Evening star., 1933-09-29

Eight distinguished men, repre-.
senting both major political parties,
haze approved and sponsored a series
OF articles presenting their UieWpoint
on the money problems OF the day
as their contribution t0,pdrd promot-
ing q clear understanding of the
monetary system in the present con-
tropersy.
The series iDill appear in this neUs-
paper in rs consecutive daily chap
ters. The fifth is presented today.
ARTICLE v.
The Money Supply and the Federal
Y Reserve System.
In articles preceding this we traced
the rise of money from its origin In
simple barter, and explained the nature
of those modern refinements of real
money known as currency and bank
credit. Assuming the general principles
of modern money have been made fairly
clear. we turn to description of the
actual mechanism by which the money
supply in the United States Is created
and controlled.
Under the Federal Reserve act men,
ber banks of the system must maintain
legal reserves averaging about 10 per
cent against their customers deposits
These reserves must be kept with their
district Reserve bank (the Reserve de-
posits were originally paid in in the
form of cash, member banks retaining
only enough cash themselves for It'll
money!.
When a member bank finds its sup
ply of currency too small to meet pres
ent or prospective demands of its Gus
toners, it sends to the Federal Reserve
for more. 1t settles for the currency
by draft against its reserves. It does
precisely what John Smith would dc
and drew out s25 Of his deposits in
currency.
Deposit Is Provided.
But the parallel between the mem
Der bank and John Smith goes further
If when he goes to draw out his $25
John Smith is told that he has not
that much left on deposit, what does
he do? Perhaps he has 500 in cash
at home, which he turns in as a de-
posit. But this is highly unlikely
Therefore, If he is business man with
sufficient standing to make a loan, he
borrows $l00 on his note. In other
words, the bank creates a deposit fol
him by advancing him funds, in the
form Of credit, against some form Of
realizable wealth-the goods on his shelf
If he is a merchant; his crops, If he i.
a farmer
It is precisely the same with the
member bank. If the bank finds that
the draft with which it pays for il:
currency is going to bring its reserves
below the legal minimum of 10 Pc,
cent of its customers deposits, it bor-
rows from the Federal Reserve. It does
this by ''rediscounting In other words
it takes out of its portfolio customers
paper discounted notes, or loans) in ar
amount corresponding to its currency
needs, adds its own signature to thi:
paper as additional security, and ot-
tains Federal Reserve Notes for it.
This process can 60 on SO long as
% there is eligible paper available
and CD the total outstanding note ISSUE
does not exceed two and ne-halt
times the gold holdings of the reserve
bank, which latter is just another way
article, that in the United States con-
vertibility of the note issue into golc
is assured by 40 per cent reserve.
Basis Of Elasticity.
It is this mechanism of obtaining
currency by rediscounting short-tern
commercial paper which gives the
modern note issue its much desired
elasticity. In the first place bank
can always get currency on short no
tice by borrowing against its earning
assets. In the second place, an excess
of currency is prevented automatically
as a member bank naturally will retire
any surplus currency to pay of It.
loans at the Reserve bank. In tht
third place, in normal times the
volume of currency fluctuates with the
volume of discountable paper, which Is
the equivalent of saying, with business
When a member bank does not neec
more currency, but wishes to expanC
its loans-and hence its deposits-il
builds up its reserves in precisely the
same way, by rediscounting. The only
difference is that in this case 1t re-
ceives instead of a package Of en-
graved circulating notes slip Of pape:
showing the amount Of the loan has
been credited to its reserve account.