gerously inelastic credit system; ineffective use of a large supply of gold; a scattering of reserves and lack of co-operative action by banks in times of stress; a rigid reserve system which induced panics; state banks and trust companies doing a commercial business but in different systems; an independent Treasury divorced from the money market which imperiled bank reserves in times of difficulty; the drift of idle funds to the call-loan market where they fed stock speculation, and the want of American banking facilities in other countries to aid our foreign trade. 142. THREE TYPES OF BANK NOTES IN THE FUTURE BY THOMAS CONWAY AND ERNEST M. PATTERSON I. PARTIAL RETENTION OF PRESENT NOTES The Federal Reserve Act does not compel the national banks to retire their circulation. They may increase it or decrease it under the old regulations and within the old limits if they see fit. Moreover, they are released by Section 17 of the act from the old requirement to purchase a stated amount of United States bonds before being authorized to commence the banking business. Retiring the national bank notes.-The first important change is that, beginning two years after the passage of the act, that is to say, on December 23, 1915, member banks may retire their circulation in whole or in part, this privilege to remain open for a period of twenty years thereafter, or until December 23, 1935. Any member bank desiring to retire any or all of its circulating notes may file with the Treasurer of the United States an application to sell for its account, at par and accrued interest, its United States bonds, now held in trust at Washington against the circulation that is to be retired. Disposition of the United States bonds.-The Treasurer shall notify the member banks of the amount of bonds sold for their account and these banks shall then assign and transfer the bonds to the reserve bank that has purchased them. The reserve bank shall then deposit lawful money with the Treasurer of the United States for the purchase of the bonds. The Treasurer shall deduct from this payment an amount sufficient to redeem the outstanding national bank notes that have in the past been secured by those bonds, and shall pay the balance, if any remains, to the member bank that formerly owned them. 1 Adapted from The Operation of the New Bank Act, pp. 132-48. (J. B. Lippincott Co., 1914.) The reserve banks are not allowed to purchase more than $25,000,000 of these bonds in any one year, and even this amount may be reduced if they choose to purchase bonds under the authorization in Section 4. There were outstanding on December 26, 1913, $756,944,194 of national banks notes, against which were held $16,147,911 of lawful money, and $743,173,000 of United States bonds. If all the national banks make application regularly and the full $25,000,000 be taken over by the Federal reserve banks each year, the process will take nearly thirty years. The act specifically limits the retirement process to a period of twenty years. Since, as we have seen, it would take nearly thirty years, at the rate of $25,000,000 a year, to retire all the outstanding notes, each bank would be left at the end of that long period with approximately one-third of its bonds still on hand. If we deduct the 3 per cent and 4 per cent United States bonds now held in trust and limit ourselves to the 2 per cent bonds, which amount to $685,996,700, the retirement of all of them would take over twenty-seven years, and at the end of twenty years the banks would be left with at least $185,996,700 unprovided for. Whether bankers will wish to continue their issues of notes as of old is an uncertain matter. If United States bonds remain low in price their cheapness may be a temptation, as in the past. The banks may actually be encouraged to issue notes. If, however, they fear that the purchases by the new reserve banks will be insufficient to sustain the market, they may prefer to retire their issues as promptly as possible. II. RESERVE BANK BOND-SECURED NOTES Reserve bank notes are to be the obligation of the Federal reserve bank issuing them and "shall be in form prescribed by the Secretary of the Treasury, and to the same tenor and effect as national bank notes now provided by law. They shall be issued and redeemed under the same terms and conditions as national bank notes, except that they shall not be limited to the amount of the capital stock of the Federal reserve bank issuing them." In other words, each reserve bank may issue an amount of these notes that is limited only by the deposit of the prescribed security. Issues of bond-secured currency of the Federal reserve banks may originate in two ways, although all of the notes will be alike in form See below.-EDITOR. and in security. The first group will arise through the retirement of the national bank notes. The reserve banks purchasing these notes may deposit them in trust with the Treasurer of the United States, receiving from the Comptroller of the Currency an amount of circulating notes equal to the par value of the bonds so deposited. There will thus be no shrinkage in the volume of the currency, the amount of the new reserve notes being equal to the national bank notes that are retired. The net result will be to relieve the national banks of the ownership of the bonds and their liability for the notes, and to transfer both the bonds and the note liability to the reserve banks. The second way in which the reserve bank notes may get into circulation is under the provisions of Section 4. The eighth of the powers conferred upon the reserve banks in that section stipulates that they may, "upon deposit with the Treasurer of the United States of any bonds of the United States in the manner provided by existing law relating to national banks," receive from the Comptroller of the Currency circulating notes equal in amount to the par value of the bonds so deposited. These notes are identical with the ones already described, the only difference being that in the first case the bonds are the ones that now secure the circulation of the national banks, while in the second the bonds may not have been securing national bank circulation at the time of purchase, and may have been bought from other owners than national banks. The significance of this provision lies in the fact that it creates a market for United States bonds. This power of the reserve banks may be of value in maintaining the price of the bonds, not only to the advantage of the present holders of those bonds, but also to the advantage of the government. It is also important because, if this power is exercised, it will limit the amount of United States bonds that the reserve banks may purchase from the national banks to retire their circulation. The total amount they are permitted to purchase from both sources may not exceed $25,000,000 per annum. Most of our government bonds are in the hands of the national banks. The owners of the balance, who are the trust companies, insurance companies, and the general public, may, especially if the market declines, dispose of their holdings to the reserve banks, which will be tempted by the lower prices to make the purchases, since they may exchange them at the Treasury Department for new 3 per cent bonds. This may be done to such an extent as to lessen the rapidity with which those banks could purchase from the national banks. Refunding the 2 per cent bonds.-If the reserve banks do not wish to keep these notes out, and wish to invest in United States securities bearing more than 2 per cent interest, they may do so through an arrangement for an exchange. "Upon application of any Federal reserve bank, approved by the Federal Reserve Board, the Secretary of the Treasury may issue in exchange for United States 2 per cent gold bonds bearing the circulation privilege, but against which no circulation is outstanding, one-year gold notes of the United States without the circulation privilege, to an amount not exceeding one-half of the 2 per cent bonds so tendered for exchange, and thirty-year 3 per cent gold bonds without the circulation privilege for the remainder of the 2 per cent bonds so tendered." The reserve bank may thus retire its note issues in the same way as the national banks do now, and then make an exchange in the manner described, getting 3 per cent securities in return for those bearing 2 per cent. The burden of the additional I per cent per annum interest charge will fall upon the government, an arrangement that is entirely proper, since for years it has borrowed at rates lower than are available for any other government in the world, and has done it by requiring the national banks to buy bonds as a prerequisite to securing a charter and issuing notes. The stipulation that "not to exceed one-half of the new securities shall be one-year gold notes" opens the way for a reduction in the national debt, if receipts to the Federal government from the earnings of the reserve banks or from any other source make such a reduction possible. The reserve bank will be required, upon receipt of these notes, to agree that as they mature year after year it will purchase such an amount of new one-year 3 per cent gold notes as the Secretary of the Treasury may tender to it, not to exceed, however, the amount of such notes issued to the bank in the first instance in exchange for the 2 per cent bonds. This obligation to purchase notes shall continue for a period not to exceed thirty years. At the end of that time, if the Secretary of the Treasury and Congress do not find it possible to retire these notes some provision for refunding them can be made. The Federal reserve notes are to be issued as follows: Any reserve bank may make application to the local Federal reserve agent (that is, the chairman of its own board of directors) for such amounts of these notes as it may require, at the same time offering, as collateral security therefor, commercial paper and bills rediscounted by it for member banks. This security must be at least equal to the notes received. Some of these securities may from time to time be withdrawn, with the approval of the Reserve Board, if at the same time other collateral of equal amount is substituted. The Reserve Board may also at any time call for additional security. As the notes may be issued for no other purpose than in exchange for such collateral, and since this collateral is in the form of rediscounted paper, it may be said that the notes are issued only through rediscounting. They will be in denominations of $5, $10, $20, $50, and $100. As there are no specifications as to the relative amounts of each, it is probable that the kind needed will always be furnished. All expenses incident to their issue and retirement must be met by the reserve bank receiving them, which shall also pay on them a rate of interest to be determined by the Reserve Board. Each note will bear the distinctive number of the reserve bank through which it is issued. In anticipation of demand for them a quantity are to be prepared and deposited in the Treasury or in the subtreasury or mint of the United States nearest the place of business of each reserve bank, where they shall be held subject to the order of the Comptroller of the Currency. 143. ELASTICITY OF NOTES UNDER THE NEW LAW1 I. SEASONAL ELASTICITY First, does the Federal Reserve Act insure 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 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 Adapted from "Elasticity of Note Issue under the New Law," Journal of Political Economy, XXII (1914), 454-60. |