Effect of Liberty Bond Issues on Bond Refunding and Conversion Bond refunding and conversions were well under way during 1916 and the first quarter of 1917. But the process was halted by the Liberty bond issues. Before that date the 3 per cent conver sion bonds could be sold at a premium, and it was profitable to the federal reserve banks to buy the 2 per cent bonds at par, convert them into 3's, and sell at a premium. The 3 per cent notes could also be sold at a premium, but the reserve banks chose to keep them as an investment. But the issue of 3%2' per cent Liberty Loan bonds destroyed the market for 3 per cent conversion bonds, and sales at par were no longer possible. At this time 3 per cent conversion bonds were held by the reserve banks to the amount of $7,000,000.
To remedy this condition a proposal has been made to raise the rate on future issues of conversion bonds to per cent. But the Federal Reserve Board hesitated to encourage the con version of bonds in this or other ways, deeming it best during the war to hold the 2 per cent bonds with the circulation privilege rather than the conversion 3 per cent bonds without the privilege, so that in an emergency the volume of federal reserve bank notes might be expanded. On December 31, 1919, the aggregate hold ings of the twelve federal reserve banks were $18.6 million of bonds with the note issue privilege, and $6.5 million of 3 per cent conversion bonds. From the fact that some $16 million of the privileged bonds bear but 2 per cent interest, it is evident that the federal reserve banks are not trying to make maximum earn ings from this investment. In 1916 the Federal Reserve Board encouraged the federal reserve banks to buy the 2 per cent bonds, but discouraged the issue of federal reserve bank notes upon them; or, if such notes were issued to a reserve bank, the board favored the barik's holding them in its vaults against a time of stress. The policy of the Treasury has been to redeem the I-year 3 per cent gold notes issued in connection with the conversions for the federal reserve banks.
Retirement of National Bank Notes One of the fundamental purposes of the federal reserve system was to eliminate the bond-secured note circulation and substitute the federal reserve note based on commercial paper and gold. The sudden withdrawal of the national bank notes was not feas ible, since they constituted a large fraction of our circulating media—in recent years averaging between $70o and $750 million —and to withdraw them would cause a violent contraction of the currency and of credit and a fall in prices. The plan adopted limits the maximum yearly reduction to $25,000,000, at which rate, if the banks made regular applications for the full amount and if the federal reserve banks bought such bonds only from the national banks and not in the open market, it .would be 3o years before all the national bank notes were retired. The law, how
ever, limits the retirement operations to 20 years and to the 2 per cent bonds; it was not, therefore, the contemplation of the law to provide for full retirement, which Congress may have regarded as less conservative and safe than the present plan. Special laws, of course, may be passed later to hasten and extend the retirement if it is found desirable.
No provision is made whereby the board is directed to give preference to the 2 per cent bonds of a bank which is forced to liquidate and throw its bonds on the open market. The board is also without instructions as to the amount of bonds which it shall require the reserve bank to buy from any particular bank. During 1916 the purchases of 2 per cent bonds by the federal re serve banks exceeded the $25,000,000 maximum which the board can compel the reserve banks to buy in any one year, and it was found unnecessary, therefore, to direct the purchase of such bonds.
The purpose of the conversion plan of the act is to maintain the market value for the 2 per cent bonds and to insure a gradual retirement of national bank notes, any resulting deficiency in the volume of circulation being made up with federal reserve bank notes.
The Pittman Act of xga8 The occasion of the Pittman Act was explained in Volume I, Chapter I, as the sudden and pressing need for a great quantity of specie to pay the adverse trade balance with India during the war, and the desire to conserve the gold supply for reserve poses. There were other incidental purposes, such as the tion of the price of silver and the encouragement of its production. The act authorized the Secretary of the Treasury to reduce and sell as bullion silver dollars up to $350 million, then held in the Treasury, and to retire the silver certificates outstanding against the silver dollars so destroyed. To prevent contraction of the currency as the certificates were retired, the Federal Reserve Board was authorized to permit or require the federal reserve banks to issue federal reserve bank notes, in any denomination authorized by the board, to an amount equal to the silver melted and sold. In order to secure these bank notes the federal reserve banks were to deposit with the Treasurer of the United States certificates of indebtedness and I-year gold notes. The Treasurer was permitted to extend the time of the certificates so deposited or to pay them before maturity, at his option, and the tax on the federal reserve bank notes so issued was to be so adjusted that the net return on the certificates of indebtedness and the gold notes would equal the net return on the United States 2 per cent bonds used to secure federal reserve bank notes. The Treasurer issued 2 per cent r-year certificates for this specific purpose. In all other respects the federal reserve bank notes are like those provided for under the Federal Reserve Act.