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® fje ^ r o t a t e
V o lu m e




E d ito r: CLYDE L. KING

A s s is t a n t E d ito r : J. H. WILLITS
CONWAY, J r ., C. H. CRENNAN, A . A .


E d it o r ia l C o u n c il:

Editors in Charge of this Volume

T h e A m erican A cademy o f P olitical a n d S ocial S cience
1 39 th S treet an d W oodland A v e n u e
P hiladelph ia

Copyright, 1922, by

T h e A m e r ic a n A cadem y o f P olitica l
All rights reserved


S o cial S c ie n c e

ENGLAND: P. S. King & Son, Ltd., 2 Great Smith Street, Westminster, London, S. W.
FRANCE: L. Larose, Rue Soufflot, 22, Paris.
GERMANY: Mayer & Muller, 2 Prinz Louis Ferdinandstrasse, Berlin, N. W.
ITALY: Giornale Degli Economisti, via Monte Savello, Palazzo Orsini, Rome.
SPAIN: E. Dossat, 9 Plaza de Santa Ana, Madrid

CONTRIBUTORS TO THIS VOLUME...................................................................................
A. D. Welton and C. H. Crennan, Editors-in-Charge
STATES THROUGH THE PANIC OF 1907 ...............................................................
B. H. Beckhart, Columbia University
N. A. Weston, University of Illinois
Harry A. Wheeler, Vice-President, Union Trust Company of Chicago
THE EDUCATIONAL CAMPAIGN FOR BANKING REFORM......................................
A. D. Welton, Continental and Commercial National Bank of Chicago
THE FEDERAL RESERVE ACT IN CONGRESS...............................................................
H. Parker Willis, Columbia University
THE ALDRICH-VREELAND EMERGENCY CURRENCY..............................................
Homer Joseph Dodge, Editor, The Federal Trade Information Service
THE RESERVE ACT IN ITS IMPLICIT MEANING........................................................
A. D. Welton, Continental and Commercial National Bank of Chicago
E. W. Kemmerer, Princeton University
Paul M. Warburg, Member of the Federal Reserve Board, 1914-1918
Arthur Reynolds, President, Continental and Commercial National Bank of Chicago
Pierre Jay, Chairman and Federal Reserve Agent, Federal Reserve Bank of New York
OF FEDERAL RESERVE BANKS................................................................................
R. M. Gidney, Controller at Large, Federal Reserve Bank of New York
FUND................................................................................................................... ..............
George J. Seay, Governor of the Federal Reserve Bank of Richmond
ELIGIBILITY FOR DISCOUNT...............................................................................................
Charles L. Powell, Counsel for Federal Reserve Bank of Chicago
AMENDMENTS TO THE FEDERAL RESERVE ACT......................................................
Walter S. Logan, General Counsel, Federal Reserve Board
PREPARATION FOR WAR AND THE LIBERTY LOANS..............................................
J. H. Case, Deputy Governor, Federal Reserve Bank of New York
Murray S. Wildman, Stanford University
E. R. Fancher, Governor, Federal Reserve Bank of Cleveland









CURVES OF EXPANSION AND CONTRACTION 1919-1921...........................................
A. C. Miller, Federal Reserve Board, Washington, D. C.
Ernest Minor Patterson, University of Pennsylvania
J. V. Farwell, President, John V. Farwell Company
CURRENCY EXPANSION AND CONTRACTION..............................................................
James B. Forgan, Chairman of the Board, the First National Bank of Chicago
POINT........................... .*.................................................................................... \ .............
John H. Rich, Chairman and Federal Reserve Agent, Federal Reserve Bank of Minneapolis
PRINCIPLES GOVERNING THE DISCOUNT RATE........................................................
W. P. G. Harding, Governor of the Federal Reserve Board
George M. Reynolds, Chairman of the Board, Continental and Commercial National
Bank of Chicago
Chester A. Phillips, University of Iowa
AGRICULTURAL AND COMMERCIAL LOANS...................................................................
J. B. McDougal, Governor, Federal Reserve Bank of Chicago
AND THE FEDERAL RESERVE BANKS.................................................................
William A. Scott, University of Wisconsin
E. E. Agger, Columbia University
THE EFFICIENCY OF CREDIT.............................................................................................
O. M. W. Sprague, Harvard University
BOOK DEPARTMENT................................................................................................................



INDEX............................................................................................................................. 225

E. E.—Associate Professor of
Economics, Columbia University.
Contributing editor to the Standard
Daily Trade Service.
For some time Assistant to President
of the National City Bank, N. Y.
Editor, American Edition of Clay’s
Economics for the General Reader and
author of articles on banking subjects.
B e c k h a r t , B. H.—Lecturer in Banking,
School of Business, Columbia University,
1921; Instructor in Economics and Social
Institutions, Princeton University, 19201921; employed at Federal Reserve Bank
of New York, 1919- 1920.
C a s e , J. H.—Deputy Governor, Federal
Reserve Bank of New York, 1917 to
Was Vice-President, Farmers Loan
and Trust Co., New York City,
also Secretary-Treasurer-Vice-President,
Plainfield Trust Co., Plainfield, N. J.
C r e n n a n , C. H.—Economist, Continental
and Commercial National Bank, Chicago;
formerly member of faculty, University
of Pennsylvania, Director, Research Bu­
reau, Pennsylvania State Chamber of
Commerce, and Assistant Editor of The
Annals of the American Academy of Po­
litical and Social Science.
Editor-in-charge of several volumes
of The Annals.
D o d g e , H o m er J.—Editor, Federal Trade
Information Service; President, The Treas­
ury Correspondents Association. During
the War reported financial and eco­
nomic news for the international News
Service, covering Treasury, Federal
Reserve Board and other business depart­
Author of numerous articles on eco­
nomic topics. Compiled speakers’ hand­
book for Four Minute Men which con­
tained information about war financing.
F a n c h e r , E. R.—Governor, Federal Re­
serve Bank of Cleveland, 1914 to
Formerly President, Union National
Bank, Cleveland.
F a r w e l l , J. V.—President, John V. Farwell Company, Chicago; Director, Na­

A g g er ,

tional Bank of the Republic, Chicago,
and Harris Safety Deposit Co., Chicago;
Director, Liverpool & London & Globe
Insurance Co.; President, First State
Pawners Society of Chicago.
Was President of the National Citizens
League for the Promotion of a Sound
Banking System.
F o r g a n , J. B.—Chairman of the Board,
First National Bank of Chicago.
Was with Royal Bank of Scotland for
three years; later with Bank of British
North America, with assignments to
Montreal, New York and Halifax; In­
spector of Agencies, Bank of Nova Scotia;
Cashier and Manager, ^ Northwestern
National Bank, Minneapolis 1888; VicePresident, First National Bank, Chicago,
1892, President, 1900, Chairman of
Board since 1916. Member Board of
Directors, Federal Reserve Bank, Chi­
cago, 1914- 1919; President, Advisory
Council, Federal Reserve Board, 19141920; Vice-Chairman, Currency Commis­
sion, American Bankers Association,
1907 to date.
G id n e y , R. M.—Controller at Large, Fed­
eral Reserve Bank of New York.
For eight years engaged in banking at
Santa Barbara and Bakersfield, Cali­
fornia. August 1914, appointed secre­
tary to A. C. Miller, member of the
Federal Reserve Board; later, Federal
Reserve examiner; 1917, Assistant Federal
Reserve Agent at the Federal Reserve
Bank of New York. Manager of the
Buffalo Branch of the Federal Reserve
Bank of New York, 1919- 1921.
H a r d in g , W. P . G.—Governor, Federal
Reserve Board, Washington, since 1916.
Vice-President, Bemey National Bank,
Birmingham, 1896, President 1902. Mem­
ber Federal Reserve Board, Washington
1914. President, Alabama State Bank­
ers’ Association 1908 and Birmingham
Chamber of Commerce, 1913.
J a y , P ie r r e —Federal Reserve Agent and
Chairman of Board, Federal Reserve
Bank of New York since 1914.
Vice-President, Manhattan Company,
New York, 1909- 1914; Bank Commis­


C o n t r ib u t o r s

sioner of Massachusetts, 1906- 1909;
Vice-President, Old Colony Trust Com­
pany, Boston, 1903- 1906.
K e m m e r e r , E. W.—Professor of Econom­
ics and Finance, Princeton University.
Professor of Economics and Finance,
1909-1912 Cornell University; Assistant
Professor Political Economy, 1906- 1909.
Financial adviser to United States
Philippine Commission, 1903; Chief,
Division of Currency, P. I., 1904- 06;
Special Commissioner Philippine Govern­
ment to Egypt, 1906; Financial adviser
to Government of Mexico 1917 and
to Government of Guatemala, 1919.
Managing editor of the Economic Bul­
letin, 1907- 1910; Associate editor, Ameri­
can Economic Review 1911- 1914.
Author numerous reports on banking
and currency questions; Money and
Credit Instruments in their Relation to
General Prices, 1907, revised 1909;
Seasonal Variations in the Relative De­
mands for Money and Capital in the
United States (in report of National
Monetary Commission) 1910; Modem
Currency Reforms 1916; The United
States Postal Savings System, 1917;
Monetary System of Mexico, 1917; The
A.B.C. of the Federal Reserve System,
L o g a n , W a l t e r S.—General Counsel to
the Federal Reserve Board. Practiced
law in New York City in the office of
Winter & Winter and also in the office
of Cadwalader, Wickersham &Taft. Be­
came Assistant Counsel to the Federal
Reserve Board July 1, 1919, and Gen­
eral Counsel July 1, 1920.
M c D o u g a l , J. B.—Governor, Federal
Reserve Bank of Chicago since 1914.
National Bank examiner, 1901- 1906;
became official examiner of associated
banks of Chicago, 1906; organized and
conducted department of examination
of the Chicago Clearing House and was
its official head until 1914.
M il l e r , A. C.—Member Federal Reserve
Board of Washington, D. C. since 1914.
Assistant to the Secretary of the interior,
Washington, 1913- 1914. Flood Pro­
fessor Economics and Commerce, Uni­
versity of California, 1902- 13; Associate
Professor Political Economy and Finance,


T h is V olum e

Cornell, 1891- 2 ; Professor of Finance,
University of Chicago, 1892- 1902; Pro­
fessor History and Politics, University
of California, 1890- 1; Instructor Eco­
nomics, Harvard, 1889- 90.
Author of papers on finance, banking,
etc. in economic and financial journals.
P h il l ip s , C. A.—Dean, College of Com­
merce, University of Iowa. Member of
the Dartmouth faculty, 1911- 1920.
Member, The Inter-American High
Editor, Readings in Money and Bank­
ing and author of Bank Credit.
P a t t e r s o n , E. M.—Professor of Econom­
ics, University of Pennsylvania, 1919 to
date. Formerly Assistant Professor of
Economics, University of Pennsylvania,
1915- 1919.
Joint author, Conway and Patterson,
The Operation of the New Bank Act.
Author, numerous articles on money and
banking questions. Editor-in-charge of
,several issues of The Annals.
P o w e l l , C h a s . L.—Member of law firm of
Mayer, Meyer, Austrian & Platt, Chi­
cago; counsel of the Federal Reserve Bank
of Chicago, 1914 to date. Practiced law
for twenty years in Iowa. Student of
banking, especially the legal aspects of
banking questions.
R e y n o l d s , A r t h u r —President, Conti­
nental and Commercial National Bank'
of Chicago, President, Continental and
Commercial Trust and Savings Bank and
President, Continental and Commercial
Securities Company.
Cashier, Guthrie County National
Bank, 1893; Cashier, Des Moines
National Bank, 1895- 97, President,
1897- 1915; First Vice-President, Conti­
nental and Commercial National Bank
1915- 1921. Chairman, Federal Legisla­
tive Committee, A.B.A. 1905; Member
Currency Commission A.B.A., Treas­
urer, A.B.A. 1910; President, A.B.A.
R e y n o l d s , G. M.—Chairman of the
Board, Continental and Commercial
National Bank of Chicago, Chairman of
the Board, Continental and Commercial
Trust and Savings Bank, Chairman of
the Board, Continental and Commercial
Securities Company. President, Con­

C o n t r ib u t o r s

tinental and Commercial National Bank,
1910- 1921. President, American Bank­
ers Association, 1908; Adviser, National
Monetary Commission, 1908; Director,
Federal Reserve Bank of Chicago, New
York Life Insurance Company, Com­
mercial Insurance Company.
R ic h , J o h n H.—Chairman of Board and
Federal Reserve Agent, Federal Reserve
Bank of Minneapolis, 1914 to date.
For many years president of a country
bank and a manufacturer. President of
the Citizens League of Minnesota, and
active in the movement to secure the
adoption of the Federal Reserve Act.
Author of numerous monographs on
Federal Reserve banking, the operations
of Federal Reserve Banks and agricul­
tural credit.
S e a y , G e o r g e J.—Governor, Federal Re­
serve Bank of Richmond. For twenty
years connected with a bank in Peters­
burg, Va. Later, a partner in the
banking firm of Scott & Stringfellow
of* Richmond. In 1909 withdrew to
carry on studies, following with close
attention agitation for banking reform
which resulted in the Reserve Act.
Prepared case for selecting Richmond
as Reserve Bank. Upon organization,
elected Class B director. Elected Gov­
ernor at first meeting of Board. Served
as member of Federal Advisory Council.
Writer on banking and railroad
S c o t t , W m . A.—Director of the Course
in Commerce and Professor of Political
Economy, University of Wisconsin,
Chairman of the Board of Directors of
the Commercial National Bank, Madison,
Wisconsin. Professor of History and
Political Science, University of South
Dakota, 1887- 90; Instructor in Johns
Hopkins University, 1890- 92.
Author, Repudiation of State Debts,
1893; Money and Banking, 1903; revised
edit. 1910; Money, 1913; Banking, 1913;
“Austrian School and Recent Develop­
ments,” ch. VII revised edit, of Ingram’s
History of Political Economy, 1915.
S p r a g u e , O. M. W.—Professor Banking
and Finance, Harvard, 1913 to date.
Assistant Professor, Banking and Fi­
nance, 1908- 1913; Professor Economics,


T h is V olum e


Imperial University of Tokyo, 1905- 08;
Assistant Professor, 1904- 5, Harvard.
Author History of Crises under the
Notional Banking System, 1910; Banking
Reform in the United States, 1911; Theory
and History of Banking, 1917, and many
economic articles.
W a r b u r g , P a u l M.—Chairman of the
Board, International Acceptance Bank,
Inc. Member Federal Reserve Board
for term 1914- 1918.
Was Director National Bank of Com­
merce, United States Mortgage and
Trust Co., B. and O. R. R. Co., National
Railways of Mexico, Wells Fargo & Co.,
Westinghouse Electric and Manufactur­
ing Company. Resigned all director­
ships and trusteeships when appointed to
Federal Reserve Board. Author many
pamphlets on banking and currency,
particularly in relation to the Reserve
System both before and after its or­
W e l t o n , A. D.—Director of Publicity,
Continental and Commercial Banks,
Chicago. General Secretary, National
Citizens League; practiced law in De­
troit; Editor, Detroit Free Press, 19051906, St. Louis Post-Dispatch, 1911 and
Journal of the American Bankers Associa­
tion, 1914- 1918.
W e s t o n , N. A.—Professor of Economics,
University of Illinois; Formerly Dean of
the College of Commerce and Business
Administration, University of Illinois.
W h e e l e r , H. A.—Vice-President, Union
Trust Company of Chicago since 1910;
Vice-President, 1899- 1901, President,
1901- 1910, Credit Clearing House, Chi­
cago; General Secretary, Chicago Asso­
ciation of Commerce, 1906- 1907, Chair­
man, Ways and Means Committee 1908,
Vice-President, 1909, Chairman, Execu­
tive Committee, 1910, President 1911.
President, Chamber of Commerce,1U.S.A.
1912- 1913, 1918- 1919. Director and
member Executive Committee, National
Citizens League.
W il d m a n , M u r r a y —Professor of Eco­
nomics, Leland Stanford, Jr., University,
1912 to date.
Founder, Cashier and Vice-President,
Henry County Bank, Spiceland, Cal.
Assistant Professor Economics, Univer-


C o n t r ib u t o r s

sit/ pi Missouri; Professor Economics
and Commerce, Northwestern Univer­
sity; Organization Secretary, National
Citizens League, 1911- 1912; Bureau
of Research, War Trade Board, and
division planning and statistics War
Industries Board, 1918- 1919.
Author Money Inflation in the United
States, 1905 and economic articles.
W il l is , H. P a r k e r —Professor of Eco­
nomics, Columbia University, Editor,
New York Journal of Commerce and
Director, Division of Analysis and Re­
search, Federal Reserve Board.


T h is V olum e

Secretary, Federal Reserve Board,
1914- 1918; Assistant to Monetary Com­
mission, 1897- 8 ; Expert, Ways and
Means Committee, House of Represen­
tatives, Washington 1911- 13; Banking
and Currency Committee, 1912- 13;
President, Philippine National Bank
1916- 7; Special Commissioner in Aus­
tralasia for Chase National Bank &
Central Trust Company, 1919.
Author, History of the Latin Monetary
Union; Principles and Problems of Modern
Banking; The Federal Reserve; American
Banking and many articles on banking.

The Integrity of the Federal Reserve System
By A. D. W e lto n a n d



H. C r e n n a n


HE Federal Reserve System has Banks give them all the business they
to do only with commercial bank­ have, except the government, which
ing.1 Commercial banking has only to their only other customer. The
do with getting goods from producer country has then a banking system
to consumer. It operates on the composed of banks of various kinds,
assumption, ordinarily valid, that the some chartered by the nation and
sale of goods to the consumer produces some by the states, brought into a
funds to discharge whatever obligation cooperating organization with the Fed­
has been created.
eral Reserve Banks as the operating
Investment banking, on the other mechanism.
hand, operates on the assumption that Over this operating mechanism of
the capital loaned will be repaid out of the cooperating organization of banks,
the earnings its use permits in a speci­ the government exercises a general
supervision. There are many people
fied number of years.
The essence of commercial banking who thought the supervising authority
is liquidity of the credit on which it should be different, but it isn’t and it
functions. Its credit instruments must doesn’t matter so long as it is com­
be of short maturity. The banks petent and impartial.
which invest in them undertake to pay The purpose of the Federal Reserve
on demand and they must have a System was to provide for business
constant inflow of funds or a means of just what has been provided. There
quickly realizing on their credit in­ was no purpose and no intention to
struments. It is necessary, therefore, establish government banks, and none
that the goods against which such credit was established. There was no pur­
is granted should be always in process pose to help or favor operating banks
of sale.
because they needed neither help nor
Primarily and fundamentally the favors. There was a purpose and
Reserve System was designed to pro­ intention to put the operating, com­
vide for the credit instruments of mercial banks in a better position to
commerce an instant sale. It was discharge their duties to business so
an attempt to organize not a new lot of that business might go on under any
banks, but a new banking machine and all circumstances, if this could
supported by the resources of all its be achieved through an economic
use of credit and competent credit
member banks.2
The Reserve System is then an machinery.
organization of banks. The Reserve In relation to business, therefore,
Banks draw their capital from banks. the Federal Reserve System is more
than a banking system. It is a code
1 Permission to national banks to receive for business behavior. It is more than
savings deposits and to exercise trust company a machine for expanding and
powers does not affect the commercial nature of tracting credit and currency. It con­
is a
the Reserve System.
2 Cf. Article by Professor Kemmerer in this means for the orderly and systematic
functioning of business credit and,


T he Annals

of the

through reapportionment of this credit,
for the stabilization of business.
No comprehensive grasp of the
System can be had if, among its
attributes, is included that of a
remedy for all business and financial
ills. It is not. It can never save the
day for the insolvent. It is man-made
and man-operated. It has and must
have limitations. It must not be
concluded because it financed the War,
that it can go on indefinitely producing
rabbits of credit and currency out of an
empty hat. It didn’t do that even in
war. It did give life and credit form to
latent and dormant resources. It did
make the unliquid at least temporarily
liquid. But war demands such per­
It might have been better if the
Reserve System had been called on to
do less, and more had been done
through other means, the Treasury,
for instance. It would have been as
well for the country and better for the
System. Had this course been followed
the Reserve Banks would have avoided
much harsh criticism for displaying
their limitations, once war pressure
was removed. Many suggestions for
changing the System would never have
been made. It would not have been
expected to bring to realization so
many fatuous dreams.
As an operating banking mechanism
the System need not, however, be
taken for what it is. Changes in the
machinery may be made if the funda­
mental structure is not impaired. Any
banking system is a thing of growth.
If, in its final form, it shows that
wisdom has been gained from experi­
ence and skill from practice, it begins
to approximate general needs. The
Reserve System is an evolution out of
more than a century of hard and bitter,
experience made harder and more bitter
by experiments. Its mechanism is,
therefore, of moment only as it per­

A m er ic a n A cadem y

mits the application of principles of
demonstrated soundness. Its funda­
ments are vital, not only because they
attest that old fallacies have been dis­
missed, but also because they have
been proved under the test of prac­
Probably, in any organization ap­
plying rules of conduct, there is a
degree of fluidity. Some measure of
change is always possible even when
not always desirable. But change for
the sake of change is not progress or
improvement. On the other hand,
there is advantage in holding to fixed
practice. It is not difficult to test
the quality of any amendment proposed
to the Federal Reserve Act. It is
necessary only to get the fundamental
purposes in mind. Anything out of
accord with them may instantly be
But a great banking system cannot
grow and develop out of itself. Deal­
ing with such an intangible as credit
and so nebulous a quality as confidence,
the attitude of the public must be
reckoned with. So susceptible are
banks generally to public opinion that
the banker subconsciously, almost, con­
siders that as a factor to be used in all
his calculations. In any event the
public is a factor in the future develop­
ment of the Reserve System, as Paul M.
Warburg points out elsewhere in this
volume. If the public is dismissed be­
cause even a meager popular under­
standing of the intricacies of banking is
beyond hope, the business man, from
whom more may be expected, stands
forth as a grim spectre.
The public, most assuredly, feels and
does not analyze. The business man
may be controlled by emotion rather
than reason. The more certain the
operations of the Reserve Banks,
therefore, the better they will come to
be understood. Eventually, although
it may be only a hope, the public will

I n te g r ity

of the

F e d e r a l R e se r v e S ystem

come to understand up to the point of
having confidence.
Thus the public is an important
factor in the development of the
Federal Reserve System. There must
be a growth without the banks as well
as within them. The public mind
must become attuned to them.
For the people the Reserve System is
a precious thing. If it is to fulfill its
work and its mission, they must view
it with confidence. Its integrity is to
be guarded with as much jealousy as
the .Constitution itself. The jealousy
must be inculcated into the popular
mind. The attainment of such a state
is taken to be desirable. If it is, the
prospect of its realization will be in
constant jeopardy unless members of
Congress can be induced to abandon
the idea that the Reserve Act is
subject to tinkering at the behest of any
amateur banker.
K n o w led g e o f B a n k in g H isto r y
H e l p s to P u b l ic U n d e r st a n d in g

Under the interpretation of the Fed­
eral Reserve System given above, its
growth, improvement and develop­
ment to the maximum of satisfaction
and efficiency can be attained only if
its fundamental purposes are under­
stood. The forces without the System
must contribute a share in this growth
and development. These outside forces
are the business men and the public
There can be no adequate under­
standing or appreciation of the System
unless there is a general familiarity
with what preceded it. To this end
the first section of this volume is
given over to an historical review. The
first article sketches the history of
banking from 1791, when the First
Bank of the United States was organ­
ized, down through the panic of 1907.3
Even cursory reading of these events
3By B. H. Beckhart.


will indicate the influence that old
experiments and controversies exerted
on the makers of the Reserve Act and
the form and content of the law. In
the struggle over note issues and
redemption of bank notes will be
found the causes for the demand that
Federal Reserve notes be made “ obli­
gations of the United States.” The
workings of the national bank system
will explain the development of re­
serve banking and the need for
elasticity of both credit and currency,
and so on.
In his article on “The Studies of the
National Monetary Commission,” Pro­
fessor Weston illuminates the defects
of the old banking system and shows
how they were studied in relation to
other systems and the probable needs
of modem business for adequate bank­
ing service.
These needs found expression in the
organization of the National Citizens’
League for the Promotion of a Sound
Banking System. The story of the
organization of that movement is
told by Mr. Harry A. Wheeler, who
participated in it and who was also one
of the organizers and the first President
of the Chamber of Commerce of the
United States.
Through the workings of the Na­
tional Citizens’ League, later supple­
mented by work of the Chamber of
Commerce, the business men and the
business organizations of the country
were bound together. A community of
thought on banking methods and
services was thus brought about and
translated into definite purpose.
To get this result—a first step
toward legislation—demanded an elab­
orate educational campaign. Success
in this venture was made more difficult
because of the many schemes for
monetary and banking reform con­
ceived and promoted by modern John
Laws. These enthusiasts, often seeing

T h e A nnals

of the

in banking the means of attaining
universal happiness, found no other
weapon than legislative compulsion or
government operation of banks. Dis­
missing the exploded theories, it need
only be said that the guaranty of
bank deposits was the measure of
reform being pressed with vigor at that
time. It had many advocates in
Congress. However, the educational
campaign was persistently prosecuted
and was successful to the extent nec­
essary in bringing attention to sound
economics in banking reform as against
the pursuit of emotional rainbows.
In his article on “The Federal Re­
serve Act in Congress,” Dr. H. Parker
Willis gives an intimate recital of facts,
many of which have not previously
been published. As expert for the
House Committee on Banking and
Currency, Dr. Willis was familiar
with every step in the development of
the bill before it was in the Committee
for discussion and subsequently. The
political factor is here disclosed as it
came forward to influence what was
an economic product. The degree of
interest of the Administration in the
measure, the pressure placed on Con­
gress and the suggestions from the
Treasury and other departments are
made clear.
In this phase of the development,
distinction must be made between the
administrative and the economic pro­
visions. Control of the System was
always a subject of contention. The
decentralizing of credit and curbing
of the supposed power of Wall Street
and the “Money Trust” were always
matters of political concern. The
tendency toward government control
of the operating banks themselves had
to be guarded against. Over the
economic provisions, there was less
trouble. There was no disagreement
of moment in this respect, but pro­
visions strictly economic were often

A m er ic a n A cadem y

under pressure because of their rela­
tion to control in execution. Thus
elasticity of note issue was confused
with distribution of credit and would
have been sacrificed or impaired if
help for the farmer could have been
secured thereby. One illustration of
the confusion of economics and politics
will suffice.
In an economic sense, rediscount­
ing for profit was at that time unthink­
able. The maturity of paper offered
for rediscount at the proposed banks
was of incidental importance. Com­
mercial banks could not consider paper
of anything but short maturity and it
was equally clear that paper for re­
discount would not be offered to the
Reserve Bank by the discounting bank
on the day of discount. But dozens of
congressmen could not or would not
understand that the farmer could have
no direct dealing with the Reserve
Bank. Hours of discussion in the
Senate were given over to the maturity
of agricultural paper. Senators who
saw in the Reserve Act only a new way
of settling the farmer’s eternal credit
problem, would have willingly de­
stroyed the commercial character of
the Reserve Banks on the chance of
settling that question. The time
agricultural paper for rediscount may
run was increased to ninety days.
This maturity would have been of no
importance if the rediscount rates had
ever been scientifically adjusted and
is of little importance anyway. In
August, 1921, the average maturity of
rediscounted paper was 15.76 days.
In September it was 1 7 .2 2 days. In
the Minneapolis Bank it was 42.06 days
and in Boston 7 .7 4 days. If maturities
had not been mentioned in the Act,
the result would probably have been
the same.
The House bill as recommended by
Chairman Glass’ Committee was the
real bill, as Dr. Willis points out.

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Senator Owen had a different bill
which he was induced, eventually, to
abandon. There was also a bill
fathered by the Treasury providing
for a central government bank with
the Treasury's gold as the capital.
The fact that the gold belonged to
the holders of the certificates issued
against it, was thought to be insig­
nificant. The advocates of this plan
floundered about in it for some time
until the President himself summarily
suppressed it.
Dr. Willis shows clearly that the
Glass bill was the Administration’s
bill. After all other proposals had been
discussed, and mechanical changes
were made—notably that providing
for retirement of the bond-secured
currency—the Act as passed was sub­
stantially the bill as it came from the
House Committee.
The true purposes of the Federal
Reserve Act will be found in the dis­
cussions and reports of the Banking
and Currency Committee of the House,
of which Carter Glass was chairman.
The beginning of the European War
brought an almost instant business
dislocation. Fear of panic was allayed
by the summary closing of the stock
exchanges. A currency famine was
supposed to be imminent. The mem­
bers of the Federal Reserve Board had
been appointed about this time—
August 9 , 1914—but the time for
opening the new Reserve Banks could
not even be predicted.
In September the dormant National
Currency Associations were awakened.
These had been formed in many dis­
tricts under the provisions of the
Aldrich-Vreeland Act, passed after the
panic of 1907. Emergency currency
was issued to these Associations and
met whatever stress there was, as
told in Mr. Dodge’s article.4


Aside from the useful service of
providing currency and thereby sus­
taining confidence, the operation of
this law was effective to prove its in­
capacity to meet anything more than a
passing strain. There were many men
—bankers included—who thought that
the demand for banking reform would
be completely met by this law or any
law which would permit the turning of
bank assets into currency. It was a bit
of good fortune that there was a dem­
onstration to show that banking effi­
ciency was a reserve and not a currency
problem. It eliminated forever from
consideration a half-hearted remedy.
E a r l y P r o blem s a n d O pe r a t io n s
t h e F e d e r a l R e se r v e B oard
and B anks


The Federal Reserve Board and
the Banks were organized without
much difficulty. The Organization
Committee toured the country to
gather information and hear the argu­
ments of the various civic and banking
committees selected to advance the
claims of the many cities which thought
themselves entitled to selection as the
homes of the Reserve Banks. There
were many contenders for these honors
and there was some bitterness. Fixing
the boundary lines of the districts also
caused contention. Political “pull”
was exerted to influence the committee
from without and political prejudice
was working within. But these mat­
ters were of minor importance com­
pared to the Organization Committee’s
interpretation of the provision as to the
number of Banks. They decided that
twelve should be immediately estab­
lished, and not eight, to be increased
to twelve later if experience showed
twelve to be necessary.
Undoubtedly the Committee felt the
pressure keenly. Southern cities were
4 “The Aldrich-Vreeland Emergency Cur­ very ambitious and very influential.
But, so far as politics was concerned,


T he A nnals

of the

its full force was not manifested until
the matter of organizing the Reserve
districts came before the Reserve
Board for review in 1915.
The Federal Reserve Act (Section 2)
says, “The determination of said or­
ganization committee shall not be sub­
ject to review except by the Federal
Reserve Board when organized” and
“the districts thus created may be ad­
justed and new districts may from
time to time be created by the Federal
Reserve Board, not to exceed twelve in
The Board seemed to think that pro­
vision mandatory. It was, therefore,
in the performance of what they con­
sidered a duty that they turned to a
study of district boundaries and the
location of Reserve Banks. In several
instances changes in boundaries were
made, but when a discussion of the
possible strengthening of the System
by combining some of the districts
(without closing any offices already es­
tablished) was begun, political power
began immediately to work.
The then Governor of the Board and
the two ex-officio members combined
to prevent any change of the kind un­
der discussion. The ex-officio members
—the Secretary of the Treasury and
Comptroller of the Currency whose
action as members of the Organization
Committee was to be reviewed—and
the Governor were a minority of the
Reserve Board. But, over the signa­
ture of the Governor and without the
authority or knowledge of the majority
of the Board, they asked the President
to transmit to the Attorney-General a
request for an opinion defining the
Reserve Board’s powers of review.
The opinion was turned out over
Saturday and Sunday, which may be
considered unusual dispatch. When
the Board met again it was faced with
the Administrations’ interpretation of
the law and the interpretation was that

A m er ic a n A cadem y

the Board had no power to review
the determination of the Organization
Committee in a manner that might
affect the existence of any of the twelve
Reserve Banks already established.
The point to be made is that the
integrity of the Reserve System is of
indifferent consequence in the face of
political exigency. Perhaps just such
a thing will not happen again but this
is the second instance in which appeal
was made to the Attorney-General to
give legal support to a plan politically
The fear of future political assaults
on the integrity of the Reserve System
is so well founded in experience that
Mr. Warburg is wholly justified in his
conclusion that the people must de­
velop a jealous regard for their banking
machinery if they wish it to endure.
Mr. Warburg, in his article, is appar­
ently less concerned with the past than
with the future. Recent experiences
indicate the correctness of his views
and the basis for his fear of political
encroachment. He worked so faith­
fully and effectively to gain and hold
for the Reserve Banks what they have
that anything he says has particular
and peculiar significance.
Once the Reserve Board was in ac­
tion, there was the usual clamor for
jobs from eager politicians but it was
mostly clamor. The positions to be
filled were hedged about by qualifica­
tions that could not be met by those
without banking experience. The po­
sition of Reserve agent attracted the
avid attention of the politically faithful.
The duties of this position were not
clearly defined. At first sight it seemed
to offer attractions of ease and afford a
quiet resting place for an agreeable ex­
something classed in political slang as
a “lame-duck.” There were, of course,
hundreds of applications for these places
and every applicant was supported by
heavy political indorsements.

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However, the Reserve Board itself
was wisely chosen. Efforts to diversify
its membership both in equipment and
representative character were success­
ful. The Board, charged with the
duty of organizing a new banking
system at the time the world was be­
ginning the greatest of wars, did not
view the task lightly or politically.
Bankers were drafted into the service
of the Reserve Banks and accepted,
often at large sacrifice. Bankers and
business men chosen to the directo­
rates of the Reserve Banks were as
much in earnest as the Reserve Board.
The political pressure was strong
enough to bring a lapse here and there,
but the general character and business
complexion of the official staffs stood
up under close inspection. This early
proceeding is to be judged only in the
light of results obtained and not by the
efforts that were made to impose upon
Board or Banks the wishes of those who
were politically moved. It is a fair
inference that, so far as jobs were
concerned, political officialdom passed
recommendations along in the serene
confidence that the banking minds
would accept the responsibility of the
refusal to concur.
In any event the Banks came into
existence as banks and were opened on
November 16, 1914. Having buildings,
equipment, officers and staffs, they
were naturally curious as to what they
might do. Could they advertise and
go out after business? No provision
had been made for such a course. They
would get business when their member
banks were hard pressed for funds.
Humiliation attached to rediscounting.
It was regarded as a sign of weakness.
Moreover, while the Reserve Banks
were open for business, reserve funds
were to be turned over to them in
installments. The banking system
was otherwise running along as before.
There was, however, much to do.


In nearly every district leading banks
rediscounted paper for the sake of
example.5 The Reserve Board had to
study the law, which settled all
difficult problems by saying “under
such regulations as the Board may
prescribe.” It must also be re­
membered that Aldrich-Vreeland emer­
gency currency was in circulation and
was to be retired or supplanted by
Federal Reserve notes.
Rules were to be made, precedents
set and the gathering of traditions
begun. Eligible paper had to be
defined; at least, a beginning had to be
made.6 Not only banking customs
but business habits would have to be
remolded and remodelled, if the Re­
serve Banks were to have anything on
which to function. Acceptances were
authorized by the Act. They were
new to the banking world. The
lessons of war were beginning to say
that gold would have to be gathered
and impounded.7 The state chartered
banks were hostile or, at best, only
neutral. It grew rapidly plainer that
they would have to be wooed and won.
The law made it mandatory that the
clearing and collection of checks and
drafts be undertaken. A first step in
this direction threw the country banks
that were members of the System into
spasms of anger and fear. It made
the state banks glad that they were
beyond such meddling.
The GoldSettlement Fund came as an
ingenious means to economy and con­
venience for member banks. It was a
first notable step in what the Reserve
Banks could do—something that would
be helpful, speedy and cheap. The plan
was worked out by the Reserve Board
8 “Early Functioning of the Federal Reserve
8 “Eligibility for Discount” by Charles L.
7 See “ Preparation for War and the Liberty
Loans” by J. H. Case.


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in conjunction with experts called
from member banks. It was simple
and easy and established itself so
quickly in favor that it was almost as
quickly forgotten as a service. It has
always worked perfectly and stands
nowas a real achievement.8 It isaservice no less to business than to banks.
The story of the winning of the
state banks and of par collections is
told in the paper by Mr. Pierre Jay,
Chairman of the Board of the Federal
Reserve Bank of New York. Mr. Jay
was called to that position from the
presidency of a state bank. It is
needless to say that his sympathetic
understanding of state bank problems,
his patience and persistence found
opportunity for display in dealing
with those institutions. But the
national banks within the System
were more rebellious than the state
banks without it. They would not be
mollified and they were impervious to
argument. They nearly disrupted the
American Bankers Association. They
forced Congress to consider amend­
ment of the Act and missed winning
completely by a narrow margin. They
went to law about it. It is possible
still to make exchange charges and
they are made, but the “par collec­
tion” competition is too strong. In
the face of all the obstacles the Reserve
Banks are now the great instruments
for check collections and they will
have competition in this field only
from banks of great reach, capable of
maintaining the necessary connections
and facilities.
However, the War, not the wooing,
brought the state banks into the
System—not all of them, of course,
but a number in point of resources
quite great enough to give the Reserve
System the necessary universality—if
there is any such thing as a degree.

A m er ic a n A cadem y

The development of the relations of
Reserve Banks to their members and
with one another immediately became
a serious problem once the Reserve
Banks were in operation. How this
was done and what was and is being
done, is told by Mr. Gidney. The
Reserve Banks can never supplant
“correspondent” banks. There are
too many services the latter render,
too many personal and long-standing
connections, but the Reserve Banks
have made great progress and have
brought their depositors to a realiza­
tion that they are customers and will
be treated as such. The development
of close relationships among the Re­
serve Banks and their officials has
also been as important as it is in­
teresting. Unity demanded it, but
systematic effort was essential to its
There will always be non-member
banks because banking is often special­
ized and men have notions of inde­
pendence. The mutual savings banks
of the East are not eligible to member­
ship. They have no capital stock.
The laws have been changed in one or
two states to permit them to invest a
part of their funds in “commercial
paper” and acceptances, but their
investments are not supposed to be
liquid, and they are far removed from
commercial banking.
Probably there will always be pri­
vate bankers with freedom to operate
within that borderland where invest­
ment and commercial banking meet
and divide, or on both sides of it. But
the Reserve System, as now formed of
Reserve Banks, national banks, state
banks and foreign trade banks, is
sufficiently inclusive and strong to
permit the statement that it is as
nearly universal as necessary. There
is nothing on the horizon, or nearer,
8“ The Evolution of the Gold Settlement to indicate that it will diminish in­
stead of grow.
Fund” by George J. Seay.

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Amendments to the Reserve Act
have been fairly numerous, but gen­
erally they have been made to meet
conditions that could not be foreseen
or to make operating conditions easier
or simpler. It is good fortune as well
as good judgment that there has yet
been no success in perverting the
provisions of the Act. Congress has
so far yielded to the guidance of the
Reserve Board and, when there was
threat of unsound doctrine, Carter
Glass, as representative and senator,
has been found on guard. The first
thrust at the integrity of the System
by the War Finance Corporation has
been parried. Even the admission
that that Corporation is now doing
commendable work and meeting an
urgent need, does not justify dismissal
of the hope that its life and the
emergency which revived it, will both
end as scheduled on July 1, 1922.
Amendments to the Act are dis­
cussed in Mr. Walter S. Logan’s
paper where their bearing and trend
may be learned. In this connection
it is not amiss to say that bankers have
contributed loyally to the effectiveness
of the Reserve Banks’ operations. If
they fought lustily, through one or
two groups, against par collections,
they cooperated zealously by sur­
rendering their gold to the Reserve
Banks. Without the War the im­
pounding of gold would have been
exceedingly difficult; as it was, it
required effort. But good teaching
and good leadership carried through,
in the closing months of 1917, a plan
whose success stood as a milestone in
the progress of the Reserve System.
Branches of the Federal Reserve
Banks were established and opened in
the interest of service to business.
The jealousies engendered by the
selection of Reserve Bank cities and
the making of reserve districts were
wiped out in this way, but the branch


banks have proved the necessity for
their existence. Governor Fancher,
of the Cleveland Reserve Bank tells
the story.9 There are, however, varia­
tions in the operation of branches. In
the far West the geographical extent
of the San Francisco district demanded
a larger independence in management
for the branches than in the East, but
telegraphic communication is always
The assumption of the functions of
the Independent Treasury—see Pro­
fessor Wildman’s article—came be­
latedly. It was probably as well that
it was deferred by politics and war.
When it did come, the banks were
experienced and ready. So far as the
public was aware the subtreasuries
slipped their moorings and drifted into
the sea of oblivion with no one’s
knowing or caring.
E x p a n s io n , C o ntra ctio n a n d
D isc o u n t R a t e — V it a l
P r o blem s


It was thought advisable by the
editors of this volume to have as wide
a discussion as possible of “Expansion
and Contraction.” Involved with
this question is the influence of the
rediscount rate on business activity
and, therefore, the relation of the
rediscount rate to business and to the
expansion and contraction of money
and credit.
The Reserve Board is charged with
many duties. The Reserve Banks
function in many ways. But no
question goes more to the vitals of the
entire scheme than the adjustment of
the discount rate of the Reserve Banks.
Whatever else they may do and how­
ever successful they may be in the dis­
charge of collateral and subsidiary
duties, around the discount rate and its
making cluster the factors that bear
9 “ The Establishment and Scope of Branches
of Federal Reserve Banks.”


T he A nnals

of the

directly on the success or failure of the
Reserve Banks as aids to commercial
business or to the member banks which
act in response to business and react to
its advantage.
The relation of the Reserve Banks’
discount rate to and influence on
business has by no means been deter­
mined. The factors to be considered
in determining the rate are pretty well
settled, but their relation to one
another and the relative importance of
each is still an open question. In
seven years of operation the deter­
mining of the discount rate has been
influenced by extraneous or distract­
ing conditions. At first when the
Banks were new, it was of no im­
portance. When war pressed, other
factors received scant attention. After
the Armistice the belief that the
unexampled prosperity would endure,
supported the Treasury’s needs for
more financing. When, finally, some­
thing had to be done to avert a
crash, it was found that no genuine
experience in adjusting the discount
rate to influence business had been
had. The first increase of the rate
to “slow up” business came as an
arbitrary decree based on a conception
drawn from British experience. That
was in January, 1920. Business did
not slow up. It went on, undoubtedly
despite the higher rate, despite the
warning, but, because of what? Pos­
sibly because of its own momentum.
Expansion increased. It was many
gloomy months after the rate was first
increased before the peak of either
credit or currency expansion was
reached. In the meantime business
generally declined to believe that the
end of war prosperity had come or that
the revival and continuation of it was
not around the corner. The Reserve
Board and the rates of the Reserve
Banks were mentioned only to be
damned. All kinds of allegations,

A m er ic a n A cadem y

charges, proposals and remedies were
made. In the end the rate was
popularly charged with undoing busi­
ness—for lack of a better reason.
All this was a new experience with
the discount rate. It was a valuable
experience because it was a first lesson
in the time relationship between busi­
ness activity and the Reserve Bank’s
discount rate which, to whatever extent
it affects business activity, can do it
only through the influence it exerts on
the rates charged by member banks.
In the articles on these questions, a
wide range of experience, supplemented
by opinion and study, was sought.
Bankers, Reserve Bank officials, mer­
chants, economists were all invited to
express themselves. Governor Hard­
ing, of the Reserve Board, has stated
the problem as it is before the Board.
Mr. John H. Rich, Chairman of the
Board of the Minneapolis Reserve
Bank, has furthered the discussion with
views and experiences in that extensive
and interesting Reserve district. Dr.
A. C. Miller of the Reserve Board, has
brought to bear on it a mind singularly
free from prejudice and admirably
equipped to ferret out and interpret
facts. Mr. John V. Farwell, from the
merchant’s interested and detached
position, gives helpful suggestions and
clear exposition. Mr. J. B. Forgan,
dean of bankers, and tried in experience
by long service on the Federal Advisory
Council, and Mr. George M. Reynolds,
from a terraced height of banking
leadership fairly won, make contribu­
tions which are supplemented by those
of Professor E. M. Patterson of the
University of Pennsylvania and Dean
Chester A. Phillips, of the University
of Iowa, theorists in the field of eco­
nomics but with practical bents and
adept in the use of scientific method.
Needless to say, these men are not
entirely in agreement. But close read­
ing of their contributions will disclose

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that they are far from hopelessly apart.
Any divergence of statement is not
over what the discount policy has
been, but rather in emphasis as to
what it should be in the future.
The problem of the time relation­
ship between the rediscount rate and
business activity seems vital in the dis­
cussion. Of the efficacy of the redis­
count rate to influence business there
is little room for question. Recent
experience, however, indicates a con­
siderable lapse between the time of
fixing the rate and the time when busi­
ness feels and responds to it. On
January 21, 1920, the first increase in
discount rate to six per cent was made.
This rate was maintained until the
following June when the rate for
Chicago and New York was increased
to seven per cent. This rate was main­
tained for a year. In June, 1921, the
lowering began.
The point made by Mr. Reynolds is
that business is not immediately affec­
ted by the rates charged by commercial
banks. The rediscount rate can affect
business activity only through its effect
on the rates of commercial banks. But
banking, as a result rather than a cause
of business activity, can react only
after business has made commitments
which it is bound to carry through
if it can. If, under the present rela­
tionship between the rediscount rate
and business activity, the rate is to be
adjusted effectively, adjustment must
be made in anticipation of a business
activity which may need restraint or of
an inactivity which may need stimula­
tion. Such an adjustment might be
precarious and it would likely be un­
certain. It is venturesome to say that
the rates charged for loans by member
banks would be a better guide in seek­
ing a basis for the rediscount rate, for
those rates have variations, as do the
rates charged for standard “commercial


The condition outlined shows the
strength of the position of those who
say the rediscount rate should always
be higher than, say, the rate for stand­
ard commercial paper charged by
member banks. However, there are
strong arguments why the rediscount
rate should sometimes be lower. At
present the lower rate is giving many
hard pressed banks in the farming
sections a needed breathing spell.
A lower rate’s influence in stimulating
business may also be problematical
unless the member banks adjust their
rates to it as quickly as possible and
with considerable speed in any event.
It is not that these statements create
a dilemma but they seem to justify no
other conclusion than that further
experience in influencing the rates of
member banks, if not further experi­
ment, is necessary before it may be
said that wisdom is justified of her
I m po rtan ce o f t h e “ O p e n
M arket”

If operation of the Federal Reserve
Banks, under stable conditions of busi­
ness, is to be seasonal and cyclical, as
many of the contributors to this volume
seem to believe, the further develop­
ment of open-market operations. will
be in order. It so happens that the
Reserve Banks, early in their careers,
found war a wonderful accelerator.
War made them busy and prosperous.
Henceforth they will operate under
changed conditions. Not that there
will not be continuous business for the
Reserve Banks, but they will not be
carrying peak loads twelve months in
the year. Their operations in the
open market will be more important
under the new conditions than in the
past. In this field they may find it
possible to exert an influence which
will make for the stabilization of
money rates.


T he A nnals o r


Mr. Agger tells of the development
and position of the open market.
From what has been achieved we may
get an idea that here is a field for
cultivation, with success reacting to
demonstrate another and large service
the Reserve Banks may render busi­
ness. The law made provision for
such conduct by the Reserve Banks and
its importance must be kept in mind.
M isc o n c eptio n s

of the

S ystem

Under the stress of financial diffi­
culties incident to war and its aftermath the Reserve Banks came in for
a full measure of criticism. It was to
be expected, and it is not surprising,
that a portion of the criticism was
hostile as well as adverse. Professor
Patterson, in his discussion of contrac­
tion and expansion, gives a very clear
elucidation of Reserve Bank operations
in their relation to government financ­
ing, foreign business and conditions
and commercial banking. In these
operations will be found such basis as
exists for real criticism. The article
might well be read with that also in
In his review of the “Popular and
Unpopular Activities of the Federal
Reserve Board and the Federal Reserve
Banks/5 Dr. Scott goes more partic­
ularly into these criticisms, the rea­
sons for them and the shallowness of
most of them, while Governor McDougal of the Reserve Bank of Chicago,
gives a striking illustration of the lean
foundation on which rest the allega­
tions of discrimination against the
agricultural districts.
It is not enough to state what the
Federal Reserve System is designed to
do, if the fundaments of that System
are to be understood. Current mis­
conceptions must be cleared away.
The prevalence of erroneous ideas
compels such procedure.
A wide-spread notion prevails, even

A m er ic a n A cadem y

among bankers, that the Federal
Reserve Banks are government banks.
They are bankers’ banks. This fact
is written into the Federal Reserve
It is implied in the provisions of that
instrument.11 It is not only recognized
by economists,12 but also indorsed by
operating officers of Reserve Banks.13
No Federal Reserve Bank stock is held
by the Federal government. The
government possesses its regulatory
power because the System is freighted
with a public interest. The govern­
ment has an interest in Reserve Bank
profits only through a franchise tax.
The Federal Reserve Banks are sub­
ject to taxation like other private
corporations. To be sure, a minority
of the directors of Reserve Banks are
appointed by the Federal Reserve Board
and members of that Board are gov­
ernment appointees exercising super­
visory powers in the public interest.
Moreover, Federal Reserve Banks do
act as fiscal agents, and in other ways,
for the government’s convenience.
Nevertheless, Federal Reserve Banks
are not government banks. They are
bankers’ banks designed to aid busi­
ness by facilitating commercial trans­
actions. The fact that the Reserve
Banks are not government banks de­
stroys the groundwork for assumptions:
(1) That the System can produce
general “prosperity,” and (2) that
it should be dominated by govern­
Under the stimulation of war the fa­
cilities of the Reserve Act for expansion
became an engine of inflation. They
cannot be made an engine of “pros-

10 See the Act and Professor Kemmerer’s paper
in this volume.
♦_ Cf. “ The Reserve Act in its Implicit Meanmg.»
12See Professor Phillips’ article, for example.
13 Cf. “ Relations of Reserve Banks to Member
Banks and Inter-Relations of Federal Reserve

I n te g r ity

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F e d e r a l R e se r v e S ystem

perity.” Neither deft nor awkward
political manipulation can turn the
Reserve System from its strictly eco­
nomic purpose. It was not designed
to salvage insolvents. It cannot create
credit out of nothing. While com­
mercial banks can control the flow of
commercial credit and thus affect the
currents of the productive processes,
business creates that credit which
banks, even the Reserve Banks, ap­
portion. Business impels; banking con­
trols the drives,—after a time. If
there must be a causal relationship
between business and banking, busi­
ness causes banking. There is actually
a functional relationship. Business
gives rise to banking and banking
reacts on business. Neither commer­
cial banks nor Reserve Banks can
create credit and thus create “pros­
One of the facts that doubtless has
obscured thinking about the funda­
mental play of commercial banking is
this one, that the Reserve Banks have
handled government issues, redis­
counted paper secured by government
obligations and otherwise performed
war functions for the Federal govern­
ment. They have been functioning, in
no small measure, on other than com­
mercial credits. This was not their
original purpose. Government promises
to pay should not be the chief grist
taken to the Reserve Bank mill. But
as a result of war operations, the
assumption that Reserve Banks can
“manufacture” credit out of nothing
seems to find justification with those
who have not seen the underlying
sources of the promises to pay on which
the Reserve Banks have been function­
ing. Business, not banking, creates
what is called “prosperity.”
An instance of government domina­
tion of the Federal Reserve System
can be found in the control of the
rediscount rates by the rate on govern­


ment bonds.14 This control was no
doubt bred of war’s necessities. The
War is over. But no end has come to
political pressure on the Reserve
System. That pressure seems now to
come through Congress, or a section
thereof, rather than through the Ad­
ministration. It is suggestive, if not
legally accurate, to say that the
Federal Reserve Board can exercise
those powers expressly granted or
necessarily and fairly resulting there­
from, while the Reserve Banks hold
residual powers. “Less government
in business” can find a starting point
in the Reserve System. Government
supervision is very different from po­
litical manipulation. These bankers’
banks should be unhampered by
A current misconception that is
giving way is the notion of dead-level
uniformity of policy and practice
among the Reserve Banks. The Fed­
eral Reserve System meets the neces­
sities of American geography and his­
tory in providing regional banks with
a centralized supervision. This fact is
attested by many of the contributors
to this volume.15 Presumably each
Reserve Bank will adapt its policy and
practice to the hard and particular facts
of the business situation in its district.16
Where differences in procedure are
necessary, they must and will be allowed
by the Federal Reserve Board, just as
differentials in discount rates are
“permitted” between districts that are
dissimilar. The Reserve Board will
play its part of leadership by function­
ing on common matters of policy and
practice without constraining the direc­
tors of the various banks in matters of
14See Governor Harding’s statement in the
article, “ Rediscount Rates, Bank Rates and
Business Activity.”
15See, for instance, the articles by B. H. Beckhart and John H. Rich.
16See the paper by H. Parker Willis in this


T he A nnals

of the

A m er ic a n A cadem y

proceeds of this year’s crop. Some of
these banks are themselves having dif­
ficulty in meeting their bills payable.
This situation is too well known to
need elaboration. The War Finance
Corporation Act expressly permits
banks with “frozen” agricultural cred­
its to apply for advances from the Cor­
T h e A v o id a n c e o f I n v e st m e n t O p e r ­ poration for six months or a year, with
a t io n s b y R e se r v e B a n k s
a renewal privilege which may give
Investment banking should have no the obligation a total life of three years.
place in the operations of Federal By getting time in which to retire its
Reserve Banks. Their reason for be­ bills payable, the bank is in a position
ing is to aid commercial banking. In­ to give farmer borrowers time in which
vestment operations can be avoided to make a new crop, or two if necessary,
by confining the paper eligible for and thus clean up their obligations.
discount at the Reserve Banks to The Bank’s obligation must be secured
commercial paper.17
by collateral which will insure ultimate
Should the Federal Reserve Banks payment, but time is given for pay­
perform such agricultural credit func­ ment. In short, the Corporation is
tions as are now being developed by functioning in the way of carrying the
the War Finance Corporation and burden of agricultural loans that are
should they be “adapted” to such slow but should ultimately be paid.
functions? The answer to this ques­ To the extent that the Corporation
tion will not only emphasize the gets funds into the agricultural sections
distinction between commercial and where frozen agricultural credits still
investment banking—in what may be prevail, the operations of the Corpora­
urged as a border-line case—but will tion will no doubt be helpful to banks
also illustrate the need of confining in those districts and indirectly to the
eligible paper to that which evidences farmer borrowers and the country
a movement of goods from producer to in general. Whether Section 2 4 of the
consumer and is self-liquidating.
War Finance Corporation Act is a
The original purpose of the War sound politico-economic measure need
Finance Corporation is of no present not now be debated. It is a fact.
moment. The essential purpose of Bankers and economists have few illu­
Section 2 4 of the War Finance Cor­ sions as to the probable extent or nature'
poration Act, under which the Corpora­ of its operations, but about one point
tion is now operating, is to give bankers there can be no doubt, namely, that
and farmers time in which to pay their this giving of time to bankers and
obligations. Banks in various agri­ indirectly to farmers puts the opera­
cultural communities have made loans tions of the Corporation in the class of
for “agricultural purposes” which can­ investment rather than commercial
not be repaid at maturity out of the banking. If the Federal Reserve Banks
17 The term commercial paper, unless in quotes were to carry loans for three years,
in this article, means commercial paper as defined they would be doing an investment
in the Federal Reserve Act and rulings of the banking business. It is the purpose of
Federal Reserve Board, and expressly includes the Federal Reserve Act to deal in selfagricultural paper. In the case of agricultural liquidating paper. The Reserve Act
paper, however, the maturity of the paper is the
might conceivably be amended to
essential point in giving it eligibility.

justifiable difference. Thus will the
System best perform its service in
facilitating commerce. Arbitrary con­
trol, political interference and deadlevel uniformity will destroy, not main­
tain, the integrity of the Federal
Reserve System.

I n te g r ity

of the

F e d e r a l R e se r v e S ystem

permit the Reserve Banks to perform
such long time banking operations as
are now entrusted to the War Finance
Corporation, but such amendment
would be a blow to the integrity of the
Federal Reserve System as a commer­
cial banking mechanism.
Should the War Finance Corpora­
tion so extend its operations in granting
agricultural credits that its capital is
exhausted, the Corporation may issue
debentures to secure additional funds.
The Corporation is empowered by the
Act to have advances to banks out­
standing at any one time to the amount
of a billion dollars. The capital stock
of the Corporation, which is owned by
the Federal government, is five hun­
dred million dollars. Should the Cor­
poration issue its debentures, these
promises to pay must be considered
investment paper. They may be used
to secure rediscounts with the Federal
Reserve Banks. Should they be so
used, they will be in the same position
as government obligations which are
used to secure rediscounts. The pro­
priety of making loans and issuing
Federal Reserve notes on the basis
of paper “collateraled” by investment
securities is a question that may well be
raised in considering the integrity of
the Reserve System as a commercial
banking institution.
Government bonds and debentures
of the War Finance Corporation are
promises to pay. They are not in
themselves evidences of a movement
of goods from producer to consumer.
They are not self-liquidating as is
commercial paper. The legal permis­
sion to secure rediscounts with invest­
ment paper is a deviation from the
original purpose of the Federal Reserve
Act. It is true that the Reserve Act
makes express provision for rediscounts
secured by government obligations.18
But it is also true that had the framers


of the Federal Reserve Act anticipated
the World War, the proviso clause in
Section 13 of the Reserve Act, which
permits rediscounts to be secured by
government obligations, would prob­
ably not have been passed.19 And
certainly there was sufficient experience
with this proviso clause of Section 13,
as to its potency for inflation, to have
warned against the amendment of the
Reserve Act so as to permit the War
Finance Corporation’s debentures to
be used to secure rediscounts. Section
24 of the War Finance Corporation Act
was not approved until August 24 ,
While government obligations are so
extensively held by individuals and
business concerns, it is perhaps im­
practicable to amend Section 13 of the
Federal Reserve Act so as to prevent
the use of government obligations to
secure rediscounts and the issuance of
Federal Reserve notes on the security
of those obligations. Until the war
bonds of the government find a final
resting place with investors—which
may mean until refunding plans are
put into operation—it would probably
be impracticable to prevent a member
bank’s offering the note of a business
man for rediscount which is secured by
government bonds. Until that time
it may be impossible to have Federal
Reserve notes issued only in response
to commercial needs, evidenced by the
offering of commercial paper for redis­
count. In the perfecting of the Reserve
Act, Section 13 might well be changed,
on the chance of a recurrence of very
large government demands. There
will be no valid excuse for permitting
the rediscounting of notes secured by
the debentures of the War Finance
Corporation should that Corporation
function extensively enough to issue
its debentures. Of course, it might be

19 See paper entitled, “ The Reserve Act in its
18 See Section 13 of the Federal Reserve Act. Implicit Meaning.”


T he A nnals

of the

difficult to sell such debentures without
this feature.
The avoidance of investment opera­
tions by Reserve Banks will be difficult
so long as Congress, or any group of
congressmen, can force amendment of
the Federal Reserve Act to take from
the Federal Reserve Board its power
to define eligible paper under the Act
as it now stands. In the spirit of the
Act the resources of the Reserve Banks
are not to be used for withholding
crops from the market to secure higher
prices. Commercial paper involves
the moving of goods to the market, not
withholding therefrom in order to insert
a price peg or even to secure “more
orderly marketing.” Measures to ad­
mit irrigation and development bonds
as paper for the Reserve Banks to
function on might conceivably be
passed by Congress. But no matter
how great the need of particular
agricultural districts, or how desirable
various measures of relief, it seems clear
that the definition of eligible paper
should be restricted to commercial
paper unless there is a general and well
considered intent to depart from the
commercial character of the Federal
Reserve System.
There may or may not be need of
specialized banking machinery to take
care of the long time financial require­
ments of farmers, due to recurrent crop
failures or price slumps, as well as their
need for long time funds in bringing
cattle to market. But in any event
that need would have to be determined
on the basis of experience that is more
than transitory or that arises from a
world-wide emergency, caused by the
distortions of war. But the fact that
these needs exist is not a sufficient
reason to destroy the integrity of the
commercial banking system that has
been established. They rather point
the way to the provision of other facili­
ties, if necessary. To destroy the line

A m er ic a n A cadem y

between commercial and long-time
banking, that was not easily estab­
lished, is to permit just such a situation
as now obtains in many country banks.
They have slow assets with which to
meet quick liabilities. It is as impos­
sible to add investment banking to
commercial banking and get security
as it is to add apples to oranges and
get peaches. And it must not be
forgot that the slow obligations of
farmer borrowers and agricultural
banks can be traced in part to land
speculation and inflated land values.
R e la tio n o f t h e R e se r v e S y st em
to I n t e r n a t io n a l F in a n c e

The Federal Reserve Act permitted
the extension of banking operations
into the foreign field. Under this au­
thorization American banks branched
out in foreign territory extensively and
not always profitably. However costly
the experience with foreign banking, it
is probably safe to say that banks man­
aged by those who are experienced in
foreign trade and foreign banking will
in the future find sufficient latitude for
profitable operation under the Reserve
The Federal Reserve Act was amend­
ed by the Edge law to permit an exten­
sion of foreign banking facilities through
the establishment of new foreign bank­
ing corporations in which commercial
banks were expressly permitted to own
stock. This fact that commercial
banks could hold the stock of Edge law
corporations is sufficient reason for the
Reserve Board’s being given supervi­
sory control. Moreover, Edge law
corporations were designed to finance
imports and exports, but especially
to aid the movement of goods from
American producers to foreign con­
sumers. They were designed to do a
foreign commercial banking business.
The Edge law merely extended the
provisions of the Reserve Act that had

I n t e g r it y

of the

F e d e r a l R e se r v e S ystem

previously permitted foreign banking.
Since the banking business of Edge
law corporations is largely commercial
in character, the Edge law is not an
attempt to graft onto the Federal
Reserve System investment features
that would have destroyed its integrity
as a commercial banking system.
Whether Edge law corporations were
or are desirable from the standpoint of
practicality is really beside the point.
The Reserve Act was extended by the
Edge law to put the Federal Reserve
System into more intimate touch with
international finance. It is merely a
matter of record that “rest in peace,”
in proper Latin phraseology, has been
written over the mammoth corporation
proposed to be operated under the
Edge law.
Dreamer’s dreams of international
banks, which would restore mint pars
of exchange and otherwise work out
the difficulties of international finance,
can be dismissed with scant considera­
tion. They do, however, contain a
warning. The capital of one such
bank was to be composed largely of
the promises to pay of “solvent foreign
governments.” The test of solvency
was prompt payment of external
obligations and the taking of steps
towards disarmament. Foreign bonds,
even of such “solvent governments,”
are scarcely to be considered banking
capital. It is difficult, also, to see how
the operations of such a bank would
rectify foreign exchange when any
adjustment depends so largely on
measures taken by European nations
themselves—such as deflation of their
currencies and balancing of their budg­
ets—to bring the purchasing power of
their moneys more nearly into align­
ment with the purchasing power of
American money. Exchange rates to­
day are on a purchasing power parity.
However fatuous such projects, they
are conceived by those holding re­


sponsible legislative positions and it is
not improbable that somehow, if a law
were passed to establish such an inter­
national bank, that bank would get
itself tied up with the Federal Reserve
System. It is against such projects
that the Federal Reserve System must
be safeguarded by an alert and vigilant
public opinion which allows no devia­
tion from its commercial character.
Though the condition of business in
the United States is affected by the
play of world-wide economic and
political forces and the Federal Reserve
System is affected by the condition of
business, that System touches the
international financial structure im­
mediately at one point, through its
control of gold. How the Federal
Reserve Board impounded gold is told
in Mr. Case’s article. The Reserve
Board’s control of the gold of the
United States is now complete. Cer­
tain it is, also, that the flow of gold
into the United States shortly after
the outbreak of the War, but particu­
larly since September, 1920, has result­
ed in such redistribution of the world’s
stock of monetary gold as to give the
United States—the Federal Reserve
Board—control of some 40 per cent of
that stock.
In this connection the article of Dr.
Sprague may be read with profit.
There is within the Reserve System, as
operated, an inherent power for expan­
sion. The manner in which gold is
handled is of the greatest importance
and Dr. Sprague has indicated the dan­
gers to be guarded against in the future
as well as those which have not been
met effectively in the past.
P u r po se

of the

V o lum e

The purpose of this volume is natu­
rally to be ascertained from the read­
ing of the various articles contributed.
Books have been written on the Reserve
System. Some of them have given its


T h e A nnals

of the

purposes and some have been devoted
to its operations and operating mecha­
nism. The editors .assumed, however,
that heretofore no opportunity has
been offered to bring together in one
volume the authoritative statements
from those who were directly interested
in framing and formulating the Act and
were, therefore, familiar with its pur­
poses; from those who were and are
actively connected with the operation
of the Reserve Banks and therefore
competent to interpret their conduct,
and from those who directly and
indirectly make use of the Banks or are
keenly interested to study the progress
of the System.
Thus we have in this volume of The
Annals the Reserve System as contem­
plated by its framers, as operated by
those in charge, and as observed by
those in a position to interpret the
operations in relation to the purpose.
In any event these three forces were
sought and have responded. The
relationship between purpose and oper­
ation is set forth and the limitations as
well as the scope of the System have
been shown.

A m er ic a n A cadem y

It is pertinent to add that sight was
never lost of the fact that the Federal
Reserve System is not generally under­
stood. It is unfortunate that it is
distinctly misunderstood. If this vol­
ume is of any assistance in clearing up
the misunderstandings and giving a
better conception of the work and the
mission of the Reserve Banks, the
editors will feel fully rewarded. They
owe everything to the contributors who
have responded so capably and gen­
erously to their requests, often, it may
be said, despite of engagements and
the pressing demands of their own
businesses. No editors were ever more
fortunate in securing cooperation from
It is only an editorial hope that the
volume may meet approval. It was
fairly intended to produce a useful and
practical work. Whether it does or
does not perform a useful service, we
feel justified in appending the message
for the book suggested by the governor
of a Reserve Bank: “It will not be easy
reading; it may not be agreeable read­
ing, but I think it mighty important that
every business man should read it.”

Outline of Banking History

From the First Bank of the United States Through the Panic
of 1907
By B. H. B eckhart


Columbia University]

HE United States was particularly The entire capital was subscribed
fortunate in having as its first within two hours on the day6 the sub­
scription books were thrown open, and
Secretary of the Treasury a veritable
genius, whose program of fiscal reform Bank was ready to begin business
quickly placed the new republic on a on December 12, 1791, with Thomas
sound financial basis. As an essential Willing as president.6 From the very
part of his program, Hamilton urged outset, the Bank proved to be a great
the establishment of a National Bank success, in providing the country with
in a report to Congress, dated Decem­ a sound and elastic currency, in supply­
ber 13,1790. Since the economic signif­ ing the needed banking facilities, and
icance of banks was then but crudely in preventing any excess issue of state
understood, Hamilton, in this now fa­ bank notes by having such state notes
mous document, first indicated the as were in its possession redeemed. In
numerous advantages resulting from the performance of its fiscal functions,
banking in general and from a National it transferred government funds and
Bank in particular, taking occasion to provided a safe depositary for them; it
dispel some of the current erroneous also helped to collect the revenues and
ideas on the subject.1 After showing provided the bullion needed by the
that no one of the three banking insti­ mint in coinage. Further, by 1795 it
tutions2 then in existence could be suit­ had loaned the government $6,200,000.
ably employed as a National Bank, In order to procure funds to repay the
he laid down in great detail the plan loan, the government by 1802 had sold
for the new institution.8 The act all of its stock at a profit of $671,860,
chartering the bank modelled upon this and while a shareholder had received
plan was signed by the President on $1,101,720 in dividends of 8f per cent.
On April 20 , 1808, the stockhold­
February 25, 1791.4
ers memorialized Congress for a re­
1Hamilton's report may be found printed in
full in the American State Papers—Finance I., newal of the charter which expired in
1811. A month later, Albert Gallatin,
pp. 67- 76.
2The Bank of North America founded in then Secretary of the Treasury, in a
1781, the Bank of Massachusetts in 1784, and report to Congress enumerated the
the Bank of New York in 1784.
3Hamilton's plan closely followed the charter fiscal services of the Bank and advised
of the Bank of England as it existed at that time. that the charter be renewed with a few
4The act provided for a capital of $10,000,000, changes. Nevertheless, the bill to con­
of which one-fifth was to be subscribed by the tinue the charter was defeated, the
government. The administration was placed in
the hands of twenty-five directors elected an­ oftener than once a week by the Treasury
nually by the shareholders. Branches were to Department.
be established where the directors saw fit. The
6July 4th, 1791, at Philadelphia.
circulation was not to exceed the capital. State­
•Formerly, president of the Bank of North
ments of condition might be called for but not America.


T he A nnals

of t h e

opponents charging that the Bank was
a “ money trust ” controlled by foreign­
ers,7 a tool in the hands of the Federal­
ists, and that the act chartering the
bank was unconstitutional—so the
First United States Bank went out of
existence on March 3, 1811.8
F in a n c ia l C h a o s, 1811-1816
It was a most unfortunate time for
the country, on the verge of a war with
England, to be deprived of the services
of the Bank. State banks sprang up on
every hand to take its place. Their
number increased from 88 in 1811 to
246 in 1816 and their circulation grew
from 22.7 million dollars in 1811 to 100
millions six years later.9 Such a rapid
inflation of the currency resulted nat­
urally in the depreciation of bank notes
in terms of gold, amounting at the
maximum to 23 per cent in Baltimore,
and 16 per cent in Philadelphia and
New York.10
The revenues of the government,
consisting largely of tariff duties, were
for the most part collected in this
depreciated currency, while it was
necessary for the nation to make large
disbursements of funds in New Eng­
land where specie payments had been
maintained. By reason of this con­
dition, it has been estimated that the
government lost $5,000,000 from 1814
7 Though three-fourths of the stock was held
abroad, the foreign shareholders exerted little
control, as they were not allowed to vote through
8 By 1834 the process of liquidating the assets
had been completed, the shareholders receiving
in all $434 for each *$400 share. The assets of
the parent bank in Philadelphia were purchased
by Stephen A. Girard, which was reopened on
May 12, 1812, as “ Girard’s Bank.”
•This increase was due to two factors: (1)
the suspension of specie payments everywhere
during August of 1814 excepting in New Eng­
land; and (2) to the withdrawal of the restraining
influence of the Bank.
10 The specie was either driven abroad or into
the New England States.

A m er ic a n A cadem y

to 1817. Further, without the assist­
ance of the Bank, the government had
difficulty in selling its bonds (even
when offered below par), and was
forced to borrow sums from the state
banks and to issue some 37 million
dollars of “Treasury notes” which
“ultimately degenerated into a kind of
currency.”11 Writing in 1831, Gallatin
stated that had the Bank been rechar­
tered, the suspension might have been
prevented and the state banks would
have been restrained within proper
T h e S eco nd B a n k o f
S t a t es


U n it e d

As early as October 14, 1814, Secre­
tary Dallas,12 in a report submitted to
Congress, called attention to the need
for a National Bank, emphasizing the
fact that such a bank could restore the
depreciated currency to a gold parity
and that in its fiscal relations with the
Treasury would be of incalculable
assistance. After seven unsuccessful
attempts within two years, the charter
of the Second Bank, closely resembling
that of the First, was passed by Con­
gress and became law on April 10,
1816.18 Through an agreement with
11Willis, H.P., American Banking. 1918, p. 209.
12Alexander J. Dallas from Pennsylvania,
appointed Secretary of the Treasury, October
6, 1812.
13The act provided for a capital of $35,000,000,
of which the government subscribed one-fifth.
There were to be twenty-five directors, twenty of
whom were to be elected annually by the share­
holders and five appointed by the government.
Branches were to be established wherever the
Bank thought necessary, managed by from seven
to thirteen directors appointed by the parent
bank. The circulation was not to exceed the
capital. Deposits of public funds were to be
made in the Bank unless the Secretary of the
Treasury should otherwise direct. The Bank
was required to pay the government a bonus of
$1,500,000 and to transfer public funds without
charge. Weekly statements of condition might
be called for and Congress was given the right to
inspect the books of the Bank.

O u t l in e


B a n k in g H isto ry

the state banks in the larger towns, the
resumption of specie payments was
brought about (nominally at least) by
February 20, 1817, thus realizing the
first purpose of the Bank. Due partly
to governmental pressure and partly to
a lack of banking training, the direc­
tors, at first, extended loans and rapidly
increased the circulation, a policy
which resulted in a heavy loss to the
Bank and in the retirement of William
Jones as president in January of 1819.
Langdon Cheves, chosen as his succes­
sor, immediately inaugurated a policy
of retrenchment and deflation. Under
his management and later under that
of Nicholas Biddle, the Bank became
“the most powerful and best managed
financial institution the country had
ever seen.”14 Its notes, circulating from
Montreal to Mexico City, were safe
and elastic, In transferring and dis­


bursing government funds, in furnish­
ing domestic exchange, in paying the
pensioners of the government, and in
acting until 1833 as the sole depositary
of public moneys, the Bank was of great
service to the whole people.
In his first message to Congress, on
December 8, 1829, President Jackson
expressed doubts as to the constitu­
tionality of the Bank and the sound­
ness of its notes. The President’s
hostility subsequently cooled, but
when the Whig party at Baltimore in
1831 took the side of the Bank, there
ensued a long and bitter struggle which
ended in the defeat of the attempt to
recharter it. The reasons as given by
Professor Catterall for this opposition
were the “widespread belief that the
Bank was unconstitutional, the hostil­
ity of the states, the opposition of the
state banks, the rise of democracy,

C hart I

T he A nnals


of t h e

and the envy and hatred which the
poor always feel for the rich.”15
Upon the failure to recharter the
Second Bank, the era of central banks,
modelled after those existing in Europe,
passed. Banking in America entered
upon entirely different lines of devel­
opment. In the years that followed,
the government was to miss keenly
the fiscal services of the Bank, and
the people, no longer protected ljy
its restraining influence on the note
issues of the state banks, suffered
severely from the resulting financial
T h e I n d e p e n d e n t T r e a su r y

From 1791 to 1811, the First Bank
was utilized to a large extent as a
depositary of government funds. After
its charter had expired the government
was forced to use the services of state
banks, from whom no security was
required for the moneys deposited, but
by whom in accordance with an agree­
ment entered into, weekly and monthly
statements of condition were to be
submitted to the Secretary of the
Treasury. The use of state banks as
depositaries proved so unsuccessful
that it wa£ provided, in the charter of
the Second Bank, that it was to be the
sole depositary except in such places
where the Bank had no branches, or
when the Secretary of the Treasury
deemed it unwise to employ it as such.
This latter provision of the act was
taken advantage of in September of
1833 by Secretary Taney, who “or­
dered the collectors of revenue to cease
depositing in the Bank of the United
States and to employ designated
state banks for that purpose.”16
A contract was entered into between
these banks (the so-called “pet banks”)

A m e r ic a n A cadem y

and the government, whereby they
were required to give security for the
funds deposited “ whenever the deposits
should exceed one-half the bank
capital paid in,” 17 or whenever the
government deemed it necessary. The
banks agreed to perform for the govern­
ment all of the fiscal services formerly
rendered by the Bank of the United
States, to render weekly reports, and
to submit to examinations when the
Secretary thought necessary. On June
28, 1836, an act was passed “to regu­
late the deposites of the public money”
following closely the provisions of
Taney’s contracts.18 In his annual
message, September, 1837, Van Buren
showed that the custody of the public
funds by state banks had proved very
unsatisfactory and urged that the
government take care of its funds itself
and require that all dues be paid in
specie. While this suggestion was
being considered, the public funds were
left in the hands of the collecting offi­
cers and a few banks.
The bill creating the Independent
Treasury, finally passed on July 4,
1840, was repealed on August 13,
1841, and was repassed on August 6,

17 Kinley, David, Independent Treasury. 1910,
26, 27.
18This act provided that the banks selected as
depositaries must furnish the Secretary with a
statement of their condition, a list of their direc­
tors, the current price of their stock and a copy
of their charter. Further, the Secretary might
examine the general accounts. Such banks must
redeem their notes upon demand, and no bank
issuing notes of a denomination of less than $5
was to be chosen. Collateral against the funds
so deposited could be called for whenever the
Secretary deemed this necessary, and must be
called for if the deposits exceeded one-half
the Bank’s capital. In return for such deposits,
the banks must render the government all the
services and duties heretofore required of the
Second Bank. It was further provided that if
15Catterall, Ralph C. H., The Second Bank of the government’s deposits exceeded a fourth
part of the Bank’s capital for at least three
the United States, p. 164.
16Kinley, David, Independent Treasury. 1910, months, interest at the rate of 2 per cent per
annum must be paid on this excess.
pp. 26, 27 .


O u t l in e



B a n k in g H isto ry

C h a r t II
Statistics of State Banks, 1836-1863
M illio n s

«# goiter*



1846.19 The act provided that all safely without loaning, using or de­
receivers of public moneys must keep positing them in banks. Further, on
such funds as were received by them and after June 1, 1847, all payments
19 The repeal of the act in 1840 necessitated a of taxes, duties, etc., to the United
return to the use of state banks as depositaries, States must be made in gold or silver
or Treasury notes. New York, Phila­
until the act was repassed.


T he A nnals

of the

delphia, Washington, Charleston, New
Orleans and St. Louis were made the
principal centers of deposit.
S t a t e B a n k s , 1836-1863
In the course of these years, “almost
every type of banking system was
attempted, and the result was the
accumulation of a great fund of experi­
ence”20 mostly as to the best way in
which not to conduct banking. In
New England and in New York the
efforts to regulate banking through
state and private means were much
more successful than in the rest of the
country. Thus, by an act passed in
1829, New York State endeavored to
„protect both the depositor and note
holder by means of a safety fund which
was built up by contributions from
the banks and which was to be used to
meet the obligations (excluding capital)
of the failed banks. This scheme was
not very successful until, beginning
with 1842, the use of the fund was
limited strictly to the redemption of
the notes of failed banks. The notes
of the banks organized under the Free
Banking Law of 1838 in New York
State were protected, not by the safety
fund, but by deposits of certain speci­
fied bonds or mortgages with the state
The success of the First and Second
United States Banks led many states
to charter banks modelled upon these.
Among the more successful were the
State Banks of Indiana, Louisiana and
Ohio, but the Bank of the Common­
wealth of Kentucky, the Banks of
Alabama, of Mississippi, of Arkansas,
of Illinois and the Union Bank of
Florida ended in dismal failures, leav­
ing the citizens with millions of dollars
of unredeemed notes and worthless
deposit accounts.
In the western and southern states,
“due to the lack of public regulation,
20 Willis, H. P., AmericanBanking, 1918, p. 212.

A m er ic a n A cadem y

to the want of any uniform system—
and to the significant fact that public
opinion was both torpid and unintelli­
gent,”21 the losses to the people from
poorly and dishonestly managed banks
were enormous. Some of these banks
were established by special charters,
some, under the Free Banking Laws;
few seemed to have been prudently or
wisely managed. Some, called “wild­
cat” or “red-dog” banks, were located
in remote sections, in order to keep
their notes in circulation longer and
render redemption more difficult. The
lack of any uniformity in the bank
notes, the failure adequately to protect
them, and the absence of governmental
control were among the motivating
factors leading to the passage of the
National Bank Act. •
T h e N a tio n a l B a n k in g S y st em

The national banking system, re­
sembling somewhat the free banking
system of New York State, was recom­
mended by Secretary Chase as early
as December, 1861. After two de­
feats, due largely to the opposition of
the state banks, the bill establishing
the system became a law February 25,
1863; but in accordance with the rec­
ommendations of Mr. Hugh McCul­
loch, the first Comptroller of the Cur­
rency, it was completely revised and
passed again on June 3, 1864.22
The predominating motive in Secre21 White, Horace, Money and Banking. 1914,
22The chief differences in these two bills were
as follows:
1. The Act of 1863 required a smaller mini­
mum of capital for a new bank than did the Act
of 1864, and required that a smaller proportion
be paid in before beginning business, and allowed
a longer time for the payment of the remainder.
2. The Act of 1863 permitted loans on real as
well as personal security.
3. The prohibition of issuing notes of a denom­
ination less than $5 took place at once in the
former act.
4. By the former act all national banks were

p . 331.

O u t l in e


tary Chase’s mind for the passage of
the act was the establishment of a
uniform currency. On, January 1,
1862, there were in the United States,
1,496 banks issuing some 7,000 different
kinds of circulating notes, “based on a
great variety of securities, of different
qualities and quantities,”23 and some
based on no security at all. The fram­
ers of the Act not only wished to rid the
country of such conditions as these,
but it was felt by many also that the
issues of state bank notes were fre­
quently redundant, were subjected to
violent expansions and contractions,
and were unequally distributed among
the various states.24
The increased demand for bonds,
which such a system would create,
was to Secretary Chase a motive of
secondary importance.25 Additional
advantages of the system, of course,
were that such banks could act as
depositaries of government funds, float
loans, stimulate patriotism, and, be­
cause of being a national system, pre­
vent future rebellions.
By the Act of 1864 the capital of the
national banks was proportioned to
the population as follows:
Cities with a population of 6,000
or less....................................... $50,000
Cities with a population of from
6,000 to 50,000........................ 100,000
Cities with a population of 50,000
and above............................... 200,000

of which 50 per cent was to be paid in
cashbefore commencingbusiness andthe
remainder within five months at a rate
not less than 10 per cent per month.26
Each national bank was required to
buy government registered bonds to
an amount not less than $30,000 or
less than one-third of the capital stock
paid in. When such bonds had been
deposited with the Treasurer of the
United States, the national bank would
be entitled to receive notes up to 90
per cent of the par or market value of
the bonds whichever was the lower, but
no bank was permitted to issue an
amount of notes greater than its paidin capital. Thus the circulation could
at no time exceed the paid-in capital
of all the banks, and in addition an
absolute maximum of $300,000,000 was
placed on the note issues. The notes
were to be receivable at par in pay­
ment of all dues to the United States
except for duties on imports, and to be
paid out at par for all the debts of the
United States except interest on the
public debt, and in redemption of the
national currency.27
It was further provided that na­
tional banks in the reserve cities must
make arrangements to redeem their
currency in New York City, and, simi26The Act made an error in not proportioning
capital to the bank’s liabilities instead of to the
population of the town in which the bank hap­
pened to be located. The requirement that the
capital be paid in cash was an effort to stop the
vicious practice begun at the time the First
Bank was chartered of allowing the shareholders
to contribute their part of the capital in their
own discounted notes.
Inasmuch as the Loan Acts of March
and March
provided that both
principal and interest be paid in coin, and the
Loan Acts of February
and March
provided for the payment
of the interest in coin, in order to help sustain
the public credit, it was necessary, therefore, as
specie payments were suspended from
that the government collect its import
duties in gold in order to obtain a supply which
could be used as required by the above acts.

required to maintain a reserve of 25 per cent
against notes and deposits.
5 . The Act of 1864 makes more complete
provision for the conversion of state banks into
national associations.
23Dewey, D. R., Financial History ofthe United
States. 1918, p. 321.
24 Chart II, brings out the first two points in
a striking fashion.
25As a matter of fact, at the time of Lee’s sur­
render, the bonds bought by the national banks
to secure their circulation were less than 4 per 1879,
cent of the total bonds floated by the govern­
ment during the war.


B a n k in g H isto ry

3, 1864,
25, 1862,
3, 1865,


30, 1864


T he A nnals

of t h e

larly, national banks in country towns
must redeem their notes at some bank
located in a reserve city.28
By an act passed on March 3, 1865,
$150,000,000 of the national bank
notes were to be apportioned among
the national banks in the several states
according to the respective populations,
while the remainder was to be propor­
tioned by the Secretary of the Treas­
ury “having due regard to the existing
banking capital, resources, and busi­
ness of such States, Districts, and
State bank notes were forced out of
circulation by a provision in the
Revenue Act of March 3,1865, levying
a 10 per cent annual tax on the notes
paid out after July 1, 1866.29
That the entrance of state banks
into the system was slow at first, was
due, according to Mr. McCulloch, to
the fear on their part that the national
banking system might be a repetition
of the free banking system in its worst
aspects. Up to November 25, 1864,
only 168 state banks had entered the
system, but with the retirement of the
state bank notes in sight, only 244 re­
mained out by the end of 1868, and
1,643 were members of the national
banking system. An amendment to
the National Bank Act passed on
28 New York was the only central reserve
city, whereas the reserve cities were St. Louis,
Louisville, Chicago, Detroit, Milwaukee, New
Orleans, Cincinnati, Cleveland, Pittsburg, Balti­
more, Philadelphia, Boston, Albany, Leaven­
worth, San Francisco, Washington City, and
later, Charleston and Richmond.
Banks in New York City were to keep on hand
a 25 per cent lawful money reserve against both
notes and deposits, while banks in the reserve
cities were to keep a 25 per cent reserve but onehalf of this might be deposited with a New York
City bank. Banks in other towns must keep
a reserve equal to 15 per cent, three-fifths of
which could be kept on deposit with a bank in a
New York or in any reserve city.
29 State bank notes made their last appearance
in the Treasury reports on July 1, 1876, when
the circulation was $1,047,335.

A m er ic a n A cadem y

June 20,1874, did away with the lawful
money reserve which was formerly
required to be held against the circu­
lation, provided for the 5 per cent
redemption fund, provided that here­
after banks would have to redeem
their notes only at their own counters
or at the Treasury Department, and
also provided that a bank which wished
to retire its circulation might with­
draw the bonds deposited with the
Treasurer of the United States, pro­
vided that lawful money to an equal
amount be deposited to redeem the
circulation still outstanding; but in no
case should the amount of bonds on
deposit for circulation be reduced
below $50,OOO.30 By the Resumption
Act of January 14, 1875, the provi­
sions in the former acts regarding the
aggregate amount of national bank
notes in circulation and their distribu­
tion were repealed.
From 1882, when the national bank
notes in circulation touched the highest
figure up to that time, 361 million dol­
lars, the amount outstanding declined
rapidly until in 1891 there were only
172 million dollars in circulation, and
of this amount more than 50 millions
were secured by lawful money. Nat­
urally one would expect a bank’s cir­
culation to increase as the population
grew and the nation’s resources were
developed, but it must be remembered
that these bank notes based on govern­
ment bonds were alone of their kind in
the world, and as the yield on
government bonds31 was decreasing
80 By the Act of July 12, 1882, banks with a
capital of $150,000 or less were permitted to
withdraw bonds, which they had deposited
against their circulation, down to one-fourth of
their capital, provided that they deposit enough
lawful money to retire the notes not covered by
bonds, but not more than $3,000,000 of National
Bank notes were to be so retired in any one
month. All bond requirements were repealed
by the act of June 21, 1917.
81By reason of the steadily rising prices of the

O u t l in e


B a n k in g H isto ry


throughout this period, it was no longer
as profitable for the banks to take out
notes, as the so-called double-profit
had declined. From 1891 to 1899, the
amount of national bank notes in­
creased, due to the increased yield on
government bonds, and to special
demands .for money during the panic
of 1893.
T h e G o ld S ta n d a r d A c t o f 1900
This act derives its name from the
fact that it provided that the dollar,
consisting of twenty-five and eighttenths grains of gold, nine-tenths fine,
should be the standard unit of value,
and all other forms of money should
be maintained at a parity of value
with the standard.32
The Act also allowed national banks
with as small a capitalization as $25,000
to be formed in towns of 3,000 inhab­
itants or less.83 This led to a rapid
increase in the number of national
banks from 3,583 in 1899 to 4,165 in
Though the notes to be issued by a
national bank were at no time to
exceed its paid-in capital, it was pro­
vided that they could be issued here­
after up to the full market or par value
of the bonds deposited, whichever was
the lower, instead of only up to 90 per
cent of such value. The refunding of
the 5 per cent bonds maturing in 1904,
the 4 per cent maturing in 1907, and
the 3 per cent maturing in 1908, repre­
senting a total amount of 839 million
dollars, into 2 per cent bonds maturing
in 1930, was provided. One purpose of

this measure was to provide a basis for
the bond-secured national bank notes
by postponing the maturity of a large
part of the public debt.84 The tax on
the notes issued remained at 1 per
cent per annum if the bonds bore more
than 2 per cent interest, but if they
bore 2 per cent interest or less, this
tax was reduced to one-half of 1 per
Under the stimulus of the Act,
especially by reason of allowing na­
tional banks to issue notes up to the par
value of the bonds, and by reason of
the increased yield of government
bonds, the amount of notes in circula­
tion increased rapidly from 332 mil­
lion dollars in 1900 to 609 millions in
The Gold Standard Act of 1900 was
not a constructive piece of legislation,
as it did little else than modify slightly
the technical details in the organiza­
tion and operation of the national
banks, and made no attempt to remedy
any of the basic defects of our banking
T h e P a n ic o f 1907
Beginning with 1896, prices in the
various gold standard nations, which
had been falling for nearly a genera­
tion, began to turn upward. This
change was due to an increase in the
production of gold and use of money
substitutes, and to the wasteful ex­
ploitation of the world’s natural re­
sources. The rise in the price level
led to such a stimulation of industry
that until 1907, aside from a local
crisis in Germany in 1900 and the
82 This act simply affirmed the gold standard “rich man’s panic” of 1903 in America,
which had really been established in the act of the period was one of general prosper1873 which demonetized the silver dollar.

w As established by the Act, the capital re­
quirements were:
In towns of less than 3,000................. $25,000
In towns of 3,000 to 6,000................... 50,000
In towns of 6,000 to 50,000................. 100,000
In towns with more than 50,000 people 200,000

84Horace White has estimated that the loss to
the government on additional interest paid by
extending the maturity of these bonds amounted
to $244 millions — a tremendous price to pay for
an increase in circulation up to 1907 of only 277
millions of dollars. Money and Banking, Horace
White. 1914, p. 406.


T he A nnals

of the

ity. This expansion in business and
the resulting increase in speculation
intensified the demand for capital.
As the demand could not be met from
the current savings of the people, com­
mercial banks began to make larger
and larger extensions of credit, a policy
which resulted in progressively lower
reserves and forced the banks to raise
discount rates and curtail extensions of
credit. This retrenchment was accom­
panied by a diminishing purchasing
power on the part of the great mass of
consumers, for wages lagged behind
prices in the upward movement, forc­
ing the sale of products at sacrifice
prices. This condition checked the
rise in the price level and brought on a
period of depression throughout the
In America, as in the nations of
Europe, prices, wages and interest
rates rose one after the other. While
this differential between prices and the
cost of production lasted, the specula­
tor optimistically capitalized the future
earnings of industry, and the prices of
stocks soared, reaching a peak in 1906.
T a b le

A— G r o w th

A m er ic a n A cadem y

Toward the end of that year it was
apparent that the demand for capital
was such that borrowers had difficulty
in being accommodated even though
bank credits were strained to the limit.
In January and February of 1907 large
blocks of securities had to be sold to
repay the loans previously procured
from the London market through the
drawing of finance bills. Prices of
stocks fell steadily and crashed in
March. After a slight recovery the
market began to fall again in August
and was still falling when the panic
In addition to the general causes of
the world crisis of 1907, there were ele­
ments of weakness in the American
banking system, reflected chiefly in
the New York money market, which
caused the crisis here to degenerate
into a panic. One of the most signifi­
cant facts in the development of Amer­
ican banking from 1896 to 1907 was the
rapid growth of state banks and trust
companies. State banks increased
particularly throughout the West and
South as the requirements of the state

o f S t a t e B a n k s a n d T r u s t C om p a n ies,
S ta t e B a n e s

1896, 1902, 1907






Proportion of
to Deposits

1896 ..............
1902 ..............
1907 ..............






14 .5 %

T r u st C o m p a n ie s




1896 ..............
1902 ..............
1907 ..............





Proportion of
Cash to Deposits
(National Bank
Notes Included)



4 . 6%

O u t l in e


B a n k in g H isto ry

banking laws were less strict there than
those of the National Bank Act.
The greatest growth in trust companies
occurred in the East, as there they
were not subject to the same strict
requirements as were state and na­
tional banks. The growth of these two
types of banking institutions is shown
in Table A on the preceding page.
As the proportion of cash to the
individual deposits of state banks and
trust companies, amounting to 8.3 per
cent and 4.9 per cent respectively, in
1907, was woefully inadequate to meet
a heavy drain, they carried balances
with national banks which they
planned to withdraw in time of an
emergency. On August 22, 1907, they
had 196.3 million dollars on deposit
with the national banks in New York
City. Though these deposits would
surely be withdrawn during a crisis, the
national banks in the performance of
their functions as reserve agents, “did
not build up reserves any larger than
they would have carried had they been
received from that class of conservative
individuals who habitually maintain
large balances with their banks.” 35
Furthermore the national banks in
New York City held a considerable
porportion of the deposited reserves of
the national banks located in the
interior, amounting on August 22 to
213.8 million dollars.36 Against the
certainty of having the bankers’ bal­
ances withdrawn during a crisis, the
New York banks maintained the
ridiculously low cash reserve of 224
million dollars in 1906 (though this was
slightly above the legal minimum)
against total deposits (including those
made by the government) of 1,162
millions, of which at least a half con­
sisted of bankers’ balances. That they
would be unable to meet heavy with88Sprague, O. M. W., History of Crises Under
the National Banking System. 1910, p. 226 .
18See footnote 37.


drawals during a crisis, a time when
banks ought to increase their loans to
save the solvent but temporarily
embarrassed borrower, is obvious.
Moreover, the Secretary of Treasury,
Leslie M. Shaw, encouraged other
unsound banking practices by a series
of innovations which he introduced
from 1902 to 1907. Among the more
radical of his changes, was the exemp­
tion of national banks from the main­
tenance of a cash reserve against gov­
ernment deposits, the acceptance of
other than United States bonds as
securities for government deposits, the
depositing of government funds where
money seemed tight, and the artificial
stimulation of gold imports.
The cause directly leading to the
panic was the announcement, on
October 21, 1907, by the NationalBank
of Commerce of New York that it
would no longer clear for the Knicker­
bocker Trust Company, whose man­
agement was under suspicion. This
action precipitated a run on the Trust
Company, which was forced to sus­
pend the following day after paying
out eight million dollars. Immedi­
ately, the alarm spread throughout the
land, a wild scramble for money ensued,
banks and individuals hastened to
withdraw their funds from the New
York City banks, and the panic was
on. The New York City banks being
ill prepared to meet these heavy with­
drawals were forced to suspend cash
payments on October 26 . The rest of
the country immediately followed their
T h e D e f e c t s i n t h e A m e r ic a n
B a n k in g S y st e m a s R e v e a l e d in
t h e P a n i c o f 1907

One of the most serious of these
defects was the rigidity and immobility
of the reserves. The proportion of
reserves to be held by national banks
against their deposits were definitely


T he Annals

of the

A m er ic a n A cadem y

fixed by statute.37 In compliance with
the provisions of the Act, on August
2 2 , 1907, national banks held cash
and deposited reserves as shown in
Table B.
The provision allowing a certain pro­
portion of the reserves to consist of
balances with other banks was intended
to provide the interior banks with ex­
change to sell on New York and other
important commercial centers. How­
ever. praiseworthy this intention might
T able

B — C ash


brokers, as call loans, which they felt
were the most liquid form, in the ab­
sence of a general discount market.
The capacity of the interior banks to
meet their depositors’ demands during
a panic depended in part upon their
ability to withdraw the funds which
they had deposited with their New
York reserve agent. But the New
York banks were unable to meet heavy
drains of cash, due to the insufficiency
of their reserves, and the unliquid

D eposited R eserves op N ational B anks , A ugust 22 , 1907

Number of Banks


Central Reserve Cities
Reserve Cities.............


$ ,

T o tal.......................


$ ,

1 205.5
1 423.4
2 627.2
5 256.1

Percentage of cash reserves against deposits =

Cash Reserves

Deposited Reserves








13 .87 % .

be, the provision led to a pyramiding character of call loans, secured by
of reserves, so that our credit structure stocks and bonds, during a panic when
represented an inverted pyramid with the prices of securities were tumbling.
a relatively small cash apex in New Far from being able to repay his loans,
York City. In fact, of the reserves the broker needed additional help from
deposited with national banks in bankers at such a time.38
central reserve cities, more than two- Realizing that it might be impossible,
thirds were held by the banks in New during a panic, to withdraw their
York City. In August of 1907 they deposited funds, national banks placed
held cash reserves against these bank­ great dependence upon their cash
ers’ balances amounting to 2 6 .5 per reserves to meet the emergency. But
cent, and, as was customary, had these, scattered as they were in 1907
loaned a large part of the remainder to among 6,429 banks, were ineffective
in allaying
When the
87 The provisions were, that national banks in cial stormthe panic.each little finan­
New York City, St. Louis and Chicago (known
endeavored to strengthen and to guard
as the central reserve cities) must keep a lawful
its own reserve against withdrawals,
money reserve of 25 per cent against their
deposits; that national banks in some fortyas there was no established agency
seven other large towns (reserve cities) must
maintain a 25 per cent reserve but one-half of
88 Prof. Sprague finds that out of a total loan
this might be deposited with a national bank in
a central reserve city; all other national banks
were to maintain a
per cent reserve but threefifths of this might be deposited with national
banks in reserve or central reserve cities.


increase by the national banks in New York
City between August 22 and December 3,
of sixty-three million dollars, call loans account
for fifty-four million dollars.— History of Crises
Under the National Banking System, p.



O u t l in e


B a n k in g H isto ry

which would grant it aid through the
extension of loans or the discounting of
its paper. Once the reserve had fallen
to the legal minimum, the bank was
not expected to extend any further
accommodation to its customers. The
cash reserves of national banks, though
large in the aggregate, were so scat­
tered, hoarded and immobile as to be
ineffective during a time of financial
Another defect in our banking sys­
tem revealed in 1907, as in every other
panic, was the inelasticity of the na­
tional bank notes. An elastic currency
should expand to meet seasonal and
cyclical demands for money, and when
these demands have been satisfied,
should contract. Cyclical demands
occur at the time of a crisis, for then
business confidence is at a low ebb and
C hart

money, rather than credit instruments,
is demanded as a medium of exchange.
The suspension of specie payments,
following the failure of the Knicker­
bocker Trust Company resulted in a
premium on currency ranging as high
as 4 per cent. The Honorable A. Piatt
Andrew has estimated that to meet
the demands for money, 334 million
dollars of currency substitutes were
issued, including clearing house loan
certificates and checks, cashiers’
checks and manufacturers’ pay
checks.39 Our bank notes did not
begin to increase until the first part of
November and by the first of the year
had increased by only fifty-four million
dollars. The reason is found in the
time it took to buy the necessary bonds
and to comply with the governmental
red tape.

3 Andrew, A. Piatt, "Substitutes for Cash in the Panic of
Economics, August,



1907.” The Quarterly Journal of


T he A nnals

of the

Seasonal demands for money arise
from periodically recurring needs, such
as the demands of the farmers for
money each fall to harvest and market
their crops. As the national bank
notes failed to expand, the interior
banks secured much of the money
needed by withdrawing their deposits
from the New York banks. To the
extent that the New York banks met
this demand with lawful money, their
reserves were lowered, necessitating a
contraction of loans and forcing up
interest rates. Chart III showing the
seasonal variations (with secular and
cyclical tendencies removed) in the
national bank notes and the notes
issued by the Reichsbank, illustrates
in a striking fashion the inelasticity
of the former.
Such powers of expansion and con­
traction as the national bank notes
possessed, depended upon the yield of
government bonds, for should this
increase, the double profit would rise
and it would become profitable for
banks to force the notes into circula­
The seasonal movements of cur­
rency into and out of the New York
City banks, producing a dearth of
money at one time and a plethora at
another, caused interest rates to vary
from artificially low levels to abnor­
mally high. Thus the average weekly
low call money rate from 1890 to 1908
was 2.31 per cent, occurring in the
second week of June, while the average
high, was 7.38 per cent,41 occurring in
the fourth week of December. Had
the seasonal demands been met, as was
true on the Continent, by an actual
increase in the amount of currency,
instead of by shifting funds from one

A m er ic a n A cadem y

section to another, and had this cur­
rency contracted, once the need was
satisfied, interest rates could have been
fairly stabilized. Furthermore, due
to the immobility of reserves, and the
concentration of banking capital in the
East, there were considerable sectional
disparities in interest rates which
could not be eliminated without central
reserve banks.
From time to time, the government
endeavored to extend relief to the
banks in order to counteract the evils
in our banking system. The innova­
tions of Secretary Shaw have been
noted. Mr. George B. Cortelyou, his
successor, continued this policy. After
the panic had begun, he transferred to
the national banks in New York City
(from October 21 to October 31) nearly
thirty-eight million dollars to help
them meet their withdrawals. Later
he offered for sale 150 million dollars
of bonds to stimulate the issue of
national bank notes. The government
had to choose between interfering in
the money market in this way or keep­
ing its funds locked up in the sub­
treasuries. This latter policy would
have had the effect of making the cur­
rency redundant at the time the gov­
ernment made disbursements and
scarce when its taxes were collected.42

40See pages 8 and 9 for a further illustra­
tion of this point.
41Kemmerer, E. W., Seasonal Variations in the
Relative Demand for Money and Capital in the 4 1907
United States.— 1910, p. 15.

25 1863

The Act passed in February
lishing the national banking system amended
the Independent Treasury Act so as to allow
national banks designated by the Secretary of
the Treasury to be depositaries of public funds,
except receipts from customs. These banks
were required to give security by the “ deposit
of United States bonds and otherwise.” By an
act passed on March
the Secretary of the
Treasury was expected to “ distribute the depos­
its herein— so far as practicable equitably be­
tween different States and sections.” Secretary
Shaw, in
, began to accept other than United
States bonds from the banks against government
deposits, interpreting the words “ and otherwise”
to mean “ or otherwise.” By the Act of March
it was provided that receipts from cus­
toms might be placed in designated depositaries.



O u t l in e


B a n k in g H isto ry


tain a reserve against deposits be
On November 18, 1896, a resolution
was adopted by the Board of Gover­
nors of the Indianapolis Board of
Trade inviting representatives from
E ffo r ts at R eform
the boards of trade of sixteen middle
It was imperative that the defects western cities to assemble at Indian­
in our currency and banking systems apolis in December of 1896 “for the
should be remedied, if the nation were purpose of considering the advisability
to escape the disaster, humiliation and of calling a larger conference,—to
ruin of recurring panics. The members consider the propriety of creating a
of the American Bankers Association non-partisan commission, to which
were among the first to realize the shall be assigned the duty of formulat­
necessity for reformation, and endorsed, ing a plan for the reform of our cur­
at a meeting held in Baltimore in rency system.”45
1894, a plan of reform known there­ Representatives from the boards of
after as the “Baltimore Plan.” This trade and similar commercial bodies
plan proposed that government bonds of eleven of the cities invited attended
be eliminated as security for national this preliminary conference and issued
bank notes, and provided for their a call for a non-partisan monetary
issue on much the same conditions convention of business men to con­
that govern the issue of the Canadian vene at Indianapolis on January 12,
1897. Delegates from twenty-six
bank notes.43
About the same time in a report to states and the District of Columbia
Congress, Mr. John G. Carlisle, Secre­ attended the convention, at which it
tary of the Treasury from 1893 to was unanimously agreed that an
1897, proposed a plan of reform re­ executive committee of fifteen be
sembling in its main outlines the appointed which would endeavor to
Baltimore Plan, but with the addition procure at the next session of Congress
that the provisions in the National legislation for the appointment of a
Bank Act requiring banks to main­ Monetary Commission by the Presi­
dent, to consider the entire question
43 The “ Baltimore plan” proposed that gov­ of currency and banking reform. In
case this effort failed it was provided
ernment bonds be eliminated as security for
bank notes and provided that each National
that the executive committee should
Bank be allowed to issue notes up to 50 per cent

Of course such policies as introduced
by Secretary Shaw were but palliatives
for the situation and could not by
themselves remedy the defects of our
banking system.

of its paid-up, unimpaired capital subject to a
tax of one-half of one per cent per annum on the
average amount of notes outstanding, and further
that an additional circulation, known as emer­
gency currency, equal to per cent of the bank’s
paid-up unimpaired capital be allowed subject
to a heavier tax. Each bank issuing notes was
to contribute an amount to a central guarantee
fund equal to per cent of its notes in circula­
tion, from which the notes of failed banks were
to be paid. If the fund were not sufficiently
large for this, the remainder of the notes were
to be redeemed from the assets of the failed
bank. A per cent redemption fund was to be
maintained as at present,




^Carlisle’s plan closely followed the Balti­
more plan, but differed in this respect that in
addition to the
per cent guaranty fund, he
would require each national bank issuing notes
to maintain
per cent lawful money reserve,
consisting of United States notes including the
Treasury notes of
, against the notes issued.
State banks were to be allowed to issue notes in
accordance with these provisions. He also pro­
posed that the provisions in the National Bank­
ing Act requiring a bank to maintain reserves
against deposits be repealed.
Report of the Monetary Commission of the
Indianapolis Convention, Chicago.— The Uni­
versity of Chicago Press,
. p. .








T he Annals

of t h e

select eleven men to make a thorough
investigation of the monetary needs of
the country. The Commission of
Eleven was appointed and held their
first meeting on September 22, 1897, in
Washington. After a series of con­
ferences lasting through the fall, a
preliminary report was adopted on
December 17, while the preparation of
the final report was entrusted to J.
Laurence Laughlin, a member of the
Commission. This report was com­
pleted by April of 1898. The prelim­
inary report simply states the Com­
mission’s plan of reform, while the
final report deals in an exhaustive way
with the subject of money and banking
from a theoretical, historical and sta­
tistical standpoint, and is a note­
worthy contribution to economics.
After advising that the existing gold
standard be maintained the Commis­
sion proposed that national banks be
allowed to issue notes up to the
amount of their paid-up unimpaired
capital, exclusive of so much as is
invested in real estate. For the first
five years after the passage of the pro­
posed measure, the notes issued up to
25 per cent of a bank’s capital were to
be secured by government bonds, 'but
thereafter the amount of bonds re­
quired to be deposited, before notes
might be issued, was to be reduced by
one-fifth each year. The notes issued
in excess of 60 per cent of the capital
and not in excess of 80 per cent were to
be taxed at the rate of 2 per cent per
annum, while those issued in excess of
80 per cent were to be taxed at the rate
of 6 per cent per annum. In order to

A m er ic a n A cadem y

protect the noteholders from loss, each
bank was to contribute to a guaranty
fund an amount in gold equal to 5 per
cent of its circulation, from which the
notes of failed banks were to be paid.
In case that the fund became impaired,
by reason of payments made to redeem
the notes, the Comptroller of the Cur­
rency was authorized to make an
assessment upon all banks in propor­
tion to their circulation. The present
5 per cent gold redemption fund was to
The plan for banking reform in­
cluded the proposals that the present
reserve requirements be maintained
against deposits with the exception that
one-fourth of the reserves required
should be held in coin in the vaults of
the bank. The establishment of branch
banks was provided for in case the
Comptroller of the Currency approved.
It was further recommended that the
organization of national banks in
towns of 4,000 or less with a m in im um
capital of $25,000 be permitted.
The Commission’s proposals would
have provided America with a safe and
elastic currency, but would not have
remedied any of the other defects of
our banking system. These could not
be removed by a modification of the
then existing system, but required the
introduction of central reserve banks.
The work of the Commission is valu­
able, not because of its immediate
effect upon legislation, but for the
reason that it awakened the public
conscience to the necessity of banking
and monetary reform, and paved the
way for the final reformatory measures.

T h e S t u d ie s

of the

M o n e ta r y C om m ission


The Studies of the National Monetary Commission

By N. A.

W esto n

University of Illinois


HE National Monetary Commis­ what was needed to correct the evils of
sion had its origin in the financial the existing situation, conflicting busi­
and banking panic of 1907. That interests and partisan political
astonishing disturbance and collapse aims, would prevent the enactment of
of credit was one of the most un­ any thorough-going measure of re­
becoming, if not disgraceful, episodes in form. The leaders of the dominant
our financial history. Popular clamor party in Congress adopted, therefore,
followed. When the air had cleared a temporizing policy and secured the
it was seen that the trouble was due to passage of a law, commonly known as
the banking system, which, ill-adapted the Aldrich-Vreeland Act, approved
to supply the needs of a progressive May 30, 1908, providing for the issu­
industrial nation under normal con­ ance of emergency currency under
ditions, was utterly inadequate for the certain conditions. This act was a
preservation of business equilibrium makeshift measure and must be re­
and the allaying of distrust in times garded as a political rather than a
of business accident and unexpected financial expedient. It was passed
with but little debate and without
Dissatisfaction with our banking previous consideration by the reg­
system began, however, long before ularly constituted committee of either
the panic of 1907. The banks received house of Congress. It was intended to
a share of the blame for the crises of satisfy the urgent public demand for
1873 and 1893, while during the ten action by Congress and to enable the
years of intense business activity party in power to say that provision
preceding the panic of 1907, banking had been made against a recurrence of
reform was a question of almost con­ the troubles that had afflicted the
stant public agitation. This was a country in the preceding autumn.
period of rapid, indeed almost revolu­
tionary, changes in industrial and T h e M o n e t a r y C o m m is s io n a n d
I t s D u t ie s
commercial organization, but the de­
velopment of banking seemed to lag But the Aldrich-Vreeland Act also
behind, owing, it was believed, to the created the National Monetary Com­
rigid character of the banking laws. mission, to be composed of nine mem­
The panic of 1907 brought the criti­ bers from the Senate and nine from
cism of the banking system to a climax the House of Representatives, pre­
and the Congress which assembled in scribed its authority and duties and
December of that year, some weeks made an appropriation to cover the
after the outbreak of the panic, was necessary expenses of its work. The
flooded with bills designed to reform work of the Commission is clearly
the monetary and banking systems of defined in Section 18 of the Act which
the country.
In this aroused state of public That it shall be the duty of this com­
opinion some action by Congress was mission to inquire into and report to
inevitable, but it was soon realized Congress at the earliest date practicable,
that widely divergent views as to what changes are necessary or desirable in


T he A nnals

of t h e

the monetary system of the United States
or in the laws relating to banking and
currency. The commission shall have the
power, through subcommittee or otherwise,
to examine witnesses and to make such
investigations and examinations, in this or
other countries, of the subjects committed
to their charge as they shall deem neces­
Within a short time after the passage
of the law, the National Monetary
Commission was organized with Sena­
tor Nelson W. Aldrich, of Rhode
Island, as chairman and Congressman
E. B. Vreeland, of New York, as
vice-chairman. The Commission was a
purely political body. The law re­
stricted membership to senators and
representatives in Congress. All sec­
tions of the country, including sixteen
different states, were represented in its
original composition. The members
could hardly be regarded as experts or
even students of banking and currency
problems and only a few of them had
had any legislative experience with
such questions. The Commission was,
therefore, forced to depend in large
measure on outside help in making its
inquiry and preparing its recommenda­
tions. Almost from the beginning, the
work of the Commission was person­
ally directed by Senator Aldrich and
was continued for a period of more
than three years with some consider­
able intervals of inactivity.
In order to make the inquiry re­
quired by the law and bring together
the information that would be needed
in formulating legislative proposals,
the Commission employed a number of
prominent economists, financial edi­
tors, bankers and government officials
in the United States and foreign coun­
tries to prepare monographs, papers
and reports on the actual operations
of banks and on their separate functions
and mutual relations. Members of the
Commission visited the leading coun­

A m er ic a n A cadem y

tries of Europe whose economic con­
ditions were most nearly like our own,
and appointed representatives to visit
other countries for the purpose of
holding personal interviews with the
officials of leading institutions con­
cerning their banking organization and
their arrangements for dealing with
reserves, note issues, commercial paper
and other banking problems. The
Commission also conducted hearings
and made inquiries in different parts of
the United States and particularly in a
dozen or more of the leading com­
mercial centers of the country for the
purpose of getting the opinions of
people in different localities and occu­
pations on desirable changes in our
banking laws. The discussion of cur­
rency and banking problems in the
meetings of various learned societies
and associations of business men and
bankers were also utilized by the
Commission as a means of securing
expert opinions.
P u b l ic a t io n s o f t h e M o n e t a r y
C o m m is s io n

The results of the studies and in­
vestigations carried on by people
enlisted in the service of the Commis­
sion, and of its own interviews, public
hearings and inquiries, together with
the report and bill submitted to
Congress by the Commission at the
conclusion of its work, have been
issued as public documents in a series
of twenty-three volumes under the
general title of Publications of the
National Monetary Commission. The
material in these volumes covers about
14,000 octavo pages and about 1,200
quarto pages, the latter containing
chiefly statistical matter. Of the total
of over 15,000 pages, about two-thirds,
or more than 9,000 pages, deals with
banking and related problems in
foreign countries. Of the whole mass
of information brought together in the

T h e S t u d ie s

of the

publications only a relatively small
part is entirely new. Some of the
material included is simply a reprint
of previous publications, and a large
part of the matter dealing with
American conditions consists of books,
monographs and reports previously
published but revised and brought up
to date and republished for the uses of
the Commission.
Some of these revisions were, how­
ever, of vital importance to the
completion of the investigation which
the commission had undertaken. This
was especially true of the two mono­
graphs by Dr. David Kinley on “The
Independent Treasury of the United
States and its Relations to the Banks
of the Country” and “The Use of
Credit Instruments in Payments in
the United States.” The study of
Treasury operations left no doubt con­
cerning the need of some new and
efficient machinery for handling the
government’s financial business, while
the investigation of the use of credit
instruments fixed attention on the
tremendously important function of
the deposit currency as a means of
employing bank credit in the trans­
action of the business of the country.
V a l u a b l e C o n t r ib u t io n s

Among the most notable of the new
contributions to the study of American
conditions were the “Seasonal Vari­
ations in the Relative Demand for
Money and Capital in the United
States” by Professor E. W. Kemmerer
and the “History of Crises under the
National Banking System” by Pro­
fessor O. M. W. Sprague. The volume
by Professor Kemmerer is an elaborate
statistical study based on a mass of
financial data, such as statements of
condition of banks, clearing house
returns, movements of money, rates of
exchange, monetary circulation, bond
prices, etc. The study was not con­

M o n e ta r y C o m m ission


fined to the New York money market
alone, but included also the markets of
Chicago, St. Louis, New Orleans and
San Francisco, to the extent that in­
formation was available. While Pro­
fessor Kemmerer’s investigation was
the most complete of any ever made in
this field, it did not result in any
modification of accepted theories of
seasonal and other periodic market
movements but served rather to con­
firm them.
Professor Sprague’s volume of 484
pages on “The History of Crises under
the National Banking System” is an
important contribution to our financial
literature and the most valuable of the
original studies made for the Monetary
Commission. It is a careful, critical
examination of the results of banking
policy and management as developed
under the National Bank Act in all the
periods of crisis from 1873 to 1907.
Professor Sprague describes the nature
of the problems that presented them­
selves from time to time and compares
the success of the methods that were
evolved to meet them. His final judg­
ment is that “it is impossible to escape
the depressing conclusion that the
banking situation in 1907 was handled
less skilfully and boldly than in 1893,
and far less so than in 1873. No new
elements of weakness were disclosed,
but no real effort was made to over­
come difficulties which had been met,
with partial success at least, on former
occasions.” The most important lesson
to be drawn from Professor Sprague’s
study is that banking reform would
prove most certain and successful if
pursued along the line of the means
naturally evolved by our bankers for
meeting their problems.
Such an inference is in accordance
with our best experience. Probably
the most successful banking system we
have had in this country was the
Suffolk system of the New England


T he A nnals

of the

states in the period before the Civil
War. This was a plan of banking
developed by bankers, slightly aided
from time to time in their efforts by
the law, to insure efficiency and safety
in the employment of bank credit on a
basis of circulating notes. If bankers
since the Civil War had been free to
act in accordance with their experi­
ence, and had been reasonably sup­
ported by the law, there is no reason
to suppose that they could not have
developed for the whole country equally
efficient and successful methods of
insuring safety in the use of bank
credit based on deposit currency.
I n v e s t ig a t io n o f F o r e ig n B a n k in g
S ystem s

In the investigation of foreign bank­
ing and currency conditions, much
more attention was given to England,
France and Germany because it was
believed that business conditions in
these countries were more nearly like
our own. Of the 9,000 pages in the
publications devoted to material re­
lating to foreign countries, over 6,500
deal with conditions in these three
countries alone, and of these pages
about 4,500 relate exclusively to Ger­
many. It was the opinion of Senator
Aldrich, as well as of some other mem­
bers of the Commission, that the bank­
ing system of Germany was of more
interest than any other to the people of
the United States because the indus­
trial and commercial interests of the
German Empire were very largely of
the same character as our own. This
German material, like that relating to
the United States, consists largely of
reprints in English translation of books,
reports and papers previously pub­
lished in German. These reprints
include the memorial history of “The
Reichsbank, 1876- 1900,” the “German
Imperial Banking Laws,” the third
German edition of Dr. Jacob Riesser’s

A m er ic a n A cadem y

“The German Great Banks and their
Concentration in Connection with the
Economic Development of Germany,”
almost the entire report and proceed­
ings of the “ German Bank Inquiry
Commission of 1908,” a series of articles
from the Frankfurter Zeitung relating
to “The Renewal of the Reichsbank
Charter” and a series of “Miscel­
laneous Articles on German Banking”
extracted mainly from the proceedings
of the Third German Bankers’ Conven­
tion. But in spite of the large amount
of space given to German material,
the publications of the Commission
contain no general review of German
banking as a whole, an omission which
can only be regarded as a defect in the
work of the Commission since so much
importance was attached to German
conditions and experience.
The information relating to English
and French conditions is much briefer
but also more useful in making a
comparative study of American ex­
perience. The monographs by Hartley
Withers on “The English Banking
System” and by R. H. I. Palgrave on
the “History of the Separation of the
Departments of the Bank of England”
are the best of the publications re­
lating to England. Mr. Withers’
statement is an illuminating account
of the complicated relations of the
Bank of England, the joint-stock and
private banks, and the accepting
houses and discount houses, and the
position of all of them in the market.
The most valuable of the publi­
cations dealing with French conditions
are the “Evolution of Credit and
Banks in France from the Founding
of the Bank of France to the Present
Time” by Andre Liesse and “The
Bank of France in its Relation to
National and International Credit.”
Some of the best information con­
cerning the operation of the foreign
banking systems, and particularly those

T h e S t u d ie s

of the

of England, France and Germany,
is to be found in the reports of the
interviews held in the summer of 1908,
The replies to questions put to bank
officials in these interviews, with re­
spect both to what they said and
what they left unsaid, often throw
more light on some aspects of the
actual working of the foreign systems
than anything else published by the
Commission. But the information
contained in these reports is not so
accessible because no attempt was
made to analyze and digest it in a
systematic manner.
D is c l o s u r e s a s t h e R e s u l t o f
C o n t r a s t in g B a n k in g S y s t e m s

The things which this extended
study of foreign banking conditions
emphasizes in contrast with American
conditions are:
1. The existence in each country of a
central institution, more or less closely
related to the government of the
country, which serves not only as a
government bank but also as a bank­
er’s bank and as a bank for the public.
2. The centralization and control
of note issue by means of these insti­
3 . The high degree of centralization
in general administration and manage­
ment of reserves in all countries.
The publication of this mass of
material relating to foreign banking
was one of the most useful services
that the National Monetary Com­
mission performed. It made avail­
able for our political leaders, banking
and financial journalists and the gen­
eral public, a vast fund of information
on banking organization and operation
in foreign countries which was formerly
known only to expert students of the
It is not easy to estimate the in­
fluence which the studies carried on
under the direction of the National

M o n e ta r y C o m m ission


Monetary Commission had in shaping
its conclusions concerning the defects
of our banking system and in devising
the necessary measures of reform
which were finally submitted to Con­
gress in the form of a report and a bill
at the beginning of 1912, three and
one-half years after the initiation of the
Commission’s work. A large portion
of the publications of the Commission
were issued in 1910 before anything
definite was known of the plan of
reform to be recommended. In Janu­
ary, 1911, Senator Aldrich personally
gave out what he described as a
“suggested plan of monetary legisla­
In substance this plan was an
elaborate central bank scheme to be
owned and controlled by the banks of
the country with due representation of
the government on its official board.
This suggested plan does not seem to
have been the product of any delibera­
tions of the National Monetary Com­
mission itself, based on the results of
the scientific inquiry it had been
conducting. No formal meetings of
the Commission as an official body were
held before the fall of 1911 when a
resolution calling for a report from the
National Monetary Commission on
January 8, following, was introduced in
Congress by Senator Cummins of
Iowa and adopted.
Although due allowance must ]be
made for the influence of American
opinion and European experience, the
suggested plan was probably the work
of Senator Aldrich, aided by the advice
of a few experienced men, ajnong
whom Mr. Paul M. Warburg, the
New York banker, is commonly re­
puted to have played an influential
part. The proposals made in this plan,
which soon came to be spoken of as the
Aldrich Plan, were fully discussed for
several months in meetings of bankers
and business men and in economic,


T he A nnals

op the

banking and financial periodicals and
newspapers. In October, 1911, the
plan was revised and redrafted in the
form of a bill and included in the
report submitted to Congress on Jan­
uary 8, 1912, as the recommendation
of the National Monetary Commission.
D e f e c t s i n t h e U n it e d S t a t e s
B a n k in g S y st e m

The defects in our banking system
which are elaborately summarized in
the report of the Commission may, for
the purposes of this paper, be briefly
recapitulated as follows:
1. The existing banking system pro­
vides no effective means for coopera­
tion by banks in crises.
2. It admits of no concentration of
the banking reserves of the country for
use in times of stringency or unusual
3 . The banknote circulation fails to
respond, through automatic expansion
and contraction, to changing needs of
4 . The existing system provides no
effective agency for facilitating ex­
changes and transfers of funds between
different localities and sections of the
5 . It affords no means of properly
regulating the foreign exchanges and
controlling the international flow of
6. Interior communities do not have
the benefits of ready access to the
central money markets.
7. Existing arrangements lead to
the congestion of banking resources in
large financial centers stimulating spec­
ulation when they are accumulating
and unsettling the market when they
are withdrawn.
8. The accumulation of government
funds in other institutions than the
banks results in constant disturbance
of bank reserves and further unsettling
of the market.

A m er ic a n A cadem y

To rectify these evils, the bill recom­
mended by the Commission proposed
to incorporate the National Reserve
Association of the United States, with
a capital of $100,000,000 to be sub­
scribed voluntarily by national banks,
and also by state banks and trust
companies under certain conditions.
Subscribing banks in contiguous ter­
ritory were to be grouped in local
associations, while these local associa­
tions were to be combined into fifteen
district associations covering the en­
tire territory of the United States and
serving as branches of the National
Association. The central association
thus organized was to have authority:
1. To take over the note issuing
function of the national banks, basing
such note issues ultimately on legal
money and first class commercial
paper instead of bonds, and further, to
have the privilege of issuing additional
notes, having the same security, on
payment of a graduated tax thereon.
2. To rediscount for national banks
first class commercial paper maturing
in short periods of time.
3 . To transfer funds for national
banks between the central association
and the branches, and between the
4 . To receive and hold deposits of
subscribing banks and the government,
but no private deposits.
To insure safety in reserve manage­
ment the National Association was
required to hold a cash reserve equal to
fifty per cent of its demand liabilities.
It was also provided that the associa­
tion should serve as a depository for
public funds and as the fiscal agent of
the Federal government. No changes
were made in the reserve requirements
of national banks except that they
could count the notes of the central
association as well as their deposits
with it as reserves.
Probably no economic measure ever

T h e S t u d ie s

of the

M o n e ta r y C o m m issio n

brought before the Congress of the
United States received at the hands of
political leaders, students of banking
and currency problems, and the general
public, such comprehensive study and
thorough discussion as this one, but in
spite of the great amount of time and
labor spent on it and the heavy ex­
pense incurred, it had no direct
consequences whatever in the way of
constructive legislation.
P o l it ic a l C h a n g e a n d t h e A l d r ic h
P lan

By the beginning of 1912 the politi­
cal situation had completely changed
and the recommendations of the Mone­
tary Commission were never brought
up in Congress for consideration.
Many of the men who had been mem­
bers of the Commission when it was
organized had either retired from
public life or had been retired in the
elections of 1910. During the dis­
cussion of Senator Aldrich’s suggested
plan, which preceded the formal sub­
mission of the Commission’s findings
and recommendations, much oppo­
sition of a general character developed
against it, not apparently because of
any lack of confidence in the soundness
of the measures proposed, but because
of a general distrust of the men who
were primarily responsible for it,
particularly of Senator Aldrich who, as
chairman, had controlled and directed
all the activities of the Commission.
Whether or not it was warranted, there
was a widespread belief in the country
that Senator Aldrich was too close to
some of the great business interests
whose purposes, it was believed, were
not always in harmony with the
highest public welfare. In view of this
attitude of the public it was not un­
natural that the new party leaders in
Congress should decline to look for
guidance in the work and findings of
the National Monetary Commission.

T h e R e se r v e A ct a n d t h e
M o n e t a r y C o m m is s io n ’ s W o r k


The extent to which the framers of
the Federal Reserve Act drew upon the
work of the National Monetary Com­
mission has been a matter of some
interest. At the time the Act was
under discussion many people regarded
it as nothing but a copy in large part of
the Aldrich Plan, but there were no
substantial grounds for such a claim,
although the two projects were similar
in many of their fundamental provi­
sions. In describing the legislative
history of the Federal Reserve Act
some months after its passage, Dr. H.
Parker Willis, who was the expert of
the House Banking Currency Com­
mittee while the bill was being drafted,
makes the following statement con­
cerning its origin:1
The Federal Reserve Act is the product
of a lengthy course of development and has
grown gradually out of the discussion and
analysis of the past twenty years. It is not
drawn, even largely, from any single
source, but is the product of comparisons,
selection and refinement upon the various
materials, ideas and data, rendered avail­
able throughout a long course of study and
agitation. Many bills embodying the same
general line of thought that now finds
expression in the new act have been
offered in Congress.
All of this might be said also, with
equal truth, of the Aldrich Plan itself.
Certain it is, that the fundamental
principles underlying the essential pro­
visions of both measures were well
established in European and American
banking theory.
The investigations of the National
Monetary Commission were limited to
the field of banking and bank currency
although the scope of the instructions
given the Commission by the law
would have permitted a wider range
1American Economic Review, Vol. IV, p. 18.


T he A nnals

of the

of activities. Many students thought
at the time that it was a good oppor­
tunity to amend some of the other
serious defects in our monetary sys­
tem. Since the beginning of the Civil
War, our money had become the most
heterogeneous and complex of any in
use by the great nations of the world.
Besides the gold basis, it included
several different types of fiduciary
money in large amounts with compli­
cated machinery for maintaining them
at a parity with the standard. A
general reform of our banking system
and bank currency was regarded by
many as furnishing the best oppor­
tunity to secure a final solution of the
greenback and silver questions, but
the National Monetary Commission
avoided these issues as did also the
framers of the Federal Reserve Act.
C u r r e n c y C o m p l e x it ie s P e r s is t

Today, it is a serious question
whether or not the addition of the
Federal Reserve notes to our monetary
circulation, without any material
change in the amount of national bank
notes or the other forms of fiduciary
money in use, has not increased the
complexity and difficulties of our mone­
tary system without improving its
efficiency as an instrument of economic
Between 1913 and 1920 the United
States passed through a period of in­
flation that exceeded in its extent
anything in our previous history.
Some of this was due to our large
acquisitions of new gold, but far more
of it was due to the release of gold
from bank reserves, made possible by
the issue of Federal Reserve notes
when the reserve requirements under
the Federal Reserve Act were changed
to their present form by the amend­
ment of June, 1917. After this change
in the law, expressions of gratification
over the great economy of money that

A m er ic a n A cadem y

would be effected thereby were very
common. But it is a strange economy
of money that results in inflation!
When the history of some of the pro­
visions of the Federal Reserve Act and
its amendments comes to be written,
the judgment will be that they were
inflationist legislation and that their
enactment added still others to a long
list of monetary errors into which the
country has fallen.
S om e U n lea r n ed L esso n s

While the National Monetary Com­
mission devoted a large amount of
attention to the organization and
working of the foreign banking sys­
tems, it neglected some aspects of those
systems, a better understanding of
which might have led to a clearer
conception of the true defects of our
own systems and of the best means of
correcting them. Perhaps the most
significant feature of the great foreign
systems, according to the studies of
the Commission, is the high degree of
centralization that exists in control
and management. But while the in­
fluence of the great central institutions
in securing this centralization is
strongly emphasized, no emphasis is
laid on the effect of extreme con­
centration in foreign banking due to the
widely extended system of branches.
A relatively few great companies or
corporations, including the central
banks, control the business of banking
in England, France and Germany.
This control is exercised from central
offices, usually located in the financial
center of the country. This is an
important, distinguishing feature of
European banking as compared with
our own.
In the United States much praise
has been conferred on the Canadian
banking system, but the chief differ­
ence between it and our own lies in the
fact that Canada has relatively few

T h e S t u d ie s

of the

M o n eta r y C o m m issio n

banking corporations with many
branches widely scattered. Between
1900 and 1912 about 15,000 new banks
were organized in the Unites States.
This meant 15,000 new boards of
directors and probably as many new
conceptions of what constitutes sound
bank policy and management. The
existence of our vast number of in­
dependent institutions needs only to be
mentioned to make it clear that no
scheme of cooperation among banks
yet devised in this country will give
the degree of centralization in control
and management that has been at­
tained under the foreign branch sys­
S u c c e s s f u l B a n k i n g P r im a r il y a
Q u e s t io n o f A d m in is t r a t io n

Another aspect of this subject is also
of vital importance. If there is any
one lesson that the study of European
experience enforces, it is that success­
ful banking is more a question of
administration than of law. As Hart­
ley Withers says, “ Good banking is
produced, not by good laws, b b y
good bankers.” An important con­
sequence of the extreme concentration
in foreign banking is that it brings the
best banking talent into positions of
responsibility and control. No doubt
our best bankers are the equals of the
best European bankers but our type
of banking does not bring them into
positions where they can exercise
complete control over the banking
business of the country.
The apparent control of the flow of
credit in the leading European coun­
tries through the manipulation of the
discount rates of the central banks, is
another feature of foreign banking
which has always been in sharp con­
trast with our own practice and which
we have tried to imitate in our banking
reform. The studies of the Monetary
Commission furnish no satisfactory


explanation of the true nature of this
control and how it is exercised. The
impression is often gained that the
bank rate determines the market rate,
but it would probably be just as true to
say that the market rate determines
the bank rate. When Lord Avebury,
partner of Robarts, Lubbock and
Company, was asked concerning the
extent to which the bank rate governed
their loan and discount transactions,
he replied, “The bank rate generally is
an expression of the market rate.”
The truth is that the market rate is a
competitive rate in the determination
of which the competition, actual or
potential, of the Bank of England with
the other banks is always a factor.
I n f l u e n c e o f B a n k i n g C o m p e t it io n

The influence of competition is more
clearly seen in the operation of the
French system than in that of England.
In replying to a direct question con­
cerning the competition of the Bank
of France with the other banks, M.
Pallain, the governor of the Bank of
France, said, “On certain points there
may be competition, and it is on
account of this salutary competition
that wherever a branch of the Bank
has been established the rate of dis­
count has been perceptibly reduced, in
the interest of commerce.”
The fact is that the control of the flow
of credit in these countries is a competi­
tive one. The central banks are not
only bankers’ banks and government
banks; they are also public banks and
compete with the other great central­
ized institutions for a share of the
banking business of the country. Their
relations to their governments, their
prestige, and the fact that their
managers think not only of profits but
of the national economic welfare,
places them in a strong competitive
position and enables them to exercise

T h e A n n a l s of t h e A m er ic a n A cadem y
an influence much out of proportion to explanation is that the Federal Re­
the amount of business they do.
serve Banks are banks for banks and
There has been much discussion banks for government and not, at
recently of the discount policy of the the same time, public banks in the
Federal Reserve Board and the control true sense of the word. They cannot
of the flow of credit under the Federal exert the competitive influence against
Reserve System. The charges of the other banks that the foreign cen­
banks to their customers have not been tral banks exert. They are not in fact
materially affected by the manipula­ in the market and cannot, in conse­
tion of the rediscount rates. The quence, share in market control.

The National Citizens’ League

A Movement for a Sound Banking System


H a r r y A . W h e e le r

Vice-President, Union Trust Company of Chicago

S a result of the panic of 1907 the and other legitimate interests of the
business men of the country be­ country;
came greatly concerned for the com­ Fourth—Said system to be absolutely
mercial safety of the future. At the free from domination or control by political
any other favored
annual meeting of the National Board orResolved, That theinterests; Board of
of Trade, held in Washington on Jan­ Trade calls upon all itsNational bodies
uary 25,26 and 27, 1910, the subject of to carefully study the fundamental princi­
monetary reform was discussed and the ples of banking and currency, in order to
following resolutions were unanimously intelligently aid the enactment of such
legislation as will best conserve the in­
terests of the entire country.
Whereas, We assume that a plan for the
revision of our currency system will be The National Board of Trade deter­
formulated after the National Monetary mined to devote one day in connection
Commission has made its final report; and with its annual meeting in 1911 a
Whereas, A revision of our currency Business Men’s Monetary
system upon a permanently sound and January 18 was set aside as Conference.
scientific basis is of vital importance to all Day.” Two hundred selected com­
interests and should be accomplished as mercial bodies were to appoint special
soon as practicable;
Resolved, That the National Board of committees to make a careful study of
Trade favors the adoption of a currency the banking question. Each organiza­
system which will be based upon the fol­ tion was requested to submit its
lowing fundamental principles and insure conclusions and recommendations to
the following results:
the National Board of Trade at least
First—Be absolutely fair to all interests one month before the meeting and to
and to all localities;
send representative to the meeting,
Second—Insure at all times an adequate to bea held in Washington beginning
supply of properly safeguarded currency; January 17, 1911. The invitation met
Third—The volume of said currency to
automatically expand and contract in with a hearty response on the part of
response to the normal demands of the the commercial organizations through­
manufacturing, commercial, agricultural, out the country and a large number

T h e N a tio n a l C it iz e n s ’ L e a g u e

of delegates participated in the con­
The Business Men’s Monetary Con­
ference, under the chairmanship of
C. Stuart Patterson of Philadelphia,
adopted resolutions which ultimately
led to the creation of the National
Citizens’League. By these resolutions,
the chairman of the Conference was
authorized to appoint a committee of
seven to organize a “Business Men’s
Monetary Reform League,” with head­
quarters in Chicago and branches in
the principal centers of the country,
whose object should be to conduct a
comprehensive compaign of education
in behalf of some kind of national
reserve association. It was agreed
that the delegates to the Conference
should endeavor to enlist the active
aid of the commercial bodies they
Acting on the authority of these
resolutions, a committee was appointed
composed of: C. Stuart Patterson, of
Philadelphia, James J. Storrow, of
Boston, Paul M. Warburg, of New
York, Irving T. Bush, of New York,
George D. Markham, of St. Louis,
Fred W. Upham, of Chicago and
Harry A. Wheeler, of Chicago. This
committee was called into conference
in Chicago on April 2 4 , 1911. The
committee was unanimous in its opin­
ion that the responsibility of creating a
national organization should be left
with the business men of Chicago, who
should conduct a nation-wide cam­
paign from their city.
On April 2 7 , 1911, a conference was
called by the committee at which were
present about fifty of Chicago’s fore­
most business men, representing both
the commercial and the financial field.
This conference, after careful delibera­
tion, agreed to accept as a duty and
privilege the responsibility of conduct­
ing the campaign from Chicago as a


The new movement was initiated by
the Chicago Association of Commerce.
A joint meeting of the Board of Direc­
tors and the Executive Committee of
the Association was held on May 2 9 ,
and took action by passing the follow­
ing resolution:
Resolved, That the Chicago Association of
Commerce recognizing the distressing ef­
fects of panics on trade, capital, and labor,
the consequent need of a sound banking
system in the interest of all the people in
the country, and the suggestion made for
the creation of a National Reserve Associa­
tion, hereby requests John G. Shedd,
Marvin Hughitt, Graham Taylor, Harry A.
Wheeler, B. E. Sunny, Cyrus H. McCor­
mick, Julius Rosenwald, Charles H. Wacker,
Frederic A. Delano, John Barton Payne,
A. C. Bartlett, A. A. Sprague, J. Laurence
Laughlin, John V. Farwell, Clyde M. Carr,
Fred W. Upham, F. H. Armstrong, and
Joseph Basch to form a National Citizens’
League, the object of which shall be to give
organized expression to the growing public
sentiment in favor of, and to aid in, securing
legislation necessary to insure an improved
banking system for the United States of
Acting under this authority, “The
National Citizens’ League for the Pro­
motion of a Sound Banking System”
was organized and a certificate of in­
corporation was granted by the Secre­
tary of State under date of June 6,
1911. Article 2 of the certificate of
incorporation is as follows: “The
object for which it is formed is to give
organized expression to the growing
public sentiment in favor of, and to
carry on a campaign of education for
an improved banking system for the
United States of America.” In organ­
ization and in operation the Citizens’
League was at once made national.
The Chicago Association of Com­
merce only accepted a responsibility
imposed upon it by the other com­
mercial bodies of the nation to take the
initiative in the conduct of a campaign


T he Annals

of t h e

to which their support had been
pledged. The only part taken by the
Chicago Association, as such, was to
launch the new League. This done,
it surrendered all control into the
hands of the Board of Directors of the
In April, 1913, pursuant to a call
from the President of the United
States and his Secretary of Commerce,
the Chamber of Commerce of the
United States was organized. It
became the sucessor to the National
Board of Trade and, recognizing its
relation to the subject of monetary
reform, established a close contact
with the Citizens’ League.
The first Annual Meeting of the
Chamber of Commerce of the United
States, in January, 1913, dealt with
the problem as of first importance to
the new incoming administration and
instructed its Board of Directors to
present the matter to the President­
elect. In February, 1913, the direc­
tors carried into effect the mandate of
the Annual Meeting by the following
The Chamber of Commerce of the
United States of America believes the
present moment to be one of grave import
to banking and currency legislation. The
country has been profoundly stirred by the
discussions of the past two years. The
defects of our present system are generally
understood to constitute a menace, both to
our domestic and to our international
trade. The business men of the country
should not again be exposed to the rigors of
another such stringency as followed the
large crop of 1912. The expected changes
in our tariffs and the financing of another
crop in 1913 make imperative immediate
action by Congress. Moreover, it is ap­
parent that the presentation of a sound
measure to Congress would crystallize
behind it the support of the business and
banking interests of the country.
Therefore be it Resolved, That the Board
of Directors of the Chamber of Commerce

A m er ic a n A cadem y

of the United States of America, acting
under instructions unanimously voted by
the convention of January twenty-first to
twenty-third, 1913, urge upon the Banking
and Currency Committee of the House of
Representatives the early submission to
Congress in extra session of a measure
which will overcome the difficulties from
which we are suffering; upon the Senate,
its prompt consideration of such measure
at the extra session; and upon President­
elect Wilson, his cordial and earnest
support in favor of early and complete
And be it further Resolved, That a copy of
this memorial be sent to President-elect
Wilson and to Honorable Carter Glass, of
the Banking and Currency Committee of
the House of Representatives.
A standing Committee on Currency
and Banking was also appointed to
press upon the Administration the
necessity for early action, to follow
legislative development, and to prepare
a report for subsequent submission to
the membership through referendum,
as provided in the rules.
This committee was composed of
Wallace D. Simmons, St. Louis, Chair­
man, John W. Craddock, Lynchburg,
Virginia, Irving T. Bush, New York
City, Edmund D. Fisher, New York
City, Edward D. Page, Oakland, New
Jersey, Joseph French Johnson, New
York City, J. Laurence Laughlin,
Chicago, George A. Mahan, Hannibal,
Missouri, William A. Scott, Madison,
Wisconsin, William George Bruce,
Milwaukee, Wisconsin, J. M. Miller,
Jr., Richmond, Virginia, Allen Cucullu,
Lynchburg, Virginia, John V. Farwell,
Chicago, Edmund D. Hulbert, Chicago.
It completed its preliminary work in
August, 1913, and sent to referendum
a report on pending legislation with
recommendations for amendment in
keeping with the principles put for­
ward by the National Citizens’
The League, having completed the

E d u c a tio n a l C a m pa ig n

work for which it was organized,
formally requested the Chamber of
Commerce of the United States to
pursue the subject through its legis­

fo r

B a n k in g R eform


lative stages and disbanded; the
Chamber, through its Committee, fol­
lowed the matter closely until its
“Federal Reserve Act” became a law.

The Educational Campaign for Banking Reform

By A. D. W e l t o n


Continental and Commercial National Bank, Chicago

RGANIZING the National Citi­ time a central bank or the central­
zens League in 1911 was no less ization of banking power was men­
tioned. The traditions of the Demo­
a task than organizing the country.
It was the final step, outside of cratic party stood as strongly in this
political declaration and legislative respect as when Andrew Jackson and
action, to bring about a demand for Nicholas Biddle fought over the Sec­
the reform of the nation’s banking ond Bank of the United States eighty
laws. The havoc of the last panic years before. The mention of asset
had been wrought. Emergency legis­ currency roused the smoldering fires
lation in the form of the Aldrich- of greenbackism and free silverism.
Vreeland Act was on the Statute It was plain that many people cher­
Books. The Monetary Commission ished the belief that issuing currency
had junketed, experted and ruminated was a sovereign power of the govern­
and Senator Aldrich was working on a ment, and Mr. Bryan was present to
insist that such was the case.
reform proposal.
From these statements it might be Every time the question of currency
gathered that public sentiment had had come up for popular considera­
at least begun to crystallize; that the tion in the three preceding decades,
subject of all this discussion and effort the believers in soundness as wrought
was nearing the point of issue and by a single gold standard had been on
action. Nothing was farther from the defensive. They merely prevented
the truth. There was no popular their enemy from doing something
comprehension of what it was all about. vicious. The one constructive bit of
Panic meant only a lack of currency. legislation was the Gold Standard
Newspaper writers were miles at sea. Act of 1898. That followed the affair
Politicians were floundering in dark­ of 1896 as the Aldrich-Vreeland Act
ness. Practical bankers were looking and the appointment of the Monetary
to their few leaders for guidance. Commission followed the panic of
The economists, however clear their 1907.
theories, were blinded by traditions,
E d u c a t io n a F o r m id a b l e
and precedents of long standing.
U n d e r t a k in g
There was a dominant desire for a
change but any suggestion of a All the studies of the Commission
practical plan raised a clamor of pointed to the necessity of a plan for
hostility to centralization, the great banking cooperation, for mobilizing
reserves, for making both currency
political bugaboo.
The persistence of political rancor and credit elastic, and for creating a
found a new demonstration every discount market. It was a formidable


T he A nnals

of the

enough undertaking to make any
considerable portion of the people
understand these things. It was a
much larger one to make a consider­
able portion of them unlearn the
financial follies they had been taught.
For this undertaking the teachers
were not many. It was necessary to
train teachers. The bankers were of
little assistance in this way. Very
few of them understood the science
of banking, however versed they
might be in the art of it; fewer
still were competent to teach the
economics of money. Moreover, the
bankers were under suspicion. Had
they not defeated Mr. Bryan in 1896
and subsequently and also subse­
quently? Mr. Bryan had frequently
testified to that fact.
Finally, Senator Nelson W. Al­
drich was Chairman of the Monetary
Commission. For years he had been
in a conspicuous position of leader­
ship. His name was synonymous with
everything abhorrent to progressive
thought. In the public mind he was
first friend of the trusts, advocate of
special privilege, the defender of Wall
Street and ally of the money devil.
Politically, it made no difference that
the Senator from Rhode Island had
worked hard for years to equip himself
for the task now on hand. It was of no
moment that his great ambition was
to give the United States a sound
banking system or that his devotion
was complete and unselfish. He was
a popular target for editorial anath­
emas and anything emanating from
him must be bad because of its origin.
In June, 1911, approval of a plan
for a new banking system meant
approval of Aldrich. The National
Citizens’ League came into existence
under a handicap.
The “Money Trust” was an active
monster of that day also. It was an
indefinite something which could be

A m er ic a n A cadem y

charged with all kinds of crimes and
would plead to no indictment. There
were two “money trusts” in fact—one
that the politicians created out of
their vivid imaginations for their
own private uses, and another, de­
fined as a “community of interest”
among powerful bankers, created by a
defective and inadequate banking sys­
tem. The imagined “Money Trust,”
linked with a plan to reform the
banking and monetary system, became
much more imposing as a political
spectre. Such a “Money Trust” must
necessarily have impious designs, and
what more natural than it should seek
to have the banking laws remodeled
to fit its own purposes!
Here was another barrier the League
had to take.
P o l it ic a l a n d P a r t i s a n
C o m p l e x it ie s

Another circumstance lets in light
on the difficulties that lay before this
economic missionary. Republicans had
passed the Aldrich-Vreeland law and
planned the work of the Monetary Com­
mission. Republicans had planned
to drive through a new banking act.
But a new Congress had been elected
with a Democratic House. There
were even predictions that the next
president would be a Democrat. Wis­
dom forbade that the League have
even a remote appearance of parti­
sanship. As a matter of fact the
manner of its organization made
partisanship impossible but it was
frequently charged in the first months
that this was “the million dollar or­
ganization formed to put over the
Aldrich banking scheme.”
It is unnecessary to go farther into
the conditions of the day to show
that the League had a large task and
that it would have to justify itself by
performance if it was to survive and

E d u c a tio n a l C a m pa ig n
E a r l y I n v e n t o r y o f t h e L e a g u e ’s
W ork

fo r

B a n k in g R eform


particular scheme of reform. It deals in
concrete plans only by way of illustrat­
ing the great general problems of efficiency
of bank reserves, a discount market, in­
dependent banking, an elastic currency and
credit system and adequate banking facili­
ties. Its belief is that when the people come
to have an understanding of the fundamen­
tal requisites of an efficient monetary and
banking system the legislation will take
care of itself. With the fundaments
understood, as they will be, the working out
of the details may be left to Congress.
How the application is made, or what the
system is called are matters impor­
tance. Who frames the measure finally
adopted or after whom it is named, are
equally inconsequential.

It succeeded so well that in March,
1912, it took account of itself as
The campaign for banking reform has
been carried into 44 states. The National
Citizens’ League has now46 organizations—
one in each of 43 states, two in California,
and the German section with headquarters
in New York City. The extension of this
organization work reflects the progress of
the sentiment for an improved monetary
and credit system.
The League came into corporate ex­
istence in June, 1911. It is a non-partisan
organization. It has no affiliations with
any class or any interest. Among the
R e c r u it in g t h e F o r c e o f
1,500 officers of its branches and its
E ducators
increasing thousands of members, men
engaged in manufacturing, merchandising It is not surprising that an organi­
and agricultural business are in the great
majority. The business element is pre­ zation so elaborately born should
ponderant. The League and its campaign have a name as elaborate. Almost
have been indorsed by resolutions adopted the first error was in this selection.
by 68 boards of trade and associations of The National Citizens’ League for the
commerce and similar organizations.
Promotion of a Sound Banking System
There is reason for this preponderance was the cumbersome heritage of the
of business men. The League had its men
origin at a meeting of the National Board givingwho later assumed the workthe
the scheme publicity. As
of Trade in Washington. The business economists—the professors
organizations represented there felt that economy—were about the of political
only ones
they should have a voice in the question
of improving anything of such vital who could write on questions of
interest to them as the monetary system. banking, they were drafted early.
C. Stuart Patterson, of Philadelphia, The work of creating organizations in
was made chairman of a committee the various states was speedily got
appointed at that meeting which later under way. Pamphlets on pertinent
conferred with the Chicago Business subjects were produced and printed.
Men’s Monetary Reform League.
The Chicago Association of Commerce recruited. mostly economists—were
A declaration the prin­
volunteered to launch the new organization ciples the League indorsedofwas made.
and requested the present Chicago Execu­
tive Committee to undertake the work. Large sums of money were spent.
Thus the National Citizens’ League came Later, and not much later, the diffi­
culty that always confronts such
into existence.
The astonihisng feature of the progress organizations, was encountered. It was
of the League is that it has met prac­ necessary to expend time and energy
tically no opposition. This is undoubt­ in raising funds to support the work.
edly due to the fact that its work has been The publicity work was conven­
wholly educative. It has indorsed no tionally organized. Pamphlets, whose
1Banking Reform Magazine, March 16, 1912. distribution called for mailing lists,


T he A nnals

of the

were a matter of course. Member­
ship in the League at $1 a year carried
with it all published matter and an obli­
gation to spread the gospel.
The state and local organizations,
in some cases self-supporting but always
with a paid secretary, supplied names
for the mailing lists and often did the
distributing. |The entire list of League
officers and directors would make a
business blue book. Local secretaries
were chosen, so far as possible, be­
cause of some familiarity with pub­
licity methods. There was no rule.
In some states publicity was the only
medium used. In others, dependence
was placed on meetings and speakers.
In still others, local business organi­
zations were enlisted. This was all
ordered by expediency or the desires
or peculiarities of the local officials.
The undertaking of the central
office in Chicago was to guide the
thought of every member of the
League, every officer of each state
organization. As loosely joined as
the organization was, a single policy
and harmony of purpose were indis­
The marvelous and general lack of
familiarity of the general run of
bankers and business men with mone­
tary problems was of great assistance.
They had to take what was given
them because they had practically no
other sources of information. The
old sources of monetary information
were dried up. Previous demands
for monetary reform were directed at
the currency and the quantity of it.
Financial progress in terms of elastic
credit and bank reserves was unprec­
edented and, considered by itself,
strikingly logical.
This is not to say that the old
“isms” did not outcrop at frequent
intervals and in unexpected places.
The local secretaries watched care­
fully for such outbursts and they

A m er ic a n A cadem y

were carefully met and countered.
Some of these were temporarily seri­
ous but usually they were ludicrous.
All were treated alike. If the op­
ponent of banking reform or the
advocate of something unsound found
space for his outpouring in a newspaper,
the same newspaper was supplied
with other material, often through a
local League representative. If the
first newspaper refused publicity, the
rival paper was tried. If both ,were
recalcitrant a local mailing list was
compiled and used.
M o n t h l y M a g a z in e s t h e G r e a t e s t
P u b l ic it y M e d iu m

The League’s monthly publication,
Banking Reform, was used in most
cases. It was the uninvited visitor
to every newspaper office in the
country. It could be, and frequently
was, used to meet some special
opposition, %
When a weekly paper
in an obscure county of California
assaulted the Monetary Commission,
the League, banking reform and every­
one interested in it, a special edition
of Banking Reform was printed and
sent to everyone in the county. It was
When a venerable, retired county
judge in Texas unlimbered a page of
heavy artillery in the county seat
paper on the sacred and sovereign
right of the government to issue money,
the case could not be ignored. The
rhetorical flood was broken up, the
facts extracted and a reply written
and sent to the paper. It was pub­
lished—two-thirds of a column. The
venerable judge countered with an­
other solid page. The reply was
short and pointed. The judge was
unwittingly doing well for the League,
He became interested in the new
proposition. He wrote to headquarters
for pamphlets. A month later he
graciously acknowledged his conver­

E d u c a t io n a l C a m paig n

sion, sent in a dollar and joined the
League. This incident had no repe­
tition. The devotees of greenbacks,
free silver and the “sovereign right
of the government” were, and are,
irreconcilable but they were not trouble­
some for long. Their attack lacked
versatility and mere continuity made
it tiresome.
From the viewpoint of real publicity
the monthly, Banking Reform, was the
mainstay of the publicity campaign.
It was the messenger to the press. It
permitted repetition and reiteration,
which were necessary to give editors
familiarity with what was to them a
new terminology. It was slow and
disheartening work for many months.
Once the fervor of early political contro­
versy had cooled and political economy
was the order, publicity results were
scant. In the central office clippings
were garnered with care and treasured in
the files. One of the first months of
effort brought only seven. The next
month there were none, which was
interpreted to mean that the seven
were accidents or incidents of edi­
torial good nature.
A T i m e W h e n P o l it ic s H e l p e d
Politics again intervened to give a
stimulus. The other side of the League’s
organization was at work. State con­
ventions of the political parties were
ahead. The League’s text book,
Banking Reform, came from the press.
The book was distributed widely to
members, whose number it was in­
strumental in increasing greatly, and
was extensively reviewed. The book
stimulated interest in the magazine
for which the demand also increased.
The clipping agency employed began
to send in bulkier packages. These
could now be read but they were no
longer filed. When the Alabama Dem­
ocratic convention had declared for
“a democratic and non-partisan re­

fo r

B a n k in g R eform


vision of our antiquated banking laws”
and demanded the creation of an
“elastic note and credit system,” the
turn came. The politicians were be­
coming familiar with the terminology.
In the platforms of state conventions
of both parties—and they followed
rapidly—there were phrases and
terms which bespoke familiarity with
the League’s literature. Naturally
these platform utterances were com­
mented on by newspapers everywhere.
The comments were almost univer­
sally favorable. The terminology in
this field began clearly to indicate
familiarity with banking reform.
In June, 1912, came the great
national conventions. Both Demo­
crat and Republican platforms had
planks on the monetary question.
Neither one of them meant anything
in particular. The Republicans called
attention to the party’s historic stand
for a sound currency, and the Demo­
crats smashed away at Wall Street
and the “ Money Trust.” The League’s
publication said that banking re­
form “is a political question only
so far as its solution requires political
attention in the highest sense of the
term. There is no chance that a
Democratic scheme of reform will be
better than a Republican scheme
because it is offered by Democrats,
or that a Republican scheme will
be superior because it is offered by
Republicans. In banking methods
neither party is at an advantage
over the other because banking is not
a matter related to their differing
conceptions of popular government.”
Committed to banking reform and
not to politics or party, the League’s
purpose was to keep, so far as possible,
the question from assuming a partisan
With the political phase formally
entered, however, the publicity cam­
paign became more difficult in one


T he A nnals

of the

aspect and much easier in another.
There was no longer difficulty in
having matter accepted and printed
by all kinds of publications. It was
in constant demand. The problem
was to hold discussion to the essentials.
Clippings now came in huge bundles
and were dumped summarily into
waste baskets. No one had time to
look at them. The venerable judge
from Texas might have flashed his
message in fire on the sky and no
League official would have heeded,
for banking reform had passed from
the stage of a vague request to &
demand for speedy political action.
It was no longer a question of a new
banking law, but what kind of new law.
E n u n c ia t io n o f F u n d a m e n t a l
P r in c ip l e s

In September, 1912, the League
stated the principles it believed should
underlie a banking bill. The statement
gave as the reasons for banking
To prevent the recurrence of money
To provide for seasonal and special
demands for currency and credit.
- To insure more uniform and steady
interest rates throughout the country.
To divorce commercial from invest­
ment banking.
To strengthen our international credit.
To establish higher standards of banking.
It is remarkable, perhaps, in the
light of current discussions that in
1912, Banking Reform said:
The National Citizens’ League believes
that these reforms in our banking and
currency system can be best brought
about by the formation of a cooperative
association of all classes of commercial
banks, with restricted powers, managed
by a board of bankers, Federal officials
and other citizens. The Association
should not be a money-making institution
and all earnings beyond a fixed rate should

A m er ic a n A cadem y

go to the national treasury. This as­
sociation should:
Hold the final banking reserves.
Act as fiscal agent of the government.
Rediscount standardized commercial paper
for banks at published rates of discount uniform
over the country.
Issue circulating notes secured by gold and
commercial paper.
Deal in gold and foreign exchange.
Establish foreign agencies.

It must be remembered that this
statement was made two months
before Woodrow Wilson was elected
president and eight months before
Congress began to debate the Glass
The League’s principles were care­
fully drawn very early in the cam­
paign. They took no account of
partisanship, except to guard against
it, as generally befitted an organization
of business men bent on securing an
economic reform. The principles were:
1. Cooperation, not dominant central­
ization, of all banks by an evolution out
of our clearing-house experiences.
2. Protection of the credit system of the
country from the domination of any group
of financial or political interests.
3. Independence of the individual banks,
national or state, and uniform treatment
in discounts and rates to ail banks, large or
4. Provisions for making liquid the
sound commercial paper of all the banks,
either in the form of credits or bank notes
redeemable in gold or lawful money.
Legalization of acceptances and time bills
of exchange in order to create a discount
market at home and abroad.
5. Elasticity of currency and credit in
times of seasonal demands and stringencies,
with full protection against over-expansion.
6. The organization of better banking
facilities with other countries to aid in the
extension of our foreign trade.
In the beginning, these six prin­
ciples were the guide in all publicity.
Their amplification came when the %

E du c a t io n a l C a m pa ig n

final political stage was reached as
noted above.
The so-called “Money Trust” in­
vestigation was an incident which
received only incidental attention.
In an educational way it had no
significance. What is known as Wall
Street never showed hostility to the
League; it gave much financial as­
sistance and seemed quite uncon­
cerned over the prospect of decen­
tralized bank reserves.
A t t it u d e o f B a n k e r s a n d O t h e r
O r g a n iz a t io n s

Bankers and bankers’ organizations
were always helpful and friendly.
They were never keen for the League’s
principles and, as a rule, they were
collectively and individually more
interested in the probable effects of
any change in laws on their estab­
lished method of operation. In this
respect they often clashed with the
business men whom the League rep­
resented but they always admitted
the need of change in the banking
As the campaign progressed other
forces came in to give assistance and
often to interfere. Usually these or­
ganizations made plans. Of plans
for a new banking system there was a
myriad. They came up from all
sides. Everyone seemed to have a
plan. The League never had one.
In that lay its strength. ?
In September, 1921, Woodrow Wil­
son spoke of the need for a new bank­
ing law in his address accepting the
Democratic nomination for the pres­
idency. Soon after his election, and
that of a Democratic House and
Senate, it became obvious that bank­
ing reform legislation would be a
Democratic action. This political
shift made it advisable to give un­
usual attention to the South because
seniority would place southern Demo­

fo r

B a n k in g R eform


crats in the important positions in
House, Senate and elsewhere.
The new President’s message on
banking reform preceded action in
Congress. That is another story.
During this period of many hearings
by the banking and currency com­
mittees the publicity was continued as
actively as ever. As the League
was concerned only with principles,
and not with administrative forms,
its printed matter gave no heed to the
latter except for informative purposes.
The magazine had naturally become the
dependence of many thousands of
persons for such information. Many
newspapers looked to it for an inter­
pretation of the news developments.
Its influence was wide. Reading of
the news and comment on the pro­
ceedings in Congress made the extent
of this influence clear and certainly
the members of Congress were not
immune to it.
When the Glass bill had passed the
House, it became apparent that the
League’s work was nearly done. It
had undertaken only to lay a founda­
tion for legislative action. It is true
its organization work had been carried
into practically every congressional
district. The gospel of banking re­
form was carried most effectively to
every congressman from his home.
But when the Glass bill had become
the Glass-Owen bill and the Senate
had it under consideration, the League
began to wind up its affairs.
C l o s e o f t h e C a m p a ig n

In the last issue of Banking Reform,
October, 1913, it was said:
The League never undertook to partici­
pate in the actual work of legislation.
Article 2 of the certificate of incorporation
The object for which it is formed is to
give organized expression to the growing
public sentiment in favor of, and to carry

T he A nnals


of the

on a campaign of education for, an im­
proved banking system for the United
States of America.
Of the success of the League’s campaign
there is no doubt. It is evidenced by the
fact that for more than two years the
question of monetary reform has been
growing in the public mind until today it is
the question of paramount political as well
as economic importance. It has occupied
the latter position for many years, but it
was not until the League’s work was well
under way that it was lifted out of classifi­
cation with the impenetrable mysteries to
that of a great, and finally the paramount,
public issue. One Congressman reduced
the situation to terse form when he said,
“No League, no bill.”
The League has distributed literally
millions of pamphlets. It has been the
means of supplying literally millions of
columns of matter to newspapers. It has
supplied speakers for thousands of meet­
ings. But the indirect results of its efforts
have been more momentous. It brought
interest in the question of monetary science
to an acute stage. It challenged every
argument founded on a false conception
of monetary economics. It supplied ma­
terial which made editorial work easier.
It translated technicalities into simple
language. It stimulated thought and dis­
cussion. It freed thousands from the
thraldom of half a century of false teaching.
The fact that the Glass bill is not per­
fectly satisfying is in nowise attributable

A m er ic a n A cadem y

to failure on the League’s part. It has been
stated many times in these columns that
the machinery by whose operation the
principles enunciated were to be given
operation might assume any one of many
forms. The Monetary Commission evolved
one form, the Glass Committee evolved
another. Neither is perfect in anticipated
operation. It is doubtful if any ma­
chinery will be perfect until made over
after practical test. But either plan has
obvious merits and forms a basis on which
can be built up an operating success.
The Executive Committee of the League
feels, therefore, that the work of the organ­
ization has been practically completed and
success has been achieved. It will retain
its corporate entity and maintain its organ­
ization intact against possible contingen­
cies until results are written in the statute
books. But unless the unexpected hap­
pens, the League will rest content that the
question of banking reform and its satis­
factory solution is in the hands of the
national legislature. Over this body it has
no control, and seeks none, as it has had
none anywhere save what was based on
logic and built up on adherence to proved
principles of monetary economics.
As a final testimony of the efficiency
of the League’s campaign, it may be
pertinent to record that the terse
statement, “No League, no bill,”
was made by the Honorable Carter

The Federal Reserve Act in. Congress

By H.

P a r k e r W il l is

Columbia University

been vaguely or errone­
MUCH hasReservethe earlythere is
ously written of
of the Federal
Act and

already a widespread misunderstanding
regarding it. Some part of this mis­
understanding is due to the fact that
much of the work on the Act was done
in committee or in caucus or in private
conference. To review the whole his­

tory of the measure would be a task of
lengthy detail. The following article
is not intended to enter into any such
elaborate review but to set forth in
compact form the chief facts, without
controversial discussion. What it offers
is merely a consecutive outline of the
history of the Federal Reserve Act
during its formation and subsequent

T h e F e d e r a l R e se r v e A ct

discussion in Congress. It will afford,
however, as definite an historical ac­
count as is possible within a very brief
space, of the various stages through
which this measure passed.
I n c e p t io n o f M e a s u r e

The inception of what afterward be­
came the Federal Reserve Act grew out
of the action of the Banking and Cur­
rency Committee of the House of Rep­
resentatives in authorizing, during the
spring of the year 1912, an investiga­
tion into currency and banking con­
ditions. This authorization led to the
organization of the Banking and Cur­
rency Committee in two parts, or
sections—the one entrusted with an
inquiry into what was at the time
known as the “Money Trust” and the
other assigned the duty of studying
and recommending legislation designed
to promote banking and currency re­
form. This second subcommittee was
organized under the chairmanship of
the Honorable Carter Glass, who had
been for several years a member of the
Banking and Currency Committee,
and its first active work was under­
taken at about the opening of April,
1912. At that time this subcommittee
retained technical assistance, and in­
structions were given to make a general
survey of pending banking and cur­
rency legislation, including especially
the proposals of the National Mone­
tary Commission which were embodied
in what had come to be known as the
Aldrich bill.
Such a survey of pending and pro­
posed legislation, both recent and
earlier, was completed and placed in
the hands of the subcommittee during
June of 1912. An informal discussion
of the question of what lines should be
followed, ensued. As a result of this
informal-discussion, it was agreed to
prepare a tentative bill which should
be based essentially upon the past


C o n g r ess


experience of the banks of the country
in organizing clearing house associa­
tions. The conclusion was definitely
reached that a central bank of issue
and deposit was not desirable but that,
instead of this, a district type of organ­
ization, in which the banks of the
country should participate, was to be
preferred. It was further agreed that
such district organizations ought to be
vested with the function of issuing note
currency upon what had come to be
known as the elastic, or “ asset secured”
plan. It was further thought that the
reserves of the country should clearly
be transferred to such organizations
and that large functions of examination
and oversight of the rank and file of
the banks should be provided for.
W o r k o f S u b c o m m it t e e

With these very general principles
definitely laid down as a basis, a bill
was drafted during the summer and
early autumn of 1912, and the sub­
stance of this bill was informally dis­
cussed at meetings of the subcommittee
which occurred during November,
1912. At that time agreement was
reached that further progress in the
development of the proposed bill would
not be possible unless the attitude of
the incoming administration (the Hon­
orable Woodrow Wilson having been
elected President early in November,
1912) could be known. Mr. Glass
accordingly addressed a letter to
President-elect Wilson informing him
generally of what had been done and
asking for his views in the matter.
An early reply was received from the
President-elect in which he expressed
agreement in the thought that a suit­
able banking measure should be devel­
oped at an early date, and a time was
set for consultation with representa­
tives of the subcommittee of the
Banking and Currency Committee.
This date was December 26, 1912, at


T he A nnals

of t h e

which time Mr. Glass visited Princeton
where President-elect Wilson was then
During the conference on the 26th of
December there was laid before Mr.
Wilson the substance of the tentative
bill already drafted and question was
asked as to his opinion regarding the
extent to which the bill should go.
Particularly was the question raised
with him whether the new bill should
provide for an emergency or permanent
type of banking organization; whether
it should provide for local organization
or for a central control of some kind;
whether reserves should be transferred
to the new banking organization and
whether new note issues should be pro­
vided for. Most of these points had
not been considered by the President­
elect except in a very general way. He
expressed himself, however, as desirous
of making the measure a thorough­
going, complete banking and currency
bill, and was positive in his thought
that there should be a central control
organization—although he accepted
the view already developed in the
subcommittee—and that actual bank­
ing should be carried on in districts
and by local organizations acting more
or less independently of one another.
He was ready to support the transfer of
reserves from existing banks to the new
organizations and, in general, granted
his support to the idea of complete
transformation of the existing banking
P u b l ic D is c u s s io n o f L e g is l a t io n

By this time the fact that a bill was
seriously under consideration in the
subcommittee on legislation had be­
come widely known throughout the
country among those who were inter­
ested in securing action from Congress.
It became necessary to consider the
question whether hearings should be
given to those who had arguments to

A m er ic a n A cadem y

present and views to express and
whether it was or was not wise to allow
the contents of the proposed bill to
become known. On both these points
a definite policy was developed as
1 . The question of holding hearings
had been discussed with President­
elect Wilson at Princeton at the meet­
ing already referred to, and he had
favored the holding of hearings. It
was now determined to make the
hearings very inclusive and to send out
letters to representatives of labor, to
manufacturers* associations, to bank­
ers, to economists and to business men.
2. It was further determined to
make public no draft of the proposed
bill but to mature it slowly and care­
fully, especially in view of the fact that
action on it could not be expected until
after the incoming of the new admin­
istration on March 4 , 1913. It was,
however, determined to make known
to persons who had a legitimate inter­
est in the pending measure the prin­
cipal lines of thought on which the
committee was working. Statements
on this subject were made from time to
time to a variety of inquirers, some of
them bankers, some, business men or
representatives of their organizations,
some, legislators. As a result there
was a crop of bills—some published,
others never printed but filed with the
committee—whose authors sought to
put down in writing what they be­
lieved to be a plan similar to that
favored by the subcommittee and
hence presumably likely to become the
official plan of the administration.
There was thus a large crop of
so-called “original bank bills” in Con­
gress. The Aldrich bill was remodeled
by advocates for possible use, free of
many objectionable features, and was
issued as a revised plan by western stu­
dents of banking. Other plans were
developed in the same way and in

T h e F e d e r a l R e se r v e A ct

sundry cases the authors of such plans
continued to take an interest in the
matter after the Federal Reserve Act
became public and as it passed from
stage to stage, eventually correcting
them and bringing them up to date as
the Reserve Act itself was perfected in
the course of its passage through the dif­
ferent legislative processes. Thus there
was at all times during the year 1913 a
considerable array of measures whose
general thought was the same that had
already been developed by the Sub­
committee on Banking and Currency,
although until such time as the Federal
Reserve Act itself became public the
terms of the various bills were, of course,
widely different both from one another
and from those of the Act itself.
During the months of January and
February, 1913, the Banking and Cur­
rency subcommittee held many hear­
ings upon the plan already laid out and
an entirely new redraft of the Federal
Reserve Act was made. This redraft
had been practically completed at the
close of the hearings in February. It
differed from the original act chiefly in
detail, embodying in one consistent
statute the various elements of the plan
which had been submitted to President­
elect Wilson in the preceding Decem­
ber. It included provision for the
transfer of reserves and the issue of
notes, for the refunding of government
bonds as well as a provision for govern­
ment supervision and control of the
Reserve Banks, although such super­
vision and control was shared between
the government itself and the bankers
of the country. This bill also included
aprovisionfor the guaranteeing of bank
deposits, insofar as the assets of the
member banks would permit, and it
also contained an elaborate plan for the
election of directors in Reserve Banks
with the aid of commercial bodies.
After the close of the hearings an­
other redraft was undertaken and was


C o ng ress


completed about the beginning of
March, 1913. This third main draft
contained principally improvements in
language and in technique but dis­
carded the plan of guaranteeing bank
liabilities and also greatly simplified
the method of electing directors.
With the preparation of this plan
and the expiration of the old Congress
on March 4, the work of the subcom­
mittee was completed and the final
draft was once more submitted to
President-elect Wilson at Trenton,
N. J., where he was visited by Mr.
Glass, and the finished work sub­
mitted to him. The President-elect
again gave to the bill in its revised form
a general preliminary approval.
W ork op the Secretary of the
T r easury

Little work was done on the Federal
Reserve Act during the month of
March, 1913, but at the beginning of
April, President Wilson entrusted to
Secretary of the Treasury McAdoo the
duty of reviewing the measure for the
purpose of reporting to him on the
subject. The measure was canvassed
section by section by the Secretary of
the Treasury and a variety of minor
changes were,fumade in it. These
changes related principally to details of
language. Two important changes
were, however, introduced during this
process. The first was the acceptance
of the idea that the notes to be issued
by the new banks should in some way
be passed upon or approved or guar­
anteed by the government, while
modifications in the plan for the re­
funding of government bonds were also
introduced. It was the thought of
Secretary McAdoo that the original
funding provision had been unduly
unfavorable to the government.
Many of the changes in language
proposed in the first instance by repre­
sentatives of the Treasury were after­


T he A nnals

of the

ward cancelled and the original lan­
guage restored when further study of
the draft had convinced the Treasury
representatives that the changes which
they were at first inclined to introduce
had not been well warranted.
One further change of great impor­
tance was introduced during this period
of the bill’s history, although not at
the instance of the Secretary of the
Treasury. This was the provision
calling for par clearance of member
bank obligations. There had been a
doubt in the minds of the subcom­
mittee whether the introduction of this
provision, in addition to the other
extensive elements of the measure,
would be desirable or not, and it was
eventually determined to present the
matter to Secretary of the Treasury
McAdoo in order to get his thought on
the subject.
The “Money Trust” section of the
Banking and Currency Committee had
in the meantime carried on a lengthy
“probe” into banking conditions in
New York and had reported that, in
no small measure, unsatisfactory con­
ditions there were due to faulty clearing
house organization. It had, therefore,
recommended certain legislation de­
signed to control clearing houses.
Secretary McAdoo was of the opinion
that some provision relating to clearing
and intended to give the clearance
power to Federal Reserve Banks would
be desirable as showing that due atten­
tion had been paid to the work of the
“ Money Trust” subcommittee. He
accordingly assented in general terms
to the plan which was placed before
him and which was therefore incor­
porated into the bill.

A m er ic a n A cadem y

dom of the measure, and he, therefore,
proposed and brought to the attention
of representative bankers a plan of his
own under the terms of which the
Treasury would have gone, more or
less extensively, into a banking busi­
ness, with the various subtreasuries as
branches. The appearance of this plan,
fathered by the Secretary of the Treas­
ury, naturally tended to throw grave
doubts upon the prospects of the Fed­
eral Reserve Act. About the end of
May the whole situation was forcefully
brought once more before the atten­
tion of the President for his decision.
Meantime a separate and independ­
ent bill had been developed by Senator
Robert L. Owen of Oklahoma, who had
become Chairman of the Banking and
Currency Committee of the Senate.
President Wilson thus had before him
the McAdoo plan, Senator Owen’s
tentative plan and the draft of the
Federal Reserve Act—as well as, of
course, a multitude of other bills,
drafts and suggestions which had been
filed with him by many citizens. After
very considerable attention the Presi­
dent determined to hold to his original
decision in favor of the Federal Re­
serve Act and accordingly announced
his determination to discard all of the
other suggestions which were then
before him. In so doing, however, he
found it necessary to consult with the
so-called Bryan element in the Cabinet
which had already been generally
advised of the intended scope of the
Federal Reserve Act.
As a result of this consultation two
further definite changes were made in
the bill: the notes to be issued by the
several banks were now definitely made
liabilities of the United States, while
A t t e m p t t o S u b s t i t u t e a n A d m i n ­ it was determined that the Federal
is t r a t io n B il l
Reserve Board should be exclusively
Careful study of the Federal Reserve composed of government appointees
Act as thus drafted, however, led to be named by the President and con­
Secretary McAdoo to doubt the wis­ firmed by the Senate. These changes

T h e F e d e r a l R e se r v e A ct


C o ng ress


(4) Provision of machinery for doing
foreign banking business.
In order to accomplish these purposes
fully it is necessary to (a) repeal certain
portions of existing law; (b) rectify various
conditions in the present national banking
system which are in some cases only indi­
rectly connected with the objects sought;
(c) furnish a new class of institutions for
the performance of some functions which
cannot well be entrusted to existing banks,
or at all events can better be performed by
others and (d) alter the present reserve
system to a very material degree.
The scope of the bill can best be under­
stood by an analytical review of its con­
C haracter of M easu r e
tents, with reference to sections and para­
It will be observed that the first graphs. This is herewith subjoined.
innovation in the terms of the original
B a s is o f P r e s e n t S it u a t io n
measure had come at the instance of
The present banking situation in the
Secretary Bryan during late May, United States rests upon the National Bank
1913. It is interesting, therefore, to
proper as slightly,
know just what the plan was which had Acttime and upon themodified from time
so-called Aldrichbeen completed for introduction into Vreeland Act (Act of May 30, 1908). Of
Congress. Space unfortunately for­ these acts the latter is completely repealed
bids a detailed description. At that (Section 1) on the ground that it has never
time, however, there was prepared for become operative, probably will not be­
the use, and at the request, of the Pres­ come operative except under extreme stress,
ident, a digest stating the chief content and was never satisfactory. The National
and purpose of the bill. This digest, Bank Act itself is modified in numerous
essential particulars
heretofore never published, is an out from time to timewhich will be pointed
in this memorandum.
authentic description of the conclu­
separate measure a general revision of
sions tentatively reached up to that In aadministrative provisions of the Na­
time and shows fairly clearly the nature the Bank Act is also provided.
of the original measure. It is accord­ tional
N e w C l a ss o f B a n k s
ingly subjoined verbatim:
Fundamental to the idea of the bill is the
M em o randum o n S cope a n d E ffec t
creation of a new class of banks (Section 2),
o f H. R .-------- , t o R e o r g a n iz e t h e
to be known as National Reserve Banks.
P r e s e n t B a n k i n g a n d C u r r e n c y The chief points about these banks are as
S y stem .
In H. R .----- prepared for introduction
(1) Number to be twenty with possible
by Representative Glass of Virginia it is increase later as provided. (Section 2.)
intended to furnish a comprehensive meas­ (2) Ownership to be in the hands of the
national banks of the twenty districts in
ure for the attainment of four objects:
(1) Provision of a place for rediscounting which the banks are situated. (Section 2.)
commercial paper of specified types.
(3) Capitalization to be 20 per cent of
(2) Provision of a basis for elastic note the capital of the stockholding banks, one
half paid in and one half subject to call.
issues properly safeguarded.
(3) Refunding of outstanding 2 per cent (Section 2.)
bonds so as not to inflict loss upon present (4) Business to be as follows:
(a) Rediscounting of paper presented by

having been agreed upon, the bill was
introduced into Congress in its existing
form and thus finally worked out.
Shortly afterward a new House bank­
ing and currency committee was ap­
pointed with Mr. Glass as chairman.
The Glass bill—the completed draft of
the Federal Reserve Act—was promptly
referred to the Banking and Currency
Committee as thus organized and the
actual work upon the measure was be­
gun. This work was vigorously under­
taken toward the end of June, 1913.


T he A nnals

of t h e

stockholding banks and by other banks
under specified conditions, provided such
paper grows out of actual agricultural,
commercial or industrial transactions and
does not run more than a specified number
of days. (Section 14.)
(b) Buying and selling government secu­
rities, gold and silverbullion andforeign coin,
foreign exchange. (Sections 16 and 17.)
(c) Government fiscal operations. (Sec­
tion £1.)
I ssu e of N otes
The bill provides for the maintenance of
existing bank notes outstanding so long as
their present issuers want to keep them
out, and also calls for the establishment of
a note issue on a new basis to be put out by
the National Reserve Banks. Provision
is, however, made for retiring the present
National Bank notes at the discretion of
their issuers. This plan comprises the
following points:
(1) Every national bank would be
allowed to continue its note issue exactly
as at present. (Section 26.)
(2) It would not, however, be allowed
to increase the issue beyond the point at
which it stood when the law was passed.
(Section 26.)
(3) No newly organized bank would be
required to purchase government bonds;
hence no new bank would have any note
issues. (Section 26.)
(4) Whenever an existing bank retired
any of its notes and withdrew its bonds it
would lose the right to put out further
issues of notes above the amount to which
its issue was thus reduced. (Section 26.)
(5) National Reserve Banks would be
allowed to issue notes secured in the same
way as their other obligations to an amount
equal to twice the par value of their capital
stock. They would also be allowed to
issue additional notes if they desired, equal
to the amount of notes withdrawn by the
individual banks which might from time to
time surrender their note issue privilege in
part or in whole. (Sections 2 3 and 2 6 .)
D i s p o s a l o f U. S. B o n d s
, Recognizing (a) that the present 2 per
cent bonds were sold to the banks on the
basis of a pledge that they might continue
to be used as a basis for circulation, and

A m er ic a n A cadem y

that therefore the government is morally
bound to maintain their value in a corre­
sponding degree; (b) and that it is desirable
to retire the bonds now held behind bank
notes and put in their place bonds whose
value is sustained solely by their incomepaying power, it is provided that:
(1) Banks now holding the bonds may
offer these bonds for redemption or con­
version into 3 per cent bonds at a rate not
to exceed one tenth of their holdings each
year. (Section 2 6 .) This would mean that
a maximum of about $65,000,000 a year
could theoretically be converted, and the
evidence is that that sum would be ab­
sorbed without difficulty by investors each
(2) At the end of ten years other holders
of bonds would be allowed to convert them
into 3 per cents. (Section 26.)
(3) As a result of these changes the gov­
ernment would be obliged to increase its
interest charge the first year of the new
arrangement by an amount not greater
than one per cent on $65,000,000, or
$650,000, while the second year a like addi­
tion would be made and so on, until at the
end of ten years a possible maximum addi­
tion of $7,300,000 in interest charges would
probably have been assumed.
P r o t e c t io n o f N o t e s

Fully admitting the necessity of an
absolute protection of note issues, the bill
seeks to safeguard those for which it pro­
vides as follows:
(1) National bank notes are safeguarded
at every point by exactly the same elements
of protection which exist to-day, none of
these being diminished in the slightest
(2) Notes issued by National Reserve
Banks are protected by a large gold reserve,
by constant close government supervision,
and by immediate and prompt redemption.
Stringent provisions are made against
counting any of these notes as a part of
bank reserves, thus insuring their speedy
return to the point of origin. (Sections
30, 31, etc.)
(3) All notes are made receivable by the
government and are to be received by every
bank in the system on deposit at par, with­
out exchange. (Section 23.)

T h e F e d e r a l R e se r v e A ct

(4) Uniformity in the currency is ob­
tained by making the National Reserve
notes identical in appearance and wording
with the National bank notes. (Section
(5) Power to oversee and control the
issue of notes is placed in the hands of a
supervisory board. (Sections 13, etc.)
G o vernm ent C ontrol

Overseeing the whole system is created
through a so-called Federal Reserve Board,
(Section 13) with the following organization
and functions:
(1) Board to consist of representatives of
(a) National Reserve Banks (b) bank
stockholders (c) the government itself.
(Section 10.)
(2) Actual working body to be an exe­
cutive committee of this Board consisting
of Secretary of the Treasury, Comptroller
of the Currency, and Attorney-General,
with four members of the Federal Reserve
Board chosen by the latter. (Section 11.)
(3) Board and Executive Committee, as
thus made up, to have power to deposit
Government funds in National Reserve
Banks, to fix rates of rediscount in such
banks, to compel any National Reserve
Bank to rediscount the paper of any other,
and to examine the banks of the system.
(Section 13.)
S t r u c t u r e o p S y st e m

The effort has been made to “popular­
ize” the control' “of* the whole system of
banking thus built up while at the same
time preserving a sufficient amount of
centralization, controlled by governmental
agency, to insure that the whole system
shall be responsive to legitimate public
demands. The bill is based on the belief
that no one should participate in the control
of the system unless he is either financially
interested himself or chosen by those who
are, save insofar as the government steps
in to exert the authority of the whole com­
munity. With this in mind the system
has been developed as follows:
(1) Organization, powers and functions
of national banks are left as at present.
(2) National Reserve Banks are incor­
porated institutions holding Federal char­
ters and in all respects managed like na­


C o ng ress


tional banks except as to the election of
directors which is provided for as follows:
(a) Banks in every district are divided
into five classes according to capitalization.
In each class the directors of the banks
nominate a candidate for the directorship
of the Reserve Bank. These are then
voted on (one bank one vote) and a director
is chosen for each of the five classes—five
in all. (Section 4.)
(b) In the five classes aforesaid bank
stockholders vote for and elect a director
for each class by a process prescribed in
each case making five in all, or with the
preceding five, ten. (Section 4.)
(c) The ten men thus named select four
others after a prescribed process, eight
votes required to elect, and the nominees
subject to rejection by the Federal Reserve
Board. (Section 4.)
(d) A fifteenth member, to be Chairman
of the Board of Directors is chosen by the
Federal Reserve Board itself. (Section 4.)
(3) The Federal Reserve Board consists
of two members from each district and the
three government officials already specified.
(Section 10.) It is not an incorporated
body, has no banking functions but is
(a) One member of the Federal Reserve
Board in each district is chosen directly by
the directors of the National Reserve Bank
of the district. (Section 10.)
(b) A second member of the Board from
each district is chosen by the bank stock­
holders of the district, voting by a pre­
scribed method. (Section 10.)
(c) These members of the two classes
referred to choose by ballot four of their
own number to join with the government
officers already mentioned as the Executive
Committee of the Board. These four are
designated by the Secretary of the Treas­
ury to hold the offices of President, first
and second Vice-Presidents and Secretary
of the Federal Reserve Board. (Section

R eserves

In the belief that the present reserve
system is antiquated and unsatisfactory,
that the massing of funds in New York and
other financial centers of which so much has
been said in recent years, is largely due to


T he A nn a ls

of th e

A m erican A cademy

the present reserve requirements of na­ industrial transactions evidenced by very
tional banks, and that in order to get the short term paper and on rare occasions
real benefit from the system of rediscount under carefully prescribed conditions to
which has been proposed as a remedy for financial operations protected by collateral.
many existing evils, it is necessary to base They will also be able to engage in foreign
such system upon an actual control of exchange operations, sales of government
reserves, provision has been made for securities, etc., as already explained.
recasting the present bank reserve system.1 (2) National banks will be subjected to
The plan includes:
precisely the same restrictions as at pres­
(1) Transfer of reserves from existing ent with a relaxation in favor of a moderate
national banks in reserve and central re­ amount of real estate loans by country
serve cities, to National Reserve Banks. banks under carefully guarded conditions.
(Section 39.)
(Section 27.)
(2) Spreading out of this process of trans­ (3) By a revision of the administrative
fer over a period of fourteen months in features of the National Banking Act,
order to give as little shock as possible to provision will be made for close oversight
market conditions. (Section 27.)
of National institutions with a view to
(3) Ultimately the establishment of a holding them strictly up to the require­
Reserve System, at the end of the transi­ ments of a legitimate banking business.
tion period in which so-called country (Text of bill still to be submitted.)
banks will have 15 per cent of reserve (i. e. (4) In order to possess themselves of the
15 per cent of total demand liabilities) such kind of paper entitling them to rediscounts,
15 per cent to be held, 5 per cent in the xnational banks will find themselves obliged
bank’s vaults, 5 per cent with the National to keep a reasonable proportion of their
Reserve Banks and 5 per cent either at assets in the form of paper eligible for
home or with the Reserve Bank; while rediscounting, and this will mean very con­
reserve and central reserve city banks will siderable emphasis upon the strictly com­
have reserves of 20 per cent of demand mercial aspects of the business done by
liabilities, of which 5 per cent will be at national institutions.
home, 5 per cent with the Reserve Bank of
P o s it io n o f S t a t e B a n k s
the district and 10 per cent either at home
or with the Reserve Bank. (Section 27.) It has not been thought wise to permit
(4) The presumed effect of this plan will State banks to own stock in the National
be to end the placing of reserves with Reserve Banks for two reasons:
central reserve city banks for use in stock (1) State banks by the terms of their
market operations, to keep reserves in organization are differently managed^and
some measure at home, and to require controlled from national.
speculators to get the funds they need in (2) The laws of the United States differ
their operations either by directly borrow­ with respect to liabilities, the collection of
ing them from persons who hold them and debts, and other matters.
want to lend the cash for that purpose, or Hence the bill has attempted only to
else by borrowing from the banks in the provide for giving these banks equal facil­
places where the operations are to be car­ ities for doing business by establishing the
following conditions:
ried on.
(1) State banks may affiliate themselves
D iv is io n o f B u s in e s s
with National Reserve Banks by maintain­
The object of the bill is to effect a mod­ ing the
erate division and classification of banking Reserve same deposits with the National
Banks that are kept by
business along indicated lines, the net banks under the proposed act. national
result, presumably, being summed up as 29.)
(2) State banks shall in these circum­
(1) National Reserve Banks will be stances be entitled to do business with and
strictly limited to actual commercial and get rediscounts from National Reserve
1 Including collections and clearances.
Banks. (Section 29.)

T h e F ederal R eserve A ct in C ongress


(3) State banks shall be subject to in­ the placing of Treasury funds in the hands
spection and examination by National of National Reserve Banks.
Reserve Banks. (Section 29.)
R e l a t io n s w it h T r e a s u r y

It is believed that the present sub­
treasury system is unsatisfactory, clumsy,
injurious to business and difficult to man­
age in times of stress. The bill therefore
provides for:
(1) The placing of all current funds of
the Treasury in National Reserve Banks
and the payment of government creditors
by check thereon. (Section 21.)
(2) The equalization of the public funds
between the different reserve banks subject
to a rate of interest to be fixed by the
Federal Reserve Board. (Section 13.)
(3) The trust funds of the Treasury are
to be held as at present in the vaults of the
F o r e ig n B a n k s
Recognizing that present banking legis­
lation under the national system is inade­
quate in its relation to foreign trade,
because it furnishes far too little recogni­
tion of the necessities of the case, and
believing that the development of foreign
banking ought to be aided and promoted
and at the same time regulated by the
national government, it has been sought in
drafting the bill to provide:
(1) A new type of institutions created
for foreign trade purposes and organized by
individuals or existing national banks or
both. (Section 41.)
(2) Permission to establish branches in
foreign countries and whenever necessary
under specified conditions to establish such
additional branches in the United States
as may seem requisite.
(3) Authority on the part of the Na­
tional Reserve Banks to deal in foreign
exchange and otherwise to facilitate oper­
ations involving international trade. (Sec­
tion 18 and Section 19.)
(4) Permission to national banks to do
an acceptance business in all matters
relating to foreign trade, the importation
and exportation of goods, the furnishing of
travellers’ funds on letters of credit, etc.
(5) The more efficient and successful
handling of financial relations between the
United States and foreign countries through

C o m m it t e e S u s t a i n s B i l l

The work of the Banking and Cur­
rency Committee covered a period of
several weeks and was largely devoted
to the improvement of details in the
pending bill. A list of these changes
would not be of special interest, even
were it possible in a brief treatment of
the history of the Federal Reserve Act.
It is enough to say that the Commit­
tee speedily developed a difference of
opinion with respect to the measure, a
substantial section of it desiring to
broaden the bill in the direction of
action which would give to agricultural
interests a larger borrowing power.
Accordingly, the maturity of paper
based upon farming operations was
increased to 180 days although all
other paper was prohibited from dis­
count for a period of over 90 days.
Some other concessions were made to
so-called farming interests. Public
control over the Reserve Banks was
strengthened and a provision creating
a so-called Federal Advisory Council,
a body of bankers drawn from the
various districts and directed to meet
at intervals for consultation with the
Federal Reserve Board, was estab­
Outside these and a relatively small
number of other amendments the
changes in the Banking and Currency
Committee of the House of Representa­
tives amounted to little more than
textual change effected for the purpose
of improving or clarifying the language
employed. When the bill, on Septem­
ber 9 , was ready for introduction in
the House of Representatives, with, a
committee report, but little alteration
in it had been made in any essential
particular. First, however, it was
necessary that the bill should pass
through the House of Representatives

T h e A nn a ls


of th e

caucus of the Democratic party. Al­
though severely attacked in the delib­
erations of this body, which were held
behind closed doors, no material change
was introduced and the bill accordingly
went to the House on September 18.
After a short debate, it was finally
adopted and sent to the Senate in a
form not very different from that
already given to it by the Committee.
S e n a t e H o s t il it y

In the Senate the Federal Reserve
Bill, for as such it was now coming to
be known, encountered much more
serious opposition than it had been
obliged to meet and overcome in the
lower chamber. The Banking and
Currency Committee as then organized
was not friendly to it. The Chairman
of that Committee, Senator R. L.
Owen, had prepared a bill of his own
which had not succeeded in making
headway. Its place was taken by the
Federal Reserve bill which he had
finally consented to introduce as drafted
in the House.
In the Banking and Currency Com­
mittee at least two Democratic groups,
neither of them friendly to the meas­
ure, were formed, while among Repub­
licans practically two other groups
existed, one inclined to favor the bill,
the other, to oppose or remodel it. In
hearings before the Senate Committee,
lengthy opportunity was given to the
advocates of a central bank to present
argument. Eventually the discussion,
although taking a wide range, settled
down about the question as to whether
there should be fewer or a larger
number of Reserve Banks, whether
the Reserve Banks themselves should
have full power over reserves and col­
lections, and whether the type of note
issue which had been favored in the
House bill should be retained. It was
with great difficulty and, probably,
only as a result of the strongest pres­

A m erican A cademy

sure on the part of the Administration
that it proved possible to obtain a
favorable report to bring the bill before
the Senate for debate and eventually
to pass it.
Analysis of the Senate debate would
be out of the question in any brief
space and may therefore be passed over
with the remark that, although the
discussion resulted in changes in the
Federal Reserve bill, which, when
combined with those already made by
the Senate Banking and Currency
Committee, produced a measure very
different from that adopted by the
House, nearly all of the changes made
by the Senate, as will presently be
seen, were ultimately surrendered in
Conference Committee, the bill being
thus shifted back in substance to the
original House form. During the Con­
ference Committee sessions, it is
worthy of remark, one important
innovation was introduced; a substi­
tute section relating to the refunding
of government % per cent bonds was
transmitted to the Committee by
Secretary McAdoo and adopted prac­
tically as it stood in lieu of the pro­
visions which had been made on that
subject by the two houses.
Changes by the Senate

It is now worth while to sketch
briefly and succinctly the changes
made by the Senate in the House draft
of the Federal Reserve Act insofar as
they were ultimately retained in the
final law. The work thus done may
be surveyed as follows:2
Turning first to the alterations in
the House bill that secured acceptance,
the principal features may be enu­
merated as follows:
(1) Introduction of provision for sale of
stock in Federal Reserve Banks to the
public in the event that not enough banks
2 From article by the author in American

Economic Review, March 1914.

T h e F ederal R eserve A ct in C ongress

subscribe for the stock to furnish an ade­
quate capital in any given district.
(2) Provision for alternative voting in
the choice of directors of Federal Reserve
Banks so as to insure prompt election.
(3) Reduction of number of Federal
Reserve not more than 12, as
against the “at least 12” of the House bill.
(4) Elimination of requirement that all
national banks recharter.
(5) Broadening of powers of Federal
Reserve Board and modification of lan­
guage relating to rediscounts between Fed­
eral Reserve Banks, so as to render such
rediscounts easier than was intended by the
House bill.
(6) Provision that the Secretary of the
Treasury might, not must, deposit public
funds in reserve banks.
(7) Reduction of reserve requirements
placed upon member banks under House
On the other hand, the following
important points were yielded by the
Senate in the conference:
(1) Omission of provision that holders
of stock sold to private individuals (if any)
should have voting power in directorates of
Federal Reserve Banks and elsewhere.
(2) Elimination of guaranty of bank
deposits, by use of surplus earnings.
(3) Elimination of provision that Fed­
eral Reserve Bank notes might be counted
in reserves of stockholding banks.
(4) Restoration of provision that many
classes of checks should be collected at par
throughout the country, and that where
such par collection was not enforced, the
charge for making collection should be
fixed by the Federal Reserve Board.
(5) Elimination of domestic acceptances,
thereby excluding them from use by stock­
holding banks and from rediscount by
Federal Reserve Banks.
(6) Modification of reserve require­
ments as formulated by the Senate so as
to require actual cash reserves in the vaults
of country banks (the Senate having
entirely dispensed with such reserves after
twenty-four months after date of the pas­
sage of the Act) and general stiffening of
reserve requirements made by the Senate,
although the final language still con­


stituted a reduction below the House
(7) Reduction of period of maturity for
which discountable paper might run from
180 days to 90 days.
While various other points of modi­
fication and concession on either side
might, of course, be enumerated, it is
believed that the foregoing presenta­
tion is representative and shows suf­
ficiently well the nature of the con­
ference work and the character of the
points conceded on either side. As­
suming that such a fair or representa­
tive selection has been made, it is
evident that the work of the confer­
ence resulted in the establishment of
the House contentions at nearly every
essential point, the exceptions to such
a remark being found in two main
particulars: (1) the reduction in the
number of Reserve Banks and their
limitation to not more than twelve at
any time, and (2) the provision that
public deposits might or might not
be made in the Reserve Banks at the
discretion of the Secretary of the
While other points were significant
and important in their way, it can
certainly be fairly concluded that on
those matters involving important
issues of theory the House virtually
held its own in most respects. In fact,
it is an accurate generalization that the
final bill as completed in conference
committee and as passed by both
Houses was a closer approach to the
original House draft of the measure
than anything that had intervened
during the time the bill was going
through the various permutations to
which it was subjected in its slow prog­
ress from one stage to another of the
legislative process.
At one other point there was marked
and vital departure from the original
House measure—the provision with
reference to the refunding of United

T he A n n a ls


of the

States 2 per cent bonds and the treat­
ment of the currency based upon such
bonds. On this subject the final
action of the conference was nearly
equivalent to the acceptance of a plan
formulated by the Administration and
designed to take the place of all of the
various other schemes that had been
recommended from different sources in
either House. The action as to bonds
was, therefore, not a concession by
either side but was a virtual surrender
by both and an acceptance of the con­
clusions of the Treasury Department.
Barring the two matters already men­
tioned, the House measure was changed
in no respect that affected its essential
working; nor could it be said that even
in these particulars it had necessarily
been subjected to modification, since,
in both, the action contemplated by
the provisions ultimately adopted was
permissive, rather than compulsory.
T h e I n s p i r a t i o n o f t h e B il l

As to the idea by which the Federal
Reserve Act was dominated or upon
which it was molded, or as some have
termed it the inspiration of the bill,
there has been much unnecessary con­
troversy. The measure as originally
made read!y for introduction was the
outgrowth of the long years of discus­
sion of the banking and currency prob­
lem through which the country had
passed from 1893 onward. The notion
of a district reserve system was directly
and confessedly drawn from the experi­
ence of the banks of the country with
local clearing house organizations.
Other features were the careful result
of foreign experience. While the bill
was thus made up of ideas drawn from
all available sources so far as these
were known to the committee of the
House of Representatives, it was pre­
pared as the result of individual study
and without the acceptance of outside
bills, suggestions or models. It was, in

A m erican A cademy

short, honest in its inception, professing
to be with all of its various defects sim­
ply what it actually was—a measure
prepared on the basis of American
experience, enlightened and adapted
by the use of such lessons as could be
drawn from European banking prac­
tice. As the writer has said on la
former occasion:3
The Federal Reserve Act is the product
of a lengthy course of development and has
grown gradually out of the discussion and
analysis of the past twenty years. It is
not drawn, even largely, from any single
source, but is the product of comparison,
selection, and refinement upon the various
materials, ideas and data, rendered avail­
able throughout a long course of study and
agitation. Many bills embodying the
same general line of thought that now finds
expression in the new act have been offered
in Congress; some have been suggested
outside that body. The most fundamental
concept of all—that of uniting the banks
of the country into organized groups—is
found in the clearing house organizations,
which in time of stress have pooled their
resources and converted bank assets into
the equivalent of reserve money. The
bills prepared by or under the direction of
the Honorable Isidor Straus, the Honorable
J. H. Walker, the Honorable Charles A.
Fowler, and the Honorable Maurice L.
Muhleman have supplied at least the basis
for many of the detailed analyses and
methods of treatment that are found in the
Federal Reserve Act. Earlier than any of
these, was the bill recommended by the
Indianapolis Monetary Commission, which
did not provide for cooperative unions of
banks, but upon which the framers of the
present act have evidently drawn for some
of their ideas.
The latest bill in the long series which was
available for study to the framers of the
Federal Reserve Act, was that prepared for
the National Monetary Commission and
called in popular language the “Aldrich
bill.” By many the new law is regarded as
a partial copy of, or plagiarism from, the
Aldrich bill; and that view has been widely
3American Economic Review, loc. eit.

T h e A ldrich -V reeland E m ergency C urrency

expressed both in and out of Congress.
That such was not the opinion of Mr.
Aldrich himself, his scathing and bitter
denunciation of the House bill seems to bear
abundant witness.4 It might be enough
for purposes of argument simply to appeal
on this point from the critics of the measure
to Mr. Aldrich himself but that would
hardly answer the purpose of historical
The Aldrich bill may be considered from
two standpoints, (1) that of its theory and
broad general plan on the one hand, and
(2) that of its machinery and technique of
construction on the other. From the first
standpoint, there is no shadow of relation­
ship or similarity between the Federal
Reserve Act and the Aldrich bill. From
the second, there is at many points a close
resemblance. The Aldrich bill provided
for a single central “reserve association”
with scanty public oversight, with control
vested practically wholly in the banks, and
with the preponderance of power in the
larger institutions which owned stock. It
so arranged things as to keep this “reserve
association” relatively inactive except upon
special occasions of panic or disturbance.


It made no direct provision for the shifting
of reserves in part from existing banks to
the proposed association, but it relied upon
inflation due to the placing of bank notes
issued by the central association in the
reserves of the stockholding banks for pro­
tection in time of danger. The new act
provides for twelve reserve banks, intro­
duces the principle of local control, calls
for strict government oversight, shifts
reserves from present correspondent banks
to the new institutions, minimizes the
influence of the larger banks in directorates,
and generally diffuses control instead of
centralizing it. It leaves banking, as such,
to be practiced by bankers; it vests the
control of banking in the hands of govern­
ment officers. The theory and purpose of
the new act are widely different from those
of the Aldrich bill. Where the Aldrich
proposal veers widely away from the
tendencies that have been developed during
the preceding ten years of American bank­
ing discussion, the Federal Reserve Act
closely follows them. Indeed, the Act of
1913 is closer to any one of half a dozen
bills of former years than to the Aldrich

The Aldrich-Vreeland Emergency Currency



H om er Jo sep h D o d g e

Editor, The Federal Trade Information Service1

HE origins of everything in the of our national activity, is not a diffi­
world, from man himself to slang cult task. Although inflation of such
words and phrases, from vast and per­
tremendous proportions previously had
fect mechanisms to manners and been unheard of, the stage was espe­
customs, or great eras and economic cially set in preparation for that event.
cycles, always have held a special As a preliminary to the more serious
fascination. And there has always later currency inflation, the United
been someone, whether it be Darwin States had innocently provided itself
or the Encyclopaedia Brittanica, to with a lively springboard from which
ferret out each firstling.
to leap.
To point to the circumstances of T h e F o r e r u n n e r o f I n f l a t i o n
the origin of the American currency
inflation, the progress of which dur­ That springboard was the Aldriching the last seven years has had so Vreeland Act which provided a sudden
profound an effect upon every branch 11 am indebted to the office of the Comptrol­

4 Proceedings of American Academy of Polit­ ler of the Currency for the statistics of the
Aldrich-Vreeland note issues.
ical and Social Science, October, 1913.


T h e A nn a ls

of the

means for issuing hundreds of millions
of dollars in emergency currency.
To be sure, it was designed merely to
meet temporary needs for additional
currency in periods of financial stress.
It was intended that this currency
should never remain long outstand­
ing, but should merely supply the
nation with a currency medium during
the brief period required to restore
confidence following a market up­
heaval or similar economic disturbance
of known dimensions and experienced
intensity. An aggregate of $500,000,000 was provided for this purpose.
That a need should develop in this gen­
eration for greater sums was undreamt.
The panic of 1907 had been a
severe lesson to the American bank­
ing fraternity and to the nation as a
whole. At that time clearing house
certificates had been issued to the
extent of $255,536,300—a great sum
then—and Congress, intent on pro­
viding a preventive against a similar
embarrassment, had passed the Aldrich-Vreeland Currency Act, which
was approved May 30, 1908. It was
regarded as an emergency implement
to be supplanted by more solid legis­
lation and, therefore, was to expire
by limitation, June 30 , 1914. The
permanent legislation was provided,
for on December 23, 1913, the Federal
Reserve Act was approved. The
Federal Reserve Banks were not
opened, however, until November 16,
1914, so when the European War
broke out the permanent system was
not ready for operation.
The War was the call-bell for the
beginning of the performance of world­
wide inflation. The American vehicle
of participation was not ready, so
Congress brought back, as a curtainraiser, the Aldrich-Yreeland Emer­
gency Currency Act. It extended
the life of the act from June 30, 1914,
to June 30, 1915.

A m erican A cademy
W ar D em and for M o ney

In times of stress of almost any
kind, money is the first support on
which mankind leans. Availability
of ample supplies of money goes far
toward alleviating almost any dis­
tress. The War had not yet had an
opportunity to bring home the lesson
that in an economic sense, goods and
services, and not money, are the king
pins. With the Stock Exchange clos­
ing, and banks and business houses and
individuals throughout the country in
a state of bewilderment over the
meaning of the War, everyone wanted
money quickly.
Europe instantly began unloading
her railroad and industrial securities
in this market. Belligerent govern­
ments began awarding contracts for
war supplies. Prices began to rise,
and a thousand new demands for
money sprang up. This demand,
coupled with a caution on the part of
the banks, arising from the native
timidity of capital in the presence of
great material forces, doubtless would
have caused serious embarrassment
had it not been for the availability of
the Aldrich-Vreeland emergency cur­
A curious fact attendant upon the
issuance of this money bears upon the
political aspect of the event. The
Federal Reserve Act had been widely
press-agented to the country as a
great achievement of the Democratic
Congress. It was a Wilson bill, one
of the heralded Democratic reforms.
Now the Aldrich-Yreeland Act, as its
very name signifies, was the creation
of an old-fashioned Republican Con­
gress. It was popularly known that
the Federal Reserve Act had been
approved; that its machinery was in
process of erection. The AldrichVreeland Act was forgotten. Where­
fore, when, in response to the demand
of the hour, m emergency currency

T h e A ldrich -V reeland E mergency C urrency

appeared, it was popularly received
as the issue of the new Federal Re­
serve System. It is not a matter of
large importance, but rather a curi­
osity of financial history, that to this
day many business men are under the
impression that the emergency cur­
rency with which they did business in
the first few months of the War was
Federal Reserve currency.
At the beginning of the crucial
period following the declaration of
war in Europe, the general stock of
currency in the United States
amounted to $3,735,579,397, of which
$368,210,467 was held in the Treas­
ury as assets of the government,
leaving the amount in circulation at
$3,367,368,930. Of the general stock,
there was in gold, $ 1,887,270,664 ;
silver, $748,287,696 ; United States
notes, $349, 114,016 ; and national bank
notes, $750,907,021.
On August 1, 1914, the stock of
incomplete currency in the custody
of the Comptroller of the Currency
and available for issue on the security
of United States bonds and other
securities, was $524,864,470. The
aggregate amount of government bonds
on deposit to secure circulation, to­
gether with the amount of such
bonds outstanding and acceptable
for that purpose, aggregated $913,317,500, of which the national banks had
on deposit to secure circulation, $740,796,910, to secure United States de­
posits, $23,047,950, and on hand
unpledged, $ 11,950,300. Hence, only
about $ 137,500,000 of the class of
United States bonds acceptable as
security for circulation were not owned
by national banks. This amount,
plus $ 11,955,300, owned but unpledged,
or in round amount, $ 149,500,000,
was the measure of the possible
increase of national bank circulation
on the security of United States


On August 1, 1914, the outstand­
ing national bank circulation amounted
to $750,907,020, of which $735,222,801 was secured by United States
bonds, and the remainder, $ 15,684,220, by lawful money deposited by
banks in liquidation and by those
that were retiring their circulation.
On September 12, 1914, the date of
the first report from national banks
following the beginning of the Euro­
pean War, the reporting banks had on
deposit with the Treasurer of the
United States as security for circu­
lation, United States bonds to the
amount of $736,685,850. On that
date the volume of circulation issu­
able under the Act of 1908, that
is, 125 per cent of the combined
capital and surplus of the banks,
amounting to $2 ,230,588,239, less
the amount of currency issued on
United States bonds, was $ 1,493,902,390. As a matter of fact, the
authorized issues of currency under
that Act, from the date of the
first issue on August 4 , 1914, to
the date of the last issue on Febru­
ary 13, 1915, were but $386,444,215, or less than one-fourth of the
maximum issuable. The amount au­
thorized included $910,500 secured by
state and municipal bonds deposited
with the Treasurer of the United
States in trust by eight national
banks, all other issues being based
upon securities deposited with na­
tional currency associations.
During the period of activity of
issues of circulation under authority
of the Act of 1908, the volume of
United States bond-secured circula­
tion was practically unchanged. The
aggregate amount of outstanding national-bank circulation reached the
maximum, during the period in which
emergency circulation was issued, in
the middle of November, 1914, namely,
$ 1,126,039,600.

T h e A nn als


of th e

P r o v is io n s f o r R e t ir e m e n t o f
A l d r i c h -V r e e l a n d C u r r e n c y

The law authorized the deposit of
lawful money or national bank notes
for the retirement of this additional
or emergency currency. By reason
of general conditions and the lack of
demand for funds, deposits for re­
tirement of the additional circulation
began to be made as early as the
middle of October, and by January 2,
1915, aggregated $238,698,460, or over
60 per cent of the total circulation
authorized to be issued. Within
nine months, that is, by May 1, 1915,
$380,039,030 of the authorized $386,444,215 of this currency had been
retired, and prior to June 30, 1915,
the entire amount issued had been
retired except the sum of $200,000,
the amount issued to a national bank
that failed and was placed in charge
of a receiver.
In addition to the securities de­
posited, the law provided that “the
banks and the assets of all banks
belonging to the association (national
currency), shall be jointly and sever­
ally liable to the United States for
the retirement of such additional
The value of the securities de­
posited with the currency associations,
that is, the market value of the state
and miscellaneous bonds and the
face value of the commercial paper
and warehouse receipts, including ex­
changes, was, roundly stated, $907,880,000 of which $651,146,000 was
in commercial paper. The net value
of the securities, that is, the gross
amount deposited less exchanges, ex­
ceeded the value of circulation issued
by more than 30 per cent.
Under the provisions of law and
the rulings of the Treasury Depart­
ment, securities deposited were classi­
fied as follows:
1. State, municipal, and county

A m erican A cademy

bonds were accepted at 85 per cent of
the market value.
2. Miscellaneous securities, includ­
ing industrial bonds, and other securi­
ties, mainly city and town notes and
warrants, were accepted at 75 per
cent of the market value.
3 . Commercial paper was accepted
at 75 per cent of the face value,
4 . Notes secured by warehouse re­
ceipts for cotton, tobacco, and naval
stores at 75 per cent of the face
The additional circulation author­
ized and secured by commercial paper
represented 57 ^ per cent of the
total amount authorized; by mis­
cellaneous securities, 28 per cent; by
state, county and municipal bonds,
14 per cent; and by notes secured by
warehouse receipts, one-half of one per
A c t iv it y o f N a t io n a l C u r r e n c y
A s s o c ia t io n s

While there were between 7,500
and 7,600 national banks in active
operation during the period in ques­
tion and 45 national currency as­
sociations organized, the membership
of these associations was but 2 , 197,
and of that number only 1,363 took
out additional circulation. None of
the banks in four currency associa­
tions, namely, Vermont, Rhode Island,
northern New York, and central New
York, applied for circulation. All the
states of the Union were included in
one or more of the currency associa­
tions excepting Maine and Wyoming.
None of the national banks in nine
states, namely, Maine, Vermont, Rhode
Island, Delaware, South Dakota, Mon­
tana, Wyoming, Idaho and Nevada, ap­
plied for additional circulation.
Eighty per cent, or $309,308,210 of
the authorized issue of $386,444,215,
was for banks in the reserve city

T h e A ldrtch -V reeland E mergency C urrency

associations. The amount authorized
for banks in the National Currency
Association of the city of New York
was $ 144,975,960 ; Boston, $24,944,500 ; Chicago, $27,070,000 ; Philadel­
phia, $ 14,883,750 ; Minneapolis and
St. Paul, $ 12,798,500 ; Dallas, $11,337,950 ; Pittsburgh, $ 10,978,000 ; St.
Louis, $10,836,500 ; Cincinnati, $9,592,500 ; and San Francisco, $8,634,500.
The tax collected on this addi­
tional circulation from August, 1914,
to June 30, 1915, was $2 ,977,066.73.
With the deposit of the requisite
amount of lawful money to provide
for the retirement of circulation issued
under authority of the Act of May 30,
1908, and the release of the securing
collateral, the duties of the national
currency associations practically ter­
minated, although the associations
were held to be in existence until the
date of the expiration of the act
providing for their formation. The
organization of the first national cur­
rency association, that of Washington,
D. C., was approved July 18, 1908, and
the last, the State of Vermont, Decem­
ber 16, 1914.
There were forty-five national cur­
rency associations organized with a
membership of 2,197 banks, or 29.15 per
cent of the total banks (7,538) that re­
ported on the call of September 12,
1914. During the month of August,
1914, 30 associations made their first
application for additional circulation,
6 in September, 4 in October; 1 did
not report the date of its first appli­
cation, and 4 associations made no
Forty-one associations approved for
issue $385,553,905 to 1,366 member
banks. The first approval was made
on August 3, 1914, and the last on
February 5, 1915. The first appli­
cation for the retirement of circula­
tion was approved September 23,
1914. By July 1, 1915, all of the


banks to which currency was issued,
with the exception of the First Na­
tional Bank of Uniontown, Pa., which,
upon becoming insolvent, was placed
in charge of a receiver, had made the
necessary deposit to retire their addi­
tional circulation.
The securities pledged with the as­
sociations aggregated $585,864,391.94,
classified as follows: commercial paper,
face value, $359,535,317.27, or 61.37
per cent of the total securities de­
posited; industrial bonds, par value,
$ 116,069,173.36, or 19.81 per cent;
state, municipal and county bonds,
par value, $70,010,846.34 , or 11.97
per cent; railway bonds, par value,
$31,333,800, or 5.37 per cent; other
sepurities, face value, $4,690,366.86,
or 0.80 per cent, and warehouse re­
ceipts secured by cotton, tobacco,
and naval stores, face value, $4,224,888.11, or 0.72 per cent. The ex­
penses of 41 currency associations,
the members of which issued circula­
tion, are reported at approximately
$ 125,000. Two non-issuing associa­
tions reported combined expenses,
$44 .57. The other two non-issuing
associations apparently incurred no
D e c l in e o f E m e r g e n c y C u r r e n c y
a n d I n c r e a se in R e se r v e N o tes

The Federal Reserve Banks had
opened in the midst of this process, on
November 16, 1914. Their machinery
was unfamiliar and therefore there
was no immediate substitution of the
new currency for the Aldrich-Vreeland
notes. Retirement of the AldrichVreeland currency, however, set in
early. Indeed, the date on which the
greatest volume actually was out­
standing was prior to the opening of
the banks—October 24, 1914. This
was due to retirement on the part of
banks which had taken care of their
emergency requirements and were


T h e A nn a ls

of the

getting in shape to carry their own
load. That the banking community
had not abandoned the emergency
currency in favor of the Federal
Reserve currency is indicated by the
fact that applications for the emer­
gency currency continued to come in
and the date on which the maximum
approvals took place was not reached
until February 13, 1915. By this time
retirements of this currency had
brought the amount outstanding down
to $45,377, 141. The period in which
the greatest volume was retired was
the week ending December 12, 1914,
and the amount, $45,144,798.
There was no full replacement by
Federal Reserve notes of the AldrichVreeland notes. By January 1, 1915,
a total of $238,698,483 of the AldrichVreeland notes had been retired while
only $ 16,530,000 in Federal Reserve
notes were in circulation. On April 1,
1915, $372,928,594 of the emergency
currency had been retired and only
$43,376,000 in Federal Reserve notes
were in circulation.
The two curves—one representing
the retiring Aldrich-Vreeland notes
and the other, the expanding Federal
Reserve notes—crossed about March
1, 1915. On March 6, 1915, there
were $27,905,376 in Aldrich-Vreeland
notes still outstanding. On March 5,
1915, there were $29,805,000 in Fed­
eral Reserve notes in circulation.
The previous reporting date for
the Aldrich-Vreeland notes was Febru­
ary 27, when there were $32,249,374
outstanding. Compare this with Feb­
ruary 26, when there were $26,172.000 in Federal Reserve notes in
circulation. The next subsequent re­
porting date was March 13, when
there were $24,357,227 in AldrichVreeland notes outstanding. Com­
pare this with March 12, when $33,965.000 in Federal Reserve notes
were outstanding. By June 30, when

A m erican A cademy

the last of the Aldrich-Vreeland notes
were retired and the Act expired by
limitation, there were about $83,000,000 in Federal Reserve notes in
So it will be seen that the AldrichVreeland currency contracted at a
much greater rate than the Fed­
eral Reserve currency was issued.
This indicates how truly the AldrichVreeland notes were an emergency
—a panic currency. They were is­
sued to allay panic or in anticipation
of it; the Federal Reserve currency
was issued in response to the actual
needs of business. A further indica­
tion of these contrasting characters
is furnished in the fact that applica­
tions for new emergency currency
continued in substantial volume for a
considerable time after the large re­
tirements by the banks which had
received supplies; this indicated that
the emergency had passed. It is true
that there was a heavy tax operating
to force the emergency currency into
retirement but this alone does not
explain the situation. Had it been
the tax which caused the AldrichVreeland money to retire so precipi­
tately, the untaxed Federal Reserve
currency would have flowed out in
greater volume. A year after the
Federal Reserve Banks had been
opened, the Federal Reserve notes in
circulation were only $ 184,000,000,
less by nearly $ 150,000,000 than
the amount of Aldrich-Vreeland cur­
rency which had been outstanding a
year ago.
These figures are surprising when
retrospect brings them in contrast
with the $2,500,000,000 in Federal
Reserve notes now outstanding and
the $3,250,000,000 outstanding a year
ago. These figures further show how
totally inadequate the maximum of
$500,000,000 in Aldrich-Vreeland notes
would have been had the act further

T h e A ldrich -V reeland E m ergency C urrency

been extended and sole reliance placed
upon it to provide an additional
currency. To be sure, there had been
retirement of other classes of currency
but not in such fantastic volume as to
match the issuance of Federal Re­
serve notes.
Economists and bankers have learned
a great deal about currencies since
the days of the Aldrich-Vreeland
issues and some rules have been
upset. The phenomenon which has
caused the most profound amazement
has been the persistent vitality of
grotesquely inflated currencies in some
countries of Europe. The German
mark is famous for its depreciation,
the Russian ruble, notorious. Both
have lost, apparently, practically all
calculable relation to metallic reserves,


yet they display a lingering vitality
and are accepted as being worth
something, although as a matter of
fact some of them are worth less than
the merchandise value of the paper on
which they are printed. A meal costs
100,000 rubles in Moscow, yet meals
still are bought with rubles. They do
circulate. The idea that the image and
superscription is a talisman of some
value, however much depreciated, en­
dures in the face of accurate knowl­
edge that the sovereignty behind these
tokens practically is defunct. The
idea of a legal tender has retained a
momentum which, although slowed
down, is yet perceptible. This fact
speaks much for an innate desire
on the part of the people to retain an
artificial circulating medium.

The Reserve Act in Its Implicit Meaning

By A. D. W e l t o n
Continental and Commercial National Bank, Chicago
GREAT banking system could a variety of things beside a statute, so
conceivably grow up of itself in the statute itself is the product of a
response to the demands of business.
variety of plans, purposes, ideas and
Such a system would be ideal because theories of a wide range. To get a
of its flexibility and freedom of adapta­ thorough understanding of a system
tion to the changing requirements of of any kind, of which a statute is the
commerce. But no such system ever nucleus, some knowledge of the dis­
did grow up or ever will. A business, cussion which preceded its formulation
involving such an element of trust, is and adoption is desirable and perhaps
necessarily conducted by human agen­ necessary. Certainly, one ambitious
cies and human agencies are uncertain to become expertly familiar with the
and often dangerous. Government Federal Reserve System would have to
everywhere, in one way or another, is study conditions long before December
concerned with banking. It is con­ 23, 1913. The purposes and intentions
cerned with the Federal Reserve Sys­ of the framers of the Act are not told
tem which has been evolved or built in the Act itself. They are concealed
up around a statute known as the in many reports, documents, and in
Federal Reserve Act, approved Decem­ many minds. They cannot all be
ber 23 , 1913.
told in brief space but discussion of a
A statute, however, is only a first few outstanding points will perhaps be
step toward a banking system which helpful in view of recent criticism of
is finally made up of operating banks. the Reserve System, newly declared
These are credit and currency machines distortions of its purposes and mis­
whose conduct, in accordance with understandings of its meaning.
the law, is guided, regulated and con­ It may be said on all the authority
trolled by rules, precedents, traditions, that exists, that the Reserve Banks
habits, customs, decisions and what not. are not government institutions, that
The mass of this material makes the they were not intended to be, and that
system. With this view of banking it any interference with their operations,
is easy to understand why the coming beyond exercise of the powers con­
of the Federal Reserve Act did not ferred on the Federal Reserve Board,
bring with it the repeal of the National is perversion of the law and its mean­
Bank Act. The statute known as the ing as understood and expressed by
National Bank Act might have been those who formulated it. The Federal
repealed but the act itself is only a Reserve Banks are privately owned
part of the national banking system. institutions. Their stock is all owned
The rules, regulations, precedents, by their member banks. The provi­
etc., which make up that system, sion of the law that, in case the banks
could, and perhaps should, be codified did not subscribe for the necessary
but anything further would bring un­ amount of stock, individuals and the
certainties and throw the entire system government could, has never been
acted upon.1
into confusion.
As a banking system is composed of 1 Act December 28, 1913, § 29 et seq.


T h e R eserve A ct in I ts I m plicit M eaning

It is possibly true that some mem­
bers of Congress voted for the bill in
the belief that it provided for the
establishment of government banks,
but it is also probably true that more
of them believed that, in some way,
the bill opened the way for punishing
or demolishing that political phantasy
—the “Money Trust.” However,
what congressmen believe is not
A n A m e n d m e n t T h a t F a il e d

It may be recalled that when the
Glass-Owen bill was under discussion
in the Senate a serious attempt was
made to give the government power
over the Reserve Banks by giving the
Reserve Board or the Secretary of the
Treasury power to appoint a majority
of the directors of each bank. Senator
Hitchcock of Nebraska offered the
amendment, which had other sup­
porters. Members of the banking and
currency committees of both Houses
were opposed to this amendment.
They maintained it was out of har­
mony with the spirit and purpose of
the measure. Chairman Glass of the
House Committee and Senator Owen
of the Senate Committee were show­
ered with telegrams from all parts of
the country, urging opposition to this
plan. The amendment failed com­
Another effort was made to give the
government, through the Treasury,
direct control over the Reserve Board.
This effort had insidious features and
was redolent of politics. During the
Senate discussion of the Glass-Owen
bill, new prints of the bill with minor
changes were frequent. In one of
these there appeared one day in
December an alteration of a para­
graph in Section 10, which was made to
read, as it still reads, as follows:
Nothing in this Act contained shall be
construed as taking away any powers


heretofore vested by law in the Secretary
of the Treasury which relate to the super­
vision, management, and control of the
Treasury Department and bureaus under
such department, and wherever any power
vested by this Act in the Federal Reserve
Board or the Federal Reserve Agent ap­
pears to conflict with the powers of the
Secretary of the Treasury, such powers
shall be exercised subject to the super­
vision and control of the Secretary.
The paragraph was innocent enough
in appearance. No one seemed in­
terested in it. Chairman Glass, of
the House Committee, disclaimed all
knowledge of its source, saying the bill
had passed from his control. Chair­
man Owen, of the Senate Committee
was non-committal. He thought the
suggestion had come from the Treasury.
The paragraph was not discussed on
the floor. It passed the Conference
Committee apparently without notice.
Many other provisions were far more
Over a year later, a newspaper item
made it known that the AttorneyGeneral of the United States had given
an opinion to the President to the
effect that the Federal Reserve Board
was an independent organization and
not a bureau of the Treasury Depart­
ment. When the President’s secretary
was queried as to the reason for re­
questing this opinion, he replied that
the President had asked it “for Mac”
but did not say whether “Mac” was
Machiavelli or McAdoo.
It is not impertinent to point out
that, when the Federal Farm Loan Act
was on passage, the question of
whether the Farm Loan Board should
or should not be a bureau of the
Treasury Department was fought out.
Every form of the bill that came from
the House Committee made the Farm
Loan Board an independent organi­
zation. The Senate Committee in­
variably made it a bureau of the


T h e A n n a ls

of the

Treasury Department. The Senate
won. The Farm Loan Board is a
bureau of the Treasury Department.
The Federal Reserve Board is not.
R eser v e B oard a n In d epen d en t
O r g a n iz a t io n

The Federal Reserve Board can be
classed only as an independent govern­
ment organization, having supervision
over the Federal Reserve Banks and
exercising in that field powers defined
by law.
The Federal Reserve Banks are
privately owned institutions, managed
by boards of directors chosen by their
stockholders and authorized to func­
tion as banks, but within the pro­
visions of law and the rules and
regulations made under authority of
law by the Federal Reserve Board.
The powers of the Federal Reserve
Board are very broad but the great
purpose of the law in creating the
Board was to conserve the public in­
terest, to provide safeguards against
domination over banking by either
financial or political interests, and to
maintain a sound banking system.
D e s ig n e d a s a n A id t o B u s in e s s

The Federal Reserve System was
designed as an aid to business. It is
applied only to commercial banking—
that form of banking which takes
account of the commercial scheme
by which commodities are got from
producer to consumer. The deposits
in commercial banks mark the storedup purchasing power of the com­
munity. Back of their loans are
merchantable goods of greater value.
Such banks must be liquid. They
must pay on demand and their loans
must, therefore, be of short maturities.
In a general way a loan should run no
longer than the estimated time it takes
to get the goods behind it to the con­
sumer. In relation to the producer,

A m erican A cademy

the jobber may be the consumer; in
relation to the jobber, the retailer
holds that position; but, in any event,
the final consumer must pay because
he destroys the goods completely or
takes them out of the class of mer­
chantable articles.
Before the Reserve System came to
give practical definition to commercial
banking, commercial and investment
banking were inextricably mixed. The
money of commerce in the form of
surplus deposits beyond the immediate
needs of the owners, or in bank re­
serves, was drawn to the centers and
chiefly to New York where it could be
employed in the call loan market: that
is, it could be loaned on demand
against securities which represent in­
vested capital. That system created
all the “Money Trust” that ever
The Federal Reserve System was
intended to divorce investment from
commercial banking. Notes secured
by investment securities are, there­
fore, ineligible for rediscount. No
matter how strong the market demand
for such securities, they are not
liquid in the sense that commercial
bank loans must be liquid. At times
they fluctuate widely in price. The
call loan rate fluctuates accordingly.
In 1907 it reached 125 per cent. An
advance in commercial discount rates
from 5 to 7 per cent indicates a
critical condition in the commercial
money market.
The plan to prevent stock market
hysteria from affecting commercial
business has been reasonably success­
ful. But investment securities have
not been kept out of the Reserve
Banks. In Section 13, defining paper
eligible for rediscount, it is provided
that such definition (of eligibility)
“shall not include notes, drafts or
bills covering merely investments is­
sued or drawn for the purpose of

T h e R eserve A ct in I ts I mplicit M eaning

carrying or trading in stocks, bonds or
other investment securities, except
bonds and notes of the Government of the
United States .”
F is c a l A g e n t s o f t h e G o v e r n m e n t

The Reserve Banks were intended
to be fiscal agents of the government
and the exception as to government
securities was natural at the time
when the World War could not be
foreseen. If anyone had thought that
the United States would be issuing
securities by billions before the Re­
serve Banks were four years old, it is
doubtful if notes secured by govern­
ment issues would have been made
eligible for rediscount so jealous were
the framers of the act of the strictly
commercial character of the Reserve
Always uppermost in the minds of
those men, both in and out of Con­
gress, was the desire to keep commer­
cial banking and the Reserve Banks
free from investment securities. In­
numerable proposals have been made
for variations from this practice. The
trials of war brought many. The
farmer’s insatiable demand for more
capital and credit has been advanced
a thousand times. It has been seri­
ously proposed that railroad bonds be
recognized as collateral for Reserve
Bank loans. The pressure for some
departure from the rule has been
continual, if not constant.2
It is undoubtedly true that many
supporters of the Federal Reserve bill
in Congress were opposed to invest­
ment securities as collateral for notes
eligible for rediscount only because of
hostility to Wall Street and hatred of
the “Money Trust.” It is probably


true that the distinction between com­
mercial and investment banking was
not clear in the minds of all who voted
for the bill. But it was clear in the
minds of enough. To confine the Re­
serve System entirely to commercial
banking may leave a gap in the
banking scheme, but sufficient experi­
ence has been had to demonstrate the
dangers of any lapse from the integrity
of the present plan.
P r o t e s t A g a in s t C o m m e r c ia l
L im it a t io n s o n R e s e r v e B a n k s

The War Finance Corporation was
the greatest protest against the com­
mercial limitations imposed on the
Reserve Banks. The exigencies of
war excused that law, if they did not
justify it, but there is substantial
ground for the suspicion, if not for the
belief, that, underlying the plan for the
War Finance Corporation, was the
political desire to get for the govern­
ment some measure of control over
investment banking. Many “Money
Trust” baiters fondly believed that
the Reserve Act would cripple Wall
Street. Some thought that control
would be given over speculative activi­
ties. The War Finance Corporation
might have had some such effect if it
had functioned to the extent predicted.
In its revival as a machine to meet an
exigency in which something beyond
the maturities permitted for redis­
counts under the Reserve Act is
necessary, it may fill a temporary need
acceptably, but it could not function
satisfactorily under other conditions,
even if it is conceded that its present
operations are satisfactory. On the
other hand, it can only be said that, if
the Reserve Banks cannot meet every
commercial banking need, they are
2 The Federal Reserve Board adopted a defective. The difficulty lies in deter­
policy in order to assist in the war financing mining just what is a commercial
which was economically unsound. Pages 62 banking need. Surely it is not to
and 63 of the hearings entitled, “Reviving the
hold up prices or make up or prevent
Activities of the War Finance Corporation.”


T h e A n n a ls

of th e

losses occasioned by cataclysmic dis­
turbances born of war. It is only
fair to say that the first duty of
commercial banks is to protect them­
selves. In doing that they protect
business. So far as the present opera­
tions of the War Finance Corporation
protect the commercial banks, the
work is probably justified.
S o m e T h in g s T h a t W e r e I n t e n d e d

A m erican A cademy

eral Reserve Bank notes of small de­
nominations. It is hoped that the latter
will soon find their way into oblivion.
Reserve Bank notes, of minor con­
sequence in any event, have a signifi­
cance as a by-product of the note
controversy. Like the provision in
Section 16 making reserve notes the
obligations of the United States—a
provision wholly at variance with the
spirit of the Act and practically quite
meaningless—Federal Reserve Bank
notes attested the strength of the
“ cheap money” element and the
desire of the advocates of soundness to
avoid a direct test of that strength.
The bond-secured national bank
currency and its retirement presented
a problem of grave import. It was
finally solved by the provisions in
Section 18 requiring the Federal Re­
serve Banks to purchase such bonds,
securing circulation, as were offered to
the amount defined. Without dis­
cussing the methods of refundirig and
retiring such bonds, it may be said
that the fiat money contingent re­
volted at the idea of having any
securities carrying the circulation priv­
ilege in the hands of the Reserve
Banks without providing a means of
issuing notes against them. The
means was provided. In due course
such notes came into existence. Thus
a law which was conceived in the idea
that one of its great purposes would be
to simplify and unify the currency,
actually opened the way for the adding
of a new patch and thereby heighten­
ing the crazy-quilt effect.

It is not an invitation to controversy
to say that the Reserve Act failed to
abolish the office of Comptroller of the
Currency for two reasons only: one was
the political desire to keep the office in
existence, and the other, the necessity
for retaining temporarily an organi­
zation which was familiar with the
bank records and had an operating
mechanism. Similarly, the Independ­
ent Treasury system with numerous
subtreasuries was marked for abolition
but the work was deferred, as is told
elsewhere in this volume.3
It was always the plan of the
framers of the Reserve Act to secure
the ultimate correction of the country’s
patch-work currency. It was a hard
task, and is, with its difficulties in­
creased by the clamors of the many
who believe in fiat currency. How­
ever, provision is made for the ultimate
retirement of both United States
notes and national bank currency. A
return to stable conditions will permit
the execution of these provisions,
although little attention has been given
them as yet. The purpose of the Act
was to give the country ultimately a
currency composed of gold and re­
C h e c k C o l l e c t io n s a n d N o t e
serve notes, with silver certificates as a
I ssu es
sort.of necessary evil to supply the
demand for small bills. The disap­ It is in Section 16 under the general
pearance of the silver during the War title of “Note Issues” that there
called forth the amendment permitting appears the provision empowering
the issuance of reserve notes and Fed- every Federal Reserve Bank to “re­
3 See “The Assumption of Treasury Functions ceive on deposit at par . . . checks
and drafts, etc.”
by the Federal Reserve Banks.”

T h e R eserve A ct in I ts I mplicit M eaning

This and the paragraph which
follows were those over which came
the bitter controversy between coun­
try banks and Federal Reserve author­
ities. Of the merits or demerits of the
arguments which that controversy
aroused, nothing need be said here.
The only significance for present
purposes lies in the fact that “par
collections” are provided for in the
section devoted to note issues.
Around the question of note issue
raged a conflict for many years prior to
1913. The conflict harked back to the
Second Bank of the United States, the
era when only the states chartered
banks and every bank was a bank of
issue. It had the savor from Civil
War financial struggles; it had been
carried through the greenback strug­
gle; it changed its form, not its sub­
stance, when free silver was the cry, and
it had redivivous whenever elasticity of
the circulating medium was mentioned.
The ancient friends of much paper
money were reasonably quiet when the
advocates of a new banking system
talked of the project in terms of bank
reserves and credit, but when circulat­
ing notes were mentioned they were at
home and rampant. Also they had to
be dealt with and dealt with kindly and
diplomatically. If they should be
rubbed against the grain, there was
danger that paper currency would be
made so pronounced an issue that
everything else would be forgotten.
This was the manner of the argu­
ment, although argument was a weapon
of dubious value in that case: “Checks
are the great currency medium through
whose use the exchanges of commerce
are effected.^ Elaborate investigation
by the Monetary Commission’s ex­
perts has shown that something be­
tween 92 and 98 per cent of all pur­
chases are paid for with checks written
against bank deposits. If checks are
the chief medium of payment, they


serve the purpose of currency which
may properly and logically be con­
sidered as expressing the same kind of
credit in a different form.”
The reply to this was that, in such a
case, checks should be as good as
currency. Certainly they should al­
ways be worth par. It was further
agreed that elasticity demanded the
constant retirement as well as the
constant issuance of notes, because
checks were instantly cancelled and
retired once their work was done.
Out of it all came the inclusion of
“par collections” in the section on
note issues.
However vigorously the subsequent
conflict raged, the demonstration of
similarity between notes and checks
stood secure. The case had been
proved, for another purpose perhaps,
but proved nevertheless. In vain was
it argued that checks are a noncirculating, not a circulating medium.
In vain were private rights defended
and pleas made that the banker also
was worthy of his hire. Par collection
stands and perhaps, after all, it was a
small price the bankers paid for the
relegation of fiat money to the limbo
of obscurity.
There have been, of course, many
departures from the plans of a reserve
system as thought out by its pro­
moters and framers. The making of
twelve instead of eight reserve banks,
is one instance. In many ways
practical experience in operation has
overthrown the theories of the system’s
sponsors. In many others business
methods have been gradually altered
and habits changed to meet the new
banking scheme’s requirements. There
is much of political interest and much
of economic value buried in the
history of the struggle for a scientific
banking system. A little trip among
these buried treasures lets in light on
later interpretations of the law. And

T he A nnals

of t h e

despite the tremendous progress made
in Reserve Bank operation as the
result of war necessities, there were
distortions and stretchings of various
provisions of the Act. Not yet has there
been sufficient experience in times of

A m er ic a n A cadem y

stable business, to permit a conclusion
as to the complete sufficiency of the Re­
serve System but the foundation has
been laid securely. The makers of the
law builded well and in the face of
very great difficulties.

The Purposes of the Federal Reserve Act as Shown
By Its Explicit Provisions
By E. W.


K em m erer

Princeton University

HAT were the chief purposes of tively few branches, instead of one
the framers of the Federal Re­ central bank with many branches.
serve Act as those purposes There was nothing like this anywhere
revealed by the explicit provisions of in the world, at the time the
the Act itself? In answering this Federal Reserve System was created
question it will be well to consider (1) and, so far as I know, there is no his­
the framework of the Federal Re­ torical example of such a group of
serve System, namely, its plan of or­ central banks.
ganization and control, and (2) its There were two important economic
reasons for providing a group of cen­
The chief contribution made by the tral banks instead of one central bank.
framers of the Federal Reserve Act These were:
was in the plan of organization they
(1) The need of a system that was
proposed, the functions assigned to adaptable to widely different condi­
the Federal Reserve Banks being es­ tions in different parts of an immense
sentially the same as those recommended country like the United States, with
a few years previously for the National particular reference to rediscount rates,
Reserve Association of the Aldrich and, (2) the desire to decentralize the
Plan, as well as those of a number of control of the American money market
central bank plans still earlier proposed in such a way as to weaken New York’s
in this country. They are, moreover, alleged domination.
not very different from the functions One serious objection to a single
performed by the leading central central bank in the United States was
banks of Europe. In this paper, there­ the difficulty arising from the fact that
fore, attention will be given almost interest and discount rates for essen­
exclusively to the framework of the tially the same kinds of paper usually
differed considerably in different parts
of the country; rates in the West and
‘R e a s o n s f o r a G r o u p o f
South normally ruled higher than
C entral B anks
those in the Middle West, and rates in
To foreigners who study the Federal the Middle West normally ruled higher
Reserve System, the most striking than those in New England and the
fact about it is that it should have Middle States. It was believed that
twelve central banks with compara­ the establishment by a single bank of

T h e P u r po se s

of the

a single rediscount rate applicable
throughout the United States to the
same kind of paper, would be of
little use to New England and the
Middle States if the rate were ad­
justed to the higher level of rates pre­
vailing in the West and South, and
that, on the other hand, if the rate
were made as low as that prevailing in
the East, it would be so attractive to
the West and South as to result in a
dangerous expansion of the bank’s
loans in those sections at the expense
of the East. In time, of course, such a
flow of funds from the East to the
West and South would equalize rates
throughout the country; but the
amounts of capital involved were so
great that it was felt that a long
period of time would be required to
achieve territorial equalization of rates,
and the East was not favorably dis­
posed to the drain of its funds to the
West and South that such a movement
toward equalization seemed to re­
quire. The maintenance by a central
bank of different discount rates in
different parts of the country on the
same kind of paper, it was believed,
would be politically (and probably
also legally) impossible.
Although there were other kinds of
desirable adaptability to different
economic conditions in different parts
of the country, it appeared on close
examination that for most purposes
sufficient autonomy could not be
given to branches of a single central
bank to enable them to adapt the
character of their services to varying
local conditions.
The second reason for preferring a
group of banks was the widespread
feeling that the banking system of the
country was being unduly central­
ized in New York City, where a very
large part of the deposited bank re­
serves of the country were held and
where control was widely believed to be

F e d e r a l R e se r v e A ct


exercised, sub rosa, by a handful of
so-called Wall Street banks. The
Pujo Committee’s “Money Trust”
investigation had strengthened this
popular belief, particularly through
the West and South. A single central
bank, it was widely believed, would be
increasingly dominated by New York,
while a group of banks, it was argued,
would weaken New York’s control by
causing the growth of a group of
territorially centralized money markets,
each of which would handle a large
part of the business of its own dis­
trict, and, to a greater or less extent,
would compete with New York for
open-market business.
These were the main reasons why
the law provided for eight to twelve
banks -instead of one, and why the
New York district was limited to such
a small area with a strong Boston
district at the northeast and a strong
Philadelphia district at the south.
C haracter of F ederal R eser v e
. B oard

The proposal that the central govern­
ing board of the new system should be
composed entirely of government ap­
pointees was met by a strong protest
throughout the country, particularly
from the banking fraternity. It was
claimed by many that such a board
would inevitably be constituted of
inefficient political appointees and
would be politically controlled, thereby
making the Federal Reserve System
the football of politics. Much was
made of the claim that the bankers,
who presumably would furnish the
entire capital of the Federal Reserve
Banks and who would be responsible
for it to their stockholders and de­
positors, would have no voice what­
ever in the appointment of the board
which was to control the broad policies
of the new banks. This central board
of seven men to be appointed exclu­


T he A nnals

of the

sively by the President was in striking
contrast to the central board pro­
posed by Senator Aldrich. Under
his plan the board was to consist
of forty-six directors of whom fortytwo, including the governor and the
two deputy-governors, were to be
appointed directly or indirectly by
Despite the vigorous opposition to
the proposal that the central board of
the Federal Reserve System be ap­
pointed entirely by the President, the
proposal was adopted. It should be
noted that this board was not to do a
banking business. That was to be
done exclusively by the twelve banks,
six of the nine members of the board of
directors of each being elected by the
member banks. It was primarily in the
field of determining broad questions of
policy that the Federal Reserve Board
was to function, and in this field, it was
claimed, the need was for financial
statesmen who would view their prob­
lems broadly from the standpoint of
public service. This was true be­
cause the functions proposed for the
Federal Reserve System, like those
that had previously been proposed for
the National Reserve Association of
the Aldrich Plan, were affected with a
great public interest. On this sub­
ject the writer in 1913, summarizing
the conclusions of an address given by
him in 1911, said as follows:1
Is not the National Reserve Association
too much of a public institution to be so
largely controlled by one type of business
interest, that is, that of the banking fra­
ternity? We must get away from the
prevalent idea that ihe National Reserve
Association is to be principally a bankers’
affair just because its capital is to be
1 See “ Banking Reform in the United States,”

American Economic Review Supplement, March,
1913, pp. 54 and 55; and “ Some Public Aspects
of the Aldrich Plan,” Journal of Political
Economy, December, 1911, pp. 819- 830.

A m er ic a n A cadem y

furnished entirely by banks. We must
bear in mind that its public deposits alone
will for some time probably exceed its
paid-up capital, that the funds which the
banks deposit with the Association will be
chiefly those which the public has de­
posited with the banks, and that the paper
which the banks rediscount with it will be
that of the business community. We
must not forget that the National Reserve
Association is to have a tremendous
public power and responsibility, through
its right to fix the bank rate of discount, its
power over the foreign exchanges and gold
shipments, its right to issue the country’s
only elastic paper currency, its supervisory
power over banks, and its function of
holding a large percentage of the country’s
reserve money, together with the privilege
of having its promises to pay, in the form
of its deposits and bank notes, counted as
lawful reserve money for banks. Now it
is possible, although by no means certain,
that the interests of bankers as a class and
those of the public are identical. It is
certain, however, that history furnishes
numerous instances in which what the
public believed to be its interest and what
bankers believed to be theirs were in con­
flict. One need not go back farther than
the last two or three years to find a striking
instance of the kind in the United States.
I refer to the movement leading to the
establishment of the United States postal
saving depositories, which was opposed
vigorously and almost unanimously by the
banking fraternity. It is furthermore
true, and perhaps of greater importance,
that a large element in the country be­
lieves the interests of bankers to be in
conflict with those of the general public on
a great many vital questions.
Although Congress and the Presi­
dent did not budge an inch in their
insistence upon making the Federal
Reserve Board an exclusively govern­
ment board, they threw a sop to the
opposition by inserting in the law the
provision for a “Federal Advisory
Council” of bankers, one member to be
selected annually by the board of
directors of each Federal Reserve

T h e P u r po se s

of t h e

Bank from its own district, making
the number of members in the Council
equal to the number of Federal Re­
serve Banks. The relations of this
Council to the Federal Reserve Board
were to be entirely advisory. Neither
voting nor veto power was given to
the Council, which was required to
meet at least four times a year and
oftener, if called by the Federal Re­
serve Board. Members of the Fed­
eral Reserve Board who were to be
“on the job” three hundred days in
the year, it was generally thought,
would not be likely to be greatly in­
fluenced as to their own job by a group
of advisers coming from widely sepa­
rated parts of the country who would
meet infrequently. Happily during
the last year or so, the Advisory
Council has belied this expectation.
F ederal R eserve B ank
D ir e c t o r a t e s

In its provisions for the directo­
rates of the Federal Reserve Banks,
the Act well reveals the purpose of its
framers to create a group of federated
organizations that at one and the
same time would (1) recognize the pub­
lic’s dominant interest in matters of
broad policy; would (2) recognize the
dominant interest of the banker and
the banker’s business customer in the
narrower banking questions, such as
the goodness of the paper against
which advances were to be made, the
amounts to be loaned individual mem­
ber banks, the quality of open-market
investments, and the like, and would
(3) permit of a democratic control
among the member banks of this
banking business.
Of the nine members of the board of
directors, three (including the chair­
man and the vice-chairman of the
board) are Class C directors, who are
appointed by the Federal Reserve
Board and are directly responsible to

F e d e r a l R e se r v e A ct


that Board. Their salaries are fixed
by the Federal Reserve Board, and
that Board may suspend Class C
directors or remove them from office.
These directors are the connecting
links between the central Board and
the Federal Reserve Bank. They
keep the central Board informed as to
the developments in each Federal Re­
serve Bank. It is through them that
the Federal Reserve Board exercises its
control over the broad policies of the
Federal Reserve System and compels
the necessary teamwork among the
twelve banks.
This same sort of representation and
control on the part of the Federal
Reserve Board is carried through to
the branches of the Federal Reserve
Banks, each of which is operated under
the supervision of a board of directors
“to consist of not more than seven
nor less than three directors, of whom
a majority of one shall be appointed by
the Federal Reserve Bank of the dis­
trict, and the remaining directors by
the Federal Reserve Board.”
The other six directors, constituting
two-thirds of the board, are elected by
the member banks. Their concern is
primarily with the banking operations
of the bank, notably the character and
quantity of its rediscounts and col­
lateral loans for member banks, its
open-market operations, its discount
rate policy (subject to the approval of
the Federal Reserve Board), and the
like. Of course, the Class C directors
likewise vote on these banking ques­
To every bank loan and to every
bank deposit, there are at least two
directly interested parties, the bank
and the bank’s customer. The bank’s
customer is usually a business man or a
business concern (using those terms
in their broader meaning). In rec­
ognition of this dual interest in most
banking operations, the Federal Re­

T h e A n n a Ls of t h e A m er ic a n A cadem y
serve Act provided that, of the six changed through the repeal of the
directors who were to be primarily requirement that each of the three
concerned with the direct banking groups of banks should “contain as
operations of the Federal Reserve nearly as may be one-third of the
Bank, three, known as Class A direc­ aggregate number of the member
tors, should “be representatives of banks of the district . . .” and the
the stockholding banks”—as a matter substitution therefor of the provision
of fact they are practically always that “the Federal Reserve Board
bankers—and that the other three, shall classify the member banks of the
known as Class B directors, should at district into three general groups or
the time of their election be “ac­ divisions,” without placing any re­
tively engaged in their district in striction whatever upon the number of
commerce, agriculture, or some other banks that should be placed in each
industrial pursuit.” Here is the recog­ group. This looked like a step away
nition of the interest of the non­ from the original democratic prin­
banking business community in the ciple of one bank one vote—a prin­
banking operations of the Federal ciple followed in the elections of most
Reserve Banks.
of the clearing house associations. It
The purpose of democratizing such clearly increased the power of the
control over the Federal Reserve Federal Reserve Board over the
Banks as should be exercised by Class election of Class A and Class B
A and Class B directors is seen in the directors.
rather unique provisions for the elec­ How far the original plan of group­
tion of directors contained in the Act ing the member banks, for purposes
as originally passed. This Act di­ of electing directors, into three ap­
vided all member banks of each proximately equal groups of banks
district into three groups, each group has since been departed from by
containing “as nearly as may be one- the Federal Reserve Board in exer­
third of the aggregate number of the cising the authority conferred by the
member banks of the district and . . . above-mentioned amendment, will be
[to] consist, as nearly as may be, of seen from the following figures. A
banks of similar capitalization.” Each week after the amendment had been
of these groups was to elect one Class passed the Board made a reclassifica­
A director and one Class B director, tion of member banks for the twelve
on the democratic plan of “one bank districts, which, when taken by totals
one vote” regardless of the size of the for all districts, placed 515 banks or 6.4
bank. Under this plan the peculiar per cent of the total number (i.e., 8,099)
interests of the small banks, of the in group I, the large-bank group;
middle-sized banks and of the large 2,384 banks, or 29.4 of the total, in
banks, respectively, were assured rep­ group II, the middle-sized-bank group;
resentation. The democracy of a and 5,200 banks, or 64.2 per cent of the
plan that gave the same voting power total, in group III, the small-sizedto the bank of $25,000 capital that it bank group. According to this re­
gave to the bank of $250,000 capital arrangement, therefore, the 515 largest
and to that of $25,000,000 capital banks in the respective districts could
made a strong appeal to those who now elect the same number of Class A
and Class B directors that the 5,200
feared “Money Trust” control.
By an act of September 26, 1918, smallest banks could elect, or the
the method of choosing directors was same number that the 2,700 largest

T h e P u r po se s

of t h e

banks could previously have elected.
There may have been good reasons for
this great change in the grouping,
increasing the power of the large bank
at the expense of the smaller, but, so
far as I know, the Federal Reserve
Board has given little or no publicity
to the change itself or to its reasons for
making it. The amendment author­
izing the change was passed at the
Board’s request.
M e m b e r s h ip

Membership in the Federal Re­
serve System was limited to commer­
cial banks and trust companies, show­
ing that the System was expected to
function in the field of short-time
active business operations rather than
in the fields of capital and real estate
transactions occupied so largely by
savings banks, private banks and in­
vestment houses. National banks,
operating as they did under Federal
charters, were expected to play the
game according to the new and im­
proved national rules laid down by the
Federal Reserve Act. If they were
unwilling to accept these rules they
were invited to get out of the national
system. State banks and trust com­
panies possessing adequate capitals
and conforming in their operations to
sound banking practices were per­
mitted and encouraged to become
members of the Federal Reserve
System. The Act clearly contem­
plated a large membership of state
C a p it a l a n d D iv id e n d s

It was hoped that enough banks
would enter the System from each
district to assure an adequate capital
for each Federal Reserve Bank, but
among bankers the opposition to the
Glass-Owen bill had been so pro­
nounced and widespread, and threats
had been so frequently expressed by

F e d e r a l R e se r v e A ct


officials of national banks that they
would give up their Federal charters
and reorganize as state institutions if
the Glass-Owen bill in anything like its
existing form should become a law,
that the framers of the Act undertook
to assure the establishment of a Fed­
eral Reserve Bank in each district by
providing that, if sufficient banks
should not join the System, the
capital could be subscribed by the
public or by the government itself.
In the early stages of the bill
through Congress the required stock
subscription was based upon the capi­
tal of the member banks, but the
basis was later changed to capital and
surplus, the percentage required being
reduced. The distinction between a
bank’s capital and its surplus is at
best a rather arbitrary one and is
essentially legal, rather than economic.
Had the basis been capital alone, a
bank desiring to keep its subscription
to Federal Reserve Bank stock low,
would have been encouraged to in­
crease its surplus at the expense of its
D i s t r i b u t i o n o f P r o f it s

The original Act provided that from
the net earnings an annual dividend of
six per cent, which should be cumula­
tive, should be paid on the paid-in
capital stock; that, of the balance of the
net earnings, one-half should be paid into
a surplus fund until the surplus should
amount to 40 per cent of the paidin capital, and that the remainder
should be paid to the United States as
a franchise tax. An amendment of
March 3, 1919, provided that after the
six per cent dividend is paid the whole
of the net earnings of each bank shall
be carried to surplus until the sur­
plus shall amount to 100 per cent of the
subscribed capital, and that, after this
100 per cent surplus shall have been
accumulated, 10 per cent of the net


T he A nnals

of t h e

earnings, above the dividend charges,
shall be transferred to surplus indefi­
nitely. A bank withdrawing from
the System receives back the capital
it has paid in and any accumulated
dividends but cannot take one cent of
the accumulated surplus. The two
hundred odd millions of surplus al­
ready accumulated by the twelve
Banks would therefore go to the
government should the Banks go out
of business.
Net earnings paid to the United
States by the Federal Reserve Banks,
the law provided, “shall in the dis­
cretion of the Secretary, be used to
supplement the gold reserve held
against outstanding United States
notes, or shall be applied to the re­
duction of the outstanding bonded in­
debtedness of the United States. . . .”
The significance of these provisions
concerning earnings, briefly stated, is
apparently as follows: The Federal
Reserve Banks are to be administered
with primary reference to the public
service, and member banks are to re­
ceive their returns chiefly in the
services rendered them directly by
the Federal Reserve Banks and in the
safer and more stable financial condi­
tions throughout the country which
the Federal Reserve System creates.
The desire for large cash profits is to
have no influence in determining the
policies of the Federal Reserve Banks.
Their actuating motives must be
found in service to the member banks
and, through the banks, to the public.
If, incidentally, large profits are real­
ized they must go to the government.
To date the profits of the twelve
Federal Reserve Banks have been so
large, chiefly as the result of war and
post-war demands upon the System,
that it seems improbable that the
call for the other 3 per cent of stock
subscription authorized by the Act
will ever be made. On November 9 ,

A m er ic a n A cadem y

1921, the paid-in capital and accumu­
lated surplus of the twelve Federal
Reserve Banks was $317,000,000, an
amount $28,000,000 greater than 6
per cent of the capital and surplus of
all the member banks plus 40 per cent,
namely, the maximum capital and sur­
plus contemplated by the Act of 1913
for the twelve Federal Reserve Banks.
When the Federal Reserve Act was
passed there was a widespread hope
among economists and bankers that
any profits accruing to the government
through this franchise tax would be
used for the first of the two purposes
authorized, i.e., “to supplement the
gold reserve held against outstanding
United States notes.” The increase
of this reserve by slightly less than
$200,000,000 would have been suffi­
cient to transform all of our green­
backs into gold certificates and thus
retire from circulation one of the most
undesirable elements in our motley
collection of paper money. Of the
$ 117,000,000 so far either paid to the
government in franchise taxes by the
twelve Banks or due and set aside by
them for the government, all has been
absorbed by the war debt and not a
dollar has gone into the building up of
the reserve against greenbacks.
F u n c t io n s o f F e d e r a l R e s e r v e
B anks

As stated at the beginning, the
limits of space will permit only a few
words concerning the purposes of the
Act as revealed in the functions
assigned the Federal Reserve Banks.
These functions are clearly defined in
the Act and their general character is
understood by all students of the
System. They are, moreover, broadly
speaking, the functions performed by
central banks throughout the world.
Chief among them are the following:
(1) The centralization and mobili­
zation of bank reserves;

T h e P u r po se s

of t h e

(2) The rendering more elastic of
bank credit, both bank notes and
bank deposits;
(3) The creation of a more efficient
and cheaper clearing and collection
system for checks;
(4) The improvement of facilities
for financing our import and export
trade at home, and finally
(5) The providing of a satisfactory
depository and fiscal agency for the
Federal government.
Reserves are centralized through
the requirement that legal reserves of
member banks shall consist exclu­
sively of deposits in their respective
Federal Reserve Banks. These re­
serves are largely centralized in the
Gold Settlement Fund and the Federal
Reserve Agents’ Fund, and are ren­
dered mobile through interbank dis­
counts and through open market
Elasticity of circulating credit is ob­
tained through the machinery of redis­
counting commercial paper, through
direct collateral loans—machinery com­
mon to most central banks—and
through open-market operations. The
old-time stone-wall reserve require­
ments are done away with, and there is
no limit below which a legal reserve
cannot now be reduced provided the
bank concerned is willing to pay the
price. An elastic asset bank-note cur­
rency is superimposed upon the old
rigid bank-note currency, although out
of deference to the opinions of certain
persons of high political influence in
1913, who believed that the issuance of
bank notes was an exercise of the essen­
tially government function of issuing
money, the Federal Reserve notes are
made to emanate from the government
and made subject to a government in­

F e d e r a l R e se r v e A ct


terest charge, at the discretion of the
Federal Reserve Board—a charge that
has never been imposed. The Federal
Reserve notes therefore, in form, have
some of the qualities of government
paper money, but, in substance, are
almost a pure asset currency possess­
ing a government guaranty, against
which contingency the government
has made ho provision whatever.
When the Glass-Owen bill was be­
fore Congress the provisions looking
toward the parring of checks through
the establishment of an extensive
clearing and collection system were
widely opposed by bankers, who
claimed that they were the work of
theorists and visionaries. The subse­
quent development of this clearing and
collection system has gone beyond the
dreams of the most visionary of the
visionaries of 1913.
The extension of the use of bank
acceptances and of dollar exchange in
the United States, and the develop­
ment of a broad and active discount
market for paper arising out of
foreign trade—objects clearly sought
by the Federal Reserve Act—were
substantially attained much more rap­
idly than had been expected, as a
result of the dominant position in the
world’s trade and finance which New
York obtained, temporarily at least,
through the War.
The movement in the direction of
making the Federal Reserve Banks the
exclusive depositaries of Federal govern­
ment funds was checked by our entrance
nto the War; but, as a result of the
discontinuance of the subtreasuries, the
fiscal agency functions of the Federal
Reserve System which were enormously
enlarged by the War, have since been
still further extended.

Political Pressure and the Future of the Federal
Reserve System*




W arb urg

Member of the Federal Reserve Board 1914-1918

ROM the earliest beginning it was target of ambitious business men or
obvious that, in order to be suc­ scheming politicians, maximum effi­
cessful, any attempt at a thorough
ciency had to be subordinated to maxi­
banking reform in the United States mum safety.
would have to approach the subject The writer’s original plan, “A United
from two angles: one, from the point Reserve Bank of the United States,”
of view of pure banking technique, the proceeded on these lines; so did, subse­
other, from the point of view of ad­ quently, the Aldrich “ National Reserve
ministration. The problem was to Association of the United States” and,
devise a plan carrying conviction not later on, the Federal Reserve plan.
only as a sound and effective piece of Each of these schemes followed the
banking machinery, but also as offering lines of merging the country’s dead
reliable safeguards against any possi­ gold reserves into one live organiza­
bility of the control of the system’s tion; of building upon this more or less
passing into the hands of either “big centralized gold an elastic note issue;
business” or the politician. If legisla­ and having thus centralized the scat­
tion was to be secured and, indeed, if tered forces of the nation into one
the future of the system was to be organic structure, of once more decen­
protected, a formula had to be found tralizing its administration and organ­
under which these two elements would ization, and circumscribing it far
be called upon to balance one another. enough to prevent the dangers of
If the new banking system was to re­ abused power and of one-sided control.
main safe and sound, its administration The advocates of a pure central bank
had to be shielded from the danger of had to reconcile themselves to a lower
becoming subservient either to business banking ideal by surrendering to
or to politics, and, conversely, safe­ the political requirements of the case.
guards had to be provided against busi­ Conversely, the sworn antagonists of a
ness’ or politics’ becoming subservient central banking system had to sur­
render their political ideal, the gospel
to the new banking system.
From the bare point of view of effi­ of decentralized banking, in order to
ciency and economy, one central bank provide a system that would be work­
with a purely business management able as a banking proposition.
would undoubtedly have yielded the Thus the Democrats, starting with
best results, but from the point of view the thought of a large number of dis­
of what was required in the larger inter­ connected reserve banks, ended in ty­
est of the country, of what was essen­ ing them together into a central bank­
tial in order to prevent the system, ing system, in its essential features not
once established, from becoming the very dissimilar (though differing in
* Adequate treatment of this subject would Aldrich important details) from the
require more time and study than was possible other end. which had started at the
under the circumstances and more space than
Disregarding the question of which
could be given in this volume. P. M. W.

P olitical P r e s su r e

side made the largest share of valuable
contributions and mistakes and, deal­
ing with the topic simply from the point
of view of sincere appreciation of the
banking system which we enjoy today,
the problem now before us is to exam­
ine what remains to be done in order to
promote and protect its future.
A study of four years from within the
System and of almost four years from
without, leads me to think that its
gravest danger lies in the gradual
ascendency of political influence.
The Federal Reserve System, as
such, is based upon the perfectly sound
and happy theory of placing the actual
management of the Federal Reserve
Banks in the hands of boards of direc­
tors, the majority of whom are ap­
pointed by business men. The direction
of the System as a whole, on the other
hand, its policies and its supervision,
are vested in the Federal Reserve
Board, which consists of five members
appointed by the President and con­
firmed by the Senate. These members
are appointed for ten-year terms and
the Governor and Vice-Governor are
designated by the President and serve
at his pleasure. The Secretary of the
Treasury and the Comptroller of the
Currency are members ex officio. The
Secretary of the Treasury is Chairman
of the Board.
Among the many Presidents, Secre­
taries of the Treasury, Senators, Con­
gressmen and Comptrollers of the Cur­
rency that I have known, there have
been good ones and bad ones, some ad­
mirably strong and some lamentably
weak. And therein lies the danger for
the future: As long as there are two ex­
officio members of the Board, who are
constantly subjected to political pres­
sure; so long as every President has the
power to play favorites with Board
members by promoting them to the
positions of Governor or Vice-Governor
or demoting them at will; so long as one

and the

F u tu r e


or two members may be vulnerable
because their terms are about to expire,
it can readily be seen how easy, and
therefore tempting, it is for the political
members to assert their influence, and
how unpleasant and unenviable may
be the lot of members struggling to
preserve their independence and selfrespect.
When members of the Board are
hounded by senators or congressmen
because they do not think it proper to
flood the country with easy money, just
because elections are coming; or when
they refuse to believe that excessive
fluctuations in foreign exchanges during
the War were due to Wall Street specu­
lation and could be regulated or con­
trolled by the Federal Reserve Board;
or when they are viciously criticised
because they will not accede to the
belief that fake easy money can coun­
teract the effects of overproduction of
important staples when a period of
reduced world consumption is encoun­
tered—it is, at best, not easy to find
men of importance willing to make
the material sacrifices involved in serv­
ice of the Federal Reserve Board.
It will become increasingly hopeless,
however, to secure such men if some of
the defects in the organization of the
Board as above described are not
promptly removed and the dignity and
independence of the office of member
are not enhanced. To state it briefly:
The Governor and Vice-Governor ought
to be elected by the Board itself;
or they should serve in rotation, and
the office of the Secretary of the Board
might, in the latter case, be developed
into that of something like a “general
manager,” or the Governor ought to
be designated for the full term of his
membership. The Governor ought to
be the Chairman of the Board and,
instead of the Secretary of the Treas­
ury, who hardly ever has the time to
attend Board meetings, the Assistant

T h e A n n a l s of t h e A m er ic a n A cadem y
Secretary of the Treasury ought to important becomes the Federal Re­
become an ex-offico member of the serve Board as the sole organic link
Board. There should be an additional connecting them all. The weaker the
member of the Board, who should ex­ single districts and the more discon­
ercise the main functions now resting nected they are, the more difficult, and
in the Comptroller of the Currency. at times desperate, becomes the task
The vast powers now vested in the of the Federal Reserve Board to coax
Comptroller are the remnants of an or club these autonomous units into
undemocratic, antiquated and danger­ prompt and effective cooperation. The
ous system. Moreover, the present Board was planned to be preeminently
condition has led in the past to costly a supervisory and directive body; ex­
delays, duplication of work, inefficiency cessive decentralization was bound to
and unbearable irritation. Examina­ force it more and more into the exercise
tions and rulings concerning banking of administrative functions, which—
operations ought to be made by one for men located at Washington, unable
body and not by two, if a prompt and to be in personal close touch with
efficient administration is to be assured. actual business conditions and opera­
In the past, Board members often have tions in twelve separate and remote
had to wait upon the good graces—or districts—naturally became more be­
bad graces—of the Comptroller before wildering and troublesome than was
any headway could be made in im­ advisable or necessary.
portant matters. The situation bris­ The fundamental thought of reserve
tled with humiliating and distasteful banking is that the idle money of one
incidents. It seems ridiculous that the industry or section should become
Board should have appeared before available for the seasonal requirements
Congress with one set of recommenda­ of another. Federal Reserve Districts,
tions and the Comptroller, a Board therefore, which are “all cotton” or
member, with another, often entirely in “all grain” were from the beginning
conflict with the policies of the Board. doomed to fail as independent districts;
Unless the Federal Reserve Board is seasonal requirements were bound to
raised to a position of the greatest exhaust their loaning power too rapidly.
possible dignity and men of real While they could secure assistance
strength, independence and knowledge through the somewhat clumsy pro­
are found to serve upon it in the future, cedure of rediscounting with other
it is to be feared that the System will Federal Reserve Banks under the di­
become the football of politics. A rection of the Federal Reserve Board,
splendid instrument of protection they generally would be inclined to
might thus become an element of dan­ hesitate to resort to these rediscount
operations, inasmuch as they would
gerous disturbance.
This danger is all the more real be­ tend to emphasize the organic weak­
cause of the unfortunate action of the ness or temporary exhaustion of their
Organization Committee in establish­ districts. Unfortunately the Organiza­
ing twelve Federal Reserve Banks in­ tion Committee disregarded this funda­
stead of beginning with eight, as the mental principle and the districts of
Federal Reserve Act had permitted St. Louis, for instance, and its sur­
them to do.
rounding Federal Reserve districts
The larger the number of Federal were delineated with about the same
Reserve Banks and the greater the regard for economic questions as were
consequent decentralization, the more Austria and her so-called Succession

P olitical P r e s su r e

States at Versailles. Owing to this
absence of a sufficient diversification
of interests and minds, local banking
factions and self-centered provincial­
ism have from the beginning played
too large a part in framing the boards
of directors, the managements and the
policies of many of the twelve Federal
Reserve Banks, with little understand­
ing of the national questions involved.
Much bitter feeling and criticism were
caused, particularly in the agricultural
sections, by unnecessary and irritating
mistakes made in fixing interest charges
or in applying ill-advised methods of
administration. Whatever anticipa­
tory words or warning in this regard
were given to Congress and later to
the Organization Committee, unfortu­
nately, have proved only too true,
including the prophecy that an ex­
cessive number of Federal Reserve
Banks would prevent the establishment
of large financial centers outside of
New York, where important open dis­
count markets could develop.
It is a great loss for the country that
at the time of the formulation of the
law and the establishment of the Sys­
tem it was impossible to convince the
sections involved that a Federal Re­
serve branch bank could convey the
same benefit as a Federal Reserve Bank;
indeed, that as a branch of a larger
district a region would be better
served than as a self-contained district.
Minneapolis, as a branch of Chicago,
would have been as well provided for as
Detroit, but it would enjoy a rate of
5 per cent instead of its present 5|
per cent rate. The same holds good
for Dallas and Atlanta.
As stated before, the weaker the
Federal Reserve Banks, the stronger
must be the Federal Reserve Board.
This is all the more essential because
the Board appoints the C class di­
rectors. The latter often constitute
very important elements of safety and

and the

F u tu r e


must be appointed, political pressure
notwithstanding, solely from the point
of view of securing the men best quali­
fied for the protection of the Banks.
Finally, the future of the local manage­
ment of all banks, in short, the morale
of the entire System, will depend upon
the character of the Federal Reserve
If the Federal Reserve System was
able to accomplish its phenomenal
development and if it could respond so
splendidly to the trying demands of
the war, and of the post-war periods,
it was largely due to the devotion,
vision and ability of members of the
Federal Reserve Board and of some of
the Federal Reserve agents and gov­
ernors of Federal Reserve Banks, who
perfected and developed the System
into the extraordinary banking organi­
zation it is today. Strong and excep­
tional men made themselves the leaders
of the rest. Without them, the System
would have failed. Such men today
are still serving the System, though
from the material point of view many
of them could do vastly better for them­
selves in other fields. If politics should
creep into the Board, these men will
gradually drop out, and from top to
bottom the System will deteriorate.
If the administration of the Federal
Reserve System, in Washington and in
the banks, should then fall into the
hands of weak and incapable men who
only see “fat jobs” in the positions,
instead of those who today devote
themselves to the work at a personal
sacrifice because they see in it an
opportunity for public service, there
are dark days ahead for the country.
Government must exercise an effec­
tive control over business in its admin­
istration of the Federal Reserve Banks;
but this control must be exerted
through a Federal Reserve Board com­
prising men of the highest integrity and
efficiency—men who do not seek the

T he A nnals


of the

job and would not hesitate to surrender
it, if either business or politics should
interfere with the independent exercise
of their duties for the best advantage of
the country as a whole.
If that is to be achieved, and the
future of the Federal Reserve System
is to be assured, the people themselves
must take a hand. They must never
fail to rally to the support of these
faithful servants when unfairly at­
tacked, and they must not lose any
opportunity of showing them that their
services are appreciated. If the people
do not prove that they honor their
leaders and stand by them loyally, what
incentive is there for these leaders to
hold out?
In a similar manner, Congress must
feel that whoever dares to encroach
upon the independence of the Federal
Reserve System attacks the most sa­
cred treasure of the people. In Wash­
ington I came to know many upright
men of the very highest type; never­
theless a large number of our political

A m er ic a n A cadem y

leaders might prefer that the Federal
Reserve System be subservient rather
than independent. They want open
doors for patronage and a ready com­
pliance with the wishes of their con­
Protection for the Federal Reserve
System must, therefore, not be expected
from Washington, unless it is possible to
arouse and strengthen the small num­
ber of distinguished men in the Admin­
istration, and in Congress, who would
understand the danger and would fight
to ward it off. They will win if the
country makes Congress understand
that its heart is in it. If the people
cease to exercise vigilance, if ever they
relax in their insistence upon the integ­
rity of their banking system, it may
develop, as it did before, from the
greatest blessing into the gravest men­
ace. A Federal Reserve System turned
into a political octopus, a national
Tammany Hall, would infest not only
the counting houses but every farm
and hovel in the country.

Early Functioning of the Federal Reserve System


A rthur R eynolds

President, Continental and Commercial National Bank of Chicago

N October 26, 1914, the Secretary the Federal Reserve Board in its first
of the Treasury sent a message report after two months of operation,
to the twelve Federal Reserve Banks, defining the general scope of activi­
then organizing, instructing them to ties of the Federal Reserve Banks.
begin definite operations on November There being no extraordinary times to
16, 1914. Great haste was made to call for the protective function as set
secure adequate quarters and a working forth in the above definition of policy,
staff. One-sixth of the capital stock the operation of the Federal Reserve
subscriptions were called on November System during the first two years was
2, 1914, and on the sixteenth of No­ confined largely to efforts, first, to
vember the Banks formally opened for “unify the banking system of the
country” by seeking new members
“Regulation in ordinary times, as among the ranks of the state banks;
well as protection in extraordinary second, to endeavor to regulate interest
times” was the principle laid down by rates and Equalize the demand for

They had been educated to believe that
deposits were the indication of strength,
and that borrowed money was a sign
of weakness. Any rediscounts or bills
payable which they might lodge with
the Federal Reserve Banks would ap­
pear in their statements, and since, in
many instances, they could obtain
credit from their city correspondents
through methods which did not involve
the direct obligation of their banks, and,
therefore, did not appear as borrowed
money, they were quite content to
utilize the credit facilities of those city
correspondents. It must be remem­
bered that at this time there were no
unusual conditions confronting the
country; rates were low and money
was easily obtainable. Bankers out­
side of reserve centers had, over a con­
siderable period of years, built up their
relationships with reserve city and
central reserve city correspondents.
Those who had occasion to borrow for
seasonal requirements were intimately
acquainted with the city banks which
had met their needs. Those banks
which had for many years maintained
balances with other banks felt that they
had a cumulative asset of which they
could avail themselves should the
occasion arise. There was mutual
understanding between correspondents,
while the Reserve System was an un­
tried departure.
It will also be remembered that the
Federal Reserve Act did not make pro­
vision for the turning of all reserve
funds over to the Reserve Banks. The
change was gradual. Old relations
between banks were, therefore, not
All of these things militated against
the fullest possible functioning of the
System in its early stages, and such
rediscounts and bills payable as were
lodged with the Federal Reserve Banks
were largely in the nature of “courtesy
transactions” on the part of friendly

E arly F u n c tio n in g

money by the purchase of bills and
acceptances in the open market, and
third, to establish a par collection
system and the clearance of all checks
on member banks.
The men charged with the operation
of the Federal Reserve System, upon
its inception, promptly sought to induce
the banks of the country to make full
use of its facilities. They were influ­
enced, undoubtedly, by the feeling on
their part that it was necessary to keep
employed such funds as were entrusted
to them in order to pay expenses and to
earn dividends upon the capital stock.
They felt that member banks should
rediscount with the Reserve Banks,
and by one means and another endeav­
ored to accomplish this. But in the
early history of the System it was des­
tined to meet with no such ready
response. The old banking practice
of the country had its basis in too many
years of actual habit, and it was but
natural that banks generally should be
hesitant and cautious in making radical
changes in their methods; indeed, a
great many of them felt that the Fed­
eral Reserve Banks, if supported too
generously, would ultimately encroach
upon and usurp some of the functions
of existing banks. They were loath,
therefore, to go farther than the mere
subscription of capital. It was inevi­
table that a great many bankers in the
country should look upon the System
as a government undertaking and fear
that transactions with it would be in­
volved in “red tape.” They feared
also that it would be influenced by
P r e j u d ic e A g a in s t R e d is c o u n t in g

Coincident with this, and one of the
greatest difficulties in the way of those
who were ambitious for the quick ac­
ceptance of the System, was the long­
time prejudice of bankers against dis­
closing their borrowings to the public.

of t h e

S ystem

T he A nnals of th e
bankers who wished to help educate
the banking fraternity to use the
Federal Reserve facilities.
“ C o u r t e s y T r a n s a c t io n s ”

A m er ic a n A cadem y

tion encountered when the Reserve
Banks undertook to make it compul­
sory upon all banks to accept their own
items at par.

T h e State B an k P roblem
Comment by the Ninth District
The early attempts to obtain new
Reserve Bank in its report for the year
1915 is illustrative of the general condi­ members from the ranks of the state
tion confronting all of the Reserve banks were bitterly opposed in many
quarters. Legislation was even re­
Banks at that time:
sorted to in combating the advances of
During the latter half of November and
the month of December, 1914 , such redis­ representatives of the Federal Reserve
counts as were afforded members were Banks in this direction. In its second
largely courtesy transactions, the greater annual report on December 31, 1915,
part representing the efforts of larger banks the Federal Reserve Board observed:

to acquaint the public with the new Federal
Reserve currency. After January 1, 1915
. . . loans dropped to the lowest ebb
in many years. Rates on commercial
paper took new low levels. . . .

The one great plaint during this time
was the non-payment of interest upon
balances carried at the Reserve Banks.
In the report containing the preceding
comment of the Minneapolis bank,
Pierre Jay, Federal Reserve agent at
New York City, said:
. . . it is among the country banks as
a class that most of the apathy and hostility
to the Federal Reserve System which still
persists is found. Their opportunities and
earnings are relatively small and they must
figure closely to live. They feel the loss of
interest on reserve deposits; the absence, as
yet, of dividends on their capital contribu­
tions, and the prospective loss or decrease
of the exchange they generally charge on
remitting for checks drawn upon them.

The institution of the par collection
system met with great disapproval
from many banks in the smaller com­
munities where the earnings derived
from exchange charges had for many
years constituted a comparatively sub­
stantial part of the total earnings.
Some banks sought to surrender their
national bank charters and incorporate
as state banks. This was only the
forerunner of the more serious opposi­

I t is an unfortunate fact that, in some of
the states, reserve requirements for state
banks and trust companies have been mate­
rially lowered by legislative enactment since
the adoption of the Federal Reserve Act.
. . . This is an element of danger in
our banking system, because the weaken­
ing of the reserves of the state banks and
trust companies makes them more vul­
nerable in times of emergency. . . . I t
would be deplorable were feelings of state
or local pride to lead any of the states into
competition with the Federal Reserve
System such as would prompt them to
lower their own banking standards or
reserve requirements with a view of ena­
bling or inducing state banks to refrain from
taking membership therein. The Board is
satisfied that state banks gain in safety and
th at states sacrifice none of their preroga­
tives or powers when such banks become
members of the Federal Reserve System,
and therefore, expresses the hope th at no
seeming divergence of interest will be per­
mitted to impede the establishment of
higher standards of banking.

Every means was employed to make
memberships in the System attractive
to state banks and later amendments
to the law aided in inducing them to
E a r n in g A s s e t s B e f o r e a n d A f t e r
the W ar

Failure to secure applications for
rediscounts to employ more than a

E a rly F u n c tio n in g

small part of the funds of the System,
caused the Reserve Banks to invest in
government bonds, acceptances and
municipal warrants. A careful study
of the graph on page 78 showing the
curves of the earning assets of all of

of the

S ystem


the Reserve Banks combined, from the
date of opening to January 1st, 1921,
gives a concrete picture of the early
functioning of the System in contrast
to its operations after the United States
entered the War.

E a r n in g A ssets o p t h e F ed era l R eserve S ystem

D ecem ber 31, 1914-O ctober 26, 1921


December 3 1 .....................

January 2 9 .........................
April 3 0 ...............................
July 3 0 .................................
October 2 9 .........................

January 2 8 .........................
April 2 8 ...............................
July 2 8 .................................
October 2 7 .........................

January 2 6 .........................
April 2 7 ...............................
July 2 7 .................................
October 2 6 .........................

January 2 5 .........................
April 2 6 ...............................
July 2 6 .................................
October 2 5 ..........................

January 3 1 .........................
April 2 5 ................................
July 2 5 .................................
October 3 1 .........................

January 3 0 .........................
April 3 0 ...............................
July 3 0 .................................
October 2 9 ..........................

January 2 8 .........................
April 2 7 ................................
July 2 7 .................................
October 2 6 ..........................

Bills discounted Bills bought in U. S. government
open market
for members































• •• •


T h e A nnals

of the

A m e r ic a n A cadem y

S t ate B a n k s


The chart of the earning assets of the
System demonstrates clearly that once
the exigencies of the war period arose,
there was no hesitancy upon the part
of member banks to make heavy de­
mands upon the facilities of the reserve
banks. Indeed, as the momentum
gained force, many bankers in their
eager rush to meet the requirements of
their customers lost sight of the earlier
scruples concerning borrowed money
and the pendulum swung to the other
extreme. Instead of seeking redis­
counts the officials of the System found
themselves striving to conserve the
financial resources of the country.
The general impression prevails that
the War caused a development of the
Federal Reserve Banks during the
seven years of their operation that prob­
ably would not have occurred in many
times that number of years under other
circumstances. Study of the early

P a r C o llectio ns


functioning of the System bears out
that assumption. The early operations
of the banks also call to mind the
point that they were less far-reaching
in their influence. Business getting ef­
forts are forgot or nearly forgot. But
what was, may, perhaps, merely pre­
sage what is to come. Under stable
conditions, the Reserve Banks may
make smaller profits, but they will not
serve a less useful purpose. Commer­
cial banking must respond to and
reflect the activities of business. In
times of great activity, whether sea­
sonal or cyclical, the Reserve Banks will
be called upon to meet a corresponding
demand. In the usual process of busi­
ness they will have recourse to openmarket operations. Through these
operations they may exert a great and
important influence on the commercial
banks, on interest rates and on business

The Federal Reserve System, State Banks and
Par Collections


By P i e r r e J a y
Chairman and Federal Reserve Agent, Federal Reserve Bank of N ew York

ULL accomplishment of the pur­ 000,000 and total resources of $11,pose of the Federal Reserve Act, 492,000,000, thus giving a membership
to provide a means whereby the the outset comprising 42.6 per cent
strength and resources of the numerous of the total banking resources of the
independent banks of the United country. But the provision for the
States would be made effective for admission of state institutions was
concerted or cooperative action for the merely to the effect that they might,
protection of the banking system and upon application, be permitted to
the service of the nation’s commerce, become members, subject to regula­
industry and agriculture, depended tions of the Federal Reserve Board,
upon membership of a very consider­ and should then have the rights and
able proportion of the banks of the privileges of other member banks.
country. The provision of the Act S t a t e I n s t i t u t i o n s S l o w t o J o in
making membership compulsory for
national banks, brought at once into Contrary to general expectation, the
the System about 7,600 national banks problem of state bank membership was
with capital and surplus of $1,788,- found complicated. Most of the state


T he A nnals

of t h e

institutions were either passive or
opposed to the plan of the Federal
Reserve System. At any rate, they
were not disposed to seek membership
therein. The number of such members
at the close of 1916 was thirty-seven,
of which only seven had a capital and
surplus of over $1,000,000. In 1917,
however, an amendment to the Act
gave the state institutions assurance
by statute, instead of by mere regula­
tion of the Federal Reserve Board, that
as members they might continue to
carry on their banking business in
substantially the same manner as they
had previously done. It also gave
them the definite right to withdraw
from the System upon six months’
Coincident with the legislative re­
moval of obstacles to membership, the
entrance of the United States into the
World War gave a new and very strong
impetus toward membership. The
necessity of strengthening the banking
system of the country to the maximum
degree possible, in order to meet the
strain of war financing, led President
Wilson in the autumn of 1917 to make
a strong appeal to state banking insti­
tutions to join the Federal Reserve
System. The officers of Federal Re­
serve Banks, pursuant to what they
believed to be their duty in the circum­
stances, carried the appeal to the indi­
vidual institutions, without, however,
bringing pressure upon them to join.
Many of the more important ones re­
sponded and during the fall of 1917
and the first half of 1918, a considerable
number of state institutions through­
out the country became members.
The movement was particularly note­
worthy with respect to the aggregate of
resources which thus augmented the
strength of the System. The major
portion of the large institutions in
New York City entered the System
promptly, and the close of the year

A m er ic a n A cadem y

1917 found the System with a state
bank and trust company membership
of 250, having aggregate capital and
surplus of $520,000,000, and aggregate
resources of about $5,000,000,000.
At the end of 1918, 936 state institu­
tions were members with total re­
sources of over $7,000,000,000.
M e m b e r s h ip S h o w s C o n t in u e d
I n c r e a s e S in c e t h e W a r

With the end of the War naturally
came a slowing down of the efforts of
the Reserve Banks to convince state
institutions of the importance of taking
membership in the Federal Reserve
System, and during the past year such
efforts have been practically discon­
tinued. But there has been, neverthe­
less, a continuous and substantial
movement of state institutions into
the System. The laws of many states
contained' provisions concerning re­
serves, character of investments or
other vital matters which have hin­
dered or prevented institutions in
those states from taking membership
in the System, and, as these obstacles
have from time to time been removed,
more and more state institutions have
taken advantage of the opportunity to
join. Many states, for example, have
now passed laws providing that a state
institution, becoming a member of
the Federal Reserve System, need keep
only the legal reserves required by the
Federal Reserve Act. The influence of
this factor is strikingly illustrated in
California where 61 institutions with
total resources of $1,110,000,000 have
become members in the eighteen months
following the amendment of the state
law in respect to reserves to be carried
by member banks.
P r e s e n t M e m b e r s h ip o f S t a t e
I n s t it u t io n s

Some of the state institutions which
became members during the war

S tate B a n k s


period, did so with the intention of
withdrawing at the end of the War, but
their experience as members was evi­
dently such that they did not deem it
necessary to carry out this intention,
for up to the present time only 37 with
resources of $34,500,000 have with­
drawn from the System. On the other
hand, the number of such members has
steadily increased and now amounts to
1,625, with total resources of $9,959,000,000, giving to the System a mem­
bership which now represents, it is
estimated, about 69 per cent of the
commercial banking resources of the
country. Approximately 9,000 state
institutions with aggregate resources
of some $9,000, 000,000, not now mem­
bers, are eligible for membership, from
which it appears that 53 per cent of
the resources and 15 per cent of the
numbers of the eligible state institutions
are now in the System. The distribu­
tion of state bank membership by
districts, is as follows:

D is t r ib u t io n


1. Boston..........................
2. New York....................
3 . Philadelphia.................
4 . Cleveland.....................
5 . Richmond.....................
6. Atlanta.........................
7. Chicago........................
8. St. Louis.......................
9 . Minneapolis.................
10. Kansas City.................
11. Dallas...........................
12. San Francisco..............
1 Latest available itemized figures.


Banking is essentially one of the most
conservative of callings, and it is not
surprising that there are many state
institutions which have not as yet


entered the Federal Reserve System
and whose not having done so may be
ascribed probably to two main causes:
1. The belief that membership in the
System involves burdens or expense dis­
proportionate to the advantages received
in return, some of which, such as the avoid­
ance of the old-fashioned money panic and
the stabilization of banking conditions,
they enjoy without membership. The fact
that the Federal Reserve Banks do not
pay interest on deposits whereas their city
correspondents and reserve agents do pay
interest on deposits is one of the apparent
expenses which they fear to assume.
2. Opposition to the plan of par check
collection which the System has established
and developed.
E x p e r ie n c e o f M e m b e r
I n s t it u t io n s

Most members of the System are
now convinced that membership does
not involve a burden or expense to a
member bank, but, on the contrary,
enables it to conduct its business in a

S tate B a n k M e m b e r s h ip


A t t it u d e o f N o n -m e m b e r
I n s t it u t io n s


P a r C o llectio ns




D istr ic ts

Total Resoura
(In thousands of dollars)




more economical and efficient manner,
entirely irrespective of the advantage
of the rediscount facilities. The loss
of interest is offset by the reduction in
the amount of reserve which member
banks were required to carry. For
example, a so-called country bank


T he A nnals

of the

under the National Bank Act for­
merly carried a reserve against both
demand and time deposits of 15 per
cent, of which 9 per cent might be on
deposit with approved reserve agents,
and at least 6 per cent must be held as
cash in vault. Assuming deposits of
$1,000,000, all payable on demand, the
bank would carry in vault at least
$60,000, upon which it would earn
nothing, and with correspondents,
$90,000 upon which it would probably
receive interest at 2 per cent, or $ 1,800
a year. The Federal Reserve Act re­
duced the bank’s reserve requirement
to 12 per cent, or $120,000, on which it
would receive no interest, but which
would give it the opportunity to loan
the $30,000 released, say at 6 per cent,
which would yield $ 1,800 and thus
compensate for elimination of interest
on the reserve balance.
In 1917 the required reserve against
demand deposits was reduced to 7 per
cent, all of which was to be carried with
the Reserve Bank and with no fixed
requirement for vault reserve. Expe­
rience shows that this has permitted an
average reduction in country bank
vault cash of around 4 per cent, which,
together with the reduction of the
required reserve against time deposits
to 3 per cent, made still greater the
compensating advantage due to low­
ered reserves. Most of the states have
passed laws permitting state institu­
tions becoming members to take ad­
vantage of these reduced requirements.
With the certainty of being able to
obtain cash by rediscounting at the
Federal Reserve Bank, member banks
have felt justified in investing their
funds more closely, carrying as their
emergency reserve, bankers’ accept­
ances, commercial paper, or govern­
ment obligations which could be
realized upon at any time, and thus
increasing their earning power.
The opposition to the System on

A m er ic a n A cadem y

account of the establishment of its
par collection plan will be discussed
incidentally in the following topic.
But it may be said that members have
found that the use of the check collec­
tion facilities of the System has re­
duced the length of time required for
the collection of checks, and enabled
them to close out many accounts
formerly required, thus further in­
creasing the proportion of their assets
which may be invested.
C h e c k C o l l e c t io n B e f o r e t h e
R e se r v e S ystem

An important feature of banking in
the United States is the extent to which
the use of bank checks has been de­
veloped. They are the most usual
means of settlement in all classes of
business, from the payment of small
household bills to payments for the
largest transactions of commerce and
finance. The presentation and col­
lection of the myriads of checks arising
in the course of daily business, and
drawn upon over 30,000 independent
banks, located in all parts of the coun­
try, creates a problem of great magni­
tude, especially as checks are common­
ly used to settle accounts not only in
the places where they are payable, but
are sent to distant points, making
necessary the use of the mails for their
Before the establishment of the
Federal Reserve System, the collection
of checks in this country was accom­
plished by special arrangements be­
tween commercial banks. It was cus­
tomary for banks in the country and in
the smaller cities having checks on
out-of-town points, to send all such
checks to their city correspondent,
which would undertake their collection
in consideration of the balances car­
ried by the smaller bank with the city
institution. It was customary, also,
for the country bank to charge the

S ta t e B a n k s


amount to its correspondent as soon as
the letter was mailed, and to treat it at
once as part of its legal reserve, this
being permissible under the provisions
of the then existing law. The city
bank to which the checks were sent,
having similar arrangements with
many correspondents, was the recip­
ient of a very large volume of checks
for collection and inasmuch as it had
usually undertaken to collect these
checks without charge, it was itself
under the necessity of finding a means
of collecting them with as little cost as
possible. The obvious and simple
method of sending the checks direct to
the banks upon which they were
drawn was not attractive because of
the fact that the custom had grown up
in many, though not all, sections of the
country for the smaller banks which
received checks on themselves through
the mail, to make a charge for remit­
ting to the sending bank for such
checks, the rate of the charge varying
with different institutions and running
from $1 per thousand dollars, to as
high as $3.50 per thousand dollars in
some cases.
This charge was known as “ex­
change,” and was made on the theory
that the bank paying the checks per­
formed a service for the bank from
which the checks had been received in
paying the latter with a draft on a
bank in some large center. The value
of this service was based upon the
approximate cost of making shipment
of currency to make the payment,
plus postage and stationery, on the
theory that payment of a bank check
can be demanded only at the bank’s
counter, and that if remittance is made
to a distant point, an additional serv­
ice is performed. In order to avoid, so
far as possible, the necessity of paying
“ exchange ” for the collection of checks,
it was usual for banks receiving checks
from their correspondents to send

P a r C o llectio ns


them on to some other bank for de­
posit and collection, charging the
remittance to the latter’s account, and
treating it at once as legal reserve.
This effort to find a means of getting
the check paid without deduction
for exchange, led to checks* reaching
their place of payment by very cir­
cuitous routes with much delay in the
time of presentation and collection,
and with increased risk of loss to the
indorsers of the checks. By this
means, also, the same check might be
counted as reserve at the same time by
several different banks, although as a
matter of sound banking principle, it
should not have been counted as
reserve for any bank until actually
These unsatisfactory check-collection practices, and the fact that the
charges made, as well as the loss due to
slowness in collection, fell on the com­
merce and industry of the country,
led to action by Congress which, in
passing the Federal Reserve Act,
included provisions requiring Federal
Reserve Banks to receive on deposit at
par from member banks or from Fed­
eral Reserve Banks, checks or drafts
drawn on any of their depositors, and
authorizing them to receive for pur­
poses of exchange or collection, checks
or drafts payable upon presentation
within their districts. The Act also
authorized the Federal Reserve Board
to require each Federal Reserve Bank
to exercise the functions of a clearing
house for its member banks.
G row th a n d A dvantag e of th e P ar
C o l l e c t io n S y s t e m

The Federal Reserve Banks did not
at once actively engage in the collec­
tion of checks under the provisions of
the law above referred to, because the
development of a comprehensive checkclearing plan presented many diffi­
culties, and it was not until July, 1916,


T he A nnals

of the

that active operations were initiated.
At that time a plan of operation was
adopted which, recognizing that checks
are payable at the counter of the pay­
ing bank, provided that the Federal
Reserve Banks, in forwarding checks
to a bank for payment by remittance,
would pay the cost of currency shipped
in payment for the checks, whenever

A m er ic a n A c adem t

tion through the mail equivalent to
presentation at the bank’s counter.
Operations under this plan have been
highly successful, as will be gathered
from the following chart showing the
number and amount of items handled
each month by the Reserve Banks,
and the number of banks in the col­
lection system.

G r o w t h o f F e d e r a l R e s e r v e C o l l e c t i o n S y ste m

(By units of one month)

the paying bank elected to make pay­
ment in that way, and would also
under certain conditions, especially for
non-member banks, supply necessary
postage and stationery, thus eliminat­
ing the elements of cost, which would
otherwise fall upon the bank making
the remittance, and making presenta-

The importance and desirability of
the check-collection system which has
developed and is now being operated
by the Federal Reserve Banks, may
be inferred from the extent to which
the chart showing the volume of
checks handled indicates that these
facilities are being availed of by banks

S t ate B a n k s


which are members of the Federal
Reserve System. They are also being
availed of indirectly by non-members.
The volume of items handled has
grown steadily since the initiation of
this method of check collection, until
at the present time it may fairly be
said that an overwhelming majority
of all out-of-town checks handled by
banks are collected through the agency
of the Federal Reserve System. The
Federal Reserve check-collection sys­
tem has reduced the average time of
collection about one-half, by the prac­
tice of the Reserve Banks of sending
checks direct to the paying bank, if
within the same district, or through a
Federal Reserve Bank or branch if
outside the district.
O p p o s i t i o n t o P a r C o l l e c t io n s

It is not to be supposed that the
system eliminating “exchange” and
bringing about the par collection of
checks should have developed so gen­
erally without encountering serious
opposition from banks which had for­
merly received substantial income from
their exchange charges. A committee
of the American Bankers Association
has from time to time during the past
five years been endeavoring to secure
legislation from Congress which would
permit banks to charge exchange
against the Federal Reserve Banks.
Not having been successful in this,
banks in Georgia, Kentucky and Ore­
gon have brought suits to prevent the
Federal Reserve Banks from presenting
checks at the counters of state banks
and a number of the southern states
have passed laws designed to prevent
the Federal Reserve Banks from col­
lecting at par checks drawn on state
C o s t o p C o l l e c t in g R e d u c e d

The effect of the development of this
efficient system of check collection has

P a r C o llectio ns


been to obtain for the business inter­
ests of the country a much more
prompt collection of checks than
formerly, reducing the risk of loss
through bad checks and reducing the
amount of credit which sellers of goods
formerly had to extend involuntarily
during the very substantial time re­
quired to collect checks. There has
been, moreover, an important direct
reduction in the cost of collecting
checks due to the removal of the socalled “exchange” charge, or the
charge made by banks for remitting
in payment of checks drawn on them­
selves, so that at the present time a
very large proportion of the country’s
checks are collected without charge.
The change which has taken place in
the schedule of charges for the col­
lection of checks may be illustrated by
the reductions made by the New York
Clearing House Association.
Before the passage of the Federal
Reserve Act the charges made by New
York banks for collecting checks on
outside points were discretionary as to
less than thirty cities and were fixed
at $1 per $1,000 for nearby states and
$2.50 per $ 1,000 for the more distant
states. The rate of charge is now dis­
cretionary (which means that in most
cases no charge is made) for eleven
entire states and the District of Colum­
bia, 25 jf per $1,000 for one state, 50£
per $1,000 for thirteen states and $1
per thousand for twenty-three states,
while twenty-eight important cities
in which Federal Reserve Banks or
branches are located are collectible at
rates lower than those quoted for the
remainder of their states.
It should be understood that the
present charge made by the New York
banks is not an “exchange” charge at all
but is made to cover interest on funds,
for which credit is given at time of
deposit, for the time which will elapse
before the items have been actually


T he A nnals

of the

collected. The former charge included
not only this element but also an
amount designed to enable the city
bank to pay the deductions of “ex­
change” made by paying banks else­
T ransfers of F u n d s

The elimination of seasonal and other
variations in the level of domestic
exchange between different parts of
the country has also been accomplished
as a necessary accompaniment to the
development of the check-collection
system, since in order that each Federal
Reserve Bank might freely handle
checks on other Federal Reserve dis­
tricts, it was necessary to provide a
means whereby the balances arising
between the districts might be settled
without the expense of gold or cur­
rency shipments. To meet this need
there was established in 1915 a Gold
Settlement Fund, made up of gold
deposited by the twelve Federal Reserve
Banks with the United States Treas­
ury, ownership being transferred from
one Reserve Bank to another as the
need arises to settle obligations be­
tween them. The books are kept by
the Federal Reserve Board at Washing­
ton, and the settlements of all obliga­
tions arising among the Federal Re­
serve Banks are made by book entry,
thus obviating the necessity for inter­
district shipment of gold. The Gold
Settlement Fund has also made col­
lected funds, that is, funds on deposit
with banks in any part of the country,
readily transferable to any other center
without discount, either by use of the
check-collection system or, if the funds
are on deposit with a member bank, by
telegraphic transfer through the Fed­
eral Reserve Banks, it being the cus­
tom of the Reserve Banks to handle
these transfers over their inter-com­
municating private wire and without
cost to the member banks concerned.

A m er ic a n A cadem y

The importance of the wire transfer
facility may be inferred from the fol­
lowing figures, showing telegraphic
transfers handled by the New York
Reserve Bank during the years 19161920 :




2,971 $485,000,000
10,302 6*768,000,000
39,099 19,384,000,000
*................. 82,321 18,245,000,000
147.302 17,022,000,000

The settlement of obligations be­
tween districts has thus been made so
easy, that there is no longer any occa­
sion for premium or discount on the
transfer of actually collected funds
between different parts of the country.
A most important result of the de­
velopment of this check-collection plan
is the lessening of the possibility of
breakdown in the operations of the
country’s check-collection system. It
will be recalled that, in the panic of
1907, a situation arose in which it was
impossible to get cash returns on
checks sent for collection to banks in
certain centers, and that the machin­
ery of check collection and domestic
exchange practically broke down. Such
a development is extremely 'unlikely
under the operation of the Federal
Reserve check-collection system sup­
ported by the borrowing facilities which
the Federal Reserve System makes
available to member banks, and which
should enable solvent banks, even in
time of severe crisis, to make payment
for checks which may be drawn upon
The Federal Reserve check-collection
system, in short, provides the machin­
ery necessary to accomplish with
maximum efficiency the necessary
function of presenting and collecting
any number of bank checks which may
result from the use of this most con­
venient instrument in the settling of
transactions of every kind.

R e la tio ns


R e se r v e B a n k s


Relations of Reserve Banks to Member Banks
Inter-Relations of Federal Reserve Banks


By R . M. G id n ey
Controller at Large, Federal Reserve Bank of New York

HE outstanding characteristic of
the American banking system—a
tremendous number of practically
dependent banks, great and small—
does not make for concerted, uniform
or effective action in dealing with
banking, credit and currency problems
on a nation-wide scale and in a broad
way. The need for means whereby
these numerous independent banks
could cooperate for mutual protection
and for greater service to the commerce,
industry and agriculture of the coun­
try, has long been recognized by
students of American banking organi­
zation and methods.
The solution suggested by the experi­
ence of other countries which have
highly developed systems of branch
banking supported by great central
banks, has never seemed acceptable to
the American public. The form of
organization adopted to supply the
elements formerly lacking in American
banking, was necessarily designed to do
so without diminishing or impairing
the independence of the existing bank­
ing institutions. The Federal Reserve
System was created to enable member
banks, while operating independently
as before, to mobilize or unite their
reserve funds and make them more
available to meet demands for increased
credit accommodation or gold with­
drawals for domestic purposes or export.
The Federal Reserve Banks were to be
supplementary to an already existing
system consisting of some 7,500 na­
tional banks and over 19,000 state
institutions, a very considerable pro­
portion of these institutions being

expected to take membership and thus
give to the system the support neces­
in­ to make it a going concern, capable
of affording to its members the facilities
and advantages which it was expected
to create. The provision for compul­
sory membership of over 7,500 na­
tional banks then in existence give
assurance of ample support at the out­
The purpose, then, of the Federal
Reserve System was to make possible
the association of the banks of the
country in order to supply the elements
of mutual protection, service and
facilities which our system of indepen­
dent banks had lacked, and, in its
essential features, it may briefly and
accurately be described as a great
cooperative banking association. It
includes at this time about 8,200
national banks, and 1,625 state banks
and trust companies. The latter have
become members voluntarily under the
permissive provision of the Federal
Reserve Act.
R e s e r v e B a n k s A r e P r iv a t e C o r ­
p o r a t io n s

The circumstances attending the
creation of the Federal Reserve System
and the distinctly governmental char­
acter of the procedure which brought
it into existence, have tended to create
the impression that the Federal Re­
serve System is a purely governmental
agency, an impression strengthened by
the highly important work done by th^
Federal Reserve Banks acting as fiscal
agents of the government in selling and
handling government securities during


T he A nnals

of t h e

and since the War. The fact is, how­
ever, that the twelve Federal Reserve
Banks are private corporations organ­
ized under an Act of Congress, their
only stockholders being the member
banks whose stock subscription is pro­
portionate to their capital and surplus.
Their operations are directed by twelve
boards of directors. Two-thirds of the
members of each board are elected by
the member banks, and one-third are
appointed by the Federal Reserve
Board. Each Federal Reserve Bank
is thus operated under the control of a
board of directors including three
government representatives, most of
whom are business men, three bankers
and three men engaged in commerce,
industry or agriculture, but not con­
nected as officer or director with any
bank. The directorates of the Federal
Reserve Banks include not only bank­
ers, but also men experienced and
successful in various lines of business,
industry or agriculture. This feature
of the relationship between the Federal
Reserve Banks and their members is
worthy of emphasis. It should be
understood that the member banks,
through their right to two-thirds of the
directors of the Federal Reserve Banks,
are in control of the actual operations
of the Federal Reserve Banks, subject
to supervision by the Federal Reserve
Relations between Federal Reserve
Banks and their members have grown
to be very much like relations between
the larger banks of the country and
their out-of-town correspondents. The
member bank stockholders of the
Federal Reserve Banks use these
Banks as depositaries for their legal
reserves in amounts determined by law,
thus bringing about the mobilization
of banking reserves contemplated by
the Federal Reserve Act, and furnish­
ing the Federal Reserve Banks with
the funds which are the basis for their

A m er ic a n A cadem y

operations. These relations constitute
the minimum which may exist between
the Federal Reserve Banks and their
members. For some time after the
organization of the Federal Reserve
Banks, a very large proportion of the
member banks did not transact any
business through them, and relations
were only of the bare minimum above
The relationship now existing between
the Federal Reserve Banks and their
members is the result of evolution and
is far closer than in the earlier days of
the System. The attitude of the na­
tional bank officers whose institutions
were practically drafted into the Fed­
eral Reserve System at the time of its
establishment, was then not altogether
friendly, and 'many of them were
strongly antagonistic to the new Sys­
tem and openly expressed their inten­
tion to have as little to do with it as
possible. These bankers had a natural
reluctance to break or impair long
established ties, and felt that the
Reserve Banks would be in a sense
government bureaus and would adopt
methods involving red tape and afford­
ing little opportunity for close and
sympathetic personal relations. Many
believed that member banks, especially
those in the smaller places, would have
little paper of a character eligible for
rediscount, and that as they would be
obliged to continue to carry reserves
with their correspondents, membership
in the System would be more of a bur­
den than a privilege.
Those entrusted with the manage­
ment of the Federal Reserve System,
appreciating and understanding the
attitude of the member banks, realized
that upon them devolved the duty
of so conducting the Federal Reserve
Banks as to disarm criticism and to
make the service of the Reserve Banks
to their members so satisfactory and
convenient that those who had antici­

R e la tio ns


R e se r v e B a n k s

pated unpleasant relations would be
obliged to revise their opinions. Not­
withstanding this forward-looking at­
titude on the part of the managers of
the Federal Reserve System, progress
toward closer relations with member
banks was slow, and did not become
really appreciable until the pressure of
problems connected with war financing
in 1917 brought about a fuller utiliza­
tion by member banks of the facilities
of the Federal Reserve System and
consequently a better understanding of
its possibilities for service.
W a r L o a n s a C e m e n t in g F a c t o r

To the Federal Reserve Banks was
given the great task of organizing in
their respective districts distributing
agencies for the huge loans which the
government found it necessary to float
and for this undertaking the aid and
support of bankers, both member and
non-member, was sought and obtained.
The splendid efforts of those associated
in this work may be inferred from re­
sults. The close relationship thus de­
veloped and the splendid cooperation of
the bankers with the Federal Reserve,
Banks in placing the government’s
loans, made for understanding and
mutual appreciation between the Re­
serve Banks and their members to
such an extent that long before the
work of government financing had
ceased to require the most active efforts
of those engaged in it, the attitude of
the member banks had changed from
passive toleration or outspoken antag­
onism, to an attitude on the part of
the majority of the member banks
distinctly friendly to the Federal Re­
serve System.
With war-time activity, came de­
mand for credit expansion which
brought into play the loaning function
of the Federal Reserve Banks. Mem­
ber banks which had been skeptical of
the value of the Federal Reserve System


and had doubted the necessity for its
existence, found themselves obliged to
borrow if they were to do their part in
war finance, and for the first time a
convincing illustration of the value of
the loaning activities of the Reserve
Banks was given. Member banks soon
found that borrowing at Reserve Banks
did not involve unnecessary formality
or red tape, as the loan policies of the
Reserve Banks have in general been
along very liberal lines. Loan applica­
tions have uniformly been acted upon
promptly on day of receipt, so that a
member bank sending in paper for
rediscount can count upon receiving
credit for the proceeds thereof as
promptly as if it were a remittance of
bank drafts. Promptness, liberality of
treatment and willingness to meet all
proper demands, which characterized
the loan activities of the Reserve
Banks, were most potent factors in
bringing about a better understanding
with their members.
Q u ic k M e e t in g o f C u r r e n c y N e e d s

At the same time the ability of the
Federal Reserve Banks, through their
power of note issue, to supply the rapid­
ly expanding currency needs of the
country, led to free development of this
function. The process by which Fed­
eral Reserve notes are issued and re­
deemed is perhaps worthy of a brief
description here. A member bank
desiring currency or coin, requests the
Federal Reserve Bank to charge its
account and if it finds itself with more
currency than it desires to retain in
vault, or has currency which is no
longer fit for use, it forwards the sur­
plus to the Federal Reserve Bank for
credit. The Reserve Banks pay the
cost of shipping currency or coin both
ways, thus facilitating the prompt
redemption of currency which is in
excess of the immediate needs of the
country and enabling member banks


T he A nnals

of t h e

to operate with a minimum of vault
reserve. The payment of cost of ship­
ment of currency to the member banks
was developed by the Federal Reserve
Banks in an effort to give member
institutions outside of the Federal
Reserve cities as nearly as possible simi­
lar service to that given banks in the
Federal Reserve cities. A similar pol­
icy for shipments of currency received
from member banks was adopted as an
incident to par check collection, with
the object of eliminating any element
of cost to a member bank in remitting
for checks sent it for collection by the
Federal Reserve Bank.
C h e c k C o l l e c t io n P l a n P r o g r e s s e d
Slow ly

The Federal Reserve check collec­
tion, on the other hand, was long an
obstacle to the development of close
relations with member banks because
of the opposition of many of the banks
in smaller places to the change in
practice which this System involved.
The collection of checks through the
Reserve Banks has, however, made
tremendous growth, and each Federal
Reserve Bank now sends daily letters
containing checks for collection to
practically all of the banks of its dis­
trict, both member and non-member.
Similar contact results from the col­
lection of notes, drafts, bills of ex­
change, coupons, maturing bonds, etc.,
which is undertaken by the Federal
Reserve Banks.
Other important facilities are trans­
ferring funds by wire between various
sections of the country without charge
to the member bank and the safekeep­
ing of securities—the Federal Reserve
Bank of New York alone now holding
in this manner for its members $1,239,215,899 of bonds and other securities.
In all the transactions between the
Federal Reserve Banks and their
members, the attitude of the Reserve

A m er ic a n A cadem y

Banks is like that of any other bank
dealing with correspondents, and mat­
ters are handled along banking lines, a
fact which has had much to do with
the development of the close relations
which now exist between Reserve
Banks and their members
B e t t e r B a n k in g M e t h o d s

An important influence has been
exerted by the Federal Reserve Banks
making for improvement of banking
methods on the part of member banks.
The practice of obtaining financial
statements from borrowers has become
much more general because there is the
possibility that the member bank may
later desire to rediscount the paper
with the Federal Reserve Bank, and
also because the requirement of bor­
rowers’ statements (for notes of $5,000
or over) by the Federal Reserve Banks
has had the effect of standardizing this
practice and leading to its adoption by
banks which had formerly not consid­
ered it feasible. Membership in the
Federal Reserve System has made for
important changes in the character of
bank investments, mainly in the direc­
tion of greater liquidity. Banks which
had formerly carried bonds or call loans
on stock exchange collateral as their socalled secondary reserve, have adopted
the sound practice of diversifying
their investments by adding to their
portfolios commercial paper purchased
in the open market and such highly
liquid elements as bankers’ acceptances
and United States certificates of indebt­
edness. Thus they have placed them­
selves in much stronger position as to
availability of funds to meet with­
drawals by carrying adequate amounts
of paper available for rediscount or sale,
and, also, at least a moderate amount
of paper of short maturity. This im­
provement in the distribution and
liquidity of member banks’ investment
holdings has enabled them with safety

R ela tio n s


to invest their funds more closely than
ever before with resulting increase in
In the important matter of check
collections, also, the practice of the
Federal Reserve Banks of deferring
credit on out-of-town checks a suffi­
cient time to permit of their actual col­
lection, has led to realization of the im­
portance of promptness in the handling
of out-of-town checks, and closer analy­
sis than formerly of accounts involving
the element of collection time. The
direct activities of the Federal Reserve
Banks in collecting checks for their
members has reduced very materially,
and perhaps cut in half, the time re­
quired to collect out-of-town checks,
and encouragement has also been given
to member banks to form county clear­
ing houses so that banks in neighboring
towns may exchange with each other
and still further reduce the time re­
quired for collection of such checks.
B a n k s N e e d L e ss C a sh in V a u lt

More economical methods as to the
holding of vault cash by member banks
have been made possible by improved
facilities for obtaining currency and
coin, and by legislation enacted in 1917,
relieving member banks from the
former requirement for a fixed amount
of cash in vault. In October, 1914, the
7,571 national banks of the country
held cash in vault equal to 16.4 per
cent of their deposits. On June 30,
1921, 9,745 member banks held vault
cash equal to only 2.6 per cent of their
The influence of the Federal Reserve
Banks making for improvement in the
technical features of bank operation,
though not readily measured, has been
of fundamental importance and is
among the most beneficial results of the
System’s operations, especially when
considered with full realization of the im­
portance in modern economic organiza­

R e se r v e B a n k s


tion of a banking machinery adapted to
the great tasks which devolve upon it.
For obvious reasons no publicity has
been given to a highly important Re­
serve Bank activity, the assistance of
member banks which for any reason
find themselves in a dangerous position;
and the confidential character of this
relationship precludes other than a very
general statement concerning it. In a
considerable number of instances the
Reserve Banks have not only extended
assistance in the way of loans, but have
also loaned members of the Reserve
Bank staff to assist the institutions
through their difficulties, with the
result, in a number of instances, that
institutions which would otherwise
have been forced to succumb, have been
rehabilitated and are now in successful
Close relations with member banks
have also been assisted in some dis­
tricts by conferences of member bankers
with Federal Reserve Bank officers, at
which the operations and functions of
the Federal Reserve Banks were clearly
and fully explained, and also by visits
to member banks at their home offices,
made by Reserve Bank representatives.
The officers of the Federal Reserve
Banks realize an obligation to extend
a service of high order to member
banks, and to promote cooperation
along banking lines rather than to take
an attitude which might lead member
banks to feel that they were dealing
with a distant and impersonal organiza­
tion operated as a government agency.
In other words, the Federal Reserve
Banks have undertaken to function as
banks and to conduct their relations
with member banks along much the
same lines as those by which the larger
banking institutions of the country have
in the past so successfully conducted
their relations with out-of-town corres­
pondents. The highly satisfactory re­
sults of this policy are to be found in


T he A nnals

of t h e

A m er ic a n A cadem y

the friendly attitude which is now mani­ A conference of governors and direc­
fest on the part of member banks tors of all Federal Reserve Banks pre­
toward the Federal Reserve Banks.
ceded the actual opening of the Banks.
Problems of general policy before the
I n t e r - r e l a t i o n s o f R e s e r v e B a n k s Banks and the Federal Reserve Board,
The establishment of twelve regional have been the subject of discussion at
Federal Reserve Banks rather than of conferences held from time to time by
a central bank, was in keeping with the governors and Federal Reserve agents.
great area of our country, which might Numerous conferences have also been
be considered as making the establish­ held by representatives of the Reserve
ment of one great central bank of Banks to deal with the more technical
doubtful advantage, and with the features of operation, such as account­
American predilection for the minimum ing and auditing methods, check col­
of banking centralization. The twelve lections, employment methods and
Federal Reserve Banks were to be, and other similar problems. The spirit of
are, operated each by its own board of cooperation and willingness to take
directors, and each is to a very large counsel together, evidenced at these
degree an independent entity, having conferences, has been typical of the
power to deal with the problems arising everyday relations between the Reserve
within its own district according to the Banks and has resulted in the develop­
judgment of its directors and officers. ment of a close-knit system in which
This has given opportunity for the the several units, though independent
development of a considerable degree in management, work together to ob­
of individuality in personnel and tain for their members and the public
methods, and for the control of e,ach the advantages to be derived from a
Federal Reserve Bank by men familiar unified banking system.
with the business of the district.
The results of cooperation among
Counteracting to a considerable de­ the Federal Reserve Banks are in some
gree this tendency to individuality in cases very tangible, as, notably, the
the management and operations of the country-wide check collection system,
several Federal Reserve Banks, is the the establishment of facilities for trans­
influence of common function and pur­ fers of funds over the private wires
pose, of interbank contact, and, also, between Federal Reserve Banks, the es­
the supervision of the Federal Reserve tablishment of a Gold Settlement Fund
Board. The practically identical rela­ through which has been obviated the
tionship of each Reserve Bank to its necessity of gold shipments between
members and the similarity of func­ different parts of the country, and,
tions, led early to efforts to coordinate perhaps most important of all, the facil­
action on all matters possible of com­ ities for interbank rediscounts by means
mon solution. Even before the organi­ of which seasonal loan demands may
zation of the Federal Reserve Board be met by the Reserve Banks whose
and the Federal Reserve Banks, the positions are relatively strong and who
preliminary Organization Committee loan to those on which the pressure is
had prepared plans for accounting and greatest. The advantage claimed for
methods which were to a considerable a central bank with ability to direct the
extent used by the Reserve Banks when flow of loanable funds to the point of
organized, though modified in many maximum need, appears to have been
ways as experience showed need for attained through this arrangement, as
interbank rediscounts have been freely

R e la tio n s


and voluntarily made in such amounts
as were necessary to meet the heavy
loan demands in many districts which
would otherwise have found themselves
with greatly impaired reserves.
The heaviest borrowers relatively
have been the Federal Reserve Banks in
the agricultural sections, the lenders be­
ing usually the banks in sections whose
activities are predominantly industrial.
The interbank loans at their high point
were as shown in the table below:
I n t e r -B a n k L o a n s



New York... . $49,305,000
Richmond... . 19,900,000
Atlanta......... 37,758,000
Chicago........ 13,050,000
St. Louis. . . . 40,410,000
Minn............. . 27,204,000
Kansas City.. . 45,807,000
Dallas........... 33,944,000
T otal . . . . $267,378,000


Reserve ages
Before After


The chart on page 94 illustrates
graphically the movements of reserves
of the Federal Reserve Banks, evidenc­
ing the pressure of demand for loans
which could be safely met only by
R e s e r v e B o a r d ’s I n f l u e n c e f o r
U n it y

Strong as were the forces which have
been mentioned in making for close
relations and cooperation on the part
of the Federal Reserve Banks, the
position of the Federal Reserve Board,
as the central element in the Federal
Reserve organization, is one of such
great influence that its policies may be
regarded as in large measure responsible
for the course which has been taken in
the development of the System pro­
vided for in general outline by the

R e se r v e B a n k s


action of Congress. The policy of the
Reserve Board, as revealed in its rul­
ings and the public utterances of its
members, has been consistently to
refrain from performing operating func­
tions in connection with the manage­
ment of the Reserve Banks and to make
its field of activity the supervision and
coordination of twelve practically inde­
pendent regional reserve institutions.
Its rulings and regulations have served
to interpret and apply the law under
F e d e r a l R e se r v e B a n k s


Amount Reserve ages
Before After
$85,896,000 72.0 51.1
Phila................. 42,722,000 63.8 52.3
Cleveland........ . 137,874,000 80.5 52.3
San Francisco..
886,000 45.2 44.9


which the Reserve Banks operate, and
also to bring about general uniformity
in the policies of the Reserve Banks,
while leaving a large discretion to the
management of each Bank as to the
acceptance or rejection of individual
paper, offered for rediscount, and as to
other problems of operation.
Thus there has been noted in the
operations of the Federal Reserve Sys­
tem a combination of uniformity of
policy and flexibility of everyday opera­
tion which would be difficult or per­
haps impossible under a system where
the operating function was controlled
by a central body. A tendency toward
similarity of discount rates at the
several Reserve Banks has been ap­
parent, though differences in condi­
tions have prevented and are likely to
prevent complete uniformity in this

T h e A nnals


of the

A m er ic a n A cadem y

R e s e r v e P er c e n t a g es F e d e r a l R e se r v e B a n k s B e f o r e I n t e r b a n k A ccom m odations

ekO ST O I




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JA A *. ■L Mr.
M M M-






particular. Practices as to check clear­
ing and collection, collection of notes
and drafts, supplying currency and
coin, and loaning operations, are much
alike at the different Reserve Banks,
yet each Bank may, independently
within the limits set by the law and the
Federal Reserve Board’s ruling and
regulations, perfect and improve its
methods of operation at its own option,



The Federal Reserve Board has
made very clear that the Federal Re­
serve System is not a central bank or its
equivalent, but that the twelve Federal
Reserve Banks are independent insti­
tutions over which the Federal Reserve
Board exercises supervisory authority,
without attempting to participate di­
rectly in the management.
It thus appears that the advantages

T he G old Settlement F und

to be expected from the free flow of
credit from one part of the country to
the other to meet demands for com­
mercial, industrial or agricultural pur­
poses, are supplied by the inter-bank
rediscounting feature of the Federal
Reserve System, but that the aim of
having the problems of each district
entrusted to directors living within the


district and to officers closely familiar
with these problems, with full discre­
tion and power to act within their own
districts, has also been attained. The
Federal Reserve System may be said to
give the advantages of the mobilization
and centralization of banking reserves
while preserving the typically American
freedom from highly centralized control.

The Evolution and Practical Operation of the Gold
Settlement Fund

By G e o r g e J. S e a y
Governor of the Federal Reserve Bank of Richmond
T is difficult to realize that only rapid than could have been expected
seven years have elapsed since the in normal times. The country seems
establishment of the Federal Reserve accustomed and seasoned to the opera­
Banks. During that period, matters tions of the Federal Reserve System,
of such tremendous import to the but, it becomes apparent from time to
world have happened and develop­ time that many people and even many
ments in banking and finance have banks have not a full appreciation of
been so revolutionary in their nature the accomplishments of the System or
and size that we have a full under­ a full understanding of the fact that
standing of the feelings of the small boy financial transactions of the magnitude
of seven who declared that, although developed within these seven years
only seven, judging by the experience were rendered possible only by the
he had had, he was ’most a hundred. operation of the System.
Since 1914, the resources of the banks The country banker, when he sends
of the United States have grown from his checks and collection items to his
2 7 billions of dollars to 53 billions, and city correspondent, may think that
bank clearings have grown from 155 thereby he is creating exchange. This
billions to 451 billions. In measuring is but the first and the lowest step in
the national debt, the income of the the creation of exchange. The proc­
Treasury and taxation, the unit is no esses involved in the collection and
longer a million but a billion.
final settlement of such items are
All the momentous and tragic ex­ numerous and they constitute the
periences of life leave an impression fabric of exchange. The Federal Re­
upon the mind of having occupied a serve System has developed the most
prolonged period. Therefore, it seems comprehensive and most effective sys­
that the Federal Reserve System has tem of exchange known to the banking
been operating for a period much world.
longer than that measured by seven The Federal Reserve Banks act as
calendar years. As a matter of fact, clearing houses for their members, and
it has, beyond doubt, developed in the various transactions engaged in by
those seven years at a pace far more these banks create balances between


T he A nnals of the A merican A cademy


them and their members and between
each other. The Federal Reserve
Board has set up machinery which
operates as a clearing house between
Federal Reserve Banks, and the Gold
Settlement Fund is the heart of the
Therefore, an account of the evolu­
tion and the practical operation of the
Gold Settlement Fund, through which
final payment is made for that vast
volume of credit instruments circu­
lating throughout the country, must
contribute to a better understanding
of the System as a whole.
E a r ly N e ed o f I n t e r -B a n k
S e t t l e m e n t M a c h in e r y

* Under the terms of the Federal
Reserve Act, the Federal Reserve
Board, in Section 16, was authorized
at its discretion to exercise the func­
tions of a clearing house for Federal
Reserve Banks. It is not to be sup­
posed that there dwelt in the minds of
the framers of this provision of the Act
any well-defined conception of the
manner in which this function would
be exercised and least of all of the
nature and magnitude of the settle­
ments which this “clearing house”
would be called upon to make within
such a short period of time.
During the early days, after the
organization of the Federal Reserve
Banks in November, 1914, they were
occupied chiefly by the receipt of pay­
ments of subscriptions to capital stock
and with the receipt from member
banks of deposits setting up the reserve
required by the Act. Payments on
account of subscriptions to capital
stock were required to be made in gold
or gold certificates. Reserve deposits
were required to be made either in gold
or lawful money, except that Federal
Reserve Banks were authorized to
receive as reserve not exceeding onehalf of each installment payment in

eligible paper, as described in Section
14. That is to say, member banks
were permitted to rediscount at that
time with their Federal Reserve Bank
to this extent in establishing reserves.
Under date of November 25, 1914,
a circular was issued by the Federal
Reserve Bank of Richmond, advising
its members that the bank was ready
to commence rediscounting in the
regular course of business and in a
position to furnish Federal Reserve
notes for the proceeds of rediscounts.
The member banks had previously
been advised that collections and
clearings could not be undertaken at
the beginning and that, therefore,
active accounts of member banks
could not be established until further
notice. They were advised, however,
that after initial payments of reserve
had been made, checks drawn on any
member bank in the cities of Rich­
mond, Washington and Baltimore,
all within the district, would be re­
ceived for the credit of the members.
The member banks were cautioned,
however, that while the Richmond
bank was accepting checks on banks in
the reserve cities of the Fifth District
“it is not intended at this stage that
the Reserve Bank shall be used merely
to transfer balances in one place in
order to make them available in
another,” and further “members are
expected to use their present clearing
connections for making collections
until greater preparation has been
made for clearing.”
Notwithstanding the restricted na­
ture of the business conducted at that
time, balances in excess of the required
reserve were created, and checks
against these balances found their way
into other districts. No machinery
had been set up to effect settlements
between Federal Reserve Banks, but
it was the understanding that any
Federal Reserve Bank would have the

T he G old S ettlement F und


the Reserve Bank Organization Com­
mittee, by those whose services were
engaged for the purpose, which con­
tained many practical suggestions as to
the organization and operation of Fed­
eral Reserve Banks. Among these was
a suggestion for a “Federal Reserve
Clearing House,” which involved the
deposit of a certain sum of gold by
each Federal Reserve Bank with the
Federal Reserve Board or with any
Federal Reserve Bank designated by
the Board to act as a clearing agent
and settle balances between Federal
Reserve Banks by means of book
entries made by a settling agent or by
certificates issued by the settling agent.
At the first conference of the
governors of the banks, held with the
Board in Washington, December 10,
11 and 12, 1914, a special committee
was appointed to study the subject
and report to the next conference.
At the second conference held in
Washington, January 20- 23, 1915, the
report of the committee was received,
discussed by the conference, and, with
several amendments, was submitted to
the Federal Reserve Board. The plan
submitted to the Board by this con­
ference was substantially that outlined
in the report of the. preliminary com­
mittee on organization, though many
details were submitted by the con­
ference. The Board took the matter
under consideration and announced in
April, 1915, that the plan of settlement
between Federal Reserve Banks had
been completed and would become
effective about the middle of May,
In the meantime, all the Federal
Reserve Banks had been maintaining
accounts with one another, which
accounts, of course, were affected by
E s t a b l is h m e n t o f t h e G o ld
all interdistrict transactions.
Settlem ent F und
Under date of May 8, 1915, the
Prior to the organization of Federal Federal Reserve Board issued its
Reserve Banks, a report was made to Bulletin No. 13, Series of 1915, out­

right to call upon any other for remit­
tances in gold to effect settlement of
balances between the two.
At that time of the year (December)
the flow of funds was towards New
York, and, as a result of the practice
of receiving from member banks for
credit checks on their balances in the
reserve cities of this district and then
permitting the banks to check on such
balances—which checks were usually
sent to New York in order to create
exchange—the Federal Reserve Bank
of Richmond became in debt to the
Federal Reserve Bank of New York
for several millions of dollars. . To
place restraint upon this practice it
became necessary to advise member
banks that such checks deposited with
the Federal Reserve Bank for the pur­
pose of creating exchange would be
subject to a charge for collection, in
accordance with Section 16 of the Act.
On January 18, 1915, in sending out
notification of the second installment
due on capital stock subscriptions,
members were advised that payments
could be made by means of checks on
national banks in New York City
instead of in gold. This was done for
the purpose of reducing the debt of the
Richmond Bank to the New York
Bank, thus, to that extent, avoiding
settlement with the New York Bank
in gold.
It will be apparent that very early in
the operation of the System the neces­
sity for providing the machinery for
making settlement between Federal
Reserve Banks was a pressing one, and
during that time careful study was
being given to the question, both by
the Federal Reserve Board and the
officers of the Federal Reserve Banks.



T he A nnals of the A merican A cademy

lining the plan of clearing between
Federal Reserve Banks. The plan
was designed to effect settlements of
all balances then outstanding and
thereafter to settle accounts between
Federal Reserve Banks weekly. The
following is a brief statement of the
principal feature of the plan: Each
Federal Reserve Bank was required to
forward to the Treasury at Washington
or the nearest subtreasury for credit
in the account of the Gold Settlement
Fund one million dollars in gold, gold
certificates or gold order certificates,
in addition to an amount at least equal
to its net indebtedness to all Federal
Reserve Banks.
The Treasury Department under­
took to advise the Federal Reserve
Banks of the receipt of the funds and
undertook further to deliver to the
Federal Reserve Board gold certificates
payable to the order of the Federal
Reserve Board in denominations of
ten thousand dollars, covering the sum
so deposited. Each Federal Reserve
Bank was required to make such
payment into the Gold Fund from
time to time as might be necessary to
maintain the balance to its credit in the
Fund at one million dollars. Federal
Reserve Banks having balances in
excess of one million dollars, as a
result of clearing operations, were
allowed to withdraw the excess at will,
payment to be made by shipment of
gold order certificates to the said bank
by the Board, or payment through the
nearest subtreasury.
The Board kept a set of books in
which there was an account for each
Federal Reserve Bank, showing at all
times the amount of gold held for each
bank. The gold order certificates
representing the gold held by the
Treasury were kept in a safe in the
Treasury vaults set apart for the ex­
clusive use of the Board, to be opened
only in the presence of two persons

designated by the Secretary and two
designated by the Board. The balance
of each Federal Reserve Bank in the
Gold Fund was permitted to be
counted as a part of the gold reserve of
the bank. Each Federal Reserve
Bank was required to keep two ac­
counts with every other Federal Re­
serve Bank, one showing the total
amount due to the other Federal
Reserve Bank and the other, the
amount due from the other Federal
Reserve Bank.
The first settlement, being historic,
will be described. It was made in the
following manner. At the close of
business, Wednesday, May 19, 1915,
each Federal Reserve Bank advised
the Federal Reserve Board by wire the
amount in even thousands due by it
to each other Federal Reserve Bank as
of that day. On Thursday, May 20,
the settling agent appointed by the
Board telegraphed each Federal Re­
serve Bank the amount of credits to
its settling account, giving the name
of each bank from which such credits
were received, also the net debit or
credit balance in the settlement. After
the receipt of these advices, but not
later than May 24, each Federal
Reserve Bank was required to put into
the Gold Fund by shipment or trans­
fers of gold or gold certificates of the
United States, directly or through the
nearest subtreasury, an amount suf­
ficient to cover its debit balance, if any,
and to establish a credit balance of at
least one million dollars. The totals
so remitted at that time were $ 18,450,000. The Federal Reserve Banks
made appropriate entries in their
accounts based upon the report of the
settling agent. Thus the Gold Settle­
ment Fund was launched. Thereafter,
settlements were made weekly, on
Thursday, upon the basis of figures tele­
graphed by each Federal Reserve Bank
at the close of business Wednesday.

T he G old S ettlement F und

The Treasury Department had not
only agreed to receive remittances
in gold and to issue ten thousand
dollar gold order certificates to the Fed­
eral Reserve Board, but had also agreed
to allow the use of the subtreasuries in
connection with remittances and with­
drawals from the Gold Fund by
Federal Reserve Banks. It was under­
stood and agreed, however, that if
the receipt of such remittances or the
making of such payments at any time
involved the actual shipment of gold
from the Treasury at Washington to a
subtreasury, or vice versa, the expense
of such shipments should be borne by
the Federal Reserve Banks.
C o m m e n c e m e n t o f a n I n t r a - D is t r ic t
C l e a r in g P l a n b y F e d e r a l
R eserve B ank s

It will be understood that the bal­
ances of member banks with their
Federal Reserve Banks were affected
chiefly by two operations: first, by
discount operations, and, second, by
the collection of checks through the
Federal Reserve Bank. Up to this
time, as before described, the collection
of checks by a Federal Reserve Bank
for its members, even within its own
district, had been very limited. In
June, 1915, most, if not all, of the
Federal Reserve Banks put into opera­
tion a voluntary plan of intra-district
collections. According to this plan, a
Federal Reserve Bank invited all of its
members to join the collection plan,
under which each member that joined
the plan could send to the Federal
Reserve Bank checks upon every other
member that had joined the plan but
upon no other members and upon no
member outside of its own district.
The Federal Reserve Bank would give
the sending member bank immediate
credit for such checks in its reserve
account. On the other hand, each mem­
ber bank joining the plan had agreed


that upon the day of receipt the
Federal Reserve Bank could charge its
reserve account with the total amount
of checks drawn upon it.
While the operations of this plan
did not primarily involve relations
between Federal Reserve Banks, such
relations were indirectly involved.
Clearings under the plan depleted the
reserve accounts of some members and
resulted in excess balances in the re­
serve accounts of others. The member
bank whose reserve accounts had been
depleted had to remit in gold or lawful
money or in some form of exchange
acceptable to the Reserve Bank. Other
banks whose clearings resulted in
excess balances had the right to check
against such balances and checks on
one Federal Reserve Bank were re­
ceived for credit by other Federal
Reserve Banks. These transactions,
in so far as they affected the accounts
between Federal Reserve Banks, tended
to increase the volume of the weekly
settlements through the Gold Settle­
ment Fund. It is because of this fact
that a description is given of the early
developments of a collection plan by
Federal Reserve Banks.
In addition to clearing weekly,
Federal Reserve Banks had the privi­
lege of transferring excess balances in
the Gold Fund to other Federal Re­
serve Banks by wire or letter to the
Federal Reserve Board. During the
week ending June 24, 1915, the
Federal Reserve Bank of San Francisco
transferred in this way to the Federal
Reserve Bank of Boston two hundred
thousand dollars. During the week end­
ing July 1, 1915, San Francisco made
two transfers, four hundred and fifty
thousand dollarstoNewYorkand thirty
thousand dollars to Chicago. These
initial transfers are mentioned because
they are historic. After that time, trans­
fers between Federal Reserve Banks
became more and more frequent.


T he A nnals of the American A cademy

The first withdrawal from the Gold
Settlement Fund by any Federal Re­
serve Bank was made on July 14, 1915,
by the Federal Reserve Bank of
Chicago. Its telegram requesting the
payment was received by the Board at
10.30 a.m. and at 2.00 p.m. on the
same day the Assistant Treasurer of
the United States at Chicago advised
the bank of his readiness to make
payment. Although in a number of
cases thereafter such withdrawals
occurred from time to time, the con­
venience and usefulness of the Gold
Settlement Fund became more and
more apparent, and there developed
a tendency to allow credit balances to
accumulate, so that the Fund passed
the one hundred million dollar mark
on November 18, 1915.
F ederal R eser v e A g ents’
G old F u n d

In the latter part of 1915, the Board
determined to enlarge the scope of the
Gold Settlement Fund by opening
accounts with the Federal Reserve
agents of the various Federal Reserve
Banks. While very little discounting
was done by Federal Reserve Banks
in the early days of the System, the
volume of Federal Reserve notes put
out was very considerable. Therefore,
almost from the beginning, each Fed­
eral Reserve agent had the custody of
and the responsibility for a consider­
able amount of gold, all of which,
except 5 per cent deposited with the
Treasurer of the United States as
redemption fund, remained in his
possession. Transactions involved in
the issue and retirement of Federal
Reserve notes necessitated frequent
payments in large sums from the bank
to the agent and from the agent to the
bank. When these payments were
made in gold or gold certificates, much
counting and recounting was necessary
on the part of the employes of the

bank and the representatives of the
Federal Reserve agents*
In the early part of September, 1915,
the Federal Reserve Board resolved
that a Gold Fund should be established
for the use and benefit of Federal
Reserve agents, not identical with, but
in close relation to and cooperation
with the Gold Settlement Fund of the
twelve Federal Reserve Banks. The
settling agent of the Board was di­
rected to open and maintain on the
books a distinct and separate account
for each Federal Reserve agent and to
receive from the said agent, or from
the Federal Reserve Bank for the
account of such agent, deposits of gold
certificates, subject to the order of the
Federal Reserve agent for whom such
deposits had been made. The fund of
the Federal Reserve agents was
handled and operated in the same
manner as the Gold Settlement Fund
of the banks, but, as before mentioned,
the funds were handled separately.
As a consequence, when transfers
were made from an agent to a bank or a
bank to an agent, it was necessary for
the representative of the Board to
make an actual shift of gold or gold
certificates from one safe to another or
from one compartment in the safe to
another compartment.
The Federal Reserve Bank of At­
lanta was the first to make such a
transfer. On September 8, 1915, $2,500.000 was passed from the account
of the bank in the Gold Settlement
Fund to the credit of the Federal
Reserve agent. Simultaneously, the
Federal Reserve agent of Atlanta
released to the Federal Reserve Bank
of Altanta the same amount in gold or
gold certificates. The second bank to
make use of this facility was the
Federal Reserve Bank of Richmond,
the amount of the transfer being $2,600.000 from the account of the bank
to the account of the agent. At the

T he G old Settlement F und

time of this writing, the Federal Re­
serve agents in five of the Federal
Reserve Banks are keeping all of the
gold deposited with them (except the
5 per cent redemption fund deposited
with the Treasurer of the United
States) in this fund. Of the remaining
seven, six have much larger amounts to
their credit in the fund than they are
holding in the vaults of their banks.
The amount to the credit of all Fed­
eral Reserve agents in the fund is
$ 1, 169,210,000, while the total amount
of gold and gold certificates held by
the several Federal Reserve agents at
their respective banks is $450,162,000 .
The total amount in the funds of the
Federal Reserve agents and Federal
Reserve Banks is $ 1,665,321,000.
S c o p e o f C l e a r in g P l a n

The voluntary intra-district clearing
plan, established by nearly all of the
Federal Reserve Banks in June, 1915,
did not prove successful because it
embraced only a comparatively small
percentage of member banks whose
operations through the Federal Re­
serve Banks were confined to the
exchange of checks upon one another.
As a matter of fact, the plan was
devised and operated partly as an
experiment to develop experience and
data necessary to the intelligent plan­
ning of a more comprehensive system.
The Federal Reserve Board and the
officers of all the Federal Reserve
Banks had given a great deal of time
and study to the situation, both in
conferences with the Board and other­
wise. On July 15, 1916, the present
clearing plan between Federal Reserve
Banks and their members and between
the Federal Reserve Banks themselves
was put in operation. The plan is now
too well known to need description.
The plan has been modified and im­
proved to some extent since its
inauguration. At the time the plan


was inaugurated, the total number of
member and non-member banks em­
braced in its operation was approxi­
mately fifteen thousand. At the
present time the number is 28,191,
or 92.8 per cent of all banks in the
country, embracing more then 98 per
cant of all banking resources. The
number of items handled by the
System in 1920 was 503,728,000,
amounting to $179,459,351,000.
The operation of the new collection
plan very greatly increased the number
of transactions between Federal Re­
serve Banks. At the same time, the
increasing issues of Federal Reserve
notes made necessary an increasing
number of transfers between each bank
and its Federal Reserve agent and
between the banks themselves and the
Treasurer of the United States in
transactions relating to the 5 per cent
redemption fund for Federal Reserve
In its Second Annual Report cover­
ing the operations of the Fund, the
Federal Reserve Board, page 79,
stated: “The Federal Reserve Board
has, up to the close of the year 1915,
settled through the Gold Settlement
Fund for the twelve Federal Reserve
Banks indebtedness aggregating $1,052,649,000 with a net change of only
$95,697,000 in ownership of gold held
in the I?und, or 8.14 per cent of the
total amount cleared. The direct
expense incident to the Gold Settlement
Fund in handling these transactions
has been approximately $1,150, prin­
cipally for equipment and telegraph
In its Third Annual Report covering
the year 1916, the Federal Reserve
Board stated that the total clearings
for the year had been $5,533,966,000.
The cost of handling the Fund was
$ 1,343.37, or $0.002| per $1,000. The
net amount of change of ownership
among Federal Reserve Banks as


T he Annals of the American A cademy

a result of these clearings was only
$223,870,000. The Board remarked,
“It may be estimated conservatively
that the shipment of coin and currency
of at least that amount was thus
avoided/’ This statement merits care­
ful attention.
A m e n d m e n t o f J u n e 21 , 1917
The next step in the evolution of the
Gold Fund was as follows: It will be
remembered that the Gold Funds of
the Federal Reserve Banks and the
Federal Reserve agents were kept
separately and that this arrangement
made it necessary for the two represen­
tatives of the Federal Reserve Board
and the representative of the Treasury
Department to open the safe in which
the Fund was held in ten thousand
dollar gold order certificates and make
actual transfers of such certificates
from one fund to the other whenever
transfers were rendered necessary.
Continued increases in the issue of
Federal Reserve notes and in the
number and amounts of transactions
between Federal Reserve Banks, in­
volving large increases in both gold
funds and a greatly enlarged number
of transactions, made the duties of the
custodians of the Gold Fund very
burdensome. Therefore, the Board
recommended to Congress an amend­
ment to the Act, which became a law on
June 21, 1917, for the purpose of
simplifying the operation of the Fund,
which had grown from $18,450,000 in
May, 1915, to considerably more than
Under the new plan, made possible
by the amendment of Section 16 of the
Federal Reserve Act, the Treasurer of
the United States opened an account
with the Federal Reserve Board,
giving credit to the Board for the sum
of deposits of Federal Reserve Banks
and Federal Reserve agents combined.
Individual accounts were kept as

formerly by the Federal Reserve Board.
The Fund was transferred to the keep­
ing of the Treasurer of the United
States, and the Board, in its bulletin
for July, 1917, in describing the trans­
fer, said: “Some idea of the magnitude
of the Fund may be had from the fact
that a truck load of gold order certifi­
cates (in ten thousand dollar denomi­
nation) was transferred from the
Federal Reserve Board to the Treas­
urer of the United States. It took
three men over two days to place a
stamped endorsement on the certifi­
cates. Had the amount represented
been in the form of gold coin, it would
have weighed 963 short tons. The
Treasury of the United States, of
course, issued its receipt to the Board
for the money.”
In its Fourth Annual Report cover­
ing the year 1917, the Federal Reserve
Board stated that the operation of the
Fund, which was, in effect, a clearing
house for the twelve Federal Reserve
Banks, had been particularly useful
during the year by reason of the
continuous transfers of very large
amounts, which had grown out of the
sale of government bonds and Treas­
ury certificates and redistribution and
disbursement of the funds realized.
The total volume of clearings and
transfers through the Fund during the
year amounted to $26,962,000,000, as
compared with $5,575,000,000 during
1916. The net balances representing
the change of ownership between the
Federal Reserve Banks of gold held in
the fund were $272,000,000. The
Board stated: “Without such an
arrangement, actual settlings between
Federal Reserve Banks would have
been accompanied with great expense
and loss of time, but by its aid these
enormous transfers have been made
automatic and instantaneous and have
been made without the inconvenience
and expense which would have been

T he G old S ettlement F und

unavoidable had a physical transfer
and shipment of money been neces­
It is not only the expense and delay
of the physical transfer and shipment
of money which was avoided. It is to
be doubted whether such transfers
would have been possible at all under
the old banking plan without creating
financial disturbances which would
have unsettled the business of the
Up to this time Federal Reserve
Banks were still making weekly settle­
ments on a basis of figures shown by
their books at the close of business
Wednesday. Practically all communi­
cations between the Federal Reserve
Banks and the Federal Reserve Board
with reference to weekly settlements
and transfers had been made by wire,
and messages had necessarily been sent
over the commercial wires. The
necessity for private wires between all
Federal Reserve Banks and branches
and the Federal Reserve Board became
too urgent to be postponed. A private
or leased wire system was put in
operation on June 4 , 1918, and all
Federal Reserve Banks employed tele­
graph operators.
D a il y S e t t l e m e n t s T h r o u g h t h e
G old F u n d

The next step in the evolution of the
Gold Fund was the institution of daily
instead of weekly settlements. On
July 1, 1918, a daily settlement plan
was put into effect. In the Bulletin
for July, 1918, the Board said:
The plan will eliminate a great deal
of work at the Federal Reserve Banks,
and through daily instead of weekly settle­
ments will provide for the proper adjust­
ment of the gold holdings to the credit of
each Federal Reserve Bank in the Gold
Settlement Fund in as nearly automatic a
way as possible. At the present time, the
Federal Reserve Banks, in addition to the


weekly settlement, have the privilege of
demanding transfers at any time upon the
net debit balance as shown in accounts
with other Federal Reserve Banks. It
must be expected that if the present plan of
weekly settlement were to be maintained,
such transfers would become more numer­
ous in the future as the calls upon the
Federal Reserve Banks became heavier.
The proposed plan (for daily settlement)
would do away with the greater part of
such transfers and will release for the
strengthening of their reserves the funds
now carried as the amounts due from other
Federal Reserve Banks. Under the law,
balances due from other Federal Reserve
Banks could not be counted as a part of the
reserve of any Federal Reserve Bank, but
under the regulations of the Board, which
then existed, such balances due from other
Federal Reserve Banks were allowed as
deductions from net deposits in making
reserve calculations.
G r o w t h in C l e a r in g T r a n s a c t io n s

Combined clearings and transfers
through the Fund during the year 1918
aggregated $50,242,000,000. Thus, by
gradual development, what seemed,
and was indeed, a formidable under­
taking was worked out. The internal
accounting operations of the Federal
Reserve Banks were readjusted and
improved, but no change was made
in the plan of settlement during
the year 1919. Clearings and trans­
fers through the Fund for the year
1919 aggregated practically 74 billion
dollars. The Board, in its annual
report for the year 1919, made the
following statement:
When it is considered that these enor­
mous transfers are made almost instan­
taneously by means of the leased wire
system without involving the physical
movement of a dollar, it will be seen that
the arrangement has been of incalculable
value to the government, the banks and the
public. The total expense of operation,
including the cost of the leased wires and
the salaries of accountants, was approxi­


T he A nnals of the A merican A cademy

mately $250,000. This represents the
basic cost of effecting domestic exchanges
between the several reserve districts. A
charge of ten cents per one hundred dollars,
if generally imposed, would have imposed
an expense on the commerce of the country
of $73,984,252.
The leased wire system had been
extended to all branches of Federal
Reserve Banks, and in many cases
these branches participated in the
Gold Settlement Fund.
The last refinement in the evolution
of the Gold Settlement Fund was made
when all transactions between Federal
Reserve Banks which are settled
through the Gold Fund were made
effective on the day on which they
occurred. This was made possible by
the introduction of a plan or practice
under which all transactions to be
settled through the Gold Fund were
wired to the Board from the banks and
the branches, and the Board made the
settlement upon its books as of that
day at the earliest possible hour on the
following morning, and wired the
settlement figures to each Federal
Reserve Bank. The Federal Reserve
Banks kept their books open until
such wires were received from the
Federal Reserve Board, and then
made the few entries necessary and
closed their bool^s as of the pre­
vious day. This plan has worked ad­
mirably and has eliminated all the
float which had to be carried by
those Reserve Banks with credit bal­
ances in the settlement under the
previous plan, by which the daily
settlement payments were not re­
ceived until the day following that
on which the settlement figures were
made up. The volume of clearing
through the Gold Fund for the year
1920 was $92,625,000,000. The aver­
age weekly volume of clearings in­
creased from $31,898,000 in 1915 to
$ 1,793,584,000 in 1920.

“Behold, how great a matter a
little fire kindleth!” Thus, from
cautious beginnings, feeling the way,
but nevertheless with unexpected rapid­
ity of progress, the Federal Reserve
System has developed the most ef­
fective, the most comprehensive and
the most economically administered
exchange system in the world of bank­
ing. When all the banks of the country
are on a par clearing basis, the system
can be made still more effective and
At the present time, a member bank
may obtain from its own Federal Re­
serve Bank, free of expense to itself, a
telegraphic transfer of funds, in any
amount, to any point in the country
where a member bank is located.
These transactions are effected between
Federal Reserve Banks and are settled
through the Gold Fund.
The Gold Fund has been of inesti­
mable value to the Treasury, and has
rendered easy of accomplishment the
most stupendous financial operations
ever undertaken. During the past
two years, the government has col­
lected taxes from every nook and
corner of the country, amounting to
about one billion dollars quarterly.
Certificates of indebtedness have been
issued, have matured and been paid,
and the receipts and disbursements
of the Treasury for a single day, on
occasions, have amounted to approxi­
mately a billion dollars each way.
All of these funds passed through
the Federal Reserve Banks; they were
adjusted and redistributed through
the Gold Fund without disturbance
of the financial equilibrium and
so smoothly as to occasion hardly
a comment. It has become a routine
Lord Byron makes the Prisoner of
Chillon say:
“ So much a lorg communion tends
To make us what we are.”

E ligibility for D iscount

So we say that the public from long
communion with these huge trans­
actions now takes them as a matter of
course, but without fully understand­


ing that it is the wonderful working
of the Federal Reserve System which
makes us commercially and finan­
cially what we are.

Eligibility for Discount
By C h a r l e s L. P o w e l l


Counsel for Federal Reserve Bank of Chicago

HE kind and character of paper
which the Federal Reserve Banks
may discount for member banks
in broad, general terms defined in Sec­
tion 13 of the Federal Reserve Act.
It is there provided that the Federal
Reserve Banks, upon the endorsement
of member banks, may discount for
them: (1) notes, drafts and bills of ex­
change issued or drawn for agricultural,
industrial or commercial purposes, or
the proceeds of which have been used
or are to be used for such purposes;
(2) acceptances of banks of the charac­
ter and kind described in the Act.
The Federal Reserve Board, by the
same section of the Act, is given the
right to determine or define the char­
acter of paper made eligible for dis­
count within the meaning of the
Act; and, the Board in the exer­
cise of this statutory right has, from
time to time, promulgated a series of
regulations for the guidance of the
Federal Reserve Banks and member
banks. These regulations, while not a
part of the statute, having been made
and promulgated by a lawfully consti­
tuted body, have the force and effect of
law.1 As is said by the Supreme Court
of the United States, in United States
v. Clark, “the Legislature cannot dele­
gate its powers to make a law, but it
can make a law to delegate a power to

determine some fact or state of things,
upon which the law makes, or intends
is make, its own action depend.” Ac­
cordingly, the regulations made by the
Federal Reserve Board defining, apply­
ing and limiting the character of paper
eligible for rediscount must be read as
part of the Act.
G e n e r a l L im it a t io n s o n E l ig i b i l it y

The limitations on eligibility for dis­
count, as provided by the Act and the
regulations of the Board, are directed
to (1) the maturity of the paper and
(2) its source of origin, or the purposes
for which it is to be used. The lan­
guage used by the Act in respect to the
latter is modeled upon many prior pro­
posals for legislation and was mani­
festly for the purpose of avoiding the
use of bank funds in two general
classes of transactions, that is to say, in
speculative transactions and in trans­
actions involving capital investments.
The reason for these two provisions
of the Act—the one relating to the
origin or purpose of the note or bill and
the other to its short maturity—is
found in the recognized necessity of
keeping the assets of the bank liquid at
all times and thus readily available to
meet the demands of commerce and
It was expected, and the operation of
the Act has proved it to be the case, that
1 United States v. Grimaud, 220 U. S. 506;
Dasterbignes Case, 122 Fed. 30 ; United States v. a large part of the banking resources of
the nation would find its way into the
Clark, 143 U. S. 664.


T he A nnals of the American A cademy

Reserve Banks. It was, and is, un­
thinkable, from a scientific standpoint,
that these resources should be tied up
in long-time investments, or in invest­
ments permanent in their nature. It
is the very essence of the Federal Re­
serve System that its funds must be in­
vested in short-time securities, which,
in theory at least, are self-liquidating.
B o a r d D e f in it io n s o f E l ig ib l e
P aper

Regulations of the Federal Reserve
Board have been promulgated and put
into effect, clarifying, amplifying and
explaining the language of the Act,
keeping in view at all times the broad
general provision of the Act that in­
vestments must be of short maturity
and must have arisen out of commer­
cial transactions. These regulations
have been revised from time to time.
The last revision was put out under
date of October 6, 1920.2 This revi­
sion was amended May 6, 1921.3
The Board’s regulations define with
particularity promissory notes, drafts,
bills of exchange, trade acceptances,
six months’ agricultural paper and
bankers’ acceptances eligible for dis­
count, but the definitions thus pro­
mulgated by the Board are well within
the usual definitions found in the Ne­
gotiable Instruments Acts of the vari­
ous states, so far as such acts deal with
similar instrumentalities of commerce.
In addition to definitions of such
ordinary instruments, a trade accept­
ance is defined as “a draft or bill of
exchange, drawn by the seller on the
purchaser of goods sold, and accepted
by such purchaser.”
Six months’ agricultural paper is de­
fined as “a note, draft, bill of exchange
or trade acceptance, the proceeds of
which have been used, or are to be
used, for agricultural purposes, in2 Federal Reserve Bulletin,
3 Ibid., :

7 545

6 : 1179.

eluding the breeding, raising, fattening
or marketing of live stock, and which
has a maturity at the time of discount
of not more than six months, exclusive
of days of grace.”
C o m m e r c ia l a n d A g r ic u l t u r a l
P u r p o se s D e f in e d

Under the regulations, paper may
be eligible because issued or drawn for
an agricultural or commercial purpose,
or it may be eligible because the pro­
ceeds have been, or are to be, used for
an agricultural or commercial purpose.
The purchase and sale of goods of any
character is a commercial transaction
from the standpoint of the seller, and
the note of a buyer given to the seller
in payment for articles purchased is a
note which has been “issued or drawn
for a commercial purpose.”
The use of the proceeds of a note to
purchase goods for re-sale is a com­
mercial purpose, even though the ar­
ticles purchased will be permanent
investments in the hands of the final
purchaser; and, accordingly, the note of
a dealer, discounted by him at a local
bank, to provide funds to purchase
articles for re-sale, may be eligible for
discount as commercial paper, irre­
spective of the character of the arti­
cles purchased; but a note of a farmer
discounted by him at his local bank to
provide funds with which to purchase
articles for agricultural uses, is eligible
or ineligible for discount according to
the character of the articles. If the
articles are in the nature of permanent
or fixed investments, then it is not
eligible; but if, on the other hand, they
are articles for agricultural uses and
have to be replaced from time to time,
the farmer’s note is eligible for dis­
count as agricultural paper.
The distinction between agricul­
tural paper and commercial paper is
important in several respects: Agri­
cultural paper having a maturity of

E ligibility for D iscount

six months may be eligible, while
commercial paper to be eligible can
have a maturity of but three months;
a farmer’s note given in payment for
articles or commodities to be used by
the farmer for agricultural purposes is
agricultural paper; but the purchase
and sale of agricultural products is a
commercial and not an agricultural
transaction, and a note given to a
farmer for agricultural products grown
by him, is eligible, if at all, as com­
mercial paper.4
L o n g - T im e F u n d s a n d G o v e r n m e n t
B onds

The Board’s regulations, following
the provisions of the Act, provide for
the discount by Federal Reserve
Banks of such notes, drafts, bills of
exchange, trade acceptances, six
months’ agricultural paper and bank­
ers’ acceptances of short maturity and
of commercial origin referred to there­
in, but such regulations, following and
expressing the spirit of the Act, pro­
vide that a note, draft, or bill of ex­
change, the proceeds of which have
been used for permanent or fixed in­
vestments, such as lands, buildings,
machinery and other capital purposes,
or which have been used, or are to be
used, for investments of purely specu­
lative character, or for the lending to
some other borrower, shall not be eli­
gible for discount.
Both the provisions of the Act and
the regulations of the Board make
eligible for discount obligations issued
or drawn for the purpose of carrying
or trading in bonds and notes of the
government of the United States,
when such obligations are of proper
maturity. Further, the Federal Re­
serve Act was, in effect, amended by
the War Finance Corporation Act, ap­
proved April 5th, 1918, whereby ob­
ligations of appropriate maturity, as
4Ibid , 6 : 1302 .


defined by the Federal Reserve Act,
when secured by bonds of the War
Finance Corporation, are made eligible
for discount. However, notes, drafts
or bills issued or drawn for the purpose
of carrying or trading in other stocks
and bonds are not eligible for discount.
Strict negotiability of instruments of
commerce is one of the prime requisites
of paper eligible for discount by a
Federal Reserve Bank. This is for the
reason that a member bank must en­
dorse paper tendered for discount, not
only for the purpose of placing the title
thereof in the Federal Reserve Bank,
but also for the purpose of assuming all
the responsibilities of an endorser upon
negotiable paper. To the end that such
liability of member banks, as endorser,
be preserved, the instrument tendered
for rediscount must be strictly nego­
tiable within the meaning of the law
applicable to commercial paper in the
particular jurisdiction.
The Federal Reserve Board has pro­
mulgated rules for the determination
of the eligibility of paper for discount,
which rules have to do merely with the
method to be pursued by the Federal
Reserve Banks in ascertaining the ulti­
mate facts as to whether or not the
paper is eligible under the provisions of
the Act and the regulations of the
Board; but such regulations are evidenciary in effect and have to do, not
with the eligibility of the paper, but
merely with the method of procedure
in ascertaining its eligibility.
C o m m e r c ia l a n d A g r ic u l t u r a l
P a p e r E l i g i b l e f o r D is c o u n t

Notes secured by mortgage, if other­
wise eligible, may be discounted.5 In­
asmuch as notes payable “on or be­
fore” a given date are negotiable
within the meaning of the Negotiable
Instruments Act, in force in most of
6 Ibid., 2: 679 .

T he A nnals of the American A cademy

Se/^Ues, and under the Law Meri&t/such notes are eligible for disThe assignment of an open
Scount is not negotiable, and is not
eligible for rediscount.7
A bill of exchange drawn by the
seller on the purchaser of advertising
space and accepted by such purchaser
is a trade acceptance and is eligible for
discount.8 The note of a farmer held
by a member bank, given for the pur­
pose of assisting the farmer to produce
a crop or to fatten his cattle, is eligible
for discount if of proper maturity,
whether or not secured by mortgage.9
A note drawn for commercial purposes,
otherwise eligible for rediscount, is not
ineligible because it is secured by a
mortgage on real estate.10 The notes
of a water works company, the pro­
ceeds of which have been, or are to be
used to provide funds for the pay roll,
purchase of coal and the like, are eligi­
ble for discount.11 The note of a pack­
ing company, the proceeds of which are
used for the purchase of live stock for
slaughter is not “based on live stock”
within the meaning of Section 13 and
is not eligible for discount if it has a
maturity in excess of 90 days.12 A
certificate of participation in a note,
which, itself, is eligible for discount, is
not eligible.13 Water sold by an irriga­
tion company to farmers and delivered
through the company’s ditches may be
classed as “ goods sold,” within the
meaning of the Board’s regulations and
a note representing the agreed pur­
chase price thereof is eligible for dis­
count.14 Natural gas actually sold and
delivered is “ goods sold” and a trade
acceptance covering such is eligible for
The note of the owner of property
*Federal Reserve Bulletin, 2 : 394.
7 Ibid., 2 : 227.
11 Ibid., 3 : 527.
8Ibid., 3 : 116.
12Ibid., 3 : 616.
• Ibid., 3 : 378.
18Ibid., 3 : 949.
10 Ibid., 3 : 458.
14Ibid., 6 : 949.
15Ibid., 4 : 435.

which is to be developed or built
up, the proceeds of which note have
been, or are to be used by him to pay
for the work of developing or building,
is not eligible for discount, but the note
of an owner given in good faith to the
contractor in actual payment of mate­
rial and services furnished by him for
the owner, may be considered tech­
nically eligible for discount as paper,
the proceeds of which have been or are
to be used for commercial or industrial
Collateral notes of Federal Farm
Loan Banks, secured by farm loan
bonds or the note of a Joint Stock
Land Bank, secured by its own bonds,
are not eligible for discount.17 Federal
Farm Loan Bank bonds are not eligible
for discount, and are not, accordingly,
eligible as collateral for member
banks.18 A note, secured by paper eli­
gible for discount, is not itself eligible
for discount unless its proceeds have
been used, or are to be used, for indus­
trial, agricultural or commercial pur­
poses.19 Under the present definitions
of a trade acceptance, it seems that a
draft drawn for an insurance premium
would not be eligible for discount.20
The note of a farmer given for a tractor
to be used on his farm may be dis­
counted as agricultural paper.21 A
note given by a farmer for the purchase
price of a commodity can be classed as
agricultural paper eligible for redis­
count when having a maturity in excess
of ninety days, if the maker is to use
the commodity for agricultural pur­
poses, regardless of whether the note is
discounted by the maker or the en­
dorser; but if not intended for such use,
then the paper is eligible for discount
as commercial paper, if having a matu­
rity not in excess of ninety days.22
16Ibid., 6: 699.
19 Ibid., 4 : 108.
17 Ibid., 6 : 609.
20 Ibid., 4 : 309.
18 Ibid., 4 : 33.
21 Ibid., 4 : 309.
22 Ibid., 4 : 312.

E ligibility for D iscount

A member bank having acquired
eligible paper in due course from a
non-member bank may discount such
paper with a Federal Reserve Bank.23
A note, the proceeds of which is used
for tilling or draining farms, may be
classed as agricultural paper and is
eligible for discount.24 A note of a non­
member bank, secured by notes of the
government of the United States, and
given for the purpose of carrying or
trading in such notes of the United
States, is eligible for discount when
presented by a member bank.25 A
member bank may obtain the discount
of its paper secured by government
bonds for a period as long as ninety
days, by acting through another mem­
ber bank, although a member bank,
acting alone, may not tender its col­
lateral note to the Federal Reserve
Bank for a longer period than fifteen
days.26 Silos are permanent improve­
ments, and notes given for their pur­
chase are not eligible for discount.27
Where a railroad company purchases
supplies and accepts the draft of the
seller and the seller discounts the draft
with a member bank, such draft is
eligible for discount.28 The six months’
maturity privilege as applied to agri­
cultural paper does not apply to the
sales a manufacturer of implements
makes to a dealer for re-sale to a
farmer.29 The actual sale of goods, and
not what is generally termed a con­
ditional sale, must be the basis of a
trade acceptance.30
A draft drawn to cover the purchase
price of goods sold, plus the cost of
installing those goods, is eligible for
discount.31 A note is not eligible for
discount as commercial paper unless
made and endorsed by a party to the
2* Ibid., 4 : 520.
24Ibid., 4 : 743.
28Ibid., 4 : 743.
26Ibid., 4 : 863.

*7 Ibid., 4 : 971.
28 Ibid., 4 : 974.
29 Ibid., 4 : 1118.
30Ibid., 5 : 964.
31Ibid., 4 : 310.


commercial transaction, out of which
it arises.32 This is but another way of
saying that the proceeds must be used
in the first instance for a commercial
purpose by the borrower. It is merely
emphasizing the thought that paper to
be eligible, must be issued or drawn un­
der such circumstances that, in the
normal course of business, there will
automatically come into existence a
fund available to liquidate each piece
of paper, that fund being the final
proceeds of the transaction out of
which the paper arose.
A note of a grain dealer or other pur­
chaser of grain, given to a grower for
grain purchased for re-sale, is commer­
cial paper and is to be discounted as
such, even though the grower subse­
quently discounts the note and uses
the proceeds for an agricultural pur­
pose. The same principle applies to a
draft drawn by the grower, and ac­
cepted by the purchaser, in whole or in
part payment for grain purchased for
re-sale.33 Here is brought into play the
rule that the transaction out of which
an instrument arises in the first in­
stance determines its classification, irre­
spective of any transaction in which
the instrument may be subsequently
A note given for the purchase of a
motor truck by a farmer is clearly held
to be eligible for discount, as agricul­
tural paper, but notes or trade accept­
ances given in the purchase of motor
trucks of a corporation engaged in the
business of furnishing motor trans­
portation are not eligible for discount,
as such trucks represent in a large ex­
tent the corporation’s capital invest­
Paper, the proceeds of which are to
be used to make loans to third parties,
is finance paper rather than commercial
or agricultural paper and is not eligible
82Ibid., 7 : 1079.
33Ibid., 7 : 1199.
34Ibid., 7 : 191.


T he A nnals of the American A cademy

for discount.35 Where a cold storage
company uses the proceeds of its notes
to make advances to customers who
have placed their goods in the com­
pany’s warehouse to be sold by the
company for the account of the cus­
tomers, and the customers give the
storage company their notes for the
amount of these advances, and as se­
curity for such notes, pledge the ware­
house receipts, and the storage com­
pany pledges the customers’ notes and
the warehouse receipts as collateral for
their own notes, such notes are not
eligible for discount.36 Growers’ drafts
accepted by cooperative marketing as­
sociations are eligible for discount with
Federal Reserve Banks, as agricultural
paper, and may have a maturity riot in
excess of six months.37 The note of an
irrigation company cannot be classed
as agricultural paper, but a farmer’s
note, given to an irrigation company in
payment for a supply of water, may be
regarded as agricultural paper.38
Notes of corporations or associations
engaged in packing and marketing
fruits should not be classed as agricul­
tural paper, but as commercial paper,
and such notes are eligible when their
maturities do not exceed ninety days.
The business of such corporations or
associations in the marketing of fruits
is a commercial business rather than
an agricultural business.39
T h e F u n c t io n o f B a n k e r s ’
A cceptances

As already noted, Federal Reserve
Banks may discount, for their member
banks, bankers’ acceptances. A bank­
ers’ acceptance is defined by the regu­
lations of the Federal Reserve Board as
“a draft or bill of exchange, whether
payable in the United States or abroad,
and whether payable in dollars or some
35 Federal Reserve Bulletin, 6:1176.
36 Ibid., 7: 308.
38 Ibid., 7: 964.
37 Ibid., 7:1199.
39 Ibid'., 7:1312.

other money, of which the acceptor is a
bank or trust company, or a firm, per­
son, company or corporation engaged
generally in the business of granting
bankers’ acceptance credits.”
The practice of banks to make ac­
ceptances is practically as old as the
business of banking, but the practice
never came into modem use in the
United States until after the enact­
ment of the Federal Reserve Act.
Prior to that Act the average American
bank merely collected the idle funds of
the community and loaned them and
its own funds to its customers. The
bank loaned capital and not credit.
On the other hand, the chief merit and
the distinguishing feature of European
banking systems, especially in England,
France and Germany, was found in the
bank acceptances by which those banks
loaned their credit. They standard­
ized bills of exchange and added new
power to them, so that by virtue of
their credit quality these bills became,
part of the circulating credit of the
country. The European banks found
the acceptance to be the cheapest form
of credit instrument. It did not de­
plete cash holdings of the accepting
bank and no reserve was needed to
safeguard the risk. This acceptance
power of European banks enabled
them cheaply to finance export and
import transactions and, doubtless, to
a large extent explains why, prior to
the Great War, all such financing was
done by European banks to the utter
exclusion of the American banks.
This salutary method of financing
transactions was grafted on our system
by the Federal Reserve Act and follow­
ing that Act most of the states have
conferred the acceptance power upon
their state banks by specific provision,
so that the granting of acceptances
by banks has come to be a part of
the general banking business in this


E ligibility fob D iscount
T h e D is c o u n t a n d P u r c h a s e o f
B a n k e r s’ A cceptances

The Federal Reserve Act and the
regulations of the Federal Reserve
Board made pursuant thereto, and the
Acts of the various states, have safe­
guarded the granting of acceptances by
member banks. Indeed it may be said
in broad general terms that bankers’
acceptances, which have had their ori­
gin in accordance with the limitations
of the Act and regulations, if not of
more than three months’ maturity, ex­
clusive of days of grace, are eligible for
discount by Federal Reserve Banks.
Federal Reserve Banks may dis­
count any bill drawn by a bank or
banker in a foreign country or depend­
encies or insular possessions of the
United States for the purpose of fur­
nishing dollar exchange as provided in
the Act and regulations of the Board,
provided such draft has not more than
three months’ maturity, exclusive of
days of grace.
Bankers’ acceptances, to be eligible
for discount, may involve: (1) the ship­
ment of goods between the United
States and any foreign country, or be­
tween the United States and any of its
dependencies or insular possessions, or
between foreign countries; (2) a ship­
ment of goods within the United
States; or (3) the storage of readily
marketable staples.
When the acceptance is based on a
shipment of goods between the United
States and any foreign country, or
between the United States and any of
its dependencies or insular possessions
or between foreign countries, shipping
documents covering goods in process
of shipment need not be attached to
the draft drawn for financing the
transaction. Neither is it essential
that each draft cover specific goods
actually in existence at the time of the
acceptance, but, in order that said
drafts be eligible for discount, it is

necessary either, (1) that shipping doc­
uments or documentary export draft
be attached at the time the draft is
presented for acceptance, or (2) if the
goods have not been shipped, that
there be in existence a bona fide con­
tract providing for the exportation or
importation of such goods and that
the customer agree that the accepting
bank will be furnished in due course
with shipping documents or with ex­
change arising out of the transaction.
A contract between principal and agent
will not be considered such bona fide
In the case of shipment of goods
within the United States, the regula­
tions provide that shipping documents
conveying security title should be at­
tached to the draft at the time of its
A bankers’ acceptance based upon
the storage of readily marketable
staples must be secured at the time of
acceptance by a warehouse, terminal or
other similar receipt, conveying secu­
rity title to such staples, and the ac­
ceptor must remain secured throughout
the life of the acceptance.
The discretion of the Board with ref­
erence to bankers’ acceptances and the
investment therein of the Federal Re­
serve Bank funds is probably broader
than its discretion with reference to
notes, drafts, trade acceptances, and
other bills of exchange.40
The rule of the Board with reference
to furnishing shipping documents in
export or import transactions is not met
by the furnishing of freight receipts or
non-negotiable copies of bills of lading.41
Shipping documents are legally in
the possession of an accepting bank
when they are held by its correspond­
ent or by some other independent
party, as its agent, both in domestic
and foreign transactions.42 The period
40 Ibid., 7:7 0.

41 Ibid., 7:191.
42 Ibid., 7:191.


T he A nnals of the A merican A cademy

for which drafts may be accepted in the
first instance should be approximately
the same as that required to complete
the shipment and finance the transac­
tion involved.43 A draft drawn by an
American exporter, covering cotton
consigned to his European agent, may
be eligible for discount, when shipping
documents covering goods actually
shipped are attached at the time the
draft is presented for acceptance, al­
though the goods covered by the doc­
uments have not been sold, but are
merely shipped on consignment to the
agent abroad.44
A Federal Reserve Bank may pur­
chase a bankers’ acceptance from the
drawer or even from the accepting
bank, but there is no obligation upon
a Federal Reserve Bank to purchase
paper offered it, even though the paper
is technically eligible.45 Where a
farmer draws a draft on his local bank
for three or four months, secured by
bills of lading covering the shipment of
cattle to the farmer for feeding, and the
local bank accepts the draft and the
farmer then discounts it with another
bank, such draft is eligible for dis­
count if it has a maturity not in excess
of three months.46
Bankers’ acceptances, growing out of
export or import transactions, having
a maturity of not more than six
months may be purchased in the open
market by Federal Reserve Banks.47
The “shipping documents” to be fur­
nished banks accepting drafts growing
out of export or import transactions
mean an order bill of lading, or a
straight bill of lading, whichever is is­
sued by the carrier in the particular
case. They do not include freight re­
ceipts or mere copies of original bills of
lading, but these documents may be
held by a correspondent or agent.48 A
43Federal Reserve Bulletin, 7 : 308.
44Ibid., 7 : 419.
4 Ibid., 7 : 815 .
46Ibid., 7 : 699.
4 Ibid., 7 : 545 .
48Ibid., 7 : 191.

bankers’ acceptance drawn by a coop­
erative marketing association, secured
by warehouse receipt covering nonperishable agricultural commodities
stored in warehouses independent of
the association, is eligible for discount.
The acceptance of drafts, secured by
bills of lading, for the primary purpose
of providing the borrower with work­
ing capital during the period required
to manufacture and re-sell the goods
covered by the bills of lading, is an
abuse of a domestic acceptance privi­
lege.49 Drafts drawn by the purchaser
of goods and secured at the time of
acceptance by bills of lading covering
the goods bought are not eligible un­
less the proceeds are to be used to pay
for the goods.50
A bankers’ acceptance secured by a
warehouse receipt covering an auto­
mobile or automobile tires is not se­
cured by “readily marketable staples”
and is not eligible for discount, but an
acceptance secured by a bill of lading
covering an automobile or automobile
tires in the process of shipment, pro­
viding the acceptance otherwise com­
plies with the terms of the law or the
regulations of the Board, is eligible for
discount.51 A bankers’ acceptance is
not eligible for discount if, at the time
of its acceptance, the period required
for a conclusion of the transaction out
of which the original draft was drawn,
shall have elapsed.52 A draft drawn
abroad, payable in the United States in
dollars, and secured by a warehouse
receipt covering readily marketable
staples stored in a warehouse in a for­
eign country, is eligible for acceptance
by a member bank and for discount by
a Federal Reserve Bank, if of appro­
priate maturity.53
The Federal Reserve Board has de­
fined a “readily marketable staple” as
49Ibid., 6 : 1301.
5 Ibid., 6: 65 .
60Ibid., 3 : 380; 6: 66. 52 Ibid., 5 : 858.

5 : 740.

E ligibility for D iscount

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 quota­
tions of prices as to make the price
easily and definitely ascertainable, and
the staple itself easy to realize upon by
sale at any time.54
Under the terms of Section 13 of the
Act, any draft or bill of exchange,
which a member bank has the power
to accept under the provisions of that
section, is technically eligible for re­
discount by a Federal Reserve Bank.66
An accepting bank, secured in a do­
mestic transaction by shipping docu­
ments or warehouse receipt s, at the time
of acceptance may release the shipping
documents or warehouse receipts prior
to payment, providing the draft or
drafts accepted for one person do not
exceed 10 per cent of the capital and
surplus of the accepting bank.66 Mem­
ber banks may legally accept drafts
drawn against them, secured by sugar
placed in bond under transit entry and
warehouse receipt issued by the col­
lector in negotiable form.67 National
banks may not accept a draft which is
secured by a chattel mortgage on cat­
tle.58 Where a dealer is engaged in
purchasing the same character of goods
for export and domestic use, a member
bank accepting his draft drawn to
finance an export transaction should
require proper assurance that the pro­
ceeds of such draft will be used for the
purchase of goods for export and that
the acceptance will be paid out of the
proceeds of sales of goods exported.69
A trust receipt in the hands of an
accepting bank which permits the pur­
chaser of the goods to procure control
of the goods is not actual security,
within the meaning of the Act.60 One
in the possession of a bill of lading cov64Ibid., 5 : 652.
67 Ibid., 4 : 520.
55Ibid., 5 : 255.
68 Ibid., 4 : 437.
66Ibid., 4 : 634.
69 Ibid., 4 : 314.
60Ibid., 3 ; 881.


ering a domestic shipment of goods
may not procure an acceptance thereon
by a member bank without regard to
the use to which the proceeds of the
draft are to be put. There must be
more than a casual connection between
the drawing of the draft and the trans­
action involved.61 A warehouse re­
ceipt, to be appropriate security for an
acceptance, should be issued by a ware­
house which is independent of the bor­
rower.62 Gold bars may be properly
considered as “ goods” and, accord­
ingly, sixty day bills, when accepted
by banks against such a shipment,
would be eligible for discount. Ex­
change drawn to finance a shipment of
gold coin from the Uuited States to
Europe or Canada, is eligible for pur­
chase when otherwise in conformity
with the Act and regulations.63
A bankers’ acceptance secured by a
bill of sale of stock on hand is not eligi­
ble for discount.64 A bankers’ accept­
ance secured by chattel mortgage on
cattle is eligible for discount65 but the
Board has ruled that a national bank
may not accept a draft so secured.66
P a per M ust B e K e pt L iq u id

The conservation of the strength of
the Federal Reserve System is depend­
ent upon the strict adherence of the
Federal Reserve Banks to the rules
governing the eligibility of paper for
discount* If those rules are adhered
to, the portfolios of the Reserve Banks
will be filled with liquid securities ma­
turing from day to day, thus bringing
into the banks a continuous flow of
money to meet the demands of com­
merce and trade. On the other hand,
if those rules are departed from, the
portfolios of the banks will become
clogged with “frozen credits,” and the
purpose for which the Reserve Banks
were organized will be defeated.
81Ibid., 3 : 380.
84 Ibid., 2: 684.
82Ibid., 3 : 30.
“ M , 2: 65 .
63Ibid., 3 : 29.
66 Ibid., 4 : 309.


T he A nnals of the A merican A cademy

Amendments to the Federal Reserve Act


W alter


L ogan

General Counsel, Federal Reserve Board

HE Federal Reserve Act has been the importation or exportation of
amended a number of times since goods.” National banks were without
it became a law on December 2 3 , 1913,
authority to accept drafts in domestic
but none of the amendments can be transactions until, by the Act of
said to have affected any fundamental September 7, 1916, they were given
change in the structure or operation of authority to accept drafts or bills in
the Federal Reserve System. Experi­ transactions involving the domestic
ence has indicated how the purposes of shipment of goods or the storage of
the framers of the Act could be ad­ readily marketable staples, subject to
vanced by further legislation, and how certain prescribed conditions.
the Federal Reserve System could best These conditions were that the bank
serve the banks and the business of the issuing acceptances in such domestic
country; Congress in the light of this transactions must be secured at the
experience has modified many of the time of acceptance by shipping docu­
provisions of the original Act. But the ments covering the goods in process of
principles upon which the Act was shipment, or by warehouse receipts or
based, the functions of the Federal other similar documents covering the
Reserve Banks and their relation to the readily marketable staples in storage.
member banks and to business and com­ There never has been any similar
merce, remain essentially unchanged. requirement of law with respect to
It will not be attempted in this acceptances in foreign transactions and
chapter to discuss every amendment, it is important to note this distinction,
for many of them are not considered of for it is the basis 'for a more liberal
sufficient general interest to warrant practice in connection with the issue
mention in a work of this character; in of foreign acceptances than has been
many cases they relate solely to the adopted with respect to domestic
internal administration of the Federal acceptances.
Because of the requirement that
Reserve Banks.1
documents representing the goods or
A c c e p t a n c e P o w e r s o f N a t i o n a l staples must be in the possession of the
B anks
accepting bank at the time of accept­
The first important amendment was ance, it is obviously impossible that
the Act of September 7, 1916. Probably domestic acceptances be issued except
the most far reaching change effected when the goods or staples are identified
by this amendment was with respect and in process of shipment or in
to the; acceptance powers of national storage. The issuance of acceptances
banks. The Act, as originally passed, to finance foreign transactions has,
authorized member banks to accept however, been authorized prior to the
only drafts and bills of exchange commencement of the actual export or
“ growing out of transactions involving import shipment, in cases where the
customer for whom the acceptances
1 For a complete list of amendments prior are issued is under a definite contract
to January 1, 1921, see the Annual Report of
to export or import goods in the future.
the Federal Reserve Board for the year 1920,
This has been authorized upon the
pages 316- 326.

A mendments to the F ederal R eserve A ct

theory that the export or import
transaction commences with the execu­
tion of the contract and that the sub­
sequent acts in fulfilment of that
contract are inherent parts of that
transaction, and may, therefore, be
financed by means of acceptances.
The Act of September 7, 1916,
further broadened the authority of
national banks to issue bankers’ ac­
ceptances by permitting them, under
regulations of the Federal Reserve
Board, to accept ninety day drafts or
bills drawn by banks or bankers in
foreign countries or dependencies or
insular possessions of the United
States for the purpose of furnishing
dollar exchange as required by the
usages of trade in those places. Under
the authority of this amendment the
Federal Reserve Board has granted
permission to member banks applying
therefor to accept ninety day dollar
exchange drafts drawn by banks or
bankers in South American countries
and in dependencies and insular pos­
sessions of the United States.
O t h e r P r o v is io n s o f t h e A m e n d ­
m e n t o f S e p t e m b e r 7 , 1916

Another important feature of the
Act of September 7, 1916, was that it
authorized Federal Reserve Banks to
make advances for fifteen days to
member banks on the promissory notes
of the member banks when such notes
are secured by paper which is eligible
for rediscount or purchase or by bonds
or notes of the United States. The
provisions of the original Act did not
permit Federal Reserve Banks to
make advances or loans but permitted
them only to rediscount eligible paper
previously discounted by member
The Act of September 7, 1916,
amended Section 25 of the Federal
Reserve Act so as to authorize national
banks with a capital and surplus of not


less than $1,000,000 to invest in the
stock of foreign corporations. This
amendment will be referred to in
connection with the amendments of
September 17, 1919, and December 24,
1919, which deal with the same general
'subject matter.
A m e n d m e n t o f J u n e 21, 1917
The second important amendment
to the Act was that of June 21, 1917.
Up to this time few state banks had
joined the Federal Reserve System,
largely because, by becoming members
under the provisions of Section 9 of the
original Act, they were made subject
to the provisions of the National Bank
Act, which prohibit national banks
from making loans to any one person
in excess of 10 per cent of the bank’s
capital and surplus, and were required
to make reports of condition to the
Comptroller of the Currency; also
because Section 21 of the original Act
required the Comptroller to examine
state member banks at least twice a
year. The argument was also made
that under the terms of the original
Act a state bank once having joined
the Federal Reserve System had no
right to withdraw. In order to make
membership in the System more
attractive to state banks and trust
companies, Section 9 was rewritten.
This section as it now reads exempts
state bank and trust .company members
from supervision or examination by the
Comptroller of the Currency and pro­
vides that “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 Reserve 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.” It also contains
a provision specifically authorizing


T he A nnals of the American A cademy

withdrawal from membership upon six
months’ notice.
The Act of June 21, 1917, also
amended the first paragraph of Section
13 of the Act so as to authorize non­
member banks, irrespective of whether
their capital is sufficient to make them
eligible for full membership, to clear
through the Federal Reserve Banks of
their clistricts checks deposited with
them, provided that they maintain
balances with such Federal Reserve
Banks sufficient to offset the items in
transit held for their accounts. While
this privilege has not been availed of
by non-member banks to any material
extent, apparently because non-mem­
ber banks are able to obtain the full
benefits of the Federal Reserve check
clearing facilities by sending checks
deposited with them to correspondent
member banks which in turn clear
such checks through their Federal
Reserve Banks, and while from a
strictly legal standpoint the Act of
June 21, 1917, in the form in which it
was finally enacted, did not have any
important bearing upon the check
clearing and collection functions of
Federal. Reserve Banks, nevertheless
a brief discussion of the subject of
check clearing and collection seems
appropriate at this point because it
was discussed at length in both the
Senate and the House of Representa­
tives when Congress had the pre­
liminary drafts of the bill under
consideration, and because the provi­
sion added by this Act at the end of the
first paragraph of Section 13 is fre­
quently referred to in discussions
relative to this general subject.
L eg a l A spect of t h e F e d er a l
R e s e r v e C l e a r in g S y s t e m

In July, 1916, a country wide Federal
Reserve check clearing and collection
system was instituted, each member
bank being required to remit at par for

all checks drawn upon it cleared through
the Federal Reserve Banks. This was
an inter-district as well as an intra­
district system, the exclusively intra­
district clearing systems, which had
previously been established but mem­
bership in which had been optional
with each member bank, having proved
unsatisfactory. Simultaneously with
the establishment of the country
wide clearing system, the Federal
Reserve Bank of Boston took over
the country collection department of
the Boston Clearing House and was
able to collect checks on all banks in
New England at par, that is, at the full
face amount without the deduction of
any exchange charge by the drawee
banks. In the other districts it was
not possible to collect at par checks
drawn on all non-member banks be­
cause many of them desired to continue
their past practice of charging exchange
when remitting for their checks. From
the first, however, it was contemplated
that the Federal Reserve check clear­
ing and collection system should be
extended gradually until it furnished
facilities for collecting at par checks on
all banks in the country, thus elimi­
nating the enormous tax with which
business and commerce has been
burdened by reason of the practice of
making exchange charges.
In their origin there was some justi­
fication for exchange charges because
such a charge then represented an
actual expense which the remitting
bank incurred in having currency
transported from where the bank was
located to the place of business of the
holder of the check who had received
it in payment of a debt. At the
present time, however, there is no
necessity for the actual transportation
of currency between Federal Reserve
districts, since the Federal Reserve
System, through its leased wires con­
necting all Federal Reserve Banks and

A mendments to the F ederal R eserve A ct

branches and through its Gold Settle­
ment Fund at Washington, offers
facilities for the instantaneous transfer
of available funds by mere book entry.
The Federal Reserve System pays the
entire cost of maintaining these leased
wires and the Gold Settlement Fund,
and the Federal Reserve Banks pay the
cost of transporting currency from
member and non-member banks in
their districts if such member or
non-member banks desire to make
remittances for their checks in this
manner. Consequently, the justifica­
tion for exchange charges has ceased to
exist and to the extent that such
charges are still made they constitute
a tax paid by business and commerce
for which no compensating service is
Following the policy of extending
the Federal Reserve check clearing and
collection system the Federal Reserve
Banks undertook to induce non-member banks to remit to them at par, and
when able to make satisfactory ar­
rangements, they also undertook to
collect checks drawn on non-member
banks which did not remit at par by
having such checks presented at the
counters of the drawee banks.
This practice caused some opposition
on the part of the non-member banks
which still desired to charge exchange
and as a result of this opposition a
provision was inserted in the bill
pending in Congress in the spring of
1917 to the effect that nothing in the
Federal Reserve Act should be con­
strued as prohibiting a member or
non-member bank from making reason­
able exchange charges. The Senate
passed the bill with this provision in it,
but the sentiment in favor of par
collection finally prevailed and in the
bill as agreed to in conference between
the committees of the Senate and the
House, and in the Act as finally ap­
proved, this particular provision was


in effect nullified by the addition at the
end of the paragraph in question, the
first paragraph of Section 13, of the
following clause: “but no such charges
shall be made against the Federal
Reserve Banks.”
The policy of extending the Federal
Reserve check clearing and collection
system has been continued until now
Federal Reserve Banks are able to
collect checks drawn on about 28,000
out of a total of approximately 30,000
banks in the United States. The
claim is made by some non-member
banks which still persist in their desire
to charge exchange when remitting
for checks, that the final clause of
Section 13 of the Federal Reserve Act
should be construed as prohibiting
Federal Reserve Banks from under­
taking to make counter presentation
of checks drawn on non-member banks
which have not agreed to remit at par
to the Federal Reserve Banks and this
issue is involved in suits which have
been instituted by such non-member
banks against several of the Federal
Reserve Banks.
A m endm ent of R eserve
R e q u ir e m e n t s

Another important amendment ac­
complished by the Act of June 21, 1917,
was the amendment to Section 19 of
the Act changing the character and
amount of the required reserves of
member banks.
Section 19 of the Federal Reserve
Act as amended by the Act approved
August 15, 1914, before the Federal
Reserve System was put into actual
operation in November, 1914, provided
that member banks in central reserve
cities should maintain reserves equal to
18 per cent of their demand deposits
and 5 per cent of their time deposits,
and that member banks in reserve cities
should maintain reserves equal to 15
per cent of their demand deposits


T he A nnals of the A merican A cademy

and 5 per cent of their time deposits,
and that other member banks should
maintain reserves equal to 12 per cent
of their demand deposits and 5 per cent
of their time deposits. Each class of
member banks was required to keep
only a part of its reserves in the form
of balances with Federal Reserve
Banks, another part being kept in the
vaults of the member banks, and the
member banks being given the option
to cany the remainder either in their
own vaults or as balances. This being
the state of the law, a large proportion
of the gold supply of the country
remained in the vaults of member
banks, where it constituted a part of
the banks’ lawful reserves.
The purchases in this country by the
belligerent nations resulted in rapid
accretions to this nation’s gold supply
and made it seem desirable to have a
more effective means of controlling a
possible over-extension of loans based
upon these new accretions. On the
other hand, the possibility of the
rapid outflow of this gold at some time
in the future made it necessary to
provide for the most effective use of the
gold supply, so that withdrawals
might be arranged without forcing any
violent contraction of loans and with­
out causing any undue disturbance to
legitimate business. For the accom­
plishment of these ends the mobiliza­
tion and concentration of gold in the
Federal Reserve Banks seemed the
most effective means.
The first legislative move in this
direction was the addition by the Act
of Sept ember 7, 1916, of subsection
ll(m ) of the Federal Reserve Act
providing that the Federal Reserve
Board may permit member banks to
carry in their Federal Reserve Banks
any portion of their reserves theretofore
required by Section 19 of the Federal
Reserve; Act to be carried in their
vaults. When this country became

directly involved in the War the
question of the mobilization of the
gold reserves of the country became
still more important and was the
primary cause of the enactment of the
Act of June 21, 1917. By this Act
member banks were required to main­
tain the entire amount of their re­
serves in the form of balances with
Federal Reserve Banks, the total
reserves required against demand de­
posits being reduced to 13, 10 and 7
per cent for member banks in central
reserve cities, reserve cities, and coun­
try districts, respectively, and the
total reserves required against time
deposits being reduced to 3 per cent
for all member banks.
T r u s t P o w e r s o f N a t io n a l B a n k s

After June, 1917, the Federal Re­
serve Act was not amended until
September 2 6 , 1918. This Act effected
changes in a number of sections but
the only one of general importance was
the revision of Section 11 (k) relative to
trust powers by national banks.
Under this section in its original
form the Federal Reserve Board was
authorized merely to grant to national
banks “when not in contravention of
state or local law, the right to act as
trustee, executor, administrator, or
registrar of stocks and bonds.” Na­
tional banks opening up trust depart­
ments, in accordance with authority
granted to them pursuant to this sec*
tion, were limited to the exercise of the
four powers specifically enumerated,
although competing state banks and
trust companies might be permitted to
exercise other fiduciary powers. Fur­
thermore, the la ^ of some states spe­
cifically, or by necessary implication,
prohibited the exercise of any fiduciary
powers by national banks, so that it
was “in contravention” of state law
for national banks to exercise such
powers, although competing state

A mendments to the F ederal R eserve A ct

banks might do so under the laws of the
state. It became more and more appar­
ent that national banks were laboring
under a serious handicap in their com­
petition with state institutions in the
exercise of trust powers, and the amend­
ment of September 26, 1918, was designed
to put national banks upon equal terms
with competing state institutions.
To this end the section was amended
so as to include among the powers
which the Federal Reserve Board
could grant, the power to act as guard­
ian of estates, assignee, receiver,
committee of estates of lunatics, or in
any other fiduciary capacity in which
competing state banks are permitted
to act. A provision was also inserted
to the effect that whenever the laws of
a state permit the exercise of fiduciary
powers by competing state corpora­
tions, it shall not be deemed to be in
contravention of state law for national
banks to exercise such powers. Various
other provisions were inserted to insure
competition upon equal terms between
national banks and competing state
corporations, including that contained
in the final paragraph of the section as
amended to the effect that no permit
shall be issued to any national bank
having a capital and surplus less than
the capital and surplus required by
state law of state institutions exercising
fiduciary powers.
The constitutionality of the original
Section 11 (k) was upheld by the
Supreme Court of the United States in
the case of First National Bank v.
Union Trust Company, 244 U. S. 416,
in which it was held that Congress had
power to grant to national banks
authority to act in fiduciary capacities.
The construction of Section 11 (k) as
amended has been involved in a number
of more recent suits. These suits have
established that it is beyond the power
of any state legislature to discriminate
against national banks by prohibiting


such banks from exercising fiduciary
powers and that it makes no difference
whether such discrimination is at­
tempted by an affirmative prohibition
against the exercise of fiduciary power
by national banks or by withholding
from the courts the powers to appoint
national banks in fiduciary capacities.
D i s c o u n t L im it a t i o n o n S i n g l e
B orrow er

The Act of March 3, 1919, amending
the Federal Reserve Act, was of im­
portance to member banks because
it substituted for the then existing
Section 11 (m), which had become
obsolete, a new Section 11 (m), author­
izing the Federal Reserve Board to
permit Federal Reserve Banks to
discount for member banks the paper
of a single borrower, up to 20 per cent
of the member bank’s capital and sur­
plus, provided that the paper is
secured by United States bonds or notes
issued since April 24, 1917, or by United
States certificates of indebtedness.
Under the terms of Sections 9 and 13 the
amount of paper of any one borrower
which a Federal Reserve Bank may
discount for any one member bank is
limited generally to 10 per cent of the
member bank’s capital and surplus.
Section 11 (m) was intended as a
temporary measure to assist in the
absorption by the investing public of
the securities issued by the government
during the War, and according to its
terms the section ceased to be effective
after December 31, 1920. This process
of absorption was not deemed to have
been completed by that date, however,
and section 11 (m) was re-enacted with
a slight modification by an Act of Con­
gress approved February 27, 1921, to
be effective until October 31, 1921.
F o r e ig n B a n k i n g A m e n d m e n t s

Acts were approved September 17,
1919, December 24, 1919, and June


T he A nnals of the A merican A cademy

14, 1921, all relating to the same general
subject matter, namely, the investment
by national banks in stock of corpora­
tions engaged in foreign banking and
other international financial operations,
and the organization and operation of
such corporations under Federal law
and subject to Federal supervision.
After the close of the War it became
apparent that the adequate financing
of foreign trade would require credit
facilities of a kind which could not
properly be furnished by banks doing a
strictly commercial banking business,
and tha t such special facilities could be
furnished in a large way only by cor­
porations with authority to purchase
foreign securities and paper represent­
ing long term credits, and with authority
to issue and sell to the public their
own debentures secured by such securi­
ties and long-term paper.
The Act of September 7, 1916, had
amended Section 25 of the Federal
Reserve Act so as to authorize the
larger national banks, that is banks
with capital and surplus of not less than
$1,000,000, to invest in the stock of
“banks or corporations . . . prin­
cipally engaged in international or
foreign banking.” There seemed to be
some doubt, however, whether this
authority to invest in stock of banks or
corporations engaged in banking gave
the right to invest in stock of these
debenture-issuing or investment cor­
porations. Furthermore, it seemed
desirable for the encouragement of
such corporations to authorize invest­
ments in their stock by all national
banks, both large and small. Conse­
quently, the Act of September 17,
1919, wa s passed authorizing national
banks until January 1, 1921, and
without regard to the amount of their
capital and surplus, to invest in the
stock of corporations “principally en­
gaged in such phases of international
or foreign financial operations as may

be necessary to facilitate the export of
goods, wares or merchandise from the
United States or any of its dependencies
or insular possessions to any foreign
Section 25, as thus amended, in
terms authorizes national banks, upon
the conditions and subject to the
limitations therein stated, to invest in
the stock of banks or corporations, of
the specified kinds, which are “char­
tered or incorporated under the laws
of the United States or any State
thereof”; but, as a matter of fact, no
provision was made for the incorpora­
tion under Federal law of such banks
and corporations until the enactment
of the so-called Edge Act, approved
December 24, 1919.
This Act added to the Federal Re­
serve Act a section, designated Section
25 (a), which authorizes the organiza­
tion of corporations “for the purpose
of engaging in international or foreign
banking or other international or
foreign financial operations,” thus
permitting the Federal incorporation
of both types of corporations referred
to in Section 25, that is, banks doing a
commercial banking business, and
corporations issuing debentures and
doing an investment business. The
Act also describes the powers of such
banks and corporations and gives to
the Federal Reserve Board full power
to examine, supervise and regulate
their operations.
Section 25 (a) as originally enacted
required that corporations organized
under it should have a capital of not
less than $2,000,000, one-quarter of
which must be paid in before the
corporation is authorized to commence
business, and the balance in ten per
cent installments at the rate of one
every two months. This requirement
was modified by the Act approved
June 14, 1921, which provides, in
effect, that a corporation with an

P reparation for W ar and the L iberty L oans

authorized capital in excess of $2,000,000 may apply for the consent of the
Federal Reserve Board that such
excess be paid in on call of the board
of directors, provided, that in all
events 25 per cent of the total au­
thorized capital must be paid in
before the corporation commences
T h e S l id in g S c a l e A m e n d m e n t

Finally, the Act of April 13, 1920,
should be mentioned. Subsection (d)
of Section 14 of the Federal Reserve
Act authorized every Federal Re­
serve Bank to establish, subject to
review and determination by the


Federal Reserve Board, rates of dis­
count for each class of paper. The
Act of April 13, 1920, added to this
section language specifically providing
that such rates “may be graduated or
progressed on the basis of the amount
of the advances and discount accom­
modations extended by the Federal
Reserve Bank to the borrowing bank.”
The purpose of this amendment was,
of course, to give to the Federal Re­
serve Banks and the Federal Reserve
Board clear authority to require mem­
ber banks habitually borrowing in
excess of their legitimate requirements
to pay higher discount rates for their
excess borrowings.

Preparation for War and the Liberty Loans
By J. H e r b e r t


C ase

Deputy Governor, Federal Reserve Bank of New York

T the entrance of the United to war financing, without unduly cur­
States into the World War in tailing the credit needs of commerce
1917 the readjustment of our credit and industry.
financial system to meet the unusual P r e p a r a t i o n f o r W a r b y R e s e r v e
demands of the Public Treasury de­
B anks
volved in a large measure upon the
Federal Reserve Banks. The financial The announcement of the entrance
activities of the government were soon of the United States into the War,
to be extended upon a scale never however, did not find the Federal
before equalled by any country and the Reserve Banks wholly unprepared to
financial resources of the country were meet the new responsibilities. Pre­
to be assembled and directed toward cautions had been taken early in the
one purpose, winning the War. To year to maintain the Federal Reserve
accomplish this purpose would require Banks in a strong condition with re­
highly developed sales organizations gard for the disturbed conditions of the
which would extend to every county world and the changing economic con­
and village in the country, and. elab­ ditions in this country. This country,
orate machinery for distributing the heretofore a debtor country, had be­
securities and collecting and disbursing come a creditor nation; gold was
the funds according to the Treasury’s flowing in, and foreign securities were
needs. More fundamental, however, being marketed here in increased
was the necessity that our banking amounts so as better to permit bellig­
system should be able to meet the erent countries to pay for heavy pur­
enlarged demands for credit incident chases of goods, purchases so heavy, in

T he A nnals of the
fact, that there had already developed
a feverish business activity. A change
in affairs was foreseen and heavy credit
demands anticipated in the eventuality
of either our participation in the War
or the conclusion of peace, and the
opportunity was taken to fortify and
strengthen the position of the Federal
Reserve Banks.
Unnecessary expansion of credits
was checked and a reduction was
effected in the holding of such bonds
and warrants as had previously been
acquired primarily for the sake of
income, The beginning of April, 1917,
found the Federal Reserve Banks in a
very strong position; the holdings of
municipal warrants had been reduced
to small proportions, the total earning
assets of the Federal Reserve Banks
had gradually been reduced from
$221,896,000 to $167,994,000 since the
beginning of the year and the reserve
ratio of the twelve Federal Reserve
Banks was about 85 per cent. More­
over, the report of the Comptroller of
the Currency and of state banking
authorities showed the banks of the
country to be in a strong condition.
I m p o u n d in g G o ld

In order that they might be prepared
for any emergency, the Federal Reserve
Banks, realizing their responsibilities
as the guardians of the country’s re­
serves, had adopted the policy of
gradually building up their gold hold­
ings in order that they might be used
as a basis of credit expansion. There
was a demandfrom the banks and the
public for the new clean notes being
issued by the Federal Reserve Banks,
and the opportunity was taken to ex­
change these notes for gold and gold
certificates. In issuing Federal Reserve
notes, however, it was necessary to
deposit as collateral with the Federal
Reserve agent eligible commercial
paper equal to 100 per cent of the

A merican A cademy

notes issued; but in the early days of
the System the available volume of
eligible paper was limited. Therefore,
in order to make the exchange, it was
necessary to adopt a circuitous method
which may be described as follows: The
Federal Reserve Bank of New York,
for example, would pledge $100,000 of
commercial paper, obtaining in ex­
change Federal Reserve notes, and
would then, as the Act authorized it to
do, deposit gold to retire its liability
for the notes and withdraw the paper.
This operation would be repeated over
and over again until enough Federal
Reserve notes had been obtained to
meet the demands for new currency.
Moreover, the gold held as security
for notes could not be used except as a
100 per cent fund to provide for their
redemption and was held by the Fed­
eral Reserve agent specifically for that
For the purpose of further strength­
ening the System, the Federal Reserve
Board in January, 1917, recommended
a number of amendments to the Fed­
eral Reserve Act, and they were again
transmitted to Congress during April
and were adopted on June 21, 1917,
substantially as recommended by the
Board. One object sought by these
amendments was to enable the Federal
Reserve Banks more effectively to con­
trol the country’s gold supply, and
therefore the process of issuing notes
was simplified by permitting their
issuance either against gold or eligible
paper, or both, as collateral. The Act
as amended not only permitted gold to
be pledged directly for notes, but al­
lowed this gold to serve as the reserve
required against the notes. The effec­
tiveness of the gold reserves held by
the Federal Reserve Banks was greatly
increased and the adaptability of the
System to the changing requirements
of the public enhanced. After the
passage of this amendment and our

P r e pa r a t io n

fo r

W ar

and the

L ib e r t y L o a n s


entrance into the War, as a part of the accounts with them for the clearing
redoubled efforts to impound the and collecting of their checks,
country’s gold where it would serve The success of the movement to
its most useful purposes, both member accumulate gold is shown in Table I
and non-member banks were repeatedly . which gives for three years the country1s
urged to transfer their gold as it ac- monetary stock of gold, the gold holdcumulated to the Federal Reserve ings of the Federal Reserve Banks and
Banks, and the appeal met with a the gold in general circulation, i.e.,
hearty response.
outside the Treasury and the holdings
The provisions concerning member of the Federal Reserve Banks:

T o tal M o n e t a r y S tock


January 1, 1 917...........
January 1 , 1 9 1 8 ...........
January 1, 1919...........


G old , G old H o l d in g s o f F e d e r a l R e s e r v e B a n k s , G old
C ir c u la t io n , 1917, 1918, 1919

Total monetary
stock of gold in
the country
3 .080.510.000

Gold held in
U. S. Treasury

Gold holdings of
Federal Reserve



banks reserves were likewise changed,
first by reducing their required reserves
to 13, 10 and 7 per cent for central
reserve city, reserve city and country
banks, respectively, and second, by
requiring that their entire reserves
should be carried as cash balances with
the Federal Reserve Banks. These
changes both augmented the gold
holdings and increased their efficiency
with a commensurate increase in the
discount power of the Federal Reserve
Banks. Member banks could no longer
count as a part of their legal reserves,
cash in their own vaults, and the priv­
ilege of country banks to keep a part
of their reserves with reserve city
banks was discontinued several months
prior to the date originally fixed for
such discontinuance. These changes
increased the cash holdings of the
Federal Reserve Banks by about
$250,000,000. At the same time non­
member banks were encouraged to
deposit their cash reserves with the
Federal Reserve Banks and to carry


Gold in


M o v em en t fo r a G r e a t e r M em ber­
s h ip

As originally provided in the Act, all
national banks are necessarily members
of the Federal Reserve System but prior
to the entrance of the United States
into the War, the membership of the
Federal Reserve Banks included less
than fifty state banks and trust com­
panies, and the combined resources of
member banks were approximately
one-half of the total banking resources
of the country. Obviously this was a
weak point in the System. In meeting
a great credit strain or unusual financial
problems, it was believed that the
Federal Reserve Banks would be called
upon to support indirectly the non­
member banks through credits granted
to member banks, which, in turn, would
aid the state institutions.
In view of the country’s needs and
the part played by the Federal Reserve
Banks in carrying on the War, it was
soon generally recognized that a moral


T h e A nnals

of the

and patriotic obligation rested upon
state bankers to support the system.
Immediately following the declaration
of war there was a decided movement
among: the stronger state institutions
toward obtaining membership, a move­
ment accompanied by some pressure
on the part of the larger member banks
which were desirous of being relieved
from the duty of financing these non­
member institutions in case of emer­
gency. The Federal Reserve Board
had adopted a liberal policy in its
regulations both as to terms of admis­
sion of state banks and as to their
rights to withdraw at their discretion,
but there existed among these institu­
tions a feeling of uncertainty and a lack
of assurance that these rulings would
be permanent without legislative sanc­
tion. The action of Congress, there­
fore, in passing the amendment ap­
proved June 21, 1917, giving to state
institutions the assurance that they
might become members of the System
and carry on their activities substan­
tially as before and, in addition, giving
them the definite right to withdraw
from the System on six months’ notice,
accelerated the movement to obtain
The climax to this movement for a
greater membership was a letter from
the President on October 13, 1917, to
state banks and trust companies, in
which he urged a complete mobiliza­
tion of the banking reserves of the
United States in order to meet the
great financial requirements imposed
upon the country by the War. In this
appeal the President said in part: “I
believe that cooperation on the part of
banks is a patriotic duty at this time,
and that membership in the Federal
Reserve; System is a distinct and signif­
icant evidence of patriotism.” Under
these various incentives and influences
many of the stronger state institutions
filed applications and were admitted

A m er ica n A cadem y

to membership. The progress of the
movement towards greater unification
of the banking system is shown by the
fact that at the end of 1917 the mem­
bership of state banks and trust com­
panies had increased to 250 and the
Board in its Annual Report for that
year estimated that the member banks
represented approximately 75 per cent
of the commercial banking assets of the
T h e L ib e r t y

L oans

While the President and Congress
were wrestling with the problem of
reorganizing our banking system, it
had become generally recognized that
the method of handling the govern­
ment’s finances through the Independ­
ent Treasury System was antiquated
and the framers of the Federal Reserve
Act happily inserted a clause authoriz­
ing the Secretary of the Treasury to
require the Federal Reserve Banks to
act as fiscal agents. At the beginning
of 1916 the Reserve Banks began to act
as fiscal agents of the government, but
prior to our entrance into the War, their
services had been limited to receiving
deposits of receipts from customs and
internal revenue and paying checks and
warrants drawn by and on the Treas­
urer of the United States. But when
the Treasury was confronted with the
problem of raising and disbursing the
huge sums necessary to carry on the
War, the Reserve Banks became the
chief agencies through which it oper­
ated; they became the administrative
centers of the various Liberty Loan
committees in addition to performing
the minor fiscal agency functions.
Floating the Liberty Loans was the
paramount financial undertaking of
the War; it was a task, the accomplish­
ment of which necessitated arousing
public opinion to a realization of the
needs of the government and enlisting
the support of every American.

P r e pa r a t io n

fo r

S e l l in g L ib e r t y B onds

W ar

Perhaps I can best explain the
methods used in selling government
bonds by a brief description of the
organization and work of the Liberty
Loan committees in the Second Dis­
trict, with which I am most familiar.
During the First and Second Liberty
Loans, the responsibility for selling
bonds in the second district rested
largely upon volunteers from the vari­
ous bond houses, banks and corpora­
tions which generously and patrioti­
cally contributed the services of their
staffs. It was soon seen, however, that
one loan was hardly completed before
preparations for another one were be­
ing made, and it was realized that with
each successive loan, as the novelty
wore off, a more intensive campaign
and more unified organization would be
requisite in order to induce the public
to do the necessary amount of saving
and investing. Consequently a fixed
establishment of paid employes was
built up.
The central Liberty Loan Committee
was the center and directing force
around which the whole organization
revolved. As finally perfected, it con­
sisted of fifteen members, many of
whom were heads of some of the largest
banks and banking houses in New York.
The chairman of the Committee was
the Governor of the Federal Reserve
Bank of New York. The Committee
met frequently during the progress of
the loans and determined the policies
to be followed and the nature of the
appeals to be made to the public.
One of the members of the Liberty
Loan Committee was chairman of the
distribution organization which had
direct charge of sales and which was
made up of bankers or partners in
bond houses. The permanent staff
of the distribution committee was
headed by the director of distribution,

and the

L ib e r t y L o an s


who was the executive in charge of the
immense and very active bond-selling
This district, with the exception of
three boroughs of New York City, was
divided into eight subdistricts and a
member of the distribution organiza­
tion was chairman of each subdistrict.
These subdistrict chairmen formed the
connection between their local Liberty
Loan committees and the central
organization. They acted as advisers
to the local chairmen and transmitted
to them the plans and material pre­
pared at headquarters. The number
of committees and subcommittees ran
into the thousands. In every com­
munity an extensive volunteer organi­
zation was formed which carried the
campaign direct to the individual in
every branch of human activity.
To the army of Liberty Loan workers,
men and women through whose energy
and patriotism the millions of subscrip­
tions were actually obtained, is due a
large part of the credit for the complete
success of the greatest financial opera­
tion of all time.
A publicity organization was estab­
lished as a necessary part of the selling
campaign. Its mission was to carry to
every citizen in the district the message
of the Liberty Loans and of America.
This message was carried in a great
variety of ways in the effort to dissemi­
nate the ideals for which America
entered the War and to point out the
financial needs of the government for
winning the War. In the newspapers
and magazines, on the billboards, houses,
lamp-posts, vehicles, flagstaffs, and in
the store and householder’s window,
the appeal appeared, showing the
obligation of every American to partic­
ipate in the work of winning the War.
Frequent Liberty Loan meetings were
held and many hundred men and women
delivered the message in public ad­


T he A nnals
P a r t ia l P a y m e n t s

of the

One of the most difficult problems
from the standpoint of the physical
handling of subscriptions in New York
City grew out of the enormous number
of applications for $50 and $100 bonds
from persons who of necessity could
purchase only on the partial payment
The fact that there were but a rela­
tively small number of banks located
in the metropolitan area to handle the
growing volume of these transactions
threatened serious congestion in the
banks. This situation, however, was
successfully met by the formation of
the Liberty Loan Association of Banks
and Trust Companies of New York,
which handled, through a coupon book
system, approximately 2,400,000 sepa­
rate partial payment accounts in con­
nection with the Third, Fourth and
Victory Liberty Loans. Under this
plan, subscribers were allowed to make
payments at any of about 1,400 pay­
ment stations designated throughout
the metropolitan district as a conven­
ience to subscribers and as a measure
of relief to the banks.
The Liberty Loan Association, under
the direction of the Federal Reserve
Bank of New York, with a staff of ap­
proximately 450 clerks operated the
system through which over 90,000,000
individual payments were received and
over 2,000,000 separate bonds were
delivered. As many as 17,500 people
called at the office of the Liberty Loan
Association at 19 West 44th Street,
New York City, during a single day.
The importance of this undertaking
is not to be measured merely by the
number of bonds distributed. Count­
less individuals could not have pur­
chased these securities on any other
than the instalment plan, and much
credit is due the banking institutions
and the hundreds of other cooperating

A m er ic a n A c adem y

agencies that made possible this great
H a n d l in g

th e

L oans

Up to the time of the First Liberty
Loan, the Federal Reserve Banks had
been operating with a comparatively
small force of clerks, sufficient only to
take care of the comparatively moderate
volume of business which the banks had
yet been called upon to do. It was
not until after the First Liberty Loan
campaign was actually under way that
the officials in charge of the Federal Re­
serve Banks began to realize that their
forces were totally inadequate to the
magnitude of the task for the govern­
ment which lay before them. The lead­
ing banks and investment houses were
then appealed to for help and responded
most effectively, willingly lending clerks,
stenographers and even heads of depart­
ments and officers. In the Second Dis­
trict the force so loaned consisted of
about 350 men who stayed with the
Federal Reserve Bank until they were
gradually replaced by a permanent staff
just prior to the Second Liberty Loan.
It became necessary to develop
special accounting systems, and control
records in order properly and success­
fully to handle the issue, exchange and
redemption of billions of dollars in
government securities. Three separate
departments were created to perform
this work. One was organized to
handle all operations in connection
with the issue of bonds; another, to
manage the sale and issue of certificates
of indebtedness; and a third, to handle
the collateral pledged by banks to
secure government deposits. Some­
thing of the magnitude of the task
performed by the government bond
departments of the twelve Federal Re­
serve Banks may be seen from Table II
which gives for the five Liberty Loans
the record of subscriptions, allotments,
exchanges and conversions.

P r e pa r a t io n

fo r

W ar

and the

L ib e r t y L o an s



S u b s c r ip t io n s , A ll o tm en ts , E x c h a n g e s


Number of



C o n v e r sio n s

fo r t h e

Number of
pieces is­
sued on


F iv e L ib e r t y L o a n s

Number of
Number of
bonds ex­
changed for
(Aug. 31,
bonds. (Aug.
31, 1921)

Victory.. . . .

4 ,000,000
4 .617.532.300

4 ,497,818,750









Other services of magnitude per­
formed by the bond departments of the
Federal Reserve Banks were exchanges
of bonds of one denomination for bonds
of another denomination, payment of
coupons from all issues of Liberty
Bonds and assistance rendered the
Treasury Department in the register­
ing of government bonds by receiving
coupon bonds for registration and
registered bonds for exchange into
coupon bonds.
The current needs of the Treasury
between the periods of bond issues and
tax receipts were met by frequent
issues of certificates of indebtedness of
short maturities, which were also
handled by the Federal Reserve Bank.
These short credits proved to be a
popular investment for our banking
institutions and were periodically con­
verted into long-time credits through
the Liberty Loan bond drive and thus
were distributed among individual
investors. The issuance of certificates
not only supplied a means of securing
current funds but afforded a protection
to the money market by distributing
the receipts from loans and taxes over
periods of time, thus avoiding periodic
heavy withdrawals of funds from the



market. On October 31, 1921 there
had been eighty-eight issues of certif­
icates of indebtedness, both loan and
tax, aggregating $32,881,000,000 of
which $30,235,000,000 had matured
and had been redeemed.
P a y m e n t b y B o o k C r e d it

In order further to minimize possi­
ble disturbances in the money market
the Federal Reserve Banks at the
request of the Secretary of the Treas­
ury extended to banks the privilege
of paying for their subscriptions to
Liberty Bonds and certificates of in­
debtedness by book credit, which sim­
ply means creating a deposit in favor
of the government .to the amount of
the subscriptions. These deposits were
withdrawn gradually from the banks
on a pro rata basis as needed by the
government. The Federal Reserve
banks as fiscal agents were required not
only to keep records of these deposits
and withdrawals, but also to receive
and hold collateral against them; at
times these deposits amounted to
about a billion dollars and the Federal
Reserve Banks were required to handle
many billions of dollars of collateral in
connection therewith.


T he A nnals

of t h e

S u b c o m m it t e e o n M o n e y

The desirability of having an orderly
money market was generally recognized
and on September 5, just prior to the
offering of the Second Liberty Loan, a
subcommittee of the Liberty Loan
Committee of the Second District was
appointed for the purpose of securing
the most complete cooperation with the
government in its financial program
by all the financial interests of the city.
This committee was composed of the
Chairman of the Liberty Loan Com­
mittee, as chairman, and the presidents
of eight of the largest financial institu­
The policy of this subcommittee on
money was to prevent the absorption
of an excess amount of credit by the
security market which might interfere
with the orderly marketing of the
government’s loans, and at the same
time to assure that sufficient funds
would be available to maintain a rea­
sonably healthy security market in
order to facilitate the successful placing
of Treasury issues. It was considered
of great importance that reasonable
and necessary control be exercised
over the employment of credit in order
to insure no interference with the finan­
cial operations of the government in
conducting the war.
This committee enjoyed the fullest
cooperation of the governors and mem­
bers of the New York Stock Exchange
who unselfishly placed in the hands of
the subcommittee confidential informa­
tion which would enable the committee
to take such steps as were calculated
to maintain an orderly money market.
M e e t in g t h e D e m a n d f o r C r e d it

The success of the Liberty Loans
depended in large measure on the in­
dividual banks throughout the country.
But the extent of their cooperation in
turn depended upon the financial sup­

A m e r ic a n A cadem y

port which they felt they could secure
from the Federal Reserve Banks. It
soon became evident that the savings
of the people in spite of the various
thrift campaigns would not prove
sufficient to meet the tremendous de­
mands of the government and that a
substantial portion of its borrowings
would have to be met through bank
credit. The banks supplied this credit
both by subscribing to the loans them­
selves and by extending credit freely
to their customers who borrowed in
order to buy government obligations.
In fact, in order to insure the
success of the government’s financial
measures, banks, life insurance com­
panies, general business corporations
and individuals were urged to subscribe
heavily to the Liberty Loans without
regard to their immediate ability to pay
for them. Preferential discount rates
were established by the Federal Reserve
Banks in favor of paper secured by
United States Government obligations
and easy terms of payment promised
by the individual bank to induce a
sufficient flow of funds from the banks
and the people to the government.
With the cooperation of and by the
support they gave to the individual
banks of the country, the Federal
Reserve Banks expanded the credit
structure sufficiently to meet the needs
of the great emergency.
The “borrow and buy” method of
securing funds leads to inflation, to be
sure, with all its consequent ills, but
any method of financing a war, except
solely out of the savings of the people,
would have the same result. War
financing always involves credit ex­
pansion unless private savings increase
commensurate with government re­
quirements. Try as we may, we can­
not get away from this fact. We may
safely say that the difference between
the government’s requirements for
funds, as expressed in the securities

T h e A ssu m ptio n


T r e a su r y F u n c t io n s

sold, and the volume paid for out of
savings, represents a good part of the
recent credit expansion. But it could
hardly be expected that private savings
would keep pace with the phenomenal
demands of the government during the
World War. Certainly no opportunity
was neglected to impress upon the
public the fact that they should save
to the limit. While the Federal Re­
serve Banks were conducting a cam­
paign urging increased borrowing as
one means of selling Liberty Bonds,
an equally intensive campaign urging
upon the people the necessity for thrift
and rigid economy was being conducted
by the same banks under the direction
of the Liberty Loan and War Savings
committees, as well as by various other
government agencies. The Food Ad­
ministration, for instance, was active
in this regard.
Furthermore, a campaign was carried
on under the direction of the Capital
Issues Committee for the purpose of
conserving capital, labor, materials and
transportation facilities for their most
effective use in the prosecution of the
War. There was a local capital issues
committee in each district which re­
ported to the central committee on all
applications for permission to issue
securities for the purpose of financing
public or private corporate expenditure.


The Capital Issues Committee of the
Second District, although in existence
less than a year, considered formal
applications for issues amounting to
$2,069,000,000, besides numberless
cases where no formal applications
were filed notwithstanding the fact
that when the Committee was first
appointed, the submitting of applica­
tions covering private issues was
largely voluntary.
The record of the Federal Reserve
Banks during the War, in my judgment,
is one of splendid achievements. They
not only organized and directed the
sales campaigns and handled the de­
tails of every loan, but also by the
support given to the individual banks
of the country made possible their
hearty cooperation and guaranteed the
success of every loan. It is a cause for
deep gratification that the banks and
the people through efficient methods
and organization were able to supply
the government with such unprece­
dented sums to meet its needs in
carrying on the War. That five great
loans, aggregating more than $21,000,000,000, were rapidly and successfully
distributed with hardly a ripple in
the financial markets, is of itself a great
testimonial to the new banking system
which has now been thoroughly tried
and has successfully met the test.

The Assumption of Treasury Functions by the Federal
Reserve Banks
By M u rra y


W ild m a n

Stanford University


HE Independent Treasury as it
functioned for three quarters of a
century was an institution unique
the field of public finance. It grew
out of the general demoralization of the
banks which followed the panic of 1837

and the downfall of the Second Bank of
the United States. When the Act of
in was passed, followed by the more
adequate Act of 1846, the need for such
legislation was real and urgent. On
the theory that the establishment and


T he A nnals

of the

regulation of banks was a duty of the
states, the care of Federal funds called
for a Federal agency. When in 1863
that theory was abandoned, the justifi­
cation for the subtreasuries passed
away with it; but in twenty years these
institutions had become rooted in our
political system.

O u t g r o w n and O b je c t io n a b le

As long as a government agency is
merely useless it may be left alone.
The subtreasury buildings are sub­
stantial and impressive features of our
cities; they housed several hundred
officials and clerks, some of whom were
devoted aids of the administration
which they served, and it was not
enough to show that the maintenance
of this establishment involved a waste
of money. Before the Independent
Treasury could be abolished it must
be shown as responsible for positive
The important ground of objection
to the subtreasuries was their evil in­
fluence in the money market. The
harm that they did was real and sub­
stantial, although it was obscure. The
great hoard of coin and bullion and
legal tender notes, which was kept
behind massive steel bars and ap­
proached through dismal passages be­
tween granite walls, while it impressed
the tourist, would have brought dis­
may to the borrower of funds if he had
been fully alive to his interest. It was
not merely the impounding of cash
that called for condemnation of the
system but the recurrence of large pay­
ments as well. The alternate collec­
tion and disbursement of the revenues
brought alternate contraction and ex­
pansion of the bank reserves and con­
sequent changes in discount rates,
which, in turn, disturbed the markets
for staple products and securities.
The establishment of the national

A m er ic a n A cadem y

banking system during the Civil War
should have been followed promptly
by the abandonment of the Independ­
ent Treasury, but at that particular
period the banking business was not
popular. The needed reform must
wait for another time of great financial
stress, and for a reorganization of the
banking system on the principle of a
single national cash reserve under
Federal control.
T h e N e w P o l ic y

The legislative acts which make
definite provision for the new policy
are two. Section 15 of the Federal Re­
serve Act of December 23, 1913, pro­
vided that “the moneys held in the
general fund of the Treasury . . .
may be deposited in Federal Reserve
Banks, which banks . . . shall act
as fiscal agents of the United States
. . . and disbursements may be
made by checks drawn against such
deposits. ”
The other measure is found in the
General Appropriation Act of May
29, 1920, which repealed the Act of
1846 in so far as it provided for sub­
treasuries, and required the Secretary
of the Treasury to transfer the duties
of the Assistant Treasurers of the
United States to the Treasurer, the
mints and assay offices and to the Fed­
eral Reserve Banks.
This Act of 1920 was belated. As
intimated above, the officers and the
employes of the subtreasuries owed
their appointments to political in­
fluences. The original intention of the
framers of the Federal Reserve Act was
to have the subtreasuries taken over
by the Reserve Banks. But, as the
bill developed out of the economic and
into the political stage in Congress, dis­
cussion arose and political force was
asserted. “The moneys held in the
general fund of the Treasury shall be
deposited” in Section 13 became “may

T h e A ssu m ptio n


be deposited” and the Secretary of the
Treasury held the power of decision.
After the Reserve Banks were opened
and had been officially designated as
fiscal agents of the government, the
Treasury made comparatively little
use of them. Other bank depositaries
were retained and treasury funds were
placed for “crop-moving purposes” as
in the past.
There was naturally adverse criti­
cism. From official sources came pleas
and explanations that the subtreasuries
were convenient to the public, if not
indispensable to the government, and
the cities where they were located had
their fears aroused that they were to
be deprived of something of value to
them. The criticism persisted,however.
In the end the matter was referred, in
March, 1917, to the Bureau of Efficiency
for investigation and report to Congress.
The investigation was thorough and
the report, made January 26, 1918,
was most competent. The report
concluded as follows:

The Bureau of Efficiency recommends
the ultimate abolition of the whole sub­
treasury system. It believes not only that
the government will save money by this
change, but also that the public will in .the
end be better served. It will be appre­
ciated that in making this recommendation
the Bureau of Efficiency seeks only to
serve the public interest. If, however,
the subtreasuries are to be continued, the
Bureau of Efficiency suggests the following
as a minimum program:
The elimination of the three subtreasur­
ies—Baltimore, Philadelphia and Cincin­
nati—which are of no essential value to the
The abolition of the post of assistant
treasurer everywhere and the transfer of
responsibility to the cashiers;
A reduction in the amount of coin-ex­
change business undertaken at the sub­
treasuries and by the cash room of the
Treasury in Washington through the charg­
ing of a fee for receiving or paying out cur­
rent coiji;

T r e a su r y F u n c t io n s


The concentration of all the redemptions
of paper currency in Washington;
Scarcely less than this can be done for
the good of the Treasury and the people.

The effect of the legislation of 1920
was to make mandatory what had hith­
erto been permissive only. But the
change of policy which these acts re­
veal had been slowly evolved out of a
long and unhappy experience in the
management of both public and private
funds. The realization of the proper
relation between Treasury and banks
has been growing through a period of
many years of nominal independence.
It was made clearer by every financial
crisis through which the country passed
that real independence was impossible.
Points of contact between Treasury
and banks were established for greater
convenience and economy in the hand­
ling of funds, and a relation of mutual
dependence was tacitly recognized.
R e la t io n o f T r e a s u r e r t o Banks

In order to save labor to both offi­
cials and the public, the subtreasury
at New York was made a member of
the clearing house on the resumption
of specie payments, January 1 , 1879.
In the latter months of the Civil War
and for several years thereafter the ex­
tensive collection of internal revenue as
well as the necessities of postmasters
led to the designation of certain na­
tional banks as United States deposita­
ries. When a few years later depleted
bank reserves coincided with surplus
revenues in the Treasury, aggravating
the stringency of the money market,
the government adopted the policy of
designating other national banks as
special depositaries of public funds.
Large sums were paid into these banks
for the single purpose of putting idle
cash to commercial use.
From the point of view of economical
Use of funds, bank depositors may be


T he A nnals

of the

divided into two groups: those who use
banks for the safe-keeping of money,
and those who use banks as agencies
for the collection and payment of bills.
The first class is typified by the savings
depositor; the second, by the commer­
cial depositor. The customary opera­
tions of the savings bank involve the
receipt and payment of cash while the
customary operations of the commer­
cial bank involve the receipt and pay­
ment of credit instruments. In the
latter case, cash is required only for a
reserve, and this reserve is only occa­
sionally brought into use. The result
is that payments in and out of the com­
mercial bank may vastly exceed the
amount of cash employed. The public
advantage in the use of this bank lies
in the fact that a given amount of cash,
when used as a reserve against deposits
or notes, will accomplish much more
than when used in payment directly.
In its use of national or state banks
as public depositaries the Treasury
never assumed the role of a commercial
depositor in the sense here described.
Funds were placed in the custody of
the banks and in due course were
ordered to be remitted to the Treasury.
Ordinary disbursements were made by
warrants drawn on the Treasurer and
not by checks drawn on the banks.
These so-called deposits were in reality
loans to the banks in so far as the spe­
cial depositaries were concerned. The
banks held the funds for a definite
period, paid interest on them and gave
security for them. The term “de­
posit ” was a misnomer and the practice
of placing funds with the special de­
positaries could not be carried out
without calling forth the charge of
favoritism. The attitude of the public
toward the banks selected to act as
regular depositaries was somewhat
different. These were chosen to serve
the convenience of the government,
but even here special collateral security

A m er ic a n A cadem y

was exacted and the relation of bank
and depositor was not a normal one.
There were no true active checking
accounts maintained by the Treasury.
S itu a t io n 1913-1916
When the Federal Reserve Act was
passed in 1913 there were 850 regular
depositaries and 685 special deposita­
ries, together holding $76,000,000, and
all of the subtreasuries except the one
at Philadelphia were members of the
clearing houses of the cities in which
they were located. To that extent the
independence of the Treasury had been
abandoned. From the establishment
of the Federal Reserve Banks there
was a rapid evolution of a new policy
on the part of the Treasury. The
twelve Reserve Banks were designated
public depositaries some time after
they were ready for business. In the
twelve cities in which these banks were
established all other government de­
posits were discontinued, except that
in some cases Federal court funds and
postmasters’ funds remained where
they had been previously kept.
But the use of the Federal Reserve
Bank as a depositary involved an im­
portant change in the attitude of the
Treasury in that these banks gave no
collateral security for the funds held.
Moreover, the funds were used by the
Treasury as checking accounts; indeed,
in some cases the Treasury received
temporary advances of funds against
an approaching issue of loan certifi­
cates, and so, for the first time since
1846, the Treasury became a bank de­
positor and borrower in the common
acceptation of these terms. But this
change of attitude in 1914 was cautious
and incomplete. The major part of
the public revenue and expenditure
continued as before to pass through
the subtreasuries. At the close of the
fiscal year, June 30, 1916, the distribu­
tion of the general fund was as follows:

T h e A ssu m ptio n


In Treasury offices........... $ 130,534,179.97
In Federal Reserve Banks 113,480,576.00
In national bank deposi­
taries................................. 62 ,833,774.43
In Philippine Treasury..
3 ,968, 122.73

The foregoing statement takes no ac­
count of the great trust funds held and
administered by the treasury.
E ffect of th e W a r

The event which established the
necessity of the new policy was our
own entry into the World War and the
great financial operations which en­
sued. Soon after war was declared it
came to be the general understanding
that our chief contribution to the joint
enterprise would be in the field of fi­
nance and supply. To this end meas­
ures were adopted for the handling of
funds of unprecedented magnitude
with the least possible friction. Im­
mediately on the passage of legislation
providing for the first Liberty Loan,
steps were taken to correlate the banks
of the country with the Treasury for
most effective team work. By the
middle of November, 1917, the number
of national banks designated as public
depositaries was raised from 518 to
1,903. State banks and trust compa­
nies were pressed into service and 1,343
of these were named as public deposita­
ries. In the Treasury circular of May
29 it was provided not only that banks
so designated should hold on deposit to
the credit of the government the funds
received by them in the sale of bonds,
but also that, when the funds should be
required from the banks, the transfer
should be made by a draft against the
balance carried by the depositary bank
in the Federal Reserve Bank in favor of
the account of the Treasury in the same
Federal Reserve Bank. That is to
say, payments on governemnt account
should be made by use of the bank’s
credit and with no reduction of its
stock of cash,

T r e a su r y F u n c t io n s


Not only were these rules applicable
to receipts from the several Liberty
Loans but also to receipts from income
taxes and excess profits taxes, as well as
from the sale of certificates of indebted­
ness which succeeded one another in
rapid succession throughout the War
and the following year. It was the
custom of the Treasury to leave the
credit as long as might be in the local
depositary banks where it would serve
the business community to the greatest
possible degree, and require transfer to
government account in the Reserve
Bank only as it was actually needed,
thence to be disbursed by government
check. These transfers of credit were
made ratably throughout the country
—a certain percentage of the deposit
on a specified date. The result of this
policy was to make the depositary
banks collection agencies of the govern­
ment, while the Reserve Bank of each
district became a disbursing agency to
a degree unknown in the past. The
effect of these operations on the dis­
tribution of the general fund at the
end of the fiscal year 1917 is shown
In Treasury offices........... $ 107,662,952.07
In Federal Reserve Banks 300,671,632.42
In special depositaries. .. 783,922,959.51
In regular depositaries. . . 49 ,681,738.91
In Philippine Treasury..
2 ,081,409 . 76

In order to appreciate the effect of
the new policy upon the business of the
Federal Reserve Banks it is only neces­
sary to remember that the ordinary
disbursements of the Treasury rose
from a total of 682 millions in 1913 to
15,365 millions in 1919. The premises
of the Reserve Banks became scenes of
the greatest activity. New and larger
quarters had to be taken, branch banks
were established, and the employed
personnel grew from 920 at the end of
1916[to 9,459 at the end of 1919. In
the same^ three years the number of


T he A nnals

of the

state banks admitted to membership
grew from 37 to 1,481, and the gold
reserve from 738 millions to 2,063
C h a n g es U n d e r A c t o f 1920
From this showing it may properly
be inferred that the expansion involved
in the transfer of the duties of assistant
treasurers under the mandatory act of
1920 had already taken place before
the act was passed. By the terms of
the law a period of thirteen months was
allowed for making the change. The
Secretary of the Treasury was permit­
ted to assign the duties of the assist­
ant treasurers to the treasurer, the
mints and assay offices and to the
Federal Reserve Banks, in such man­
ner as might in his opinion best pro­
mote the public interest. It was pro­
vided further that the Secretary of the
Treasury might assign to the Federal
Reserve Banks such rooms, vaults and
equipment as might be needed, and the
employes of the various subtreasuries
should have preference in application
for positions in other departments of the
government. However, most of them
were taken over by the Reserve Banks.
In order that the transfer of business
might go forward with the least disturb­
ance of routine the change was made
by degrees. The subtreasury at Bos­
ton was closed on October 25, 1920,
that at Chicago, November 3; New
York, December 6; San Francisco,
December 20; New Orleans, January
5, 1921; St. Louis, January 8 ; Balti­
more, January 14; Philadelphia, Feb­
ruary 3, and Cincinnati, February 10.
In the case of six of these cities the
work was taken over by the Reserve
Banks located there, but in New Or­
leans, Baltimore and Cincinnati the
functions of the subtreasury were
transferred to branches of Reserve
Banks located in those cities. But
functions of the Independent Treas­

A m er ic a n A cadem y

ury were not confined to banks and
branches in the nine cities in which
subtreasuries were to be found. By
Treasury circulars issued August 30
and October 19, all the Federal Reserve
Banks and their branches were defi­
nitely constituted fiscal agencies of the
United States Treasury. The effect of
this was to extend the facilities for­
merly available in only nine cities to
thirty-five cities at the outset and to as
many more as might be favored with a
branch bank in the future.
One important duty of the subtreas­
uries had been to account for the
special trust funds such as the gold
coin held against United States notes,
gold coin and bullion held against gold
certificates, and the silver dollars held
against silver certificates. The care
of these funds was transferred to the
Treasurer of the United States at
Washington, to be assisted as may be
desirable by the mints and assay
T r e a s u r y D u t ie s o f R e s e r v e

The new duties now devolving upon
the Reserve Banks are:
The receipt of gold coin and silver
dollars for exchange; the receipt of
United States notes, Treasury notes,
gold and silver certificates, subsidiary
and minor coin for redemption; the ex­
change of various forms and issues of
money for others; the cancellation or
cleaning of currency unfit for circula­
tion; the receipt from depositary banks
of internal revenue, customs, postal
and other funds; the receipt of depos­
its from other than depositary banks
for money payable to the government
from many sources; the payment of
United States interest coupons; the
payment of checks and warrants drawn
against the Treasurer, and the receipt
of government funds for transfer to
other points.

From what has been said it will be currency and bonds, and for the housing
clear that the actual abandonment of of such employes as are required for the
the Independent Treasury did not custody and exchange of these bonds.
greatly augment the work of the Re­ Sig n if ic a n c e o f t h e N e w P o l ic y
serve Banks. For example, on the
date of transfer the bank at New York The importance of the change there­
already held $11,298,000 of govern­ fore consists not in the magnitude of
ment deposits, while the subtreasury in the new enterprise which the Reserve
that city, whose normal business was Banks have undertaken but in the
far greater than that of any other, held significance of it. For all this coin and
only $1,448,000. This sum was all in currency, insofar as it belongs to the
coin. The building was turned over to general fund, now becomes a part of
the use of the bank under a lease but the banking reserve of the country.
the title remains in the government. Large disbursements of government
In Minneapolis, where there was no funds will never again stimulate specu­
subtreasury, the assumption of the lation on the stock exchanges nor will
new duties was not so easily effected. the collection of a great surplus of
The vaults of the bank were not revenue cause a chill in the markets
adequate to meet the new demands of staple products. By adjustments
and outside vault space was rented. through the Gold Settlement Fund
Moreover, the clerical staff was con­ maintained by the Federal Reserve
siderably enlarged. In San Francisco Board at Washington the Reserve
the entire staff employed in the sub­ Banks will be able to make the largest
treasury was taken over by the bank. payments, collections and transfers
The buildingwas occupied under a lease without affecting the magnitude of the
and is used as a place of storage of coin, reserves at any point.
S c ope


B r a n c h es


F e d e r a l R e se r v e B ank s

The Establishment and Scope of Branches of Federal
Reserve Banks

By E. R. F a n c h e r


Governor, Federal Reserve Bank of Cleveland

HE establishment and operation
of the Federal Reserve Banks and
branches is the direct result of
tensive research and study on the
part of economists, financiers and
statesmen regarding the inadequacy
of the banking system of the United
States as developed under the national
banking system, established in 1863,
remodeled by enactment of Congress
in 1864, and patched up from time to
time by more than sixty legislative
amendments. The national banking
system as it formerly existed, was sup­

plemented by the state banks and
trust companies created by state laws,
in­ functioning independently or sepa­
rately. The entire system passed
through various so-called panics up to
1907, at which time the attention of
the whole country was brought sharply
to the inherent weaknesses of our
banking and credit system, while the
crisis of that year compelled definite
action along remedial lines. The sys­
tem had proved inadequate to cope
with modern commercial needs. It
failed to supply commerce and in­


T h e A nnals

of the

dustry with adequate credit facilities
in normal times, and in times of finan­
cial stress it broke down completely,
spreading disaster and ruin throughout
the land.
The Aldrich-Vreeland Currency Act,
approved by the President May 30,
1908, in providing for emergency
currency based upon certain classes
of securities other than government
bonds, authorized the uniting of ten or
more national banks in any one city or
community into a “National Currency
Association.” It may be stated that
that law was the beginning of the
regional idea, and of its later develop­
ment into the thought of additional
services and conveniences to areas, com­
munities or centers, which has brought
about establishment of branches of
Federal Reserve Banks. The National
Monetary Commission was also au­
thorized by the Aldrich-Vreeland Act.
B r a n c h e s o f F ir s t a n d S econd
B a n k s o f t h e U n it e d S t a t e s

Alexander Hamilton’s original plan
for the First Bank of the United
States, organized in Philadelphia in
December, 1791, did not contem­
plate the establishment of branches;
but early in 1792 branches were opened
in New York, Boston, Baltimore and
Charlestown, and later, additional ones
were opened at Norfolk, Savannah,
Washington and New Orleans, making
in all, eight branches.
In stating the advantages derived
from the bank by the government,
Secretary of the Treasury Gallatin
laid stress upon the safe-keeping and
transmission of the public funds, the
economical collection of the revenue,
and the aid furnished to the govern­
ment in the matter of loans. The
punctuality of payments introduced by
the banking system, and the facilities
afforded by the bank to importers
indebted for revenue bonds, were

A m er ica n A cadem y

among the causes which had enabled
the government to collect with such
facility and with so few losses, the
great revenue derived from imports.
The numerous state banks might afford
considerable assistance to the govern­
ment in its fiscal operations, but they
could not effect the transmission of
public funds with the same facility or
to the same extent as the Bank of the
United States through its several
The Second United States Bank,
chartered in 1816, commenced opera­
tions in January, 1817, and by October,
1817, nineteen branches in fourteen
states had been designated, and,
subsequently, eight other branches or
agencies were established.
The establishment of branches was
the most characteristic and the most
essential feature of the plan of the
First and Second Banks of the United
States. Without them they would
have been virtually useless to the
government, unable to exercise an
efficient control over the state banks,
and incapable of furnishing accom­
modations in discounts and exchange
throughout a country unprovided with
a note circulation of uniform value,
or with any extended currency.
The general control of the branches
was almost wholly in the power of the
central directorate through its author­
ity to appoint the local directors and to
create by-laws for the branches, the
election of the president being the one
important privilege left to the un­
controlled will of the branch direc­
torates. It was, of course, essential
to the safety of the bank, to the
security of its operations and to the
unity of its policy, that the control of
the central board over the branch
officials and directors should be real
and effective.
Both the First and Second Banks of
the United States became involved in

S cope


B r a n c h es


F e d e r a l R e se r v e B a n k s

political strife without any intention of
their own and in spite of their earnest
efforts to avoid such entanglements.
These two central banks were very
largely government instrumentalities;
out of them grew the independent
treasury system established in 1846,
and from that time until the Civil War
the government made its collections
and disbursements entirely in specie
and kept its funds in the Treasury and
its branches, called subtreasuries. Im­
portant changes were made in this
system during and after the war,
bringing the Treasury into close rela­
tions again with the banking and
credit system of the country.

the bill suggested by the National
Monetary Commission, as a result of
its investigations, provision was in­
cluded for a central reserve association,
for at least fifteen branches of the
parent association and for further dis­
tricts when necessity might arise. All
through the studies of the National
Monetary Commission and in the
various important writings of financiers
and economists, the necessity for
adequate accommodations in industrial
communities or centers, the interest of
which might demand direct personal
contact with properly accredited rep­
resentatives of the parent institution,
was recognized.

T he I n d e p e n d e n t T r e a s u r y
a n d I ts B r a n c h e s

P o p u l a r O p p o s it io n t o C e n t r a l

The national banking system, es­
tablished in 1863, grew out of the
financial difficulties of the Civil War.
After the adoption of the independent
treasury system in 1846, the govern­
ment had no relation with the banks
of the country, keeping its funds with
the various subtreasuries established
in several leading cities. When the
war broke out the government was
compelled to turn to the banks for
help. Instead of meeting the war
expenses by taxation, it resorted to
loans, which could be obtained quickly
only from the banks.
The policy of separating the fiscal
activities of the government from banks
and banking—which was adopted with
the establishment of the independ­
ent treasury system—was discontinued
when the national banking system
came into existence, and thereafter the
subtreasuries became largely deposi­
taries of surplus coin, distributers
of currency and coin, and redemption
Under the Aldrich-Vreeland Act
there were formed no less than eighteen
national currency associations, and in

Throughout the history of the
country, it is apparent that the people
have been opposed to placing in one
single institution the financial power
which a. central bank might exercise.
This was manifest in the failures of
both the First Bank of the United
States and the Second United States
Bank to secure charter renewal; and
the antagonism which was most ap­
parent during the administrations of
President Jackson continued and as­
serted itself in the preparation of the
legislation that finally resulted in the
enactment of the Federal Reserve Act,
approved by the President, December
23, 1913.
Division of the United States into
regions, as begun in the formation of
the Currency Association, prevailed in
the Act; and the establishment of not
exceeding twelve independent Federal
Reserve Banks with power in each of
the banks to establish and operate
branches was provided.
The original law, Section 3 of the
Act, was as follows:

Each Federal Reserve Bank shall es­
tablish branch banks within the Federal


T h e A nnals

of the

Reserve district in which it is located and
may do so in the district of any Federal
Reserve Bank which may have been
suspended. Such branches shall be oper­
ated by a board of directors under rules
and regulations approved by the Federal
Reserve Board. Directors of branch banks
shall possess the same qualifications as
directors of the Federal Reserve Banks.
Four of said directors shall be selected by
the Reserve Bank and three by the Federal
Reserve Board, and they shall hold office
during the pleasure, respectively, of the
parent bank and the Federal Reserve
Board. The Reserve Bank shall designate
one of the directors as manager.

The Organization Committee, pro­
vided in the Act, gave consideration
to these provisions and reported at
length regarding the development of
branches. The final recommendations
of the Committee, in part, were as
It is recommended that in the event of
the establishment of such branches they
be assigned a proportionate capitalization
based upon the capitalization and surplus
of the member banks included within the
territory assigned to the branch. This,
however, should be only a tentative matter,
and such assignment of resources should
be merely to bridge over the period during
which it is found from experience about
what amount of paper will on the average
be presented by the banks in each branch
district. When sufficient experience has
been had to determine this point the re­
sources to be employed should be distrib­
uted among the branches in proportion to
the quantity of paper presented on the
average by the member bank in each such
branch district.
It is recommended further that the
parent bank of the district shall in every
case retain for itself a substantial portion
of the district as a territory from which
paper shall be directly presented for re­
discount. This would mean simply that
the branch districts would be established
whenever there was a special need for them
in a particular part of a district which
presented a clear cut, independent trading

A m er ic a n A cadem y

area, whose territory was an economic
unit and whose member banks naturally
stood in close relationship to one another.
The suggestion also amounts to a rejection
of any plan for subdividing a district com­
pletely into branch areas while the District
Reserve Bank itself exercised no distinct
banking functions except those of over­
sight. It is believed that this latter plan
would not be desirable, but that in every
district there should be a strong independ­
ent Reserve Bank organization perform­
ing actual banking functions and directly
rediscounting the paper of a considerable
number of the member banks included
within such district.

In responding to criticism of the
Organization Committee in fixing Fed­
eral Reserve districts and designating
Federal Reserve cities, the Honorable
Carter Glass, then Chairman of the
House Committee on Banking and
Currency, stated early in 1914:

With my knowledge of facts and study of
the situation, covering a period of sixteen
months, I would not, had I the power,
make more than a single change in the
districts as defined by the Organization
Committee, and that change I do not care
to point out, as no good could be expected
from any suggestion that now might be
made. Referring again to the relative
importance of the branch banks and the
regional Reserve Banks, in the practical
operation of the system, no business center
will lose its identity nor have its business
relations seriously interrupted. The bank­
ing operations and the commercial trans­
actions of any given territory will be practi­
cally maintained as they exist today, for
the reason that such territory will transact
its\business with the branch bank, if more
convenient than with the regional reserve
bank, so that there is no earthly reason
why any large financial or commercial
community should be in the least degree
uneasy over the prospect of losing any
business which it now commands.
E a r l y D is a d v a n t a g e s

In the original Federal Reserve Act,
the mobilization in the Federal Reserve

S cope


B r a n c h es


Banks of reserves of member banks
extended over a period of thirty-six
months. In carrying these provisions
of the law—as long as they existed—
into effect, it became apparent that
the cities in which Federal Reserve
Banks were located had an advantage
over cities of former equal standing,
especially in regard to accounts of
country banks, and the advantage of
correspondent banks in Federal Re­
serve cities was further accentuated
when the early steps in the par collec­
tion of checks were taken. At first,
banks in the other cities endeavored
to offset the advantage by main­
tenance of excess reserves in the
Federal Reserve Banks and agreement
for immediate charging against such
reserves of their checks by the Federal
Reserve Banks. This proved both
burdensome and unsatisfactory.
In its Second Annual Report to
Congress, for the year 1915, the
Federal Reserve Board states:

The question of branches of Federal
Reserve Banks has received careful at­
tention during the past year. There has
been intimation from several quarters that
the establishment of a branch at a given
point would be acceptable to the banks of
that place. Only in one instance—that of
New Orleans—did the Board receive a def­
inite request from a Federal Reserve Bank
to establish a branch. Believing that New
Orleans and the adjacent territory could
make advantageous use of this additional
banking machinery, the Board authorized
the establishment of a branch of the
Federal Reserve Bank of Atlanta to be
located in New Orleans, and this branch
was opened for business on September 10,
1915 . Operations at the New Orleans
branch have proceeded satisfactorily, and
the institution has been of considerable use
to the local banks. The branch is already
more than self-supporting.
Investigation and experience have seemed
to show that, at least for some years to
come, the organization of branches with
completely equipped offices, vaults, and

F e d e r a l R e se r v e B a n k s


the like, and with a full staff of salaried
officials, will be too heavy an expense for
most of the reserve banks, yet, that valu­
able service could be performed by local
offices of the several banks in not a few
places. The Board has, therefore, had
under consideration the question whether
establishing local agencies might not meet
the requirements of the case better than
the more fully organized branch office.
Competent legal opinion is to the effect
that the creation of such local offices is
permissible under the terms of the law, and
the Board believes that it may prove
practicable to meet banking necessities in
many sections of the country by this

The entrance of the United States
into the Great War in April, 1917,
forced upon the Federal Reserve Banks
greatly increased responsibilities and
duties. By reason of the govern­
ment’s financial requirements and the
assistance rendered to member banks
to enable them to meet obligations and
give the wonderful support accorded by
the banks to the nation’s demands, the
Federal Reserve Banks were enabled
to show substantial earnings, and, on
account of the favorable position thus
attained, the early establishment of
branches was possible.
The section of the Act relating to
branches was amended in June, 1917,
and in its Fourth Annual Report, the
Federal Reserve Board made the fol­
lowing statements:

As originally enacted, this section pro­
vided that each Federal Reserve Bank
“shall establish branch banks ” to be “ oper­
ated by a board of directors under rules
and regulations approved by the Federal
Reserve Board,” and provided also that
there be seven directors having the same
qualifications as directors of Federal Re­
serve Banks. The section as now amended
provides that the Federal Reserve Board
may permit or require any Federal Re­
serve Bank to establish branches within its
district, and that such branches, subject to
such rules and regulations as the Federal


T he A nnals

of the

Reserve Board may prescribe, shall be
operated under the supervision of a board
of directors to consist of not more than
seven or less than three directors, of whom
a majority of one shall be appointed by the
Federal Reserve Bank of the district and
the remaining directors by the Federal
Reserve Board.
During the year branches have been
established at Omaha by the Federal Re­
serve Bank of Kansas City, at Louisville,
by the Federal Reserve Bank of St. Louis,
and at Portland, Seattle and Spokane, by
the Federal Reserve Bank of San Francisco,
and are now in operation. The Board has,
in addition, authorized the establishment
of branches at Pittsburgh and Cincinnati by
the Federal Reserve Bank of Cleveland, at
Detroit, by the Federal Reserve Bank of
Chicago, at Baltimore, by the Federal Re­
serve Bank of Richmond, and at Denver
by the Federal Reserve Bank of Kansas
City. It is expected that all of these
branches will begin business at an early
The policy of the Board in the establish­
ment of these new branches has been to
recognize the unity and paramount re­
sponsibility of the Federal Reserve Bank,
while extending full facilities to the banks
in the territory served by the branch. By
avoiding duplications in bookkeeping, and
by a consolidated control of accounts at
the Federal Reserve Bank, it is expected
that branches can be operated at a com­
paratively small expense.

In the organization of the branches
in the various Federal Reserve dis­
tricts, the parent banks have retained
definite portions of their districts in
which they exercise distinct banking
functions for member banks, and have
delegated to the branches like func­
tions for member banks in territories
or areas assigned to such branches.
B r a n c h e s A r e S u b s id ia r y

There are now in operation twentyfour branches of the twelve Federal
Reserve Banks. These branches have
all been located in the several districts
in harmony with the underlying direc­

A m er ic a n A cadem y

tion of the Act that they shall exist
“with due regard to the convenience
and customary course of business.”
The actual operation of all the branches
in the final results is subsidiary to the
parent banks and forms part of their
functions. The figures of the branches
are embraced in the reports and state­
ments of their parent. Matters of
policy and questions of operation are
determined by the head offices in the
respective districts.
By reason of remoteness from the
head office, some of the branches
maintain separate books and perform
practically all of the functions of the
parent bank in relations with member
banks in their assigned zones or terri­
tories. In others, a method prevails
by which all figures and accounts are
maintained in the head office through
private telegraphic connections with
the branches and under a satisfac­
tory system of communication and
F u n c t io n s o f B r a n c h B a n k s

The powers and functions exercised
by the branches of the Federal Reserve
Banks embrace:
(1) Receiving deposits of member
banks and the government;
(2) Paying out currency and coin
to banks;
(3) Receiving from member banks
applications for loans and discounts
and tenders of bills eligible for pur­
chase by Federal Reserve Banks, and
examining all paper presented for
technical defects, generally passing
immediate credit for proceeds subject
to final review by the head office;
(4) Operating city and country col­
lection departments for handling of
bonds, coupons, notes, trade accept­
ances, sight, time, and documentary
drafts, insurance and railroad vouchers,
and certificates of deposits;
(5) Operating a transit department

S cope


B r a n c h es


F e d e r a l R e se r v e B a n k s

for handling checks and bank drafts
and other cash items payable on de­
(6) Clearing of checks and drafts
and other clearable items payable
through clearing houses in cities
wherein branches are located;
(7) Making wire transfers to and
from other Federal Reserve and branch
cities for member banks in branch
(8) Converting, exchanging and in­
terchanging all issues of Liberty Loan
bonds, Victory Liberty Loan notes and
certificates of indebtedness;
(9) Redemption of United States
securities, coupons, War Savings Cer­
tificates and stamps.
In the establishment of branches of
the Federal Reserve Banks, efforts
were made to give to those communi­
ties wherein the branches are located
the fullest measure of Reserve Bank
service demanded by banking and
business conditions within limits of
reasonable expenditure and avoiding
unnecessary duplication of work. In
each branch there is maintained an
adequate currency supply to meet the
needs of the community. The sub­
treasuries were discontinued, prior to
July 1 , 1921, under an amendment by
Congress to the organic law, and the
functions and duties of those offices
have been undertaken also by the
Federal Reserve Banks and branches.
B r a n c h e s A id C o l l e c t io n s

The branches have been notably
effective in the collection operations
as developed in the Federal Reserve
System. Checks and drafts and other
collection items upon banks in a given
branch or parent bank territory are
sent directly to the branch or bank
serving that territory by all other
Federal Reserve Banks and branches,
and arrangements have been perfected
permitting the larger member banks


in the centers to send direct to the
proper Federal Reserve Bank or
branch all such items payable in its
respectively allotted areas.
It is apparent that, in every practi­
cable way, the banks in cities and areas
wherein branches of Federal Reserve
Banks are located are accorded all the
facilities and services of the System in
like manner as those in designated
Federal Reserve cities. Capital stock
adjustments and dividend payments
naturally appertain to the head offices,
and these functions are necessarily re­
served, but otherwise the branches
render available in their cities and
assigned areas all Federal Reserve
banking powers.
A notable instance of the use to
which these facilities have extended is
that, in one of the leading branches
during the calendar year, 1920, over
$510,000,000 in currency was de­
posited, and approximately $490,000,000 paid out and about 14,000,000
checks, aggregating nearly $9,000,000,000, were handled by this one
B r a n c h B a n k s G r o w in g R a p i d l y

In many of the locations the facili­
ties demanded and accorded have
already assumed such magnitude and
importance as to require the services
of large clerical staffs occupying con­
siderable office space, and in not a few
instances, already, the branches have
been compelled to acquire separate
buildings or to plan independent
quarters in order to secure proper
safeguards and efficient handling of the
volume of work passing through their
hands. Some of the Federal Reserve
Banks now have under consideration
necessary office location of branches;
some branches now already established
are being placed in their own buildings,
the property of the parent banks. It
is manifest that considerable expendi­

T h e A nn als


of th e

ture by the Federal Reserve Banks
for office buildings and vaults for
branches is necessary in order to con­
duct the work properly.
It is not improbable that in the
future development and progress of
the Federal Reserve System, there will
arise the necessity for the location of

A m erican A cademy

other branches to meet the demands
or requirements of business com­
munities or industrial centers. These
situations will be met and provided for
and any additional functions which
may be properly assumed by the
Federal Reserve Banks will likewise
be allotted to the branches.

Curves of Expansion and Contraction, 1919-1921
By A. C. M i l l e r


Federal Reserve Board, Washington, D. C.

HE economic vicissitudes through credit caused expansion or contraction
which the country has passed dur­ of business and the rise and fall of
prices, or whether the movement of
ing the past year have brought to
everyone a vivid and memorable ex­ was determined by the move­
perience of the actualities of expansion ments of business and prices. The
and contraction and have made the correlation of the business and finan­
study of the conditions which eventu­ cial factors involved in the economic
ate in these violent alternations of the developments of the past three years
curves of business and credit, a matter presents too complex a problem to be
undertaken within the limits of this
of profound practical importance*
War, and its immediate aftermath of paper. For the assistance of any who
business inflations, made the credit are ambitious to penetrate the eco­
expansion. After-war readjustment, nomic mysteries of recent expansion
with its inevitable liquidation, has and contraction, there is, nevertheless,
made the credit contraction. So much appended to this article a collection of
is already clear from the outside point data covering most of the determi­
of view and is now admitted by most nable factors involved in the problem.
fair-minded people. But what is fur­ In order to make the fluctuations in
ther revealed and how does the matter the different items comparable, they
look when the operations of the bank­ are expressed in the form of index
ing system are viewed from the nearby, numbers based on the 1919 average.
or Federal Reserve, point of view? A second table shows the absolute
For this whole recent experience raises figures upon which the index numbers
some questions of great moment with of banking are based.
regard to the functioning of the coun­ M e a s u r e m e n t o f E x p a n s io n a n d
try’s new credit mechanism.
C o n t r a c t io n
It is not the purpose of this discus­
sion to go into the economics of the The object of the present discussion
expansion and contraction of 1919- is to ascertain what light recent ex­
1921. It is not at all concerned with perience throws on the question as to
questions of economic causation. No whether the Reserve System possesses
attempt will be made to determine a sensitive and accurate indicator of
whether expansion or contraction of changes in the credit and business

So 2 .

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C urves o E xpansion


C o n t r a c t io n


T he A nnals

of the

changes in the volume of the country’s
The volume of business in general
depends on four factors, or, in mathe­
matical language, is a function of four
variables: ( 1) physical volume of pro­
duction; (2) price level; (3) activity of
trade (rapidity of turnover); and (4)
speculative and other transactions in
securities, exchange, etc. A change in
any one of these factors affects the total
volume of business, and this, in turn,
affects the total volume of credit re­
quired. In any exhaustive analysis of
the business or economic situation to
ascertain what factors are affecting the
demand for credit facilities, or, let us
say, the expansion or contraction of
credit, careful attention must always,
of course, be given to variations in any
of the elements affecting the volume of
C h a n g e s in t h e B u sin ess S itu a tio n ,

Beginning about midyear, 1919, and
extending to the end of the year, there
was a pronounced expansion of busi­
ness accompanied by great speculative
activity involving commodities as well
as securities. Increased activity of
business (rapidity of turnover) and
rise of prices were the important factors
in this development. The index of the
physical volume of production (for
manufactures) shows no noteworthy
change during this interval.
Economic reaction set in early in
1920, and continued throughout the

American A cademy

year. Business recession was much
in evidence and gained in momentum
after mid-summer, 1920. In the first
quarter of 1921 the reaction reached
the stage of acute liquidation. There­
after business pursued a steadier
course. This period of reaction and
liquidation was marked by dimin­
ished physical volume of production
(for manufactures) after mid-summer,
1920, and by the drop of wholesale
prices. The index for manufactures
declined from 102.3 in July to 77.9
in December, 1920, and to 68.5 in
July, 1921. The price index declined
from 123.6 in July to 89.2 in December,
1920, and 69.8 in July, 1921. These
changes in the business situation, 19191921—that is, the rise and the fall in
the volume of business transactions—
are clearly reflected in the curve of
business. Its trends are unmistakable.
How well are these changes in the
business situation—in brief, the ex­
pansion and contraction of the volume
of business—reflected in the curves of
credit, first, that of the member banks,
and second, that of the Federal Re­
serve Banks?
M e m b e r B a n k C r e d it C u r v e o f
E x p a n s io n a n d C o n t r a c t io n

The member bank credit curve re­
flects pretty faithfully the business ex­
pansion which went on in the second
half of the year 1919, and again, the
liquidation which was in process in the
early part of the year 1921. It will be
noticed that the liquidation of the loan
* As measured by debits to individual accounts account of the reporting member banks
in banks in about 150 leading clearing-house in the first six months of the year 1921
centers. In order to eliminate short-time approximately cancels the expansion
fluctuations due to the difference in the number
of business days in a month, to mid-month and of the loan account of these banks in
end of the month payments, and to Treasury the second six months of the year 1919.
operations in connection with the quarterly in­ Through the year 1920, however, it will
stallment of income taxes, the volume of business be noticed that the curve of credit of
curve on the chart has been smoothed by means the member banks shows a different
of a moving average which shows for each month
the average volume of business for the month trend from the curve of business. The
business recession which was in process
g,nd the two preceding months.

C urves of E xpansion and C ontraction

in 1920 is not at all reflected in the
member bank curve of credit. There
was no contraction of credit until the
last quarter of the year. On the con­
trary, the banks were expanding their
accommodation throughout the year
and until after the crop-moving season
was over. Agriculture was in distress,
while business was in the midst of the
crisis of readjustment and needed as­
sistance in effecting the transition from
the period of expansion through the
period of liquidation. That assistance
was being extended by the banks, as
both of the curves of credit clearly
indicate, and thus was liquidation of
business moderated and kept orderly
by comparison with what it would have
been, had it not been for the steadying
and easing influence of our new credit
T h e R e s e r v e B a n k C u r v e o f C r e d it

Turning to the Reserve Bank curve
of credit, it appears that the curve of
credit of the Federal Reserve Banks
parallels the curve of business more
closely than does the curve of credit of
the member banks, both in the period
of rapid expansion in 1919 and in the
period of acute liquidation in 1921.
It will be noticed on the chart that the
Reserve Bank curve of credit in the
period under review twice cuts through
the member bank curve of credit—
once in October, 1919, on the upward
swing of business, and again in April,
1921, on the downward swing of busi­
ness. By comparison with the mem­
ber bank curve, the ascent of the Re­
serve Bank curve was more pronounced
on the rise, as was also its descent on
the fall. On the other hand, through­
out nearly the whole of 1920, when the
business curve was showing a decided
downward trend (until the last quarter,
when a slight rise is shown due to sea­
sonal influences) the Reserve Bank
curve of credit showed an opposite, or


upward, trend. Both curves of credit
in the critical year 1920, therefore,
followed a different trend from the
curve of business, but it is noteworthy
that the difference is much more pro­
nounced in the Reserve Banks’ curve
than in the member banks’ curve.
T h e G old I n f l u x a n d R e s e r v e
B a n k C r e d it C u r v e

There still remains to be considered
the curve of gold reserves. The sharp
and prolonged drop in the Reserve
Bank curve of credit through the year
1921 and the liquidation which it re­
flects cannot be understood without
reference to the great influx of gold into
the country and into the Federal
Reserve Banks, which has been in
process during the past twelve months.
Reference to the chart brings out the
opposite movements in these two sig­
nificant and related curves. Reference
to the index numbers shows that the
index of the Federal Reserve System’s
gold holdings rose from 94 in Oct6ber,
1920, to 130 in October, 1921, while the
index of bill holdings declined from
137 in October, 1920, to 63 in October,
1921. Over 45 per cent of the liquida­
tion of the loan account of the Federal
Reserve System, it appears, may be at­
tributed to the increase of its gold hold­
ings. The influence to be attributed to
the gold factor in Federal Reserve
Bank liquidation is still greater in the
case of the Federal Reserve Bank of
New York, which has been the chief
recipient of the gold flowing from
Europe to our shores. The index of
bill holdings for that bank fell from 126
in October, 1920, to 37 in October,
1921. Its gold index for the same
period shows a rise from 74 to 156.
The gold factor is thus seen to account
for over 73 per cent of the liquidation
experienced by the loan account of the
Federal Reserve Bank of New York.

The great stream of gold which has


T h e A n n als

of the

poured into the United States from
Europe during the past year has come
in liquidation of foreign indebtedness
to us, and has been turned over by
member banks to the Federal Reserve
Banks in liquidation of their own in­
debtedness. The pronounced and con­
tinuous downward trend of the Re­
serve Bank loan curve during the past
year is therefore seen to be due largely
to foreign liquidation. The course of
business shows considerable steadiness
after the first quarter of 1921, and the
member bank curve of credit, after the
second quarter; but the Reserve Bank
curve of credit continues its downward
course in 1921 without abatement in
quick and close response to the con­
tinuously upward course of the curve of
gold reserves. As an indicator of the
degree and rapidity of domestic liqui­
dation, the Reserve Bank curve of
credit is misleading, owing to the dis­
turbing influence of the gold factor.
T h e R e s e r v e B a n k C u r v e o f C r e d it
t h e M o r e S e n s it iv e I n d ic a t o r
o f C r e d it C h a n g e

Comparing the two curves of credit
with one another, it is clear that while
both curves are influenced by the same
changes in the business situation, their
response is not the same. A glance at
the chart brings out the fact that the
Reserve Bank curve moves very much
more readily and markedly than the
member bank curve. The member
bank curve appears flat by comparison
with the Reserve Bank curve, and gives
a less lively impression of the business
and credit developments and changes
which were in process. What is the
explanation of the difference, and which
of the two curves is the better index of
expansion and contraction?
The relative flatness of the member
bank credit curve during the year 1920
as compared with the Reserve Bank
curve is due to several circumstances,

A m erican A cademt

some transitory in character. It will
be recalled that the loan and invest­
ment account of the banks of the coun­
try was greatly swollen during the War
by heavy investments in Liberty bonds
and Certificates of Indebtedness, and
by accomodation granted subscribers
to government war loan issues. After
the War, the process was reversed.
There has been constant liquidation of
bank holdings of government securities
and of loans collateraled by such securi­
ties. Reporting member banks’ hold­
ings of government securities dropped
from 3,083 millions in May, 1919, to
1,938 millions in January, 1920, and
1,318 millions in January, 1921. Fig­
ures of holdings of paper secured by
government securities are not available
until December, 1919, when they
amounted to 1,337 millions. From
this point they declined to 899 millions
in December, 1920, and 577 millions in
October, 1921. The liquidation in the
loan and investment account of the
member banks from these sources has
therefore been very considerable. But
it does not appear to be reflected in the
movement of the member bank curve
of credit in 1920. That curve was
ascending in spite of liquidation from
these sources. But had it not been for
this liquidation, it is altogether reason­
able to assume that it would have
ascended still more. The credit thus
released by liquidation of war loan secu­
rities and paper was apparently being
used to expand the commercial and
speculative loan accounts of the banks.3
3 Something similar occurred in the early
autumn of 1919, when it will be noticed the
member bank curve was rising, while the Re­
serve curve was declining, the banking expansion
then in process being able to proceed without
increased borrowings from Federal Reserve
Banks. This is explained by the fact that the
floating debt of the government was reduced at
this time by almost 500 millions of dollars, the
banks using the funds thus made available to
the expansion of their


commercial loans.

C urves of E xpansion and C ontraction

When we come to the period of
liquidation in the autumn of 1920 and
the following winter, there appeared an
influence of an opposite character to
that just described—namely, the socalled “frozen credit.” By “frozen
credit” is meant credit that has con­
tinued its existence beyojid the time
when the transactions which gave rise
to the credit should normally have
liquidated themselves. It is made up
of credits which have not been liqui­
dated because the transactions under­
lying the credits have not been able to
rim their course and liquidate them­
selves. It is well known that large
volumes of goods produced last year
have been carried by the producers for
lack of satisfactory markets. Prices
were falling, markets were collapsing,
and there was congestion of goods at
points of primary production and dis­
tribution. The owners of these goods
had to be “carried.” There is no
means of approximating the amount of
these frozen credits, but there is reason
to believe that they constitute a very
substantial fraction of the total loans
and discounts carried by the commer­
cial banks of the country.
The member bank loan curve shows
resistance to the forces of liquidation.
It was this retarded or “orderly” liqui­
dation which kept the curve from de­
scending as swiftly as it otherwise
would have if it had been influenced
merely by the volume of current busi­
ness transactions. Moreover, the li­
quidating power of a dollar paid in by
a member bank to its Reserve Bank in
a period of liquidation appears, on the
basis of the past two years, to be very
much less than the credit-supporting
power of a dollar loaned by a Federal
Reserve Bank to a member bank in a
period of active expansion.4 And fur-


thermore, the Federal Reserve Bank
loan curve, as has already been pointed
out, represents in a peculiar degree the
liquidating effect on the Federal Re­
serve loan account of the huge influx of
gold which has been continuous during
the past twelve months. Besides these
transitory influences which have helped
to give the member bank loan curve a
relatively flat character, there is the
additional important and regular in­
fluence exercised by the far greater
volume of member bank loans com­
pared with Reserve Bank loans. Ow­
ing to the fact that the base figure is
much larger for member banks than for
Reserve Banks, the same change in
absolute amounts will result in a much
larger percentage change and, con­
sequently, in a much steeper movement
in a Reserve Bank curve than in a mem­
ber bank curve. But this arithmetical
fact does not fully explain the discrep­
ancy. There is a further reason of an
economic character to be noted in a
study of the curves of expansion and
The great bulk of the loans of the
member banks at any time represents
loans incident to the ordinary volume
and requirements of business, and

29, 1921) the increase in the loans of the member
banks was 6.7 times as great as the increase in
the discounts of the Federal Reserve Banks,
while during the following year the decrease in
the loans was only 2.3 times as large as the
decrease in Federal Reserve Bank discounts.
For the reporting member banks, for which data
on more significant dates are available (July
25, 1919, before the speculative expansion began,
October 15, 1920, when the peak was reached,
and November 2, 1921, the latest date for which
data are available) their investment and loan
account increased 3.2 times as fast during the
period of expansion as their borrowings from the
Federal Reserve Banks, while during the period
of liquidation the reduction in the investment
and loan account of the reporting member banks
4 During the period of expansion between 1919 is 1.6 times as large as the corresponding reduc­
and 1920 (dates for which information is avail­ tion in their borrowings from Federal Reserve
able being June 27, 1919, June 25, 1920, and June Banks.


T he A nnals of the American A cademy

exercises, even in times of marked
changes in the business situation, a
steadying influence on the member
bank credit curve. The situation of
the Reserve Banks is different. Their
loan account does not reflect the normal
volume of credit in use. Under normal
conditions, their operations are not
large. It is not the absolute amount of
credit in use, but the ebb and flow of
credit, which affects the loan account
of the Federal Reserve Bank. The
Federal Reserve Bank has little part in
the ordinary credit business of the
country. It does not deal with busi­
ness borrowers directly. The relations
of the business man are with his mem­
ber bank, the member bank in turn
dealing with the Reserve Bank as oc­
casion may necessitate. The Federal
Reserve loan is not the first line of
credit, but the second line of credit.
The expansion and contraction of
the Reserve Bank loan account are
twice removed from the expansion and
contraction of the volume of busi­
ness as reflected in commercial bank
The Federal Reserve is called into
activity when the supply of ordinary
credit facilities is inadequate. It sup­
plements the resources of its members.
It is, so to speak, the increments and
decrements in the country’s credit re­
quirements that are reflected in the up­
ward and downward movement of the
Federal Reserve loan account. It is
when business is speeding up beyond
their normal credit capacity that the
commercial banks must resort to the
Federal Reserve Banks for accommo­
dation. When business is receding and
liquidating in a period of economic
reaction, slackening of credit require­

ments will result in a marked reduction
of borrowings from Federal Reserve
Banks. The Reserve Bank curve con­
sequently reflects movement, change
—the more or less of credit required—
and not the actual total volume of
credit in use by business. On a rela­
tive basis the Reserve Bank curve has
a tendency to magnify what is in proc­
ess in times either of rapid expansion or
of acute liquidation; in other words,
to give an exaggerated or heightened
impression of these movements.
A G u id e t o C r e d i t P o l i c y
Therein consists its importance as
an administrative guide. While it
may be faulty as a gauge of the degree
of credit expansion or contraction, its
very sensitiveness gives it a peculiar
value as a quick indicator of what
changes in the business and credit
situation are in process or even im­
pending. For while the Reserve Bank
curve, during the period under review,
has been over sensitive and gives an
exaggerated impression of credit de­
velopments, the member bank curve,
for reasons already discussed and
primarily because, at any moment, it is
more influenced by what has taken
place than by what is taking place,
tends to give an inadequate impression
of changes which are in process, at least
so far as they affect the credit situation.
In times of rapid expansion or contrac­
tion, it is not the total volume of out­
standing bank loans which is significant,
but additions to that volume, or reduc­
tions in it. From this point of view,
the Reserve Bank curve is a truer in­
dex of business and credit development
than the member bank curve, and a
better guide to credit policy.

C urves of E xpansion and C ontraction

. 89

M arch...
April. . . .
May . . . .
June . . . .
August ..

M arch...
April . . . .
May . . . .
August ..
March. . .
April . . . .
May . . . .
June . . . .
August ..



R note

G ld reserves

F. R. B ank of
N ew York
Bill holdings

F. R. note

G ld reserves

Bill holdings

All F ederal
R eserve B anks

1919 = 100)

R eporting
M ember B anks

i l


(Monthly averages for

^V2 CeQ




Volume of


Volume o business


Net demand
























116.7 117.0
108.4 119.3
107.1 125.0
108.6 128.3
106.9 126.9
103.6 123.6
101.2 117.9
98.4 114.2
100.3 106.1
104.3 97.6
104.6 89.2













a Including rediscounts with Federal Reserve banks.
b As measured by debits to individual accounts, three-months' moving averages.
0 U. S. Bureau of Labor Statistics.
d Harvard Committee on Economic Research.


. . . .
. . . .

T he A nnals of the A merican A cademy


BAN KIN G D ATA: 1919-1921
(Monthly averages: amounts in millions of dollars)

R eporting
M ember B anks
i i

Ratio of F.
R. accommo­
dation to to­
tal loans and
(per cent)

M ay....................

January .............
M ay.....................
M a y ...................





















938 415
922 413
826 500
676 650
608 682
479 822
432 846
396 862
315 966
298 1,001



10,816 1,947
10,583 1,878
10,404 1,792
10,201 1,601
10,194 1,421
10,182 1,267
10,037 1,167


e Including rediscounts with Federal Reserve banks.

l l

Net demand


F. R. note


G ld reserves



ill holdings

G ld reserves

F. R. B ank of
N ew Y ork

Bill holdings

All F ederal
R eserve B anks

4 ^
I I *


E xpansion


C ontraction


Expansion and Contraction Under the Federal
Reserve System

E r n e s t M in o r P a tte r s o n
University of Pennsylvania

MUCH confusion of thoughtcon­
thesubject of expansion and

traction is due to our failure to dis­
tinguish clearly between three different
problems. An economic system, which
operates on a money and credit basis,
and which maintains business relations
with the systems of other countries,
cannot well escape these difficulties.
Each of the three facts involved is
at times referred to as “depreciation.”




h ree


in d s

e p r e c ia t io n ”


One of them is the relation of a given
financial system, such as that of the
United States, to that of other countries
as reflected in foreign exchange quo­
tations. The British pound is worth
at mint par $4.8665, the German
mark, 23.8 cents, the French franc,
19.3 cents and so on. When, as at
present, these moneys are bought and
sold in our markets at about $3.80,
one-third of a cent and 7.25 cents,
respectively, it is customary to say
that the moneys of those countries are
depreciated. During the late War
the moneys of the belligerent countries
were thus depreciated in the United
States, while at the same time our
money was depreciated in certain
neutral countries.
The causes of such a condition we
need not here explain, but one point
needs emphasis. In every case where
such depreciation occurs there is
merely an increase in the value of the
first money in terms of the second
and a decrease in the value of the sec­
ond in terms of the first. In terms
of the American dollar the pound
sterling is now lower than usual, and

in terms of the pound sterling our dol­
lar is higher than usual. For a pe­
riod of time several years ago the
American dollar was lower than usual
in terms of the money of Sweden, and
Sweden’s money was higher than usual
in terms of our dollar. Foreign ex­
change quotations are for the most part
merely a barometer or index, an effect
and not a cause, but what they state is
a change in the relative position of the
moneys of two countries. The ap­
preciation of one involves the deprecia­
tion of the other, and vice versa.
A second kind of depreciation is
found when one form of money, say
the standard money gold, changes in
its relationship to some other form
of money in the same country. Such
a change occurred in the United States
during the Civil War, when the “green­
backs” or United States notes were
issued in very large quantities and were
acceptable at less than their face value
in exchange for gold. At one time a
dollar of gold would purchase as much
as $1.85 in greenbacks. The green­
backs had depreciated in terms of
gold, and gold had appreciated in
terms of greenbacks. Again it is a
question of the relationship between
the two.
A third type of depreciation is to
be observed when the general price
level changes. If prices in general
rise to a higher level than that of the
past it may be said that the value of
commodities in the country has ap­
preciated in terms of money and that
the value of the money has depreciated
in terms of the commodities. Simi­
larly, if the general price level falls,
there is an appreciation of the value


T he A nnals

of the

of the money in terms of commodities
and a depreciation of the value of the
commodities in terms of money.
These three forms of depreciation
are well understood by most persons
who are at all acquainted with finan­
cial questions. Nevertheless, they are
closely interrelated, and when a par­
ticular problem is up for consider­
ation these interrelationships may be
overlooked and confusion of thought
“ E x p a n s io n ” a n d “ I n f l a t io n ”

One other definition is necessary.
“Expansion” is a word that is used
very loosely. Sometimes, though not
always, it is employed as a synonym
for “ inflation.” With these two words,
or rather in contrast to them, are “con­
traction” and “deflation.”
Any and every increase in the vol­
ume of circulating medium in the
United States is not inflation. As
population grows and as business
activity increases a larger amount of
circulating medium is needed if the
price level is not to decline. If its
amount should remain the same the
price level would fall and we .would
suffer all of the accompanying hard­
ships. As the volume of trade in­
creases it is better to have an increase
in the volume of circulating medium.
If this occurs and at the same rate as
the growth in trade there are no harm­
ful effects, and it would not be correct
to say there had been inflation. A
mere increase in the volume of money
or credit is not inflation, for the in­
crease must be viewed in its relation
to the demand for it. Similarly, a
decrease is not to be referred to as de­
flation if it merely corresponds to a
decline in the volume of business, i.e .,
to a reduction in demand. The price
level is not affected and no hardship
Changes in the volume of money and

American A cademy

credit that only adjust their supply
to the demand for them are better re­
ferred to as a contraction and an ex­
pansion that merely evidence the
elasticity of a monetary and banking
system. For years the Canadian bank
note issues have increased in the fall of
each year to meet the demand for cropmoving, and have later contracted when
that demand ceased. Such changes
ought not to be referred to as inflation
and deflation, but as a most desirable
expansion and contraction.
It is true that expansion of this
kind might become dangerous, but
it is not probable. The volume of
note issues or of deposit liabilities in
relation to reserves might become
too large as compared with the re­
serve held for redemption purposes.
Public knowledge of this situation
might result in a rim on the banks
and the failure of some of them, even
though the expansion had occurred
merely to meet the needs of a rapidly
growing trade. However, this kind of
expansion is not apt to take place.
There are both seasonal and cyclical
fluctuations in the demand for money
and credit, but in actual experience
they are not likely to result in a con­
dition of the sort just described.
While an expansion does take place,
ordinary trade demands are not apt
to lower seriously the percentage of
reserves held.
There are two periods of activity
for analysis in this article. One ex­
tends from the formation of the Fed­
eral Reserve System in the autumn of
1914 to the spring of 1920. The sec­
ond continues from that time to the
That in the first of these two pe­
riods there occurred an increase in the
volume of circulating medium does
not need to be argued here. Nor need
we stop to demonstrate in detail that
this increase was more rapid than the

E xpansion


growth in the volume of trade. Pro­
fessor Kemmerer, in his volume High
Prices and Deflation ,J has shown that
from 1913 to 1918 there was an in­
crease of 13 per cent in the country’s
physical volume of business, while in
1919 it actually declined from the 1918
level being only 9.6 per cent greater
than in 1913.
During this same period of time
there was an increase in wholesale
prices as reflected in the United States
Bureau of Labor index number of 112
per cent over the 1913 level. Also,
the exchange market showed a de­
preciation of the pound sterling, the
mark, the franc, the lira and other
foreign currencies in terms of our dollar.
We have already pointed out that there
are three kinds of depreciation, and the
period in question may be examined
with a view to determining whether
the Federal Reserve System and its
management were responsible for such
depreciation as occurred.
First, let us notice the increase in
the volume of the circulating medium.
From November 1,1913, to November
1, 1918, the amount of money in the
United States increased from $3,755,994,000 to $7,590,173,000. Of this
increase $1,173,883,000 was in gold
(and gold certificates), and $2,660,296,000 in other forms of money. The
increase in our stock of gold had a def­
inite connection with affairs abroad,
and will be considered a little later.
But there was an increase in the issue
of Federal Reserve notes, from nothing
to $2,705,737,000, and in the Federal
Reserve Bank notes from nothing to
$71,647,260. Also during approxi­
mately the same period the deposit
liabilities of the national banks in­
creased from $6,051,689,000 to $11,013,330,000. There was without doubt
an expansion in our circulating medium
more rapid than in the demand for it.
3 13.

1 See pages -

C ontraction


What was the occasion for this and
where does responsibility rest?
Increased D

e p o s it

L ia b il it ie s

There were three leading reasons.
One is found in the very nature of
the Federal Reserve System. Our na­
tional banking organization as it ex­
isted prior to 1914 was said to lack
elasticity. Expansion to meet any
seasonal or cyclical growth in trade
needs was difficult to secure, as was
also contraction when the need had
passed. Explanation of this difficulty
need not be presented here, as the
reasons for it are fully understood by
most students of the subject, and have
been set forth many times.
Under the old law, country banks
were required to maintain a reserve of
15 per cent of their deposit liabilities,
of which two-fifths, or 6 per cent, had
to be in actual cash in their own vaults;'
reserve city banks, 25 per cent, of
which one-half had to be in cash; and
central reserve city banks, 25 per
cent in cash. The net effect was
that there could be on the average
about $8 of deposit liabilities on each
$1 of reserves held by the national
banks of the country, or an av­
erage cash reserve of 12| per cent.
This varied slightly from time to
time, and there have been slight dif­
ferences in the estimates of students
of the question, but the figures are
sufficiently accurate for our present
Under the Federal Reserve Act,
particularly as amended, all this was
changed. By a concentration of cash
in the vaults of the twelve Reserve
Banks each dollar could be utilized
much more effectively. Accompany­
ing this there was a reduction in the
reserve requirements of the member
banks, and the net result was that $1
of reserve furnished the basis for per­
haps $11.50 of deposit liabilities, or an


T he A nnals

of the

average cash reserve of about 9 per
cent.2 Although there may be differ­
ences of opinion as to this particular
figure, there can be no dispute over
the fact of a very pronounced change
in the direction indicated.
Whether a change of this kind,
which permitted and even encouraged
an expansion in deposit liabilities, was
wise cannot here be argued, but will
be assumed. The United States had
been paying too dear a price for its
banking system. Greater elasticity
was important. It could not be se­
cured except by a centralization of
reserves, and centralization of reserves
means that each dollar is more effective
than before. Under such circum­
stances an average cash reserve for
the country of more than say 10 per
cent or 11 per cent would be very dif­
ficult and probably impossible to main­
tain. Such a change as this would have
resulted under any plan of banking
reform and under any management.
Our circulating medium would have ex­
panded more rapidly than the growth
in trade demand and, ceteris paribus ,
would have caused a rise in the general
price level.
I n c r e a s e d G o ld R e s e r v e

A merican A cademy

addition of about $12,324,193,000 to
the deposit liabilities of our banks.
It thus appears that a plan of bank*
ing reform was deliberately adopted
by the country, after a discussion ex­
tending over a number of years, which
was one that was sure to increase the
deposit liabilities of our banks. More­
over, any other reform, such as the socalled Aldrich Plan, would have had a
similar effect.
But can the Federal Reserve System
or its management be held responsible
for the importation of gold that fur­
nished an additional basis for this ex­
pansion? There is certainly no reason
for such a view. The intense demand
for our commodities and the rapid
growth in our export balance threw on
the European belligerents the burden
of righting in some manner their un­
favorable position. Commodities and
securities, particularly the latter, were
hurried over to us, and especially in
the earlier part of the struggle large
amounts of gold were sent also. The
movement was a part of the general
situation, and would have occurred had
we still been operating under the old
National Bank Law.
In fact, the existence of the Federal
Reserve organization facilitated rather
than impeded credit transactions, and
thus made it easier to check the gold
movement. If the older system had
still been in operation much more gold
might conceivably have been imported
into the United States during that

This assumes no alteration in the
volume of the gold reserve. A re­
duction in gold supply would have off­
set this tendency to expansion, while
any increase would enhance it. On
this point we need merely refer to the
facts, which are that from August 1 ,
1914, to January 1,1919, there was an St r a in o f F in a n c in g W a r P u r ­
importation (net) of gold into the
United States amounting to $1,071,- But the analysis is not complete.
669,000, which made possible (accord­
the new reserve re­
ing to the above ratio of 11| to 1 ) an Admitting thatthe importation of gold
quirements and
encouraged a considerable expansion,
2 “ Mechanism of Expansion Under the Federal
it may be argued that the expansion
Reserve System” ; Monthly Review of Credit
that really occurred was extreme,
and Bunness Conditions in the Second Federal
going so far that the percentage of
Reserve District, September 1, 1921, p. 12.

E xpansion


reserve actually held by the system
was for a long time very close to the
legal limit. With the New York
Reserve Bank this was particularly
noticeable. While the situation was
a very strained one for the System as a
whole, the condition of the New York
Bank was at times especially weak,
and was even disguised, though rather
poorly, by a change in the form of its
weekly reports. Had this been pre­
sented in the same form as used by the
other eleven banks and by the System
as a whole, there would have been
shown a smaller percentage of reserve
than that prescribed by the law. The
form of report adopted by the New
York Bank may have been as good or
even superior to the other form, but
the difference referred to illustrates the
strain on that bank. At one time, too,
the situation was materially helped by
the timely deposit by the Federal
government of a considerable amount
of silver with the New York Bank.
Also, the twelve banks of the System
gave each other extensive relief by
rediscounting heavily for each other,
a form of assistance that was of general
aid, but was particularly valuable to
the New York Bank after November,
There was clearly a considerable
apiount of strain on the System. As
has just been pointed out, the altered
reserve requirements would have made
possible a very considerable expansion
in deposits, and heavy importations
of gold increased this tendency, but
neither of these facts explains the
strain just referred to.
In the period from 1914 to April,
1917, there was a very heavy demand
upon American banks to assist in war
financing. The United States was
not yet in the conflict, but the vast
movements of goods, chiefly to allied
countries, called for a large amount of
financing, and American banks, in­

C ontraction


cluding the Federal Reserve Banks,
assumed the burden.
The Federal Reserve System was
designed primarily to aid commercial
banking, that is, to assist in those
banking transactions that facilitate
the movement of goods from producer
to consumer. To this general state­
ment a few qualifications should be
added by way of reference to such pro­
visions as those regarding savings de­
posits and trust powers, but in general
the statement is correct. When war
supplies moved from the United States
to Europe our banks gave their assist­
ance. The volume was large but ex­
pansion was possible under the Federal
Reserve System and with the in­
creased gold supplies prevented any
serious strain on the System prior to
our entrance into the War anji for a
considerable time thereafter. Our par­
ticipation in the conflict and the con­
sequent demand for war financing by
our own government definitely altered
the situation.
E f f e c t o f T r e a s u r y P o l ic ie s

Just what policies should have been
followed by the Treasury Department
in meeting the war emergency is some­
thing on which we probably cannot
agree. The facts, however, are clear.
The problem was one of securing max­
imum production and of diverting to
war uses a very large fraction of that
total product. Two main devices
were employed to divert output to
the government—taxation and bond
issues (including certificates of in­
debtedness). Both of these were in­
tended to secure the desired funds by
encouraging saving. Taxation took
funds from a taxpayer, usually much
against his will, while he was expected
to buy bonds voluntarily.
But the war needs amounted to
some $18,000,000,000 per annum, and
at one period payments were as high


T he A nnals

of the

as $2,000,000,000 per month, or at
the rate of $24,000,000,000 per year.
Prior to the War our annual savings
are estimated to have been at the rate
of no more than $6,000,000,000 or
$7,000,000,000 per year. To treble
or more than treble the amount avail­
able was probably too great a task for
taxation and bond issues combined.
At any rate, policies were adopted
that resulted in an inflation of the cur­
rency and hence forced loans from the
general public.
R e s e r v e B a n k F a c il it ie s f o r W a r
F in a n c in g

If one is to appreciate the position
of the Federal Reserve Banks in war
financing, several facts must be kept
in mind. One is the altered reserve
requirements of member banks already
referred to. Some of the reductions
were made after we entered the War,
particularly by the provision that the
reserves specified were to be kept, not
in the member bank’s own vault, but
as a deposit account with the Reserve
Bank of its district. Along with this
must be remembered the other amend­
ment to the Jaw that allowed gold in
the hands of the Federal Reserve agent
held by him against issues of Federal
Reserve notes to be counted as part of
the required reserve of his Federal
Reserve Bank. Also, there must be
mentioned the policy early adopted by
the Reserve System of concentrating
the gold and gold certificates of the
country in the vaults of the Reserve
Banks, Federal Reserve notes being
issued in their place.
There were two other important
provisions of the law. One of them
states that the Reserve Banks are to
be fiscal agents of the government.
This places them in a position in which
they are compelled to cooperate in
methods of financing decided upon by
the Treasury Department.

American A cademy

The other provision is one that ap­
pears to the casual reader as of slight
significance, but it furnished the basis
for many of the important operations
of war financing. In Section 13 of the
Federal Reserve Act the powers of
the Reserve Banks are enumerated.
Among the prohibitions there set forth
is one against loans on “notes, drafts
or bills covering merely investments,
or issued or drawn for the purpose of
carrying or trading in stocks, bonds,
or other investment securities, except

bonds and notes of the Government of
the United States.

The exception in the last words of
this quotation was not particularly
significant at the time of the passage
of the Act—in fact it was rather com­
monplace. Yet it became very im­
portant during the War. The Reserve
Banks could and did lend on govern­
ment bonds and notes as security.
To the large amount of latitude thus
allowed additions were made from
time to time through rulings made by
the Federal Reserve Board. Thus it
does not seem entirely clear to the lay­
man whether the law permits a Re­
serve Bank to discount the direct ob­
ligation of a member bank. The writer
was of the opinion that it did not, and
that only the rediscounting of custo­
mers’ paper was acceptable. That
he was wrong is shown by the fact
that this direct discounting was per­
mitted on a very large scale. Member
banks discounted their own notes ac­
companied by Liberty Bonds as col­
lateral security.
Closely associated with this policy
were the decisions that notes of this sort
might run for as short a time as fifteen
days, that they might be renewed some­
what freely as they matured, and that
there should be charged for such loans
a discount rate no higher than the
interest rate paid by the government
on the frond offered as collateral.

E xpansion and C ontraction

The provisions of the law as cited
opened the way, and the decisions
just mentioned let down the bars com­
pletely. What followed may be vis­
ualized if one’s imagination permits
him to assume two printing presses
in the Treasury Department. On one
of them were printed government
bonds for sale to the public through
the Reserve Banks, which were the
fiscal agents of the government. The
Reserve Banks delivered the bonds to
member banks for actual sale. A
customer who was besought to buy a
bond protested that he had not the
funds, but was informed that he need
pay only a small amount at a time, his
bank agreeing to advance a loan, retain­
ing the bond as collateral security and
charging only the same rate of interest
as paid by the government on the bond.
This seemed generous and so aided
the sale of bonds that the banks were
in need of help to carry their part of
the load. They were reassured by
being told that they could give their
own fifteen-day notes to their respec­
tive Reserve Banks, provided they
would present with them as collateral
these same Liberty Bonds that had
been purchased by their customers,
but which were not to be delivered
until fully paid for. They were also
assured of the same low interest rate
and of an easy renewal of the notes as
they fell due.
Imagine still further that this offer
brought such general response from
the banks that the Reserve Banks
were overwhelmed and their officers
hurriedly and urgently besought the
Secretary of the Treasury for relief,
because of their lack of funds. His
answer, however, was reassuring. He
merely pointed to the other printing
press on which were being printed
great quantities of Federal Reserve
notes, which were furnished to the
Federal Reserve Banks as needed.


Thus the Treasury on one press
printed paper money (Federal Reserve
notes) which it delivered to the twelve
Federal Reserve Banks. They in turn
gave them to their members in return
for the notes of these banks secured by
Liberty Bonds. The member banks
were then able to pay the government
for the bonds struck off on the other
printing press.
The description may be fanciful,
but only slightly so. In the good old
days, say in the Civil War, the process
was much more simple and direct. The
government printed the United States
notes—the greenbacks—and put them
directly into circulation. The mod­
ern method is more complex and has
its advantages, but in many of its
features it is the same.
R e s p o n s ib il it y f o r I n f l a t io n

As a result of the, analysis we have
been making, it seems clear that the
Federal Reserve Board and the officials
of the Federal Reserve Banks cannot
be charged with responsibility for any
“inflation” that occurred down to the
summer or fall of 1919. It was due to
(1) altered reserve requirements; (2)
an influx of gold, and (3) the policies
of war financing for which the Treasury
Department was chiefly responsible.
Of the three kinds of depreciation
mentioned at the beginning of this
article two were evident. The Amer­
ican dollar had greatly appreciated in
terms of the leading European curren­
cies, so much so that various stabilizing
devices were employed. Foreign cur­
rencies had depreciated in terms of
our dollar. For this condition neither
the government nor the Federal Re­
serve System was responsible. If we
had been still operating under the old
National Bank Act with all of its
rigidity, the foreign exchange situa­
tion would have been no better and
might have been worse. After a tew


T he A nnals

of the

months of wild fluctuations foreign
governments gained control of the ex­
changes by using “pegging” devices,
an arrangement that would have been
much harder to make if our banking
system as a whole had been less well
organized. After we entered the War
responsibility for this control was
largely taken over by our government,
which of course used the Federal Re­
serve System as its fiscal agent. From
the proceeds of Liberty Bond sales,
advances were made to foreign govern­
ments, our Treasury Department re­
ceiving and holding their notes for the
amounts involved.
There was also a depreciation of our
own money, the dollar, in terms of
commodities. Prices rose rapidly, but
as we have noted this was due in the
main to (1 ) the greater possibility of
expansion that would have existed
under any reorganization of our bank­
ing system; (2) the heavy importa­
tions of gold and (3) the fiscal policy
of the Government.
The second form of depreciation did
not occur; at least, there were no out­
ward evidences of it. Our various
forms of paper money at no time were
depreciated in terms of gold. In
case an open gold market had existed,
the situation might have been different,
and a premium on gold might have
appeared, though probably not.
P o st -A r m is t ic e T r e n d s

But what can be said of conditions
from the close of the War late in 1918
until the spring of 1920? During
this period prices continued to rise,
while the volume of Federal Reserve
notes and of deposit liabilities rapidly
expanded. Gold imports had ceased
and in 1919 the movement was reversed,
considerable amounts of gold leaving
the country. The exchanges of many
of the countries that had been neutral
during the War (and even those of

A merican A cademy

many of the minor belligerents) were
against us, and, as restraints on the
exportation of gold were gradually
removed, the gold started out. The
War was over, but prices still rose,
while note issues and deposit liabilities
kept increasing in spite of the fact that
the gold reserve was being withdrawn.
The percentage of reserves held by the
Federal Reserve Banks declined until
it was perilously close to the legal min­
In this period, what kinds of ap­
preciation and depreciation occurred?
At the end of 1918 a number of the
exchanges were against us, but by
the fall of 1920 all of the leading ex­
changes were in our favor, with the
exception of Hongkong, Shanghai and
Yokohama, and they were rapidly
falling, especially the first two. Ex­
changes that had already been in
our favor were becoming more so.
The American dollar was appreciating
in terms of nearly every other money
in the world, or, to reverse it, those
moneys were depreciating in terms of
our dollar.
Commodities were clearly appreciat­
ing in terms of our own money, the
evidence being the rise of the price
level until well into 1920. Our money
was depreciating in value in terms of
commodities. There was also a tend­
ency toward a depreciation of paper
money (including bank deposits) in
terms of gold. Reserves were declin­
ing and liabilities expanding with a
resultant decline in the percentage of
reserve held. Considerable uncertainty
and doubt appeared, but there was
no actual premium on gold recorded.
There was merely a tendency that
operated as a distinct warning and
that called for corrective action.
The movement was therefore a
mixed one. Our dollar was appre­
ciating in terms of foreign money, but
was depreciating in terms of com­

E xpansion and C ontraction

modities, while our paper money and
our bank deposits were being placed
in a more and more precarious posi­
tion with reference to our standard
money—gold. The exportation of
gold was helping to appreciate our dol­
lar in terms of foreign currencies, but
was imperilling the gold standard at
home by weakening our gold reserves
while bank liabilities were mounting.
C o n d it io n s H in d e r in g R e s e r v e
O f f ic ia l s

In fairness to the Federal Reserve
officials, several facts should be pointed
out. First of all war financing was by
no means over. The Victory notes
were issued in June, 1919, followed
from time to time by large blocks of
certificates of indebtedness. The ac­
tual fighting of the War was over, but
the fiscal operations were not. As
fiscal agents for the government'the
Reserve Banks could not immediately
•free themselves from the responsibilities
that have already been described.
Next it should be remembered that
what occurred in the United States
was in part paralleled in other coun­
tries. Prices were rising in England,
France, Italy, Sweden and elsewhere,
much more rapidly than in the United
States. It is true that many of these
countries were more seriously affected
by the War than we were, but it is
not unfair to urge that many of the
same influences that were operating
abroad were also affecting us. Com­
plete dissociation from so world-wide
a movement could not reasonably
have been expected. The upward
movement which had lifted prices
prior to the signing of the Armistice
was not exhausted, and the rise con­
tinued. Just as military activities
were in evidence for a long time, so
the economic forces set loose between
1914 and 1918 could not suddenly
be reversed.


But this crude analogy between
military and economic facts is apt to
be very misleading* A more satis­
factory explanation is to be found in
the fact that the Federal Reserve
System was (and for that matter still
is) in the first phase of its development.
Some of its most important features
are not yet fully understood even by
many bank officials. Several years
after the organization of the Reserve
Banks a prominent banker who was
serving as director of one of the
twelve institutions was said to be un­
able to grasp some of the fundamentals
of the law, and even today a thorough
comprehension of some of its leading
features is by no means common.
One of the misconceptions that has
persisted is the idea that the System
is to be merely a source of relief in
times of difficulty. That assistance
through rediscounting is needed in
times of seasonal and cyclical strain
is easily understood, but that the Re­
serve Banks should at all times exercise
a supervision over the banking system
and often impose its control is not
fully realized. Even when the pos­
sibility of this control is understood
the result is often intense resentment
at what seems to be unwarranted in­
Such control is, however, the usual
thing abroad, and the Federal Reserve
Act has in it numerous provisions
which give a similar power to our
system. But legislative authorization
is not in itself adequate. The Federal
Reserve Board and the officials of the
twelve Reserve Banks cannot move
too far ahead of public opinion, es­
pecially banking opinion, nor can they
go too violently in opposition to it.
Perhaps the most important single
device by which the Reserve Banks
can control the money market is the
rediscount rate, but the mere state­
ment of that fact does not mean that


T he A nnals of the A merican A cademy

they can freely employ this device.
An important measure of public sup­
port is necessary in case such a power
is actually to be used.
W h y t h e D is c o u n t R a t e W a s N ot
R a is e d

It has been argued that at the close
of active hostilities the Reserve Banks
should have exercised this power by
rapidly raising their rediscount rates
until they were above the rates charged
by member banks to their customers.
There would then have been no gain
to the member banks in rediscounting;
they would have curtailed accommo­
dations to their customers and infla­
tion would have quickly been checked.
The Bank of England thus controls
the money market of England. Why
could not our Reserve Banks do the
same? What reply can be made to
this argument?
Two observations may be made.
First of all, the British method has
been employed for many years, and the
banking community of England is ac­
customed to it, accepting it as a matter
of course. Our Reserve System was
authorized in 1913 and not organized
until 1914, several months after the
Great War had started.
Next, it is to be remembered that
from 1914 to 1918, and especially
during 1917 and 1918, the fiscal policy
of our government made it impossible
to initiate such a policy of control. A
rediscount rate higher than the market
rate, or, at least, one higher than the
rate of interest on Liberty Bonds,
would have made impossible the meth­
ods of financing that were employed.
From 1914 to April, 1917, the Federal
Reserve Bank of New York did suc­
ceed in keeping its discount rate
above that for commercial paper,
thus adhering to the policy of the lead­
ing foreign banks. With the entrance
of the United States into the War,

conditions changed. During 1917 and
1918 the minimum discount rate of
the Bank of England was (as is regularly
true in England) considerably higher
than the market rate on ninety-day
bills in London, but during this period
the discount rate of the New York
Federal Reserve Bank for commercial
paper was regularly lower than the
prevailing market rate in New York
for the same kind of paper. If control
of the market had been the only pur­
pose to be kept in mind during this
period, it would have been wise to
have raised the discount rates of the
Reserve Banks more rapidly than
market rates rose, and thus have es­
tablished control.
Armistice Day found the Reserve
Banks still not in control of the sit­
uation, and able to influence it only to
a minor degree by a scrutiny of par­
ticular paper presented for discount
or by oversight of the rediscounting
done by particular member banks. A
Victory Loan had to be floated, and
other post-war financing was necessary.
Moreover, member banks had dis­
counted large amounts of their own
obligations at the Reserve Banks with
Liberty bonds as security. On No­
vember 15, 1918, the total volume of
bills discounted with the Reserve Banks
secured by government war obligations
was $1,358,416,000, and on February
87, 1920, it was $1,572,980,000.
Difficulties were accordingly very
numerous. To place restraints upon
the expansion from 1918 to 1920 would
have been difficult, and, even if practi­
cable and desirable, would have
called for a very high degree of wisdom
and courage. It is the opinion of the
writer that our government was very
unwise in its decision to float its war
issues of bonds and certificates of in­
debtedness at such low rates of interest.
When so large an amount of saving
was needed much higher rates would

E xpansion and C ontraction

have been better. The low rates
actually offered kept the general se­
curity market quiet for a considerable
time, but such a policy inevitably
meant a rise in prices that injured the
general public, including holders of
securities, far more than would the offer
of higher rates on the new government
issues. Nevertheless, the policy was
adopted, rates were kept down and
the Reserve Banks were and still are
the fiscal agents of the government.
So long as they are fiscal agents the
way in which they perform their other
functions must be affected by this
T h e N e c e s s it y f o r H ig h e r D is ­
count R ate s

By the spring of 1920 conditions
had somewhat altered. The larger
part of war and post-war financing
had been completed, and the re­
sponsibilities of the Reserve Banks to
the government were somewhat les­
sened. A large volume of rediscounts
was still in the possession of the Re­
serve Banks, but more freedom of
movement than before was possible.
Accordingly, their policy was altered.
It was clearly time. A very strong
case could have been developed for
earlier action, but certainly longer de­
lay would have been unwise. Prices
were still rising, discounts with the
Reserve Banks were increasing and
their deposits and their issues of
Federal Reserve notes were mounting
with leaps and bounds. The per­
centage of reserves held was near the
legal minimum. All banking experi­
ence indicated that danger was ahead.
Speculation was rampant, and was
sure to be followed by a reaction whose
seriousness would be proportionate to
the delay in its appearance.
There were several special reasons
for concern. Our own spring demand
for money was at hand, to be followed


the next fall by the usual fall demands
for crop-moving purposes. Also the
situation in Europe was most dis­
quieting. Monetary systems there
were developing alarming tendencies.
Prices were rising, bank liabilities ex­
panding and reserves declining far
more than in the United States. If
a general collapse had occurred we
would have been unable to meet it
without a general breakdown of our
entire business and financial structure.
We were already strained almost to
the breaking point.
Under such circumstances it was
not possible to rely on the judgment
of American business men to impose
checks of their own. A few began
to contract their operations, but the
larger number went on piling up their
own liabilities at the banks and ex­
tending credits abroad and at home
with little or no appreciation of the
unsound condition. Early in 1920
the rates were raised. It was none
too soon. First in Japan and later in
other countries the reaction came and
prices began to crumble.
In the face of this collapse credits
were extended by member banks to
customers, often unwisely, but on the
whole with a view to easing business
through the trying period of the crisis
and the subsequent depression. In
turn the Reserve Banks gave assis­
tance to member banks at the new
and higher rates, but with a very
considerable freedom. After a few
months deposits and note issues began
to decline and reserve percentages to
rise, until a condition of comparative
banking security was attained.
It was, however, a trying experience.
Those who suffered from the fall in
prices resented bitterly the new policy
that seemed to them responsible for
their losses. The sufferers as separate
individuals were not, in most cases,
to blame. They were merely a part

T he A nnals of the American A cademy


of a cumbersome and faulty business
organization in which periods of ex­
cessive expansion and contraction are
a frequent and somewhat regular oc­
currence. In many individual cases
injustice was doubtless done borrowers,
but on the whole our constructive
criticism should be directed at an
economic organization that makes such
an outcome possible.
C a u t io n S t i l l I m p e r a t iv e

Nor is the danger by any means
over. The period ending in 1920 was
one in which money was depreciating
rapidly in terms of commodities, and
our deposits and paper money in danger
of depreciating in terms of gold, as
they have actually done in many other
countries. The danger in these di­
rections has for the present at least
disappeared. But the very policy of
higher discount rates which aided in
giving this relief brought with it cer­
tain unfortunate consequences. To­
day the currency of nearly every
foreign country is at a heavy discount
in New York. Gold was for a time
being exported from the United States,
but from January 1 to November 1,
1921, the net importations of gold
have been about $564,000,000, and
the gold holdings of the Reserve Banks
have increased by about $666,000,000.
This influx of gold, together with a
decrease in deposit and note issue
liabilities, has increased the percentage
of reserves held, and relieved us from
one serious danger—that of a reserve
deficit. But we are at once faced with
another. As reserve ratios rise bor­
rowers cannot understand restraints
on borrowing. Depreciated exchanges
carry no warning to most of us.
Foreign government budgets that fail
to balance and the imminence of de­
faults and perhaps repudiations cause
little alarm. A default by Germany in
her next reparation payment, now

almost due, seems at this writing al­
most certain. If it occurs, the effects
on French finances and business, and
through France on all Europe, will
be almost incalculable in their gravity.
It is a time for the exercise of the
greatest caution. No matter what
policy we adopt, hardships will result.
Our choice is merely between evils,
and no matter what our decision the
path ahead is by no means bright.
Higher discount rates in the face of
the depreciated exchanges means still
heavier gold imports. Withdrawal of
gold from foreign countries weakens
them still more, and adds to our stock
of gold that is already disproportion­
ately large.
On the other hand, low interest
rates encourage an expansion which
ought for our own sakes to be held in
check. High bank reserves are by no
means a sufficient excuse for a generous
loan policy at the present time. A
combination of low rates with a care­
ful limitation of loans is the ideal, but
very difficult of attainment.
Since default by Germany seems so
imminent the sooner it is faced the
better, even if it is disguised as a
moratorium. After it comes there
will be a more general appreciation of
what is ahead, and plans can be more
effectively made for real recovery.
One of our present dangers is the pos­
sibility of developing an unhealthy
optimism that will lead to a business
expansion, too rapid and in wrong
directions. If it occurs, the reaction
will be worse than a prolongation of
the present depression. Gradual re­
covery is trying, but will be far better.
Then, too, we may hope that during
the period of readjustment our Federal
Reserve Bank will be able to secure con­
trol of the money rate. Such a control
will be no panacea, but it will be an im­
portant aid in bringing more stability
in our monetary and banking system.

E xpansion and C ontraction


Expansion and Contraction as Seen by a Business Man

By J. V. F a r w e l l


President, John V. Farwell Company, Chicago

XPANSION and contraction in as when the war purchases were being
volume of business and in credits made, and that prices are going higher.
have always existed in modern times. is this thought that produces his act
Human nature is such and conditions of expansion. This thought and this
of production and consumption are act are often contagious, so that other
such that there can be no dead level. people take up the idea and a feverish
Unfortunately, these tendencies nearly state of mind, like an epidemic, sets in
always run to extremes, so that we among all buyers, which results in
usually have, about once in so often, large purchases for delivery running
periods of over-expansion, and, as a over a long period of time.
consequence, we get over-contraction.
s C u ld
Many bankers will admit the existence How B a n k e rE x p aon sionC h e c k O v e r of the first of these extremes, but they
are not so ready to admit the second. In the distributing business, for
It seems to me that both are very real, instance, such buying requires at the
and that in many cases both of these start very little credit, and necessitates
hardly any simultaneous credit expan­
extremes can be prevented.
As the process of expansion is going sion. The wholesaler might place an
on, each business sees most clearly the order for one thousand cases of cotton
part that applies to its own experience, goods to be delivered during six months,
while the rest of the process is often beginning three to six months after
either unseen or obscure. A business date of purchase, the seller being sold
man, either in manufacturing or distrib­ up until that time. All that the manu­
uting, comes in contact with the proc­ facturer has to do is to cover his cotton
esses of expansion, from the beginning on the cotton exchange and put up a
to the end, from the time when the margin for so doing. The wholesaler
contract is first made to the end when puts up no money at all and no credit.
credit is made for financing and the In fact, no credit would be required
credit given in selling. Over-expansion from the banks for, say, sixty to ninety
is pretty sure to occur whenever such days, when the first shipment of cotton
contract is made for a larger quantity is to be paid for, and no bank credit
than a normal amount used by the asked for by the distributer or whole­
business concern, or when it runs saler for perhaps six months, when the
through a longer period of time in the bill of the first delivery becomes due.
future than is ordinarily contracted It is obvious, therefore, that while
for by the company, or when the con­ the business man sees expansion both
tract is made for a price considerably at time of making the contract and at
in excess of the cost of production.
the time when he asks for credit to pay
The first step in this expansion is his bill, the banker would know noth­
caused, as a rule, by the state of mind ing, except in a general way, of the
of the buyer, who thinks he sees a much great mass of purchases so made until
larger business ahead than the company some time after the contracts were
has ever had before, or who believes signed, and perhaps not until the bills
that goods are going to be very scarce, came due. Bankers are well posted

T he A nnals of the A merican A cademy


in a general way only as to what their
customers are doing or expect to do.
In my judgment, they should always
find out from their customers not only
what their stock on hand is at a given
time, but also what their commitments
or advance purchases are, as these
commitments are often the source of
as great a loss in the case of a falling
market as is stock on hand. If bank­
ers asked these questions continually,
especially at the period of requiring
statements from their customers, they
would be in a better position to check
over-expansion at the start, by either
discouraging purchases or refusing to
give the necessary credit or raising the
rate of interest charged.
If, in turn, the Federal Reserve Banks
were kept in close touch with all these
movements through the leading banks
and merchants, as is now being done
in many centers, this frenzied state of
mind could be cooled off, and large
contracts for future high prices pre­
vented. The disease would be stopped
before it becam e an epidem ic. It is for
this reason that it seems to a business
man that rates of the Federal Reserve
System should be raised just as soon as
bankers see this situation of expanding
contracts coming on, not when the bill
comes due and the customer asks for
credit to pay for it. At that time, the
banker can do only one of three things:
First, grant the credit; second, advise
the customer to repudiate the contract,
which he would do under the circum­
stances, and third, let him squirm out
as best he can, no matter what the loss.
The last course would probably cause
many failures.
F ear

C h e c k s O v e r -E x p a n s io n

Over-expansion can be prevented
only by arousing in the mind of the
buyer a fear that if he makes an exces­
sive contract at high prices, he will get
into trouble. He has been led to think

in a general way that under the Federal
Reserve System his bank would always
look after him and there could be no
trouble. Many told him if a decline
in prices did occur, it would come grad­
ually, even though all history tells us
that over-expansion breaks suddenly
and prices come down sharply. Even
with prices raised to three or four times
above normal, it was often felt that no
merchandising difficulties could arise,
for do we not have the Federal Reserve
Under the old system, before the
Federal Reserve Act was passed, every
bank had to depend to a great extent on
its own resources, and to live or die ac­
cording to the distance it got from shore
in a storm. This restricted the banker’s
available credit and lessened the mer­
chant’s confidence in getting help. Both
banker and business man had a very
well defined fear of over-expanding.
While the Great War was on, and
even after the Federal Reserve Act
was passed, no merchant felt like buy­
ing a large amount of goods at high
prices for long-time future delivery, as
no one could tell when it would be over.
When it was started, some thought it
would last ninety days, some thought
it would last one year, and some two or
three years, but it was all uncertain,
and bankers and merchants stayed
pretty close to shore. They were
assisted in not buying at high prices by
the action of the government in arrang­
ing price fixing bureaus.
When the War did end, there were no
large contracts outstanding at high
prices and it took only three or four
months to make the proper re-adjustments. "After that, however, mer­
chants and bankers lost not only all the
fear which they had had before the
Federal Reserve Act was passed, and
which formerly produced panics, but
also all the fear which existed while the
War was on.

E xpansion and C ontraction
N e e d o p a P r o g r e s s iv e R e d is c o u n t
R ate

As this fear is very necessary to both
banker and business man, I am much in
favor of the progressive rate of redis­
count, so that those who have the dis­
position to offend will know in advance
that they will be heavily penalized. As
the phrase goes, that clause “puts
teeth in the law” and the one who first
over-expands should be bitten first. A
level rate puts all in advance in the
same category and does not stop over­
expansion at the particular source
where it has started. Another reason
why the progressive rate law should
never be repealed is that in many dis­
tricts in the United States 8 per cent
is the normal rate, and 10 per cent not
uncommon. Instead of there being a
penalty in charging such banks 7 per
cent there is a constant inducement
left for them to expand. Federal
Reserve Banks must have a sliding
scale of rates to meet such common
As this over-expansion did not occur
in the case of all banks and in all dis­
tricts, but with only a certain percent­
age of the banks in every district, and
as some large banks in big districts were
just as bad offenders as the small
banks in country places, it seems to me
obvious that such a law is not only wise
but necessary, in order to prevent
over-expansion at the real source
whenever it may crop out.
I n te r e st R ate s On l y On e C h e c k on
O v e r -E x p a n s io n

Perhaps I have laid too much stress
on the efficiency of the rate of interest
to stop over-expansion. It is only
one of the remedies. Bankers them­
selves will have many instances where
they will have to curb banks and mer­
chants who are willing to pay high rates,
if only they are allowed to continue in


their mad careers. Federal Reserve
Banks, more than ever before, will have
to hold a tighter rein to stop such
careers by flatly refusing to make
loans and especially by stating before­
hand that they will so act. Only such
advance information, inspiring the
proper fear, will prevent the first acts
of over-expansion, which, if allowed,
bring all others in their train with all
the consequent disasters.
The solution is in the hands of the
banker. If he will get at the facts and
use his strategic position in granting or
refusing loans and regulating rates of
interest, he could check this over­
expansion before it becomes dangerous.
In saying this, I do not mean that the
banker is as responsible as the business
man in starting over-expansion, for the
business man is the one who acts first.
However, the banker often has a
broader view of general conditions, not
only in this country, but all over the
world, and can, therefore, see the
general trend of things earlier. It is
for this reason that I have at other
times contended that the various
Federal Reserve Banks should have
raised their rate sharply in November
and December, 1919, when the large
buying movement at high prices began.
Instead of doing that, rates then were
as low as 4 | per cent for rediscount
with the Federal Reserve Banks. This
was almost an invitation to buy heavily
and certainly would lead an ordinary
business man to assume there would be
nothing wrong with the credit situation
in the near future.
P r e v e n t io n o f I n v e n t o r y
Sh r in k a g e

The second important process in
general expansion takes place when the
various business concerns find their
excessive bills coming due and are
obliged to resort to banks for large
loans. As these goods have been


T he A nnals of the A merican A cademy

bought in large quantities at high
prices, it takes from two to three times
a normal loan to carry a given amount
of actual merchandise. This is , re­
peated many times all over the country
and all down the line through the
different processes of manufacturing.
The deposits and loans go up and dis­
counts at the Federal Reserve Banks
increase. While tl^is paper so dis­
counted is, in one sense, self-liquidating,
as the term goes, that is only true inso­
far as the prices at which goods are
bought can be maintained.
If prices go down half rather sharply,
as they did in the fall of 1920, it is only
one-half self-liquidating, and if the
quantities bought at the high prices
are far above normal, it may only be
one-fourth self-liquidating, because the
concern which bought the goods has no
normal channels through which the
merchandise can be sold. This brings
upon the market so-called “distressed
merchandise” which is sold regardless
of cost or competition, and aggravates
still further an already disastrous situa­
tion. It is for this reason that the
banker should be somewhat familiar
with the prices at which goods are
bought, as compared with normal prices,
before he encourages a merchant to
buy, or before he gets the whole eco­
nomic structure, including Federal Re­
serve rediscounts, built up on the
basis of high prices.
The Federal Reserve Banks have, in
my opinion, been very unjustly criti­
cised for raising rates above six per
cent, as though the raising of the rates
in the spring of 1920 caused all the
trouble. My only criticism is that
they did not raise them early enough
and before all the harm was done by
the making of the vast amount of long­
term contracts at the highest prices
since the Civil War. They had to
act some time, and it was better late
than never. The inverted pyramid

would have toppled over any way, but
less damage would have been done by
the fall if the base, which was up in the
air, had not been allowed to grow so
P r e v e n t io n


O v e r -C o n t r a c t io n

While nearly every one admits that
over-expansion can be checked, all do
not agree that over-contraction can be
prevented. Many bankers have told
me that we must have a thorough liqui­
dation, which means, in the last analy­
sis, that prices must go below cost of
production, mills close up, business
stop, much of the circulation of credit
and merchandise cease, until this
thorough liquidation has run its course.
Before the days of doctors and the use
of remedial measures, it was undoubt­
edly thought that all epidemics would
have to run their course, that nothing
could be done but let the people die.
In other words, we must have a thor­
ough “ liquidation ” and death of people.
It is well known that a proper mental
condition of the patient is often just as
necessary as some stimulus to help out
the heart action. So in business affairs,
proper mental attitude and some assis­
tance from banks and business men
generally is necessary to prevent con­
traction’s going the limit. I think that
there are often times when it is
evident that contraction has about
reached the end, and when the mer­
cantile speculation fever at least has
gone. At that time interest rates
should be reduced before the irredu­
cible minimum has arrived and some
inducement made for people to go
ahead and do business, so as to bring
about a movement of merchandise and
a better employment of the great army
of unemployed, which always increases
greatly during an aftermath of extreme
The War Finance Corporation has
stepped in and done some of this work

CttmfeNCY E x p a n sio n

during the last nine months with great
judgment and success. It is extremely
fortunate that we had some such or­
ganization to prevent the so-called
complete and disorderly liquidation,
which some interests seemed to think
absolutely essential to better times.
E d u c a t io n t h e R e m e d y f o r O v e r E x p a n s io n a n d O v e r -C o n t r a c t io n

It is evident that the banker and
the business man are in a sense trustees
of the prosperity of the nation, in that
their combined acts, if unchecked, may
bring about hard times and unemploy­
ment to thousands of men who have
no power of decision in starting a
movement which will result so disas­
trously. I say they have no decision
in making the start, although, after it
is about half way along, the wage
earners have much to say when they
begin to buy heavily, and, feeling

a nd

C ontractio n


higher and rising cost of living, begin
to demand more pay, which, in turn,
adds to the price of the manufactured
On the other hand, in times of over­
contraction, the business man and the
banker have often lost their power of
direction and voluntary decision. They
are controlled almost entirely by the
general populace, which refuses to buy,
and by the wage earner, who will not
consent to a reduction of his wages
commensurate with the changed cost
of living and the new world conditions
brought about by the collapse of the
boom. It seems to me, therefore, that
education is needed on both sides, first
to prevent expansion from becoming
over-expansion and contraction from
becoming over-contraction. Sound
common sense and experience will
finally be the teachers if expert econo­
mists are not.

Currency Expansion and Contraction

By James B. F o r g a n


Chairman of the Board, The First National Bank of Chicago

S is well known, the Federal Re­ rency system needed a thorough re­
serve System is the result of the vision. In 1902 Charles N. Fowler,
financial panic of 1907. At least, Charles G. Dawes and Horace White
was this financial crisis that hastened made addresses dealing with the cur­
the establishment of a more rational rency problem at the convention of
system of issuing currency than had the American Bankers Association.
previously prevailed in the United The chief difference of opinion in that
States. To be sure, there had been day was between the advocates of a
earlier movements to make possible highly taxed emergency currency and
an automatic expansion and contrac­ those of a low taxed credit currency,
tion of our currency. As far back as or, as General Dawes spoke of it, “a
1902, and probably earlier, there are system of asset currency subject only
to be found discussions in regard to to a nominal tax.” As a result of this
our currency at every convention of agitation, there was appointed at that
the American Bankers Association. meeting, held in New Orleans, a special
Long before the Federal Reserve Act Currency Committee, a forerunner of
was thought of, it was clear to any the Currency Commission which still
thinking banker that our whole cur­ exists. The Currency Committee ap­


T he A nnals of the A merican A cademy

pointed in 1902 made a report at the
meeting of the American Bankers
Association held in San Francisco in
1903, in which it favored an emergency
circulation subject to a heavy tax,
which, it was hoped, would insure the
redemption of this currency as soon as
the emergency which had called it
forth had passed. Discussions con­
tinued until the agitation finally led
to the appointment by the Association
at its convention in St. Louis, October
16-9, 1906, of the present Currency
Commission, of which Mr. A. B. Hep­
burn of New York has been Chairman
and the writer of this article, ViceChairman, ever since its creation. Its
first report appears (pages 100 and
following) in the Appendix of the Pro­
ceedings of the Thirty-Third Annual
Convention of the American Bankers
Association, held at Atlantic City,
September 24-7, 1907. Practically
everything that now appears in the
Federal Reserve Act was foreshadowed
in the discussions of this Commission.
L e s s o n o f M o n e y P a n ic o f 1907
Probably these discussions would
have continued to be haphazard and
without practical result had it not
been for the financial panic of 1907.
There is no need to go into the history
of this panic in this article. Its in­
terest to us is due to the fact that it
made clear to the public at large what
had long been known to experienced
bankers, that the country was liable
at any moment to suffer all the evils
of business depression, not because
of any inherent difficulties in the busi­
ness situation but owing solely to the
faulty mechanism which prevented
the expansion and contraction of the
circulating media in accordance with
momentary requirements. The panic
of 1907 was due simply to the fact that
the government was unable to issue
a sufficiently large amount of paper

money to tide over a temporary situa­
tion, and, owing to this inability, a
number of banks failed, and perfectly
solvent corporations and business firms
found themselves in financial diffi­
culties without in the least being guilty
of any commercial sins of commission
or omission. The situation had to be
tided over by extra legal methods,
such as the issuance by clearing houses
of certificates which really took the
place of ordinary currency and were,
therefore, a direct violation of the pro­
visions of the Federal Constitution.
A recent writer has summarized the
condition as follows:

The chief defect of the old national bank­
ing system was its decentralization re­
sulting in scattered bank reserves. Even
though the national banks of the United
States possessed enormous aggregate cash
reserves yet, before the establishment of
the Federal Reserve System, those reserves
were ineffective. There was no method
of mobilizing cash for use where and when
it was needed. No responsible body was
empowered to adopt or carry out discount
or other policies to avoid a financial panic
or to handle a panic when it occurred.
Other countries had economic crises; the
United States not only had crises but
financial panics as well. This is the reason
that under the national banking system
the United States was called “an inter­
national financial nuisance/’1

As a result of the experiences of 1907,
public opinion compelled Congress to
take some action, and it appointed
the National Monetary Commission.
Thereafter, the Currency Commission
of the American Bankers Association
acted largely in an advisory capacity
to the governmental body with which
it held frequent conferences in Wash­
ington. Out of this grew, first, the
Aldrich-Vreeland Act, and, later on,
the Federal Reserve Act.
1 Persons, “ Basis fot Credit Expansion.”
Harvard Committee on Economic Research.
Vol. II, p. *1.

C urrency E xpa n sio n
C u r r e n c y F u n c t io n o f R e s e r v e
Sy s t e m

The Federal Reserve Act, in the
first instance, is designed not so much
for the purpose of compelling banks
to keep certain fixed reserves and the
like, as, primarily, to meet the changing
requirements for currency, a function
which the large central banks of
Europe have performed for their re­
spective countries for many decades.
It is difficult to see how we could have
weathered the storm of the War and
the years immediately following with­
out some such arrangement as that
provided by the Federal Reserve
System. It is a well known fact that
the banks have been and are carrying
many industries which would have
been forced to the wall, injuring our
whole credit structure, had it not been
for the fact that the banks in turn
have been able to obtain needed cur­
rency from the Federal Reserve Banks
by rediscounting notes. Since banks
are compelled to meet the demands
made upon them by payment of cur­
rency over their counters, they would
otherwise have reached the end of their
resources almost immediately, owing
to the tremendous expansion of busi­
ness caused by the War. They would,
therefore, in order to meet their own
liabilities, have been compelled to call
upon business houses to pay off their
loans and, if necessary, would have had
to demand the liquidation of perfectly
solvent business enterprises in order
to obtain the needed repayment. The
banks, fortunately for our whole
country, have not needed to resort
to such extreme measures, owing to
the rediscount privileges inaugurated
by the Federal Reserve System, with
which rediscount privileges our cur­
rency system is closely connected.
The Federal Reserve Act provides
that any Federal Reserve Bank may
issue Federal Reserve notes based on


C ontraction


collateral security consisting of notes,
drafts, bills of exchange or acceptances
acquired either by purchase in the
open market or through the rediscount
privileges exercised by its member
banks. The Bank is compelled, in ad­
dition, to maintain reserves of gold
of not less than forty per centum
against its Federal Reserve notes in
actual circulation. This gold reserve
held against Federal Reserve notes may
fall below forty per centum, in which
case “the Federal Reserve Board shall
establish a graduated tax of not more
than one per centum per annum upon
such deficiency until the reserves fall
to thirty-two and one-half per centum,
and when said reserve falls below
thirty-two and one-half per centum,
a tax at the rate increasingly of not less
than one and one-half per centum per
annum upon each two and one-half
per centum or fraction thereof that
such reserve falls below thirty-two and
one-half per centum.” 2
It is interesting to note that practice
has shown that this check provided by
the Act has proved to be entirely
sufficient under the most exacting
and trying conditions. Though there
have been times within the last few
years when the net reserve of gold
against Federal Reserve notes out­
standing was dangerously close to the
legal minimum required, .the ratio
never actually fell below forty per
It is under these provisions that the
so-called expansion and contraction of
our currency has taken place and is
taking place. The total circulation of
currency of all kinds in the country
on September 1,1921, was $4,672,030,221, of which more than one-half
was represented by Federal Reserve
notes. While at the beginning of this
year the total circulation of all cur­
rency amounted to $5,500,702,153, the
2 Federal Reserve Act.

Sec. 11 (c).


T he A nnals of the American A cademy

changes were almost entirely in the item From this it is evident that under
of Federal Reserve notes, since the rest the Federal Reserve Act we have had
of the currency is more or less constant. almost no experience in expansion and
contraction, though more than enough
C u r r e n c y I n f l a t io n a n d
in inflation and, at present, in defla­
D e f l a t io n
tion. In other words, the establish­
Before going further into this ques­ ment of the Federal Reserve System
tion of expansion and contraction of our was followed almost immediately by
currency, it is necessary to distinguish the crisis brought on by the European
sharply between currency expansion War, which, owing to governmental
and currency inflation. A recent article needs, brought about an inflation of
defines these terms as follows:
the currency entirely out of pro­
portion to the ordinary normal busi­
Currency expansion is the absolute in­
crease in currency of various forms—chiefly ness requirements. Likewise, the re­
gold, silver, bank notes, government notes, action that has taken place since last
and deposits subject to check. Its op­ year is a process of deflation, again out
posite is contraction of the currency. of all proportion to what is to be
Currency inflation , on the other hand, is
expected under normal and regular
relative, that is to say, an expansion of business conditions. One thing, how­
currency out o f 'proportion to the increase ever, has been proved, and
in the absolute quantities of goods and the raising and lowering thatthethat
services exchanged, due allowance being discount rates by the Federal Reserve
made for variations in offsets of book credits,
in the “rapidity of circulation” of currency, Banks influences very greatly the lend­
and in the frequency with which goods and ing of money by the banks. The
services are exchanged. The reverse is question may be raised whether this is
currency deflation—a decline in currency not due more to the pressure of the
relative to the amount of goods and services example set by the Federal Reserve
exchanged. Currency inflation rarely takes Banks than to the mere change of a
place in exact proportion to currency ex­ relatively small percentage in the
pansion, or deflation in proportion to con­ rediscount rate. But be that as it may,
traction, since changes in quantities of
country have fol­
goods and services exchanged are constant­ the bankslead thethe Federal Reserve
lowed the
ly taking place. For the same or other
causes, the equivalent of currency inflation System. Possibly it would have been
or deflation, or, one might say, effective well if the raising of the rediscount
currency inflation or deflation, may take rates after the Armistice had taken
place without corresponding changes in place earlier. It is an open secret that
the quantity of currency. So, after the the members of the Federal Reserve
Civil War, deflation in the United States Board, as well as of the Federal Ad­
was accomplished in the main, by “growing visory Council, advocated such a
up to the currency” rather than by con­ policy long before it was put into
traction. On the other hand, changes in effect. The needs of the government,
the currency requirements ordinarily take
place slowly; consequently, a marked ex­ however, intervened, and the necessity
pansion of currency usually involves cur­ for the Treasury to complete its war­
rency inflation; and deflation is usually time funding operations superseded
accomplished but slowly if it is unaccom­ the dictates of a sound economic
panied by contraction of the currency.3
policy. Likewise, the successive low­
ering of the rediscount rate may be due
3 Davis, “ World Currency Expansion.” Har­
more to the exigencies of politics than
vard Committee on Economic Research. Vol.
of sound banking practice. A recent
II, p. 8.

C urrency E xpansion and C ontraction

pamphlet issued by the Chase National
Bank of New York has presented
many effective arguments which tend
to show that the rediscount rates ought
to be determined by the prevailing
commercial paper rate, rather than by
other considerations.
The peak of Federal Reserve notes
in actual circulation was reached on
October 22, 1920, at which time these
amounted to $3,356,199,000. These
notes were first issued in November,
1914, but in the beginning increased
very slowly. Even as late as July 1 ,
1917, the total of Federal Reserve
notes outstanding was only $544,412,775. By July 1,1918, the amount had,
however, more than trebled, amount­
ing at that time to $1,713,074,255. At
the time of the Armistice, the amount
had increased to $2,562,517,000, and
on September 21, of this year, the
amount in circulation was still $2,474,676,000, a reduction, however, of
nearly one billion dollars from the
highest point. It is to be hoped that
this reduction will continue until we
reach a point which may be regarded
as meeting the normal requirements
of business. Until now, banks of the
country have acted in a patriotic man­
ner and have generally forced liquida­
tion. It may be feared, however, that
such an unselfish policy will not be
continued indefinitely if the Federal
Reserve Banks, by keeping the re­
discount rate below the ordinary com­
mercial rate, make it profitable for
their member banks to lend as much
as possible. We therefore face the
danger of a period of renewed inflation
which must not be confounded with
normal expansion as defined above.


contraction of the currency, demanded
by the continuing changes in business
conditions. As the country becomes
more densely settled and industrial
development continues, there will be
need for a gradual permanent expan­
sion of currency which will be met
partly by increase in actual metal,
but largely by the increase in other
forms of currency. Beside such per­
manent increase, there will be the
seasonal expansion and contraction
which appears in the statistics of the
central banks of all the larger coun­
tries. These seasonal changes do not
coincide in the various countries. In
countries with little agriculture, which
are, therefore, compelled to import
most of their raw materials, the time
of largest expansion is apt to fall at a
different time of the year from that
in countries which are solely or very
largely agricultural. We are in a
transition period and what is true to­
day may not be true a few decades
hence. At present, however, our
period of largest expansion is likely
to be at crop-moving time, with con­
traction taking place after the opera­
tions connected with the movement of
the crops have been completed.
Probably for the present, the ex­
periences of Canada are most likely
to furnish us an example. Canada’s
banking system is centered in a group
of so-called chartered banks, of which
there were twenty-four in 1914 and
only eighteen in 1920. These banks
have over four thousand branches
throughout the Dominion, providing
for its commercial needs and, in ad­
dition, serving as the chief savings
institutions of the country. They are
subject to comparatively little govern­
C u r r e n c y E x p a n s io n a n d
mental supervision, although the Cana­
C o n t r a c t io n
dian Bankers’ Association is a public
As already indicated, the real func­ institution whose secretary-treasurer
tion of the Federal Reserve System is has supervisory power over note
to make possible the expansion and issues. The banks are required to

T he A nnals of the American A cademy


make a monthly report of their con­
dition to the minister of finance.

Canada’s currency consists for the most
part of bank notes. The banks are auth­
orized by law to issue notes up to the amount
of their paid-up, unimpaired capital plus
any amount they may have on deposit in
the central gold reserve. In addition to
that, during the crop-moving season they
are permitted to issue additional notes up
to 15 per cent of their capital and surplus
combined, but this additional circulation
bears interest at 5 per cent. The privilege
of issuing additional circulation may be
extended to cover the entire year, and, as
a matter of fact, has been so extended dur­
ing recent years. The chartered banks
are not required to carry any special re­
serves against their circulation, except
that they must deposit with the minister
of finance, gold or Dominion notes up to
5 per cent of their average circulation.
These deposits constitute the bank-note
redemption fund. The principal security
against circulation, however, is found in
the fact that the notes are a first lien on
the banks’ total assets and in the further
fact that the stockholders are subject to
double liability on the notes. Bank notes
are legal tender throughout the Dominion.
It is to the interest of each bank to main­
tain as high a circulation of its own notes
as the law permits. Each bank will, there­
fore, pay its customers over its counter
only notes issued by itself. When the
community’s need for circulation contracts,
notes will be deposited in the banks and
the banks will return to the issuing banks
the notes in their possession, and thus re­
duce the outstanding volume of circulation.
In other words, since the notes are obtain­
able from any bank on demand and on the
other hand can always be deposited with
the banks as soon as they are not needed,
the circulation in the hands of the public
does not exceed the requirements of trade
and industry.4

O H IQC 1 •oo i>
) O
fit H H H I
Q* < * O* < 1 <


Federal Reserve Bulletin.





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The Canadian statistics for the
years immediately preceding the War
and those since the War are given in
next column.



ji S'S «

to & £ S 8


C urrency E xpansion and C ontraction

It will be noticed that the circula­
tion increases very largely in the last
months of each year and decreases at
the beginning of the year. This has
been true even since the War, in spite
of the fact that Canada has had a
period of inflation similar to our own.
It is also interesting to note in this
table that naturally there has been a
very large increase of bank notes since
the War, and that the contraction
which has taken place has by no
means been sufficient to bring the
total back to that of the pre-war
period. Probably this is due in Canada,
as in our own country, to the fact that
part of the apparent inflation is really
a natural expansion due to general
commercial development within the
In the case of the European coun­
tries, on the other hand, the inflation
has been much more severe, culmin­
ating in Austria Hungary, where the
note issues of the central banks in­
creased twenty-fold. Everywhere the
elasticity of the currency provided by
central banking institutions has pre­
vented the most severe financial pan­
ics, though, of course, nowhere could
it prevent commercial crises due to
the general situation.
P r o p e r P o l ic y a s to
R e d is c o u n t R a t e s

To summarize: Bankers have had
too little experience to state definitely
how the expansion and contraction of
the currency under the Federal Re­
serve System is going to work under
normal conditions. The unusual stress
to which the Federal Reserve System
was subjected at the very outset must
make bankers and business men every­
where realize that the System, if prop­
erly managed and kept free from
politics, ought to have no difficulty
whatsoever in functioning satisfacto­


rily during normal and less trying
years. It will be necessary, however,
for the Federal Reserve Banks to
educate the bankers of the country
gradually to a conception that the
Federal Reserve Banks are to be re­
garded strictly, as their name implies,
as a last resort, and that the redis­
count privileges are to be used, there­
fore, sparingly and only in times of
stress and strain. There is a danger
that, owing to the peculiar conditions
under which the System began, its
reserve function may have been for­
gotten. If the Federal Reserve Banks
will have the courage to keep the
rediscount rates above the prevailing
market rate, banks and bankers will
gradually learn to make use of their
rediscount privileges only in case of
real necessity.
This may cut down the large profits
which the Federal Reserve Banks
have earned in recent years but, after
all, the reason for the establishment
of these banks was not to earn money
either for themselves or for the govern­
ment, but to prevent losses to the
business and banking communities of
the country. Every true well-wisher
of the Federal Reserve System will de­
sire that in course of time it limit itself
to the purposes for which it was
created, that it may be kept out of
politics, and that it may not be used
as a panacea for all financial evils
threatening the country as a whole,
or any class or section thereof. Its
real, primary and sole function is,
and ought to be, to provide an elastic
currency which may prevent unneces­
sary financial panics of which we have
experienced too many in the past. As
one who had much to do with the dis­
cussions preceding its creation and
who acted as a fatherly adviser during
the years of its infancy, the writer
expresses the wish: vivat, crescat.floreat.


T he A nnals of the American A cademy

Expansion and Contraction from the Federal Reserve





ic h

Chairman and Federal Reserve Agent, Federal Reserve Bank of Minneapolis

IFwill aidclearly in mind, severaloffacts
in an understanding the

problems which the Federal Reserve
Banks have encountered in attempting
to exercise an appropriate and scientific
control over the expansion and con­
traction of both currency and credit.
The United States is a country of im­
mense extent, of the greatest diversity
in its stages of development, in produc­
tion and in the local availability of
capital and investment funds. It is a
comparatively new country and in the
less developed sections banking is more
of a business than a profession. As a
nation we lack the beneficial influences
of custom, precedent and the fruits of
ancient experience. Instead of a hom­
ogeneous population, we have invited
racial elements from every part of the
earth, who have brought with them
their own peculiar ideas and customs,
all of which must be recognized from
the standpoint of practical banking,
and all of which tend to exert influences
that retard the adoption of uniform
practices and scientific banking meth­
ods. Bank management is of as di­
verse a character as the primary inter­
ests of the various states, and, broadly

speaking, is a matter of adaptability to
circumstances rather than the product
of careful observance of economic law,
sound financial principles and scien­
tific methods. This thought might be
summarized in the statement that
banking is in a highly evolutionary
condition in the United States, and
that for the past ten years the period
has been a transition from a rather
archaic and outworn banking system
to a modern and scientific mechanism,
somewhat broader than banking itself,
that will eventually provide the United
States with the efficient system for
banking, exchange and credit control
which it needs as its equipment for a
proper participation in the financial
activities of the world.
P ow ers

No. of Banks................
Sur. & Undiv. Pf..........
Total Resource.............
Loans & Dis. & Redis. . .
BaJ. due from banks. . . .
Individual deposits . . . .
N ts.& Bills redis...........
Bills payable................

3 ,454,639,000

In F. R. Sys.b

eser ve

S y s t e m L im it e d


Per Cent
Per Cent
Total Out of F. R. Sys. Total

• Comptroller of Currency’s Press Statement, October 31, 1921.
b Federal Reserve Board Report, June 30, 1921.


In the nature of things, the Federal
Reserve System is not all-inclusive.
The System embraces in it only the
national banks of the United States,
although the Federal Reserve Act also
extends liberal privileges to the much
more numerous state banks and trust
companies. In membership,1 the Fed­
eral Reserve System embraces 9,745

1 U. S. Bank Figures— Jnne 30, 1921.




3 4 .2
3 5 .8

Standpoint on E xpansion and C ontraction


institutions out of 30,815 in this coun­
try, or 31.6 per cent. It includes 63.9
per cent of the banking capital of the
United States; 65.8 per cent of the sur­
plus and undivided profits, and it
comprehends 62.2 per cent of the total
resources, and was carrying on June 30
of the present year, 64.2 per cent of the
loans and discounts, including redis­
counts, of the country. It then held a
little more than half of the individual
deposits of the United States. With
two-thirds of the membership and more
than one-third of the resources of the
banks of the country outside of the
system, it is obviously impossible to
expect it to exercise any complete con­
trol over expansion and contraction of
credit. Its power over currency expan­
sion and contraction is limited, due
to the competition of other forms of
money than Federal Reserve and Fed­
eral Reserve Bank notes.2
The rather powerful influence which
the Federal Reserve System exer­
cised during the war period, particu­
larly since the radical advances in com­
modity prices, was fortuitious and
due largely to the fact that under the
country’s pressing need for a sharply
increased volume of currency with
which to handle its current exchanges,
its previously existing and rather in­
flexible issues were submerged to the
extent that the overburden of Federal
Reserve notes and Federal Reserve
Bank notes became the dominating
factor in the currency situation. This

was due to the quick responsiveness of
these notes to any demands for issue
and the fact that they cannot be kept
in circulation except in response to
Another factor of great importance
in connection with the whole question
of expansion and contraction relates to
the actual degree of power which the
Federal Reserve System is able to exer­
cise over its membership. Its powers
are specifically indicated in the law 8and
are in the main of a general and super­
visory character. The law seems to in­
dicate quite clearly what specific rights
a member in the Federal Reserve Sys­
tem enjoys, but limits in quite a distinct
way the power and control over mem­
bers to be exercised either by the Fed­
eral Reserve Banks or the Federal Re­
serve Board. In a certain sense and
considering the subject purely from a
practical standpoint, the real powers
of a Federal Reserve Bank over its
members are indirect and rise out of its
contact and association with members
at times when they are borrowing. It
is difficult to see what very practical
powers a Federal Reserve Bank might
exercise over the non-borrowing ele­
ment in its membership. Every Fed­
eral Reserve Bank has had such an
element of rather substantial propor­
tions throughout the war period. It is
authorized to insist that its members
maintain their capital stock at the
figures fixed by law, that they carry
unimpaired reserves and that they
make appropriate periodic reports. It
2 The Secretary of the Treasury’s Circulation is divested of any power to control the
Statement of October 1, 1921 shows gold coin
policies or loan operations of members
and bullion, $903,163,0 0 0 ; gold certificates, $514,and has no authority whatsoever over
901,0 0 0 ; silver dollars, $75,388,0 0 0 ; silver cer­
the rates charged by a member to its
tificates, $226,610,0 0 0 ; subsidiary silver, $261,customers.
602,00 0 ; treasury notes of 1890, $1,562,00 0;
United States notes, $341,613,00 0; national bank
It naturally has no powers of any
notes, $728,314,0 0 0 ; or a total of $3,053,153,000
as compared with $2,518,963,000 of Federal
Reserve notes and $119,163,000 of Federal Re­
serve Bank notes, or a total of $2,638,126,000 of
Federal Reserve issues.

3 See Section 13 of the Federal Reserve Act.
Powers of Federal Reserve Banks— Section 11.
Powers of the Federal Reserve Board— Section
4 . Corporate powers of Federal Reserve Banks.


T he A nnals of the American A cademy

character over the numerous non­
member banks, except that through
wise leadership it may inspire the de­
sire to conform to sound policies. In
a period of inflation the rapid expan­
sion of member banks’ loans and dis­
counts becomes a matter of first im­
portance. Over such a rising tide of
borrowings the power of a Federal Re­
serve Bank is limited. It can restrict,
or, for cause, it might refuse the appli­
cation of a member to rediscount; but
its ability to control is largely centered
in its position as an adviser in which it
would employ the facts developed by its
examiners and endeavor to create a
clear understanding of all the factors
which the situation might involve. In
this capacity its value would be largely
through wise suggestion and guidance.
There is therefore some question as
to the degree of power to control which
the Federal Reserve System has over
even its own membership. Its real
power, which cannot be denied, lies not
in legal authorization or specific grant
of regulatory authority, but in the
confidence it can inspire because of
sound leadership and the value it can
give to membership because of the busi­
ness advantages flowing therefrom.
An important degree of voluntary coop­
eration has existed and extends far
beyond the confines of its own mem­
bership, due to the enlightened selfinterest of progressive institutions. It
might be said that in a sense the
Federal Reserve System, while it is an
efficient organization, is more like a
voluntary federation of common inter­
ests for their own good.

plished is clearly stated in the law 4 un­
der which each Federal Reserve agent
in each Federal Reserve Bank, with the
approval of the Federal Reserve Board,
is authorized to draw from the Comp­
troller of the Currency and issue to his
Federal Reserve Bank on the presenta­
tion of gold and proper collateral, Fed­
eral Reserve notes for issue to member
banks. Upon the application of a mem­
ber bank in good standing, accom­
panied by a tender of eligible paper for
rediscount and credit, the Federal Re­
serve Bank in practice immediately de­
livers Federal Reserve and Federal
Reserve Bank notes in such amounts
as may be requested. The process of
issue is therefore as nearly automatic
as may be, and is properly founded
upon the assumption that member
banks will not request Federal Reserve
issues unless they need them and that
the necessities of their communities
will rule.
Once issued, the Federal Reserve
note moves through the member bank
into the hands of the public and when
it is no longer needed will find its
way back into a bank. Banks which
have accumulated more currency than
they have use for, will remit to their
correspondents or to their Federal Re­
serve Bank direct. The correspondents
are largely members of the Federal Re­
serve System and the remittance of
their excess accumulations is a matter
of daily routine. Upon receipt by a
Federal Reserve Bank, returned notes
are sorted and under the law must be
shipped at once for credit to the bank
of issue. The particular Federal Re­
serve Bank has therefore no right of
reissue except as to its own notes.
C u r r e n c y E x p a n s io n a n d
Those consigned to other Federal Re­
C o n t r a c t io n
serve Banks will reissue or not as the
Not a great deal need be said of cur­ demand of that Federal Reserve Dis­
rency expansion and contraction as it trict may indicate. If they do not rerelates to Federal Reserve issues. The 4 Federal Reserve Act, Section 1 6 . Note
mechanism by which this is accom­ Issues.

S tandpoint


E x pa n sio n

issue, they are ordinarily returned for
credit to the Federal Reserve agent or
if worn and unfit find their way to
early redemption and destruction. If
fit, they are stored against the next peri­
od of demand. The method of retire­
ment and redemption is therefore quite
as automatic, although somewhat
slower in process, than the method of
issue. There can be no question but
that the mechanism instituted under
the Federal Reserve Act to create flex­
ibility of currency expansion and con­
traction has operated with entire suc­
cess, and that Federal Reserve notes
possess these highly desirable qualities
which were lacking in other currency
issues of this government and in na­
tional bank notes.
The course of Federal Reserve note
issues since late in 1920 has been down­
ward. They reached their peak in
November, when the aggregate issue
was $3,349,000,000, and by October 1 ,
1921, declined to $2,518,963,000. This
recession of $830,496,000 was as sig­
nificant of the power of contraction in­
herent in Federal Reserve notes, as
was the earlier rise indicative of their
responsiveness to the issue demand.
In due time Federal Reserve Bank
notes amounting to $119,163,000 will
be retired. At a later date under pro­
visions of the law, national bank notes
(on October 1 , 1921, amounting to
$728,314,000) will likewise disappear
from circulation. Treasury notes of
1890 are a small factor and their grad­
ual retirement has been provided for
by law. There will remain $341,613,000 of United States notes for which no
retirement provision is included in the
law, and the gold and silver certificates.
It is therefore probable that with the
gradual fall in Federal Reserve issues
there will also be a gradual drift toward
the elimination of competing factors in
the circulation, with the ultimate re­
sult that Federal Reserve notes will


C ontraction


control and currency will at last be
upon a strictly flexible basis and will
have the scientific basis which was
contemplated in drafting the Federal
Reserve Act.
The course of Federal Reserve note
circulation in connection with the price
movement during 1920 was very in­
teresting. United States wholesale
prices, based on the percentage of 1913
average prices,5 reached their high
point of 264 in May of that year.
United States retail prices, based on
the percentage of 1914 average prices,6
held during June and July, 1920, at
their high point of 215. The high point
of Federal Reserve issues was reached
during the last week of October7 and
the first week of November, or sixty
days later than the peak of retail prices
and since that time have steadily de­
clined. The comparative curves tend
to prove the accuracy of the view that
currency expansion was the product
and not the cause of price inflation and
that currency contraction (Federal
Reserve issues being the only issues
having a real flexibility) was the nat­
ural product of the downward turn in
prices. In paying cash for wheat at
country elevators, it obviously takes
more currency to buy wheat at the
high point of more than three dollars
than at the current price of about one
dollar. In the agricultural districts the
natural result is that member banks
will request Federal Reserve notes in
larger volumes during periods of rising
prices and that their use for currency
will fall off sharply on a declining
An important element in maintaining
the flexibility and responsiveness of
Federal Reserve issues to influences
that tend to expand or contract them,
is the fact that in current rediscounting
5 Federal Reserve Board’s Price Index.
6 United States Bureau of Labor Statistics.
7 See Footnote reference on page 178.

T he A nnals of the A merican A cademy


operations the larger part of Federal
Reserve membership wants credit and
not notes. Its demand for notes is
wholly the product of local conditions
and there is no occasion to request cur­
rency shipments unless the local cur­
rency supply is insufficient. Credit at
the Federal Reserve Bank is more
adaptable to its ordinary needs.
It may therefore be said that cur­
rency issues from the standpoint of
the Federal Reserve Bank occasion
practically no concern. They increase
or diminish as the fluctuating condi­
tions of each business day may indi­
cate and their connection with such
conditions is of the most intimate char­
acter. The rise and fall of Federal Re­
serve issues is so nearly automatic that
it requires no extraneous suggestions
or encouragement.

C r e d it E x p a n s io n a n d C o n t r a c t io n

The currency provisions of the Fed­
eral Reserve Act have proved a distinct
achievement in financial legislation.
The expansion and contraction of
credit is not so simple a problem. In
considering it from a Federal Reserve
standpoint the membership figures of
the System become in some respects
more significant than other items of
the consolidated bank statement of the
country. Less than one-third of the
country’s banks are in direct contact
with the twelve Federal Reserve Banks.
Even this one-third may not be as­
sumed to have continuous contact,
since even during the recent period of
very severe credit strain it has con­
tinuously included a substantial non­
borrowing element with which the con­

7 Trend of Wholesale and Retail Prices and Bills Discounted by Federal Reserve System and Fed­
eral Reserve Notes in circulation January, 1920 to September, 1921.

U. S. W
Prices Per Cent
Price {Federal
Reserve Board)


M a y ..................

U. S. Retail Prices
Per Cent of
Average Price
(U. S. Bureau of
Labor Statistics)






Bills Discounted
By Whole F. R.
System on Last
Reported Date in
Month (


Federal Reserve
Notes in Actual
Circulation Whole
F. R. System on
Last Reported
Date in Month
(000*s Om

2 ,801,297

3 ,019,984
3 ,120,138
3 ,203,637
3 ,279,996
3 ,325,538


2 ,930,729
2 ,830,118
2 ,634,475
2 ,457,196

M a y ..................

S t a n d po in t


E x p a n s io n

tact of the Federal Reserve Bank was
of a limited and oftentimes of quite an
indirect character. In this situation
probably lies the seeds of the failure of
the theory that a fluctuating rediscount
rate is an engine for credit control.
Obviously Federal Reserve redis­
count rates can control, if at all, only
such banks as pay them, and such
banks may not confine their borrow­
ings to the Federal Reserve—in fact
they seldom do. The influence of the
rediscount rate must be of an indirect,
and probably of a very tenuous char­
acter as to all non-borrowing banks,
member or non-member alike. In most
of the Federal Reserve Banks there has
been some disappointment at the doubt­
ful effectiveness of the rediscount rate
in periods of rapid expansion of credit.
To the man whose mind is fastened
upon a prospective profit it is alto­
gether improbable that an upward
revision of one-half of 1 per cent in
a rediscount rate which he does not
pay directly, will tend to curb him or
moderate his activities. Over the agri­
cultural portion of the United States
the bank rate of interest is as near to
a stable rate as any example that the
United States affords. In developed
agricultural sections the tendency of
the bank rate is to remain at practi­
cally the same level throughout the year,
and, for that matter, over a period of
years. The same tendency is notice­
able in the less developed agricultural
sections, although the rate levels are
higher, and even where bank rates
reach their highest levels the rate it­
self is subject to comparatively little
Where there are surplus capital and
funds for investment, it is natural that
the importance of agriculture should
be recognized and that ample funds
should translate themselves into fairly
stable and relatively low rates to agri­
cultural borrowers. The reverse, how­


C o ntra ctio n


ever, is not true. In the partially de­
veloped sections of the West it has been
the habitual practice to attract outside
funds by offering attractive rates on
time deposits, which, once established,
have automatically forced up the loan
rate of the bank to its customers.
Rates on time money change very little
in western United States and they, more
than any other factor, dominate and
control the rate which must be charged
to the borrower if the bank is to make a
It would appear that the only points
where the interest rate shows a proper
responsiveness to the rise and fall of
free funds is at the commercial cen­
ters or in the sections which have
attained their development. In the
very large western areas it has been
noticeably true that the rate to the
farmer and stock raiser has changed
but little throughout the entire war
period including the last twenty-two
months of very severe strain on credit.
This applies particularly to the best
names. The availability of credit
fluctuates more than the rate. Such a
condition has not prevailed at the cen­
ters where the rate even to the best
names has fluctuated in accordance
with a changing money market. These
were conditions which the Federal Re­
serve Banks were not called upon to
encounter until after the war period of
artificial prosperity had largely spent
itself. It then became apparent that
they entailed very serious problems,
the gravest of which did not develop
until the sharp fall in prices began to
cause cancellations and extraordinary
inventory losses, and to impair the
credit standing of many responsible
firms. In the stock-growing districts
the market for wool collapsed. Live
stock prices receded sharply. In the
agricultural sections farmers who antic­
ipated a continuance of the extremely
profitable price levels saw corn drop to


T he A nnals of the A merican A cademy

a point where it was more profitable to the financial and business judgment of
burn it than buy coal; and wheat went the country will strongly support the
down to a third of its high war price. policies pursued by the Federal Reserve
Banks when they are properly under­
R e s e r v e B a n k P o l ic y D u r in g
stood. A narrow or hidebound interpre­
B u s in e s s C o n t r a c t io n
tation of the law, irrespective of the very
If every merchant and farmer caught great physical difficulties which must
in the jaws of this distressing situation be encountered in any effort to trace
had been improvident, lacking in fore­ the movement of the proceeds of redis­
sight and not entitled to bank support counts through a large city institution,
and bank credit, the problem might would immediately have meant the
have been easier. It would then have failure of many hundreds of state in­
been simple to say that Mr. Smith and stitutions, a large proportion of which
Mr. Jones had reaped the fruits of their were, under the Federal Reserve Act,
own errors and to have permitted them ineligible for membership because of
to take the usual course through bank­ insufficient capital. The strain upon
ruptcy. The conditions, however, were the Federal Reserve System was severe
somewhat different. While a certain enough and there could have been no
amount of recklessness, extravagance justification for inviting the crisis
and failure to consider the future, which would have been precipitated
doubtless existed, price changes were had the very numerous non-member
so radical as suddenly to cripple and banks lacked a place to go to borrow.
often seriously to embarrass, entirely What happened during the year end­
worthy and reputable commercial, in­ ing April 28,1921, is very interestingly
dustrial and agricultural interests. It shown in a chart prepared under the
was necessary in such cases that the direction of Mr. Benjamin Strong,
banks show no hesitancy in supporting Governor of the Federal Reserve Bank
every worthy borrower to the full ex­ of New York. Classifying all the mem­
bers in the Federal Reserve System by
tent of their power.
It is an interesting fact that this their location in agricultural, semipower to help was, to an extraordinary agricultural, and non-agricultural coun­
extent, based upon the power of the ties, we find that during this period the
Federal Reserve System to extend aggregate deposits of banks in noncredit. Access to the Federal Reserve agricultural counties fell off 4 per cent.
Banks was a right enjoyed, under In semi-agricultural counties the de­
specific provisions of the law, by every crease was 5 per cent; but in the agri­
member bank. There was, however, cultural counties the decrease was 11
no legal bar to loans by city corre­ per cent. As to their aggregate loans,
spondents to non-member country the decrease in non-agricultural coun­
banks, and the immediate result was ties was 6 per cent, and in semi-agri­
that the very heavy rediscounting of cultural and wholly agricultural coun­
banks at the centers was translated ties the decrease was in each case, 1
into equally heavy loans to non-mem­ per cent. In their aggregate borrow­
ber institutions at widely scattered ings from Federal Reserve banks, nonpoints, irrespective of the provision of agricultural counties fell off 29 per cent,
the Federal Reserve Act that denies while semi-agricultural counties re­
the use of the credit facilities of the ceded only 2 per cent and wholly
Federal Reserve System to non-mem­ agricultural counties increased their
bers. There is no question but that borrowings 57 per cent. In aggregate

Standpoint on E xpansion and C ontraction

borrowings from other sources than the
Federal Reserve System, the non-agricultural counties increased 1 per cent;
the semi-agricultural counties, 19 per
cent and the agricultural counties, 66
per cent. It therefore appears that
agriculture, in which is included live
stock, drew down its deposits, failed to
decrease its loans, and in both cases
made extraordinary increases in its
A situation such as this was sure to
produce peculiar problems in a Federal
Reserve Bank. Let us suppose that in
one of these agricultural sections a
member bank had already increased
its loans and discounts to the limit of
safety while carrying reasonable redis­
counts with its Federal Reserve Bank
and substantial bills payable with cor­
respondents. The long delayed liqui­
dation in its territory fails to develop.
Its farmer customers, perhaps five or
six hundred in number, are man and
man alike obliged to pay their debts
contracted on a basis of high wheat
and high corn, with wheat and corn
having an abnormally shrunken mar­
ket. Obviously the bank would fail in
its responsibility to its community if it
arbitrarily refused loans and forced
payment. The facts were that in very
numerous cases the enforcement of
payment was practically an impos­
sibility, since the crops lacked liqui­
dating power. The Federal Reserve
Bank’s problem, therefore, became
broader than that of the bank itself.
It became a problem of carrying
through the farmers or business men
until they could again find a safe
In some sections of the West it
was necessary to continue this policy
through four successive failures of the
crop. The bank’s alternative was to
loan the minimum that was necessary
to enable its customers to weather the
storm or encounter a prompt insol­


vency. Within a very brief period
fifty-three banks in a certain western
state, and numerous banks in the
South and in other portions of the
country, mainly in districts that are
agricultural, went to the wall. In such
an emergency it is fruitless to rely upon
the fluctuations of a discount rate. An
increase of 1 per cent would not de­
ter a bank in very grave difficulties
from presenting eligible paper for
rediscount at a Federal Reserve Bank.
There can be no question of the legal
right of a member in the Federal Re­
serve System to present eligible paper
for rediscount. Upon the presentation
of such paper the problem becomes one
for the executive committee and execu­
tive officers to solve. They must deter­
mine whether in view of all the facts
and circumstances the rediscount of
particular applications is justifiable.
I have indicated that during the recent
abnormal period the justification of re­
discount did not necessarily depend
wholly upon the credit standing of the
applicant or upon the character of the
paper presented. Because of these con­
ditions, which nullify the effect of dis­
count rate changes, it is frequently
necessary to carry a bank beyond what
would ordinarily be considered safe or
prudent limits in order to protect its
depositors and its community and
maintain the stability of the general
banking situation. This has been par­
ticularly true where loans were “ frozen ”
and slow rather than doubtful.
With a clean and reputable member
under capable management in acute
distress and faced with the alternative
of obtaining additional assistance or
closing its doors, there can be no ques­
tion as to what the policy of the Federal
Reserve Bank should be. It is better
to save the reputable banks, assist their
worthy customers, whether business
men or farmers, to weather the storm,
and hope for rehabilitation later, than


T he A nnals of the American A cademy

to take a narrow view and force the
bank to the wall, unsettle public confi­
dence and perhaps precipitate again
such conditions as were a quite familiar
experience prior to the establishment
of the Federal Reserve System.
T h e R e d is c o u n t R a t e
R eg ulato r


C r e d it

Any discussion of credit control at
the present time is necessarily colored
by recent experiences and may perhaps
have a less practical value because of
the abnormal nature of the period from
the beginning of 1920 down to date.
Such a period does, however, carry its
own lessons. One of the most impor­
tant is that dependence upon the dis­
count rate is a fallacy until the discount
rate can be made generally applicable
to the borrowings of all banking insti­
tutions in the country. Pending such
development the real control of credit
in the Federal Reserve System will lie
not in the rate but in the accuracy and
precision of judgment of the boards of
directors, executive committees and
executive officers in each of the Fed­
eral Reserve Banks, with the able lead­
ership and excellent advice which they
have unfailingly received from the
Federal Reserve Board.
To the borrowing individual or bor­
rowing bank, such strain and emer­
gency destroy the effectiveness of con­
trol through the rediscount rate. The
question then becomes one of expedi­
ency and safety and not one involving
scientific application of a theory, which,
while it works well in smaller and
better developed nations, will have a
doubtful practicability in the United
States until it reaches equal develop­
ment and has an equally well-knit
population, properly seasoned by prec­
edent, custom and established rule.
On the other hand, it cannot be
doubted that the existence of a dis­
count rate has been an influence of ex­

ceptional value. Some of the critics of
its result in operation have apparently
overlooked the fact that the Federal
Reserve System during the period of
the War was necessarily dominated by
Treasury policies, and that it did not
have an opportunity to work out a
discount rate policy of its own. Within
a very recent period a certain group of
eastern banks encountering relatively
the same conditions have gone to a
flat 4 | per cent basis. A second group
of banks, between the better developed
East and the partially developed West,
but having much the same problems to
meet, have adopted a 5 per cent basis.
The remaining banks in the undevel­
oped sections have gone to a per
cent basis. We have therefore in the
Federal Reserve System, for the first
time, what is practically a uniform
policy in the fixing of rediscount rates,
and the new rates are as uniform as
may be as to the districts where condi­
tions are similar.
Under normal conditions there
should be a differential between the
developed East and the undeveloped
West. Such a differential cannot al­
ways exist because it will be affected
temporarily by stress and unusual de­
velopments in the money market. It
has the merit of affording guideposts
by which the 30,000 banks in the
United States may judge country-wide
credit conditions, and while their free­
dom and independence in making rates
to their customers is in no wise im­
paired, it will unquestionably prove
that Federal Reserve discount rates
which maintain the proper relation be­
tween the different areas of the United
States and which keep reasonably in
line with their upward or downward
movement, will have a very material
indirect influence. They will probably
tend in the long run to equalize bank
rates in sections where conditions are
similar and to prevent abnormal differ­

P rinciples G overning the D iscount R ate

ences in the customers’ rate in different
sections of the country.
From a practical standpoint the con­
trol of credit is largely a matter of lead­
ership and example. It is becoming
clear that each rediscount application
in a Federal Reserve Bank must receive
a high degree of individual study and
that there must be devoted to it a
specialized judgment which takes full
cognizance of all the facts surrounding
it. In western Reserve Banks, at least,
it is improbable that the conditions of
any two borrowing banks will prove to
be exactly parallel. These differences
must be recognized and as they develop
they call for keen banking judgment
rather than the application of a rule.
In the last analysis the control of credit
through the Federal Reserve System is,
therefore, a matter for the executive
officers and executive committee in each
individual case. They must set up their
own policies, form their own judgments,
and endeavor to hold all applications
from borrowers to proper standards,
which if they are to be valuable must
not be inflexible. From an intimate
viewpoint it is clear that the success


the Federal Reserve Banks have had in
enabling this country to avoid disaster,
while not complete, was still extra­
ordinary and that it had its foundations
not in any question of rate control but
in the application of shrewd and pre­
cise judgment to many thousands of
separate and distinct problems.
In checking expansion, the prompt­
ness and courage of the Federal Re­
serve Banks in taking a stiff stand
against inflation is likely to prove more
efficacious than any decision to ad­
vance the rate, although both actions
must go hand in hand. In reality it
might be said that an advancing or
receding discount rate is of material
advantage as a warning signal but that
the practical work of the Federal Re­
serve Bank is in its executive commit­
tee and that the degree of control which
it exercises, which is necessarily limited
by the insufficiency of its membership,
will be proportionate to the farsighted
vision and courage of the Federal Re­
serve Board, which supervises, and the
executive control in each Federal Re­
serve Bank, to which each problem
must ultimately come for settlement.

Principles Governing the Discount R ate 1

By W. P. G. H


a r d in g

Governor of the Federal Reserve Board

ONTROL over discount rates, as reaching powers ever delegated by
exercised by the Federal Reserve Congress to another instrumentality.
Banks and the Federal Reserve Board, grant ranks with the power given
is one of the most important and far- the Interstate Commerce Commission
to regulate railroad rates. While it
1 Remarks at the opening session of the joint is necessary that powers of this kind
conference of the Federal Reserve Board with
should be vested in a few hands, they
the Federal Reserve Agents and Governors of
should be used with discretion and the
Federal Reserve Banks held at Washington,
D. C., October 25- 28, 1921.
effect of a change in rate should be care­
Because of his official position, Governor
fully considered before the change is
Harding did not feel at liberty to express a per­
sonal opinion. In this paper, however, he
The principle is well established
states the problem as it has been brought before
that in theory the Federal Reserve
Federal Reserve authorities.

T he A nnals of the A merican A cademy
Bank discount rate should be slightly and the volume of reserve money is conse­
in excess of current rates. There has quently increased through a mere increase
been much discussion of the reductions in the deposit liabilities of the Reserve
increase in the volume of
which have been made in discount Bank. With anmember banks, there is an
rates during the last six months and, reserves of tendency to a reduction in the
disregarding the opinions of the preju­ general level of discount rates throughout
diced and the uninformed, let us con­ the country, placing them below the level
sider the conflicting views of some which open market conditions would
whose opinions are worthy of attention otherwise call for and creating a tempta­
and respect.2
tion for the uneconomical use of bank funds.
There is particularly a temptation to use
V ie w s o n R e d is c o u n t R a t e s
bank funds in an excessive degree for
capital purposes, and for the ordinary
A New York banker and an eastern
of the country, misled
economist expressed themselves as banksexcess of liquid cash, toby the arti­
tie up too
great a part of their assets in non-liquid
The basic idea in this policy of keeping form. The Reserve Bank which makes
the rediscount rate above the market is rediscount rates too low, therefore, instead
that Reserve Bank money is for excep­ of performing its function of increasing the
tional and unusual use—that it is not the
of the banking
province of a Reserve Bank to supply a liquidity destroy liquidity. system, tends
rather to
substantial part of the ordinary funds
employed in the market in ordinary times. A Chicago banker reiterates the
Of course, it is expected that a Reserve opinion, expressed by him
Bank shall make money for its stock­ times, that the Federal Reserve several
holders and shall employ such of its funds and the Federal Reserve Board Banks
as may be necessary to meet expenses and
to pay dividends. One provision of the to proceed very slowly in lowering the
Federal Reserve Act, permitting open present rates. He anticipates that
market operations on the part of the Fed­ there is considerable danger, in case
eral Reserve Banks, was designed to give the rates are lowered precipitately, of
them discretion in this matter, whether a renewed inflation, with a consequent
the member banks should rediscount with reaction more violent than that through
them or not. But the position of a Re­ which we are
passing. He
serve Bank is a very peculiar one. If an the view that,nowgeneral, it is a takes
ordinary bank makes a loan, checks come plete mistake to have the rediscount
in against it, as a consequence of the loan,
which it must meet out of its reserve unless rates lower than the prevailing market
it should happen that, simultaneously, new rates for commercial loans, for if banks
deposits are made with it of checks drawn are enabled to rediscount their paper
on other banks. Loans made by a Reserve at a lower rate than they themselves
Bank, however, need not lead to drains on receive, obviously a continued in­
its reserve. When, in making a loan, it flation is profitable to them. His
issues its notes or gives a deposit credit to a opinion coincides with the views of the
rediscounting bank, that note or a trans­
banker and the economist
fer of that deposit credit will be accepted eastern quoted, and he stresses the
as ultimate payment by some other insti­ point that our large gold reserve is,
tution. The deposit liabilities of the Re­
serve Bank count as ultimate reserve after all, due only to the fact that gold
for the other banks of the country, is not being circulated at the present
2 The quotations which follow are from a moment and that much of this gold is
symposium recently published in a financial likely to flow out of the country as
soon as there is a change in the bal­

P rinciples G overning the D iscount R ate

ances of trade. He concurs, also, in
the view that a certain amount of the
gold which the Federal Reserve Banks
have at present is, in a sense, merely
held in trust for Europe. He re­
gards as entirely fallacious the argu­
ment made by adherents of a policy of
lowering rediscount rates that such
action is desirable because the reserve
ratio and gold accumulations of the
Federal Reserve Banks justify a re­
laxation of the official rates.
A Milwaukee banker who contends
that the policy should be in accord
with the money market tendency,
The main point made by those opposed
to the lowering of Federal Reserve discount
rates is that the rediscount rate should al­
ways be above the market rate. This is
laid down as a general principle to which
there are no exceptions. Federal Reserve
funds are only emergency funds, it is said,
and it should not be possible for banks to
make a profit by rediscounting at a lower
rate than the market.
When the demand for credit is excessive
and increasing, the Reserve Banks should
move into a dominating position by raising
their rates above the market rates for
money. But the same necessity for dis­
couraging resort to Federal Reserve Banks
does not exist when the demand for credit
slows down, loans are being paid off and
reserves are accumulating. What has
happened as a result of the recent lowering
of rediscount rates? Has it resulted in an
expansion of loans or reinflation? Not at
all. On the other hand, the published
records show that member banks have
continued to reduce their rediscounts and
borrowings and to do this have brought
pressure upon their customers to liquidate.
Customers who have voluntarily liqui­
dated and got themselves back into good
financial condition are offered lower rates
on new loans. This, of course, is an in­
centive to those who have not done so to
liquidate. This is the practical way in
which the leadership of the Federal Re­
serve Banks in reducing their rates has
worked. There has not been the slightest


tendency toward renewed inflation. Rather
the tendency has been to further liquida­
tion. . . . The general principle of keep­
ing Federal Reserve rediscount rates above
the market rate for money is sound, but it
does admit of exceptions as in the present
condition of things. The present Federal
Reserve policy is in accord with the
tendency of the money market and it is
hard to see how it has had, or will have, any
but a wholesome and constructive effect.
In a recent publication a well-known
banker and economist has asserted that the
best index of the money market in this
country is the rate on line-of-credit loans
to borrowers from two or more banks, and
not the rate on bank acceptances, as in
England. 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 accept­
ance rates. Bank acceptance rates are
fixed in the open market and are pub­
lished. Line-of-credit loans have no open
market and there are no published rates.
Line-of-credit loans are not as competitive
as they may seem. A small firm com­
monly maintains a line of credit only at its
own bank. Large corporations usually
have lines of credit not only with their
home banks but with large banks in finan­
cial 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. The latter rep­
resent the minimum rates for the best class
of paper and, because this is so, they indi­
cate far beyond their actual money volume
the drift of the market. The present rate
on eligible bank acceptances of 5| to 5
per cent is a better indication of what is
taking place and what may be expected in
the open money market than rates on lineof-credit loans which reflect market condi­
tion more slowly.
Another Chicago banker takes an
extremely conservative view. He would
like to see many of the so-called
“war amendments” to the Federal


T he A nnals of the American A cademy

Reserve Act repealed and states that
as the law stands, “nothing but the
courage and wisdom of the manage­
ment prevents it from becoming a
disastrous engine of inflation.” He
objects particularly to the amendment
which forces member banks to carry
their entire lawful reserves in the form
of collected balances with the Federal
Reserve Banks and believes that this
amendment, which he regards as
practically demonetizing gold, is most
dangerous in normal times. Referring
to the complaints which have .been
made that the agricultural districts
have been discriminated against, he
believes that exactly the opposite is
the case and appears to believe, also,
that the Federal Reserve System has
worked a great injury to the country
as well as inestimable benefits. He
In a time of inflation such as we had a
year ago, it nullifies the operation of the
usual normal remedies for such conditions.
If it had not been for the Federal Reserve
Banks, farmers generally would have been
compelled to sell their crops a year ago and
pay their debts. This would have saved
them and the country from the disaster
that has overtaken them. Also, had it
not been for the Federal Reserve Banks,
manufacturers and merchants would have
been unable to accumulate or carry the
heavy inventories entailing losses in a
single year which it will take a generation
to replace.
The solution to this is to keep the
Federal Reserve discount rates above cur­
rent market rates, so that there will be no
temptation on the part of the member
banks to profiteer through the Federal
Reserve Banks. So long as the Federal
Reserve rates are kept below current rates,
there is, in my judgment, no way in
which this kind of inflation can be pre­
vented. On the other hand, if borrowers
compel their banks to rediscount in order
to enable them to carry crops or goods for
higher prices, they are put on notice that
they are acting against the general judg­

ment. In normal times member banks
should understand that they are not ex­
pected to borrow except to meet emer­
gencies, and they should be made to feel
that borrowing at such times is an indica­
tion of weakness and needs explanation.
He expresses the hope that the
Federal Reserve Board will make a
public statement of what its future
policy will be regarding rates and ex­
presses the belief that the confidence
of the country in the Board is such
that any clear statement of funda­
mental principles made by it would be
acquiesced in.
Another New York banker while
convinced that under normal condi­
tions it is logical that the Federal Re­
serve rate should be higher than the
prevailing commercial rate, believes
that in view of the world-wide con­
ditions that exist today, the adoption,
at this time, of artificial means to
accelerate the process of readjustment
would be a dangerous course to pursue.
He states:
Considering the extent to which credit
for speculative purposes has been liqui­
dated, and also taking into consideration
the present reserve and gold position of
the Reserve Banks, it would seem that the
reduction in rate is fully justified. Further­
more, I do not believe the reduction at this
time in the rate will appreciably encour­
age a tendency toward renewed credit
inflation. The question of rates has, on
the whole, been ably and courageously
handled by the Federal Reserve Banks and
the Federal Reserve Board.
He says that if he were to offer a
critical observation,* it would be to
remark upon the “salutary modifica­
tion of the need for deflation that
would have resulted had the high
rates been put into effect in the
spring of 1919 instead of the summer
of 1920.”
A Boston banker takes the view that
the Federal Reserve System was

P rinciples G overning the D iscount R ate

organized for the purpose of furnishing
credit, by means of rediscounting, to
the commercial banks of the country.
He says:
In a general way the time when this
credit is needed is just before, during and
immediately after, a credit crisis, or credit
pinch, and it seems clear that at such time
the rate charged for rediscounting should
be at about the current market rate
charged by the commercial banks to their
customers. To make the rate higher than
the prevailing rate would tend to restrict
the granting of necessary credits to mer­
chants and similar borrowers. To make
the rediscount rate much lower than the
prevailing rate would tend to encourage
over-loaning by the commercial banks. In
fixing the rediscount rates, the managers of
the Federal Reserve Banks should try, as
far as possible, to keep their minds free
from influences other than those which
directly concern the prevailing rates of
money, but they certainly are justified,
when fixing rediscount rate, in being in­
fluenced by motives of the safety of the
Federal Reserve Banks themselves, and
when the rediscounts appear to be ap­
proaching a dangerous total, they should
use their rate-fixing power to check specu­
lation and to prevent any possible danger
to the Federal Reserve Banks, which are
the foundation of our whole banking
system. It was never intended, and never
should be intended, that the Federal
Reserve Banks consciously use their
power and authority either to encourage
or to discourage business. Their chief
purpose should be to assist commercial
banks and to fix the rates of rediscount so
as to best accomplish this, and at the
same time to protect their own position
from any possible overstrain.
He regards as one of the greatest
dangers to which the Federal Reserve
System can be subjected, the attacks
and manoeuverings of politicians to
make the System serve political ends.
Another leading banker does not
believe that the time has yet arrived
when discount rates should be held up


to a point above the rates for com­
mercial paper because the conditions
of business are not yet on a normal
basis. Ee says that it has been the
habit of commercial bankers to argue
with their commercial customers that
the rate to their customers is based on
the Federal Reserve Bank discount
rate and that it should be enough
higher than the discount rate so that
there would be a profit to the banker
between the discount rate and his
rate to his customers. He says further:
There is yet in our banks a large amount
of so-called frozen loans which may be
described as loans which are probably
good but which the borrowers are not in a
position to pay off at the present time.
Therefore, they are not in a position to
trade on market rates on an even basis
with the banker. Under these conditions,
a high discount rate of the Federal Reserve
Banks simply has helped the commercial
banker to get higher rates from his cus­
tomers than are justified by the conditions
of credit. Therefore, it was desirable and
necessary for the Federal Reserve Banks to
reduce their discount rates from 6 or 7 per
cent to
per cent in order to inform
the commercial community that the
credit situation no longer demanded these
high rates.
He takes the view that “ Federal
Reserve Bank discount rates should
not be made with the idea of con­
trolling business or market prices of
commodities,” but that “they should
be indications of the effect that the
present business is having on the sup­
ply of credit and of anticipated condi­
tions that will affect the supply of
credit in the near future.” He be­
lieves that “when the business com­
munity has become trained to the
point of watching the reserve position
and discount rates of the Federal
Reserve Banks and has come to an
understanding of what these figures
mean, it will be helped very much


T he A nnals of the American A cademy

by studying the published conditions
of the Federal Reserve Banks and will
appreciate what a change in discount
rates means, provided of course that
the officers and directors of the
Federal Reserve Banks are not ham­
pered in using their judgment in these
matters by outside influences.”
A Chicago merchant notes the dif­
ference of opinion among experts as to
the proper time for raising or lowering
the Federal Reserve rediscount rates.
He points out that neither the Federal
Reserve System nor any part of it can
be run on any formula, and that if it
could, very little brains would be re­
quired for that part after the formula
had been found. He believes:
If we are to be a world power in com­
merce, as we may be, we shall have to
make the New York, or some other district
rate attractive for the discount of the
world’s import and export bills. We
might, of course, be above the English
rate for a short time, for adjustment or
other purposes, but if we make a rule to
have the rate always above the commercial
paper rate in New York, our ambition to be
the world’s bankers, or to compete with
England in commerce and finance, will
vanish into thin air.
He takes the view that in crises and
extraordinary emergencies a Reserve
Bank may well be justified in violating
temporarily the ordinary canons of
sound finance, but emphasizes the fact
that under normal conditions and
under conditions when it is possible to
take a long-run view, the well estab­
lished traditions covering a Reserve
Bank’s operations must be followed.
The chief of these canons is that the
rediscount rate of Reserve Banks
should be kept above the market.

bear a direct relation to a Federal Re­
serve Bank’s reserve and to the general
money market, and that, in addition,
consideration should be given to the
items enumerated in the Council’s
recommendation of May 17, 1921, as
1. The reserves of the Federal Reserve
System as a whole.
2. The reserve position of the Federal
Reserve Bank whose rate it is contem­
plated to change.
3. The condition of all the banks of the
country as a whole, and of the several
Federal Reserve districts.
4. The economic and financial condition
of this country.
5. World conditions, both economic and
6. The eventual establishment of a
credit rate policy for the Federal Reserve
Banks by which the rediscount rate to
member banks is higher than the prevailing
commercial rate, taking due consideration
of the prevailing open-market rates for
various classes of loans both in this coun­
try and abroad.
7. Uniformity of rates, while at times
practicable and desirable, should not be
adopted as a fixed policy, the System being
predicated upon the principle that varying
conditions might exist in different sections
of the country.
With reference to the general money
market, the following factors were
suggested by the Board as those which
should be considered in arriving at a
conclusion as to what is the current
rate for money:
1. Rates charged by banks to their reg­
ular customers.
2. Rates for one-name paper bought
through note brokers.
3. Open market rates on bankers’ ac­
4. Rates on Treasury certificates.
R e c o m m e n d a t io n o f A d v i s o r y
C o u n c il
The Board asked the Council for its
The Federal Advisory Council, at views as to the relative importance of
its last meeting on September 20, 1921, each of these factors and the Council
expressed its belief that rates should expressed the view that all four items

P rinciples G overning the D iscount R ate

mentioned are important in determin­
ing the money market but there may
be other factors which should likewise
be given consideration, such as general
business conditions and the reserve
position of a Federal Reserve Bank.
It was the view of the Council that
the ruling rate for money in a district
will adjust itself automatically to these
conditions. The Council expressed
the view, also, that a Federal Reserve
Bank while it is borrowing should not
lower its rate, but stated that special
conditions might exist in a district
which would make a reduction de­
sirable and would justify such a
R e d is c o u n t P r o b l e m C o n f r o n t in g
th e B oard

It seems clear to the Board that it is
not practicable in this country for
Federal Reserve Banks to maintain
rates of discount higher than current
market rates if line-of-credit loans are
to be accepted as the criterion. The
rates of interest permitted in many
states are so high as to preclude this
as a possibility. In ordinary circum­
stances when the credit risk is at a
minimum the rates paid for high
grade commercial paper sold in the
open market may be regarded as a
measure of the market rate for money,
but it is evident that at present there
is much consideration to be given to
the basis on which short time obliga­
tions of the Treasury are sold and to
market rates for prime bankers’ ac­
ceptances. The problem, therefore,
is more simple at this time in districts
like New York, Chicago and Phila­
delphia, where the Federal Reserve


cities are dominant in their districts;
but in other districts which cover a
larger territory and where the busi-"
ness is more distributed and diversified,
the problem is more difficult. At the
present time, four Federal Reserve
Banks are rediscounting about $45,000,000 with three other Federal Re­
serve Banks. The directors of one of
these borrowing banks more than a
month ago voted to reduce their dis­
count rate from 6 per cent to 5| per
cent on all classes of paper, but the
Federal Reserve Board has not yet
approved the reduction. No evidence
has been presented to show that cur­
rent rates for bank accommodations
are less than the Federal Reserve Bank
rate, or that current rates would be
reduced by lowering the Reserve Bank
rate, but the directors argue that the
consolidated reserve position of the
System justifies a lower rate.
The Board has been inclined to the
view that the reserve percentage of
each Federal Reserve Bank, as well as
that of the System, should be taken
into consideration as one of the de­
termining factors in fixing the discount
rate. If the Federal Reserve Bank of
Chicago, with a reserve of around 70
per cent and the Federal Reserve Bank
of St. Louis, with a reserve of 63 per
cent do not feel justified in reducing
their discount rates below the present
level of 6 per cent, what argument is
there for a borrowing bank, like
Atlanta, having a reserve without re­
discounts of only 3 2 per cent, to have
per cent rate? On the other
hand, what are the arguments against
a reduction in districts which have so
high a percentage of reserve?


T he A nnals of the American A cademy

Rediscount Rates, Bank Rates and Business Activity

By G e o r g e M. R e y n o l d s
Chairman of the Board, Continental and Commercial National Bank of Chicago
HE problem of greatest interest England and America are so different
and importance now confronting that the British rule as to the bank
the Federal Reserve Banks, the com­ contains little of value except for
mercial banks and the business world, suggestion, and even this little de­
is the rediscount rate and its effect on creases as the banking and commercial
paper customs of the two countries are
or relation to business activity.
The simple answer to the question contrasted. In the United States, for
whether the rediscount rate of the instance, the Reserve Banks have no
Reserve Banks should be higher or direct relations with the public and
lower than the rate charged by com­ receive deposits only from banks and
mercial banks—whether this means the government. In this country the
the line-of-credit rate, over-the-coun­ “open market” has few points in
ter rate or commercial paper rate is common with the English bill market.
not clearly defined—is that the re­ In the United States there are over
30,000 independent banks scattered
discount rate should be higher.
This answer seems to flow readily through a vast territory whose activi­
from British practice and recent ties are tremendously varied, instead of
American experience. But the eco­ a few banks with thousands of branches
nomic situation, at home and abroad, serving a country of high industrial and
is not so simple as to permit this commercial development.
offhand and categorical answer. Amer­ The view is often expressed that the
ican experience under the Reserve rediscount rate should be invariably
System has not been sufficient for the higher than the market rate—usually
dogmatic statement of a formula for meaning the prevailing rate for com­
the future. The Reserve System has mercial paper—because the Reserve
not functioned to any extent under Banks are, after all, reserve banks and
conditions it was designed to meet; it should be called on for rediscounts only
has faced chiefly the very unusual when the bank desiring to borrow is
conditions which attended the prosecu­ under strain. There can be no disagree­
tion of war and the uncertainties and ment about the desirability of the
abnormalities that followed. At this increase in rediscount rates when busi­
time it seems impossible to do much ness expansion needs to be checked, and
more than state the problem as it is there may be reason for keeping them
made out of and affected by a great regularly higher than the market rate.
variety of elements. The ascertainment It must not be forgotten that, what­
of these elements involves investiga­ ever the Reserve Banks may be in law,
tion of business customs, bank habits, in fact, they are regarded no less by
government operations and, perhaps, bankers than by business men and the
the psychological influence of public public as a kind of financial hospital to
which all classes may go to have their
It is hardly possible to base any rule wounds treated, regardless of the
of future action in regard to rediscount causes of the wounds. The banker, and
rates on experience as gained by the the business man through his banker,
Bank of England. Conditions in wishes the same treatment whether he


R ediscount R ates , B ank R ates and B usiness

has been hurt through his own dere­
lictions or through a conjunction of
economic causes, unforeseeable and
uncontrollable. But the determination
of a rediscount policy for the future
calls for close analysis.
Influences T hat H ave A ffected
R e d is c o u n t R a t e s

Since the depression following the
War the factors influencing rediscount
rates have been given serious consider­
ation. At its meeting in September,
1921, the Federal Advisory Council
expressed the view that rediscount
rates should bear a direct relation to a
Federal Reserve Bank’s reserve and
to the general money market, and that,
in addition, consideration should be
given to the items enumerated in the
Council’s recommendation of May 17,
1921, as follows:
1. The reserves of the Federal Reserve
System as a whole.
2. The reserve position of the Federal
Reserve Bank whose rate it is contemplated
to change.
3. The condition of all the banks of the
country as a whole, and of the several
Federal Reserve districts.
4. The economic and financial condition
of the country.
5. World conditions, both economic and
6. The eventual establishment of a
credit rate policy for the Federal Reserve
Banks by which the rediscount rate to
member banks is higher than the prevailing
commercial rate, taking due consideration
of the prevailing open-market rates for
various classes of loans both in this country
and abroad.
7. Uniformity of rates, while at times
practicable and desirable, should not be
adopted as a fixed policy, the System being
predicated upon the principle that varying
conditions might exist in different sections
of the country.
It was further suggested that with
reference to the general money market


the following factors should be con­
sidered in arriving at a conclusion as to
what is the current rate for money:
1. Rates charged by banks to their
general customers.
2. Rates for one-name paper bought
through note brokers.
3. Open-market rates on bankers’
4. Rates on Treasury certificates.
This series of rules is apparently
given potentially. What have been
the determining factors in fixing
rediscount rates heretofore seem
nowhere to have been given in a
similar summation. In the first year
or two of the Reserve Banks’ opera­
tions little attention was given to the
rediscount rate. Money was plentiful
and there was little rediscounting. The
War and its demands brought a change.
It is no secret that government
financing took precedence over every­
thing else. The rediscount rate, re­
gardless of any influence it might have
on business, was adjusted so that the
purchasers or holders of war bonds
would receive preferential treatment.
Otherwise, it is doubtful, with adher­
ence to the Reserve Banks as the
instruments whereby credit was to be
made available for war purposes, if the
war bonds could have been success­
fully sold at the rates they bore. It
was when this need became apparent
that the rate was placed at a low
point. Business was, of course, a
beneficiary. There was no departure
from this policy during the War nor,
as is often pointed out, until some
time after the Armistice.
On pages 62 and 63 of the hearings
entitled “Reviving the Activities of
the War Finance Corporation,” will
be found the following by Governor
The Federal Reserve Board adopted a
policy in order to assist in the war financing


T he A nnals of the A merican A cademy

which was economically unsound. I say
this frankly. Congress authorized certain
loans. It authorized the Secretary of the
Treasury to determine the rates at which
the loans should be issued. The Secretary
of the Treasury asked the advice of ex­
perts and then fixed the rates of interest to
be borne by the several issues of bonds,
notes, and certificates. During the time
we were actually at war, something like
$18,000,000,000 of bonds were sold to the
people, an amount certainly in excess of the
normal investment power of the American
people in such a short time, and the only
way in which those loans could be financed
was through the instrumentality of the
banks. The only way the banks could
undertake to do it was to get some assis­
tance from the Federal Reserve Banks and
at a low rate. The low rate of interest
borne by these bonds was fixed with a view
of holding down the expenses of the
government as far as possible. Anyway,
that is something the Federal Reserve
Board has no responsibility for. In order
to make possible the floating of these bonds
we fixed a rate less than their coupon rate.
Some member banks announced that for a
period of six months there would be a rate
of 4 Per cent on notes secured by govern­
ment obligations. The result was that
there was no loss to subscribing banks
pending the distribution of the bonds to the
public. There were successive bond issues.
The principal reason why discount rates
were not increased earlier than they were in
1919 was on account of Treasury financing.
Thus it appears that government
financing and the desire to have war
bonds bear low rates of interest were
the determining factors until disaster
was scented in 1919. Then present and
impending troubles dictated the in­
crease of rates, which was belated.
It was some time before this increase
that liquidation began. It was a
considerable time afterward that defla­
tion became a visible reality. It may
be said only with diffidence that the
increased rates had anything more
than a moral effect. Members of the
Reserve Board said repeatedly, and

cited figures to show, that the peak of
credit and currency expansion was
reached some months after higher
rates were made effective. This in­
dicates either that business had such
an impetus that rediscount rates had
no effect in stopping it, or, if they had
any effect, considerable time was re­
quired to make it apparent. If this
experience is to be taken as a demon­
stration of the efficiency of an increased
rediscount rate to stay business activ­
ity, it must also be taken as a first
indication of the time relation between
an advance or change of rate and
business operations.
But whether the high rediscount
rate did or did not halt business and
force deflation and liquidation, or
whether business toppled over for
other reasons, there is no doubt that it
toppled. Gradually the credit situa­
tion cleared and is still clearing.
Coincident therewith further study of
the rediscount rate and its influence
and effect began. As the reserve per­
centages of the Reserve Banks began
to mount, the demand for lowering of
the rates became more and more in­
sistent. The increase of reserves was
not, however, due entirely to liquida­
tion. The flow of gold from abroad
was steady, and became a very im­
portant, if not the most important,
factor in building reserves up to a high
point. It must also be noted that the
rates charged by commercial banks
did not go down either simultaneously
with those of the Reserve Banks, or
proportionately to them. Commercial
banks were affected only indirectly by
the great inflow of gold. It required
liquidation by business to permit them
to build up their reserves and pay off
their debts to the Reserve Banks.
This would seem to show that re­
discount rates were fixed with no
consideration of the rates charged by
the commercial banks. The assump-

R ediscount R ates , B ank R ates and B usiness

tion of a causal relationship between
the two, therefore, remains to be
proved by the presentation of evidence
that the experiences of the past two
years does not offer.
T h e T im e R e l a t io n s h ip B e t w e e n
B u s i n e s s C o m m it m e n t s a n d
B o r r o w in g

If no relationship, or one that is
indirect or nebulous, exists between
rediscount rates and commercial bank
rates, it becomes apparent that there
can be no relationship, or, at least only
a very remote one, between rediscount
rates and business activity; it is the
commercial bank rate that business
pays, not the rediscount rate.
For present purposes, then, the
question may be stripped down to the
time relationship between the redis­
count rate and the commercial bank
rate, between the commercial bank
rate and business activity, and then
between the rediscount rate and the
latter. For the present, also, it will be
necessary to ignore the manifest in­
fluence of remote and indirect causes.
In a business scheme so intricate as
that of the world today, it would be
hazardous to be dogmatic about such
relationships. The problem is, how­
ever, to determine, if possible, the
more immediate relationships—the
causes which act and react on one
another so as to permit the application
of direct evidence. It is pertinent here
to note, for instance, that there are
some thousands of banks which are
not members of the Reserve System;
that each operating bank is an inde­
pendent entity, subscribing to no
rules as to interest charges and often
getting “all the traffic will bear”;
that loan risks vary with classes of
business and in different districts, and
that the demand for capital forces
new and undeveloped sections to bid
high in order to attract funds. It is


probably only in the large centers and
well developed industrial districts that
money rates are subject to the con­
trolling influence of reserve condition,
supply and demand, gold imports, etc.
To get at the time relationship
between business activity and bor­
rowing, it is permissible to take for
example the customary operations of
a merchant or manufacturer. It is
common knowledge that his interest
in the present state of all business and
of his own business is shared with his
concern for what the future holds. He
plans and manufactures and buys for
a coming season. No matter how
active present operations, the future
concerns him as much. He may or
may not sound out his banker as to his
coming financial needs. Whether he
does or not, he makes contracts and
commitments for a coming season. If
the banker has committed himself in
such cases, he will to some extent have
foreknowledge of the demand to be
made upon him. But often, if not
usually, he may be wholly unaware of
what his customer contemplates. Busi­
ness men will not arrange in advance
for credit unless they foresee the im­
possibility of meeting their obligations
out of current resources. If they have
a line of credit, they will not indicate
their intention to use it at a particular
time or during a particular season
unless it promises to be insufficient for
their prospective needs. Nor will the
member bank signify its intention to
rediscount in the future.
In such circumstances the business
world, each unit operating by itself,
may be building the foundation of a
credit structure in the autumn; the
commercial banks may" not be called
on for loans until spring and it may be
midsummer before the contracts and
commitments made months before are
reflected by a demand for rediscounts
at the Federal Reserve Banks. How


T he A nnals of the A merican A cademy

is a rediscount rate going to meet an
over-extended condition, in the sum­
mer, which was produced by opera­
tions begun and completed many
months before?
Commercial bank officials and those
of Reserve Banks, also, study business
conditions constantly. Many of them
have information and statistical or­
ganizations. They gather the best
statistical evidence they can, but the
Reserve Bank officers have no privity
of interest and no intimacy of relation­
ship with business men. Even with
superior advantages in this respect,
officers of member banks cannot an­
ticipate conditions except in a very
general way. One banker might be
alarmed at the prospect of a large
demand for loans and his competing
neighbor have no evidence of such
impending events at all.
It is such conditions that call into
play the highest banking skill and judg­
ment. Such conditions demand of the
banker a prescience which can come
only from such a familiarity with busi­
ness that he feels rather than knows
what is before him. In making his halfintuitional estimates he will, of course,
take account of the fact that the
Reserve Bank is ready at hand if there
is need. He will take care of his
customers and try to adjust his rates
to competitive conditions. His con­
clusive “no” will send potential bor­
rowers to other banks, to the levelling
of the business of all of them and a
fairly accurate adjustment of interest
rates. But, dealing only with banks,
Federal Reserve officials will have an
imperfect knowledge of these condi­
tions. And yet upon them rests the
obligation of leadership in checking or
stimulating business by a proper
adjustment of the rediscount rate, if
the rediscount rate can do it.
It seems fair to say that while an
effort may have been made or is being

made to adjust rediscount rates on the
basis of ascertained future business
operations, the probability is that the
rate has been fixed only in relation to
what is or what has been, so far as it
has been fixed at all in relation to
business activity.
C o n c l u s io n s

The import of this article has been:
1. That rediscount rates cannot be fixed
on the basis of British experience.
2. The opinion that rediscount rates
should be higher than commercial bank
rates is based on experience during war
conditions and business contraction which
may not be a sufficient guide for the
3. Rediscount rates have heretofore been
fixed chiefly by consideration of factors
other than their possible effect on business
4. Rediscount rates can affect business
activity only through bank rates which
bank customers must pay.
5. Bank rates are not only different in
different sections, but are determined by
present conditions, whereas business com­
mitments are made for the future.
6. To influence business activity, bank
rates would have to be determined in
relation to the future commitments of
customers and the rediscount rate would
have to be in correspondence with the bank
rate, both as to amount and time.
7. It is the knowledge and judgment of
bank officers and reserve officers on which
reliance must be placed for the control of
business conditions through credit.
8. Insofar as the rediscount rate can
affect business activity, it must be deter­
mined far in advance if it is to have any
appreciable effect.
There has been no disagreement
among bankers as to the necessity for
raising the rediscount rate when the
need of checking business activity was
certain. If recent conditions gave
promise of permanency, there could be
no question as to the desirability of
having rediscount rates always higher
than bank rates. On the basis of

T heoretical C onsiderations on B ank C redit

actual recent experience only one
policy has been warranted. But as to
a policy to control in the future,
further experience must be the guide.
In any event, changes in rediscount


rates must be made well in advance of
foreseeable changes in business activity,
if the rates are to be used for the
purpose they are commonly supposed
to serve.

Theoretical Considerations Bearing on the Control of
Bank Credit Under the Operation of the
Federal Reserve System



C h e s te r


P h illip s

University of Iowa

HE most important change in our money in their tills. But the swelling
banking machinery entailed by the of pocket and till money involved a
withdrawal of cash from the commer­
Federal Reserve Act as bearing upon
the question of the expansion and cial banks. As money left the banks,
contraction of our circulating media is their lending power was curtailed, and
the introduction of compulsory bank­ expansion of credits and rising prices
ers’ banking. The essence of bankers’ were brought to a halt.
banking in the United States is the Under the operation of the Federal
reserve dependence of the commercial Reserve Act an expansion of loans and
banks upon the regional institutions. a consequent expansion of deposits,
The deposits on the books of the re­ accompanied by rising prices and ex­
gional banks are the reserves of the panding physical volume of trade, also
commercial banks. Inasmuch as the impel men to carry more “money” in
deposits of the regional banks are their pockets and merchants, more in
themselves expansible and contractile, their tills. Since 1914, however, the
the deposits of member banks, which demand for additional pocket and till
would be elastic even if their reserve money has been met by the issue of
foundation were inelastic, now have 'promises of the Federal Reserve Banks
an elasticity raised to the second to pay money. Lawful money is no
longer lost by commercial banks. In­
Moreover, the elasticity of both the stead it is held by the Federal Reserve
deposits of the regional banks and of Banks as a foundation on which is
the members are buttressed and sup­ reared a three-fold credit structure: (1)
ported by the Federal Reserve note- deposits of Federal Reserve Banks;
issue provisions. Under the old na­ (2) deposits of member banks and (3)
tional banking system an expansion of Federal Reserve notes.
loans and a consequent expansion of The control of credit under our
deposits in the banking system was Federal Reserve System, therefore,
ordinarily accompanied by a rising becomes a matter of greater impor­
physical volume of trade and rising tance than under the old regime.
prices. The growth in business trans­ Formerly an automatic check was
actions, coupled with higher prices, imposed on credit expansion before
impelled men to carry more money in extreme limits were reached. Today,
their pockets and merchants more in the absence of that automatic check,


T he A nnals of the A merican A cademy

we are to depend upon regulation of the to the bank in question, would be paid
rediscount rate as a chief means of in cash or its equivalent. It is true
that some of the checks drawn by
borrowers would be sent to creditors
A M em ber B an k C annot M ake
who were depositors in the drawers’
M a n if o l d L o a n s
bank; in that event there would be no
Now the effectiveness of the redis­ immediate corresponding loss of cash
count rate as an instrument of con­ by the lending of the bank. It is also
trolling bank loans and, therefore, true that some borrowers would not
deposits, hinges on the relation between withdraw all the funds borrowed. If
the amount borrowed by a member due allowance is made for these two
bank and the amount that the same considerations, we may conclude that
bank is able to lend as a result. If a for every dollar that a typical Ameri­
member bank is able to lend five dol­ can bank lends, it loses not less than
lars on the basis of one dollar bor­ eighty cents through direct cash with­
rowed, it is evident that the borrowing drawals by borrowers and through
bank would be willing and able ordi­ unfavorable clearing balances.1 In
narily to pay more than 4 or 6 per cent other words, the typical banker is able
for borrowed funds. On the other to lend approximately $1.25 for each
hand, if the borrowing bank is able to $1.00 borrowed. It follows that redis­
lend only dollar for dollar on the basis count rates roughly equal to the
of borrowed funds, that bank will not market rates (if the expense of carrying
ordinarily pay a higher rate of redis­ on the banking business is consid­
count than it receives at its counter. ered) will ordinarily be sufficiently
What are the facts at this point?
high to serve as a check on borrowing
It would at first appear that a bor­ by member banks.
rowing bank would be able to make
B orrow ed R e se r v e S u ppo r ts
manifold loans on the basis of borrowed
M a n if o l d L o a n s i n t h e
reserve. Does not the balance sheet
B a n k in g S y st e m
of a typical national bank show loans
(and deposits) equal to several times It may be added that borrowed
its reserve? If reserves of $100,000 reserve normally does become the
support loans of $1,000,000 (and depos­ foundation of manifold loans in the
its of the same approximate amount), banking system. Bank A borrows $100,would not the acquisition of additional 000 from the Federal Reserve Bank
reserves of $100,000 enable the bank to and in turn lends $ 125,000, more or
less, to customers. The borrowing
support total loans of $2,000,000?
Normally, the bank that attempted customers draw checks against their
to increase its loans by $1,000,000 on replenished balances and those checks
the basis of $100,000 new reserve are remitted to creditors. The credi­
would quickly be face to face with the tors deposit the checks in their own
problem of how to meet unfavorable banks. When the checks are cleared
clearing balances of large proportions. and collected, not only will the drawee
The borrowers of the $1,000,000, bank lose approximately $100,000 but
leaving the proceeds of their loans on other banks—banks B, we may say for
deposit, would draw checks against 1For a more
their bank balances for most of the tailed statementnearly accurate and more de­
see the writer’s
$1,000,000; those checks would be sent The Macmillan Company, New Bank Credit,,
York, 1921
far and wide to creditors and, returning Chapter III.

T heoretical C onsiderations on B ank C redit


same rate, would it not be possible for
individual banks to make a several­
fold loan expansion, consequent upon
a reserve acquisition, without losing
cash through unfavorable clearing
balances, thereby rendering control of
credit expansion possible only by
raising the rate of rediscount unprecedentedly?
If the First National Bank of
Dayton, Ohio, borrows $100,000 from
the Federal Reserve Bank of Cleve­
land at a time when other banks in the
same credit area are likewise borrow­
ing, and all expand their loans in such
a manner that what each would nor­
mally lose in reserve is met and offset
by streams of funds coming from other
banks, the First National Bank of
Dayton would be able to lend several
dollars for each dollar borrowed, even
if allowance is made for the likelihood
that the proceeds of loans secured from
the regional bank at Cleveland would
be taken partly in Federal Reserve
notes. Under these conditions, with
the bank in question able to lend four
or five dollars to each dollar borrowed,
it has often been contended that a
rate of rediscount that fell appreciably
short of being four or five times the
rate of discount or market rate would
not be effective. That the contention
is ill-founded may easily be shown.
When all banks in a given credit
area are expanding their loans, the
additional lending power of each is
traceable to two quite different facts or
forces. The first is the fund borrowed
by the commercial or member bank,
and the second is the fund or funds
that such a bank receives through
deposit channels and as a result of the
C a n a B a n k M a k e M a n i f o l d L o a n s lending operations of other banks.
D u r in g P e r io d o f L o a n
The point to be stressed is that what a
E x p a n s io n ?
member bank borrows does not deter­
At this point a crucial question mine the amount that it will receive in
arises. If all banks within a credit deposits that arise out of the lending
area were expanding their loans at the operations of other banks. If within a
convenience—will have gained that
amount in deposits, and a correspond­
ing amount in reserve. The lending
officers of banks B, mindful of the fact
that a reserve must be held against
the newly acquired deposit liabilities
as well as against any deposits arising
from additional loans made on the
basis of the reserve freshly acquired,
will be constrained to add to their loans
not $ 1.25 for each dollar deposited, but,
approximately $1.10.
If banks B now lend $110,000 on the
basis of $100,000 newly lodged in those
banks, they will tend to lose to other
banks—banks C—approximately 80
per cent of the amount loaned, or $88,000; the $12,000 left in banks C, may
be regarded as reserve against the
$100,000 in deposit liabilities growing
out of the lodgment of that amount of
checks drawn on bank A and against
additional deposits growing out of the
$110,000 in loans. Banks C, having
acquired $88,000, are in a position to
lend approximately $96,800 ($1.10 for
each dollar of deposited reserve). If
80 per cent of their loans are lost to
other banks, banks C would lose $77,440 and retain $ 10,560 ($88,000 —$77,440) as reserve against $88,000 in
deposit liabilities arising from the
lodgment of that amount of checks
drawn on banks B and against addi­
tional deposits growing out of the
$96,800 in loans.
This chain of operations continues
until the original $100,000 becomes very
widely distributed and the total loan
expansion results in deposits sufficient
to cover or absorb the borrowed re­


T he A nnals of the A merican A cademy

credit area where all member banks
are borrowing and expanding their
loans, one institution suddenly ceases
to borrow, the stream of increasing
deposits flowing from the expanding
banks will tend to continue to swell the
deposits and, therefore, the lending
power of the bank that has ceased to
borrow. A resumption of borrowing by
the exceptional bank will enhance the
lending power of that bank by an
amount only slightly in excess of the
amount borrowed.
A clear cut distinction must be
drawn in banking between lending
power that owes its existence to funds
borrowed by a given bank and lending
power that owes its existence to reserve
acquired as a consequence of expanding
loans on the part of other banks. When
that distinction is clearly drawn the
persistent contention referred to loses
its semblance of validity.
Having seen on what grounds of
sound theory the control of bank
credit, i.e., loans and deposits, rest, we
may now be permitted briefly to ex­
amine the question whether the redis­
count rate ought to be higher or lower
than the market rate.
C o n t r o l o f B a n k C r e d it T h r o u g h
t h e R e d is c o u n t R a t e

The rediscount policy of the Federal
Reserve Board has gone counter to
that of the great central banks of
Europe, notably the Bank of England,
the European policy having been to
maintain the rediscount rate above the
market rate.
Numerous guides have been followed
by the directorate of the Bank of
England in the determination of the
bank rate: the reserve ratio, the
state of trade, international gold
movements and the market rate. Like­
wise, our Federal Reserve Board has
also been governed by no single factor.
While the state of trade, the reserve

ratio, the fiscal needs of the govern­
ment, etc., have all received attention,
the writer believes that too little effort
has been made to bring the market
rate into harmony with what may be
called the natural rate of interest, the
natural rate being the rate at which the
supply of and demand for loanable cap­
ital goods, as distinct from “money,”
may be equated.
Although it is impossible always
accurately to ascertain what the nat­
ural rate of interest is, it is not difficult
to detect a wide disparity between the
market and natural rates. The dis­
parity between the market and the
natural rates during the early period of
credit expansion under the operation
of the Federal Reserve Act, was due
measurably to an inflationists policy
with a low rate of rediscount as its
central feature. With a low rate of
rediscount obtaining, our market rates
were low and general prices rose in
conjunction with an expansion of loans
and deposits. Rising prices gave birth
to rising profits, and the predictable
increased demand for funds, with a
consequent extreme rise in the market
rate of interest, was soon in evidence.
In a country like the United States
where capitalis highly productive and
preference for present goods over
future is pronounced, cheap money
can be had only by making everything
else dear; depression of interest rates
engenders credit expansion and rising
prices. Indeed, the price level is itself
an index of the relation of the market
to the natural rate when allowance is
made for the changing phases of the
business cycle.
Our extreme and recurrent expansion
and contraction in industry and trade
can be avoided, not by keeping the rate
of rediscount invariably above the mar­
ket rate, but by keeping it distinctly
above the market rate during periods of
expansion and less markedly so, or

A gricultural and C ommercial L oans

even below the market rate, during
periods of crisis and depression. Let
the brakes of high rediscount rates be
set early, long before the bottom of the
hill is reached; and let the accelerating


force of low rates be applied with
similar promptness and decision. If
the market rate is kept in harmony
with the natural rate, violent changes in
the general price level can scarcely occur.

Agricultural and Commercial Loans

A Comparison of Loans Made in a Great Agricultural State with
Loans to the Largest Bank and to Member Banks in the
Largest City in the Seventh Federal Reserve District
By J. B. M cD ougal
Governor, Federal Reserve Bank of Chicago
be too
IT wouldpublic tomuch tomore thanthea

casual comprehension of banking or of
the relations of the Federal Reserve
Banks to other banks or to business.
It is not expected that the public will
understand the operations of a factory
which makes electrical machinery or of
the electrical machines that are made.
Still any well informed man may
know in a general way what a dynamo
is and have a grasp of what is meant by
horse power. So might he know that
a bank in a great central city probably
generates a large horse power in credit
and that comparison of the operations
of such a bank with those of any smal­
ler bank can be valuable or informative
only if relative size is considered.
In this country there are banks of
all kinds and sizes. The customary
method of grading banks is by “capital
and surplus,” and “deposits.” It
takes 40 banks with $25,000 capital
each to measure up in capitalization
to one with $1,000,000. It takes 400
such banks to equal a $10,000,000
institution. If the comparative figures
are carried far enough, and total re­
sources are used as the basis, it will
be found that there are single banks in
New York and Chicago with resources

larger than the combined resources of
all member banks in certain individual
states or perhaps in several states.
These large banks have as customers
many small banks, as well as individ­
uals and corporations. When borrow­
ing from the Federal Reserve Banks,
their transactions are usually in large
amounts. It is natural that what is con­
sidered moderate borrowing for a large
bank should appear extravagant when
compared with the amount borrowed
by a small bank. A loan of fifty million
dollars appears very large when com­
pared with one of fifty thousand. Re­
latively, however, fifty millions may
be much more moderate than fifty
thousand, if due consideration is given
the respective reserve balances main­
tained with the Federal Reserve Bank
by the institutions involved.
For instance, an officer of a country
bank called at the Reserve Bank one
day and asked for an additional loan.
At the time his bank had become so
extended that its excessive borrowings
had been the subject of considerable
correspondence. He was told that a
definite limit must be placed on his
borrowings at a point not far from the
amount already borrowed. The coun­
try banker was piqued. He called at­


T he A nnals of the A merican A cademy

tention to the many millions loaned
to some of the Chicago banks. The
country bank’s debt was less than two
hundred thousand. A comparison
was made at once. It was found that
on the basis of reserve deposits the
big banks might have owed the Federal
Reserve Bank nearly three times as
many millions if they had borrowed in
the same proportion as the small bank.
A part, at least, of the criticism of
the operations of the Reserve Banks
during the recent trying times seems
to be based on instances of similar
misconception of facts and figures. A
moderate borrowing by a large bank
may appear out of proportion when
compared to an actually excessive
borrowing by a small bank, if only
absolute figures are used.
In connection with the work of the
Joint Committee on Agricultural In­
quiry, which was instructed to “in­
vestigate . . . the banking and finan­
cial resources and credits of the
country, especially as affecting agri­
cultural credits,” the Federal Reserve
Bank of Chicago made a careful study
of its loans to member banks. The
purpose was to ascertain if there had
been any discrimination, real or ap­
parent, against banks serving agri­
cultural communities.
Section 4 of the Federal Reserve
Act was kept in mind. This section,
in outlining the duties of directors of
Federal Reserve Banks, provides as
Said board shall administer the affairs of
said bank fairly and impartially and with­
out discrimination in favor of or against any
member bank or banks and shall, subject to
the provisions of law and the orders of the
Federal Reserve Board, extend to each
member bank such discounts, advancements
and accommodations as may be safely
and reasonably made with due regard for
the claims and demands of other member

The study developed some interest­
ing facts that are pertinent to this
discussion. The loan records of com­
mercial banks are not kept in such
form that borrowers can be classified
by occupations in any comprehensive
way. It is true that for some time
past Federal Reserve Banks have
required member banks in their appli­
cations for rediscount to specify the
business of customers whose notes are
offered. But this information pro­
vides no adequate measure of the extent
of the service rendered to agriculture.
It is well known that many country
banks make a practice of using their
farmers’ paper for rediscount only after
exhausting their supply of other eligible
paper which is presumably better
known at the Federal Reserve Bank,
such as, “commercial paper” and notes
secured by United States government
No statistics are available to show
the absolute amounts loaned to various
industries, but the Federal Reserve
Bank of Chicago was able, by a com­
parison of its loans to member banks,
to obtain conclusive evidence that it
had not discriminated against agricul­
ture. Loans to and reserve deposits of
member banks in a preeminently agri­
cultural state were compared with
similar figures for member banks in the
other states as well as the largest
cities in the district.
One of the tabulations made is
printed in full on page 201 and presents
an interesting comparison of the relative
borrowings by all member banks in the
preeminently agricultural state with
all member banks in the city of Chicago
and with the individual bank whose
borrowings exceeded those of any other
bank in the Federal Reserve District.
The table on page 201 includes per­
centages, showing the ratio of amounts
borrowed to reserve deposits kept in
the Federal Reserve Bank, a method

A gricultural


C ommercial L oans


L oans

to A ll M e m b e r B a n k s in a G r e a t A g r ic u ltu r a l S t ate C o m par ed w it h L o a n s to
t h e L a r g e st B o rr o w in g B a n k in t h e S e v e n t h F e d e r a l R e se r v e D istr ic t a n d L o a n s
to A ll M e m b e r B a n k s in th e C it y of C h ic a g o ; also , C o m par ativ e R e se r v e D epo sit
F ig u r e s .

(In thousands of dollars)

All member banks Largest borrowing All member
in Agricultural
bank in the
banks in
July 2,1920 .... *Reserve Deposit
Per cent loans to reserve
October 2, 1920 . *Reserve Deposit
Per cent loans to reserve
January 5, 1921 . ^Reserve Deposit
Per cent loans to reserve
April 2, 1921 ... ^Reserve Deposit
Per cent loans to reserve
July 1, 1921 .... *Reserve Deposit
Per cent loans to reserve
October 1, 1921 . ^Reserve Deposit
Per cent loans to reserve

63,000 .
300 .
78,000 .

32,000 .
80,000 .
250 .
31,000 .
78,000 .

94,000 .
470 .
75,000 .
375 .
18,000 .
64,000 .

30,000 .
70,000 .

18,000 .
62,000 .

135,000 .
252,000 .
133,000 .
250,000 .
130,000 .
187,000 .

28,000 .
71,000 .

188,000 .

29,000 .
33,000 .

123,000 .
128,000 .

32,000 .
7,000 .

127,000 .
51,000 .



* Average for month.

of comparing accommodations granted
which is familiar to all bankers. The
figures are given at intervals of three
months and cover the period of
greatest expansion of credit in the
United States. It is worthy of note
that the total borrowings for all mem­
ber banks in the agricultural state were
on one day nearly five times their total
reserve deposits, while the total bor­
rowings of the largest borrowing bank
in the Federal Reserve District at the
peak were about two and one-half

times its reserve deposit. It is also
interesting to note that while on
October 1, 1921, the largest borrowing
bank in the Federal Reserve District
was indebteded to the Federal Re­
serve Bank to the extent of only 22
per cent of its reserve deposit, the total
borrowings for all member banks in the
agricultural state on the same date
were 344 per cent of their total reserve
It will also be noted from the chart
on page 202 showing these percentages,


T he A nnals of the American A cademy

A ctivities of R eserve B oard and B anks
that since April 2 , 1921, there has been was no discrimination against agriculgreat decrease in the amounts owed by
the city banks, while the curve for the
agricultural state does not show a
proportionate decline.
This examination of actual figures
makes clear two points: (1) There

ture by the Chicago Reserve Bank,
Member banks in cities were not
favored. (2) Relative, rather than
absolute, figures must be used if an
accurate idea of the situation is to be

Popular and Unpopular Activities of the Federal
Reserve Board and the Federal Reserve Banks
By W illiam A. S cott


University of Wisconsin

N account of the extraordinary problems. The financial difficulties
conditions under which our Fed­ which speedily followed made most
eral Reserve System has been obliged thankful for their existence and
to operate, public opinion towards it created a feeling of dependence upon
has taken peculiar twists and turns. them. No one was disposed to hamper
Hopefulness, uncertainty and lack of them by criticism.
enthusiasm characterized it at the start, Before our entrance into the War,
a condition easily explainable by the their activities do not seem to have
party controversy which preceded its attracted public attention to an extent
establishment, differences of opinion sufficient to arouse either its criticism
regarding the details of the law govern­ or its approval. The policy developed
ing it and conflicts of interest among during this period of concentrating in
the people most directly affected by it. their vaults as large a part of the
Those who had fought and bled for the rapidly increasing gold supply as possi­
Aldrich plan were naturally critical ble by exchanging their notes with the
of this one and uncertain regarding the banks for gold, important though it
manner in which it would work. The was in checking somewhat the rapidly
state bankers, generally, were hostile expanding bank credits and in render­
towards it because they feared that ing this mass of the precious metal
some of their sources of profits would easily available for any purpose for
be jeopardized, and many national which it might be needed, seemed to
bankers did not like its coercive fea­ excite curiosity rather than interest .
tures. The undiscriminating public
W ar C ompulsions
undoubtedly hoped that it would suc­
ceed and was disposed to give it a fair With our entrance into the War in
April, 1917, the Federal Reserve Banks
The outbreak of the European War, were called upon to assist the Treasury
three months before the Federal Re­ in its colossal financial operations. As
serve Banks were ready to begin opera­ financial agents of the government,
tions, cleared the atmosphere and they performed the work of executing
smoothed the pathway for them so far its plans and measures and, what is
as public opinion was concerned, though more important, so long as the War
in other respects it complicated their lasted and for some time thereafter,


T he A nnals of the A merican A cademy

their policies were shaped primarily
with reference to the government’s
needs and interests.
The greatest of these was the flota­
tion of billions of bonds and short time
notes, and the Reserve Banks’ part in
the work was to act as the government’s
agents in the sale of these securities
and to aid in creating a market for
them. To this end they established
discount rates considerably below the
market with a differential in favor of
loans on the security of government
bonds and notes, rates low enough, in
fact, to make it possible, with the aid
of rediscounts, for member banks to
loan without loss to bond buyers at
rates not higher than the bonds and
notes themselves yielded.
There can be no doubt that this was
a violation of the rules of sound com­
mercial banking. It opened the doors
to the inflation of bank credit and to
the evils which follow in its train.
Conscious though they were of this
fact, the Federal Reserve Banks and
the Federal Reserve Board were forced
to adopt this policy. The Liberty
loans could not otherwise have been
floated. Without borrowing from their
banks, the people could not have
purchased their necessary allotment of
bonds, and the banks could not have
made these loans unless the Federal
Reserve Banks had rediscounted for
them on the security of these loans at
rates which did not involve loss. Had
the Reserve Banks refused to adopt this
policy, public opinion would certainly
have condemned them and probably
Congress would have forced them to it.
R esp o n sib ility for th e R is e and
F a l l of P r ices

One of the penalties that had ulti­
mately to be paid for this violation of
sound banking principles was misun­
derstanding and criticism, not criticism
of this policy, which had the hearty and

even enthusiastic endorsement of pub­
lic opinion, but criticism of the meas­
ures the Federal Reserve Banks had
ultimately to adopt in order to save
themselves and the credit system of
the country from the consequences of
this policy.
This misunderstanding and criticism
resulted from the contemporaneous ex­
pansion of bank credits and the rise of
prices. Both were necessary results
of the same causes, namely, the read­
justments in the relations between the
demand and supply of important groups
of commodities and the transfer on a
large scale of demand operations from
private individuals and corporations to
the government. But the people, with
the assistance of a group of economists,
interpreted the causal relations differ­
ently. They insisted that the expan­
sion of bank credits was the cause of
the rising prices, and, since the discount
policy of the Federal Reserve Banks
was held to be chiefly if not wholly
responsible for the inflation, these
banks were held responsible for the
high prices.
This theory aroused no widespread
criticism of the Federal Reserve Banks
so long as prices continued to rise and
prosperity to be general, but, when the
high price period came to an end and
the opposite movement got under way,
the belief that the Federal Reserve
Banks and the Federal Reserve Board
could greatly influence and perhaps
control price movements subjected
them to pressure from people who were
being, or thought they were being,
injured by the slump in prices and,
.when the banks did not yield to this
pressure, to the severe criticism of these
The course of events which resulted
in such pressure and criticism seems to
have been about as follows: The Arm­
istice was succeeded by about a year
and a half of booming business, accom­

A ctivities


R eserve B oard

panied by extravagance, speculation
and soaring prices. Bank credits, in­
cluding those of the Federal Reserve
System, expanded rapidly, and bank
reserves rapidly declined. Towards
the end of 1919 ordinary prudence and
a decent regard for the safety of our
credit system demanded that a halt be
called. The Federal Reserve Board
and the responsible officers of the
Federal Reserve Banks felt and knew
that good banking policy would have
required them to put on the breaks
much earlier, but they were stopped by
the financial exigencies of the govern­
ment whose need for floating large
loans did not end with the Armistice.
The government needed the aid of the
Federal Reserve Banks quite as much
as during the War.
During the year 1919 the Federal
Reserve Banks and the Federal Re­
serve Board tried in vain to moderate
the pace of the member banks by moral
suasion and other indirect methods and
it was not until December of that year
that the financial condition of the
government freed their hands to such
an extent that they felt free to apply
the brake of increasing discount rates.
The upward movement of prices
came to an end in the early summer of
1920 and the slump that followed syn­
chronized very closely with the period
of high discount rates at the Federal
Reserve Banks. The pressure upon
the banks to carry people who were in
trouble on account of the rapidly
shrinking value of inventories, and
farmers whose crops could either not
be marketed at all or at prices much
below the cost of production, was very
great. The Federal Reserve Banks
and the Federal Reserve Board urged
the member banks to extend all possi­
ble assistance to these distressed people
and supported them in this policy by
liberal rediscounts, with the result that
the total loans and discounts of the


B anks


banks continued to increase for several
months after the slump in prices started
and did not show any tendency to
decline until near the end of the year
1920. The demand for bank accom­
modations was so great as to keep rates
at a high level and to make excessive
rates possible in individual cases.
P ressur e


L ow er R ediscount
R a tes

In times of financial distress people
always search for an explanation in the
hope of finding some means of relief,
and, in this case, the process of reason­
ing outlined above, running from Fed­
eral Reserve Bank discount rates
through general bank credits to prices,
seemed to furnish the key and also to
suggest a remedy. Proof that low
discount rates result in expanding
bank credits and rising prices and high
discount rates in contraction of credits
and falling prices, seemed to be at hand
in the fact, easy to establish by statis­
tics and graphs, that prices did rise
during the period of low discount rates
and began to fall soon after the policy
of higher discount rates was inaugura­
ted. The remedy seemed clearly to be
a radical cut in discount rates, which,
it was claimed, would result in the
expansion of credits or, at least, in pre­
venting contraction and in a check on
the price slump and, if continued, in
an upward movement of prices.
The spokesmen of the distressed
classes in the community deluged the
Federal Reserve Board with appeals
for this kind of relief and, upon its re­
fusal to grant it, with criticism and, in
some instances, even with abuse. The
Board was clearly between the devil
and the deep sea. There was no ques­
tion about the necessity for high dis­
count rates and the removal of the
differentia] in favor of government
paper-secured loans if the credit sys­
tem of the country was to be kept in a

T he A nnals of the A merican A cademy
sound condition; but it was equally progressive rate policy or even greatly
clear on the other hand that that policy to modify it when cases of what were
was unpopular.
regarded by the critics as excessive rates
were brought to its attention, and that
R e c e n t C riticism s o f R ese r ve
it refused to reverse its rate policy when
B oard P o licy
the harm being wrought by the slump
The old saw that misfortunes never in prices became apparent.
come singly proved true in this case.
In support of these charges, the
At this truly critical time the Federal critics indulged in fallacious reasoning,
Reserve Board was publicly attacked misuse of statistics and the familiar
in newspapers and before Congress. tricks of the political stump speaker.
Beside the abolition of the progressive They frequently disregarded those
rates in force in four of the districts and parts of the Federal Reserve Act which
a general cutting of discount rates, it is determined the distribution of powers
not easy to determine precisely what and duties between the Federal Reserve
these critics wanted the Board to do, Banks and the Federal Reserve Board,
but one demand seems to have been for or put an interpretation upon them
it to undertake the task of cleaning which varied from that made by the
up all the dirty places in our banking Board. * In matters of this kind there
system even to the extent of correcting is often room for differences of opinion,
the bad practices of individual bankers. but the critical energy was moved by
Through the examinations conducted the assumption that the Board was
by the Controller of the Currency a wrong and refused to conform to the
number of these had been discovered or judgment of a superior wisdom.
at least it was so thought. It was also Apparently the critical force had no
demanded that the Board use its influ­ conception of the consequences that
ence with the Federal Reserve Banks would follow the Board’s failure strictly
to force or to induce them to refuse to to follow general rules of action impar­
grant credit to member banks that tially applied. Even if the laws under
were not playing the banking game in which it operates gave it the right so
the manner in which the critics thought to do, the attempt to deal with the cases
of individual bankers or of individual
it ought to be played.
In the course of this campaign of borrowers would soon swamp it with
criticism, a number of charges were an unmanageable mass of detail and
brought against the Federal Reserve render impossible the execution of any
Board and the Federal Reserve Banks, policy however necessary or desirable.
especially that of New York City.
The favorite method of proving that
The chief of these were: that the Board Wall Street was being favored and the
is suffering from “ bureaumania” and farmers pinched was to quote statistics
is unsympathetic, governing itself by that show that the Federal Reserve
general rules which it refuses to relax Bank of New York was loaning at one
in individual cases which are thought time to one member bank, or to a few
to appeal to the sympathy of its mem­ large member banks, more than certain
bers; that it is extravagant, sanctioning other Reserve Banks in the agricultural
too high salaries and other unnecessary sections were loaning to large numbers
expenditures; that it has permitted an or to all their member banks. That
inequitable distribution of credit, Wall it is necessary to observe the relation
Street being favored and the farmers between the amount of the real credit
pinched; that it refused to abandon the needs of all the constituents of each

A ctivities o r R eserve B oard

Federal Reserve Bank and the total
amount of loans in each case before
such statistical comparisons can have
any significance, either never occurred
to the critics or they chose to ignore the
fact in order to make an effect on their
audience. Moreover, these facts were
not emphasized: That Reserve Banks
in the farming country borrowed from
other Reserve Banks, usually in the
East, or that large banks in centers like
Chicago ran up their indebtedness at
the Federal Reserve Banks, in part if
not chiefly, to help their correspond­
ents located in agricultural sections.
Much was also made of the fact that
some member banks in the New York
district, rediscounting heavily at the
Federal Reserve Bank, were them­
selves loaning heavily to speculative
customers, without attempting to show
what was the proportion of such
loans to the total in each case or how
cutting down the lines of discount of
these banks at the Federal Reserve
Bank would have affected their con­
stituents as a whole; or without even
debating the question whether it would
be good policy for the Federal Reserve
Bank in New York to refuse to redis­
count good, eligible paper for a bank
on the ground that it disapproves some
of its loans.
The opponents of Reserve Board
policy appear to believe that the Fed­
eral Reserve Bank of New York and
the Federal Reserve Board are guilty of
sins of omission or of commission rela­
tive to the New York call loan market.
They argue that high rates on that
market attract funds from other parts
of the country which ought to be
loaned at home and otherwisewouldbe.
Just how they would use the Federal
System to prevent this they nowhere
make clear. Perhaps they would have
the Federal Reserve Bank of New York
refuse to rediscount for a bank that
loans on the call market!


B anks


With almost hysterical enthusiasm
were cited the cases of a little bank in
Alabama and a few others in which the
application of the progressive rate rule
had resulted in very high rates on a
few loans. These were exploited to the
limit in public addresses. The mem­
bers of the Reserve Board probably dis­
liked these extreme results of the pro­
gressive principle quite as much as
anyone else, but they stubbornly
thought out their own remedy. They
recommended a rebate of the excessive
interest payments in these cases and
the deferring of final judgment on the
principle itself until wider experience
should give them more light. The
critics had their own notions, however,
and one was to play upon the feelings
and prejudices of their audiences
through the use of these extreme cases.
The refusal of the Board to lower
discount rates when the slump in
prices occurred was classed as “unpar­
donable.” The arguments disclosed
complete unconsciousness of the fact
that there was room for differences of
opinion regarding the best policy to
pursue at that time or of the reasons
for the Board’s refusal. The Board’s
action could only be accounted for on
the ground of “inertia” or “inability
to comprehend the meaning of events.”
D iscrim ination A gain st th e F arm er

The criticism that the Federal Re­
serve System has discriminated against
the farmers seems to have been endorsed
by a good many people in agricultural
sections, especially in the South and
some parts of the West where farmers
have been especially hard pressed by
the slump in prices. The real credit
needs of these farmers have been very
great and their desire for credit in
many cases has been in excess of their
needs, since they wanted loans to en­
able them to hold their crops for costof-production-plus-profits prices for the


T he A nnals of the American A cademy

realization of which there were no real
prospects. In many cases, doubtless,
these needs and desires have not been
satisfied and the Federal Reserve Banks,
or the Federal Reserve Board, or both,
have been held responsible for the
failure. Why?
The testimony of Governors Hard­
ing, Strong and others before the Joint
Commission of Agricultural Inquiry
clearly shows that the Federal Reserve
System has not been at fault in this
matter; that, on the contrary, the
resources of this System have been put
at the disposal of member banks in the
agricultural sections without stint and
that member banks have been urged
to respond to the farmers’ needs to the
fullest extent possible. There is no
evidence that rediscounts of eligible
paper have been refused member banks
in these sections, but, on the contrary,
the evidence shows that the Federal
Reserve Banks in these regions have
borrowed heavily from other Federal
Reserve Banks and stretched the eligi­
bility rules to the limit in order to ac­
commodate such banks. There is also
abundant evidence that member banks
have taken advantage of these privi­
leges and as a whole have responded
liberally to the farmers’ needs. Their
rediscounts and loans have expanded
rapidly since the slump in prices began,
the former passing far beyond the
normal lines of credit set for them by
the regulations of the Federal Reserve
Banks, and in many cases member
banks have gone beyond the limits set
by sound practice in order to accom­
modate their farmer customers.
L im itation s of C ommercial B a n k in g

The explanation of the farmers’
criticisms must be sought in a mis­
understanding of the limitations of our
commercial banking system, on the one
hand, and of our Federal Reserve Sys­
tem, on the other. These critics do

not know that the chief stock-in-trade
of commercial banks is short time selfliquidating paper, that .the amount of
any other kind of paper they should
carry is strictly limited and that, if
they go beyond this limit, they get
themselves and everybody else into
trouble. Nor do these critics realize
that a large part of their own paper in
normal times, and most of what they
have to offer in these critical times, is
not of the short term self-liquidating
kind. It is unfortunate that we do
not have institutions especially fitted to
satisfy these credit needs, but the fact
is that we have not. Our banking
system is defective at this point, but
from this fact it does not follow that it
would be good policy, or any advantage,
even to the farmer, to wreck our com­
mercial banks in an effort to do what
they are unfitted to do.
Neither do these farmer critics seem
to know that a Federal Reserve Bank
can serve them only through a member
bank and then only by means of redis­
counting eligible paper. If the mem­
ber bank with which the farmer deals
does not have eligible paper or is un­
willing to offer it for rediscount, the
Federal Reserve Bank can do nothing.
M isguided O pposition

The farmer has also misunderstood
the operation of high rediscount rates,
especially those of the progressive
variety. He has thought that these
rates have prevented rediscounts by
his bank and in this way have made it
impossible for his banker to accom­
modate him. In some cases, doubtless,
he has been given this impression by
the banker himself who has preferred
“passing the buck” to the Federal
Reserve Bank to giving his customer
the true reason for his unwillingness to
accommodate him. That rediscounts
in agricultural sections have not been
prevented by high rediscount rates is

A n O pen M arket for C ommercial P aper

shown by the facts. The rediscount
item has increased in spite of these
rates. What these high rates were
intended to accomplish and what they
evidently did accomplish, was to force
more careful discrimination between
real and unreal and between greater
and lesser needs and to cut down the
volume of speculation.
Farmers have also been infected by
the theory that the so-called deflation
policy of the Federal Reserve Banks
caused the slump in prices.
P u blic S upport or C lass C ontrol

No one would be so rash as to claim
infallibility for the Federal Reserve
Board or for the responsible officers of
the Federal Reserve Banks, least of all
these persons themselves. It would
be strange if they had not made mis­
takes. They have had to conduct a
new institution during a period in
which conditions were excessively ab­
normal and in which principles and
rules of action, seemingly well estab­
lished by experience, were clearly in­
applicable. They have had to blaze
new trails and to settle new problems
upon which very little light was thrown
by past experiences here or in other
countries. But no fair-minded person
can read and digest the testimony of
Governors Harding, Strong, Miller and
others before the Joint Commission of
Agricultural Inquiry and escape the
conviction that every policy they


adopted was carefully thought out in
the light of the actual conditions con­
fronting them, that these policies
worked on the whole extremely well
and in the best interests of the country,
that these men are able and conscien­
tious and know their business and that
the country was very fortunate to
have the operation of the Federal
Reserve System in their hands during
this extremely critical period in its
The unfortunate thing is that few
of the fair-minded people of the coun­
try can or will read that testimony.
The ordinary man knows little about
banking and would find it difficult to
understand discussions regarding it if
he did read them. Public opinion
regarding such matters is not formed
by careful reflection and weighing of
the facts. Large numbers of people
are bound to be influenced and to have
their opinions determined by such
criticisms as have been made. Since
the charter period of the Federal Re­
serve Banks extends for several more
years, the effect of this misguiding of
the public mind and feeling is likely to
be demands upon Congress for modifi­
cations of the Federal Reserve System
in the direction of making it subservient
to special interests and attempts to
put the system in the control of men
who will use it in the promotion of such
interests. It is time for the friends of
sound banking to be on the alert.

The Development of an Open Market for
Commercial Paper
By E. E.

A gger
Columbia University


T is the function of an open discount the free sale and purchase of bills and
market to promote mobility, elastic- paper acceptable as a basis of dealing
ity and maximum economy in the use in the market. Where pressure is felt
of credit. Mobility is assured through bills are offered for sale and the result15


T he A nnals op the American A cademy

ing funds relieve the pressure. The
funds are offered by those districts
where temporary abundance prevails,
and where, therefore, a profitable
employment of the surplus is sought.
Thus, through the instrumentality of
the discount market, funds are trans­
ferred from places where they are
wanted less to places where they are
wanted more. This is the essence of
credit mobility. Just as an open dis­
count market promotes mobility of
credit it also promotes elasticity,
namely, expansion and contraction in
response to changing demand. An
increase in demand is indicated by a
growing abundance of paper offered in
the market. A decrease in demand is
likewise reflected in the liquidation of
maturing paper, and in the diminution
in the volume of new paper flowing into
the market and offered for sale. The
more abundant offering of new paper
tends to lead to credit expansion, while
the liquidation of that which matures,
and which is not offset by a corre­
sponding offer of new paper, results in
An open discount market can be
developed irrespective of the system
of reserve organization that may
characterize a given country. Even
under a system of scattered reserves,
there is nothing to prevent banks and
individuals in different sections of the
country from buying and selling dis­
counts from and to one another and
from developing whatever market
machinery may be necessary for the
purpose. Yet since such operations
necessarily imply large and rapid
movements of funds, it is obvious that
under a centralized scheme of reserves,
with effective clearing machinery, the
inevitable shifting of funds growing
out of open market operations can
be executed with least friction and
Moreover, under a centralized system

of reserves an open discount market
contributes toward economy of opera­
tion of the credit system because, by
promoting the free flow of funds, it
permits the full utilization of available
credit in the market before further
expansion by the central institution
becomes necessary. If pressure devel­
ops in any area, through the facilities
of the open market the surpluses of
other areas can immediately be drawn
upon without initial resort to the
reserve holding agency. With an open
discount market the free credit tends
to be completely absorbed before the
central reserve agency is called upon
for the expansion that usually implies
a weakening of basic reserves.
Lastly, it may be said that an open
market may also be serviceable in the
international flow of credit and in the
safeguarding of the domestic reserve
situation. If the market is sufficiently
well established, and if the dealings in
it are of a nature and a scope to en­
gender the necessary confidence, the
foreigner may be induced to enter in
it and to invest in its wares such sur­
plus funds, temporarily available, as
he can command. As demand increases
and as rates of discount rise, larger and
larger sums may be attracted from
abroad. This tends favorably to affect
the exchange rates and may obviate the
necessity of bullion shipments.
C onditions C r e a t in g a n O pen
D iscount M a r k et

Since an open discount market can­
not create itself, it follows that the
development of such a market must be
contingent upon a favorable conjunc­
ture of circumstances.
First of all, an open discount market
requires forms of discountable credit
instruments that will lend themselves
to a free market handling. Not all
credit instruments, of course, are avail­
able for open market operations. Un­

A n O pen M arket For C ommercial P aper

der the old national banking system,
both law and practice checked the
development of satisfactory open mar­
ket instruments. The typical Ameri­
can credit instrument under that
system was the single name promis­
sory note, which, owing to the obvi­
ously personal character of the credit
which it represented, was not adapted
to open market operations. We had a
so-called “commercial paper market,”
but its facilities were at the service
only of large and nationally known
firms. Moreover, it was a market for
the first placement rather than for the
free rehandling of paper. It would
therefore hardly be regarded as a real
discount market.
Similarly, the old commercial time
draft which had been a common in­
strument in pre-Civil War days, de­
generated, under the pressure of the
cash-discount and the open-account
system, into a sort of “dunning”
instrument, employed, in all except a
few lines, for the purpose of collect­
ing overdue accounts. The bankers’
acceptance, on the other hand, which
is admirably adapted to free and rapid
exchanging, was practically unlawful
down to the time when provision was
made for it in the Federal Reserve Act
and in some state laws. Thus we had
no open discount market in this coun­
try because we had no paper that could
be handled in such a market.
But in addition to a satisfactory
commodity to be handled in a market,
it is also necessary to have prospective
buyers and sellers. In other words,
there must be a favorable attitude
toward the market and a willingness to
use its facilities on the part of those who
are expected to resort to it. But in
this respect, also, American banking
practice had developed along different
lines. We had put the emphasis on
independent, highly competitive local
institutions, each more or less distrust­


ful of the rest and safeguarding its
business secrets with a peculiar jeal­
ousy. The cash-discount and single­
name system also tended to emphasize
the direct relations between the banker
and his client and was thus inimical to
the development of a system which
implied the free handling of paper in
an open market. In general, except in
their relations with their regular metro­
politan correspondents, bankers did
not wish to confess the need for any
assistance. Hence there was a strong
tendency for them to hold on to the
paper that they had originally dis­
counted. They also often objected to
disclosing the rates which they orig­
inally charged, and some have accused
them also of wishing to “hog” the
whole interest and of being unwilling
to split it with others through a proc­
ess of rediscounting or reselling in an
open market. However all this may
be, the fact remains that our bankers
were not particularly well disposed
toward open discount market opera­
T h e R e se r v e S ystem P rovides a n
Open M arket

The framers of the Federal Reserve
Act thus had a task on their hands.
The advantages of an open discount
market were freely enough conceded,
but how were they to provide the neces­
sary technical expedients? And how
lay the foundation for a favorable
attitude toward such a market? In an
earlier article, published in T he A nn als
in January, 1916, the writer discussed
the provisions of the Federal Reserve
Act and the regulations of the Federal
Reserve Board bearing on the subject
of commercial paper and promulgated
up to that time. The great contribu­
tion of the Act itself was a system of
reserve centralization and control, the
basis of a system of domestic clearings
and transfers, and the legalization of

T he A nnals of the A merican A cademy

bankers’ acceptances. These accept­
ances were at first limited to export
and import transactions, but were later
made applicable to domestic transac­
tions as well. Similarly, the amount
of acceptances for which a member
bank might make itself liable was
increased from 50 per cent to 100 per
cent of its combined capital and sur­
plus. The Board’s contribution is to
be found in the regulations which it
has drawn up in connection with the
different forms of commercial paper
and in the policies which it has pur­
sued toward encouraging the use of,
and the investment in, paper accept­
able for open market operations.
At the present time it may be said
that Section 13 of the Reserve Act
supplies the member banks with their
authority to engage in the acceptance
business. The acceptances which they
create must have a maturity not
greater than six months, exclusive of
days of grace. They may grow out of
transactions involving the exportation
or importation of goods or out of those
involving domestic shipments, but in
the latter case the acceptances must
be accompanied by shipping docu­
ments conveying or securing title at the
time the member bank makes the
acceptance, or they must be secured by
warehouse receipts or other such docu­
ments conveying or securing title
covering readily marketable staples.
Similarly, under regulations drawn up
by the Board, member banks may
accept drafts or bills of exchange
drawn upon them by banks or bankers
abroad where the purpose is to furnish
dollar exchange required by the usages
of trade. Such acceptances must not,
however, have more than three months’
sight to run.
The total amount of acceptances for
each member bank is restricted to a
sum equal to one-half of its paid-up and
unimpaired capital and surplus, al­

though under general regulations the
Reserve Board may authorize a mem­
ber bank to accept bills growing out of
exports and imports up to the full
amount of its capital and surplus.
There is, however, the proviso that in
no event may the domestic or the dol­
lar exchange acceptances exceed a total
of fifty per cent of the member banks’
capital stock and surplus. Similarly,
there is a general restriction to the
effect that no member bank may accept
for any one person or firm to an amount
greater than 10 per cent of its paid-up
and unimpaired capital and surplus
unless the member bank is secured
either by attached documents or by
some other adequate security growing
out of the same transaction as the
acceptance. All acceptances in these
different classes which mature within
three months, exclusive of days of
grace, and carry the indorsement of at
least one member bank, are eligible
for discount at Federal Reserve
But more important still, so far as an
open discount market is concerned,
are the provisions of Section 14 of the
Federal Reserve Act. This section
authorizes Federal Reserve Banks,
under regulations prescribed by the
Board, to purchase and sell in the open
market, at home or abroad, from or to
domestic or foreign banks, firms, cor­
porations, or individuals, cable trans­
fers and bankers’ acceptances and bills
of exchange of the kinds and maturi­
ties made eligible for rediscount, with
or without the indorsement of a mem­
ber bank.1
Since nothing like an open discount
market had developed in this country,
it was foreseen that in trying to build
one up and to win the support of the
1 In this connection attention should be called
to the fact that som of the states have also
authorized their banking institutions to engage
in the acceptance business.

An O pen M arket for C ommercial P aper
member banks, the leadership of the
Reserve Banks would have to be relied
upon. This is what gives special sig­
nificance to the provisions of Section
14. For the same reason much sig­
nificance attaches also to the regula­
tions of the Board bearing on the
eligibility of paper for rediscount at
and for open market purchases by the
Reserve Banks.
In general, it may be said that paper
to be eligible for discount must have
grown out of a transaction involving
“producing, purchasing, carrying or
marketing goods in one or more of the
steps” of “production, manufacture
or distribution, or for the purpose of
carrying or trading in bonds or notes
of the United States.”2 On the other
hand, it must not be paper whose pro­
ceeds are to be used for fixed invest­
ments of any kind or for other capital
purposes; or paper used for specula­
tive purposes or for lending to others.
Various expedients such as statements,
shipping documents, warehouse re­
ceipts, etc., are relied upon to guarantee
the essential nature of the paper and
to safeguard its security. For pur­
poses of rediscount Section 13 of the
Reserve Act made eligible notes, drafts
and bills of exchange of certain types.
But open market purchases by the
Reserve Banks were limited to bankers*
acceptances and bills of exchange of
the kinds and maturities made eligible
for rediscount by Section 13. The
effect of this limitation was to rule the
promissory note out of the field of open
market purchases, leaving within this
field bankers’ acceptances, bills of
exchange and so-called trade accept­
ances which are defined as drafts or
bills of exchange “drawn by the seller
or the purchaser of goods sold, and
accepted by such purchaser.”3
2 Regulations A, Series of 1920.
3Regulation A, Series 1920, Section V.


T he R ese r v e System E ncou rages
a n O pen D iscount M a r k et

From the beginning the Reserve
Board has done all that it could to
further the development of an open
discount market. It encouraged the
Reserve Banks in their efforts to
emphasize the importance of accept­
ances as investments, not only by
their own purchases but also in the
favorable rates that were accorded
them. The Board has cordially ap­
proved the acceptance service that
some of the Reserve Banks have
provided for their member banks. Sim­
ilarly, the Board has also dealt gen­
erously with acceptances in its regula­
tions and decisions, although it has
tried at the same time to maintain the
principles laid down in the Reserve
Act with respect to the fundamental
character of the paper. During and
immediately after the War the Board
stretched a point with respect to
renewal paper, but only in exceptional
cases can such paper now be considered
Favorable rates of discount were
recognized from the outset as the
strongest practical stimulant to the
growth of an acceptance market. In
their open market purchases the Re­
serve Banks, that were primarily con­
cerned, quoted more favorable rates
for acceptances than for other com­
mercial paper and granted the same
discrimination also for acceptances
directly discounted for the member
banks. Such preference was consid­
ered fully justified by the essential
character of the paper. On the other
hand, the Reserve Banks allowed the
open market rates to control buying
rates as largely as possible, shading
the rate slightly where a strong indorse4 See Sixth Annual Report of the Federal Reserve
Board covering operations for the year 1919,
page 22. Ibid., page 38.


T he A nnals of the A merican A cademy

ment justified it. To induce broader
purchases by member banks the Board
itself recognizes that a differential rate
must be maintained in favor of prime
bills indorsed and rediscounted by
member banks. Such differential always
assures the member bank of some
profit should it find it necessary or desir­
able to rediscount at its Reserve Bank
the acceptances that it has purchased.5
S p e c ia l I nducem en ts to B u y
A cceptances

As a further inducement to member
banks to invest in acceptances, some
of the Reserve Banks have maintained
special lines of service. The New York
Bank, for example, has for several years
bought bills in the open market on
member bank account. If desired, the
Reserve Bank retains the paper, col­
lects it at maturity and credits the
member bank’s account.6 The Rich­
mond Reserve Bank also buys accept­
ances for its member banks and allows
the member bank to specify the names
of the acceptors whose paper is wanted.7
The Richmond Bank also has been
buying unindorsed bills directly from
the acceptors. This encourages the
member bank to utilize its acceptance
powers, and, at the same time, affords
the Reserve Bank the opportunity of
keeping well informed concerning the
methods employed in the granting of
acceptance credits. The Boston Bank
has been making persistent efforts to
cultivate investment in acceptances
for secondary reserve purposes. The
Cleveland and Chicago Banks report
a steady broadening of the market as
a result of successful missionary work

with their member banks through their
member bank relations department.*
In the development of the accept­
ance market it was recognized that the
dealer would of necessity play an
important part. It is essential to the
success of the, acceptance that it be
quickly sold after acceptance has been
effected. The dealer has been increas­
ingly relied upon to effect a rapid dis­
tribution of the paper as it is created.
Naturally, unless there is a rapid turn­
over in the market, the dealer may
have to carry large amounts. This
requires more capital than most dealers
can afford, and hence some of the
Reserve Banks have followed the prac­
tice of carrying a part of this load.
The Banks take the paper for fifteen
day periods under a re-purchase agree­
ment, pending distribution.9 This has
made it possible for the dealers to
operate continuously on a much larger
scale than would otherwise be the case,
and it has meant much, therefore, in
the upbuilding of the market.
E x t e n t o f th e A c cepta n ce M a r k e t

The principal market into which
acceptances flow is, of course, New
York. This has thrown a special bur­
den on the NewYorkReserve Bank, but
through allotments to other Reserve
Banks this burden has been distributed
to some extent.10 Purchasers of accept­
ances were at first only the larger
banks, but today dealers have as
clients in addition to many banks,
corporations, firms and private indi­
viduals.11 During the past year heavy
purchases on foreign account have also
been made.12 Moreover, in some states

5See Sixth Annual Report of the Federal Reserve 8Seventh Annual Report of the Federal Reserve
Board covering operations for the year 1919, Board., page 52.
9 Ibid., page 51.
page 23.
6Report of Federal Reserve agent, Sixth 10 Ibid., page 51.
Annual Report of the Federal Reserve Board, 11Ibid., page 50, p. 366.
12See Report Federal Reserve agent, New
page 319.
7Seventh Annual Report of the Federal Reserve York District—Seventh Annual Report of the
Federal Reserve Board, p. 382.
Board, page 52.

A n O pen M arket for C ommercial P aper

by act of legislature bankers’ accept­
ances have been made eligible invest­
ments for savings banks and this prom­
ises a fruitful source of demand. The
main development has naturally come
in the larger industrial and commercial
centers. The Board states that, as a
rule, in the South, Southwest and
certain parts of the West, member
banks have only partially exercised
their acceptance powers, while pur­
chasers of acceptances are almost
exclusively banks in the larger centers


of these districts.13 But it is reasonable
to suppose that as time goes on the
advantage of the acceptance as a
liquid, short-time investment will be
quite generally recognized and the
scope of the market should be more
nearly countrywide than it is now.
The general trend of the acceptance
may be indicated by a few tables.
Table I shows the acceptance liabilities
of member banks at each controller’s
call since November, 1915.
Tables II and IIA show the Reserve

V o lu m e op M e m b e r B a n k A c c e p t a n c e s a s p e r t h e C o n t r o l l e r ’s
C a l l f o r t h e S p e c ifie d D a t e s a

(In thousands)
November 10,1915 .............................................................................
December 31, 1915 .............................................................................. 32,876
March 7, 1916..................................................................................... 42,677
May 1, 1916........................................................................................ 62,452
June 30, 1916...................................................................................... 73,641
September 12, 1916............................................................................. 81,290
December 27, 1916.............................................................................. 107,909
March 5, 1917..................................................................................... 108,550
May 1,1917 ........................................................................................ 118,799
June 20, 1917...................................................................................... 157,870
September 11, 1917............................................................................. 138,231
November 20, 1917............................................................................. 153,645
December 31, 1917.............................................................................. 217,190
March 4,1918 ................................................................................. ;. 230,164
May 10, 1918....................................................................................... 250,323
June 29, 1918...................................................................................... 231,805
August 31, 1918 .................................................................................. 243,772
November 1, 1918............................................................................... 332,719
December 31, 1918.............................................................................. 305,101
March 4, 1919..................................................................................... 269,173
May 12, 1919....................................................................................... 224,150
June 30, 1919....................................................................................... 272,035
September 12, 1919............................................................................. 323,226
November 17, 1919............................................................................. 359,109
December 31, 1919.............................................................................. 407,639
February 28, 1920............................................................................... 424,669
May 4, 1920........................................................................................ 438,430
June 30,1920 ....................................................................................... 431,196
September 8, 1920............................................................................... 414,583
November 15, 1920............................................................................. 406,525
December 29, 1920.............................................................................. 375,416
February 21, 1921............................................................................... 345,644
April 28, 1921...................................................................................... 304,231
June 30, 1921....................................................................................... 250,925
a Specially prepared by the Drvision of Analysis and Research of the Federal Reserve Board.
13 See Report Federal Reserve agent, New York District—Seventh Annual Report of the Federal
Reserve Board, p. 382.


T h e A nnals op the A merican A cademy
F e d e r a l R e s e r v e B a n k D is c o u n t s a n d P u r c h a s e s o f T r a d e a n d B a n k e r s ’
A cc e pt a n c e s b

(In thousands)
D isc o u n t s

Y ear


1921-9 M o ................................................



P urch ases







D iscounts

Ope n M arket


Sam e D a t a by M o n th s f o r





to D a te

P urchases in Open M arket



M ay.................................................
Ju ly.................................................





M ay.................................................









9 Months........................................



b Specially prepared by the Division of Analysis and Research of the Federal Reserve Board.


O pen M arket for C ommercial P aper



B i l l s B o u g h t in O p en M a r k e t®

(In Thousands of Dollars)

Federal Reserve Bank





New York...........................
St. Louis..............................
Kansas City........................
San Francisco.....................




1921 (9 mos.)


0Yearly returns Seventh Annual Report Federal Reserve Board, Z>. 52.

Bank discounts and purchases of
bankers’ and trade acceptances for
indicated periods.
Table III shows the purchases in
the open market by or for the account
of each Federal Reserve Bank during
the years 1917-1920 included and for
the first nine months of the present
F u ture D evelopm ent T hrough
B a n k e r s’ A cceptances

It will be observed that from the
spring of 1920 down to the last quarter
of 1921 the volume of operations
declined. This was due primarily to
the great decline in our foreign trade,
but the collapse at home also exerted a
considerable influence. Another no­
table circumstance is the specially
large drop in trade acceptances as
contrasted with bankers’ acceptances.
The experience with trade acceptances
has not been particularly encouraging.
In nature, the trade acceptance differs
diametrically from the bankers’ accept­

ance and experience seems to prove
that it lends itself to serious abuse.14
Evils have been complained of also in
connection with bankers’ acceptances,
but such evils can be handled through
the banks more easily than trade
acceptance abuses can be remedied
through the more numerous and less
amenable private business firms. The
future development of the open market
is thus likely to rest more and more
completely on the bankers’ acceptance,
and a great impetus would be given to
this development if in domestic busi­
ness a credit procedure based on the
bankers’ acceptance were more widely
14 The Federal Reserve agent of District No.
1 in his 1920 report to the Board says: “ The
development of the use of trade acceptance—
at least the domestic trade acceptance—unlike
that of the bankers’ acceptances, does not appear
to have been entirely satisfactory. That they
have been misused there is little question, and
for the most part the banks in the district do not
feel any more favorably disposed, if as much so,
to encourage their use than in the past.


T he A nnals of the American A cademy
The Efficiency of Credit
By 0 . M. W. S p r a g u e


Harvard University

GOOD irrigation system and a banking arrangements brought about
perfect system of credit would by the establishment and operation of
exhibit strikingly similar characteris­ Reserve Banks. The reduction in
tics. The supply of credit, as of water, reserve requirements for member banks
would be abundant, produced at a min­ and the concentration of those re­
imum cost, and free from interruption serves in the Reserve Banks, where
or exhaustion. Adequate means of they become in turn the basis for
distribution would be developed to further credit in the form of Federal
furnish the water in the one case and Reserve notes and also of reserve bal­
credit in the other to every part of the ances, have greatly reduced the amount
territory to be served. And then, to of gold or other reserve money re­
secure good results, judgment must quired to support a given volume of
needs be exercised in both cases. Unin­ credit. Estimates of the saving tfius
telligent and lavish use of the water secured vary somewhat, but for our
will be harmful to the crops and may present purpose it is sufficient to note
exhaust the most abundant sources of that all calculations agree in the con­
supply. Similarly with credit, unre­ clusion that gold is now a basis for at
strained use has an unfavorable effect least twice as much credit as in the
upon industrial output, stimulates a period before the Reserve System was
rank growth of speculation and is the established.
principal cause of extreme fluctuations A reduction in the amount of gold
in the general level of prices. Irriga­ required to support a given volume of
tion experience also teaches that ex­ credit would be followed by a positive
tensions and improvements in one reduction in the cost of bank credit if
direction may be wasteful and even the volume of credit was not enlarged.
positively hazardous unless they are Less gold would then be used for bank­
accompanied by balancing develop­ ing purposes, and the surplus could be
ments in other directions. This essen­ used in the arts or exported in payment
tial requirement, if a credit system is to for goods, services or securities. Again,
develop in a satisfactory fashion, is insofar as additional credit might serve
commonly overlooked. The estab­ to increase production, a positive
lishment and operation of the Reserve advantage would be derived from the
Banks has introduced many and im­ reduction in reserve requirements.
portant changes in our banking system. But manifestly the amount of addi­
Whether that development has been a tional credit that can exert a favorable
well balanced development is, in my influence upon production is small. A
judgment, the most searching and im­ large increase in the supply of credit,
portant question raised by our credit if freely used, is a positive detriment
experience during the last six years. to industry. Its effects are seen in
rapidly advancing prices, an over-exM o r e C r e d it a t L o w e r C o st
tended condition of business concerns
An increase in the supply of credit generally, and widespread speculation,
and a reduction in basic costs are culminating in crises and followed by
definite results of the changes in our trade depression.

Leaving out of consideration the to which the conduct of business is
special case of the use of credit in subject.
financing the War, it is not easy to
T h e D is t r ib u t io n o f C r e d it
discover any positive gain that the
country has realized from economy of Turning now to the distribution of
gold which has been secured through credit, the Reserve System is found to
the establishment of the Reserve Sys­ have made considerable, though by no
tem. So far, the results have been means fundamental, changes. On
unfavorable. The additional credit account of the almost complete ab­
was freely extended and we now are sence of branch banking in the United
enduring the inevitable consequences. States, credit is far less fluid in this
So far as the supply of credit is con­ country than elsewhere. The supply
cerned, a repetition of this experience is of credit in each community, and
entirely possible. Loan liquidation, especially in the smaller ones, is in
always an incident of periods of depres­ large measure limited to the resources
sion and abnormal gold imports, is of the local banks eked out by such
placing the banks in position to grant amounts as they may choose or are
billions of additional credit as soon as able to borrow from banks in other
places. Through the Reserve Banks
an active demand develops.
A more certain gain from the Re­ the borrowing facilities of many local
serve System is the assurance that the banks have been materially enlarged.
flow of credit will not be interrupted But it still remains true that credit is
through exhaustion of supply or by the far less fluid than in the countries
working at cross purposes of the banks where banking is conducted by banks
as happened in successive crises down operating regional or nation-wide sys­
to and including the crisis of 1907. tems of branches. This is the price,
This assurance that the flow of credit not necessarily too high a price, that
will not be interrupted in the future is we pay for our system of independent
not the result of the increase in the sup­ local banks.
ply of credit. It could have been It is in the employment of credit that
gained without any increase whatever the least change has followed the
in credit supply. The exhaustion of establishment of the Reserve System.
the lending power of the banks on Aside from certain general restrictions,
future occasions of financial strain is each local bank, and properly, is free
altogether unlikely because the Re­ to employ its funds as may seem to it
serve Banks recognize responsibility advisable. The Federal Reserve Act
for the general credit situation in this widened the scope of the lending activ­
regard, and regularly hold in reserve, ities of the banks somewhat by author­
power to extend credit on an extensive izing them to accept a limited range of
scale to be used freely in case of emer­ bills of exchange and to lend a moder­
gency. Through the Reserve System ate amount on mortgage security.
the banks of the country have also The Act also aimed at making com­
become closely knit together for settle­ mercial loans more attractive by ex­
ment purposes, and there is therefore cluding other loans, with the exception
no longer reason to fear that they will of those secured by United States
suspend payments on future occasions government obligations, from redis­
of financial strain. In short, that a count at the Reserve Banks.
future crisis will degenerate into a These changes in the law and modi­
panic is no longer one of the hazards fications in banking practice are im**

T h e E f f ic ie n c y o f C r e d it


T he A nnals of the A merican A cademy

portant, but were not expected to well within legal reserve requirements.
change materially the general char­ On the basis of the credits secured
acter of the assets of the banks.
through these rediscounts the com­
mercial banks of the country would be
M o r e C r e d i t W i t h o u t N e w U s e s able to extend loans by from two to
This, then, is the gist of the situation three times the amount discounted.
resulting from the establishment and In other words, it may be conserva­
operation of the Federal Reserve tively estimated that there is at least
System: an enormous increase in the ten billion dollars of unused bank
available supply of credit and no con­ credit in the United States at the
siderable new uses for this credit. No present time.
new uses for credit are needed to ab­
sorb this additional supply. The bulk T h e D is c o u n t R a t e a n d t h e P r i c e
L evel
of this additional credit cannot be
employed with advantage to the com­ In the Federal Reserve System we
munity, but only to its positive dis­ have an agency which has the power to
advantage. Credit serves a productive make a vast increase in the supply of
purpose by facilitating the transfer of credit for the bulk of which there is
capital assets and of goods in process only one influence that will create an
of production and marketing. But intense demand. That influence is
when business is active, and people rising prices. A moderate advance in
are already fully employed, additional prices may indeed have a beneficial
doses of credit do not result in a larger
physical output of goods. Additional effect on production after a period of
depression, but prolonged upward
credit then subjects all industry to swing of prices a creates speculative
the unhealthful influence of protracted conditions, stimulates speculative ac­
advance in prices. The demand for tivities, and tends to bring all but the
credit grows more and more intense most cautious business concerns into
and is practically without limit. At an over-extended condition. Such a
such times, moreover, the thousands of prolonged upward movement of prices
competing banks are quite incapable with all its disastrous
of imposing restraint upon borrowers hardly possible withoutconsequences is
large use of the
so long as they possess unused lending credit resources of the Reserve Banks.
power. The fear that desirable deposi­ It would seem, therefore, that the
tors will go elsewhere is strong and
warps judgment. In these circum­ effect of advancingshould on the general
business situation
be a factor of
stances, cautions and warnings from
the first importance in shaping the
the Reserve Banks have little effect;
discount policy of the Reserve Banks,
they were not heeded in 1919.
The Reserve Banks now have a re­ assuming more and more importance
serve which is nearly 75 per cent of as a period of business activity con­
their demand liabilities, with prospects tinues. The management of the
good for a still higher ratio before con­ Reserve Banks is, however, by no
ditions become favorable for a period means inclined to this view of the
of renewed business activity. Redis­ matter. Responsible officers of the
counts to the amount of about $3 ,000,- banks land also members of the Federal
000,000 could be granted and still, in the Reserve Board roundly assert that
absence of gold exports,—an unlikely they are not concerned with the course
event—the Reserve Banks would be of prices and that in the determination

T h e E f f ic ie n c y o f C r e d it

of discount policies the price situation
is not a definite factor.
The attitude of the management of
the Reserve Banks in regard to re­
sponsibility for the course of prices
forcibly recalls an experience of the
most ancient of central banks. For
more than a generation, the directors
of the Bank of England stoutly in­
sisted that the Bank was no more
responsible for the situation in time of
crisis than any other London bank.
Finally, largely as a result of repeated
onslaughts by Bagehot in The Econ­
omist—given more permanent form in
Lombard Street—the policy of the
Bank was definitely reversed and the
course that has become universal
practice in handling crises was adopted.
There is unhappily little doubt that
the Reserve System has lost somewhat
in general public estimation during the


last two years. It bears much of the
burden of the consequences of the
unwise low discount policy which the
Treasury Department unwisely in­
sisted must be continued for more
than a year after the Armistice. The
wisdom subsequently manifested in
refusing to give way to demands for
additional credit, which would have
made a bad situation worse, could not
be expected to make a strong appeal
to the people at large. For the future,
if not prevention, at least clear evi­
dence that the Reserve System has not
contributed to the creation of the
intense activity that breeds depression
is a reasonable demand on the part of
the public. This expectation will not
be realized if large additional supplies
of credit are furnished by the Reserve
Banks at times when prices are rising
rapidly and persistently.

Book Department

D. C. Capital Control in New
York (State). Pp.xxiv, 225. Price, $3.00.
New York: McDevitt-Wilson’s Inc., 1921.
Up to a few years ago, many public
utilities had the habit of claiming that “a
contract was a contract,” while, lately, a
large part of the consuming public has been
inclined to adopt the slogan as its own.
But there has of late been evident a grow­
ing realization on the part of the public
that while revenge may be sweet, it has its
limitations as a steady diet. We can exist
without the utilities, but we cannot “live”
without them; not only are they indispen­
sable to our present standard of comfort,
but they are already lagging far behind our
demands upon them. The utilities, on
the other hand, cannot serve us without a
sound basis of credit, the foundation of
which is a budget which not only balances,
but allows for the necessary reserve and
emergency funds. The result of the har­
rowing experiences of the last five years is
that now, after the pendulum has been
allowed to swing both ways, both the
utility corporations and the public have
experienced a deeper realization than ever
before of the mutual benefit to be derived
from the proper governmental control of
the issuance of securities.
In view of the more widespread realiza­
tion of this fact brought about by recent
events, a study of the regulation of securityissues accomplished in the State of New
York is welcome at this time. New York
was one of the first of our commonwealths
to inaugurate effective control in this mat­
ter, and, being the wealthiest and most
populous of the states, the problems in­
volved were especially numerous and com­
plex; in fact, the First District Commission,
with jurisdiction over the city of Greater
New York, had to cope with problems that
were unique and without a parallel, either
in this country or in Europe.
The author of this monograph has traced
the growth of New York’s administrative
regulation of security-issues from the first
crude and nominal beginnings in the early
fifties of the last century to the middle of
1918, since which time little of constructive
B a l d w in ,

significance has been accomplished. Really
effective control of securities in the State
of New York dates from the going into
effect of the Public Service Commissions
Law (July 1, 1907). This act was fathered
by Governor Hughes and its final enact­
ment was due almost wholly to his per­
sistent efforts. The passage of this act
marked an epoch in public utility regulation.
For years the control of the issuance of
securities by regulative bodies had been
recognized as the key to all the other as­
pects of utility regulation, and this act,
creating the Public Service Commissions of
the First and Second Districts, respectively,
not only granted them power to compel the
rendering of adequate service to the public,
but also clothed them with authority to
approve or reject proposed issues of stocks
and bonds. In the ten years following
1907, the New York Commissions ac­
complished a vast amount of pioneer work
with the aim of securing as conservative
capitalizations as were possible in the face
of the chaotic conditions with which they
were confronted, to the end that the in­
vesting public might be protected without
the necessity of exploiting the consuming
public either through the furnishing of
inadequate service or the charging of
exorbitant rates.
The principles worked out by the Com­
missions during this period, and subse­
quently upheld or modified by the courts,
make an interesting study both from the
standpoint of governmental authority and
of investment protection. In the further
elaboration of sound governmental control
of security-issues, which recent experience
has shown to be so necessary for all parties
concerned, these principles will be regarded
as among the most valuable precedents
H a y e s , E d w a r d C a r y . Sociology and
Ethics. Pp. viii, 354. Price, $3.00 net.
New York: D. Appleton and Company,
This book may be said to be a footnote
to a paragraph in the author’s Introduction
to Sociology, published five years ago, ii*

B ook D epartment

which he wrote (page 4): “Sociology aims
at nothing less than the transfer of ethics
from the domain of speculative philosophy
to the domain of objective science.” The
book is essentially a plea for an objective
scientific ethics—for a sociology which is
an objective scientific ethics.
Ethical theory, according to Dr. Hayes,
who is professor of Sociology at the Uni­
versity of Illinois and now president of the
American Sociological Society, has passed
through the “three stages of progress” of
Comte’s famous classification. It first had
its theological stage, in which the moral
law was regarded as the voice of God in
the soul of man. Then followed the met­
aphysical period, with the concept of moral
law as an abstraction emanating from the
“Ding an Sich.” Finally, it is in process
of entering the “scientific” stage, in which
rightness and goodness of conduct will be
determined by scientific study of the real­
ities of life, wherein the values of life will
be determined objectively.
It is a thought-provoking book. Soci­
ologists who have emphasized the pure
rather than the applied side of their sub­
ject will find their practice sharply chal­
lenged. Historical ethics is reminded of
its a priori assumptions and preoccupations
with an abstract individualism. ^Theo­
logians and moralists, alarmed by the
deterministic implications of social science,
are reassured, such implications being rec­
onciled in their traditional views. Al­
though the book is marred by a deal of
repitition, obviously the result of inter­
mittent effort scattered over a number
of years, it is a searching but optimistic
analysis that will repay careful perusal.
J a m e s H. S. B o ssa r d .
University of Pennsylvania.
B a r k e r , J . E l l is : Modern Germany, Her
Political and Economic Problems. Pp. vii,
496. Price, $6.00. E . P. Dutton & Co.,
This is the sixth edition “entirely re­
written and very greatly enlarged.” The
writer is a widely known and very able
authority, whose writings in the leading
British journals have attracted wide atten­
tion. In this edition he had condensed


much that appeared in earlier editions and
included seven new chapters.
L ip p in c o t t , I s a a c : Economic Develop­
ment of the United States. Pp. xvi, 691.
Price, $3.50. New York: D. Appleton and
Company, 1921.
One of the greatest needs of American
students has been for a suitable economic
history of the United States. Perhaps
time is necessary for the scholars of any
country to produce such a work because
of all that is involved. At any rate, for
that reason or for some other, there has
been a dearth of satisfactory studies. Even
the monographic literature has been com­
paratively meager.
Professor Lippincott has taken a great
step in advance in his treatment. As he
observes in the introduction, he has not
limited himself to a mere record of indus­
trial progress, but has endeavored to bring
together causes and results. After an in­
troductory section on factors in economic
development, the treatment is by periods
through 1914 with a concluding chapter on
the war period from 1914 to 1920. Empha­
sis is well distributed over the different peri­
ods and a common defect of such studies—
over-emphasis on the earlier years—seems
to have been avoided. The distribution
of space between different phases of develop­
ment may, however, be more open to crit­
icism. For the period from 1860 to 1914
only two chapters are given to the extrac­
tive industries and two to agriculture,
a total of 89 pages, while to manufactures
and commerce are given eight chapters
or 220 pages. We are still nearly fifty
per cent a rural population. This fact
and the acute problems presented by our
rural conditions would seem to warrant a
different emphasis.
The volume is the best study yet avail­
able, both for private reading and for the
class room, andwill doubtless find a wide use.
B o w m a n , I s a ia h , Ph. D. The New World.
Pp. vii, 632. Price, $6.00. New York:
World Book Company, 192X.
The past few months have been months
of intensive education of the American peo­
ple in affairs international. The conclusion


T he A nnals of the A merican A cademy

of the World War with its remaking of maps
and its reordering of industries and of
markets has made this world a very small
one. This book gives a wealth of world facts
each citizen should have at his disposal.
The book is a geography replete with
maps reliable and up to date; but it is more
than a geography. The book is a history
in that the important epochs in the his­
torical, industrial, social and racial develop­
ments of each of the countries are noted;
but it is more than a history: It is a treatise
of world-wide industry in that it gives the
location and output of coal mines, and iron
mines and other natural resources; it lo­
cates the world’s industries, it outlines the
world’s waterways, pictures the world’s
routes for trade, and gives the industrial
backbone of every nation. And yet it is
more than a book on industry. It is also
replete with matters political in their de­
velopment and social in their origin. And
yet it is something more than a source
book on the leading social and industrial
facts of the nations of the earth. The
book is a mine of information as broad as
human life itself and this information is
concisely put and is accurate in its scholar­
ship. Only one in close touch with the ex­
tensive sources of the American Geograph­
ical Society, and in close touch with all the
information open to government officials
preparatory to the many recent world con­
ferences, could have had access to the diver­
sified sources from which the knowledge in
this volume has come.
The book discusses the problems of im­
perial Britain, the political and colonial
aims of France, Belgium as the crossroads
of Europe, the Italian situation, the dem­
ocratic drift in Spain, Portugal’s colonial
policies, transportation and industrial prob­
lems of Switzerland, the Scandinavian
countries and Holland, the problems of the

German people, the national existence of
Austria, the new Hungary, the domain of
the Czecho-Slovaks, Jugo-Slavia and the
Adriatic, the new frontiers of Rumania, the
mountaineers of Albania, the reunited
Greek lands, the borderlands of Poland, the
development of Lithuania, land tenure and
trade outlets in Esthonia and Latvia, the
geographical setting and the problems of
Finland, the ethnic groups of the Russian
Empire with the background of the Russian
disorder, Constantinople as a European
thoroughfare, the Jewish homeland—
Palestine, Anatolia—the last remnant of
the Turkish Empire, the Transcaucasian
peoples, the interests of Persia in their re­
lation to British industry, the unsettled
land of the Nomad in inner Asia, the raw
materials in the Far East and their control,
the expansion of Japan toward the main­
land of Asia, the conflict of Chinese and
Japanese interests, the Pacific realm and
Australia, the past and present status of
colonies, the European powers in Africa,
boundary disputes in Latin America and
the relations between Latin America and
the United States.
Such a recital of the contents of the book
gives some idea as to its value as a reference
book at these times. Not the least valuable
part of the book is its carefully prepared
bibliography covering each of the points
mentioned above and many, many others.
In an Appendix is given a list of dates and
names of principal treaties and agreements
from 1814 to 1920. In addition to the
maps are many choice illustrations re­
flecting the natural and industrial activi­
ties of many of the leading countries of the
world. The book is a credit not only to
the author but to American scholarship in
C l y d e L. K in g .
University of Pennsylvania.

Acceptances: authorization of, by Reserve Act,
xv, 211, 212; definition of trade, 106, 213; the
discount and bankers’, 111- 3, 212; extent of,
market, 214- 7 ; function of bankers’, 110, 217;
the open market and, 211- 3 ; Reserve Bank
purchases of, 216; special inducements to buy,
214; volume of member bank, 215.
A g g e r , E. E. The Development of an Open
Market for Commercial Paper, 209- 18.
A g r i c u l t u r a l a n d C o m m e r c ia l L o a n s.
J. B. McDougal, 199- 203.
Agricultural loans: charge of discrimination
against, 203, 206, 207- 8 ; commercial and, 201,
202; rediscount rates and, 208; relation of, to
reserve deposits, 201; relative nature of, 199201. See Agricultural paper.
Agricultural paper: definition of, 106; eligibility
of, for discount, 106- 10; maturity of, xii, 106- 7.
Aldrich Plan: comparison with Reserve Act, 23,
48- 9, 64; lack of public confidence in, 23,
30 ; substance of, 21. See Aldrich-Vreeland
emergency currency.
Aldrich-Vreeland emergency currency: avail­
ability for war demand, 50 ; Federal Reserve
notes and, 54- 5 ; National Currency Associa­
tions and, 52- 3, 136; provisions of act granting,
50, 52 ; retirement of, 53-4 ; statistics of, 51.
A ld r ic h - V r e e la n d E m e r g e n c y C u r r e n c y ,
T h e . Homer Joseph Dodge, 49- 55 .
Amendments to Federal Reserve Act: Act of
April 13, 1920, 121; Act of June 21, 1917,
115- 6 ; Act of March 3, 1919, 119; Act of Sep­
tember 7, 1916, 114- 5, 120; Act of September
26, 1918, 118- 9 ; bearing and trend of, xvii;
foreign banking, 119- 20.
A m en d m en ts t o t h e F e d e r a l R e s e r v e A c t.
Walter S. Logan, 114- 21.
American Bankers Association: xvi, 15, 167, 168.
A ssu m p tio n op T r e a s u r y F u n c t io n s b y t h e
F e d e r a l R e s e r v e B a n k s , T h e . Murray
S. Wildman, 129- 35.
Baltimore Plan: 15.
B a n k in g H is t o r y fr o m t h e F ir s t B a n k op
t h e U n it e d S t a t e s t h r o u g h t h e P a n ic
o p 1907, O u t lin e o f . B . H . Beckhart, 1- 16.

Banking reform: educational campaign for, 2936; experiments of 1836-1863 in, 6; general
efforts at, 14- 6 ; the national banking system
and, 6- 7 ; the National Citizens’ League and,
26- 9, 34 ; question of administration, 25;
recommendations of National Monetary
Commission, 22- 3.
Bank rates: 193, 194.
B a n k R a t e s a n d B u s in e s s A c t iv it y , R e ­
d is c o u n t R a t e s . George M. Reynolds,


B. H. Outline of Banking History
from the First Bank of the United States
Through the Panic of 1907, 1- 16.
Branches: development of, 141- 2 ; early disad­
vantages of, 138- 9 ; establishment of, 137- 8,
139; functions of, 140- 1 ; organization of, 140.

B eck h a rt,

B r a n c h e s o f F e d e r a l R e s e r v e B a n k s,
T h e E s t a b lis h m e n t a n d S c o p e o p . E . R .

Fancher, 135- 42.
Business Men’s Monetary Conference: 27.
C a se , J. H. Preparation for War and the Liberty
Loans, 121- 9.
Centralization: 24, 62, 70, 137.
Check-collection system: 60- 1, 69 \ before Re­
serve System, 82- 3, 95 ; “exchange,” 83.
See Par collection system.
Collection System: See Par collection system,
Check-collection system.
Commercial banking: ix, xii, 58- 9, 155, 187, 208.
Commercial paper: acceptance of, as security, 52;
distinction of, from agricultural, 106; eligibility
for discount, 107- 10, 69 ; open market for,
209- 18.
C o m m e r c ia l P a p e r , T h e D e v e lo p m e n t op
a n O p en M a r k e t f o r . E. E. Agger, 209- 18.
C o n g r e s s , T h e F e d e r a l R e s e r v e A c t in .
H. Parker Willis, 36- 49.
Contraction: See Expansion and contraction.
C o n t r a c t io n a s S e e n B y a B u s in e s s M a n ,
E x p a n sio n a n d . J. V . Farwell, 163- 7.
C o n t r a c t io n , 1919- 1921, C u r v e s o f E x p a n ­
s io n a n d . A . C . Miller, 142- 50.
C o n t r a c t io n fr o m t h e F e d e r a l R e s e r v e
S ta n d p o in t, E x p a n sio n a n d . John H. Rich,
174- 83.
C o n t r a c t io n u n d e r t h e F e d e r a l R e s e r v e
S y ste m , E x p a n sio n a n d . E . M. Patterson,
151- 63.
Country banks: conflict of, on note issues, 61 ;
general advantage of system to, 81- 2 ; old
collection system and, 82- 3 ; proportionate
borrowings of, 199- 200. See Agricultural
Credit: business, and Reserve System, ix-x, xxi,
142- 4, 192; commercial banking and, ix; control
of, 25, 182- 3, 195- 9 ; distribution of, 219- 20;
expansion and contraction of, 69, 178- 82 ;
Federal Reserve System and, 219- 21 ; a guide
to, policy; 148; member bank, curve, 144- 5,
147; more, at lower cost, 218; more, without
new uses, 220; an open discount market and
mobility of, 210-11; Reserve bank, curve,
145- 8 .
C r e d it , T h e E f f ic ie n c y o f . O. M . W.
Sprague, 218- 21.



T he A nnals op the A merican A cademy

C r e d it u n d e r t h e O p e r a tio n o f t h e F e d ­
e r a l R e s e r v e S y ste m , T h e o r e t i c a l C on ­
s id e r a t io n s B e a r in g o n t h e C o n t r o l o f
B a n k . Chester A. Phillips, 195- 9 .
C r e n n a n , C . H. The Integrity of the Federal

Reserve System, ix-xxvi.
Currency: appreciation and depreciation of, 151,
157- 8 ; complexities of our, 24, 60 ; expansion
and contraction of, 170- 3 ; function of Reserve
System, 89, 169, 173, 176- 7 ; inflation and de­
flation of, 170- 1 ; revision of, 26- 9 ; shipment
of, by Reserve Banks, 90.
Currency Commission: 167- 8.
C u r r e n c y E x p a n sio n a n d C o n t r a c t io n .
James B. Forgan, 167- 73.
C u r v e s o f E x p a n sio n a n d C o n t r a c t io n ,
1919- 1921. A. C . Miller, 142- 50.

Deflation: See Inflation and deflation.

D e v e lo p m e n t o f a n O p en M a r k e t f o r
C o m m e r c ia l P a p e r , T h e . E. E. Agger,

209- 18.
Directorates of Federal Reserve Banks: Class
A directors, 65- 6 ; Class C directors, 65- 6, 73 ;
purpose of, 65, 88; Reserve Board and, 65- 7,
D is c o u n t , E l i g i b i l i t y f o r . Charles L. Powell,
105- 13.
Discount rate: Act of April 13, 1920 and, 121;
adjustment of, of Reserve Banks, xviii, 18490 ; agricultural paper and, 107- 10; bankers*
acceptances and, 110- 3 ; commercial paper
and, 107- 10; open market, 209- 18; price level
and, 220- 1 ; question of raising of, 160, 165,
166; Table of Reserve Bank, 1915- 1921, 216;
variations in, 62- 3. See Open market, Re­
discount rate.
D is c o u n t R a t e , P r in c ip le s G o v e r n in g t h e .
W. P . G. Harding, 183- 9.
D o d g e , H o m e r J o se p h . The Aldrich-Vreeland
Emergency Currency, 49- 55.
E a r l y F u n c t io n in g o f t h e F e d e r a l R e ­
s e r v e S y ste m . Arthur Reynolds, 74- 9 .

Earning assets of the Federal Reserve System,
77- 8 .
Edge law corporations: xxiv-xxv.
Educational campaign for banking reform: aid
from politics, 33 ; magnitude of undertaking,
29- 30 ; publicity media, 31- 3 ; recruiting of
forces, 31 ; success of, 36.
E d u c a t io n a l C am paign f o r B a n k in g R e ­
fo r m , T h e . A. D . Welton, 29- 36.
E f f i c ie n c y o f C r e d it , T h e . O . M . W .
Sprague, 218- 21.
E l i g i b i l i t y f o r D is c o u n t . Charles L. Pow­
ell, 105- 13.
E s t a b lis h m e n t a n d S c o p e o f B r a n c h e s o f
F e d e r a l R e s e r v e B an k s, T h e. E . R .

Fancher, 135- 42 .

Exchange charges: xxv, 83, 95, 116, 117.
Expansion and contraction: business viewpoint,
163- 7 ; contrast with inflation and deflation,
152; currency, 170- 3 ; determinable factors in,
149, 150; discount rate and, 159, 160- 2, 164,
165, 166; of Federal Reserve notes, 177; in­
creased gold reserve and, 154; measurement
of, 142- 4 ; member bank credit curve of, 144- 5 ;
possibility for bankers to check over-expansion, 163- 5 ; prevention of over-expansion and
over-contraction, 166- 7 ; Reserve Bank credit
curve and, 146- 8.
E x p a n sio n a n d C o n t r a c t io n a s S e e n b y a
B u s in e s s M a n . J. V. Farwell, 163- 7 .
E x p a n sio n a n d C o n t r a c t io n , C u r r e n c y .
James B. Forgan, 167- 73.
E x p a n sio n a n d C o n t r a c t io n , 1919- 1921,
C u r v e s o f . A. C. Miller, 142- 50 .
E x p a n sio n a n d C o n t r a c t io n fr o m t h e F e d ­
e r a l R e s e r v e S ta n d p o in t. Joh n H. R ic h ,
174- 83.
E x p a n sio n a n d C o n t r a c t io n U n d e r t h e
F e d e r a l R e s e r v e S y ste m . E . M. P a tterso n ,
151- 63.
E v o lu t io n a n d P r a c t i c a l O p e r a tio n o f t h e
G o ld S e t t l e m e n t F u n d , T h e . George J.
Seay, 95- 105.
F a n c h e r , E. R. The Establishment and Scope
of Branches of Federal Reserve Banks, 135- 42 .
Farmer: charge of discrimination against, 186,
203, 206, 207- 8 ; Reserve Banks’ problem, 1812. See Agricultural loans.
F a r w e l l , J. V. Expansion and Contraction as
Seen by a Business Man, 163- 7.
Federal Advisory Council: 64- 5, 170, 188- 9 .
Federal Reserve Act: amendments to, xvii, 11421; attempts at change in, xvi, 57 ; attempts at
substitutes for, 40- 1; changes by Senate, 46- 7 ;
comparison with Aldrich Plan, 23, 48- 9 ;
digest of preliminary measure, 41- 5 ; establish­
ment of open market under, 211- 13; inception
of measure, 37, 48 ; increased deposit liabilities
under, 153- 4 ; meaning and purpose of, ix, 56,
58, 60, 62, 68- 9, 87, 169, 173; Mr. McAdoo
and, 39- 40 ; passage by House, 45- 6 ; public
hearings on, 38- 9 ; relations of, to international
finance, xxiv-xxv.
F e d e r a l R e s e r v e A c t in C o n g r e s s , T h e .
H. Parker Willis, 36- 49.
Federal Reserve agents: Gold Fund, 100-1.
Federal Reserve Banks: avoidance of investment
operations by, xxii, xxiv; capital and dividends
of, 67; clearings and transfers of, through Gold
Settlement Fund, 97- 9, 102, 103- 4 ; commer­
cial scope of, ix, 58, 59 ; credit curve of, 145- 8 ;
criticism and defense of activities of, 206- 9 ;
as depositaries, 132- 3 ; directorates of, xv, 657, 88, 200; early operation of, xiii-v, 74- 5 ;
facilities of, for war financing, 156- 7, 121; as

I ndex
fiscal agents of the government, 59, 87, 124,
134, 161, 203- 4 ; functions of, 68- 9, 72, 74- 5 ;
impounding of gold by, 122- 3, 162, 192; inter­
relations of, 92- 5 ; intra-district clearing plan
of, 99- 100,101; as Liberty Loan agents, 125- 9,
156- 7, 204; loaning operations of, 93, 94, 199203; nature of, ix, xx, 56, 58, 87- 8 ; necessity
for, to adhere to rules of eligibility for discount,
113; par collection system of, 83- 5, 141, 61, 75,
76, 116; regional character of, xxi, 62- 3, 92 ;
relations with Reserve Board, 72, 73, 93- 4 ;
relations with member banks, 88- 9, 91- 2, 1756, 178- 9 ; Treasury duties assumed by, 134- 5 ;
violation of sound banking principles by,
204- 5 ; war compulsions as cementing factor
of, 89, 203- 4.

F e d e r a l R e s e r v e B a n k s , P o p u la r a n d Un­
p o p u la r A c t iv it ie s o f t h e F e d e r a l R e ­
s e r v e B o a r d a n d t h e . William A . Scott,

Federal Reserve Board: character of the 63- 5,
71 ; criticisms and defense of, policy, 206- 9 ;
definitions of eligible paper by, 106; early
operation of the, xiv, 74- 5 ; independence of,
57- 8, 74; personnel of, xv, 71, 72, 73- 4 ; politi­
cal pressure and the, xiv, 71- 4 ; Reserve Bank
directorates and, 65- 7, 71 ; Reserve Banks and,
xxi, 72, 73, 93- 4 ; rediscount problem con­
fronting, 189; suggested remedy for certain
defects in, 71- 2.

F ed e ra l R eserv e B oard and th e F ed e ra l
R e s e r v e B a n k s , P o p u la r a n d U n p o p u la r
A c t iv it ie s o f t h e . William A . Scott, 203- 9 .

Federal Reserve Notes: xxiii, 24, 53, 60, 69, 89,
122, 169, 171, 176- 8, 195.
F e d e r a l R e s e r v e S y ste m , S t a t e B a n k s a n d
P a r C o l l e c t i o n s , T h e . Pierre Jay, 79- 86.
First United States Bank: 1-2, 6, 136- 7.
Foreign banking systems: 20, 24, 25, 160, 171- 3,
F o r g a n , J am es B. Currency Expansion and
Contraction, 167- 73.
F u n c t io n in g o f t h e F e d e r a l R e s e r v e S y s­
te m , E a r ly . Arthur Reynolds, 74- 9 .
G id n e y , R. M. Relations of Reserve Banks to
Member Banks and Inter-Relations of Federal
Reserve Banks, 87- 95.
G o ld : control of, by Federal Reserve System,
xxv; impounding of, by Reserve Banks, 122- 3 ;
increased, reserve, 154, 169, 192; influx of,
xxv, 162, 192; Table.of, 1917- 1919, 123. See
Gold Settlement Fund.
Gold Settlement Fund: Amendment of June 21,
1917, 102- 3 ; daily settlements through the,
103- 4 ; early need for, 96- 7 ; establishment of,
97-9; Federal Reserve agents’ Gold Fund and,
102; final refinement of, 104.
G o ld S e t t l e m e n t F u n d , T h e E v o lu tio n



P r a c t i c a l O p e r a tio n o f t h e . George J.
Seay, 95- 105.
Gold Standard Act: 9.
Government bonds: xxiii, xxv, 39, 59, 107, 167,
H a r d in g , W. P. G. Principles Governing the
Discount Rate, 183- 9.
Independent Treasury: bill creating, 4- 5, 129;
branches, 137; changes in, under Act of 1920,
134; effect of War on, 133; new policy super­
seding, 130- 1; outgrown system, 130; situa­
tion, 1865- 1913, 131- 2 ; situation, 1913- 1916,
132- 3.
Inflation and deflation: as contrasted with
expansion and contraction, 152; responsibility
for inflation 1914- 19, 157; under Reserve Act,
I n t e g r i t y o f t h e F e d e r a l R e s e r v e S y ste m ,
T h e . A. B. Welton and C. H. Crennan, ixxxvi.
Investment banking, ix, xxii, 58- 9.
J a y , P ie r r e . The Federal Reserve System,
State Banks and Par Collections, 79- 86.
K em m e re r , E. W. The Purposes of the Federal
Reserve Act as Shown by Its Explicit Pro­
visions, 62- 9.
Liberty Loans: cementing factor in Reserve
System, 89; handling of, by Federal Reserve
Banks, 126- 9, 156- 7 ; machinery for floating,
124- 6 ; partial payments, 126; payment of, by
book credit, 127.
L ib e r t y L o a n s, P r e p a r a t io n f o r W a r a n d
t h e . J. H. Case, 121- 9 .
L o g a n , W a l t e r S. Amendments to the Federal
Reserve Act, 114- 21.
M c D o u g a l, J . B. Agricultural and Commercial
Loans, 199- 203.
Member banks: advantages of System to, 81- 2,
85, 89- 90, 91 ; credit curve of, 144- 5, distribu­
tion of, by districts, 81 ; loans to, 200- 3 ; rela­
tions of, with Reserve Banks, 88- 9, 91- 2,
175- 6, 178- 9 ; reserve requirements for, 117- 8 .
M em ber B an k s a n d I n te r -R e la tio n s o f
F e d e r a l R e s e r v e B a n k s , R e l a t io n s o f
R e s e r v e B a n k s t o , R . M . Gidney, 87- 95.

Membership: 174- 5. See National banks, State
M i l l e r , A. A. Curves of Expansion and Con­
traction, 1919- 1921, 142- 50.
Money trust: xii, 30, 35, 37, 40, 57, 58.
National Bank Act: 6- 7, 8, 11, 15, 56, 154, 157.
National banks: acceptance powers of, 114- 5 ;
and Aldrich-Vreeland emergency currency


T h e A nnals of the American A cademy

52- 3 ; foreign banking provisions for, 120;
Contraction Under the Federal Reserve
membership in Reserve System, xvi, 67, 79, 87,
System, 151- 63.
123- 4, 174; in panic of 1907, 11- 12; trust P h illips , C hester A. Theoretical Considera­
powers of, 118-9 ; under Act of 1864, 7 ; under
tions Bearing on the Control of Bank Credit
Act of 1865, 8 ; under the Gold Standard Act, 9.
Under the Operation of the Federal Reserve
System, 195- 9.
National banking system: aims and establish­
ment of, 6- 7 ; difficulty of open market opera­ P olitical P r e ssu r e a n d th e F u t u r e of th e
F ed era l R e se r v e S ystem . Paul M . Warburg,
tions under, 211; entrance of state banks into,
70- 4 .
8; weaknesses of, 11- 15, 22- 3, 135, 153, 168.
National bank notes: inelasticity of, 13- 14; Politics: dangers to integrity of Federal Reserve
System, 71- 4.
issue of, under plan of Monetary Commission,
16; seasonal variations in, 13, 14; under Act of P opular a n d U npo pu lar A ctivities o f th e
F ederal R eserve B oard a n d th e F ed era l
1864,7 ; under Gold Standard Act, 9.
R ese r v e B a n k s . William A . Scott, 203- 9 .
National Citizens’ League: influence on Glass
bill, 36; organization and development of, 27-9 P ow ell , C harles L. Eligibility for Discount,
105- 13.
31; politics and the, 33 ; publicity of the 31- 3 ;
purpose and result of, xi, 35- 6 ; resolutions P reparatio ns for W ar an d th e L iberty
L oans . J. H. Case, 121- 9.
leading'to formation of, 26- 7 ; statement of
P rin ciples G overning th e D isco un t R a te .
principles of, 34.
W. P . G . Harding, 183- 9.
N ational C itizen s ’ L e a g u e ; A M ovem ent for
Public opinion and the Reserve System, ix-xi,
a S ound B a n k ing S ystem , T h e . H. A. Wheeler
xx, xxii, 159, 203, 209.
26- 9.
po ses
ed era
ese r v e
National Currency Associations, xiii, 52- 3, 136, P urhow n bof it se EFxplicitl PRrovisionsA ct haes.
, T
E . W. Kemmerer, 62- 9.
National Monetary Commission: disclosures of
studies by, 21- 2, 61; duties of, 17- 18; origin Rediscount rate: Act of September 7, 1916 and,
of, 17, 168; publications of, 18- 21; investiga­
115, advantages of Reserve Bank, facilities,
tion of foreign banking by the, 20; recommen­
81- 2, 89, 169, 180- 1; as credit regulator, 159,
dations of, 22- 3 ; the Reserve Act and the, 23;
182- 3, 196, 198- 9 ; early prejudice against, 75unlearned lessons from, 24- 5 .
6; the farmer and the, 208; influences affecting,
N atio nal M onetary C ommission , T h e S tu dies
191- 4 ; interbank, 92, 155, 161; market rate
o f th e . N . A. Weston, 17- 26.
and, 184, 185, 186, 187, 188, 190, 198- 9, 204;
Non-member institutions: attitude of, 81; in­
pressure for lower, 205- 6 ; problem confronting
evitability of, xvi; par collection system and,
Reserve Board, 189; a progressive, 165;
117; provision for clearing by, under Amend­
proper policy as to, 173, 184- 90 ; question of
ment of June 21, 1917, 116.
raising the, 160, 161- 2 ; 165, 166, 170; recom­
mendations of Advisory Council as to, 188- 9,
Open Market: bills bought in, 217; conditions
191- 2 ; relation of, to expansion and contrac­
creating an, 210-11; establishment of, by
tion, xvii, 179, 192- 3, 205. See Discount Rate.
Reserve System, 211- 14; function of, 209- 10; R edisco unt R ates , B a n k R ates a n d B u sin e ss
importance of the, xix-xx; Reserve Bank
A ctivity . George M . Reynolds, 190- 5 .
purchases in, 216.
R elations of R eserve B a n k s to M em ber
O p e n M arket for C ommercial P a per , T he
B a n k s an d I nter - R elations of F ederal
D evelopm ent of a n . E. E. Agger, 209- 18.
R ese r v e B a n k s . R . M . Gidney, 87- 95.
Organization Committee: xiii, 73, 92, 138.
R e se r v e A ct in it s I m plicit M ea n in g , T h e .
A. D . Welton, 56- 62.
Panic of 1907: general causes of, 10; immediate R eynolds , A rth ur . Early Functioning of the
Federal Reserve System, 74- 9.
causes of, 10-11; lesson of, 168; measures for
relief, 14; results of, 167, 168; revelation of R eynolds , G eorge M . Rediscount Rates, Bank
weakness in American banking system through,
Rates and Business Activity, 190- 5 .
12- 3, 167.
R ich , J ohn H. Expansion and Contraction
from the Federal Reserve Standpoint, 174- 83.
Par collection system: aid of branches in, 141;
growth and advantage of, 83- 85, 90, 117;
inclusion in section on note issues, 61 ; institu­ S cott, W illiam A. Popular and Unpopular
tion of, 76, 75, 116; non-member banks and,
Activities of the Federal Reserve Board and
117; opposition to, on part of non-member
the Federal Reserve Banks, 203- 9.
institutions, 81, 85 ; transfers of funds under, S eay , G eorge J. The Evolution and Practical
86, 117.
Operation of the Gold Settlement Fund, 95105.
P a t t e r s o n , E r n e s t M in o r . Expansion and

I ndex
Second Bank of the United States: 2- 4, 6, 61, T r e a s u r y F u n c tio n s b y t h e F e d e r a l R e­
136- 7.
s e r v e B an k s, T h e A ssum p tion o f. Murray
S prag ue , 0 . M . W . The Efficiency of Credit,
S. Wildman, 129- 35.
218- 21.
Trust companies: growth of, 1896- 1907, 10; in
State banks: entrance of, into national banking
panic of, 1907, 11; membership in Reserve
systems, 8; growth of, 1896- 1907, 10; in chaos
System, 87, 80, 115, 174.
of 1811- 1816, 2, 4 ; in panic of 1907, 11; mem­
bership in Federal Reserve System, xvi, 74, 76, War Finance Corporation: xvii, xxii, xxiii, 5960, 107, 166- 7, 191.
79- 81, 88, 115- 6, 124, 174; statistics of, from
1836- 1863, 5- 6 ; unsuccessful use of, as de­ W arburg , P au l M. Political Pressure and the
Future of the Federal Reserve System, 70- 74.
positaries, 4 .
S tate B an k s a n d P ar C ollections , T h e W elton , A. D. The Educational Campaign for
Banking Reform, 29- 36. The Integrity of the
F ederal R eser v e S ystem , Pierre Jay, 79- 86.
Federal Reserve System, ix-xxvi. The Reserve
S tu dies of th e N ational M onetary C ommis ­
Act in Its Implicit Meaning, 56- 62.
sion , T h e . N . A. Weston, 17- 26.
Subtreasuries: assumption of duties of, by Re­ W esto n , N. A. The Studies of the National
Monetary Commission, 17- 26.
serve Banks, 130- 1, 134- 5 ; general abandon­
ment of, 134; investigation of, 131; objec­ W h e ele r , H arry A. The National Citizens'
tionable features of, 130. See Independent
League: A Movement for a Sound Banking
System, 26- 9.
W ildm an , M urray S. The Assumption of
T heoretical C onsiderations B earing on
Treasury Functions by the Federal Reserve
Banks, 129- 35.
the C ontrol of B a n k C redit U n d e r th e
O peration of th e F ederal R ese r v e W illis H. P ar k er . The Federal Reserve Act
in Congress, 36- 49.
S ystem . Chester A. Phillips, 195- 9.