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amount of 100 per cent certain forms of high grade collateral. This collateral may consist of: (1) Paper endorsed by member banks and drawn for strictly commercial, industrial or agricultural purposes, or for the purpose of carrying or trading in securities of the United States Government, in other words, paper of the type hereafter described' which is eligible for rediscount at a federal reserve bank. (2) Bills of exchange endorsed by a member bank and bankers' acceptances bought by the federal reserve bank in the open market. (3) Gold and gold certificates.

Except under special circumstances, to be considered later, a gold reserve of not less than 40 per cent must be kept by each federal reserve bank against its outstanding federal reserve notes. Gold specifically pledged with the federal reserve agent as collateral for the notes may be counted in making up this 40 per cent reserve, as may also gold kept in the redemption fund with the treasurer of the United States at Washington for the redemption of the notes.

Elasticity of Federal Reserve Notes

As regards the matter of elasticity, these notes have in a high degree the quality of expansibil1 Pages 61-63.

2 Pages 53-54.

ity, namely, of having their circulation easily increased in times of need. If member banks in a given section of the country need an increased supply of currency to meet local demands, they may rediscount eligible paper with their federal reserve bank and take the proceeds of the rediscounts in federal reserve notes, which pass readily as hand-to-hand money and are satisfactory till money for the banks. The federal reserve bank, if its supply of notes is inadequate, secures, on application to the federal reserve agent, additional notes by depositing with the agent the rediscounted paper or other eligible paper in its portfolio. This process may continue as long as the federal reserve bank has paper available for deposit with the federal reserve agent and its gold reserve does not fall below the normal legal minimum of 40 per cent. In case of great emergency, however, the federal reserve board may permit a reduction of the note reserve below 40 per cent, provided it imposes a graduated tax upon the amount of the deficiency—a tax which must be added to the rates of interest and discount fixed by the federal reserve board. Furthermore, to meet extreme emergencies the board is authorized "to suspend for a period not exceeding thirty days, and from time to time to renew such suspension for periods not exceeding fifteen

days any reserve requirement" specified by the Act. It is thus seen that the federal reserve notes have ample power of expansion in time of emergency and that there no longer exists a stone-wall limit beyond which expansion cannot go and go promptly. There is no fixed limit, but beyond a certain point further expansion can be secured only at a rapidly increasing expense to those wishing the notes.

The notes issued by federal reserve agents to the twelve federal reserve banks amounted to $3,222 millions on February 20, 1920. Back of these notes there was held by the twelve federal reserve agents the following collateral: Millions

(1) Gold coin and certificates...
(2) Gold in redemption fund at
Washington

$241

103

(3) Gold with federal reserve board 807
(4) Eligible paper, (representing
$763 millions above the minimum
required by law)

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2,834

.$3,985

The figures show that 36 per cent of the federal reserve notes issued were backed dollar for dollar by gold collateral. The total gold resources of the twelve federal reserve banks on

the above date were $1,970 millions, which on the basis of the 40 per cent reserve required by law would represent a gold reserve sufficient for a circulation of $3,526 millions federal reserve notes, after setting aside the legal minimum lawful money reserve of 35 per cent against deposits. This would increase by about 18 per cent the amount of federal reserve notes in actual circulation on February 20, 1920. Obviously there still resides in the federal reserve system some power of note expansion-a power which, in the present conditions of currency and credit inflation, should be used, if at all, with extreme caution.

For the purpose of contracting the circulation of federal reserve notes when the business demands for currency decline, the machinery is as follows. When the demand for notes in the pockets of the people and the tills of merchants falls off, as it does, say, after the harvesting season in the autumn, the surplus notes are deposited by the public in the banks. Inasmuch as national * banks cannot count these notes in their vaults as legal reserve money, they will tend to send to their federal reserve banks for deposit any notes they receive in excess of the amount needed for till money. Notes which were issued by the federal reserve bank of the district may thus be withdrawn from circulation. Notes so received which

were issued by other federal reserve banks are sent back to the issuing banks. On this subject the law says: "Whenever federal reserve notes issued through one federal reserve bank shall be received by another federal reserve bank, they shall be promptly returned for credit or redemption to the federal reserve bank through which they were originally issued or, upon direction of such federal reserve bank, they shall be forwarded direct to the Treasurer of the United States, to be retired. No federal reserve bank shall pay out notes issued through another under penalty of a tax of ten per centum upon the face value of notes so paid out" (Section 16). This requirement that federal reserve banks shall send back promptly the notes of other federal reserve banks will obviously increase in its effectiveness as a means of currency contraction with the increase in the number of branches of federal reserve banks established throughout the country.

Another device calculated to encourage the retirement from circulation of bank notes whenever they become redundant is the provision of the law authorizing the federal reserve board to charge such a rate of interest as it may deem desirable on federal reserve notes uncovered by gold or gold certificates issued to federal reserve banks.

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