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512 W, P, G. HARDING, GOVIRHOI ALBIRT STRAUSS, VICI GOVlRHOft J11X OI'PICIO MI!MS&II8 ADOLPH C. IIILLIR DAVID P.Hq_~roN CHARLES B. HAll LIN HENRY A.IIOEHLINPAH SICRIIT'XliY~HI TRI.UURY CHAIR II AN ' FEDERAL RESERVE BOARD JOHN SKELTON WILLIAMS 111. T.CHAPIIAN, SICRITARY R. G. EIIERSON.AISIITANT SICRITAIY COIIPTIOLLIR OF THI CURRENCY ·- ADDRESS REPLY TO Subject: w.JI,JIILAY, FIScAL AIIHT WASHINGTON FEDERAl,. RESERVE BOARD June 15,1920. Editorial Frcrn "The Dallas Morning News." Dear Sir:The Federal Reserve :Soard requests that you bring to the attention of your member banks the following editorial which appeared in "The Dallas Morning News", of Friday, June llth,l920. "THE ADVANCING COST OF :SANK CREDIT" "It seems to have become the policy of banks to advance their discount rates commensurately with the advances made in the rediscount rates of the Federal Reserve :Sanks. Some of them ·seem not to have been content to limit their advances to the advances zmde by the Federal Reserve :Sanks, but to have made the action of the Federal Reserve :Sariks a pretext to widen the previously existing difference between the discount and the rediscount rates. We use the word pretext· for the reason that the action of a Federal Reserve Barik in increasing its rediicount rates does not necessarily warrant merd:>er banks in making any increase, whatever. The idea that it does, which idea seems to govern the policy of member banks, betrays a most surprising misconception of the purposes and functions of the Federal Reserve System. "It was not the purpose in creating the Federal Reserve System to enable the member banks to make a. ~rofit out of their rediscount operations. Nor was it the purpose even to enlarge their opportunities for increasing their earnings in any way. The salient pur• pose was to create and maintain a reservoir of credit for use in times of stress. Whenever rediscount rates are advanced, therefore, it is done chiefly to husband the resources of the Federal Reserve Bariks. Under nor~ conditions, the rates of a central bank, in countries which have long had them, are higher than the open market rates, so that bariks which rediscount lose instead of gain by the operation; and -properly so, since the effect is to restrict the use of credit, which is the purpose of the central barik in advancing its rediscount rates. It is obvious that 'if member banks are to make a profit on their rediscount operations they will be under no inducement to contract the volwr.e of cred1 t, and hence ~· ' X-1953 5:13 X-1953 -2- • ..... .- the purpose of the Federal Reserve Bank in advancing its rediscount rates will be sorcewhat balked, if not defeated. "That there is a species of ptofitesring in advancing discount rates on no other warrant than the fact that the Feder.al Reserve Barks have adV'anced their rediscount rates will became apparent on a moment 1 s reflection. For it is but a small percentage - about 12 per cent, w~· believe - of the loans made by member banks are rediscOtmted at the Federal Reserve Banks. In other words, about 88 percent of their loans are made from their own funds, so that when they advance their discount rates comrr:enaura.tely with an advance made in the rediscount rates of the Federal Reserve Bariks they,are merely increasing their profits an nearly 90 percent of the loans they make at the advanced rates. Thus what they in reality do is to :put a 'replacement value' on their funds, but without, however. always replacing them; so that they have even less excuse than the dealers in sugar for adopting that thrifty rule of pricing. If the member banks had all of their loanable f'llllds outstanding, or even any very large percentage of them, it might be both just and expedient to make additional loans at the rates of the Federal Reserve Banks, or even at rates higher . than those of the Federal Reserve Bar:iks. l3u t when they make their rates advance with those of the Federal Reserve Banks without being under the necessity of rediscounting the loans made at those advanced rates, it is evident that they are merely exploiting an opportunity which arises from an u:nheal thful condition of finance and industry. There is the less excuse for doing this in the fact that the Federal Reserve .Act has freed for use a great deal of the money which the old law required them to keep in their vaults. Since greater percentage of their funds is thus made available for lending, they can make their rates lower and still n~e their discount o~rations as profitable as they were before the institution of the Federal Reserve System. "The action of the banks throughout the country in advan.cing their discount rates has engendered no little dissatisfaction, and that dissatisfaction vents itself in complaints against the Federal Reserve Barks. That this is an injustice to those insti tu.tions is made clear by what has been said." a Very truly yours, Governor. To Chairznen of all F.F. Banks.
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