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federal reserve machine and the technical language in which this machinery is usually described. In a democracy, however, widespread ignorance, among the voters, of the country's financial system is fraught with danger.
America's leading manufacturing, transportation and commercial concerns years ago attained heights of economic efficiency which made them the envy of foreigners. None, however, envied us our banking system. None followed it except soon regretfully to turn back. This was true, despite the fact that our old American banking system had many substantial merits. It was reasonably safe, it yielded good profits, it was adaptable to the local needs of widely varying communities, and it developed the check and clearing system to a degree of perfection found in few if any other countries. Along with these meritorious features, however, it contained a number of very serious defects. The chief of these may be grouped conveniently under four heads: I. Decentralization. II. Inelasticity of credit. III. Cumbersome exchange and transfer system. IV. Defective organization as regards relationship with federal treasury. In the four succeeding chapters these four groups of defects will be considered, and in the following four chapters will be discussed the respective remedies provided by the federal reserve system.
DECENTRALIZATION OF AMERICAN BANKING PRIOR TO FEDERAL RESERVE SYSTEM
In 1912 the United States had many times more commercial banks than any other country in the world, and these banks averaged much smaller than those of any other important country. Official figures at that time placed the number of independent banking establishments of all kinds in the United States at approximately 30,000, and of this number something like 28,000 were banks whose business was wholly or partly of a commercial character. These commercial banks were owned for the most part by the residents of the communities in which they were placed, and the business of most of them was chiefly local in character. The great majority of national banks were national in nothing but name. Except for the rather loose association of the banks in the clearing houses of our principal cities and a growing community of interest, most of these banks were independent units, each working for itself. There was little team work. In
times of threatened panic the different parts of the system worked at cross purposes. They were without effective leadership at those times when prompt cooperation under national leadership was urgently needed.
The most serious feature of this decentralization was the scattering of reserves. Thirty thousand different banks meant 30,000 cash reserves, and these reserves for the commercial banks were more than the mere "till money" which the "cash balances" of most foreign banks represent. They were actual reserves, substantial in amount, upon which the banks placed their prime dependence for times of emergency. It is true that most banks had so called "deposited reserves," namely, funds on deposit in other banks, which they were allowed to count as part of their "legal reserves"; and they had so called "secondary reserves," namely, funds invested in securities and call loans, which were supposed to be quick assets that could be liquidated at once in time of need. Strictly speaking, however, neither of these "reserves" was a reserve at all. The deposited reserve was after all merely a deposit in another bank, which the depository bank loaned out— commonly at call on the stock exchange-and
against which it held its own reserve, a reserve which in turn was often further attenuated by being placed on deposit in a third bank, there again to be loaned out on stock exchange collateral. In times of emergency, therefore, the "deposited reserve" could be realized upon only to the extent that call loans could actually be called, and this meant to the extent that stock exchange securities could be sold. Invested "secondary reserves" could be realized upon, likewise, only to the extent that securities could be sold. In times of threatened panic, however, stocks and bonds can not be sold on any extensive scale except at great sacrifices and at the risk of financial co1lapse. Experience has shown that securities are not sold to any large extent by banks at such times. The losses involved would be too great. The result was that in times of serious danger the banks of the country were forced to rely to a very large extent upon their own cash reserves, which, as a consequence, had to be maintained at a high level-higher than in other advanced countries. This situation gave the vault reserve in American commercial banks an importance not found in the commercial banks of Europe. European joint-stock banks normally carry little cash in vault; they place their reliance for emergency funds directly or indirectly upon the
central banks. In America bank reserves were so scattered and so jealously guarded that in times of threatened panic they were comparatively ineffective in staying the storm. The situation was analogous to what would happen today if after drilling our American army to a high point of fighting efficiency, we should scatter the men in small units all over the United States to protect the country from a threatened invasion. Each community would be jealous of its own squad of soldiers, but the invader would come and the efficiency of our well drilled soldiers would be practically nil. The point of the illustration will be clear to everyone recalling the mad scramble for reserve money on the part of banks throughout the country at the time of the panic of 1907. Our supply of reserve money was large. In fact we had at that time in the United States the largest supply of gold in the world. It was ineffective, however, because widely scattered; hence, suspension of cash payments throughout the country, currency premiums, the breakdown of our domestic exchanges, the illegal issue of millions of dollars of money substitutes, and all the other disgraceful accompaniments of an American panic.