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The F e d e ra l R eserve S y ste m

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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

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B a n c o C e n tr a l

B a n c o d o B r a sil

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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