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X-1155 THBFEDERAL RESERVE NOIE, I?5 JUNCTIONS AND, LIMIT42£0NS JTBGM m ADDRESS OF W* P. G« HARPING, GOVERNOR OF THE FEEERAL RESERVE BOARD, BEFORE THE CONVENTION QF THE OHIO BANKERS ASSOCIATION AT COLUMBUS, .OHIO, THURSDAZ, 3FE0MBER 5, .1918* FOR RELEASE IS MOKETIKG FAEERS OF FRIDAY, SEP95KBER-6th# *Hh& flapUen or short t i t l e of the Federal Reserve Act defines i t as M,An act to provide for the establishment -of Federal reserve banks, t t furnish an e l a s t i c currency, t o afford means of r e d i s counting commercial paper, to e s t a b l i s h a more e f f e c t i v e superv i s i o n »f banking i n the United S t a t e s , and f o r other purposes." It i s evident therefore, th&t two of the principal objects :«f the act are (1) T6:feLrnish a n e l a s t i c currency, and (2) To afford means of discounting commercial paper* Section 16 provides that the e l a s t i c currency referred t # , namely. Federal reserve notes, may be "issued a t the d i s c r e t i t n of -2~ the Federal Reserve Board tot the purpose of making advances to Federal reserve banks * * * and for no other purposes." That the relationship between the currency authorized and the r e discounting of commercial paper is a close one t i s clear, for the reason that Section 16 as originally enacted provided that ap~ plications,of the Federal Refeerve agent for Federal reserve notes must be accompanied with a tfender of c o l l a t e r a l in amount equal td the sum of Federal reserve nfates applied for and that the collateral security thus offered shall ie notes and b i l l s accepted for r e discount under the provision^ of Section 13, which section r e l a t e s not to open market transactions, but e n t i r e l y to eligible notes* b i l l s and acceptances which may be discounted by & Federal reserve bahk under R e i f i e d tei*ms dfcd conditions* In addition to requir ing the pledge of 100% of discounted paper, Federal reserve banks were also obliged to maintain reserves in gold and lawful money of not less than 40 per centum against their Federal reserve notes in actual circulation and not offset by gold or lawful money deposited with the Federal Reserve agent* Un&er a strictmconstruction of this section, i t would have been d i f f i c u l t , if not impossible, for the Fuueral reserve banks to mobilise in their OTOI v a u l t s the gold holdings of the country, since the extent to which Federal reserve notes could be issued depended entirely upon the amount of commercial paper held under discount by >-3*- these batiks, and in as much as they are required to maintain a 40% gold reserve against Federal reserve notes, they could not acquire gold in exchange for Federal reserve not4s, unless the notes wfere f i r s t issued a©,inst an equal amount of commercial payer. It was, therefore, necessary to resort to the expedient of f i r s t issuing n6tes against 100% commercial paper and of subsequently permitting the Federal reserve banks to deposit gold in order to reduce their l i a b i l i t y against such notes and thereafter to issue additional notes against commercial paper which was released by t h i s process* I t was also difficult to mobilize the gold in the Federal reserve bank, because of the fact that Section 19 of the act, as originally passed, required manber banks to maintain only a part of their required reserves with the Federal reserve banks* the balance being held in gold or lawful money i n t h e i r vaults, or carried with correspondent banks. In order to enable the Federal reserve laanks more effectively to control the countiy*s gold which was widely diffused, being used for purposes of circulation and held in the vaults of manber and nonwcember banks, and to be in position a t the same time to issue notes in such volume as might be necessary to supply an adequate c i r c u l a t i n g medium, Congress amended the act on June 2i f 1917 by providing that a l l of the lawful reserves of member tanks be kept - 3 A- sn deposit with the Federal reserve banks and that Federal reserve notes might be issued to the reserve banks without limit against deposits of gold or gold certificates* any gold thus obtained to be counted as part of the 40$ gold reserve which the reserve banks -4a r e obliged t o hold a g a i n s t outstanding Federal reserve n o t e s . Thus the new method permits the d i l u t i o n of gold with commercial paper and r e q u i r e s only 60$ of paper in a d d i t i o n t o 40$ of gold a s a g a i n s t 100$ of paper and 40$ of gold as provided in the original enactment* The e f f e c t of these amendments has been t o add enormously t o t h e gold holdings of the several Federal reserve hanks and t o enlarge the discounting paver of the reserve system* The r i g h t t o issue Federal reserve n o t e s a g a i n s t deposits of gold has been a v a i l e d of very f r e e l y , and gold received in t h e course of the d a i l y t r a n s a c t i o n s of t h e hanks has been r e t a i n e d and pay ments have been made in reserve n o t e s instead of in gold* This p r a c t i c e has boon urged repeatedly upon the reserve banks and a l s o upon member and non-member banks, which have been asked t o t r a n s f e r t h e i r gold a s i t accumulates t o the Federal reserve banks, the argument being t h a t i n the v a u l t s of the reserve banks gold i s a v a i l a b l e a s a b a s i s e i t h e r of now note i s s u e s , or a s a means of extending t h e i r loaning f a c i l i t i e s , while i n c i r c u l a t i o n or d i s t r i b u t e d among t h e 25,000 or more commercial banks of tho country i t i s of no moro value than any other fonn of currency* Since the amendments t o the a c t the issue of Federal reserve notes outstanding has expanded g r e a t l y , having r i s e n from something over $500,000,000 on June 1,1917, t o s l i g h t l y more than $2,000,000,000 on August 23,1918. The fact t h a t t h i s growing volume of our papor currency has been accompanied by a continuous -5- advanco in wages and commodity p r i c e s has boon frequently coniEontcd upon and has subjected the Federal reserve system t o sons unmerited c r i t i c i s m . H a l f - t r u t h s arc often the most dangerous falsehoods, and while t h e e v i l s of c o n s t a n t l y r i s i n g p r i c e s and i n f l a t i o n are beyond question, and while i t i s undeniable t h a t present p r i c e s might in ordinary circumstances be j u s t l y a t t r i b u t e d t o currency i n f l a t i o n , wo ^fcculd in considering the Federal reserve note a s a f a c t o r in our p r e s e n t economic and f i n a n c i a l s i t u a t i o n , analyzo the circumstances out of which our present s i t u a t i o n has resulted* The outbreak of the European war in August 1914, was followed immediately by a convulsion i n business and a f i n a n c i a l c r i s i s throughout t h e world. In t h i s c o u n t r y , r e l i e f was afforded by the i s s u e of about $375,000,000 of emergency national, bank n o t e s , and following the establishment of t h e Federal reserve banks on November 16,1914 t h e r e was a rapid r e t u r n t o more normal conditions* The e f f e c t of purchases in t h i s country by b e l l i g e r e n t n a t i o n s began t o bo f e l t e a r l y in 1915 and t h e volume of those purchases increased r a p i d l y during t h a t and the succeeding y e a r . As there was no c o - o r d i n a t i o n i n tho purchases of the r e s p e c t i v e governments, thoy wore placed in the p o s i t i o n of bidding a g a i n s t each o t h e r , and a s t h e i r needs for l a r g e q u a n t i t i e s of raw m a t e r i a l and manu factured goods and munitions was u r g e n t , — quick d e l i v e r i e s being d e s i r e d above everything e l s e — t h e r e was no r e s t r a i n t upon p r i c e s . -fr Very large profits woro obtained by sellers; labor naturally demanded and obtained a part of tho profits in tho shape of increased wages, and the large volume Of gold which came into the country to pay for goods purchased, amounting to about $1,200,000,000 during these two years, affected all priGeS and brought about a sympathetic advance in those articles which were not needed for shipment abroad as well as those which were in demand for war purpbses. There is no doubt that we felt tho effect in 1915 and 1916 of an inflated currency, but tho inflation was a gold inflation, and it became necessary, in order to avoid tho greater evils which would have resulted from a sudden and unregulated outflow of gold, — a gold contraction, — to take staps to impound the gold in order that its use and outflow might be kept under control. When this country entered the war in April 1917, prices had already advanced from the low point in 1914 to a greater extent than they have since advanced, index figures being as follows: ( From the Official Bulletin of the U*S. Bureau of Labor Statistics) Index Number 'I " n January 1914 July 1914 March 1917 Increase about 55$ July 1918 Increase since l&rch 1917, about 28$ 100 99 155 198 -7- Attention i s called t o a comparative statement showing monoy outside the Treasury and the Federal reserve banks a s of November 2, 1914, just p r i o r t o the opening of the Federal reserve banks; on February 1, 1917, the date of our break with Germany* and on August 1, 1918, the l a t e s t date for which accurate figures are available?• Cln thousar.dd of dollars) November 2, 1914 February 1, 1917 August 1, 1918 Gold coin $665,800 $448,900 $641,500 Gold c e r t i f i c a t e 498,000 1,281,900 913,300 Standard s i l v e r dollars 77,300 •s 70,300 71,000 Silver c e r t i f i c a t e s 353,100 461,500 482,800 Subsidiary s i l v e r 218,900' 162,500 187,900 Treasury notes of 1890 1,800 2,400 2,000 United Staies botes 295,000 329,700 234,900 *«Federal reserve notes 1^855,300 258>4Q0 Federal reserve bank notes 11,700 3,500 689t700 678.900 1.083.500 * National bank notes $3,615,500 $3,916,300 $4,449,700 * Including $360,000,000 w Aldrich-Vrooland currency." and the t o t a l stock of gold in the United States on these dates i s estimated a t November 2, 1914 $1,835,000,000 respectively. February 1, 1917 $2,912,465,116 August 1, 1918 $3,080,767,801 ~8- While t h e amount of Federal reserve notes i n c i r c u l a t i o n i n c r e a s e d between Febriiary 1 7 1317 ard August 1, 1918 by a b t u t $1,596,$00,030, t h e r e was a dacreaso- during the same p e r i o d , in gold and gold c e r t i f i c a t e s , r e p r e s e n t e d by the increased holdings i n gold of the F e d e r a l r e s e r v e banks, of about a b i l l i o n d o l l a r s , and t h e r e has been a s l i g h t decrease i n the volume outstanding i n fether forms of currency, so t h a t the n e t increase i n c i r c u l a t i o n betweeri these two d a t e s has been $ 5 3 3 , 3 6 3 , ^ 0 * As com~ pared with Noveinber Z\ 1914 t h e f i g u r e s for August 1, 1918 shew an i n c r e a s e of $83433S0P6U£«. On making allowance for the Aldrich-Vreeland n o t e s outstandtag on November 1, 1914, ($360,300,000) which have a l l been r e t i r e d , the increase i n c i r c u l a t i o n outstanding has been $1,194,000,000. to our g a i n i n geld during t h a t period* fpst about equal In the meantime t h e r e h a s been since the f a l l of 1914 a very large increase i n the da ps s i t s and i n the loans and d i s c o u n t s of the n a t i o n a l banks and of the s t a t e banks and t r u s t companies* A comparative statement of t h e s e i t e m s a s shown by the a b s t r a c t ef r e p o r t s of n a t i o n a l banks on the d a t e s c a l l e d by t h e Comptroller which are n e a r e s t t» the d a t e s used in making the comparison of c i r c u l a t i o n outstanding foll<3ws: ^9- TOTAL GROSS DEPOSITS OF NATIONAL BANKS, TOTAL LOANS AND CISCOUNTS ( INCLUDING OVERDRAFTS) OF NA TIONAL BANKS* October 31,1914 $8,075, 942,000 $6,335,276,000 Ifarch 5,1917 12,958,172,000 8,720,250,000 Juno 29,1918 14,016,087,000 9,632,899,000 The exact f i g u r e s for the s t a t s banks and t r u s t companies aro not a v a i l a b l e , but t h e i r a d d i t i o n would make a t o t a l s o u t h i n g mora than double t h e figures for the n a t i o n a l banks alone* I t i s e v i d e n t , t h e r e f o r e , t h a t the d e p o s i t s of member and non-member banks were increased from October 30,1914 t o Juno 29,1918, by more than $11,000,000,000 and the loans by about $7,000,000,000* There i s of course a d i r e c t r e l a t i o n between the deposits and loans of the banks, the normal condition being; t h a t thsy move up or down t o g e t h e r . I t should be remembered t h a t the use of Fed e r a l reserve n o t e s has never a n t i c i p a t e d an increase in d e p o s i t s or l o a n s of the banks except in so f a r as notes may have been used in exchange for gold* Increased loans of member banks, which c r e a t e a d d i t i o n a l deposit l i a b i l i t y , r e s u l t in rediscounts a t Federal reserve banks and tho issue of Federal reserve n o t e s follows the rodiscounting of e l i g i b l e paper* The Federal reserve note t h e r e f o r e , does not i n i t i a t o expansion. I t i s merely an incident -10- of an expansion which has alroady taken place-* It is true how- over, that the machinery which has boon .provided for the issue of Federal reserve notes and the knowledge on the part of the mon>ber "banks that Federal reserve notes are available if ncoded has undoubtedly encouraged discounting at local banks. But the provisions of the act as to eligibility of paper which nay bo re— discounted by the Federal reserve banks are rigid, and have 'boon strictly enforced by the Federal Reserve Board. Mombor banks have been repeatedly and consistently advised to keep themselvos in liquid condition and to confine their loans as far as possible to short time commercial paper issued for essential purposes^ in order to maintain themselves in position to cooperate with the Treasury in the unparalleled financial operations which war requirements have forced it to undertake* On July 6th the Federal Reserve Board addressed a letter to all the banks and trust companies in the United States, calling attention to the necessity for a gradual, but consistent curtailment of non-essential credits and urging that the banks oxercise a reasonable discretion in restricting credits which are cloarly not needed for the prosecution of the war or for the health and necessary comfort of tho public. In this letter the Board called attention to the fact that in order to prosecute tho war •11- s u c c e s s f u l l y , tho Government i s compelled t o issuo o b l i g a t i o n s t o provido for i t s largo expenditures which involve waste and de s t r u c t i o n r a t h o r than a permanent a d d i t i o n t o the n a t i o n a l wealth. War i s inexorable in i t s demands, and any f i n a n c i a l plan which i n volves tho expenditure of $24,000,000,000 a year, unless based e n t i r e l y upon t a x a t i o n of a confiscatory c h a r a c t e r , n e c e s s a r i l y forces expansion of c r e d i t s and i s apt t o cause an advance in the price of n o c o s s i t i o s . Abnormal demands "by tho Government, unavoidable and necessary in tho proseiri: eircumstancos, must bo counteracted by increased production and by a g r e a t e r oconomy on tho part of the civilian* population which must decrease, by combined e f f o r t , the normal was to i n c i d e n t t o domestic l i f e and business p u r s u i t s * The Federal Reserve Board has had constantly in mind tho dangers of i n f l a t i o n , -While i t has devoted i t s o l f assiduously t o b u i l d i n g up the ?old holdings of the Federal reserve banks i t h a s , i n permitting; the issuance of Federal reserve n o t o s , always i n s i s t e d t h a t they bo used a s s p a r i n g l y as possible,, with the double purpose of maintaining* tho s t r e n g t h of the banks and of avoiding redundancy. While the Federal r e s e r v e note i s a d i r e c t obligation of the Government, the safeguards and l i m i t a t i o n s thrown around i t by law Five i t many of t h e c h a r a c t e r i s t i c s of a bank n o t e . -12- It is not a legal tender, but is receivable by all national and member banks and Federal reserve banks and is receivable for all taxes, customs and other public dues; it bears a distinctive lottor and serial number indicating the Federal reserve bank through which it is issued, and cannot be paid out by any other Federal reserve bank under penalty of a tax of ton per centum upon the face value of notes so paid out* It is redecixable in gold on denand at the Treasury or in gold or lawful money at any Federal reserve bank, and is a first and paramount lien upon the assets of the issuing bank, which is required to maintain a roscrvo in gold of not l3ss than forty per centum against the total of fits Federal reserve notes in actual circulation^ The consolidate statement* of all Federal reserve banks as of August 23rd shows that there wore $2,032^837,000 of Federal re servo notes in actual circulation on that date* The actual gold reserves held by these banks on the same date amounted to $2,003,051,000, -After setting aside the reserve required by law against deposits, the ratio of gold reserves to Federal reserve notes in actual circulation, was 73,7$, the notes being otherwise secured by eligible paper and acceptances discounted or acquired by the banks. Federal reserve notes should not be confused with Federal reserve bank notes, of which there were in circulation on August 23rd, $16,864,000* These notes are direct obligations of -13- tho Federal roservo Panics and are s i m i l a r in t h e i r c h a r a c t e r t o n a t i o n a l bank n o t e s . Thoy may "bo issued a g a i n s t any bond of the United S t a t e s which has the c i r c u l a t i o n p r i v i l e g e , a g a i n s t Treasury one year notes and a g a i n s t t r e a s u r y c e r t i f i c a t e s of indebtedness* ment "fthon :(ss"iu& a g a i n s t a ?$ obligation of tho Govern thoy a r 3 tar.od a t tlv* r a t e of i$> pet anm^m., and if issued a g a i n s t Government obligations* bearing a higher r a t e , tho t a x i s increased correspondingly* Vheso ^ o t e s a r e being issued in small denominations t o take the place of s i l v e r c e r t i f i c a t e s which have been r e t i r e d under the Act of April 5. 1918 for the purpose of r e l e a s i n g s i l v e r d o l l a r s t o be broken up and melted for efc^oirt t o I n d i a and othei* foreign countries* !fho amount of s i l v e r which may be usod in t h i s way i s l i m i t e d t o $350,000,,000. The issue of these n o t e s i s t h u s limited' t o t h i s amount and a s they merely replace s i l v e r as withdrawn,, thay have no effect upon the volume of c i r c u l a t i o n outstanding* The Federal reserve note should not be confused with f i a t i s s u e s of o t h e r times,* nor i s i t a bond s&cur&fi/currency* Its issue i s c a r e f u l l y saf oguarded, and while a gradual i n c r e a s e in the volume outstanding vrill no doubt be necessary for sons time t o come, thus t e s t i n g one phase of i t s e l a s t i c q u a l i t y , t h e r e i s no -14- doubt t h a t whonovor the requirements of tho country permit, i t w i l l provo i t s f l e x i b i l i t y by i t s c o n t r a c t i o n or by tho increase* of gold roscrvo a g a i n s t i t t o a point \tfiero i t w i l l more n e a r l y approximate a gold c e r t i f i c a t e . I t was o r i g i n a l l y intended t h a t tho Federal reserve note supersede i n tho courso of twenty y e a r s , tho n a t i c r u l bank n o t e . Provision was rrado in the Federal Reserve Act for tho purchase by t h e Fedoral reserve banks of the bonds securing n a t i o n a l bank n o t e s and for tho r e s a l e of tho bonds to the Treasury f o r cancellation* This process was w e l l under way when i t was i n t e r r u p t e d by t h e war, but the increase i n n a t i o n a l bank noto c i r c u l a t i o n has boon s l i g h t , — only about $11,000,000 since Fobruary, 1917* Contraction of Federal r e s e r v e note c i r c u l a t i o n , in so far a s i t i s secured by e l i g i b l e paper, w i l l be n a t u r a l and autorratic as tho discount operations of t h o banks a r e reduced, b u t the noto i s in no sonso an etrsrgoncy currency, for i t i s and w i l l rornain our p r i n c i p a l c i r c u l a t i n g iredium, i t s dominance in t h i s respect i n c r e a s i n g a s tho regaining $900,000,000 of gold vvhich i s outsido of t h e Treasury and the f e d e r a l reserve banks a r e absorbed by tho reserve banks% Ever s i n c e the establishment of tho Fedoral reserve banks tho Board has endeavored p e r s i s t e n t l y and c o n s i s t e n t l y t o increase the aggregate gold holdings of tho banks. Since tho e n t r y of tho *-15** United S t a t o s i n t o the war, tho n e c e s s i t y for such an effort has boon emphasized^, while tho i n c l i n a t i o n of tho public and Of the banks t o cooperate has been marked* More than $2,000,000,000 of gold and gold c e r t i f i c a t e s have been withdrawn from c i r c u l a t i o n and t r a n s f e r r e d i n t o tho v a u l t s of the Federal reserve banks, but a s a l r e a d y s t a t e d , there s t i l l roirains in c i r c u l a t i o n and in bank v a u l t s abou-v $900,001,000 )i void c e r t i f i c a t e s and coin, most of which can be depositee 3 and Fheuld bo deposited, t h e i r place t o bo taken as f a r a s necessary by Fodor&l reserve notes* I t i s tho i n t e n t i o n of the Board in tho f u t u r e , a s i n the p a s t , t o watch c l o s e l y the loaning operations of tho banks, and i t i s not i t s purpose in mobilising the gold of tho country i n t o tho v a u l t s of the Federal re servo banks^.to incroaso tho volume of loans boyond the amount a c t u a l l y r e q u i r e d , but those a r e war times, and any i n a b i l i t y on the p a r t of Foderal reserve banks t o respond t o l e g i t i m a t e domands made upon thorn would be d i s a s t r o u s . I t i s c l o a r t h a t in proportion as t h e gold holdings of the Federal reserve banks are i n c r e a s e d , the a b i l i t y of such banks t o extend nocdod accommodation t o o t h e r banks or t o issuo n o t e s i s e n l a r g e d . ^ s reserve holdings a r e c u r t a i l e d , the lending power of the banks i s correspondingly roducod* As member banks are no longer requirod to carry r e s e r v e s -16- *>f lawful money in t h e i r own v a u l t s , i t follows that gold held by them i s of no mote value than aiy other form of currency * and every dollar of gold that i s hoarded by iridividuals i s withdrawn, not only from reserve use, "but a l s o from circulation; the community* ani i s a net l o s s to 03ie e f f e c t of hoarding therefore, i s to impair the a b i l i t y of the Board to provide the strongest possible gold cover for our growing volume of Federal re&exve notes and deposits, — and deposits w i l l necessarily contihtie to increase during the continuance of the war. It i s desirable in the e x i s t i n g circum- stances to have every dollar of gold in the Federal reserve banks, l e t t i n g the c i r c u l a t i n g medium consist of currency based on gold* Money of every Kind, whether gold or s i l v e r , should be deposited i n bank and used, but not hoarded* Surrender to the Federal reserve banks of gold coin and gold c e r t i f i c a t e s and abstention from hoarding means an increase i n the volume of bank credit available for the community and increased a b i l i t y to finance the war and fee n e c e s sary requirements of business* I t seems proper, i n t h i s connection, in view of the general impression that because of i t s power t o control discount r a t e s the Board can regulate the volume of rediscounted paper, to say something regarding the discount policy of the Board. During the year 1915 and for the greater part of 1916, owing to the abnormal ease -17- of the money market, there was "but l i t t l e r e s o r t to the discount f a c i l i t i e s of the Fedcml re so we D;>nkG# flaring this period the deposits of rseub'Si- *i.-& no:i-member banks were increasing by leaps and bounds, aad 'jb& ^a^'s as a rule *are able to take care of the legitimate needs of cus'omors ani to make large purchases of com mercial pape* without using their c r e d i t either with correspondent banks or with the Federal reserve banks# in such ciroumstances, i t i s clear that tho Board*s control ever disccunt *atee was merely nominal* Deserve bank r a t e s were low, in conformity with the general trend of the money market, and even by engaging in open market operations the Federal reserve banks found i t d i f f i c u l t to invest a sufficient portion of their funds to enable them to meet in f u l l t h e i r dividend requirements- Kicter rales would of course have brought in even a snailer volume of business. Late in the year 1916, rates began to stiffen and the volume of discounts with the Federal reserve banks shewed a tendency to increase, but the banks generally s t i l l hedd a surplus of funds and any drastic advance i n Federal reserve discount rates would not have materially affected tfie money market* After our entrance into the war the whole situation underwent a r a d i c a l change♦ Eie President, in an address to Congress on April 2 f 1917f pledged the e n t i r e resources #f the nation to the staceessful conduct of the v(&rf and war became the paramount business asof the country* An issuo of Treasury c e r t i f i c a t e s announced immediately, was followed "by the f i r s t Liberty bond campaign, tho avowod purpose of which was t o secure s u b s c r i p t i o n s t o $2,000,000,000 of "bonds "boaring 3a$ i n t e r e s t * I t was apparent t h a t t h i s issuo would be followed by o t h e r s , and i t was n a n i f o s t l y the duty of tho Board to support tho f i n a n c i a l plan of the Troasury, Within twolvo months aboUt $10,000,000,000 of bonds wore sold by the Government, and since April 1917, there has been outstanding an average of about $1,000,000,000 of Treasury c e r t i f i c a t e s , issued in a n t i c i p a t i o n of t a x e s or Of the proceeds of bond s a l o s . Mindful of the of f e e t which high i n t e r e s t r a t e s on Government o b l i g a t i o n s would have upon investment s e c u r i t i e s and the money market a s a whole, i t has been the aim of the Secretary of the Treasury t o Hold r a t e s do^rn t o t h e lowest possible l e v e l , and i t i s now h i s announced purpose t o niaintain as a maximum a r a t e of 4kfo on Treasury c e r t i f i c a t e s and 4^$ on Liberty bonds* In these circumstances, the Federal Reserve Board has f e l t t h a t i t should d i r e c t tho p o l i c i o s of tho system so as t o insure prompt accom modation t o banks whose customers might require a s s i s t a n c e , e i t h e r in providing f o r commercial demands caused by increasod business -19d c t i v i t i o s , or in making t h e i r payments f o r bonds, a s woll a s t o banks which bought "bonds for t h o i r own accounts I t was dcemod important t h a t .there should "be no disturbance i n tho money market and t h a t i n t o r o s t r a t o s should bo kept a s n e a r l y normal and t r e e from f l u c t u a t i o n as possible* Thoroforo the Board, heforo tho s u b s c r i p t i o n s to tho f i r s t L i b e r t y bond issue woro cl*ched, o s t a b l i s h o d a p r e f e r e n t i a l rato of discount f o r notes of momber banks socured by Government o b l i g a t i o n s , who tho r c e r t i f i c a t e s or bonds, and, in order f u r t h e r t o a s s i s t tho Treasury in disposing of bonds, the Board a u t h o r i s e d Federal reserve banks t o discount for non-member banks upon tho endorsement of a momber bank, notes secured by Government o b l i g a t i o n s , who tho r made by non-member banks thornsclvos or by t h e i r customers, when tho proceeds had been or woro to be usod for the purposo of carrying Treasury c e r t i f i c a t e s or United S t a t o s bonds* Tho Board, t h o r o f o r o , d i s t i n g u i s h e d "bo two on commorcial loans and loans made upon tho s o c u r i t y of Government, o b l i g a t i o n s , by giving a p r e f e r e n t i a l in favor of the l a t t e r . The p o l i c y of tho Board has thus f a r been j u s t i f i e d hy r e s u l t s . Tho "bonds were widely d i s t r i b u t e d cvnd each subsoquont issue has. shown a l a r g e r number of subscribers than the proceeding one, the number of s u b s c r i b e r s to. the t h i r d L i b e r t y loan boing more than 17,000,000 Only 4$ of the t o t a l amount of bonds issued up t o t h i s time were •20- h e l d on June 29th a s investments by tho n a t i o n a l banks/ or 2.29$ of t h e i r r e s o u r c e s , while thoy were carrying loans secured by L i b e r t y bonds amounting t o $457,000,000, or 2.56$ of t h e i r re s o u r c e s . As tho r a t e s on Government o b l i g a t i o n s were advanced, the p r e f e r e n t i a l r a t e s on paper secured by these obligations wore increased correspondingly a t the Federal reserve banks* So t h a t instead of a r a t e ef from 3 t o 3 | $ as f i r s t established, r a t e s a t the banks ate now ranging from 4 i o 4%% on paper s o cured by Government issued* with a maxinum r a t e of b^fo on 90 day c commercial paper and 5^f> on 6 months a g r i c u l t u r a l paper. The Board does not believe t h a t in the e x i s t i n g s i t u a t i o n marked advances in r a t e s would be advisable in view of the obvious n e c e s s i t y of avoiding any policy l i k e l y t o d i s t u r b the f i n a n c i a l operations of the Treasury* The needs of those, i n d u s t r i e s and commercial e n t e r p r i s e s which are d i r e c t l y contributory t o the conduct of tho war must bo supplied a t a l l hazards, and a d r a s t i c advanco in discount r a t e s would not reduce the f i n a n c i a l r e q u i r e ments of such concerns, but would merely impose an added cost upon the people* In i t s l e t t e r of July 6 t h , t o which reference has a l r e a d y been made, the Board c a l l e d a t t e n t i o n t o the importance of a wise d i s c r i m i n a t i o n between e s s e n t i a l and n o n - e s s e n t i a l c r o d i t s . I t ~21~ b e l i e v e s t h a t the e x e r c i s e of d i s c r i m i n a t i n g judgnent on the p a r t of the banks throughout t h e country i h making t h e i r loans w i l l be more e f f e c t i v e i n c o u n t e r a c t i n g any tendency toward c r e d i t e x pansion t h a n an advance In r a t e s would b e . Bie suggestion has been made by the Board t h a t the f e d e r a l reserve banks organize, each in i t s own d i s t r i c t , l o c a l groups comprising leading bankers and b u s i n e s s men, in order to discusa ways and means o£ bringing about the t e s u l t desiredU I t i s exceedingly d i f f i c u l t t o lay down any f i x e d and. d e f i n i t e r u l e s to govern In d i s t i n g u i s h i n g between e s s e n t i a l and non-essential credits* A loan raigit be d e s i r e d for what appears a t f i r s t glance to be a n o n - e s s e n t i a l purpose, and y e t f a i l u r e to o b t a i n the c r e d i t might c r e a t e a condition which might i n d i r e c t l y have a d i s t i n c t l y harmful e f f e c t upon the a b i l i t y of productive e n t e r p r i s e s i n the community t o o b t a i n c r e d i t * In the same way> i n t h e l a r g e r c e n t e r s , r e f u s a l by banks as a group to lend on standard s e c u r i t i e s would s e r i o u s l y impair the l i q u i d i t y of i n vestments and would force l i q u i d a t i o n which mi$it d i s t u r b s e r i o u s l y the whole f i n a n c i a l s i t u a t i o n . very I t i s important t o avoid sharp and r a d i c a l readjustments of c r e d i t and wherever p o s s i b l e l i n e s should be reduced without undue hardship to the borrower o r without causing a shock which would render the g r a n t i n g -22- of necessary credits more difficult* I t would seem that those i n t e r e s t s and enterprises obviously catering to extravagances and luxuries should be considered first* Upon investigation i t may develop that industries of this Kind need hot be closed down, no* their labor thrown out of employment* but t h a t they can be gradually diverted to essential lines of production and d i s t r i b u t i o n Existing high prices are creating an added s t r a i n on the financial resources of the country and are contributing enormously to the cost of the war. I t is probably impossible to effect dhy redubtich in tiie prices o£ necessary materials and commodities or in the compensation of those engaged in producing them, but there are two means5 and the employment of both w i l l be necessary, of retarding a further advance* One i s by curtailing credits which are not necessary and by diverting such portion of these credits as map be needed into productive channels; and the other i s to increase the production of the raw materials and manufactured a r t i c l e s which are needed in our military and naval operations and which are essential for the sustenance and necessary comfort of the people* In times like these, high prices and high wages do not always increase production* We see too frequently a disposition to -23- accept a s ample? tho roturns from l i m i t e d production and from fewer working days t o the week* We have now 1,500,000 men on the s h e l l scarred f i o l d s of Franca, and t h o i r deods of v a l o r have a l r e a d y t h r i l l e d tho a l l i e d world. Soon t h i s number w i l l grow to 3,000,000, then t o 4,000,000, t h u s a s s u r i n g complete and glorious v i c t o r y and the perpetuation of t h a t h e r i t a g o of l i b e r t y for vthyGh our f o r e f a t h e r s fought t o give u s ; and those m i l l i o n s of us who a r e unable t o take our places a t tho f r o n t ; but who must roirain behind t o do t h a t work which i s necessary t o s u s t a i n the n a t i o n a t hocce, and t o maintain our f i g h t i n g heroes in France, should s t r a i n every nerve t o furnish a l l t h a t i s n e c e s s a r y , in gold, c r e d i t , s e r v i c e s and goods, and we should not overlook or s l u r tho fourth Corrarandmont, — t h a t Divine injunction t o Moses, wherein wo are d i r e c t e d not merely t o r e s t on tho seventh day, hut a r e sharply rominded of our presont duty in tho comoand, "Six days s h a l t thou l a b o r and do a l l t h a t thou h a s t t o d o , " The war must ho won by force of arms abroad, supported by g r e a t e r production, econony and t h r i f t a t homo.