The measure tended to increase the amount of circulation outstanding and also to keep it out very much longer than would otherwise have been the case, that being the injurious effect always observed under similar conditions. Shortly after the United States entered the war there was developed a feeling that gold should be closely "conserved." Such conservation had become fashionable in Europe and while there was no occasion for it in the United States, owing to the fact that the balance of trade had been continuously and enormously favorable to us ever since the outbreak of the war in 1914, it was determined to follow European methods. The export of gold was forbidden, foreign exchange was subjected to strict government regulation, banks were encouraged to deposit their specie of every kind in the reserve institutions, and the public was practically although never technically refused the redemption of notes in gold. Gold certificates had constituted an important part of the general circulating medium, while United States notes greenbacks had been another element of some, although decreasing, significance. Both now disappeared from common use and their place was taken by Federal Reserve notes or by Federal Reserve bank notes. Owing to these many and influential elements the circula tion of reserve notes enormously increased and at the close of 1920 reached a figure close to $3,400,-000,000. Meanwhile the policy of lending upon the direct obligations of member banks secured by government bonds, instead of rediscounting commercial paper, had become fixed as a result of our war finance policy so that the ideal of a note circulation resting on "commercial paper" was again lost, the real basis of the currency being the new so-called Liberty bonds.

During the year or two after the war many came to the conclusion that the Federal Reserve notes had become an instrument of inflation and, that while they could be expanded very rapidly, contraction of them was out of the question. This notion, however, was in a measure proved erroneous after May, 1920, when a very rapid decline of prices and slowing down of business decreased the amount of hand to hand currency that was needed, while it also curtailed the amount of applications to reserve banks for credit. The note issue in the space of a year shrank by very nearly a third, reaching a figure of about $2,400,000,000 at the close of 1921. This rapid reduction was referred to as an evidence of elasticity, in popular discussion, but could not properly be so regarded by scientific students of the banking situation. It was an adjustment due to the change in the level of prices and to the reduction in the general volume of business, but had only a remote, if any, connection with the seasonal changes in the volume of demand for accommodation which are ordinarily thought of in discussions of elasticity in the currency. The reserve banks have provided a uniform, reliable and easily expansible currency which has served a valuable purpose, but the changes made by Congress in the fundamental provisions of the law have completely altered its effects in the establishment of an elastic currency, and such a circulation has never yet been developed.

An essential but little understood feature of the Federal Reserve system is found in the so-called clearance and collection provisions of the law. These were simple in the extreme. They authorized every Federal Reserve bank to act as a clearing house for its members and they further au-. thorized the Federal Reserve Board to act as a clearing house for all the Federal Reserve banks. The provision was a new one which had never figured in the legislative proposals for banking and currency reform that had been prominent during the twenty-five years preceding the adoption of the Act. No mention had been made of it in the work of the National Monetary Commission. It is difficult to see why so serious an omission should have been made. There is nothing in banking experience to show that a banking system established in a country where the bulk of the business is done on a credit deposit basis can exist and render much service unless it has a steady flow of deposit items to it. And yet such a flow cannot be maintained without performing the service of collection. This truth had for many years been recognized by the reserve-holding banks of the cities; indeed, one of their principal forms of competition with one another had been furnished by the terms which they held out for the collection and deposit of items sent them by their correspondents all over the country. The Federal Reserve Act, however, was bitterly opposed by the banks which had been in the habit of charging high rates of exchange not merely for the cashing of items drawn upon other banks, but also for those drawn upon themselves, if such items came from institutions outside of their immediate locality. Their opposition was continued after the Act had been passed, and rendered it doubtful how far the Federal Reserve System would go in introducing the collection system.

Nevertheless, it became so clear within a very few months after the organization of the reserve banks that a means of communication and settlement among them was essential, that the Federal Reserve Board ordered the establishment of a gold clearance system at Washington known as the "gold settlement fund." The plan for the estab-lishment of this fund had been carefully worked out in advance by the committee of technical experts which had framed the plans for the reorganization of reserve banks. These plans were followed in detail and the result was the establishment on June 1, 1915, of a fund formed by the deposit of $1,000,000 gold by each Federal Reserve bank with the Board at Washington.1 Clearance was effected telegraphically each week. Later, gold settlement was effected every day, and the fund in the hands of the Board gradually increased to a maximum for the banks and reserve agents combined of near $1,000,000,000. The effect of the working of the fund was to convert items held by reserve banks upon one another into immediate reserve claims, the gold in the hands of the Board at Washington being reckoned as a part of the vault reserves of the Federal Reserve banks themselves. Transactions under the gold settlement fund have run as high as $500,000,000 a day over long periods, and the service of this method of clearance both during and since the war has been invaluable, resulting as it has in largely terminating the shipment of gold.2