§ 4. #Federal reserve notes#. In 1914 there were outstanding about $750,000,000 of what we may now call the old-style bank notes (bond-secured). These were by the new act not forcibly retired at once; but, as the law is shaped, they probably will be retired at the rate of about $25,000,000 a year, and will all disappear from circulation in thirty years.[5]
Whenever the banks having old-style bank notes outstanding desire to retire any of their circulating notes, the Federal reserve banks are required[6] to purchase the bonds in due quota (not to exceed $25,000,000 in any one year). On the deposit of these bonds with the Treasurer of the United States, the Federal reserve banks may receive other circulating notes (essentially of the old style) called Federal reserve bank notes, or may receive 3 per cent bonds not bearing the circulating privilege.
The new kind of notes provided by the act are called Federal reserve notes. They are not secured by the deposit of government bonds, but they are secured beyond all question in other ways. First, they are obligations of the United States receivable for all taxes, customs, and other public dues, and are redeemable in gold on demand at the Treasury of the United States. Secondly they are receivable by all member banks in the twelve districts and by all Federal reserve banks, and redeemable by the latter in gold or lawful money (which includes greenbacks and gold and silver certificates). Thirdly, their credit and prompt redemption is insured by certain elastic rules as to reserves in gold which must be kept for the redemption of outstanding notes. Fourthly, they are secured by collateral, consisting of notes and bills accepted for rediscount from member banks, which must be deposited by a Federal reserve bank with the Federal reserve agent of its district, dollar for dollar for every note it receives. Fifthly, the notes become "a first and paramount lien on all the assets of the bank." This is what gives the notes their character of asset currency. It is evident that the notes unite in a manner without example the characteristic of asset bank notes with the characteristics of political paper money.[7]
No notes, it will be observed, are issued by or on request of the member banks, but only on request of a Federal reserve bank. After the notes have been issued, the bank may reduce its liability any day by depositing lawful money with the Federal reserve agent who is right there in the bank. The Federal reserve banks and the United States Treasury must promptly return to the banks through which they were issued all notes as fast as they are received, and "no Federal reserve bank shall pay out notes issued through another on penalty of a tax of ten per centum." The regulations do not apply to the member banks, but their effect must be to keep notes from circulating long in any district except that for which they were issued.
§ 5. #Reserves against Federal reserve notes.# The rule applying in normal times to reserves against note issues is that each bank must provide a reserve in gold equal to 40 per cent "against the Federal reserve notes in actual circulation, and not offset by gold or lawful money deposited with the Federal reserve agent." At least 5 per cent is to be on deposit in the Treasury of the United States. The proportion of reserves to the liability for note issues by any bank, however, may be allowed to fall below 40 per cent, on condition that the Federal Reserve Board shall establish a graduated tax of not more than 1 per cent per annum (it evidently might be made less if the board chose) upon such deficiency, until the reserves fall to 32-1/2 per cent and thereafter a graduated tax of not less than 1-1/2 per cent on each additional 2-1/2 per cent deficiency or fraction thereof.[8]
This tax must be paid by the reserve bank, but it must add an amount equal to the tax to the rates of interest and discount charged to member banks. The effect of these rules is to give a power of note issue in time of emergency without compelling the reserve banks to lock up their reserves held against notes. Suppose for example that the circulating notes were in normal times $1,000,000,000 and the reserves, therefore, were $400,000,000 and the rate of discount 5 per cent. Then the circulation might be doubled with the same reserves, the proportion thus falling to 20 per cent of outstanding notes, and the rate of discount to customers rising to 13.5 per cent (5 plus 8.5). Or, to take a most extreme supposition, suppose that the withdrawal of gold had been so great as to reduce the reserves against notes to $50,000,000; yet outstanding notes might be doubled (becoming $2,000,000,000,) the proportion falling to 2.5 per cent, the rate of discount rising to 24 (5 plus 19).
§ 6. #Reserves against Federal reserve bank deposits.# Every Federal reserve bank shall, under normal conditions, maintain reserves in lawful money of not less than 35 per cent against its deposits. But the Federal Reserve Board may suspend any reserve requirement in the Act for a period not exceeding 30 days and from time to time renew the suspension for periods not exceeding 15 days; but in that case it must establish a graduated tax upon the amounts by which the reserve requirements may be permitted to fall below the levels specified as to note issues. Altho the amount of the tax on the deficiency of reserves against deposits is not indicated in the act (as it is in respect to excess note issues) it is plainly the thought that the Board, to which discretion is left, will follow somewhat the same rule in both cases. The great discretionary power as to reserve requirements thus lodged in the hands of the Board makes possible at times of emergency the use of the reserves both of the reserve banks and of the member banks, down to the last dollar, if need be, without violation of law. This gives practically unlimited opportunity to expand credit both by the issue of bank notes and by discount and deposit in periods of financial crises.
§ 7. #Reserves in member banks.# A fundamental change is made in the rules as to the reserves against deposits that must be maintained by the member banks. A new distinction is made between time and demand deposits. Time deposits are defined as those payable after thirty days or subject to not less than thirty days' notice; and demand deposits as those payable within thirty days. In every case the reserve requirement against time deposits is only 5 per cent. This gives encouragement to banks to maintain savings departments.
The requirements as to reserves against demand deposits are not uniform, being the lowest for banks in smaller cities (the great majority), larger for banks in the reserve cities, and largest for banks in the three central reserve cities (New York, Chicago, St. Louis). The act substitutes the new Federal reserve banks for the banks in reserve and central reserve cities as the depositories of funds that may[9] be counted as a part of the reserves of member banks. The new rule requires that one-third must be in the bank's own possession, a fraction slightly over a third must be in the Federal reserve bank, and the remainder may be kept in either place. This may be tabulated as follows:
Not in In reserve In central reserve cities cities reserve cities