The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
The F e d e ra l R eserve S y ste m • B a n c o d e M e x ic o B a n c o C e n tra ? de V e n e z u e la + B a n c o C e n tr a l B a n c o d o B r a sil • Federal Reserve Bank of Richmond Branches in Baltimore and Charlotte 1962 Annual Report F E D E R A L R E S E R V E B A N K OF R I C H M O N D TO OUR MEM BER B A N K S : W e are pleased to present the Annual R ep ort o f the F ed eral R e serve Bank o f R ichm ond fo r the year 1962. This y ea r’s report featu res the central banks o f the w orld with special referen ce to the F ederal Reserve System. A lso in cluded in the report are com parative financial statements, a brief sum m ary o f our operations, and a current list o f officers and directors o f our Baltim ore, Charlotte, and R ichm ond offices. On b e h a lf o f our directors and staff, w e wish to express our ap preciation fo r you r fine coop eration and support throughout the year. Sincerely yours, Chairman of the Board. President. Contents Notes on Central Banks 1 The Nature and Characteristics 2 The Note Issue Function 7 The C ollection Function 13 The Fiscal A g en cy Function 16 The M onetary P olicy Function 19 The International E conom y and Central Banks 26 Summary of Operations 34 Comparative Statement of Condition 36 Comparative Statement of Earnings and Expenses 37 Federal Reserve Bank of Richmond— Directors 38 Federal Reserve Bank of Richmond— Officers 39 Baltimore Branch— Officers 39 Charlotte Branch— Officers 39 Baltimore Branch— Directors 40 Charlotte Branch— Directors 40 Photo Credits Federal Reserve Bank of Richmond Board of Governors of the Federal Reserve System Bank of England Bank of Canada Banque de France The Central Bank of China (Taiwan) Banca d’ltalia Colonial Studios Reserve Bank of Australia Central Bank of the Philippines International Monetary Fund The Bank of Japan Notes 011 CENTRAL BANKS In every major country of the world the central bank is the central arch of the monetary and financial system. Its activities are essential to the proper functioning of the private economy and indispensable to the fiscal operations of the national government. Yet the central bank is usually taken for granted. Even among those who frequently come into contact with its operations, only Board of Governors of the Federal Reserve System a few have a full understanding of what a central bank is, what it does, and why. Often there are illusions and misunderstandings as to the purposes and functions of central banks and confusion or imperfect understanding of the differences between a central bank and a commercial bank. The purpose of these notes is to explain in simple terms the nature, char acteristics, and functions of central banks and the rationale behind them. At tention will be centered on broad, general characteristics and functions. Any given statement may not be true of a particular bank since no two central banks are exactly alike. From time to time special attention will be directed to the Fedral Reserve System as the central banking organization of the United States. The Nature and Characteristics S e v e r a l re a s o n s a c c o u n t f o r t h is r a p id g r o w t h in r e c e n t d e c a d e s . P e r h a p s th e m o s t im p o r t a n t is th e e x is te n c e o f a g r e a t m a n y m o r e in d e p e n d e n t n a tio n s in th e w o r ld , e a c h w i t h it s o w n m o n e t a r y a n d b a n k in g s y s te m t o b e m a n a g e d a n d s u p e r v is e d . S e c o n d , th e n a t io n s o f th e w o r ld h a v e a lm o s t e n t ir e ly a b a n d o n e d th e in t e r n a t io n a l g o ld s t a n d a r d w h ic h p r o v id e d s o m e d e g re e o f a u t o m a t ic c o n t r o l o v e r a c o u n t r y ’ s m o n e t a r y s y s te m . I n th e a b s e n c e o f t h a t a u t o m a t ic c o n t r o l, a c e n t r a l b a n k is n e c e s s a r y t o p r o v id e s o m e c o n s c io u s a n d d is c r e t io n a r y c o n t r o l o v e r m o n e t a r y a ff a ir s . T h i r d , m o n e t a r y a n d b a n k in g s y s te m s a re la r g e r , m o r e c o m p le x , a n d m o r e t e c h n ic a l th a n th e y w e r e a c e n t u r y a g o a n d f o r t h a t r e a s o n t h e y r e q u ir e c lo s e r a n d m o r e e ff e c t iv e c o n t r o ls . F in a l ly , in t e r n a t io n a l f in a n c ia l r e la t io n s a re m o r e im p o r t a n t in th e w o r ld t o d a y , a n d c e n t r a l b a n k s a r e n e e d e d b o th to c o n d u c t o r s u p e r v is e th o s e r e la t io n s a n d t o d e a l w it h a n y d o m e s tic d is t u r b a n c e s t h e y m a y c re a te . What is a Central Bank The Bank of England I t is r e p o r t e d t h a t o n o n e o c c a s io n W i l l R o g e r s s a id , “ T h e r e h a v e b e e n th r e e g r e a t in v e n t io n s s in c e th e b e g in n in g o f t i m e : f ir e , th e w h e e l, a n d c e n tr a l b a n k in g / ' H e m a y h a v e b e e n k id d i n g w h e n h e s a id t h is , f o r i t is d o u b t f u l i f c e n t r a l b a n k in g b e lo n g s in s u c h e x a lt e d c o m p a n y . B u t i t is t r u e t h a t th e c e n t r a l b a n k is o n e o f th e m o s t u s e fu l in s t it u t io n s m o d e r n m a n h a s d e v e lo p e d t o h e lp h im m a n a g e h is c o l le c t iv e f in a n c ia l a ff a ir s . A lt h o u g h th e r o o ts o f s o m e c e n t r a l b a n k s g o b a c k 2 0 0 v e a r s o r m o r e , c e n t r a l b a n k in g as w e k n o w i t t o d a y is m o s t ly a r e c e n t d e v e lo p m e n t. S o m e w o u ld c o n te n d t h a t i t is a lm o s t e n t ir e ly a p r o d u c t o f th e t w e n t ie t h c e n t u r y . I n 1 9 0 0 n o t a s in g le c e n t r a l b a n k e x is t e d in th e W e s t e r n H e m is p h e r e . T h e F e d e r a l R e s e r v e S y s te m w a s n o t c r e a te d u n t il 1 9 1 3 a n d th e B a n k o f C a n a d a d id n o t a p p e a r o n th e s c e n e u n t il 1 9 3 4 . N o w e v e r y in d e p e n d e n t n a t io n in th e h e m i s p h e re e x c e p t o n e h a s i t o w n c e n t r a l b a n k . A c c o r d in g t o a v a ila b le in f o r m a t io n , th e r e a re n o w 8 8 c e n t r a l b a n k s in th e w o r ld . O f th o s e , 4 7 , o r s lig h t ly m o r e t h a n h a lf , h a v e b e e n e s ta b lis h e d s in c e 1 9 4 0 . I t is n o t p o s s ib le t o g iv e a n y b r ie f d e f in it io n o f a c e n t r a l b a n k w h ic h w i l l b e b o t h c o m p r e h e n s iv e a n d a c c u ra te . T o a c o n s id e r a b le e x t e n t th e n a t u r e o f a c e n t r a l b a n k d e p e n d s o n it s f u n c t io n s , a n d th o s e f u n c t io n s v a r y f r o m c o u n t r y t o c o u n t r y a n d f r o m t im e to t im e . M a n y c e n t r a l b a n k s , e s p e c ia lly th e e a r lie r o n e s , a c c u m u la te d t h e ir f u n c t io n s a s t h e y w e n t a lo n g : lik e T o p s y , t h e y “ ju s t g r o w e d . ” N e v e r th e le s s , i t is p r o p e r t o s a y t h a t t o d a y a n y f u ll- f le d g e d c e n t r a l b a n k m u s t p e r f o r m a t le a s t t h r e e b r o a d f u n c t i o n s : i t m u s t b e a b a n k e r s ’ b a n k , i t m u s t a c t a s f is c a l a g e n t f o r th e n a t io n a l g o v e r n m e n t , a n d i t m u s t m a n a g e th e n a t i o n ’s m o n e t a r y s y s te m . T h e s e f u n c t io n s w i l l be d is c u s s e d in s o m e d e t a il la t e r , b u t t h e y w i l l b e b r ie f ly d e s c r ib e d h e r e . A B a n k fo r B a n k e rs U n d e r th e fir s t tw o g ro u p s of a c t iv it ie s , a c e n t r a l b a n k p e r f o r m s f o r th e c o m m e r c ia l b a n k in g s y s te m a n d f o r th e n a t io n a l government th e b a s ic f u n c t io n s w h ic h th e c o m m e r c ia l b a n k in g s y s te m p e r f o r m s f o r in d i v id u a ls a n d b u s in e s s f ir m s . A s a b a n k e r s ’ b a n k i t h o ld s th e r e s e r v e s o f c o m m e r c ia l b a n k s , c le a r s a n d c o lle c ts c h e c k s , d is t r ib u t e s c u r r e n c y a n d c o in to th e b a n k s , m a k e s s h o r t - t e r m a d v a n c e s t o b a n k s u n d e r c e r t a in c o n d it io n s , a n d a c ts a s ‘ ‘th e le n d e r o f la s t r e s o r t . ” F u r t h e r , th e c e n t r a l b a n k m a y , a n d u s u a lly d o e s , e x e r c is e s o m e d e g re e o f s u p e r v is io n a n d r e g u la t io n o v e r th e a c t iv it ie s o t c o m m e r c ia l b a n k s , a lt h o u g h t h is is n o t e s s e n tia l t o th e c e n t r a l b a n k in g f u n c t io n . Banker for the G overnm ent I n i t s c a p a c it y a s fis c a l a g e n t th e c e n t r a l b a n k re c e iv e s , h o ld s , t r a n s f e r s , a n d p a y s o u t th e fu n d s o f th e n a t io n a l g o v e r n m e n t. I n a d d it io n , i t re c e iv e s a n d a llo ts s u b s c r ip t io n s t o n e w s e c u r it y is s u e s , m a k e s e x c h a n g e s o f s e c u r it ie s , re d e e m s in t e r e s t c o u p o n s a n d m a t u r in g s e c u r it ie s , a n d , u n d e r c e r t a in c o n d it io n s , m a k e s s h o r t t e r m a d v a n c e s t o th e g o v e r n m e n t . I n a lm o s t a ll c o u n t r ie s t h e c e n t r a l b a n k is th e p r in c ip a l f in a n c ia l a d v is e r o r c o n s u lt a n t to th e g o v e r n m e n t a n d in s o m e c a s e s i t a c t u a lly m a n a g e s th e p u b lic d e b t. M anager of the M on etary System P e rh a p s th e m o s t d is t in g u is h in g f u n c t io n o f a c e n t r a l b a n k is it s c o n t r o l o f th e n a t io n ’s m o n e y a n d b a n k in g s y s te m . O n e a u t h o r it y o p e n s a t r e a t is e o n c e n t r a l b a n k in g w it h th e s e w o r d s : “ T h e e s s e n c e o f c e n t r a l b a n k in g is d is c r e t io n a r y c o n t r o l o f th e m o n e t a r y s y s t e m / ' I n p e r f o r m in g t h is f u n c t io n , c e n t r a l b a n k s e x e r c is e o n e o f th e p r e r o g a t iv e s a n d p o w e r s o f th e s o v e r e ig n g o v e r n m e n t . T h is m e a n s t h a t th e p o w e r m u s t b e e x e r c is e d p r i m a r i l y f o r th e a c h ie v e m e n t o f n a t io n a l e c o n o m ic g o a ls , a n d t h a t a c e n t r a l b a n k is a p u b lic s e r v ic e o r g a n iz a t io n , p la c in g th e n a t io n a l in t e r e s t a b o v e a n y c o n s id e r a t io n o f it s o w n p r o f i t o r w e lf a r e . I n a c t in g a s a b a n k e r s ’ b a n k a n d a s m a n a g e r o f th e c o u n t r y ’ s m o n e t a r y s y s te m , a c e n t r a l b a n k f r e q u e n t ly c re a te s m o n e y . I t d o e s t h is w h e n i t m a k e s a n a d v a n c e t o a b a n k o r b u y s s e c u r itie s in th e o p e n m a r k e t. T h e m o n e y t h u s c r e a te d is “ h ig h - p o w e r e d ” m o n e y — m o n e y w h ic h th e c o m m e r c ia l b a n k s c o u n t a s r e s e r v e s a n d o n th e b a s is o f w h ic h t h e y , a s a b a n k in g s y s te m , e x p a n d t h e ir e a r n in g a s s e ts a n d d e p o s its t o a n a m o u n t s e v e r a l t im e s th e a m o u n t c r e a te d b y th e c e n t r a l b a n k . e v e r d e a l d ir e c t ly w i t h c e n t r a l b a n k s . T h is p r o b a b ly is a m a jo r re a s o n w h y th e p u b lic g e n e r a lly is n o t w e ll a c q u a in te d w it h c e n t r a l b a n k a c t iv it ie s . I t is c u s t o m a r ily r e g a r d e d a s in a p p r o p r ia t e t o m ix c e n t r a l a n d c o m m e r c ia l b a n k in g f u n c t io n s . T h e o b je c t iv e s a n d th e m e th o d s o f th e t w o a re q u it e d i f f e r e n t, a n d i t m ig h t b e d if f i c u lt to k e e p th e t w o a c t iv it ie s p r o p e r ly s e p a ra te d . T h e c e n t r a l b a n k p la c e s p r i m a r y e m p h a s is o n th e a t t a in m e n t o f n a t io n a l e c o n o m ic g o a ls w h ile c o m m e r c ia l b a n k s n e c e s s a r ily p u t th e m a jo r e m p h a s is o n r u n n in g a p r o f it a b le b u s in e s s . F u r t h e r , i f a c e n t r a l b a n k d id e n g a g e in c o m m e r c ia l b a n k in g , it w o u ld h a v e a n u n f a ir a d v a n ta g e . F o r e x a m p le , th e c e n t r a l b a n k m ig h t h a v e to e x a m in e a n d s u p e r v is e it s c o m p e t it o r s . N a t u r a lly , t h is w o u ld te n d t o a n t a g o n iz e th e c o m m e r c ia l b a n k s a n d w o u ld t h r e a t e n t h e ir fr e e c o o p e r a t io n , w h ic h is v i t a l l y n e c e s s a r y f o r s u c c e s s fu l c e n t r a l b a n k o p e r a tio n s . In s u m m a r y , th e n , a c e n t r a l b a n k m a y b e b r o a d ly d e fin e d a s a p u b lic s e r v ic e o r g a n iz a t io n w h ic h d o e s n o t e n g a g e in c o m m e r c ia l b a n k in g , b u t w h ic h f u n c t io n s r a t h e r a s a b a n k e r s ’ b a n k , a c ts a s fis c a l a g e n t a n d a d v is e r f o r th e n a t io n a l g o v e r n m e n t , a n d m a n a g e s th e c o u n t r y ’ s m o n e y a n d c r e d it s y s te m . T he Bank of Canada N o C om m ercial B anking T o r o u n d o u t th is b r ie f d e f in it io n , i t is w e ll t o n o te o n e t h i n g w h ic h a c e n t r a l b a n k d o e s not d o . A lt h o u g h th e r e a re e x c e p t io n s , c e n tra l b a n k s o r d in a r ily d o n o t c o n d u c t a c o m m e r c ia l b a n k in g b u s in e s s f o r th e g e n e r a l p u b lic . I n fa c t , in d iv id u a ls a n d p r iv a t e b u s in e s s f ir m s ( e x c e p t c o m m e r c ia l b a n k s a n d a f e w s e c u r it y d e a le r s ) s e ld o m i f 3 e m p h a s is o n m a k in g p r o f it s d o e s n o t m e a n th a t th e y d o n o t m a k e p r o fit s . O n th e c o n t r a r y , t h e ir p o w e r to a c q u ir e e a r n in g a s s e ts b y c r e a t in g m o n e y is a m o s t lu c r a tiv e s o u rc e o f p r o f it s . Banque de France Characteristics of Central Banks A lt h o u g h th e c h a r a c te r is tic s o f c e n tr a l b a n k s w id e ly , th e r e a re a fe w e s s e n tia l o n e s w h ic h a re e n t in a lm o s t e v e r y im p o r t a n t b a n k . T h e s e w d is c u s s e d u n d e r t w o b ro a d h e a d in g s : f ir s t , th e o f th e p r o f it m o tiv e a n d , s e c o n d , r e la tio n s h ip s th e n a tio n a l g o v e rn m e n t. v a ry p re s ill be p la c e w it h Place of the Profit Motive O n e o f t h e m o s t i m p o r ta n t c h a r a c te r is tic s o f a c e n tr a l b a n k , a n d th e o n e w h ic h d is tin g u is h e s i t m o s t s h a r p ly f r o m a c o m m e r c ia l b a n k , is its s u b o r d in a tio n o f p r o f it c o n s id e ra tio n s to its r e s p o n s ib ilit y f o r p u b lic s e rv ic e . I f a c e n tr a l b a n k w e re o p e ra te d p r im a r ily f o r p r o f it , i t w o u ld t r y t o s ta y “ lo a n e d u p ” — b y m a k in g a p p r o x im a t e ly a ll th e lo a n s , d is c o u n ts , a n d in v e s tm e n ts it s r e s e rv e p o s it io n w o u ld p e r m it . T h is w o u ld b e in a p p r o p r ia t e f o r tw o re a s o n s . F ir s t , i t w o u ld n o t a llo w th e b a n k t o g iv e p r im a r y a tte n tio n , as it s h o u ld , to m a n a g in g th e c o u n t r y 's m o n e y s y s te m in a c c o rd a n c e w it h th e c h a n g in g n e e d s o f th e n a t io n ’s e c o n o m y . I t s n o r m a l p o lic y w o u ld be to c re a te re s e rv e s w h ic h w o u ld k e e p th e c o u n t r y ’s m o n e y s u p p ly e x p a n d e d as f a r a s le g a l p r o v is io n s w o u ld a llo w . S u c h a p o lic y w o u ld a lm o s t c e r t a in ly c a u s e s e rio u s fin a n c ia l c o m p lic a tio n s b o th d o m e s tic a lly a n d in t e r n a tio n a lly . S e c o n d , i f th e c e n tr a l b a n k is to f u n c t io n as a le n d e r o f la s t r e s o r t i t m u s t h a v e s o m e re s e rv e le n d in g p o w e r — s o m e c u s h io n — to m e e t e x tr a o r d in a r y s itu a tio n s . T h is it w o u ld n o t h a v e i f i t o r d in a r ily s ta y e d lo a n e d u p a s f a r as its re s e rv e s p e r m itte d . T h e fa c t t h a t c e n tr a l b a n k s d o n o t p la c e p r im a r y 4 Disposition of Profits I f a c e n t r a l b a n k is e n t ir e ly o w n e d a n d c o n t r o lle d b y th e n a t io n a l g o v e r n m e n t, as is f r e q u e n t ly th e c a s e , th e r e is n o p ro b le m in c u r b in g th e p r o f it m o t iv e , s in c e g o v e r n m e n ts d o n o t u s u a lly c o n d u c t t h e ir o p e r a t io n s f o r th e p u rp o s e o f m a k in g p r o fit s . B u t i f s o m e o r a ll o f th e c e n tra l b a n k s to c k is o w n e d b y p r iv a t e s to c k h o ld e r s , it is u s u a lly c o n s id e re d n e c e s s a r y to p la c e s o m e lim it o n th e r e t u r n th e y c a n r e a liz e f r o m th e s to c k so as to d is c o u ra g e th e m f r o m p u t t in g to o m u c h e m p h a s is o n e a r n in g s . T h is u s u a lly ta k e s th e f o r m o f p la c in g a r ig id l i m i t o n th e d iv id e n d s w h ic h c a n b e p a id o n th e s to c k o f th e b a n k . A n y e x c e s s e a r n in g s a re u s u a lly p la c e d in a r e s e r v e f u n d o r p a id to th e g o v e r n m e n t a s a t a x o r a fr a n c h is e fe e . T h is m a y be s tr e n g th e n e d f u r t h e r b y a p r o v is io n t h a t in case th e b a n k s h o u ld b e liq u id a t e d , th e s to c k h o ld e r s w o u ld be p a id th e p a r v a lu e o f t h e ir s to c k a n d a n y a m o u n t r e m a in in g w o u ld b e lo n g t o th e g o v e r n m e n t. T h is p r e v e n ts a n y p o s s ib ilit y o f s to c k h o ld e r s b e n e fitin g f r o m p la c in g la r g e a m o u n ts in re s e r v e s . T h e p ro v is io n s g o v e r n in g th e p r o f it s o f th e F e d e r a l R e s e rv e S y s te m a re p e r h a p s t y p ic a l o f th e a b o v e a r r a n g e m e n ts . T h e s to c k o f th e F e d e r a l R e s e r v e B a n k s is o w n e d b y th e m e m b e r b a n k s . T h e r e t u r n o n th a t s to c k is lim it e d to a n a n n u a l 6 % c u m u la t iv e d iv i d e n d . A f t e r t h a t d iv id e n d is p a id , e a c h R e s e rv e B a n k a d d s to its s u r p lu s a n y a m o u n t n e e d e d to b r in g its s u r p lu s u p to t w ic e th e p a r v a lu e o f its o u ts ta n d in g s to c k . A l l e a r n in g s r e m a in in g a f t e r t h is o p e ra t io n a re p a id to th e F e d e r a l G o v e r n m e n t . T h is la s t p a y m e n t is m a d e in a c c o rd a n c e w it h la w r u n d e r a r e g u la t io n o f th e B o a r d o f G o v e r n o r s . I n 1 9 6 1 th e g ro s s e a r n in g s o f th e 12 R e s e rv e B a n k s w e re $ 9 4 5 m il lio n ( $ 9 3 8 m il lio n f r o m in te r e s t o n U . S . G o v e r n m e n t s e c u r itie s , $ 4 m illio n f r o m p r o f it o n sa le s o f s e c u r itie s , a n d $ 3 m il lio n f r o m e a r n in g s o n d is c o u n ts a n d a d v a n c e s ) . C u r r e n t e x p e n s e s a m o u n te d to $ 1 6 1 m il lio n , le a v in g n e t e a r n in g s o f $ 7 8 4 m illio n . O f t h is a m o u n t, $ 2 6 m il lio n w a s p a id a s d iv id e n d s o n th e s to c k o f th e R e s e r v e B a n k s , $ 7 1 m illio n w a s a d d e d t o t h e ir s u r p lu s , a n d $ 6 8 7 m illio n w a s p a id to th e U . S . G o v e r n m e n t . T h u s , th e F e d e ra l G o v e r n m e n t r e c e iv e d 7 3 % o f th e g ro s s e a r n in g s a n d 8 8 % o f th e n e t e a r n in g s o f th e S y s te m . O v e r th e fiv e y e a rs 1 9 5 7 -6 1 , F e d e r a l R e s e r v e p a y m e n ts to th e F e d e r a l T r e a s u r y a v e r a g e d $ 7 1 2 m il lio n p e r y e a r. Profits of the Federal Reserve System R e la t i o n s h i p s w i t h N a t io n a l G o v e r n m e n t T h e r e la tio n s h ip s o f c e n t r a l b a n k s w it h t h e ir n a tio n a l g o v e r n m e n ts v a r y w id e ly b u t u s u a lly a re b r o a d , c lo s e , u n iq u e , a n d c o m p le x . T h e y v a r y b e c a u s e th e y w e re n o t fa s h io n e d a c c o r d in g to o n e c o m m o n p a t t e r n b u t s im p ly g re w T o r e v o lv e d . T h u s , th e y w e re in flu e n c e d b y e a c h c o u n t r y ’s c o n d it io n s a n d d e v e lo p m e n ts . M a n y o f th e e a r ly b a n k s w ^h ic h p e r fo r m e d s o m e c e n tr a l b a n k in g f u n c t io n s b e g a n as p r iv a t e ly o w n e d in s t it u t io n s , o p e r a te d f o r p r iv a t e p r o f it . W i t h th e p a s s a g e o f t im e t h e y a s s u m e d m o r e a n d m o r e c e n tr a l b a n k in g f u n c t io n s , a n d th e g o v e r n m e n ts th e n in s is te d u p o n e x e r c is in g a n in c r e a s in g a m o u n t o f c o n t r o l. I n a n u m b e r o f ca se s th e y a s s u m e d c o m p le te o w n e r s h ip a n d c o n t r o l. A g a in , i t m u s t b e re m e m b e re d t h a t th e s e c lo s e r e la tio n s d e v e lo p e d b e c a u s e c e n t r a l b a n k s e x e rc is e , a s o n e o f t h e ir m o s t e s s e n tia l fu n c t io n s , o n e o f th e m o s t im p o r t a n t p o w e r s o f a s o v e r e ig n g o v e r n m e n t— th e p o w e r to c re a te m o n e y . I n a ll c a s e s th e c e n t r a l b a n k o p e ra te s u n d e r a s p e c ia l g r a n t o f p o w Te r, u s u a lly e m b o d ie d in a c h a r t e r w Tit h v a r io u s a m e n d m e n ts a n d s u p p le m e n ts . T h is le g is la t io n , o f c o u rs e , is e n a c te d b y th e n a t io n a l p a r lia m e n t o r c o n g re s s a n d th u s c a n b e m o d ifie d a t a n y tim e . O n s o m e p o in t s t h is le g is la tio n is lik e ly t o be in f a i r ly b r o a d a n d g e n e r a l te r m s , a llo w in g s o m e r o o m f o r in t e r p r e t a t io n . F u r t h e r , a s t im e p a s s e s n e w s it u a t io n s a ris e w h ic h w e re n o t c o n te m p la te d in th e o r ig in a l le g is la tio n , a n d s o m e o f th e s e m a y n o t b e c o v e r e d b y s p e c ific a m e n d m e n ts to th e la w . A s a r e s u lt th e r e la tio n s h ip s s e t f o r t h in th e o r ig in a l le g is la t io n a re lik e ly to b e m o d ifie d a n d s u p p le m e n te d s o m e w ’h a t b y in t e r p r e t a t io n , p re c e d e n t, a n d p r a c tic e , so t h a t a c tu a l o p e r a t in g r e la tio n s h ip s m a y v a r y f r o m th o s e o r ig in a lly e s ta b lis h e d . O w n e r s h ip a n d C o n t r o l A s n o t e d a b o v e , m o s t o f th e e a r ly in s t it u t io n s w h ic h p e r fo r m e d s o m e c e n tr a l b a n k in g f u n c t io n s w e re p r iv a t e ly o w n e d . I n c o n tr a s t, n e a r ly a ll o f th e b a n k s c re a te d in re c e n t y e a rs a re o w n e d e n t ir e ly b y th e g o v e r n m e n t, a n d g o v e r n m e n ts h a v e a s s u m e d o w n e r s h ip o f s o m e o f th e e a r ly o n e s . I n a d d it io n , as r e la te d a b o v e , g o v e r n m e n ts u s u a lly in s is t u p o n a la r g e s h a re o f th e p r o fit s , i n c lu d in g th e r e s id u a l s h a re . A ls o , th e g o v e r n m e n t is u s u a lly th e r e s id u a l c la im a n t in ca s e th e b a n k s h o u ld b e liq u id a t e d . R e g a rd le s s o f th e e x te n t to w h ic h th e n a t io n a l g o v e r n m e n t s h a re s in o w n e r s h ip , i t in v a r ia b ly p a r tic ip a te s in c o n t r o l. T h is u s u a lly ta k e s th e f o r m o f a p p o in t in g th e g o v e r n in g b o a r d o r s e v e ra l o f th e to p o ffic ia ls . W h e r e th e g o v e r n m e n t o w n s th e b a n k c o m p le te ly , it , o f c o u rs e , h a s c o m p le te c o n t r o l a n d th e o n ly q u e s tio n t h a t r e m a in s is h o w t h a t c o n t r o l s h a ll b e e x e rc is e d . P o s it io n in t h e G o v e r n m e n t a l S t r u c t u r e T h e e x a c t p o s it io n w h ic h th e c e n t r a l b a n k s h o u ld o c c u p y in th e g o v e r n m e n t h a s lo n g b e e n a d e lic a te a n d d if f ic u lt q u e s tio n . S in c e th e b a n k e x e rc is e s a m a jo r g o v e r n m e n t a l p o w e r a n d s in c e th e g o v e r n m e n t a h v a y s e x e rc is e s a c o n s id e r a b le c o n t r o l o v e r i t a n d o fte n o w n s i t o u t r ig h t , w h y s h o u ld th e b a n k n o t b e a r e g u la r g o v e r n m e n t b u r e a u , p r e s u m a b ly in th e t r e a s u r y o f th e e x c h e q u e r ? T h a t w o u ld s e e m t o b e th e d ir e c t a n d s im p le s o lu t io n , b u t h is t o r y p r o v id e s m a n y w a r n in g s a g a in s t it . The Central Bank of China, Taiwan Banca cTItalia I n th e fin a n c ia l f ie ld th e g o v e r n m e n t e x e rc is e s t w o m a jo r fu n c tio n s . T h e f ir s t is th e fis c a l f u n c t io n ; i t m u s t ra is e th e fu n d s to c o v e r th e c o s ts o f th e m a n y a c tiv it ie s it c a r r ie s o n . T h is is u s u a lly d o n e b y t a x a tio n , b u t ta x e s a re u n p le a s a n t a n d p o lit ic a lly u n p o p u la r . T h e s e c o n d m a jo r f u n c t io n is t h a t o f p r o v id in g a n a d e q u a te a n d s o u n d m o n e ta r y s y s te m . T h e g o v e r n m e n t h a s th e s o le p o w e r to c o n t r o l th e c re a t io n o f m o n e y . T h e im m e d ia te e ffe c t o f in c r e a s in g th e m o n e y s u p p ly is lik e ly to b e w id e s p re a d e x h ila r a t io n a n d s u p e r fic ia l p r o s p e r it y f o r n e a r ly e v e r y b o d y w h e r e a s in c re a s e d t a x a t io n is lik e ly t o h a v e o p p o s ite e ffe c ts . I n th e lo n g r u n , h o w e v e r, in f la t in g th e m o n e y s u p p ly is a m e th o d o f t a x a t io n a n d h is t o r ic a l e x p e r ie n c e in m a n y c o u n tr ie s h a s s h o w n t h a t u l t i m a te ly i t is b o th in e q u ita b le a n d d is a s tro u s . I f a s in g le a u t h o r it y w it h in th e g o v e r n m e n t h a s c o n t r o l o v e r b o th th e fis c a l a n d m o n e y fu n c tio n s t h e r e w il l a lw a y s b e th e t e m p ta tio n to c o v e r c u r r e n t e x p e n d it u r e s b y c r e a tin g m o n e y r a t h e r th a n r a is in g it t h r o u g h t a x a t io n . I f th e g o v e r n m e n t is w e a k , in c o m p e te n t, s h o r ts ig h te d , o r b e s e t w it h s t r o n g p o litic a l fo r c e s , i t is lik e ly to ta k e th e e a s y r o u te o f in f la t io n . 6 T h e r e s u lt is a lm o s t c e r t a in t o b e a s te a d ily r is in g m o n e y s u p p ly a n d a n u n c o n t r o lle d in f la t io n . F in a n c ia l h is t o r y a ffo r d s s c o re s o f e x a m p le s o f th e d a n g e rs o f p la c in g b o th th e fis c a l a n d m o n e t a r y fu n c tio n s u n d e r th e im m e d ia te c o n t r o l o f o n e o ff ic ia l. I n n e a r ly a ll c o u n t r ie s th e n a t io n a l g o v e r n m e n t is th e la r g e s t b o r r o w e r in th e c o u n t r y . T h e c h ie f f i n a n c ia l o ffic e r o f th e g o v e r n m e n t m u s t p la n th e g o v e r n m e n t ’ s b o r r o w in g a n d r e f u n d in g . T h e c e n tra l b a n k , t h r o u g h it s m o n e t a r y p o lic y , c a n s u b s ta n tia lly a ffe c t, a t le a s t f o r s h o r t p e r io d s o f t im e , th e ra te o f in te r e s t w h ic h m u s t b e p a id in s u c h o p e r a tio n s . I f o n e m a n h a s im m e d ia te c o n t r o l o f b o t h b o r r o w in g a n d m o n e ta r y p o lic y , h e w i l l b e f o r c e d to d e a l w it h h im s e lf a n d w i l l b e s u b je c t t o p e r s is te n t a n d in s id io u s p re s s u re t o s e t p o lic ie s w h ic h w i l l f a c ilit a t e b o r r o w in g a n d k e e p in t e r e s t c o s ts d o w n r e g a rd le s s o f w h e th e r s u c h p o lic ie s a re th e b e s t f o r th e e c o n o m y a s a w h o le . F u r t h e r , th e h ig h ly s p e c ia liz e d a n d te c h n ic a l o p e r a tio n s w h ic h c e n t r a l b a n k s e n g a g e in r e q u ir e a s p e c ia l r e la tio n s h ip w it h c o m m e r c ia l b a n k s w h ic h fe w , i f a n y , o th e r g o v e r n m e n t a g e n c ie s h a v e w it h f ir m s in th e p r iv a t e e c o n o m y . T h e s e c o n d it io n s c a n n o t e x is t u n le s s th e c e n t r a l b a n k h a s s o m e d e g re e o f in d iv id u a lit y a n d a u to n o m y . I n a d d it io n , th e g o v e r n m e n t n e e d s e x p e r t a n d p o lit ic a lly im p a r t ia l a d v ic e o n fin a n c ia l m a tte r s . T o p r o v id e s u c h a d v ic e is o n e o f th e m a jo r r e s p o n s ib ili tie s o f a c e n tr a l b a n k . M r . M o n t a g u N o r m a n , re g a r d e d a s o n e o f th e g r e a te s t G o v e r n o r s o f th e B a n k o f E n g la n d , s ta te d o n o n e o c c a s io n : “ I lo o k u p o n th e B a n k as h a v in g th e u n iq u e r i g h t t o o f f e r a d v ic e a n d to p re s s s u c h a d v ic e e v e n to th e p o in t o f n a g g in g ; b u t a h v a y s o f c o u rs e s u b je c t t o th e s u p r e m e a u t h o r it y o f th e g o v e r n m e n t . ” A n a s tu te o b s e r v e r o f th e A m e r ic a n sce n e a r r iv e d a t m u c h th e s a m e c o n c lu s io n : “ I t w o u ld n o t be t o le r a te d to h a v e a c e n t r a l b a n k . . . in th e h a n d s o f p r iv a te p e r s o n s a s d is t in g u is h e d f r o m re p r e s e n ta tiv e s o f th e p e o p le . T h e c e n t r a l b a n k is a n in s t r u m e n t o f g o v e rn m e n t a n d m u s t a h v a y s be so. H o w e v e r, it is n o t a n in s t r u m e n t o f th e fis c a l a u t h o r it y . W h a t is n e e d e d is t h a t th e t w o a u t h o r it ie s b e re p re s e n te d b y p e rs o n s o f e q u a l r a n k ; e q u a lit y o f r a n k is e s s e n tia l f o r e ffe c tiv e c o o p e r a tio n . T h is s h o u ld b e re c o g n iz e d ( 1 ) b y th e fis c a l a n d m o n e t a r y a u t h o r it ie s th e m s e lv e s a n d ( 2 ) b y C o n g re s s a n d th e P r e s id e n t a n d th e g e n e r a l p u b lic . ” T h e a d v ic e , th e p e r s is te n c e , a n d th e e q u a lit y o f r a n k e n v is io n e d in th e s e s ta te m e n ts wro u ld n o t be a v a ila b le i f th e c e n t r a l b a n k w e r e a n o r d in a r y g o v e rn m e n t b u re a u . The Note Issue Function T h e f u n c t io n o f is s u in g b a n k n o te s is a lm o s t u n i v e r s a l w it h c e n t r a l b a n k s . I n m o s t c a s e s th e b a n k s h a v e h a d t h is p r iv ile g e f r o m th e b e g in n in g ; in d e e d , in m a n y in s ta n c e s th e p r im a r y p u r p o s e o f e s ta b lis h in g th e b a n k w a s t o p r o v id e a p a p e r m o n e y is s u e , a n d o fte n th e t e r m “ b a n k o f is s u e ” w a s u s e d s y n o n y m o u s ly w it h “ c e n t r a l b a n k . ” O n e s c h o la r h a s s ta te d t h a t “ T h e p r im a r y d e f in it io n o f c e n tr a l b a n k in g is a b a n k in g s y s te m in w h ic h a s in g le b a n k h a s e it h e r a c o m p le te o r a r e s id u a r y m o n o p o ly o f th e n o te is s u e .” T h e im p o r t a n c e o f th e n o te is s u e f u n c t io n h a s v a r ie d g r e a t ly o v e r t im e a n d a m o n g c o u n tr ie s . I t is a m a jo r f u n c t io n o f v ir t u a l ly a ll c e n tr a l b a n k s s in c e t h e ir n o te s m a k e u p a v e r y la r g e p a r t o f th e c ir c u la t in g c u r r e n c y . I t is th e d o m in a n t f u n c t io n in th o s e c o u n tr ie s w h e r e th e n o te is s u e is th e d y n a m ic o r d e t e r m in in g e le m e n t in th e t o t a l m o n e y s u p p ly . I n th e m o r e a d v a n c e d c o u n tr ie s o f th e W e s t e r n W o r ld , h o w e v e r , d e m a n d d e p o s its m a k e u p th e b u lk o f th e m o n e y s u p p ly a n d a re th e m e d iu m t h r o u g h w h ic h m o s t c h a n g e s in t h a t s u p p ly a re b r o u g h t a b o u t. T h e n o te is s u e f u n c t io n is c o r r e s p o n d in g ly le s s im p o r t a n t in s u c h c o u n tr ie s . D e v e lo p m e n t o f B a n k N o te s T h e m o d e rn b a n k n o te h a d its b e g in n in g in th e s e v e n te e n th c e n t u r y a t a b o u t th e s a m e t im e th e e a r lie s t c e n tr a l b a n k s w e re b e in g e s ta b lis h e d . I n th e m o r e d e n s e ly p o p u la te d a n d e c o n o m ic a lly a d v a n c e d c o u n tr ie s , u s e o f th e n o te s s p re a d r a p id ly b e c a u s e p a p e r o ffe r e d o b v io u s a d v a n ta g e s o v e r th e h e a v y a n d b u lk y c o in s o f th e d a y . A n d , o f c o u rs e , b a n k s p r o m o te d th e t r e n d s in c e a s s e ts a c q u ir e d b y th e is s u e o f n o te s w e re th e m a jo r s o u rc e o f t h e ir p r o fit s . E a r ly b a n k n o te s o fte n r a n in t o c o m p e t it io n f r o m a n o th e r f o r m o f p a p e r m o n e y — t r e a s u r y n o te s is s u e d b y g o v e r n m e n ts . S u c h g o v e r n m e n t is s u e s p r o v e d to b e a c o n v e n ie n t s u b s titu te f o r t a x a t io n a n d w e re u s u a lly m a d e b y g o v e r n m e n ts in p r e s s in g n e e d o f fu n d s . T h e s iz e o f th e is s u e s b o r e n o r e la tio n s h ip t o th e e c o n o m y ’s m o n e t a r y r e q u ir e m e n ts , b u t r a t h e r d e p e n d e d o n th e s iz e o f th e is s u in g g o v e r n m e n t s ’ d e fic its . M o n e t a r y s tu d e n ts s o o n n o te d t w o im p o r t a n t d is a d v a n ta g e s o f s u c h m o n e y . F ir s t , th e is s u e s s e ld o m re d u c e d th e g o v e r n m e n t s ’ d e fic its . In s te a d , b y d r iv in g u p th e p r ic e s o f th e th in g s th e g o v e r n m e n ts b o u g h t th e y te n d e d t o p e r p e tu a te th e d e fic its , th e r e b y r e q u ir in g f u r t h e r is s u e s , w h ic h f r e q u e n t ly le d t o a n in f la t io n a r y s p ir a l. S e c o n d , s u c h is s u e s w 'e re n o t “ e la s t ic ;” t h a t is , th e y c o n ta in e d n o fe a tu r e s w h ic h c a u s e d th e m to e x p a n d w h e n th e m o n e t a r y n e e d s o f th e e c o n o m y ro s e o r t o c o n t r a c t w 'h e n th o s e n e e d s d e c lin e d . O n th e c o n t r a r y , u n d e r a p r o p e r ly r e g u la te d s y s te m , b a n k n o te s w e r e p a id o u t o n ly w h e n th e r e w a s a d e m a n d f o r t h e m — w h e n th e e c o n o m y r e q u ir e d m o r e m o n e y . I f r e q u ir e m e n ts d e c lin e d , th e n o te s w e re b r o u g h t b a c k to th e is s u in g b a n k f o r r e d e m p tio n o r f o r u s e in r e p a y in g b a n k lo a n s . I n e it h e r ca se th e n o te s w e r e r e t ir e d f r o m c ir c u la t io n f o r th e t im e b e in g . O v e r th e y e a r s re p e a te d in s ta n c e s o f in f la t io n c a u s e d a lo s s o f c o n fid e n c e in t r e a s u r y - is s u e d p a p e r m o n e y a n d a r e a liz a t io n t h a t a w e ll- r e g u la t e d s y s te m o f b a n k n o te is s u e p r o v id e d a s u p e r io r m o n e t a r y a r 7 e s p e c ia lly i f th e r e is le s s t h a n c o m p le te c o n fid e n c e in th e b a n k in g s y s te m . F in a lly , as th e t h e o r y a n d p r a c tic e o f c e n tr a l b a n k in g d e v e lo p e d a n o th e r p r o b le m e m e r g e d . T h e a b ilit y o f a c e n tr a l b a n k to c o n t r o l th e t o t a l m o n e y s u p p ly ( in c lu d in g d e m a n d d e p o s its ) d e p e n d s in p a r t o n th e s u p p ly o f c o in a n d c u r r e n c y , w h ic h in c lu d e s n o te is s u e s . W h e n a la r g e p a r t o f th e c u r r e n c y s u p p ly is m a d e u p o f c o m m e r c ia l b a n k n o te s , t h a t s u p p ly is s u b je c t t o e r r a t ic a n d u n p r e d ic ta b le f lu c tu a tio n d e p e n d in g o n a c tio n s ta k e n b y th e b a n k s a n d w h im s o f th e p u b lic r e s u lt in g f r o m c h a n g e s in c o n fid e n c e o r o th e r fa c to r s . T h u s , th e u s e o f c o m m e r c ia l b a n k n o te s c o m p lic a te d th e p r in c ip a l ta s k o f c e n t r a l b a n k s . r a n g e m e n t. S lo w ly a n d in v a r io u s w a y s s y s te m s o f b a n k n o te is s u e s c a m e to re p la c e , a t le a s t in la rg e p a r t, t r e a s u r y p a p e r is s u e s . D e f e c t s o f C o m m e r c ia l B a n k N o t e s T h e a r r a n g e m e n ts u n d e r w h ic h b a n k s c a m e to is s u e n o te s d e v e lo p e d d if f e r e n t ly in d if fe r e n t c o u n tr ie s . I n s o m e th e r e w a s n o c e n tr a l b a n k f o r a lo n g tim e a n d n o te s w e re is s u e d s o le ly b y c o m m e r c ia l b a n k s . W h e r e c e n tr a l b a n k s h a d b e e n e s ta b lis h e d , th e y u s u a lly h a d n o m o n o p o ly o f th e n o te is s u e b u t r a t h e r is s u e d n o te s w h ic h c o m p e te d w it h th o s e o f c o m m e r c ia l banks. M a n y d if fic u lt ie s a n d p ro b le m s d e v e lo p e d w it h n o te is s u e s b y c o m m e r c ia l b a n k s . W i t h o u t a d e q u a te r e g u la t io n , s o m e b a n k s a b u s e d th e is s u e p r iv ile g e , o v e r is s u e d n o te s , a n d fa ile d . E v e n w h e n th e n o te s w e re re d e e m a b le a t p a r b y th e is s u in g b a n k , th e y s o m e tim e s f e ll t o a s ig n ific a n t d is c o u n t a t d is t a n t p o in ts i f th e r e w e re n o a rr a n g e m e n ts f o r r e d e m p tio n a t c o n v e n ie n t lo c a tio n s . T h is w a s q u ite im p o r t a n t in la r g e c o u n tr ie s , e s p e c ia lly th o s e w it h in a d e q u a te c o m m u n ic a t io n a n d t r a n s p o r t a t io n fa c ilitie s , b e c a u s e it r e s u lte d in v a r y in g v a lu e s f o r d if fe r e n t c o m p o n e n ts o f th e m o n e y s u p p ly . F u r t h e r , th e n o te s fr e q u e n t ly w e re n o t u n if o r m a s to s iz e , s h a p e , c o lo r , o r q u a lit y o f p r in t i n g o r e n g r a v in g . T h e s e d iffe re n c e s o fte n e n c o u r a g e d c o u n t e r f e it in g w h ic h s o m e tim e s b e c a m e a m a jo r p r o b le m . M o r e o v e r , s y s te m s o f c o m m e r c ia l b a n k n o te is s u e s f a ile d to p r o v id e f o r “ e m e rg e n c y e l a s t i c i t y t h a t is , a r r a n g e m e n ts f o r s u s p e n d in g f o r s h o r t p e r io d s o f tim e th e n o r m a l r e g u la t io n g o v e r n in g n o te is s u e s to a llo w la r g e r a m o u n ts to b e is s u e d t o m e e t p u b lic d e m a n d s c a u s e d b y p a n ic s o r o th e r a b n o r m a l s itu a tio n s . L o n g a n d p a in f u l e x p e rie n c e h a s s h o w n th a t s u c h a r r a n g e m e n ts a re e s s e n tia l, 8 W h y A C e n t r a l B a n k M o n o p o ly T h e d is a d v a n ta g e s d e s c rib e d a b o v e c a n , in la r g e m e a s u re , be o v e rc o m e b y g iv in g th e c e n t r a l b a n k a m o n o p o ly o f th e n o te is s u e . T h e c e n t r a l b a n k w i l l n o t f a il, so n o te h o ld e r s w i l l n o t lo s e f o r t h a t re a s o n . I n a d d i tio n , th e n o te s a re u s u a lly m a d e le g a l te n d e r a n d g u a ra n te e d b y th e n a t io n a l g o v e r n m e n t . T h e b e s t fa c ilit ie s a n d w o r k m a n s h ip a v a ila b le a re u s e d in p r in t i n g a n d e n g r a v in g th e n o te s s o t h a t c o u n t e r f e it in g is d is c o u ra g e d . I f r e d e m p t io n is p e r m it te d a n d is s ig n ific a n t, r e d e m p t io n p o in t s a re e s ta b lis h e d a t v a r io u s p la c e s so t h a t th e n o te s d o n o t g o t o a d is c o u n t b e c a u s e o f d is ta n c e . E m e r g e n c y e la s t ic ity is p r o v id e d b e c a u s e th e c e n tr a l b a n k c a n s a fe ly b e e n tr u s te d w it h th e p o w e r to s u s p e n d n o r m a l r e g u la tio n s f o r lim it e d p e r io d s o f tim e . T h e p o w e r t o c o n t r o l th e n o te is s u e , e v e n t h o u g h in c o m p le te , s im p lif ie s th e c e n tr a l b a n k ’s ta s k o f c o n t r o llin g th e w h o le m o n e y s u p p ly . F in a lly , s in c e th e n o te is s u e is th e s o u rc e o f la rg e p r o fit s , w h ic h c o m e f r o m th e e x e r c is e o f o n e o f th e s o v e re ig n p o w e r s o f g o v e r n m e n t , i t is g e n e r a lly b e lie v e d t h a t i t s h o u ld b e c o n c e n tr a te d in o n e o r g a n i z a tio n n o t o p e ra te d f o r p r o f it a n d c lo s e ly s u p e rv is e d b y th e g o v e r n m e n t so t h a t th e b u lk o f th e p r o f it s ca n m o r e e a s ily b e re c o u p e d b y th e g o v e r n m e n t. The desirability of concentrating the note issue in the central bank came to be realized slowly, mostly during the nineteenth century. But accomplishing that step was not an easy matter. The commercial banks wanted very much to retain the right to issue notes, both because of the profit it conferred and be cause of the prestige it carried. The process of transferring the note issue power was long and in volved. One method w to deny the note issue to ras new commercial banks and allow the central bank to assume any issue powers possessed by banks which went out of existence. In the United States commercial banks issued notes until 1935. The First and Second Banks of the United States, which functioned to some extent as central banks, T issued notes along with state-chartered banks. From the end of the Second United States Bank (1836) until the Civil W ar, state bank notes were the only paper money in the country. While some states devised safe and sound systems of note issue, many states were lax in their regulation and many banks T abused the note issue privilege, causing losses to the public. In 1863 the National Banking System was estab lished, providing for a safe and uniform bank note issue under Federal supervision and secured by the pledge of certain United States Government bonds which had the “circulation privilege.” A Federal tax on state bank notes first levied in 1865 soon drove them out of existence, leaving the note issue solely to national banks. The only other form of paper money then in circulation was the United States note ( “Greenback” ), but the gold certificate and silver certificate were added a little later. National bank notes represented a great improve ment in that they were uniform and safe. They were greatly lacking, however, in elasticity, both ordinary and emergency. This, along with other defects in the system, was primarily responsible for the re curring money panics which scourged the country from 1870 until 1907. Those panics did much to stimulate the reform movement which culminated in the establishment of the Federal Reserve System in The United States Experience 1913. Federal Reserve Banks issued notes from the be ginning, and it was expected that those notes would soon displace national bank notes. Provisions w^ere made whereby national banks could retire their notes easily without loss, but they were not required to do so and few did. In fact, in 1932, when the Reserve Federal Reserve notes being readied for shipment to Fifth District banks Banks were experiencing difficulty in meeting the great demand for currency caused by widespread bank failures, national banks w^ere allowed to in crease their note issue substantially for a short time. Only a few banks took advantage of the law and the increase in notes was modest. Shortly afterward the regulations governing the issue of Federal Re serve notes were liberalized so that Reserve Banks could meet the currency need. In 1935 all United States bonds with the “circulation privilege” were retired and national banks ceased issuing notes. Since then the notes have been gradually retired and now Federal Reserve Banks have a monopoly of the issue of bank notes. In the past the most important features of a system of bank note issue were provisions setting the maximum amount that could be issued, insuring the security or value of the notes, and giving elasticity to the issue. Where notes constitute the largest and most dynamic part of Regulation and Collateral 9 amount of notes outstanding is left to the discretion of the central bank or, more likely, to the automatic operation of the banking system as explained below. This situation prevails in many countries of the world today. Redeemability Provisions Most bank notes are now issued by central banks, and there are few problems in insuring their security since a government cannot allow its central bank to fail or to default on its obligations. In fact, in most countries it might be said that there can be no prob lem of security or redemption since no meaningful redemption is allowed and the central bank note is in practice the ultimate form of money. Usually various forms of collateral are pledged to secure the notes. If no specific assets are so pledged, note holders have a claim against the general assets of the bank and may have a preferred status, ahead of depositors. Further, the security of central bank notes (in terms of the country’s monetary unit) is further assured by the fact that they are usually made legal tender and are guaranteed by the national gov ernment. Where necessary, the maintenance of the notes at a uniform value throughout the country is assured by the establishment of a number of redemp tion centers. Security and the money supply, those provisions are still of major importance. Also, in countries which maintain any form of the gold standard it is generally considered necessary to require some reserve against notes in the form of gold or gold certificates, or, in many countries, foreign exchange assets. Methods of Limiting Volume Various methods or devices, together with modifications and combina tions of them, are employed to limit the maximum amount of notes which may be issued. In many gold-standard countries it is customary to require a minimum reserve in gold or gold certifi cates. The remaining collateral may be in the form of discounted paper, government bonds, or general assets of the bank. The gold reserve requirement thus sets a limit to the total amount of notes which may be issued. Another method, long used in England, is to pro vide for a limited “fiduciary” issue of notes secured by government bonds and to require that all notes beyond that be fully backed by gold. That system was quite inelastic and is not used anywhere today. Still another method is to require that the notes be secured by certain specific issues of government bonds which are limited in amount. This method was used in part to limit the volume of national bank notes in this country. A widely used method of control is for the govern ment to prescribe a maximum amount of notes which may be outstanding. The government, of course, is free to raise or lower that maximum from time to time as it sees fit. Finally, reserve and collateral requirements may be abolished or indefinitely suspended, leaving the notes subject to the same regulation as the deposits or other liabilities of the bank. This means that the 10 The Federal Reserve note was designed to add “automatic elasticity” to the uniformity and safety which had characterized the national bank note. This was to be accomplished by requiring “eligible paper” as the principal form of collateral. Eligible paper represents primarily short-term business loans which commercial banks make to their customers. The theory was that com mercial banks would make more such loans when there was need for more money and would, in turn, rediscount more of the paper with Federal Reserve Hanks, which would then have the necessary col lateral to enable them to issue more Federal Reserve notes. When the need for money declined the re verse would happen. Originally, there was a reserve requirement of 40cc in gold plus a collateral requirement of 100c/c / in the form of eligible paper. This was soon changed, however, to a minimum of 407c in gold and the re mainder in eligible paper, which permitted combina tions of collateral including 60%, 80c /c, or even 100% in gold. Also, changes were made which allowed collateral other than eligible paper to be pledged, but until 1932 United States obligations could not be so used. The Federal Reserve Note W ith the onset of the Great Depression after 1929, commercial banks held less and less eligible paper, and the amount of such paper held by Reserve Banks declined. A t the same time, widespread bank failures caused depositors to convert more and more of their deposits into currency. W hen the Reserve Banks bought United States obligations in the open market in an effort to ease credit, the rediscounting of eligible paper declined further. The Reserve Banks had plenty of gold, and the ratio of gold to notes outstand ing rose to a very high level. A severe crisis de veloped, however, when substantial amounts of gold left the country after England suspended the gold standard in 1931. The demand for currency con tinued to grow and the Reserve Banks had difficulty meeting it, not because of a shortage of gold but be cause of a deficiency of other collateral, since their chief earning asset— United States obligations— could not be pledged as collateral for the notes. To relieve this situation Congress first permitted a temporary increase in national bank notes as indi cated above. W hen this proved ineffective, the Re serve Banks were permitted, in 1932, to pledge United States obligations as collateral. During most of the period since that time, Government obligations have constituted the principal collateral for notes. In this way the original theory of automatic elas ticity in the note issue was tested, found wanting, and abandoned. Automatic elasticity is now pro vided in another way. Automatic Elasticity Today It is axiomatic to day that provisions must be made to allow holders of demand deposits to convert those deposits into cur rency in any amounts they wish. It could not prop erly be otherwise. If depositors feared that they might not be able to convert, large numbers of them would immediately demand conversion. If the cur rency were not available, there would be a panic and the financial system would be paralyzed. Today most central banks are in a position to meet any probable demand for currency, either because there is no limit on the note issue or because the banks have the authority to suspend any such limit temporarily. If neither of those situations exists, it is quite likely that, in an emergency, the national government would act quickly to enact the necessary legislation. In general, it is safe to have such arrangements because, in the more advanced countries of the world, demand deposits are the dominant form of money and the demand for currency is closely related to and derived from those deposits. Given proper regula tion and control of demand deposits, the amount of bank notes in circulation can safely be allowed to find its ow'n level without elaborate regulation as to limits and collateral. O n the contrary, it is not feasible, in a modern economy, to regulate the total money supply by strict regulation of the note issue. During W orld W ar II the gold certificate reserve requirement was reduced from 40% to 25%. At present the reserve held behind nearly $30 billion of Federal Reserve notes is composed of approximately $8 billion of gold certificates and over $23 billion of United States obligations. COMPOSITION OF THE UNITED STATES PAPER MONEY SUPPLY $0.2 Bil. $2.3 Bil. $4.0 Bil. $29.9 Bil. State Bank Notes □ United States Notes □ Silver Certificates □ N a tio n a l Bank Notes G o ld Certificates | 1860 1910 Note: Am ounts less than 1% are not shown. 1925 1 Federal Reserve Notes 1961 D ata are for m idyear. 11 COLLATERAL FOR FEDERAL RESERVE NOTES Gold and Gold Cert. | 1 Eligible Paper □ L —J u. S. Govt. Se< Securities (Billions of Dollars at Year End) 2.7 1916 1920 1928 1931 31.3 3.0 1940 1961 Note: Amounts less than }% are not shown. As one authority has expressed it, . . the law was clutching at a slippery eel when it sought to apply a rule of thumb to the monetary situation by regulat ing the issue of bank notes alone.” Effects of A Large Increase In Notes To some it might appear that indefinite or nonexistent limitations on bank notes could be inflationary by permitting a large increase in their issue. Is this a real danger? On the contrary, it is probable that under present conditions a large increase in central bank notes would be deflationary for two primary reasons. First, the notes can be obtained only by surrendering demand deposits, thus exchanging one form of money for another and leaving the total money supply unchanged at the moment. The rea son for such a conversion presumably would be some uncertainty or lack of confidence causing the depositor to want to have in his possession the ultimate means of payment. He would not want currency for the purpose of making an immediate payment or pur chase ; he could do that with a check. In short, he would want the notes so that he could hoard them, which would be deflationary. Second, a sharp increase in notes would greatly reduce bank reserves. Suppose notes increased by $3 billion. Commercial banks would have to obtain them by drawing down their reserves at the central banks by approximately that same amount. The re quired reserves of the commercial bank would also 12 be reduced but by only about one-sixth as much. This would leave a large reserve deficiency which could be eliminated only by the central bank creat ing new reserves through open market purchases or rediscounting or by the commercial banks reducing their deposits by several times the amount of the in crease in notes. The latter would be very deflation ary, and the former would happen only if the central bank considered it sound policy. Summary Bank notes usually make up a large majority of all paper money. Central banks cus tomarily have a monopoly of the note issue privilege, although there are numerous but usually minor ex ceptions to this generalization. Bank notes are im portant but they are not the dominant and dynamic form of money they once were, having been displaced in this respect by demand deposits. In the Western World the demand for notes is normally derived from and dependent on the volume of demand de posits ; if the deposits are properly regulated, the volume of bank notes can safely be allowed to find its own level. Where any effective connection with the gold standard remains, a country must maintain gold, gold certificate, or “key currency” reserves against both the deposits and the notes of the central bank. Otherwise, however, the tendency is to give central banks wide discretion in the issuing of notes and to abolish or suspend regulations fixing limits or requiring specified forms of collateral. The Collection Function In addition to their principal task of formulating and administering monetary policy, central banks perform a number of service functions for their na tional governments, for commercial banks, and for the financial community generally. The nature and scope of central bank service func tions vary greatly from country to country, making it difficult to generalize about them. For that rea son and also because information is more readily available about the work of the Federal Reserve Sys tem, the discussion below gives more than usual emphasis to the service functions as they are per formed in the United States. Demand deposits in banks make up the bulk of the money supply in the larger countries of the Western World. Those deposits function as a means of payment or medium of exchange only when they are transferred, usually by checks written against them. Billions upon billions of checks are written every year and circulate widely. The task of the banking system is to develop a system or mechanism in which each check can quickly and economically be returned to the bank on which it is drawn and in which that bank can easily, quickly, and safely make T payment to the bank presenting the check. Unless there is such a system, the delays and costs involved will impede the free use of deposit money and cause it to circulate at varying discounts in different parts of the country. While the collection of checks is not an essential central bank function and has relatively little sig nificance for monetary policy, it is in some countries an important service which a central bank can per form for the public. The importance depends upon the banking structure, the geographical area of the country, and the extent to which checks are used in making payments. A Good Collection System A good system of check collection has several characteristics. It in cludes, so far as possible, all the banks in a country. If it does not, there must be duplicate systems, en tailing unnecessary shipments of checks and currency and the accompanying delays and costs. The bank ing system of the United States afforded outstanding examples of such disadvantages before 1913. Second, the system provides for the quickest and cheapest possible methods of collection. This requires the best utilization of all available forms of transporta tion and communication. Finally, the system affords a convenient, economical, and safe method whereby banks can “clear” or settle balances among them selves. In the absence of such an arrangement it may be necessary to ship large amounts of currency between different cities and regions. The Central Bank and Collections The central bank has facilities which greatly simplify the collec tion process when the banking system is composed of many banks spread over a large area. The central bank usually has a wide network of branches or other representatives reaching all parts of the country. It also has contacts with most or all banks for other reasons. Finally, it holds the reserves of most banks and thus is in a position to settle balances by the mere process of debiting and crediting accounts. Some of the 3.7 billion checks which were collected through the Federal Reserve Banks in 1961 These machines help move billions of checks annually through Federal Reserve Banks for collection These facilities are of comparatively little impor tance in a country with a very small number of banks, each of which has a nationwide system of branches (e.g., Canada), especially if it is small in area (e.g., England). In the United States, however, condi tions are quite different. Here there are thousands of independent unit banks spread over a large area with no nationwide branch banking systems. Further, the use of checks has been highly developed, giving rise to a tremendous volume of checks. It would be impossible for our present banking system to operate with anything approaching its present speed and efficiency without one basic clearing and collection system, an arrangement which could hardly be operated by any organization other than the Federal Reserve System. The Federal Reserve Collection System Limited space prevents any detailed description of the elab orate collection and clearing system which has been developed in this country. Locally, banks exchange checks drawn against each other either directly or at a local clearing house. Federal Reserve Banks often function as clearing members of local clearing houses, and other members may settle balances by drawing on their accounts at the Reserve Bank. 14 When a bank receives a check drawn on an outof-town bank, the usual procedure is to send it to the Federal Reserve Bank or branch. If the drawee bank is in the same Federal Reserve district, the Re serve Bank can make payment by adjusting the ac counts of the two banks. If the check is drawn on a bank in another Federal Reserve district, the local Reserve Bank sends it to the Reserve Bank of that district, which transmits it to the drawee bank. Each Reserve Bank makes the proper adjustment on the accounts of the bank affected. This process gives rise to balances owing from one Reserve Bank to another. Such balances are settled without the ship ment of currency by adjustments on the books of the Interdistrict Settlement Fund— a clearing house for Federal Reserve Banks operated by the Board of Governors. The assets of the Fund consist of gold certificates deposited by the 12 Reserve Banks. Pay ments among the Banks merely change the equity of the different Banks in the Fund. This feature is especially important in avoiding large interregional flows of currency which once were a major feature of the clearing system in this country. The accompanying chart shows that over the past ten years the number of checks (including noncash items) collected annually through Federal Reserve Banks increased by approximately 59c from 2.3 bil /c, lion to 3.7 billion. The dollar amounts represented by these checks rose about 48 c /c, from a little over $800 billion to $1.2 trillion, indicating a small decline in the average size of checks collected. The W ire Transfer System In addition to col lecting checks and settling balances between banks, the Federal Reserve System operates a system for making telegraphic transfers of funds from one part of the country to another. Transfers are made for member banks in multiples of $1,000 without charge; transfers of odd amounts and for the accounts of others are made at a small charge. This service is a great convenience to the financial world, and its use has been increasing rapidly. Between 1952 and 1961 the annual number of transfers approximately doubled, and the amounts involved rose from less than $800 billion to $2.7 trillion. On an average business day more than $5 billion of transfers and payments are made through the Interdistrict Settlement Fund. Over the years the Federal Reserve System, in cooperation with the commercial banks, has greatly increased the efficiency and reduced the cost of col lecting checks and transferring funds. By increas ing the scope of the check collection system it has lowered unit costs and reduced the balances which had to be settled. Through its wire transfer system it makes possible almost instantaneous transfers of funds to any part of the country in any amount, free or at a very small cost. The Interdistrict Settle ment Fund makes it possible to settle regional bal ances through bookkeeping transfers and minimizes the movements of currency among Federal Reserve districts. W ithin districts, Federal Reserve Banks pay the cost of shipping currency and coin to and from member banks. In all of these ways the Sys tem facilitates the free movement of money wT ithin and among regions and helps maintain money at a uniform value throughout the country. The collection process requires the efforts of ap proximately one-third of the employees of the 12 Reserve Banks— the largest fraction engaged in any System function. If to this are added those employees engaged in the closely related work of handling cur rency and coin, the figure is raised to over two-fifths. Par and Nonpar Banks The Reserve System col lects only those checks drawn on par banks; that is, those banks which remit the full amount of checks drawn on them and presented by mail. Banks which deduct an exchange fee or charge are known as non par banks. A ll member banks must remit at par, and most nonmember banks do so voluntarily; there fore, checks drawn on them are permitted to clear through Reserve Banks. Checks on nonpar banks must be collected outside the Federal Reserve Sys tem through correspondent banks. For years the Federal Reserve System has en couraged all banks to clear at par. The policy is slowly succeeding, as evidenced by a drop in the num ber of nonpar banks from 2,629, or 18% of all banks, in 1939, to 1,636, or 12 c c, at the end of 1961. In 34 / states all banks are on the par list. Nonpar banks are heavily concentrated in the upj>er mid western and southeastern states. In general, they are small banks and checks on them account for only a very small proportion of all checks written. Nevertheless, exchange charges on these checks still amount to several millions of dollars every year. Federal Reserve Float W hen a central bank operates a clearing system, float may affect its ad ministration of monetary policy. W hen a Reserve Bank receives a check for collection, for example, it gives the sending bank either immediate or deferred credit, depending generally on the assumed time re quired to present the check to the drawee bank. In this country, deferred credit is granted according to a time schedule, with a maximum of two business days. On the average, it takes a little longer to col lect the checks than the time schedule allows, and thus the sending bank receives credit before the drawee bank is charged. Thus, the sending bank, in effect, receives a loan or advance for a day or two on some fraction of the checks it sends to a Reserve Bank for collection. The amount of this advance credit is known as Federal Reserve float. It is credit ex tended by the Reserve Bank and is added to member bank reserves, which affects the capacity of the bank ing system to expand earning assets. The amount of Federal Reserve float usually varies between $1 billion and $2 billion and is affected bv such things as the number and amount of checks written, the interregional movements of goods and services, and, especially, the speed and efficiency of the transportation system. It rises regularly with seasonal increases in business and may shoot up sharply when a strike or a severe storm interrupts transportation. In the latter case the central bank may find that bank reserves are increased overnight by several hundred million dollars, making it nec essary to move quickly to prevent an overabundance of reserves. Conversely, it may have to act as quick ly in the opposite direction to prevent a crippling stringency of reserves when transportation difficulties are removed. 15 I Fiscal Agency Function Like business corporations and individuals, gov ernments need banking services. Modern govern ments engage in a tremendous volume of financial transactions. These require many varied banking services, often far exceeding those needed by private economic units. Usually only central banks, with their great size, countrywide facilities, numerous contacts with the financial world, expert techniques, large research staffs, and accumulated experience, can adequately provide such services. While most of these services are routine, some are closely related to monetary policy. The relationship becomes closer as the volume of government transactions increases and as fiscal and monetary policy are more closely integrated. Further, the relationship between gov ernment funds and bank reserves is very close, mak ing it necessary for the central bank to keep closely in touch with both in order to manage monetary policy. In addition to providing routine banking services, the central bank usually acts as agent for the national government in many fields and is usually the gov ernment’s top adviser on financial affairs and policies. Deposit Services The most obvious and the most usual service performed under the fiscal agency func tion is the receiving, holding, and paying out of gov ernment funds. This means that the central bank accepts deposits, receives and collects checks payable to the government, holds and transfers funds, and charges government checks and bond coupons against the treasury account. The wire transfer service of the Federal Reserve System described earlier greatly facilitates the movement of Treasury funds to the points where they are needed. Tn the United States, as the accompanying chart shows, the number of items paid by the Federal Re serve Banks for the Government, including Govern ment checks, postal money orders, and bond coupons, increased from 697 million in 1958 to 706 million in 1961. Their value rose from $109 billion to $125 billion. Data for earlier years are not available on a comparable basis. W h ile Re serve Banks hold virtually all the Government’s checking account and do most of the work in trans ferring funds and other similar services, they by no means hold all United States Government deposits. In fact, they usually hold a small minority of such Treasury Tax and Loan Accounts 16 deposits. The reason is quite simple. The United States Government frequently has very large receipts concentrated in a few days such as on tax payment dates or on payment dates for a large issue of bonds sold for cash. If all such amounts w ere paid directly T into the Federal Reserve Banks, they would dras tically reduce member bank reserve accounts and create an acute shortage of reserves. Conversely, as those balances wr ere paid out through Government disbursements, they would soon build up an em barrassing surplus of bank reserves. To avoid such a tremendous ebb and flow of bank reserves, the Treasury tries to keep from $500 mil lion to $1 billion in its accounts at Reserve Banks and holds the remainder of its balances in Treasury Tax and Loan Accounts at commercial banks. A large majority of all commercial banks— over 11,000 of them— hold such accounts, secured by the pledge of proper collateral. From these “T T and L ac counts” funds are transferred to the Reserve Banks periodically in relatively small amounts so as to avoid large changes in bank reserves. The small reduc tions in bank reserves caused by these “calls” are largely offset by the regular Government disburse ments from Reserve Banks. Occasionally, if the Treasury accounts at the Reserve Banks become larger than desired, funds are transferred back to the T T and L accounts. GOVERNMENT CHECKS, MONEY ORDERS, AND BOND COUPONS COLLECTED BY FEDERAL RESERVE BANKS Millions of Pieces 1958 1961 $ Billion W ire transfer speeds the exchange of Government securities thus reducing the cost of transactions and creating a national market One of the routine duties of the Reserve Banks as fiscal agents is to maintain a check to see that ade quate collateral is pledged to secure the many T T and L accounts in commercial banks and to take steps to bring it up if it is inadequate. Servicing the Public Debt National governments usually have large debts, and the task of servicing and refunding them is a huge one. National treas uries could do this clerical work, but usually it is more efficient to let the central bank do it. The authority and the influence of central banks in shaping debt management policy vary from coun try to country, but apparently no bank has full power to manage the debt. The Bank of Canada and the Bank of England each has somewhat more extensive powers along this line than does the Federal Reserve System, but each is still subject to the final decision of the government of the day. Usually, however, the central bank, as the chief financial adviser of the government, is consulted when the terms of any important new issue of securities are being determined. Once those terms have been set and the issue announced, the central bank usually takes over and does most of the work from that point. Typically, the central bank disseminates information, receives subscriptions, notifies subscribers of allot ments, issues the securities, and receives payment into the government account. It is also usual for the bank to make denominational exchanges of se curities and to pay maturing interest coupons. When the securities mature or are called, the bank usually redeems them in cash or exchanges them for new ones if a refunding is made. The extent of this work in the United States is indicated by the fact that in issuing, redeeming, and exchanging securities, the 12 Reserve Banks in 1952 handled 163 million pieces with a value of $355 billion. By 1961 the number of pieces had risen to 192 million and their value to $560 billion. W ire Transfer of Securities A special service of the Reserve System is the transfer of Government securities by wire. Without this service, the sale of securities between distant points would involve some delay, risk, and considerable expense. But now each Reserve Bank and branch maintains a stock of unissued securities. If a security dealer in New 17 York sells a million dollar Treasury bill to a buyer in Richmond, the dealer can deliver the bill to the New York Reserve Bank, which “retires” the bill and wires the Richmond Reserve Bank to issue a new one of the same denomination to the buyer when he pays for it. Such a transaction could be completed within an hour. This service affords substantial savings of time and money and thus greatly facilitates the opera tion of the Government securities market and assures the Treasury of an effective national market for its securities. Loans to Government A major banking func tion is the granting of loans to customers. As part of the fiscal agency function, central banks make loans to their governments. Often governments have legitimate need for short-term advances which only central banks may be able to meet. On the other hand, the most common abuse of central banks and the usual source of any major inflation is overbor rowing by governments from central banks. To control such borrowing, provisions have at times been inserted into central bank charters limiting direct advances to governments. The great weakness of such method of limitation is that it may be changed or eliminated at the will of the borrower. If there is a well-developed money market and if treasury operations are properly organized, govern ments can usually accomplish the necessary borrow ing without resort to the central bank. It is neces sary and proper, however, to have such borrowing available in case of need. In the United States, the 12 Reserve Banks as a group may not hold at any one time more than $5 billion of United States se curities purchased directly from the Treasury. Such securities have been held on only two days since March 1954 and then for only small amounts. Central banks may and do, through open market operations, affect the terms on which governments borrow and can, in effect, make indirect loans to them. Such operations constitute the most impor tant tool used in the administration of monetary policy and cannot feasibly be limited or restricted to prevent their abuse in government borrowing. In any event, it should be recognized that in time of war or other major emergency any central bank will often have to provide special facilities for government bor rowing, over and beyond what might be justified bv sound monetary policy. Other Services In addition to the above, central banks perform many other fiscal agency functions for governments and governmental agencies. These in 18 clude such activities as the acquisition and manage ment of foreign exchange needed for expenditures abroad, operations in the foreign exchange market for stabilization funds or the complete management of such funds, the purchase and sale of securities for government trust funds, and the safekeeping of se curities and earmarked gold. In the United States, two examples of routine Federal Reserve activities along these lines are the verification and destruction of currency for the Treasury Department and, more recently, the retirement and destruction of food stamps for the Department of Agriculture. In addi tion, the Reserve Banks devote much effort to facili tating and servicing the Savings Bond Program. Somewhat more specialized is the activity in guar anteeing V-loans. During World W ar II and on a much reduced scale since then, the Reserve Banks have acted as fiscal agent for several departments and agencies of the Federal Government in guaran teeing loans made by commercial banks and other private financing institutions to industrial firms which have the capacity to produce goods important to national defense but which are in a financial condi tion which does not permit them to borrow on satis factory terms. As an example of another specialized service, the Federal Reserve Bank of Richmond acts as fiscal agent for the Housing and Home Finance Agency of the Federal Government. When the Agency makes a loan, the Richmond Bank receives the bonds given by the borrower and maintains a record of them. As interest coupons or the securities themselves mature, the Bank collects the funds and deposits them to the Agency s account. When loans are made in another Federal Reserve district, the Reserve Bank of that district acts as subagent of the Richmond Bank, re ceiving and holding the bonds, making collections, and reporting transactions to the Richmond Bank. In terms of manpower, the fiscal agency function is one of the major functions of the Reserve Banks, accounting for the work of more than 2,000 em ployees, or about 11% of total employment. For most of this work the Banks are reimbursed by the Treasury and other agencies, the total reimburse ment in 1961 amounting to nearly $20 million. In addition to salaries, reimbursement covers rent of space and equipment, printing, postage, telephone and telegraph charges, and numerous other items. Under present conditions, however, reimbursement is merely an accounting transaction of little significance since it adds an approximately similar amount to the pavment which the Banks make to the Treasury as in terest on Federal Reserve notes. The Monetary Policy Function “Central banking is a subject that does not lend itself to precise definition and universal rules. Its goals. A brief but broader look at the rationale or strategy of monetary policy will afford some per essence is discretionary control of the banking system, spective which will be helpful in the more detailed but if we try to elaborate this we shall soon find our discussion which follows. selves at variance with what has been done or is being done by some central bank or other/' Thus Mr. R. S. Sayers, the eminent British economist, Goals Generally the goals of central banks are the same in all countries of the free world today. points out the central characteristics of central banks Briefly, they are to provide monetary and credit con and notes their changing, evolving techniques. ditions favorable to the realization o f : (1) a high Previous sections have described the characteristics level of employment; (2) relative stability in the of central banks and discussed their major service general price level: (3) economic growth; and (4) functions. stability of the country’s monetary unit in inter This section discusses the most essential function of central banks— that of formulating and national markets. administering monetary policy. discussion of these goals, and of the methods and In making and administering monetary policy, central banks aim at certain definite goals. A more complete explanation and techniques mentioned below, can be found in a Their number of publications such as The Federal R eserve methods and techniques vary because of institutional at W ork published by this Bank and The Federal differences among countries, but all policy actions R e s e n r S ystem : Purposes and Functions published are aimed at the realization of one or more of those by the Board of Governors. 19 To accomplish these allow the banking system to maintain a money supply, broad goals central banks use various methods and and the market to set interest rates, which will strike techniques which have been develoj>ed over the past a happy medium between the two situations described Methods and Techniques century, most of them during the last four decades. above. Of course, there are many other factors which The more important ones are explained and discussed affect prices, production, and economic growth, and below, but perhaps it should be noted here that nearly for that reason it is not possible to exercise any pre all of them exert their effects through the reserves cise control over economic activity by monetary of commercial banks. measures alone. In fact, a very large part of the work connected with monetary policy consists of Certain conditions are essential if a central bank creating, mobilizing, holding, and shifting reserves is to be effective in regulating money and credit. and setting reserve requirements. First, the central bank must have the necessary This is true be cause in modern banking systems the volume of bank statutory powers and financial resources. credit and the size of the money supply are closely substantially all important commercial banks must Second, dependent on the amount of bank reserves and, to a be subject to the central bank’s influence. Finally, lesser extent, on their distribution among banks willing and intelligent cooperation of the commercial which have different reserve requirements. banks will greatly facilitate the implementation of The manipulation of bank reserves and other mone central bank policy. It follows that a central bank tary policy actions are, of course, not ends in them has a more difficult problem where there are many selves. banks than where there are only a few. Indeed, no monetary action is ever an end The problem in itself, but rather the means to some more impor is still further accentuated if any substantial number tant economic purpose. What, then, is the relation of the banks are not subject to the direct influence ship between the methods used to administer mone of the central bank or will not cooperate fully with tary policy and the goals of that policy? its policies. This ques tion goes to the heart of monetary theory on which hundreds of volumes have been written. Here only a few sentences must suffice to summarize a very complex theory. A pyn M n t r P l c p l i g o e a y oi First, it is essential to note that money is not the driving force or the motive power which keeps the economy going. It is only the medium through which economic transactions are carried out. In the following sections various techniques of ad ministering or applying monetary policy are dis Or, to cussed, roughly in the order in which they developed. shift the analogy, it may be likened to the governor Here attention is focused not on the detailed and which regulates the speed of an engine by adjusting precise way in which these techniques exert their the flow of fuel to the engine to meet varying loads. effects but rather upon their broad and general char In the economy it is the demand for goods and acteristics and the ways in which they evolved. As services which provides the motive for economic ac noted above, most of these involve acting upon bank tivity— for production. But a shortage of money or reserves. For that reason it may be w ell to look briefly T very high interest rates may slow' production by de at bank reserves before the advent of central banks. laying the start of new projects, forcing the liquida tion of inventories, and other similar ways. Con versely, abnormally low interest rates and an over abundant money supply will cause inflation, encourage Bank Reserves Before Central Banks In the absence of a central bank, private commercial banks must make their own arrangements for obtaining funds needed to meet cash demands of depositors. speculation, and stimulate a rate of economic activity If a bank were completely independent and had no which cannot be sustained. Central banks endeavor connection with other banks, it would have to hold to provide an amount of bank reserves which will in its own vaults enough legal tender to meet the 20 largest probable cash withdrawals. If the demands banks. This may be ordinary or routine discounting should exceed that amount and if the bank were un to meet seasonal needs or special needs which develop able to obtain cash by selling assets, it would be seri with certain individual banks or in certain areas. Or ously embarrassed if not forced to close. In the it may be emergency discounting to meet a condition distant past, reserves equal to 30% to 40% of de of great stringency or near panic caused by a general posits were sometimes carried. lack of liquidity in the whole banking system. Banks can, however, substantially reduce the need ed reserves by voluntary joint action. They can, through correspondent relations, carry accounts with In the latter case the central bank acts as a lender of last resort since there is no other institution in the country capable of meeting the demands. each other, and agree to rediscount paper for, or make loans to, each other in time of need. On the logical How Central Banks Create Reserves If the assumption that they will not all experience their commercial banks presenting paper for rediscount peak demands at the same time, they can by these should take the proceeds in gold, silver, or Govern means safely reduce the total reserves carried. The ment-issued paper money, the central bank could principle is much the same as the one whereby a do no more than make available the mobilized re group of householders can profit by joint action in serves which had been deposited with it. fire protection. If each household must keep enough practice most of the proceeds from rediscounting are water to provide adequate protection against fire, taken in the form either of notes issued by the cen the total is very large. But if a hundred householders tral bank or of deposits in that bank. But in This practice join together and build a water tank for the group, permits the central bank, within the limits set by law, the total can be greatly reduced and still provide to create reserves in these two forms, and thus to adequate protection. augment the total of reserves available. But in banking as in fire pro This is the tection there is some risk of a general conflagration principal source of the central bank’s power to in in which protection is needed everywhere at the same fluence monetary and credit conditions. There is no complete protection against a In acting as lender of last resort, the central bank monetary panic in which cash withdrawals would be should have some reserve of unused lending power excessive, but a strong central bank can provide and also emergency power to suspend temporarily the much more protection than joint action by the banks ordinary limits of credit creation. themselves. the central bank’s responsibility as a lender of last time. Recognition of resort began to develop more than a century ago and As the early central reached its full development in England in the 1870’s. banks developed it was natural for other banks to The underlying theory is that the only feasible way to deposit a part of their reserves in such banks. In this meet a threatened money panic is for the central Central Bank Discounting way the central bank mobilised a large part of the banks to grant accommodations freely but at a high, bank reserves of the country at one point under one penalty rate. control. met but the high rate will force a contraction of total In the beginning the practice of placing re serves with the central bank was entirely voluntary, In that way urgent demands will be credit outstanding. and it remains so in many countries today. The prac Until World W ar I, discounting was almost the tice of requiring commercial banks to hold part or all only channel through which central bank funds were of their reserves with the central bank was started made available to the commercial banking system, with the establishment of the Federal Reserve Sys although the Bank of England had started some ele tem in 1913, but it has been adopted by many other mentary forms of open market operations by making countries since then. One way in which central banks make available occasional purchases of certain kinds of paper in the market. Such operations had not developed for two the mobilized reserves under their control is by dis principal reasons. counting paper for, or making loans to, commercial markets in which they could be conducted. First, there were very few money Second, 21 many central banks did not have the statutory au thority to engage in them, in many cases because of the recognized danger in allowing central banks to buy Government obligations. The more efficient use of reserves under well-de veloped central banking systems made it possible for a given amount of reserves to support more bank lending and investing. In this respect the estab lishment of the Federal Reserve System was especial ly opportune and dramatic because money and credit markets had been badly disorganized by the out break of war in Europe. In its first Annual Report the Federal Reserve Board made these comments on the new reserve requirements: “The change in reserve requirements . . . re leased, not only in Xew York but throughout the country, a very considerable amount of funds which had previously had to be held idle by the banks in order to bring or keep themselves with in the requirements of the lawr. . . . the release of actual cash was very large and . . . the in crease of lending power on the part of member banks was correspondingly larger. Member banks were thereby enabled to extend loans to their customers very much more freely, with a com mensurate decline of discount rates as a conse quence.” * * Another significant effect of the change was a re duction in the rather sharp seasonal fluctuations in interest rates. The accompanying chart shows that interest rates on commercial paper in New York fluctuated considerably less from month to month in the five years after the establishment of the Federal Reserve System than in the five years before that date. The discounting mechanism is used as a medium for the implementation of monetary policy by moving the discount rate up and down. An increase in the rate may have both a direct and a psychological effect. The direct effect is that it makes borrowing from the Limitations of Discounting Credit control through the discount rate represented a significant advance in banking theory and practice. In modern econ omies, however, situations frequently develop which r require, on short notice, relatively large increases or decreases in bank reserves. The discount rate mech anism may not be able to provide such changes at the time and in the amounts needed. Discounting is undertaken at the initiative, not of the central bank, but of borrowing banks. Hence, the central bank may see a need for more reserves but be unable to take the initiative in supplying them. Further, many banks are reluctant to borrow heavily and may re duce their discounting while there is still need for more reserves. In open market operations central banks developed a tool to offset the above shortcomings. Accordingly, such operations have become the major tool of credit * “The reduction of reserve requirements was only a part, however, of the beneficial effects of the new system. Appreciation of the fact that when the new lending power should all have been absorbed there would still remain the great credit ]X)tentialities of the Federal reserve banks, fur nished a basic element of confidence which helped to lower the abnormally high rate of in terest that had existed.” 22 central bank more expensive and thus may cause banks to curtail their borrowing and reduce their willingness to lend. The psychological effect is that it is a signal to the business world that the central bank has embarked on a program of credit restraint and that further restraining moves may fol low unless credit expansion slows down. A lower ing of the discount rate has the opposite effects. AVERAGE MONTHLY INTEREST RATES ON COMMERCIAL PAPER IN NEW YORK 1909-13 and 1915-19 Per Cent policy in most important financial nations. The ac companying chart shows how discounting and open market operations have changed in relative impor tance as the channels through which Reserve Bank credit is created in the United States. The dis counting function declined in importance partly be cause central banks provided liquidity as needed through open market operations and partly because commercial banks have come to hold large amounts of short-term Government securities which can be sold when funds are needed. Open Market Operations Open market opera tions consist of the purchase and sale of securities in the open market by the central bank. Almost always the securities are Government obligations and usually they are short-term. Such operations have been developed largely in the past 40 or 50 years. Orig inally they were regarded as supplementary to the discount rate and were used “to make the discount rate effective” by creating conditions which encour aged the banks to borrow more or less. Later, and especially in the 1930’s, they became the principal method through which bank reserves were varied. Outside of the United States and the United King dom, open market operations have developed quite recently and still are used as a major tool in only a very few countries— probably not more than eight or ten. Open market operations constitute a direct and comprehensive instrument of credit control with a number of advantages. They enable the central bank to take the initiative and to affect directly both the amount of bank credit and the volume of bank re serves. Further, open market operations are very flexible in two ways. They can be used to produce very small or very large changes in reserves. Also, the direction in which they are used can be reversed quickly if conditions warrant. Finally, they can be employed without overt publicity if that is desired. But if publicity is desired it can be obtained by a change in the discount rate or by means of a public announcement. Several conditions are essential for the successful conduct of open market operations. Of course, the central bank must have the necessary statutory powers and the necessary financial resources. In ad dition, there must be a large volume of Government securities outstanding and a broad, active, and wellorganized market in those securities. This is essen tial because at times the central bank must engage in very large operations amounting, in the United States, to several hundreds of millions of dollars in one week. The market must be sufficiently large and active that such operations can be carried out without disrupting or upsetting the market and caus ing wide price changes. In practice, a large part of the outstanding securities must have short-term maturities because long-term securities are usually permanently placed in investment accounts and the trading in them is relatively “thin.” Since the above requirements are met in only a very few countries, open market operations are used as a major instrument in only a handful of nations. Other countries must continue to depend primarily on other means of control. Changes in Reserve Requirements A compara tively new method of credit control is the changing of the reserve requirements of commercial banks. It was first authorized in the United States in the Bank ing Act of 1933, but since then has been copied by a number of central banks. An increase in require ments can wipe out existing excess reserves and even create a deficiency of reserves, forcing commercial banks to discount with the central bank or sell short term liquid assets. This should exert a definite tightening influence 011 the volume of bank credit. A 23 reduction of requirements would ordinarily have the making the banks pay more heed to the statements, opposite effect. This technique can be broad and sweeping, affect powr ers do not exist in the United States except in ing immediately every bank to which the require one respect. ments apply. suggestions, and policies of the central bank. Such In 1933, Federal Reserve Banks and It has been looked upon as a blunt in the Board of Governors were empowered to deny strument and, until recently, has not been used for discount privileges to any bank which has been ex small, temporary reserve adjustments. cessive in financing speculation. Rather, it Generally, central has been used chiefly to adjust to broad and appar banks are averse to using control devices against ently permanent changes in the total availability of particular banks or groups of banks because they are reserves. A variation of this technique is the system of likely to cause friction and charges of discrimination. M oral suasion, or “jaw-bone control” as it is some “special deposits” used by a number of central banks. times called, is a device used occasionally by many Under this system banks are required to lodge as central banks. special deposits with the central bank some speci policies which banks should follow. fied percentage of the increase in their deposits over because the central bank finds it difficult or impossi some time period chosen as a base. Used skillfully ble to put together a combination of moves which and firmly, this technique can remove much of the will accomplish exactly the desired objectives or incentive of banks to extend credit and thus can be because it believes the end can be accomplished more a powerful factor in stopping an inflationary growth smoothly by persuasion than by pressure. of credit. fectiveness of such statements depends heavily on It is the practice of “suggesting” It may be used The ef Still another related technique, much discussed but the prestige of the central bank and the extent to seldom used, is the power to require banks to main which the financial community believes that more tain secondary reserves, usually in the form of Gov powerful actions, if necessary, will follow the state ernment securities, in addition to their primary re ments. serves of cash and deposits in the central banks. Its tive in countries such as Canada and the United purpose is to limit the amount of credit banks can Kingdom in which a large part of the banking re extend to the private sector of the economy in the sources is concentrated in a few banks. form of loans. They are likely to be relatively more effec One of its dangers is that it may There is almost no limit to the areas or subjects create artificially favorable conditions and low inter which may be covered by moral suasion, but it must est rates in the Government securities market and be used very carefully and very sparingly. General ly its effectiveness is likely to decline in direct pro portion to the frequency of its use. thus encourage deficit financing by the Government. Other Methods of Credit Control There are sev eral other methods of controlling or influencing credit which are especially appropriate for smaller coun tries with relatively rudimentary money markets. One is credit rationing, in which the central bank sets a limit to the total amount of discounts it will accept or assigns quotas to particular banks or groups of banks. Another is direct action, in which the central bank acts to limit the interest rates, maturities, and purposes of the loans and investments which com mercial banks may make. A substantial number of the central banks established in recent years have this power, usually stated in broad, loose terms. It has not been used extensively, but it may be influential in 24 Publicity may be used as an adjunct to, or as a substitute for, moral suasion. In this case, the cen tral bank endeavors to keep the banking system and the public fully informed about financial conditions and the general line of central bank policy. This is done in the hope that the banking system, from its analysis of conditions, will arrive at sound decisions as to the correct policy and will agree with the cen tral bank’s general position. If this should be true, then the banks would conclude that their own inter ests and the interests of the country as a whole would be best served by following the central bank’s policy and would not require pressure to move them in that direction. C N R C IO A D H U 6 O ST U T N N 0 SIN W p M l RETAIL I t r s o R s r eDHOLESALEs t TIME ne e t n e e v e ois StttSKftUV IM BTf) I _____ S U W M U T t tJ B T H M M if c J J T B m u s rm Quite often commercial banks which keep their reserves with a central bank express dissatisfaction because they do not receive interest on such deposits. One view is that the central bank makes large profits through the use of such deposits and the depositing banks should, in equity, receive a part of those earn ings. This complaint goes back at least as far as the first year of the Federal Reserve System. Lim i tations of space prevent any full treatment of this topic but a few pertinent points may be noted. This view rests on a misconception about the na ture of commercial and central banking. A com " S S ijm PRICES mercial banker knows that if he gains additional re serves he can use most of them to expand his earn ing assets and, since he is in business for profit, he normally keeps his earning assets about as high as his reserves permit. He does not create the re serves ; they come to him from cash deposited by his Many kinds of information are considered in shaping monetary policy customers or through the clearing house. A central bank, on the other hand, is not oper ated primarily for profit, and it usually does not ex pand its earning assets to the full amount permitted than the reserves needed under a central banking by its reserves. system. Further, the central bank, in prac When a central bank is established and the tice, is not dependent on the reserves deposited by commercial banks deposit their gold and currency commercial banks in the same way as commercial reserves in the central bank, the commercial banks banks are dependent on their reserves. suffer no loss of interest since they merely exchange The central bank acquires assets— discounted paper or invest one nonearning asset for another. ments— by creating liabilities against itself, initially because of the lower amount of reserves required. in the form of deposits. On the other hand, the central bank cannot increase Those deposits must remain In fact, they gain in the central bank unless they are withdrawn in cur its income when gold or legal tender is transferred rency, in which case the central bank will almost to it. certainly substitute its notes for its deposit liabilities, earnings. since the notes are legal tender. tral bank might have to sell earning assets in order Conversely, when a commercial bank builds up its reserves at the cen tral bank it does so by depositing currency or de posits which are liabilities of the central bank. Ob Indeed, it might experience a reduction of If the transfer were substantial, the cen to keep the bank reserves at the desired level. The heart of the matter is that according to the principles under which central banks operate, their viously, its own liabilities cannot function as reserves earning power is not increased by the deposits which for the central bank. commercial banks carry with them, regardless of the In the absence of a central bank the commercial way in which those deposits are created. Rather, banking system must hold certain nonearning assets the great profitability of central banks is due to the — gold or legal tender currency— as reserves. fact that they exercise the sovereign power of gov As we have seen, the total of those reserves is greater ernments to create money. 25 m Central banks generally set their policies primarily to influence the level of domestic economic activity. Domestic objectives, however, cannot always be pursued without regard to a country’s economic re lations with the rest of the world. The level of eco nomic activity at home is closely interrelated with a country’s exports and imports of goods, services, and capital. Moreover, these exports and imports, as reg istered in the balance of payments, play a crucial role 111 determining the strength of a country’s currency in foreign exchange markets. The latter consideration is of special significance to countries whose currencies function as "key currencies,” that is, as substitutes for gold in the reserves of foreign central banks. In the international payments system that has emerged since World W ar II, the major key cur rencies are the United States dollar and the United Kingdom’s pound sterling. Accordingly, interna tional considerations, while important for all central banks, are of special importance to the Federal Re serve System and to the Bank of England. Policy Goals The ultimate goal of central bank policy in the international sphere is usually stated as the maintenance of international economic and finan cial equilibrium. The term “international equilib rium” denotes a condition in which there is no tend ency for international economic and financial develop ments to disturb the smooth functioning of the domestic economy. In this perspective, the inter national functions of a central bank become a logical 26 extension of domestic programs designed to maintain high and stable levels of employment, reasonable price stability, and a maximum sustainable rate of eco nomic expansion. The connection between international and domestic objectives of central bank policy is obvious when one considers the clear implications of export and import trade for domestic levels of prices and employment and for the rate of expansion of the domestic econo my. But this connection is a two-way avenue. Do mestic developments themselves react strongly on the international economic situation. For example, changes in the domestic price level will almost cer tainly affect the volume of a country’s exports and imports. Similarly, domestic interest rate move ments influence the flow of capital between a country and the rest of the world. The effects of such price and interest rate movements on the international flow of goods, services, and capital in turn react on the do mestic economy. Thus, the domestic and the inter national aspects of central bank policy objectives com prise a whole which cannot logically be separated. Policy Conflicts Despite the obvious unity of in ternational and domestic policy objectives, there may be a certain disharmony in actions directed at these objectives. For example, easy money and low in terest rate policies encourage domestic business ex pansion and generally work to take up any existing slack in the rate of use of resources at home. On the other hand, the same policies tend to make domestic commodity prices and investment yields less attrac tive relative to foreign markets. Thus, if a central bank is confronted simultaneously with a domestic business slowdown and a serious balance of payments deficit, it may be caught, so to speak, between the upper and the nether millstone. Easy money, low interest rate policies directed at promoting domestic recovery may also increase imports, reduce exports, and encourage some kinds of capital outflows, thus aggravating the balance of payments deficit and the international disequilibrium which it represents. Since the advent of central banking institutions, attitudes respecting the relative importance of do mestic and international objectives have undergone a rather pronounced evolution. In the early years of central banking, and especially in the period of the “old gold standard” (roughly 1870-1914), in ternational objectives appeared to take precedence. Then in the inter war period (1920-1940) domestic considerations predominated, with international ob jectives relegated to a subordinate position. Since World War II, and especially over the past few years, central banks have increasingly tended to give equal weight to the two sets of objectives and to seek an acceptable balance in the simultaneous promotion of domestic and international equilibrium. T eG l Sa d r E a h od t n a d r Under the old gold standard, central banks were concerned more with international than with do mestic developments. A primary objective was to maintain public confidence in convertibility, that is, in the general exchangeability of currency into gold on demand. This was of prime importance in that period, since a crisis in confidence could be expected to lead to wholesale redemptions of bank notes for gold specie, with corresponding reductions in the money supply, bank credit, and domestic and foreign commerce. Frequently, threats to convertibility were initiated by external drains of gold which resulted from balance of payments deficits. Such drains diminished the banking system’s reserves and, if pro longed, damaged public confidence in the ability of banks to continue redeeming their notes. Because of this, central banks generally tried to halt adverse gold flows with reasonable speed. Gold Standard Features The gold standard em bodies certain features which automatically make for stability in certain important aspects of international economic relationships. When most countries were on a gold standard, the important currencies of the world were defined in terms of gold, and the various monetary authorities stood ready at all times to buy and sell gold at prices corresponding to the gold con tent of their respective currencies. These conditions resulted in relatively fixed ex change rates, or value relationships between cur rencies. Exchange rates could vary only within narrow limits set by the cost of shipping gold. Automatic Equilibrium The relative fixity of ex change rates under the gold standard worked to maintain international equilibrium of a sort, but tended to generate episodic disturbances domesticallv. A balance of payments deficit for a given country increased the supply of that country’s currency held by foreigners and diminished the foreign currency holdings of the deficit country’s residents. This tended to drive up the exchange rates on foreign cur rencies. If the deficit persisted, the cost of foreign currencies tended to rise to a point at which pay ments abroad could be made cheaper by buying and shipping gold. Under such circumstances the deficit country experienced gold losses. This tightened money and credit conditions, tending to depress domestic prices and incomes and to push up interest rates. At the same time, the foreign countries re ceiving the gold experienced monetary expansion, which exerted upward pressure 011 prices and in comes and downward pressure on interest yields. As a result of these developments, capital was at tracted to the deficit country to take advantage of the higher yields. Moreover, the price and income changes tended to increase the deficit country’s ex ports and to reduce its imports. In this fashion, the forces automatically set in motion under the inter national gold standard tended to eliminate deficits and to restore international equilibrium. But it should be noted that this automatic equili brating process was not without hazard, especially to the deficit country. Reduced prices and incomes there could well be accompanied by business failures and unemployment. Moreover, the gold losses could touch off serious banking disturbances that might lead to temporary business paralysis. In the coun tries receiving the gold, inflation became a danger. These possibilities made balance of payments develop ments a matter of prime concern to central banks. 27 The Rules of the Game In the gold standard period, the general prescription for dealing with in ternational disequilibrium called for central bank action to support the forces automatically set in motion by the gold movements. In a deficit country, the central bank was supposed to reinforce the de flationary effects of its gold losses by raising the dis count rate or selling securities in the open market. Opposite action was called for by the central bank of a country experiencing gold and capital inflows. This prescription, which really amounted to helping nature take its course, came to be known as follow ing “the rules of the game.” It is sometimes assumed that the period of the gold standard was an idyllic age in which central banks faithfully supplemented the automatic equilibrating forces inherent in the monetary system. In practice, however, central banks often hesitated to deflate further the domestic economy when a balance of payments deficit coincided with a domestic reces sion. Conversely, they were often reluctant to in flate the domestic economy deliberately in opposite circumstances. In such situations, therefore, cen tral banks sometimes did nothing or even adopted policies which offset the effects of market develop ments. It must be said, however, that convertibility and international equilibrium were regarded as the principal goals during the gold standard period. Consequently, central banks rarely, if ever, took action to offset completely the effects of international gold movements. Abandonment of the Gold Standard The gold standard era came to an end with the outbreak of W orld W ar I when one country after another re sorted to inconvertible paper standards. Most na tions regarded the suspension as temporary, but in the economic confusion that followed the end of hostilities, restoration of the gold standard in its pre war form proved impossible. Only the United States, among the major nations, w able to return *as promptly to prewar arrangements. England, long the world's financial center, was not able to reinstate gold until 1925, and then in a form somewhat dif ferent from its prewar system. Most other nations, eager to maintain some con nection with the gold standard despite their meager gold holdings, adopted the gold exchange standard. Under this system a country’s central bank held part of its reserves in currencies which were convertible into gold at fixed prices. These convertible cur rencies became “key currencies” in the sense that 28 they supported the monetary and credit systems of other nations. Therefore, the gold stock of the gold-rich countries performed double duty, support ing the domestic currencies and also providing a base on which a huge inverted pyramid of international liquidity rested. Gold Exchange Features Under the gold ex change standard, relatively large claims on key cur rency countries are held abroad. When a key cur rency country experiences a balance of payments deficit, these foreign claims grow. As foreign cen tral banks accumulate the key currency beyond their reserve needs they are likely to convert it into gold and the key currency country experiences gold losses. Continued gold losses may eventually impair con fidence in the key currency to the point that for eigners begin wholesale conversions into gold. In deed, such conversions might be touched off, inde pendently of a balance of payments deficit, by any of a variety of developments, economic or political, which might affect world confidence in the currency. T The collapse of a key currency is likely to be ac companied by serious worldwide dislocations. The monetary systems of numerous countries would be affected and the value relationship among the world’s currencies, that is, the exchange rate structure, would be seriously disturbed. Inevitably, sharp curtail ments in the volume of international trade and invest ment would follow. T eI t r a P ro h ne w r e i d The rules of the game apply in general in the gold exchange as well as in the old gold standard. But under the gold exchange standard of the interwar period the major countries of the world were T little disposed to followr those rules. Nor were they prepared to engage in the kind of cooperation that is necessary for the continued success of a gold ex change system. Rather, each country wr as pre occupied with domestic problems of unemployment and with the thorny reparations issue, both a legacy of World W ar I. International equilibrium in this period was sacrificed to these preoccupations. The gold exchange system of this period collapsed in 1931 with a run on the British pound, the prin cipal key currency of that time. In that year, Brit ain was forced off the gold standard, with disastrous effects upon the monetary systems of most other countries. The ensuing curtailment of international trade and investment was a major factor in the severity and persistence of the Great Depression. Exchange Stabilization Funds Other countries soon followed Britain in abandoning gold. As a re sult, rates were torn loose from their gold moorings and began to fluctuate widely. Moreover, the world tended to divide itself into currency blocs— the ster ling area, the exchange control group, and the “gold bloc/' In that environment, central banks acquired additional functions and revised their views of their immediate policy responsibilities. Widely fluctuating exchange rates introduced added risks and complications in making international payments and discouraged world trade and invest ment. Accordingly, one of the first problems con fronting the monetary authorities of the various countries was that of restoring some order in the ex change rate structure. To this end some countries set up exchange stabilization funds to buy and sell foreign currencies with a view to limiting exchange rate fluctuations. For the most part those exchange stabilization funds were managed by central banks. Thus central banks were called on to perform a func tion which was discharged automatically under the old gold standard. A New Orientation From 1931 to the outbreak of World W ar II central banks, following the lead of their governments, concerned themselves primarily with promoting recovery from the Great Depression. International economic relationships were evaluated primarily from the standpoint of their immediate impact on domestic employment. Most countries introduced close controls over international trade in order to insulate the domestic economy from adverse employment effects arising out of foreign trade. Gone were the days when central banks permitted balance of payments deficits to exert deflationary pressures on domestic business. Rather, the general practice was to pursue policies of active ease at home T and to cushion the balance of payments effects of these policies through a comprehensive set of re strictions on foreign intercourse. Indeed, whenever it was possible to employ these restrictions to help T domestic employment, even at the expense of another country, this practice was commonly followed. Exchange Controls Am ong the various restric tions employed in this period were protective tariffs, import quotas, and exchange controls. The latter were perhaps the most important. Central banks played an important role in administering these be cause their effective employment required the coop eration of the commercial banking system. 29 Iti essence, exchange controls involved the mobili zation of the foreign exchange earned by residents and the allocation of this exchange among importers and others wishing to make payments abroad. The execution of exchange control policy was by no means simple. The exchange control authority had to decide such things as how much to allocate for specific imports and for other purposes, what coun tries to favor, what domestic industries to encourage, and so forth. These decisions affected not only the external relations of the country but also the struc ture and performance of the domestic economy. Hence, exchange controls involved much more than mere financial manipulation. Exchange controls, exchange rate manipulation, and the various other restrictions adopted in the period proved an effective set of tools in subordinat ing international economic relations to the require ments of domestic programs to restore full employ ment. The extremes to which they were carried in the 1930’s lead many economic historians to characterize this period as one of monetary nationalism. While the restrictions may have made short-run contribu tions to the solution of unemployment problems, they suffered from one serious shortcoming. All coun tries could employ them, in beggar-thy-neighbor fashion, to help themselves at the expense of other countries. In practice they degenerated into vicious instruments of foreign policy and became an impor tant factor contributing to the embittered internation al relations that preceded World W ar II. Their net economic effect was to reduce the volume of foreign trade and investment and to divert the resources of the world to less efficient uses. P s w rD v l p e t ot a e eo m ns World W ar II further disrupted the pattern of world trade and investment, and restrictive practices were much tighter at the end than at the beginning. Monetary authorities the world over, however, felt keenly the need for a revitalized system of inter national payments under which multilateral trade could flourish. The estab lishment of the International Monetary Fund (IM F ) in 1944 was a first step in the creation of a new and more wholesome environment of international eco nomic relations. This institution aimed at abolition of exchange controls, restoration of exchange rate stability, and the institution of a system of interna tional payments under which national governments could pursue full employment objectives while at the same time enjoying all the advantages of relatively free international trade and investment. Basically, the IM F agreement envisaged a world payments system which had the advantages of the gold standard without its more significant disadvan tages. By requiring all member nations to establish fixed, or par, values for their currencies in terms of either gold or United States dollars and to limit ex change rate fluctuations within 1% of the par value, the IM F set up an exchange rate structure similar to that under the gold standard. In the chaotic eco nomic conditions following W orld W ar II, it was The International Monetary Fund recognized that the aims of the new organization could not be achieved at short range. Therefore, special provisions were made to allow countries to move gradually over to the newTsystem without prej udice to their programs for promoting reconstruction and recovery from the dislocations of the war. For example, member countries were allowed to main tain exchange controls and other restrictions, but with the understanding that these w'ould be abolished as soon as recovery allowed. Very relevant for monetary policy was the crea tion of a currency pool on which members could draw in the event of temporary deficits. This pool, managed by the Fund, made available a supply of supplemental reserves which could be drawn upon in time of need. These reserves allowed member countries to weather temporary deficits without deflating their domestic economies or devaluing their currencies. In addition, member nations w ’ere allowed to change the par value of their currencies by 10% on their own authority or by any amount with the ap proval of the Fund if they could show this was neces sary to correct a basic disequilibrium. The latter arrangement provided a means for correcting balance of payments deficits without domestic deflation, for lower exchange rates encouraged a country’s exports and discouraged its imports. As the Fund has developed, it has also become an important forum through which the world's major central banks work to coordinate their activities to maintain international equilibrium as well as domestic full employment. Other agencies which supplement this function include the Bank for International Set tlements and the recently established Organization for Economic Cooperation and Development. The New Gold Exchange Standard The pains taking efforts of international organizations like the IM F and the cooperation of the countries of the Free World led to the emergence by the late 1950’s of a distinctly new international payments system. In form, the new system is a gold exchange standard, bearing a close resemblance to that of the 1925-31 period. In several important respects, however, the present system differs from its earlier counterpart. First, the major countries of the world regard it as a permanent, workable system, not as a temporary expedient. Also currencies may be defined in terms of either gold or the United States dollar. Thus, the United States dollar, rather than the British pound, has become the prime key currency, although the pound is the second major such currency. D ISC O U N T RATE A N D RESERVES BA N K OF ENG LAND In the present system, pyramiding on the world’s gold base has been carried somewhat further than in the 1920’s. In other words, a larger proportion of the world’s international reserves is in the form of foreign exchange holdings, which means that the gold stock available to the Free World has to support a relatively larger volume of outstanding claims against it. The greater degree of pyramiding, however, by no means implies greater instability. While pyramid ing involves problems, it also serves a very useful purpose in economizing gold and making possible a sizable increase in international liquidity to accomo date the expanding volume of international transac tions. Fundamentally, the stability of the system rests on continued cooperation among the world’s several monetary authorities, and this appears to be forthcoming today to a much greater extent than in the 1920’s. More specifically, the system’s work ability depends on continuing confidence of the rest of the world in the key currencies, and this places great responsibility on the key currency country to manage its external affairs, as well as its internal fi nances, with prudence. The situation is analogous to that of the banker whose deposit liabilities are far in excess of his reserves. So long as his customers’ confidence is maintained, he can continue to provide his community with a satisfactory payments system. But public confidence rests ultimately on demon strated prudence in the management of his affairs. 31 Balance of payments developments become of acute significance to the central bank of a key cur rency country. A balance of payments surplus, for example, will deprive other countries of their re serves and generate problems for them. On the other hand, persistent deficits, by placing increasing amounts of the key currency in the hands of foreign central banks, create the danger of large-scale conver sions into gold. Disequilibrating balance of payments developments may l> associated with international e trade in goods and services or with international capi tal movements. The latter, especially those of a speculative nature, can be particularly hazardous. For that reason, the central bank of a key currency country must pay close attention to a variety of fac tors bearing on foreign trade and foreign capital movements. In particular it must be acutely alive to exchange rate movements, in both spot and for ward markets, to international price differentials, and especially to international interest rate differentials and other factors that affect capital flows. The Federal Reserve and the New System The key position of the United States in the present world payments system represents a new role for this coun try. Traditionally, economic activity in this country has had a predominantly domestic orientation, and foreign trade and investment have been of less rela tive importance than in the major trading countries of Europe and Asia. Moreover, the United States in the first half of the twentieth century had no ex perience with serious disequilibrium in its balance of payments. Consequently, interest in balance of pavments developments has not been as great in this country as elsewhere. After 1950, however, balance of payments deficits began to develop. The deficits between 1950 and 1958 were persistent but relatively small, in a mag nitude of about $1 billion per year. In these years foreign private interests were quite willing to hold dollars, and foreign central banks were willing to hold most of the dollars presented to them in exchange for local currencies. Since 1958 the deficits have been much larger, averaging $3.4 billion per year. These deficits have added some $15 billion to the dollar holdings of foreigners, a large part of which has ac crued to foreign central banks. Increasingly, these foreign central banks have shown a tendencv to con vert their additional dollar holdings to gold, and about $7 billion has been so converted over the past five years. The threat to the dollar’s world position which has been posed by these gold losses was dram atized in the fall of 1960 by the sharp rise in the price 32 of gold on the London gold market and by the shift ing of short-term funds to Europe. These short-term capital movements involved large-scale conversions of dollars into local currencies by foreigners and placed large amounts of additional dollar balances in the hands of foreign central banks, many of which already held more dollars than thev customarily held for their reserve needs. Such move ments, if continued over any extended period, could result in foreign demands on the United States gold stock of dangerously large proportions. In these circumstances, the Treasury’s Exchange Stabilization Fund began more vigorous operations in the foreign exchange market in order to absorb ex cess dollars in foreign markets through purchases of dollars with foreign currencies and thus to reduce the purchase of gold by foreign central banks. In addition, it aimed to influence lx>th spot and forward prices of dollars in terms of foreign currencies in order to reduce the underlying incentive for specula tive movements of capital out of this country. To help the Treasury achieve its goal, which was also vital to the System, the Federal Reserve System began foreign exchange operations early in 1962. Operations for both the Treasury and the Federal Reserve are conducted by the Federal Reserve Bank of New York, and frequent telephone conversations between the Treasury, the New York Bank, the Board, and other Reserve Banks insure coordination in the use of both funds. The Treasury and Federal Reserve have also co operated to maintain short-term interest rates com petitive with those abroad. To help keep short rates up, the Treasury has added significantly to the sup ply of short-term debt outstanding. For its part, the Federal Reserve now conducts its open market oper ations throughout the list of Treasury issues with a view to minimizing downward pressure on short term yields. When, for example, the Federal Reserve needs to supply reserves to the commercial banking system, it can do so with a minimum of dow nw ard pressure on short rates by purchasing intermediateor long-term securities. Through interest rate policy and foreign exchange operations, the Treasury and Federal Reserve Sys tem have thus far been able to moderate foreign pres sure on the dollar and the United States gold stock. Inter-Central Bank Cooperation In its new oper ations in the arena of international finance, the Fed eral Reserve has received the wholehearted coopera tion of foreign central banks and monetary authori ties. This cooperation has been forthcoming in large measure from a realization that self-interest requires it. The important trading countries have a vital stake in the new gold exchange system and can illafford to risk its destruction. But cooperation is not a one-way street. The U. S. Treasury and the System have acted on a number of occasions to ease the problems of other countries. Cooperation has manifested itself in a number of ways. In the first place, the foreign currency re sources required for the Federal Reserve’s new operations have been acquired as a result of “swap” arrangements with foreign monetary authorities. These involve granting dollar credits to these authori ties in exchange for foreign currency credits, under agreements that the dollars thus acquired will not be converted into gold but rather retired by the Federal Reserve with foreign currencies purchased when the markets are more favorable. Most of these “swap” agreements have been on a stand-by basis to be implemented in time of need. A notable example of cooperation occurred in the last half of 1960 when several of the European coun tries most directly involved took appropriate action to prevent flights of short-term capital from the United States and to restore confidence in the dollar. Monetary authorities of Germany and England adopted policies of greater credit ease, and the Bank of Switzerland sought to discourage the inflow of foreign capital by changing the regulations governing time deposits and the flotation of bond and stock issues on the Swiss market. Another example occurred in March of 1961 when the pound sterling came under pressure as a result of large-scale short-term capital flights to Germany and the Netherlands touched off by revaluations of the currencies of those two continental countries. To protect English reserves, the central banks of Europe agreed to hold sterling balances instead of converting them into gold. They also issued a joint announce ment to the effect that the central banks were co operating closely to prevent speculative capital move ments. The most recent and perhaps most dramatic evidence of international cooperation occurred in June 1962, when the International Monetary Fund, the Export-Import Bank, the Federal Reserve Sys tem, and the Bank of England extended to Canada over $1 billion in short-term credit. Conclusion In recent years the international payments mechanism has been the subject of much controversy. Some argue that the existing system is obsolete and should be replaced by an international central bank which would perform for the entire world a function similar to that performed by a cen tral bank for an individual country. On the other extreme, some advocate returning to the gold coin standard of pre-World W ar I days. The countries of the Free World have rejected these extremes. All nations feel keenly the need of a satisfactory system of international payments, but they are also interested in preserving existing insti tutions. Consequently, their monetary authorities are cooperating to meet problems as they occur. They appear determined to make the gold exchange standard a workable, efficient system of international payments. 33 Summary of Operations In its forty-eighth year of operation, the number of other publications were distributed by our Bank. of checks cleared by the Bank passed the 300 million In addition to the annual college survey, in which This was 15 million more than in 1961 and suitable publications are offered for classroom use 97 million greater than the 209 million handled just to professors of economics and related subjects, the ten years earlier. Bank conducted a similar high school survey to en mark. During the year the amount of currency handled courage the teaching of economics at that level. was close to $5.5 billion, surpassing 1961 by about Requests for publications were received from ap 5 per cent. proximately 750 Fifth District high schools. Coin received and paid out topped $161 Our million, up $10 million from the previous year. money displays which are made available to District Transfers of funds showed a significant increase with member banks for one-week periods were in great a 1962 figure of $119 billion, 14 per cent above the demand throughout the year. The annual Young Bankers Seminar was held in 1961 level. The volume of bank borrowing at the discount April of 1962. The Seminar was attended by 176 window has not been large in recent years as a re bankers, representing 97 District member banks and sult of the easy money policy pursued by the Federal branches. Reserve System since mid-1960 and the increasing the spring of 1963. A similar two-day session is planned for popularity of the Federal Funds Market as a source of short term credit. Although small in relation to earlier years, the 1962 borrowings of nearly $2.4 bil lion were higher than the $1.8 billion of 1961 when the level of borrowings reached their lowest point E e g n yP e a e n s mr e c rprd e of the last ten years. Our net earnings before payments to the United States Treasury increased by over $7 million, total ing $55,456,864.51. Member banks received statu Arrangements were completed this year with selected member banks located strategically through tory dividends of $1,272,977.39 during the year. The out the District to serve as cash agents. Bank’s surplus account was increased $3,960,900.00 the Cash Agent Plan are contained in Emergency Details of (surplus is twice paid in capital), and the remaining Circulars 6 and 7, distributed to all banks in the Dis net earnings of $50,222,987.12 were paid to the U. S. trict on March 30, 1962. Treasury as interest on Federal Reserve notes. Emergency Circular was distributed, which describes Capital stock increased by $1,980,450.00, reflecting the increase in the capital and surplus of member banks. the plans made by this Bank for operations essential to the continuity of banking during an emergency. Preparation and stocking of fallout shelters to meet Publications and statistical reports of the Bank were widely distributed during the year. At year end a General Over Civil Defense standards was completed for each of our three offices in 1962. 138,000 copies of our M onthly R eview were sent to Some progress was made this year by commercial bankers, businessmen, educators, students, and other banks in the field of emergency preparedness but interested individuals, and more than 228,000 copies much remains to be done. 34 Ee t o i s l c r nc N w e b rH n s e Mm e a k In 1961 the decision was made to install high-speed Six newly formed Fifth District banks entered the electronic equipment for both check handling and Reserve System during the year, and two former internal data processing requirements. An International Business Machine 1401 R A M AC nonmember banks converted to System membership. data processing system was installed at the Richmond were: the First National Bank of Vienna, Vienna, offiice in late June, 1962, and by year end approxi Virginia, February 23 ; the First National Bank of mately 75 per cent of the accounting and statistical Lancaster, Lancaster, South Carolina, April 16; the Member banks opening for the first time during 1962 operations previously handled on tabulating equip Metropolitan National Bank, Wheaton, Maryland, ment had been transferred to computer processing. June 18; the Peoples National Bank of Gloucester, The system consists of a central processor, a card Gloucester, Virginia, August 31 ; the District of read punch, a printer, a disk storage unit, and a con Columbia National Bank, Washington, D. C., Octo sole inquiry station. ber 3; and the First National Bank of St. George, St. On October 26 a Burroughs B 270 electronic check processing system was delivered to the Richmond office. George, South Carolina, November 15. The Bank of Commerce, Charlotte, North Caro This system consists of the central processor, lina, joined the System as a state member on Novem a sorter-reader, card reader, card punch, and a multi ber 19; and Richmond National Bank and Trust The sorter-reader is capable of read Company, formerly Richmond Bank and Trust Com ing and sorting documents encoded with magnetic pany, became the 424th Fifth District member on ink at speeds up to 1,560 items per minute, and the December 1. ple tape lister. multiple tape lister prints on two tapes simultaneous ly at speeds up to 1,600 lines per minute. Within two weeks after installation checks were C a g si Of cf l h n e n Saf ft i i a being processed on the equipment, and by the end of the year upwards of 50,000 checks per day were being processed. The year 1962 brought about several changes in the Bank’s official staff. For high-speed handling, checks must have the The many friends of Vice President James M. Slay were saddened by his routing symbol-transit number and the amount prop death on May 10. erly encoded in magnetic ink. named vice president and senior adviser. More than two-thirds In June B. U. Ratchford was of the checks clearing through the Richmond office Robert P. Black and Raymond E. Sanders, Jr., now have the routing symbol-transit number encoded formerly assistant vice presidents, were elected vice on them in magnetic ink. An increasing number received from other Federal Reserve Banks as well as from member banks are amount encoded. Our night Transit force is presently amount encoding most of the checks that are processed on the high presidents in June and July, respectively. Appointed to the official staff at the Richmond office were James Parthemos, J. Lander Allin, Jr., and Arthur V. Myers, Jr. Mr. Parthemos was named assistant vice president in Research; Messrs. Allin and Myers were elected assistant cashiers in speed system, but this situation is expected to change Accounting and Bank and Public Relations, respec rather rapidly as more and more member banks in tively. stall electronic check processing equipment. cashier at our Charlotte office in September. Winfred W . Keller was named assistant IB M high-speed check processing systems will be Robert R. Fentress and William H. Gentry, Jr., installed in the Baltimore and Charlotte Branches resigned to accept positions with commercial banks early in 1963. of the District. 35 C m a a i eSa e e t o C n i i n o p r tv t t m n f o dt o ASSKTS; D e c e m b e r 31,1962 Gold certificate account ______________ _ ___ _ Decem ber31,1961 $ 894,629,406.31 $1,087,526,464.63 100,516,830.00 95,166,005.00 Redemption fund for Federal Reserve notes 995,146,236.31 1,182,692,469.63 Federal Reserve notes o f other banks ______ 36,860,300.00 40,868,860.00 Other cash __________________ _________________ 25,644,066.01 21,451,866.15 Discounts and advances ___ ___ ______________ 995,000.00 1,165,000.00 206,976,000.00 TOTAL GOLD CERTIFICATE RESERVES .... U. S. Governm ent securities: Bills __________ ____________________________ 165,733,000.00 Certificates ______________________ _________ 894,553,000.00 110,158,000.00 Notes ________________________ ___ __________ 727,296,000.00 1,295,353,000.00 Bonds ______________________________________ 280,729,000.00 249,280,000.00 TOTAL U. S. GOVERNM ENT SECURITIES . 2,068,311,000.00 1,861,767,000.00 TOTAL LO A N S AND SECURITIES __________ 2,069,306,000.00 1,862,932,000.00 Cash items in process o f collection _________ 572,259,096.25 514,301,381.09 Bank premises ____________________________ _ _ 5,116,166.03 5,589,901.25 Other assets _________________________________ 22,311,118.99 15,487,701.03 T O T A L A S S E T S ________ $3,726,642,983.59 $3,643,324,179.15 $2,525,031,750.00 $2,380,497,515.00 LIA B IL IT IE S: Federal Reserve n o t e s _______________ D ep osits: Member bank— reserve accounts 761,009,058.90 759,969,411.63 U. S. T reasurer— general account 27,944,548.68 49,871,083.28 Foreign ___________________________ 11,700,000.00 12,190,000.00 Other _____________________________ 10,181,264.10 6,032,204.32 TOTAL DEPOSITS 810,834,871.68 828,062,699.23 D eferred availability cash items 320,368,007.44 370,799,639.99 4,254,904.47 3,752,224.93 3,660,489,533.59 3,583,112,079.15 Other liabilities _________________ T O T A L L IA B IL IT IE S CAPITAL ACCOUNTS: Capital paid in ___________________________ 22,051,150.00 20,070,700.00 Surplus 44,102,300.00 40,141,400.00 $3,726,642,983.59 $3,643,324,179.15 $ $ ___________________________________ T O T A L L IA B IL IT IE S A N D C A P IT A L A C C O U N T S Contingent liability on acceptances purchased fo r foreign correspondents 3,784,500.00 5,750,000.00 C m a a i eS a e e t o E r i g a dE p n o p r tv t t m n f a nn s n x e E A R N IN G S : 1962 1961 Discounts and advances ------------------------------- ----- ----------------------------------------------- $ 238,006.42 Interest on U. S. Government se cu ritie s----------------------------------------------------------- 67,479,037.72 Foreign currencies -------------------------------------------------------------------------------------------- 157,607.00 Other earnings --------------------------------------------------------------------------------------------------13,387.64 TOTAL CURRENT EARNINGS _________________________________________________ $ 152,702.60 59,258,665.26 ________ 17,151.11 67,888,038.78 59,428,518.97 11,541,987.12 301,900.00 684,468.53 10,581,541.90 287,400.00 697,278.71 NET EXPENSES 12,528,355.65 11,566,220.61 CURRENT NET EARNINGS 55,359,683.13 47,862,298.36 130,618.22 33,988.44 219,353.67 515.24 164,606.66 219,868.91 67,425.28 3,594.91 97,181.38 216,274.00 $55,456,864.51 $48,078,572.36 $ 1,272,977.39 50,222,987.12 3,960,900.00 $ 1,168,329.36 44,327,343.00 2,582,900.00 $55,456,864.51 $48,078,572.36 $40,141,400.00 3,960,900.00 $37,558,500.00 2,582,900.00 $44,102,300.00 $40,141,400.00 $20,070,700.00 2,049,450.00 $18,779,250.00 1,318,050.00 22,120,150.00 69,000.00 20,097,300.00 26,600.00 $22,051,150.00 $22,051,150.00 $20,070,700.00 EXPEN SES: O perating expenses (including depreciation on bank premises) after deduct ing reimbursem ents received fo r certain Fiscal Agency and other expenses Assessments fo r expenses o f Board o f G o v e r n o r s_____________________________ Cost o f Federal Reserve c u r r e n c y _____________________________________________ A D D IT IO N S TO C U R R E N T N E T E A R N IN G S : Profit on sales o f U. S. Governm ent securities (net) All other _____________________________________________ TOTAL ADDITIONS D E D U C T IO N S FRO M C U R R E N T N E T E A R N IN G S Net additions _________________________________________ N E T E A R N IN G S B E FO R E P A Y M E N T S TO U. S. T R E A S U R Y .. Dividends paid ______________________________________________________________ Paid U. S. Treasury (interest on Federal Reserve notes) ------------------------T ran sferred to surplus _____________________________________________________ TOTAL SURPLUS ACCOUNT Balance at close o f previous year __ Addition account o f profits fo r year B A L A N C E A T CLOSE OF C U R R E N T Y E A R CAPITAL STOCK ACCOUNT (R epresenting amount paid in, which is 50% o f amount subscribed) Balance at close o f previous y e a r _____________________________________________ Issued during the year _______________________________________________________ Cancelled during the year B A L A N C E A T CLOSE OF C U R R E N T Y E A R ------------------------------ 37 Federal Reserve Bank of Richmond Dr c o s iet r (December 31, 19ti2) Alonzo G. Decker, jr . Chairman o f the Board and Federal Reserve Agent Succeeded by : Edwin Hyde Edwin Hyde Deputy Chairman o f the Board Succeeded b y : W illiam H. G rier H. H. Cooley President, The Round Hill National Bank Round Hill, V irginia (T erm expires D ecem ber 31, 1962) Succeeded by : David K. Cushwa, Jr., President The W ashington County National Savings Bank W illiam sport, M aryland (Term expires Decem ber 31, 1965) Addison H. Reese President, North Carolina National Bank Charlotte, North Carolina (T erm expires Decem ber 31, 1963) J. McKenny W illis, Jr. Director, M aryland National Bank Easton, Maryland (Term expires Decem ber 31, 1964) Robert Richardson Coker President, Coker’s Pedigreed Seed Com pany Hartsville, South Carolina (T erm expires D ecem ber 31, 1964) Robert E. L. Johnson Chairman o f the Board, W oodw ard & Lothrop, Inc. W ashington, D. C. (T erm expires Decem ber 31, 1963) Raymond E. Salvati Chairman o f the Board, Island Creek Coal Com pany Huntington, W est V irgin ia (T erm expires Decem ber 31, 1965) Alonzo G. Decker, Jr. President, The Black & Decker M an ufacturin g Com pany Towson, Maryland (Term expires Decem ber 31, 1962) CL A SS A C L A SS B C L A SS C Succeeded by : W ilson H. Elkins, President U niversity o f M aryland College Park, M aryland (T erm expires Decem ber 31, 1965) W illiam H. Grier President, Rock Hill P rinting & F inishing Com pany Rock Hill, South Carolina (T erm expires Decem ber 31, 1963) Edwin Hyde President, Miller & Rhoads, Inc. Richmond, V irginia (Term expires Decem ber 31, 1964) M EM BER F E D E R A L A D V IS O R Y COUNCIL Robert B. Hobbs 38 Chairman o f the Board, F irst N ational Bank o f M aryland Baltimore, M aryland (T erm expires Decem ber 31, 1963) Federal Reserve Bank of Richmond Of c r fi e s Edward A . W ayn e Aubrey N. Heflin President Robert P. Black Vice President Donald F. Hagner Vice President John L. Nosker Vice President Raymond E. Sanders, Jr. Vice President H. Ernest Ford Assistant Vice President Victor E. Pregeant, III Assistant Vice President and Secretary Clifford B. Beavers A ssistant Cashier Robert L. M iller Assistaiit Cashier First Vice President J. Gordon Dickerson, Jr. Vice President W elford S. Farmer General Counsel Edmund F. Mac Donald Vice President Upton S. Martin Vice President Joseph M. Nowlan B. U. Ratchford Vice President and Cashier John G. Deitrick Vice President and Senior A dviser Stuart P. Fishburne A ssistant Vice President W illiam B. Harrison, III A ssistant Vice President Assistant Vice President James Parthemos Assistant Vice President J. Lander Allin, Jr. Joseph F. Viverette Assistant Vice President A ssistant Cashier John C. Horigan John E. Friend Chief Exam iner Assistant Cashier Arthur V . Myers, Jr. W ythe B. W akeham Assistant Cashier Assistant Cashier Roger P. Schad G. Harold Snead Assistant General Auditor General Auditor B l i o eB a c at m r r nh Donald F. Hagner Vice President B. F. Arm strong Assistant Cashier A . A . Stewart, Jr. Cashier E. Riggs Jones, Jr. Assistant Cashier A . C. W ienert Assistant Cashier C a l t eB a c h ro t r nh Edmund F . Mac Donald Vice President W infred W . K eller Assistant Cashier Stanhope A . Ligon Cashier Fred C. K rueger, Jr. Assistant Cashier E. Clinton Mondy Assistant Cashier 39 Baltimore Branch Dr c o s iet r (December 31, 19fi2) Gordon M. Cairns Dean o f Agriculture, U niversity o f M aryland College Park, M aryland (T erm expires Decem ber 31, 1962) Succeeded by : E. W ayne Corrin, President Hope N atural Gas Com pany Clarksburg, W est V irgin ia (Term expires Decem ber 31, 1965) Leonard C. Crewe, Jr. President and Treasurer Maryland Fine and Specialty W ire Com pany, Inc. Cockeysville, M aryland (T erm expires D ecem ber 31, 1964) Harry B. Cummings Vice President and General M anager Metal Products Division, K oppers Com pany, Inc. Baltimore, M aryland (T erm expires Decem ber 31, 1963) Harvey E. Emmart Senior Vice President and Cashier Maryland National Bank Baltimore, M aryland (T erm expires Decem ber 31, 1964) James W . McElroy Director, F irst National Bank o f M aryland Baltimore, M aryland (T erm expires Decem ber 31, 1962) Succeeded b y : Joseph B. Browne, President Union Trust Com pany o f M aryland Baltimore, M aryland (T erm expires Decem ber 31, 1965) Martin Piribek Executive Vice President The F irst National Bank o f M organtow n M organtown, W est V irginia (Term expires Decem ber 31, 1964) J. N. Shumate President, The Farm ers National Bank o f A nnapolis Annapolis, M aryland (T erm expires Decem ber 31, 1963) Charlotte Branch Dr c o s iet r (December 31, 1962) George H. Aull Agricultural Econom ist, Clemson College Clemson, South Carolina (T erm expires Decem ber 31, 1963) W allace W . Brawley President, The Commercial N ational Bank o f Spartanburg Spartanburg, South Carolina (Term expires Decem ber 31, 1964) J. C. Cowan, Jr. W . W . McEachern G. Harold Myrick Joe H. Robinson Clarence P. Street 40 Vice Chairman o f the Board, Burlington Industries, Inc. Greensboro, North Carolina (Term expires December 31, 1965) President, The South Carolina N ational Bank Greenville, South Carolina (T erm expires Decem ber 31, 1963) Executive Vice President and T rust Officer F irst National Bank Lincolnton, North Carolina (Term expires December 31, 1965) Senior Vice President, W achovia Bank and T ru st Company Charlotte, North Carolina (Term expires December 31, 1964) President, M cDevitt and Street Com pany Charlotte, North Carolina (Term expires December 31, 1964) t ll t Sveriges Riksbank #5 t.S u o m e n • • Pankki State Bank of »he U S S R Banque de France Banco d 'ltalia The Peoples Bank of China w f • w Banque de I'A lg e n e X? Bank of Japan 1 • State Bank of Pakistan Central Bank of China r \ I# Reserve Bank of India Bank of Sudan Central Bank of N igeria Bank of Indones South African lReserve Bank The A fg h a n istan Bank • Banque de I'Etat A lb a n a is Banque N atio n ale de Belgique • The Peoples Bank of China bank (West) • # Banco N ation ale de Cuba Deutsche N otenbank Central Bank of Iraq Ze alan d • • • (East) # • # • Bank of Israel • • Banco Central de la Republica A rgen tin a • Banque de Grece • Banca d 'lta lia • • N orges Bank Bank of the Ryukyus • • Reserve Bank of A ustralia • Oesterreichischc Banque Nation ale de Bulgarie • Union Bank of Burma • Banque N ationale du C a m b o d g e • Statm' Ban ka Ceskoslovenskd Central Bonk of Nigeria Banque d'Etat de la Republique Populaire Roumaine • Banco do Brasil • Bank of G h a n a Central Bank of Ireland # Banco N acion a l de N ic a rag u a land • FRASER Digitized for Banque Centrale de Tunisie Banque de I'A lgerie Banco Central de Bolivia • D an m arks N a tio n a lb a n k Banco de G u ate m ala • Bank of Jam aica • • # Banco Central de la Republica Dom inicana Banque N ationale de la Republique d Haiti • Bank of Japan State Bank of Pakistan • # Bank of Korea • Banco N acion al de Pa n a m a Ban Banque N atio n ale du Lac • Banco Central del Parc Banco Central de Reserva de El Sa lva d or • Banca N a zio n ale Som ala • • Banque Centrole de la Republique de Turquie • Banco de la Republica Oriental del U rugu ay • # Banco C< South A frican Rest The Federal Reserve System • State Bant