[The whole system is to be supervised and controlled by the The Federal

Reserve Federal Reserve Board,] to consist of seven members; the Secre

Board. tary of the Treasury and the Comptroller of the Currency ex officio, and five members appointed by the President. ... Of the five appointed members, at least two must be persons experienced in banking or finance. Not more than one shall be appointed from any Federal Reserve district, and due regard is to be given to the different commercial, industrial and geographical divisions of the country. The term of office of the appointed members is ten years; but those first selected are to serve one for two, one for four years, and so on, so that the term of office of one member may expire every two years.

Organization of the system will be complete with the selection The Federal of the members of the Federal Advisory Council. This Council is Advisory

Council to consist of as many members as there are Federal Reserve districts, and its

function. the board of directors of each Federal Reserve Bank selecting one member. The function and powers of the Council are purely consultative. It is to meet regularly four times each year at Washington, and at other times there or elsewhere if deemed necessary by the Council itself. It is authorized to confer directly with the Federal Reserve Board, to call for information, and make oral or written representations concerning matters within the jurisdiction of the Federal Reserve Board. ..

1

185. Centralization under the Federal Reserve System At the time of the panic of 1907, the United States had the largest The Federal

Reserve supply of gold of any country in the world. The difficulty was that

System under the old national banking system this supply of gold was in- provides

for the effective, because widely scattered. A second difficulty was that

centralization our reserves were not only scattered, but were immobile. There and mobility

of bank was no effective way of quickly gathering them together and massing them at the points of financial danger. These two difficulties the Federal Reserve System overcomes by provision for, first, the centralization of bank reserves, and, second, the mobility of those reserves. The following discussion of this subject is by Dr. Kemmerer:

a

Member [At the present time] every bank, banking association or trust banks must

company belonging to the Federal Reserve System (must] maintain maintain their entire its entire legal reserve in the form of a deposit at the Federal Reserve legal reserve

Bank of its district. ... [Thus commercial banks belonging to the in the Federal system no longer tie] up their legal reserve money by depositing it Reserve

in the banks of our money market centers, there to be loaned out Bank of their district. at call to speculators on the stock and produce exchanges. This

divorcing of the legal reserves of nearly 8,000 commercial banks from the speculative and capital loans of the stock market ... is one of the big achievements of the Federal Reserve System. The Federal Reserve law, as amended, recognizes only one form of legal reserve,

and that is a member bank's deposit in its Federal Reserve Bank. This secures

Member banks may keep as much or as little cash on hand for the district centralization

till money as they wish to. They may keep balances in other banks of reserves. if it suits their convenience to do so - all that is their own affair

for which their responsibility is to their stock holders and their customers — but their legal reserve, the reserve which the Government looks upon as the minimum below which the public interest demands that banks should not go, that reserve must all be kept on deposit in Federal Reserve Banks, the nation's reservoirs of re

serve money. Mobility of A corollary to the district centralization of reserves is their mobi

lization. Reserve money must not only be piped into a few large reservoirs, but these large reservoirs must be piped together, and there must be a pumping engine of sufficient power to force the reserves promptly and in large quantities to any place desired. The Federal Reserve System creates just this machinery. [It provides for the mobility of reserves, first, between the different districts of the system, and second, between the different member banks of any one district. Mobility of reserves between different Federal Reserve

districts is provided for in a number of ways, notably as follows:] between In case there is an exceptionally heavy demand for reserve money different

in any section of the country a demand heavier than the banks Federal Reserve of that section can reasonably meet the reserve banks in other districts,

sections where money is more plentiful will come to the rescue, either voluntarily or under compulsion [by the Federal Reserve Board], and will rediscount the paper of the reserve bank in the

reserves

.

section under financial stress. This process, of course, will cause a flow of cash from the reserves of the former banks to the reserve of the latter, thereby easing the money market in the threatened section. [Thus] the reserves of the twelve reserve banks are so closely piped together ... that they may reasonably be considered to be closely connected tanks of a single large reservoir. ... [There is also provision for the mobility of reserves between the and between

the member banks of a single Federal Reserve district.] The forces which act

banks of for the increasing mobility of reserve money within the boundaries any one

Federal of a Federal Reserve district are essentially the same as those just

Reserve explained for that between districts. Obviously [commercial] paper district. of wide acceptability flows from place to place within a district more freely than paper whose merits are less widely recognized; and, within a district as between districts, the widely marketable paper flows from the places where the discount rates are high and bank funds scarce, to the places where the rates are low and funds are more plentiful. Furthermore, the bank reserves of the district which have been piped to the one reservoir, namely, the Federal Reserve Bank, can be readily pumped to the banks of any section where funds are in heavy demand.

If banks throughout the district were rediscounting in moderate sums with the Federal Reserve Bank, and if a sudden emergency should cause an exceptionally heavy demand for funds in any section, the Federal Reserve Bank could raise its rate of discount, thereby reducing the rediscount demands of the banks less urgently in need of the funds, and could then turn larger amounts into the section where the demand was heaviest.

1

186. Elasticity under the Federal Reserve System In addition to providing for the centralization and mobility of In addition

to the bank reserves, the Federal Reserve Act secures a considerable degree

centralization of elasticity. Elasticity means that the amount of money or credit and mobility will increase when a great deal of business is being transacted, and

of reserves,

there is will decrease when business becomes slack. We have seen that under elasticity of the Federal Reserve System, the reserves of the several districts

Bank-note currency:

a

how it may be expanded

can be centralized and piped to banks where they are needed; it remains to be pointed out that there must be provision for enlarging the amount of money or credit when the mechanism of exchange is called upon to handle a great volume of business, and that when business has subsided there must be some way of reducing the amount of money and credit in circulation. Elasticity under the Federal Reserve System is explained by Dr. Kemmerer as follows:

[First, the elasticity of the bank-note currency is secured by] the so-called Federal Reserve notes. These notes, which are obligations of the United States Government, and Care issued by the] Federal Reserve Banks, have back of them specifically pledged with the Federal Reserve agent to the amount of 100 per cent certain forms of high-grade collateral. ... Except under special circumstances,

a gold reserve of not less than 40 per cent must be kept by each Federal Reserve Bank against its outstanding Federal Reserve notes. .

As regards the matter of elasticity, these notes have in a high degree the quality of expansibility, namely, of having their circulation easily increased in times of need. If member banks in a given section of the country need an increased supply of currency to meet local demands, they may rediscount eligible paper with their Federal Reserve Bank and take the proceeds of the rediscounts in Federal Reserve notes, which pass readily as hand-to-hand money and are satisfactory till money for the banks. The Federal Reserve Bank, if its supply of notes is inadequate, secures, on application to the federal reserve agent, additional notes by depositing with the agent the rediscounted paper or other eligible paper in its portfolio. This process may continue as long as the Federal Reserve Bank has paper available for deposit with the Federal Reserve agent and its gold reserve does not fall below the normal legal minimum of 40 per cent. In case of great emergency, however, the Federal Reserve Board may permit a reduction of the note reserve below 40 per cent, provided it imposes a graduated tax upon the amount of the deficiency.

For the purpose of contracting the circulation of Federal Reserve notes when the business demands for currency decline, the machinery is as follows. When the demand for notes in the pockets of the people and the tills of the merchants falls off, as it does, say, after

the harvesting season in the autumn, the surplus notes are deposited by the public in the banks. Inasmuch as national banks cannot count these notes in their vaults as legal reserve money, they will tend to send to their Federal Reserve Banks for deposit any notes they receive in excess of the amount needed for till money. Notes which were issued by the Federal Reserve Bank of the district may thus be withdrawn from circulation. . . . Another device calculated to encourage the retirement from circulation of bank notes whenever they become redundant is the provision of the law authorizing the Federal Reserve Board to charge such a rate of interest as it may deem desirable on Federal Reserve notes uncovered by gold or gold certificates issued to Federal Reserve Banks. . The most important device of the Federal Reserve System for secur- Deposit

credit: ing elasticity of deposit currency, as well as of bank-note currency, is found in the machinery enabling member banks to borrow funds of their Federal Reserve Bank. Funds so borrowed, when left on deposit with the Federal Reserve Bank, serve as legal reserve money for how it may

be expanded the member banks. The making of such loans to member banks is one of the chief functions of Federal Reserve Banks. [Member banks may secure these loans either by rediscounting eligible paper at the Federal Reserve Bank of their district, or by borrowing from the Federal Reserve Bank on the security of certain types of collateral.]... The contraction of deposit currency, as soon as the need for it and

contracted falls off, is brought about by the pressure of high discount rates, to which the pressure of the graduated tax is added. This double pressure encourages borrowers to pay off their loans. This fact, and the increasing restrictions which Federal Reserve Banks place upon rediscounts as money market conditions become easier, tend to contract the circulation of deposit currency and restore the reserves to a normal condition.

Some critics of the Federal Reserve System believe that the machin- A criticism. ery it provides for contracting both deposit and bank-note currency, in times of currency redundancy, needs strengthening. [However this may be], there is no question but that the Federal Reserve System has added greatly to the elasticity of both our deposit currency and our bank-note currency.