back to top THE FEDERAL RESERVE SYSTEM: ­­ Its Purposes and Functions

UNITED STATES OF AMERICA

WASHINGTON: 1939 Foreword This book is intended primarily for students, bankers, business men, and others who desire an authoritative statement of the purposes and functions of the Federal Reserve System. It is neither a primer, nor is it an exhaustive treatise. The aim has been to have it cover the middle ground between those extremes and to make it clear and readable without neglect of essentials. The Federal Reserve System is 25 years old this year. Its operations have become a factor of greatest importance in American economic life. While they chiefly concern banks and the Government, their effects extend into all forms of economic activity and are felt indirectly by everyone. It is desirable, therefore, that the Federal Reserve System be as fully understood as possible by the public in whose interest it was established and in whose interest it is administered. [2] The text of the book has been prepared by Bray Hammond and the staff of the Board of Governors of the Federal Reserve System. The Board of Governors of

The Federal Reserve System Washington, D.C.

May 1, 1939. back to top CHAPTER I A General Outline of the Federal Reserve System The Federal Reserve System comprises the Board of Governors, the Federal Open Market Committee, the Federal Advisory Council, and the member banks; the System's functions lie in the field of money, credit, and banking. The Federal Reserve System was organized in 1914. As now constituted, the System comprises the following: The Board of Governors. The twelve Reserve Banks. The Federal Open Market Committee. The Federal Advisory Council. The member banks (14,537). Responsibility for the Federal Reserve policy and decisions rests on the first three of the above. In some matters the law puts primary responsibility on the Board, in some on the Reserve Banks, and in some on the Committee, though in practice there is close coordination of action. Accordingly, for the sake of simplicity, the term "Federal Reserve authorities" is frequently used when it is unnecessary to indicate which of the three is responsible for action or to what extent the responsibility is shared. 1. The Board of Governors is composed of seven members. Their appointments are made by the President of the United States and confirmed by the Senate. Members are appointed for terms of fourteen years, so arranged that one term expires every two years. The Board's responsibilities lie in the field of money and banking. Their object in a broad sense is to maintain sound banking conditions and an adequate supply of credit at reasonable cost for use in commerce, industry, and agriculture. The Board supervises the operations of the twelve Federal Reserve Banks. Its offices are in Washington, D.C. 2. Each Federal Reserve Bank serves a district comprising several states or parts of states. The Federal Reserve districts, and the location of the Federal Reserve Banks and their branches are shown on preceding map. [not available -ed.] They are as follows: back to top CHAPTER II The Service Functions of the Federal Reserve Banks The twelve Federal Reserve Banks hold the legal reserves of member banks, furnish currency for circulation, facilitate the collection and clearance of checks, exercise supervisory duties with respect to member banks, and are fiscal agents of the United States Government. One of the primary functions of the Federal Reserve Banks is to hold the legal reserves of member banks. The member banks do not normally let these reserves lie idle awaiting an emergency but keep them in active use. This usually entails a heavy amount of continuous work for the Federal Reserve Banks: furnishing the member banks coin and paper money of all denominations; receiving and sorting deposits of currency; and receiving, sorting, collecting and clearing checks. Furnishing Currency for Circulation On December 31, 1938, the amount of United States money in circulation ­­ that is, the amount of currency outside the vaults of the Treasury and the Federal Reserve Banks ­­ was $6,856,000,000. It was made up of the following classes: back to top CHAPTER III The Function of Bank Reserves [13] The amount of reserves held in relation to legal requirements is a controlling factor in the lending policy of banks. The aggregate deposits in the banking system represent mainly funds lent by banks or paid by banks for securities, mortgages, and other forms of investment obligations. It may seem that it ought to be the other way around ­­ that bank loans and investments would be derived from bank deposits instead of bank deposits being derived from loans and investments: and it Is true that deposits would not grow out of loans if currency were used by the public for monetary payments to the exclusion of bank deposits transferable by check. But as it is, the public in general prefers to have its monetary funds ­­ including what it borrows ­­ on deposit in banks rather than in the form of currency in its own possession. The result of this preference is that the proceeds of loans go on deposit to be disbursed by check, and aggregate deposits are increased. Suppose, for example, that a man borrows $1,000 from a bank and took his loan in currency. The bank would have $1,000 less currency than before and in its place a promissory note for $1,000. Its deposits would remain untouched and unchanged. But suppose that the borrower, preferring not to take currency, asked for $1,000 deposit credit instead. In that case the bank's currency would remain unchanged it would have the promissory note and it would have $1,000 more deposits on its books. The loan instead of decreasing the bank's cash holdings would have increased its deposits. Or suppose that the bank purchases a $1,000 Government bond from one of its customers. The customer does not want payment in currency. He wants payment in deposit credit. Accordingly, the bank acquires a $I,000 bond and its deposits increase by $1,000. The bank's currency is not involved in the transaction and remains what it was. [14] It does not follow that bank deposits can be enlarged without limit by increased bank loans and investments. When banks give deposit credit to their customers, they assume an obligation to pay the customers' checks. Consequently, they must have funds on hand for the purpose; though ordinarily the amount need not be more than a fraction of the total deposit liability. How much it must be depends largely on circumstances. But its amount relative to deposit liabilities limits the ability of banks to lend and to invest. The fact that banks can not increase their loans and investments unless adequate funds are available to them makes bank reserves of key importance. Upon the adequacy of reserves hinges the power of banks to expand loans and investments and therewith to expand deposits. Upon reserves also hinges the power of the Federal Reserve authorities to influence the credit policy of the member banks. Bank reserves need to be understood from both the operating and the legal point of view. From the operating point of view, they may be described as that portion of a bank's assets which the bank has not lent or invested but holds in cash or other forms readily available for use. In the early years of banking, reserves consisted of gold and other coin kept by each bank in its own chests; later on, reserves included also the funds which a bank might keep on deposit with another bank ­­ usually with a larger one situated in an important financial center. The more conservative a banker was the larger and more liquid the reserves he was inclined to maintain. Such reserves usually meant a sacrifice of income, but they also meant protection in time of emergency. Although sound banking practice called for the maintenance of adequate reserves, there were banks that failed to observe sound banking practices. Consequently, about a hundred years ago, legislatures began to adopt legal standards, which might require, for example, that a bank's reserves be not less than 10 percent of its note and deposit liabilities. But, while a legal requirement made certain that reserves be maintained, it also might interfere with their availability, since occasions would arise when a bank could not make the necessary use of its reserves without reducing them below the legal minimum. Just at a time when it was especially desirable, in the public interest, for banks to lend, they might be impelled to stop lending in order to avoid depleting the reserves which the law required them to maintain. Accordingly, it became clear after long and painful experience that to require reserves to be maintained in certain volume was not enough ­­ there should also be means whereby banks could obtain additional reserve funds when needed. This need was met by the establishment of the Federal Reserve Banks and the organization of the Federal Reserve System; member banks were required to maintain reserves of a certain volume with the Federal Reserve Banks,and at the same time the Federal Reserve Banks were given power to advance additional reserve funds to them either by lending to them directly or by purchasing securities and other forms of obligations in the open market. Since it became possible under its power for the earning assets of banks to be converted readily into cash and reserve funds, the maintenance of large liquid reserves by individual banks became less necessary. Banks were put in a more secure position than they'd been in when no means existed for enlarging their reserves. In addition, the Federal Reserve authorities were directed to use their power not merely so as to assure ample credit for the legitimate monetary needs of commerce, industry and agriculture, but so as to curb the use of credit in speculation. Under these circumstances, reserve requirements took on a new significance. They became important as a means of giving effectiveness to the regulatory powers to be exercised directly with respect to volume of bank reserves and indirectly with respect to the extension of credit by banks. Reserve Requirements As stated in the Federal Reserve Act, the reserve balance that must be maintained by member banks with their Federal Reserve Banks are as follows: For member banks in central reserve cities (New York City and Chicago), not less than 13 percent of demand deposits (checking account) and 3 percent of their time deposits (including savings). For member banks in reserve cities (sixty other cities of lesser size), not less than 10 percent of their demand deposits and 3 percent of their time deposits. For member banks in reserve cities called "country banks", not less than 7 percent of their demand deposits and 3 percent of their time deposit. The greatest number of banks fall in this third classification, but the total volume of their deposits is smaller than that of either of the other classes. The law permits the foregoing requirements to be changed by the Board of Governors of the Federal Reserve System, "In order to prevent injurious credit expansion and contraction." It limits the possible range however; requirements may not be made lower than those stated in the law nor more than twice as high. The following table shows the reserve requirements that have been in effect at different periods since 1917: back to top CHAPTER IV The Expansion and Contraction of Bank Reserves The ability of member banks to lend is largely dependent upon the volume of their reserves; they are required to keep their reserves on deposit with the Federal Reserve Banks: and the Federal Reserve authorities are empowered to extend Federal Reserve Bank credit for the expansion of these reserves. Therefore, the Federal Reserve authorities, through the medium of bank reserves, are able to influence the extension of member bank credit. There are three prominent factors that, in the absence of operations by the Federal Reserve authorities, may render bank reserves inadequate in amount. One is an increased demand for borrowed funds, which, as banks increase their loans and investments in response to it, result in an expansion of bank deposits without a corresponding expansion of reserves. The second is an increased demand by the public for circulation currency: as the currency is withdrawn, it reduces both the reserves and the deposits of banks by the same amount, but the reduction in reserves is relatively greater than the reduction in deposits, since reserves are smaller than deposits. The third is a drain of gold out of the country, a condition which, like withdrawals of currency, effects a reduction of reserves relatively greater than the reduction it effects in deposits. Payment of federal taxes by the public and purchases by the public of new issues of Government securities also tend temporarily to reduce bank reserves, but these reductions are soon offset when the Government disburses the funds it has received. When any of the factors renders member bank reserves insufficient, an occasion arises for Federal Reserve Bank credit ­­ that is, for funds which the Federal Reserve authorities are empowered to supply for the specific purpose of replenishing or increasing member bank reserves. This need may be confined to relatively few banks or it may affect banks in general. It may be met through loans to individual banks or through open market purchases, depending on prevailing credit conditions and policies. Discounts and Advances for Member Banks The loans which individual member banks may obtain from the Federal Reserve Banks are of two main classes: (1) the discount of so­called eligible paper; and

(2) advances. Eligible paper consists principally of notes, drafts, and bills of exchange used to finance payments for agricultural and industrial products. Such obligations are eligible for discount if their maturates at the time of discount are not more than ninety days in the case of commercial or industrial paper and not more than nine months in the case of agricultural paper. A member bank owning such obligations may transfer them by endorsement to the Federal Reserve Bank, which will credit the proceeds thereof to the member bank's reserves after deducting a discount or interest charge at the established rate. Advances may be made by a Federal Reserve Bank to a member bank on the latter's promissory note secured by collateral. An advance secured of not more than ninety days and in subject to the same discounts or interest charges as eligible paper itself. An advance secured by other collateral satisfactory to the Federal Reserve Bank may have a maturity of not more than four months and is subject to a rate of interest not less than one­half of one percent per annum above the current discount rate on eligible paper. Under the two foregoing provisions a Federal Reserve Bank may supply a member bank with any amount of additional reserves the member bank needs, the only limitation being the amount of good assets the member bank may offer the Federal Reserve Bank as security. Discount Rates Although the discount or interest rate which the Federal Reserve Banks charge their member banks is generally lower than the rate which commercial banks charge their customers, banks do not make it a practice to borrow from the Federal Reserve Banks for the purpose of gaining a profit by lending at a higher rate, nor has it been the policy of the Federal Reserve authorities to encourage borrowing for such purpose. When member banks borrow, it is for the immediate reason that they need to in order to avoid a deficiency in their reserves. The Federal Reserve authorities may raise or lower the discount rate from time to time, accordingly as it seems advisable to impose restraint upon the lending activities of banks or to encourage such activities. During the earlier period of the System's operation ­­ that is, until very recent years ­­ member banks had no excess reserves and in the aggregate were substantially in debt to the Reserve Banks. Under such circumstances, changes in the discount rates, which made this indebtedness either more or less expensive, were the principal instrument by which the Federal Reserve authorities gave effect to credit policy.In recent years, however, banks have had a large volume of excess reserves, there has been little occasion for them to borrow from the Federal Reserve Banks, and the discount rates have not had the importance they formerly had. Since 1934 they have been maintained at a low level. Throughout the entire year, 1938 discount rates on eligible paper were 1 percent at the Federal Reserve Bank of New York,and 1 ½ percent at the other eleven Federal Reserve Banks, whereas inthe 1920'sthey varied from 3 percent to 7 percent at different Federal Reserve Banks at different times. The Federal ReserveBank discount rates are more closely related to the so­called open market rates than to rates on the loans that banks make to their customers. Open market rates include the rates on commercial paper, bankers' acceptances, Treasury bills, stock market call loans, and other forms of obligations that may be bought and sold in the open market or called without regard to the borrowers' convenience. Open market rates are more sensitive to Federal Reserve credit policy or to market developments than are the rates banks charge their customers, because it isopen market paper that banks usually purchase first when they have an excess of funds and dispose of first when they need funds. The relationship between open market rates and Federal Reserve Bank discount rates tends to be close when banks are borrowing and less close when they are not borrowing. Open Market Operations The second method of supplying banks with additional reserve funds is through open market purchases of Government securities and other obligations. These purchases are undertaken at the initiative of the Federal Reserve authorities and not of individual member banks. They do not have particular banks in view, but the aggregate reserves of the banking system as a whole. Securities purchased by the Federal Reserve authorities in the open market come out of the portfolios either of banks themselves or of investors and corporations that are thecustomers of banks. If they come out of the portfolios of investors and corporations, the checks given in payment by the Federal Reserve authorities are deposited by the investors and corporations in their respective banks, and as a result bank deposits are increased. The banks in turn deposit the checks in their accounts at the Federal Reserve Bank, so that bank reserves also are increased. If the securities come out of the portfolios of banks, however, there is no resulting increase in bank deposits, because the funds paid for the securities are received directly by the banks themselves ­­ not through their customers. There is a resulting increase in bank reserves however, for funds received by banks are deposited by them in their reserve accounts at the Federal Reserve Bank. [17] Open market purchases of securities always increase the reserves of banks, therefore, but whether they increase deposits as well depends on whether the securities purchased come out of the portfolios of banks themselves or of bank depositors. To the extent that open market purchases increase bank reserves relative to bank deposits, they tend to furnish member banks a larger basis for credit expansion, because expansion is limited by the excess of reserves over the ratio required by law to be held against deposits. Thus if $100,000,000 of securities purchased by the Federal Reserve authorities came from the portfolios of investors, with the result that bank deposits as well as reserves were increased by that amount, a portion of the reserves ­­ say $20,000,000 ­­ would be required as reserves against the $100,000,000 of new deposits, and only the portion remaining ­­ in this case, $80,000,000 ­­ would be available for credit expansion. If, however, the $100,000,000 of securities came from the portfolios of the banks themselves, the whole amount, when received by the banks and added to their reserves would be available as a basis for credit expansion. The funds paid for securities by the Federal Reserve authorities do not necessarily remain with the banks that happen to receive them first. Demand will determine to what particular banks the funds will go, in what volume, or how long they'll stay with certain banks before being transferred to others. No matter what bank happens at any time to have possession of the funds, however, they continue to be a part of the aggregate reserves of the banking system as a whole. The reverse of the process described in preceding paragraphs occur when the Federal Reserve authorities sell, rather than buy securities. If the securities are purchased by investors and corporations ­­ that is by the customers of banks ­­ there will be a reduction not only in bank reserves but also in bank deposits. If they are purchased by banks, the reduction will be in bank reserves only. In either event the reduction in reserves tends to diminish the amount of credit that banks can extend, but a reduction in reserves without a reduction of deposits tends to diminish it more rapidly, because there is no accompanying reduction in the amount or reserves required. Open market operations have different objectives at different times. At times their purpose may be to expand reserves, in which case securities are purchased. At other times their purpose may he to reduce reserves, in which case securities are sold. This (of course) does not mean that open market operations are a mechanical process by which any desired result may be obtained at will. On the contrary their efficacy is dependent upon a variety of conditions. In recent years, with reserves at a high and rising level chiefly because of the gold inflow, but with business recovery still incomplete, the policy of the Federal Reserve authorities has been to maintain the existing portfolio in substantially unchanged volume. This policy has effected the purpose of the Federal Reserve authorities to contribute to the maintenance of monetary conditions that would encourage recovery of commerce, industry, and agriculture. The accompanying chart (Federal Reserve Bank Credit) shows the amount of Federal Reserve Bank credit year by year for the period the Federal Reserve Banks have been in operation. It reflects the fact that in the 1920's Federal Reserve Bank credit was principally in the form of discounts for member banks, whereas in recent years it has been in the form of United States Government securities purchased in the open market.

Federal Reserve Bank Credit and Member Bank Credit Loans and purchases of securities by the Federal Reserve authorities are one of the important sources of member bank reserves; member bank reserves in turn are the basis of member bank credit ­­ that is, of the loans and investments of member banks. And member bank credit is a source of the bank deposits transferable by check wherewith business men and other persons make the bulk of their monetary payments. Member bank reserves function, therefore, as a link between Federal Reserve policyand member bank policy. Thus, for example, when there is an active demand for goods, there is a corresponding need for means of payment wherewith the purchasers may settle their obligations to the sellers. This need is reflected in part in a demand for member Bank credit ­­ that is, they lend the funds ­­ only if they have adequate reserves. Butadditional reserve funds are always available to them in the form of Federal Reserve Bank credit,which they may get either as the proceeds of loans made to them by the Federal Reserve Banks or as proceeds of purchases of securities by the Federal Reserve Banks. In other words, member bank credit is used chiefly in the form of member bank deposits subject to check: Federal Reserve Bank credit is used chiefly in the form of member bank reserves held on deposit with the Reserve Banks, and the volume of member bank reserves ­­ deriving in greater or less degree from Federal Reserve Bank credit ­­ determines the ability of member banks to meet the demands of their borrowers for member Bank credit. It is important to note, however, that Federal Reserve Bank credit and member bank credit are not the equivalent to each other, dollar for dollar. Member bank reserves do not have to be increased by $500,000,000 of Federal Reserve Bank credit in order to make possible an increase of $500,000,000 in member bank credit. The additional Federal Reserve Bank credit needed will be only a fraction of the additional member bank credit to be extended.The explanation of this goes back to the fact that an increase in member bank credit brings about an increase in bank deposits, because the funds that banks customers borrow commonly go on deposit; and the fact that reserves which member banks are required to maintain are only a fraction of their deposits. Suppose that banks were required to maintain reserves of 20 percent and that they had just 20 percent and no more. Then if their deposits were to be increased by $500,000,000 they would have to increase their reserves by but $100,000,000. Accordingly, $100,000,000 of Federal Reserve Bank credit obtained by borrowing or by the sale of securities to the Federal Reserve Bank would increase their reserves sufficiently to enable them to expand their own credit by $500,000,000. Under varying circumstances, depending on what the reserve requirements are at the time and on the character of the deposits, the expansion of deposits may be as much as ten times the expansion of required reserves. In recent Years the possible expansion of deposits would be considerably less than ten times the expansion of reserves. But, however the ratio may vary, the fact remains that when the Federal Reserve authorities have occasion to provide the amount of reserves necessary to facilitate a given expansion of member bank credit and member bank deposits, the amount of Federal Reserve Bank credit that they may need to supply is only a fraction of such expansion. This situation is different when a deficiency of member bank reserves arise from withdrawals of currency by the public for circulation or from shipments of gold abroad Whatever the deficiency, it must be made up in full, and the Federal Reserve authorities may in such circumstances have to supply their member banks with Federal Reserve Bank credit to the whole amount of currency or gold withdrawn. Since the ability of member banks to lend is largely dependent upon the volume of their reserves, since they are required to keep their reserves on deposit with the Federal Reserve Banks, and since the Federal Reserve authorities are empowered to extend Federal Reserve Bank credit for the expansion of those reserves, it follows that the Federal Reserve authorities by the extension of Federal Reserve Bank credit, may influence very considerably the extension of Member bank credit. By enlarging the volume of member bank reserve funds they can make it possible for the latter to direct almost any conceivable volume of demand by borrowers; and by reducing the volume of reserve funds they can apply restraints to an over­extension of member bank credit. Yet, while Federal Reserve authorities have very great powers, they are also very much limited in the exercise of these powers. They can expand member bank reserves and to the extent that they do so, they can subsequently contract reserves. But they have no power to compel an extension of member bank credit. The initiative must be taken by business men and others who wish to borrow. The member banks may extend credit as long as they may have adequate reserves; when their reserves become inadequate, Federal Reserve Bank Credit is available with which to replenish these reserves; to the extent that their enlarged reserves permit, the member banks can expand their loans ­­ as long as there is sufficient demand. Thus, the Federal Reserve Bank credit can not insure a demand for member Bank credit; it can and does insure the availability of ample member bank credit when and if a demand exists. [18] back to top CHAPTER V The Composition of Bank Reserves Federal Reserve Bank credit and gold are the two main sources of bank reserves; checks are the principal means by which reserves are transferred from bank to bank. From the point of view of member banks taken collectively, reserves are derived chiefly from the following sources: Federal Reserve Bank Credit, in the form of loans by the Federal Reserve Banks and purchases by them of bills and securities.

Gold, either produced from domestic sources or received from other countries. From the point of view of the individual banker, the funds with which he currently maintains his reserves are : Checks and other bank currency Although the principal sources of bank reserves are Federal Reserve bank credit and gold, this does not mean that every individual bank, in order to have reserves, must have borrowed from its Federal Reserve Bank or have come into possession of gold. On the contrary, gold may be and actually is the basis of reserves of banks that have not possessed it, and Reserve Bank credit may be and actually is the basis of reserves of banks that have not borrowed. How Reserve Funds Move from Bank to Bank When the Federal Reserve Bank receives a deposit of gold or when it makes a loan or a purchase of securities, and the resulting credits are entered on the reserve accounts of the member banks concerned, the additional reserve funds resulting from the transaction immediately lose their connection with the transaction. They become simply reserve funds, indistinguishable from other reserve funds and transferable to other banks, regardless of how they originated. Like water circulating through connecting chambers, what is introduced at one point mingles with the rest and flows freely throughout the system. Suppose, for example, a gold mining company has produced $100,000 worth of gold, has sold it to the United States Treasury, and has received a check in payment for it from the Treasury. The company deposits the check with the X National Bank, and receives credit for $100,000 in its checking account. The bank then deposits the check with the Federal Reserve Bank and receives credit for $100,000 in its reserve account. The mining company buys equipment, pays salaries, and distributes profits; in the process it issues checks aggregating $100,000 which are deposited by their recipients in other banks. These banks having given their depositors credit for their checks, send them to the Reserve Bank and receive credit for them in their reserve accounts. At the same time the checks are paid out of the reserve balances of the X National Bank. Thereby the reserve funds derived from the original sale of gold become the reserve funds of banks which never heard of the gold. The other banks know then that checks drawn on the X National Bank were deposited by them in the Reserve Bank and that their reserve accounts have been credited accordingly. It is gold imports rather than domestic mining that has produced the great increase in our gold stock since 1933; but gold from whatever source gives rise to bank deposits and bank reserves substantially as just described. 20 The same is true of Reserve Bank credit. If the X National Bank borrows $100,000 at the Reserve Bank or receives funds paid for securities purchased by the Federal Reserve Bank, its reserve account is increased by a corresponding amount. It uses these additional funds incorporated in its reserves to pay checks drawn against it by its customers, and in the process, the funds leave its account and become credited to the reserve accounts of other banks. The fundsare part of the total reserves, dispersed in hundreds of thousands of reserve accounts and constantly circulating in and out of each. No connection remains between them and the particular transaction which called them into being. Although comparatively few banks receive gold and Federal Reserve Bank credit directly, yet all banks are daily receiving checks on one another. About a billion such checks were handled by the Federal Reserve Banks in 1938; no doubt many times that number cleared locally, and through banks in financial centers, never reached a Federal Reserve Bank. But,by whatever means they are cleared, checks deposited in banks other than those on which they are drawn maintain a constant flow of reserve funds from bank to bank. The Flow of Funds and the Volume of Funds Sometimes a banker receives larger check payments from other banks than they received from him. When that is the case, he gains reserves. Sometimes other banks receive more from him than he receives from them. In that case he loses reserves. It is obvious, however that when a check is deposited in the reserve account of one bank and charged to the reserve account of another, the total volume of reserves, taking all banks together, is not increased or decreased at all. One bank loses what another bank gains. But the gold is deposited and the reserve balance of a given bank is increased thereby, there is no corresponding charge to the reserve balance of any other bank, for the gold came either from abroad or out of an American mine. In this case, consequently, not merely the reserve balance of one bank but the total volume of reserves held by all banks taken together is increased. The same is true if the Reserve Bank makes a loan or buys securities; resulting increase in reserves of banks directly affected is not offset by a charge to the reserves of other banks. Instead, total reserves are increased. In both cases, the total remains at the higher level regardless of stream of checks by which funds are transferred from one reserve account to another. It remains at a higher level until any one of these things happens: Federal Reserve sells securities; loans by Federal Reserve are paid; or, currency or gold is withdrawn. When any one of these things occurs, and is not offset by a factor of opposite effect, there occurs a decrease in the aggregate amount of reserves. It comes about because the securities sold by the Reserve Bank are paid for by a charge against the reserves of the bankers by whom or by whose customers the securities were purchased; or because the loans are repaid by a charge against the reserves of the bankers that borrowed; or because the currency account or gold when withdrawn is charged to the reserve account of the bankers by whom it was withdrawn; and because the charges to these reserve balances are not offset by any corresponding credits to other reserve balances. [21] From the individual bank's point of view, therefore, reserves are principally maintained by the depositof checks on other banks; and from the point of view of all banks as a whole, reserves consist fundamentally of Federal Reserve Bank credit and gold. In other words, Federal Reserve Bank credit and gold are the two important basic factors in which bank reserves originate, and checks are the principal means by which reserves come to be transferred and distributed among all banks. Every banker has daily experience of the transfer of reserve funds resulting from check transactions and of his own consequent gain or loss of reserves; but experience of the origination and extinction of reserve funds resulting from gold transactions, open market operations, and Reserve Bank loans, is far less common. Very few banks outside those cities where gold shipments are received or Government obligations are bought and sold in large amounts ever have any direct experience of gold transactions and open market operations; and borrowings from the Reserve Bank, while not common, are never a matter of daily routine as checking transactions are. Other Factors Other factors affect the aggregate volume of bank reserves, but mostly in a minor or transitory way as compared with gold or Federal Reserve Bank credit. Acquisition of silver by the Treasury has the same effect on member bank reserves as the acquisition of gold, but the dollar amount of silver is less than gold. Chief among the transitory factors affecting the aggregate volume of reserves are receipts and expenditures by the United States Treasury. When Federal taxes are paid, the effect is to reduce the reserve balances of banks and to enlarge the cash balances of the Treasury. The same is true when banks use current funds to pay for new Government obligations issued by the Treasury. When the funds are disbursed by the Treasury, the effect is to reduce the Treasury's cash balance, and restore the reserve balances of the banks. The Treasury's transactions are in this way constantly producing large fluctuations which in the long run cancel each other. Similarly, fluctuations in the volume of currency in circulation affect the volume of reserves, but mostly in a temporary way. Currency on going into circulation is charged to member bank reserves and reduces them, and on retirement from circulation it is credited to reserves again and increases them. While these factors are of importance in explaining current fluctuations in the volume of reserves, they do not alter the fact that the basic constituents of reserves are gold and Federal Reserve Bank credit. The Relation Between Federal Reserve Bank Credit and Gold Before the Federal Reserve Banks were established, the basic reserves of the banking system consisted almost exclusively of gold, silver, and currency. There was no Federal Receive Bank credit, nor any institution whose purpose it was to supply additional reserve funds. Banks could borrow from one another, but that meant merely the use of existing reserve funds, not the creation of new ones. Moreover, with banks holding one another's reserves and advancing reserves to one another, the aggregate bank reserves shown on the books of banks always included duplication and exceeded the amount of gold and other currency that could be counted as reserves. Reserves shown in excess of this amount, however, were fictitious. In times of stringency it always developed that reserves were actually less than they appeared to be. With the establishment of the Federal Reserve Banks these faults were corrected. Existing reserves were transferred to the Federal Reserve Banks and the Reserve Banks were empowered to create additional reserve funds. The result is that the aggregate volume of reserves became a definitely known figure, without duplication; and the Reserve authorities can create the necessary additional funds, either by lending to individual banks or by purchasing securities in the open market. Since the establishment of the twelve Federal Reserve Banks, therefore, bank reserves have consisted basically of gold, the amount of which is not readily subject to control, and the Reserve Bank credit, the amount of which is wholly subject to control. Neither is fixed either in amount or in relation to the other. At times Reserve Bank credit has been a more decisive factor and at times gold. The two tend to displace each other; that is, the more gold there is coming into the country the less need there tends to be for Reserve Bank credit, and the less gold there is coming in or the more gold there is going out the more need there tends to be for Reserve Bank credit.The movement of gold is largely independent of control; although under certain conditions an increase in the volume of Reserve Bank credit may tend to drive gold out of the country by bringing about lower money rates, and a decrease in its volume may tend to draw gold into the country by bringing about higher money rates. If, for example, there were a reversal of the gold movement of recent years, and gold, because of altered international conditions, began to be exported in large volume, the Reserve authorities, by lending or by the purchase of Government securities and other obligations, could furnish funds which would add to member bank reserves as fast as the gold withdrawals subtracted from them. The Reserve authorities could by this action prevent the banks of the country from suffering such a depletion of reserves as would force them to make drastic reductions in their loans and investments. [22] back to top CHAPTER VI Reserves of the Individual Bank and of the Banking System as a Whole Additional reserve funds that enable the individual bank to enlarge its own loans by an almost equal amount, enable the banking system as a whole to enlarge the aggregate of loans by several times as much. Bank deposits result chiefly from loans and other extensions of credit by banks. This does not mean though, that an individual banker can increase his deposits to any desired extent simply by lending. He can not do that, because when his customers borrow they use the money they borrow: they pay it to others by whom most or all of it will be deposited in other banks. The banker has to part with most of what he lends and must be prepared for reduction of his reserves accordingly. When he makes a loan and the funds are credited to the deposit account of the borrower and then checked out, the funds sooner or later leave the bank and go on deposit in another bank.Under the circumstances, his loan increases another bank's deposits. If the other banker is also lending, then the deposits of both will increase still further. Each gets a part of most of what the other lends. So, in fact, the individual banker normally has more money to lend when other bankers are lending than he has when they are not lending. It is only when this process of lending is general and simultaneous on the part of many bankers that it may cause a rapid growth of bank deposits. No one banker has control of such a process. He has no means of making other bankers lend ­­ no means of making customers start borrowing. He has to feel his way, constantly watching the volume of his reserves. Unless his reserves are adequate, he will not wish to lend and run the risk of having them depleted. Accordingly, the requirement that he maintain a certain ratio between his reserves and his deposits is in effect a limitation on his power to lend. Assuming There Were Only One Bank Suppose there were on/v one bank instead of several thousand, and that this one bank did all the commercial banking business in the country. Suppose further that this bank were required by law to have reserves equal to at least 20 percent of its deposits. Thus if it had deposits of $5,000,000,000, its reserve balance with the Reserve Bank would have to be at least $1,000,000,000. Suppose that it had just exactly that ­­ $5,000,000,000 of deposits and $1,000,000,000 of reserves, with $4,000,000,000 of loans and investments. In such case, if it were to lend a simple additional dollar it would reduce its reserves below the legal requirement, because if it did make a loan, the borrower would be given credit for it in his checking account. The bank's deposits would go up, its reserve balance would not go up, and in consequence the reserve balance would be less than 20 percent of the bank's deposits. The borrower, of course, would write a check for the amount he wanted to use, and so his deposit balance would be reduced; but the money would not necessarily leave the bank, or if it did, it would come right back. For if the check were deposited by its recipient it would merely transfer a certain amount of deposit credit from the borrower's account to the recipient's account. Or if it were cashed by the bank, the currency would sooner or later be deposited, and the funds which went out of the bank through one account would come back in through another. The bank's deposits would be increased by the loan in any event, except only if the money were kept in circulation, sent out of the country, or permanently lost, destroyed or hidden. There would be no other bank for it to go to. Realizing that any additional loans it made would increase its deposits out of proportion to its reserves, the commercial bank might stop making the loans.Suppose, however, that the Reserve authorities were of the opinion that more loans might advantageously be made and that the bank should be provided with additional reserves so that it could make them. Suppose they therefore purchased $20,000,000 of securities in the open market. The sellers of the securities would deposit in the commercial bank the money they received in payment. The commercial bank in turn would deposit it in its reserve account at the Reserve Bank. Having these additional reserves of $20,000,000, the commercial bank, by making loans, could increase its deposits to five times as much, or $100,000,000 ­­ the $20,000,000 being the 20 percent reserves required against deposits of $100,000,000. Another possibility is that the commercial bank might borrow the $70,000,000 from the Reserve Bank. But whether the commercial bank took the initiative in borrowing or the Federal Reserve authorities took the initiative in purchasing securities, in either event the sum total of reserve funds would be increased, and lending on an increased scale would be possible. In either event also, the Reserve authorities would not need to advance the full amount that the commercial bank would lend, but only enough to supply the 20 percent reserve required against the increased deposits resulting from its lending. Taking All Banks Together The same principle that would operate if there were only one bank holds true of all banks taken together ­­ the great difference being that effects which are immediately and directly discernible when there is assumed to be only one bank are much more difficult to follow when the explanation is applied individually to the thousands of banks actually in operation. What is true of banks as a whole is not true of every individual bank; there are always exceptions. When bank reserves in the aggregate are in excess of requirements, there nevertheless will be individual banks with no excess reserves; and when, therefore, banks in general are in a position to extend abundant credit, there nevertheless will be individual banks in no such easy condition. In particular, when the sum total of reserve funds is augmented by Federal Reserve or other action the increase will manifest itself first at certain individual banks which happen to be recipients of the additional funds. But no bank can expect to keep permanently what it receives. Its customers are always checking its funds elsewhere. By the normal and active process of clearing the enormous number of checks that are constantly being drawn on one bank and deposited in another ­­ thereby entailing the transfer of funds from the reserve balance of one bank to the reserve balance of another ­­ a rapid movement or circulation of reserve funds is maintained. The result is that an increase in the total volume of reserve funds tends sooner or later to spread itself from the few banks where it originates to many other banks, if not all. Let us assume that the Reserve authorities realize that banks as a whole have insufficient reserves for the expansion of credit that is needed and proceed to buy Government securities in order to supply the money market with additional funds. Suppose as before that they buy $20,000,000 worth and that the entire sum happens to he deposited in some one bank. That particular banks' deposits and reserves will both be increased by $20,000,000. But the bank is not required to have reserves of more than 20 percent, and 20 percent of the increase is $4,000,000. Therefore, $16,000,000 of what the bank receives is excess reserves. It lends the $16,000,000 ­­ assuming it can find borrowers ­­ and the whole amount, let us suppose, is checked out and deposited in a second bank. This second bank with increased deposits of $l6,000,000 against which it is required to keep reserves of only 20 percent, or $3,200,000, gets in consequence excess reserves of $12,800,000. It lends these funds, and they are checked out by the borrowers and deposited in a third bank. The third bank, having to keep reserves of only 20 percent against the increase of $12,800,000 in its deposits, gets excess reserves of $10,240,000 to lend. It lends, and the amount is checked out by the borrowers and deposited in a fourth bank. It is evident that this process could go on till the amounts involved for successive banks were negligibly small. Including six more banks in the illustration, or ten in all, the additional deposits, loans, and reserves made possible by the Federal Reserve Bank's disbursement of $20,000,000 would be as follows: (see following chart). The figures assume, for the sake of simplicity, that every bank is able to find borrowers for the full amount that it can lend and that the full amount of every loan is checked out to some one other bank; that there are no left­overs and that the different banks come into the picture one at a time. They make no allowance for the fact that an individual bank in making loans is not limited to its excess reserves, because it can bring them up to the required level by borrowing from its Reserve Bank. On this basis, the figures show that the first ten banks had additional reserves of $17,852,516, additional loans of $71,410,066, and additional deposits of $89,262,582. Other banks sharing in the remaining portion of the $20,000,000 of additional reserves would increase their loans by $8,589,934 and would have additional deposits of $10,737,418. In the end, accordingly, an expansion of deposits amounting to $100,000,000 would be made possible by the $20,000,000 of additional reserves created by Federal Reserve action. The result would be the same if the banks were to purchase securities instead of making loans. [23]

back to top CHAPTER VII Federal Reserve Powers and Limitations Although Federal Reserve powers are important and extensive, they are nevertheless constantly subject to limitations inherent in the conditions under which they are exercised. The limitations upon the powers of the Federal Reserve authorities are partly statutory and partly practical. Those that are statutory relate primarily to the reserves that the Federal Reserve Banks are required to maintain against their note and deposit liabilities. The circulating notes issued by the Federal Reserve Banks and the reserve deposits maintained with them by member banks are alternative forms of Federal Reserve Bank liability. As of December 31, 1938, Federal Reserve notes in circulation amounted to about $4,500,000,000, and member bank reserve balances on deposit with the Reserve Banks amounted to about $8,700,000,000. When a member bank needs additional Federal Reserve notes, they are obtained from its Federal Reserve Bank, which charges their amount to the member bank's reserve balance. Correspondingly, when a member bank finds that it has more Federal reserve notes on hand than it needs, it may send the notes to the Federal Reserve Bank and have their amount credited to its reserve balance. The Federal Reserve authorities expand the volume either of notes or of reserve balances in response to the demands of the public and of the member banks. Although they may at times take action to reduce the volume of bank reserves, they never need take action to reduce the amount of notes in circulation. Currency in excess of the public's needs is promptly deposited in banks and by them is deposited in the Federal Reserve Banks. The process is spontaneous. In effect, therefore, the amount of money in circulation is governed by the public's action, not by action of the issuing authorities, and no more currency will remain in use than is required. Legal Limitations The Federal Reserve Act stipulates that the Federal Reserve Bank shall have reserves of gold certificates equal to at least 40 percent of the Federal Reserve notes in circulation and reserves comprising gold certificates or lawful money equal to at least 35 percent of their deposits, Taking the figures as of December 31, 1918, this means that the Federal Reserve Banks must have at least $1,800.000,000 in gold certificates as the 40 percent reserve against their Federal Reserve notes of $4,500,000,000, and $3,535,000,000 of gold certificates ­­ assuming they have no other lawful money ­­ as the 35 percent reserve against their $10,100,000,000 of total deposits. That is $5,335,000,000 of gold certificates, taking the two requirements together. Actually, however, the Federal Reserve Banks had $12,000,000,000 in gold certificates, or more than twice the maximum amount required. Notes in circulation and reserve deposits could therefore be more than doubled on the basis of present gold reserves, so far as the law is concerned. And since the Reserve authorities, are empowered to suspend for limited periods the requirements stated in the law, the volume of notes and reserve deposits could be much more than doubled if an emergency should make it necessary. The accompanying chart (Federal Reserve Banks - Reserve Position) shows the volume of Federal Reserve Bank liabilities in the form of deposits and circulating notes during twenty-four years of Reserve System operations. It also shows the ratio of the Reserve Banks' reserves, which at their lowest, during 1920, were about 40 percent of note and deposit liabilities, but in recent years have been about 80 percent.

Practical Limitations The practical limitations on Federal Reserve powers to expand note circulation and reserve deposits can best be understood when Federal Reserve notes and member bank reserves (which are deposits on the books of the Federal Reserve Banks) are considered together with Federal Reserve Bank credit and gold. These four factors are closely interrelated, and no one of them can change without a corresponding change in one or more of the other three. They are the four principal items on the Federal Reserve Banks' statement of condition. Rounding them off and disregarding other items, they may be shown in balance as follows:

back to top CHAPTER VIII Member Bank Reserves and Related Items The principal factors involved in Federal Reserve policy are member bank reserve balances, gold stock, Federal Reserve Bank credit, money in circulation, and Treasury cash and balances. In the four preceding chapters the factors of Federal Reserve policy have been discussed at length. The accompanying chart (Member Bank Reserves and Related Items) shows the movement of the more important of these factors from the early years of the Federal Reserve System to the present. This chart, slightly modified for present purposes, and the chart (Member Bank Reserve Balances) which appears later in this chapter, are regularly published in the Federal Reserve BULLETIN to portray current monetary developments. The chart shows five lines, which may be considered in the following order: Member Bank Reserve Balances

Gold Stock

Reserve Bank Credit

Money in Circulation

Treasury Cash and Deposits From 1918 through 1932 member bank reserve balances in the aggregate never exceeded $2,500,000,000 for more than a few days at a time, and until 1932 and 1933 their total fluctuated relatively little. Since 1933 the amount of these balances has greatly increased, until by the end of 1938 that is ­­ in a period of five years ­­ they were $9,000,000,000, or three times as much as they ever were before the increase began. These reserve balances are a potential base for a credit expansion far in excess of anything this country has ever experienced. Gold and Federal Reserve Bank Credit As explained in preceding chapters, the principal sources of reserve balances are gold and Federal Reserve Bank credit. Which of these is responsible for the remarkable increase in reserve balances since 1933? It is obvious from the chart that it. is gold, the total amount of which has doubled since 1934, while the amount of Reserve Bank credit has remained practically stationary; gold has risen to about $15,000,000,000, while Reserve Bank credit is only $2,500,000,000. Before 1934, however, and prior to the recent large increase in the gold stock, the volume of Federal Reserve Bank credit showed wide fluctuations. It was then a more active factor in the volume of reserves. Before 1932 banks generally had no reserves at the Federal Reserve Banks in excess of what was required, and they frequently found occasion to borrow. At the same time and for the same reason, the Federal Reserve authorities had more occasion to buy and sell securities currently in the open market as a means of increasing and decreasing the volume of reserve funds. When the Reserve Banksincreasedtheir holdings, banks gained reserves and were enabled to pay off their borrowings and extend additional credit; when the Reserve Banksdecreasedtheir holdings, banks lost reserves and were forced to borrow or else curtail their extensions of credit. In 1932 and 1933 the Reserve Banks increased their holdings of United States Government securities, and the funds given in payment for their purchases first enable the member banks to reduce their borrowings and then increased their excess reserves. Since 1933 the rapid inflow of gold shown by the chart has increased member bank reserves much more rapidly than bank credit has been expanded. Consequently, banks have held large amounts of reserves in excess of requirements, and there has been little occasion for them to seek Federal Reserve Bank credit, or for Federal Reserve Bank credit to be expanded by open market operations Money in Circulation, Treasury Cash, and Treasury Balances It will be noted from the chart that at all times the volume of bank reserves has been less than the total of gold and Federal Reserve Bank credit combined. This reflects the fact that gold and Federal Reserve Bank credit are the principal sources not only of bank reserves, but also of money in circulation, which consists principally of Federal Reserve notes. They were also a source of the cash held in the Treasury or deposited by it in its checking account with the Federal Reserve Banks. The amount of these Treasury balances was relatively small until 1934, when it was substantially enlarged by the increased value of the gold stock resulting from revaluation of the dollar. As explained in a preceding chapter, fluctuations in Treasury balances generally represent a temporary rather than a permanent or basic use of funds. When the Treasury collects taxes, it receives the bulk of the payments by check. These checks in effect transfer money from the commercial banks to the Treasury; that is, they enlarge the Treasury's balances at the Federal Reserve Banks and reduce the reserve balances of member banks. The same thing occurs, in effect, when the Treasury borrows. On the other hand, when the Treasury expends the funds it has received, its own balances at the Federal Reserve Banks are reduced and the reserve balances of member banks are increased. Because Treasury receipts and disbursements alternately decrease and increase the reserves of banks, they tend to cancel out; though at any given time they may account for current changes of considerable magnitude in the volume of bank reserves and of Reserve Bank credit. Another factor of potential importance, not shown on the chart, is Treasury currency. This includes coin, silver certificates, and United States notes. When these forms of money go into circulation, they are ordinarily deposited by the Treasury in the Federal Reserve Banks and are paid out by them to member banks as currency is required by the public. Like gold and Federal Reserve Bank credit, they are a source of bank reserves. They are not funds obtained by the Treasury from existing reserves through borrowing or taxation. Accordingly, an increase in the issue of coin, silver certificates, or United States notes will tend to increase bank reserves. [27] Interrelations Between Factors All of the factors shown on the chart are closely and necessarily interrelated. Some of them are not directly subject to control by the Federal Reserve authorities, while others are subject to control in part. Increases and decreases in the volume of gold are relatively uncontrollable. The same is true of money in circulation; whatever the public requires is supplied without delay or interference. Changes in Treasury cash and deposits and in Treasury currency generally reflect fiscal requirements and occasionally monetary policies (e.g., revaluation of gold, gold sterilization, and issuance of silver certificates); at any rate they are not among the factors directly subject to control by the Federal Reserve authorities. This leaves Federal Reserve Bank credit as the one factor that is largely controllable. As explained in the preceding chapter , the fact that it is controllable is the reason for its existence; it can be increased or decreased as a counterweight to changes in the less controllable factors. At the present time, the interplay of the foregoing controllable and uncontrollable factors determines the volume of member bank reserve balances. At any given moment this volume may be affected by the uncontrolled movement of gold, or changes in the amount of money in circulation, or Treasury receipts and disbursements, and by the controlled increase and decrease in the volume of Federal Reserve Bank credit. Bank reserves are not always or necessarily, however, so passive a resultant of other factors as they are under present conditions. At times when member banks have almost no reserves in excess of what they are required to have, as they did before the gold influx of recent years, there will be a greater need for Federal Reserve Bank credit, and member banks will borrow from the Reserve Banks. Under these circumstances changes in the volume of reserves will be a governing cause of changes in the volume of Federal Reserve Bank credit. It will be noted that prior to 1934 there was a very close relation between money in circulation and Reserve Bank credit, seasonal fluctuations in the two lines almost duplicating each other. This reflects the fact that increases in the volume of money in circulation means withdrawal of currency from the Federal Reserve Banks, with a consequent decline in the volume of member bank reserves. Similarly, when currency is retired from circulation, and deposited in the Federal Reserve Banks, it is credited to the reserves balances of member banks and increases them. When the reserve balances represent merely what banks are required to have and there is no excess, the withdrawals of currency for circulation purposes have to be offset by extensions of Federal Reserve Bank credit. A given member bank, for example, that needs $100,000 in currency, but has no reserves, will borrow $100,000 from the Federal Reserve Bank and have the amount credited to its reserve account so that the withdrawals will not reduce its reserves below the required amount. And, correspondingly, as soon as the member bank accumulates sufficient currency, it will deposit what it can spare in the Federal Reserve Bank and pay off its borrowing. Therefore, when banks have only such amounts of reserves as they are required to have ­­ as was generally true before 1934 ­­ increases and decreases in the amount of money in circulation bring about corresponding increases and decreases in the volume of Federal Reserve Bank credit. But when banks have large excess of reserves ­­ as they have had since 1934 ­­ increases and decreases in the amount of money in circulation do not appreciably affect the volume of Federal Reserve Bank credit but only the volume of the excess reserves. A striking feature of the chart (Member Bank Reserve Balances) is the abrupt increase in the gold in 1934. This reflects revaluation of the dollar, by which the price of gold was raised from $20.67 to $35 an ounce. Before this action was taken, all gold already in the country which for the most part was held by the Federal Reserve Bank was turned over to the Treasury. The whole increase in the monetary value of gold went to the United States Government, therefore, and was added to the Treasury's cash balance. Except to the extent that a part of this increment was later expended by the Treasury, the increase in the value of the gold stock had no effect in member bank reserves.

Required and Excess Reserves The preceding chart (Member Bank Reserve Balances) shows reserve balances divided into required reserves and excess reserves. Required reserves are the part of total reserves which banks must keep in proportion to their own deposits, and excess reserves are the part in excess of what is required. Before 1932, banks had almost no excess reserves. They maintained just what they were required to maintain and little more. When they needed larger reserves they used Federal Reserve Bank credit, which was therefore a much more active factor, as already explained, than it is now. [28] back to top CHAPTER IX What the Twelve Federal Reserve Banks Own and What They Owe The central banking functions of the Federal Reserve System are reflected in the balance sheet of the Federal Reserve Banks. The functions described in the preceding chapters are all reflected in the balance sheet of the twelve Federal Reserve Banks, which is made public every Friday and shows the condition of the Reserve Banks as of the Wednesday immediately preceding. It appears in the Friday issue of the principal daily newspapers of the country and is usually accompanied by explanatory comment, particularly as to changes in member bank reserves and related factors.



The statement as of December 31, 1938, in condensed form is as follows, only the most important items being shown separately.

back to top CHAPTER X Federal Reserve Bank Earnings The operations of the Federal Reserve Banks, although not conducted for profit, yield an income which is ordinarily sufficient to cover expenses. The Federal Reserve authorities have special power to curb the use of credit for speculation in securities. The creation of Federal Reserve Bank credit through lending and through purchases of securities incidentally yields an income to the Federal Reserve Banks in the form of interest. Ordinarily this income is adequate to cover the necessary expenses of the Federal Reserve Banks and the Board of Governors and to leave a balance. Around the year 1920, the net earnings of the Federal Reserve Banks were large, to a great extent because of operations in connection with war financing, but since that period they have been relatively small. Some of the Federal Reserve Banks in certain years have operated at a loss. In twenty­four years (1914­1938) the total earnings of the twelve Federal Reserve Banks have amounted to $1,277,000,000. The distribution of these earnings is shown in the accompanying chart (Distribution of Earnings of Federal Reserve Banks, 1914-1938). In round numbers, earnings have been used as follows:

back to top CHAPTER XI Margin Requirements The regulatory powers of the Federal Reserve authorities so far described relate to the volume and cost of bank credit in general, without regard to the particular field of enterprise or economic activity in which the credit is used. In one respect, however, the Federal Reserve authorities are enjoined by law to give particular attention to the use to which credit is put. That is its use in speculation. Speculation may occur in almost any field. It may occur in land, in commodities, or in securities, and wherever it occurs it is apt to have marked effect upon credit conditions in general. The Reserve authorities are instructed by the statute to keep themselves informed as to "whether undue use is being made of bank credit for the speculative carrying of or trading in securities, real estate, or commodities" and are authorized to take certain actions to prevent undue use of credit in these fields. In addition, they have special power to curb the use of credit for speculation in securities. This power is exercised by limiting the amount which holders of securities may borrow upon them, either from banks or from brokers and securities dealers, for the purpose of purchasing or carrying securities. The amount is a percentage of the current market value of the securities. It is determined by the Board of Governors of the Federal Reserve System. Since 1934, when Congress gave the Board this authority, the figure has been as low as 45 percent and as high as 60 percent. A figure of 60 percent means, for example, that a person owning listed stocks currently worth $1,000 may borrow on them for speculative purposes no more than $600. The limitation does not apply, however, to any loan for commercial purposes, even though the loan be secured by stocks. When it appears that there is borrowing on a large and growing scale to finance purchases of stock, and that it is in the public interest to exercise further restraint on speculation in securities, the Board may reduce the percentage which can be borrowed. As indicated, the limit has been as low as 45 percent. In this field, as in the general field of credit regulation, therefore, the Reserve authorities undertake to exercise a stabilizing and corrective influence. This power to establish loan values for securities is commonly spoken of as a power to establish "margin requirements," that is, the amount of collateral which must be put up by the borrower in excess of the amount of his loan. If one is buying $1,000 worth of securities, and the loan value is 60 percent, he may borrow $600 against the securities and must furnish the other $400 himself. The banker or broker who makes him the loan then holds collateral worth $400 in excess of the amount of the loan. This is his margin. The Board's regulation may be thought of therefore, either as prescribing minimum margin requirements or as limiting maximum loan values. The Board's regulation applies to the margin required at the time the loan is made. If the collateral security subsequently declines in value, the regulation does not make it necessary either to put up additional collateral or to reduce the loan. Aside from having to do with a specific use of credit, the authority with respect to security loans differs from other Federal Reserve powers in reaching outside the Federal Reserve System to banks which are not members of the System and to brokers and dealers in securities. It is closely related, however, to other regulatory powers of the Federal Reserve authorities, because the use of credit for purchasing or carrying securities has a very important bearing upon its use for business purposes in general. The greater part of credit used in carrying securities is extended by brokers, whose customers pay only partly in cash for the securities they purchase and go into debt to the broker for the balance. The broker himself must pay in full for the securities he buys, however, and ordinarily he borrows from his bank. Since brokers could not carry customers on any substantial scale unless they were themselves carried by the bank, most of the credit used by the customers in buying the securities is in reality furnished by the banks, and fluctuations in bank loans to brokers, as in any other bank loans, directly affect the bank's reserve position. A strong demand on brokers for credit, reflected in a strong demand by brokers for bank loans, may occasion substantial changes in money rates. By limiting the amount that can be borrowed on securities, therefore, and so restraining such demand for credit, the Federal Reserve authorities are able to impose restrictions on the use of bank funds for stock market speculation without restricting the volume of credit available for commercial and industrial needs or raising its cost. [32] back to top CHAPTER XII Summary The Federal Reserve System has successfully overcome certain difficulties that formerly beset American economic life and imposed upon it great losses; the System still has constantly to meet new problems and difficulties. The basic powers of the Federal Reserve authorities relate to money and banking. They are monetary in that they deal with the means of payment, which consists in part of currency, in part of deposit credit originating from gold, and in part of deposit credit originating in loans and in purchases of securities by banks. Before the Federal Reserve System was organized, the outstanding defects of American banking were diagnosed as "Inelastic currency" and "scattered bank reserves." Establishment of the System promptly cleared the way for the anticipated improvements. Elasticity of the currency was achieved. The machinery for note issue proved adequate for the purpose and in time was found to work almost automatically. For many years now the volume of money in circulation has expanded and contracted smoothly and efficiently in accordance with the varying requirements of the public, and the currency function of the Federal Reserve Banks has become virtually a matter of routine, entailing no uncertainties and no difficult administrative problems. The reserve function, on the other hand, has assumed far greater importance. It has come to be recognized as much more than a matter of "Pooling" or "mobilizing" scattered reserves and making available to banks in need of funds the surplus reserves of banks that have more than they need. It involves a power tocreate reserve funds and toextinguish them. If the funds lent by a Federal Reserve Bank, or paid by it for securities, were merely the funds deposited with it by its member banks, the loans and the purchases would not enlarge the total volume of reserve funds. In fact, however, theydo enlarge the total volume of reserve funds. By acquiring the obligation of a member bank or other obligor and in exchange crediting an equivalent amount to the reserve balance of the member bank, a Federal Reserve Bank expands both its assets and its liabilities, and the expansion continues in effect so long as the obligation is held. The action is creative. This does not mean that the power of the Federal Reserve authorities is unlimited and that they can create something out of nothing. The law itself limits their power to expand their deposits ­­ that is, the reserve balances of member banks ­­ and to expand their note issue by requiring that their liabilities not exceed a certain ratio to their holdings of gold certificates. Although this limitation has lost effectiveness, because of the present large gold stock, a fully effective limitation of more practical nature remains. This is that Federal Reserve action will not result in an increased use of bank credit unless there is a demand from the public for additional funds. The Federal Reserve authorities have considerable control over the volume of bank reserves, but they have no corresponding control over the use of bank reserves, and in particular they do not have power to create a demand for credit. They are able to expand bank reserves to meet almost any conceivable demand for credit once that demand comes into existence and also to curb or discourage a demand for credit when it shows signs of developing speculative excesses. They possess no means, however, of impelling bank customers to borrow or of impelling bankers to lend. The purpose of Federal Reserve functions, like that of Governmental functions in general, is the public good. Federal Reserve policy can not be adequately understood, therefore, merely in terms of how much the Federal Reserve authorities have the power to do and how much they have not the power to do. It must be understood in the light of its objective which is to maintain monetary conditions favorable for an active and sound use of the country's productive facilities, full employment, and a rate of consumption reflecting widely diffused well­being. In carrying out their policy, the Federal Reserve authorities take into account the factors making up the prevailing situation and use their powers in the way that seems to them best calculated to contribute, with other agencies, to economic stability. In recent years the most important problems affecting Federal Reserve policy have arisen from the enlargement of bank reserves as the result of the increasing amount of gold in this country. This increase has been contributed to by increased production of gold from domestic mines, but to a much larger extent it has been the result of movements of gold into this country from abroad. The stock of gold in the United States has become about four times as great as it ever was before 1934 and amounts to about 60 percent of all the monetary gold in the world. Various causes have brought about this unprecedented accumulation, but the principal cause has been the disturbed economic and political situation in Europe. The result of the accumulation has been the expansion of the reserves of American banks to an amount and degree never before approximated. Member bank reserve balances, which scarcely ever exceeded $2,500,000,000 before 1933, have amounted to $9,000,000,000 and more ­­ principally as a result of gold shipments from other countries. The potential lending power derived by banks from receipt of this gold creates an unprecedented problem of control; because the unusual reserve of banks are much greater than can be absorbed by the Federal Reserve authorities under present powers. If changed conditions should result however in a return of gold to Europe the powers of the Federal Reserve authorities would be found highly effective in protecting American interests from being hurt by the withdrawal. The principal means through which the Federal Reserve authorities may exercise their powers over bank reserves are in review the following: OPEN MARKET OPERATIONS. These operations directly affect the volume of reserves: purchases of securities by the Federal Reserve authorities supply banks with additional reserve funds, and sales of securities diminish the volume of such funds. As a means of credit expansion, these operations are limited only by the supply of bills and securities available for purchase and by the reserve position, of the Federal Reserve Banks themselves, assuming a demand for bank credit. As a means of credit contraction, they are limited by the amount of bills and securities held by the Reserve Banks. At the end of 1938 this amounted to about $2,500,000,000, which of course is considerably less than the amount of member banks' excess reserves. DISCOUNTS. Through the power to discount and make advances, the Federal Reserve authorities are able to supply individual banks with additional reserve funds and may make these reserve funds more or less expensive for member banks by raising or lowering the discount rate. Discounts can expand only when member banks need to borrow. RESERVE REQUIREMENTS. Raising or lowering requirements as to the reserves which member banks maintain on deposit with the Federal Reserve Banks has the effect of diminishing or enlarging the volume of funds that member banks have available for lending. Under existing law, the requirements may be raised from the present level by only about one-seventh and lowered by about three-elevenths. As already stated, the foregoing powers directly affecting the volume of member bank funds have no immediate effectiveness with respect to the utilization of those funds. In the field of stock market speculation, however, the Reserve authorities have a direct means of control over the use of funds ­­ namely, through margin requirements. The Reserve authorities may also exercise limited influence over the credit practice of banks through bank examinations. In addition to the credit functions which have just been described, the Federal Reserve Banks perform certain services of which the most important are: holding member bank reserve balances; furnishing currency for circulation; facilitating the clearance and collection of checks and the transfer of funds; and acting as fiscal agents, custodians, and depositories of the United States Government. Establishment of the Federal Reserve System has made it possible to meet and over­come many difficulties that formerly beset American economic life and imposed upon it great losses. The System has accomplished improvements in the monetary and banking field that are now taken for granted. Yet new problems and needs are always arising. Those that result from recent changes in monetary conditions here and abroad are especially complex and difficult. Federal Reserve policies must be constantly adapted to conditions in an ever changing world. back to top THE END OF REPRINT STORY The above completes the story of banking as told in the 1939 edition of the "THE FEDERAL RESERVE SYSTEM" ­­ Its Purposes and Functions. We changed the format, compressing the material on just half as many pages, left out the pictures of Reserve bank buildings, filled in resulting blank species with comments. We commend this reprint, with our comments, to you for your serious consideration. if there should be any question in your mind, please write us, and we will frankly answer your question. It is astounding, an unbelievable thing, that Congress would farm out to private corporations the creation of money and control of the nation's credit, free, then in emergency force the Government to borrow its own credit, and compel the people to pay billions of dollars taxes a year as interest on bonds the nation gave them. It is also astounding that the educated people who have read this book and know of this book, these crimes, have remained silent! Lincoln said, "To sin by silence when one should speak makes cowards of all men." S.W. Adams, publisher

801 Herndon Lane

Austin, Texas THESE FACTS SHOULD OUTLAW BANKING "We shall nobly save or meanly lose the last best hope of earth." Abe Lincoln. The Whole story of the Creation of New Bank Deposits ­­ Money This following quotation is lifted from the 1939 Edition of THE FEDERAL RESERVE SYSTEM ­­ Its Purposes and Functions: Paragraph 3: "Realizing that any additional loan it (the member bank) made would increase its despots out of proportion to its reserves, the commercial bank might stop making loans. Suppose, however, that the Reserve authorities were of the opinion that more loans might advantageously be made and that the bank should be provided with additional! reserves so that it could make them. Suppose they therefore purchase $20,000,000 of securities in the open market. The seller of the securities would deposit in the commercial bank the money ( the Reserve authorities' check against no funds) he receives in payment. The commercial bank in turn would deposit it (the seller's check received from the Reserve authorities) in its account, the Reserve Bank. Having these additional reserves of $20,000,000, the commercial bank, by making loans, could increase its deposits to five times (or 10 times today, 1958), as much, or to $100,000,000 (or now $200,000,000) ­­ the $20,000,000 being the 20 percent bank reserves required against deposits of $100,000,000!" End of quote. The parentheses enclose my explanatory statements.

S.W. Adams, author of the "Legalized Crime of Banking, and a Constitutional Solution." Banking was conceived in iniquity and born in sin. Bankers own the earth. Take it away from them, but leave them the power to create money and control credit, and with the flick of the pen they will create enough money to buy it back again. Take this great power, away from the bankers and all great fortunes like mine will disappear, and they ought to disappear, for this would be a better and happier world to live in, But if you want to continue the slaves of bankers and pay the cost of your own slavery, let them continue to create money and to control credit.



Sir Josiah Stamp in '20s

the then president of the Bank of England

and the second richest man in England. The Reserve authorities may do this, create with one check $20 million new commercial bank deposits, and $20 million new commercial bank reserves; and the commercial bank may expand its loans (new deposits) from $100 million to $200 million, on basis of the free $20 million reserves they got gratis. The Reserve authorities are now before Congress seeking to make across-the-board ten percent reserve requirement, which would mean that every time a commercial bank received an additional dollar in its reserve account, it could lend $10. How would you like to multiply your bank deposits by 10 at any time? That is exactly what the banks do. In the above "supposed" case given by the Reserve authorities, when under the influence of the Dr. Franklin Delano Roosevelt humanizing serum at their own instigation, they added $120 million to monetary funds of the Nation, just by buying $20 million corporation stock. You will note that the Reserve check set in motion a chain reaction in creating money: it added $20 million to the corporation's bank account, it added $20 million to the commercial bank's reserve account, the commercial bank multiplied its new reserves by 5 (in this supposed case) and wrote on its own books $100 million, it used these $100 million to make loans or buy investment obligations, this added $100 million to the bank's customers' deposit accounts, it also added to their portfolio of securities, your notes, mortgages, bonds, etc., another $100 million, and when the securities were paid off, the customers transferred all of the $100 million they borrowed from the banks, got their notes, and the banks transferred the $100 million to their undivided profit and surplus column ­­ securities were "canceled out" at the cost of the borrowers, but no deposits were canceled out. Let's trace all the wealth that "grew" out of that one Reserve check: $20 million to corporation depositor, $100 million to commercial Bank customers, and another $100 million in securities to the commercial bank ­­ total $220 million dollars; but when the notes were paid off, $100 million they represented were canceled out, leaving $120 million in the permanent deposit column ­­ $20 million in the hands of the people, and $100 million in the banker's hands. The people either sold the corporation goods or served it for the $20 million, but all the bank did was to do some ordinary bookkeeping! Remember this sort of thing is going on all of the time, so when you take into consideration the Nation's 14,000 member Banks doubling and multiplying our deposits continuously, you will begin to understand why our real estate and material resources are rapidly falling into the hands of the few ­­ and Sir Josiah's words take on a more sinister meaning. The $20 million out of the above supposed case that went to the customers of the corporations were earned by the recipients. The $100 million that finally became the deposit assets of the banks cost the bank nothing ­­ the $20 million in reserves cost them nothing, and the interest on the $100 million they loaned paid them the cost of bookkeeping, the cashing and clearing the depositors' checks, with a handsome profit, of course! We boast of having liberated four million slaves, but we are careful to cancel the ugly fact that by our iniquitous money system, we have nationalized a system of oppression more refined but none the less cruel than the old system of chattel slavery. Horace Greely on the passage of the National Banking Act,

our first legalizing the crime of debt dollars,

and the expansion of credit five to ten times. And Sir Josiah Stamp said, "If you want to continue the slaves of bankers

and pay the cost of your own slavery,

let bankers continue to create money and control credit!" back to top THE PAUPER AND THE RICH MAN The pauper (the Federal Reserve System) with assets of only $52 billion with no productive know­how, with no productions of goods, and less than 100,000 stock holders, loaned (?) the rich man (the United States of America) with a trillion in productive capacity and know-how, with well over $500 billion in assets and 170 million stock holders, including the aforesaid 100,000 bank stockholders, $250 billion to fight World War II. Can you imagine the greatest corporation on earth, The Government of the U.S., with 110 million alert full­of­know-how stockholders, and assets running over $600 billion, turning to a small segment of its population, with more than 100,000 stockholders and assets of only $52 billion to borrow money? Can you conceive of Rockefeller saying to his chauffeur, "Tom, I am transferring my personal bank account which is well over $1 billion, to your account. You may spend it as you please; provided as often as I ask for money, you will let me have it. Of course, I will give you my note for cash I receive, and try to rustle from my children enough money to pay you interest on the borrowed money." Well, that is exactly what Congress did in 1913 when it passed the Reserve Act. To fight World War II, we gave the bankers of the United States $250 billion in U.S. Bonds that we might use our own, the Nation's credit. In addition, we permitted them to take credit in their reserve accounts for $250 billion This gave them $1 trillion 250 billion bank credit. They now want to make it double! These credits are to the bankers what your deposits are to you. They can lend it, or use it to buy investment obligations ­­ it is cash to them! So adding the $250 billion in U.S. Bonds we absolutely gave to them their $1 trillion 250 billion bank credit, and we find that the bankers (the then paupers) came out of World War II $1,500 billion richer, and the (then rich man) the United States Government came out $250 billion in debt to the bankers (the paupers) thanks to the stupidity and/or venality of our Congressmen, newspapers, journals, and educated people of the nation. back to top Appendix to The Federal Reserve Book AND THIS IS THE LAW ­­ CONSTITUTIONAL MANDATE TO CONGRESS Article 1, Sections 8 and 10: The Congress shall have the power

. . . to coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures.

No, state shall . . . . coin money, emit bills of credit; make anything but gold and silver coin a tender in payment of debt. If no state may coin money, then certainly no private corporation may constitutionally do that. With above comments, I submit this Reprint of The "Federal Reserve System Its Purposes and Functions" to you for your serious study and considerations. Respectfully submitted, this the 2nd day of March, 1958. Sincerely yours, S.W. Adams, publisher, 901 Herndon Lane, Austin 4, Texas, BANKERS ARE NEVER SATISFIED! In 1957 they passed through an unwitting Congress, S. 1451, an act to revise and amend all banking laws, stretching out to 100,000 words. This year, first days of the Second Session of the 85th Congress, they have reintroduced the same text "to again revise and amend" the 252 page law. Congressman Abraham J. Multer of New York, said after hearing the banking experts testify before house banking and currency committee: "My purpose at this moment is to alert the membership to the situation presented by the attempt to enact this bill. Every witness who testified before this committee referred to and discussed changes in the Federal (Reserve System) statutes "of major importance." If the bill is enacted with these changes, most of the safeguards written into our banking laws since the 1920's will be eliminated and destroyed. Bank depositors and stockholders will again be put at the mercy of the moneyed Interests, and the big bankers of the country. "The money changers who were driven out of the temple in the 1930's will not only be back in the temple, but they will take it over "lock, stock, and barrel." That last is a misstatement of fact ­­ in '33, emergency palliatives saw bankers merely scolded, given billions of dollars, and sent down the same road of wreck and ruin they have traveled for 190 years: and a benign (?) Congress graciously demonetized pesky gold, and authorized banking gamblers to go into the open markets and buy corporation stock in act of creating bank reserves. This nice provision Congress left in the bill bankers wrote has enriched the bankers, moneychangers, the neat sum of $1 trillion 500 billion out of just World War II, and the threatened depression they now have hanging over our heads was planned and begun that they might scare Congress into passing the 1958 version of what they admit is "of major importance" (to them). They will assure these Congressmen that if they will "revise and amend" existing banking laws, they will be good boys, and slow down the siphon, turn on the pumps and we will all go back to work again, and eat, and buy gadgets, and be as foolish as we have been since the World War II. THE SIMPLICITY OF MONEY Money is anything a government provides that is in common use as a medium of exchange; therefore, money is a medium of exchange. Honest money represents the surplus products of man's labor. Originally money was a substance, usually gold or silver, coined into units by the government. Before man began to use money men with surpluses bartered ­­ the man gave five bushels of wheat for a goat. When buyer and seller became too remote from each other to barter, and the seller had a surplus of products and there was no one wanting it at the time, the government hit upon the plan of coining metals, and the holder of surplus products could dispose of them selling them to a dealer, and the dealer would pay him in the gold coin, which he could hold until he found something he wanted to buy, and he paid for it with the coin he held, and the dealer would hold his products until a buyer came along with coin, and sold to him ­­ so a third party came into the picture, became a part of the medium of exchange. All of this was barter of the products of labor. The gold was a product of labor, so when the producer sold to the dealer, it was in reality a barter of wheat for gold, and the government did not have to put a redemptive clause on the gold coin, because the seller would readily receive it for his goods, knowing that another buyer would readily accept it for goods. But when the supply of gold was exhausted, the government began the practice of printing money, putting on the bills a redemptive clause, making the money redeemable in gold. So the sellers would take it, if they could not get gold, believing they could get dollar for dollar in gold from the government if they demanded it ­­ and many did; for as late as the post­Civil War period, sellers demanded repayment in gold coin. Even our United States Constitution provides that "states may not emit bills of credit," paper money, and could make nothing but gold and silver coin legal tender in the payment of debts. When banks began to keep the people's money on deposit, it was an easy step to another money, the personal check, which was good money if written by a person of integrity, who had funds in the bank to cover the check. This form of money is used to make the great bulk of our monetary payments; and currency is used only for pocket and cash register change for payment of goods over the counter. It would be the best money on earth if the government took over the keeping of the people's deposits, cashing and clearing their checks. The producers of goods have a prior right to have the money, and those serving the producers have a joint prior right to receive the money. Those who do not produce goods nor serve in the production of goods, have only a secondary right to have the money. Gamblers, of all sorts, have no legitimate right to have the money. So long as all money in circulation is the production, surplus products dollar, and the government makes available to the producers additional money as the surpluses mount, it is an honest, sound, useful dollar. But under our Federal Reserve System we have no honest, production, surplus dollars ­­ all of them are the gamblers' dollars, debt dollars, upon which the people must pay an interest charge, which runs into many, many billions of interest dollars annually. This takes money out of production, out of hands of consumers. The flood of debt dollars, all created by banks, has become so great that the products of labor now cost the consumers four to five times what they would have to pay if we were using an honest, production dollar. The Government should take over the money, out of the hands of the bankers, gamblers in the stock markets, and establish Treasury depositories everywhere in the Nation, as post offices are located, keep the people's deposits, cash and clear their checks ­­ but lend no money, buy no investment obligations, nor dabble in the stock­market gambling. And the Government should see that no dollar enters the volume of money that is not a production dollar, an earned dollar, an honest dollar, an interest­free dollar, then add to the money supply of dollars as often as production, the annual turnover of business, grows larger than volume of money ­­ having as its goal the simple matter of keeping the volume of money that amount required to carry on the Nation's business at any and all times. This would make an honest man of the banker, who has said during the years that he lends the depositors' money, while as a matter of fact, he has never loaned the depositors' dollar, he has loaned his own created dollars, debt dollars, which have cost the people so many billions of dollars over the years ­­ the phony dollars, the gamblers' dollars, the dishonest dollars. back to top GLOSSARY RESERVE ACT OF 1913 ­­ Created the Federal Reserve System, by which Congress abdicated its Constitutional authority to create money and control the Nation's credit, turning this important function of government over to private banking corporations, bent on gain, profit! Reserve Act of 1934 ­­ Demonetized gold and substituted corporation stock as our "standard of money", raised price of gold from $20.67 to $35 an ounce, and outlawed the selling of gold in any form to other than the Government, and made it illegal for a person to own gold coin or bullion, except that which he bought from the Government to be used in the arts; making it compulsory that the Government buy all gold mined in the United States, or sent to the United States. Reserve Act of 1957 ­­ Greatly extended the powers of the Reserve authorities. They are asking this year (1958) to lower reserve requirements by half, etc. Federal Reserve System ­­ The 12 Federal Reserve Banks with some 14,000 commercial member banks, trust companies and savings institutions, combined into a giant private corporation with the power to issue money, create deposits, control the Nation's credit, and dominate the entire national economy ­­ it holds the power of life and death over all business ­­ every person in the Nation. Reserve Board of Governors ­­ Seven persons appointed by the President and confirmed by the Senate, and serving 14 years. They supervise the operations of the 12 Reserve banks, have more power than Congress or the President, and make no report to any Governmental agency, not even to Congress or the President. Twelve Reserve Banks ­­ One located in a district, with its branch banks. Each is a corporation. Member banks are their stockholders, and their principal functions are to control the credit of their district, receive and hold their member banks' reserves, clear their checks. Reserve Open Market Committee ­­ Is composed of the seven Board of Governors and five members of the 12 Reserve Banks. The committee directs the open market operations of the Reserve banks; that is