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852 Released for publication v'hon delivered but net earlier than 12.00 o' clock noon, Oct. 24, 1916. -- oOc-- THE FEDERAL RESERVE SYSTEM: LOOKING AHEAD (Managing the gold supply to meet a foreign drain) Address of A. 0. IJ I L L E R Member of the Federal Reserve Board. -- oOo--Delivered Oct. 24, 1916 at the Annual Convention of the INDIANA BANKERS * ASSOCIATION at Indianapolis 852 TABLE OF CONTENTS. Page 1. Changing position, o? the United States in international finance. 1 2. Problem of dealing with our gold supply. 5 3. Europe's need of our gold after the war, 6 4. How will Europe recover gold. 11 5. Our problem to regulate, not to prevent gold outflow. 15 6. Estimated dimensions o5 gold outflow. 16 7. Gold position of the United States and the new banking system 1.7 8. How the Reserve Banks can handle the situation 15 9. Member banks should increase reserve deposits with Reserve Banks 24 10. Mobilizing the floating gold supply of the coianunity. 26 11. European securities held here as offset to gold demands. 30 12. Protecting the situation by Reserve Bank discount rates. 31 Summary and conclusion. 34 85L M L F S J Z M L Re s e t s system look rag ahead. (Managing, the_ gold, sup piv to meet_ a foreign drain) "The European .-ar has pushed forward the day on which America has taken its place as a leader in the international money market, and its banking system had, in the very nick of time, beer reorganise,d in such a way that it is ready to face the problems of in ternational finance...... The new system came into being at a time of stress, and so far has faced i.d.th admirable composure and success a series of problems for which no experience could have prepared it. America is now one of the leading powers in international finance, and on the wise and skillful use of its strength the future prosperity of the civilized world will, to a great extent, depend." These 'words, quoted from a recent book on international finance by Hartley 7ithers, England's most brilliant financial writer, reflect the growing appre ciation of the profound alteration which has taken place in the posi tion of our country in the sphere oi international finance resulting from the disorganisation and dislocation in established relationships and ways of doing things growing out of the great war. Mr. VJithers has not exaggerated the change in our situation and the new responsi bilities with which our country is being confronted in the region of world finance. The world has changed r:uch during the two years since the Federal Reserve System was put into operation, and there is every evidence that it is going to keep on changing at a rapid pace and for a long time, to come. ” 'e are right now in the midst of a most acutely SL'3 -2transitional position - more marked than any that has evsr hitherto overtaken our foreign coranerce. Our commerce is changing and will keep on changing, not only in its magnitude but in its character; we shall be trading in new things and with new countries and our indus tries are changing to keep pace -with our commerce. And since the country’ s obligations and opportunities in the field of international finance depend upon its position in international commerce, it is clear that our banking machinery must change and gain in strength to accommo date our expanding and changing commerce. have lived through a generation. In the last twq years, we Changes in our banking methods and the scope of banking operations which were foreshadowed in the Federal Reserve Act, and for y/hich provision was then made for the first time in the history of American banking legislation, are coming with a speed which was not anticipated and which could not have been anticipat ed. Before the outbreak of the European war, our country had very lit tle to do in the field of international finance except as a borrower and so it had no occasion to develop the machinery of international banking. It sought such international banking facilities as it re quired from other countrin;j/ and took then on such terms as were given. American banking had been developed strictly on domestic lihes as an incident to the internal development of the country’ s industry and trade. The country was so large and rich, and offered so attractive a field for the investment of capital at home, that it left little or no margin of surplus banking capital for foreign operations, but instead attracted immense investments of foreign capital to it. As long as this condition continued v/e were content to let other countries take d52 -3- care of the business of international banking so far as our needs were concerned, for much the same reason that we were content to let other countries supply our needs for ocean carrying service. More than one occasion, however, had shown that the time was approaching when our country must look to its own facilities and resources for a larger measure of accommodation in international bank ing. The dependence upon foreign countries was being felt to be pre carious. The Federal Reserve Act, therefore, undertook to create agencies which would give to the banking machinery of the country a greater measure of control over those factors in international finance which were of consequence to the stability and ease of American trade. For this purpose, it authorised National banks to establish foreign branches; for the first time it authorized National banks to accept against transactions arising out of the foreign trade of this country; in brief, created "dollar exchange". And what is perhaps destined to be of equal importance with either of these, it authorized the Federal Reserve Banks with their considerable resources to enter the field of foreign banking by the establishment of foreign agencies and correspond ents in any part of the world, and to engage in operations in foreign exchange, purchase and sale of bullion, etc, How much the unprecedent ed prosperity that our foreign trade and-industry have enjoyed during the past two years is due to the banking facilities created by the Fed eral Reserve Act, it would be difficult to exaggerate. The acceptance business, hitherto a strange and unknown field in American banking,has been entered with marked success; "dollar exchange", hitherto an un known quantity or symbol in the world of international commerce, is 852 -4now recommending itself to the favor of trading nations as the most stable unit of international payment. To maintain our exchange on a stable basis through lean times as -veil as through fat times, is clear ly so important a prerequisite to our expanding commerce and industry as to make the agencies of its maintenance and control a matter of pri mary concern to every banker and business man in the nation. The nevsr- to-be-forgotten events of the early autumn of 1914, when there was a complete demoralization of the foreign exchanges and a more or less com plete suspension of trade, need only to be recalled to induce an appre ciation of what stable exchange means to a country. The heroic and costly efforts which England and other foreign .countries have been mak ing to protect their trade with the United States by stabilizing their exchange as far as they could through shipments of gold, shipments and sales of securities, and borrowing, emphasize the same truth,, and sug gest that we should carefully examine our banking machinery with a view to determining whether it is in all respects equal tc the task of doing the work in international finance -which is clearly destined to fall to us in the critical period of reconstruction which will be entered upon by the great trading nations after the conclusion of the war. For we shall have to do our part, not only industrially and commercially but s.lso financially, in helping the nations and peoples of Europe to industrial and financial rehabilitation when this most costly and destructive of wars is finally finished. Banking responsibil ity always attaches to countries which are financially strong and able. The American banker is clearly destined to have not only a place of larger importance in the affairs of his own country, but to play a role 852 -5of first importance- in the affairs of other countries. Now is the tima to get ready for this work, so far as we are not yet fully prepared; to take reckoning of the demands which will be made upon u»; to take stock of our resources and capabilities, and to supplement these where they seem inadequate. There are many different angles to the problems of internation al finance which may be expected to affect us after the war. There is one in particular, however, which has riveted the attention of banking circles of late and been regarded by many as of such vital concern as to make it a problem of great urgency. It is the problem of devising effective ways of dealing with our gold supply. It is this problem to which I venture to direct your attention to-day, for, without sharing the extravagant anticipations, often expressed, of the difficulty that we shall encounter in dealing with this problem, I nevertheless feel that the problem is a real problem and worthy of careful thought. But I do not hesitate, at the outset, to express the opinion that it can be dealt with easily and c o m p w e ing banking machinery effectively. know how to use our exist I may go further, and add that I think there is danger, if we exaggerate unduly the magnitude and dif ficulties of the problem, of distorting and disfiguring our banking system to its own prejudice and to the prejudice of the country's real interests. In dealing with any problem into which so many novel, uncer tain, and incalculable factors enter, it is next to impossible to dis tinguish between the possibilities and the probabilities, and this error, I believe, has been made by some who have been considering the problem ^52 -6- of hovv this country will meet the export demands for gold after the close of the war. But this is not the only or the principal matter regarding which I differ with them. Granting what nobody is in a posi tion to forecast - that there will be extremely heavy demands for gold made upon us - I feel that there is a choice of methods or means of meeting such demands to which the banking and business public should not be indifferent. It is a matter of common knowledge that, up to date, the United States has received from Europe, since August 1, 1914, on settlement of the international trade account $631,097,000 of gold. If the present gold movement into the country sustains its pace to the end of the calendar year (as seems likely if those who estimate a trade balance in our favor of not much less than 2-} billions of dollars are right) this amount will be increased greatly. Indeed, so long as there is gold to be laid hold of, it is likely that the gold exports to us will grow (unless we take steps to check them I) because of the diminution and gradual disappearance of the supply of European-held securities marketable in this country. The result will be, indeed is already close at hand, that the United States, simply in its capacity as a trading country and without any de sign or ambition on its part, will have come more nearly having a control of the supply of the most fundamental and important instrumentality of modern commerce and finance than has ever been witnessed. But the gold which the European nations have been sending us because they must now have our goods, it seems clear they will endeavor, after the war, to get back from us, because, without it, it is extremely unlikely that they could reestablish their position ate trading nations. 852 -7 Problems of finance will be to the forefront in Europe because finan cial reconstruction must accompany, if not indeed precede, commercial and industrial reconstruction. V/e are likely to see the experience of the United States, in the unsettled and uncertain decade following the Civil War, repeated on a gigantic scale in Europe. The vast debts piled up by the European belligerents (now estimated at close to 50 billions of dollars) the huge issues of paper currency in one form or another, make the problems of the restoration of credit, the refunding of debts, and the resumption of specie payments among the most urgent and the most difficult with which they will be confronted - problems for which no solution will be found which does not involve more or less participa tion and help on the side of the United States. It was well nigh ten years after the close of the Civil V7ar before we were able to put through the successful refunding of our national debt, and it was four teen years before we had wiped out the discount on our paper currency by the resumption of specie payments. How long the process of financial restoration in Europe will take, can not be foretold; but we may assume to that, with our costly American experience as a warning examples/say noth ing of the knowledge derived from some of their own past experiences, every effort will be made to shorten and hasten the process of recovery by shaping their policies and bending their energies toward the achieve ment. Specifically., and concretely this means that they must put an adecredit quate foundation of gold under their inflated./systems and their over strained banking structures; and their chief reliance in undertaking to secure the necessary gold must be the neutral countries whose gold hoards 852 -8 havs augmented, so rapidly as a result of the vicissitudes of war. The Scandinavian countries, Holland and ourselves,, among neutrals, and Japan among the 'belligerents, have been the chief recipients of the outflowing gold. All of these countries are likely, therefore, to have an oppor - tunity to part with much of their recently acquired gold, but we are likely, yes, almost certain, to be the principal market in which the yellow metal will be sought, because of our vast holdings and acqui sitions. We may also expect that the more rapid the process of finan cial recovery undertaken by the countries of Europe, the more intense will be the demands made upon us for gold. I repeat, therefore, that the problem of the wise and effective management of our gold supply is a very real problem. I am not overlooking the suggestion, which has not infre quently been made within the past year by careful observers and students of the financial demoralization which is going on in Europe, that the commerce of the future will be organized upon some basis of barter and credit which will dispense with the necessity of having the liberal supply of gold necessitated under the old ways of international trading and banking. The suggestion certainly merits attention. It may be admit ted that everything will be done which ingenuity, sharpened by the drastic experiences of war, can suggest, to economize the use of gold in the credit systems of the European nations. There is undeniable evidence of energet ic efforts being made by the great banks of France and Germany to inau gurate a reign of economy in the handling of their gold 852. _ S - by the transplantation of credit devices and expedients borrowed from the banking practice of England and the United States, such as the substitution of the checking account for the uneconomical and clumsy bank note* There is much evidence of a closer banking cooperation between the leading groups of belligerents. of international settlement is being devised. New and improved machinery This, doubtless, is one of the objects of the Economic Conference of the Entente Powers, and it is possible that some substantial and considerable changes in the gold oaonomy of Europe will result; but it would, in my opinion be highly unsafe for us, as the leading gold bolding nation of the world, to predicate our banking policies upon the supposition that gold is destined not to return to its former position of supremacy as the medium of international payment and account after the close of the war. The history of commerce shows that banking traditions die slow and hard; and so, in my judgment, it will'be with the tradition that there is but one medium of international payment which is uni versally valid in the modern world, namely, gold. I do not doubt that we shall get speedy and decisive testimony to this effect as soon as, or even before, the war is over. Take for example the case of # Germany. Her position is in no wise different from that of her neigh bors - friends or enemies - exeept in degree; that is, the strain upon her credit and upon her banking structure by reason of the war has been more severe, as evidenced by the magnitude of her debts and the volume of her credit circulation. Her previous position as a trading nation ^vas the second in Europe. That trade has been completely and decisively 852 . - cut off by the war. 10 - Germany's problem, therefore, presents only in somewhat exagerated fora the situation of the other belligerent countries. All of them are straining public credit to the limit and involving the management of their great central banking institutions under the pressure of public necessity, in hazardous ventures in the field of finance. All, with the exception of England, have long since suspended specie payment - even though by one fora of financial concealment or another they are attempting to mask the real situation and England herself, long renowned as the world’s one and secure free gold market, is rapidly approaching the point where there will be no escape for her from a suspension of specie payment, if the war con tinues much longer. Such a step as the abrjidoment of specie pay ment and the dethronement of the pound sterling from its position of high prestige will be taken, we may believe, most reluctantly and as a last resort in a struggle of peculiar desperation and of national ex istence. And why? Because this greatest and oldest of the trading nations recognizes full well how essential gold is to the maintenance of her position in international trade and in international banking. And so it will be with Germany and the others. No one will be quicker to appreciate than her clear-sighted economists and finan cial advisers, that she can not hope to recover her foreign trade with out a sound system of banking and finance behind it. To invite others to trade with it, a nation must be in a position to inspire confidence in the stability and integrity of its financial system. The German mark, now seriously depreciated (estimated as much as 2 6 f>) must be brought 852. - 11 - back to a parity with gold. There is but one certain method for this purpose - to increase the gold supply of the country. V7e may expect, therefore, that no effort will be spared by Germany, England, or the other countries in a simialr position, to attain this object at the end of the war; - namely, to build up their gold supplies so as to bring them more nearly and more swiftly into equilibrium with their credit currency. Without indulging for a moment in any exaggerated fears of a so-called "gold war", we may nevertheless expect that the world will experience in an intensified form a condition analagous to that which was experienced in the decade 1870-1880, when the adoption of the gold standard by Germany and other countries, and the resumption of specie payments by the United States, Italy, and other nations, caused such a repid succession of demands for gold as to have led to its characterization, at the time, as a "scramble for gold". The question, then, which is at once a concern to Europe and to us, is, first, where is the gold to come from, and second, what is the process by which it is going to be obtained. The answer to the first question hardly admits of any doubt, in view of the impending loss of the position, long held and filled by England as the world’ s one free gold market, and in further view of the unequivocal and decisive shifting, if not for all time at any rate for a sufficiently long time,.of the center of financial gravity to the United States. As a nation we now possess the largest stock of gold ever held by any single cpuntry, and we are at present the only considerable free gold market in the world. Every present indication 852 . - 12 is that our position in both of these ways will be cumulatively strengthened as the war goes on. It is clear beyond question, there fore, that the nations of Europe, in rehabilitating their finances, will look to the United States for gold* This question thus disposed of, the further questions for us to consider are, how is our banking organization situated to meet such foreign demands for gold as may arise, and by tohat process or processes may demands for our gold be expected to make themselves felt? As regards the methods by which Europe will seek to recover some part of her gold supply, there are three which deserve notice; (1) the establishment of credits here to be taken out in gold; (2) the establishment and maintenance of discount rates sufficiently high to attract some part of our supply of floating capital, and (3) the establishment of a favorable balance of trade, which would require gold remittances by us. The successful flotation in the American market during the past two years of foreign government issues may have be gotten the expectation that considerable loans can be placed here on the return of peace; and such may be the case for a short time and for loans of a special character and of limited amount. But it is not probable that any such method of taking gold from us could obtain large dimensions or last very long. It is probable, however, that for a while at least, some of our floating funds might be diverted to the European market by higher discount rates. If such a shifting should attain undesirable dimensions, however, it could easily be controlled by raising our own rates. European countries desiring gold from us 852 . - 13 will, therefore, have to rely' mainly upon the natural processes of trade. Just as England and other countries have parted with enormous quantities of securities and gold to us because of their unfavorable balance of trade, so it will be by reversing the process and establish ing a balance of trade In their favor that they will be most likely to succeed in "repatriating" their lost gold. A country in times of peace can not, of course, be forced to part with its gold except by commercial pressure or inducement; in other words, except as it is its interest and advantage to do so. That will be when its gold has a higher value in a foreign market than it has in the home market. Prices and discount rates are the chief agencies through which gold distributes itself in proportion to normal commercial requirements among the gold-using countries. Gold will leave this country because, and to the extent, that gold prices are higher here than elsewhere, or discount rates lower. We may expect that after the war prices for staple commodities in the leading world's markets will find their new level gradually, and that gold will •. distribute itself so as to maintain prices in the different countries in conformity with the new price level. It is possible, and is probably a contingency not to be overlooked, that a replenishment of gold stocks may be so essential to some of the European countries that they will attempt by artificial means, (that is, through the stimulation of ex ports and by high discount rates) to establish the balance of trade in their favor. No doubt some such view or fear as this is in the minds of those who believe, or profess to believe, that so-called "raids" will be made upon our gold supply by means of "dumping". 852 . - 14 - ought, of course, be in a position to protect ourselves against any such artificial methods of trade should occasion arise, and for this purpose, as well as other purposes, have wisely created a tariff com mission. But I venture to suggest that such anticipations are not to be taken too seriously. No one can foretell what changes in the competitive capacities and relative positions of the leading trading nations as debtor and creditor will result in the economic and financial readjustments that will follow from the war* It is easy to draw a picture of Europe industrially exhausted, prostrate, and helpless after the war, and re quiring many years for recovery. It is equally easy to conceive a Europe emerging from the trenches made strong, resolute, and formidable by the hard discipline of war. There will no doubt be elements both of strength and of weakness in the economic capabilities and recupera tive powers of Europe’ s industrial leaders. ’ Thich way the balance will tip in the case of particular countries, no one can foresee* ’ '’ hat is, therefore, important for us is that, while carefully watching de velopments and signs, not to make the error on the one hand of exag gerating «*the difficulties with which we shall be confronted, nor, on the other hand, of minimizing the possibilities which attach to the situation. My own view and expectation is that the United States may be expected for a long time, perhaps permanently, to hold the position of a creditor nation, to which she has attained during the war: first, because of the practical extinction of our financial obligations to 852- - 15 - Europe, the interest on which had long been a very important element in the international account; secondly, because of the considerable financial obligations that Europe has incurred to us; and thirdly, because industrially and commercially our position as the leading source of supply of many of the most important requisites of commerce will be strengthened by reason of the depletion of stocks of raw materials, etc., in Europe, and because the "forced draught" which war orders have given to the establishment and expansion of many of our leading manufacturing industries has given an impulse to our outward commerce which is likely for years to lead to a mass and value of ex ports which will pay or more than pay for all the goods and services we shall need from Europe. Indeed, it is conceivable that a situation may exist for some considerable time after the war in which the problem will be rather how to get rid of some of our redundant gold advantage- . ously, than how to hold on to it. ’ .?3 now have more gold than we need. The hard necessities of war have obliged Europe to send us gold in excess of our normal and proper requirements. Prices for commodities generally have been driven up by leaps and bounds. There are many things that we need from Europe much more than we do gold, and in return for which we should be glad and ready to part with our surplus stock of gold. Good financial policy on our part will, therefore, be directed not toward under taking to maike provision against a return of gold to Europe, but toward making provision for its return by a gradual, orderly, and wellcontrolled process. This problem, I repeat, which has inspired a 852 . - 16 - feeling of grsat anxiety and even of alarm in some, really presents no difficulties which we can not easily master, even if we assume that the problem may be cne of very much larger dimensions than there is now good reason for expecting* T7hat dimensions the gold movement to Europe may be expected to attain to, we can only conjecture. VTnether, in the course of time, we shall return to Europe all the gold that we have received from her may be doubted; certainly not for some considerable time. V7e shall not, therefore, be erring on the side of under-statement of the possibilities of the situation, if we assume that the maximum amount of gold which we may be called upon in time to send back to Europe, will be approximately equal to what we have received. Thus far, we have received since August 1, 191*+.i $631^097^000 more gold than we have exported. If we assume, further, that the rapidity with which the return will be made will be approximately identical with the rate of rapidity at which we have received it, we should be far within the limits of safe calculation if we fixed upon some $500,OCX),000 or $600,000,000 at the present time, as the gold export demand which the banking system of the country might be called upon to meet within a period of two years. If the war runs another year, we may have to take more millions of European gold and might have to raise correspondingly the approximate amount of gold which might have to be returned to Europe. I say "might" rather than "would", because of my firm expectation that we shall not have to 852, - 17 return so large an amount, and also because I realize the importance of toeing prepared to deal with possibilities, in the face of so un precedented a situation, however* remote the possibilities may seem, and finally because of my strong conviction that there is nothing what ever in the possibilities which need embarrass us* Assuming, then, that we may have to return in the course of some two years, some $500,- 000,000 or $S00 >000,000 of gold, how is our banking machinery prepared to cope with the problem of its orderly management? This problem is one which concerns every part of our American banking system. But it may be admitted that it is in a peculiar sense a problem of concern to the Federal Reserve System. The Federal Re serve Banks were specifically created, among other important objects, to manage the banking reserves of their members and to regulate the movements of gold. ,_hat, then, is the gold position of the country and of the Several component parts of its banking system, and especially, what is the gold position of the Federal Reserve Banks? The total gold holdings of the United States at this time, are estimated at $2,600,000,000. Of this amount, approximately $280,000,000 is in the Treasury of the United States, the balance being distributed amongst the banks of the country, including.the Federal Reserve Banks, and the hands of the general public. Over oo° $500,000^3 held by the member banks of the Federal Reserve System, over $300,000,000 is estimated to be held by State banks and trust 852. - 18 - companies, and the rest, it may "be conj ecturally estimated, is in the hands of the general public. The total amount of gold held in and by the Federal Reserve System is $616,000,000. (October 13 , 1916 ). This is made up of $406,000,000 held by the Federal Reserve Banks, and $210,000,000 held by the Federal Reserve Agents, this last being some of the redundant gold of the country which has been impounded in ex change for Federal reserve notes, and Which is in the keeping of the Federal Reserve Agents, to be held until the occasion for its use arises. It should.not be inferred, howeveir, that all of the $6 l6 ,000,- 000 held in the Federal Reserve System is free gold available to meet a foreign drain. Certain deductions must be made in arriving at a statement of the Federal Reserve System’ s free gold assets. The most important deductions are the reserves of 35$ required by the law to be held against the reserve deposits of member banks, and of kOfo against outstanding Federal reserve notes. $195,000,000. These deductions now aggregate After allowing for these reserves, and, in addition, for a 40$ reserve against Federal reserve notes now secured by gold in the hands of the Federal Reserve Agents which could be replaced by the deposit of eligible commercial collateral to secure such notes, the amount of the Federal Reserve System’ s available gold may be set down as $3^5 .>000,000. (In November of this year, a further installment of member bank reserves will be deposited with the Reserve Banks, to an estimated amount of about $60,000,000. If this should all be deposited in gold, the free gold holdings of'the Federal Reserve Banks, after allowing for the required 35 ^ reserve against the new deposits, would be increased by $38 ,500,000, bringing the total free gold of the system to over $380 ,000,000.) 852 18-a Gold Lending Power of Federal Reserve Banks. (’ Tithout calling in money invested in open market purchases of comrercial) (paper and municipal warrants) Condition of all Federal Reserve Banks at close of business Oct. 13. 1916. Items As pub After (l) re (in thousands of lished deeming Fed Dollars) eral reserve notes on hand, and (2 ) deduct ing from depos its the amount "Due from other Federal Reserve Banks Assets: G-old and lawful money 405,725 424,483 Bills discounted: For Member Banks 22,099 22,099 B't in open market 77,387 17,387 U.S.Bonds & Notes 53,086 53,086 Municipal Warrants 31,542 31,542 Federal Reserve Notes 15,280 Due from other Federal Reserve Banks 30,089 Other assets 3.045 3.045 638.253 611,642 Liabilities: Capital paid in Deposits : Gov't. 24,715 Bank 544.043 F. R. Notes F. R. Bank notes in circulation Other liabilities FEDERAL RESERVE AGTS: Fed. Res. Notes: In circulation Held by F.R.Bks. Issued to the banks Gold held to retire F„ R. Notes Commercial paper held as collateral for Federal reserve notes 55,682 55,682 568,758 12,316 538,669 15,794 1,033 464 538,253 1,033 464 611.642 Amount of gold available after setting aside all required reserves. Gold held by 424,483 banks Less required reserve of .35x538,669= 188,534 .40x15,794 = 6.317 194.851 229,632 Available Gold held by F.R.Agents Less reserve which would be required were commer cial paper substituted as backing for the Feder al reserve notes now cov ered by this gold .40x191,330= Available Total Free Gold 207,124 18,758 225.882 207.124 210,088 191,330 15,794 15,794 2077124 207.124 191,330 76,532 114.798 344.430 852. - 19 - $3 U5 ,000,000 of free gold is certainly an imposing aggregate. It is the largest amount of gold that has ever been massed under ef fective and unified banking control in this country. To many it will seem altogether sufficient to answer any probable needs. Indeed if we were to be guided in our judgment cf the probable provision that should be made, purely by our past experience, and neglect the profound changes which have come to pass in the world of finance during the past two years, we might well believe that this amount would not only be ample but more than ample, easily to provide for any probable demands. But I have already stated my reasons for believing that it will be prudent, in making our calculations,to take note of the possibilities as well as the probabilities, particularly as the latter are so incalculable, and to accept $500,000,000 or $600,000,000 as the figure to bear in mind in estimating the amount of the possible gold demands that might be made upon us. Taking this figure as the goal of our cal culations, it is clear that the present resources of the Federal Re serve System, big as they are, are not to be regarded in any btrt an optimistic calculation as cortainly equal to meeting any possible drains of gold that might develop at the close of the war, and be equal, at the same time, to supplying any needs of our domestic bank ing situation which may develop. The practical problem confronting the managers of the Federal Reserve System is, therefore, how best to proceed in undertaking to mobilize from the extensive gold supply of the country outside of the Federal Reserve System, an amount of 852. - 29 gold which will bring tho free holdings of the System up to, say $500,000,000 or $600,000,000; that is to say, how to bring under the control or management of the Federal Reserve Banks an additional po tential of $U00,000,000 of gold, of which $260,000,000 would be over and above the required reserves. This looks like a big order, but this is a day and a country of big things, and we are equal to the order. The problegi should of-.. fer no great difficulty if we are alive to its importance; for the $H00,000i000 additional gold required by the Federal Reserve System is but one-sixth of the country's total supply* The problem has had the careful attention of the managers of the Federal Reserve System, and in its general aspects had the attention of the Congress which enacted the Federal Reserve Act; for while such a sensational con tingency as that with which we are now confronted could not have been foreseen when the Federal Reserve Act was framed, it m s fore seen that situations which would call for an effective marshalling of our gold resources would arise, and many of the fundamental features of the Reserve System were shaped with reference to this requirement; for the problem of handling the country’ s gold supply is, in a very special sense, a problem in reserve banking# In England, France, and Germany, the marshalling and handling of the gold supply has long been regarded as the problem and respon sibility of the great central banks, and the methods approved in their experience and practice will be our best guides in finding the solution for our problem, if we kiiow how to make a discriminating 85 2. - 21 - application of their experience to our conditions. And because the general banking habits of our country parallel those of England much more closely than they do those of continental Europe, it would seem that in developing our banking machinery for the purpose of managing the gold export problem, the analogy of the Bank of England rather than that of either the Reichsbank of Germany or the Bank of France would be the one most likely to suggest or indicate the methods to be followed by us; all the more, as England’ s banking methods were developed in connection with the position long successfully maintained by her as the world's one free gold market — a position and respon sibility which there are good reasons for believing may henceforth be ours. The main difference between the banking methods of England and of continental Europe concerns their habits with respect to the use of the bank note and the bank check. The central banks of France and Germany are primarily note-issuing-banks, deposit credits holding a very unimportant, almost a negligible, place among their liabilities. The bank note is their most characteristic form of credit, the means by which they build up their gold holdings, issuing their notes in exchange for gold and then holding the gold among their working assets. T7ithout the note they cound not function. In England, the situation is very different. There, the bank note has a very subordinate place, and as a form of currency i 852 . - is rapidly growing obsolete. 22 - It was long since effectively super seded in the preference of the English banking community by the deposit and checking account. currency. The Bank of England issues no credit Its notes are practically bullion certificates, and yet the Bank of England sustains a more intimate, vital, responsible and strategic relation - as a reserve holding bank - to the whole banking and credit structure of England than that of any other of the great central banks. The great joint stock banks of England have long recognized their dependence upon the Bank of England, and maintain the larger part of their banking reserves with the Bank of England in the form of deposit credits. How successfully this system has worked, is one of the proudest chapters in the history of British banking, and it was this system which the framers of the Reserve System had in mind when they provided for the establishment of a similar relation ship between the banks of our country and the Federal Reserve Banks; with this difference, that the deposit of a certain percentage of the banking reserves of the member banks with the Federal Reserve Banks, was made a legal requirement instead of being left to the voluntary action of the banks. The Reserve Act originally provided, after the shifting of reserves incident to the establishment of the Federal Resen/e System is completed in November 1917 j for the maintenance of reserves by the banks of central reserve cities, reserve cities, and so-called country 852 -23banks, respectively, in the following percentages, with their Federal Reserve Banks:- 7/l8ths, 6/l5ths, and 5/l2ths of their demand deposits. A certain percentage of the balance of their reserves, after November 1917, they were, by the terras of the original Act, to be required to carry in their own vaults, as follows; 6/l8ths for central reserve city banks, 5/l5ths for reserve city banks, and 4/l2ths for country banks. The remainder could be carried at their option either in vault or at Federal Reserve Banks. If the requirements I have stated my reasons for believing the Federal Reserve System might be called upon to meet are reasonable, it would appear that the disposition of the reserves of member banks originally made in the Act may not put the System in a sufficiently strong position in view of the new circum stances in which the country is finding itself as a result of the •war. The logical and natural course to follow in meeting the situa tion would seem to be a further development of our scheme of Reserve Banking along the lines originally laid down in the Federal Reserve Act; that is, by providing for a lerger concentration of the cash holdings of the national banks in the Federal Reserve System. Provision to accomplish this purpose was, therefore, -wisely made by Congress in the recent amendments made by it to the Reserve Act, in an amendment which relieves member banks henceforth of the necessity of holding any fixed percentage of their legally required reserves in vault, and by leaving them free to carry such portion as they see fit with their Federal Reserve Banks, thus opening a natural .vay of adding to the cash holdings of the Reserve Banks. A similar 852 -24result could, of course, have been reached by introducing into the Federal Reserve Act a freer system of note issue by the Reserve Banks patterned after the model of the German or French systems, but such a solution would, in my judgment, be attended with such grave dangers and be so ill adapted to American banking conditions and practices and the fundamental principles of our system of regional reserve banking that it could not but be viewed with serious misgiving by those who appreciate that the note issue system of the Federal Reserve Act makes every reasonable provision for the issue of an elastic bank note cur rency without inviting its abuse. I therefore regard the recent amend ment to the Reserve Act allowing the member banks to increase their reserve deposits with their Reserve Banks, without limitation or re striction except such as their own judgment of their interests and necessities may impose, as one of the most important steps that could have been taken in the further development of the Federal Reserve Sys tem. It provides a simple, direct and natural way of strengthening the Reserve Banks as that becomes necessary, and forestalls any oc casion for resort to alternative methods of doubtful expediency. The situation in which we now happily find ourselves as a consequence of the opportunity thus given for the development of a closer relationship between the Federal Reserve Banks and-their member banks, is that the American banking system, of which the Reserve Banks are the very heart and center (as managers of the country's banking re serve) can be made as strong for handling the problems and conditions •which rr.ay confront us, as you member bankers are willing to make it. 852 -25I repeat with all emphasis that the object of this new provision of the law allowing, but not requiring, the deposit of member banks 1 vault reserve money in their Federal Reserve Banks, is to strengthen the gold position of the Reserve Banks. I do not doubt that it can be so used as to afford an effective solution of any gold problem which rray confront us. Without any inconvenience or risk to them selves, without unduly trenching upon their cash holdings in vault or till, the member banks of the Federal Reserve System can easily spare the amount of cash which will be necessary to bring up the free gold holdings of the Federal Reserve Banks at the present time to $500,000,000 or $600,000,000. The National banks to-day have cash holdings of over $750,000,000. State banks and trust companies outside of the Federal Re serve System are estimated to hold upwards of $330,000,000 in gold. How much longer State banks will delay in entering the Federal Reserve System can not be foretold, but they are not likely to find their posi tion on the outside of the Federal Reserve System a very comfortable or reassuring one, when the financial readjustments at the close of the war are under way. Accessions to the State bank membership of the Sys tem are then likely to become the order of the day. The larger the membership and the resources of the banks composing the Federal Re serve syster, the easier, of course, will it be to provide the $400,C0C,000, more or less, which the Federal Reserve Banks will require in order to bring their free gold holdings to $600,000,000. But even sup posing that the whole burden would have to be borne by the present mem 852 -26bership of the System, the required addition to the Reserve Banks' gold could be provided and yet leave the banks with over $350,000,000 of till money. The member banks in the three central reserve cities alone hold $340,000,000 of cash which would enable them to part with $246,000,000 to their Federal Reserve Banks and yet hold in till an amount ($97,000,000) equal to 3^$ of their deposits. ’ Then it is added that the central reserve cities and many of the reserve cities of the country are either Federal Reserve Cities or else near Federal Reserve Cities and are there fore in close contact with their Federal Reserve Banks, it is evident that they would have no difficulty in keeping themselves supplied with till money should their requirements run beyond the estimated 3 to 5 per cent. English experience has shown that in countries where the checking account is the customary method of payment, banks can in all ordinary circumstances run along safely with till money averaging about 2% of their demand liabilities. If the shifting of cash would be promoted by a change in the form of your condition statement which would show your cash in vault and in the Federal Reserve Bank as one item, I see no good reason why this should not be done and could not be done. The further solution of the problem is, therefore, in your hands. We have a splendid piece of machinery in the Reserve System, and you have it in your hands to n.ake it an engine of gigantic power for handling, as an orderly and well-controlled process, any gold export movement that may set in, 'by bringing your spare cash to your Federal Reserve Banks, as the law contemplates you should and will do. It is, of course, conceivable, though extremely improbable, that a gold export movement after the war might develop which would call for a larger previa ion than ,/hat I have thus far taken as the basis of 852 *■21our calculations. To many it will seem so improbable as hardly to merit attention, but I have stated why we should be prepared to deal with possibilities. It should not, therefore, be overlooked that there are methods of tapping the community*s extensive holdings of gold which are outside of the banks, and in any event let us not lose sight of the fact that gold lost by the banks to meet a foreign drain would, in the natural course, be replaced from the community's holdings quite speedily. Only the first impact of a foreign demand for gold would be felt by the banks. The ultimate incidence of such a demand would be the now superabundant gold stores of the corrmunity. Gold holdings in the hands of the general community are estimated, at the present time, to amount to the huge aggregate of $900,000,000, and dissatisfaction is not infrequently expressed with the fact that our circulation should be so substantially made up of gold in the pockets of the people instead of being replaced by some form of credit currency. But the experience of the greatest trading and banking na tions shows that a solid substratum of gold in the general circulation of a country is one of the surest foundations of a secure banking and financial system. It is wrong to assume that gold thus distributed in the channels of circulation can not be effectively mobilized when occasion arises, and be drawn into the banking reserves. The European nations in recent months have given us some impressive examples cf such mobilization. I believe that the floating gold supply of the United States is a matter quite largely within the control of the banks of the country, and that the banks will exercise that control in their own interest and in the interest of the country, as it becomes necessary 852. - 28 The moment that gold grows in demand for the purpose of meet ing foreign shipments and replenishing reserves, banks which are now indifferent or careless as to -whether they pay out over their counters in response to currency demands, gold certificates. National bank notes or Federal reserve notes, will begin to discriminate. They will segregate their gold certificates, and as the withdrawal of these from general circulation reduces the volume of the community’ s necessary currency, the banks will find it to their interest to meet counter demands for cash by taking out Federal reserve notes. In other words, gold and gold certificates will be reserved for such uses as can not be met by the Federal reserve note; - to wit, meeting a foreign demand for gold, or increased bank reserves - and the Federal Reserve currency will be substituted to the extent that the circulating medium of the country requires it. Because at the present moment we are the only considerable country that is on a gold basis and have acquired on settlement of the international trade balance a volume of gold that has made gold so redundant in this country that gold certificates are for the moment a cheap medium of circulation, we should not hastily assume that changed conditions will not reverse the process and lead by natural and inevitable means to a substitution of the Federal Re serve note in large measure for the gold certificate. The whole ques tion of tho attitude to be adopted in the matter of the control of our gold supply turns upon whether we shall continue to have faith in the natural and normal processes of money and trade, or whether we are going to allow ourselves to be frightened into assuming that things 852- - 29 - have so changed that those processes are going to fail, and that henceforth we shall have to resort to artificial shifts and manipu lations. You bankers know how rapidly currency circulates in this country - more rapidly, in fact, than it does in any other country of the world. It is a familar fact that the American bank check is a highly flexible medium of credit, but the velocity of movement of ordinary bank or Government currency is not so highly appreciated. The fact is that these turn over with marvellous frequency compared with such countries as France, or even Germany, where the movement of the bank note is sluggish; in part because large quantities are carried idle in the pockets of the people or are locked away in the strong boxes of shop-keepers. The turn over of the average piece of paper currency in the United States (outside of banks and the United States Treasury) has been estimated as high as twenty-two times in a year. You bankers also know as a matter of daily experience that the chan nels through which the paper c.£»ney of the United States circulates, lead into and out of the banks, so that in the course of a year, prac tically the whole volume of the country's paper currency passes through the hands of the banks many times. It is therefore no unwarranted assumption to conclude that the banks have it in their power easily to withdraw the gold certificate from circulation and to substitute the Federal reserve note, when c cnditions indicate such a course to be desirable or necessary. In brief, in a country whose habits with respect to the circulation of the bank note are what they are in the 852- - 30 United States, the mobilization of a very considerable part of the gold currency of the country in a comparatively short period of time is a matter easily within the banks' power. This is a fact of such fundamental importance that it must not be neglected in estimating just what could be done in developing and making effective a policy to mobilize the gold supply of the country. Nor should we overlook the extraordinary ability of the country to protect itself against any violent loss of gold by using for this purpose some part of the extensive holdings of European securities which we have recently acquired. To date, we have purchased European securities to the extent of $1,227>000,000. These are all of short maturity, the amounts maturing in the years 1917 and 1918, which presumably will see the close of the war, amounting to no less than $360 ,000,000 . MATURITIES OF EUROPEAN OBLIGATIONS HELD IN THE UNITED STATES. 1916 $30 ,000,000 1917 103 ,000,000 1918 260,000,000 1919 150 ,000,000 1920 500,000,000 1921 50 ,000,000 1923 5 ,000,000 Uncertain 129,000,000 $1 ,227 ,000,000 852 -3 1The events of the past two years have shown that American securities of undoubted solidity possess the quality of international currency, and are likely to figure to an important extent in the settlement of international accounts between this country and Europe. The great extension of the international loan market which has been one accompan iment of the war is certain to result in a greatly enlarged use of ac ceptable securities as a means of international payment and as a sub stitute for gold in making international settlements. There is every reason for believing that the recent experience of European countries in converting their American securities into gold have given to these securities an enviable position as secondary bank reserves,, and that this will insure the reappearance of some demand for American securi ties after the war, thus broadening their market and facilitating their continuing use as a medium of international payment. But, finally, let us not overlook the powerful instrument of control which the Reserve Banks possess in a movable discount rate for protecting their own and the country’ s gold supply, should it be threatened with too large or too sudden a foreign drain. This is the method employed by the great reserve and central banks in England and Europe. It is in particular tho method, the use of which has been most effectively developed and extensively applied in England, whose money market has been more exposed than that of any other country to foreign demands for gold, because of her extensive and intimate commercial relations with the world, and because of her position as the 852. - 32 - world's principal gold market. ’ Whenever the Bank of England has found that gold is "being drawn out of the London market too rap idly, it has raised the bank rate so as to make the process of withdrawal more ex pensive, and thus to temper it to what the banking situation could stand. This method has been so frequently employed that a rise of the bank rate is commonly regarded as the most accurate barometer of the English reserve situation; And it is also the means by which the Bank of England exercises a strategic control over English banking at times when such control is all-important. In the twenty-five years between 1875 and 1900, ^he English bank rate was altered 167 times, which means an average duration of the same rate, of only 5^ days. Indeed, not only were changes of rate frequent, but their range was also considerable - such as four or five percent of variation in the course of a year. This same instrument of control, our Reserve Banks possess, and the success of our new banking system will in large measure depend upon the wisdom and skill its managers and the Federal Reserve Board develop in handling it. It must be admitted that frequent changes of discount rates are in and of themselves not desirable. Stability of rate is a great advantage to industry and the internal banking situation, but too much stability of Reserve Bank rates must not be expected in a country whose money market has attained the international importance which ours has, at least for the present, and which it will continue to hold so long as its position in international trade is that of a creditor, and so long as it has a vast stock of gold to be dispensed. At any rate, 852- -,33 - whatever internal disadvantages may attach to a changeable discount rate, there it is, a powerful weapon for exercising a control over the reserve and gold situation by the Federal Reserve Banks at cri tical times, and should not’ be omitted from our calculation when • examining our protective capacity against an undue drain of gold- It would be an especially effective and necessary weapon against any at tempt of European markets to bid away gold from us more rapidly than would be consistent with our interests, by raising their discount rates. More than that, it would be an effective method by which the Reserve Banks could throw upon the many powerful banks of the country which have large holdings of cash and foreign commitments, their pro per part of the burden of supplying gold for foreign shipment, should they be tinluly disposed to divert demands made upon them to the Federal Reserve Banks. Indeed, demands for foreign gold remittances would make themselves felt in the first instance as a demand by customers of these banks. To meet such demands, they would have the alterna tive of taking the gold out of their own accumulations or of drawing it out of Federal Reserve Banks by rediscounting or open market sales. But it is not to be expected that the Reserve Bank managers would nit idly or carelessly by and allow their gold reserves to be need lessly depleted, when they could stop such depletion by the simple device of raising their rates, unless, or until, a situation had arisen which was beyond the ability of the ordinary banks to handle ivith their own resources and without difficulty- 852. - 3^ - This survey shows that there are many elements that enter into the problem of handling our gold supply and many factors that enter into the organization of the machinery for most effectively mobilizing it. It may be convenient before dismissing the subject to assemble them in a summary statement. 1. They are? Europe may be expected in time to recover a large part of the gold she has sent us. There being no present method of estimate ing the probabilities, attention must be paid to the possibilities. 2. Europe having sent us thus far over $630,000,000, prudent calculations will address themselves toward considering how an amount of $500,000,000 or $600,000,000 of gold might best be mobilized for the purpose of meeting a foreign drain should it attain such a magni tude. 3« The Federal Reserve Banking System, including therein the member banks, possesses over $1 ,366,000,000 in cash, of which over $1,100,000,000 is gold (which is something short of one-half of the total gold supply of the country), the remainder being exchangeable for gold at the Treasury of the United States c 4. The total gold v/ithin the immediate control of the Federal Reserve Banks amounts to $6l6,000,000, of which $3^5,000,000 may be regarded as free gold; that is, the amount of gold lending power without any impairment of reserves. 5- To raise the gold lending power of the Reserve Banks to tho point which would bo necessary to enable them to meet (what is, however, 852 - 35 . - in view of present probabilities unlikely) possible demands of $500,000,000 or $b00..000. 000^ approximately $400,000,000 would have to be added to the Reserve Banks deposits in order to give them,after setting aside the necessary reserve of 35^’ > additional free gold to the amount of $260,030,000. 6. This amount can be spared from vault cash now carried by member banks without unduly reducing their holdings of till money, and therefore presents the basis for the solution of the problem. 7* Gold lost by the banks to meet foreign demands would be replaced by mobilizing a part of the present floating supply of the community into their hands. This process would be facilitated by the ease with which Federal reserve notes could be issued to fill the void created by the withdrawal of gold or other forms of currency. 8. The Reserve B**nks possess an important leverage of control in their movable diaoo’ .'nt rate, which could be adjusted to counter any undue attempt of foreign markets to attract our gold by high rates. 9» An important element of strength in the protective capacity of the country against an undue drain of gold is the heavy holding of foreign government obligations which run off in the next few years. 10. Finally, while realizing the importance of being alive to the possibilities in the face of a situation for which there is no parallel, let us not make the mistake of "overtraining" or of com mitting ourselves in advance to any definite single expectation of what is going to occur and in consequence lose that balance of judg ment which will not hesitate to shape and reshape its conclusions 852* - 36 - in accordance with the facts as they develop or change. An essential element in our preparation will "be the ability to deal with the unexpected as well as with the anticipated. The conclusion warranted by this survey is that the Reserve Banks can easily, with the cooperation of their member banks be put in a position where they can master any situation which may arise. Some of you may say that it is a heavy bill that I am proposing the Federal Reserve System shall draw on you, but this is the day of the bankers’acceptance in our new American banking system, and I feel confident, from the hearty cooperation that our member banks and the country by and large are giving to the Federal Reserve System., that . you will not protest the draft but accept it. The bankers of the United States had to meet several severe tests in the trying months following the outbreak of the great war. telligently sind resolutely- Those tests they met in I do not doubt that this ono also will be met intelligently and resolutely, and that each one of our members will take careful reckoning of v/hat he can do and do it. The Federal Reserve System is but two years old, a brief period in the life of a groat and new banking experiment, but the system has already made a record for itself and an enviable place in our new financial and credit system, and is no longer an experiment in tho sense that there is any uncertainty as to its high value and entire practicability. It is experimental only in the sense that there may be a question as to how 852 -37- rapidly it will develop its full potentialities as the shaping and guiding influence in American banking affairs. A great banking system is as much a matter of growth and development as it is of legislation. The English banking system, which has long been the admiration of the ./vorld, has grown up pretty much without legislative guidance or interference. The Federal Re serve Act, wonderfully conceived as it was, is, therefore, to be re garded only as a beginning. It presents an opportunity. How fully the opportunity will be improved to develop a great system must depend upon the combined wisdom and vision of those of us immediately charged with the administration of the law, and the thousands of you bankers who are the partners through whom and with whom we must work. A banking system is not a set of principles and rules formulated and imposed by law, but a set of habits, practices, customs and traditions forged out of experience. Many of these that are excellent we already pos sess, but others we still must make. most important of these. I have pointed out one of the Our country has become a dominant factor in the world of commerce and the world of finance. Our banking system must be made equal to our matchless opportunities and our large responsibilities. ’ Thether Are like or desire the great changes which have ccme to pass in our position in the world of affairs makes little difference; we are there by fate and circumstance- and we must cultivate the habits of thought and action which will enable us to do our part and do it well. Parochial habits and provincial customs 852. - 36 - must yield to the larger way of viewing things and the larger way of doing things. This is the day of banking cooperation and the Federal Reserve System is your rallying point in helping yourselves and helping the country. It is the best rallying point that bank ing wisdom and legislative ingenuity have ever given the bankers of any country, and is worthy of your every confidence and support.
@FedFRASER