1 Bank of Bay City v. Fellows; Federal Reserve Bulletin, Vol. iii., p. 534.

The history of the Federal Reserve System may be roughly divided into three periods, the first extending from shortly after its formal organization up to the date of our entry into the European War on April 6, 1917; the second extending from this latter date to a period shortly after the Armi-"stice on November II, 1918; and the third covering the years since the close of the second period. It would be practicable to make several distinct subdivisions within these periods, but for general purposes the history of the system is well marked off into the three main chronological divisions.

During the two and one half years prior to our entry into the European War the Federal Reserve System may be regarded as having passed through a purely formative stage. Its operations were small and its direct influence upon the banking and discount situation limited Indirectly it was a factor of very great influence because of the knowledge that a satisfactory organization had been provided around which the individual banks could, if they chose, at any time consolidate their forces. Nevertheless during this early period it was always doubtful what part the system would be able to play. Several reasons may be mentioned for this state of things. In the first place, the Federal Reserve Act, by reason of its having reduced re-serve requirements and limited the necessities of the national banks, and thereby of the banks in general, for immediate accommodation, had established a margin of credit-granting power which was sufficient to carry the banks through a period of very considerable increase in demand without subjecting them to the necessity of resorting to Federal Reserve banks. During this first period, however, very abnormal conditions had also manifested themselves. Not long after the opening of the European War an immense trade in munitions, supplies and food had sprung up between this country and the belligerent nations. In a general way our sellers of goods demanded payment in cash or American securities and the result was a great inflow of both gold and American securities into the United States. This tended to lessen the degree of commercial dependence upon the bank-ing system, or of banks on Federal Reserve banks, and would have done so regardless of the type of organization. Furthermore, there was a very general attitude on the part of city banks that was hostile to the reserve system itself. Bankers who would ordinarily have rediscounted sought to avoid doing so in order to refrain from having any business dealings with the reserve system. Finally, the system had not yet learned to adapt itself completely to the needs of the community and some of its regulations were of a nature that tended to limit or restrict the conditions under which free use could be made of the new banks. Altogether, therefore, the first two and one half years of its history were years in which growth was directed along lines that were abnormal or unusual.

The second period of the Federal Reserve System's history was even more greatly disturbed by unusual and abnormal conditions than the first. With our entry into the war it became necessary for us to take over in very large measure the business of financing it. During the two years from June, 1917, to June, 1919, we had provided various foreign countries with $9,500,000,000 of advances besides incurring expenses on our own account which probably ran to about $34,000,000,-000, of which latter sum some $24,000,000,000 constituted additions to our public debt. From the outset of the war it was a serious question how far to rely on borrowing and how far on taxation, in the effort to take practically the entire available surplus of savings or new wealth produced by the country from month to month. The eventual basis of our war finance theoretically contemplated the policy of levying a dollar in taxes for every three dollars in bonds or certificates of indebtedness sold, but it was subsequently found that the program of financing was so large as to exceed the pressure of continuous and heavy rediscounting, but they came to consist very largely of the direct notes of member banks collateralled by government bonds, or certificates of indebtedness.

The Federal Reserve banks themselves, on the other hand, became the nucleus around which was built up the organization whose mission it was to sell bonds to the community, while in the banks themselves no small part of the actual routine labor consisted in clearing, collecting, and routing the checks growing out of government receipts and payments. As will be seen at another point, the banks themselves had eventually been obliged to take over the function of holding government de-posits, and as a result of the enormously increasing operations of the Treasury attendant upon the expansion of the budget from something like $1,000,000,000 in pre-war years to over $5,000,-000,000 in 1919, there was a correspondingly great increase in the scope of the routine activities of the Federal Reserve banks. Altogether, therefore, the service of the Federal Reserve banks during the war, although invaluable from the national standpoint, was very different from any service that would ordinarily be expected from such institutions in time of peace.

One of the factors in the general financial situation which had contributed largely to the troubles that existed before the war had been the method of collecting, keeping, and disbursing government funds. Ever since 1846 we had had in operation the so-called Independent Treasury Act which had superseded the older system of keeping public funds in State institutions subject to all of the current dangers of loss and suspension of payment. Under the Independent Treasury Act provision was made for collecting, keeping, and paying out public funds in cash. The method was injurious, as experience showed, not merely because it was inconvenient and expensive but because it resulted in withdrawing large sums at times when they were needed in the market, while on other occasions they were suddenly poured out into current. use,or were placed in parts of the country where they were not needed, by the plan of depositing them in specially favored banks.