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functions of discount are not hemmed in by detailed legislative prohibitions; fortunately, one must say, because discounting must always remain a matter of judgment, and much must be left to the management. Yet, on the other hand, this very freedom from restraint might result, under unwise management, in inflation and danger. This is inherent in the very nature of banking; since under any system, good or bad, everything depends upon the kinds of loans made.

Those loans, it should be noted, which result in deposit-accounts at Federal Reserve Banks (and which are not drawn down by requests for notes), directly increase the reserves of member banks until transferred by check. Thus the lending power of the member bank is more quickly and extensively enlarged by this process than by the issue of notes. Herein lies the pivotal question of overexpansion. Passing by the question of overexpansion through the issue of notes, it is desired mainly to study here that arising only from the use of deposit-accounts and checks, because these operations are less understood and are more elusive. Here the possibility of expansion is even greater than in connection with notes, because the proceeds of a loan at a Reserve Bank, if left there, at once count as reserves, and permit another increase of loans.

To this possibility of serious expansion what are the checks to be found in the bill? They may briefly be listed as follows:

1. The Reserve Banks must carry against deposits reserves of 35 per cent in gold or lawful money. But expansion will develop first in the member banks; and they are not required to keep as large reserves against deposits as before. They can make more profit with the same reserves by carrying more loans. Thus there is no restriction here, except that of refusal of loans by the Reserve Bank.

2. The Reserve Banks can use the rate of discount as a means of preventing undue expansion. This is the real means of control over expansion in Europe. The rate of discount must be raised early and not after the expansion has arrived. Watch must be kept on the particular bank beginning to expand its loans, and the treatment must be individually applied at the source.

3. A still more important check resides in the provision (sec. 13) that Reserve Banks shall rediscount only "notes, drafts, and bills of exchange arising out of actual commercial transactions," having a maturity of not over 90 days, although a limited amount of live-stock paper may have a maturity not exceeding six months. The final definition of all such paper is left to the Reserve Board. But loans secured by investment security cannot be rediscounted. The spirit of the act forbids loans for carrying

goods in storage for a higher price, and should confine loans to paper based on goods actually sold. Just how to define such paper lays a heavy responsibility on the Federal Board. On it will finally depend the kind of assets allowed to Reserve Banks.

4. A real restriction exists in making rediscounts on only short-time paper; but 90 days is somewhat too long for the best liquidity of assets. It was asserted, however, that country banks would gain no advantage by the new system because they had little or no short-time paper. The call of the Comptroller of August 9, 1913, showed that the 6,736 country banks held $1,735,000,000 loans having a maturity of 90 days or less and $1,137,000,000 maturing over 90 days. That is, one-half has a maturity of 90 days or less. In the city banks the ratio is 58 per cent 90 days or less to 42 per cent over 90 days. There is obviously enough paper to allow of expansion so far as quantity goes. The real check must be in passing on the paper.

5. The exclusion of investment paper cuts off all possibility of expansion by stock exchange speculation through the help of rediscounts at Reserve Banks.

6. Rediscounts at the Reserve Banks must be indorsed by the borrowing bank. Hence there will be some check here.

7. Also, no member bank may loan more than 10 per cent of its capital and surplus to any one person or firm. That is much the same now.

8. A real check is found in the restriction of discounts on acceptances to those based on importation or exportation of goods; and even these shall not exceed one-half the paid-up capital and surplus of the borrowing member bank. The omission of domestic acceptances is a serious handicap to the desired discount market, but it works toward a restriction of potential expansion.'

9. In practice the paper must pass rigid scrutiny in more than one step. First, it must satisfy the member bank; secondly, it must be satisfactory to the Reserve Bank; and, thirdly, if notes are wanted, it must pass the judgment of the Agent of the Reserve Board.

10. The power of the Reserve Board to examine into the operations of reserve banks, and the frequent or special examinations of member banks, will give an important control over expansion, or unsound banking, if legitimately used (secs. 21, 22, 23).

II. Again, it is to be noted that, in rediscounting, a large number of individual banks will be related to each other in a co-operative fashion. Something of an institutional character has been introduced, and it is possible to place responsibility here and there as was never possible before. This development should gradually and by experience prove of importance in controlling overexpansion.

This has since been modified. See below, selection No. 154.-EDITOR.

It must be emphasized that the possibilities of undue expansion of credit cannot be removed by any legal provisions in an act. It may create machinery, but the speed with which it will be run will depend upon the judgment of the man at the throttle. Elasticity of credit has been given us with all its possibilities of good to business, together with all its possibilities for abuse. The whole safety of our credit fabric, therefore, rests upon those who pass on the paper discounted. Consequently, the success of the new system depends primarily on the men selected to manage the several Reserve Banks. In practical operation they are more important than those on the Reserve Board.

145. AID IN THE MOVING OF CROPS UNDER THE

NEW SYSTEM1

The first public deposits made by the Secretary of the Treasury in the Federal reserve banks was on September 4-7, 1915. In speaking of these deposits the Secretary makes the following statement:

After a conference with my colleagues in the Federal Reserve Board I have concluded that the best plan for extending aid to the cotton producers of the South is to deposit the $30,000,000 in gold, concerning which I made an announcement a short time ago, in the three Federal reserve banks located at Richmond, Atlanta, and Dallas instead of in the member banks of the Federal reserve system.

Five million dollars ($5,000,000) will be deposited immediately in each of these banks, making a total initial deposit of $15,000,000. The Federal reserve banks have the organization, the knowledge of local conditions, and the powers under the Federal reserve act and the regulations of the Federal Reserve Board through which the proposed aid may be most effectively rendered.

Today the Board adopted regulations concerning "commodity paper." Under these regulations all national banks and State banks which are members of the Federal reserve system, which may lend money to farmers or others on notes secured by cotton, properly warehoused and insured, at a rate of interest, including commissions, not exceeding 6 per cent per annum, may rediscount such notes with the Federal reserve bank of their district. To illustrate how the proposed relief is available to the cotton producer the following is given as an example: A borrower asks his local bank for a loan on his note, secured by warehouse receipts for cotton. If the bank is satisfied that the cotton is in a responsible warehouse, properly insured, and that the note is good, it may make the loan. If the local bank charges the bor

1 From Federal Reserve Bulletin, October, 1915, p. 301.

rower a rate of interest, including commission, not exceeding 6 per cent per annum, it may indorse the note over to the Federal reserve bank of its district, and the Federal reserve bank may advance to the local bank the full amount of the loan. The rate of interest which the Federal reserve bank will charge the local bank will be sufficiently low, say 3 per cent, to enable the local bank to make loans at a rate of interest not exceeding 6 per cent per annum and have a liberal margin of profit on such transactions.

It must not be inferred that the regulations adopted by the Federal Reserve Board concerning commodity loans apply only to cotton. These regulations apply to all nonperishable and staple commodities in all parts of the country and, like credit facilities, are available to producers in all parts of the country.

146.

GREENBACKS AND THE FEDERAL RESERVE

SYSTEM1

By A. D. WELTON

At the meeting between the Conference of Governors of the Federal reserve banks, the Executive Committee of the National Bank Section, and the Committee on Federal Legislation in Washington last month, the representatives of the American Bankers' Association proposed that the greenbacks be retired and canceled. A joint committee was appointed to prepare and submit a plan for this purpose. It was suggested that the $150,000,000 of gold which is held as a reserve against the greenbacks be increased by $200,000,000 through the medium of a bond issue, in order to secure funds to pay these obligations of the Government. The Federal reserve banks would probably have to be designated as redemption agencies, and it will doubtless also be necessary to make silver and gold certificates legal tender as well as to fix a date after which greenbacks cannot be used as reserve money.

It was proposed many times when the Federal Reserve Act was in process of formulation that provision be made for the retirement of the greenbacks. If this proposal was not summarily brushed aside as neither desirable nor warranted, action was halted by the argument that the inclusion of the proposal in the general plan for a new banking system would excite so much controversy and arouse so much antagonism that matters of greater importance would be placed in jeopardy and the whole bill might fail. The greenbacks were let alone.

It was impossible to foresee what the monetary condition of the country would be two years after the bill creating the Federal reserve Adapted from Journal of American Bankers' Association, VIII (1916), 662–63.

I

system became a law. It is this condition that makes the suggestion for the retirement and cancellation of the greenbacks logical and pertinent. More than any other factor in the currency system these promises of the Government to pay prevent the Reserve Act from bringing to realization what was its first and most important purpose, providing an elastic currency. All the currency of all kinds that the country had before the Reserve Act went into operation is still in existence.

For issues of Federal reserve notes there has been small demand. The amount of them now outstanding, chargeable as a net liability of the reserve banks, is inconsequential. It is impossible to contract the currency below the fixed element in it when the flow of gold is toward this country and when business does not demand Federal reserve notes. The currency is, therefore, not flexible. It does not expand or contract according to the volume of business. It remains practically fixed when it would be much smaller if the quantity of it were measured by the commercial demand. It was presumed that with the natural growth of the nation's commerce it would grow up to the fixed elements in the currency and the Federal reserve notes would then provide all the elasticity needed. The influx of gold in consequence of the war is one reason for failure in this direction. The greenbacks, therefore, are water in the stock of currency, which is inflated in consequence.

If the Federal Reserve Act is not speedily amended so that flexibility may be provided and the necessary contraction in the currency may take place, the chief purpose of the Act, to provide an elastic currency, will have been defeated. The retirement of the greenbacks seems to be the simplest method of providing the necessary contraction. It would cause no disturbance. If progress toward a sound and scientific currency system is to continue, the sooner the greenbacks are out of the way the nearer will be this achievement. Just at present the continued existence of this form of currency is preventing a fair test of the adequacy of the whole Federal reserve system. 147. REDISCOUNTING AND EXPANSIBILITY OF DEPOSITS1 By E. E. AGGER

Let us consider the provisions made in the new law for insuring the "elasticity" of bank credit. The problem here is chiefly one of maintaining a proper relation between reserves and liabilities. The

'Adapted from "The Federal Reserve System," Political Science Quarterly, XXIX (1914), 271-78.

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