By the issue of Federal reserve notes the new system is expected to provide an elastic currency. The clause providing for these notes reads as follows: "Federal reserve notes, to be issued at the discretion of the Federal Reserve Board, for the purpose of making advances to the Federal reserve banks through the Federal reserve agents as hereinafter set forth, and for no other purpose, are hereby authorized. The said notes shall be obligations of the United States and shall be receivable by all national and member banks and Federal reserve banks and for all taxes, customs, and other public dues. They shall be redeemed in gold on demand at the Treasury Department of the United States, or in gold or lawful money at any Federal reserve bank." Reserve banks wishing to take out these notes must make application to the local Federal reserve agent and deposit as collateral security an amount of commercial paper which it has redis-counted for member banks, equal to the amount of notes to be taken out. With the approval of the Reserve Board this rediscounted paper may be withdrawn from time to time as it matures, and similar paper substituted. The Board may if it chooses refuse a part or all of any application for notes, and through its Federal reserve agent may impose an interest charge on them. It may also call for additional security at any time.

1 Conway and Patterson: The Operation of the New Bank Act, p. 141.

2 0. M. W. Sprague: "The Federal Reserve Act of 1913," Quarterly Journal of Economics, Feb., 1914, p. 242.

These notes are issued in denominations of $5, $10, $20, $50 and $100. They bear the distinctive letters and serial numbers assigned by the Reserve Board to the reserve banks through which they are issued. The Comptroller of the Currency is required to have a supply of notes ready for each reserve bank, and in order that they may be immediately available when needed they are to be kept in the Treasury or in the sub-treasury or mint nearest the place of business of each reserve bank. All expenses connected with their issue and retirement must be met by the reserve banks using them. These notes are receivable at par by all reserve banks and all member banks, and also by the United States Government for all public dues; but they are not legal tender in payments to individuals, nor may national banks count them as part of their legal reserves. The total amount of reserve notes that may be issued is limited only by the discretion of the Reserve Board and the supply of rediscounted commercial paper available as collateral.

To prevent over-expansion each Federal reserve bank is required to hold a reserve in gold of not less than 40 per cent against reserve notes in actual circulation and not offset by gold or lawful money deposited with the Federal reserve agent. A part of this gold reserve, but not less than 5 per cent, must be deposited with the United States Treasury to redeem the notes. To avoid too great rigidity the Reserve Board has the right to suspend this 40 per cent requirement, but to prevent this privilege from degenerating into inflation a check is provided in the requirement that if the gold reserve against reserve notes falls below 40 per cent a graduated tax shall be paid by the reserve bank. This tax shall be not more than 1 per cent per annum on the reserve deficiency below 40 per cent and above 32 1/2 per cent, and not less than 1 1/2 per cent on each 2 1/2 per cent that the reserves fall below 32 1/2 per cent. This tax is paid in the first instance by the reserve bank concerned, but the bank is required to add the tax to the rates of interest fixed for it by the Reserve Board.

The Act makes ample provision for the retirement of reserve notes when they are no longer needed. As previously noted, they may not be counted as lawful money for reserve purposes either by reserve banks or by member banks. It will be to the interest of a member bank, therefore, to deposit these notes with its reserve bank as promptly as possible. The paying out by one reserve bank of the reserve notes of another reserve bank is subject to a penalty of 10 per cent of the amount so paid out. Each reserve bank is required to keep in the Treasury at Washington sufficient gold to redeem the Federal reserve notes issued to it. As notes are presented for redemption at the Treasury, payment will be made from this redemption fund and the redeemed notes returned to the Federal reserve bank concerned, which must then reimburse the fund in the Treasury. If in redeeming these notes the Treasury pays out gold or gold certificates, the Secretary may require reimbursement in like funds. Reserve notes received by the Treasury otherwise than for redemption may be exchanged for gold in the redemption fund or may be returned to the issuing bank for credit to the Government. Should a reserve bank wish to reduce its liability for reserve notes, even if its own notes are not obtainable, it may deposit with the Federal reserve agent any reserve notes, gold, gold certificates or lawful money.

It is evident that elasticity of note issues - expansion in time of need and contraction when the need has passed - is fully provided for in the reserve notes. They will be promptly available when business calls for more money, and they can be just as promptly retired when the business demand slackens. Not only are they elastic, but they are also safe beyond question, as they are secured, first, by a gold reserve of 40 per cent; second, by the pledge of high-grade discounted paper equal in value to 100 per cent of the notes issued; third, by a first lien on all the assets of the reserve bank putting them out; and, fourth, by the guaranty of the Government.

While the bill was before Congress some attempt was made to discredit the reserve notes as being fiat money, but notes safeguarded by the deposit of prime commercial paper, dollar for dollar, plus a gold reserve of 40 per cent, cannot properly be classed as fiat. Moreover, though the notes are made obligations of the Government, which also undertakes to redeem them at Washington, they are not in any real sense government issues, any more than are national bank notes. As Professor Laughlin well says: "The Treasury has no power to issue them in payment of government expenses, since the initiative must come from the reserve banks, and only on the offer of commercial paper originating in a private business transaction. Although not stated literally, the notes are liabilities of the reserve banks since they must redeem them, and since the notes are a first lien on all the assets of such banks."1 The obligation of the Government is in addition to the real and primary obligation of the reserve banks and was so added in deference to the prevalent belief that the issue of money is a government function.

The net earnings accruing to the United States from the operations of the Federal reserve banks may, in the discretion of the Secretary of the Treasury, be applied either to the reduction of the national debt or to supplement the gold reserve held against the United States notes. If applied to the latter purpose it is possible that in the course of years a gold reserve may be accumulated sufficient to redeem the entire $346,000,000 of greenbacks. They could then be retired or allowed to circulate as gold certificates. The Act reaffirms the gold standard and provides that the Secretary of the Treasury may, for the purpose of maintaining the parity of all forms of money and to maintain the gold reserve, borrow gold on the security of United States bonds or of one-year 3 per cent treasury notes, or sell the same if necessary to obtain gold.

1 Journal of Political Economy, May, 1914, p. 408.