7/17/2019 frsbog_mim_v22_0257.pdf

http://slidepdf.com/reader/full/frsbogmimv220257pdf 1/7

TO: The  Fed er al Res erv e Board X-431 4

257

F ro m: Di v i s i o ns

  o f

  Bank Ope rat ion s

  3;nd

  Res ea rch

  a n d

  S t a t i s t i c s .

THE

  MCFAD3EN BILL

  TO

  REVISE

  THE

  FEEERAL RESERVE

  ACT

Genera l purposes  o f t h e  amendments

T h e  amendments  t o t h e  F edera l Res erv e  A c t  pro po s ed  by  Congressman McFadden

i m m e d i a t e l y p r i o r  t o t h e  adjournment  o f t h e  l a s t Co ngres s a pp a re nt l y ha v e  two

p u r p o s e s :  ( 1 ) T o  r e e s t a b l i s h  a  c l o s e r c o n n e c t i o n b e t w e e n  t h e  volume  o f  F edera l

r e s e r v e n o t e s  i n  c i r c u l a t i o n  a n d t h e  currency requ i rements  o f  bu s i ne s s . Wi th

t h i s  i n  v i ew  t h e  b i l l p r o h i b i t s  t h e u s e b y  t e s e r v e b a n k s  o f  g o l d  a n d o f  a c c e p -

t a n c e s p u r c h a s e d  i n t h e  open market  a s  c o l l a t e r a l  f o r  F e d e r a l r e s e r v e n o t e s ,

l e a v i n g d i s c o u n t e d p a p e r  a s t h e  s o l e a u t h o r i z e d c o l l a t e r a l .  ( 2 ) T o  reduce  t h e

l end i ng po wer

  o f t h e

  res erv e ba nks ,

  b y

  permitt ing member banks

  t o

  withdraw from

t h e  res erv e ba nks ,  a n d t o  h o l d  i n  t h e i r  ow n  v a u l t s ,  a  p a r t  o f  t h e i r r e q u i r e d

r e s e r v e s .  #

Both

  o f

  t h e s e o b j e c t s a p p ea r

  t o b e

  b a s e d l a r g e l y

  o n

  m i s c o n c e p t i o ns a r i s -

i n g  f ro m i m p e r f e c t a p p r e c i a t i o n  o f t h e  e x p e r i e n c e  o f t h e  s y s t e m .  The  f i r s t  o f

them assume s t ha t  t h e  volume  o f  F e d e r a l r e s e r v e n o t e s  i n  c i r c u l a t i o n c u r r e n t l y

depends upon  t h e  c h a r a c t e r  o f t h e  pa per  o r  o t h e r c o l l a t e r a l w h i c h  m a y b e  us ed

a s  c o v e r  f o r t h e  n o t e s ,  b u t  e x p e r i e n c e  h a s  d e m o n s t r at e d t h a t t h i s  i s n o t t h e

c a s e . N o t e s

  g e t

  i n t o g e n e r a l c i r c u l a t i o n o n l y w he n c u s t o m e r s

  o f

  member

  o r

nonraeiaber banks withdraw currency  t o  meet t h e i r cu rr en t ne e ds . Member banks

r e t a i n  i n  t h e i r  o w n  v a u l t s o n l y su c h  a n  amount  o f  c u r r e n c y  a s  they need  t o

meet da i l y requ i rements , beca us e

  i t

  does

  n o t p a y

  t h e n

  t o

  keep more,

  a n d i t i s

o n l y when th es e da i l y requ i rement s i n cr ea s e ,  b y  reason  o f t h e  demands  o f t h e

pu b l i c , th at member banks f i n d  i t  n e c e s s a r y  t o  ob ta in more curr enc y from  t h e

r e s e r v e b a n k , u s i n g

  a n y

  a c c e p t a b l e c o l l a t e r a l t h a t t h e y

  n a y

  h a v e .

  The

7/17/2019 frsbog_mim_v22_0257.pdf

http://slidepdf.com/reader/full/frsbogmimv220257pdf 2/7

258

- 2 -  X-4314

e l a s t i c i t y

  o f t h e

  Federal reserve note doas

  n o t

  depend

  o n t h e

  c h a r a c t e r

  o f

c o l l a t e r a l that- member banlcs

  u s e t o

  obt ain curr ency . Federa l res erv e no tes

i s su ed ag a in s t go ld cone  i n f o r  re t l i r cnent  a s  prompt ly  a s  r o t e s s e c u r c d  by

commercial paper.  I t i s  through  t h e  Fe de ra l r e s e r v e barics -  m e e t i n g  t h e c u r -

rency demand when  i t  a r i s e s t h a t  t h e  amount  o f  currency  i n  c i r c u l a t i o n  i s c o n -

s t a n t l y a d j u s t e d

  t o t h e

  requirements

  o f

  b u s i n e s s .

The

  provis ion author iz ing member banks

  t o

  hold par t

  o f

  t h e i r r e s e r v e s

  i n

t h e i r  ow n  v a u l t s , w h i c h  i s  apparent ly in t ended  t o  d i m i n i s h  t h e  lending power

o f t h e  re se rv e banks, through  a  r e d u c t i o n  o f  t h e i t r e s e r v e s , w o ul d h av e l i t t l e

e f f e c t , when t aken  i n  conj unc t i on w i t h  t h e  other proposed amendments, because

member banks would have  no  inducement  t o  e x e r c i s e t h e i r o p t i o n  t o a n y  e x t e n t .

That port ion

  o f

  t h e i r re so urce s which

  t h e l a w o r

  e x p e r i e n c e r e q u i r e s

  t h e

  member

banks  t o  h o l d  a s  re ser ve s would remain in ac t i ve  a n d  unproduc t ive  o f  earn ings ,

under  t h e  proposed amendment  a s i t i s  under ex i s t ing laws ,  a n d a  mere trans-

f e r o f  re se rv es from res er ve banks  t©  member banks would  n o t  i n c r e a s e  t h e

member banks

  1

  lending power

  o r

  e a r n i n g c a p a c i t y ,

  b u t

  wo uld mere ly reduce

  t h e

l ending power  o f t h e  reserve banks#

  %

Gold with

  t h e

  r e s e r v e a g e n t s

  n o t t o

  count

  a s

  r e s e r v e s

The  p r o v i s i o n  i n t h e  McFadden b i l l th at g ol d h e l d wi th  t h e  F edera l  r e -

serve agent sha l l  n o t  count  a s  p a r t  o f t h e  r e s e r v e s  o f t h e  reserve bank  i s a

repea l  o f a n  amendment adopted  i n 1 9 1 7 ,  p r i n c i p a l l y  f o r t h e  purpose  o f f a -

c i l i t a t i n g n ot e i s s u e s

  a n d

  p e r m i t t i n g

  t h e

  reserve banks

  t o

  count

  a l l t h e

  gold,

whether he ld  b y t h e  a g e n t  o r b y t h e  reserve bank,  a s  p a r t  o f  t h e i r r e s e r v e s #

Notes were exchanged  f o r  g o l d p r i o r  t o t h e  amendment butthis  w a s  accompl ished

i n a  roundabout  w a y , a n d i t w a s  thought best  t o  a u t h o r i z e  t h e  direct exchange#

7/17/2019 frsbog_mim_v22_0257.pdf

http://slidepdf.com/reader/full/frsbogmimv220257pdf 3/7

- 3 -

  X-4314

The  e f f e c t  o f  this proposal  a t t h e  pr es en t time would be.that  o f t h e

$1,700,000,000

  of

  Federal reserve notes

  i n

  ci rc ul at io n, only about $400,000,000

could continue

  t o be a

  l i a b i l i t y

  of t he

  reserve banks because this

  i s t h e

total amount  of  disc ount ed paper hel d  b y t h e  twelve re se rv e ban ks. Against

t h e  remainder  o f t h e  no tes ,  t h e  Federal reserve agents  now  hold gold  a n d i n

order  t o  comply with  t h e  proposed amendment  t h e  re se rv e banks would have  t o

fo l low

  one of two

  courses ; e i t he r

  t o p a y

  this gold

  b u t

  i n t o c i r c u l a t i o n

  i n e x -

change  f o r a n  equivalent amount  o f  Federal reserve notes;  o r t o  impound  t h e

gold with  t h e  agent  to be  h e l d  by him  e x c l u s i v e l y  f o r t h e  redemption  of  notes.

The  reserve banks would probably adopt  t h e  procedure  of  l e t t i n g  t h e

$1,300,000,000

  o f

  gold held

  b y t h e

  agents

  a s

  cover

  f o r

  notes

  b e

  a p p l i e d

  to t he

r educ t ion

  o f t h e

  barks

1

  l i a b i l i t y

  on

  re se rve no te s. Thus

  t h e

  gold

  a s a n a s -

s e t a n d a n  equivalent amount  of  notes  a s a  l i a b i l i t y w o u l d  b e  taken  out of

t h e  reserve banks

1

  balance sheet  a n d  would appear only  i n t h e  account  of t h e

Federal res erv e ag en ts . Under pr es en t con dit ion s  t h e  reserve banks would

a f t e r t h i s t r a n s a c t i o n s t i l l h a v e

  a

  r e s e r v e

  of

  about

  6 0 p e r

  cent against

their combined note

  a n d

  de po si t l i a b i l i t y .

  I n

  some

  o f t h e

  reserve banks,

however,  t h e  resul t would  b e a  d e f i c i e n c y  of r e se rve s even  a t t h e  pr es en t t ime.

The  reserve banks could increase  t h e  volume  of  p a p e r e l i g i b l e  a s  note

cover  a t  t h e i r d i s p o s a l ;  i . e . ,  p a pe r e l i g i b l e  a s  cover under  t h e  amendments,

b y

  se l l ing accep tances

  a n d

  s e c u r i t i e s

  a n d

  thereby causing member banks

  t o

discount paper with  t h e  rese rv e banks. While te ch ni ca l l y th is would  be a

method  of  i n c r e a s i n g  t h e  volume  of  p a p e r e l i g i b l e  f o r  note cover,  i t  would

involve  a  complete withdrawing  of  Federal reserve banks from open-market

opera t ions .

Under

  t h e

  McFadden proposal

  t h e

  note- i ssuing power

  o f t h e

  reserve banks,

7/17/2019 frsbog_mim_v22_0257.pdf

http://slidepdf.com/reader/full/frsbogmimv220257pdf 4/7

  k

- 4 -  X—'-JlU

which  is new  l i m i t e d  by  reser ve requirements , w i l l  oe  l i m i t e d  i n  adJ.i t ion

b y t h e  amount  of  el ig ib le paper avai la.be  a s  c o l l a t e r a l  f o r  note i s sue .  As

po in t ed  o u t  ea r l i e r , t h i s add i t i on a l l im i t a t i on does  n o t  i n c r e a s e  t h e e l -

a s t i c i t y  o f t h e  reserve no te  b u t  merely erects  a  cumbersome piece  of  mach-

inery that might under cer ta in condi t ions prevent  t h e  smooth performance

of

  t h e i r f u n c t i o n s

  by the

  reserve banks.

  A

  si tu at io n might even ar is e ,

under

  t h e

  proposed amendment, where reserve banks,

  by

  reason

  of l ow re -

se rves  - n d  shor tage  of  e l i g i b l e paper , cou ld  n o t  issue Federal reserve

n o t e s  to  memoir banks unless these banks borrowed  $ 3 . ~ 0  from  t h e  reserve

banks,  and  kept $2.00  of  t h i s  on  deposit with  t h e  reserve banks,  i n  order

t o  obtain  $ 1 .0 0 o f  Federal res erv e not es . Under cond i t ion s  of  unusual

c r e d i t

  and

  currency demand, therefore,

  t h e

  McFadden amendment would cause

u n n e c e s s a r y d i f f i c u l t i e s

  to our

  banking system,

  and

  since

  t h e

  t e s t

  of t he

soundness  of a  banking system  i s t he way i t  would stand  u p  under  a  s t r a i n  —

t h i s  i s a  serious argument against  the . propo sa l .

I n

  cons ide r ing

  t h e

  poss ib l e e f f ec t

  of

  these amendments

  i n

  decreasing

t h e

  gold re se rv es

  o f t h e

  reserve banks through fur ther increases

  of

  gold

  i n

c i r c u l a t i o n ,  t h e  fact should  n o t b e  overlooked that  th e  gold  now  he ld  by

t h e  reserve banks  f o r t h e  most part  was n o t  withdrawn from domestic ci r c u l -

a t i o n  but was  i mpo rted f rom abroad*  As th e  r e s u l t  o f  paying  o u t  gold cer t -

i f i c a t e s  t h e  volume  of  gold  i n  c i r c u l a t i o n  a t t h e  present t ime  i s  nea r ly  a s

l a r g e  a s  be fo re  t h e  system  was  e s t a b l i s h e d ,  a n d t h e  reserve banks  i n r e -

cent months have also

  met out of

  the i r r e se rves

  a

  considerable demand

  f o r

gold

  f o r

  export .

7/17/2019 frsbog_mim_v22_0257.pdf

http://slidepdf.com/reader/full/frsbogmimv220257pdf 5/7

The

  c hi e f e f f e c t

  o f t h e

  pro po s ed

  :• man

 demerit r e l a t i n g

  t o

  &old cover

appears  to b e t J  lower  t h e  r e s e r v e r a t i o  o f t h e  re ser ve banks  b y i m -

pounding  a  p a r t  c f  the i r res erv es w i th  t h e  F e d e r a l r e s e r v e a g e n t s .  At

a  time when reserves  a r e  ample,  a s a t  p r e s e n t ,  t h e  impounding  o f t h e

gold would

  n o t

  b r i n g

  th e

  res erv e ra t i o nea r

  t h e

  l e

e

,al minimum,

  b u t

u n d e r c o n d i t i o n s  o f  except ional ly large demand  f o r  c r e d i t  and  currency

t h e

  amendment woulj interfere with

  t h e

  smooth operat ion

  o f t h e

  reserve

banks  and  might make ne ce ss ar y  a  s us pens i o n  o f  res erv e requi rements .

A c c e p t a n c e s i n e l i g i b l e

  a s

  c o l l a t e r a l a g a i n s t n o t e s

I n  p r o h i b i t i n g  t h e u s e o f  a c c e p t a n c e s  a s  c o v e r  f o r  Federal res erv e

n o t e s ,  t h e  amendment pl ac es a cc ep ta nc es  i n  regard  t o  i n e l i g i b i l i t y  s-s

c o v e r  f o r  n o t e s  o n t h e  s ame f o o t i n g w i t h U n i t e d S t a t e s s e c u r i t i e s ,  t he

o t h e r c l a s s  o f  open-market pu rc ha se s  Of the  re se rv e banks . Accep tance s ,

however ,  a r e a s  d i r e c t l y c o n n e c t ed w i t h  t h e  f i n a n c i n g  o f  c u r r e n t b u s i -

n e s s  a s a r e  pro mi s s o ry no tes ,  an d  r e f l e c t  t h e  underly ing commercia l

t r a n s a c t i o n s

  i n

  c o n t r a s t

  t o

  paper secu red

  b y

  U n i t e d S t a t e s o b l i g a t i o n s

whi ch  i s n o w  e l i g i b l e  and  would continue  t o be  e l i g i b l e u nd er  t h e

amendment,

  t o

  s e r v e

  a s

  cover

  f o r

  Federa l res erv e no tes .

  I t i s

  probable

t h a t  t h e  o b j e c t  o f  this amendment  i s n o t s o  much  t o  i n c r e a s e  t h e  e l a s t i c -

i t y o f t h e

  Federa l res erv e no te

  a s t o

  l i m i t

  t h e

  rese rv e oanks ' open-

market operat ions .

7/17/2019 frsbog_mim_v22_0257.pdf

http://slidepdf.com/reader/full/frsbogmimv220257pdf 6/7

Autuc r i t y

  t o h o i J

  p a r t

  of

  r e se rves

  i n

  numbers

1

  vau l t s

The

  proposa l

  t o

  au th or iz e member banks

  t o

  hold par t

  of

  their required

r e s e r v e s

  i n

  t h e i r

  own

  vaults would

  i n i t s

  p r e s e n t form per n. it member banks

t o

  count

  a s

  p a r t

  of

  t- ie i r reserves

  t h e

  vault cash which they

  now

  ca r ry

  a s

t i l l money•  I f t h e  amendment were adopted without increasing  t h e  reserve

requirements

  o f

  member banks,

  i t

  would make a v a i l a b l e

  t o t h e

  member banks

about $5vC,vCv,CGv which they could

  u s e

  e i t h e r

  a s a

  b a s i s

  f o r

  add i t i ona l

l end ing

  o r to

  reduce indebtedness

  a t t h e

  r e s e r ve banks* When

  i n 1 9 1 7 r e -

serve requirements changed

  so as to

  make only balances

  a t t h e

  reserve

banks count

  a s

  lega l rese rves

  f o r

  member banks,

  a t t h e

  same time required

reserve percentages were reduced

  in

  recogni t ion

  of the

  f ac t t ha t

  t h e

  cash

which member banks would continue  t o  car ry  i n  their vaul ts would  x?0  longer

count

  a s

  r e s e r v e s .

  The

  prese nt proposal

  to

  permi t

  t h e

  vaul t , cash

  of

  member

banks

  to be

  counted

  a s

  reserves without correspondingly increasing

  t h e

legal reserve requirements would result

  i n

  reduced borrowing

  a t t h e r e - .

serve banks  and in  member banks see kin g in cr ea se d inve stm ent  f o r  the i r

re leased funds .

I f t h e

  proponents

  o f the

  b i l l would upon con sid era tio n de cide

  t o i n -

c lude  i n t h e  amendment  an  inc rea se  i n  reserve requirements equal  to the

amount

  of

  cash

  i n

  v a u l t ,

  t h e

  proposa l would have re la t i ve ly l i t t l e e f f ec t

on the

  c r e d i t s i t u a t i o n .

7/17/2019 frsbog_mim_v22_0257.pdf

http://slidepdf.com/reader/full/frsbogmimv220257pdf 7/7

263

- 7 -  X-U^lU

E x ' l s t i n g p r o v i s i o n s  n o t  emergency measure s

The Mc Fad de n  proposa l  h a s  been genera l ly unders t ood  t o  have  t h e  obj ec t

o f  r e s t o r i n g  t h e  Federal Reserve  A c t t o i t s  o ri g in a l form through repea l

of war  time amendments. Exp eri enc e in di ca te s th at  t h e 1 ^ 1 ?  amendments,

though the ir passage  may  have been exped ite d  by th e war  emergency,  a r e n o t

i n t h e

  n a t u r e

  o f

  emergency pr ov i s io ns ,

  b u t a r e a

  l o g i c a l r o u n d i n g

  cut o f

t h e  reserve sys t em.  In  e f f e c t  t h e  McFadden p r o po s a l would hav e  t h e  system

r e t u r n

  t o t h e

  i d e a s

  and

  t h e o r i e s

  o f t h e

  framers

  o f t h e

  Federal Reserve

  A c t

p r i o r  t o t h e  s y s t e m ' s e s t a b l i s h m e n t ,  and  wo ul d t h u s s a c r i f i c e  t h e  l e s s e n s

o f  prac t i ca l exper ience acquired dur ing  t h e  decade  o f i t s  o p e r a t i o n ,