During the period 1917-1918 the gold in the federal reserve banks was greatly increased by several factors. For one thing the Federal Reserve Act had provided for a gradual transfer of the deposits of member banks from their correspondents to the federal reserve banks, and the amendment of June 21, 1917, provided for the immediate completion of that process. Again, the state banks and trust companies were empowered by law in many states to carry their reserves, in whole or part, to the federal reserve banks; all institutions of this kind which joined the system were automatically forced to carry their full reserve with the federal reserve banks, and many others found it expe dient to do so to avail themselves of the clearing and collection facilities of the federal reserve system. Then, too, the banks of the country were importuned to concentrate their reserves in the federal reserve banks and thus strengthen the system for the strains of war financing. Moreover, the reserve banks have issued notes for gold at every opportunity, and have advised against withdrawals of gold. Finally, heavy importations of gold during 1915-1917, and the prohibition or regulation of gold exportations during the war, have favored the accumulation of large specie holdings.
The amendment of June 21, 1917, also provided for the joint custody and control of gold, lawful money, and federal reserve notes heretofore held by the federal reserve agents alone. These funds are now kept in safes with two locks or combinations, one in control of the federal reserve agent and his representative, the other in control of the officers of the reserve bank, and a joint record and periodic audit of accounts are made. The amendment made no provision for the joint custody of the commercial paper and other eligible securities pledged as collateral for federal re serve notes, but the board has recommended the same treatment for these also.
The Federal Reserve Act provides that a gold reserve of not less than 4o per cent must be maintained by the federal reserve bank against its federal reserve notes in actual circulation and not offset by gold or lawful money deposited with the federal reserve agent. The federal reserve notes are redeemable in gold, on demand, at the United States Treasury in Washington, or in gold or lawful money at any federal reserve bank. The board must require each federal reserve bank to maintain on deposit in the Treasury a sum in gold sufficient, in the judgment of the Sec retary of the Treasury, for the redemption of the federal reserve notes issued to each bank, but in no event less than 5 per cent of the amount of these notes. This redemption fund may be counted as part of the 4o per cent reserve required against the notes.
Tax on Deficiency of Reserves To provide against extreme emergencies, provision is made for the increase of federal reserve notes. The Federal Reserve Board
may suspend, for a period not exceeding 3o days (though it may from time to time renew such suspension, for periods not exceed ing 15 days) any reserve requirement of the Federal Reserve Act, provided it assesses at the same time a certain tax on the notes. That is, notes may be issued reducing the reserve below the required 4o per cent on the condition that the Federal Reserve Board assesses a graduated tax of not more than i per cent per annum upon the deficiency of the reserve, until the reserve is reduced to 32I2 per cent, and thereafter a graduated tax of not less than 1;4 per cent on each additional 2I 2 per cent deficiency or fraction thereof. The following table indicates the tax rates if the board fixes the maximum r per cent and the minimum IY2' per cent as just described: This indeed provides an elastic limit and makes possible the use of reserves for defensive purposes, but the tax rates soon be come prohibitive. It is further provided that the federal reserve bank must add an amount equal to these tax rates to its rates of interest and discount. The discount rate, therefore, will also soon become prohibitive. This elastic limit is less awkward of initia tion than the English plan of suspending the reserve requirement by act of Parliament. As compared with the German 5 per cent flat tax rate on the excess issue, the American plan is less severe at first but more severe ultimately.
Other Devices for Obviating Deficiencies of Reserves The paragraph of the Federal Reserve Act prescribing the conditions when the reserve requirement may be suspended, and the penalties for violation, is very loosely drawn. It provides a graduated tax for deficiencies of reserves against notes, but not against deposits. Formerly, in order to determine whether a deficiency of reserve existed, the practice of the federal reserve banks had been to subtract 35 per cent of the deposits from the existing reserve and see whether the amount remaining equaled 4o per cent of the federal reserve notes outstanding. But in February, 1920, when this method showed that actual deficiencies existed, the method was changed, so that now 4o per cent of the federal reserve notes is subtracted from the actual reserves, and the deficiency or excess is shown with respect to deposits. By this change in method of calculation, therefore, the provisions of the law which aimed at checking inflation of the credit of reserve banks through the graduated tax on deficiencies of reserves, and through rising discount rates, were nullified. Hence, until the law is amended this phase of the law is held in suspension, and the 4o per cent requirement is rather a danger sign than anything else.