plus of the bank. This restriction does " not apply to the discount of bills of exchange drawn in good faith against actually existing values."

In the beginning the reserve banks were the only banks of rediscount. Later banks of rediscount were organized under state supervision in some of the larger cities. As this movement grows and the funds of American investors are attracted to the safety and liquidity of commercial paper, the competition for paper of the rediscount class may build up a great private market. In such event the rate of discount offered by these private corporations might be lower than the Federal reserve rate, permitting these banks to be used for emergency operations which would automatically check inflation in the issue of Federal reserve notes.

In 1923 the intermediate credit banks were started and the rediscount agricultural credit corporations authorized. Both kinds of institutions will do rediscounting, but the paper will be of longer maturity than that handled by the commercial banks.

242. Open market operations. Not only do the reserve banks rediscount but they buy and sell in the open market, at home or abroad, from and to anybody, with or without the indorsement of a member bank, cable transfers of money, bankers' acceptances, and bills of exchange which are eligible for rediscount. They may deal in coin or bullion here or in foreign countries and "buy and sell at home or abroad bonds and notes of the United States, and bills, notes, revenue bonds, and warrants with a maturity from the date of purchase of not exceeding six months, issued in anticipation of the collection of taxes or in anticipation of the receipt of assured revenues by any state, county, district, political subdivision, or municipality in the continental United States, including irrigation, drainage, and reclamation districts, such purchases

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to be made in accordance with rules and regulations prescribed by the Federal Reserve Board." They may "purchase and sell in the open market, either from or to domestic banks, firms, corporations, or individuals, acceptances of Federal intermediate credit banks and of national agricultural credit corporations, whenever the Federal Reserve Board shall declare that the public interest so requires." 3

The importance of these powers has been discussed by Professor Charles A. Dice of Ohio State University. In an unpublished paper he says: "It is through open market operations alone that the Federal reserve banks come into direct contact with individuals, firms, and corporations. By this means it is possible for any financial institution, or a business or industrial corporation to sell commercial paper direct to a Federal reserve bank or to buy directly from a Federal reserve bank. All paper eligible for rediscount with or without the indorsement of a member bank may be bought by a Federal reserve bank except that promissory notes may not be bought in the open market. On May 1, 1923, nearly one fourth of the total bills held by the twelve Federal reserve banks was bought in the open market.

"It is believed that open market operations by the Federal reserve banks will tend to equalize and stabilize interest rates throughout the United States through the encouragement of commercial paper houses and through the fact that the resources of the Federal reserve system are made available directly to the commercial paper market.

"One of the most powerful tools which the Federal reserve banks have to enforce their rediscount rates is their ability to enter the open market. They may buy com

3 Federal Reserve Act, Section 14, paragraph (b); and paragraph (f), amendment of March 4, 1923.

mercial paper creating a demand for paper and at the same time, in making payment, putting into the market loanable funds. On the other hand, the Federal reserve banks may enter the market to sell paper thus taking out of the market loanable funds and at the same time increasing the supply of paper in the market. The first kind of operation tends to force discount rates down, while the second tends to force them up."

An increasing proportion of paper that is eligible for purchase is appearing in the market. The Federal Reserve Board, exercising its statutory right to regulate the purchase of bills of exchange and acceptances, has determined that a bill of exchange or acceptance, to be eligible for purchase by Federal reserve banks under this provision of section 14, must have been accepted by the drawee prior to such purchase unless it is either accompanied or secured by shipping documents or by warehouse, terminal, or other similar receipt conveying security title or bears a satisfactory banking indorsement, and must conform to the relative requirements of Regulation A [for rediscounts], except that (a) A banker's acceptance growing out of a transaction involving the importation or exportation of goods may be purchased if it has a maturity not in excess of six months, exclusive of days of grace, provided that it conforms in other respects to the relative requirements of Regulation A.

(b) A banker's acceptance growing out of a transaction involving the storage within the United States of goods actually under contract for sale and not yet delivered or paid for may be purchased, provided that the acceptor is secured by the pledge of such goods; and provided further, that the acceptance conforms in other respects to the relative requirements of Regulation A; and (c) A banker's acceptance drawn by a grower, or by a coöperative marketing association composed exclusively of growers, of non-perishable, readily marketable, staple agricultural products, to finance the orderly marketing of such products grown by such grower or growers and secured at the time of acceptance by a warehouse, terminal, or other similar receipt, issued by a party inde

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pendent of the borrower and conveying security title to such products, may be purchased if it has a maturity at the time of purchase not in excess of six months, exclusive of days of grace; provided, that the acceptor remains secured throughout the life of the acceptance, and that the acceptance conforms in other respects to the relevant requirements of Regulation A.

"A bill of exchange, unless indorsed by a member bank, is not eligible for purchase until a satisfactory statement has been furnished of the financial condition of one or more of the parties thereto.

"A banker's acceptance, unless accepted or indorsed by a member bank, is not eligible for purchase until the acceptor has furnished a satisfactory statement of its financial condition, in form to be approved by the Federal reserve bank and has agreed in writing with a Federal reserve bank to inform it upon request concerning the transaction underlying the acceptance." 4

The greater the development of the open market in the United States the easier it will be for large banking institutions to rely upon the purchase and sale of prime bankers' acceptances and treasury certificates to give elasticity to their funds available for loans. In discussing the advisability of such an ideal for strong American banks President Paul M. Warburg of the American Acceptance Council in his annual address made the following statement as to European practice:

"A strong, proud bank in England or France would feel humiliated if in normal times it were forced to borrow directly from its central bank, because, forsooth, it had not maintained a supply of liquid loans and investments large enough to meet by means of its balances and open market operations any demands made upon it. In other words, normally the strongest banks in such countries would draw funds from the open market, either through calling loans or selling liquid assets from their portfolios. If, as a result of the operations of all the banks, the open market should become overloaded, the market would then resort to the central bank, i.e., the bill 4 The Federal Reserve Board, Regulation B, Series of 1922.

brokers would sell acceptances to, or borrow from, note-issuing central institutions. However, it would not have been the individual bank in that case that had taken recourse to the central bank, but the market as a whole. This is the highest standard of banking in normal times."

243. Issue of Federal reserve notes. The funds of a Federal reserve bank consist of its unused capital and surplus, deposits of the United States, and deposits of member and other banks. The reserve banks are required to maintain reserves of gold or lawful money equal to 35% against their deposits. Since these banks are also required to maintain a reserve in gold of 40% against those Federal reserve notes in actual circulation for which gold or gold certificates were not deposited as security, it is necessary to conserve the supply of gold so as to be in readiness to meet all demands for notes. Therefore when a bank calls on a reserve bank for money on a loan, a rediscount, or a check against a deposit, it may be considered advisable to pay out notes instead. To obtain notes the bank applies to its local Federal reserve agent. These notes are the obligations of the United States. They are issued at the discretion of the Federal Reserve Board in order that the Government may make advances to the banks to satisfy the demands of commerce for money. They are receivable for taxes, customs, other public dues, and by all Federal reserve and member banks. They are redeemable on demand in gold at the U. S. Treasury, or in gold or lawful money at any Federal reserve bank. When a Federal reserve bank applies for an advance of these notes it must present collateral security to the amount of notes it desires. This security must consist of notes, drafts, bills of exchange, or acceptances, acquired under the provisions of section thirteen of this act, or bills of exchange indorsed by a member bank of any Federal reserve district and purchased under the provisions of

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