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ment fund (to be described later, pages 75-78), that they may reasonably be considered to be closely connected tanks of a single large reservoir.

Open-Market Operations

While the federal reserve banks are essentially bankers' banks, since their stock is owned exclusively by member banks and since their only regular domestic customers are banks and the federal government, it is none the less true that Congress found it necessary to confer upon these banks certain limited rights of dealing with the outside public. The possession of such rights by the federal reserve banks appeared necessary, first, as part of the machinery for conserving the American money market and making their discount rates effective and second, as a method of profitably employing their funds in times of easy money, when member banks are making few calls

• If, for example, a federal reserve bank raises its discount rate in order to prevent dangerous loan expansion on the part of member banks or to prevent an undue outflow of gold from the country, it may happen that the member banks may not be convinced of the need of such precautionary measures, and, not being in need of securing funds from the federal reserve bank by way of rediscount, may ignore the efforts of the federal reserve bank to conserve the money market. The banks may accordingly continue the policy of loan expansion at low discount rates. Under such circumstances the federal reserve rate would be said to be "ineffective." To meet this situation and force the banks "into line" the federal reserve bank may go into the open market and sell bank acceptances, commercial bills, municipal warrants and government bonds, and, by withdrawing from the market the

upon them for rediscount.' The dealings with the outside public so authorized are known as "open-market operations," and are provided for in section 14 of the Act. Into the details of this important section we need not go. For our purposes it is sufficient to note that federal reserve banks may buy and sell in the open market either * at home or abroad commercial bills of exchange, bankers' acceptances, and certain specified kinds of government obligations. Under this authority a federal reserve bank in one section of the country may buy and sell eligible commercial paper and government securities in any other section of the country. Such dealings, of course, tend to cause a flow of reserve money from the district of the buyer to that of the seller. If the San Francisco federal reserve bank, for example, buys $1,000,000 worth of trade acceptances, bank acceptances and municipal warrants in the open market in New York, its settlement check to whomever paid is likely to be deposited in a New York bank, and for that bank to be collected by funds received in payment therefor, may tighten the market, and force up the discount rate thereby bringing the market rate into harmony with the federal reserve rate.

7 In the early days of the federal reserve system when the member banks were making very little call upon the federal reserve banks for rediscounts or other advances, the federal reserve banks invested substantial sums in municipal warrants and bank acceptances in the open market, and by that means covered a large part of their running expenses.

the New York federal reserve bank from the San Francisco federal reserve bank. Unless offset by payments in the other direction, the payment by San Francisco will necessitate a transfer of reserve money, presumably through the "gold settlement fund," from San Francisco to New York. If the New York bank, in which the million dollar check was originally deposited, leaves the proceeds on deposit with the New York federal reserve bank, federal reserve "reserve money" will be transferred from the bank in San Francisco to the bank in New York. In this manner open market operations transfer reserve money from places of redundancy to places of scarcity, and tend to maintain a national equilibrium in our money rates.

Creation of a Broader Discount Market for Commercial Paper

The third method by which the federal reserve system is rendering more mobile our reserve money is through the creation of a broader discount market for commercial paper. As we have already seen, under the old banking system the great bulk of American commercial paper was essentially local paper with little or no market outside of the community in which it was created. The federal reserve system has provided the 8 The gold settlement fund is described on pages 75-78.

machinery by which high grade commercial paper can be rediscounted throughout the United States, and, in this connection, has sought to encourage by preferential discount rates and otherwise the use of trade acceptances and bank acceptances-credit devices widely used in Europe.

When the seller of merchandise draws a trade bill upon the buyer at, say, 60 days sight for the amount of the bill, and the buyer writes across its face "accepted" and signs his name with the date of acceptance, a credit instrument is created which has very pronounced advantages over the open-book account, from the standpoint of the seller, the buyer and the bank. The seller has a definite acceptance of the goods which the buyer cannot question in the future without very good reason; he has a promise from the buyer to pay at a definite date; and he has the buyer's obligation expressed in the form of a negotiable instrument which is highly liquid, and which enjoys preferential rediscount rates at all federal reserve banks and therefore presumably at the seller's local bank and in the open market. The buyer of the merchandise who accepts the bill places his credit standing at a higher level than it would be if he bought on open book account. His improved credit should enable him to buy on better terms. Having his accounts thus given definite maturities he is less likely to be tempted to overbuy than

he would be under the loose open-book account method. The buyer is also a seller, and if he uses trade acceptances in connection with his purchases he is in a stronger position to demand them in connection with his sales. From the banker's point of view the trade acceptance is an ideal form of commercial paper. It bears two names, usually carries with it evidence that it represents a self-liquidating commercial transaction and not an accommodation loan, it is almost certain to be paid at maturity and not to seek renewal, is not subject to the provision of the national banking law which prohibits a national bank from loaning to one customer an amount in excess of ten per cent of the bank's capital and surplus (Revised statutes, section 5200), and it is very easy to turn into cash before maturity either by sale in the open market or by rediscount at a federal reserve bank because of the preferential discount rates given such paper. The trade acceptance is therefore incomparably more liquid than the open-book account, and, other things equal, is more liquid than one-name paper.

Even more liquid than the trade acceptance, because the acceptor is ordinarily of more widely recognized financial standing, is the domestic bank acceptance authorized by the federal reserve law. The bank acceptance is similar to the

• The statutory provisions concerning bank acceptances will be found in section 13, paragraph 5 of the federal reserve act.

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