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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 Notes which were issued by the federal reserve bank of the district may thus be withdrawn from circulation.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.

The fact that federal reserve notes are not legal tender is believed by some to exercise an influence in the direction of causing their retirement when they become redundant. In view of the fact, however, that the question of legal tender is rarely raised in connection with money which is not depreciated, it is doubtful if the lack of legal tender adds anything to the "homing quality" of the notes.

Elasticity of Deposit Currency Elasticity of deposit currency, although it has not received the attention in our economic literature received by elasticity of bank-note currency, is of greater importance because the amount of business done by means of deposit currency

is

many times larger than that done by means of bank notes. Prior to the establishment of the federal reserve system, as we have seen, our deposit currency, although not as inelastic as

8 The estimates of Professor Irving Fisher give for the year 1913, the last antebellum year, the average rate of monetary turnover for the country as 21, and the total amount of business effected by deposit currency as $440 billion. The bank-note circulation for July 1 of that year was $759 million, which multiplied by the average rate of monetary turnover would give the total business transacted by means of bank notes as $16 billion, or a sum equal to only 1/27 of that transacted by means of deposit currency.

+ See pages 17-18.

our bank-note currency, was none the less deficient in the quality of elasticity. How has the federal reserve system remedied this defect?

We have just seen how by increasing the mobility of bank reserves, the federal reserve system has enabled bank funds in the form of deposit credits to flow quickly to any section of the country where bank funds are much needed. This mobility of funds is often spoken of as depositcredit elasticity. In the present discussion, however, we are using the word elasticity in its stricter sense of "expansibility and contractility," and do not include in the term mere mobility of funds, namely, their capacity to move quickly and with little friction from one place to another.

The federal reserve system increases the elasticity of our deposit currency in a number of ways. In the first place, it has removed the rigid legal reserve requirements of our former national banking system and has put in their place much less rigid ones. The only legal reserves now required of national banks are the deposited reserves in the federal reserve bank. For till money banks are permitted to hold in their own vaults as much or as little money as they individually need, and the kinds of money they desire.

Federal reserve banks in turn are required to keep against deposits a legal reserve of lawful

money equivalent to 35 per cent. Unlike member banks, however, the federal reserve banks are not strongly pressed by competition and by the desire for profits to take up all the slack and reduce their reserves in ordinary times to this normal legal minimum. There has been no evidence that federal reserve banks will keep their credit extended to the legal limit, as individual banks have so widely done in the past. Despite the urgent need of funds brought about by war conditions, our federal reserve banks have adopted the policy of maintaining reserves well above the legal minimum. They have little profiteering motive to reduce their reserves to a dangerously low figure, because all the profits of federal reserve banks above a six per cent cumulative dividend to the stock owned by member banks go

to the Government. Fortunately there has ap

5The law (as amended March 3, 1919) provides that after the 6 per cent cumulative dividend claims have been met, the net earnings of each bank shall be paid to the United States as a franchise tax; except that the whole of such net earnings shall be paid into a surplus fund until the surplus shall amount to 100 per cent of the subscribed capital stock. After this 100 per cent surplus is accumulated, 10 per cent of the net earnings, above 6 per cent dividend charges is to be added annually to the surplus. Upon the liquidation of a federal reserve bank or the withdrawal of a member bank none of this surplus goes to the member banks. Ultimately it all goes to the Government.

Although the federal reserve banks are administered with the primary object of public service rather than profit, they have none the less realized good profits on the capital invested. For the year 1917 the net earnings for all 12 banks represented 18.9 per cent of the average paid-in capital, for the year 1918 72.6 per cent, and for the year 1919 98.2 per cent.

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