the largest that had yet been asked from the country, as then estimated. In the spring of 1919 it appeared that the amount of the Victory loan might be $6,000,000,000. And not only that, but the post war expenditures of this great war machine that had been set up by the Government made its expenditures still in excess of its In other words, the volume of Government borrowing was increasing.132

revenues.

The Federal Reserve Bulletin for December 1918, described the post-war problem as one of preventing credit from expanding too far and of reducing so far as practicable any excess then existing.133 The Bulletin continued:

With the return of peace, the close of the period of urgent Government financing through the sale of long or short term obligations comes in sight, and the resumption of their function as a regulator of credit becomes a duty for Federal Reserve Banks.

The Bulletin recommended as a program of financial reconstruction that the loans on war paper be reduced, that government bonds be absorbed by the public through savings, that portfolios of banks be made more liquid, that loans for non-essential industries be curtailed and that members of the Reserve System desist from rediscounting steadily.

Obstacles in Way of Raising Discount Rates. The hope expressed by the Board that it might soon regulate and control credit through the discount rate and that member banks might cease rediscounting steadily was not realized. The financial necessities of the Government and the methods utilized by the Treasury in floating its obligations prevented the Reserve System from raising its rates. In the Bulletin for June 1919,134 it is explained that the failure to check speculation by advancing discount rates was due to the necessity of promoting the absorption of government securities. It will be remembered that the Reserve Banks had agreed, as a means of facilitating the flotation of the Victory loan, to carry the commercial banks of the

132 Part 13, pp. 763-764. See, also, Forgan, Currency Expansion and Contraction, p. 170. Through this period the New York Bank took the position that increases in rates had to be the main reliance for bringing about deflation, Federal Reserve Board Conference, May 18, 1920, p. 46.

133 P. 1164.

134 P. 524.

country for six months at rates equal to those borne by the notes. Another factor standing in the way of advancing the discount rates, which seemed quite an obstacle to the Treasury Department, was the deposit rate agreement reached between several of the Reserve Banks and the clearing house banks located in the financial centers.

The Deposit Rate Agreement. Early in 1918 some of the larger banks throughout the country began to compete sharply with one another for bankers' balances offering inducements in the form of increased rates of interest.135 On the 26th of February Governor Harding issued a statement deprecating this practice and explaining that in diverting funds from the interior it tended to interfere with government financing.136 As a result of his apprehensions the clearing house banks in New York agreed to fix a minimum rate of 24% on bankers' balances payable on demand which would be increased by 4 of 1% for every advance of 1⁄2 of 1% in the Bank rate on ninety-day commercial paper. In any event the deposit allowance rate was not to exceed 3%.137 As this agreement continued after the armistice, the Board feared through 1919 that an advance in the ninety-day rate at the New York Reserve Bank might lead to a scramble for deposits and disturb the whole banking situation.138 Toward the end of 1919 the Board had become convinced of the necessity of raising the Bank rate and of modifying the agreement. Accordingly it invited clearing-house associations to send representatives to attend a conference to be held in Washington on the 6th of January 1920. The consensus of opinion at this conference was that the existing agreement was not satisfactory and that the Reserve Banks should be free to establish their rates of discount without reference to the interest paid on bankers' balances.139 At a second conference held in Chicago on January 23, the resolution was adopted that the present agreement be abrogated and that banks and trust companies in the various reserve districts pay no more than 24% on the net and available daily balances of banks and trust companies. 140 On the date of the abrogation of this agreement the 135 Federal Reserve Bulletin, 1920, p. 3.

136 Ibid., 1918, p. 160.

137 Ibid., 1920, p. 3, and Norton, Bank Rate in the United States, p. 480. In July the Chicago Clearing House banks adopted the same agreement. 138 Sixth Annual Report of the Federal Reserve Board, p. 4.

139 Federal Reserve Bulletin, 1920, p. 157.

140 Ibid.

rate on ninety-day commercial paper at the Federal Reserve Bank of New York which had stood at 434% since April 6, 1918, was advanced to 6%.

Another obstacle preventing the Reserve Banks from increasing their rates through this period was the fear on the part of the Treasury that a policy of deflation would bring in its wake a period of depression, unemployment, and radicalism, and would impede the rapid re-absorption of soldiers into industrial life. The price theories held by the Board and its skepticism of the efficacy of the Bank rate might also in some measure account for the delay in advancing the rates. These obstacles were not insurmountable. Far better it would have been for the Treasury to have altered its method of selling its obligations and for the deposit allowance agreement to have been abrogated immediately following the armistice than for the Bank rates to have been held to artificially low levels.

Through November and December, 1919, all rates of discount at the Federal Reserve Bank of New York except those on agricultural paper and on ninety-day commercial paper were advanced. This action which was really a turning point in the policy of the System was foreshadowed in the Bulletin for October and November. In the Bulletin for October 141 the Board reviewed its war-time discount policy and set forth some of the difficulties standing in the way of an effective control of credit. It stated:

The disappearance of the Treasury from the long-term loan market and the rapid reduction of its requirements for short-term accommodation foreshadows the approach of the time when financial operations of the Government will cease to be the important factor in shaping Reserve Bank policies which they have been, and Federal Reserve Bank rates once more will be fixed solely "with a view of aiding commerce and business."

In the November Bulletin the Board said: 142

A review of all the conditions in the banking situation has confirmed the Board in the view that in the application of its discount policy an advance of rates should no longer be deferred.

In pursuance of these policies advances were made in the rates. of discount. Few believed that the slight increases which had

141 P. 910.

142 P. 1011.

been made were final. It was recognized that others must follow. subsequently.

In January 1920, the System was finally freed from Treasury domination and the deposit rate agreement with the result that on the 23rd of the month further increases were made. These, the Board stated, were an effort to restrict the rapid growth in credit which had not declined as it should with the passage of the holiday trade. 143 Rediscounts continued to grow and market rates continued upward which forced another advance in the Bank rates the first of June. In reading through the Bulletin we find that the objects the Board desired to attain by raising the Bank rates were several. The advances in the discount rate,

it is stated, were intended to restrict the rapid growth of credit, to regulate and govern the flow of credit with careful regard to the economic welfare of the country, and to restrict the speculative use of credit.144 In the June 1920 Bulletin the Board expressed the wish that credit expansions might be checked without curtailing essential production, an impossibility as we have explained. In another issue the Board declared that the Bank rate should be sufficiently high to eliminate the profitableness of rediscounting by the member banks.

The Phelan Act. Before 1913 national banks were not allowed to rediscount to an amount greater than their own capital. At the time of the passage of the Reserve Act this earlier provision was altered and an exception made in the case of the indebtedness of national banks to Reserve Banks. The result was that no limit was imposed on the amount of member bank borrowings from the Reserve Banks. During 1919 a few member banks began to borrow from Reserve Banks on such a scale that the

143 Federal Reserve Bulletin, 1920, p. 118.

145

"With the year 1920 the federal reserve banks entered upon the exercise of their function of regulating credit in accordance with business and economic conditions, and, under circumstances of extraordinary difficulty and for the first time since the outbreak of the war undertook to develop a policy of credit control by means of discount rates." At the same time the Treasury Department adopted the policy of adjusting interest rates on certificates of indebtedness to conditions in the money market. Miller, Federal Reserve Policy, p. 190.

144 Federal Reserve Bulletin, 1919, pp. 910-911, 1010-1011; 1920, pp. 223, 456, 582-583.

A number of conferences attended by officials of the Reserve System were held during 1920 on April 7-10, May 8 and 18, to discuss means of regulating and controlling credit.

145 In January, 1920, fourteen banks in Kansas City had absorbed 34 per cent of the normal lending power of the Federal reserve bank and nine Omaha banks had absorbed 23.5 per cent. Therefore, these two cities alone had

resources of the Reserve Banks would not have been sufficient to cope with the demand had all member banks borrowed proportionately,146 The excessive borrowings by a few banks was really in violation of the spirit of Section of the Act which directed the Board of Directors of each Reserve Bank to administer its affairs fairly and impartially and without discrimination in favor of or against any of the member banks, and to extend to each of the members such discounts, advancements and accommodations as might safely and reasonably be made with due regard to the claims of the other members. As a corrective for this condition the Board recommended the passage of what later came to be known as the Phelan Act. This Act, which was simply an amendment to subdivision d, Section 14, permitted the Reserve Banks, with the approval of the Board:

1) To determine the normal maximum rediscount line of each member bank, and

2) To fix graduated rates on an ascending scale applicable equally and ratably to all member banks rediscounting on a scale in excess of the normal line.

absorbed 57 per cent of the normal lending power of the Kansas City Federal Reserve Bank. There was a slight recession in the borrowings of these banks due to temporary seasonal deflation, in the early part of 1920, but by April, 1920, the fourteen Kansas City banks were absorbing 50 per cent of the normal lending power of the Kansas City Federal Reserve Bank and nine Omaha banks were absorbing 23 per cent, representing a total of 73 per cent of the normal lending power of the Kansas City Federal Reserve Bank, and leaving 27 per cent of the normal lending power available for the 1,063 other member banks in the Kansas City district.

In the period from April 19, 1920, to December 31, 1920, banks which had not been previously borrowing increased their borrowings to 12 per cent of the normal lending power of the Kansas City Federal Reserve Bank. During the same period the number of banks borrowing in the Kansas City Federal reserve district increased from 178, or 16.8 per cent of all the bank, to 416, or 38.3 per cent of all the banks. In the same period, the amount borrowed by all borrowing banks increased from $106,851,047 to $117,328,475. While banks not borrowing previously to April 19, 1920, when the progressive rate became effective, were increasing their borrowings, the borrowings of the fourteen Kansas City member banks paying the progressive rate decreased to 36 per cent of the normal lending power of the Kansas City Federal Reserve Bank, and the borrowings of the nine Omaha member banks paying the progressive rate decreased to 13 per cent of the normal lending power of the Kansas City Federal Reserve Bank. Interest Charges of Federal Reserve Banks, pp. 8-9

146 For a discussion of the need of the Phelan Act see Sixth Annual Report of the Federal Reserve Board, pp. 70-71, and Interest Charges of Federal Reserve Banks.