Anticipating that redis-counting for member banks may not keep all the funds of the Federal reserve banks actively employed, provision is made for them to engage in certain open market operations. These operations will also make it possible for the reserve banks to exercise a general control over money market conditions, and to some extent over the flow of gold. There are three kinds of open market operations in which the reserve banks are permitted to engage, viz.: (1) dealings in government securities and in obligations of the states and municipalities, maturing within six months; (2) dealings in foreign exchange; (3) dealings in domestic bills or exchange. In periods of inactive demand for rediscounts reserve banks will doubtless invest surplus funds in the kinds of securities permitted. These include "bonds and notes of the United States, and bills, notes, revenue bonds, and warrants with a maturity from date of purchase of not exceeding six months, issued in anticipation of the collection of taxes or in anticipation of the receipt of assured revenues by any State, county, district, political subdivision, or municipality in the continental United States, including irrigation, drainage and reclamation districts."

1 J. Laurence Laughlin: "The Banking and Currency Act of 1913," Journal of Political Economy, May, 1914, p. 426.

2 Ibid., p. 424.

Further opportunity to invest surplus funds and to develop a broad discount market is afforded the Federal reserve banks in the authority to "purchase and sell in the open market, at home or abroad, either from or to domestic or foreign banks, firms, corporations or individuals, cable transfers and bankers' acceptances and bills of exchange of the kinds and maturities by this Act made eligible for rediscount, with or without the indorsement of a member bank." The right to deal in cable transfers will give the reserve banks some control over the movements of gold in and out of the country. The exercise of this right will bring the reserve banks into competition with the banks and trust companies now dealing in foreign exchange.

A second provision for open market operations relates to bankers' acceptances. As noted elsewhere, this form of paper is widely used in foreign countries. The method of making a bank acceptance is as follows: A merchant needing credit goes to a banker or an acceptance house, which after proper investigation grants him, for a commission, the right to draw on them for a certain amount. When the draft is presented the banker accepts it, thus making himself responsible for its payment when due. These acceptances are always salable in the open market and are purchased largely by the discount houses and by the joint stock banks. Hitherto bank acceptances have not been permitted under our banking laws. Under the new Act this prohibition has been lifted in part. Section 13 of the Act provides that "Any member bank may accept drafts or bills of exchange drawn upon it and growing out of transactions involving the importation or exportation of goods having not more than six months' sight to run; but no bank shall accept such bills to an amount equal at any time in the aggregate to more than one-half its paid-up capital stock and surplus."

It will be noted that the privilege of acceptance is limited to bills growing out of foreign trade, and that the total amount of such acceptances by any bank shall not exceed one-half of its paid-up capital and surplus. One draft of the bill proposed to include acceptances of domestic drafts, but this was rejected because of the fear of undue expansion of credit. The acceptor of a draft does not advance any money to the customer; it merely guarantees that the draft will be paid when due. Since the Bank, by accepting a bill drawn on it, would not incur a deposit liability against which a fixed reserve would have to be kept, it was feared that banks unused to this practice might be tempted to accept bills beyond the limits of safety. Many believe, however, that a broad discount market cannot be developed until the privilege of acceptance is extended to domestic bills, and that when the new system gets well under way the act will be amended to permit domestic acceptances. On the other hand, it is held that the business practice of this country has become thoroughly wedded to the promissory note as a borrowing instrument, and that there will be comparatively little demand for bank acceptances. In this country, cash payments are encouraged by the granting of trade discounts considerably more favorable than bank discounts. Under such conditions time bills of exchange will not readily come into existence.

It is universally acknowledged that the mere legalizing of bank acceptances will not create an acceptance market.

The acceptance business can be developed only as the result of a large foreign trade to be financed. "In addition," says one authority, "it is difficult to see how American bankers can make much headway in developing their acceptance business until they can succeed in establishing a ready market for the paper which they have accepted in the discount markets of Europe. If European buyers of commercial paper continue to look with relative disfavor upon it, as they have done in the past, then it will be difficult, if not impossible, to get American importers to take 'dollar drafts' and to arrange to finance their transactions entirely through their American banks rather than to follow their present methods. It is very probable that, as time goes on, certain American banks will establish a high credit rating abroad and their acceptances will sell readily. To what extent this will be true is a matter which cannot be foretold."1

In this connection it should be noted that the foreign operations of American banks will be greatly aided by the permission to establish foreign branches. With the consent of the Federal Reserve Board the reserve banks are allowed "to open and maintain banking accounts in foreign countries, appoint correspondents, and establish agencies in such countries wheresoever it may deem best for the purpose of purchasing, selling and collecting bills of exchange, and to buy and sell, with or without its indorsement, through such correspondents or agencies, bills of exchange arising out of actual commercial transactions which have not more than ninety days to run and which bear the signature of two or more responsible parties." Not only will such agencies provide an outlet for exchange purchased in the United States, but by standing ready to buy drafts on American bankers drawn in dollars instead of pounds sterling, as at present, they will eventually overcome the prejudice against the former and raise their standing abroad. The status of American banks abroad will be further strengthened by the establishment of foreign branches by national banks. Under the Act any-national bank having a capital and surplus of $1,000,000 or more may, subject to the approval of the Reserve Board, establish branches in foreign countries "for the furtherance of the foreign commerce of the United States, and to act, if required to do so, as fiscal agents of the United States." Now that foreign branches are legalized, some of the larger banks, especially in New York, are sure to enter the foreign field, where they will help to establish American credit and promote American trade in the world markets.

1 Conway and Patterson: The Operation of the New Bank Act, p. 127.