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- For releci.se in morning papars Frida.y, Saptember 23, l9Zl. • . "THE t.ED'ERAL ni;SERVE SYSTEM ... WHAT IT IS Aln> WHAT I'l IS NOT." ·Address by W. P. G.. HARDL~ . GOVERNOR~ FEDERAL RESERVE BOARD at the "MADE-IN-QAROLlNAS 11 EXPOSITIOU at CHARLOTTE, N.. C• .September 2~, 1921. 994 .. X-32~ .'i: ·,, ~ ' ·.; THE J'ED.IRAL RIS!RVi S'fSTEM - IHAT IT IS AND WHAT IT IS NOT. Nearly aeYen years have elapsed since the establishment of the Federal Res.. ve Banks ani yet there is still a surprising lack of knowledge of what they really are and of wbat their proper functions are, not only on the part of the public but among bankers as well • • Much has been said and writteJl reaardin& them~ which 1$ oalc'l.lla.ted to create entirely wrong iDtreseiona and .while it ia 1~~pose1ble, in the brief space of time whioa can properly be allotted to a public address, to enter into an elaborate 4iecusaion of the subject, I shall endeavor this afternoon to describe concisely the character aDd some of the 4ia:tinctive tunctioua ·of the Federal Reserve Banks 'and of the Federal Reserve System. The Federal Reaerve Act, ~hiob is responsible for the existence of the Fe4eral ReseJ"Ye Board and the Fe4eral Reserve Banke, was approved on December 2J, Congress. 1913; and; has, at variou• times since, been amended bf The qenc1J3nts, lor the .m.ost part, haYe been the result of . suggestions made by the Federal Reserve Board and were designed to render the Act more effective, The general purpoaea of the Act are outlined in its caption or short title, which is as followa: "An Act 'to prGvide for the establishment of Federal reserve banke, to furniah an elastio currency1 to affor4 meana of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, apd for other purposes." X-3202 - 2 The need for a more efficient banking system in the United States had been felt for many years. Ever sin~e the year 1890 the subject was one which was discussed frequently at bankers' conventions and at gatharings of commercial bodies, but the event which gave great movement for banking reform along constructive lines was 1907. imp~tus th~ to the panic of The following year Congress created a Monetary CommissionJ wllich after a long and thorough study of the banking systems of the world nubmitted an exhaustive report. During the years 1911 and 1912 a committea of the House of Representatives 1 commonly known as the 11 Pujo Cornmittee" 1 investigated banking methode in this country and submitted a report. With this wealth of information in hand 1 Congress. early in the year 1913 took up the matter of banking reform in earnest and the Federal Reserve Act was put upon the statute books before the close of the year. This Act is universally admitted to be a great constructive piece of legislation and is applauded b9th by friends and critics of t_he Federal Reserve System, by those who understand the Act as well as those who do not. It is,because so many have no real conception of the purposes or meaning of the Act that there has been eo much criticism of its administration. The Federal Reserve Act did not estab+ish a central bank. contrary~ On the it made possible the establishment of as many as twelve Federal Reserve Banks1 each almost wholly independent of the others in operationJ as well as in local policies. From a legal standpoint these banks are private corporations, organized under a special act of Congress, namelyJ the Federal Reserve Act. They are not in the strict sense of the word Government banks 1 but are only quasi-Governmental institutions 1 in that ... 3 they are under the general supervision of the Federal Reserve B':lar:! a:1d have on their boards of directors three men, representing the Gvvem'illln't, who are a~pointed by the Federal Reserve Board. Eaah bank has nine directors and the other six are choson by the member banks, which are the sole stockholders of the Federel Bank. The law does not permit the Federal Reserve Banks to P~£~rve ccmpet~ f o1· business with each other or with the national banta, state banks &~ trust companies of the country. depos~.ts They are not allowed to receive from. the public and can accept deposits only from their ~mber banks~ from the United States Government and, solely for the purposes of exchange or collection, from non-member banks or trust companies~ They are not allowed to make loans or advances direct to the public, but can ler.d only to the United States, to their member banks and, subject to certain ~onditions, for periods not exceeding six months, in anticipation of the collection of taxes or the receipt of assured revenues, to states# counties~ municipalities and other political subdivisions in the United States. rn lending to their UBmber banks Federal Reserve Banks are not permitted by law to use the same discretion that is allowed national banks, state banks and trust companies, but they must observe the limitations prescribed by law as to the character and maturity of the notes offered them by member banks for discount. Except as to notes, drafts and bills, drawn or issued for agricultural purposes or baaed an live stock, ~hich a Federal Reserve Bank may discount for a member bank if the maturity does not exceed six months, a Federal Reserve Bank can not discount any paper which has longer than three months to run, exclusive of days Pi grace, c· ~-':~""-~ X-3202 - 4The law puts a limitation also upon the character of, a note which a Federal Reserve Bank may discount for a member bank. A Federal Reserve bank may make advances to its member banks on their promissory notes., for a period not exceeding fifteen days, provided, such promissory notes are secured by the deposit or pledge of bonds or notes of the United States 1 or by notes, drafts and bills of exchange or bankers• ccceptances which are themselves eligible for rediscount or purchase by a Federal Reserve Bank. To be technically eligible for rediscount a note must be endorsed by a member bank, its maturity must be withint the time limit prescribed by law and it must have been issued or drawn for agricultural, industrial or commercial purposes, and it must also be shewn that the proceeds of the note have been used or are to be used for such purposes. Federal Reserve Banks are forbidden by law from discounting notes, drafts or bills, covering merely investments, or issued or drawn for the purpose of carrying or trading in stocks, bonds or other investment securities, except bonds and notes of the Government of the United States. The Federal Reserve Act, as amended, has changed both the amount and character of the reserves which all national banks and state member banks must carry against their deposit liabilities. of years~ For a long period it has beenthe practice of American banks to carry as a reserve in cash and on deposit with other banks, a certain prop·ortion of their deposits. Before the passage of the Federal Reserve Act, the national banks in the three central reserve ei ties were required to keep in their own vaUlts as reserve in gold or lawful money an amount equal to 2'5% of their net deposits 1 and in other cities and towns they were required to keep a part of their required reserves in cash in their own vau1 ts ij.,..i' ,._... ~~· X-J202 * -5· a. pArt on deposit with other banka. !'be laws regarding the reaerfM of state banks varied in the different states. Under the FederEU. Reserve Act the percentage of reserve required has been substantially reduced~ and iu6mber as amended 1 no national bank and no stat~bank is required to keep any definite amount of cash in its own vaults and whatever amount of cash is kept on hand by 1be member banks6 as deemed necessary by the judgment and experience of their officers~ does not count as part of the banks 1 lawful reserve. The entire legal reserves of all member banks must be kept on deposit with the Federal Reserve Banks. As a consequence 1 the cash resources of the Federal Reserve Banks are necessarily very· large and their holdings of gold 1 in particular, constitute a very large proportion of all the gold tn the country. The gold held by the Federal Reserve Banks is equal substan- tially to all the gold that might have been held by all the banks throughout the country if there had been no Federal Reserve Banks established. As the Federal· Reserve Banks are made the sole custodians of the legal reserves of all member banks; the object of Coxtgress in throwing safeguards and limitations around "their loan transactions is evident. It is necessary that Federal Reserve Banks should keep themselves in a "liquidtt position~ that is, their bills discounted must be of short maturity and should be readily collectible. The strength of the entire banking system of the United Stater:s ia directly related to the strength of the Federal Reserve Banks. If a Federal Reserve Bank should find itself in a weak~ over- extended or unsafe position1 all its member banka would be directly affected • .,.lac~:i While Congress has--- · ·--- upon the Federal Reserve Board the responsibility of defining eligible paper 1 within the mean~1g of the Federal .. : X-32Cl2 - 6 Reserve Act, it has entrusted the management of the Federal Reserve Banks, under the general supervision of the Federal Reserve Board, to their own directors. Ea~h FederaReserve Bank has power to appoint1 by its board of directors, such officers ar.d employees as are not otherwise provided for in the Federal Reseri/'e Act ani to define their duties, to prescribe by-laws, not inconsistent with the law, regulating the manner in which its general busiressmay be conducted, and to exercise, by its board of directors, or duly authorized officers or agents, all powers specifically granted by law and such incidental .powers as may be necessary to carry on the bus5.ness of banking within the limitations prescribed by law. Each Federal Reserve Bank is conducted under the supervision and control of its board of directors, who are charged by law to perform the duties usually appertaining to the office of directors of banking associations and to administer the affairs of the bank fairly and impartially and without discrimination in favor of or against any member bank or banks and, subject to the provisions of law and the orders of the Federal Reserve Board, to extend to each member bank such discounts, advancements and accommodations as may be safely and reasonably made with due regard for the claims and demands of other member banks. The Federal Rese1·ve Board does not appear to be authorized by law to pass upon the paper which is offered for discount to Federal Reserve Banks. This is a function which must be exercised by the directors of the Federal Reserve Bank or by their duly authorl.zed officers or agents. While the law ·does not prescribe any fixed limit as to the amount of loans that a Federal Re·serve Bank may make to a member bank, it does require that due regard must be given to the claims and demar.ds of other member banks, that - 7 is~ to their possible needs for credit acco~nodation. It also provides that a Federal Reserve Bank must extend to each member bank such discounts and accommodations as may bs "safely and reasonably made" ... This means that the directors of a Federal Reserve Bank ani the officers appointed by them must exercise their best judgment in granting discount a.ccon:rro'dations. They must assure themselves that the discounts are such as can be safely made., and reasonably made., with duEJ regard to •the pO!:;sible requirements of other member ban~s which may ask for accommodations later on. This discretion is not vested in the Federal Reserve Board and the reason for this is probably tv.-o-f old. is not a central bank. First: the Federal Reserve System It is a regional system comprising twelve banks. Congress did not intend that there should be a centralized control of credits. Second: in a country embrasing so vast an area as the United States., it would be a very difficult task, if not an impossibility.~ for a central Board to pass intelligently upon the security of the paper offered ior discount, which must necessarily come from all sections of the ~ountry. I have already called yourattention to the fact that Federal Ro:::.wve Banks are not permitted by law to make loans direct to individuals, L or corporations, and that they can only rediscount paper which bears endorsement of a member bank. c~:.u ~he It is evident) therefore) that in orde;:· for a Federal Reserve Bank to render financial assistance to those engaged in commerce or indus-.:. ry., in agriculture or in the raising of live stock, the loans must first be negotiated with member banks. There are· many loans1 however, which member banks may legally and properly make >Yhi ch can not be rediscounted with Federal Reserve Batl}(s for the - g ... reason that the as eligible. l~w does not edmit of the classification of such p~rer A Federal Reserve Barik, therefore, can not disCOU"l.t .. any paper however good it may be, which is not technically eligible under the terms of the Federal Reserve Act. and, on the other hand, it is entirely within its rights in declining to discount notes which, even-though . technicall7 eligible, are not satisfactory from a credit standpoint • While the Federal Reserve ~ct was intended to strengthen the bank- ing system of the United StJ:Otes and to provide ready means of rediscountin!Z certain classes of paper., it is e.lso the evident intention of the Act to disturb as little as possible the business of the member and non-member banks, or their deelin~ with their customers. There is nothing in the Federal Reserve Act which gives either the Federal Reserve Board or a Federal Reserve Bank eny control over the loan polieyrof any rr.ember bank. A Reserve Bank cannot compel a merriber bank to make a loan which it does not desire to make nor restrain it from making a loan which it wishes to make even though it is forbidden by law. I have already explained that a Federal Reserve Bank cannot lend directly to the customers of· a member bank, nor does it, in fact. take the initiative in making loans to a member bank for the purpose of enabling the member bank to distribute the funds so advanced to its customers. The Federal Reserve Bank lends to the member bank against trans.actions alreedy made, for the purpose of enablin~ the member bank to restore its reserva to the legal requirement, after the reserve has been impaired or is about to be impaired because of increased loans and deposits. I know that there is a very general popular udsconception regarding• X-3032 - 9this and I think that some of the n:ember banks are responsible for this misunderstanding, although~ I am sure~ they ha.Ye not been actuated ,by ' malicious motives. I have been in the banking business myself and I think that I know something of banking psychology. ~mit do not like to Banks.. as a rule. to customers that they are short of loanable funds nor do they like to arouse e~ty in declining to make loant or in asking for a reduction of a. loan e.lready ma.de. I know thPt there are some bank officers w·ho are able frankly to · decline an e:ppltcation for a loan in a way which leaves no sting, but which on the contrary gives-the applic~nt the impression that therejection of his application is a f~vor to him. ha.ve such tact. "But not I? 11 bank•. officers Some are frl?nk enough but their bluntness hurts the feelings of the would-be borrower. It is not unusual, therefore, for bank officers in declining loans to look for .,a buffer, or some one to whom they can "pass the buc~. ~s ~ede e~pacity. useful in this In the old days, the board of directors By way of illustration I ~ going to tell you a story which~ told me by ~naative of North Carolina and who, by the wey., was one of the best citizens that the Old North State ever ga.ve to /llabama, the Honor~.ble Joseph F. Johnston, who we.s Governor of .Alabama for two terms and who died some years ago while he was a Senator of the United States. He w~:~s formerly president of a bank in Birmingham and he used to enjoy telling this joke on himself. It seems that one day a man, who.m I shall call Jones, who had no credit res-ponsibility and no·.-v:isible means of sup-port, but who was an all-around good fellow end had some little :politiGJal influence in local elections* came into the bank and wanted to borrow ~300. Governor Johnston asked him whet collateral he had. X-3202 - 10- "Well", said Jones, 11 1 haven't got any. If I had any collateral I would sell it end I would not wtmt to borrow r=>.ny money". "Well a, Governor Jomston said, "Who is going to endorse your paper for you't" Jones replied, "I do not know anybody who will endorse my paper. I want to borrow it on my own name·" Governor Johnston wa.s wr the will tell you money~ wh~t ~nxious I will do. not to offend the fellow, so he said, I cannot promise offhand to let you have but I Hill see our directors about it end if they approve the loan I will be verv g:lad to rtr-lke it for you". directors ?nd they all so Jones got busy ~nd ~d offices in the business section of the town, went ero,·nd and sew each one of the directors of the bank and he ascertained <:!lso ~he - There were only seven v. 'r '-he next directors' rr:eeting would be held .. day following the (irectors' meeting Jones came in with his note all filled out Pnd said: "ftll rig~, here ~ is my note. Let me have the rr.oney". Governor Johnston seid, "I ron very sorry, my- friend, I cannot make the loan; the directors turned it down". "WhPt", Jones exclaimed, "Did they turn thr=>t loan down"7 "Yes, they did". "Well", s::>id Jones, "Th~t is very queer. I saw Mr• .A and Mr. I:; I sew evary one of the directors, and they all s2id I could have the money. All of them were in favor of it". ~.Well", Governor Johnston s 2id, "I cannot hel:P what they told yoo;. I brought the matter up at the ali rectors 1 meeting and they all voted to turn it down". "Well", Jones replied, "ftll I have to s~y, Governor Johnston. is that personally and seperatsly you: directors are a very clever set of men. but collectively they are the bigpest liars in Dirminghe.nl'- - 11 X-3202 In these days, however, banlz- officers find in the Federal R.eserve Board or the Federa~. ""'"' rve Bank a rr,uch more satisfactory buffer than a local board of directors. wr :r:? 1 mow of Tany cas :,s banks have found it very convenient to uass the buck to the F3dera1 Reserve Bank or the Feaeral Reserve Board, and rave stated to a borrower or would-be borrower that they asked f u.: ~ermit 01 it. wouldp.l~s to grant the extension make the loan desired, but the Federal Tie serve would not Such a procedure has a tendency to relieve the situation as far as the local barik is concerned but it is certainly unfair to the Federal Reserve System. This evasion of responsibility ras subjected the Federal Reserve Banks to augreat amount of unjust criticism and has given the public a wrong impression of the authority and attitude of the Federal Reserve Banks and the Federal ~eserve Board. It has aroused indignation ·which is entirely natural. in the circurr:- stances and has caused rnuch correspondence with the Federal Reserve Board direct and with Congressmen and United States Senators, whose ire has been aroused because of these alleb~d arbitrary methods. It is entirely true trat a Federal Reserve Barik, mindful of its resvonsibility under the law and acting in accordance with the dictates of ordinary banking prudence, rray have bad occasion to call the attention of some of its larger ··oorrow·ing banks to their ~. . . . . . '' discount lines, which have run in some cases over < without. being reduced, and have cc:~.lleci :. . . banks.to. the necessity - th,e '. 1 a.c,' "~tioi of y;:Q.rs, ,--;··- t ditton~ion 1 cil wdtlung th~msul\tos in\o & of t~ borro;Jing strongor position But in no cd.SJ wttt.iu d:e k1o·vl0dg0 of ·t..l<.~ :F..t.;...H'd.l Reserve Boar<l has any F~ieral Res.fr·le; Bd:.k u:':..ic:ttakm to ~·dy pc:~.rticular ~0 a tiiefubJt bank wba.t loans it should call or ask to ~vo l'J~UCoi. ~ - 12 X-3202. I will give you a concrete example. In anotaer state, not in ,, this Federal Reserve District, there is a national bank \vb.ich has for a long time beun a large and continuous borrower at the Federal Reserve B~, the amount of its red.iseounts being several times greater than its capital stock and. its fair proportion of the loanable funds of tb.e Reserve Bank. It sec ..s that this bank has made frequent promises to roduco its discount line to a more reasonable sum, but as it collected notes it would cons'tantly send in otllers for rediscount. t~t I hold in my band a notice this bank appears to have beJn senling to soma of its borrowing customers, which roals as follows: "Your note for $_ _ _falls d.U:o - - - - ·"OUr FEDERAL RESERVE BANK owns this noto, having rediscountoJ. it for us, As i t has bo.;n r(.)ruwod several times, t.uoy are INSISTING ON A PAYMENT of $____ or more. It is A.BSOLUTELY NECESSARY to arrange this note on th0 day of its maturity. Yours truly. Casi:l.L1r. 11 The Casaior of this Bc:l.nk recently wrote the Federal Rcsorvu Bar~~~ as follows: "We wish to assure you that we appruciate your help an-i could not have gotten along without it. t.uan you are to have us io it, we are more anxious to reduce our line To show you howmiesirous we arc to get our line d.oNn I wn enclosing a. notice w.uicb. we have lately gotten out anJ. whlch is proiucing exccller. . li results. ---- Now be patient with us just a little long~r and we will show you to a Nspectabla size, th~t we can reduce our lino we thank you just the same. 11 To this the Fedoral Reserve Bank replied promptly: "We aro plaa.sed to note froo your letter of. Septeober 9th that you anticipate bcin~ ablo before very long to materially redu~o your - 13 X-3202 large borrowings from us t~t a inj;rc;~.d.u.:a.l you are justifiad in son1ing a w~ I'OCinniJr. notic~ do not, b.ow;;ver, f.;~l to borrowing customers as per the form which you onclosod, as it makes sta.tuments that ar.J entirely uncalled for. with us and which The ~:apors acc~pt..:c' w0 that you hl::l.vo bad under Ndi$count '""'; being 3ligi ble in oricr to extend to you nvc·_:ei c;;a.iii, NpNs.3nt +oa.ns t~t t~ officurs of your oanl;: h.:a.ve passed upon from the stcl.nipoint of the ere-lit worth involvel, an.l, no douct, witil W.C.Cn ~Ue, t~e considerc;o.tion as to t.c.eir collactib.ility and, therefore, Wh3n t.c.e timo CO~CS for making colluction, it would souc that, ooing conversant wit.c. local conditions, w.:a.ys and moans for ~kin3 colliJction coull ba devise~ by the same officors wi tnout laying t.c.c. buru.on upon tho FJicr<.<.l Rosorvo B.::..nk. This Bank has nover sot forth to your institution whd.t loans it shoula or should not make, nor has it stated t~t anyparticul~r nota or notes tllat it bas held under ro.iiscount from your bank should oc collected. purio~ Wa havo ext~nded acco~dation which, in our opinion, was the timo order to aid your c~tomcrs in th~ir to you over a long wh~n credit was needed i~ commercial, iniustria.l a.nd agricultural operc:Ltions. b' - w.b.an the b.d.rvesting and marketing period arrived a.nd t.c.ere sccmod to ings, w..; d.;;:.n:n~d ~ _ 1.i ttlc or no reduction in your borrow- it a.dvisa.ble to bring to your d.tt;;.;ntion tu.;; d~:sLci.- bility of efforts oeing made to get out from your seriously c::.ct.3ndcl position. Tho dJsirod your iniivid~l your dir~ctors ~unt customers is of curt~ilmont ~matter tbat should be wor~d out oy and officers, they bearing in mind tho oxtcnded position of your institution and its safety. tlld.t you discontinue in tho indcbtJdnoss of c~.t W+J would. ask t.uorcforo once using t.ll.c fon:. of notice :t;ofcrr;.;c.l. to - 14 X-3;;;02 and tbd.t yo,~ also rocall the noticos. of a similar tenor that have a.lr,;Ji:Ld.y oevn sont to your customers." To this tho meteor oa~k replied: "Your lott0r of tno lOth instant wa.s received this morning. ~ny Fortunately wo had not issued ~v0 of the notices in question and dustroyc:i tno entire su}ply. .AJn sorry the incidGnt occurrod. 11 No J.ouJt tn:.! Fc:iera.l R.:;serve Board. will receive many complaints growing out of tills incidJnt. Tr..ere is por~ps even gre.;~.ter confusion in t.h3 public mind rog.;;.rdiu§; the issuu of FvJ.erd.l Reserve Notes tl4m tr..ere is regarding the rediscounting functions of tne FeJ.eral Reserve Banks. T~e im- pression seews to prevd.il very generally that the Federal R0scrve Board ~s poNor to expd.Ud or contract the currency of tne country at will and so~e oelieve that it aroitrary manner. 3o61.rJ. s~ll ~ve .!lciS exercised this powor in a. Wnile th3 law prescribes th~t r~ckloss and tne Federal Reserve the right, cl.Ctin g through the Federal Reserve Agent, to grdnt in whold or in part or to reject entirely the application of ar1y Fed3ral Reserve B~ 0xercis3l this right. for Federal Reserve Notes, it bas never on the contrd.ry, it hcls always approved prorr.ptly ev.;;ry appliccl.tion wnicn has been :rrJa.J.o for th() issue of Federal Reserve Notes. on~ of the p,brposes of the Federal Reserve Act, as stdtcd in its caption, is to furnis.u an elastic cur runcy'. out there ar8 ffidnyWhose idea of oldsticity is continuous stretching. Currency to be really elastic must be susceptiole of expar1sion or t:ae reverse. as t:Oe needs of industry ar1d. com:nerco IDi::l.Y require. Many believe t.c.at there was d. preordained contrd.ction of the currency luring the y.aar 1920, determined upon in order to reduce ];:rices. - 15 X-3202 The f~cts, wnich cct.rt oe readily ascertGin~d from the figures which were puolisned every we0k during the year 1920, impression is ~osolut~ly unwarranted. s~ow t~t t~is · Tliw Federal Reserve Boari said in its Anrruct.l Report for 1919: 11 Tnc expansion of credit set ill ruotior;. oy tr..e war must oe checked. cr~ait must be brought undor effective control and its flow be once more regulated and governed with caruful regard to tho econorrdc welfare of the country and the needs of its producing inJ::.:;.s tries. and ct. Defla.tion, however, merely for the so.k.3 of deflation speeJ.y return to 11 noi'l1ld.l" - deflation merel;)' for the sake of r.astoring security Vct.lu-3s "' .d. cnr.:unodi ty pric0s to their prewar levels without regard to other consequences, would bo an insensate procee;iing in tile existing posture of nation.:.l cmd world affct.irs. It said also i~ 11 tDat report: "It must never bo forgotten toot productive industry is profoundly affected by cNdi t conditions. credit. one of its lifo-giving MoJ.ern business is do:1e on principl~s is credit. T~ mood and tempt::r of t.ue businuss cormnuni ty ar.: deeply c.tffected by state of credit and mct.y edsily be d~sturbed t~e by ill-considered or precipi. tate action.-.. ,Too ra-pid or too drastic defla.tion would J._;i vat the very purpose of ct. well-r~gulated credit system oy the needlGss unsettlement of mind it would produce and the disdstrous reaction that such unsGttlement would have uponFroJuctive and drastic deflation is not, therafore, a policy of further u.Xpdnsion. only to disaster .;1nd must L industr~ Radicdl "in contempld.tion, nor is Either course would in the 0nd lead c be pormittad. to develop. our economic -16X-3202 and financial position is essentially strong. There need oe no occasion for apprehension as to our ability to effect the transition from war-time to peace-time conditions if reasonable safeguards against the abuse of credit ar0 respected, Tnero is, however, no need for precipitate action or extreme measures. Extremes must be avoided, t.b.\3 process of adjusting the volume of credit to a no:I'IIl.ll basis should bo effected in an orderly manner, and its rapidity must be governed by conditions and circumstances as they develop. Much ,will depend upon the cooperation of t:O.c business and general comrnunity. Indeed without such cooporation progress can be nei thor rapid nor sub;stantial. Much will depend also upon the rapidity with which t:O.O unabsorbed portion of the outstanding issues of war securities passes into th~ hands of pCFillancnt holders. As the national debt is tbus absorbed and as it is reduced tnrough toe operation of the sinking fund, t.u.e loan accounts of too banks SL.Ould be reduced corNspond.ingly until t:U.e proper balance betwecin t.lle volume of crcdi t and tue volume of concrete things, whic.ll crodi t h13lps to produce and whico. aro thu normal basis of credit, is NstorocL Tnis equilibrium, it cannot be too frequently or too emphGtically stated, .can be restored only by speeding up the processes of production, by the orderly J.istribu- tion of goods, by the avoidance of wasteful consumption, and by the increas~d accumul~tion process0s upon which B~nks rr:rust depend. tuos~ procssscs Effic~cious ~t of savings. th~ TnosG arc tn~ fund~£ntal proper functioning of tnc Federal Reserve The Federal Reserve System it can not of itself and action along economic th~se Ccln ~lone do ruucb. to assist compel them. lines involves the intelligent ani - 17 X-320t:earnest cooperation of t:U.J tho Fuderal Reserve ,simss and general community. Bo~rd wil~ ~lways deponlence of credit ~•d \Vnile oe mindful of tile inter- industry and of tile influence axerted on prices by tne general volume of credit, tnu Board nevertheless CaQ not assume to oe an arbiter of industry or prices. as t.n.:l i,~rdian Its prir~ry duty. of t.ne Nation's ultimate be:alking reserve, is to see tb.d.t tnG bi:l.l'1ks under its supervision function eff\Jctivcly ani :properlyas reserve banks." It is not tne function of t~ Federal Reserve System or of any banking system to atter.1pt to fix or control prices. B:.il'lks ar..; conc;,;rned vvi t.l:l prices only in so fa..r a..s the security of tJ.leir loans lilcl.Y be involved, and t:aey are interested more in the sta.bi.lity of prices and tueir margin of collateral than in t.lle' price level itself. Banks do not create general conu.i tions, but t~y must adjust t.J.emsclves to clld.nging conditions, wnich, in the recent ev .mtful ::;onths, .ilave been brougnt about by til.; ir _Jsis tible force of popular sentir.::ent throughout tne world. Tnere wa.s mt only no d~ring the year 1920 contr~ction but on tr.~ in Federal Resdrvv Note currency ot!ler .hd.ni th~ total voluw·J of Federal Reserve Not0s Ll' c.trcula.tion silows an -...lmost continuous upward trend during tJ.Jo.t y0ar, rising frorr. $£:, to $3,404,000,000 time t J....; ~n 8~:t4, 000,000 on J'-'r.!U.6.ry 23rd, December 23rd, a Ncord high r.kl.rk. Sincu t.u.a.t volume of F.Jderet.l Reserve Not;:;s in circul.:.tion ila.s been gred.tly reduced, until on Szpt<Jmb::;r 14, 19-dl it stood a.t $2,491,651,000. I wisil to rei terdte that n3i t.a.ar tee increaso r,or t:.o .i0cre.::1so in volume of Fadoral R3survo Not0s outstanding is tu~ r0sult of any ·~L....; - 18 - X-3202 preordained policy or premeditated d0sign, for tho volume of Federal Rcservo Notes in circulation d.cp~nd.s ontirely upon the activity of business, and upont.aa kind of activityw.uic:O. calls for currency ratuer than book credits. As I dlrGady stat0d. one of, the ~ve purposes of t:ne ]\;deral Reserve Act was to provide a3:1 elastic curr~nc~ Unit0d States notes, or legal tenders. are required by law to remain at d fixed amount, $346,681,016. are secured by Government bonas and qualities of elastic currenc~ t~ese T:O.eir National Bank note$ notes do not vol~ :aas n~var ~ve the depended upon the actual need for currency so much as upon tue price of Government bonds wn.ic.o. .aave tne circulation privilege and the.rc .aas been only a moderd.te cbd.nge in t..a.e volume of National Bank Notes outstanding for severd.l years past. Federal Reserve Notes, on the contrary, are distinctly elastic. T.a.cy may be issued to Federal Reserve Banks against collateral in an amount equal to the sum of the Federal Reservo Notes applied for, w..a.ic.o. collateral security is requir~d to be notes and bills discounted or acquired by the banks, or gold or gold certificates. The lawprovid~s furt:nor that eacn FedvrGl R~serve Bcink snall maintain a reserve of forty per cent in gold against its Federal Reserve Notes in actUcll circulation. As ~1 evid~ncc of tn~ eld.S tic qu.:Ui ty of Federal Reserve Notes rna.y be cited the fact that on April 1, 19l'i tne tot02.l outstanding was $357,239,000; on August 1, 1919 t~e total amount outstanding LGd increased tv· $2,506,820,000 and, as nas just been stated, tae rnaximum amount ever in $3,404,000,0001 was rcac.aed Oll December 23, 1920, altnoug.o. :pric3S i:J.aJ. dlready begun to decline several montns before circulation~ t~t dd.te. -lSX-3202 Since the first of the present year t.u.e loans of the Federal Reserve B~nks to tneir membJr banks decreosed ~ t a.•JOU ~d as the notes discounted witn Feieral Reserve $1 1 200 , 000 , 000 Bru~ up to September 1st nave been paid off Federal Reserve Note currency nas come of.~ back to the banks and in tne absence been reissued. U,pon deposited to secure p~ymen~ co~~rci~l of Federa~ :P:"'~ 2rve ei tner an imr:ncdiate return of an bank or an dUtowatic de4dnd for it, has not ~fotes, equiv<;~lent increase in t.ue av...ilable for tL,;,eir reJemption.. paper which nas been · t.uere necessarily results ar.aount of notJs to tn,:; percent~ge of golJ reserve Federal Reserve Notes are not legal tender, nor J.o t.u.ey count as reserve moriey for member banks. are issued only as .... need. for tc.em develops and Q.S they Tc.ey becor~e rc- dundc:mt in any locality t.aey are ret'J.rned for creJ.i t or for rau.emption to t.ue Federal Reserve Banks or to t.ue Treasury o.t Was.nL1c;;ton. t~ere tl.4i:in ru~d T.._us, cannot be at any time more Fed.er<.il Reserve Notes in circul ..... tio." t.ue needs of tne country C:!-t tne prevailin€; level of prices wa3es stan~ing re~uire, and as t~e deillcind abates tna volume of notes out- will be corraspondingly reduced tnrougu reJ.emptio~ T~e iucredsed volume of F3d3ral Reserve Notes in ci:r:-cula.tion from 1917 to the end of t.ue yea_r 1':320 w~s, in so far <;~,S it Wd.S not t.ue result of direct excnanges for gold and gold certificdtes, tne effect of as advanging wages and prices , :.J. DOt t.ueir cause, just t.ae reduction wJ::Ucll .na.s taken pl<.ice during t.ne present ;yec:~.r is t.ue result of lo·'iur prices. ~•~l s;na,ller volur..:e of business, rCA.t.G.er t.:..:m t.ueir ccms.:;. more fu.lly employed c:.nl as productioa increases ~nd d.istribution 1Ci3 X-3202 becomes more active, tbare follows a demand for greater discount accoilJlJ::;Odations and a. need for more currency, dlld t.l:le incred.sed volume of discounts furnisnes a means of providing t~~ increased vol~ of currency required.. As long as Fe.iaral Res~rve notes c;a.re r3del.3mable ;in gold .:and t:O.e ID4intGined~ r0quired reserves are it is difficult to s~e ~w tnere can be any inflc;a.tion of tue currency growing out of tne issue of F-3derc;a.l Reserve HotcJs. Tne .notes Cl;a!l only be issued in exc£iange for gold or gold certificates or against t40 security of commercial paper w.nicn first A;i.S inflC~.tion J.iscount0a. wi t.h some be~n w.aich now axis ts L a.~ tuis country during memb~Jr bank. T.ue cur;rency ot.uer countries. a.nd wmc.u cxis ted in after t.ue Civil War, is due, first: to the suspension of gold. payments• second:; to an unba.lal ced budget, tl::c..t is, insufficient revcnuJs to . mablo til<.: Gove.rru:lent to pay its currerJ.t expenses, and t.w.irJ.: to t.u.e iSS'.le of irredeamd.ble pc;~.per currency ei tuer by tile Governm.mt direct or by a centr.:l.l bank agc;:a.inst Gova:mment s~curities, cind of Government t~e forcing of sucn notes into obli~tions c;:a.nJ private circul~tion in inJebt~dn0ss. T.c.e most conspicuous examples to..ka.y of countries uc.tving Here i:-. t~c Sout.w., we in t.L:ie price of cotton. loc;i.l'ls of tAle FoJlare:.l c;~.rf;;l infla.t~i ctll rejoicing over t.L:ie recent ca.dvd.l:.<ce T~is d.livance is not ..iue to Rl)s~rve p~~1m~t Ba.nks or to ciJ:ly increca.se in t.n~ any expansion of t..o.e currency. As a. matter of fact, t.i:l.l amount of FGd.er.,.l Res.Jrvcl Notes in circula.tic"' today is <:~.bout $500,000,000 less tw.n w.aJn cotton r<Ja.c.c.Gd. its lo-.-o~est point last spring. T.a~ eoonondc causss, to t.aa a.dvar._J in t.::. e price of cotton is due to opor~tion of tue inevita.olo law of supply X-3202 -.Gl- and demand. Aft.-;r tna lct.st roport of tnc Department of Agriculturat to t~o fact tnat the prasont crop is abnormcilly the world awakened small and tnat probably loss tnan s~vcn million bales will be produced. In ordinary circumstar.ces a partial crop failure of tnis kind would havJ been calamity to tne Soutn, but owing to tDc large dffiount of cotton left in the .oands of prod:uc<:>rs from last s..;ason, i t will be a benefit becau~o a more non~~ equilibrium of tha mark0t will ba re- stored and t.aeroforG tne debt-paying and purc.Jasing power of tile Sout.o. tllis fall will ba far graa.tor tnan bad boan anticipated. I wish to empnclsizu, however, the fct.ct that this nappy result is due, not to CNdit or currency expansion but rather to the defla- • tion of t.ne anticipated supply of cotton. Touc.ning aga.in upon the crvdit policies of the Foderal Reserve Banks during the -year J920 and at t.ae present time, 1 wish to remind you tho.t a cn.:..nge_ in t.ae discount ra.to is not nucossarily a c:t..a.nge in policy. Centrd.l banks in for0ign countries nave been accustomed for generations to ad:v:a.~•ce or reduce t.aeir rd.tas of discount in e:.ccorddnc..:; wi t.a cbd.l1.3:ing concl..i tions L1. t.u.eir money markets and. t.c.dr action is. d.CCepte:i wi t.c..out populd.r protest. . T~e discount rd.tGs of yed.r 1919 were below tne t~c Federal Reserve Banks Quring the ~rkot r~tos, as Wd.S tue gred.ter part of tue period wnen tno country Wd.S d.t CciS0 war. during tho T.ue war did not endt however, in a find.nci""l s;:msej'Ni. tu the siguing of the armistice cinQ t~ exigencies of tnc Tr~asury scomod to ra~uire a continuance for sm:.:.0 mont.as of tee Fed0ra.l Reserve discount ratos v1.aicn prava.ilcd during thG war. ""C··~ _._ X-3~0Z -22In January, 1920, howevor, Resurvc ·Fed~ral rat~s were advdnCed generally to six pGr cont, wllicn, by taa way, is the bighest rate that bas ever been cnarged by tJl::: Federal Reservo Banko f Richmond- This advance in ratos took place a.t a. timo when there !lad bC3en ample opportuni ty to market t.nc crops of 1919 and before preparations weN rna.d.o for planting T~c t~c crops of 1~. effect of tais .increase in discount rates at tae serve Banks was to Feder~! Rc- tae degree of expansion of their loans, al- r~ducc thougJl tnc volume of ~deral Reserve discounts ·still continued to she~ a teniency to increa.se. assets of t~e At tl:J.e end of JanUd.ry, 1 920, t.ac tot.;..l <Ja.m,ing Federal RJscrve Banks, wl:J.ica member banks, 4mountJd to $3,039,191,000, at tnc enj of octob~r, 1930. D~ring ~s compared tnis period prices l:J.ci.d. already set in._ alt.c..o-u;;.a. t.aere rediscounts for inclu~c ~c;i.d tn~ wit~ $3.396,0~3,000 drastic doclinJ i~ ·ocon a very substdlltial. . increase botJl in t.ae volume of rediscounts of tne Federal Reserve Banks and in tJle amount of t.c..vir Federal Reserve Notes in circulation. T~ere is no occdSion for rue to say that tno year 1920 was a criticdl and disastrous stat~ who Cdn on~~ T~er~ cir~ tuous~~s bear witness to tnis out of of pcopl0 in tJlis t~ir ~in ~1owl0Jg~ ar~ 0xperience, -.,ut t.ara orded.l t.arough w.i:lic.u you .i:lo.v~ pass~.i ord·J~l by ;people in all otl:J.er w.aich was undergon~ g.t .tho same timo is the same statas in this country and by millions of people throughout the civilized world. brought about by Tho reaction, when it world-wid~ was overdue and was oconorudc causes, wbicn wore cntirwly beyond tne control of any group of Government. cam~, ba1~, of any Board or of any ,. . ; _li_ f -· X-3202 -23- fM President of the United States in en address to the Sena.t• le.&\ July ea1d: "Our land has its share of the financial chaos and the indust- rial depression of the world. We little heeded the growth of indebtedness or the limits of expenditure during the wa.r because we could not stop to count the cost. Our one thot,ght then was the winning of the war and the survival of the Nation. V:e borrowed and loaned - indiViduals to the Na- tion and the Government to other Governments, and to those who served the Nation, with little thought of settlement. because nat1onai .life was at stake• It was relatively easy then, In the sober aftermath we face the order of reason, rather than act amid the passions of war, a.nd our own land and the world are feeing problems never solved before. There can be no solution unless we face the grim truths and seek to solve them in resolute devotion to duty .. ,, •..• It is unthinkable to expect a business revival and the resumption of the normal ways of peace while maintaining the excessive taxes of war .•..• The slump which is now upon us is an inevitable part of war's aftermath. since the world began. It has followed in the wake of war There was the unavoidable readjustment, the inev.. itable charge-off, the unfailing attendance of losses in the wake of bigh prices, the inexorable deflation which inflation had preceded. been wholly proper to seek to apply Gover-nment relief to It has ~nimize the hardships and the Government has aided wherever possible, and is aiding now, but all the special acts ever dreamed of 1 all the particular favors ever conceived will not avoid all the distresses nor ward off a.ll the losses. The pro~er mentPl state of our people will commit us resolutely and confidently. to .:·Our ta.ks, and definite assurances as to taxation and expenditure will contribute to tha.t helpful mental order. Tbe only sure X- 3?02 - 24 - man experience." When things go wrong, e•pecially in matters pertaining to economics tmd fina"lcet there are elwl".ys many people who are unwilling to c(,....,s!' r abstract cemses, but prefer to seek the concrete and the personal. demand a personal scapegoat. t}.-' They Some people have made it their business to chBrge, end may have deluded others into believing, that the Federal Re· serve Banks and the Federal Reserve Board, particularly, have caused a great economic crisis, which was foreseen by those responsible for the management of the Federal Reserve System, but which was most certainly not brought about by them. On the other ha"ld they did everything within the bounds of reason and the limitations of lew to relieve the crisis and. to avert a. financial panic, which everyone will now acln:it h:::.-s been averted, whether the Federal Reserve System be commended or criticized for the part it played in the drama) which but for its existence would have developed into the gre~test financial tra~edy of modern times. I wish now to introduce the testimony of one who is at present th'~' star witness of those who seek to hold the administration of the Federal Reserve System responsible for the financial and economic ills which efflict the country. I hold in my hand the report of the Comptroller of the Currency for the yePr 1920. This report is dated December 6. 1920 but was actually sent to Congress in page proof form on February . , 7, 1921. i There is .nothir.g in this report which reflects in any way upon the administration of the Federal Reserve System nor is there enyNh6re a auggesti6n that the precipitate decline in prices and the general depression -25- X-3202 whiCh set in during the last half of the year was due in any respect to the policies or operl'tting methods of the Federal Reserve System. On the Contrary several pages are devoted to a discuss ion of the world- wide economic c9.uses which brou9ht about the drastic reaction, and I sh~ 11 now read to you sever~l :passages in the report which refer to th:. Federal Reserve System. From page 6: "The story of Japan•s industrial and financial exper- ience is largely similar to the experience of South American and European countries - s.on:e of them our allies 1 and others neutral. Some of these countries are now going through a b~siness cataclysm similar to. that through which Jap~ bas so recently passed. In our own country we have been thus far fort'lmate enough'- thanks largely to the splendid efficiency end stabilizing influence of the Federal Raserve System- to avoid the financi~l crises end complete disorgani~ation which have ~ade h~voc elsewhere. We have passed with coWParative safety through exceed- in~ly troubled and nerve-racking times; but difficult and dgn£erous problen:s remain to be solved, the solution of which will demand clear heads and steady nerves." From page 11: •The deflation which at that time (1919) was obviously inevitable has corr-e, and tt~ co~try is now in many respects on a sounder basis, econorrdcally, than it hes been for yeers." From page 52: "Largely through the a.id and excellent functioning of the Federal Reserve System. the business and ba~ing interests of the country have passed succe~sfully through the ~erils of inflation and the strain end losses of deflation without panic end without the demoralization which has been produced in the past at various times from far less. X-3202 serious 8nd r~ckin~ c;>uses. 'l'hose banking and other interests which at the outset so Vi§'orously opposed the Federal Reserve Sys tern are now among its ' .warmest advocates.n Fron; page 291: "The past seven ~e8rs have been, in numbers of persons and extent of interests involved, the most momentous and critical in the history of this Republic. We have had to fpce and solve gigantic and un- p.recedented p.t ob:i.err's, and the banking and financial rna.chi:aery of the country • ·has been subjected to a. test 8-nd strain unrarallelled. the duty of our country very largely to fin~nce It has been the world, and in cl'lrry- 1ng out .the program which fate imposed upon us we have overcome successth~t fully difficulties met every righteous at tirees seerred alrrost insurmountable and we have derr~nd mede upon us. Our Federal Reserve financial ~md banking sys tern, inaugur~ted in 1914, has been of inestimable value; qnd without its aid, tr->sks which we have so successfully accomplished would have been impossible.ft I fee 1 th?t I should not close without saying something about present conditions and future prospects. The banking sit~~tion has &reatly iiT~ proved· and. with respect to it the gloomy forebodin;;zs of last Ninter are no longer justified ~nd can be dismissed. The process of reedjustment bPs not yet been completed but evidences are multiplying ~s been turned and th-'='t hq.vc •vefp~ssed the most "!.CUte stage th~.t of the corner the readjust- rnent period. Mu,ch will depend Ul'On developments in the tCJgricultur"-'1 sections of the country end upon the rn.an.."ler in which the crops are marketed. all sections h?~e While suffered, the burden of debt Rnd the lack of buying po•ver is felt more keenly in the fermin~ districts "nd no sust,ined for- ward movement in commerce and industry ean be expected unless en improve X-3032 -27- ment is seen and felt in these districts, in which normally so large a part of the country's power lies. purchasin~ With preFer cooperation on the part of merchents P.nd bankers, those engaged in agriculture have op~ortunities now it~s ago and P.nd prospects which were not anticipated a fe• months of vital importance that this It should be remembered, also) th~t cooper~tian in order to proiuction we must push our foreign tr!3.d.e. th"n Re need for our own use. maint~in articles of great variety In the chenged conditions resultine from the war, Pmerice occuries ::. new re latianship to the world. ~debtor our rQte of We produce more cotton, more manuf~ctured fot2dstuffs, more copper and more be given. We 8I"e no longer nation, as we were in 1914, but today Ne are the world's great creditor nation.. We h2ve l"n enonnous stock of gold, much of which has come to ua during recent months from ell q,uarters of the globe in pasnnent of corrrr.odities purch~sed We cannot forever from us. rnaint~in our forei~ of the gold stock of other nations. trade, however, on the Some memns must be devised for ex- tending long time credits abroAd or of interestin§ forei~n so properties he~vilv ~~?inst "'!ld. b~sis Arneric~n investors in securities, in or:der thet the exch!"'n2e which now runs other nations rr.a~ be corrected. We rrust contimue to buy from foreign countries those things which they can pr~uce 'Ni th t 1-.e,-. better or more cheaply then we can and exchange commodities If we deterroine to do business with and for ourselves alone, i t seems inevitable thPt ·ve must reduce our production to meet merely Pmerican requirements. One word more about the Federal Reserve System. do the impossible. ~'1d it c~?n.'lot. Do not expect it to It is not & panacea for all economic and financial ills however skillful its administration rr:ay be., pra\Yent periods .i -28- Y.-3?.02 of depression in the future, although it can do nuch to mod,ffy them. Other nations, such as Great Britain and France, with thetr great central banking institutions, have always had their years of prosperity and their periods of depression, although they have been free from the money :panics which we formerly had in this country as a result of our inade~uate ~11 bankin? system. history shol"Ts that -reriods of prosp~rlty Pnd de:prer-sio~ come ~in cycles, the rotation being about as follows: (l) Prosperity, (.!!) ti~uid.ation, (3) Stagnation, and (4) Revival~ flt the present time the Frocess of liquid· ation is well advanced and the end of stagnation and the beginning of the period of revival seem now to depend upon certain tbings which are susceptible of. accomplishment in the near future, among which may be enumerated the financial rehabilitation of our great transportation detennination syste~s and the of the policy of the Governrrent with respect to revenues and the tariff. When the period of revival does definitely set in, to be followed by a new -era of prosperity, let us remember that the greater the wave of pros. peri ty and the more unrest rained the exp-"'nsion and the speculation accompanyin? it, the sm>rper will be the depression thB.t will follow. the lessons of the past v•o If, however, years are remembered, the next period of pros- parity will be of longer dura.tion than any we bave had before and the subsequent reaction will be far less severe • • . }:·J ·\ . ·. ·. /
@FedFRASER