision that holders any time, and (2) the provision that of stock sold to private individuals (if any) public deposits might or might not should have voting power in directorates of be made in the Reserve Banks at the Federal Reserve Banks and elsewhere. discretion of the Secretary of the (2) Elimination of guaranty of bank Treasury. deposits, by use of surplus earnings. While other points were significant (3) Elimination of provision that Fed­ and important in their way, it can eral Reserve Bank notes might be counted certainly be fairly concluded that on in reserves of stockholding banks. (4) Restoration of provision that many those matters involving important classes of checks should be collected at par issues of theory the House virtually throughout the country, and that where held its own in most respects. In fact, such par collection was not enforced, the it is an accurate generalization that the charge for making collection should be final bill as completed in conference fixed by the Federal Reserve Board. committee and as passed by both (5) Elimination of domestic acceptances, Houses was a closer approach to the thereby excluding them from use by stock­ original House draft of the measure holding banks and from rediscount by than anything that had intervened Federal Reserve Banks. during the time the bill was going (6) Modification of reserve require­ ments as formulated by the Senate so as through the various permutations to to require actual cash reserves in the vaults which it was subjected in its slow prog­ of country banks (the Senate having ress from one stage to another of the entirely dispensed with such reserves after legislative process. twenty-four months after date of the pas­ At one other point there was marked sage of the Act) and general stiffening of and vital departure from the original reserve requirements made by the Senate, House measure—the provision with although the final language still con­ reference to the refunding of United

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 48 T he A nnals of the American A cademy States 2 per cent bonds and the treat­ short, honest in its inception, professing ment of the currency based upon such to be with all of its various defects sim­ bonds. On this subject the final ply what it actually was—a measure action of the conference was nearly prepared on the basis of American equivalent to the acceptance of a plan experience, enlightened and adapted formulated by the Administration and by the use of such lessons as could be designed to take the place of all of the drawn from European banking prac­ various other schemes that had been tice. As the writer has said on la recommended from different sources in former occasion:3 either House. The action as to bonds The Federal Reserve Act is the product was, therefore, not a concession by of a lengthy course of development and has either side but was a virtual surrender grown gradually out of the discussion and by both and an acceptance of the con­ analysis of the past twenty years. It is clusions of the Treasury Department. not drawn, even largely, from any single Barring the two matters already men­ source, but is the product of comparison, tioned, the House measure was changed selection, and refinement upon the various in no respect that affected its essential materials, ideas and data, rendered avail­ able throughout a long course of study and working; nor could it be said that even agitation. Many bills embodying the in these particulars it had necessarily same general line of thought that now finds been subjected to modification, since, expression in the new act have been offered in both, the action contemplated by in Congress; some have been suggested the provisions ultimately adopted was outside that body. The most fundamental permissive, rather than compulsory. concept of all—that of uniting the banks of the country into organized groups—is T h e I n s p ir a t io n o f t h e B il l found in the clearing house organizations, As to the idea by which the Federal which in time of stress have pooled their Reserve Act was dominated or upon resources and converted bank assets into the equivalent of reserve money. The which it was molded, or as some have bills prepared by or under the direction of termed it the inspiration of the bill, the Honorable Isidor Straus, the Honorable there has been much unnecessary con­ J. H. Walker, the Honorable Charles A. troversy. The measure as originally Fowler, and the Honorable Maurice L. made read!y for introduction was the Muhleman have supplied at least the basis outgrowth of the long years of discus­ for many of the detailed analyses and sion of the banking and currency prob­ methods of treatment that are found in the lem through which the country had Federal Reserve Act. Earlier than any of passed from 1893 onward. The notion these, was the bill recommended by the of a district reserve system was directly Indianapolis Monetary Commission, which and confessedly drawn from the experi­ did not provide for cooperative unions of banks, but upon which the framers of the ence of the banks of the country with present act have evidently drawn for some local clearing house organizations. of their ideas. Other features were the careful result The latest bill in the long series which was of foreign experience. While the bill available for study to the framers of the was thus made up of ideas drawn from Federal Reserve Act, was that prepared for all available sources so far as these the National Monetary Commission and were known to the committee of the called in popular language the “Aldrich House of Representatives, it was pre­ bill.” By many the new law is regarded as pared as the result of individual study a partial copy of, or plagiarism from, the and without the acceptance of outside Aldrich bill; and that view has been widely bills, suggestions or models. It was, in 3 American Economic Review, loc. eit.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he Aldrich-Vreeland E mergency Currency 49 expressed both in and out of Congress. It made no direct provision for the shifting That such was not the opinion of Mr. of reserves in part from existing banks to Aldrich himself, his scathing and bitter the proposed association, but it relied upon denunciation of the House bill seems to bear inflation due to the placing of bank notes abundant witness.4 It might be enough issued by the central association in the for purposes of argument simply to appeal reserves of the stockholding banks for pro­ on this point from the critics of the measure tection in time of danger. The new act to Mr. Aldrich himself but that would provides for twelve reserve banks, intro­ hardly answer the purpose of historical duces the principle of local control, calls analysis. for strict government oversight, shifts The Aldrich bill may be considered from reserves from present correspondent banks two standpoints, (1) that of its theory and to the new institutions, minimizes the broad general plan on the one hand, and influence of the larger banks in directorates, (2) that of its machinery and technique of and generally diffuses control instead of construction on the other. From the first centralizing it. It leaves banking, as such, standpoint, there is no shadow of relation­ to be practiced by bankers; it vests the ship or similarity between the Federal control of banking in the hands of govern­ Reserve Act and the Aldrich bill. From ment officers. The theory and purpose of the second, there is at many points a close the new act are widely different from those resemblance. The Aldrich bill provided of the Aldrich bill. Where the Aldrich for a single central “reserve association” proposal veers widely away from the with scanty public oversight, with control tendencies that have been developed during vested practically wholly in the banks, and the preceding ten years of American bank­ with the preponderance of power in the ing discussion, the Federal Reserve Act larger institutions which owned stock. It closely follows them. Indeed, the Act of so arranged things as to keep this “reserve 1913 is closer to any one of half a dozen association” relatively inactive except upon bills of former years than to the Aldrich special occasions of panic or disturbance. proposal.

The Aldrich-Vreeland Emergency Currency By Homer Joseph Dodge Editor, The Federal Trade Information Service1 HE origins of everything in the of our national activity, is not a diffi­ world, from man himself to slang cult task. Although inflation of such words and phrases, from vast and per­tremendous proportions previously had fectT mechanisms to manners and been unheard of, the stage was espe­ customs, or great eras and economic cially set in preparation for that event. cycles, always have held a special As a preliminary to the more serious fascination. And there has always later currency inflation, the United been someone, whether it be Darwin States had innocently provided itself or the Encyclopaedia Brittanica, to with a lively springboard from which ferret out each firstling. to leap. To point to the circumstances of the origin of the American currency T h e F o r e r u n n e r o f I n f l a t io n inflation, the progress of which dur­ That springboard was the Aldrich- ing the last seven years has had so Vreeland Act which provided a sudden profound an effect upon every branch 11 am indebted to the office of the Comptrol­ 4 Proceedings of American Academy of Polit­ ler of the Currency for the statistics of the ical and Social Science, October, 1913. Aldrich-Vreeland note issues.

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means for issuing hundreds of millions W a r D e m a n d f o r M o n e y of dollars in emergency currency. In times of stress of almost any To be sure, it was designed merely to kind, money is the first support on meet temporary needs for additional which mankind leans. Availability currency in periods of financial stress. of ample supplies of money goes far It was intended that this currency toward alleviating almost any dis­ should never remain long outstand­ tress. The War had not yet had an ing, but should merely supply the opportunity to bring home the lesson nation with a currency medium during that in an economic sense, goods and the brief period required to restore services, and not money, are the king confidence following a market up­ pins. With the Stock Exchange clos­ heaval or similar economic disturbance ing, and banks and business houses and of known dimensions and experienced individuals throughout the country in intensity. An aggregate of $500,000,- a state of bewilderment over the 000 was provided for this purpose. meaning of the War, everyone wanted That a need should develop in this gen­ money quickly. eration for greater sums was undreamt. Europe instantly began unloading The panic of 1907 had been a her railroad and industrial securities severe lesson to the American bank­ in this market. Belligerent govern­ ing fraternity and to the nation as a ments began awarding contracts for whole. At that time clearing house war supplies. Prices began to rise, certificates had been issued to the and a thousand new demands for extent of $255,536,300—a great sum money sprang up. This demand, then—and Congress, intent on pro­ coupled with a caution on the part of viding a preventive against a similar the banks, arising from the native embarrassment, had passed the Al- timidity of capital in the presence of drich-Vreeland Currency Act, which great material forces, doubtless would was approved May 30, 1908. It was have caused serious embarrassment regarded as an emergency implement had it not been for the availability of to be supplanted by more solid legis­ the Aldrich-Vreeland emergency cur­ lation and, therefore, was to expire rency. by limitation, June 30, 1914. The A curious fact attendant upon the permanent legislation was provided, issuance of this money bears upon the for on December 23, 1913, the Federal political aspect of the event. The Reserve Act was approved. The Federal Reserve Act had been widely Federal Reserve Banks were not press-agented to the country as a opened, however, until November 16, great achievement of the Democratic 1914, so when the European War Congress. It was a Wilson bill, one broke out the permanent system was of the heralded Democratic reforms. not ready for operation. Now the Aldrich-Yreeland Act, as its The War was the call-bell for the very name signifies, was the creation beginning of the performance of world­ of an old-fashioned Republican Con­ wide inflation. The American vehicle gress. It was popularly known that of participation was not ready, so the Federal Reserve Act had been Congress brought back, as a curtain- approved; that its machinery was in raiser, the Aldrich-Yreeland Emer­ process of erection. The Aldrich- gency Currency Act. It extended Vreeland Act was forgotten. Where­ the life of the act from June 30, 1914, fore, when, in response to the demand to June 30, 1915. of the hour, m emergency currency

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he A ldrich-Vreeland E mergency Currency 51 appeared, it was popularly received On August 1, 1914, the outstand­ as the issue of the new Federal Re­ ing national bank circulation amounted serve System. It is not a matter of to $750,907,020, of which $735,222,- large importance, but rather a curi­ 801 was secured by United States osity of financial history, that to this bonds, and the remainder, $15,684,- day many business men are under the 220, by lawful money deposited by impression that the emergency cur­ banks in liquidation and by those rency with which they did business in that were retiring their circulation. the first few months of the War was On September 12, 1914, the date of Federal Reserve currency. the first report from national banks At the beginning of the crucial following the beginning of the Euro­ period following the declaration of pean War, the reporting banks had on war in Europe, the general stock of deposit with the Treasurer of the currency in the United States United States as security for circu­ amounted to $3,735,579,397, of which lation, United States bonds to the $368,210,467 was held in the Treas­ amount of $736,685,850. On that ury as assets of the government, date the volume of circulation issu­ leaving the amount in circulation at able under the Act of 1908, that $3,367,368,930. Of the general stock, is, 125 per cent of the combined there was in gold, $1,887,270,664; capital and surplus of the banks, silver, $748,287,696; United States amounting to $2,230,588,239, less notes, $349,114,016; and national bank the amount of currency issued on notes, $750,907,021. United States bonds, was $1,493,- On August 1, 1914, the stock of 902,390. As a matter of fact, the incomplete currency in the custody authorized issues of currency under of the Comptroller of the Currency that Act, from the date of the and available for issue on the security first issue on August 4, 1914, to of United States bonds and other the date of the last issue on Febru­ securities, was $524,864,470. The ary 13, 1915, were but $386,444,- aggregate amount of government bonds 215, or less than one-fourth of the on deposit to secure circulation, to­ maximum issuable. The amount au­ gether with the amount of such thorized included $910,500 secured by bonds outstanding and acceptable state and municipal bonds deposited for that purpose, aggregated $913,317,- with the Treasurer of the United 500, of which the national banks had States in trust by eight national on deposit to secure circulation, $740,- banks, all other issues being based 796,910, to secure United States de­ upon securities deposited with na­ posits, $23,047,950, and on hand tional currency associations. unpledged, $11,950,300. Hence, only During the period of activity of about $137,500,000 of the class of issues of circulation under authority United States bonds acceptable as of the Act of 1908, the volume of security for circulation were not owned United States bond-secured circula­ by national banks. This amount, tion was practically unchanged. The plus $11,955,300, owned but unpledged, aggregate amount of outstanding na- or in round amount, $149,500,000, tional-bank circulation reached the was the measure of the possible maximum, during the period in which increase of national bank circulation emergency circulation was issued, in on the security of United States the middle of November, 1914, namely, bonds. $1,126,039,600.

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P r o v is io n s f o r R e t ir e m e n t o f bonds were accepted at 85 per cent of A l d r ic h -V r e e l a n d C u r r e n c y the market value. The law authorized the deposit of 2. Miscellaneous securities, includ­ lawful money or national bank notes ing industrial bonds, and other securi­ for the retirement of this additional ties, mainly city and town notes and or emergency currency. By reason warrants, were accepted at 75 per of general conditions and the lack of cent of the market value. demand for funds, deposits for re­ 3. Commercial paper was accepted tirement of the additional circulation at 75 per cent of the face value, began to be made as early as the and— middle of October, and by January 2, 4. Notes secured by warehouse re­ 1915, aggregated $238,698,460, or over ceipts for cotton, tobacco, and naval 60 per cent of the total circulation stores at 75 per cent of the face authorized to be issued. Within value. nine months, that is, by May 1, 1915, The additional circulation author­ $380,039,030 of the authorized $386,- ized and secured by commercial paper 444,215 of this currency had been represented 57^ per cent of the retired, and prior to June 30, 1915, total amount authorized; by mis­ the entire amount issued had been cellaneous securities, 28 per cent; by retired except the sum of $200,000, state, county and municipal bonds, the amount issued to a national bank 14 per cent; and by notes secured by that failed and was placed in charge warehouse receipts, one-half of one per of a receiver. cent. In addition to the securities de­ posited, the law provided that “the A c t iv it y o f N a t io n a l C u r r e n c y banks and the assets of all banks A ssociations belonging to the association (national While there were between 7,500 currency), shall be jointly and sever­ and 7,600 national banks in active ally liable to the United States for operation during the period in ques­ the retirement of such additional tion and 45 national currency as­ circulation.” sociations organized, the membership The value of the securities de­ of these associations was but 2,197, posited with the currency associations, and of that number only 1,363 took that is, the market value of the state out additional circulation. None of and miscellaneous bonds and the the banks in four currency associa­ face value of the commercial paper tions, namely, Vermont, Rhode Island, and warehouse receipts, including ex­ northern New York, and central New changes, was, roundly stated, $907,- York, applied for circulation. All the 880,000 of which $651,146,000 was states of the Union were included in in commercial paper. The net value one or more of the currency associa­ of the securities, that is, the gross tions excepting Maine and Wyoming. amount deposited less exchanges, ex­ None of the national banks in nine ceeded the value of circulation issued states, namely, Maine, Vermont, Rhode by more than 30 per cent. Island, Delaware, South Dakota, Mon­ Under the provisions of law and tana, Wyoming, Idaho and Nevada, ap­ the rulings of the Treasury Depart­ plied for additional circulation. ment, securities deposited were classi­ Eighty per cent, or $309,308,210 of fied as follows: the authorized issue of $386,444,215, 1. State, municipal, and county was for banks in the reserve city

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he A ldrtch-Vreeland E mergency Currency 53 associations. The amount authorized banks to which currency was issued, for banks in the National Currency with the exception of the First Na­ Association of the city of New York tional Bank of Uniontown, Pa., which, was $144,975,960; Boston, $24,944,- upon becoming insolvent, was placed 500; Chicago, $27,070,000; Philadel­ in charge of a receiver, had made the phia, $14,883,750; Minneapolis and necessary deposit to retire their addi­ St. Paul, $12,798,500; Dallas, $11,- tional circulation. 337,950; Pittsburgh, $10,978,000; St. The securities pledged with the as­ Louis, $10,836,500; Cincinnati, $9,592,- sociations aggregated $585,864,391.94, 500; and San Francisco, $8,634,500. classified as follows: commercial paper, The tax collected on this addi­ face value, $359,535,317.27, or 61.37 tional circulation from August, 1914, per cent of the total securities de­ to June 30, 1915, was $2,977,066.73. posited; industrial bonds, par value, With the deposit of the requisite $116,069,173.36, or 19.81 per cent; amount of lawful money to provide state, municipal and county bonds, for the retirement of circulation issued par value, $70,010,846.34, or 11.97 under authority of the Act of May 30, per cent; railway bonds, par value, 1908, and the release of the securing $31,333,800, or 5.37 per cent; other collateral, the duties of the national sepurities, face value, $4,690,366.86, currency associations practically ter­ or 0.80 per cent, and warehouse re­ minated, although the associations ceipts secured by cotton, tobacco, were held to be in existence until the and naval stores, face value, $4,224,- date of the expiration of the act 888.11, or 0.72 per cent. The ex­ providing for their formation. The penses of 41 currency associations, organization of the first national cur­ the members of which issued circula­ rency association, that of Washington, tion, are reported at approximately D. C., was approved July 18, 1908, and $125,000. Two non-issuing associa­ the last, the State of Vermont, Decem­ tions reported combined expenses, ber 16, 1914. $44.57. The other two non-issuing There were forty-five national cur­ associations apparently incurred no rency associations organized with a expense. membership of 2,197 banks, or 29.15 per cent of the total banks (7,538) that re­ D e c l in e o f E m e r g e n c y C u r r e n c y ported on the call of September 12, a n d I n c r e a s e i n R e s e r v e N o t e s 1914. During the month of August, The Federal Reserve Banks had 1914, 30 associations made their first opened in the midst of this process, on application for additional circulation, November 16, 1914. Their machinery 6 in September, 4 in October; 1 did was unfamiliar and therefore there not report the date of its first appli­ was no immediate substitution of the cation, and 4 associations made no new currency for the Aldrich-Vreeland application. notes. Retirement of the Aldrich- Forty-one associations approved for Vreeland currency, however, set in issue $385,553,905 to 1,366 member early. Indeed, the date on which the banks. The first approval was made greatest volume actually was out­ on August 3, 1914, and the last on standing was prior to the opening of February 5, 1915. The first appli­ the banks—October 24, 1914. This cation for the retirement of circula­ was due to retirement on the part of tion was approved September 23, banks which had taken care of their 1914. By July 1, 1915, all of the emergency requirements and were

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 54 T he A nnals of the American A cademy getting in shape to carry their own the last of the Aldrich-Vreeland notes load. That the banking community were retired and the Act expired by had not abandoned the emergency limitation, there were about $83,000,- currency in favor of the Federal 000 in Federal Reserve notes in Reserve currency is indicated by the circulation. fact that applications for the emer­ So it will be seen that the Aldrich- gency currency continued to come in Vreeland currency contracted at a and the date on which the maximum much greater rate than the Fed­ approvals took place was not reached eral Reserve currency was issued. until February 13, 1915. By this time This indicates how truly the Aldrich- retirements of this currency had Vreeland notes were an emergency brought the amount outstanding down —a panic currency. They were is­ to $45,377,141. The period in which sued to allay panic or in anticipation the greatest volume was retired was of it; the Federal Reserve currency the week ending December 12, 1914, was issued in response to the actual and the amount, $45,144,798. needs of business. A further indica­ There was no full replacement by tion of these contrasting characters Federal Reserve notes of the Aldrich- is furnished in the fact that applica­ Vreeland notes. By January 1, 1915, tions for new emergency currency a total of $238,698,483 of the Aldrich- continued in substantial volume for a Vreeland notes had been retired while considerable time after the large re­ only $16,530,000 in Federal Reserve tirements by the banks which had notes were in circulation. On April 1, received supplies; this indicated that 1915, $372,928,594 of the emergency the emergency had passed. It is true currency had been retired and only that there was a heavy tax operating $43,376,000 in Federal Reserve notes to force the emergency currency into were in circulation. retirement but this alone does not The two curves—one representing explain the situation. Had it been the retiring Aldrich-Vreeland notes the tax which caused the Aldrich- and the other, the expanding Federal Vreeland money to retire so precipi­ Reserve notes—crossed about March tately, the untaxed Federal Reserve 1, 1915. On March 6, 1915, there currency would have flowed out in were $27,905,376 in Aldrich-Vreeland greater volume. A year after the notes still outstanding. On March 5, Federal Reserve Banks had been 1915, there were $29,805,000 in Fed­ opened, the Federal Reserve notes in eral Reserve notes in circulation. circulation were only $184,000,000, The previous reporting date for less by nearly $150,000,000 than the Aldrich-Vreeland notes was Febru­ the amount of Aldrich-Vreeland cur­ ary 27, when there were $32,249,374 rency which had been outstanding a outstanding. Compare this with Feb­ year ago. ruary 26, when there were $26,- These figures are surprising when 172.000 in Federal Reserve notes in retrospect brings them in contrast circulation. The next subsequent re­ with the $2,500,000,000 in Federal porting date was March 13, when Reserve notes now outstanding and there were $24,357,227 in Aldrich- the $3,250,000,000 outstanding a year Vreeland notes outstanding. Com­ ago. These figures further show how pare this with March 12, when $33,- totally inadequate the maximum of 965.000 in Federal Reserve notes $500,000,000 in Aldrich-Vreeland notes were outstanding. By June 30, when would have been had the act further

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he A ldrich-Vreeland E mergency Currency 55 been extended and sole reliance placed yet they display a lingering vitality upon it to provide an additional and are accepted as being worth currency. To be sure, there had been something, although as a matter of retirement of other classes of currency fact some of them are worth less than but not in such fantastic volume as to the merchandise value of the paper on match the issuance of Federal Re­ which they are printed. A meal costs serve notes. 100,000 rubles in Moscow, yet meals Economists and bankers have learned still are bought with rubles. They do a great deal about currencies since circulate. The idea that the image and the days of the Aldrich-Vreeland superscription is a talisman of some issues and some rules have been value, however much depreciated, en­ upset. The phenomenon which has dures in the face of accurate knowl­ caused the most profound amazement edge that the sovereignty behind these has been the persistent vitality of tokens practically is defunct. The grotesquely inflated currencies in some idea of a legal tender has retained a countries of Europe. The German momentum which, although slowed mark is famous for its depreciation, down, is yet perceptible. This fact the Russian ruble, notorious. Both speaks much for an innate desire have lost, apparently, practically all on the part of the people to retain an calculable relation to metallic reserves, artificial circulating medium.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis The Reserve Act in Its Implicit Meaning By A. D. W e l t o n Continental and Commercial National Bank, Chicago GREAT banking system could a variety of things beside a statute, so conceivably grow up of itself in the statute itself is the product of a Aresponse to the demands of business.variety of plans, purposes, ideas and Such a system would be ideal because theories of a wide range. To get a of its flexibility and freedom of adapta­ thorough understanding of a system tion to the changing requirements of of any kind, of which a statute is the commerce. But no such system ever nucleus, some knowledge of the dis­ did grow up or ever will. A business, cussion which preceded its formulation involving such an element of trust, is and adoption is desirable and perhaps necessarily conducted by human agen­ necessary. Certainly, one ambitious cies and human agencies are uncertain to become expertly familiar with the and often dangerous. Government Federal Reserve System would have to everywhere, in one way or another, is study conditions long before December concerned with banking. It is con­ 23, 1913. The purposes and intentions cerned with the Federal Reserve Sys­ of the framers of the Act are not told tem which has been evolved or built in the Act itself. They are concealed up around a statute known as the in many reports, documents, and in Federal Reserve Act, approved Decem­ many minds. They cannot all be ber 23, 1913. told in brief space but discussion of a A statute, however, is only a first few outstanding points will perhaps be step toward a banking system which helpful in view of recent criticism of is finally made up of operating banks. the Reserve System, newly declared These are credit and currency machines distortions of its purposes and mis­ whose conduct, in accordance with understandings of its meaning. the law, is guided, regulated and con­ It may be said on all the authority trolled by rules, precedents, traditions, that exists, that the Reserve Banks habits, customs, decisions and what not. are not government institutions, that The mass of this material makes the they were not intended to be, and that system. With this view of banking it any interference with their operations, is easy to understand why the coming beyond exercise of the powers con­ of the Federal Reserve Act did not ferred on the Federal Reserve Board, bring with it the repeal of the National is perversion of the law and its mean­ Bank Act. The statute known as the ing as understood and expressed by National Bank Act might have been those who formulated it. The Federal repealed but the act itself is only a Reserve Banks are privately owned part of the national banking system. institutions. Their stock is all owned The rules, regulations, precedents, by their member banks. The provi­ etc., which make up that system, sion of the law that, in case the banks could, and perhaps should, be codified did not subscribe for the necessary but anything further would bring un­ amount of stock, individuals and the certainties and throw the entire system government could, has never been into confusion. acted upon.1 As a banking system is composed of 1 Act December 28, 1913, § 29 et seq.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he R eserve A ct in Its Implicit M eaning 57 It is possibly true that some mem­ heretofore vested by law in the Secretary bers of Congress voted for the bill in of the Treasury which relate to the super­ vision, management, and control of the the belief that it provided for the Treasury Department and bureaus under establishment of government banks, such department, and wherever any power but it is also probably true that more vested by this Act in the Federal Reserve of them believed that, in some way, Board or the Federal Reserve Agent ap­ the bill opened the way for punishing pears to conflict with the powers of the or demolishing that political phantasy Secretary of the Treasury, such powers —the “Money Trust.” However, shall be exercised subject to the super­ what congressmen believe is not vision and control of the Secretary. evidence. The paragraph was innocent enough A n A m e n d m e n t T h a t F a il e d in appearance. No one seemed in­ It may be recalled that when the terested in it. Chairman Glass, of Glass-Owen bill was under discussion the House Committee, disclaimed all in the Senate a serious attempt was knowledge of its source, saying the bill made to give the government power had passed from his control. Chair­ over the Reserve Banks by giving the man Owen, of the Senate Committee Reserve Board or the Secretary of the was non-committal. He thought the Treasury power to appoint a majority suggestion had come from the Treasury. of the directors of each bank. Senator The paragraph was not discussed on Hitchcock of Nebraska offered the the floor. It passed the Conference amendment, which had other sup­ Committee apparently without notice. porters. Members of the banking and Many other provisions were far more currency committees of both Houses important. were opposed to this amendment. Over a year later, a newspaper item They maintained it was out of har­ made it known that the Attorney- mony with the spirit and purpose of General of the United States had given the measure. Chairman Glass of the an opinion to the President to the House Committee and Senator Owen effect that the Federal Reserve Board of the Senate Committee were show­ was an independent organization and ered with telegrams from all parts of not a bureau of the Treasury Depart­ the country, urging opposition to this ment. When the President’s secretary plan. The amendment failed com­ was queried as to the reason for re­ pletely. questing this opinion, he replied that Another effort was made to give the the President had asked it “for Mac” government, through the Treasury, but did not say whether “Mac” was direct control over the Reserve Board. Machiavelli or McAdoo. This effort had insidious features and It is not impertinent to point out was redolent of politics. During the that, when the Federal Farm Loan Act Senate discussion of the Glass-Owen was on passage, the question of bill, new prints of the bill with minor whether the Farm Loan Board should changes were frequent. In one of or should not be a bureau of the these there appeared one day in Treasury Department was fought out. December an alteration of a para­ Every form of the bill that came from graph in Section 10, which was made to the House Committee made the Farm read, as it still reads, as follows: Loan Board an independent organi­ Nothing in this Act contained shall be zation. The Senate Committee in­ construed as taking away any powers variably made it a bureau of the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 58 T he A nnals of the American A cademy Treasury Department. The Senate the jobber may be the consumer; in won. The Farm Loan Board is a relation to the jobber, the retailer bureau of the Treasury Department. holds that position; but, in any event, The Federal Reserve Board is not. the final consumer must pay because he destroys the goods completely or R e s e r v e B o a r d a n I n d e p e n d e n t takes them out of the class of mer­ O rganization chantable articles. The Federal Reserve Board can be Before the Reserve System came to classed only as an independent govern­ give practical definition to commercial ment organization, having supervision banking, commercial and investment over the Federal Reserve Banks and banking were inextricably mixed. The exercising in that field powers defined money of commerce in the form of by law. surplus deposits beyond the immediate The Federal Reserve Banks are needs of the owners, or in bank re­ privately owned institutions, managed serves, was drawn to the centers and by boards of directors chosen by their chiefly to New York where it could be stockholders and authorized to func­ employed in the call loan market: that tion as banks, but within the pro­ is, it could be loaned on demand visions of law and the rules and against securities which represent in­ regulations made under authority of vested capital. That system created law by the Federal Reserve Board. all the “Money Trust” that ever The powers of the Federal Reserve existed. Board are very broad but the great The Federal Reserve System was purpose of the law in creating the intended to divorce investment from Board was to conserve the public in­ commercial banking. Notes secured terest, to provide safeguards against by investment securities are, there­ domination over banking by either fore, ineligible for rediscount. No financial or political interests, and to matter how strong the market demand maintain a sound banking system. for such securities, they are not liquid in the sense that commercial D e s ig n e d a s a n A id t o B u s in e s s bank loans must be liquid. At times The Federal Reserve System was they fluctuate widely in price. The designed as an aid to business. It is call loan rate fluctuates accordingly. applied only to commercial banking— In 1907 it reached 125 per cent. An that form of banking which takes advance in commercial discount rates account of the commercial scheme from 5 to 7 per cent indicates a by which commodities are got from critical condition in the commercial producer to consumer. The deposits money market. in commercial banks mark the stored- The plan to prevent stock market up purchasing power of the com­ hysteria from affecting commercial munity. Back of their loans are business has been reasonably success­ merchantable goods of greater value. ful. But investment securities have Such banks must be liquid. They not been kept out of the Reserve must pay on demand and their loans Banks. In Section 13, defining paper must, therefore, be of short maturities. eligible for rediscount, it is provided In a general way a loan should run no that such definition (of eligibility) longer than the estimated time it takes “shall not include notes, drafts or to get the goods behind it to the con­ bills covering merely investments is­ sumer. In relation to the producer, sued or drawn for the purpose of

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he R eserve Act in Its Implicit M eaning 59 carrying or trading in stocks, bonds or true that the distinction between com­ other investment securities, except mercial and investment banking was bonds and notes of the Government of the not clear in the minds of all who voted United States .” for the bill. But it was clear in the minds of enough. To confine the Re­ F is c a l A g e n t s o f t h e G o v e r n m e n t serve System entirely to commercial The Reserve Banks were intended banking may leave a gap in the to be fiscal agents of the government banking scheme, but sufficient experi­ and the exception as to government ence has been had to demonstrate the securities was natural at the time dangers of any lapse from the integrity when the World War could not be of the present plan. foreseen. If anyone had thought that the United States would be issuing P r o t e s t A g a in s t C o m m e r c ia l securities by billions before the Re­ L im it a t io n s o n R e s e r v e B a n k s serve Banks were four years old, it is The War Finance Corporation was doubtful if notes secured by govern­ the greatest protest against the com­ ment issues would have been made mercial limitations imposed on the eligible for rediscount so jealous were Reserve Banks. The exigencies of the framers of the act of the strictly war excused that law, if they did not commercial character of the Reserve justify it, but there is substantial Banks. ground for the suspicion, if not for the Always uppermost in the minds of belief, that, underlying the plan for the those men, both in and out of Con­ War Finance Corporation, was the gress, was the desire to keep commer­ political desire to get for the govern­ cial banking and the Reserve Banks ment some measure of control over free from investment securities. In­ investment banking. Many “Money numerable proposals have been made Trust” baiters fondly believed that for variations from this practice. The the Reserve Act would cripple Wall trials of war brought many. The Street. Some thought that control farmer’s insatiable demand for more would be given over speculative activi­ capital and credit has been advanced ties. The War Finance Corporation a thousand times. It has been seri­ might have had some such effect if it ously proposed that railroad bonds be had functioned to the extent predicted. recognized as collateral for Reserve In its revival as a machine to meet an Bank loans. The pressure for some exigency in which something beyond departure from the rule has been the maturities permitted for redis­ continual, if not constant.2 counts under the Reserve Act is It is undoubtedly true that many necessary, it may fill a temporary need supporters of the Federal Reserve bill acceptably, but it could not function in Congress were opposed to invest­ satisfactorily under other conditions, ment securities as collateral for notes even if it is conceded that its present eligible for rediscount only because of operations are satisfactory. On the hostility to Wall Street and hatred of other hand, it can only be said that, if the “Money Trust.” It is probably the Reserve Banks cannot meet every commercial banking need, they are 2 The Federal Reserve Board adopted a policy in order to assist in the war financing defective. The difficulty lies in deter­ which was economically unsound. Pages 62 mining just what is a commercial and 63 of the hearings entitled, “Reviving the banking need. Surely it is not to Activities of the War Finance Corporation.” hold up prices or make up or prevent

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 60 T he Annals of the American A cademy losses occasioned by cataclysmic dis­ eral Reserve Bank notes of small de­ turbances born of war. It is only nominations. It is hoped that the latter fair to say that the first duty of will soon find their way into oblivion. commercial banks is to protect them­ Reserve Bank notes, of minor con­ selves. In doing that they protect sequence in any event, have a signifi­ business. So far as the present opera­ cance as a by-product of the note tions of the War Finance Corporation controversy. Like the provision in protect the commercial banks, the Section 16 making reserve notes the work is probably justified. obligations of the United States—a provision wholly at variance with the S o m e T h in g s T h a t W e r e I n t e n d e d spirit of the Act and practically quite It is not an invitation to controversy meaningless—Federal Reserve Bank to say that the Reserve Act failed to notes attested the strength of the abolish the office of Comptroller of the “cheap money” element and the Currency for two reasons only: one was desire of the advocates of soundness to the political desire to keep the office in avoid a direct test of that strength. existence, and the other, the necessity The bond-secured national bank for retaining temporarily an organi­ currency and its retirement presented zation which was familiar with the a problem of grave import. It was bank records and had an operating finally solved by the provisions in mechanism. Similarly, the Independ­ Section 18 requiring the Federal Re­ ent Treasury system with numerous serve Banks to purchase such bonds, subtreasuries was marked for abolition securing circulation, as were offered to but the work was deferred, as is told the amount defined. Without dis­ elsewhere in this volume.3 cussing the methods of refundirig and It was always the plan of the retiring such bonds, it may be said framers of the Reserve Act to secure that the fiat money contingent re­ the ultimate correction of the country’s volted at the idea of having any patch-work currency. It was a hard securities carrying the circulation priv­ task, and is, with its difficulties in­ ilege in the hands of the Reserve creased by the clamors of the many Banks without providing a means of who believe in fiat currency. How­ issuing notes against them. The ever, provision is made for the ultimate means was provided. In due course retirement of both United States such notes came into existence. Thus notes and national bank currency. A a law which was conceived in the idea return to stable conditions will permit that one of its great purposes would be the execution of these provisions, to simplify and unify the currency, although little attention has been given actually opened the way for the adding them as yet. The purpose of the Act of a new patch and thereby heighten­ was to give the country ultimately a ing the crazy-quilt effect. currency composed of gold and re­ serve notes, with silver certificates as a C h e c k C o l l e c t io n s a n d N o t e sort.of necessary evil to supply the I s s u e s demand for small bills. The disap­ It is in Section 16 under the general pearance of the silver during the War title of “Note Issues” that there called forth the amendment permitting appears the provision empowering the issuance of reserve notes and Fed- every Federal Reserve Bank to “re­ 3 See “The Assumption of Treasury Functions ceive on deposit at par . . . checks by the Federal Reserve Banks.” and drafts, etc.”

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he R eserve A ct in Its Implicit M eaning 61 This and the paragraph which serve the purpose of currency which follows were those over which came may properly and logically be con­ the bitter controversy between coun­ sidered as expressing the same kind of try banks and Federal Reserve author­ credit in a different form.” ities. Of the merits or demerits of the The reply to this was that, in such a arguments which that controversy case, checks should be as good as aroused, nothing need be said here. currency. Certainly they should al­ The only significance for present ways be worth par. It was further purposes lies in the fact that “par agreed that elasticity demanded the collections” are provided for in the constant retirement as well as the section devoted to note issues. constant issuance of notes, because Around the question of note issue checks were instantly cancelled and raged a conflict for many years prior to retired once their work was done. 1913. The conflict harked back to the Out of it all came the inclusion of Second Bank of the United States, the “par collections” in the section on era when only the states chartered note issues. banks and every bank was a bank of However vigorously the subsequent issue. It had the savor from Civil conflict raged, the demonstration of War financial struggles; it had been similarity between notes and checks carried through the greenback strug­ stood secure. The case had been gle; it changed its form, not its sub­ proved, for another purpose perhaps, stance, when free silver was the cry, and but proved nevertheless. In vain was it had redivivous whenever elasticity of it argued that checks are a non- the circulating medium was mentioned. circulating, not a circulating medium. The ancient friends of much paper In vain were private rights defended money were reasonably quiet when the and pleas made that the banker also advocates of a new banking system was worthy of his hire. Par collection talked of the project in terms of bank stands and perhaps, after all, it was a reserves and credit, but when circulat­ small price the bankers paid for the ing notes were mentioned they were at relegation of fiat money to the limbo home and rampant. Also they had to of obscurity. be dealt with and dealt with kindly and There have been, of course, many diplomatically. If they should be departures from the plans of a reserve rubbed against the grain, there was system as thought out by its pro­ danger that paper currency would be moters and framers. The making of made so pronounced an issue that twelve instead of eight reserve banks, everything else would be forgotten. is one instance. In many ways This was the manner of the argu­ practical experience in operation has ment, although argument was a weapon overthrown the theories of the system’s of dubious value in that case: “Checks sponsors. In many others business are the great currency medium through methods have been gradually altered whose use the exchanges of commerce and habits changed to meet the new are effected.^ Elaborate investigation banking scheme’s requirements. There by the Monetary Commission’s ex­ is much of political interest and much perts has shown that something be­ of economic value buried in the tween 92 and 98 per cent of all pur­ history of the struggle for a scientific chases are paid for with checks written banking system. A little trip among against bank deposits. If checks are these buried treasures lets in light on the chief medium of payment, they later interpretations of the law. And

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e A n na ls of the A m erican A cademy despite the tremendous progress made stable business, to permit a conclusion in Reserve Bank operation as the as to the complete sufficiency of the Re­ result of war necessities, there were serve System but the foundation has distortions and stretchings of various been laid securely. The makers of the provisions of the Act. Not yet has there law builded well and in the face of been sufficient experience in times of very great difficulties.

The Purposes of the Federal Reserve Act as Shown By Its Explicit Provisions By E. W. K e m m e r e r Princeton University HAT were the chief purposes of tively few branches, instead of one the framers of the Federal Re­ central bank with many branches. serve Act as those purposes There are was nothing like this anywhere Wrevealed by the explicit provisionselse of in the world, at the time the the Act itself? In answering this Federal Reserve System was created question it will be well to consider (1) and, so far as I know, there is no his­ the framework of the Federal Re­ torical example of such a group of serve System, namely, its plan of or­ central banks. ganization and control, and (2) its There were two important economic functions. reasons for providing a group of cen­ The chief contribution made by the tral banks instead of one central bank. framers of the Federal Reserve Act These were: was in the plan of organization they (1) The need of a system that was proposed, the functions assigned to adaptable to widely different condi­ the Federal Reserve Banks being es­ tions in different parts of an immense sentially the same as those recommended country like the United States, with a few years previously for the National particular reference to rediscount rates, Reserve Association of the Aldrich and, (2) the desire to decentralize the Plan, as well as those of a number of control of the American money market central bank plans still earlier proposed in such a way as to weaken New York’s in this country. They are, moreover, alleged domination. not very different from the functions One serious objection to a single performed by the leading central central bank in the United States was banks of Europe. In this paper, there­ the difficulty arising from the fact that fore, attention will be given almost interest and discount rates for essen­ exclusively to the framework of the tially the same kinds of paper usually plan. differed considerably in different parts of the country; rates in the West and ‘R e a s o n s f o r a G r o u p o f South normally ruled higher than C e n t r a l B a n k s those in the Middle West, and rates in To foreigners who study the Federal the Middle West normally ruled higher Reserve System, the most striking than those in New England and the fact about it is that it should have Middle States. It was believed that twelve central banks with compara­ the establishment by a single bank of

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e P urposes of the F ederal R eserve A ct 63 a single rediscount rate applicable exercised, sub rosa, by a handful of throughout the United States to the so-called Wall Street banks. The same kind of paper, would be of Pujo Committee’s “Money Trust” little use to New England and the investigation had strengthened this Middle States if the rate were ad­ popular belief, particularly through justed to the higher level of rates pre­ the West and South. A single central vailing in the West and South, and bank, it was widely believed, would be that, on the other hand, if the rate increasingly dominated by New York, were made as low as that prevailing in while a group of banks, it was argued, the East, it would be so attractive to would weaken New York’s control by the West and South as to result in a causing the growth of a group of dangerous expansion of the bank’s territorially centralized money markets, loans in those sections at the expense each of which would handle a large of the East. In time, of course, such a part of the business of its own dis­ flow of funds from the East to the trict, and, to a greater or less extent, West and South would equalize rates would compete with New York for throughout the country; but the open-market business. amounts of capital involved were so These were the main reasons why great that it was felt that a long the law provided for eight to twelve period of time would be required to banks -instead of one, and why the achieve territorial equalization of rates, New York district was limited to such and the East was not favorably dis­ a small area with a strong Boston posed to the drain of its funds to the district at the northeast and a strong West and South that such a movement Philadelphia district at the south. toward equalization seemed to re­ quire. The maintenance by a central C h a r a c t e r o f F e d e r a l R e s e r v e bank of different discount rates in . B o a r d different parts of the country on the The proposal that the central govern­ same kind of paper, it was believed, ing board of the new system should be would be politically (and probably composed entirely of government ap­ also legally) impossible. pointees was met by a strong protest Although there were other kinds of throughout the country, particularly desirable adaptability to different from the banking fraternity. It was economic conditions in different parts claimed by many that such a board of the country, it appeared on close would inevitably be constituted of examination that for most purposes inefficient political appointees and sufficient autonomy could not be would be politically controlled, thereby given to branches of a single central making the Federal Reserve System bank to enable them to adapt the the football of politics. Much was character of their services to varying made of the claim that the bankers, local conditions. who presumably would furnish the The second reason for preferring a entire capital of the Federal Reserve group of banks was the widespread Banks and who would be responsible feeling that the banking system of the for it to their stockholders and de­ country was being unduly central­ positors, would have no voice what­ ized in New York City, where a very ever in the appointment of the board large part of the deposited bank re­ which was to control the broad policies serves of the country were held and of the new banks. This central board where control was widely believed to be of seven men to be appointed exclu­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 64 T h e A nnals of the A m erican A cademy sively by the President was in striking furnished entirely by banks. We must contrast to the central board pro­ bear in mind that its public deposits alone posed by Senator Aldrich. Under will for some time probably exceed its paid-up capital, that the funds which the his plan the board was to consist banks deposit with the Association will be of forty-six directors of whom forty- chiefly those which the public has de­ two, including the governor and the posited with the banks, and that the paper two deputy-governors, were to be which the banks rediscount with it will be appointed directly or indirectly by that of the business community. We bankers. must not forget that the National Reserve Despite the vigorous opposition to Association is to have a tremendous the proposal that the central board of public power and responsibility, through the Federal Reserve System be ap­ its right to fix the bank rate of discount, its pointed entirely by the President, the power over the foreign exchanges and gold shipments, its right to issue the country’s proposal was adopted. It should be only elastic paper currency, its supervisory noted that this board was not to do a power over banks, and its function of banking business. That was to be holding a large percentage of the country’s done exclusively by the twelve banks, reserve money, together with the privilege six of the nine members of the board of of having its promises to pay, in the form directors of each being elected by the of its deposits and bank notes, counted as member banks. It was primarily in the lawful reserve money for banks. Now it field of determining broad questions of is possible, although by no means certain, policy that the Federal Reserve Board that the interests of bankers as a class and was to function, and in this field, it was those of the public are identical. It is certain, however, that history furnishes claimed, the need was for financial numerous instances in which what the statesmen who would view their prob­ public believed to be its interest and what lems broadly from the standpoint of bankers believed to be theirs were in con­ public service. This was true be­ flict. One need not go back farther than cause the functions proposed for the the last two or three years to find a striking Federal Reserve System, like those instance of the kind in the United States. that had previously been proposed for I refer to the movement leading to the the National Reserve Association of establishment of the United States postal the Aldrich Plan, were affected with a saving depositories, which was opposed great public interest. On this sub­ vigorously and almost unanimously by the banking fraternity. It is furthermore ject the writer in 1913, summarizing true, and perhaps of greater importance, the conclusions of an address given by that a large element in the country be­ him in 1911, said as follows:1 lieves the interests of bankers to be in Is not the National Reserve Association conflict with those of the general public on too much of a public institution to be so a great many vital questions. largely controlled by one type of business interest, that is, that of the banking fra­ Although Congress and the Presi­ ternity? We must get away from the dent did not budge an inch in their prevalent idea that ihe National Reserve insistence upon making the Federal Association is to be principally a bankers’ Reserve Board an exclusively govern­ affair just because its capital is to be ment board, they threw a sop to the opposition by inserting in the law the 1 See “Banking Reform in the United States,” American Economic Review Supplement, March, provision for a “Federal Advisory 1913, pp. 54 and 55; and “Some Public Aspects Council” of bankers, one member to be of the Aldrich Plan,” Journal of Political selected annually by the board of Economy, December, 1911, pp. 819-830. directors of each Federal Reserve

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e P urpo ses of the F ederal R eserve A ct 65 Bank from its own district, making that Board. Their salaries are fixed the number of members in the Council by the Federal Reserve Board, and equal to the number of Federal Re­ that Board may suspend Class C serve Banks. The relations of this directors or remove them from office. Council to the Federal Reserve Board These directors are the connecting were to be entirely advisory. Neither links between the central Board and voting nor veto power was given to the Federal Reserve Bank. They the Council, which was required to keep the central Board informed as to meet at least four times a year and the developments in each Federal Re­ oftener, if called by the Federal Re­ serve Bank. It is through them that serve Board. Members of the Fed­ the Federal Reserve Board exercises its eral Reserve Board who were to be control over the broad policies of the “on the job” three hundred days in Federal Reserve System and compels the year, it was generally thought, the necessary teamwork among the would not be likely to be greatly in­ twelve banks. fluenced as to their own job by a group This same sort of representation and of advisers coming from widely sepa­ control on the part of the Federal rated parts of the country who would Reserve Board is carried through to meet infrequently. Happily during the branches of the Federal Reserve the last year or so, the Advisory Banks, each of which is operated under Council has belied this expectation. the supervision of a board of directors “to consist of not more than seven F e d e r a l R e s e r v e B a n k nor less than three directors, of whom D irectorates a majority of one shall be appointed by In its provisions for the directo­ the Federal Reserve Bank of the dis­ rates of the Federal Reserve Banks, trict, and the remaining directors by the Act well reveals the purpose of its the Federal Reserve Board.” framers to create a group of federated The other six directors, constituting organizations that at one and the two-thirds of the board, are elected by same time would (1) recognize the pub­ the member banks. Their concern is lic’s dominant interest in matters of primarily with the banking operations broad policy; would (2) recognize the of the bank, notably the character and dominant interest of the banker and quantity of its rediscounts and col­ the banker’s business customer in the lateral loans for member banks, its narrower banking questions, such as open-market operations, its discount the goodness of the paper against rate policy (subject to the approval of which advances were to be made, the the Federal Reserve Board), and the amounts to be loaned individual mem­ like. Of course, the Class C directors ber banks, the quality of open-market likewise vote on these banking ques­ investments, and the like, and would tions. (3) permit of a democratic control To every bank loan and to every among the member banks of this bank deposit, there are at least two banking business. directly interested parties, the bank Of the nine members of the board of and the bank’s customer. The bank’s directors, three (including the chair­ customer is usually a business man or a man and the vice-chairman of the business concern (using those terms board) are Class C directors, who are in their broader meaning). In rec­ appointed by the Federal Reserve ognition of this dual interest in most Board and are directly responsible to banking operations, the Federal Re­ 6

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CO T h e A n n a Ls of the A m erican A cademy serve Act provided that, of the six changed through the repeal of the directors who were to be primarily requirement that each of the three concerned with the direct banking groups of banks should “contain as operations of the Federal Reserve nearly as may be one-third of the Bank, three, known as Class A direc­ aggregate number of the member tors, should “be representatives of banks of the district . . .” and the the stockholding banks”—as a matter substitution therefor of the provision of fact they are practically always that “the Federal Reserve Board bankers—and that the other three, shall classify the member banks of the known as Class B directors, should at district into three general groups or the time of their election be “ac­ divisions,” without placing any re­ tively engaged in their district in striction whatever upon the number of commerce, agriculture, or some other banks that should be placed in each industrial pursuit.” Here is the recog­ group. This looked like a step away nition of the interest of the non­ from the original democratic prin­ banking business community in the ciple of one bank one vote—a prin­ banking operations of the Federal ciple followed in the elections of most Reserve Banks. of the clearing house associations. It The purpose of democratizing such clearly increased the power of the control over the Federal Reserve Federal Reserve Board over the Banks as should be exercised by Class election of Class A and Class B A and Class B directors is seen in the directors. rather unique provisions for the elec­ How far the original plan of group­ tion of directors contained in the Act ing the member banks, for purposes as originally passed. This Act di­ of electing directors, into three ap­ vided all member banks of each proximately equal groups of banks district into three groups, each group has since been departed from by containing “as nearly as may be one- the Federal Reserve Board in exer­ third of the aggregate number of the cising the authority conferred by the member banks of the district and . . . above-mentioned amendment, will be [to] consist, as nearly as may be, of seen from the following figures. A banks of similar capitalization.” Each week after the amendment had been of these groups was to elect one Class passed the Board made a reclassifica­ A director and one Class B director, tion of member banks for the twelve on the democratic plan of “one bank districts, which, when taken by totals one vote” regardless of the size of the for all districts, placed 515 banks or 6.4 bank. Under this plan the peculiar per cent of the total number (i.e., 8,099) interests of the small banks, of the in group I, the large-bank group; middle-sized banks and of the large 2,384 banks, or 29.4 of the total, in banks, respectively, were assured rep­ group II, the middle-sized-bank group; resentation. The democracy of a and 5,200 banks, or 64.2 per cent of the plan that gave the same voting power total, in group III, the small-sized- to the bank of $25,000 capital that it bank group. According to this re­ gave to the bank of $250,000 capital arrangement, therefore, the 515 largest and to that of $25,000,000 capital banks in the respective districts could made a strong appeal to those who now elect the same number of Class A feared “Money Trust” control. and Class B directors that the 5,200 By an act of September 26, 1918, smallest banks could elect, or the the method of choosing directors was same number that the 2,700 largest

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e P urposes of the F ederal R eserve A ct 67 banks could previously have elected. officials of national banks that they There may have been good reasons for would give up their Federal charters this great change in the grouping, and reorganize as state institutions if increasing the power of the large bank the Glass-Owen bill in anything like its at the expense of the smaller, but, so existing form should become a law, far as I know, the Federal Reserve that the framers of the Act undertook Board has given little or no publicity to assure the establishment of a Fed­ to the change itself or to its reasons for eral Reserve Bank in each district by making it. The amendment author­ providing that, if sufficient banks izing the change was passed at the should not join the System, the Board’s request. capital could be subscribed by the public or by the government itself. M e m b e r s h ip In the early stages of the bill Membership in the Federal Re­ through Congress the required stock serve System was limited to commer­ subscription was based upon the capi­ cial banks and trust companies, show­ tal of the member banks, but the ing that the System was expected to basis was later changed to capital and function in the field of short-time surplus, the percentage required being active business operations rather than reduced. The distinction between a in the fields of capital and real estate bank’s capital and its surplus is at transactions occupied so largely by best a rather arbitrary one and is savings banks, private banks and in­ essentially legal, rather than economic. vestment houses. National banks, Had the basis been capital alone, a operating as they did under Federal bank desiring to keep its subscription charters, were expected to play the to Federal Reserve Bank stock low, game according to the new and im­ would have been encouraged to in­ proved national rules laid down by the crease its surplus at the expense of its Federal Reserve Act. If they were capital. unwilling to accept these rules they were invited to get out of the national D istribution o f P r o f it s system. State banks and trust com­ The original Act provided that from panies possessing adequate capitals the net earnings an annual dividend of and conforming in their operations to six per cent, which should be cumula­ sound banking practices were per­ tive, should be paid on the paid-in mitted and encouraged to become capital stock; that, of the balance of the members of the Federal Reserve net earnings, one-half should be paid into System. The Act clearly contem­ a surplus fund until the surplus should plated a large membership of state amount to 40 per cent of the paid- institutions. in capital, and that the remainder should be paid to the United States as C a p it a l a n d D iv id e n d s a franchise tax. An amendment of It was hoped that enough banks March 3, 1919, provided that after the would enter the System from each six per cent dividend is paid the whole district to assure an adequate capital of the net earnings of each bank shall for each Federal Reserve Bank, but be carried to surplus until the sur­ among bankers the opposition to the plus shall amount to 100 per cent of the Glass-Owen bill had been so pro­ subscribed capital, and that, after this nounced and widespread, and threats 100 per cent surplus shall have been had been so frequently expressed by accumulated, 10 per cent of the net

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 68 T h e A nna ls of the A m erican A cademy earnings, above the dividend charges, 1921, the paid-in capital and accumu­ shall be transferred to surplus indefi­ lated surplus of the twelve Federal nitely. A bank withdrawing from Reserve Banks was $317,000,000, an the System receives back the capital amount $28,000,000 greater than 6 it has paid in and any accumulated per cent of the capital and surplus of dividends but cannot take one cent of all the member banks plus 40 per cent, the accumulated surplus. The two namely, the maximum capital and sur­ hundred odd millions of surplus al­ plus contemplated by the Act of 1913 ready accumulated by the twelve for the twelve Federal Reserve Banks. Banks would therefore go to the When the Federal Reserve Act was government should the Banks go out passed there was a widespread hope of business. among economists and bankers that Net earnings paid to the United any profits accruing to the government States by the Federal Reserve Banks, through this franchise tax would be the law provided, “shall in the dis­ used for the first of the two purposes cretion of the Secretary, be used to authorized, i.e., “to supplement the supplement the gold reserve held gold reserve held against outstanding against outstanding United States United States notes.” The increase notes, or shall be applied to the re­ of this reserve by slightly less than duction of the outstanding bonded in­ $200,000,000 would have been suffi­ debtedness of the United States. . . .” cient to transform all of our green­ The significance of these provisions backs into gold certificates and thus concerning earnings, briefly stated, is retire from circulation one of the most apparently as follows: The Federal undesirable elements in our motley Reserve Banks are to be administered collection of paper money. Of the with primary reference to the public $117,000,000 so far either paid to the service, and member banks are to re­ government in franchise taxes by the ceive their returns chiefly in the twelve Banks or due and set aside by services rendered them directly by them for the government, all has been the Federal Reserve Banks and in the absorbed by the war debt and not a safer and more stable financial condi­ dollar has gone into the building up of tions throughout the country which the reserve against greenbacks. the Federal Reserve System creates. The desire for large cash profits is to F u n c t io n s o f F e d e r a l R e s e r v e have no influence in determining the B a n k s policies of the Federal Reserve Banks. As stated at the beginning, the Their actuating motives must be limits of space will permit only a few found in service to the member banks words concerning the purposes of the and, through the banks, to the public. Act as revealed in the functions If, incidentally, large profits are real­ assigned the Federal Reserve Banks. ized they must go to the government. These functions are clearly defined in To date the profits of the twelve the Act and their general character is Federal Reserve Banks have been so understood by all students of the large, chiefly as the result of war and System. They are, moreover, broadly post-war demands upon the System, speaking, the functions performed by that it seems improbable that the central banks throughout the world. call for the other 3 per cent of stock Chief among them are the following: subscription authorized by the Act (1) The centralization and mobili­ will ever be made. On November 9, zation of bank reserves;

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e P urposes of the F ederal R eserve A ct 69 (2) The rendering more elastic of terest charge, at the discretion of the bank credit, both bank notes and Federal Reserve Board—a charge that bank deposits; has never been imposed. The Federal (3) The creation of a more efficient Reserve notes therefore, in form, have and cheaper clearing and collection some of the qualities of government system for checks; paper money, but, in substance, are (4) The improvement of facilities almost a pure asset currency possess­ for financing our import and export ing a government guaranty, against trade at home, and finally which contingency the government (5) The providing of a satisfactory has made ho provision whatever. depository and fiscal agency for the When the Glass-Owen bill was be­ Federal government. fore Congress the provisions looking Reserves are centralized through toward the parring of checks through the requirement that legal reserves of the establishment of an extensive member banks shall consist exclu­ clearing and collection system were sively of deposits in their respective widely opposed by bankers, who Federal Reserve Banks. These re­ claimed that they were the work of serves are largely centralized in the theorists and visionaries. The subse­ Gold Settlement Fund and the Federal quent development of this clearing and Reserve Agents’ Fund, and are ren­ collection system has gone beyond the dered mobile through interbank dis­ dreams of the most visionary of the counts and through open market visionaries of 1913. operations. The extension of the use of bank Elasticity of circulating credit is ob­ acceptances and of dollar exchange in tained through the machinery of redis­ the United States, and the develop­ counting commercial paper, through ment of a broad and active discount direct collateral loans—machinery com­ market for paper arising out of mon to most central banks—and foreign trade—objects clearly sought through open-market operations. The by the Federal Reserve Act—were old-time stone-wall reserve require­ substantially attained much more rap­ ments are done away with, and there is idly than had been expected, as a no limit below which a legal reserve result of the dominant position in the cannot now be reduced provided the world’s trade and finance which New bank concerned is willing to pay the York obtained, temporarily at least, price. An elastic asset bank-note cur­ through the War. rency is superimposed upon the old The movement in the direction of rigid bank-note currency, although out making the Federal Reserve Banks the of deference to the opinions of certain exclusive depositaries of Federal govern­ persons of high political influence in ment funds was checked by our entrance 1913, who believed that the issuance of nto the War; but, as a result of the bank notes was an exercise of the essen­ discontinuance of the subtreasuries, the tially government function of issuing fiscal agency functions of the Federal money, the Federal Reserve notes are Reserve System which were enormously made to emanate from the government enlarged by the War, have since been and made subject to a government in­ still further extended.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Political Pressure and the Future of the Federal Reserve System* By P a u l M. W a r b u r g Member of the Federal Reserve Board 1914-1918 ROM the earliest beginning it was target of ambitious business men or obvious that, in order to be suc­ scheming politicians, maximum effi­ cessful, any attempt at a thoroughciency had to be subordinated to maxi­ bankingF reform in the United States mum safety. would have to approach the subject The writer’s original plan, “A United from two angles: one, from the point Reserve Bank of the United States,” of view of pure banking technique, the proceeded on these lines; so did, subse­ other, from the point of view of ad­ quently, the Aldrich “ National Reserve ministration. The problem was to Association of the United States” and, devise a plan carrying conviction not later on, the Federal Reserve plan. only as a sound and effective piece of Each of these schemes followed the banking machinery, but also as offering lines of merging the country’s dead reliable safeguards against any possi­ gold reserves into one live organiza­ bility of the control of the system’s tion; of building upon this more or less passing into the hands of either “big centralized gold an elastic note issue; business” or the politician. If legisla­ and having thus centralized the scat­ tion was to be secured and, indeed, if tered forces of the nation into one the future of the system was to be organic structure, of once more decen­ protected, a formula had to be found tralizing its administration and organ­ under which these two elements would ization, and circumscribing it far be called upon to balance one another. enough to prevent the dangers of If the new banking system was to re­ abused power and of one-sided control. main safe and sound, its administration The advocates of a pure central bank had to be shielded from the danger of had to reconcile themselves to a lower becoming subservient either to business banking ideal by surrendering to or to politics, and, conversely, safe­ the political requirements of the case. guards had to be provided against busi­ Conversely, the sworn antagonists of a ness’ or politics’ becoming subservient central banking system had to sur­ to the new banking system. render their political ideal, the gospel From the bare point of view of effi­ of decentralized banking, in order to ciency and economy, one central bank provide a system that would be work­ with a purely business management able as a banking proposition. would undoubtedly have yielded the Thus the Democrats, starting with best results, but from the point of view the thought of a large number of dis­ of what was required in the larger inter­ connected reserve banks, ended in ty­ est of the country, of what was essen­ ing them together into a central bank­ tial in order to prevent the system, ing system, in its essential features not once established, from becoming the very dissimilar (though differing in * Adequate treatment of this subject would many important details) from the require more time and study than was possible Aldrich Plan, which had started at the under the circumstances and more space than other end. could be given in this volume. P. M. W. Disregarding the question of which

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis P olitical P ressure and the F uture 71 side made the largest share of valuable or two members may be vulnerable contributions and mistakes and, deal­ because their terms are about to expire, ing with the topic simply from the point it can readily be seen how easy, and of view of sincere appreciation of the therefore tempting, it is for the political banking system which we enjoy today, members to assert their influence, and the problem now before us is to exam­ how unpleasant and unenviable may ine what remains to be done in order to be the lot of members struggling to promote and protect its future. preserve their independence and self- A study of four years from within the respect. System and of almost four years from When members of the Board are without, leads me to think that its hounded by senators or congressmen gravest danger lies in the gradual because they do not think it proper to ascendency of political influence. flood the country with easy money, just The Federal Reserve System, as because elections are coming; or when such, is based upon the perfectly sound they refuse to believe that excessive and happy theory of placing the actual fluctuations in foreign exchanges during management of the Federal Reserve the War were due to Wall Street specu­ Banks in the hands of boards of direc­ lation and could be regulated or con­ tors, the majority of whom are ap­ trolled by the Federal Reserve Board; pointed by business men. The direction or when they are viciously criticised of the System as a whole, on the other because they will not accede to the hand, its policies and its supervision, belief that fake easy money can coun­ are vested in the Federal Reserve teract the effects of overproduction of Board, which consists of five members important staples when a period of appointed by the President and con­ reduced world consumption is encoun­ firmed by the Senate. These members tered—it is, at best, not easy to find are appointed for ten-year terms and men of importance willing to make the Governor and Vice-Governor are the material sacrifices involved in serv­ designated by the President and serve ice of the Federal Reserve Board. at his pleasure. The Secretary of the It will become increasingly hopeless, Treasury and the Comptroller of the however, to secure such men if some of Currency are members ex officio. The the defects in the organization of the Secretary of the Treasury is Chairman Board as above described are not of the Board. promptly removed and the dignity and Among the many Presidents, Secre­ independence of the office of member taries of the Treasury, Senators, Con­ are not enhanced. To state it briefly: gressmen and Comptrollers of the Cur­ The Governor and Vice-Governor ought rency that I have known, there have to be elected by the Board itself; been good ones and bad ones, some ad­ or they should serve in rotation, and mirably strong and some lamentably the office of the Secretary of the Board weak. And therein lies the danger for might, in the latter case, be developed the future: As long as there are two ex­ into that of something like a “general officio members of the Board, who are manager,” or the Governor ought to constantly subjected to political pres­ be designated for the full term of his sure; so long as every President has the membership. The Governor ought to power to play favorites with Board be the Chairman of the Board and, members by promoting them to the instead of the Secretary of the Treas­ positions of Governor or Vice-Governor ury, who hardly ever has the time to or demoting them at will; so long as one attend Board meetings, the Assistant

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis n T he A nnals of the A m erican A cademy Secretary of the Treasury ought to important becomes the Federal Re­ become an ex-offico member of the serve Board as the sole organic link Board. There should be an additional connecting them all. The weaker the member of the Board, who should ex­ single districts and the more discon­ ercise the main functions now resting nected they are, the more difficult, and in the Comptroller of the Currency. at times desperate, becomes the task The vast powers now vested in the of the Federal Reserve Board to coax Comptroller are the remnants of an or club these autonomous units into undemocratic, antiquated and danger­ prompt and effective cooperation. The ous system. Moreover, the present Board was planned to be preeminently condition has led in the past to costly a supervisory and directive body; ex­ delays, duplication of work, inefficiency cessive decentralization was bound to and unbearable irritation. Examina­ force it more and more into the exercise tions and rulings concerning banking of administrative functions, which— operations ought to be made by one for men located at Washington, unable body and not by two, if a prompt and to be in personal close touch with efficient administration is to be assured. actual business conditions and opera­ In the past, Board members often have tions in twelve separate and remote had to wait upon the good graces—or districts—naturally became more be­ bad graces—of the Comptroller before wildering and troublesome than was any headway could be made in im­ advisable or necessary. portant matters. The situation bris­ The fundamental thought of reserve tled with humiliating and distasteful banking is that the idle money of one incidents. It seems ridiculous that the industry or section should become Board should have appeared before available for the seasonal requirements Congress with one set of recommenda­ of another. Federal Reserve Districts, tions and the Comptroller, a Board therefore, which are “all cotton” or member, with another, often entirely in “all grain” were from the beginning conflict with the policies of the Board. doomed to fail as independent districts; Unless the Federal Reserve Board is seasonal requirements were bound to raised to a position of the greatest exhaust their loaning power too rapidly. possible dignity and men of real While they could secure assistance strength, independence and knowledge through the somewhat clumsy pro­ are found to serve upon it in the future, cedure of rediscounting with other it is to be feared that the System will Federal Reserve Banks under the di­ become the football of politics. A rection of the Federal Reserve Board, splendid instrument of protection they generally would be inclined to might thus become an element of dan­ hesitate to resort to these rediscount gerous disturbance. operations, inasmuch as they would This danger is all the more real be­ tend to emphasize the organic weak­ cause of the unfortunate action of the ness or temporary exhaustion of their Organization Committee in establish­ districts. Unfortunately the Organiza­ ing twelve Federal Reserve Banks in­ tion Committee disregarded this funda­ stead of beginning with eight, as the mental principle and the districts of Federal Reserve Act had permitted St. Louis, for instance, and its sur­ them to do. rounding Federal Reserve districts The larger the number of Federal were delineated with about the same Reserve Banks and the greater the regard for economic questions as were consequent decentralization, the more Austria and her so-called Succession

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis P olitical P r essu re and the F uture 73 States at Versailles. Owing to this must be appointed, political pressure absence of a sufficient diversification notwithstanding, solely from the point of interests and minds, local banking of view of securing the men best quali­ factions and self-centered provincial­ fied for the protection of the Banks. ism have from the beginning played Finally, the future of the local manage­ too large a part in framing the boards ment of all banks, in short, the morale of directors, the managements and the of the entire System, will depend upon policies of many of the twelve Federal the character of the Federal Reserve Reserve Banks, with little understand­ Board. ing of the national questions involved. If the Federal Reserve System was Much bitter feeling and criticism were able to accomplish its phenomenal caused, particularly in the agricultural development and if it could respond so sections, by unnecessary and irritating splendidly to the trying demands of mistakes made in fixing interest charges the war, and of the post-war periods, or in applying ill-advised methods of it was largely due to the devotion, administration. Whatever anticipa­ vision and ability of members of the tory words or warning in this regard Federal Reserve Board and of some of were given to Congress and later to the Federal Reserve agents and gov­ the Organization Committee, unfortu­ ernors of Federal Reserve Banks, who nately, have proved only too true, perfected and developed the System including the prophecy that an ex­ into the extraordinary banking organi­ cessive number of Federal Reserve zation it is today. Strong and excep­ Banks would prevent the establishment tional men made themselves the leaders of large financial centers outside of of the rest. Without them, the System New York, where important open dis­ would have failed. Such men today count markets could develop. are still serving the System, though It is a great loss for the country that from the material point of view many at the time of the formulation of the of them could do vastly better for them­ law and the establishment of the Sys­ selves in other fields. If politics should tem it was impossible to convince the creep into the Board, these men will sections involved that a Federal Re­ gradually drop out, and from top to serve branch bank could convey the bottom the System will deteriorate. same benefit as a Federal Reserve Bank; If the administration of the Federal indeed, that as a branch of a larger Reserve System, in Washington and in district a region would be better the banks, should then fall into the served than as a self-contained district. hands of weak and incapable men who Minneapolis, as a branch of Chicago, only see “fat jobs” in the positions, would have been as well provided for as instead of those who today devote Detroit, but it would enjoy a rate of themselves to the work at a personal 5 per cent instead of its present 5| sacrifice because they see in it an per cent rate. The same holds good opportunity for public service, there for Dallas and Atlanta. are dark days ahead for the country. As stated before, the weaker the Government must exercise an effec­ Federal Reserve Banks, the stronger tive control over business in its admin­ must be the Federal Reserve Board. istration of the Federal Reserve Banks; This is all the more essential because but this control must be exerted the Board appoints the C class di­ through a Federal Reserve Board com­ rectors. The latter often constitute prising men of the highest integrity and very important elements of safety and efficiency—men who do not seek the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 74 T h e A nnals of the A m erican A cademy job and would not hesitate to surrender leaders might prefer that the Federal it, if either business or politics should Reserve System be subservient rather interfere with the independent exercise than independent. They want open of their duties for the best advantage of doors for patronage and a ready com­ the country as a whole. pliance with the wishes of their con­ If that is to be achieved, and the stituents. future of the Federal Reserve System Protection for the Federal Reserve is to be assured, the people themselves System must, therefore, not be expected must take a hand. They must never from Washington, unless it is possible to fail to rally to the support of these arouse and strengthen the small num­ faithful servants when unfairly at­ ber of distinguished men in the Admin­ tacked, and they must not lose any istration, and in Congress, who would opportunity of showing them that their understand the danger and would fight services are appreciated. If the people to ward it off. They will win if the do not prove that they honor their country makes Congress understand leaders and stand by them loyally, what that its heart is in it. If the people incentive is there for these leaders to cease to exercise vigilance, if ever they hold out? relax in their insistence upon the integ­ In a similar manner, Congress must rity of their banking system, it may feel that whoever dares to encroach develop, as it did before, from the upon the independence of the Federal greatest blessing into the gravest men­ Reserve System attacks the most sa­ ace. A Federal Reserve System turned cred treasure of the people. In Wash­ into a political octopus, a national ington I came to know many upright Tammany Hall, would infest not only men of the very highest type; never­ the counting houses but every farm theless a large number of our political and hovel in the country.

Early Functioning of the Federal Reserve System By A r t h u r R e y n o l d s President, Continental and Commercial National Bank of Chicago N October 26, 1914, the Secretary the Federal Reserve Board in its first of the Treasury sent a message report after two months of operation, to the twelve Federal Reserve Banks,for defining the general scope of activi­ thenO organizing, instructing them to ties of the Federal Reserve Banks. begin definite operations on November There being no extraordinary times to 16, 1914. Great haste was made to call for the protective function as set secure adequate quarters and a working forth in the above definition of policy, staff. One-sixth of the capital stock the operation of the Federal Reserve subscriptions were called on November System during the first two years was 2, 1914, and on the sixteenth of No­ confined largely to efforts, first, to vember the Banks formally opened for “unify the banking system of the business. country” by seeking new members “Regulation in ordinary times, as among the ranks of the state banks; well as protection in extraordinary second, to endeavor to regulate interest times” was the principle laid down by rates and Equalize the demand for

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E arly F unctioning of the System 75 money by the purchase of bills and They had been educated to believe that acceptances in the open market, and deposits were the indication of strength, third, to establish a par collection and that borrowed money was a sign system and the clearance of all checks of weakness. Any rediscounts or bills on member banks. payable which they might lodge with The men charged with the operation the Federal Reserve Banks would ap­ of the Federal Reserve System, upon pear in their statements, and since, in its inception, promptly sought to induce many instances, they could obtain the banks of the country to make full credit from their city correspondents use of its facilities. They were influ­ through methods which did not involve enced, undoubtedly, by the feeling on the direct obligation of their banks, and, their part that it was necessary to keep therefore, did not appear as borrowed employed such funds as were entrusted money, they were quite content to to them in order to pay expenses and to utilize the credit facilities of those city earn dividends upon the capital stock. correspondents. It must be remem­ They felt that member banks should bered that at this time there were no rediscount with the Reserve Banks, unusual conditions confronting the and by one means and another endeav­ country; rates were low and money ored to accomplish this. But in the was easily obtainable. Bankers out­ early history of the System it was des­ side of reserve centers had, over a con­ tined to meet with no such ready siderable period of years, built up their response. The old banking practice relationships with reserve city and of the country had its basis in too many central reserve city correspondents. years of actual habit, and it was but Those who had occasion to borrow for natural that banks generally should be seasonal requirements were intimately hesitant and cautious in making radical acquainted with the city banks which changes in their methods; indeed, a had met their needs. Those banks great many of them felt that the Fed­ which had for many years maintained eral Reserve Banks, if supported too balances with other banks felt that they generously, would ultimately encroach had a cumulative asset of which they upon and usurp some of the functions could avail themselves should the of existing banks. They were loath, occasion arise. There was mutual therefore, to go farther than the mere understanding between correspondents, subscription of capital. It was inevi­ while the Reserve System was an un­ table that a great many bankers in the tried departure. country should look upon the System It will also be remembered that the as a government undertaking and fear Federal Reserve Act did not make pro­ that transactions with it would be in­ vision for the turning of all reserve volved in “red tape.” They feared funds over to the Reserve Banks. The also that it would be influenced by change was gradual. Old relations politics. between banks were, therefore, not interrupted. P r e j u d ic e A g a in s t R ediscounting All of these things militated against Coincident with this, and one of the the fullest possible functioning of the greatest difficulties in the way of those System in its early stages, and such who were ambitious for the quick ac­ rediscounts and bills payable as were ceptance of the System, was the long­ lodged with the Federal Reserve Banks time prejudice of bankers against dis­ were largely in the nature of “courtesy closing their borrowings to the public. transactions” on the part of friendly

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 76 T h e A nnals of th e A m erican A cademy bankers who wished to help educate tion encountered when the Reserve the banking fraternity to use the Banks undertook to make it compul­ Federal Reserve facilities. sory upon all banks to accept their own items at par. “ C o u r t e s y T ransactions ” Comment by the Ninth District T h e S t a t e B a n k P r o b l e m Reserve Bank in its report for the year The early attempts to obtain new 1915 is illustrative of the general condi­ members from the ranks of the state tion confronting all of the Reserve banks were bitterly opposed in many Banks at that time: quarters. Legislation was even re­ During the latter half of November and sorted to in combating the advances of the month of December, 1914, such redis­ representatives of the Federal Reserve counts as were afforded members were Banks in this direction. In its second largely courtesy transactions, the greater annual report on December 31, 1915, part representing the efforts of larger banks the Federal Reserve Board observed: to acquaint the public with the new Federal It is an unfortunate fact that, in some of Reserve currency. After January 1, 1915 the states, reserve requirements for state . . . loans dropped to the lowest ebb banks and trust companies have been mate­ in many years. Rates on commercial rially lowered by legislative enactment since paper took new low levels. . . . the adoption of the Federal Reserve Act. . . . This is an element of danger in The one great plaint during this time our banking system, because the weaken­ was the non-payment of interest upon ing of the reserves of the state banks and balances carried at the Reserve Banks. trust companies makes them more vul­ In the report containing the preceding nerable in times of emergency. . . . It comment of the Minneapolis bank, would be deplorable were feelings of state Pierre Jay, Federal Reserve agent at or local pride to lead any of the states into New York City, said: competition with the Federal Reserve System such as would prompt them to . . . it is among the country banks as lower their own banking standards or a class that most of the apathy and hostility reserve requirements with a view of ena­ to the Federal Reserve System which still bling or inducing state banks to refrain from persists is found. Their opportunities and taking membership therein. The Board is earnings are relatively small and they must satisfied that state banks gain in safety and figure closely to live. They feel the loss of that states sacrifice none of their preroga­ interest on reserve deposits; the absence, as tives or powers when such banks become yet, of dividends on their capital contribu­ members of the Federal Reserve System, tions, and the prospective loss or decrease and therefore, expresses the hope that no of the exchange they generally charge on seeming divergence of interest will be per­ remitting for checks drawn upon them. mitted to impede the establishment of The institution of the par collection higher standards of banking. system met with great disapproval Every means was employed to make from many banks in the smaller com­ memberships in the System attractive munities where the earnings derived to state banks and later amendments from exchange charges had for many to the law aided in inducing them to years constituted a comparatively sub­ join. stantial part of the total earnings. Some banks sought to surrender their E a r n in g A s s e t s B e f o r e a n d A f t e r national bank charters and incorporate t h e W a r as state banks. This was only the Failure to secure applications for forerunner of the more serious opposi­ rediscounts to employ more than a

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E arly F unctioning of the System 77 small part of the funds of the System, the Reserve Banks combined, from the caused the Reserve Banks to invest in date of opening to January 1st, 1921, government bonds, acceptances and gives a concrete picture of the early municipal warrants. A careful study functioning of the System in contrast of the graph on page 78 showing the to its operations after the United States curves of the earning assets of all of entered the War. E a r n in g A ssets op t h e F ederal R eserve System D ecember 31, 1914-O ctober 26, 1921 Bills discounted Bills bought in U. S. government Municipal Date for members open market securities warrants

1914 December 3 1 ...... 9,909,000 205,000 734,000 1915 January 2 9 ...... 13,955,000 .... 2,015,000 11,165,000 April 3 0 ...... 22,774,000 13,812,000 6,813,000 18,656,000 July 3 0 ...... 29,102,000 11,625,000 7,923,000 16,107,000 October 2 9 ...... 30,448,000 13,619,000 10,505,000 25,014,000 1916 January 2 8 ...... 26,901,000 26,314,000 21,372,000 20,602,000 April 2 8 ...... 21,448,000 47,585,000 45,841,000 36,933,000 July 2 8 ...... 27,594,000 83,454,000 48,656,000 27,220,000 October 2 7 ...... 21,131,000 86,085,000 40,469,000 29,890,000 1917 January 2 6 ...... 15,711,000 97,697,000 55,769,000 12,249,000 April 27...... 35,043,000 71,400,000 117,818,000 14,999,000 July 2 7 ...... 138,459,000 195,097,000 76,953,000 1,469,000 October 2 6 ...... 397,094,000 177,590,000 110,042,000 233,000 1918 January 2 5 ...... 627,632,000 273,912,000 123,194,000 4,902,000 April 2 6 ...... 901,743,000 302,844,000 78,853,000 2,722,000 July 2 6 ...... 1,302,151,000 205,274,000 57,012,000 103,000 October 2 5 ...... 1,546,164,000 398,623,000 350,311,000 24,000 1919 January 3 1 ...... 1,601,128,000 281,293,000 294,784,000 4,000 April 2 5 ...... 1,950,412,000 185,822,000 218,636,000 July 2 5 ...... 1,867,602,000 375,556,000 239,400,000 October 3 1 ...... 2,128,547,000 394,355,000 301,254,000 1920 January 3 0 ...... 2,174,357,000 561,313,000 303,521,000 April 3 0 ...... 2,535,071,000 407,247,000 293,514,000 July 3 0 ...... 2,491,630,000 345,305,000 325,380,000 October 2 9 ...... 2,801,297,000 298,375,000 296,371,000 1921 January 2 8 ...... 2,456,475,000 165,058,000 287,320,000 April 2 7 ...... 2,063,739,000 103,609,000 267,792,000 July 2 7 ...... 1,650,496,000 19,424,000 249,488,000 • • • • October 2 6 ...... 1,308,749,000 62,326,000 190,946,000 ....

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 78 T h e A n na ls of the A m erican A cademy

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis State B ank s and P ar C ollections 79 The chart of the earning assets of the functioning of the System bears out System demonstrates clearly that once that assumption. The early operations the exigencies of the war period arose, of the banks also call to mind the there was no hesitancy upon the part point that they were less far-reaching of member banks to make heavy de­ in their influence. Business getting ef­ mands upon the facilities of the reserve forts are forgot or nearly forgot. But banks. Indeed, as the momentum what was, may, perhaps, merely pre­ gained force, many bankers in their sage what is to come. Under stable eager rush to meet the requirements of conditions, the Reserve Banks may their customers lost sight of the earlier make smaller profits, but they will not scruples concerning borrowed money serve a less useful purpose. Commer­ and the pendulum swung to the other cial banking must respond to and extreme. Instead of seeking redis­ reflect the activities of business. In counts the officials of the System found times of great activity, whether sea­ themselves striving to conserve the sonal or cyclical, the Reserve Banks will financial resources of the country. be called upon to meet a corresponding The general impression prevails that demand. In the usual process of busi­ the War caused a development of the ness they will have recourse to open- Federal Reserve Banks during the market operations. Through these seven years of their operation that prob­ operations they may exert a great and ably would not have occurred in many important influence on the commercial times that number of years under other banks, on interest rates and on business circumstances. Study of the early activity.

The Federal Reserve System, State Banks and Par Collections By P ie r r e J a y Chairman and Federal Reserve Agent, Federal Reserve Bank of New York ULL accomplishment of the pur­ 000,000 and total resources of $11,- pose of the Federal Reserve Act, 492,000,000, thus giving a membership to provide a means whereby theat the outset comprising 42.6 per cent strengthF and resources of the numerous of the total banking resources of the independent banks of the United country. But the provision for the States would be made effective for admission of state institutions was concerted or cooperative action for the merely to the effect that they might, protection of the banking system and upon application, be permitted to the service of the nation’s commerce, become members, subject to regula­ industry and agriculture, depended tions of the Federal Reserve Board, upon membership of a very consider­ and should then have the rights and able proportion of the banks of the privileges of other member banks. country. The provision of the Act making membership compulsory for S t a t e I nstitutions S l o w t o J o in national banks, brought at once into Contrary to general expectation, the the System about 7,600 national banks problem of state bank membership was with capital and surplus of $1,788,- found complicated. Most of the state

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 80 T h e A n na ls of the A m erican A cademy institutions were either passive or 1917 found the System with a state opposed to the plan of the Federal bank and trust company membership Reserve System. At any rate, they of 250, having aggregate capital and were not disposed to seek membership surplus of $520,000,000, and aggregate therein. The number of such members resources of about $5,000,000,000. at the close of 1916 was thirty-seven, At the end of 1918, 936 state institu­ of which only seven had a capital and tions were members with total re­ surplus of over $1,000,000. In 1917, sources of over $7,000,000,000. however, an amendment to the Act gave the state institutions assurance M e m b e r s h ip S h o w s C o n t in u e d by statute, instead of by mere regula­ I n c r e a s e S in c e t h e W a r tion of the Federal Reserve Board, that With the end of the War naturally as members they might continue to came a slowing down of the efforts of carry on their banking business in the Reserve Banks to convince state substantially the same manner as they institutions of the importance of taking had previously done. It also gave membership in the Federal Reserve them the definite right to withdraw System, and during the past year such from the System upon six months’ efforts have been practically discon­ notice. tinued. But there has been, neverthe­ Coincident with the legislative re­ less, a continuous and substantial moval of obstacles to membership, the movement of state institutions into entrance of the United States into the the System. The laws of many states World War gave a new and very strong contained' provisions concerning re­ impetus toward membership. The serves, character of investments or necessity of strengthening the banking other vital matters which have hin­ system of the country to the maximum dered or prevented institutions in degree possible, in order to meet the those states from taking membership strain of war financing, led President in the System, and, as these obstacles Wilson in the autumn of 1917 to make have from time to time been removed, a strong appeal to state banking insti­ more and more state institutions have tutions to join the Federal Reserve taken advantage of the opportunity to System. The officers of Federal Re­ join. Many states, for example, have serve Banks, pursuant to what they now passed laws providing that a state believed to be their duty in the circum­ institution, becoming a member of stances, carried the appeal to the indi­ the Federal Reserve System, need keep vidual institutions, without, however, only the legal reserves required by the bringing pressure upon them to join. Federal Reserve Act. The influence of Many of the more important ones re­ this factor is strikingly illustrated in sponded and during the fall of 1917 California where 61 institutions with and the first half of 1918, a considerable total resources of $1,110,000,000 have number of state institutions through­ become members in the eighteen months out the country became members. following the amendment of the state The movement was particularly note­ law in respect to reserves to be carried worthy with respect to the aggregate of by member banks. resources which thus augmented the strength of the System. The major P r e s e n t M e m b e r s h ip o f S t a t e portion of the large institutions in I nstitutions New York City entered the System Some of the state institutions which promptly, and the close of the year became members during the war

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis State B ank s and P ar C ollections 81 period, did so with the intention of entered the Federal Reserve System withdrawing at the end of the War, but and whose not having done so may be their experience as members was evi­ ascribed probably to two main causes: dently such that they did not deem it 1. The belief that membership in the necessary to carry out this intention, System involves burdens or expense dis­ for up to the present time only 37 with proportionate to the advantages received resources of $34,500,000 have with­ in return, some of which, such as the avoid­ drawn from the System. On the other ance of the old-fashioned money panic and hand, the number of such members has the stabilization of banking conditions, they enjoy without membership. The fact steadily increased and now amounts to that the Federal Reserve Banks do not 1,625, with total resources of $9,959,- pay interest on deposits whereas their city 000,000, giving to the System a mem­ correspondents and reserve agents do pay bership which now represents, it is interest on deposits is one of the apparent estimated, about 69 per cent of the expenses which they fear to assume. commercial banking resources of the 2. Opposition to the plan of par check country. Approximately 9,000 state collection which the System has established institutions with aggregate resources and developed. of some $9,000,000,000, not now mem­ bers, are eligible for membership, from E x p e r ie n c e o f M e m b e r which it appears that 53 per cent of I nstitutions the resources and 15 per cent of the Most members of the System are numbers of the eligible state institutions now convinced that membership does are now in the System. The distribu­ not involve a burden or expense to a tion of state bank membership by member bank, but, on the contrary, districts, is as follows: enables it to conduct its business in a

D istribution of S tate B an k M em bersh ip by D istricts District Number Capital Surplus Total Resoura (In thousands of dollars) 1. Boston...... 41 36,411 38,951 709,890 2. New York...... 134 187,255 190,561 3,903,409 3. Philadelphia...... 48 25,821 48,738 390,902 4. Cleveland...... 113 64,436 79,344 1,041,392 5. Richmond...... 62 15,160 9,798 152,271 6. Atlanta...... 116 27,025 17,271 323,928 7. Chicago...... 364 101,012 85,092 1,753,034 8. St. Louis...... 102 30,203 22,081 400,809 9. Minneapolis...... 133 10,747 3,994 126,369 10. Kansas City...... 60 13,335 4,272 178,032 11. Dallas...... 205 16,500 6,598 128,288 12. San Francisco...... 217 57,625 25,218 900,811 1 Total...... 1,595 585,530 531,918 10,009,135 1 Latest available itemized figures. more economical and efficient manner, A t t it u d e o f N o n -m e m b e r entirely irrespective of the advantage I nstitutions of the rediscount facilities. The loss Banking is essentially one of the most of interest is offset by the reduction in conservative of callings, and it is not the amount of reserve which member surprising that there are many state banks were required to carry. For institutions which have not as yet example, a so-called country bank 7

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 82 T h e A n na ls of the A m erican A cademy under the National Bank Act for­ account of the establishment of its merly carried a reserve against both par collection plan will be discussed demand and time deposits of 15 per incidentally in the following topic. cent, of which 9 per cent might be on But it may be said that members have deposit with approved reserve agents, found that the use of the check collec­ and at least 6 per cent must be held as tion facilities of the System has re­ cash in vault. Assuming deposits of duced the length of time required for $1,000,000, all payable on demand, the the collection of checks, and enabled bank would carry in vault at least them to close out many accounts $60,000, upon which it would earn formerly required, thus further in­ nothing, and with correspondents, creasing the proportion of their assets $90,000 upon which it would probably which may be invested. receive interest at 2 per cent, or $1,800 a year. The Federal Reserve Act re­ C h e c k C o l l e c t io n B e f o r e t h e duced the bank’s reserve requirement R e s e r v e S y s t e m to 12 per cent, or $120,000, on which it An important feature of banking in would receive no interest, but which the United States is the extent to which would give it the opportunity to loan the use of bank checks has been de­ the $30,000 released, say at 6 per cent, veloped. They are the most usual which would yield $1,800 and thus means of settlement in all classes of compensate for elimination of interest business, from the payment of small on the reserve balance. household bills to payments for the In 1917 the required reserve against largest transactions of commerce and demand deposits was reduced to 7 per finance. The presentation and col­ cent, all of which was to be carried with lection of the myriads of checks arising the Reserve Bank and with no fixed in the course of daily business, and requirement for vault reserve. Expe­ drawn upon over 30,000 independent rience shows that this has permitted an banks, located in all parts of the coun­ average reduction in country bank try, creates a problem of great magni­ vault cash of around 4 per cent, which, tude, especially as checks are common­ together with the reduction of the ly used to settle accounts not only in required reserve against time deposits the places where they are payable, but to 3 per cent, made still greater the are sent to distant points, making compensating advantage due to low­ necessary the use of the mails for their ered reserves. Most of the states have collection. passed laws permitting state institu­ Before the establishment of the tions becoming members to take ad­ Federal Reserve System, the collection vantage of these reduced requirements. of checks in this country was accom­ With the certainty of being able to plished by special arrangements be­ obtain cash by rediscounting at the tween commercial banks. It was cus­ Federal Reserve Bank, member banks tomary for banks in the country and in have felt justified in investing their the smaller cities having checks on funds more closely, carrying as their out-of-town points, to send all such emergency reserve, bankers’ accept­ checks to their city correspondent, ances, commercial paper, or govern­ which would undertake their collection ment obligations which could be in consideration of the balances car­ realized upon at any time, and thus ried by the smaller bank with the city increasing their earning power. institution. It was customary, also, The opposition to the System on for the country bank to charge the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis State B a nk s a nd P ar C ollections 83 amount to its correspondent as soon as them on to some other bank for de­ the letter was mailed, and to treat it at posit and collection, charging the once as part of its legal reserve, this remittance to the latter’s account, and being permissible under the provisions treating it at once as legal reserve. of the then existing law. The city This effort to find a means of getting bank to which the checks were sent, the check paid without deduction having similar arrangements with for exchange, led to checks* reaching many correspondents, was the recip­ their place of payment by very cir­ ient of a very large volume of checks cuitous routes with much delay in the for collection and inasmuch as it had time of presentation and collection, usually undertaken to collect these and with increased risk of loss to the checks without charge, it was itself indorsers of the checks. By this under the necessity of finding a means means, also, the same check might be of collecting them with as little cost as counted as reserve at the same time by possible. The obvious and simple several different banks, although as a method of sending the checks direct to matter of sound banking principle, it the banks upon which they were should not have been counted as drawn was not attractive because of reserve for any bank until actually the fact that the custom had grown up collected. in many, though not all, sections of the These unsatisfactory check-collec- country for the smaller banks which tion practices, and the fact that the received checks on themselves through charges made, as well as the loss due to the mail, to make a charge for remit­ slowness in collection, fell on the com­ ting to the sending bank for such merce and industry of the country, checks, the rate of the charge varying led to action by Congress which, in with different institutions and running passing the Federal Reserve Act, from $1 per thousand dollars, to as included provisions requiring Federal high as $3.50 per thousand dollars in Reserve Banks to receive on deposit at some cases. par from member banks or from Fed­ This charge was known as “ex­ eral Reserve Banks, checks or drafts change,” and was made on the theory drawn on any of their depositors, and that the bank paying the checks per­ authorizing them to receive for pur­ formed a service for the bank from poses of exchange or collection, checks which the checks had been received in or drafts payable upon presentation paying the latter with a draft on a within their districts. The Act also bank in some large center. The value authorized the Federal Reserve Board of this service was based upon the to require each Federal Reserve Bank approximate cost of making shipment to exercise the functions of a clearing of currency to make the payment, house for its member banks. plus postage and stationery, on the theory that payment of a bank check G r o w t h a n d A d v a n t a g e o f t h e P a r can be demanded only at the bank’s C o l l e c t io n S y s t e m counter, and that if remittance is made The Federal Reserve Banks did not to a distant point, an additional serv­ at once actively engage in the collec­ ice is performed. In order to avoid, so tion of checks under the provisions of far as possible, the necessity of paying the law above referred to, because the “ exchange ” for the collection of checks, development of a comprehensive check- it was usual for banks receiving checks clearing plan presented many diffi­ from their correspondents to send culties, and it was not until July, 1916,

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 84 T h e A n na ls of the A m erican A cademt that active operations were initiated. tion through the mail equivalent to At that time a plan of operation was presentation at the bank’s counter. adopted which, recognizing that checks Operations under this plan have been are payable at the counter of the pay­ highly successful, as will be gathered ing bank, provided that the Federal from the following chart showing the Reserve Banks, in forwarding checks number and amount of items handled to a bank for payment by remittance, each month by the Reserve Banks, would pay the cost of currency shipped and the number of banks in the col­ in payment for the checks, whenever lection system. Growth of Federal Reserve Collection System (By units of one month)

the paying bank elected to make pay­ The importance and desirability of ment in that way, and would also the check-collection system which has under certain conditions, especially for developed and is now being operated non-member banks, supply necessary by the Federal Reserve Banks, may postage and stationery, thus eliminat­ be inferred from the extent to which ing the elements of cost, which would the chart showing the volume of otherwise fall upon the bank making checks handled indicates that these the remittance, and making presenta- facilities are being availed of by banks

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis State B ank s and P ar C ollections 85 which are members of the Federal been to obtain for the business inter­ Reserve System. They are also being ests of the country a much more availed of indirectly by non-members. prompt collection of checks than The volume of items handled has formerly, reducing the risk of loss grown steadily since the initiation of through bad checks and reducing the this method of check collection, until amount of credit which sellers of goods at the present time it may fairly be formerly had to extend involuntarily said that an overwhelming majority during the very substantial time re­ of all out-of-town checks handled by quired to collect checks. There has banks are collected through the agency been, moreover, an important direct of the Federal Reserve System. The reduction in the cost of collecting Federal Reserve check-collection sys­ checks due to the removal of the so- tem has reduced the average time of called “exchange” charge, or the collection about one-half, by the prac­ charge made by banks for remitting tice of the Reserve Banks of sending in payment of checks drawn on them­ checks direct to the paying bank, if selves, so that at the present time a within the same district, or through a very large proportion of the country’s Federal Reserve Bank or branch if checks are collected without charge. outside the district. The change which has taken place in the schedule of charges for the col­ O p p o s it io n t o P a r C o l l e c t io n s lection of checks may be illustrated by It is not to be supposed that the the reductions made by the New York system eliminating “exchange” and Clearing House Association. bringing about the par collection of Before the passage of the Federal checks should have developed so gen­ Reserve Act the charges made by New erally without encountering serious York banks for collecting checks on opposition from banks which had for­ outside points were discretionary as to merly received substantial income from less than thirty cities and were fixed their exchange charges. A committee at $1 per $1,000 for nearby states and of the American Bankers Association $2.50 per $1,000 for the more distant has from time to time during the past states. The rate of charge is now dis­ five years been endeavoring to secure cretionary (which means that in most legislation from Congress which would cases no charge is made) for eleven permit banks to charge exchange entire states and the District of Colum­ against the Federal Reserve Banks. bia, 25jf per $1,000 for one state, 50£ Not having been successful in this, per $1,000 for thirteen states and $1 banks in Georgia, Kentucky and Ore­ per thousand for twenty-three states, gon have brought suits to prevent the while twenty-eight important cities Federal Reserve Banks from presenting in which Federal Reserve Banks or checks at the counters of state banks branches are located are collectible at and a number of the southern states rates lower than those quoted for the have passed laws designed to prevent remainder of their states. the Federal Reserve Banks from col­ It should be understood that the lecting at par checks drawn on state present charge made by the New York institutions. banks is not an “exchange” charge at all but is made to cover interest on funds, C o st o p C o l l e c t in g R e d u c e d for which credit is given at time of The effect of the development of this deposit, for the time which will elapse efficient system of check collection has before the items have been actually

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 86 T h e A nna ls of the A m erican A cademy collected. The former charge included The importance of the wire transfer not only this element but also an facility may be inferred from the fol­ amount designed to enable the city lowing figures, showing telegraphic bank to pay the deductions of “ex­ transfers handled by the New York change” made by paying banks else­ Reserve Bank during the years 1916- where. 1920: Number Amount T r a n s f e r s o f F u n d s 191 6 2,971 $485,000,000 The elimination of seasonal and other 191 7 10,302 6*768,000,000 variations in the level of domestic 191 8 39,099 19,384,000,000 exchange between different parts of 191 9 *...... 82,321 18,245,000,000 the country has also been accomplished 192 0 147.302 17,022,000,000 as a necessary accompaniment to the The settlement of obligations be­ development of the check-collection tween districts has thus been made so system, since in order that each Federal easy, that there is no longer any occa­ Reserve Bank might freely handle sion for premium or discount on the checks on other Federal Reserve dis­ transfer of actually collected funds tricts, it was necessary to provide a between different parts of the country. means whereby the balances arising A most important result of the de­ between the districts might be settled velopment of this check-collection plan without the expense of gold or cur­ is the lessening of the possibility of rency shipments. To meet this need breakdown in the operations of the there was established in 1915 a Gold country’s check-collection system. It Settlement Fund, made up of gold will be recalled that, in the panic of deposited by the twelve Federal Reserve 1907, a situation arose in which it was Banks with the United States Treas­ impossible to get cash returns on ury, ownership being transferred from checks sent for collection to banks in one Reserve Bank to another as the certain centers, and that the machin­ need arises to settle obligations be­ ery of check collection and domestic tween them. The books are kept by exchange practically broke down. Such the Federal Reserve Board at Washing­ a development is extremely 'unlikely ton, and the settlements of all obliga­ under the operation of the Federal tions arising among the Federal Re­ Reserve check-collection system sup­ serve Banks are made by book entry, ported by the borrowing facilities which thus obviating the necessity for inter­ the Federal Reserve System makes district shipment of gold. The Gold available to member banks, and which Settlement Fund has also made col­ should enable solvent banks, even in lected funds, that is, funds on deposit time of severe crisis, to make payment with banks in any part of the country, for checks which may be drawn upon readily transferable to any other center them. without discount, either by use of the The Federal Reserve check-collection check-collection system or, if the funds system, in short, provides the machin­ are on deposit with a member bank, by ery necessary to accomplish with telegraphic transfer through the Fed­ maximum efficiency the necessary eral Reserve Banks, it being the cus­ function of presenting and collecting tom of the Reserve Banks to handle any number of bank checks which may these transfers over their inter-com­ result from the use of this most con­ municating private wire and without venient instrument in the settling of cost to the member banks concerned. transactions of every kind.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis R elations of R eserve B a nk s 87 Relations of Reserve Banks to Member Banks and Inter-Relations of Federal Reserve Banks By R. M. G idney Controller at Large, Federal Reserve Bank of New York HE outstanding characteristic of expected to take membership and thus the American banking system—a give to the system the support neces­ tremendous number of practically in­sary to make it a going concern, capable dependentT banks, great and small— of affording to its members the facilities does not make for concerted, uniform and advantages which it was expected or effective action in dealing with to create. The provision for compul­ banking, credit and currency problems sory membership of over 7,500 na­ on a nation-wide scale and in a broad tional banks then in existence give way. The need for means whereby assurance of ample support at the out­ these numerous independent banks set. could cooperate for mutual protection The purpose, then, of the Federal and for greater service to the commerce, Reserve System was to make possible industry and agriculture of the coun­ the association of the banks of the try, has long been recognized by country in order to supply the elements students of American banking organi­ of mutual protection, service and zation and methods. facilities which our system of indepen­ The solution suggested by the experi­ dent banks had lacked, and, in its ence of other countries which have essential features, it may briefly and highly developed systems of branch accurately be described as a great banking supported by great central cooperative banking association. It banks, has never seemed acceptable to includes at this time about 8,200 the American public. The form of national banks, and 1,625 state banks organization adopted to supply the and trust companies. The latter have elements formerly lacking in American become members voluntarily under the banking, was necessarily designed to do permissive provision of the Federal so without diminishing or impairing Reserve Act. the independence of the existing bank­ ing institutions. The Federal Reserve R e s e r v e B a n k s A r e P r iv a t e C o r ­ System was created to enable member p o r a t io n s banks, while operating independently The circumstances attending the as before, to mobilize or unite their creation of the Federal Reserve System reserve funds and make them more and the distinctly governmental char­ available to meet demands for increased acter of the procedure which brought credit accommodation or gold with­ it into existence, have tended to create drawals for domestic purposes or export. the impression that the Federal Re­ The Federal Reserve Banks were to be serve System is a purely governmental supplementary to an already existing agency, an impression strengthened by system consisting of some 7,500 na­ the highly important work done by th^ tional banks and over 19,000 state Federal Reserve Banks acting as fiscal institutions, a very considerable pro­ agents of the government in selling and portion of these institutions being handling government securities during

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 88 T h e A n nals of the A m erican A cademy and since the War. The fact is, how­ operations. These relations constitute ever, that the twelve Federal Reserve the minimum which may exist between Banks are private corporations organ­ the Federal Reserve Banks and their ized under an Act of Congress, their members. For some time after the only stockholders being the member organization of the Federal Reserve banks whose stock subscription is pro­ Banks, a very large proportion of the portionate to their capital and surplus. member banks did not transact any Their operations are directed by twelve business through them, and relations boards of directors. Two-thirds of the were only of the bare minimum above members of each board are elected by described. the member banks, and one-third are The relationship now existing between appointed by the Federal Reserve the Federal Reserve Banks and their Board. Each Federal Reserve Bank members is the result of evolution and is thus operated under the control of a is far closer than in the earlier days of board of directors including three the System. The attitude of the na­ government representatives, most of tional bank officers whose institutions whom are business men, three bankers were practically drafted into the Fed­ and three men engaged in commerce, eral Reserve System at the time of its industry or agriculture, but not con­ establishment, was then not altogether nected as officer or director with any friendly, and 'many of them were bank. The directorates of the Federal strongly antagonistic to the new Sys­ Reserve Banks include not only bank­ tem and openly expressed their inten­ ers, but also men experienced and tion to have as little to do with it as successful in various lines of business, possible. These bankers had a natural industry or agriculture. This feature reluctance to break or impair long of the relationship between the Federal established ties, and felt that the Reserve Banks and their members is Reserve Banks would be in a sense worthy of emphasis. It should be government bureaus and would adopt understood that the member banks, methods involving red tape and afford­ through their right to two-thirds of the ing little opportunity for close and directors of the Federal Reserve Banks, sympathetic personal relations. Many are in control of the actual operations believed that member banks, especially of the Federal Reserve Banks, subject those in the smaller places, would have to supervision by the Federal Reserve little paper of a character eligible for Board. rediscount, and that as they would be Relations between Federal Reserve obliged to continue to carry reserves Banks and their members have grown with their correspondents, membership to be very much like relations between in the System would be more of a bur­ the larger banks of the country and den than a privilege. their out-of-town correspondents. The Those entrusted with the manage­ member bank stockholders of the ment of the Federal Reserve System, Federal Reserve Banks use these appreciating and understanding the Banks as depositaries for their legal attitude of the member banks, realized reserves in amounts determined by law, that upon them devolved the duty thus bringing about the mobilization of so conducting the Federal Reserve of banking reserves contemplated by Banks as to disarm criticism and to the Federal Reserve Act, and furnish­ make the service of the Reserve Banks ing the Federal Reserve Banks with to their members so satisfactory and the funds which are the basis for their convenient that those who had antici­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis R elations of R eserve B ank s 89 pated unpleasant relations would be and had doubted the necessity for its obliged to revise their opinions. Not­ existence, found themselves obliged to withstanding this forward-looking at­ borrow if they were to do their part in titude on the part of the managers of war finance, and for the first time a the Federal Reserve System, progress convincing illustration of the value of toward closer relations with member the loaning activities of the Reserve banks was slow, and did not become Banks was given. Member banks soon really appreciable until the pressure of found that borrowing at Reserve Banks problems connected with war financing did not involve unnecessary formality in 1917 brought about a fuller utiliza­ or red tape, as the loan policies of the tion by member banks of the facilities Reserve Banks have in general been of the Federal Reserve System and along very liberal lines. Loan applica­ consequently a better understanding of tions have uniformly been acted upon its possibilities for service. promptly on day of receipt, so that a member bank sending in paper for W a r L o a n s a C e m e n t in g F a c t o r rediscount can count upon receiving To the Federal Reserve Banks was credit for the proceeds thereof as given the great task of organizing in promptly as if it were a remittance of their respective districts distributing bank drafts. Promptness, liberality of agencies for the huge loans which the treatment and willingness to meet all government found it necessary to float proper demands, which characterized and for this undertaking the aid and the loan activities of the Reserve support of bankers, both member and Banks, were most potent factors in non-member, was sought and obtained. bringing about a better understanding The splendid efforts of those associated with their members. in this work may be inferred from re­ sults. The close relationship thus de­ Q u ic k M e e t in g o f C u r r e n c y N e e d s veloped and the splendid cooperation of At the same time the ability of the the bankers with the Federal Reserve, Federal Reserve Banks, through their Banks in placing the government’s power of note issue, to supply the rapid­ loans, made for understanding and ly expanding currency needs of the mutual appreciation between the Re­ country, led to free development of this serve Banks and their members to function. The process by which Fed­ such an extent that long before the eral Reserve notes are issued and re­ work of government financing had deemed is perhaps worthy of a brief ceased to require the most active efforts description here. A member bank of those engaged in it, the attitude of desiring currency or coin, requests the the member banks had changed from Federal Reserve Bank to charge its passive toleration or outspoken antag­ account and if it finds itself with more onism, to an attitude on the part of currency than it desires to retain in the majority of the member banks vault, or has currency which is no distinctly friendly to the Federal Re­ longer fit for use, it forwards the sur­ serve System. plus to the Federal Reserve Bank for With war-time activity, came de­ credit. The Reserve Banks pay the mand for credit expansion which cost of shipping currency or coin both brought into play the loaning function ways, thus facilitating the prompt of the Federal Reserve Banks. Mem­ redemption of currency which is in ber banks which had been skeptical of excess of the immediate needs of the the value of the Federal Reserve System country and enabling member banks

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 90 T h e A nna ls of the A m erican A cademy to operate with a minimum of vault Banks is like that of any other bank reserve. The payment of cost of ship­ dealing with correspondents, and mat­ ment of currency to the member banks ters are handled along banking lines, a was developed by the Federal Reserve fact which has had much to do with Banks in an effort to give member the development of the close relations institutions outside of the Federal which now exist between Reserve Reserve cities as nearly as possible simi­ Banks and their members lar service to that given banks in the Federal Reserve cities. A similar pol­ B e t t e r B a n k in g M e t h o d s icy for shipments of currency received An important influence has been from member banks was adopted as an exerted by the Federal Reserve Banks incident to par check collection, with making for improvement of banking the object of eliminating any element methods on the part of member banks. of cost to a member bank in remitting The practice of obtaining financial for checks sent it for collection by the statements from borrowers has become Federal Reserve Bank. much more general because there is the possibility that the member bank may C h e c k C o l l e c t io n P l a n P r o g r e s s e d later desire to rediscount the paper S l o w l y with the Federal Reserve Bank, and The Federal Reserve check collec­ also because the requirement of bor­ tion, on the other hand, was long an rowers’ statements (for notes of $5,000 obstacle to the development of close or over) by the Federal Reserve Banks relations with member banks because has had the effect of standardizing this of the opposition of many of the banks practice and leading to its adoption by in smaller places to the change in banks which had formerly not consid­ practice which this System involved. ered it feasible. Membership in the The collection of checks through the Federal Reserve System has made for Reserve Banks has, however, made important changes in the character of tremendous growth, and each Federal bank investments, mainly in the direc­ Reserve Bank now sends daily letters tion of greater liquidity. Banks which containing checks for collection to had formerly carried bonds or call loans practically all of the banks of its dis­ on stock exchange collateral as their so- trict, both member and non-member. called secondary reserve, have adopted Similar contact results from the col­ the sound practice of diversifying lection of notes, drafts, bills of ex­ their investments by adding to their change, coupons, maturing bonds, etc., portfolios commercial paper purchased which is undertaken by the Federal in the open market and such highly Reserve Banks. liquid elements as bankers’ acceptances Other important facilities are trans­ and United States certificates of indebt­ ferring funds by wire between various edness. Thus they have placed them­ sections of the country without charge selves in much stronger position as to to the member bank and the safekeep­ availability of funds to meet with­ ing of securities—the Federal Reserve drawals by carrying adequate amounts Bank of New York alone now holding of paper available for rediscount or sale, in this manner for its members $1,239,- and, also, at least a moderate amount 215,899 of bonds and other securities. of paper of short maturity. This im­ In all the transactions between the provement in the distribution and Federal Reserve Banks and their liquidity of member banks’ investment members, the attitude of the Reserve holdings has enabled them with safety

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis R elations of R eserve B anks 91 to invest their funds more closely than tion of a banking machinery adapted to ever before with resulting increase in the great tasks which devolve upon it. profit. For obvious reasons no publicity has In the important matter of check been given to a highly important Re­ collections, also, the practice of the serve Bank activity, the assistance of Federal Reserve Banks of deferring member banks which for any reason credit on out-of-town checks a suffi­ find themselves in a dangerous position; cient time to permit of their actual col­ and the confidential character of this lection, has led to realization of the im­ relationship precludes other than a very portance of promptness in the handling general statement concerning it. In a of out-of-town checks, and closer analy­ considerable number of instances the sis than formerly of accounts involving Reserve Banks have not only extended the element of collection time. The assistance in the way of loans, but have direct activities of the Federal Reserve also loaned members of the Reserve Banks in collecting checks for their Bank staff to assist the institutions members has reduced very materially, through their difficulties, with the and perhaps cut in half, the time re­ result, in a number of instances, that quired to collect out-of-town checks, institutions which would otherwise and encouragement has also been given have been forced to succumb, have been to member banks to form county clear­ rehabilitated and are now in successful ing houses so that banks in neighboring operation. towns may exchange with each other Close relations with member banks and still further reduce the time re­ have also been assisted in some dis­ quired for collection of such checks. tricts by conferences of member bankers with Federal Reserve Bank officers, at B a n k s N e e d L e s s C a s h i n V a u l t which the operations and functions of More economical methods as to the the Federal Reserve Banks were clearly holding of vault cash by member banks and fully explained, and also by visits have been made possible by improved to member banks at their home offices, facilities for obtaining currency and made by Reserve Bank representatives. coin, and by legislation enacted in 1917, The officers of the Federal Reserve relieving member banks from the Banks realize an obligation to extend former requirement for a fixed amount a service of high order to member of cash in vault. In October, 1914, the banks, and to promote cooperation 7,571 national banks of the country along banking lines rather than to take held cash in vault equal to 16.4 per an attitude which might lead member cent of their deposits. On June 30, banks to feel that they were dealing 1921, 9,745 member banks held vault with a distant and impersonal organiza­ cash equal to only 2.6 per cent of their tion operated as a government agency. deposits. In other words, the Federal Reserve The influence of the Federal Reserve Banks have undertaken to function as Banks making for improvement in the banks and to conduct their relations technical features of bank operation, with member banks along much the though not readily measured, has been same lines as those by which the larger of fundamental importance and is banking institutions of the country have among the most beneficial results of the in the past so successfully conducted System’s operations, especially when their relations with out-of-town corres­ considered with full realization of the im­ pondents. The highly satisfactory re­ portance in modern economic organiza­ sults of this policy are to be found in

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 92 T h e A nnals of the A m erican A cademy the friendly attitude which is now mani­ A conference of governors and direc­ fest on the part of member banks tors of all Federal Reserve Banks pre­ toward the Federal Reserve Banks. ceded the actual opening of the Banks. Problems of general policy before the I n t e r -r e l a t io n s o f R e s e r v e B a n k s Banks and the Federal Reserve Board, The establishment of twelve regional have been the subject of discussion at Federal Reserve Banks rather than of conferences held from time to time by a central bank, was in keeping with the governors and Federal Reserve agents. great area of our country, which might Numerous conferences have also been be considered as making the establish­ held by representatives of the Reserve ment of one great central bank of Banks to deal with the more technical doubtful advantage, and with the features of operation, such as account­ American predilection for the minimum ing and auditing methods, check col­ of banking centralization. The twelve lections, employment methods and Federal Reserve Banks were to be, and other similar problems. The spirit of are, operated each by its own board of cooperation and willingness to take directors, and each is to a very large counsel together, evidenced at these degree an independent entity, having conferences, has been typical of the power to deal with the problems arising everyday relations between the Reserve within its own district according to the Banks and has resulted in the develop­ judgment of its directors and officers. ment of a close-knit system in which This has given opportunity for the the several units, though independent development of a considerable degree in management, work together to ob­ of individuality in personnel and tain for their members and the public methods, and for the control of e,ach the advantages to be derived from a Federal Reserve Bank by men familiar unified banking system. with the business of the district. The results of cooperation among Counteracting to a considerable de­ the Federal Reserve Banks are in some gree this tendency to individuality in cases very tangible, as, notably, the the management and operations of the country-wide check collection system, several Federal Reserve Banks, is the the establishment of facilities for trans­ influence of common function and pur­ fers of funds over the private wires pose, of interbank contact, and, also, between Federal Reserve Banks, the es­ the supervision of the Federal Reserve tablishment of a Gold Settlement Fund Board. The practically identical rela­ through which has been obviated the tionship of each Reserve Bank to its necessity of gold shipments between members and the similarity of func­ different parts of the country, and, tions, led early to efforts to coordinate perhaps most important of all, the facil­ action on all matters possible of com­ ities for interbank rediscounts by means mon solution. Even before the organi­ of which seasonal loan demands may zation of the Federal Reserve Board be met by the Reserve Banks whose and the Federal Reserve Banks, the positions are relatively strong and who preliminary Organization Committee loan to those on which the pressure is had prepared plans for accounting and greatest. The advantage claimed for methods which were to a considerable a central bank with ability to direct the extent used by the Reserve Banks when flow of loanable funds to the point of organized, though modified in many maximum need, appears to have been ways as experience showed need for attained through this arrangement, as change. interbank rediscounts have been freely

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis R elations of R eserve B anks 93 and voluntarily made in such amounts action of Congress. The policy of the as were necessary to meet the heavy Reserve Board, as revealed in its rul­ loan demands in many districts which ings and the public utterances of its would otherwise have found themselves members, has been consistently to with greatly impaired reserves. refrain from performing operating func­ The heaviest borrowers relatively tions in connection with the manage­ have been the Federal Reserve Banks in ment of the Reserve Banks and to make the agricultural sections, the lenders be­ its field of activity the supervision and ing usually the banks in sections whose coordination of twelve practically inde­ activities are predominantly industrial. pendent regional reserve institutions. The interbank loans at their high point Its rulings and regulations have served were as shown in the table below: to interpret and apply the law under

In ter-B an k L oans of F ederal R eserve B an k s Borrowers Lenders Per­ Per­ cent­ cent­ Bank Amount Reserve ages Bank Amount Reserve ages Before After Before After New York... . $49,305,000 35.3 38.6 $85,896,000 72.0 51.1 Richmond... . 19,900,000 35.4 45.8 Phila...... 42,722,000 63.8 52.3 Atlanta...... 37,758,000 23.2 40.5 Cleveland...... 137,874,000 80.5 52.3 Chicago...... 13,050,000 37.9 39.5 San Francisco.. 886,000 45.2 44.9 St. Louis.... 40,410,000 21.0 41.3 Minn...... 27,204,000 17.0 39.0 Kansas City.. . 45,807,000 17.4 42.5 Dallas...... 33,944,000 13.2 40.9

T otal. . . . $267,378,000 $267,378,000 The chart on page 94 illustrates which the Reserve Banks operate, and graphically the movements of reserves also to bring about general uniformity of the Federal Reserve Banks, evidenc­ in the policies of the Reserve Banks, ing the pressure of demand for loans while leaving a large discretion to the which could be safely met only by management of each Bank as to the rediscounting. acceptance or rejection of individual paper, offered for rediscount, and as to R e s e r v e B o a r d ’s I n f l u e n c e f o r other problems of operation. U n it y Thus there has been noted in the Strong as were the forces which have operations of the Federal Reserve Sys­ been mentioned in making for close tem a combination of uniformity of relations and cooperation on the part policy and flexibility of everyday opera­ of the Federal Reserve Banks, the tion which would be difficult or per­ position of the Federal Reserve Board, haps impossible under a system where as the central element in the Federal the operating function was controlled Reserve organization, is one of such by a central body. A tendency toward great influence that its policies may be similarity of discount rates at the regarded as in large measure responsible several Reserve Banks has been ap­ for the course which has been taken in parent, though differences in condi­ the development of the System pro­ tions have prevented and are likely to vided for in general outline by the prevent complete uniformity in this

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 94 T h e A n na ls of the A m erican A cademy

R eserv e P ercentages F ederal R eserve B anks B efo r e I nter bank A ccommodations e k O S T O I PHI LADELPHIA i 10 o * ' V*—. ■■ V80 / > ,/ - -nA. » V V\ 60 / , / ' y V " V J 40 20 0 tm. as— 1ML. JAN. JUL. oat. JAM. OCT.

V \M 7 \ --- V JAM AM*. ■ML- Mr. ALL DISTRICTS 100 -1920 60 60 40

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0 ML. OCT. particular. Practices as to check clear­ The Federal Reserve Board has ing and collection, collection of notes made very clear that the Federal Re­ and drafts, supplying currency and serve System is not a central bank or its coin, and loaning operations, are much equivalent, but that the twelve Federal alike at the different Reserve Banks, Reserve Banks are independent insti­ yet each Bank may, independently tutions over which the Federal Reserve within the limits set by the law and the Board exercises supervisory authority, Federal Reserve Board’s ruling and without attempting to participate di­ regulations, perfect and improve its rectly in the management. methods of operation at its own option, It thus appears that the advantages

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he Gold Settlement F und 95 to be expected from the free flow of district and to officers closely familiar credit from one part of the country to with these problems, with full discre­ the other to meet demands for com­ tion and power to act within their own mercial, industrial or agricultural pur­ districts, has also been attained. The poses, are supplied by the inter-bank Federal Reserve System may be said to rediscounting feature of the Federal give the advantages of the mobilization Reserve System, but that the aim of and centralization of banking reserves having the problems of each district while preserving the typically American entrusted to directors living within the freedom from highly centralized control.

The Evolution and Practical Operation of the Gold Settlement Fund By G e o r g e J. S e a y Governor of the Federal Reserve Bank of Richmond T is difficult to realize that only rapid than could have been expected I seven years have elapsed since the in normal times. The country seems establishment of the Federal Reserve accustomed and seasoned to the opera­ Banks. During that period, matters tions of the Federal Reserve System, of such tremendous import to the but, it becomes apparent from time to world have happened and develop­ time that many people and even many ments in banking and finance have banks have not a full appreciation of been so revolutionary in their nature the accomplishments of the System or and size that we have a full under­ a full understanding of the fact that standing of the feelings of the small boy financial transactions of the magnitude of seven who declared that, although developed within these seven years only seven, judging by the experience were rendered possible only by the he had had, he was ’most a hundred. operation of the System. Since 1914, the resources of the banks The country banker, when he sends of the United States have grown from his checks and collection items to his 2 7 billions of dollars to 53 billions, and city correspondent, may think that bank clearings have grown from 155 thereby he is creating exchange. This billions to 451 billions. In measuring is but the first and the lowest step in the national debt, the income of the the creation of exchange. The proc­ Treasury and taxation, the unit is no esses involved in the collection and longer a million but a billion. final settlement of such items are All the momentous and tragic ex­ numerous and they constitute the periences of life leave an impression fabric of exchange. The Federal Re­ upon the mind of having occupied a serve System has developed the most prolonged period. Therefore, it seems comprehensive and most effective sys­ that the Federal Reserve System has tem of exchange known to the banking been operating for a period much world. longer than that measured by seven The Federal Reserve Banks act as calendar years. As a matter of fact, clearing houses for their members, and it has, beyond doubt, developed in the various transactions engaged in by those seven years at a pace far more these banks create balances between

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 96 T he Annals of the American Academy them and their members and between eligible paper, as described in Section each other. The Federal Reserve 14. That is to say, member banks Board has set up machinery which were permitted to rediscount at that operates as a clearing house between time with their Federal Reserve Bank Federal Reserve Banks, and the Gold to this extent in establishing reserves. Settlement Fund is the heart of the Under date of November 25, 1914, System. a circular was issued by the Federal Therefore, an account of the evolu­ Reserve Bank of Richmond, advising tion and the practical operation of the its members that the bank was ready Gold Settlement Fund, through which to commence rediscounting in the final payment is made for that vast regular course of business and in a volume of credit instruments circu­ position to furnish Federal Reserve lating throughout the country, must notes for the proceeds of rediscounts. contribute to a better understanding The member banks had previously of the System as a whole. been advised that collections and clearings could not be undertaken at E a r l y N e e d o f I n t e r -B a n k the beginning and that, therefore, S e t t l e m e n t M a c h in e r y active accounts of member banks * Under the terms of the Federal could not be established until further Reserve Act, the Federal Reserve notice. They were advised, however, Board, in Section 16, was authorized that after initial payments of reserve at its discretion to exercise the func­ had been made, checks drawn on any tions of a clearing house for Federal member bank in the cities of Rich­ Reserve Banks. It is not to be sup­ mond, Washington and Baltimore, posed that there dwelt in the minds of all within the district, would be re­ the framers of this provision of the Act ceived for the credit of the members. any well-defined conception of the The member banks were cautioned, manner in which this function would however, that while the Richmond be exercised and least of all of the bank was accepting checks on banks in nature and magnitude of the settle­ the reserve cities of the Fifth District ments which this “clearing house” “it is not intended at this stage that would be called upon to make within the Reserve Bank shall be used merely such a short period of time. to transfer balances in one place in During the early days, after the order to make them available in organization of the Federal Reserve another,” and further “members are Banks in November, 1914, they were expected to use their present clearing occupied chiefly by the receipt of pay­ connections for making collections ments of subscriptions to capital stock until greater preparation has been and with the receipt from member made for clearing.” banks of deposits setting up the reserve Notwithstanding the restricted na­ required by the Act. Payments on ture of the business conducted at that account of subscriptions to capital time, balances in excess of the required stock were required to be made in gold reserve were created, and checks or gold certificates. Reserve deposits against these balances found their way were required to be made either in gold into other districts. No machinery or lawful money, except that Federal had been set up to effect settlements Reserve Banks were authorized to between Federal Reserve Banks, but receive as reserve not exceeding one- it was the understanding that any half of each installment payment in Federal Reserve Bank would have the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he Gold Settlement F und 97 right to call upon any other for remit­ the Reserve Bank Organization Com­ tances in gold to effect settlement of mittee, by those whose services were balances between the two. engaged for the purpose, which con­ At that time of the year (December) tained many practical suggestions as to the flow of funds was towards New the organization and operation of Fed­ York, and, as a result of the practice eral Reserve Banks. Among these was of receiving from member banks for a suggestion for a “Federal Reserve credit checks on their balances in the Clearing House,” which involved the reserve cities of this district and then deposit of a certain sum of gold by permitting the banks to check on such each Federal Reserve Bank with the balances—which checks were usually Federal Reserve Board or with any sent to New York in order to create Federal Reserve Bank designated by exchange—the Federal Reserve Bank the Board to act as a clearing agent of Richmond became in debt to the and settle balances between Federal Federal Reserve Bank of New York Reserve Banks by means of book for several millions of dollars. . To entries made by a settling agent or by place restraint upon this practice it certificates issued by the settling agent. became necessary to advise member At the first conference of the banks that such checks deposited with governors of the banks, held with the the Federal Reserve Bank for the pur­ Board in Washington, December 10, pose of creating exchange would be 11 and 12, 1914, a special committee subject to a charge for collection, in was appointed to study the subject accordance with Section 16 of the Act. and report to the next conference. On January 18, 1915, in sending out At the second conference held in notification of the second installment Washington, January 20- 23, 1915, the due on capital stock subscriptions, report of the committee was received, members were advised that payments discussed by the conference, and, with could be made by means of checks on several amendments, was submitted to national banks in New York City the Federal Reserve Board. The plan instead of in gold. This was done for submitted to the Board by this con­ the purpose of reducing the debt of the ference was substantially that outlined Richmond Bank to the New York in the report of the. preliminary com­ Bank, thus, to that extent, avoiding mittee on organization, though many settlement with the New York Bank details were submitted by the con­ in gold. ference. The Board took the matter It will be apparent that very early in under consideration and announced in the operation of the System the neces­ April, 1915, that the plan of settlement sity for providing the machinery for between Federal Reserve Banks had making settlement between Federal been completed and would become Reserve Banks was a pressing one, and effective about the middle of May, during that time careful study was 1915. being given to the question, both by In the meantime, all the Federal the Federal Reserve Board and the Reserve Banks had been maintaining officers of the Federal Reserve Banks. accounts with one another, which accounts, of course, were affected by E stablishment o f t h e G o l d all interdistrict transactions. S e t t l e m e n t F u n d Under date of May 8, 1915, the Prior to the organization of Federal Federal Reserve Board issued its Reserve Banks, a report was made to Bulletin No. 13, Series of 1915, out­ 8

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 98 T he Annals of the American Academy lining the plan of clearing between designated by the Secretary and two Federal Reserve Banks. The plan designated by the Board. The balance was designed to effect settlements of of each Federal Reserve Bank in the all balances then outstanding and Gold Fund was permitted to be thereafter to settle accounts between counted as a part of the gold reserve of Federal Reserve Banks weekly. The the bank. Each Federal Reserve following is a brief statement of the Bank was required to keep two ac­ principal feature of the plan: Each counts with every other Federal Re­ Federal Reserve Bank was required to serve Bank, one showing the total forward to the Treasury at Washington amount due to the other Federal or the nearest subtreasury for credit Reserve Bank and the other, the in the account of the Gold Settlement amount due from the other Federal Fund one million dollars in gold, gold Reserve Bank. certificates or gold order certificates, The first settlement, being historic, in addition to an amount at least equal will be described. It was made in the to its net indebtedness to all Federal following manner. At the close of Reserve Banks. business, Wednesday, May 19, 1915, The Treasury Department under­ each Federal Reserve Bank advised took to advise the Federal Reserve the Federal Reserve Board by wire the Banks of the receipt of the funds and amount in even thousands due by it undertook further to deliver to the to each other Federal Reserve Bank as Federal Reserve Board gold certificates of that day. On Thursday, May 20, payable to the order of the Federal the settling agent appointed by the Reserve Board in denominations of Board telegraphed each Federal Re­ ten thousand dollars, covering the sum serve Bank the amount of credits to so deposited. Each Federal Reserve its settling account, giving the name Bank was required to make such of each bank from which such credits payment into the Gold Fund from were received, also the net debit or time to time as might be necessary to credit balance in the settlement. After maintain the balance to its credit in the the receipt of these advices, but not Fund at one million dollars. Federal later than May 24, each Federal Reserve Banks having balances in Reserve Bank was required to put into excess of one million dollars, as a the Gold Fund by shipment or trans­ result of clearing operations, were fers of gold or gold certificates of the allowed to withdraw the excess at will, United States, directly or through the payment to be made by shipment of nearest subtreasury, an amount suf­ gold order certificates to the said bank ficient to cover its debit balance, if any, by the Board, or payment through the and to establish a credit balance of at nearest subtreasury. least one million dollars. The totals The Board kept a set of books in so remitted at that time were $18,450,- which there was an account for each 000. The Federal Reserve Banks Federal Reserve Bank, showing at all made appropriate entries in their times the amount of gold held for each accounts based upon the report of the bank. The gold order certificates settling agent. Thus the Gold Settle­ representing the gold held by the ment Fund was launched. Thereafter, Treasury were kept in a safe in the settlements were made weekly, on Treasury vaults set apart for the ex­ Thursday, upon the basis of figures tele­ clusive use of the Board, to be opened graphed by each Federal Reserve Bank only in the presence of two persons at the close of business Wednesday.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he Gold Settlement F und 99 The Treasury Department had not that upon the day of receipt the only agreed to receive remittances Federal Reserve Bank could charge its in gold and to issue ten thousand reserve account with the total amount dollar gold order certificates to the Fed­ of checks drawn upon it. eral Reserve Board, but had also agreed While the operations of this plan to allow the use of the subtreasuries in did not primarily involve relations connection with remittances and with­ between Federal Reserve Banks, such drawals from the Gold Fund by relations were indirectly involved. Federal Reserve Banks. It was under­ Clearings under the plan depleted the stood and agreed, however, that if reserve accounts of some members and the receipt of such remittances or the resulted in excess balances in the re­ making of such payments at any time serve accounts of others. The member involved the actual shipment of gold bank whose reserve accounts had been from the Treasury at Washington to a depleted had to remit in gold or lawful subtreasury, or vice versa, the expense money or in some form of exchange of such shipments should be borne by acceptable to the Reserve Bank. Other the Federal Reserve Banks. banks whose clearings resulted in excess balances had the right to check C ommencement o f a n I n t r a -D is t r ic t against such balances and checks on C l e a r in g P l a n b y F e d e r a l one Federal Reserve Bank were re­ R e s e r v e B a n k s ceived for credit by other Federal It will be understood that the bal­ Reserve Banks. These transactions, ances of member banks with their in so far as they affected the accounts Federal Reserve Banks were affected between Federal Reserve Banks, tended chiefly by two operations: first, by to increase the volume of the weekly discount operations, and, second, by settlements through the Gold Settle­ the collection of checks through the ment Fund. It is because of this fact Federal Reserve Bank. Up to this that a description is given of the early time, as before described, the collection developments of a collection plan by of checks by a Federal Reserve Bank Federal Reserve Banks. for its members, even within its own In addition to clearing weekly, district, had been very limited. In Federal Reserve Banks had the privi­ June, 1915, most, if not all, of the lege of transferring excess balances in Federal Reserve Banks put into opera­ the Gold Fund to other Federal Re­ tion a voluntary plan of intra-district serve Banks by wire or letter to the collections. According to this plan, a Federal Reserve Board. During the Federal Reserve Bank invited all of its week ending June 24, 1915, the members to join the collection plan, Federal Reserve Bank of San Francisco under which each member that joined transferred in this way to the Federal the plan could send to the Federal Reserve Bank of Boston two hundred Reserve Bank checks upon every other thousand dollars. During the week end­ member that had joined the plan but ing July 1, 1915, San Francisco made upon no other members and upon no two transfers, four hundred and fifty member outside of its own district. thousand dollarstoNewYorkand thirty The Federal Reserve Bank would give thousand dollars to Chicago. These the sending member bank immediate initial transfers are mentioned because credit for such checks in its reserve they are historic. After that time, trans­ account. On the other hand, each mem­ fers between Federal Reserve Banks ber bank joining the plan had agreed became more and more frequent.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 100 T he Annals of the American Academy The first withdrawal from the Gold bank and the representatives of the Settlement Fund by any Federal Re­ Federal Reserve agents* serve Bank was made on July 14, 1915, In the early part of September, 1915, by the Federal Reserve Bank of the Federal Reserve Board resolved Chicago. Its telegram requesting the that a Gold Fund should be established payment was received by the Board at for the use and benefit of Federal 10.30 a.m. and at 2.00 p.m. on the Reserve agents, not identical with, but same day the Assistant Treasurer of in close relation to and cooperation the United States at Chicago advised with the Gold Settlement Fund of the the bank of his readiness to make twelve Federal Reserve Banks. The payment. Although in a number of settling agent of the Board was di­ cases thereafter such withdrawals rected to open and maintain on the occurred from time to time, the con­ books a distinct and separate account venience and usefulness of the Gold for each Federal Reserve agent and to Settlement Fund became more and receive from the said agent, or from more apparent, and there developed the Federal Reserve Bank for the a tendency to allow credit balances to account of such agent, deposits of gold accumulate, so that the Fund passed certificates, subject to the order of the the one hundred million dollar mark Federal Reserve agent for whom such on November 18, 1915. deposits had been made. The fund of the Federal Reserve agents was F e d e r a l R e s e r v e A g e n t s ’ handled and operated in the same G o l d F u n d manner as the Gold Settlement Fund In the latter part of 1915, the Board of the banks, but, as before mentioned, determined to enlarge the scope of the the funds were handled separately. Gold Settlement Fund by opening As a consequence, when transfers accounts with the Federal Reserve were made from an agent to a bank or a agents of the various Federal Reserve bank to an agent, it was necessary for Banks. While very little discounting the representative of the Board to was done by Federal Reserve Banks make an actual shift of gold or gold in the early days of the System, the certificates from one safe to another or volume of Federal Reserve notes put from one compartment in the safe to out was very considerable. Therefore, another compartment. almost from the beginning, each Fed­ The Federal Reserve Bank of At­ eral Reserve agent had the custody of lanta was the first to make such a and the responsibility for a consider­ transfer. On September 8, 1915, $2,- able amount of gold, all of which, 500.000 was passed from the account except 5 per cent deposited with the of the bank in the Gold Settlement Treasurer of the United States as Fund to the credit of the Federal redemption fund, remained in his Reserve agent. Simultaneously, the possession. Transactions involved in Federal Reserve agent of Atlanta the issue and retirement of Federal released to the Federal Reserve Bank Reserve notes necessitated frequent of Altanta the same amount in gold or payments in large sums from the bank gold certificates. The second bank to to the agent and from the agent to the make use of this facility was the bank. When these payments were Federal Reserve Bank of Richmond, made in gold or gold certificates, much the amount of the transfer being $2,- counting and recounting was necessary 600.000 from the account of the bank on the part of the employes of the to the account of the agent. At the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he Gold Settlement F und 101 time of this writing, the Federal Re­ was inaugurated, the total number of serve agents in five of the Federal member and non-member banks em­ Reserve Banks are keeping all of the braced in its operation was approxi­ gold deposited with them (except the mately fifteen thousand. At the 5 per cent redemption fund deposited present time the number is 28,191, with the Treasurer of the United or 92.8 per cent of all banks in the States) in this fund. Of the remaining country, embracing more then 98 per seven, six have much larger amounts to cant of all banking resources. The their credit in the fund than they are number of items handled by the holding in the vaults of their banks. System in 1920 was 503,728,000, The amount to the credit of all Fed­ amounting to $179,459,351,000. eral Reserve agents in the fund is The operation of the new collection $1,169,210,000, while the total amount plan very greatly increased the number of gold and gold certificates held by of transactions between Federal Re­ the several Federal Reserve agents at serve Banks. At the same time, the their respective banks is $450,162,000. increasing issues of Federal Reserve The total amount in the funds of the notes made necessary an increasing Federal Reserve agents and Federal number of transfers between each bank Reserve Banks is $1,665,321,000. and its Federal Reserve agent and between the banks themselves and the S c o p e o f C l e a r in g P l a n Treasurer of the United States in The voluntary intra-district clearing transactions relating to the 5 per cent plan, established by nearly all of the redemption fund for Federal Reserve Federal Reserve Banks in June, 1915, notes. did not prove successful because it In its Second Annual Report cover­ embraced only a comparatively small ing the operations of the Fund, the percentage of member banks whose Federal Reserve Board, page 79, operations through the Federal Re­ stated: “The Federal Reserve Board serve Banks were confined to the has, up to the close of the year 1915, exchange of checks upon one another. settled through the Gold Settlement As a matter of fact, the plan was Fund for the twelve Federal Reserve devised and operated partly as an Banks indebtedness aggregating $1,- experiment to develop experience and 052,649,000 with a net change of only data necessary to the intelligent plan­ $95,697,000 in ownership of gold held ning of a more comprehensive system. in the I?und, or 8.14 per cent of the The Federal Reserve Board and the total amount cleared. The direct officers of all the Federal Reserve expense incident to the Gold Settlement Banks had given a great deal of time Fund in handling these transactions and study to the situation, both in has been approximately $1,150, prin­ conferences with the Board and other­ cipally for equipment and telegraph wise. On July 15, 1916, the present services.” clearing plan between Federal Reserve In its Third Annual Report covering Banks and their members and between the year 1916, the Federal Reserve the Federal Reserve Banks themselves Board stated that the total clearings was put in operation. The plan is now for the year had been $5,533,966,000. too well known to need description. The cost of handling the Fund was The plan has been modified and im­ $1,343.37, or $0.002| per $1,000. The proved to some extent since its net amount of change of ownership inauguration. At the time the plan among Federal Reserve Banks as

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 102 T he Annals of the American Academy a result of these clearings was only formerly by the Federal Reserve Board. $223,870,000. The Board remarked, The Fund was transferred to the keep­ “It may be estimated conservatively ing of the Treasurer of the United that the shipment of coin and currency States, and the Board, in its bulletin of at least that amount was thus for July, 1917, in describing the trans­ avoided/’ This statement merits care­ fer, said: “Some idea of the magnitude ful attention. of the Fund may be had from the fact that a truck load of gold order certifi­ A m e n d m e n t o f J u n e 21, 1917 cates (in ten thousand dollar denomi­ The next step in the evolution of the nation) was transferred from the Gold Fund was as follows: It will be Federal Reserve Board to the Treas­ remembered that the Gold Funds of urer of the United States. It took the Federal Reserve Banks and the three men over two days to place a Federal Reserve agents were kept stamped endorsement on the certifi­ separately and that this arrangement cates. Had the amount represented made it necessary for the two represen­ been in the form of gold coin, it would tatives of the Federal Reserve Board have weighed 963 short tons. The and the representative of the Treasury Treasury of the United States, of Department to open the safe in which course, issued its receipt to the Board the Fund was held in ten thousand for the money.” dollar gold order certificates and make In its Fourth Annual Report cover­ actual transfers of such certificates ing the year 1917, the Federal Reserve from one fund to the other whenever Board stated that the operation of the transfers were rendered necessary. Fund, which was, in effect, a clearing Continued increases in the issue of house for the twelve Federal Reserve Federal Reserve notes and in the Banks, had been particularly useful number and amounts of transactions during the year by reason of the between Federal Reserve Banks, in­ continuous transfers of very large volving large increases in both gold amounts, which had grown out of the funds and a greatly enlarged number sale of government bonds and Treas­ of transactions, made the duties of the ury certificates and redistribution and custodians of the Gold Fund very disbursement of the funds realized. burdensome. Therefore, the Board The total volume of clearings and recommended to Congress an amend­ transfers through the Fund during the ment to the Act, which became a law on year amounted to $26,962,000,000, as June 21, 1917, for the purpose of compared with $5,575,000,000 during simplifying the operation of the Fund, 1916. The net balances representing which had grown from $18,450,000 in the change of ownership between the May, 1915, to considerably more than Federal Reserve Banks of gold held in $500,000,000. the fund were $272,000,000. The Under the new plan, made possible Board stated: “Without such an by the amendment of Section 16 of the arrangement, actual settlings between Federal Reserve Act, the Treasurer of Federal Reserve Banks would have the United States opened an account been accompanied with great expense with the Federal Reserve Board, and loss of time, but by its aid these giving credit to the Board for the sum enormous transfers have been made of deposits of Federal Reserve Banks automatic and instantaneous and have and Federal Reserve agents combined. been made without the inconvenience Individual accounts were kept as and expense which would have been

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he Gold Settlement F und 103 unavoidable had a physical transfer weekly settlement, have the privilege of demanding transfers at any time upon the and shipment of money been neces­ net debit balance as shown in accounts sary.” with other Federal Reserve Banks. It It is not only the expense and delay must be expected that if the present plan of of the physical transfer and shipment weekly settlement were to be maintained, of money which was avoided. It is to such transfers would become more numer­ be doubted whether such transfers ous in the future as the calls upon the would have been possible at all under Federal Reserve Banks became heavier. the old banking plan without creating The proposed plan (for daily settlement) financial disturbances which would would do away with the greater part of have unsettled the business of the such transfers and will release for the strengthening of their reserves the funds nation. now carried as the amounts due from other Up to this time Federal Reserve Federal Reserve Banks. Under the law, Banks were still making weekly settle­ balances due from other Federal Reserve ments on a basis of figures shown by Banks could not be counted as a part of the their books at the close of business reserve of any Federal Reserve Bank, but Wednesday. Practically all communi­ under the regulations of the Board, which cations between the Federal Reserve then existed, such balances due from other Banks and the Federal Reserve Board Federal Reserve Banks were allowed as with reference to weekly settlements deductions from net deposits in making and transfers had been made by wire, reserve calculations. and messages had necessarily been sent over the commercial wires. The G r o w t h i n C l e a r in g T ransactions necessity for private wires between all Combined clearings and transfers Federal Reserve Banks and branches through the Fund during the year 1918 and the Federal Reserve Board became aggregated $50,242,000,000. Thus, by too urgent to be postponed. A private gradual development, what seemed, or leased wire system was put in and was indeed, a formidable under­ operation on June 4, 1918, and all taking was worked out. The internal Federal Reserve Banks employed tele­ accounting operations of the Federal graph operators. Reserve Banks were readjusted and improved, but no change was made D a il y S e t t l e m e n t s T h r o u g h t h e in the plan of settlement during G o l d F u n d the year 1919. Clearings and trans­ The next step in the evolution of the fers through the Fund for the year Gold Fund was the institution of daily 1919 aggregated practically 74 billion instead of weekly settlements. On dollars. The Board, in its annual July 1, 1918, a daily settlement plan report for the year 1919, made the was put into effect. In the Bulletin following statement: for July, 1918, the Board said: When it is considered that these enor­ The plan will eliminate a great deal mous transfers are made almost instan­ of work at the Federal Reserve Banks, taneously by means of the leased wire and through daily instead of weekly settle­ system without involving the physical ments will provide for the proper adjust­ movement of a dollar, it will be seen that ment of the gold holdings to the credit of the arrangement has been of incalculable each Federal Reserve Bank in the Gold value to the government, the banks and the Settlement Fund in as nearly automatic a public. The total expense of operation, way as possible. At the present time, the including the cost of the leased wires and Federal Reserve Banks, in addition to the the salaries of accountants, was approxi­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 104 T he Annals of the American Academy mately $250,000. This represents the “Behold, how great a matter a basic cost of effecting domestic exchanges little fire kindleth!” Thus, from between the several reserve districts. A cautious beginnings, feeling the way, charge of ten cents per one hundred dollars, but nevertheless with unexpected rapid­ if generally imposed, would have imposed ity of progress, the Federal Reserve an expense on the commerce of the country System has developed the most ef­ of $73,984,252. fective, the most comprehensive and The leased wire system had been the most economically administered extended to all branches of Federal exchange system in the world of bank­ Reserve Banks, and in many cases ing. When all the banks of the country these branches participated in the are on a par clearing basis, the system Gold Settlement Fund. can be made still more effective and The last refinement in the evolution useful. of the Gold Settlement Fund was made At the present time, a member bank when all transactions between Federal may obtain from its own Federal Re­ Reserve Banks which are settled serve Bank, free of expense to itself, a through the Gold Fund were made telegraphic transfer of funds, in any effective on the day on which they amount, to any point in the country occurred. This was made possible by where a member bank is located. the introduction of a plan or practice These transactions are effected between under which all transactions to be Federal Reserve Banks and are settled settled through the Gold Fund were through the Gold Fund. wired to the Board from the banks and The Gold Fund has been of inesti­ the branches, and the Board made the mable value to the Treasury, and has settlement upon its books as of that rendered easy of accomplishment the day at the earliest possible hour on the most stupendous financial operations following morning, and wired the ever undertaken. During the past settlement figures to each Federal two years, the government has col­ Reserve Bank. The Federal Reserve lected taxes from every nook and Banks kept their books open until corner of the country, amounting to such wires were received from the about one billion dollars quarterly. Federal Reserve Board, and then Certificates of indebtedness have been made the few entries necessary and issued, have matured and been paid, closed their bool^s as of the pre­ and the receipts and disbursements vious day. This plan has worked ad­ of the Treasury for a single day, on mirably and has eliminated all the occasions, have amounted to approxi­ float which had to be carried by mately a billion dollars each way. those Reserve Banks with credit bal­ All of these funds passed through ances in the settlement under the the Federal Reserve Banks; they were previous plan, by which the daily adjusted and redistributed through settlement payments were not re­ the Gold Fund without disturbance ceived until the day following that of the financial equilibrium and on which the settlement figures were so smoothly as to occasion hardly made up. The volume of clearing a comment. It has become a routine through the Gold Fund for the year matter. 1920 was $92,625,000,000. The aver­ Lord Byron makes the Prisoner of age weekly volume of clearings in­ Chillon say: creased from $31,898,000 in 1915 to “ So much a lorg communion tends $1,793,584,000 in 1920. To make us what we are.”

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E ligibility for D iscount 105 So we say that the public from long ing that it is the wonderful working communion with these huge trans­ of the Federal Reserve System which actions now takes them as a matter of makes us commercially and finan­ course, but without fully understand­ cially what we are.

Eligibility for Discount By C h a r l e s L. P o w e l l Counsel for Federal Reserve Bank of Chicago HE kind and character of paper determine some fact or state of things, which the Federal Reserve Banks upon which the law makes, or intends may discount for member banks isto make, its own action depend.” Ac­ inT broad, general terms defined in Sec­ cordingly, the regulations made by the tion 13 of the Federal Reserve Act. Federal Reserve Board defining, apply­ It is there provided that the Federal ing and limiting the character of paper Reserve Banks, upon the endorsement eligible for rediscount must be read as of member banks, may discount for part of the Act. them: (1) notes, drafts and bills of ex­ change issued or drawn for agricultural, G e n e r a l L im it a t io n s o n E l ig ib il it y industrial or commercial purposes, or The limitations on eligibility for dis­ the proceeds of which have been used count, as provided by the Act and the or are to be used for such purposes; regulations of the Board, are directed (2) acceptances of banks of the charac­ to (1) the maturity of the paper and ter and kind described in the Act. (2) its source of origin, or the purposes The Federal Reserve Board, by the for which it is to be used. The lan­ same section of the Act, is given the guage used by the Act in respect to the right to determine or define the char­ latter is modeled upon many prior pro­ acter of paper made eligible for dis­ posals for legislation and was mani­ count within the meaning of the festly for the purpose of avoiding the Act; and, the Board in the exer­ use of bank funds in two general cise of this statutory right has, from classes of transactions, that is to say, in time to time, promulgated a series of speculative transactions and in trans­ regulations for the guidance of the actions involving capital investments. Federal Reserve Banks and member The reason for these two provisions banks. These regulations, while not a of the Act—the one relating to the part of the statute, having been made origin or purpose of the note or bill and and promulgated by a lawfully consti­ the other to its short maturity—is tuted body, have the force and effect of found in the recognized necessity of law.1 As is said by the Supreme Court keeping the assets of the bank liquid at of the United States, in United States all times and thus readily available to v. Clark, “the Legislature cannot dele­ meet the demands of commerce and gate its powers to make a law, but it trade. can make a law to delegate a power to It was expected, and the operation of 1 United States v. Grimaud, 220 U. S. 506; the Act has proved it to be the case, that Dasterbignes Case, 122 Fed. 30; United States v. a large part of the banking resources of Clark, 143 U. S. 664. the nation would find its way into the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 106 T he Annals of the American Academy Reserve Banks. It was, and is, un­ eluding the breeding, raising, fattening thinkable, from a scientific standpoint, or marketing of live stock, and which that these resources should be tied up has a maturity at the time of discount in long-time investments, or in invest­ of not more than six months, exclusive ments permanent in their nature. It of days of grace.” is the very essence of the Federal Re­ serve System that its funds must be in­ C o m m e r c ia l a n d A gricultural vested in short-time securities, which, P u r p o s e s D e f in e d in theory at least, are self-liquidating. Under the regulations, paper may be eligible because issued or drawn for B o a r d D e f in it io n s o f E l ig ib l e an agricultural or commercial purpose, P a p e r or it may be eligible because the pro­ Regulations of the Federal Reserve ceeds have been, or are to be, used for Board have been promulgated and put an agricultural or commercial purpose. into effect, clarifying, amplifying and The purchase and sale of goods of any explaining the language of the Act, character is a commercial transaction keeping in view at all times the broad from the standpoint of the seller, and general provision of the Act that in­ the note of a buyer given to the seller vestments must be of short maturity in payment for articles purchased is a and must have arisen out of commer­ note which has been “issued or drawn cial transactions. These regulations for a commercial purpose.” have been revised from time to time. The use of the proceeds of a note to The last revision was put out under purchase goods for re-sale is a com­ date of October 6, 1920.2 This revi­ mercial purpose, even though the ar­ sion was amended May 6, 1921.3 ticles purchased will be permanent The Board’s regulations define with investments in the hands of the final particularity promissory notes, drafts, purchaser; and, accordingly, the note of bills of exchange, trade acceptances, a dealer, discounted by him at a local six months’ agricultural paper and bank, to provide funds to purchase bankers’ acceptances eligible for dis­ articles for re-sale, may be eligible for count, but the definitions thus pro­ discount as commercial paper, irre­ mulgated by the Board are well within spective of the character of the arti­ the usual definitions found in the Ne­ cles purchased; but a note of a farmer gotiable Instruments Acts of the vari­ discounted by him at his local bank to ous states, so far as such acts deal with provide funds with which to purchase similar instrumentalities of commerce. articles for agricultural uses, is eligible In addition to definitions of such or ineligible for discount according to ordinary instruments, a trade accept­ the character of the articles. If the ance is defined as “a draft or bill of articles are in the nature of permanent exchange, drawn by the seller on the or fixed investments, then it is not purchaser of goods sold, and accepted eligible; but if, on the other hand, they by such purchaser.” are articles for agricultural uses and Six months’ agricultural paper is de­ have to be replaced from time to time, fined as “a note, draft, bill of exchange the farmer’s note is eligible for dis­ or trade acceptance, the proceeds of count as agricultural paper. which have been used, or are to be The distinction between agricul­ used, for agricultural purposes, in- tural paper and commercial paper is 2 Federal Reserve Bulletin, 6 : 1179. important in several respects: Agri­ 3 Ibid., 7 : 545. cultural paper having a maturity of

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E ligibility for D iscount 107 six months may be eligible, while defined by the Federal Reserve Act, commercial paper to be eligible can when secured by bonds of the War have a maturity of but three months; Finance Corporation, are made eligible a farmer’s note given in payment for for discount. However, notes, drafts articles or commodities to be used by or bills issued or drawn for the purpose the farmer for agricultural purposes is of carrying or trading in other stocks agricultural paper; but the purchase and bonds are not eligible for discount. and sale of agricultural products is a Strict negotiability of instruments of commercial and not an agricultural commerce is one of the prime requisites transaction, and a note given to a of paper eligible for discount by a farmer for agricultural products grown Federal Reserve Bank. This is for the by him, is eligible, if at all, as com­ reason that a member bank must en­ mercial paper.4 dorse paper tendered for discount, not only for the purpose of placing the title L o n g -T im e F u n d s a n d G o v e r n m e n t thereof in the Federal Reserve Bank, B o n d s but also for the purpose of assuming all The Board’s regulations, following the responsibilities of an endorser upon the provisions of the Act, provide for negotiable paper. To the end that such the discount by Federal Reserve liability of member banks, as endorser, Banks of such notes, drafts, bills of be preserved, the instrument tendered exchange, trade acceptances, six for rediscount must be strictly nego­ months’ agricultural paper and bank­ tiable within the meaning of the law ers’ acceptances of short maturity and applicable to commercial paper in the of commercial origin referred to there­ particular jurisdiction. in, but such regulations, following and The Federal Reserve Board has pro­ expressing the spirit of the Act, pro­ mulgated rules for the determination vide that a note, draft, or bill of ex­ of the eligibility of paper for discount, change, the proceeds of which have which rules have to do merely with the been used for permanent or fixed in­ method to be pursued by the Federal vestments, such as lands, buildings, Reserve Banks in ascertaining the ulti­ machinery and other capital purposes, mate facts as to whether or not the or which have been used, or are to be paper is eligible under the provisions of used, for investments of purely specu­ the Act and the regulations of the lative character, or for the lending to Board; but such regulations are evi- some other borrower, shall not be eli­ denciary in effect and have to do, not gible for discount. with the eligibility of the paper, but Both the provisions of the Act and merely with the method of procedure the regulations of the Board make in ascertaining its eligibility. eligible for discount obligations issued or drawn for the purpose of carrying C o m m e r c ia l a n d A gricultural or trading in bonds and notes of the P a p e r E l ig ib l e f o r D is c o u n t government of the United States, when such obligations are of proper Notes secured by mortgage, if other­ maturity. Further, the Federal Re­ wise eligible, may be discounted.5 In­ serve Act was, in effect, amended by asmuch as notes payable “on or be­ the War Finance Corporation Act, ap­ fore” a given date are negotiable proved April 5th, 1918, whereby ob­ within the meaning of the Negotiable ligations of appropriate maturity, as Instruments Act, in force in most of 4 Ibid, 6: 1302. 6 Ibid., 2: 679.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he Annals of the American Academy Se/^Ues, and under the Law Mer- which is to be developed or built i&t/such notes are eligible for dis- up, the proceeds of which note have The assignment of an open been, or are to be used by him to pay Scount is not negotiable, and is not for the work of developing or building, eligible for rediscount.7 is not eligible for discount, but the note A bill of exchange drawn by the of an owner given in good faith to the seller on the purchaser of advertising contractor in actual payment of mate­ space and accepted by such purchaser rial and services furnished by him for is a trade acceptance and is eligible for the owner, may be considered tech­ discount.8 The note of a farmer held nically eligible for discount as paper, by a member bank, given for the pur­ the proceeds of which have been or are pose of assisting the farmer to produce to be used for commercial or industrial a crop or to fatten his cattle, is eligible purposes.16 for discount if of proper maturity, Collateral notes of Federal Farm whether or not secured by mortgage.9 Loan Banks, secured by farm loan A note drawn for commercial purposes, bonds or the note of a Joint Stock otherwise eligible for rediscount, is not Land Bank, secured by its own bonds, ineligible because it is secured by a are not eligible for discount.17 Federal mortgage on real estate.10 The notes Farm Loan Bank bonds are not eligible of a water works company, the pro­ for discount, and are not, accordingly, ceeds of which have been, or are to be eligible as collateral for member used to provide funds for the pay roll, banks.18 A note, secured by paper eli­ purchase of coal and the like, are eligi­ gible for discount, is not itself eligible ble for discount.11 The note of a pack­ for discount unless its proceeds have ing company, the proceeds of which are been used, or are to be used, for indus­ used for the purchase of live stock for trial, agricultural or commercial pur­ slaughter is not “based on live stock” poses.19 Under the present definitions within the meaning of Section 13 and of a trade acceptance, it seems that a is not eligible for discount if it has a draft drawn for an insurance premium maturity in excess of 90 days.12 A would not be eligible for discount.20 certificate of participation in a note, The note of a farmer given for a tractor which, itself, is eligible for discount, is to be used on his farm may be dis­ not eligible.13 Water sold by an irriga­ counted as agricultural paper.21 A tion company to farmers and delivered note given by a farmer for the purchase through the company’s ditches may be price of a commodity can be classed as classed as “goods sold,” within the agricultural paper eligible for redis­ meaning of the Board’s regulations and count when having a maturity in excess a note representing the agreed pur­ of ninety days, if the maker is to use chase price thereof is eligible for dis­ the commodity for agricultural pur­ count.14 Natural gas actually sold and poses, regardless of whether the note is delivered is “goods sold” and a trade discounted by the maker or the en­ acceptance covering such is eligible for dorser; but if not intended for such use, discount.15 then the paper is eligible for discount The note of the owner of property as commercial paper, if having a matu­ * Federal Reserve Bulletin, 2: 394. rity not in excess of ninety days.22 7 Ibid., 2: 227. 11 Ibid., 3: 527. 8Ibid., 3: 116. 12 Ibid., 3: 616. 16 Ibid., 6: 699. 19 Ibid., 4: 108. • Ibid., 3: 378. 18 Ibid., 3: 949. 17 Ibid., 6: 609. 20 Ibid., 4: 309. 10 Ibid., 3: 458. 14 Ibid., 6 :949. 18 Ibid., 4: 33. 21 Ibid., 4: 309. 15 Ibid., 4: 435. 22 Ibid., 4: 312.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E ligibility for D iscount 109 A member bank having acquired commercial transaction, out of which eligible paper in due course from a it arises.32 This is but another way of non-member bank may discount such saying that the proceeds must be used paper with a Federal Reserve Bank.23 in the first instance for a commercial A note, the proceeds of which is used purpose by the borrower. It is merely for tilling or draining farms, may be emphasizing the thought that paper to classed as agricultural paper and is be eligible, must be issued or drawn un­ eligible for discount.24 A note of a non­ der such circumstances that, in the member bank, secured by notes of the normal course of business, there will government of the United States, and automatically come into existence a given for the purpose of carrying or fund available to liquidate each piece trading in such notes of the United of paper, that fund being the final States, is eligible for discount when proceeds of the transaction out of presented by a member bank.25 A which the paper arose. member bank may obtain the discount A note of a grain dealer or other pur­ of its paper secured by government chaser of grain, given to a grower for bonds for a period as long as ninety grain purchased for re-sale, is commer­ days, by acting through another mem­ cial paper and is to be discounted as ber bank, although a member bank, such, even though the grower subse­ acting alone, may not tender its col­ quently discounts the note and uses lateral note to the Federal Reserve the proceeds for an agricultural pur­ Bank for a longer period than fifteen pose. The same principle applies to a days.26 Silos are permanent improve­ draft drawn by the grower, and ac­ ments, and notes given for their pur­ cepted by the purchaser, in whole or in chase are not eligible for discount.27 part payment for grain purchased for Where a railroad company purchases re-sale.33 Here is brought into play the supplies and accepts the draft of the rule that the transaction out of which seller and the seller discounts the draft an instrument arises in the first in­ with a member bank, such draft is stance determines its classification, irre­ eligible for discount.28 The six months’ spective of any transaction in which maturity privilege as applied to agri­ the instrument may be subsequently cultural paper does not apply to the negotiated. sales a manufacturer of implements A note given for the purchase of a makes to a dealer for re-sale to a motor truck by a farmer is clearly held farmer.29 The actual sale of goods, and to be eligible for discount, as agricul­ not what is generally termed a con­ tural paper, but notes or trade accept­ ditional sale, must be the basis of a ances given in the purchase of motor trade acceptance.30 trucks of a corporation engaged in the A draft drawn to cover the purchase business of furnishing motor trans­ price of goods sold, plus the cost of portation are not eligible for discount, installing those goods, is eligible for as such trucks represent in a large ex­ discount.31 A note is not eligible for tent the corporation’s capital invest­ discount as commercial paper unless ment.34 made and endorsed by a party to the Paper, the proceeds of which are to be used to make loans to third parties, 2* Ibid., 4: 520. *7 Ibid., 4: 971. is finance paper rather than commercial 24 Ibid., 4: 743. 28 Ibid., 4: 974. 28 Ibid., 4: 743. 29 Ibid., 4: 1118. or agricultural paper and is not eligible 26 Ibid., 4: 863. 30 Ibid., 5: 964. 82 Ibid., 7: 1079. 33 Ibid., 7: 1199. 31 Ibid., 4: 310. 34 Ibid., 7: 191.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 110 T he Annals of the American Academy for discount.35 Where a cold storage other money, of which the acceptor is a company uses the proceeds of its notes bank or trust company, or a firm, per­ to make advances to customers who son, company or corporation engaged have placed their goods in the com­ generally in the business of granting pany’s warehouse to be sold by the bankers’ acceptance credits.” company for the account of the cus­ The practice of banks to make ac­ tomers, and the customers give the ceptances is practically as old as the storage company their notes for the business of banking, but the practice amount of these advances, and as se­ never came into modem use in the curity for such notes, pledge the ware­ United States until after the enact­ house receipts, and the storage com­ ment of the Federal Reserve Act. pany pledges the customers’ notes and Prior to that Act the average American the warehouse receipts as collateral for bank merely collected the idle funds of their own notes, such notes are not the community and loaned them and eligible for discount.36 Growers’ drafts its own funds to its customers. The accepted by cooperative marketing as­ bank loaned capital and not credit. sociations are eligible for discount with On the other hand, the chief merit and Federal Reserve Banks, as agricultural the distinguishing feature of European paper, and may have a maturity riot in banking systems, especially in England, excess of six months.37 The note of an France and Germany, was found in the irrigation company cannot be classed bank acceptances by which those banks as agricultural paper, but a farmer’s loaned their credit. They standard­ note, given to an irrigation company in ized bills of exchange and added new payment for a supply of water, may be power to them, so that by virtue of regarded as agricultural paper.38 their credit quality these bills became, Notes of corporations or associations part of the circulating credit of the engaged in packing and marketing country. The European banks found fruits should not be classed as agricul­ the acceptance to be the cheapest form tural paper, but as commercial paper, of credit instrument. It did not de­ and such notes are eligible when their plete cash holdings of the accepting maturities do not exceed ninety days. bank and no reserve was needed to The business of such corporations or safeguard the risk. This acceptance associations in the marketing of fruits power of European banks enabled is a commercial business rather than them cheaply to finance export and an agricultural business.39 import transactions and, doubtless, to a large extent explains why, prior to T h e F u n c t io n o f B a n k e r s ’ the Great War, all such financing was A c c e p t a n c e s done by European banks to the utter As already noted, Federal Reserve exclusion of the American banks. Banks may discount, for their member This salutary method of financing banks, bankers’ acceptances. A bank­ transactions was grafted on our system ers’ acceptance is defined by the regu­ by the Federal Reserve Act and follow­ lations of the Federal Reserve Board as ing that Act most of the states have “a draft or bill of exchange, whether conferred the acceptance power upon payable in the United States or abroad, their state banks by specific provision, and whether payable in dollars or some so that the granting of acceptances 35 Federal Reserve Bulletin, 6:1176. by banks has come to be a part of 36 Ibid., 7: 308. 38 Ibid., 7: 964. the general banking business in this 37 Ibid., 7:1199. 39 Ibid'., 7:1312. country.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Eligibility fob D iscount 111 T h e D is c o u n t a n d P u r c h a s e o f necessary either, (1) that shipping doc­ B a n k e r s ’ A c c e p t a n c e s uments or documentary export draft The Federal Reserve Act and the be attached at the time the draft is regulations of the Federal Reserve presented for acceptance, or (2) if the Board made pursuant thereto, and the goods have not been shipped, that Acts of the various states, have safe­ there be in existence a bona fide con­ guarded the granting of acceptances by tract providing for the exportation or member banks. Indeed it may be said importation of such goods and that in broad general terms that bankers’ the customer agree that the accepting acceptances, which have had their ori­ bank will be furnished in due course gin in accordance with the limitations with shipping documents or with ex­ of the Act and regulations, if not of change arising out of the transaction. more than three months’ maturity, ex­ A contract between principal and agent clusive of days of grace, are eligible for will not be considered such bona fide discount by Federal Reserve Banks. contract. Federal Reserve Banks may dis­ In the case of shipment of goods count any bill drawn by a bank or within the United States, the regula­ banker in a foreign country or depend­ tions provide that shipping documents encies or insular possessions of the conveying security title should be at­ United States for the purpose of fur­ tached to the draft at the time of its nishing dollar exchange as provided in acceptance. the Act and regulations of the Board, A bankers’ acceptance based upon provided such draft has not more than the storage of readily marketable three months’ maturity, exclusive of staples must be secured at the time of days of grace. acceptance by a warehouse, terminal or Bankers’ acceptances, to be eligible other similar receipt, conveying secu­ for discount, may involve: (1) the ship­ rity title to such staples, and the ac­ ment of goods between the United ceptor must remain secured throughout States and any foreign country, or be­ the life of the acceptance. tween the United States and any of its The discretion of the Board with ref­ dependencies or insular possessions, or erence to bankers’ acceptances and the between foreign countries; (2) a ship­ investment therein of the Federal Re­ ment of goods within the United serve Bank funds is probably broader States; or (3) the storage of readily than its discretion with reference to marketable staples. notes, drafts, trade acceptances, and When the acceptance is based on a other bills of exchange.40 shipment of goods between the United The rule of the Board with reference States and any foreign country, or to furnishing shipping documents in between the United States and any of export or import transactions is not met its dependencies or insular possessions by the furnishing of freight receipts or or between foreign countries, shipping non-negotiable copies of bills of lading.41 documents covering goods in process Shipping documents are legally in of shipment need not be attached to the possession of an accepting bank the draft drawn for financing the when they are held by its correspond­ transaction. Neither is it essential ent or by some other independent that each draft cover specific goods party, as its agent, both in domestic actually in existence at the time of the and foreign transactions.42 The period acceptance, but, in order that said 40 Ibid., 7:70. 41 Ibid., 7:191. drafts be eligible for discount, it is 42 Ibid., 7:191.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 112 T he Annals of the American Academy for which drafts may be accepted in the bankers’ acceptance drawn by a coop­ first instance should be approximately erative marketing association, secured the same as that required to complete by warehouse receipt covering non- the shipment and finance the transac­ perishable agricultural commodities tion involved.43 A draft drawn by an stored in warehouses independent of American exporter, covering cotton the association, is eligible for discount. consigned to his European agent, may The acceptance of drafts, secured by be eligible for discount, when shipping bills of lading, for the primary purpose documents covering goods actually of providing the borrower with work­ shipped are attached at the time the ing capital during the period required draft is presented for acceptance, al­ to manufacture and re-sell the goods though the goods covered by the doc­ covered by the bills of lading, is an uments have not been sold, but are abuse of a domestic acceptance privi­ merely shipped on consignment to the lege.49 Drafts drawn by the purchaser agent abroad.44 of goods and secured at the time of A Federal Reserve Bank may pur­ acceptance by bills of lading covering chase a bankers’ acceptance from the the goods bought are not eligible un­ drawer or even from the accepting less the proceeds are to be used to pay bank, but there is no obligation upon for the goods.50 a Federal Reserve Bank to purchase A bankers’ acceptance secured by a paper offered it, even though the paper warehouse receipt covering an auto­ is technically eligible.45 Where a mobile or automobile tires is not se­ farmer draws a draft on his local bank cured by “readily marketable staples” for three or four months, secured by and is not eligible for discount, but an bills of lading covering the shipment of acceptance secured by a bill of lading cattle to the farmer for feeding, and the covering an automobile or automobile local bank accepts the draft and the tires in the process of shipment, pro­ farmer then discounts it with another viding the acceptance otherwise com­ bank, such draft is eligible for dis­ plies with the terms of the law or the count if it has a maturity not in excess regulations of the Board, is eligible for of three months.46 discount.51 A bankers’ acceptance is Bankers’ acceptances, growing out of not eligible for discount if, at the time export or import transactions, having of its acceptance, the period required a maturity of not more than six for a conclusion of the transaction out months may be purchased in the open of which the original draft was drawn, market by Federal Reserve Banks.47 shall have elapsed.52 A draft drawn The “shipping documents” to be fur­ abroad, payable in the United States in nished banks accepting drafts growing dollars, and secured by a warehouse out of export or import transactions receipt covering readily marketable mean an order bill of lading, or a staples stored in a warehouse in a for­ straight bill of lading, whichever is is­ eign country, is eligible for acceptance sued by the carrier in the particular by a member bank and for discount by case. They do not include freight re­ a Federal Reserve Bank, if of appro­ ceipts or mere copies of original bills of priate maturity.53 lading, but these documents may be The Federal Reserve Board has de­ held by a correspondent or agent.48 A fined a “readily marketable staple” as 43 Federal Reserve Bulletin, 7 : 308. 44 Ibid., 7 : 419. 46 Ibid., 7 : 815. 49 Ibid., 6 : 1301. 51 Ibid., 6: 65. 46 Ibid., 7 : 699. 47 Ibid., 7 : 545. 60 Ibid., 3 : 380; 6: 66. 52 Ibid., 5 : 858. 48 Ibid., 7 : 191. njbid., 5 : 740.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E ligibility for D iscount 113 an article of commerce, agriculture or ering a domestic shipment of goods industry, of such uses as to make it the may not procure an acceptance thereon subject of constant dealings in ready by a member bank without regard to markets, with such frequent quota­ the use to which the proceeds of the tions of prices as to make the price draft are to be put. There must be easily and definitely ascertainable, and more than a casual connection between the staple itself easy to realize upon by the drawing of the draft and the trans­ sale at any time.54 action involved.61 A warehouse re­ Under the terms of Section 13 of the ceipt, to be appropriate security for an Act, any draft or bill of exchange, acceptance, should be issued by a ware­ which a member bank has the power house which is independent of the bor­ to accept under the provisions of that rower.62 Gold bars may be properly section, is technically eligible for re­ considered as “goods” and, accord­ discount by a Federal Reserve Bank.66 ingly, sixty day bills, when accepted An accepting bank, secured in a do­ by banks against such a shipment, mestic transaction by shipping docu­ would be eligible for discount. Ex­ ments or warehouse receipt s, at the time change drawn to finance a shipment of of acceptance may release the shipping gold coin from the Uuited States to documents or warehouse receipts prior Europe or Canada, is eligible for pur­ to payment, providing the draft or chase when otherwise in conformity drafts accepted for one person do not with the Act and regulations.63 exceed 10 per cent of the capital and A bankers’ acceptance secured by a surplus of the accepting bank.66 Mem­ bill of sale of stock on hand is not eligi­ ber banks may legally accept drafts ble for discount.64 A bankers’ accept­ drawn against them, secured by sugar ance secured by chattel mortgage on placed in bond under transit entry and cattle is eligible for discount65 but the warehouse receipt issued by the col­ Board has ruled that a national bank lector in negotiable form.67 National may not accept a draft so secured.66 banks may not accept a draft which is secured by a chattel mortgage on cat­ P a p e r M u st B e K e p t L iq u id tle.58 Where a dealer is engaged in The conservation of the strength of purchasing the same character of goods the Federal Reserve System is depend­ for export and domestic use, a member ent upon the strict adherence of the bank accepting his draft drawn to Federal Reserve Banks to the rules finance an export transaction should governing the eligibility of paper for require proper assurance that the pro­ discount* If those rules are adhered ceeds of such draft will be used for the to, the portfolios of the Reserve Banks purchase of goods for export and that will be filled with liquid securities ma­ the acceptance will be paid out of the turing from day to day, thus bringing proceeds of sales of goods exported.69 into the banks a continuous flow of A trust receipt in the hands of an money to meet the demands of com­ accepting bank which permits the pur­ merce and trade. On the other hand, chaser of the goods to procure control if those rules are departed from, the of the goods is not actual security, portfolios of the banks will become within the meaning of the Act.60 One clogged with “frozen credits,” and the in the possession of a bill of lading cov- purpose for which the Reserve Banks 64 Ibid., 5: 652. 67 Ibid., 4: 520. were organized will be defeated. 55 Ibid., 5: 255. 68 Ibid., 4: 437. 81 Ibid., 3: 380. 84 Ibid., 2: 684. 66 Ibid., 4: 634. 69 Ibid., 4: 314. 82 Ibid., 3: 30. “ M , 2: 65. Ibid., 3 881 63 Ibid., 3: 29. 66 Ibid., 4: 309. 9 60 ; .

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 114 T he Annals of the American Academy Amendments to the Federal Reserve Act By W a l t e r S. L o g a n General Counsel, Federal Reserve Board HE Federal Reserve Act has been the importation or exportation of amended a number of times since goods.” National banks were without it became a law on December 2 3 , 1913authority, to accept drafts in domestic butT none of the amendments can be transactions until, by the Act of said to have affected any fundamental September 7, 1916, they were given change in the structure or operation of authority to accept drafts or bills in the Federal Reserve System. Experi­ transactions involving the domestic ence has indicated how the purposes of shipment of goods or the storage of the framers of the Act could be ad­ readily marketable staples, subject to vanced by further legislation, and how certain prescribed conditions. the Federal Reserve System could best These conditions were that the bank serve the banks and the business of the issuing acceptances in such domestic country; Congress in the light of this transactions must be secured at the experience has modified many of the time of acceptance by shipping docu­ provisions of the original Act. But the ments covering the goods in process of principles upon which the Act was shipment, or by warehouse receipts or based, the functions of the Federal other similar documents covering the Reserve Banks and their relation to the readily marketable staples in storage. member banks and to business and com­ There never has been any similar merce, remain essentially unchanged. requirement of law with respect to It will not be attempted in this acceptances in foreign transactions and chapter to discuss every amendment, it is important to note this distinction, for many of them are not considered of for it is the basis 'for a more liberal sufficient general interest to warrant practice in connection with the issue mention in a work of this character; in of foreign acceptances than has been many cases they relate solely to the adopted with respect to domestic internal administration of the Federal acceptances. Reserve Banks.1 Because of the requirement that documents representing the goods or A c c e p t a n c e P o w e r s o f N a t io n a l staples must be in the possession of the B a n k s accepting bank at the time of accept­ The first important amendment was ance, it is obviously impossible that the Act of September 7,1916. Probably domestic acceptances be issued except the most far reaching change effected when the goods or staples are identified by this amendment was with respect and in process of shipment or in to the; acceptance powers of national storage. The issuance of acceptances banks. The Act, as originally passed, to finance foreign transactions has, authorized member banks to accept however, been authorized prior to the only drafts and bills of exchange commencement of the actual export or “growing out of transactions involving import shipment, in cases where the customer for whom the acceptances 1 For a complete list of amendments prior to January 1, 1921, see the Annual Report of are issued is under a definite contract the Federal Reserve Board for the year 1920, to export or import goods in the future. pages 316- 326. This has been authorized upon the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Amendments to the F ederal R eserve Act 115 theory that the export or import less than $1,000,000 to invest in the transaction commences with the execu­ stock of foreign corporations. This tion of the contract and that the sub­ amendment will be referred to in sequent acts in fulfilment of that connection with the amendments of contract are inherent parts of that September 17, 1919, and December 24, transaction, and may, therefore, be 1919, which deal with the same general financed by means of acceptances. 'subject matter. The Act of September 7, 1916, further broadened the authority of A m e n d m e n t o f J u n e 21, 1917 national banks to issue bankers’ ac­ The second important amendment ceptances by permitting them, under to the Act was that of June 21, 1917. regulations of the Federal Reserve Up to this time few state banks had Board, to accept ninety day drafts or joined the Federal Reserve System, bills drawn by banks or bankers in largely because, by becoming members foreign countries or dependencies or under the provisions of Section 9 of the insular possessions of the United original Act, they were made subject States for the purpose of furnishing to the provisions of the National Bank dollar exchange as required by the Act, which prohibit national banks usages of trade in those places. Under from making loans to any one person the authority of this amendment the in excess of 10 per cent of the bank’s Federal Reserve Board has granted capital and surplus, and were required permission to member banks applying to make reports of condition to the therefor to accept ninety day dollar Comptroller of the Currency; also exchange drafts drawn by banks or because Section 21 of the original Act bankers in South American countries required the Comptroller to examine and in dependencies and insular pos­ state member banks at least twice a sessions of the United States. year. The argument was also made that under the terms of the original O t h e r P r o v is io n s o f t h e A m e n d ­ Act a state bank once having joined m e n t o f S e p t e m b e r 7, 1916 the Federal Reserve System had no Another important feature of the right to withdraw. In order to make Act of September 7, 1916, was that it membership in the System more authorized Federal Reserve Banks to attractive to state banks and trust make advances for fifteen days to companies, Section 9 was rewritten. member banks on the promissory notes This section as it now reads exempts of the member banks when such notes state bank and trust .company members are secured by paper which is eligible from supervision or examination by the for rediscount or purchase or by bonds Comptroller of the Currency and pro­ or notes of the United States. The vides that “subject to the provisions of provisions of the original Act did not this Act and to the regulations of the permit Federal Reserve Banks to board made pursuant thereto, any make advances or loans but permitted bank becoming a member of the them only to rediscount eligible paper Federal Reserve System shall retain previously discounted by member its full charter and statutory rights as banks. a State bank or trust company, and The Act of September 7, 1916, may continue to exercise all corporate amended Section 25 of the Federal powers granted it by the state in Reserve Act so as to authorize national which it was created.” It also contains banks with a capital and surplus of not a provision specifically authorizing

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 116 T he Annals of the American Academy withdrawal from membership upon six all checks drawn upon it cleared through months’ notice. the Federal Reserve Banks. This was The Act of June 21, 1917, also an inter-district as well as an intra­ amended the first paragraph of Section district system, the exclusively intra­ 13 of the Act so as to authorize non­ district clearing systems, which had member banks, irrespective of whether previously been established but mem­ their capital is sufficient to make them bership in which had been optional eligible for full membership, to clear with each member bank, having proved through the Federal Reserve Banks of unsatisfactory. Simultaneously with their clistricts checks deposited with the establishment of the country them, provided that they maintain wide clearing system, the Federal balances with such Federal Reserve Reserve Bank of Boston took over Banks sufficient to offset the items in the country collection department of transit held for their accounts. While the Boston Clearing House and was this privilege has not been availed of able to collect checks on all banks in by non-member banks to any material New England at par, that is, at the full extent, apparently because non-mem­ face amount without the deduction of ber banks are able to obtain the full any exchange charge by the drawee benefits of the Federal Reserve check banks. In the other districts it was clearing facilities by sending checks not possible to collect at par checks deposited with them to correspondent drawn on all non-member banks be­ member banks which in turn clear cause many of them desired to continue such checks through their Federal their past practice of charging exchange Reserve Banks, and while from a when remitting for their checks. From strictly legal standpoint the Act of the first, however, it was contemplated June 21, 1917, in the form in which it that the Federal Reserve check clear­ was finally enacted, did not have any ing and collection system should be important bearing upon the check extended gradually until it furnished clearing and collection functions of facilities for collecting at par checks on Federal. Reserve Banks, nevertheless all banks in the country, thus elimi­ a brief discussion of the subject of nating the enormous tax with which check clearing and collection seems business and commerce has been appropriate at this point because it burdened by reason of the practice of was discussed at length in both the making exchange charges. Senate and the House of Representa­ In their origin there was some justi­ tives when Congress had the pre­ fication for exchange charges because liminary drafts of the bill under such a charge then represented an consideration, and because the provi­ actual expense which the remitting sion added by this Act at the end of the bank incurred in having currency first paragraph of Section 13 is fre­ transported from where the bank was quently referred to in discussions located to the place of business of the relative to this general subject. holder of the check who had received it in payment of a debt. At the L e g a l A s p e c t o f t h e F e d e r a l present time, however, there is no R e s e r v e C l e a r in g S y s t e m necessity for the actual transportation In July, 1916, a country wide Federal of currency between Federal Reserve Reserve check clearing and collection districts, since the Federal Reserve system was instituted, each member System, through its leased wires con­ bank being required to remit at par for necting all Federal Reserve Banks and

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Amendments to the F ederal R eserve Act 117 branches and through its Gold Settle­ in effect nullified by the addition at the ment Fund at Washington, offers end of the paragraph in question, the facilities for the instantaneous transfer first paragraph of Section 13, of the of available funds by mere book entry. following clause: “but no such charges The Federal Reserve System pays the shall be made against the Federal entire cost of maintaining these leased Reserve Banks.” wires and the Gold Settlement Fund, The policy of extending the Federal and the Federal Reserve Banks pay the Reserve check clearing and collection cost of transporting currency from system has been continued until now member and non-member banks in Federal Reserve Banks are able to their districts if such member or collect checks drawn on about 28,000 non-member banks desire to make out of a total of approximately 30,000 remittances for their checks in this banks in the United States. The manner. Consequently, the justifica­ claim is made by some non-member tion for exchange charges has ceased to banks which still persist in their desire exist and to the extent that such to charge exchange when remitting charges are still made they constitute for checks, that the final clause of a tax paid by business and commerce Section 13 of the Federal Reserve Act for which no compensating service is should be construed as prohibiting received. Federal Reserve Banks from under­ Following the policy of extending taking to make counter presentation the Federal Reserve check clearing and of checks drawn on non-member banks collection system the Federal Reserve which have not agreed to remit at par Banks undertook to induce non-mem- to the Federal Reserve Banks and this ber banks to remit to them at par, and issue is involved in suits which have when able to make satisfactory ar­ been instituted by such non-member rangements, they also undertook to banks against several of the Federal collect checks drawn on non-member Reserve Banks. banks which did not remit at par by having such checks presented at the A m e n d m e n t o f R e s e r v e counters of the drawee banks. R equirements This practice caused some opposition Another important amendment ac­ on the part of the non-member banks complished by the Act of June 21, 1917, which still desired to charge exchange was the amendment to Section 19 of and as a result of this opposition a the Act changing the character and provision was inserted in the bill amount of the required reserves of pending in Congress in the spring of member banks. 1917 to the effect that nothing in the Section 19 of the Federal Reserve Federal Reserve Act should be con­ Act as amended by the Act approved strued as prohibiting a member or August 15, 1914, before the Federal non-member bank from making reason­ Reserve System was put into actual able exchange charges. The Senate operation in November, 1914, provided passed the bill with this provision in it, that member banks in central reserve but the sentiment in favor of par cities should maintain reserves equal to collection finally prevailed and in the 18 per cent of their demand deposits bill as agreed to in conference between and 5 per cent of their time deposits, the committees of the Senate and the and that member banks in reserve cities House, and in the Act as finally ap­ should maintain reserves equal to 15 proved, this particular provision was per cent of their demand deposits

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 118 T he Annals of the American Academy and 5 per cent of their time deposits, directly involved in the War the and that other member banks should question of the mobilization of the maintain reserves equal to 12 per cent gold reserves of the country became of their demand deposits and 5 per cent still more important and was the of their time deposits. Each class of primary cause of the enactment of the member banks was required to keep Act of June 21, 1917. By this Act only a part of its reserves in the form member banks were required to main­ of balances with Federal Reserve tain the entire amount of their re­ Banks, another part being kept in the serves in the form of balances with vaults of the member banks, and the Federal Reserve Banks, the total member banks being given the option reserves required against demand de­ to cany the remainder either in their posits being reduced to 13, 10 and 7 own vaults or as balances. This being per cent for member banks in central the state of the law, a large proportion reserve cities, reserve cities, and coun­ of the gold supply of the country try districts, respectively, and the remained in the vaults of member total reserves required against time banks, where it constituted a part of deposits being reduced to 3 per cent the banks’ lawful reserves. for all member banks. The purchases in this country by the belligerent nations resulted in rapid T r u s t P o w e r s o f N a t io n a l B a n k s accretions to this nation’s gold supply After June, 1917, the Federal Re­ and made it seem desirable to have a serve Act was not amended until more effective means of controlling a September 2 6 , 1918. This Act effected possible over-extension of loans based changes in a number of sections but upon these new accretions. On the the only one of general importance was other hand, the possibility of the the revision of Section 11 (k) relative to rapid outflow of this gold at some time trust powers by national banks. in the future made it necessary to Under this section in its original provide for the most effective use of the form the Federal Reserve Board was gold supply, so that withdrawals authorized merely to grant to national might be arranged without forcing any banks “when not in contravention of violent contraction of loans and with­ state or local law, the right to act as out causing any undue disturbance to trustee, executor, administrator, or legitimate business. For the accom­ registrar of stocks and bonds.” Na­ plishment of these ends the mobiliza­ tional banks opening up trust depart­ tion and concentration of gold in the ments, in accordance with authority Federal Reserve Banks seemed the granted to them pursuant to this sec* most effective means. tion, were limited to the exercise of the The first legislative move in this four powers specifically enumerated, direction was the addition by the Act although competing state banks and of Sept ember 7, 1916, of subsection trust companies might be permitted to ll(m) of the Federal Reserve Act exercise other fiduciary powers. Fur­ providing that the Federal Reserve thermore, the la ^ of some states spe­ Board may permit member banks to cifically, or by necessary implication, carry in their Federal Reserve Banks prohibited the exercise of any fiduciary any portion of their reserves theretofore powers by national banks, so that it required by Section 19 of the Federal was “in contravention” of state law Reserve; Act to be carried in their for national banks to exercise such vaults. When this country became powers, although competing state

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Amendments to the F ederal R eserve Act 119 banks might do so under the laws of the such banks from exercising fiduciary state. It became more and more appar­ powers and that it makes no difference ent that national banks were laboring whether such discrimination is at­ under a serious handicap in their com­ tempted by an affirmative prohibition petition with state institutions in the against the exercise of fiduciary power exercise of trust powers, and the amend­ by national banks or by withholding ment of September 26,1918, was designed from the courts the powers to appoint to put national banks upon equal terms national banks in fiduciary capacities. with competing state institutions. To this end the section was amended D is c o u n t L im it a t io n o n S in g l e so as to include among the powers B o r r o w e r which the Federal Reserve Board The Act of March 3, 1919, amending could grant, the power to act as guard­ the Federal Reserve Act, was of im­ ian of estates, assignee, receiver, portance to member banks because committee of estates of lunatics, or in it substituted for the then existing any other fiduciary capacity in which Section 11 (m), which had become competing state banks are permitted obsolete, a new Section 11 (m), author­ to act. A provision was also inserted izing the Federal Reserve Board to to the effect that whenever the laws of permit Federal Reserve Banks to a state permit the exercise of fiduciary discount for member banks the paper powers by competing state corpora­ of a single borrower, up to 20 per cent tions, it shall not be deemed to be in of the member bank’s capital and sur­ contravention of state law for national plus, provided that the paper is banks to exercise such powers. Various secured by United States bonds or notes other provisions were inserted to insure issued since April 24, 1917, or by United competition upon equal terms between States certificates of indebtedness. national banks and competing state Under the terms of Sections 9 and 13 the corporations, including that contained amount of paper of any one borrower in the final paragraph of the section as which a Federal Reserve Bank may amended to the effect that no permit discount for any one member bank is shall be issued to any national bank limited generally to 10 per cent of the having a capital and surplus less than member bank’s capital and surplus. the capital and surplus required by Section 11 (m) was intended as a state law of state institutions exercising temporary measure to assist in the fiduciary powers. absorption by the investing public of The constitutionality of the original the securities issued by the government Section 11 (k) was upheld by the during the War, and according to its Supreme Court of the United States in terms the section ceased to be effective the case of First National Bank v. after December 31, 1920. This process Union Trust Company, 244 U. S. 416, of absorption was not deemed to have in which it was held that Congress had been completed by that date, however, power to grant to national banks and section 11 (m) was re-enacted with authority to act in fiduciary capacities. a slight modification by an Act of Con­ The construction of Section 11 (k) as gress approved February 27, 1921, to amended has been involved in a number be effective until October 31, 1921. of more recent suits. These suits have established that it is beyond the power F o r e ig n B a n k in g A m e n d m e n t s of any state legislature to discriminate Acts were approved September 17, against national banks by prohibiting 1919, December 24, 1919, and June

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 120 T he Annals of the American Academy 14, 1921, all relating to the same general be necessary to facilitate the export of subject matter, namely, the investment goods, wares or merchandise from the by national banks in stock of corpora­ United States or any of its dependencies tions engaged in foreign banking and or insular possessions to any foreign other international financial operations, country.” and the organization and operation of Section 25, as thus amended, in such corporations under Federal law terms authorizes national banks, upon and subject to Federal supervision. the conditions and subject to the After the close of the War it became limitations therein stated, to invest in apparent that the adequate financing the stock of banks or corporations, of of foreign trade would require credit the specified kinds, which are “char­ facilities of a kind which could not tered or incorporated under the laws properly be furnished by banks doing a of the United States or any State strictly commercial banking business, thereof”; but, as a matter of fact, no and tha t such special facilities could be provision was made for the incorpora­ furnished in a large way only by cor­ tion under Federal law of such banks porations with authority to purchase and corporations until the enactment foreign securities and paper represent­ of the so-called Edge Act, approved ing long term credits, and with authority December 24, 1919. to issue and sell to the public their This Act added to the Federal Re­ own debentures secured by such securi­ serve Act a section, designated Section ties and long-term paper. 25 (a), which authorizes the organiza­ The Act of September 7, 1916, had tion of corporations “for the purpose amended Section 25 of the Federal of engaging in international or foreign Reserve Act so as to authorize the banking or other international or larger national banks, that is banks foreign financial operations,” thus with capital and surplus of not less than permitting the Federal incorporation $1,000,000, to invest in the stock of of both types of corporations referred “banks or corporations . . . prin­ to in Section 25, that is, banks doing a cipally engaged in international or commercial banking business, and foreign banking.” There seemed to be corporations issuing debentures and some doubt, however, whether this doing an investment business. The authority to invest in stock of banks or Act also describes the powers of such corporations engaged in banking gave banks and corporations and gives to the right to invest in stock of these the Federal Reserve Board full power debenture-issuing or investment cor­ to examine, supervise and regulate porations. Furthermore, it seemed their operations. desirable for the encouragement of Section 25 (a) as originally enacted such corporations to authorize invest­ required that corporations organized ments in their stock by all national under it should have a capital of not banks, both large and small. Conse­ less than $2,000,000, one-quarter of quently, the Act of September 17, which must be paid in before the 1919, wa s passed authorizing national corporation is authorized to commence banks until January 1, 1921, and business, and the balance in ten per without regard to the amount of their cent installments at the rate of one capital and surplus, to invest in the every two months. This requirement stock of corporations “principally en­ was modified by the Act approved gaged in such phases of international June 14, 1921, which provides, in or foreign financial operations as may effect, that a corporation with an

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Preparation for War and the Liberty Loans 121 authorized capital in excess of $2,000,- Federal Reserve Board, rates of dis­ 000 may apply for the consent of the count for each class of paper. The Federal Reserve Board that such Act of April 13, 1920, added to this excess be paid in on call of the board section language specifically providing of directors, provided, that in all that such rates “may be graduated or events 25 per cent of the total au­ progressed on the basis of the amount thorized capital must be paid in of the advances and discount accom­ before the corporation commences modations extended by the Federal business. Reserve Bank to the borrowing bank.” The purpose of this amendment was, T h e S l id in g S c a l e A m e n d m e n t of course, to give to the Federal Re­ Finally, the Act of April 13, 1920, serve Banks and the Federal Reserve should be mentioned. Subsection (d) Board clear authority to require mem­ of Section 14 of the Federal Reserve ber banks habitually borrowing in Act authorized every Federal Re­ excess of their legitimate requirements serve Bank to establish, subject to to pay higher discount rates for their review and determination by the excess borrowings.

Preparation for War and the Liberty Loans By J. H e r b e r t C a s e Deputy Governor, Federal Reserve Bank of New York T the entrance of the United to war financing, without unduly cur­ States into the World War in tailing the credit needs of commerce 1917 the readjustment of our credit andand industry. financialA system to meet the unusual demands of the Public Treasury de­ P r e p a r a t io n f o r W a r b y R e s e r v e volved in a large measure upon the B a n k s Federal Reserve Banks. The financial The announcement of the entrance activities of the government were soon of the United States into the War, to be extended upon a scale never however, did not find the Federal before equalled by any country and the Reserve Banks wholly unprepared to financial resources of the country were meet the new responsibilities. Pre­ to be assembled and directed toward cautions had been taken early in the one purpose, winning the War. To year to maintain the Federal Reserve accomplish this purpose would require Banks in a strong condition with re­ highly developed sales organizations gard for the disturbed conditions of the which would extend to every county world and the changing economic con­ and village in the country, and. elab­ ditions in this country. This country, orate machinery for distributing the heretofore a debtor country, had be­ securities and collecting and disbursing come a creditor nation; gold was the funds according to the Treasury’s flowing in, and foreign securities were needs. More fundamental, however, being marketed here in increased was the necessity that our banking amounts so as better to permit bellig­ system should be able to meet the erent countries to pay for heavy pur­ enlarged demands for credit incident chases of goods, purchases so heavy, in

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis m T he Annals of the American Academy fact, that there had already developed notes issued; but in the early days of a feverish business activity. A change the System the available volume of in affairs was foreseen and heavy credit eligible paper was limited. Therefore, demands anticipated in the eventuality in order to make the exchange, it was of either our participation in the War necessary to adopt a circuitous method or the conclusion of peace, and the which may be described as follows: The opportunity was taken to fortify and Federal Reserve Bank of New York, strengthen the position of the Federal for example, would pledge $100,000 of Reserve Banks. commercial paper, obtaining in ex­ Unnecessary expansion of credits change Federal Reserve notes, and was checked and a reduction was would then, as the Act authorized it to effected in the holding of such bonds do, deposit gold to retire its liability and warrants as had previously been for the notes and withdraw the paper. acquired primarily for the sake of This operation would be repeated over income, The beginning of April, 1917, and over again until enough Federal found the Federal Reserve Banks in a Reserve notes had been obtained to very strong position; the holdings of meet the demands for new currency. municipal warrants had been reduced Moreover, the gold held as security to small proportions, the total earning for notes could not be used except as a assets of the Federal Reserve Banks 100 per cent fund to provide for their had gradually been reduced from redemption and was held by the Fed­ $221,896,000 to $167,994,000 since the eral Reserve agent specifically for that beginning of the year and the reserve purpose. ratio of the twelve Federal Reserve For the purpose of further strength­ Banks was about 85 per cent. More­ ening the System, the Federal Reserve over, the report of the Comptroller of Board in January, 1917, recommended the Currency and of state banking a number of amendments to the Fed­ authorities showed the banks of the eral Reserve Act, and they were again country to be in a strong condition. transmitted to Congress during April and were adopted on June 21, 1917, I m p o u n d in g G o l d substantially as recommended by the In order that they might be prepared Board. One object sought by these for any emergency, the Federal Reserve amendments was to enable the Federal Banks, realizing their responsibilities Reserve Banks more effectively to con­ as the guardians of the country’s re­ trol the country’s gold supply, and serves, had adopted the policy of therefore the process of issuing notes gradually building up their gold hold­ was simplified by permitting their ings in order that they might be used issuance either against gold or eligible as a basis of credit expansion. There paper, or both, as collateral. The Act was a demandfrom the banks and the as amended not only permitted gold to public for the new clean notes being be pledged directly for notes, but al­ issued by the Federal Reserve Banks, lowed this gold to serve as the reserve and the opportunity was taken to ex­ required against the notes. The effec­ change these notes for gold and gold tiveness of the gold reserves held by certificates. In issuing Federal Reserve the Federal Reserve Banks was greatly notes, however, it was necessary to increased and the adaptability of the deposit as collateral with the Federal System to the changing requirements Reserve agent eligible commercial of the public enhanced. After the paper equal to 100 per cent of the passage of this amendment and our

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis P reparation for W ar and the L iberty L oans 123 entrance into the War, as a part of the accounts with them for the clearing redoubled efforts to impound the and collecting of their checks, country’s gold where it would serve The success of the movement to its most useful purposes, both member accumulate gold is shown in Table I and non-member banks were repeatedly . which gives for three years the country1’s urged to transfer their gold as it ac- monetary stock of gold, the gold hold- cumulated to the Federal Reserve ings of the Federal Reserve Banks and Banks, and the appeal met with a the gold in general circulation, i.e., hearty response. outside the Treasury and the holdings The provisions concerning member of the Federal Reserve Banks:

TABLE I T otal M onetary Stock of G old, G old H oldings of F ederal R e serv e B an k s, G old in Circulation, 1 9 1 7 , 1 9 1 8, 1919

Total monetary Gold holdings of Gold held in Gold in Date stock of gold in Federal Reserve U. S. Treasury Circulation the country Banks

January 1, 1 9 1 7 ...... $2 ,8 6 4 ,842,000 $2 3 3 ,945,000 $7 3 7 ,787,000 $1,8 9 3 ,110,000 January 1 , 1 9 1 8 ...... 3 .0 4 0 .439.000 2 1 2 .231.000 1.5 5 8 .116.000 1,2 7 0 ,092,000 January 1, 1 9 1 9 ...... 3 .0 8 0 .510.000 3 2 7 .239.000 1.9 1 6 .656.000 8 3 6 ,615,000 banks reserves were likewise changed, first by reducing their required reserves M o v e m e n t fo r a G r e a t e r M em b er ­ to 13, 10 and 7 per cent for central s h ip reserve city, reserve city and country As originally provided in the Act, all banks, respectively, and second, by national banks are necessarily members requiring that their entire reserves of the Federal Reserve System but prior should be carried as cash balances with to the entrance of the United States the Federal Reserve Banks. These into the War, the membership of the changes both augmented the gold Federal Reserve Banks included less holdings and increased their efficiency than fifty state banks and trust com­ with a commensurate increase in the panies, and the combined resources of discount power of the Federal Reserve member banks were approximately Banks. Member banks could no longer one-half of the total banking resources count as a part of their legal reserves, of the country. Obviously this was a cash in their own vaults, and the priv­ weak point in the System. In meeting ilege of country banks to keep a part a great credit strain or unusual financial of their reserves with reserve city problems, it was believed that the banks was discontinued several months Federal Reserve Banks would be called prior to the date originally fixed for upon to support indirectly the non­ such discontinuance. These changes member banks through credits granted increased the cash holdings of the to member banks, which, in turn, would Federal Reserve Banks by about aid the state institutions. $250,000,000. At the same time non­ In view of the country’s needs and member banks were encouraged to the part played by the Federal Reserve deposit their cash reserves with the Banks in carrying on the War, it was Federal Reserve Banks and to carry soon generally recognized that a moral

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 124 T h e A nnals of the A m erican A cademy and patriotic obligation rested upon to membership. The progress of the state bankers to support the system. movement towards greater unification Immediately following the declaration of the banking system is shown by the of war there was a decided movement fact that at the end of 1917 the mem­ among: the stronger state institutions bership of state banks and trust com­ toward obtaining membership, a move­ panies had increased to 250 and the ment accompanied by some pressure Board in its Annual Report for that on the part of the larger member banks year estimated that the member banks which were desirous of being relieved represented approximately 75 per cent from the duty of financing these non­ of the commercial banking assets of the member institutions in case of emer­ country. gency. The Federal Reserve Board had adopted a liberal policy in its T h e L ib e r t y L o an s regulations both as to terms of admis­ While the President and Congress sion of state banks and as to their were wrestling with the problem of rights to withdraw at their discretion, reorganizing our banking system, it but there existed among these institu­ had become generally recognized that tions a feeling of uncertainty and a lack the method of handling the govern­ of assurance that these rulings would ment’s finances through the Independ­ be permanent without legislative sanc­ ent Treasury System was antiquated tion. The action of Congress, there­ and the framers of the Federal Reserve fore, in passing the amendment ap­ Act happily inserted a clause authoriz­ proved June 21, 1917, giving to state ing the Secretary of the Treasury to institutions the assurance that they require the Federal Reserve Banks to might become members of the System act as fiscal agents. At the beginning and carry on their activities substan­ of 1916 the Reserve Banks began to act tially as before and, in addition, giving as fiscal agents of the government, but them the definite right to withdraw prior to our entrance into the War, their from the System on six months’ notice, services had been limited to receiving accelerated the movement to obtain deposits of receipts from customs and membership. internal revenue and paying checks and The climax to this movement for a warrants drawn by and on the Treas­ greater membership was a letter from urer of the United States. But when the President on October 13, 1917, to the Treasury was confronted with the state banks and trust companies, in problem of raising and disbursing the which he urged a complete mobiliza­ huge sums necessary to carry on the tion of the banking reserves of the War, the Reserve Banks became the United States in order to meet the chief agencies through which it oper­ great financial requirements imposed ated; they became the administrative upon the country by the War. In this centers of the various Liberty Loan appeal the President said in part: “I committees in addition to performing believe that cooperation on the part of the minor fiscal agency functions. banks is a patriotic duty at this time, Floating the Liberty Loans was the and that membership in the Federal paramount financial undertaking of Reserve; System is a distinct and signif­ the War; it was a task, the accomplish­ icant evidence of patriotism.” Under ment of which necessitated arousing these various incentives and influences public opinion to a realization of the many of the stronger state institutions needs of the government and enlisting filed applications and were admitted the support of every American.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis P reparation for W ar and the L iberty L oans 125 who was the executive in charge of the Se l l in g L ib e r t y B onds immense and very active bond-selling Perhaps I can best explain the organization. methods used in selling government This district, with the exception of bonds by a brief description of the three boroughs of New York City, was organization and work of the Liberty divided into eight subdistricts and a Loan committees in the Second Dis­ member of the distribution organiza­ trict, with which I am most familiar. tion was chairman of each subdistrict. During the First and Second Liberty These subdistrict chairmen formed the Loans, the responsibility for selling connection between their local Liberty bonds in the second district rested Loan committees and the central largely upon volunteers from the vari­ organization. They acted as advisers ous bond houses, banks and corpora­ to the local chairmen and transmitted tions which generously and patrioti­ to them the plans and material pre­ cally contributed the services of their pared at headquarters. The number staffs. It was soon seen, however, that of committees and subcommittees ran one loan was hardly completed before into the thousands. In every com­ preparations for another one were be­ munity an extensive volunteer organi­ ing made, and it was realized that with zation was formed which carried the each successive loan, as the novelty campaign direct to the individual in wore off, a more intensive campaign every branch of human activity. and more unified organization would be To the army of Liberty Loan workers, requisite in order to induce the public men and women through whose energy to do the necessary amount of saving and patriotism the millions of subscrip­ and investing. Consequently a fixed tions were actually obtained, is due a establishment of paid employes was large part of the credit for the complete built up. success of the greatest financial opera­ The central Liberty Loan Committee tion of all time. was the center and directing force A publicity organization was estab­ around which the whole organization lished as a necessary part of the selling revolved. As finally perfected, it con­ campaign. Its mission was to carry to sisted of fifteen members, many of every citizen in the district the message whom were heads of some of the largest of the Liberty Loans and of America. banks and banking houses in New York. This message was carried in a great The chairman of the Committee was variety of ways in the effort to dissemi­ the Governor of the Federal Reserve nate the ideals for which America Bank of New York. The Committee entered the War and to point out the met frequently during the progress of financial needs of the government for the loans and determined the policies winning the War. In the newspapers to be followed and the nature of the and magazines, on the billboards, houses, appeals to be made to the public. lamp-posts, vehicles, flagstaffs, and in One of the members of the Liberty the store and householder’s window, Loan Committee was chairman of the the appeal appeared, showing the distribution organization which had obligation of every American to partic­ direct charge of sales and which was ipate in the work of winning the War. made up of bankers or partners in Frequent Liberty Loan meetings were bond houses. The permanent staff held and many hundred men and women of the distribution committee was delivered the message in public ad­ headed by the director of distribution, dresses.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 126 T h e A nnals of the A m erican A cademy agencies that made possible this great P a r t ia l P a y m e n t s undertaking. One of the most difficult problems from the standpoint of the physical H a n d l in g t h e L o an s handling of subscriptions in New York Up to the time of the First Liberty City grew out of the enormous number Loan, the Federal Reserve Banks had of applications for $50 and $100 bonds been operating with a comparatively from persons who of necessity could small force of clerks, sufficient only to purchase only on the partial payment take care of the comparatively moderate plan. volume of business which the banks had The fact that there were but a rela­ yet been called upon to do. It was tively small number of banks located not until after the First Liberty Loan in the metropolitan area to handle the campaign was actually under way that growing volume of these transactions the officials in charge of the Federal Re­ threatened serious congestion in the serve Banks began to realize that their banks. This situation, however, was forces were totally inadequate to the successfully met by the formation of magnitude of the task for the govern­ the Liberty Loan Association of Banks ment which lay before them. The lead­ and Trust Companies of New York, ing banks and investment houses were which handled, through a coupon book then appealed to for help and responded system, approximately 2,400,000 sepa­ most effectively, willingly lending clerks, rate partial payment accounts in con­ stenographers and even heads of depart­ nection with the Third, Fourth and ments and officers. In the Second Dis­ Victory Liberty Loans. Under this trict the force so loaned consisted of plan, subscribers were allowed to make about 350 men who stayed with the payments at any of about 1,400 pay­ Federal Reserve Bank until they were ment stations designated throughout gradually replaced by a permanent staff the metropolitan district as a conven­ just prior to the Second Liberty Loan. ience to subscribers and as a measure It became necessary to develop of relief to the banks. special accounting systems, and control The Liberty Loan Association, under records in order properly and success­ the direction of the Federal Reserve fully to handle the issue, exchange and Bank of New York, with a staff of ap­ redemption of billions of dollars in proximately 450 clerks operated the government securities. Three separate system through which over 90,000,000 departments were created to perform individual payments were received and this work. One was organized to over 2,000,000 separate bonds were handle all operations in connection delivered. As many as 17,500 people with the issue of bonds; another, to called at the office of the Liberty Loan manage the sale and issue of certificates Association at 19 West 44th Street, of indebtedness; and a third, to handle New York City, during a single day. the collateral pledged by banks to The importance of this undertaking secure government deposits. Some­ is not to be measured merely by the thing of the magnitude of the task number of bonds distributed. Count­ performed by the government bond less individuals could not have pur­ departments of the twelve Federal Re­ chased these securities on any other serve Banks may be seen from Table II than the instalment plan, and much which gives for the five Liberty Loans credit is due the banking institutions the record of subscriptions, allotments, and the hundreds of other cooperating exchanges and conversions.

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TABLE II Subscriptions, A llotm ents, E xchanges a n d C o nversio ns for th e F iv e L iber ty L o ans

Number of temporary Number of Number of bonds ex­ Number of Amount Amount pieces is­ conversions Loan changed for subscribers subscribed allotted sued on (Aug. 3 1 , permanent allotments 1 92 1 ) bonds. (Aug. 3 1 , 1 9 2 1 )

First...... 4 ,000,000 3 .0 3 5 .226.850 1.9 8 9 ,455,550 7 ,513,627 1,322,834 3 ,717,955 Second...... 9 ,400,000 4 .6 1 7 .532.300 3 ,8 0 7 ,865,000 14,938,073 5 ,610,948 12,317,448 Third...... 1 8,308,325 4 .1 7 6 .516.850 4 ,1 75,650,050 2 4 ,406,982 1 4,459,383 Fourth...... 2 2 ,777,680 6 ,9 9 3 ,073,250 6 ,9 6 4 ,581,250 3 3 ,024,445 1 7,405,606 Victory..... 1 1,803,895 5 .2 4 9 .908.300 4 ,4 9 7 ,818,750 17,498,172 636,960

Total...... 6 6 ,289,900 2 4 ,0 7 2 ,257,550 2 1 ,4 3 5 ,370,550 9 7 ,381,299 3 8 ,798,771 1 6,672,363

Other services of magnitude per­ market. On October 31, 1921 there formed by the bond departments of the had been eighty-eight issues of certif­ Federal Reserve Banks were exchanges icates of indebtedness, both loan and of bonds of one denomination for bonds tax, aggregating $32,881,000,000 of of another denomination, payment of which $30,235,000,000 had matured coupons from all issues of Liberty and had been redeemed. Bonds and assistance rendered the Treasury Department in the register­ P a y m e n t b y B oo k C r e d it ing of government bonds by receiving In order further to minimize possi­ coupon bonds for registration and ble disturbances in the money market registered bonds for exchange into the Federal Reserve Banks at the coupon bonds. request of the Secretary of the Treas­ The current needs of the Treasury ury extended to banks the privilege between the periods of bond issues and of paying for their subscriptions to tax receipts were met by frequent Liberty Bonds and certificates of in­ issues of certificates of indebtedness of debtedness by book credit, which sim­ short maturities, which were also ply means creating a deposit in favor handled by the Federal Reserve Bank. of the government .to the amount of These short credits proved to be a the subscriptions. These deposits were popular investment for our banking withdrawn gradually from the banks institutions and were periodically con­ on a pro rata basis as needed by the verted into long-time credits through government. The Federal Reserve the Liberty Loan bond drive and thus banks as fiscal agents were required not were distributed among individual only to keep records of these deposits investors. The issuance of certificates and withdrawals, but also to receive not only supplied a means of securing and hold collateral against them; at current funds but afforded a protection times these deposits amounted to to the money market by distributing about a billion dollars and the Federal the receipts from loans and taxes over Reserve Banks were required to handle periods of time, thus avoiding periodic many billions of dollars of collateral in heavy withdrawals of funds from the connection therewith.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 128 T h e A nnals of the Am erican A cademy port which they felt they could secure Subcommittee o n M o n e y from the Federal Reserve Banks. It The desirability of having an orderly soon became evident that the savings money market was generally recognized of the people in spite of the various and on September 5, just prior to the thrift campaigns would not prove offering of the Second Liberty Loan, a sufficient to meet the tremendous de­ subcommittee of the Liberty Loan mands of the government and that a Committee of the Second District was substantial portion of its borrowings appointed for the purpose of securing would have to be met through bank the most complete cooperation with the credit. The banks supplied this credit government in its financial program both by subscribing to the loans them­ by all the financial interests of the city. selves and by extending credit freely This committee was composed of the to their customers who borrowed in Chairman of the Liberty Loan Com­ order to buy government obligations. mittee, as chairman, and the presidents In fact, in order to insure the of eight of the largest financial institu­ success of the government’s financial tions. measures, banks, life insurance com­ The policy of this subcommittee on panies, general business corporations money was to prevent the absorption and individuals were urged to subscribe of an excess amount of credit by the heavily to the Liberty Loans without security market which might interfere regard to their immediate ability to pay with the orderly marketing of the for them. Preferential discount rates government’s loans, and at the same were established by the Federal Reserve time to assure that sufficient funds Banks in favor of paper secured by would be available to maintain a rea­ United States Government obligations sonably healthy security market in and easy terms of payment promised order to facilitate the successful placing by the individual bank to induce a of Treasury issues. It was considered sufficient flow of funds from the banks of great importance that reasonable and the people to the government. and necessary control be exercised With the cooperation of and by the over the employment of credit in order support they gave to the individual to insure no interference with the finan­ banks of the country, the Federal cial operations of the government in Reserve Banks expanded the credit conducting the war. structure sufficiently to meet the needs This committee enjoyed the fullest of the great emergency. cooperation of the governors and mem­ The “borrow and buy” method of bers of the New York Stock Exchange securing funds leads to inflation, to be who unselfishly placed in the hands of sure, with all its consequent ills, but the subcommittee confidential informa­ any method of financing a war, except tion which would enable the committee solely out of the savings of the people, to take such steps as were calculated would have the same result. War to maintain an orderly money market. financing always involves credit ex­ pansion unless private savings increase M e e t in g th e D e m an d fo r C r e d it commensurate with government re­ The success of the Liberty Loans quirements. Try as we may, we can­ depended in large measure on the in­ not get away from this fact. We may dividual banks throughout the country. safely say that the difference between But the extent of their cooperation in the government’s requirements for turn depended upon the financial sup­ funds, as expressed in the securities

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e A ssum ption of T reasury F unctions 129 sold, and the volume paid for out of The Capital Issues Committee of the savings, represents a good part of the Second District, although in existence recent credit expansion. But it could less than a year, considered formal hardly be expected that private savings applications for issues amounting to would keep pace with the phenomenal $2,069,000,000, besides numberless demands of the government during the cases where no formal applications World War. Certainly no opportunity were filed notwithstanding the fact was neglected to impress upon the that when the Committee was first public the fact that they should save appointed, the submitting of applica­ to the limit. While the Federal Re­ tions covering private issues was serve Banks were conducting a cam­ largely voluntary. paign urging increased borrowing as The record of the Federal Reserve one means of selling Liberty Bonds, Banks during the War, in my judgment, an equally intensive campaign urging is one of splendid achievements. They upon the people the necessity for thrift not only organized and directed the and rigid economy was being conducted sales campaigns and handled the de­ by the same banks under the direction tails of every loan, but also by the of the Liberty Loan and War Savings support given to the individual banks committees, as well as by various other of the country made possible their government agencies. The Food Ad­ hearty cooperation and guaranteed the ministration, for instance, was active success of every loan. It is a cause for in this regard. deep gratification that the banks and Furthermore, a campaign was carried the people through efficient methods on under the direction of the Capital and organization were able to supply Issues Committee for the purpose of the government with such unprece­ conserving capital, labor, materials and dented sums to meet its needs in transportation facilities for their most carrying on the War. That five great effective use in the prosecution of the loans, aggregating more than $21,000,- War. There was a local capital issues 000,000, were rapidly and successfully committee in each district which re­ distributed with hardly a ripple in ported to the central committee on all the financial markets, is of itself a great applications for permission to issue testimonial to the new banking system securities for the purpose of financing which has now been thoroughly tried public or private corporate expenditure. and has successfully met the test.

The Assumption of Treasury Functions by the Federal Reserve Banks B y M u r r a y S. W ild m an Stanford University HE Independent Treasury as it and the downfall of the Second Bank of functioned for three quarters of a the United States. When the Act of century was an institution unique in1841 was passed, followed by the more theT field of public finance. It grew adequate Act of 1846, the need for such out of the general demoralization of the legislation was real and urgent. On banks which followed the panic of 1837 the theory that the establishment and 10

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 130 T h e A n nals of the A m erican A cademy regulation of banks was a duty of the banking system during the Civil War states, the care of Federal funds called should have been followed promptly for a Federal agency. When in 1863 by the abandonment of the Independ­ that theory was abandoned, the justifi­ ent Treasury, but at that particular cation for the subtreasuries passed period the banking business was not away with it; but in twenty years these popular. The needed reform must institutions had become rooted in our wait for another time of great financial political system. stress, and for a reorganization of the banking system on the principle of a A n Outgrown and Objectionable single national cash reserve under System Federal control. As long as a government agency is merely useless it may be left alone. T h e N e w P o l ic y The subtreasury buildings are sub­ The legislative acts which make stantial and impressive features of our definite provision for the new policy cities; they housed several hundred are two. Section 15 of the Federal Re­ officials and clerks, some of whom were serve Act of December 23, 1913, pro­ devoted aids of the administration vided that “the moneys held in the which they served, and it was not general fund of the Treasury . . . enough to show that the maintenance may be deposited in Federal Reserve of this establishment involved a waste Banks, which banks . . . shall act of money. Before the Independent as fiscal agents of the United States Treasury could be abolished it must . . . and disbursements may be be shown as responsible for positive made by checks drawn against such harm. deposits. ” The important ground of objection The other measure is found in the to the subtreasuries was their evil in­ General Appropriation Act of May fluence in the money market. The 29, 1920, which repealed the Act of harm that they did was real and sub­ 1846 in so far as it provided for sub­ stantial, although it was obscure. The treasuries, and required the Secretary great hoard of coin and bullion and of the Treasury to transfer the duties legal tender notes, which was kept of the Assistant Treasurers of the behind massive steel bars and ap­ United States to the Treasurer, the proached through dismal passages be­ mints and assay offices and to the Fed­ tween granite walls, while it impressed eral Reserve Banks. the tourist, would have brought dis­ This Act of 1920 was belated. As may to the borrower of funds if he had intimated above, the officers and the been fully alive to his interest. It was employes of the subtreasuries owed not merely the impounding of cash their appointments to political in­ that called for condemnation of the fluences. The original intention of the system but the recurrence of large pay­ framers of the Federal Reserve Act was ments as well. The alternate collec­ to have the subtreasuries taken over tion and disbursement of the revenues by the Reserve Banks. But, as the brought alternate contraction and ex­ bill developed out of the economic and pansion of the bank reserves and con­ into the political stage in Congress, dis­ sequent changes in discount rates, cussion arose and political force was which, in turn, disturbed the markets asserted. “The moneys held in the for staple products and securities. general fund of the Treasury shall be The establishment of the national deposited” in Section 13 became “may

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e A ssum ption of T reasury F unctions 131 be deposited” and the Secretary of the The concentration of all the redemptions Treasury held the power of decision. of paper currency in Washington; After the Reserve Banks were opened Scarcely less than this can be done for and had been officially designated as the good of the Treasury and the people. fiscal agents of the government, the The effect of the legislation of 1920 Treasury made comparatively little was to make mandatory what had hith­ use of them. Other bank depositaries erto been permissive only. But the were retained and treasury funds were change of policy which these acts re­ placed for “crop-moving purposes” as veal had been slowly evolved out of a in the past. long and unhappy experience in the There was naturally adverse criti­ management of both public and private cism. From official sources came pleas funds. The realization of the proper and explanations that the subtreasuries relation between Treasury and banks were convenient to the public, if not has been growing through a period of indispensable to the government, and many years of nominal independence. the cities where they were located had It was made clearer by every financial their fears aroused that they were to crisis through which the country passed be deprived of something of value to that real independence was impossible. them. The criticism persisted,however. Points of contact between Treasury In the end the matter was referred, in and banks were established for greater March, 1917, to the Bureau of Efficiency convenience and economy in the hand­ for investigation and report to Congress. ling of funds, and a relation of mutual The investigation was thorough and dependence was tacitly recognized. the report, made January 26, 1918, was most competent. The report Relation of Treasurer to Banks concluded as follows: 1865-1913 The Bureau of Efficiency recommends In order to save labor to both offi­ the ultimate abolition of the whole sub­ cials and the public, the subtreasury treasury system. It believes not only that at New York was made a member of the government will save money by this the clearing house on the resumption change, but also that the public will in .the of specie payments, January 1 , 1879. end be better served. It will be appre­ ciated that in making this recommendation In the latter months of the Civil War the Bureau of Efficiency seeks only to and for several years thereafter the ex­ serve the public interest. If, however, tensive collection of internal revenue as the subtreasuries are to be continued, the well as the necessities of postmasters Bureau of Efficiency suggests the following led to the designation of certain na­ as a minimum program: tional banks as United States deposita­ The elimination of the three subtreasur­ ries. When a few years later depleted ies—Baltimore, Philadelphia and Cincin­ bank reserves coincided with surplus nati—which are of no essential value to the revenues in the Treasury, aggravating system; the stringency of the money market, The abolition of the post of assistant treasurer everywhere and the transfer of the government adopted the policy of responsibility to the cashiers; designating other national banks as A reduction in the amount of coin-ex­ special depositaries of public funds. change business undertaken at the sub­ Large sums were paid into these banks treasuries and by the cash room of the for the single purpose of putting idle Treasury in Washington through the charg­ cash to commercial use. ing of a fee for receiving or paying out cur­ From the point of view of economical rent coiji; Use of funds, bank depositors may be

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 132 T h e A nnals of the A m erican A cademy divided into two groups: those who use was exacted and the relation of bank banks for the safe-keeping of money, and depositor was not a normal one. and those who use banks as agencies There were no true active checking for the collection and payment of bills. accounts maintained by the Treasury. The first class is typified by the savings depositor; the second, by the commer­ S itu a tio n 1913-1916 cial depositor. The customary opera­ When the Federal Reserve Act was tions of the savings bank involve the passed in 1913 there were 850 regular receipt and payment of cash while the depositaries and 685 special deposita­ customary operations of the commer­ ries, together holding $76,000,000, and cial bank involve the receipt and pay­ all of the subtreasuries except the one ment of credit instruments. In the at Philadelphia were members of the latter case, cash is required only for a clearing houses of the cities in which reserve, and this reserve is only occa­ they were located. To that extent the sionally brought into use. The result independence of the Treasury had been is that payments in and out of the com­ abandoned. From the establishment mercial bank may vastly exceed the of the Federal Reserve Banks there amount of cash employed. The public was a rapid evolution of a new policy advantage in the use of this bank lies on the part of the Treasury. The in the fact that a given amount of cash, twelve Reserve Banks were designated when used as a reserve against deposits public depositaries some time after or notes, will accomplish much more they were ready for business. In the than when used in payment directly. twelve cities in which these banks were In its use of national or state banks established all other government de­ as public depositaries the Treasury posits were discontinued, except that never assumed the role of a commercial in some cases Federal court funds and depositor in the sense here described. postmasters’ funds remained where Funds were placed in the custody of they had been previously kept. the banks and in due course were But the use of the Federal Reserve ordered to be remitted to the Treasury. Bank as a depositary involved an im­ Ordinary disbursements were made by portant change in the attitude of the warrants drawn on the Treasurer and Treasury in that these banks gave no not by checks drawn on the banks. collateral security for the funds held. These so-called deposits were in reality Moreover, the funds were used by the loans to the banks in so far as the spe­ Treasury as checking accounts; indeed, cial depositaries were concerned. The in some cases the Treasury received banks held the funds for a definite temporary advances of funds against period, paid interest on them and gave an approaching issue of loan certifi­ security for them. The term “de­ cates, and so, for the first time since posit ” was a misnomer and the practice 1846, the Treasury became a bank de­ of placing funds with the special de­ positor and borrower in the common positaries could not be carried out acceptation of these terms. But this without calling forth the charge of change of attitude in 1914 was cautious favoritism. The attitude of the public and incomplete. The major part of toward the banks selected to act as the public revenue and expenditure regular depositaries was somewhat continued as before to pass through different. These were chosen to serve the subtreasuries. At the close of the the convenience of the government, fiscal year, June 30, 1916, the distribu­ but even here special collateral security tion of the general fund was as follows:

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e A ssum ption of T reasury F unctions 133 In Treasury offices...... $130,534,179.97 Not only were these rules applicable In Federal Reserve Banks 113,480,576.00 to receipts from the several Liberty In national bank deposi­ Loans but also to receipts from income taries...... 62,833,774.43 taxes and excess profits taxes, as well as In Philippine Treasury.. 3,968,122.73 from the sale of certificates of indebted­ The foregoing statement takes no ac­ ness which succeeded one another in count of the great trust funds held and rapid succession throughout the War administered by the treasury. and the following year. It was the custom of the Treasury to leave the E ffe c t of t h e W a r credit as long as might be in the local The event which established the depositary banks where it would serve necessity of the new policy was our the business community to the greatest own entry into the World War and the possible degree, and require transfer to great financial operations which en­ government account in the Reserve sued. Soon after war was declared it Bank only as it was actually needed, came to be the general understanding thence to be disbursed by government that our chief contribution to the joint check. These transfers of credit were enterprise would be in the field of fi­ made ratably throughout the country nance and supply. To this end meas­ —a certain percentage of the deposit ures were adopted for the handling of on a specified date. The result of this funds of unprecedented magnitude policy was to make the depositary with the least possible friction. Im­ banks collection agencies of the govern­ mediately on the passage of legislation ment, while the Reserve Bank of each providing for the first Liberty Loan, district became a disbursing agency to steps were taken to correlate the banks a degree unknown in the past. The of the country with the Treasury for effect of these operations on the dis­ most effective team work. By the tribution of the general fund at the middle of November, 1917, the number end of the fiscal year 1917 is shown of national banks designated as public below: depositaries was raised from 518 to In Treasury offices...... $107,662,952.07 1,903. State banks and trust compa­ In Federal Reserve Banks 300,671,632.42 nies were pressed into service and 1,343 In special depositaries. .. 783,922,959.51 of these were named as public deposita­ In regular depositaries... 49,681,738.91 ries. In the Treasury circular of May In Philippine Treasury.. 2,081,409.76 29 it was provided not only that banks so designated should hold on deposit to In order to appreciate the effect of the credit of the government the funds the new policy upon the business of the received by them in the sale of bonds, Federal Reserve Banks it is only neces­ but also that, when the funds should be sary to remember that the ordinary required from the banks, the transfer disbursements of the Treasury rose should be made by a draft against the from a total of 682 millions in 1913 to balance carried by the depositary bank 15,365 millions in 1919. The premises in the Federal Reserve Bank in favor of of the Reserve Banks became scenes of the account of the Treasury in the same the greatest activity. New and larger Federal Reserve Bank. That is to quarters had to be taken, branch banks say, payments on governemnt account were established, and the employed should be made by use of the bank’s personnel grew from 920 at the end of credit and with no reduction of its 1916[to 9,459 at the end of 1919. In stock of cash, the same^ three years the number of

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 134 T h e A nna ls of the Am erican A cademy state banks admitted to membership ury were not confined to banks and grew from 37 to 1,481, and the gold branches in the nine cities in which reserve from 738 millions to 2,063 subtreasuries were to be found. By millions. Treasury circulars issued August 30 and October 19, all the Federal Reserve Changes Under Act of 1920 Banks and their branches were defi­ From this showing it may properly nitely constituted fiscal agencies of the be inferred that the expansion involved United States Treasury. The effect of in the transfer of the duties of assistant this was to extend the facilities for­ treasurers under the mandatory act of merly available in only nine cities to 1920 had already taken place before thirty-five cities at the outset and to as the act was passed. By the terms of many more as might be favored with a the law a period of thirteen months was branch bank in the future. allowed for making the change. The One important duty of the subtreas­ Secretary of the Treasury was permit­ uries had been to account for the ted to assign the duties of the assist­ special trust funds such as the gold ant treasurers to the treasurer, the coin held against United States notes, mints and assay offices and to the gold coin and bullion held against gold Federal Reserve Banks, in such man­ certificates, and the silver dollars held ner as might in his opinion best pro­ against silver certificates. The care mote the public interest. It was pro­ of these funds was transferred to the vided further that the Secretary of the Treasurer of the United States at Treasury might assign to the Federal Washington, to be assisted as may be Reserve Banks such rooms, vaults and desirable by the mints and assay equipment as might be needed, and the offices. employes of the various subtreasuries should have preference in application T r e a s u r y D u t ie s of R ese r v e for positions in other departments of the B a n k s government. However, most of them The new duties now devolving upon were taken over by the Reserve Banks. the Reserve Banks are: In order that the transfer of business The receipt of gold coin and silver might go forward with the least disturb­ dollars for exchange; the receipt of ance of routine the change was made United States notes, Treasury notes, by degrees. The subtreasury at Bos­ gold and silver certificates, subsidiary ton was closed on October 25, 1920, and minor coin for redemption; the ex­ that at Chicago, November 3; New change of various forms and issues of York, December 6; San Francisco, money for others; the cancellation or December 20; New Orleans, January cleaning of currency unfit for circula­ 5, 1921; St. Louis, January 8; Balti­ tion; the receipt from depositary banks more, January 14; Philadelphia, Feb­ of internal revenue, customs, postal ruary 3, and Cincinnati, February 10. and other funds; the receipt of depos­ In the case of six of these cities the its from other than depositary banks work was taken over by the Reserve for money payable to the government Banks located there, but in New Or­ from many sources; the payment of leans, Baltimore and Cincinnati the United States interest coupons; the functions of the subtreasury were payment of checks and warrants drawn transferred to branches of Reserve against the Treasurer, and the receipt Banks located in those cities. But of government funds for transfer to functions of the Independent Treas­ other points.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Scope op B ranches of F ederal R eserve B anks m From what has been said it will be currency and bonds, and for the housing clear that the actual abandonment of of such employes as are required for the the Independent Treasury did not custody and exchange of these bonds. greatly augment the work of the Re­ serve Banks. For example, on the Significance o f th e N e w P o lic y date of transfer the bank at New York The importance of the change there­ already held $11,298,000 of govern­ fore consists not in the magnitude of ment deposits, while the subtreasury in the new enterprise which the Reserve that city, whose normal business was Banks have undertaken but in the far greater than that of any other, held significance of it. For all this coin and only $1,448,000. This sum was all in currency, insofar as it belongs to the coin. The building was turned over to general fund, now becomes a part of the use of the bank under a lease but the banking reserve of the country. the title remains in the government. Large disbursements of government In Minneapolis, where there was no funds will never again stimulate specu­ subtreasury, the assumption of the lation on the stock exchanges nor will new duties was not so easily effected. the collection of a great surplus of The vaults of the bank were not revenue cause a chill in the markets adequate to meet the new demands of staple products. By adjustments and outside vault space was rented. through the Gold Settlement Fund Moreover, the clerical staff was con­ maintained by the Federal Reserve siderably enlarged. In San Francisco Board at Washington the Reserve the entire staff employed in the sub­ Banks will be able to make the largest treasury was taken over by the bank. payments, collections and transfers The buildingwas occupied under a lease without affecting the magnitude of the and is used as a place of storage of coin, reserves at any point.

The Establishment and Scope of Branches of Federal Reserve Banks By E. R. F a n c h e r Governor, Federal Reserve Bank of Cleveland HE establishment and operation plemented by the state banks and of the Federal Reserve Banks and trust companies created by state laws, branches is the direct result of in­all functioning independently or sepa­ tensiveT research and study on the rately. The entire system passed part of economists, financiers and through various so-called panics up to statesmen regarding the inadequacy 1907, at which time the attention of of the banking system of the United the whole country was brought sharply States as developed under the national to the inherent weaknesses of our banking system, established in 1863, banking and credit system, while the remodeled by enactment of Congress crisis of that year compelled definite in 1864, and patched up from time to action along remedial lines. The sys­ time by more than sixty legislative tem had proved inadequate to cope amendments. The national banking with modern commercial needs. It system as it formerly existed, was sup­ failed to supply commerce and in­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 136 T h e A nnals of the A m erican A cademy dustry with adequate credit facilities among the causes which had enabled in normal times, and in times of finan­ the government to collect with such cial stress it broke down completely, facility and with so few losses, the spreading disaster and ruin throughout great revenue derived from imports. the land. The numerous state banks might afford The Aldrich-Vreeland Currency Act, considerable assistance to the govern­ approved by the President May 30, ment in its fiscal operations, but they 1908, in providing for emergency could not effect the transmission of currency based upon certain classes public funds with the same facility or of securities other than government to the same extent as the Bank of the bonds, authorized the uniting of ten or United States through its several more national banks in any one city or branches. community into a “National Currency The Second United States Bank, Association.” It may be stated that chartered in 1816, commenced opera­ that law was the beginning of the tions in January, 1817, and by October, regional idea, and of its later develop­ 1817, nineteen branches in fourteen ment into the thought of additional states had been designated, and, services and conveniences to areas, com­ subsequently, eight other branches or munities or centers, which has brought agencies were established. about establishment of branches of The establishment of branches was Federal Reserve Banks. The National the most characteristic and the most Monetary Commission was also au­ essential feature of the plan of the thorized by the Aldrich-Vreeland Act. First and Second Banks of the United States. Without them they would B r a n c h e s of F ir s t a n d Second have been virtually useless to the B a n k s of th e U n it e d Sta t e s government, unable to exercise an Alexander Hamilton’s original plan efficient control over the state banks, for the First Bank of the United and incapable of furnishing accom­ States, organized in Philadelphia in modations in discounts and exchange December, 1791, did not contem­ throughout a country unprovided with plate the establishment of branches; a note circulation of uniform value, but early in 1792 branches were opened or with any extended currency. in New York, Boston, Baltimore and The general control of the branches Charlestown, and later, additional ones was almost wholly in the power of the were opened at Norfolk, Savannah, central directorate through its author­ Washington and New Orleans, making ity to appoint the local directors and to in all, eight branches. create by-laws for the branches, the In stating the advantages derived election of the president being the one from the bank by the government, important privilege left to the un­ Secretary of the Treasury Gallatin controlled will of the branch direc­ laid stress upon the safe-keeping and torates. It was, of course, essential transmission of the public funds, the to the safety of the bank, to the economical collection of the revenue, security of its operations and to the and the aid furnished to the govern­ unity of its policy, that the control of ment in the matter of loans. The the central board over the branch punctuality of payments introduced by officials and directors should be real the banking system, and the facilities and effective. afforded by the bank to importers Both the First and Second Banks of indebted for revenue bonds, were the United States became involved in

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis S cope of B ranches of F ederal R eserve B a nk s political strife without any intention of the bill suggested by the National their own and in spite of their earnest Monetary Commission, as a result of efforts to avoid such entanglements. its investigations, provision was in­ These two central banks were very cluded for a central reserve association, largely government instrumentalities; for at least fifteen branches of the out of them grew the independent parent association and for further dis­ treasury system established in 1846, tricts when necessity might arise. All and from that time until the Civil War through the studies of the National the government made its collections Monetary Commission and in the and disbursements entirely in specie various important writings of financiers and kept its funds in the Treasury and and economists, the necessity for its branches, called subtreasuries. Im­ adequate accommodations in industrial portant changes were made in this communities or centers, the interest of system during and after the war, which might demand direct personal bringing the Treasury into close rela­ contact with properly accredited rep­ tions again with the banking and resentatives of the parent institution, credit system of the country. was recognized.

T he I n d e p e n d e n t T r e a s u r y P o p u la r O p p o s it io n to C e n t r a l a n d I ts B ran c h e s B a n k s The national banking system, es­ Throughout the history of the tablished in 1863, grew out of the country, it is apparent that the people financial difficulties of the Civil War. have been opposed to placing in one After the adoption of the independent single institution the financial power treasury system in 1846, the govern­ which a. central bank might exercise. ment had no relation with the banks This was manifest in the failures of of the country, keeping its funds with both the First Bank of the United the various subtreasuries established States and the Second United States in several leading cities. When the Bank to secure charter renewal; and war broke out the government was the antagonism which was most ap­ compelled to turn to the banks for parent during the administrations of help. Instead of meeting the war President Jackson continued and as­ expenses by taxation, it resorted to serted itself in the preparation of the loans, which could be obtained quickly legislation that finally resulted in the only from the banks. enactment of the Federal Reserve Act, The policy of separating the fiscal approved by the President, December activities of the government from banks 23, 1913. and banking—which was adopted with Division of the United States into the establishment of the independ­ regions, as begun in the formation of ent treasury system—was discontinued the Currency Association, prevailed in when the national banking system the Act; and the establishment of not came into existence, and thereafter the exceeding twelve independent Federal subtreasuries became largely deposi­ Reserve Banks with power in each of taries of surplus coin, distributers the banks to establish and operate of currency and coin, and redemption branches was provided. agencies. The original law, Section 3 of the Under the Aldrich-Vreeland Act Act, was as follows: there were formed no less than eighteen Each Federal Reserve Bank shall es­ national currency associations, and in tablish branch banks within the Federal

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 138 T h e A nnals of the A m erican A cademy Reserve district in which it is located and area, whose territory was an economic may do so in the district of any Federal unit and whose member banks naturally Reserve Bank which may have been stood in close relationship to one another. suspended. Such branches shall be oper­ The suggestion also amounts to a rejection ated by a board of directors under rules of any plan for subdividing a district com­ and regulations approved by the Federal pletely into branch areas while the District Reserve Board. Directors of branch banks Reserve Bank itself exercised no distinct shall possess the same qualifications as banking functions except those of over­ directors of the Federal Reserve Banks. sight. It is believed that this latter plan Four of said directors shall be selected by would not be desirable, but that in every the Reserve Bank and three by the Federal district there should be a strong independ­ Reserve Board, and they shall hold office ent Reserve Bank organization perform­ during the pleasure, respectively, of the ing actual banking functions and directly parent bank and the Federal Reserve rediscounting the paper of a considerable Board. The Reserve Bank shall designate number of the member banks included one of the directors as manager. within such district. The Organization Committee, pro­ In responding to criticism of the vided in the Act, gave consideration Organization Committee in fixing Fed­ to these provisions and reported at eral Reserve districts and designating length regarding the development of Federal Reserve cities, the Honorable branches. The final recommendations Carter Glass, then Chairman of the of the Committee, in part, were as House Committee on Banking and follows: Currency, stated early in 1914: It is recommended that in the event of With my knowledge of facts and study of the establishment of such branches they the situation, covering a period of sixteen be assigned a proportionate capitalization months, I would not, had I the power, based upon the capitalization and surplus make more than a single change in the of the member banks included within the districts as defined by the Organization territory assigned to the branch. This, Committee, and that change I do not care however, should be only a tentative matter, to point out, as no good could be expected and such assignment of resources should from any suggestion that now might be be merely to bridge over the period during made. Referring again to the relative which it is found from experience about importance of the branch banks and the what amount of paper will on the average regional Reserve Banks, in the practical be presented by the banks in each branch operation of the system, no business center district. When sufficient experience has will lose its identity nor have its business been had to determine this point the re­ relations seriously interrupted. The bank­ sources to be employed should be distrib­ ing operations and the commercial trans­ uted among the branches in proportion to actions of any given territory will be practi­ the quantity of paper presented on the cally maintained as they exist today, for average by the member bank in each such the reason that such territory will transact branch district. its\business with the branch bank, if more It is recommended further that the convenient than with the regional reserve parent bank of the district shall in every bank, so that there is no earthly reason case retain for itself a substantial portion why any large financial or commercial of the district as a territory from which community should be in the least degree paper shall be directly presented for re­ uneasy over the prospect of losing any discount. This would mean simply that business which it now commands. the branch districts would be established whenever there was a special need for them E a r l y D isadvantages in a particular part of a district which In the original Federal Reserve Act, presented a clear cut, independent trading the mobilization in the Federal Reserve

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis S cope of B ranches of F ederal R eserve B ank s 139 Banks of reserves of member banks the like, and with a full staff of salaried extended over a period of thirty-six officials, will be too heavy an expense for months. In carrying these provisions most of the reserve banks, yet, that valu­ able service could be performed by local of the law—as long as they existed— offices of the several banks in not a few into effect, it became apparent that places. The Board has, therefore, had the cities in which Federal Reserve under consideration the question whether Banks were located had an advantage establishing local agencies might not meet over cities of former equal standing, the requirements of the case better than especially in regard to accounts of the more fully organized branch office. country banks, and the advantage of Competent legal opinion is to the effect correspondent banks in Federal Re­ that the creation of such local offices is serve cities was further accentuated permissible under the terms of the law, and when the early steps in the par collec­ the Board believes that it may prove tion of checks were taken. At first, practicable to meet banking necessities in banks in the other cities endeavored many sections of the country by this to offset the advantage by main­ means. tenance of excess reserves in the The entrance of the United States Federal Reserve Banks and agreement into the Great War in April, 1917, for immediate charging against such forced upon the Federal Reserve Banks reserves of their checks by the Federal greatly increased responsibilities and Reserve Banks. This proved both duties. By reason of the govern­ burdensome and unsatisfactory. ment’s financial requirements and the In its Second Annual Report to assistance rendered to member banks Congress, for the year 1915, the to enable them to meet obligations and Federal Reserve Board states: give the wonderful support accorded by The question of branches of Federal the banks to the nation’s demands, the Reserve Banks has received careful at­ Federal Reserve Banks were enabled tention during the past year. There has to show substantial earnings, and, on been intimation from several quarters that account of the favorable position thus the establishment of a branch at a given attained, the early establishment of point would be acceptable to the banks of branches was possible. that place. Only in one instance—that of The section of the Act relating to New Orleans—did the Board receive a def­ branches was amended in June, 1917, inite request from a Federal Reserve Bank to establish a branch. Believing that New and in its Fourth Annual Report, the Orleans and the adjacent territory could Federal Reserve Board made the fol­ make advantageous use of this additional lowing statements: banking machinery, the Board authorized As originally enacted, this section pro­ the establishment of a branch of the vided that each Federal Reserve Bank Federal Reserve Bank of Atlanta to be “shall establish branch banks ” to be “ oper­ located in New Orleans, and this branch ated by a board of directors under rules was opened for business on September 10, and regulations approved by the Federal 1915. Operations at the New Orleans Reserve Board,” and provided also that branch have proceeded satisfactorily, and there be seven directors having the same the institution has been of considerable use qualifications as directors of Federal Re­ to the local banks. The branch is already serve Banks. The section as now amended more than self-supporting. provides that the Federal Reserve Board Investigation and experience have seemed may permit or require any Federal Re­ to show that, at least for some years to serve Bank to establish branches within its come, the organization of branches with district, and that such branches, subject to completely equipped offices, vaults, and such rules and regulations as the Federal

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 140 T h e A n nals of the A m erican A cademy Reserve Board may prescribe, shall be tion of the Act that they shall exist operated under the supervision of a board “with due regard to the convenience of directors to consist of not more than seven or less than three directors, of whom and customary course of business.” a majority of one shall be appointed by the The actual operation of all the branches Federal Reserve Bank of the district and in the final results is subsidiary to the the remaining directors by the Federal parent banks and forms part of their Reserve Board. functions. The figures of the branches During the year branches have been are embraced in the reports and state­ established at Omaha by the Federal Re­ ments of their parent. Matters of serve Bank of Kansas City, at Louisville, policy and questions of operation are by the Federal Reserve Bank of St. Louis, determined by the head offices in the and at Portland, Seattle and Spokane, by respective districts. the Federal Reserve Bank of San Francisco, and are now in operation. The Board has, By reason of remoteness from the in addition, authorized the establishment head office, some of the branches of branches at Pittsburgh and Cincinnati by maintain separate books and perform the Federal Reserve Bank of Cleveland, at practically all of the functions of the Detroit, by the Federal Reserve Bank of parent bank in relations with member Chicago, at Baltimore, by the Federal Re­ banks in their assigned zones or terri­ serve Bank of Richmond, and at Denver tories. In others, a method prevails by the Federal Reserve Bank of Kansas by which all figures and accounts are City. It is expected that all of these maintained in the head office through branches will begin business at an early private telegraphic connections with date. The policy of the Board in the establish­ the branches and under a satisfac­ ment of these new branches has been to tory system of communication and recognize the unity and paramount re­ accounting. sponsibility of the Federal Reserve Bank, while extending full facilities to the banks F u n c tio n s of B r a n c h B a n k s in the territory served by the branch. By The powers and functions exercised avoiding duplications in bookkeeping, and by the branches of the Federal Reserve by a consolidated control of accounts at Banks embrace: the Federal Reserve Bank, it is expected (1) Receiving deposits of member that branches can be operated at a com­ banks and the government; paratively small expense. (2) Paying out currency and coin In the organization of the branches to banks; in the various Federal Reserve dis­ (3) Receiving from member banks tricts, the parent banks have retained applications for loans and discounts definite portions of their districts in and tenders of bills eligible for pur­ which they exercise distinct banking chase by Federal Reserve Banks, and functions for member banks, and have examining all paper presented for delegated to the branches like func­ technical defects, generally passing tions for member banks in territories immediate credit for proceeds subject or areas assigned to such branches. to final review by the head office; (4) Operating city and country col­ B r an c h e s A r e Su b s id ia r y lection departments for handling of There are now in operation twenty- bonds, coupons, notes, trade accept­ four branches of the twelve Federal ances, sight, time, and documentary Reserve Banks. These branches have drafts, insurance and railroad vouchers, all been located in the several districts and certificates of deposits; in harmony with the underlying direc­ (5) Operating a transit department

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis S cope of B ranches of F ederal R eserve B a nk s 141 for handling checks and bank drafts in the centers to send direct to the and other cash items payable on de­ proper Federal Reserve Bank or mand; branch all such items payable in its (6) Clearing of checks and drafts respectively allotted areas. and other clearable items payable It is apparent that, in every practi­ through clearing houses in cities cable way, the banks in cities and areas wherein branches are located; wherein branches of Federal Reserve (7) Making wire transfers to and Banks are located are accorded all the from other Federal Reserve and branch facilities and services of the System in cities for member banks in branch like manner as those in designated territory; Federal Reserve cities. Capital stock (8) Converting, exchanging and in­ adjustments and dividend payments terchanging all issues of Liberty Loan naturally appertain to the head offices, bonds, Victory Liberty Loan notes and and these functions are necessarily re­ certificates of indebtedness; served, but otherwise the branches (9) Redemption of United States render available in their cities and securities, coupons, War Savings Cer­ assigned areas all Federal Reserve tificates and stamps. banking powers. In the establishment of branches of A notable instance of the use to the Federal Reserve Banks, efforts which these facilities have extended is were made to give to those communi­ that, in one of the leading branches ties wherein the branches are located during the calendar year, 1920, over the fullest measure of Reserve Bank $510,000,000 in currency was de­ service demanded by banking and posited, and approximately $490,000,- business conditions within limits of 000 paid out and about 14,000,000 reasonable expenditure and avoiding checks, aggregating nearly $9,000,- unnecessary duplication of work. In 000,000, were handled by this one each branch there is maintained an branch. adequate currency supply to meet the needs of the community. The sub­ B r a n c h B a n k s G r o w in g R a p id l y treasuries were discontinued, prior to In many of the locations the facili­ July 1, 1921, under an amendment by ties demanded and accorded have Congress to the organic law, and the already assumed such magnitude and functions and duties of those offices importance as to require the services have been undertaken also by the of large clerical staffs occupying con­ Federal Reserve Banks and branches. siderable office space, and in not a few instances, already, the branches have B r an c h e s A id C o lle c tio n s been compelled to acquire separate The branches have been notably buildings or to plan independent effective in the collection operations quarters in order to secure proper as developed in the Federal Reserve safeguards and efficient handling of the System. Checks and drafts and other volume of work passing through their collection items upon banks in a given hands. Some of the Federal Reserve branch or parent bank territory are Banks now have under consideration sent directly to the branch or bank necessary office location of branches; serving that territory by all other some branches now already established Federal Reserve Banks and branches, are being placed in their own buildings, and arrangements have been perfected the property of the parent banks. It permitting the larger member banks is manifest that considerable expendi­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 142 T he Annals of the American A cademy ture by the Federal Reserve Banks other branches to meet the demands for office buildings and vaults for or requirements of business com­ branches is necessary in order to con­ munities or industrial centers. These duct the work properly. situations will be met and provided for It is not improbable that in the and any additional functions which future development and progress of may be properly assumed by the the Federal Reserve System, there will Federal Reserve Banks will likewise arise the necessity for the location of be allotted to the branches.

Curves of Expansion and Contraction, 1919-1921 By A. C. M i l l e r Federal Reserve Board, Washington, D. C. HE economic vicissitudes through credit caused expansion or contraction which the country has passed dur­ of business and the rise and fall of ing the past year have brought toprices, or whether the movement of Teveryone a vivid and memorable ex­credit was determined by the move­ perience of the actualities of expansion ments of business and prices. The and contraction and have made the correlation of the business and finan­ study of the conditions which eventu­ cial factors involved in the economic ate in these violent alternations of the developments of the past three years curves of business and credit, a matter presents too complex a problem to be of profound practical importance* undertaken within the limits of this War, and its immediate aftermath of paper. For the assistance of any who business inflations, made the credit are ambitious to penetrate the eco­ expansion. After-war readjustment, nomic mysteries of recent expansion with its inevitable liquidation, has and contraction, there is, nevertheless, made the credit contraction. So much appended to this article a collection of is already clear from the outside point data covering most of the determi­ of view and is now admitted by most nable factors involved in the problem. fair-minded people. But what is fur­ In order to make the fluctuations in ther revealed and how does the matter the different items comparable, they look when the operations of the bank­ are expressed in the form of index ing system are viewed from the nearby, numbers based on the 1919 average. or Federal Reserve, point of view? A second table shows the absolute For this whole recent experience raises figures upon which the index numbers some questions of great moment with of banking are based. regard to the functioning of the coun­ try’s new credit mechanism. M ea s u r e m e n t of E x p a n s io n a n d It is not the purpose of this discus­ C o n tr a c t io n sion to go into the economics of the The object of the present discussion expansion and contraction of 1919- is to ascertain what light recent ex­ 1921. It is not at all concerned with perience throws on the question as to questions of economic causation. No whether the Reserve System possesses attempt will be made to determine a sensitive and accurate indicator of whether expansion or contraction of changes in the credit and business

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Federal http://fraser.stlouisfed.org/ Digitized Reserve for

FRASER ft So 2 . GO 0 rn

Bank % H i I S.® §-.5* s * BANK CREDIT, GOLD RESERVES AND VOLUME OF BUSINESS of i § & s ^ 1919 -1921

St. If 3M - cL Cgp "5 s > r INDEX NUMBERS; 1919 AVERAGE = 100)

Louis o w ft «+ 2 < o S- * i w § J PER PER hiJ o• h22 P s- CENT CENT r+* fc* 150 150 g-Cf§ h 8 o •§ C ft ft M l s urves ft 140 140 ft 3 .. *d u- o ft* P< ft •"* >■* 130 ■ <**•*..... 130 a 5* \ of cs k 120 s ~ 120 E OQ *— *£- I-£ !„ y - - ft S s § ...... B “5S 5S-S P — too £ £ X ? • _ 100 ®. x *'''*•« \ E'5-Bw ^ ft ft £ {3- -*P \ \ 3 iL$ ST IT 7 ft § 90 1 P .... ------\ 9 0 •• •• 80 80 and \ C 70 \ 70

% n io t c a tr n o 60 60

50 50

4 0 40 fSAND INVESTMENTS OF REPORTING MEMBER BANKS 30 30 HOLDINGS OF F. R. BA N K S 20 —.eou) RESERVES OF F. R. BANKS 20

10 10

...... J. F. M. A. M. J. J. A. S. 0. N. D.' J. F. M. A. M. J. J. A. S. 0. N. D.1 J. F. M. A. M. J. J. A. S. 0. N. 0. g B- 1919 1920 1921 -S'S* FSS -ftls CO 144 T he Annals of the American Academy changes in the volume of the country’s year. Business recession was much business.2 in evidence and gained in momentum The volume of business in general after mid-summer, 1920. In the first depends on four factors, or, in mathe­ quarter of 1921 the reaction reached matical language, is a function of four the stage of acute liquidation. There­ variables: (1) physical volume of pro­ after business pursued a steadier duction; (2) price level; (3) activity of course. This period of reaction and trade (rapidity of turnover); and (4) liquidation was marked by dimin­ speculative and other transactions in ished physical volume of production securities, exchange, etc. A change in (for manufactures) after mid-summer, any one of these factors affects the total 1920, and by the drop of wholesale volume of business, and this, in turn, prices. The index for manufactures affects the total volume of credit re­ declined from 102.3 in July to 77.9 quired. In any exhaustive analysis of in December, 1920, and to 68.5 in the business or economic situation to July, 1921. The price index declined ascertain what factors are affecting the from 123.6 in July to 89.2 in December, demand for credit facilities, or, let us 1920, and 69.8 in July, 1921. These say, the expansion or contraction of changes in the business situation, 1919- credit, careful attention must always, 1921—that is, the rise and the fall in of course, be given to variations in any the volume of business transactions— of the elements affecting the volume of are clearly reflected in the curve of business. business. Its trends are unmistakable. How well are these changes in the Changes in the Business Situation, business situation—in brief, the ex­ 1919-1920 pansion and contraction of the volume Beginning about midyear, 1919, and of business—reflected in the curves of extending to the end of the year, there credit, first, that of the member banks, was a pronounced expansion of busi­ and second, that of the Federal Re­ ness accompanied by great speculative serve Banks? activity involving commodities as well as securities. Increased activity of M e m b er B a n k C r e d it C u r v e of business (rapidity of turnover) and E x p a n s io n a n d C o n t r a c t io n rise of prices were the important factors The member bank credit curve re­ in this development. The index of the flects pretty faithfully the business ex­ physical volume of production (for pansion which went on in the second manufactures) shows no noteworthy half of the year 1919, and again, the change during this interval. liquidation which was in process in the Economic reaction set in early in early part of the year 1921. It will be 1920, and continued throughout the noticed that the liquidation of the loan * As measured by debits to individual accounts account of the reporting member banks in banks in about 150 leading clearing-house centers. In order to eliminate short-time in the first six months of the year 1921 fluctuations due to the difference in the number approximately cancels the expansion of business days in a month, to mid-month and of the loan account of these banks in end of the month payments, and to Treasury the second six months of the year 1919. operations in connection with the quarterly in­ Through the year 1920, however, it will stallment of income taxes, the volume of business curve on the chart has been smoothed by means be noticed that the curve of credit of of a moving average which shows for each month the member banks shows a different the average volume of business for the month trend from the curve of business. The g,nd the two preceding months. business recession which was in process

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Curves of Expansion and Contraction 145 in 1920 is not at all reflected in the upward, trend. Both curves of credit member bank curve of credit. There in the critical year 1920, therefore, was no contraction of credit until the followed a different trend from the last quarter of the year. On the con­ curve of business, but it is noteworthy trary, the banks were expanding their that the difference is much more pro­ accommodation throughout the year nounced in the Reserve Banks’ curve and until after the crop-moving season than in the member banks’ curve. was over. Agriculture was in distress, while business was in the midst of the T h e G old I n f l u x a n d R eserve crisis of readjustment and needed as­ B a n k C r e d it C u r v e sistance in effecting the transition from There still remains to be considered the period of expansion through the the curve of gold reserves. The sharp period of liquidation. That assistance and prolonged drop in the Reserve was being extended by the banks, as Bank curve of credit through the year both of the curves of credit clearly 1921 and the liquidation which it re­ indicate, and thus was liquidation of flects cannot be understood without business moderated and kept orderly reference to the great influx of gold into by comparison with what it would have the country and into the Federal been, had it not been for the steadying Reserve Banks, which has been in and easing influence of our new credit process during the past twelve months. machinery. Reference to the chart brings out the opposite movements in these two sig­ T h e R eserve B a n k C u r v e of C r e d it nificant and related curves. Reference Turning to the Reserve Bank curve to the index numbers shows that the of credit, it appears that the curve of index of the Federal Reserve System’s credit of the Federal Reserve Banks gold holdings rose from 94 in Oct6ber, parallels the curve of business more 1920, to 130 in October, 1921, while the closely than does the curve of credit of index of bill holdings declined from the member banks, both in the period 137 in October, 1920, to 63 in October, of rapid expansion in 1919 and in the 1921. Over 45 per cent of the liquida­ period of acute liquidation in 1921. tion of the loan account of the Federal It will be noticed on the chart that the Reserve System, it appears, may be at­ Reserve Bank curve of credit in the tributed to the increase of its gold hold­ period under review twice cuts through ings. The influence to be attributed to the member bank curve of credit— the gold factor in Federal Reserve once in October, 1919, on the upward Bank liquidation is still greater in the swing of business, and again in April, case of the Federal Reserve Bank of 1921, on the downward swing of busi­ New York, which has been the chief ness. By comparison with the mem­ recipient of the gold flowing from ber bank curve, the ascent of the Re­ Europe to our shores. The index of serve Bank curve was more pronounced bill holdings for that bank fell from 126 on the rise, as was also its descent on in October, 1920, to 37 in October, the fall. On the other hand, through­ 1921. Its gold index for the same out nearly the whole of 1920, when the period shows a rise from 74 to 156. business curve was showing a decided The gold factor is thus seen to account downward trend (until the last quarter, for over 73 per cent of the liquidation when a slight rise is shown due to sea­ experienced by the loan account of the sonal influences) the Reserve Bank Federal Reserve Bank of New York. curve of credit showed an opposite, or The great stream of gold which has xi

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 146 T he A nnals of the American A cademt poured into the United States from some transitory in character. It will Europe during the past year has come be recalled that the loan and invest­ in liquidation of foreign indebtedness ment account of the banks of the coun­ to us, and has been turned over by try was greatly swollen during the War member banks to the Federal Reserve by heavy investments in Liberty bonds Banks in liquidation of their own in­ and Certificates of Indebtedness, and debtedness. The pronounced and con­ by accomodation granted subscribers tinuous downward trend of the Re­ to government war loan issues. After serve Bank loan curve during the past the War, the process was reversed. year is therefore seen to be due largely There has been constant liquidation of to foreign liquidation. The course of bank holdings of government securities business shows considerable steadiness and of loans collateraled by such securi­ after the first quarter of 1921, and the ties. Reporting member banks’ hold­ member bank curve of credit, after the ings of government securities dropped second quarter; but the Reserve Bank from 3,083 millions in May, 1919, to curve of credit continues its downward 1,938 millions in January, 1920, and course in 1921 without abatement in 1,318 millions in January, 1921. Fig­ quick and close response to the con­ ures of holdings of paper secured by tinuously upward course of the curve of government securities are not available gold reserves. As an indicator of the until December, 1919, when they degree and rapidity of domestic liqui­ amounted to 1,337 millions. From dation, the Reserve Bank curve of this point they declined to 899 millions credit is misleading, owing to the dis­ in December, 1920, and 577 millions in turbing influence of the gold factor. October, 1921. The liquidation in the loan and investment account of the T h e R ese r v e B a n k C u r v e of C r e d it member banks from these sources has t h e M ore Se n s it iv e I n d ic a t o r therefore been very considerable. But of C r e d it C h a n g e it does not appear to be reflected in the Comparing the two curves of credit movement of the member bank curve with one another, it is clear that while of credit in 1920. That curve was both curves are influenced by the same ascending in spite of liquidation from changes in the business situation, their these sources. But had it not been for response is not the same. A glance at this liquidation, it is altogether reason­ the chart brings out the fact that the able to assume that it would have Reserve Bank curve moves very much ascended still more. The credit thus more readily and markedly than the released by liquidation of war loan secu­ member bank curve. The member rities and paper was apparently being bank curve appears flat by comparison used to expand the commercial and with the Reserve Bank curve, and gives speculative loan accounts of the banks.3 a less lively impression of the business and credit developments and changes 3 Something similar occurred in the early autumn of 1919, when it will be noticed the which were in process. What is the member bank curve was rising, while the Re­ explanation of the difference, and which serve curve was declining, the banking expansion of the two curves is the better index of then in process being able to proceed without expansion and contraction? increased borrowings from Federal Reserve The relative flatness of the member Banks. This is explained by the fact that the floating debt of the government was reduced at bank credit curve during the year 1920 this time by almost 5 0 0 millions of dollars, the as compared with the Reserve Bank banks using the funds thus made available to curve is due to several circumstances, them for the expansion of their commercial loans.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Curves of E xpansion and Contraction 147 When we come to the period of thermore, the Federal Reserve Bank liquidation in the autumn of 1920 and loan curve, as has already been pointed the following winter, there appeared an out, represents in a peculiar degree the influence of an opposite character to liquidating effect on the Federal Re­ that just described—namely, the so- serve loan account of the huge influx of called “frozen credit.” By “frozen gold which has been continuous during credit” is meant credit that has con­ the past twelve months. Besides these tinued its existence beyojid the time transitory influences which have helped when the transactions which gave rise to give the member bank loan curve a to the credit should normally have relatively flat character, there is the liquidated themselves. It is made up additional important and regular in­ of credits which have not been liqui­ fluence exercised by the far greater dated because the transactions under­ volume of member bank loans com­ lying the credits have not been able to pared with Reserve Bank loans. Ow­ rim their course and liquidate them­ ing to the fact that the base figure is selves. It is well known that large much larger for member banks than for volumes of goods produced last year Reserve Banks, the same change in have been carried by the producers for absolute amounts will result in a much lack of satisfactory markets. Prices larger percentage change and, con­ were falling, markets were collapsing, sequently, in a much steeper movement and there was congestion of goods at in a Reserve Bank curve than in a mem­ points of primary production and dis­ ber bank curve. But this arithmetical tribution. The owners of these goods fact does not fully explain the discrep­ had to be “carried.” There is no ancy. There is a further reason of an means of approximating the amount of economic character to be noted in a these frozen credits, but there is reason study of the curves of expansion and to believe that they constitute a very contraction. substantial fraction of the total loans The great bulk of the loans of the and discounts carried by the commer­ member banks at any time represents cial banks of the country. loans incident to the ordinary volume The member bank loan curve shows and requirements of business, and resistance to the forces of liquidation. It was this retarded or “orderly” liqui­ 29, 1921) the increase in the loans of the member dation which kept the curve from de­ banks was 6.7 times as great as the increase in scending as swiftly as it otherwise the discounts of the Federal Reserve Banks, would have if it had been influenced while during the following year the decrease in the loans was only 2.3 times as large as the merely by the volume of current busi­ decrease in Federal Reserve Bank discounts. ness transactions. Moreover, the li­ For the reporting member banks, for which data quidating power of a dollar paid in by on more significant dates are available (July a member bank to its Reserve Bank in 25, 1919, before the speculative expansion began, a period of liquidation appears, on the October 15, 1920, when the peak was reached, and November 2, 1921, the latest date for which basis of the past two years, to be very data are available) their investment and loan much less than the credit-supporting account increased 3.2 times as fast during the power of a dollar loaned by a Federal period of expansion as their borrowings from the Reserve Bank to a member bank in a Federal Reserve Banks, while during the period of liquidation the reduction in the investment period of active expansion.4 And fur- and loan account of the reporting member banks 4 During the period of expansion between 1919 is 1.6 times as large as the corresponding reduc­ and 1920 (dates for which information is avail­ tion in their borrowings from Federal Reserve able being June 27, 1919, June 25, 1920, and June Banks.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 148 T he Annals of the American Academy exercises, even in times of marked ments will result in a marked reduction changes in the business situation, a of borrowings from Federal Reserve steadying influence on the member Banks. The Reserve Bank curve con­ bank credit curve. The situation of sequently reflects movement, change the Reserve Banks is different. Their —the more or less of credit required— loan account does not reflect the normal and not the actual total volume of volume of credit in use. Under normal credit in use by business. On a rela­ conditions, their operations are not tive basis the Reserve Bank curve has large. It is not the absolute amount of a tendency to magnify what is in proc­ credit in use, but the ebb and flow of ess in times either of rapid expansion or credit, which affects the loan account of acute liquidation; in other words, of the Federal Reserve Bank. The to give an exaggerated or heightened Federal Reserve Bank has little part in impression of these movements. the ordinary credit business of the country. It does not deal with busi­ A Guide to Credit Policy ness borrowers directly. The relations Therein consists its importance as of the business man are with his mem­ an administrative guide. While it ber bank, the member bank in turn may be faulty as a gauge of the degree dealing with the Reserve Bank as oc­ of credit expansion or contraction, its casion may necessitate. The Federal very sensitiveness gives it a peculiar Reserve loan is not the first line of value as a quick indicator of what credit, but the second line of credit. changes in the business and credit The expansion and contraction of situation are in process or even im­ the Reserve Bank loan account are pending. For while the Reserve Bank twice removed from the expansion and curve, during the period under review, contraction of the volume of busi­ has been over sensitive and gives an ness as reflected in commercial bank exaggerated impression of credit de­ loans. velopments, the member bank curve, The Federal Reserve is called into for reasons already discussed and activity when the supply of ordinary primarily because, at any moment, it is credit facilities is inadequate. It sup­ more influenced by what has taken plements the resources of its members. place than by what is taking place, It is, so to speak, the increments and tends to give an inadequate impression decrements in the country’s credit re­ of changes which are in process, at least quirements that are reflected in the up­ so far as they affect the credit situation. ward and downward movement of the In times of rapid expansion or contrac­ Federal Reserve loan account. It is tion, it is not the total volume of out­ when business is speeding up beyond standing bank loans which is significant, their normal credit capacity that the but additions to that volume, or reduc­ commercial banks must resort to the tions in it. From this point of view, Federal Reserve Banks for accommo­ the Reserve Bank curve is a truer in­ dation. When business is receding and dex of business and credit development liquidating in a period of economic than the member bank curve, and a reaction, slackening of credit require­ better guide to credit policy.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Curves of E xpansion and Contraction 149

INDEX NUMBERS OF BANKING AND BUSINESS DEVELOPMENTS: 1919-1921 (Monthly averages for 1919 = 100)

All Federal F. R. Bank of Reporting b © Reserve Banks New York Member Banks j

(8 note i*- n . . 11

R I** 1 i ls l e Volume of of business Volume of Volume Gold Gold reserves Gold Gold reserves Bill holdings F. F. circulation circulation Bill Bill holdings F. R. note i l Net demand deposits ^w V2 CQ 1 manufacture* 1919 January. 89 99 97 94 95 92 94 95 88 95.8 101.6 February.. 93 100 95 100 92 90 94 94 94 .... 92.9 86.7 March... 96 101 96 97 105 96 96 95 98 85.6 94.8 92.6 April.... 96 102 98 93 115 100 96 96 97 83.3 95.8 93.7 May . . . . 97 102 97 98 112 101 98 99 101 88.7 97.6 95.7 June . . . . 93 103 96 89 119 100 99 98 92 95.1 97.6 95.9 July...... 100 99 97 106 98 102 98 100 98 102.5 103.3 101.9 August .. 97 98 98 98 94 102 101 102 94 103.4 106.6 107.2 September 95 98 101 89 94 102 103 104 93 101.2 103.8 103.8 October.. 109 101 105 109 91 103 106 105 112 104.6 105.2 104.4 November 118 100 108 114 94 104 107 107 119 113.5 108.5 102.2 December 119 98 113 114 91 108 108 106 117 116.4 112.3 102.1 1920 January.. 122 96 111 119 87 105 110 109 121 116.7 117.0 115.9 February. 128 93 114 126 83 110 110 108 136 111.0 117.5 104.6 March... 128 91 117 123 77 113 111 109 138 108.4 119.3 118.0 April .... 128 92 118 117 86 114 112 109 139 107.1 125.0 108.8 May . . . . 131 92 119 122 86 115 112 109 140 108.6 128.3 111.8 June...... 128 92 119 120 84 116 112 109 133 106.9 126.9 109.6 July...... 128 93 121 122 81 117 112 108 135 103.6 123.6 102.3 August .. 131 93 122 125 75 116 112 107 139 101.2 117.9 104.9 September 133 93 126 118 76 117 113 107 142 98.4 114.2 101.4 October.. 137 94 128 126 74 119 113 106 150 100.3 106.1 101.2 November 136 95 128 125 74 119 111 104 148 104.3 97.6 88.9 December 132 96 128 124 71 118 110 102 143 104.6 89.2 77.9 1921 January.. 120 99 121 116 65 109 109 102 131 104.7 83.5 78.3 February. 115 100 117 114 64 108 107 100 126 98.2 78.8 75.0 March... 109 103 115 102 78 108 106 98 121 90.1 76.4 80.6 April .... 100 107 110 84 101 104 104 96 108 85.0 72.6 75.8 May . . . . 91 112 107 75 106 98 102 96 96 85.9 71.2 79.3 June . . . . 83 115 103 59 128 94 101 96 85 85.9 69.8 75.9 July...... 78 118 100 53 132 89 99 95 79 85.2 69.8 68.5 August .. 70 122 96 49 134 87 98 94 67 81.6 71.7 .... September 66 127 95 39 150 87 98 94 61 80.2 71.7 .... October.. 63 130 94 37 156 86 99 95 57 82.3 ------

a Including rediscounts with Federal Reserve banks. b As measured by debits to individual accounts, three-months' moving averages. 0 U. S. Bureau of Labor Statistics. d Harvard Committee on Economic Research.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 150 T he Annals of the American Academy

BANKING DATA: 19 1 9 - 1 9 2 1 (Monthly averages: amounts in millions of dollars)

All Federal F. R. Bank of Reporting Reserve Banks New York Member Banks Ratio of F. R. accommo­

• dation to to­ ! j 4 ^ tal loans and i i i investments (per cent) Bill Bill holdings Bill holdings Gold Gold reserves Gold reserves F. F. R. circulation note Net demand Net l l deposits II* 1919 January...... 1,992 2,100 2,534 757 611 676 14,178 10,048 1,306 9 February...... 2,084 2,119 2,465 804 593 665 14,257 9,908 1,400 10 March...... 2,147 2,138 2,506 780 677 709 14,578 10,115 1,449 10 April...... 2,138 2,156 2,547 751 740 738 14,559 10,135 1,443 10 May...... 2,168 2,177 2,532 795 721 743 14,886 10,439 1,497 10 June...... 2,089 2,177 2,500 721 765 736 14,969 10,393 1,361 9 July...... 2,241 2,112 2,527 852 632 749 14,813 10,604 1,454 10 August...... 2,174 2,079 2,543 789 602 748 15,204 10,800 1,395 9 September...... 2,136 2,086 2,627 718 605 753 15,577 10,984 1,383 9 October...... 2,436 2,136 2,742 883 587 756 15,961 11,140 1,660 10 November...... 2,633 2,116 2,821 923 607 761 16,143 11,330 1,765 11 December...... 2,661 2,089 2,959 921 587 796 16,337 11,244 1,739 11 1920 January ...... 2,720 2,037 2,892 963 557 775 16,670 11,576 1,803 11 February...... 2,867 1,979 2,962 1,018 535 810 16,630 11,482 2,019 12 March...... 2,856 1,936 3,041 997 498 834 16,813 11,600 2,053 12 April...... 2,853 1,950 3,075 949 552 838 16,935 11,546 2,069 12 May...... 2,934 1,943 3,092 981 555 848 16,941 11,506 2,085 12 June...... 2,857 1,964 3,115 968 538 857 16,926 11,499 1,981 12 July...... 2,875 1,975 3,145 985 518 860 16,876 11,466 2,005 12 August...... 2,933 1,974 3,172 1,006 483 854 16,862 11,299 2,072 12 September...... 2,973 1,975 3,277 956 490 862 17,012 11,286 2,117 12 October...... 3,071 1,998 3,338 1,014 477 872 17,147 11,266 2,222 13 November...... 3,033 2,011 3,329 1,013 474 876 16,827 11,027 2,200 13 December...... 2,952 2,043 3,344 1,005 459 871 16,692 10,823 2,132 13 1921 January...... 2,692 2,092 3,159 938 415 805 16,402 10,816 1,947 12 February...... 2,570 2,127 3,054 922 413 793 16,131 10,583 1,878 12 March...... 2,444 2,192 2,986 826 500 791 16,021 10,404 1,792 11 April...... 2,241 2,283 2,871 676 650 764 15,733 10,201 1,601 10 M ay...... 2,039, 2,370 2,784 608 682 723 15,466 10,194 1,421 9 June...... 1,865 2,439 2,682 479 822 690 15,319 10,182 1,267 8 July...... 1,735 2,503 2,594 432 846 657 15,020 10,037 1,167 8 August...... 1,566 2,598 2,506 396 862 638 14,876 9,921 996 7 September...... 1,471 2,694 2,485 315 966 638 14,857 9,953 906 6 October...... 1,415 2,755 2,452 298 1,001 634 14,897 10,107 854 6

e Including rediscounts with Federal Reserve banks.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E xpansion and Contraction 151 Expansion and Contraction Under the Federal Reserve System By Ernest Minor Patterson University of Pennsylvania UCH confusion of thought on in terms of the pound sterling our dol­ M thesubject of expansion and con­ lar is higher than usual. For a pe­ traction is due to our failure to dis­ riod of time several years ago the tinguish clearly between three different American dollar was lower than usual problems. An economic system, which in terms of the money of Sweden, and operates on a money and credit basis, Sweden’s money was higher than usual and which maintains business relations in terms of our dollar. Foreign ex­ with the systems of other countries, change quotations are for the most part cannot well escape these difficulties. merely a barometer or index, an effect Each of the three facts involved is and not a cause, but what they state is at times referred to as “depreciation.” a change in the relative position of the moneys of two countries. The ap­ T h e T h r e e K in d s o f preciation of one involves the deprecia­ “D epreciation ” tion of the other, and vice versa. One of them is the relation of a given A second kind of depreciation is financial system, such as that of the found when one form of money, say United States, to that of other countries the standard money gold, changes in as reflected in foreign exchange quo­ its relationship to some other form tations. The British pound is worth of money in the same country. Such at mint par $4.8665, the German a change occurred in the United States mark, 23.8 cents, the French franc, during the Civil War, when the “green­ 19.3 cents and so on. When, as at backs” or United States notes were present, these moneys are bought and issued in very large quantities and were sold in our markets at about $3.80, acceptable at less than their face value one-third of a cent and 7.25 cents, in exchange for gold. At one time a respectively, it is customary to say dollar of gold would purchase as much that the moneys of those countries are as $1.85 in greenbacks. The green­ depreciated. During the late War backs had depreciated in terms of the moneys of the belligerent countries gold, and gold had appreciated in were thus depreciated in the United terms of greenbacks. Again it is a States, while at the same time our question of the relationship between money was depreciated in certain the two. neutral countries. A third type of depreciation is to The causes of such a condition we be observed when the general price need not here explain, but one point level changes. If prices in general needs emphasis. In every case where rise to a higher level than that of the such depreciation occurs there is past it may be said that the value of merely an increase in the value of the commodities in the country has ap­ first money in terms of the second preciated in terms of money and that and a decrease in the value of the sec­ the value of the money has depreciated ond in terms of the first. In terms in terms of the commodities. Simi­ of the American dollar the pound larly, if the general price level falls, sterling is now lower than usual, and there is an appreciation of the value

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 15* T he Annals of the American Academy of the money in terms of commodities credit that only adjust their supply and a depreciation of the value of the to the demand for them are better re­ commodities in terms of money. ferred to as a contraction and an ex­ These three forms of depreciation pansion that merely evidence the are well understood by most persons elasticity of a monetary and banking who are at all acquainted with finan­ system. For years the Canadian bank cial questions. Nevertheless, they are note issues have increased in the fall of closely interrelated, and when a par­ each year to meet the demand for crop- ticular problem is up for consider­ moving, and have later contracted when ation these interrelationships may be that demand ceased. Such changes overlooked and confusion of thought ought not to be referred to as inflation result. and deflation, but as a most desirable expansion and contraction. “E x p a n s io n ” a n d “ I n f l a t io n ” It is true that expansion of this One other definition is necessary. kind might become dangerous, but “Expansion” is a word that is used it is not probable. The volume of very loosely. Sometimes, though not note issues or of deposit liabilities in always, it is employed as a synonym relation to reserves might become for “ inflation.” With these two words, too large as compared with the re­ or rather in contrast to them, are “con­ serve held for redemption purposes. traction” and “deflation.” Public knowledge of this situation Any and every increase in the vol­ might result in a rim on the banks ume of circulating medium in the and the failure of some of them, even United States is not inflation. As though the expansion had occurred population grows and as business merely to meet the needs of a rapidly activity increases a larger amount of growing trade. However, this kind of circulating medium is needed if the expansion is not apt to take place. price level is not to decline. If its There are both seasonal and cyclical amount should remain the same the fluctuations in the demand for money price level would fall and we .would and credit, but in actual experience suffer all of the accompanying hard­ they are not likely to result in a con­ ships. As the volume of trade in­ dition of the sort just described. creases it is better to have an increase While an expansion does take place, in the volume of circulating medium. ordinary trade demands are not apt If this occurs and at the same rate as to lower seriously the percentage of the growth in trade there are no harm­ reserves held. ful effects, and it would not be correct There are two periods of activity to say there had been inflation. A for analysis in this article. One ex­ mere increase in the volume of money tends from the formation of the Fed­ or credit is not inflation, for the in­ eral Reserve System in the autumn of crease must be viewed in its relation 1914 to the spring of 1920. The sec­ to the demand for it. Similarly, a ond continues from that time to the decrease is not to be referred to as de­ present. flation if it merely corresponds to a That in the first of these two pe­ decline in the volume of business, i.e., riods there occurred an increase in the to a reduction in demand. The price volume of circulating medium does level is not affected and no hardship not need to be argued here. Nor need results. we stop to demonstrate in detail that Changes in the volume of money and this increase was more rapid than the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E xpansion and Contraction 153 growth in the volume of trade. Pro­ What was the occasion for this and fessor Kemmerer, in his volume High where does responsibility rest? Prices and Deflation,J has shown that from 1913 to 1918 there was an in­ I n c r e a s e d D e p o s it L i a b i l i t i e s crease of 13 per cent in the country’s There were three leading reasons. physical volume of business, while in One is found in the very nature of 1919 it actually declined from the 1918 the Federal Reserve System. Our na­ level being only 9.6 per cent greater tional banking organization as it ex­ than in 1913. isted prior to 1914 was said to lack During this same period of time elasticity. Expansion to meet any there was an increase in wholesale seasonal or cyclical growth in trade prices as reflected in the United States needs was difficult to secure, as was Bureau of Labor index number of 112 also contraction when the need had per cent over the 1913 level. Also, passed. Explanation of this difficulty the exchange market showed a de­ need not be presented here, as the preciation of the pound sterling, the reasons for it are fully understood by mark, the franc, the lira and other most students of the subject, and have foreign currencies in terms of our dollar. been set forth many times. We have already pointed out that there Under the old law, country banks are three kinds of depreciation, and the were required to maintain a reserve of period in question may be examined 15 per cent of their deposit liabilities, with a view to determining whether of which two-fifths, or 6 per cent, had the Federal Reserve System and its to be in actual cash in their own vaults;' management were responsible for such reserve city banks, 25 per cent, of depreciation as occurred. which one-half had to be in cash; and First, let us notice the increase in central reserve city banks, 25 per the volume of the circulating medium. cent in cash. The net effect was From November 1,1913, to November that there could be on the average 1, 1918, the amount of money in the about $8 of deposit liabilities on each United States increased from $3,755,- $1 of reserves held by the national 994,000 to $7,590,173,000. Of this banks of the country, or an av­ increase $1,173,883,000 was in gold erage cash reserve of 12| per cent. (and gold certificates), and $2,660,296,- This varied slightly from time to 000 in other forms of money. The time, and there have been slight dif­ increase in our stock of gold had a def­ ferences in the estimates of students inite connection with affairs abroad, of the question, but the figures are and will be considered a little later. sufficiently accurate for our present But there was an increase in the issue purpose. of Federal Reserve notes, from nothing Under the Federal Reserve Act, to $2,705,737,000, and in the Federal particularly as amended, all this was Reserve Bank notes from nothing to changed. By a concentration of cash $71,647,260. Also during approxi­ in the vaults of the twelve Reserve mately the same period the deposit Banks each dollar could be utilized liabilities of the national banks in­ much more effectively. Accompany­ creased from $6,051,689,000 to $11,- ing this there was a reduction in the 013,330,000. There was without doubt reserve requirements of the member an expansion in our circulating medium banks, and the net result was that $1 more rapid than in the demand for it. of reserve furnished the basis for per­ 1 See pages 3- 13. haps $11.50 of deposit liabilities, or an

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 154 T he Annals of the American Academy average cash reserve of about 9 per addition of about $12,324,193,000 to cent.2 Although there may be differ­ the deposit liabilities of our banks. ences of opinion as to this particular It thus appears that a plan of bank* figure, there can be no dispute over ing reform was deliberately adopted the fact of a very pronounced change by the country, after a discussion ex­ in the direction indicated. tending over a number of years, which Whether a change of this kind, was one that was sure to increase the which permitted and even encouraged deposit liabilities of our banks. More­ an expansion in deposit liabilities, was over, any other reform, such as the so- wise cannot here be argued, but will called Aldrich Plan, would have had a be assumed. The United States had similar effect. been paying too dear a price for its But can the Federal Reserve System banking system. Greater elasticity or its management be held responsible was important. It could not be se­ for the importation of gold that fur­ cured except by a centralization of nished an additional basis for this ex­ reserves, and centralization of reserves pansion? There is certainly no reason means that each dollar is more effective for such a view. The intense demand than before. Under such circum­ for our commodities and the rapid stances an average cash reserve for growth in our export balance threw on the country of more than say 10 per the European belligerents the burden cent or 11 per cent would be very dif­ of righting in some manner their un­ ficult and probably impossible to main­ favorable position. Commodities and tain. Such a change as this would have securities, particularly the latter, were resulted under any plan of banking hurried over to us, and especially in reform and under any management. the earlier part of the struggle large Our circulating medium would have ex­ amounts of gold were sent also. The panded more rapidly than the growth movement was a part of the general in trade demand and, ceteris paribus, situation, and would have occurred had would have caused a rise in the general we still been operating under the old price level. National Bank Law. In fact, the existence of the Federal I n cr ease d G old R e s e r v e Reserve organization facilitated rather than impeded credit transactions, and This assumes no alteration in the thus made it easier to check the gold volume of the gold reserve. A re­ movement. If the older system had duction in gold supply would have off­ still been in operation much more gold set this tendency to expansion, while might conceivably have been imported any increase would enhance it. On into the United States during that this point we need merely refer to the period. facts, which are that from August 1 , 1914, to January 1,1919, there was an St r a in o f F in a n c in g W a r P u r ­ importation (net) of gold into the chases United States amounting to $1,071,- But the analysis is not complete. 669,000, which made possible (accord­ Admitting that the new reserve re­ ing to the above ratio of 11| to 1) an quirements and the importation of gold encouraged a considerable expansion, 2 “ Mechanism of Expansion Under the Federal Reserve System” ; Monthly Review of Credit it may be argued that the expansion and Bunness Conditions in the Second Federal that really occurred was extreme, Reserve District, September 1, 1 9 2 1, p. 12. going so far that the percentage of

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E xpansion and Contraction 155 reserve actually held by the system cluding the Federal Reserve Banks, was for a long time very close to the assumed the burden. legal limit. With the New York The Federal Reserve System was Reserve Bank this was particularly designed primarily to aid commercial noticeable. While the situation was banking, that is, to assist in those a very strained one for the System as a banking transactions that facilitate whole, the condition of the New York the movement of goods from producer Bank was at times especially weak, to consumer. To this general state­ and was even disguised, though rather ment a few qualifications should be poorly, by a change in the form of its added by way of reference to such pro­ weekly reports. Had this been pre­ visions as those regarding savings de­ sented in the same form as used by the posits and trust powers, but in general other eleven banks and by the System the statement is correct. When war as a whole, there would have been supplies moved from the United States shown a smaller percentage of reserve to Europe our banks gave their assist­ than that prescribed by the law. The ance. The volume was large but ex­ form of report adopted by the New pansion was possible under the Federal York Bank may have been as good or Reserve System and with the in­ even superior to the other form, but creased gold supplies prevented any the difference referred to illustrates the serious strain on the System prior to strain on that bank. At one time, too, our entrance into the War anji for a the situation was materially helped by considerable time thereafter. Our par­ the timely deposit by the Federal ticipation in the conflict and the con­ government of a considerable amount sequent demand for war financing by of silver with the New York Bank. our own government definitely altered Also, the twelve banks of the System the situation. gave each other extensive relief by rediscounting heavily for each other, E ffe c t o f T r e a s u r y P o lic ie s a form of assistance that was of general Just what policies should have been aid, but was particularly valuable to followed by the Treasury Department the New York Bank after November, in meeting the war emergency is some­ 1919. thing on which we probably cannot There was clearly a considerable agree. The facts, however, are clear. apiount of strain on the System. As The problem was one of securing max­ has just been pointed out, the altered imum production and of diverting to reserve requirements would have made war uses a very large fraction of that possible a very considerable expansion total product. Two main devices in deposits, and heavy importations were employed to divert output to of gold increased this tendency, but the government—taxation and bond neither of these facts explains the issues (including certificates of in­ strain just referred to. debtedness). Both of these were in­ In the period from 1914 to April, tended to secure the desired funds by 1917, there was a very heavy demand encouraging saving. Taxation took upon American banks to assist in war funds from a taxpayer, usually much financing. The United States was against his will, while he was expected not yet in the conflict, but the vast to buy bonds voluntarily. movements of goods, chiefly to allied But the war needs amounted to countries, called for a large amount of some $18,000,000,000 per annum, and financing, and American banks, in­ at one period payments were as high

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 156 T he Annals of the American Academy as $2,000,000,000 per month, or at The other provision is one that ap­ the rate of $24,000,000,000 per year. pears to the casual reader as of slight Prior to the War our annual savings significance, but it furnished the basis are estimated to have been at the rate for many of the important operations of no more than $6,000,000,000 or of war financing. In Section 13 of the $7,000,000,000 per year. To treble Federal Reserve Act the powers of or more than treble the amount avail­ the Reserve Banks are enumerated. able was probably too great a task for Among the prohibitions there set forth taxation and bond issues combined. is one against loans on “notes, drafts At any rate, policies were adopted or bills covering merely investments, that resulted in an inflation of the cur­ or issued or drawn for the purpose of rency and hence forced loans from the carrying or trading in stocks, bonds, general public. or other investment securities, except bonds and notes of the Government of R e se r v e B a n k F a c il it ie s fo r W a r the United States. F in a n c in g The exception in the last words of If one is to appreciate the position this quotation was not particularly of the Federal Reserve Banks in war significant at the time of the passage financing, several facts must be kept of the Act—in fact it was rather com­ in mind. One is the altered reserve monplace. Yet it became very im­ requirements of member banks already portant during the War. The Reserve referred to. Some of the reductions Banks could and did lend on govern­ were made after we entered the War, ment bonds and notes as security. particularly by the provision that the To the large amount of latitude thus reserves specified were to be kept, not allowed additions were made from in the member bank’s own vault, but time to time through rulings made by as a deposit account with the Reserve the Federal Reserve Board. Thus it Bank of its district. Along with this does not seem entirely clear to the lay­ must be remembered the other amend­ man whether the law permits a Re­ ment to the Jaw that allowed gold in serve Bank to discount the direct ob­ the hands of the Federal Reserve agent ligation of a member bank. The writer held by him against issues of Federal was of the opinion that it did not, and Reserve notes to be counted as part of that only the rediscounting of custo­ the required reserve of his Federal mers’ paper was acceptable. That Reserve Bank. Also, there must be he was wrong is shown by the fact mentioned the policy early adopted by that this direct discounting was per­ the Reserve System of concentrating mitted on a very large scale. Member the gold and gold certificates of the banks discounted their own notes ac­ country in the vaults of the Reserve companied by Liberty Bonds as col­ Banks, Federal Reserve notes being lateral security. issued in their place. Closely associated with this policy There were two other important were the decisions that notes of this sort provisions of the law. One of them might run for as short a time as fifteen states that the Reserve Banks are to days, that they might be renewed some­ be fiscal agents of the government. what freely as they matured, and that This places them in a position in which there should be charged for such loans they are compelled to cooperate in a discount rate no higher than the methods of financing decided upon by interest rate paid by the government the Treasury Department. on the frond offered as collateral.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E xpansion and Contraction 157 The provisions of the law as cited Thus the Treasury on one press opened the way, and the decisions printed paper money (Federal Reserve just mentioned let down the bars com­ notes) which it delivered to the twelve pletely. What followed may be vis­ Federal Reserve Banks. They in turn ualized if one’s imagination permits gave them to their members in return him to assume two printing presses for the notes of these banks secured by in the Treasury Department. On one Liberty Bonds. The member banks of them were printed government were then able to pay the government bonds for sale to the public through for the bonds struck off on the other the Reserve Banks, which were the printing press. fiscal agents of the government. The The description may be fanciful, Reserve Banks delivered the bonds to but only slightly so. In the good old member banks for actual sale. A days, say in the Civil War, the process customer who was besought to buy a was much more simple and direct. The bond protested that he had not the government printed the United States funds, but was informed that he need notes—the greenbacks—and put them pay only a small amount at a time, his directly into circulation. The mod­ bank agreeing to advance a loan, retain­ ern method is more complex and has ing the bond as collateral security and its advantages, but in many of its charging only the same rate of interest features it is the same. as paid by the government on the bond. This seemed generous and so aided R esponsibility fo r I n f l a t io n the sale of bonds that the banks were As a result of the, analysis we have in need of help to carry their part of been making, it seems clear that the the load. They were reassured by Federal Reserve Board and the officials being told that they could give their of the Federal Reserve Banks cannot own fifteen-day notes to their respec­ be charged with responsibility for any tive Reserve Banks, provided they “inflation” that occurred down to the would present with them as collateral summer or fall of 1919. It was due to these same Liberty Bonds that had (1) altered reserve requirements; (2) been purchased by their customers, an influx of gold, and (3) the policies but which were not to be delivered of war financing for which the Treasury until fully paid for. They were also Department was chiefly responsible. assured of the same low interest rate Of the three kinds of depreciation and of an easy renewal of the notes as mentioned at the beginning of this they fell due. article two were evident. The Amer­ Imagine still further that this offer ican dollar had greatly appreciated in brought such general response from terms of the leading European curren­ the banks that the Reserve Banks cies, so much so that various stabilizing were overwhelmed and their officers devices were employed. Foreign cur­ hurriedly and urgently besought the rencies had depreciated in terms of Secretary of the Treasury for relief, our dollar. For this condition neither because of their lack of funds. His the government nor the Federal Re­ answer, however, was reassuring. He serve System was responsible. If we merely pointed to the other printing had been still operating under the old press on which were being printed National Bank Act with all of its great quantities of Federal Reserve rigidity, the foreign exchange situa­ notes, which were furnished to the tion would have been no better and Federal Reserve Banks as needed. might have been worse. After a tew

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 158 T he Annals of the American Academy months of wild fluctuations foreign many of the minor belligerents) were governments gained control of the ex­ against us, and, as restraints on the changes by using “pegging” devices, exportation of gold were gradually an arrangement that would have been removed, the gold started out. The much harder to make if our banking War was over, but prices still rose, system as a whole had been less well while note issues and deposit liabilities organized. After we entered the War kept increasing in spite of the fact that responsibility for this control was the gold reserve was being withdrawn. largely taken over by our government, The percentage of reserves held by the which of course used the Federal Re­ Federal Reserve Banks declined until serve System as its fiscal agent. From it was perilously close to the legal min­ the proceeds of Liberty Bond sales, imum. advances were made to foreign govern­ In this period, what kinds of ap­ ments, our Treasury Department re­ preciation and depreciation occurred? ceiving and holding their notes for the At the end of 1918 a number of the amounts involved. exchanges were against us, but by There was also a depreciation of our the fall of 1920 all of the leading ex­ own money, the dollar, in terms of changes were in our favor, with the commodities. Prices rose rapidly, but exception of Hongkong, Shanghai and as we have noted this was due in the Yokohama, and they were rapidly main to (1) the greater possibility of falling, especially the first two. Ex­ expansion that would have existed changes that had already been in under any reorganization of our bank­ our favor were becoming more so. ing system; (2) the heavy importa­ The American dollar was appreciating tions of gold and (3) the fiscal policy in terms of nearly every other money of the Government. in the world, or, to reverse it, those The second form of depreciation did moneys were depreciating in terms of not occur; at least, there were no out­ our dollar. ward evidences of it. Our various Commodities were clearly appreciat­ forms of paper money at no time were ing in terms of our own money, the depreciated in terms of gold. In evidence being the rise of the price case an open gold market had existed, level until well into 1920. Our money the situation might have been different, was depreciating in value in terms of and a premium on gold might have commodities. There was also a tend­ appeared, though probably not. ency toward a depreciation of paper money (including bank deposits) in P ost-A r m is tic e T ren d s terms of gold. Reserves were declin­ But what can be said of conditions ing and liabilities expanding with a from the close of the War late in 1918 resultant decline in the percentage of until the spring of 1920? During reserve held. Considerable uncertainty this period prices continued to rise, and doubt appeared, but there was while the volume of Federal Reserve no actual premium on gold recorded. notes and of deposit liabilities rapidly There was merely a tendency that expanded. Gold imports had ceased operated as a distinct warning and and in 1919 the movement was reversed, that called for corrective action. considerable amounts of gold leaving The movement was therefore a the country. The exchanges of many mixed one. Our dollar was appre­ of the countries that had been neutral ciating in terms of foreign money, but during the War (and even those of was depreciating in terms of com­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E xpansion and Contraction 159 modities, while our paper money and But this crude analogy between our bank deposits were being placed military and economic facts is apt to in a more and more precarious posi­ be very misleading* A more satis­ tion with reference to our standard factory explanation is to be found in money—gold. The exportation of the fact that the Federal Reserve gold was helping to appreciate our dol­ System was (and for that matter still lar in terms of foreign currencies, but is) in the first phase of its development. was imperilling the gold standard at Some of its most important features home by weakening our gold reserves are not yet fully understood even by while bank liabilities were mounting. many bank officials. Several years after the organization of the Reserve C o n d itio n s H in d e r in g R ese r ve Banks a prominent banker who was O f f ic ia l s serving as director of one of the In fairness to the Federal Reserve twelve institutions was said to be un­ officials, several facts should be pointed able to grasp some of the fundamentals out. First of all war financing was by of the law, and even today a thorough no means over. The Victory notes comprehension of some of its leading were issued in June, 1919, followed features is by no means common. from time to time by large blocks of One of the misconceptions that has certificates of indebtedness. The ac­ persisted is the idea that the System tual fighting of the War was over, but is to be merely a source of relief in the fiscal operations were not. As times of difficulty. That assistance fiscal agents for the government'the through rediscounting is needed in Reserve Banks could not immediately times of seasonal and cyclical strain •free themselves from the responsibilities is easily understood, but that the Re­ that have already been described. serve Banks should at all times exercise Next it should be remembered that a supervision over the banking system what occurred in the United States and often impose its control is not was in part paralleled in other coun­ fully realized. Even when the pos­ tries. Prices were rising in England, sibility of this control is understood France, Italy, Sweden and elsewhere, the result is often intense resentment much more rapidly than in the United at what seems to be unwarranted in­ States. It is true that many of these terference. countries were more seriously affected Such control is, however, the usual by the War than we were, but it is thing abroad, and the Federal Reserve not unfair to urge that many of the Act has in it numerous provisions same influences that were operating which give a similar power to our abroad were also affecting us. Com­ system. But legislative authorization plete dissociation from so world-wide is not in itself adequate. The Federal a movement could not reasonably Reserve Board and the officials of the have been expected. The upward twelve Reserve Banks cannot move movement which had lifted prices too far ahead of public opinion, es­ prior to the signing of the Armistice pecially banking opinion, nor can they was not exhausted, and the rise con­ go too violently in opposition to it. tinued. Just as military activities Perhaps the most important single were in evidence for a long time, so device by which the Reserve Banks the economic forces set loose between can control the money market is the 1914 and 1918 could not suddenly rediscount rate, but the mere state­ be reversed. ment of that fact does not mean that

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 160 T he Annals of the American Academy they can freely employ this device. conditions changed. During 1917 and An important measure of public sup­ 1918 the minimum discount rate of port is necessary in case such a power the Bank of England was (as is regularly is actually to be used. true in England) considerably higher than the market rate on ninety-day W h y t h e D isc o u n t R a t e W a s N ot bills in London, but during this period R aise d the discount rate of the New York It has been argued that at the close Federal Reserve Bank for commercial of active hostilities the Reserve Banks paper was regularly lower than the should have exercised this power by prevailing market rate in New York rapidly raising their rediscount rates for the same kind of paper. If control until they were above the rates charged of the market had been the only pur­ by member banks to their customers. pose to be kept in mind during this There would then have been no gain period, it would have been wise to to the member banks in rediscounting; have raised the discount rates of the they would have curtailed accommo­ Reserve Banks more rapidly than dations to their customers and infla­ market rates rose, and thus have es­ tion would have quickly been checked. tablished control. The Bank of England thus controls Armistice Day found the Reserve the money market of England. Why Banks still not in control of the sit­ could not our Reserve Banks do the uation, and able to influence it only to same? What reply can be made to a minor degree by a scrutiny of par­ this argument? ticular paper presented for discount Two observations may be made. or by oversight of the rediscounting First of all, the British method has done by particular member banks. A been employed for many years, and the Victory Loan had to be floated, and banking community of England is ac­ other post-war financing was necessary. customed to it, accepting it as a matter Moreover, member banks had dis­ of course. Our Reserve System was counted large amounts of their own authorized in 1913 and not organized obligations at the Reserve Banks with until 1914, several months after the Liberty bonds as security. On No­ Great War had started. vember 15, 1918, the total volume of Next, it is to be remembered that bills discounted with the Reserve Banks from 1914 to 1918, and especially secured by government war obligations during 1917 and 1918, the fiscal policy was $1,358,416,000, and on February of our government made it impossible 87, 1920, it was $1,572,980,000. to initiate such a policy of control. A Difficulties were accordingly very rediscount rate higher than the market numerous. To place restraints upon rate, or, at least, one higher than the the expansion from 1918 to 1920 would rate of interest on Liberty Bonds, have been difficult, and, even if practi­ would have made impossible the meth­ cable and desirable, would have ods of financing that were employed. called for a very high degree of wisdom From 1914 to April, 1917, the Federal and courage. It is the opinion of the Reserve Bank of New York did suc­ writer that our government was very ceed in keeping its discount rate unwise in its decision to float its war above that for commercial paper, issues of bonds and certificates of in­ thus adhering to the policy of the lead­ debtedness at such low rates of interest. ing foreign banks. With the entrance When so large an amount of saving of the United States into the War, was needed much higher rates would

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E xpansion and Contraction 161 have been better. The low rates the next fall by the usual fall demands actually offered kept the general se­ for crop-moving purposes. Also the curity market quiet for a considerable situation in Europe was most dis­ time, but such a policy inevitably quieting. Monetary systems there meant a rise in prices that injured the were developing alarming tendencies. general public, including holders of Prices were rising, bank liabilities ex­ securities, far more than would the offer panding and reserves declining far of higher rates on the new government more than in the United States. If issues. Nevertheless, the policy was a general collapse had occurred we adopted, rates were kept down and would have been unable to meet it the Reserve Banks were and still are without a general breakdown of our the fiscal agents of the government. entire business and financial structure. So long as they are fiscal agents the We were already strained almost to way in which they perform their other the breaking point. functions must be affected by this Under such circumstances it was relationship. not possible to rely on the judgment of American business men to impose T h e N ec e ssity fo r H ig h e r D is ­ checks of their own. A few began co u nt R a te s to contract their operations, but the By the spring of 1920 conditions larger number went on piling up their had somewhat altered. The larger own liabilities at the banks and ex­ part of war and post-war financing tending credits abroad and at home had been completed, and the re­ with little or no appreciation of the sponsibilities of the Reserve Banks to unsound condition. Early in 1920 the government were somewhat les­ the rates were raised. It was none sened. A large volume of rediscounts too soon. First in Japan and later in was still in the possession of the Re­ other countries the reaction came and serve Banks, but more freedom of prices began to crumble. movement than before was possible. In the face of this collapse credits Accordingly, their policy was altered. were extended by member banks to It was clearly time. A very strong customers, often unwisely, but on the case could have been developed for whole with a view to easing business earlier action, but certainly longer de­ through the trying period of the crisis lay would have been unwise. Prices and the subsequent depression. In were still rising, discounts with the turn the Reserve Banks gave assis­ Reserve Banks were increasing and tance to member banks at the new their deposits and their issues of and higher rates, but with a very Federal Reserve notes were mounting considerable freedom. After a few with leaps and bounds. The per­ months deposits and note issues began centage of reserves held was near the to decline and reserve percentages to legal minimum. All banking experi­ rise, until a condition of comparative ence indicated that danger was ahead. banking security was attained. Speculation was rampant, and was It was, however, a trying experience. sure to be followed by a reaction whose Those who suffered from the fall in seriousness would be proportionate to prices resented bitterly the new policy the delay in its appearance. that seemed to them responsible for There were several special reasons their losses. The sufferers as separate for concern. Our own spring demand individuals were not, in most cases, for money was at hand, to be followed to blame. They were merely a part 12

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 162 T he Annals of the American Academy of a cumbersome and faulty business almost due, seems at this writing al­ organization in which periods of ex­ most certain. If it occurs, the effects cessive expansion and contraction are on French finances and business, and a frequent and somewhat regular oc­ through France on all Europe, will currence. In many individual cases be almost incalculable in their gravity. injustice was doubtless done borrowers, It is a time for the exercise of the but on the whole our constructive greatest caution. No matter what criticism should be directed at an policy we adopt, hardships will result. economic organization that makes such Our choice is merely between evils, an outcome possible. and no matter what our decision the path ahead is by no means bright. C a u t io n St il l I m p e r a t iv e Higher discount rates in the face of Nor is the danger by any means the depreciated exchanges means still over. The period ending in 1920 was heavier gold imports. Withdrawal of one in which money was depreciating gold from foreign countries weakens rapidly in terms of commodities, and them still more, and adds to our stock our deposits and paper money in danger of gold that is already disproportion­ of depreciating in terms of gold, as ately large. they have actually done in many other On the other hand, low interest countries. The danger in these di­ rates encourage an expansion which rections has for the present at least ought for our own sakes to be held in disappeared. But the very policy of check. High bank reserves are by no higher discount rates which aided in means a sufficient excuse for a generous giving this relief brought with it cer­ loan policy at the present time. A tain unfortunate consequences. To­ combination of low rates with a care­ day the currency of nearly every ful limitation of loans is the ideal, but foreign country is at a heavy discount very difficult of attainment. in New York. Gold was for a time Since default by Germany seems so being exported from the United States, imminent the sooner it is faced the but from January 1 to November 1, better, even if it is disguised as a 1921, the net importations of gold moratorium. After it comes there have been about $564,000,000, and will be a more general appreciation of the gold holdings of the Reserve Banks what is ahead, and plans can be more have increased by about $666,000,000. effectively made for real recovery. This influx of gold, together with a One of our present dangers is the pos­ decrease in deposit and note issue sibility of developing an unhealthy liabilities, has increased the percentage optimism that will lead to a business of reserves held, and relieved us from expansion, too rapid and in wrong one serious danger—that of a reserve directions. If it occurs, the reaction deficit. But we are at once faced with will be worse than a prolongation of another. As reserve ratios rise bor­ the present depression. Gradual re­ rowers cannot understand restraints covery is trying, but will be far better. on borrowing. Depreciated exchanges Then, too, we may hope that during carry no warning to most of us. the period of readjustment our Federal Foreign government budgets that fail Reserve Bank will be able to secure con­ to balance and the imminence of de­ trol of the money rate. Such a control faults and perhaps repudiations cause will be no panacea, but it will be an im­ little alarm. A default by Germany in portant aid in bringing more stability her next reparation payment, now in our monetary and banking system.

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Expansion and Contraction as Seen by a Business Man By J. V. F a r w e l l President, John V. Farwell Company, Chicago XPANSION and contraction in as when the war purchases were being volume of business and in credits made, and that prices are going higher. have always existed in modern times.It is this thought that produces his act HumanE nature is such and conditions of expansion. This thought and this of production and consumption are act are often contagious, so that other such that there can be no dead level. people take up the idea and a feverish Unfortunately, these tendencies nearly state of mind, like an epidemic, sets in always run to extremes, so that we among all buyers, which results in usually have, about once in so often, large purchases for delivery running periods of over-expansion, and, as a over a long period of time. consequence, we get over-contraction. Many bankers will admit the existence How Bankers Could Check Over- of the first of these extremes, but they E xpansion are not so ready to admit the second. In the distributing business, for It seems to me that both are very real, instance, such buying requires at the and that in many cases both of these start very little credit, and necessitates extremes can be prevented. hardly any simultaneous credit expan­ As the process of expansion is going sion. The wholesaler might place an on, each business sees most clearly the order for one thousand cases of cotton part that applies to its own experience, goods to be delivered during six months, while the rest of the process is often beginning three to six months after either unseen or obscure. A business date of purchase, the seller being sold man, either in manufacturing or distrib­ up until that time. All that the manu­ uting, comes in contact with the proc­ facturer has to do is to cover his cotton esses of expansion, from the beginning on the cotton exchange and put up a to the end, from the time when the margin for so doing. The wholesaler contract is first made to the end when puts up no money at all and no credit. credit is made for financing and the In fact, no credit would be required credit given in selling. Over-expansion from the banks for, say, sixty to ninety is pretty sure to occur whenever such days, when the first shipment of cotton contract is made for a larger quantity is to be paid for, and no bank credit than a normal amount used by the asked for by the distributer or whole­ business concern, or when it runs saler for perhaps six months, when the through a longer period of time in the bill of the first delivery becomes due. future than is ordinarily contracted It is obvious, therefore, that while for by the company, or when the con­ the business man sees expansion both tract is made for a price considerably at time of making the contract and at in excess of the cost of production. the time when he asks for credit to pay The first step in this expansion is his bill, the banker would know noth­ caused, as a rule, by the state of mind ing, except in a general way, of the of the buyer, who thinks he sees a much great mass of purchases so made until larger business ahead than the company some time after the contracts were has ever had before, or who believes signed, and perhaps not until the bills that goods are going to be very scarce, came due. Bankers are well posted

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 164 T he Annals of the American Academy in a general way only as to what their in a general way that under the Federal customers are doing or expect to do. Reserve System his bank would always In my judgment, they should always look after him and there could be no find out from their customers not only trouble. Many told him if a decline what their stock on hand is at a given in prices did occur, it would come grad­ time, but also what their commitments ually, even though all history tells us or advance purchases are, as these that over-expansion breaks suddenly commitments are often the source of and prices come down sharply. Even as great a loss in the case of a falling with prices raised to three or four times market as is stock on hand. If bank­ above normal, it was often felt that no ers asked these questions continually, merchandising difficulties could arise, especially at the period of requiring for do we not have the Federal Reserve statements from their customers, they Banks? would be in a better position to check Under the old system, before the over-expansion at the start, by either Federal Reserve Act was passed, every discouraging purchases or refusing to bank had to depend to a great extent on give the necessary credit or raising the its own resources, and to live or die ac­ rate of interest charged. cording to the distance it got from shore If, in turn, the Federal Reserve Banks in a storm. This restricted the banker’s were kept in close touch with all these available credit and lessened the mer­ movements through the leading banks chant’s confidence in getting help. Both and merchants, as is now being done banker and business man had a very in many centers, this frenzied state of well defined fear of over-expanding. mind could be cooled off, and large While the Great War was on, and contracts for future high prices pre­ even after the Federal Reserve Act vented. The disease would be stopped was passed, no merchant felt like buy­ before it became an epidemic. It is for ing a large amount of goods at high this reason that it seems to a business prices for long-time future delivery, as man that rates of the Federal Reserve no one could tell when it would be over. System should be raised just as soon as When it was started, some thought it bankers see this situation of expanding would last ninety days, some thought contracts coming on, not when the bill it would last one year, and some two or comes due and the customer asks for three years, but it was all uncertain, credit to pay for it. At that time, the and bankers and merchants stayed banker can do only one of three things: pretty close to shore. They were First, grant the credit; second, advise assisted in not buying at high prices by the customer to repudiate the contract, the action of the government in arrang­ which he would do under the circum­ ing price fixing bureaus. stances, and third, let him squirm out When the War did end, there were no as best he can, no matter what the loss. large contracts outstanding at high The last course would probably cause prices and it took only three or four many failures. months to make the proper re-adjust- ments. "After that, however, mer­ F e a r C h e cks O v e r -E x p a n s io n chants and bankers lost not only all the Over-expansion can be prevented fear which they had had before the only by arousing in the mind of the Federal Reserve Act was passed, and buyer a fear that if he makes an exces­ which formerly produced panics, but sive contract at high prices, he will get also all the fear which existed while the into trouble. He has been led to think War was on.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis E xpansion and Contraction 165 their mad careers. Federal Reserve N eed o p a P ro g ressive R ed iscount Banks, more than ever before, will have R a t e to hold a tighter rein to stop such As this fear is very necessary to both careers by flatly refusing to make banker and business man, I am much in loans and especially by stating before­ favor of the progressive rate of redis­ hand that they will so act. Only such count, so that those who have the dis­ advance information, inspiring the position to offend will know in advance proper fear, will prevent the first acts that they will be heavily penalized. As of over-expansion, which, if allowed, the phrase goes, that clause “puts bring all others in their train with all teeth in the law” and the one who first the consequent disasters. over-expands should be bitten first. A The solution is in the hands of the level rate puts all in advance in the banker. If he will get at the facts and same category and does not stop over­ use his strategic position in granting or expansion at the particular source refusing loans and regulating rates of where it has started. Another reason interest, he could check this over­ why the progressive rate law should expansion before it becomes dangerous. never be repealed is that in many dis­ In saying this, I do not mean that the tricts in the United States 8 per cent banker is as responsible as the business is the normal rate, and 10 per cent not man in starting over-expansion, for the uncommon. Instead of there being a business man is the one who acts first. penalty in charging such banks 7 per However, the banker often has a cent there is a constant inducement broader view of general conditions, not left for them to expand. Federal only in this country, but all over the Reserve Banks must have a sliding world, and can, therefore, see the scale of rates to meet such common general trend of things earlier. It is conditions. for this reason that I have at other As this over-expansion did not occur times contended that the various in the case of all banks and in all dis­ Federal Reserve Banks should have tricts, but with only a certain percent­ raised their rate sharply in November age of the banks in every district, and and December, 1919, when the large as some large banks in big districts were buying movement at high prices began. just as bad offenders as the small Instead of doing that, rates then were banks in country places, it seems to me as low as 4| per cent for rediscount obvious that such a law is not only wise with the Federal Reserve Banks. This but necessary, in order to prevent was almost an invitation to buy heavily over-expansion at the real source and certainly would lead an ordinary whenever it may crop out. business man to assume there would be nothing wrong with the credit situation I n te r e s t R a te s On l y On e C h e c k o n in the near future. Ov e r -E x p a n s io n Perhaps I have laid too much stress P r e v e n t io n of I n v e n t o r y on the efficiency of the rate of interest Sh r in k a g e to stop over-expansion. It is only The second important process in one of the remedies. Bankers them­ general expansion takes place when the selves will have many instances where various business concerns find their they will have to curb banks and mer­ excessive bills coming due and are chants who are willing to pay high rates, obliged to resort to banks for large if only they are allowed to continue in loans. As these goods have been

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 166 T he Annals of the American Academy bought in large quantities at high would have toppled over any way, but prices, it takes from two to three times less damage would have been done by a normal loan to carry a given amount the fall if the base, which was up in the of actual merchandise. This is , re­ air, had not been allowed to grow so peated many times all over the country large. and all down the line through the different processes of manufacturing. P r e v e n t io n of Ov e r -C o n t r a c t io n The deposits and loans go up and dis­ While nearly every one admits that counts at the Federal Reserve Banks over-expansion can be checked, all do increase. While tl^is paper so dis­ not agree that over-contraction can be counted is, in one sense, self-liquidating, prevented. Many bankers have told as the term goes, that is only true inso­ me that we must have a thorough liqui­ far as the prices at which goods are dation, which means, in the last analy­ bought can be maintained. sis, that prices must go below cost of If prices go down half rather sharply, production, mills close up, business as they did in the fall of 1920, it is only stop, much of the circulation of credit one-half self-liquidating, and if the and merchandise cease, until this quantities bought at the high prices thorough liquidation has run its course. are far above normal, it may only be Before the days of doctors and the use one-fourth self-liquidating, because the of remedial measures, it was undoubt­ concern which bought the goods has no edly thought that all epidemics would normal channels through which the have to run their course, that nothing merchandise can be sold. This brings could be done but let the people die. upon the market so-called “distressed In other words, we must have a thor­ merchandise” which is sold regardless ough “ liquidation ” and death of people. of cost or competition, and aggravates It is well known that a proper mental still further an already disastrous situa­ condition of the patient is often just as tion. It is for this reason that the necessary as some stimulus to help out banker should be somewhat familiar the heart action. So in business affairs, with the prices at which goods are proper mental attitude and some assis­ bought, as compared with normal prices, tance from banks and business men before he encourages a merchant to generally is necessary to prevent con­ buy, or before he gets the whole eco­ traction’s going the limit. I think that nomic structure, including Federal Re­ there are often times when it is serve rediscounts, built up on the evident that contraction has about basis of high prices. reached the end, and when the mer­ The Federal Reserve Banks have, in cantile speculation fever at least has my opinion, been very unjustly criti­ gone. At that time interest rates cised for raising rates above six per should be reduced before the irredu­ cent, as though the raising of the rates cible minimum has arrived and some in the spring of 1920 caused all the inducement made for people to go trouble. My only criticism is that ahead and do business, so as to bring they did not raise them early enough about a movement of merchandise and and before all the harm was done by a better employment of the great army the making of the vast amount of long­ of unemployed, which always increases term contracts at the highest prices greatly during an aftermath of extreme since the Civil War. They had to contraction. act some time, and it was better late The War Finance Corporation has than never. The inverted pyramid stepped in and done some of this work

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CttmfeNCY E xpan sio n and C ontraction 167 during the last nine months with great higher and rising cost of living, begin judgment and success. It is extremely to demand more pay, which, in turn, fortunate that we had some such or­ adds to the price of the manufactured ganization to prevent the so-called articles. complete and disorderly liquidation, On the other hand, in times of over­ which some interests seemed to think contraction, the business man and the absolutely essential to better times. banker have often lost their power of direction and voluntary decision. They E d u c atio n th e R e m e d y fo r O v e r - are controlled almost entirely by the E x p a n s io n a n d O v e r -C o n tr a c t io n general populace, which refuses to buy, It is evident that the banker and and by the wage earner, who will not the business man are in a sense trustees consent to a reduction of his wages of the prosperity of the nation, in that commensurate with the changed cost their combined acts, if unchecked, may of living and the new world conditions bring about hard times and unemploy­ brought about by the collapse of the ment to thousands of men who have boom. It seems to me, therefore, that no power of decision in starting a education is needed on both sides, first movement which will result so disas­ to prevent expansion from becoming trously. I say they have no decision over-expansion and contraction from in making the start, although, after it becoming over-contraction. Sound is about half way along, the wage common sense and experience will earners have much to say when they finally be the teachers if expert econo­ begin to buy heavily, and, feeling mists are not.

Currency Expansion and Contraction By James B. F o rg a n Chairman of the Board, The First National Bank of Chicago S is well known, the Federal Re­ rency system needed a thorough re­ serve System is the result of the vision. In 1902 Charles N. Fowler, Afinancial panic of 1907. At least, Charles it G. Dawes and Horace White was this financial crisis that hastened made addresses dealing with the cur­ the establishment of a more rational rency problem at the convention of system of issuing currency than had the American Bankers Association. previously prevailed in the United The chief difference of opinion in that States. To be sure, there had been day was between the advocates of a earlier movements to make possible highly taxed emergency currency and an automatic expansion and contrac­ those of a low taxed credit currency, tion of our currency. As far back as or, as General Dawes spoke of it, “a 1902, and probably earlier, there are system of asset currency subject only to be found discussions in regard to to a nominal tax.” As a result of this our currency at every convention of agitation, there was appointed at that the American Bankers Association. meeting, held in New Orleans, a special Long before the Federal Reserve Act Currency Committee, a forerunner of was thought of, it was clear to any the Currency Commission which still thinking banker that our whole cur­ exists. The Currency Committee ap­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 168 T he Annals of the American Academy pointed in 1902 made a report at the money to tide over a temporary situa­ meeting of the American Bankers tion, and, owing to this inability, a Association held in San Francisco in number of banks failed, and perfectly 1903, in which it favored an emergency solvent corporations and business firms circulation subject to a heavy tax, found themselves in financial diffi­ which, it was hoped, would insure the culties without in the least being guilty redemption of this currency as soon as of any commercial sins of commission the emergency which had called it or omission. The situation had to be forth had passed. Discussions con­ tided over by extra legal methods, tinued until the agitation finally led such as the issuance by clearing houses to the appointment by the Association of certificates which really took the at its convention in St. Louis, October place of ordinary currency and were, 16-9, 1906, of the present Currency therefore, a direct violation of the pro­ Commission, of which Mr. A. B. Hep­ visions of the Federal Constitution. burn of New York has been Chairman A recent writer has summarized the and the writer of this article, Vice- condition as follows: Chairman, ever since its creation. Its The chief defect of the old national bank­ first report appears (pages 100 and ing system was its decentralization re­ following) in the Appendix of the Pro­ sulting in scattered bank reserves. Even ceedings of the Thirty-Third Annual though the national banks of the United Convention of the American Bankers States possessed enormous aggregate cash Association, held at Atlantic City, reserves yet, before the establishment of September 24-7, 1907. Practically the Federal Reserve System, those reserves were ineffective. There was no method everything that now appears in the of mobilizing cash for use where and when Federal Reserve Act was foreshadowed it was needed. No responsible body was in the discussions of this Commission. empowered to adopt or carry out discount or other policies to avoid a financial panic Lesson of Money Panic of 1907 or to handle a panic when it occurred. Probably these discussions would Other countries had economic crises; the have continued to be haphazard and United States not only had crises but without practical result had it not financial panics as well. This is the reason been for the financial panic of 1907. that under the national banking system There is no need to go into the history the United States was called “an inter­ of this panic in this article. Its in­ national financial nuisance/’1 terest to us is due to the fact that it As a result of the experiences of 1907, made clear to the public at large what public opinion compelled Congress to had long been known to experienced take some action, and it appointed bankers, that the country was liable the National Monetary Commission. at any moment to suffer all the evils Thereafter, the Currency Commission of business depression, not because of the American Bankers Association of any inherent difficulties in the busi­ acted largely in an advisory capacity ness situation but owing solely to the to the governmental body with which faulty mechanism which prevented it held frequent conferences in Wash­ the expansion and contraction of the ington. Out of this grew, first, the circulating media in accordance with Aldrich-Vreeland Act, and, later on, momentary requirements. The panic the Federal Reserve Act. of 1907 was due simply to the fact that 1 Persons, “ Basis fot Credit Expansion.” the government was unable to issue Harvard Committee on Economic Research. a sufficiently large amount of paper Vol. II, p. *1.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Currency E xpansion and Contraction 169

C u r r e n c y F u n c t io n of R e s e r v e collateral security consisting of notes, Syste m drafts, bills of exchange or acceptances The Federal Reserve Act, in the acquired either by purchase in the first instance, is designed not so much open market or through the rediscount for the purpose of compelling banks privileges exercised by its member to keep certain fixed reserves and the banks. The Bank is compelled, in ad­ like, as, primarily, to meet the changing dition, to maintain reserves of gold requirements for currency, a function of not less than forty per centum which the large central banks of against its Federal Reserve notes in Europe have performed for their re­ actual circulation. This gold reserve spective countries for many decades. held against Federal Reserve notes may It is difficult to see how we could have fall below forty per centum, in which weathered the storm of the War and case “the Federal Reserve Board shall the years immediately following with­ establish a graduated tax of not more out some such arrangement as that than one per centum per annum upon provided by the Federal Reserve such deficiency until the reserves fall System. It is a well known fact that to thirty-two and one-half per centum, the banks have been and are carrying and when said reserve falls below many industries which would have thirty-two and one-half per centum, been forced to the wall, injuring our a tax at the rate increasingly of not less whole credit structure, had it not been than one and one-half per centum per for the fact that the banks in turn annum upon each two and one-half have been able to obtain needed cur­ per centum or fraction thereof that rency from the Federal Reserve Banks such reserve falls below thirty-two and by rediscounting notes. Since banks one-half per centum.” 2 are compelled to meet the demands It is interesting to note that practice made upon them by payment of cur­ has shown that this check provided by rency over their counters, they would the Act has proved to be entirely otherwise have reached the end of their sufficient under the most exacting resources almost immediately, owing and trying conditions. Though there to the tremendous expansion of busi­ have been times within the last few ness caused by the War. They would, years when the net reserve of gold therefore, in order to meet their own against Federal Reserve notes out­ liabilities, have been compelled to call standing was dangerously close to the upon business houses to pay off their legal minimum required, .the ratio loans and, if necessary, would have had never actually fell below forty per to demand the liquidation of perfectly centum. solvent business enterprises in order It is under these provisions that the to obtain the needed repayment. The so-called expansion and contraction of banks, fortunately for our whole our currency has taken place and is country, have not needed to resort taking place. The total circulation of to such extreme measures, owing to currency of all kinds in the country the rediscount privileges inaugurated on September 1,1921, was $4,672,030,- by the Federal Reserve System, with 221, of which more than one-half which rediscount privileges our cur­ was represented by Federal Reserve rency system is closely connected. notes. While at the beginning of this The Federal Reserve Act provides year the total circulation of all cur­ that any Federal Reserve Bank may rency amounted to $5,500,702,153, the issue Federal Reserve notes based on 2 Federal Reserve Act. Sec. 11 (c).

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 170 T he Annals of the American Academy changes were almost entirely in the item From this it is evident that under of Federal Reserve notes, since the rest the Federal Reserve Act we have had of the currency is more or less constant. almost no experience in expansion and contraction, though more than enough C u r r e n c y I n f l a t io n a n d in inflation and, at present, in defla­ D e f l a t io n tion. In other words, the establish­ Before going further into this ques­ ment of the Federal Reserve System tion of expansion and contraction of our was followed almost immediately by currency, it is necessary to distinguish the crisis brought on by the European sharply between currency expansion War, which, owing to governmental and currency inflation. A recent article needs, brought about an inflation of defines these terms as follows: the currency entirely out of pro­ Currency expansion is the absolute in­ portion to the ordinary normal busi­ crease in currency of various forms—chiefly ness requirements. Likewise, the re­ gold, silver, bank notes, government notes, action that has taken place since last and deposits subject to check. Its op­ year is a process of deflation, again out posite is contraction of the currency. of all proportion to what is to be Currency inflation , on the other hand, is expected under normal and regular relative, that is to say, an expansion of business conditions. One thing, how­ currency out of 'proportion to the increase in the absolute quantities of goods and ever, has been proved, and that is that services exchanged, due allowance being the raising and lowering of the re­ made for variations in offsets of book credits, discount rates by the Federal Reserve in the “rapidity of circulation” of currency, Banks influences very greatly the lend­ and in the frequency with which goods and ing of money by the banks. The services are exchanged. The reverse is question may be raised whether this is currency deflation —a decline in currency not due more to the pressure of the relative to the amount of goods and services example set by the Federal Reserve exchanged. Currency inflation rarely takes place in exact proportion to currency ex­ Banks than to the mere change of a pansion, or deflation in proportion to con­ relatively small percentage in the traction, since changes in quantities of rediscount rate. But be that as it may, goods and services exchanged are constant­ the banks in the country have fol­ ly taking place. For the same or other lowed the lead of the Federal Reserve causes, the equivalent of currency inflation System. Possibly it would have been or deflation, or, one might say, effective well if the raising of the rediscount currency inflation or deflation, may take rates after the Armistice had taken place without corresponding changes in place earlier. It is an open secret that the quantity of currency. So, after the the members of the Federal Reserve Civil War, deflation in the United States was accomplished in the main, by “growing Board, as well as of the Federal Ad­ up to the currency” rather than by con­ visory Council, advocated such a traction. On the other hand, changes in policy long before it was put into the currency requirements ordinarily take effect. The needs of the government, place slowly; consequently, a marked ex­ however, intervened, and the necessity pansion of currency usually involves cur­ for the Treasury to complete its war­ rency inflation; and deflation is usually time funding operations superseded accomplished but slowly if it is unaccom­ the dictates of a sound economic panied by contraction of the currency.3 policy. Likewise, the successive low­

3 Davis, “ World Currency Expansion.” Har­ ering of the rediscount rate may be due vard Committee on Economic Research. Vol. more to the exigencies of politics than II, p. 8. of sound banking practice. A recent

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Currency Expansion and Contraction 171 pamphlet issued by the Chase National contraction of the currency, demanded Bank of New York has presented by the continuing changes in business many effective arguments which tend conditions. As the country becomes to show that the rediscount rates ought more densely settled and industrial to be determined by the prevailing development continues, there will be commercial paper rate, rather than by need for a gradual permanent expan­ other considerations. sion of currency which will be met The peak of Federal Reserve notes partly by increase in actual metal, in actual circulation was reached on but largely by the increase in other October 22, 1920, at which time these forms of currency. Beside such per­ amounted to $3,356,199,000. These manent increase, there will be the notes were first issued in November, seasonal expansion and contraction 1914, but in the beginning increased which appears in the statistics of the very slowly. Even as late as July 1 , central banks of all the larger coun­ 1917, the total of Federal Reserve tries. These seasonal changes do not notes outstanding was only $544,412,- coincide in the various countries. In 775. By July 1,1918, the amount had, countries with little agriculture, which however, more than trebled, amount­ are, therefore, compelled to import ing at that time to $1,713,074,255. At most of their raw materials, the time the time of the Armistice, the amount of largest expansion is apt to fall at a had increased to $2,562,517,000, and different time of the year from that on September 21, of this year, the in countries which are solely or very amount in circulation was still $2,- largely agricultural. We are in a 474,676,000, a reduction, however, of transition period and what is true to­ nearly one billion dollars from the day may not be true a few decades highest point. It is to be hoped that hence. At present, however, our this reduction will continue until we period of largest expansion is likely reach a point which may be regarded to be at crop-moving time, with con­ as meeting the normal requirements traction taking place after the opera­ of business. Until now, banks of the tions connected with the movement of country have acted in a patriotic man­ the crops have been completed. ner and have generally forced liquida­ Probably for the present, the ex­ tion. It may be feared, however, that periences of Canada are most likely such an unselfish policy will not be to furnish us an example. Canada’s continued indefinitely if the Federal banking system is centered in a group Reserve Banks, by keeping the re­ of so-called chartered banks, of which discount rate below the ordinary com­ there were twenty-four in 1914 and mercial rate, make it profitable for only eighteen in 1920. These banks their member banks to lend as much have over four thousand branches as possible. We therefore face the throughout the Dominion, providing danger of a period of renewed inflation for its commercial needs and, in ad­ which must not be confounded with dition, serving as the chief savings normal expansion as defined above. institutions of the country. They are subject to comparatively little govern­ C u r r e n c y E x p a n s io n a n d mental supervision, although the Cana­ C o n t r a c t io n dian Bankers’ Association is a public As already indicated, the real func­ institution whose secretary-treasurer tion of the Federal Reserve System is has supervisory power over note to make possible the expansion and issues. The banks are required to

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 172 T he Annals of the American Academy make a monthly report of their con­ dition to the minister of finance. Canada’s currency consists for the most part of bank notes. The banks are auth­ 1 O)fit H HIQ HCO I >• ooo 05i> orized by law to issue notes up to the amount Q* <5* O* <51 < ! 0* rH of their paid-up, unimpaired capital plus any amount they may have on deposit in the central gold reserve. In addition to 'pW®«) 00 o f CO < co t- S ©*00 00 00 05 00 001>i to 15 per cent of their capital and surplus ©* 05 COrH eo 1 combined, but this additional circulation CO <5* § s < bears interest at 5 per cent. The privilege of issuing additional circulation may be extended to cover the entire year, and, as a matter of fact, has been so extended dur­ I 05 CO CO 00 rH 00 CO co oo « 5 05 I O b* « 00 05 ^ 0 0 b - ing recent years. The chartered banks ^ 00 *0 ^ 05 CO oo 00 © ' ^ oT co ©f tjTo f 05 00 rH I 05 e * CO 00 rH co i> rH are not required to carry any special re­ ^ oo »o i> co 00 O o co serves against their circulation, except > © co oo 05 e f oo oo 0 5 © f. OO*' i> that they must deposit with the minister :! Ho* Ha* ©*©*©<©*fi) H N el ©*w ©* < of finance, gold or Dominion notes up to 5 per cent of their average circulation. These deposits constitute the bank-note ^COJ>HC005H^0505H»0 redemption fund. The principal security h COt^OrHOSCO^OS *0 CO 00 ^ against circulation, however, is found in Ho »o®^oi>i>rooco*c^i>co the fact that the notes are a first lien on fc S 8 § S § § 3 § S 8 3 3 the banks’ total assets and in the further S l>®foOO?»Cr05»crrH00050005O05OO05OHHHO fact that the stockholders are subject to double liability on the notes. Bank notes are legal tender throughout the Dominion. It is to the interest of each bank to main­ H 00 00 H OO 00 ' «5 00 ©5 00 08 *6 < tain as high a circulation of its own notes O* 05 0> H l> H rf O W 00 rH »«H^HH(SO«05!>^ as the law permits. Each bank will, there­ 05 OOSOOi-HOOOOOWiOOCO^O fore, pay its customers over its counter 000005050500500HHH00^ OO*1 OO1 »C W WJ rH ^ o' O only notes issued by itself. When the community’s need for circulation contracts, notes will be deposited in the banks and the banks will return to the issuing banks the notes in their possession, and thus re­ HiQOOOOXQftOCOHCO^J>00»QOOH051>001«««50 «l>t^O©?aoao©i>«sooi> h. a) rr\ kT >^T duce the outstanding volume of circulation. ri VJA wi CO H H 00 05 tP 00 rH^OSO^COOOCO^OQil^rHOO^O^O In other words, since the notes are obtain­ l> 05 H 00 H oo* a o*1 1* " H o ? able from any bank on demand and on the l>i>QOQ00000000505000 other hand can always be deposited with the banks as soon as they are not needed, the circulation in the hands of the public does not exceed the requirements of trade and industry.4 The Canadian statistics for the years immediately preceding the War and those since the War are given in next column. to & £ S 8 4 Federal Reserve Bulletin. December 1919, 1 ji S'S« ? 11 p. 1142.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Currency Expansion and Contraction 173 It will be noticed that the circula­ rily during normal and less trying tion increases very largely in the last years. It will be necessary, however, months of each year and decreases at for the Federal Reserve Banks to the beginning of the year. This has educate the bankers of the country been true even since the War, in spite gradually to a conception that the of the fact that Canada has had a Federal Reserve Banks are to be re­ period of inflation similar to our own. garded strictly, as their name implies, It is also interesting to note in this as a last resort, and that the redis­ table that naturally there has been a count privileges are to be used, there­ very large increase of bank notes since fore, sparingly and only in times of the War, and that the contraction stress and strain. There is a danger which has taken place has by no that, owing to the peculiar conditions means been sufficient to bring the under which the System began, its total back to that of the pre-war reserve function may have been for­ period. Probably this is due in Canada, gotten. If the Federal Reserve Banks as in our own country, to the fact that will have the courage to keep the part of the apparent inflation is really rediscount rates above the prevailing a natural expansion due to general market rate, banks and bankers will commercial development within the gradually learn to make use of their country. rediscount privileges only in case of In the case of the European coun­ real necessity. tries, on the other hand, the inflation This may cut down the large profits has been much more severe, culmin­ which the Federal Reserve Banks ating in Austria Hungary, where the have earned in recent years but, after note issues of the central banks in­ all, the reason for the establishment creased twenty-fold. Everywhere the of these banks was not to earn money elasticity of the currency provided by either for themselves or for the govern­ central banking institutions has pre­ ment, but to prevent losses to the vented the most severe financial pan­ business and banking communities of ics, though, of course, nowhere could the country. Every true well-wisher it prevent commercial crises due to of the Federal Reserve System will de­ the general situation. sire that in course of time it limit itself to the purposes for which it was P r o pe r P o l ic y a s to created, that it may be kept out of R ed isco un t R a te s politics, and that it may not be used To summarize: Bankers have had as a panacea for all financial evils too little experience to state definitely threatening the country as a whole, how the expansion and contraction of or any class or section thereof. Its the currency under the Federal Re­ real, primary and sole function is, serve System is going to work under and ought to be, to provide an elastic normal conditions. The unusual stress currency which may prevent unneces­ to which the Federal Reserve System sary financial panics of which we have was subjected at the very outset must experienced too many in the past. As make bankers and business men every­ one who had much to do with the dis­ where realize that the System, if prop­ cussions preceding its creation and erly managed and kept free from who acted as a fatherly adviser during politics, ought to have no difficulty the years of its infancy, the writer whatsoever in functioning satisfacto­ expresses the wish: vivat, crescat.floreat.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 174 T he Annals of the American Academy Expansion and Contraction from the Federal Reserve Standpoint

By J o h n H. R ic h Chairman and Federal Reserve Agent, Federal Reserve Bank of Minneapolis F kept clearly in mind, several facts speaking, is a matter of adaptability to I will aid in an understanding of the circumstances rather than the product problems which the Federal Reserve of careful observance of economic law, Banks have encountered in attempting sound financial principles and scien­ to exercise an appropriate and scientific tific methods. This thought might be control over the expansion and con­ summarized in the statement that traction of both currency and credit. banking is in a highly evolutionary The United States is a country of im­ condition in the United States, and mense extent, of the greatest diversity that for the past ten years the period in its stages of development, in produc­ has been a transition from a rather tion and in the local availability of archaic and outworn banking system capital and investment funds. It is a to a modern and scientific mechanism, comparatively new country and in the somewhat broader than banking itself, less developed sections banking is more that will eventually provide the United of a business than a profession. As a States with the efficient system for nation we lack the beneficial influences banking, exchange and credit control of custom, precedent and the fruits of which it needs as its equipment for a ancient experience. Instead of a hom­ proper participation in the financial ogeneous population, we have invited activities of the world. racial elements from every part of the earth, who have brought with them P o w e r s o f R e s e r v e S y s t e m L im it e d their own peculiar ideas and customs, In the nature of things, the Federal all of which must be recognized from Reserve System is not all-inclusive. the standpoint of practical banking, The System embraces in it only the and all of which tend to exert influences national banks of the United States, that retard the adoption of uniform although the Federal Reserve Act also practices and scientific banking meth­ extends liberal privileges to the much ods. Bank management is of as di­ more numerous state banks and trust verse a character as the primary inter­ companies. In membership,1 the Fed­ ests of the various states, and, broadly eral Reserve System embraces 9,745 1 U. S. Bank Figures— Jnne 3 0 , 1 9 2 1 . Per Cent Per Cent Total* In F. R. Sys.b Total Out of F. R. Sys. Total

No. of Banks...... 30,815 9,745 3 1 . 6 21,070 6 8 . 4 Capital...... $2 ,9 0 4 ,511,000 $1,8 5 8 ,710,000 6 3 . 9 $1,0 4 5 ,801,000 36. 1 Sur. & Undiv. Pf...... 3 ,4 5 4 ,639,000 2 ,2 7 3 ,795,000 6 5 . 8 1 ,1 8 0 ,844,000 3 4 .2 Total Resource...... 4 9 ,6 8 8 ,839,000 3 0,8 8 3 ,023,000 6 2 . 2 1 8,8 0 5 ,816,000 3 7 . 8 Loans & Dis. & Redis... 2 8 ,9 4 4 ,708,000 18,5 5 1 ,120,000 6 4 . 2 10,3 9 3 ,588,000 3 5 .8 Investments...... 11,3 8 4 ,334,000 6 ,1 04,655,000 5 3 . 6 5 ,2 7 9 ,679,000 4 6 . 4 BaJ. due from banks. . . . 4 ,7 9 5 ,387,000 2 ,9 7 8 ,276,000 62.1 1,8 1 7 ,111,000 3 7 . 9 Individual deposits .... 3 5 ,4 7 2 ,563,000 19,6 5 8 ,809,000 5 5 . 4 15,8 1 3 ,754,000 4 4 . 6 Nts.& Bills redis...... 1,2 7 1 ,684,000 1,2 4 3 ,764,000 9 7 . 8 2 7 ,920,000 2 . 2 Bills payable...... 1,3 7 6 ,891,000 8 1 2 ,241,000 5 9 . 0 5 6 4 ,650,000 4 1 . 0 • Comptroller of Currency’s Press Statement, October 3 1 , 1 9 2 1 . b Federal Reserve Board Report, June 3 0 , 1 9 2 1 .

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Standpoint on E xpansion and Contraction 175 institutions out of 30,815 in this coun­ was due to the quick responsiveness of try, or 31.6 per cent. It includes 63.9 these notes to any demands for issue per cent of the banking capital of the and the fact that they cannot be kept United States; 65.8 per cent of the sur­ in circulation except in response to plus and undivided profits, and it demand. comprehends 62.2 per cent of the total Another factor of great importance resources, and was carrying on June 30 in connection with the whole question of the present year, 64.2 per cent of the of expansion and contraction relates to loans and discounts, including redis­ the actual degree of power which the counts, of the country. It then held a Federal Reserve System is able to exer­ little more than half of the individual cise over its membership. Its powers deposits of the United States. With are specifically indicated in the law 8 and two-thirds of the membership and more are in the main of a general and super­ than one-third of the resources of the visory character. The law seems to in­ banks of the country outside of the dicate quite clearly what specific rights system, it is obviously impossible to a member in the Federal Reserve Sys­ expect it to exercise any complete con­ tem enjoys, but limits in quite a distinct trol over expansion and contraction of way the power and control over mem­ credit. Its power over currency expan­ bers to be exercised either by the Fed­ sion and contraction is limited, due eral Reserve Banks or the Federal Re­ to the competition of other forms of serve Board. In a certain sense and money than Federal Reserve and Fed­ considering the subject purely from a eral Reserve Bank notes.2 practical standpoint, the real powers The rather powerful influence which of a Federal Reserve Bank over its the Federal Reserve System exer­ members are indirect and rise out of its cised during the war period, particu­ contact and association with members larly since the radical advances in com­ at times when they are borrowing. It modity prices, was fortuitious and is difficult to see what very practical due largely to the fact that under the powers a Federal Reserve Bank might country’s pressing need for a sharply exercise over the non-borrowing ele­ increased volume of currency with ment in its membership. Every Fed­ which to handle its current exchanges, eral Reserve Bank has had such an its previously existing and rather in­ element of rather substantial propor­ flexible issues were submerged to the tions throughout the war period. It is extent that the overburden of Federal authorized to insist that its members Reserve notes and Federal Reserve maintain their capital stock at the Bank notes became the dominating figures fixed by law, that they carry factor in the currency situation. This unimpaired reserves and that they make appropriate periodic reports. It 2 The Secretary of the Treasury’s Circulation is divested of any power to control the Statement of October 1, 1921 shows gold coin policies or loan operations of members and bullion, $9 03 ,163,0 0 0 ; gold certificates, $5 1 4 ,- 9 0 1 ,0 0 0 ; silver dollars, $7 5 ,3 8 8 ,0 0 0 ; silver cer­ and has no authority whatsoever over tificates, $22 6 ,6 1 0 ,0 0 0 ; subsidiary silver, $26 1 ,- the rates charged by a member to its 6 0 2 ,0 0 0 ; treasury notes of 1 8 9 0 , $1,5 6 2 ,0 0 0 ; customers. United States notes, $3 4 1 ,6 1 3 ,0 0 0 ; national bank It naturally has no powers of any notes, $7 2 8 ,3 1 4 ,0 0 0 ; or a total of $3,0 5 3 ,153,000 as compared with $2 ,5 1 8 ,963,000 of Federal 3 See Section 13 of the Federal Reserve Act. Reserve notes and $1 19 ,163,000 of Federal Re­ Powers of Federal Reserve Banks— Section 11. serve Bank notes, or a total of $2,6 3 8 ,126,000 of Powers of the Federal Reserve Board— Section Federal Reserve issues. 4 . Corporate powers of Federal Reserve Banks.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 176 T he Annals of the American Academy character over the numerous non­ plished is clearly stated in the law4 un­ member banks, except that through der which each Federal Reserve agent wise leadership it may inspire the de­ in each Federal Reserve Bank, with the sire to conform to sound policies. In approval of the Federal Reserve Board, a period of inflation the rapid expan­ is authorized to draw from the Comp­ sion of member banks’ loans and dis­ troller of the Currency and issue to his counts becomes a matter of first im­ Federal Reserve Bank on the presenta­ portance. Over such a rising tide of tion of gold and proper collateral, Fed­ borrowings the power of a Federal Re­ eral Reserve notes for issue to member serve Bank is limited. It can restrict, banks. Upon the application of a mem­ or, for cause, it might refuse the appli­ ber bank in good standing, accom­ cation of a member to rediscount; but panied by a tender of eligible paper for its ability to control is largely centered rediscount and credit, the Federal Re­ in its position as an adviser in which it serve Bank in practice immediately de­ would employ the facts developed by its livers Federal Reserve and Federal examiners and endeavor to create a Reserve Bank notes in such amounts clear understanding of all the factors as may be requested. The process of which the situation might involve. In issue is therefore as nearly automatic this capacity its value would be largely as may be, and is properly founded upon the assumption that member through wise suggestion and guidance. banks will not request Federal Reserve There is therefore some question as issues unless they need them and that to the degree of power to control which the necessities of their communities the Federal Reserve System has over will rule. even its own membership. Its real Once issued, the Federal Reserve power, which cannot be denied, lies not note moves through the member bank in legal authorization or specific grant into the hands of the public and when of regulatory authority, but in the it is no longer needed will find its confidence it can inspire because of way back into a bank. Banks which sound leadership and the value it can have accumulated more currency than give to membership because of the busi­ they have use for, will remit to their ness advantages flowing therefrom. correspondents or to their Federal Re­ An important degree of voluntary coop­ serve Bank direct. The correspondents eration has existed and extends far are largely members of the Federal Re­ beyond the confines of its own mem­ serve System and the remittance of bership, due to the enlightened self- their excess accumulations is a matter interest of progressive institutions. It of daily routine. Upon receipt by a might be said that in a sense the Federal Reserve Bank, returned notes Federal Reserve System, while it is an are sorted and under the law must be efficient organization, is more like a shipped at once for credit to the bank voluntary federation of common inter­ of issue. The particular Federal Re­ ests for their own good. serve Bank has therefore no right of reissue except as to its own notes. C u r r e n c y E x p a n s io n a n d Those consigned to other Federal Re­ C o n t r a c t io n serve Banks will reissue or not as the Not a great deal need be said of cur­ demand of that Federal Reserve Dis­ rency expansion and contraction as it trict may indicate. If they do not re- relates to Federal Reserve issues. The 4 Federal Reserve Act, Section 1 6 . Note mechanism by which this is accom­ Issues.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Standpoint on E xpansion and Contraction 177 issue, they are ordinarily returned for control and currency will at last be credit to the Federal Reserve agent or upon a strictly flexible basis and will if worn and unfit find their way to have the scientific basis which was early redemption and destruction. If contemplated in drafting the Federal fit, they are stored against the next peri­ Reserve Act. od of demand. The method of retire­ The course of Federal Reserve note ment and redemption is therefore quite circulation in connection with the price as automatic, although somewhat movement during 1920 was very in­ slower in process, than the method of teresting. United States wholesale issue. There can be no question but prices, based on the percentage of 1913 that the mechanism instituted under average prices,5 reached their high the Federal Reserve Act to create flex­ point of 264 in May of that year. ibility of currency expansion and con­ United States retail prices, based on traction has operated with entire suc­ the percentage of 1914 average prices,6 cess, and that Federal Reserve notes held during June and July, 1920, at possess these highly desirable qualities their high point of 215. The high point which were lacking in other currency of Federal Reserve issues was reached issues of this government and in na­ during the last week of October7 and tional bank notes. the first week of November, or sixty The course of Federal Reserve note days later than the peak of retail prices issues since late in 1920 has been down­ and since that time have steadily de­ ward. They reached their peak in clined. The comparative curves tend November, when the aggregate issue to prove the accuracy of the view that was $3,349,000,000, and by October 1, currency expansion was the product 1921, declined to $2,518,963,000. This and not the cause of price inflation and recession of $830,496,000 was as sig­ that currency contraction (Federal nificant of the power of contraction in­ Reserve issues being the only issues herent in Federal Reserve notes, as having a real flexibility) was the nat­ was the earlier rise indicative of their ural product of the downward turn in responsiveness to the issue demand. prices. In paying cash for wheat at In due time Federal Reserve Bank country elevators, it obviously takes notes amounting to $119,163,000 will more currency to buy wheat at the be retired. At a later date under pro­ high point of more than three dollars visions of the law, national bank notes than at the current price of about one (on October 1, 1921, amounting to dollar. In the agricultural districts the $728,314,000) will likewise disappear natural result is that member banks from circulation. Treasury notes of will request Federal Reserve notes in 1890 are a small factor and their grad­ larger volumes during periods of rising ual retirement has been provided for prices and that their use for currency by law. There will remain $341,613,- will fall off sharply on a declining 000 of United States notes for which no market. retirement provision is included in the An important element in maintaining law, and the gold and silver certificates. the flexibility and responsiveness of It is therefore probable that with the Federal Reserve issues to influences gradual fall in Federal Reserve issues that tend to expand or contract them, there will also be a gradual drift toward is the fact that in current rediscounting the elimination of competing factors in 5 Federal Reserve Board’s Price Index. the circulation, with the ultimate re­ 6 United States Bureau of Labor Statistics. sult that Federal Reserve notes will 7 See Footnote reference on page 1 7 8 . 13

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 178 T he Annals of the American Academy operations the larger part of Federal Reserve membership wants credit and Cr e d it E x p a n s io n a n d C o n tr a c t io n not notes. Its demand for notes is The currency provisions of the Fed­ wholly the product of local conditions eral Reserve Act have proved a distinct and there is no occasion to request cur­ achievement in financial legislation. rency shipments unless the local cur­ The expansion and contraction of rency supply is insufficient. Credit at credit is not so simple a problem. In the Federal Reserve Bank is more considering it from a Federal Reserve adaptable to its ordinary needs. standpoint the membership figures of It may therefore be said that cur­ the System become in some respects rency issues from the standpoint of more significant than other items of the Federal Reserve Bank occasion the consolidated bank statement of the practically no concern. They increase country. Less than one-third of the or diminish as the fluctuating condi­ country’s banks are in direct contact tions of each business day may indi­ with the twelve Federal Reserve Banks. cate and their connection with such Even this one-third may not be as­ conditions is of the most intimate char­ sumed to have continuous contact, acter. The rise and fall of Federal Re­ since even during the recent period of serve issues is so nearly automatic that very severe credit strain it has con­ it requires no extraneous suggestions tinuously included a substantial non­ or encouragement. borrowing element with which the con­

7 Trend of Wholesale and Retail Prices and Bills Discounted by Federal Reserve System and Fed­ eral Reserve Notes in circulation January, 1920 to September, 1 9 2 1 . U. S. Wholesale U. S. Retail Prices Bills Discounted Federal Reserve Prices Per Cent Per Cent of 191k By Whole F. R. Notes in Actual of 1913 Average Average Price System on Last Circulation Whole Price {Federal (U. S. Bureau of Reported Date in F. R. System on 1920 Reserve Board) Labor Statistics) Month (000*s Last Reported Omitted) Date in Month (000*s Omitted)

January...... 2 4 2 $2 ,174,357 $2 ,850,944 February...... 2 4 2 2 ,453,511 3 ,019,984 March...... 2 4 8 196 2 ,449,230 3 ,048,039 April...... 2 6 3 2 0 7 2 ,535,071 3 ,074,555 M ay...... 2 6 4 211 2 ,519,431 3 ,107,021 June...... 2 5 8 215 2 ,431,794 3 ,116,718 July...... 250 2 15 2 ,491,630 3 ,120,138 August...... 234 2 0 3 2 ,667,127 3 ,203,637 September...... 2 2 6 199 2 ,704,464 3 ,279,996 October...... 2 0 8 194 2 ,801,297 3 ,351,303 November...... 190 189 2 ,735,400 3 ,325,538 December...... 171 175 2 ,719,134 3 ,344,686 1921 January...... 163 169 $2 ,456,475 $3,090,748 February...... 154 155 2 ,396,254 3 ,051,706 March...... 150 1 53 2 ,286,648 2 ,930,729 April...... 143 149 2 ,063,739 2 ,830,118 M ay...... 1 42 142 1,870,256 2 ,734,804 June...... 139 141 1,771,562 2 ,634,475 July...... 141 145 1,650,496 2 ,537,617 August...... 143 152 1,491,935 2 ,481,466 September...... 1,402,903 2 ,457,196

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Standpoint on E x pa n sio n and Contraction 179 tact of the Federal Reserve Bank was ever, is not true. In the partially de­ of a limited and oftentimes of quite an veloped sections of the West it has been indirect character. In this situation the habitual practice to attract outside probably lies the seeds of the failure of funds by offering attractive rates on the theory that a fluctuating rediscount time deposits, which, once established, rate is an engine for credit control. have automatically forced up the loan Obviously Federal Reserve redis­ rate of the bank to its customers. count rates can control, if at all, only Rates on time money change very little such banks as pay them, and such in western United States and they, more banks may not confine their borrow­ than any other factor, dominate and ings to the Federal Reserve—in fact control the rate which must be charged they seldom do. The influence of the to the borrower if the bank is to make a rediscount rate must be of an indirect, profit. and probably of a very tenuous char­ It would appear that the only points acter as to all non-borrowing banks, where the interest rate shows a proper member or non-member alike. In most responsiveness to the rise and fall of of the Federal Reserve Banks there has free funds is at the commercial cen­ been some disappointment at the doubt­ ters or in the sections which have ful effectiveness of the rediscount rate attained their development. In the in periods of rapid expansion of credit. very large western areas it has been To the man whose mind is fastened noticeably true that the rate to the upon a prospective profit it is alto­ farmer and stock raiser has changed gether improbable that an upward but little throughout the entire war revision of one-half of 1 per cent in period including the last twenty-two a rediscount rate which he does not months of very severe strain on credit. pay directly, will tend to curb him or This applies particularly to the best moderate his activities. Over the agri­ names. The availability of credit cultural portion of the United States fluctuates more than the rate. Such a the bank rate of interest is as near to condition has not prevailed at the cen­ a stable rate as any example that the ters where the rate even to the best United States affords. In developed names has fluctuated in accordance agricultural sections the tendency of with a changing money market. These the bank rate is to remain at practi­ were conditions which the Federal Re­ cally the same level throughout the year, serve Banks were not called upon to and, for that matter, over a period of encounter until after the war period of years. The same tendency is notice­ artificial prosperity had largely spent able in the less developed agricultural itself. It then became apparent that sections, although the rate levels are they entailed very serious problems, higher, and even where bank rates the gravest of which did not develop reach their highest levels the rate it­ until the sharp fall in prices began to self is subject to comparatively little cause cancellations and extraordinary change. inventory losses, and to impair the Where there are surplus capital and credit standing of many responsible funds for investment, it is natural that firms. In the stock-growing districts the importance of agriculture should the market for wool collapsed. Live be recognized and that ample funds stock prices receded sharply. In the should translate themselves into fairly agricultural sections farmers who antic­ stable and relatively low rates to agri­ ipated a continuance of the extremely cultural borrowers. The reverse, how­ profitable price levels saw corn drop to

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 180 T he Annals of the American Academy a point where it was more profitable to the financial and business judgment of burn it than buy coal; and wheat went the country will strongly support the down to a third of its high war price. policies pursued by the Federal Reserve Banks when they are properly under­ R e serve B a n k P o l ic y D u r in g stood. A narrow or hidebound interpre­ B u siness C o n t r a c t io n tation of the law, irrespective of the very If every merchant and farmer caught great physical difficulties which must in the jaws of this distressing situation be encountered in any effort to trace had been improvident, lacking in fore­ the movement of the proceeds of redis­ sight and not entitled to bank support counts through a large city institution, and bank credit, the problem might would immediately have meant the have been easier. It would then have failure of many hundreds of state in­ been simple to say that Mr. Smith and stitutions, a large proportion of which Mr. Jones had reaped the fruits of their were, under the Federal Reserve Act, own errors and to have permitted them ineligible for membership because of to take the usual course through bank­ insufficient capital. The strain upon ruptcy. The conditions, however, were the Federal Reserve System was severe somewhat different. While a certain enough and there could have been no amount of recklessness, extravagance justification for inviting the crisis and failure to consider the future, which would have been precipitated doubtless existed, price changes were had the very numerous non-member so radical as suddenly to cripple and banks lacked a place to go to borrow. often seriously to embarrass, entirely What happened during the year end­ worthy and reputable commercial, in­ ing April 28,1921, is very interestingly dustrial and agricultural interests. It shown in a chart prepared under the was necessary in such cases that the direction of Mr. Benjamin Strong, banks show no hesitancy in supporting Governor of the Federal Reserve Bank every worthy borrower to the full ex­ of New York. Classifying all the mem­ tent of their power. bers in the Federal Reserve System by It is an interesting fact that this their location in agricultural, semi- power to help was, to an extraordinary agricultural, and non-agricultural coun­ extent, based upon the power of the ties, we find that during this period the Federal Reserve System to extend aggregate deposits of banks in non- credit. Access to the Federal Reserve agricultural counties fell off 4 per cent. Banks was a right enjoyed, under In semi-agricultural counties the de­ specific provisions of the law, by every crease was 5 per cent; but in the agri­ member bank. There was, however, cultural counties the decrease was 11 no legal bar to loans by city corre­ per cent. As to their aggregate loans, spondents to non-member country the decrease in non-agricultural coun­ banks, and the immediate result was ties was 6 per cent, and in semi-agri­ that the very heavy rediscounting of cultural and wholly agricultural coun­ banks at the centers was translated ties the decrease was in each case, 1 into equally heavy loans to non-mem­ per cent. In their aggregate borrow­ ber institutions at widely scattered ings from Federal Reserve banks, non- points, irrespective of the provision of agricultural counties fell off 29 per cent, the Federal Reserve Act that denies while semi-agricultural counties re­ the use of the credit facilities of the ceded only 2 per cent and wholly Federal Reserve System to non-mem­ agricultural counties increased their bers. There is no question but that borrowings 57 per cent. In aggregate

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Standpoint on Expansion and Contraction 181 borrowings from other sources than the vency. Within a very brief period Federal Reserve System, the non-agri- fifty-three banks in a certain western cultural counties increased 1 per cent; state, and numerous banks in the the semi-agricultural counties, 19 per South and in other portions of the cent and the agricultural counties, 66 country, mainly in districts that are per cent. It therefore appears that agricultural, went to the wall. In such agriculture, in which is included live an emergency it is fruitless to rely upon stock, drew down its deposits, failed to the fluctuations of a discount rate. An decrease its loans, and in both cases increase of 1 per cent would not de­ made extraordinary increases in its ter a bank in very grave difficulties borrowings. from presenting eligible paper for A situation such as this was sure to rediscount at a Federal Reserve Bank. produce peculiar problems in a Federal There can be no question of the legal Reserve Bank. Let us suppose that in right of a member in the Federal Re­ one of these agricultural sections a serve System to present eligible paper member bank had already increased for rediscount. Upon the presentation its loans and discounts to the limit of of such paper the problem becomes one safety while carrying reasonable redis­ for the executive committee and execu­ counts with its Federal Reserve Bank tive officers to solve. They must deter­ and substantial bills payable with cor­ mine whether in view of all the facts respondents. The long delayed liqui­ and circumstances the rediscount of dation in its territory fails to develop. particular applications is justifiable. Its farmer customers, perhaps five or I have indicated that during the recent six hundred in number, are man and abnormal period the justification of re­ man alike obliged to pay their debts discount did not necessarily depend contracted on a basis of high wheat wholly upon the credit standing of the and high corn, with wheat and corn applicant or upon the character of the having an abnormally shrunken mar­ paper presented. Because of these con­ ket. Obviously the bank would fail in ditions, which nullify the effect of dis­ its responsibility to its community if it count rate changes, it is frequently arbitrarily refused loans and forced necessary to carry a bank beyond what payment. The facts were that in very would ordinarily be considered safe or numerous cases the enforcement of prudent limits in order to protect its payment was practically an impos­ depositors and its community and sibility, since the crops lacked liqui­ maintain the stability of the general dating power. The Federal Reserve banking situation. This has been par­ Bank’s problem, therefore, became ticularly true where loans were “ frozen ” broader than that of the bank itself. and slow rather than doubtful. It became a problem of carrying With a clean and reputable member through the farmers or business men under capable management in acute until they could again find a safe distress and faced with the alternative footing. of obtaining additional assistance or In some sections of the West it closing its doors, there can be no ques­ was necessary to continue this policy tion as to what the policy of the Federal through four successive failures of the Reserve Bank should be. It is better crop. The bank’s alternative was to to save the reputable banks, assist their loan the minimum that was necessary worthy customers, whether business to enable its customers to weather the men or farmers, to weather the storm, storm or encounter a prompt insol­ and hope for rehabilitation later, than

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 182 T he Annals of the American Academy to take a narrow view and force the ceptional value. Some of the critics of bank to the wall, unsettle public confi­ its result in operation have apparently dence and perhaps precipitate again overlooked the fact that the Federal such conditions as were a quite familiar Reserve System during the period of experience prior to the establishment the War was necessarily dominated by of the Federal Reserve System. Treasury policies, and that it did not have an opportunity to work out a T h e R ed isco unt R a t e as C r e d it discount rate policy of its own. Within R e g u lato r a very recent period a certain group of Any discussion of credit control at eastern banks encountering relatively the present time is necessarily colored the same conditions have gone to a by recent experiences and may perhaps flat 4| per cent basis. A second group have a less practical value because of of banks, between the better developed the abnormal nature of the period from East and the partially developed West, the beginning of 1920 down to date. but having much the same problems to Such a period does, however, carry its meet, have adopted a 5 per cent basis. own lessons. One of the most impor­ The remaining banks in the undevel­ tant is that dependence upon the dis­ oped sections have gone to a per count rate is a fallacy until the discount cent basis. We have therefore in the rate can be made generally applicable Federal Reserve System, for the first to the borrowings of all banking insti­ time, what is practically a uniform tutions in the country. Pending such policy in the fixing of rediscount rates, development the real control of credit and the new rates are as uniform as in the Federal Reserve System will lie may be as to the districts where condi­ not in the rate but in the accuracy and tions are similar. precision of judgment of the boards of Under normal conditions there directors, executive committees and should be a differential between the executive officers in each of the Fed­ developed East and the undeveloped eral Reserve Banks, with the able lead­ West. Such a differential cannot al­ ership and excellent advice which they ways exist because it will be affected have unfailingly received from the temporarily by stress and unusual de­ Federal Reserve Board. velopments in the money market. It To the borrowing individual or bor­ has the merit of affording guideposts rowing bank, such strain and emer­ by which the 30,000 banks in the gency destroy the effectiveness of con­ United States may judge country-wide trol through the rediscount rate. The credit conditions, and while their free­ question then becomes one of expedi­ dom and independence in making rates ency and safety and not one involving to their customers is in no wise im­ scientific application of a theory, which, paired, it will unquestionably prove while it works well in smaller and that Federal Reserve discount rates better developed nations, will have a which maintain the proper relation be­ doubtful practicability in the United tween the different areas of the United States until it reaches equal develop­ States and which keep reasonably in ment and has an equally well-knit line with their upward or downward population, properly seasoned by prec­ movement, will have a very material edent, custom and established rule. indirect influence. They will probably On the other hand, it cannot be tend in the long run to equalize bank doubted that the existence of a dis­ rates in sections where conditions are count rate has been an influence of ex­ similar and to prevent abnormal differ­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis P rinciples Governing the D iscount R ate 183 ences in the customers’ rate in different the Federal Reserve Banks have had in sections of the country. enabling this country to avoid disaster, From a practical standpoint the con­ while not complete, was still extra­ trol of credit is largely a matter of lead­ ordinary and that it had its foundations ership and example. It is becoming not in any question of rate control but clear that each rediscount application in the application of shrewd and pre­ in a Federal Reserve Bank must receive cise judgment to many thousands of a high degree of individual study and separate and distinct problems. that there must be devoted to it a In checking expansion, the prompt­ specialized judgment which takes full ness and courage of the Federal Re­ cognizance of all the facts surrounding serve Banks in taking a stiff stand it. In western Reserve Banks, at least, against inflation is likely to prove more it is improbable that the conditions of efficacious than any decision to ad­ any two borrowing banks will prove to vance the rate, although both actions be exactly parallel. These differences must go hand in hand. In reality it must be recognized and as they develop might be said that an advancing or they call for keen banking judgment receding discount rate is of material rather than the application of a rule. advantage as a warning signal but that In the last analysis the control of credit the practical work of the Federal Re­ through the Federal Reserve System is, serve Bank is in its executive commit­ therefore, a matter for the executive tee and that the degree of control which officers and executive committee in each it exercises, which is necessarily limited individual case. They must set up their by the insufficiency of its membership, own policies, form their own judgments, will be proportionate to the farsighted and endeavor to hold all applications vision and courage of the Federal Re­ from borrowers to proper standards, serve Board, which supervises, and the which if they are to be valuable must executive control in each Federal Re­ not be inflexible. From an intimate serve Bank, to which each problem viewpoint it is clear that the success must ultimately come for settlement.

Principles Governing the Discount Rate1

By W. P. G. H a r d in g Governor of the Federal Reserve Board ONTROL over discount rates, as reaching powers ever delegated by exercised by the Federal Reserve Congress to another instrumentality. CBanks and the Federal Reserve Board,The grant ranks with the power given is one of the most important and far- the Interstate Commerce Commission to regulate railroad rates. While it 1 Remarks at the opening session of the joint conference of the Federal Reserve Board with is necessary that powers of this kind the Federal Reserve Agents and Governors of should be vested in a few hands, they Federal Reserve Banks held at Washington, should be used with discretion and the D. C., October 25- 2 8 , 1 9 2 1 . effect of a change in rate should be care­ Because of his official position, Governor fully considered before the change is Harding did not feel at liberty to express a per­ sonal opinion. In this paper, however, he made. states the problem as it has been brought before The principle is well established Federal Reserve authorities. that in theory the Federal Reserve

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 184 T he Annals of the American Academy Bank discount rate should be slightly and the volume of reserve money is conse­ in excess of current rates. There has quently increased through a mere increase been much discussion of the reductions in the deposit liabilities of the Reserve Bank. With an increase in the volume of which have been made in discount reserves of the member banks, there is an rates during the last six months and, immediate tendency to a reduction in the disregarding the opinions of the preju­ general level of discount rates throughout diced and the uninformed, let us con­ the country, placing them below the level sider the conflicting views of some which open market conditions would whose opinions are worthy of attention otherwise call for and creating a tempta­ and respect.2 tion for the uneconomical use of bank funds. There is particularly a temptation to use V ie w s o n R e d is c o u n t R a t e s bank funds in an excessive degree for A New York banker and an eastern capital purposes, and for the ordinary economist expressed themselves as banks of the country, misled by the arti­ follows: ficial excess of liquid cash, to tie up too The basic idea in this policy of keeping great a part of their assets in non-liquid the rediscount rate above the market is form. The Reserve Bank which makes that Reserve Bank money is for excep­ rediscount rates too low, therefore, instead tional and unusual use—that it is not the of performing its function of increasing the province of a Reserve Bank to supply a liquidity of the banking system, tends substantial part of the ordinary funds rather to destroy liquidity. employed in the market in ordinary times. Of course, it is expected that a Reserve A Chicago banker reiterates the Bank shall make money for its stock­ opinion, expressed by him several holders and shall employ such of its funds times, that the Federal Reserve Banks as may be necessary to meet expenses and and the Federal Reserve Board ought to pay dividends. One provision of the to proceed very slowly in lowering the Federal Reserve Act, permitting open present rates. He anticipates that market operations on the part of the Fed­ there is considerable danger, in case eral Reserve Banks, was designed to give the rates are lowered precipitately, of them discretion in this matter, whether a renewed inflation, with a consequent the member banks should rediscount with them or not. But the position of a Re­ reaction more violent than that through serve Bank is a very peculiar one. If an which we are now passing. He takes ordinary bank makes a loan, checks come the view that, in general, it is a com­ in against it, as a consequence of the loan, plete mistake to have the rediscount which it must meet out of its reserve unless rates lower than the prevailing market it should happen that, simultaneously, new rates for commercial loans, for if banks deposits are made with it of checks drawn are enabled to rediscount their paper on other banks. Loans made by a Reserve at a lower rate than they themselves Bank, however, need not lead to drains on receive, obviously a continued in­ its reserve. When, in making a loan, it flation is profitable to them. His issues its notes or gives a deposit credit to a opinion coincides with the views of the rediscounting bank, that note or a trans­ fer of that deposit credit will be accepted eastern banker and the economist as ultimate payment by some other insti­ above quoted, and he stresses the tution. The deposit liabilities of the Re­ point that our large gold reserve is, serve Bank count as ultimate reserve after all, due only to the fact that gold for the other banks of the country, is not being circulated at the present 2 The quotations which follow are from a moment and that much of this gold is symposium recently published in a financial likely to flow out of the country as journal. soon as there is a change in the bal­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis P rinciples Governing the D iscount R ate 185 ances of trade. He concurs, also, in tendency toward renewed inflation. Rather the view that a certain amount of the the tendency has been to further liquida­ gold which the Federal Reserve Banks tion. . . . The general principle of keep­ ing Federal Reserve rediscount rates above have at present is, in a sense, merely the market rate for money is sound, but it held in trust for Europe. He re­ does admit of exceptions as in the present gards as entirely fallacious the argu­ condition of things. The present Federal ment made by adherents of a policy of Reserve policy is in accord with the lowering rediscount rates that such tendency of the money market and it is action is desirable because the reserve hard to see how it has had, or will have, any ratio and gold accumulations of the but a wholesome and constructive effect. Federal Reserve Banks justify a re­ In a recent publication a well-known laxation of the official rates. banker and economist has asserted that the A Milwaukee banker who contends best index of the money market in this country is the rate on line-of-credit loans that the policy should be in accord to borrowers from two or more banks, and with the money market tendency, not the rate on bank acceptances, as in states: England. The volume of line-of-credit The main point made by those opposed loans in this country is far larger than the to the lowering of Federal Reserve discount volume of bank acceptance credits, but it rates is that the rediscount rate should al­ may be doubted whether the rates on such ways be above the market rate. This is loans are as competitive as bank accept­ laid down as a general principle to which ance rates. Bank acceptance rates are there are no exceptions. Federal Reserve fixed in the open market and are pub­ funds are only emergency funds, it is said, lished. Line-of-credit loans have no open and it should not be possible for banks to market and there are no published rates. make a profit by rediscounting at a lower Line-of-credit loans are not as competitive rate than the market. as they may seem. A small firm com­ When the demand for credit is excessive monly maintains a line of credit only at its and increasing, the Reserve Banks should own bank. Large corporations usually move into a dominating position by raising have lines of credit not only with their their rates above the market rates for home banks but with large banks in finan­ money. But the same necessity for dis­ cial centers, not necessarily because they couraging resort to Federal Reserve Banks can secure lower rates, but because no one does not exist when the demand for credit bank wants to take care of their full needs. slows down, loans are being paid off and For these reasons it is to be doubted reserves are accumulating. What has whether line-of-credit loans afford as good happened as a result of the recent lowering an index of money market tendencies as the of rediscount rates? Has it resulted in an bank acceptance rates. The latter rep­ expansion of loans or reinflation? Not at resent the minimum rates for the best class all. On the other hand, the published of paper and, because this is so, they indi­ records show that member banks have cate far beyond their actual money volume continued to reduce their rediscounts and the drift of the market. The present rate borrowings and to do this have brought on eligible bank acceptances of 5| to 5 pressure upon their customers to liquidate. per cent is a better indication of what is Customers who have voluntarily liqui­ taking place and what may be expected in dated and got themselves back into good the open money market than rates on line- financial condition are offered lower rates of-credit loans which reflect market condi­ on new loans. This, of course, is an in­ tion more slowly. centive to those who have not done so to liquidate. This is the practical way in Another Chicago banker takes an which the leadership of the Federal Re­ extremely conservative view. He would serve Banks in reducing their rates has like to see many of the so-called worked. There has not been the slightest “war amendments” to the Federal

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis m T he Annals of the American Academy Reserve Act repealed and states that ment. In normal times member banks as the law stands, “nothing but the should understand that they are not ex­ courage and wisdom of the manage­ pected to borrow except to meet emer­ ment prevents it from becoming a gencies, and they should be made to feel disastrous engine of inflation.” He that borrowing at such times is an indica­ objects particularly to the amendment tion of weakness and needs explanation. which forces member banks to carry He expresses the hope that the their entire lawful reserves in the form Federal Reserve Board will make a of collected balances with the Federal public statement of what its future Reserve Banks and believes that this policy will be regarding rates and ex­ amendment, which he regards as presses the belief that the confidence practically demonetizing gold, is most of the country in the Board is such dangerous in normal times. Referring that any clear statement of funda­ to the complaints which have .been mental principles made by it would be made that the agricultural districts acquiesced in. have been discriminated against, he Another New York banker while believes that exactly the opposite is convinced that under normal condi­ the case and appears to believe, also, tions it is logical that the Federal Re­ that the Federal Reserve System has serve rate should be higher than the worked a great injury to the country prevailing commercial rate, believes as well as inestimable benefits. He that in view of the world-wide con­ states: ditions that exist today, the adoption, In a time of inflation such as we had a at this time, of artificial means to year ago, it nullifies the operation of the accelerate the process of readjustment usual normal remedies for such conditions. would be a dangerous course to pursue. If it had not been for the Federal Reserve He states: Banks, farmers generally would have been compelled to sell their crops a year ago and Considering the extent to which credit pay their debts. This would have saved for speculative purposes has been liqui­ them and the country from the disaster dated, and also taking into consideration that has overtaken them. Also, had it the present reserve and gold position of not been for the Federal Reserve Banks, the Reserve Banks, it would seem that the manufacturers and merchants would have reduction in rate is fully justified. Further­ been unable to accumulate or carry the more, I do not believe the reduction at this heavy inventories entailing losses in a time in the rate will appreciably encour­ single year which it will take a generation age a tendency toward renewed credit to replace. inflation. The question of rates has, on The solution to this is to keep the the whole, been ably and courageously Federal Reserve discount rates above cur­ handled by the Federal Reserve Banks and rent market rates, so that there will be no the Federal Reserve Board. temptation on the part of the member He says that if he were to offer a banks to profiteer through the Federal critical observation,* it would be to Reserve Banks. So long as the Federal remark upon the “salutary modifica­ Reserve rates are kept below current rates, there is, in my judgment, no way in tion of the need for deflation that which this kind of inflation can be pre­ would have resulted had the high vented. On the other hand, if borrowers rates been put into effect in the compel their banks to rediscount in order spring of 1919 instead of the summer to enable them to carry crops or goods for of 1920.” higher prices, they are put on notice that A Boston banker takes the view that they are acting against the general judg­ the Federal Reserve System was

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis P rinciples Governing the D iscount R ate 187 organized for the purpose of furnishing to a point above the rates for com­ credit, by means of rediscounting, to mercial paper because the conditions the commercial banks of the country. of business are not yet on a normal He says: basis. Ee says that it has been the In a general way the time when this habit of commercial bankers to argue credit is needed is just before, during and with their commercial customers that immediately after, a credit crisis, or credit the rate to their customers is based on pinch, and it seems clear that at such time the Federal Reserve Bank discount the rate charged for rediscounting should rate and that it should be enough be at about the current market rate higher than the discount rate so that charged by the commercial banks to their there would be a profit to the banker customers. To make the rate higher than between the discount rate and his the prevailing rate would tend to restrict rate to his customers. He says further: the granting of necessary credits to mer­ chants and similar borrowers. To make There is yet in our banks a large amount the rediscount rate much lower than the of so-called frozen loans which may be prevailing rate would tend to encourage described as loans which are probably over-loaning by the commercial banks. In good but which the borrowers are not in a fixing the rediscount rates, the managers of position to pay off at the present time. the Federal Reserve Banks should try, as Therefore, they are not in a position to far as possible, to keep their minds free trade on market rates on an even basis from influences other than those which with the banker. Under these conditions, directly concern the prevailing rates of a high discount rate of the Federal Reserve money, but they certainly are justified, Banks simply has helped the commercial when fixing rediscount rate, in being in­ banker to get higher rates from his cus­ fluenced by motives of the safety of the tomers than are justified by the conditions Federal Reserve Banks themselves, and of credit. Therefore, it was desirable and when the rediscounts appear to be ap­ necessary for the Federal Reserve Banks to proaching a dangerous total, they should reduce their discount rates from 6 or 7 per use their rate-fixing power to check specu­ cent to per cent in order to inform lation and to prevent any possible danger the commercial community that the to the Federal Reserve Banks, which are credit situation no longer demanded these the foundation of our whole banking high rates. system. It was never intended, and never should be intended, that the Federal He takes the view that “Federal Reserve Banks consciously use their Reserve Bank discount rates should power and authority either to encourage or to discourage business. Their chief not be made with the idea of con­ purpose should be to assist commercial trolling business or market prices of banks and to fix the rates of rediscount so commodities,” but that “they should as to best accomplish this, and at the be indications of the effect that the same time to protect their own position present business is having on the sup­ from any possible overstrain. ply of credit and of anticipated condi­ tions that will affect the supply of He regards as one of the greatest credit in the near future.” He be­ dangers to which the Federal Reserve lieves that “when the business com­ System can be subjected, the attacks munity has become trained to the and manoeuverings of politicians to point of watching the reserve position make the System serve political ends. and discount rates of the Federal Another leading banker does not Reserve Banks and has come to an believe that the time has yet arrived understanding of what these figures when discount rates should be held up mean, it will be helped very much

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 188 T he Annals of the American Academy by studying the published conditions bear a direct relation to a Federal Re­ of the Federal Reserve Banks and will serve Bank’s reserve and to the general appreciate what a change in discount money market, and that, in addition, rates means, provided of course that consideration should be given to the the officers and directors of the items enumerated in the Council’s Federal Reserve Banks are not ham­ recommendation of May 17, 1921, as pered in using their judgment in these follows: matters by outside influences.” 1. The reserves of the Federal Reserve A Chicago merchant notes the dif­ System as a whole. ference of opinion among experts as to 2. The reserve position of the Federal the proper time for raising or lowering Reserve Bank whose rate it is contem­ the Federal Reserve rediscount rates. plated to change. He points out that neither the Federal 3. The condition of all the banks of the Reserve System nor any part of it can country as a whole, and of the several Federal Reserve districts. be run on any formula, and that if it 4. The economic and financial condition could, very little brains would be re­ of this country. quired for that part after the formula 5. World conditions, both economic and had been found. He believes: political. If we are to be a world power in com­ 6. The eventual establishment of a merce, as we may be, we shall have to credit rate policy for the Federal Reserve make the New York, or some other district Banks by which the rediscount rate to rate attractive for the discount of the member banks is higher than the prevailing world’s import and export bills. We commercial rate, taking due consideration might, of course, be above the English of the prevailing open-market rates for rate for a short time, for adjustment or various classes of loans both in this coun­ other purposes, but if we make a rule to try and abroad. have the rate always above the commercial 7. Uniformity of rates, while at times paper rate in New York, our ambition to be practicable and desirable, should not be the world’s bankers, or to compete with adopted as a fixed policy, the System being England in commerce and finance, will predicated upon the principle that varying vanish into thin air. conditions might exist in different sections He takes the view that in crises and of the country. extraordinary emergencies a Reserve With reference to the general money Bank may well be justified in violating market, the following factors were temporarily the ordinary canons of suggested by the Board as those which sound finance, but emphasizes the fact should be considered in arriving at a that under normal conditions and conclusion as to what is the current under conditions when it is possible to rate for money: take a long-run view, the well estab­ 1. Rates charged by banks to their reg­ lished traditions covering a Reserve ular customers. Bank’s operations must be followed. 2. Rates for one-name paper bought The chief of these canons is that the through note brokers. rediscount rate of Reserve Banks 3. Open market rates on bankers’ ac­ should be kept above the market. ceptances. R ecommendation o f A d v is o r y 4. Rates on Treasury certificates. C o u n c il The Board asked the Council for its The Federal Advisory Council, at views as to the relative importance of its last meeting on September 20, 1921, each of these factors and the Council expressed its belief that rates should expressed the view that all four items

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis P rinciples Governing the D iscount R ate 189 mentioned are important in determin­ cities are dominant in their districts; ing the money market but there may but in other districts which cover a be other factors which should likewise larger territory and where the busi-" be given consideration, such as general ness is more distributed and diversified, business conditions and the reserve the problem is more difficult. At the position of a Federal Reserve Bank. present time, four Federal Reserve It was the view of the Council that Banks are rediscounting about $45,- the ruling rate for money in a district 000,000 with three other Federal Re­ will adjust itself automatically to these serve Banks. The directors of one of conditions. The Council expressed these borrowing banks more than a the view, also, that a Federal Reserve month ago voted to reduce their dis­ Bank while it is borrowing should not count rate from 6 per cent to 5| per lower its rate, but stated that special cent on all classes of paper, but the conditions might exist in a district Federal Reserve Board has not yet which would make a reduction de­ approved the reduction. No evidence sirable and would justify such a has been presented to show that cur­ course. rent rates for bank accommodations are less than the Federal Reserve Bank R e d is c o u n t P r o b l e m C o n f r o n t in g rate, or that current rates would be t h e B o a r d reduced by lowering the Reserve Bank It seems clear to the Board that it is rate, but the directors argue that the not practicable in this country for consolidated reserve position of the Federal Reserve Banks to maintain System justifies a lower rate. rates of discount higher than current The Board has been inclined to the market rates if line-of-credit loans are view that the reserve percentage of to be accepted as the criterion. The each Federal Reserve Bank, as well as rates of interest permitted in many that of the System, should be taken states are so high as to preclude this into consideration as one of the de­ as a possibility. In ordinary circum­ termining factors in fixing the discount stances when the credit risk is at a rate. If the Federal Reserve Bank of minimum the rates paid for high Chicago, with a reserve of around 70 grade commercial paper sold in the per cent and the Federal Reserve Bank open market may be regarded as a of St. Louis, with a reserve of 63 per measure of the market rate for money, cent do not feel justified in reducing but it is evident that at present there their discount rates below the present is much consideration to be given to level of 6 per cent, what argument is the basis on which short time obliga­ there for a borrowing bank, like tions of the Treasury are sold and to Atlanta, having a reserve without re­ market rates for prime bankers’ ac­ discounts of only 3 2 per cent, to have ceptances. The problem, therefore, a per cent rate? On the other is more simple at this time in districts hand, what are the arguments against like New York, Chicago and Phila­ a reduction in districts which have so delphia, where the Federal Reserve high a percentage of reserve?

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 190 T he Annals of the American Academy

Rediscount Rates, Bank Rates and Business Activity By G e o r g e M. R e y n o l d s Chairman of the Board, Continental and Commercial National Bank of Chicago HE problem of greatest interest England and America are so different and importance now confronting that the British rule as to the bank the Federal Reserve Banks, the com­rate contains little of value except for mercialT banks and the business world, suggestion, and even this little de­ is the rediscount rate and its effect on creases as the banking and commercial or relation to business activity. paper customs of the two countries are The simple answer to the question contrasted. In the United States, for whether the rediscount rate of the instance, the Reserve Banks have no Reserve Banks should be higher or direct relations with the public and lower than the rate charged by com­ receive deposits only from banks and mercial banks—whether this means the government. In this country the the line-of-credit rate, over-the-coun­ “open market” has few points in ter rate or commercial paper rate is common with the English bill market. not clearly defined—is that the re­ In the United States there are over discount rate should be higher. 30,000 independent banks scattered This answer seems to flow readily through a vast territory whose activi­ from British practice and recent ties are tremendously varied, instead of American experience. But the eco­ a few banks with thousands of branches nomic situation, at home and abroad, serving a country of high industrial and is not so simple as to permit this commercial development. offhand and categorical answer. Amer­ The view is often expressed that the ican experience under the Reserve rediscount rate should be invariably System has not been sufficient for the higher than the market rate—usually dogmatic statement of a formula for meaning the prevailing rate for com­ the future. The Reserve System has mercial paper—because the Reserve not functioned to any extent under Banks are, after all, reserve banks and conditions it was designed to meet; it should be called on for rediscounts only has faced chiefly the very unusual when the bank desiring to borrow is conditions which attended the prosecu­ under strain. There can be no disagree­ tion of war and the uncertainties and ment about the desirability of the abnormalities that followed. At this increase in rediscount rates when busi­ time it seems impossible to do much ness expansion needs to be checked, and more than state the problem as it is there may be reason for keeping them made out of and affected by a great regularly higher than the market rate. variety of elements. The ascertainment It must not be forgotten that, what­ of these elements involves investiga­ ever the Reserve Banks may be in law, tion of business customs, bank habits, in fact, they are regarded no less by government operations and, perhaps, bankers than by business men and the the psychological influence of public public as a kind of financial hospital to sentiment. which all classes may go to have their It is hardly possible to base any rule wounds treated, regardless of the of future action in regard to rediscount causes of the wounds. The banker, and rates on experience as gained by the the business man through his banker, Bank of England. Conditions in wishes the same treatment whether he

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis R ediscount R ates, Bank R ates and Business 191 has been hurt through his own dere­ the following factors should be con­ lictions or through a conjunction of sidered in arriving at a conclusion as to economic causes, unforeseeable and what is the current rate for money: uncontrollable. But the determination 1. Rates charged by banks to their of a rediscount policy for the future general customers. calls for close analysis. 2. Rates for one-name paper bought through note brokers. I n f l u e n c e s T h a t H a v e A f f e c t e d 3. Open-market rates on bankers’ R e d is c o u n t R a t e s acceptances. Since the depression following the 4. Rates on Treasury certificates. War the factors influencing rediscount This series of rules is apparently rates have been given serious consider­ given potentially. What have been ation. At its meeting in September, the determining factors in fixing 1921, the Federal Advisory Council rediscount rates heretofore seem expressed the view that rediscount nowhere to have been given in a rates should bear a direct relation to a similar summation. In the first year Federal Reserve Bank’s reserve and or two of the Reserve Banks’ opera­ to the general money market, and that, tions little attention was given to the in addition, consideration should be rediscount rate. Money was plentiful given to the items enumerated in the and there was little rediscounting. The Council’s recommendation of May 17, War and its demands brought a change. 1921, as follows: It is no secret that government 1. The reserves of the Federal Reserve financing took precedence over every­ System as a whole. thing else. The rediscount rate, re­ 2. The reserve position of the Federal gardless of any influence it might have Reserve Bank whose rate it is contemplated on business, was adjusted so that the to change. purchasers or holders of war bonds 3. The condition of all the banks of the country as a whole, and of the several would receive preferential treatment. Federal Reserve districts. Otherwise, it is doubtful, with adher­ 4. The economic and financial condition ence to the Reserve Banks as the of the country. instruments whereby credit was to be 5. World conditions, both economic and made available for war purposes, if the political. war bonds could have been success­ 6. The eventual establishment of a fully sold at the rates they bore. It credit rate policy for the Federal Reserve was when this need became apparent Banks by which the rediscount rate to that the rate was placed at a low member banks is higher than the prevailing commercial rate, taking due consideration point. Business was, of course, a of the prevailing open-market rates for beneficiary. There was no departure various classes of loans both in this country from this policy during the War nor, and abroad. as is often pointed out, until some 7. Uniformity of rates, while at times time after the Armistice. practicable and desirable, should not be On pages 62 and 63 of the hearings adopted as a fixed policy, the System being entitled “Reviving the Activities of predicated upon the principle that varying the War Finance Corporation,” will conditions might exist in different sections be found the following by Governor of the country. Harding: It was further suggested that with The Federal Reserve Board adopted a reference to the general money market policy in order to assist in the war financing

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis i n T he Annals of the American Academy which was economically unsound. I say cited figures to show, that the peak of this frankly. Congress authorized certain credit and currency expansion was loans. It authorized the Secretary of the reached some months after higher Treasury to determine the rates at which the loans should be issued. The Secretary rates were made effective. This in­ of the Treasury asked the advice of ex­ dicates either that business had such perts and then fixed the rates of interest to an impetus that rediscount rates had be borne by the several issues of bonds, no effect in stopping it, or, if they had notes, and certificates. During the time any effect, considerable time was re­ we were actually at war, something like quired to make it apparent. If this $18,000,000,000 of bonds were sold to the experience is to be taken as a demon­ people, an amount certainly in excess of the stration of the efficiency of an increased normal investment power of the American rediscount rate to stay business activ­ people in such a short time, and the only way in which those loans could be financed ity, it must also be taken as a first was through the instrumentality of the indication of the time relation between banks. The only way the banks could an advance or change of rate and undertake to do it was to get some assis­ business operations. tance from the Federal Reserve Banks and But whether the high rediscount at a low rate. The low rate of interest rate did or did not halt business and borne by these bonds was fixed with a view force deflation and liquidation, or of holding down the expenses of the whether business toppled over for government as far as possible. Anyway, other reasons, there is no doubt that it that is something the Federal Reserve toppled. Gradually the credit situa­ Board has no responsibility for. In order to make possible the floating of these bonds tion cleared and is still clearing. we fixed a rate less than their coupon rate. Coincident therewith further study of Some member banks announced that for a the rediscount rate and its influence period of six months there would be a rate and effect began. As the reserve per­ of 4 Per cent on notes secured by govern­ centages of the Reserve Banks began ment obligations. The result was that to mount, the demand for lowering of there was no loss to subscribing banks the rates became more and more in­ pending the distribution of the bonds to the sistent. The increase of reserves was public. There were successive bond issues. not, however, due entirely to liquida­ The principal reason why discount rates tion. The flow of gold from abroad were not increased earlier than they were in was steady, and became a very im­ 1919 was on account of Treasury financing. portant, if not the most important, Thus it appears that government factor in building reserves up to a high financing and the desire to have war point. It must also be noted that the bonds bear low rates of interest were rates charged by commercial banks the determining factors until disaster did not go down either simultaneously was scented in 1919. Then present and with those of the Reserve Banks, or impending troubles dictated the in­ proportionately to them. Commercial crease of rates, which was belated. banks were affected only indirectly by It was some time before this increase the great inflow of gold. It required that liquidation began. It was a liquidation by business to permit them considerable time afterward that defla­ to build up their reserves and pay off tion became a visible reality. It may their debts to the Reserve Banks. be said only with diffidence that the This would seem to show that re­ increased rates had anything more discount rates were fixed with no than a moral effect. Members of the consideration of the rates charged by Reserve Board said repeatedly, and the commercial banks. The assump-

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis R ediscount R ates, Bank R ates and Business 193 tion of a causal relationship between probably only in the large centers and the two, therefore, remains to be well developed industrial districts that proved by the presentation of evidence money rates are subject to the con­ that the experiences of the past two trolling influence of reserve condition, years does not offer. supply and demand, gold imports, etc. To get at the time relationship T h e T im e R elationship B e t w e e n between business activity and bor­ B u s in e s s C o m m it m e n t s a n d rowing, it is permissible to take for B o r r o w in g example the customary operations of If no relationship, or one that is a merchant or manufacturer. It is indirect or nebulous, exists between common knowledge that his interest rediscount rates and commercial bank in the present state of all business and rates, it becomes apparent that there of his own business is shared with his can be no relationship, or, at least only concern for what the future holds. He a very remote one, between rediscount plans and manufactures and buys for rates and business activity; it is the a coming season. No matter how commercial bank rate that business active present operations, the future pays, not the rediscount rate. concerns him as much. He may or For present purposes, then, the may not sound out his banker as to his question may be stripped down to the coming financial needs. Whether he time relationship between the redis­ does or not, he makes contracts and count rate and the commercial bank commitments for a coming season. If rate, between the commercial bank the banker has committed himself in rate and business activity, and then such cases, he will to some extent have between the rediscount rate and the foreknowledge of the demand to be latter. For the present, also, it will be made upon him. But often, if not necessary to ignore the manifest in­ usually, he may be wholly unaware of fluence of remote and indirect causes. what his customer contemplates. Busi­ In a business scheme so intricate as ness men will not arrange in advance that of the world today, it would be for credit unless they foresee the im­ hazardous to be dogmatic about such possibility of meeting their obligations relationships. The problem is, how­ out of current resources. If they have ever, to determine, if possible, the a line of credit, they will not indicate more immediate relationships—the their intention to use it at a particular causes which act and react on one time or during a particular season another so as to permit the application unless it promises to be insufficient for of direct evidence. It is pertinent here their prospective needs. Nor will the to note, for instance, that there are member bank signify its intention to some thousands of banks which are rediscount in the future. not members of the Reserve System; In such circumstances the business that each operating bank is an inde­ world, each unit operating by itself, pendent entity, subscribing to no may be building the foundation of a rules as to interest charges and often credit structure in the autumn; the getting “all the traffic will bear”; commercial banks may" not be called that loan risks vary with classes of on for loans until spring and it may be business and in different districts, and midsummer before the contracts and that the demand for capital forces commitments made months before are new and undeveloped sections to bid reflected by a demand for rediscounts high in order to attract funds. It is at the Federal Reserve Banks. How 14

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 194 T he Annals of the American Academy is a rediscount rate going to meet an made to adjust rediscount rates on the over-extended condition, in the sum­ basis of ascertained future business mer, which was produced by opera­ operations, the probability is that the tions begun and completed many rate has been fixed only in relation to months before? what is or what has been, so far as it Commercial bank officials and those has been fixed at all in relation to of Reserve Banks, also, study business business activity. conditions constantly. Many of them have information and statistical or­ C o n c l u s io n s ganizations. They gather the best The import of this article has been: 1. That rediscount rates cannot be fixed statistical evidence they can, but the on the basis of British experience. Reserve Bank officers have no privity 2. The opinion that rediscount rates of interest and no intimacy of relation­ should be higher than commercial bank ship with business men. Even with rates is based on experience during war superior advantages in this respect, conditions and business contraction which officers of member banks cannot an­ may not be a sufficient guide for the ticipate conditions except in a very future. general way. One banker might be 3. Rediscount rates have heretofore been alarmed at the prospect of a large fixed chiefly by consideration of factors other than their possible effect on business demand for loans and his competing activity. neighbor have no evidence of such 4. Rediscount rates can affect business impending events at all. activity only through bank rates which It is such conditions that call into bank customers must pay. play the highest banking skill and judg­ 5. Bank rates are not only different in ment. Such conditions demand of the different sections, but are determined by banker a prescience which can come present conditions, whereas business com­ only from such a familiarity with busi­ mitments are made for the future. ness that he feels rather than knows 6. To influence business activity, bank what is before him. In making his half- rates would have to be determined in relation to the future commitments of intuitional estimates he will, of course, customers and the rediscount rate would take account of the fact that the have to be in correspondence with the bank Reserve Bank is ready at hand if there rate, both as to amount and time. is need. He will take care of his 7. It is the knowledge and judgment of customers and try to adjust his rates bank officers and reserve officers on which to competitive conditions. His con­ reliance must be placed for the control of clusive “no” will send potential bor­ business conditions through credit. rowers to other banks, to the levelling 8. Insofar as the rediscount rate can of the business of all of them and a affect business activity, it must be deter­ fairly accurate adjustment of interest mined far in advance if it is to have any rates. But, dealing only with banks, appreciable effect. Federal Reserve officials will have an There has been no disagreement imperfect knowledge of these condi­ among bankers as to the necessity for tions. And yet upon them rests the raising the rediscount rate when the obligation of leadership in checking or need of checking business activity was stimulating business by a proper certain. If recent conditions gave adjustment of the rediscount rate, if promise of permanency, there could be the rediscount rate can do it. no question as to the desirability of It seems fair to say that while an having rediscount rates always higher effort may have been made or is being than bank rates. On the basis of

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T heoretical Considerations on Bank Credit 195 actual recent experience only one rates must be made well in advance of policy has been warranted. But as to foreseeable changes in business activity, a policy to control in the future, if the rates are to be used for the further experience must be the guide. purpose they are commonly supposed In any event, changes in rediscount to serve.

Theoretical Considerations Bearing on the Control of Bank Credit Under the Operation of the Federal Reserve System By C h e s te r A. P h illip s University of Iowa HE most important change in our money in their tills. But the swelling banking machinery entailed by the of pocket and till money involved a Federal Reserve Act as bearing uponwithdrawal of cash from the commer­ theT question of the expansion and cial banks. As money left the banks, contraction of our circulating media is their lending power was curtailed, and the introduction of compulsory bank­ expansion of credits and rising prices ers’ banking. The essence of bankers’ were brought to a halt. banking in the United States is the Under the operation of the Federal reserve dependence of the commercial Reserve Act an expansion of loans and banks upon the regional institutions. a consequent expansion of deposits, The deposits on the books of the re­ accompanied by rising prices and ex­ gional banks are the reserves of the panding physical volume of trade, also commercial banks. Inasmuch as the impel men to carry more “money” in deposits of the regional banks are their pockets and merchants, more in themselves expansible and contractile, their tills. Since 1914, however, the the deposits of member banks, which demand for additional pocket and till would be elastic even if their reserve money has been met by the issue of foundation were inelastic, now have 'promises of the Federal Reserve Banks an elasticity raised to the second to pay money. Lawful money is no power. longer lost by commercial banks. In­ Moreover, the elasticity of both the stead it is held by the Federal Reserve deposits of the regional banks and of Banks as a foundation on which is the members are buttressed and sup­ reared a three-fold credit structure: (1) ported by the Federal Reserve note- deposits of Federal Reserve Banks; issue provisions. Under the old na­ (2) deposits of member banks and (3) tional banking system an expansion of Federal Reserve notes. loans and a consequent expansion of The control of credit under our deposits in the banking system was Federal Reserve System, therefore, ordinarily accompanied by a rising becomes a matter of greater impor­ physical volume of trade and rising tance than under the old regime. prices. The growth in business trans­ Formerly an automatic check was actions, coupled with higher prices, imposed on credit expansion before impelled men to carry more money in extreme limits were reached. Today, their pockets and merchants more in the absence of that automatic check,

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 196 T he Annals of the American Academy we are to depend upon regulation of the to the bank in question, would be paid rediscount rate as a chief means of in cash or its equivalent. It is true control. that some of the checks drawn by borrowers would be sent to creditors A M e m b e r B a n k C a n n o t M a k e who were depositors in the drawers’ M a n if o l d L o a n s bank; in that event there would be no Now the effectiveness of the redis­ immediate corresponding loss of cash count rate as an instrument of con­ by the lending of the bank. It is also trolling bank loans and, therefore, true that some borrowers would not deposits, hinges on the relation between withdraw all the funds borrowed. If the amount borrowed by a member due allowance is made for these two bank and the amount that the same considerations, we may conclude that bank is able to lend as a result. If a for every dollar that a typical Ameri­ member bank is able to lend five dol­ can bank lends, it loses not less than lars on the basis of one dollar bor­ eighty cents through direct cash with­ rowed, it is evident that the borrowing drawals by borrowers and through bank would be willing and able ordi­ unfavorable clearing balances.1 In narily to pay more than 4 or 6 per cent other words, the typical banker is able for borrowed funds. On the other to lend approximately $1.25 for each hand, if the borrowing bank is able to $1.00 borrowed. It follows that redis­ lend only dollar for dollar on the basis count rates roughly equal to the of borrowed funds, that bank will not market rates (if the expense of carrying ordinarily pay a higher rate of redis­ on the banking business is consid­ count than it receives at its counter. ered) will ordinarily be sufficiently What are the facts at this point? high to serve as a check on borrowing It would at first appear that a bor­ by member banks. rowing bank would be able to make manifold loans on the basis of borrowed B o r r o w e d R e s e r v e S u p p o r t s reserve. Does not the balance sheet M a n if o l d L o a n s i n t h e of a typical national bank show loans B a n k in g S y s t e m (and deposits) equal to several times It may be added that borrowed its reserve? If reserves of $100,000 reserve normally does become the support loans of $1,000,000 (and depos­ foundation of manifold loans in the its of the same approximate amount), banking system. Bank A borrows $100,- would not the acquisition of additional 000 from the Federal Reserve Bank reserves of $100,000 enable the bank to and in turn lends $125,000, more or support total loans of $2,000,000? less, to customers. The borrowing Normally, the bank that attempted customers draw checks against their to increase its loans by $1,000,000 on replenished balances and those checks the basis of $100,000 new reserve are remitted to creditors. The credi­ would quickly be face to face with the tors deposit the checks in their own problem of how to meet unfavorable banks. When the checks are cleared clearing balances of large proportions. and collected, not only will the drawee The borrowers of the $1,000,000, bank lose approximately $100,000 but leaving the proceeds of their loans on other banks—banks B, we may say for deposit, would draw checks against 1For a more nearly accurate and more de­ their bank balances for most of the tailed statement see the writer’s Bank Credit, $1,000,000; those checks would be sent The Macmillan Company, New York, 1921, far and wide to creditors and, returning Chapter III.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T heoretical Considerations on Bank Credit 197 convenience—will have gained that same rate, would it not be possible for amount in deposits, and a correspond­ individual banks to make a several­ ing amount in reserve. The lending fold loan expansion, consequent upon officers of banks B, mindful of the fact a reserve acquisition, without losing that a reserve must be held against cash through unfavorable clearing the newly acquired deposit liabilities balances, thereby rendering control of as well as against any deposits arising credit expansion possible only by from additional loans made on the raising the rate of rediscount unprec- basis of the reserve freshly acquired, edentedly? will be constrained to add to their loans If the First National Bank of not $1.25 for each dollar deposited, but, Dayton, Ohio, borrows $100,000 from approximately $1.10. the Federal Reserve Bank of Cleve­ If banks B now lend $110,000 on the land at a time when other banks in the basis of $100,000 newly lodged in those same credit area are likewise borrow­ banks, they will tend to lose to other ing, and all expand their loans in such banks—banks C—approximately 80 a manner that what each would nor­ per cent of the amount loaned, or $88,- mally lose in reserve is met and offset 000; the $12,000 left in banks C, may by streams of funds coming from other be regarded as reserve against the banks, the First National Bank of $100,000 in deposit liabilities growing Dayton would be able to lend several out of the lodgment of that amount of dollars for each dollar borrowed, even checks drawn on bank A and against if allowance is made for the likelihood additional deposits growing out of the that the proceeds of loans secured from $110,000 in loans. Banks C, having the regional bank at Cleveland would acquired $88,000, are in a position to be taken partly in Federal Reserve lend approximately $96,800 ($1.10 for notes. Under these conditions, with each dollar of deposited reserve). If the bank in question able to lend four 80 per cent of their loans are lost to or five dollars to each dollar borrowed, other banks, banks C would lose $77,- it has often been contended that a 440 and retain $10,560 ($88,000—$77,- rate of rediscount that fell appreciably 440) as reserve against $88,000 in short of being four or five times the deposit liabilities arising from the rate of discount or market rate would lodgment of that amount of checks not be effective. That the contention drawn on banks B and against addi­ is ill-founded may easily be shown. tional deposits growing out of the When all banks in a given credit $96,800 in loans. area are expanding their loans, the This chain of operations continues additional lending power of each is until the original $100,000 becomes very traceable to two quite different facts or widely distributed and the total loan forces. The first is the fund borrowed expansion results in deposits sufficient by the commercial or member bank, to cover or absorb the borrowed re­ and the second is the fund or funds serve. that such a bank receives through deposit channels and as a result of the C a n a B a n k M a k e M a n if o l d L o a n s lending operations of other banks. D u r in g P e r io d o f L o a n The point to be stressed is that what a E x p a n s io n ? member bank borrows does not deter­ At this point a crucial question mine the amount that it will receive in arises. If all banks within a credit deposits that arise out of the lending area were expanding their loans at the operations of other banks. If within a

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 198 T he Annals of the American Academy credit area where all member banks ratio, the fiscal needs of the govern­ are borrowing and expanding their ment, etc., have all received attention, loans, one institution suddenly ceases the writer believes that too little effort to borrow, the stream of increasing has been made to bring the market deposits flowing from the expanding rate into harmony with what may be banks will tend to continue to swell the called the natural rate of interest, the deposits and, therefore, the lending natural rate being the rate at which the power of the bank that has ceased to supply of and demand for loanable cap­ borrow. A resumption of borrowing by ital goods, as distinct from “money,” the exceptional bank will enhance the may be equated. lending power of that bank by an Although it is impossible always amount only slightly in excess of the accurately to ascertain what the nat­ amount borrowed. ural rate of interest is, it is not difficult A clear cut distinction must be to detect a wide disparity between the drawn in banking between lending market and natural rates. The dis­ power that owes its existence to funds parity between the market and the borrowed by a given bank and lending natural rates during the early period of power that owes its existence to reserve credit expansion under the operation acquired as a consequence of expanding of the Federal Reserve Act, was due loans on the part of other banks. When measurably to an inflationists policy that distinction is clearly drawn the with a low rate of rediscount as its persistent contention referred to loses central feature. With a low rate of its semblance of validity. rediscount obtaining, our market rates Having seen on what grounds of were low and general prices rose in sound theory the control of bank conjunction with an expansion of loans credit, i.e., loans and deposits, rest, we and deposits. Rising prices gave birth may now be permitted briefly to ex­ to rising profits, and the predictable amine the question whether the redis­ increased demand for funds, with a count rate ought to be higher or lower consequent extreme rise in the market than the market rate. rate of interest, was soon in evidence. In a country like the United States C o n t r o l o f B a n k C r e d it T h r o u g h where capitalis highly productive and t h e R e d is c o u n t R a t e preference for present goods over The rediscount policy of the Federal future is pronounced, cheap money Reserve Board has gone counter to can be had only by making everything that of the great central banks of else dear; depression of interest rates Europe, notably the Bank of England, engenders credit expansion and rising the European policy having been to prices. Indeed, the price level is itself maintain the rediscount rate above the an index of the relation of the market market rate. to the natural rate when allowance is Numerous guides have been followed made for the changing phases of the by the directorate of the Bank of business cycle. England in the determination of the Our extreme and recurrent expansion bank rate: the reserve ratio, the and contraction in industry and trade state of trade, international gold can be avoided, not by keeping the rate movements and the market rate. Like­ of rediscount invariably above the mar­ wise, our Federal Reserve Board has ket rate, but by keeping it distinctly also been governed by no single factor. above the market rate during periods of While the state of trade, the reserve expansion and less markedly so, or

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Agricultural and Commercial Loans 199 even below the market rate, during force of low rates be applied with periods of crisis and depression. Let similar promptness and decision. If the brakes of high rediscount rates be the market rate is kept in harmony set early, long before the bottom of the with the natural rate, violent changes in hill is reached; and let the accelerating the general price level can scarcely occur.

Agricultural and Commercial Loans A Comparison of Loans Made in a Great Agricultural State with Loans to the Largest Bank and to Member Banks in the Largest City in the Seventh Federal Reserve District By J. B. M cD ougal Governor, Federal Reserve Bank of Chicago T would be too much to expect the larger than the combined resources of Igeneral public to have more than a all member banks in certain individual casual comprehension of banking or of states or perhaps in several states. the relations of the Federal Reserve These large banks have as customers Banks to other banks or to business. many small banks, as well as individ­ It is not expected that the public will uals and corporations. When borrow­ understand the operations of a factory ing from the Federal Reserve Banks, which makes electrical machinery or of their transactions are usually in large the electrical machines that are made. amounts. It is natural that what is con­ Still any well informed man may sidered moderate borrowing for a large know in a general way what a dynamo bank should appear extravagant when is and have a grasp of what is meant by compared with the amount borrowed horse power. So might he know that by a small bank. A loan of fifty million a bank in a great central city probably dollars appears very large when com­ generates a large horse power in credit pared with one of fifty thousand. Re­ and that comparison of the operations latively, however, fifty millions may of such a bank with those of any smal­ be much more moderate than fifty ler bank can be valuable or informative thousand, if due consideration is given only if relative size is considered. the respective reserve balances main­ In this country there are banks of tained with the Federal Reserve Bank all kinds and sizes. The customary by the institutions involved. method of grading banks is by “capital For instance, an officer of a country and surplus,” and “deposits.” It bank called at the Reserve Bank one takes 40 banks with $25,000 capital day and asked for an additional loan. each to measure up in capitalization At the time his bank had become so to one with $1,000,000. It takes 400 extended that its excessive borrowings such banks to equal a $10,000,000 had been the subject of considerable institution. If the comparative figures correspondence. He was told that a are carried far enough, and total re­ definite limit must be placed on his sources are used as the basis, it will borrowings at a point not far from the be found that there are single banks in amount already borrowed. The coun­ New York and Chicago with resources try banker was piqued. He called at­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 200 T he Annals of the American Academy tention to the many millions loaned The study developed some interest­ to some of the Chicago banks. The ing facts that are pertinent to this country bank’s debt was less than two discussion. The loan records of com­ hundred thousand. A comparison mercial banks are not kept in such was made at once. It was found that form that borrowers can be classified on the basis of reserve deposits the by occupations in any comprehensive big banks might have owed the Federal way. It is true that for some time Reserve Bank nearly three times as past Federal Reserve Banks have many millions if they had borrowed in required member banks in their appli­ the same proportion as the small bank. cations for rediscount to specify the A part, at least, of the criticism of business of customers whose notes are the operations of the Reserve Banks offered. But this information pro­ during the recent trying times seems vides no adequate measure of the extent to be based on instances of similar of the service rendered to agriculture. misconception of facts and figures. A It is well known that many country moderate borrowing by a large bank banks make a practice of using their may appear out of proportion when farmers’ paper for rediscount only after compared to an actually excessive exhausting their supply of other eligible borrowing by a small bank, if only paper which is presumably better absolute figures are used. known at the Federal Reserve Bank, In connection with the work of the such as, “commercial paper” and notes Joint Committee on Agricultural In­ secured by United States government quiry, which was instructed to “in­ obligations. vestigate . . . the banking and finan­ No statistics are available to show cial resources and credits of the the absolute amounts loaned to various country, especially as affecting agri­ industries, but the Federal Reserve cultural credits,” the Federal Reserve Bank of Chicago was able, by a com­ Bank of Chicago made a careful study parison of its loans to member banks, of its loans to member banks. The to obtain conclusive evidence that it purpose was to ascertain if there had had not discriminated against agricul­ been any discrimination, real or ap­ ture. Loans to and reserve deposits of parent, against banks serving agri­ member banks in a preeminently agri­ cultural communities. cultural state were compared with Section 4 of the Federal Reserve similar figures for member banks in the Act was kept in mind. This section, other states as well as the largest in outlining the duties of directors of cities in the district. Federal Reserve Banks, provides as One of the tabulations made is follows: printed in full on page 201 and presents an interesting comparison of the relative Said board shall administer the affairs of borrowings by all member banks in the said bank fairly and impartially and with­ preeminently agricultural state with out discrimination in favor of or against any all member banks in the city of Chicago member bank or banks and shall, subject to the provisions of law and the orders of the and with the individual bank whose Federal Reserve Board, extend to each borrowings exceeded those of any other member bank such discounts, advancements bank in the Federal Reserve District. and accommodations as may be safely The table on page 201 includes per­ and reasonably made with due regard for centages, showing the ratio of amounts the claims and demands of other member borrowed to reserve deposits kept in banks. the Federal Reserve Bank, a method

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Agricultural and Commercial Loans 201

L o ans to A ll M em ber B an k s in a G reat A gricultural S tate C om pared w ith L o ans to th e L argest B orrow ing B an k in th e Seven th F ederal R eserv e D istrict an d L oans to A ll M em ber B an k s in the C ity of C hicago; also, C om parative R eserv e D eposit F ig u r es. (In thousands of dollars) All member banks Largest borrowing All member in Agricultural bank in the banks in State District Chicago July 2,1920 .... *Reserve Deposit 21,000. 32,000. 135,000. Loans 63,000. 80,000. 252,000. Per cent loans to reserve deposit 300. 250. 186.6 October 2, 1920. *Reserve Deposit 21,000. 31,000. 133,000. Loans 78,000. 78,000. 250,000. Per cent loans to reserve deposit 371.4 251.6 187.9 January 5, 1921. ^Reserve Deposit 20,000. 30,000. 130,000. Loans 94,000. 70,000. 187,000. Per cent loans to reserve deposit 470. 233.3 143.8 April 2, 1921 ... ^Reserve Deposit 20,000, 28,000. 121,000. Loans 75,000. 71,000. 188,000. Per cent loans to reserve deposit 375. 253.5 155.3 July 1, 1921 .... *Reserve Deposit 18,000. 29,000. 123,000. Loans 64,000. 33,000. 128,000. Per cent loans to reserve deposit 355.5 113.7 104.0 October 1, 1921. ^Reserve Deposit 18,000. 32,000. 127,000. Loans 62,000. 7,000. 51,000. Per cent loans to reserve deposit 344.4 21.9 40.1 * Average for month. of comparing accommodations granted times its reserve deposit. It is also which is familiar to all bankers. The interesting to note that while on figures are given at intervals of three October 1, 1921, the largest borrowing months and cover the period of bank in the Federal Reserve District greatest expansion of credit in the was indebteded to the Federal Re­ United States. It is worthy of note serve Bank to the extent of only 22 that the total borrowings for all mem­ per cent of its reserve deposit, the total ber banks in the agricultural state were borrowings for all member banks in the on one day nearly five times their total agricultural state on the same date reserve deposits, while the total bor­ were 344 per cent of their total reserve rowings of the largest borrowing bank deposits. in the Federal Reserve District at the It will also be noted from the chart peak were about two and one-half on page 202 showing these percentages,

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Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Activities of R eserve Board and Banks 20s that since April 2, 1921, there has been was no discrimination against agricul- great decrease in the amounts owed by ture by the Chicago Reserve Bank, the city banks, while the curve for the Member banks in cities were not agricultural state does not show a favored. (2) Relative, rather than proportionate decline. absolute, figures must be used if an This examination of actual figures accurate idea of the situation is to be makes clear two points: (1) There had.

Popular and Unpopular Activities of the Federal Reserve Board and the Federal Reserve Banks By W illiam A. Scott University of Wisconsin N account of the extraordinary problems. The financial difficulties conditions under which our Fed­ which speedily followed made most eral Reserve System has been obligedpeople thankful for their existence and toO operate, public opinion towards it created a feeling of dependence upon has taken peculiar twists and turns. them. No one was disposed to hamper Hopefulness, uncertainty and lack of them by criticism. enthusiasm characterized it at the start, Before our entrance into the War, a condition easily explainable by the their activities do not seem to have party controversy which preceded its attracted public attention to an extent establishment, differences of opinion sufficient to arouse either its criticism regarding the details of the law govern­ or its approval. The policy developed ing it and conflicts of interest among during this period of concentrating in the people most directly affected by it. their vaults as large a part of the Those who had fought and bled for the rapidly increasing gold supply as possi­ Aldrich plan were naturally critical ble by exchanging their notes with the of this one and uncertain regarding the banks for gold, important though it manner in which it would work. The was in checking somewhat the rapidly state bankers, generally, were hostile expanding bank credits and in render­ towards it because they feared that ing this mass of the precious metal some of their sources of profits would easily available for any purpose for be jeopardized, and many national which it might be needed, seemed to bankers did not like its coercive fea­ excite curiosity rather than interest . tures. The undiscriminating public undoubtedly hoped that it would suc­ W ar C ompulsions ceed and was disposed to give it a fair With our entrance into the War in trial. April, 1917, the Federal Reserve Banks The outbreak of the European War, were called upon to assist the Treasury three months before the Federal Re­ in its colossal financial operations. As serve Banks were ready to begin opera­ financial agents of the government, tions, cleared the atmosphere and they performed the work of executing smoothed the pathway for them so far its plans and measures and, what is as public opinion was concerned, though more important, so long as the War in other respects it complicated their lasted and for some time thereafter,

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis £04 T he Annals of the American Academy their policies were shaped primarily even enthusiastic endorsement of pub­ with reference to the government’s lic opinion, but criticism of the meas­ needs and interests. ures the Federal Reserve Banks had The greatest of these was the flota­ ultimately to adopt in order to save tion of billions of bonds and short time themselves and the credit system of notes, and the Reserve Banks’ part in the country from the consequences of the work was to act as the government’s this policy. agents in the sale of these securities This misunderstanding and criticism and to aid in creating a market for resulted from the contemporaneous ex­ them. To this end they established pansion of bank credits and the rise of discount rates considerably below the prices. Both were necessary results market with a differential in favor of of the same causes, namely, the read­ loans on the security of government justments in the relations between the bonds and notes, rates low enough, in demand and supply of important groups fact, to make it possible, with the aid of commodities and the transfer on a of rediscounts, for member banks to large scale of demand operations from loan without loss to bond buyers at private individuals and corporations to rates not higher than the bonds and the government. But the people, with notes themselves yielded. the assistance of a group of economists, There can be no doubt that this was interpreted the causal relations differ­ a violation of the rules of sound com­ ently. They insisted that the expan­ mercial banking. It opened the doors sion of bank credits was the cause of to the inflation of bank credit and to the rising prices, and, since the discount the evils which follow in its train. policy of the Federal Reserve Banks Conscious though they were of this was held to be chiefly if not wholly fact, the Federal Reserve Banks and responsible for the inflation, these the Federal Reserve Board were forced banks were held responsible for the to adopt this policy. The Liberty high prices. loans could not otherwise have been This theory aroused no widespread floated. Without borrowing from their criticism of the Federal Reserve Banks banks, the people could not have so long as prices continued to rise and purchased their necessary allotment of prosperity to be general, but, when the bonds, and the banks could not have high price period came to an end and made these loans unless the Federal the opposite movement got under way, Reserve Banks had rediscounted for the belief that the Federal Reserve them on the security of these loans at Banks and the Federal Reserve Board rates which did not involve loss. Had could greatly influence and perhaps the Reserve Banks refused to adopt this control price movements subjected policy, public opinion would certainly them to pressure from people who were have condemned them and probably being, or thought they were being, Congress would have forced them to it. injured by the slump in prices and, .when the banks did not yield to this R esponsibility for the R ise and pressure, to the severe criticism of these F all of P rices people. One of the penalties that had ulti­ The course of events which resulted mately to be paid for this violation of in such pressure and criticism seems to sound banking principles was misun­ have been about as follows: The Arm­ derstanding and criticism, not criticism istice was succeeded by about a year of this policy, which had the hearty and and a half of booming business, accom­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Activities of R eserve Board and Banks 205 panied by extravagance, speculation banks continued to increase for several and soaring prices. Bank credits, in­ months after the slump in prices started cluding those of the Federal Reserve and did not show any tendency to System, expanded rapidly, and bank decline until near the end of the year reserves rapidly declined. Towards 1920. The demand for bank accom­ the end of 1919 ordinary prudence and modations was so great as to keep rates a decent regard for the safety of our at a high level and to make excessive credit system demanded that a halt be rates possible in individual cases. called. The Federal Reserve Board and the responsible officers of the P ressure for L ower R ediscount Federal Reserve Banks felt and knew R ates that good banking policy would have In times of financial distress people required them to put on the breaks always search for an explanation in the much earlier, but they were stopped by hope of finding some means of relief, the financial exigencies of the govern­ and, in this case, the process of reason­ ment whose need for floating large ing outlined above, running from Fed­ loans did not end with the Armistice. eral Reserve Bank discount rates The government needed the aid of the through general bank credits to prices, Federal Reserve Banks quite as much seemed to furnish the key and also to as during the War. suggest a remedy. Proof that low During the year 1919 the Federal discount rates result in expanding Reserve Banks and the Federal Re­ bank credits and rising prices and high serve Board tried in vain to moderate discount rates in contraction of credits the pace of the member banks by moral and falling prices, seemed to be at hand suasion and other indirect methods and in the fact, easy to establish by statis­ it was not until December of that year tics and graphs, that prices did rise that the financial condition of the during the period of low discount rates government freed their hands to such and began to fall soon after the policy an extent that they felt free to apply of higher discount rates was inaugura­ the brake of increasing discount rates. ted. The remedy seemed clearly to be The upward movement of prices a radical cut in discount rates, which, came to an end in the early summer of it was claimed, would result in the 1920 and the slump that followed syn­ expansion of credits or, at least, in pre­ chronized very closely with the period venting contraction and in a check on of high discount rates at the Federal the price slump and, if continued, in Reserve Banks. The pressure upon an upward movement of prices. the banks to carry people who were in The spokesmen of the distressed trouble on account of the rapidly classes in the community deluged the shrinking value of inventories, and Federal Reserve Board with appeals farmers whose crops could either not for this kind of relief and, upon its re­ be marketed at all or at prices much fusal to grant it, with criticism and, in below the cost of production, was very some instances, even with abuse. The great. The Federal Reserve Banks Board was clearly between the devil and the Federal Reserve Board urged and the deep sea. There was no ques­ the member banks to extend all possi­ tion about the necessity for high dis­ ble assistance to these distressed people count rates and the removal of the and supported them in this policy by differentia] in favor of government liberal rediscounts, with the result that paper-secured loans if the credit sys­ the total loans and discounts of the tem of the country was to be kept in a

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 206 T he Annals of the American Academy sound condition; but it was equally progressive rate policy or even greatly clear on the other hand that that policy to modify it when cases of what were was unpopular. regarded by the critics as excessive rates were brought to its attention, and that R ecen t C riticisms of R eserve it refused to reverse its rate policy when B oard P olicy the harm being wrought by the slump The old saw that misfortunes never in prices became apparent. come singly proved true in this case. In support of these charges, the At this truly critical time the Federal critics indulged in fallacious reasoning, Reserve Board was publicly attacked misuse of statistics and the familiar in newspapers and before Congress. tricks of the political stump speaker. Beside the abolition of the progressive They frequently disregarded those rates in force in four of the districts and parts of the Federal Reserve Act which a general cutting of discount rates, it is determined the distribution of powers not easy to determine precisely what and duties between the Federal Reserve these critics wanted the Board to do, Banks and the Federal Reserve Board, but one demand seems to have been for or put an interpretation upon them it to undertake the task of cleaning which varied from that made by the up all the dirty places in our banking Board. * In matters of this kind there system even to the extent of correcting is often room for differences of opinion, the bad practices of individual bankers. but the critical energy was moved by Through the examinations conducted the assumption that the Board was by the Controller of the Currency a wrong and refused to conform to the number of these had been discovered or judgment of a superior wisdom. at least it was so thought. It was also Apparently the critical force had no demanded that the Board use its influ­ conception of the consequences that ence with the Federal Reserve Banks would follow the Board’s failure strictly to force or to induce them to refuse to to follow general rules of action impar­ grant credit to member banks that tially applied. Even if the laws under were not playing the banking game in which it operates gave it the right so the manner in which the critics thought to do, the attempt to deal with the cases it ought to be played. of individual bankers or of individual In the course of this campaign of borrowers would soon swamp it with criticism, a number of charges were an unmanageable mass of detail and brought against the Federal Reserve render impossible the execution of any Board and the Federal Reserve Banks, policy however necessary or desirable. especially that of New York City. The favorite method of proving that The chief of these were: that the Board Wall Street was being favored and the is suffering from “bureaumania” and farmers pinched was to quote statistics is unsympathetic, governing itself by that show that the Federal Reserve general rules which it refuses to relax Bank of New York was loaning at one in individual cases which are thought time to one member bank, or to a few to appeal to the sympathy of its mem­ large member banks, more than certain bers; that it is extravagant, sanctioning other Reserve Banks in the agricultural too high salaries and other unnecessary sections were loaning to large numbers expenditures; that it has permitted an or to all their member banks. That inequitable distribution of credit, Wall it is necessary to observe the relation Street being favored and the farmers between the amount of the real credit pinched; that it refused to abandon the needs of all the constituents of each

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Activities or R eserve Board and Banks 207 Federal Reserve Bank and the total With almost hysterical enthusiasm amount of loans in each case before were cited the cases of a little bank in such statistical comparisons can have Alabama and a few others in which the any significance, either never occurred application of the progressive rate rule to the critics or they chose to ignore the had resulted in very high rates on a fact in order to make an effect on their few loans. These were exploited to the audience. Moreover, these facts were limit in public addresses. The mem­ not emphasized: That Reserve Banks bers of the Reserve Board probably dis­ in the farming country borrowed from liked these extreme results of the pro­ other Reserve Banks, usually in the gressive principle quite as much as East, or that large banks in centers like anyone else, but they stubbornly Chicago ran up their indebtedness at thought out their own remedy. They the Federal Reserve Banks, in part if recommended a rebate of the excessive not chiefly, to help their correspond­ interest payments in these cases and ents located in agricultural sections. the deferring of final judgment on the Much was also made of the fact that principle itself until wider experience some member banks in the New York should give them more light. The district, rediscounting heavily at the critics had their own notions, however, Federal Reserve Bank, were them­ and one was to play upon the feelings selves loaning heavily to speculative and prejudices of their audiences customers, without attempting to show through the use of these extreme cases. what was the proportion of such The refusal of the Board to lower loans to the total in each case or how discount rates when the slump in cutting down the lines of discount of prices occurred was classed as “unpar­ these banks at the Federal Reserve donable.” The arguments disclosed Bank would have affected their con­ complete unconsciousness of the fact stituents as a whole; or without even that there was room for differences of debating the question whether it would opinion regarding the best policy to be good policy for the Federal Reserve pursue at that time or of the reasons Bank in New York to refuse to redis­ for the Board’s refusal. The Board’s count good, eligible paper for a bank action could only be accounted for on on the ground that it disapproves some the ground of “inertia” or “inability of its loans. to comprehend the meaning of events.” The opponents of Reserve Board policy appear to believe that the Fed­ D iscrimination A gainst the F armer eral Reserve Bank of New York and The criticism that the Federal Re­ the Federal Reserve Board are guilty of serve System has discriminated against sins of omission or of commission rela­ the farmers seems to have been endorsed tive to the New York call loan market. by a good many people in agricultural They argue that high rates on that sections, especially in the South and market attract funds from other parts some parts of the West where farmers of the country which ought to be have been especially hard pressed by loaned at home and otherwisewouldbe. the slump in prices. The real credit Just how they would use the Federal needs of these farmers have been very System to prevent this they nowhere great and their desire for credit in make clear. Perhaps they would have many cases has been in excess of their the Federal Reserve Bank of New York needs, since they wanted loans to en­ refuse to rediscount for a bank that able them to hold their crops for cost- loans on the call market! of-production-plus-profits prices for the

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 208 T he Annals of the American Academy realization of which there were no real not know that the chief stock-in-trade prospects. In many cases, doubtless, of commercial banks is short time self- these needs and desires have not been liquidating paper, that .the amount of satisfied and the Federal Reserve Banks, any other kind of paper they should or the Federal Reserve Board, or both, carry is strictly limited and that, if have been held responsible for the they go beyond this limit, they get failure. Why? themselves and everybody else into The testimony of Governors Hard­ trouble. Nor do these critics realize ing, Strong and others before the Joint that a large part of their own paper in Commission of Agricultural Inquiry normal times, and most of what they clearly shows that the Federal Reserve have to offer in these critical times, is System has not been at fault in this not of the short term self-liquidating matter; that, on the contrary, the kind. It is unfortunate that we do resources of this System have been put not have institutions especially fitted to at the disposal of member banks in the satisfy these credit needs, but the fact agricultural sections without stint and is that we have not. Our banking that member banks have been urged system is defective at this point, but to respond to the farmers’ needs to the from this fact it does not follow that it fullest extent possible. There is no would be good policy, or any advantage, evidence that rediscounts of eligible even to the farmer, to wreck our com­ paper have been refused member banks mercial banks in an effort to do what in these sections, but, on the contrary, they are unfitted to do. the evidence shows that the Federal Neither do these farmer critics seem Reserve Banks in these regions have to know that a Federal Reserve Bank borrowed heavily from other Federal can serve them only through a member Reserve Banks and stretched the eligi­ bank and then only by means of redis­ bility rules to the limit in order to ac­ counting eligible paper. If the mem­ commodate such banks. There is also ber bank with which the farmer deals abundant evidence that member banks does not have eligible paper or is un­ have taken advantage of these privi­ willing to offer it for rediscount, the leges and as a whole have responded Federal Reserve Bank can do nothing. liberally to the farmers’ needs. Their rediscounts and loans have expanded M isguided Opposition rapidly since the slump in prices began, The farmer has also misunderstood the former passing far beyond the the operation of high rediscount rates, normal lines of credit set for them by especially those of the progressive the regulations of the Federal Reserve variety. He has thought that these Banks, and in many cases member rates have prevented rediscounts by banks have gone beyond the limits set his bank and in this way have made it by sound practice in order to accom­ impossible for his banker to accom­ modate their farmer customers. modate him. In some cases, doubtless, he has been given this impression by L imitations of C ommercial B anking the banker himself who has preferred The explanation of the farmers’ “passing the buck” to the Federal criticisms must be sought in a mis­ Reserve Bank to giving his customer understanding of the limitations of our the true reason for his unwillingness to commercial banking system, on the one accommodate him. That rediscounts hand, and of our Federal Reserve Sys­ in agricultural sections have not been tem, on the other. These critics do prevented by high rediscount rates is

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis An Open M arket for Commercial Paper 209 shown by the facts. The rediscount adopted was carefully thought out in item has increased in spite of these the light of the actual conditions con­ rates. What these high rates were fronting them, that these policies intended to accomplish and what they worked on the whole extremely well evidently did accomplish, was to force and in the best interests of the country, more careful discrimination between that these men are able and conscien­ real and unreal and between greater tious and know their business and that and lesser needs and to cut down the the country was very fortunate to volume of speculation. have the operation of the Federal Farmers have also been infected by Reserve System in their hands during the theory that the so-called deflation this extremely critical period in its policy of the Federal Reserve Banks history. caused the slump in prices. The unfortunate thing is that few of the fair-minded people of the coun­ P ublic Support or C lass C ontrol try can or will read that testimony. No one would be so rash as to claim The ordinary man knows little about infallibility for the Federal Reserve banking and would find it difficult to Board or for the responsible officers of understand discussions regarding it if the Federal Reserve Banks, least of all he did read them. Public opinion these persons themselves. It would regarding such matters is not formed be strange if they had not made mis­ by careful reflection and weighing of takes. They have had to conduct a the facts. Large numbers of people new institution during a period in are bound to be influenced and to have which conditions were excessively ab­ their opinions determined by such normal and in which principles and criticisms as have been made. Since rules of action, seemingly well estab­ the charter period of the Federal Re­ lished by experience, were clearly in­ serve Banks extends for several more applicable. They have had to blaze years, the effect of this misguiding of new trails and to settle new problems the public mind and feeling is likely to upon which very little light was thrown be demands upon Congress for modifi­ by past experiences here or in other cations of the Federal Reserve System countries. But no fair-minded person in the direction of making it subservient can read and digest the testimony of to special interests and attempts to Governors Harding, Strong, Miller and put the system in the control of men others before the Joint Commission of who will use it in the promotion of such Agricultural Inquiry and escape the interests. It is time for the friends of conviction that every policy they sound banking to be on the alert. The Development of an Open Market for Commercial Paper By E. E. A gger Columbia University T is the function of an open discount the free sale and purchase of bills and market to promote mobility, elastic- paper acceptable as a basis of dealing Iity and maximum economy in the use in the market. Where pressure is felt of credit. Mobility is assured through bills are offered for sale and the result- 15

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 210 T he Annals op the American Academy ing funds relieve the pressure. The of reserves an open discount market funds are offered by those districts contributes toward economy of opera­ where temporary abundance prevails, tion of the credit system because, by and where, therefore, a profitable promoting the free flow of funds, it employment of the surplus is sought. permits the full utilization of available Thus, through the instrumentality of credit in the market before further the discount market, funds are trans­ expansion by the central institution ferred from places where they are becomes necessary. If pressure devel­ wanted less to places where they are ops in any area, through the facilities wanted more. This is the essence of of the open market the surpluses of credit mobility. Just as an open dis­ other areas can immediately be drawn count market promotes mobility of upon without initial resort to the credit it also promotes elasticity, reserve holding agency. With an open namely, expansion and contraction in discount market the free credit tends response to changing demand. An to be completely absorbed before the increase in demand is indicated by a central reserve agency is called upon growing abundance of paper offered in for the expansion that usually implies the market. A decrease in demand is a weakening of basic reserves. likewise reflected in the liquidation of Lastly, it may be said that an open maturing paper, and in the diminution market may also be serviceable in the in the volume of new paper flowing into international flow of credit and in the the market and offered for sale. The safeguarding of the domestic reserve more abundant offering of new paper situation. If the market is sufficiently tends to lead to credit expansion, while well established, and if the dealings in the liquidation of that which matures, it are of a nature and a scope to en­ and which is not offset by a corre­ gender the necessary confidence, the sponding offer of new paper, results in foreigner may be induced to enter in contraction. it and to invest in its wares such sur­ An open discount market can be plus funds, temporarily available, as developed irrespective of the system he can command. As demand increases of reserve organization that may and as rates of discount rise, larger and characterize a given country. Even larger sums may be attracted from under a system of scattered reserves, abroad. This tends favorably to affect there is nothing to prevent banks and the exchange rates and may obviate the individuals in different sections of the necessity of bullion shipments. country from buying and selling dis­ counts from and to one another and C onditions C reatin g an O pen from developing whatever market D iscount M arket machinery may be necessary for the Since an open discount market can­ purpose. Yet since such operations not create itself, it follows that the necessarily imply large and rapid development of such a market must be movements of funds, it is obvious that contingent upon a favorable conjunc­ under a centralized scheme of reserves, ture of circumstances. with effective clearing machinery, the First of all, an open discount market inevitable shifting of funds growing requires forms of discountable credit out of open market operations can instruments that will lend themselves be executed with least friction and to a free market handling. Not all delay. credit instruments, of course, are avail­ Moreover, under a centralized system able for open market operations. Un­

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis An Open M arket For Commercial P aper 211 der the old national banking system, ful of the rest and safeguarding its both law and practice checked the business secrets with a peculiar jeal­ development of satisfactory open mar­ ousy. The cash-discount and single­ ket instruments. The typical Ameri­ name system also tended to emphasize can credit instrument under that the direct relations between the banker system was the single name promis­ and his client and was thus inimical to sory note, which, owing to the obvi­ the development of a system which ously personal character of the credit implied the free handling of paper in which it represented, was not adapted an open market. In general, except in to open market operations. We had a their relations with their regular metro­ so-called “commercial paper market,” politan correspondents, bankers did but its facilities were at the service not wish to confess the need for any only of large and nationally known assistance. Hence there was a strong firms. Moreover, it was a market for tendency for them to hold on to the the first placement rather than for the paper that they had originally dis­ free rehandling of paper. It would counted. They also often objected to therefore hardly be regarded as a real disclosing the rates which they orig­ discount market. inally charged, and some have accused Similarly, the old commercial time them also of wishing to “hog” the draft which had been a common in­ whole interest and of being unwilling strument in pre-Civil War days, de­ to split it with others through a proc­ generated, under the pressure of the ess of rediscounting or reselling in an cash-discount and the open-account open market. However all this may system, into a sort of “dunning” be, the fact remains that our bankers instrument, employed, in all except a were not particularly well disposed few lines, for the purpose of collect­ toward open discount market opera­ ing overdue accounts. The bankers’ tions. acceptance, on the other hand, which is admirably adapted to free and rapid T he R eserve System P rovides an exchanging, was practically unlawful Open M arket down to the time when provision was The framers of the Federal Reserve made for it in the Federal Reserve Act Act thus had a task on their hands. and in some state laws. Thus we had The advantages of an open discount no open discount market in this coun­ market were freely enough conceded, try because we had no paper that could but how were they to provide the neces­ be handled in such a market. sary technical expedients? And how But in addition to a satisfactory lay the foundation for a favorable commodity to be handled in a market, attitude toward such a market? In an it is also necessary to have prospective earlier article, published in T he A nnals buyers and sellers. In other words, in January, 1916, the writer discussed there must be a favorable attitude the provisions of the Federal Reserve toward the market and a willingness to Act and the regulations of the Federal use its facilities on the part of those who Reserve Board bearing on the subject are expected to resort to it. But in of commercial paper and promulgated this respect, also, American banking up to that time. The great contribu­ practice had developed along different tion of the Act itself was a system of lines. We had put the emphasis on reserve centralization and control, the independent, highly competitive local basis of a system of domestic clearings institutions, each more or less distrust­ and transfers, and the legalization of

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T he Annals of the American Academy bankers’ acceptances. These accept­ though under general regulations the ances were at first limited to export Reserve Board may authorize a mem­ and import transactions, but were later ber bank to accept bills growing out of made applicable to domestic transac­ exports and imports up to the full tions as well. Similarly, the amount amount of its capital and surplus. of acceptances for which a member There is, however, the proviso that in bank might make itself liable was no event may the domestic or the dol­ increased from 50 per cent to 100 per lar exchange acceptances exceed a total cent of its combined capital and sur­ of fifty per cent of the member banks’ plus. The Board’s contribution is to capital stock and surplus. Similarly, be found in the regulations which it there is a general restriction to the has drawn up in connection with the effect that no member bank may accept different forms of commercial paper for any one person or firm to an amount and in the policies which it has pur­ greater than 10 per cent of its paid-up sued toward encouraging the use of, and unimpaired capital and surplus and the investment in, paper accept­ unless the member bank is secured able for open market operations. either by attached documents or by At the present time it may be said some other adequate security growing that Section 13 of the Reserve Act out of the same transaction as the supplies the member banks with their acceptance. All acceptances in these authority to engage in the acceptance different classes which mature within business. The acceptances which they three months, exclusive of days of create must have a maturity not grace, and carry the indorsement of at greater than six months, exclusive of least one member bank, are eligible days of grace. They may grow out of for discount at Federal Reserve transactions involving the exportation Banks. or importation of goods or out of those But more important still, so far as an involving domestic shipments, but in open discount market is concerned, the latter case the acceptances must are the provisions of Section 14 of the be accompanied by shipping docu­ Federal Reserve Act. This section ments conveying or securing title at the authorizes Federal Reserve Banks, time the member bank makes the under regulations prescribed by the acceptance, or they must be secured by Board, to purchase and sell in the open warehouse receipts or other such docu­ market, at home or abroad, from or to ments conveying or securing title domestic or foreign banks, firms, cor­ covering readily marketable staples. porations, or individuals, cable trans­ Similarly, under regulations drawn up fers and bankers’ acceptances and bills by the Board, member banks may of exchange of the kinds and maturi­ accept drafts or bills of exchange ties made eligible for rediscount, with drawn upon them by banks or bankers or without the indorsement of a mem­ abroad where the purpose is to furnish ber bank.1 dollar exchange required by the usages Since nothing like an open discount of trade. Such acceptances must not, market had developed in this country, however, have more than three months’ it was foreseen that in trying to build sight to run. one up and to win the support of the The total amount of acceptances for 1 In this connection attention should be called each member bank is restricted to a to the fact that some of the states have also sum equal to one-half of its paid-up and authorized their banking institutions to engage unimpaired capital and surplus, al­ in the acceptance business.

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member banks, the leadership of the T he R eserve System E ncourages Reserve Banks would have to be relied an O pen D iscount M arket upon. This is what gives special sig­ From the beginning the Reserve nificance to the provisions of Section Board has done all that it could to 14. For the same reason much sig­ further the development of an open nificance attaches also to the regula­ discount market. It encouraged the tions of the Board bearing on the Reserve Banks in their efforts to eligibility of paper for rediscount at emphasize the importance of accept­ and for open market purchases by the ances as investments, not only by Reserve Banks. their own purchases but also in the In general, it may be said that paper favorable rates that were accorded to be eligible for discount must have them. The Board has cordially ap­ grown out of a transaction involving proved the acceptance service that “producing, purchasing, carrying or some of the Reserve Banks have marketing goods in one or more of the provided for their member banks. Sim­ steps” of “production, manufacture ilarly, the Board has also dealt gen­ or distribution, or for the purpose of erously with acceptances in its regula­ carrying or trading in bonds or notes tions and decisions, although it has of the United States.”2 On the other tried at the same time to maintain the hand, it must not be paper whose pro­ principles laid down in the Reserve ceeds are to be used for fixed invest­ Act with respect to the fundamental ments of any kind or for other capital character of the paper. During and purposes; or paper used for specula­ immediately after the War the Board tive purposes or for lending to others. stretched a point with respect to Various expedients such as statements, renewal paper, but only in exceptional shipping documents, warehouse re­ cases can such paper now be considered ceipts, etc., are relied upon to guarantee eligible.4 the essential nature of the paper and Favorable rates of discount were to safeguard its security. For pur­ recognized from the outset as the poses of rediscount Section 13 of the strongest practical stimulant to the Reserve Act made eligible notes, drafts growth of an acceptance market. In and bills of exchange of certain types. their open market purchases the Re­ But open market purchases by the serve Banks, that were primarily con­ Reserve Banks were limited to bankers* cerned, quoted more favorable rates acceptances and bills of exchange of for acceptances than for other com­ the kinds and maturities made eligible mercial paper and granted the same for rediscount by Section 13. The discrimination also for acceptances effect of this limitation was to rule the directly discounted for the member promissory note out of the field of open banks. Such preference was consid­ market purchases, leaving within this ered fully justified by the essential field bankers’ acceptances, bills of character of the paper. On the other exchange and so-called trade accept­ hand, the Reserve Banks allowed the ances which are defined as drafts or open market rates to control buying bills of exchange “drawn by the seller rates as largely as possible, shading or the purchaser of goods sold, and the rate slightly where a strong indorse- accepted by such purchaser.”3 4 See Sixth Annual Report of the Federal Reserve 2 Regulations A, Series of 1920. Board covering operations for the year 1919, 3 Regulation A, Series 1920, Section V. page 22. Ibid., page 38.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 214 T he Annals of the American Academy ment justified it. To induce broader with their member banks through their purchases by member banks the Board member bank relations department.* itself recognizes that a differential rate In the development of the accept­ must be maintained in favor of prime ance market it was recognized that the bills indorsed and rediscounted by dealer would of necessity play an member banks. Such differential always important part. It is essential to the assures the member bank of some success of the, acceptance that it be profit should it find it necessary or desir­ quickly sold after acceptance has been able to rediscount at its Reserve Bank effected. The dealer has been increas­ the acceptances that it has purchased.5 ingly relied upon to effect a rapid dis­ tribution of the paper as it is created. Special I nducements to B u y Naturally, unless there is a rapid turn­ A cceptances over in the market, the dealer may As a further inducement to member have to carry large amounts. This banks to invest in acceptances, some requires more capital than most dealers of the Reserve Banks have maintained can afford, and hence some of the special lines of service. The New York Reserve Banks have followed the prac­ Bank, for example, has for several years tice of carrying a part of this load. bought bills in the open market on The Banks take the paper for fifteen member bank account. If desired, the day periods under a re-purchase agree­ Reserve Bank retains the paper, col­ ment, pending distribution.9 This has lects it at maturity and credits the made it possible for the dealers to member bank’s account.6 The Rich­ operate continuously on a much larger mond Reserve Bank also buys accept­ scale than would otherwise be the case, ances for its member banks and allows and it has meant much, therefore, in the member bank to specify the names the upbuilding of the market. of the acceptors whose paper is wanted.7 The Richmond Bank also has been E x ten t of the A cceptance M arket buying unindorsed bills directly from The principal market into which the acceptors. This encourages the acceptances flow is, of course, New member bank to utilize its acceptance York. This has thrown a special bur­ powers, and, at the same time, affords den on the NewYorkReserve Bank, but the Reserve Bank the opportunity of through allotments to other Reserve keeping well informed concerning the Banks this burden has been distributed methods employed in the granting of to some extent.10 Purchasers of accept­ acceptance credits. The Boston Bank ances were at first only the larger has been making persistent efforts to banks, but today dealers have as cultivate investment in acceptances clients in addition to many banks, for secondary reserve purposes. The corporations, firms and private indi­ Cleveland and Chicago Banks report viduals.11 During the past year heavy a steady broadening of the market as purchases on foreign account have also a result of successful missionary work been made.12 Moreover, in some states 5 See Sixth Annual Report of the Federal Reserve 8 Seventh Annual Report of the Federal Reserve Board covering operations for the year 1919, Board., page 52. page 23. 9 Ibid., page 51. 6 Report of Federal Reserve agent, Sixth 10 Ibid., page 51. Annual Report of the Federal Reserve Board, 11 Ibid., page 50, p. 366. page 319. 12 See Report Federal Reserve agent, New 7 Seventh Annual Report of the Federal Reserve York District—Seventh Annual Report of the Board, page 52. Federal Reserve Board, p. 382.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis An Open M arket for Commercial Paper 215 by act of legislature bankers’ accept­ of these districts.13 But it is reasonable ances have been made eligible invest­ to suppose that as time goes on the ments for savings banks and this prom­ advantage of the acceptance as a ises a fruitful source of demand. The liquid, short-time investment will be main development has naturally come quite generally recognized and the in the larger industrial and commercial scope of the market should be more centers. The Board states that, as a nearly countrywide than it is now. rule, in the South, Southwest and The general trend of the acceptance certain parts of the West, member may be indicated by a few tables. banks have only partially exercised Table I shows the acceptance liabilities their acceptance powers, while pur­ of member banks at each controller’s chasers of acceptances are almost call since November, 1915. exclusively banks in the larger centers Tables II and IIA show the Reserve TABLE I. Volume op Member Bank Acceptances as per the Controller’s Call for the Specified Dates a (In thousands) November 10,1915...... 266 December 31, 1915...... 32,876 March 7, 1916...... 42,677 May 1, 1916...... 62,452 June 30, 1916...... 73,641 September 12, 1916...... 81,290 December 27, 1916...... 107,909 March 5, 1917...... 108,550 May 1,1917...... 118,799 June 20, 1917...... 157,870 September 11, 1917...... 138,231 November 20, 1917...... 153,645 December 31, 1917...... 217,190 March 4,1918...... ;. 230,164 May 10, 1918...... 250,323 June 29, 1918...... 231,805 August 31, 1918...... 243,772 November 1, 1918...... 332,719 December 31, 1918...... 305,101 March 4, 1919...... 269,173 May 12, 1919...... 224,150 June 30, 1919...... 272,035 September 12, 1919...... 323,226 November 17, 1919...... 359,109 December 31, 1919...... 407,639 February 28, 1920...... 424,669 May 4, 1920...... 438,430 June 30,1920...... 431,196 September 8, 1920...... 414,583 November 15, 1920...... 406,525 December 29, 1920...... 375,416 February 21, 1921...... 345,644 April 28, 1921...... 304,231 June 30, 1921...... 250,925 a Specially prepared by the Drvision of Analysis and Research of the Federal Reserve Board. 13 See Report Federal Reserve agent, New York District—Seventh Annual Report of the Federal Reserve Board, p. 382.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 216 T he Annals op the American Academy TABLE II. Federal Reserve Bank Discounts and Purchases of Trade and Bankers’ A cceptances b (In thousands)

D iscounts P urch ases in Op e n M ark et Y ear Bankers Trade Bankers Trade 1915...... 1,959 64,814 31 1916...... 5>212 369,762 16,333 1917...... 37,771 1,046,765 30,948 1918...... 19,940 187,373 1,748,503 61,036 1919...... 71,643 138,420 2,788,619 36,558 1920...... 187,162 192,157 3,143,737 74,627 1921-9 M o...... 49,810 101,129 996,851 6,687

TABLE IIA. Same Data by Months for 1920 and 1921 t o D a te

Discounts Purchases in Open Market 1920 Bankers Trade Bankers Trade January...... 17,226 16,520 299,746 2,706 February...... 28,611 11,001 296,959 3,349 March...... 34,534 23,383 298,459 4,901 April...... 28,172 15,296 240,704 6,890 May...... 15,254 16,541 270,498 3,739 June...... 9,431 13,938 261,333 24,419 July...... 7,069 13,457 209,296 10,168 August...... 5,490 14,011 247,438 12,270 September...... 8,103 17,160 255,858 2,131 October...... 10,354 19,389 280,162 1,670 November...... 13,275 15,143 230,832 1,008 December...... 9,643 16,318 252,452 1,376 Year...... 187,162 192,157 3,143,737 74,627 1921 January...... 8,430 20,171 121,135 1,064 February...... ♦... 6,159 13,256 167,362 2,079 March...... 11,512 11,709 148,698 557 April...... 7,404 10,860 121,412 2,099 May...... 6,560 9,768 137,980 622 June...... 3,790 9,937 64,599 75 July...... 1,942 8,673 46,623 47 August...... 1,408 8,781 107,270 33 September...... 2,605 7,974 81,772 111 9 Months...... 69,810 101,129 996,851 6,687 b Specially prepared by the Division of Analysis and Research of the Federal Reserve Board.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis A n Open M arket for Commercial Paper 217 TABLE III. Bills Bought in Open Market® (In Thousands of Dollars) Federal Reserve Bank 1917 1918 1919 1920 1921 (9 mos.) Boston...... 86,481 194,158 360,784 304,445 New York...... 445,307 945,498 1,211,399 1,697,330 Philadelphia...... 70,710 77,686 14,049 41,232 Cleveland...... 51,007 122,800 261,750 294,602 Richmond...... 54,759 70,766 52,977 51,712 Atlanta...... 25,388 45,477 51,661 39,576 Chicago...... 61,142 122,787 292,012 345,021 St. Louis...... 22,788 26,096 87,503 36,020 Minneapolis...... 16,397 13,903 108,714 18,060 Kansas City...... 17,561 14,691 26,086 17,173 Dallas...... 9,743 25,024 12,415 8,348 San Francisco...... 48,018 150,653 345,827 364,845 Totals...... 909,301 1,809,539 2,825,177 3,218,364 0 Yearly returns Seventh Annual Report Federal Reserve Board, Z>. 52. Bank discounts and purchases of ance and experience seems to prove bankers’ and trade acceptances for that it lends itself to serious abuse.14 indicated periods. Evils have been complained of also in Table III shows the purchases in connection with bankers’ acceptances, the open market by or for the account but such evils can be handled through of each Federal Reserve Bank during the banks more easily than trade the years 1917-1920 included and for acceptance abuses can be remedied the first nine months of the present through the more numerous and less year. amenable private business firms. The future development of the open market F u t u r e D e v e l o p m e n t T h r o u g h is thus likely to rest more and more B a n k e r s ’ A c c e p t a n c e s completely on the bankers’ acceptance, It will be observed that from the and a great impetus would be given to spring of 1920 down to the last quarter this development if in domestic busi­ of 1921 the volume of operations ness a credit procedure based on the declined. This was due primarily to bankers’ acceptance were more widely the great decline in our foreign trade, employed. but the collapse at home also exerted a 14 The Federal Reserve agent of District No. considerable influence. Another no­ 1 in his 1920 report to the Board says: “The table circumstance is the specially development of the use of trade acceptance— large drop in trade acceptances as at least the domestic trade acceptance—unlike contrasted with bankers’ acceptances. that of the bankers’ acceptances, does not appear to have been entirely satisfactory. That they The experience with trade acceptances have been misused there is little question, and has not been particularly encouraging. for the most part the banks in the district do not In nature, the trade acceptance differs feel any more favorably disposed, if as much so, diametrically from the bankers’ accept­ to encourage their use than in the past.

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The Efficiency of Credit By 0 . M. W. S p r a g u e Harvard University GOOD irrigation system and a banking arrangements brought about perfect system of credit would by the establishment and operation of exhibit strikingly similar characteris­the Reserve Banks. The reduction in tics.A The supply of credit, as of water, reserve requirements for member banks would be abundant, produced at a min­ and the concentration of those re­ imum cost, and free from interruption serves in the Reserve Banks, where or exhaustion. Adequate means of they become in turn the basis for distribution would be developed to further credit in the form of Federal furnish the water in the one case and Reserve notes and also of reserve bal­ credit in the other to every part of the ances, have greatly reduced the amount territory to be served. And then, to of gold or other reserve money re­ secure good results, judgment must quired to support a given volume of needs be exercised in both cases. Unin­ credit. Estimates of the saving tfius telligent and lavish use of the water secured vary somewhat, but for our will be harmful to the crops and may present purpose it is sufficient to note exhaust the most abundant sources of that all calculations agree in the con­ supply. Similarly with credit, unre­ clusion that gold is now a basis for at strained use has an unfavorable effect least twice as much credit as in the upon industrial output, stimulates a period before the Reserve System was rank growth of speculation and is the established. principal cause of extreme fluctuations A reduction in the amount of gold in the general level of prices. Irriga­ required to support a given volume of tion experience also teaches that ex­ credit would be followed by a positive tensions and improvements in one reduction in the cost of bank credit if direction may be wasteful and even the volume of credit was not enlarged. positively hazardous unless they are Less gold would then be used for bank­ accompanied by balancing develop­ ing purposes, and the surplus could be ments in other directions. This essen­ used in the arts or exported in payment tial requirement, if a credit system is to for goods, services or securities. Again, develop in a satisfactory fashion, is insofar as additional credit might serve commonly overlooked. The estab­ to increase production, a positive lishment and operation of the Reserve advantage would be derived from the Banks has introduced many and im­ reduction in reserve requirements. portant changes in our banking system. But manifestly the amount of addi­ Whether that development has been a tional credit that can exert a favorable well balanced development is, in my influence upon production is small. A judgment, the most searching and im­ large increase in the supply of credit, portant question raised by our credit if freely used, is a positive detriment experience during the last six years. to industry. Its effects are seen in rapidly advancing prices, an over-ex- M o r e C r e d it a t L o w e r C o s t tended condition of business concerns An increase in the supply of credit generally, and widespread speculation, and a reduction in basic costs are culminating in crises and followed by definite results of the changes in our trade depression.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e E f f ic ie n c y o f C r e d it 219 Leaving out of consideration the to which the conduct of business is special case of the use of credit in subject. financing the War, it is not easy to discover any positive gain that the T h e D istribution o f C r e d it country has realized from economy of Turning now to the distribution of gold which has been secured through credit, the Reserve System is found to the establishment of the Reserve Sys­ have made considerable, though by no tem. So far, the results have been means fundamental, changes. On unfavorable. The additional credit account of the almost complete ab­ was freely extended and we now are sence of branch banking in the United enduring the inevitable consequences. States, credit is far less fluid in this So far as the supply of credit is con­ country than elsewhere. The supply cerned, a repetition of this experience is of credit in each community, and entirely possible. Loan liquidation, especially in the smaller ones, is in always an incident of periods of depres­ large measure limited to the resources sion and abnormal gold imports, is of the local banks eked out by such placing the banks in position to grant amounts as they may choose or are billions of additional credit as soon as able to borrow from banks in other an active demand develops. places. Through the Reserve Banks A more certain gain from the Re­ the borrowing facilities of many local serve System is the assurance that the banks have been materially enlarged. flow of credit will not be interrupted But it still remains true that credit is through exhaustion of supply or by the far less fluid than in the countries working at cross purposes of the banks where banking is conducted by banks as happened in successive crises down operating regional or nation-wide sys­ to and including the crisis of 1907. tems of branches. This is the price, This assurance that the flow of credit not necessarily too high a price, that will not be interrupted in the future is we pay for our system of independent not the result of the increase in the sup­ local banks. ply of credit. It could have been It is in the employment of credit that gained without any increase whatever the least change has followed the in credit supply. The exhaustion of establishment of the Reserve System. the lending power of the banks on Aside from certain general restrictions, future occasions of financial strain is each local bank, and properly, is free altogether unlikely because the Re­ to employ its funds as may seem to it serve Banks recognize responsibility advisable. The Federal Reserve Act for the general credit situation in this widened the scope of the lending activ­ regard, and regularly hold in reserve, ities of the banks somewhat by author­ power to extend credit on an extensive izing them to accept a limited range of scale to be used freely in case of emer­ bills of exchange and to lend a moder­ gency. Through the Reserve System ate amount on mortgage security. the banks of the country have also The Act also aimed at making com­ become closely knit together for settle­ mercial loans more attractive by ex­ ment purposes, and there is therefore cluding other loans, with the exception no longer reason to fear that they will of those secured by United States suspend payments on future occasions government obligations, from redis­ of financial strain. In short, that a count at the Reserve Banks. future crisis will degenerate into a These changes in the law and modi­ panic is no longer one of the hazards fications in banking practice are im**

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 220 T he Annals of the American Academy portant, but were not expected to well within legal reserve requirements. change materially the general char­ On the basis of the credits secured acter of the assets of the banks. through these rediscounts the com­ mercial banks of the country would be M o r e C r e d it W it h o u t N e w U s e s able to extend loans by from two to This, then, is the gist of the situation three times the amount discounted. resulting from the establishment and In other words, it may be conserva­ operation of the Federal Reserve tively estimated that there is at least System: an enormous increase in the ten billion dollars of unused bank available supply of credit and no con­ credit in the United States at the siderable new uses for this credit. No present time. new uses for credit are needed to ab­ sorb this additional supply. The bulk T h e D is c o u n t R a t e a n d t h e P r ic e of this additional credit cannot be L e v e l employed with advantage to the com­ In the Federal Reserve System we munity, but only to its positive dis­ have an agency which has the power to advantage. Credit serves a productive make a vast increase in the supply of purpose by facilitating the transfer of credit for the bulk of which there is capital assets and of goods in process only one influence that will create an of production and marketing. But intense demand. That influence is when business is active, and people rising prices. A moderate advance in are already fully employed, additional prices may indeed have a beneficial doses of credit do not result in a larger physical output of goods. Additional effect on production after a period of credit then subjects all industry to depression, but a prolonged upward the unhealthful influence of protracted swing of prices creates speculative advance in prices. The demand for conditions, stimulates speculative ac­ credit grows more and more intense tivities, and tends to bring all but the and is practically without limit. At most cautious business concerns into such times, moreover, the thousands of an over-extended condition. Such a competing banks are quite incapable prolonged upward movement of prices of imposing restraint upon borrowers with all its disastrous consequences is so long as they possess unused lending hardly possible without large use of the power. The fear that desirable deposi­ credit resources of the Reserve Banks. tors will go elsewhere is strong and It would seem, therefore, that the warps judgment. In these circum­ effect of advancing prices on the general stances, cautions and warnings from business situation should be a factor of the Reserve Banks have little effect; the first importance in shaping the they were not heeded in 1919. discount policy of the Reserve Banks, The Reserve Banks now have a re­ assuming more and more importance serve which is nearly 75 per cent of as a period of business activity con­ their demand liabilities, with prospects tinues. The management of the good for a still higher ratio before con­ Reserve Banks is, however, by no ditions become favorable for a period means inclined to this view of the of renewed business activity. Redis­ matter. Responsible officers of the counts to the amount of about $3,000,- banks land also members of the Federal 000,000 could be granted and still, in the Reserve Board roundly assert that absence of gold exports,—an unlikely they are not concerned with the course event—the Reserve Banks would be of prices and that in the determination

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis T h e E f f ic ie n c y o f C r e d it mi of discount policies the price situation last two years. It bears much of the is not a definite factor. burden of the consequences of the The attitude of the management of unwise low discount policy which the the Reserve Banks in regard to re­ Treasury Department unwisely in­ sponsibility for the course of prices sisted must be continued for more forcibly recalls an experience of the than a year after the Armistice. The most ancient of central banks. For wisdom subsequently manifested in more than a generation, the directors refusing to give way to demands for of the Bank of England stoutly in­ additional credit, which would have sisted that the Bank was no more made a bad situation worse, could not responsible for the situation in time of be expected to make a strong appeal crisis than any other London bank. to the people at large. For the future, Finally, largely as a result of repeated if not prevention, at least clear evi­ onslaughts by Bagehot in The Econ­ dence that the Reserve System has not omist—given more permanent form in contributed to the creation of the Lombard Street—the policy of the intense activity that breeds depression Bank was definitely reversed and the is a reasonable demand on the part of course that has become universal the public. This expectation will not practice in handling crises was adopted. be realized if large additional supplies There is unhappily little doubt that of credit are furnished by the Reserve the Reserve System has lost somewhat Banks at times when prices are rising in general public estimation during the rapidly and persistently.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Book Department B a l d w in , D. C. Capital Control in New significance has been accomplished. Really York (State). Pp.xxiv, 225. Price, $3.00. effective control of securities in the State New York: McDevitt-Wilson’s Inc., 1921. of New York dates from the going into Up to a few years ago, many public effect of the Public Service Commissions utilities had the habit of claiming that “a Law (July 1, 1907). This act was fathered contract was a contract,” while, lately, a by Governor Hughes and its final enact­ large part of the consuming public has been ment was due almost wholly to his per­ inclined to adopt the slogan as its own. sistent efforts. The passage of this act But there has of late been evident a grow­ marked an epoch in public utility regulation. ing realization on the part of the public For years the control of the issuance of that while revenge may be sweet, it has its securities by regulative bodies had been limitations as a steady diet. We can exist recognized as the key to all the other as­ without the utilities, but we cannot “live” pects of utility regulation, and this act, without them; not only are they indispen­ creating the Public Service Commissions of sable to our present standard of comfort, the First and Second Districts, respectively, but they are already lagging far behind our not only granted them power to compel the demands upon them. The utilities, on rendering of adequate service to the public, the other hand, cannot serve us without a but also clothed them with authority to sound basis of credit, the foundation of approve or reject proposed issues of stocks which is a budget which not only balances, and bonds. In the ten years following but allows for the necessary reserve and 1907, the New York Commissions ac­ emergency funds. The result of the har­ complished a vast amount of pioneer work rowing experiences of the last five years is with the aim of securing as conservative that now, after the pendulum has been capitalizations as were possible in the face allowed to swing both ways, both the of the chaotic conditions with which they utility corporations and the public have were confronted, to the end that the in­ experienced a deeper realization than ever vesting public might be protected without before of the mutual benefit to be derived the necessity of exploiting the consuming from the proper governmental control of public either through the furnishing of the issuance of securities. inadequate service or the charging of In view of the more widespread realiza­ exorbitant rates. tion of this fact brought about by recent The principles worked out by the Com­ events, a study of the regulation of security- missions during this period, and subse­ issues accomplished in the State of New quently upheld or modified by the courts, York is welcome at this time. New York make an interesting study both from the was one of the first of our commonwealths standpoint of governmental authority and to inaugurate effective control in this mat­ of investment protection. In the further ter, and, being the wealthiest and most elaboration of sound governmental control populous of the states, the problems in­ of security-issues, which recent experience volved were especially numerous and com­ has shown to be so necessary for all parties plex; in fact, the First District Commission, concerned, these principles will be regarded with jurisdiction over the city of Greater as among the most valuable precedents New York, had to cope with problems that available. were unique and without a parallel, either in this country or in Europe. H a y e s, E dw ard C a r y . Sociology and The author of this monograph has traced Ethics. Pp. viii, 354. Price, $3.00 net. the growth of New York’s administrative New York: D. Appleton and Company, regulation of security-issues from the first 1921. crude and nominal beginnings in the early This book may be said to be a footnote fifties of the last century to the middle of to a paragraph in the author’s Introduction 1918, since which time little of constructive to Sociology, published five years ago, ii*

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Book D epartment 223 which he wrote (page 4): “Sociology aims much that appeared in earlier editions and at nothing less than the transfer of ethics included seven new chapters. from the domain of speculative philosophy to the domain of objective science.” The L ippin c o tt, I sa a c : Economic Develop­ book is essentially a plea for an objective ment of the United States. Pp. xvi, 691. scientific ethics—for a sociology which is Price, $3.50. New York: D. Appleton and an objective scientific ethics. Company, 1921. Ethical theory, according to Dr. Hayes, One of the greatest needs of American who is professor of Sociology at the Uni­ students has been for a suitable economic versity of Illinois and now president of the history of the United States. Perhaps American Sociological Society, has passed time is necessary for the scholars of any through the “three stages of progress” of country to produce such a work because Comte’s famous classification. It first had of all that is involved. At any rate, for its theological stage, in which the moral that reason or for some other, there has law was regarded as the voice of God in been a dearth of satisfactory studies. Even the soul of man. Then followed the met­ the monographic literature has been com­ aphysical period, with the concept of moral paratively meager. law as an abstraction emanating from the Professor Lippincott has taken a great “Ding an Sich.” Finally, it is in process step in advance in his treatment. As he of entering the “scientific” stage, in which observes in the introduction, he has not rightness and goodness of conduct will be limited himself to a mere record of indus­ determined by scientific study of the real­ trial progress, but has endeavored to bring ities of life, wherein the values of life will together causes and results. After an in­ be determined objectively. troductory section on factors in economic It is a thought-provoking book. Soci­ development, the treatment is by periods ologists who have emphasized the pure through 1914 with a concluding chapter on rather than the applied side of their sub­ the war period from 1914 to 1920. Empha­ ject will find their practice sharply chal­ sis is well distributed over the different peri­ lenged. Historical ethics is reminded of ods and a common defect of such studies— its a priori assumptions and preoccupations over-emphasis on the earlier years—seems with an abstract individualism. ^ Theo­ to have been avoided. The distribution logians and moralists, alarmed by the of space between different phases of develop­ deterministic implications of social science, ment may, however, be more open to crit­ are reassured, such implications being rec­ icism. For the period from 1860 to 1914 onciled in their traditional views. Al­ only two chapters are given to the extrac­ though the book is marred by a deal of tive industries and two to agriculture, repitition, obviously the result of inter­ a total of 89 pages, while to manufactures mittent effort scattered over a number and commerce are given eight chapters of years, it is a searching but optimistic or 220 pages. We are still nearly fifty analysis that will repay careful perusal. per cent a rural population. This fact Jam es H. S. B o ssard. and the acute problems presented by our University of Pennsylvania. rural conditions would seem to warrant a different emphasis. B a r k er , J. E l l is: Modern Germany, Her The volume is the best study yet avail­ Political and Economic Problems. Pp. vii, able, both for private reading and for the 496. Price, $6.00. E . P. Dutton & Co., class room, and will doubtless find a wide use. 1921. This is the sixth edition “entirely re­ B ow m an, I sa ia h , Ph. D. The New World. written and very greatly enlarged.” The Pp. vii, 632. Price, $6.00. New York: writer is a widely known and very able World Book Company, 192X. authority, whose writings in the leading The past few months have been months British journals have attracted wide atten­ of intensive education of the American peo­ tion. In this edition he had condensed ple in affairs international. The conclusion

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis ZM T he Annals of the American Academy of the World War with its remaking of maps German people, the national existence of and its reordering of industries and of Austria, the new Hungary, the domain of markets has made this world a very small the Czecho-Slovaks, Jugo-Slavia and the one. This book gives a wealth of world facts Adriatic, the new frontiers of Rumania, the each citizen should have at his disposal. mountaineers of Albania, the reunited The book is a geography replete with Greek lands, the borderlands of Poland, the maps reliable and up to date; but it is more development of Lithuania, land tenure and than a geography. The book is a history trade outlets in Esthonia and Latvia, the in that the important epochs in the his­ geographical setting and the problems of torical, industrial, social and racial develop­ Finland, the ethnic groups of the Russian ments of each of the countries are noted; Empire with the background of the Russian but it is more than a history: It is a treatise disorder, Constantinople as a European of world-wide industry in that it gives the thoroughfare, the Jewish homeland— location and output of coal mines, and iron Palestine, Anatolia—the last remnant of mines and other natural resources; it lo­ the Turkish Empire, the Transcaucasian cates the world’s industries, it outlines the peoples, the interests of Persia in their re­ world’s waterways, pictures the world’s lation to British industry, the unsettled routes for trade, and gives the industrial land of the Nomad in inner Asia, the raw backbone of every nation. And yet it is materials in the Far East and their control, more than a book on industry. It is also the expansion of Japan toward the main­ replete with matters political in their de­ land of Asia, the conflict of Chinese and velopment and social in their origin. And Japanese interests, the Pacific realm and yet it is something more than a source Australia, the past and present status of book on the leading social and industrial colonies, the European powers in Africa, facts of the nations of the earth. The boundary disputes in Latin America and book is a mine of information as broad as the relations between Latin America and human life itself and this information is the United States. concisely put and is accurate in its scholar­ Such a recital of the contents of the book ship. Only one in close touch with the ex­ gives some idea as to its value as a reference tensive sources of the American Geograph­ book at these times. Not the least valuable ical Society, and in close touch with all the part of the book is its carefully prepared information open to government officials bibliography covering each of the points preparatory to the many recent world con­ mentioned above and many, many others. ferences, could have had access to the diver­ In an Appendix is given a list of dates and sified sources from which the knowledge in names of principal treaties and agreements this volume has come. from 1814 to 1920. In addition to the The book discusses the problems of im­ maps are many choice illustrations re­ perial Britain, the political and colonial flecting the natural and industrial activi­ aims of France, Belgium as the crossroads ties of many of the leading countries of the of Europe, the Italian situation, the dem­ world. The book is a credit not only to ocratic drift in Spain, Portugal’s colonial the author but to American scholarship in policies, transportation and industrial prob­ general. lems of Switzerland, the Scandinavian C lyde L. K in g . countries and Holland, the problems of the University of Pennsylvania.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Index Acceptances: authorization of, by Reserve Act, B e c k h a r t, B. H. Outline of Banking History xv, 211, 212; definition of trade, 106, 213; the from the First Bank of the United States discount and bankers’, 111-3, 212; extent of, Through the Panic of 1907, 1- 16. market, 214-7; function of bankers’, 110, 217; Branches: development of, 141-2; early disad­ the open market and, 211-3; Reserve Bank vantages of, 138-9; establishment of, 137-8, purchases of, 216; special inducements to buy, 139; functions of, 140-1; organization of, 140. 214; volume of member bank, 215. Branches of Federal Reserve Banks, A g g er, E. E. The Development of an Open The Establishment and Scope op. E. R. Market for Commercial Paper, 209-18. Fancher, 135-42. Agricultural and Commercial Loans. Business Men’s Monetary Conference: 27. J. B. McDougal, 199-203. Agricultural loans: charge of discrimination C ase, J. H. Preparation for War and the Liberty against, 203, 206, 207-8; commercial and, 201, Loans, 121-9. 202; rediscount rates and, 208; relation of, to Centralization: 24, 62, 70, 137. reserve deposits, 201; relative nature of, 199- Check-collection system: 60-1, 69\ before Re­ 201. See Agricultural paper. serve System, 82-3, 95; “exchange,” 83. Agricultural paper: definition of, 106; eligibility See Par collection system. of, for discount, 106- 10; maturity of, xii, 106-7. Collection System: See Par collection system, Aldrich Plan: comparison with Reserve Act, 23, Check-collection system. 48-9, 64; lack of public confidence in, 23, Commercial banking: ix, xii, 58-9, 155, 187, 208. 30; substance of, 21. See Aldrich-Vreeland Commercial paper: acceptance of, as security, 52; emergency currency. distinction of, from agricultural, 106; eligibility Aldrich-Vreeland emergency currency: avail­ for discount, 107-10, 69; open market for, ability for war demand, 50; Federal Reserve 209-18. notes and, 54-5; National Currency Associa­ Commercial Paper, The Development op tions and, 52-3, 136; provisions of act granting, an Open M arket for. E. E. Agger, 209-18. 50, 52; retirement of, 53-4 ; statistics of, 51. Congress, The Federal Reserve Act in. Aldrich-Vreeland Emergency Currency, H. Parker Willis, 36- 49. T h e. Homer Joseph Dodge, 49-55. Contraction: See Expansion and contraction. Amendments to Federal Reserve Act: Act of Contraction as Seen By a Business Man, April 13, 1920, 121; Act of June 21, 1917, Expansion and. J. V . Farwell, 163-7. 115-6; Act of March 3, 1919, 119; Act of Sep­ Contraction, 1919- 1921, Curves of Expan­ tember 7, 1916, 114-5, 120; Act of September sion and. A. C. Miller, 142-50. 26, 1918, 118-9; bearing and trend of, xvii; Contraction from the Federal Reserve foreign banking, 119-20. Standpoint, Expansion and. John H. Rich, Amendments to the Federal Reserve Act. 174-83. Walter S. Logan, 114-21. Contraction under the Federal Reserve American Bankers Association: xvi, 15, 167, 168. System, Expansion and. E. M. Patterson, Assumption op Treasury Functions by the 151-63. Federal Reserve Banks, The. Murray Country banks: conflict of, on note issues, 61; S. Wildman, 129-35. general advantage of system to, 81-2; old collection system and, 82-3; proportionate Baltimore Plan: 15. borrowings of, 199-200. See Agricultural Banking History from the First Bank op loans. the United States through the Panic Credit: business, and Reserve System, ix-x, xxi, op 1907, Outline of. B. H. Beckhart, 1- 16. 142-4,192; commercial banking and, ix; control Banking reform: educational campaign for, 29- of, 25, 182-3, 195-9; distribution of, 219-20; 36; experiments of 1836-1863 in, 6; general expansion and contraction of, 69, 178-82; efforts at, 14-6; the national banking system Federal Reserve System and, 219-21; a guide and, 6-7; the National Citizens’ League and, to, policy; 148; member bank, curve, 144-5, 26-9, 34; question of administration, 25; 147; more, at lower cost, 218; more, without recommendations of National Monetary new uses, 220; an open discount market and Commission, 22-3. mobility of, 210-11; Reserve bank, curve, Bank rates: 193, 194. 145-8. Bank Rates and Business Activity, Re­ Credit, The Efficiency of. O. M . W. discount Rates. George M. Reynolds, Sprague, 218-21. 190-5. 16 225

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 226 T he Annals op the American Academy Credit under the Operation of the Fed­ Exchange charges: xxv, 83, 95, 116, 117. eral Reserve System, Theoretical Con­ Expansion and contraction: business viewpoint, siderations Bearing on the Control of 163-7; contrast with inflation and deflation, B an k . Chester A. Phillips, 195-9. 152; currency, 170-3; determinable factors in, Crennan, C. H. The Integrity of the Federal 149, 150; discount rate and, 159, 160-2, 164, Reserve System, ix-xxvi. 165, 166; of Federal Reserve notes, 177; in­ Currency: appreciation and depreciation of, 151, creased gold reserve and, 154; measurement 157-8; complexities of our, 24, 60; expansion of, 142-4; member bank credit curve of, 144-5; and contraction of, 170-3; function of Reserve possibility for bankers to check over-expan- System, 89, 169, 173, 176-7; inflation and de­ sion, 163-5; prevention of over-expansion and flation of, 170- 1; revision of, 26-9; shipment over-contraction, 166-7; Reserve Bank credit of, by Reserve Banks, 90. curve and, 146-8. Currency Commission: 167-8. Expansion and Contraction as Seen by a Currency Expansion and Contraction. Business Man. J. V. Farwell, 163-7. James B. Forgan, 167-73. Expansion and Contraction, Currency. Curves of Expansion and Contraction, James B. Forgan, 167-73. 1919-1921. A. C . Miller, 142-50. Expansion and Contraction, 1919-1921, Curves of. A. C. Miller, 142-50. Deflation: See Inflation and deflation. Expansion and Contraction from the Fed­ Development of an Open Market for eral Reserve Standpoint. John H. R ich, Commercial Paper, The. E. E. Agger, 174-83. 209-18. Expansion and Contraction Under the Directorates of Federal Reserve Banks: Class Federal Reserve System. E. M. Patterson, A directors, 65-6; Class C directors, 65-6, 73; 151-63. purpose of, 65, 88; Reserve Board and, 65-7, Evolution and Practical Operation of the 71. Gold Settlement Fund, The. George J. Discount, Eligibility for. Charles L. Powell, Seay, 95-105. 105-13. Discount rate: Act of April 13, 1920 and, 121; F a n ch er, E. R. The Establishment and Scope adjustment of, of Reserve Banks, xviii, 184- of Branches of Federal Reserve Banks, 135-42. 90; agricultural paper and, 107- 10; bankers* Farmer: charge of discrimination against, 186, acceptances and, 110-3; commercial paper 203, 206, 207-8; Reserve Banks’ problem, 181- and, 107- 10; open market, 209- 18; price level 2. See Agricultural loans. and, 220-1; question of raising of, 160, 165, F a r w e ll, J. V. Expansion and Contraction as 166; Table of Reserve Bank, 1915- 1921, 216; Seen by a Business Man, 163-7. variations in, 62-3. See Open market, Re­ Federal Advisory Council: 64-5, 170, 188-9. discount rate. Federal Reserve Act: amendments to, xvii, 114- Discount Rate, Principles Governing the. 21; attempts at change in, xvi, 57; attempts at W. P . G. Harding, 183-9. substitutes for, 40-1; changes by Senate, 46-7; Dodge, Homer Joseph. The Aldrich-Vreeland comparison with Aldrich Plan, 23, 48-9; Emergency Currency, 49-55. digest of preliminary measure, 41-5; establish­ ment of open market under, 211- 13; inception Early Functioning of the Federal Re­ of measure, 37, 48; increased deposit liabilities serve System. Arthur Reynolds, 74-9. under, 153-4; meaning and purpose of, ix, 56, Earning assets of the Federal Reserve System, 58, 60, 62, 68-9, 87, 169, 173; Mr. McAdoo 77-8. and, 39-40; passage by House, 45-6; public Edge law corporations: xxiv-xxv. hearings on, 38-9; relations of, to international Educational campaign for banking reform: aid finance, xxiv-xxv. from politics, 33; magnitude of undertaking, Federal Reserve Act in Congress, The. 29-30; publicity media, 31-3; recruiting of H. Parker Willis, 36-49. forces, 31; success of, 36. Federal Reserve agents: Gold Fund, 100-1. Educational Campaign for Banking Re­ Federal Reserve Banks: avoidance of investment form, The. A. D . Welton, 29-36. operations by, xxii, xxiv; capital and dividends Efficiency of Credit, The. O. M. W. of, 67; clearings and transfers of, through Gold Sprague, 218-21. Settlement Fund, 97-9, 102, 103-4; commer­ Eligibility for Discount. Charles L. Pow­ cial scope of, ix, 58, 59; credit curve of, 145-8; ell, 105- 13. criticism and defense of activities of, 206-9; Establishment and Scope of Branches of as depositaries, 132-3; directorates of, xv, 65- Federal Reserve Banks, The. E. R. 7, 88, 200; early operation of, xiii-v, 74-5; Fancher, 135-42. facilities of, for war financing, 156-7, 121; as

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Index W t fiscal agents of the government, 59, 87, 124, Practical Operation of the. George J. 134, 161, 203-4; functions of, 68-9, 72, 74-5; Seay, 95- 105. impounding of gold by, 122-3, 162, 192; inter­ Gold Standard Act: 9. relations of, 92-5; intra-district clearing plan Government bonds: xxiii, xxv, 39, 59, 107, 167, of, 99- 100,101; as Liberty Loan agents, 125-9, 157. 156-7, 204; loaning operations of, 93, 94, 199- 203; nature of, ix, xx, 56, 58, 87-8; necessity H ard in g , W. P. G. Principles Governing the for, to adhere to rules of eligibility for discount, Discount Rate, 183-9. 113; par collection system of, 83-5, 141, 61, 75, 76, 116; regional character of, xxi, 62-3, 92; Independent Treasury: bill creating, 4-5, 129; relations with Reserve Board, 72, 73, 93-4; branches, 137; changes in, under Act of 1920, relations with member banks, 88-9, 91-2, 175- 134; effect of War on, 133; new policy super­ 6, 178-9; Treasury duties assumed by, 134-5; seding, 130- 1; outgrown system, 130; situa­ violation of sound banking principles by, tion, 1865- 1913, 131- 2; situation, 1913- 1916, 204-5; war compulsions as cementing factor 132-3. of, 89, 203-4. Inflation and deflation: as contrasted with Federal Reserve Banks, Popular and Un­ expansion and contraction, 152; responsibility popular Activities of the Federal Re­ for inflation 1914- 19, 157; under Reserve Act, serve Board and the. William A. Scott, 170. 203—9. Integrity of the Federal Reserve System, Federal Reserve Board: character of the 63-5, T h e. A. B. Welton and C. H. Crennan, ix- 71; criticisms and defense of, policy, 206-9; xxvi. definitions of eligible paper by, 106; early Investment banking, ix, xxii, 58-9. operation of the, xiv, 74-5; independence of, 57-8, 74; personnel of, xv, 71, 72, 73-4; politi­ Jay, Pierre. The Federal Reserve System, cal pressure and the, xiv, 71-4; Reserve Bank State Banks and Par Collections, 79-86. directorates and, 65-7, 71; Reserve Banks and, xxi, 72, 73, 93-4; rediscount problem con­ K em m erer, E. W. The Purposes of the Federal fronting, 189; suggested remedy for certain Reserve Act as Shown by Its Explicit Pro­ defects in, 71-2. visions, 62-9. Federal Reserve Board and the Federal Reserve Banks, Popular and Unpopular Liberty Loans: cementing factor in Reserve Activities of the. William A . Scott, 203-9. System, 89; handling of, by Federal Reserve Federal Reserve Notes: xxiii, 24, 53, 60, 69, 89, Banks, 126-9, 156-7; machinery for floating, 122, 169, 171, 176-8, 195. 124-6; partial payments, 126; payment of, by Federal Reserve System, State Banks and book credit, 127. Par Collections, The. Pierre Jay, 79-86. Liberty Loans, Preparation for War and First United States Bank: 1-2, 6, 136-7. th e . J. H. Case, 121-9. Foreign banking systems: 20, 24, 25, 160, 171-3, Logan, W alter S. Amendments to the Federal 190. Reserve Act, 114-21. Forgan, James B. Currency Expansion and McDougal, J. B. Agricultural and Commercial Contraction, 167-73. Loans, 199-203. Functioning of the Federal Reserve Sys­ Member banks: advantages of System to, 81-2, tem, Early. Arthur Reynolds, 74-9. 85, 89-90, 91; credit curve of, 144-5, distribu­ tion of, by districts, 81; loans to, 200-3; rela­ G id n ey, R. M. Relations of Reserve Banks to tions of, with Reserve Banks, 88-9, 91-2, Member Banks and Inter-Relations of Federal 175-6, 178-9; reserve requirements for, 117-8. Reserve Banks, 87- 95. Member Banks and Inter-Relations of G old : control of, by Federal Reserve System, Federal Reserve Banks, Relations of xxv; impounding of, by Reserve Banks, 122-3; Reserve Banks to, R. M. Gidney, 87-95. increased, reserve, 154, 169, 192; influx of, Membership: 174-5. See National banks, State xxv, 162, 192; Table.of, 1917- 1919, 123. See banks. Gold Settlement Fund. M ille r , A. A. Curves of Expansion and Con­ Gold Settlement Fund: Amendment of June 21, traction, 1919-1921, 142-50. 1917, 102-3; daily settlements through the, Money trust: xii, 30, 35, 37, 40, 57, 58. 103-4; early need for, 96-7; establishment of, 97-9; Federal Reserve agents’ Gold Fund and, National Bank Act: 6-7, 8, 11, 15, 56, 154, 157. 102; final refinement of, 104. National banks: acceptance powers of, 114-5; G old Settlem ent F u n d , T h e E volution an d and Aldrich-Vreeland emergency currency

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 228 T he Annals of the American Academy 52-3; foreign banking provisions for, 120; Contraction Under the Federal Reserve membership in Reserve System, xvi, 67, 79, 87, System, 151- 63. 123-4, 174; in panic of 1907, 11- 12; trust P hillips, Chester A. Theoretical Considera­ powers of, 118-9; under Act of 1864, 7; under tions Bearing on the Control of Bank Credit Act of 1865,8; under the Gold Standard Act, 9. Under the Operation of the Federal Reserve National banking system: aims and establish­ System, 195-9. ment of, 6-7; difficulty of open market opera­ P olitical P ressure and the F uture of the tions under, 211; entrance of state banks into, F ederal R eserve System. Paul M . Warburg, 8; weaknesses of, 11- 15, 22-3, 135, 153, 168. 70-4. National bank notes: inelasticity of, 13-14; Politics: dangers to integrity of Federal Reserve issue of, under plan of Monetary Commission, System, 71-4. 16; seasonal variations in, 13, 14; under Act of P opular and U npopular A ctivities of the 1864,7; under Gold Standard Act, 9. F ederal R eserve B oard and the F ederal National Citizens’ League: influence on Glass R eserve B anks. William A. Scott, 203-9. bill, 36; organization and development of, 27-9 P owell, Charles L. Eligibility for Discount, 31; politics and the, 33; publicity of the 31-3; 105-13. purpose and result of, xi, 35-6; resolutions P reparations for W ar and the L iberty leading'to formation of, 26-7; statement of L oans. J. H. Case, 121- 9. principles of, 34. P rinciples Governing the D iscount R ate. N ational Citizens’ League; A M ovement for W. P. G. Harding, 183-9. a Sound B anking System, T h e. H. A. Wheeler Public opinion and the Reserve System, ix-xi, 26-9. xx, xxii, 159, 203, 209. National Currency Associations, xiii, 52-3, 136, P urposes of the F ederal R eserve A ct as 137. Shown by its E xplicit P rovisions, T h e . National Monetary Commission: disclosures of E. W. Kemmerer, 62-9. studies by, 21- 2, 61; duties of, 17- 18; origin of, 17, 168; publications of, 18-21; investiga­ Rediscount rate: Act of September 7, 1916 and, tion of foreign banking by the, 20; recommen­ 115, advantages of Reserve Bank, facilities, dations of, 22-3; the Reserve Act and the, 23; 81- 2, 89, 169, 180- 1; as credit regulator, 159, unlearned lessons from, 24-5. 182-3, 196, 198-9; early prejudice against, 75- 6; the farmer and the, 208; influences affecting, N ational M onetary Commission, T he Studies 191-4; interbank, 92, 155, 161; market rate of the. N . A. Weston, 17-26. and, 184, 185, 186, 187, 188, 190, 198-9, 204; Non-member institutions: attitude of, 81; in­ pressure for lower, 205- 6; problem confronting evitability of, xvi; par collection system and, Reserve Board, 189; a progressive, 165; 117; provision for clearing by, under Amend­ proper policy as to, 173, 184- 90; question of ment of June 21, 1917, 116. raising the, 160, 161- 2; 165, 166, 170; recom­ mendations of Advisory Council as to, 188-9, Open Market: bills bought in, 217; conditions 191-2; relation of, to expansion and contrac­ creating an, 210-11; establishment of, by tion, xvii, 179, 192-3, 205. See Discount Rate. Reserve System, 211- 14; function of, 209-10; R ediscount R ates, B ank R ates and B usiness importance of the, xix-xx; Reserve Bank A ctivity. George M . Reynolds, 190-5. purchases in, 216. R elations of R eserve B anks to M ember Open M arket for Commercial P aper, T he B anks and Inter-R elations of F ederal D evelopment of a n . E. E. Agger, 209- 18. R eserve B anks. R . M . Gidney, 87-95. Organization Committee: xiii, 73, 92, 138. R eserve A ct in its Implicit M eaning, T h e. A. D . Welton, 56-62. Panic of 1907: general causes of, 10; immediate R eynolds, Arthur. Early Functioning of the causes of, 10-11; lesson of, 168; measures for Federal Reserve System, 74-9. relief, 14; results of, 167, 168; revelation of R eynolds, George M . Rediscount Rates, Bank weakness in American banking system through, Rates and Business Activity, 190-5. 12-3, 167. R ich, John H. Expansion and Contraction Par collection system: aid of branches in, 141; from the Federal Reserve Standpoint, 174-83. growth and advantage of, 83-85, 90, 117; inclusion in section on note issues, 61; institu­ Scott, W illiam A. Popular and Unpopular tion of, 76, 75, 116; non-member banks and, Activities of the Federal Reserve Board and 117; opposition to, on part of non-member the Federal Reserve Banks, 203-9. institutions, 81, 85; transfers of funds under, S eay, George J. The Evolution and Practical 86, 117. Operation of the Gold Settlement Fund, 95- Patterson, Ernest Minor. Expansion and 105.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Index Second Bank of the United States: 2-4, 6, 61, Treasury Functions by the Federal Re­ 136-7. serve Banks, The Assumption of. Murray Sprague, 0. M. W. The Efficiency of Credit, S. Wildman, 129-35. 218-21. Trust companies: growth of, 1896-1907, 10; in State banks: entrance of, into national banking panic of, 1907, 11; membership in Reserve systems, 8; growth of, 1896- 1907, 10; in chaos System, 87, 80, 115, 174. of 1811- 1816, 2, 4; in panic of 1907, 11; mem­ bership in Federal Reserve System, xvi, 74, 76, War Finance Corporation: xvii, xxii, xxiii, 59- 79-81, 88, 115-6, 124, 174; statistics of, from 60, 107, 166-7, 191. 1836-1863, 5-6; unsuccessful use of, as de­ W arburg, P aul M. Political Pressure and the positaries, 4. Future of the Federal Reserve System, 70-74. State B anks and P ar Collections, T he W elton, A. D. The Educational Campaign for F ederal R eserve System, Pierre Jay, 79-86. Banking Reform, 29-36. The Integrity of the Studies of the N ational M onetary Commis­ Federal Reserve System, ix-xxvi. The Reserve sion, T h e. N . A. Weston, 17-26. Act in Its Implicit Meaning, 56- 62. Subtreasuries: assumption of duties of, by Re­ W eston, N. A. The Studies of the National serve Banks, 130- 1, 134-5; general abandon­ Monetary Commission, 17-26. ment of, 134; investigation of, 131; objec­ W heeler, H arry A. The National Citizens' tionable features of, 130. See Independent League: A Movement for a Sound Banking Treasury. System, 26-9. W ildman, M urray S. The Assumption of T heoretical Considerations B earing on Treasury Functions by the Federal Reserve the Control of B ank Credit U nder the Banks, 129-35. Operation of the F ederal R eserve W illis H. Parker. The Federal Reserve Act System. Chester A. Phillips, 195-9. in Congress, 36-49.

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