Readings in Money and Banking / Selected and Adapted

by Chester Arthur Phillips

From the point of view of cover, the gold certificate is completely inelastic. It stands at one extreme of our currency, with a dollar of gold set aside behind each dollar of paper. At the other extreme stands the national-bank note, with only 5 cents of gold set aside behind each dollar of paper. The assets of the issuing bank make it good, but its elasticity is nullified by the requirement that it must be secured dollar for dollar by government bonds.

Between these two extremes the Federal Reserve note, a new form of currency, has been introduced. For each dollar of this paper there is set aside from 40 cents to $1 of gold. As in the case of the national-bank note, the obligation of the United States and the assets of the issuing bank secure it.

The process in which this and other Federal Reserve Banks have been engaged is the substitution, as a circulating medium, of a note which is elastic in quality for the inelastic gold certificate. Gold is the most uneconomical medium of hand-to-hand circulation since, when held in bank reserves, it will support a volume of credit equal to four or five times its own volume. What the reserve bank does in accumulating gold behind its Federal Reserve notes is to establish with the holder of each note a credit which may be availed of whenever the occasion requires. With this credit established it can convert at will its gold-covered notes into notes covered partly by gold and partly by commercial paper. In times when credit is becoming strained and bank reserves need strengthening or when gold must be exported, this conversion will take place, and after the strain is over the gold cover will be restored through the repayment of the rediscounts substituted for it. In this way elasticity of quality in our currency is obtainable. But it should not be construed as in any way a deterioration of the currency contemplated by the act. Quite the reverse is true. The act provides for the issue of Federal Reserve notes in unlimited amounts, with 40 cents of gold behind each dollar of paper. This is elasticity of quantity and it becomes operative with the minimum of gold cover. Elasticity of quality, on the other hand, operates with a gold cover always above the 40 per cent. minimum and ranging as high as 100 per cent.

In order to be prepared for any currency demands which might be made upon it, the Federal Reserve Bank of New York in the spring of 1915 adopted the policy of having printed and keeping constantly on hand a supply of Federal Reserve notes substantially in excess of the amount of emergency currency which, experience shows, this district might be called upon to supply. The maintenance of this policy and of the policy of issuing Federal Reserve notes freely has entailed a heavy cost upon this bank. Unissued Federal Reserve notes are carried at cost on the books of the bank, and at the end of each month the amount of notes issued to the bank during the month is charged off at cost. The shipment of notes unfit for circulation to the Comptroller of the Currency at Washington for cancellation and destruction is a further item of expense in connection with the maintenance of these policies. The directors and officers of the bank, however, feel that the results accomplished amply justify the expense incurred, and consider that the added strength furnished the bank by the gold thus accumulated is perhaps the most important result of the operations of the period.

Some reduction has already been made in the cost of printing Federal Reserve notes, and it is to be hoped that further experience and study will enable other substantial reductions to be made in the cost of preparing for issue what has already become an important element of the circulating medium of the country. The act provides that all expenses in connection with the issue and redemption of Federal Reserve notes shall be borne by the Federal Reserve Banks, and in view of the service the banks are performing in accumulating gold through the medium of these notes, the feeling is quite general among their officers that the notes should be furnished to them at the lowest possible cost consistent with the high quality of workmanship required.

The design of the notes is not altogether satisfactory for efficient handling. In sorting notes it is necessary to be able readily to distinguish between notes of this bank and notes of other reserve banks. This would be greatly facilitated if the printing of the distinctive number and letter of each bank were made more general on the face of the note.

The Financial Policy of the Federal Reserve Banks[302]

It seems clear that the cardinal principle in the management of the Federal Reserve Banks will be to disregard the course which will lead to maximum profits, following instead the path which will lead to the greatest safety and which will permit these banks to be of the greatest service to the nation. Large reserves should be maintained, and these should consist chiefly of gold. The payment of interest upon bankers' deposits and government deposits should be avoided, if possible, for the reason that the payment of interest will force the keeping of smaller reserves, if the cumulative dividend is to be earned. The banks should be managed, not from the standpoint of profit, but from the standpoint of safety.

Yet this is but one side of the policy of the Federal Reserve Banks. Their power and influence can be made to extend much farther than would result solely from the wise management of their own affairs. These banks are the financial trustees of the nation. The country will look to them to see that they exercise over the member banks a closer supervision and discipline than has been possible in the past. Supplementing a negative control by the bank examiners, who are powerless so long as the letter of the law is observed, the federal reserve banks will be a great positive force. The Federal Reserve Banks, with the approval of the Federal Reserve Agent or the Federal Reserve Board, may conduct examinations of a member bank, both for the purpose of ascertaining its condition, and, what will be of equal importance, for the purpose of determining the lines of credit which are being extended by it.

In the long run, the greatest work which the Federal Reserve Banks can do for the business men of this country is to improve and standardize the methods of commercial borrowing. I believe it is possible for these banks, with the approval of the Federal Reserve Board, under the power just quoted, to establish a comprehensive credit information clearing service through which the aggregate loans of all large borrowers can be known by any bank official and through which excessive borrowing or the lending of money to concerns pursuing unwise financial policies can be checked before disaster overtakes them. This is one of the greatest needs of our banking system....