Chapter XXXI: The Federal Reserve System (2)

The right to engage in foreign exchange dealings will also be similarly useful, surplus funds being invested in foreign bills. Moreover, if any of the Reserve Banks find that their resources are regularly in excess of domestic requirements, they may be used to facilitate the financing of the foreign trade of the country with domestic capital. It is also very generally believed that the power to engage in foreign exchange operations may be so used that it will be possible to rely upon securing abundant foreign funds in periods of financial strain. This is most unlikely. It is entirely possible for a small country to rely upon holdings of foreign bills as a means of influencing the foreign exchanges, and even for such supplies of gold as may be needed on occasions when confidence is threatened. But the banks of a large country must rely mainly upon domestic resources, since the amount of cash and credit needed in an emergency is too great to be secured from foreign money markets. It should be the policy of the Reserve Banks to maintain themselves in a condition of such abundant strength as to be wholly independent of foreign assistance. Moreover, if they maintain strong reserves in ordinary times, they will not be disturbed on account of gold exports. Gold exports amounting to fifty, or even a hundred million dollars should not be made the occasion for obstructive measures such as are adopted by many of the European central banks. Measures of this kind are generally an indication that the credit structure rests upon an inadequate foundation. New York has been a free gold market in the past, and even under our imperfect banking system, there has always been a sufficient amount of gold for every banking purpose. Moreover, restrictions placed upon gold movements can have but temporary effects; in the long run the distribution of gold among the various commercial countries is determined by fundamental influences which override all such artificial barriers.

The act permits only one kind of banking business between Reserve Banks and the general public. They are allowed to buy and sell to or from individuals, firms, and corporations, as well as domestic and foreign banks, bills of exchange of the kinds which are made eligible for rediscount. The purpose of this provision in the act is to enable the Reserve Banks to secure some employment for their funds when the demand for rediscounts slackens, and to develop a broad discount market. A broad discount market may be developed under the new banking arrangements; but the prediction is ventured that this provision in the act will not contribute to its development and that in general it will be barren of results. It should be observed that the promissory note, the usual borrowing instrument in this country, although it may be used for rediscounting purposes, cannot be bought and sold in the open market by the reserve banks. Aside from foreign trade, the mercantile bill of exchange, payable at a future date, has largely fallen into disuse in most advanced commercial countries. More and more cash payments are either insisted upon, or are favored by the offer of trade discounts for cash considerably greater than bank discounts. When a purchaser pays cash, obviously a mercantile time bill of exchange cannot come into existence. In European countries, many purchasers who pay at once often draw a bill of exchange on their own bank and, after it has been accepted, discount it in the open market. In this country banks are to be allowed under the act to accept only bills drawn in connection with merchandise exports and imports. Material will, therefore, be lacking for a broad discount market, if its development is dependent upon open market operations by the Reserve Banks.

Fortunately the development of a broad discount market does not require open market operations on their part. A broad discount market is one to which many borrowers resort with full assurance that they will find many lenders. Even under past banking arrangements, many borrowers and lenders have been brought together through note brokers; but owing to the lack of an available supply of cash and credit with which to meet emergencies, this market has been subject to violent perturbations, and at times dealings have been almost entirely discontinued. In the future a solvent borrower will feel more certain that his paper can always be marketed by his note broker; and banks will purchase more largely, since they will prefer to use such paper for rediscounting purposes rather than that of their own regular customers.

ADDITIONAL POWERS OF NATIONAL BANKS

Nearly half of the national banks have established savings departments and now hold more than eight hundred millions of savings deposits. This has been a recent development, and one for which there was no specific authority in the national banking law; but under the liberal interpretation of that law by the Comptroller of the Currency in recent years, it has been permitted because it was not forbidden. Many have doubted, however, whether the banks could enforce the thirty and sixty days' notice of the withdrawal of deposits which, following the practice of regular savings banks, appeared on the passbooks issued to depositors. This uncertainty has been removed by implication by the new act, which includes in its definition of time deposits, savings accounts subject to at least thirty days' notice. It is of course a great advantage to the national banks, that in the employment of these deposits they are subject to much less restriction than is imposed upon savings banks in many of the states.

Subject to the permission of the Federal Reserve Board, and when not in contravention of state laws, national banks may act as trustees, executors, administrators, and registrars of stocks and bonds. Many banks will find this a useful extension of their powers. If trust companies may properly engage in banking, there can be no good reason why banks should not undertake trust functions. The department store principle in banking has made rapid headway in most countries in recent years. Under proper supervision every kind of reasonable and safe financial business can be handled by a single institution safely and in a way which is convenient for the business community. In some states legislation may be necessary to permit national banks to undertake trust functions. In Massachusetts, it seems to be the opinion among lawyers that no legislation is required.

Inability to lend on mortgage security has been the most serious disadvantage experienced by country national banks in competition with state institutions. Land has been by far the best local security available over large parts of the country. Rural bankers have, in fact, taken it into account in making loans and by various devices have succeeded in making it the security for many of the loans which they have granted. Under the Federal Reserve Act all banks, except those in central reserve cities, may lend for periods not exceeding five years 25 per cent. of their capital and surplus, or one-third of their time deposits, on the security of unencumbered and improved farm land to 50 per cent. of its market value.

Two changes are made in the law for the purpose of facilitating financial business with foreign countries. National banks having a capital of at least one million dollars may establish foreign branches, subject to the approval of the Federal Reserve Board, and to such regulations as it may formulate for conducting this business. Banks may also accept bills of exchange maturing within six months drawn in connection with exports and imports of merchandise. These are desirable changes in the law. It is not, however, probable that many foreign branches will be established in the near future, and it is most unlikely that the American acceptance will make rapid headway in foreign markets.

The scope of the following provision in the act is uncertain. "Other than the usual salary or director's fee paid to any officer, director, or employee of a member bank, and other than a reasonable fee paid by said bank to such officer, director, or employee for services rendered to such bank, no officer, director, employee, or attorney of a member bank shall be a beneficiary of, or receive, directly or indirectly, any fee, commission, gift, or other consideration for or in connection with any transaction or business of the bank." This prohibition obviously covers payments to bank directors and officers in return for aid in securing accommodation from the banks. It may be held that all purchases by a bank of commercial paper from a firm of note brokers, or of securities from a banking house, are forbidden if any of the partners of such firms are on its board of directors. In this event, a few banks would lose valuable directors; but the question of the wisdom of such exclusion is too complex to be given consideration in this paper.[292]

SUPERVISORY FUNCTIONS OF THE FEDERAL RESERVE BOARD

A variety of functions of a supervisory or administrative nature are to be exercised by the Federal Reserve Board. It is to formulate detailed regulations regarding various matters concerning which only general provisions are contained in the act. Among important matters regarding which the Board is to formulate regulations may be mentioned: rules for conducting branch offices; the regulation of state banks which become member banks; rules defining precisely commercial loans eligible for rediscount; and the regulations for the operation of foreign branches.[293] The Board is to exercise many supervisory functions over the reserve banks which are similar to those which have long been exercised by the Comptroller of the Currency over the national banks. Examination of the Reserve Banks is under its direction. There must be one examination each year, and additional examinations must be ordered upon the application of ten member banks.[294] The Board is also to publish once each week, a statement showing the condition of each Reserve Bank, and a consolidated statement for all these institutions. It is also given a number of important powers to be exercised at its discretion. It may suspend reserve requirements for a period of thirty days, and renew such suspension for successive fifteen day periods. For violations of law, it may suspend the operation of a reserve bank, and administer or liquidate it. The Board may also reclassify cities as reserve or central reserve cities, or terminate their designation as such.

The method of banking reform which has now been adopted, necessarily involves placing somewhere enormous power to expand credit. This power cannot be surrounded by sufficient safeguards to prevent all possibility of its misuse, because in so doing, its wise use would be quite as seriously interfered with. Competent management is therefore absolutely essential if satisfactory results are to follow the passage of the Federal Reserve Act. In the operation of the new system, the boards of directors of the reserve banks may prove the most important part of the organization; or that place may be occupied by the Federal Reserve Board. The boards of directors will exercise all the ordinary powers of such boards, except in so far as they are subject to control by the Board. All the loans of the Reserve Banks are to be made by the boards of those banks. In this matter, the Board has no power whatever, except that it may require, on the affirmative vote of five members, one Reserve Bank to rediscount paper for others. Here is a power that seems to be designed merely to prevent any working at cross purposes among the Reserve Banks. Few or no occasions for its use will present themselves if all the Reserve Banks are well managed by their own boards. All rates of discount are to be fixed in the first instance by the boards, subject to review and determination by the Federal Board. Here again the decision of the Reserve Bank boards is altogether unlikely to be overruled if these banks are skilfully managed.

The power of the Federal Reserve Board to restrain the Reserve Banks is vastly greater than its power to force them to take positive action which might lead to the inflation of credit. This was clearly the purpose in view in giving the Board the more important of its many powers. It may, for example, reject applications of Reserve Banks for notes, but this will not endanger assets, it will simply lessen power to expand operations. Its power over the discount rates of Reserve Banks will obviously be more effective when used to advance rates which it deems too low than it will be if used to enforce a rate lower than the management approves. The directors of the Reserve Bank would still determine the amount of accommodation which it might safely grant to member banks at the enforced low rate. Officers and directors of Reserve Banks may be removed at any time by the Federal Board, which is merely required to communicate its reasons for removal in writing; but the right of member banks to choose successors will still remain.

While it is impossible to make any prediction as to the relative place which the Reserve Bank directors and the Federal Board will hold, it is evident that, in the absence of harmonious co-operation, the system will not work smoothly, even if it can be made to work at all. If all the Reserve Banks and the Federal Board adopt a wise and conservative policy, the system will surely work well. If the Reserve Banks alone are conservative, the system may work well but with much friction. If the Federal Board alone is conservative, it may force good results from the system. On the other hand, if some of the Reserve Banks and the Federal Board are reckless, the system will probably break down; and if all the Reserve Banks and the Federal Board adopt a reckless policy, the results will be disastrous.

Both the directors of Reserve Banks, and the Federal Board will be confronted with numerous problems, many novel and some intricate. The possibilities of the new system cannot be foreseen, and the extent and nature of the responsibilities resting upon the Reserve Banks cannot be determined beforehand....

THE FEDERAL RESERVE ACT--AN EXPERIMENT

[295]Banking is the most delicate and sensitive of all businesses in which men engage. It goes without saying that it is a business in which the law maker should not needlessly interfere. Perhaps some of you may not know that modern banking is a product of evolution. In this respect it is like all great human institutions. No language worth while was ever invented by a human being. Speech, with all its intricacies and inconsistencies of grammar and syntax, was not planned by some master mind centuries ago, but is the result of countless ages of effort on the part of the human animal, guided only by his sub-conscious intelligence--that which we call instinct in the lower animals--to give expression to his emotions and his more or less hazy concepts. Language, like the comb in which the bee stores its honey, has come to us as the product of the labor of our ancestors through many millions of years. Money, credit, and banking are in like manner evolutionary products. If we attempt to tinker with them artificially without regard to the lessons of experience and in disregard of the forces of evolution, believing that our reason transcends the consolidated experience of our ancestry, we shall meet the fate that we deserve, the fate of the conceited bee who thinks he can improve the honey comb, or of the conceited grammarian who would make me walk a literary Bridge of Sighs for saying "it is me."...

I am quite willing to admit that in some of its details the Federal Reserve Act[296] has taken leaves from the experience of banking institutions of this and other countries, but in its essentials, in its anatomy, in its bony structure as it has been called, it is an animal absolutely unknown to the natural history of finance. Let me briefly call attention to the following novelties in banking:

First. It provides for a system of twelve competing banking institutions which shall control the currency supply of this country, and over which there shall be no controlling body with power sufficient to compel them to regard the national welfare in the issue of currency and in the extension of their credit. It is taken for granted that the financial welfare of the people will be safe provided that these competing regional banks are required to hold gold or lawful money reserves of 35 per cent. against deposits and 40 per cent. gold (free from tax) against notes, and are not permitted to issue notes except upon deposit of good commercial paper.[297]

Second. The act provides that the Federal Reserve Banks shall have the right to deal only with banks, nay more, they may deal only with such banks as have contributed to their capital stock. This again is a novelty in the banking world. If these banks are to be in touch with all American business and industry and be powerful agents for the prevention and alleviation of panic, why should they be thus restricted in their operations?

Third. The capital of these regional banks is not a matter of voluntary subscription. It is not founded on business principles. The framers of the measure seemed to fear lest the banks they were planning might not prove profitable investments, hence, they have provided that our national banks must subscribe the necessary capital or forfeit their charters. No country on this green and prosperous earth has ever found it necessary to resort to such undemocratic compulsion in order to persuade people to go into the profitable business of banking.

Fourth. The bank notes issued by these Federal Reserve Banks are called government obligations and must be redeemed on demand by the United States Treasury. In no country will you find that any such bank note has ever been issued or even proposed, and I submit that in the United States, whose people for half a century have confessedly been subject to periods of anxiety and distress and panic because of the Government's liability for the daily redemption of paper money, this provision of the Federal Reserve Act is amazing, inexplicable, and indefensible. The United States Treasury is not a bank and is not made one by this act. It cannot control the issue of the notes, nor the credit operations of the banks who do issue them. Why then should the treasury be compelled to redeem these notes?

Fifth. The Federal Reserve Act provides for an arbitrary shifting of bank reserves such as has never been attempted before. Nobody can foretell what the result will be, but we know nothing of the sort has ever been attempted before and we also know that many banks will be obliged to reduce their loans and discounts, and that their customers, the business men of the country, may suffer serious losses in consequence.

The United States has tried many financial experiments--indeed, our present national banking system was an experiment in finance and has been found wanting--but the Federal Reserve Act, if it could be put on exhibition in a world's financial museum, would, I feel sure, be voted the newest and most spectacular thing we have yet constructed.

THE FEDERAL RESERVE ACT AND DEMOCRACY IN BANKING

[298]Beneath his skin every American citizen of every station and avocation, and whatever party name he may wear, is a Democrat in all the essentials and fundamentals. That is, he is attached passionately to the principles of local self-government, of the widest individual liberty compatible with the general weal and order of society. This new currency measure is democratic essentially. It looks to decentralisation of direct financial control, to financial local self-government, so far as is consistent with stability and the general safety; to a currency which will be worth its face value everywhere, which will be based on the actual values it purports to represent, as well as the faith and credit of the General Government, and which yet will be elastic, expanding to meet needs where and when they develop, receding when not needed; a system fitted to meet any emergency, moving smoothly and noiselessly for the ordinary uses of business in tranquil times.

Too much money and too little money are alike evil and dangerous. Opinions differ as to which is the worse. Probably one is as bad as the other. The design of the new law is to supply just enough money or credit, when and where business needs it, to create for our commerce, as has been said, foundations so even, so broadly laid, and so deeply planted that they can not be shaken.

As it is, the country bleeds and sweats to the big financial centres. Take the South as an instance--and the conditions with which you here in North Carolina are familiar exist everywhere in the country. Most of our railway systems are controlled frequently through the trust known as the voting trust--by men who are interested in the great banks in the three central reserve cities. So it happens that the large deposits of the railways, their collections from the Southern people, as also from the Western people, are sent on largely to those banks. The same is true of the telegraph and telephone companies, the life and fire insurance companies, and of many of the larger manufacturing enterprises. The merchants and manufacturers of North Carolina pay their freight bills to the railways. The money goes largely and promptly to New York, and is lent out and used there in stock-market operations, or as the directors of the banks, who are also often the directors of the roads and other corporations, may elect. Of course there is no law which provides for the carrying of the reserves and bank balances of railways and industrial corporations in the central reserve cities, where the national banks of the country have also been accustomed to keep their reserves.

When North Carolina needs money to move the cotton crop her banks must call on New York for money which should be in their own vaults; for the return of money paid in here in freight bills, insurance premiums, and otherwise; and your banks sometimes think themselves lucky if they can be allowed the use of any part of it....

It is not hard to see how centralization of financial resources and money supply and concentration of financial power has been forced, and the invisible and irresponsible despotism created by acts of Congress and policies of government made necessary by those acts.

Now, we do not propose to use violence to force disintegration and decentralization, to do anything with a jolt and a jerk. It is understood clearly that to rush headlong and at full speed over an evil or an obstacle may cause derailment or jarring, uncomfortable and bad for passengers. The thought or plan, as I understand it, is to invite decentralization, to encourage it, to give opportunity for it, to make local self-government possible, to remove the influences which draw to a few centres the money that is paid out to the corporations and deposited in the local banks....

The law does not require a single business man to change his account from the bank with which he has kept it or any business man or bank to suspend dealings with the bank or banks in the central reserve or reserve cities with which they have in the past been doing business. It does offer to banks freedom of choice. It says to the banker that he can follow his preferences, sentiments, or habit in selecting the source of his borrowing; and the member banker of any federal reserve district may feel free and peaceful and at ease when he knows that he has in his portfolio notes, drafts, and bills of exchange arising out of actual commercial transactions, which he can convert into money at his federal reserve bank with greater ease and promptness than it has sometimes been possible for him to withdraw his cash balances from his reserve agents and almost with as much ease as it has ever been possible to draw on credit balances with any correspondent. He is not dependent on the whims or fortunes of any other bank. He need not shiver at the prospect of abundant crops for fear he may not have available the funds with which to meet demands for moving them. He will know that if he needs money to accommodate the bank's customers he can, as a matter of right, call on his federal reserve bank.

Among other benefits the new currency law, by its direct system of clearances, will release and make available for purposes of trade and commerce hundreds of millions of dollars which under the old system have been tied up in tedious processes of collection. It will also save to banks and to merchants and business men generally some millions of dollars which they are now paying, directly and indirectly, for the collection of country checks and checks on outside cities.

To refer more particularly to your own district, the fifth, I will try to explain to you how the new method will work in transactions of domestic exchange.

In this district, embracing the States of North and South Carolina, Virginia, West Virginia (except four counties), the District of Columbia, and Maryland, there are some 475 member banks.

A cotton mill at Columbia, S. C., under the old plan sends its check on its Columbia bank for a shipment of coal to the coal company at Bluefield, W. Va. The local bank at Bluefield forwards this check to its correspondent in Richmond. This correspondent sends the check to its own correspondent in Columbia, who makes the collection from the Columbia bank and then draws a check on New York for New York exchange, which it remits to Richmond. The Richmond bank thereupon notifies the Bluefield bank of the collection of the item. The collection and exchange charges on distant country banks amount usually to from one-tenth to one-fourth of 1 per cent., or possibly more, and probably a week or more elapses between the remittance of the South Carolina check to the Bluefield bank and the time when the Bluefield bank gets its report that the item has been collected and placed to its credit in Richmond.

Under the new currency act "every Federal Reserve Bank shall receive on deposit at par from member banks ... checks and drafts drawn upon any of its depositors." That means that the Bluefield bank receiving the check on the Columbia, S. C., bank mails it to the federal reserve bank at Richmond. The federal reserve bank at Richmond thereupon charges the Columbia bank with the amount of the check, credits the Bluefield bank with the proceeds, and notifies the two banks accordingly.

The Federal Reserve Act also provides that each federal reserve bank shall receive at par, and credit accordingly, all checks and drafts drawn upon any of its member banks, from every other federal reserve bank; that all checks and drafts drawn by any depositor--that is to say, by any member bank--on any federal reserve bank shall be received and credited at par by every other federal reserve bank. This means that the checks of the member banks in the country towns throughout these five States are worth their full face value, without deduction for exchange or collection charges, to every other member bank, and that the amount of each check may be cashed at par immediately, without following the devious and roundabout courses now observed in the collection of checks. Virtually every bank in the fifth district is only one night distant from Richmond, and a check mailed one afternoon in the most distant portions of the district should reach Richmond the following day in time to be included in that day's operations of the federal reserve bank.

Let us now consider another aspect of the new law: Under the old National Bank Act a national bank with a capital of, say, $200,000, deposits of, say, $1,500,000, bills receivable amounting to $1,200,000, and $300,000 reserve, would only be permitted to borrow a total of $200,000, the amount of its capital. If a run should start on such a bank, the amount which it could raise by loans, if strictly held to the old law, would be but $200,000, the amount of its capital, which might be quite inadequate to meet a run, and the bank, though thoroughly solvent, might be forced to suspend.

Under the new law, however, if a bank with $200,000 capital and deposits of $1,500,000 should have loaned $1,200,000 to its customers on commercial paper and should encounter an unexpected run, in addition to borrowing $200,000, the amount of its capital, such a bank would have authority to rediscount with the federal reserve bank of which it is a member, notes, drafts, and bills of exchange issued or drawn for agricultural, industrial, or commercial purposes, having not more than ninety days to run, to any reasonable extent which may be approved by the federal reserve bank to which application for such rediscounts may be made....

We can not overestimate the value of the additional security which this provision of the act confers upon every honestly, capably managed member bank, and the relief from strain and anxiety and from the fear and apprehension of panics and unreasoning runs which it gives to the officers of every member bank.

Another important change provided by the Federal Reserve Act is the new arrangement for the compensation of national bank examiners. Under the present law the compensation of national bank examiners is based, except as to reserve cities, on the capital stock of the bank examined. Under the operations of this law a national bank examiner has been receiving for the examination of a certain national bank in the fifth district, with over $9,000,000 of assets and many thousands of accounts, the munificent sum of $25. It is, of course, clear that an examiner could make only an imperfect examination of such a bank in the space of three days at a compensation of, say, $8 per day, out of which $8 allowance he has to pay his own railroad fare, hotel expenses, as well as clerical assistance. It is not unnatural that but few examiners would willingly spend the ten days or two weeks which it might require to make a thorough examination of such a bank when he is running personally in debt in doing so.

Under the new currency law the Federal Reserve Board, upon the recommendation of the Comptroller of the Currency, is given authority to fix the compensation of bank examiners on the basis of annual salary, so that those banks which need additional time and attention from the examiner may receive the careful, close scrutiny which the case may call for. It is believed that the new system of bank examinations will reduce materially the number of bank failures and enable the department to check up many abuses and correct many evil situations which in the past have been ignored or glossed over by examiners in their hasty and incomplete investigations.

I thank you, gentlemen, for the opportunity to address you. Approaching the study of this new and revolutionary measure with the caution natural to every man trained in banking under the system with which we have grown up, I have become more thoroughly aroused to its merits and more deeply impressed as I have watched the methods of construction, the processes of growth, and have considered the underlying principles directing those who did the work.

THE ELASTICITY OF NOTE ISSUE UNDER THE NEW CURRENCY LAW[299]

To anyone who has been interested in currency reform for, say, twenty years, probably nothing is more striking than the change in emphasis which has taken place among the advocates of reform during this period. The typical reform plan of the earlier time, for example the so-called Baltimore plan brought forward in 1894, devoted itself almost exclusively to providing a thoroughly elastic note issue, based on ordinary assets. In contrast, the new law has as its central, primary object the organization into at least regional unity of something like the entire banking system of the country. Doubtless this difference in the two reform plans was not altogether due to a fundamental difference of opinion with respect to what would be the ideal scheme. The reformers of the earlier period were not indifferent to the need for centralized organization in the banking system. But they considered any scheme involving a central bank, like the old Bank of the United States, quite chimerical; and they were probably right. But times change; and men change with them. For one reason or another we have all become more tolerant of centralization in business matters, as also more tolerant of that increase in governmental control which increased centralization in business seems to make necessary. With at least fairly general approval, a system of regional organization has been set up, involving a very high degree of centralization and a very high degree of governmental control. But with this change in the method of reform, it became inevitable that the more important ends which earlier schemes sought to accomplish by giving the note a high degree of elasticity should be, in no small measure, attained by other means. In consequence, the need for elasticity in the note issue will be much diminished under the new law. Nevertheless, it is admitted that this need will not disappear altogether. Elasticity in the note issue will be wanted partly to assist in utilizing the newer methods of dealing with the difficulties involved and partly to supplement those newer methods. Accordingly, the question "How far does the note issue under the new system seem likely to prove an elastic one?" is still important.

From the beginnings of agitation for currency reform the advocates of elasticity have recognized more or less clearly two kinds: (1) what we may call _seasonal_ or ordinary elasticity, and (2) what we may call _emergency_ elasticity. By the former was meant the power of a note issue to adjust its volume to those moderate changes in the need for money which show themselves in the course of an ordinary year. By emergency elasticity was meant the power of a note issue to adjust its volume to those extraordinary changes in need which connect themselves with the typical banking panic. The evils which it was believed that seasonal or ordinary elasticity would remedy were principally (1) the summer shortage of currency for moving crops, together with the temporary but more or less serious stringency in the New York money market which accompanies that shortage, and (2) the plethora or excess of currency which usually appears three or four months after the crop-moving period has terminated. The evils which emergency elasticity was expected to relieve were principally (1) the stringency which precipitates the panic, (2) the money famine consequent on general bank suspension after the panic has fully developed, and (3) the glut of currency which attends the depression following a panic, often leading to excessive exports of gold and thus endangering the whole credit system of the country.

Let us, now, take up seasonal or ordinary elasticity, and ask ourselves whether the new notes are likely to possess this characteristic. First, how about the expansibility needed to supply adequate funds for crop-moving? At this point, it must at once be admitted that the new currency does not meet the demands of the case in quite the thoroughgoing way which the earlier schemes thought to be necessary. The ideal of the earlier plans was to provide an adequate and easily utilized power of issue, located at the very place where the need for expansion is felt, _i. e._, in the local bank. The new law gives up this idea entirely. The local bank will not have power to issue the new currency at all. In so far as its customers are to get any benefit from that currency the benefit must come through two channels which the country bank could use in getting the needed funds, even if the currency had no expansibility, namely, (1) calling in its balances kept with banks more centrally situated, and (2) borrowing from such central banks. In other words, the new power of issue will help out in the crop-moving period merely because it will put the reserve banks in a better position to respond to the call of the country banks for the return of their own balances and for advances on discounted paper. Judged from this point of view only, the elasticity provided by the new law is doubtless adequate. If the reserve banks have not kept themselves in a position to meet the calls of their country members from money already in possession, they will surely be able to put themselves into such a position by expanding their issue of notes. In one sense, then, the new issue has adequate expansibility for ordinary needs. There still perhaps remains a doubt whether effective elasticity is after all assured, for it is not clear that the country bank which needs money for crop-moving purposes will have the wherewithal to get advances from the reserve bank--that is, that it will have paper of the proper kind and in sufficient amount for rediscount. However, it seems probable that the act as finally passed has met this need by providing that agricultural paper shall be admitted on rather more liberal terms than paper arising out of ordinary commercial or manufacturing business. If this be so, it would seem that the provisions of the new law for securing one phase of seasonal elasticity--expansibility--are fairly adequate.

Passing, now, to the other side of elasticity--_i.e._, contractility--can we say as much? Will the new issues promptly retire when their special task is over? _Prima facie_, the verdict here is less favorable than in the previous case. In general, there are two principal processes by which a note circulation may be contracted: (1) _driving_ the notes out of circulation, and (2) _drawing_ them out. In so far as the former process is depended upon, means are devised to make sure that the notes shall persistently return to the issuer even against his will--they shall have good homing power. By the second process, it is made to the advantage of the issuer of the notes to hasten their withdrawal himself.

As respects insuring contractility by the former of these processes, the act certainly cannot claim to promise high efficiency. The driving-out process requires roughly the fulfilment of two conditions: (1) keeping the channels for the return of notes to the issuer fairly open, and (2) supplying outsiders with a motive for sending the notes home. As regards the former of these conditions, the new system probably is all right. The return of the notes to the issuer seems not to be impeded by the inconvenience or expensiveness of the process. All member banks and all reserve banks must receive these notes; and the reserve banks will probably have branches within easy reach of any part of the district. Hence, any holder desiring to get notes back to the issuing bank will find the process easy and the way open. But good homing power requires more than this. It requires, namely, that adequate motives be supplied to people generally, or, at least, to banks generally, for seeing that the notes get back. It is not enough that the track be smooth; people must desire to use it. Now, earlier plans for securing elasticity relied on two principal motives for inducing holders to send notes back to the issuer: (1) the desire of such holders to make room for their own notes, and (2) their desire to exchange money which has various limitations imposed upon it for money which is free from those limitations. It is plain that the new system makes only a limited use of the former of these methods of procedure. _Within_ the district for which any particular reserve bank is the central bank, this particular force will be practically inoperative; for the power to issue notes on the basis of common assets is not given to any but the reserve banks, and the profitableness of the power to issue the old type of note has always proved too low to induce banks generally to take much trouble to get their own notes into circulation. As between the reserve banks of the different districts, however, this particular motive will, of course, be more or less in evidence, since these reserve banks will all be competitors for this opportunity. But even here the motive in question will not play a large part, since more effective means for insuring the return of the notes from outside reserve banks are provided in other parts of the law.

As regards the second motive for returning idle notes--that is, the desire to exchange a money subject to various limitations or disabilities for one not subject to those limitations--the new act does somewhat better than it does in respect to the first motive. It is, indeed, true that, within their own district, no special disability, like being forbidden to be paid out by other banks, is put on the new notes. But they are always subject to the disability of not being legal reserve money in the case of federal banks; and hence such banks will be more or less disposed to return the notes issued by their own reserve banks, in order to exchange them for reserve money. It may be doubted, however, whether in ordinary times this will prove a very potent force, since country banks will usually keep reserves considerably in excess of legal requirements, and so will not need to discriminate nicely between the two sorts of money. As between different districts, the case for the homing power of the new notes is rather stronger, since reserve banks are prohibited from paying out the notes of other reserve banks under penalty of a 10 per cent. tax. Even here, however, the provisions are none too adequate. While the notes of a particular reserve bank must not be paid out by the reserve banks of other districts, there is no prohibition against their being paid out by the member banks of other districts; and it is doubtful whether there is sufficient motive to induce said member banks of other districts to send in these notes to their own reserve banks and so start them on their homeward journey. The desire to exchange money which cannot be used as reserve for that which can be would have some force; but, under many circumstances, it would probably prove rather inadequate.

Another disability which contributes to the homing power of a bank note, and which is actually used in the case of our old note, is not used with this new note--I mean, the fact that they are not receivable for customs dues. The decision to omit this provision was perhaps wise; but it throws out a potent motive for sending notes home, and thus throws away an opportunity to make better provision for their contractility.

On the whole, then, it must be acknowledged that, in so far as homing power is dependent on giving to outsiders strong and persistent motives for sending notes home, the new law is not altogether satisfactory.

We have seen that there is very little in the new system to secure that the notes shall have good homing power--shall get home by what we have called the _driving-in_ process. Is the system better off as respects the _drawing-in_ process? Are matters so arranged that the issuing bank will have the power and the desire to withdraw its notes--or at least contract the currency proportionately--when the need for the notes has fallen off? As respects the first part--making sure that the issuing bank shall have the power to retire its notes, or at any rate to effect a corresponding contraction of the currency--the new system is practically perfect, as indeed was the old one. That is, any reserve bank desiring to contract its note obligations may at its discretion deposit with the federal reserve agent reserve notes, gold, or lawful money. Obviously, this, if not strictly a contraction of its note circulation, at least brings about the desired contraction of the general circulation.

When, however, we consider the provisions of the new law for insuring that reserve banks shall desire to contract their circulation when the special need has passed, we find that the law does not promise quite so well. The favorite device for accomplishing this result has been, of course, a tax on issues, similar to the 5 per cent. tax of the German system. Apparently, the new law provides for something equivalent to this in the shape of an interest charge by the Federal Reserve Board, the rate to be fixed by said board. How far this device will prove effective in practice it is not safe to predict. In order that it should induce the banks to contract their circulation, circumstances must have arisen under which the issuing bank would be earning on its outstanding notes a profit smaller than the tax itself. Now, it does not seem certain that an excessive issue of notes would necessarily bring about this condition. In the first place, in the absence of good homing power, a volume of notes in excess of business needs would not necessarily cause an accumulation of those notes in the vaults of the bank issuing them. Secondly, so long as member banks are free to keep their balances in banking institutions other than their reserve banks, an excess of notes would not necessarily cause the general cash holdings of reserve banks to be abnormally large. For, so long as the ordinary New York banks are permitted to pay interest on bankers' balances, country banks will to a considerable extent keep their balances with these outside New York banks; and it seems not unlikely that the excessive monetary stock thus accumulating in New York City would, instead of getting into the hands of the New York reserve bank, largely remain in the hands of the outside banking institutions and be employed more or less as it has been in the past, that is, in financing doubtful enterprises and supporting excessive speculation. But if the reserve banks do not feel the pressure of excessive issues in the shape of accumulations of notes or some form of money in their own vaults, they may conceivably be able to invest advantageously all the funds in their possession, and, in that case, the rate of interest charged by the Federal Reserve Board will not furnish an adequate motive for the retirement of their issues. Doubtless, however, this may in some degree be answered by saying that even an excess which was felt only outside the reserve bank would, after all, compel the reserve bank to contract its issues, since it would lower the rate of discount so greatly that reserve banks could not profitably invest their ordinary holdings, and consequently would wish to get rid of the interest charge. Perhaps this is true; but it would by no means insure the prompt and full contraction which most reformers have considered desirable.

From the foregoing it would seem that one of the devices for inducing the reserve banks to contract their issues after the need for them had passed--that is, charging interest upon such issues--is not certain, at any rate, to prove adequate; it will not surely eliminate the winter plethora in New York City which is supposed to stimulate and support excessive stock speculation. But the new law contains another provision which may be viewed as a device for supplying the issuing banks with a motive for contracting their issues, namely, the requirement that such banks shall keep a gold reserve equal to 40 per cent. of their issues. Is this likely to prove effective? Probably not. Whatever might be true in panicky times, it seems certain that in an ordinary year the gold holdings of a reserve bank will be much above 40 per cent. of its note issue. If this be true, the maintenance of this 40 per cent. could become difficult only when the excess of money was so great as to cause a dangerous exportation of gold from the country, and this surely would show a very inadequate degree of contractility. In short, the new law does not insure that issuing banks shall be sufficiently disposed to draw in their notes any more than it insures that outsiders will drive them in. It would seem, then, that the new law does not promise to give to the note issue the degree of contractility which has hitherto been considered desirable. In other words, there is some point in the fear expressed by many bankers that the new law will result in note inflation--at least in so far as the avoiding of this danger is dependent on the contractility of the note issue. Very likely, however, the possibility of such inflation is sufficiently guarded against by other provisions of the law.

We have discussed the adequacy of the new note issue in respect to seasonal or ordinary elasticity. We pass on now to consider its adequacy in respect to emergency elasticity--the elasticity which enables a currency to adjust itself to those extraordinary fluctuations in need which mark a banking panic and the depression that follows. Broadly speaking, it is pretty certain that at this point the new law will get a more favorable verdict than in the previous case. As pointed out in an earlier connection, the banking panic, when fully developed, gives rise to three difficulties and so to three needs: (1) funds to relieve the antecedent stringency which threatens a complete collapse of the credit structure; (2) a circulating medium for ordinary trade when a general suspension of payment by the banks has brought on a money famine; and (3) a prompt and thoroughgoing contraction of the circulation in the depression which follows the panic. Now, there surely can be no doubt that, under the new law, the availability of an issue sufficient in volume instantly to relieve the antecedent stringency, and so to put a stop to a panic before it had developed serious dimensions, is assured. In fact, it is not at all improbable that, under the new system, the reserve banks will be able to check the development of such a panic at the very outset without increasing at all their note issues. But, if this does not prove true--if it turns out that more currency is needed for this purpose--there would seem to be no shadow of doubt that the new system will insure the forthcoming of such currency both of a quality and in a quantity which will be fully adequate to the task put upon it. (1) The notes to be issued, being obligations of the Federal Treasury, will be as acceptable as gold even on the eve of a panic. (2) There is no limit to the absolute amount of these notes. (3) The practical limit set by the requirement that discounted paper shall be furnished as a basis for their issue is of no real significance, since such paper will undoubtedly be vastly greater in volume than any need which could arise. Accordingly, there can be no doubt that the new system provides all the expansibility needed to abort, or reduce to comparative harmlessness, any panic which might arise.

A word now with respect to the second need which an emergency circulation is supposed to meet, that is, an ordinary circulating medium for trade when banks have by common consent suspended payment. In the first place, if we are right in supposing that the new law will surely prevent any panic from reaching such a degree of intensity, it is obvious that we shall not have occasion to meet the particular difficulty here under consideration--that our note issue will not be called on to display this particular sort of elasticity. If, however, it be supposed that the foregoing prediction does not turn out to be correct--if experience proves that panics can still go so far as to cause banks generally to suspend payments, to hold on to every form of reasonably solid money, and to try to satisfy the public with substitutes--our verdict for the new currency would necessarily be less favorable. We should have to admit that the new law does little or nothing to relieve such a situation. Broadly speaking, the new money will be altogether too good to meet this particular need. Banks that had reached a stage of panic sufficiently intense to cause them to suspend payment--to hoard the ordinary forms of money--would be sure to hoard money as good as those notes are bound to be. That is, the new issue would immediately pass into hoards, as did the greenbacks which the Secretary of the Treasury reissued during the panic of 1873, and, therefore, would bring little if any relief to the currency famine which had developed. In fact, it is almost impossible to conceive any form of note fitted for this particular task except one which was so bad that there was no danger of its being hoarded. That is, the only proper way to meet this particular need of a severe panic is to make sure that it does not arise at all; and, in this respect, the new law promises well.