section under financial stress. This process, of course, will cause a flow of cash from the reserves of the former banks to the reserve of the latter, thereby easing the money market in the threatened section. .. [Thus] the reserves of the twelve reserve banks are so closely piped together . . . that they may reasonably be considered to be closely connected tanks of a single large reservoir. . . ... the member banks of any one Federal Reserve [There is also provision for the mobility of reserves between the and between banks of a single Federal Reserve district.] The forces which act for the increasing mobility of reserve money within the boundaries of a Federal Reserve district are essentially the same as those just explained for that between districts. Obviously [commercial] paper district. of wide acceptability flows from place to place within a district more freely than paper whose merits are less widely recognized; and, within a district as between districts, the widely marketable paper flows from the places where the discount rates are high and bank funds scarce, to the places where the rates are low and funds are more plentiful. Furthermore, the bank reserves of the district which have been piped to the one reservoir, namely, the Federal Reserve Bank, can be readily pumped to the banks of any section where funds are in heavy demand. If banks throughout the district were rediscounting in moderate sums with the Federal Reserve Bank, and if a sudden emergency should cause an exceptionally heavy demand for funds in any section, the Federal Reserve Bank could raise its rate of discount, thereby reducing the rediscount demands of the banks less urgently in need of the funds, and could then turn larger amounts into the section where the demand was heaviest. 1 to the centralization 186. Elasticity under the Federal Reserve System In addition to providing for the centralization and mobility of In addition bank reserves, the Federal Reserve Act secures a considerable degree of elasticity. Elasticity means that the amount of money or credit and mobility of reserves, will increase when a great deal of business is being transacted, and there is will decrease when business becomes slack. We have seen that under the Federal Reserve System, the reserves of the several districts 1 From Edwin Walter Kemmerer, The A B C of the Federal Reserve System. Princeton University Press, Princeton, N. J., 1920; pp. 50-53, 55-56, 61, 64-65. elasticity of money and credit. Bank-note currency: how it may be expanded and contracted. can be centralized and piped to banks where they are needed; it remains to be pointed out that there must be provision for enlarging the amount of money or credit when the mechanism of exchange is called upon to handle a great volume of business, and that when business has subsided there must be some way of reducing the amount of money and credit in circulation. Elasticity under the Federal Reserve System is explained by Dr. Kemmerer as follows: [First, the elasticity of the bank-note currency is secured by] the so-called Federal Reserve notes. These notes, which are obligations of the United States Government, and [are issued by the] Federal Reserve Banks, have back of them specifically pledged with the Federal Reserve agent to the amount of 100 per cent certain forms of high-grade collateral. . . . Except under special circumstances, a gold reserve of not less than 40 per cent must be kept by each Federal Reserve Bank against its outstanding Federal Re serve notes. As regards the matter of elasticity, these notes have in a high degree the quality of expansibility, namely, of having their circulation easily increased in times of need. If member banks in a given section of the country need an increased supply of currency to meet local demands, they may rediscount eligible paper with their Federal Reserve Bank and take the proceeds of the rediscounts in Federal Reserve notes, which pass readily as hand-to-hand money and are satisfactory till money for the banks. The Federal Reserve Bank, if its supply of notes is inadequate, secures, on application to the federal reserve agent, additional notes by depositing with the agent the rediscounted paper or other eligible paper in its portfolio. This process may continue as long as the Federal Reserve Bank has paper available for deposit with the Federal Reserve agent and its gold reserve does not fall below the normal legal minimum of 40 per cent. In case of great emergency, however, the Federal Reserve Board may permit a reduction of the note reserve below 40 per cent, provided it imposes a graduated tax upon the amount of the deficiency. . ... For the purpose of contracting the circulation of Federal Reserve notes when the business demands for currency decline, the machinery is as follows. When the demand for notes in the pockets of the people and the tills of the merchants falls off, as it does, say, after the harvesting season in the autumn, the surplus notes are deposited by the public in the banks. Inasmuch as national banks cannot count these notes in their vaults as legal reserve money, they will tend to send to their Federal Reserve Banks for deposit any notes they receive in excess of the amount needed for till money. Notes which were issued by the Federal Reserve Bank of the district may thus be withdrawn from circulation. . . . Another device calculated to encourage the retirement from circulation of bank notes whenever they become redundant is the provision of the law authorizing the Federal Reserve Board to charge such a rate of interest as it may deem desirable on Federal Reserve notes uncovered by gold or gold certificates issued to Federal Reserve Banks. how it may be expanded The most important device of the Federal Reserve System for secur- Deposit credit: ing 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. [Member banks may secure these loans either by rediscounting eligible paper at the Federal Reserve Bank of their district, or by borrowing from the Federal Reserve Bank on the security of certain types of collateral.] ... contracted. The contraction of deposit currency, as soon as the need for it and 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. . Some critics of the Federal Reserve System believe that the machin- A criticism. ery it provides for contracting both deposit and bank-note currency, in times of currency redundancy, needs strengthening. [However this may be], 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. Questions on the foregoing Readings 1. Explain the importance of the commercial bank. 2. Trace the steps by which a banker discovers that he can safely loan out money left with him for safe-keeping. 3. What is the chief function of the commercial bank? 4. What is meant by saying that the banker must exercise a great deal of judgment in loaning funds? 5. Explain what is meant by the statement that before 1913 our banking system was a system in name only. 6. To what extent did the smaller banks formerly deposit a large share of their reserves with larger banks? 7. Explain how this creates a feeling of inter-dependence among the banks. 8. Why was this inter-dependence dangerous? 9. Name a panic which clearly illustrated the defects of the national banking system as it éxisted prior to 1913. 10. Trace the beginnings of financial distress in New York during the earlier part of this panic. II. What happened when alarm spread through the country? 12. Why was the Federal Reserve Act of 1913 passed? 13. What was the purpose of this act? 14. What, in brief, are the duties and powers of the Federal Reserve Banks? 15. Explain the organization of the Federal Reserve Board. 16. What is the function of the Federal Advisory Council? 17. Why must member banks keep all of their legal reserve in the Federal Reserve Bank of their district? 18. May they keep any reserves in other banks? Explain. 19. Explain what is meant by the district centralization of reserves. 20. Show how the Act of 1913 provides for the mobility of bank reserves between (a) different districts, and (b) between the different banks of a single district. 21. Why must the supply of money and credit be elastic? 22. Show how the bank-note currency may be (a) expanded and (b) contracted under the Act of 1913. 23. How may deposit credit or deposit currency be expanded and contracted under the Act? 24. What criticism has been brought against the Federal Reserve System with respect to the contraction of deposit and banknote currency? CHAPTER XXXII TAXATION 187. Defects of American taxation 1 system. There can be no doubt but that discontent with our taxation Increasing discontent system is steadily increasing. Not only is the increasing cost of with our government demanding greater and greater revenues, but the failure taxation to change our taxation policies to keep pace with the growing complexity of our industrial life renders more and more inadequate our traditional methods of taxation. In brief, more is demanded of our taxation system than ever before, but that system is unable to respond effectively. American taxation systems are highly defective, as Professor Seligman points out in the following selection: What, then, are the chief difficulties in our tax system which are coming more and more to be recognized everywhere throughout the length and breadth of the land? I should sum them up under eight taxation: heads. The eight defects of American breakdown of the general property tax, First and foremost is the breakdown of the general property tax, (1) the which is almost everywhere still the chief reliance of state and local government. The general property tax works well only amidst most primitive conditions, for which alone it was calculated. . . . The administration of the general property tax is everywhere attended with increasing difficulty, and in our large industrial centers it has become, to use the words of a recent tax report, "a howling farce." Second, a growing lack of equality in tax burdens, not only as between classes in the community, but as between individuals of the same class. ... Third, the application to general purposes of what was intended 1 From State and Local Taxation, First National Conference, November 12-15, 1907. Addresses and Proceedings. Edwin R. A. Seligman, "The Separation of State and Local Revenues." The Macmillan Company, New York, 1908; pp. 486489. (2) in equality in tax burdens, |