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been, of course, a tax on issues similar to the 5 per cent tax of the German system. Apparently, the new law provides for something equivalent to this in the shape of an interest charge by the Federal Reserve Board, the rate to be fixed by said board. How far this device will prove effective in practice is not safe to predict. In order that it should induce the banks to contract their circulation, circumstances must have arisen under which the issuing bank would be earning on its outstanding notes a profit smaller than the tax itself. Now, it does not seem certain that an excessive issue of notes would necessarily bring about this condition. In the first place, in the absence of good homing power, a volume of notes in excess of business needs would not necessarily cause an accumulation of those notes in the vaults of the bank issuing them. Secondly, so long as member banks are free to keep their balances in banking institutions other than their reserve banks an excess of notes would not necessarily cause the general cash holdings of reserve banks to be abnormally large. For so long as the ordinary New York banks are permitted to pay interest on bankers' balances, country banks will to a considerable extent keep their balances with these outside New York banks; and it seems not unlikely that the excessive monetary stock thus accumulating in New York City would, instead of getting into the hands of the New York reserve bank, largely remain in the hands of the outside banking institutions and be employed more or less as it has been in the past; that is, in financing doubtful enterprises and supporting excessive speculation. But if the reserve banks do not feel the pressure of excessive issues in the shape of accumulations of notes or some form of money in their own vaults, they may conceivably be able to invest advantageously all the funds in their possession, and, in that case, the rate of interest charged by the Federal Reserve Board will not furnish an adequate motive for the retirement of their issues. Doubtless, however, this may in some degree be answered by saying that even an excess which was felt only outside the reserve bank would, after all, compel the reserve bank to contract its issues, since it would lower the rate of discount so greatly that reserve banks could not profitably invest their ordinary holdings, and consequently would wish to get rid of the interest charge. Perhaps this is true; but it would by no means insure the prompt and full contraction which most reformers have considered desirable.

From the foregoing it would seem that one of the devices for inducing the reserve banks to contract their issues after the need for them

had passed—that is, charging interest upon such issues-is not certain, at any rate, to prove adequate; it will not surely eliminate the winter plethora in New York City which is supposed to stimulate and support excessive stock speculation. But the new law contains another provision which may be viewed as a device for supplying the issuing banks with a motive for contracting their issues, namely, the requirement that such banks shall keep a gold reserve equal to 40 per cent of their issues. Is this likely to prove effective? Probably not. Whatever might be true in panicky times, it seems certain that in an ordinary year the gold holdings of a reserve bank will be much above 40 per cent of its note issue. If this is true, the maintenance of this 40 per cent could become difficult only when the excess of money was so great as to cause a dangerous exportation of gold from the country, and this surely would show a very inadequate degree of contractility. In short, the new law does not insure that issuing banks shall be sufficiently disposed to draw in their notes any more than it insures that outsiders will drive them in. It would seem, then, that the new law does not promise to give to the note issue the degree of contractility which has heretofore been considered desirable. In other words, there is some point in the fear expressed by many bankers that the new law will result in note inflation-at least in so far as the avoiding of this danger is dependent on the contractility of the note issue. Very likely, however, the possibility of such inflation is sufficiently guarded against by other provisions of the law.

II. ELASTICITY IN TIME OF CRISIS

The banking panic, when fully developed, gives rise to three difficulties and so to three needs: (1) funds to relieve the antecedent stringency which threatens a complete collapse of the credit structure; (2) a circulating medium for ordinary trade when a general suspension of payments by the banks has brought on a money famine; and (3) a prompt and thoroughgoing contraction of the circulation in the depression which follows the panic.

1. There surely can be no doubt that, under the new law, the availability of an issue sufficient in volume instantly to relieve the antecedent stringency, and so to put a stop to a panic before it has developed serious dimensions, is assured. In fact, it is not at all improbable that, under the new system, the reserve banks will be able to check the development of such a panic at the very outset without increasing at all their note issues. But if this does not prove true—

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.

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

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

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