Readings in Money and Banking / Selected and Adapted

by Chester Arthur Phillips

In another way it was deemed desirable that the Federal Reserve Board should help to facilitate the restoration of customary conditions in the financial market. Almost immediately after the outbreak of war it was seen that, unless hostilities should terminate within a very much shorter period than anyone thought likely, serious injury would be inflicted upon the cotton-producing states. As is well known, the cotton crop is largely grown for export, about two-thirds of the total production of the United States being annually sold abroad. It happened that an unusually large crop had been planted and was approaching maturity at the moment of the outbreak of the war. This would in any event have depressed prices of cotton, even under ordinary conditions. The almost immediate closing of the cotton exchanges of the country was, however, precipitated by reason of the interruption to the movement of cotton and the general understanding that, in view of the great area involved in the hostilities, it would not be reasonable to expect a normal demand for the staple to manifest itself. With the exchanges closed, and with shipments of cotton interrupted, the price was unstable and abnormally low, many sales undoubtedly having occurred at five cents per pound. Inasmuch as the cotton crop is raised very largely upon credit, it was necessary to provide some means whereby the Southern planter could be assisted to such extension of accommodation as he might require in meeting the obligations he would ordinarily have provided for by the sale of his crop in the open market. Various suggestions were brought to the attention of the Federal Reserve Board, one of them being that of Mr. Festus J. Wade of St. Louis, who suggested, both to the Board and to the Secretary of the Treasury, the establishment of a cotton loan fund somewhat similar in purpose and management to the gold exchange fund. After very anxious consideration, the conclusion was reached that some measure of the sort would probably furnish relief to cotton-growers. Various conferences were held with banking interests for the purpose of securing their co-operation and advice in regard to the matter. Ultimately the bankers of New York pledged fifty million dollars in subscriptions to the fund, provided that fifty millions more should be raised from other bankers in non-cotton-producing states. It was understood that to the one hundred million dollars thus raised should be added thirty-five million dollars contributed by the bankers of the cotton-producing states under a special plan devised for that purpose.[314]

IV

It was not, however, through any of these artificial means that real relief was brought to the community. While bankers were laboring to perfect the gold fund, and while the negotiations with Great Britain were in progress, foreign trade was being re-established through the effective policing of the North Atlantic, the re-establishment of demands, and the resumption of the ordinary course of business. What took place during the months of August and September can be understood from ... comparative figures for importation and exportation which make an impressive showing of the suffering to which the United States was subjected through this decline in business. With the opening of October there came, however, a decided improvement. Time had now been given for the establishment of normal conditions....

V

With foreign trade in a fair way to recover, it was still necessary to secure a restoration of normal trade conditions within the United States, and for this purpose the thing most fundamentally necessary was the setting in motion of the federal reserve banking system which had been provided for by act of Congress the 23d of December preceding. The time intervening between December 23, 1913, and the opening of the war had been occupied in carrying out the preliminaries of organization; but it still remained for the Federal Reserve Board, the controlling mechanism of the new system, to appoint officers and to provide for the active operation of the banks under its direction. The first detail to which the Board necessarily addressed itself was the completion of the boards of directors of the several institutions, it being necessary to select and elect three in each institution, or thirty-six in all. The task required an elaborate process of comparison of the names and qualifications of the several candidates and was not completed until early in October. With the announcement of the thirty-six directors, it was possible to proceed to the active opening of the institutions. The Board called for the first payment of capital stock on November 2, and the Secretary of the Treasury, who by law had been vested with that function, named November 16 as the actual date for opening....

The establishment of the system ... greatly relieved the banking situation.... Sec. 19 of the Federal Reserve Act provided for a readjustment of reserves upon a new and lower basis....

This readjustment, by the terms of the law, took effect immediately upon the establishment of the new banks, i. e., on November 16. From the outbreak of hostilities in Europe, there had been a difficult reserve situation in most of the financial centers, New York banks particularly being much of the time largely under their reserve requirements because of the heavy drafts made upon them by interior banks and by the public. The change in reserve requirements, however, made a very material alteration in this condition of affairs, and released, not only in New York, but throughout the country, a very considerable amount of funds which had previously been held by the banks in order to bring themselves within the requirements of law. Precisely what amount of reserves was thus released throughout the country has not been accurately estimated, and probably cannot be. It is, however, an undoubted fact that the release of actual cash was very large, and that the release of lending power as computed on the basis of reserves on the part of member banks was correspondingly larger. Member banks were thereby enabled to extend loans to their customers very much more freely than they had previously been able to do, while at the same time they were able to grant lower rates of interest in due proportion. The prevailing rate of discount for prime commercial paper in New York at the beginning of November was about 6 per cent., while other paper was considerably higher than that figure, and even more difficult conditions prevailed elsewhere. The opening of the reserve system enabled New York banks, because of the very great relief given to them through the release of reserves, to reduce this rate largely, and within two weeks after the new banks had come into existence prevailing interest rates for the best paper went as low as 3-1/2 per cent. and 4 per cent. while acceptances, which had been provided for by the Federal Reserve Act, were marketed at a still lower rate. In some parts of the South, Northern bankers were able to grant accommodation as low as 4 per cent. and in considerable amounts. In view of the greater ease and material relief which was thus accorded, the federal reserve banks were naturally not called upon to assist member banks with accommodation, such banks naturally refraining from asking aid when they themselves were fully able to meet the situation.

The opening of the reserve banks released, as already shown, a large amount of bank funds, and thereby rendered it possible to extend many loans which otherwise could not have been carried by the banks. It was also seen, soon after November 16, that the existence of the cotton fund, as was the case with the gold fund, had done its work by stimulating confidence and by leading to a more liberal extension of credit. With the cotton fund available for long-time loans, and with short-term credit much more freely extended by member banks in view of the reduction of national bank reserve requirements, it was possible for the reserve banks to open with full confidence that the work thus done in safeguarding the situation would relieve them from undue strain, while fully protecting the cotton-producers who were willing to pay a moderate rate of interest in order to carry their cotton until such time as would enable them to realize full market value for it.

As has been shown by the Secretary of the Treasury in his annual report,[315] an early phenomenon of the war was the issue by clearing-houses in many cities of clearing-house certificates. Simultaneously therewith large quantities of emergency currency were issued under the provisions of the act of 1908, which had been amended and extended by the Federal Reserve Act, and which were still further amended by Congress on August 4, so as to permit the freer issue of notes.... The total amount of the emergency currency taken out by associations had aggregated about three hundred and eighty million dollars, but it is probable that the clearing-house certificates were issued to a considerably larger sum. The channels of circulation were thus clogged long before the end of the summer, notwithstanding the fact that large quantities of gold and gold certificates were withdrawn and hoarded either by banks or by individuals. This condition of affairs made it certain that the reserve banks, upon their organization, would not be instantly pressed for the issue of reserve notes. Two factors combined to produce this result—the circumstance that many banks had placed their best paper with the national currency associations in order to protect emergency currency, and the further circumstance that the tax on this currency at the lower rate established by Congress would not, for some considerable time, be likely to approximate the rate of discount which every bank would have to pay to federal reserve banks in order to get the rediscounts that would enable them to obtain the notes they needed. Combined with these factors was, of course, the natural inertia which in all such cases tends to prevent the withdrawal of one kind of currency and the issue of another. Upon the organization of the federal reserve banks, moreover, the urgent pressure for note accommodation passed away as quickly as it had come. Gold reappeared in circulation at an early date, and the retirement both of the clearing-house certificates and of the emergency currency was undertaken. In those cities where rates of interest on clearing-house certificates were very high, the reserve banks aided in the retirement of the certificates remaining in circulation.