CHAPTER XXVI

ORIGIN OF THE FEDERAL RESERVE SYSTEM1

I. DEFECTS IN THE NATIONAL BANKING SYSTEM.

DEFICIENCIES in the national banking system were perceived comparatively early in its history, but did not make themselves felt in a way so serious as to enlist active effort for their correction until about twenty-five years after the system had first become operative. Moreover, during this period of twenty-five years the difficulties which were most seriously felt were not those that afterward caused most annoyance and led to most active effort for improvement. Probably the first inconvenience that was experienced in the management of the national circulation after the national banking system had been definitely created and the Act had been amended to meet the earlier requirements of the conditions then existing, was the prospect that the supply of government bonds available at prices that would enable the banks to put out circulation based thereon would be insufficient. In 1880-83 this problem, as seen at an earlier point, had become acute, the twenty-year bonds which had been issued by the federal government during the Civil War at 5 and 6 per cent interest expiring, and the question what should be done in connection with them being unsettled. The problem was disposed of by refunding the bonds for another twenty years and thus enabling the national banks to get the securities they needed as a basis for their circulation. With the growth of the great surpluses of revenue during the decade 1880-90, a new type of problem appeared; for the purchases made by the Treasury Department, in order thus to use up the surplus, had brought the bonds to a premium and made it quesAdapted in part from "The Federal Reserve" by H. P. Willis, by permission of the publishers, Messrs. Doubleday, Page & Co.

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tionable whether the maintenance of the circulation on a satisfactory basis providing for the issue of enough of the notes would be feasible. Discussion of the question was, however, only sporadic. The national system was proving itself in so many ways better adapted to the needs of the country than the system of banking which had preceded it, that comparatively few persons were disposed to attack it seriously.

The difficulty in getting an adequate supply of notes had been making itself more and more felt prior to that time, and when the panic of 1893 came on this phase of the problem became suddenly very acute. During the panic of 1893 there was a tremendous shortage of currency and many expedients had to be resorted to for the purpose of supplying even the bare necessities of the country for a circulating medium. Not only clearing-house certificates, but a great variety of forms of local obligations which serve as currency substitutes, were injected into the circulation from time to time, and served as a means of relieving the strain upon national-bank notes. As for the national-bank notes themselves, it was almost out of the question to obtain sufficient amounts of them. Even when a national bank had deposited its bonds with the Treasury and had made application for notes, fully three weeks were necessary in order to get delivery of the finally completed currency. This delay was necessary in order that the notes might be printed, dried, and shipped to their destination. The process of signing them and putting them out required more time. Altogether, the delay involved in making the currency available was so great that the experience of the panic convinced practically all observers of the unsatisfactory nature of the prevailing system for issuing notes as a practical matter, entirely independent of the question whether the method of note issue provided in the National Act was or was not theoretically satisfactory or desirable. II. THE BALTIMORE PLAN.

The result of these events was to draw the attention of American bankers toward the practice of other countries.

Many persons believed that the past experience of the United States with so-called central banking, as exemplified in the history of the First and Second banks of the United States, had been such as practically to put resort to such expedients out of the question. The Canadian Bank Act, which had been lately revised, offered as its most striking feature, from the standpoint of American bankers, an issue of currency protected by a joint guaranty fund contributed by all of the banks. At a meeting of the American Bankers' Association in 1894, at Baltimore, a plan of a somewhat similar sort was advocated. This was designated as the "Baltimore Plan," and became to many minds synonymous with what has long been called "currency reform." Unsatisfactory conditions in the currency situation had their share in contributing to the growth of the silver agitation, but the presidential campaign of 1896 turned almost entirely about the question of remonetizing silver. Discussion of banking and currency, as distinct from that relating to the standard of value in money, practically disappeared in the struggle over silver. Immediately after the election of President McKinley, however, an effort was made by business men and bankers throughout the country to direct attention once more toward the question of an appropriate note issue. Legislative leaders, nevertheless, showed almost complete indifference to the whole subject, and the "currency reform" movement after 1896, therefore, naturally became an effort to secure definite goldstandard legislation, and only incidentally improvement of the banking situation.

III. INDIANAPOLIS CURRENCY COMMISSION.

The most notable movement of the four years from 1896 to 1900 was that embodied in what was called the Indianapolis Currency Commission. This was a body appointed by a convention of boards of trade and commercial organizations generally, which had met at Indianapolis, Indiana. The commission did its work largely in Washington, and ultimately issued a report which called for three principal changes in existing legislation: (1) The definite establish

ment of the gold standard; (2) the separation of the gold fund protecting greenbacks or United States notes in the Treasury Department from the other funds of the Treasury, with provision for reconstituting this fund by the issue of bonds; and (3) the issue of bank notes based upon commercial paper and duly protected in various ways.

IV. GOLD STANDARD ACT.

It is probable that this report would have evoked immediate action by Congress to some effect had not the SpanishAmerican War intervened. The close of the war found the United States approaching another presidential election. Congressional leaders then hastily framed a measure known as the gold-standard law of 1900, which became a statute on March 14th of that year. In this gold-standard law provision was made for the segregation of the funds of the Treasury, so that $150,000,000 should always be available behind the greenbacks, and authority was given to the Secretary of the Treasury to sell bonds for the purpose of re-establishing this fund if at any time it should fall below $100,000,000 fixed for it. The Act declared the standard of money in the United States to be the gold dollar, although it was defective in making no provision for the redemption of the silver dollar in gold or for the issue of bonds to maintain parity. Outstanding bonds were to be refunded into 2-per-cent consols, and these 2-per-cent bonds were made available to protect national-bank currency. Prior to 1900, $50,000 had been the minimum capitalization of a national bank, but the new Act reduced this sum to $25,000 in towns of 3,000 inhabitants. This reduction and the issue of the 2-per-cent bonds were expected to enable country communities to organize national banks and take out the currency they needed. The fact that prior to 1900 the outstanding bonds had brought a large premium, while banks could obtain only 90 per cent of the par value of their bonds in currency, had made it unprofitable for the banks to issue. For example, if a bank had to pay for $100,000 of government bonds, say, $112,000, while it could get only $90,000 in currency, there would be a gap of $22,