For the purpose of keeping the assets of federal reserve banks liquid, the law and the administrative regulations of the federal reserve authorities place rigid limitations upon the kinds of paper eligible for rediscount. These limitations have reference both to the length of time the paper is to run, and to the purpose for which it is issued. As to time, notes rediscounted must have a maturity at the time of rediscount of not more than 90 days (exclusive of days of grace); except that a limited amount of bills drawn for agricultural purposes or based on live stock may be rediscounted, provided they have a maturity not exceeding six months (exclusive of days of grace). As to the purpose for which the bills are issued, the law limits rediscounts to two classes of paper. They are: (1) Notes, drafts and bills of exchange bearing the endorsement of a member bank and "arising out of actual commercial transactions," that is, issued or drawn "for agricultural, industrial, or commercial purposes, or the proceeds of which have been used, or are to be used for such purposes"; and (2) Notes, drafts and bills of exchange bearing the endorsement of a member bank and issued or drawn for the purpose of carrying or trading in "bonds and notes of the Government of the United States." Except for United States Government securities, the law specifically prohibits the rediscounting

by federal reserve banks of paper issued or drawn "for the purpose of carrying or trading in stocks, bonds, or other investment securities."

Collateral Loans

The second type of loan is the discount of collateral notes of member banks. These notes must be for periods not exceeding fifteen days, and the only permissible collateral is "such notes, drafts, bills of exchange, or bankers' acceptances as are eligible for rediscount or for purchase by federal reserve banks," and bonds or notes of the United States Government. There was no provision in the original act for collateral loans, but experience soon showed that member banks frequently wished to secure from federal reserve banks advances for brief periods, so brief that they were reluctant to rediscount customers' paper for the purpose. To meet the difficulty an amendment to the federal reserve act was passed September 7, 1916, authorizing these short-time collateral loans. The authority to make such loans has proven to be particularly useful in connection with the financing by the banks of Liberty bond purchases either for themselves or for their customers-purchases which are likely to involve heavy drains upon the banks for very brief periods. During the years 1917, 1918, and 1919

these collateral loans have constituted by far the most important form of advance made by federal reserve banks to member banks. The great bulk of them are secured by United States certificates of indebtedness and Liberty bonds.

Contraction of Circulating Credit

So far we have been speaking of the elasticity of deposit currency under the new banking system in the direction of expansion in times of increasing currency demand. The contraction of deposit currency, as soon as the need for it falls off, is brought about by the pressure of high discount rates, to which the pressure of the graduated tax is added. This double pressure encourages borrowers to pay off their loans. This fact, and the increasing restrictions which federal reserve banks place upon rediscounts as money market conditions become easier, tend to contract the circulation of deposit currency and restore the reserves to a normal condition. In this respect a great public responsibility rests upon the federal reserve authorities to conserve the banking strength of the country in times of easy money, so that it can be called upon in times of emergency. Some critics of the federal reserve system believe that the machinery it provides for contracting both deposit and bank

note currency, in times of currency redundancy, needs strengthening. Upon this subject it is difficult as yet to pass a safe judgment because times have been so abnormal since the system went into operation.

There is no question but that the federal reserve system has added greatly to the elasticity of both our deposit currency and our bank-note

currency.

CHAPTER VIII

DOMESTIC AND FOREIGN EXCHANGE UNDER FEDERAL RESERVE SYSTEM

We may now pass to the consideration of the federal reserve system is meeting the diff ties of the old banking régime as regards mestic and foreign exchange. Domestic change will be considered first.

Domestic Exchange

Under the old régime the collection and cl ing of out-of-town checks for country banks handled largely by the banks in reserve and tral reserve cities, which were the depositories the legal reserves of the country banks. The vice of collecting these out-of-town checks rendered to the country bank as a partial co pensation for the use of its reserve deposits a low rate of interest, and as a lure to secure ot business from the country bank, competition h ing been keen among large banks in money m ket centers for the accounts of out-of-town ban When Congress decided, therefore, that the s