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

• 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.

4 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?

This

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. 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.

peared no evidence of competition among the federal reserve banks to see which can show the largest profits. Under the leadership of the federal reserve board, the great emphasis has been on competition for public service. The result is that the federal reserve banks have been conserving their strength for times of emergency. Under such circumstances the federal reserve banks should have substantial powers of credit expansion to call upon in times of emergency, before their reserve position is forced down to anything like the 35 per cent legal limit.

This limit itself, however, is not a rigid one. It may be passed in times of extreme emergency, although only by paying a price. The federal reserve law provides, as we have previously noted, that the federal reserve board may "suspend for a period not exceeding thirty days, and from time to time. . . renew such suspension for periods not exceeding fifteen days, any reserve requirement specified in this act: provided, that it shall establish a graduated tax upon the amounts by which the reserve requirements" against deposits are permitted to fall below the level of 35 per cent (Section 11). Inasmuch as this tax would presumably be added to the rate of discount charged by the reserve bank, there would be an increasingly heavy charge upon loans made when the reserve was below the normal legal minimum. None the less, such loans could be

made without limit to those who could give the security and would pay the price.

The most important device of the federal reserve system for securing elasticity of deposit currency, as well as of bank-note currency," is found in the machinery enabling member banks to borrow funds of their federal reserve bank. Funds so borrowed, when left on deposit with the federal reserve bank, serve as legal reserve money for the member banks. The making of such loans to member banks is one of the chief functions of federal reserve banks. Broadly speaking the loans are of two kinds, rediscounts, and loans on collateral. Let us consider briefly each of these types of loans.

Rediscount

Federal reserve banks always stand ready to rediscount in time of need eligible paper for member banks.

A member bank, say a country bank, whose reserve is in danger of running below the 7 per cent of demand deposits, and 3 per cent of time deposits, required by law, or which is in need of more cash for till money, may take, say $10,000 of its eligible commercial paper to its federal reserve bank and have it rediscounted for, say, 60 days at 42 per cent. The proceeds would be $9,925, which at 7 per cent would represent a legal reserve sufficient for $141,714 of demand deposits, and would therefore greatly increase the bank's lending power. Any part of the proceeds of the rediscount in excess of that needed to maintain the bank's 7 per cent legal reserve with the federal reserve bank could be checked against and taken in cash, presumably in federal reserve notes, for the bank's till money.