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.
We come, finally, to the third need which emergency elasticity is supposed to meet, that is, a prompt and great contraction of the circulation when the panic has passed and the inevitable business depression consequent upon such a panic has set in. Here, again, though not in the same degree as in the last case, if the new law proves as successful as many conservative students expect, the need in question will be little, if at all, experienced. We shall usually escape the extreme business inflation of the antepanic period; the panic itself will be much abated, if not completely eliminated; and, in consequence, the trade reaction which naturally follows a panic will be much diminished in intensity. If this turns out to be true, the circulation will never again show such an extraordinary glut as characterized the winter of 1893-94. Nevertheless, it can hardly be doubted that, after even an incipient panic, there will be some reaction, and consequently a more or less plethoric condition of the currency will follow. Will the new issue have sufficient contractility to meet this need? Earlier in this paper we have seen that the conditions attached to the new issue are in general not favorable to contractility, in that they do not provide for either the prompt driving home or the prompt drawing home of the notes when the necessity for their issue is past. Outsiders lack adequate motives for sending the notes home; issuers lack adequate motives for calling them home. The case for emergency contractility, however, is somewhat better than the case for ordinary contractility. First, it is probable that the homing power of the note will prove greater at such a time than in an ordinary year, for, at such a time, outside banks will not be able to find investments for their funds, since speculative trading will disappear altogether and business generally will be at a very low ebb. Again, it seems certain that the issuing bank will, in this case, have more than the usual motive for bringing about a contraction of the circulation. The chief reason why such a bank may not be eager in ordinary times to hasten the retirement of its notes is the fact that, provided the notes do not accumulate in its own vaults, such a bank will gain more by using the funds in its possession to make loans than it would by using them to retire notes, assuming that the interest charge made by the Federal Reserve Board is not placed excessively high. But it is practically certain that, in the depression which follows a panic, no reserve bank will have opportunities for keeping all of its funds busy; and since, in that case, the interest charge, however small, will be a dead loss, the bank will have adequate motive for effecting, as promptly as possible, an adequate contraction of its note liabilities. This motive would be still further strengthened should the glut prove sufficient to cause a decided drain of gold, since, in that case, the reserve banks will find difficulty in maintaining the required 40 per cent. reserve. On the whole, then, we seem warranted in affirming that, as respects emergency elasticity, the new notes will give no serious disappointment.
Finally, as respects elasticity in general, though the note issue, viewed by itself, does not seem quite fitted to satisfy the tests which an old-fashioned advocate of elasticity is inclined to impose upon it, yet, when we take the new law as a whole, it seems not unreasonable to affirm that it promises to accomplish, directly or indirectly, most of the ends which we had hoped to attain through elasticity and hence promises to give us a system which in essentials is truly and adequately elastic.
Notes Printed and Issued
[300]During the year 1915 the circulation of Federal Reserve notes has increased to $188,817,000 as of December 31, 1915. Believing that the country should be prepared against any contingency, the Board had authorized the printing of about $700,000,000 of these notes. Almost one-quarter of the total supply printed has been placed in circulation. On December 31, 1915, however, only $16,675,000 of notes secured by commercial paper pledged with the Federal Reserve Agents was outstanding as an obligation of the Federal Reserve Banks. The liability of the Federal Reserve Banks as to the remainder has been discharged by the deposit with the Federal Reserve Agents of a like amount of gold and lawful money. This result has been achieved by the Federal Reserve Banks in responding to requirements, for currency by issuing Federal Reserve notes rather than by parting with gold. While the gold pledged with the Federal Reserve Agents represents a very valuable protection in case of a substantial demand for gold, it must be observed that the process is expensive without, at the same time, giving to the Federal Reserve Banks that additional strength and lending power which they would secure in case the law were amended so that the Federal Reserve Banks would remain liable for the outstanding notes, but, on the other hand, would retain property title to the gold delivered to the federal reserve agents, which, in that case, would not be paid in to extinguish the liability upon the notes but would be deposited as collateral security against them.
Impounding Gold
[301]On November 16, 1914, the first shipment of Federal Reserve notes was received by the Federal Reserve Agent [of the Federal Reserve Bank of New York] from the Comptroller of the Currency. On November 19 the bank pledged with the Federal Reserve Agent $500,000 of commercial paper rediscounted by member banks and received from him a similar amount of Federal Reserve Notes. These notes were not required by the banks which made the rediscounts, as they had already withdrawn by checks the credits so established. They were taken by this bank for its general use. The issue of Federal Reserve notes gave the reserve bank the opportunity of affording to its member banks complete interchangeability between book and note credits. The bank therefore established the policy of issuing Federal Reserve notes freely to any member bank desiring them whether the credit thus withdrawn was established by it through rediscounting, or the deposit of checks, or the deposit of gold or lawful money. In practice, however, most credits withdrawn by notes have been established by the deposit of checks which have been collected by this bank in gold or lawful money through the clearing house. Accordingly, the accumulation of cover in the hands of the Federal Reserve Agent has been mainly gold, with but a small amount of rediscounts. The processes provided by the act for the issue of Federal Reserve notes to the reserve bank permit complete interchangeability between gold and rediscounts held by the agent. Gold may be substituted for rediscounts and rediscounts for gold, in accordance with the requirements of the reserve bank. During the entire period its requirements have been for notes with which it might exercise its statutory right to "exchange federal reserve notes for gold, gold coin, or gold certificates."
The policy of the Federal Reserve Bank has resulted in greatly strengthening its gold position and its ability to assist its member banks or other Federal Reserve Banks should they at any future time seek credit in order to withdraw gold for domestic or foreign uses. Through this policy also it has been able potentially, at least, to retard the expansion of credit by impounding in the hands of the agent a large volume of gold which might otherwise have found its way into bank reserves already superabundant.
Furthermore, through this policy it has been able to take the first step toward accomplishing one of the purposes of the act set forth in its title, e. g., "to furnish an elastic currency." There are two forms of elasticity, one of quantity and the other of quality, both provided for in the act.