This method of retirement at first resulted in impounding gold and gold certificates in the hands of the federal reserve agents and substituting in the circulating media of the country federal reserve notes for the gold and gold certificates. On the basis of pledges of eligible commercial paper—bought in the open market or received as rediscounts—federal reserve notes were issued by the federal reserve agent to the reserve bank; at matur ity of this paper the bank would recover it with gold, gold cer tificates, and lawful money, leaving the federal reserve notes in circulation. This policy was deliberately pursued by the Federal Reserve Bank of New York, which retained the gold and gold certificates that came into its hands, and paid out its federal reserve notes. The gold and gold certificates thus acquired it used to recover commercial paper pledged with the federal re serve agent, and did not present its notes for redemption. This was a roundabout method of issuing federal reserve notes for gold, the direct issuance of notes for gold being prohibited by the Federal Reserve Act as originally passed.
The purpose of the New York bank in so doing was to concen trate the gold reserves of the country in the federal reserve system, and put them behind the federal reserve notes rather than behind the gold certificates. Since the gold certificate is but a warehouse receipt for the gold itself, the impounding of the receipts was equivalent to the impounding of the gold, and both may be counted as reserves.
Effect of Gold Reserve Concentration Several important results flowed from this operation under the original provisions of the Act: i. The federal reserve notes became themselves practically gold certificates, the federal reserve agent holding in gold about 90 per cent of the face value of the outstanding notes as security against them.
2. The federal reserve notes, instead of being quickly returned after issue and redeemed, were kept in circulation; the seasonal variations which it was expected would characterize the volume of federal reserve notes were less evident, and the volume kept increasing as fast as the gold and gold certificates in circulation decreased.
3. The federal reserve banks were put in a position to extend to the member banks quantities of federal reserve notes, in ex change for deposits of checks and the deposit of gold or gold certificates, as well as through rediscounting, which was prob ably the method contemplated by the Federal Reserve Act.
4. The federal reserve bank was given perfect facilities for effecting, according to the requirements of the bank, an inter change between the gold and rediscount paper held by the agent.
5. The federal reserve bank had sufficient stock of gold to meet the requirements of any member bank or other federal reserve bank, should such bank at any time seek credit in order to withdraw gold for foreign or domestic use. At the same time
the increased circulation of its federal reserve notes did not im pair the rediscount power of the federal reserve bank, since the gold to which the bank had access increased faster than the volume of its rediscounts. In fact its rediscount capacity was increased; if there were an unusual demand for redemptions and a corresponding reduction of notes in circulation, and a contrac tion of the currency threatened, the reserve banks might grant rediscounts more freely, without check from the reserve require ment until the reserve had been reduced to 4o per cent of the note and 35 per cent of the deposit liabilities. By the concentra tion of reserves the ultimate power of credit expansion is very greatly increased.
6. The defensive power of the banking system was increased as against the credit contraction that needs must follow the ex portation of gold; for if the gold had been withdrawn from the federal reserve bank by the presentation of notes for redemption it would have reduced very little the country's supply of credit, since the credit based on the gold scarcely exceeded the amount of the gold; but if the gold had been withdrawn from member banks the credit contraction would have been great, since each dollar of gold in the member banks supported a superstructure of many dollars of credit. This defensive power, however, has re cently been lessened through the greater expansion of federal reserve notes than of the reserve itself.
Direct Issue of Notes for Gold On June 21, 1917, the Federal Reserve Act was amended to permit the direct issue, by the federal reserve agent to the federal reserve bank, of federal reserve notes for gold and gold certificates. By this amendment the federal reserve bank need no longer resort to the roundabout method described above. Gold and gold certificates were thereby added to the list of collateral receivable by the federal reserve agent as security for notes, and it was provided that, when the federal reserve agent holds gold or gold certificates as collateral for federal reserve notes issued to the bank, such gold or gold certificates are to be counted as part of the gold reserve which the bank is required to maintain against its outstanding federal reserve notes. The 4o per cent gold re serve required by the Act of 1913 was not intended as collateral but as a protection against undue and excessive issues; it was a requirement in addition to that of the roc) per cent deposit of the commercial paper pledged. Today, however, the gold and the paper together make no more than roo per cent—that is, 4o per cent gold and 6o per cent eligible paper—and the lending power of the banks is therefore increased.