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LIBRARY
UNIVERSITY OF
CALIFORNIA
•ANTA CRUZ

The Reserve Banks
and the Money Market

THE RESERVE BANKS
AND THE

MONEY MARKET
By

W. RANDOLPH BURGESS
Assistant Federal Reserve Agent
Federal Reserve Bank of New York

With an Introduction by

BENJAMIN STRONG
Governor of the
Federal Reserve Bank of New York

HARPER y BROTHERS PUBLISHERS
New York and London

THE RESERVE BANKS AND THE MONET MARKET

A-C

INTRODUCTION
The twenty years of discussion of banking and
currency reform which preceded the enactment of
the Federal Reserve Act showed the extent to which
political and sectional dissension even to the point
of bitterness can be aroused by such subjects. Our
history from the beginning of the government is
filled with controversies about “money.” It was in
this atmosphere that the Federal Reserve Act was
drafted and the System inaugurated.
Further difficulties arose from the existing com
plication of our banking system. While the Na
tional Bank Act prescribed uniform structure, func
tions, and supervision for national banks, the
forty-eight states had separate systems with widely
varying characteristics, In general, state banks
were of three classes—commercial banks, trust com
panies, and mutual savings banks; but they had
various reserve requirements, conducted a great
variety of business, and supervision differed greatly.
Since the enactment of the Federal Reserve Act the
number of these independent banks of all sorts has
varied from 25,000 to 30,000. No change in our
currency and banking system would have been ac
cepted which involved any general disturbance to
the existing practices and the vested rights of this
great number of banks. The new organization had
to be superimposed upon an already complicated

INTRODUCTION

system, and the execution of each one of the func
tions of the Reserve Banks involved more or less
competition with the member banks which fur
nished the capital and deposits of the Reserve
Banks.
With this rather ominous outlook the Reserve
Banks came into being at the beginning of the
greatest war in history. No specific provision
could have been made in the Act for such an emer
gency, as its authors had no thought of even the
possibility of so serious a world calamity. It is im
mensely to their credit that this great piece of legis
lation, prepared without special regard to the
exigencies of war, so nearly met the needs of war
finance.
Undoubtedly, what would have been a normal de
velopment of the System in time of peace is greatly
obscured by the occurrences of the war, which in
volved the System in operations of such magnitude
and of so unusual a character that judgment as to
what its normal development will be should even
now be suspended. For a time criticism and objec
tion were dormant, the preoccupation of the war
having turned men’s minds in other directions. But
after the war emergency had passed, discussion and
criticism of the System, its functions, operations,
and policies, became vigorously active.
In view of these circumstances it is not strange
that much, if not most, of the public discussion of
the Federal Reserve System has been controversial
and has centered upon the part played by the Sys
tem in the so-called “war inflation” and “agricul-

INTRODUCTION

vii

tural deflation,” or upon those various instances in
which the System appears to have clashed with
what were regarded as the vested rights of the coun
try's thousands of independent banks. As the
System has gained general public approval, disputes
have also arisen as to who may rightfully claim its
authorship.
More recently, however, interest in the Reserve
System has shifted, and there has grown up a de
mand for more information as to the significance of
its normal daily operations and more explanation
of the basal considerations in determining Federal
Reserve policies. The controversies over the part
played by the System in the war and post-war
period are receding into history. Member banks
generally have accepted as minor costs of a major
improvement such losses as may occasionally result
from Federal Reserve competition. The passage
early in 1927 of the bill providing for indeterminate
charters for the Reserve Banks has marked the pass
ing of the early controversies. In their place there
has arisen increasing discussion as to the precise re
lationships between the Reserve Banks and the
money markets and the effects of Federal Reserve
action upon credit conditions.
The operating officials of the Reserve Banks, not
withstanding the mass of literature which has al
ready appeared, are constantly being asked for some
description of the System’s functions and methods
which will show its place in the economic life of the
country, which will be comprehensive and at the
same time sufficiently simple and illuminating as to

viii

INTRODUCTION

be truly instructive to the average reader. Dr. Bur
gess has undertaken to prepare such a book in
response to a widespread demand both in this coun
try and abroad. He has scrupulously avoided elabo
ration of the intricate technicalities of reserve
banking and exploration into the unlimited field of
theory. But the book is more than a popular
treatise; though written in simple language, it con
stitutes an important contribution to economic
science. Dr. Burgess’s experience in a responsible
office in the Federal Reserve Bank of New York for
the past seven years has been of a character which
gives him intimate knowledge of the functions and
services not only of the Federal Reserve Bank of
New York, but of the System as a whole.
He and his coworkers have over a series of years
conducted scientific studies of various aspects of
Federal Reserve operations, especially of the rela
tion of the System to the money market, which have
proved of daily practical value to the operating offi
cers of the New York Reserve Bank. The results
of several of these research studies are reported in
this book.
Should it appear to the reader that undue weight
is given to the relation of the Federal Reserve Sys
tem to the country’s central money market, there
are certain facts in that connection which may well
be considered. While the Federal Reserve System
is truly a regional system, each Reserve Bank being
largely autonomous in its domestic operations, it
nevertheless is a national system and does not at
tempt to encourage or enforce banking or financial

INTRODUCTION

development in this country in twelve separate
watertight compartments. Such an extreme appli
cation of the regional principle would have been in
jurious to the nation as a whole. So the evolution
of the System’s affairs has resulted in a very proper
and necessary coordination of the operations and
policies of the Reserve Banks. Investment and
open-market transactions must be conducted har
moniously and, necessarily, the largest volume of
these transactions is executed in New York. The
same applies to the immense services performed as
fiscal agents for the United States Government, and
to all the foreign business of the Federal Reserve
System.
Many of these most important phases of Federal
Reserve operations center about the New York
money market, where the financial headquarters of
many national industries are located, where money
rates are determined, and where most of the contacts
with foreign money markets occur. In devoting
itself so largely to money-market relationships this
volume, therefore, selects for special treatment
phases of Federal Reserve operations which are
much broader than the operations of the New York
bank alone and are central to any understanding
of the influence of the Reserve System upon credit
and currency in this country.
Probably no business organization has ever been
created which has had so rapid and substantial a
growth as has the Federal Reserve System, nor has
any yet been developed which has so promptly taken
its place as a world influence. Its service to our own
country and to the world at large, not only in con-

INTRODUCTION

nection ^ith the financing of the war but in facili
tating the world’s recovery from its devastating
effects, will be promoted by a better understanding
of its operations and of its purposes. This is the
design of the book.
Benjamin Strong.
New York City,
September 20,1927.

PREFACE
Every institution gradually gathers around itself
a group of facts about its operations, and an inter
pretation of these facts which becomes its operating
philosophy. This book is an attempt to set down
some of the facts and philosophy of Federal Reserve
operations which have grown up about the Federal
Reserve Bank of New York, as they appear to one
member of the staff.
The sources for the book include the official re
ports of the Federal Reserve Bank of New York and
the Federal Reserve Board, testimony at various
congressional hearings, the excellent general descrip
tion of Federal Reserve structure and functions in
Goldenweiser’s Federal Reserve System in Opera
tion, the “Letters to College Classes” prepared by
Deputy Governor Peple of the Federal Reserve
Bank of Richmond, and other previously published
works on the Federal Reserve System by Kemmerer,
Willis, Reed, Beckhart, Harding, and Glass, and
many unpublished memoranda and unwritten dis
cussions. As an attempt to set down something of
the working philosophy of the New York Reserve
Bank, the book owes a large debt to all those of the
staff of the bank who have helped to formulate that
philosophy and particularly to Benjamin Strong,
governor, and Pierre Jay, former chairman of the
board, who together organized the bank, fostered

xii

PREFACE

its growth, and were its tutors in its development to
an important place in the world family of banks of
issue.
The writer owes a personal debt to Mr. Strong
and Mr. Jay for their encouragement in writing this
book, for their review of the manuscript, and their
many helpful suggestions. Acknowledgment of in
debtedness is also made to Deputy Governor J.
Herbert Case and other operating officers of the
bank, who have tested many theories in the crucible
of experience; to Carl Snyder, the writer’s associate
in the statistical work of the bank, who has been
ever a friendly councilor, and to the members of
the Reports Department, all of whom directly or in
directly had a part in the making of this book. In
particular, Alfred Inge, Harold Roelse, Charles
Kayser, Berenice Vance, Elizabeth Hicks, and
Lucile Bagwell have given invaluable painstaking
aid in checking statistics, verifying references, and
reading proof, and Anna Rock has spent many hours
in preparing manuscript. All the diagrams and
maps were prepared by Frederic Ehrlich and his
assistants.
Special thanks are also due to E. A. Goldenweiser,
Director of the Division of Research and Statistics
of the Federal Reserve Board, Walter W. Stewart,
Henry A. E. Chandler, Leonard P. Ayres, George B.
Roberts, Robert Warren, and May Ayres Burgess,
who have read parts or all of the manuscript and
made valuable suggestions.
The book had its earliest beginnings in a series
of brief articles descriptive of System operations ap
pearing in the Monthly Review of the New York

PREFACE

xiii

Reserve Bank, and prepared jointly by Pierre Jay,
Shepard Morgan, and the writer. Some of the ma
terial appeared during 1925 and 1926 as articles in
the American Bankers Association Journal and the
Harvard Review of Economic Statistics, and is re
produced here by permission.
The author is alone responsible for the selection
of material, expressions of opinion, and errors.
W. R. B.

CONTENTS
p«t*

I
II
III
IV
V

VI
VII
VIII
IX

X
XI

XII
XIII
XIV
XV
XVI

Introduction bt Benjamin Strong . . .
Preface............................................................
A Changed Banking World....................
Structure and Growth of the Reserve
System....................
9
Changes in Bank Reserves and Their Use
Changes in the Currency .......
Improved Methods of Business Settle
ments .................................................
65
Bankers for the Government................
The New York Money Market . . . .
The Bill Market.................... .... . . . .
An Analysis of Changes in the Money
Market...................................... . 150
The Mechanism of Credit Policy . . .
Credit Policy—Tradition and the Dis
count Rate....................................... 179
Credit Policy—Open-Market Opera
tions .................................................. 206
Other Instruments of Policy . . . .. .
The Gold Paradox............................... 240
Interest Rates—AMeasureof Results
Meaning of the Weekly Statement of
Condition................................. 297
Appendices................................................ 316
Index............................................................ 321

v
xi
1

24
41

87
110
126

168

230
275

MAPS AND DIAGRAMS
PAGE

MAP

1 Federal Reserve Offices...............................................................
2 The Federal Reserve Telegraphic Transfer System
Provides a Free Flow of Funds about the Country.
Bookkeeping by Telegraph Largely Replaces Cur
rency Shipments...............................................................
82

diagram

4
5

7
8

Member Banks Are about 1/3 or All Banks in Number
but Are More Than 2/3 in Banking Power on June
30, 1926....................................................................................
13
The Number of Member Banks Has Decreased
Slightly in Recent Years Due Largely to Bank
Mergers and Liquidations; but Resources or Mem
bers Have Continued to Increase............................
14
Resources of Member Banks Range from 93 Per cent
or All Bank Resources in Rhode Island to 37 Per
cent in Mississippi..........................................................
17
Some or the System's Operating Statistics........................
The Disposition or Gross Earnings of All Federal
Reserve Banks by Years. In 12 Years a Surplus of
$229,000,000 Has Been Built Up and $140,000,000 Has
Been Paid the U. S. Treasury as a Franchise Tax
Working Reserves of National Banks, in Percentage
or Deposits, Have Been Much Reduced under the
Federal Reserve System............................................. 32
Nature of the Reduction Since 1913 in the Working
Reserves of National Banks...............................................
Savings Deposits Have Kept Pace with Total Bank
Deposits in the United States Due Principally to
Rapid Increases in Savings Deposits in Commercial
Banks ...............................................................................................
Millions of Dollars of Paper Money in Circulation in
the United States.
The Federal Reserve System
Has Provided the Necessary Elasticity..........................
Currency Requirements Are a Major Factor in Call
ing Reserve Bank Credit into Use.....................................
Before 1914 the Currency of Canada Was Flexible in
Meeting Changes in Business Needs, but Currency
xvii

42
49

xviii

MAPS AND DIAGRAMS

DIAGRAM

13
14

15
16

22
23
24

PAGE

United States Was Rigid and Inflexible.
Since 1914 Both Have Been Flexible.................................. 54
Money in Circulation in the United States Now Has
Seasonal Fluctuations Corresponding Somewhat to
the Seasonal Changes in Canadian Currency...........
55
Wage Payments and Retail Trade Abe Two Major
Factors in Determining the Need fob Currency. ... 56
Growth of Clearing House Operations in the United
States .................................................................................... 68
Growth of the Federal Reserve Check-Collection
System .................................................................................. 79
Under the Reserve System Treasury Balances Have
Been Largely Kept in Commercial Banks Whebe
They Abb Available fob the Use of Business, Instead
of Being Locked Up in Treasury Offices...........
95
Before the Reserve System the Time-Money Rate Was
Closely Related to the Surplus ob Deficit of Re
serves of New York City Banks.......................... 116
Surplus Reserves of New York City Banks Now Show
Little Fluctuation and Money Rates Are Related
to the Amount of Bank Borrowing from the Re
serve Bank ....................................................................... 118
The Bill Market and the Government Security
Market Have Direct Approach to the Reserve Banks,
but the Other Principal Money Markets Have No. ...
Such Direct Access................................................................... 119
Daily Changes in Money Conditions in the New
York Market During 1924 Were Reflected Directly
in the Loans and Investments of the Federal Re
serve Bank of New York........................................... 123
Growth of the Bill Market Is Shown by the Esti
mated Amount of Bankers’ Bills Outstanding in
the United States on December 31 of Each Year. ... 127
Illustration of the Financing of an Import Transac
tion by a Bankers’ Acceptance................................ 130
Transactions Financed by Bankers’ Bills Outstanding
at the End of 1926......................................................
132
Farm Products Rank High in the List of Commodities
the Movement or Storage of Which Was Financed
Through Bills Purchased Outright by the Reserve
Banks During 1926........................................................ 133
Open-Market Rates fob Bills Average About One Per
in

the

MAPS AND DIAGRAMS
DIAGRAM

xix
PAGE

Under Commebcial-Paper Rates and Abe Close
to the Rates on Shobt-Tebm Government Secubities 138
26 Holdings bt the Reserve Banks of Bills Bought in
the Open Market Reflect Closely Trade Activity
and Credit Conditions.................................................... 145
27 Average Reserves of 23 New York City Banks Com
pared with Reserve Requirements ..................... 152
28 Daily Excess or Deficit in Reserves of 23 New York
City Banks and the Closing Call-Loan Rate........... 154
29 Daily Reserve Position of 23 New York City Banks
and Gains and Losses to Reserve Through Com
cent

MERCIAL AND AGENCY TRANSACTIONS AND THE USB OF

39
40

Federal Reserve Credit.................................................. 160
Open-Market Interest Rate for Prime 4-6 Months’
Commercial Paper and Monthly Averages of Daily
Bills Discounted for Member Banks by All Federal
Reserve Banks ................................................................. 183
Money Rates in New York: 4 to 6 Months’ Com
mercial Paper, 90-day Acceptances, and the Discount
Rate of Federal Reserve Bank of New York.... 192
The Volume of Trade Compared with the Trend of
Growth of Past Years.............................................................
Wholesale Commodity Prices in the United States..
Money Rates at New York and Discounts and United
States Securities Held by the Federal Reserve Bank
of New York..................................................................................
Changes in Kinds of Federal Reserve Credit in Ube. ..
Volume of Discount and Open-Market Operations and
Some of the Related Economic Movements .............
By Buying Securities the Reserve Banks Enable Mem
ber Banks and the Market to Liquidate Some of
Their Indebtedness and to Lend More Freely^ and
the Usual Consequence is Easier Money Rates
Which in Turn Make a Reduction in Federal Re
serve Discount Rates Logical.............................. 225
Before the Establishment of the Federal Reserve
System, Bank Deposits Rested Directly on the
Country’s Gold Stock and Both Bank Deposits and
Prices Felt the Impact of Changes in the Gold
Stock ...................................................................................................
Yearly Net Imports and Exports of Gold Since 1873..
Since the Establishment of the Federal Reserve Sys-

197
198

202
212

223

243
245

MAPS AND DIAGRAMS

DIAGRAM

PAGE

Bank Deposits Have Rested on Gold Plus
Federal Reserve Credit, and a Cushion or Fedbal
Reserve Credit Has Broken the Impact on
Bank Deposits or Changes in the Gold Stock.
The Gold Movement Has Not Had the Same Effect
on Prices as before the Operations of the System.
The Shaded Part of the Diagram, Federal Reserve
Credit, Represents the Total Amount of Crmht Ex
TENDED AT DIFFERENT TIMES ST THE RESERVE BANKS. . 247
41 Changes in Demand Deposits Have Moved More
Closely with Changes in the General Price Level
Than in Specific Kinds of Prices, Such As Whole
sale Commodity Prices, Wages, and Rents...................... 252
42 Interest Rates on 60-90 Day Commercial Paper in the
Open Market ................................................................................ 277
43 Since the Establishment or the Federal Reserve
System the Spread Between Rates for Different
Maturities of Open-Market Commercial Paper Has
Been Much Reduced and Rates Fluctuate Less........... 283
44 In Recent Years the Difference Between the In
terest Rates Chicago Banks Charge Their Cus
tomers and the Rates New York Banks Charge Has
Been Reduced .....................................................................
287
45 Before the Reserve System Was Established, the
Usual Seasonal Swing or Business Resulted in a
Seasonal Swing in Interest Rates Because the
Country’s Credit System Was Inelastic. Now the
Seasonal Changes in Business Have Little Effect
on Interest Rates, Because Credit is Elastic........... 291
46 Total Bills and Securities Reflect Promptly Seasonal
Variations in Business, and Changes in Business
Conditions as well.........................
305
47 Percentage or Reserves to Net Demand and Time De
posits or Country National Banks.............................. 316
48 Percentage of Reserves to Net Demand and Time De
posits or National Banks in Reserve Cities............. 316
49 Percentage or Reserves to Net Demand and Time De-. .. posits or National Banks in the Central Reserve
Cities, New York and Chicago....................................... 317
50 Percentage or Reseeves to Net Demand and Time
Deposits or All National Banks..................................... 317
51 Bankers Balances in National Banks in New York
tem

MAPS AND DIAGRAMS
DIAGRAM

xxi
PAGE

City (Manhattan) in Dollars and in Per Cent of
Net Demand and Time Deposits......................................... 318

TABLES
TABLE

3
4
5
6
7
8

9
10
11

12
13
14

15
16

17
18

PAGE

Number and Resources of Members of the Federal
Reserve System ............................................................... 14
Summary of Changes in Membership in the Federal
Reserve System 1919 through 1928.......................... 15
Percentage of Reserves Required on Demand Deposits 31
Growth of Savings Deposits Relative to All Deposits—
All Banks in the U. 8............................................... 38
How Currency Flows In and Out of the Reserve
Banks ...................................................................................... 58
Daily Net Currency Movement in New York City
To or From the Federal Reserve Bank of New York 60
Wire Transfers Made by the Federal Reserve Bank
of New York.......................................................................
84
Treasurer’s Account, Second Federal Reserve District
—Month of September, 1925 ....................................... 88
Treasury Issues Sold Through Federal Reserve Banks 106
Loss and Gain to Market, October 30, 1925............ 158
Data Supporting Diagrams 27 to 29 (Reserves and Net
Gain or Loss to Reserves of City Banks and Closing
Call-loan Rate) .......................................................................... 166
Money Rates at London and New York............................ 193
Number of Member Banks Accommodated Through
Discount Operations, by Months........................ 234
Number of Member Banks Borrowing in Excess of
Capital and Surplus Continuously for a Month or
More ................................................................................................... 236
Average Open-Market Rates—New York................................ 281
Average Interest Rates on Customers’ Prime Com
mercial Paper, 4-6 Months.......................................... 288
Resources and Liabilities of the Twelve Federal Re
serve Banks Combined.................................................. 298
Statement of Condition of the Federal Reserve Bank
of New York...................................................................... 319

The Reserve Banks
and the Money Market

The Reserve Banks
and the

Money Market
CHAPTER I

A Changed Banking World
A BOUT twenty years ago the writer took part

in a debate on the subject, “Resolved that the
United States should adopt the Canadian banking
system/’ When examined in cold blood the impli
cations of such a proposal were startling. At that
time there were in the United States some 18,000
separate independent banks, whereas in Canada
there were only 34 banks, each with many branches.
The adoption of the Canadian system here would
have involved thousands of bank consolidations and
the development of an altogether different technique
of bank management, different not only from what
we had in the United States, but different also from
anything in the world because of the prodigious dis
tances any branch system would have to cover. To
reap the benefits of nation-wide branch banking,
this country would have needed banks with their
branches so far separated as the distances between
London and Moscow, Constantinople and Paris, or
Madrid and Vienna. It was a radical proposal the
I

THE RESERVE BANKS

adoption of which, if possible at all, could only have
been effected over a long period of years and with
doubtful results.
Yet the serious discussion of a topic of this sort
was in keeping with the economic thought of that
period. There was such dissatisfaction with the
country’s banking system that people were willing
to consider drastic remedies. It was a time when
almost every economic publication contained some
reference to banking reform. Out of this discus
sion the Federal Reserve System was eventually
born.
The Reserve System was a much less drastic
remedy for banking evils than the adoption in this
country of a system of branch banking such as has
developed in Canada. It was a less drastic remedy
than many of the proposals considered. It left un
disturbed the American system of many independent
banks, each operated by its own local officers and
directors and free from distant control. The adop
tion of a system of regional Reserve Banks instead
of one central bank preserved the American prin
ciple of local autonomy. In these and other respects
the Reserve System was a less violent change than
might easily have occurred if other suggestions had
been followed.
Yet, looking at the matter in perspective, one
can see that the introduction of the Federal Reserve
System has brought great changes. In thirteen years
the banking mechanism and banking processes have
been vastly altered. Among the important changes
in banking structure may be mentioned the fol
lowing:

AND THE MONEY MARKET

The country’s bank reserves are largely centralized in
twelve Federal Reserve Banks instead of being scattered
among thousands of independent banks. Out of 4%
billion dollars of monetary gold in the country about
3 billions are held by the Federal Reserve Banks.
A new kind of paper money, the Federal Reserve note,
has been put into circulation. At one time in 1920 the
new currency constituted more than two-thirds of the
total paper money in circulation, and now in 1927
amounts to more than one-third of the total.
The Reserve System has furnished a new means by
which banks which need larger reserves or more cur
rency may borrow them from the Reserve Banks, and
thus our credit and currency system has been given
elasticity.
The Federal Reserve System with its twelve Reserve
Banks and twenty-four branch banks, and the office of
the Federal Reserve Board in Washington, has provided
a new mechanism for transferring funds from one part
of the country to another.
The Reserve System has provided a new mechanism
for collecting checks and drafts in all parts of the
country.
A new credit instrument—the bankers’ acceptance—
has been put into use in an amount which now totals
currently about 700 million dollars.
A new open market has been developed where short
term Treasury securities may be readily bought and
sold.
A new method of handling government financial oper
ations, through the Reserve System, has replaced the
old independent Treasury.
Under the leadership of the Reserve System an Amer
ican banking policy has become possible.

These changes and many others have altered the
banking structure and removed many of the old
landmarks of bank operations. For example, in
the old days one of the best guides which the banker

THE RESERVE BANKS

could use for determining his lending policy, or
the business man for judging credit conditions, was
the report published each Saturday by the New
York Clearing House. This showed the cash re
serves of the New York Clearing House banks, com
pared with the amount of reserves these banks were
required by law to keep in their vaults. When these
banks showed a continued reduction in their sur
plus of actual reserves over legal requirements, or an
occasional deficit, the banker or business man knew
he should look for foul weather ahead. Today this
report of surplus reserves has become of little sig
nificance because the reserve position of the banks
depends largely on the amount of money which they
are borrowing from the Federal Reserve Banks. The
New York City banks have been partly superseded
by the Reserve Banks as a last resort in time of
trouble. The student of credit conditions has a new
set of statistics to follow in the reports of the Fed
eral Reserve System.
Another landmark to disappear has been the quo
tation of inland exchange rates. There is no longer
a premium on Chicago funds or New York funds,
because the Federal Reserve wire-transfer system
has done away with the cost of moving funds about
the country.
Still another change in the financial landscape
appears in the movement of interest rates. In the
old days the shrewd banker or business man ad
justed his operations to take advantage of a char
acteristic seasonal swing in interest rates. This
seasonal movement has now been largely ironed
out, and the practice of banker or business man

AND THE MONEY MARKET

has required a corresponding adjustment to new
conditions.
The changes in American banking which have
followed the introduction of the Reserve System
have been blurred somewhat by the interruption of
the war. Attention was focused on the dramatic
aspects of the System’s war service rather than on
the permanent structure which grew more quietly
and more steadily. Even now, well beyond the con
clusion of the war, we are just beginning to realize
the extent of the change which has occurred.
The general opinion clearly is that the new bank
ing system is good. Frequent comments when the
Federal Reserve System is mentioned are, “It is a
wonderful institution," or, “I don’t know what we
should have done without the Federal Reserve.”
But when it comes to a precise description of what
service the Federal Reserve System performs in the
economic structure, it cannot fairly be said that
there is general understanding of the ways in which
our banking system has been altered and the way
the present mechanism operates. In fact, the pres
ent tendency appears to be to ascribe rather too
much virtue and power to the Federal Reserve Sys
tem. Some appear to believe that the Federal Re
serve System is or should be a cure-all for economic
ills: that it should somehow completely stabilize
commodity prices, prevent bank failures, suppress
speculation, and eliminate the fluctuations of the
business cycle.
It is not surprising that there should be some
rather hazy and indefinite notions prevalent con
cerning the Federal Reserve System and its place in

THE RESERVE BANKS

the financial scheme. For, in the first place, the pub
lic does not come in contact with the Federal Re
serve System. The Reserve Banks are bankers’
banks and deal almost exclusively with the member
banks and not with the public. To the general pub
lic the Reserve System is almost an abstract idea.
In the second place, it takes time for institutions to
become thoroughly imbedded in a civilization and to
be thoroughly understood. The Reserve System is
only thirteen years old and of these years almost
none has been passed in a normal period. The years
during which it has been possible to observe its oper
ations under anything approaching normal condi
tions are certainly too few to justify final conclusions
as to the changes in American banking which result
from the presence of the System.
In any analysis of the significance of Federal Re
serve operations there is, however, one important
aid in the availability of more complete financial
statistics than ever before existed in this country,
or are available in any other country in the world.
The Reserve System publishes a remarkably com
plete weekly report consisting of thirty-seven differ
ent items, as compared with a statement of about
ten items which the Bank of England regularly
makes public. Even more complete data concerning
all forms of Federal Reserve operations are pub
lished by the Federal Reserve Board in the Federal
Reserve Bulletin and by the several Federal Reserve
Banks in their monthly reviews. The Reserve Board
and Banks maintain careful daily records of many
of their operations which form a basis for as minute

AND THE MONEY MARKET

a study of the interplay of Reserve Bank activity
and the money market as may be desired.
In addition the Reserve Board and Banks collect
and publish banking statistics each week relating
to the operations of about 700 of the larger member
banks in principal cities, whose total resources equal
about 60 per cent of the resources of all member
banks and a little less than 50 per cent of the total
banking resources of the United States. Through
their economic services the Reserve Banks and other
agencies make available a wealth of material with
regard to money rates and commercial and indus
trial activity on a scale which is not approached
by any other country and which is far ahead of
anything previously possessed in this country.
Because of the existence of this large body of re
liable data it should now be possible, even with
only a few years of experience of the operations of
the Reserve System, at least to describe in quanti
tative terms some of the relations between Reserve
Bank operations and the money market and perhaps
to draw some tentative conclusions as to the effects
of these operations on American business and
finance. The following chapters are an attempt in
this direction.
SUMMARY

1. While the Reserve System was a less drastic rem
edy for banking evils than many other proposals,
its operations have made a great change in Amer
ican banking.
2. Such a familiar landmark as the quotation on

THE RESERVE BANKS

inland exchange has disappeared; the meaning
of the New York Clearing House statement has
been quite changed; and the seasonal movement
of money rates has been altered.
3. Because the Reserve System is remote from daily
experience, public opinion about it, while approv
ing, is comparatively uninformed.
4. Thirteen years under abnormal conditions are too
short a period to pass final judgment on the ac
complishments of the System.
5. With the aid of the remarkably comprehensive
statistics which are available it is possible to
describe quantitatively some of the relations of
the Reserve Banks and the money market, and
to draw some tentative and limited conclusions
as to results.

CHAPTER II
Structure and Growth of the Reserve System

HE Federal Reserve System is so remote from
the general public that it seems desirable to
preface any discussion of what the System does
with a brief account of its structure and growth.
There are twelve Reserve Banks in twelve im
portant cities of the country and each one of these
banks is now housed in a building of its own. In
addition there are twenty-four branches and two
agencies, many of these in their own buildings.
Housed in the Treasury Building in Washington is
the Federal Reserve Board, the governmental body
which supervises the operations of the System. The
total staff of the whole System is over 10,000 per
sons. The locations of the different offices are
shown in the accompanying map.
The Federal Reserve Board.—In the congressional
discussions which preceded the passage of the Fed
eral Reserve Act one of the proposals given serious
consideration provided for the establishment of a
single central bank of issue, rather than twelve Re
serve Banks. When the decision was reached for
a number of banks of issue rather than one, it was
essential to provide a mechanism for coordinating
their activities. It would be an impossible situation
to have completely independent Reserve Banks in
different parts of the country acting upon differ-

AND THE MONEY MARKET

ent policies, maintaining different standards in
making loans, and perhaps competing with one an
other. It was essential to have a central coordinat
ing body with adequate powers to weld the sepa
rate Reserve Banks into a system. The Federal
Reserve Board is this coordinating body. The Board
consists of eight members, two of whom are the
Secretary of the Treasury and the Comptroller of
the Currency, ex officio, and the other six are ap
pointed by the President for ten-year terms with
the advice and consent of the Senate.
The Board prescribes regulations governing meth
ods and procedure of Federal Reserve operations
in all those matters where uniformity is necessary.
Discount rates are fixed by the several Federal Re
serve Banks subject to “review and determination
of the Federal Reserve Board.” The Board has cer
tain limited operating functions in serving as a
central clearing house for check collections and wire
transfers. It has a force of examiners who examine
the Reserve Banks periodically, and it maintains
a complete statistical record and analysis of Fed
eral Reserve operations, much of which is made
public through the Board’s weekly press statements,
monthly bulletin, and the annual report to Con
gress. In addition to these and a number of other
specific functions, the Board exercises general su
pervision over the operations of the Reserve Banks.
Not Government Banks,—The twelve Federal Re
serve Banks, although supervised by the Federal
Reserve Board, are not themselves government in
stitutions, nor yet are they private institutions in
the same sense as is the ordinary commercial bank.

THE RESERVE BANKS

Their corporate stock is owned wholly by member
banks of the districts in which they are located,
but under the terms of the law their policies are
directed towards the public welfare and not private
gain, and the dividends on their stock are limited
to 6 per cent. They may well be termed semi-gov
ernmental institutions.
The public nature of the Reserve Banks is indi
cated by the character of their directorate. Three of
the nine directors of each bank are appointed by
the Federal Reserve Board and one of these ap
pointees is chairman of the board of directors. The
other six directors are elected by the banks in the
district which are member banks—that is, which are
stock-owners in the Reserve Bank. The public
character of the Reserve Bank’s business is further
emphasized by the provision that none of the three
appointive members of the board may be an active
banker, except the chairman, who gives all his time
to the Reserve Bank. Moreover, of the six elective
members of the board three must be actively en
gaged in commerce, agriculture, or industry in the
district. On the board of each of the banks business
men are in the majority.
Membership in the System..—'The members of the
Federal Reserve System comprise over 9,000 na
tional and state banks and trust companies—ap
proximately one-third of all the incorporated banks
in the country. This proportion of about one-third
does not hold uniformly in all the states, but varies
from about 12 per cent to as high as 80 per cent.
In point of resources, the member banks represent
more than two-thirds of the banking strength of the

AND THE MONEY MARKET

country. This general relationship of the number
and strength of member banks to all banks in the
country is illustrated in Diagram 1.
Under the Federal Reserve Act all national banks
are members of the Federal Reserve System; and
state banks and trust companies may apply for ad
mission under certain eligibility conditions. State
institutions may also withdraw from the System.

TOTAL BANKS IN THE
UNITED STATES
27,000

DIAGRAM 1—:MEMBER BANKS WERE ABOUT % OF ALL BANKS IN NUM

BER BUT MORE THAN % IN BANKING POWER ON JUNE 30,

1926.

(Mutual Savings Banks and Private Banks excluded.)

The following table shows the number of member
banks, both national and state, and their resources
on June 30 of each year since 1915.
The greatest growth in membership was during
and following the war period, when banks needed
most urgently the help of the Reserve System, and
when it became a patriotic duty to join the Reserve
System as a means of strengthening the country’s
banking structure. The war thus stimulated a rapid
growth in state bank membership, which would
probably have taken many more years under ordi-

THE RESERVE BANKS

Table 1.—Number and Resources of Members of the
Federal Reserve System

Number of Banks
Year
(as of
June
Na
30) tional State Total
1915
1916
1917
1918
1919
1920
1921
1922
1923
1924
1925
1926

7,598
7,572
7,600
7,700
7,780
8,025
8,150
8,244
8,236
8,080
8,066
7,972

17
34
53
513
1,042
1,374
1,595
1,648
1,620
1,570
1,472
1,403

Resources (in millions)
Na
tional

State

Total

7,615 $11,790 $
97 $11,887
7,606 13,920
307 14,227
756 17,038
7,653 16,282
8,213 18,347
6,104 24,451
8,822 21,228
8,628 29,856
9,399 23,402 10,351 33,753
9,745 20,510 10,426 30,936
9,892 20,698 11,026 31,724
9,856 21,502 12,293 33,795
9,650 22,555 13,222 35,777
9,538 24,339 14,766 39,105
9,375 25,302 15,543 40,845

SLIGHTLY IN RECENT YEARS DUE LARGELY TO BANK MERGERS AND
liquidations; but resources of members have continued to

INCREASE.

AND THE MONEY MARKET

nary circumstances. While the state bank member
ship is not now large in point of numbers, this mem
bership includes most of the large state institutions,
and it may be noted that resources of state bank
members are more than half as large as those of
national bank members.
Some slight decreases in membership in recent
years are due largely to bank mergers and liquida
tions. Membership has more than held its own rela
tive to the country’s total banking resources. The
causes of changes in membership since 1919 are
shown in the following table.
Table 2.—Summary of Changes in Membership in the
Federal Reserve System 1919 Through 1926
(Number of banks)
1919

1920

1921

Active member banks
at first of year..... 8,692 9,066 9,606
Banks joining the Sys
384
518
679
tem ......... ..
Banks withdrawing
69
53
41
from the System 1
Net increase from
banks joining and
626
343
withdrawing........449
Banks loot to mem
bership through
mergsza between
member banks,
75
86
170
suspensions, etc.
Net change for the
+374 +840 +173
year...............
Active member banks
at end of year... 6,066 9,606 9,779

1922

1923

1924

1925

1926

9,779

9,859

9,774

9.587

9,489

301

228

168

237

174

100

125

260

150

137

180

235

280

235

278

+80

-85

-187

-98

-229

9,859

9,774

9,587

9.489

9,260

* Includes withdrawals which were incidental to the absorption of banka by
easting non-member banks.

Membership in Various States.—The variations
among the different states in the proportion that
resources of member banks bear to the total re-

THE RESERVE BANKS

sources of all banks appear in Diagram 3. The per
centages are based upon figures as of June 30, 1926
taken from the Federal Reserve Bulletin and the
report of the Comptroller of the Currency.
The variations between states in the proportion
of bank resources which are in the Federal Reserve
System reflect to a considerable extent the different
banking laws of the various states. Some of them
prescribe such low reserves for state banks that the
banks would lose money by becoming members of
the Federal Reserve System, and there are other
difficulties in the state laws which restrain banks
from becoming members. Another reason for dif
ferences between states is found in the size of banks.
Banks have to be of certain size to be eligible for
membership, and in general the states with large
cities and large banks tend to show larger percent
ages of membership.
What Membership Means.—State institutions ap
plying for membership are ordinarily required to
have at least the minimum paid-up capital required
of newly established national banks. For example,
the minimum capital required of a national bank
established in a rural community is $25,000, and
state banks having a capital of less than that are
not now eligible for membership, except that un
der an amendment of the Federal Reserve Act,
effective March 4, 1923, a state bank may be admit
ted to membership with a capital of not less than 60
per cent of the amount sufficient to entitle it to
become a member bank, provided it shall increase
its capital stock to the required minimum within
five years after its admission to membership. How-

too
PFR3MT.

RESOURCES ^MEMBER BANKS
Mm ISLAND

NEW YORK

na!
87.6

MASSACHUSETTS X
COLORADO

OKLAHOMA

^■^■■^^^^■87.4

TEXAS

■^■■■^^^■•O-1

OREGON

^^■■i^HHBie.i

MONTANA

^■■■^^■77.9

WASHINGTON

g^^^^^Hl^g 77.8

OHIO

MICHIGAN

■^■^^^^■76.3
^^^^■^^■75.6
■^^^Hf'5.3

NEW MEXICO

ALABAMA

CALIFORNIA

■■■i^e^Mii 73.7
i^■■^^■l77 5

IDAHO

^■■■^^■70 7

MISSOURI

■■■^■■■1706

PENNSYLVANIA I

■^■■^■1 70.3
^^■^^■170./

NEW IER5EY!
VIRGINIA

ILLINOIS

GEORGIA

LOUISIANA

WYOMING-

TENNESSEE

^■^^■MM.d
■■l^^e 66.9
^■^^■B 66 /
^■^■^■669
^■^■■65.7

KENTUCKY

UTAH

■#^■1 63/
■^■■i 62-6
■■■6/ 9
■■■■6/6

MINNESOTA

^^^M 6/.0

ARKANSAS

NEW HAMPSHIRE!

DELAWARE

MAINE

■^■1 59.9
^■■564
i^ee 57.6
l^eB57 6

FLORIDA

^■e 54.9

N°CAROLINA I

■■ 54 5
■■54.3

SSCAROLINA I

MARYLAND
WISCONSIN
W. VIRGINIA

N°DAKOTA
Dof COLUMBIA

ARIZONA '

■■ 5*0
■■ 55.9
^■53.7

■H330
■■527

IOWA

■I5/.2
■ 48 O
■ 47 2

SSDAKOTA

■ 46.9

INDIANA

145.6

CONNECTICUT

KANSAS

VERMONT
NEBRASKA

43 9

NEVADA

MISSISSIPPI
TOTAL

36.6

72.9

DIAGRAM 3—RESOURCES OF MEMBER BANKS RANGE FROM 93 PER CENT
OF ALL BANK RESOURCES IN RHODE ISLAND TO 37 PER CENT IN MIS
SISSIPPI. (Mutual Savings Banks and Private Banka excluded.)

THE RESERVE BANKS

ever, few banks have taken advantage of this
amendment. In many agricultural states a large
number of rural banks having small capital are in
eligible for membership and so are without direct
access to the Federal Reserve Banks. There are
more than 10,000 state banks and trust companies
which are eligible but are not members.
In all cases state institutions applying for mem
bership are subject to examination by the Federal
Reserve Bank before admission, so that their con
dition and policies may be ascertained.
A member bank must subscribe for stock in its
Federal Reserve Bank in the amount of 6 per cent
of its own capital and surplus; thus far the member
banks have been called upon to pay in only 50 per
cent of the amount of stock subscribed for. As a
member bank’s capital and surplus increase it must
increase its ownership of stock in the Federal Re
serve Bank. The member banks are the sole owners
of Reserve Bank stock. This stock is not trans
ferable and so cannot be sold, thus preventing a
concentration of control of the Federal Reserve
Banks. If a bank liquidates or retires from the
System, the shares held by it are canceled, and the
bank receives back what it paid in. Dividends are
cumulative and have been paid at the rate of 6
per cent annually upon the paid-in capital.
A member bank keeps all of its legal reserves on
deposit with its Reserve Bank. These reserves
form the principal volume of deposits of the Re
serve Banks. They are in fixed proportion to the
amount of deposits of the member banks, on the
average 7% per cent.

AND THE MONEY MARKET

To all member banks are available the various
services provided by the Federal Reserve Banks.
These include loans to members, the supplying of
currency, the collection of checks, the transfer of
funds by wire, and other services. In fact, the Re
serve Banks perform for the banks of the country
much the same service that the banks themselves
perform for their customers. They are in this sense
bankers’ banks, although they are not designed to
serve simply the banking interest, but rather to
serve business through the member banks.
Size of the System’s Operations_Naturally the
operations of the Reserve Banks are much larger
in volume than the operations of commercial banks.
Their customers are not individuals, but banks, each
with its own thousands of customers. The money
which these customers use, the government securi
ties they buy, many of the checks they draw, and a
part of the commercial paper upon which they bor
row pass through the Reserve Banks. These banks,
therefore, handle money, checks, credit instruments,
and securities not in retail but in wholesale volume.
In 1926, for example, the twelve Reserve Banks
received and counted between 4 and 5 billion sepa
rate pieces of currency and coin with a value of
more than 13 billion dollars; they handled for col
lection 800 million checks valued at about 275 bil
lion dollars; they issued, redeemed, or exchanged
more than 4% million United States certificates,
notes, or bonds valued at about 5 billion dollars.
The growth in the volume of operations of the
Reserve Banks is illustrated in Diagram 4. In a
number of these operations the volume is a reflec-

THE RESERVE BANKS

tion of changing economic conditions. The gold
reserves reflect largely the flow of gold to or from
this country. The total loans and investments re
flect the country’s demands for credit, and reached
their highest point some months after the peak of

DIAGRAM 4—SOME OF THE SYSTEM’S OPERATING STATISTICS.

high prices in 1920. Check settlements, particu
larly since prices have become more stable, are a
reflection of the steady growth in the country’s
business. Over a long term of years experience has
shown that the volume of business in this country
tends to increase at a rate of between three and
four per cent a year, and banking operations have

AND THE MONEY MARKET

grown at an even more rapid rate. The business
of the Reserve Banks is so closely related to the
country’s banking operations that it may be ex
pected to grow at a somewhat corresponding rate.
Experience in the more normal years since 1921 ap
pears to indicate that this is in fact taking place.
Disposition of Earnings.—The Federal Reserve
Banks are organized and operated not for the pur
pose of making profits, but, as the title of the Fed
eral Reserve Act states, “to furnish an elastic
currency, to afford means of rediscounting commer
cial paper, to establish a more effective supervision
of banking in the United States, and for other pur
poses.” Accordingly, the provisions of the Federal
Reserve Act dealing with earnings are so framed as
to make the public welfare the sole consideration
determining its policy. The Act provides that the
member banks shall be entitled to a 6 per cent an
nual dividend on the paid-in capital stock. Earn
ings beyond expenses and dividends are to be paid
into a surplus fund until that fund equals the sub
scribed capital of the bank, and beyond that amount
10 per cent of net earnings in excess of expenses and
dividends is paid each year into the surplus fund.
All remaining net earnings are paid to the United
States Government as a franchise tax which takes
the place of the tax on note issues which govern
ments customarily levy when they delegate the
note-issuing power to a bank of issue. These pro
visions are designed to remove the profit-making
motive from Federal Reserve policy.
The earnings of the banks since their inception
have responded directly to their use as seasonal

THE RESERVE BANKS

or emergency institutions. The heaviest earnings
reflected the large borrowings of the war and post
war years. Under more normal conditions the banks
have earned little, if any, beyond their expenses
and dividends. At times when earnings have been
particularly heavy the government has received as
a franchise tax a large portion of those earnings.
181

RESERVE BANKS BY YEARS. IN 12 YEARS A SURPLUS OF $229,000,000
HAS BEEN BUILT UP AND $140,000,000 HAS BEEN PAID THE U. 8.
TREASURY AS A FRANCHISE TAX.

Since the beginning the Reserve Banks have paid
$140,000,000 to the Treasury as franchise tax.
The earnings of the System and their disposi
tion since the Reserve Banks began operations are
shown in Diagram 5.
SUMMARY

1. The Reserve System consists of a Federal Re
serve Board, twelve Reserve Banks, and twenty-

AND THE MONEY MARKET

2.
3.

four branches and two agencies with a total staff
of over 10,000 persons.
The Reserve Board is a central supervisory body
to coordinate the activities of the System.
There are over 9,000 member banks, one-third of
the commercial banks in the country with over
two-thirds of the resources.
The number of member banks has recently de
creased slightly, due to mergers and liquidations,
but the resources of members have continued to
increase steadily and rapidly.
Member banks own all the capital stock of the
Reserve Banks, keep their legal reserves with
them, and benefit from many services the Re
serve Banks provide.
The operations of the Reserve System are whole
sale in character and reflect the volume and
growth of the country’s vast banking operations.
The law is designed to remove the profit-making
motive from Federal Reserve policy, and profits
are incidental to public service. Dividends are
limited to 6 per cent, and profits beyond expenses,
dividends, and a reasonable surplus are turned
over to the United States Treasury.

CHAPTER III
Changes in Bank Reserves and Their Use

LOM the first the banking system in this coun
try has given expression to the American ideal
of individuality and freedom. Almost any respon
sible group of people with a little capital could start
a bank, and the result is about 27,000 incorporated
independent banks compared with a score or two in
most other countries. In the United Kingdom there
are forty-six incorporated commercial banks of de
posit and in Canada eleven; in France the banking
business is largely in the hands of six credit com
panies, and in Germany largely in the hands of ten
banks.
American laws on bank reserves have been a di
rect result of the large number of scattered banks.
In most countries the kind and amount of reserves
maintained by banks are matters of prudent bank
ing practice, not of law. But in this country it was
found necessary to set up rigid requirements as to
the minimum reserve each kind of bank should
carry, and enforce them by public inspection in or
der to secure some degree of strength and safety
for our thousands of banks.
Defects of Old Scheme.—The consequence was
that the gold and currency which represented the
underlying banking reserves of the country were
scattered about in the vaults of thousands of sepa-

AND THE MONEY MARKET

rate banks. The reserves were also pyramided, made
to do double duty, by the practice of counting bank
balances as legal reserves. While this state of affairs
may have conformed with traditions of independ
ence, the results were not satisfactory. The diffi
culties with bank reserves were analogous to an ex
perience a European city is reported to have had
at one time with cabs. The city fathers, as the
story goes, were greatly troubled because there were
frequently not sufficient cabs available at cab stands.
They, therefore, passed an ordinance that each cab
stand should have at least one cab waiting all the
time. The result of this ordinance was, of course,
to accentuate the difficulty. Laws as to bank re
serves had a corresponding result. Each bank was
required at all times to maintain a legal minimum
reserve. This plan was satisfactory and desirable
in times when credit was ample, but in periods of
stringency it locked up the reserves which in emer
gencies should have been put to use. A few cour
ageous bankers at such times paid out their reserves
freely to meet unusual needs, but many bankers,
following the more natural instinct of fear for their
safety, locked their reserves in their vaults. The
law encouraged, and strictly speaking required, just
that procedure, and there was no regular method by
which reserves could be put to work.
The Federal Reserve System is a method for put
ting bank reserves to work in busy seasons and emer
gencies. The first step was to remove a part of
the reserves from the scattered vaults of individual
banks and centralize them in the vaults of the Re
serve Banks—custodians with no selfish ends to

THE RESERVE BANKS

serve and prepared to administer the reserves in
the public interest. The second step was to set up
a method for using reserves in emergencies and busy
seasons either by paying out the reserves them
selves, or, more commonly, by building a larger
credit structure upon them.
The Insurance Principle.—The shift of required
reserves from the vaults of member banks to the
vaults of the Federal Reserve Banks was not simply
a change in physical location. It effected a change
in the character and effectiveness of the reserves and
enabled them to serve more adequately their orig
inal purposes.
A basal principle which gives greater effectiveness
to reserves under the Federal Reserve System is
the insurance principle of distributing the risk.
Suppose that you or I own a house. One of the
dangers we constantly face is the danger of fire, and
every prudent house owner makes some provision
against this danger. There are various ways in
which it could be done. One way would be to start
a special bank deposit which we might call our fire
insurance deposit. We would lay aside something
in that account each month, so that in case the
house were damaged by fire we should have some
thing available towards repairing or rebuilding it.
While this is a possible method of insurance, it is
a ridiculous one, because we should never have suffi
cient funds to meet an emergency, and the method
is too expensive.
What we actually do is enter a cooperative or
ganization with thousands of other house owners,
which we call a fire insurance company. Each one

AND THE MONEY MARKET

of the house owners pays a small sum regularly to
a central fund. There are enough house owners co
operating and enough small sums paid in to make
a very large reserve fund, which is available to re
pair or rebuild the houses of any one or several
of the cooperating house owners. The insurance
principle here is simply that the risk of loss through
fire is distributed over thousands of house owners.
This is somewhat the same principle as the Fed
eral Reserve System. Under the old scheme of bank
reserves, each bank set aside its own funds against
emergencies. The result was that no single bank
was able to set aside a sufficient sum to meet its
needs in case of a real emergency. But under the
Federal Reserve System the reserves of the cooper
ating banks are pooled and the emergency of any
single member can be met, provided the member has
not impaired his borrowing power by dishonest or
imprudent banking methods. The strength of the
combined reserves is so great that they can be drawn
upon heavily at times of general need without fear
of exhaustion. And there is the additional im
portant consideration that when the reserves are
pooled with the Reserve Banks they can be used
without being paid out as they form the basis for
issues of Federal Reserve notes or further exten
sions of credit.
Putting Reserves to Work.—Granted the strength
of the pooled reserves and their power to serve the
banks in emergencies, the second part of the prob
lem was devising a scheme for putting some of the
pooled reserves to work without flooding the mar
ket with funds and creating inflation.

THE RESERVE BANKS

The method devised was that banks might bor
row from the Reserve Banks just as the customer
borrows from the commercial bank. The safety and
liquidity of loans to banks is guaranteed by the
shortness of the time for which banks may borrow
and the character of the collateral which banks are
required to furnish as security for loans.
Loans to banks take two forms, rediscounts and
advances. A bank may indorse and send to the
Reserve Bank its customers’ promissory notes rep
resenting actual commercial or agricultural trans
actions. The Reserve Banks will discount commer
cial paper of this sort with a maturity of ninety
days or less, or, in the case of certain kinds of agri
cultural paper, nine months. This is called a dis
count or rediscount. Or a bank may give a Federal
Reserve Bank its own promissory note payable in
fifteen days and secured by commercial paper, or
by United States Government bonds, notes, or cer
tificates. This form of loan is known as an advance.
The Reserve Banks examine with great care all
paper presented to them for rediscount or as col
lateral for an advance and see to it that the con
cerns whose paper is presented are in liquid con
dition. Otherwise the paper is not accepted. Mem
ber banks are required to file the statements of the
makers of all paper presented for discount which
is over 15,000 in value. The Reserve Banks main
tain extensive credit files. The Federal Reserve
Bank of New York alone, for example, has on file
statements and other data concerning 50,000 to 60,
000 individuals and business concerns. Similarly,
the Reserve Banks study continuously the condition

AND THE MONEY MARKET

of the member banks. They maintain staffs of bank
examiners who from time to time examine member
banks and still more frequently collaborate with
Federal and state authorities in such examinations.
With these provisions for safety, losses by the Re
serve Banks have been negligible.
The problem of restraining member banks from
borrowing too freely and so flooding the market
with money is the most difficult problem which the
Reserve Banks have to face. It is what is generally
termed the problem of Federal Reserve policy.
Briefly the general principle is that reserve funds
should be used (either paid out or as a basis for
credit) whenever they are genuinely needed, but
should not be used beyond that need. The de
termination of what are genuine needs is a major
problem. The principal method of restraining the
use of reserve credit is through the price charged
member banks on loans, called the discount rate.
But these questions of policy are another and a
broader question and will require a separate chapter.
Elasticity of Reserves.—Concerning the use of
reserve funds just described it is important to note
that the reserve funds themselves are not commonly
withdrawn from the Reserve Banks. The member
bank which borrows at a Reserve Bank receives a
deposit credit at the Reserve Bank which counts
as part of the reserves of the member bank. If
the bank needs currency it usually draws Federal
Reserve notes. Save under exceptional circum
stances the only two cases in which the gold reserves
of the Reserve Banks are actually withdrawn are
when member banks withdraw gold for export or

THE RESERVE BANKS

gold certificates for circulation. Ordinarily, bor
rowing by member banks simply increases the de
posits or the note circulation of the Reserve Banks.
Since these deposits require only 35 per cent re
serves and notes only 40 per cent gold reserves, a
Reserve Bank can in an emergency lend to its
member banks nearly three times its actual reserves,
unless gold is required for export or circulation.
This principle of expansion or elasticity of reserve
funds is one of the two basic principles of bank
reserves under the Reserve System, to be bracketed
with the insurance principle of distributing the risk
by concentrating the funds. These two principles
give the Reserve System its strength.
Economy in Reserves.—While the concentration
and elasticity of reserves, making them more service
able in busy seasons and emergencies, are the most
important changes in bank reserves resulting from
the establishment of the Reserve System, there are
other interesting changes, and one of these is a re
duction in the amount of reserves. Because existing
reserves have become more mobile, more usable,
and more efficient, it has been possible to reduce
the amount of reserves. Recognizing this principle,
the Federal Reserve Act reduced the legal reserve
requirements of member banks and left more to the
discretion of the individual banker. Then in 1917
an amendment of the Federal Reserve Act reduced
reserves still further.
The precise changes in the legal reserves against
demand deposits of national banks may be sum
marized in tabular form as follows, for the period
from 1887 to the inauguration of the Reserve Sys-

AND THE MONEY MARKET

tem, for the first three years of its operation, and
for the years since the 1917 amendment.
Table 3.—Percentage of Reserves Required
Demand Deposits

Central
Reserve Reserve
City
City
Country
Banks Banks
Banks

National Bank Act Amended
1887
Cash in vault (minimum)
With approved agents....

25
0

12.5
12.5

Total...............................

Amendment of 1917
All in Federal Reserve
Banks..............................

Federal Reserve Act Effect
ive 1914
Cash in vault (minimum)
With Federal Reserve
Banks (minimum)....
In vault or with Federal
Reserve Banks*............

6
9

* For thirty-six months from 1914 reserve city and country banks
had the option of carrying these amounts with approved agents.

The reduction in reserve requirements for time
deposits, those deposits, consisting largely of savings

THE RESERVE BANKS

accounts, on which the bank could require thirty
days’ notice before withdrawal, was still greater.
Under the National Bank Act both time and de
mand deposits carried the same reserve require
ments. In 1914 the reserve against time deposits
was reduced to 5 per cent for all member banks, and
in 1917 to 3 per cent.

AGE OF DEPOSITS, HAVE BEEN MUCH REDUCED UNDER THE FEDERAL
RESERVE SYSTEM,

The essential facts about these changes in re
serves are that the legally required reserves have
been reduced to a minimum, all to be held in the
Reserve Banks, and that no requirements are pre
scribed for cash in vault or balances with banks,
which are no longer counted as reserves, and the
amounts of which are left wholly to the discretion of
the member banks.

AND THE MONEY MARKET

Since the Federal Reserve Act was enacted in
1914, banks have in one way or another reduced
steadily the amount of discretionary reserves car
ried in excess of the legally prescribed minimum.
The figures for all national banks for the dates of
Comptroller’s calls are shown in Diagrams 6 and 7.

reserves of national banks.

(In Percentage of Deposits.)

The aggregate of working reserves, which we may
think of as composed of cash in vault, balances due
from banks, and balances due from Reserve Banks,
has been reduced from 34 per cent of total time
and demand deposits in 1913 to 20.5 per cent in
1926. The total of cash in vault and reserves with
Federal Reserve Banks is now 9.4 per cent of de
posits, as compared with 13% per cent of cash in
vault alone in 1913.

THE RESERVE BANKS

The first important fact about this reduction in
reserves is that it has released some funds for in
vestment or loans, with corresponding benefit to the
earnings of member banks. A comparison of types
of banks, which is given in Appendix A, shows that
central reserve city banks have gained most from
the release of cash, but this gain has been partly
offset by the loss of reserve deposits from out-of
town banks. Country banks have had little cash
released, but have been able to reduce the balances
maintained with city correspondents. Reserve city
banks have gained moderately in both ways. All
groups have gained through a release of funds for
profitable employment.
Generally, any such release of reserve funds tends
to result in expansion of bank credit, which may be
the forerunner of price inflation. Fortunately, the
principal change in reserve requirements occurred
during the war, when credit expansion was almost
inevitable and took place in every country of the
civilized world. The readjustment in our reserves
probably made our credit expansion more orderly
than it would otherwise have been.
By a curious turn in events this reduction of the
ratio of reserves to deposits in the commercial banks
has been practically offset by a flood of gold im
ports which have been absorbed by the Federal
Reserve Banks, and have built up an additional
reserve back of the war-expanded deposits. As a
consequence, the ratio of the country’s total gold
stock to bank deposits is now nearly as high as
before the war. The figures follow.

AND THE MONEY MARKET

Percentage of Monetary Gold in Country
to Total Individual Bank Deposits

1913.................................................................. 10.3
1920.................................................................. 8.4
1923.................................................................. 10.0
1926................................................................... 9.5

The absorption of gold imports by the Reserve
System without an accompanying credit expansion
and price inflation has been an apparent riddle, with
actually a simple explanation which will be dis
cussed later.
A future contingency which must always be borne
in mind in discussing bank reserves in this country
is the possibility of exports of part of this large
store of gold. In view of this possibility and in
view of the considerable reduction in bank reserves
in relation to deposits which has resulted from thir
teen years of operation under the Federal Reserve
Act—a reduction in fact probably greater than the
framers of the Act or the 1917 amendment esti
mated—any proposals for further reductions should
be carefully weighed.
Reserves in Other Countries,^In this connection
it is interesting to compare the amount of reserves
carried by banks in this country with the amounts
currently carried by banks in other countries. It
is, of course, difficult to secure figures which are
strictly comparable, partly because they are affected
by the particular days on which reports are made,
but the following table was compiled in 1925 and
1926 from the best available data. The reserve
figure shown for each country is the percentage of
cash, plus balances with banks of issue, to total

THE RESERVE BANKS

deposits as nearly as they can be determined. In
view of different banking practices in different
countries, it is remarkable how nearly uniform are
the percentages of reserve carried.
Typical Reserve
United States member banks.....................
9.5
Ten London clearing banks.............................
11.5
Four French credit companies........................
11.5
Swiss private banks.....................................
8.0
Chartered banks of Canada.............................
11.0

Encouragement of Savings Deposits,—Part of the
reduction in reserves shown in Diagram 6 was due
to changed reserves on time or savings deposits and
to a large increase in such deposits. Before 1914
as large reserves were required on time deposits as
on demand. By the Federal Reserve Act, as already
indicated, the reserve on time deposits was lowered
to 5 per cent, and by amendment in 1917 to 3 per
cent for all member banks.
There has followed a remarkable change in the
character of business done by national banks. The
amount of time deposits in 1914 was a little over
1 billion, but by 1926 was over 6 billion dollars.
Time deposits increased from 17 per cent of the
total individual deposits of national banks to 37
per cent.
Just what these largely increased time deposits
represent is a much-debated question. Do they rep
resent simply a reclassification of deposits previ
ously treated as demand deposits? Do they repre
sent business which would otherwise have gone to
the savings banks? Or are they new savings deposits
stimulated by the offering of more convenient sav-

AND THE MONEY MARKET

ings facilities and by extensive advertising? There
is no way of answering these questions finally. Some
light is shed on the problem by a comparison of
the growth of time deposits in all commercial banks
and deposits in mutual savings banks. The figures
are shown in the following diagram and table.
We may summarize these findings as follows:
1. Despite war changes and more widespread
buying of government and other investment securiWLLlOHS
Of POLLAM

DIAGRAM 8—SAVINGS DEPOSITS HAVE KEPT PACE WITH TOTAL BANK
DEPOSITS IN THE UNITED STATES DUB PRINCIPALLY TO RAPID INCREASES
IN SAVINGS DEPOSITS IN COMMERCIAL BANKS.

ties, total savings deposits, including time deposits,
have kept pace with the rapid growth of total bank
deposits.
2. Savings deposits in commercial banks have
grown at a more rapid rate than deposits of mutual
savings banks.
3. The writer’s tentative conclusion from these

THE RESERVE BANKS

Table 4.—Growth of Savings Deposits Relative
All Deposits—All Banks in the U. S.

(In millions of dollars)
Savings Deposits

All
Mutual Com
Savings mercial
Year Banks Banks
(Time
deposits)
1911
1912
1913
1914
1915
1916
1917
1918
1919
1920
1921
1922
1923
1924
1925
1926

3,459
3,609
3,812
3,910
3,945
4,102
4,339
4,382
4,732
5,058
5,568
5,818
6,273
6,693
7,152
7,525

4,504
4,795
4,736
4,802
4,862
5,357
6,537
7,153
8,308
10,256
10,933
11,761
13,454
14,496
15,982
17,171

Total

7,963
8,404
8,548
8,712
8,807
9,459
10,876
11,535
13,040
15,314
16,501
17,579
19,727
21,189
23,134
24,696

Per Cent
of Savings
and other
Time De
Total
posits to
Individual Total Indi
Deposits vidual De-*
posits

15,604
16,742
18,122
18,891
18,674
22,065
22,831
24,518
28,449
32,361
34,233
36,336
40,491
41,064
45,464
47,472

51
50
47
46
47
43
47
47
46
47
48
48
49
51
51
52

Source: Report of the Savings Bank Division, American Bankers
Association.

figures and other evidence is that time deposits in
commercial banks are to a considerable extent genu
ine savings deposits; that the convenient facilities

AND THE MONEY MARKET

and vigorous advertising campaigns of these banks
have brought out considerable new savings. There
are, however, undoubtedly large time deposits which
represent transfers from demand deposits of cor
porations and other funds not needed for imme
diate use.
The recent growth of time deposits raises the fur
ther important questions as to whether reserve re
quirements are adequate, and how the growth of
time deposits is changing the character of the busi
ness of commercial banks. A commercial bank
which finds itself for the first time holding a large
amount of time deposits may need a complete over
hauling of its loan and investment policy.
The protection of time depositors is a part of the
problem. In case of a run on a commercial bank,
the demand deposits might conceivably be with
drawn by check through the clearing house and the
bank’s assets exhausted, while the time depositors
stood in line at the tellers’ windows or were per
haps required to wait thirty or sixty days. The
combining of commercial and savings business on a
large scale in one institution raises a number of
such questions, to which careful bankers are now
giving much thought.
The Changes Wrought—The Federal Reserve
Act, in its revision of bank reserves, has opened the
way for many changes in banking practice. Some
of these changes are now becoming apparent: a
gradual reduction in cash in vault; the growth of
savings deposits in many banks to an equal place
with demand deposits. Other changes may well be
going on under the surface, changes in investment

THE RESERVE BANKS

policy, changes in the amount and kind of second
ary reserves maintained, and many others.
But the change of supreme importance which has
made possible these other changes is the pooling
of the reserves of member banks in cooperatively
governed institutions, not organized for profit, but
devoted to the public service. This coordination of
banking power has given new strength and stability
to the banking system.
SUMMARY

1. Before the Federal Reserve System bank reserves
were scattered among thousands of individual
banks and our reserve laws were so inflexible that
reserves could not be used in emergencies.
2. The Reserve System made two great changes in
reserves:
A. It concentrated the reserves and made them
mobile and usable.
B. It provided a plan for credit expansion based
upon these reserves.
3. Concentration and greater efficiency of reserves
have made possible a large reduction in the
amount each member bank is required to main
tain.
4. Lower reserve requirements on time or savings
deposits have been followed by rapid increases in
these deposits in commercial banks, with a con
sequent change in the character of the business
of these banks.

CHAPTER IV
Changes in the Currency

HE changes which the inauguration of the Re
serve System has brought about in the coun
try’s currency may be summarized under three
headings. This country has—
1. A new kind of currency.
2. A new storage place for reserve currency.
3. A new mechanism for supplying currency.
As a consequence of these changes there have
come about important differences in what is termed
“elasticity” of the currency, and there have also
been effected economies in handling it.
A New Kind of Currency.—The Federal Reserve
note constitutes the principal physical point of con
tact between the man in the street and the Federal
Reserve System. For almost every adult person,
almost every day, handles Federal Reserve notes.
They constitute between one-third and one-half of
the total amount of paper money in circulation
in the United States, and at one time in 1920 they
were more than two-thirds of the total.
Diagram 9 shows the make-up of the actual cir
culation of paper money in the United States (out
side of the Treasury and the Reserve Banks) in
1914, and more recently. The increase in currency
which the war and high world prices made neces
sary was provided almost wholly by issues of Fed-

THE RESERVE BANKS

eral Reserve notes. War wages and war prices were
largely paid with this new currency, and now that
more normal conditions have returned the Federal
Reserve note remains the largest single element in
the currency system.

JULY 1

NOV. 1

1914

1920

JAN 1
1927

DIAGRAM 9—MILLIONS OF DOLLARS OF PAPER MONEY IN CIRCULATION
IN THE UNITED STATES. THE FEDERAL RESERVE SYSTEM HAS PRO
VIDED THE NECESSARY ELASTICITY.

The Federal Reserve note was designed, in both
its nature and method of issue, to provide currency
expansion in emergencies. By its nature the Fed
eral Reserve note is directly related to the trade
activity which makes its issuance necessary, for it
may be issued partly against the security of com
mercial paper.

AND THE MONEY MARKET

Prior to the establishment of the Federal Reserve
System there were in general use four kinds of paper
money, all of which are still issued: first, gold cer
tificates, secured dollar for dollar by gold held in
the Treasury of the United States, and susceptible
of being increased or decreased only as the volume
of gold in the Treasury was increased or decreased;
second, silver certificates, secured dollar for dollar
by coined silver, the amount of which is limited
by law; third, United States notes, the greenbacks
of the Civil War, which were originally secured by
nothing but the promise of the government to pay,
but are now secured by gold to the amount of about
50 per cent of the total in circulation; the amount
of these in circulation is also limited by statute to
$346,000,000; fourth, national bank notes, issued by
the national banks of the country and secured by
United States Government bonds, which bear low
rates of interest but carry the privilege to the bank
holding them of issuing currency. For purposes
of redemption each national bank is obliged to
maintain a fund of lawful money in Washington
amounting to 5 per cent of its notes in circulation.
The amount of national bank note circulation is
limited to the amount of bonds carrying the circu
lation privilege and for some years past has been
close to the possible maximum.
It will be noted that, although these four kinds
of paper currency are interchangeable dollar for
dollar one with another, the security behind them is
in some cases 100 per cent metallic and in other
cases mainly government obligations; also that the
amount of the total circulation made up of these

THE RESERVE BANKS

forms of currency was so fixed that it could neither
be decreased readily in slack seasons and dull years,
nor be increased readily in busy seasons and periods
of emergency.
The Federal Reserve Act in prescribing the se
curity behind Federal Reserve notes introduced a
new principle into our currency system. It specified
a security which is sound and at the same time
increases and decreases with the business and agri
cultural needs of the country when it provided that,
apart from a minimum gold reserve, Federal Reserve
notes might be secured by short-term promissory
notes representing industrial, commercial, and agri
cultural transactions, or bankers’ acceptances.
The paper used as security represents agricultural
products or other goods in the process of production,
or in movement from producer to retailer, in process
of export or import, or on the shelves of retailer
or wholesaler awaiting sale. The paper must bear
the indorsement of a member bank and its maxi
mum maturity at the time of rediscount is ninety
days, except in the case of agricultural paper, which
may run for nine months. A war-time amendment
of the Reserve Act also provided that fifteen-day
collateral notes of member banks secured by govern
ment obligations or eligible paper might be ac
cepted as security for Reserve note issues. The
acceptance of this kind of paper as collateral was
essential in the war, and at present it offers the most
convenient form for short-time member bank bor
rowing and usually represents business needs for
funds as truly as paper having the form of a busi
ness obligation.

AND THE MONEY MARKET

The use of the Federal Reserve note gives a possi
ble power of currency expansion adequate for almost
any conceivable emergency. In the latter part of
1920, for example, when currency in circulation was
at its highest point, the Reserve Banks could still
have issued an additional 800 million dollars of
Federal Reserve notes before the reserve percentage
for the System would have reached the legal mini
mum.
A New Storage Place for Reserve Currency,—
While in a serious emergency the power of the Re
serve Banks to issue notes secured in part by com
mercial paper is an important power, in recent years
this power has been of less importance than the
mechanism for storing and handling all kinds of
currency. The gold holdings of the Reserve Banks
have been so large that notes in circulation could be
secured almost dollar for dollar with gold. The kind
of collateral security for the currency has, therefore,
been less important than the mechanism by which it
goes into or returns from circulation.
In the old days the country’s reserve supply of
currency was stored in the vaults of individual banks
and particularly in the vaults of the central re
serve city banks of New York, Chicago, and St.
Louis. As was shown in a previous chapter, “cash in
vault” of all national banks amounted to 13.5 per
cent of their deposits, whereas today it amounts to
only 2 per cent. The cash, consisting of gold and
currency, which constituted the legal reserves of
the banks, has been shifted physically from the
vaults of the individual banks to the vaults of the
Reserve Banks. Bank reserves are thus no longer

THE RESERVE BANKS

in the form of “cash in vault,” but in the form
of “balances with the Federal Reserve Bank.”
Banks only carry enough currency in their own
vaults and tills to meet the needs of their customers
from day to day.
When a member bank needs more currency for
any purpose it draws it from the Reserve Bank in
just the same way as the ordinary bank customer
draws money from his bank. A bank simply draws
its check against its “balance with the Reserve
Bank” and takes the proceeds in cash. If this op
eration brings its reserve below requirements the
bank restores it by borrowing. Conversely, when
a bank has a little more currency on hand than
it needs to meet customers’ needs, it returns the
money to the Reserve Bank and gets a deposit
credit for it, and repays any loan it may owe the
Reserve Bank. Non-member banks follow some
what the same procedure with their city corre
spondents, which in turn draw upon the Reserve
Banks.
The first result of this change in location of the
country’s reserve cash is that the cash is central
ized in the Reserve System instead of being scat
tered among thousands of individual bank vaults.
This means that the cash is more readily available
whenever there is an unusual need.
The second result of the concentration of reserve
currency in the Reserve Banks, which also have the
note-issuing power, is that the process of “extrac
tion” of currency from the Reserve Bank in time of
seasonal or emergency need is less painful than the
operation used to be at times when currency cir-

AND THE MONEY MARKET

culation could be increased only by withdrawing
from individual banks their cash reserves.
Before the Federal Reserve System, bankers
throughout the country who needed currency drew
on New York or other centers, and when the need
was past returned surplus funds to those centers.
The banks in principal centers and particularly New
York were the nearest approach to bankers’ banks,
and they planned as far as they could to keep
enough margin of cash on hand to meet seasonal
and emergency needs. This meant that at most
times they had more cash than was needed and at
other times less than was needed. The maintenance
of these cash reserves on which the country might
draw was an expensive procedure, for which the
banks in the centers were paid by large bankers’
balances maintained with them and by high inter
est rates at periods of greatest demand. In any
considerable emergency the supply of cash was in
adequate, because at such a time banks were nat
urally unwilling and were also forbidden by law to
pay out their minimum legal reserves. Elasticity
was limited and was obtained at a stiff price.
The Federal Reserve Act with its amendments
placed the country’s reserve cash in institutions not
organized for profit which can afford to let cash
lie idle in readiness for seasonal and emergency
needs, and which have as well the note-issue privi
lege and are thus in a position to meet almost any
need. The outside limit to paying out currency, in
the absence of special action by the Federal Reserve
Board, is the legal requirement that each Reserve
Bank must have a gold reserve of 40 per cent against

THE RESERVE BANKS

Federal Reserve notes and 35 per cent gold or law
ful money against deposits. Within this limit re
straint on issues of currency by the Reserve Banks
is found in the discount rate and other instruments
of Federal Reserve policy.
A New Mechanism for Supplying Currency.—As
indicated earlier the operation by which currency in
the Reserve Banks is put to use is that when mem
ber banks need currency for their customers they
draw it from the Reserve Bank. Their withdrawal
of any considerable amount of currency usually re
duces their balances at the Reserve Bank below
their required reserve and they accordingly bring up
their balances by borrowing from the Reserve Bank
at its established discount rate. Conversely, when
ever currency in circulation becomes larger than is
required by the needs of business, it begins to return
to the banks and they immediately utilize it to pay
off indebtedness at the Reserve Banks, on which
they are paying interest. Even if banks are not in
debt at the Reserve Bank they return any surplus
currency to the Reserve Bank, because a deposit in
the Reserve Bank, against which checks may be
drawn, is much more useful to them than currency
in buying securities or otherwise employing their
funds. Currency in the tills of a member bank
earns nothing and does not count as reserve, but a
balance at a Reserve Bank may be drawn against or
counted as reserve.
It is important to note that there is a close re
lationship between the total amount of Federal Re
serve credit in use and the amount of currency
in circulation. The demand for currency is nor-

AND THE MONEY MARKET

mally the principal reason for the putting in use
of Federal Reserve credit. This relationship may
be illustrated by Diagram 10, quoted from the Fed
eral Reserve Bulletin for July, 1926. One line shows
the total amount of money in circulation at the
first of each month and the second line shows the
total amount of Reserve Bank credit in use, in-

CALLING RESERVE BANK CREDIT INTO USE.

eluding not only loans directly to member banks,
but purchases of bills and securities by the Fed
eral Reserve Banks as well.
The amount of Reserve Bank credit required from
time to time is, of course, influenced by other fac
tors than currency, including gold exports and im
ports and changes in requirements for bank reserves
because of changes in bank deposits. In the period

THE RESERVE BANKS

from 1922 to the middle of 1924, for example, Re
serve Bank credit was decreased because heavy gold
imports were used by the banks of the country to
repay loans at the Reserve Banks. But in normal
times, when the gold movement is smaller, changes
in currency are by far the most influential factor
in calling forth additional Reserve Bank credit or
in retiring it. To put the matter in its simplest
terms, changes in the amount member banks borrow
from the Reserve Banks are due principally to
changes in their customers’ currency requirements,
and changes in the total amount of Federal Reserve
credit in use are due principally to changes in mem
ber bank borrowing.
It is the fact that the country’s marginal supply
of currency is obtained by borrowing from the Re
serve Banks that in normal times gives the currency
elasticity. Banks feel free to borrow to get what
currency they need, but they always try to repay
their loans by returning currency at the earliest
possible moment.
In currency transactions the Federal Reserve
Banks are largely passive. They do not force money
into circulation nor force it back from circulation.
A low discount rate may make it easier for mem
ber banks to borrow and so obtain currency; a high
discount rate may make it more difficult. But the
initiative in withdrawing or returning currency is
always taken by the member bank.
It is the facility with which member banks can
borrow at the Reserve Banks which is primarily
responsible for currency elasticity and it makes
little difference at first whether the Federal Reserve

AND THE MONEY MARKET

Bank pays out to the member bank Federal Reserve
currency, gold certificates, silver certificates, United
States notes or any national bank notes it may have
on hand. In a certain sense the Federal Reserve Sys
tem has made all types of currency elastic, because
all can be paid out in amounts required and they all
tend to flow back to the Reserve Banks when they
are not required in the business of the country.
It is only in periods of emergency, when the re
sources of the Reserve Banks are strained, that the
characteristics of the Federal Reserve note in re
quiring a gold reserve of only 40 per cent and being
otherwise secured by discounted paper become im
portant.
At such times it makes a real difference in the
Federal Reserve statement whether it meets de
mands for currency by issuing gold certificates or
Federal Reserve notes. A $100 Federal Reserve
note may represent only $40 in gold, because a gold
reserve of only 40 per cent is required against Fed
eral Reserve notes. On the other hand, a $100 gold
certificate must represent $100 in gold. Thus the
Federal Reserve Banks could issue, in any emer
gency, in response to commercial demands which
provide collateral security, two and one-half times
as many Federal Reserve notes as gold certificates.
For example, the present amount of reserves of
the Reserve Banks is about $3,000,000,000; the
total amount of deposit and note liabilities is $4,
000,000,000. The reserve ratio is thus three-fourths
or 75 per cent. If the System paid out some $1,400,
000,000 of gold certificates this reserve ratio would

THE RESERVE BANKS

be reduced to 40 per cent, but it could issue $3,500,
000,000 additional Federal Reserve notes before the
ratio reached 40 per cent. This computation in
tabular form is as follows:
At Present:
Reserves............ $3,000,000,000
Liability for notes anddeposits. $4,000,000,000

If $1,400,000,000 Gold Certificates Are Paid Out:

Reserves............ $1,600,000,000
Liability for notes anddeposits. $4,000,000,000

If $3,500,000,000 Federal Reserve Notes Are Paid
Out:
Reserves....................................... $3,000,000,000 _
Liability for notes and deposits. $7,500,000,000
0

The importance of this secondary elasticity of
currency, due to the expansive power it gives the
Federal Reserve System, was illustrated during and
after the war, when in response to war and post-war
demands Federal Reserve notes were issued to the
amount of $3,405,000,000, a maximum reached on
December 23, 1920. Without the elasticity which
the Federal Reserve note provided the situation
could not have been met without extraordinary
measures.
The gold holdings of the Reserve Banks are at
present so large that a major part of the demand for
currency could be met by payments of gold cer
tificates rather than Federal Reserve notes. But
in any emergency the power to issue these notes
increases by 150 per cent the amount of currency
which might be supplied to the country. It gives

AND THE MONEY MARKET

a secondary elasticity which has been important
once and may be equally important at some fu
ture time.
Elasticity in Practice.—An interesting test of the
elasticity of the currency under the Reserve System
may be made by comparing currency movements in
this country with those of Canada. For many years
before the adoption of the Federal Reserve System
the Canadian banking system was frequently held
up as a model which might be copied, from the point
of view of currency elasticity at least. Canada is a
country peculiarly in need of an elastic currency,
for the nation’s business is centered in agriculture,
which requires much larger amounts of currency in
the fall than at other times of year. Canadian bank
note currency, an asset currency, has proved itself
flexible.
Diagram 11 shows the fluctuations in paper
money in circulation in Canada and in the United
States before and since the establishment of the
Federal Reserve. The two lines prior to 1914 tell the
story of this country’s currency difficulties. While
the flexible Canadian currency responded regularly
to changes in the seasonal need, our own was rigid,
inflexible.
In the fall of 1914 the shock of the World War
forced the use of the temporary Aldrich-Vreeland
currency, but shortly thereafter the Reserve Banks
were opened for business and Federal Reserve notes
became a part of this country’s currency. From that
time on there began to be fluctuations here corre
sponding somewhat to the changes in Canadian cur
rency. The United States does not need as large

THE RESERVE BANKS

a percentage of fluctuation in its currency as Can
ada; its industries and trade are more diversified.
But the way the currency has fluctuated since an
elastic element was added demonstrates that we
had been suffering in the past from a kind of cur
rency paralysis.

DIAGRAM 11—BEFORE 1914 THE CURRENCY OF CANADA WAS FLEXIBLE
IN MEETING CHANGES IN BUSINESS NEEDS, BUT CURRENCY IN THE
UNITED STATES WAS RIGID AND INFLEXIBLE. SINCE 1914 BOTH HAVE
BEEN FLEXIBLE.

Diagram 12 shows an enlargement of two parts
of Diagram 11 to bring out more clearly the present
seasonal changes in note circulation compared with
pre-war.
Currency, Wages, and Trade.—The typical sea
sonal changes which now appear to be characteristic
of currency circulation are largely a reflection of the
seasonal changes in wage payments, and the retail
expenditure for which currency is principally used.
A vast part of the country’s business requires little

AND THE MONEY MARKET

or no currency. Foreign trade, wholesale trade, se
curity transactions, freight movements, etc., are
carried on by the use of checks or other credit de-

DIAGRAM 12—MONEY IN CIRCULATION IN THE UNITED STATES NOW
HAS SEASONAL FLUCTUATIONS CORRESPONDING SOMEWHAT TO THE
SEASONAL CHANGES IN CANADIAN CURRENCY.

vices. Wage payments and family expenditures are
the principal uses of currency.
Diagram 13 illustrates the relation between cur
rency in circulation and a combined index of wage

THE RESERVE BANKS

payments and retail trade, quoted from the Federal
Reserve Bulletin, July, 1926. The data included in
the combined index are only a sampling of the many
uses of currency, but the correspondence between
the movements of the two lines indicates a close
connection between them.

FACTORS IN DETERMINING THE NEED FOR CURRENCY.

Characteristic Movements.—An interesting by
product of the centralization of currency reserve in
the Reserve Banks is that it is now possible to
trace day by day currency changes which were quite
lost to view when they were scattered among in
dividual banks. It is possible to observe in detail
the relationships between trade and currency move
ments which have been commented upon broadly in
the preceding paragraph.

AND THE MONEY MARKET

Take as an example what happened to currency
circulation over the Christmas period in 1924. Re
tail trade at Christmas time is always larger than at
other times in the year; in fact, department stores
of New York City and other cities usually do about
one-seventh of their year’s business in the month
of December alone. This results in a considerable
increase in the need for hand-to-hand currency, and
there are other needs as well arising from increased
payrolls, Christmas gifts, increased travel, larger
food purchases, etc. The figures for currency with
drawals and receipts at the Federal Reserve Banks
illustrate the way in which this special demand for
currency was met. Prior to Christinas there was
paid out about $300,000,000 of currency, all of which
was returned to the Reserve Banks within the two
or three weeks following Christmas, as shown in the
table on the next page.
Here is a typical case of currency elasticity. Cur
rency was put into circulation to meet a temporary
need and then retired. An interesting and important
fact about the movement was that elasticity was
not confined to Federal Reserve notes. Gold cer
tificates moved into and out of circulation just as
freely.
Payrolls and Holidays,^-.A regular though less
spectacular currency movement is the typical
weekly movement largely reflecting withdrawals for
payrolls and the return of this currency as it is re
deposited in banks. This movement is so regular
that with a few exceptions one week is almost a
repetition of another. On Thursday banks begin
to withdraw from the Federal Reserve Banks the

THE RESERVE BANKS

Table 5.—How Currency Flows In and Out of the
Reserve Banks
(In millions of dollars)

Paid Into Circulation
(Net)
Week
Ended

1924
Nov. 26
Dec. 3
Dec. 10
Dec. 17
Dec. 24
Dec. 31
1925
Jan. 7
Jan. 14

Received From Circu
lation (Net)

Other
Other
Federal Money
Federal Money
Reserve Mostly Total Reserve Mostly Total
Notes Gold
Notes Gold
Certif
Certif
icates*
icates

22
4
5
18
70

18
10
23
45
54

••

40
14
28
63
124

154

57
67

39
22

96
89

* Payments include gold drawn for export.

currency which their customers will require for their
weekly payrolls and for week-end expenditures.
Thursday and Friday there are large withdrawals
for these purposes. Saturday there are smaller
withdrawals. On Monday this money begins to flow
back to the Reserve Banks and the flow continues
on Tuesday and Wednesday. Of course, there are

AND THE MONEY MARKET

some withdrawals on Monday, Tuesday, and Wed
nesday, and some deposits on ■ Thursday, Friday,
and Saturday, but deposits almost always exceed
withdrawals on the first three days of the week
and withdrawals exceed deposits in the last three
days.
This weekly currency movement may be illus
trated by the daily figures for a typical half year
at the Federal Reserve Bank of New York. Table
6 shows the net movement each day from April 5
to October 2, 1926, between New York City banks
and the Federal Reserve Bank. The “+” signs in
dicate net deposits of currency in excess of with
drawals and the “•—” signs net withdrawals.
The first notable feature of the table is the clean
division between the first and second halves of the
week. The first half shows predominantly the “+”
signs of net deposits and the second half “—” signs
of net withdrawals. The average or typical weekly
movement is shown at the foot of the table. The
period was one of increasing demands for currency
and hence withdrawals somewhat exceeded deposits.
A careful study of the table leads to a number of
other conclusions about the country’s use of cur
rency. There is a distinct tendency towards heavy
withdrawals at the end of the month for monthly
payrolls and a less noticeable tendency around the
fifteenth of the month. There are larger withdraw
als just before holidays, and deposits afterwards.
On the basis of these figures payrolls and holidays
seem to account for most of the day-to-day fluctua
tions in currency circulation.

THE RESERVE BANKS

Table 6.—Daily Net Currency Movement in New
York City To or From the Federal Reserve Bank
of New York
(+ indicates deposits in the Reserve Bank, and — with
drawals from the Reserve Bank)
(In millions of dollars)

Week
Begin
ning

Apr. 5
12
19
26
May 3
10
17
24
31

Mon
day

Tues
day

+
+
+
+
+ 0.1 +
+ 3.5 +
+ 0.8 +
+ 2.6 +
Holiday +
+ 6.1 +
— 0.3 +
+ 3.2 +
— 0.9 +
+
+
+
+

5.4
3.0
2.6
1.5

June 7
14
21
28
July 5 Holiday +
12 + 4.0 +
19 + 0.8 +
26 + 1.1 +
Aug. 2 -4.6 +
9 + 2.2 +
16 - 0.7 +
23 + 2.3 +
30 - 2.3 Sept. 6 Holiday +
13 + 3.2 +
20 + 1.5 +
27 - 8.5 +
Average + 12 +

Fri
day

Wed Thurs
nesday day

11.7
7.7
8.3
5.9
8.1
9.3
7.8
6.3
0.7

+
+
+
+

6.7
3.3
4.1
3.5

2.5
8.7
7.0
10.8

+
+
+
+
+

6.5
3.9
5.8
2.9
7.2

5.7
9.1
6.8
13.5
5.2

9.8
3.7
7.7
1.6

+
+
+
-

5.0
3.0
4.1
1.2

4.5
10.0
6.7
6.5
5.5
7.2
4.6
7.0
1.8

+
+
+
+

12.8
3.6
4.3
0.8

+
+
+
+
+

3.2
3.1
3.2
3.4
3.9

5.5
7.7
7.5
14.8
0.8
7.8
7.5
10.5
8.7
9.8
8.8
9.2
11.1

0.8
8.4
7.5
5.6
6.2

+
+
+
+

7.9
2.2
4.4
0.9
4.2

Satur
day

4.5 - 1.3
8.0 - 2.0
5.2 - 1.0
13.7 -3.8
5.5 - 0.3
9.7 - 2.2
7.2 - 0.9
12.4 - 4.0
5.4 + 0.4

- 1.3
- 1.6
- 1.2
- 0.8
+ 1.0
- 2.1
- 1.2
- 3.8
-0.3
- 2.6
- 0.6
- 1.3
- 1.8
6.0 - 4.5 + 0.6
8.3 - 6.3 -0.4
6.2 - 6.0 - 0.3
13.5 - 11.4 - 2.7
8.2 - 7.8 - 1.4
-

7.1
6.8
8.2
14.0
4.1
6.3
7.2
9.6
7.2
9.3
8.2
7.7
8.2

AND THE MONEY MARKET

Size of Currency Operations.—Most of the bills
and coin in use in this country have been placed in
circulation by the Federal Reserve Banks. The
principal exception is national bank notes, which
are put into circulation by national banks. Other
forms, gold certificates, silver certificates, United
States notes, and Federal Reserve notes are placed
in circulation principally by the Reserve Banks.
These banks are constantly receiving from the
Bureau of Engraving and Printing of the Treasury
Department in Washington, where all money is
printed, supplies of new money. They are con
stantly receiving from the member banks currency
in all stages of wear. Used currency is sorted and
all badly worn notes are eliminated, and new notes
issued instead.
There is now in circulation in this country, in the
pockets of individuals, in the safes and tills of busi
ness concerns and banks, and actually passing from
hand to hand in trade a little less than $5,000,000,
000 of money. In 1926 over $13,000,000,000 of cur
rency and coin passed through the hands of the Re
serve Banks. At this rate the total amount of
money in circulation passes through the Reserve
Banks about two and one-half times a year or once
every five months.
To handle so large a volume smoothly and to be
prepared for emergencies the Reserve System car
ries in Washington and in the vaults of the twelve
Reserve Banks and their twenty-six branches and
agencies a reserve of $3,000,000,000 of new currency
in addition to the working stock of old currency.
Practically no bank is distant more than twenty-

THE RESERVE BANKS

four hours and the vast majority of banks are dis
tant only overnight from one of these currency
depots. An adequate supply of currency is thus
always readily obtainable.
The mechanical handling of currency is, in terms
of volume of work, one of the largest of the func
tions of the Federal Reserve Banks. In the case
of the Federal Reserve Bank of New York, for ex
ample, a force of about 300 people out of a total
staff of 2,400 is employed solely in handling cur
rency and coin. Counting of coin has for some years
been a machine operation and recently a machine
has been invented and adopted for counting paper
money, which almost doubles the per capita daily
output of employees counting money. The expense
of the currency and coin operations of the New
York Reserve Bank, including printing costs, for
which the bank pays the Bureau of Engraving and
Printing, the cost of sorting, counting, wrapping,
paying, and shipping, and including overhead ex
pense is about 11,800,000 a year or about 28 per
cent of the total expenses of the bank. In the other
Federal Reserve Banks the expense of handling
money has much the same relation to total ex
penses. In taking over and absorbing the cost of
this work the Federal Reserve Banks have relieved
the United States Treasury, which used to do much
of the work through the old Subtreasuries (now
abandoned), and have also relieved the large banks
in money centers, which used to do much of this
work for their out-of-town correspondents. The
centralization of the work, moreover, in the Reserve
Banks makes a quantity job of it. In addition to its

AND THE MONEY MARKET

service in giving the currency elasticity the Federal
Reserve currency mechanism is an effective public
economy.
SUMMARY

1. The Federal Reserve System has supplied a new
kind of currency, the Federal Reserve note, which
now constitutes between one-third and one-half
of the total paper money in circulation in the
country.
2. This new currency, secured in part by commercial
paper or bank obligations, can be increased or
decreased to meet fluctuations in the need for
money.
3. The concentration of reserve supplies of cur
rency in the Reserve Banks gives elasticity to
all forms of currency, for added amounts can be
drawn into use when needed.
4. Member banks draw currency from the Reserve
Banks in much the same way that any customer
draws money from a bank. When the need for
currency is large, member banks usually have
to borrow from the Reserve Banks to maintain
their reserves. The desire of banks to repay this
borrowing is one of the forces that bring cur
rency back to the Reserve Banks promptly when
the unusual need is passed.
5. The change that has taken place in the elasticity
of currency may be illustrated by comparing the
seasonal variations in the amount of currency in
circulation in this country and Canada. Formerly
the Canadian currency responded promptly to

THE RESERVE BANKS

seasonal changes in business, but this country’s
currency was inflexible. Now the currency here
shows seasonal fluctuations much like those in
Canada.
6. Fluctuations in currency circulation reflect prin
cipally changes in payrolls and retail trade.
There are notable increases at regular payroll
periods and at holidays, particularly at Christ
mas.
7. The mechanical handling of currency is in terms
of volume of work one of the largest functions
of the Reserve Banks. In 1926 the Reserve Banks
handled $13,000,000,000 of currency and coin.
The total amount of money in circulation passes
through the Reserve Banks about once every five
months.

CHAPTER V

Improved Methods

Business Settlements

N the days before the Federal Reserve System
when Peter Brown, hardware merchant of Can
yon, Colorado, settled his bills for the month it
was quite a complicated process. The bill from the
United Hardware Company of Madison, Wisconsin,
bore the legend, “This bill payable only in Chicago
funds.” The Buffalo Steel Plow Company invoice
called for a draft on New York.
The St. Louis
Screw Corporation asked for settlement in St. Louis
funds. Brown’s check book on the People’s Bank
of Canyon could not be used in paying most of
his out-of-town bills, and every month Brown had
to purchase at his bank seven or eight drafts on
Chicago, New York, and other centers. He paid
several dollars a month for these drafts.
Today when Peter Brown pays his bills he rarely
has to buy a draft. He can settle practically all
bills with his own checks on the People’s Bank. This
is because, in general, invoices no longer specify
that settlement must be made in drafts on particu
lar centers. Checks on the People’s Bank of Canyon,
Colorado, are accepted in every part of the country.
It seems a simple thing for concerns doing a na
tional business to omit from their invoices a single
line specifying what funds will be accepted in pay
ment, but that omission reflects a transformation
65

THE RESERVE BANKS

in the methods of check collection, a transforma
tion which constituted a new and important step
in the evolution of sound and efficient methods of
business settlements in the United States.
Evolution of Business Settlements.—Perhaps the
first step taken by the United States as a nation
in providing adequate means for business and finan
cial settlements was the passage of the Coinage Act
of 1792, which gave the country a standardized
coinage which might circulate at par value, 100
cents on the dollar.
Paper currency provided our next series of prob
lems in business settlements. During the first half
of the nineteenth century we were trying various
experiments in securing a satisfactory currency with
which debts might be paid and business transactions
settled. During that period our people were under
the necessity of scrutinizing every bank note which
came to them, and frequently incurred losses be
cause paper money received, even when issued by
perfectly sound banks, could not be redeemed at
its full face value. Banker and merchant kept at
hand a “Ready Detector” to identify currency and
determine its true value. This condition was largely
remedied by the passage of the National Bank Act
in 1863-1865, which taxed out of existence the old
state bank notes and provided for the issuance of
a national bank note currency, secured by govern
ment bonds and accepted at every national bank at
par value.
Checks were the third means of business settle
ment which called for standardization. The second
half of the nineteenth century, which was notable

AND THE MONEY MARKET

for the growth of organized industry, remarkable
railroad expansion, and a corresponding financial
development, was notable as well for the widespread
development by American business and finance of
a new means for making settlement in business
transactions—the bank check. By the end of the
century studies carried forward in the office of the
Comptroller of the Currency indicated that between
80 and 90 per cent of the country’s business was
settled by check and only 10 to 20 per cent by the
use of coin and currency.
The problems arising from the widespread use of
checks were similar to the old currency problems.
As the business man previously had scrutinized the
currency he received to make sure it could be re
deemed at its face value, without deductions, so at
a later date he scrutinized checks to make sure that
they could be turned into cash rapidly at par value,
100 cents to the dollar. The acceptability of checks
as substitutes for coin or currency depended on
rapid convertibility into cash, dollar for dollar.
Clearing House Introduced.—The first step in
securing rapid settlement of checks was the intro
duction of the clearing house. The New York City
Clearing House, the first in this country, was estab
lished in 1853. Before that time each of the fiftytwo banks in New York City sent a messenger to
each of the other banks with packages of notes and
checks. Each of the fifty-two banks kept detailed
ledger accounts for each of the other fifty-one banks.
Under this cumbersome practice daily settlements
were impossible and a weekly settlement was made
every Friday. This postponement of the day of

THE RESERVE BANKS

reckoning and the abuses it fostered, together with
the inefficiency of the old plan, made reform es
sential to any wide use of checks. The clearing
house was successful immediately upon its estab
lishment, although four of the original fifty-two
banks could not stand the test of daily settlements,
and were expelled.

DIAGRAM 14—GROWTH OF CLEARING HOUSE OPERATIONS IN THE

UNITED STATES.

The clearing house idea spread rapidly to most
of the large cities and the amount of checks handled
through clearing houses rose, as shown in Diagram
14, from about one billion dollars a year, when only
the New York Clearing House was in operation,
to over 500 billions at present
A Major Defect.—But there was still one major
defect in the check-collection scheme—there was
no simple economical method for collecting checks

AND THE MONEY MARKET

between different towns and cities; there was no
nation-wide system for the collection of checks cor
responding to the city clearing house.
To collect checks drawn on out-of-town banks,
each bank had to make special arrangements with
special banks in other centers, and the machinery
of check collection thus became a complicated maze
of special relationships between banks. As a result
check collection was expensive, slow, and at times
uncertain.
The expense of check collection to the business
man was of two kinds: The first expense resulted
from the time required for collection. While the
check was in process of collection the bank in which
the check was deposited lost the use of the funds,
if it allowed the depositor to draw against the check
before collection. To cover this expense most banks
made an interest charge, sometimes called a collec
tion charge, or required the customer to keep a
balance sufficient to cover checks in process of col
lection. This charge was sometimes made even when
customers were not allowed to draw against un
collected funds.
The second kind of expense was a charge made,
not by the bank collecting the check, but by the
bank paying its own check. This charge purported
to cover the cost of providing funds to pay the check
in a distant city. In theory the paying bank had
to ship currency or pay the cost of maintaining a
bank balance in a distant center. In practice, of
course, checks presented to a bank for payment
from other cities were largely offset by checks mov
ing in the opposite direction, and only the balance

THE RESERVE BANKS

between incoming and outgoing checks had to be
settled. But because the payment of every check
presented from a distance involved in theory an ex
pense it was the custom for most banks outside of
large centers to make a small charge when they
paid checks drawn on themselves presented from
out-of-town. When they paid a check for $100 they
deducted from 10 to 25 cents and paid only $99.90
or $99.75. This deduction from face value in pay
ing checks was known as an exchange charge, be
cause the bank making the payment was, in theory
at least, exchanging local funds for funds in some
other center. It was in theory a transaction in in
land exchange; and in those days there was fre
quently a premium or discount on inland exchange.
Some banks when collecting checks for their cus
tomers absorbed the exchange charges they had to
pay, but most banks passed the charge back to the
customer. If the business man accepted in payment
of a bill a check for $100 drawn on a distant bank,
it was worth not $100, but perhaps $99.75. It was
largely to avoid this loss, which on thousands of
transactions amounted to a considerable sum, that
the United Hardware Company, the Buffalo Steel
Plow Company, and the St. Louis Screw Corpora
tion of our illustration declined to take checks from
Peter Brown drawn on the Canyon, Colorado, bank.
Expense, Delay, and Risk.—Business men and
bankers were constantly searching for ways in which
they could avoid the payment of this exchange
charge. One way of avoiding the charge was, as we
have seen in the case of Peter Brown, for wholesale
houses to accept only drafts on large near-by cen-

AND THE MONEY MARKET

ters. Another way was to accept out-of-town checks,
but make special arrangements to present them for
payment, not by mail from a distance, but from
the same or a near-by town; so that the paying bank
would have no occasion for charging exchange. If
a St. Louis bank received a Canyon, Colorado, check
it might send it to a bank in Denver, Colorado,
which regularly collected checks on the Canyon
bank, and by reason of its special arrangements
could make the collection without being charged
exchange.
But the St. Louis bank might not have a corre
spondent in Denver and therefore might send the
check to a Chicago bank which did have such a
correspondent. A check might be sent to three or
four cities before it was collected. Indirect routing
of this sort added further delay to a check-collection
scheme, which, for lack of any nation-wide system,
was slow at best.
Delay of this sort increased the amounts of in
terest which banks charged their customers for the
use of uncollected funds.
Delay also increased the risk of non-collection.
Every day which elapsed before the check was pre
sented for collection increased the danger of return
for lack of funds, and the danger from the failure
of some bank handling the check on its long jour
ney or of the bank on which the check was drawn.
Each day of delay before the depositor of a check
was notified of its non-payment delayed the presen
tation of claims and increased the risk of non
payment.
The old lack of system in collecting country

THE RESERVE BANKS

checks thus bore fruit in expense, delay, and risk,
and banks were constantly searching for means by
which these evils might be corrected. Many city
clearing houses organized country check depart
ments to systematize, in part at least, the collection
of out-of-town checks. Many country banks sit
uated near cities arranged to have checks drawn
upon them settled through their correspondent in
the city clearing house. These and other schemes
were only partly successful, and when Federal Re
serve legislation was under discussion there was gen
eral insistence that it should include a nation-wide
plan for check collection.
A New Mechanism,—The Federal Reserve System
provided a mechanism for nation-wide check collec
tion, to do very much for the banks of the nation
what the clearing house does for the banks of the
city. Twelve Reserve Banks, with twenty-four
branches, provide offices within easy reach of every
bank in the country. Over 9,000 member banks,
with more than two-thirds of the country’s banking
resources, keep their reserves deposited at these
Reserve Banks—a natural basis for check settle
ments. Debits from collections can be charged to
these reserve deposits, and credits can be added to
reserve deposits.
For settlements between the Reserve Banks there
has been set up that ingenious device, the gold set
tlement fund, lodged in Washington with the Fed
eral Reserve Board, and represented by a gold credit
on the books of the Treasurer of the United States.
This fund is owned by all the Federal Reserve

AND THE MONEY MARKET

Banks, and settlements between Reserve Banks are
daily effected by bookkeeping entries, on telegraphic
advice, changing the proportion of the gold fund
which the different banks own.
In these ways the Reserve System provides
channels through which the funds represented by
checks may flow readily from one part of the coun
try to another, and through which settlements of
these checks may be made with great rapidity and
at a minimum of expense.
The operation of the Federal Reserve check-col
lection mechanism in its simplest form is as fol
lows: When Peter Brown’s check on the People’s
Bank of Canyon, Colorado, comes to the St. Louis
Screw Corporation, it is deposited with the Third
Trust Company of St. Louis, and collection takes the
following course:

1. The Third Trust Company deposits it for
collection with the Federal Reserve Bank
of St. Louis.
2. The Federal Reserve Bank of St. Louis sends
it to the Denver branch of the Federal Re
serve Bank of Kansas City.
3. The Denver branch sends it direct to the
People’s Bank of Canyon.
4. The People’s Bank settles with the Denver
branch in Denver funds or Federal Reserve
funds.
5. On receipt of this remittance check the Den
ver branch gives the Federal Reserve Bank
of St. Louis credit immediately. On the
same day the Federal Reserve Bank of St.

THE RESERVE BANKS

Louis gives the Third Trust Company credit.
An immediate bookkeeping settlement be
tween Reserve Banks thus takes the place of
mail remittance.
As a matter of practice, the average time it takes
for the collection of a check drawn on any point
has been established by experience and is reflected
in a printed schedule which each Federal Reserve
Bank prepares and distributes to its members. Ac
cordingly, the Federal Reserve Bank of St. Louis
automatically gives the Third Trust Company
credit for Peter Brown’s check five days after it is
deposited. Before the Federal Reserve System it
would have taken about ten days. The principal
saving arises from the elimination of remittance by
mail which is replaced by telegraphic settlement
between Federal Reserve Banks. Time is also saved
by more direct handling.
There are other special arrangements which have
been worked out to secure greater speed of check
collections. Some of the Reserve Banks have their
own post offices and send their mail pouches direct
to mail trains, and thus save the few hours that
would be required to send mail to central post
offices. Many member banks handling large
amounts of checks have made arrangements to send
checks direct to Federal Reserve Banks of other
districts instead of through their own Reserve
Banks. Settlement, however, is effected on the
books of their own Reserve Banks. A number of
county clearing arrangements have been devised by
which banks in the same county may exchange

AND THE MONEY MARKET

checks directly and the balances may be settled at
the Federal Reserve Bank.
Cause of Exchange Charge Removed.—The ex
change charge formerly made by many banks in
paying their own checks was made, as we have seen,
on the theory that it cost a banker something to
pay his out-of-town checks, either in the shipment
of currency or in maintaining out-of-town balances.
With the existence of the Federal Reserve collec
tion system the occasion for such exchange charges
disappeared. It no longer costs the banker whose
checks go through the Federal Reserve collection
system anything extra to pay his checks from outof-town, because these checks are presented through
the nearest Federal Reserve Bank, or branch, and
not from a distance. He no longer has to make pay
ment at a distant point but at the nearest Federal
Reserve office, and the Reserve Bank pays the cost
of all currency shipments.
It is thus logical that under the law the Federal
Reserve System can accept and collect only checks
payable at par, without exchange deduction. This
elimination of exchange charges for most of the
country’s checks removes one of the principal causes
of delay in collection.
Time Saved.—The Federal Reserve System saves
time in collecting out-of-town checks in three prin
cipal ways:

1. Systematic and wholesale handling.
2. Elimination of the indirect routing which
formerly prevailed to escape exchange
charges.

THE RESERVE BANKS

3. Telegraphic settlement between
Banks.

Reserve

The time for collecting checks under the Federal
Reserve System varies from one day in the case of
near-by cities, where there are Reserve Banks and
branches and where checks are presented at the
local clearing house, to nine days in the case of the
most distant transcontinental points. In general,
the time required to collect checks has been cut in
half.
Money Saved.—The Federal Reserve collection
system saves money for banks and business in the
following principal ways:

■

1. Reduction in the number of times checks
have to be handled.
2. Handling large numbers of checks by quan
tity methods.
3. Reduction in amount and distance of cur
rency shipments.
4. Reduction in number of out-of-town drafts.
5. Reduction in interbank balances for collec
tion purposes.
6. Reduction in accounting costs.
7. Absorption by Reserve Banks of costs of
check handling and currency shipments.

There is no way of computing accurately the sav
ing to the country from the operations of the sys
tem, because the saving reaches all the way from
the small country bank to the large city bank, and
from the small business man or farmer to the large
industrial enterprise. The total is certainly many
millions of dollars a year.

AND THE MONEY MARKET

There is similarly no way of knowing just how
the benefits of the system have been divided be
tween banks and their customers, because banking
customs differ so widely in different parts of the
country.
Certain of the savings to customers are perhaps
more direct and obvious than the savings to banks.
The Peter Browns who sell hardware and other
merchandise in all parts of the country no longer
have to buy drafts or keep accounts in the large
cities to pay their out-of-town bills. Except in rare
cases wholesale houses no longer suffer the deduc
tion of exchange charges when they collect their
out-of-town checks.
The interest (or collection) charges which busi
ness men pay their banks for advancing the amount
of out-of-town checks while they are being col
lected have been much reduced because the time of
collection has been shortened. Of the more than 325
clearing houses in the United States only twentyfive now require banks in their membership to make
charges of this sort.
Loss through non-payment has been reduced be
cause checks are presented more rapidly and notifica
tion of non-payment is received more rapidly.
All these are direct and obvious money benefits
to business resulting from the Federal Reserve col
lection system.
To the extent that banks used to absorb the cost
represented by exchange and interest charges they
have been direct gainers from the new system. But
most of the benefits to banks have been somewhat
less obvious and direct, such as a reduction in risk

THE RESERVE BANKS

of loss because of the shortened time of collection,
reduced clerical labor in handling and accounting
for checks, reduction in the amount of currency
shipments and payment of costs of such shipments
by the Reserve Banka, and reduction in the num
ber and amount of out-of-town bank accounts. Per
haps the most important benefit is that the country
check has become an acceptable means of payment
for out-of-town bills. The country bank can now
offer its customers checking facilities which before
could only be offered by the city bank. The country
bank can, therefore, retain deposits which before
would have been diverted to cities.
Every new invention and every forward step in
industrial and social evolution has brought with it
necessary readjustments. When the cotton gin was
invented, it threw many out of work. So the type
writer and the adding machine made shifts in occu
pations necessary. The linotype forced many a type
setter to learn practically a new trade or be out of
a job. When the National Bank Act taxed state
bank notes out of existence, it deprived the state
banks of a profitable business. When the city clear
ing house was introduced, a number of banks, as
we have seen in the case of New York City, were
not able to adjust their operations to the new
scheme.
The establishment of the Federal Reserve collec
tion system, based on par payment, has made rad
ical changes in this phase of banking, but the banks
of the country have adjusted themselves to the
changed conditions with remarkable rapidity. Fol
lowing a period of experimentation, the collection

AND THE MONEY MARKET

system in its present form was inaugurated in July,
1916. Today, after eleven years, it is estimated that
98 per cent of the checks drawn in the United States
are payable at par through the Federal Reserve Sys
tem. The Reserve System now handles for collec
tion probably 95 per cent of all out-of-town checks.
The twelve Reserve Banks handle over 2% million

checks a day for collection, with a value of about
900 million dollars. The total value of checks col
lected each year is well over 250 billion dollars, an
amount equal to about five times the country’s

THE RESERVE BANKS

total bank deposits. This work is done without
charge, and checks are collected in about half the
time it took under the old plan.
While most of the banks in the country have
cheerfully assisted in the development of the Fed
eral Reserve check-collection system and have been
willing, for the sake of the other advantages they
enjoyed, to pay their checks at par and give up
the charging of exchange, there have been a few
small banks, particularly in country districts in the
South and West, which have resisted the new plan
or have not been able to satisfy the requirements
of the System for the prompt payment of checks
drawn on them. These few banks have continued
to charge exchange and their checks, therefore, can
not be handled by the Federal Reserve Banks since
the law provides that “no such charges shall be
made against the Federal reserve banks.” Checks
drawn upon these banks are still handled by the old
haphazard methods.
At one time when the check-collection system
was being introduced the Reserve Banks made a
vigorous effort to bring some of the recalcitrant
banks into the par system. When banks would not
remit at par for checks sent to them by mail, the
Reserve Banks proceeded through local agents to
present checks over the counters of these banks,
thus requiring settlement without deduction of ex
change. Some of the banks objected vigorously to
this practice, and litigation was instituted both by
these banks and also by some of the banks which
were paying their checks at par. The history of
these suits, involving as they did many technical-

AND THE MONEY MARKET

ities of interpretation of banking practice and of
law, has no place in this book. Several of the cases
were carried to the United States Supreme Court.
In brief, the result was that the Federal Reserve
par collection system was upheld in its entirety,
even to the right of the Reserve Banks to present
checks over the counter for collection when banks
would not remit at par by mail. In view, however,
of the small number of banks not remitting at par,
and the opposition aroused in forcing par payment,
by counter presentation, the Reserve Banks have
discontinued that practice and do not handle for
collection checks drawn on banks which charge ex
change. It is believed that the importance to the
bank customer of having his bank use the Federal
Reserve collection system will in time make it
essential for all banks to remit at par and enjoy
the advantages of the nation-wide collection system.
Wire Transfer of Funds.—Along with the devel
opment of the Federal Reserve check-collection sys
tem has gone the development of a system for trans
ferring funds by wire more rapidly and at smaller
cost than before the Reserve System was estab
lished. What the check-collection system has done
for settlements by check the wire transfer system
has done for telegraphic settlements.
Only a few years ago a man in Chicago having
a bill to pay immediately in New York would
usually buy “New York exchange,” in just the same
way as a New York merchant buys London exchange
in the course of overseas trade. Domestic exchange
was subject to many of the rules that govern the
foreign exchanges; it fluctuated, was bought and

THE RESERVE BANKS

sold, and registered the ebb and flow of business
currents. Often, as in the foreign exchanges, the
shipment of gold or currency was required to settle
net balances of payments between different parts of
the country. These shipments were expensive and
subject to the hazards of transportation. There was
a normal seasonal movement toward the West in
the autumn, when the crops were being harvested,

MAP 2—THE FEDERAL RESERVE TELEGRAPHIC-TRANSFER SYSTEM PRO
VIDES A FREE FLOW OF FUNDS ABOUT THE COUNTRY. BOOKKEEPING
BY TELEGRAPH LARGELY REPLACES CURRENCY SHIPMENTS.

and a flow back to New York in the winter, when
goods were being paid for and investments made.
All of this was expensive, not only because of the
cost of shipment and insurance, but because of the
unproductivity of funds while in transit.
Under the Federal Reserve System shipments
of gold and currency for the purpose of settling bal
ances have been almost wholly eliminated. While
writers still describe movements and transfers of

AND THE MONEY MARKET

funds quite as if shipments were being made, they
refer to transfers accomplished instantly and at par
over the wires of the Federal Reserve System.
Physical shipments are now practically restricted
to the supplying of hand-to-hand currency for use
as till money to member banks by their Reserve
Banks and to the return to the Reserve Banks of
such currency as is not needed by the business of
the country.
The mechanism of wire transfers through the Re
serve System is that the X bank in New York, for
example, wishing to transfer $1,000,000 to the Y
Bank in Chicago, advises the Federal Reserve Bank
of New York. The following steps are taken:
1. The New York Reserve Bank telegraphs the
Chicago Reserve Bank and simultaneously
debits the reserve account of the X bank
$1,000,000.
2. A few minutes later the Chicago Reserve
Bank credits the reserve account of the Y
bank $1,000,000 and notifies the bank, which
may use the funds immediately.
3. At the end of the day the New York and
Chicago Reserve Banks report to the Re
serve Board in Washington the total debits
or credits resulting from their operations
with each other and settlement is made by
changes in the ownership of the gold settle
ment fund.
'
The general principle of wire transfers is thus
similar to the principle of check collection through
the Reserve System. The various offices of the

THE RESERVE BANKS

System in all parts of the country, with their welldeveloped means of communication and their plan
for daily settlement of accounts through the gold
settlement fund, provide a ready channel for the
rapid movement of bank funds about the country.
Transfers of member bank balances in round
amounts are handled free of charge over the leased
wires, but transfers for member banks for the ac
counts of banks, individuals, firms, or corporations
are made over commercial wires, for which there
is a charge to cover the cost of the telegram. Such
transfers may be for any purpose or for any amount.
The volume of wire transfers made by the twelve
Reserve Banks has grown rapidly to an enormous
business, as may be illustrated by the following
figures for transfers made each year by the Federal
Reserve Bank of New York alone.
Table 7.—Wire Transfers Made by the Federal
Reserve Bank of New York

Number of Transfers Amount of Transfers
1917..............
1918..............
1919..............
1920..............
1921..............
1922........
1923..............
1924..............
1925..............
1926..............

10,000
39*000
84*000
154'000
215'000
236,000
284*000
293'000
294'000
329'000

$ 6,768,000,000
19*384 XX)'000
18365'000^000
17,410,000,000
18'160 OOO'OOO
25'126^000'000
28'032'000'000
35j183^000*000
38'821'000'000
44'392'000'000

AND THE MONEY MARKET

SUMMARY

1. Three important steps in the evolution of means
of payment in the United States have been the
standardization of coinage, the standardization
of paper money, and the development of sys
tematic methods for check collections.
2. What the clearing house did for city checks the
Federal Reserve System has done for out-of
town checks in providing a means of systematic
handling and thus reducing expense, delay, and
risk in collections.
3. The Reserve System with its twelve banks and
twenty-four branches provides a mechanism for
the expeditious routing and collection of checks,
and remittance time is shortened by telegraphic
book settlements through the gold settlement
fund.
4. Since the Reserve Banks now make settlements
between distant points there is no more occasion
for the “exchange charge” which banks used to
make in paying their own checks presented from
a distance.
5. Since the Reserve System has cut in half the
time required to collect checks, it has greatly
reduced the “interest charge” which some banks
make for the use of funds represented by uncol
lected checks.
6. Savings to business men and bankers from the
Federal Reserve check-collection system include
Reduction in number of times checks have to
be handled, because of more direct routing.

THE RESERVE BANKS

Reduction in the credit risk by speeding up
check collections.
Reduction in amount and distance of currency
shipments.
Reduction in interbank balances for collection
purposes.
Reduction in need for purchase of special bank
drafts.
7. Under the present plan the check on the coun
try bank has become as acceptable a means of
payment as the check on the city bank.
8. The banks of the country have adjusted them
selves rapidly to the improved check-collection
mechanism, and 98 per cent of the checks drawn
in the United States are now payable at par
through the Federal Reserve System.
9. The Federal Reserve private wire system and
gold settlement fund are also used for transferring
funds between all parts of the country, with large
saving of expense and inconvenience.

CHAPTER VI
Bankers

for the

Government

HE United States Government is the largest
customer of the Federal Reserve Banks. It
sometimes deposits in these banks as much as
$100,000,000 in a single day and it frequently makes
payments totaling even larger amounts. The
volume of Treasury operations with the Reserve
Banks is illustrated by Table 8, on the next page,
showing the debits and credits to Treasury account
at the Federal Reserve Bank of New York for the
month of September, 1925. The nature of the
transactions may be gathered by running one’s eye
down the items listed in this table.
The following comments may be made concerning
certain of the items in the table:
Checks and Warrants.—Treasury checks in
payment of pensions, war risk insurance, or any
other Treasury disbursements are payable at any
one of the twelve Federal Reserve Banks or their
twenty-four branches. The commercial banks with
which such checks are deposited present them at the
Federal Reserve Banks for payment. These checks
come through in enormous volume. The govern
ment check division of the Federal Reserve Bank of
New York, for example, handles about 36,000 sep
arate government .checks each day and the value of
these checks averages in the neighborhood of 4

THE RESERVE BANKS

Table 8.—Treasurer’s Account, Second Federal Re
serve Districtu—Month of September, 1925
Debits

Checks and warrants paid.......................... $ 81,234,000
39,548,000
Coupons paid...... .........................................
127,681,000
Treasury notes and certificates redeemed.
Funds transferred from New York............
49,952,000
PurchasesaccoimtTreasury,variousbureaus
53,455,000
278,000,000
Special one-day certificates redeemed. . . .
5,000,000
Payment to Republic of Colombia............
$634,870,000
Total debits...........................................

Credits
Income taxes................................................. $119,695,000
49*477^000
Internal revenue receipts............................
28,722,000
Other receipts................................................
3,437,000
Withdrawals from government depositaries
155,987,000
Funds transferred to New York................
R. R. payments and sale of railroad notes
2,312,000
778,000
Sales account Treasury, various bureaus...
278,000,000
Special one-day certificates issued.............

Total credits..........................................
$638,408,000

million dollars. Checks and warrants of this sort
paid by the twelve Reserve Banks in 1926 totaled
about 4 billion dollars.
Coupons Paid.—The Reserve Banks also cash the
coupons of government bonds. The bulk of this
work is done when the interest becomes due on the
15th of certain months, but thousands of dollars’

AND THE MONEY MARKET

worth of coupons are presented for redemption each
day, largely by member banks, at each of the Re
serve Banks. During 1926 about 40 million sep
arate coupons were paid with a value of more than
600 million dollars.
Treasury Notes and Certificates Redeemed.,—
Government securities of all kinds are redeemed at
the Federal Reserve Banks or branches when they
mature, and this redemption is such a large trans
action when it occurs that it not only places a peak
load of work on the Federal Reserve Banks at the
quarterly tax dates, but causes exceedingly interest
ing movements in the money market, which will be
described later in this chapter. Redemptions
throughout the System amounted to 2% billion
dollars in 1924.
•
Funds Transferred from New York.—Through
the private telegraph wires of the Federal Reserve
Banks the Treasury transfers millions of dollars from
one part of the country to another to utilize its avail
able funds to the fullest advantage in meeting its
engagements in all parts of the country.
Purchases for Account of Treasury.—There
are a number of government agencies which have
funds to invest, such as the Veterans’ Bureau and
the Alien Property Custodian. In addition, the
Treasury from time to time buys government secur
ities in the open market from surplus revenues and
for account of the sinking fund. AU of these pur
chases are handled by the Federal Reserve Banks,
which, through their close association with the
money market, are able to arrange these large trans-

THE RESERVE BANKS

actions at satisfactory prices and with a minimam
of disturbance to the market.
Special Certificates.—To make unusually heavy
payments in redeeming maturing obligations on
tax dates the Treasury overdraws its account at the
Federal Reserve Banks. The overdraft takes the
form of a purchase by the Reserve Banks of a oneday special Treasury certificate of indebtedness, the
amount of which is reduced each day by the use of
funds which have become available during the day.
It is only at the quarterly tax dates, on March 15,
June 15, September 15, and December 15, that this
special borrowing by the Treasury becomes neces
sary for a few days. The amount of this one-day
borrowing frequently runs as high as 150 to 200 mil
lion dollars on the 15th and is rapidly reduced on
succeeding days until it is completely repaid within
from three days to a week.
Most of the other items in the summary table of
the September transactions with the Treasury do
not require explanation in detail. The table clearly
indicates the wide range and the large volume of
operations which are carried forward by the Reserve
Banks in their capacity as bankers for the govern
ment. There are still further activities, which do
not appear in Table 8, including the issue of new
securities; the exchange or transfer of registered and
coupon securities; the holding in safekeeping of se
curities; and the operation of a system for the tele
graphic transfer of short-term government securities.
An analysis of the personnel and expenditures of
the Federal Reserve Bank of New York indicates
that out of a total staff of 2,400 people the full time

AND THE MONEY MARKET

of about 200 is now employed in handling banking
transactions for the United States Government. An
analysis of the expense account shows that more
than 10 per cent of the bank’s entire expenses, or
in the neighborhood of $650,000 a year, is fairly
chargeable to Treasury banking business. For all
the Federal Reserve Banks the number of workers
handling such transactions is about 750 and the an
nual expense is probably over 2 million dollars.
Some years ago the Federal Reserve Banks were
reimbursed by the Treasury for most of this ex
penditure, but in 1921, by agreement with the Treas
ury, this ceased to be the case. There is now
reimbursement for only certain specified expendi
tures in connection with new security issues, and
nine-tenths of the work done for the Treasury is
done without charge, although the Treasury to
some extent pays indirectly, since the expense of
work done for the Treasury reduces the amount of
net earnings available at the end of each year for
payment to the Treasury as a franchise tax.
With all its vast turnover of funds, amounting
for the System as a whole to between half a billion
and a billion dollars a month, the Treasury Depart
ment carries an average balance with the Reserve
Banks of about 30 million dollars, a smaller bal
ance than is carried by some of the large member
banks. Treasury deposits thus have a rate of turn
over in the neighborhood of twenty-five times a
month or 300 times a year.
Earlier Experiments,—'The United States Govern
ment had been looking for a satisfactory banking
agency for a long time before the inauguration of

THE RESERVE BANKS

the Federal Reserve System and several experi
ments had been tried. As a bank customer the
government is exacting in its requirements, carries
on an enormous volume of banking transactions,
keeps a small balance, objects to paying a service
charge, and requires very detailed accounting. Any
banking agency for the government must meet four
requirements:

1. It must be absolutely sound.
2. Transactions with it must involve no fa
voritism.
3. It must transact operations efficiently and
rapidly.
4. Its transactions must not disturb the money
market.

Not only in the United States, but in foreign
countries as well, the problem of the relationship
between the state and the money market has been
almost, if not quite, as troublesome as the relation
between the state and religion. The relation of
state and money market cannot be settled in the
same way as the problem of state and religion, for
it is impossible to draw a line of cleavage between
the state and the money market so long as the
state must raise revenue and pay bills.
In this country divorcing state finance from the
money market has been tried. After some prelim
inary experiments during the first half of the nine
teenth century in various forms of government bank
ing practice, and when some organized system was
found to be essential after the Second Bank of the
United States had been discontinued, a plan was

AND THE MONEY MARKET

set up in 1846 called the Independent Treasury Sys
tem, and designed to separate state finance from
the money market as completely as possible. The
government decided that it would be its own banker
and have nothing to do with the privately organized
banking institutions of the country. Government
banking offices were set up in the six cities of New
York, Boston, Charleston, St. Louis, Philadelphia,
and New Orleans, and at those offices the govern
ment collected revenues and paid its bills. Under
this system revenues had to be paid in specie, and
disbursements were likewise made in specie. Gov
ernment balances were locked up in cash.
The history of the succeeding sixty years is a
record of the gradual breakdown of the Independent
Treasury System. The scheme could not endure.
It received its first serious setback at the outset of
the Civil War, when the attempt to collect in specie
the funds which the Treasury required to conduct
the war immediately forced private banks to sus
pend specie payment. Some way out had to be
discovered before the conclusion of the war and
the result was the establishment of the National
Banking System, which proved itself, according to
Hugh McCulloch, Secretary of the Treasury at
the conclusion of the war, “a vast improvement upon
the systems which it superseded, and one admir
ably adapted to our peculiar form of government.”1
The national banks aided the government greatly
in floating war issues and generally handling the
nation’s funds. Before the end of the war a sub1 Report of the Secretary of the Treasury on the State of the
Finances for the Year 1866, p. 16.

THE RESERVE BANKS

stantial part of the Treasury balance was main
tained on deposit with the national banks.
Relations with the Money Market.—From that
time forward the Treasury was no longer com
pletely independent, but certain of its funds were
continuously on deposit with the national banks.
The proportion of the Treasury funds so deposited
varied greatly from time to time. Each succeed
ing Secretary of the Treasury had his own views as
to the propriety of these deposits under the Inde
pendent Treasury law, and the amount of deposits
reflected these varying views. Diagram 16 shows
over a long period of years where the Treasury’s
balances were deposited on June 30 of each year.
The changes in these figures are important because
under the scheme which existed up to the time of
the establishment of the Federal Reserve System
all balances held by the Treasury itself and not
placed in depositary banks represented coin or cur
rency withdrawn from circulation or from the re
serves of the banks. In the Independent Treasury
we had an agency which from time to time drew
money out of the market or poured money into it,
frequently without any particular regard to the
effect of this action on the money market. In
judging the effects of this action it should be noted
that the funds so withdrawn from the market or
poured into it represented reserve funds—that is,
they were specie or currency. And the effect on
the credit situation of changing the volume of re
serve funds is greater than the effect of changing
ordinary bank deposits.

DIAOHAM

16 — UNDER THE RESERVE SYSTEM TREASURY BALANCES HAVE BEEN LARGELY KEPT IN COMMERCIAL BANKS
WHERE THEY ARE AVAILABLE FOR THE USB OF BUSINESS, INSTEAD OF BEING LOCKED UP IN TREASURY OFFICES.

BALANCES m GENERAL FUND < / #w TREASURY

THE RESERVE BANKS

When the National Monetary Commission made
its report in 1911 it included an analysis by Profes
sor David Kinley, of the University of Illinois, of
the effects on banking and the money market of the
Independent Treasury System. In a careful statis
tical study Professor Kinley demonstrated how the
changes in the balances held by the Treasury De
partment in its own vaults were immediately
effective in lowering or raising the available reserve
funds of banks and hence tended to result in abrupt
changes in money-market conditions. One can im
agine the disorganizing influence on the money
market if the huge Treasury receipts and payments
of today were made in cash.
We find in the reports of a number of Secretaries
of the Treasury as we go back over the years of the
Independent Treasury, a recognition that the sys
tem was placing upon the Treasury Department
great responsibility with respect to the money
market. The Treasury was forced into the position
of assuming certain functions of a bank of issue.
Even as early as 1866 we find the following para
graph in the report of the Secretary of the Treas
ury. In discussing the course which the Secretary
had pursued with regard to the gold in the vaults
of the Treasury, he said:
He has permitted it to accumulate when the use or the
sale of it was not necessary for paying government obli
gations, or to prevent commercial panics, or successful
combinations against national credit; and he has sold
whenever sales were necessary to supply the Treasury
with currency, to ward off financial crises, or to save the
paper circulation of the country as far as practicable

AND THE MONEY MARKET

from unnecessary and damaging depreciation. For mak
ing sales he alone is responsible.1

In the reports of the Treasury we frequently find
phrases like the following, quoted from the report
of the Treasurer for the year 1879:
It is becoming apparent that should the withdrawal
of money continue the market would be affected unfav
orably. . . . 2

Forced to be Financial Dictator.—It was in
periods of financial crises that the Treasury Depart
ment was most frequently forced to assume the
role of financial dictator. The Treasury came to
the rescue of the money market by depositing Treas
ury funds in banks, buying government securities
in the market, or anticipating interest payments on
the debt in practically every one of the important
financial crises. It was at times the regular prac
tice of the Treasury to put money out in the fall
when credit demands were greatest, and draw it in
again in the early winter.
There are many difficulties with this type of de
pendence of the money market on the Treasury for
support. The Secretary of the Treasury is one of
the President’s political family and policies change
with each change of administration. The Secretary,
moreover, had a dual responsibility. His primary
task was to administer government finance with
regard to the provisions of the law and with the
maximum of economy and efficiency. To the extent
1 Report of the Secretary of the Treasury on the State of the
Finances for the Year 1866, p. 10.
* Report of the Secretary of the Treasury on the State of
Finances for the Year 1879; report of the Treasurer, p. 340.

THE RESERVE BANKS

that his decisions were based on these motives, the
effects of his action on the money market tended to
be subordinate and secondary. Moreover, as a polit
ically appointed officer, the Secretary of the Treas
ury was under constant criticism in dealing with
individual depositary banks; banks were always
bringing to bear political pressure to obtain deposits
and the cry of favoritism, of “pet banks,” was con
stantly raised.
To the credit of our Secretaries of the Treasury
it must be said that under these difficulties and
working under the restrictions to which all govern
ment departments are subject, their record is sur
prisingly good. The trouble was more with the ma
chinery than with the operators.
Middleman Needed,—What was needed was a
middleman between the Treasury Department and
the banks of the country, a thoroughly trustworthy
agent without political affiliations, and with per
manent tenure; in close contact with the money
market but not engaged in money-making. This is
what the Federal Reserve System provided. The
Reserve Banks are not government banks because
all of their stock is owned by the member banks
and six of the nine directors of each bank are elected
by the member banks. The public interest is
guarded by the supervision over the banks by the
Federal Reserve Board, a body appointed by the
President. This Board appoints three of the nine
directors of each Reserve Bank. The Reserve Sys
tem, moreover, is removed by the terms of its basic
legislation from those profit-making motives which

AND THE MONEY MARKET

must necessarily determine the activities of private
banks.
.
A Typical Instance.—The way in which the Re
serve System conducts large financial operations
for the government without serious disturbance to
the money market may be illustrated by quoting
from the Monthly Review of the Federal Reserve
Bank of New York for April 1, 1927 the account of
the quarterly tax day operations on and following
March 15, 1927. At two or three points explanatory
phrases have been added to the account.
Treasury transactions for the country as a whole in
cluded the redemption of $660,000,000 of Treasury notes,
the largest maturity in some years; the issuance of two
new series of certificates of indebtedness, $170,000,000 at
3% per cent for six months, and $314,000,000 at 3^ per
cent for one year; the issuance of $1,355,000,000 of
Treasury 3% per cent three to five year notes in exchange
for Second Converted 4% per cent Liberty Loan bonds,
redeemed with interest to May 15, 1927; the payment of
$90,000,000 of interest; the withdrawal of $192,000,000
of government deposits from depositary banks; and the
receipt of over $500,000,000 of income taxes. The total
turnover of government funds on and about March 15
was well over 3 billion dollars. Much of this, particu
larly the collection of income taxes, was spread over a
number of days and distributed about the country. The
first day of the tax period, the 15th of the month, is al
ways the heaviest day, however, and in all such opera
tions between one-third and one-half of all transactions
take place in New York. As a consequence, the volume
of operations of the New York Reserve Bank on March
15 was one of the largest for any day in its history. The
total turnover of funds on that single day, including both
transactions for Treasury account and ordinary banking

100

THE RESERVE BANKS

operations, was close to 2 billion dollars. This total was
made up roughly as follows:

Fiscal Agency Operations
Securities redeemed..........................
$ 343,000,000
Securities exchanged........ ...................
548,000,000
Subscriptions to new issues................
136,000,000
Interest paid.........................................
32,000,000
8^000,000
Income taxes collected........................

Total..................................................
$1,067,000,000
Banking Operations
Checks and other collections..............
Wire transfers............................... .......
Currency payments and receipts.......
New loans to member banks..............
Member bank loans paid....................

$ 530,000,000
243,000,000
28^000,000
10,000,000
75'000'000

Total..................................................

$ 886,000,000

Total, all Operations................

$1,953,000,000

Certain of these very large Treasury operations have
no effect on the money market beyond some churning
about of funds. They do not involve any gain to the
money market or any loss to the market. The exchange
of 3% per cent notes for Second Liberty 4%’s, for ex
ample, neither withdraws funds from the market nor
puts funds into the market. Similarly, the issue of new
certificates does not affect the money market, since these
certificates are largely paid for by deposit credit to the
account of the government on the books of the subscrib
ing banks, and there is no withdrawal of funds until the
Treasury from time to time makes calls upon these de
posits as it has need for funds. The Treasury operations
which did exercise an important effect upon the money

AND THE MONEY MARKET

101

market were the redemption of maturing notes, the pay
ment of interest, the call of funds from depositary banks,
and the collection of income taxes.
The immediate effect of Treasury operations on March
15 was to pour into the money market about 265 million
dollars of funds, because payments by the Treasury to
redeem maturing notes and to pay interest were imme
diately available, whereas the actual collection of income
tax checks by the Treasury was spread over a number of
days. (The Treasury obtained the funds to meet this
large excess of payments over receipts by selling the Re
serve Bank a one-day special certificate of indebtedness
which was renewed in reduced amounts for several
succeeding days.) The money-market problem, in which
the Federal Reserve Bank was concerned, was to prevent
this huge gain in funds by the market on March 15 from
upsetting the market. The extra funds put into the mar
ket by the Treasury were absorbed in the following ways:
1. Member banks in New York City allowed their
reserves to run below requirements for a few days
prior to March 15, so that they came to March 15
with an accumulated deficiency of 85 million dol
lars.
2. On March 15, banks repaid the Reserve Bank 63
million dollars of loans.
3. In addition, 18 million dollars of Federal Reserve
credit was retired through decreases in holdings of
bills and government securities under sales con
tract.
4. The Reserve Bank made a temporary sale of 60
million dollars of government securities to several
member banks.
5. Maturities of $25,000,000 of securities from the
System’s holdings were not replaced until the fol
lowing week.

By these means the greater part of the 265 millions
of excess funds was withdrawn from the market and as
a consequence there was no serious average of funds in

102

THE RESERVE BANKS

the market. Money rates in the stock exchange market
only went below 4 per cent for a few hours on March
16; on March 17 and 18 (as income-tax checks were col
lected) the member banks resold to the Reserve Bank
the securities they had purchased, and on March 18 they
found it necessary to borrow 117 million dollars from the
Reserve Bank to bring their average reserves up to re
quirements. Thus money conditions were maintained at
a stable level during the week.
The Reserve Bank’s temporary sale of government se
curities to the member banks was of interest partly be
cause it took a new form. Temporary sales of securities
have frequently been made in the past at tax periods to
prevent unduly easy money, but such sales have usually
been made from the securities in the System’s open mar
ket account, which are lodged in New York. The sale
during the March tax period took the form of the sale
of participations in the special one-day certificates of in
debtedness, which the Treasury issued to the New York
Bank to cover the funds which it borrowed from the
New York Bank to meet its temporary excess of expendi
tures over receipts.

A complete picture of all shifts in funds between
the Federal Reserve Bank and the market during
such a time as the tax period would require more
space than this chapter allows. This outline sketch
indicates the way in which the intimate relation
between the Federal Reserve country-wide mechan
ism and the money markets of the country, together
with the power of the Reserve Banks to extend ad
ditional credit to the government or to member
banks when necessary, provides the means by which
Treasury operations may be handled smoothly and
effectively and without disturbance to the markets.
Another reference to Diagram 16 will show that
even with the present gigantic size of government

AND THE MONEY MARKET

103

financial operations the Treasury is today able to
operate with a smaller balance than in many of the
earlier years when the volume of operations was
small in comparison.
War Service.—One reason for giving such a de
tailed account of quarterly tax-day operations is
that these operations are typical of the procedure
which was followed in carrying through the vast
amount of war financing. During the war it was
the Federal Reserve Banks which organized the sale
of Liberty bonds and Victory notes and of short
term certificates of indebtedness, and it was these
banks which handled the proceeds and paid them
out again from time to time at the direction of the
government. It was the power of the Federal Re
serve banks to extend credit which enabled member
banks, and through them the public, to subscribe as
they did to the war loan issues.
These things are all a matter of current record
and vivid memory, and it is perhaps only important
to point out here the fact that these huge opera
tions were carried forward without any disorgani
zation of the money market. The secret of the
smoothness with which these operations were con
ducted in the money market was that funds were
never allowed to pile up in the Federal Reserve
Banks or the Treasury, but were only called in to be
paid out immediately. When banks made payments
for Liberty bonds they took the form of deposits to
the credit of the Federal Reserve Banks as fiscal
agents of the Treasury, and the operation of buy
ing bonds was in the main simply a transfer of
deposits on the books of the banks from the ac-

104

THE RESERVE BANKS

counts of customers to the account of the Treasury.
The government drew down its balance only as the
funds were needed to be paid out, and by these
payments for services, munitions of war, loans to
the Allies, etc., it created new balances to the ac
counts of bank customers. Back of all these opera
tions stood the Federal Reserve Banks ready to
make advances to the member banks whenever
necessary.
A second principle which was important in main
taining stability in the money market during and
after the war was that, except for a single three
months’ loan of $50,000,000 in April, 1917, and for
occasional issues of special one-day certificates of
indebtedness, the Treasury to its everlasting credit
did not borrow directly from the Reserve Banks.
To the extent that Federal Reserve credit was re
quired to finance the war, it was created by borrow
ing on the part of member banks, with the obliga
tion which that involved for the eventual return of
the loan, or it took the form of open market pur
chases by the Reserve Banks of commercial obliga
tions which were saleable in the open market. The
Reserve Banks were thus in a position at all times
to exercise an influence toward stability.
This principle of independence of the Reserve
Banks from direct Treasury borrowing was a sound
principle to follow and saved our banks of issue
from many of the troubles that have overtaken cer
tain of the European banks of issue, which have
found themselves under government domination
and out of contact with the money market.
It is illuminating to try to visualize what the

AND THE MONEY MARKET

105

situation would have been if the Treasury had bor
rowed directly from the Federal Reserve Banks.
Suppose that at the maximum in 1920 $3,000,000,000
of the total of $3,400,000,000 credit extended by the
Reserve Banks had been lent directly to the Treas
ury instead of to the member banks. Would the
Treasury have repaid the Reserve Banks rapidly
enough to avoid continued serious inflation? Treas
ury repayments would have depended upon the
Treasury budget and political decisions, rather than
on the needs of the country for credit. There would
have been every temptation to consider borrowings
from the Reserve Banks as a more or less permanent
part of the national debt. The Reserve System
might have been drawn into a maelstrom of dispute
and controversy which might have wrecked it.
The principle that was followed, of not lending
directly to the Treasury but lending to banks, re
sulted in a semi-automatic liquidation of Reserve
Bank credit as prices fell and gold was imported.
The bejiks used all surplus funds to pay off their
indebtedness, and the volume of Reserve Bank
credit was adapted to changes in credit require
ments. Such a result would have been most difficult
if not impossible if the debt had been owed by the
government.
The importance during the war period of these
principles which have just been outlined is realized
most vividly when they are reviewed in connection
with the figures for the size of the war financing.
Its huge volume is summarized in Table 9.
Subtreasuries Taken Over.,—When the Federal
Reserve Banks first started operations, the Treas-

106

THE RESERVE BANKS

Table 9—Treasury Issues Sold Through Federal
Reserve Banks
(In millions of dollars)

Year

Liberty
and
Victory
Loans

Treas
ury
Bonds

1917.......
5,797
1918....... 11'140
1919.......
4,495
1920.....
1921.......
1922.......
1923.......
1924.......
1925.......
1926.......

757
290
495

Total.. 21,432

2,308

764

Treas
ury
Notes

Certifi
cates of
Indebt
edness

Total

702
2,511
1'035

3,881
10'742
11'247
3'940
2,910
1'427
1'264
985
1,048
608

9,678
21'882
15,742
3,940
3^612
4'702
2'299
1’742
1'338
1'103

4,248

38,052

66,038

ury continued to maintain Subtreasury offices in
nine important cities. In succeeding years the func
tions of these offices were gradually transferred to
the Federal Reserve Banks. During the years 1920
and 1921, by Act of Congress, the remaining Sub
treasury functions were taken over by the Reserve
Banks and the Subtreasuries closed. Thus the Fed
eral Reserve Banks are now the only sources of sup
ply for coin and currency, outside Washington
except for national bank notes initially circulated by
national banks. With these exceptions all the money
in circulation is distributed through the Federal Re-

AND THE MONEY MARKET

107

serve Banks. Old money is retired from circulation
and new money is put out. The Treasury is saved
not alone the expense of operating the Subtreas
uries, but also the cost of carrying so large a working
supply of coin and currency. The 38 offices of the
Federal Reserve System provide a wider distribu
tion of facilities for conducting Treasury business.
Open Market for Treasury Certificates,—A further
interesting service which the Federal Reserve Banks
have been able to perform for the Treasury and for
the money market lies in the aid they have given
to the establishment of an open market for short-;
term Treasury issues in the form of certificates of
indebtedness or Treasury notes. During the war the
Treasury found it imperative to finance in some or
ganized way the temporary advances it required
pending the receipt of taxes or the receipt of returns
from Liberty Loan sales. As a consequence, there
were sold to banks and private investors short-term
securities running for from one to twelve months.
As the war progressed it was necessary to issue
larger and larger amounts of these securities and
they began to accumulate in banks. To aid in a
wider distribution steps were taken to establish an
open market for these securities. Dealers were en
couraged to buy and sell Treasury certificates and
in so doing were given the support of the Federal
Reserve Banks, which adopted a policy of standing
ready to purchase Treasury certificates from dealers
from time to time whenever the market became
congested or money rates rose to such high points
that dealers could not secure the call loans they
required to carry their portfolios of certificates at

108

THE RESERVE BANKS

rates approximating the rates borne by the cer
tificates.
The way this worked out was that when call
money rates were temporarily high or when the
supply of Treasury securities was much larger than
the demand, dealers sold some of these securities
to the Reserve Banks under an agreement to repur
chase them within fifteen days. The dealers re
purchased the securities as soon as the temporary
condition was passed, usually well before fifteen
days elapsed. Even now the market requires this
type of support from time to time for a few days.
Through this arrangement it is possible for dealers
always to stand ready to buy and sell certificates
at the market price.
The establishment of this open market stimulated
the use of Treasury certificates as means of employ
ing surplus funds. The assurance of a ready sale
at all times enables banks and others to use Treas
ury certificates and notes as secondary reserves,
which may be liquidated whenever funds are re
quired. The open market for Treasury certificates
greatly aids the Treasury in handling its short-dated
debt, and enables it to secure better terms for its
sale.
SUMMARY

1. The Reserve Banks provide a trustworthy bank
ing agency for the use of the government, with
which the Treasury may deal without fear of
accusation of favoritism.
2. It is an agency in constant contact with the

AND THE MONEY MARKET

109

money market, with offices in all parts of the
country, and performs work for the Treasury
practically without charge.
3. The presence of the Reserve System relieves the
Treasury of much of the direct responsibility
which it formerly carried for the money market.
It is no longer necessary for the Treasury Depart
ment to make special deposits or purchases of
securities for the purpose of relieving business
crises, nor again is it necessary for the Treasury
to depend upon some syndicate of bankers to
rescue the Treasury itself in periods of emergency.
4. The presence of the Reserve System as a credit
reservoir for the adjustment of the volume of
credit to business needs, not only relieves the
Treasury from what had been one of its most
onerous burdens, but provides in addition a credit
reservoir available to support the credit needs of
the Treasury in emergencies.
5. The result of the presence of the Reserve Sys
tem is to make the Treasury more truly inde
pendent of the money market than was ever the
case under the so-called Independent Treasury
System.

CHAPTER VII
The New York Money Market

HE New York money market is the national
market for surplus funds. As the leading
money market of the country, it is the center to
wards which the idle money of all sections gravi
tates to find employment, pending the time when it
is needed. Banks and large business concerns all
over the country which have funds temporarily idle
because of seasonal variations in the demand for
funds or for other reasons, send these funds to the
New York money market. The funds are there kept
on deposit with banks; invested in short-term secur
ities such as bills, Treasury certificates, or other
short obligations; or are lent in the stock exchange
money market for a definite period as time money or
on a day-to-day basis as call money.
■ The distinctive feature of this use of funds is
that the funds are available when they are needed,
either at a specified time or, in the case of call
money or money invested in bills or Treasury cer
tificates, on a day’s notice at any time. Call loans
can be called and bills and Treasury certificates can
be sold whenever the funds are needed. The money
in the money market may thus be thought of not
simply as surplus funds, but as the secondary re
serves of banks and business all over the country.
In these days of keen competition and narrow

AND THE MONEY MARKET

111

margins of profit, banks and business concerns find
it necessary to keep their funds as fully employed
at interest as possible. Ten million dollars lying
idle for a single day costs as much as a year’s work
of a clerk or about 300 clerks for one day; and the
difference between profit and loss may be found in
keeping all available funds employed. The money
market provides a place where funds may be put to
work for a week or even a day and still be available
to meet the foreseen or the unforeseen need of the
lending bank or corporation.
The importance of the money market does not
lie in its size, because the total amount of funds in
the market is small in comparison with the total
banking funds of the country. The importance lies
rather in the liquidity of the market, in its capacity
for furnishing cash at a few hours’ notice. What a
bank balance is to the individual the money market
is to the country’s credit system. Both represent
ready cash available for immediate needs.
Since the New York money market employs funds
from all parts of the country, it reflects changes in
the need for funds from any quarter. Increases in
the use of funds for business and trade draw funds
from the New York market, and decreases in such
use pour funds into the New York market. When
the wheat crop is being harvested, when Christmas
shopping creates a need for more currency, or when
factory payrolls increase, funds are drawn from New
York. But when winter dullness settles over the
farms, when Christmas currency returns to the banks,
or when the factories begin to reduce payrolls, then
funds flow back to New York. In recent years the

112

THE RESERVE BANKS

New York market has reflected not only the chang
ing financial needs of agriculture and business in
this country, but has reflected foreign conditions as
well because considerable amounts of foreign funds
have found employment here.
One result of the wide distribution of ownership
of funds in the New York money market is that they
are in constant movement, for there is almost never
a time when some need for funds is not arising from
one quarter or another. The rapidity of movement
of funds in the money market may be seen in the
statistics for the velocity or rate of turnover of bank
deposits. These figures show that bank deposits in
New York City have a rate of turnover of about
eighty times a year, whereas the rate of turnover in
other large cities is only about half as great. This
rapid movement of funds puts to the test the or
ganization of the money market.
Small movements of funds sometimes have large
effects in the market. A transfer of as little as
$25,000,000 from New York may cause an increase
of % per cent in the call-loan rate. For the money
market is a point at which adjustments take place
between the country’s supply of and demand for
funds. A transfer of $25,000,000 from New York
may be the indication that the country’s supply of
funds is short of the demand at the rates which have
been prevailing. In the New York market we are
dealing with what economists call the marginal sup
ply and the marginal demand, which are the first
to show any changes in conditions.
In financial panics in this country it has been
in the New York money market that the first signs

AND THE MONEY MARKET

113

have appeared, just as in England it has been in
London that financial crises have centered. Year in
and year out the great bulk of all ordinary financial
operations throughout the country is carried on
smoothly and quietly, with the supply of funds tak
ing care of the demand without question. Trouble
only comes with the extra demand, or the extra sup
ply, and the money market is the place where extra
supply and extra demand make their first appear
ance. The country’s financial stability depends not
a little on the capacity of the money market for
making a smooth adjustment to the new condition
when extra supply or extra demand begins to appear.
If at any time it becomes impossible for out-of-town
lenders to convert instantly into cash the funds they
have placed in the New York market, the result is
apt to be a money panic.
Place of the New York Banks.,—New York com
mercial banks have several kinds of relationships
with the money market. In the first place, these
banks are large investors in the money market.
They keep about a billion dollars in the stock ex
change money market. They keep substantial but
smaller amounts employed in bills, Treasury cer
tificates and notes, and commercial paper.
In the second place, the New York banks act as
agents for out-of-town banks, corporations, and in
dividuals who employ funds in the money market.
When the Tenth National Bank of Muncie, In
diana, wants to buy commercial paper or put funds
out on call, it usually transfers the funds to its New
York correspondent. The amounts of out-of-town
funds placed in the market in this way are fre-

114

THE RESERVE BANKS

quently larger than the amounts placed for the ac
count of the New York banks themselves. For
example, the figures reported by New York City
member banks at the end of 1926 show that their
loans to brokers and dealers for their own account
averaged $900,000,000, whereas their loans of this'
character for the account of out-of-town banks
averaged $1,050,000,000. Moreover, the New York
City banks had on deposit from other banks about
$1,000,000,000.
‘
In the third place, the New York City banks are
bankers for the money market. The market keeps
its funds on deposit with them. When a dealer
secures funds he deposits them in one of these
banks. When he makes a payment he does it with
a check on one of them. The deposits of New
York banks thus constantly reflect money-market
operations.
Any extra demand for or supply of funds is thus
registered in one way or another in the condition
of the New York banks, and the elasticity and
stability of the market depend on the reserves of
these banks.
Suppose the wheat crop is unusually large and in
order to pay off extra harvesting help the banks of
the West call $25,000,000 of call loans in New York.
The procedure would be about as follows: When
brokers Smith & Jones, or Peters & Hall, who were
borrowing this money from out-of-town lenders
for the use of their customers, get notices calling
their loans, they probably borrow the amount from
New York City banks and pay off their called loans.
As the funds are transferred to the West, reserves

AND THE MONEY MARKET

115

of New York banks are correspondingly reduced.
Or suppose the banks in the West, instead of calling
loans, sold securities in New York. They would
probably be paid by checks drawn on New York
City banks, with the same consequence in reducing
the reserves of those banks. No matter what form
an outside withdrawal of funds from the market
takes, it usually results promptly in a reduction of
the reserves of New York City banks. If this
process continues it tends to result in higher money
rates and a gradual liquidation of money-market
loans, and frequently a reduction in security prices.
These changes eventually reduce both the deposits
and the reserve requirements of New York City
banks. But the immediate result is to reduce only
the actual reserves of these banks. They bear the
brunt of shifts of funds to and from the market.
Elasticity Before 1914.—In the days before the
Federal Reserve System the surplus reserves of
New York banks were the best measure of the
country’s ability to deal with any financial emer
gency, because they showed the extent to which the
money market could be drawn upon to meet needs
for funds in any part of the country. There were,
it is true, other possible means of meeting serious
crises, such as the import of gold from abroad,
Treasury deposits of gold in the banks, or the issu
ing of clearing house loan certificates; but the re
serves of New York banks, and to a lesser extent of
banks in other cities, were the first line of defense.
When these reserves were reduced to the legal mini
mum, and there were no longer any surplus reserves,
then the credit situation became strained. There

116

THE RESERVE BANKS

was still plenty of money in the banks, but it could
not be used because the law prescribed a legal mini
mum below which reserves should not go. ‘ There
was no machinery by which these reserves could be
either used with safety or increased with prompt
ness.

DIAGRAM 17----BEFORE THE RESERVE SYSTEM THE TIME-MONEY RATE
WAS CLOSELY RELATED TO THE SURPLUS OR DEFICIT OF RESERVES
OF NEW YORK CITY BANKS.

The close dependence of money conditions on
bank reserves is illustrated by Diagram 17, in which
one line show's the average monthly surplus or
deficit of reserves of New York City banks, and the
other line shows the average monthly rate for time
money. When there were large surplus reserves,
money rates were low; when reserves were low,
money rates were high.

AND THE MONEY MARKET

117

One impressive feature of the diagram is the nar
rowness of the margin of reserves. For many months
average surplus reserves were under $10,000,000.
In November, 1907, an average deficit of $50,000,000
in reserves was accompanied by soaring money rates
and by temporary suspension of specie payments in
many parts of the country.
Under these conditions one of the most valuable
indicators of the country’s credit condition was the
Saturday report of the New York Clearing House
banks, which showed their surplus reserves. These
surplus reserves were the principal basis for any
elasticity which the country’s banking system
possessed.
Elasticity Today.—The fundamental change
which the Federal Reserve System has made in this
situation is to shift much of the burden of meeting
the fluctuations in the demand for credit from the
reserves of the member banks to the Reserve Banks,
which through the strength of their holding of
pooled reserves and through their power of note
issue and deposit expansion can provide almost any
extra funds required.
The change which has taken place may be illus
trated by Diagram 18, showing for recent years the
same datd as Diagram 17, with an additional line*
There is now practically no fluctuation in the aver
age surplus reserves of clearing house banks. In
stead, the adjustment to changes in the supply of
and demand for credit takes place in the loans of
the Reserve Bank. Credit demands which in the old
days drew heavily on bank reserves now lead to in
creased Federal Reserve loans instead.

118

THE RESERVE BANKS

Another effect of the establishment of the Re
serve System has been to divert from the New
York market some of the adjustments of marginal
funds. Member banks in all parts of the country
may now meet extra demands for funds by borrow-

DIAGRAM 18—SURPLUS RESERVES OF NEW YORK CITY BANKS NOW
SHOW LITTLE FLUCTUATION AND MONEY RATES ARE RELATED TO THE
AMOUNT OF BANK BORROWING FROM THE RESERVE BANK.

plies of funds to pay off any such borrowings. More
over, with the support of the Reserve Banks local
money markets of increasing importance arc devel
oping in certain of the Federal Reserve cities.
While these changes have diverted many transac
tions from New York to other centers and have
made the country’s finance somewhat less dependent
on New York, the New York money market remains

AND THE MONEY MARKET

119

the country’s principal center for the use of surplus
funds, and for the adjustment of banking reserves.
The precise methods by which the money market
gains elasticity and stability through the operations
of the Federal Reserve Bank of New York are there
fore of interest.
Access to the Reserve Bank.—The money market
and the Federal Reserve Bank of New York are

MARKET HAVE DIRECT APPROACH TO THE RESERVE BANKS, BUT THE
OTHER PRINCIPAL MONEY MARKETS HAVE NO BUCH DIRECT ACCESS.

connected by several channels of communication.
Diagram 19 is an attempt to illustrate these chan
nels.
.
Of the four principal markets which make up the
money market, two have direct access to the Re
serve Banks. Under the terms of the Reserve Act,
the Reserve Banks may buy bills (bankers’ accept
ances) and government securities in the open mar
ket. but they cannot buy commercial paper or make

120

THE RESERVE BANKS

loans in the stock exchange money market. The
Reserve Banks can also buy short-time municipal
warrants issued in anticipation of taxes and obliga
tions of the Federal Farm Loan System, but such
purchases have in practice been so small that this
market has not been included in the diagram.1
It is through the member banks that the money
market has its principal connection with the Reserve
Banks. The amount of Reserve Bank funds which
goes directly into the money market is small com
pared with the amount which is advanced to mem
ber banks and reaches the market indirectly. The
member banks pass on to the Reserve Banks the
securities dealt in by three of the four money mar
kets: bills, United States Government securities, and
commercial paper. They sell bills to the Reserve
Banks; they borrow with bills, United States secur
ities, or commercial paper as collateral; or they
rediscount bills or commercial paper. In addition,
they rediscount or secure advances upon their cus
tomers’ commercial paper. Non-member banks sell
bills to the Reserve Banks.
1 In this connection mention should be made of a new informal
money market which has developed in recent years, the market
for Federal funds. A bank which finds itself with surplus reserve
deposits at the Federal Reserve Bank frequently sells these funds
to some other bank which is deficient in its reserves and thus
obtains funds to make its reserves good without borrowing at
the Reserve Bank. Federal funds are different from other funds
because they represent immediate cash that day at the Reserve
Bank, whereas an ordinary bank check is not cash until it has
gone through the clearings the following morning. The buyer
of Federal funds pays for them with a check which will be
collected through the clearings the following day. The trans
action amounts to buying today’s money with tomorrow’s money
and paying interest for a day. The market for Federal funds
adds to the fluidity of the money market; it helps demand and
supply to become adjusted rapidly. Federal funds are as a rule

AND THE MONEY MARKET

121

It should be noted that in all but one of these
types of transactions by which the markets or banks
secure Federal Reserve funds, the initiative is taken
by the dealer or the banker. It is only in the pur
chase of United States Government securities that
the Reserve Banks ordinarily take the initiative,
and even such purchases if made under a repurchase
agreement are made on the initiative of the dealers
in government securities who require assistance in
carrying their portfolios.
Another interesting feature of the relationship be
tween Reserve Bank and money market is that in
certain of the transactions in bills and government
securities the New York Reserve Bank acts as the
agent of other Federal Reserve Banks. A consider
able part of the holdings of acceptances and govern
ment securities of all the Reserve Banks is pur
chased in New York and distributed to all Federal
Reserve Banks through the medium of an Open
Market Investment Committee consisting of the
governors of five of the Reserve Banks.
Through these various channels there has devel
oped an organic connection between the New York
money market and the Reserve System. The
operations of the Reserve Bank of New York, and
in lesser degree of the other Reserve Banks, have
come to reflect money-market changes in much the
same way as the reserves of New York City banks
formerly reflected such changes. Today when
$25,000,000 is withdrawn from New York to meet
bought and sold by individual negotiation between banks,
although some of the dealers in bills and securities also deal
in Federal funds.

122

THE RESERVE BANKS

a demand for currency for harvesting, the demand
often falls as before on the money market and
through the market on the New York City banks.
But these banks no longer rely solely on their sur
plus reserves in meeting such a demand. They can
borrow at the Reserve Bank.
This extra demand for funds can be met with
much less strain on the credit situation than in the
days when bank reserves bore the brunt of any in
crease in demand. Increases in borrowing at the
Reserve Bank do have, it is true,' some effect upon
the money position. Funds from the Reserve Bank
have to be paid for at the discount rate and the use
of additional Federal Reserve funds is frequently
accompanied by some firming in money rates, as was
the putting to use of surplus reserves. The principal
difference between the two operations lies in their
possible extent. In the old days there were rigid
Mid not far distant limits to the reserves available;
now the mechanism of the Reserve System pro
vides for a much larger possible expansion. It
gives much greater elasticity while providing also
restraints against too great expansion. This elas
ticity results in much more stability of rates and
practically eliminates the fear of money panic which
could never be wholly out of mind in the old days.
The close relationship between money-market
movements and the Reserve Bank may be illus
trated by a comparison of the day-to-day fluctua
tions of the call-loan rate, the most sensitive index
of money-market conditions, and the changes in the
amount of Reserve Bank credit in use. This com
parison is made in Diagram 20. It shows that when

AND THE MONEY MARKET

123

money is in demand, as shown by high call-loan
rates, the banks and the market draw funds from
the Reserve Bank, and the amount of Reserve Bank
credit in use is increased. Conversely, when the
supply of funds increases, as shown by low call
rates, funds are returned to the Reserve Bank. Just
as the country as a whole is constantly adjusting
its credit supply to its needs through the New York
market, so the New York market is daily adjusting

DIAGRAM 20—DAILY CHANGES IN MONEY CONDITIONS IN THE NEW
YORK MARKET DURING 1924 WERE REFLECTED DIRECTLY IN THE LOANS
AND INVESTMENTS OF THE FEDERAL RESERVE BANK OF NEW YORK.

its supply to the demand through the Reserve
Banks.
The character of Federal Reserve transactions
with the banks and the money market, which con
sist primarily of operations for the adjustment of
reserve position, is revealed by the rapidity with
which loans are made and paid off. The average
amount of bills and securities (including loans to
member banks) held by the Federal Reserve Bank
of New York during 1925 was $287,000,000. The

124

THE RESERVE BANKS

total amount of bills and securities acquired during
the same period was $19,900,000,000. Thus the
average loan or investment was for only five days.
The average number of days for which different
types of paper were held was as follows:
Discounts and advances.......... 3 days
Bankers’ bills............................. 15 days
U. S. securities........................... 50 days

The Reserve Bank is thus constantly advancing
funds to the member banks and to the market and,
in turn, constantly being paid off.
A more detailed statistical analysis of the inter
action between the New York Reserve Bank and
the money market will follow in a later chapter,
after a more detailed discussion of the bill market.
SUMMARY

1. The New York money market is the national
market for surplus funds, the marginal market
where supply and demand meet.
2. Before the Federal Reserve System the elasticity
of the money market depended largely on the
surplus reserves of New York City banks; an ad
ditional call for funds led to withdrawals of these
reserves and a surplus of funds increased these
reserves. Money rates reflected directly the con
dition of these reserves.
3. The margin of surplus reserves was often narrow
and the fear of financial panic because of money
stringency was never wholly out of mind.
4. Under the Reserve System the burden of meeting

and the money market

125

the fluctuations in the demand for funds has
been shifted from the reserves of member banks
to the Reserve Banks, whose resources are ade
quate to meet almost any emergency.
5. Access of the money market to the Reserve Banks
is largely through the member banks, but in part
also through the markets for bills and govern
ment securities. The average duration of a loan
or investment of the New York Reserve Bank is
only five days.
6. Just as the country as a whole is constantly ad
justing its credit supply to its needs through the
New York market, so the New York market is
daily adjusting the supply to the demand through
the Reserve Banks.
7. The presence of the Reserve System gives greater
elasticity to the supply of funds and stability to
the money market and removes the fear of money
panics.

CHAPTER VIII
The Bill Market

NE of the four money markets described in the
preceding chapter has a peculiarly intimate
connection with the Reserve System, and that is the
bill market, or the bankers’ acceptance market. The
“bankers’ acceptance,” or “bankers’ bill,’’ or more
familiarly the “bill,” is a comparatively new member
of the society of credit instruments in this country.
The bill of exchange was used in this country be
fore the Civil War, but its use was then practically
discontinued and the law did not thereafter permit
our banks to "accept” bills. The bankers’ accept
ance is therefore an adopted child. It did not grow
up from gradual and unconscious beginnings, as do
most of our institutions, but it was taken over from
Europe at the same time that the Federal Reserve
System was inaugurated.
The adoption of the bankers’ bill was a matter of
curiously unanimous consent. In the years from
1908 to 1913 banking reform was a major topic for
congressional investigation and many bills were
prepared dealing with the topic. Practically every
one of these bills included some provision for estab
lishing in this country a market in which accept
ances might be bought and sold as they are in the
discount market in London. In all the discussion
surrounding the consideration of these bills and the

126

AND THE MONEY MARKET

127

debate over the Federal Reserve Act, there was
hardly a dissenting voice to the proposal for estab
lishing a discount market. Hence the Federal Re
serve legislation granted to banks in this country
the power to accept drafts drawn upon them. These
accepted drafts were made eligible for purchase by
the Federal Reserve Banks, and thus the necessary
foundations were laid for a discount market.

MATED AMOUNT OF BANKERS’ BILLS OUTSTANDING IN THE UNITED
STATES ON DECEMBER 31 OF EACH YEAR.

In the past twelve years the adopted infant has
been growing up in the midst of war and disturbed
world credit conditions. Year by year the numbers
and kinds of bills drawn have been increasing, and
the market for bills has been expanding.
Size of Market.—The rapid growth of the volume
of bills drawn is shown in Diagram 21, which gives

128

THE RESERVE BANKS

the estimates by the American Acceptance Council
of the total amount of bankers’ bills outstanding at
the end of each year. Under the stimulus of post
war trade activity a volume of business was reached
in 1919 and 1920 of about one billion dollars. Price
decreases and recessions in trade in 1921 and 1922
were accompanied by reductions in the value of
bills in the market, but since that time there has
been a recovery and the amount outstanding at the
end of 1926 was about $750,000,000. The dollar
amount is much affected from year to year by
changes in prices of basic commodities. The actual
volume of transactions financed through the bill
market is probably larger now than in any preceding
year.
Perhaps the size of the bill market may best be
realized by comparing it with the commercial-paper
market. The commercial-paper market has been in
existence in this country for more than fifty years
as a well-recognized means for commercial financing.
In recent years the Federal Reserve Bank of New
York has undertaken to collect figures for the vol
ume of commercial paper outstanding and to that
end has received each month reports from twentysix of the dealers who handle a large percentage of
the amount of paper sold in this country. These
figures show a total of about $525,000,000 of paper
outstanding at the end of December, 1926. Allow
ance should also be made for about 10 per cent, or
$52,000,000, additional handled by dealers not re
porting. So, as nearly as can be estimated, the
amount of financing now done through the bill mar-

AND THE MONEY MARKET

129

ket is larger than the amount carried on through
the long-established commercial-paper market.
Another interesting comparison may be made be
tween the size of the bill market in this country and
the size of the London bill market, which has been
for many years the recognized center for financing
world trade. Before the war it was estimated by a
number of competent authorities that there were
currently outstanding through the London market
something like 325 million pounds sterling of
bankers’ bills, or a little over 1% billions of dollars.
Since the war the amount of bills in the London
market has probably been smaller, partly due to
the fact that some transactions formerly financed in
sterling are now financed in dollars, and perhaps
partly due also to the large volume of Treasury bills
in the market available as a form of investment.
Mr. D. Spring-Rice, of one of the important London
discount houses, has estimated (Bankers Magazine,
London, March, 1923) that in January, 1923, there
were only about $800,000,000 to $900,000,000 of
sterling bills outstanding. Since then the amount
has probably increased somewhat.
Thus the bill market in the United States in the
few years of its existence has grown to a position
of real importance, not only in the money markets
of this country, but in fact in the money markets
of the world. One may then appropriately ask what
the results of the establishment of this market have
been for trade and for finance.
Nature of the Bank Bill.—There is no field of
finance more deeply buried in technical jargon than
the bill market, partly because there is hardly any

DIAGRAM 2 2 — ILLUSTRATION OF THE FINANCING OF AN IMPORT TRANSACTION BY A BANKERS’ ACCEPTANCE.

AND THE MONEY MARKET

131

more complicated series of transactions than some
of those which involve bank acceptances. There
are many different kinds of bank acceptances, and
the instrument itself appears in many languages
and in many forms.
The essence of the simplest form of the transac
tion is that a seller of goods wants to get money
before a buyer is ready to pay. The buyer’s bank,
however, gives the seller a guaranty of payment on
a given date and this guaranty can be sold. The
guaranty is in the form of a draft on the buyer’s
bank on which the bank has put its stamp “ac
cepted.” The accepted draft has a ready sale to
banks or others who want a short-term investment
with a bank guaranty. Thus the seller can get his
money in a transaction before the buyer is ready
to pay. This is particularly important when buyer
and seller are many miles separated and it is several
weeks before the buyer receives his goods from the
seller. In import and export trade the bill covers
the length of the voyage. The consignee ordinarily
will not or cannot pay until the goods arrive. The
seller therefore draws a bill of exchange and realizes
on it from his own banker, who has the bill accepted
by the buyer’s bank and sells it. There are many
forms of bank acceptances and detailed regulations
as to their use, but they are all variations of the
form just outlined. A typical acceptance transac
tion is outlined in Diagram 22.
Who Uses Bills?—Bankers’ acceptances are used
primarily to finance the movement of exports and
imports, although large amounts are also drawn
against readily marketable staples held in ware?

132

THE RESERVE BANKS

houses here and abroad, and some are drawn for
the domestic movements of goods. This is illus
trated in Diagram 23, which shows a classification
of the general purposes for which bills outstanding
at the end of last year were drawn.

DIAGRAM 23—TRANSACTIONS FINANCED BT BANKERS' BILLS OUT
STANDING AT THE END OF 1926.

An investigation made by the Federal Reserve
Board enables us to say still more precisely how
bills are being used to finance trade. The Board
made a detailed classification by commodities of all
the bills purchased by the Reserve Banks (exclusive

AND THE MONEY MARKET

133

of those acquired under repurchase agreement) in
the year 1926. These bills purchased by the Reserve
Banks may be considered as representative of all
the bills outstanding. The analysis shows that
more than one-third of these acceptances were

Iron a Steel
Flour
Wood Puls
Fruits
Fur?
Tea

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B»

Cocoa

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g/y
■’

'Cotton Mfr? 1?
Jlllot^et
■■■■■^■l^^■■^■■■■■■l^■i^■'M
DIAGRAM 24—FARM PRODUCTS RANK HIGH IN THE LIST OF COMMOD
ITIES THE MOVEMENT OR STORAGE OF WHICH WAS FINANCED THROUGH
BILLS PURCHASED OUTRIGHT BY THE RESERVE BANKS DURING 1926.

drawn to finance the movement or storage of Ameri
can farm products. A large part of the total was
drawn to finance the export or storage of a single
commodity—cotton; the second largest commodity
was sugar; then came bills drawn to finance the
movement or storage of coffee, silk, and grains.
Diagram 24 shows the figures in graphic form.

134

THE RESERVE BANKS

The type of transaction financed through the bill
market is in large measure different from the trade
activity financed through the commercial-paper mar
ket. As contrasted with the figures shown in Dia
gram 24, it is estimated by the National Credit
Office that about one-third of the concerns using
commercial paper are in the textile industries, while
the next largest groups deal in foodstuffs, metals,
leather, and lumber.
The commerciabpaper market generally tends to
finance domestic manufacture and trade, whereas
the bill market finances more largely the movement
of raw materials and foodstuffs, and particularly
their movement in foreign trade. Commercial
paper is issued against the general credit of the
concerns using the market, whereas each bankers’
acceptance represents specific commodities in stor
age or transit.
From these differences there arise certain inter
esting differences in the activity of the two markets.
Financing in the commercial-paper market is
rather evenly distributed throughout the year, but
tends to be most active in the spring or early
fall, when spring and fall trade are most active;
on the other hand, the bill market is highly seasonal
and experiences its largest volume of financing in
the late fall and the winter, when the movement and
storage of crops is largest and when the largest ex
portation of cotton is under way.
Sendee to Trade.—The most direct and obvious
effect of the establishment of a bill market in this
country has been its benefit to those who deal in
the commodities listed in Diagram 24. The bill

AND THE MONEY MARKET

135

market furnishes a more satisfactory means than
has before been available for financing the move
ment of these commodities.
Domestic transactions now handled through the
bill market were. previously financed largely by
direct loans at banks, frequently with some difficulty
and at higher rates. Through the bill market co
operative marketing associations and cotton and
grain dealers are able to tap the supplies of funds
in the central money markets instead of relying
wholly upon local banking facilities.
For example, the New County Farmers' Associa
tion desires to hold 2,000 bales of cotton in storage
for ninety days before selling. In the early fall
when demands for funds for picking and transporta
tion are heavy, the local New County banks may
not be in a position to make the required loans on
the cotton, even at high rates. But acceptance
credit, secured by the cotton in independent ware
houses, can be obtained from one or more wellknown accepting banks. The association draws
drafts on these banks payable in ninety days and
takes them to the banks, together with the receipts
of the storage warehouse, and the banks write "ac
cepted” across the face of the drafts. These banks
thus become liable for the amount of the drafts
and hold as security the warehouse receipts. For
their service and the loan of their credit the accept
ing bank charges about 1 to 2 per cent per annum.
The association holds accepted drafts, which may be
sold readily in the nearest money center at a dis
count today (January, 1927) of about 3% per cent
per annum. Thus the association obtains for its

136

THE RESERVE BANKS

members the immediate use of funds at a moderate
rate. Without the bankers’ acceptance the funds
would be more expensive and would frequently be
difficult to secure. The acceptance is a means of
breaking down barriers between country districts
and central money markets.
The country’s central money market thus shares
with the local bank the financing of agriculture.
The planting and harvesting of the crop are financed
by local banks which in turn lean upon the regional
Federal Reserve Bank. The storage of the crop, and
its movement to market, may be financed, through
the acceptance by the central money market, which
in its turn leans upon the Federal Reserve Bank of
New York, acting for itself and the other Reserve
Banks in the money market.
For the exporter or importer the American bill
market is a great convenience. Formerly it was
usually necessary in financing exports and imports
to make arrangements to draw drafts on some Eng
lish or continental bank. The trader had to take the
risk of loss on fluctuations in sterling exchange, or
else incur the expense of buying forward cover. The
European bank collected the commission and dis
count. It is now possible to carry forward the whole
transaction with an American bank. There is no
risk of exchange and the American bank earns the
commission and discount formerly collected by
others.
Who Buys Bills?—The advantage of the bankers’
acceptance to the business man or farmer whose
transaction is financed is perhaps more obvious than
the advantage to the buyer of bills. Why should

AND THE MONEY MARKET

137

anyone buy bills at 3^ per cent when he can buy
commercial paper at 4% per cent or get 4 to 4%
per cent in call loans? Part of the answer may be
found in an inspection of the safety and convenience
with which funds may be employed in the different
short-term money markets.
We now have in this country, as was indicated in
Chapter VII, four markets in which surplus funds
may be employed for short periods:

1.
2.
3.
4.

Stock exchange money market.
Commercial-paper market.
Treasury certificate market.
Bill market.

The first two of these markets have been here
for many years; the latter two are developments of
the past ten years. Generally the rates in the first
two of these markets are near together and from %
per cent to 1 per cent above the rates in the third
and fourth. The Treasury certificate and bill mar
kets justify low rates in two particulars. First, they
offer unusual security. The Treasury certificate is
a government obligation. The bill is an obligation
of a bank of recognized standing. Second, funds
placed in the certificate or bill market may be with
drawn at any time by the sale of the certificate or
bill to a dealer, or, under certain conditions, to a
Federal Reserve Bank. Both the certificate and
bill markets are “two-way” markets in the sense
that certificates and bills can be sold to the market
as well as bought. This is in contrast with commer
cial paper, which must be held until maturity, un
less it is rediscounted at a Reserve Bank. The call-

138

THE RESERVE BANKS

money market is in effect a “two-way” market be
cause funds placed in it can usually be withdrawn
readily, but call loans cannot be rediscounted with
or sold to the Reserve Banks.
A comparison may also be made between an in
vestment in bills and a bank balance yielding 2 to

DIAGRAM 25----OPEN-MARKET RATES POR BILLS AVERAGE ABOUT ONE

PER CENT UNDER COMMERCIAL-PAPER RATES AND ARE CLOSE TO THE
RATES ON SHORT-TERM GOVERNMENT SECURITIES.

2^ per cent. The bank balance has only the one
bank back of it; the bill has the drawer of the bill,
the accepting bank, frequently a second bank name,
and still another endorser. It can be realized upon
as promptly as the bank balance, and yields a much
better rate of return.
Certificates and bills carry low rates because of
their practically complete security and liquidity.

AND THE MONEY MARKET

139

They have proved acceptable investments for those
who have funds to employ for limited or uncertain
periods and wish the maximum safety and avail
ability. ’
Some time ago an inquiry was made by the New
York Reserve Bank to ascertain just who the buyers
of acceptances were other than such well-known
buyers as city and country banks, savings banks,
and insurance companies. Among the buyers men
tioned by discount houses were the following:
.
Salt, iron, and petroleum companies in California.
A creamery and a telephone company in Colorado.
A hospital and various manufacturing plants in Con
necticut.
Cotton mills in Georgia.
Many concerns in Illinois, ranging from publishing
houses to manufacturers of screen doors.
A lumber mill in Indiana.
Elevators and milling companies in Kansas.
Manufacturing concerns and municipal finance boards
in Maine.
An athletic club in Maryland.
.
A linseed company in Minnesota.
Coke and chemical concerns in Missouri.
Butchers, laundrymen, and a boys’ club in New York.
A varied range of buyers from steel companies to sani
tariums in North Carolina.
A coal miners’ mutual association in Pennsylvania.
A Utah candy company.
Texas cotton companies.
■ . ■
A feed store in West Virginia.
. A dairy farm in Wisconsin.
■
Also, scattered throughout the country, trustees of
Protestant churches, bishops of Roman Catholic dioceses,
the Salvation Army, colleges large and small, lodges of
Elks, and other fraternal and welfare organizations.

140

THE RESERVE BANKS

Also, very large purchases of bills by foreign govern
ments and by foreign banks having branches in this
country, many foreign banks in cities as widely separated
as Constantinople and Tokio, as well as many individuals
in England, Switzerland, Holland, and other foreign
countries.

Place of the Reserve Banks.—The list of buyers
of bills is not complete without including the Fed
eral Reserve Banks, for these banks usually hold
considerable portfolios of bills and at certain times
in the past have held as much as half of the bills
outstanding in this country. The method by which
these large holdings are acquired and the results of
their purchase constitute a little understood but
most interesting phase of present-day money mar
ket operations.
From one-third, to one-half of the bills held by
the Reserve Banks (including bills under repur
chase agreement) are purchased from houses which
deal in bills, and the remaining bills are purchased
from banks. If we exclude bills purchased under
“sales contract,” not far from three-quarters of all
bills held are purchased from banks. Suppose we
discuss first purchases from dealers because those
purchases make possible the continued existence of
a bill market.
The bill market could not exist without the Fed
eral Reserve Banks, just as the bill market in Lon
don could not exist without the Bank of England.
The bill market is dependent upon the existence of
dealers who stand always ready to buy and sell bills
and who cany an assortment of bills on their
shelves, just as a grocery store carries groceries.

AND THE MONEY MARKET

141

But bills are expensive commodities to keep on
one’s shelves. Ordinary capital funds cannot be
invested largely in securities which yield 3 or 4 per
cent; the bill dealer to carry his stock in trade re
quires a constant supply of borrowed money at low
rates.
The practice is for the dealer to borrow from day
to day in the money market the money with which
he carries his stock. Ordinarily, the bill dealer can
obtain call money at a rate about ^ to ^ per cent
under the quoted market rate for call money because
of the type of security he offers. But there are
often times in the money market when money is
not available at low enough rates; at these times the
bill dealer needs some place of refuge where he may
obtain funds to tide him over the temporary period
of stringency. The Federal Reserve Banks furnish
that place, for they always stand ready to buy
bankers’ acceptances at their current buying rates.
The practice of the Reserve Banks in this regard
is similar in principle, though differing in detail,
to the practice of the Bank of England, which
always stands ready to buy bills from the London
bill dealers at its current discount rates.
In addition to the unconditional purchase of bills
from dealers, the Reserve Banks at times buy bills
from them under repurchase agreement or “sales
contract” by which the dealer agrees to repurchase
the bills within fifteen days. This arrangement is
the same as that made from time to time with
dealers in government securities mentioned in
Chapter VI.

142

THE RESERVE BANKS

The majority of bills purchased outright by
Reserve Banks are purchased from banks, and here
again the initiative is ordinarily taken by the sellers.
The Reserve Banks always stand ready to buy bills
at their current buying rates, but do not ordinarily
go into the market offering to purchase bills.
The sale of bills to the Reserve Banks is a con
venient way for banks to adjust their reserve posi
tions. If a bank has been losing funds through cur
rency withdrawals, out-of-town transfers, or any
other withdrawal of deposits, it may quickly restore
its reserve position by selling bills to its Reserve
Bank. It thus secures reserve funds without ap
pearing in its statement as a direct borrower from
the Reserve Bank. Many banks keep portfolios of
bills primarily because they offer so convenient a
means for adjusting their reserve positions. It is
through transactions of these sorts that the bill port
folios of the Reserve Banks are principally built up.
The Reserve Banks, as a rule, only buy bills after
they have been held for some weeks by banks or
other investors. The maturity of the bill holdings
is reported each week in the press statement. The
report for February 16, 1927, shows, for example,
the following figures for the amounts maturing
within specified numbers of days.
Bills maturing within 15 days.............. $175,000,000
Bills maturing in 16 to 30 days.........
69,000,000
Bills maturing in 31 to 60 days.........
49,000,000
Bills maturing in 61 to 90 days.........
19,000,000
Bills maturing in 91 days to 6 months
3,000,000

Total holdings................................ $315,000,000

AND THE MONEY MARKET

143

The portfolio of bills held by the Reserve Banks
is thus made up largely of short bills. Through the
year about 10 million dollars of bills mature each
day, and the whole portfolio turns over rapidly.
Results to Money Market.—When the establish
ment of a discount market in this country was dis
cussed prior to the passage of the Federal Reserve
Act, the conveniences which such a market might
offer to trade and to the investor were emphasized.
But even greater emphasis was laid on the reforms
in the money market which a discount market might
be expected to bring about. The hope was expressed
by some that the development of a discount market
might reduce the flow of liquid funds into the stock
exchange money market and dimmish the extent of
speculative activity. No such spectacular develop
ment has taken place. The bill market has grown
up beside the call market without revolutionizing
the character of the older market. Rates for stock
exchange money are somewhat steadier than they
were, and the supply of funds is less volatile, but
this market continues as in the past to be the largest
field for the employment of surplus funds. Perhaps
the principal change in these market relationships
has been a tendency for commercial credit to be a
little cheaper and credit for the security markets to
be a little dearer than before, as will be discussed
more fully later.
It is easy to conceive that gradual changes in
practice and larger experience with the bill market
may in time lead to a much larger volume of bills
and a larger flow of funds into that market as com
pared with the stock exchange money market, but

144

THE RESERVE BANKS

for the present at least the principal changes in the
money market, which may be ascribed to the influ
ence of the bill market, are in other directions. Two
important consequences of the presence of the dis
count market may be mentioned briefly.
In the first place, the bill market provides a
medium by means of which additional Federal Re
serve credit is obtained in time of temporary money
strain and returned when the strain is passed. If
the money market incurs a heavy loss of funds and
rates move up, the banks promptly sell bills to the
Reserve Banks and the dealers obtain funds by sell
ing bills under repurchase agreement, and Reserve
Bank credit is thus drawn into the market and eases
the strain. As soon as the situation is easy again
the portfolios of the Reserve Banks decline ps ma
turities each day exceed new offerings, and the
dealers take back the bills sold under repurchase
agreement.
The way in which the bill holdings of the Reserve
Banks respond to changing trade and credit condi
tions is illustrated by Diagram 26, which shows the
System’s holdings of bills at the end of each month.
Every fall when trade calls for the largest use of
credit and currency, the amount of bills in the mar
ket increases and bill holdings of the Reserve Banks
tend to increase. After the turn of the year they
decrease. In periods of easy money, as in the sum
mer of 1924, they are small, and in periods of firmer
money they increase. Through the bill market Fed
eral Reserve funds flow into the market or out of
it without as much pressure on the market as is
involved in direct borrowing by member banks.

AND THE MONEY MARKET

145

A second consequence of the presence of the bill
market is that it facilitates a freer flow of funds
and closer relations between this country and for
eign money centers. Foreign bankers are accus
tomed to buying bills. The introduction of the bill
market here has made our market a more attractive
place for foreign bankers to employ balances. In
the past few years many foreign banks have estabMILLIONS
OF DOLLARS

DIAGRAM 26—HOLDINGS BY THE RESERVE BANKS OF BILLS BOUGHT
IN THE OPEN MARKET REFLECT CLOSELY TRADE ACTIVITY AND CREDIT
CONDITIONS.

lished agencies here and large amounts of foreign
money have been invested here in bills, and these
funds have thus been available at low rates for the
use of trade between the United States and other
countries. Similarly, our own banks are becoming
accustomed to buying bills and are more ready than
formerly to employ their funds in the purchase of
bills in foreign centers when money is easy at home.

146

THE RESERVE BANKS

The presence of the bill market thus improves the
mechanism for the free movement of funds and ad
justment of the exchange between our own and
other countries. By this means some of the barriers
of international financial communication are broken
down, and as a consequence conditions of strain or
ease in any market tend to be more readily adjusted
to world conditions by the movement of funds back
ward or forward.
The use of dollar bills in financing trade with all
nations has built up a market for dollar exchange
in all foreign centers and has vastly increased the
contacts between our own and foreign banks. It
has brought to our banks a whole range of new
business. It has aided in making our money market
international in scope.
As to the Future.—The development of the bill
market in this country is far from complete. There
are hundreds of domestic transactions which might
be financed through the bill market more advantage
ously than by the methods now employed. The
limitation is principally lack of knowledge of the
bankers’ acceptance and the persistence of old habits.
The market for bills in this country is now too
narrow and too dependent upon the Federal Re
serve Banks. No small proportion of the purchase
of bills in the New York market is for foreign ac
count in employing the large balances maintained
here by foreign banks, corporations, and individuals.
While domestic buyers of bills cover a wide range
of concerns and individuals, the market would often
be narrow if it were not for the buying for foreign
account. There are comparatively few American

AND THE MONEY MARKET

147

banks which carry large bill portfolios in marked
contrast with the practice of British banks which
carry large amounts as a secondary reserve. A part
of this difference is due to the fact that bills or
money lent to bill dealers constitute the principal
means by which British banks replenish their re
serves. The bills can always be allowed to mature
or the money called. The British banks do not
ordinarily borrow directly from the Bank of Eng
land. In this country, on the other hand, the mem
ber banks borrow directly from the Reserve Banks
with some freedom. American banks, therefore, do
not have the same incentive for buying bills as do
the British banks.
•
Moreover, in this country, the bill market is in
continuous competition for funds with the stock
exchange money market, which offers almost as much
liquidity, usually a somewhat higher rate, and per
haps somewhat greater ease of access, because it is
easier to check over stock exchange collateral offered
as security for a loan than a bundle of bankers’
acceptances coming from the four corners of the
earth.
Furthermore, there is no such supply of surplus
money in this market available at a low rate for use
of the bill dealers as there is in London. Here sur
plus money flows back pretty promptly to the
Reserve Banks, since some banks are almost always
in debt at the Reserve Banks and anxious to repay
the debt.
These are serious difficulties which must be over
come before there is likely to be a wide further ex
pansion of the bill market in the United States. But

148

THE RESERVE BANKS

the bill market is so important in our foreign and
domestic trade, and so desirable a feature of our
money market, that it seems certain that adjust
ments will take place to circumvent difficulties. The
rapid progress that the bill market has already made,
in a little over twelve years, justifies confidence in
its future.
SUM MABY

1. In the past twelve years a new money market,
the bill market, has grown up in this country and
is now larger than the commercial-paper market.
2. The bankers’ bill provides a means by which,
through the use of bank credit, the seller of
goods may receive immediate payment for goods
shipped before the buyer has received or paid
for the goods.
3. More than one-third of the bills drawn in this
country are drawn to finance the storage or move
ment of American farm products.
4. The bankers’ bill enables the farmer to tap
central money-market funds to store or move his
harvested crops. It makes credit available at
lower rates. It provides exporters and importers
convenient means of financing their transactions.
5. The bankers’ bill is a form of investment of al
most complete security and liquidity and despite
low rates is therefore attractive for the employ
ment of temporarily surplus funds.
6. By standing ready to buy bills at currently estab
lished rates the Reserve Banks support the bill
market.
7. The bill market provides a medium by which

AND THE MONEY MARKET

149

additional Federal Reserve funds are put into the
market at times of strain and funds withdrawn
at times of ease.
8. The presence of an American bill market en
courages a freer flow of funds between this and
other countries and aids in making our money
market international in scope.
9. A number of difficulties, mainly in the organiza
tion of our money market, stand in the way of
much further immediate expansion of the bill
market in this country, but the rapid progress
made thus far gives reason for hoping these diffi
culties may be overcome.

CHAPTER IX

An Analysis of Changes in the Money Market

AS an illustration of the way in which the relar
tionships between the money market and the
New York Reserve Bank work out in daily practice
it is proposed in this chapter to report some of the
results of a method of analysis of day-to-day move
ments of the New York money market which is be
ing employed at the Federal Reserve Bank of New
York. The method is a joint product of the star
tistical department and certain of the operating offi
cers of the Bank, and the results are used currently
by the directors and officers.
Traditionally, the money market is thought of as
an aggregation of a number of markets where liquid
funds are employed in the purchase of short-term
securities, or in advances against stock and bond
collateral. For the purpose of this study of the
market an entirely different approach has been taken
and attention has been devoted to an analysis of
the movement of the reserves of New York City
banks. The reason for this procedure is not obvious
on its face. The total amount of funds of every
character employed in the New York market is diffi
cult to estimate, but it is probably as much as 5 or 6
billion dollars, whereas the reserves of New York
City banks total only about 700 million dollars.
But the significant fact is that practically every
150

AND THE MONEY MARKET

151

movement of consequence in the whole money mar
ket is reflected either in the reserves of individual
city banks or in the aggregate of the reserves of all.
Bank Reserves the Key.—Practically no money
market transactions are carried on with currency
or coin; the banks and others keep small amounts
of currency, and what is kept is largely for uses
quite apart from the money market, such as the pay
ment of wages and pocket money. Money-market
business is transacted by checks which are drawn
on bank deposits which are based on bank reserves.
When William Smith buys securities from Peter
Jones he gives him a check on Bank A. Peter Jones
deposits the check in Bank B, and unless there are
offsetting transactions Bank A loses reserves to
Bank B in the clearing house settlements. If Smith
has to borrow from his bank to buy the securities,
the total of loans and deposits is increased and bank
reserves must be increased, unless there is a corre
sponding liquidation of some other loan. The net
of all such transactions is reflected in the required
and actual amounts of bank reserves.
The New York Federal Reserve Bank is in an
advantageous position to observe the movements
of the money market as reflected in bank reserves,
for practically all the large New York City banks
are members of the Federal Reserve System and
carry their reserves with the Reserve Bank. Thus
it holds nearly all the ultimate bank reserves which
are back of the credit used by the New York money
market. The Bank is thus, in a sense, bookkeeper
for the New York money market.
Diagram 27 illustrates for a typical period of two

152

THE RESERVE BANKS

months the movement of reserves of New York
banks compared with requirements. The line which
consists of a series of plateaus represents the reserve
requirements of twenty-three of the largest New
York City banks, which deal most largely in money
market funds. Under the Federal Reserve require
ments as to reserves, the banks compute their re
quired reserves each week for the period from Satur
day to Friday. For this period the New York City
banks are required to maintain average reserves
equal to 13 per cent of their average daily net de
mand deposits, plus 3 per cent of their average daily
time deposits. The line for required reserves is,
therefore, a straight line for the week, running from
Saturday to Friday.

DIAGRAM 27—AVERAGE RESERVES OF 23 NEW YORK CITY BANKS
COMPARED WITH RESERVE REQUIREMENTS.

The fluctuating line on the diagram shows the
average daily reserves from the beginning of the
reserve week. It is an accumulative average line,
and this line must by the end of the week, in com-

AND THE MONEY MARKET

153

pliance with law, be as high as the figure for re
quired reserves. It will be noted on the diagram
that this is what actually occurs at the end of each
week: the average line is a little above the require
ments line. Banks plan to use their funds to the
maximum and hence there is seldom any large ex
cess of reserves above requirements at the end of
the week.
Diagram 27 brings out an important fact about
movements of bank reserves: that reserve require
ments change slowly and move within a compara
tively narrow range, but that there is a much larger
fluctuation in actual or average reserves. To put
this another way, we may say that in the New York
market, changes in the supply of funds are much
larger and more rapid than changes in the demand.
Reserves and Money Rates.—The intimate rela
tion between bank reserves and money-market con
ditions may be illustrated by a comparison of the
day-to-day movement of reserves and the call-loan
rate, which is the most sensitive index of money
market conditions. Such a comparison is made in
Diagram 28. The figures for reserves are here shown
in terms of accumulative excesses above or de
ficiencies below requirements. For example, if
actual reserves are 10 millions below requirements
for three successive days, it is shown as a total
deficit of 30 millions. To put it another way, the
diagram shows how much must be added to reserves
or subtracted from reserves on any one day to bring
average reserves exactly to the required amount.
It is clear from the diagram that call rates
and bank reserves show an inverse relationship.

154

THE RESERVE BANKS

When average reserves are below requirements call
money rates tend to be high, and when average
reserves are above requirements call-money rates
tend to be low.
There is nothing mysterious or remarkable about
this close relationship between rates and reserves,
if one thinks of what actually happens in the banks

yoke

crrr

banks and the closing call-loan hath.

concerned. In each of the large New York City
banks there is some person who is responsible for
maintaining the bank’s reserve position. To his
desk flows a stream of current information as to any
important changes in the bank’s reserves, its de
posits, or its loans. It is he who handles the bank’s
most flexible funds, which are employed mostly in
call loans, holdings of bankers’ acceptances, and
Treasury notes and certificates. If this officer finds

AND THE MONEY MARKET

155

on a certain morning that his average reserves for
the week to date are below requirements, he looks
about for a means of building up these reserves.
The call-loan market is still the principal market
through which reserve adjustments take place, and
so it is a natural thing for this officer, after con
sultation with other officers of the bank, to call
enough loans in the stock exchange money market
to bring in the funds required. If other banks are
in a similar position, it is clear that the result must
be to raise the rate for stock exchange money, Con
versely, when bank reserves are above requirements
funds are placed on the market and rates decline.
There are other methods of adjusting reserves be
sides the shifting of funds to and from the call mar
ket. Maturing loans may or may not be replaced,
acceptances, United States securities, or other securi
ties, may be bought or sold, or paper may be re
discounted at the Reserve Bank. The practices of
different banks in adjusting their reserves are dif
ferent. Some banks customarily adjust reserves by
rediscounting paper at the Reserve Bank; others sell
bills in the market or to the Reserve Bank, but
there are still enough who operate largely through
the call-loan market so that any general shortage
of reserves affecting many banks (and shortages
travel the round of the banks rapidly) will almost
surely be reflected in higher call rates. Moreover,
even when a bank adjusts its reserves by borrowing
from the Reserve Bank, its efforts to secure funds
to pay off this loan usually place pressure directly
or indirectly on the call-loan money market.
Thus the reserve position of the New York City

156

THE RESERVE BANKS

banks is a prime factor in determining the day-to
day movement of money rates. It is the balance
sheet of requirements and reserves on the desk of
the operating official of the New York City bank
which is the most significant set of facts with re
gard to money-market changes. If one could set
up a balance sheet for the banks in New York City
as a whole, which would be simply a summary of
the balance sheets on the desks of the executives
in the principal banks, one would know from hour
to hour and from day to day the principal forces
which were moving in the money market.
A Reserve Balance Sheet,,—.In the Federal Reserve
Bank of New York an attempt has been made to
set up just such a balance sheet which might indi
cate what was going on in the money market. The
basis of the balance sheet is the figures of Diagram
27 for the actual and required reserves of banks.
Figures for actual reserves are taken from the books
of the Reserve Bank at the opening of business every
morning for twenty-three of the largest banks. The
banks report their reserve requirements only once
a week, at the end of the week, but more frequent
estimates of the changes in these requirements are
made from daily reports of deposits of principal
banks. Reserve requirements change slowly and
therefore an estimate of changes during the week
serves the purpose.
There are thus available every morning figures
showing the estimated required reserves of these
twenty-three banks and, compared with them, the
average reserves actually maintained for this period.
These figures alone reveal with a considerable de-

AND THE MONEY MARKET

157

gree of accuracy whether money is likely to be easy
or tight for the next day or two, but more than that
was wanted—some account of the changes in the
situation from hour to hour and the reasons for the
changes.
Therefore, an analysis was made of the factors
affecting reserves, and the available data for each
of these factors were assembled at hourly intervals.
It was found that practically every transaction which
increases or diminishes the reserves of member banks
is traceable in the records of the Reserve Bank.
These transactions are summarized in an hourly
report substantially in the form of Table 10.
In general there are two major types of changes
which result in increasing or diminishing bank re
serves. The first consists of ordinary commercial
or agency operations, including the transfer of funds
to and from other centers (either by direct wire
transfers or in settlement for check-collection
operations), currency withdrawals or deposits, gold
imports or exports, and operations in which the Fed
eral Reserve Banks act as agents for the government,
or for foreign banks, of issue in putting funds into
the market or withdrawing them from the market.
Each one of these operations may have the effect
of increasing or diminishing the reserve balance of
member banks at the Reserve Bank. The upper
part of Table 10 shows the operations in these cate
gories which actually took place on October 30, 1925,
„ the figures being shown in net round amounts.
The second type of operation affecting the mar
ket is that involving the extension of Reserve Bank
credit. When the bank officer in charge of a member

158

THE RESERVE BANKS

Table 10.—Loss and Gain to Market, October 30,1925
(In millions of dollars)

Net
Loes
Commercial and Agency* Transactions:
Wire transfers............................................
Check settlements........... .........................
Currency and coin.....................................
Gold imports..............................................
Foreign accounts........................................

Net
Gain

10
11

9
1

Total......................................................

Net...........................................................

-•

Reserve Bank Credit:
Bills owned.............................................
Bills (sales contract)..................................
U. S. securities owned..............................
U. S. securities (sales contract)...............
Loans...........................................................

7
2
3

Total........................................................

Net...........................................................

-•

Net gain or loss for day................................

•-

• In Agency transactions are included those transactions in which
the Reserve Bank acts as fiscal agent for the Treasury or as agent
for a foreign correspondent bank.

AND THE MONEY MARKET

159

bank’s position finds that his reserves are deficient,
due to such changes as those just listed, he may
build up his reserves by borrowing at the Reserve
Bank or selling acceptances to it. Similarly, the
government security and bill dealers may in case of
need temporarily secure funds to meet their obliga
tions or to enable them to carry an increased port
folio by making temporary sales of securities or
acceptances to the Reserve Bank, accompanied by
an agreement to repurchase them within fifteen
days. The funds thus secured are promptly de
posited in a member bank, which in turn redeposits
them in the Reserve Bank, increasing its reserves.
In these ways the banks may obtain the funds they
require to build up deficient reserves.
An experiment of about two years with an hourly
report like Table 10 indicates that the net gain or
loss which such a report shows at the end of the
day corresponds closely with the change finally
shown when the reserve accounts of the member
banks are totaled the following morning. It will be
noted from the table that on October 30 it happened
that the amount of Federal Reserve money which
was called into use and became available to increase
bank reserves, was very close to the amount which
was lost to the market through other transactions.
It is, of course, largely a matter of chance that this
should occur in any single day, but it is exactly what
occurs from week to week. Federal Reserve credit
is called into use precisely as it is required for the
adjustment of the reserve position of member banks.
Interplay of Market and Reserve Banks.—Dia
gram 29 illustrates over a term of two months the

GAINS AND LOSSES TO RESERVES THROUGH COMMERCIAL AND AGENCY
TRANSACTIONS

AVERAGE RESERVES OF 23 NEW YORK CITY BANKS COMPARED WITH
RESERVE REQUIREMENTS
-MOOT

-lOOl-------------- ---------- ---------- ------------------------------------------------------- U.
4

SEPTEMBER

1925

OCTOBER.

GAINS AND LOSSES TO RESERVES THROUGH USE OF FEDERAL RESERVE
CREDIT

DIAGRAM 29—DAILY RESERVE POSITION OF 23 NEW YORK CITY BANKS
AND GAINS AND LOSSES TO RESERVES THROUGH COMMERCIAL AND
AGENCY TRANSACTIONS AND THE USE OF FEDERAL RESERVE CREDIT.

AND THE MONEY MARKET

161

reaction on bank reserves of gains and losses to the
market from ordinary commercial transactions, and
gains and losses through changes in the amount of
reserve credit outstanding. The top line of the dia
gram is a day-to-day record of gains and losses
through commercial and agency operations, such
as have been listed in the top half of Table 10. The
two lines in the middle of the diagram are the same
as were shown in Diagram 27 and the third line
represents gains and losses to the market by in
creases or decreases in the amount of reserve credit
in use in New York.
If this diagram is followed week by week one sees
that changes in bank reserves reflect the aggregate
result of the gains and losses to the market shown
in the lines at the top and bottom of the diagram.
For example, average reserves started the month of
September, 1925, $15,000,000 above reserve require
ments. The market lost funds through commercial
transactions (actually through the transfer of funds
out of town) and the banks finished the statement
week on September 4, with average reserves only
about $5,000,000 above requirements. At the be
ginning of the next week (September 4 to 11) a loss
of funds for several days in commercial transactions
reduced reserves to a low point, and about the middle
of the week the banks borrowed heavily from the
Reserve Bank to bring their reserves up to require
ments.
The following week was the quarterly tax period.
The banks began the week with reserves under the
requirement. Then occurred the phenomenon fa
miliar to tax-day periods. Government disburse-

162

THE RESERVE BANKS

ments to redeem maturing issues and pay interest
were larger for a few days than receipts from income
taxes, checks for which are collected slowly. Thus
for a few days the government put funds into the
market (shown in the diagram as a heavy gain in
commercial and agency transactions); bank reserves
were sharply increased and the banks paid off their
loans at the Reserve Bank. For a few days the
Treasury borrowed from the Reserve Bank on a
special certificate of indebtedness to cover its excess
of payments over receipts. As income-tax checks
were collected, bank reserves were drawn down,
the banks were forced to borrow once more at the
Reserve Bank, and the Treasury paid off its special
certificate.
Meantime, there was an interesting movement in
the relation with other districts. The amount of
Treasury obligations redeemed in New York is al
ways large because New York is an investment
center. To help meet the overdraft at the Reserve
Bank caused by the heavy redemptions, the Treasury
transferred funds from other districts. But the
money pulled out of other districts created a vacuum
there and banks in those districts drew upon their
balances in New York to maintain their reserves.
This withdrawal of funds, shown by the sharp drop
in the top line, was another influence supplementary
to the collection of income-tax checks in causing a
downward movement of reserves.
So the reader may find in the record of other
weeks shown in Diagram 29 the interaction of com
mercial and agency transactions, bank reserves, and
Federal Reserve credit.

AND THE MONEY MARKET

163

As a result of this experiment the conclusion may
be drawn that the call rate in New York reflects
primarily the balance sheet of bank reserves and it
is possible to analyze the changes in bank reserves to
show the principal causes which had led to the
changes.1
More broadly, a study of the money market by
the methods suggested in this chapter suggests im
mediately certain generalizations concerning the
operation of the money market.
1. Small movements of funds frequently have
large results in creating easier or firmer money con
ditions. A gain or loss to the market of 20 or 30
million dollars of reserve money may frequently
make a difference of % per cent in the call-money
rate. Although a large amount of funds is employed
in the money market, the market is delicately bal
anced and easily affected by small movements in
either direction. In fact, the market illustrates the
law of marginal differences.
2. The Federal Reserve Banks are in practically
constant contact with the money market. One fre
quently reads in current discussions that the Reserve
Banks are out of contact with the market, and that,
therefore, their rates have no influence. This is
almost never true. As the constant ebb and flow
of funds between the New York money market and
other centers takes place, the New York City banks
call on their Reserve Bank for constantly changing
*It may be noted that while many of the data reported here
are available currently and daily only in the records of the Fed
eral Reserve Banks, the basic data for required and actual re*rves are publicly available in the Saturday statement of New
York clearing house banks.

164

THE RESERVE BANKS

amounts of accommodation, so that there are daily
fluctuations in their use of Reserve Bank facilities.
It is only rarely—as, for example, for a few weeks
during the period of easy money in the summer of
1924—that the New York market is in any sense
independent of the Reserve Bank and out of con
tact with it. As a rule the contact is continuous.
3. The use of Reserve Bank credit by the money
market is in the main a semi-automatic operation.
The amount of such credit called into use at any
time is the result of the composite action of the
officers of many member banks and occasionally of
dealers in bills and securities. In the main the use
of reserve credit is on the initiative of these people
and not on the initiative of the Bank. This does
not mean that Reserve Bank policy in fixing its rate
and dealing at times in government securities is not
important. It means that the Bank helps to set
the stage by fixing its discount and buying rates,
and beyond that point the operation is ordinarily
semi-automatic as far as the Bank is concerned. The
use of reserve credit by the market is a direct re
sponse to changing conditions in the market. This
semi-automatic adjustment of Reserve Bank credit
to market needs is a major force for financial sta
bility and is one of the most effective contributions
. which the Reserve System makes to American
finance.
SUMMARY

1. Almost all transactions in the money market are
reflected at one point or another in changes in
bank reserves.

AND THE MONEY MARKET

165

2. Daily changes in the call-loan rate reflect pri
marily the balance sheet of required and actual
reserves; and a small change in the reserve posi
tion often leads to a change in rate.
3. Reserve requirements change slowly; but the sup
ply of reserve funds changes rapidly.
4. Changes in the supply of reserves reflect vari
ous commercial and Treasury operations, such as
transfers to and from other centers, currency de
posits and withdrawals, gold movements, etc.; and
reflect also changes in the amount of Federal
Reserve credit in use.
5. Federal Reserve funds are called into use in
direct response to changes in reserves due to all
other causes—Federal Reserve credit is used to
adjust reserves to requirements.
6. The Federal Reserve Bank of New York is thus
in almost continuous daily contact with the
money market.
7. The daily semi-automatic use of Federal Reserve
funds for reserve adjustments, on the initiative
of the member banks and market, is a major
service towards financial stability.

THE RESERVE BANKS

1G6

Table 11.—Data Supporting Diagrams 27 to 29
Reserves of 23 New York
City Banks—Close of
Business
(In millions of dollars)

1925

Net Gain or Loss to
Reserves of City
Banks Through Day’s
Operations
Clos (In millions of dollars)
ing
Call
Com
loan
Ac
Aver
Re
cumu Rate mercial
age
serve
and
Re
lated
Actual Week
Bank Net
quired
Excess
Agency
to
Oper Total
or
Trans
Date
ations
actions
Deficit

Sept. 1
2
3

t4
5
6
7
8
9
10

tu
• 12
13
14
15
16
17

tis
19
20
21
22
23
24

K
26
27
2a
29
30

579
...

*..
573
...
..-

579

.**

576

♦

606
602
567
550
550
550
550
571
615
629
583
562
562
591
673
596
548
554
545
545
550
613
625
573
590
564
564
573
602
631

593
595
590
584
550
550
550
555
567
578
578
562
562
572
597
597
589
584
545
545
547
564
576
575
577
564
564
567
576
587

+ 9.6
+ 2.4
-18.1
+ 8.4
+ 17.0

+ 56
+ 80
+ 66
+ 35

4^
4
4
4
...

- 1.2
- 5.0
- 22 .3
- 21.6
- 13.5

-72
-30
+ 30
+ 35
....

5^
4^
4
4
...

- 15.1 + 34.2 + 19.1
+ 27.9 + 19.5 + 47.4
.6 + 13.4 + 12.8
- 11.5 -34.8 — 46.3
+ 2.5 -22.1 -19.6

-21
+ 72
+ 90
+ 60
+ 35

W
3^
5

+
+
-

7.0
160.7
46.2
45.8
42.7
27.6

+ 16.9
-66.2
-45.5
+ 12.0
+ 45.8
+ 30.5

+ 23.9
+ 94.5
— 91.7
— 33.8
+ 3.1
+ 2.9

-87
-48

6
5

+
+
-

20.6
13.8
28.2
19.2
21.2
7.5

+ 25.9
+ 51.5
-12.9
-28.2
+ 39.8
-25.5

+ 5.3
+ 65.3
+ 15.3
-47.4
+ 18.6
-33.0

4^
- 6
+ 7

4
5

-51
-32
+ 15

53^

5^
6

+ 8.4
- 2.6
-40.4
-13.2
+ 3.5

- 2.7 + 16.5 + 13.8
+ 5.8 + 25.2 + 31.0
+ 17.0 + 1.6 + 18.6

t Bold-face figures indicate end of reserve week.

AND THE MONEY MARKET

167

Table 11.—(Continued)
Reserves of 23 New York
City Banks—Close of
Business
(In millions of dollars)

Net Gain or Loes to
Reserves of City
Banks Through Day's
Operations
Clos (In millions of dollars)
ing
CaJJCom
Ac
loan
Re
Aver
cumu Rate mercial
age
serve
and
lated
Net
Re
Bank
Actual Week
Agency
Excess
Total
quired
Oper
to
Trans
or
ations
Date
actions
Deficit

1925

Oct.

584

3
4
5
6
7
8

te
10
11
12
13
14
15

116
17
18
19
20
21
22
to
24
25
26
27
28
29

IM
31

582
...

...
585
...

.-.
...

588
...

.--

587

620
555
560
560
602
591
616
583
598
584
584
584
586
589
622
596
602
602
620
608
586
596
578
557
557
570
635
624
634
631
594

592
587
560
560
574
578
586
588
587
584
584
584
585
586
592
592
602
602
608
608
603
602
599
557
557
561
580
588
596
601
594

+ 48
+ 21

4^
5
...

- 9.4 -16.6 - 26.0
- 33.8 - 9.4 -43.2
.9 - 1.8 - 2.7

-24
-16
+ 20
+ 18
+ 35

5^
5^
4^
4^
4^

- 2.9 + 42.1 + 39.2
+ 30.3 -27.6 + 2.7
+ 16.1 + 6.5 + 22.6
- 7.0 -22.7 -29.7
.1 + 20.5 + 20.4
+
1.5 - 17.3 -15.8

6^
+ 5
+ 42
+ 49
....

5^
5^
4^

- 4.7 + 2.0 - 2.7
- 7.5 + 12.5 + 5.0
+ 16.5 + 11.0 + 27.5
+ 19.6 -48.2 -28.6
+ 15.4 - 9.0 + 6.4

+ 60
+ 80
+ 75
+ 84
+ 77
..,-

4^
4
4
4*4
4K
...

+ 32.5 - 2.7 + 29.8
+
3 - 5.7 - 5.4
- 5.3 -22.7 — 28.0
- 17.9 + 32.8 + 14.9
- 8.3 - 3.6 -11.9
- 6.5 -13.4 -19.9

-78
-28
+ 5
+ 54
+ 98
....

5
5
4%
5

+
+
+
+
-

13.1 + 5.1
32.8 + 32.7
8.4 -24.4
1.7 + 12.1
19.0 + 17.3
26.9 — 15.7

+ 18.2
+ 65.5
- 16.0
+ 13.8
- 1.7
-42.6

CHAPTER X

The Mechanism

Credit Policy

HE preceding three chapters have described in
some detail the mechanism by which reserve
funds flow from the Reserve Banks into the money
market when additional funds are needed, and flow
back into the Reserve Banks when the need has
passed, but little has been said thus far about the
general policies governing the flow of funds. In
fact, emphasis has rather been laid upon the semi
automatic phases of the movement.
But the Reserve Banks have a most important
responsibility in connection with this movement of
reserve funds into and out of use. That respon
sibility concerns the restrictions which are thrown
around the use of reserve funds. The problem is
to set up the mechanism in such fashion that re
serve funds will be used as fully as necessary to
provide business with adequate funds, without at
the same time encouraging too free use of these
funds. To put it another way, the problem is to
aid in the adjustment of the volume of credit to the
volume of business. Maladjustments in this rela
tionship tend toward inflation, rising prices, and
speculation on the one hand, or deflation, falling
prices, and depression on the other.
In their determination of the price of reserve
funds and the general conditions under which mem168

AND THE MONEY MARKET

169

ber banks and others may secure such funds, the
Federal Reserve Banks and Board thus carry a
heavy responsibility. For their influence in making
reserve funds easy or difficult to obtain may have
large economic and social consequences. Decisions
on these matters by the boards of directors of the
Reserve Banks and by the Federal Reserve Board
are the most difficult and important that they make.
The problem in this field with which the public is
most familiar is the determination of the discount
rate—which is simply the price which member banks
must pay for the funds they borrow from the Re
serve Banks. But there are other similar problems
just as perplexing: the problem of open-market
policy, the problem of dealing with individual mem
ber banks which may be abusing the borrowing
privilege, and the problem of publicity. All these
are phases of the general problem of credit policy.
Before considering in detail any of these policy
problems it will be well to Say something as to the
general mechanism of the Reserve System for de
ciding policies, and particularly something as to who
it is who makes the decisions.
It may well be noted first that it is a new thing
in this country to have anybody considering and
able to exercise an influence upon the country’s
general credit policy. In the old days, with the
country’s bank reserves scattered among many thou
sands of separate banks, each working for its own
interest and each organized for profits, no continu
ous common policy was feasible. No one was re
sponsible for general credit conditions. In times
of emergency when some joint action was impera-

170

THE RESERVE BANKS

tive, powerful private individuals and the clearing
houses took command of the situation and enforced
some plan for a short period. In other countries
banks of issue have continuous leadership, but here
we had no such agency before the Reserve System
was established, save for the two periods when the
first and second banks of the United States were
in operation. The Reserve Act provided an organi
zation, not operated for profit, continuously inter
ested in the country’s monetary and banking
policies.
Local Autonomy.—Turning to the mechanism for
determining Federal Reserve policy, one of its
fundamental principles is its provision for safe
guarding local interest, while at the same time in
suring a measure of national unity in policy.
Beginning with the local member bank the prin
ciple of local self-government is respected. The Fed
eral Reserve Banks do not tell their member banks
what loans they may or may not make to their
customers, what investments they may buy, or what
deposits they may accept. All these are matters
for decision by the member bank, under the general
restrictions of national or state banking law.
Similarly, the twelve Federal Reserve Banks are
autonomous units in dealing with the member
banks. Each Federal Reserve Bank is operated by
its own directors and the officers appointed by its
board of directors. Each Reserve Bank decides how
much or how little it will lend to member banks.
Each Reserve Bank is responsible for initiating
changes in its discount rate and for deciding its
policy in open-market transactions. It is clear in

AND THE MONEY MARKET

171

the Federal Reserve Act that Congress had.no in
tention of creating a central bank in this country,
but a regional banking organization, with only a
certain measure of centralization in those matters
in which uniformity of practice and policy is
essential.
There are certain of the functions of the Reserve
Banks which are country-wide in scope, including
the collection and wire-transfer systems, in which
uniformity of practice is necessary, and for these
functions the Federal Reserve Board prepares uni
form regulations. In matters of policy, moreover,
a certain coordination is necessary and the law pro
vides that discount rates established by the indi
vidual Reserve Banks are subject to “review and
determination of the Federal Reserve Board.” Co
ordination in open-market purchases of acceptances
and government securities is effected through a com
mittee of governors of five of the Reserve Banks,
which in consultation with the Federal Reserve
Board makes recommendations to the banks as to
open-market policy.
The provision in the mechanism of the Reserve
System for safeguarding both national and local in
terests was referred to as follows by President Wil
son in a letter to Senator Underwood:
No group of bankers anywhere can get con
trol. . . . No one part of the country can concentrate the
advantages and conveniences of the system upon itself
for its own selfish advantages. . . . I think we are justi
fied in speaking of this as a democracy of credit Credit
is at the disposal of every man who can show energy
and assets. Each region of the country is set to study
its own needs and' opportunities and the whole country

172

THE RESERVE BANKS

stands by to assist.
democracy.

It is self-government as well as

Who Decides Policy.—Another feature of the
mechanism of the Federal Reserve System, which is
a guaranty of the representative character of deci
sions as to policy, is the method of selection of the
people who decide policy.
The Federal Reserve Board consists of eight mem
bers including the Secretary of the Treasury and
the Comptroller of the Currency ex officio. The six
other members are appointed by the President for
ten-year terms, by and with the advice and consent
of the Senate. Not more than one of the six mem
bers shall come from any one Federal Reserve Dis
trict, and they must be appointed with “due regard
to a fair representation of the financial, agricultural,
industrial, and commercial interests, and geographi
cal divisions of the country.” Of the six appointed
members of the board in 1926, two were formerlylawyers and the others were farmer, merchant, news
paper publisher, and economist.
The selection of directors of the individual Re
serve Banks was discussed in the Monthly Review
of the Federal Reserve Bank of New York for Jan
uary 1,1926, as follows:
Of the nine directors (of each Reserve Bank), six are
elected by the member banks and three are appointed by
the Federal Reserve Board. Of the six elected by mem
ber banks three may be bankers, and the other three
must be actively engaged in commerce, agriculture, or
industry in the district, and while serving as Reserve
Bank directors may not serve as directors or officers of
any other bank. Of the three directors appointed by the

AND THE MONEY MARKET

173

Federal Reserve Board, one acts as chairman of the
Board, a man of banking experience, and devotes his
entire time to the Federal Reserve Bank, carrying in ad
dition the title and duties of Federal Reserve Agent.
The other two appointed by the Federal Reserve Board
must have no other banking connection while serving as
directors. Hence they are usually business men.
Business Men in the Majority.—Thus, of the nine di
rectors of each Reserve Bank, five are ordinarily business
men, three are active bankers (frequently with business
interests in addition), and one is chairman and Federal
Reserve Agent. Directors hold office for three years
and may be reappointed or reelected.
Of the present 108 directors of the 12 Reserve Banks,
12 are the chairmen of the board and 36 are active
bankers. The remaining 60, constituting the majority,
are as follows:
19
14
4
4
2
3
3
2

manufacturers
merchants
farmers
lumbermen
insurance men
investment bankers
retired business men
publishers

2 lawyers
2 railroad men
1 cattleman
1 contractor
1 public utilities man
1 mining official
1 savings bank officer

In each of the 12 Federal Reserve districts it is men
with this wide range of interests and familiar with con
ditions in the district who are responsible for the man
agement of the Reserve Bank.
In addition to the directors of the 12 Reserve Banks
each of the 23 branches has a board of seven1 directors,
residents of the branch territory, of whom four are
appointed by the Federal Reserve Bank of the district
and three by the Federal Reserve Board. The directors
of branches have a range of occupations and interests
similar to that indicated above for the directors of the
banks. Their jurisdiction in credit matters is limited to
1 Changed to seven or five by later amendment of regulations.

174

THE RESERVE BANKS

passing upon loans to member banks in the territory
served by the branch.
The Federal Reserve Act provides for a Federal
Advisory Council consisting of one member from
each district, selected by the board of directors of
the Reserve Bank in that district. This council
meets at least four times a year at Washington and
discusses with the Federal Reserve Board important
problems of policy. The council members are
bankers and business men of national reputation.
As a still further means for the coordination of
Federal Reserve policy the Federal Reserve Board
has made it a custom to call conferences each year
of the chairmen and governors of the twelve Fed
eral Reserve Banks. These conferences meet in
Washington in the offices of the Federal Reserve
Board and are the occasion for a thorough review of
important phases of Federal Reserve policy.
So we see that under the terms of the Federal
Reserve Act and current procedure, the manage
ment of the Federal Reserve System is so designed
as to bring to bear upon any important question
of policy both local and national points of view, to
gether with the opinions of men of many different
occupations and interests.
Not Operated for Profit.—By the terms of their
establishment the Federal Reserve Banks have a dif
ferent philosophy from that of commercial banks.
The mechanism is devised so as to remove from their
decisions as completely as possible the motive of
profit. Any net earnings beyond 6 per cent divi
dends to member banks on the paid-in capital stock
and the provision for a reasonable accumulation of

AND THE MONEY MARKET

175

surplus are required by law to be turned over to
the United States Government as a franchise tax.
This removes the incentive to operate the banks for
the purpose of making large profits and leaves them
free to concentrate their policy upon public service.
More positively, the Federal Reserve Act lays
down the principle that the discount rate shall be
determined “with a view of accommodating com
merce and business.” These are general terms, but
they at least indicate that public service and not
profit is the end to be sought. A similar principle
has been adopted and promulgated by the Federal
Reserve Board as the guiding principle in purchases
and sales of government securities.
Furthermore, there is no question with the Re
serve Banks of getting or retaining customers; they
cannot solicit business and that which they have
cannot be taken away by competitors; there are no
special arrangements for particular customers. In
fact, the Reserve Act specifically forbids “discrimina
tion in favor of or against any member bank.” In
each district the largest bank and the smallest bank
borrow at the same rate.
The whole atmosphere of Reserve Bank policy
making is thus quite different from that of the com
mercial institution. It encourages impartial de
cisions, with the public welfare as the goal.
Economic Information.—From the earliest years
of their operation the Federal Reserve Board and
Banks recognized the need of having as an aid in
determining policy the fullest possible information
on business and credit conditions. The Federal Re
serve Board organized a Division of Analysis and

176

THE RESERVE BANKS

Research in 1918, and all the Reserve Banks have
organized statistical departments. At the present
time the reporting and statistical service of the
System is one of the most highly developed in the
country.
The result is that when a board of directors of a
Reserve Bank or when the Federal Reserve Board
considers a question of policy, it has before it a
wide range of data as to the condition of business
and banking. The information includes a great
deal of data collected by the Reserve System di
rectly from original sources. These data include, for
example, current reports upon the following:
Federal Reserve operations.
Condition of member banks.
Money market rates and conditions.
Gold movements.
Movements of funds about the country.
Brokers’ loans.
Commercial paper outstanding.
Interest rates charged by banks.
Savings-bank deposits.
Bank debits.
Condition of foreign banks of issue.
Money rates abroad.
Foreign exchange rates.
Foreign and domestic financing.
Sales and stocks of department stores.
Sales arid stocks of wholesale dealers.
Sales of chain stores and mail-order houses.

The Reserve Board and Banks compute a variety
of indexes, including indexes of prices, production,
employment, wages, building, transportation, vol
ume of trade, bank debits, velocity of deposits,
wholesale trade, retail trade, failures, etc.

•

AND THE MONEY MARKET

177

These data are presented to the Federal Reserve
Board and the directors of the Reserve Banks as
they become pertinent to any problem under dis
cussion. The diagrams illustrating Chapters XI and
XII, for example, are copies of several of the large
charts which are regularly presented at the weekly
meeting of the directors of the Federal Reserve
Bank of New York, along with detailed data in the
form of typed reports. This comprehensive body of
facts has an important place in the mechanism of
the Reserve System for policy determination.
In passing it may be noted that most of this in
formation is made public regularly (in the form of
aggregates) in the Federal Reserve Bulletin and the
monthly reviews of credit and business conditions
published by the Federal Reserve Agents of the
twelve banks.
A Test of the Mechanism.—One of the best tests
of the mechanism of the Federal Reserve System
for policy determination is found in the type of men
who are willing to accept appointment to the boards
of directors of the Reserve Banks. In each district
election or appointment to the board of the Reserve
Bank has come to be regarded as an honor which
is seldom refused. The boards are made up of men
of character and reputation, and their presence on
these boards is a safeguard against political or other
outside influence.
SUMMARY

1. Previous chapters have dealt largely with the
semi-automatic phases of the use of Federal Re-

178

THE RESERVE BANKS

serve funds by the member banks and the mar
ket; but the Reserve System has at its command
means for exercising an important influence on
the extent of use of reserve funds. This is the
field of Federal Reserve policy.
In policy decisions the principle of local auton
omy is observed; the Federal Reserve System is
not closely centralized, but each Reserve Bank
is largely autonomous. It is only in certain mat
ters where uniformity of practice and policy is
essential that central coordination is provided for.
The provisions governing the appointment of the
Federal Reserve Board and the election of the
directors of the Reserve Banks give assurance
that the people who decide policy will represent
all parts of the country and a wide range of busi
ness and banking interests.
The Federal Reserve mechanism is so designed as
to remove the profit-making motive as completely
as possible from its policy. Profits are limited
and the “accommodation of commerce and busi
ness” is set as the aim of policy.
As an aid in policy determination the Reserve
Board and Banks maintain qualified research
staffs continuously engaged in the collection and
analysis of economic information.

CHAPTER XI

Credit Policy—Tradition and the
Discount Rate
A FTER the preliminary observations in the pre/ '^ceding chapter as to the general organization
of the Federal Reserve System for policy decisions,
it is well to examine more specifically some of the
kinds of decisions which have to be made, some of
the factors taken into consideration in reaching de
cisions, and some of the results of decisions, as far
as they can be traced.
Broadly speaking, the aim of Federal Reserve
credit policy is to help bring about such an adapta
tion of the volume of credit to the volume of busi
ness that every legitimate need for credit will be
met, but that the volume of credit will not be ex
panded beyond the legitimate need.
As a fundamental principle, the Federal Reserve
Banks do not deal directly with the consumers of
credit, but with the member banks and the money
market. The Reserve System, therefore, cannot
prescribe the uses to which credit shall be put. That
decision rests with the individual member bank.
The Reserve System deals with credit quantita
tively and not qualitatively. Its influence is upon
the total amount of credit in use and not upon the
method of its employment.
A member bank almost never borrows from a Fed179

180

THE RESERVE BANKS

eral Reserve Bank in order to make a particular
loan. It borrows rather when its balance sheet shows
that reserves are deficient after the day’s operations
are completed. The borrowing comes as a net re
sult of the making of loans, the payment for checks
drawn, the receipt of deposits, and all the rest of the
day’s transactions. It is seldom possible to say just
what transaction has led to borrowing at the Re
serve Bank.
There is ordinarily no connection between the
character of the paper which the borrowing bank
offers to a Reserve Bank and the transaction which
has made borrowing necessary. Almost all mem
ber banks have on hand at all times amounts of
government securities and other eligible paper on
which they could borrow much larger amounts than
are necessary except in extreme emergency. The
bank which finds it necessary to borrow uses the
most readily available paper. Eligibility require
ments influence the character of employment of
bank funds only to the extent that banks are some
what predisposed to make loans which give them
eligible paper. Thus a Reserve Bank cannot tell
from the nature of its loans what the money will
be used for.
Still further difficulty in tracing the use of Fed
eral Reserve funds arises from the fact that the
funds lent are frequently, if not usually, put to
employment by some other bank (or individual)
than the bank borrowing the money. For exam
ple, suppose Mr. Jones draws a check for $2,000,000
on Bank A to pay a mortgage owing to Trust Com
pany B. Bank A finds its reserve impaired and bor-

AND THE MONEY MARKET

181

rows $2,000,000 from its Federal Reserve Bank. But
it is not Bank A, but Trust Company B, which may
not even be a member bank, that has the employ
ment of the $2,000,000. Clearly the Reserve Bank
has no means of prescribing how the money shall
be spent, nor even knowing how it is spent. This
is not an exceptional case, for the most frequent
cause leading a bank to borrow is a loss of deposits
leading to a deficiency in reserves.
It is thus impossible for a Reserve Bank to dic
tate how its credit shall be put to employment. It
cannot, for example, restrict loans on the stock ex
change and at the same time encourage loans to the
farmer. Reserve Bank loans to a farming commu
nity bank may, and often do, find their way
promptly to the stock exchange money-market. The
specific use of credit is the business of the indi
vidual member and non-member bank, and the Re
serve System is no substitute for sound banking
practice. The judgment of the officers of our many
thousands of banks is still the principal safeguard
against the improper use of credit.
It is the business of the Reserve System to in
fluence the amount of credit in use, and try to bring
about a proper adaptation of the total volume of
credit to the volume of business. Even in the de
termination of the volume of credit it should be kept
continuously in mind that it is usually the member
bank which exercises the initiative in putting addi
tional Federal Reserve funds to work. The Reserve
Banks stand ready to lend to member banks at their
discount rate or to buy bills at the established buy
ing rates. It is ordinarily the banker who decides

182

THE RESERVE BANKS

whether or not he shall call Reserve Bank funds
into use. What the Reserve Banks do primarily is
to fix the price at which their funds may be pur
chased and in certain other ways influence the con
ditions under which their funds are used.
Restraints on Use of Reserve Funds-^Five re
straints which tend to prevent the excessive use of
Reserve Bank funds may be distinguished. One of
these is applied by the member banks. The other
four are administered by the Reserve System and
are the instruments by which Federal Reserve credit
policy finds expression. These five restraints are:
1.
2.
3.
4.
5.

Tradition against borrowing.
Discount rate.
Open-market operations.
Direct dealing with individual banks.
Publicity.

These five will now be discussed in order.
Tradition Against Borrowing-,—It may seem
strange to speak of tradition as having an important
influence upon the operations of an institution only
thirteen years old. The word is justified because
there appears to have been transferred to the Re
serve System an inheritance from the past.
Somewhat as in the old days the bank which bor
rowed largely and continuously from its correspon
dents was looked upon with suspicion, so today there
exists generally a feeling against large and continu
ous borrowing from a Federal Reserve Bank. This
is a feeling which the officers of the Reserve Sys
tem have encouraged. Federal Reserve funds are
the country’s banking reserves and should be used in

AND THE MONEY MARKET

183

busy seasons and emergencies, and not as a sub
stitute for bank capital.
The facts as to the unwillingness of banks to
remain heavily in debt at the Reserve Banks for
long periods are illustrated by Diagram 30, in which
one line shows the amount of borrowing at Reserve
Banks, or total bills discounted, by all member
banks, and the other shows the interest rate on
prime 4 to 6 months’ commercial paper in the open

DIAGRAM 30—OPEN-MARKET INTEREST RATE FOR PRIM 4-6 MONTHS’

COMMERCIAL PAPER AND MONTHLY AVERAGES OF DAILY BILLS DIS
COUNTED FOR MEMBER BANKS BY ALL FEDERAL RESERVE BANKS.

market. The remarkable parallelism between these
two lines is perhaps best explained as a result of
the tradition discussed in the preceding paragraph.
When the member banks find themselves continu
ously in debt at the Reserve Banks, they take steps
to pay off that indebtedness. They tend to sell se
curities, call loans, and restrict their purchases of

184

THE RESERVE BANKS

commercial paper. The consequence is that when
a large number of member banks are in debt money
generally becomes firmer, commercial paper sells
less rapidly, and rates increase. Conversely, when
most of the member banks are out of debt at the
Reserve Banks, they are in a position to invest
their funds, and money rates, including commercial
paper rates, become easier. This relationship rests
on the unwillingness of banks to remain in debt at
the Reserve Banks.
If the discount rates of the Reserve Banks were
high the unwillingness of member banks to stay in
debt could easily be accounted for on that ground
alone. But the Reserve Banks have seldom charged
rates above the rates banks have charged their cus
tomers, and tradition is probably more important
than the rate in preventing continuous borrowing.
In certain states where there have been large
numbers of bank failures in recent years, and where
the position of the banks is scrutinized for any sign
of weakness, the feeling against showing bills pay
able to a Reserve Bank in a bank statement has
been carried to an unfortunate extreme, and has
spread from banker to general public. This is, of
course, a temporary situation and the psychological
background in these states and elsewhere may
change at any time and banks may feel that occa
sional indebtedness to a Reserve Bank is normal.
The Discount Rate.—To the general public the
discount rate has become the symbol of Federal
Reserve policy. Because changes in the discount
rate have been so widely commented upon in the
press and in economic literature, they have assumed

AND THE MONEY MARKET

185

an importance far beyond their purely economic
significance as changes in the price which member
banks pay for accommodation at a Reserve Bank.
The importance of a change in discount rate lies
principally in its being a public recognition by a
group of responsible and well-informed people of a
change in the credit situation. For example, a
change in the discount rate from 4 to 3% per cent
is equivalent to an announcement that credit con
ditions are easier, and the Reserve Bank making the
change feels justified in lending its money at a little
lower rate.
Discount rates do not change frequently. In
the past five years the Federal Reserve Bank of
New York has changed its discount rate ten times,
or twice a year on the average. Thus an announce
ment of change has also the importance of rarity.
A change of discount rate is voted by the board
of directors of a Reserve Bank and then approved
by the Federal Reserve Board.1 Under the ordinary
procedure a discussion of the discount rate is on the
agenda for every meeting of Reserve Bank directors.
The discussion is facilitated by the presence of
memoranda, reports, and charts, such as those used
to illustrate this and the following chapter. When
once the directors have agreed upon a change, the
decision is telephoned or telegraphed to the Federal
Reserve Board for its approval. The Federal Re
serve Board convenes at once to consider the matter
and usually gives its approval or disapproval im1 Since this was first written the Federal Reserve Board has
in one instance initiated a change in rate at a Reserve Bank.
Question has been raised as to whether this action was legal.

186

THE RESERVE BANKS

mediately. Immediate action is possible because
there has usually been preliminary informal dis
cussion of the prospective change. A change in rate
is usually announced at the close of business that
same day. No reasons for the rate change are
ordinarily given out, partly because the decision
represents the views of so many people, who have
perhaps acted for somewhat different reasons, that
it would be an extremely difficult and time-consum
ing task to phrase a statement which would fairly
represent the views of all the directors of the Re
serve Bank concerned and the members of the Fed
eral Reserve Board, and partly because it would
be equally difficult to make any statement which
did not either exaggerate the importance of the
change or minimize it. Such a statement is always
subject to misinterpretation, as has been repeatedly
illustrated. Instead of making statements explain
ing specific rate changes, the Reserve System has
followed the practice of making public in its reports,
as fully as possible, the data which the Federal Re
serve directors and Board have before them when
they make their decisions.
Precedent of Limited Value.—In making de
cisions as to discount rates the Reserve System has
found precedent of limited value. This is partly be
cause there has been in this country since 1920 an
unprecedented situation as to gold reserves. In Eu
rope the practice had been for banks of issue to
raise their rates when necessary in order to pro
tect their gold reserves, and reduce them when this
protection was no longer necessary.
The Reserve Banks have held such large reserves

AND THE MONEY MARKET

187

that there has been no time in the past six years
when concern for their protection was necessary. On
the contrary, the incoming gold might in any dif
ferent circumstances have caused considerable em
barrassment. Instead of considering means of
attracting gold it has been necessary to consider
means of repelling it.
The mechanical means of measurement by which
banks of issue have in the past watched their gold
positions has been the reserve ratio. Such a ratio
is published as a part of the weekly statement of
the Federal Reserve System. In our case it is the
ratio of total reserves to liabilities for Federal Re
serve notes and deposits. During the war years
this ratio was something of a guide to credit policy
just as the reserve ratio of the Bank of England
has always been a guide to the directors of that
institution. Historically, banks of issue the world
over have watched their reserve ratios and, other
things being equal, have raised their discount rates
when the reserve ratio went down, and lowered dis
count rates when it went up. In 1919 and 1920 we
had to watch our reserve ratio closely, for at times
it came close to the minimum, and in 1919 and
1920 the sinking of the reserve ratio was one of the
factors making discount rate increases imperative.
Then as gold poured into the country in 1921 and
1922 the reserve ratio rose by leaps and bounds and
lost its significance as a guide to credit policy. Since
then discount rates have been increased or decreased
without any necessary relation to the movement of
the reserve ratio. The ratio is now so far above the
legal minimum, and in fact so far above any work-

188

THE RESERVE BANKS

ing minimum which might reasonably be set by
custom or policy, that its movement for the Sys
tem as a whole can, for the present, be ignored.
Thus one time-honored mechanical aid to rate pol
icy has had to be discarded.
Another frequently quoted rule of thumb from
British experience which has not appeared to be ap
plicable in this country has been the rule that the
discount rate should be “above the market.” The
Bank of England has always maintained its dis
count rate above the open-market rate on bankers’
acceptances, the paper which the bank discounts
and to which the discount rate applies. In this coun
try there was, and to some extent still is, a school of
thought which felt that this rule should be taken
over bodily, despite a very different banking or
ganization. The rule is interpreted to mean that the
discount rate of a Federal Reserve Bank should be
above the open-market rate or bank rate to a cus
tomer on commercial paper, the general type of
paper to which the discount rate applies. The gen
eral principle back of this rule was that banks should
not be able to make money by borrowing at a Re
serve Bank.
The application of this formula to this country
needs close scrutiny. For in the first place it should
be noted that the whole structure of the London and
New York markets is different and the term “dis
count rate” means totally different things in the two
markets. The outstanding difference for the pur
pose of this discussion is that the British banks
make advances to their customers largely in the
form of overdrafts and do not require the promis-

AND THE MONEY MARKET

189

sory notes which are in general use in this country.
The British bank does not ordinarily borrow di
rectly from the Bank of England, but adjusts its
position through its holdings of bankers’ bills and
Treasury bills and its loans to bill brokers. These
bill brokers, when necessary, sell bills to the Bank
of England at the discount rate or borrow from the
Bank on bills. The rates at which the British banks
lend to their customers are usually somewhat above
the Bank of England discount rate. The discount
rate in this country applies to the promissory notes
which member banks present with their indorsement
to the Reserve Banks or to the member banks’ own
notes secured by their customers’ notes or by govern
ment obligations. These two situations are so dif
ferent that there is certainly no presumption that a
formula which applies in one case should apply in
the other.
But the formula is so often quoted that it may be
worth while to carry the scrutiny further. Would it
be possible or desirable for the Reserve Banks to
keep their discount rates above the rates banks
charge their customers and thus make it unprofit
able for banks to borrow—make the rate a penalty
rate?
There are several practical difficulties—one of
which is that there is no uniformity in the rates
banks charge their customers; there is no “market”
for customers’ commercial paper. At the present
time of writing (June, 1927) New York City banks
are charging their best customers 4% to 4% per
cent, while country banks in New York and New
Jersey are charging 6 per cent and country banks in

190

THE RESERVE BANKS

parts of the West and South, where there is no com
petitive market for money, are charging 8 per cent
or more. But clearly a discount rate of over 6 per
cent in New York and over 8 per cent in some of the
Southern and Western districts would prohibit
borrowing.
The problem is perhaps clarified by a closer anal
ysis of the economics involved. It should be noted
that the commercial paper a member bank brings to
a Reserve Bank for rediscount is quite different
from open-market commercial paper or the notes
a bank receives from its customers. The difference
consists in a bank indorsement. The member bank
puts its own name on commercial paper when it
brings the paper to a Reserve Bank. When a bank
accepts a bill of exchange it charges from 1 to 2 per
cent per annum for its guaranty, and this may be
taken as some guide to the value of a bank indorse
ment. Thus if a member bank lends its commercial
customer on his note at 5 per cent, the value of this
note with a bank indorsement might be represented
by a rate not far from 3% to 4 per cent. If the
Federal Reserve Bank rate is 4 per cent, it is really
equal to or above the rate which represents the
paper’s true value, and offers no temptation to the
member bank to borrow. When a bank lends money
to a customer it assumes considerable risk. It as
sumes also the cost of serving the customer. This
risk or cost is not passed on to the Reserve Bank
when the member bank has indorsed the paper and
made itself responsible for payment. It is, there
fore, logical that the rate at which member banks
lend to customers should be higher than the Fed-

AND THE MONEY MARKET

191

eral Reserve discount rate without necessarily of
fering temptation to member banks to borrow.
Banks in large centers which figure their risks and
their expenses carefully do not ordinarily feel that
they are making a profit by borrowing and relending
the funds. The case is somewhat different with
banks outside of the money centers which charge
their customers higher rates. But presumably the
risks and costs of administration which these banka
assume are correspondingly higher.
A Fair Price for Reserve Money.—Even though
the foreign precedent that the discount rate should
be above the market has not been found a prac
tical guide in this country, nevertheless the Fed
eral Reserve authorities have found one of their
most important guides for rate policy in the move
ment of money rates in the open market. By the
practical test of trial and error it has been found
that a discount rate between the open market rate
for commercial paper and the open market rate for
ninety-day bankers’ acceptances is a rate at which
member banks will usually borrow freely to meet
the seasonal or unusual needs of agriculture, pro
duction, and trade, but will not ordinarily borrow
for investment or speculative loans.
Diagram 31 shows the way in which the discount
rate of the Federal Reserve Bank of New York has
settled into a rather constant relation with open
market rates for commercial paper and bills. The
discount rate has moved within a ribbon whose bor
ders are the commercial-paper rate and the bill
rate.
There is probably a good reason behind the fact

192

THE RESERVE BANKS

that the relationships shown in Diagram 31 have
been so steadily maintained. The Reserve Banks
are buying credit instruments, termed “paper” by
the banker, from their member banks and the dis
count rate is the price they pay for this paper. The
price charged should be a fair price for the goods

DIAGRAM 31—MONET RATES IN NEW YORK! 4 TO 6 MONTHS* COMMER
CIAL PAPER, 90-DAY ACCEPTANCES, AND THE MISCOUNT RATE OP
FEDERAL RESERVE BANK OF NEW YORK.

purchased. If the price is fair the offerings of paper
will naturally tend to be limited to the amount the
banker must sell to meet his genuine needs for
funds. What is a fair price for the paper the Fed
eral Reserve Banks buy from member banks? It
is paper that is better than open-market commercial
paper because it bears the name of a member bank.

AND THE MONEY MARKET

193

It is a little less good than most bankers' accept
ances, for it bears the name of only one bank, and
bankers’ acceptances in the market frequently bear
two bank names, both of them well known. A rate
between the commercial-paper rate and the accept
ance rate is thus logical and natural. This rate re
lationship, arrived at largely by experiment, thus
appears to have a sound economic basis, and it repre
sents not simply the adjustment of the discount rate
to other money rates but also the adjustment of
other rates to the discount rate.
It is also interesting to observe that in the whole
scale of money rates in New York and London the
discount rate here occupies a position not greatly
different from the Bank of England discount rate.
Suppose we take a time when the discount rates in
both centers were the same, in May, 1924, and list
the different rates which are typical in the two mar
kets:
Table 12.—Money Rates

London

and

New York

London New York

Bank loans direct to customers. . . .
Ninety-day time money on stock ex
change.........................................
Open-market commercial paper....
Discount rate of bank of issue........
Three months’ bankers’ bills...........
Short Treasury obligations..............
(a) ■ Approximate.

4^-5^
3^-4
4^
4
3^
3

194

THE RESERVE BANKS

In studying this comparison of rates it should be
remembered that the commercial banks in London
do not ordinarily borrow directly from the Bank of
England, but replenish their reserves by letting their
bills run off, or calling loans to bill brokers, who in
turn can, if necessary, sell bills to the Bank of Eng
land at the discount rate. Banks in this country
can, and do, follow the same general course, but the
more frequent procedure is to borrow directly from
the Reserve Bank at the discount rate, using com
mercial paper or government securities as collateral.
The discount rate applies to different paper in the
two markets, but the cost of obtaining reserve funds
is relatively not far different.
It, of course, remains to be seen whether the rate
relationship which has maintained generally in the
past six years will be a permanent one. The effec
tiveness of the discount rate is now due in part at
least to the tradition against continuous borrowing.
If this tradition should ever lose its power a higher
rate, more in the nature of a penalty rate, might
become necessary at times to prevent excessive bor
rowing. But at present the rate does appear to be
generally effective.
While the movement of money rates offers the
Reserve Bank directors and the Federal Reserve
Board perhaps their best current guide in determin
ing discount rates, there are many other factors
which have to be considered. The judgment as to
whether the discount rate should be maintained high
or low relative to other money rates, and hence
whether reserve money should be relatively easy or
difficult to obtain, depends on other factors, all of

AND THE MONEY MARKET

195

them indicators as to whether business is getting the
credit it needs, or too little, or too much.
Volume of Credit.—Considerable guidance as to
whether the discount rate should be lowered to make
reserve funds easier to obtain or raised to make them
harder to obtain, is secured by watching the changes
in the volume of credit. For the past fifty years the
total amount of bank loans and investments in this
country has increased at the rate of 6 to 7 per cent
a year in order to provide the funds required by
the increasing population, the increasing volume of
the nation’s business, the increasing use of credit
in business transactions, and the rising standard of
living. There have been, of course, large variations
from one year to another in the rate of increase of
credit, and such variations are to be expected, as
trade fluctuates and as methods of financing busi
ness change from time to time. The rate of growth
in the past 50 years, during part of which prices were
rising, may have been higher than is desirable in the
future. But in general, departures from a steady
rate of growth call for scrutiny and may give guid
ance in deciding policy.
In order to study currently the changes in the
volume of credit in use the Federal Reserve Board
at the end of 1917 set up a reporting system, under
which several hundred (June, 1927, about 670)
member banks in principal cities report each week
through the twelve Reserve Banks their principal
items of condition. These weekly figures reflect
pretty accurately the banking trends throughout the
country and give an early indication of any ab
normal changes in the volume of credit.

196

THE RESERVE BANKS

Similarly, the condition of the Federal Reserve
Banks themselves reveals immediately the current
changes in the use of credit. Any abnormal expan
sion of credit usually leads immediately to addi
tional demands upon the Reserve Banks for loans.
These changes in the volume of credit are watched
closely by those charged with the decisions as to
discount rates.
How Credit is Being Used.—The next step to
watching the changes in the volume of credit is the
analysis of how credit is being employed as a basis
for judging whether further increases are to be en
couraged. The reports which the Reserve Banks
receive from member banks and transmit to the Fed
eral Reserve Board are itemized to give an analysis
of changes in loans and investments to show whether
increases are in loans on securities, or in other loans
which are largely commercial in nature, or in invest
ments. In January, 1926, a series of special reports
by the New York City banks was inaugurated giv
ing their loans to brokers and dealers secured by
stocks and bonds.
From many other sources the Reserve Banks draw
information as to how credit is being used. They re
ceive from the Comptroller of the Currency, who is
responsible for examining national banks, and from
the state banking authorities, copies of the exami
nations of all member banks, analyzing the loans
and investments of those banks. The Reserve Banks
have their own examiners who work with the na
tional and state authorities and keep constantly
informed as to the character of loans the member
banks are making.

AND THE MONEY MARKET

197

Condition of Business.—Perhaps even more is
learned from a continuous study of business condi
tions. When business is booming and employment is
full, there is usually no need to make credit easier
to obtain, but, on the contrary, that is frequently a
time of danger when the proper policy should be
one of caution and the price of credit should be
relatively high. When, on the other hand, business

or growth or past years. (Index of 56 individual series combined
and shown as percentages of the computed trend of past years.)

is in the doldrums and employment is slack, the
price of credit may well be relatively cheap, aided
by relatively low discount rates. A rate policy
which, other things being equal, threw its influence
towards firm money conditions when business was
very active and towards easy money when business
was in depression, might be expected to offer effec
tive aid towards reducing the fluctuations of the
business cycle. Thus a continuous study of the con-

198

THE RESERVE BANKS

dition of general business in relation to the trends
of normal growth indicated by the experience of past
years becomes an important aid in determining rate
policy.
Prices.—Another useful external measure of the
relation between credit and business is found in the

DIAGRAM 33—WHOLESALE COMMODITY PRICES IN THE UNITED STATES.
(1913-100 PER CENT.)

movement of prices. When more credit is available
than business can use profitably, credit tends to find
its way into increases in prices; it may be prices of
commodities, or wages, or securities, or real estate.
Similarly, a scarcity of credit may lead to declining
prices of one kind or another. Price changes are
useful as danger signals. They are subject, how
ever, to so many other influences besides domestic

AND THE MONEY MARKET

J 99

credit conditions, that they cannot be wholly
trusted as guides to policy. They are affected very
largely, for example, by international conditions.
Frequently, moreover, the evidence of price changes
is mutually contradictory—one kind of price often
goes up while another is going down. In 1925 and
1926, for example, wholesale commodity prices de
clined slightly while security prices rose.
International Conditions.—At many points
business and finance in the United States are influ
enced by conditions abroad, and this influence can
not be neglected in Federal Reserve rate policy. The
condition of affairs in 1924 illustrates this principle.
Gold was pouring into the United States from for
eign countries at the rate of about $300,000,000 a
year, largely because the countries of Europe had
not yet been able to restore the gold standard. This
gold flow carried a threat of serious inflation if it
continued unabated. Money rates were higher here
than in London. European crops had been poor,
but power to purchase our crops was limited. Prices
of farm products were declining. Domestic business
was depressed. It was altogether a situation which
easy money conditions were likely to benefit. Easy
money would diminish the attraction for gold here.
It would stimulate a flow of American capital
abroad, which would aid Europe in her struggle
back to the gold standard. It would enable Europe
to purchase American farm products more freely,
with consequently better prices for these products.
These are just a few of the outstanding features.
There were other considerations, but these are suf
ficient to suggest that at times the international

200

THE RESERVE BANKS

situation becomes one of the important features of
discussions of Federal Reserve policy.
A Complex Problem.,—'The preceding paragraphs
suggest a number of the factors which the board of
directors of a Reserve Bank and the Federal Re
serve Board consider when they make a decision
with regard to the discount rate. There are certain
mechanical aids to judgment in the movement of
money rates, changes in the volume of credit, the
way credit is being employed, changes in the vol
ume of trade and prices, and the direction of gold
movement. Seldom do all of these guides to policy
point in the same direction and the importance of
the different factors varies from time to time. In
the last analysis, the question of a prospective rate
change becomes a question of judgment as to
whether slightly easier or slightly firmer money will
have a beneficial influence on the whole business
and credit situation. This judgment, moreover,
must project itself into the future and consider the
long time as well as the immediate effect of pros
pective changes.
In its nature a change in the discount rate, and
in fact Federal Reserve policy generally, is more
like a shotgun than a rifle. Policy can never be de
signed to deal with only one phase of a credit sit
uation; its influence is upon the total volume of
credit. For example, in the autumn of 1925 com
modity prices were declining but stock prices were
booming upward and the stock market was using
constantly increasing amounts of bank credit. Busi
ness also was very active. A rate policy designed
to make money easier in view of declines in prices

AND THE MONEY MARKET

201

would probably have encouraged a wild speculation.
Any discussion of rate policy which centers its at
tention on only one feature of the situation is futile.
Rate changes cannot be aimed at any single target,
but affect the whole volume of bank credit.
Effects of Rate Changes.-—There is as yet
available too limited experience to allow the drawing
of any comprehensive conclusions as to the effects of
changes in discount rates. One of the laws of scien
tific measurement is that the phenomenon to be
measured must be isolated; another law is that valid
conclusions can only be drawn from many cases.
Discount rate action can never be isolated; it oc
curs simultaneously with many other causes. The
same considerations which lead the Reserve Banks
to raise their discount rates lead business men to
exercise caution, and business prophets to issue
warnings. There must be available many more cases
of rate changes before final conclusions can be drawn
as to their influence.
Certain tentative and limited conclusions do ap
pear reasonable. First, it is evident that discount
rate changes ordinarily have an immediate influence
on short-term money rates. A study of Diagram 34
indicates that rate changes have usually followed
some movement in open-market rates, but have in
turn been followed by further changes of perhaps
% of 1 per cent in rates for commercial paper and
bankers’ acceptances. The extent to which discount
rate changes have influenced other money rates has
depended somewhat on the relative position of rates
before the change.
There does not usually appear to be any direct

202

THE RESERVE BANKS

connection between the rate and the total amount
of member-bank borrowing from the Reserve Banks.
A decrease in rate does not immediately check a de
cline in borrowing, nor does an increase in rate usu
ally check a rise in borrowing. Diagram 34 shows
these figures for the New York Reserve Bank.

DIAGRAM 34—MONET RATES AT NEW YORK AND DISCOUNTS AND
UNITED STATES SECURITIES HELD BY THE FEDERAL RESERVE
BANK OF NEW YORK.

Other possible causal relationships which will
warrant careful exploration as more instances are
available, include any connection between rate
changes and security prices, rate changes and gold
exports and imports, and rate changes and com
modity prices. The evidence now available would
appear to indicate that these relationships have
been much closer at some times than at others.

AND THE MONEY MARKET

203

But clearly any generalization on these points would
be premature.
. '
.
. ■
■
■
Perhaps the most important influence of the rate
is one concerning which a satisfactory conclusion
can never be drawn, and concerning which men will
always hold widely differing opinions—the psycho
logical influence. As a public pronouncement by
well-informed men concerning the state of the credit
situation, a discount rate change may have a large
influence. How much and in what direction will
always be in doubt.
So for the present at least every change in dis
count rate must be considered as in some measure an
experiment in the technique of central banking.
The guaranties against serious error are the trust
worthiness and intelligence of those making the de
cision, the breadth of information available to them,
and their maintenance of an open-minded attitude.
■

•

SUMMARY

1. Broadly speaking, the aim of Federal Reserve
credit policy is to bring about an adaptation
of the volume of credit to the volume of
business.
■
2. The Reserve Banks cannot influence directly
■ the ways nr which credit is employed, but can
influence only the total volume of credit. They
deal with credit quantitatively and not qualita
tively.
3. There are five principal restraints against the
excessive use of Federal Reserve credit.
A. Tradition against borrowing.

204

THE RESERVE BANKS

B. Discount rate.
C. Open-market operations.
D. Direct dealing with member banks.
E. Publicity.
Member banks are unwilling to remain in debt
to a Reserve Bank for long periods. This tradi
tion against continued borrowing is a powerful
restraint against excessive borrowing.
A change in discount rate is important as a pub
lic recognition by a group of responsible and
well-informed people of a change in the credit
situation.
In deciding discount policy two European prec
edents have been of little value: the reserve
ratio of the Reserve System has been so high
that it had to be ignored; and the rule of thumb
that the discount rate should be “above the
market” has not proved applicable because of a
totally different money-market structure, and
different method of access to the bank of issue.
The discount rate should be a fair price for Fed
eral Reserve funds. Some guidance as to the
going price for money is furnished by the move
ment of money rates in the open market In
practice the discount rate has usually been be
tween the open-market rates for ninety-day
bankers’ acceptances and 4 to 6 months’ com
mercial paper.
Other factors to be considered in determining
rate policy include:
A. Changes in the total volume of credit in
relation to the usual rate of growth which
goes forward from year to year.

AND THE MONEY MARKET

205

B. The ways in which credit is being used.
C. The condition of business.
D. The movement of all kinds of prices, in
cluding wholesale and retail commodity
prices, security prices, rents, wages, etc.
E. International conditions, including their in
fluence upon the movement of gold.
9. Thus a wide range of complex considerations
enters into discount rate decisions. In the last
analysis reliance must be placed on judgment
rather than formulas.
10. Changes in discount rates have an influence on
open-market money rates, but the psychological
effect is probably equally important. Experience
in this country with rate changes is too limited
to justify final conclusions as to results.

CHAPTER XII
Credit Policy—Open-Market Operations

HE term “open-market operations” is used in
two different senses. In a broad sense it is
used to signify all those transactions in which the
Reserve Banks employ their funds besides their
loans to member banks. In this sense open-market
operations include the purchase and sale of bankers’
acceptances, of government securities, and of other
limited types of securities eligible for purchase, as
prescribed in Section 14 of the Federal Reserve Act.
In a narrower sense the term is used to signify only
those transactions in which the Reserve Banks or
dinarily exercise the initiative, that is the purchase
and sale of government securities.
Since this is a chapter on Federal Reserve credit
policy, it will be devoted largely to a discussion of
the narrower field of open-market operations, the
purchase and sale of United States Government obli
gations, because it is mainly in these transactions
that policy finds positive expression. But before
concentrating upon this one type of open-market
operation it may be well to pause a moment to
remind ourselves of the scope of the open-market
operations of the System in their broader aspects.
Broad Powers in Open Market.—The Federal Re
serve Act gives the Reserve Banks broad powers to
deal in the open market, that is to deal in specified
206

AND THE MONEY MARKET

207

matters with individuals and concerns other than
the member banks. These powers are defined in
Section 14 of the Federal Reserve Act. Aside from
the power to deal in gold, which is essential to any
bank of issue, the powers include the right to buy
or sell the following securities:
Cable transfers, bankers’ acceptances, and bills of ex
change arising out of commercial transactions and of
specified maturities.
Bonds and notes of the United States.
Bills, notes, revenue bonds, and warrants of states,
cities, or other political subdivisions in the United States
(maturity not over six months from date of purchase).
Acceptances or debentures of Federal Intermediate
Credit Banks and National Agricultural Credit Corpora
tions.
Farm-loan bonds.

There are certain notable omissions from the list:
the Reserve Banks have no power to buy corpora
tion stocks, bonds, or notes, nor the obligations of
foreign governments nor long-term obligations of
states or municipalities.
While the list of securities which the Reserve
Banks can buy is a fairly long one, and while some
purchases have been made of practically each one
of the items listed, open-market purchases are in
practice confined principally to bankers’ acceptances
and United States Government obligations. Other
purchases have been small and infrequent.
Policy in Buying Bills—The general plan under
which the Reserve Banks buy bankers’ acceptances,
or bills, has been discussed at some length in previ
ous chapters. Generally the Reserve Banks stand

208

THE RESERVE BANKS

ready to purchase bills which are offered to them,
at rates which are fixed from time to time in accord
ance with market conditions. These rates are usu
ally close to the rates at which the bills sell in the
open market. The purchase of bills is in one im
portant respect similar to discounting paper for
member banks, in that the usual control the Reserve
Banks exercise over the volume of bills purchased
is a rate control, a control of the price. But the
fixing of the price for buying bills is much less a
matter of policy than the fixing of the discount rate
for loans. The buying rate for bills follows very
closely the open-market rates for bills and does not
ordinarily reflect judgment as to the general credit
situation.
Dealings in Government Securities..—It is in
transactions in United States Government securities
that Federal Reserve policy finds more direct ex
pression. For purchases and sales of these securities
are usually made on the initiative of the Reserve
Banks themselves.
There are, it is true, certain transactions, even in
government securities, in which the Reserve System
is passive except for rate control. These transac
tions have already been referred to in Chapter VI;
they are the purchase of government securities
under sales contract. In order to support the mar
ket for short-term government obligations, the Re
serve Banks stand ready to buy these obligations
from dealers under an agreement by which the
dealer contracts to repurchase the securities within
a period of fifteen days. Operations of this charac
ter, however, only occur at intervals and the amounts

AND THE MONEY MARKET

209

involved are relatively small, seldom larger than 15
or 20 million dollars. To the extent that they do
take place, they result in putting additional amounts
of Federal Reserve credit into the market at times
when money is in active demand and thus relieving
strain.
But the transaction in which Federal Reserve
open-market policy finds its most important expres
sion is the outright purchase or sale of United
States Government obligations. These purchases
or sales of securities are at times as effective an in
strument for influencing the credit situation as the
discount rate, or any other instrument of policy
which the Reserve Banks possess. They are, more
over, a method for preparing for discount rate
changes and making them more effective, as will
appear upon examination.
Immediate Effect.—Without careful analysis it
might be supposed that the effect on the credit
situation of a purchase of government securities by
the Reserve Banks would be an immediate increase
in the total volume of credit. The Reserve Bank
purchasing the securities pays for them with Fed
eral Reserve funds. The seller of the securities
deposits these funds in his own bank, and that bank
in turn deposits the funds in the Federal Reserve
Bank and thus finds itself in the possession of addi
tional reserves which might conceivably form the
basis for making additional loans or investments.
Since these are reserve funds they might form the
basis for an increase in the volume of bank credit
considerably greater than their dollar amount. One
might expect, therefore, that purchases of govern-

210

THE RESERVE BANKS

ment securities by the Reserve Banks would result,
first, in an increase in the total loans and invest
ments, or total earning assets, of the Reserve Banks;
and, second, in an increase of several times that
amount in the total volume of bank credit in use.
As a matter of practice this seldom takes place.
It was noted in the preceding chapter that when
ever the member banks are in debt at the Reserve
Banks they try to pay off that indebtedness. Under
these conditions, when a member bank receives a
Federal Reserve check put into the market through
the purchase of government obligations, that bank
will use the check to liquidate any borrowings from
the Federal Reserve Bank rather than use it for a
further extension of credit. In case the member
bank receiving the check is not in debt at the Re
serve Bank and therefore employs the funds by
purchasing additional investments or making addi
tional loans, the extra amount of credit thus put
into the market usually finds its way promptly to
some bank which is in debt at the Reserve Bank.
Thus the usual effect of a purchase of government
securities by the Reserve Banks is a corresponding
reduction in the borrowing of member banks.
The effect is not limited, however, to member
bank borrowing, but purchases of securities may re
sult in a reduction of the amount of credit dealers
in bills or securities are receiving from the Reserve
Bank under sales contract agreement; or they may
result in a reduction in the amounts of bills which
are sold to the Reserve Banks. But since the bor
rowing of member banks is ordinarily the largest
element in the total credit extensions of the Reserve

AND THE MONEY MARKET

211

Banks, it usually feels most directly the results
of security purchases.
Thus the usual effect of purchases of securities
by the Reserve Banks is not an increase in their
total loans and investments, but rather a reduction
in loans which about offsets the purchase of secur
ities and leaves the total little changed. Further
more, there is little immediate increase in the vol
ume of member-bank credit. This rule does not
hold when the banks in the principal money centers
owe the Reserve Banks little or nothing. This state
of affairs has been rare, but was present in 1922 and
1924 for several months.
Conversely, when a Reserve Bank sells govern
ment securities it receives in payment a check
drawn on some member bank. This check is charge
able against the reserve deposit of the member bank
at the Reserve Bank, and the member bank, unless
there is some offsetting credit, finds itself deficient
in its reserves. In order to correct this reserve
deficiency the member bank either borrows from the
Reserve Bank or sells it bills, or else throws the
burden on some other bank by selling investments
or calling loans to brokers in the open market.
The net result is usually an increase in member
bank borrowings or in some other form of Reserve
Bank credit.
This general tendency for the purchases or sales
of government securities to be almost directly offset
by changes in other forms of Reserve Bank credit
in employment is illustrated in Diagram 35. In a
sense one may speak of total holdings of govern-

212

THE RESERVE BANKS

ment securities as assets which have been voluntar
ily acquired by the Federal Reserve Banks, whereas
loans to member banks, bill holdings, and holdings
of bills and government securities under sales con
tract, have been acquired in a sense involuntarily,

because the initiative in each case has been taken
by the bank requesting the loan or the bank or
dealer offering the securities. It will be observed
that increases or decreases in holdings of govern
ment securities purchased outright (voluntary) have
been accompanied by almost corresponding changes
in bills discounted, bankers’ acceptances held, and

AND THE MONEY MARKET

213

holdings of bills and securities under sales contract
(involuntary).
Not an Aid to Earnings.—There are a number of
interesting implications which follow from the rela
tionships just described. Some years ago, before
there had been any considerable experience in the
operations of the Reserve System, it was believed
that the purchase of government securities by the
Reserve Banks was a means of increasing their
earning assets and thus supplementing their earn
ings. In fact, it is probable that the management
of some of the Reserve Banks held this view early
in 1922, when large increases in holdings of govern
ment securities were made. But it soon developed
in experience that such purchases did not ordinarily
result in increasing the total earning assets of the
System, but simply changed one kind of earning
asset for another kind. Increases in government
securities were offset by decreases in bills discounted
and bankers’ acceptances. Furthermore, the yield
from the government securities was usually less than
the yield from loans to member banks, and thus the
purchase of government securities diminished in
stead of increased the earnings of the Reserve Banks.
Thus, while in the early days the Reserve Banks had
sometimes purchased government securities for the
purpose of supplementing their earnings, this has
not been the reason for such purchases in recent
years. The only times at which the purchase of
government securities would result in an increase in
the earning assets of the System and in increased
earnings would be times when the member banks,
and particularly the member banks in money cen-

214

THE RESERVE BANKS

ters, were substantially out of debt at the Reserve
Banks.
How Policy Is Served.—What are, then, the
effects of purchases and sales of securities from the
point of view of Federal Reserve policy? What may
the Reserve Banks hope to accomplish by these
open-market operations? It might seem from the
foregoing paragraphs that, since the purchase or sale
of securities does not ordinarily affect the amount
of Federal Reserve credit in use, that therefore such
purchases and sales would not have any effect on
the credit situation. But this conclusion is not
warranted.
The influence of these operations lies in their
i effect upon the amount of indebtedness of member
banks to the Reserve Banks. By increasing their
holdings of government securities the Reserve Banks
lighten the indebtedness of the member banks, and
by selling securities they increase this indebtedness.
The significance of this operation arises from the
unwillingness of the member banks to remain con
tinuously in debt at the Reserve Banks. Their
lending and investing policy is very closely related
indeed to the amount of their indebtedness at the
Reserve Banks. This relationship was illustrated
by Diagram 30 in Chapter XI, which shows that in
terest rates have fluctuated in close relationship with
the amount of member-bank borrowings at the Re
serve Banks.
.
The result of open-market operations may be
summarized by saying that purchases of securities by
Reserve Banks tend to relieve member banks from
indebtedness to the Reserve Banks, and thus lead

AND THE MONEY MARKET

215

them to adopt a somewhat more liberal lending
policy. Money rates become easier. Such pur
chases tend to create a borrower’s market. Con
versely, sales of securities by the Reserve Banks in
crease member-bank borrowing and lead the banks
to adopt a somewhat less liberal lending policy.
Money rates grow firmer. Sales of securities tend to
create a lender’s market.
It can thus be seen that buying and selling secur
ities is not only an important independent influ
ence on the credit situation, but may and often has
been used as a means of preparing for discount rate
changes and making them more effective. For open
market operations serve to increase or decrease the
amount of borrowing subject to the discount rate.
If the member banks are not borrowing, any change
of discount rate is ineffective, except for its psycho
logical influence. On the other hand if the member
banks are borrowing heavily even a small change of
discount rate is effective. Thus the effectiveness of
discount rate changes depends not a little upon the
amount member banks are borrowing.
Organization for Open-Market Operations.,—Prior
to 1922 there was no thoroughgoing attempt to co
ordinate the open-market operations of the twelve
Federal Reserve Banks. Each Reserve Bank pur
chased and sold bankers’ acceptances and govern
ment securities in accordance with the decision of
its own directors, and executed these orders through
whatever channels it chose. One consequence of this
procedure was that there was constant danger that
the Reserve Banks would be competing with one
another in the open market, and by creating, more-

216

THE RESERVE BANKS

over, an artificial market for government securities,
complicate the Treasury’s program of financing.
Because of this danger the governors of the Reserve
Banks in the spring of 1922, at their annual spring
meeting, appointed a committee consisting of the
governors of the Federal Reserve Banks of Boston,
New York, Philadelphia, and Chicago (the governor
of the Cleveland bank was added later), whose duty
it would be to execute purchases and sales of gov
ernment securities at the request of the different
Federal Reserve Banks. It was understood that all
transactions not purely local in character should be
executed through this committee. The organisa
tion of this committee was an important forward
step in that it did away with competition between
the Reserve Banks in the central money market.
Concerning the relation of the work of this com
mittee to the several Reserve Banks the following
statement was made by Governor Strong of the
New York bank before the House Committee on
Banking and Currency in April, 1926:
It is important to know, however, that the supervision
of these purchases and sales by the committee was not
intended and never has been intended to extend into any
interference with the local autonomy of any Reserve
Bank, or its relations with its member banks, or its deal
ing in government securities with its member banks. It
simply had to do, in the first instance, with the execution
of orders in an orderly way in the open market.1

This method of handling System purchases and
sales of securities was reviewed by the Federal Ad1 Stabilization Hearings before the Committee on Banking and
Currency, House of Representatives—H. R. 7895, Sixty-ninth
Congress, first session, p. 310.

AND THE MONEY MARKET

217

visory Council in September, 1922, and approved.
In October of that year, by agreement among the
governors of the Federal Reserve Banks, the duties
of the committee were extended into the field of
policy when the committee was asked to make rec
ommendations from time to time to the Reserve
Banks with regard to their purchases and sales of
government securities.
The next important step was taken in the spring
of 1923, when the Federal Reserve Board reorgan
ized the committee procedure by itself appointing
an open-market investment committee, which con
sisted of the same members as the old committee
which had been appointed by the governors them
selves. In its new form the committee carried the
additional authority of appointment by the Federal
Reserve Board.
The principles to be followed by this committee
and the terms of its appointment were set forth by
the Federal Reserve Board as follows:
“That the time, manner, character, and volume of
open-market investments purchased by Federal Reserve
Banks be governed with primary regard to the accommo
dation of commerce and business, and to the effect of
such purchases or sales on the general credit situation.
That in making the selection of open-market pur
chases, careful regard be always given to the bearing of
purchases of United States Government securities, es
pecially the short-dated issues, upon the market for such
securities, and that open market purchases be primarily
commercial investments, except that Treasury certificates
be dealt in, as at present, under so-called ‘repurchase*
agreement.
In order to provide for the proper administration of

218

THE RESERVE BANKS

the policy defined above, the Board rules that on and
after April 1, 1923, the present committee of governors
bn centralized execution of purchases and sales of gov
ernment securities be discontinued, and be superseded
by a new committee known as the open-market invest
ment committee for the Federal Reserve System, said
committee to consist of five representatives from the
Federal Reserve Banks and to be under the general super
vision of the Federal Reserve Board; and that it be the
duty of this committee to devise and recommend plans
for the purchase, sale, and distribution of the open-mar
ket purchases of the Federal Reserve Banks in accord
ance with the above principles and such regulations as
may from time to time be laid down by the Federal Re
serve Board.”1

In the autumn of 1923 a still further step in co
ordinating System open-market policy was taken,
when arrangements were made, with the approval
of the Federal Reserve Board and the boards of
directors of all twelve Federal Reserve Banks, for
the creation of a System open-market investment
account and to be increased or decreased by the com
mittee, with the approval of the Federal Reserve
Board and the directors of the Federal Reserve
Banks. The holdings in the special investment ac
count were to be prorated among the several Re
serve Banks with due regard to the size of the dif
ferent banks, their holdings of' other earning assets,
etc.
It was the understanding that this special invest
ment account should be used as an instrument for
carrying out Federal Reserve policy. It offered a
‘Stabilization Hearings before the Committee on Banking and
Currency, House of Representatives—H. R. 7895, Sixty-ninth
Congress, first session, p. 311.

AND THE MONEY MARKET

219

more effective means towards this end than any
operation which involved dealing with securities
held by the twelve different banks in their own
vaults. Changes in the holdings of government
securities by the Reserve Banks since 1923 have
reflected largely the changes in this special invest
ment account, whereas changes before that time
represented largely the individual action of the
twelve Federal Reserve Banks operating inde
pendently.
The machinery for handling open-market opera
tions has changed little since 1923 beyond the
changes in smoothness of operation which ordi
narily accompany experience with such an organiza
tion. The responsibility of the committee for super
vising the purchase and distribution of bankers’ ac
ceptances, as well as government securities, is now
more clearly recognized than it was at the begin
ning, and the methods of dealing with specific money
market situations have been more fully worked out.
Since the principal money market of the country
is in New York City, the Federal Reserve Bank of
New York has executed the majority of the orders
of the committee and the governor of the New York
Bank has served as the chairman of the committee.
. In addition to its supervision over domestic
operations the open-market investment committee
has supervised arrangements made by the Reserve
Banks with foreign banks of issue and the earnings
from such transactions have been divided among the
Federal Reserve Banks which have wished to par
ticipate. The central task of the committee, how
ever, has been to make recommendations to the

220

THE RESERVE BANKS

Federal Reserve Board and to the boards of direc
tors of the several Federal Reserve Banks concern
ing open-market policy, and to execute the policies
agreed upon.
Effects of Buying and Selling Securities.^The
major operations undertaken by the Federal Re
serve System in the purchase or sale of government
securities have been as follows:
January,
June,
December,
November,
April,
August,

1922—May,
1922—July,
1923—Sept.,
1924—March,
1926
1926—Sept.,

purchase of
sale of
purchase of
sale of
purchase of
1926, sale of
1922,
1923,
1924,
1925,

$400,000,000
525,000,000
510,000,000
260,000,000
65,000,000
75,000,000

The purchases in 1922, occurred at a time when
business was just recovering from the depression of
1921 and when agricultural prices were seriously de
pressed. These purchases, together with gold im
ports, had the effect of enabling member banks to
diminish their indebtedness at the Reserve Banks
from over 1 billion dollars to 400 millions, and thus
put the banks of the country in a position to ad
vance funds more freely to their customers, and
aided in the recovery of business and agriculture
from the conditions of 1921. Since part of the
purchases occurred when member banks in prin
cipal centers were largely out of debt to the Reserve
Banks and purchases were accompanied by gold im
ports, there was following the purchases an increase
in the total amount of bank credit in use. The
purchases were followed by reductions in the dis
count rates of several of the Reserve Banks.
The sale of securities from June, 1922, to July,

AND THE MONEY MARKET

221

1923, took place at a time when business recovery
had progressed to a point where excesses were be
ginning to appear, prices were rising rapidly, a labor
shortage was beginning to be apparent, and there
was some evidence of overproduction. The sale of
securities resulted in an increase in the direct bor
rowing by member banks and thus put more largely
upon the member banks the responsibility for the
amount of credit in use, and at the same time the
cost of borrowing was increased by increases in the
discount rates of the New York, Boston, and San
Francisco Reserve Banks. The sales, together with
rate changes, probably aided in giving stability to
the situation and preventing a period of over
expansion.
The purchases between December, 1923, and Sep
tember, 1924, which were the first ones to be handled
as a part of the joint investment account, were
made at a time of some business recession and price
decline. They were made at a time also when cer
tain of the European countries were beginning to
consider the return to a gold standard. This at
tempt would be considerably furthered by moder
ately easy money conditions in the United States,
which would make credits more easily available for
those countries. The purchases during 1924 had
the effect of diminishing the amount of indebted
ness of member banks at the Reserve Banks, and
particularly the ‘indebtedness of member banks in
principal cities. • Simultaneously, a number of the
Reserve Banks lowered their discount rates. This
made it possible for the member banks to extend
credit more freely and money conditions were con-

222

THE RESERVE BANKS

sequently easy. As in 1922, there was a consider
able increase in the total volume of credit.
The sale of securities between November, 1924,
and March, 1925, was made at a time when business
was at a high level, speculation was active, and
prices were rising. It had the effect of increasing
somewhat the responsibility of the member banks
for the current amount of bank credit in use, and
led the way to an increase of the discount rate by
the New York Reserve Bank.
The purchase and sale in 1926 were smaller in
amount but occurred under circumstances somewhat
similar to those described in the preceding
paragraphs.
It is, of course, impossible to give in a few para
graphs a complete analysis of the conditions which
surrounded the open-market operations which have
just been reviewed, but the general principles per
haps appear from the foregoing very brief state
ment. A further illustration of some of the broad
movements related to open-market operations is
shown in the accompanying diagram. One may sum
marize the relationships which the diagram illus
trates by saying that purchases of securities have
taken place in periods of business recession, price
weakness, and disturbed psychology, and that the
purchases have usually been accompanied and fol
lowed by a reduction in member-bank indebtedness
at the Reserve Banks, easier money, and on two
occasions by increases in the total volume of credit.
They have frequently been accompanied or followed
by reductions in discount rates. On the other hand,
sales of securities have taken place at times of great

M6LI0N5 c/DOLLAR

ATIONS AND SOME OF THE RELATED ECONOMIC MOVEMENTS.

224

THE RESERVE BANKS

business activity, rising prices, and speculative
tendencies. The sales have usually been followed
by increases in member-bank borrowings and in
creases in discount rates, and, in sequence, by
greater stability in the total volume of credit.
One is tempted to try to trace further the causal
relationship between open-market operations and
the condition of business, commodity prices, move
ment of the stock market, and so forth, but clearly
the experience in these matters has covered too brief
a time to make possible any safe generalization.
Open-market operations have been only one of a
large number of factors which have been present
during the period under review. It has been a
period during which the informed public has
scrutinized the business and credit situation care
fully and constantly and has tended itself to apply
the correctives to any unhealthy situation. It is
impossible as yet to reach definite conclusions as
to how far the movements which have taken place
are due to Federal Reserve operations and how far
to other causes.
Open-Market Operations and the Discount Rate.—
The two main instruments of credit policy—discount
rates and open-market operations—are not wholly
separate and unrelated. In practice they have been
used, as the foregoing paragraphs have suggested,
to supplement each other. Open-market operations
frequently pave the way for discount rate changes.
By buying securities the Reserve Banks enable mem
ber banks to liquidate some of their indebtedness
and to lend more freely, and the usual consequence
is easier money rates, which in turn make a reduc-

AND THE MONEY MARKET

225

tion in Federal Reserve discount rates logical. Con
versely, the sale of securities tends to increase the
indebtedness of member banks and to make money
rates firmer, and may pave the way for an increase
in discount rates. Open-market operations may also

MEMBER BANKS AND THE MARKET TO LIQUIDATE SOME OF THEIR
INDEBTEDNESS AND TO LEND MORE FREELY, AND THE USUAL CON
SEQUENCE IS EASIER MONEY RATES WHICH IN TURN MAKE A REDUC
TION IN FEDERAL RESERVE DISCOUNT RATES LOGICAL.

be undertaken following a change in discount rates
to make the discount rate more or less effective.
The foregoing diagram indicates the relationship be
tween discount-rate changes of the Federal Reserve
Bank of New York and System open-market
operations.

226

THE RESERVE BANKS

Other Operations.—In addition to the open
market operations as a matter of general credit
policy which have been discussed in the preceding
pages, purchases and sales of government securities
for the special investment account are used at times,
usually in small amounts and for brief periods, to
exercise a stabilizing influence in the money market.
One illustration of this type of operation is fur
nished by the transaction that is often carried
through at the quarterly tax periods. On the 15th
of March, June, September, and December, when
the Treasury redeems large amounts of certificates
and borrows from the Reserve Banks temporarily to
bridge the gap pending the receipt of proceeds from
income-tax checks, a large amount of Treasury
money is thrown into the market. When the banks
are heavily in debt they use these funds to repay
their indebtedness at the Reserve Banks, and the
market is not disturbed. But at times when the
member-bank indebtedness is small, the putting out
of 150 to 200 million dollars or more of Treasury
money sometimes results temporarily in very easy
money. In order to “mop up” some of this plethora
of funds in the market at these periods, the open
market investment committee has sometimes sold
securities from the special investment account under
an agreement to repurchase them within a few days.
The effect of this arrangement is to enable the
member banks to employ their surplus reserves and
thus prevent disturbance to the money market.
Another somewhat similar transaction has been
the occasional purchase of securities for the special
investment account over the last week of the year,

AND THE MONEY MARKET

227

when there is an unusually heavy demand for funds,
and the sale of these securities after the turn of the
year. The purchase of perhaps 50 millions of secur
ities in the last week of December has had the effect
of putting funds into the money market to meet the
extraordinary demands of that season, and to avoid
too great stringency; and the later sale of these
securities in January has had the effect of abating
somewhat the ease which usually characterizes that
period due to the return flow of currency from cir
culation and the transfer of funds from the interior
to the money centers.
Still another important type of operation has
been the purchase or sale of securities to neutralize
effects of gold movements on the money market.
A purchase of gold by the Reserve Banks has the
effect of putting money into the market, but any
influence on money conditions can be avoided if
sales of securities are made simultaneously to take
an equivalent amount of funds out of the market.
Similarly, gold sales can be offset by purchases of
securities. In this way sales and purchases of securiities in April, May, and June, 1927, neutralized the
influence of large purchases and sales of gold at that
time.
SUMMARY

1. While the Federal Reserve Act gives the Reserve
Banks broad powers to deal in the open market,
the majority of operations in practice is in bank
ers’ acceptances and government securities; and

228

THE RESERVE BANKS

open-market policy finds expression largely in
purchases and sales of government securities.
Purchases or sales of government securities by
the Reserve Banks do not ordinarily increase or
diminish the amount of Reserve Bank credit in
use, for they are usually offset by changes in
member-bank borrowing and acceptances owned.
Purchases of government securities do not ordi
narily increase the earnings of the Reserve Banks,
because purchases are offset by declines in other
earning assets.
The effectiveness of purchases and sales of gov
ernment securities as an instrument of policy
lies in their effect on the indebtedness of member
banks at the Reserve Banks. Purchases enable
member banks to pay off loans and thus tend to
make money easier; sales lead banks to borrow
more heavily and thus tend to make money
firmer. Government security transactions sup
plement and enforce discount policy.
Coordination of System open-market operations
is secured through a committee of governors of
five of the Reserve Banks.
Purchases of government securities have usually
been made in periods of business recession and
price weakness, and have usually been followed
by the credit conditions which may be described
as a borrower’s market.
Sales of government securities have usually been
made in periods of very active business, rising
prices, and heavy speculation, and have usually
been followed by the credit conditions which may
be described as a lender’s market.

AND THE MONEY MARKET

229

8. Experience is too limited to justify final conclu
sions as to the extent of the influence of pur
chases and sales of securities. They have been
simultaneous with many other influences on the
credit situation tending to operate in the same
direction.
9. Aside from operations as matters of general
credit policy, purchases and sales of securities
are made at times to stabilize the money market
against unusual temporary disturbing influences
such as • Treasury tax-day operations or gold
movements.

CHAPTER XIII
Other Instruments of Policy

N the chapters just preceding are discussed the
two outstanding methods by which Federal Re
serve policy finds expression—the discount rate and
open-market operations. It is the purpose of this
chapter to deal with two other policy instruments,
which are less commonly recognized, but are im
portant means for aiding in the adjustment of the
volume of credit to the volume of business. These
two instruments are the direct dealing with indi
vidual banks, and publicity.
Dealing With Individual Banks.—Discount rate
and open-market operations are impersonal and gen
eral in their operation, but the adjustment of credit
to trade is, in the last analysis, personal and indi
vidual. Just as the volume of bank credit is decided
when the banker and business man sit down together
and decide on a line of credit, so the amount of
Federal Reserve credit in use is at least in part de
termined when officers of the member bank and the
Reserve Bank sit down together. The proper use
of reserve funds is probably determined as largely
through individual negotiations between the Re
serve Banks and the member banks as by more ab
stract decisions as to discount rates and open-market
operations.
The principles governing the arrangements which

230

AND THE MONEY MARKET

231

the Reserve Banks make with individual member
banks as to their borrowing were set forth in the
annual report of the Federal Reserve Board for the
year 1926, as follows:
In general, the basis of credit to be extended by a Re
serve Bank to its member banks is defined in Section 4
of the Federal Reserve Act, which states that the board
of directors of a Reserve Bank shall “extend to each
member bank such discounts, advancements, and accom
modations as may be safely and reasonably made with
due regard for the claims and demands of other mem
ber banks.” This statement in the basic law of the Fed
eral Reserve System underlies to a large extent the policy
of the Reserve Banks and their attitude in individual
cases toward extending credit to the member banks. The
principle set forth in the Act goes beyond the question
of the technical eligibility and even of the intrinsic sound
ness of paper offered by a member bank to a Reserve
Bank. Even where the paper is unexceptionable in every
respect, the Reserve Bank must be fully assured in addi
tion that further credit may be granted to this member,
not only “safely and reasonably,” but also “with due
regard for the claims and demands of other member
banks.”
This question arises not infrequently in cases where
a member bank remains continuously in debt to a Re
serve Bank for a considerable length of time. In such
cases inquiry may fairly be made as to whether the mem
ber bank’s use of Reserve Bank credit does not in effect
amount to increasing its own capital out of Reserve Bank
funds. Such use of funds arising from a cooperative
pooling of bank reserves, which is the basis of the Fed
eral Reserve Banks’ lending power, would not be in ac
cordance with the spirit of the Federal Reserve Act and
would not be fair to the other member banks which may
be active competitors of the borrowing bank. It may

232

THE RESERVE BANKS

also impair the ability of the borrowing bank in case of
insolvency to meet its obligations to depositors.
Though there are circumstances that may explain and
justify continuous borrowing by a member bank over a
considerable period of time, particularly if the need for
the borrowing arises from general economic conditions in
the borrowing bank’s locality, the funds of the Federal
Reserve Banks are primarily intended to be used in meet
ing the seasonal and temporary requirements of members,
and continuous borrowing by a member bank as a general
practice would not be consistent with the intent of the
Federal Reserve Act. In most cases the member bank
can make adjustments of different kinds in its own
affairs, which will enable it to repay its borrowings at
the Reserve Bank and at the same time to strengthen its
own position. The bank may find it advisable, for ex
ample, to increase its own capital or to bring about a
better adjustment of the volume and maturities of its
investments to the credit requirements of its local cus
tomers.
In using their influence to discourage member banks
from making continuous use of the lending facilities of
the Reserve Banks, the operating officials of the Reserve
Banks are not only protecting the resources of the Fed
eral Reserve System as a whole, but are also helping in
dividual member banks to conserve their capacity to
borrow at the Reserve bank at times when adverse eco
nomic conditions in their localities and among their
customers may make additional dependence upon the
resources of the Reserve System not only justifiable but
necessary. In this manner the Reserve Banks are not
only discharging their responsibility to the member banks
under the Act, but are also exerting their influence to
ward sounder general banking conditions in the interests
alike of the member banks, their depositors, and the
public.1
1 Thirteenth Annual Report of the Federal Reserve Board
covering operations for the year 1826, pp. 4, 5.

AND THE MONEY MARKET

233

Methods Used.—With most of the member banks
no question ordinarily arises concerning the safety
or reasonableness of their borrowing from the Re
serve Banks. Out of over 9,000 member banks the
average number borrowing each month from the
Federal Reserve System is usually in the neighbor
hood of 3,000, and the banks which are borrowing
are constantly changing. The temporary character
of most of the loans is indicated by the fact that the
average maturity is about eight days. There is, of
course, a difference between the city and country
banks in this regard. The city banks, whose busi
ness naturally turns over much more rapidly than
the country banks, usually borrow for only one day
at a time, and if it is necessary to continue the loan
for more than one day they ordinarily make a new
loan. The banks in small communities, on the
other hand, whose business ordinarily turns over
more slowly, usually borrow for longer periods.
Banks borrow generally to meet seasonal and other
temporary needs for funds and pay off their loans
when the temporary needs are passed. Since the
unusual demand for funds falls on different banks
at different times, there are always some banks bor
rowing, although the number borrowing is usually
larger in the spring and summer when seasonal
needs are felt in the largest number of banks.
In dealing with most of the member banks it is
possible, with propriety, to give the banks ready
access to the borrowing facilities of the Federal Re
serve Banks without the necessity for special nego
tiation for each loan. Applications for loans and
discounts are received by mail or messenger and

234

THE RESERVE BANKS

Table 13.—Number of Member Banks Accommodated
Through Discount Operations, by Months1
Jan.
1914.
1915.
1916.
1917.
1918.
1919.
1920.
1921.
1922.
1923.
1924.
1925.
1926.

398
614
309
1,432
3,316
3,461
5,293
5,350
3.294
3,663
2,554
2,838

Feb.

Mar. Apr. May June July Aug. Sept. Oct.

469
570
451
535
262
315
1,353 ,1568
3,091 3,575
3,338 3,670
5,107 5,320
4,847 4,701
2,976 3,282
3,465 3,516
2,415 2,731
2.659 3,045

60
606
384
2,100
3,875
4,175
5,568
4,738
3,507
3,744
3,016
3,155

693
655
590
2,793
4,035
4,642
5,632
4,636
3,942
3,795
3,209
3,282

813
678
900
3,021
4,047
4,948
5,745
4,436
3,999
3,706
3,289
3,458

760
642
960
3,462
3,685
4,858
5,607
4,167
4,110
3,432
3,207
3,190

711
483
990
3,671
3,460
4,780
5,453
4,042
3,960
3,052
2,979
3,016

761
448
953
3,464
3,722
4,758
5,437
3,944
3,600
2,786
2,729
2,879

794
383
1,140
3,610
3,839
4,952
5,572
3,793
3,752
2,663
2,796
2,856

Nov. Dee.
132
835
336
1,574
3,667
3,649
5,275
5,622
3,859
3,732
2.573
2,876
2,871

339
754
314
1,701
3,288
3,659
5,551
5,676
3,873
3,698
2,783
3,021
3,024

acted upon immediately, in much the same way as
the commercial bank extends loans to a commercial
borrower after his line of credit has been established.
There are usually some banks, however, which tend
to overuse the borrowing privilege, and careful pro
vision has to be made to prevent its misuse. As an
example of the methods which are employed to
prevent too constant or too large use of the bor
rowing facilities of the Reserve System, the follow
ing methods are employed by the Federal Reserve
Bank of New York:
(1) Bank examinations by state and national au
thorities are analyzed in order that Reserve Bank
officers may be familiar with the condition and
methods of operation of each member bank.
(2) A special list of banks is maintained whose gen
eral condition is in one way or another unsatis
factory, and loans to this group of banks are scru
tinized with particular care.
(3) Every bank which is continuously in debt at the
1 Thirteenth Annual Report of the Federal Reserve Board
covering operations for the year 1926, p. 89.

AND THE MONEY MARKET

235

Reserve Bank for what seems an unreasonably
' long period in view of the nature of its business
is made the subject of special inquiry to deter■ mine the necessity for the borrowing.............
. (4) Every bank borrowing in excess of its capital and
surplus is automatically listed for observation.

Thus in every case where the borrowing threatens
to become unreasonable in amount or duration, or
unsafe, the bank is made the subject of special in
quiry and is reminded of the principles governing
the use of Federal Reserve credit. On rare occa
sions it has been necessary to prescribe for individual
banks lines of credit which they should not exceed,
and at times to insist upon liquidation of borrow
ings. In dealing with such cases it is never possible
to lay down rigid rules, but each case has to be con
sidered on its own merits.
The limited number of banks which have bor
rowed in large amounts for as long as a month is
shown by the following table, taken from the annual
report of the Federal Reserve Board for 1926. It
shows for quarterly dates the number of member
banks that had been borrowers continuously for a
month or more at a Reserve Bank in an amount
exceeding the borrower’s capital and surplus.
■
Particular significance attaches to borrowings in
excess of capital and surplus, because prior to the
establishment of the Federal Reserve System na
tional banks were not permitted by law, with cer
tain exceptions, to borrow in excess of their own
capital. Thus member banks that are borrowing in
excess of that amount have been enabled to do so
by provisions of the Federal Reserve Act, and the

236

THE RESERVE BANKS

System, therefore, has a special interest in observ
ing the extent to which this privilege is utilized.
Table 14.—Number of Member Banks Borrowing in
Excess of Capital and Surplus Continuously for a
Month .or More 1

Year

March

June

1923........
1924........
1925........
1926........

(a)
326
140
111

(a)
431
218
193

September December

543
364
202
198

357
179
133
113

(a) Not available.

In their relations with individual member banks
the Federal Reserve Banks encounter a series of
problems not unlike, in their variety and complexity,
the problems which the commercial bank encounters
in its contacts with its borrowing customers. Each
case is unique and requires individual treatment,
although there are certain broad principles which
apply to all.
Take as an example the perplexing problem of
lending to a bank in the farming area of the Middle
West in recent years. The First National Bank of
Crestland is loaded with doubtful farm paper, much
of it representing sometime equities in real estate.
They bring all their good paper to the Reserve Bank
to rediscount. Shall the Reserve Bank take it and
lend them the money? If the Reserve Bank refuses,
•Thirteenth Annual Report, of the Federal Reserve Board
covering operations for the year 1926, p. 5.

AND THE MONEY MARKET

237

failure may follow. If it makes the loan, it assumes
the responsibility of continuing in operation a bank
probably insolvent. If failure should then come the
depositors might find much of the good assets re
discounted at the Reserve Bank and unavailable to
pay depositors. The Reserve Bank must consider
not only the safety of its loan, but the interests of
the depositors. Can the bank be saved by a loan?
If not, will the depositors be better off under an im
mediate liquidation, or a later liquidation, when
the bank may have dissipated many of its best
assets? These are some of the questions the Re
serve Bank has to face. The answer depends on a
careful scrutiny of each bank, in constant coopera
tion with state and national supervisory authorities.
This is, of course, an extreme case, but all Federal
Reserve loans in greater or less degree involve credit
problems with many of the same earmarks as the
problems faced by commercial banks in their lend
ing operations, with this addition: that the Reserve
Banks have always to consider the public interest
and the impartial service of all member banks. In
ho phase of Federal Reserve operations has the
experience of the past few years proved of more
value. There is increasing understanding by the
member banks of the principles of the use of re
serve funds, and the Reserve Banks have been de
veloping more fully their standards of practice.
Publicity^—Still a fourth method of assuring an
intelligent and proper use of Federal Reserve funds
has been the publication by the Federal Reserve
System of a wide range of information, not only
concerning the Federal Reserve System itself but

238

THE RESERVE BANKS

concerning credit and business conditions. The
published statement by the Federal Reserve Board
of the condition of the Federal Reserve System is
one of the most complete and revealing statements
published by any bank of issue in the world, and
in addition the Federal Reserve Board publishes in
weekly form a report of the condition of member
banks in principal cities and reports of the volume
of bank transactions in principal centers throughout
the United States. Weekly reports of gold exports
and imports at New York and daily foreign exchange
rates at New York are released by the New York
Reserve Bank. Each Federal Reserve Bank pub
lishes a monthly review of credit and business con
ditions, and the Federal Reserve Board publishes a
monthly bulletin containing a comprehensive re
view of credit and business conditions. Copies of
these publications go not only to the member banks,
but to the general public as well.
This wide range of information available to the
banker and to the public forms a background in
view of which banker and business man may make
wise decisions as to their use of credit. The avail
ability of this information may well be as important
a factor making for financial stability as discount or
open-market policy.
SUMMARY

1. The amount of Federal Reserve credit in use is
determined in part by individual negotiations be
tween the Reserve Banks and their member banks.

AND THE MONEY MARKET

239

2. It is the accepted general principle that Federal
Reserve funds should be used in meeting seasonal
and temporary requirements of member banks
and not for capital uses.
3. This principle is followed by most of the member
banks as indicated by the rapid turnover of Fed
eral Reserve loans and the constant change in the
list of borrowing banks.
4. To guard against abuse of the borrowing privilege
and to safeguard the interests both of the Re
serve Bank and the bank depositor, the Reserve
Banks make a continuous study of the condition
of the member banks.
5. All Federal Reserve loans involve in greater or
less degree credit problems akin to the credit
problems of the commercial bank, with the addi
tion that the Reserve Banks must put the public
interest ahead of all other considerations.
6. The publication by the Reserve System of com
prehensive information covering its own opera
tions and credit and business conditions is a
further important aid towards financial stability.

CHAPTER XIV
The Gold Paradox

EDERAL Reserve credit policy has encountered
perhaps its most perplexing problem since the
war in the huge import movement of gold which
has increased the monetary gold stock of the United
States from $2,700,000,000 in June, 1920 to $4,600,
000,000 in March, 1927. The way in which the
Federal Reserve mechanism and Federal Reserve
policy reacted to this gold movement illustrates
certain of the virtues and limitations of the Reserve
System. The net result of it all was an economic
paradox, which has puzzled the economists of the
world.
Gold and Prices..—'The paradox was to be found
in the unusual relationship of gold and commodity
prices. Economic theory for many years has recog
nized a close relationship between the gold supply
and commodity prices. Increases in a country’s gold
supply have led to increases in the supply of money.
Increases in the supply of money have usually been
associated with increases in commodity prices. But
since the spring of 1921 the gold stock of this coun
try was increased by 50 per cent, while the index of
the general level of commodity prices showed almost
no net change. Theoretically a gold inflation seemed
inevitable. But no such result was reflected in the
commodity-price figures.

240

AND THE MONEY MARKET

241

Observing this curious phenomenon, many have
reached the conclusion, not unnaturally, that the
happy result may be traced wholly to the credit
policy of the Federal Reserve System. This belief
was expressed by Sir Josiah Stamp, the eminent
British economist, in an article in the London Ob
server of December 5,1924. In discussing a possible
price inflation in the United States, he said:
The memories of 1920-21 make the banking authori
ties exceedingly nervous. They accordingly have a
“credit policy” which by a complex process keeps prices
steady, partly by “sterilizing” the gold as it arrives, and
acting almost as though it does not exist.

It is safe to say that this explanation by Sir Josiah
Stamp has been the one most commonly accepted,
not only abroad, but in this country as well. It is
an explanation which warrants most careful scrut
iny. What has been the complex process by which
incoming gold has been sterilized and prices kept
steady?
Pre-war Gold Movements.—As a background for
an understanding of the economics of gold imports,
the facts as to the movement may first be con
sidered. Before the World War the stock of mone
tary gold in the United States was estimated at
$1,900,000,000. In pre-war years this stock had
been increasing on the average at the rate of about
60 million dollars a year, partly from domestic
production and partly from net imports from abroad.
At times the increase was more rapid than at others,
and at times, particularly during the '90s, there was
a net loss of gold.
These pre-war movements of gold were accom-

242

THE RESERVE BANKS

panied by related changes in bank deposits and in
prices. Over periods when gold came in slowly or
was drawn out, prices declined but when the im
ports were larger, as from 1896 to 1907, prices ad
vanced. A rather constant ratio of demand deposits
to gold was maintained: deposits were roughly four
or five times as large as the country’s gold stock.
The banking law of the country prescribed the
amount of reserves the banks should maintain, and
gold and gold certificates made up a large part of
these reserves. When gold imports arrived and were
deposited in the banks they increased bank reserves
and supported expansion of bank'loans and deposits.
Conversely, gold exports reduced bank reserves and
tended to retard the growth of bank loans and de
posits. Prices and bank deposits were closely re
lated, though deposits reflect the normal growth
of the country’s business and therefore show a
constant upward trend which is not true of prices.
To the extent that the increase in gold stock and
bank deposits was just sufficient to keep up with
the growth of population and trade, prices were
ordinarily not affected, but when gold stock and
bank deposits grew faster than trade, prices tended
to rise, and conversely, when their rate of growth
was less than the rate of growth of trade, prices
tended to decline.
The pre-war relation between gold stock, bank de
posits, and prices is shown in Diagram 38.
In interpreting diagram 38 it is necessary to add
one most important qualification to the foregoing
discussion. While the particular data shown in the
diagram are for the United States they are simply

AND THE MONEY MARKET

243

illustrative of a world relationship. The changes in
bank credit and prices in this country paralleled
similar changes in the countries of Europe. The
history of past years teaches that commodity price

DIAGRAM 38----BEFORE THE ESTABLISHMENT OF THE FEDERAL RESERVE
SYSTEM, BANK DEPOSITS RESTED DIRECTLY ON THE COUNTRY’S GOLD
STOCK AND BOTH BANK DEPOSITS AND PRICES FELT THE IMPACT OF
CHANGES IN THE GOLD STOCK.

movements are world phenomena and no single
country can depart from world trends except for
brief periods. In fact the only notable examples
of divergence from world tendencies by particular
countries have been those occasions when prices
have been measured in depreciated currencies. The

244

THE RESERVE BANKS

divergences are probably greater in other prices such
as wages, rents, and securities than those for com
modities at wholesale. Wholesale commodity prices
are largely determined in world markets whereas
these other sorts of prices are affected more com
pletely by domestic conditions.
War and Post-war Movements.—When the World
War broke out the world’s gold equilibrium was
upset. Europe urgently required food and muni
tions and paid in any way she could, by loans, by
selling securities, and by gold. The consequence
was a gold flow of quite unprecedented size to the
United States, which had food and munitions to
sell.
A comparison between the gold flood of recent
years and the modest pre-war shipments is made
in Diagram 39.
The flood that started in 1915 continued until this
country entered the war in April, 1917. Then the
allied nations borrowed, instead of paying with gold,
and gold exports were allowed only under special
license. There were neither imports nor exports of
gold in any quantity. In 1919, with the removal of
these restrictions, this country lost gold to the neu
tral countries from whom it had purchased raw ma
terials for war use. But towards the end of 1920 the
gold flood from Europe began again, and from that
time to the autumn of 1924 brought here over a
billion and a half dollars worth of gold. Since 1924
the flow has varied in direction and has more nearly
resembled the pre-war movement.
The first large gold import in 1915 and 1916, ac
companied as it was by urgent competitive demand

AND THE MONEY MARKET

245

for various war materials, and huge foreign borrow
ing and spending here, was followed by the usual
economic consequences. As the gold stock increased,
bank deposits expanded and prices rose just as they
were rising in European countries. A paper-currency
inflation abroad xvas paralleled by something of a

DIAGRAM 39----YEARLY XET IMPORTS AND EXPORTS OF GOLD SINCE 1873.

gold inflation here. During this period the Reserve
Banks had just been organized; little of their credit
was in use; and they had little influence on the
situation.
But with the entry of the United States into the
war in 1917 unusual credit developments began to
appear. Without any further additions to the gold
stock, and without leaving the gold standard, this

246

THE RESERVE BANKS

country began a large credit expansion to meet war
demands. Prices rose also.
'
. '
. '■ .
In 1921 the operation was reversed.. Gold im
ports were heavier than ever before, over 650 million
dollars in one year, but bank deposits and■ prices
declined.
.
.
■
■
In 1922, 1923, and 1924, as gold imports con
tinued at a rate of 250 to 300 million dollars a year,
the economic consequences were somewhat more
orthodox, for bank deposits increased, and at first
there were some commodity price increases, but the
price increases were short-lived. It was the failure
of prices to continue their upward movement, to
gether with the wholly contrary events of 1921,
which proved puzzling to economic authorities.
In attempting an explanation of these perplexing
events, it is well to consider first what happened in
1917, 1918, and 1921, and then to deal separately
with the later movement, which reflected the influ
ence of a number of new factors.
A Cushion of Reserve Bank Credit.—The unusual
relationships between gold, bank deposits, and
prices, from the spring of 1917 to the end of 1921,
can perhaps be explained best in connection with
Diagram 40.
As the diagram indicates, there was during this
period no close relationship between the changes in
the stock of gold in the country and the changes in
bank deposits,1 notwithstanding the fact that the
country during the entire period remained on a gold
basis. The explanation of this paradox is, found in
* Demand deposits are used—the active deposits which pre
sumably are most closely related to price changes.' '

AND THE MONEY MARKET

247

the use of Federal Reserve credit. In 1917, when
war demands for credit and currency called for in
creases in bank reserves, the banks supplemented
their reserves by borrowing from the Federal Re-

DIAGRAM 40—SINCE THE ESTABLISHMENT OF THE FEDERAL RESERVE
SYSTEM BANK DEPOSITS HAVE RESTED ON GOLD PLUS FEDERAL RE
SERVE CREDIT, AND A CUSHION OF FEDERAL RESERVE CREDIT HAS

BROKEN THE IMPACT ON BANK DEPOSITS OF CHANGES IN THE GOLD
STOCK.
THE GOLD MOVEMENT HAS NOT HAD THE SAME EFFECT ON
PRICES AS BEFORE THE OPERATIONS OF THE SYSTEM. THE SHADED
PART OF THE DIAGRAM, FEDERAL RESERVE CREDIT, REPRESENTS THE

TOTAL AMOUNT OF CREDIT EXTENDED AT DIFFERENT TIMES BY THE
RESERVE BANKS.

serve Banks. The balances at the Reserve Banks
which the member banks obtained by this borrow
ing could be counted as reserves, just the same as
balances created by the deposit of gold, or they
might be withdrawn in currency. Thus, Federal

248

THE RESERVE BANKS

Reserve loans supplemented our gold supply; and
the country’s bank deposits rested not on gold alone,
but on gold plus Federal Reserve credit. As the
war progressed banks borrowed still more largely
at the Reserve Banks, and the country’s bank de
posits rested still more largely upon Federal Reserve
credit. This is the same principle that was dis
cussed in Chapter III. By centralizing bank re
serves the Federal Reserve Act made it possible in
emergencies to use those reserves more fully. The
method of use was simply the extending of loans
by the Reserve Banks, secured by commercial paper
and government bonds, or the investment by these
banks in bilb or government securities.
The use of Federal Reserve credit as a supplement
to gold was most extensive in the autumn of 1920,
following gold exports and continued expansion of
bank deposits.
Towards the end of 1920 the situation changed
abruptly. Prices and business activity were moving
to lower levels, credit needs were thus reduced, and
deposits began to decline. At the same time gold
imports began in large volume. Under the old bank
ing system the natural result of these gold imports
would have been an increase in the volume of credit,
just at a time when less credit was required. But
the increase in gold and the lessened credit demand
were both offset by decreases in Reserve Bank credit.
As bank loans were liquidated and as gold flowed in
from abroad, the member banks paid off their loans
at the Reserve Banks. Thus the basis for credit
was automatically reduced.
This may be put another way by saying that dur-

AND THE MONEY MARKET

249

ing this period, from 1917 to the end of 1921, Federal
Reserve credit acted as a kind of cushion between
gold movements and bank deposits. It broke the
impact of gold exports or imports upon bank credit
and made possible a continuous adjustment of
credit to the needs of business.
It should be observed that there was nothing par
ticularly complex or mysterious about this whole
operation. In amount it probably surpassed any
thing which the devisers of the Federal Reserve Act
had in mind, but it was, nevertheless, a logical use
of the machinery of the Reserve System for enlarg
ing the basis of credit in times of emergencies. Of
course Federal Reserve policy, in fixing the discount
rate, had something to do with the amount of Fed
eral Reserve credit that was called into use during
the war period and the rapidity with which it was
retired in 1921. But in neither of these movements
was the policy principally devised as a means of
offsetting gold movements, but rather with regard
to the domestic credit situation. It was in no sense
a mysterious gold policy.
It may further be noted at this point that the use
fulness of the Federal Reserve System in offsetting
the influence of gold imports depended upon the
existence of a volume of Federal Reserve credit
outstanding, which might be liquidated in an
amount equal to gold imports. If gold imports in
large volume should occur at a time when the mem
ber banks owed the Reserve Banks nothing, and the
Reserve Banks had no acceptances or government
securities which could be liquidated, it might be ex
pected that gold imports would have their usual

250

THE RESERVE BANKS

pre-war effect upon bank deposits and upon prices
of one kind or another, unless unusual measures were
taken.
1922 to 1926...—.As has been indicated, the gold,
credit, and price relationships since 1922 have been
of a different character from those of the preceding
period. The first important difference has been that
in the recent period gold imports have been accom
panied by large increases in bank deposits. Be
tween January, 1922, and January, 1927, the coun
try’s gold stock was increased by about 850 million
dollars. During this same period demand deposits
of all banks in the country have increased about 5
billion dollars, or about six times as much as the
increase in the gold stock, and there has been an
increase of about 8 billion dollars in time, savings,
deposits. Thus, since 1922 gold imports appear to
have had something of their usual relationship to
the amount of credit in use.
But this increase in bank deposits has not been
accompanied by any corresponding increase in com
modity prices. In January, 1927, the index figure
for wholesale commodity prices compiled by the U.
S. Department of Labor was 147, compared with 138
in January, 1922, an increase of only 6% per cent.
This lack of parallelism between bank deposits and
prices could be made the subject of an exhaustive
economic treatise. The briefest plausible explanar
tion seems to be that the credit was used for other
purposes. It financed an increase in the volume of
trade larger than the usual year-to-year growth, in
cluding a huge amount of new building construction
and an extraordinary growth in the automobile in-

AND THE MONEY MARKET

251

dustry. It financed as well a large increase in
wages, an increase in real estate values, a record
breaking volume of new financing both domestic and
foreign, and an increase in security prices. But in
the field of commodity prices it encountered re
sistance—resistance from business which was prac
ticing a new efficiency based partly upon low in
ventories, and, of much more importance, a resist
ance from foreign markets where credit was dear
and economy necessary. These years have pro
vided an interesting demonstration of the truth that
wholesale commodity prices are influenced more by
world conditions than by domestic conditions.
It is not true to say that the gold imports since
1921 have brought with them no increase in prices.
They brought no important increase in commodity
prices, but have had their effect on wages, and on
prices of real estate and securities. An attempt to
picture these relationships is made in Diagram 41.
The best measure of the influence of increased
credit on prices is probably to be found in an index
of the general price level, which includes wages
of workingmen, rents, and retail prices, as well as
wholesale commodity prices. This index has moved
in some relationship with bank deposits, though the
use of deposits in financing the large volume of
trade, new financing, etc., has given them an em
ployment which may account for the more rapid
growth of deposits than the general price index.
Thus the first characterization of the 1922 to
1926 period of gold imports is that gold imports had
something of their normal pre-war influence, espe-

DIAGRAM 4 1 — CHANGES IN DEMAND DEPOSITS HAVE MOVED MOBS CLOSELY WITH CHANGES IN THE GENERAL PRICE
LEVEL THAN IN SPECIFIC KINDS OF PRICES, SUCH AS WHOLESALE COMMODITY PRICES, WAGES, AND RENTS.

AND THE MONEY MARKET

253

cially when we analyze closely the influence on
prices of various kinds.
Federal Reserve Gold Policy,—The second im
portant feature of the period is that it marked the
development of Federal Reserve policies designed
specifically to deal with the gold movement.
Whereas the adjustment of Federal Reserve credit
to gold changes from 1917 through 1921 had been
in large measure semi-automatic, and subordinated
of necessity to other considerations, the adjustment
of the later period was more conscious and more
specific in aim. Federal Reserve gold policy found
expression in four ways:
1.
2.
3.
gold
4.

Resistance to secondary expansion.
Putting gold into circulation.
An open-market and discount policy adjusted to
movements.
Aid to restoration of the gold standard abroad.

These policies did not completely sterilize the
imported gold; they tended to reduce its influence
and sought to correct the chief cause, which was
unstable currencies abroad. The operation of each
of these policy methods can be described without
encountering serious technical difficulties.

1. Resistance to Secondary Expansion
The meaning of this somewhat obscure phrase
may perhaps be explained most readily by following
through a typical gold import.
A shipment of gold bars packed in boxes is un
loaded from the steamer to an armored car and
taken to the Federal Reserve Bank under the care

254

THE RESERVE BANKS

of a representative of the Twelfth National Bank
to whom the gold was shipped. The Reserve Bank
receives the gold and pays for it, giving the Twelfth
National a credit in its reserve balance immediately
for a large percentage of the volume of the gold,
and in a few days for the rest after it has been
weighed. Other imports of gold may be handled
through the United States Assay Office, but the ulti
mate result is the same: some bank, the Twelfth
National in this case, finds its balance at the Re
serve Bank increased by the amount of the gold
imported.
If the Twelfth National is in debt at the Reserve
Bank it can use this balance to pay off its debt or
to make further extensions of credit. When banks
are out of debt and find themselves with any excess
credit at the Reserve Bank, they, of course, put it
to work. This credit becomes the basis for an in
crease in bank deposits several times the amount of
the credit, just as did gold imports before 1914.
We may call the resulting increase in bank credit
primary expansion. It is the direct and inevitable
result of gold imports when member banks are out
of debt at the Reserve Banks and when the Reserve
Banks hold no securities they can sell to offset the
movement. In 1922, for example, total bank de
posits increased about 4% billion dollars and in
1924 about 3% billions, largely due to gold imports
when banks in New York and other principal cities
were mostly out of debt at the Reserve Banks, and
no accompanying sales of securities were made by
the Reserve Banks.

AND THE MONEY MARKET

255

There is another further or secondary expansion
which may, but does not necessarily, take place.
When the incoming gold is deposited in the Federal
Reserve Bank, it does more than increase the re
serve balance of the member bank; it increases the
gold holdings of the Reserve Bank and hence its
power to make loans and investments. Since a Re
serve Bank only needs to retain a 35 per cent re
serve against deposits and a 40 per cent reserve
against notes, it can make loans or investments equal
to between 2 and 3 times the amount of new gold
it receives, depending upon whether this gold is paid
to the Reserve Bank to pay off a debt or is de
posited and increases the deposit liability. On the
basis of the 1% billions of gold received since 1920
the Reserve Banks could have made loans to mem
ber banks, or investments of over 3 billion dollars,
in addition to the 3i^ billions of loans and invest
ments outstanding in the autumn of 1920. If this
additional amount of Reserve Bank credit had been
put into use a much larger increase of member-bank
credit certainly would have been built upon it, run
ning as high as 10 to 15 billion dollars.
But there has been no such secondary expansion
resulting from gold imports since 1920. Reserve
Bank loans and investments have been reduced, not
expanded.
There are two strong restraints against secondary
expansion. The first is the member bank’s reluc
tance to borrow heavily at a Reserve Bank. This
reluctance is partly due to the pressure of the Fed
eral Reserve discount rate. But member-bank pol-

256

THE RESERVE BANKS

icy as to borrowing goes beyond considerations of
profit. It is not regarded as sound banking for a
bank to be always leaning on the Federal Reserve.
The member banks generally have been unwilling
by borrowing to put to its full use the huge hoard
of gold acquired by the Reserve Banks.
The second barrier against secondary inflation has
been the influence of the Reserve Banks themselves.
It is the business of the Federal Reserve Banks to
fix their discount rates and pursue their open-market
policy “with a view of accommodating commerce
and business,” as the Federal Reserve Act puts it.
It would clearly be contrary to the best interests of
commerce and business to encourage a great credit
and price inflation through putting to full use the
gold stored in the Reserve System. The Reserve
Banks have refrained from investments which would
put the new gold to work, and their discount and
open-market policy has tended from time to time
to discourage its use by the member banks.
Because of these restraints, secondary expansion,
on the basis of the new gold, has been, in the past,
as it will be in the future, restrained. Ordinarily,
under present conditions the only effect of imported
gold on the credit situation is felt through what
ever primary expansion takes place upon its receipt.
It should perhaps be added that primary expansion
alone gives incoming gold a credit-making power
fully as large as in pre-war days. That a secondary
expansion is mechanically possible is due solely to
the elasticity of the Federal Reserve System, de
signed for emergency, not ordinary use.

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2. Putting Gold into Circulation

During the war gold certificates were largely re
tired from circulation and were replaced by Federal
Reserve notes, which require only a 40 per cent gold
reserve instead of the 100 per cent which gold cer
tificates require. Since July, 1922, gold certificates
have again been placed in circulation and the yellowbacked tens and twenties are again a common sight.
About 1,100 million dollars of them are now again
in use—nearly the same amount as before the war.
It has been supposed by some that Federal Reserve
Banks, by placing imported gold in circulation in
this form, have sterilized it—have prevented it from
having any influence on the credit situation. As a
matter of fact this action has had no such sweeping
effect, but has simply been a psychological aid to
avoiding secondary expansion.
The effects of issuing gold certificates may be
seen by reviewing what happens when gold enters
the country. When the member bank by the sale
of imported gold obtains a credit at the Reserve
Bank, this credit may be used to pay off indebted
ness at the Reserve Bank or may be used as a basis
for an expansion of bank loans and deposits, which
we have called primary expansion. What the Re
serve Bank does with the gold later does not affect
this first primary expansion in any way, but has
its influence solely on any possible secondary expan
sion. Suppose that a Reserve Bank after receiving
a gold shipment of 1 million dollars decides to put
1 million dollars of gold certificates into circulation.
The method is the same as any commercial bank

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THE RESERVE BANKS

would use- Just as a commercial bank has a stream
of currency coming in at the receiving teller’s win
dow and a stream going out the paying teller’s
window, so the Federal Reserve Banks have a
stream of currency coming in and another going
out, but by truck loads instead of in small packages.
The Reserve Bank ordinarily exercises no more
choice as to how much currency will be paid out in
a day than does the commercial bank. It responds
to the demands of its customers. So when a Re
serve Bank decides to put gold certificates into cir
culation it does not force them out. The yellow
backs are simply paid out in response to currency
demand instead of Federal Reserve notes. There
is no increase or decrease in the amount of money in
circulation. One million dollars of gold certificates
is substituted in circulation for 1 million of Federal
Reserve notes. The only effect on the credit situa
tion is that the cash reserves of the Federal Reserve
Bank are reduced 1 million dollars and its liabilities
for Federal Reserve notes are also reduced 1 million
dollars. Its reserve percentage, the percentage of
reserves to note and deposit liabilities, is lowered
slightly.
It should also be remembered that the country’s
paper money flows to and from the Reserve Banks
so rapidly, about two and one-half times a year,
that if the reserve position of the System needs
strengthening, the gold can be retired from circula
tion again rapidly and replaced by Federal Reserve
notes. By this means a rapid decline in the reserve
ratio due to gold exports could be checked.
Putting gold into circulation in place of Federal

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259

Reserve notes has not in practice “sterilized” im
ported gold. The only effect has been to reduce
temporarily the reserve percentage of the System,
to reduce a little the size of the gold show piece, and
perhaps thereby reduce slightly the temptation to
wards secondary expansion.

3. An Open-Market and Discount Policy Adjusted
to Gold Movements
Every policy decision that the Federal Reserve
authorities have made in recent years has probably
been influenced somewhat by gold. In two ways in
particular has gold constantly obtruded itself into
the credit picture. There has always been some
danger that the gold stored in the Reserve System
might be used for a credit inflation. This was a
situation calling for high discount rates, made effec
tive by open-market operations. But there has been
also a constant threat of additional gold imports,
particularly at times when money rates have been
firm and our money market, therefore, attractive
to international funds. Additional gold imports
would not only have increased the danger of infla
tion here, but would also draw gold from countries
already suffering from stringent credit and thus de
lay world business recovery and react unfavorably
on the foreign trade of the United States. This
situation called for low discount rates and an easy
money policy that more gold might not be attracted
here.
Credit policy has had to thread its difficult way
between these two opposite necessities\—.high

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THE RESERVE BANKS

enough rates to avoid inflation, and low enough
rates to avoid attracting more gold—and simultane
ously adapt itself to a changing domestic credit
situation.
In this delicate position open-market operations
in government securities have proved perhaps the
most valuable instrument of policy. By purchase
of securities, funds have been made more readily
available to the money market at times when the
process of European financial recovery might be
facilitated by lower money rates and more favorable
opportunities for foreign financing in this market,
without at the same time fostering too rapid credit
expansion in this country. The purchase of secur
ities during 1924, which has been referred to in a
previous chapter, was an example of such an opera
tion. Such purchases of securities were designed
not only for their effect on the domestic money
market, but also served the purpose of acquiring
for the Reserve Banks a portfolio of government
securities, the sale of which at any time would have
the effect of increasing the indebtedness of member
banks to the Reserve Banks and thus counteract
any tendency to too rapid credit expansion. Sales
of securities early in 1923 and early in 1925 were
of this character. Such purchases and sales of
securities were effective not solely as independent in
struments of Federal Reserve policy, but as means
of preparing for discount rate changes or making
them more effective.
An example of the more direct use of transactions
in government securities to offset the influence of

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261

gold movements took place in May, 1927. Early in
May the Reserve Banks purchased abroad nearly
60 million dollars of gold. This purchase would
ordinarily have the effect of putting 60 million
dollars into the money market, since the gold would
be paid for by credits to member-bank account in
New York. The purchase of gold, however, was
accompanied by a sale of government securities in
equivalent amount and thus the influence of the
gold purchase on the money market was directly
offset. A few weeks later the Reserve Banks sold
a somewhat larger amount of gold to foreign ac
count in New York, and the effects of this sale on
the money market were directly offset by purchases
of securities in corresponding amount.
In these various ways open-market and discount
policy has been adapted to gold movements, the
action in each particular case depending upon all the
circumstances of the credit situation at the time.
As to the final consequences of the policies which
have been adopted, it is still too early to judge.
But thus far at least no seriously excessive credit
expansion appears to have taken place. The amount
of Federal Reserve credit in use has decreased rather
than increased since 1922 despite some increase in
currency requirements, and the flow of gold to this
country has considerably abated.

Aid to Restoration of the Gold Standard Abroad

The three means just described of dealing with
gold imports are palliatives, not cures. The financial
disease which brought us so much gold was de-

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THE RESERVE BANKS

predated and fluctuating currencies abroad; and
the only real cure was stabilization. This disease
was responsible not only for the gold flow that
threatened inflation, but for other ills as well. It
curtailed Europe’s power to buy this country’s
products and made for instability of prices. It in
terfered with American purchases of merchandise
abroad. It subjected international financial transac
tions to disorganization and speculation.
Each country must in large measure work out its
own cure for currency disorders. It must balance
its governmental budget, collect its taxes, and devise
a sound banking plan for the guaranty of its cur
rency and the stabilization of its exchange. Other
countries can help only at the final step, when the
plan is ready to announce to the world. At that
point a large foreign credit has always proved de
sirable, if not essential. When the United States
resumed gold payments in 1879, John Sherman, then
Secretary of the Treasury, secured a gold credit of
$15,000,000 in London by the sale of bonds, ready
to be used if necessary to assure the stability of
dollar exchange.
In the past few years the United States has had
a chance to perform a similar service for a number
of other countries, and in this action the Federal
Reserve System has had an important part, not
alone by extending credits itself, but less directly as
well by at times fostering conditions under which
the American investment and credit market might
be more open to foreign borrowers.
Powers Under the Act.—The Federal Reserve Act,

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263

in Section 14, gave the Federal Reserve Banks cer
tain powers to deal with banks in foreign countries
and to conduct certain banking operations abroad.
With the approval of the Federal Reserve Board
the Reserve Banks may buy or sell cable transfers,
eligible bankers’ acceptances, and bills of exchange,
may deal in gold coin or bullion at home or abroad,
make loans on gold, open and maintain accounts in
foreign countries, appoint correspondents, and estab
lish agencies in such countries for the purpose of
buying and selling and collecting bills of exchange,
and open and maintain banking accounts for for
eign correspondents or agencies.
During the first ten years of the operations of
the Reserve System the transactions in the exercise
of these powers were in relatively small volume,
partly because of disturbed monetary conditions
abroad. Mutual correspondent relationships were,
however, established with the principal foreign
banks of issue, and the business transacted with
foreign banks has gradually increased in size, par
ticularly in the past few years. Operations have
consisted largely of the maintenance of deposit ac
counts for foreign banks of issue and the investment
of balances in bankers’ acceptances and government
securities. The power to make loans secured by
gold has also been exercised at times.
In these transactions with foreign banks of issue
negotiations and active management of the accounts
are conducted by the New York Reserve Bank, since
that bank is located in the country’s central money
market and at the point of contact with the money

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THE RESERVE BANKS

markets of foreign countries. The several Reserve
Banks, however, participate ratably in the Sys
tem’s foreign operations, and the conduct of these
operations is under the general supervision of the
Open-Market Investment Committee and the Fed
eral Reserve Board.
The powers granted by the Federal Reserve Act
and the correspondent relationships which had been
developed placed the Federal Reserve System in a
position to extend aid to foreign banks of issue in
the reestablishment of the gold standard in Europe.
The first important act of this sort was the extend
ing of a credit to the Bank of England in the spring
of 1925. While the inauguration of the Dawes
Plan, which included the stabilization of the Ger
man currency, was perhaps the first important step
in the restoration of monetary stability in Europe,
the return of England to the gold standard was a
second, and perhaps even more important step, for
England has occupied such a strategic position in
world finance that her return to the gold standard
carried with it large implications for the world as a
whole. As a matter of fact, Holland, Australia,
and New Zealand and the Dutch East Indies with
drew their embargo on gold exports simultaneously
with Great Britain’s action, and South Africa and
Austria and a number of other countries made some
what similar announcements just preceding and fol
lowing the British action.
Credit to Bank of England.—The specific ar
rangements made by the Federal Reserve Banks
with the Bank of England and the conditions sur
rounding them were described as follows in the

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265

annual report of the Federal Reserve Board for
1925:1
On April 28, 1925, the British Chancellor of the Ex
chequer announced that the law of 1920 prohibiting gold
exports for a period of five years, except under special
license, would be permitted to lapse on December 31,
1925, and that for the remainder of the year the Bank
of England would be given a general license to export
gold. Control of gold exports in Great Britain, which
from the outbreak of the war until the legal prohibi
tion in 1920 had been by informal methods, applied
after that time to exports of all gold with the exception
of newly-mined gold produced in the British Dominions
and imported into England. In removing restrictions
upon gold exports the British Government considered it
essential to obtain the assurance of foreign credits upon
which England could draw during the transition period
in case its ability to maintain a free gold market was
threatened by heavy withdrawals of gold. In these cir
cumstances the Bank of England applied to the Federal
reserve system for the right to draw upon the reserve
banks for gold up to an amount of $200,000,000, if re
quired, over a period of two years. At the same time the
British Government arranged for an additional credit of
$100,000,000 with a private group of bankers in this
country. In approving the arrangement entered into
with the Bank of England, the board acted on the con
viction that the reestablishment of the gold standard
would be an important step in the direction of the re
storation of monetary stability throughout the world,
and that business and credit conditions in this country
would greatly benefit by this increased stability. Amer
ican exporters of agricultural and other products whose
business had been exposed for a decade to the hazard
and expense of dealing with countries having currencies
with unstable values, would, by the reestablishment of
1 Twelfth Annual Report of the Federal Reserve Board cover
ing operations for the year 1925, pp. 11-13.

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THE RESERVE BANKS

the gold standard, be relieved of the risks arising from
unstable exchanges. American credit conditions would
no longer be disturbed by the continuous and uncon
trollable inflow of gold which had been for more than
four years the principal cause of a rapid growth in bank
credit With the principal money markets of the world
once more free gold markets, and the exchanges be
tween them stable, the flow of funds between markets
would respond more freely to differences in money rates
and credit conditions. Thus the resumption of gold
payments by the chief trading countries of the world
would furnish a basis for the functioning of those forces
which before the war had operated to maintain a close
contact between the money markets of the world.
Moved by these considerations, the Federal Reserve
Board approved the arrangement entered into by the
Federal Reserve Bank of New York, with the participa
tion of the other reserve banks, with the Bank of Eng
land. Under this arrangement the Federal Reserve Bank
of New York undertook to sell gold on credit to the
Bank of England from time to time during the follow
ing two years, but not to exceed $200,000,000 outstand
ing at any one time. The credit was to bear interest,
to the extent that it was actually used at a rate of 1
per cent above the New York Reserve Bank’s discount
rate, with a minimum of 4 per cent and a maximum
of 6 per cent, or, if the Federal reserve discount rate
exceeds 6 per cent, then at the discount rate of the
bank. The rate of interest to be paid by the British
Government on the credit which it established with
private bankers was to be determined in a similar man
ner. Upon the purchase of gold the Bank of England
would place on its books to the credit of the Federal
Reserve Bank of New York an equivalent deposit in
pounds sterling. This deposit might be used from time
to time by arrangement with the Bank of England in
the purchase of eligible sterling commercial bills which
will be guaranteed by the Bank of England, and in
that case discount earned on the bills would be applied

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267

to the payment of interest. The repayment of any in
terest or principal of this credit outstanding at the end
of two years was guaranteed by the British Treasury.
The system’s arrangement, however, was strictly a bank
ing transaction with the Bank of England and not in
any sense an agreement with the British Government.
Since the restoration of the gold standard in Great
Britain, banking developments in that country have
been such that no necessity has arisen for making use
of any part of the credit with the reserve bank.
The arrangements entered into between the Bank of
England and the Federal Reserve Bank of New York
involved no commitment as to the policies to be pur
sued by either bank in dealing with domestic credit con
ditions or with changes in discount rates.

No use of this credit was made by the Bank of
England, and it lapsed in May, 1927, but its exis
tence undoubtedly added assurance as to the suc
cess of the project for the return to the gold stand
ard.
Credit to National Bank of Belgium.—A further
action of somewhat similar character was taken in
October, 1926, when arrangements were made to
assist in the stabilization of the Belgian currency.
In addition to an international loan of 100 million
dollars offered in the money markets of England,
Holland, Sweden, Switzerland, and the United
States, credit arrangements were made by the Na
tional Bank of Belgium with a number of banks
of issue in other countries. These arrangements
were described as follows in the Monthly Review
of the Federal Reserve Bank of New York for No
vember 1, 1926:
As a part of the plans which have been completed for
the stabilization of the Belgian currency, the Federal

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THE RESERVE BANKS

Reserve Bank of New York, in association with other
Federal Reserve Banks, has indicated its readiness to
cooperate with the Belgian bank of issue, the Banque
Nationale de Belgique, by participating with other banks
of issue in credit arrangements under which the Fed
eral Reserve Bank of New York has agreed, if desired,
to purchase up to a total amount of ten million dollars
of prime commercial bills from the Banque Nationale
de Belgique. In these arrangements the Federal Re
serve System is acting in collaboration with the central
banks of Austria, England, France, Germany, Holland,
Hungary, Japan, and Sweden.

Results.—The action taken by the Federal Re
serve System in extending these credits to the Bank
of England and the National Bank of Belgium,
greatly furthered the return to monetary stabiliza
tion abroad. If these countries had had to depend
altogether on credits with private bankers, their
undertaking would have lacked the assurance which
arises from the aid of banks of issue, which naturally
carry a financial prestige of somewhat different
character from that which attaches to private bank
ing organizations.
Since Great Britain’s return to a gold standard
in 1925, the flow of gold to the United States has
diminished to manageable proportions. In fact there
was a net loss of gold in 1925 and a gain of less
than 100 millions in 1926. While the future gold
movement is far from clear, it seems evident that
the stabilization of most of the important countries
of Europe has eliminated the principal cause of the
huge flow of gold which came to this country from
1920 to 1924. The steps which the Reserve Banks
have taken in facilitating this change have prob-

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269

ably been more important in the avoidance of a
gold inflation in this country than any of the tem
porary correctives to gold imports discussed earlier
in this chapter.
.
Present Tendencies.—While stabilization in Eu
rope has lessened, it has not finally removed the
danger of embarrassingly large gold imports into
the United States. The world produces each year
some 400 million dollars’ worth of gold. Of this
amount 150 to 200 million dollars’ worth is usually
sold through world markets for monetary use.
Many of the countries recently stabilized or about
to stabilize would like some of this gold, but few
can afford to take it. Much of it may come to this
country for lack of other bidders.
Many countries, to avoid the cost of buying gold
and keeping it idle, have resorted to a substitute
in the form of balances abroad—“valuta” or “divisen.” Such balances are treated as primary or sec
ondary reserves, and have the advantage that they
are invested in short securities or bills or on deposit
at interest and earn an income. Foreign money
employed in this way in New York now amounts
certainly to well over 1 billion dollars. This is in
part a temporary substitute for gold reserves—tem
porary because in the long run, in a world of fre
quent political disturbance, balances abroad are not
as good as gold in vault. In the long run each goldstandard country is likely to seek to maintain a re
serve of actual gold proportionate to the credit and
currency in use. In the meantime, however, part
of each year’s new gold crop may go begging in

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THE RESERVE BANKS

world markets and find its way to this country be
cause others are either unable or unwilling to take it.
Not every means of avoiding gold inflation has
yet been used. There are other possible methods
of absorbing gold, such as retiring the greenbacks
or putting more gold behind them, retiring national
bank notes, reclassifying cities for reserve purposes,
reducing the float the Reserve Banks carry, and
requiring a larger reserve against time deposits.
These and other means may be considered if the
gold inflow increases again.
But there are other problems besides the new gold.
In 1927 this country finds itself with a gold stock
amounting to about half of the world’s store of
monetary gold. The total amount of monetary gold
in the world is estimated at 10 billion dollars. The
United States holds over 4% billions compared with
less than 2 billions before the war. With the facili
ties of the Reserve System for the economy of gold,
this gold stock could finance an inflation of truly
gigantic proportions.
Of course a huge gold stock is not in itself a bad
thing, but a very good thing. With such a gold
stock this country should be free for many years
from the checks to prosperity which arise from in
sufficient credit resources. Already since 1921 we
have enjoyed a period of prosperity of exceptional
duration, .based in part on an ample supply of
credit. The prime essential is proper restraint in
the use of the gold.
In addition to the evils of inflation there is fur
ther excellent reason for avoiding excessive credit

• AND THE MONEY MARKET

271

expansion on the basis of the gold store. The gold
may not stay here forever.
The billion dollars and more of foreign balances
in this country has a direct claim upon our gold re
serves, which may some day be exercised for sub
stantial amounts. Many countries of the world
need gold and will need more gold when their trade
has returned to normal volume. The world has
learned to operate much more largely with paper
money than before the war, but on the other hand
credit and currency requirements are increased by
a general price level in gold 50 to 75 per cent above
pre-war. Larger bank reserves are needed and it is
reasonable to believe that foreign balances will not
be a permanently satisfactory substitute for gold.
The future is difficult to foresee, but this is clear—
this country should be so prepared for a consid
erable gold export movement that it would not seri
ously disturb credit conditions.
When gold was imported one of two things
happened, a loan or investment at the Federal Re
serve Bank was paid off or bank deposits were
expanded several times the gold imports. When
gold is exported exactly the reverse takes place. A
bank must either borrow from, the Federal Reserve
to get the gold (or the Reserve Banks increase
their investments), or bank deposits or currency
must be contracted. When gold is exported it is
necessary to travel back over the road taken when
the gold arrived. If the gold imports had led to
credit inflation the country would be facing credit
deflation as a future possibility.
Fortunately, bankers and business men have used

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THE RESERVE BANKS

the incoming gold mainly to pay debts rather than
to contract fresh ones, and the slate is clean. The
machinery of the Federal Reserve System has pro
vided a way for storing the gold ready for the use of
other nations when they have reached sufficient sta
bility to require it. When gold exports begin the
Reserve mechanism will again be useful, for mem
ber banks may secure the gold for export by bor
rowing at the Reserve Banks, or the Reserve Banks
may assume the burden by increasing their holdings
of securities. A cushion of Federal Reserve credit
may thus protect the credit structure from the di
rect impact of exports, just as in the past few years
this cushion has shielded it from the full force of
gold imports.
SUMMARY

1. The way in which this country has absorbed
since 1920 a huge amount of gold without any
increase in commodity prices has constituted
a puzzling economic paradox.
2. Before the war there was a fairly constant re
lationship between the country’s gold stock,
bank deposits, and commodity prices reflecting
a world condition.
3. Since 1917 there has been no such constant re
lationship, and the principal explanation is to
be found in the presence of a cushion of Federal
Reserve credit which has broken the impact of
gold on bank credit.
4. Additional reasons for the comparative stability
of commodity prices, particularly since 1922,

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273

may be found in international credit and trade
conditions, and, in this country, in the absorp
tion of additions to the credit supply in very
active trade, large domestic and foreign new
financing, advanced wages, and higher real es
tate and security prices.
Federal Reserve gold policy has found expres
sion in four principal ways:
A. Resistance to secondary expansion.
B. Putting gold into circulation.
C. An open-market and discount policy ad
justed to gold movements.
D. Aid to restoration of the gold standard
abroad.
Gold imports lead directly and inevitably to
increases in the volume of credit unless they
are offset by decreases in Federal Reserve credit.
Such direct increases may be termed primary
expansion. Any later use of the gold as a basis
for increases in Federal Reserve credit may be
termed secondary expansion and is more closely
under the control of the Reserve Banks. There
has been no secondary expansion on the basis
of gold imported since 1920.
Putting part of the imported gold into circu
lation in the form of gold certificates has not
sterilized the gold. It has simply reduced the
gold show piece of the Reserve System, and the
reserve percentage.
Open-market and discount policy has had to
thread its way between two opposite necessi
ties—high enough rates to avoid inflation, and
low enough rates to avoid attracting more gold

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THE RESERVE BANKS

—and simultaneously adapt itself to a changing
domestic situation.
9. The only real cure for the conditions which
brought the flood of gold to this country was
world monetary stabilization. The Reserve Sys
tem has had a share in aiding the return of the
countries of the world to the gold standard not
alone by extending credit itself, but less directly
also by at times fostering conditions under
which the American investment and credit mar
ket might be more open to foreign borrowers.
10. In the future this country must face the pos
sibility of either a further continued influx of
gold or a loss of gold. The credit situation must
be so maintained and Federal Reserve policy
must be so designed as to be ready for either
contingency.

CHAPTER XV
Interest Rates—A Measure of Resuizts

RECEDING chapters have traced in some de
tail the banking changes resulting from the
Federal Reserve System—changes in bank reserves,
currency, check collections, government finance,
credit policy, gold movements, the money market,
etc. At various specific points it has appeared that
the operations of the Reserve System result in a
sounder economic organization and practice. Turn
ing, however, from the consideration of specific
phases of Federal Reserve operations, the question
may well be asked whether there is any way of
measuring the broad results. Can we measure the
social consequences of the Federal Reserve System?
It will be easier to answer this question twentyfive years from now, when information is available
as to what happens for a term of years under the
Reserve System to prices, the cost of living, wages,
business success and failure, and the nation’s ac
cumulation of wealth. Experience is now so limited
and relationships in these fields are so complex, that
sweeping conclusions cannot be drawn.
There is, however, one somewhat more restricted
field in which data are available to measure in lim
ited degree the results of Federal Reserve operations,
and that is the field of interest rates. To the extent
that the Reserve System exercises an influence upon

275

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THE RESERVE BANKS

social welfare in this country it does so by insuring
a supply of credit adapted to the needs of the peo
ple. And interest rates are perhaps the best avail
able measure of the adaptation of the credit supply
to the country’s needs.
Interest rates are interesting primarily not as the
price we pay for money, but as indicators of credit
conditions. When William Jones, hardware mer
chant, is considering an increase in his stock of hard
ware, his decision does not rest largely on whether
his bank will charge him 5 or 6 per cent on his loan.
The real question is whether he can get the money
and whether his banker will give him assurance of
future accommodation.
When interest rates are high or rising, it is less
easy for Jones to get a loan or the assurance of fu
ture loans, because the banker is “loaned up” and is
having difficulty in maintaining his reserves. When
interest rates are low, it means that funds are read
ily available, and the banker is anxious to make
loans.
For the banker interest rates themselves are im
portant, but much less important than the under
lying credit conditions which determine the banker’s
ability to maintain the volume of deposits, to keep
funds steadily employed, and to avoid losses.
Changes in interest rates are the outward evidence
of changes in underlying credit conditions which are
of great social importance.
A history of interest rates in this country reveals
the financial crises of the country. This may be il
lustrated by Diagram 42, which shows the interest
rates on commercial paper in the open market each

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THE RESERVE BANKS

year since 1831. The cross-bar shows the average
for each year, while a line extends from this bar up
ward to the highest point of the year and another
line downward to the lowest point of the year. High
interest rates mark the business disturbances of
1836, 1848, 1857, 1873, 1893, 1896, 1907, and 1920.
When in the future the historian looks back on
the history of interest rates in this country, it seems
not improbable that he will recognize two outstand
ing events which have led to greater stability of in
terest rates. The first one was the establishment of
the National Banking System, the full effects of
which were not clearly observable (as Diagram 42
shows) until some years after the close of the Civil
War; and the second, the establishment of the Fed
eral Reserve System, the effects of which are only
now gradually becoming evident.
The stress of the Civil War resulted in the estab
lishment of the National Banking System and the
placing of the nation’s currency on a sounder basis.
After the strain of the war had passed and after
specie resumption in 1879, the sounder organization
of our credit system was reflected in lower and more
stable interest rates. Even the severe financial dis
turbances of the ’90s failed to produce such fluctua
tions of rates as occurred in the ’30s, or the ’50s.
But there were still defects in the structure of
the country’s credit system. Every year there was a
characteristic seasonal credit strain, with a corre
sponding movement of interest rates. In times of
emergency there were erratic and violent movements
of money rates reflecting recurrent credit strain.
The movement of rates for call money in 1907 is

AND THE MONEY MARKET

279

described as follows in a report by the Senate Bank
ing and Currency Committee in November, 1913:
. . . during the year 1907 the range of interest for
money was from 2 to 45 per cent in January, from 3
to 25 per cent in March, from 5 to 125 per cent in Oc
tober, from 3 to 75 per cent in November, and from 2
to 25 per cent in December, with currency bringing a
premium from 1 to 4 per cent during November and
December. The blighting effect of these violent fluctua
tions of the interest rates is demonstrated by the rate
charged for 90-day time loans, which during November
and December, 1907, were running as high as 12 to 16
per cent, with no business done in time loans of a longer
period during the entire month of November and no
business being done at times on prime commercial bills
during the same months.1

One of the purposes which the Congress had in
mind in the establishment of the Federal Reserve
System was the eradication of some of these vio
lent movements of interest rates.
Like the National Banking System, the Federal
Reserve System was inaugurated at a period of
financial strain. It was plunged into the midst of
war finance before it had proved itself by any period
of ordinary operations. It is rather fruitless to spec
ulate on what would have happened to interest rates
during the war if there had been no Federal Reserve
System. Some other means would of necessity have
been found in the emergency for dealing with war
needs for additional credit. It is reasonably sure
that these emergency means would not have been
as effective as the Reserve System which provided
* Report of the Senate Banking and Currency Committee, No
vember 1013, p. 22.

280

THE RESERVE BANKS

an organization ready for the emergency; but as
far as the facts in the case go, they indicate simply
that, while interest rates rose to high figures shortly
following the war—and there was considerable credit
strain.—there was nothing like the same credit dis
turbance as had occurred in this country at the time
of the Civil War, and as occurred during and after
the World War in most other countries of the world.
But there are now, in addition to the war experi
ence, over five years of operation of the Federal Re
serve System, under conditions which, despite very
heavy gold imports, and disturbed financial and in
dustrial conditions abroad have more nearly ap
proached normal. From the records of these years,
in addition to the war experience, it is possible to
learn something of the effects of Reserve Bank opera
tions on interest rates.
Are Rates Higher or Lower?'—In the long run
interest rates are determined by the supply of and
demand for capital. The Federal Reserve System
has no power to increase or diminish the country’s
gradual accumulation of capital. Its influence is felt
primarily in the short-term credit markets. To the
extent that the existence of the System makes the
supply of credit less uncertain and so lessens the risk
in business and investment, and to the extent that
the System provides for economy in the use of bank
reserves, there is some tendency towards lower rates.
The increase in the country’s wealth from year to
year furthers the same tendency. But the existence
of the System has much less influence on the long
time average level of rates than on shorter tenden-

AND THE MONEY MARKET

281

cies of rates and the relationship between different
rates.
The following table makes a comparison, be
fore and after the inauguration of the Reserve Sys
tem, of those rates commonly quoted in the New
York market:
Table 15.—.Average Open-Market Rates—New York
Commercial paper

Stock Exchange
loans

Period

1900 to 1913..
1915 to 1926..
1922 to 1926..

60 to 90day

4 to 6
months

On call

60 to 90day

4^
5
4)4

5H
5^
4H

3%
4^
4^

4)4
5
4)4

If we take a general view of these figures, we con
clude that there has been no very large change in
the average level of open-market rates since the Re
serve System was inaugurated.
A more careful inspection of the figures shows
that the changes have been quite different in dif
ferent kinds of loans: commercial paper rates have
tended to be lower, and loans on stock exchange
collateral higher. The tendency thus far has been
for business money to be cheaper and for stock ex
change money to be dearer.
Reduced Spread Between Maturities.—A further
interesting fact which the table given above dis-

282

THE RESERVE BANKS

closes is that since 1914 the spread between rates
for longer and shorter maturities of commercial
paper has been almost eliminated.
Diagram 43 shows for the past thirty-seven years
the rates in the New York open market for four to
six months’ commercial paper, compared with the
rates on 60 to 90-day paper. In the years before
the Reserve System was established there was a con
siderable spread between the two rates, so that it
cost the borrower from % to 1 or even 2 per cent
more to borrow for four to six months than it cost
for the shorter period.
Since the Reserve System has been in operation,
however, the spread between shorter and longer ma
turities has been steadily reduced, and early in 1924
rates on 60 to 90-day paper were no longer quoted
separately. While at times there is a spread between
the maturities, they are frequently sold at the same
rates.
There are a number of explanations for these
changes. A. first consideration is that the Federal
Reserve System has provided credit elasticity which
makes it much easier for banks to adjust their re
serve positions. In the old days very careful dating
of loans and investments was necessary that a bank
might be prepared to meet its specified obligations,
such as tax or dividend payments, or unexpected
calls on its resources, without impairing its reserve.
There were no ready means, always assured, by
which a bank could secure temporary aid to tide it
over difficult periods unless a bank had sufficient
maturities or call loans available on every business
day of the year to meet possible impairments of re-

284

THE RESERVE BANKS

serve. The short-term obligation was, therefore, a
very desirable employment for funds, because it kept
funds coming back, ready for the expected or unex
pected demand.
The Federal Reserve System has greatly simpli
fied the problem of adjusting reserves. The member
bank can now tide itself over an emergency by bor
rowing from its Reserve Bank. The non-member
bank can secure accommodation from its city cor
respondent more readily, because the city correspon
dent can borrow from the Reserve Bank.
Besides direct borrowing from a Reserve Bank,
there are now additional facilities for the adjust
ment of bank reserves in the existence of two new
and important markets for the employment of funds
for short periods, the bill market and the market
for short-term government securities.
The existence of these two markets, in addition
to call loans, as avenues for reserve adjustments,
together with the possibility of direct borrowing
from the Reserve Banks, gives banks greater free
dom as to the maturities of their loans and removes
much of the difference in desirability between dif
ferent maturities.
A still further explanation for the narrowing
spread between rates for different maturities has
been set forth by Colonel Leonard P. Ayres, vice
president of the Cleveland Trust Company:
The dominant reason for this difference (reduced spread
between maturities) appears to have been that in those
days it was far more hazardous to loan money for as
much as six months than it was to loan it for only two
or three months. In the years when recurrent panics

AND THE MONEY MARKET

285

and crises were among the expected events of our finan
cial operations no one could know what even the next
six months might bring forth, and lenders had to be
paid for taking the risks of making the longer loans.
. . . Under the Federal Reserve System many of the
uncertainties and sudden changes in money conditions
have been removed and hence there is little difference
between the rates charged for short and long periods.1

Reduced Spread Between Cities of West and East.
—'When the Federal Reserve Act was being dis
cussed in Congress, the hope was expressed that the
proposed legislation might result in lessening the
disparity between interest rates in different parts
of the country. It has been disturbing that the
Minnesota farmer should pay 6 to 8 per cent for
his money, while money sometimes went begging at
2 per cent in the call-loan market in New York.
This difference in rates is the result of a number
of factors, several of which probably will always be
operative, no matter what kind of banking system
exists. The rural bank explains high rates on the
ground that it costs more to make the loan to the
farmer because of the high cost of maintaining a
local bank, handling many small accounts, deter
mining the farmer’s credit, following up the loan,
and taking the risk of crop failure. And the money
lent to the farmer is tied up for an indefinite num
ber of months, whereas the call Ioan can be liqui
dated at any time. AU of these are differences in
the character of the two loans which the Federal
Reserve System cannot alter.
‘Pascagoula National Bank vs. Federal Reserve Bank of At
lanta ; In the District Court of the United States for the
Northern District of Georgia; Answer of Federal Reserve Bank
of Atlanta and Supporting Affidavits, p. 68.

286

THE RESERVE BANKS

But there are other factors in the difference in
interest rates between different parts of the country,
and these factors have to do with the fluidity of
the country’s credit. In the old days there were
a number of barriers to the free flow of funds
throughout the country. Settlements between dif
ferent parts of the country required eventually the
expensive shipment of currency. Under the old
check-collection system with its exchange charges,
its indirect routing, and complex special arrange
ments, it took twice as long to make settlements
as it does at present. There was usually a premium
or discount on New York funds in Chicago or other
Western centers; the purchase of New York or other
out-of-town funds was like the purchase of for
eign exchange.
These barriers hindered surplus funds in one part
of the country from finding employment in some
other part. There was limited automatic correc
tion for high rates by the flow of funds from the
center where they were in ample supply to the cen
ter where they were dear.
Barriers Broken Down.—The Federal Reserve
System has broken down many of the barriers
which hindered a free movement of funds. Check
collections have been made faster, safer, and
cheaper. Transfers of collected funds are made by
telegraph without cost to member banks. Settle
ments no longer require the shipment of currency,
but are made by bookkeeping entries on the re
serve accounts of the Federal Reserve Banks. Banks
are now much less dependent on the New York
money market, since adjustment of reserves can

AND THE MONEY MARKET

287

be effected at their local Federal Reserve Bank.
At the same time access to the New York money
market has become easier, and the money markets
of Chicago, Boston, and other centers have grown
in importance. All of these changes in the mechan
ism of banking intercommunication may be ex
pected to reduce the spread between interest rates
in different parts of the country.
Wt

RATI

DIAGRAM 44—IN RECENT TEARS THE DIFFERENCE BETWEEN THE
INTEREST RATES CHICAGO BANKS CHARGE THEIR CUSTOMERS AND THE
RATES NEW YORK BANKS CHARGE HAS BEEN REDUCED.

It is not possible to secure complete data to test
statistically the soundness of this logic, but some
few are available. Some years ago Bradstreet’s be
gan collecting from typical banks in certain centers
the rates which they charged their customers on
prime commercial loans. The Annalist began a sim
ilar report in 1911. The Federal Reserve Banks
have been collecting such figures in recent years.
The New York and Chicago rates, as reported by

288

THE RESERVE BANKS

these agencies, for three years just before the Sys
tem was established, are compared in Diagram 44
with the figures for 1922, 1923, and 1924. The dia
gram indicates that before 1914 rates were at times
twice as high in Chicago as in New York, and the
difference was usually considerable. Now the spread
between rates is almost negligible. While these fig
ures are subject to some error, partly because the
data for the earlier period cannot very well be
checked, and partly because it is always difficult to
secure accurate quotations for the rate on loans
made in each case by private negotiation, the figures
may be relied upon as illustrating the kind of change
that has taken place.
Table 16, prepared from the same sources, indi
cates that, for other centers as well, the gap between
rates in the central money market and in other
parts of the country has been narrowed. More
nearly than ever before, the country’s supply of
Table 16.—Average Interest Rates on Customers’
Prime Commercial Paper, 4-6 Months

New York...............................
Boston.....................................
Philadelphia............................
St. Louis..................................
Chicago....................................
Minneapolis...............
New Orleans...........................
Kansas City............................

1911-1913

1922-1924

4.74
4.86
4.97
5.87
5.98
6.15
7.11
8.00

5.03
4.99
5.22
5.27
5.28
5.49
6.10
5.96

AND THE MONEY MARKET

289

credit has become a single pool accessible to all
parts of the country, and differences in rates now
represent not so much the influence of artificial
barriers as genuine differences in risk and cost of ad
ministration.
Of course, the problem of the Minnesota farmer
is far from solved. He pays rates higher than the
call rate in New York or the bank customer’s rate
in Chicago or St. Louis. He will continue to pay
high rates until a method has been discovered to
administer banking service for the farmer more eco
nomically than now and to take out of the farm
loan some of the present uncertainty and delay in
repayment. But the existence of the Federal Re
serve System, together with the accompanying de
velopment of the country’s money" markets, has
brought the farmer one long step nearer to the
central money market, and rates in many Western
centers are now more nearly on a par with rates
in New York. The banks in these centers are
thus placed in a position to serve agriculture more
effectively and reasonably, by financing the move
ment of farm products, by buying agricultural ac
ceptances, and by serving correspondent banks in
rural districts.
Seasonal Changes..—Another fact of major import
ance revealed by Diagrams 43 and 44 is that money
rates fluctuated from month to month much more
rapidly and widely before the Federal Reserve Sys
tem was established than they do at present. The
reader will have noted that these fluctuations were
partly due to a more or less regular seasonal swing
of interest rates. In January and February money

290

THE RESERVE BANKS

tended to be easy. In the early spring rates rose,
as the demand for funds increased with the planting
of crops and spring trade. Towards summer rates
fell, but rose again to the year’s high point in the
autumn with harvesting and autumn trade. They
continued generally high throughout the holiday
period with its heavy currency requirements.
Changes in rates thus reflected directly changes in
business and agricultural activity; for in the old
days there was no way by which the supply of
funds could be increased or diminished to corre
spond with changes in the demand.
Since the establishment of the Federal Reserve
System, such seasonal swings of interest rates have
been much reduced.
Diagram 45 is an attempt to summarize more
clearly the change which has taken place in the sea
sonal swings of interest rates. The top section shows
the seasonal movement of the volume of trade. Re
tail and wholesale trade do the heaviest part of their
business in the autumn. The building industry is
most active in the spring. Agriculture calls for
largest amounts of currency and credit for the spring
planting and the autumn harvesting of crops. The
line in the diagram, which is a composite of many
kinds of business, reflects this concentration of ac
tivity in spring and autumn.1
The middle section of the diagram shows the
‘The line shown is a combined index of the seasonals of the
fifty-six series of figures included in the index of the volume of
trade of the Federal Reserve Bank of New York described by
Carl Snyder in the quarterly journal of the American Statistical
Association, December, 1923. The weights used in thia seasonal
index are the same as those used in the volume-of-trade index.

DIAGRAM 45—BEFORE THE RESERVE SYSTEM WAS ESTABLISHED, THE

USUAL SEASONAL SWING OF BUSINESS RESULTED IN A SEASONAL SWING
IN INTEREST RATES BECAUSE THE COUNTRY’S CREDIT SYSTEM WAS
INELASTIC. NOW THE SEASONAL CHANGES IN BUSINESS HAVE LITTLE
EFFECT ON INTEREST RATES, BECAUSE CREDIT IS ELASTIC.

292

THE RESERVE BANKS

typical monthly fluctuations of interest rates from
1890 to 1908, and reflects the strain on the banks
which resulted from the seasonal swings of business.
The lowest section shows the typical monthly fluc
tuations of rates from 1917 to 1924. Rates no longer
reflect credit strain in the spring and autumn, but
are relatively steady throughout the year.
The explanation of the striking change which has
taken place in the monthly fluctuations of rates is
found in the credit elasticity provided by the Re
serve System. When money tends to be in small
demand, the member banks Utilize any surplus funds
to pay off the indebtedness at the Reserve Banks
incurred during the period of demand. Surplus
funds are not thrown on the market as they used to
be, except at periods when banks may be out of debt
at the Reserve Banks; thus there is now less tend
ency for rates to be unduly reduced in times of small
demand. Similarly, when the demand for funds is
large in the spring and in the fall, the member banks
may secure necessary additional funds from the Re
serve Banks, either by borrowing or by the sale of
acceptances, so that they are in a position to meet
the demands upon them without any considerable
tightening in credit.
The significance of all this is that in the old days
business men were subjected to a constantly fluc
tuating price for funds. This, perhaps, was no dis
advantage for those businesses whose borrowing was
so flexible that it could be done at any time of
year, But it was hard on the man who had to bor
row in the fall or the spring, and it was particularly
hard on agriculture, because money was tight just

AND THE MONEY MARKET

293

at the time when seed had to be planted and when
crops had to be harvested.
For bankers the chief disadvantage in the old
fluctuations in interest rates, and the credit changes
they signified, was that the banker constantly faced
either a plethora or a dearth of available funds,
with a consequent continuous problem in keeping
his reserve position adjusted. As both plethora and
dearth can now usually be avoided through the
Federal Reserve System in the manner above indi
cated, the banker can maintain his position with
a narrower margin of working reserve, thus employ
ing his funds more fully at steadier rates. He can
compute more readily the rate of interest he can
afford to pay on deposits and adjust expenses to
income more precisely.
While the old seasonal fluctuations of interest
rates were important in themselves, because of the
way they penalized certain forms of business and
because of the difficulty in which they placed the
banker in the employment of his funds, the fluctua
tions had their most serious consequences in periods
of crisis when the seasonal credit strain was added
to a credit strain from other causes. It was not
by accident that most of the money panics in this
country occurred in the fall of the year; it was in
the fall that the usual seasonal strain, added to
an unusual credit and currency stringency, became
the last straw that broke the camel’s back.
Rates in the Business Cycle..—Aside from the sea
sonal movement described above, there is another
movement of business which has come to be known
as the business cycle. The cycle has attracted much

294

THE RESERVE BANKS

attention to itself because it was at one particular
stage of the business cycle that the business panic
or crisis frequently made its appearance.
When business reached a point of maximum oper
ations, large additional amounts of credit were called
into being, and large amounts of currency were
needed for circulation. On these occasions banks
were put to it to maintain their reserves, and at
times the credit structure cracked under the strain.
Banks reached a point where they could lend no
further without impairing their reserves. Money
rates rose to high figures. The business man who
had expanded his business to the utmost suddenly
found himself shut off from additional credit, and
business and bank failures were the order of the
day. It was a situation of this sort in 1907 that
the Senate Committee was describing in the report
quoted in the early part of this chapter.
Since the establishment of the Federal Reserve
System there have been no money panics and no
such sudden violent movements of interest rates as
characterized former periods. The elasticity of
credit and currency which the Reserve System pro
vides makes it unlikely that the country will ever
again experience a financial panic of this sort.
There were, of course, in the old days business cy
cles which did not result in financial panics, in
which the period of prosperity came to a culmina
tion without serious financial distress. Experience
is too limited as yet to indicate precisely what the
movement of rates will be in the course of a normal
business cycle under the Federal Reserve System.
The only complete cycle in reasonably normal years

AND THE MONEY MARKET

295

has been in the years from 1922 to 1924, during
which rates were remarkably steady, despite tre
mendous gold movements and considerable fluctua
tions in business activity. Some years from now it
will be possible to judge whether this was a nor
mal or exceptional rate movement under the Fed
eral Reserve System. There is good reason to hope
that the swing of the business cycle will be reduced
in extent.
SUMMARY

1. From the foregoing evidence it appears that since
the establishment of the Federal Reserve System
the following important changes in interest rates
have taken place:
A. The spread between long and short maturities
.
has been reduced.
B. The spread between the cities of West and
East has been reduced.
C. Seasonal fluctuations of rates have been re
duced.
D. Panic rates have disappeared.
In all of these ways the result has been to give
rates greater stability, to diminish change and
uncertainty.
2. The business man with good credit can be sure
of funds for conducting his necessary operations,
and he does not have to pay abnormally high
rates simply because he has to borrow at a par
ticular time, or for a longer rather than a shorter
period, or because he lives in a Western rather
than an Eastern center.

296

THE RESERVE BANKS

3. The banker can be sure of more continuous em
ployment for his funds than in the past at stead
ier rates throughout the year. With greater
assurance as to the future, he can adjust his in
terest payments and other costs to his income.
He can provide the business of the country with
more assured banking accommodations at steadier
rates.

CHAPTER XVI
Meaning of the Weekly Statement of
Condition
This chapter has been added in an attempt to answer some
frequently asked questions. The weekly statement is the means
by which the Reserve System reports its operations regularly to
the public. While there is a growing appreciation of the sig
nificance of the statement, there is as yet no general understand
ing of its meaning.

HE Federal Reserve System publishes each
week one of the most complete statements of
its operations of any bank of issue in the world.
The statement includes thirty-seven items and is
published in combined form for the Reserve System,
and separately as well for each of the twelve Federal
Reserve Banks. This statement appears in the daily
papers every Friday morning, giving the condition
as of the close of business on Wednesday night.
A copy of the one published September 2, 1927, is
shown on pages 298 and 299.
Changes in the statement of the Federal Reserve
Banks reflect directly two-thirds of the banking
operations of the United States, for Federal Reserve
membership includes more than two-thirds of the
country’s commercial banking resources, and they
reflect indirectly the operations of the non-member
banks as well. These Federal Reserve reports pro
vide a kind of epitome of the nation’s banking con
ditions. Since the condition of the banks in turn
reflects certain phases of the nation’s business, these

297

298

THE RESERVE BANKS

Table 17.—Resources and Liabilities of the
Twelve Federal Reserve Banks Combined
(In thousands of dollars)

Rssouscjja

Aug. 31,
1927

Aug. 24,
1927

Sept. 1,
1926

Gold with Federal reserve agents 1,640,260 1,615,271 1,395,311
Gold redemption fund with U. S.
36,670
Treasury........... . . . . .........
40,689
53,622
Gold held exclusively against
F. R. notes.............................. 1,676,930 1,655,960 1,448,933

Gold settlement fund with F. R.
Board.....................................
Gold and gold certificates held
by banks.............................. .

631,491

643,573

732,717

689,502

710,308

646,661

Total gold reserves................. 2,997,923 3,009,841 2,828,311

Reserves other than gold.........

147,813

147,663

138,032

Total reserves.................... 3,145,736 3,157,504 2,966,343

Non-reserve cash.......................
Bills discounted:
Sec. by U. S. Government obligations.............................
Other bills discounted...........
Total bills discounted...........

Bills bought in open market...
U. S. Government securities:
Bonds........................... ... . . .
Treasury notes......................
Certificates of indebtedness..
Total U. S. Government securities..................... ........

48,050

53,039

49,328

217,817
182,707
400,524
185,128

217,677
196,480
414,157
178,809

320,675
305,673
626,348
253,481

212,077
99,642
161,095

203,557
89,333
151,931

45,605
217,702
55,657

444,821 318,964
3,700
320
320
Other securitie.........................
Total bills and securities. 1,058,786 1,038,107 1,202,493
744
12,248
23,629
Due from foreign banks...........
Uncollected items..................... 603,366 609,876 620,052
59,931
59,455
59,452
Bank premises........... . .............
16,696
17,747
17,032
All other resources...................
4,915,587
TOTAL RESOURCES. 4,945,388 4,958,639
472,814

AND THE MONEY MARKET

299

Table 17.—Continued
Liabilities

Aug. 31,
1927

Aug. 24,
1927

Sept. 1,
1926

F. R. notes in actual circulation 1,676,440 1,670,831 1,702,902
Deposits:
Member bank — reserve ac
count.............................. 2,298,880 2,305,727 2,223,902
19,247
Government..........................
12,699
24,326
5,536
4,935
Foreign bank.........................
15,166
Other deposits.......................
24,168
23,973
18,926
Total deposUe.................... 2,341,283 2,353,882 2,282,320
Deferred availability items.... 555,002 561,147 568,299
Capital paid in.......................... 130,727 130,730 123,490
Surplus...................................... 228,775 228,775 220,310
13,274
18,266
All other liabilities............. . . .
13,161
TOTAL LIABILITIES 4,945,388 4,958,639 4,915,587
Ratio of total reserves to de
posit and F. R. note liabilities
74.4%
combined...........................
78.3%
78.5%
Contingent liability on bills pur
chased for foreign correspon
165,746 162,087
44,875
dents...................................

weekly statements of the Federal Reserve Banks
should give the acute observer an index of business
conditions. The statements are available more
promptly than any other index of such wide scope
and afford an understanding of conditions which are
current and not several weeks past.
But the statement with its thirty-seven items is
a rather complicated affair and its full significance
is understood by relatively few people. One has
to be something of an expert to understand the
meaning of the changes from week to week in all
of the items.

300

THE RESERVE BANKS

For the less expert there are available in the Fed
eral Reserve Bulletin and in the Monthly Reviews
published by the several Federal Reserve Banks,
interpretations of the more significant features of
the statement. But even without these aids the
statement should yield some meaning to even the
casual reader. The problem is one of selection, of
knowing just what items of the thirty-seven are most
significant. Fortunately, such selection is possible.
Generally, the statements of the individual Reserve
Banks may be ignored and attention given solely to
the consolidated statement for all twelve Banks.
Moreover, the reader whose interest is general and
not technical may well ignore many of the items and
concentrate upon a few which reflect most directly
changes in the country’s business. Of these few
the most important is “Total bills and securities.”
Total Bills and Securities.—The nomenclature of
this item was changed in 1925 from “Total earn
ing assets” to “Total bills and securities.” It rep
resents the total amount of credit the Reserve Banks
are extending in the form of either loans or invest
ments. Its significance lies in its revealing cur
rently the adjustment between the country’s supply
of and demand for funds. When demand for funds
increases relative to supply, total bills and securities
go up; when demand declines relative to supply,
total bills and securities go down. They respond
even more promptly and accurately to changing
conditions than do interest rates.
The item “Total bills and securities” is our best
present substitute for the old statement of reserves
of the New York Clearing House. The clearing

AND THE MONEY MARKET

301

house statement, issued each Saturday, showed the
amount of reserves the clearing house banks were
required to keep to satisfy the percentages pre
scribed by law and showed actual reserves in rela
tion to these requirements. The most significant
figure was that for “excess reserves” beyond re
quirements, or in rare instances the deficit below
requirements.
Excess reserves represented the banks’ unused
lending power, the margin of possible expansion and
of safety. They were the point where the relation
between supply and demand could be measured.
When the demand for funds increased relative to the
supply, excess reserves declined. When demand de
creased relative to supply, excess reserves rose.
Since in those days New York was, even more than
at present, the storage place for the country’s re
serve funds, the reserve position of the New York
banks was an index of the national money situation.
In the old days prudent bankers, and business
men as well, followed closely the statement for ex
cess reserves of the New York banks. A decrease
in excess reserves was one of the surest signs of a
storm ahead. In the summer of 1907, for example,
a decrease in excess reserves from $8,700,000 in
August to an actual deficit preceded the panic which
broke in October. The very close relationship be
tween the reserve position of the New York banks
and interest rates was shown in Diagram 17 on page
116.
Since the Federal Reserve System has been in
operation the figure for excess reserves of the New
York City banks, though it is still published by the

302

THE RESERVE BANKS

New York Clearing House, has lost its old signifi
cance. The reason is that the banks no longer carry
any excess reserves, but simply the legally required
minimum, relying upon the Reserve Banks to help
them out in any emergency. Thus for week after
week, in good times or bad, when interest rates are
high or low, the excess average reserves of the clear
ing house banks appear in the Saturday statement
at a figure just above the legally prescribed amounts.
The statement has quite lost its old significance.
A word should be said about the clearing house
statement of actual reserves, as distinguished from
average reserves, for the meaning of this feature
of the statement, under present conditions, is fre
quently misunderstood. The figure for actual re
serves gives the position on Friday night. In the
old days it was interesting to compare the Fridaynight position with the average for the week, to see
whether the reserve position was getting better or
worse during the week.
In the statement as published today the average,
as indicated above, shows little change from week
to week, but the actual figure for Friday night fre
quently fluctuates widely and shows excesses of as
much as 75 million dollars and at times shows
deficiencies. A study of these changes in actual re
serves shows that they bear no consistent relation
to money conditions. Money is frequently tight
when there are excess reserves on Friday and easy
when there is a deficiency of actual reserves. The
explanation is simple. This excess or deficiency
is the result of changes in the amount the banks are
borrowing from the Reserve Bank. Sometimes re-

AND THE MONEY MARKET

303

serves are allowed to run below requirements early
in the week. Then, to bring average reserves up to
requirements for the week, which ends on Friday
for purposes of computing reserves, the banks bor
row heavily at the Reserve Bank on Thursday and
Friday, and the report for Friday night shows a
large excess reserve, due solely to heavy borrowing
at the Reserve Bank. Conversely, a deficit in ac
tual reserves on Friday night may result from excess
reserves early in the week, as a consequence of
which the banks repay some of their borrowing at
the Reserve Bank, and still finish the week with
average reserves equal to or above legal require
ments. Thus the position of actual reserves reflects
largely changes in borrowing at the Reserve Bank
and has none of its old significance.
As the usefulness of the New York Clearing
House statement has diminished as an index of the
money situation, a substitute has appeared in the
Federal Reserve statement. The figure for total
bills and securities of the Reserve Banks is an index
which corresponds somewhat to the old figure for
excess reserves. The country's reserve funds are
stored in the Reserve Banks and the figure for total
bills and securities shows how much of these -funds
is being put to work by the extension of credit based
upon them. Just as the wise banker or business
man used to proceed a little more cautiously when
excess bank reserves dwindled, and more freely
when excess reserves were large, so today he may
well act with more caution when total bills and
securities of the Reserve Banks are high and rising
and move more freely when they are low.

304

THE RESERVE BANKS

A Reflection of Business Activity.—Total
bills and securities, since they represent the total
amount of credit the Reserve Banks are extending
to the member banks or the money market, respond
quickly to changes in business. For when business
expands it needs more currency and credit, and when
it contracts it needs less. They also reflect changes
in the supply of credit from such causes as gold im
ports or exports—ordinarily not a large factor, but
important in recent years. Business changes usually
dominate.
It is the additional demand for currency which
always accompanies increasing business that ordi
narily makes necessary increased use of Federal Re
serve credit. This was illustrated in Diagram 10,
on page 49.
Because they reflect changes in currency and
credit demands these total bills and securities have
a characteristic seasonal movement as is shown by
Diagram 46. Each succeeding year duplicates to a
considerable extent the movement of preceding
years. When business is dull in January and cur
rency returns from holiday circulation, the banks
repay some of what they have borrowed from the
Federal Reserve Banks; when spring comes they
call upon the Reserve Banks more largely for
credit; in midsummer, when trade is quiet, the bills
and securities of the Reserve System are reduced;
then, in the autumn, trade expansion is followed
by an increased call on the Reserve Banks cul
minating in a large expansion to meet currency
needs at Christmas time. In order that the reader
of the Federal Reserve statement may make allow-

AND THE MONEY MARKET

305

ance for seasonal tendencies, the statement gives
each week not only the figures for the preceding
week, but also the figures for the corresponding week
a year ago.
PER CEM

S&KSO^KL NKKLMROW IN BUSINESS, AND CHANGES IN BUSINESS CON

DITIONS AS WELL.

Diagram 46 illustrates not only the seasonal
variations, but also the promptness with which total
bills and securities reflect changes in business. All

306

THE RESERVE BANKS

during the greater part of 1926 they ran ahead of
1925, and then in October they dipped down and
began to run behind 1925. It was one of the earli
est evidences of a temporary slowing down in busi
ness, which was revealed clearly as the production
figures appeared later.
Important Subdivisions.—The total of bills and
securities is made up of three principal items:
1. Total bills discounted.
2. Bills bought in the open market.
3. Total U. S. Government securities.

■ “Total bills discounted” represents the amount
which member banks are borrowing directly at the
Federal Reserve Banks. It is the amount of Federal
Reserve credit in use for which the member banks
feel direct responsibility. The importance of this
item was discussed in Chapter VII, where it was
pointed out that the money market is very sensitive
to changes in it. For when the member banks are
heavily in debt at the Reserve Banks they are con
stantly striving to get out of debt; they are calling
loans, selling investments, and are a bit cautious in
their lending. Conversely, when the member banks
owe little to the Reserve Banks they lend more
freely and money tends to be easier. There is,
therefore, a close correlation between money rates
and total borrowings of member banks at the Fed
eral Reserve Banks, represented in the statement by
"Total bills discounted.” Thus, "Total bills dis
counted,” is a good index of the condition of the
money market. Increases in this item are prophetic

AND THE MONEY MARKET

307

of rising interest rates, and decreases are prophetic
of falling interest rates.
“Bills bought in the open market” reflects two
things: conditions in the bill market and, more gen
erally, conditions in the money market. The par
ticular conditions which give rise to larger holdings
of bankers’ acceptances by the Reserve Banks have
been described in Chapter VIII. It should perhaps
be reiterated that these holdings of bills do not or
dinarily express the direct operation of Federal
Reserve policy. The initiative in the purchase of
bankers’ acceptances by a Reserve Bank is taken not
by the Reserve Bank itself, but by member banks
and dealers. The holdings thus respond directly to
conditions in the market.
“Total U. S. Government securities” held by the
Reserve Banks reflects largely Federal Reserve open
market policy, as it was described in Chapter XII.
Increases in holdings of government securities or
dinarily reflect an effort on the part of the Reserve
Banks to bring about somewhat easier money condi
tions, and conversely, decreases in these holdings
indicate an attempt to bring about firmer money
conditions. There are three important exceptions to
this interpretation of the figures. The first excep
tion arises from the occasional purchase by the Re
serve Banks of securities under sales contract. As
was described in Chapter VI, purchases of this sort
are made in order to provide the market for govern
ment securities with funds when money tightens
temporarily. Such purchases are initiated by the
dealers in government securities and are thus in a
sense involuntary, as far as the Reserve Banks are

308

THE RESERVE BANKS

concerned, and are similar in character to the pur
chases of acceptances from dealers. The second ex
ception takes place at the quarterly tax dates. At
those times the Treasury usually has to pay out
large sums of money to redeem maturing issues be
fore it has received the returns from income taxes.
To bridge the gap the Treasury borrows from the
Reserve Banks by selling to them temporary one-day
certificates of indebtedness, and these appear in the
weekly statement in the holdings of government
securities. Increases in such holdings, due to this
cause, do not in any way represent open-market
policy, but are temporary accommodations extended
to the Treasury Department. Still a third exception
is the case when purchases or sales of securities are
used to offset such influences on the market as gold
exports or imports. But with these three exceptions
changes in holdings of government securities reflect
policy.
Thus, these three types of loans and investments
of the Reserve Banks have different meanings and
each of them tells some story about the condition of
the money market or Federal Reserve policy.
Currency.—It is possible from the Federal Re
serve statement to find out each week approximately
the increases or decreases in the amount of money
in circulation in the country—a most important eco
nomic fact, for currency in circulation reflects
changes in payrolls, and payrolls reflect changes in
industrial activity. Figures for currency in circula
tion frequently explain the causes of changes in total
bills and securities.
But the drawing out from the statement of cur-

AND THE MONEY MARKET

309

rency figures is not as simple as it looks. One might
suppose that he could look at the one item, “Fed
eral Reserve notes in actual circulation,” and find
therein a record of changes in the total amount of
money in circulation, but that is not the case. Two
other items have to be considered; “Total reserves”
and “Non-reserve cash,” for these items include vari
ous kinds of currency (except Federal Reserve
notes) which may be paid into circulation. An in
crease in reserves and non-reserve cash usually indi
cates a decrease of money in circulation, and vice
versa, but there is a still further qualification that
has to be made. The reserves of the System increase
or decrease not alone as a result of the payments of
currency into circulation, or the return of currency
from circulation, but they also reflect gold exports
or imports. Thus, the first step is to make allowance
for changes due to gold imports or exports, which is
possible since the total exports and imports at the
Port of New York are given out every Thursday
afternoon by the Federal Reserve Bank of New
York. After this correction has been made, changes
in money in circulation can be computed roughly
from total reserves, non-reserve cash, and Federal
Reserve notes in actual circulation. The computa
tion is subject to some error because of the possi
bility of gold earmarkings and exports and imports
from other parts of the country than New York and
several other less important transactions, but the
error is usually a small one.
Deposits.—The four deposit items which appear
in the Federal Reserve statement are not ordinarily
of general public interest, but they are of interest to

310

THE RESERVE BANKS

the careful student of the money market. The
member-bank reserve account represents deposits of
member banks with the several Federal Reserve
Banks to satisfy the law as to bank reserves, which
requires them to maintain with the Federal Reserve
Banks deposits in proportion to their liability for
their customers’ deposits. Variations in the amount
of this item reflect changes in the amount of bank
deposits throughout the country. Over a long term
of years they tend to increase gradually as bank
deposits increase with the growth of the country,
and in periods of credit expansion these reserve de
posits reflect rapidly increases which will be shown
in member-bank deposits published later. Week to
week fluctuations are mostly due to temporary sur
pluses of reserves on certain days and temporary de
ficiencies of reserves on other days, which average
out over a period of weeks.
Government deposits represent the working bal
ance of the United States Government with the Fed
eral Reserve Banks, against which the government
draws checks* for current payments of various kinds,
ranging from pensions to purchases of commissary
supplies. When these government deposits are de
pleted they are restored by calling in deposits from
depositary banks, where deposits have been created
by the sale of government short-term issues for book
credit. The item “Government deposits” usually
shows little fluctuation and is maintained at a figure
generally between 10 and 30 millions. Sometimes
it runs above that amount, when the Treasury is
receiving income taxes more rapidly than it dis
burses or reinvests the money, and on such occasions

AND THE MONEY MARKET

311

an increase in government deposits to 70 or 80
millions is frequently accompanied by firm money
conditions because this money is drawn out of the
money market. But this is a rare occurrence and
ordinarily the item is an unimportant one. It is
only when it reaches unusual size that it becomes a
factor in explaining tendencies in the money market.
Foreign bank deposits are the deposits placed
with the Reserve Banks by foreign banks of issue,
largely to meet their current payments in this mar
ket. In late years, as was indicated in Chapter XIV,
foreign banks of issue have kept considerable sums
in this country, but most of these sums are in the
form of investments, and the balances maintained
with the Reserve Banks are simply working bal
ances. The amounts invested by the Reserve Banks
for these foreign banks are not reported upon ex
cept as they appear in the last item in the state
ment, “Contingent liability on bills purchased for
foreign correspondents.” A part of the funds which
the Reserve Banks have invested in this country
for foreign correspondents has been invested in
bankers’ acceptances, and when these carry an ob
ligation of the Federal Reserve Bank they are
shown as a contingent liability. Foreign bank de
posits are ordinarily a small item and fluctuate but
little, but any fluctuations have the same effect on
the money market as fluctuations in government de
posits.
Other deposits represent largely the deposits of
non-member banks, which have clearing accounts at
the Reserve Banks. This is an item which also fluc
tuates very little.

312

THE RESERVE BANKS

Collection Accounts,,—1Two other comparatively
large items in the statement which have not been
commented upon have to do with the operations
of the Reserve Banks in handling checks for collec
tion. On the resources side an item appears as “Un
collected items,” which represents the checks which
the Reserve Banks have received for collection, but
for which they have not been reimbursed. On the
liabilities side another item appears as "Deferred
availability items,” for the proceeds of these un
collected checks are to be credited to member-bank
accounts at the end of certain specified periods, in
accordance with the time schedule which was de
scribed in Chapter V. The amount for “Uncollected
items” is always a little larger than that for the
“Deferred availability items,” for the Reserve Banks
are constantly giving banks credit for the checks
deposited with them, in accordance with a time
schedule and without waiting for the actual collec
tion of the checks. The time schedule is a little
more generous than the time which is in fact re
quired to collect the checks, and thus the Reserve
Banks currently advance a small amount of funds
to the banks.
Reserve Ratio,,—1
The reserve ratio is the ratio of
the total reserves of the Reserve Banks to their
liability for deposits and notes in actual circulation.
This ratio is of importance because the law pre
scribes that a ratio of 35 per cent of gold or law
ful money must be always maintained against de
posits, and a ratio of 40 pet cent in gold against
note circulation. In the published statement the
percentages against notes and against deposits are

AND THE MONEY MARKET

313

not treated separately, but are lumped together for
purposes of convenience. In recent years the re
serve ratio has had little significance because the
reserves of the System have been so large that
fluctuations in the reserve ratio could be completely
disregarded in the determination of Federal Re
serve policy.
Using the Statement.—The Federal Reserve state
ment, as must have appeared from this discussion,
is not a simple affair. It cannot be simple because
it is an epitome of the nation’s banking affairs, which
are not simple. It has been suggested here that the
casual reader can learn much of the current trends
in business and finance if he will observe the move
ment of a few items in the statement, including
total bills and securities, bills discounted, total gov
ernment securities, and possibly the movement of
currency, as revealed in total reserves and Federal
Reserve notes in circulation. These items tell a
revealing story of the changes in the nation's busi
ness and finance.
For the more expert student of the money mar
ket, other items in the statement will assume sig
nificance. The Federal Reserve Banks represent
practically the only avenue through which funds
may be put into the money market, or through
which funds may be withdrawn from the money
market. And it is possible from the weekly state
ment to compute the gains and losses to the money
market each week in much the same way as these
computations are made in Chapter IX.
As an added explanation of some of the items in
the statement, concerning which little has been stud

314

THE RESERVE BANKS

in this chapter, there is included as an appendix
to this book a statement quoted from the annual
report of the Federal Reserve Bank of New York,
which attempts to explain briefly the significance
of each item in the statement
SUMMABY

1. The Federal Reserve System publishes one of
the most complete weekly statements of any
bank of issue in the world.
2. This statement reflects each week the country’s
banking operations and indirectly the movement
of business.
3. The most significant single item in the state
ment is “Total bills and securities,” which shows
the total amount of credit extended by the Re
serve Banks.
4. “Total bills and securities” today takes the place
of the reserve statement of the New York Clear
ing House banks as the best index of the coun
try’s credit position.
5. “Total bills discounted” represents total bor
rowing by member banks at the Reserve Banks
—■
the amount of Reserve Bank credit in use for
which member banks feel direct responsibility.
6. “Bills bought in the open market” reflects con
ditions in the bill market and in the money
market generally.
7. “Total U. S. Government securities” reflects
largely Federal Reserve open-market policy.
8. Changes in money in circulation can be esti
mated from the Federal Reserve statement by
combining changes in “Federal Reserve notes

AND THE MONEY MARKET

315

in actual circulation” with changes in "Total
reserves” and “Non-reserve cash” after allow
ance for gold exports and imports.
9. Changes in the four deposit items are primarily
interesting because increases in these deposits
withdraw funds from the money market and
decreases put funds into the market.
10. The reserve ratio has had little significance in
recent years. Reserves have been so large that
the ratio could be ignored in determining policy.
11. Since the Reserve Banks are practically the only
avenue through which funds may be added to
or withdrawn from the money market, a care
ful analysis of the statement reveals the causes
of money market changes.

APPENDIX A

DIAOBAM 47—FBBCBNTAOB OF BSSBBVBS TO NBT DEMAND AND TIME

deposits of national banks in bbsbbvb cities.

(St. Louis included throughout; prior to July 1, 1922, it was classi
fied as a central reserve city.)

APPENDIX A.—।
Continued

DEPOSITS OF NATIONAL BANKS IN THS CENTRAL BB8SBVB CtTnBS,
NSW YORK AND CHICAGO.

DIAGRAM 60—PERCENTAGE OF RE8XRVK8 TO NET DEMAND AND TW

DSP0BIT8 OF ALL NATIONAL BANKS.

APPENDIX A—Continued

DIAGRAM 51—BANKERS* BALANCES IN NATIONAL BANKS IN NEW TOM
CITI (MANHATTAN) IN DOLLARS AND IN PER CENT OF NBT DEMAND
and time deposits.

(Nearest date to June 30 each year.)

APPENDIX B
Table 18—Statement of Condition Federal
Reserve Bank of New York
Reeooecw

Deo. 31. 1926

Dee. 31, 1925

Cam Rnmhver held by this bank

against its deposits and note cir
culation:
Gold held by the Federal Reeerve
Agent as part of the collateral de
posited by the bank when it obtains
Federal Reserve notes. This gold
is lodged partly in the vaults of
the bank and partly with the
Treasurer of the United States... 8
Gold redemption fund in the hands
of the Treasurer of the United
States to be used to redeem such
Federal Reserve notes as are pre
sented to the Treasury for redemp
tion....................................................
Gold and gold certificates in vault...
Gold in the gold settlement fund
lodged with the Treasurer of the
United States for the purpose of
settling current transactions be
tween Federal Reserve districts...
Legal tender notes, silver, and silver
certificates in the vaults of the
bank (available as reeerve only
■Satinet deposits)...........................

383,987,466.59

8 829,996,016.59

15,197,976.79
439,891,808.08

18,516,129.74
331,325,694.40

223,474,611.85

254,226,803.87

22,523,994.00

37,256,282.00

Total cash reserves......................

984.075,856.76

8 956,220,926.60

Non-reserve cash consisting largely of
national bank notes, and minor coin

15,893,779.00

16,966,978.42

146,589,450.00

197,709,000.00

Loans and Investments:

Loans to member banks:
On the security of obligations of
the United States.....................
By the discount of commercial or
agricultural paper or acceptances
Acceptances bought in the open
market.......................... ..................
United States Government bonds,
notes, and certificates of indebted-

Foreign loans on gold...........................
Total loans and investments....

87,935,764.92

85,234,620.12

101,443,211.79

42,019,987.59

58,868,750.00

57,199,050.00
2,106,000.00

344,782,176.71

16,276,254.61

334,268,607.71

Miscellaneous Resources:

Bank premises....................................
Checks and other items in process of
collection..........................................
All other miscellaneous resources ...

Total miscellaneous resources... 8
Total resources...............................

206,515,083.65

81,551,366,896.13

16,617,060.69

170,992,613.34
4,162,451.37

188,450,3^.86
1,788,471.18
1

191,772,124.30

81,499,238.637.08

APPENDIX B—Continued
Table 18—(Continued)
LiABiLxrxae

Dee. 31.1926

Dec. 31. 1935

None nt Cxbculattoic:
Federal Reserve notes in actual cir
culation, payable on demand.
These notes are secured in full by
gold and discounted and purchased

Total notes in circulation............

416,874,133.50

393.036,813.50

416,874,12250

393,036,812.50

835,959,724.96

8 847,348,506.07

498,341.80

3,183,106.57

Deposits:

Reserve deposits maintained by
member banks as legal reserves
against the deposits of their cus
tomers ...............................................
United States Government deposits
carried at the Reserve Bank for
current requirements of the TreesOther deposits including foreign de
posits, deposits of nonmember
banks, etc.........................................

Total deposits.................................

11,282,630.44

34,844.167.75

871,302,234.51

861,714,242.08

162,884,891.11
2,142,447.92

•

150,262,580.52
1,856.109.53

165,027,339.03

152,118,690.05

36,449,350.00

32,394,500.00

92,358,892.40

Miscellaneous Liabilities:

Deferred items, composed mostly of
uncollected checks on banks in all
parts of the country. Such items
are credited as deposits after the
average time needed to collect
them elapses, ranging from 1 to
8 days...............................................
All other miscellaneous liabilities... .

Total miscellaneous liabilities...
Capital and Surplus:

Capital paid in, equal to 3 per cent,
of the capital and surplus of mem
ber banks.........................................
8
Surplus—That portion of accumu
lated net earnings which the bank
is legally required to retain........

61,613,950.08

Total capital and surplus............

98,063,200.08

Total liabilities...............................

81,551,266,896.13

59,964,392.40

81,499,328,637.08

INDEX
Acceptances, bankers'. See Bill
market
Advisory Council, Federal, 174
Agricultural paper as security
for Federal Reserve notes,
44
Agriculture, use of acceptances,
133
American. Acceptance Council,
estimate of bills outstand
ing, 128
Ayres, Leonard P., quoted as
to effect of System on in
terest rates, 284

Balances, bankers’, in relation
to deposits, App. A
due from banks, as reserves,
33
due to banks by national
banks, App. A
foreign in New York City,
_ 269
Bank deposits. See Deposits
Bank examinations, use in
credit policy, 234
Bank of Belgium, credit to, 267
Bank of England, credit to, 264
relation of rate to market,
188, 193
Bank reserves. See Reserves
Bankers’ acceptances. See Bill
market
Bankers’ balances. See Bal
ances
Belgium, credit to, 267
Bill dealers, relation to Reserve
banks, 140

Bill market, description of, 126
place in New York money
market, 119
relation to call money mar
. ket, 143
size of, London, 129; United
States, 127
Bills, amount held by Reserve
Banks, 145
financing of exports by, 132
financing of farm products
by, 133
maturity of, 142
policy in purchase of, 207
rates for, 138
rates for compared with dis
count rate, 192
who buys them, 139
Bills and securities of Reserve
Banks, meaning of, 300
rate of turnover at Reserve
Bank of New York, 124
Borrowing, by member banks,
principles governing, 231
in excess of capital and sur
plus, 235
number of borrowing banks,
234
'
tradition against, 182
British money market, com
parison with U. 8., 147
Bureau of Engraving and
Printing, 61
Business, activity, as reflected
in Federal Reserve state
ment, 303
conditions, influence on dis
count rate, 197

821

322

INDEX

Business, cycle, effect of Re
serve System upon, 393
settlements, 65
Call money market, 119
relation to bill market, 143
Call rate, relation to bank re
serves, 153
Canada, number of banks in, 24
Canadian Banking System, pro
posal to adopt in U. S., 1
Canadian currency, elasticity
of, 53
Cash in vault as reserves, 31
Cash reserves of New York
City banks, 47
Certificates of indebtedness,
amount issued, 106
open market for, 107
special, 90
Check collections, delay, 71
interest charges, 69 .
Check settlements, 65
Checks, exchange charges liti
gation, 80
routing of, 71
Christmas demand for cur
rency, 57
Circulation. See Currency
Clearing-house banks, relation
of reserves to time money
rate, 116
Clearing-house report, changed
meaning of, 4, 300
Clearing houses, growth and
volume of operations, 67
Collection accounts of Reserve
Banks, 311
Collection system, mechanism
of, 72
Collections, 65
delay in, 71
methods of, under Reserve
System, 72
Commercial paper market,
place in money market,
119

Commercial paper outstanding,
138
Commercial paper rates, com
pared with discount rate,
192
in relation to bill rates, 138
relation to discounts, 184
since 1830, 276
spread between maturities,
281
Conferences of governors and
chairmen of Reserve
Banks, 174
Coupons, Treasury, paid by
Reserve Banks, 88
Credit departments, Reserve
banks, 28
Credit, effect on discount rate,
195
expansion on basis of gold,
253
to Bank of England, 264
to National Bank of Bel
gium, 267
use of, affecting discount
rate, 196
volume of, adjustment to
business, 168
Credit policy, dealing with in
dividual broke, 230
mechanism of, 168
open market operations, 206
tradition and the discount
rate, 179
use of bank examinations in,
234
Currency, changes due to Re
serve System, 41
changes in gold certificates in
circulation, 257
characteristic movements, 56
Christmas demand for, 57
daily movement of, 59
elasticity of, 51, 53
expense of, 62
greenbacks, 43

INDEX
Currency, in circulation, as re
vealed by Federal Reserve
statement, 308
mechanism for supplying, 48
national beak notes in circu
lation, 42
operations, size of, 61
security behind, 43
silver certificates, 42
storage place for, 45

Dealers in bills, relation to Re
serve Banks, 140
Deposits, and prices, 247
growth of, 36, 37
of Federal Reserve Banks,
character of, 300
rate of turnover in New
York City, 112
ratio of, to gold stock, 35
relation to gold, 243
time, character of, 39; growth
of, 37
Directors of Reserve Banks,
method of appointment, 12
selection and character, 172
Discount market. Se$ Bill
market
Discount policy in relation to
gold, 269
,
Discount rate, affected by vol
ume of credit, 195
and open market operations,
224
compared with commercial
paper rates and bill mar^
ket, 192
effects of, 201
influence on money market,
122
influenced by international
conditions, 199
principles determining, 175,
179
relation to gold movements,
249, 259
relation to market rates, 188
relation to prices, 198

323

Discount rate, relation to re
serve ratio, 186
significance of, 183
Discounted paper, statements
by makers of, 28
Discounts, of Reserve Banks,
general character of, 28
relation with money rates,
183
Disposition of earnings of Fed
eral Reserve Banks, 21, 22
District map, 10
Dividends paid by Federal Re
serve Banks, 18, 21, 22
Dollar exchange, bills drawn
for, 132
Domestic exchange, 81
Drafts, purchase of, to pay bills,
65

Earnings of Reserve Banks,
disposition of, 21, 22
how affected by open mar
ket operations, 213
Economic information, use of
by Reserve System, 176
Economy in reserves, 30
Elasticity of currency, 51, 53
Elasticity of reserves, 27
Eligible paper, amount of, 180
Employees in Federal Reserve
System, number of, 9
England, Bank of, credit to,
264
Engraving and Printing, Bu
reau of, 61
Examinations of banks, use in
credit policy, 234
Examiners of Federal Reserve
Banks, 28
Exchange charges, cause re
moved, 75
in check collections, 70
litigation over, 80
Exchange, domestic, 81
Expansion of credit on basis
of gold, 258

324

INDEX

Expenses of Reserve Banks, 21,
22
Exports, financed by bills, 132

Fann products, financed by
bills, 133
Federal
Advisory
Council,
function of, 174
Federal funds, market for, 120
Federal Reserve Act, amend
ment in 1917, 31, 35
Federal Reserve Board,
function in coordination of
System, 171
function of, 9
sets forth principles of open
market operations, 217
statement on dealing with in
dividual banks, 231
Federal Reserve collection sys
tem, mechanism of, 72
Federal Reserve Districts, map
of, 10
Federal Reserve gold policy,
253
Federal Reserve notes.
See
Currency
Federal Reserve policy, mecha
nism of, 168
Federal Reserve wire transfer
system, 81
Fiscal agency operations, 87
Foreign balances in New York,
269
France, number of banks, 24
Franchise tax, payment of, by
Reserve Banks, 21, 22
Germany, number of banks, 24
Gold, exports, effect of, 245,
271
.
.
imports, offsetting reduction
in reserves, 34
in circulation, 257
primary expansion on the
basis of gold, 254
relation to bank deposits, 243

Gold, secondary expansion on
the basis of gold, 253
Gold certificates, circulation,
42, 257
circulation at Christmas time,
57
Gold exchange standard, 269
Gold movements, before the
war, 241
offset by open market opera
tions, 227, 259
relation of discount policy to,
259, 249
relation to prices, 240
relation to Reserve credit,
246
Gold paradox, 240
Gold policy of Reserve Banks,
253
Gold standard, aided by Re
serve Banks, 261
Great Britain, return to, 264
stabilisation of world on, 269
Gold stock, ratio of, to bank
deposits, 35
Government, relation of Re
serve Banks to, 11, 12
Reserve Banks as bankers
for, 87
Government securities.
See
U. 8. Government securi
ties.
Greenbacks, 43
Great Britain, number of banks
in, 24
return to the gold standard,
264
'
Growth of Reserve Bank oper
ation, 19, 21
Imports, financed by bills, 132
Individual banks, method of
dealing with, 231
Inland exchange, 81
Interest charges in check col
lections, 69

INDEX
Interest rates,
average level of, 280
charged by banks in New
York and Chicago, 287
history of, in United States,
276
how affected by Federal Re
serve System, 275
in New York and Western
centers, 285
Leonard P. Ayres quoted as
to effect on System, 284
money rates in New York
and London, 193
relation of money rates to
bank reserves, 115, 153
relation of money rates to
discounts, 183
seasonal movement of, 289
spread between maturities,
281
See also
Bills, rates for; Call rate;
Commercial paper rates;
Discount rate
International conditions, affect
ing policy, 262
Liberty bonds, total sale of, 106
Loans to member banks,
general character of, 28
principles governing, 231
Local autonomy in Federal Re
serve Bank policy, 170
London, and New York mar
kets compared, 188
and New York money rates,
193
bill market, size df, 129

Map of Federal Reserve Dis
' ■ tricts, 10
Marginal difference, illustrated
by money markets, 112,
_
163
Market for money, See Money
market

325

McCulloch, Hugh, quotations
from report, 93
Membership, of state banks,
requirements for, 16
in Reserve System, number
and resources, 12-18
Money in circulation.
See
Currency
Money market, affected by
Treasury operations, 94, 99
161
analysis of changes in, 150
comparison of British with
U. S., 147
description of, 110
government security market,
place in, 119
influence of discount rate on,
122
'
place of commercial paper
market in, 119
structure of, 119
Money rates. See Interest rates
Mutual savings banks, growth
of deposits in, 37
National Bank Act, reserve re
quirements under, 31
National bank notes in circula
tion, 42
New York and London money
markets compared, 188
New York City banks, cash re
serves of, 47
deposits turnover, 112
■
place in money market, 113
New York Clearing House,
meaning of statement, 4,
300
New York Clearing House
banks, relation of reserves
to time money rate, 116
New York money market, de
scription of, 110
New York money rates com
pared with London, 193

INDEX
326
Reserve adjustment, methods
Open market, powers of Re
of, 155 .
_ t
serve Banks in, 363
Reserve funds, impossible to
Open market investment com
trace, 180
mittee, 121, 215
Reserve position, adjustment
Open market operations, 206
of, 142, 154
and the discount rate, 224
Reserve ratio, as affected by
at quarterly tax period, 226
currency, 51
effects of, 206 220
mes-aiag of, 312
offsetting gold movements,
relation to discount rates, 180
227
•
Reserves,
24
principles governing, 217,
balances due from ;«ix», *
Open market policy in relation
cash in vault as, 31
.
to gold, 227, 250
cash of New York City
Operations of Reserve Banks,
banks, 47
gise of, 19, 20
changes in amount, App. A
economy in, 30
Panics, first appear in money
elasticity of, 27
market, 112
percentage of, required on de
Par payment. See Exchange
mand deposits, 31
,
charges
reduction, offset by gold im
Policy, Federal Reserve, af
ports, 34
fected by international
relation to money ibarket,
conditions, 262
151, 153
local autonomy in, 170
surplus, meaning in Clearing
mechanism of credit, 168
House statement, 115; re
open market operations, 206
lation to time money rates,
tradition and the discount
116
rate, 179
Reserves of banks in other
with individual banks, 230
countries, 36 _ _
Pre-war gold movements, 241
Reserves
of New York City
Prices, and bank deposits, 247
banks, relation to time
and gold movements, 240
money rates, 116
relation to discount rate, 198
Resources
of member banks,
Primary expansion on the basis
12-17
of gold, 254
Rediscounting, tradition
Profits, Reserve Banks not in
against, 182
terested in, 170, 174
Publicity by Reserve Banks, Release of funds through re
duced reserves, 24
237
Reports made by Reserve
Banks, statistical, 237
Quarterly tax period, effect of
Reports
of Reserve Banks,
on money market, 99, 161
statement of condition, 297
open market operations at,
Retail trade, relation to cur
226
rency, 54
Bate of discount. See Dis Routing of checks indirectly,
71
count rate

INDEX

327

Savings deposits, growth of, 36, Tax period, effect on money
37
market, 99, 161
Seasonal movement, business
open market operations at,
and interest rates, 289
226
Seasonal variation in currency, Telegraphic transfer system, 81
Time deposits, character of, 39
53
Secondary expansion on basis
growth in, 37
of gold, 253
Time money rates, relation to
Security behind currency, 43
bank reserves, 116
Self-government, respected by Total bills and securities,
Reserve System, 170
meaning of, in statement,
Silver certificates, 42
300
Sue of operations of Reserve Trade, relation to currency, 54
Banks, 19, 20
Tradition against borrowing,
Special certificates of indebted
182
Transfer of funds by wire, 81
ness, 90
Stabilisation of world on gold Treasury, bonds and notes,
standard, 289
amount issued, 106
Stamp, Josiah, quoted as to
borrowing from Reserve
gold policy, 241
Bank, 104
coupons, paid by Reserve
State bank membership, re
quirements for, 16
Banks, 88
Statement of condition, Re
experience in banking agency,
serve Banks, meaning of,
91
297, 298, 300
financing, effect on money
Statement by makers of dis
market, 94, 99, 161
counted paper, 28
independent, 93
Statistics, reports made by Re
operations, effect of, on
serve Banks, 237
money market, 94
use of by Reserve System,
Reserve Banks as bankers
175
for, 87
Stock exchange money market, Treasury certificates, open mar
119
ket for, 107
Stock in Reserve Banks, owner
rates in relation to bill rates,
ship of, 12
138
Subtreasuries, taken over by
United Kingdom, number of
Reserve Banks, 105
banks, 24
Surplus funds, employment of,
in money market, 110
United States Government se
Surplus of Reserve Banks, 21,
curities, certificates of in
22
debtedness, amount, 106
Surplus reserves, in Clearing
certificates of indebtedness,
House statement, meaning
open market for, 107
of, 300
certificates of indebtedness,
relation to time money rates,
special, 90
116
effects of purchase of, 209

328

INDEX

United States Government Se
curities, Liberty bonds, total
sale of, 106
meaning of in statement, 307
place of in money market, 119
policy in purchase of, 208
Treasury bonds and notes,
amount issued, 106
United States Government se
curity market, place in
money market, 119
United
States
Government.
See also Treasury
United States notes, 42
Use of Reserve funds, impos
sible to trace, 180
Velocity of bank deposits in
New York City, 112

Volume of credit, adjustment
to volume of business, 168
Volume of operations of Re
serve Banks, 19, 20
Voluntary holdings of bills and
securities by Reserve
Banks, 212

Wages, relation to currency, 54
War service of the Reserve
System, 103
Warehouse credits through bill
market, 132
Weekly statement of condition,
meaning of, 297
Wire transfer of funds, 81
Withdrawals from Reserve Sys
tem, 15