Evening star., 1932-03-13
How the Federal Reserve Works
The Systems Machinery.
BY FREDERIC ]. H4SKIN.

The Federal Reserve System IS en-
barking an an epochal experiment to
determine whether it is possible to start
currency and credit imitation and yet
keep it sufficiently under control to
avoid the subversive reaction which nor
mally follows boom expansion. A meas
ure amending the Federal Reserve act,
sponsored by Senator Glass in the upper
body Of Congress and by Representative
Steagall in the Lower House, provides
| for the issuance of millions Of new
money in Federal Reserve notes and
J broadens the eligibility of securities
| which may be acquired by Federal Re-
serve Banks.
1t is the usual experience of bankers
that imitation Is apt to act like run
away horse, which, once started, be-
comes frightened by It's own clatter and
gets more and more out of control.
The new bank measure has been de-
signed to set limit on the extent Of
| imitation at the outset. The next
/ months should reveal whether such a
managed imitation is feasible.
The Federal Reserve act was ap-
proved December %, 1918, for the pur-
pose OF completely remodeling the
tenn and providing an elastic monetary
AACOAAAA. 4AO AA0bAOAAdA SdAAh bNI was q
Civil War measure and provided for
the issuance Of circulating notes secured
by United States bonds. Economists
believed that its weakness resided in
| its inelasticity. National banks could
issue notes as they saw fit and retire
them arbitrarily. The currency was not
automatically responsive to the volume
of business being done in the country
at any one time. In periods of great
business activity the volume of circu-
lating notes was too small: at other
| times it was so plentiful that prices
rose abnormally.
The basic theory Of the Federal Re
serve System Is that currency shall
expand and contract exactly in pro-
portion to business demands. In gen.
eral, two kinds Of securities have been
| back of Federal Reserve notes At no
| time is the gold cover permitted to fall
below 40 per cent of the volume of
| notes outstanding. In addition, evi-
whole issue. AS matter Of practice,
the volume Of notes outstanding has
not usually been great enough to draw
the gold reserve down to the 40 per
cent minimum limit. At times this gold
ratio has been as high as 85 per cent.
That has meant that this paper money
was good as gold and. in addition, was
secured by real consumable values.
Only once in the history Of the system
has the 40 per cent minimum been
touched. That was in the 1920-21 de-
preston.
How the Machinery Works.
One may best comprehend the work.
! ings Of the Federal Reserve Systems
basic machinery by tracing a CONNER
cial transaction through its ramifica-
tions of production and distribution.
Let us start with a shoe manufacturer
in New England mill town. He is
operating with given amount Of cap
ital which does not prove sufficient
at all times to cover his needs He has
regular pay roll cost to meet and
the usual fixed charges of any manu-
featuring plant. He follows the hide
and leather market and, thinking a
given time propitious, buys several car
loads of leather-sole leather, upper
leather and the various other varieties
which go into the manufacture Of foot
wear The transaction runs into, say,
$4,000.
The manufacturer does not feel that
| he can conveniently spare cash for this
within the 80 days in which he has