The Discount Market As A Stabilizer Of Interest Rate Levels Within The Country

It is a proven fact that interest rates in the United States fluctuate on a much wider scale than in European countries. Interest rates in Europe in normal times are much more steadier than in the United States, moving, except in rare cases, by only one-sixteenth of one per cent., and on the whole within narrower limits. In the United States, however, rates fluctuate from one-fourth of one per cent. to one per cent. at each instance.

A broad discount market would connect the money centers and the credit centers of abroad with this country, and by the movement of money from one center to the other, according to the movement of rates, it would tend to lessen fluctuation and would eliminate erratic movements of interest and exchange rates which are always the feature of isolated markets.

The Discount Market As A Stabilizer Of Gold Movements Between Countries

Gold movements between this country and other foreign countries have always been a factor of considerable importance to the American merchant, for the transfer of gold has greatly influenced the rates of exchange on foreign points.

The effect of exchange rates between two countries, the currency of one of which is of lesser value when measured in the terms of the currency of the other, is to cause banks to increase their holdings of the bills of the country the rates of which are lower. As an illustration, upon the decline in value of the dollar, foreign banks would increase their holdings of American bills on account of the cheap dollar exchange rate, while American banks would sell their holdings of foreign bills on account of the high exchange rates on foreign countries. This would tend to ward off gold movements for a time.

The leading banks of Europe have followed this process of accumulating a line of foreign bills at low rates and disposing of them when conditions are reversed. It has been carried on successfully with advantageous profits accruing to the foreign banks. Not many banks engage in the business of exporting or importing gold, this being confined principally to a small number of private banks or firms doing a banking business. The exportation or importation of gold is carried on by these banks for the purpose of yielding a profit, however small. A discount market would tend to eliminate these wasteful and temporary shifts of gold, unnecessary in the majority of cases, as settlement by commercial paper would be more resorted to.

What Is Necessary To The Maintenance Of A Discount Market

Before the passage of the Federal Reserve Act, there was no such thing that we could very well call a discount market existing in this country. The European countries which had developed extensive and effective banking systems of the highest order, all possessed wide markets affording facilities for the discount of credit instrument. It was observed by these European countries that a standardized instrument of credit would be necessary, and it is for this reason that there was developed a so-called two name and three name paper as the best and safest way in which credit might be extended and circulated.

The Federal Reserve Board realized the handicap of unstandardized paper to the creation of a discount market, and readily chose the acceptance as a high form of credit instrument upon which the existence of such market could be based; and by making a distinction as to trade and bank acceptances with their attendant advantages, has substantially eliminated to a large degree the responsibilities and dangers involved in the open book account method and that of written instrument of various sorts as evidences of debt.

A prime banker's acceptance is a credit instrument of the highest sort and is preferred by the Reserve banks for purchase and investment. A large amount of their reserves is invested in this class of paper.

A trade acceptance, moreover, arising out of transactions involving the sale of goods, is from its very nature a more certain form of credit than a mere promissory note or a draft, which may have been drawn for a number of purposes. The Reserve banks have given their full support to the acceptance, knowing well from experience both in this country and abroad, that this method of transacting and financing business is by far superior to the open account method or to single name paper dealings. It is due to these two instruments of credit, the trade acceptance and the bank acceptance, that the foreign discount markets depend, and it is upon these two instruments of credit that the American discount market will eventually be supported.