Issuance Of National Bank Notes By Banks

The second form of credit circulation exists in the issuance of Federal Reserve bank notes. Before the adoption of the Federal Reserve System, the national banks had obtained the privilege of note circulation in the usual way then provided by law, that is, upon the deposit of proper security in the form of Government bonds with the Comptroller of the Currency. National banks would then receive the privilege of issuing their notes to circulate at par. The practice of issuing national bank notes was very much indulged in by the national banks as it secured for them a double profit. The bonds which they were required to deposit with the Comptroller of the Currency, as security for the issuance of national bank notes, usually paid the bank interest at the rate of from two to three per cent. Upon the amount of money circulated by national banks in the form of bank notes they were able to earn a full six per cent., making it in all from eight to nine per cent, on their investment, less taxes of about one-half per cent.

Besides the profit accruing to the banks from their issuance, national bank notes served as one of the most important mediums of credit circulation, and it was for this reason that the Federal Reserve Board did not desire immediately to withdraw this privilege from them, but enacted laws looking forward to their gradual retirement. The amount of notes so outstanding at the passage of the Act was about seven hundred millions of dollars, and it was evident that the contraction of this important form of bank credit would work an undue hardship on the banks as well as on business.

Provisions Of Federal Reserve Re Note Issues

The Federal Reserve Act provided for the issuance of Federal Reserve notes to be (a), "a first and paramount lien on all the assets of the Federal Reserve Banks issuing them," and (b), "secured by collateral of the highest grade to the extent of one hundred per cent, of the value of circulation notes issued." The collateral secured, upon being deposited with either the Federal Reserve agents in the various districts, or with the Federal Reserve Board at Washington, secures for the Federal Reserve Banks the proceeds in Federal Reserve notes, to be circulated by them as an item of credit.

Character Of Commercial Paper

The required commercial paper must be of the following classes:

1. Such as may be indorsed by member banks and drawn for commercial, industrial, or agricultural purposes, or drawn for the purpose of carrying on trading in securities of the United States Government;

2. Bills of exchange indorsed by a member bank, and bankers' acceptances bought by the Federal Reserve Banks in the open market;

3. Gold and gold security certificates.

Security In The Form Of Gold

Forty per cent, of the amount of Federal Reserve notes issued are required to be secured by gold, pledged with the Federal Reserve agents who represent the Federal Reserve Board at Washington, and who are stationed at the Federal Reserve banks. The security may also be placed with the Treasury of the United States at Washington.

Expansion And Contraction Of Reserve Notes

The elasticity of Federal Reserve notes is made possible by the easy manner in which their circulation may be increased in times of need, and decreased in times when their circulation is not necessary. Member banks in any section of the country, may, at times require an increased supply of such notes to meet local demands. These notes may be obtained by member banks, by the rediscount of "eligible paper" with their Federal Reserve banks, the former taking the proceeds in Federal Reserve notes, thus supplying themselves with hand to hand as well as "till" money. The amount of notes issued by the Federal Reserve banks for circulation towards the end of 1918 amounted to over two billion seven hundred and fifty million dollars, secured by gold to the extent of one billion one hundred and fifty million dollars, and eligible paper amounting to two billions of dollars.

Not only may member banks obtain Federal Reserve notes by the rediscount of their commercial paper holdings with the Federal Reserve banks, but the Federal Reserve banks as well, are enabled, by the process of discounting with the Federal Reserve Board to acquire the circulation of Federal Reserve notes when needed.

The contraction of Federal Reserve note issues as an item of credit is brought about in the following way: After they have served their purpose in meeting local demands, they are again deposited with the banks, which, for the reason that the latter are not permitted to count such notes as a legal reserve, they are again deposited with the Federal Reserve Bank (Federal Reserve notes are not legal tender), to be re-forwarded by them to Washington for retirement.