if it turns out that more currency is needed for this purpose-there would seem to be no shadow of doubt that the new system will insure the forthcoming of such currency both of a quality and in a quantity which will be fully adequate to the task put upon it. (a) The notes to be issued, being obligations of the federal Treasury, will be as acceptable as gold on the eve of a panic. (b) There is no limit to the absolute amount of these notes. (c) The practical limit set by the requirement that discounted paper shall be furnished as a basis for their issue is of no real significance, since such paper will undoubtedly be vastly greater in volume than any need which could arise. Accordingly, there can be no doubt that the new system provides all the expansibility needed to abort, or reduce to comparative harmlessness, any panic which might arise.

2. If panics should develop, however, and the banks be forced to suspend specie payments, does the new law insure an expansion of notes to meet the needs of ordinary trade? Our verdict in such an event would necessarily be less favorable. We should have to admit that the new law does little or nothing to relieve such a situation. Broadly speaking, the new money will be altogether too good to meet this particular need. Banks that had reached a stage of panic sufficiently intense to cause them to suspend payments-to hoard the ordinary forms of money-would be sure to hoard money as good as those notes are bound to be. That is, the new issue would immediately pass into hoards, as did the greenbacks which the Secretary of the Treasury reissued during the panic of 1873, and, therefore, would bring little if any relief to the currency famine which had developed. In fact, it is almost impossible to conceive any form of note fitted for this particular task except one which was so bad that there was no danger of its being hoarded. That is, the only proper way to meet this particular need of a severe panic is to make sure that it does not arise at all; and, in this respect, the new law promises well.

3. We come, finally, to the third need which emergency elasticity is supposed to meet, that is, a prompt and great contraction of the circulation when the panic, if one should develop, has passed and the inevitable business depression consequent upon such a panic has set in. While we shall doubtless escape the extreme business inflations of former ante-panic periods, nevertheless it can hardly be doubted that, after an incipient panic, there will be some reaction, and consequently a more or less plethoric condition of the currency will follow. Will the new issue have sufficient contractility to meet this need?

Earlier in this paper we have seen that the conditions attached to the new issue are in general not favorable to contractility, in that they do not provide for either the prompt driving home or the prompt drawing home of the notes when the necessity for their issue is past. Outsiders lack adequate motives for sending the notes home; issuers lack adequate motives for calling them home. The case for emergency contractility, however, is somewhat better than the case for ordinary contractility. First, it is probable that the homing power of the note will prove greater at such a time than in an ordinary year, for, at such a time, outside banks will not be able to find investments for their funds, since speculative trading will disappear altogether and business generally will be at a very low ebb. Again, it seems certain that the issuing bank will, in this case, have more than the usual motive for bringing about a contraction of the circulation. The chief reason why such a bank may not be eager in ordinary times to hasten the retirement of its notes is the fact that, provided the notes do not accumulate in its own vaults, such a bank will gain more by using the funds in its possession to make loans than it would by using them to retire notes, assuming that the interest charge made by the Federal Reserve Board is not placed excessively high. But it is practically certain that, in the depression which follows a panic, no reserve bank will have opportunities for keeping all of its funds busy; and since, in that case, the interest charge, however small, will be a dead loss, the bank will have adequate motives for effecting, as promptly as possible, an adequate contraction of its note liabilities. This motive would be still further strengthened should the glut prove sufficient to cause a decided drain of gold, since, in that case, the reserve banks will find difficulty in maintaining the required 40 per cent reserve. On the whole, then, we seem warranted in affirming that, as respects emergency elasticity, the new notes will give no serious disappointments.

Finally, as respects elasticity in general, though the note issue, viewed by itself, does not seem quite fitted to satisfy the tests which an old-fashioned advocate is inclined to impose upon it, yet, when we take the new law as a whole, it seems not unreasonable to affirm that it promises to accomplish, directly or indirectly, most of the ends which we had hoped to attain through elasticity, and hence promises to give us a system which in essentials is truly and adequately elastic.

144. ELASTICITY OF CREDIT UNDER THE NEW LAW'

By J. LAURENCE LAUGHLIN

How does the act touch the reserves and the rediscounts so that it may bring about the much-desired elasticity of credit? This is the nerve center of the whole act. The pivotal provisions are those which allow any member bank to have certain kinds of short-time paper rediscounted at its Federal Reserve Bank. At this institution the loan creates in favor of the borrowing bank a deposit-account. Then the pith of the operation resides in the fact that all sums kept on deposit at a Reserve Bank count as legal reserves for the given member bank. That is, the rigidity of credit-banking in the past, the destructive snatching for reserves, are displaced by a system which allows good commercial paper-under certain limitations—to be converted into lawful reserves. This is the process which directly touches the lending power of a member bank to its customers. Therefore in a time of panic-if any such arrives-there will be no reason for a run on cash reserves, or, if there is a semblance of it, there will be a quick and ready way by which the reserves can be replenished. There can be no serious run on the cash by the public, because the member bank can furnish at will reserve notes by making request for them at the Reserve Bank and having them charged against its deposit-account there. But it must still be kept in mind that banks deal primarily in credit and only incidentally in money. A sale of goods, which forms the basis of commercial paper, is thereby coined into a means of payment, and gives rise to its own medium of exchange without necessarily calling on any forms of money. And yet the elasticity of the notes and of credit are, as they should be, linked together. In short, both notes and deposits (on which checks can be drawn) respond directly to the volume of commercial loans, and these loans are directly related to the general volume of goods bought and sold. Thus automatically the amount of notes and the deposits adjust themselves to the needs of trade. This outcome is one which no system of notes directly issued by a government could possibly bring about.

Such being the provisions of the new act regarding elasticity of credit, are there any dangers of expansion? Fortunately the essential

' Adapted from "The Banking and Currency Act of 1913," Journal of Political Economy, XXII (1914), 423-29.

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.1

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.