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tEtje JUbetsrtbe $res!S
C A M B R ID G E • M A S S A C H U S E T T S
P R I N T E D I N T H E U .S .A .

to the unusual character of the period during
which its policy has been developed, many misconceptions
have become current regarding the nature and purpose of
the Federal Reserve banking system. Some of these mis­
conceptions are so far-reaching as to create serious dif­
ficulties for its management. No central banking system
can be administered efficiently in an atmosphere of preju­
dice and misunderstanding. The business public, in its
appraisal of the system’s management, must be led to
apply the tests of sound principles of economics and
finance rather than those merely of immediate, individual
advantage. It, accordingly, has been the writer’s en­
deavor to do what little his capacities permit to stimu­
late a proper spirit of inquiry regarding Federal Reserve
It has appeared to the writer that a careful examina­
tion of the development of the reserve system could be
made most opportunely by one not connected with its
management. As a minor spur to the writer’s efforts
there has been the belief that no study offers superior op­
portunities for investigating the working of the principles
of money and credit under contemporary conditions of
business and industry. While the book was written for
the general reading public, rather than for classroom
purposes, it may serve as a second book to follow the
reading of one of the elementary texts in college courses
in Money and Banking.
On this occasion the writer would like to express his
O w in g



gratitude to those who have helped him to sustain his in­
terest in finance and economics. Among these he would
like to mention the names of Professor Kemmerer, of
Princeton University; Professor Davenport, of Cornell
University; Dean Joseph French Johnson, of New York
University; Dean Turner, of New York University;
Dean Gephart, of Washington University, now VicePresident of the First National Bank of St. Louis; Pro­
fessor Willcox, of Cornell University; and Professor A. S.
Johnson, at present a member of the editorial staff of the
New Republic. Professor Allyn A. Young, of Harvard
University, has been a constant source of inspiration.
April 30, 1922.




Vfie 3Mbtr*fte

to the unusual character of the period during
which its policy has been developed, many misconceptions
have become current regarding the nature and purpose of
the Federal Reserve banking system. Some of these mis­
conceptions are so far-reaching as to create serious dif­
ficulties for its management. No central banking system
can be administered efficiently in an atmosphere of preju­
dice and misunderstanding. The business public, in its
appraisal of the system’s management, must be led to
apply the tests of sound principles of economics and
finance rather than those merely of immediate, individual
advantage. It, accordingly, has been the writer’s en­
deavor to do what little his capacities permit to stimu­
late a proper spirit of inquiry regarding Federal Reserve
It has appeared to the writer that a careful examina­
tion of the development of the reserve system could be
made most opportunely by one not connected with its
management. As a minor spur to the writer’s efforts
there has been the belief that no study offers superior op­
portunities for investigating the working of the principles
of money and credit under contemporary conditions of
business and industry. While the book was written for
the general reading public, rather than for classroom
purposes, it may serve as a second book to follow the
reading of one of the elementary texts in college courses
in Money and Banking.
On this occasion the writer would like to express his

O w in g



gratitude to those who have helped him to sustain his in­
terest in finance and economics. Among these he would
like to mention the names of Professor Kemmerer, of
Princeton University; Professor Davenport, of Cornell
University; Dean Joseph French Johnson, of New York
University; Dean Turner, of New York University;
Dean Gephart, of Washington University, now VicePresident of the First National Bank of St. Louis; Pro­
fessor Willcox, of Cornell University; and Professor A. S.
Johnson, at present a member of the editorial staff of the
New Republic. Professor Allyn A. Young, of Harvard
University, has been a constant source of inspiration.
April 30, 1922.

I. T


W o r k in g

of th e

I I . C h e c k C o l l e c t io n s


R e g io n a l S y ste m


C learan ces

under th e


F ed eral R eserve
III. Sta te B a n k M

e m b e r s h ip


F ederal R e ­

th e



IV . A d v a n c e s
V . D ir e c t


R e s e r v e B a n k s — R e d is c o u n t s

C ollateral

A dvances



em ber


B anks
V I. T



D evelopm ent

of th e

A g r ic u l t u r a l C r e d it




A cceptance

under th e

F ederal R e ­


ser ve







D evelopm ent

of th e

O p e n -M a r k e t

B an k A cceptan ce

O p e r a t io n s



R eserve


B anks
X . A dvances



A dvances

R e s e r v e B a n k s — N o t e I ssu es
R e s e r v e B a n k s — D e p o s it s




R eserves
X II. F ederal



R eser ve
D ecem ber,

E a r l y P roblem s


D evelopm ent, N ovem ber,


X I I I . F e d e r a l R e s e r v e D e v e l o p m e n t , Ja n u a r y ,

A p r il ,


W ar

F ed er al R eser ve D evelopm ent, M a y ,
N ovem ber




W a r - T im e C r e d it E x p a n s io n



F in a n c i a l P r e p a r a t i o n



O r g a n iz a t io n






X V . F e d e r a l R e s e r v e D e v e l o p m e n t , N o v e m b e r 12,



M a y , 1920

P e r io d


P o s t -W a r C r e d it E x p a n s io n

X V I. F ed eral R eser ve D evelopm ent, M
th e



P resent T
P e r io d

In d ex




im e



3 16

B u s in e s s R e a d j u s t m e n t



I n the matter of structure, organization, and administra­
tion, the most characteristic feature of the Federal Reserve
banking plan is the system of district reserve banks. The
regional system was also the most surprising outcome of
the legislative planning which preceded the framing of the
final provisions of the act. Since 1907 the question of
banking reform had revolved about the idea of establish­
ing, for the entire country, a single large and powerful
institution which should hold a portion of the reserves of
the member institutions and whose advances should be
controlled by a single board or directorate. It was felt by
many that a banking organization more centralized in con­
trol and resources offered far greater possibilities of avoid­
ing credit collapses than our old decentralized system.
Demands for banking reform were thus predicated upon a
belief in the desirability of a single central bank. While it
was anticipated that such a bank must establish local
branches or agencies, it was not expected generally that
there would be established in each of a dozen different dis­
tricts a bankers’ bank which should deal for the most part
only with the banks of its own territory. It was not antici­
pated that a group of independently operating bankers’
banks would be set up, with no one bank possessing domi­



nating authority. It was not predicted that the board
with general control would not be allied to any one bank
in particular.
The motives influencing the legislators to this generally
unforetold conclusion are now well known. Despite the
admittedly great possibilities of a central bank, there were
many fears that such an institution would employ its
resources with partiality. Recollections of the old preju­
dices against such an institution surviving from the time
of Andrew Jackson made it appear the part of political
wisdom to the Congressional leaders of both parties to
soften the emphasis upon the idea of control by the direc­
torate of one all-powerful institution. In the Aldrich Bill
the plan which might be said to represent the Republican
attempt to secure banking reform, the idea of cooperation
and not of control was to be suggested by the name of the
new system. It was to bear the name, not of a bank, but
rather of the National Reserve Association. Furthermore,
its machinery was to be such as not to exert any large
measure of continuous control. By the issue of notes
carrying a progressively increasing tax, it was designed
primarily to offer relief in periods of emergency and threat­
ened credit collapse.
The underlying theory of the Federal Reserve system
was somewhat different. The reserve institutions were to
bear the names of banks, and it was hoped that they would
operate more or less continuously. But lest the objections
to the idea of a central bank should prove too strong,
attacks were to be parried in another way. There was to
be no single, all-powerful central bank. Twelve regional
banks, distinct in membership and direction, were to be
set up, their several operations to be harmonized and
coordinated by a single board. The Democratic plan, the
Federal Reserve plan, was thus based upon the idea of



preserving for the banks of each locality as much control
over the district bankers’ bank as seemed financially expe­
dient. Such a solution was indeed typical for a party
whose political traditions are founded so largely upon the
doctrine of States’ rights and local autonomy.
The wisdom of the regional idea was attacked strenu­
ously by many. A t the time of greatest controversy,
however, the ultimate manner of the operation of the
Federal Reserve system was more or less a matter of
doubt. There was no experience by which to measure the
importance of the numerous objections. But now, after
nearly a decade of experience, the value of the regional
idea can be appraised more accurately. What, then, does
past operation suggest regarding the practicability of the
plan? An inquiry, such as this projects, renders it desir­
able to recall some of the earlier points upon which the
regional system was attacked. An advantage of restating
these objections now is that by virtue of recent experience
the haziness which beclouded the form of their original
statement may be avoided, in part at least.
In the first place, it was felt that the regional plan would
create too much temptation to the frequent use of the
reserve bank’s resources. The basic idea was to bring the
bankers’ bank more close to the member institutions.
Direction was so planned as to subject its management to
pressure and influence exerted by the member banks of
the locality. Six of the nine district directors were to be
chosen by the member banks. Moreover, the regional idea
was asserted to be merely a substitute for the plan which
contemplated only occasional or emergency relief for the
member institutions. It was evident to all that many
dangers must lie in the path of any system designed to
exercise day-to-day control over the money market. To
render any such control effective the advances of the re­

serve banks must be large. The acceptance of <the Euro­
pean 1 rule of procedure — keeping the central bank’s rate
above the market — might leave the reserve banks a piece
of unused and costly machinery. In view/of the concentra­
tion of reserve money and the consequently great possi­
bilities of pyramiding credits, it was perceived that an
unexampled expansion of bank advances might take place.
In short, the regional plan, instead of guarding against,
seemed actually to make provision for, price inflation.
It was asserted, furthermore, that the regional idea was
solely a compromise, the outgrowth of the desire to avoid
popular objection. Considerations of financial wisdom
were held to have been subordinated to those of political
expediency. Few have been the occasions when compro­
mise has proved successful in matters financial, and it
scarcely could be hoped that banking reform would con­
stitute an exception. If our old difficulties were due prima­
rily to decentralization, in credit control, note issues, and
reserve holdings, the greatest advantage could be realized
only by utilizing to the utmost the idea of centralization.
The greatest degree of benefit could be obtained only by es­
tablishing a single bankers’ bank dominating the member
institutions of the entire country. Any other solution
must perpetuate among the reserve banks the old evil
formerly pertaining to the individual banks — scrambling
for reserves in periods of emergency and excessive compe­
tition in the period of business activity. To be sure,
attempts could be made to unify the operations of the
reserve banks by granting certain powers of control to the
Federal Reserve Board. But this, it was argued, would be
merely a patchwork device. The regional system must
limit somewhere the possibilities of centralized control
1Only in a very general sense is it correct to imply that the dominating policy
of European central banks has been to keep the official rate above the market
rate. There are, of course, many exceptions.



and concerted action. Otherwise what would be its advan­
tage over a single central bank?
Opponents of the plan argued also that it represented an
attempt to isolate different territories of finance, to estab­
lish sectionalism in an impossible field. Finance, any more
than trade, cannot be confined within artificial borders.
The call-rate policy of the metropolitan bank may affect
the Southern cotton planter in as real (though a more in­
direct) a manner as the credit policy of his own local bank.
Even under our old faulty banking system many were the
means by which bank capital could be transferred from
one locality to another. The call rates of city banks must
exert some influence upon the place of investment of sur­
plus bank capital. Our various banking channels cross
somewhere, even if in a haphazard manner. The rivulets of
credit, sluggish though they be, carry eventually their
deposits to the deeper channels. If the various districts
of the country are related in fact, why not recognize this
relationship in the structure of the banking system? Fail­
ure to recognize it must create only difficulty. If twelve
different open markets for commercial paper exist, wherein
has correction been found for the old evil — inability to
mobilize efficiently a large portion of our surplus bank
reserves at the point of greatest need?
These were some of the more earnestly developed
attacks upon the regional plan. Let us next consider as
completely as may be their respective merits. In doing
this, however, an attempt must be made to avoid for the
present those aspects of the problem which involve ultra­
complicated features of reserve banking.
In the light of recent experience much justification is
afforded the view that the regional system is peculiarly
susceptible to undue credit expansion. Local pressure for
enlarged credit grants is always most intense. Business



thrives on easy money; rising prices usually create the
situation of a widening margin between costs of produc­
tion and sale proceeds. Those who are injured by price
inflation, those whose money incomes are incapable of
quick adjustment, exert only feeble pressure upon the
banking administration. Wage-eamers scarcely ever
emphasize this cause of their woes; they are much more
prone to employ the devices of strikes and concerted
action. The middle class has no influence upon the bank­
ing administration. Occasionally entrepreneurial activity
is injured by the rising scale of prices, as, for instance, in
the public utility and railroad fields. But the petitions of
industrial entrepreneurs, in the same manner as those of
the wage-eamers, are scarcely ever addressed to the bank­
ing administration. Prayers for higher rates offer greater
prospects of relief. Because of the nature of things, it is
peculiarly necessary that the banking structure be such as
to make easy denial of demands for excessive credits. It is
necessary that banking control be lodged in the hands of
those well equipped to resist the credit demands of those
who are not responsible for the interests of all classes in
society, and who do not have in mind merely the shorttime requirements of business.
One means of ensuring conservatism in the operations
of the central bank is to emphasize the emergency charac­
ter of the institution. Let the rates on the advances of the
central institution be normally above the market rate.
Advances from the central bank are thus rendered unprofit­
able on ordinary occasions. But aid, costly though it be to
secure it, is available for periods of credit strain.
It has been stated previously that the regional idea is
based on the theory of continuous control of the money
market. It necessitates accordingly constant employment
of reserve funds. This, in turn, imposes the necessity of



keeping the rates sufficiently low to occasion demand for
the funds of the reserve system. The rule of remaining out
of the market except in emergencies is not so easy of
acceptance under the regional system. Control by member
banks is too direct. And so far as the particular facts of
the reserve system are concerned, the regional idea was
invoked as a substitute for a previous plan in which the
emergency character of the institution was emphasized.
It may be that in the course of time a means may be
developed whereby the volume of reserve advances may be
stabilized in relation to the needs of trade even though the
reserve banks are kept continuously in the market. In the
opinion of the writer, however, the principles for regulating
the volume of reserve advances have not yet been formu­
lated with sufficient definiteness.1
The above paragraphs should not be interpreted as
advocating absolute aloofness from the market except in
periods of strain. Those who stress the emergency charac­
ter of the reserve banks would admit the necessity of some
measure of continuous functioning. But such operations
need not be so extensive in volume. It was asserted, fur­
thermore, that if the share contributions of member banks
to the capital of reserve banks could be returned, there
would be even less pressure to find continuous use of
reserve bank funds. If the idea of emergency advances
only were developed, could not the reserve institutions
develop enough investment power without share capital
contributions from member banks? Reserve banks would
still possess the resources based upon their holdings of
member banks’ reserves. But further discussion of this
aspect of the problem can best be postponed till a later
ISee infra, Chapter XVI.
aSee infra, Chapter XII.



In reply to the second objection, that the regional plan
was based upon the idea of divorcing various banking
channels, it was replied that the scheme represented no
more sectionalism than existed in fact. Attention was
called to the great differences in banking customs and
needs of the various districts of the country. It was
asserted that nowhere in the world was there an illustra­
tion of a central bank successfully dominating so large and
diverse a banking territory as that of continental United
States. In the words of H. P. Willis:1
So far as area is concerned, then, there would be room in the
United States for a number of institutions corresponding to the
total number of central banks throughout the European con­
tinent. The mere fact that international lines divide the Bank
of France from the Bank of England or the Bank of Germany
has no relationship to the economics of the situation. It is a
fact that no such extent of territory as the United States is dealt
with by one single central bank. The Federal reserve system,
with its series of reserve-holding institutions, therefore, does
in fact correspond much more nearly to European practice than
would a single central institution with branches. Each Federal
reserve bank includes within its district a territory which, as
the nation expands and its business increases, will rank with
the territory tributary to one of the European central insti­
From the point of view of directness and efficiency in
administration, justification for Mr. Willis’s remarks is
clear. The regional character of the system has eliminated,
undoubtedly, many anticipated difficulties of direction.
But has this been accomplished at the expense of destroy­
ing all possibilities of financial cooperation between the
various reserve banks? Has the reserve system meant the
segregation of financial territories and the consequent de­
struction of any effective means of establishing a country­
wide market for commercial paper of various origin, in
1 The Federal Reserve, p. 128.



such a way as to enable the surplus funds of the country to
be mobilized effectively? More precisely, have the reserve
banks shown willingness to aid each other, by means of the
rediscounting or direct purchase of each other’s paper?
In developing this inter-district harmony the succession
of events has favored the administration. In the early
years of operation, the period when no past experience in
cooperation was possessed, a time accordingly when at­
tempts to secure mutual aid would be difficult, there was
little demand for this sort of reserve activity. Due to the
reduction of reserve minima under the terms of the act and
to the importation of gold from abroad, reserves of all the
district banks were generally high. When the need of
inter-district aid did develop, the Nation was engaged in a
war so enveloping as to render apparent to all the neces­
sity of subordinating considerations purely of sectional
advantage. In such a situation it was easy for the Board
to insist, in the determination of the inter-district shifting
of funds, upon principles which ordinarily might have
created some objection. A t a time when so many devices
of expansion were available, concessions by one bank
would not necessarily impair its own lending power.
Accordingly, as a guiding principle, reserves were to be
equalized between the various district banks regardless of
the cause of any bank’s need for aid.
The accompanying table on page 10 indicates the volume
of such inter-district operations during some of the years
when their amount was exceedingly heavy.
Needless to remark, operations so large in volume have
affected greatly the reserve positions of the district banks
on numerous occasions, increasing the reserves of some and
lowering those of others. Indicative of this is the accom­
panying table on page n . 1
rSee Report of the Federal Reserve Board for 1919, p. 8.



I n t e r - D i s t r ic t M o v e m e n t o f D is c o u n te d a n d P u r c h a s e d P a p e r 1
F o r

th e Y e a r


F o r

th e

Y e a r


F o r

th e

Y e a r


E xcess
M ove­

E xcess
M ove­

E x cess
M ove­

E x cess
M ove­

E xcess
M ove­

m e n t

B ank

E xcess
M ove­

m e n t

m e n t

m e n t

m e n t

m e n t

t o 8





fr o m 2

In T h o u sa n d s o f D o lla r s 4

New York . . . .

$ 92,046

$ 131,165



Philadelphia . .

$ 56,562

Cleveland . . . .



Richmond . . . .





St. L o u is.........

$ 463,909



$ 986,280
$ 764,219



Minneapolis . .




Kansas City . .





San Francisco.
T o ta l..........






$3,201,987 $3,201,987



*The following extract from the Federal Reserve Bulletin for October, 1920 (p. 1015), is
explanatory of the relation of the Gold Settlement Fund to the inter-district shifting of
“ Originally established for the purpose of expediting the settlement of balances in gold
between Federal Reserve Banks arising out of exchange and clearing operations, the shift­
ing of funds from district to district m connection with rediscount transactions between
Federal Reserve. Banks has become one of the principal services of the fund under present
conditions, and its efficacy has been strikingly exemplified during the heavy credit strain
incident to the financing of our present crops.
“ When a Federal Reserve Bank, through the Federal Reserve Board, has been granted
an extension of credit, and such extension has been allocated to some other Federal Reserve
Bank, the extension is made effective through the transfer of title to gold in the gold settle­
ment fund at Washington. The gold settlement fund . . . consists of deposits of gold
which have been made by the Federal Reserve Banks and agents with the Treasury, which
holds them in trust. . . . The gold in this fund is seldom physically moved, though it
frequently changes ownership, transfer of ownership being effected through the mechanism
of the fund without the need of moving. Ownership in the fund being represented by entries
in the books of the fund, an applicant Federal Reserve Bank which has been granted credit
extension receives its accommodation, and the gold to which it is entitled, through a credit
entry in the gold clearing books of the Federal Reserve Board. Inasmuch as the gold
settlement fund is a part of the gold reserve of each of the Federal Reserve Banks, this
transfer amounts to shifting a given volume of reserve metal from a granting bank to the
applicant bank. The effect is to transfer a corresponding amount of credit-granting or
credit-lending, power from the granting institution to the applicant. The latter is then at
liberty to use it as it may see fit in extending further accommodation to the member banka
within its district.The transaction has, in short, really amounted to a temporary shifting
of banking funds from one district to another.”
1 By this operation the bank gains in reserve money. It is given credit on the Gold Settle­
ment Fund. See note 1for description of the working of this fund.
* By this operation the bank loses in reserve money. It is debited on the Gold Settlement
Fund. See note 1 for description of the working of this fund.
* Figures are compiled from the yearly Reports of the Federal Reserve Board.

R a tio



T o t a l R e s e r v e s t o C om bin ed N e t D e p o s it a n d F e d e r a l
R e s e r v e N o t e L i a b i li t i e s , D e c e m b e r 26, 1919
A f t e r A d ju s t m e n t o f R e s e r v e s b y D e d u c t in g
A m ount

B an k

A ctu al


B il l s

R e d is c o u n t e d

w it h


S old to O th er F e d e r a l R e s e r v e B a n k s an d
A d d i n g A m o u n t o f B iit l s D i s c o u n t e d f o r o r
P urch ased


O ther

F ederal

R eserve

B anks

Boston.. . .............
New York..............
Atlanta........ .
St. Louis...............
Kansas City...........
San Francisco.........
For all banks........ .





4 i *3


The amount of inter-district lending of funds has thus
been great. But to what factors shall we ascribe the will­
ingness of the various banks to cooperate in this way?
Has it been due to the unusual circumstances of the period
when operations of this sort were the greatest? Has it been
merely an aspect of the problems of war and post-war
finance? Or has it been the desire of the lending bank to
establish a basis for its own pleas for aid when it itself
should become the needy institution? Answers to such
queries as these should throw some light upon the prob­
able future amount of inter-district operations.
Some explanation of the preceding problems is afforded
by the following sentence from the Federal Reserve Bulletin
for October 1,1920:1
The process of shifting bank resources through inter-reserve
rediscounting was necessarily called into play and has become
a regular and important feature of the working of the Federal
Reserve System.
1 Page 1014.



As to how this function of the reserve has developed, it
will be recalled that in the earlier years under the reserve
system the effectiveness of the machinery for transferring
funds from district to district was not fully tested. The
release of reserves on the inauguration of the reserve sys­
tem and the inflow of gold from abroad in the following
years made unnecessary the use of reserve funds to any
appreciable extent. But after the period of rising prices
during the war and the getting more completely into the
market of the Federal Reserve, inter-district aid became
necessary on the part of the district subjected to unusual
crop-moving or seasonal demands. Since, however, the
peak of money demand is not reached simultaneously in
all districts, it is possible for the Reserve Board to offset
the seasonable fluctuations and changes in demand against
one another. In this way the strain previously thrown
upon the city banks in the financial centers by the calls
from the interior becomes merely a transfer of surplus
reserve funds from one district to another.
Various are the circumstances which determine the
extent to which any one district bank may require such
aid. Industries dependent largely upon agriculture must
experience usually greater seasonal fluctuations in the
demand for bank capital than those more largely manu­
facturing. Districts covering a territory diversified in
climate and in the nature of their industries may be able
more easily to finance exceptional demands in one part by
reliance upon surplus funds in another without drawing
heavily upon other districts. A section thus diversified is
Number 12, the Pacific Coast Section, including States
from the Canadian border to the boundary line of Mexico.
B y relying upon the principle of reciprocity in the meet­
ing of their mutual seasonal and emergency demands, it
may be possible to avoid to some extent the objection of



sectional financial isolation. It is true that the regional
system creates some obstruction to the free flow of funds
from district to district. Some friction will be encountered
always in mobilizing effectively free bank funds. But this
difficulty can be mitigated greatly and is perhaps justified
by the administrative efficiency and political advantage of
the regional plan.
One difficulty remains, however. If inter-district shift­
ing of funds is regularly contemplated, wherein lies the
advantage of the regional system in meeting objections
emphasizing possibilities of sectional discrimination?
Rediscounts by one reserve bank for another can be
required by the Federal Reserve Board. According to the
liberality with which it treats one district, and the con­
servatism another, the display of sectional partiality is
easily possible. If exercised, its results would be identical
with the more direct partiality displayed by the director­
ate of a single central bank.
In the opinion of the writer, however, partiality in
requiring reserve banks to render inter-district aid is not
nearly so probable. Under the reserve system it will be
expected that the borrowing districts in normal years shall
not merely clear their books in the off season, but also
shall be able to render aid to other districts in the slack
season. In the long run the advances to member banks in
any one district must bear some relation to the resources
of the reserve bank, resources which represented originally
the contributions of the members. Under a single bankers’
bank the determination of the legitimate amount of
advances to any one locality must be based on more hypo­
thetical grounds. Failure to map out definite and per­
manent districts would create much more difficulty in
determining the relative merits of the demands of the
various sections of the country. Under the present sys-

tem the resources of each reserve bank are real and the
advances to anyone section do not depend so largely upon
the rulings of a single directorate.
A query, of possibly greater importance, relating to the
political expediency of the regional plan, necessitates some
concluding discussion. How effective has been the regional
plan in enabling the general administrative body — the
Federal Reserve Board — to confine complaints to the
district in which the discontent has arisen? To what
extent has the Board been able to disclaim responsibility
for policies initiated by the district directorate? In what
measure has each district been held responsible by the
public for conditions logically the result of its own poli­
cies? Very important is the answer to this query because
the system is much more likely to be modified by legis­
lative action when complaints are directed against the
central administrative body than when directed merely
against one of the twelve administrative subdivisions.
It must be admitted at the outset that there has been a
persistent refusal by the general public to recognize the
regional character of the system. In the period of agricul­
tural depression following the spring of 1920, nothing was
more clear than this. Newspapers and journals of the
Middle West and South wrote many an editorial and pub­
lished many a cartoon to establish the partiality of the
Federal Reserve Board toward the metropolitan financial
interests. In virtually all of these the existence of different
reserve banks in the various sections of the country was
ignored. “ The men who grew the wheat ” could not obtain
credit to hold their crops for a fair price, whereas the “ men
who tried to corner the wheat market,” it was asserted,
were bountifully supplied with funds emanating from the
Federal Reserve. No attention at all was ordinarily paid
to the fact that the National City Bank of New York is



served by the New York Reserve Bank; whereas the First
National Bank of Waycross, Georgia, is served by the
Atlanta Reserve Bank.1
Indicative further of this point of view, there is even to
be found an address of the former Comptroller of the Cur­
rency, and ex-officio member of the Federal Reserve
Board, Mr. John Skelton Williams, delivered in Augusta,
Georgia, July 14, 1921.2 The following extract may be
quoted from this address:
While small banks in the farming districts were being taxed
in this manner, great banks in New York were being supplied
with practically unlimited amounts of money at 5, 6, and 7
per cent. The official record will show that while the Reserve
Bank collected $2100 (equal to 8 per cent on the bank’s entire
capital stock for 12 months) from a little bank in your adjoining
State of Alabama, for the use of about $112,000 for two weeks
in crop-moving time, a year ago, a big bank in New York,
whose funds were largely employed in speculative operations
and deals, for the same cash consideration, or, say, $2100, was
given the use of about $800,000 for the same time.
And in his charges of wasteful and uneconomical expendi­
tures before the Atlanta audience the bulk of the illustra­
tions were drawn from the experience of the New York
bank. The financial layman could easily gain the impres­
sion that the Federal Reserve Board was a bank with its
main office in New York City.
In view of such assertions as these by a former member
of the general administrative body, it is not at all surpris­
ing that a large portion of the lay public has been induced
easily to convict the Board of sectional partiality, even
1 It is indisputable that reserve funds found their way in large amounts in the
post-war period to the speculative markets. But in the opinion of the writer
this was an inevitable, though unintended result of the “easy-money policy”
of the financial administration in the war and post-war period. This aspect
of the problem will be discussed in later chapters.
3This address is published in the Commercial and Financial Chronicle, July 23,
1921, pp. 354~58.



thojagjiits regulations have been general and scarcely ever
j/messed merely a sectional application.
/'Despite repeated assertions regarding the limitation of
its own powers to points of general policy, the Federal
Reserve Board has found it exceedingly difficult to define
the sphere of regional responsibility. Attempts to estab­
lish the accountability of the district directorate for its
own specific acts have always occasioned severely adverse
criticism. Indeed one of the legislators, possibly more
responsible for the final form of the Reserve Act than any
other one man, Senator Owen, complained on one occasion
most bitterly1 that the Board’s policy meant the abdica­
tion of its powers. Thus:
The Federal Reserve Board was created to control, regulate,
and stabilize credit in the interest of all the people. . . . [It] is
the most gigantic financial power in all the world. . . . Instead
of using this great power as the Federal Reserve Act intended
that it should be used, the Board abdicated. Instead of using
this power in the interests of all the people, the bankers in­
cluded, it delegated this power to the bankers.’
As long as the act entrusts to the Board such general
powers as supervision of rediscount rates; since decisions
in such matters must always affect some districts more
vitally than others, it will prove most difficult to place
upon the shoulders of the district directorate any large
measure of responsibility for what is believed to be the
industrial and business results of its general credit policy.
No matter how refined the game of “ passing the buck,”
success stands to be won by the body most frequently in
contact with the public. The local banker, in denying
credit accommodations lays responsibility upon the dis­
trict directorate; the district board calls attention to the
warnings of the Board against the granting of “ unessen1 Cf. Commercial and Financial Chronicle, July 30,1921, p. 475.
aSix of the nine district directors are selected by the member banks.



tial credits. ” The Board, however, can find no body
higher up, unless it be the legislators responsible for the
terms of the statute.
Nevertheless, the writer believes that the regional plan
has many merits of political expediency. The reserve sys­
tem is new, and much educational work still remains to be
done in acquainting the public with the nature of its
organization and operations. Because of the exceptionally
abnormal period during which it has lived, it has been
impossible for the Board to develop a permanent principle
regulating reserve bank advances.
*Furthermore, the responsibility of the district director­
ate has undoubtedly rendered it easier on many occasions
for the Board to resist the directly expressed demands of
certain special interests for credit advances. It has enabled
the Board to insist that it itself was not a bank and had no
money to loan. Thus Governor Harding was enabled to
write Senator Smoot of Utah in the summer of 19 11:1
In view of the fact that the twelve Federal Reserve Banks
are independent bodies corporate and are controlled and directed
each by its own board of directors, subject only to the general
supervision of the Federal Reserve Board, Whose authority with
respect to discount is confined principally to defining eligible
paper in accordance with the terms of section 13 of the Federal
Reserve Act, it seems to me that the statement which many,
both in Congress and on the outside, urge be issued by the
Federal Reserve Board, stating that the Federal Reserve Banks
will adopt certain policies in connection with the rediscounting
of agricultural paper, would have to be made by the Federal
Reserve Banks themselves. The Federal Reserve Board has no
power to interfere with the discretion given or the responsibility
imposed by law upon the directors of a Federal Reserve Bank
with respect to passing upon the merits of eligible paper offered
for discount.
xThis letter, written July ii, 1921, is published in complete form, in the Fed­

eral Reserve Bulletin, August, 1921, pp. 895-99.



Congress did not establish a central bank in this country. It
established twelve banks under the general supervision of the
Federal Reserve Board, which does not exercise bankingfunctions.1
These functions are exercised exclusively by the Federal Reserve
We are now in a position to derive a general conclusion
regarding the merits of the regional system. Politically it
appears to the writer to have been a clever device. It has
served to some extent in the past, and undoubtedly should
serve to a greater extent in the future, to localize sectional
complaints, and thus to ward off attacks which otherwise
would be launched upon the reserve system as a whole. In
an administrative way it has rendered possible an enor­
mous increase in business with a minimum of friction.
Had the plan of 1913 been that of a single central bank, it
is by no means impossible that by administrative develop­
ment it would have been organized finally upon lines some­
what similar to those of the reserve system of to-day.
Many duties can best be performed locally; district
branches must be provided under any central banking
system to assist in the work of check clearances, examina­
tions of condition of member banks, analysis of the quality
of paper of local origin offered for rediscount. Should such
a system get into the market continuously, the work of
these branches might not prove far different from that of
the regional banks of to-day.
The most vulnerable point of the regional system, in
the mind of the writer, is the closeness of contact between
the district directorates and the member banks. As indi­
cated previously, this feature was dependent upon the
desire to establish a group of bankers’ banks which should
exercise some measure of continuous control over the
money market. The advantages of a smoothly working
xThe italics are the writer's.



system of this sort are evident to all. But unless there are
developed principles of credit control, more sound econom­
ically than those enunciated in the past, the plan may
prove to have been too ambitious. It might have been
better to have proceeded upon the more modest lines of
devising merely an emergency machine. But, as it is, the
problem of the future is to develop sound rules for the
regulation of the credit advances of a set of banks per­
manently in the market.

early treatment of the subject of check collections
and clearances may evoke some surprise in the mind of the
reader. In criticisms of the old banking system following
the crisis of 1907, principal attention was not devoted to
the country’s clearance difficulties, and in most current
discussions major emphasis has been placed upon the new
system’s discount functions. Nevertheless, the writer
feels that the development of the Federal Reserve’s par
clearance system should be given a position of prominence.
Prior to 1914 clearing houses and clearing systems
represented the most important institutions of coopera­
tion developed through the initiative of the banks them­
selves. But the work of these institutions was not the
most efficiently coordinated and systematized. In par­
ticular, the various sections of the country were not served
by any single set of clearing institutions. What has been
done under the Federal Reserve is to establish common
centers for each of the districts under conditions whereby
the work of each will be closely related. If we hold to the
view that the reserve system was established primarily to
secure more effective cooperation in banking, the impor­
tance of the clearing functions of the new banks is clear.
Check clearances, moreover, indicate more largely than
any other single function the need of the continuous opera­
tion of the reserve banks. The volume of rediscounting
must alter greatly with changing business conditions; it



may be that on certain occasions there will be very little
demand for the reserve system's funds. In the early years
of operation, for instance, little success was achieved in
the desire to get the reserve banks actively in the money
market through their discount functions. Then, especially,
was it highly important that a service be developed for
which member banks would find a constant need.
In no matter of government and administration, fur­
thermore, has more tact and diplomacy been required
than in the efforts to extend the scope of the reserve clear­
ing system. In the early legislative history of the statute
no provisions were more vehemently attacked than those
providing for country-wide par collections. After the date
of inauguration each step in the development of the clear­
ing system has been carefully observed and analyzed by
the great number of country banks. In view of the im­
possibility of building an imposing reserve edifice upon
the insufficient foundations of limited membership, this
attitude of the country banks often compelled the modi­
fications of plans which the requirements of efficiency
would otherwise have dictated.
Difficulties in check collections existing prior to 1914
are generally understood. In the first place, the indirect
routing of distantly drawn checks created much delay in
securing the return of checks to the drawee bank. As a
second aspect of this difficulty reserves were built up in an
exceedingly unscientific manner and consisted frequently
to a large degree of checks in the mails. In the third place,
check collections were rendered more expensive because
the local clearing system usually comprised a portion only
of the banks in the locality. It is a well-known principle of
check clearances that the possibilities of offsetting clearing
debits by clearing credits are limited when the system does
not embrace a large portion of the banks which mutually



receive and collect each other’s checks.' One bank may
receive in a day about the same volume of checks drawn
against other banks as the other banks receive against it.
But there is no guarantee that in a collection system of
limited scope any one bank’s credits may not greatly
exceed its debits and vice versa.
But to consider these difficulties more in detail, let us
first turn our attention to the matter of the indirect routing
of checks. The purpose of this prevailing custom was to
enable some bank to avoid the deduction of exchange
charges imposed by the drawee institution. Bank A, in
one district, receives checks drawn against Bank B in
another district. If A sends these checks directly to B, B
would customarily remit something less than their full
face value. Justification for this deduction was in part the
clerical labor and other expense necessitated in the making
of remittance. Bank B must remit by dispatching cur­
rency by registered mail or express, or by drawing against
a foreign balance previously established for this particular
purpose. The building-up of these foreign accounts, be it
by the purchase of exchange, the shipping of currency, or
the discounting of its own note, was costly. Bank A in turn
might attempt to recoup itself for this exchange deduction
by imposing an exchange charge upon the individual who
deposits the check. In many situations, however, banking
customs were so firmly established and banking competi­
tion so keen as to render impracticable such a practice in
the case of regular clients. All the greater, consequently,
was the necessity of avoiding if possible the loss through
the deduction of exchange in Bank B ’s remittance.
One of the means of escaping such a loss would be for
Bank A to establish par relations with banks in foreign
territory. Two banks located in different parts of the
country could agree to collect for each other checks drawn



against banks in a certain prescribed territory.1 Thus
Bank A gives full par credit to Bank C for the deposit of
checks drawn against banks in the neighborhood of Bank
A. Bank C does the same for Bank A. If Bank B is lo­
cated in the district of Bank C, Bank A is able to collect
through C without loss checks drawn against B. But in
order to induce some outside bank to collect at par and
thereby absorb the exchange charge, it was often necessary
for one of the banks to maintain a deposit balance in the
other. Thus:
The First and Old Detroit National Bank carries deposits
accounts in banks scattered over the country for the purpose of
getting checks collected at par. In fact such checks are not
collected at par, because the bank loses the use of its funds on
deposit. The interest on such funds is the price paid for the
“par” collections.3
But the point most to be emphasized here is that the
existence of such par points served to impede the direct
return of checks. Instead of being sent directly to the
drawee bank for remittance, they would be dispatched to
the par or free city, where perhaps they would be again
indirectly routed to the drawee bank.
Bank A, for
instance, dispatches checks drawn against Bank B not
directly to B, but to its collection correspondent, Bank C.
This devious routing increased the number of banks
through which the “ homing” check passed and padded
the expenses of collection. But possibly more important
than this increased expense was the manner in which such
distantly drawn checks were customarily handled in the
creation of legal reserves. B y the practice previously per1A good account of such arrangements is contained in an address by William
J. Gray, at Portland, Michigan, August, 1916. This address was published in
the Michigan Investor and quoted by the Commercial and Financial Chronicle,
August 19, 1916, pp. 636-37.




mitted by the Comptroller of the Currency, the country
bank remits a cash letter to the bank which acts as its
collecting agent in the reserve city, “ and on that day
charges the amount of that cash letter to its reserve agent
and considers it a cash balance and part of its reserve.” *
Needless to remark, the reserve agent may find it impossi­
ble to collect from the drawee bank for some days. It, in
turn, may forward the check indirectly through one of its
par correspondents and thereby create a reserve balance
for itself. The same check may suffice finally to establish
several fold its face value in reserve money before being
charged to the account of the drawer. As a final outcome
the check may retrace its path marked “ no funds.” A t
one time it was estimated that the amount of checks in the
mails— the so-called “ float” — amounted to three hun­
dred millions of dollars daily.*
The desirability of correcting such evils as these would
appear to have furnished sufficient warrant for the altera­
tion of former collection methods. But certain special
circumstances, possibly less fundamental in their impor­
tance, supplied in large measure the raison d’etre for the
new machinery. Among these was the fact that under the
reserve system it became necessary for the reserve banks
to assume many functions previously provided for by the
city correspondents of the country banks. There is no
doubt but that in the discussion over banking reform
victory was won by the “ interior” as against the finan­
cial interests in the metropolitan centers. In the panic of
1907, interior banks found themselves unable to secure
funds by drawing upon their New York deposits. This,
xFrom an address by Benjamin Strong, Jr., delivered June 24, 1915, before
the New York State Bankers' Association at Saratoga Springs, New York. A
portion of this address is published in the Economic World, July 17,1915, pp.
*Cf. E. W. Kemmerer, The A B C of the Federal Reserve System, pp. 20-21.



above all, explains, in the opinion of the writer, the willing­
ness of the country banker to lend an ear to discussions of
banking reform. Academic criticisms of the old methods
were not nearly so determining.
But what was the source of the 1907 difficulty in the
financial centers? W not primarily this — bankers’
balances were not invested properly, were not kept in
sufficiently liquid form? Therefore must there be set up
new institutions whose resources should be available for
the members in time of need, institutions whose invest­
ments must be kept liquid. The reserve banks were to
become the city correspondents of country banks. But if
the reserve banks were to function in this manner they
must give credit for checks forwarded for collection by the
member institutions. Otherwise the member banks would
find the new machinery costly. To the foreign deposits
established for purposes of collection must be added
deposits the Reserve Act required to be kept with reserve
banks. To avoid such duplication of deposits and, accord­
ingly, of expense, the reserve banks, themselves, must act
as collection agents. But if the credits, the reserves, of
member banks were to be real and not hypothetical, the
old method of establishing reserves must be modified.
The “ float” feature must be abolished.
Banking reform, moreover, was not solely the result of
criticism by bankers. It was to a very great degree the
result of the demands of business which had been insisting
for years that exchange exactions were unduly burdensome.
It has been stated previously that, in their eagerness
to secure deposits of country banks, city institutions
were often willing to absorb exchange charges by giving
immediate and full credit for the deposit of country bank
checks. Often no attempt was made to recover this loss
from the public. Nevertheless, the amount of exchange



charges paid by the public aggregated an enormous sum
and there was an insistent demand that by the establish­
ment of more efficient methods of check collections the
burden borne by the public should be lightened.
These exchange exactions, moreover, were not always
imposed equitably, a feature which served to increase the
public discontent. In Baltimore,1 for instance, there was
an old rule of the Clearing House that out-of-town items
would be taken at par only from depositors who had been
regular customers of their banks at the time, years ago,
when a new rule was adopted requiring such charges of
new depositors. But if an old customer should change his
account to another bank, he was considered as a “ new
account” and lost his privilege of depositing at par.
Change from one bank to another was not free. New cor­
porations and new enterprises explained their hesitancy
to establish themselves in this city on the ground that they
would be handicapped in their competition with the older
firms. In one case the par-deposit privilege was lost merely
by a change in the firm name. The new name compelled
the application of the rule applying to new businesses.
Amid such conditions as these there was a widespread
demand that the reserve system provide for the limitation
of such exchange exactions.
In the earlier legislative stages of the Federal Reserve
Act provisions were inserted the intent of which was to
eliminate these charges entirely. But the bill thus framed
met speedy and vigorous objection on the part of a great
majority of the exchange-charging banks. Many country
banks asserted that the elimination of such charges would
impair very seriously their profits. Nor would they accept
the argument that in the course of time their interest
1 Cf. weekly circular of Nelson, Cook & Co., of Baltimore, issued August 5,
1916. References to this circular are to be found in the Commercial and Finan­
cial Chronicle, August 12, 1916, p. 534.



charges automatically would be increased to compensate
for such loss; that since the competition between banks
must determine the rates on bank loans, equal treatment
to all could mean no discrimination against any one in par­
ticular. Country banks maintained that in many situa­
tions local competition was not operative in large degree;
that custom and law were frequently so determinative as
to prevent the shifting of such loss to the borrowing pub­
lic. All banking communities, furthermore, display some
rivalry one with another. The time has passed when
banking custom can decree uniformly that a local indus­
try shall depend exclusively upon the local bank. Elimina­
tion of such charges would handicap most those institu­
tions which in the past had depended upon exchange for a
considerable portion of their profits. By the proposed new
law the city institutions would often gain more than they
would lose. In the past many of them had been willing to
absorb such charges for the privileges of receiving the
accounts of the country banks. It was often forgotten that
under the Reserve Act these city institutions stood to lose
a large portion of bankers’ deposits through the transfer of
reserves to the reserve banks. It was accordingly asserted
that the elimination of exchange charges must affect most
injuriously those banking institutions which previously
had experienced the greatest difficulties in realizing reason­
able profits.
The collective legislative influence of the country
bankers was enormous. Not merely did their number
enable them to bring pressure to bear upon very many
legislators, but it was peculiarly essential that the provi­
sions of the act be not such as to cause the refusal of any
large number of eligible banking institutions to join the
system. It is not difficult, then, to account for the altera­
tion in the terms of the bill according to which it was



expressly stipulated that nothing in the act should be so
construed as to prohibit a member bank from charging its
actual expenses incurred in collecting and remitting funds,
or for exchange sold its patrons.
We may now summarize the various provisions of the
act as finally enacted dealing with check collections and
clearances. First, there was the provision of section 16
Every Federal reserve bank shall receive on deposit at par
from member banks or from Federal reserve banks checks and
drafts drawn upon any of its depositors, and when remitted by
a Federal reserve bank, checks and drafts drawn by any depos­
itor in any other Federal reserve bank or member bank upon
funds to the credit of said depositor in said reserve bank or
member bank.1
This provision is made subject to the exception noted
above. Since a Federal ReseiVe Bank is thus required to
give credit to other banks, economy and efficiency would
demand that it clear the checks thus received, in order to
employ the most economical method of determining the
net credit or debit balance due from or to any bank.
Accordingly there was enacted the further provision in the
same section that the Federal Reserve Board
may also require each such [reserve] bank to exercise the func­
tions of a clearing house for its member banks.
This last-quoted provision would concern intra-district
clearings. But the receipt by one reserve bank of checks
drawn against member banks in other districts would
create debits and credits among the various reserve banks.
Bank A of district one receives credit for a check drawn
against Bank B of district two. The reserve bank of dis­
trict one recoups itself by charging to the reserve bank of
district two. In similar fashion the reserve bank of district
xA similar provision was contained in the first paragraph of section 13.



three receives items collectible in district two and vice
versa. Accordingly another sentence of section 16 gives
the Federal Reserve Board discretionary power to
exercise the functions of a clearing house for such Federal re­
serve banks.
This, as noted in Chapter I, made necessary the later
establishment of the Gold Settlement Fund at Washington.
From the wording of the act, it would appear as if the
exchange-charging banks had won a complete victory.
The law provided that the reserve banks “ shall” receive
at par checks drawn on member banks. It furthermore
reserved expressly the right to the drawee bank to deduct
reasonable exchange for expenses incurred in collecting
and remitting funds. Must not the reserve banks be
obliged, therefore, to absorb the costs of collecting checks?
Means of escaping the absorption of such charges would
seem to lie, therefore, in the following lines of action:
First, the “ shall ” in the clause of section 16 above referred
to might be construed as permissive and not mandatory.1
Such a construction, however, was unlikely, as it would
involve a perversion of the meaning usually understood to
pertain to the word “ shall.” Second, the reserve bank
might agree to bear the expense of remittance of funds
from member to reserve banks,. and thus, by eliminating
this item of expense, destroy, partially at least, the right
of the drawee bank to charge exchange. If necessary
checks could be presented at the counter and their full
face value demanded. In the third place, the permissive
“ m ay” of the last paragraph of section 16, relating to the
clearing functions of reserve banks, might be so construed
as to deny membership in the clearing system to those
member banks which insisted on deducting exchange. In
1Some slight confirmation of this view is afforded by the fact that the similar
provision of section 13 contained the permissive “ may.’'



other words, the permissive “ m ay” might enable reserve
banks to refuse to clear for banks which would not agree
to whatever conditions should be imposed upon clearing
members. One of these conditions might be the agreement
of a member bank to remit at par. The final outcome of
the clearance problem must depend much upon future
statutory interpretation and administrative procedure.
Because the work of the reserve banks must be built up
anew on bed-rock foundations, it was not to be expected
that the reserve banks, immediately in 1914, should begin
the exercise of all the functions contemplated for ultimate
development. Neither was it expected that the various
reserve banks should all operate at the outset in precisely
the same manner. Beginnings were slow and varied much
between the various district banks. In the early days the
New York Reserve Bank, for instance, would receive
checks drawn only on reserve banks and those drawn by
a member bank on another member institution in the
cities of New York, Albany, and Brooklyn.1 On December
I, 1914, the Federal Reserve Board granted the reserve
bank of Kansas City power to clear checks presented by
member banks drawn on member banks.® St. Louis was
also among the first to provide such service and on the 4th
of March, 1915, it was announced by the Board that the
Chicago Federal Reserve Bank had been clearing checks
between the member banks of the seven Reserve and Cen­
tral Reserve cities of the district.3 But on the same date it
was announced that only three reserve banks, those of
Kansas City, St. Louis, and Chicago, had taken advan­
tage of the clearance privileges conferred by the act.
1 Cf. letter by Governor Strong, of the New York Reserve Bank, in the Com­

mercial and Financial Chronicle, December 5,1914, p. 1636.
3Cf. Commercial and Financial Chronicle, December 5, 1914, p. 1635.
aCf. ibid,, March 13, 1915, p. 867.



Aside from the initial pressure of new work and duties
there were additional reasons for delay. Inter-district
clearings awaited the development of the Gold Settlement
Fund, an undertaking not successfully completed until
June, 1915.1 Intra-district clearings uncovered some legal
it being argued that there is no power to compel a member bank
not located in a Federal Reserve city to pay or have charged to
its account at the Federal Reserve Bank of its district a check
which it had not seen and approved prior to the times of presen­
tation at its own counter.2
There was also a natural hesitancy to establish a clearing
system, which, on the one hand, might admit the right
of the drawee bank to charge exchange, or, on the other
hand, to create early opposition to the system by definitely
eliminating such charges. Furthermore, because final
transfer of reserves to reserve banks was not to be com­
pleted for three years, financial considerations created
some solid basis for opposition to the immediate introduc­
tion of a complete clearance system which might neces­
sitate the maintenance of balances with reserve banks.
During the period in which reserves could be kept par­
tially with city institutions, it might be a hardship to com­
pel city banks to give up this clearance work to the reserve
or to compel country banks to transfer balances to the
reserve institutions for clearing work. Balances with the
reserve banks would draw no interest. For these various
reasons the Reserve Board began to work first on the
establishment of a voluntary-reciprocal plan of clearances.
It was believed that sufficient success might be achieved
with such a system to render unnecessary measures ultracompulsory in nature.
1 Cf. Report of the Federal Reserve Board for the year 1915, p. 14.
aI b i d p. 15.

In the spring of 1915 the Federal Reserve Board began
to send to the various reserve banks descriptive circulars
of the new voluntary-reciprocal plan.1 According to this
plan membership was to be purely voluntary. Checks
would not be cleared drawn upon banks which would not
agree to remit at par. But, on the other hand, banks not
agreeing to remit the full face value of checks drawn
against them could not avail themselves of the facilities
of the reserve system in collecting checks drawn upon
other banks. Details of operation would differ in the vari­
ous districts. In the Chicago district,* the costs of operat­
ing the system were to be borne by the reserve bank and
each bank must maintain sufficient funds on deposit with
the reserve bank to permit the immediate charge of debit
balances. The amount of such balances would be deter­
mined by experience gained as the system continued its
operation. But regardless of the details, the clearing sys­
tem in each district was to be open to every bank which
would agree to permit the deduction at par of its own debit
items. The motives for joining the system would be: first,
the economies realizable in the collection of checks drawn
against other banks; second, increased acceptability of
the member’s own checks.
In the opinion of the great majority of the banks, how­
ever, either the time for entrance was inopportune, or the
obligations greatly outweighed the privileges. By Janu­
ary, 1916, it was stated3that only about twenty-six hun­
dred out of a total number of eight thousand member
institutions had subscribed to the provisions necessary
for admittance. Accordingly, the Board felt that more
compulsory measures were necessary. As a consequence
of this belief there was devised a new system which began
* Cf. Bulletin, May I, 1915, pp. 6-7.
a Cf. ibid., pp. 7-9.
* Cf. Commercial and Financial Chronicle, January I, 1916, p. 15.



operation on July 15,1916. This plan provided the nucleus
for the development of the present clearance system.
B y the terms of this new plan, member banks, regard­
less of their own volition, were to be required to pay with­
out deduction checks drawn upon themselves and pre­
sented at their own counters. Remittance by the reserve
banks through the mail was to be construed as presenta­
tion at their own counters. Settlement could be made by
acceptable checks on other banks or by the shipment of
lawful money or Federal Reserve notes1 at the expense of
the reserve bank. It would not be necessary, therefore, for
banks to maintain balances at reserve banks for clearing
purposes. For its services as a collection agent the reserve
bank could collect a small service charge of, say, one and a
half to two cents an item from the bank for whom collec­
tions were made. In the course of time, however, such
charges were eliminated.
The only compulsory feature of the new plan was that
Requiring payment at par from drawee member banks.
Member banks were free to keep clearing balances else­
where and to clear through private agencies if they so
desired. But it was not believed that many member banks
would find it to their advantage to clear elsewhere than
through the reserve. If they must remit at par to the
reserve banks, why not gain the advantages of collection
of credit items at par? B y construing the sending of checks
through the mails as presentment at the counter, it was
believed that legal objection could not be made to the
denial of the right of a bank to deduct exchange.
Under the new system checks would also be received
drawn upon such non-member institutions as could be
collected at par. Desire to avail of the economies in the
collection of credit items and to increase the circulatory
* See Bulletin, June i, 1916, pp. 262-64.



power of their own checks might be appealing motives
influencing non-member institutions to remit at par. To
make the law more clear regarding the status of non­
member banks, an amendment was secured to the Federal
Reserve Act on September 7, 1916, expressly permitting
reserve banks to receive deposits of all checks and drafts
payable upon presentation.
This amendment, however, contained no mandatory
provision regarding the remittances of State banks. Re­
fusal of any large number of such banks to become clearing
members must weaken the system seriously. The services
rendered by the reserve banks must depend upon the
volume of checks collectible for each clearing member.
Consequently, some of the reserve banks began to search
for various means of compelling membership. The meas­
ures adopted were often expensive, but were undertaken,
nevertheless, on the theory that if, by presentation at the
counter, the State banks could be forced to make par
remittance, they would perceive the desirability of joining
the reserve clearance system and thereby gain whatever
advantages this system offered as an agency for the col­
lection of their own credit items.
Collection at the counter necessitated local agencies to
protest items not promptly paid. In case a member bank
was located in the town, there would be no great difficulty
in establishing such an agency. Otherwise arrangements
must be made to secure the services of some other institu­
tion. A t one time a project was developed whereby post­
masters might act sis agents of the reserve banks in towns
where no member bank was situated.1 But undoubtedly
because of its doubtful political expediency this project
was abandoned. Often notaries and express agents would
be employed. In some cases it is asserted that the reserve
1 Cf. Commercial and Financial Chronicle, July 2 2 ,1916, p. 284.



bank or its agent would save up the checks of the State
bank until they amounted to a considerable volume. Then
they would be dispatched to the drawee bank by automo­
bile or otherwise and presented in bulk.
Such arrangements were pushed zealously and possibly
in some cases with excessive vigor. In an address delivered
in the House, Representative Reavis complained on one
occasion that in the town of Pierce, Nebraska, representa­
tives of the reserve bank saved up checks until they
amounted to $41,000.* Then they went in an automobile
to this town and demanded payment in cash. Inasmuch
as every bank bases its operations on an approximate
daily correspondence of daily income and daily outgo, such
measures must prove exceedingly embarrassing. Repre­
sentative Reavis also charged that in its endeavor to force
this bank to terms the reserve bank had a man on the
ground endeavoring to organize a competing national bank.
These attempts at coercion inevitably occasioned the
utmost of protest by the non-member State banks. Their
protests were expressed in various ways. Bankers’ asso­
ciations were exhorted to exert pressure in their behalf,
and efforts were made to secure the enactment of legisla­
tion prohibiting the coercive measures. In suits at law,
moreover, the reserve banks were accused of exceeding
their lawful powers.
As an outcome of such protests laws were enacted in
several States unfriendly to the Board’s plans. Among
these States were North Carolina, Tennessee, and Missis­
sippi. As a type of such legislation the Mississippi law is
well worth summarizing.* First, it definitely legalized what
it called “ the established custom” of banks of that State
1 Extracts from this address are published in the Commercial and Financial

Chronicle, February 7, 192a, pp. 515-16.
3The complete text of this law may be found in the Bulletin, April, 1920, p. 387.



to charge a service fee commonly called exchange for col­
lection and remittance. Second, banks were given discre­
tionary power to deduct exchange on items presented by
any bank, “ post-office, express company, or any collection
agency, or by any other agency whatsoever.” In the third
place, State officers were deprived of power to “ protest
for nonpayment any such ‘ cash item’ when such non­
payment is solely on account of the failure of any of such
agencies to pay such exchange.” Furthermore, there
should be “ no right of action, either at law or in equity,
against any bank in this State for refusal to pay such cash
item, when such refusal is based alone on the ground of the
nonpayment of such exchange.”
Various suits at law were begun also to test the validity
of the coercive measures. The most important of these was
the American Bank and Trust Company et al. v. Federal
Reserve Bank of Atlanta. On appeal this suit was brought
to the Supreme Court of the United States.1 In this case
it was alleged that the practice of the Atlanta Reserve
Bank had been to accumulate a large number of checks
upon the exchange-charging banks, then present them at
the counter, and demand cash in payment. It was com­
plained that such methods were employed with malicious
intent, for the purpose of injuring the business of the non­
member drawee banks. In the decision of the district
court it was held that the defendant’s right to cash checks
in this way was absolute, and that the matter of malicious
intent was irrelevant. This ruling, however, was reversed
in the decision of the higher court. Consequently the case
was remanded to the original court for decision upon its
Because of its probable future importance, certain
* The opinion delivered by Mr. Justice Holmes is printed in the Bulletin,
June, 1921, pp. 700-01.



remarks of Mr. Justice Holmes, who delivered the opinion
for the Supreme Court, are well worth quoting. Thus:
The defendants say that the holder of a check has a right to
present it to the bank upon which it was drawn for payment
over the counter, and that however many checks he may hold
he has the same right as to all of them and may present them all
at once, whatever his motive or intent. . . . But the word
“ right*9is one of the most deceptive of pitfalls; it is so easy to
slip from a qualified meaning in the premise to an unqualified
one in the conclusion. Most rights are qualified.
And then, after a few illustrations of the necessity of
guarding carefully our concept of “ rights” :
Banks, as we know them, could not exist if they could not
rely upon averages and lend a large part of the money that they
receive from their depositors on the assumption that not more
than a certain fraction of it will be demanded on any one day.
If without a word of falsehood, but acting from what we have
called disinterested malevolence, a man by persuasion should
organize and carry into effect a run upon a bank and ruin it, we
can not doubt that an action would lie.
To determine the lawful procedure for the defendants (the
reserve bank)
it is not enough to refer to the general right of a holder of checks
to present them, but it is necessary to consider whether the
collection of checks and presenting them in a body for the pur­
pose of breaking down the petitioner's business as now con­
ducted is justified by the ulterior purpose in view.
The probable results of this decision were variously
interpreted. Many exchange-charging banks hailed it as
the legal solution of their difficulties, and predicted as the
final outcome the withdrawal of many non-member banks
from the par list and the final acknowledgment by the
reserve institutions of the drawee bank’s right to deduct
exchange. In this vein writes Mr. L. R. Adams,1 in the
Journal of the American Bankers' Association:2
1 Mr. Adams was secretary-treasurer of the Country Bankers’ Association
of Georgia.
2 Issue of June, 1921, pp. 776-79.



We anticipate that the final effect of the Supreme Court’s
decision will be that both member and non-member banks will
be given the right to charge reasonable exchange on checks
cleared through the Federal reserve system or otherwise. How­
ever that may be, it appears that the country banks of Georgia
. . . have laid out a road which the Supreme Court has paved
with concrete principles of justice, over which the non-member
banks may safely and smoothly travel, using as a vehicle the
equity processes of the Federal courts, to a safe haven in which
they may exercise their lawful functions without fear of “embar­
rassing, annoying and expensive” methods of forcing their com­
pliance with unauthorized demands.
When the case was remanded to the lower court, how­
ever, for a decision on its merits, the opinion of the court
was hostile to the plaintiffs. United States District Judge
Beverly D. Evans held1 that the reserve banks properly
could collect all checks payable upon presentation, includ­
ing checks drawn on non-member banks, and that they
could not pay any exchange charges. As regards the
method of collection the court stated:
(3) In the discharge of its duties with respect to the collection
of checks deposited with them, and with respect to performing
the functions of a clearing house, the several Federal reserve
banks are empowered to adopt any reasonable measure designed
to accomplish these purposes. To that end a Federal reserve
bank may send checks to the drawee bank directly, for remit­
tance through the mails, of collections without cost of exchange.
If the drawee bank refuses to remit without deduction of the
cost of exchange, it is in the power of the several Federal reserve
banks to employ any proper instrumentality or agency to col­
lect the checks from the drawee bank, and it may legitimately
pay the necessary cost of this service.
(4) The process of the daily collection of checks, in the exer­
cise of the clearing-house functions, is not rendered unlawful
* This opinion is printed in the April, 1922, Bulletin, p. 436.



because of the fact that of the checks handled two or more of
them may be drawn on the same bank.
Only in one respect did this opinion grant comfort to
the complaining banks. It was held that there should not
be publication on the par list of the name of a non-member
bank without its consent. While it might be true that the
checks of a certain non-member bank could be collected
at par, it might also be that this bank had not consented to
the par clearance plan. But this is a matter of minor
But before the opinion of Judge Evans was announced
it did not appear to the writer that the enthusiastic predic­
tions of Mr. Adams could be fulfilled. It would seem as if
always the burden of proof regarding the matter of mali­
cious intent would rest on the complainants. Furthermore,
courts, very likely, will be inclined to be liberal in inter­
preting the collection difficulties of the reserve banks. It
cannot be expected that the reserve bank shall submit to
unnecessary expense in the collection of a single check.
Economy will justify their collection in batches. To
determine when malicious motives are present will require
special evidence in every case. The expense of such litiga­
tion may operate to deter many of the small country
banks from bringing suit.1 Finally, not everything in the
opinion of Justice Holmes was favorable to the contention
of the plaintiffs. For one matter, it was held that in a
case of this sort the Federal and not the State courts
possessed jurisdiction. If it be true that the general body
of business opinion is hostile to the exchange charges, re­
serve banks may prefer to have such cases decided in the
United States courts, which are more likely to be in­
fluenced by the general attitude of the country as a whole
and not that of a single community.
* Of course attempts may be made to distribute this expense through the for­
mation of associations of bankers.



If this conclusion be correct, relief for the exchangecharging banks can be had only by securing changes in the
Federal statute. As a matter of previous development
such statutory alterations already had been vigorously
attempted. A t first only success was achieved. In the
spring of 1917 the so-called Hardwick amendment to the
Federal Reserve Act was passed in the Senate expressly
legalizing the deduction by the drawee bank of a reason­
able charge for the collection and remittance expenses, and
in the House, on May 10,1917, by a vote of more than two
to one, conferees were directed to accept the substance of
this amendment. Before the conferees came to an agree­
ment, however, it was charged that intensive lobbying was
employed in order to defeat the amendment. Regarding
this Mr. Thralls states:x
A nation-wide campaign had been conducted by the Credit
Men’s Association, the mail-order houses, manufacturers,
jobbers, wholesalers, and merchants in the large centers for the
defeat of the Hardwick amendment. These interests were ably
assisted by the Federal Reserve Banks.
Material changes, which if literally interpreted will defeat the
purpose of the amendment, were made in conference. When
the bill was reported for consideration in the House, the point of
order that the managers of the House had not obeyed instruc­
tions was overruled. This ruling, in the minds of many, is con­
trary to parliamentary precedents. The Administration pres­
sure was turned on, and the report was accepted. It contained
two modifications:
1. Providing that the charges are to be determined and regu­
lated by the Federal Reserve Board.
2. Providing that no such charges shall be made against the
Federal Reserve banks.
This last modification, when it became law, took the
x Cf. Mr. Jerome Thralls, secretary of the National Bank and Clearing House
Sections of the American Bankers’ Association, in the Journal of the American
Bankers’ Association for July, 1917. The substance of this address is printed in
the Commercial and Financial Chronicle, July 21,1917, pp. 235-36.



teeth out of the amendment. It completely turned the
tables on the exchange-charging banks. So far as the law
was altered at all, it affirmed more definitely than ever the
right of the reserve banks to refuse exchange deductions
by drawee banks.
Mr. Thralls’s charge that the Hardwick amendment was
unfairly defeated may be true. But aside from the means
employed, the Federal Reserve Board had an exceedingly
strong case. In the first place, expense of remittance to the
collection agent was reduced by the agreement of the
reserve bank to absorb such costs on checks cleared
through it. A part of the justification for the earlier prac­
tice was thus eliminated. In the second place, the pro­
hibited charges related only to those sought against the
reserve banks and did not apply to those levied upon the
public. In view of the economies of collecting through
an efficient clearing system, such levies, however, should
be much more reasonable than those exacted under the
old banking system. Banks would no longer be obliged
to maintain deposits in outside private banks in order to
facilitate the collection of their own checks. If the reserve
banks give credit at par, should they not be permitted to
collect at par? If the reserve banks are considered as act­
ing merely as an agent for the member banks, elimination
of exchange charges could not affect them at all in the
aggregate. To the extent that one bank is denied an item
of income, another is saved an item of expense.
It will always be extremely difficult to ascertain the real
attitude of the banks toward the Board’s clearance plan.
Many bankers who disliked this feature of reserve opera­
tion may have withheld vigorous objection because of
their dependence upon other functions of the Federal
Reserve. On the other hand, some of the larger city banks
may have felt it impracticable to take a leading part in the



agitation for the spread of the plan for fear of estranging
the country banks for whom they wished to continue to
serve as city agents. In point of numbers, however, it is
undoubtedly true that the decision of the bankers would
be decidedly unfriendly. A t least, the results of most
referenda indicate general hostility toward the plan. In
one such referendum, conducted by Mr. Jerome Thralls,
of the Clearing House and National Banks Sections of the
American Bankers’ Association, more than three fourths
of the replies gave a negative answer to the following ques­
tion: “ Is the plan of clearing and check collection now
operated by the Federal Reserve banks satisfactory to
you?” 1 On another occasion Governor Harding, of the
Federal Reserve Board, admitted that probably twenty
thousand out of twenty-four thousand acquiescing banks
had agreed to the system unwillingly.2 Mr. Harding justi­
fied the plan on the ground that it represented solely the
sincere desire to administer the law. If relief was desired,
he insisted that pressure should be brought to bear upon
the legislative branch of the Government and not upon the
Federal Reserve Board. Stating further that the Board
desired to clear up any possible vagueness as to the intent
of the legislators, he even suggested the terms of a possible
amendment to the law which would preserve the right of
exchange deductions.3 This attitude of Mr. Harding,
however, can be reconciled only with difficulty with his
policy at the time of legislative consideration of the Hard­
wick amendment. Then he took an active, and not merely
passive, position of hostility to the terms of the amendment
suggested by the exchange-charging banks.
Aside, however, from the popularity of the par collec­
tion system the Board has met with remarkable success in
1 See Commercial and Financial Chronicle, December 16 ,1916, p. 2199.
* CL ibid., May 15,192a, pp. 2034-36.
3 See Commercial and Financial Chronicle, May 15,1920, pp. 2036-37.



its endeavors to extend the scope of the new plan. It is
true that at first much difficulty was encountered. In the
Federal Reserve Bulletin for February i, 1918, we read:1
Where good progress has been made it has been almost invar­
iably due to energetic solicitation by one or more members of
the staff of the bank who have devoted their attention to the
matter and have done actual work for the purpose of adding to
their par list.
Nevertheless, on February 15, 1922, 28,906 member and
non-member institutions were on the par list and only
2,327 not on this list. On this date every bank in the Bos­
ton, New York, Philadelphia, Chicago, and San Francisco
districts was a member of the clearing system. The vol­
ume of work accomplished has increased enormously. In
the month January 16 to February 15, 1922, total items
handled amounted to nearly eleven billions of dollars.
It has been suggested previously that the attitude of
business in its desire to avoid exchange charges has been
the principal support of the reserve banks in the employ­
ment of their coercive measures. Undoubtedly much of
the approval of business in the early days was due to the
mistaken belief that as a final outcome all exchange
charges would be absolutely eliminated. As previously
indicated, this is not true. There is now legal warrant for
the exaction from the public of certain minimum charges.
While on the whole such charges are less than in the old
days, there are numerous exceptions due to the desire of
many banks to make up in charges to the public what has
been lost in exactions against other banks. Thus the
Farmers & Merchants National Bank of Los Angeles,
California, stated in its monthly letter on September 15,
1 Page 75.
3 Extracts from this letter are printed in the Commercial and Financial Chron­
icle, September 23, 1916, pp. 1083-84.

The banks on the Pacific Coast, for instance, have heretofore
accepted Eastern drafts at par. They recoup themselves by
selling exchanges against Eastern funds thus obtained. To-day,
if a man walks into a Pacific Coast bank with a draft drawn by
a solvent party on an Eastern bank, and wants immediate
credit for the proceeds thereof, he will be compelled to pay for
the use of the money until the bank cashing the draft has re­
ceived its proceeds from the party upon whom it is drawn. If a
merchant deposits out-of-town items and gets immediate credit
for them, he will be compelled to pay the bank with whom he
makes the deposit for the use of the money advanced on those
items until the bank has collected them. There are a thousand
and one services which banks have gratuitously performed for
their customers that they will now charge for.
It will be generally agreed that such practices, if not
carried to undue lengths, are as they should be. Nobody
will argue that the bank should perform such services
gratis. Losses encountered in one operation must be made
up in others. What has been accomplished under the
Federal Reserve has been to place the various services of a
bank on such a basis as to increase the likelihood that each
will carry a larger portion of its own cost. As previously
indicated, the aggregate burden borne by the public
should be considerably reduced under the new plan. No
longer need so many deposits be maintained at various
points throughout the country for domestic exchange pur­
poses. No longer need checks be indirectly routed with
resulting increases in clerical and postage expense. No
longer is the principal clearance work of the country per­
formed entirely by unrelated and uncoordinated clearing
organizations. These economies should redound ultimately
to the benefit of the public.
In order that the reserve banks should function satis­
factorily as the correspondent banks of the members, it
soon became necessary that they handle other items than
bank checks. It would have worked a hardship to require



member banks to maintain balances with city correspond­
ents in addition to those with reserve banks. Accordingly
in the Bulletin for September 1, 1917,1 we read that the
Board requests the various reserve banks to establish
collection departments for time items. At the present
time the reserve system handles, in cases where satisfac­
tory arrangements exist for collecting checks, such items
as promissory notes, trade bills, trade drafts, coupons and
acceptances. This extension of the reserve activities was
necessary if the reserve banks were to be effective substi­
tutes for the former reserve agents of member banks.
The growth in this collection work has necessitated a
considerable enlargement of the functions of the Gold
Settlement Fund. Prior to the development of the inter­
district system it was employed largely to handle transfers
or drawings between reserve banks. Later it became the
means by which individual banks could be benefited
directly. Transfers originating with one member bank
can be made in the interest of another member bank of
another district. In the course of its development it be­
came the agency by which transfers could be made on note
accounts between the Federal Reserve agents and the
reserve banks which they represent. Finally it became
the clearance fund for the inter-district collection system.
It is impossible to stress too highly its functions in ena­
bling to run smoothly the machinery of domestic exchange.
What now shall be our conclusions regarding the merits
of the par collections controversy? Shall we take the posi­
tion that because of its economy and efficiency its further
progress should not be impeded? Or should we conclude
that, while an economy may have been wrought for the
banks as a whole, it has discriminated unfairly against the
small country bank?
* Page 661.



It is clear, first of all, that the law does not prevent the
country bank from levying upon the depositor of a check
drawn upon a foreign bank. Some banks, however, receive
fewer checks drawn upon foreign banks than are presented
to them for collection. Such charges may not be sufficient
to overcome the loss due to the necessity of remitting for
its own checks at par. If this be the situation, then, why
not levy upon the depositor who sends a check to a distant
point and thereby imposes upon the bank the burden of
providing remittance?
It is obvious that much friction would be created if any
such per-item expense were imposed. The necessity of
such a charge would not be understood generally, and
banking has so developed that the depositor has come to
feel it his innate right to emit checks drawn against his
account to any distant point. As a matter of business
policy the country bank cannot recoup in this manner.
But there still remains the possibility of recouping in­
directly. Cannot the depositor be required to maintain a
larger average balance? If not this, cannot it be recog­
nized that, since former collection profits are lost, the inter­
est charge on the original loan must be permitted to adjust
itself to a higher point?
Much can be said in behalf of the method of requiring
larger minimum balances. Many accounts are unprofit­
able; should not the country as well as the city bank en­
deavor to refrain from doing any portion of business at a
distinct loss? The balance idea, moreover, would prove
helpful in other connections, such as to render it more
difficult to overdraw accounts, and to preserve for the
bank funds the depositor does not require in his period of
slack business.1 The only objections to such methods would
* The balance idea tends to encourage a borrower to keep, in his slack season,
as large balances as possible in order that the yearly average may be high.



be the difficulties of introducing new and unwelcome
methods into a competitive situation where old customs
have had time to harden.
But are these objections sufficient to warrant the resto­
ration of the old custom of permitting deductions against
the foreign bank of deposit? Should the Federal Reserve
Act be so amended as to permit reasonable charges to be
levied against the collection agents of the banks of deposit,
the reserve banks?
Many difficulties to such a solution appear immediately.
A charge against the reserve bank is an indirect charge
against its member banks.1 Why should the reserve bank
lessen the earnings available for the group in order that
the drawee bank, which may not even be a member of the
reserve system, may have its checks cleared without cost
and possibly at a profit? W hy should the bank, member
or non-member, whose checks are distributed in largest
volume in distant communities, derive extra commissions
as against banks which have not created so much work
and expense for outside collection agencies? Is not the
reserve bank already rendering in direct as well as indirect
ways, a sufficiency of free services for the non-member
banks of the country? Will not the proper regulation of
the reserve system prove all the more difficult if the twelve
reserve banks are put under added pressure to earn at all
times sufficient to offset these and similar costs?
Answers to these queries are not promising: With the
change in old methods, the substitution of reserve banks
for independent private banks as reserve agents, there is
no longer the same justification for the imposition of large
charges against the collecting bank. The solution for the
country exchange-charging bank must be found in re1 The member banks are the stockholders of the reserve banks. Of course, the
burden would be borne by the Government if the earnings were more than
sufficient to meet the minimum amount permitted for stockholders.



couping from the depositors of foreign items, by direct
exchange charges imposed upon the public, by requesting
offsetting balances from customers who demand the right
to circulate checks outside the neighborhood of their
banks, or by permitting the original discount rate to
adjust itself so as to compensate for the loss.
In a rather marked manner the par collections contro­
versy recalls the old contest for sound banking methods
in the wild-cat days prior to the Civil War. Then banks
customarily refused to meet willingly their obligations at
par. Then they sought court action to avoid payment in
full of their obligations. Then they endeavored to prevent
the development of a system whereby the parity of all the
elements in the currency system could be maintained.
Then, however, the controversy had to do with bank notes
and not with checks. But the checks of to-day occupy the
place of the note issues of yesterday. Issues of banks pay­
able to bearer are becoming relatively less important.
More and more their position is being occupied by checks.
A temporary loss of profit to a portion of the banks
should not be permitted to impede the development of the
system of par collections. Undoubtedly some banks have
a grievance. In some cases the reserve officials may have
displayed an excess of zeal in their coercive measures. It
may have been true that the reserve administration has
not always been absolutely sincere in its defense of its own
course of action. In many instances its interpretation of
the law was not the only reasonable one; in other instances
reserve officials advertised their own indifference to the
terms of the law and insisted their function was solely to
administer the statute as bequeathed to them by law­
makers, while at the same time they were exerting every
endeavor to prevent a legislative change. Nevertheless,
the writer believes that in the par collections controversy



the Board has displayed rare good tact in coordinating
concession and firmness; that, in so far as it has possessed
discretionary power, it has employed it solely for the pur­
pose of correcting former abuses in our methods of domes­
tic exchange.

A t the time of the framing of the Federal Reserve Act few
problems presented more difficulties than those relating
to the requirements for admission into the new system.
A priori the weight of advantage seemed to lie on the side
of a large membership. Not only would a small member­
ship mean that the resources of the reserve banks would
be small, but also that a large number of banks, by remain­
ing outside the system, would not be affected directly by
the policies of the reserve administration. In its open
market, or purchase operations, a reserve system of limited
membership would not have the funds to exercise any
large measure of control over the money market by com­
peting with privatefinstitutions. In its rediscount opera­
tions few banks would be dependent upon the reserve and,
accordingly, capable of being affected by the rate policy
of the Federal Reserve Board.
On the other hand, however, it was generally agreed
that it would be a mistake, perhaps irretrievable, to make
in the beginning too many concessions in order to secure
the entrance of a large number of banks. The assets of the
reserve banks would consist largely of paper endorsed by
member banks. Should this paper prove to be of inferior
quality, the resources of the reserve system must be
impaired. The character of the reserve management,
furthermore, must depend largely upon the member insti­
tutions. Out of the nine district directors six were to be



chosen by the member banks. The importance of an able
membership in the district directorates was clear to all.
It could not be expected that the Federal Reserve Board
could concern itself greatly with the detailed application
of its policies to individual cases. Such duties must de­
volve largely upon the district directorates. Too great
liberality as regards membership might also produce
unfortunate results outside the system. In the attempt to
maintain a place for State non-member banks, State legis­
latures might lessen the strictness of banking laws, and
thus create an unhealthy situation in which the State and
the Nation would be obliged to compete one with another
for more lax, rather than for more sound, conditions of
bank control. Subsequent history furnishes some con­
firmation as to the correctness of this fear. From the
Report of the Federal Reserve Board for the year 19151
we read that some States had lowered reserve requirements
materially since the adoption of the Federal Reserve in
order to enable non-member institutions to compete more
effectively with the members.
It was understood also that early mistakes in the direc­
tion of excessive conservatism could be corrected more
easily than those of excessive liberality. It is easier to
grant concessions than to employ new measures of control.
Since, in all probability, the reserve framework must be
altered after some years of experience, it appeared prefer­
able to build a small superstructure on a sound foundation
rather than a lofty though shaky banking house upon
imperfect supports.
Too great strictness in the beginning, however, might
defeat the purpose of the lawmakers. If the reserve insti­
tutions should not display at an early date the strength
which comes from a large membership, popular faith, and
* Page 13.



accordingly popular support for the new banking system
might disappear. It is therefore easy to understand the
difficulties of applying the preceding general observations
to the specific facts of initial organization.
Over a portion of the banks of the country, the national
banks, the Federal lawmakers possessed mandatory power.
The only alternative to membership for these institutions
would be the surrender of their national charters. Since,
furthermore, it was expected that most of these banks,
would discern the helpful possibilities of the system, the
strict provisions were inserted in the law that any national
bank failing to signify its acceptance of the terms of the
act within sixty days after proper notification to subscribe
to the stock of its district reserve bank must cease to act
as a reserve agent. If within one year after the passage of
the act it failed to comply with the provisions of the act,
it must forfeit its Federal charter. During the days of
organization, many insinuations were current regarding
the refusal of some of the country’s most powerful na­
tional banking institutions to accept these terms. But it
finally appeared that in many cases the motive for these
veiled threats represented pressure to secure more favor­
able terms in the act or the endeavor of some of the banks
"which favored the bill to get the public in the correct
psychological attitude forsanctioningtheplan. It may well
be that after the experience with the Aldrich plan, a scheme
interpreted primarily as a measure of public control or
public coercion would enlist popular support more easily.
Over the State banks, however, direct power of control
was lacking. To secure their admission permissive and
not mandatory provisions were inserted in the act. The
more important conditions of membership for these banks
Were the following:1
* See section 9 of the original act.

(a) First, they must comply with the requirements
relating to capital and reserves imposed by law upon
national banks. Laws relating to national banks prohibit­
ing the purchase of or loans upon their capital stock, the
withdrawal of capital, or its dissipation through payment
of unearned dividends, must also apply to State member
banks. Their capital, furthermore, must be such as to
entitle them to become national banking associations
according to the population of the place in which they were
(b) Secondly, they must submit to examinations and
regulations prescribed by the Federal Reserve Board, and
must make certain reports of dividends to the Comptroller
of the Currency. In the event of failure to comply with
the terms of the act or with the regulations of the Reserve
Board, they could be required to surrender their stock in
the reserve bank.
(c) In the third place, the banks must conform to the
provisions of law imposed on national banks “ respecting
the limitation of liability which may be incurred by any
person, firm, or corporation to such banks. ”
These were the pertinent provisions of the law. What
has been their effect upon the entrance of State banks.
Historically, State admissions may be classified as falling
into two periods: first, the period succeeding organization
to June 21, 1917; second, that which followed the summer
of 1917. Let us first consider the State admissions in the
early period.
On June 27,1914, it was announced that only fifty State
banks had made application for membership.1 In the
Report of the Federal Reserve Board for the year 1914 we
1 See news item in the Commercial and Financial Chronicle, July 4, 1914,
p. 16. The Federal Reserve Bulletin was not published until May 1,1915.
a Page 20.



Since the passage of the Federal reserve act, there have been
converted into National banks 93 State banks and trust com­
panies, with a capital and surplus of $9,151,306. There have
been admitted to the system as members thereof 9 State banks
and 4 trust companies, the aggregate capital and surplus of the
13 institutions being $17,884,000. Those State institutions
which have already been admitted to the system have entered
upon the understanding that they are to accept any regulations
the Board may make regarding the conduct of member banks.
There are pending at the present time 51 State banks and trust
companies. These applicants have preferred to await the
issuance of regulations governing the admission of State banks.
Three years later, June 21, 1917, 53 State banks and
trust companies with aggregate capital and surplus of
#78,491,165 and resources of $825,000,000 were members.1
In view of the infinitely larger number and resources of the
non-member institutions, it appears in this first period
that the conditions of membership were not appealing to
the great body of State institutions.
To what facts shall we attribute this unwillingness to
join. Would it not appear that the statutory provisions
regarding eligibility were extremely liberal? Were not the
general terms of the act such as to render attractive mem­
bership for the typical country institutions? For one mat­
ter, small institutions could not object seriously to the
method of selecting district directors. The method
adopted was specially devised to ensure representation for
the smaller banks. Legal reserve requirements, further­
more, were reduced by the act for all member institutions.2
The statute also contained no prohibitory measure regard­
ing loans on real estate. The regulations of the Board
regarding real estate loans were liberal, merely requiring
that they be not carried in such liberal amounts as to
1 Cf. Report of the Federal Reserve Board for the year 1917, p. 14.
* If State laws should impose higher requirements, these would govern banks
chartered by the State.



impair the general liquidity of the bank’s assets. In view
of the great reliance of many state banks upon real estate
loans, the generosity of these provisions was of great im­
First among the reasons explanatory of the refusal of
the great number of State banks to pay the price required
to share in the benefits of the organization was the doubt­
ful legal position of the applying bank. Regarding this
matter the following news item published in the Commer­
cial and Financial Chronicle for July 4, 1914, is pertinent:1
Advices from the Organization Committee state that there
are only twenty States in which the Treasury Department
officials are sure that it is possible for State banking institutions
to become members of the new Federal reserve system without
some modification of the laws. These States are Vermont,
New York, New Jersey, Delaware, Maryland, Virginia, West
Virginia, Kentucky, Tennessee, Ohio, Indiana, Illinois, South
Carolina, Alabama, Mississippi, Arkansas, Texas, Arizona,
California, and Oregon. Two of these States — Kentucky and
South Carolina — passed enabling acts since the passage of
the Federal Reserve Act which make it possible for the State
banks and trust companies to enter the Federal reserve bank
system. In New Mexico and Montana it is possible for trust
companies, but not for State banks, to become member banks
of Federal reserve banks. The information of the Reserve
Bank Organization Committee is based largely, it is said, on
letters written by State officials in reply to inquiries concerning
their State laws and the necessity for amendment of their
statutes, so that their .financial institutions may participate in
the new system. Without exception, it is added, the State offi­
cials gave assurance that steps would be taken to make changes
in State laws which will enable State banks to join the Federal
reserve banks, if they so desire. However, in many States the
legislatures do not convene until 1915.
Gradually, however, the necessary legislation was en­
acted in most States and difficulty on this score largely
1 Page 16.



removed. But the delay thus enforced may have caused
some State banks, whose enthusiasm was aroused in the
beginning, to postpone application at a time when interest
in banking reform was the most intense. With each day of
delay the general attitude became more and more one of
indifference. The money market was easy in the first few
years succeeding 1914 and the need did not appear for any
great reliance upon the Federal Reserve. In the interval
during which the permissive legislation was being framed,
State bankers had ample opportunity to study the terms
of the statute and analyze its apparent defects. Some of
the resulting objections were sound and some were un­
sound. But attitude toward membership was primarily a
matter of the bankers1 beliefs and only secondarily a mat­
ter of the financial soundness of their views.
Among the most emphasized of difficulties was the fear
that membership would subject State banks to many
prohibitions applying to national banks even though these
prohibitions were not contained in the Federal Reserve
Act. For instance, it was asserted frequently that mem­
bership would subject the shareholders to double liability
in the event of insolvency, even though the law in the
State of incorporation did not impose such requirements.
This fear, however, was soon dispelled by the publication
of an Opinion of Counsel in the September 1, 1915, issue of
the Federal Reserve Bulletin* in which it was held that this
provision of national banking law was not applicable to
State banks. The only double liability resulting from
membership in the Federal Reserve Act was that pertain­
ing to the stock subscriptions in the reserve banks. Liabil­
ity of shareholders on this account would be small. Of
course, State member banks would be subject to the regu­
lations of the Reserve Board. But these regulations must
1 Page 273.

be based upon, rather than in conflict with, statutory law.
But aside from restrictions and limitations of powers,
what about the advantages of membership? Would the
rediscounting privilege in particular be of any great benefit
to the great number of State banks? More specifically
would State banks possess much of the paper eligible for
rediscount? In the days of organization there was current
a general belief that the Board would require financial
statements of the maker of the paper to accompany redis­
count applications. In its first regulations such conditions
were imposed as a basis for ultimate procedure. But small
banks ordinarily do not need to require, and often are not
in a position to demand, such statements. It is not strange,
therefore, that in a referendum conducted by the Bankers’
Information Service of Washington1 the consensus of
opinion was:
That although they will be compelled to pay a portion of
their capital into the capital of the Federal Reserve System,
where it will be tied up, they may receive no benefit because the
class of commercial paper they handle is not eligible for dis­
count under the regulations of the Federal Reserve Board.
Expressing the same prevalent view, also, was the follow­
ing editorial extract from the Commercial and Financial
Chronicle: 2
Manifestly, since the regional Reserve bank is made up out
of the stock contributions of all the banks large and small,
nationals, proportionate to their stock and surplus, the benefits
of the system should inhere to each in like manner, and the
access for rediscount should be free to all. Yet we find that the
status of the large bank and the small, or the country bank, is
reversed by the provisions governing rediscount. Formerly it
was the country bank that rediscounted its paper most freely,*
the large central institutions rediscounting very little and that
against principle. Now, such are the provisions governing that
1 Cf. Commercial and Financial Chronicle, March 27,1915, p. 1047.
a Issue of January 20, 1917, p. 197.

kind of paper admissible, the city bank is meant to be, and can
be, the easy and extensive borrower at the Federal Reserve
Bank, while the country bank finds it extremely difficult to
come within the provisions, owing to the nature of its local
business, and is, in fact, scarcely at all a borrower from the said
As a matter of subsequent history such fears do not
appear to have been justified. In later chapters evidence
will be presented that the reserve administration went the
limit of liberality in its endeavors to make the reserve
banks useful to all classes of institutions. Requirements
concerning the filing of financial statements were altered
early in 1915 so as to constitute virtually no bar to the
applying member bank. The testimony of reserve bank
directors has been almost unanimous that where the re­
serve bank was permitted to cooperate, it was found the
member bank's portfolio contained much paper, either
directly admissible, or of such a character as to enable it
easily to be made eligible. Confirmatory of such a view
are the following remarks of Governor Strong, of the New
York Reserve Bank, before a group of the New York State
Bankers’ Association:1
The statement has also been made by some bankers of our
district that very little, if any, of the paper held by their banks
is eligible for rediscount with the Federal Reserve Bank. Those
bankers who make this statement are liable to create the impres­
sion that this opinion is held generally by member banks; but
an examination of statements filed with us disclosed that only
about 80 banks, out of our 480 members, reported that they
had very little, if any, paper eligible for rediscount. With these,
we have communicated, in order to ascertain upon what theory
their reports were based. By correspondence and personal
interview, with many of them, we have satisfied them, as well
as ourselves, that one half or more of the paper they hold is
eligible for rediscount.
1 A part of this address is printed in the Commercial and Financial Chronicle,
June 5, I9 i 5>P- 1880.



Such conclusions as these represented the usual results of
investigation in other districts.
In the rare cases where no eligible paper existed, the
resources of the reserve bank might furnish indirect aid.
The needy member bank might borrow on its note pay­
able from another member bank which did possess eligible
paper. Furthermore, eligible paper might be purchased
from commercial paper houses or from other banks. Such
paper, rediscounted, would increase the reserve of the bor­
rowing institution; while, if arrangements could be made
whereby the seller would obtain for the time being only a
credit upon the bank’s books, payment for this paper need
not mean an immediate and corresponding loss in cash or
reserve money.
The above arguments were addressed to the State banks
however, largely from the point of view of their collective
strength and not that of individual profit. From the stand­
point of its own individual gain the necessity was not
always clear for joining a set of rediscount institutions
whose funds should be husbanded carefully for emergen­
cies. From a selfish viewpoint many a bank might reason
that the reserve system might be maintained by other
institutions; that so far as it required rediscount aid, it
could rely upon its old city correspondents, who in turn
could secure aid from the reserve banks. With such insti­
tutions it had in the past maintained occasional redis­
count relations, and it appeared easier to continue these
old customs than to take the trouble of investigating redis­
count regulations applicable to the new reserve banking
system. Particularly likely was such a position to be taken
at a time of great ease in the money market.
In other situations it was not so much a matter of inabil­
ity to ascertain the advantages of membership, but rather
a belief that admission would involve direct disadvantages.



In this connection discussions of systems of check clear­
ances assumed much importance. Would the reserve
banks develop clearing departments which would remove
the necessity of depending upon outside city correspond­
ents? The law gave discretionary power to the Reserve
Board to require reserve banks to act as clearing agencies,
but did not make this function mandatory. If this service
was not certain to be developed, membership might prove
costly. In addition to deposits with reserve banks, ac­
counts with city correspondents for clearance purposes
might continue to be necessary. There was no probability
that city banks would discontinue bidding for country
bank deposits. As long as they paid interest on bankers'
deposits it would seem preferable to maintain deposits
with them than with the reserve banks which paid no
But even if the reserve banks should make provision for
clearances, it was not certain that the new facilities would
offer any economies in making collections. What if the
reserve banks should refuse to clear checks drawn on non­
member institutions? Unless checks on both classes of
banks were to be cleared, members might be obliged to
maintain balances with city correspondents for the collec­
tion of non-member bank items in addition to those
deposited with reserve banks.
There was also uncertainty about the future rights of
banks to deduct exchange on remittances for their own
checks. As indicated previously, such charges constituted
a large part of the profits of some of the smaller institu­
tions and the prevailing custom was one working in favor
of the country bank. In the early stages of the bill in Con­
gress, the provision prohibiting these exchange deductions
proved very shocking to these banks. Although this objec­
tionable provision was modified later, it was doubtful



whether the rights, of country banks as determined by
established custom was sufficiently safeguarded. The con­
cessions granted to them in the final draft of the bill pre­
served their rights to deduct exchange only to the extent
that costs were incurred in collection and remittance. It
was foreseen by some that it was within the province of
possibilities for the reserve collection system to develop in
such a way as to eliminate all costs incurred in remittance.
Would not the presentation of checks at the counter de­
stroy 1the justification for such charges? If so, would it not
be better to refrain from adding to the resources and
thereby to increase the prestige of the reserve system until
definite guarantees were given regarding the right to con­
tinue to impose such charges?
On what terms also could State member banks withdraw
from the system? Since the days of Andrew Jackson no
American bank had had any experience with such a bank­
ing system. The success of the Federal Reserve was prob­
lematical. Its future relations to member banks must
depend largely upon its management. It might become a
helpful organization securing for our banking system a
stability never before possessed. On the other hand, it
might become the '‘ monster’’ of the time of the Second
United States Bank. If so, could an early mistake in
becoming a member be corrected easily? Must withdrawal
necessitate voluntary liquidation?
Particularly important were such questions to those
State banks which were performing functions not legal
for member national banks. If, after membership, such
functions were being exercised, would inability to with­
draw necessitate the abandonment of that kind of business ?
It is true that in its early regulations the Board endeavored
to calm the fears of the banks by making such withdrawals
1 See supra, pp. 34-37.



easily possible. But the Federal Reserve Board was a
body, not with a permanent, but rather with a shifting
personnel. In the course of time, because of a change
either in viewpoint or membership, its regulations might
be altered. Regulations, alone, did not se^m to provide a
sufficient safeguard.
Provisions regarding examinations were also distasteful
to many State banks. By the terms of the statute certain
powers of examination were conferred upon the Federal
Reserve Board, and the Comptroller of the Currency had
the right to require statements of condition and operation.
These powers of examination and inquiry were to be added
to those possessed by the State Banking Department and
mayhap also to those of the local clearing house. An
excess of examination was easily possible. Not merely
might this involve much loss of time to the officers and
clerical staff of the bank, but examination is always unwel­
come because of the possibility of bank secrets being
spread in this way. It would be much more difficult to
trace the origin of such disclosures when examinations
could be conducted by so many differently constituted
In order to quiet discontent on this score, the Board
made every feasible concession. Particularly, since every
bank was to be contingently liable for its rediscounted
paper, and because neither the Board nor the district di­
rectorate could be expected to make careful investigations
of the credit standing of the original borrower in all cases,
it was unwilling to dispense with the investigation. But
wherever possible there was to be cooperation with the
State banking authorities in order that visits of examiners
might fall as nearly as possible on the same days, and in
order that there should be no useless duplication of work.
In these ways objections were somewhat mitigated.



It was understood generally that the prime purpose of
the new banking system was not to secure profits for
stockholders. Dividend provisions were written in the act
merely to lessen the possibility of total loss of income on
the capital subscription to the reserve bank. Nevertheless,
the average banker could not refrain from taking into con­
sideration this aspect of the question. Under the terms of
the law six per cent represented the utmost dividends
possible on the stock of the reserve banks. Additional
earnings must go to the Government as a franchise tax, or
to surplus. In the early years, even six per cent dividends
seemed impossible, in view of the small volume of redis­
counting and there was the fear of spreading, by virtue of
excessive open-market operations, the belief that the
reserve banks were designed to compete with, and not to
render service to, the member institutions. Many banks
felt their capital could be made to earn much more than
six per cent, and were unwilling to place it, even in small
quantities, in a field where its profit-getting opportunities
were thus limited.
Because of these numerous doubts, queries, and objec­
tions, because the state of the money market was not such
as to create great dependence upon the Federal Reserve,
because arguments were based so largely on advantage to
the group and possibly not to so great an extent on the
self-interest of each bank, it does not appear surprising
that the great number of banks, not accustomed to assum­
ing positions of leadership in the banking fraternity,
should prefer to await future developments; that, in other
words, they adopted the policy of watchful waiting. It is
no doubt true that the assumption of this attitude placed
the non-member institutions in a stronger strategic posi­
tion. It was not to be expected at the time of the framing
of the original act that the lawmakers would make every



feasible concession to the State institutions. With more
experience in the operation of the system, further conces­
sions could be made later. And possibly the framers of
the act had in mind the desirability of holding back some­
thing for future bargaining purposes. A t any rate, it is
probable that the few State institutions which joined prior
to the middle of 1917 were those which were strongly
impressed by this opportunity of stamping themselves
with whatever guarantees of soundness and progressive­
ness membership in the Federal Reserve implied. Mem­
bership was an advertising feature of no mean advantage.
But after the date of our participation in the World War,
the situation altered itself abruptly. It was understood
everywhere that war finance must increase greatly the
demands upon all classes of banks. Not merely was it
expected that the general level of commodity prices was
destined to advance, but the necessities of military de­
mands must throw greater strain upon our productive and
industrial organization. To wait longer in applying for
admission might prove costly. Entrance into the Federal
Reserve could not be accomplished on the moment; some
delay must be encountered while the merits of the applica­
tion for entrance were being considered. Previously the
Reserve Board had rejected many applications because
the past record or present condition of the bank was unsat­
isfactory.1 Nor was there certainty that indirect aid could
continue to be had from the Federal Reserve. The
increasing strain upon the banks might place the city cor­
respondent institutions in a position where they must
think more largely of their own requirements* A t the
same time the occasion appeared ripe for some of our high
Government officials to base their pleas for membership on
patriotic motives. Early in May, 1917, a letter from Secre1 Cf. 1
Report of the Federal Reserve Board for 1915, p. 12.



tary McAdoo1 indicative of such appeals was read before
the Executive Council of the American Bankers’ Associa­
tion. The following sentences may be quoted from this
The time may come when the financial resources of the coun­
try will not be commensurate with the national purpose, if the
nation remains half State bank and half national bank in its
organization. The State banks will find greater security for
themselves, if disaster should threaten, if they are members of
the Federal Reserve system; and the system will be irresistibly
strong if the State banks unite with the national banks in mak­
ing them an extremely useful national instrument.
I commend this question to your earnest and patriotic con­
sideration, with the sincere hope that love of our common
country should surmount every other consideration and bring
about this supremely desirable result.
At the same time it began to appear as if the non-mem­
bers had gained all possible advantage from remaining
aloof. In an address delivered in Chicago in April,3 Paul
M. Warburg called attention to the fact that the Board
had gone the limit in its endeavors to provide favorable
terms for the entrance of State banks. He insisted that
since State banks profited by the institution they were
under obligation to support it.
In the matter of friendly legislation much progress had
also been recently accomplished. In the previous year or
so some of the few States which had been tardy in enacting
the necessary enabling legislation wrote statutes empower­
ing State institutions to become stockholders in the Fed­
eral Reserve Banks. These States were Delaware, Idaho,
Kansas, Montana, North Dakota, South Dakota, and
Washington. Furthermore, Federal legislation of very
1 This letter is printed in part in the Commercial and Financial Chronicle for
May 12, 1917, pp. 1834-35.
3 Cf. Commercial and Financial Chronicle, April 14, 1917, pp. 1450-51.



great importance was enacted in the amendment to the
Federal Reserve Act on June 21, 1917. The most impor­
tant concessions therein granted were the following:1
1. Any State bank or trust company desiring to withdraw
from membership in a Federal Reserve bank may do so, after
six months’ written notice shall have been filed with the Federal
Reserve Board, upon the surrender and cancellation of all its
holdings of capital stock in the Federal Reserve bank.
2. Subject to the provisions of this act and to the regulations
of the board made pursuant thereto, any bank becoming a
member of the Federal System shall retain its full charter and
statutory rights as a State bank or trust company, and may
continue to exercise all corporate powers granted it by the State
in which it was created. . . .
The first of these concessions placed in definite statu­
tory form what previously had been merely a ruling of the
Board. In case withdrawal should be desired, voluntary
liquidation would no longer be necessary. B y the second
concession guarantee was given that entrance into the
system need not result in the loss of rights and powers
possessed at the time of entrance, provided these were not
in conflict with the terms of the act or the regulations of
the Board. And aside from the clauses relating directly
to the terms of membership in the system, a further wel­
come feature of this amendment was the lowering in the
legal reserve minima. After these statutory concessions
had been granted, the President felt justified shortly
afterward in asserting2 that “ membership in the Federal
Reserve system is a distinct and significant evidence of
patriotism. ”
The effect of these appeals, of these statutory changes,
and of the altered financial condition of the country was
1 See Section 9 of the amended act.
2Statement of President Wilson made public through the Federal Reserve
Board. See Bulletin, November, 1917, pp. 827-28.



soon made manifest by an increased membership. It has
been remarked that on June 21, 1917, the number of mem­
ber State institutions was 53 with total resources of $825,000,000. By January 31, 1918, 296 State institutions with
total resources of more than five billions of dollars had
become members.1 B y September 1, 1921, more than 1600
State institutions were members with total resources of
nearly ten billions of dollars.2
It seems undeniable, therefore, that remarkable suc­
cess was achieved finally in enlisting members from State
banks and trust companies. It is true that the total num­
ber of non-member institutions, with resources, enormous
in the aggregate, far outnumber those which have joined.
Many of these, however, would not be eligible for member­
ship, and many would not add to the strength of the sys­
tem if they were admitted. It should not be forgotten that
a number of applications have been refused, and the effect
of these refusals has undoubtedly influenced many other
banks, whose financial strength was somewhat similar,
not to make applications. It is true that many strong and
powerful institutions remain outside the fold, but suffi­
cient success has been achieved to render improbable the
danger of warfare between members and non-members.
When one recalls that in one matter of the utmost impor­
tance to the State banks — the clearance and collection of
checks — no concession of principle was made, it appears
that the Board should be lauded for its general good tact
and administrative efficiency. Few proposals of the sort
once most earnestly advocated are now to be heard, pro­
posals which if worked out might have split the country
into two rival camps, proposals that non-members estab­
lish a country-wide clearing system of their own. Of
1 See Bulletin, February 1, 1918, p. 92.
3See ibid., issue of September, 1921, p. 1078.



course it may be true that the accretion in membership
was merely the by-product of a too liberal discount policy.
But this is another problem and calls for special discussion
in a later chapter.
One interesting aspect of the State bank membership
problem remains for discussion. What has been the effect
of the legislative efforts to attract State bank members
upon laws governing the operations of national banks?
With no concession to national banks their position as
competitors of State banks would become less secure.
There was danger of stunting the growth of the national
banks. To check this danger, legislation was enacted
broadening under certain circumstances the powers of
national banks. Legislation of this sort was contained in
the act of September 26, 1918. The import of this can be
understood best by quoting an Opinion of Counsel of the
Federal Reserve Board as to its application:1
Under the provisions of section 11 (k) as amended by the act
of September 26,1918, the Federal Reserve Board may properly
permit any national bank to exercise any of the fiduciary
powers authorized by that section, unless there is some express
provision of the laws of the State in which such bank is located
which either directly or by necessary implication prohibits
national banks from exercising such powers, and even if there
is such an express statute, the Board may issue its permit if any
State bank, trust company or other competing corporation in
that State is permitted to exercise the powers applied for by
the national bank.
An indirect result of the problem of State bank member­
ship has thus been to encourage the tendency toward
“ department store” banking. It is probable that there
will be a further development of this tendency in the
future. Many national bank directorates feel that the law
is not quite fair to their institutions. In many respects,
1 See Bulletin, April, 1919, p. 363.



such as that of prestige, membership in the Federal
Reserve serves all the purposes previously requiring
national incorporation. These directorates are considering
reincorporation as State banks in order to gain the advan­
tage of more liberal legislation. Particularly in the matter
of the establishment of branches there is a general demand
that national banking law be made more affirmatively



purpose of this chapter is to explain the machinery
and conditions under which the funds of reserve banks
through the medium of rediscounts may be made avail­
able for member institutions. The reader will bear in mind
that rediscounting is not the sole means by which reserve
banks may employ their resources. Through an amend­
ment to the original act, later to be discussed, reserve
banks secured authority for rendering direct aid by dis­
counting the notes of the member banks themselves.
Indirectly also, through their open-market operations,
further aid may be extended. Our present purpose, how­
ever, is to discuss one type only of reserve bank operations,
rediscounts, or the discount of paper which originated at a
prior date, the parties concerned being in most cases the
member bank and one of its clients.
It seems logical to give rediscounts rather than the
other operations the place of priority in our discussion.
Not for a considerable period after the date of inaugura­
tion were reserve banks given permission to make direct
advances to member institutions. While reserve banks did
possess from the very beginning certain powers of direct
dealings in the open market, such functions were not the
most emphasized. In the exercise of their open-market
powers the reserve banks often must assume the position
of competitors of member banks; their policies may have
been adopted for the purpose of controlling the money

market, possibly with the result of interfering with the
profit-making operations of the member institutions. If
conducted, not for the purpose of control, but merely
for the sake of securing more complete employment for
their resources, these direct dealings may lessen the de­
pendence of the public upon the member institutions.
Only in rediscount operations is the character of the
reserve system displayed consistently as of a cooperative
nature, only then does the reserve system appear as an
institution designed to render service to its member banks.
Since in the early years of operation every device of sound
banking must be employed in order to secure the alle­
giance of the individual banks of the country; since with­
out their generous support the Federal Reserve must have
failed to secure the resources and influence necessary to
enable it to function as intended, the helpful possibilities
of the system have been the most advertised. To-day a
layman, asked to define the functions of the reserve banks,
would undoubtedly reply — they are institutions de­
signed to aid member banks by rediscounting commercial
Statutory provisions regarding rediscounts are con­
tained in section 13 of the act. The general purport of the
terms of this section was to encourage sound methods of
commercial banking and to maintain liquid the assets of
the reserve banks. Accordingly reserve banks may redis­
count only paper which arises in the short-time, selfliquidating operations of trade, industry, and agriculture.
More specifically the leading provisions of this section
Reserve banks are permitted to rediscount paper en­
dorsed by member banks which arises out of and the proceeds of
which are employed for agricultural, industrial or commercial



(2) Paper covering merely investments or drawn for the
purpose of carrying or trading in stocks, bonds, or other invest­
ment securities is rendered ineligible.
(3) The definition of ineligible paper, however, does not cover
“ that issued or drawn for the purpose of carrying or trading in
. . . bonds and notes of the Government of the United States.”
(4) Paper drawn for agricultural purposes or based on live
stock may have a maturity at the time of discount by the re­
serve bank of six months. Other eligible paper must have a
maturity not in excess of three months.
So much emphasis has been placed upon the desira­
bility that rediscounted paper should comply with these
requirements that it is commonly assumed that it would
not have been in the interests of sound or conservative
reserve banking to have included other varieties of eligible
paper. Of late, however, some voices have been heard
denying the assumption that eligible paper should be
defined thus narrowly.1 In order that later we may form a
judgment as to the desirability of the qualifications con­
tained in the act, it may be well to recall some of the lead­
ing objections offered to the rediscount of speculative or
investment paper.
First of all, it was believed that these restrictions were
necessary in order to keep liquid the funds of the reserve
banks. In the course of time it was expected that the loan­
ing power of the reserve institutions would become the
ultimate reserve of the country. Far more important then
would it be that the reserve funds should be easily avail­
able than those of any private bank. Member banks could
rely if necessary upon the reserve institutions for aid, but
no easily accessible source of relief would be open to the
reserve institutions. Their reserves would constitute the
last line of defense in a period of threatened liquidation.
1 Cf. for instance, Anna Youngman, “ The Efficacy of Changes in the Discount
Rates of the Federal Reserve Banks,” American Economic Review, September,
1921, pp. 463-86.

In the second place, there was a general desire to seize
every opportunity offered by the establishment of the new
system to encourage sound banking methods on the part
of the member institutions. Not merely does the strength
of the reserve system-depend largely upon the strength of
the member banks, but the advantages to the public
arising from the formation of the reserve system might be
lost if member banks should be encouraged to invest too
large a proportion of their resources in slow assets. From
the standpoint, then, of the condition of member banks,
every effort should be exerted to maintain the liquid char­
acter of the paper in their portfolios.
Certain objections, somewhat of a political character,
also lay in the way of the admission of paper arising out of
investment or speculative operations. As remarked in a
previous chapter the support of the interior banks and of
the business public could not easily have been secured for
a plan whereby the reservoir of funds for investment and
speculative activities could be increased by the use of the
contributions of all member banks, large as well as small,
metropolitan as well as rural. To repeat a former observa­
tion, the Federal Reserve plan was directed largely against
Wall Street; its support among a large class of bankers
depended, not so much on any sound conviction as to the
merits of the numerous technical objections to the old
system, as to discontent arising out of the difficulties
experienced by banks of the interior in securing the return
of funds invested in 1907 in the securities market of New
York City. Allegiance to the reform system could not be
secured easily without the guarantee that the surplus re­
serves of commercial banks should be kept available for the
needs of commerce and agriculture instead of swelling in
the slack seasons and years the reservoir of stock market
funds. Rediscounting of speculative paper must be refused.



What, moreover, about the inflationary possibilities of
the new system? Everywhere was it understood how, by
the concentration of reserves and the resulting pyramiding
of credits, the reserve system would make possible vastly
enlarged amounts of bank advances. Would expanding
credit grants, thus rendered possible, exert a lifting influ­
ence upon the general price level and exaggerate the diffi­
culties already generally attributed to a faulty standard
of deferred payments? In answer to such queries there was
a general denial by the members of a certain school of
currency students of any direct connection between
expanding grants of commercial credit and the general
level of commodity prices. This school argued that only
when bank funds were borrowed for investment or specu­
lative purposes the cause of a resulting higher level of
prices could be attributed to any enlargement of bank
advances. The real.danger lay in pouring too large a
proportion of the country’s banking resources into the
investment reservoir. Possibly the clearest brief statement
of this point of view is that of Professor C. C. Arbuthnot
in the American Economic Review for December, 1920.1
His statement was made for another application, but well
summarizes certain views earlier expressed regarding Fed­
eral Reserve policy. To quote from his argument:
In the ordinary processes of business the credit of commercial
banks is used to assist in the purchase and sale of marketable
goods. It takes the form of short-time notes which are to be
paid from the receipts from the sold goods. The extension of
credit to permit buying is accompanied almost simultaneously
by an offer in the market of the salable commodities. The effec­
tive demand for goods thus made possible is accompanied by the
supply of goods. The equilibrium between supply and demand
is not seriously disturbed and the extension of credit has no
1 Cf. pp. 779-80. The subject of Mr. Arbuthnot1 article was “A Stabilized

lifting influence on the general level of prices. As long as com­
mercial bank credit serves this purpose there is no inflation.
As will be indicated later, this view does not harmonize
with that of the writer. Nevertheless, with various modi­
fications and refinements it represented the view of many.
Since it was inevitable that the reduction of reserve min­
ima under the Federal Reserve would expand greatly the
potential volume of bank credit, acceptance of this view
necessitated a careful attempt to restrict the use of reserve
resources for investment purposes.
The above fears of price inflation had to do with the
probable results of too great advances to the investment
market. But when bank funds are employed for another
purpose, the withholding of goods from early consumption
— for commodity speculation, in other words — there
was general agreement as to the lifting influence upon the
price level of the bank funds thus advanced. Clearly, it was
unanimously agreed, reserve funds must not be made
available to the commodity speculator.
Many controversial points were involved in the argu­
ments stated above. It is the writer’s belief that to-day
there is an even greater tendency to dispute the validity
of some of these tenets. But their truth accepted, the
practical problem became that of framing measures which
would effectively discourage the use of reserve funds for
speculation or investment. In other words, it was a matter
of devising tests or standards according to which the com­
mercial character of the paper offered for rediscounts could
best be determined. Several possibilities received some
attention in this connection. First, admissible paper must
be of the double-name rather than of the single-name type.
Second, statements of conditions of the maker’s assets
could be required. Finally, in a more informal way, reli­
ance could be placed upon the knowledge of the applying



banker as to the purpose for which the funds originally
obtained were employed. Let us first turn our attention to
the matter of double-name paper.
The case for admitting double-name paper only was
based upon a number of arguments. In the first place, its
form was such as to offer greater indication of the com­
mercial nature of the underlying transaction. Every
operation of trade involves at least two parties. If admis­
sion of the indebtedness is evidenced by a draft, the seller
of the goods becomes the drawer, the purchaser the
drawee. If the promissory note is employed, the payee or
his agent is the seller, the maker the purchaser. Since
these two parties are always involved in a trade transac­
tion, why not require their names and their combined
security in the paper which arises when resort is had to
bank funds. In case two-name paper cannot be supplied,
there is greater likelihood that in the underlying transac­
tion the purchaser is not to liquidate his account out of the
proceeds of the sale of the goods, and the paper is not
liquid. If two-name paper can be supplied, there is one in­
dication, not conclusive to be sure, but informative, never­
theless, of the liquidating character of the transaction.
In the second place, it was asserted that single name paper
indicates more often lax customs of trade credit. The buyer
is more tempted to buy unwisely, the seller to overextend
credit or accept bad debt accounts, when the buyer is not
compelled to acknowledge immediately his indebtedness.
Single-name paper often originates because of the desire of
the buyer to postpone the date of formal acknowledgment
of his obligation. A t the time of shipment and for a certain
period thereafter he insists upon being carried on the open
book account. Inevitably this delay must increase the
likelihood of bad debts, slow payments, expensive collec­
tions— in short, irregularities in our trade credit methods.

As a special irregularity thus created, it was further­
more insisted that single-name paper necessarily gives rise
to many duplications. These duplications could usually be
attributed to the ability of the buyer to avoid the im­
mediate creation of paper which when discounted would
render him subject to a call from the bank. In the absence
of careful analysis of financial statements, single-name
methods permit the same person to borrow from a bank and
from a commercial paper house. Some firms established
connections with several note brokerage concerns and sell
through them all. The practice of registering with a trust
company paper thus sold had its origin in the endeavor of
some firms to prove they were not duplicating security in
this manner. Some firms borrow largely on their showing
of book account and later assign these to selling agents.1
If one party could not obtain bank funds without joining
simultaneously the other party to the trade transaction,
such duplications would become more difficult.
Finally it was contended that the admission of single­
name paper must encourage the acquirement of precisely
the sort of paper for which there was little foreign demand.
In Europe a broad market existed only for prime paper of
the double-name type. One of the underlying purposes of
the Federal Reserve Act was to create a constant open
market for prime paper, both in the home and foreign
markets. A broader home market alone would not solve
difficulties due primarily to such international facts as
excessive gold exports arising from an unfavorable balance
of trade. In defining eligible paper a wonderful opportu­
nity existed to correct the situation wherein commercial
banks were induced to invest surplus funds in stock ex­
change activities. But to secure the utmost of advantage
1 Cf. E. E. Agger, “The Commercial Paper Debate,” Journal of Political

Economy, July, 19x4, pp. 670-71.



the requirements of foreign as well as of domestic demand
must be taken into account. Single-name paper possessed
inferior standing abroad.
Many objections of a practical character, however, must
be met by those insisting upon the exclusive acceptance of
double-name paper. One of the most obvious, as well as
most compelling of these, was the very great lack of good
double-name paper in the American market. It has been
asserted that at the time of the framing of the act, trade
paper arose in less than three per cent of the total credit
transactions of the country.1 Of this three per cent a very
large part consisted of paper arising in settlement of postdue accounts. With double-name paper alone admissible,
it Was clear that the reserve system could render little real
aid to the member banks. If it was not to degenerate into
an impotent and unused mechanism, it must take account
of the actualities of the situation and not merely hypothet­
ical or idealistic considerations. Of course the reserve ad­
ministration would be expected to plan consistently for the
development of more sound methods of trade and bank cre­
dit. Some time must elapse, however, before any consider­
able alteration of existing methods could be accomplished.
The above argument could be addressed to practically
all the commercial banks of the country. But an espe­
cially appealing objection could be addressed to the great
number of small bankers on the ground that double-name
paper alone must mean discrimination in favor of the
large city institutions. In the main, it was argued, the
small bank is the bank of the retailer; whereas the whole­
saler, jobber, and manufacturer must depend on the urban
banking house. Because of the small amount and informal
character of his average credit transaction, the retailer
1 Cf. E. E. Agger, “ The Commercial Paper D ebate," Journal of Political

Economy, July, 1914, p. 663.

cannot offer his banker any large amount of double-name
paper. Except in cases of post-due accounts and slow pay­
ments, custom and competition do not permit him to
demand notes or to require the acceptance of drafts from his
customers. In the wholesalers* transactions, however,
wherein considerations of custom must be somewhat less
important relatively than those of business efficiency, a
future field for the creation of double-name paper was dis­
cernible. But what would be the justice and the political
expediency of a programme which would admit as eligible
only paper contained in large volume in the portfolios of
the city institutions? Acceptance of this proposal would
compel country banks to purchase paper in the open mar­
ket in case they desired to draw upon the reserve. But the
advantage of such a course of action would be dubious. It
is true that rediscounting would increase the bank’s
reserve. But payment for the paper purchased would tend
to tear it down in corresponding degree.
Neither, it was insisted, was there any guarantee that
funds obtained by the discount of two-name paper would
not be employed for investment or speculative purposes.
The funds obtained by the discount of admissible paper
might be put to any use desired. In the words of Moulton,
written for another purpose:1
It will be recalled, from our previous analysis of the relation
of the commercial banking system to the financing of stock
exchange speculation, to the outright purchase of securities,
to the making of collateral loans for fixed capital purposes and
to the activities of investment bankers engaged in the marketing
of securities, that the funds of the commercial banking system
constitute the support for the entire financial fabric, invest­
ment and speculative, as well as commercial.
Of course it might be argued that to make this class
of paper alone admissible would increase its desirability to
1 Financial Organization of Society, p. 633.



the member banks. But ought not the general liquidity
of the borrower’s assets and not the form of the paper to
determine the right to request Federal Reserve aid.
Because of the nature of their operations some borrowers
cannot gain possession of double-name paper. If their
assets in general are sufficiently liquid, should not their
paper be rediscountable? As Sprague puts i t : 1
The fundamental point at issue is whether an analysis of the
entire financial position of the borrower or a series of particular
transactions affords the lender better safeguards against loss.
It could be contended, furthermore, that discrimination
in favor of double-name paper might tend to increase the
volume of unsound paper. Eligibility for rediscounts is
purely a matter of arbitrary definition. Nevertheless, it
might become one of the principal bases offered in the open
market for testing its worth. Single-name paper, because
of the possible misuse of the funds, because of the fact that
only one party is responsible, puts the purchaser on guard.
He is not nearly so likely to avoid the usual safeguards of
examination and inquiry when his paper is not of the sort
encouraged by the definition of eligibility. In the discount
of two-name paper, no margin of collateral over credit
obtained would usually be required.
In a pragmatic sort of way, some measure of truth may
be contained in this objection. Too much attention to
form might lessen dependence upon careful analysis of the
borrower’s condition. If such abuses should appear, how­
ever, the method of correction would be easily available.
Merely let there be redoubled devotion to the usual safe­
guards. In Warburg’s words:*
It has never been contended by the champions of the trade
1 See O. M. W. Sprague, “The Federal Reserve Banking System in Opera­
tion,” Quarterly Journal of Economics, August, 1916, p. 649.
1 See Bulletin, July i, 1918, pp. 604-06.

acceptance th at these acceptances should be bought b y an y one
who has not familiarized himself thoroughly with the financial
condition of the maker of the paper; he should take this pre­
caution just as if he were buying a single-name note, and as
long as he does th at there is no reason whatever w hy he should
not be capable of judging solvency and standing from the state­
m ent of a borrower who sells the trade acceptance he receives
just as he can from the statem ent of a firm which borrows only
on its own note.

Admonitions of this sort, however, were frequently
sufficient to lessen the ardor of many advocates of double­
name paper. It was expected by many that a change in
the form of trade paper must lessen the need of tedious and
careful examination. When it became apparent that a
mere change in form could not accomplish everything,
there was a marked reaction to the view that the main pre­
requisite of eligible paper must be the general character
of the borrower’s assets.
As a final objection to the sole admission of two-name
paper, it was argued that its use would transfer part of the
work of rating the credit of the buyer from the bank to the
selling merchant. Under the single-name paper method the
bank must satisfy itself regarding the standing of the bor­
rower (the buyer). Under the double-name plan the borrow­
er’s ability to obtain credit would depend in the first in­
stance upon the seller’s rating of the buyer. Because of the
addition of the seller’s contingent liability in the bank bor­
rowing, dubious trade paper might become the basis for
bank credit. In other words, it was insisted that the buyer’s
bank ordinarily possesses superior means of testing the
buyer’s solvency to that of the seller of the merchandise.
Undoubtedly there was a good deal of force in this argu­
ment. But it merely emphasizes the necessity of careful
analysis of the standing of the buyer as well as of the seller.
It also brought into clearer relief the viewpoint that the



principal consideration was the credit rating of the parties
and not primarily the form of the paper. There did not
appear to be sufficient warrant for the absolute rejection of
single-name paper. Accordingly, the principal statutory
provision relating to eligible paper makes the test, not the
form of the paper, but the purpose for which the proceeds
have been or are to be employed.
But were there not certain other feasible means of
increasing the use of trade paper? Could not less strict
qualifications and less complete information as to the
nature of the transaction be required in the case of double­
name paper? In view of the difficulties just disclosed
regarding the dangers of insufficient examination, such a
course would appear extra-hazardous. But if not this,
could not the total volume of rediscounts obtainable by
one member bank be made the greater in cases where the
applications were in large part double-name paper? Objec­
tion to such a policy was the probability that some sec­
tions of the country would be unfairly treated. Many
communities, particularly the rural and the village, could
not be expected to originate any large volume of two-name
paper. There thus remained the possibility of granting a
preferential rate of discount to applications covering the
new kind of paper. To anticipate future discussion, the
policy of preferential rate treatment has been adopted
during a large part of the period of reserve operation.
The Federal Reserve Board’s first regulations regarding
discountable paper may now be briefly summarized. In an
early communication, Circular Number 13,1 reserve banks
were requested to confine their operations to short-time,
self-liquidating paper arising from commercial, agricul­
tural, or industrial needs, and to exercise particular care to

This circular is accessible in convenient form in the Commercial and Finan­

cial Chronicle, November 14,1914, pp. 1416-17.

avoid furnishing capital merely for investment or specula­
tive purposes. Funds desired for fixed improvements
would fall in the ineligible class. The maturities of the
paper rediscounted should be well distributed, and the
paper should be non-renewable. To quote from the cir­
cular regarding the distribution of the maturities:
It is a general rule (in Europe) not to purchase paper having
more than 90 days to run. T h e maturities of these notes and
bills are so well distributed as to enable these banks within a
short time to strengthen their hold on the general money mar­
k et b y collecting a t m aturity or b y reinvesting a t a higher rate
a very substantial proportion of their assets. A ctin g on this
principle, the Federal Reserve banks should be in position to
liquidate, whenever such a course is necessary, substantially
one third of all their investments within a period of 30 days.
Departure from this principle will endanger the safety of the
system . I t is observance of this principle that affords justifica­
tion for perm itting member banks to counj; balances with Fed­
eral R eserve banks as the equivalent of cash reserves.

As a means of determining the self-liquidating character
of the paper, the method of procedure is next outlined.
The Board was evidently impressed by the desirability of
considering more than the nature of the specific underlying
transaction, for the procedure outlined to become effective
after January 15,1915, practically called for a statement of
condition of the borrowing firm. Since, however, the
Board did not wish to lay down rules which might involve
needless delay or difficulty in rediscounting, it was not
insisted that a statement of condition be attached to each
bill sold to a reserve bank. But it was to be required as a
basis of permanent procedure that the original borrower
should file such a statement with his member bank. For
the time being, certified accountants’ statements need not
be submitted. It was suggested, however, that at a later
date these might be required. Even though the statement



of condition need not be attached to each bill, the paper
must bear on its face evidence that it was eligible, and that
the seller had filed a statement of condition with the mem­
ber banks. This evidence might be vouchsafed by the
officers of the member applying bank through the means
of a rubber stamp.
These regulations were exceedingly exacting, so far, at
least, as methods of procedure were concerned. Few of the
smaller banks, particularly those in the rural sections, were
in position to supply the required evidence that a satisfac­
tory statement of condition was on file. In the face of an
almost entire lack of rediscounting, it soon appeared that
the severity of these regulations must be relaxed. Accord­
ingly, on January 12, 1915, three days before these regula­
tions were to become effective, the Board extended the
date from January 15 to July 15 of the same year. But the
lack of a genuine desire to rediscount still asserted itself
and in Regulation B, Series of 1915,1 it was ruled that
statements of condition need not be on file in certain types
of borrowing where it was believed it would be difficult to
obtain them. To be specific, these requirements were to be
1. If the bill bears the signature of the purchaser and seller
of the goods and presents prima facie evidence that it was issued
for goods actually purchased or sold; or
2. If the aggregate amount of obligations of such a depositor
actually rediscounted and offered for rediscount does not exceed
$5000, but in no event a sum in excess of 10 per centum of the
paid-in capital of the member bank; or
3. If the bill be specifically secured by approved warehouse
receipts covering readily marketable staples.
In succeeding circulars regulations with a similar trend
were sent out. In view of the very great desire of the Board
to improve the admitted deplorable conditions in the trade
x See Bulletin, May 1 , 1915, pp. 37-38.

and bank credit situation, it appears to the writer that the
Board cannot be convicted of endeavoring to establish
ultra-bureaucratic methods of procedure.
The purposes of the Board’s regulations were two-fold.
First, they were designed to state the precise terms accord­
ing to which the more general terms of the statute could be
made applicable to individual cases; and, second, to lay
down rules governing rediscount operations in cases where
the statute appeared to be silent. But even the regula­
tions themselves could not be expected to deal specifically
with the multitude of complicated cases which must
inevitably arise. Accordingly, as a means of disseminating
such information, the Board began the publication in its
official organ, the Federal Reserve Bulletin, issued monthly
first of its own informal rulings, and second of the opinions
of counsel in the Law Department. In these we find replies
to the inquiries of member banks, reserve bank officials,
private individuals, and governmental representatives. By
these methods much was accomplished in the way of har­
monizing the policies of the various district board direc­
torates. To a very marked extent the wisdom or lack
of wisdom of the Board’s policies is set forth in these
The difficulties of avoiding confusion and inconsisten­
cies in these rulings are easily apparent. To consider that
prime difficulty of fundamental application — when is an
operation commercial and when is it merely investment in
character? A distinction, such as this would involve, could
not be set up by any generally accepted method of eco­
nomic reasoning. Fundamentally this query touches a prob­
lem which has never been withdrawn from the field of
theoretical economic controversy — what is capital? Ever
since the precepts of the science of economics have been
formulated systematically, the masters have quarreled



over the proper means of delimiting this concept. To-day
opposite viewpoints are still displayed. One school would
define capital from the point of view of the form of the
good — whether or not it is of a kind primarily applicable
to the creation of other consumable goods. The other
school would define solely from the acquisitive, individual­
istic point of view. Thus capital comprises those goods, no
matter what the form, which are employed not to provide
direct psychic income, but rather to enable the possessor
better to derive a money income. This fundamental diffi­
culty appears again and again in the determination of
eligible paper.
Many less far-reaching criteria were current also in 1914
regarding the proper definition of commercial paper. One
of these was this — it is paper the proceeds of which are
employed in order to acquire readily salable goods. The
note of the coal dealer to secure the funds for the purchase
of coal to be speedily resold to his customers, of the fruit
buyer to acquire fruit for his current sales, would be eligi­
ble commercial paper. But what about paper arising in
the individual’s desire to acquire tracts of standing timber?
The timber as well as the timber land might be sold speed­
ily, yet the individual owner. might have in mind more or
less permanent ownership. The nature of his possession
might create no hardship in holding permanently. Unlike
the coal or the fruit, the timber would continue to improve
in physical quantity. There would be much more likelihood
of its being held indefinitely than in the case of the coal or
of the fruit. But should the paper be refused merely
because the asset of the borrower and accordingly the
security for the bank improves?
In this case the existence of another quality of standing
tracts of timber rendered more easy a statement of the
Board’s opinion. This extraneous quality enabled the

Board to base its ruling on the desirability of preserving
liquid the banks’ assets. Timber is subject to forest fires
and severe winds. To quote from the Bulletin for July I,
While it is true that there are times when timber lands, that
have been thoroughly cruised and reported upon by competent
experts, are readily salable, there are other conditions relating
to properties of this kind which must be taken into considera­
tion. Forest fires sometimes destroy a good deal of standing
timber, and sometimes wind storms greatly diminish the value
of such properties.
The precedent would be a dangerous one, as owners of coal
and ore lands might ask to have their coal and ore in the grounds
appraised on a royalty basis, and ask to have paper, based upon
their holdings of such lands, made eligible for discount at Federal
reserve banks.
But without the possibility of relying upon this quality
of timber land — possibility of great deterioration in physi­
cal quality — how much more difficulty must have at­
tended the ruling?
Let us therefore suppose another case in which no such
condition exists. What if the contractor wishes to borrow
in order to secure funds for the erection of a building? Is
his operation commercial, or investment, or even specula­
tive in its nature?
Here again the Board was enabled to rely upon a fact of
attending circumstance — whether or not at the time of
borrowing the contractor possessed a contract of sale.
Thus we are informed by the Bulletin for July, 1920,* that
the proceeds are for fixed improvements and the note is
ineligible in case the paper is that of the owner. But if it is
that of the contractor, it may be regarded as commercial in
character. Thus another quality of paper is introduced —
1 Page 126.
a Page 699.



existence of contract for sale of that which has been ac­
quired or constructed by the use of the proceeds of the
But if intention to liquidate quickly is the uniform cri­
terion, the Board must face another difficulty— one which
must occasion frequent discontent with the management
of the system. One borrower might be the maker of an
eligible note, another of an ineligible note, even though in
both cases the proceeds were employed to purchase the
same sort of a good. In one case the Board held eligible a
farmer’s note to secure the funds for the purchase of farm
tractors. Using this as a precedent, it was insisted1 by a
corporation engaged in the business of furnishing motor
transportation that its notes to secure funds with which to
purchase motor trucks were eligible. This corporation ar­
gued that its paper was even superior to that of the farmer
since the life of a motor truck ordinarily is less than
that of a farm tractor. Motor truck paper would be less of
an investment nature than tractor paper. Accordingly the
Board is here compelled to make a distinction dependent
entirely upon a matter of degree. To quote a part of its
Farm tractors constitute only a small part of the entire
equipment of a farm, whereas the motor trucks of a corporation
engaged in the business of furnishing motor transportation
necessarily constitute a very large part of the corporation’s
entire equipment. If the notes of such a corporation, the pro­
ceeds of which are used to purchase motor trucks, were declared
eligible for rediscount by Federal Reserve Banks, the result
would be that paper representing in the aggregate a very large
part of the corporation’s capital investment would be eligible
.for rediscount, and it would not be reasonable to assume that
W'inch notes could be liquidated out of the corporation's current

lletin,, February, 1921, p. 191.

Obviously the task of deciding what is and what is not a
fixed investment is fraughttwith difficulty. Frequently the
decisions do not meet the issue squarely. Dependence upon
facts of attendant circumstance must make future rulings
largely a matter of following precedent, with the danger of
confusion, inconsistencies, and reliance upon arbitrary,
discretionary judgment.
But to summarize our conclusions as reached thus far
“ readily salable goods” is not a concept easily determined
and easily applied. In some cases conclusions must depend
upon the risks of deterioration; in others, upon the exist­
ence of contracts to sell. In others, it would seem to depend
upon the extent to which the value of the goods acquired
by the proceeds of the borrowing measure up to that of the
other assets of the company. Fortunately for the Board,
the provisions of the statute inserted the word mere in the
prohibitory clause relating to investment paper.
Let us next consider another basis for determining the
eligible character of the paper. Are the proceeds to be
employed to further some definite stage of production,
distribution, or manufacture? If the proceeds are not to be
employed in such a way as to hasten their journey toward
acquirement by the ultimate consumer, clearly the expendi­
tures were for capital and not for commercial purposes.
But in practice it must be very difficult to determine
whether a given operation is a necessary part of the process
of production or commerce. How classify the note of the
dealer who borrows in order to acquire grain or cotton
which for the time being at least is not to be sold? Is mere
warehousing to be considered a necessary part of the dis­
tribution process? If it is thus to be considered, would not
dangerous precedents be developed, precedents which
might seem to justify Federal Reserve advances for com­
modity speculation? What if the purpose of the borrower



was primarily to put himself in a position to create a tem­
porary scarcity by withholding the goods from the market?
No practice in market distribution is more frowned upon
by the public than commodity speculation of this sort. In
our recent period of unrest over the rising cost of living,
much legislation and many administration measures were
directed against devices of this sort. Nevertheless, loans
to store goods are very essential to the marketing of many
crops. The supply appears suddenly on the market, and if
credit cannot be obtained by the grower, the crop must be
sacrificed at depressed prices. The purchasers, presum­
ably often in a better position to obtain bank capital,
would then be in as good a position as the local dealer to
withhold from sale for the sake of influencing the price
unduly. Rejection of applications based on paper of this
sort would seem to create injustices as between different
classes of grain dealers.
It is obvious that the ideal solution would be for the
Board to be guided by the existing situation in the market
and not by any easily ascertainable fact of the paper. As
long as the goods are not unduly obstructed in their flow
to the market, the reserve advances appear to be justified.
In the words of the Board, the test is whether the funds are
requested in order to facilitate the orderly and regular
marketing of the crops. Thus in the Bulletin for December
I, 1919,1 we read of certain remarks addressed to cotton
The Board has consistently advocated during the past five
years the policy of orderly marketing of crops. Assuming that
adequate warehousing facilities are available, it seems to be in
the interest of the consumer as well as of the producer that staple
commodities remain as far as possible in the hands of producers
until sold for consumption. This policy gives the producer the
benefit of an average price in that he is not required to “ dump”
1 Page 1109.

his products upon the market in excessive volume, thereby
depressing the price to the advantage of favored consumers or
of speculators who do not as a rule pass the advantage on to the
consumer. Owing to the great number of producers there will
alw ays be competition between them to sell, which would not
be the case if large syndicates were able to acquire control of the
bulk of the crop.

But no matter how wide the difference in results between
speculative borrowing and those necessary for the orderly
moving of the crops, the determination of the precise situa­
tion can never be easy. The eligibility of any single note
must depend upon general market and business conditions.
Under some situations the note of a grain dealer should be
accepted; under other situations the note of the same
dealer for an identically similar purpose must be rejected.
Day-to-day considerations must govern.
What help can be obtained by following through another
criterion? Were the proceeds originally employed in order
to purchase goods in form fairly complete, or close to the
point where marketable? Or, on the other hand, were the
proceeds invested in goods which must be completely
altered in form in order to render marketable? If this be
the basis of distinction, the reserve funds must render less
aid to the production and industrial than to the distribu­
tive interests of society. Coal purchased by a gas company
is not to be marketed until completely altered in form.
Labor purchased by an electric light company emerges in
salable condition only in form of electric current. But
might not the note of the gas company be just as liquid
when the proceeds are used to purchase coal as the note of
a grain dealer to secure funds for acquiring grain? Is not
the pay-roll expense of the electric light company as
speedily contributory to income as the expenditure of the
grocery dealer for canned goods? The labor employed is
not sold, but the products speedily are. It is evident that



little aid is to be obtained by focusing attention upon the
form of the goods purchased by the proceeds of the note.
Shall another criterion be accepted — the speed with
which the borrower should be able to liquidate his loan?
Shall it be the shortness of the period within which the
expenditures bring in returns which determines eligibility?
Should reserve funds be withheld from operations, in all
other respects as commercial as any other, in which for
technical reasons a longer period than ninety days is
required? It is evident that such a course would involve
much partiality. As stated in the Bulletin for June 1 , 1915:1
There are many processes of production which take a longer
time than 90 days, and while no Federal Reserve Bank should
enter into an agreement for the renewal of discounted paper,
nevertheless, in cases where the “ process of production” dis­
tribution covers a period longer than 90 days, there is no reason
why a borrower should not renew his 90 day borrowing.
In general, as stated in another connection, “ Liquidity should
not be tested by standards that are too narrow, arbitrary or
It thus appears that no one yardstick is available in
determining the eligible character of the paper offered for
rediscount. Neither liquidity, nor existence of a contract
to sell the product, nor the form of the goods acquired by
the proceeds of the borrowing, nor the probable speed of
liquidation, alone, is sufficient. Distinction between eli­
gible and ineligible paper must often depend upon mere
matters of degree or emphasis. Differences are often only
relative. It is pertinent to inquire, therefore, whether in
the original act it was not somewhat futile to place so much
emphasis upon the commercial character of the paper. Are
the distinctions between commercial and non-commercial
paper too difficult to employ consistently in practice?
Should discriminations have been waived and certain
1 Page 74.

types of investment paper rendered admissible? Queries
such as these must be postponed until a later chapter. But
this much is now clear: under the present regulations much
reliance must be placed upon theldiscretionary judgment,
first of the member bank, second of the reserve bank direc­
torate, and lastly of the Federal Reserve Board. If this be
true, it appears desirable to inquire whether other means of
restricting the unwise use of reserve bank facilities were
contained or should have been contained in the statute.
One obvious method of preventing excessive use of
reserve funds would be to limit the amount of rediscounts
obtainable by any one member institution. Since all mem­
ber banks contribute to the resources of the reserve banks
according to their capital and surplus, their rediscounting
privileges might be determined on the same basis. In this
way an outside limit could be placed on the extent to
which any one bank could rely upon the reserve facilities,
and any one bank could be prevented from using funds
so excessively as to diminish the power of reserve banks
to render aid to other member institutions in periods of
Such a restriction did not commend itself to the framers
of the act. It is true that another statute1 prevents a
national bank from incurring certain indebtedness in excess
of its capital stock. But to the application of this law there
are certain exceptions. One of these exceptions2relates to
any indebtedness incurred under the provisions of the Re­
serve Act. It has accordingly been ruled that a member
bank may rediscount paper to any amount permitted by the
district directorate. It was felt that in periods of emergency
the power of the district board to render relief should not
be curtailed. In periods of business confidence, it was
xSection 5202 of the Revised Statutes.
aSee section 13, Federal Reserve Act.



believed that most reliance should be placed upon the
good judgment of the district bank directorate. Restric­
tion of rediscounts for any one bank is accordingly a matter
of the discretionary power of management.
A second plan would be to restrict the amount of rediscountable paper bearing the signature of any one party.
Such a limitation might appear to be much more equitable.
Should one borrower of one bank be refused accommoda­
tions at a time when the paper of another no more deserv­
ing borrower of another bank is admitted? Should not
discriminations take account of facts of justice between
individuals, rather than primarily between banks? Acting
on this point of view, the framersof the statute prohibited the
rediscount of paper bearing the signature of the same name,
provided such paper exceeds ten per centum of the unim­
paired capital and surplus of the lending bank. To this
general statement exceptions are to be made in case of
“ bills of exchange” drawn in good faith against actually
existing values. Furthermore, in order to encourage the
purchase and acquirement of war securities an act of lim­
ited duration was enacted, according to which, on April 16,
1919, the Board ruled it permissible for a reserve bank to
rediscount paper of a single borrower to an amount equal­
ing twenty per cent of the capital and surplus provided the
excess above ten per cent was secured by a like face amount
of Liberty bonds or certificates of indebtedness.1
But would the paper of any borrowing individual redis­
counted with the reserve bank be included within the
limitations of section 5200 of the Revised Statutes.
Would the creditor be considered to be the member bank
or the reserve bank? In view of the fact that rediscounts
must be endorsed by the member bank, and accordingly
comprise a contingent liability of the bank, a good case
x Cf. Commercial and Financial Chronicle, April 19,1919, p. 1561,

would seem to exist for regarding them in this light. But
by an Opinion of Counsel it was ruled in the Bulletin for
September 1, 1918, th a t:1
A note or bill rediscounted in good faith by a member bank
which is no longer owned or held by the bank need not be in­
cluded as a liability of the maker to the bank within the meaning
of section 5200, Revised Statutes.
The effect of this opinion is to confirm the view that
rediscounting offers a process by which a bank may increase
greatly its loans to any one client. In case the paper of any
one borrower approaches the ten per cent limit, such
paper may be rediscounted. In this case it becomes an
obligation, not to the member, but to the reserve bank.
A consideration of these various limitations perhaps
justifies this general conclusion: provided a member bank
possesses a sufficient quantity of rediscountable paper,
effective limitation of the rediscounts must depend almost
solely on the good judgment of the district directorate and
the Federal Reserve Board. Restraints of a direct nature,
arbitrary refusals to accept the applications of certain
classes of paper, depend largely upon the reserve director­
ates. Indirect restraint, those relating to the cost of redis­
counting, depend ultimately upon the Board, because of
its power to review rates of rediscount. The development
of the reserve system is thus largely a story of manage­
ment. Statutory provisions reduce themselves in large
measure to the discretionary judgment of direction. The
most important restrictions relate to the prohibitions on
speculative and investment paper. But for the most part
the Board’s rulings and regulations have been exceedingly
It was not contemplated by the framers of the act that
reserve banks should lend their facilities to non-member
1 Page 867.



institutions. These banks were not rendered subject to
examination by the Federal Reserve Board and make no
contribution to the capital of the reserve institutions. To
rediscount this paper must destroy one of the principal
incentives to membership in the Federal Reserve.
What, however, was enacted about indirect means of
securing the use of reserve funds? Could not the member
bank accept the paper of non-member institutions and by
rediscounting this paper free its own resources? In this
way the reserve could be made the indirect source o f
advances to non-member institutions.
It was felt by the lawmakers that this would be a situa­
tion necessitating much discrimination in judgment. On
some occasions it might be a service to member banks for
reserve banks to aid non-members in this indirect way. Such
action might be the means of restoring general business
confidence. In other situations, however, such advances
might not be necessary and might have the sole effect
of discouraging membership in the system. Accordingly,
the law requires that, in case the purpose of such applica­
tions was to secure funds to reloan non-member banks, the
permission of the Federal Reserve Board must be obtained.
During the war period, however, matters of Government
finance were deemed sufficient to warrant a very liberal
application of the statute. For a certain period it was left
to the discretion of the district bank directorates to deter­
mine whether such accommodations should be afforded the
non-member institutions.1
1 Cf. Bulletin, June 1 , 1917, p. 426.

the Federal Reserve system began operations in the
fall of 1914, advances could not be made, under the author­
ity of section 13, by direct discounts of member banks’
notes. Leaving out of account their open-market opera­
tions, reserve banks could grant accommodations only
upon the tender of paper which had originated previously
in an advance by the member bank to one of its clients.
In other words, the reserve bank’s portfolio would consist
of paper, the makers of which were the customers of the
member bank. For the sake of ensuring the safety of this
paper and accordingly of the soundness of the reserve
banks’ assets, member banks were required to endorse the
paper offered for rediscount. But the member banks’ re­
sponsibility was contingent and not direct.
The reasons motivating the lawmakers to discriminate
against direct discounts were several. In the first place, the
paper accepted would be single — and not double-name.
Only the member bank would be responsible for ultimate
payment; whereas in the case of a rediscount, the member
bank’s contingent responsibility would be additional to
that of the original borrower. Secondly, rediscounting
operations emphasized more strongly the direct public
benefits which the reserye system was intended to accom­
plish. In case of a direct discount for a bank, it might be
difficult for many to understand just how the business pub­
lic was being aided; whereas in the case of a rediscount the

W hen



ability of a bank to finance a specific transaction would
seem to depend more directly upon the willingness of the
reserve bank to accept such paper. Rediscount operations
appeared to bring the reserve banks more closely in con­
tact with the public. Finally, it was feared that direct
advances might be dangerous. If the member bank pos­
sessed short-time eligible paper, it could secure aid through
rediscounts; in case it possessed no such paper, its purpose
very likely would be to secure capital for long-time com­
mitments. To refuse to make direct advances would not
seem to penalize the institution which held paper of the
eligible sort. But it would penalize the bank whose assets
consisted largely of investment or speculative paper.
Applications for direct discounts would be the resource of
those institutions which did not possess eligible paper, and
whose assets, therefore, were presumably, non-liquid.
Of these various objections, the last was apparently the
most impressive. For one illustration we may quote the
following extracts from the reply of John Perrin, Chairman
of the San Francisco Reserve Bank, to the appeals of the
Orange County Bankers’ Association of California for an
amendment to the act which would permit direct discounts
of member banks’ paper:1
Bank reserves under requirements of the old system were at
times found inadequate and financial panic resulted. Your
resolution seems to us to advocate not only a continuance of the
evils of the old system, but, in advocating loans of indifferent
liquidity out of diminished reserves, urges a further weakening.
It would seem to us that no policy could be more suicidal and
none more certain to involve both the banks and their custom­
ers in disaster. . . .
The development of liquid commercial paper is a fundamental
essential of banking progress. In lowering reserve requirements
the Federal Reserve Act contemplates that a bank's paper
* See Commercial and Financial Chronicle, January 22, 1916, p. 300.

eligible for rediscount w ith Federal Reserve bank will consti­
tute an im portant part of its real reserve. T h is fortification
your resolution would sweep aside, though it should be clear
th at while the Federal Reserve bank m ay convert shortly m atur­
ing liquid paper into means of paym ent it has no power to con­
vert a non-liquid loan into one which will speedily convert itself
into a m oney reserve.

If direct discounts should be made to members who did
not possess the necessary amount of eligible short-time
paper, the truth of the above statement would be clear.
But might not a member bank desire frequently to offer
its own note even though its portfolio did contain liquid
admissible paper? Might not a bank find direct discounts
more convenient and feasible? An affirmative answer to
this query might be based on the following grounds:
(a) The member bank might wish to borrow for very
short periods of time. To discount customers’ paper of
longer maturity would subject the applying bank to the
heaviest discount applying to the paper with longer matur­
ity. Rather than submit to this heavier charge, the coun­
try bank, in particular, might continue to seek aid from
its city correspondent instead of applying to the reserve
bank. Such action would render it all the more difficult for
the reserve system to extend its membership and improve
its prestige and power to regulate the money market.
(b) In the second place, it was argued that direct dis­
counts would reduce greatly the labor of computing inter­
est on many small notes. Discounts would have to be
figured only on the member’s note; when this note fell
due, it could be paid off and the collateral, consisting per­
haps of customers’ paper of various maturities, could be
(c) In the third place, direct advances collateraled by
customers’ notes could be made to offer some margin of
security to the reserve bank. The face value of the collat­



eral could be made higher than the amount of the advance.
In the case of an uncollateraled rediscount, there could be
no margin of security over the advance of the reserve
With the lessons of experience thus indicating that di­
rect discounts, properly regulated, could be supported by
arguments relating to safety as well as to those of conve­
nience, a general demand arose for a change in the statute.
Accordingly, on September 7, 1916, an amendment to the
Reserve Act was passed according to which such advances
were to be permitted in cases where the member bank’s
note was limited to fifteen days’ maturity and in cases
where the collateral consisted either of the kind of paper
eligible for rediscount or of Government securities. The
specific wording of this amendment was as follows:1
Any Federal reserve bank may make advances to its member
banks on their promissory notes Tor a period, not exceeding
fifteen days at rates to be established by such Federal reserve
banks, subject to the review and determination of the Federal
Reserve Board, provided such promissory notes are secured by
such notes, drafts, bills of exchange, or bankers’ acceptances
as are eligible for rediscount or for purchase by Federal reserve
banks under the provisions of this Act, or by the deposit or
pledge of bonds or notes of the United States.
The reasons for the inclusion of the several restrictions
on direct collateral advances should be clear. Unless the
objection of rendering the reserve assets more non-liquid
was to hold, member banks should possess paper of an
eligible sort. If they held such paper, it would be no hard­
ship to require them to forward it as collateral for the ad­
vance. The basis of limiting the maturity of the member’s
note seems obvious, likewise. If the previous difficulty
was need of funds for a period shorter than the maturities
1 See section 13 of the amended act.

of customers’ paper, member banks could not object to
the limitation of fifteen days for the period of advance.
After the date of the amendment, the advantages of
direct borrowing frequently proved appealing aside from
considerations of convenience. In the seven months or so
preceding the outbreak of hostilities, the reserve adminis­
tration continued to stress, as a means of preparation for
any future emergency, the desirability of maintaining the
liquid character of the reserve system’s assets. Fifteenday paper accordingly was much in demand by the reserve
banks. After the outbreak of the war, direct loans collateraled by Government securities rendered great aid in the
Treasury’s war finance policy. Prior to September 7, 1916,
member banks which might have acquired Government
bonds could not liquidate them by means of rediscount
operations. It is true that customers’ paper, the proceeds
of which had been used to purchase Government bonds,
was eligible. But in the Treasury’s war finance campaign
it proved necessary frequently to rely heavily upon the
subscriptions of the member banks themselves. To guar­
antee banks against loss through the fact that the bond
subscriptions might temporarily drain them of funds, mem­
ber banks were permitted to discount their own notes collateraled by Government war securities at very low rates.
On May 25, 1917, for instance, a special rate of from two
to four per cent was established at the New York Reserve
Bank for member banks’ one-day collateral notes arising
from the Government’s loan operations. This was raised
to three to four and one-half per cent on December 7 ,1917.1
For these reasons the use made of the direct collateral
advance was great. For the years 1917-20 inclusive the
amount of such operations was as follows:2
1 Cf. Report of the Federal Reserve Board for 1917, p. 37.
a Figures were compiled from the Report of the Federal Reserve Board for
various years.





M e m b er B a n k s C o l l a te r a l N otes
A ccepted b y R e s e r v e B a n k s

W 7.............

$ 7,742,806,186

1919 .............


T otal A m o u n t of B il l s
D isc o u n te d

$ 8,968,990,818
3 9 .7 5 2 .9 3 3 .8 4 7
7 9 .1 7 3 .9 6 9 .7 3 0


The direct collateral loans thus came to constitute by
far the most important form by which advances were made
by Federal Reserve banks to member banks. The great
bulk of these loans were secured by United States certifi­
cates of indebtedness and Liberty bonds. This is indicated
by the following figures:1


em ber B a n k s C o l l a te r a l N o tes !T otal A m o u n t or D ir e c t C ol ­
S e cu red b y W ar P a p e r
l a t e r a l L o a n s to M e m b er B a n k s

IQI7 .........
*7 */«•••••
IQ A ........
*7 IQ #• • • • •





The amount of reliance placed by member banks upon
the direct collateral loan after the fall of 1916 cannot be
stressed too highly. In the first place, after the first issue
of Government war securities in 1917, we hear no more
about the inability of member banks to take advantage of
the reserve system’s rediscount facilities because of the
lack of eligible paper. Practically every member bank
possessed at some time or other considerable quantities of
war paper. This sort of an advance, moreover, rendered it
easy for the Treasury to carry out its easy-money policy
of financing the war. As long as member banks could re­
discount their own notes thus collateraled at rates approxi­
mately equal to the rates borne by the bonds, and as long
1 Figures were compiled from the Report of the Federal Reserve Board for
various years.



as the reserve banks continued to announce their policy
of cooperating with the Treasury, they need stand in no
great fear of over-subscribing to the war issues. The key
to the ability of the Treasury to float billions of dollars
of bonds at a low interest rate lay in the ability of mem­
ber banks to obtain funds on easy terms from the re­
serve banks. Permitting the notes to be collateraled by
Government securities virtually offered an additional
means by which funds could be obtained from the Federal
Direct advances also rendered it far easier for the banks
to carry customers who employed borrowed funds to pur­
chase the war bonds. In case the customer should not com­
plete his payments and the bond should revert to the bank,
the bank could liquidate, at least temporarily, by relying
upon the reserve bank. In large measure the apparent ease
with which the Treasury obtained a market for its issues
can be attributed to this amendment of September, 1916.
In opposite fashion, whatever evils resulted from the easymoney policy of war finance can likewise be attributed
largely to the working of this amendment.
It is true that advances of this sort were limited to bor­
rowings of fifteen days’ duration. Nevertheless, the Fed­
eral Reserve administration was very liberal in its renew­
als. The only limitation was that the reserve bank must
not obligate itself to make such renewal.1 Such an agree­
ment might create the situation in which the maturing
note would be paid off out of the proceeds of the new dis­
counts, and the fifteen-day limitation be virtually sus­
pended. But if the requirements of the bank should be due
to the emergency character of the general financial situa­
tion or to its own liberal subscriptions, there was little
doubt but that faith could be reposed in the ability to
* See Opinion of Counsel, Law Department, Bulletin, October 1 , 1917, p. 765.



obtain such renewals. To quote from the Opinion of
Counsel of the Board:1
If, however, the Federal Reserve Bank is under no such agree­
ment and has the option to require payment in cash, it may at
the maturity of a 15-day note discount another for the same
amount, secured by the same or substituted collateral, so long
as the two transactions are independent of each other.
The question of how far this practice should be encouraged
by Federal Reserve Banks is one of policy rather than law. It
may be reasonably assumed that the Federal Reserve Banks
will not permit its abuse.
1 See Opinion of Counsel, Law Department, Bulletin, October 1,1917, p. 765.

I n the earlier days of reform-discussion there was a sharp
difference of opinion regarding the necessity of a new bank­
ing structure. On the one hand, it was argued that despite
many imperfections of detail the national banking system
would not so frequently have failed to function adequately
had there existed in this country a strong controlling
bankers’ bank. It was insisted that such an institution, by
compelling credit-restraint in the years of excessive activ­
ity, and by making its resources easily available in time of
emergency, could do much to prevent the periodic collapses
of the credit structure. This school admitted it was un­
fortunate that our note issues were based upon the public
debt; that our reserves for bank deposits were rigidly
defined at law and improperly employed by the metropoli­
tan financial institutions; that the peculiar credit needs of
foreign trade industries had been so largely overlooked.
Such difficulties as these were admittedly serious; but,
nevertheless, it was insisted that a central bank of even
moderate resources could do much to moderate the inten­
sity of our credit ills. The major defect was held to be
decentralization in reserve holdings, in note issues, and in
A second school, however, endeavored to formulate the
tenet that no new banking structure was required or was
even desirable. In view of the prevailing hostility to the
idea of a central bank, it would be futile politically to



endeavor to devise a dominating bankers’ bank. Rather,
reform measures should proceed on less ambitious lines.
Instead of retaining rigid reserve requirements for depos­
its, we should provide for elasticity by the employment of
a graduated tax on deficient reserves; note issues should be
based on the general commercial assets of a bank rather
than upon its holdings of Government bonds; foreign
trade difficulties should be corrected by bestowing addi­
tional powers upon national banks such as the right to
accept bills and drafts for international commerce pur­
poses. Finally, as a matter of very great importance, many
improvements could be wrought in our commercial paper
and trade credit usages. In particular, the attempt could
be made to increase the use in commercial transactions of
two-name trade paper.
As the controversy progressed, however, these two
schools of thought became less sharply differentiated. On
the one hand, it came to be more widely perceived that a
central bank might encounter serious difficulties unless
reserve requirements were rendered less rigid; note issues
less inelastic; commercial paper less unsound. On the
other hand, it was gradually recognized that the adminis­
trative, development of many proposed reforms would
require the sponsorship of a large dominating central
institution. In particular a more liquid type of commer­
cial paper could be popularized only by a propaganda
more effective than any private agencies without power to
act could conduct. Was not this the teaching of past finan­
cial history? Despite the admitted evils of earlier trade
credit methods, the privately controlled banks had failed
to develop a wide open market for sound commercial
paper. The only hope of improvement lay in the forma­
tion of a strong central institution with power to guide and



Viewed in this light, the campaign for double-name
commercial paper becomes one of the most prominent
aspects of the reform begun in 1914. The Federal Reserve
banks were not to be solely discount institutions; they
also were to be the sponsors and the leaders in the propa­
ganda for more sound methods of commercial banking.
In this respect was realized the special contribution of a
man who played a peculiarly important r61e in banking
progress. Prior to 1913 Paul M. Warburg was closely
identified with credit-reform, and after the passage of the
Owen-Glass Bill he was a member of the first Federal
Reserve Board. The life of his work survived many
changes of political and legislative control. During the
period of preparation of the Aldrich Bill, his contribution
to the publications of the National Monetary Commission
was The Discount System in Europe. In this work the main
contrast between European and American banking meth­
ods was asserted to be no more the lack of a central bank
here than that
The European financial system is constructed upon discounts
as its foundation; the American system is constructed upon
stocks and bonds as its foundation.1
The especial virtue of the European credit mechanism was
that its “ discount system mobilizes the resources of the
banks. ” 2 Further:
The discount and central bank system enables the Nation to
meet these situations by concerted but varying action adjusted
to meet each individual case.3
The historical causes of present methods of trade credit
are now generally understood. Prior to the Civil War the
bill of exchange, drawn by the seller against the buyer, was
1 Page 23.
aPage 39
3Page 37. Italics are the writer’s.



c$rtim6nly employed. The bill, when accepted, would be
'discounted at the seller’s bank. In this way the seller
rendered liquid his trade assets; the seller’s bank commonly
- had available a supply of easily negotiable commercial
paper; and the buyer endeavored to conduct his opera­
tions in such a way as to ensure his ability to meet his
obligations on the promised date.
Gradually, however, this custom was superseded by the
open book account system coupled with the offer of a lib­
eral discount for prompt cash payment. This change in
methods is explained by the writers as due largely to two
causes.1 First, the fluctuating value of the dollar in the
greenback days rendered tradesmen anxious to close their
accounts as soon as possible. Many of them began to offer
large discounts to ensure early payments. Since it would
not do to obligate the buyer to pay on a future date, his
indebtedness would be carried currently as a book account.
In this way, two-name trade paper became less and less
common. To acquire the funds for his remittance the
buyer would offer his banker his own single-name note.
Control over trade credit has passed more and more from
the hands of the wholesaler’s bank and has been lodged in
the hands of the local banker. If the buyer did not remit
promptly, the seller might be obliged to obtain a line of
bank credit. But the paper of the seller was his own single­
name, and did not evidence any particular transaction.
We are also informed, as a second explanation of the
change in trade credit methods, of the development of the
work of the traveling salesman in such a way as to alter
the legal position of the buyer. When the retailer selected
from the stock of the wholesaler as in the earlier days and
had an opportunity to examine the quality of the goods,
1 Cf., for instance, E. E. Agger, “The Commercial Paper Debate,” Journal of

Political Economy, July, 1914, pp. 663-67



the legal doctrine of caveat emptor prevailed. But when
he bought from sample, he had a right to insist that the
goods conform to the quality of the sample. Before ac­
knowledging his indebtedness he must have an opportu­
nity to inspect the goods. He prefers to be carried on the
books in the meanwhile and consequently objects to
accepting immediately a draft.
But despite these facts it seems difficult to account for
the extremely great scarcity of good two-name trade paper
in 1914. It would seem as if the demand on the part of the
bank with surplus funds to invest would have created at
least a limited field for this type of paper. It would seem
reckless to assert that the requirements of the capitalist
were absolutely impotent.
Answers to this query may be had, however, by noting
the type of transactions to which paper similar in form to
the bill of exchange was customarily employed. The draft
had been relegated in trade transactions largely to the
slow accounts. It was employed in many cases because
the seller had become so suspicious regarding the buyer’s
ability to pay or so impatient at his delay that he demands
a definite acknowledgment of the buyer’s obligation to
remit on a definite date. Two-name commercial paper was
in bad company.
Some difficulty, moreover, was experienced frequently
in the collection of two-name paper. The drafts were
usually not made payable at any bank specified by the
buyer of the goods. In this respect its position differs
somewhat from that of the modern trade acceptance. Under
the Negotiable Instruments Law, recognized in a large
majority of our States, a trade acceptance made payable
at a specified bank operates in the same manner as a check.
Upon maturity, if presented for payment, it will be charged
to the account of the buyer provided there are sufficient
funds to meet it.



Banking facts, also, h,elp to explain our inability to
develop good two-name trade paper. For various reasons
there existed no broad open market, upon which the bank
could depend confidently for the sale of its short-time
commercial paper. With a strong central bank in exist­
ence, directed from the standpoint of public needs, there
should not have been the same difficulty in time of emer­
gency of liquidating upon holdings of such paper. Since
the time of Andrew Jackson, however, no such institution
had existed in this country. It seemed preferable, there­
fore, in establishing a secondary reserve to invest in securi­
ties for which the stock exchanges furnished continuous
quotations. This was the basis of Warburg’s remark, pre­
viously quoted,1 that “ the American system is constructed
upon stocks and bonds as its foundation.”
Finally, unlike the currency systems of most continental
European countries, our banking law placed no premium
on commercial paper as a basis for note issues. The bondsecured note issue has much for which to answer.
If, then, it was generally agreed in 1913 that the Federal
Reserve must assume a large measure of responsibility for
the development of an improved type of trade paper, what
were the pertinent provisions of the original statute? It
has been stated previously that, while the matter was con­
sidered seriously, the lawmakers refused to designate twoname trade paper as the sole type eligible for rediscount.
B y the terms of section 13, reserve banks were given the.
right to discount any of the following: “ notes, drafts, and
bills of exchange arising out of actual commercial trans­
actions.” Eligible paper was to depend, therefore, upon
the nature of the underlying transaction and not upon the
form of the paper. The concessions of this section (number
13) are confined to certain permissions for the rediscount
1 See supra, p. 107.



of a larger amount of paper bearing the signature of one
party than in the case other types of paper are offered.
This matter will be discussed briefly toward the close of the
It is in the open-market section (number 14) that we
find the principal concession to trade paper. Reserve
banks are empowered to purchase “ from member banks
and to sell, with or without its indorsement, bills of
exchange arising out of commercial transactions.” This
constitutes an evident discrimination in favor of two-name
trade paper, since nowhere is the promissory note included
in the permissible class of open-market investments. De­
spite these concessions, however, statutory recognition of
two-name trade paper is so limited that its later develop­
ment must be credited largely to the discretionary acts of
the reserve administration.
Before investigating the trade paper policy of the reserve
administration, it may be desirable to recall some of the
advantages urged in behalf of encouraging the use of a
proper type of the commercial bill of exchange. These
supposed advantages have been heralded so widely and
discussed so generally that we shall attempt to do no more
here than to mention them briefly. These advantages may
be classified as falling under three heads: first, those of
special concern to the seller of the goods; second, those
addressed primarily to the buyer; and, lastly, those ap­
pealing most directly to the self-interest of the banker.
To the seller the arguments were based on the oppor­
tunity of securing almost immediately upon the sale of the
goods a definite agreement of the buyer to pay on a certain
date, an agreement, moreover, which is couched in nego­
tiable form. Much preferable, therefore, is it to the uncer­
tain and unadmitted obligation of the buyer as evidenced
only by the seller’s book records. Bad debts and slow pay­



ments must be lessened by the encouragement of such
paper. If payments of the purchaser are speeded up, the
bank borrowings of the seller need not be nearly so g rea t;
and the cost of securing working capital is reduced, a fac­
tor, moreover, which competition must gradually cause to
redound to the benefit of the public. But even if no speed­
ing up of payments is induced, trade paper may still per­
mit the seller to liquidate his assets more quickly. The
book accounts of the seller, ordinarily, were difficult to
assign. Requests for borrowed funds on the basis of such
assigned accounts were interpreted frequently as evidence
of the faulty financial position of the seller. Because such
assignments were in general disuse, such requests were
frequently interpreted as evidence of the impaired finan­
cial standing of the applicant. The accepted draft of the
buyer, drawn at the time of shipment, should prove much
more negotiable, and therefore enable the local banker to
make advances even though his own ability to continue to
hold the acceptance is doubtful. In other words, the wider
the market for commercial paper, the greater the ability
to liquidate trade assets quickly.
It has proved somewhat more difficult to convince the
buyer of the advantages to be derived by the substitution
of trade paper for the open account. It is true that it was
easy to argue that any system which would render more
certain to the seller the redeemability of his payments re­
ceivable must gradually through the force of competition
lessen the charges exacted by the seller. But would it secure
immediately, in the specific transaction in hand, and with
relation to his own competitors, any cheaper terms? It
must be borne in mind that the average buyer makes one
transaction at a time and is only indirectly interested in
improving methods employed by trade as a whole. Too
often the propaganda has confused general and long-time



advantages with those of special and immediate interest
to the buying business man. It may be true also that the
trade acceptance method may serve to check reckless buy­
ing on the part of the purchaser. But must it not be
difficult to convince any one purchaser that his buying
habits are so loose as to necessitate his obligating himself
to make payment on a specific, definite date? Clearly,
arguments to the purchaser have greater force when the
appeal is based upon specific individual advantages in the
particular transaction in which his acceptance is requested.
Arguments of immediate individual advantage might
be the following: In the first place, the buyer who agrees
to obligate himself definitely regarding the time of pay­
ment improves his credit position with his banker. Often a
query of the banker is this — do you accept trade drafts?
An affirmative answer may raise the buyer’s credit rating.1
It is to be admitted, of course, that the underlying expla­
nation of this discrimination is to some extent artificial.
The motive of the member banks in encouraging the
acceptance frequently has been their desire to secure a
type of paper rediscountable with the Federal Reserve at
a low, preferential rate. But whatever the source of dis­
crimination, it has been made to apply with increasing
force. In some industries, firms which accept trade drafts
have been able to insist upon better terms as regards cost
of goods and quantity obtainable. These firms could
advance the argument that the acceptance enables the seller
to obtain his bank credit at a cheaper rate. Frequently
also the acceptance offered a means by which the small
and comparatively unknown firms were able to place
themselves more largely upon a position of credit equality
with those of a more firmly established credit standing.
The advantages of trade paper could also be heralded to
1Certain exceptions to this statement will be discussed later in this chapter.



the commercial banker. It has been remarked that in the
past it was customary in the slack seasons for the interior
banks to invest in large volume surplus funds in the secur­
ity market or to place them on deposit with their corre­
spondents in the financial centers. In recent years the work
of the note broker had so developed that it was compara­
tively easy to find an outside market for these surplus
funds by investments in short-time commercial paper.
But the ability in an emergency to liquidate such paper in
advance of the date of maturity was a factor of doubt.
Commercial paper investments, sufficiently attractive so
far as yield was concerned, did not make a good secondary
reserve. The limited open market for such paper explains,
therefore, in large measure the huge volume of commercial
bank funds regularly invested in the bond market or rede­
posited with the financial institutions in the stock market
centers which bid for such funds.
The danger of these practices was called to the public’s
attention forcibly in the panic of 1907. The call of the inte­
rior banks for New York funds and the general attempt
to liquidate quickly on security investments soon caused
a general suspension of payments in our financial center.
But correction of this difficulty was not easy. Crisis
and financial panics are not ordinarily contemplated as of
inevitable recurrence. A change from old methods could
be induced only by establishing in normal times a wide
open market for commercial paper. The market should be
so broad and steady as to offer the same means of liquidat­
ing assets as those furnished by bank redeposits and bond
investments. Here was the place for the trade acceptance.
It was two-name, had its origin presumably in an automat­
ically liquidating commercial operation, and with proper
backing from reserve authorities could be converted into
cash on occasions of real need.



It was accordingly possible to make for the acceptance
an appeal to all classes of the business public. As to the
means which must necessarily be employed to increase its
use, it has been stated previously that these depended
largely upon the discretionary power of the reserve admin­
istration. It was not a matter of slavish devotion to the
terms of the statute. Favorable discrimination was con­
fined by the act to the provisions relating to open-market
operations and to those bearing upon the amount of rediscountable paper bearing the signature of any one party.
It is therefore necessary to inquire next as to the precise
means employed by the reserve management to extend
the use of such paper.
In circulars issued November 16, 1914, and April 2,
1915, the Federal Reserve Board outlined certain special
privileges and preferential rates of discount to be enjoyed
by the acceptance. But the trade acceptance as a distinct
class of commercial paper dates its origin to the issuance of
Regulation J, Series of 1915. By this regulation the name,
“ trade acceptance,” is devised for double-name commer­
cial paper which conforms to certain requirements. The
intention was to find a means of distinguishing this new
type of commercial paper from other paper, similar in
form, but lacking some of its essential characteristics. For
instance, the trade acceptance would be similar in form to
a draft arising from other sorts of transactions than those
purely commercial. To deserve the title of “ trade accept­
ance” and to enjoy the special privileges which it was
proposed to grant it, the paper must conform to the follow­
ing qualifications: First, it must be drawn by the seller of
the goods against the buyer. Second, it must be drawn on
account of the indebtedness created by the transfer of the
goods and for no other reason. Third, it must be accepted
by the buyer under conditions whereby the date of pay­



ment is made certain. When presented to a reserve bank
for discount, such paper must bear the endorsement of a
member bank, and must have a maturity at time of redis­
count of not more than ninety days. Evidence of the
nature of the underlying transaction could consist of a cer­
tificate to the effect that “ The obligation of the acceptor
of this bill arises out of the purchase of goods from the
drawer.” If it so desired, the district directorate could
inquire into the exact nature of the basic operation.
A perusal of the terms of this regulation will suggest the
answer to the query as to why this favored class of paper
must be made out solely in the form of the draft. Would
not a promissory note for the amount of the goods ten­
dered to the seller by the purchaser possess the virtues
desired for the trade acceptance, namely, that the paper
be double-name and that it arise out of an operation of
commerce? Discrimination in favor of the draft depended,
not on belief that the form of the paper proves the nature
of the operation, but upon the belief that a trade transac­
tion can ordinarily be proved more readily when the paper
is in the form of a draft. In case of the draft the seller and
not the buyer takes the initiative in making out the trans­
action. The buyer may postpone so long the making out
of the note that it might be difficult to determine which of
a series of operations was financed by any one piece of
paper. The draft lends itself readily to the requirement
that proof of the transaction be available at the time the
paper is presented to the banker. If desired, the bank can
insist that the bill of lading and other shipping documents
be attached to the note which is offered for discount.
What success has been realized in the endeavor to popu­
larize such paper? Complete and accurate information
regarding this matter is difficult or impossible to obtain.
Some indication of the use of this paper may be had by



examining the discount operations of the reserve banks in
such a way as to compare the amount of trade acceptances
discounted to commercial paper of all classes. Figures are
not given for open-market operations, since the volume of
these reflects too greatly the volition of the reserve man­
agement. What we need to obtain is information indica­
tive of the holdings of member banks.1
T rade
Y ear

A cceptan ces

c o u n ted

D is ­

M em ber


T otal of all

C lasses

D isc o u n t e d P a pe r

P ercen tage of T rad e
A cceptan ces
C lasses

B anks

co u n te d



a ll

D is ­

P aper

In T h ousan ds of D ollars

192 0 . .




1918 ..
191 7 •.
1 9 1 6 ..





$ 85,320,874


79, 173.970
39 ,752,934
8 ,968,990


". 4

These figures do not indicate any such startling growth
in the use of trade acceptances as to suggest a sudden and
complete revolution in trade credit methods. Of course
the nature of reserve bank operations does not portray
with exactness the condition of member bank portfolios.
But the larger the amount of acceptances held by member
banks, the greater the probability that the proportion of
this paper discounted to that of other classes will be large,
and vice versa. But in one way these figures may not do
exact justice to the acceptance. In the earlier years of
reserve operations the trade acceptance was discountable
at a lower rate than other classes of paper. Later this
preference was eliminated. A t no time, however, was
there a rate discrimination against the trade acceptance.
And the general conclusion derived by examining the fig­
ures is confirmed by the prevailing type of literature upon
the subject. A very large portion of it attempts to explain
x Figures are obtained from the Annml Reports of the Federal Reserve Board.



the nature of the difficulties encountered in the endeavor
to secure its popularization. Let us next, therefore, at­
tempt to state some of the obstacles which stood in the way
of a wide extension of its use.
A first difficulty was the easily explained hostility of
many of the stronger firms in various industries. Many
such hesitated to encourage the use of a new instrument
which tends to place their smaller rivals on a position of
credit equality. In Warburg’s words:1
When borrowing on its own note, the strong firm, with wellestablished credit, can obtain larger loans and on more favor­
able terms than its small competitor, and it is, therefore, in
position to finance its purchases and its sales on a more favor­
able basis than the small firm. It gains the advantage both as
to the larger scope of business it can do and the lower interest
rate it enjoys. True, it could probably do a larger business than
at present by adopting the trade acceptance plan, but by thus
adopting the trade acceptance basis small firms would probably
profit more in proportion than the larger ones; their handicap
would be lightened.
It is necessarily more difficult to secure an inroad for
the acceptance by appealing to the smaller establishments.
Their customs and methods are not studied so thoroughly
by the trade as are those of their larger rivals. The lead
must be taken by the leaders. And it could not be expected
that weaker establishments, those with a very low credit
rating, could be led easily tofseize the opportunity of
removing their credit disadvantage by adopting the accept­
ance. These weak firms object to binding themselves to
pay on a definite date. Moreover, there has been no desire
on the part of the acceptance propagandists to make this
type of paper the resort of the weak firm. No paper can
classify more highly than the standing of the obligee.
Much difficulty has also been experienced in converting
xFrom address published in part in Bulletin, July, 1918, p. 605.



the commercial banker to the new method* To quote
Warburg again:*
Some bankers assert th at in buying a promissory note the
mere fact th at th e y are conscious of buying the naked note
of a customer furnishes a reason for their feeling obliged to
carefully analyze the statem ent of the customer and to judge
the merit of the borrower upon the statem ent of the latter's
financial condition. T h e y allege th at this practice is safer than
that of purchasing a trade acceptance issued b y the same firm,
because, as th ey say, in th at case th ey are likely to rely on the
legitim ate character of this double-name paper w ithout exam in­
ing as cautiously as th ey otherwise would the general condition
of the borrower.

The answer to this view has been stated previously.
Bankers who purchase acceptances should examine the
financial condition of the parties as carefully as when dis­
counting a single-name promissory note. It never was
contemplated that a change in the form of paper would
eliminate the necessity of such examination. Such a result
would be an unfortunate by-product of the trade accept­
ance movement.
Some firms which employ the trade acceptance are
obliged frequently to borrow on their own single-name
note. A question which confronts the banker in such situa­
tions is whether the use of the acceptance in other trans­
actions impairs the quality of this paper. Some bankers
have answered this question in the affirmative by announc­
ing their reluctance to buy the single-name paper of a
borrower who practices the sale of his trade acceptances.3
T h e reason given for this view is th at whoever buys a trade
acceptance acquires the first lien on w hat would otherwise have
represented one of the accounts receivable of the concern which
drew the acceptance, and in addition to th at lien, in case of
1 From address published in part in Bulletin, July, 1918, p. 604.
* Ibid,



bankruptcy of the drawer of the acceptance, the holder of
that acceptance would rank equally with the unsecured note
holder as a general creditor for any part of the acceptance which
the acceptor might not have paid.
The answer to this contention has already been indi­
cated. Examination and financial analysis are as necessary
as in the case of the unsupported single-name note. With
proper care this objection should not hold. Unless its
privileges are abused, the practice of accepting should
improve the borrower’s credit rating. It implies a willing­
ness to meet obligations on a definite date and a desire to
avoid buying in excess of ability to pay.
All in all it appears that the reserve management has
been amply justified in lending its aid to the trade accept­
ance movement. But the moment special privileges are
granted, new difficulties arise. Inevitably attempts are
made to create a paper, similar in form to the trade accept­
ance, but for purposes not contemplated by the reserve
administration. Unless such attempts are checked, the
distinctive place of the trade acceptance as an easily
liquidated type of commercial paper is lost.
One of these objectionable methods has been to employ
it in old accounts. Because of the greater proportion of
bad debts, in such cases it would not have been surprising
had the Board ruled that the draft thus drawn did not con­
form to its conception of the trade acceptance. The Board
might have ruled that the draft must be drawn only at the
time of the transfer of the goods. But in this matter the
Board’s ruling was liberal. In an Informal Ruling we read:1
A bill drawn by a retail dealer on his retail customer to finance
the sale of goods to that customer is a trade acceptance within
the meaning of the Board’s regulations, even though it is drawn
after the purchaser has failed to remit promptly on an open
1 Bulletin, January, 1918, p. 30.



But even though such drafts might be held technically
admissible, it is suggested, as a matter of not subordinating
“ the trade acceptance to the open account by suggesting
it as a last resort for bad debts,” that reserve banks
“ should be encouraged to discriminate against them as far
as possible. . . . ”
In the minds of some, doubt existed as to the status of
the trade draft on occasions when the purpose of the buyer
was not to resell the goods, but to use them for some other
purpose. The argument against the admission of these
drafts would be that such use destroys their character as
paper automatically redeemed out of the sale of the goods.
Aside, however, from the difficulty of ascertaining the
facts in each case, such a limitation might confine the
acceptance too largely to the field of distribution and ren­
der it more difficult for the manufacturer and producer to
derive advantage through the development of this new
type of trade paper. On strictly logical grounds, moreover,
it might not make so much difference whether the goods
were to be resold. They might be used in such a way as to
aid the purchaser in the sale of other goods. They might
assist in increasing the liquidation of other goods.
But the basic transaction must be real and not ficti­
tious. Various subterfuges are attempted frequently to
enable the drawing of the drafts, which are then paraded
as bona fide acceptances. One of the more common of
these devices is the formation of subsidiary sales corpora­
tions which act as the acceptors of the drafts. In reality
the transaction may not involve even the transfer of goods
from one department of the business to another. Such
bills come close to classifying as those in which the drawer
makes out the draft against himself.
In another connection the status of a bill, which in effect
was drawn by the drawer against himself, was stated in an



opinion of M. C. Elliott, then Counsel of the Federal
Reserve Board:1 “ In substance such an instrument is a
promissory note, single-name paper and no more.” But
subsidiary corporations, subsidiary though they be, pos­
sess an independent corporate life. Would, then, a “ draft
drawn by a lumber corporation upon a sales corporation
which it and a number of other lumber concerns have
organized . . . when accepted, become a trade accept­
ance, even though the selling corporation is a stockholder
of the sales corporation. . .
. ” ?*
The opinion of counsel in this case was couched in very
general terms. The status of the paper would depend upon
the purpose underlying the existence of the sales corpora­
tion. Such paper could be classified as trade acceptance
paper if the sales corporation was organized in good faith
and not merely as an agent of the selling corporation, to
evade the law. Such a conclusion would follow logically
from the acceptance of the premise that the transaction
must display evidence of some real progress in the process
of manufacture, production, or distribution. The transfer
of goods from a corporation to a mere agent or subsidiary
might not be an essential step in hastening the goods in
their journey toward the ultimate consumer, even though
the buying corporation did possess an independent corpo­
rate life.
Another difficulty concerned the use of the trade accept­
ance in renewals. It is clear that, if merchants should
develop the practice of taking new bills in renewal for
those maturing, the distinctive quality of trade acceptance,
a bill quickly redeemable out of the sale proceeds, would be
destroyed. Such a renewal trade draft would be much
akin to that arising in the settlement of past-due accounts.
1 Bulletin, September i, 1916, pp. 462-63.
* Ibid., January 1, 1918, p. 33.



Accordingly we find the American Acceptance Council
insisting that
if an extension of the credit is given, it should be in the form of
a promissory note with interest.1
Opinions vary considerably regarding the extent to
which the acceptance has been thus employed. Regarding
this matter the American Acceptance Council states:3
So far as we have learned, however, these practices have been
largely, if not entirely, confined to houses of minor importance,
and they were possibly not surprising in view of the period of
credit strain which was endured last summer and autumn,
particularly in the textile lines, regarding which the complaints
were most general, and the ignorance or lack of appreciation
among the smaller and less well-informed commercial concerns
as to the proper use of the trade acceptance. A flabbiness of
commercial moral fibre may also have been a contributing cause.
These were a few of the difficulties encountered in the
endeavor to win for the acceptance a reputation as the
purest type of commercial paper. Continuous vigilance
was necessary to prevent misuse. But problems of policy
also arose which retarded its rapid development. One of
these related to the number and strength of the firms
whose allegiance to the acceptance should be sought.
In this matter the financial administration was con­
fronted with two alternatives. Either the acceptance must
be pushed zealously among all firms indiscriminately,
irrespective of their credit standing, and for multitudinous
sorts of transactions; or, the propaganda must be begun
slowly and cautiously, confining its use to firms with high
credit rating and for bona fide commercial transactions.
The latter was the only feasible policy. Little improve­
ment over former methods would have been achieved by
the adoption of the acceptance in all types of transactions.
1 Cf .Commercial and Financial Chronicle, April 2, 1921, p. 1345.
a Ibid.



In fact, the trade acceptance presented some grave ele­
ments of danger if its use became general. One of these —
over-buying — may easily arise in situations where the
banker neglects to take the usual precautions of examina­
tion. This depends upon the fact that the trade accept­
ance is, in form, readily negotiable. Many illustrations of
this danger were presented in the crisis of 1920-21. Some
receiverships were explained as due to over-buying encour­
aged in just this way. When the seller hesitated to tie up
more funds by sales on credit, he would be requested to
continue to ship goods, taking in payment an acceptance,
which, it was argued, could be discounted easily. The very
liquidity of the trade acceptance created the temptation
to sell in excess of the normal volume. When the crisis
came, many firms were caught with excessive stocks on
their shelves and in their warehouses.
It is true that a more conservative bank-credit policy
would have served to check such excessive activity quite
irrespective of the sort of trade paper available. But the
trade acceptance rendered it easier for the banks to fur­
nish the unsound credits. Bankers had to be impressed
again and again with the fact that nothing in the nature of
the acceptance justifies refusal to take due precautions
regarding the analysis of the credit standing of the parties
to the bill. It appears, therefore, fortunate that the propa­
ganda has proceeded slowly and cautiously, that in the
beginning the main campaign was begun among the strong,
representative firms in lines of industry where the accept­
ance was expecially applicable. It would have been a mis­
take, perhaps irretrievable, to have tried to encourage its
use among firms of poor credit rating. Care also had to be
taken not to push the acceptance too rapidly into indus­
tries where the buyer would interpret its use as a reflection
upon the soundness of his financial standing.



With this brief discussion of the difficulties of extending
the use of the acceptance, we may now be prepared to offer
a more conclusive answer regarding the necessity of a cen­
tral banking system in our credit structure. Experience
seems to have proven that, no matter how great may be
the advantages ultimately obtainable from the use of the
acceptance, a rapid increase in its use would have brought
many evils. Despite the encouragement of an active propa­
ganda and of a preferential rate of rediscount, the trade
acceptance to-day is employed relatively infrequently.
Without a strong central institution to foster its use by
rediscounts and direct purchase, its sound growth must
have been even less rapid. No small part of its present
attainments is due to the belief that the reserve banks were
ready to employ their funds if necessary in the acquire­
ment of the acceptances of prime quality.
A final query yet remains for brief consideration. What
limitations exist regarding the amount of trade accept­
ances discountable by member and reserve banks? Let us
first consider the matter of limitations applicable to the
member banks in their discounts for their clients.
It will be recalled that section 5200 of the Revised
Statutes limits the amount of advances to any one person,
firm, or corporation to an amount not exceeding ten per
cent of the bank’s capital and surplus. But to this general
statement there are certain exceptions. Among these is
“ commercial or business paper actually owned by the per­
son negotiating the same.” It has been held that this
exempts the trade acceptance, since it classifies as paper of
this sort. To quote from an Opinion of Counsel in the
. . . a trade acceptance negotiated in good faith by the bona
fide owner would be exempt from the limitations of section 5200
1 October 1,1918, p. 974.



as “ commercial or business paper actually owned by the person
negotiating the same.”
But what is the situation with respect to the amount of
trade acceptances permissible for rediscount by a reserve
bank? Section 13 of the act limits the amount of paper
bearing the name of any one borrower to an amount equal
to ten per cent of the member bank’s capital and surplus.
But an exception to this statement is made by the follow­
ing clause:
This restriction shall not apply to the discount of bills of ex­
change drawn in good faith against actually existing values.
The decisive question relates to the question of when a
bill will be considered as drawn against “ actually existing
values.” Here there are two possibilities: first, when the
bill is discounted before acceptance; second, when dis­
counted subsequently to acceptance.
Before accepted by the buyer, the bill could not be
interpreted as being properly secured by the personal
obligation of the buyer. Actually existing values must
then be proved by the goods themselves. Unaccepted bills
do not form an exception to the general provision unless
title can be shown to the goods. To quote from an Opinion
of Counsel in the March 1, 1917, Bulletin: 1
A bill of exchange discounted before acceptance may be said
to be drawn against actually existing value, within the meaning
of section 13 of the Federal Reserve Act, when and only when
it is accompanied by shipping documents, warehouse receipts,
or other papers securing title to the goods sold.
An accepted bill, however, may be considered as drawn
against actually existing values
if drawn against the drawee at the time of, or within a reason­
able time after, the shipment or delivery of the goods sold.
1 Page 195.



[But] In this latter case there must be reasonable grounds to
believe that the goods are in existence in the hands of the drawee
either in their original form or in the shape of the proceeds of
their sale.
Bills accepted before sale or delivery of the goods could
not be treated as drawn against actually existing values,
however, unless the goods have been placed in storage
under the order of the drawee. Such goods would not be in
the possession of the drawee in original form or in the
shape of the proceeds of the sale. The essential commer­
cial nature of the transaction would then be lacking.

I t has long been recognized that the credit needs of the
agricultural classes differ widely from those of the purely
commercial or mercantile interests. Among other charac­
teristics agricultural credit needs are relatively long-time,
and are subject to pronounced seasonal variations. It
might have been expected, accordingly, that a special set
of institutions would have been evolved in this country to
obtain capital from the investment public for agricultural
purposes. For the most part, however, these institutions
have been undeveloped here, and the national banking
institutions with which the farmer has dealt have been
patterned more in accordance with the needs of commerce
and distribution. Mercantile and distributive credit
requirements are far different from those of agriculture.
Justification for the restrictions relating to real estate
loans in the National Banking Law, however, was easy to
establish. In most part these restrictions were the result
of past disasters which developed when bank funds were
employed to promote excessive land speculation. From
the standpoint of logic, also, the desirability of limiting
loans on real estate security seemed clear. Since the great
bulk of the deposits of the national banks are demand
deposits, should not institutions whose obligations are
payable on call be required to keep their assets liquid?
Had not past experience proved the slowness of real estate
paper? At any rate, these restrictions were a part of the
National Banking Law.



It has sometimes seemed difficult to account for the
marvelous development of an industry thus handicapped
in its borrowing facilities. Explanation is twofold. First,
credit has been obtained largely from other sources;
second, the farmer’s past credit needs were relatively
limited. Land was cheap and farming could be begun with
a limited amount of equipment. As cultivation was con­
ducted on a more and more intensive scale, new capital
was required, but this was supplied largely out of past
profits. Farming was creating in large measure its own
funds for extensions. The industry was seasonal in its
nature, but during the slack seasons employment was fur­
nished by the work of further clearing, building erection,
extension of the cultivated area. Goods were brought on
time from the local merchant, and, although the price
paid for this sort of credit has undoubtedly been high, the
farmer has been somewhat slow to perceive that the cost
of credit emerged in the price exacted for the goods.
Gradually, however, the dependence of the farmer upon
the bank, even for short-term credit, has become more
intense. Farm machinery is costly, and the amount
required by modem methods is increasing. The horse is
beginning to give away to the tractor; this is an era of the
automobile, motor truck, gasoline engine, steam plough,
artificial fertilizer, and blooded live stock. Between 1900
and 1910 census figures show a per-acre increase in the
value of farm implements and machinery of 61.8 per cent.
Development of new land has become more difficult with­
out credit aid. Very little cheap and easily cultivated land
is now available; farm-land extension has necessitated
expensive methods of cultivation, such as dry-farming and
irrigation. A t the same time education and propaganda
have become more and more convincing in regard to the
high cost of credit obtained indirectly from the store­



keeper. Under the store lien system the farmer obtaining
credit obliges himself to sell his goods through the store­
keeper. He obtains customarily low prices on his sales and
pays very high prices on his supplies. In an article on
agricultural credit Professor E. W. Kemmerer quotes Mr.
George K. Holmes, of the United States Department of
Agriculture, as follows:1
The rate of interest on the liens on the cotton crop of the
South, it is safe to say, probably averages 40 per cent a year.
All cotton men will agree that it is at least that. The store sys­
tem of the South is a sort of peonage; that is what it amounts
to with the cotton planter.
With similar experiences elsewhere, the desirability as well
as the necessity of drawing more largely upon the commer­
cial bank became apparent.
The growing needs of bank credit granted, we may next
inquire as to the ability of existing institutions to supply
it. Attention has already been called to the provision of
the National Banking Law limiting loans on real estate
security. But State bank restrictions were usually not
onerous. It was often not so much a matter of the legal
impossibility of making the credit advance as of the finan­
cial undesirability to the banker of the farmer’s paper. As
previously mentioned, agricultural credit of necessity must
be relatively long-time. The farmer is engaged in a pro­
ducing activity; not until he has a product in salable form
is he in shape to make repayment of the loan. A note
drawn to obtain funds for the purchase of cattle or seedgrain cannot be redeemed out of the sale proceeds until
sufficient time has elapsed for the cattle to be fattened or
for the grain to become the harvested crop. The farmer’s
operations are much more akin to those of the manufac1 Cf. E. W. Kemmerer, “Agricultural Credit in the United States,” American

Economic Review, December, 1912, pp. 852-72.



turer than to those of the retailer, jobber, or wholesaler.
Three months is ordinarily a very short maturity for the
average farmer’s note.
It should be borne in mind that it may be much more
hazardous for the farmer to depend upon renewals than
for the retailer or wholesaler. It may be inconvenient for
either of the latter to have their notes called. But a forced
sale, by marking down prices, is usually possible. Goods
unsold exist presumably in salable form. Not until after
the harvesting season, however, is the farmer in possession
of readily marketable goods.
But is it legitimate for the farmer to depend upon the
commercial bank for such credit needs? Has he a right to
insist that the commercial bank supply capital not return­
able in a very short period? The answer is several fold.
Many of his needs are for purposes much more quickly
and easily liquidated than the sort of advances which in
the early days created the prejudice against real estate
loans. Then our difficulties arose in the purchase of land
before cultivation was practicable. Loans for the purchase
of machinery or cattle are far different in character. But
irrespective of all this, the commercial bank supplies much
more capital to the merchantile interests for developmental
purposes than is ordinarily supposed. The stock and bond
investments of the commercial bank have been enormous.
But at any rate the commercial bank may be the only
institution available for the farmer. He cannot offer his
stock or bonds to the investment public through the in­
strumentality of the bond house. Neither have there been
perfected here cooperative credit institutions for the pur­
pose of appealing to the investing public. In Europe, by
way of contrast, such associations have accomplished
much. Details of their organization vary. But usually the
plan involved the acquirement by the society of the mort­



gages on the property of the members who desire advances.
On the basis of these mortgages, the society offers its
paper to the public. The investor is thus protected by the
collective security of the members’ obligations. But in
America orgainzations had not even developed to such an
extent as to preserve for the agricultural borrower funds
saved by members of his own class. Savings bank invest­
ments, built up in part from farmer’s deposits, have been
made customarily in corporate bonds of industrial enter­
prises. In the course of time such institutions as the Landschaften in Germany may take root here. But sudden
development cannot be expected. In the meanwhile the
commercial bank must be organized to offer legitimate
credit aid to the farmer.
Not only are the farmer’s requirements long-time; they
are also subject to pronounced seasonal fluctuations.
Banks which commit their funds to industrial undertak­
ings in the off season may find themselves unable to take
care of the fanner during the busy spring-planting or fall
crop-moving period. Deposits with banks in the financial
centers could normally be withdrawn without difficulty.
But during the season of agricultural strain the security
market might be temporarily low and render inadvisable
liquidation of bond investments. Limitations on the
farmer’s ability to sell commercial paper in the open market
already have been mentioned. The frequent preference
of the banker for industrial rather than for agricultural
clients may be traced in part to the unsteady credit appe­
tite of the agricultural borrower.
The special needs of the farmer understood, a next in­
quiry was to ascertain the means by which relief could be
granted. Everywhere the hope was expressed that there
should be a continued development of cooperative agri­
cultural credit societies. But what r61e should the com­



mercial national bank play in all this? Of course it was
insisted that the legal restrictions of the National Banking
Law be modified. It was asserted that the real estate loan
limitations were driving business from national banks
to State banks, and that attempts to avoid this loss of
business explained many subterfuges and indirect methods
of evading the terms of the statute. Frequently the stock­
holders of a national bank would organize a State bank in
the same building and under the same roof. The same set
of officers would keep the books of the two institutions,
direction would be harmonized, clients would be mutual.
Only in one respect were they separate institutions, and
that was in the fact of their separate corporate life. Bor­
rowers on real estate mortgages would be “ recommended ”
to the “ other” bank under the archway. To the extent
that the law created subterfuges of this sort, the chief
result was to lessen the size of the national banking system
and add to the prestige of the State banks.
It could also be argued that the restrictions of the law,
in many situations, lessened rather than increased the
soundness of national bank assets. National banks could
not loan on real estate security, but were permitted to dis­
count the unsupported note of a farmer. Before the matur­
ity of the unmortgaged note, the borrower might execute
a lien in another borrowing operation in favor of a State
bank. In case of the insolvency of the borrower, the
national bank’s claim to the property would be inferior to
that of the State institution. The national bank could
have acquired a prior lien had it been permitted at the
time of the loan to demand a mortgage.
But one fact relating to the safety of farm loans seems
strangely to have been overlooked by many students of
agricultural credit. It is true that in the past some of our
most severe crises were due to over-speculation in land. It



is also true that farm borrowings are for a relatively long
period of time and that the commercial bank deposits
should be protected by easily liquidated holdings. Still, in
past depressions the speed with which agriculture has
recovered often has been astounding. Poor years may
come, markets or crops may fail, but the nucleus of the
farm organization remains intact. It is the exceptional
case to find the farm in a good agricultural district totally
deserted and rendered destitute of equipment. It is seldom
abandoned as may be the case in an unprofitably estab­
lished factory or shop. And steadily land values have
increased. The big drops in this country have been due
usually to temporary speculative reaction and represent
only momentary oscillations on a steadily ascending curve.
These considerations should not be interpreted as an
argument for the total removal of restrictions on real
estate loans. The commercial bank must keep its assets
in fairly liquid shape; it cannot base its advances on ulti­
mate prospects. But no large proportion of a bank’s
assets need ordinarily be liquidated suddenly. Would
there not be justification, accordingly, for permitting to a
limited extent investments protected by real estate
But what provisions should have been inserted in the
Federal Reserve Act relating to agricultural credit? The
reserve banks were to be bankers’ banks to guarantee,
particularly in periods of emergency, the redeemability of
member bank assets. They were to be the ultimate reserve
holding institutions of the country. It, accordingly, was a
matter of absolute necessity that they maintain their own
assets liquid. The paper discountable was to be of the
short-time, automatically liquidating variety. What room
would there be in the Federal Reserve Act for a provision
rendering it possible for a member bank to lend on real



estate security? Logically none, unless such paper were
eligible for rediscount or direct purchase. A change in the
law not concerning directly the operations of reserve banks
should appear in the form of an amendment to the National
Bank Act. Nevertheless, a provision of this sort did
appear in the Federal Reserve Act. In addition to this
modification of the previous legal difficulty regarding real
estate loans, it would be expected that something would
have been attempted in the way of removing the financial
undesirability of agricultural paper. Accordingly, certain
preferences are granted agricultural over other sorts of
commercial paper in the rediscount operations of reserve
banks. '
We may now quote the provisions of the Federal Reserve
Act of special importance to the agricultural borrower.
The most important provisions of the statute are three.
The first of these, in section 24, is not related to rediscount­
ing. The original act read as follows in this section:
Any national banking association not situated in a central
reserve city may make loans secured by improved and unen­
cumbered farm land situated within its Federal reserve district,
but no such loan shall be made for a longer time than five years,
nor for an amount exceeding fifty per centum of the actual
value of the property offered as security. Any such bank may
make such loans in an aggregate sum equal to twenty-five per
centum of its capital and surplus or to one-third of its time
deposits and such banks may continue hereafter as heretofore
to receive time deposits and to pay interest on the same.
Then followed a statement to the effect that the Federal
Reserve Board could add to the list of cities in which
national banks would not be permitted to make loans.
Except for this, this section is not related in any direct way
to the reserve mechanism.
This section was later amended. Under certain restric­
tions banks in the permitted cities may make loans on real



estate as well as upon farm-land. Also, the bank advanc­
ing the funds need not be situated within the same dis­
trict, provided the real estate or farm-land is “ located
within one hundred miles of the place in which such bank
is located.”
The second of the agricultural credit provisions is found
in the rediscounting section, 13. Whereas eligible com­
mercial paper must have a maturity of three months or less,
notes, drafts, and bills drawn or issued for agricultural purposes
or based on live stock and having a maturity not exceeding six
months may be discounted in an amount to be limited to a per­
centage of the capital of the Federal reserve bank, to be ascer­
tained and fixed by the Federal Reserve Board.
This is the most important concession to the special needs
of the agricultural interests to be found in the act. The ac­
complishments under this section later will be considered.
The last of these provisions of special importance to
agriculture is to be found in the amendment to the act
bestowing upon national banks power to accept certain
types of domestic bills and drafts. Since no specific prefer­
ential treatment is hereby granted agricultural paper, it
might not appear to warrant mention in a chapter devoted
to agricultural credit. But the domestic acceptance should
prove peculiarly useful in removing many difficulties
hitherto encountered in the marketing of farm crops. As
will appear more clear later, the bank acceptance is a
method whereby the client’s bank is enabled to aid him to
secure funds from other banks. If the local banker is tem­
porarily without funds and cannot discount the applicant’s
note, it may agree to accept a draft drawn against it by
the prospective borrower. This accepted draft may be
peddled around the market and because of the financial
standing of the acceptor should find a ready market. It is
as if the local bank had guaranteed the note of the client./



The farmer is in peculiar need of reaching the outside
investment market in some such way as this. The seasonal
character of agricultural operations often creates a strain
too severe for the local banker. But the farmer unassisted
has no way of securing the use of idle funds available else­
where. He cannot have his notes peddled over the country
by the note broker. His standing in the investment mar­
ket is not such as to permit this. In view of these facts it
seems strange to the writer that the special applicability
of the acceptance to the farmer’s marketing problems so
frequently has been overlooked.
With these, the pertinent provisions of the statute, we
may next inquire as to the agricultural credit policy of the
reserve management. Has it adopted a liberal or illiberal
policy in the administration of its duties? Inasmuch as a
prime function of the Federal Reserve Board is to define
eligible paper, we may first test its liberality by examining
some of its most important decisions so far as these have to
do with the admission of paper to the agricultural class.
Undue strictness and conservatism would tend to restrict
the willingness of member banks to make loans of needed
maturity to the applicant farmers.
A first problem had to do with the interpretation of
these words of the statute, “ based on live stock. ” A
strict construction might have held “ based on live stock”
to be synonymous with “ secured by live stock.” The
Board ruled, however, that the farmer’s note need not be
protected by a chattel mortgage on the stock.1 “ Based on ”
is thus made to refer to the purposes of the farmer’s note.
If the funds were borrowed in order to acquire the stock
the stock comprises part of the assets of the farmer guai>
anteeing his ability to pay. This ruling made possible,,
accordingly, theemployment of less red tape in the advance
of funds to the farmer.
1 See Bulletin, June I, 1915, p. 72.



A second interesting ruling related to the eligibility of
notes given by farmers in payment for tractors to be used
in agricultural operations. It is to be assumed, of course,
that the tractors were not intended to be resold. The main
question here was whether tractors were to be classified as
a permanent fixed investment. If they were so classified,
the farmer’s note would not be rediscountable. It would
appear as if much justification would exist for such a clas­
sification. It is to be expected that the life of the tractor
would extend over several seasons, and it could not be
regarded as an expense chargeable to the revenues of any
one season. Would not expenditures of this’sort correspond
to those invested in permanent drainage improvements, in
silos, and in buildings?
The act, however, stipulated as eligible paper that
based upon live stock. Would it be possible to show the
similarity of tractor paper to that of live-stock paper?
If the law was to be construed strictly, this would appear
to offer the sole means of holding such paper agricultural.
This means was seized upon by the Board. In the words of
the ruling:1
Horses and mules bought for farm work are purchased with
several years' use in view, yet there can be no question that a
note given by a farmer in payment of a pair of mules to be used
in farm work, maturing within six months, is eligible as agri­
cultural paper. Where tractors are used to supplement the work
of horses or mules or are used altogether instead of these ani­
mals, it seems to the Board that notes given by farmers for the
purchase price of tractors, and maturing within six months,
should be admitted to discount as agricultural paper. . . .
Implement paper, however, would present a situation
in which solution could not be found by stressing the
similarity to live-stock paper. Very early the Board was
compelled to decide between a wide and a narrow con* Bulletin, April i, 1918, pp. 309-10.



struction of the act. Decision in this matter comes closer
to indicating the desire of the Board to render as available
to the farmer as possible the facilities 4 the reserve
The Board admitted 1 that it was
a very close question whether agricultural implements are to
be considered as permanent improvem ents or as a part of the
cost of operation.

But as ground for liberality
it must be considered th at machinery of this kind is not of a
permanent character. I t wears out rapidly and in most cases
has to be replaced within a com paratively short time, so that it
m ay be assumed th at a certain am ount of m oney would be spent
annually and regularly for the purchase and replacement of
machinery of this kind.

It seems to the writer that it is extremely doubtful
whether in other situations so much stress would be placed
upon the fact that capital expenditures may be distrib­
uted fairly evenly over a series of years. Would a manu­
facturer’s notes be eligible for the purpose of constructing
buildings in such a way as to keep the erection costs
approximately equal from year to year? Would the equip­
ment notes of a railroad company be eligible because the
replacement costs for rolling stock might display yearly
Prophetic vision is not required to answer these queries
in the negative. The real intent of the Board appears to be
expressed in the following:2
A s the Board b y its regulations does not desire unnecessarily
to restrict, b u t rather to encourage, the facilities to be given, as
far as th at m ay be done consistently w ith prudence, it would
appear th at the wider interpretation in this case should be
given. . . .
Bulletin, February 1, 1916, p. 67.

* Ibid.



Certainly in such cases the burden of doubt is not placed
against the farm borrower.
Would it make any difference, however, who was
the presenter of the note for discount? Would the Board
be obliged, for instance, to refuse to admit as agricultural
the paper presented by a dealer, and insist that the maker,
the farmer, must be the presenter of the paper? In case
the farmer had given his note to the dealer, which note had
been discounted, would eligible agricultural paper have
been created? Or, since the facilities are granted to the
dealer and not to the farmer, must it not be classified as
non-agricultural paper?
It is clear that the purpose of the act was to give “ spec­
ial facilities to farmers.” 1 The question, then becomes
this — How can these facilities best be granted? In cer­
tain situations the farmer might be accommodated to
advantage by encouraging the method of note-giving to
the dealer. Such a note would be double-name, and very
likely would be discounted at a cheaper rate than the
farmer’s own single-name note. The Board ought not to
insist upon the more expensive means of financing agri­
cultural operations. It ruled accordingly that to classify
as agricultural paper, the maker of the note need not be
the presenter.2
But let us return to other cases in which the question at
issue was whether or not the expenditure was for fixedcapital or long-time developmental purposes. One im­
portant problem was the classification of notes given for
the purpose of draining and tilling farm-land. How liquid
would such notes be? How soon would such expenditures
contribute to increased farm revenues? Questions of this,
sort might well involve the amount of expenditures pro1 Bulletin, February I, 1916, p. 67.
* Ibid.



portionately to the total farm investment. The Board’s
ruling, however, made the decision depend upon the nature
of land. In its own language: 1
cases may arise in the reclamation of swamp lands where such
lands could not be treated as farm land until expensive drainage
systems have been installed. In such case there is doubt of the
eligibility of the notes, the proceeds of which are used for this'
purpose. Where, however, the land drained is already in use as
farm land, the draining may be treated as incidental to the culti­
vation of the land, and notes given for such purpose may be
rediscounted as agricultural paper.
The liberality of this ruling is easily apparent. Ques­
tions relating to the amount of such expenditures and
their nature, are not even to be raised. The only criterion
is whether or not the land previously has been under culti­
vation. But even in the case of cultivated land, if such
operations as draining do not constitute permanent im­
provements — fixed-capital expenditures, in other words
— it is difficult to know what might be. Such paper may
vary widely from the automatically liquidating variety.
A similar sort of decision is raised in connection with
farmers* paper arising in the purchase of dairy cattle. In
one query to the Board it was stated 2 that the
cows will be used as dairy cattle which will be retained for a
considerable length of time 3to produce milk, butter, cheese, etc.,
and that the loan is not made, strictly speaking, for the
“ breeding, raising, fattening, and marketing of live stock.”
Nevertheless, the Board held such paper agricultural,
since “ live stock includes cows.”
It would have been very easy, however, to hold that
dairy cows, to be held permanently, were not “ live stock’*
within the meaning of the act. Live stock is ordinarily
1 Bulletin, August 1, 1918, pp. 743-44.
a Bulletin, March 1, 1916, p. 112.
3 Italics are the writer’s.



sold when fattened. In this sense live-stock paper is auto­
matically liquidating. Dairy cattle, however, may not be
sold, but contribute to income slowlyk Their present sell­
ing price represents the capitalization of their future earn­
ings. In reality, dairy cattle is as much a fixed-capital
expenditure as that required to purchase a building which
is to be rented, or a locomotive which is gradually to earn
its own replacement cost.
These are some of the more interesting and illustrative
of the Board’s rulings bearing upon the differentiation
between agricultural and non-agricultural commercial
paper. Our next query concerns the method of identifica­
tion of agricultural paper. Has so much red tape been
required in the process that the farmer is harassed?
This question relating to implement paper was answered
by the Federal Reserve Board, December 30, 1915.1 We
may quote the following:
The nature of the bill, the name of the acceptor, and the name
of the drawer would probably indicate that a farmer was the
purchaser and an implement dealer the seller of the goods.
However, the purchasing member bank will have to satisfy
itself in some satisfactory way that the bill is substantially
of an agricultural character. A simple memorandum attached
to the bill, stating that the bill was drawn in payment of agri­
cultural implements, signed either by the acceptor or the drawer,
would probably be considered sufficient evidence by the member
bank and the Federal Reserve Bank.
It will be recalled that by the terms of the statute the
amount of agricultural paper purchased by a reserve bank
could not exceed a certain percentage of its capital stock.
The amount of this percentage was to be fixed by the
Federal Reserve Board. Some light may be thrown upon
the Board’s attitude by noting the percentages thus estab­
lished. In every case this percentage has been fixed at
ninety-nine per cent. This appears very liberal.
* Bulletin, February 1 , 1916, pp. 67-68.



In still another way a ruling of the Board was such as to
make more difficult charges that it was ultra-technical
or bureaucratic in matters relating to farm credit. In an
informal Ruling in the June, 1915, Bulletin,z it held that a
member bank need not make an exhaustive inquiry as to
the use of funds borrowed in order that the paper might be
classed as agricultural. It need only satisfy itself that the
primary purpose was agricultural. The agricultural char­
acter of the paper would not be destroyed even if it
should be established that part of the funds were em­
ployed for the support of the borrower’s family.
So far as commerce and industry are concerned, the
reserve system has never endeavored to regulate the inter­
est or discount rates member banks might exact. In the
marketing of farm crops, we find the sole exception. Dur­
ing a portion of its life, reserve banks, in order to facilitate
crop marketing, established a discount rate lower than for
other classes of paper. But member banks could redis­
count at this low rate only on condition that they would
pass this advantage on to the borrower. The borrower’s
paper was not rediscountable if the member bank origi­
nally exacted a rate higher than a certain published maxi­
mum. This was the special “ commodity” rate.
The establishment of a special commodity rate grew out
of the endeavor of thereserve administration in thesummer
of 1915 to be prepared for any contingencies which might
arise in connection with the marketing of the cotton crop.
All were aware of the disaster which befell the South and
the entire country the year previous because of the sudden
cutting off, at the outbreak of the World War, of the
European market for the South’s most important article
of commerce. Accordingly, a committee of the Board
sought to inform itself in the summer of 1915 regarding
* Page 72.



conditions in that industry. It learned that the reduction
in cotton acreage had been such that ample storage facili­
ties were available in the South for the warehousing of such
portion of the crop as might have to be carried over. Hav­
ing ascertained that the physical means were at hand for
the orderly marketing of the crop, it appeared that the
special need was to ensure a sufficiency of bank credit to
finance the carry-over.
The committee entertained the view that warehouse receipts
for cotton, grain, and other staple non-perishable agricultural
products of a readily marketable character, form an excellent
basis for bank loans.1
Accordingly, on September 3,1915, the Board issued regu­
lations according to which notes secured by non-perishable
staples receive the benefit of the low special rate.
Since the Board was especially desirous that the advan­
tage of this low rate should be passed on by the member
bank to its customers, it was provided that only paper
should be eligible for rediscount at the special rate upon
which the member bank’s charge was not more than six
per cent per annum inclusive of all commissions. This
special rate was not to be applied exclusively to cotton,
but might serve for other staple commodities such as
grain, cotton, and wool. The rate might be adopted by any
reserve bank, and was not confined to any one district.
To illustrate the manner in which credits might be
granted, the following selection is quoted from a statement
by the Secretary of the Treasury on September 3, 1915:*
A borrower asks his local bank for a loan on his note, secured
by warehouse receipts for cotton. If the bank is satisfied that
the cotton is in a responsible warehouse, properly insured, and
that the note is good, it may make the loan. If the local bank
* Cf. Report of the Federal Reserve Board for 1915, p. 7,
9Bulletin, October I, 1915, p. 301.


charges the borrower, a rate of interest, including commission,
not exceeding 6 per cent per annum, it may indorse the note
over to the Federal reserve bank of its district, and the Federal
reserve bank may advance to the local bank the full amount of
the loan. The rate of interest which the Federal reserve bank
will charge the local bank will be sufficiently low, say 3 per cent,
to enable the local bank to make loans at a rate of interest not
exceeding 6 per cent per annum, and have a liberal margin of
profit on such transactions.
The principal problem relating to the applicability of
this special rate was that of the definition of 4 readily
marketable staples.” By this phrase, the intent was
merely to confine the use of funds obtained from the
reserve bank to goods capable of being graded, and for
which a wide market usually existed, a market not ultra­
sensitive to changes in consumers’ whims and tastes. In
one ruling it was held th at1
Potatoes, properly graded and packed and stored in a
weatherproof and responsible warehouse, as evidenced by its
receipt, would undoubtedly constitute a readily marketable,
non-perishable staple within the meaning of the regulation.
Although the
so-called commodity rate was established some time ago in
order to give a preferential rate particularly to farmers during
the crop-moving season2
it was ruled that manufactured goods, such as cotton yam
and flour, were staples within the meaning of regulations
dealing with this class of paper.3 But such manufactured
goods must be non-perishable and have a wide ready
They must be goods generally produced and well established
in commerce, not an extraordinary or unusual commodity for
which there is no ready market.
1 Cf. Bulletin, August 1,1917, pp. 614-15.
9Bulletin, January 1, 1918, p. 30.
3 See Regulations for Series of 1915 and Bulletinf October I, 1916, p. 523.



The use made of the commodity rate is indicated by the
following figures:1
September 8,1915, to December 31,1915......... $10,315,000
January 1 , 1916, to December 31,1916......... 16,813,200
January 1,1917, to December 31,1917......... 11,244,271
These figures display only limited reliance upon this
special rate. In the Report of the Federal Reserve Board
for 1915 we read the following:2
The effect of the commodity paper regulation was mainly
anticipatory and protective. The certain assurance that what­
ever funds might be necessary for the gradual and orderly
marketing of the cotton crop would be available at moderate
rates had an immediate and stimulating effect on sentiment.
But as the cotton market improved after the fall of 1915,
and as general ease in the money market prevailed, it no
longer seemed desirable to offer this special rate. Accord­
ingly, we read in the Bulletin for January, 1918,3 that it
was merged with the general commercial rate. The prin­
cipal significance of the special commodity rate appears to
the writer to consist of its indication of the friendly atti­
tude of the reserve administration toward the credit needs
of agriculture.
Let us now consider the matter of the rate of rediscount
on six-months agricultural paper with a view of comparing
them with commercial paper rates of lesser maturity. On
account of the many different rates, and the changes in the
basis of classification from time to time, as well as the fact
that differences existed between the rates of the various
reserve banks, it would be onerous to endeavor to state
these results in tabular numerical form. But the follow­
ing observations may be made:
xFigures obtained from the Annual Report of the Federal Reserve Board.
8Page 8.
3Page 30.



1. From November 16, 1914, to January I, 1915, the
six-months rate exceeded the rates on shorter maturities
never by more than one half of one per cent. In many
districts there was no differentiation on the basis of
2. On January 1, 1916, the average rate in the twelve
districts on agricultural and live-stock paper maturing
after ninety days was five per cent. The corresponding
average for the twelve reserve banks on 61-90-day paper
was 41/6 per cent.
3. On January 1, 1917, the average rate on agricultural
and live-stock paper maturing after ninety days was 4 7/8
per cent; 61-90-day paper averaged 4.2 plus per cent.
4. On January 1, 1918, the average rate on 6-months
paper was 5.1 per cent. Corresponding average on 61-90day paper was 4 5/8 per cent.
5. On January 1, 1919, the average rate on 6-months
agricultural paper was 5.27 per cent, The corresponding
average on 61-90-day paper was 4.79 per cent.
6. On January 1, 1920, the average rate on commercial
and industrial paper maturing within ninety days was 4.79
per cent. The rate on 6-months paper was 51/8 per cent.
7. October 31, 1921, the average rate on ninety-day
plus paper was 5 2/3 per cent. Corresponding rate on 90day paper was the same.
8. A t no time has agricultural paper been discriminated
against as such. The only discrimination has been that
due to the length of the maturity. Agricultural paper
maturing within ninety days has been discounted at the
same rates as other commercial paper. Part of this period,
a preferentially low rate of discount was available to the
member bank offering a certain type of commodity paper.
There has been displayed no hostility against the agricul­
tural interests in the Reserve Board’s rate policy.



With this conclusion reached regarding rates, it becomes
difficult to convict the Federal Reserve Board of any fail­
ure to recognize the legitimate needs of agriculture. In
many cases it has been shown that the definition of eligible
agricultural paper has possibly been something more than
fair. Bureaucratic methods of identification and certifica­
tion have been conspicuous by their absence. A t one
period, agriculture, by means of the special commodity
rate, was given a special low rate under conditions whereby
a maximum rate was fixed for member bank charges.
Liberality was displayed finally by the Reserve Board in
determining the percentage of each reserve bank’s resources
which might be invested in member bank’s six-months
agricultural or live-stock paper. Unfairness to agriculture
must, if it existed at all, have occurred by means of direct
methods employed by the district directorates. B y direct
methods we refer to the refusals of these directorates to
accept for discount or purchase good eligible paper from
the member banks. Let us next ascertain, so far as is possi­
ble, the extent to which agriculture may have encountered
hostility in this manner.
The period in which to search for this hostile discrimina­
tion must be that of 1921-21, the years of deflation in
agricultural prices. Nobody accused the reserve manage­
ment of illiberality in the earlier years. Until the war
period the chief concern of the reserve management seems
to have been to secure more complete employment fot
reserve funds. During the war period and for a year fol«
lowing the armistice, credit expansion proceeded at an
unexampled rate. What, then, does the evidence show
regarding the relative treatment of agriculture and other
industry in the years 1920-21?
In the Bulletin for August, 1921,1 Governor Harding, of
1 Pages 895-99.



the Reserve Board, in a letter to Senator Owen gives cer­
tain figures bearing upon this matter. Some of these may
be quoted:
On Ju ly 9, 1920, the total bills on hand a t all Federal reserve
banks amounted to $2,934,184,000. On J u ly 6, 1921, this total
amounted to $1,832,499,000, a decrease of $1,101,685,000. . . .
T h e total of agricultural, commercial, and live-stock paper on
hand, rediscounted for member banks, on Ju ly 6, 1921, was
$1,126,968,000 as against a total of $1,265,243,000 on Ju ly 9,
1920, a decrease of only $138,257,000, which is more than
accounted for b y the decrease in the holdings of paper of this
kind b y the Federal Reserve Banks of Boston, N ew Y ork, and

In other words,
T h e bank liquidation which has taken place has been m ainly
in financial and industrial centers, and the figures do not indi­
cate th at there has during the past 12 months been an y decrease
in Federal Reserve accommodations to banks in the agricultural
and live-stock districts, but on the contrary there has been a
considerable increase.

Similar figures chosen for other dates of 1920-21 point
toward the same general conclusion.
But such figures as these do not tell the whole story. As
prices decline, the need for credit to accomplish the same
volume of business recedes also. In the depression of busi­
ness in 1920-21, the decline in agricultural prices pro­
ceeded much faster than the reduction of credits. Since in
the nine agricultural districts there was no decline in hold­
ings of agricultural paper, it would appear as if in relation
to the state of prices reserve funds were being enlarged
considerably for the benefit of agriculture. The fall in the
prices of wholesale agricultural products for this period is
indicated by the following group index numbers supplied
by the United States Bureau of Labor Statistics:1
1 Commodities have been regrouped by the Federal Reserve Board and the
index numbers are published monthly in the Bulletin.



= 259
= 155

January = 155
February = 145
« 136
= 126
= 125
= 122
August =123

These facts do not answer the question as to the treat­
ment of the farming class accorded by the member banks
themselves. But it should be remembered that the reserve
manangement has no direct control over member banks'
discount policy* So far as its operations are concerned, the
reserve system appears to have displayed every desire to
lessen the shock of the liquidation of 1920-21.
It may be true also that the reserve management’s
general rediscount policy preceding the depression of 192021 is to be condemned. However this may be, it will later
be shown that ample warnings were given for the rate
increases of the fall of 1919 and for 1920;1 that these rate
increases were made only when the reserves of the reserve
banks were so low as to necessitate restrictive measures.
Moreover, the reserve banks’ discount rates tended to
follow rather than to precede those of the general money
market. The causes of the deflation were many; but fig­
ures show that the responsibility of the reserve manage­
ment, so far as the volume of discounts is concerned, was
confined to checking the rate of credit expansion. There
had to be a stop some time.
In view of these many evidences of exceptional favors,
to be found not merely in the statute, but also in the man­
agement of the system, it is interesting to attempt to
1 See infra, Chapters XV and XVI.



explain the general discontent with the reserve system
manifested by the agricultural classes after the depression
of 1920-21. That a genuine feeling of hostility has been
created, in the farming districts of the Middle West and
South particularly, cannot be doubted by anyone who has
had the opportunity of coming into close personal contact
with the farmers of these sections. The following explana­
tions are offered:
First of all, the farmer suffered relatively the most of all
classes by the general price decline. Index figures for
wholesale prices furnished by the United States Depart­
ment of Labor’s Bureau of Labor Statistics show that
while farm products fell from a figure of 287 on July, 1920
(1913-100), to 122 on July, 1921, all commodities fell in
the same period from 262 on July, 1920, to 148 on July,
1921. Retail prices fell even much more slowly. Of all
classes the farmer was probably more convinced than any
other that the price gains of the war period would be main­
tained. Encouraged by his political representatives, by
editors of agricultural journals, by officers of his organiza­
tion, he was led to believe that the old order had changed
once for all. Instead of creating rainy-day funds for future
emergencies, his profits of war-time were employed to
finance larger personal expenditures and the purchase of
new land and more expensive equipment. In many local­
ities of every agricultural State, land speculation forced
prices up to a point where only the most careful husbandry
could produce a fair return on the inflated values. The
transportation breakdown and high freight rates contrib­
uted to the decline in farm-products values. In all this
the local banker was not without blame. It was his duty
to prevent the use of bank funds for excessive speculation.
In the localities where he failed most to assume this
obligation, recovery from the depression was most difficult.



When pressed for credit he did not feel able to grant, the
local banker frequently found it possible to throw respon­
sibility upon the reserve management. The local banker
pointed to the increased rediscount rates exacted by the
district bank, and to warnings of the district directorate.
The district bank could refer to the warnings and admoni­
tions of the Federal Reserve Board. Political representa­
tives in Congress, often without any real understanding
of the nature of the reserve system, added to the pressure
brought to bear against the Board. It was a grand old
game of “ passing the buck.” In all this the emergency
character of the reserve system was forgotten, as also the
exceptional character of the war period. It was assumed
that the reserve system was obligated to furnish funds for
private profit-making purposes. To the writer it seems
unfortunate that this turn of affairs was not anticipated
earlier. The mistake of the reserve management (a mis­
take, however, Treasury policy made it difficult to avoid)
lay in permitting the expansion of the post-war period, not
in checking it when it appeared about to pass all bounds of
There were also current many misconceptions as to the
nature of the reserve system. As previously indicated, the
regional character of the system often was overlooked. It
was forgotten that the reserve bank in Kansas City is a
different bank from that of New York. It serves a different
set of industries and interests, and is managed by directors
selected by a different group of men. The fact that credits
are made available in one district for purposes denied in
another does not necessarily indicate sectional partiality.
It may mean solely that one reserve bank was previously
more careful in its credit grants, and had built up a greater
reserve to support new financing.
It may have been unfortunate that in the financial



centers security speculation could not have been subjected
to more strict control. But our methods of war finance
rendered this control difficult. We floated our bond issues
at cheap rates by placing the resources of the reserve banks
at the beck and call of member banks. Until the war-paper
holdings of member banks were reduced it was difficult to
render effective a policy of credit restraint. Finally the
credit situation got out of hand. A check in the rate of
increased grants of reserve funds was inevitable. Many
mistakes were doubtless made in all this. But they were
not mistakes of attempted and purposed discrimination
against the agricultural borrowers.
Finally, the farming class, as also others, has failed
often to perceive the real character of the sort of opera­
tions permitted for the reserve banks. The reserve system
was intended to be an institution dealing, with a few ex­
ceptions, in paper of a commercial character. Its reserves
are the country’s final and ultimate. They must be kept
liquid. It never was contemplated that the reserve system
should supply funds through the discount of paper arising
in land or commodity speculation or for long-time develop­
mental purposes. It may be legitimate for credits of this
sort to be supplied by such institutions as*the War Finance
Corporation or the Federal Farm Loan Banks. The writer
would be one of the first to admit the necessity of develop­
ing institutions for the sake of procuring for the farmer the
funds of the saving and investing classes. But reserve
funds are intended for other purposes. The reserve system
is a set of regional banks designed to guarantee the liquid­
ity of sound paper of commercial banks.

Jn a previous chapter mention was made of the impor­
tance generally ascribed to the work of popularizing the
trade acceptance. Among the anticipated advantages was
the devising of a type of paper which should command a
broad and steady market and therefore comprise a suit­
able investment for commercial banks. But in this respect
the development of the bank acceptance deserves even
greater mention. It would seem that no paper could be
more liquid in open-market transactions than that ac­
cepted by an institution with the financial status of a bank.
The essential function of the bank acceptance is to sub­
stitute for the inferior credit of the individual the more
easily liquidated obligation of a bank. Because of the wide
market for the bank acceptance, the bank may be able to
meet the needs of its customer even though it itself is
unable or non-desirous of making a straight loan. Instead
of discounting its customer’s note and furnishing the funds
itself, the bank merely assists its customers to obtain the
advance from some other institution. B y accepting this
draft the bank places the customer in possession of paper
which may be sold to some other banking institution. The
accepting bank assumes no responsibility until the date of
the maturity of the draft. But on or before the date when
payment becomes due, the customer is expected to pro­
vide funds for the meeting of the draft. This may have
been accomplished previously by the opening of a credit in
favor of the individual, or by turning over to the bank for



collection customers’ paper maturing at approximately the
same date as the bank acceptance and aggregating perhaps
a substantially equivalent amount.
In the import trade past events had shown the necessity
of the development of the acceptance method. When the
seller of the goods resides in a foreign country, it is pecu­
liarly desirable that the importer’s bank be permitted to
accept the draft. The standing of the importer may not be
sufficient to enable him, by means of his own acceptance,
to add much strength to the bill drawn by the foreign ex­
porter. Prior to 1913 acceptance powers were not con­
ferred by law upon national banks. Accordingly, when
occasions arose which necessitated the substitution of a
bank for the American importer as acceptor, reliance
might have to be placed upon some foreign banking insti­
tution. This could be accomplished by the American
bank’s issuance to its customer of a letter of credit ad­
dressed to some London institution requesting that it
accept the bill. Arrangements would be made whereby the
London institution would be supplied with funds to meet,
on maturity, any draft drawn under the letter of credit.
In several ways this financing through London was not
thoroughly satisfactory to American trade and banking
interests. In the first place, this method virtually required
the American firm to pay two commissions, the one repre­
senting compensation for the service of the Americas
institution in issuing the letter of credit, the other compen­
sation for the London bank in honoring it. The entire
service could have been rendered by the American institu­
tion had legal authority for the acceptance existed. In the
aggregate the yearly charges upon American industry
which went to swell the revenues of London institutions
were very great. London was securing business which
might have been performed by our own banks.



Reliance upon London increased the difficulty, more­
over, of developing the use of the dollar exchange in inter­
national transactions. Drafts drawn against English
houses must necessarily be couched most frequently in
terms of sterling. When the time arrived for furnishing
“ cover,” the American firm would be obliged to provide
whatever sum in dollars the prevailing quotations on
sterling would make necessary. The risks of exchange
fluctuations were borne by American trading interests.
In the endeavor to avoid this loss by exchange, the
American firm might make forward contracts for the
amount of sterling credits necessary for cover. But this
only meant that the risk in exchange was placed on
the shoulders of another party. The assumption of this risk
was a service demanding compensation^ Payment for it
represented an increase burden upon American trade.
In the financing of the export trade a similar necessity
existed for the bank acceptance. Let us suppose that an
exporter in New York ships goods to a buyer in Buenos
Aires. Immediately he draws a draft upon the buyer and
attaches thereto the shipping documents covering the
goods sold. In case the shipper’s bank is in position to dis­
count the draft, no difficulty would arise in the financing
of the transaction. The seller secures his funds at once,
and is liable only in case of the inability of the bank to
collect from the purchaser in Buenos Aires.
In many situations, however, the ability of the bank to
discount these bills would be limited. The bills ran cus­
tomarily for a long period of time. Relatively speaking,
South American countries have been capital-poor coun­
tries. They must buy largely on time. Their industries,
moreover, are dependent largely upon agriculture. In
years of poor crops or of a depressed foreign market abroad
for their agricultural produce, the period of liquidation is



prolonged. Frequent renewals become necessary. Under
these conditions the American bank might feel obliged to
refuse a straight discount.
By means of the acceptance, however, the bank may be
able to aid the seller to secure the funds immediately in the
open market. The exporter draws another draft against
his bank, which accepts it under condition that the trade
draft will be turned over to it for collection, the proceeds
to be employed to cancel the acceptance credit. The bank,
either directly or through some other American house,
forwards the trade draft with the shipping document to a
Buenos Aires correspondent. When the buyer accepts the
draft he receives the shipping documents. By this method
the American seller is given negotiable paper, which can
be discounted in the general market because of the strength
given by the bank’s acceptance.
Not only was it argued that bank acceptance would
enable the exporter to secure his funds quickly, but it was
also anticipated that it would offer a means whereby the
financing of foreign trade could be deflected from New
York to London as money market conditions might neces­
sitate. Regarding this point we read in the Bulletin for
May 1, 1915:1
The importance of the development of this banking instru­
ment is now beginning to be generally understood, and inquiries
which have been made indicate that additional banks are pre­
paring to offer accepting facilities to their customers. From
the point of view of the development of a stable market in New;
York City for dollar acceptances, this is of importance, for such
a market depends primarily upon a large, steady volume and
low, steady rates. Several banks and firms dealing in bills have
also, largely within the present month, begun to quote forward
rates on bills drawn in dollars, so that exporters in distant
countries may be able to calculate the comparative negotiable
1 Page 53.



value of sterling and dollar drafts. This is also of fundamental
importance in the development of the acceptance business.
When the movement of our exports and imports has been suffi­
ciently standardized through bankers’ acceptances, so that it
may be facilitated as easily in the New York as in the London
market, even though the volume in the New York market may
be much smaller, we should be enabled readily in the future,
when we wish to protect our reserves or when they are needed
for domestic expansion or seasonal movements of commodities,
to deflect the financing of our foreign trade from New York to
London by raising New York rates above London rates and
making it cheaper for the shipper to draw on London than on
New York. Conversely, when we are ready to finance it again
we should be able, in normal times, to recover the business from
London by reducing our rates below those of London. At other
times, of course, London may take the initiative in readjusting
the rates for one or another of these purposes, just as its rates
have been raised substantially during the past 30 days as a
protection to its reserves.
In general the bank acceptance was regarded as necessary
in order that our financial centers might assume, in the
field of international finance, the place commensurate with
the importance of American trade and industry.
Most of the above considerations were stressed also in
discussions relating to the financing of domestic trade.
Aside from the fact that foreign trade involves the trans­
lation of the medium of exchange of one country into that
of another, distant domestic transactions offer the same
problems as foreign. It is still necessary to find a means of
substituting bank time-credit for the credit of the indi­
vidual. But the points emphasized most largely in the days
of banking-reform discussion were the aid which the ac­
ceptance might render; first, in the campaign to create a
broad and steady market for commercial paper; and second,
in the equalization in some degree of money rates in dif­
ferent sections of the country.



In regard to the first matter it was argued that the bank
acceptance would do much to standardize the commercial
paper available for bank investments. The credit of
individuals varies in quality, but paper representing the
obligations of banks should possess some degree of uni­
formity. The bank acceptance offered a means of substi­
tuting the one type of paper for the other. If commercial
paper could be thus standardized, much would be accom­
plished in the way of relieving the stock market from the
uncertainties of the call-loan market. As an element in
banks’ secondary reserves it was anticipated that the
acceptance might become the most important item. It was
argued that this would constitute an advantage for the
security investment as well as for the banking interests.
Stocks and bonds of fluctuating value should be financed
by time loans. In no other way can they be relieved on
intimate dependence upon momentary changes in money
As a second advantage, it was urged that the acceptance
would assist in the transfer of banking funds from the capi­
tal-poor to the capital-rich sections of the country. Pre­
viously, such a redistribution in the employment of bank
funds was made difficult because of the inferiority of pri­
vate credit in the borrowing sections. The acceptance
offered a means of overcoming this difficulty to some extent
in short-time transactions. Eastern banks would bfl
expected to show more willingness to purchase paper
accepted by a Western bank than that of a private
Under the terms of the banking laws of some States
recognition of the merit of the acceptance had been made
prior to the passage of the Federal Reserve Act. In the
Report of the Board for the year 1919 we read:1
1Page 21.



Incorporated banks were first permitted to accept about 10
years ago under the laws of some of the States in which they
were domiciled.
It is by the terms of the act, however, that national banks
are first endowed with acceptance powers. According to
the terms of the original statute member banks were given
the right to 1
accept drafts or bills of exchange drawn upon it and growing
out of transactions involving the importation or exportation
of goods having not more than six months’ sight to run.
In view of the arguments previously advanced in behalf
of the use of the acceptance in domestic trade, it may seem
strange to note that the original act confined its use to
foreign-commerce transactions. Explanation for this fact,
however, is not difficult to find. In the first place, itwas not
desired that in the beginning the bank-acceptance method
should be pushed among all sorts of institutions. It was
hoped that its use might be confined *to banks of the high­
est degree of solvency. As a rule institutions which had
been prominent in foreign-trade financing were classified
among those of highest solvency.
In the second place, it was perceived that the foreign
trade acceptance was necessary in order to encourage the
use of the dollar exchange. As long as London banks
accepted for international trade purposes, the banker’s
bill, in the great majority of cases, would be drawn in
terms of sterling money. This was a matter which involved
rivalry with a foreign banking mart; it seemed especially
important that restrictions preventing our banking institu­
tions from competing on even terms with the foreign should
be removed.
Finally, the inflationary possibilities of the bank ac* Section 13.



ceptance were recognized. As indicated previously the
acceptance method offers a means whereby local indus­
tries may be permitted to draw upon surplus funds in the
outside banking community. There was danger that credits
should be offered too liberally; credits not merely in the
aggregate, but also in the amount extended to a single firm.
Accordingly, the original act confined its use to one single
type of transactions.
Subsequently,1 however, the act was amended to permit
of its employment in other types of transactions. These
were : first, for the purpose of creating dollar exchange;
secondly, to finance the domestic shipments of goods;
thirdly, to permit the temporary storage of staples pend­
ing a reasonably prompt sale or distribution.
The reader of section 13 may be somewhat confused by
the very many restrictions confining the use of the bank
acceptance. Some of these restrictions were a part of the
original act; others were introduced in subsequent amend­
ments. It may be desirable, therefore, to inquire as to the
motives of the lawmakers in inserting these restrictions in
the statute. Aside from matters previously mentioned —
the desire to preserve for the acceptance a distinctive
place as a superior type of commercial paper available for
member banks’ secondary reserves, and the fear of its
inflationary possibilities — the following explanations
may be ventured. First, it was made available for redis­
count or purchase by reserve banks at a specially low rate.
For a considerable period after the acceptance regulations
were issued by the Board, the rates on such rediscounts
were announced as varying between two and four per cent.
The minimum figure was considerably less than the average
rate on other paper. A consideration determining whether
the rate would correspond more closely with the maximum
1 By the amending act of September 7, 1916.



or minimum would be the standing of the firm acting as
acceptor. A higher rate would be a means of discouraging
the offer of undesired acceptances. As stated by the Board
in an Informal Ruling in the November 1 , 1915, Bulletin: 1
It is, of course, understood that the Board would not wish to
see concerns regarded as eligible acceptors which are not in
the habit of carrying on some acceptance business regularly
and are not generally of such character and standing as to qual­
ify their, acceptance as a banker's acceptance.
As in the case of the trade acceptance, it was to be expected
that many illegitimate attempts would be made to gain the
advantage of the low rates.
As a second explanation, it was to be expected that the
bank acceptance as a superior type of commercial paper
would come to occupy a prominent place in the portfolios
of reserve banks. In the early days of operation the sup­
port of the reserve banks would be necessary in order to
encourage its use. Later, large amounts of acceptances
would be purchased by reserve banks as a part of their
open-market operations. It was emphatically necessary
that the reserve banks keep their assets in liquid shape.
Precautions were felt to be peculiarly necessary in order to
prevent an unduly rapid growth of such paper.
Finally, with certain exceptions, the limitations of sec­
tion 5200 would not apply to the bank acceptance. The
theory justifying this exception is that an acceptance is not
a loan of money. The accepting bank merely lends its
credit to the maker of the bill. The bank’s responsibility
is contingent only and not direct. Because of the remote­
ness of loss under this contingent guarantee, it was not
esteemed necessary to provide for the application of the
same laws which govern the straight loan. Accordingly,
1 Page 36.



by the amendment of September 7, 1916, a sentence in
section 13 was made to read:
N o member bank shall accept, whether in a foreign or domes­
tic transaction, for an y one person, com pany, firm, or corpora­
tion to an am ount equal a t an y time in the aggregate to more
than ten per centum of its paid-up and unimpaired capital stock
and surplus, unless the bank is secured either b y attached
documents or b y some other actual security growing out of the
same transaction as the acceptance.

This was a negative way of providing that acceptances
thus secured might be made to an amount exceeding ten
per cent of the capital and surplus. But if not secured, the
liability of the bank, contingent though it be, was con­
sidered too great. If law established for the acceptance
no such limitation as section 5200 provided for the straight
loan, all the greater appeared the necessity of imposing
other restrictions.
While discussing this matter intrepretation should be
made of the phrase, “ attached documents or by some
other actual security.” It is evident that the documents
must be surrendered to the purchaser before the latter
can obtain the goods, and that after their surrender the
documents are not in the possession of the bank. To cover
this situation the following ruling was announced by the
Board in the February, 1919, Bulletin: 1
I t [a member bank] cannot accept in domestic transactions
w ithout being secured at the time of acceptance, but m ay re­
lease the security after acceptance upon the execution of a trust
receipt or an agreement b y the customer th at so much of the
proceeds of the sale of the goods covered b y the security as m ay
be necessary to p a y the draft will be deposited with the accept­
ing bank when available and will not be used for other purposes.

Under certain conditions, however, an acceptance would
* Page 143.



become for all practical purposes a loan or a discount.
Under such conditions section 5200 would apply. One of
these situations would be that in which the accepting bank
some time subsequent to acceptance purchases its own
This practice, the purchase by the bank of its own
acceptance, was not welcomed as customary procedure. An
acceptance is a means whereby some other bank is to fur­
nish the funds. On certain occasions, however, such action
might prove necessary. If no outside demand for the
acceptance occurred, the only means of protecting the
acceptance market would be for the accepting bank to make
the purchase. Such action might be defended on the
ground that the acceptance method must not be permitted
to fall into disrepute.
Ordinarily, however, such action should not prove nec­
essary. So desirous have the reserve authorities been that
the bank-acceptance method should be encouraged for
legitimate purposes, and so well fortified have the reserve
banks been in their open-market powers, that the market
should not customarily fail for prime acceptance paper.
Although somewhat handicapped by the slow develop­
ment of special discount corporations, the acceptance
demand has been enlarged recently on the part of other
institutions, as, for instance, savings banks. In some
cases, furthermore, it appeared that the purchase of the
bank’s own acceptance was an attempt to evade the limi­
tations of section 5200 and find a means of advancing more
to one party than an amount corresponding to ten per
cent of the bank’s capital and surplus. By an Informal Ruling, however, announcement was
made that such practices could not be permitted to accom­
plish their purposes.1 It was insisted that acceptances
xBulletin, January i, 1917, p. 28.



purchased by the accepting bank must be considered as
loans. In such cases the bank’s obligation is direct, and
not merely contingent.
The acceptance method, furthermore, contemplated
that the acceptance credit would be eliminated by remit­
tance of “ cover” to the bank on or before the maturity of
the acceptance. If the indebtedness of the drawer is not
destroyed, the bank assumes the position of making a
direct advance. Exception to this statement might be
made only in case the payee permitted the renewal of the
acceptance. It is not surprising, therefore, to find in the
Bulletin for February, 1916,1 an Informal Ruling to the
effect that
the provisions of section 5200 of the United States Revised
Statutes would apply to the indebtedness arising between the
drawer of the bill and the accepting bank in case the drawer
fails to furnish funds with which to meet the acceptance.
A somewhat confusing situation might arise, however,
in the case of the rediscount of an acceptance which had
been purchased previously by the accepting bank. By the
act of rediscount, which transfers the paper to another
institution, the bank ceases to occupy the position of a
lender of money. After rediscount its liability is precisely
the same as that which existed before the purchase of the
bill. The bank’s obligation becomes,contingent only. Sec­
tion 5200 does not apply.3
We may next consider the conditions governing the use
of the acceptance for various classes of permitted pur­
poses. Let us first turn our attention to the use of the
acceptance in the establishment of the dollar exchange.
By the amendment of September 7, 1916, member banks
* Page 64.
3 Cf. Opinion of Counsel, Bulletin, September 1 , 1917, p. 696,



were empowered, with the special permission of the Fed­
eral Reserve Board, to accept drafts
for the purpose of furnishing dollar exchange as required by the
usages of trade in the respective countries, dependencies, or
insular possessions.
The Federal Reserve Board was given power to determine
whether the country’s trade usages were such as to necessi­
tate the acceptance of drafts originating therein. In the
December 1,1916, Bulletin,x we are informed that appli­
cations had been granted for the acceptance of drafts
drawn in Porto Rico, Santo Domingo, Costa Rica, Peru,
Chile, Brazil, Venezuela, Argentina and Bolivia. The
Board refused2 to include England or France in this list.
Thereason for this discrimination was explained asfollows:3
The purpose of this Act and the regulation made pursuant
thereto was to enable the American banks to provide dollar
exchange in countries where the check is not the current means
of remittance in payment of foreign debts, but where the three
months’ bankers’ draft is generally used for that purpose. . . .
The Board is informed that the bankers’ custom of selling
three months’ drafts in preference to checks originated in coun­
tries where the mail connections were irregular and the foreignexchange market was a limited one, and where it would have
been difficult for the drawing banker to be certain that he could
find a cover against the checks drawn by him in time to forward
it by the same mail, whereas, in drawing a three months’ draft,
he would feel assured of being able to forward remittances
before his obligation fell due.
In other words, irregular mail connections make it
impossible frequently to depend upon the immediate
remittance of “ cover.9 In such cases, a time bill is desired,
giving sufficient opportunity for remittance.
x Page 665.
a Ibid., p. 666.
* Ibid., pp. 665, 666.



In a ruling by the Board 1 it appears that attempts have
been made to draw such bills when the usages of trade
were not such as to require them. In some countries where
the dollar was at a premium such drafts would be drawn
to supply the needed exchange. The Board ruled that
these drafts could not be accepted by American banks. It
appears, therefore, that “ the usages of trade” refers solely
to the customs created because of the lack of regular mail
Statutory limitations upon the ability of banks to accept
such drafts were as follows: In no case could the amount
of acceptances exceed one half the capital and surplus of
the accepting bank. Ten per cent of the capital and sur­
plus would be the maximum unless “ the draft or bill of
exchange is accompanied by documents conveying or
securing title or by some other adequate security. ”
The second class of bankers’ acceptances were those
arising out of the importation or exportation of goods. In
absence of special permission from the Board, member
banks are given the right to accept to an amount equal to
fifty per cent of their capital and surplus. The Board is
empowered, however, to grant permission to applying banks
to accept up to one hundred per cent of the capital and
surplus. In pursuance of this power the Board has regu­
larly published the names of banks which are to be per­
mitted to accept the larger amount.
The reason for the insertion of such restrictions in the
statute is not difficult to explain. The acceptance is a
means whereby the accepting bank aids its customer to
secure funds from the outside banking community.
Clearly no one bank should be permitted to draw too heav­
ily upon other banks for the benefit of its own customers.
Stating the limitation in terms of a maximum and a mini1 Bulletin, August, 1920, p. 835.



mum gives the Board some discretion regarding the sort
of banks which are to be granted in greatest degree the
acceptance privilege. In order to ensure the acceptance
against misuse, the Board has been unwilling to encourage
its employment on the part of firms whose standing is not
of the highest.
During the foreign-trade boom following the armistice,
assertions were made frequently that these limitations
were too severe. It may well be that, in the course of time,
a further amendment to the statute will be necessary. But
in this period the volume of foreign trade was extraor­
dinarily great. Under more normal conditions the need of
the acceptance should not prove so great. It may be
preferable, furthermore, to extend its use among a larger
number of banks before granting greater powers to any one.
As in the case of the domestic acceptance, member
banks may accept drafts which arise in foreign trade hav­
ing a maturity of six months. The maturity of a draft,
rediscounted by a reserve bank, however, must not exceed
three months. It cannot be granted under an agreement
to renew.1 The purpose of the acceptance was merely to
finance transactions capable of being liquidated in a com­
paratively brief period. Funds, desired for longer pur­
poses, should be obtained by means of a straight loan.
Since a direct loan would be subject to the restrictions of
section 5200, Revised Statutes, agreement to renew an
acceptance would offer virtually a means of evading the
terms of the statute.
This should not be interpreted, however, as denying a
member bank the privilege of granting an acceptance
credit outrunning six months. The acceptance credit may
be considered merely as permission to draw the drafts. The
limitation applies to the maturity of the drafts, not to the
1 Cf. Opinion of Counsel, Bulletin, March, 1920, pp. 777-78.



length of the period during which such drafts may be
A problem of some difficulty had to do with the means
of identifying a foreign-trade transaction. How could it be
distinguished from an operation of domestic trade? In
case the dealer handled only goods in foreign trade, the
presumption would be clearly in favor of classifying it as
a foreign-trade acceptance. But if the party handled goods
for the domestic as well as for the foreign trade, it would
be more difficult to determine to which class it belonged.
In the latter case, accordingly, it has been ruled that the
dealer could be required to display a contract for foreign
sale. It would not be necessary, however, to identify in
the export trade the specific goods placed on board ship.1
In the early days of reserve operation it was easy to
understand the necessity of distinguishing between foreign
and domestic-trade acceptances. Then, acceptances could
be given only to finance transactions arising out of the
importation or exportation of goods. But later amend­
ments permitted domestic acceptances under conditions
substantially similar to foreign. In what, then, consists
the value of this distinction to-day? The answer consists
in part of the provision that whereas member banks may
be permitted to accept both classes of bills up to an amount
equal to one hundred per cent of their capital and surplus,
“ acceptances growing out of domestic transactions shall
in no event exceed fifty per cent of such capital stock and
surplus. ” To determine whether any one bank is exceed­
ing its acceptance powers, it is necessary to learn how
large are its acceptances for domestic and how large for
foreign-trade financing.
The provisions of the original act relating to foreigntrade transactions were drawn in rather general terms. It
1 Cf. Informal Ruling, Bulletin, December I, 1915, pp. 405-06.



was merely stated that the transaction must involve the
importation or exportation of goods. Would it be suffi­
cient, then, if the ultimate object of the transaction was to
supply goods for export?
The Opinion of Counsel in this matter is stated in the
Bulletin for September 1, 1915.1 To quote the terms of the
inquiry stated therein:
A domestic corporation, which for convenience will be desig­
nated 4Company A,” enters into a contract with another
domestic corporation, designated “ Company B,” to furnish
material to be used by Company B in the manufacture of
products which Company B is under contract with a foreign
purchaser to export. Query: Can a national bank accept a
draft or bill of exchange drawn by Company A and accompanied
by the necessary documents?
It is obvious that to hold such an operation “ foreign
trade” would be to widen enormously the permitted
classes of acceptance transactions. Many domestic trans­
actions result finally in a foreign sale. Many of them fre­
quently would be difficult to trace. It is not surprising,
therefore, that Counsel ruled that the transaction itself
must involve a foreign sale or purchase. It is not enough
that the domestic transaction be merely related to the
Let us now turn out attention to domestic acceptances.
The first class of these acceptances permitted by the
statute are those growing out of domestic shipments of
goods secured by the attachment of shipping documents
conveying title to the goods. In this respect such domes­
tic acceptances stand on a different basis from the foreigntrade acceptance. In the case of the latter the provisions
of the statute were intended merely to ensure the fact that
there had been a shipment. Congress evidently intended,
1 Page 276c



however, to restrict domestic acceptances to a greater
extent, because it provided that the shipping documents
must convey to the accepting bank title to the goods. Such
goods can be released to the purchaser, however, on the
execution of a deed of trust stipulating that the proceeds
from the sale shall first be devoted to the cancellation of
the acceptance credit.1 The release of the security would
cause, however, the limitations of section 5200 to apply.
In that case the bank is secured neither by the attached
documents nor by the actual security of the goods.2
Thelmore strict limitations upon domestic acceptances
were due to the possibilities of greater abuses. The volume
of domestic transactions is much greater than that of for­
eign. Greater possibilities of evil attach, therefore, to the
domestic acceptance.
The duration of these acceptances may be as great as
six months. But in no case may they run for a period
longer than necessary to finance the sale.3
An interesting question arises as to the power to accept
when a corporation is making a shipment of goods to its
own agent. Such a transfer could not be considered as a
sale. It would not seem legitimate to permit a draft to be
accepted for any other purpose than to finance the ship­
ment, to offset temporarily the cost of transporting the
goods. In this case the maturity of the draft should
approximate the duration of their transit.4
The principal concern of the Board has thus been to con­
fine the use of this type of the bank acceptance to the
financing of the shipment or the sale of the goods. Funds
desired to enable the goods to be carried through the
process of manufacture into finished products should not
1 Cf. supra, pp. 180-181.
2 Cf. Informal Ruling, Bulletin, March, 1921, p. 308.
3Ibid., p. 308.
4Cf. Informal Ruling, Bulletin, September 1,1917, p. 690.



be financed by the acceptance. The acceptance should not
be employed to secure working capital. Funds for such
uses should be obtained by the discount of the borrower’s
promissory note. The acceptance contemplates the ex­
tinction of the credit from the proceeds of the goods
obtained by the sale of the acceptance.
The second class of permitted domestic acceptances
was those secured at the time of the acceptance by ware­
house receipts conveying title to readily marketable
goods. The function of this acceptance is to assist the
producer in the orderly marketing of farm crops. If funds
could not be obtained freely to hold the products of the
farm in the locality of their production for a reasonably
quick sale, the producer would be more largely dependent
upon the offer of outside capital. The producer can well
argue that means should be found to place him on the
same basis as the outside purchaser with reference to his
ability to obtain banking capital. Banking capital may be
scarce in the growing section. Since the security must
be that of “ readily marketable staples” only, the risk of
the bank which grants the acceptance credit should not
be great ordinarily.
Such methods as these could be abused easily if no
limit were placed on the period for which the funds thus
obtained could be employed. B y a permanent advance of
funds the bank might be supplying capital for commodity
speculation. Legitimate use of the acceptance for this pur­
pose was thus stated by Counsel of the Board as follows:
The purpose must be
to carry goods covered by warehouse receipt pending a reason­
ably immediate shipment, a reasonably immediate sale, or a
reasonably immediate distribution into the process of
* Cf. Opinion of Counsel, Bulletin, January X 1920, p. 67.



The acceptance must not be made subject to renewals.*
The security may be cattle provided the maturity is no
longer than that required to fatten and resell.2
The use made of this type of the acceptance must depend
upon the definition of “ readily marketable staples.” In
the Bulletin for July, 1919,3 the Board stated:
A readily marketable staple may be defined as an article of
commerce, agriculture, or industry of such uses as to make it
the subject of constant dealings in ready markets with such
frequent quotations of prices as to make (a) the price ’easily
and definitely ascertainable and (b) the staple itself easy to
realize upon by sale at any time.
This definition would bar the use of the acceptance for the
great majority of manufactured articles. Acceptances
secured by warehouse receipts to automobiles and auto­
mobile tires were held by the Board in the January, 1920,
Bulletin4 to be unwarranted. This class of acceptances
may be considered, therefore, as devised in largest
measure to meet the special marketing needs of the
agricultural borrower.
The restrictions thus far mentioned relate to the power
of member banks to accept. It is necessary next to learn
the conditions governing the power of reserve banks to
acquire acceptances.
Under its discount powers, reserve banks can acquire
acceptances maturing within three months from date of
discount. Six-months acceptances must be held, there­
fore, for a period of three months before they become
eligible for discount with a reserve bank. Until May,
1921, the acceptance was treated as a commercial bill, and
1 Bulletin, March, 1920, p. 277.
8Gf. Informal Ruling, Bulletin, July, 1921, p. 315.
3Page 652.
* Page 65.



subject, therefore, to the statutory limitations applicable
to such paper. But in that month foreign trade conditions
were interpreted to be such as to warrant an extension of
maturities. Accordingly, in the desire to encourage the
granting of acceptances of longer maturity by member
banks, an exception was made by a ruling of the Board
whereby acceptancesgrowing out of transactions involving
the importation or exportation of goods might be eligible
for purchase by reserve banks even though the maturity
at the time of purchase was as great as six months.1
A further reason for this regulation was to widen the
acceptance market by adapting acceptances to the re­
quirements of savings banks. Foreign-trade acceptances
might be desired by these institutions if the reserve
banks had power to protect the market by acquiring
acceptances of longer maturities. By extending the
maturities of bills eligible for purchase the protecting
power of reserve banks would be enlarged.*
Bankers' acceptances rediscounted under the terms of
section 13 must be endorsed by a member bank. Openmarket purchases under section 14. need not be endorsed.
Nevertheless, the policy of the Board has been to take all
feasible steps to ensure the worth of paper thus acquired.
Accordingly, by Section B, Series of 1921, it was held that
an unendorsed acceptance “ is not eligible for purchase
until the acceptor has furnished a satisfactory statement
of its financial condition,” and agrees to submit any
information concerning the underlying transaction re­
quested by the Federal Reserve bank.
An endorsement by the accepting bank adds little, how­
ever, to the strength of the acceptance. Accordingly, the
Board has not welcomed purchases directly from the
1 See infra., pp. 191-192.
aCf. Bulletin, June 1,1921, p. 648.



accepting bank. It prefers that the acceptance should be
acquired from another bank. It was only because of the
weak market for acceptances in some districts that pur­
chase directly from the accepting institution has been
condoned. But in February, 1920, reserve banks were
instructed to make all such purchases at the rate appli­
cable to commercial paper rather than at the preferential
rate applicable to bankers’ acceptances.1
Open market purchases under section 14 are not subject
to the requirements of section 13, that the paper acquired
by reserve banks shall not bear the name of a borrower
indebted to the member bank to an amount exceeding ten
per cent of the bank’s capital and surplus. Nevertheless,
as a matter of banking policy the Board announced that it
desired member banks to recognize this restriction as ap­
plicable to open-market purchases. Discretion in this
matter, however, is left to the district banks.
The preceding discussion relates exclusively to the
acceptance powers of member and reserve banks. By a
series of amendments to section 25 of the act, member
banks have been endowed gradually with powers to invest
in the stock of corporations possessing certain acceptance
privileges. Let us turn our attention next to this matter of
syndicate acceptance development.
Section 25 of the original act gave national banking
associations, with a capital and surplus of more than
$1,000,000, power to establish branches in foreign coun­
tries for the “ furtherance of the foreign commerce of the
United States, and to act, if required to do so, as fiscal
agents of the United States. ” In the discussion preceding
the passage of the act on December 23, 1913, the public
had been rather thoroughly educated regarding the
necessity of such foreign branches. In the matter of for1 Cf. Bulletin, June, 1921, p. 699.



eign trade some foreign agency must act sis the foreign
correspondent of the American bank in such matters as
the making of collections on export bills, honoring and
issuing letters of credit, supplying credit information for
the benefit of American industry. Foreign banks, under
the control of, and devoted primarily to the welfare of,
foreign industry could not be expected to perform all
these services with strict secrecy and impartiality. It was
a matter of frequent comment that American trade
secrets found frequent disclosure through the medium of
foreign banks. It is not strange, therefore, that our legis­
lators decided to equip certain types of our banks with
powers more in accordance with those possessed by their
foreign banking competitors.
Under the terms of this section many foreign branches
were established. It soon appeared, however, that the act
did not go quite far enough. Banks which were not
desirous themselves of establishing these foreign branches
insisted that they should be permitted to cooperate with
other banks in the organization of foreign banking institu­
tions. Accordingly, the amendment of September 7, 1916,
contained a provision permitting certain types of banks to
subscribe to stock in institutions “ chartered or incorpo­
rated under the laws of the United States or of any State
thereof, and principally engaged in international or for­
eign banking.”
The work of institutions of this sort must be largely of a
commercial nature. Their advances must be, in large meas­
ure, short-time advances. In the period following the
signing of the armistice, however, it became clear that the
industrial needs of Europe were such as to demand the
granting of credits running for a relatively long period of
time. By a further amendment to section 25, signed by
the President on September 17, 1919, national banks were



empowered to assist in the formation of institutions to
provide investment as well as commercial credit. Corpo­
rations to be formed under the authority of this legislation
must be “ principally engaged in such phases of inter­
national or foreign financial operations as may be neces­
sary to facilitate the export of goods. ”
But while stock might be subscribed in such institu­
tions, no means were provided for the Federal incorpora­
tion of foreign banking corporations. By further amend­
ment to section 25, which became law on December 24,
1919, the so-called Edge Act, this difficulty was eliminated.
A t the time of the passage of the Edge Act its purpose
was generally proclaimed to be the assisting of Europe in
the reconstruction programme. In the April, 1920, Bulle­
tin,1 however, we are informed that it should not be re­
garded as merely of temporary importance. Its permanent
endeavor was to provide for the establishment of federally
incorporated institutions with sufficient power to compete
on even terms with foreign institutions. In Europe insti­
tutions of the type of the “ investment trust” had long
since been developed to encourage foreign trade and for­
eign investment. The basic purpose of these institutions
is to substitute for the investor domestic for foreign securi­
ties. To obtain capital from its investing public its own
debentures are offered. These debentures should be safer
than those possible of individual selection. The invest­
ments of the company are much more widely diversified
than an individual’s of limited means possibly can be.
They are superintended by an official with special oppor­
tunities to investigate the worth of foreign securities pur­
chased. The investment trust, furthermore, can conduct
its operations on a scale impossible for that of the indi­
vidual. Its capital is collected from a number of savers.
* Pages 379-82.



Finally, the purchaser of the debentures could be fortified
by the knowledge that shrinkage of earnings would be
borne first by the company’s shareholders, and that not
until the losses wipe out the capital and surplus is his own
equity disturbed. Corporations organized in this coun­
try under the Edge Act would possess power to purchase
securities in companies conducting a business engaged in
foreign trade.
Corporations formed under this act may operate either
on a debenture or on an acceptance basis. In view of the
fact that the framers of the legislation undoubtedly had in
mind an institution of the type of the foreign ‘ *investment
trust, ” it may seem difficult to account for its acceptance
powers. It might appear that the issuance of debentures
alone would suffice. It must be remembered, however,
that the purpose of these corporations was to supply for
foreign-trade purposes short- as well as long-term credit. In
the matter of short-term acceptance credits, member
banks felt the limitations on the aggregate permitted by
section 13 rather severe. The Edge Act offers a means of
lessening this difficulty.
Under the terms of the law the acceptance of bills and
drafts was to be subject to any limitations and restric­
tions the Federal Reserve Board might impose. By Regu­
lation K, Series of 1920, the Board has permitted corpora­
tions which issue no debentures to make acceptances for
the purpose of supplying dollar exchange and for the pur­
pose of furthering the importation or exportation of goods
Bills accepted of the first class may run for three months,
those for the last class six months. For one drawer accept­
ances cannot exceed ten per cent of the capital and surplus
“ unless the transaction be secured or represents an expor­
tation or importation of commodities and is guaranteed by
a bank or banker of undoubted solvency.” Limitations



upon the aggregate volume of acceptances were to be
governed by the following regulations:
W henever the aggregate of acceptances outstanding a t an y
time (a) exceeds the am ount of the subscribed capital and sur­
plus, 50 per cent of all the acceptances in excess of the am ount
shall be fully secured; or (b) exceeds twice the am ount of the
subscribed capital and surplus, all the acceptances outstanding
in excess of such am ount shall be fully secured. T h e Corpora­
tion shall elect whichever requirement (a) or (b) calls for the
smaller am ount of secured acceptances.

Dollar exchange acceptances are not permitted to exceed
fifty per cent of the banks’ subscribed capital and surplus.
Although the liability of the bank is only contingent in
the case of a draft drawn under an acceptance credit, it
seemed desirable to ensure a sufficiency of liquid assets
against these acceptances. Accordingly, certain reserve
provisions were inserted in the Regulations.
Banks of this country displayed no immediate haste to
take advantage of this authority to form such corpora­
tions. In the early part of 1921 announcement was made
of the formation of the Foreign Trade Financing Corpora­
tion under the sponsorship of the American Bankers’
Association. The capital of this corporation was to be
#100,000,000. A t that time there were only two other
Edge Act corporations in existence. These possessed capi­
tal stock of #7,000,000 and #2,100,000 respectively.1
Much difference of opinion exists regarding the future
of such institutions. Lack of sudden growth may be ex­
plained in part by the inevitable friction and delay in
securing the large amount of capital such institutions
would require. The depreciation of the dollar value of
foreign currencies also rendered it uncertain to make ad­
vances to foreign traders. The development of some such
1 See Report of the Federal Reserve Board for 1920, p. 26.



plan of supplying international credits as the Ter Meulen
may lessen the future need of Edge Act institutions. It has
been anticipated, however, that the Ter Meulen bond
would be issued to importers in foreign countries largely
for the purposes of enabling them to obtain raw nlaterials.
The supplying of capital for such purposes as the purchase
of machinery may establish a place for the Edge Act
Full development of any institution of this sort must
wait, however, in large measure upon the rectification of
certain unsound financial practices employed at the pres­
ent by European countries. As long as these countries
refuse to balance their budgets and continue to meet
deficits by new creations of currency, as long as credits are
employed for non-reproductive purposes, as long as cur­
rency ihflation continues, relief to Europe will be difficult.
But these corporations have another purpose than aiding
in the reconstruction of Europe. A leading motive was to
develop machinery whereby American financial institu­
tions may be unhampered in meeting the legitimate re­
quirements of foreign trade.
As a concluding inquiry let us turn to the policy of the
reserve banks in the endeavor to encourage the use of the
acceptance. For the years 1915, 1916, and a part of 1917,
the discount rate on bankers’ acceptances varied from two
to four per cent. The Board sanctioned the application of
minimum and maximum figures in order to permit reserve
banks to differentiate according to their own discretion
between paper of various degrees of solvency. In this early
period the market for acceptances was largely that estab­
lished by the reserve banks. The paper was new, and
special discount corporations had not been formed to such
an extent as to offer an immediate market for this paper.
Accordingly, it was made possible for a very low rate to be



There is no doubt but that the reserve authorities were
genuinely eager to encourage the use of this type of paper.
Aside from any considerations thus far noted, acceptances
would be expected to evoke a more intense foreign demand
than that for any other grade of paper. With such a for­
eign market created, it was hoped that it would be possible
to shift the purchase from London to New York by alter­
nate changes in discount rates.
During 1917, however, the rates hardened. By the end
of the year they had risen to 3 to 4 1/2 per cent, except for
three reserve banks where the rates were 3 to 5 per cent.
The latter part of the year open-market charges on bank­
ers’ acceptances maturing within 3 months were 4 per
cent as a minimum. This was slightly less than the rates
on 61-90-day paper secured by United States war obliga­
tions (4 1/4 per cent). Relatively the same figures were
maintained during the year 1918.
This lessening of the rate advantage given to the accept­
ance may be explained on several grounds. First,
It was thought th at a lower rate for an y class of paper than
that borne b y member banks’ 15-day collateral notes secured
b y Governm ent obligations m ight have an unfavorable effect
upon the T reasu ry’s operations.1

In other words, it was not desired to do anything which
might interfere with the sale or the market for war securi­
ties. Secondly, sufficiently good progress had been
achieved in the acceptance movement to render less neces­
sary an extremely low preferential rate. The increase in
the open-market purchases by Federal Reserve banks is
indicated by the following figures:2
19 1 5
191 6
191 7


191 8
: 1,809,539,000
* Report of the Federal Reserve Board for 1918, p. 19.




Finally, money-market conditions during 1918 were
such as to render it unnecessary to endeavor to meet the
lower British rate. Free shipments of gold were suspended
and connection between the two markets was destroyed.
The higher rate exacted here did not mean the driving of
financing to London because of the disturbances wrought
in foreign trade and finance.
Since 1918 the policy of the reserve administration has
been to establish a greater similarity for the different
classes of paper of corresponding maturities. On Decem­
ber 21,1921, the average rates charged on bankers’ accept­
ances maturing within three months was the same as the
commercial paper rate. Figures showing the purchases by
reserve banks from 1917 to 1920 were as follows:1

191 7


$ 909 301,000

19 1 8
1 9 1 9 ...................................... 2,825,177,000
1920............................. ........ 3,218,364,000

The holdings of reserve banks of bankers’ acceptances
on certain dates of 1920 and 1921 were as follows:*

September, 1920....................$306,295,000
Decem ber, 1920..................... 276,096,000
M arch, 1 9 2 1 ........................... 132,106,000
June, 1 9 2 1..............................
September, 1 9 2 1 ....................

These figures show a decided falling off in the acceptance
activities of reserve banks during the year 1921. A similar
decline is indicated by available figures bearing on member
bank acceptance activities. Through inquiries sent out by
the American Acceptance Council it was ascertained, in
1 Report of the Federal Reserve Board, 1920, p. 52,
*Bulletin, November, 1921, p. 1269.



417 answers out of 482 inquiries, that bankers’ acceptances
outstanding on April 1, 1920, amounted to as much as
#799,000,000. B y April 1, 1921, this figure had shrunk to
$644,000,000. Investigation of the Federal Reserve Board
indicates an approximately similar decline for the same
Many factors serve to account for the decline in accept­
ances in possession of reserve banks in 1921. The lessening
volume of foreign trade and the fact that the preferential
rate enjoyed by the acceptance has been virtually elimi­
nated have retarded both the necessity and the desire of
member banks to finance in this way. The general easing
of the money market has enabled many banks, which
would depend otherwise upon the acceptance, to finance
their clients by the straight loan. A t the same time, the
improvement in the money market has enabled many
banks to hold in their own portfolios acceptances pur­
chased, until maturity. On the part of foreign branch
banks there has been an increased competition with the
reserve banks in the purchase of this paper. This latter
fact would not concern, however, the operations of mem­
ber banks.
Despite these facts long-time prospects for the accept­
ance development appear favorable. In some States, such
as New York and Massachusetts, recent legislation per­
mits savings-bank acquirement of acceptances. The
Board’s ruling in May, 1921, lengthening the maturity of
eligible acceptances to six months, should render this
paper more desirable for savings banks. As the period of
depression gives way to activity, more and more situa­
tions will arise in which customers’ requirements will be
too heavy to be met by direct advances. Education and
propaganda, moreover, may accomplish much, and a
1 Bulletin, July, 1921, pp. 775-76.



great deal of work still remains for some reserve banks in
lending their facilities to member banks in the purchase of
acceptance paper.
The future development of the acceptance market is
highly necessary. Otherwise, surplus funds of member
banks will again be entrusted in large volume to the callmoney market. The call-money market is not under the
direct control of the reserve system. Stock exchange paper
is not eligible for rediscount or purchase.

I n the mind of the public much confusion has existed
regarding the difference between the open-market and dis­
count operations of the reserve banks. The first class of
operations are authorized by section 14 of the act, and the
latter class by section 13. But in what way can a distinc­
tion be made between the character of the work which can
be performed under the authority of these two sections?
A widely accepted belief has been that in the open-market operations the reserve banks deal directly with the
public; whereas by their discount powers they operate
only with the member banks. Color is lent to this view by
noting certain facts about the early legislative history of
the act. The report by Chairman Glass for the House
Banking and Currency Committee on September 9, 1913,1
contained the following statement:
I t [the committee] recommends th at these bankers’ banks
shall be given a definite capital, and th a t th ey shall do "business
on ly w ith the banks aforesaid, and w ith the Governm ent.

The later inclusion of section 14 in the act is interpreted,
therefore, as the extension to reserve banks of powers to
deal directly with the public. However this may be, sec­
tion 14 of the final bill authorized reserve banks to “ pur­
chase and sell in the open market, . . . either from or to
domestic orforeign banks,” 2certain specified classes of paper.
* House Report, 63d Congress, 1st Session, pp. 16 et seq.
* Italics are the writer’s.



Under the terms of this section reserve banks may deal
with banks. All that can be said for this point of view,
therefore, is that the open-market powers are the sole
authorization for direct dealings with individuals and cor­
porations. Such powers are not granted by section 13.
Section 14 also permits a reserve bank to deal with other
than its own member banks. It may buy or sell certain
types of securities and commercial paper from or to mem­
ber banks in other districts. It cannot rediscount under
section 13 for the member banks of other districts.
Neither can complete distinction be found by noting
whether there has been endorsement by the member bank
of the paper offered the reserve bank. It is true that redis­
counted paper must be endorsed by member banks,
whereas the statute does not require paper purchased
under the authority of section 14 to be endorsed. Never­
theless, the Board has endeavored by its regulations to
encourage the practice of giving precedence to endorsed
paper in the reserve banks’ open-market purchases.
Nor can conclusive distinction be had by noting the types
of paper which may be acquired under the authority of the
two sections. It is true that certain types of Government
securities and municipal warrants may be purchased
under section 14 only, and that promissory notes
can be acquired by reserve banks only by a discount
authorized by section 13. The original bill permitted the
open-market purchase of “ notes, drafts, and bills of ex­
change.” But in the final draft the words “ notes” and
“ drafts” were stricken out of section 14, although they are
retained in section 13. But even after these alterations
bankers’ acceptances and bills of exchange could be dealt
in by the authority granted by either section. Classifica­
tion of securities and paper in the two sections overlaps.
In the case of bank acceptances, however, nearly all the



paper acquired from member banks has been in accordance
with the authority granted by section 14. This is due to
the fact that the rate on prime acceptances bought in the
open market has been lower than the rediscount rate for
commercial or agricultural paper. The principal exception
to this statement relates to bankers’ acceptances unen­
dorsed by a bank or banker other than the acceptor. In
this latter case the higher rate on rediscounted paper
If the paper is authorized by both sections and is ac­
quired from a member bank, section 14 must be regarded,
therefore, as conferring additional powers by which reserve
banks may deal with member banks. As stated previously,
however, the open-market regulations have been such as to
discourage the applications of member banks involving
paper not of the highest degree of liquidity.
In view of the fact that the House Committee in its
report of September 9, 1913, recommended that the bank­
ers’ banks must confine their dealings to member banks and
the Government, it is peculiarly interesting to inquire into
the motives which led to the inclusion of the open-market
section in the final bill. It was understood, of course, how
desirable such powers would be in enabling reserve banks
to make profitable investment of their surplus funds. On
occasions when the volume of rediscounting falls off, the
earnings of reserve banks would diminish unless they could
be permitted to go out in the open market and find invest*
ment use for their funds. This consideration would hold
for any central banking system. But the structure of the
Federal Reserve was such as to render it peculiarly
necessary that the district banks possess these powers.
Member banks were compelled to subscribe to the stock of
the reserve banks. Their interest and enthusiasm in the
new system must pall unless a reasonable dividend is



received on stock subscriptions. A t least, it is not desirable
that reserve banks operate at a direct loss.
Open-market operations, moreover, represent under
some situations the only effective means whereby reserve
banks can take aggressive action in the control of the money
market. There can be no rediscounting unless the member
banks take the initiative by making applications to the
reserve banks. On occasions when member banks’ reserves
are plentiful, increase in rediscount rates may result in no
correction of member banks’ practices in advancing credits
freely. Member banks may then ignore the advice and
warnings of the reserve administration. Accordingly, if
the reserve banks are to be more than a mere set of emer­
gency institutions, they should be given power to effect
general money-market conditions by their purchases or
by their sales. Such measures are especially necessary in
the endeavor to realize, first, more uniform rates through­
out the country; and, second, to control the Nation’s gold
movements in such a way as to avoid excessive outflow at
one period followed by enormous inflow in another. Direct
sale and purchases are needed to accomplish the first result
when banks in other districts are not attracted by the
higher rates in the capital-poor sections. As a matter of
fact, there have always been many obstacles in the way of
the free flow of bank funds to the district of high rates.
Rediscounting alone may not affect the situation markedly.
In the matter of controlling gold movements, a principal
past difficulty has been the inability of our many exchange-dealing banks to adopt a unified policy regarding
alterations in our discount rates as it appeared necessary
to attract or to repel gold. No institution, furthermore, was
charged with the responsibility of accumulating the supply
of foreign credits which could be drawn upon in lieu of
gold shipments in time of a declining exchange.



Finally, it was anticipated that some of the open-market
powers would prove very helpful in encouraging the use
of dollar credits. If foreign countries are to be induced to
employ dollar exchange as a means of international pay­
ment, they must be satisfied that a ready market will exist
in this country for the discount of the bills which their
bankers and merchants draw. When the domestic market
fails for prime bills of this sort, the reserve banks must
protect it by their purchases. In opposite fashion, the
institution responsible for the control of the Nation’s
gold movements should be given power to establish credits
abroad which may be drawn upon in times when the
balance of payment is unfavorable. Such drawings may
make unnecessary shipments of gold. Accordingly, certain
specified types of operations are permitted by section 14
in order to accomplish this purpose.
One aspect of this question is of peculiar importance
in the establishment of the dollar exchange. This is the
matter of quoting forward discount rates. As stated by
Paul M. Warburg before the Pan-American Financial
A bank in a foreign country, when b u yin g a dollar acceptance,
m ust be assured of the rate a t which the bill will be discounted
when it reaches our country. O n this rate it will largely depend
whether the foreign shipper will use his European or his Am erican credit facilities. T h e Federal Reserve banks are fully alive
to the importance of this question, and I m a y state on behalf
of some of the largest of these banks th a t th ey will be prepared
to give the greatest possible assistance b y adopting a liberal ’
policy in quoting such forward rates, good for a certain d ate or
for delivery upon the arrival of mail b y a given steamer.

It seemed clear to the framers of the act that paper
permissible for open-market dealings must be highly
1 Quoted from Bulletin, July 1,1915, pp. 132-36.



liquid. Purchases at one season or year become sales at
another. Control of the market involves sales quite as
much as purchases. It was insisted, therefore, that reserve
banks should not buy large amounts of paper or securities
which would not command a broad market in the period
when it is desired to unload.
It may seem strange, therefore, to note the inclusion in
section 14 of certain classes of investment paper. Through­
out the act, the underlying theory appears to be that
short-time paper growing out of commercial transactions
is preferable to investment paper as an item in reserve
banks’ portfolios. It might seem as if investment paper
would have been excluded in section 14 quite as throughly
as in section 13. But there was the desire to make the
Federal Reserve system of especial service to the Federal
Government and the local subdivisions. Accordingly,
by section 14, permission is given for investment in certain
specified classes of Government securities. As a matter of
fact, similar powers are granted by section 13. Therein eli­
gible paper is made to include that drawn for the purpose of
carrying or trading in bonds and notes of the Government
of the United States. On purely financial grounds it might
have been argued that Government securities frequently
rise in price in time of extensive liquidation. The fear at­
taching to private securities in period of liquidation seems
often to increase the demand for Governments. These se­
curities possess a more stable market than the general
mass of obligations issued by private corporations*
Paper purchasable under section 14 falls into four classes.
We may mention first the Governments. Section 14b
states that reserve banks may
buy and sell, at home or abroad, bonds and notes of the United
States, and bills, notes, revenue bonds, and warrants with a
maturity from date of purchase of not exceeding six months,



issued in anticipation of the collection of taxes or in anticipation
of the receipt of assured revenues b y an y State, county, dis­
trict, political subdivision, or m unicipality in the continental
United States, including irrigation, drainage and reclamation
districts, . . .

Two facts in this sentence deserve emphasis. In the
first place, municipal warrants must be issued solely in
anticipation of later receipts. Fears as to the wisdom of
including them may be mollified somewhat on this ac­
count. In the second place, irrigation and reclamation
districts are included in the class of governmental sub­
divisions whose issues are purchasable under the authority
of this section. There appears to be no attempt here to
discriminate against agriculture or land-development.
A second class of open-market paper consists of bills of
exchange and bankers’ acceptances. Need for these powers
has been explained in previous chapters. The bankers’
acceptance is peculiarly necessary for foreign-trade financ­
ing and it was believed that its rapid development necessi­
tated the sponsorship of central banking authority.
An interesting question relates to the period within
which purchasable bankers’ acceptances must mature.
This section empowers reserve banks to purchase and sell,
in the open market,
cable transfers and bankers’ acceptances and bills of ex­
change of the kinds and maturities b y this A c t made eligible
for rediscount, . . .

Since discounted paper, by the terms of section 13,
must be payable within three months, it might appear as
if purchasable bankers’ acceptances must have no longer
maturity. If this be true, it would be puzzling to under­
stand the legal authority for the Board’s Regulation B, as
amended in May, 1921, wherein reserve banks are author-



lzed to purchase bankers’ acceptances arising out of
foreign-trade transactions and having maturities as extended
as six months,x
In reply to the writer’s query on this matter the Board
stated its position as follows:2
T h e question of whether the B oard’s regulation authorizing
the purchase of six-months’ acceptances is in conflict w ith the
terms of the Federal Reserve A c t depends upon whether or not
the phrase * of the kinds and maturities b y this act made eligible
for rediscount” refers both to bankers’ acceptances and to bills
of exchange or refers only to bills of exchange. I t cannot, of
course, refer to cable transfers, because cable transfers are not
eligible for rediscount under a n y circumstances. T h e phrase
m ight, however, qualify both bankers’ acceptances and bills of
exchange or m ight qualify on ly bills of exchange. T h e Federal
Reserve Board has always interpreted it as applying on ly to
bills of exchange, and in its regulations of the Series of 1915,
1916, 1917, and 1920, it has authorized the purchase in the open
market b y Federal reserve banks of acceptances growing out
of the domestic storage of goods, although the only acceptances
eligible for rediscount as growing out of domestic storage trans­
actions are those growing out of the storage of readily market­
able staples. T h e term “ go od s” is, of course, more inclusive
than the term, “ readily m arketable staples.” Consequently,
the B oard’s R egulation B , Series of 1921, m aking eligible for
purchase in the open market, subject to certain conditions,
acceptances with maturities not in excess of six months which
grow out of foreign transactions, was not predicated upon an y
new interpretation of the law.
Looking only a t the language of this particular provision of
the Federal Reserve A ct, it is not clear whether the phrase
“ of the kinds and maturities b y this a ct made eligible for re­
d iscou nt” qualifies both bankers’ acceptances and bills of
exchange or qualifies only bills of exchange, b u t as heretofore
indicated the latter interpretation now has the sanction of estab­
lished usage, and this would, I think, have great w eight w ith an y
1 See supra, p. 174.
a In a letter to the writer.



court which had to pass upon the question. Furthermore, the
legislative history of the Federal Reserve A c t indicates th at the
B oard’s interpretation of the provision is the correct one. T h e
corresponding paragraph of the bill as first passed the House of
Representatives provided “ T h a t an y Federal reserve bank
m ay, under rules and regulations prescribed b y the Federal
Reserve Board, purchase and sell in the open market, . . .
prime bankers’ bills, and bills of exchange of the kinds and
maturities made eligible for rediscount, and cable transfers.”
T h e words “ and bills of exchange of the kinds and maturities
b y this act made eligible for rediscount” thus constituted one
separate and complete clause w ith a comma a t the beginning
and at the end, and it is quite clear th at the term “ prime bank­
ers’ b ills” was not intended to be qualified b y the words “ of
the kinds and maturities b y this A c t made eligible for redis­
count.” There is nothing to indicate th at the subsequent
amendment which the Senate made in the phraseology of the
provision was intended to give an y broader application to the
phrase “ O f the kinds and maturities b y this A c t made eligible
for rediscount,” and the fact th at the provision as thus amended
is at least am biguous is indicative of the absence of such intent.

The last class of permitted open-market powers re­
lates to dealings in cable transfers and gold coin and
bullion. Section 14 states that reserve banks shall have
to deal in gold coin and bullion a t home or abroad, to make
loans thereon, exchange Federal reserve notes for gold, gold
coin or gold certificates, and to contract for loans of gold coin
or bullion, givin g therefor, when necessary, acceptable security,
etc., etc.

These powers were conceived to be necessary in order to
enable the reserve banks to exercise some control over the
exchange market and to protect the dollar exchange. By
acquiring foreign credits or accumulating gold holdings
abroad the reserve banks may be able to provide American
industry with the means of foreign payment on such



occasions as might otherwise result in a depreciation in the
dollar or an excessive outflow of gold.
The reserve system went into operation in a period
marked by much confusion and uncertainty. In the haste
to secure the functioning of the system it was not deemed
essential that provision be made at the outset for the
complete exercise of its open-market functions. Accord­
the Board determined to"confine itself in the beginning to those
matters which were deemed absolutely essential to setting the
banks in motion upon a basis of reasonable efficiency. I t was
felt that the regulations relating to discount operations and
commercial paper in general were fundamental and th ey should
be prepared and issued a t once.1

Nevertheless, on December 18, 1914, authority was given
for the purchase of Government bonds. Shortly after­
wards, December 23, regulations were sent out relating
to the purchase of warrants and municipal bonds. Early
in 1915 regulations were issued relating to bankers’ ac­
ceptances, and by a
letter of October 8, confirmed b y a circular and regulation oi
Decem ber 6, the Board authorized the several institutions to
purchase, a t rates to be fixed b y them within certain limits
prescribed b y the Federal Reserve Board, all those classes
of bills of exchange which are b y the A c t m ade eligible for

Several points in these circulars deserve mention. The
first relates to the purchase of acceptances. By Circular 19
of November 29, 1915, reserve banks were authorized to
purchase domestic as well as foreign-trade acceptances.
Since the act permitted national banks to accept only to
finance transactions arising out of the importation or
exportation of goods, the question may arise as to the
1 Report of the Federal Reserve Board, 1914, pp. 8-9.



d o m e stic -tra d e

a c c e p ta n ce s.



an sw er


t h a t since th e e n a c tm e n t o f th e F ed e ra l R e se rv e A c t a
n u m b e r o f S ta te s h a d a d o p te d leg isla tio n p e r m ittin g th e
d o m e stic a c c e p ta n ce , an d th ese w ere m a d e e lig ib le b y th e
B o a rd for p u rch ase b y th e reserve b an k s.

T h is a c tio n

foretold th e la ter a d v o c a c y b y th e B o a rd o f an am en d m e n t
to th e a c t p e r m ittin g n a tio n a l b a n k s to a c c e p t for d o m e stictra d e purposes.

I f such a c tio n w a s n o t a n tic ip a te d , th e

B o ard p r o b a b ly w o u ld n o t h a v e m a d e S t a t e b a n k d o m e stic
a c c e p ta n ce s p u rch asab le b y reserve b a n k s.

I t w a s also

a d v o c a te d in th is circu lar t h a t reserve b a n k s should g iv e
to acceptances endorsed b y a member bank, discounted under
section 13, not on ly because of the additional protection that
such endorsement affords b u t also because of the reason that
acceptances discounted under section 13 m ay be used as col­
lateral security for the issue of Federal Reserve notes.1
P a r tic u la r ly b e ca u se o f th e d istu rb e d co n d itio n s ab ro a d ,
th e B o a rd a d v o c a te d ca u tio n in fo reign -exch an ge d ealin gs.
W h ile th e B o a rd d id n o t in sist t h a t foreign b ills o f e xch a n g e
shou ld


a c c e p te d


p urchase,


d id


th a t

u n a cce p te d bills e ith e r shou ld b e secured b y d o c u m e n ts or
b e a r a sa tis fa c to r y en d orsem en t o th e r th a n t h a t o f th e
a c c e p to r or draw er.
A f t e r th e issu an ce o f th ese circu lars reserve b a n k s w ere
a u th o rized to exercise to th e fu ll 'exten t p e rm itte d th e
p ow ers conferred b y section 14.

In v ie w o f th e fa c t t h a t

th e o p e n -m a rk e t section e v id e n ce s m ore c le a rly th a n a n y
o th e r th e in te n tio n o f th e fram ers t h a t th e reserve b a n k s
should o p e ra te c o n tin u o u sly a n d n o t m e re ly d u rin g em er­
gen cies, it is e sp e c ia lly n ecessary to n o te th e use w h ich h as
b een m a d e o f th e se pow ers.

T h e fo llo w in g figures e n a b le

1 Circular No. 20. By amendments to the original act acceptances purchased
under section 14 may be used as collateral security for Federal Reserve notes.



comparisons to be made between the volume of the discount
and open-market operations by years from 1915 to 1920:

Y bar



T o t a l B il l s

A cceptan ces

U n it e d

T otal

D is c o u n t e d

B o u g h t in

S tates S ecur­

In vestm en t


M em ber
B anks

th e

O pen

M a rk et1

it ie s



P er

P er



C ent

O p e r a t io n s

M u n ic ip a l




W arrants

1915.. $ 161,353,000 $ 64,845,000 $ 81,572,770 $ 307,770,800
9,014,186,454 1,077,712,509
1918.. 39,752,933,847 1,809,538,795 5,852,058,075
1919.. 79,173,969,730 2,825,177,002 4,737,920,421 * 86,737,067,153
1920.. 85,320,874,000 3,218,364,000 7,988,310,000 3 96,527,548,000

C ent


O pen

M arket




1 The first purchase of bankers* acceptances was made February 15/ 1915.
aIncludes only $1000 of municipal warrants.

3No purchases of municipal warrants.

In the early years of operation, 1915 and 1916, the openmarket operations were relatively very important. There
was then little demand for discounts, and reserve banks
were forced to make open-market purchases in order to find
even moderate employment for their funds. In these years
the reserve ratios of the reserve banks were very large.
But after the outbreak of the European War the discounts
requested by member banks were so great that open-market
purchases declined in comparison. In aggregate volume,
however, they increased year by year without interruption.
In every year from 1915 to 1920 the total volume of openmarket purchases exceeded that of the previous year.
One of the most interesting objections to the open-market
provisions of the Reserve Act was voiced by Miss Anna
Youngman in the September, 1921, number of the Amer­
ican Economic Review.l She argued that it was a mistake
to endeavor to discriminate against the promissory note in
reserve banks’ purchase operations. Our trade credit
system is based upon the note and not upon the bill of
1 Pages 463-85. The Efficacy of Changes in Discount Rates of Federal Re­
serves Banks.



exchange, and attempts to foster the use of the bank ac­
ceptance do not appear to her to have been exceptionally
successful. She calls attention to the decline in the volume
of bankers’ acceptances in 1921, and alludes to the fact that
this decline would have been all the more startling were it
not for the large volume of acceptance credits covering
sugar and those granted for the creation of dollar exchange.
Bankers’ acceptances appear to her of principal value in
foreign-trade transactions. Accordingly, the present openmarket policy of the reserve banks is characterized as an
attempt to secure effective control of the market by confin­
ing dealings to a paper arising in a small and relatively un­
important class of transactions. She advocates that reserve
banks’ open-market powers should be extended to include
notes as well as bills growing out of commercial transactions.
It also seemed plausible to her that, to a limited extent,
reserve banks should be permitted to purchase, as well as
discount, paper representing loans on stock exchange
Miss Youngman’s objection to great dependence upon
the bankers’ acceptance is also based upon her belief that
the market for this paper is highly uncertain. There is the
competitive English demand for bankers’ acceptances, and
the English rate must be met if the financing is to be done
in the New York market. As long as acceptances grow
largely out of international transactions, reserve banks
must come to the rescue of dealers when the English rate is
lowered, even though such action is contrary to our own in­
vestment needs. Open-market transactions in commercial
paper should be based more largely upon domestic paper.
Her argument for extending reserve bank operations to
stock exchange paper is based upon the belief that all money
rates should be subject to influence, if not to control, by
the reserve banks. Unless call rates can be influenced by



reserve activities, rates on other loans are also difficult to
influence. To a certain degree banks have their choice in
selecting the market which offers highest compensation.
The reserve banks should be in a position to break abnor­
mally high rates by direct lending. If they cannot do so,
their rediscount policy may be rendered futile.
The reader’s reaction to these somewhat revolutionary
views will depend largely upon the degree of control he is
willing to repose at the present time in the reserve adminis­
tration. Granted that the reserve banks can be managed
impartially, with economic foresight, without fear of
political hostility, the argument is entirely in favor of
widening the classes of open-market paper. The greater
the variety of paper which can be dealt in, the more com­
plete the power of the reserve administration. Possibilities
of evil are also greater. The reserve banks are governed by
men, not by automatons. They have, or ought to have,
personal interests to protect in the stock and investment
market. No matter how great the endeavor to keep pri­
marily in mind the needs of the public, personal responsibil­
ities would tend always to create an unconscious bias.
Aloofness from the stock exchange loan market is not an
ideal situation, but it is perhaps the price that must be paid
to limit plutocratic domination.
On purely political grounds, Miss Youngman’s pro­
gramme is unworkable. Even at the present time, when
direct advances on stock exchange security are impossible,
there is a widespread belief that security speculation has
benefited more largely than commerce or agriculture from
the use of the reserve system’s funds. The insistence upon
an agricultural representative upon the Federal Reserve
Board is one indication of this widespread belief. How
much greater must have been the discontent with the
reserve management if direct purchase of security paper

had been permitted? The writer is convinced that the
unpopularity of a system possessing such powers would
have caused a complete remodeling of the system, possibly
to the detriment of all classes, in the agricultural depression
of 1920 and 1921. Political considerations are quite as im­
portant as financial. The present system is better than the
old; too much should not be expected of the reserve banks ,
until the elementary principles of finance are more widely
understood. Development cannot be too rapid. It is more
desirable that slowly but soundly foundations be built for
the more imposing edifice of the future.
In regard to the inclusion of the note arising from com­
mercial transactions the writer will agree that too much
attention may have been reposed in the bankers’ accept­
ance. But the trade acceptance arising from domestic
operations is eligible for purchase. In the past the popular­
ization of the trade acceptance has encountered many
obstacles. But part of the difficulties are due to the in­
sistence that its progress should be sound rather than
merely rapid. It might be better at the present time to
admit the promissory note to open-market dealings. But
many dangers would lie in such a course, and it appears the
part of wisdom to postpone discussion of the admission of
the note until the trade acceptance has had a more complete
trial. Many will hold, furthermore, that the abuses of the
open book-account system are sufficient to warrant some
lessening of the reserve banks’ powers.
Miss Youngman’s proposals are based largely upon her
doubts as to the efficacy of changes in rediscount rates to
affect general money charges. In many localities high loan
rates will persist despite any lowering of reserve banks'
rates. In such localities banking competition may be
absent and the high charges represent some degree of
monopolistic extortion. The only means of breaking such



rates lies in permitting reserve banks to step in as competi­
tors of local banks by their direct purchases. But such
action could be made effective only by permitting dealings
in the type of paper customarily employed. Since the trade
acceptance is unfitted for the needs of many buyers, it is
argued that reserve banks should be permitted to purchase
Final conclusion upon this point must wait upon the dis­
cussion of the relation of reserve banks’ rediscount rates
to those exacted in the general market.1 But it will be
generally agreed, perhaps, that as a matter of public policy
the present is not the time to introduce the reserve banks
in the r61e of more active competitors of member banks.
Present clamor directed against the reserve system is suffi­
ciently great without adding this new source of discontent.
During the World War a situation arose which led Sen­
ator Robert L. Owen, then Chairman of the Senate Banking
and Currency Committee, to propose the establishment of
a separate reserve bank in order to relieve the other
reserve banks of a portion of their responsibilities under
section 14 of the act.1 This proposed new Federal Re­
serve bank was to be charged with the responsibility of pre­
venting the dollar exchange from depreciating abroad
and with furnishing American commerce with the credits
required in foreign transactions. If the plan which he
advocated had been enacted into law, the regional charac­
ter of our reserve system would have been altered to that
extent. His ball proposed that in the field of international
credits one new reserve bank should serve for all American
industry and not primarily for any one district.
The cause of Senator Owen’s investigations was the
* See infra, pp. 339,340.
a Cf. H. L. Reed, “Senator Owen's Proposal to Stabilize Foreign Exchange
Rates," American Economic Review, September, 1918, pp. 661-69.

falling of the dollar below its normal gold par in some of the
neutral countries of Europe, particularly Spain, Norway,
Denmark, Netherlands, and Sweden. This depreciation
occurred in spite of the fact that during the years 1916 and
1917 the United States possessed a favorable trade balance
with each of these countries as well as with the world at
large. But credit extended by the United States to its
European allies resulted in a plethora of dollar credits pos­
sessed by merchants in these countries. When purchases
were made from Spain by England, or France, payment was
frequently made by drawing upon these dollar credits.
Possessing a favorable trade balance with the world as a
whole, Spain acquired more dollar credits than needed to
balance its own requirements. Since shipments of gold
were suspended, the dollar shrank in terms of pesetas.
In many ways this depreciation of the dollar was un­
welcome. As a matter of first importance, perhaps, it was
argued that it rendered somewhat more difficult the cam­
paign to assert the superiority of dollar credit as a medium
of international payments. The supremacy of sterling ex­
change in the past was due in no small measure to its
stability in terms of gold. Here was the opportunity to
establish the dollar as the one class of exchange which had
not depreciated in the general financial confusion engen­
dered by the World War. Nevertheless, for the reason
given, the dollar declined in terms of the currencies of some
of the countries with which the balance of trade was in our
The discount on the dollar abroad also increased the cost
to our merchants who had remittances to make for their
imports. A premium on the peseta of twenty-five per cent
meant that, instead of the dollar buying five pesetas, it
bought only four. But aside from any direct material loss
the psychological effect of a falling dollar was held not to



be good. In normal situations a falling exchange points
toward future gold withdrawals. The dollar exchange has
fallen in most of our financial crises. Its depreciation dur­
ing the World War could be pointed to by our enemies as
evidence of our financial instability.
Attempts on the part of private bankers to remedy this
difficulty had been productive of little benefit. Private
negotiations for the necessary loans in Spain had failed.
Accordingly, Senator Owen proposed that the reserve
banks should grapple with this problem. But as they were
then constituted they lacked the machinery and powers
necessary to secure effective results. No single one of the
reserve banks was specified by the statute as responsible
for the maintenance of the parity of the American dollar,
and it would be impolitic to delegate this responsibility to
any one. Charges of sectional discrimination would
inevitably arise. It was asserted, furthermore, that each
reserve bank was already so completely occupied with
matters of domestic finance that it could not give the prob­
lem of supplying foreign trade with the credits it required
the necessary attention.
Senator Owen proposed, accordingly, that
the Federal Reserve Act be so amended as to provide for the
establishment o f a Federal Reserve foreign bank.1
This bank would assume the responsibility of furnishing
American Commerce with a stable exchange. It would
have power to establish foreign branches generously
equipped with power to acquire and sell foreign credits. If
necessary these credits could be established in foreign
countries by the sale of Government bonds. No individual
x See remarks of Hon. Robert L. Owen on Senate Bill 3928 to establish the
Federal Reserve Foreign Bank, etc., in the Senate of the United States, Febru­
ary 25, 1918. Cong* Rec„ pp. 2817-325.

or bank other than this foreign bank would have the legal
right to
sell dollar balances a t less than gold par, except as paym ent
for merchandise imported into the U nited States, w ithou t the
express authority of the Federal Reserve Board.1

It would be directed by a board of nine men appointed by
the President of the United States, and all of these would
be merchants and not bankers. Bankers would be excluded
from the directorate, for
Our American bankers have not sufficiently realized th at
banking grows w ith commerce . . . the banker who thinks in
terms of interest and commission and profit exaction is not
happily constituted to determine the best methods of serving

This would explain why reliance could not be placed on
the recently established foreign branches of private banks.
The proposed bank would be a reserve bank.3
This proposal met with some opposition from such men
as Mr. Harding, and Mr. Warburg. Mr. Harding, for in­
stance,3 felt that the situation was not sufficiently serious
to justify the setting up of such elaborate machinery as was
called for by Owen’s plan. He did not feel that the tempo­
rary dislocation of exchange with a few European neutrals
would interfere with the campaign to encourage the use of
the dollar exchange. The Orient and South America would
not be affected directly by the discount on the dollar in
these European nations, and it was in the Orient and South
America that the best opportunity existed for encouraging
the use of the dollar exchange. The continent of Europe
would probably readopt earlier methods.
1 Cong. Rec., pp. 2817-825.
’ Ibid.
* Bulletin, August 1,1918, p. 724S.



The rather sudden termination of hostilities, bringing
with it the elimination of the dollar discount, seemed in the
minds of most financiers to render Owen’s machinery un­
necessary. If the plan had been adopted, however, it would
have marked the first departure from the regional idea.
The writer ventures to remark that, if the regional plan is
to be altered in the future, the opening wedge may prove
to be some modification of the open-market powers. It is
in the employment of these powers that the reserve banks
can exercise their greatest initiative in the attempt to con­
trol money-market conditions.

commercial bank creates credit or credit money of
two forms, note issues and deposits. Although to-day both
in Great Britain and the United States the deposits exceed
note issues in volume and importance, early banking in
both countries was primarily a matter of issuing notes. It
is correct in the main to state that modem English banking
found the germ of its development in the evolution of the
bank note. The goldsmith’s receipt of the fifteenth and
sixteenth centuries, supposedly representing a value in
coin or bullion equivalent to its face, gradually was adapted
to the requirements of a circulating medium. In the course
of time it was made payable to bearer and did not require
endorsement when transferred to another party. It came
to be made out in round even sums instead of to the
amount representing the deposit of the owner. When ac­
cepted by the public, even though issued to an amount
exceeding its security, the trick of modem commercial
banking had been learned.
The issuance of circulating promises to pay exceeding
the value of the coin or bullion security subjects the
economic world to many dangers. Excessive issues of
bank paper currency may produce the same results as the
undue issue of Government paper money. The price
level may advance rapidly to new heights, the gold of the
country may be driven out as a consequence of the adverse
trade balance engendered by the excessive issues, and if




non-redeemable an important element in the currency may
depreciate. For these reasons attempts to restrict its issues
would be expected. It might be argued, however, that
unregulated deposits could create the same undesired re­
sults. However this may be, note issues were developed
before deposits, and the early dangers of uncontrolled
banking were attributed largely to note issues. Accord­
ingly, in English and American banking law, we find greater
restrictions imposed upon banks in their note-issue powers
than in their powers to create book credits subject to check.
It may be that the discrimination against the note rests
upon a sound economic basis. The note is payable to bearer
and possesses a greater circulation power than the bank
check. It may circulate for a considerable period far from
the place of its issue. It may get into the pocket of an in­
dividual who has no opportunity to learn of the solvency
of the issuing bank. Because of its tendency to stay in
circulation longer, the ability of the bank which issued it
to redeem is not so speedily tested as in the case of the bank
deposit. Since a check is not adapted for continuous cir­
culation, a bank is automatically restrained from issuing
too large a volume of deposit credits. So large an amount
of checks drawn against it may be presented to the clear­
ing house by other banks that a deficit in cash arises. But
if the issue is a note, some time may elapse before the issu­
ing bank is called upon to make redemption. The penalty
may not be visited so speedily.
A t any rate, either because of these considerations or
because of precedents established in the era of state bank­
ing, or because of the historical fact that early banking
abuses were largely note-issue abuses, the framers of the
National Banking Act enacted the most rigid note-issue
regulations. As finally amended the law rendered it im­
possible for national banks to issue notes to an amount



exceeding the par or market value of Government bonds,
whichever is the lowest, deposited with the Treasury to
secure them. Basing note issues on the public debt made
their inelasticity inevitable. Their volume tended to
fluctuate more in accordance with the state of the bond
market than with the needs of trade. Consequently plans
of banking reform prior to the panic of 1907 usually took
the direction of basing note issues more largely upon a
wider class of bank assets. Commercial paper, in general,
was to be the security instead of Government bonds. And
while the Aldrich-Vreeland Act evidenced the influence
of the opponents of an asset currency, provision was made
for the issue of notes in periods of emergencies collateraled
by a wider range of securities.
Had bank note issues continued to occupy their old
position of prominence the need of a more elastic bank
note currency would have been uncontrovertible. But
since the date of the writing of the National Bank Act
the use of bank deposits has become relatively much more
important. A t the present time it is estimated that the
check is employed as a means of payment in from eightyfive to ninety per cent of our total transactions. If deposit
credits under the national banking system had possessed a
large measure of elasticity, it would have been logical to
attribute our currency ills primarily to the bank note.
But, largely because of our rigid reserve requirements, de­
posits also were insufficiently elastic. The case for an asset
currency was not quite so clear as it otherwise would have
These facts may be crudely illustrated by noting the
customary train of events in past periods preceding general
collapse. As reserve ratios fall, banks become more and
more hesitant to advance needed credits. The demand for
loans becomes all the more intense as the market begins to



decline. By the time general public confidence is disturbed,
runs upon banks may ensue. Since these runs represent a
demand for currency, the inability of banks to expand
their bank note issues freely appears to constitute the
principal weakness of the banking system. But would the
public demand for cash have arisen if at an earlier period
banks had been permitted to expand their grants of de­
posit credits in the necessary amount?
There are many occasions when the demand upon a
particular set of banks is primarily a demand for a circulat­
ing medium. In the autumnal season of harvesting strain,
crop-moving expenses could not be met by expanding
deposits alone. Checks given to transient laborers, for
instance, would be presented speedily to the banks for
encashment. An. enlargement of the volume of bank
currency appeared the necessary requirement. But if re­
serves against deposits had been less rigid, the d ifficu ltie s
created by the currency demands would not have been so
intense. The currency would have been supplied at the
expense of reserve money, but the penalty of slightly im­
paired reserves would not have been so great.
By the time the Federal Reserve Act was written, how­
ever, these facts were more widely accepted. In the mind
of the writer the principal point of progress marked by the
Federal Reserve over previous plans is the greater recogni­
tion of the need of elasticity of deposits. A thorough-going
reform plan could not confine itself to an attempt to secure
merely an asset currency.
It was agreed nevertheless, that the ideal plan of reform
would secure elasticity in bank note issues as well as in de­
posits. Bank note currency provides a means of supplying
the public with a circulating medium without impairing a
bank’s supply of reserve money. Elastic bank note issues are
part of the problem of securing more flexible deposit credits.



T h e s e m a tte r s o f e le m e n ta ry b a n k in g p rin cip le g r a n te d ,
th e p ro b lem o f b a n k in g reform b e ca m e t h a t o f d e te rm in in g
w h a t se t o f b a n k s shou ld possess th e b a n k n o te issue re­
s p o n sib ility .

S h o u ld b a n k n o te s co n tin u e to b e issued b y

th e m e m b e r b a n k s or shou ld th eir issue b e c o n ce n tra te d in
th e h a n d s o f reserve b a n k s o n ly ? B e a rin g in m in d th e fa c t
t h a t th e reform m o v e m e n t w a s in p a r t an a t t e m p t to secure
g r e a te r c o n ce n tra tio n in c re d it con tro l, it is n o t surp risin g
to mote th e d ecision to co n ce n tra te th e n e w b a n k n o te
issu in g p ow ers in th e h an d s o f th e reserve b a n k s. T h e id ea
o f cen tra lize d co n tro l w a s jo in e d to t h a t o f g r e a te r e la s tic ­
i t y in th e m e d ia o f exch an g e .
I t h as been p o in te d o u t fr e q u e n tly t h a t b a n k n o te issues
are n o t a b s o lu te ly essen tia l to c e n tra l b a n k o p eratio n .
its p o w er to co n tro l c re d it b e sufficient,


th e ce n tra l b a n k

m a y m e e t th e d e m a n d s u po n it b y a c c u m u la tin g in o r­
d in a r y tim e s a surplus s u p p ly o f reserve m o n e y to p r o v id e
for season al or e m e rg e n cy needs.

I t is p r o b a b ly true, h o w ­

eve r, t h a t p u b lic con fidence in a sy s te m w ith o u t b a n k n o te
issue pow ers w o u ld n o t b e so grea t.

P ossessing such p ow ers

it ap p ea rs a s if th e cen tra l b a n k ’s a b ility to m a n u fa c tu re
th e n e cessary m e d ia o f e x ch a n g e is in ca p a b le o f e xh au stio n .
A s in d ic a te d p re v io u sly , m oreover, th e gen eral p u b lic h a s
com e to a t t a c h an e x a g g e ra te d im p o rtan ce to

b a n k n o te

B u t w h a t shou ld b e

d o n e w ith th e o ld b o n d -secu red

issues o f n a tio n a l b a n k s? T h e r e w a s m u ch to offer a g a in s t

p rogram m e

o f e lim in a tin g or su b o rd in a tin g

th ese

issues. T h e y c o n s titu te d a defin ite p a r t o f ou r m o n e y su p ­
p ly a p p ro x im a tin g

$750,000,000 an d cou ld n o t b e w ith ­

d ra w n im m e d ia te ly w ith o u t su b je c tin g th e c o u n tr y to a
m o n e y fam in e .

F u rth erm o re, b a n k s h a d p u rch ased th e

b on d s n o t so m u ch for th eir in v e s tm e n t y ie ld as for t h e
s e c u r ity o f th eir b a n k n o te issues. T h is a r tific a lly c re a te d



demand caused the price of the bonds to move to a higher
point than warranted by their income return. Because of
the circulation privilege attaching to its bonds, the United
States has been able to borrow money at cheaper rates than
almost any other country in the world. In the pre-war
period, while the United States two per cents, bearing the
circulation privilege, were selling at about par, British two
and a half per cent consols were selling only slightly above
seventy, and French three per cent rentes at about eightyfive. Justice demanded that the Government take no action
confiscating bond values bought in good faith.
In order to reconcile the legitimate interests of the banks
with the requirements of commerce for a more elastic
currency a means was provided by the act for the gradual
purchase from the national banks of a portion of their
bonds by the Federal Reserve banks. B y the terms of
section 18 any member bank desiring to retire any of its
circulating notes is permitted to “ file with the Treasurer
of the United States an application to sell for its account,
at par and accrued interest, United States bonds securing
circulation to be retired. ” Such applications can be made
in the twenty-year period, December, 1915, to December,
1935. A t the end of every quarterly period the Treasurer
of the United States is required to furnish the Federal
Reserve Board with a list of such applications. The Board
may require the reserve banks to purchase these bonds,
which are then to be apportioned among the twelve reserve
banks pro rata according to their relative capital and
surplus. It was provided that the reserve banks could not
be compelled to purchase more than #25,000,000 of these
bonds in any one year, and that this amount must include
whatever amount of bonds the reserve banks may have
purchased directly from the public without the inter­
vention of the Federal Reserve Board.



In this manner provision was made for the eventual
acquirement by the reserve banks of bonds bearing the
circulation privilege and the gradual retirement of the
bank notes outstanding against them. The reserve banks
were authorized to utilize these bonds in one of two ways.
First, they may deposit them with the Treasurer of the
United States and upon this security issue bank notes to
the par value of the bonds. The law stated that such
notes shall be the obligations of the Federal reserve bank
procuring the same, and shall be in form prescribed b y the
Secretary of the Treasury, and to the same tenor and effect as
national-bank notes now provided b y law.

In case, however, no vital need exists for this currency,
the bonds may be converted into one-year gold notes or
three per cent thirty-year old bonds not possessing the
circulation privilege. Such an exchange is to be made on
the basis of par and accrued interest. If this method is
availed of, the bond-secured bank notes may be reduced
gradually in volume. But this reduction may be very slow,
since reserve banks cannot be required to purchase more
than #25,000,000 of these bonds in any one year. But at
any rate provision was made for a reduction relative to the
volume of other currencies. As the country grows in
population and resources and the other elements in the
circulation increase, the bond-secured bank notes will
decline in importance.
The extent to which the reserve banks have availed of
these provisions in order to issue their own bond-secured
currency is indicated for certain selected dates by the
following figures:
F e d e r a l R e s e r v e B a n k N o t e s in C ir c u l a t io n
A m o u n t O u t s t a n d in g

January 4, 1918. . $ 8,000,000
June 28, 1 9 1 8 . . . .
December 27, 1918 117,122,000

December 31, 1919 $273,450,800
December 31, 1920 249,467,000
November 1, 1921



Without further information it might appear as if the
reduction in national bank circulation, particularly in the
years 1918 and 1919, must have been exceedingly heavy.
This would seem to follow from the fact that the reserve
bank notes were required to be secured by Government
bonds, and that the surrender of these bonds to the reserve
banks must compel a reduction in national bank currency.1
But the figures show no such reduction in national bank
circulation. A t the close of 1921 it was approximately the
same as in 1914 and had increased somewhat since 1917.
T o t a l V o l u m e o f N a t io n a l B a n k N o t e s C ir c u l a t in g i n
U n it e d St a t e s

July 1 , 1 9 1 7 . . . $715.420,010
January 1 1918 719,212,630
July 1 , 1 9 1 8 . . . 724,205,485

th e

January 1, 1919.. $723,532,210
January i, 1920.. 724,338,692
November 1,1921 743,288,847

Clearly the increase in the volume of Federal Reserve
bank notes was not at the expense of the aggregate circu­
lation of national bank notes. To what, then, can the in­
creased circulation of reserve bank notes be attributed?
During the World War the attention of Congress was
drawn to the uses which might be made of the stock of
silver dollars reposing in the Treasury of the United States.
Several Oriental countries were accumulating balances
against the United States and our allies and it was not de­
sired to meet these claims by exporting gold. So far as
silver could be used economically for this purpose, it would
seem that the Treasury’s stock should be drawn upon.
For years this stock had been lying idle as the metallic
backing for the silver certificates.
Accordingly, by the Pittman Act of April 23,1918, the
Secretary of the Treasury was authorized to melt down
1 Unless offset by the purchase of other bonds possessing the circulation



and sell as bullion not more than #350,000,000 standard
silver dollars. The bullion could be sold for the following
purposes: first, to conserve the Nation’s stock of gold;
secondly, to facilitate with silver-using countries the
settlement of adverse trade balances; thirdly, to provide
silver for subsidiary coinage or domestic use. In order to
protect the silver market it was provided that the bullion
should be sold at a price of not less than $1 per ounce of
silver 1000 fine, and that the silver thus withdrawn must
be repurchased by the Treasury at the same price. Since
the melting down of the silver dollar would destroy the
security for the silver certificates, it was provided that
these certificates should be retired at the rate of $1 for
each dollar melted down or broken up.
This would involve a reduction in one of the elements
in our currency. In order to prevent a corresponding
contraction in the general circulating medium the Federal
Reserve Board was given authority to require reserve
banks to issue Federal Reserve bank notes to an amount
not exceeding the amount of standard silver dollars thus
destroyed. The reserve banks issuing these were required
by law to deposit as security United States certificates of
indebtedness or one-year United States gold notes.
The amount of Federal Reserve notes thus issued under
the terms of the Pittman Act was as follows on certain
I nclu d in g

December 31, 1918
December 31, 1919
December 31, 1920

$110,803, O X

The Pittman Act was regarded merely as a temporary
measure. Section 6 required that, as the silver dollars are
recoined through the purchase of silver bullion by the
Secretary of the Treasury, Federal Reserve bank notes



shall be retired in an amount equal to the volume of the
dollars so coined. Such purchases of bullion must be
made at the rate of #I an ounce. On April i, 1921,1 it was
announced by the Secretary of the Treasury that the re­
tirement of Pittman Act certificates had been begun and
would be continued gradually.
The Pittman Act proved decidedly useful during the
war and post-war period. It seems unfortunate, however,
that the Treasury was required to repurchase the amount
of silver obtained by melting down the dollars. Securing
silver certificates by silver coin or bullion is an anomaly
in a gold-standard country. The real security for any of
our currency, gold, could have been obtained on favorable
terms by the final sale o f the silver bullion at the highest
market silver has commanded in years. We lost our oppor­
tunity to work off without great loss our silver, the exist­
ence of which had really been a source of embarrassment in
previous years. But it may have been politically unwise
to estrange the silver interests during the period of
But no progress in elasticity was made by the issues
of Federal Reserve bank notes. It was by the means of
another note creation, the Federal Reserve note, that the
endeavor was made by the Act of 1913 to provide the truly
elastic element in our currency system. These notes are
the issues of reserve banks upon the security of commercial
paper, and each note bears the distinctive number of the
district in which it is issued.
B y the terms of the original act the method of issue was
as follows: Any reserve bank could make application to
the Federal Reserve Agent— the member of the district
directorate who is the official representative of the Federal
Reserve Board— for such amount of the notes as it may
* See Bulletin, April, 1921, p. 374.



require. Such applications must be accompanied by a
tender of collateral equal to the amount applied for. B y
the original act the collateral offered in the application
must be notes and bills accepted by the reserve bank for
rediscount. But the act was later amended in such a way
as to include in the collateral paper purchased in the open
market. Section 16 now states that
the collateral security thus offered shall be notes, drafts, bills
of exchange, or acceptances [acquired] under the provisions
of section thirteen of this act, or bills of exchange indorsed b y a
member bank of an y Federal reserve district and purchased
under the provisions of section fourteen of this A ct, or bankers’
acceptances purchased under the provisions of said section four­
teen, or gold or gold certificates.

The Federal Reserve Board can at any time call upon the
reserve bank for additional security.
These notes were made receivable by all members and
reserve banks. They are obligations of the United States
and are receivable for all taxes. They are not legal tender
for private payments. They may not be counted as a part
of the legal reserve of a member batik. Whether or not they
may be counted as reserve money by a State bank depends
upon law in that State.
The first line of security behind these notes is the com­
mercial paper (gold in lieu of paper) deposited with the
Federal Reserve agent. Reserve banks must also main­
tain a forty per cent gold reserve behind these notes. This
requirement, however, may be suspended by the Federal
Reserve Board. But if the reserve is permitted to fall below
forty per cent, a graduated tax paid by the reserve bank
will operate as a penalty.
These notes will be issued to member banks through the
process of rediscount, and offer a means whereby reserve
banks can supply the member banks with counter money



without depleting their own reserves. Since they are
issued through rediscounts, prevention of excessive issues
becomes a part of the problem of rediscount policy. Rate
increases, more careful scrutiny of the paper offered by
member banks, direct refusals, represent the means of pre­
venting unduly large issuance or of compelling their
But what means were provided to secure their speedy
return on occasions when the need has passed? The follow­
ing devices were included in the Federal Reserve Act.
First, the notes of one reserve bank may not be paid out
by another reserve bank save by paying as a penalty a
ten per cent tax upon the face value of the notes. A mem­
ber bank however, located within or without the district
of issue may pass them out without restriction. Since a
Federal Reserve note may circulate for a long time before
being deposited with a reserve bank, this provision cannot
be expected to do much in the way of compelling their
quick redemption. Secondly, the notes may not be
counted as a part of the legal reserves of any member
bank. A member bank in need of reserve money will be
impelled, therefore, to save them for redemption. But on
other occasions of ample reserves member banks may not
find it necessary to establish their reserves by the redis­
count method. In this situation the return of the notes is
not likely to be rapid. Finally, the notes are issued only
upon the deposit with the reserve agent of commercial
paper. If the reserve banks are rediscounting freely,
ample paper should be available to replace the collateral
upon its maturity. But if the reserve banks refuse or dis­
courage renewals, they may compel member banks to
return the notes or their equivalent in other currency.
There is no doubt but that the act provides ample
means for redemption in cases where redemption is



desired. They must be received by any member bank and
by any reserve bank; if they reach the counter of another
reserve bank, they may be collected either directly from
the reserve bank of issue or indirectly through the Gold
Settlement Fund at Washington. But while there is an
open avenue for rapid redemption, nothing short of a
strict rediscount policy is likely to result in their being
driven home against the will of the holder. They may get
into the vaults of State banks which are permitted to
count them as reserve money, they may repose in the tills
of merchants or pockets of the people, they may form part
of the counter money reserve of member banks. Only one
situation is likely to explain their return against the will
of the holder, that in which they are acquired by another
reserve bank than that which issued them. Expansion of
these notes in time of need is easy, but whether or not
there is to be contraction in slack season and years depends
upon the rigor with which the reserve management exer­
cises its powers of rediscount control.
Mention should be made, however, of a provision in the
act which gave the Federal Reserve Board power to exact
from the reserve bank an interest charge on all notes
issued to the reserve bank not covered by gold or gold cer­
tificates in the hands of the agent. The purpose of this
provision was to give the Board some power in the way of
compelling contraction. Reserve banks compelled to meet
such a charge would likely exert, by means of higher rates,
pressure upon member banks to return the notes or their
equivalent in other money. In case, however, the reserve
bank directorate was working in close harmony with the
Board, and did not endeavor to thwart the Board’s advice
to restrict rediscounts, such pressure would not be re­
quired. The writer is not aware that a tax of this sort has
yet been imposed upon reserve banks.



In the early period of its existence the volume of re­
discounting by reserve banks was exceedingly limited.
Nevertheless, a rather large amount of notes got into cir­
culation. Since the notes are issued to member banks
through the process of rediscounting, the public was at
first somewhat puzzled at the existence of so large an out­
standing circulation. On analysis, however, it developed
that notes once issued were not being retired upon the
maturity of the paper rediscounted. Instead of returning
the notes to the agent, the reserve bank would deposit
gold as “ cover.” Reserve banks, when called upon by
member banks for currency, would offer the Federal
Reserve notes instead of gold. In this way the notes were
becoming virtually gold certificates.
A few figures will indicate the extent to which this prac­
tice was carried on. On July 2, 1915, the total amount of
notes issued to the reserve banks was #84,000,000. As
security for these the Federal Reserve^ agents held lawful
money to the.amount of $70,000,000.1 On June 30, 1916,
the amount of note issues was $176,000,000. $165,000,000
of the cover for this was lawful money. On June 29, 1917,
$402,000,000 of the security for $550,000,000 of notes was
legal tender money. In other words, the accumulation of
cash in the hands of the reserve agents was chiefly cash and
only to a limited extent paper.
This policy of the Federal Reserve Board was bitterly
condemned in certain quarters. The Commercial and
Financial Chronicle, for instance, asserted vigorously1
that there was no authority for keeping the notes out­
standing in this manner, and that the plain intent of the
law was to secure their retirement upon the maturity of
their paper collateral. Furthermore, the Board was
charged with usurpation of authority. The act did not then
1 Issue of August 7,1915, pp. 398-400.



permit notes to be issued to reserve banks by the deposit
of gold with the agent. But the Board was accomplishing
virtually this result by, first, issuing the notes on commer­
cial paper security, and then, upon the maturity of the
paper, making gold the cover. In reality, urged the Chron­
icle, the Board was breaking the spirit of the law.
Those closely connected with the management of the
reserve system did not hesitate sharply to defend this
policy. Governor Strong, of the New York Reserve Bank,
denied vigorously that the Board was exceeding its
authority.1 If it had been intended that the notes should
represent only paper, a simple provision could have been in­
serted in the act to that effect. It was clearly the purpose
of the act that the notes should become a part of the gen­
eral circulation and the policy of the Board was designed
merely to hasten this result. Furthermore, the impound­
ing of gold meant no inflation, but, on the contrary, a
restriction of bank credit. For neither by reserve banks
nor by member banks could the notes be counted as
reserve money.
As the law then stood there can be little question as to
the correctness of Governor Strong’s views. The deposit
of gold cover with the reserve agents did not restrict the
possibilities of credit expansion. But the law was subse­
quently amended in many ways, with the general result
of increasing the ability of the reserve and member banks
to expand their deposits. The. Chronicle was correct in
surmising that the practice of impounding gold as cover
was a forerunner of many later events the general trend of
which was to alter radically the working of the system. In
the development of these plans it was incidentally neces­
sary to create a larger field for the circulation of the notes.
These subsequent events will be discussed in the follow* Issue of August 7,1915, pp. 412-13.



ing chapter. They can be treated best in connection with
certain amendments altering the reserve requirements for
member banks deposits. To-day the Federal Reserve note
is the most important element in our general circulation.
Its supremacy over other moneys can be noted by examin­
ing the following figures:1
M oney

H eld

O u t s id e

th e

U n it e d


T reasu ry


th e

F e d e r a l R e s e r v e S y s t e m , N o v e m b e r i , 19 2 i

Gold coin (including bullion) . . $ 373,456,004
Gold certificates................
Standard silver dollars............
Silver certificates.....................
Subsidiary silver.....................
Treasury notes of 1890...........
United States notes........... .
Federal Reserve notes............. 2,446,481,946
Federal Reserve Bank notes ..
National bank notes...............

A t the present time the national bank note is dwarfed
by the Federal Reserve note. Even though the national
bank issues aggregate an amount somewhat comparable
to that of 1914, they have become relatively unimportant.
Their place has been seized by the new Federal Reserve
note. But whether or not the new note is to be truly
elastic, whether or not it is to display the qualities of
contractility, is dependent mainly upon the discount
policy adopted by the Federal Reserve management.
‘ Obtained from the Bulletin, December, 1921, p. 1495.


I n the preceding chapter it was remarked that the move­
ment in this country for banking reform took first the
direction of attempts to secure an asset currency. The
plan formulated by the American Bankers’ Association
in 1894, known as the Baltimore plan, may be interpreted,
for instance, as a direct attack on the bond-security
theory. According to this plan it was proposed to permit
the issue of bank notes by national banks secured by
commercial assets. Protection for the noteholder would
consist of: first, the prior lien upon the assets of the failed
bank; secondly, restriction of bank note issues to a certain
percentage of the capital stock; thirdly, the double lia­
bility of stockholders. The plan may be regarded, there­
fore, as an attempt to ensure the safety of the bank notes
by relying upon other requirements than the deposit of
Government bonds. But it disregarded totally the prob­
lem of securing a more elastic deposit currency.
It may appear as if a similar disregard of the importance
of deposit currency was displayed in the Aldrich-Vreeland
Act of 1908. It could be asserted, for instance, that the
panic of 1907 had demonstrated clearly that the principal
difficulty of our banking machinery was the concentration
of the reserves of the interior banks in New York City.
Because of certain misuses of these funds the deposits
could not be withdrawn. After the default of the New
York depository banks, substitutes for money, such as



clearing house loan certificates, had to be devised. In
many localities they were believed to have brought relief.
What was accomplished under the Aldrich-Vreeland Act
was to make regular provision for the issue of emergency
currency under the regulation of the Federal Govern­
ment. This act did not attempt to go to the root of the
difficulty. It contained nothing to prevent future diffi­
culties of a similar sort from again arising. It was purely
palliative and not surgical.
But despite its apparent necessity the matter of revising
our deposit machinery was a difficult task. It would seem
to involve the prohibition of the employment in the finan­
cial centers of interior bank deposits for the purpose of
supporting stock market loans. Plans which contemplated
such restrictions must arouse a great deal of opposition.
It was easier to confine efforts to the securing of an asset
currency. Such efforts could be made to appear solely in
the light of concessions to the banks. They would be
given powers which previously were denied. But by the
time of the Wilson Administration public opinion had
crystallized itself more definitely. The country had begun
to understand that any reform which reached the roots of
previous difficulties must do something more than merely
to provide for emergency note issues. It also must alter
old methods relating to the employment of bank reserves.
As a final result of the legislative endeavors culminating
in the Federal Reserve Act, four leading provisions were
enacted regarding the reserves of member banks. First,
it was stipulated that after three years nothing could count
as reserve for any member bank except cash in its own vault
or deposits with the reserve bank of its district. This did
not mean that member banks would be prohibited from
keeping deposits with other than the reserve institutions.
Banks in the interior could continue to keep deposits with



big city banks in any amount desired for purposes of
domestic exchange and the securing of whatever interest
such deposits would command. The only prohibition of the
act related to the use which could be made of these deposits.
They no longer could be counted as a part of the required
legal reserve for the depository banks.1
Secondly, the act reduced considerably the amount of
the reserve percentages. The theory accepted was that with
reserves massed in central reservoirs the same protection
could be furnished the depositor with a smaller amount of
reserve money. It was a matter of realizing the economies
of reserve concentration. As a result of this reduction it is
estimated that in 1914-15 an economy of four or five hun­
dred millions of dollars was effected.
Thirdly, it was provided that the transfer of money from
private correspondent banks in the central reserve cities
to the Federal Reserve banks might be gradual. The law
stated that the transfer must be completed within three years
after the establishment of the Federal Reserve bank in the
district in which the bank was located. A specified amount
of the reserve must be transferred to the district reserve
bank immediately, another specified portion at the end of
the year, and later installments at semiannual intervals.
The purpose of these provisions was to effect the transfer
of reserves without subjecting the stock market to a sudden,
severe shock. Banks in the central reserve cities were to be
permitted gradually to make the necessary rearrangements
in their loan position. It was hoped that some progress
might be made in establishing the custom of financing
sharply fluctuating securities by time instead of by call loans.
Lastly, the act stated a distinction between demand de­
1 Exception could be made to this statement during the period prior to the
completion of the process of transferring reserve money from central reserve



posits and time deposits. Deposits subject to immediate call
necessarily require a larger reserve than those withdrawable
only after the expiration of a certain period of time. As to
the distinction between demand deposits and time deposits
a paragraph of section 19 stated that
Dem and deposits within the meaning of this A c t shall com ­
prise all deposits payable within th irty days, and time deposits
shall comprise all deposits payable after th irty days, and all
savings accounts and certificates of deposit which are subject
to not less than th irty d a ys’ notice before paym ent.

These reserve requirements for member banks under the
original act may be represented by the following scheme:
1. Banks in the Central Reserve Cities (New York, Chicago, St. Louis).
18 per cent demand deposits and 5 per cent time deposits.
(a) In own vault 6-18.
(b) In reserve banks of its district 7-18.
(c) Balance optional with the bank.
2. Banks in Reserve Cities.
15 per cent demand deposits, 5 per cent time deposits.
( (a) 5-15 in own vaults.
After three years • (b) 6-15 in reserve bank.
( (c) Balance optional.
3. Country Banks.
12 per cent demand deposits, 5 per cent time deposits.
(a) 4-12 in own vault.
(b 5-12 in reserve bank.
(c) Balance optional.

Four methods were provided by which deposits could be
established with the reserve bank. First, lawful money
might be remitted. Secondly, checks or other items might
be forwarded for collection to the reserve bank. (In a pre­
ceding chapter account has been made of the gradual de­
velopment of this work. A t the present time the reserve
banks receive for collection daily an enormous volume
of cash items as well as of time items.) Thirdly, commercial
paper might be rediscounted according to the terms of sec­



tion 13. Lastly, certain types of paper or securities specified
by section 14 might be sold directly to the reserve bank.
But how far could the reserve banks go in granting mem­
ber banks book credits? This would depend upon the vol­
ume of reserve money possessed by reserve banks. Section
16 states that
E ve ry Federal reserve ban k shall maintain reserves in gold
or lawful m oney of not less than thirty-five per centum against
its deposits. . . .

Since the establishment of the reserve system the mini­
mum reserve percentages for reserve banks have been
unchanged. But those for member banks have been altered.
Let us next endeavor to find explanation for these
Although the provisions of the act created a reduction in
the aggregate volume of reserves, the new arrangements
were not altogether satisfactory to the member banks.
Many of their criticisms were unsound; nevertheless, their
general effect was to prepare the way for a change. The
first criticism was purely the result of a misunderstanding.
It involved the belief that member banks would not be
permitted to keep deposits in banks other than the district
reserve banks. This view was, of course, erroneous. The act
prohibited only the counting of such deposits as reserve
Secondly, it was asserted frequently that in reality the
act increased reserve requirements. Many banks argued
that they would be forced for exchange or other purposes to
keep deposits with city correspondents as well as with the
reserve banks. The two deposits combined might exceed
those customarily maintained under the old law.
Reply to this was that since the reserve banks would
make collections on checks and other items and credit these



to the account of the forwarding bank, deposits in other
banks for collection purposes would be necessary no longer.
In the beginning, however, there was some doubt as to how
completely the reserve banks would function in these mat­
ters. Would the reserve banks give immediate credit for the
remittance of checks drawn against non-member State
banks? Would they collect time as well as demand items?
Would their service charge be unduly high? These, at first,
were matters of doubt. Some time must elapse before
reserve banks could demonstrate that in every feasible
way they would endeavor to perform the services previously
rendered by the correspondent banks of the financial centers.
But even though reserve banks would perform these
services, they could not pay interest on deposits. In the
past, city banks were willing to make collections, receive at
par checks drawn against the bank, as well as pay interest
on the balance. The reserve banks would pay no interest.
This objection, however, overlooked the savings effected
through the reduction in the amount of the reserve required.
Suppose, for instance, that the country bank had outstand­
ing before the establishment of the new system $100,000 of
demand deposits. The minimum reserve for this would be
$15,000. Three fifths of this amount, or $9000, might be
carried as a balance with its city correspondent. The year’s
interest on this amount at 2 per cent would be $180. This
appeared to be a direct loss.
But under the new arrangement the required reserve
would be $12,000 instead of $9000, or a saving of $3000. If
this could be invested to realize 6 per cent, the interest would
cancel entirely the apparent loss of $180.
In the matter of the “ float, ” finally some member banks
felt themselves harshly treated. In an early chapter men­
tion was made of the loose practices formerly permitted by
the Comptroller according to which country banks could



establish reserves. Checks drawn against outside banks
would be dispatched to the city correspondents and im­
mediately considered as reserve money. Under the clearing
plan finally worked out by the Reserve Board, distantly
drawn checks would not be credited to the account of the
forwarding bank until sufficient time had elapsed in which
to make collections. Despite the logic and the necessity of
this practice, many banks asserted that they were being
harshly treated.
Whether or not these complaints alone would have se­
cured any concessions for member banks cannot be as­
certained definitely. But it happened that the plans of the
reserve administration were such as to lend’its influence to
the lowering of reserve minima. The endeavor of the admin­
istration was to devise a means of gaining control of a larger
portion of the country’s gold. The natural method of accom­
plishing this result would be to require member banks to
keep a larger portion of their reserves with reserve banks
than that law at first compelled. But it was understood that
this could be brought about only by lessening the amount
which must be kept in the banks’ own vaults. Since it was
felt that the concentration of reserve money under the
control of reserve banks would be a more economical use of
reserve money, the final outcome was a reduction in the
aggregate legal minima.
It is easy to understand the importance ascribed by the
reserve management to the accomplishment of the purpose
of accumulating the Nation’s gold more largely in the vaults
of reserve banks. Such gold would form the basis for a much
larger issue of Federal Reserve notes or of book credits to
member banks. The war in Europe resulted in an enormous
inflow of gold to America and there was no assurance that
tffter the war there would not be an outflow of similar pro­
portions. In order to guarantee our ability to meet any.



post-war demands, it would be desirable to have it under
the control of the Board, which was supposed to keep the
general public needs foremost in mind. Then again the
disregard of neutral rights had gone so far in the European
conflict that it was not at all certain whether the United
States could continue to assume an inactive r61e. If war
should come, the demands upon our banks would be heavy.
A much greater expansion of credits would be possible if
the gold was lodged in reserve banks’ vaults.
As expressive of the views of one member of the Federal
Reserve Board the following remarks may be quoted from
an address of Paul M. Warburg:1
W e are faced w ith the simple question: W ill we be strong
enough to share our plenty, during the coming period of stress,
with other nations and be the world’s banker, or will we be so
weak that, when these demands come, we must stop them a t
once b y raising our discount rates high enough to retain our gold
a t home? K eep all the gold in your vaults, gentlemen, where it
is useless for yourselves and deprived of the additional force th at
it m ay gain in the hands of the federal reserve banks; keep every
cash till in hotels, railroad stations, d ry goods stores and w hat
not, filled with gold certificates, and you will rob the country
of its legitim ate opportunity of growth, of helping itself, and
of helping the world. Our foreign competitors will proclaim th at
only a country willing to part freely with its gold m a y safely
be accepted as a world's banker, and th ey will point to the fact
th at in past critical periods, our banks stopped payin g in gold.
I t is our d u ty to give the world an overwhelming evidence of our
ab ility and determination in the future to m aintain our gold
obligations under an y and all circumstances.

A discussion of the measures employed by the reserve
administration to accomplish this purpose forms one of the
1Delivered before the American Bankers* Association at Kansas City. See

Journal of the American Bankers' Association, October, 1916, pp. 307-19. Cf.
also address by A. C. Miller, another member of the Board, delivered before
the Indiana Bankers’ Association. Ibid., November, 1916, pp. 385-90.

m o st in terestin g ch ap te rs in financial h isto ry. A t th e in cep ­
tio n o f th e n e w system , it w a s n o t clear w h a t m a ch in ery
cou ld b e e m p lo ye d to b rin g under th e B o a r d ’s con tro l a n y
large am o u n ts o f gold .

T h e a c t required m em b er b a n k s 1

to m a k e p a y m e n ts for th eir ca p ita l sto c k su b scrip tio n s in
go ld .

M e m b e r b a n k s m u st also k e ep a portion o f their

reserves w ith reserve b an ks, b u t th e final tran sfer o f re­
serves from reserve or cen tral reserve cities w o u ld n o t b e
com p leted for th ree years. T h e s e reserves m ig h t b e e s ta b ­

p a rtia lly ,

m oreover,

re m itta n ce o f specie.


rediscou nts an d

n o t th e

A lto g e th e r these m easures w o u ld

brin g th e reserve b a n k s o n ly a sm all portion o f th e N a tio n ’s
gold. A cc o rd in g ly , th e in g e n u ity o f th e B o ard h it upon th e
p revio u sly m en tioned d e v i c e 2 o f im p ou n d in g go ld as c o v e r
for n o te issues. B y th is m ean s a large q u a n tity o f go ld w a s
g o t in to th e h an d s o f th e reserve agents. B u t th is go ld w a s
im m obile.

I t m u st rem ain as collateral for th e F ed eral

R ese rve notes, an d could n o t b e e m p lo yed to su p p o rt fu rth er
issues o f n o tes or d ep osit cred its exten d ed b y reserve b an ks.
B u t for th e tim e b ein g th e B o ard w a s ob liged to confine
its efforts to th e su b stitu tio n in th e gen eral circu latio n o f
F ed eral R ese rve notes for go ld , an d to th e a c cu m u la tio n
o f this go ld in th e han ds o f th e agents. In th is con nection it
is in te re stin g to read a le tte r sen t b y th e B o ard on S e p te m ­
ber I I , 19 16, to th e vario u s d istrict b an ks. I t h a d d e ve lo p ed
t h a t one o f th e reserve b a n k s h ad been m e e tin g th e c u rre n cy
requ irem en ts o f its m em bers b y sh ip m en ts o f go ld certifi­

G o ld certificates cou ld b e ob tain ed


little m ore

c h e a p ly th a n th e F ed eral R e se rv e notes. S e c tio n 16 s ta te s
th a t

The plates and dies to be procured by the Comptroller of the
Currency for the printing of such circulating notes shall remain
‘ Section 2.
aSee supra, Chapter X, pp. 217-219.



under his control and direction, and the expenses necessarily
incurred in executing the laws relating to the procuring of such
notes, and all other expenses incidental to their issue and retire­
ment, shall be paid by the Federal reserve banks . . .
The Board, however, requested the reserve banks to ignore
their desire to save a small expense and to issue, instead,
whenever possible Federal Reserve notes,
thereby helping to concentrate gold certificates in the vaults of
the Federal Reserve banks.1
But to what extent would member banks be willing to
receive Federal Reserve notes? If their need was for re­
serve money, they could return the notes to the reserve
bank and demand redemption. But for counter money
purposes the notes would be as good a currency as any.
They would be acceptable also by such State banks as were
permitted to count them as reserve money.
Nevertheless, there were limits to the willingness of mem­
ber banks to absorb the notes. They would not be ac­
ceptable when held in excess of the amount necessary for
till money and when legal reserves were low. Accordingly
the Board began to move for changes in the act which would
create a wider field for the Federal Reserve note circulation.
It proposed an amendment which would permit reserve
banks to issue Federal Reserve notes directly against the
deposit of gold with the Federal Reserve agents. This sug­
gestion was rejected by Congress together with another
proposal that the Federal Reserve notes should be made
legal reserve money for member banks. But in the amend­
ments of September 7,1916, it was enacted that
Upon the affirmative vote of not less than five of its members
the Federal Reserve Board shall have power, from time to time,
by general ruling covering all districts alike, to permit member
* Bulletin, October 1,1916, p. 512.



banks to carry in the Federal Reserve Banks of their respective
districts an y portion of their reserves now required b y section
nineteen of this A c t to be held in their own vaults.

The Board ruled immediately (September 8, 1916)1 that un­
til further notice
an y member bank so desiring shall be permitted to carry in the
Federal Reserve B an k of its district an y portion of its reserves
now required b y law to be held in its own vau lts.

This amendment did much to increase the willingness of
country member banks to transfer their deposits from city
reserve agents to reserve banks. It tended also to render the
Federal Reserve notes more acceptable. A member bank
possessing a sufficient amount of credits on the books of its
reserve bank need not worry about the kind of money in its
own vaults. For counter-money purposes the notes were
as good as gold.
But helpful as this amendment was, its accomplishments
were negative so far as rendering any outright advantage
to member banks was concerned. Shifting reserves to re­
serve banks would not increase the member bank’s loaning
power. If the member bank did not heed the Board’s implorations, it would not be subject to penalty. Accordingly, the
Board pressed for a change in the law which would make 1
compulsory what previously had depended entirely on the
discretion of the member bank. Success crowned its efforts
by the enactment of the amendment of June 21,1917. This
amendment stated that thereafter member banks must hold
their legal reserves entirely on deposit with reserve banks.
The only legal reserve would be credits on the books of the
reserve banks. Of course the member bank would be ob­
liged to keep on hand a supply of money for payments over
the counter. But the amount of this till money would
depend upon the discretion of the member bank.
*Bulletin, October i, 1916, p. 508.



According to one of the Board’s earlier suggestions to
Congress, the percentage of till-money reserve would be
definitely stated by law. Leaving the matter entirely to the
discretion of the member bank, therefore, may be regarded
as a step toward the abolishment of the rigid reserve require­
ments of the earlier days.
There has been a disposition on the part of some banks
to insist that this amendment increased rather than de­
creased the real reserves required of member banks. This
argument was based upon the fact that the requirements of
the new law made no mention of till money. Whatever
amounts must be kept for payments over the counter must
be added to the legal requirements. But even with ,this
addition the writer’s investigations lead him to believe that
for all the banks of the country there was a considerable
reduction. At any rate, as will shortly be explained, the abil­
ity of reserve banks to rediscount for member banks was
increased by this measure enormously. Member banks
establish reserves by rediscounting. They were benefited
by the terms of this amendment.
The percentage of member banks’ net deposits which
must be held as credits with the reserve banks has been as
follows since the amendment of June 21, 1917.

Banks in central reserve cities..
Banks in reserve cities...........
Banks in all other cities..........



In the opinion of the writer this amendment is by far the
most important which has been superimposed upon the
original act. Occurring shortly after our entrance into the
World War, it rendered absolutely certain the ability of our
banks, for the time being at least, to guarantee the success
of the Treasury’s bond sales. It made possible a pyramid­
ing of credits unexampled in the history of banking. It



contained great possibilities of good as well as of evil. The
expansion of credit which has taken place since 1917 is in
large measure due to the working of the amendment of
June, 1917.
Let us now endeavor to explain how efficient gold in the
possession of reserve banks has become in furnishing a
basis for member banks’ deposit credit advances to the
business public. First, let us view the situation from the
standpoint of the country bank. Taking into account only
demand deposits and assuming no till money to be neces­
sary, $24.50 of lawful money in the possession of the re­
serve bank would permit a country bank to extend $1000
of deposit credits to its clients. The $24.50 would be the
35 per cent reserve for the $70 of bqok credits granted by
the reserve bank to the member bank. This $70 would be
the member bank’s 7 per cent reserve for $1000 deposits
granted one of its customers. In other words, a dollar of
legal tender currency lodged in the vaults of a reserve
bank would enable a country bank to loan more than $40
of deposit credits.
This same sort of pyramiding of reserves existed under
the old national banking system. But then the utmost
that could be done was to enable the country bank to loan
$13 for a dollar of reserve money lodged in the vaults of a
central reserve city bank. The old reserve percentage for
country banks was $1000. Fifteen per cent of $1000=
$150. Of this, $90 might be held as a deposit with a re­
serve city bank whose minimum reserve was 25 per cent.
Twenty-five per cent of $90=$22.50. Half of this $22.50,
or $11.25, might be held as a deposit credit on the books
of a central reserve city bank which must keep a straight
25 per cent reserve. Twenty-five per cent of $11.25 is
$2.81; $60 plus $11.25 plus $2.81 is $74.06; $1000 divided
by $74.06 is 13 plus.



Let us now view the situation from the standpoint of
the reserve city bank. Under the old system pyramiding
of reserves could go to a point where $1000 of its deposit
could be backed by $156.25. The reserve city bank’s 25
per cent reserve for $1000 is $250. Half of this might be
kept in the form of a deposit with a central reserve city
bank whose reserve must be 25 per cent. Twenty-five per
cent of #I25=#3I.25; #31.25 plus $I25=$I56.25. In
other words, the real reserve minimum was 15.6 per cent.
After the amendment, however, the actual reserve for
this class of banks need be only 3.5 per cent; 10/100 of
#1000 of 35/100=$35. In central reserve city banks a
straight 25 per cent reserve was required. Now it need be
only 4.55 per cent; 13/100 of $1000 of 35/100=$45.50.
Some allowance, however, should be made for the mem­
ber bank’s till-money requirements. Let us assume that a
counter-money reserve of 5 per cent would be sufficient,
and that this be composed entirely of Federal Reserve
notes. Behind these notes the reserve bank must keep a
40 per cent gold reserve. Forty per cent of 5 per cent is 2
per cent. Two per cent, therefore, should be added to the
percentages given above.
But, even after making this addition, it will be per­
ceived that a dollar of gold or lawful money in the posses­
sion of the reserve bank was rendered extremely efficient
in supporting member bank advances. Our reserve mech­
anism after June, 1921, was very similar to the English
system wherein the reserves of private banks consist
largely of credits on the books of the Bank of England.
But the English custom was the result of a long and slow
development. Never before was a currency measure
enacted which enabled banks on the moment to multiply
so enormously their grants of credit to the business public.
Not only was gold becoming more efficient as reserve

money, but the inflow of gold to this country prior to the
amendment had been enormous. In a few years the net
inflow was more than a billion dollars. If this gold could
be got into the reservoirs of the reserve system, the power
of the new system would be established once for all. Here
was an opportunity of centuries and the reserve manage­
ment did not overlook it. In every possible way the en­
deavor was made to substitute notes for gold certificates
in the general circulation, and to accumulate the gold in
the reserve banks’ vaults.
One difficulty in accomplishing this purpose resulted
from the fact that the Federal Reserve notes could not be
issued in sufficiently small denominations. The act
limited these issues to denominations of #5 and above. It
was impossible under these circumstances to keep the
notes circulating in as large a volume as otherwise might
be accomplished. When the need was for money in small
denominations, the Federal Reserve notes would be pre­
sented for redemption. The problem was thus to over­
come the difficulty created by the large denominations
of the notes.
Partial solution for this difficulty, however, was found
by an act passed on October 5, 1917, which was designed
to create a larger field for the circulation of the notes. To
quote the Bulletin on this matter:1
T h e passage of the act of October 5, 1917, authorizing national
banks to issue not more than $25,000 each in denominations of
$1 and $2 and authorizing them to issue notes of $5 on the same
basis as other denominations is intended to provide a larger
volum e of small bills. T h e Treasury Departm ent, as is well
known, has for some time past been converting large green­
backs or U nited States notes into notes of small denominations,
thereby probably finding a permanent field of circulation for
them. A s the greenbacks thus move out of the larger and into
1Bulletin, November 1 , 1917, pp. 833-34.



the small denominations, an increasing field for Federal Reserve
notes is opened. The Treasury, Federal Reserve Board, and
the Federal Reserve Banks are consistently cooperating in
substituting Federal Reserve notes for the circulation of gold
certificates, and they are effectively supported in this under­
taking by the national banks and those of the State banks and
trust companies which have joined the system.
Various other devices were being employed in the mean­
while to discourage the issuance of gold into the general
circulation. By the fall of 1917 the banking law of New
York State had been amended so as to permit State banks
and trust companies to count Federal Reserve notes as
part of their vault reserves.1 In the securing of such
statutes various associations of bankers played an impor­
tant r61e. April 10, 1917, the executive committee of
the American Bankers' Association at a meeting in New
York resolved: 2
That this committee urgently recommends to the trust com­
panies of the United States that immediate steps be taken to
secure amendments, where necessary, to the State laws in order
that the trust companies may be permitted to carry their gold
reserves on deposit with the Federal Reserve Banks in their
several districts, and that as soon as such action can be legally
taken, the trust companies offer to deposit these reserves with
the Federal Reserve Banks.
In its issue of January 29,1919, the Chicago Tribune con­
tained an announcement of the position of the Subtreasury
of Chicago and the Federal Reserve bank of that city. It
was stated that the Federal Reserve notes bear the words:
This note is redeemable in gold, on demand, at the Treasury
Department of the United States in the City of Washington,
or in gold or lawful money3at any Federal Reserve Bank.
Accordingly, the Subtreasury and the bank were within
xCf. Commercial and Financial Chronicle, August 25,1917, pp. 760-61.
*See Bulletin, May 1, 1917, p. 335.
* Italics are the writer's.



their legal rights in suggesting that the party who wanted
gold could go to Washington to get it. They announced
that they themselves would not pay out a single gold coin
for any purpose whatsoever.
By such methods as these the reserve notes were made
to take the place in the general circulation of the legal
tenders so that the latter could be available for the re­
serves of reserve banks. But prior to June 21, 1917, the
law relating to the collateral securing reserve notes was
such as to limit the possibilities of substituting notes for
gold. When the collateral originally securing Federal
Reserve notes matured, gold would be deposited with the
Federal Reserve agent, and the notes would be retained
for reissue to the member banks. This gold could not be
counted as a part of the reserve for deposits. Accordingly,
the effectiveness of the policy of impounding gold as cover
for the notes was limited.
This difficulty was lessened, however, by the amend­
ment of June 21, 1917, which paved the way for a still
greater expansion of bank credits. Prior to this amend­
ment, money deposited with the Federal Reserve agent
as cover for the notes could not be counted as part of the
reserve for deposits. But after this amendment, gold
deposited with the agent as security for the reserve notes
could be counted as a part of the reserve bank’s 40 per
cent gold reserve for notes. This would enable other gold,
which previously had been earmarked as the note reserve,
to support a larger volume of book credits granted to
member banks. The limit was further removed within
which note issues might restrict reserve banks’ power to
create money deposits for member banks.
By such legal and administrative measures the reserve
management had answered with finality the question of
its future power and influence. The gold holdings of
reserve banks became steadily larger, and more and more



banks became members of the system. The expansive
power of our credit structure was increased wonderfully.
In later chapters figures will be given regarding the
amount of increase in credit advances to member banks
rendered possible by these measures.1 But enough has
been presented to indicate that, as a result of the admin­
istrative and legal changes culminating in the amendment
of June 21, 1917, the working of the reserve system was
altered definitely.
One or two matters of banking technique may now be
considered briefly. The first relates to the method of
computing member banks’ reserve percentages. Specifi­
cally, what was the law’s definition of net deposits to
which the reserve percentages applied? To answer this
we can do no better than to quote from an Opinion of
Counsel in the Law Department in the Bulletin: 2
Member banks, in determining the amount against which
reserves must be carried, may deduct all Government deposits,
except postal savings’ deposits,3 and may deduct from the
amount of balances due to other banks the amount of balances
due from bank checks drawn on banks located in the same place
and exchanges for clearing houses. The law, however, does not
permit member banks to deduct checks on other banks located
in the same place or exchanges for clearing houses from gross
demand deposits, nor does it permit cash on hand to be deducted
from gross demand deposits.
In a later chapter certain information will be given
regarding the determination of the reserve banks’ reserves
for deposits granted member banks.
xSee infra, Chapter XIV.
*Bulletin, September 1 , 1917, p. 692.
3Bulletin, June 1, 1917, p. 458. This exemption of Government deposits was
the result of an act approved April 24, 1917. While the prime purpose was to
assist in financing the war, the law referred to all Government moneys and not
merely to the proceeds of bond sales. The purpose was in part to enable the
Treasury to keep as long as possible, to the advantage of the local banks, funds
m the localities which supplied them.

1914, TO DECEMBER, 1916
I n each of the preceding chapters attention has been
focused upon some one aspect of Federal Reserve opera­
tion. The problems confronting the reserve management
cannot be well presented, however, by employing this
method alone. It is necessary that we understand the
relation of each project to the others in the gradual devel­
opment of Federal Reserve policy. For this purpose we
have divided the life of the reserve system into four
periods. The first period, extending from November,
1914, to December, 1916, was primarily one of organization-development and preparation for future emergencies.
The second period, January, 1917, to May, 1917, is char­
acterized chiefly by two facts. First, the reserve banks
by their discount and purchase operations were beginning
to secure some degree of effective control over the money
market; and, secondly, the reserve system was being made
ready to bear the financial strain of the war that began to
appear more and more imminent. In the third period,
June 1,1917, to November 11,1918, the management was
absorbed in the task of cooperating with the Treasury in
meeting the problems of war finance. The fourth period,
extending from the armistice to the spring of 1920, may
be characterized as that of post-war credit and trade
expansion. The final period concerns the relation of the
reserve system to business and industry in the depression
of 1920-21.



The Federal Reserve Act became law December 23,
19x3. It provided for the appointment of an Organization
Committee composed of the Secretary of the Treasury,
the Secretary of Agriculture, and the Comptroller of the
Currency. Among this committee’s duties was the map­
ping out of the country into the various districts, each to
be served by a reserve bank. After this work was com­
pleted, the committee served notice upon the national
banks of the country to subscribe to the capital stock of
the new banks. As soon as a sufficient amount of capital
was guaranteed in this way, the formalities were begun
of granting corporate life to the reserve banks and pro­
ceeding with the election of directors for the district
boards. In the meanwhile the President was engaged in the
task of appointing the members of the Federal Reserve
Board. In this some delay was encountered. President
Wilson had announced that in the selection of the Board
he did not wish suggestions of the sort usually offered in
the making of appointments. He appeared to be convinced
that the selection of a strong personnel was of the utmost
importance to the Nation. But after his nominations were
made, some further delay was caused by the action of the
Senatorial Banking Committee in holding up, on the
ground of their business affiliations, the appointments of
Mr. Warburg and Mr. Jones. Mr. Warburg refused to
submit to cross-examination by the committee. His nomi­
nation, however, eventually was confirmed.1
In these ways the spring and summer of 1914 slipped by,
and it seemed that the opening of the reserve banks for
business must be postponed until the spring of 1915. But
in the meanwhile the European conflict broke out, creating
such financial disturbances as to cause to be reconsidered
the question of the date of operation.
* Cf., Commercial and Financial Chronicle, July n , 1914, pp. 91-92.

DEVELOPMENT, NOV., 1914, TO DEC., 1916


The nature of the upset to the Nation’s finances
created by the sudden outbreak of hostilities is now thor­
oughly familiar to the general public. In a very brief
period European security exchanges were closed and New
York became the world’s dumping ground for a great mass
of internationally owned securities. This sudden selling
pressure induced such weakness in the securities market
that to prevent the collapse of bank credit exceptional
action was taken. New York followed the lead of Paris
and London and closed to trading the country’s leading
securities exchange.
In a number of ways this upset in stock market circles
occurred at a very inopportune time. A large block of
New York City Subway notes held by foreign capitalists
was about to mature, and, moreover, there had been the
usual drawing of finance bills in the pre-autumnal period
to provide a portion of the funds for the moving of the
crops. The expectation was that these bills would be
covered out of the proceeds of agricultural exports sub­
sequent to the fall harvesting period.
For the time being, however, there was a virtual stop­
page in the export trade and a cessation of active trading
in some of the leading articles of commerce. Some time
was required for the English and French navies to clear
the sea lanes of German raiders, and it was understood
that foreign countries must economize wherever possible
in the consumption of American products. Food products
were necessaries, however, and it is interesting to note that
throughout the emergency the Produce Exchange of
New York as well as the grain exchanges remained open
and did an enormous business. It was perceived that the
European purchase of food products could not long be
postponed. But the leading product of an entire section
of the country, cotton, could not be moved, and its price



declined in a very brief period from twelve or thirteen to
seven or eight cents a pound. No basic article of agricultural
production is financed more largely by credit than cotton.
Under these circumstances all sorts of plans were
conceived to relieve the strain upon the Southern banks.
The “ Buy-a-Bale-of-Cotton” movement was launched and
projects were formulated involving loans upon cotton
evaluated by semi-governmental agencies at prices higher
than existing quotations. These plans came to naught,
but Northern Bankers were induced to pool their resources
by organizing a cotton loan fund.
Gold could not be shipped until the sea lanes were made
safe, and, moreover, there was displayed a general dis­
inclination of American bankers to let gold go out of the
country. With the cessation of gold shipments sterling
exchange moved far above the normal export point.
It was felt generally that these adverse conditions could
not continue indefinitely. It was expected that European
demand for cotton must finally renew itself, the resump­
tion of export selling would lessen the demand upon our
gold, the quieting of conditions in European financial
centers would lessen the likelihood of reckless security
dumping and make safe the opening of our exchanges.
But despite this undercurrent of confidence the shock was
of almost unprecedented severity. It is generally believed
that the banking system of 1907 would have succumbed
quickly in this crisis.
Fortunately the Aldrich-Vreeland Act was available to
provide legal sanction for the issuance of bank notes
secured by other collateral than Government bonds. It
will be recalled that the terms of this act were such as to
permit of these notes being issued without much formality.
Banks were empowered to organize into associations and
the issues would be protected by the collective collateral

DEVELOPMENT, NOV., 1914, TO DEC., 1916


of the association. In August the act was amended by
Congress in such a way as to enable the issuance of these
bank notes to a larger proportion of the banks’ capital
than at first authorized. Altogether something like
#380,000,000 of emergency currency notes were put out.1
In many of our cities also large volumes of clearing house
certificates were issued. As additional measure of relief
the Secretary of the Treasury adopted some rather
extraordinary measures. Mr. McAdoo took the position
that in a situation so grave, a situation, moreover, in
which the provision for emergency issues existed, no bank
was justified in refusing legitimate demands of its cus­
tomers for credit. Consequently, publication was begun
of a so-called blacklist in which were stated the names of
banks whose reserves were extraordinarily large. Possibly
because of the aid rendered by such measures the credit
stringency was prevented from becoming acute.
It was undoubtedly unfortunate that the reserve
system was not in operation at the time of the crisis. It
provided for a reduction in reserves somewhat comparable
to the total amount of Aldrich-Vreeland notes and clearing
house certificates issued.2 With its note-issuing powers
there would have been little doubt of its ability to meet all
legitimate demands. With the reserve banks operating,
many of the emergency measures, such as the Cotton
Loan Pool and the Foreign Exchange Fund, would have
been unnecessary. If the stock exchange could have been
kept open, our willingness to pick up at bargain prices the
securities of frightened European holders would have been
1 Cf. Report of the Federal Reserve Board, 1914, p. 15.
2According to figures based upon the Comptroller's call of September 12, the
reduction would be $464,919,076. This makes no allowance, however, for the
duplication and triplication of items under the old law. The real cash reduction
would be considerably less. Vice-Governor Delano's estimate of the actual
reduction was $250,000,000. (Cf. Commercial and Financial Chronicle, Novem­
ber 21,1914, p. i486.) But at any rate the psychological effect was good.



one of the strongest indications of our financial power. If
gold exports could have been maintained freely, Withers1
would not have found opportunity for chiding New York
at becoming panic-stricken at her first opportunity of
supplanting London as the world’s banker. He would not
have been able to assert that a temporary little difficulty
in Lombard Street threw Wall Street into utter confusion.
The reserve banks could have furnished all the relief of
the emergency measures without outward confession of
the existence of strain.
It was felt, however, that it would be a mistake to begin
the operation of the reserve banks until its organization
was more complete. Inability to function properly might
lessen permanently the prestige of the new system. Some
difficult readjustments, moreover, would be occasioned
by its establishment. For one matter, the transfer of
reserve funds from the banks of the central reserve cities
to the Federal Reserve banks might create some acuteness
in the financial centers. But in a short period financial
conditions became less disturbing. By the end of August
it was noted that the emergency currency notes were
being returned in large quantities and there was less dis­
cussion of plans involving the valorization of cotton.
Money rates in the financial centers began to ease, and on
the last Saturday of October the New York Clearing
House report showed that the reserve deficiency which
had existed since the outbreak of the European war had
been replaced by a substantial cash surplus. The demand
for funds, moreover, began to lessen under the influence
of reduced speculative activity in the stock market.
Accordingly, toward the close of October the Secretary
of the Treasury announced that all of the twelve reserve
banks would begin operation November 16.
* Cf. Hartley Withers, War and Lombard Street, pp. 98-111.

DEVELOPMENT, NOV., 1914, TO DEC., 1916


The time of their opening was thus synchronized with
the restoration of activity in the export trade. Accord­
ingly, the return to normal conditions was rapid. The
first week in December tradings under a minimum price
were resumed in the New York Stock Exchange, and
shortly thereafter all restrictions were removed. The
emergency issues continued to come in for redemption.
In the haste to get the reserve banks into operation
they were not equipped at first with full power. The Board
was able to issue regulations covering only such operations
as were deemed essential to their functioning with reason­
able efficiency. In Circular No. 13 addressed to all the
Federal Reserve agents on November 10,1 the Board
confined its recommendations to discount operations.
Open-market dealings were to be reserved for slow devel­
opment, and no attempt was to be made for the time being
to establish a unified system of clearances.
The discount demands upon the banks immediately
after opening were light, however, and the administra­
tion's efforts were confined largely to developing the
internal organizations of the banks and to the determina­
tion of certain broader questions of policy. The most
important of the latter was this: What should be the nor­
mal place of the reserve banks in our financial structure?
Should they be continuously in the market, or should they
husband their resources for use primarily in emergencies?
There were many at that time who stressed the emergency
character of the machinery. It was the outgrowth, it was
held, of the movement for banking reform which first
reached greatest proportions in the framing of the Aldrich
plan. In that project, avowedly, the new machinery in
large degree was designed for emergency operation.
Except on occasion of financial disturbance the National
1 Cf. Report of the Federal Reserve Board, 1914, p. 9.



Reserve Association’s activities would be limited. But in
period of credit strain it would offer its notes to the stock­
holding banks.
It was also argued that the permanent functioning of
the reserve machinery must mean undue competition
with the member banks. It was insisted that its rediscount
rate should normally be higher than the general money
rate. If not, its funds would be used to the profit of the
banks which rediscounted their paper, and the resources
of the system, derived from the contributions of all the
banks, would be unavailable in time of disturbance.
Partiality in the distribution of its funds must not be
permitted. In this vein writes C. W. Barron in his book
on the Federal Reserve Act. He states:1
If the new Federal Reserve Board is of the desired quality
and character it will be the most unpopular board that ever sat
in Washington. It will turn deaf ears to all political and sec­
tional considerations. The greater the clamor for cheap money
the tighter it will holdrthe reserves within or without the coun­
try. It will keep watchful eye upon every section to see that
banking facilities for cornering potatoes in Maine, or cotton
in Texas; lumber in Oregon or the Carolinas, corn in Illinois, or
wheat in Kansas or Minnesota, are absolutely not furnished
by any part of the reserve system over which the board presides.
To follow out this argument, the only means of avoiding
sectional partiality is to remain absolutely aloof from the
money market except on occasion of great need.
In a somewhat similar manner argued Mr. Arthur
Reynolds, then President of the American Bankers’ Asso­
ciation, in an address delivered on June 27, 1914. He
regretted that every line of the Reserve Act contained an
invitation to rediscount. He feared over-expansion of
credit if this invitation was generally accepted.2
1 Page 13.
* See Commercial and Financial Chronicle, July 4,1914, p. 20.

DEVELOPMENT, NOV., 1914, TO DEC., 1916 247
A similar view was also the editorial expression of the
Commercial and Financial Chronicle. To quote one sen­
tence of their statement:1
The point which should not escape attention is that the re­
serves having been passed over to the keeping of the Federal
Reserve banks, the member banks no longer have any control
over them, and yet they are the property of the member banks
and their character has not been changed; they are still the
reserves of these member banks.
Consequently they should not be dissipated except on
occasion of intense need.
These views, however, failed to commend themselves
to the reserve management. Unless the reserve banks
should get into the market, their earnings would be small.
Earnings were held to be necessary to pay the operating
expenses of the reserve banks, to yield a dividend on the
stock subscriptions, to finance internal developments, and
to maintain the prestige of the banks in the eyes of the
public. It was argued that the resources of the reserve
banks, if employed sparingly and wisely, need not become
unavailable for the member banks. They could be in­
vested mainly in such short-time liquid investments as
could be convertible into cash without difficulty upon
occasion of need.
Time and experience [it was stated] will show what the
seasonal variations in the credit demands and facilities in each
of the Reserve Banks of the several districts will be and when
and to what extent a Reserve Bank may, without violating its
special function as a guardian of banking reserves, engage in
banking and credit operations.2
The relation between earnings and prestige was stated
1 Commercial and Financial Chronicle, January 30,1915, pp. 334-35.
* Cf. Report of the Federal Reserve Board, 1914, p. 18.



as follows in one of the annual reports of the Federal
Reserve Bank of San Francisco:1
While there seems no economic defense for an effort under
existing conditions to employ a Federal Reserve bank’s funds
for the purpose of earning profit, yet what may be called the
psychological importance of reasonable earnings seems so great
as to become a well-defined economic factor. . . . Earnings
constitute the gauge of success applied by a large section of the
public including many bankers. It is characteristically human
to uphold the successful enterprise and to obstruct the unsuc­
cessful. A smaller percentage of money reserve, coupled with
unqualified approval, will constitute more potent power of
support than larger reserves with less or popular confidence.
It was furthermore argued that a piece of banking
machinery unused in normal periods could not be made to
operate with efficiency on occasions of disturbance. The
organization would not be intact when needed. To quote
from an address by F. A. Delano, a member of the first
Federal Reserve Board:2
It might be assumed from what has been said that, these
twelve Federal Reserve banks exist solely to take care of the
unusual, spasmodic or seasonable demands of business, or else
those excessive demands which periodically come upon us at
greater intervals of time. That alone might well be called a
worthy object to attain, but it would have to be admitted that
a ponderous and costly machine had been created to serve an
additional demand; and it might be doubted whether a machine
thus kept in comparative idleness two thirds of the year would
operate smoothly and successfully when the steam was turned
In its Report for the year 1914, the Federal Reserve
Board rejected the theory that continuous operation
would lessen the ability of the banks to meet the panic or
1 Cf. Commercial and Financial Chronicle, April 8,1916, p. 1311.
* Cf. Ibid., February 27, 1915, p. 697.

DEVELOPMENT, NOV., 1914, TO DEC., 1916


emergency needs of their members.1 What was required
was such a control of credit, in times of business optimism
as well as of depression, that serious difficulties would
never arise. In periods of excessive activity, the banks
should exercise a restraining influence by withdrawing
support from the markets. In periods following extensive
liquidation, they should offer their funds freely.
Normally, therefore, a considerable proportion of its resources
should always be kept invested by a Reserve Bank in order
that the release or withdrawal from active employment of its
banking funds may always exercise a beneficial influence.
But no matter what decision should be reached on
grounds of business expediency, the reserve administra­
tion held the terms of the statute were such as clearly to
indicate the desire of the lawmakers that operation should
be continuous. Aside from any duty of earning dividends
for shareholders, section 14 of the act stated that the rates
of discount “ shall be fixed with a view of accommodating
commerce and industry.” For occasions on which there
was no demand for discounts, reserve banks were endowed
with open-market powers. It seems to the writer that
throughout the Reserve Act there is indicated the inten­
tion of the lawmakers that reserve banks should do some­
thing more than merely to offer emergency relief. The
reserve system was intended to operate continuously.
But the problem of getting into the market was one of
great difficulty. Because of the reduction in reserve re­
quirements, member banks could expand their loans con­
siderably without engaging in any large amount of redis­
counting. In the early part of 1915 the export trade was
heavy and gold imports on an enormous scale began. The
member banks were in so strong a reserve position that,
* See pp. 17-19



despite the very moderate rates demanded by the reserve
banks, there was no large demand for rediscounts. In this
situation, accordingly, the reserve banks were forced to
turn to their open-market powers in order to find effective
use for their funds. Dealings in Government bonds and
municipal warrants were especially large in 1915.
But there were limits to the extent to which openmarket purchases could be made with expediency. The
reserve system was in its infancy, and it was particularly
necessary that it avoid creating the appearance of being a
competitor of member banks. The problems^of attracting
a larger membership from State institutions and of secur­
ing the allegiance of all classes of banks to the voluntary
clearance plans had still to be worked out. Despite the
fact that the volume of operations at first was ;not much
more than sufficient to meet the expenses of operations,
there was a general disposition on the part of member
banks to view the reserve banks as rivals and not as ser­
vants. Now and then the argument was advanced that
the capital stock subscriptions of member banks should be
returned. As typical of such views the following utter­
ances may be quoted from an address delivered in August,
1915, by Frank C. Mortimer, Cashier of the First National
Bank of Berkeley, California:1
The present law appears to place the Federal Reserve banks
in competition with member banks through open market opera­
tions. This has already been availed of by the purchase of war­
rants and other instruments of credit. The abnormally heavy
reserves now carried by national banks might have been profit­
ably employed by them, at fair rates of interest, through the
purchase of the very obligations now held by the Federal
Reserve banks.
The open market operations of the Federal banks are
expected, in a measure, to regulate interest rates throughout
1 C i. Commercial and Financial Chronicle, September 18,1915, p. 888.

DEVELOPMENT, NOV., 1914, TO DEC., 1916


the country and should be exercised in the manner indicated.
Since their organization there has been no complaint regarding
abnormally high interest charges. Therefore, there appears to
be no valid reason for any open market operations at this time.
In buying in the open market the Reserve banks already
have been in competition with member banks, and they appear
to have demonstrated that they are operating, not altogether
as emergency banks, to be used during periods of financial
stress but as open competitors of member banks.
The question naturally arises: At times, when there is no
demand for the rediscounting privilege, are the Federal Reserve
banks forced to compete with member banks by going into the
open market and buying municipal and other warrants, in order
that they may earn expenses and pay the expected dividend of 6
per cent.
If this is the situation, there exists a very good reason for the
return of the capitalization to the membef banks and the elimi­
nation of the implied obligations on the part of the Reserve
banks of earning a dividend of 6 per cent.
The return of the capital stock of Federal Reserve banks to
member banks has more than incidental bearing on the success
of the whole system. With the elimination of this feature,
which never has set well upon the national banks, the State
banks, recognizing the value of the rediscount feature, in all
probability would voluntarily and quickly apply for membership.
The desirability of returning the paid-in capital of the
reserve banks will depend upon the reader’s conception of
the nature of the reserve system. If he believes it desirable
that the reserve banks should attempt to exercise any
large measure of continuous control over the money
market, then he would oppose the proposal. Not until the
influence of the reserve bank system was more firmly
established would it appear feasible to lessen its resources.
If, on the other hand, the reserve system is to operate in a
purely palliative manner, if it was intended to confine its
services primarily to occasions of financial disturbance,
greater objection would be made to the capital stock



feature. For such a system the apparent necessity of
earning dividends must prove a frequent source of embar­
rassment. It might compel the abandonment or modifi­
cation of policies formulated solely in the interest of finan­
cial necessities. But the whole question throws into strik­
ing relief the difficulties confronting the management at
the beginning of this period. The reserve system must get
into the market in order to fulfill its purpose. But the
task of getting into the market rendered inevitable many
serious problems of financial readjustment. To employ
Delano’s figure of speech:1
It was like the problem of reconstructing a great office
building, changing an antiquated construction and substituting
therefor steel and marble, yet accomplishing it all without
serious inconvenience to the tenants.
As regards the rate policy of the Board it has been re­
marked previously that it was believed desirable to act
with prudence and conservatism at first. Accordingly, in
the first schedule, rates were fixed at from
to 6}4 per
cent. But as in the case of qualifications for eligibility,2
it was soon perceived that these requirements were too
high. Accordingly, upon the applications of the various
reserve banks the rates were lowered from time to time.
On December 30, 1914, the rate on 30-day paper was 4 ^
per cent in four districts and 5 per cent in all the others.3
Paper of longer maturity commanded slightly higher
rates. On this date the differentials were based entirely
on maturities.
In 1915 further reductions were made. A t the close of
the year the rate on bankers’ acceptances was 2 to 4 per
1 See Bulletin, October 1 , 1915, p. 298.
aSee supra, Chapter IV, pp. 82-83.
3See Report of the Federal Reserve Board, 1914, Exhibit M, p. 203.

DEVELOPMENT, NOV., 1914, TO DEC., 1916


cent, the lowest figure usually prevailing; and 90-day
trade acceptances were discountable in most districts at
per cent. The 30-day commercial paper rate was 4
per cent in all districts, save the San Francisco district,
where the rate was 3 per cent.1
Save for a slight tendency toward stiffening at the close
of the year, these rates were not altered greatly during
In order to indicate the general discount situation
during these years, the table on page 254 (Table No. 1) is
presented. The figures show that the total volume of
discounts (column 5) increased considerably in 1916 over
I9I5! 1916 also showed a marked shifting in the maturities
of the paper. In 1915 paper maturing in less than 30 days
was exceeded both by the 30-60-day paper and the 60-90day paper. In 1916, however, paper of the shorter matur­
ity exceeded all other classes combined. In fact, for the
month of December, 1916, discounts of paper maturing
within 30 days was considerably larger than the year’s
total for any of the other classes. This may be interpreted
possibly as evidence of the increasing strain upon the
money market toward the close of the year. Rediscount­
ing was becoming more general and member banks were
offering a more representative lot of paper on their redis­
count applications.
As to the district origin of the paper Table No. 2 on
page 254 gives information. In 1915 there was little de­
mand for rediscounts save in the three Southern districts
of Richmond, Atlanta, and Dallas. But in 1916 the re­
discounts in the Boston, New York, Philadelphia, and
Chicago districts compared favorably with those in the
three Southern districts.
x See Report of the Federal Reserve Board, 1915, Exhibit A, p. 27.
a Cf. Ibid., 1916, Exhibit A, pp. 35-39*


T able N o. i

V o lu m e o f D is c o u n t s f o r E n t i r e S y s te m b y T y p e s o f P a p e r


C la s s ific a tio n
M a t u r in g
W it h in
30 D a y s

D ate

6 0 D a y s to

A g . P aper

90 D a y s

3 0 D a y s to

M a t u r in g
A f t e r 90 D a y s

60 D a y s



I n T h ousands


T otal C om ­
P aper
D is c o u n t e d

m e r c ia l



D ollars

19 14



7 ,3 0 6 .2


1 ,9 2 9 .1


5 8 5 .6


12 8 .2


9 ,9 4 9 .1

5 ,0 7 4 .5

3 ,2 5 0 .9

4 ,1 0 9 .3
2 ,9 5 7 .5

3 ,6 2 7 .0
5 ,4 2 1 .7
5 ,2 5 7 .4

2 ,3 6 5 .1
3 ,2 6 5 .9

6 1 1 .4
8 8 5 .2

1 0 ,7 1 2 .8

5 ,1 6 2 .9

1 ,1 8 0 .8

3 ,5 0 0 .9
3 ,8 0 0 .8
3 ,9 0 5 .3

4 ,1 6 6 .4
4 ,3 3 1 .1
5 ,1 8 7 .2

1 ,6 4 3 .0
2 ,3 8 2 .3
2 ,5 0 3 .2

5 ,2 9 4 .3

1 ,7 1 5 .4
1 ,0 2 2 .4

1 3 ,3 9 9 .7
1 0 ,5 4 9 .3
1 2 ,1 4 5 .7
1 3 ,4 0 6 .0
1 3 ,2 3 8 .0

2 ,6 2 0 9

5 1 5 .6

1 1 ,4 6 1 .9

19 15

Total, 1 9 1 5

1 ,7 9 8 .6
1 ,2 3 9 .0
1 ,6 3 1 .5
1 ,8 1 0 .3
1 ,7 1 5 .9

4 ,5 1 2 .4
4 ,9 9 0 .9
6 ,1 8 0 .0
5 ,3 2 7 .4

1 ,7 0 0 .3
1 ,8 2 9 .9

1 2 ,5 3 0 .3

2 ,7 3 0 .8
2 ,8 2 5 .7

6 ,2 4 2 .0
5 ,0 7 1 .6

4 ,5 2 0 .1
5 ,3 0 6 .5
5 ,6 7 1 .0
6 ,7 9 1 .2
5 ,2 6 0 .7

2 ,2 5 4 .0

1 5 ,4 1 2 .0


2 6 ,5 0 9 .2

$ 5 7 ,8 3 7 .4

$ 5 7 ,3 2 2 .4

$ 1 9 ,6 8 4 .0

$ 1 6 1 ,3 5 3 .0


2 ,1 1 8 .8





2 ,1 6 0 .4

1 2 ,2 3 3 .7

1 ,0 8 8 .6
1 ,8 9 2 .0
2 ,5 0 5 .7

1 4 ,4 0 5 .0
1 5 ,0 5 0 .8
1 8 ,2 6 9 .7

19 16

Total, 1 9 1 6

1 ,1 0 4 .3
1 ,2 0 2 .1
4 ,3 6 3 .9
3 ,2 2 0 .0
3 ,2 7 1 .6
1 0 ,6 4 5 .0
8 ,3 3 9 .6
5 ,3 4 2 .6
4 ,3 9 2 .7
1 3 ,4 9 7 .3
5 7 ,5 5 5 .5
$ 1 1 5 ,0 5 3 .1

3 ,3 5 9 .2
2 ,5 5 8 .4
3 ,1 7 6 .7
2 ,3 7 3 .2
2 ,6 2 3 .3

4 ,1 2 1 .6

1 ,5 1 5 .4

1 1 ,1 1 5 .0

2 ,3 7 7 .6
2 ,7 4 7 .5
3 ,4 4 7 .3
3 ,8 9 8 .4
3 ,4 9 2 .6
1 ,6 2 6 .1
2 ,7 4 2 .6

2 ,9 9 5 .8
3 ,8 0 5 .5
3 ,0 1 7 .1
2 ,9 6 1 .3
3 ,0 8 4 .4
4 ,9 6 5 .8
4 ,5 2 1 .7
4 ,1 0 7 .4
3 ,1 2 6 .4
1 ,8 9 5 .9
2 ,9 7 3 .7

1 ,0 0 6 .1
1 ,2 0 3 .0
1 ,7 6 7 .3
2 ,3 9 0 .9
2 ,9 2 6 .4
1 ,8 2 4 .7
r 1 ,0 4 3 .2
9 6 0 .4
8 5 1 .5
8 8 4 .8
4 4 2 .2

7 ,6 6 4 .6
9 ,3 8 7 .3
1 1 ,5 2 1 .5
1 1 ,1 9 5 .5
1 1,6 6 0 .0
2 0 ,1 8 3 .0
1 7 ,3 5 1 .8
1 4 ,3 0 8 .8
1 1 ,8 6 2 .9
1 7 ,9 0 4 .1
6 3 ,7 1 6 .0

$ 3 4 ,4 2 2 .9

$ 4 1 ,5 7 6 .6

$ 1 6 ,8 2 5 .9

$ 2 0 7 ,8 7 0 .5

1 Figures taken from A nnual Reports of the Federal Reserve Board.
T a b le N o.



D i s t r i b u t i o n o f D is c o u n t s b y D i s t r i c t s
In T housands of D ollars

N ov.

D is t r ic t

16 , 1 9 1 4 -D e c . 3 1, 19 15
P er

A m ount

New York---Philadelphia .
Richmond ...
St. Louis.......
Kansas C ity ..
San Francisco

$ 2,386.9

9 ,668.7
6 ,839.7
5 ,201.3
5 ,870.3


J a n . 1, 1 9 1 6 -D e c . 3 1, 19 16

C ent
19 15



A m ount


6 ,792.4



P er C en t




DEVELOPMENT, NOV., 1914, TO DEC., 1916 255
During these years discounting for banks in the Nation’s
financial center, New York City, was conspicuous because
of its almost total absence. The exceptional nature of
rediscounts for the metropolitan institutions is indicated
by the following statement issued by the New York Fed­
eral Reserve Bank early in December, 1916:1
During the course of the day a number of New York City
banks, including among others . . . made use of the rediscount
facilities of the Federal Reserve Bank of New York. While the
amounts of the rediscounts were not large, the facility and
promptness with which the credits were obtained serves to illus­
trate in a practical way, for the first time in the history of the
bank, the readiness of the Federal Reserve system to meet the
calls made upon it. The officers of the Reserve Bank expressed
themselves as much gratified with the attitude of the member
banks in making use of their facilities, it being apparent that
the rediscounting had been undertaken not so much because
there was any necessity for it, but rather to inaugurate the prac­
tice which, while already -a commonplace at other Federal
Reserve banks, had not heretofore become an established pro­
cedure in New York.
The number of member banks accommodated through
the discount of commercial paper was somewhat similar
in the two years. In 1916, 23.4 per cent of all member
banks received discount credits from reserve banks. The
figures for 1914, 1915, and 1916 were as in Table No. 3
on page 256.
According to the figures of Table No. 4 on page 256,
the amount of paper most commonly discounted during
1916 was #1000 to #2500. But approximately an equiva­
lent amount of pieces in size from $250 to #500 and #500
to $ 1000 were discounted. More pieces of paper under $100
were discounted than from $5000 to #10,000. These facts
1 Cf. Commercial and Financial Chronicle, December 9, 1916, p. 2118.


T a b l e No. 3

N um ber of

T hrough

D is c o u n t








M em ber B anks A ccom m odated
o f C o m m e r c ia l P a p e r

D ist r ic t

Nov. 16, 1914- D e c . 31,1915

New York.................
St. Louis...................
Kansas C ity .. . . . . . . .
San Francisco............

24 8


i 43
20 2




12 9





2 58





16 9



2 ,0 7 3

1,9 2 0

1 ,7 8 8

T a b le N o.


C o m m e r c ia l P a p e r D is c o u n t e d b y S iz e f o r t h e Y e a r
S iz e

N u m b e r o f P ie c e s

A m o u n t in T h o u sa n d s

To $100..................................................

2500- 5000. .....................................
5000- 10,000....................................
Over $ 10,000....................................


1 4 .9 0 7
15 4 6 0

3 .3 9 1


D ollars


4 4 0 7



1916 *



5 , 670.8


26, 120.4
38, 756.2
26, 750.9
96, 720.7
207, 870.5

1 See Report of the Federal Reserve Board, 1916, p. 91.

tend to combat the assertion that the principal advantages
of the reserve system would enure to the large borrower.
Table No. 5 on page 257 gives certain information
regarding the amount of the open-market purchases dur­
ing 1915 and 1916.

DEVELOPMENT^ NOV., 1914, TO DEC., 1916 257
T a b le N o.


T o t a l I n v e s t m e n t O p e r a t io n s ( P u r c h a s e d P a p e r a n d D is c o u n t e d
_________ _____ ______________
I n T h ousands
C ommercial
P aper
D iscoun ted

D ate



D ollars

P urch ased 1
A cceptan ces
B a n k e r s ’ and
T rade

$ 9.949-1





Total 1915


January . . . . $ 11,115
February ...
n .195
October . . . .
November ..
December . ..
Total 1916 .


U n ited S ta tes
B onds
P urch ased


M u n icipa l
W ar ra nts
P u rch ased








$ 9,602

$ 6,627

$ 9,806

$ 2,666






ii, 75o
4 .115
i ,370








$ 386,095



1First purchase of acceptances, February 19,1915.

By means of these operations the reserve banks were
able to make a fair showing regarding earnings in 1915



and 1916. In these two years all earned expenses and were
able to contribute a small amount to dividends. From the
Report of the Federal Reserve Board for the year 1916 we
The figures for the whole system to December 31, 1916,
show an average net earning since organization of 3 per cent on
the actual paid-up capital, while for the year 1916 they show
an average net earning of 5 per cent.
In comparing reserve banks’ operations with those of
private institutions, it must be remembered, however,
that a portion of their capital is obtained without the
issuance of stock. The law required member banks to
deposit a portion of their reserves with the reserve banks.
Because of the rather limited scale of its operations, the
reserve system approached the close of this period with
exceedingly high reserves. December 30, 1916, the ratio
of the gold reserves of the reserve banks to the net deposit
and Federal Reserve note liabilities was 79.4 per cent.
On this date the cash reserve ratio was 81.4 per cent.
Despite the limited demands upon its resources, it
appears undeniable to the writer that in this period the
reserve management should be credited with a remarkable
achievement. The legitimate needs of business were met
without the sacrifice of principle on the one hand or the
establishment of unduly bureaucratic methods upon the
other. The requirements for eligibility of paper presented
for rediscount were fair. The practice of discounting had
become sufficiently prevalent to point the way to member
banks for the solution of their future emergency require­
ments. Analysis of the number of banks served, of the
size of the paper discounted, of the districts of origin, gave
results which could not be employed to justify charges of
favoritism. The reserve management had convinced the
1 Page 13.

DEVELOPMENT, NOV., 1914, TO DEC., 1916 259
member banks that its services were at the disposal of all
banks and all districts.
While progress in popularizing the trade acceptance
was slow, it had proceeded upon a sound basis. The firms
won over to its use were in large measure those of high
credit rating. Progress in the popularization of the bank­
ers* acceptance was favorable.
In check collections the reserve system had proceeded
slowly but cautiously. But by the middle of 1916 the
foundations had been laid for a country-wide par clearance
scheme which was finally to include the greater part of the
country’s banks, non-member as well as member. These
steps had to be taken in the face of much legislative and
political objection engendered by the large number of
exchange-charging banks.
By amendments to the act and various administrative
measures, much progress had been made in the movement
to conserve the Nation’s gold supply. On December 29,
1916, its total gold reserve was $453,000,000. On the same
date a total of $282,000,000 was deposited with the re­
serve agents as cover for the Federal Reserve note issues.
The reserve banks were accumulating gradually a larger
and larger portion of the country’s gold. This concentra­
tion of gold increased the reserve system’s power for evil
as well as for good. But it would not have been courageous
to have declined to accept this opportunity.
No occasions for inter-district rediscounting occurred
in this period. But knowledge of the possibilities of secur­
ing extra-district aid enabled industry to count upon
the support of its banks with greater certainty.
In the Gold Settlement Fund at Washington the begin­
nings had been laid for a machinery which finally was to
enable domestic transfers of currency to be made with a
minimum of cost and physical effort.



The principal disappointment had to do with the refusal
of the great majority of State banks to enter the system.
But it seems clear that only by undesirable concessions
could the system have been made such as to attract the
voluntary entrance of many.
Lastly, the internal organization had been developed
to meet the requirements of the future. The preliminary
work had been accomplished. This period was one of
achievement. But primarily the achievements were those
of preparation.

TO APRIL, 1917
In the early period of reserve operation the demand for
rediscounts was light and the reserve banks were able to
exercise little control over the money market. Toward the
close of 1916, however, the general boom in industry had
begun to throw some strain upon the credit mechanism.
As a consequence several reserve banks in December, 1916,
increased their rates slightly and for the first period of
their existence the member banks became somewhat sensi­
tive to their rediscount policy. As stated by Governor
Harding in the January, 1919, Bulletin:
the only period when the Federal Reserve Board was able to
exercise any effective control over the banking situation was
during the last two or three months of 1916 and the first quarter
of 1917.'
It might be expected, accordingly, that 1916 would
mark the close of the period of experiment and prepara­
tion, and that permanent principles governing rediscount
and open-market operations would soon crystallize. Prior
to 1917 there was no danger of credit and currency infla­
tion. The inflow of gold from Europe and the reduction
of reserve requirements by the terms of the act left mem­
ber banks in an exceedingly strong reserve position. Under
this situation member banks could provide credits without
great deference to the policy of the reserve administra­
tion. There was then little objection to be made to the low
* Page 2.



rates. Rather they appeared to be an outright advantage.
In the first place, these low rates tended to encourage
member banks to make rediscount applications and thus
emphasized the helpful possibilities of the system. Sec­
ondly, they served to indicate the fundamental soundness
of America’s financial condition.
No system of central banking, however, can continue
forever to serve as an agency for credit expansion, and it
might be expected, accordingly, that in 1917 a beginning
would be made in establishing a permanent basis for
advances to member banks. The principle accepted might
be to keep the reserve banks’ rates above those of the
general market or to base the volume of rediscounts upon
the productive requirements of the community where the
applications arose. But no matter what the basis of pro­
cedure, it was clear to all thinkers that in the first two
years of operation no real progress had been made in this
direction. Financial conditions in these years were such
as to make unnecessary the solution of this problem.
As political events shaped themselves, however, neither
1917 nor any subsequent year was to be such as to permit
idealistic consideration of the proper basis for rediscount
operations. Very early in 1917 it became clear that only
by receding from our oft-stated position regarding the
rights of neutrals armed clash with Germany could be
avoided. Prospects of entering the conflict overshadowed
all other considerations, and the task of the reserve admin­
istration was to place the reserve banks in shape to meet
the financial strain of war. It was understood that the
Treasury’s plan would involve huge borrowing operations
and that these could be rendered successful only by the
active cooperation of the banks. Credits would be re­
quired, not merely to finance our own expenditures, but
also those of our allies whose purchase of war supplies in

DEVELOPMENT, JAN., 1917, TO APRIL, 1917 263
this country would increase as a result of our declaration
of war. A credit system, moreover, not efficiently ordered
before war, could scarcely be expected to be prepared
during hostilities for the requirements of post-war recon­
struction. The problem then would exist of transferring
labor and capital from the production of war supplies to
the industries of peace.
It was during this period, accordingly, that much of the
work of concentrating the control of the country’s gold
was accomplished. In January the Board proposed the
amendments which became law June 21, 1917, and which
required member banks to maintain their entire legal
reserves with reserve banks. The Board also suggested
that it be given power to raise the reserve requirements of
member banks in emergencies. Congress refused, however,
to accept this amendment. A t the same time proposals
were made to render membership more attractive to State
banks and trust companies and preparations were made
for ensuring an adequate supply of Federal Reserve notes.
D uring the months of January and February it placed addi­
tional orders w ith the Bureau of En graving and Printing,
through the Com ptroller of the Currency, for more than
$900,000,000 of notes, and arranged also th at the stock of notes
on hand should no longer be reduced through withdrawals for
current needs, b u t th at as drawn upon b y the Federal R e­
serve Banks new orders in equal amount should be placed
autom atically.1

In view of the anticipated future strain it might have
been expected that discount rates would have been in­
creased during this period. The state of the money
market, however, was such as to necessitate compara­
tively few alterations. For instance, the rates on commer­
cial paper maturing within 61 to 90 days were increased
x Report of the Federal Reserve Board, 1917, p. 2.



in this period in only two districts. In January, the
Atlanta and Dallas banks increased their charges one half
of one per cent.
With these rates the discounts for member banks of
the first quarter of the year totaled #67,523.7 thousand.
This compares with totals of #28,166.9 thousand and
#36,642.8 thousand in the corresponding periods of 1916
and 1915. The dependence of member banks upon re­
discounting was increasing somewhat.
It might be surmised that this increased rediscounting
must have been at the expense of the reserve banks’ legal
reserves. It is true that the reserve accounts of members
on the books of reserve banks increased somewhat. On
January 26, members’ reserve accounts were #687,841,000.
On February 23, they were #692,475,000 and on March 30,
#720,411,000. The circulation of Federal Reserve notes,
on January 26, was #259,768,000; on February 23,
#303,171,000; and, on March 30, #357,6x0,000. But as a
result of the continuous impounding of gold the total cash
reserves advanced steadily from #758,242,000 on January
5 to #962,662,000 on April 6.1 Consequently, the ratio of
cash reserves to aggregate net deposits and Federal Re­
serve note liabilities remained continuously above 82
per cent. On April 6, the date of the declaration of war,
it was 84 per cent.
The enlarging gold holdings of the reserve banks made
possible also an increase in the open-market investment
operations without lowering the reserve ratio. This is
indicated by the table on page 265.a
On January 5, 1917,3 the gold of the reserve banks
in excess of required reserves — free gold, in other
1 Report of the Federal Reserve Board, 1917, p. 64.
* I b i d p.
* Ib id ., p.


DEVELOPMENT, JAN., 1917, TO APRIL, 1917 265
A m ount P urch ased




J an u ar y
$ 4 9 ,10 5 ,3 5 6

23.450 .30 0

F e br u a r y





words — amounted to #421,155,000. On April 6 it had
increased to $545,959,000. On the basis of this free gold
an enormous expansion of credit advances to member
banks or of Federal Reserve note issues was possible.
This free gold would provide a 40 per cent reserve for a
deposit or note expansion of $1,164,697,500. This would
exceed the sum of the outstanding Federal Reserve note
circulation and book credit advances to member banks
($1,134,729,000) by $29,978,500. And the process of
attracting gold into the reserve reservoir had yet to attain
full proportion. Few State banks had joined the system,
and the amendment of June 21, 1917, requiring member
banks’ legal reserves to be kept in their entirety in reserve
banks, had not yet been enacted.
In view of the fact that this period closes before the
amendment of June 21, 1917, and in view of the further
fact that the reserve banks’ reserves were to be enlarged
by successive accretions of gold, it would be unprofitable
to calculate the amount of credit and note-issue expansion
which the reserve banks’ reserves would support on the
date of the outbreak of the war. But a few facts relating
to the conditions of member banks will serve to enable us
better to understand the credit situation at this time.
March 5, 1917, the required reserve for the net deposits
of member banks was not quite 15.5 hundred millions of
dollars. On this date the actual reserve (vault reserve,
plus amount due from Federal Reserve banks plus amount
due from reserve agents) was almost 26.5 hundred



millions.1 Irrespective of any further aid to be secured
through rediscounts, the member banks, as a whole, were
in an exceedingly strong reserve position.
These facts should not be interpreted, however, as pro­
viding solely a basis for congratulation. It is true that
the public and the banks were destined to support a war
finance programme of unparalleled magnitude. It is also
undebatable that without the Federal Reserve all this
would have been impossible. But it is still true that the
huge surplus reserves gave a false sense of security. They
seemed to justify expenditures by the Government- of any
amount for any purpose. Much delay and many mishaps
were to be encountered before it came to be realized that
the problem of war finance was not primarily one of sup­
plying dollars, but rather one of securing for war purposes
labor and materials. Some time was to elapse before it
could be understood generally that labor and materials
were limited in supply even if dollars were not.
1 Cf. Bulletin, June i, 1917, p. 484.

TO NOVEMBER n , 1918
h e general policy of the Federal Reserve administration
during the period of our participation in the World War
may be epitomized briefly as one of complete and cordial
cooperation with the Treasury. Once the Treasury had
announced its plans, the banking machinery was adapted,
so far as possible, to the work of furnishing the necessary
financial support. To quote from the Bulletin for January
I, 1918:1
Under the leadership of the Secretary of the Treasury 2 the banks
have done their duty admirably in placing both the short- and
long-term securities of the Government.


The financial story of the war can thus be read to a very
large extent in the policies of the Federal Reserve Board.
The first respect in which the reserve banks were called
upon to lend their facilities to the Treasury was in con­
nection with the sale of short-term'Treasury certificates.
Only to a limited extent were funds for war purposes
obtained in advance of disbursements by means of taxa­
tion or bond sales. In large measure funds would be
acquired first through the sales of short-term certificates.
Upon their due dates the accumulated certificates would
be retired through the proceeds of taxation and bond sales.
The Treasury announced at an early date its intention
to follow this policy. On April 20,1917, Secretary McAdoo
xPage 1.
* Italics are the writer's*



stated that as soon as the War Loan Bill became law sev­
eral hundred million three per cent certificates, payable
June 30, would be issued.1 In order to avoid temporary
shortage of banking funds in the communities where the
certificates were purchased, the Treasury stated that
disbursements would be made in such a way “ that as far
as possible money paid in will be promptly returned to the
market.” 2 But in case these measures should prove in­
sufficient, it was announced by Governor Harding that 3
“ the Federal Reserve Banks may be counted upon by
offering liberal terms of rediscounting to do their utmost
in counteracting any effect of temporary dislocation of
banking funds.” Within a month there were three issues
of these certificates totaling $650,000,000.
But what specific measures should be provided to
render effective this offer of support to member banks?
It was evident that no alterations need be made in the laws
or regulations governing eligible paper. The original act
permitted the reserve banks to rediscount customers’
paper drawn for the purpose of carrying bonds of the
Government of the United States. Since the amendment
of September 7, 1916, provision had existed for the direct
discount of member banks’ promissory notes secured by
“ pledge of bonds or notes of the United States” as well as
by eligible paper. Federal Reserve support was in large
measure, therefore, a question of the rates of discount.
In the Bulletin of June 1, 1917, we read:4
The Board, therefore, recently took under consideration the
question of establishing a rate of discount for the short-term
notes of member banks secured by Liberty bonds or by short­
term certificates as collateral, as well as the question of a favor1 Bulletin, May 1,1917, pp. 341-42
* Ibid,.
3Ibid., p. 342.
* Page 425.

DEVELOPMENT, MAY, 1917, TO NOV. n , 1918


able rate of rediscount for customers’ notes collateraled by such
bonds or certificates and offered by the member banks to the
reserve banks with their own endorsement.
As a result of this consideration the Board announced in
May its willingness to approve a rate of 3 per cent on
member banks’ notes collateraled by war paper. On May
22, it issued a circular stating that it would ratify a rate
3/^ per cent on the rediscount of customers’ notes
maturing within ninety days secured by Government
bonds or Treasury certificates. Since the first war bonds
bore interest at 3 ^ per cent, the bond subscriber was
iuirly well protected against the dangers of subscriptions
exceeding his ability to pay.
Inasmuch as the rate of interest increased on later issues
of war bonds, it would be expected that the reserve banks’
rates would increase also. Accordingly on the date of the
armistice the rate was 4 X per cent on 16-90-day paper
secured by war issues. In addition to these measures
some use was made of a 3 -4 ^ per cent rate on one-day
discounts arising in connection with the Government’s
loan operations.
It did not seem feasible to the reserve management to
establish high rates on other types of paper even in this
period of capital-strain. All rates of interest are more or
less closely related. High money charges exacted from the
public on business loans would increase the difficulty of
selling war bonds at low rates. Accordingly the 90-day
rate on commercial paper, which on April 30, 1917, was
4 per cent in five districts, and 4yi. per cent in seven, was
advanced only slightly during the period of hostilities.
On the date of the armistice it was 4 ^ per cent in seven
districts and 5 per cent in the others.
But the reserve banks did not confine their efforts to
keeping their own rates low. In many ways they endeav-



ored to bring pressure on member banks to offer loans to
the public cheaply, as well as to maintain low rates on
deposits. For instance, in the schedule of rates for Octo­
ber 31/1918, the member banks’ ability to secure a 4
rather than a 4 ^ per cent rate would depend, in two
districts, upon whether the customer’s paper had been
discounted at a rate not exceeding that borne by the
bonds. On several occasions we find the reserve admin­
istration cautioning banks against raising rates allowed on
deposits. To quote from a letter by Governor Harding of
February 26, 1918:1
Banks should remember that when deposits are reduced
reserves are released. Reckless competition for deposits sup­
ported by high interest rates will tend to force the Government
to pay higher rates, thereby imposing additional burdens on the
people; and any forced and artificial expansion of banking
credits will promote rather than check inflationary tendencies,
which should be guarded against at the present time. There
does not seem to be any demand on the part of depositors for
increased rates of interest on their balances, and the Board
wishes it understood that it does not favor any movement to
increase these rates and that it will do all in its power to dis­
courage it.
Because of the enormous demand upon the reserve
banks’ rediscounting facilities during the war, mere sug­
gestions from the Board were undoubtedly more than
ordinarily efficacious. But enough has been stated to indi­
cate the complete cooperation of the reserve banks with
the Treasury. The writer has found no important instance
in which there was displayed an unwillingness to refuse
support for the Treasury’s low interest policy in the sale
of war bonds.
In the preceding chapter2 some information has been
1 See Bulletin, April 1, 1918, p. 252.
a See supra, pp. 264, 265.

DEVELOPMENT, MAY, 1917, TO NOV. n , 1918 271
given regarding the ability of the reserve and member
banks to meet the demands upon them. There it was
shown that, at the outbreak of hostilities, the member
banks’ surplus reserves were huge and that the free gold
of the reserve banks would permit more than a doubling
of the issues of Federal Reserve notes and of credit
advances to member banks. But the expansive possi­
bilities of the system should be calculated on a date sub­
sequent to the amendment of June 21,1917, which lowered
reserve requirements and provided for their transfer in
entirety to reserve banks. Since the Comptroller’s figures
bearing upon the condition of national banks may be had
for November 20, 1917, the writer has selected November
23 as the date for his calculations as to the amount of
bank credits the surplus reserves of reserve banks might
enable member banks to grant the public. All figures are
given in thousands — i. e., 000 omitted.1
1. Gold reserve for federal reserve notes.
On N ovem ber 23, 1917, the gold reserve for note issues
totaled $635,497 ($623,948 deposited with the reserve agents
plus $11,549 in the gold redemption fund).
On this d ate the notes in actual circulation totaled $1,051,892.
T h e actual gold reserve was — or 62.5 per cent. T h e
minimum 40 per cent required would be $406,356.
T h e excess reserve for notes was $635,497 less $406,356 or
2. Possibilities of further note expansion.
Supposing the excess reserve for inotes to be used to support
the maximum value of notes, a further note issue is possible of
2)4 times $229,140 or $572,850.
3. Reserve for member bank deposits/
1 This calculation is quoted from H. L. Reed, “ Credit Expansion under the
Federal Reserve,” American Economic Review, June, 1918, pp. 270-82. See
pp. 279, 280.



On November 23, 1917, the net deposits of all the reserve
banks totaled $1,546,122; computed as follows:
Government deposits............................... $ 196,411
Due to members (reserve account).............. 1,426,648
Due to non-members (clearing account)_
Collection items................. .....................
Total gross deposits..............................
Due from other reserve banks, net.............
Uncollected items....................................

$ 11,872

Total deductions...................................


Net deposits..........................................



The gold reserve for net deposits totaled $969,207, as follows:
Gold coin and certificates in vault............... $530,045
Gold settlement fund................................. 385,662
Gold with foreign agencies.......................... 52,500

qA 207
The gold reserve for deposits was.----- - or 62.6 per cent.
The total lawful money reserve for depos­
its (gold reserve plus legal tender notes,
silver, etc.) was $969,207 plus $54,058
The lawful money reserve required (35
per cent minimum) would be..............

The surplus reserve for deposits was....... $ 482,123
4. Possibilities of further expansion of deposit credits of re­
serve banks.
‘Supposing the"surplus reserve for deposits to be used to sup­
port the maximum volume of member bank deposits, an increase
in these is possible o f--- times $482,123 or $1,377,494. This
represents a potential increase of more than 95 per cent. (Mem­
ber bank deposits with reserve banks on November 23 equaled
5. Possibilities of further expansion of deposit liabilities of
member banks.

DEVELOPMENT, MAY, 1917, TO NOV. 11, 1918 273
Supposing th at the required reserve for member banks aver­
ages 10 per cent, and that the $ 1,3 77 ,4 9 4 should be used to the
m aximum am ount to support their deposit grants to the public,
an increase in these is possible of to 10 times $ 1,3 77 ,4 9 4 or
$ 13 ,774 ,9 4 0 . T h is represents a potential expansion of more
than 90 per cent. (T otal deposit liabilities of national banks
on N ovem ber 20, were $14,798,000.) A n increase of note issues
b y $572,850 would probably furnish all the till money necessary
to support the $ 13 ,77 4 ,9 4 0 of bank deposits.

But even these figures do not show the full possibilities
of credit expansion on this date. No account is taken of
the huge surplus cash then reposing in the vaults of mem­
ber banks. Much new gold, moreover, was to continue
to accumulate in the vaults of reserve banks and many
large and powerful State institutions were yet to enter
the system.
To what extent we may next inquire was this expansive
power of the Federal Reserve utilized during the period
of hostilities? The following figures show the amount of
the total investment operations of reserve banks.1
M a y ........................................ $ 174,128,766
Ju ly.........................................
October.................................. 2,770,806,092
November............................... 3,394416,518
December................................ 1,137,104,390

January................................... $1 ,525,984,729
1443 ,795,053
March...................................... 1,993,080,060
April........................................ 2,605,719,776
1Figures do not include rediscounts and sales of discounted paper between
Federal Reserve banks nor purchases of United States certificates of indebted*
ness. See Report of the Federal Reserve Board, 1918, pp. 191-92.


M a y ......................................... 3,309,207,111
Ju ly.........................................3.490,037,616
August......................................3 .955.6 i i ,937
September............................... .4 .953 .969.540

The following table shows the changes in the reserve
banks’ total earning assets, member banks’ reserve ac­
count, and Federal Reserve notes in actual circulation for
various dates: 1
o o o ’s O m it t e d
D ate

T otal E arning
A ssets

F ederal R eserve
N otes in A ctual
C irculation

M ember Banks'
R eserve
A ccount

A p ril 27............
M a y 25 . . . . . .
June 29..............
Ju ly 27..............
A ugu st 31 . . . .
Septem ber 28 .
O cto b e r 26. . . .
N ov em b er 30 .
D ecem b er 28. .



3 8i»o6 3



700,212 j


813,326 ,
1,033,460 '
1, 135,456
1. 136,930

January 25 . . .
F ebruary 21 . .
M a rch 28-29 • •
A p ril 26............
M a y 3 1 ............
June 28 ............
Ju ly 26..............
A ugu st 30 . . . .
Septem ber 27 .
October 2 5 . . . .
November 29 .

$ 1,029,670

1 ,286,162
1,345, 1 »
1 ,716,987

2 ,312,359

i ;452.838

1 ,870,835

$ 1,480,743


Some surprise may be evoked by the fact that the
growth of the note issues was so much greater than that
of the book credits granted to member banks. This is
* See Reports of the Federal Reserve Board, 1917, p. 60; 1918, pp. 122 and 117.

DEVELOPMENT, MAY, 1917, TO NOV. 11, 1918 275
explained in large measure, however, by the fact that the
notes were being substituted for gold in the general circu­
lation. The process was one by which notes were issued
to meet member banks’ counter-money needs and the
gold of the reserve banks was being deposited with the
Federal Reserve agents as cover. This is shown by
the following figures:
G old C o v e r


F e d e r a l R e s e r v e N o t e C ir cu latio n 1
(000,000’s O m itt e d )

D ate
June 2 9 . . .............................. .............. $ 402
July 2 7 ......... ....................................... ....434
August 3 1 .................................................493
September 2 8 ...........................................558
October 26................................................614
N ovember 30....................................... .... 661
December 2 1 ...................................... ..... 746
January 25......................................... .$ 793
February 2 1 .........................................
March 29..............................................
April 26................................................
M ay 3 .................................................
June 28..................... ..........................
July 26.................................................
August 30............................................. 1,016
September 2 7 ..................................... . 1,161
October 25............................................ 1*184
November 29....................................... 1,216

To a greater and greater extent the country’s gold was
being drawn into the hands of the reserve agents where,
according to the amendment of June 21, 1917, it would be
counted as part of the reserve banks’ 40 per cent required
reserve. B y this process other gold in the reserve banks’
vaults was released to serve as the reserve for deposit
grants to member banks.
xSee Reports of the Federal Reserve Board, 1917, p. 47; 1918, pp. 97,98.



The effect of the discount operations upon reserve
banks’ ratio of cash reserve to net deposits and notes is
next indicated:
R a t io o f T o t a l C a s h R e s e r v e s t o N e t D e p o s it s a n d F e d e r a l
R eserve N otes 1

March 30..................................... ............ 89.0
June 29................................ ................... 75.4
August 3 ........ ..........................................81.9
November 2 ................ . ........................ 69.0
December 28............................................ 63.6
February 2 1 ............................................. 66.0
April 1 9 .................................................. 62.9
M ay 3 1 ................................................... 62.0
July 1 ..................................................... 59-8
August 3 0 ........................... ....................56.4
November 22 .. ........................................ 50.5

Great, however, as was this reduction in the reserve
ratio, it would have been much greater had it not been for
the new accretions of gold by the reserve banks. On April
5-6, 1917, for instance, the total gold holdings of reserve
banks (gold in vaults plus gold with foreign agencies plus
Gold Settlement Fund plus gold deposited with Federal
Reserve agents as cover for the notes) was $943,552,000.
On November 15, 1918, this total was $2,056,777. Credit
and currency expansion were so great and so rapid that
the huge surplus reserves of April 6, 1917, would have
fallen far short of meeting the demands. Only the attrac­
tion of gold from the general circulation enabled reserve
banks to maintain a favorable ratio. As it was, the reserve
ratio fell approximately forty per cent in little more than a
year and a half of hostilities.
Let us next ascertain the effect of the war upon the
operations of member banks. Between May 1, 1917, and
1 See Reports of the Federal Reserve Board, 1917, p. 15; 1918, pp. 9,10.

DEVELOPMENT, MAY, 1917, TO NOV. n , 1918 277
November 1, 1918, demand deposits of all national banks
responding to the Comptroller’s c a ll1 increased from
$7,618,011,000 to $8,640,818,000, or more than a billion
dollars. Time deposits increased in the same period by a
sum approaching $300,000,000. Loans and discounts
advanced in the same time from $8,751,679,000 to
$10,096,940,000, or approximately one and a quarter
billion dollars. Total resources displayed a gain of
In view, however, of the huge increase in reserve bank
operations some surprise may be evoked because the in­
crease of member bank advances was not even more large.
Deposits with reserve banks comprise the legal reserves
for member banks. Each dollar of deposits with a reserve
bank forms the legal minimum reserve for many dollars
of its own deposits. The advances of reserve banks furnish
the basis for a several-fold expansion in member bank
We must recall the effect, however, of the amendment
of June 21, 1917, which required the deposit of all reserve
money with reserve banks. As country banks transferred
their funds from their city reserve agents to the reserve
banks, the deposits of the city reserve agents diminished
and those of the reserve banks increased. For instance,
the condition of reserve banks prior to the amendment is
indicated by the weekly statement of June 22, 1917. On
that date the reserve banks due-to-members account was
$806,209,000. The final transfer of reserves was com­
pleted July 20, 1917. On this date the reserve account of
members had increased to $1,164,995. More than
$350,000,000 of reserve bank deposits represented the
1 See Comptroller's Report, 1917, vol. 1, p. 35; 1918, vol. 1, p. 16. Figures for
May, 1917, are for 7,589 banks. Those for November 1, 1918, are for 7,754



shifting of reserves to reserve banks. So far as the increase
of Federal Reserve note issues is concerned, it has been
shown that they represented in large measure the sub­
stitution of notes for gold in the general circulation.
An increasing volume of currency and credit indicates
one of several results.1 First, it may point to a higher
degree of industrial and business activity. If the general
level of prices remains unchanged, greater production and
more numerous exchanges necessitate an increased circu­
lation of money. Secondly, the increased circulation may
indicate, not greater economic activity, but rather a higher
price level at which exchanges take place. Third, the
enlarged circulation may indicate changes either in the
amount of productivity or in the general level of prices.
Let us next endeavor to ascertain in which direction the
effect was felt most largely.
The figures of the United States Bureau of Labor Statis­
tics 2show an enormous rise of wholesale prices in this
period. Considering 1913 as a base year the index number
of wholesale prices for all commodities advanced as follows:
April.......... .172
M a y ......... .182
June.......... .185
July........... .186
A u g u st.. . . .185
September . .183
October . .. .181
November . .183
December.. .182

January. ..
February ..
March . . . .
M a y ..........
Ju ne.........



, J u ly ..........
August. . . . .202
September . .207
October . . . .204
November . .206
1 No account is taken here of changes in the rate of turnover of money. Un­
doubtedly money was becoming more efficient in this period. The Gold Settle­
ment Fund and the Federal Reserve Clearing System, for instance, lessened
enormously the amount of money required to effect inter-bank balances. To
the extent that the efficiency of money was increasing, we have another expla­
nation of the rise in commodity prices.
2Bulletin No. 269, July, 1920, pp. 16-19

DEVELOPMENT, MAY, 1917, TO NOV. 11, 1918 279
In the field of retail prices the movement for the same
period is indicated by the following index numbers of the
Bureau of Labor Statistics representing twenty-two
articles of food: 1
1913 = 100

April........... •145
M a y ........... .151
J u n e........... •152
J u l y . . . . . . . 14.6
I 4.Q
September . • 153
October . .. .157
November . .155
December . .157


January ..
February .
March . .
April . . . .
M a y .........
June... .
J u l y . . ..
August. . .
October . .

. 161


. 162


Both wholesale and retail prices displayed an excep­
tionally large advance. Let us next endeavor to ascertain
whether the volume of trade increased in anything like a
similar degree. Figures in this field cannot be accepted
with so much confidence because the increase in business
activity is bound up with that of increased prices. Bank
clearings, for instance, may show no more the effect of
increasing trade activity than the heightened price level
at which exchanges of goods and services were made. This
problem of entangling prices from the volume of business
has been most successfully attempted, however, in statis­
tics relating to the production of raw materials. According
to figures contributed by Professor Wesley C. Mitchell,
the following index numbers represent changes in the
production of ninety commodities. In order to eliminate
the effect of the change in the price level the value of all
commodities is figured oh the basis of 1917 prices.3
* Bulletin No. 270, February, 1921, p. 27.
9Cf. Bulletin, April i f 1919, p, 337.


I n d e x N u m b e r o f a l l C o m m o d it ie s
Y e a r l y P r o d u ctio n T im e s 1917 P r ic e s

1 9 13 .................. .............................................100

I 9 H - .............................................................. 99
191 5
191 6


191 7


191 8

..................................... 116

These figures would seem to indicate that the with­
drawal of labor to the field and camp almost overcame the
effect of speeding up industry by resort to the devices of
more complete employment, longer hours for labor, and
the bonus system. The year 1918 shows only a slight
increase over 1917. While the field of production statistics
has received little attention until recently these results
agree sufficiently closely for our purposes with those of
other statisticians. Walter W. Stewart, for instance, using
1913 as the equivalent of 100, shows the advance in 1918
over 1917 to be one point (125-124).1
These facts show that the enlarged media of exchange
correlates more closely with the rise of commodity prices
than with increasing trade activity. We may next inquire
as to the causal relationship between the increase in the
media of exchange and the advance in commodity prices.
It is clear that the bond method of war finance resulted
in an increasing money demand for goods. The part
played by the banks in furnishing funds for bond pur­
chases was such as to supply the means whereby the
Government and the consuming public were brought into
sharp competition one with the other. The Government
was given credit not previously in existence, and this credit
was employed for the purchase of labor and materials. So
far as these became more scarce relative to the demands
1 Cf. W. W. Stewart, “An Index Number of Production,” American Economic

Review, March, 1921, p. 68.

DEVELOPMENT, MAY, 1917, TO NOV. n , 1918 281
for them, the individual could secure them only by offering
higher prices. It is true, however, that this was not the
result of all types of Government bond purchases. If the
individual purchased the Government bonds out of sav­
ings, no enlarged money demand for goods was made
possible. Credit previously possessed by the subscriber
was transferred to the Government. To the extent that
this enabled the Government to offer money for goods,
the individual’s demand must be lessened. The Govern­
ment merely took the place of the individual and the con­
ditions of demand were not greatly altered.
But in many cases, war bond subscriptions resulted in
something more than the mere transfer of existing bank
credit from the bond purchaser to the Government. If the
bond was bought by a bank, bank credit was given to the
Government, but loans to the bank’s customers need not
be reduced. In case of a shortage of loanable funds, the
bank had merely to call upon the reserve bank for a dis­
count. In such a situation customers of the bank retained
the funds they possessed before, and the Government
entered the market with new credit to bid for goods.
The same results followed when the individual hypothe­
cated his bonds with his bank as collateral for a loan, or
purchased the bond out of money loaned by the bank. In
these cases the individual’s bank account was not corre­
spondingly lessened by the bond purchase, and the net
result of the transaction was to furnish the Government
with dollars in such a way as not to lessen the bond pur­
chaser’s ability to offer dollars for goods. Finally, if the
bond was used itself as a medium of exchange, it operated
in much the same way as Government paper money.
The effect, however, of an enlarged monetary demand
for goods need not necessarily result in higher prices. The
increased demand may make possible production on a



larger scale in such a way as to lessen per-unit expenses.
To the extent that competition prevailed in the industry,
lower production costs would be reflected in lower prices.
Slight reflection, however, is required to indicate that
this could not have been the usual result. In order to
remove labor from peace to war industries, the wage scale
necessarily had to be advanced. New standards of labor
remuneration were thus established which unionized labor
insisted upon realizing elsewhere. The tremendous de­
mand for war materials made it necessary throughout the
industrial field to extend production to the relatively
inefficient plant. There was much work for the marginal
concern. These factors seem to have more than counter­
balanced the economies occasionally realized of large;-scale
production. Enlarged demand necessitated greater perunit expenses and accordingly higher prices. The only
means of preventing such a result would have been to
employ a method of war finance whereby advances of bank
credit to the Government could be made only by lessening
the public’s command over dollars of credit or currency.
The bond method obviously could not do this.
It is no part of the purpose of the writer to elaborate the
objectionable features of the war-time price advance. The
difficulties created, particularly for the unorganized
worker, the bondholder, public utilities, endowed univer­
sities and hospitals, in general for the recipients of rela­
tively fixed incomes, have been sufficiently elaborated in
popular discussion. It is fully understood, also, how the
destruction of old standards of fair prices, standards which
were the crystallization of past competitive conditions,
made it virtually impossible for the consuming public to
keep a close check upon the profiteer. Labor disturbances
also and the consequent interference withy war materials’
production were frequently attributable to the worker’s

DEVELOPMENT, MAY, 1917, TO NOV. n , 1918 283
unwillingness to submit to a reduction in the real value
of his wage. Altogether, price inflation enabled a small
class of society to levy undeserved tribute upon the other
classes. Profound and permanent changes in the social and
economic structure of society were the inevitable results.
Most of these changes, affecting extremely harshly the
middle classes and the organized worker, were not such as
to render easier the preservation of real democracy in this
country’s future.
But the writer would prefer to emphasize two special
aspects of the war-time price increase. In the first place,
it rendered more difficult, if not impossible, the satisfac­
tory solution of many international as well as of domestic
post-war financial problems. Secondly, it retarded the
speedy mobilization of this country’s material and man­
power for war.
It was clear to careful observers that our post-war
requirements would be such as to necessitate easy money
and liberal credits. The release of soldiers from field and
camp and the cessation of work in the munitions’ factories
would demand the rapid return of these men into indus­
try. To fail to secure their speedy reentry must mean
unemployment, discontent, and unrest. Accordingly, the
post-war banking policy must be one of easy money rates
and liberal credits. The banks should offer this stimulus
to industry after the war.
Every dollar of credit expansion during the war ren­
dered this post-war relief more difficult, however. Even
despite the sudden cessation of hostilities the war-time
advance was such as to render a further increase almost
unendurable to the non-entrepreneurial classes of society.
As it was, prices got further out of line with each other,
and the inevitable readjustment was rendered more
serious. But if the war-time price advance could have



been retarded, a slight post-war increase, made possible
by offer of liberal bank credits, could have been withstood
with comparative ease.
The price increase of the war period rendered more
difficult also our post-war position as the world’s banker.
Despite the enormous advances to Europe made in the
days following the signing of the armistice, there seems no
doubt in the mind of the writer that we fell far short of the
demands upon us. This should not be construed as mean­
ing that we did not loan Europe sufficient sums for non­
productive purposes. On the contrary, the writer feels
that one of our greatest mistakes of the reconstruction
days was our failure to restrict Europe’s purchases to the
goods needed for her industrial revival. We permitted
her to dissipate her credit in the purchase of luxuries and
consumption goods until the point arrived when her pur­
chases must necessarily be restricted. Rather suddenly,
American export industries lost their European market.
There need have been no such loss of this foreign market.
If Europe’s purchases could have been confined to ma­
chinery, necessary raw materials, production goods in
general, her ability to continue to buy from us need not
have been impaired. The resuscitation of her industries
would have enabled her in time to purchase our goods
through offer of the credits established throughout the
world by sale of the products of her revived industries.
But as it was, Europe used up her credit quickly without
restoring her earning power. We could have afforded to
loan far more to her had the credits been used for wise
reconstruction purposes. The delay of reconstruction in
Europe helped to usher in this country’s depression of
But was price inflation necessary to win the war? Were
not bond subscriptions necessary to furnish the dollars

DEVELOPMENT, MAY, 1917, TO NOV. 11, 1918 285
required by speedy mobilization and rapid war prepara­
tion? Were not cheap rediscount rates necessary to
enable banks to guarantee their customers the funds for
their bond subscriptions? Could the twenty-odd billions
of dollars have been obtained other than by a policy of
Nobody would argue that any such colossal sum of
money could have been obtained in any other way. If our
total national annual income prior to the war was no more
than fifty billions of dollars, for which estimate there is
reputable statistical authority, nothing like fifteen or
twenty billions a year could have been obtained by taxa­
tion or borrowing from the public’s savings. Our economic
life was not so ordered as to permit the devotion of one half
or one third our total income for war purposes. The only
means of securing such a stupendous sum lay in direct
or indirect bank advances. But under this method each
dollar bought less than would the dollars contributed
under a tax or buy-a-bond-out-of-savings-only programme.
To secure the speediest mobilization of our war re­
sources, the funds for military purposes should have been
obtained from the existing volume of money and credit.
The lessening of funds expendable for peace goods would
have hastened the transfer of labor from the industries of
peace to the industries of war. The most rapid shifting
could be compelled only by lessening that portion of our
income stream customarily spent for civil goods. Credit
and currency expansion delayed the process of war
Since the war, when more leisurely reflection is possible,
there has been an increasing disposition to accept these
views. But these views, we are informed, represent judg­
ment ascertained after instead of before the fact. They
indicate only the hindsight of the parlor observer. In order



to make clear the writer’s position in this matter, he would
like to quote from an article prepared by him in the winter
of 1917-18 in the midst of our warlike preparations: 1
To what purposes, then, should the reserve banks’ surplus
gold be put? Should it be used at the present time to enable
member banks to increase their loans to the business public,
Or should it be carefully husbanded to meet post-bellum re­
quirements? Now is the time when this question of policy must
be met squarely. The Board that controls the largest surplus
stock of gold the country has ever held surely ought not to con­
tent itself with mere day-to-day decisions. Let the maximum
amount of credit be extended to-day and heightened commodity
prices will render this gold unavailable for later purposes. More
bank loans, and consequently more gold, will be needed to
finance the same volume of transactions. Deflation can take
place only slowly and gradually and with resultant depression
to business.
In the minds of the great majority of the people the Board
can make but one choice. We are reminded that the present
need for funds exceeds that of any previous period, that the
gravity of the war situation demands that every possible dollar
be used to meet existing requirements regardless of any oppor­
tunities to come. National defense, we are told, supersedes all
future trade advantages. By liberal offer of its credit the Board
should quicken, therefore, the course of present industry. If
inflated prices result, these must be accepted as part of our
sacrifice to the cause of democracy.
Each day, however, the fallacy of this view grows more obvi­
ous. It is becoming clear that the production of war supplies is
fundamentally not a problem of securing dollars, but rather one
of commandeering labor and materials. The real problem of war
finance is to shift labor and equipment with the least possible
delay from the unessential to the necessary war industries. No
matter what financial programme is adopted, it is clear that only
by restricting the operations of the non-war industries can there
be the largest possible increase in the production of military
xCf. H. L. Reed, 1 Credit Expansion under the Federal Reserve,” American

Economic Review, June, 1918, pp. 270-82.

DEVELOPMENT, MAY, 1917, TO NOV. 11, 1918 287
supplies. The stream of purchasing power that ordinarily flows
to the one must in large measure be transferred to the other.
The quickest transition can take place, not by increasing the
total volume of bank dollars, but by diverting dollars from
former fields of expenditures. The funds for financing war indus­
tries and activities should be obtained in largest part from the
existing volume of money and credit.
In the last analysis the real gain from economizing our gold
does not arise from an internal expansion of credit. By virtue
of price adjustment domestic industry can accommodate itself
either to a large or to a small volume of bank credit. The ad­
vantage of refining our credit system results rather from foreigntrade operations. To support our credit structure with less gold
releases the surplus for foreign purchases, virtually enabling us
to obtain the products of foreign industry without the expendi­
ture of labor or the sacrifice of material on our part. To the
extent, therefore, that foreign countries are not in a position to
sell to us to-day, our surplus gold should be retained for postbellum needs. In the measure that we use this gold at the pres­
ent time to support domestic loans, and thereby inflate the
general level of prices, we lose our power to reap the final and
ultimate gains.
Inflation is sometimes defended on the ground that
rising prices have a stimulating effect upon industry. So
much accustomed are we to think in terms of dollars,
rather than in terms of their purchasing power, that an
increase of money incomes may exert a favorable psycho­
logical effect upon business and labor. As David Hume
once described the effect of the gold and silver discoveries
of the sixteenth century:1
Accordingly we find that, in every kingdom into which money
begins to flow in greater abundance than formerly, everything
takes a new face: labor and industry gain life: the merchant
becomes more enterprising, the manufacturer more diligent
and skillful and even the farmer follows his plow with greater
alacrity and attention.
* Essays, Moral, Political and Literary.



This argument was scarcely applicable, however, to the
period of our participation in the war. Our financial
problem was as much to repress the industries of peace as
to stimulate the industries of war. The rising prices stimu­
lated the unnecessary quite as much as the necessary war
industries. Rapid preparation for war could come only
by withdrawing capital from the industries of peace at the
same time that funds were being made available for those
of war.
There is no doubt but that the general public was un­
prepared for heroic financial measures. Our patriotism is
a curious thing. It is fit that men be conscripted to die
upon the firing line. It is not fit that there be conscription
of the civilian’s income, not his capital, to equip the sol­
dier. Yet those who resist taxation, the logical method of
transferring funds from civil to war expenditures, are the
stuff out of which war heroes are made! We seem to prefer
to bear the financial burden of war indirectly, rather than
directly, in the form of higher living costs. But this sort
of a sacrifice is most inequitably imposed upon the people
of society.
Would it have been possible, however, to educate the
public to the fact that the bond method, in the same
manner as any other, involves a real burden which the
public cannot shift to another generation by borrowing
from its own people? In the last analysis the economic
burden of war consists in the using up of commodities and
human services for purposes of destruction, thus lessening
the volume of production for civil uses. Selling bonds to
its citizens does not mean the shifting of the burden to a
future generation. An internal debt is not a burden for a
people as a whole. To the extent that some are taxed to
pay the interest and the principal of the bonds, others
benefit by receiving these taxes in the form of bond inter-

DEVELOPMENT, MAY, 1917, TO NOV. n , 1918 289
est and principal repayment. If bonds are not in the next
generation a burden upon the people as a whole, there
could be no shifting of the burden from the generation
which witnessed the conflict.
It may be that it would have been impossible to secure
general confirmation of these simple economic principles
by the ordinary processes of education and propaganda.
But if so great attention had not been drawn to the virtu­
ally unlimited supply of dollars in the reserve bank reser­
voirs, the necessity of higher taxes and more restrictive
rationing methods would have become apparent much
more early. Gradually we should have seen that a modem
world war necessitates financial as well as military con­
scription. But the part played by our public authorities
was such as to deaden our perception of these facts. We
were encouraged to buy bonds on such terms as inevitably
to create price inflation. Individual subscribers were
offered funds indirectly obtained from the Federal Re­
serve; banks virtually were informed that they would be
protected by the Federal Reserve banks against over­
subscription on their own part or on the part of their cus­
tomers. Everything possible was done to lull instead of to
arouse a spirit of critical analysis by the public.
But what was the responsibility of the Federal Reserve
administration in all this? Should the Federal Reserve
Board have refused to cooperate with the Treasury?
Should it have based its rediscount policy upon general
banking and financial considerations alone and have
ignored the Government’s fiscal programme? Should the
reserve banks have ignored the bond issues in the forma­
tion of their discount policies?
Only slight consideration is required to indicate the
undesirability of any hostile attitude. During time of war
the various governmental agencies cannot refuse mutual



cooperation. They cannot work at cross-purposes. Coiv*
gress had sanctioned the bond method of war finance, and
the treasury undoubtedly acted in accordance with the
general point of view in recommending the “ low interest”
policy. When Congress enacted the Federal Reserve Act
it provided specifically for ex-officio membership on the
Board of the Secretary of the Treasury and the Comp­
troller of the Currency. Was not this the expression of its
desire that there be close cooperation between the Treas­
ury and the reserve banking authorities?
From the standpoint of political expediency it would
have been extremely unwise for the Reserve Board to have
refused full cooperation with the Treasury. From the
time of Andrew Jackson the public has accepted the dic­
tum that the management of a central banking system
must consider itself a servant of public authority. During
the World War it could not have established for itself an
independent position.
Whatever responsibility can be placed on the shoulders
of the Board, therefore, can only be those resulting from
its encouragement of an unsound financial policy. The
final question to be investigated, therefore, is whether or
not the Board’s counsel was such as to encourage infla­
tionary tendencies.
There is no doubt regarding the Board’s position in this
matter. Throughout the war it preached the doctrine of
conservation of credit as well as of goods. To quote from
its official pronouncements in the January I, 1918,
Events are, however, every day making it clearer that the
conservation of our financial strength is not of itself sufficient
to ensure the successful financing of the war. The financing
of the war is only in part a money problem; in very large part

DEVELOPMENT, MAY, 1917, TO NOV. n , 1918 291
it is an economic problem — a problem of conserving the
economic as well as the financial strength of the Nation. . . .;
Nobody should, therefore, consume goods except to the extent
that their consumption is necessary to maintain health and
Let the public realize that it is more respectable in such war
times as confront us to be seen in old clothes than in new ones.
Let the banks tell the people of their communities and their
authorities, the mayors and governors, that this is not the time
for cities to be spending money on public works. . . . ;
. . . it must nevertheless be our constant concern to keep
every dangerous tendency in the banking situation under con­
trol and particularly to retard the too rapid expansion of bank­
ing credit. . . .
The effectiveness of such implorations may well be
questioned. Spending cannot be lessened while the means
of spending increase. Nevertheless, the Board’s record,
during this period, was clear. Whatever the evils of the
easy-money policy of war finance the responsibility can­
not be laid at its doors. The fault was that of the Treas­
ury, of Congress, and of the people. So infrequently does
war occur that the requirements of successful war finance
are not generally understood. No nation ever taxed itself
sufficiently highly during a great war. Any other policy
must be inflationary. During the Civil War the inflation
was a matter of greenback issues. During the World War
it was a matter of note issue and bank credit expansion.
But throughout this period the reserve banks were merely
financial instruments through which the Treasury en­
deavored to accomplish its aims.

1918, TO MAY, 1920
f t e r the signing of the armistice, the industrial outlook
was extremely uncertain. It is true that most of the long­
time forces seemed to point toward the early resumption
of general prosperity. The labor and the materials that
had been utilized for war purposes would now be available
to supply our normal wants, and, moreover, the cessation
of hostilities enabled industries to be freed shortly from a
host of restrictive measures. Gradually embargoes upon
certain articles of export were removed, the list of pro­
hibited imports reduced, and the priority rules established
under the rationing policy of the W ar Industries Board
abandoned. Shipping was increasing in quantity, building
and construction were no longer to be discouraged by
public authority, and the war restrictions relating to the
securing of investment capital for private enterprise were
repealed. With these fetters removed, it appeared that
the general economic welfare soon would improve.1
Expressions of confidence frequently overlooked, how­
ever, the fact that in our existing economic society indus­
trial activity depends upon the volition and the appraisals
of the entrepreneur. If he does not feel the situation ripe
with profit-making possibilities, industrial stagnation is
our lot. Instead of demobilization increasing the more
complete utilization of our labor force, it might mean


1 Cf. H. L. Reed, “ The Industrial Outlook,” Journal of Political Economy,
April, 1919, pp. 225-40

DEVELOPMENT, NOV. 12, 1918, TO MAY, 1920


merely the recruiting of the army of the unemployed. The
essential question at the close of 1919 was whether or not
industrial and financial conditions were such as to arouse
enthusiasm on the part of the entrepreneur.
In very many respects the situation was cloudy. Money
wages of the laborer had increased far above their pre-war
level and it did not appear that they could be reduced
quickly. Organized labor appeared determined to hold
what it considered to be the gains of the war period, to
insist upon the prevailing wage scale even though com­
modity prices should fall to a lower level. It is true that
the manner in which wages were increased was frequently
such as to offer hopes of speedy reduction. The elimina­
tion of extra hours of labor would remove the necessity of
paying high rates for the products of the hours of greatest
fatigue. With the suspension of work in the war industries
the employer’s bargaining power would be still further
increased. A strike could take place only in a situation
where many unemployed would be looking on. The return
of soldiers, moreover, would enable the employer to take
his pick and select only the fit. During the war, labor costs
were high, not merely because of the high money wages,
but also because employment had to be offered to the most
inefficient of the labor group. Nevertheless, there was the
likelihood that the life of the soldier had been such as to
unfit him for steady work in monotonous tasks. War
necessarily creates a spirit of unrest and independence,
not consistent with strict industrial discipline.
As to finding markets for industry’s products there
appeared to be much less uncertainty. The economies of
the war period left many demands unsatisfied. Work on
the roads, on buildings, on capital equipment of various
sorts, could not continue to be neglected. In the course of
time the Government demand for investment funds would



relax and enable a part of society’s income stream to be
redevoted to the purchase of neglected goods and services.
In one way it was particularly fortunate that a large
portion of our soldiers did their fighting three thousand
miles from the United States, and that many months
elapsed before all of them could be returned home. In­
dustry was not required to plan for the immediate absorp­
tion of all of these millions. Demobilization began with
certain special units in this country and was extended
gradually. As the men first discharged worked their way
into industry, their own wages would help to create the
demand for the production of other goods. By the time
the divisions from the battle front returned, industry
might be revived sufficiently to offer them general
From the banking standpoint the situation was some­
what more hopeful. A t the close of hostilities the reserve
ratio of the reserve banks was approximately fifty per
cent. It would appear that this would be sufficient to
guarantee ample funds for a moderate volume of new
financing. It was true that the expenditures of the war
had not terminated. One new bond issue was yet to be
offered to the public, and it was plain that for some time
the Treasury must appear in the loan market as a bidder
for investment capital. There were also certain possibili­
ties of a considerable drain of gold from the reserve bank
reservoirs. During the war the embargo upon gold pre­
vented us from balancing our indebtednesses by shipments
of the money metal, particularly to the neutral countries
of Europe and to certain nations of the Orient. Unpaid
balances as well as new indebtedness might create a heavy
demand for this purpose. It might be that our inability
to collect gold from the warring nations of Europe might
subject us to a loss of gold even though our general trade

DEVELOPMENT, NOV. 12, 1918, TO MAY, 1920 295
balance was favorable. But all in all the sudden termina­
tion of hostilities left our banks in fairly good shape.
It was in the matter of prices, however, that the greatest
uncertainty existed. There was grave doubt everywhere
as to whether the war level could be maintained. Un­
doubtedly the common prediction was that the removal of
war conditions would destroy the cause of the high prices,
and that in a short period the restoration of production
would bring about their decline. It is true some difficulty
was experienced in explaining how there could be enhanced
production in a situation of tumbling prices. Would not
weakening prices destroy the entrepreneurial incentive
to productive activity? The general feeling, nevertheless,
seemed to be that the war level was an abnormal level,
and that normal conditions would mean the return of the
pre-war level.
Such, for instance, was the prediction of Mr. B. M.
Anderson. To quote from his argument:1
The belief that there will be a drastic drop in prices is based
on obvious conditions. With a vast volume of labor rapidly
being discharged from munition factories the world over to
resume the production of normal supplies; with steel, copper,
coal, shipping and other essentials released; with 50,000,000
soldiers returning to farms and factories, there will be an
immense increase in the volume of goods available for civilian
consumption. Prices should fall, even before this actual trans­
formation is carried far, because wholesale markets commonly
forecast impending changes.
It must be admitted that the price movement, shortly
after the armistice, tended to confirm these views. The
wholesale price index of the Bureau of Labor Statistics
showed for December, 1918, a decline in the clothing,

1 “When War Ends and Prices Drop,” Economic World, November 23, 1918,



metal, and chemicals groups.1 Both in January and in
February the index for all commodities fell somewhat.
The first two months of 1919, moreover, displayed a de­
cline in the index number of retail food prices.2
In the belief that a continuous price decline was in­
evitable, certain projects were launched for the purpose of
hastening the return to the “ rock-bottom” level, the level
at which industry could figure upon the immediate revival
of activity. No positive achievements resulted from these
projects, but there was no disposition to impose harsh
restrictions upon industry. The Federal Reserve banks
held their rates low. For January, 1919, the average rate
charged on all paper discounted by the reserve banks was
4.18 per cent and for February 4.14 per cent.3
In a short time, however, it appeared that predictions
of price decline were not to be fulfilled. Both in March and
in April the all commodities wholesale index of the Bureau
of Labor Statistics showed a slight increase, and the
expected 'difficulties of finding employment for the
returned soldiers did not seem insurmountable. Undoubt­
edly most observers were amazed at the rapidity with
which industry adjusted itself to the new conditions. It is
probable that not one tenth as much discussion was heard
of the problems of reconstruction as had been anticipated.
The May, 1919, Bulletin noted that price recessions had
not been as rapid as predicted. It stated:4
What is now happening seems to indicate that business will,
after a period of initial readjustment in prices, proceed upon a
level not far removed from that established during the war,
leaving the question as to the ultimate level of prices to the
future and to more slowly acting forces.
1 See jBulletin No. 269, July, 1920, pp. 16-19.
a See Bureau of Labor Statistics, Bulletin No. 270, February, 1921, p. 27. The
index numbers are made up of the prices of twenty-two articles of food.
3Report of the Federal Reserve Board, 1919, p. 176.
4 Page 411.

DEVELOPMENT, NOV. 12, 1918, TO MAY, 1920 297
Various were the explanations which were offered for
this unexpected firmness of prices. For one, the foreign
demand for our products proved much stronger than
anticipated. Also during the war, the prices of many
commodities had been held artificially low by the pricefixing activities of Government agencies. When the
restrictions were removed, supply and demand conditions
were such as to exert a tendency for these prices to move
to a higher point. On the part of entrepreneurial manage­
ment there was undoubtedly also a recognition of the fact
that the time was not opportune for a conflict with labor,
that since labor insisted upon a high level of money wages
it would be best for the time being to proceed upon the
assumption that wages were not to be reduced. Wages
could be put in proper relation to other prices by per­
mitting the general level to advance. But whatever the
correct explanation, it was recognized generally by the
spring of 1919 that the period of price uncertainty was
over and that the industrial barometer pointed toward
increasing activity.
The financial events of the following year are now well
understood in their general outlines. The country was to
experience a rise in prices, an expansion of currency and
credit, and a boom in industrial and Speculative activity
which exceeded by far even that of the war period. This
is indicated by the following facts:
April 25, 1919, the reserve account of member banks
with reserve banks was $1,664,320,000. April 23, 1920, it
was $1,859,062,000, a gain of nearly $200,000,000. In the
same period the circulation of Federal Reserve notes
increased more than $500,000,000 and earning assets over
$800,000,000. On May 12,1919, the Comptroller’s reports
show loans and discounts for 7773 national banks to be
$9,904,821,000. M ay 4, 1920, 7990 national banks pos­



sessed loans and discounts of #12,288,582,000. This was a
gain of more than two and a third million dollars. The
activity on the stock exchanges, the boom in security
prices, the rise of call-money rates exceeded past prece­
dent. In the field of wholesale prices the movement was
as follows:
B ureau


L abor

S t a t is t ic s * I n d e x

N um bers


W h o lesale

P r i c e s f o r A l l C o m m o d i t i e s . B a s e 1913 « i o o

1917-Marc h

................... .......................... 161

1918-Marc h


1919-Marc h
........... 201
April.................... .....................................203
M a y .. . ................................................... 207
June.......................................................... 207
Ju ly...........................................................219
August...................................................... 222
November.......... ...................................... 230
.............................. 248
1920-Januar y
February.................. , .............................. 248
March....................................................... 253
April.............................. ...........................266
M a y .......................................................... 272

In view of the fact that this currency and credit expan­
sion was so great as to cause the reserve ratio to fall from
71.7 per cent on May 2, 1919, to 43 per cent on May 7,
1920, and that on many occasions the New York Reserve
Bank’s ratio1 was on the margin of falling below the legal
1A slight change in the method of computing reserve banks* reserve ratio was
introduced February 12, 1920. Regarding this the January, 1920, Bulletin
(p. 3) states: “ Beginning with February 12, 1920, the reserve to be carried by
Federal Reserve Banks against deposits will be computed against immediately
available deposits only. Items on the liability side whose availability is deferred
and uncollected items on the resource side of the bank statement will be dis­
regarded in determining the liability upon which reserve is computed. This
action will tend to apply a more severe standard of computation, especially in
the case of those banks which have been carrying a relatively large float. ”

DEVELOPMENT, NOV. 12, 1918, TO MAY, 1920 299
minimum, some astonishment may be evoked because the
reserve administration permitted this enormous expansion
of credit and currency. It should be emphasized that this
expansion rendered possible an unexampled1 price in­
crease in time of peace. It had generally been expected
that the post-war era would witness an attempt to return
to pre-war conditions.3 As stated in the Bulletin for
March, 1919:3
The era of inflated prices maintained by aid of legislation or
by Government administrative action thus draws to a close, and
the aim to be sought is not that of perpetuating war conditions,
but that of returning to a stable footing upon the terms and con­
ditions that would be just and fair to all concerned. There is
much agreement with the Secretary of the Treasury in his
statement that the readjustment must begin with a reduction
in the cost of living to the consumer, sorely tried as the latter
has been by the grea{: inflation of prices and the additions made
to his living costs in many directions.
It should be kept in mind, furthermore, that in the latter
part of 1919 many speculative excesses were commonly at­
tributed to the rapid growth in the volume of bank credit.
Explanation of the credit policy of the reserve adminis­
tration may be attempted by considering the following
First, the short-time fiscal requirements of the Govern­
ment were such as to cause the Treasury to demand
easy money rates.
Secondly, there was the fear that higher rates would
work a hardship upon the holders of the war bonds by
depressing further the market price of their securities.
Thirdly, it was believed that easy credits were necesxUnexampled in this country since the greenback era.
2 As stated in the previous chapter, the writer does not believe this would have
been good policy.
s Page 191.



sary to enable industry to readjust itself quickly to the
new conditions.
Fourthly, there was a failure to perceive the correct
relation between expanding credits and rising prices in a
period of great industrial activity. The theory was appar­
ently accepted that prices were determined by other forces
than the volume of currency and credit.
Fifthly, a restriction of credits would have been politi­
cally unpopular. The public does not understand the
necessity of restraint in the manufacture of bank credit.
Its complaints are directed most largely against the results
of an unduly rapid expansion and not against the expan­
sion itself.
Sixthly, there was much doubt as to the effectiveness of
the weapons possessed by reserve banks to curb continu­
ous increases in the reserve banks. In no previous period
of Federal Reserve operation had restrictions been em­
ployed vigorously. Precedent and experience were lacking.
In regard to the short-time fiscal requirements of the
Treasury, it will be recalled that the Victory notes were
issued in the spring of 1919, and that in the succeeding
months the Treasury continued to meet its current re­
quirements by selling low-interest-bearing short-time
certificates. To have increased rediscount rates on paper
collateraled by these issues would have rendered their sale
difficult. It will always be a grave question as to whether
the continuation of the low-interest policy was justified.
Despite the depreciation of the dollar, it is probable that
such a policy was to the immediate advantage of the
Treasury. Since a large portion of the Government’s
disbursements were fixed in terms of dollars, its expendi­
tures did not increase proportionately with the decline in
the value of the dollar.
Whether or not there was warrant for subordinating

DEVELOPMENT, NOV. 12, 1918, TO MAY, 1920 301
banking considerations to Treasury requirements is an­
other matter. But as the situation developed it was not
until after January, 1920, when the Treasury gave up its
policy of floating certificates at abnormally low rates, that
considerations of banking policy became the controlling
But Government finance exerted its influence in other
guise than in the Treasury’s short-term requirements. It
was understood that the market quotations oi war bonds
must be further depressed if rediscount rates were in­
creased. If member banks could not rediscount paper
collateraled by war bonds, the banks could not carry the
subscribers without loss. Was not the Government mor­
ally obligated to protect those who had heeded its call to
borrow and buy bonds?
Thorough analysis seems to indicate that there was no
possible manner in which the interests of these bondhold­
ers could be protected fully. Bond prices could be upheld
only by a policy of inflation. But inflation meant a de­
cline in the purchasing power of the dollars realized by the
sale of the bonds. What if they did sell near par? The
proceeds would purchase less and less either in other secur­
ities or in goods, the greater the depreciation in the pur­
chasing power of the dollar. In other words, the sacrifice of
the bond-buyer in purchasing low interest securities must
mean loss to him. No policy of inflating to keep money
rates low could avoid this loss. Only an ease in the money
market, determined freely and without artificial control,
could aid him.
Those connected with the Treasury have not hesitated,
however, to defend its policy on the ground of war neces­
sity. To quote from R. C. Leffingwell, Assistant Secretary
of the Treasury:1
* See American Economic Reviewf March, 1921, pp. 30-36.



During the whole period of the war any attempt of the
Federal Reserve Board to control credit through rates would
have been futile. The Treasury would have had to meet any
rate they made at home, and the federal reseiVe bank rate could
have no effect upon the international situation, because the
international movements of goods, gold, and capital was con­
trolled by foreign governments or our own for the purposes of
the war. The adoption of a “ dear money” policy during the
war, with a view to preventing inflation would have failed of
that purpose unless it had been carried to such an extreme as to
bring about such conditions in war time as exist to-day, in which
case we should have lost the war and would have had to inflate
afterwards in order to pay the indemnity which Germany would
have imposed upon us.
If Leffingwell means by this that a higher rate on bonds
would not have enabled the Government to obtain many
more dollars from the bond subscriber, we may express
agreement. To a very large extent considerations of
interest and income were ignored by the bond-buyer in
the making of his subscription and a higher rate might not
have attracted greater purchases. No matter what the
rate, the national income was not large enough to permit
a large portion of the subscriptions to be made from
savings. Banks were obliged to advance a large part of
the funds, expecting individual subscribers to take them
up at a later date. But to the extent that these considera­
tions are true, we have another argument against relying
upon borrowing as the chief means of securing war reve­
nues. A t an earlier date heavier taxation would have
aided the process of speedy mobilization and would have
confined the financial disturbances more largely to the
period of hostilities.
But to continue Leffingwell’s statement:
After the war was over in the fighting sense, it went right on
in the Treasury sense. We reached the peak of expenditures in

DEVELOPMENT, NOV. 12, 1918, TO MAY, 1920 303
the three months, November and December, 1918, and January,
1919. We spent two billion dollars a month. That was as much
as the First Liberty Loan each month. Since armistice day
this Government has paid out as much as before armistice day,
twenty billions before and twenty billions after. The gross debt
of the Government on armistice day was eighteen billions. Nine
months later it was twenty-six and a half billions. While the
Government debt was mounting thus, the same condition
continued which had existed during the period of active warfare.
It was no more practicable to exercise control of credit by the
use of dear money than it had been before. Indeed, it was less
practicable, because the enthusiasm, devotion and self-sacrifice
of the American people while war was on vanished over night
with the signing of the armistice. The bills did not get paid any
easier, but a good deal harder, because the Germans had
And further:
Though something may be said for the view that in the latter
part of 1919 there might have been a somewhat earlier and
greater advance in rates on commercial paper and in the open
market buying rates for acceptances, my own judgment is that
this is a question of detail rather than of substance, and that the
effort to make money really dear before January, 1920, when the
Government was first able to reduce its floating debt to manage­
able amounts and maturities, would have risked more than it
could have hoped to gain.
The undesirability of any pronounced increase in re­
discount rates, as well as in the rates borne by the Treas­
ury certificates in the post-war period, seems clear to the
writer. But the matter of a slight increase at a date prior
to the fall of 1919 appears to be something more than a
mere matter of detail. While the enhanced cost of bank
credit in and of itself might not have been of great effect
upon industry it would have furnished the most forcible
statement possible of the reserve administration's dis­
content with the existing situation, and of its purpose to



restrict credits as soon as the condition of the Treasury
made such action possible. It might have prevented so
thin a stretching of the speculative bubble. Despite the
warnings of the Federal Reserve Board and of the reserve
bank directorates, very many came to look upon the
reserve system in the wrong light. For the first time in the
period of reserve operation, rediscounting began, to be
considered generally as primarily a means of securing
funds for profit-making opportunities. As stated by the
Board in its April, 1919, Bulletin: 1
Already some well-managed member banks are showing in
their statements the extent to which they are in debt to Fed­
eral Reserve Banks. It has been the opinion of the Board that
the borrowing of member banks at Federal Reserve Banks
might very easily be carried to excess, the loans being placed
there primarily for the purpose of profit and not for any more
general public or fundamental object. In a general letter to
banks, issued on November 19, (1918), and referred to in the
Federal Reserve Bulletin for December, the Board took occasion
to caution member banks which it was thought were in some
danger of overdoing their rediscounting, that the purpose of
such rediscount operations was not primarily that of assisting
the member institutions which placed the rediscount to obtain
the funds for further profitable operations, but was rather to be
determined upon the basis of general banking advantage or
upon that of relief for banks which found themselves hard
pressed or were suffering from reductions in reserve account.
The writer does not believe, however, that such warn­
ings as these were interpreted very seriously. Without
positive action in the form of rate increases they seem to
have been regarded merely as indicative of the Board’s
viewpoint, a viewpoint not likely to warrant coercive
measures. The crisis of 1920-21 was due to many causes.
One of these was excessive commodity speculation which
* Page 311.

DEVELOPMENT, NOV. 12, 1918, TO MAY, 1920 305
was fanned by the belief that credits would continue to
remain cheap. The only way to dissipate this belief would
have been to raise rates before the bull movement had
spread far.
An increase of a half per cent or so on the Treasury’s
short-term borrowings would not of itself have been an
important consideration. A few millions of extra charges
would have been a negligible consideration compared with
the losses suffered by this country in the industrial collapse
of 1920-21. Part of these losses might have been prevented
by initiating at an earlier date a policy of rate increases.
Strengthening, however, the view that rates should be
kept low was the desire to enable industry to readjust
itself quickly to new conditions. It was a matter of supply­
ing the stimulus of easy credits. Not until the summer of
1919 was there manifested any strong disposition to look
at the matter from the standpoint of the consumer’s
interests. In the general demand for lower living costs
which followed the Railway Brotherhoods’ insistence that
either their wages should be increased or the cost of living
lowered, there was manifested a general inclination on the
part of those prominent in the reserve administration to
lay the emphasis upon the necessity of wage revision
rather than upon a reduction in prices. Mr. A. C. Miller,
a member of the Federal Reserve Board, declared, for
instance, that
Some mechanism by which wages may promptly be adjusted
to changes in the cost of living must be accepted as an essential
part of the American wage system.1
He did not state what should be done to relieve the recipi­
ent of a fixed income, the bondholder, the bank depositor,
the endowed university or hospital.
« Cf. Bulletin, October 1 , 1919, p. 915.



Prior to the cost-of-living controversy in the summer of
1919 there had been no clear statement of the Board’s
position regarding the relation of an increasing volume
of currency to the general level of prices. But on August 8,
1919, in a letter replying to an inquiry of the Senate Com­
mittee of Banking and Currency, Governor Harding
expressed his views on this question. To quote a brief
extract from Governor Harding’s statement:1
The difficulty, indeed the impossibility, of keeping in circu­
lation an excessive volume of Federal Reserve notes should be
understood. . . . They are issued only as need for them devel­
ops, and as they become redundant in any locality they are
returned to the Treasury at Washington or to a Federal Reserve
bank for redemption. Thus there cannot be at any time more
Federal Reserve notes in circulation than the needs of the coun­
try at the present level of prices require.
In other words, the volume of note issues depends upon
the height of prices. Instead of the volume of currency
determining the general level of prices, it is a matter of the
level of prices determining the height of the price level.
Because the increase in circulation of notes had exceeded
the increased grants of book credit to member banks,
Harding’s communication dealt almost entirely with note
issues. It appears to the writer, however, that the same
position must be taken regarding deposit credits granted
by member banks. The underlying theory of Federal
Reserve note issues was that the notes should be emitted
under regulations more similar to those governing deposits.
In reality the nature of the note and the deposit are
identical. They both represent ways by which banks may
create credit or credit money. It is true that the note
possesses a greater circulation power and is needed by
banks to avoid losing reserve money on occasions when
x Bulletin, August 1, 1919, p. 699 ff.

DEVELOPMENT, NOV. 12, 1918, TO MAY, 1920 307
there is a drain on counter money. But so far as their
effect on prices is concerned, and that is the question now
under discussion, both must be regarded as part of the
general circulating medium.
If this theory be true, that the volume of the circulating
medium depends upon the height of prices, the reserve
administration’s responsibility would appear to be lessened
considerably. It never could issue more Federal Reserve
notes than the “ needs of the country at the present level
of prices require.” Its policy in creating credits or cur­
rency could never be attacked. Prices are determined by
other factors and other causes, without direct regard to
the acts of the reserve administration.
Since this theory, if accepted, would relieve the Board
of many attacks and adverse criticisms, it is not surprising
that the Board was inclined to emphasize it. But is it
Viewed superficially, the theory appears to be correct.
Every business man knows that there are countless trans­
actions in which prices are agreed upon first, and that the
bank credit to satisfy the purchaser’s indebtedness is
granted later. In such situations it appears that the
height of prices, independently fixed, determines the vol­
ume of credit later to be created. But what led our buyer
let us say a retail dealer, to agree to pay such and such a
price? The principal consideration was whether so high a
price must be paid to get the goods, and whether the
demand of consumers would be sufficiently strong to en­
able him to unload at a profit. It requires but a moment’s
analysis to demonstrate that both of these factors are
subject to influence by the banks in their grants of credit
to the business public.
Why did our dealer agree to pay the stipulated price?
Obviously, because the seller of the goods could obtain a



favorable price elsewhere. What enabled other dealers to
bid up prices for the goods? Obviously, it was a matter of
the general volume of currency or credit at their command.
In the creation of this credit, the banks elsewhere played
their part in determining the strength of the outside com­
petitive demand. If they had been more illiberal in their
advances, our buyer could not have been compelled to
offer so high a price.
It is also clear that banks’ advances help to determine
the terms on which the dealer can unload his goods. The
credit first advanced to him in the making of a purchase
is gradually diffused throughout all classes in society.
From the hands of the retailer it is passed successively,
perhaps, into the hands of the wholesaler, wage-eamer,
and landowner. It thus helps to determine the intensity
of the money demand of consumers for the goods.
But even if the effect of this advance of credit upon
supply and demand conditions elsewhere is ignored, it is
clear that the price our dealer will pay will be influenced
by his knowledge of the bank’s attitude toward his re­
quests for credit. In making credit available for the dealer,
the bank exerted an influence upon the money demand for
the goods.
The writer does not mean to argue that there are no
limitations upon banks’ ability to affect the price level by
the liberality of their credit grants. Under certain con­
ditions, particularly those of declining confidence in the
future stability of the market, banks’ discount policies
may have little effect on market prices. Bank credit can­
not be forced upon a reluctant business community. But
in a situation of increasing business confidence and rising
markets, of business activity and commodity speculation,
such a situation in fact as that of the summer and fall of
1919, banks did hold the key to the situation. They fur­

DEVELOPMENT, NOV. 12, 1918, TO MAY, 1920 309
nished the credits which enabled buyers to shove up prices
in their eager desire to get goods quickly.
As indicated in the previous chapter,1 however, an en­
larged money demand does not always bear as its prin­
cipal fruit higher prices. The enlarged money demand may
enable the scale of production to be increased on terms of
lower per-unit costs. To quote from the writer’s statement
in another connection:2
Suppose the situation is one in which additional labor and
materials are easily available, that new orders need not necessi­
tate enlargements of plants or changes in equipment. Larger
production may create possibilities of economy in the amount
of overhead or fixed charges allocated to each unit of output.
If, under these circumstances, retailers are stimulated to a
reasonable extent by information that the required credit will
be forthcoming, prices are not necessarily disturbed. As a
matter of fact they may even be lowered in that the retailers*
orders may make possible production under conditions of greater
efficiency. It may no longer be a matter of setting up greater
dollar competition for the limited quantity of goods, but rather
using more dollars to affect the transfer of more goods. Easy
and abundant credit may thus affect either the level of prices
or the volume of production or both. Undoubtedly the situa­
tion in which prices and production are both affected outnum­
ber the cases in which abundant credit works upon the one alone.
But as to which is most influenced an a priori answer is not
possible. It all depends on the industrial situation.
It is unnecessary to present evidence regarding the
nature of the industrial situation in the period following
the spring of 1919. It was a boom period of the most pro­
nounced character. Little good unemployed labor was to
be had, goods and materials could be acquired only by
bidding against competitors who were also short in sup1 See supra, pp. 281, 282.
3 Cf. H. L. Reed, “A Stabilized Dollar,” American Economic Review, March,
1921, pp. 91-93.



plies, extra production could be had only by expensive
enlargements of buildings and changes in machinery.
Production could not be speeded up so rapidly as credits
were increasing. Speculation, and not social production,
absorbed a large portion of the volume of bank credit, and
speculation tended to accelerate the rapidity of price
advance. This was a situation in which bank credit
played its part in increasing the buying competition and
in diffusing throughout the business community the buy­
ing power in terms of dollars, on the basis of which prices
were fixed.
Simple as is this principle, it is extremely difficult to
secure assent to it by the general public. No matter what
the industrial situation, restrictions of credit grants are
always unpopular. It is always asserted that the banks
are handicapping productive enterprise. It is not under­
stood that when the productive engine is running at full
speed more fuel will not aid it. It is not clear that credit
granted to this enterprise in a boom period may not add
to the total volume of production. It is forgotten that too
great activity soon brings the inevitable reaction by en­
couraging unsound enterprise. Money is confused with
wealth, and the public’s first reaction is always to side
with the proponents of easy money.
Expressive of the popular point of view the following
quotation might be made from a letter of a New Jersey
banker, E. C. Stokes, written in the summer of 1920, to
Senator Owen, commending the latter on his protest at the ’
Board’s belated policy in raising its discount rates:1
Increased credit is not the cause of high prices. Increased
credit is the result of high prices and is necessary because
prices are high. If the industries and business of the land could
be assured of more and cheaper credit, production would be
1 See Commercial and Financial Chronicle, June 5,1920, pp. 2344-45.

DEVELOPMENT, NOV. 12, 1918, TO MAY, 1920 311
encouraged, and with an increase of production prices would
fall. With assurance of the proper amount of credit at reason­
able rates, intensive production would follow and prices would
be cheaper, even without a reduction in wages. This production
however, will never be undertaken by the manufacturer or even
by the farmer if he thinks his loans are going to be called or
curtailed and he himself forced into bankruptcy because of
inability to carry his enterprise to completion.
There then follow illustrations of the very many projects
which it would be desirable to encourage. Not a sentence
in the entire letter displayed an inkling of an understand­
ing of where the labor and materials for these vast new
projects could be found. There was no recognition of the
fact that unduly rapid credit grants at one period cannot
accelerate continuously the speed of the industrial
machine. All that was understood was that economic
activity increases in the early periods of cheap and abun­
dant credit. But price adjustment to new and higher
levels makes the advantage of easy money only temporary.
Only continued increases in bank advances enable the
boom to go on. There has to be a stop sometime. It is
desirable that the brake be put on before the situation has
become ripe for a violent reaction. The industrial situa­
tion must be contemplated from a long- as well as from a
short-time point of view.
It must be admitted, however, that such demands for
unlimited credits as those just quoted from the letter of
Mr. Stokes are the natural fruit of the price theory, for­
mulated by the Governor of the Federal Reserve Board,
that prices determine the volume of advances the banks
must make.
But this was not all. Reserve banks deal mainly
with member banks, and there was much doubt as to the
effect of rediscount rate increases upon the operations of



the latter. The spread between the prevailing commercial
rate and the reserve rate appeared to be so great as to
make rediscounting profitable despite moderate redis­
count rate increases. These rate increases could only be
moderate because of the Treasury’s low-interest-bearing
flotations. It is true that a higher rate could have been,
and as a matter of fact was, decreed for non-war paper.
But this meant merely that member banks offered war
instead of commercial paper in their rediscount appli­
cations. There was much doubt, moreover, as to how
efficiently a rate increase would work. There was not
sufficient past experience to guide the reserve adminis­
tration in the formation of its discount policy. Expression
was given to this difficulty by the following statement of
the October, 1919, Bulletin: 1
The extent to which Federal Reserve Bank rates may nor­
mally be expected to be “ effective,” in the sense in which that
term is used in Continental Europe, still remains to be deter­
mined. Our experience under the Federal Reserve system is too
brief to enable definite conclusions to be drawn with reference
to this matter. It seems doubtful, however, whether, for a long
time to come and taking the country as a whole, there will be
any such close connection of Federal Reserve Bank rates with
the volume of credit in use as was to be noted, for example, in
pre-war days in England, the home of central banking. Our
nearest approach to an effective Federal Reserve Bank rate
was reached in the closing months of the year 1916.
This matter will be discussed more completely in the
following chapter. But sufficient explanation should have
been offered regarding the hesitation of the Board to insist
upon higher rates in the early part of the industrial boom
of 1919.
The situation, however, soon became such as to demand
restrictive measures. The loss of gold to foreign countries,
* Page 911.

DEVELOPMENT, NOV. 12 , 1918, TO MAY, 1920 313
together with the great increase of advances to member
banks and note issues resulted in considerable worry re­
garding the adequacy of the reserve ratio.1 These facts
are expressed by the following figures:

D ate

o tal




e se r v e s of




B anks







D e p o s it s
R eserve

L ia b il it ie s

a t io





p o s it s a n d




a sh



R e­
D e­



L ia ­

b il i t i e s

O ’s

June 6 ...........
July 3 ........
August I .......
September 5 ..
October 3 .......
November 7 ..
December 26...


O m it te d


4 ,324,351
4 ,235,814




Meanwhile also the dates were approaching upon which
member banks would no longer be obligated to carry the
bond subscriber. Most banks had agreed to make oneyear loans to subscribers for the Fourth Liberty Loan and
six months’ loans to purchasers of the Victory notes.
According to such arrangements these loans would expire
in October and November. Although the Treasury’s short­
term floating debt increased throughout the summer of
1919, it reached its peak on August 31, 1919, and it be­
came probable that the Treasury’s requirements would no
longer be so controlling a factor. As stated in the October
1, 1919, Bulletin:2
The disappearance of the Treasury from the long-term loan
market and the rapid reduction in its requirements for short­
term accommodations foreshadows the approach of the time
when the financial operations of the Government will cease to
be the important factor in shaping Reserve Bank policies which
they have been, and Federal Reserve Bank rates once more
xFrom January 1, 1919, to Noverrlber 10, 1919 (the approximate date of the
mte increases), the excess of gold exports over gold imports was $226,089,000.
9Page 910.



will be fixed solely “ with a view of accommodating commerce
and business.”
By the fall of 1919, moreover, it was becoming clear that
new creations of currency and credits were no longer exert­
ing a stimulating effect upon the country’s productive
activities. Much worry was occasioned also because of the
undesirable quality of paper in member banks’ portfolios.
In particular, the percentage of renewals was far too large.
What theory had predicted confidently at an earlier date
was now being exemplified by results. The country’s pro­
ductive mechanism could not accommodate too big a load.
In the early part of November, accordingly, rates were
increased slightly at all reserve banks as a means of
indicating the determination to raise rates still higher if
the reserve ratio fell further. On December 11, after
the autumnal demand for funds had subsided, another
slight rate increase was sanctioned by the Board.
The reluctance of the reserve administration to adopt
these measures is evidenced by the fact that the increase
was preceded by many warnings. For instance, on June
10, 1919, the Board made public the following letter which
had been sent out to all Federal Reserve agents:1
The Federal Reserve Board is concerned over the existing
tendency toward excessive speculation, and while ordinarily
this could be corrected by an advance in discount rates at the
Federal Reserve Banks, it is not practicable to apply this check
because of Government financing. By far the larger part of the
invested assets of Federal Reserve banks consists of paper
secured by Government obligations, and the Board is anxious
to get some information on which it can form an estimate as to
the extent of member bank borrowings on Government collat­
eral made for purposes other than for carrying customers who
have purchased Liberty bonds on account, or other than for
purely commercial purposes.
* Cf. Bulletin, December 1,1919, p. 1108.

DEVELOPMENT,.NOV. 12, 1918, TO MAY, 1920 315
The rate increases of 1919 were continued in the early
months of 1920. In January, after the Treasury had
raised the rate on short-term certificates to
per cent,
the Board approved a similar increase on paper secured by
these certificates.
Toward the end of January, however, the rate on paper se­
cured by Liberty bonds and Victory notes was advanced to
per cent and the rates on all classes of commercial paper,
including trade acceptances and agricultural and live-stock
paper, to 6 per cent.1
Except in the financial centers of the country these
increased rates had little real effect in checking the con­
tinuous expansion of credits. By the end of April, 1920,
the total earning assets of reserve banks were considerably
larger than in December, 1919. But it had become evident
that the rate of credit and currency increase was falling
and that the speculative boom was collapsing. With the
spring of 1920, one stage in the post-war business cycle
was drawing to a close.
1 Report of the Federal Reserve Board, 1920, p. 57.

I t is no part of the writer’s purpose to measure statistically
the relative influence of the various factors which cooper­
ated to create the industrial reaction of 1920-21. Such a
task would far exceed the limits of the present chapter. It
will suffice for our plans to indicate the instability of the
industrial situation in the spring of 1920 and to state
briefly the causes of the subsequent depression.
In the opinion of many the post-war boom had carried
us to a new and permanently higher level of prices. A very
large part of the world’s total gold supply had come to the
United States, and this gold, in large measure deposited
in the vaults of the Federal Reserve banks, had furnished
the basis for the creation of a much larger volume of
deposits and note issues than the country ever before had
witnessed. Relatively to commodities the media of ex­
change had been greatly increased. The international
trade situation, moreover, was not such as to indicate any
early redistribution of our gold among the nations of
Europe. Consequently, a larger volume of bank deposit
and note currency could be supported without endanger­
ing in the immediate future the maintenance of the gold
standard. There were no indications, furthermore, that
our banking administration would endeavor to deflate for
the purpose of restoring the old price level. All the evi­
dence pointed toward the acceptance of the belief that
attempts to correct financial maladjustments should



assume the form of such devices as wage advances and
railway rate increases. The rises in rediscount rates of the
preceding period clearly had been initiated only as a means
of preserving the reserve ratio and of preventing the inclu­
sion in bank portfolios of too large a quantity of unsound
Nevertheless, the memories of a lower price level were
still vivid to a large portion of the people. It is true there
had been no indication of a sudden return to the 1913
level. But any temporary decline in the market would be
interpreted generally as the beginning of the process of
reestablishing “ normality” in prices. In this situation a
voluntary lowering of prices to relieve congestion in the
warehouses or on the shelves of merchants might not have
the effect of increasing buying suddenly. If this viewpoint
should be adopted generally, orders might be cancelled in
large volume, the demand for labor lessened, and the re­
duction in money wages restrict the ability of the public
to purchase goods. All that was required to set in motion
a continuously accelerating buyers’ strike was evidence of
temporary weakness in the market.
The unhealthiness of the situation was due also to the
rapidity of the price advance. All the weaknesses which
normally develop in a period of- prosperity had been accen­
tuated by the amazing speed in the upward movement of
the market. Commodity and security speculation had
been overdone grossly; labor was losing its discipline; the
assumption of unwise ventures had been encouraged by
artificial cheapness of money; bank reserves were falling
rapidly. On the New York Stock Exchange the shares
traded in during 1919 were almost fourfold as great as in
1913, and bond activity was multiplied almost sevenfold.
Total bank clearings for the Nation were approximately
two and a half times as great in 1919 as in 1913. The



Comptroller’s reports showed that net deposits of national
banks had increased from 7.1 billions of dollars on October
21, 1913, to 12.2 billions on September 12, 1919.
It is inevitable in such eras that values and operations
become based not solely upon confidence that former
growth will be maintained, but that the rate of accelera­
tion will be continued. Present speculation rests upon
future anticipations. But by the spring of 1920 it was
evident that, while the limit of their resources had not been
reached, banks were genuinely worried as to their ability
to finance new projects. The maturities of paper were
growing and the percentage of renewals increasing. Con­
siderations of public finance pointed also toward higher
rates in the near future. In 1920 the Treasury advanced
the rates on six months’ certificates to 5 ^ per cent and to
6 per cent for twelve months’ maturities. The Treasury
was no longer to dominate the reserve banks so completely
in the formation of discount policies. The money market
was no longer to be kept so low by artificial measures. The
true rate of interest was to be permitted to emerge. Coin­
cidentally with the rise in rates the member banks were
being cautioned against the granting of unessential credits.
Further credit expansion was possible, but the rate of past
growth must fall.
Had the physical volume of production been less large
in 1919 and 1920 the date of the reaction might have been
postponed. But the volume of production, particularly in
the first half of 1920, was enormous. The Government’s
crop forecasts for 1920 were exceedingly favorable, presag­
ing one of the best years on record. Mills and factories
were thought generally to be working close to maximum
capacity. But railroads found themselves unequal to the
strain thrown upon them. The reports of the American
Railroad Association disclosed a net shortage of cars three



of the last four months of 1919 and for every month of the
first half-year of 1920. Shipments which might have been
dispatched on advantageous terms were delayed until an
enormous quantity of goods accumulated in the centers of
production. It required not much of a shock to induce a
general order of price cutting in order to move goods.
It had been apparent for some time that the inter­
national trade situation was growing more and more un­
healthy. The balance of trade for 1919 was over four
billions of dollars in our favor, exceeding all past records.
But in each of the first four months in 1920 the balance in
our favor was much less than that for 1919. In several
markets 1920 was to witness a sharp price break. After the
early collapse of the silk market in Japan, there were rapid
declines in the prices of sugar, coffee, and other products
of Cuba and Latin-American countries. The Federal
Reserve Board’s international wholesale price index
showed a price decline1 in April for Japan, and a May de­
cline for the United Kingdom, France, Italy, and Japan.
In June, 1920, the Bureau of Labor Statistics’ index num­
ber for wholesale prices of all commodities in the United
States was to show the first recession experienced since the
early part of 1919. The accumulation of goods created
by the inability of the railroads to furnish sufficient cars
and the crash in foreign markets may have been the imme­
diate factors causing the first severe shock to business con­
fidence. Once this check had been felt, it was impossible
to prevent the manifestation of all the weaknesses in the
industrial system which have been developing gradually
in the preceding boom period. The buyers’ strike became
soon, not a matter of volition, but of downright necessity.
The reduction in money incomes created less demand for
labor’s services.
1See Report of the Federal Reserve Board for 1920, p. 7.



A large part of the Federal Reserve administration’s
policy during the crisis may be told statistically. The
following figures depict the situation regarding changes in
the reserve ratio, note issues, member banks’ reserve
account, total earning assets, and rates of discount on
ninety-day paper.
D is c o u n t
R ate on
D is c o u n t

T otal

D ate

E a r n in g

A sset s

F ed er al
R eserve
N otes in
C ir cu la ­

R a te on
M em ber

B an k s '
R eserve

A ccount

9 0 -D a y

C ash

P a p e r in

R e ser v e
R atio

E ffe c t

9 0 -D a y
P aper
S ecured


L ib e r t y
B ond and

F ir s t D a y

V ic t o r y

o f th e


N otes th e

M o n th 1

F ir s t D a y

M onth *

In billions of dollars

In percentage

May 7 . . . .
June 4 . . . .
July 2 .......
Aug.6 .....
Sept. 3 . . . .
Oct. 1 .......

New. 5 . . . .
Dec. 3 . . . .


„ 3 .3 i






Jan. 7 ........
Feb. 4.......
March 4 . ..
April 1 . . . .
May 4 . . . . . ~ 2.42
June 1 . . . .
July 6.......
Aug. 3 . . . .
Sept. 7 . . . .
Oct. 5 ......
Nov. 2 . . . .
Dec. 28 . . .

‘ 5*77











4 5*95
5* 6

1 Average for the twelve Districts.

These facts show that there was no contraction of cur­



rency or credits enforced by Federal Reserve authority
during the depression. The combined Federal Reserve
note circulation and member banks’ reserve account at
the close of 1920 exceeded that of the spring of the year. It
should be kept in mind that these advances were main­
tained in volume despite the drop in prices. Since lower
prices lessen the need for credits, the growth in reserve
bank advances was in reality much larger than the figures
indicate. The wholesale price index of the Bureau of Labor
Statistics, which was 272 in May, 1920, had fallen to 189
in December of the same year. So willing were the reserve
authorities to employ their resources for the legitimate
requirements of member banks that it was not until after
the beginning of the new year that the reserve ratio began
to move to a point commanding confidence. Discount
rates increased until the spring of 1921, but they were
never unusually high relatively to market rates. As a
matter of fact they followed rather than preceded the
movement of money rates in the financial centers. Until
the summer of 1921 rates on four to six months’ prime
commercial paper were close to eight per cent in the New
York market.
Recovery from the crisis was slow and uncertain. Bond
and stock prices began to move upward sharply in the
early summer of 1921. But security price movements
precede usually the revival of business confidence. It was
not until the close of 1921 that the volume of new securi­
ties issued became such as to indicate any general return
of confidence. Nevertheless, at the close of the year statis­
tics of failures portrayed greater mortality than at any
preceding date of the crisis.
The public was somewhat slow to perceive the extreme
severity of the depression. Had there been no Federal
Reserve system to prevent credit contraction, a financial



panic of unexampled dimensions might easily have
occurred. What the reserve system has done has been to
draw out the period during which liquidation took place.
But so far-reaching were the maladjustments which had
developed in the preceding boom period that no sudden
revival of confidence was possible. Too many prices got
out of line with each other. Relatively to other prices,
agricultural commodities fell too far. As a consequence
the agricultural demand for manufactured products con­
tinues low. Unless, furthermore, adequate machinery is
developed for supplying Europe with production goods for
restoration purposes, we cannot count on the foreign
demand. Building, however, is rapidly developing into
the dimensions of a boom, and in this lies the germ of
speedy resumption of industrial activity.
With the clearing of the industrial situation it is espe­
cially desirable that Federal Reserve policy for the future
be formulated more definitely. In all the eight years of
Federal Reserve operation there has not been a period
when the administration was free to make a comprehen­
sive statement of the relation of the reserve banks to other
parts of the financial mechanism. Until 1917 the problem
was that of acquainting member banks with the reserve
banks’ facilities and of getting into the market at a time
when member banks’ reserves were high. From 1917 to
the armistice the requirements of war or of war prepara­
tion were dominant considerations. In the post-war ex­
pansion period the Treasury’s needs were such as to cause
purely banking requirements to be subordinated. In the
period of depression the inevitable charges of undue sever­
ity made the situation inopportune for any clear state­
ment of future discount policy. But in the coming period
of industrial revival it is important that the essentials of
rediscount control be developed. If this be not done,



industrial activity again may attain unhealthy dimensions
thus breeding the forces of another reaction. The late
depression has shown that, while the reserve system may
serve to prevent sudden liquidation and thus to lessen the
acuteness of the shock, it cannot prevent unhealthy
tendencies from asserting themselves in the form of
destroyed business confidence.
A t the present time the surplus reserves of the reserve
banks are enormous. December 28, 1921, the total re­
serves of the reserve banks were 2992.2 millions of dollars.
This would form a forty per cent reserve for 7480 millions
of note issues and deposit credits granted to member
banks. Assuming member banks require a fifteen per cent
counter money and legal reserve combined, this 7480 mil­
lions would enable them to advance 49,866 millions to the
business public. Since the total net deposits of national
banks on the Comptroller’s report for September 6, 1921,
was 10.8 billions of dollars, an approximate fourfold expan­
sion in national member banks’ advances is possible. Here
lie opportunities for inflation never before possessed in like
measure by any banking system. If any large part of this
new credit supply is utilized suddenly, the price level must
react correspondingly. It is not possible that our physical
volume of production be increased in any such meas­
ure. Too rapid credit expansion must mean price inflation.
It, therefore, is more essential now than ever before
that definite principles of credit control be formulated.
Day-to-day considerations cannot be permitted to gov­
ern unless the reserve banks are to become mere engines
of inflation.
Until business confidence is restored there is no danger
of unduly rapid creations of currency or credits. New
issues would become redundant. But in the next era of
business revival it will be necessary to know when the



endeavor should be made by reserve banks to restrict
credit increases. Let us consider accordingly the wisdom
and practicability of the following bases of credit control:
(a) Regard should be had primarily for the reserve
ratios of reserve banks. In other words, reserve banks
should take into account the same sort of considerations
which guide the loan policies of member banks. They
should concern themselves primarily with their ability to
meet their obligations.
(b) Credit advances of reserve banks should be regu­
lated in such a manner as to maintain the price level as
stable as possible.
(c) Credit advances should be regulated in such a man­
ner as to maintain the productive activities of the Nation
as great as possible. Regard should be had, however, for
long rather than for short-time considerations.
(d) Since certain excesses, such as impaired liquidity,
appear whenever industrial activity is fanned by excessive
credit grants, restriction should be begun whenever these
evils become more than ordinarily prominent.
Let us consider these possibilities in turn.
There appears to be much to offer for a policy of utiliz­
ing the reserve ratio as a guide for rediscount policy. In
Sprague’s words:1
It is definite and obvious. Public opinion may be expected
to support the always unwelcome policy of credit restraint
when that policy is enforced by a depleted reserve. It is un­
happily very doubtful whether the public would have been
reconciled to the advance in rates made last spring [1920] if
the reserve banks had had, let us say, a reserve ratio of 55
per cent, and yet, all other things being the same, an advance
in rates would have been no less desirable.

Cf.O. M. W. Sprague, “The Discount Policy of the Federal Reserve Banks, ’

American Economic Review, March, 1921, pp. 27, 28.



There is no substitute for the reserve ratio which possesses its
peculiar virtues of simplicity and definiteness.
It is extremely unfortunate, therefore, that the situation
frequently may develop to necessitate credit restriction
even at a time when reserves are increasing. In a season
of very active trade, payment of foreign balances might
compel the shipment of gold to this country. In that
situation our bank reserves would increase, yet the possi­
bilities of too rapid expansion might then exist. The quan­
tity of gold in the reserves is a product of more or less for­
tuitous circumstance and bears no necessary relation to
the credit requirements of business.
There is also much to say for making price stability the
test. The injustices of a rapidly changing price level are
now recognized fully. Since bank credit is our most impor­
tant medium of exchange, its volume should be regulated
in such a way as to ensure a fair degree of price-stability
over a course of time. It is also true that a chief evil created
in a boom period is the throwing out of adjustment of
various prices. The greater the rise in the general level, the
greater the probability that their normal relationship will
be disturbed. To maintain the level of prices stable,
therefore, might accomplish much in the way of eliminat­
ing periodic disturbances in business.
It is doubtful, however, whether public opinion would
ever sanction the use of such a guide. As indicated pre­
viously, the people of this country lean innately toward
the side of easy money. Particularly true is this of seasons
of activity. The matter of legal authority for such a test
is also doubtful. Mr. A. C. Miller, of the Federal Reserve
Board, has stated:1
1 “ Federal Reserve Policy,” American Economic Review, June, 1921, p. 193.



There is now no warrant in the statute under which the federal
reserve banks are organized for undertaking to regulate their
credit operations on any such basis. The economic logic of the
Federal Reserve act is clearly predicated upon the theory that
the federal reserve banks shall be operated with regard to re­
serve ratios, and “ rates be fixed with a view of accommodating
commerce and business/' It would imply a very latitudinarian
construction of the term “ accommodating commerce and
business” for the Federal Reserve Board and the federal
reserve banks; to adopt the “ observed effects of credit on prices ”
as their rule of action in the future. There is not, however, the
slightest reason for supposing that such a procedure on the part
of the federal reserve banks would be viewed with public
approval. Quite the contrary. Public sentiment in the United
States is, and always has been, highly sensitive in matters of
credit control, and precisely, among other reasons, because
of the bearing that such control has, or is believed to have upon
the movement of prices.
Mr. Miller’s efforts accordingly are designed to alter the
reserve machinery in such a way as to make it more safe
to depend upon the use of reserve ratios as a guide.
Mr. R. C. Leffingweirs vigorous statement on this
matter is as follows:1
I share Dr. Miller’s objection to Professor Sprague’s sugges­
tion that federal reserve rates should be determined by price
movements. There is no man, or group of men, to whom the
American people will, or should, accord the right to determine
whether they shall be prosperous or miserable, whether thay
shall have high prices or low prices, whether they shall have
good times or bad times. The day Professor Sprague’s sugges­
tion is adopted by the Federal Reserve Board marks the end of
the federal reserve system. It would be absurd for the Federal
Reserve Board to ignore price movements as symptoms of the
general situation, but it cannot base its discount policy upon
Both Miller and Leffingwell admit that the reserve
1 “The Discount Policy of the Federal Reserve Banks,” American Economic
Review March, 1921, p. 35.



ratio alone cannot be an adequate guide. But in order to
enable it to be utilized with effectiveness, they make cer­
tain proposals designed to remove the dangers connected
with its use. Leffingwell suggests1 that
If the reserve gets big enough to be embarrassing, the best cure
for the situation which will then arise is to pay out gold and
gold certificates, and restore them to circulation.
This would have the effect of reducing the reserve ratio to
a more manageable point. In an opposite situation, one
in which the reserve ratio is low, gold could be retained
when paid in by member banks and Federal Reserve
notes issued to meet the general currency requirements.
Miller’s suggestion is much more involved. He desires2
the Federal Reserve notes to become more similar to the
issues of the Bank of England. If a larger gold reserve
could be allocated for note issues, the reserve ratio for
deposits could be made such as to render it safer to depend
upon it. Calls by the public for more credits, calls which
arise in time of rapid expansion, would reduce rapidly the
reserve for deposits in such a way possibly as to justify
efforts to restrict further advances. In this way the reserve
ratio could be made a more workable guide.
Dr. Miller’s suggestion is so important as to justify,
perhaps, a somewhat extended quotation from his re­
marks. Speaking first of the administrative changes that
need to be made he states:
The main change in the published weekly statement of the
’ federal reserve banks that would be necessary would be to
report the specific note reserve, held by the Federal Reserve
Agent, and the specific deposit reserve held by the bank. The
existing practice of stating the reserve position theoretically
in the form of a ratio derived from a comparison of total re1

“The Discount Policy of the Federal Reserve Banks,” American Eco­

nomic Review, March, 1921, p. 36.
•Op, cit.



serves with combined note and deposit liabilities should be dis­
continued, or, if continued, be given merely for purposes of
theoretical comparison, by the federal reserve system, and a
form of statement should be set up which would show the re­
serves actually held against deposits and notes respectively and
separately, as the law contemplates.
The existing gold holding of the reserve banks should be re­
apportioned between the deposit reserve and the note reserve.
To the deposit reserve might be allocated an amount of reserve
money equivalent, say, to 45 per cent of their deposit liabilities
as of the date when the new form of accounting would become
effective. To the note reserve should be allocated all the remain­
ing reserve, and, as the law requires, be in the form of gold.
The reserve thus allocated to the deposit reserve should be
regarded as the working reserve of the banking or discount
department of the federal reserve bank. The banks should be
expected to conduct their discount operations on the basis of
this reserve. Until conditions justified, the amount of this
reserve should not be changed. Fresh accessions of gold re­
ceived by the banking department should be transferred to the
note reserve by way of substitution for other collateral held
by the Federal Reserve Agent, or in exchange for federal
reserve notes. Withdrawals of gold from federal reserve banks
for foreign shipment should, for the present at least, be taken
out of the note reserve by the presentation of federal reserve
notes for redemption in gold or by the substitution of com­
mercial collateral for gold in the security held by the Federal
Reserve Agent. The deposit reserve held by the banking
department would thus be fairly constant in amount; the note
reserve, on the other hand, would be variable in amount,
fluctuating mainly in accordance with changes in the inter­
national flow of gold, increasing when an influx was in progress
and decreasing when an outflow was in process.
While the deposit reserve under the arrangement proposed
above would be constant, the deposit reserve ratio would not be
constant but would fluctuate. Any expansion of the loan
account of the federal reserve banks would quickly reflect itself
in the diminution of the reserve ratio below 45 per cent; any
diminution of their loan account would quickly reflect itself in
an increase of the reserve ratio above 45 per cent. In brief,



fluctuations in the reserve ratio would reflect quickly and accu­
rately changes in the volume of the reserve banks’ discounts.
From time to time the situation of the reserve banks as a
whole, and of the several reserve banks individually, should be
reviewed in the light of current credit conditions and needs in
order to determine whether any reapportionment of reserves
should be made; whether, e. g., any given bank should enlarge
its deposit reserve at the expense of its note reserve. The
modus operandi for effecting such enlargement would be for
the bank in question to substitute commercial paper for gold
as for collateral security pledged with the Reserve Agent for
notes issued to the bank, the gold thus released being covered
into the deposit reserve. So far as the bank’s reserve position
was concerned, this would be tantamount to the transfer of a
certain amount of gold from the note reserve to the deposit
reserve in order to give the bank an enlarged basis of lending.
Under this arrangement the reserve ratio would decline
rapidly in an era of credit expansion. “ It would be a
faithful indicator of what was going on.” It could be
relied upon much more confidently than at present. A t
the same time, the public could anticipate with much more
certainty future credit policy.
Adequate preparation, furthermore, would have been
made for future outflows of gold to foreign countries. It
seems impossible that the world’s gold can continue per­
manently to be apportioned as inequitably as at the pres­
ent time. Future withdrawals will likely be of enormous
volume. Under Dr. Miller’s plan the gold for these with­
drawals would be conserved in the note reserve instead
of having become demobilized by forming the necessary
reserve for enlarged credit advances. This matter of mak­
ing provision for future gold withdrawals, furthermore,
might be accepted by the public as justification for this
proposed change much more readily than the desire to
protect the system against future price inflation.
Although these suggestions represent merely an attempt



to remodel the Federal Reserve system more closely on the
pattern of the Bank of England, they appear to the writer
to deserve credit as a constructive proposal of great merit.
It is particularly fortunate that they were formulated by a
member of the Board.
But valuable as these suggestions may be, their adop­
tion would not provide a complete solution. There would
still remain the question as to just how great pressure
should be exerted at any one time to keep the credit situa­
tion under control. How close to the legal minimum could
the deposit reserve be permitted to sink without endan­
gering its eventual sufficiency? And what would be the
reply of the reserve administration if it were argued that
its policy had been to the economic detriment of the
country and that the gold earmarked as the deposit
reserve had been made either too large or too small. In the
final analysis the test of economic results must be applied
to the reserve administration’s acts. Making the reserve
ratio a more accurate indicator will not accomplish every­
The writer agrees with Miller and Leffingwell that there
is no authority in the act for making price stability the test
of discount policy. Neither would it comprise per se an
infallible test from the standpoint of economic theory.
High prices may be due to other causes than excessive
issues of currency or credit. They may be due to physical
causes of scarcity, scanty rainfall, depredations of insect
pests, labor troubles, and a host of other factors. The
remedy for such a situation would not be restricted credit.
Rather, the difficulties due to such causes might demand
extra advances from the banks. To enable the producers
to avoid financial failure, it might be that the banks would
be required to supply the funds necessary to meet current



It has been mentioned previously that there are situa­
tions in which slightly rising prices exert a tonic effect upon
industry. Such a situation might be that following a
period of subnormal activity. Federal Reserve policy
should be adapted so far as possible to the requirements of
productive efficiency and not to those of price stability.
Over a series of years the volume of credit grants should be
such as would lead to the maximum amount of produc­
tion. The final test of the discount policy must be what
production indices show regarding the effects of previous
credit grants. If the curve of production is rising, there is
justification for continued liberality. If past increases in
the volume of credit have not correlated with an approxi­
mately corresponding enlargement of physical production,
the situation, in the absence of other counteracting factors,
calls for restrictive measures. To quote from a previous
statement by the writer:1
Increase in the volume of rediscounts should be permitted
so long as the main effect is to enlarge the volume of production
and not to raise the level of prices. Decreases in rediscounts
should be enforced when it appears that the volume of business
and consequently the need for credit is declining. Over a long
period of time increases in rediscounts should be apportioned
to the natural rate of growth in the productive capacities of the
people. To express the matter in terms of the equation o(
exchange (P —MV)2 M should be altered when its principal
effect will be borne by T and not by P.
It should not be difficult to educate the public to this
point of view. In every review of the month the produc­
tion achievements of the country should be stressed promi1H. L. Reed, “The Work of the Federal Reserve Board,” Journal0}Political
Economy, January, 1921, p. 76.
2 In this equation, symbol P refers to the price level, M to the amount of
money in actual circulation, V to the rapidity with which the average unit of
money circulates, T the volume of trade for the period.



nently. Attention should be called to the amount of credit
advances for previous months and the attempt made to
analyze their effects. Many would soon get in the habit of
justifying credit advances according to their effect upon
industrial activity. It should be seen that in a period of
iabor unemployment,5 of surplus stocks in the hands of
producers and dealers, liberal bank loans may mean pri­
marily the enlargement of production, the bringing on to
the market of goods which otherwise would not be created.
In an opposite situation, one of full labor employment, of
shortage in supplies and materials, the effect of credit
advances should be higher money terms on which business
men bid for the scanty supply of goods, materials, and
labor. Expansion then must mean price inflation.
In other words, the reserve bank which increases its
operations should be made to defend its action on the
ground that more credits were required to unlock unused
productive resources. The writer is aware that the de­
tailed rules for such a policy would call for a large measure
of fine discrimination and that controversy must arise
continually in their application. Nevertheless, there must
be a correct formulation of the relation of increasing bank
credits to the level of prices and the volume of trade. No
ideal solution is otherwise possible.
It should not be difficult to find authority in the act for
such a policy. The act states that rates should be fixed
“ with a view of accommodating commerce and industry.”
In so far as commerce and industry require the credits to
function most efficiently, an attempt should be made to
render them available. But if trade and production can­
not be increased in approximately corresponding measure
by use of a larger volume of credit, restrictive measures
should be employed. It should be easy to secure assent to
these principles by endeavoring continuously to lead the



public to compare changes in the volume of production
with those in the volume of credit and currency.
Decisions regarding the justification for increasing
credits sheuld be influenced also by qualitative considera­
tions. In every season of unduly rapid activity certain
excesses appear. Commodity and security speculation
exceed past records, borrowers demand repeated renewals
and loans of greater maturity, the liquidity of paper in
general is reduced. By means of statistical comparisons
with the usual or standard conditions, aid could be had
in ascertaining whether there is justification for permitting
the volume of reserve bank advances to be enlarged.
At the present time there is ji wide demand that as a
permanent solution reserve banks’ rates should be kept
above the market rates. The argument is that the reserve
banks should not contribute permanently any large part
of the country’s credit supply. The reserve banks’ funds
should be drawn upon only to meet extraordinary yearly
or seasonal requirements. It is insisted that they should
keep out of the market except in such situations. When a
member bank rediscounts with a reserve bank, it should
do so only at a sacrifice. This, we are informed, is an
accepted principle of central banking procedure. “ Since
1871,” for instance, “ there has not been a single year
when the official bank rate of the Bank of England was
not above the market rate on yearly averages.” 1
A serious difficulty with this proposal is that of deter­
mining which of the various interest or discount rates
should be taken as expressive of the general market rate.
Should it be the rate on line-of-credit loans or should it be
the rate on bank acceptances? Regarding this a Mil­
waukee banker states:
1 Cf. “The Gold and Rediscount Policy of the Federal Reserve Banks,” by A.
Barton Hepburn and Benjamin M. Anderson, Economic World, July 23, 1921,
p. 112.



The volume of line-of-credit loans in this country is far larger
than the volume of bank acceptance credits, but it may be
doubted whether the rates on such loans are as competitive as
bank acceptance rates. Bank acceptance rates are fixed in the
open market and are published. Line-of-credit loans are not
as competitive as they may seem. A small firm commonly
maintains a line of credit only at its own bank. Large corpora­
tions usually have lines of credit not only with their home banks
but with large banks in financial centers, not necessarily because
they can secure lower rates, but because no one bank wants to
take care of their full needs. For these reasons it is to be doubted
whether line-of-credit loans afford as good an index of money
market tendencies as the bank acceptance rates.1
Although the acceptance rate may represent best the
drift of the market, it might not be practicable to rely
upon it. In many situations line-of-credit rates are far
above the more competitive acceptance rate. A Federal
Reserve rate based upon the acceptance rate might nothave
the anticipated effect of keeping the reserve banks out of
the market except in emergency conditions. A reserve rate
based upon line-of-credit rates, on the other hand, might
remain too uniform instead of displaying the proper degree
of flexibility.
It is believed, therefore, that no conscious effort should
be exerted to make this the fundamental consideration. A
rate fixed on the basis of preserving a reserve ratio, ren­
dered manageable by the adoption of some such plan as
Miller’s, and modified according to production indices,
ordinarily would be above the bank-acceptance rate. But
as to how high above this rate it should be, this proposal *
gives no information. A reserve rate kept above all bank
rates in all communities would, frequently at least, be too
high to be workable. A reserve discount rate kept just
* SeeW. P. G. Harding, “ Principles Governing the Discount Rate,” The

Annals, January, 1922, pp. 183-89.
* The proposal that reserve rates be kept above the genera! market rate.



above the open market commercial paper rate might not
be high enough to be effective.
The preceding brief discussion is designed to throw some
light upon the question as to when reserve bank advances
should be restricted. Let us next endeavor to ascertain
the means which should be employed to restrict credits on
occasions of necessity. Shall principal reliance be placed
on rate increases? Or, will it be necessary to insist on
direct rejections of applications on the basis of the quality
of the paper offered? Or, finally, must greatest measure of
attention be devoted to reserve banks’ open-market
There is much to be offered in behalf of reliance upon
rate increases. It is the only means of restricting credit
grants which does not subject the bank to charges of par­
tiality. The general public undoubtedly has no adequate
understanding of the pressure which is brought to bear
upon the district directorates in such a period as that
following the fall of 1919. Nothing can create more bitter
criticism than the feeling that the bank discriminates
unjustly against some portion of itscustomers. Particularly
true is all this of the FederalReserve banks. Their resources
depend upon the contributions of all their members. Each
member bank accordingly feels it has a claim upon the
resources of the reserve bank on occasions of need. It is a
requirement of policy that rate increases be made before
other measures are attempted.
The efficiency of rate increases may be considered from
two points of view. First, will a higher rate exacted by
reserve banks be reflected in an increased loan rate by
member banks? Secondly, will an increase in the general
market rate discourage most largely desirable or undesir­
able business activities?
For a time a certain theory was current which, if true,



would have denied the effectiveness of the rate-increase
method. Rediscounts create reserves for member banks.
For every dollar of reserve money, member banks may
loan six or seven or more dollars to their own customers.
Since they receive interest on several dollars,! must not
the discount paid on the one dollar obtained from the
reserve bank be a minor consideration? Any slight
advance in rediscount rates would appear to be of little
effect. To be really effective it would seem that the reserve
banks’ rates must be absurdly high, as, forinstance twenty
or thirty per cent. From the standpoint of commanding
political support such a rate would be impracticable.
Answers to this puzzling question were several. Some
argued that rate increases would be effective merely
because most bankers had got into the habit of comparing
the rates they receive on loans with the rate they paid on
rediscounts. If the reserve bank rate was the higher, loans
to customers would be reduced. It was held to be not so
much a question of what bankers should think, but what
they usually did think.
More complete analysis, however, would have indicated
that there was little or no profij: in paying a higher dis­
count rate than that at which the funds were loaned. As a
matter of fact banks cannot loan anything like six or seven
or eight times the amount of credit obtained by the redis­
counting operation. Inter-bank relationships render this
Suppose, for instance, a bank rediscounts sufficient
paper to obtain a deposit credit of one dollar with a
reserve bank. This one dollar of reserve money would
enable the member bank to loan its customers, let us say
ten dollars of deposit credits. In a short time, however,
checks would be written against these deposits, and many
of them deposited with other banks. In this way the other



banks would receive the right to demand cash from the
original bank. To meet these demands our bank would be
obliged to give up cash or engage in further rediscounting.
It must figure, therefore, if its reserve was insufficient
originally, upon rediscounting almost as many dollars as it
loaned its customers. Because of this fact, banks would
lose if they paid a rediscount charge very much greater than
that received on their Own loans.
It might be argued that the loss of cash to other banks
need not occur if other banks were expanding their loans
as rapidly as the bank we.have in mind. Our .bank would
be receiving as many dollars of checks drawn upon other
banks as they would receive against it. But if this were
the situation, the loans of our bank prevent it from gaining
cash through a favorable clearing house balance. Cash it
might have gained in this way, upon being deposited with
a reserve bank, would enable it to loan several fold its
amount. The rediscount finally necessitated the cutting
down of its loans to an approximately equal amount.
Bankers were correct in refusing to admit profits unless
they receive from their own customers approximately the
same rate they pay to the reserve bank.1
A second objection to the efficacy of rate increases is
based upon the fact that many loans are exceedingly high,
due to the fact that they are not subject to a high degree
of competition. Many borrowers are unable to offer their
paper outside their own community. In such situations
the rates charged may represent some degree of monopo*
listic extortion. It is well known that in many newly
developing sections of the South and West it is customary
for banks to exact a charge of ten, twelve, fourteen per
cent. As a matter of fact there may be some justification
1 For a more elaborate discussion of this matter see Chester A. Phillips,

Bank Credit, pp. 1-76.



for such high rates. The volume of business done in such
communities may be so limited as to necessitate the alloca­
tion of higher overhead charges to each dollar loaned. But,
in such non-competitive situations, it would seem that an
advance of a half per cent or so in rediscount rates might
be a negligible consideration.
There is much to offer on the other side, however. It is
questionable the extent to which the abuses of over-rapid
credit expansion arise in such communities. Commodity
and security speculation, the securing of capital for new
industrial enterprises, in general the activities at the basis
of a boom, are financed much more largely by funds
obtained from banks in the larger cities where competitive
conditions do prevail. With money dear in these places,
unduly rapid industrial activity might be discouraged to a
greater or less degree regardless of what takes place in the
smaller localities.
By the application of the principle of progressive rates,
moreover, banks even in these non-competitive communi­
ties might be made to feel the effect of the reserve bank’s
rate increase. Authority for the establishment of a pro­
gressive rate schedule has existed since the Phelan Bill
became law on April 13, 1920. According to the terms of
this bill rediscount rates may be increased for those mem­
ber banks whose rediscounts exceed a specified base line to
which the normal rate applies. During the latter part of
1920 effective use was made of this plan in two districts.
In some cases member banks’ applications were made as
high as nine per cent for a portion of their borrowings.
The progressive-rate plan has not been highly popular,
and during the period of its application there was a more
or less general demand for its abolition. Some such meas­
ure, however, seems necessary if rate increases are to be
made effective in communities where strong competition



does not prevail. In situations demanding strict control of
credit, inability to employ it may necessitate the use of
other undesirable measures, such as the downright refusal
to accept certain paper regardless of the amount of the dis­
count that would be paid.
Many of the doubts regarding the effectiveness of rate
increases are based upon the experience of the system
during the latter half of 1920 during which reserve ad­
vances increased despite higher rates. But so over-ex­
tended had most banks become in the preceding boom
period that the process of liquidation was attended with
great difficulty. There is general agreement that the rate
increases of that year prevented the volume of advances
from becoming as large as otherwise they would have been.
It is not expected that many situations similar to those
facing the reserve administration in the spring of 1920 will
arise in the future. The credit and industrial situation at
that time was intolerable. But it was due in large measure
to the previous inability of the reserve banks to raise rates
because of the Treasury’s easy money programme.
It may be that the effect of rate increases will be most
la te ly sentimental; that they are effective only in so far
as they give hint of the determination of the administra­
tion to resort to stricter and more direct methods in the
future. If this be true, it becomes necessary to develop
standards for the application of methods designed to
eliminate unessential paper. Such standards, however,
should not be impossible of determination on the part of
the district directorates. The former Director of the
Division of Analysis and Research of the Federal Reserve
Board has suggested that the proper test is that of liquid­
ity. He states:1
1 See H. Parker Willis, “ Discrimination in Inflation,” Commercial and Finan­

cial Chronkte, September 11,1920, pp. 1040-41.



If, for example, it should appear that a borrower had fallen
into a way of business which required the extension of a longet
and longer credit to customers, or that he was drawing upon
securities of which he might stand possessed in order to protect,
or collateral paper which he was keeping practically permanently
in bank, or for which he was asking repeated renewals, the situ­
ation would be such as to raise a strong presumption against the
essentiality of his borrowing.
But whatever the proper standards, they can be developed
for use in situations where rate increases may not succeed
in accomplishing their purpose.
In a brilliant article in the American Economic Review1
Miss Anna Youngman argues that the warning effect of
rate increases cannot be sufficient unless it is known that
the reserve banks possess the power to break local rates
which remain high in spite of the discount policy of the
reserve bank. She insists that rate increases cannot be
effective if the local banks previously have been exacting
much higher charges than those of the reserve banks. In
such situations the warnings of the reserve banks will be
ignored. Accordingly she advocates the extension of the
open-market powers of the reserve banks to include the
promissory note as well as the bill of exchange. If reserve
banks were empowered to deal directly in the prevailing
type of paper, they would be in a position to keep rates so
closely in touch with those of the reserve banks that
advances in the latter should prove more effective.
As mentioned previously, however, such a course would
be politically hazardous. Nothing creates a greater degree
of animosity toward the reserve system than the feeling
that the district banks are competing with the member
banks by using funds contributed by the latter. The
weapons of the reserve system to-day are not perfect. But
1 Issue of September, 1921, pp. 466-85. “ The Efficacy of Changes in the Rates
of the Federal Reserve Banks.”



it is believed they will be more powerful in ordinary situa­
tions than it is generally felt. As reiterated often, the
reserve banks could exercise no real control over the loan
market in the post-war boom period. Requirements of
Government finance were then the dominant considera­
tions. Rather than increase the reserve banks’ power to
compete at all times more largely with member banks, it
may be more expedient for the present to grant them
further weapons in the use of their discount facilities. It
may be preferable to permit them to “ enforce reasonable
regulations regarding usury or to refuse rediscounts to a
bank that lends at extortionate rates.” 1
The preceding discussion has emphasized the fact that
an important question is the extent to which increases in
reserve bank rates could be passed on to the business
public. To what degree would higher rates discourage the
public’s demand for loans? It has been argued frequently
that American business is commonly conducted on the
basis of such liberal margins above cost that higher rates
might not have the effect of limiting seriously the demand
for credit. In the final analysis, however, all this would be
a concern merely of the member banks. Member banks
in the same manner as reserve banks desire to avoid direct
refusals of loan operations. They would first proceed very
likely on the basis of rate increases. But if the rate in­
creases did not lessen the demand for loans, direct meth­
ods, however unpopular, must be employed. This, how­
ever, would not be a responsibility of the reserve banks. It
would be a problem solely for the member banks.
It may be true that rate increases would not be ideal in
that they do not distinguish between socially desirable
and socially undesirable demands for credit. Rate in­
creases would impose the same handicap upon all regard* American Economic Review, September, 1921, p. 478.

less of the quality of the economic service rendered by the
borrower. It may be true that higher rates can be with­
stood more easily by the borrower whose services are the
least necessary to society. The margin of profit may be
greater in the field of commodity speculation or in the sale
of adulterated goods. But it is impossible for the reserve
management to attempt to distinguish between the legiti­
macy of the various demands for credit. This, to repeat,
is a problem primarily for the member bank.
It is not believed, therefore, that the time is ripe to
grant further weapons to the reserve banks. What is most
necessary now is that some means be found which will
relieve the reserve banks from undue pressure to grant in
the next boom period all the credits their present huge
reserves would render possible. Two things in the writer’s
opinion need now to be emphasized. First, the reserve
ratio should be made more manageable by transferring to
the note reserves all reserve money except that which
forms a workable basis for advances to member banks.
Secondly, no opportunity should be overlooked to con­
vince the public that an increase in the credit volume is
defensible only when it is necessary to give full play to the
country’s productive powers. The effect of credit upon
production should be most closely observed. Production
indices should be given a position of prominence in every
issue of the Bulletin.
The reserve system has been well managed. Although
its policy has been developed in the stormiest years of
American financial history, concessions have not been
made destructive of its power and influence. Despite
present attacks there is no doubt but that it has come to
command the respect of the thinking American public.
Bitter critics should remember that there has not yet been
a period in its existence when the general situation would



permit the formation of ideal policies for future credit
control. The present, accordingly, is not the time to grant
compromise to the advocates of easy money and cheap
credit. The system must be fortified to meet the demands
of the coming period of industrial revival. In that period
will be tested the ability of the American people and of
the reserve administration to adapt the powers of a won­
derful financial mechanism to the requirements of presentday business and industry.



Acceptance, trade, development of,
105-27; bank, development of,
154-84; foreign-trade and domes­
tic-trade, 169-71, 194, 195. See
Bank, Trade.
Adams, L. R., quoted on deducting
exchange, 37, 38.
Advances, of reserve banks, redis­
counts, 70-96; direct collateral, to
member banks, 97-104; note is­
sues, 205-20; of reserve bank
deposits and reserves, 221-38. See
Deposits, Note issues, Redis­
counts, Reserves.
Agricultural credit, characteristics of,
128, 130, 132; restrictions on loans
on real estate, 128-30, 133, 134;
need of commercial bank for farm­
ers, 131,132; provisions in Reserve
Act relative to, 134-37.
Agricultural paper, eligibility of, 13742; identification of, 142, 143; sixmonths, rate of discount on, 146,
147Agriculture, legitimate needs of,
not neglected, 148-50; extent of
hostility encountered by, 148. See
Aldrich Bill, the, 2.
Aldrich-Vreeland Act, the, 221, 222,
American Acceptance Council, 123.
Anderson, B. M., quoted on proba­
bility of decline in prices, 295.
jArbuthnot, Professor C. C., quoted
on banking resources, 74.
Asset currency, attempts to secure,
205-08, 221.
Atlanta Reserve Bank, and Supreme
Court decision concerning cashing
of checks, 36-38.

Balances, minimum, 46.
Baltimore plan, the, 221.
Bank acceptances, essential function
of, 154; in import trade, 155, 156;
in export trade, 156-58; advan­
tages of, 158-60; types of trans­
actions in which it is permitted,
160, 162; restrictions on use of,
161-65; conditions governing use
for permitted purposes, 165-69;
foreign and domestic trade, iden­
tification of, 169-71; classes of
domestic, permitted, 171-73; re­
strictions governing power of re­
serve banks to accept, 173-75;
syndicate acceptance, 175-80;
policy in encouragement of use of,
180-82; decline in, 182,183; future
development of, 183, 184.
Bank notes, issuing of, confined to
reserve banks, 209; bond-secured,
211, 212; cause of increased cir­
culation of, 212-14; Federal Re­
serve, and Federal Reserve notes,
213, 214; issuance of, under Aldrich-Vreeland Act, 242, 243.
Bankers’ acceptances, 191.
Bankers’ bank, 1-3, 105, 106.
Banking systems, of Europe and
America, 107.
Banks, germ of, in note issues and
deposits, 205.
Barron, C. W., quoted on distribu­
tion of funds, 246.
“ Based on live stock,” ruling of
Board on, 137.
Bills of exchange, before the Civil
War, 107; advantages urged in
behalf of encouraging use of, 11114; an open-market paper, 191.
Bonds, and bank notes, of national



J banks, 209-12; involve present Clearing houses and clearing systems,
burden, 288, 289; prices of, 301-

03Book credits, 225, 237.
“ Buy-a-Bale-of-Cotton ” movement,

before 1914, 20.
Collateral loans, 100-04.
Collections, check, difficulties of,
prior to 1914, 21-25; provisions
dealing with, 28, 29; voluntaryreciprocal plan of, 31, 32; new
system of, 33; attitude of banks
toward Board’s plan of, 41, 42;
extension of system to time items,
44, 45; conclusions regarding par
collections controversy, 45-49.
Commercial bank, the farmer’s need
of, 131, 132.
Commercial paper, definition, 85, 86.
Commodities, prices of, 278, 298.
See Prices.
Commodity rate, 143-46.
Contract for sale, 87, 88.
Cooperative credit institutions, 131,
Cotton* at time of Great War, 241,
Cotton loan fund, 242.
Country banks and city banks, ex­
change exactions, 25-28, 45-49.
Credit, regional system susceptible
to expansion of, 5, 6; principles of
control needed, 19; agricultural,
under the Federal Reserve, 12853; two forms of, note issues and
deposits, 205; way open for ex­
pansion of, by amendment of June
21,1917, 237; bank, on November
23, 1917, 271-73; delayed process
of war mobilization, 285; period of
post-war expansion of, 292-315;
and prices, as bearing on Reserve
policy, 299-311; and production
314,342; bases of control of, 32335; means of restricting, 335; and
rate increases, 335-41.
Credits, book, 225, 237.
Currency, volume of, relation to
price level, 306.

Cable Transfers, 195.
Capital, definition of, 85, 86.
Cash reserves, ratio of, to net de­
posits and Federal Reserve notes,
Central bank, fears of, 2; emergency
character of, 6; arguments for and
against, 105, 106; question of
necessity of, 125; and bank note
issues, 209.
Checks, collections and clearances of,
importance of, 20; indicate need
of continuous operation of reserve
banks, 20; difficulties of, prior to
1914, 21-25; indirect routing of,
22-24; exchange exactions, 25-28;
provisions of act dealing with
collections and clearances of, 28,
29; means of absorption of charges,
29, 30; methods of collecting and
clearing, at first various, 30; voluntary-reciprocal plan of clearances,
31, 32; new system of clearances
beginning operations July 15,1916,
33; attempts at coercion in connec­
tion with new system, 34-36; Su­
preme Court decision concerning
method of cashing, 36-39; the
Hardwick Amendment, 40, 41;
attitude of banks toward Board’s
clearance plan, 41, 42; conclusions
regarding par collections contro­
versy, 45-49; extent of use of, 207.
Circulating medium, demand for,
City banks and country banks, ex­
change exactions, 25-28, 45-49.
Clearances, check.
See Checks,
Dairy cattle paper, 141, 142.
Clearing house certificates, 243.
Clearing house functions, and Fed­ Delano, F. A., quoted on purpose of
reserve system, 248, 252.
eral Reserve Board, 28, 29.

t4Department store” banking, 68.
Deposits, a form of credit, 205;
increase of importance of, 207;
recognition of need of elasticity of,
208; demand and time, 223, 224;
with reserve banks, methods of
establishing, 224, 225; net, the
law’s definition of, 238; effect of,
on prices, 306, 307.
Depreciation of the dollar, 200, 201.
Discount, on ninety-day paper, rates
of, 320.
Discount operations, and openmarket operations, comparative
volume of, 196; of newly estab­
lished Federal Reserve banks, 245.
Discount rates, acceptance and lineof-credit, 333-35.
See Rates,
Discountable paper, regulations re­
garding, 82-S5.
Discounts, direct, not permissible at
first, 97; reasons for discrimination
against, 97-99; arguments for, 99;
amendment permitting collateral
loans, 100; use of direct collateral
loan, 101, 102; advantages of di­
rect loans, 102-04; in first years of
the system, 253-57.
District directorate, responsibility of,
16, 17; and member banks, close­
ness of contact of, 18.
Dollar, depreciation of, 201, 202.
Dollar exchange, 165, 166, 189, 203.
Domestic-trade and foreign-trade ac­
ceptances, 136, 169-71, 194, 195.
Double name and single-name paper,
75-82, 107-11.
Draft, in slow accounts, 109; trade
acceptance in form of, 115, 116;
status of, for goods to be used, 121;
can be peddled, 136; for foreign
trade, 166-69.
Draining and tilling, notes for, 140,
Earning assets, 320.
Edge Act, 177, 178, 180.
Elliott, M, C., quoted, 122.


Emergency relief, or continuous
operation, question of, 245-49.
European banking methods, and
American, 107.
Evans, Judge Beverly D., his opin­
ion concerning collection of checks,


Exchange exactions, 25-28; means
of absorbing, 29, 30; Mississippi
law concerning, 35, 36; effect of
Supreme Court decision concerning
cashing of checks, 36-39; and
Hardwick amendment, 40, 41;
attitude of banks toward Board’s
plan, 41, 42; legal warrant for, 43,
44; conclusions regarding, 45-49.
Export trade, use of trade accept­
ances in, 156-58.
Farmers, discontent with reserve
system, 151-53. See Agriculture,
Federal Reserve Act, the Hardwick
amendment, 40, 41; amendment of
June 21,1917,66,231-33,237,238,
263, 277; amendment of Septem­
ber 7, 1916, 100, 176, 230; provi­
sions in, relative to agricultural
credit, 134-37; permitting national
banks to accept for domestic pur­
poses, 195; amendment of Sep­
tember 17, 1919, 176; amendment
of December 24, 1919, 177; be­
comes law, 240.
Federal Reserve bank notes and
Federal Reserve notes. See Note
issues, Notes.
Federal Reserve Banks, emergency
character of, 6, 7; begin operation,
244, 245; questions of policy con­
cerning, 245; for continuous oper­
ation, 245-49; earnings for 1915
and 1916, 257, 258; operations,
compared with those of private
institutions, 258. See Reserve
Federal Reserve Board, and the
question of regional responsibility,
16,17; and Federal Reserve Banks,



17, 18; and clearing house, 28, 29;
regulations of, regarding discount­
able paper, 82-85; appointment of
members of, 240; cooperated with
the Treasury during the War, 26770; cooperation with the Treasury
a proper proceeding, 289-91; credit
system of, 299, 307. See Credit.
Federal Reserve Clearing System,
278 n.
Federal Reserve System, district re­
serve banks the most character­
istic feature, of, 1; the underlying
, theory of, 2; general considera­
tions concerning admission into,
50-52; national banks and, 52; con­
ditions of membership in, for State
banks, 52, 53; reasons for unwill­
ingness of State banks to join, 5464; appeal for entrance of State
Banks into, 65,66; increased mem­
bership of State banks in, 67;
considerations on State bank
* membership, 67-69; periods of,
239; not in operation at beginning
of Great War, 243, 244; meant
to operate continuously, 245-49;
difficulties of getting into the
market, 249-52; rate policy, 252,
253; discounts in first years, 25357; open-market purchases in
1915 and 1916, 256, 257; state­
ment of policy during first period,
258-60; in the industrial depres­
sion of 1920-21, 320-22; future
policy of, 322, 331, 342, 343.
4 Float,” 24, 25, 226.
Foreign branches, of American banks,

X75* 176.

Gold Settlement Fund, relation of,
to inter-district shifting of funds,
29; enlargement of functions
of, 45; establishment of, 259; and
inter-bank balances, 278 n.
Government bonds, 190, 194, 250.
Harding, Governor, quoted on duties
of Federal Reserve Banks and
Federal Reserve Board, 17, 18;
his attitude toward the Board’s
clearance plan, 42; opposed to
plan of Senator Owen, 203; on
Federal Reserve control of banking
situation, 261; on notes, 270; on
currency-volume and price level,


Holmes, George K., 37, 130.
Implement paper, eligibility of, 138,
139, 142.
Import trade, use of trade accept­
ances in, 155, 156.
Industrial reaction of 1920-21, 31622.
Inflation, price, during the War,
278-84; due to method of financ­
ing the War, 284-91; after the
War, 295-99. See Prices.
Inter-district lending of funds, 9-


Investment operations of reserve
banks, in 1917 and 1918, 273, 274.
Investment paper, objections to
rediscount of, 72-75; criterion of,
85-93; and open-market opera­
tions, 190.
Investment trust, 177.
Irrigation, 191.

Foreign-trade and domestic-trade
acceptances, 169-71, 194, 195.
Jones, Mr., of the Federal Reserve
Foreign Trade Financing Corpora­
Board, 240.
tion, 179.
Kemmerer, Professor E. W., 130.
Gold, accumulating in reserve banks,
227-30, 235-37; in reserve banks, Leffingwell, R. C., quoted, on rates,
efficiency of, 233, 234; inflow of,
301-03; on reserve ratio, 326, 327.
235; holdings of, increased, 237, Live-stock paper, 137, 138, 141,
264, 265, 275, 276.

100-04; real
estate, National and State, restric­
tions on, 128, 130, 133, 134; effect
of rates on, 341, 342.


developed before deposits, 206;
subject to strict regulations by
National Banking Act, 206; elas­
ticity of, 208; concentrated in
hands of reserve banks, 209; of
Federal Reserve notes, 214; method
of, 214-16; effect of, on prices,
306, 307.
Notes, bank, issuing of, confined to
reserve banks, 209; bond-secured,
211, 212; cause of increased circu­
lation of, 212-14; issued to replace
standard silver dollars destroyed,
213; issuance of, under AldrichVreeland Act, 242, 243.
Notes, farmers’, 137-42. See Agri­
cultural credit.
Notes, Federal Reserve, issuance of,
by Act of 1913, 214; receivable
by member and reserve banks,
215; lien behind, 215; issued
through rediscounts, 215, 216;
return of, 216,217; interest charges
on, 217; outstanding of, 218-20;
most important element in our
general circulation, 220; made more
acceptable by amendment of Sep­
tember 7, 1916, 231; substitution
of, for gold, 235; to be counted
as part of vault reserves, 236; take
place of legal tender, 237; changes
in circulation of, for various dates,
274, 320; gold cover for circulation
of, 275; effect of, on prices, 306,

McAdoo, Secretary, quoted on en­
trance of State banks into Federal
Reserve System, 65.
Member banks, and district direc­
torates, 18; State banks, 50-69;
advances to, in form of rediscounts,
70-96; direct collateral advances
to, 97-104; restrictions on their
power to accept bank acceptances,
167-73; and redemption of bank
notes, 215-17; reserves of, 22224; methods of establishing de­
posits with reserve banks, 224,
225; and book credits, 225; reserve
percentages for, 225-27, 232, 238;
legal reserves of, to be held entirely
on deposit with reserve banks, 231,
232, 263; and the question of
capital stock subscriptions, 250-52;
conditions of, in second period,
265, 266; reserve account of, in
1917 and 1918, 274; effect of War
on operations of, 276, 277.
Miller, A. C., quoted on wages and
cost of living, 305; his plan of
credit control, 325-30.
Mississippi law, as regards exchange,
35 , 36 .
Mitchell, Professor Wesley C., 279.
Mortimer, Frank C., quoted on re­
turn of capital stock subscrip­
tions, 250, 251.
Open book account system, 108.
Moulton, Mr., quoted, 79.
Open-market operations, and dis­
count operations, difference be­
Municipal bonds, 194.
tween, 185-87; extension of, to
Municipal warrants, 250.
reserve banks, 185; reasons for
inclusion of, in final bill, 187-89;
National banks, membership of, 52;
legislation broadening powers of,
on quoting forward discount rates,
189, 190; classes of paper per­
68; bonds and bank notes of, 20912, 220.
mitted in, 190, 191; as regards
National Reserve Association, 2.
maturity of bankers’ acceptances,
192, 193; as regards dealings in
Net deposits, the law’s definition of,
cable transfers and gold coin and
bullion, 193; as regards purchase of
Note issues, a form of credit, 205;



acceptances, 194, 195; compara­ Real estate loans, National and
tive volume of, 196; objections to,
State restrictions on, 128, 130,
196-200; proposal for separate
133, 134reserve bank, 200-04; during 1915 Reclamation districts, 191.
and 1916, 256, 257.
Rediscounts, cooperative function of
Organization Committee, 240.
reserve banks, 70, 71; provisions
Owen, Senator, quoted on abdica­
regarding, 71, ^72; of speculative
tion of Board, 16; his proposal for
and investment paper, objections
separate reserve bank, 200-04.
to, 72-75; single-name and double­
name paper, 75-82; regulations
Perrin, John, quoted on direct dis­
regarding discountable paper, 82counts, 98.
85; determination of eligible paper,
Phelan Bill, 338.
85-93; the question of limitations,
Pittman Act, 212-14.
93-96; and direct discounts, 97, 98;
Prices, wholesale, rise of, in period
rate of, on six-months agricultural
1917-1918, 278-80; retail rise of,
paper, 146, 147; no great demand
in period 1917-1918, 279, 280;
for, at first, 250; rates of, 303-05,
311-15; control of, essentials should
relationship between media of
exchange and, 280-82; results of,
be developed, 322; policy, reserve
282-84; due to method of financing
ratio as guide for, 324, 325, 327the War, 284-91; after the War,
30; policy, price stability as test
295-99; relation of, to volume of
for, 324, 325, 330-32; increase in
rates of, as means of restricting
currency. 306; factors determining,
307; and bank-credits, 308-11; as
credits, 335-41.
affected by enlarged money de­ Reed, H. L.f articles of, quoted, 286,
mand, 309; in industrial reaction
287, 309, 33i.
of, 1920-1921,316-22; stability of, Regional banks, system of twelve, 2.
as test for rediscount policy, 324, Regional responsibility, 16, 17.
Regional system, surprising outcome
325, 330- 32.
Production, as guide to future Fed­
of legislative planning, 1; state­
ment of objections made to, 3-5;
eral Reserve policy, 331-33; and
consideration of objections to, 5credit, 342.
18; and credit expansion, 5, 6; and
Rates, 5-7; commodity, 143-46; dis­
continuous functioning, 6, 7; and
count, quoting forward, 189, 190;
rates, 6,7; and sectionalism, 8; and
policy of Board in regard to,
inter-district harmony, 9-14; and
marked by conservatism, 252,
complaints of sectional partiality,
14-16; and regional responsibility,
253; on commercial paper, in­
16,17; merits of, 18; most vulner­
creased, 263, 264; from May,
1917, to November 11, 1918,
able point of, 18.
268-70; rediscount, 303-05, 311- Renewal trade draft, 122.
15; of discount on ninety-day Reserve account, of member banks,
paper, 320; of reserve banks, and
market rates, 333; acceptance and Reserve bank, proposal for separate,
line-of-credit, 333, 334; reliance
on, as means of restricting credit Reserve banks, and check collections
and clearances, 20-49; advances
(progressive rate plan), 335-41;
of rediscounts, 70-96; condition
effect of, on demand for loans,
governing the power of, to acquire
34 *> 342.

acceptances, 173-75; open-market
operations of, 185-204; advances
of, note issues, 205-20; advances
of, deposits and reserves, 221-38;
their bank credits with member
banks, 225; reserve percentages
for, 225; efficacy of gold in, 233,
234; and the question of capital
stock subscriptions, 250-52; re­
serves of, 264; investment opera­
tions of, 273, 274; earning assets
of, 274; ratio of cash reserves to
net deposits and Federal Reserve
notes, 276; relation of, to other
parts of system, should be for­
mulated, 322; surplus reserves of,
enormous, 323; rates of, 333~35See Federal Reserve Banks.
Reserve clearing system. See Checks.
Reserve funds, used for speculative
purposes, 15 n.
Reserve percentages, 225-27, 238.
Reserve ratio, changes in, 298, 320;
as a guide for rediscount policy,
324-30; should be made more
manageable, 342.
Reserves, of member banks, 222-24;
percentages for reserve and mem­
ber banks, 225-27; gold, 227-30;
to be held entirely with reserve
banks, 231, 232; surplus of re­
serve banks, 323.
Reynolds, Arthur, 246.
Sectionalism, and the regional plan,
5, 8-14.
Short-time paper, in open-market
operations, 190.
Silver dollars, melting down of, in
accordance with Pittman Act,
Single-name and double-name paper,
75-82, 108-11.
Speculation, reserve funds used in,
land, 133, 134, 151; boom,


Speculative paper, objections to re­


discount of, 72-75;' criterion of,

8 -93.

Sprague, 0 . M. W., quoted, 80, 324.
State banks, conditions for member*
ship of, in the Federal Reserve
System, 52, 53; unwillingness of,
to join Federal Reserve System,
54; doubtful legal position of, 55,
56; question of double liability of,
56; on rediscountability of paper
held by, 57-59; other reasons for
unwillingness, 59-64; increased
membership, 65-67; considerations
on membership of, 67-69.
Stewart, Walter W., 280.
Stokes, E. C., quoted, 310, 311.
Strong, Governor, 58, 219.
Syndicate acceptance, 175-80.
Ter Meulen, 180.
Thralls, Mr., quoted on the Hard­
wick Amendment, 40.
Timber, 86, 87.
Time items, collection department
for, 44, 45.
Tractor paper, 138.
Trade acceptances, operating in
same manner as check, 109; ad­
vantages urged in behalf of en­
couraging use of, m -1 4 ; means
employed to extend use of, 115;
origin as distinct class of commer­
cial paper, 115; qualifications to
which it must conform, 115, 116;
why drawn in form of draft, 116;
comparative amount of, dis­
counted, 117; obstacles in the way
of wide extension of its use, 11820; aid to, justified, 120; objec­
tionable methods of using, 12023; in renewals, 122; on strength
of firms whose allegiance to, was
sought, 123, 124; used relatively
infrequently, 125; limitations re­
garding amount of, 125-27.
Trade credit, historical causes of
present methods of, 107.
Trade paper, provisions pertinent
to, 110.



Treasury certificates, short-term, is­
sues of, in the War, 267,268; shorttime fiscal requirements of, 300.
Two-name paper. See Double-name.

on trade acceptances, 118, 119; on
quoting forward discount rates,
189; on the storing of gold, 228; his
appointment to Federal Reserve
Board, 240.
Warrants, 194, 250.
Williams, John Skelton, quoted on
speculative use of reserve funds, 15.
Willis, H. P., quoted on central
bank, 8.
Wilson, President, 240.
Withers, Hartley, 244.

Wages, 305.
War, the Great, effect on finances,
240-42; effect of, on operations
of member banks, 276, 277; con­
ditions following, 292-97.
War finance, successful and unsuc­
cessful, 284-91.
Warburg, Paul M., 65; quoted on
trade acceptances, 80, 81; on the Youngman, Anna, her objection to
contrast between European and
open-market operations, 196-200;
American banking methods, 107;
on rate increases, 340.