VII

INDEPENDENCE OF THE RESERVE BOARD.

The question is often asked as to wherein the political character of the Federal Reserve Board was essentially changed from the House Bill since a new Administration during its term of office can change the character of the board. An illustration from life insurance may make this clear. Formerly any suicide forfeited his life insurance. Under the modern insurance policy, the man who does not commit suicide within a reasonable time is not regarded as having taken out a policy in fraud or with intention to commit suicide. If he commits the act years afterward, it is due to mental aberration, sickness, or causes not contemplated when he took out the policy. There is a change of state that causes the act, and he can be insured against this just as against any other form of accident or illness.

When a new Administration comes in, it places upon the Federal Reserve Board of seven members a new Secretary of the Treasury and, possibly, a new Comptroller of the Currency and during the first year nominates a new member of the Board. Then for two years

the new Administration is in the minority.

If in that time the conservative members of the Board, appointed for ten years, have not been able to educate their new associates to their form or methods of control, it is time for a seasonable change and the Administration may then prevail. But there has been nothing accomplished by haste or hasty radicalism, and four of the nine members during that Administration with their presumably large experience are there to watch and protect. And there are behind them the regional reserve banks with their six out of nine directors elected by member banks and there is also the advisory council created by Section 12, and elected by Federal reserve bank directors, one for each Federal reserve district. They meet at least four times a year in Washington to (1) "confer directly with the Federal Reserve Board on general business conditions;" (2) "to make oral or written representations concerning matters within the jurisdiction of said board"; (3) "to call for information and make recommendations in regard to discount rates, re-discount business, note issues, reserve conditions," etc.

Under these restraining influences it is safe to say that it would take two Administrations to fully change the character of the Board, and if the Board were rightly constituted at first it would, by practical education, convert radicals to conservatives.

The members of the Federal Reserve Board have little to look forward to beyond their ten years of service and the honor of such service. To perform their duty aright they must be unpopular and they are forbidden to enter the banking business, for two years after they retire, by "any office, position, or employment in any member bank."

The danger in the Federal Reserve Board membership is that an unscrupulous Administration might pay its political debts through two terms by the appointment of weak or incompetent men thereto. But this would reflect upon the Administration. The Board's usefulness and influence might then gradually disappear and the conduct and conservation of the banking system remain with the Federal reserve banks, whose directors being appointed by the member banks in that district must for safety take up the duties of conservation so far as the Federal Board dropped them.

Should there arise an issue between the different sections of the country a weak Federal Reserve board forcing low discount rates, which might be availed of in the newer sections of country— the older reserve sections might immediately conserve their reserve forces through their foreign agencies or establish foreign branches as they may do under this Act, and discount abroad for reserve purposes, and answer to the Federal Reserve Board, when called upon to re-discount for the newer sections, “We are full up and you cannot ask us to pay the legal penalties for drawing upon our reserves. You can transfer your Government money to the weaker banks and be responsible for their security, but you can take your choice between letting us alone or permitting us to withdraw and dissolve the regional reserve bank in our district, after which you may set it up again by any public subscription you may be able to command."

It would seem therefore as though the protection against radicalism, within or without, or from Washington, or from political parties, was fairly complete.

Its completeness is due to the pressure the Administration put upon Congress for prompt passage of some bill before Christmas, and Congress had to throw matters of dispute into the powers of the Federal Reserve Board. To get the banks to come into the system, they gave the control of the regional banks to the member banks, and threw in other safeguards.

The possibilities of expansion, both in note issue and re-dis

counts, by a possible conspiracy between all the member banks and regional reserve banks and the government at Washington, may be later considered academically.

Such expansion, however, from a practical point of view can be better considered in a year or two, when the regional reserve banks have, as contemplated in the Act, established foreign agencies and branches and entered the discount markets of the world and brought home the instrumentalities of exchange common in Europe, such as international drafts, endorsed bills, acceptances, etc.

The powers of this act are so broad as to put our national banking system into the markets of the world for everything in the way of loaning, or buying, gold and exchange and lending and accepting on pretty much everything from gold to merchandise; but to the member banks is reserved the dealing in, and loaning upon, stocks and bonds. The regional reserve banks must deal with gold and the instruments of exchange which relate to merchandise and commerce. In their vaults must be kept gold, money and commercial bills or acceptances based upon the commerce of the country. This gives great possibility of expansion in the stock and bond market to all member banks and state banks and trust companies and private bankers. Fundamentally, the new bank act relieves Wall Street, not only of a part of its bank reserves, but of its commercial paper, and leaves it with opportunity to grow on a sounder investment basis, and to grow as it never grew before.

VIII

REDUCTION IN BANK RESERVES.

A large portion of the trouble in the American banking system has arisen from a high fixity of reserve without penalty in fines, or any regulated interest rates, when depositors draw their money from bank reserves. Banks under the National Bank Act are forbidden to make new loans the moment there is a deficiency in their reserve requirements but they are permitted to renew existing loans. The moment a bank refuses to discount for its depositors, the withdrawal of reserves by the depositors begins.

All novices in banking fail to understand why deposits disappear when loans are curtailed. They do not realize that deposits arise largely from loans.

The bank president who does not understand that discounts. make deposits is very much in the position of the old lady who declared that throughout her life she had never been able to understand why her hens were the most obstinate in the world. Whether she brought up Plymouth Rocks or Rhode Island Reds, when eggs commanded good prices her hens would never lay. When business is booming and money is in demand the conservative bank president is apt to curtail his loans and then wonder why his deposits run lowhe finds his hens won't lay. Also when a bank strikes its fixed reserve and refuses to loan, away fly the deposits.

What fixity of reserve means may be illustrated from the fact that with $3,400,000,000 money as at present in the country a general requirement of 25% for state and national banking reserve would absorb all the money in the country when the deposits in the banks reached four times this sum, or $13,600,000,000.

Individual deposits in national and state banks last June were just about $12,700,000,000. Fortunately, however, the cash reserves in the state banks and trust companies were only $532,000,000, against $890,000,000 in the national banks. The deposits of the state banks (including trust companies) were the larger by 10%, yet their cash reserves were $360,000,000 less. Had the state banks attempted to carry cash reserves equal to the national banks, we should have been in financial trouble.

In December, 1913, the country was bumping along with little

margin in its banking reserves and business by no means at the maximum. Had the reserves with state and national banks been universally at 25%, the people could have held in their pockets (on the basis of their bank deposits) less than $2 per capita.

The 7500 national banks in the country carry about $900,000,000 cash, which, applied to the individual deposits of $6,000,000,000, makes a cash reserve of just about 15%.

These figures do not include credits between banks. The banking system is here treated as a unit in respect to what it owes individual depositors and what it holds in cash to meet the individual depositors' liability.

Altogether, the state and national banks hold steadily month in and month out about $1,400,000,000 in money, which is 44% of the money the Treasury Department, by its figures, declares monthly to be "in circulation."

With the money in savings and private banks this 44% may sometimes approach 50%, or one-half the money of the country.

Any encroachment upon this half of our money is viewed with alarm, and any serious dip into it creates such a panic as causes people to use the lever of $12,700,000,000 of deposits to get their part of the $1,400,000,000 of money remaining in the banks as reserves. Including savings and private banks the total of individual deposit is easily about 17 billions.

Some bankers have declared that any fixity of reserve is a danger and that there should be no such fixity. They maintain that any bank reserves should be according to the necessities of the situation; that while some bankers might very properly conduct their business year in and year out with no more than 5% of their deposits in their cash drawer, other bankers according to the character of the demands. upon them might well require nearer 50%, and that fixity of reserve creates alarm instead of confidence.

Reverting to the above figures it may be noted that the national banks and state banks combined hold only 11% of their deposits in cash reserve. It may well be doubted if this percentage of reserve ever varies materially in normal times. Reinforced by United States Treasury moneys and other reserve moneys properly centralized it may well be reduced as is contemplated in the Reserve Act.

Recent computations have been made indicating that the gigantic banking business of Great Britain is carried on with less than 7% of reserve moneys,-61% is the actual figure. All effort from economic writers and theorists of the whole world to induce England to carry a larger gold reserve has been unavailing. In the first ten years of this century England did not increase her gold by so much