Discount Market Makes Mobility Possible

We have seen also that by the introduction of the Federal Reserve System, the reserves of the country were made capable of transfer from one part to another according to the needs of the localities. Suppose one Federal Reserve Bank finds itself in need of money at short notice. It would then discount the commercial paper held by it of another Federal Reserve bank, taking the proceeds by transfer, thus causing a flow of money from a place where it is abundant to a place where it is needed. The same is true as between bank and Federal Reserve bank, the latter rediscounting the commercial paper holdings of the former.

Equalizing Interest And Discount Rates Within The Country

By the simple process of discounting as above described, supposing one locality should have a surplus of funds. In that event, money there would invariably loan out at a low rate. On the other hand, let us take a district where the demand for money exceeds the supply. Interest rates there would necessarily be higher. The total money supply would always tend towards maintaining equilibrium, that is, the greater supply of money would flow towards the lesser supply of money, and thus rates of interest in these two districts under consideration would thereby be equalized. This is accomplished by the discounting of bills, acceptances and other commercial paper, either between member banks and the Federal Reserve Bank or between the Federal Reserve banks themselves. Undoubtedly, it cannot be assumed that at all times it is possible to maintain a market equalized in every respect, but the variance in the rates between two markets can be kept so close to one another that its difference will not be felt so very much.

The Discount Market As An Equalizer Of Discount Rates Between The United States And Foreign Countries

A discount market operates as an equalizer of discount rates between the United States and foreign countries in the same manner as it acts as an equalizer of rates between different sections of this country. In the London discount market, because of the facilities provided and the opportunities afforded foreign banks for the investment of their resources, they have collected there in large numbers and have brought with them considerable funds which are loaned out in commercial paper transactions and so support the discount market. It is believed by bankers, economists and authorities on banking and finance that the result in the United States would be similar, and that the use of acceptances would more than anything else contribute to the development of a broad discount market.

Interest rates in two countries are seldom the same at any one time, and bankers and investors seek employment for their funds according to the higher rate of interest which is afforded in the relative markets.

The existence of a broad discount market in the United States would encourage foreign banks and investors to purchase our bills and acceptances as an investment when rates are higher in this country than abroad. This would tend to move our interest rates in sympathy with the level of interest rates in foreign countries. Should the rates decline in this country, the banks and investors here would enter foreign markets for the purchase of their bills, and foreign banks and investors would also reduce their holdings of American bills, because of the lower rates of interest. A movement would thus set in to equalize rates and keep them as nearly on a par with each other as is possible.