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(This is the memo referred to in the Vandenberg Letter 6/14/38)



September 21*, 1936
Three fundamental facts must bo kept in mind in order to -understand
the functions of the Federal Reserve banks in relation to the country* s
supply of currency. These facts aret

(l) The Federal Reserve banks are

semi-public institutions v*ith Government representation on the Boards of
Directors; they operate under the general supervision and in some vital
matters under the control of the Board of Governors of the Federal Reserve
System* a Governmental body, appointed by the President.

(2) The Federal

Reserve banks are not operated for the purpose of making profits, but for
the purpose of serving the public interest in ways prescribed by the law®
Earnings of the Federal Reserve banks above expenses and dividends go into
a surplus account which in case of liquidation belongs to the Government*
(3) The amount of money in circulation is determined by the needs of the
public and not by the Federal Reserve banks. This is what is meant b y an
elastic currency.
1 . Federal Reserve banks are send-public institutions
Each of the twelve Federal Reserve banks has nine directors, of whom
three, including the chairman, are appointed by the Board of Governors in
Washington. The appointments by the directors of the presidents and first
vice presidents and all salaries fixed for officers and employees of the
Reserve banks are subject to approval by the Board of Governor3»

The Board

of Governors also has control over discount rates, that i s , the rates that
the Reserve banks charge for their loans to member banks, and constitutes
a majority of the Federal Open Market Committee, which determines the amount

of Government securities the Federal Reserve banks shall buy or sell*


Federal Reserve banks are privately owned institutions in the sense that
their capital stock is ovmed by the member banks, but under the provisions
of the law the stockholders elect only six of the nine directors, and the
actions of the directors in all matters of national importance are subject
to review by the Board of Governors in Washington*
Under the law the Board of Governors through its local representative,
the Federal Reserve agent, has authority "to grant in whole or in part, or
to reject entirely, the application of any Federal Reserve bank for Federal
Reserve notes.


The frequently made assertion that the Government has turned

over the power to issue money to a private agency which uses such power for
its ovm profit is, therefore, contrary to the facts both as a saatter of law
and as a matter of practical operation^

Federal Reserve banks are not operated for profit
The Federal Reserve banks were created for purposes stated as follows

in the preamble to the Federal Reserve Acts


To furnish an elastic currency,

to afford ireans of re discounting coismarcial paper, and to establish more effective supervision of banking in the United States t


They were not created

for the purpose of making profits for private interests*

The principal

functions of the Federal Reserve System are to exert an influence on changes
in the supply and cost of credit with the view to accomodating commerce and
business, to hold the reserves of member banks and to m k e advances to them
when they are in need of additional funds, to supply an elastic currency, to
facilitate the collection of checks and interregional transfers of credit, to
act as fiscal agents and depositaries of the United States Treasury and other
Governmental agencies •




Earnings of the Federal Reserve banks are derived from interest obtained on their loans and investments * the voluiae of "which reflects principally credit policies adopted in the public interest and not for the
purpose of obtaining profits*

Of the total earnings since their establish-

ment in 191U* the Federal Reserve banks have spent nearly one-half in
meeting expenses, a large part of T/hich represents the cost of collecting
checks drami on deposit balances in meriber and nonmtibar banks and in the
maintenance and distribution of an adequate supply of currency*
After the Federal He serve banks* expenses have been met* they are required to pay out of their earnings a 6 percent cumulative dividend to
stockholding member banks * Of the amount earned by the Be serve Banks above
expenses from the tise of their establishment to the end of 193$* about onefourth has been paid as dividends to member banks, which in addition to their
contribution to the capital funds of the Reserve banks are required to hold
much larger reserve balances vrfLth the Reserve banks on which they receive
no interestj one-fourth has been paid as a franchise tax to the United States
Government, under a provision repealed in 1933* one-fourth was appropriated
by Congress in 1933 as a contribution to the capital of the Federal Deposit
Insurance Corporation* on Tfhich the Federal Reserve banks are not entitled
by 1 m to any return, and the remaining fourth has been paid into the Reserve


surplus account#

The surplus increases the ability of the banks to

serve the public and* vrhen earnings are insufficient to pay expenses and
dividends, it may be drawn upon to make up the deficiency*

In case a Federal

Reserve bank is liquidated* its surplus* after meeting all obligations* becoinss
the property of the United States Government*

-lilt is apparent, therefore, that three-fourths of the net earnings of the
Reserve banks since their establishment have been devoted to public purposes*

The Federal Reserve banks provide an elastic currency
The amount of money in circulation at a given time represents what the

public collectively wants, since currency always moves out of the Federal
Reserve banks when the demand for it increases and returns to them when
the demand subsides. This is what is meant by an elastic currency*


currency is needed, the public obtains it from its local banks, and the
latter obtain it from the Federal Reserve banks*

"When it is not needed* the

public deposits it in the local banks, and the local banks in turn redeposit
it in the Federal Reserve banks*

The Federal Reserve banks m a y b e regarded

as reservoirs from which additional currency is drawn when the public requires it and to which currency not required by the public is returned®
The Federal Reserve banks have no direct way of keeping in circulation a
larger amount of currency than the public requires, or reducing the amount
of currency that the public needs to finance its current operations*
The demand for currency is determined by various conditions*

A certain

minimum is required to day-to-day cash expenditures of individuals} a certain minimum is required for payrolls*

There are times when personal expendi-

tures rise, as during holidays, and there are times when payrolls rise, as
during harvest*

Certain individuals, businesses, and communities have their

own periods when they need more or need less cash than ordinarily*

The net

effect of all of these factors is a normal and regularly repeated cycle of
demand for currency year after year —

slack after the first of January, when

retail trade falls off following the holidays, larger during the succeeding


5 -

spring months, when payrolls increase and outdoor industries become active,
slack again in mid-summer, and steadily increasing during autumn and early
winter to the regular peak in December*
In addition to this regular annual cycle, the amount of currency also
responds to increases and decreases in the volume of retail trade and of
payrolls as the amount of business done by the country increases or decreases*
There have been times also when the demand for currency m s greatly increased
as in the period preceding the banking holiday in 1933• In the course of a
few weeks at that critical time the Federal Reserve banks furnished the
public with as much as $2,000,000,000 of additional currency*
For more than twenty years the Federal Reserve banks have fully met
the normal demands of the country for currency; they have also fully met
peak demands both in tiuaes of prosperity and in times of depression, and
they have made it possible for the volume of money to decline automatically
when the public demand for it declined*

The elasticity of our currency is

Machinery of note issue
Before a Federal Reserve bank can obtain Federal Reserve notes it must
deposit as security vdth the local representative of the Government, known
as the Federal Reserve agent, collateral at least equal in amount to the notes
to be issued*

This collateral, as provided

following assets:

law, may consist only of the

(l) promissory notes, drafts, bills of exchange, or ac-

ceptances, usually referred to as "eligible paper*; (2) gold certificates on
hand or due from the United States Treasury; and (3), until March 3 , 1937,
United States Government securities bought in the open market*

In addition

- 6


to being secured by the pledge of specific collateral, Federal Reserve notes
are a first lien on all the assets of the issuing Federal Reserve bank, and a
iiO percent reserve in gold certificates must be maintained against them*
In all cases Federal Reserve notes are issued only for an adequate consideration*

The currency an individual receives from his local bank is charged

against the amount he already has to his credit on the bank's books, and the
currency the local bank receives from the Federal Reserve bank is charged

against the amount it already has to its credit on the latter s books*
Issuing currency for purposes of circulation is at all points, therefore,
an exchange of cash for southing of equal value•
As of September 2, 1936, the Federal Reserve banks had obtained
000,000 of Federal Reserve notes, of which $h$000,000,000 were in circulation
and 0300,000,000 were held in the vaults of the Federal Reserve banks. The
collateral held against these notes was as follows:
Gold certificates on hand and due froia U . S . Treasury
United States Govermnent securities
Eligible paper




Gold certificates are receipts -which are issued to the Federal Reserve banks
by the United States Treasury for gold deposited m t h it in compliance m t h
the Gold Reserve Act of 193k* 'rfiich required all monetary gold in the United
States to be delivered to the Treasury. The Federal Reserve banks have no
right to pay out these gold certificates. As indicated, the Federal Reserve
banks have pledged

300,000,000 of these certificates against


of their own notes in circulation. Federal Reserve notes, therefore, at
present are virtually substitutes for gold held in the United States Treasury.
They constitute about two-thirds of the total of

200,000,000 of money in




The Emergency Banking Act of March 9$ 1933$ authorized the Federal Reserve banks during the period of ths emergency to issue Federal Reserve
bank notes, which are to be distinguished from Federal Reserve notes. These
notes, when issued, must be secured l^y at least an equal amount of collateral,
which may consist either of direct obligations of the United States or of
promissory notes, drafts, bills of exchange, or bankers


acceptances acquired

by the Federal Reserve banks under the provisions of the Federal Reserve Act*
There are about $50,000,000 of these notes in circulation, but the Federal
Reserve banks have deposited a sufficient aaount of lawful money with the
Treasury to provide for their redemption. So such notes are now being issued*
National bank notes alsoare no longer being issued. The privilege
of issue which national banks formerly had has been discontinued, and the
banks have deposited vdth the Treasury sufficient funds to redeem all their outstanding notes. All other kinds of money —
tificates, and coin —

are issued exclusively

United States notes, silver certhe United States Treasury*