125. How a Panic Was Averted in 191481

It is possible that there have never been two months in the history of the United States since the Civil War when so many and such far-reaching financial and commercial problems were presented as have been offered during August and September of this year. Beginning with the sudden outbreak of the war, drastic and unprecedented fluctuations in securities, cotton, chemicals, and other commodities were witnessed. They were accompanied by a suspension of practically all communication with outside countries, due to the unwillingness of shipowners to continue the operation of their vessels from fear of capture. The total annihilation of export trade for the time being, as well as the partial destruction of import business, produced serious financial and labor difficulties in the United States. At the basis of the whole situation lies the financial problem that was forced to the front by the declaration of war.

Hardly had the actual outbreak of the war become known when the closing of the European exchanges gave the signal for similar action in the United States. On August 1, the New York Stock Exchange closed its doors, and this example was shortly followed by the cotton and coffee exchanges, and by the Consolidated Stock Exchange. The immediate reason for the closing of the New York Stock Exchange was twofold: (1) Europeans, foreseeing a tremendous draft on their resources, hastened to sell investment securities in the only great market untouched by war. To this end European holders of American stocks and bonds cabled their bankers in New York to dispose of securities at practically any price. This process was in operation during the days before the closing of the Exchange and had already caused heavy shipments of gold to Europe. Had it been allowed to continue, it would have, almost certainly, deprived the United States of a very large proportion of its gold stock; (2) Stock Exchange operators who had obtained bank loans protected by collateral security saw that the reduction of prices on the Exchange which would necessarily ensue would effectually "wipe them out," while the banks which were "carrying" these persons. understood that, if obliged to "call" the loans thus made, they would still further aggravate the pressure of selling orders and would bring about widespread ruin in the financial world.

The confessed closing of the exchanges, because of the danger of loss of gold and of depreciation of prices, naturally tended to arouse serious alarm in many minds, and withdrawals of cash both from the banks and from the Treasury began to be heavy. Almost

"Adapted from "Washington Notes," in the Journal of Political Economy, XXII, 791-793 (1914).

simultaneous with this condition was the declaration of a so-called "moratorium" by most of the principal countries of Europe. This prevented Americans who had maturing European claims from collecting the amounts due them until a later date than they had expected. Hence such persons were compelled to draw more heavily upon their home bank accounts and so far as possible finance themselves through fresh loans at the banks. Fearing the heavy draft on their resources that was thus threatened, the New York banks almost immediately had recourse to the "national currency association" which had been organized after the adoption of the AldrichVreeland Act.32 Other banks promptly took like action. Applications were at once made to the government for the issue of emergency currency, and it was resolved also to employ an issue of clearinghouse certificates. Both of these methods were sanctioned by the government on August 2, and on the following day the work of issuing the certificates and notes was actively begun. It was found, however, that the Aldrich-Vreeland Act placed some serious obstacles in the way of an easy issue of currency. In consequence a bill for the relief of this state of things was introduced in Congress and was signed by the President on August 4. This amendatory act reduced the tax on Aldrich-Vreeland notes for the first three months of their circulation to 3 per cent and raised the limit of issues to 125 per cent of capital and surplus. While no public announcement was made of the issue of clearing-house certificates, it is known that in both New York and elsewhere an enormous amount of such certificates were issued. The emergency currency taken out under the amended legislation already referred to expanded so rapidly that by the opening of September more than $250,000,000 of it had been issued. The emergency currency was freely accepted by individuals, and banks in New York as well as elsewhere adopted the policy of paying it out whenever possible while holding gold. Thus the financial stringency was narrowly averted.

The Aldrich-Vreeland Act of May 30, 1908, attempted to create an elastic currency for use in emergencies. It provided for the formation of "national currency associations" by ten or more national banks having an aggregate capital of $5,000,000. Upon application of one of these associations, the Comptroller of the Currency, with the approval of the Secretary of the Treasury, was permitted to issue circulating notes not to exceed 75 per cent of the commercial paper or 90 per cent of the state, county, and municipal bonds which were required to be deposited with the Treasury as security. The total of additional notes for the entire country was not to exceed $500,000,000. A tax of 5 per cent per annum for the first month was imposed upon the issue of these notes. An additional tax of 1 per cent per annum was imposed for each month until a tax of 10 per cent per annum was reached.-EDITOR.

126. Provisions for Elasticity in the New Currency Act33

BY L. M. JACOBS, JR.

The new banking system of the United States, as provided in the Act of December 23, 1913, has as its central feature the establishment of twelve Federal reserve banks,34 under the control of a Federal Reserve Board appointed by the President. The United States is to be divided into twelve districts, in each of which a city is to be designated as a Federal reserve city. National banks are required and state banks, under certain conditions, are eligible, to become members of regional reserve bank associations.

The Federal Reserve Board is to be the dominant factor in the new banking system. It consists of seven members, the Secretary of the Treasury, the Comptroller of the Currency, and five persons appointed by the President, with the approval of the Senate. Two of the five are to be experienced bankers. The regular term of these members is ten years. This Board is to have, within the law, general supervision of the banking system. The functions of the Federal Advisory Council, composed of representatives from the Federal districts, is largely advisory.

Each Federal reserve bank is to have nine directors, three selected by the Federal Reserve Board, and six elected by the member banks. They are authorized to receive from member banks deposits of currency or cheques and drafts upon solvent member banks payable on presentation.

Upon the indorsement of any of the member banks any Federal reserve bank may discount notes, drafts, and bills of exchange arising out of actual commercial transactions. The Federal Reserve Board is to have the right to determine the character of the paper thus eligible for discount. Paper to be admitted to discount must have a maturity of not more than 90 days, except that paper growing out of agricultural transactions with a maturity not exceeding six months may be discounted in limited amounts. No limitation is placed upon the amount of rediscounts a Federal reserve bank may handle for a member bank, but the rediscounts are to be subject to such restrictions as may be imposed by the Federal Reserve Board. Each Federal reserve bank is authorized to establish from time to time, subject to the review of the Federal Reserve Board, the

33

Adapted from "The Federal Reserve Law of the United States of America," in Journal of the Institute of Bankers, XXXV, 250-259 (1914).

The act as passed provided for a minimum of eight and a maximum of twelve regional reserve banks. The organization of the system has proceeded on the basis of twelve.

rate of discount to be charged for each class of paper, which shall be fixed with a view to accommodating commerce and business.

The law provides that every Federal reserve bank shall maintain reserve in gold or lawful money of not less than 35 per cent against its deposits, and reserves in gold of not less than 40 per cent against its Federal reserve notes in actual circulation. The Federal Reserve Board, however, is empowered to suspend, for a period not exceeding thirty days, any reserve requirement in the act. It can also renew such suspensions for periods not exceeding fifteen days each. However, a graduated tax is to be established upon the amounts by which the reserve requirements may be permitted to fall below the specified level. When the reserve falls between 40 and 321⁄2 per cent, the tax is not to be more than 1 per cent upon such deficiency; if the reserve falls below the latter figure, the tax is to be not less than 12 per cent upon each 21⁄2 per cent or fraction below 321⁄2 per cent. Banks in central reserve cities are required to maintain a reserve of 18 per cent of their demand deposits and 5 per cent of their time deposits. Banks in cities of the second class are required to keep 15 per cent of demand deposits and 5 per cent of time deposits. Country banks are required to maintain 15 per cent reserve against all deposits.

The act authorizes the issuance of Federal reserve notes at the discretion of the Federal Reserve Board for the sole purpose of making advances to the Federal reserve banks. These notes are to be obligations of the United States and to be receivable by all national and member banks and for all taxes. They are to be redeemed in gold on demand at the Treasury Department or in gold or lawful money at any Federal reserve bank. Any Federal reserve bank may make application for such amount of Federal reserve notes as it may require, the application to be accompanied with a tender of collateral equal to the amount of notes applied for. This collateral is to be comprised of notes and bills acceptable for rediscount. The Federal Reserve Board may at any time call upon the Federal reserve bank for additional security to protect the notes issued to it.

Each Federal reserve bank is to maintain reserves in gold of not less than 40 per cent against its Federal reserve notes in actual circulation. Not less than 5 per cent of the gold reserve held by a Federal reserve bank to protect the notes outstanding must be deposited with the Treasurer of the United States, and further amounts may be called for.

The Federal Reserve Board is given the right to accept or reject in whole or in part the application of any Federal reserve bank for Federal reserve notes, but to the extent that such application may be granted the Federal Reserve Board will supply Federal reserve notes

to the bank so applying. The bank will be charged the amount of the notes and will pay such rates of interest as may be established by the Federal Reserve Board.

When Federal reserve notes are issued to a Federal reserve bank they will have printed on their face a distinguishing number by which Federal reserve banks will be known, and it is made unlawful, subject to a penalty of 10 per cent of the amount, for any Federal reserve bank to pay out the notes of any other Federal reserve bank. Notes of other Federal reserve banks received by a Federal reserve bank are to be promptly forwarded for credit or redemption to the issuing bank.

127. Emergency Elasticity of Credit

BY HAROLD G. MOULTON

Emergency elasticity of credit and loans will be secured under the currency system through what is known as rediscounting commercial paper.

Suppose the First National Bank of Joliet should, when the country is face to face with a crisis, find itself confronted with a heavy demand for commercial loans. This means that a large number of business concerns wish to borrow on their promissory notes, and receive a deposit account against which they can draw checks to meet current payments. It will be remembered that a bank must keep a certain percentage of cash reserves to deposits. Suppose now the cash of this bank is at a minimum, and that, if it makes further loans on commercial paper, the reserves will fall below the legal requirement. Under the old system the bank would have had to refuse the loans to the detriment of legitimate business enterprise. But under the new law the Joliet bank is enabled to increase its reserves, and thereby enlarge its loaning capacity by rediscounting some of the promissory notes in its possession with the Federal Reserve Bank in Chicago. Let us make this matter of rediscounting clear.

When John Jones needs money he may take a note for $1,000 that he holds against William Wilson to his bank in Joliet and sell it to the bank for cash. The bank will give him $1,000 minus interest for the time the note has yet to run. What the Joliet bank does for John Jones is precisely what the Federal Reserve Bank in Chicago will do for the First National Bank of Joliet. When this bank needs cash it can take this note which it has discounted and have it discounted by the Federal Reserve Bank. The Joliet bank will get $1,000 less the interest for the short time the note still has to run.