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The Federal Reserve Act 



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Editor's Note 



VI IlK' II 



.\ |twlii>il I- Aniiol 

 .d.ral reserve nci 



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tJum l.iiiiilM-r Miimifinlnr.rii' .\«« 

 cniiliirr iif tile I'omiiK'rt'lnl Ituii 

 rolntlon to flnnnrliil pniilm. I 



I. Ml M<'iii|ilil~. Miiy III, nil nililremi « 



Irllnl *'cilll|>llll.v lit Mellipllln, nil (lie Kll 



III Ih- futiiitl a mimiiiiir)' of tlii- nditreiu 



Mr. Armidrouis's «d<lrc«« eontniiiwl a history of llii' |iniiio8 of the 

 e..iiiitry wliich eamc nt irrogiilnr but too fr<H|iii>iit inH-rviilH from ISSa 

 to 19i:i. Tluit norioil witne«i«l the viirioim atlompts to jiliiec the 

 eountryV ItnnkinK on n Hoiiiid luiKis, ami aluo wiw soiiip of the (lis 

 aiitroiis rediilts which follo«e<l. The broad woiie of rnited States 

 banks, and the fitful and misehievous careers of state and wildcat 

 banks, were inchiiled in that century and a third of the country's 

 ■'•Kincial history. 



Mile financiers and econoniistw from time to time saw the way 

 Miund business, as far as banking could make it sound, but politics 

 x>:is always a menace. Unfortunately, the destroyer was frequently 

 more |>owerful. and generally more agKressive, than the builder, 

 with tlie result tluit more than a century passed before n broad and 

 suflicient foundation was laid for the country's financial superstructure. 

 Such a foundation lias now been laid in the present banking meas- 

 ure, the new fe<leral reserve act. 



The s|H'aker declared that the bankiiid systems of every great 

 nation in the world, except the United States, were revolutionized 

 more than half a century ago, and panics in England, l>anee and 

 t'lennany have been unknown during the past fifty years, while fear 

 of panics has been the nightmare of American business life. The 

 l>eginning of the new order of things in this country dates with 

 the passage of the Ahlrich-Vreeland act, which was intended as a 

 temporary measure, creating what was to be known as "emergency" 

 note circulation, and appointing a monetary commission to study the 

 system of banking and currency in England, France and Germany, 

 and report to Congress such recommendations as in their judgment 

 seemetl advisable. They were charged with the duty of formulating 

 a system of banking and currency that would become adaptable, 

 and calculated to supply the requirements of the commerce of this 

 country. Their recommendations, the Aldrieh bill, were reported to 

 Congress, but for some reason, notwithstanding the fact that Senator 

 Aldrich was master of the Congress from which he voluntarily re- 

 tired, the bill failed to pass. 



IXEL.\STIC ClRltKNCV SY.STEM 



It was discovered that the nation's currency system was inelastic, 

 ilue to the fact that the portion of the currency that fhould have 

 fluctuated was inflexible, because secured by government bonds. It 

 was discovered also that credit was inelastic, and this was due to a 

 ."ivstem of rigid reserve requirements. Other salient defects were a 

 lack of banking co-operation and absence of a rediscount system, 

 by which commercial paper could be made liquid, instead of a dead 

 asset in the hands of the holder until maturity, and the fact that 

 our system provided no means of control of the international flow 

 of gold, and no foreign banking facilities. Our banking foundation 

 seemed to be laid in unliquid. or we might say semi-liquid stocks 

 and bonds, which are paid only after some years, and probably 

 9S the result of accumulation in sinking funds, and not from the 

 moving wealth of the country pas-sing from producer to consumer. 



There was no mobilization of reserves, a means whereby the re- 

 sources of all the banks might be used by all the banks for the com- 

 mon good and the general commercial welfare. An adequate redis- 

 count system was wanting. The best assete of the country could not 

 be quickly converted into money. By rediscount much of the wealth 

 can be made fluid. 



This moving wealth in the form of merchandise passing to eon- 

 sumption is the best wealth we have. It is represented in the realm 



clothes, have sheller and heat and the iiocesMitic* of life. In llu-.- 

 days what were once luxuries have become neci>uitip|i. 



Kl.ASTK- ("IIKIUT 



Aiiiilher thing llio financinl and economic jihysiciHiis fouml ni-ri". 

 Miry was elastic credit. Under the system still in operation credit 

 as distinguished from currency is not ehiHtie. Inelasticity of credit 

 is due to the rigid reserve system. Hanks, national banks u( least, 

 must keep their fifteen or twenty-five per cent cash on hand, or within 

 easy reach. If their reserves run below the legal requirements, they 

 must stop lending. If they stop lending, business boeomes stag- 

 nant. It is natural to consider that liaiik reservcw are designed to 

 be used in an emergency. Theoretically, this may be 'so. Practically, 

 if a national bank allows its reserves to run below the legal limit, 

 it may be dosed by the Comptroller of Ciirreney, after due notice 

 has been given to replenish. To be exact, the bank is on thirty days' 

 probation, and then the penalty is cej<satioii of businei-s. So long 

 has this system obtained that we have come to consider the great test 

 of a bank's stability the condition of its reserves. The true test 

 should be its power to continue the extension of credit to its cus- 

 tomers. If a rediscount system is instituted, and one will be, then 

 a bank can turn its commercial collnternlH into currency or credit, 

 and so replenish its reserves. Then the credit scheme will be elastic. 

 Then loaning may be continued. There niaj: be depressions, string- 

 encies, high money rates, but there will be no panics. 

 An Elastic Cuurkscv 



Elastic currency is an incident to ela,stic credit. The currency 

 by which exchanges in this country are effected is made up very 

 largely of checks and drafts. This check or deposit currency, rep- 

 resented in exchange by the usual credit instruments, is the currency 

 of commerce. Where does this currency come from? IIow does it 

 originate? Obvious as its origin seems, there is still apparent a 

 irroat misunderstanding of bank deposits and how they are created. 

 (Jcncrally speaking, bank discounts and bank deposits are intimately 

 related, niscounts and deposits will .always be found rising and 

 falling together. Discounts create deposits. Discounts or loans rise 

 or fall with the commercial demand for credit. 



This check or deposit currency corresponds not with comparative 

 but with absolute exactness to the demands of business. It comes into 

 existence when business needs it, and it goes out of existence when 

 its work is done. It is perfectly clastic. The only defect in it comes 

 from the rigid reserve system which jilaces a limitation on loaning 

 and so limits the amount of deposit currency that can be created. 

 The new law revises the reserve system. It provides a rediscount 

 market, or opens the way for the creation of what is known abroad 

 ns n bill market. 



Limits to Elastic Ckkdit 



Under the new scheme the deposit currency will do its work more 

 efljeienfly. A bank with convertible assets can always get them redis- 

 counted and so continue loaning, and the creation of deposits may be 

 continued, which is all that is necessary for the creation of a currency 

 which answers ninety-eight per cent of the needs of the trade. 



Of course there are limitations and restrictions against^such infla- 

 tion, and inflation of credit is more dangerous than inflation of 

 currency, because it is more subtle and insidious. The limitations are 

 in capital supplies, in gold reserve requirements, and. most of all, 

 in the good .judgment and sound sense of bankers. 



To return to the currency question, it is obvious that there is need 



of credit by commercial paper, and commercial paper is the best of a note currency to suiiplement the system of which the check or 



security anv bank can have. The reason is simple. Back of this deposit currency is the chief component. There is demand for a 



wealth is not only the power of the community to pay, but the neces- form of currency generally acceptable and susceptible of passage from 



sitv of the community to consume. Whatever happens, whatever the hand to hand without question. Now, if this currency is to work 



condition of the people as the result of stress, war, famine, fire. properly, if it is to be elastic, if it is to correspond in quantity with 



flood or disaster thev must, and do go on eating, they must wear business demands, it should come into existence in response to the 



