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.

basic units of the system, namely, the member banks, are, within the limits prescribed by the national banking law with respect to loans to individuals, etc., free to expand deposits until their reserves fall to the prescribed minimum. As the deposits in the federal reserve banks themselves constitute the reserves for a considerable portion of the deposit liabilities of member banks, the reserve requirements for the federal reserve banks are properly more exacting. As the purpose of prescribing reserves is to check expansion, the banks are prohibited from making new loans, and incidentally from paying any dividends, when reserves fall below the prescribed percentages. Yet in order that the reserve requirements may not constitute an impassable "dead line” irrespective of the emergency, the Federal Reserve Board is authorized to suspend all the reserve requirements for a period of thirty days and, if necessary, to renew the suspension for periods of fifteen days. But to prevent this emergency expedient from resulting in turn in the evil of inflation, it is provided that when the Federal Reserve Board suspends the reserve requirements it must levy a graduated tax on the amounts by which the reserve may be permitted to fall below the specified level, and the reserve banks must then add such tax to the discount rates established by the Federal Reserve Board. A more adjustable check on expansion that can be applied before reserves drop to the danger point is found in the authority vested in the Federal Reserve Board to review and determine the rates of discount which the federal reserve banks may establish. How efficacious this authority will be remains to be seen. Much will depend upon the extent to which the discount rates of the federal reserve banks can be made to control the general market rates in their several districts.

Consideration should now be given to the plan by which the new system makes the centralized reserves and the notes of the reserve banks available to the member banks. First, it may be noted that the deposit balances in the reserve banks due to member banks are, within the limits already noted, to be counted as reserves by the member banks. This is of course a necessary corollary of centralized reserves. These deposits may be checked against member banks or be simply drawn down in reserve notes or lawful money. The important consideration for the member banks is therefore the maintenance of an adequate balance with the federal reserve bank.

This is made possible by provisions for rediscounting. With the indorsement of a member bank the federal reserve bank may discount

for such member bank certain notes, drafts, and bills of exchange. On the whole, therefore, it may be concluded that as long as a member bank keeps the required proportion of its reserves in lawful money in its own vaults the question of obtaining hand-to-hand money or that of strengthening reserves is simply one of having on hand an adequate supply of bills acceptable for rediscounting.

In connection with rediscounting, however, one important question remains. This relates to the provision made for one reserve district to get the advantage of possibly reduntant reserves in other districts. Students generally agree that nothing is so effective in bringing about a free flow of funds as an open discount market. With an open market under a system of centralized reserves local banks need turn to the central banks only when the credit on the basis of a given ratio of reserves has been entirely absorbed. Each bank buys or sells according to its own needs. If the paper available be of the proper character, and if the interbanking relations are such as to inspire the necessary confidence, this free flow of funds may not only characterize the country as a whole, but may also enter as an important possibility in international operations. Understanding the advantages of an open market, the framers of the law have endeavored to provide at least some of the facilities necessary to its creation. Member banks are permitted to "accept" on commission drafts or bills of exchange growing out of exports or imports having not more than six months' sight to run. The amount so accepted, however, is limited to half the bank's paid-up capital and surplus. For bills with strong banks as the acceptors there ought to be a wide demand. Such bills ought to flow wherever the rate of discount is lowest. To facilitate this dispersion, the law permits the federal reserve banks to discount these acceptances when they have the indorsement of at least one member bank. But should it be impossible to build up an open market, or should the possibilities of such a market prove at any time inadequate, there is the provision that the Federal Reserve Board may permit, and on vote of five members may compel, the reserve banks to rediscount for each other. Moreover, the Federal Reserve Board fixes the rates at which such rediscounts are made. Thus under a system of district centralization the effort is made to get the advantages of complete centralization.

For regulations of the Federal Reserve Board governing this business, see selection No. 156.-EDITOR.