Rediscounts and Sales of Discounted and Purchased Paper Between Federal Reserve Banks

[In thousands of dollars.]

The effect of the system thus was that of transferring liquid reserves from one district to another and making payment for them at a later date when current sales of products had proceeded far enough to provide the means requisite for that purpose. As this system accordingly developed, the reliance of country banks upon city institutions fell off and the total volume of accommodation obtained in that way was undoubtedly much lessened.

In thus surveying the general service of the reserve banks in the distribution of credit, there is one technical phase of the domestic operations of the system which should be carefully noted. The Federal Reserve Act had in a degree been based upon a preference for so-called two-name paper, - paper of the acceptance variety, whether bankers or trade, - as against paper with one name representing the direct borrowing of a bank customer. The Federal Reserve Board, endeavoring to carry out the direct intent of the law, (had established highly preferential rates for bankers acceptances and had also granted a moderate preference to commercial or trade acceptances when endorsed by a banker. The effort thus conservatively made to encourage the growth of two-name paper did not prove entirely successful. This was largely because, over a period of almost half a century, the American business man as well as the American banker had steadily accustomed himself to the single name type of borrowing based upon a line of credit granted by a bank. In order to differentiate between the customer of high credit and prompt payment and the customer whose necessities called for longer term accommodation, most American manufacturers and dealers generally have adopted the practice of allowing a discount for cash. Terms are habitually quoted as from 2 to 5 per cent, off for cash within ten days of date of invoice, with 1 to 2 per cent. off for cash within thirty or sixty days, and full payment thereafter. It was difficult to adjust this system to the use of two-name paper drawn for a specified amoun at the time of shipment of goods since the shipper could not, and the buyer often did not, know which method of payment he would probably employ. The effort to encourage the use of such trade or commercial acceptances was urgently pressed during the years 1918-1920, and there was a general disposition to claim for the trade acceptance many merits which it did not possess. Un-familiarity with it and lack of conservatism in its use stimulated the growth of abuses and severe losses were incurred by banks which had discounted such paper with too little restraint. The reserve banks themselves never held many acceptances growing out of domestic business. Both the trade acceptances and the domestic bankers acceptances held by them have been small in volume, but considerable harm was done to the banking system in general by unskillful use of both instruments. The conclusion is unavoidable that the acceptance movement in the United States has been only partially successful. Whether two-name paper of this kind will ever be largely introduced in the United States is doubtful.

Greater success was experienced in developing the use of the acceptance for the financing of the foreign trade From a non-existent type of paper in 1913 the bankers acceptance including both paper made by non-members as well as that made by members rose to a level estimated at the close of 1920 as high as $1,000,000,000. Reserve banks discounted such acceptances at times in large volume and while they succeeded in 1920-21 in inducing member banks to purchase and hold one another's acceptances in considerable quantity as investments, the amount in their own portfolios was always large.

Since the adoption of the Federal Reserve Act, the various problems growing out of the general credit situation have been so serious as largely to obscure the old controversy about note issues and elastic currency. These matters had, however, as already seen, been among the principal factors leading to the movement for banking reform. While elastic note issues were not, in a country like the United States, an absolute fundamental they were nevertheless a very desirable means of meeting the credit necessities of member banks and of the country at large, in many parts of the South and West the use of checks instead "of currency had, and still has, reached only a relatively low stage of advancement A In such regions rediscount accommodation was most easily and conveniently extended by means of note issues. Accordingly in the original draft of the Federal Reserve Act provision was made for a note currency which should be the joint liability of all of the reserve banks combined and which was to be secured by commercial paper dollar for dollar. As banks desired to withdraw commercial paper, either because it had reached maturity or for some other reason, they were to be allowed to deposit an equal amount of gold with the Federal Reserve agent, who was made the holder of this collateral as well as the medium through which notes were to be received from the Treasury department where alone they were to be printed. The political discussion centering around the Act developed as one of its principal elements a demand that these notes should be given a quality as government currency and eventually, as a concession to this view, they were made liabilities of the government, such action being palliated by the fact that every effort was made to provide for their safety, security, and elasticity so that the government guarantee was of only technical significance.

Soon after the new banks had been organized, however, the note issue controversy assumed a new form. Banks found that it was desirable for them to get notes as a matter of convenience to their customers in exchange for gold or legal tender money, and while this could be effected through a shifting of commercial paper back and forth between the reserve agent and his bank, that was not a convenient or satisfactory way of dealing with the matter. On the other hand, there had always been a desire to be allowed to use bank notes as a constituent in reserves - a policy indefensible from the standpoint of banking soundness. It was argued that inasmuch as credit on the books of the reserve bank counted as reserves, and inasmuch as reserve bank notes could be redeposited with the issuing bank and thus immediately give rise to reserve credit, there was no reason why the notes should not be permitted to count directly in the reserves of banks. Hence a demand for permission thus to count them in reserves and a well-organized movement to bring this about. Such a request would probably not have received much consideration had it not been for the entry of the United States into the war. When this event occurred it was, however, urged that reserve banks should be put into position to grant the maximum amount of credit and it was argued that by allowing their notes to count as vault reserves very much more flexible conditions would be established. A compromise was finally arrived at with the result that reserve ratios were cut down from 18, 12, and 7, according to the location of the bank affected, to 13, 10, and 7 per cent with the proviso that the entire amount should be carried in the reserve banks, no vault reserves being required. This left the member banks free to use reserve bank notes as "till money" if they chose, and since experience showed that about 4 or 5 per cent. of deposits must be carried in the vaults of members in the form of cash, it left the banks free to hold Federal Reserve notes to that extent as what was practically but not technically an element in their reserves.