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:a -J FEDERAL RESERVE BOARD WASHINGTON address official correspondence t o the federal reserve board X-6125 September 4, 1928. SUBJECTi T o p i c f o r j o i n t c o n f e r e n c e - D e d u c t i o n of f o r e i g n b a l a n c e s i n c o m p u t i n g member b a n k reserves. Dear S i r : The B o a r d h a s v o t e d t o r e f e r t o t h e f a l l c o n f e r e n c e s of G o v e r n o r s a n d F e d e r a l R e s e r v e A g e n t s t h e a t t a c h e d correspondence r e l a t i v e to a suggestion by Mr. F r e d I . K e n t , Hew York C i t y , t h a t t h e B o a r d r e v o k e t h e r u l i n g made by i t i n 1919, t o t h e e f f e c t t h a t b a l a n c e s due f r o m f o r e i g n b a n k s may n o t be d e d u c t e d f r o m b a l a n c e s due t o o t h e r b a n k s by a member bank i n c a l c u l a t i n g i t s r e s e r v e s . The s u b j e c t i s a l s o b e i n g r e f e r r e d t o t h e n e x t m o o t i n g of t h e F e d e r a l A d v i s o r y C o u n c i l . Very t r u l y y o u r s , E . M. M c C l e l l a n d , Assistant Secretary. TO AIL GOVERNORS # D FEDERAL RESERVE AGENTS. COPY FRED I . KENT 100 Broadway Hew York X-6125-a J u n e 22, 1928, Hon; Roy A. Young, Governor, F e d e r a l R e s e r v e B o ar d , W a s h i n g t o n , B.C. Dear Mr. Young: , E n c l o s e h e r e w i t h copy of one l e t t e r w h i c h I f o r w a r d e d Mr. C u r t i s s o n , J u l y 19, 1924, e x c e p t t h a t due t o t h e f a c t t h a t t h e copy i n t h e f i l e s of t h e B a n k e r s T r u s t Co. was m u t i l a t e d and o n l y a few l i n e s of page 2 were with t h e l e t t e r I have h a d t o r e c o n s t r u c t i t f r o m memory. However, a s i t i s t h e argument you d e s i r e a n d n o t t h e s p e c i f i c w o r d i n g I am c e r t a i n t h a t i t w i l l serve your p u r p o s e . Cordially yours, (S) FIK-F Enc. Fred I . Kent. C O P Y X-6125-1) J u l y 19, 1924. Mr. F r e d e r i c H., C u r t i s s , Chairman, F e d e r a l R e s e r v e Bank of B o s t o n , 30 P e a r l S t . , B o s t o n , Mass. Dear F r e d : R e f e r r i n g t o y o u r l e t t e r of June 2 7 , c o n c e r n i n g r e s e r v e s r e q u i r e d of "banks, members of t h e F e d e r a l R e s e r v e System, would say t h a t i t seems t o nle t h a t i n t h e c o n s i d e r a t i o n of t h i s s u b j e c t we s h o u l d s t e e r c l e a r of t h e academic i n so f a r a s i s p o s s i b l e a n d conf i n e o u r s e l v e s t o t h e p r a c t i c a l p h a s e s of t h e q u e s t i o n . I n t h e f i r s t p l a c e i t m i g h t "be w e l l t o say t h a t the whole t h e o r y of r e s e r v e s a s c a r r i e d out i n t h i s c o u n t r y i s wrong. When a r e s e r v e c a n n o t "be u s e d i n time of emergency i t i s no r e s e r v e a t a l l i n s t e a d i t merely a c t s to c u r t a i l "business. There i s no d o u b t , however, "but t h a t a s y s t e m o f "banking which c a r r i e s w i t h i n i t t h o u s a n d s of i n d i v i d u a l t a n k i n g i n s t i t u t i o n s must f o r t h e " b e t t e r p r o t e c t i o n of a l l c o n c e r n e d "be r e q u i r e d t o c a r r y c e r t a i n s p e c i f i c r e s e r v e s y e t t h e aim s h o u l d "be t o f i x such r e s e r v e s a t a s low a f i g u r e a s i s c o n s i s t e n t w i t h s a f e t y a n d b e a r i n g i n mind t h a t the n e c e s s i t y to carry r e s e r v e s i s not going to prevent l o s s e s t h a t a r e due t o f r a u d o r d e l i b e r a t e t h e f t a n d t h a t c o n s e q u e n t l y t h e r e s e r v e r e q u i r e m e n t i s o n l y e f f e c t i v e a s a means t o p r e v e n t t h e e x e r c i s e of b a d judgment on t h e p a r t of i n d i v i d u a l b a n k e r s who m i g h t b e t e m p t e d t o l o a n o r i n v e s t a l a r g e r p r o p o r t i o n of t h e i r a s s e t s t h a n t h e n a t u r e of t h e i r p a r t i c u l a r b u s i n e s s w a r r a n t e d . I n c o n n e c t i o n w i t h t h e change i n t h e r e g u l a t i o n s made by t h e F e d e r a l R e s e r v e System u n d e r which member b a n k s were n o t a l l o w e d t o d e d u c t b a l a n c e s m a i n t a i n e d w i t h f o r e i g n b a n k s f r o m b a l a n c e s due from banks i n o r d e r to a r r i v e a t the n e t b a l a n c e upon which r e s e r v e s were t o be m a i n t a i n e d , n o t h i n g was a c c o m p l i s h e d t o w a r d s t r e n g t h e n i n g t h e b a n k i n g s y s t e m of t h e c o u n t r y i n my o p i n i o n . With few e x c e p t i o n s t h e b a n k s which m a i n t a i n f o r e i g n b a l a n c e s a r e l a r g e M e t r o p o l i t a n i n s t i t u t i o n s which b e t w e e n them c a r r y on t h e f o r e i g n exchange b u s i n e s s of t h e U n i t e d S t a t e s . I t goes w i t h o u t s a y i n g t h a t s u c h "business i s of tremendous i m p o r t a n c e t o our p e o p l e and t h a t our export t r a d e a f f o r d s an o u t l e t f o r our p r o d u c t i o n which h a s r e s u l t e d i n making i t p o s s i b l e t o d e v e l o p mass p r o d u c t i o n t h a t h a s e n a b l e d t h e m a n u f a c t u r e of s u f f i c i e n t u n i t s of t h e c o n v e n i e n c e s which t h e p e o p l e d e s i r e t o r e a c h a tremendous p o r t i o n of our p o p u l a t i o n . The i n s t i t u t i o n s d o i n g such b u s i n e s s i n f i g u r e s of i m p o r t a n c e a r e g e n e r a l l y s i t u a t e d i n c i t i e s where t h e r e a r e F e d e r a l R e s e r v e banks or b r a n c h e s of such b a n k s a n d t h e y a r e t h e r e f o r e i n p o s i t i o n t o o b t a i n c r e d i t s or currency, i f i t i s r e q u i r e d , a g a i n s t discounts without l o s s of t i m e . Such b a n k i n g i n s t i t u t i o n s c a r r y s u f f i c i e n t s t a f f s of o f f i c e r s of l a r g e e x p e r i e n c e i n b a n k i n g t o e n a b l e t h e a p p l i c a t i o n of c o m p o s i t e i n t e l l i g e n c e t o t h e c o n s i d e r a t i o n of t h e i r o p e r a t i o n s a s t h e y m i g h t be a f f e c t e d by a weaker o r s t r o n g e r r e s e r v e p o s i t i o n . I t i s p r o b a b l e i n so f a r a s t h e s e p a r t i c u l a r i n s t i t u t i o n s a r e c o n c e r n e d t h a t t h e y would be o p e r a t e d a l o n g l i n e s of a s g r e a t s a f e t y i f t h e y were n o t o b l i g e d t o m a i n t a i n any s p e c i f i c r e s e r v e s b u t w e r e a l l o w e d —2*" X-6125-b t o u s e t h e i r judgment from daj- t o day a s t o what r e s e r v e s t h e y s h o u l d c a r r y . Under our l a r g e i n d i v i d u a l system of "banking, however, i t goes w i t h o u t s a y i n g t h a t t h i s would "be q u i t e i m p o s s i b l e t o a r r a n g e and t h a t t h e r e f o r e i t i s e n t i r e l y i n o r d e r t h a t t h e y s h o u l d come u n d e r t h e l a w w i t h a l l o t h e r "banking i n s t i t u t i o n s . D i s c r i m i n a t i o n a g a i n s t such i n s t i t u t i o n s , however, such a s a c t u a l l y o c c u r r e d t h r o u g h t h e change, i n r e g u l a t i o n s r e f e r r e d t o , n o t o n l y a p p e a r s t o "be u n j u s t i f i a b l e "but i t c l e a r l y imposes a n u n n e c e s s a r y t a x on t h e e x p o r t t r a d e of t h e c o u n t r y . When t h e change i n r e g u l a t i o n s was made i t "became n e c e s s a r y f o r many "banks d o i n g a f o r e i g n exchange "business t o go t o t h e i r F e d e r a l B e s o r v e "banks and "borrow i n o r d e r t o make t h e i r r e s e r v e s good. T h i s a c t d i d n o t s t r e n g t h e n t h e "banks i n any p a r t i c u l a r a s t h e y c o u l d h a v e "borrowed e x a c t l y a s w e l l on t h e c o l l a t e r a l which t h e y a c t u a l l y p u t u p , i f t h e o p e r a t i o n s of t h e i r "banks made i t n o c e s s a r y i n o r d e r t o m a i n t a i n t h e i r r e s e r v e s under the former r e g u l a t i o n s . The n e x t i m p o r t a n t r e s u l t was t h a t i t d e v e l o p e d a c e r t a i n amount of f r i c t i o n "between "banking d e p a r t m e n t s a n d f o r e i g n d e p a r t m e n t s t h a t s h o u l d n e v e r e x i s t . Banking d e p a r t m e n t s i n o r d e r t o keep t h e i r r e s e r v e s i n o r d e r u n d e r t h e r e g u l a t i o n s h a v e "brought f o r c e t o b e a r upon t h e f o r e i g n d e p a r t m e n t s t o c u r t a i l t h e i r f o r e i g n "balances, which h a s r e s u l t e d i n many i n s t i t u t i o n s h a v i n g s e n i o r o f f i c e r s c a l l upon f o r e i g n d e p a r t m e n t s f o r f u n d s when i t was a g a i n s t t h e i n t e r e s t s of t h e "banks to r e d u c e s u c h f u n d s and a l s o a g a i n s t t h e i n t e r e s t s of t h e f o r e i g n t r a d e of t h e c o u n t r y t o h a v e them do s o . When such b a l a n c e s c o u l d bo d e d u c t e d f r o m g r o s s d e p o s i t s i n a s c e r t a i n i n g n e t d e p o s i t s , such a s i t u a t i o n d i d not develop. I t i s n e c e s s a r y i n o r d e r f o r b a n k e r s t o c a r r y on a f o r e i g n b u s i n e s s a n d g i v e a s a t i s f a c t o r y s e r v i c e f o r them t o c a r r y b a l a n c e s i n f o r e i g n b a n k s . I t i s t h r o u g h such b a l a n c e s t h a t t h e y o b t a i n r a t e s needed to give a p r o p e r s e r v i c e t o e x p o r t e r s and importers and while they a r e a l w a y s f r e e t o w i t h d r a w such b a l a n c e s , and i n p r a c t i c a l l y a l l c a s e s t o o v e r d r a w a n o c c a s i o n , y e t i t i s e x p e c t e d t h a t t h e y s h a l l have a s a t i s f a c t o r y a v e r a g e d e p o s i t i n f o r e i g n b a n k s commensurate w i t h t h e s e r v i c e which i s e x t e n d e d t o them. A g a i n i t becomes n e c e s s a r y o c c a s s i o n a l l y f o r e x p o r t e r s t o t u r n i n b i l l s of exchange a f t e r t h e f o r e i g n m a r k e t s a r e c l o s e d a n d when t h e b a n k a c c e p t i n g them i s o b l i g e d t o c a r r y them o v e r u n t i l t h e n e x t d a y . I t seems u n r e a s o n a b l e t o e x p e c t a b a n k e r t o m a i n t a i n a r e s e r v e a g a i n s t such b a l a n c e s f o r i £ the b i l l s a r e r e f u s e d , he i s i n p o s i t i o n t o c h a r g e them b a c k a n d so r e d u c e d e p o s i t s . The b a n k e r i s a l s o o b l i g e d u n d e r p r e s e n t r u l i n g s t o h a v e i n mind t h e e f f e c t u p o n h i s r e s e r v e s when t a k i n g exchange f r o m e x p o r t e r s a n d i s o b l i g e d t o c o n s i d e r t h e e x t r a c o s t to the bank. There i s a l s o s e r i o u s doubt a s t o t h e a d v i s a b i l i t y of f o r c i n g American b a n k s t o c u r t a i l t h e i r f o r e i g n d e p o s i t s i n o r d e r to h o l d up t h e i r r e s e r v e s i n s t e a d of a l l o w i n g t h e f r e e d o m which i s n e c e s s a r y t o e n a b l e t h e f o r e i g n exchange b a n k e r t o h a n d l e h i s b u s i n e s s s a f e l y , e c o n o m i c a l l y a n d p r o f i t a b l y . I n c a s e of a d o m e s t i c c r i s i s , f o r e i g n b a l a n c e s have a l w a y s p r o v e d of g r e a t v a l u e . I n 1907 i n p a r t i c u l a r , i t was o n l y b e c a u s e of t h e f o r e i g n b a l a n c e s a v a i l a b l e t h a t American banks i n t h e m e t r o p o l i t a n c i t i e s were a b l e t o o b t a i n t h e g o l d which was r e q u i r e d i n o r d e r t o r e s t o r e c o n f i d e n c e . While t h e c o n d i t i o n s u n d e r t h e F e d e r a l R e s e r v e System a r e somewhat d i f f e r e n t t h e n p r e v a i l e d t h e n , —3 *— X-6135-b y e t a f t e r t h e p r e s e n t u n n a t u r a l s i t u a t i o n developed, "by t h e war h a s p a s s e d , a s i t w i l l , t h e a b i l i t y t o draw g o l d from a b r o a d i s a g a i n g o i n g t o be a v a l u a b l e a s s e t and f o r e i g n b a n k e r s a r e g o i n g t o be much f r e e r i n g i v i n g up g o l d i f American banks a r e i n t h e h a b i t of k e e p i n g r e s p e c t a b l e b a l a n c e s on d e p o s i t w i t h them t h a n would o t h e r w i s e be t r u e . The n e x t q u e s t i o n i s t h a t of a v a i l a b i l i t y of f o r e i g n b a l a n c e s i n c a s e s of n e c e s s i t y a n d a s to t h i s t h e r e i s no q u e s t i o n a t a l l u n l e s s a c r i s i s d e v e l o p e d where a l l banks were o b l i g e d t o s e l l t h e i r f o r e i g n exchanges a t t h e same time and such a s i t u a t i o n does n o t o c c u r w i t h o u t w a r n i n g s , d u r i n g w h i c h many i n s t i t u t i o n s d i s p o s e of t h e i r h o l d i n g s . F u r t h e r , a n emergency of s u c h c h a r a c t e r would mean t h a t some s e r i o u s c r i s i s h a d d e v e l o p e d i n which t h e b a n k i n g s y s t e m a s a whole would have t o s t a n d t o g e t h e r and a g a i n s t which i t i s t h o r o u g h l y uneconomic to make p r o t e c t i o n i n good t i m e s a n d b a d . While t h e r e i s always a b r o a d e r m a r k e t f o r c e r t a i n f o r e i g n e x c h a n g e s t h a n f o r o t h e r s , y e t t h e v e r y f a c t of a narrow m a r k e t r e s u l t s i n s m a l l f o r e i g n b a l a n c e s i n such m a r k e t s , so t h a t i t does n o t seem n e c e s s a r y o r a d v i s a b l e t o even c o n s i d e r the q u e s t i o n of a l l o w i n g t h e d e d u c t i o n of c e r t a i n exchanges and n o t o t h e r s . I n s t e a d i n so f a r as s a f e t y to i n d i v i d u a l i n s t i t u t i o n s i s concerned, they should be a l l o w e d t o d e d u c t f o r e i g n b a l a n c e s w h e r e v e r h e l d . I f bank e x a m i n e r s f o u n d c e r t a i n i n s t i t u t i o n s were c a r r y i n g t o o l a r g e sums i n t h e i r o p i n i o n i n f o r e i g n exchanges h a v i n g a l i m i t e d market, they could e a s i l y c a l l i t t o t h e a t t e n t i o n of t h e b a n k s so o p e r a t i n g . I t must be b o r n e i n mind i n c o n s i d e r i n g t h e q u e s t i o n of r e s e r v e s t h a t b a n k s d o i n g a f o r e i g n b u s i n e s s h a v e t o compete w i t h f o r e i g n b a n k s which a r e n o t o b l i g e d t o m a i n t a i n any r e s e r v e s and t h a t e v e r y a d d i t i o n a l u n n e c e s s a r y e x p e n s e made f o r t h e American f o r e i g n exchange bank i n c r e a s e s our d i f f i c u l t y i n s u c c e s s f u l l y competing w i t h f o r e i g n b a n k s . T h i s s i t u a t i o n a s t o r e s e r v e s h a s t e e n r e c o g n i z e d by t h e F e d e r a l R e s e r v e Board i n t h e i r a p p l i c a t i o n of the r e s e r v e law t o f o r e i g n b r a n c h e s of American b a n k s members of t h e F e d e r a l R e s e r v e S y s tem and i t i s j u s t a s i m p o r t a n t t h a t t h e y s h o u l d do so i n c o n n e c t i o n w i t h b a n k s i n t h e U n i t e d S t a t e s d o i n g a f o r e i g n b u s i n e s s . The e f f e c t of p r o h i b i t i n g t h e d e d u c t i o n of f o r e i g n b a l a n c e s , which i s u n q u e s t i o n a b l y l e g a l under t h e F e d e r a l Reserve Act, although i t i s p r o h i b i t e d by r e g u l a t i o n , i s e q u i v a l e n t t o p u t t i n g a t a x u p o n f o r e i g n d e p o s i t s . D a r i n g t h e t i m e s of most v i o l e n t f l u c t u a t i o n s i n t h e f o r e i g n exchange m a r k e t s i t h a s a l w a y s b e e n p o s s i b l e t o s e l l b a l a n c e s a n d t h e q u e s t i o n a s t o w h e t h e r a bank d o i n g / b u s i n e t s ^ n a y make a l o s s i n t u r n i n g o v e r s u c h b a l a n c e s i n c a s e of emergency h a s n o t h i n g to do w i t h t h e q u e s t i o n of r e s e r v e s , a l t h o u g h a b a n k e r i s more a p t t o meet w i t h a l o s s w i t h o u t e n t i r e freedom i n h a n d l i n g h i s b a l a n c e s than i s o t h e r w i s e t r u e . As a m a t t e r of f a c t I know of l a r g e l o s s e s which b a n k s h a v e s u s t a i n e d b e c a u s e t h e y were o b l i g e d t o s e l l t h e i r f o r e i g n exchange a t i n o p p o r t u n e t i m e s t o meet r e s e r v e r e g u l a t i o n s . This p a r t i c u l a r p o i n t i n t h e s i t u a t i o n i s , of c o u r s e , one t h a t i s more a p p a r e n t t o f o r e i g n exchange men t h a n t o t h o s e who h a v e n o t a c t u a l l y o p e r a t e d i n exchange t h e m s e l v e s , b u t t h e r e i s no doubt b u t t h a t i n a b i l i t y t o d e d u c t f o r e i g n exchange b a l a n c e s on t h e whole h a s a t e n d e n c y t o r e d u c e exchange p r o f i t s r a t h e r t h a n o t h e r w i s e . X-6125-b Taking e v e r y t h i n g i n t o c o n s i d e r a t i o n , t h a t i s the s a f e t y of "banks, t h e i r o p p o r t u n i t y t o o p e r a t e a t a p r o f i t , t h e i r a b i l i t y to g i v e a s e r v i c e t o e x p o r t e r s and i m p o r t e r s , t h e i r s u c c e s s i n m e e t i n g c o m p e t i t i o n from f o r e i g n "banking i n s t i t u t i o n s and f o r t h e gtiod of t h e c o u n t r y a s a w h o l e , t h e r e would seem e v e r y r e a s o n why "bankers i n a s c e r t a i n i n g t h e i r n e t r e s e r v e s s h o u l d "be a l l o w e d t o d e d u c t t h e "balances due them f r o m f o r e i g n "banks. C e r t a i n "barkers h a v i n g no "banking d e p o s i t s h a v e on o c c a s i o n o b j e c t e d to t h e p r i n c i p l e of a l l o w i n g any d e d u c t i o n of "bank "balances i n a s c e r t a i n i n g n e t d e p o s i t s and t h e change ifi. r e g u l a t i o n s t h a t a u t h o r i z e d such d e d u c t i o n o n l y t o t h e e x t e n t t h a t d e p o s i t s were h e l d f o r o t h e r "banks i s u n d e r s t o o d t o h a v e "been made "because of such o b j e c t i o n . The same "bankers o r o t h e r s who c a r r y no f o r e i g n "balances a r e a l s o "believed t o h a v e e x p r e s s e d a n o p i n i o n a g a i n s t a l l o w i n g t h e d e d u c t i o n of f o r e i g n "balances f r o m d e p o s i t s . I n "both c a s e s t h e r e must have "been a m i s u n d e r s t a n d i n g of t h e r e a s o n f o r r e q u i r i n g t h e m a i n t e n a n c e of r e s e r v e s a n d f u r t h e r t h e r e must have "been a "belief t h a t i n some i n d e f i n a b l e way a l l o w i n g t h e d e d u c t i o n of "bank "balances "by a "banker who h a d them t o d e d u c t was a d i s c r i m i n a t i o n a g a i n s t a "banker who d i d not h a v e such "balances, which i s , of c o u r s e , u n t r u e . A "banker who h a s to c a r r y "bank "balances i n o r d e r t o meet h i s "banking r e q u i r e m e n t s i s t y i n g up f u n d s a t low i n t e r e s t r a t e s which m i g h t o t h e r w i s e "be l o a n e d a t higher r a t e s . When i t comes t o t h e q u e s t i o n of f o r e i g n "balances t h e same t h i n g i s t r u e i n so f a r a s t h e i n t e r e s t r e t u r n i s c o n c e r n e d , a s f o r e i g n "balances p r o b a b l y do n o t a v e r a g e a s a whole a r e t u r n of 2 $ . T h e i r m a i n t e n a n c e , however, e n a b l i n g a s i t does t h e f u r t h e r i n g of t h e f o r e i g n t r a d e of t h e c o u n t r y r e a c t s d i r e c t l y t o t h e b e n e f i t of matoy b a n k e r s who do n o t do a f o r e i g n b u s i n e s s t h e m s e l v e s , b u t who make commission p r o f i t s f r o m t h e f o r e i g n e x c h a n g e of t h e i r c u s t o m e r s t h a t i s t a k e n f r o m them by t h e f o r e i g n exchange b a n k e r s a n d i n d i r e c t l y t h r o u g h h e l p i n g t h e t r a d e of t h e i r c l i e n t s . T h i s i s of g r e a t v a l u e t o a l l bankers and t h e i r b e s t i n t e r e s t s l i e i n h a v i n g u n n a t u r a l b a r r i e r s removed f r o m t h e i r f o r e i g n t r a d e . A s s u r i n g you t h a t I s h a l l be g l a d t o go o v e r t h e m a t t e r w i t h you i n d e t a i l sometime when you a r e i n Hew York s h o u l d you d e s i r e t o h a v e me doso, I am Very t r u l y y o u r s , Vice P r e s i d e n t FIK:B COPY FSDSMXj RSSERTE BAHK OF EBW YORK X-6125-c June 2 0 , 1928. Dear G o v e r n o r : R e f e r r i n g t o y o u r l e t t e r of June 13 a n d t h e s u b j e c t of Mr. F r e d I . K e n t ' s l e t t e r of June 5, copy of which was e n c l o s e d t h e r e w i t h , and h i s f u r t h e r l e t t e r of June 14 of which copy was a l s o r e c e i v e d , I am w r i t i n g t o a d v i s e you t h a t we h a v e g i v e n c a r e f u l c o n s i d e r a t i o n t o t h e s t a t e m e n t s made "by Mr. Kent a n d have a l s o c a r e f u l l y r e v i e w e d h i s p r e v i o u s a r g u m e n t s a l o n g t h e same l i n e , c o n t a i n e d i n h i s l e t t e r of J a n u a r y 21, 1921, a d d r e s s e d t o Governor H a r d i n g . We do n o t a p p e a r t o h a v e i n o u r f i l e s a copy of h i s l e t t e r t o Jjlr. C u r t i s t o w h i c h h e r e f e r s b u t i t i s t h e r e c o l l e c t i o n of our o f f i c e r s t h a t h i s l e t t e r t o Governor H a r d i n g i n J a n u a r y , 1921, c o n t a i n e d a complete e x p o s i t i o n of h i s viows a t t h a t t i m e . F o r e i g n exchange b a l a n c e s a r i s e f r o m a v a r i e t y of o p e r a t i o n s i n c l u d i n g t h e c o l l e c t i o n of c u s t o m e r s ' comm e r c i a l d r a f t s and "bills r e c e i v a b l e payable abroad i n f o r e i g n cyrrcncios, but r e l a t i v e l y that constitutes but a s m a l l p a r t of t h e o r d i n a r y o p e r a t i o n s of t h e l a r g e r American b a n k s t h a t d e a l i n f o r e i g n e x c h a n g e . I t i s a b u s i n e s s e n g a g e d i n f o r t h e p r o f i t a b l e employment of l o a n a b l e f u n d s a n d i n c l u d e s t h e b u y i n g a n d s e l l i n g of c a b l e t r a n s f e r s , t h e d i s c o u n t i n g of l o n g a n d s h o r t b i l l s , t h e e s t a b l i s h m e n t a n d m a i n t e n a n c e of f i x e d d e p o s i t s r e p a y a b l e on demand a t s h o r t n o t i c e or a f t e r s p e c i f i e d l o n g e r p e r i o d s , a n d t h e e x e c u t i o n of c o n t r a c t s f o r t h e r e c e i p t o r d e l i v e r y of e x c h a n g e a t f u t u r e d a t e s . I n t h e e x e c u t i o n of t h i s b u s i n e s s a c c o u n t s a r e m a i n t a i n e d w i t h f o r e i g n c o r r e s p o n d e n t s and f r e q u e n t l y r e c i p r o c a l a c c o u n t s a n d b a l a n c e s a r e m a i n t a i n e d by f o r e i g n c o r r e s p o n d e n t s w i t h American b a n k s . B a l a n c e s i n such a c counts o r d i n a r i l y b e a r i n t e r e s t and a h i g h e r r a t e i s u s u a l l y p a i d on b a l a n c e s a r r a n g e d f o r f i x e d t e r m s , say t h i r t y , s i x t y or n i n e t y d a y s , t h a n on b a l a n c e s i n a c c o u n t c u r r e n t which may be v a l u e d a g a i n s t by demand d r a f t o r c a b l e t r a n s f e r . Overd r a f t f a c i l i t i e s a r e f r e q u e n t l y e x t e n d e d , f a c i l i t i e s of r e discount i n f o r e i g n countries are o f t e n a v a i l e d o f , and b a l a n c e s a r e f r e q u e n t l y s h i f t e d between f o r e i g n c o u n t r i e s o r b r o u g h t home, d e p e n d i n g upon where t h e f u n d s may b e most •2- X-6125»c p r o f i t a b l y employed., The whole "business i s l a r g e l y one of a r b i t r a t i n g r a t e s and h a s l i t t l e t o do d i r e c t l y w i t h dom e s t i c d e p o s i t s , a l t h o u g h of c o a r s e a change i n t h e volume of d o m e s t i c d e p o s i t s may i n c r e a s e o r d e c r e a s e t h e f u n d s • a v a i l a b l e f o r exchange a n d o t h e r l o a n o r i n v e s t m e n t o p e r a t i o n s of t h e b a n k . C o n s i d e r i n g p r i m a r y r e s e r v e s of a "bank f r o m a b a n k e r ' s viewpoint as being an ursmployed fund maintained f o r t h e p u r p o s e of a d e q u a t e l y m e e t i n g demands f o r re p a y m e n t of d e p o s i t s a n d o t h e r c u r r e n t l i a b i l i t i e s of t h e b a n k , we can s e e no j u s t i f i c a t i o n f o r p e r m i t t i n g i n t h e ' c o m p u t a t i o n of r e q u i r e d minimum r e s e r v e s t h e d e d u c t i o n f r o m d e p o s i t l i a b i l i t y of f u n d s employed i n t h e f o r e i g n exchange opera-* t i o n s above r e f e r r e d t o , e v e n when such o p e r a t i o n s h a v e r e s u l t e d i n b a l a n c e s of c o l l e c t e d f u n d s due f r o m f o r e i g n b a n k s . The f a c t t h a t t h e s e b a l a n c e s may be c o n v e r t e d r a t h e r p r o m p t l y i n t o d o l l a r s i s , we b e l l e v a c b e s i d e t h e q u e s t i o n , a n d t h a t seems t o be t h e p r i n c i p a l r e a s o n s t a t e d by Mr. Kent i n h i s a r g u m e n t f o r t h e d e d u c t i o n . I f t h a t wore t h e t e s t i n t e n d e d by C o n g r e s s i t would bo d i f f i c u l t t o e x p l a i n t h e e x c l u s i o n of cash i n v a u l t as a d e d u c t i b l e item or even i t s non-allowance as a c t u a l r e s e r v e . We b e l i e v e t h a t t h e r e s e r v e s now r e q u i r e d r e p r e s e n t a f a i r minimum a n d t h a t i t would be u n w i s e t o p e r m i t t h e i r f u r t h e r diminution through a l l o w i n g deductions from g r o s s d e p o s i t s of monies employed a b r o a d or i n exchange o p e r a t i o n s . Very t r u l y y o u r s , ( S ) GATES W. McGAKEtAH, Chairman. Eon. E , A. Young, Governor, F e d e r a l Reserve Board, W a s h i n g t o n , D. C. COPY / FRED I . KE17T 100 Broadway Hew York X-6125~d June 14, 1928. Hon. Roy A. Young, Governor, F e d e r a l Reserve Board, W a s h i n g t o n , B.C. Bear Mr. Young: Your l e t t e r of t h e 1 3 t h i n s t . r e c e i v e d . Upon i n v e s t i g a t i o n I f i n d t h a t my l e t t e r t o Mr. C u r t i s was w r i t t e n i n 1921 a n d i t w i l l "be n e c e s s a r y f o r t h e B a n k e r s T r u s t Co. t o send t o t h e i r a r c h i v e s , which a r e f i l e d i n a n o t h e r c i t y t o g e t i t out& so t h a t I w i l l h a v e t o s e n d i t t o you l a t e r . I n t h e meantime a n s w e r i n g y o u r i n q u i r y c o n c e r n i n g Time B i l l s of Exchange would say t h a t w h i l e i t i s u n d o u b t e d l y t h e custom of most "banks t o k e e p t h e i r Time B i l l s of Exchange i n t h e i r "balances due f r o m f o r e i g n "banks "because t h e y a r c e q u i v a l e n t t© c a s h i n so f a r a s u t i l i z a t i o n i s c o n c o r n e d "by t h e "bank, y e t a l l "books, f a r as I h a v e e v e r h e a r d , a r e m a i n t a i n e d i n such manner t h a t t h e a c t u a l c a s h "balance i s a l w a y s a v a i l a b l e a n d c o u l d be u s e d f o r p u r p o s e s of deduction as a p o s i t i v e f i g u r e . Time B i l l s of Exchange a r e p u r c h a s e d f r o m e x p o r t e r s d a i l y by most b a n k s d o i n g a f o r e i g n exchange b u s i n e s s . Such b i l l s a r e e i t h e r d i s c o u n t e d a n d t u r n e d i n t o c a s h on a r r i v a l or t h e y a r e c a r r i e d toward m a t u r i t y b e f o r e d i s c o u n t i n g , or they a r e allowed t o r u n t o m a t u r i t y a s Time B i l l s . The d e t e r m i n a t i o n of t h e banks a s t o how s u c h b i l l s s h o u l d be h a n d l e d i s b a s e d upon money r a t e s a n d exchange conditions. I f , f o r i n s t a n c e , Time B i l l s of Exchange on London can be d i s c o u n t e d i n t h e London m a r k e t a t 4 $ a n d t h e money u s e d i n New York a t 6$ u n d e r i. t o r d i n a r y exchange c o n d i t i o n s b i l l s would be d i s c o u n t e d t o a r r i v e a s r a p i d l y a s t h e y were p u r c h a s e d e i t h e r by c a b l e on t h e day of p u r c h a s e or by c a b l e on t h e day of a r r i v a l , d e p e n d i n g upon t h e a p p a r e n t t e n d e n c y of money i n London. As a m a t t e r of f a c t i n so f&r a s t h e a v a i l a b i l i t y of t h e b i l l s i s concerned t h e y a r e a c t u a l l y e q u i v a l e n t to cash because the buyers of s u c h b i l l s i n t h e U n i t e d S t a t e s c a n s e l l exchange a g a i n s t them on t h e day t h a t t h e b i l l s a r e p u r c h a s e d i f t h e y so d e s i r e . T h i s was p r o v e d c o n c l u s i v e l y i n 1907 when t h e c u r r e n c y p a n i c was s t o p p e d t h r o u g h i m p o r t a t i o n s of g o l d f r o m London t h a t was o b t a i n e d f r o m p r o c e e d s of discounted b i l l s . B e f o r e g o i n g i n t o t h e m a t t e r i n more d e t a i l I would l i k e t o w a i t u n t i l I s e e j u s t what i s c o v e r e d i n Mr. C u r t i s ' l e t t e r . As you e x p e c t t o be away on a h o l i d a y I w i l l n o t have t h e B a n k e r s T r u s t Co. s e n d a s p e c i a l messenger f o r Mr. C u r t i s ' l e t t e r b u t w i l l a s k them when t h e y n e x t go t o t h e a r c h i v e s t o g e t t h e l e t t e r . FIKiF Cordially yours, (S) Fred I . Kent, COPY X-6125-e June 13, 1 9 2 8 . S e a r Mr. McGarraht D u r i n g 1919 t h e F e d e r a l R e s e r v e Board i s s u e d a r u l i h g , wMch was p u b l i s h e d on p a g e 963 of t h e F e d e r a l Resel-ve B u l l e t i n f o r t h a t y e a r , t o t h e e f f e c t t h a t f o r t h e p u r p o s e of f i g u r i n g r e s e r v e r e q u i r e m e n t s , b a l a n c e s due from f o r e i g n "banks c a n n o t he d e d u c t e d f r o m b a l a n c e s due t o o t h e r "banks. There i s a t t a c h e d h e r e t o ,a l e t t e r d a t e d J u n e 5 f r o m Mr. F r e d I . K e n t , r e f e r r i n g t o a s u g g e s t i o n made w h i l e i n Washington a t t e n d i n g t h e r e c e n t m e e t i n g of t h e Chamber of Commerce of t h e U n i t e d S t a t e s , t h a t t h i s r u l i n g be r e v o k e d on t h e g r o u n d t h a t t h e c o n d i t i o n s which l e d t o i t s a d o p t i o n i n 1919 no longer e x i s t . B e f o r e t a k i n g any a c t i o n t h e B o a r d would l i k e v e r y much t o h a v e y o u r views and t h e views of t h e o f f i c e r s of y o u r bank a s t o t h e a d v i s a b i l i t y of reversing the ruling in question. Very t r u l y y o u r s , R. A. Young, Governor. Mr. G a t e s W. McGarrah, F e d e r a l R e s e r v e A g e n t , F e d e r a l R e s e r v e Bank, New York, Hew Y o r k . COPY X-5125-f June 13, 1928 Dear Mr. K e n t : I was v e r y g l a d t o g e t y o u r l e t t e r of J u n e 5, and. I would a l s o "be v e r y p l e a s e d to h a v e you f o r ward t o me a copy of t h e l e t t e r which you s e n t t o Mr. C u r t i s sometime a g o . I h a v e b e e n e x t r e m e l y b u s y t r y i n g t o c l e a n up my desk so t h a t I c o u l d g e t away tomorrow f o r a s h o r t v a c a t i o n , which w i l l e x p l a i n t h e d e l a y i n r e p l y i n g t o your communication, a n d a s soon a s I r e t u r n I s h a l l "bring t h e m a t t e r r e f e r r e d t o i n y o u r l e t t e r "before t h e B o a r d . During t h e i n t e r i m I would a p p r e c i a t e i t v e r y much i f you would f u r n i s h me w i t h a l i t t l e a d d i t i o n a l i n f o r m a t i o n . I have been informed t h a t a l a r g e p e r c e n t a g e of t h e b a l a n c e s c a r r i e d by American banks w i t h t h e i r f o r e i g n c o r r e s p o n d e n t s i s upon a t h i r t y - * s i x t y - , or n i n e t y - d a y b a s i s . In other words, they a r e more i n t h e n a t u r e of a d v a n c e s t h a n f o r e i g n b a l a n c e s . Aiy i n f o r m a t i o n you can g i v e me i n r e f e r e n c e t o t h i s w i l l bo g r e a t l y a p p r e c i a t e d . Yours v e r y t r u l y , (S) Mr. F r e d I . K e n t , 100 Broadway. Hew York C i t y , H. Y. E . A. Young, Governor. FEED I . KEHT 100 .Broadway New York X-6125-g June 5, 1 9 2 8 . Hon. Boy A. Young, Governor, F e d e r a l Reserve Board, W a s h i n g t o n , B.C. Dear Mr. Young: Y e s t e r d a y a t t h e c o n f e r e n c e i n W a s h i n g t o n I was t a k e n w i t h a r e a l l y f r i g h t f u l h e a d a c h e a s I s t e p p e d up t o t h e P l a t f o r m t o s p e a k . T h i s was u n d o u b t e d l y due t o t h e f a c t t h a t I h a d "been i n s t e a d y c o n f e r ence u n t i l m i d n i g h t d u r i n g t h e p r e v i o u s t h r e e days a n d was g r e a t l y e x h a u s t e d . My o n l y r e a s o n f o r b r i n g i n g t h i s m a t t e r t o y o u r a t t e n t i o n i s my d e s i r e t o h a v e you know e x a c t l y what I h a d i n mind i f f o r any r e a s o n "because of my c o n d i t i o n I d i d not make i t e n t i r e l y c l e a r . The F e d e r a l B o s e r v e a u t h o r i t i e s a l l o w e d member b a n k s t o d e d u c t f r o m t h e i r t o t a l d e p o s i t s b a l a n c e s h e l d i n f o r e i g n banks a s w e l l a s b a l a n c e s h e l d i n d o m e s t i c banks u n t i l some time a f t e r t h e w a r . Then member b a n k s were n o t i f i e d t h a t t h e y c o u l d o n l y d e d u c t b a l a n c e s h o l d w i t h American b a n k s . At t h e time t h e r e was s e e m i n g l y r e a l r e a s o n f o r t a k i n g t h i s a c t i o n a s t h e f o r e i g n exchanges were so s e r i o u s l y u p s e t t h a t t h e d o l l a r v a l u e s of b a l a n c e s h e l d i n f o r e i g n b a n k s were c o n s t a n t l y f l u c t u a t i n g i n l a r g e p e r c e n t a g e s . While a c t u a l l y t h i s was n o t a s imp o r t a n t a s i t seemed, b e c a u s e banks h o l d i n g f o r e i g n exchange b a l a n c e s c o u l d a l w a y s s e l l them a t t h e r a t e s a t which t h e y were f i g u r e d when a s c e r t a i n i n g t h e i r r e s e r v e s , y e t t h e u n c e r t a i n t i e s t h a t d e v e l o p e d were s u f f i c i e n t t o a t l e a s t j u s t i f y a c o n s i d e r a t i o n of t h e m a t t e r a t the t i m e t h e a c t i o n was t a k e n . Today, however, c o n d i t i o n s h a v e so changed f o r t h e b e t t e r a n d t h e f o r e i g n e x c h a n g e s a r e s u f f i c i e n t l y " S t a b l e so t h a t t h e r e a s o n f o r c h a n g i n g t h e r u l i n g a n d p r o h i b i t i n g t h e d e d u c t i o n of b a l a n c e s h e l d i n f o r e i g n b a n k s does n o t now e x i s t . I t i s my f i r m c o n v i c t i o n t h a t i n t h e i n t e r e s t s of our f o r e i g n t r a d e a n d i n a l l f & i r n e s s t o t h e banks which e n a b l e t h e c a r r y i n g on of f o r e i g n t r a d e t h r o u g h t h e p u r c h a s e of b i l l s of exchange r e p r e s e n t i n g e x p o r t s t h a t t h e y s h o u l d be a l l o w e d t h i s d e d u c t i o n . W i t h o u t g o i n g f u r t h e r i n t o t h e m a t t e r would s a y t h a t I p r e s e n t e d t h e r e a s o n s t o Mr. C u r t i s , Chairman of t h e F e d e r a l E e s e r v e Committee h a v i n g t h e q u e s t i o n of r e s e r v e s i n c h a r g e , some t i m e a g o , which I o n l y m e n t i o n t h i n k i n g t h a t i f t h e m a t t e r i s b r o u g h t up a g a i n you might w i s h t o h a v e s u c h d e t a i l b e f o r e y o u . I f f o r any r e a s o n you p r e f e r to h a v e me s e n d you a copy of ray l e t t e r I w i l l v e r y g l a d l y g e t i t o u t . I t was my i n t e n t i o n t o e x p l a i n t h e s i t u a t i o n a l i t t l e more f u l l y y e s t e r d a y b u t when I f o u n d t h a t I was h a v i n g t o f i g h t s e v e r e p a i n a t t h e same t i m e I d i d n o t f e e l w a r r a n t e d i n a t t e m p t i n g t o do s o . Hoping t h a t t h i s s t u d y of t h e F e d e r a l B e s e r v e s y s t e m t h a t h a s b e e n u n d e r t a k e n by t h e Chamber w i l l have r e s u l t s t h a t i n your o p i n i o n n o t o n l y j u s t i f y i t b u t p r o v e of v a l u e t o t h e s y s t e m , a n d w i t h k i n d r e g a r d s , I am Cordially yours, FIK:F (S) Fred I . Kent
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