tion or exportation of goods, heretofore covered by Regulation R, but also the purchase of certain domestic acceptances authorized by certain State laws.

The Federal Reserve Board has determined that bankers' domestic acceptances, as defined and restricted in the appended regulation, are a very useful type of paper, and the Board has not felt justified, therefore, when admitting State banks and trust companies into the Federal Reserve System, in stipulating that such domestic acceptances should not be continued under reasonable limitations as a part of their business.

Inasmuch as the making of these domestic acceptances has been recognized by the Board as the exercise of a legitimate banking function when authorized by law, it was thought that they are of the character to make desirable investments for Federal Reserve Banks. The Board has, therefore, issued the appended regulation, not only embodying the authority given in Regulation R, series of 1915, to purchase bankers' acceptances based on the importation or exportation of goods, but also authorizing the purchase of bankers' domestic acceptances within the limits prescribed in the appended regulations.

1. A banker's domestic acceptance must be based on a transaction covering the shipment of goods, such transaction to be evidenced at the time of acceptance by accompanying shipping documents, or must be secured by a warehouse receipt covering readily marketable staples and issued by a warehouse independent of the borrower, or by the pledge of goods actually sold.

2. A banker's domestic acceptance must bear on its face or be accompanied by evidence in form satisfactory to the Federal Reserve Bank that it is based on a transaction or is secured by a receipt or pledge. Such evidence may consist of a certificate in general form similar to that suggested in (d) Circular No. 18, governing foreign acceptances.1

3. Provision (e) in Circular No. 18 is also made applicable to domestic acceptances.

4. The following provisions supersede (g) and (h) in Circular No. 18: a) The aggregate of bills, domestic and foreign, of any one drawer, drawn on and accepted by any bank or trust company and purchased or discounted by a Federal Reserve Bank, shall at no time exceed 10 per cent of the unimpaired capital and surplus of such bank or trust company, but this restriction shall not apply to the purchase or discount of bills drawn in good faith against actually existing values; that is, bills the acceptor of which is secured by a lien on or by a transfer of title to the goods to be transported, or by other adequate security, such as a warehouse receipt, or the pledge of goods actually sold.

For the provisions of Circular No. 18, see selection No. 153.-Editor.

b) The aggregate of bills, domestic and foreign, of any one drawer. drawn on and accepted by any firm, person, company, or corporation (other than a bank or trust company) engaged in the business of discounting or accepting, and purchased or discounted by a Federal Reserve Bank, shall at no time exceed a sum equal to a definite percentage of the paid-in capital of such Federal Reserve Bank, such percentage to be fixed from time to time by the Federal Reserve Board; but this restriction shall not apply to the purchase or discount of bills drawn in good faith against actually existing values; that is, bills the acceptor of which is secured by a lien on or by a transfer of title to the goods to be transported or by other adequate security, such as a warehouse receipt, or the pledge of goods actually sold.

c) The aggregate of bankers' acceptances, domestic and foreign, made by any one firm, person, company, or corporation (other than a bank or trust company) engaged in the business of discounting or accepting, purchased or discounted by a Federal Reserve Bank, shall at no time exceed a sum equal to a definite percentage of the paid-in capital of such Federal Reserve Bank; súch percentage to be fixed from time to time by the Federal Reserve Board.

No Federal Reserve Bank shall purchase a domestic or foreign acceptance of a "banker" other than a member bank which does not bear the indorsement of a member bank, unless there is furnished a satisfactory statement of the financial condition of the acceptor in form to be approved by the Federal Reserve Board.

POLICY AS TO PURCHASES

Federal Reserve Banks should bear in mind that preference should be given wherever possible to acceptances indorsed by a member bank, discounted under section 13, not only because of the additional protection that such indorsement affords, but also because of the reason that acceptances discounted under section 13 may be used as collateral security for the issue of Federal Reserve notes.

155. FEDERAL RESERVE BANKS AND THE FOREIGN

EXCHANGES

By E. E. AGGER

Important provisions are to be noted in connection with the foreign exchanges and the international movements of gold. Most of the foreign trade of the United States has heretofore been financed by foreign bankers. The new system permits the home institutions to enter the field for this business. Member banks are allowed

Adapted from "The Federal Reserve System," Political Science Quarterly, XXIX (1914), 279-81.

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within certain limits to accept on commission drafts and bills of exchange growing out of exports and imports, and these may be sold in the open market or ultimately rediscounted at the federal reserve banks. National banks with a capital and surplus of $1,000,000 or more may, with the permission of the Federal Reserve Board, establish branches abroad. Similarly the reserve banks, when duly authorized, may open accounts in foreign countries and may establish branches for purchasing, selling, and collecting bills of exchange bearing at least two names and maturing within ninety days. But the extent to which American bankers will be able to supplant the foreigner will depend, of course, largely upon the acceptability of bills drawn in dollars. This will depend, among other things, upon the market rate of discount in the United States in competition with the rates abroad. If the new system successfully establishes American credit in the world markets, a large part of the tribute that American commerce now pays to foreign bankers will stay at home.

The provisions bearing on the foreign exchanges and gold movements are of special interest. In addition to the dealings with their member banks, the reserve banks are permitted to purchase and sell in the open market, at home and abroad, cable transfers of funds, bankers' acceptances, and bills of exchange of the kind that are eligible for rediscount, with or without the indorsements of a member bank. Furthermore, they may deal in gold coin and bullion, at home and abroad, may make loans thereon, may exchange federal reserve notes for gold in bullion and in coin, or for gold certificates, and they may contract for loans of gold. Finally, under rules prescribed by the Federal Reserve Board, they may buy and sell, at home and abroad, United States bonds, and notes, bills, bonds, revenue warrants, etc., of the stated and minor political divisions.

The significance of these provisions can hardly be overestimated. Taken together, they mean that in the foreign exchange market the reserve banks will not only become competitors of existing banks but also that they are likely to become the controlling factors in that market. In normal times, owing to their extensive resources and wide powers, they will markedly influence the general drift of the exchanges, while in times of strain they ought to be in position to render most helpful aid. Their buying of bills in the open market will enable them to support the demand side when rates are low, and 1 Subsequent rulings of the Federal Reserve Board have greatly strengthened the acceptance features of the law. See selections Nos. 153 and 154.-EDITOR.

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will at the same time enable them to throw exchanges on the market when rates are high. European experience has shown this to be a most useful expedient in checking unnecessary gold movements. Moreover, the full authority granted to the reserve banks to deal in, to borrow, or to make loans against gold at home and abroad and to buy and sell governmental securities, secures the possibility of creating credits that can be used either as an offset for debts, the payment of which would otherwise necessitate gold exports, or as a means of obtaining gold to strengthen reserves at home. Furthermore, through the final control of discount rates, if that control can in practice be made effective, the Federal Reserve Board acting through the reserve banks may check the outward flow of gold. If the nation's credit position is strong enough, it may even attract gold to the home market from abroad. As final guarantee to the world of the solidarity of the whole system, the gold standard is reaffirmed and the Secretary of the Treasury is authorized to purchase gold if necessary with one-year 3 per cent notes or to borrow it on the security of United States bonds.

156. OPEN-MARKET OPERATIONS1

There remain still to be dealt with under "Open-Market Operations" the purchase and sale of "cable transfers" and bills of exchange, both domestic and foreign, of the kinds and maturities by this Act made eligible for rediscount, and bankers' acceptances payable in foreign countries and in foreign currencies. The present circular and regulation is intended to cover these items. The Board wishes particularly to call attention to the purpose of the open-market section of the Federal Reserve Act. It enables the Federal Reserve Banks to exert a steadying influence upon prevailing rates of interest by the use of their purchasing power whenever conditions make such influence desirable, and when, owing to the lack of applications for rediscounts, they are unable to influence rates through the latter means. It also affords to the Federal Reserve Banks the opportunity of purchasing in the open market paper with a view to providing for their expenses and dividends. The Board is of the opinion that the Federal Reserve Banks should, when occasion warrants, stand ready to engage in openmarket transactions, as buyers or sellers, to the extent that it is necessary to carry out the purposes of the Act.

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1 Adapted from Federal Reserve Board Circular No. 20, December 4, 1915.

GENERAL OPEN-MARKET OPERATION

I. DEFINITION

Open-market operations, as contemplated under the Federal Reserve Act, are all those transactions authorized by section 14 of the Act which involve dealings with persons or institutions—whether or not members of the Federal Reserve System-and which do not require the indorsement of a member bank.

II. CABLE TRANSFERS AND FOREIGN BILLS OF EXCHANGE

In order to carry on open-market transactions in cable transfers and foreign bills of exchange (including foreign bankers' acceptances)—that is, payments to be made in, or bills payable in, foreign countries-it will be necessary for Federal Reserve Banks to open accounts with correspondents or establish agencies in foreign countries. Such bills of exchange and foreign acceptances must comply with the applicable requirements of sections 13 and 14. As the law prescribes that these connections are to be established only with the consent of the Federal Reserve Board, Federal Reserve Banks will be required to communicate with the Federal Reserve Board whenever they are ready to enter these foreign fields.

The Federal Reserve Board realizes that in dealing in foreign exchange the Federal Reserve Banks must necessarily have wide discretion in determining the rates at which they will buy or sell. It is not necessary that the bills shall have been actually accepted at the time of purchase. The Federal Reserve Board, however, will require that unaccepted "long bills," payable in foreign countries, when purchased, unless secured by documents, shall bear one satisfactory indorsement other than those of the drawer or acceptor, preferably that of a banker. Federal Reserve Banks should exercise due caution in dealing in foreign bills, and boards of directors should fix a limit within which the acceptances or bills of a single firm may be taken.

III. DOMESTIC BILLS OF EXCHANGE

The Federal Reserve Board has determined that a domestic bill of exchange, in order to be eligible for purchase under section 14 by a Federal Reserve Bank, at the rate to be established for open-market operations—

a) Must be a bill the proceeds of which have been used, or are to be used, in producing, purchasing, carrying, or marketing goods in one or more steps of production, manufacture, and distribution; but shall not be eligible if its proceeds have been used, or are to be used, for a permanent or fixed investment of any kind; for example, land, buildings, machinery, etc., or for any investment of a merely speculative character.

b) Must have been drawn by a domestic or foreign firm, company, corporation, or individual upon a firm, company, corporation, or individual in the United States; but need not bear the indorsement of a member bank. c) Must have been accepted by the drawee prior to the purchase by a