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The Reserve Problem

The Future of the Federal Reserve System

Address of
before the
Convention of the

September 29, 1916

Reprinted by the
Federal Reserve Bank of Minneapolis





H E directors and officers of the Federal Reserve
Bank of Minneapolis commend to the careful
attention of every thoughtful banker and business
man, the address of Honorable Paul M. Warburg, reprinted
on the following pages. Mr. Warburg is considered to be
one of the ablest American authorities on foreign exchange
and international banking. His long experience in banking,
both in Europe and America; his recognized ability and
clear judgment; and his experience as a member, since its
organization, of the Federal Reserve Board, give him a
peculiar ability to speak with authority upon the problems
that confront the Federal Reserve Banks and the banking
institutions of the United States.
In this address, Mr. Warburg has been able to show with
great clearness, what place is to be filled by the Federal
Reserve System in the financial life of this country, and
what burdens it must carry in the future. Mr. Warburg's
discussion of conditions after the close of the great war in
Europe is one that should receive the attention of business
men and bankers. It is of such value that it has seemed
desirable to reprint his address in such form as to permit
of its general circulation.


It has been suggested that I address you upon the subject
of "the future of the Federal Reserve System." To venture
to predict the future is always a risky undertaking, and I, for
one, dislike to attempt the role of prophet. But if our new
banking system is to attain its fullest measure of success, we
must have in our minds a very definite ideal, a clear concep­
tion of the goal towards which we are striving, so that each
consecutive step may be a consistent move in that direction.
I deem it, therefore, a privilege to be afforded this opportunity
of addressing the leading association of American bankers upon
a topic in which its members are so keenly and vitally inter­
ested, and which—if we are to achieve the most fruitful results
—should be solved by their own efforts rather than by legisla­
tive initiative.
The well known British writer, Mr. Hartley Withers, in
his new book, "International Finance," makes the following
"London's credit machinery has grown up in almost complete
freedom from legislation, and it has consequently been able to
grow without let or hindrance along the lines that expediency and
convenience have shown to be most practical and useful."

When I read this paragraph, there came to me again the
feeling of regret that American banking had not developed in
a similar manner; that—owing to reasons which it is unneces­
sary to review here—our banking methods had proceeded
along lines that had proved disastrous, and that multiplicity
of banks, diversity of interests, and divergence of views
precluded any possibility of voluntary agreement concerning
the adoption of uniform, scientific, and adequate modern
banking methods. That failure rendered necessary banking
under government regulation, and, to a certain extent, in the


Federal Reserve Act, even under compulsion. By many, this
method has been viewed with regret, but unfortunately there
appeared no other possibility of success.
I believe it is safe to say that, in general, those laws have
proved the best which put into legal form existing usages
already recognized by actual experience as sound both in
principle and practice. With us, it was impossible to use
existing banking habits as the basis for our legislation. It
was necessary to take those banking practices that had proved
their worth in other countries and to adopt them as our model,
with such adaptations as our own conditions rendered neces­
It is a most difficult task, however, to remodel fundamentally
the structure of a fully developed organization, and to do it
while the machinery is kept going at top speed. It is evident
that it cannot be accomplished without some temporary
inconvenience and that it must be done step by step. The
tracks in the new depot of the New York Central Railway in
New York had to be moved many hundreds of times in order
to keep the trains running while the larger basis of operation
was being perfected.
I am profoundly convinced that the Federal Reserve Act
will prove one of the most constructive contributions ever
made by Congress, and that the further the system develops,
the more apparent will this become.
Present Federal Reserve Act Not a
Finality, But a Beginning
But, in expressing my unbound confidence in the future of
the system, I am fully conscious of the fact that, in its present
form, it is not a finality, but a beginning. The tracks will
have to be shifted many a time, and, as the fields opened by
the new organization are developed, substantial changes in
machinery will have to be made in order to cope with new
Indeed, the Federal Reserve Act would prove a failure if
these changes in the system did not become necessary from


time to time. In this process of developing the new machinery
to its fullest degree of usefulness, the bankers of the United
States will have to play the most prominent part, and it is for
this reason that I am particularly anxious that we all should
reach a clear understanding about the future course of
American banking, its hopes and its fears. Only if we take
this more comprehensive view shall we be able to plan wisely
—not for the morrow, not for single interests, but for the larger
future and the benefit of all.
Importance of Co-operation of American Bankers Association
I have no doubt that your association is in harmony with
these views, and that, in co-operating along these lines, it
will prove a most important and helpful factor in the simul­
taneous evolution of good banking practice and good banking
legislation. The natural development will be that Congress
will call upon the Federal Reserve Board more and more to
act as an expert body in questions of banking—though,
unfortunately, this does not mean that our advice will always
be heeded. Our conferences with your committees will
assist us in the future, as they have in the past, to do our
duties fairly in administering the Federal Reserve System,
and in planning for its future growth.
The Real Meaning of "Reserves"
Let us try to review as briefly as possible the main features
adopted from European banking, and to establish where we
stopped half-way and what still remains to be done. Time
will not permit me to cover each of the various phases involved,
but it may be possible to deal fairly comprehensively with the
topic of reserves, which, after all, is to many the most puzzling,
and to all the most vital question involved in the problem.
In 1910, I published a tentative plan entitled, "A United
Reserve Bank of the United States." Later on, Senator
Aldrich called the system that he proposed, "A National
Reserve Association;" and finally the Owen-Glass committees
devised the "Federal Reserve System," which was enacted

into law. The word ''reserve" has been embodied in all these
varying names, and this is significant because the adoption of
the principle of co-operative reserves is the characteristic
feature of each of these plans.
"Monetary and banking reform" made its greatest step
forward when public opinion recognized that it was not
essentially a question of note issues but one of reserves. But,
though this reserve problem has thus been before us for many
years, it is a strange fact that there still exists a singular
confusion in the minds of bankers, writers, and students as to
what the word "reserve" actually means in this connection.
There are all kinds of reserves. There are military and
naval reserves. We speak of reserves in dealing with water
supply, with food, raw materials, rolling stock, electric power,
and what not. In each case its meaning depends upon the
requirements of the organization maintaining the reserve.
Reserve is, as the name implies, what one holds back. It
generally means an extra supply of something kept idle for the
purpose of being immediately available to take care of an
increased demand in excess of normal requirements. Now,
if we wish to get a clear conception of the meaning of reserves
in connection with the Federal Reserve System, we must under­
stand that it is necessary to recognize central banks as entirely
different organizations from the commercial banks and trust
companies, and,' consequently, that their respective reserves
differ as much as those of an ice factory and a summer hotel—
the one a producer and the other a consumer of ice.
Reserves of central banks and reserves of the general stock
banks are two entirely different things.
For the sake of greater simplicity, I shall in this address call
the national banks, state banks and trust companies, the
"stock banks" and their reserves, "banking reserves," and I
shall term the reserves of the central banks "gold reserves,"
leaving it open at this point whether or not these latter reserves
should include silver and greenbacks.
The Federal Reserve System is a co-ordination of twelve
central banks; and the same principle as to reserves, therefore,
applies as if we were dealing with one central bank. I shall,

therefore, in this address, class the Federal Reserve System
with the central banks.
Functions of Stock Banks in Central Bank Countries
Let us consider first the functions of the stock banks in
central bank countries.
Deposit banking is the art of wisely employing the deposi­
tors' stored up purchasing power. It is based on the principle
that there is a sufficient variety of conditions amongst the
depositors and borrowers of a bank so as normally to preclude
the probability of the depositors' withdrawing and using their
own money faster than it can be collected from the borrowers,
to whom the depositors' purchasing power temporarily has
been transferred. The bank's own capital and the uninvested
part of its deposits form the insurance, or reserve fund to act
as an equalizer in balancing these scales. It is essentially a
question of exchanging credits, and, where there is a central
banking machinery enabling the stock banks to liquidate a
sufficient amount of their assets to make good any deficits that
may occur, the whole system is safe and complete. The
central banking organization provides the member banks
either with balances to be used in the clearing, or, if currency
should be required, with notes which will be accepted by
their depositors in settlement of the stock bank's obligations.
In countries where these notes of the central banks are
generally accepted in settlement of debts by business men and
banks, the ''banking reserves" of the stock banks may safely
consist of the central bank currency, or of a balance kept with
the central bank, convertible into such currency. These form
the first line of banking reserves. The second line consists of
those assets which, with certainty and promptness, may be
converted into credit balances with the central bank. It is
simply a question of having a reserve of such credit currency,
or of power to produce such credit balances, as will provide an
acceptable means of satisfying depositors.
Balances with the central bank, and its notes, entitles the
stock banks, like any other holder, to payment in legal tender;


and if legal tender is demanded by creditors of the stock banks,
the latter must rely upon the central bank to furnish it. The
duty to keep its own deposit and note obligations sufficiently
protected by a proper proportion of metallic cover rests with
the central bank and its reserves, therefore, must consist
exclusively of the metal in which its obligations are payable.
In central bank countries there does not exist any law that
requires stock banks to keep in actual specie in their own
vaults a certain proportion of their deposits. All the central
bank usually requires is that the stock banks, and other firms,
maintain with it free balances commensurate with the scope
of their transactions. As a matter of fact, if we study the
statements of European stock banks we find one single cash
item which includes the combined holding of gold, silver,
bank notes, and the balance with the central bank.
I still remember that when I had my initiation into banking
in Europe, twenty-eight years ago, we never bothered much
about our cash in vault. We never had more than we needed
as till money. If we accumulated too much, we sent it to the
central bank to be credited to our account. If we ran short,
we sent over to the central bank and got what currency we
required. The cash item was of very little interest to us, but
we watched continually the balance with the.central bank,
and if our balance approached the prescribed minimum, we
would strengthen it by sending over for discount some short
paper maturing within five, ten or fifteen days—or, if demands
were extraordinarily heavy and unexpected, wre might have
to send over paper of longer maturity. Or, at times, when the
discount rate of the central bank was higher than the ruling
rate of the stock banks, the latter would take our short paper—
just as we would make short loans to them when we had surplus
funds to lend. If conditions became such that the stock banks
were crowded so that the central bank would notice that the
maturities it was discounting were gradually becoming longer,
the central bank would have to consider whether or not it was
time for it to raise its rate. If the increased demand was due
to seasonal requirements, the central bank would maintain
its rate and go deeper into its reserves. If the central bank


suspected that over-expansion or speculation, or gold exports
of alarming proportions, were at the bottom of the increased
inroads into its reserves, it would counter with an increase in
its rate.
Difference Between Old and New Systems in the
United States
In the United States our old State banking systems did not
provide for any central organization to protect the banks'
gold obligations, nor did they furnish the machinery by which,
in case of need, banks could convert their commercial assets
into cash or credit balances. The National Bank Act, there­
fore, required every national bank to maintain against its
deposits a certain percentage of actual lawful money reserve,
which it was considered should constitute its contribution to
the general gold protection of the nation; in addition, credit
bank balances in Reserve and Central Reserve Cities were to
provide a certain liquidity in case of emergencies. The vicious
shortcomings of this old method are well known to everybody
here, and need not be elaborated.
The Federal Reserve Act brought about a most radical
change. It created a system of twelve central banks which,
co-operating with one another, were from then on to exercise
two important functions in relation to their member banks;
first, to provide a sufficient gold cover for the country's gold
obligations; and, second, to provide the machinery for turning,
whenever desired, the member banks' commercial assets into
available credit balances, or cash.
The first function relieved the member banks of the necessity
of keeping in their vaults large amounts of gold for the general
protection of the country; the second rendered unnecessary the
so-called reserve balances with correspondents in Reserve and
Central Reserve Cities. The safe and effectual transfer of
these burdens to the Federal Reserve Banks must be pred­
icated, however, upon a sufficient mobilization and concentra­
tion of gold in the hands of the Federal Reserve Banks, and,
furthermore, upon the existence of a large volume of standard­
ized commercial and banking paper, easily rediscountable


without .red tape with the Federal Reserve Banks. This is
where the Federal Reserve Act stopped half way. It did not
say to the member banks, ''Maintain with the Federal Reserve
Bank a minimum balance sufficient for the general safety of the
country, and whatever cash you keep in excess of that in your
own vaults—be that gold or silver or Federal Reserve notes—
is your own concern. But bear in mind that the larger the
gold fund produced by the combined contributions from your
own vaults, the stronger will be the protection to you and the
entire country." The law continued, instead, the anomaly of
requiring member banks to lock up in their vaults hundreds of
millions of dollars, thus preventing them by legal enactment
from giving additional strength to their own protective system,
even if they should want to do so. It further created the
anomalous situation that, while a balance with a Federal
Reserve Bank could be considered as reserve, the Federal
Reserve note could not be so counted, despite the fact that it
is a prior lien against the assets of the bank and is the obliga­
tion of the United States, while the balance is not.
This inconsistency—to a certain extent at least—has been
cured; Congress having passed, upon the recommendation of
the Board, a most important amendment authorizing the
Board to permit member banks to keep any portion of their
required vault reserve as balances with their Federal Reserve
Banks. In passing this amendment, Congress has opened the
path for great strides in advance, and it remains to be seen
now, how far the bankers of the United States will be able to
seize this opportunity of doubling the strentgh of their Federal
Reserve Banks.
There has been a great deal of grumbling, particularly on
the part of the country banks, to the effect that their reserve
requirements are too heavy, and they have sometimes sug­
gested that they be permitted to continue to count as reserve
certain balances kept with their correspondent banks. If
member banks' reserve requirements should be found unneces­
sarily heavy, let us reduce them outright; but do not let us
continue the confusion of counting as reserve what—by plain
reasoning—should not be called or treated as a reserve. Let


us, in our plans for the future, try to look at the problem as a
simple question of keeping a sufficient balance with the
Federal Reserve Bank, and when that is maintained, leave it
to the member bank to keep liquid and strong in its own way.
Do not let us apply the term reserve to a balance with another
member bank, which may be invested in securities or loaned on
the stock exchange; nor let us count as reserve checks in
process of collection, and yet, at the same time, treat Federal
Reserve notes as an asset that cannot be counted as a banking
Can We Meet Post-Bellum Demands
In dealing with the problem of adequate reserves, we must
first and always consider the question of whether or not our
Federal Reserve Banks are sufficiently strong for the protection
of the country or whether they are stronger than necessary.
Whenever the latter question can be answered in the affirma­
tive, then only will we be justified in considering the advisa­
bility of reducing the member banks' reserve requirements.
What is the Federal Reserve System's lending power today?
If we set aside a gold reserve of only 40%—which may do in
times of stress, but is not a proper and sufficient basis in
normal times—we find that we have a free gold reserve of
about $206,000,000* or, if we include the gold now held in cold
storage by the Federal Reserve Agents, about $380,000,000.
This means that, by additional rediscount operations, or
purchases in the open market, for home requirements or for
export, we are able to stand a loss of gold of from two to three
*Present lending power of the Federal Reserve Banks (September 1, 1916):
Net deposits (Govt, and bank deposits) less
35% thereof
Note liability
40% thereof
Total required reserve against deposit and note
Total cash reserve
Cash equivalent to F. R. notes on hand
Additional lending power of F. R. banks if loans are taken
in lawful money
Additional lending power if loans are taken in F. R. notes




hundred million dollars. $200,000,000 is a very large amount,
but when we realize that the Nation's gold holding in one
year has increased by about $500,000,000, it is well for us to
consider whether or not we shall be able to hold this gold at the
end of the war. It is impossible to predict what will then be
our economic and financial situation. Perhaps we may find
ourselves in an over-expanded or generally unsatisfactory
condition, and we may have to face a readjustment in which
all our banking strength may be required. On the other hand,
things may go well with us, but in the rest of the world there
may be a great deal of financial distress. In that case (and it
may be the more likely of the two) we shall have almost
boundless opportunities, but serious obligations as well.
Foreign loans in the old and the new world may draw away our
capital at interest rates far in excess of our own. Our ex­
porters will have to meet the keen competition of other
nations, and even though at first there will probably be a
strong demand for certain of our raw materials, the purchasing
power of many a country will be found materially reduced.
These are conditions which, in the long run, may be the cause
of heavy gold exports from the United States and which, if we
remain unprepared, may seriously check our progress. If, on
the other hand, we forearm, we may grasp the opportunity of
taking our place as the strongest of the world's bankers and
furnish our industries with the basis for a solid expansion.
Amount of Free Gold Mobilized Ridiculously Small
Does it not appear ridiculous that a country owning over
two billions and a half of gold should not be able to mobilize
a larger free gold reserve than two or three hundred millions
of dollars, particularly when it is apparent that its future
financial and economic growth will depend upon the extent of
the "preparedness" that it can provide in this respect?
During the critical period following the outbreak of the
war in 1914, there were issued $386,000,000 of currency under
the so-called Aldrich-Vreeland Act. Has it occurred to you
that if a similar amount were needed under the Federal Reserve


Act it would absorb a gold reserve, on a 40% basis, of $154,000,000? But financial history has shown that each crisis
develops larger demands than its predecessor, and, with our
constantly growing pyramid of deposits and loans, and with
the gigantic scale upon which financial transactions are now
conducted, it is our duty to be prepared for ever larger
demands. The fact that we are strongly forearmed, far
beyond a limit expected to be actually reached, will be the
only means of restraining these demands to safe and reasonable
bounds. We ought to be able, therefore, to lose $300,000,000
to $500,000,000 and still have $200,000,000 or $300,000,000 of
free gold to serve as a basis for emergency operations.
I cannot urge you too strongly, therefore, to co-operate to
the utmost of your abilities in keeping your balances with the
Federal Reserve Banks high, and your vault money down to
the minimum that your own till requirements will safely and
conveniently permit. It is obvious that, in strengthening the
Federal Reserve Banks, you are strengthening yourselves.
If a country bank with $25,000 in capital and $150,000 in
deposits keeps in its vaults $5,000 or $10,000 of gold, does it
expect that, in case of a national emergency, it could protect
itself with that amount of legal tender in the event the Federal
Reserve Banks stopped paying in gold or stopped rediscounting? If a country bank's depositors want cash, they will be
perfectly satisfied to take Federal Reserve notes. But the
power to furnish these notes, or credit, is limited by the amount
of gold held by the Federal Reserve Banks. While the $5,000
gold in vault of the member bank will not, therefore, protect it,
the specie and legal tender notes held by all of them collectively
(about $770,000,000) can be made to form the strongest
possible bulwark of protection for all if deposited in the
Federal Reserve Banks.
But you may ask me how is it that in Europe central banks
control these vast amounts of gold while the deposit balances
maintained by the stock banks are comparatively small, and
why then should it be necessary for American member banks
to keep such large deposit balances? This is, again, because
we have stopped half way. The Bank of England issues notes


only against gold. The other leading central banks of Europe
issue notes against gold (in certain countries gold and silver)
and commercial paper. There may be 100% of gold, but
there may not be less than a prescribed minimum gold reserve.
But they do not provide that notes may not be issued against
gold without a certain reserve of commercial paper. That
theory—which makes all Europe laugh at us—is, however, the
one underlying the Federal Reserve Act. The Board urged
Congress to remedy the law in this respect. The Senate
responded favorably by passing a bill on these lines, but
unfortunately, it was lost in conference.
Europe's Successful Experience Not to Be
Arbitrarily Condemned by Us
It is hard to comprehend why, if this principle has been
universally and successfully adopted by the leading central
banks, and has been the root of their surprising strength during
the last two years of terrific strain, it should be arbitrarily
condemned or disregarded by us. Let us examine the state­
ments of some of these central banks as they appeared before
the war:


Metallic Reserves of the Principal Central Banks of Europe*
at the End of the Calendar Year 1913, and the Percentage of Their Demand Liabilities Which
Were Represented by Notes in Circulation and Deposits
Reserves Notes in
Circulation Deposits Deposits Deposits
Per Mill Per Mill Per Mill Per
Dollars Doll. cent Doll. c'nt Doll. c'nt Doll. cent

Bank of France
Russian State Bank
Austro-Hungarian Bank
Bank of Italy
Bank of Netherlands
National Bank of Belgium..
Swiss National Bank

800 1,165

Federal Reserve Banks,
September 1, 1916



85 63 5 142 "To 205
57 490 33 142 10 632
75 40 1 98 18 138
2 1
3 1 17 8 20


9* 485 88 536




It is evident from these statistics that the United States
is following a course diametrically opposed to that of all other
central banks. While our central gold reserve, disregarding
capital, is made up 97% from deposits and 3 % from note issue,
the statement of the Bank of the Netherlands shows that it
obtains 99% of its metal from circulation and 1% from
deposits. This is the most extreme case, but the table speaks
*I have not included the Bank of England, because its organization does not provide
for so-called elastic note issue, and, because, during the recent critical period, it proved
anew its inferiority in this respect as compared with modern central banks like the Banque
de France and the Reichsbank. Owing to the rigidity of the structure of the Bank of
England, that country could not promptly meet the first pressure following the beginning
of the war. There was an inelastic and insufficient note issuing power, and the consequence
was that a situation developed in which the government credit had to be thrown into the
scales to a much larger extent than with any other nation. The British government had
to guarantee acceptances, discounts, and stock exchange loans to an almost unlimited
degree; it had to issue, in August, 1914, ^37,603,000 of small notes to provide the needed
currency. I believe it is safe to say t hat the moratorium and the great inconveniences
and losses inflicted upon England's debtor nations might have been avoided if the organiza­
tion of the Bank of England had be n more modern and possessed of greater elasticity.
England's unparalleled power as the ^world's creditor nation, which was brought into play
with marvellous boldness and ingenuity, saved the day for Great Britain and overcame
the Bank of England's organic weakness, which, with any other nation, might have proved


for itself in showing that, with the exception of Russia, where
public deposits (for reasons which it would lead too far to
explain here) are extraordinarily large, the important European
central banks secure their gold reserve from circulation to an
extent varying between 75 and 99%.
It may be worth our while to analyze further what would be
the effect of permitting Federal Reserve Banks to issue notes
in exchange for gold in the manner recommended to Congress
by the Federal Reserve Board.
Exchange of Federal Reserve Notes for Gold
Certificates Would Afford Protection
If we added $500,000,000 to the Federal Reserve Bank's
gold holdings by withdrawing gold certificates from circulation
and issued against this gold $500,000,000 of Federal Reserve
notes, the exchange in itself would not alter the volume of the
country's total circulation. But our power of protection
would be increased. If, after such exchange, member banks
rediscounted with Federal Reserve Banks $300,000,000 of
paper and shipped $300,000,000 of gold to Europe out of the
credit balances thus secured, the Federal Reserve Banks'
balance sheet would show against these transactions:
Gold $200,000,000
300,000,000 Rediscount
against gold shipped.

Notes Outstanding


So that the mere exchange would have enabled us to bear a loss
of $300,000,000 of gold which otherwise might have affected
seriously our financial situation. This argument is based
upon the theory that possibly $700,000,000 to $750,000,000 of
gold certificates and gold, in addition to other kinds of cur­
rency, are at present carried in the pockets of the people and
in business tills where Federal Reserve notes would serve
equally well. The obligation of the United States, secured by
all the assets of the Federal Reserve Banks and a large cover


of gold, would remain a trusted medium of exchange unless
indeed the credit of the United States went to pieces. Ex­
perience has shown that a large and constant volume of notes
remains outstanding at all times, and that, during a crisis, the
amount rather increases than decreases. It is certain, there­
fore, that a very large sum of gold could be permanently
withdrawn from circulation, and that, as in Europe, the bank
note circulation would take its place. Against this well
recognized practice, the hue and cry of inflation has been
raised. It is hard to see why a process that spells "elasticity''
in France, Germany, Holland, Belgium, Austria, Italy,
Sweden, Norway, Russia, Switzerland, and other countries,
should spell "inflation" with us. Elasticity without restraint
may lead to inflation. But elasticity well regulated by rigid
supervision and definite requirements of gold cover, elasticity
subject to widest publicity and constant ruthless scrutiny, may
be trusted not to go very far astray.
As I said the other day, if you need police protection, you
must not deny the policeman the right to carry a modern
revolver for fear that he might shoot the wrong man. If the
Federal Reserve Banks and the Board wanted to run amuck,
their present powers are sufficiently large to enable them to do
harm. Their ability to do mischief would hardly be increased
by the added power, but their ability to protect would grow
Opportunity of Conserving $600,000,000
Gold Imports Lost
Since the Federal Reserve Banks opened, there has come
into the United States from abroad over $600,000,000 gold.
This stream of gold should have benefited the Federal Reserve
Banks. They should have impounded the gold and issued
their Federal Reserve notes against it. As it is, they have lost
this unique opportunity of gaining additional strength; they
have had to stand by idly and let the gold flow into the
.member banks or go into circulation. Let us throw the
searchlight on this bogey that procuring additional gold by


note issue is dangerous, while to obtain it by additional
member bank deposits is safe. This will best be accomplished
by taking our present combined statement and adding
$500,000,000 gold obtained by additional deposits, or, as an
alternative, adding $500,000,000 obtained by issuing notes in
exchange for a like amount of gold, and then comparing the

Millions of


Cash reserve 365 plus 500
Earning assets
All other assets

Reserve, 3 5 % on 1036
4 0 % on
Free gold..



Government deposits
Bank deposits 485 plus 500..
Note liability
Other liability


496 purchasing power.
1,240 note issuing power.

g ^




In case law permitted issue of F . R.
notes against gold or paper, or both,
as proposed by Federal Reserve
Millions of

Cash reserve 365 plus 500....
Earning assets
All other assets



Government deposits
Bank deposits
Note liability 14 plus 500
Other liability

Reserve, 3 5 % on 536
40%? on 514

. 865
471 purchasing power.
1,178 note issuing power.

Millions of


"Inflation" Arguments Answered
It follows from this illustration that the increase in power
"to inflate" is smaller if the added power is obtained by note
issue than by deposits. Unwillingness to grant an increase of
power cannot be accepted, therefore, as the motive of a
Congress which encouraged increase of power by authorizing
larger member bank balances. There must be, therefore,
another reason. Our critics say: "The theory of the Federal
Reserve Act was to issue Federal Reserve notes which were to
be redeemed at once when the underlying commercial trans­
action has been completed, and that, by making Federal
Reserve notes reserve money, or by issuing them in exchange
for gold, the note would not be presented promptly for
redemption." But have these critics considered that an
individual note is never elastic, that it is only the aggregate
of notes outstanding, the volume of the entire circulation,
which fluctuates and is being made elastic? The degree of
this elasticity is controlled by the aggregate of investments
made by the Federal Reserve Banks. Whenever the Federal
Reserve Banks collect their investments at maturity and do
not reinvest, they are paid in their own notes, or in lawful
money. The result in both cases is the redemption of their
notes. In the latter case the Federal Reserve notes remain in
circulation but the lawful money takes the place of the
maturing paper as cover for the Federal Reserve notes, and
reduces the volume of outstanding circulation to its level
before the Federal Reserve Bank made its investment. As
long as the Federal Reserve notes remain outstanding an
equivalent of lawful money is withdrawn from circulation.*
♦Some of our critics strenuously object to the comparatively small accumulation of
gold in the hands of the Federal Reserve agents as brought about under present circuitous
and very cumbersome methods of partially accomplishing the results sought by the pro­
posed amendment. It appears difficult to make these writers see that an exchange par
for par of a $10 Federal Reserve note for a $10 gold certificate is not increase of circulation,
but a substitution of one note for the other. As long as the gold remains with the Federal
Reserve agent, the Federal Reserve note is, in effect, a gold certificate; with this difference
only, that its holder has agreed in advance, in case the Federal Reserve Banks should be
called upon to rediscount heavily, to change his gold secured Federal Reserve note into
one secured by commercial paper with a gold reserve of not less than 40%. Instead of
remaining limited by the free gold secured from member bank balances, the Federal Reserve


Let us take an extreme case to make our point clear: If we
suppose that we had issued two billion dollars of Federal
Reserve notes against gold, and then, in addition, issued two
hundred million dollars of Federal Reserve notes against
commercial paper, there would be two billion, two hundred
million dollars of Federal Reserve notes outstanding, against
which there would be about 90% of gold cover and 10% of
paper. If the makers of the two hundred millions of commer­
cial paper paid it at maturity with the two hundred millions of
Federal Reserve notes the status quo ante would clearly be re­
established. But it would be just as clearly re-established if
the makers of the two hundred millions of commercial paper
paid it in gold. Then we should have two billion, two hundred
million of Federal Reserve notes outstanding, against which
the bank would hold two billion, two hundred millions of
gold. It would simply mean that two hundred millions of
gold formerly in circulation, and possibly much worn by use,
had been replaced by an equal amount of new and clean
Federal Reserve notes. In other words, the two hundred
millions are redeemed in both cases, no matter whether the
specific Federal Reserve note is resting in a vault in Oshkosh
or is being carried around in the pocket of a farmer in Texas.
Whenever the Federal Reserve Banks collect their paper their
notes are in effect redeemed—no matter where or how they are
being held. But, under the proposed amendment, instead of
having a circulation of which, let us say, 90% is entirely
secured by gold and 10% is secured by commercial paper with
a 40% gold reserve, we would have all such outstanding notes
secured by about 90% of gold and 10% of paper; and if the
method I am describing prevailed, the Federal Reserve Banks
could keep their normal reserves much higher than under
the present system. If this method were adopted, I, for one,
should be in favor of beginning to tax Federal Reserve notes
at a higher point that at present—let us say whenever the
banks are trying to build up a further gold reserve from noteholders willing to trust Uncle
Sam, whether he gives them his promise to pay in the form of a gold certificate, silver
certificate, greenback, or Federal Reserve note. It is needless to add that, in thus
strengthening themselves, the Federal Reserve banks are acting well within the powers
given them by the act.


reserve went below 60% instead of 40%. This would probably
satisfy the fearful minds which apprehend that the increased
power might be abused, but it would not prevent the country
from securing the greater protective power to which it is
It will be said that the gold that actually circulated in
France and Germany at the beginning of the war proved a
most valuable second line of emergency reserve. That is true
and a similar reserve would undoubtedly remain with us,
because even if the full program here outlined were realized,
we should succeed in concentrating a certain portion only of
all our gold. But it has been estimated that the central banks
of France and Germany controlled before 1914 about two to
three times as much gold as was drawn into their vaults from
circulation during the war, while we have only one-fifth of our
gold under control and four times that much, that is, two
billions, scattered in circulation and in the stock banks.
Moreover, there never was before in the world a period of
inflation such as is now in process in Europe, and the adjust­
ment after the war will create the keenest competition for the
yellow metal.
Our critics say that, by concentrating the gold in the Federal
Reserve Banks, we shall make them the target for gold
withdrawals. But they will be that target anyhow. The
only question is will they be able to resist without being forced
to take premature and unnecessarily drastic measures of
defense. Let us suppose that our member banks' excess cash
reserves have been wiped out, either by gold export or by
expansion of the loan and deposit structure; let us suppose
that our discount and investment rates are fairly low as com­
pared with those prevailing in Europe; let us suppose that our
shipments to foreign countries will no longer exceed our im­
ports. Then, as money flows where it can safely earn the
highest returns, our bankers will probably have to finance
foreign countries both in government loans and individual
transactions. Suppose then that Mr. Ivanoff, in Petrograd,
draws $100,000 at 90 days sight on an American banker
against a credit granted to him, rediscounts that paper in


New York, and, against this balance, Russia wants gold.
Where will it come from? The member banks have no more
excess reserves; shall we then begin to withdraw it from
circulation, and how, and against what? The New York
member bank will rediscount $100,000 of bankers' acceptances
or commercial paper with its Federal Reserve Bank and ask for
gold. Ultimately, therefore, the demand for gold will be made
upon the Federal Reserve Banks. We are faced with the
simple question: will we be strong enough to share our plenty,
during the coming period of stress, with other nations and be
the world's banker, or will we be so weak that, when these
demands come, we must stop them at once by raising our
discount rates high enough to retain our gold at home? Keep
all the gold in your vaults, gentlemen, where it is useless for
yourselves and deprived of the additional force that it may
gain in the hand of the Federal Reserve Banks; keep every
cash-till in hotels, railroad stations, dry goods stores, and what
not, filled with gold certificates, and you will rob the country of
its legitimate opportunity of growth, of helping itself, and of
helping the world. Our foreign competitors will proclaim
that only a country willing to part freely with its gold may
safely be accepted as a world's banker, and they will point to
the fact that, in past critical periods, our banks stopped paying
in gold. It is our duty to give to the world an overwhelming
evidence of our ability and determination in the future to
maintain our gold obligations under any and all circumstances.
Accumulation of Gold Necessary for Ultimate
Diminution of Bond-Secured Currency
The vast accumulation of gold in the hands of the Federal
Reserve Banks which I am urging, is of great moment in its bear­
ing upon the future of the national bank currency. The objects
contemplated in this respect by the Federal Reserve Act are
highly to be commended; but carrying this scheme into effect
is subject to too many delays. More comprehensive action
from the beginning would have brought about better results.
The ultimate aim which we must have in mind is the conversion


of a large portion of the 2 % Government bonds, now securing
circulation, into new 3 % bonds, a substantial portion of which
will gradually be absorbed by the people. This would have
the consequence of reducing the amount of national bank
circulation, so that, at a given point, whatever 2 % bonds the
Federal Reserve Banks acquired would ultimately be carried
by Federal Reserve note circulation, and this, in turn, would
be of material assistance to the Federal Reserve Banks in
earning their dividends. As the absorption of the 3 % bonds
by the public proceeded, and as the growing acceptance
market offered a wider field of investment for the Federal
Reserve Banks, Federal Reserve notes would take the place of
Federal Reserve Bank notes, bankers' acceptances and com­
mercial paper would take the place of Government bonds,
and an elastic and live currency would replace the present
inelastic Government bond secured currency.
In order to carry out this process, however, it will be neces­
sary normally to maintain against Federal Reserve notes at
least the 40% reserve required by law, as against the 5 % of
reserves now required against national bank notes. And this,
again, is an added reason for facilitating the concentration of
gold in the Federal Reserve Banks, so that they may be strong
enough to sustain this large volume of circulation on the higher
reserve basis.
The larger powers which we should enjoy would not, there­
fore, be employed to inflate circulation. On the contrary, as
a net result, it would be used for the purpose of building up a
circulation covered by a far stronger gold reserve than that
of the national bank notes.
Until the volume of the latter has been materially reduced,
and until Federal Reserve notes may be accepted as reserve
money by the member banks, the lending power of the Federal
Reserve Banks will remain hampered.
Federal Reserve Banks Have Not Increased
Volume of Circulation
In spite of all that has been said by superficial critics about


inflation caused by the issue of Federal Reserve notes, the
Federal Reserve Banks combined, as a net result, have added
to the circulation of the country no more than $14,000,000
of Federal Reserve notes.* All the rest has in effect been
redeemed by depositing gold. In Federal Reserve Bank notes,
as a net result, there have been placed in circulation less than
$2,000,000, while $55,000,000 Government bonds have been
purchased from member banks and national bank circulation
has been reduced by about $50,000,000. We certainly have
not inflated there!
It has been said by some critics that Federal Reserve Banks
should not, under any circumstances, issue Federal Reserve
Bank notes. There is no doubt that the national bank note
circulation is an objectionable feature in our monetary system,
but the fact remains that the country is accustomed and
adjusted to a certain volume of currency, and we could not
eliminate about $700,000,000 of it without putting something
in its stead. It is most important that the process of filling
demands for currency by issuing national bank notes should
stop, and that, by a gradual reduction of the outstanding
volume, a vacuum be created for Federal Reserve note circu­
lation. But, pending this process of gradual substitution—
that is, the process of purchasing Government bonds from
member banks, conversion into 3 % bonds and one-year notes,
sale to the public of 3 % bonds, and reinvestment of the pro­
ceeds in commercial or banking paper—there will be an inter­
regnum when Federal Reserve Bank notes must be issued
temporarily, until there is available a sufficient amount of
paper to take the place of Government bonds, a sufficient
absorption of these bonds by the public, and a sufficient
strength in gold reserves.
Let us bear in mind that Federal Reserve Bank circulation
is not added circulation, but a partial substitution of new
notes for redeemed old national bank circulation, and that,
*If we bear in mind that on September 1, 1916, the Federal Reserve banks had on hand
a total of about $24,000,000 Federal Reserve notes, we must admit that, as a net result of
their issue activities, the volume of the country's circulation has not expanded, but has
been actually contracted to the extent of over $6,000,000.


when issued by Federal Reserve Banks, it will have a certain
degree of elasticity, because it will be issued from time to time
only in harmony with the general policy of the Federal
Reserve Banks, and not kept out perpetually for the sake of
the profit involved, as now done by the national banks.
How the Present Law Dissipates Federal Reserve
Banks' Gold Holdings
The Federal Reserve Banks have made investments aggre­
gating at present about $180,000,000, and have outstanding a
net circulation of about $16,000,000. That means that for
$164,000,000 of investments they have paid gold, and thereby
have reduced their reserve power to that extent.
If they could have paid in Federal Reserve notes instead of
gold, as they should have been permitted to do, they would
have wasted only 40% of this amount and would have retained
the balance, that is, about 100 millions, as a potential reserve
for additional note issue. As stated before, it does not neces­
sarily follow that Federal Reserve Banks would have made
larger investments at this time; it is not at all likely that they
would have done so. But emphasis must be laid upon the
resulting reduction of their power to assist the country in an
The argument is used that if Federal Reserve notes had been
paid out and could have been counted as reserve-money by
the stock banks, these notes would have gone into the vaults
of the member banks as reserve money, and caused a further
expansion of loans. But we must not forget that the same
result has followed by the Federal Reserve Banks' paying out
gold. As far as the member banks are concerned, the effect
is the same whether they receive $164,000,000 in gold or in
Federal Reserve notes which may be counted as gold. But
the difference is, as we have stated, that, under the present
system, the lending power of the Federal Reserve System is
being impaired too fast.
Federal Reserve notes "shall be obligations of the United
States and shall be receivable by all national and member


banks and the Federal Reserve Banks and for all taxes, customs
and public dues. They shall be redeemed in gold at the
Treasury," etc.
Did we not stop half-way when we provided that banks are
thus to receive Federal Reserve notes in payment of debts
between each other, and from their depositors, but cannot
count them as reserve for the purpose of discharging their
deposit liabilities? As a consequence, banks when settling
with each other through the clearing do not accept Federal
Reserve notes but must settle with lawful reserve money—
that is, substantially in gold. If, however, a bank settled
directly with another bank it could pay in Federal Reserve
notes and the payee bank could then send the Federal Reserve
notes to its Federal Reserve Bank, create a balance and then
count that as reserve.
It is fortunate that the new amendment will permit member
banks to carry any part of their required vault reserve as a
balance with the Federal Reserve Bank and to count it as
reserve. It is hoped that this will cause member banks
promptly to adopt the habit of settling their balances with
each other by transfer of credit through their Federal Reserve
Banks, thereby releasing gold needlessly tied up in clearing
operations and in their vaults, and remedying, to a certain
extent at least, these anomalous conditions.
Must Rid the Country of Confusing
Multiplicity of Currency
In dealing with this question of reserves and note issue, it is
proper and necessary that we proceed step by step. Splendid
progress has been made in these last two years, and we realize,
of course, that the tracks must be shifted many a time before
we can reach our final goal. But we must be clear about this
ultimate aim and we must recognize the absolute necessity of
taking certain consecutive steps before monetary and banking
reform will be complete.
Ultimately we must rid our country of the confusing multi­
plicity of currency with which we are now afflicted, and the


Treasury will have to stop issuing small denomination gold
certificates. The circulating currency of the country ought
to be silver certificates in the small denominations, and
Federal Reserve notes. The best place for gold and gold
certificates will be in the Federal Reserve Banks. The
national bank currency ought to be systematically withdrawn,
and the greenbacks ought to be gradually turned into gold
certificates as the missing gold cover from time to time is
produced by the excess profits to be received from the Federal
Reserve Banks or by some more rapid process that the future
may evolve. While this process is taking its course, I think
we are fully justified in permitting the Federal Reserve Banks
to count greenbacks as part of their metallic reserve. It is
freely admitted that this is not absolutely good banking theory.
But, with the $153,000,000 gold behind these notes and the
power given to the United States to provide the additional
gold cover by a sale of Government bonds, we may be war­
ranted in temporizing and not making an over-rigid dis­
One cannot deal with the future of our Federal Reserve
System and our reserve problem without being puzzled by the
question, what will be the coming standard of differentiation
between Central Reserve Cities, Reserve Cities, and country
bank places when, after November 16, 1917, balances with
correspondent banks will no longer count as reserve? I
cannot undertake to discuss that problem today, but I think
it is timely to point to this phase and invite you to give it your
most careful consideration. The time is not distant when we
shall have to deal with this conundrum, and we shall welcome
—indeed, we shall need—your very best thoughts in the
The Federal Reserve System is the beginning of an imposing
structure to be erected upon a broad foundation. It will
prove a costly edifice unless it is developed to its full growth
along these broad lines. Member banks and the country at
large have a very vital and obvious interest in this, and they
may w^ell insist that there be no stopping half-way or hap­
hazard additions or little patch work here and there.


The banks and the country are now entitled to enjoy, and
will soon require, the strongest possible system, and the
further it progresses, the more the concentration of gold in the
Federal Reserve Banks proceeds, the further the discount
market develops and the further grows the habit of banks,
large and small, to invest in bankers' and trade acceptances,
the less will it be necessary for them to keep unduly large sums
locked up in their vaults, and the easier will it be for Federal
Reserve Banks to return a portion of their paid-in capital.
The roads to reduced reserve and capital requirements lie in
these directions.
If member banks are to rely for their protection primarily
upon their ability to create balances with their Federal Reserve
Banks, they must be certain that they have in their possession
an easy means of approach, a reliable key that will open for
them the door leading to the Federal Reserve Banks' vaults.
Amendments to the Law of Great Importance
The amendments just passed by Congress are of great
importance in this respect. Domestic acceptances will prove
not only an efficient means of directing idle funds to dis­
tricts where they may be profitably employed, thus working
towards greater equalization of interest rates—but the
increased supply of eligible banking paper will render much
more easily accessible the credit facilities of the Federal
Reserve Banks.
I do not think that I should dwell here on what I said to the
New York State banking institutions at Atlantic City a few
months ago. Let me only state again that I consider it the
duty, and, at the same time, the best self-interest of strong
State banks and trust companies to join the system and con­
tribute their share to the gold reserve fund that is being
augmented for the protection and progress of the United States.
We have liberalized to the utmost of our ability the conditions
under which these institutions may enter and be members of
the System. They may join with all their banking powers
practically undiminished. It has been the aim of the Board to


bring about a basis of parity between State banks and National
banks—not by needlessly tying the hands of the State institu­
tions, but rather by unshackling the hands of the National
banks where they are needlessly tied.
The amendments recommended by the Board, most of
which have now become law, such as power by ownership of
certain bank stock to operate in. foreign countries, to accept
drafts for domestic transactions, and for certain classes of
finance drafts for the promotion of our foreign banking, to
make loans on mortgages, etc., are evidences of the Board's
policy in this respect. In the same spirit, the Board hopes that
National banks will be granted the power to operate branches
in cities where State laws do not prohibit State banking institu­
tions from operating similar branches. Some banks have
raised a cry of alarm and have severely arraigned us for appear­
ing to foster a branch banking monopoly apt to crowd out the
small bank. But where State banks and trust companies
enjoy the right to operate branches (in New York City alone
there are over 100 branches of such institutions) small banks
are already subject to the competition of these State bank and
trust company branches. National bank branches would,
therefore, hardly add to the alleged discomfort of the small
banks, while it appears unfair to deny this right to national
banks where their competitors, the State institutions, freely
exercise it.
Canadian or European Branch Bank System
Inadvisable Here
I do not believe that we should adopt the Canadian or
European branch banking system. It contains elements of
excessive centralization that, with the American spirit of
aggressive fight for supremacy and control, would lead to un­
sound and undesirable conditions. But, restricted to city
lines—where State laws permit—branch banking would not
justify an outburst of hysterical fear of the octopus. It
would rather give an opportunity to the smaller and weaker
banks to combine. It would thus enable them more effectively


to meet the competition of their more powerful neighbors, to
make better profits and to give better facilities to the customers
they serve.
Duty of State Institutions to Join
Federal Reserve System
Self-respect and public opinion will not permit the State
institutions long to remain in the position of shirking their
duty towards the nation; and the State banks, at the expense
of the National banks, and to the detriment of the entire
country, cannot afford to refuse to bear their fair share of the
burden, nor can they afford to be deprived of their fair share
of the advantages.
I do not deny that, for some State institutions, particularly
those that have private bankers on their boards, it may prove
a hardship to lose some valuable directors, and that free
balances with Federal Reserve Banks mean some loss of
interest for most of these potential State member banks. But
if that is the price to be paid for a system which is to insure
the banks and the industries of the country against the horrors
of some of the panics of the past, and which will give us the
possibility of future growth in relative safety under a modern
system of mutual protection—then these sacrifices ought to be
borne cheerfully by everybody as, indeed, being none too
Suggestions for Elimination of Harmful and Unnecessary
Restrictions in Operations of National Banks
While thus I do not hesitate to confess freely that there are
certain necessary inconveniences that have to be borne for the
general good, I hold with equal emphasis that it is our duty to
remove the unnecessary shackles that hamper and inconvenience
the banks of our country more than those of any other nation
in the world. My vision of the future would be very un­
satisfactory indeed if it did not permit me to hope for the
reversing of many an antiquated ruling, court decision, or law,


which needs overhauling. Indeed, I see herein one of the most
fruitful fields for the study and activity of the Federal Reserve
It would lead too far at this time to do more than barely
epitomize these thoughts. If banking in Europe is being
carried on largely by cash advances on deposit account, why
should it be unlawful with us to grant such overdrafts to
business concerns? Do you realize that all rulings in this
respect have been based mainly upon a court decision rendered
in 1828, involving a construction of the powers of a bank
operating under a charter granted by Congress in 1812, about
50 years prior to the passage of the National Bank Act?
Let me ask you further: Why should it be unlawful to
charge interest in excess of 6%? The present discount rate
of the Bank of England is 6% and large corporations and firms
in that country no doubt pay more than 6% for their present
credit facilities without the stigma of usury attaching to the
British banks charging the higher rates. When money gen­
erally is worth 3 % , a charge of 5% may be excessive; but when
money is generally worth 6%, a charge of 7% should not be
considered usury. I strongly believe in the protection of the
public against extortionate rates, and to stabilize rates as far
as practicable on a moderate basis is one of the chief aims and
objects of the Federal Reserve Act. But we should have
reasonable laws, laws recognizing the fluctuating value of
money, like that of any other commodity, and recognizing
that usury exists only where there is a question of extortion—
where the borrower finds himself in a helpless condition. But
where strong and solvent concerns, of their own free will,
contract for loans, there can be no question of usury. We
should modernize our laws in this respect.
Why should National banks be prevented from taking
commissions? In Europe the commission account of banks is
the one to which they point with the greatest pride. Any
bank may execute orders for the investment of funds. I
cannot see why the investment of depositors' funds should
not be a proper function of banks.
We have discussed the structure of the Federal Reserve


System—the foundation, and the building we expect to see
erected upon it. Now the final question—who shall be the
master of the house? Shall it be business or politics or a
neutral non-business and non-partisan, judicial administration?
I have no doubt that the country wants the latter, and I am
delighted to say that the character of the Reserve Board and
of the administration of the Reserve Banks is of that nature
today. But if we want to be certain of the future, I believe
that nothing should be left undone that will insure the greatest
independence of the Board and will thus make the positions of
members of the Board such that, in coming generations, these
offices will be coveted by men of worth like seats on the
Supreme Bench of the United States. The safety of the
country and the confidence that the Federal Reserve System
will enjoy are dependent upon the character and the ability
of the men charged with its administration. If a safe future
is to be assured to the System, the Act must be perfected where
it stopped half way in this respect. Of course, there must be
at all times intimate relations between the Treasury and the
Federal Reserve Board, and co-operation in broad questions
of national policy, but there must be only one banking and
discount policy and not the possibility of two. The law should
provide that the administration of the Treasury funds within
the Federal Reserve System should be subject to some control
by the Board, and emergency relief operations ought to be
carried out through the Federal Reserve Banks and not
directly through deposits with member banks by the Treasury.
Adjustment of Relations Between Reserve Board
and the Treasury Necessary
The business and banking community should feel certain
that the adjustment between Treasury and member banks
will take place at all times in a natural, well-regulated manner,
in keeping with the general banking policy adopted by the
Federal Reserve Board and the Federal Reserve Banks. If at
certain periods large payments are to be made by the member
banks to the Treasury, there should be an easy adjustment by


having the money withdrawn operate to strengthen the
Federal Reserve System, ieaving it to the Board and the
Federal Reserve Banks, by rediscounting short paper, to
return to the member banks sufficient funds to re-establish the
equilibrium. But this important function of balancing the
scales ought to be the constant care of the Board, under a con­
sistent plan of operation, and not the domain of the changing
and arbitrary policies and views of each succeeding Secretary of
the Treasury. That was the original plan of the Glass bill;
unfortunately it was changed in conference. It is much to be
hoped that a return be made very soon in the direction of the
original project so that the danger be removed that at some
future time Federal Reserve Banks or member banks may ask
and secure Treasury deposits without consultation with, and
even in opposition to, the wishes and policy of the Federal
Reserve Board.
In a similar way, the Board's authority and efficiency ought
to be strengthened by providing that examinations and
rulings by the Comptroller's office, and the compilation of
banking statistics should be carried on under the auspices of
the Board. However the present members may have been
able, by personal effort, to nieet the organic defects of the law—
the fact remains that, as it stands today, it places the Board
half way between independence and dependence. It cannot
remain long in that position. Evolution will carry it either in
one direction or the other. The country will have to decide
which development it desires and express itself in no uncertain
I need hardly say that, whatever views I have expressed in
this address I have given you as my own personal convictions
without attempting in any way to speak for my colleagues.
I want to emphasize furthermore that whatever I have just
said concerning relations between the Treasury department,
the Comptroller's office, and the Board, must be considered as
a strictly impersonal statement, having no relation whatever
to present incumbents, wTho are bound by the law as it stands,
and applying solely to principles which have an important
bearing upon the future.


Central Bank Unwise, But Fewer Districts Would
Strengthen the System
And now, in closing, let me say again that, I am an unquali­
fied believer in, and an enthusiastic supporter of, the Federal
Reserve System. Its fundamental principles are sound; its
benefits to the country have been immense and will become
more apparent with each succeeding year. Though from the
point of view of banking technique, one single central bank
would have been easier to administer, and, in some respects,
might have been more economical and efficient, I am convinced
that the undisturbed development of our financial system is
better assured, and that danger of business or political control
are more certain to be avoided by a system of co-ordinated
central banks. That the system might possibly be simplified
and made stronger and more efficient by merging some of the
districts, is an opinion held by many, a view which I enter­
tained before the organization of the districts, and to which I
am still wedded.
The Federal Reserve System is an ingenius combination of
centralization and decentralization. But decentralization
carried too far defeats its own ends. If you try to create 100
independent centers, each will be too weak to act as a point of
crystallization, and, as a result, they will all depend upon the
one that is the strongest amongst them. If it is the object of
the system to counteract the preponderance of one district,
the other districts must be strong enough to become inde­
pendent centers of importance, containing a sufficient degree
of diversity of interests, and sufficiently imposing to command
undoubted prestige and confidence. By merging a few
districts into twin districts, greater strength, greater efficiency,
and cheaper operation might be secured, without changing or
weakening the intimate touch now secured by the respective
local organizations.
But actual experience will guide us ultimately in adjusting
this problem. The principle, as I have said, is sound, and it is
the duty of every one of us to devote all our energy and our
best thoughts towards bringing it to its fullest fruition. Let


us be frank in our criticism, but at the same time fair. We
are never more severe than when we criticize our own children
—that is because we love them best and entertain for them the
highest ambitions. That is why I have been frank today—
because I do care for this system, because I do care for this
country and w^ant it to succeed and take its proper place as a
financial and industrial power amongst nations. That is why
I think that the bankers of the country whose own success or
failure is so closely linked to the future development of the
Federal Reserve System should now set their minds upon its
problems in the same spirit, as friends of the Systems, as
fathers—if you please—who want to see their child grow and
develop, even if it entails some sacrifices upon the parents.
Plea for Co-operation by Bankers in Bringing About
Greater Unselfishness and Broader Vision
The greatest obstacle in the way of the Federal Reserve
System's freest and most beneficial Development is, on the one
hand, selfishness on the part of some of our members, whose
vision does not reach beyond their own limited sphere, and
who are unable to grasp the larger question of the safety and
future of the country. On the other hand, it is suspicion,
prejudice, and half knowledge. These obstacles will be over­
come by public opinion based upon better education. In this
work of national scope and importance, your association can
render the greatest service. It can lead within its member­
ship in developing sound banking practices and good banking
ethics; and, as towards the public, it can lead in the work of
teaching the gospel of modern and clean banking and help in
enacting sound practices into sound law.
At the time of the opening of the Federal Reserve Banks,
Sir George Paish said to me, ' T h e future of your system will
depend upon your ability to get under the control of the Federal
Reserve Banks the scattered gold of your country." Two
years have passed since. We have made great headway in
many respects, but the organized control of our gold is still
in its incipient stage. One reason for this disappointing con-


dition is that the State institutions have not done their duty
towards the System; the other is that there has not been
enough clear thinking and too much immature criticism.
Congress will not give us the necessary relief until there is
greater accord in the minds of the banks and our financial
Has it occurred to some of our critics that, before assailing
us, it should be their duty to stop to consider that there is a
difference between reserves of central banks and member
bank reserves, and that a greenback and a Federal Reserve
note are as different as day and night—the one issued as a
perpetual currency to pay 200 millions of the Government's
debts, and the other issuable only against the purchase of
self-liquidating paper, expanding and contracting according to
the amounts so invested, and secured by a generous minimum
reserve of gold? Let them bear in mind that it was that
kind of superficial but persistent criticism that stood in the way
of banking reform in years gone by; that made us endure the
painful experience of 1907 before submitting to the remedy
of more modern methods and that delayed final action until,
half prepared, we had to meet the storm of 1914, subject to
disturbances and sufferings which we might have avoided,
and losing opportunities which should have been ours.
Some of these critics, sitting in their little chairs at their
little desks, within their four little walls, with very little
knowledge and very big words, stake their own local views
against the world's acknowledged experience. They disregard
the fact that buildings have grown so high and reached such
dimensions that fire engines and water mains—the weapons
of protection—must be of the most powerful and most modern
type. Some of them appear to think "that the engine that
was used when father's house burnt down to the ground is good
enough for everybody and that the big new houses won't burn
anyhow;" others have a fire engine of their own invention,
never tried, but better than all the rest; others are sore because
they, themselves, are no longer the fire chiefs; and some object
because they do not wish to pay their share for adequate


But, gentlemen, let those of us who believe in foresight,
experience, and co-operation, stand together and let us secure
the very best possible protection, without hysteria and ex­
travagance—not as schemers, but as conservative and con­
scientious men; as cautious captains alive to our responsibilities
and to the storms that must come.
Immediately after the beginning of the war, Hartley Withers
wrote, in ' T h e War and Lombard Street":
"It was the chance of a century for New York. American
ambition has long informed the world t h a t the United States,
having been the world's granary, is now the world's most pro­
gressive manufacturer, and means soon to be the world's banker.
This may happen some day, and might have happened already if
American policy in currency, financial and fiscal matters had
been more thrifty. But they have tied their credit system in the
bonds of narrow banking laws and their trade in those of a cramp­
ing tariff. These bonds they have just begun to shake off, and
if the crisis had happened a few years later, they might, perhaps,
have made a bid for London's place as the world banker."
" I t was the chance of a century, but New York could not take it.
When London called in its credits from other countries, any centre
t h a t could have said to these countries: 'We will give you the
credit t h a t London has cut off, and lend you the money to pay
London,' would have stepped straight on to London's financial
throne and set London a very difficult task to regain it after the
war was over. In spite of the large amounts of gold taken from
America to Europe before the war, the United States had still a
huge store within its borders—some estimates of it ranged up to
400 millions sterling. If the United States had had the courage
to use this mountain of metal and let other countries draw on it,
London would have had more gold than it knew what to do with,
and New York would have had a big slice of London's business.
But America feared to use its gold and held on to it as tightly as
it could, fearful of internal trouble and a run on its banks if too
much of the metal went abroad."

Since writing the above, two years ago, Mr. Withers has
greatly modified his views. In his latest book, "International
Finance," published a few months ago, he says:
"America is now one of the leading powers in international


finance, and on the wise and skilful use of its strength the future
prosperity of the civilized world will, to a great extent, depend."

Shall we be found wanting? The answer will largely depend
upon you, the Bankers of the United States; upon the strength
you give to your Federal Reserve System, and upon your
contribution to the moulding of its future.