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A&ctrQ33 isafto boforo Students of Graduate Collc^o, Harvard University, Canteidga, Massachusetts. Tuesday, I’ovanbcr 23 , 19132. L»iiis® the 'j/eow cil Iio«»rvo ftanl;s were established, and, in reccnt yoars in increasing quantity, tho report3 of the System have been so complete and have do<»cribod tho operations in ouch detail that students of banking require hardly more than, the official reports to Gain a fairly ccmplete knowledge of the business con ductccl by tho System* .I'vcn thoco rho havo not studied thi3 literature understand that the Reservo Eanks hold tho fcanUing reserves of tho cotmtry? for their member banks? that they discount paper that they Invest in bills or bankers ecceptancos end in the securities of the United States Government; that thoy issue and redeem the princi pal currency of the country and distribute the metallic money coined by the mints; that they collect checks and practically all other types of instruments of payment for their members; effect the settlement of the don.estic exchanges; and, in their capacity aB fiscal agents of the Treasury, borrow all the money required for the Treasury's operations; ues; handle the Government debt; receive on deposit the reven and pay checks drawn by the disbursing; officers* It is important that this business be visualized as to volume as well as character. Bearing ia mind that the Federal Reserve Bank of New York does about 405» of the business of the whole System, its transactions for the ten months of this year were briefly as follows: practically all cold; It held an average of §1,150,000,000 of reserves, discounted 46,000 pieces of paper aggregating £5,200,000,000 for Its members; purchased 81,000 acceptances for itself and for other Reserve Banks and for member banks and foreign banks aggregating £1,150,000,000; and far account of all Reserve and other banks and of the Government and foreign banks purchased and * sold $2,400,000,000 of Government and other securities; it counted and handled 315,000,000 pieces of paper currency aggregating £2 ,0 0 0 ,0 0 0 ,0 0 0 and handled a dally average of 20 tons of coin; collected 118,300,000 checks, notes, drafts, coupons and other negotiable Instruments aggregating $51,000,000,000; and effected payments by telegraph, over the 15,000 miles of telegraph wires which the System now operates, z ascrer,atin- 017,000,000,000. Its transactions for the Treasury as the Government *s Oiecal arent wore of too great a volume and variety to express briefly in figures* Those figures are recounted for the purpose of emphasizing the character and extent of the contact of the Reserve System with the credit and currency opera tions of tka country and, consequently, the significance of the functions which the T>cservo Bruits exercise.. As to the Systea’a policies end the purposes xJhieh inspired thorn, there is now an extensive literature in the shape of critical hooks, magazine articles and public addresses. It would be but repetition for me to go over ground so fully dis cussed by so many competent students and critics. There is, however, one function of the Reserve System the importance of which cannot be over-emphasized and which I have determined to discuss tonight be cause it is, in fact, the heart of the System upon which the operation of every other part depends. I refer to the entirely new element which was superimposed up on our banking System in 1914 by the establishment of the Reserve Banks, i&ich wore given the poorer to in!luence or to regulate or to control the volume of credit* Every other function exercised by the Reserve Banks sinks* into insignificance along side of the far reaching importance of this major function* Without recard to the .views which you may entertain as to the various theories in regard to the purchasing power of money, or what may be more popularly described as the quantity theory of money, there is hardly anyone who is familiar with these matters who will not agree that no influence upon prices is so great in tho long run as is the influence of considerable changes in the quantity of money, by which I mean not only metal coins and paper money,, but bank deposits upon which checks may be drawn* The Iteserve Act did in fact, whether by conscious design of its authors, or not, bring about an almost revolutionary change in three important particulars in bank credit which may in turn have had an Important relation to prices. (1) The Act originally reduced the reserve requirements of the national ^-■danks, and, subsequently in 1917, reduced the-a a^ain. The effect of this v/as to make reserve money more efficient in that it v.as permitted to sustain a larger vol ume of loans and dopocits than previously had been permitted, (2) By conferring the so-CD-llod clearin'- house functions upon the Reserve Eanks, it speeded up the whole System of payments; checks are collected and paid more promptly; the course of currency shipments throughout the country has been creatly shortened and currency passes more promptly to points of redemption; and the country-wide clearing house, known as the Gold Scttlcncnt Fund, operated on the basis of daily telegraph settle ments, has greatly shortened the length of time required to effect settlement of the entire domestic exchanges of the country. (3) But the most important change, as I have stated, is that conferring the po?/er upon the Reserve Banks to actually permit or influence changes in the volume of money which serves as bank reserves or circulates as currency. My thesis, therefore, is addressed solely to this ques tion of the ref^ilation of the volume of credit and to make clear what a change has taken place because of the granting of this power. Let me refresh your memory as to how credit matters operated prior to 1914: Practically all of the commercial banks and trust companies of the country were subjcct to various statutory limits as to the minimum amounts of cash and re deposited reserve which they were required to carry* Except by legislative change in reserve requirements, there was no possibility of increasing the supply of re serve money beyond what arose through cold production or gold imports, neither could the supply of reserve monoy be contracted unless nold was exported. So it may be conerally stated that the total reserves of all the banks was incapable of con traction cxcept by paying it out to the public or exporting it; and equally incap able of expansion unlessredeposited by the public or unless gold flowed into the country from abroad or was produced from the mines. not percentage. Bear in mind I Bay total and This had serious consequences in its relation to that mysterious plioaorr.onoa rbich Is no*.v so carcfully invcnticatcd ana v;hich wo call the busi ness (or, as I would prefer to call it, the credit) cycle. At one extreme of the V. ' cycle tho reserves of the banks re::ulorly becaso ir.paired* rith deficient bank re serves vo wore liable to see rates for "speculative" money advance to 10C& or even rnoro at timoo, and the charge for credit to merchants and manufacturers became a severe burdon upon production and distribution* In such a situation elmost any per cussion cap trottld start an explosion* In 1893-5 deficient revenues of the Government and an unfavc^cblo trade balance v;Jiieh resulted in gold exports, costing at a tine when there was agitation for a change in our monetary lavs led to great uneasiness* Tho reserves of 13x0 Now York Clearing House banks showed shortages from § to $ * Fear daveloped that the Treasury would not have sufficient gold to meet its obligations and finally the crash cone on (date) resulting in tho New York banks, end lionks generally throughout the country, suspending cur rency payments; very largely suspending cash settlements between themselves for checks sent for collection not only through the local Clearing House but throughout the country. At that time a total of $ Clearing Bouse loan certifi cates were issued* Much the same thing happened in 1907, when,' after a period of deficient t>& banking reserves running from $ the extended condi tion of a number of New York City banks caused alarm and general suspensions of like character to those of the early 00*s throughout the country. Call money loaned as high as & currency went to # premium; and the domestic exchanges again wore frozen. Then arain at the other extrene of tho cycle, after a period of liquida tion, surplus reserves poured into the money centers. After this same liquidation in tho early 90*s the New York Clearing Bouse banks at one time showed surplus reserves of $ » And bear in mind that at that time the total re quired reserves of the New York Clearing House banks were but # of what they now are* Honey then loaned at less than 1$* And the same occurrence was witnessed 5 after tho- liquidation of 1*07 vlion tbo surplus reserves of' the New York City Clearing House- banks rose to 0 . While under the conditions first described, every bank was seeking to withdraw loans, under the conditions last described, the banks were forcing money into the r.^cet. Honoy would becomo almost unlosmble and the tcaptation to the spcfinlaicr a nl his kind vas cxtrcno* I, personally, rocall caking loans on the Hear York Stock Exchange at 3/4 of 1a * these extreme credit conditions arose because there was no stretch. V."hen the period of surplus reserves arose fends poured into the speculative mar kets. Ehen the period of deficient reserves arrived all the banks sought to con tract their loans to mako good their reserves and we witnessed the extremes of speculation and of business embarrassment. There was neither control of the vol ume of credit, nor moderating influence as to rates of interest* And, finally, there was no control over the movements of gold in and out of the country. I re call the Governor of the Bank of England telling me in 1916 that one of the most menacing influences on their reserve position was the possibility of a gold move ment to America or from .America as a result of our erratic money market, «hioh no influence that they could exert was capable of steaming; of their regarding our so-called free gold market as one of the worst menaces to the stability of their own credit position. I have refreshed your meenory as to the conditions which prevailed under the old System in order to bring out in contrast the extent to which it differs from present conditions. As things are now, vrhen a period of business expansion arrives, whether it be an annual and seasonal one, or whether it be due to a series of favorable crops at home and bad harvests abroad, - in other vords whether it be the short cycle of seasons or the long cyclo of periods of years, - such expansion, whatever its cause, can now be easily financed because of the power of the Federal Reserve System to furoidi the required reserve money as needed and thereby permit 6 the nurs'bor banks In turn and in larger volusio to incroa&e thoir loans and discountc, £)nd» corrcopondin ?ly, their de?or*its* Bat now we ccao to ono cc tv/o grave fallacies in Syatea. to the Reserve X fear there aro many people who still hold to tho notion that some mys terious inflv.-aco or proccss rill operate when this enlarged volume of credit is no loassp co ll&t it vjill.fcs ifilnasd, without any convulsion or pemosion^ con- placeatly to sail: back to tho Reserve Dank and surrender itself fox* cancellation# And possibly cnothsr fallacy still prevails ozzovr, those who believe that because of certain very csactinj; requirements of the Federal Reserve Act, and tho regulations of the Reserve Board, as to tho tjpe of loan which tho Reserve Bonks m y make, or the character of the paper which they m y discount, that there is .som control exer cised by the Reserve System as to the uses to ahich the credit so extended by the Reserve Banks shall be applied by the borrowing meraber bank* Practical experience in the operation of the Reserve System seems to have disclosed something of impor tance as to the way credit is extended; as to the way that eredit is retired when it is no longer needed; and as to the impossibility of control of the use that shall be made of it while it is in existence* First as to the extension of credit* which nay be described as normal or seasonal or necessary and legitimate* Practically the only motive which trapels a member bank to borrow from the Reserve Bonk is to make good an existing, or ex pected, impairment of its reserve* I think you nay accept ny statement that this is true, but let me give one Illustration* Every member bank is required by law to maintain a cortain minimum rcr.crve on deposit with its Reserve Bank and if it fails to do so it is subject to on interest penalty upon the amount of the inpairmont considerably higher than the regular rate of discount of the Reserve Bank* This reserve in sane cities is figured as a weekly average and in the rest of the country as the average of a fortnight* Every member bank must report Its reserve position and submit to penalty if the average la impaired* Now, in practice, the way this works is very simple, and Z shall use the ease of a large New York City bonk to illustrate: U.wly ia tho nomine It sends Its exchanges throuch tho Qoorins House and, as ths result, it has to pay out reserve money or receives sur plus reserve money according to uhother it is debtor or creditor* Throughout the day it has deposits made and withdrawn; paid; it buys and sells scsuritics; it makes new loans sad has old loans re and foreign exchange and furnishes currency to cuytolars. And as iho rc:>uli or these end c»hor transactions, at sccae hour of the day the member bank must make up wL^t it calls its’^ocition." If its reserve has becone ir^atired as the result of the day's business it borrows from us to make £0 0 d its reserve* If the day's transactions give rise to a surplus reserve with us, tho proper thin? for the member bank to do would be to at once repay any funds which it had already borrowed from the Reserve Bonk, although it may not -do so* The chanccs are that if it does not do so it will be because it has an opportunity to employ the funds in scone more profitable way than in paying off the Reserve Bask, - that is to say it can lend tho money at a higher rate than the rate which it pays us upon its loan, namely our discount rate* You will observe that in every ease, and practically every day, the member bank, in gauging its reserve position, .must of necessity determine whether it shall borrow, and if so how much, or whether it shall repay borrowings already made, and if so how much, and the alternative to borrowingor repaying is either withdrawing loans from the market in some form, if it is short, or making additional loans, if it is over, without reoourse to the Reserve Bank in either ease* Now, in the long run, it is my belief that the greatest influence upon the member bank in adjusting its daily position is the influence of profit or loss; that rhile It m y regularly borrow to make good impaired reserves, it will repay its borrowings at the earliest possible moment unless the inducement of profit leads it to continue borrowing and to employ any surplus that arises in fresh loans* It may, therefore, be safely stated that as business expands for seasonal reasons or for any other reason, member banks will borrow from the Reserve Banks to make good deficient reserves caused by 8 the expansion of their leans, provided the rate at the P.cscrvo ^ank is .not so hich to EiOke that bGrrosrin^ too coctly* But, on tho other hand, if borrowing at tho Reserve Bank ie profitable beyond a certain point, thore Kill be strong temptation to use surplus reserves when they arise for the making of additional loans rather than for repaying tho Uecorvo Ecnk* I shall discuss tho question of rato control later, but I wish first to emphasize this important fact: Practically all borrowing hy member hanks from the Reserve Bonks is ex post facto* The condition which Rave rise to the need for borroTTin* had already caao into existence before the application to borrow from the Reserve Bank v/as node, and exporience has shorn that large borrowings in New York City have in the past usually been explained by the member bank as caused by the borrowing operation of the Treasury, by seasonal demands* but; more frequently be cause of the withdrawal of deposits* Now as to the limitations which the Federal Reserve Act seeks to Impose as to the character of paper tiiich a Reserve Bank may discount* Whoa a member bank’s reserve balance ie impaired, it borrows to make it good, and it is quite impossible to determine to what particular purpose the money so borrowed may have been applied* It is simply the net reserve deficiency caused by a great mass of transactions* The borrowing member bank selects the paper which it brings to the Reserve Bank for dis count not with regard to the rate which it bears, but with regard to various elements of convenience, that is the denomination of the paper, its maturity, whether it is in form to bo oasily and' inexpensively delivered physically to the Reserve Bank or not, and it mokes little difference to the borrowing bank what transactions may have caused the impairment of its reserve, because the paper which it discounts with the Reserve Bank may have no relation whatever to the impairment that has arisen* To specify mare exactly, because this is an Important point, suppose a member bank's reserve became inipaired solely because on a given day it had made a number of loans on the stock exchange; it might then come to us with commercial paper which it had 9 discounted two uoAlka b^foj-o end vhich h:id no relation that c y s t to the trsnncoticrw of the day; and with the proceeds of the discount make rood the impairment* If it was the dooirn of tho authors of tho Tcderal Tloserve Act to prevent these funds co advanced by Federal Reserve Barto from be inn- loaned on the stock exchange or to nonmember state banka or in any other type of ineligible loan, there would be only one m y to prevent the fnndo boin*r so usofl, and tint is by preventing the raeraber banks froa caking tny incliGiblo loans trhatsoover, or deny it loan3 if it had* « £nd, in fact, during the peak of tho period of e;:pansion I believe tho amount of paper which had been discounted with the Federal Reserve Banks equalled only about 14$ of the loans and discounts of th 3 inesibsr backs. The nonber banks undoubtedly had a very much larger eaount of eligible paper than indicated by this small percentage, but, beyond that, a great mass of inelioible loans, and surely it cannot b© claimed that tho provisions of the Act, which specify so exactly what paper is eligible, can pos sibly have exercised any influence upon the application of the proceeds of these loans by the member banks, I havo enlarged upon this point so as to bring out this fact: - that the expansion of the loan account of the Federal Reserve Banks, which as you know fur nishes the foundation for a much greater expansion of loans and deposits of the conmarcial bankt<. can be brought about as the result of any expansion in the banking position of the country, no matter what may be its cause. The eligible paper we discount is simply the vehicle through which the credit of the Reserve System is conveyed to the members. But the definition of eligibility does not effect the slightest control over the use to which the proceeds are applied* Goinf; a stop further, this means that the Reserve Banks will be subject to demands upon them, expressed to be sure in tho form of eligible paper but which may have had their origin in any sort of expansive development, stock speculation, real estate speculation, crop moving, building operation, foreign bond issues, or anything else* Such an influence can arise through the borrowings not only of the 10 United States 0overmcnt in the r,arket, but, indirectly, through borrowinns of all Oinds which have the effect of inpairins reserves. Nov going still one step further, let me emphasize the contrast between the conditions which prevailed in the old System and those which have now arisen* I have pointed out hov, in the extremes of the trade cycle wo have cm the one hand impaired reserves and very hirjtx interest rates and on the other hand surplus reserves and very lor interest rates* That condition has now quite disappeared* In actual operation, ?&en the reserves of the member banks become impaired they promptly bor row and they do not have to scramble around amons their customers or on the stock exchange to call loans so as to make good the impairment* So, on the other hand, when they have surplus rescarves they are Generally inclined to repay what they may have already borrowed from us rather than make new loans, provided, of course, our rates are properly adjusted to market rates, and they will continue to do so unless borrowing from the Reserve Bank becomes so profitable as to be a temptation* How you will observe that under the old System we experienced these periods of reserve deficiency and extremely high rates for money and reserve surpluses and extremely low rates for money, but under the present System all that has changed* Broadly speaking, there is no surplus reserve in the hands of the banks, whether members of the System or not* V?hen business expansion or new loans cause impaired reserves the member banks borrow' from us; when surplus reserves arise for one reason or another, they repay to us* The consequence of this is, of course, that we have no such extraordinarily hi£h or low interest rates as sometimes obtained* The funds flow In and out of the Bosorve Bank day by day as sort of a leveling off process, so to speak. How in a banking System where 10,000 banks, which represent over 55$ of the banking deposits of the country, have convenient access to a source of bor rowing such as the Reserve Banks, what are the possibilities that this borrowing may get beyond control; that the volume of credit may become dangerously enlarged and that in consequonce we may be guilty of furnishing credit which might only re sult in marking up prices without any increase in production, with all of the 11 injustices which are sure to result? ^lio chances cf such a development can only bo understood if ono is familiar with credit conditions in allparts of the country. They could veil be expressed in the f o m of a nap upon which current local rates of interest through out the country uould *00 orpreeoed as nape cere shaded to indicate mountain ranges and their peats • 'It vould he found that over a larco p;.rt or tho cculli, consid erable portions of 'ths rdddle nest, and Generally throughout the Rocfcy Mountain region interest rates are not only hi"h» but in sacy cases as high as 1 Hot only do tho vsury laws of some states permit banks to lend coney as high as 10 $ ctr IZpt but in practice a very largo masher of the smaller banks throughout the coun try in states crhich permit hi~h rates make practically all of their loans at rates ranging all the m y from Bp to 12$, and there are many banks that charge even higher rates by various round about methods. But the rate difficulty becomes more acute when it is realized that even within one Federal Reserve district of large area like Kansas City or San Francisco, there nay be sections where rates as high as 12 $ are charged, fut, on the contrary, in the money centers, especially in the city where the Reserve Bank is located, the rates may be little if any higher than those prevailing in Near York City. Bearing in mind, however, that a member bank may be impelled to borrow not only because deposits are withdraim but equally because it has made loans, in all of those sections where the loaning xate is much higher than the Reserve Bank rate the temptation will naturally be ever present to expand leans indefinitely so long as the Reserve Bank is in a position to lend* This situation, which prevails in some parts of the country, is quite different from that in New York City, where the vast bulk of bank loans are made at a fairly uniform rate and taiere it is pos sible for the Reserve Bonk, by an adjustment of its rate, to exert some restraint upon the extent to which its members borrow from it. 12 Deferring until later cny furtlter dlocus3ion of methods of control of Obrrowing, which means control of tho voluue of credit, lot me non rel'cr to what appears to mo to "bo the most perplexing difficulty In the exercise of such con trol as m y be possible through the discount rate* It is a condition which has arisen as a rooult of tho tvar end it is appropriate to introduce this part of the discussion by quoting fron the report nada by tho British Cojooittee on Curroncy and Foreign Lxchange, frequently called tho Cunlifxc report, as follows: "whenever before tiio war tho bank’s reserves were being depleted, the rate of discount was raised* This* as we have al ready explained, by reacting upon tho rates for money generally, cebed as a ehoslc vriich operated in t~o trays* On tho one hand, raised money rates tended directly to attract rold by lessoning ilio d'::;or-.C.3 for lc-ns for business purposes, they tended to check expenditures and so to lower prices in this country, with the re sult that irports were discouraged and exports encouraged, and the exchanges thereby turned in our favor* Unless this twofold check is kept in working order tho v.holo currency system will be imperilled. To maintain the connection between a gold drain end a rise in the rate of discount is essential*w Various influences were set in motion by the war Which have resulted in oar receiving over $2,000,000,000, in gold in excess of what we held before the war started, giving us now a total gold stock of about $3,800,000,000 of which nearly $3,100,000,000 is held by the Reserve Banks* This is roughly a billion and three-quarters in excess of what the minimum legal reserve requirements of the Federal Reserve Act would now require us to hold against our present deposit and •>» note liabilities. Undor the provisions of the Federal Reserve Act as originally passed by Congress, the Federal Reserve Banks, when all of the reserves had been paid in, would have had a loaning power of roughly § . With this enormous m s s of gold now in our hands, we have a lending power at present in excess of the billion and one-quarter of loans and investments sow made of roughly £ * Bad there been no war there would have been no disturbance to the foreign exohanges* With the forei&i exchanges fluctuating within the gold shipping points any considerable expansion of credit in this country which caused prices to sharply advanc 3 vovl& very probably have been Qsnalized by a cold expert movement • With tho CJcchcE,~c3 as thoy no^ are, that Is with the dollar at a premium practically tlie world over, cold cannot be ex ported, certainly not in large quantity except after such a period of expansion and rising prices in this country as -Bould crrtc.il a veritable orgy of speculation; such a dehruioh in credit, in fact, as would l tliO J.UV- of tho dollar progressively first possibly to tiio lc.cl of tho currencies of the neutral countries, then to sterling, then to the franc, etc. And this brings mo to the point which is of such importance to the mana^onent of the Reservo System* Before the war, as is set out in the Cunliffe report, a large gold ex* port movement was the visible end convincing evidence, not only to the management of the bank of issue, but to the country generally, that the bank rate must be raised* To be sure other conditions then a gold movement could well justify increasing the rate of discount of the bank of issue, but a large gold export move*' ment, such, for instance, as we suffered in the' early 90fs, which even impaired the gold reserves of the Government of the United States, would require little argu ment or explanation to convince the country that the bank of issue must take steps to protect the gold reserve* As we are now situated, it is true vhat we may from time to time lose small amounts of gold to those countries where the currency 1ms not been greatly depreciated* We have recently shipped some gold to Canada and it was a natural movement because the Canadian exchance had gone to a premium and dollars to a discount as the result of a larce lean which the Canadian Government floated in this country* And from time to time the currents of trade and the balance of international payments may indeed result in small amounts of our excessive gold holdings being withdrawn, but, with the currencies of most of the trading and banking nations of the world so much depreciated below ours — ranging tram. 10j£ in the case of sterling to the vanishing point in the case of Germany, Austria and Russia it eccnn altogether unlikely that any considerable ersount of our Qurplue gold will bo taken frcxa no. Other than such a Cobaucli of •expansion as I havo described, the only possibilities of early losses in gold that I eon see ro'dia bo thrcu-h radical chcn~eo in the nonotary lavra of those nations whose cvrreneloa cure ??reatly depredated, ir^lyin^;, of course, the balancing of tholr noverrnsatol revm ica and expenditures* In the absonco of the possibility, I may say evon tho remote possibil ity, of any such movement and in the face of the conditions which I have described as to interest rates in different sections of tho country, 'shat should be the policy of the Fcdoral Reserve System in exorcising this function which Is of such supreme importance of regulating or influencing the volume of credit* This brings us in fact to those important questions of policy In which human judgnent plays so large a part. Various suggestions as to the polley of the Reserve System have been advanced by eritios and students* They all seen to lead back to the two methods of regulation of eredit volume which ore, after all, fun damental. one may be described as the exercise of discretion by each Reserve Benk as to the ancunt which it is frilling or which it thinks vise to lend to borrowing members* The other is the exercise of such influence cr control as is possible through the fixing of the discount rate* It night at first seem that these two methods of regulation were in conflict with each other, but they are In fact both necessary and coraplesientory; both have advantages and limitations* In a general m y it is my opinion, although others may differ tram me, that, bo lon/> as present conditions exist, rate regulation will operate effectively in the long run as to tho groat m s s of American bank credit, that is as to those banks i&ich hold the principal amount of deposits and loans, provided the rates dre wisely established by all of the Reserve Banks, and especially by those Reserve Banks which are located in the larger cities of the east* It Is in those centers that Interest rates are lowest anl most stable and where the range is narrowest 15 between minimum and maximum rates; but in the sections of the country nore remote O r e m the money centers, where interest rates ore higher, as was earlier described, the exercise of a wise discretion by the management of the Reserve Bank is impera tive, otherwise the f&cilities of the Reserve System Blight be abused by member bankB borrowing excessively for profit* Let me describe some of the difficulties of exercising dlsci’oLiou, rirc*, the discretion, as I have earlier described, must be exercised ex post facto. Tho transactions giving rise to impaired reserves by the borrowing members have already occurred when the borrowing from the Reserve Bank is desired, .Applying discretion to the borrowings of members under these circumstances really rssana that all one can do is to scold tfcesu If the funds are not advanced to make good the reserve, then indeed the reserve balance is used by the member just the same only the penally rate is higher. In the course of time that bank would restore its reserve bocauee the law would prevent its paying dividends or making near loans until it is restored. That type of scolding, however, generally causes irritation, A second difficulty is geographical* Bow can discretion be exercised in the case of applications for loans by member banks so remote that even the nail takes four days one way? A third difficulty arises as to the basis upon which discretion shall be exercised* iTho is to judge as tto whether the transactions which cause the reserve impairment were justified or unjustified? A loss of deposits, theoretically, would always justify borrowing, but if the impairment arises because of loans made how is.. a judgment possible as to any one loan without judging equally of all loans made by a member bank? Fourth, even assuming that such judgment were possible, who shall say hew much each member bank shall be permitted to borrow without exceeding the bounds of prudence? Is it fair to assume that a member bank should liquidate once a year, or 16 twice a year, so that its borrowing require,, into : JL cnly, er should v?o /e&alt that a cortoin er^ount of bcx-rov;in~ frcn tho Reserve Ben!:s m y be permanent? Section 4 of the Act provides that a Reserve T.u^k ehs.ll ’’extend to each member bonk such discounts, advancements and accommodations as i&ay be safely and reasonably made with duo re~cxd for tho da l e s and dexands of other nedber bonks." LIuch difficulty rill bo cxj .rienccd \"j W o bonl: r.~v -rzs of cue cn? district in r.nlrin~ these nico dccicicns ix:i to i':s o~u i.ictrict s.£&*vo only, but, cfr-enuing this to all tho ncc.c~ors of the tvjlvo licj^rvo Bxilcs, -.vith tho 10,CC0 members vdth which they nust deal, it Hould indeed appear to be inpossible to exercise such discretion with universal justice* Indeed it may well be that in tho absence of a Branch Banking System tho Federal Reserve System Trill bo tho vehicle for furnishing a certain anount of credit permanently ,to those reiaoto sections of the country TJhore interest rates are high and where liquid capital is deficient* A fifth difficulty appears to arise as to the regulation of the total amount of credit for the rtiole banking system, as distinguished from the total • which any one member may be allowed to borrow* Obviously the twelve Reserve Banks cannot work out such a nice mathematical arrangement of credit as would serve the requirements of all the banking System and work smoothly, because these requirements vary greatly at different seasons of the yeax and in different sections. A sixth difficulty is at once obvious were the System to assume responsibility for declining loans to members which made it nocessary for those nusobers to docline loans to customers* It has always seemed to me that the primary responsi bility fear any loan made by a bank to its customer should rest with the officers and direotors of that bank and that the Roscrvo Bonk should never assume that responsibility nor be willing to accept the consequences of exercising it* And-a seventh and last difficulty, although this may not indeed be all of them, Is one which I regard as more serious than any of the others, - the exer cise of powers conferred by the Reserve Act upon the Reserve Banks by this rule 17 of personal discretion, I fear, T.ould develop inevitably in tine a bureaucratic attitude of nind on the part of tho managers of the Reserve Banks Which would be 0 unfortunate indcod far tho rolfare of the whole banking Systoa* Power excites ap petite for tioro po«or* renkera in ti^o vrould rebel and the public would rebel* Vox?, on the other Land, it bo a & l U c d that if a member bank is eblo to Ic'an all of it? furds nt Ift/* cr ct 1%*., cad if it in jr*?in- as hi^i eo 85 inter cet v?oa its Co|;r>titc, tu\Z tos tit© ojo-o^luaity to discount pr«per at its Reserve Bank at 1 1/~.!, tho tcr.rjto.tion to tiako tho additional profit by enlarf^Lng its business and discountin,*’ freely cannot well be escaped* Nor can the Reserve Bank charge that member bunk a rate ’which \rould operate aa a restraint to its borrowing without chsrln:~ a like rate to r.cc.bor banks in itsosrn city or in tho money centres of its district which would put the ro&ourcos of the Roaetrve Bank entirely beyond the reach of nost, if not all, of the large bonks of the district* Therefore, however, dif ficult nay be tho exercise of discretion, in some Reserve districts that would appear for the present to be the only means of exercising a regulatory influence* On the other hand, let us see how the rate will operate* I think one should look upon the credit structure of tho country as aa inverted pyramid at the base of which is a foundation of bricks of gold which enjoy the peculiar power of sustaining each its own proportion of the entire inverted pyramid* Those bricks of gold are the bank reserves Held by the Reserve Bonk* Xf one brick is taken out *• of the base, the series of stonos resting upon it, representing the volume of credit sustoinod by that reserve brick, must, inevitably, come down* And if a brick is addod, by so much tho pyramid is very shortly enlarged* If the Reserve Bank rate is so low as to be an inducement to borrowing additional tiers of bricks will be laid at the foundation and the pyramid will be by so much enlarged; and the re verse is equally true if the rate does not induce borrowing, - the size of the pyramid may be kept unehangod, or even reduced* 13 A rate control of. tho voluno o? crc&Lt hr.n a variety of advao-ta-os. Q 3 that it is democratic* expostulation On© li c.^1103 to all tOliko an! it rcixiirtss littlo, if cay, remonstrance to reake it effoctivo* It r:ust bo a&!itted that an advance in tho discount rates by the Reservo Ban;:o trf.ll not necessarily influence promptly Via .-*,unt&in peaks of hirh interest rat os in cccra sections* But I rather doubt vrhcChcr it ic noco..on-y that it u^oulu Ho £.0 . Altijsurrh cc*t capable of sta tistical support, I think the statement tiay be hazarded frca past experience that a rate vrliich is effective in chec’tiLns bon*ov/in7 in the wcnoy centers, car oven in refi-.’Cina bcrrawins, will indirectly bo on influcnco in all sections of the.country* It certainly has tho cffcet of that 1 cdrht doccriho as "driving borrowers took hono." It is customary for many concerns which do a large business to borrow in the cheapest money markets, no natter where their offices and business nay bo locat ed* If lic«7 York, for instance, should advance discount rates and nottsber banks in turn advanced rates to their customers, a certain nuraber of these out-of-tom bor rowers would go to their local banks far their loans if the rates thero ore satis factory co as to enable the borrower to pay off in New York* This process I believe would be found, could It be analyzed, to be many times repeated, so that the effect of rate changes in the twelve Reserve cities is not confined alone to those cities but extends throughout the country* Another point frequently overlooked in regard to tho effect of the rate Is duo to lack of understanding of the way in which borrowing from the Reserve Bank originates, - that is through inpairod reserves* Every bank knows about what Its loanable funds cost it on tho average and about what it receives oa all of the nonoy which it Is loaning* It knows about what its expenses and overhead amount to and the differonce Is its profit* Vsh.cn a bank’s reserve becomes irapaired so that It must borrow, it does not pick out a particular ploce of paper whiofc it has discounted at a hiphor rate of Interest and then rediscount that paper at the Reserve Bank rate and figure that it Is making a profit, but it is nuch more liable to see whether 19 the borrowing from tho Reserve Bank at tho Reserve Bank rate Involves In point of -fact an absolute loss, or Whether It may not be less expensive to reduce loans or sell investments and avoid borro^itiss. Expressing it differently, the rate at which a Reserve Bank lends to its member bank has no particular relation to tho rate which a member bank receives on any of its transactions, but it has a relation to tho avora,^o of all rates reeoi-ved by the member bank and tho average cost of all •of its loanable funds* And from this I have always concluded what I firmly believe to be tho fact, that a Reserve Bank rate in order to be effective in restraining un due borrowing, does not necessarily need to be a penalty rate, that is to say a rate fixed eo hir-h that there will bo no differential in favor of tho borrowing bank on any paper which, it may have taken from its customers, even tho highest rate paper* But an effective rate will likely bo somewhere within the range between tho average cost of all its loanable funds, including overhead, and the average that it receives upon all of its earning aosets, with due allowance, of course, for loss of interest on reserves. The chief advantage of rate control, however, is in tho way it serves more definitely to regulate tho total volume of credit as distinguished from the total amount of loans to any one individual member bank* I would regard the determination of the amount tu bo loaned to an individual member bank as a credit matter to be determined just as any loan would be dotermined by any bank to any customer* But, on the other hand, I v?ould regard tho rate policy of the Federal Reserve System as a national credit policy moro directly related to regulating tho volume of credit in the country so as to maintain stable credit conditions* Finally, however, we must recognize that there aro many people who believe that more money, and cheap money, moans prosperity and happiness* To those people an advance of discount rates may at times bo difficult to explain. It is on that account that the absence of natural movements of gold is most unfortunate; end it is for that reason, as wall as for many others, that the world will be better off 20 by a prompt return to tho cold standard and free rpld payments* Permit mo now to t-ako a brief resumo of this Ions &r.;w.;cat: VI,e ivoservc Banks have been r^voa the poorer to croate reserve balances and to a' lorse extent to rcr^ulate tho volumo of credit* That volume of credit expands in response to ex poet fncto berrc-in't by member Innks; the macs of their transactions Causing the borrow!n~ having already ca.cvrrc:’, there is no ncuno by which the noserve Hank can coutrol tho uco zldch ic r.zlo of the fine’s vrhich it loans to its J.ierc'cors* Credit so borrowed frosi tho fiescrvo Banks is less likely to roturn for cancellation whoa no leaser lecitimtely rc^Air^d if discount rates are too Ion?, and a hir,h discount rato will operate to induco its return* situation vlierc there is no r.urylnz of there is not likely to be a deficiency* perconvane of tho Reserve Basics* Tho present banking System has created a bartcin.3 reserves in tho country, and The real reserve borosnetar is the tahere reserve Tho impulse which will lead the Reserve System to chanrtt rate3 oust for the present largely oriso from general conditions, and it cannot be expccted that the impulse to advance rates will be given by gold exports for a lone time to cone* Therefore, the regulation of the volume of credit which is tho chief function of the Reserve System crust be effected by a combination of rate changes and due caution as to members* borrowings* The Federal Reserve System has always impressed me as being essentially a social institution. It is not-a super-Government, it is siinply the creature of C Congress, brought into being in response to a public demand* It m s not created only to serve the banker, tho Conner, the manufacturer, nor the merchant, nor the Treasury of the United States* guiding influence is not profit* to the Government. It was brought into being to sorve thorn all. Practically all its receipts over expenses go For some the scrvice it performs is direct, for others it is indiroct, but is not loss definite nor any loss important. It needs and asks that it be given the benefit of intelligent study and enlightened criticism* Its future depends upon its own good behaviour and upon its success in winning and holding the Its confidence of tho public.
@FedFRASER