Two specificobjects are in view when the rate of discount is advanced - the diminution of the domestic demand for loans and a modification in foreign exchange rates so that gold exports may be checked and gold imports perhaps be stimulated. But an advance in the rate of discount by a central bank is of little service unless market rates follow the bank rate. To bring this about is the most difficult problem with which a central bank is confronted. When the strain upon the reserve is merely anticipated or of moderate proportions, it is frequently difficult to make the market follow the bank. If the other banks have abundant funds and if the necessity of caution is not obvious, the immediate effect of the advance of the bank rate upon the market rate may be imperceptible. The central bank will then secure little new business. In countries where its proportion of the lending business is large, it is true that the increased demand for loans at the other banks will soon force up the market rate. But, as the business of central banks is small in proportion to the total credit business in most countries, it frequently happens that the outside market is able to shoulder the entire lending business without advancing rates to the point desired by the central banks. In recent years both the Bank of England and the Bank of Germany have found it necessary with increasing frequency to deprive the market of its surplus funds. This is accomplished in England by the sale of government securities, and in Germany by the rediscounting of Treasury bills. This device has answered its purpose to a striking degree. Its effectiveness is a direct consequence of the narrow foundation of balances with the central bank, upon which rest the vast liabilities of the other banks. In London, for example, it is supposed that bankers' balances may amount to half the deposits of the Bank of England, say £25,000,000. If these balances are reduced even by a million pounds through the sale of government securities by the Bank of England,1 the other banks are obliged to contract their loans and reduce their deposits by many times that amount, in order to preserve the customary proportion of balances to their credit liabilities. The credit structure is so delicately poised upon its foundation of Bank of England balances that it is sensitive to very slight influences.

The effectiveness of this device of withdrawing funds from the market, it is important to note, is in large measure limited to periods when the resources of the other banks are already well employed and no additional resources are becom-ing available. While it is of much utility in preparation for a period of financial strain which is in imminent prospect, it cannot be used to give constant control over the credit situation. When, for example, the course of foreign payments is such as to bring large supplies of gold into a coun-try, a central bank is powerless to prevent the rapid expansion of credit on the part of other banks, even though such expansion may be re-

1 The balances of the other banks would almost certainly be reduced by this step unless the securities were sold to individual depositors of the Bank of England. If the securities were purchased by the other banks or by their customers, checks in payment would swell the clearing-house exchanges of the Bank of England. If they were sold to bill brokers or their customers, the result would be the same, though there would be one or more additional transfers of credit required to complete the operation, sponsible for the development of a highly hazardous state of affairs. Even should a central bank be able at such times to bring about a moderate advance in rates it is by no means certain that this would greatly strengthen the domestic banking situation. In periods of great business and speculative activity very high discount rates may indeed reduce somewhat the demand for loans for purely domestic purposes, but not necessarily the demand for those which are most undesirable. A central bank is not an institution with powers sufficient to remove the causes of all financial ills. At times it can control, but more frequently it must rely upon the potent influence which a conservatively managed central institution acquires as the result of long years of wise operation. By example and precept the dangerously rapid expansion of credit by the banks as a whole in periods of active business may be somewhat diminished, but it would require an impossible and indeed undesirable exercise of power to control such tendencies. The measures which a central bank takes to keep itself in position to meet periods of financial strain, will to some extent moderate tendencies toward the dangerously rapid expansion of credit by the banks as a whole, but they will not eliminate such tendencies. General speculative movements have been less violent in Europe than in the United States, but this difference is properly ascribable, not to the absence of a central bank, but to the greater opportunities for rapid development in a new country with large undeveloped natural resources. Germany, which in late years has been in manufactures and commerce virtually a new country, has experienced highly speculative movements, which the Reichsbank has been seemingly powerless to control. After all, a central bank can do little more than husband its own resources for the future, at a time when the other banks have abundant funds and a spirit of general over-confidence pervades the business community.

It is significant that the exportation of gold or the movement of the foreign exchanges toward the gold export point is the most frequent occasion of an advance in the rate of discount by central banks. Gold exports are not by any means always an indication of an unsound condition of affairs and the approach of a period of financial strain, but in periods of great trade activity and of rapid credit expansion they are commonly an indication that precautionary measures may well be taken. Ordinarily, the foreign exchanges are distinctly more sensitive to an advance in discount rates than the domestic demand for loans. There is a large volume of business of various kinds which can be financed by borrowers in the money markets of more than one country. Bills of exchange accepted by leading banks and bankers arising out of foreign trade or based on securities as collateral furnish the bulk of the material for these international loans. These bills are offered for discount in the market in which the lowest rates can be secured. For an understanding of the somewhat complicated processes of international borrowing some knowledge of foreign exchange operations is required. This is a subject which will be considered in the next chapter. 'Here it is sufficient to note that an advance in discount rates in any money market tends to induce foreign borrowers to finance their requirements more largely either at home or in the money markets of other countries. Foreign creditors also may be induced to employ money in the market in which rates have advanced instead of drawing it home as they might have done if rates had remained stationary.