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X-4833
SUBJECT:
Memorandum regarding Cuban Agency prepared by the Federal Reserve
Bank of New York and submitted toy Deputy Governor Case at hearing "before Federal Reserve Board on November 11, 1926.
The proposal for some kind of Federal Reserve Agency in Cuba appears to
hate arisen primarily in the search for some means of improving the physical condition of the currency in Cuba. Cuba uses wholly United States currency, which
is the only legal tender currency there. The total amount of the circulation
in Cuba is estimated at about $100,000,000 as compared with total bank deposits
of perhaps something less than $200,000,000. This very high ratio of currency
to deposits indicates that the people of Cuba transact their business largely by
currency and their use of and confidence in banks is limited. Before the establishment of Federal Reserve agencies the currency was supplied largely through
the branches in Cuba of the National City Bank of New York, the American Foreign
Banking Corporation, later absorbed by the Chase National Bank of New York, the
Royal Bank of Canada, the Canadian Bank of Commerce, and the Bank of Nova Scotia,
which do a large part of the banking business of the island.
The shipment of currency to and from New York or Jacksonville and the
maintenance in Cuba of an adequate currency reserve were expensive. Financial
disturbances approaching money panics were of frequent occurrence and at such
times these banks found it necessary to ship huge amounts of currency to Cuba.
It was frequently difficult to get currency there quickly enough to meet emergencies and the currency reserves which the banks found it necessary to carry were
probably at times as large as $50,000,000., Shipments of currency from New York
to Cuba (either directly or through Atlanta) averaged about $30,000,000 a year
for the years from 1920, 1921, and 1922.
The question of Cuban agency of a reserve bank appears to have been first
raised in 1921 by Mr. George B. Roberts, vice-president of the National City
Bank of New York. With reference to a proposal which had been made to establish
in Cuba a central bank, modeled, perhaps, on the Federal Reserve System, Mr. Roberts suggested to Governor Strong in a letter that "the best thing that could
possibly be done would be to have a branch of the Federal Reserve Bank of New
York located at Havana". Governor Strong stated to Mr. Roberts his opposition to
this proposal, saying that he thought Cuba should have a separate bank of issue
under American supervision; that in any event he was against the establishment
by our bank of issue of offices to carry on normal banking functions outside the
United States. The governor advised Mr. Roberts .farther that means could be found
for retiring mutilated and worn-out currency in circulation in Cuba and issuing
fresh supplies "without the reserve bank being involved in a banking business in
Havana."
In September 1921, to meet an emergency situation, the National City
Bank of New York was appointed correspondent and agent of the Federal Reserve Bank
of New York in Cuba. The Federal Reserve Board approved of this appointment, with
the understanding that no actual transactions would be engaged in until regulations had been prescribed by the Federal Reserve Board. This appointment was
made with the object of restoring confidence in Cuba and stopping runs on Cuban
branches of the National City Bank# At the same time the National City Bank sent
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$5,000,000 to its Cuban "branches, in order to afford the desired relief.
In February 1923 Mr. Dwiglit Morrow proposed that this bank circulate
gold notes in Cuba with a view to supplying the Island with paper money fit for
circulation. Governor Strong at this time stated that he was opposed to this bank
undertaking any expense, duty or responsibility in the matter unless directed to
do so by Congress.
In April 1923 the Federal Reserve Bank of Boston applied to the Federal
Reserve Board for permission to establish an agency in (Xiba, to which application
it appeared that the Departments of State and Treasury at least made no objection.
A hearing on the application was set by the Federal Reserve Board for April 30,
1923. Governor Strong at that time was absent from the city in Colorado and by
telegram he renewed his objection to the proposal, on the ground that it was not
authorised by law and for various practical reasons, including expense and the assumption of responsibilities for which the bank had no liability and the fact that
a currency clean-up could be effected by other means. Further, that Boston should
not open an office to conduct business practically all of which was for Hew York*
The Federal Reserve Banks of Hew York, Philadelphia, and Atlanta, and others were
invited to attond the hearing before the Federal Reserve Board on May 7, 1923,
and this bank was represented by Messrs. McGarrah,and Case. Mr. Mitchell, President of National City Bank also attended. The views of this bank were expressed
in a formal memorandum, prepared after consultation among all concerned. The
memorandum was as follows:
"The Federal Reserve Bank of Hew York desires to present its views and
the following consideration in regard to the application to the Federal Reserve
Board by the Federal Reserve Bank of Boston for permission to establish an agency
in Havana, Cuba, under Section 14-B of the Federal Reserve Act*
"Attitude of Federal Reserve Bank of Hew York.
"1.
While for reasons set forth in the memorandum it is opposed to
any Federal Reserve Bank establishing an agency in Cuba, nevertheless if the
Federal Reserve Board reaches the determination that an agency of a Federal Reserve Bank should be established in Hayana, the Federal Reserve Bank of Hew York
would prefer HOT to be selected and could not therefore object to the selection
of the Federal, Reserve Bank of Boston or of any other Federal Reserve Bank.
"Purpose of Application.
"2.
At the hearing on this subject before the Federal Reserve Board
on April 30, 1923, it appeared that the application was made primarily to improve
the quality of the paper money now in circulation in Cuba. It appeared also that
branches of American banks in Cuba, as well as other banks operating there, might,
if the agency were established, feel justified in carrying a much smaller supply
of currency than at present* Our information leads us to believe that the banks
would thereby save; many hundreds of thousands of dollars.
"It further appeared that it might be ultra vires for the Federal Reserve Board to grant an application for the establishment of an agency for currency purposes alone, since Section 14*36 does not include carrying a reserve of
currency, and the issuing and redeeming of currency among the purposes for which
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%
a Federal Reserve Bank may establish an agency in a foreign country.
"The application, therefore, takes the form of a proposal to establish
an agency in Havana for the purpose of dealing in exchange, presumably for the
following two reasons:
"(a) In order that it may comply with the provisions of Section 14-E
under which such an agency may be established;
"(b) In order that by dealing in foreign exchange tho considerable expense of maintaining the agency may be met.
"Dealings in Foreign Exchange by Federal Reserve Banks.
"3* We have always been opposed, and ve believe the Federal Reserve
Board has held a similar view to the idea that a Federal reserve bank should deal
in exchange in the United States:
"(a) Because the number of dealers and the supply of capital engaged
in foreign exchange dealings was ample;
"(b) Because it would put the Federal reserve banks in direct competition with member hanks in all parts of the country who have highly developed exchange departments;
"(c) Because of the risks involved.
"With respect to dealings in foreign exchange by Federal reserve hanks
in foreign countries, it has been our belief that Section 14-E intended to provide
not for the establishment of independent agencies in foreign countries but for the
appointment of "banks in foreign countries as correspondents and agents of Federal
reserve banks. Through these agencies, the reserve banks, when such a course
seemed desirable, could purchase bills in foreign countries for the purpose of
assisting in the stabilization of international gold movements. We have, therefore, with the approval of the Board, entered into agency agreements with a number of foreign banks of issue whereby on order they will purchase for us with
their guaranty prime bills in their markets, and likewise, on order, we will purchase prime bills in their markets, and likewise, on order, we will purchase for
them with our guaranty prime bills in our markets. In each of these agreements
all other Federal reserve banks, in accordance with Section 14-E, have been invited to participate and have done so.
"We are opposed generally to the idea that a Federal reserve bank should
conduct a foreign exchange business ip a foreign country merely for the profit
involved. We are opposed specifically to the idea that a Federal Reserve bank
should conduct a foreign exchange business in Cuba merely for the profit involved:
"{*) Because there is no important international credit movement between Cuba and the United States to be stabilized, and if we are correctly advised,
(except in times of crisis) the fluctuations in exchange are limited to the cost
of shipping currency to or from the United States, say 1/8 of 1 per cent,
"(b) Because such business could be done only in active competition
with member and other banks with ample resources, now engaged in it.
"(e) Because of the risk involved.
#(d) Because the paper or the contracts purchased would not have the
number of names equivalent to those to which in the United States we restrict our
~4"
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26:1
open market purchases of "bills, (i.d., two tanking names).
"(e) Because it is a proceeding for which we "believe there is no precedent in the experience of other important "banks of issue.
"4. We are opposed to the principle of the establishment of a.direct
agency of a Federal reserve "bank in Cuba if any other means can "be found of accomplishing the desired results:
"(a) Because it renders some of our assets subject to the laws and the
courts of a foreign country,
"(h) Because of the expense involved in an undertaking which is not
the responsibility of the Federal Reserve System.
"(c) Because it creates a precedent for the establishment of direct
agencies elsewhere.
"(d) Because it raises the question of the responsibility of a Federal
reserve bank to redeem in a foreign country in gold or lawful money any or all
Federal Reserve notes that may happen to circulate in that country. The law provides that any Federal Reserve note (regardless of the bank of issue) may be redeemed in gold or lawful money at any Federal Reserve Bank, and a foreign agency
would in all probability be considered the Reserve Bank in law, just as much as
branches in this country are. Consequently, if the present application is approved and the Federal Reserve Bank of Boston actually opens its own office or agency
in Cuba might it not be expected as a matter of law '"to redeem in gold or lawful
money' all of the Federal Reserve notes now circulating in Cuba, estimated to be
well in excess of $100,000,000. As a practical matter it would of course not be
feasible for a small agency always to be prepared for redemption on such a large
scale."
On May 16, 1923, the Federal Advisory Council asked the Board for an
opportunity to be heard, later, Mr. Warburg and' others appeared before the Board
and expressed views adverse to the proposal, which were substantially the same
as those of the officers of this bank. Mr. Warburg, member of the Federal Advisory Council, prior to his appearance before the Board, asked the counsel of the
bank for an opinion as to the legality of the proposal. An opinion was rendered
(copy of which will appear later in the record) by letter of May 18, 1923, against
the legality of the proposal.
Mr. Warburg suggested to the Board other means by which a currency clean
up in Cuba might be effected.
By resolution passed June 27, 1923, and amended July 30, 1923, the Federal Reserve Board granted permission to the Federal Reserve Banks of Boston and
Atlanta to establish agencies in Havana, it being understood that the1Atlanta
bank would furnish the currency required for use on the Island, while the Federal
Reserve Bank of Boston would execute all exchange transactions, including cable
transfers. The agencies were accordingly set up and the business has been conducted on this basis.
On September 1, 1923, the appointment of the National City
York as agent and correspondent in Cuba of the Federal Reserve Bank
was terminated. This was by direction of the Federal Reserve Board
incident with the opening for business of the Cuban agencies of the
serve Banks of Boston and Atlanta.
Bank of Hew
of New York
and was coFederal Re-
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X-4833
On Friday, April 9, 1926, there xras a run on the banks in Havana, On
Saturday, April 10, this bank was advised of the fact and informed that the run
was chiefly on the Royal Bank of Canada; also that large amounts of currency were
needed to meet the situation. Several of our member banks in this city deposited Federal reserve notes with us and directed this bank to make wire transfers of
large amounts — a total of $31,950,000 — with instructions to make payment in
Havana in currency. It then developed that the amount of currency held by the
Federal Reserve Bank of Atlanta at its agency in Havana did not exceed eight or
nine million dollars, "sfaile the payments directed to be made amounted to several
times that sum, so that the Federal Reserve Bank of Atlanta was unable to satisfy the cable transfers. The Cuban banks passed over the difficulty by dosing
at noon on Saturday, April 10. The New York correspondents of the Cuban banks
urged the Federal Reserve Bank of New York to take stops to see to it that there
was an adequate supply of currency there on Monday, April 12, to enable the
agencies of the Federal Reserve Banks of Boston and Atlanta in Havana to make the
necessary payments. This was finally arranged through the Federal Reserve Board,
which ordered the Federal Reserve Bank of Atlanta to charter a special train to
take the currency to Jacksonville. The money was then transported to Cuba by a
Cuban gun-boat. The fact that the run occurred on Saturday and a Sunday intervened before the next business day was the only thing which prevented the development of a serious situation.
^
Under date of June 17, 1926, in a letter addressed to Mr. Hamlin of
the Federal Reserve Board, Governor Harding outlined his objections to the dual
agencies in Havana and in particular his objections to the establishment of an
agency of a Federal reserve bank in Cuba for the purpose of providing the people
of Cuba with currency fit for circulation and for the purpose of enabling a Federal reserve bank to keep in circulation in Cuba a large volume of its Federal
reserve notes. Governor Harding, in commenting generally on the situation, also
stated his view that the functions of such an agency should be limited to the
purchase of bills of exchange and the purchase and sale of cable transfers, which
transaction he regards as authorized under Section 14 of the Federal Reserve Act,
since they would result in the stabilization of exchange rates in Cuba, and that
the agency should be confined to one Federal reserve bank. He stated that unless
the Board were willing to consolidate the two agencies under the direction and
control af the Federal Reserve Bank of Boston, the agency of the Federal Reserve
Bank of Boston in Havana should be discontinued.
On October 22, 1926, the Federal Reserve Board wrote this bank a letter
announcing that a hearing would be held before the Board on November 11, with
respect to the following proposals:
"(1) To consolidate the Havana agencies of the Federal reserve banks of
Boston and Atlanta, and
"(2) To place under the supervision of the Federal Reserve Bank of Atlanta an agency performing all of the functions now performed by the existing
agencies."
The officers of the bank have reviewed the situation in the ligfct of
existing conditions and see no reason to change the views which they have hitherto expressed on the matter, i.e., they are opposed to the maintenance of any direct agency of a Federal reserve bank in Cuba.
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X-4833
(The letter referred to by Mr. Case is as follows:)
"FEDERAL RESERVE BANK OF HEW YORK, ifay 18, 1923.
"Paul M. Warburg, Esq.,
"31 Pine Street,
"New York, IT. Y.
"Dear Sir:
"You. have asked for my opinion as to the respective rights of Federal
re.erve banks and their tranches and foreign 'agencies' of Federal reserve hanks
to issue currency.
"Under Section 16 of the Federal Reserve Act it is provided that Federal
reserve notes are to he issued at the discretion of the Federal Reserve Board for
the purpose of making advances to Federal reserve "banks through the Federal reserve agents of the various districts, and for no other purpose.
"Branch offices of Federal reserve banks are provided for in Section 3
of the Act. They may be established on the initiative of the Federal reserve
banks or upon the mandate of the Federal Reserve Board within the Federal reserve
district of the bank of which they are made a branch, or within the district of
any suspended Federal reserve bank. They are subject to such rules and regulations as the Federal Reserve Board may prescribe, and the law provides that they
shall Ibe operated under the supervision of a board of directors of not more than
Ejlsven or less than three, of whom a majority of one shall be appointed by the
Federal reserve bank of the district and the remainder by the Federal Reserve
Board. It is provided that these directors shall hold office during the pleasure of the Federal Reserve Board. It should be noted that the operations of the
banks and their branches are expressly limited to their respective districts.
Also it will be noted that the law provides safeguards for the operation of banks
and branches, and that the establishment of branches was authorized in order to
extend to the various business communities within the Federal reserve district all
the facilities of the Federal reserve banks. The Federal Reserve Board has expressed the opinion that branches are merely extensions of the corporate entities
of the banks. In my opinion, the note issue power extended to the banks through
the Federal Reserve Board applies to branches as well.
"Section 14 provides for the appointment of agencies of Federal reserve
banks in foreign countries. The origin and pre-enactment history of this section
and its administration are sufficiently well known to you and clearly indicate
that its only purpose was to extend in proper cases the exchange operations of the
System. Ho express authority for the extension of the note issue privilege to
foreign agencies can be found in this section or elsewhere in the Act, nor can
such power be implied in the light of other limitations of the law1 and the history
and purpose of this section.
"You ask also whether the language of Section 14 (e) properly interpreted means that the Federal reserve banks are restricted to the appointment of for**
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eign banks or "banking firms as agents in foreign countries for the transaction
of foreign exchange business. The language of Section 14 (e) is that Federal
reserve hanks may 'appoint correspondents and establish agencies in such countries\
A fair construction of this language makes extremely doubtful, to say the least,
the power of the reserve banks to initiate a foreign agency as an integral), part
Of their own organization. That an already existing institution may be designated as a correspondent or agent is clear, but that the reserve banks may establish
in the sense of 1 found1 their own agency would seem to depend on the interpretation of the word 1 establish1. This word may mean 'appoint', (see Webster's
International Dictionary); and that this meaning, rather than that of 'found',
was intended appears from the language of the last sentence of the section, where
we find that in providing for the use of a foreign agency of one Federal Reserve
bank by the other banks the law says: 'Whenever any such account has bee# opened
or agency or correspondent has been appointed;1 and again, we find the language:
1
through the Federal reserve bank opening such account or appointing such agency
or correspondent.' A further consideration in support of this construction of
the law is that all of the purposes sought to be accomplished by Section 14 (e)
may be effected by the appointment of an existing foreign bank or banking firm
and consequently there can be no need for the extension by a reserve bank of its
own organization. There being no such need, it is hardly to be supposed that this
method was intended. If a charge should be made that an agency had been founded
instead of appointed, and that what was in name an agency was in reality a branch,
I think the courts would hold the transaction ultra vires and void.
"You inquire finally as to the obligation on the part of a foreign agency
to redeem in gold or lawful money Federal reserve notes.
"The Federal Reserve Act provides in Section 16 that Federal reserve
•notes shall be obligations of the United States' that they 'shall be redeemed in
gold on demand at the Treasury Department of the United States or in gold or lawful money at any Federal reserve bank*' From what I have said heretofore the conclusion seems inevitable that a branch of a Federal reserve bank is included in
the term Federal reserve bank for this as well as all ether purpose. The law,
therefore, imposes a plain mandatory duty on Federal reserve banks and branches
to redeem these notes in gold or lawful money. If it should appear that the
agency was in reality an agency for the purpose contemplated in Section 14, and
not a branch, I think the courts would hold that there is no binding legal obligations to redeem Federal reserve notes in Cuba in gold or lawful money, though it
seems quite clear that under the apparent arrangement now contemplated in Cuba
there would be a practical necessity to do so. If, on the other hand, a Federal
reserve bank should establish in Cuba what would prove to be in fact a branch,
though purporting to be an agency authorized by Section 14, and the question
should arise as to the obligation of such a branch to redeem Federal reserve notes
in gold or lawful money, it is my opinion that the courts would hold that the obligation of the branch to redeem in gold or lawful money is absolute, notwithstanding the ultra vires nature of such establishment.
"Very truly yours,
Signed) L.B.Mason, General Counsel."
@FedFRASER