As a result of our disastrous experience with the greenbacks and free silver there has persisted to this day a lively fear of over-expansion or inflation, as it is generally called. While the Federal Reserve Act was under consideration in Congress the opinion was freely offered that it opened the way to inflation both of the currency and of bank loans. It was contended that, since the Act fixes no limit to the amount of the new reserve notes to be issued, nor provides any effective check upon their issue by means of a surtax, as in the German and Canadian systems and in the Aldrich-Vreeland Act, these notes may be put out in such volume as to drive lawful money out of circulation and lead to a dangerous exportation of gold. It was claimed, further, that the increased supply of cash in the vaults of the banks and set free by the lower bank reserve requirements may encourage bankers to lend money more freely and so stimulate speculation.
As already noted, safeguards against these supposed dangers of inflation are provided in part in the Act itself. The Federal reserve notes cannot be issued at the whim of the Government; they must originate with the Federal reserve banks and can be secured only by the pledge of rediscounted commercial paper which has passed the scrutiny of both the member banks and the Federal reserve agent. These notes are also protected by a 40 per cent gold reserve, and they may be subjected to a tax imposed by the Reserve Board. They cannot be counted as legal reserves by member banks or reserve banks and one member bank cannot pay out the notes of another, under a penalty of ten per cent of such payment. The danger of over-expansion of credit, however, is in the form of deposits rather than of notes. It has been urged that the restriction upon member banks limiting their loans to any one borrower to ten per cent of the capital and surplus is nullified by the qualification that "this restriction shall not apply to the discount of bills of exchange drawn in good faith against actually existing values." This criticism seems to overlook the fact that the paper eligible for rediscount is limited to "notes, drafts and bills of exchange issued or drawn for agricultural, industrial or commercial purposes," and that the character of such commercial paper is subject to definition or determination by the Reserve Board. Furthermore, paper representing investments or speculative transactions is specifically excluded from the privilege of rediscount. Only paper representing an actual commercial transaction, or "secured by staple agricultural products, or other goods, wares, or merchandise," maturing in the first case within ninety days and in the other within six months, can be rediscounted. Banks are permitted to discount acceptances based on exports and imports up to one-half of their paid-in capital and surplus, but as this practice is not likely to grow rapidly, over-expansion should not be feared from that source. It must be clearly recognized, however, that in the final analysis the real check upon over-expansion of credit rests not upon legal provisions and regulations, but upon the wise and experienced management of the bankers who pass on the paper discounted. Safety depends primarily upon the judgment and wisdom of the men selected to manage the affairs of the several reserve banks, and finally upon the members of the Federal Reserve Board who will have supervision over the system as a whole.