State banks which join the system must maintain the same total reserve as that required of national banks, but a part of the reserve might, until Novem ber 17, 1917, be deposited with other banks, whether national or not, where the state laws required it. "Ex cept as thus provided, no member shall keep on de posit with any non-member bank a sum in excess of ten per centum of its own paid-up capital and sur plus." 2. Combined reserves.—A part of the bank re serves of the country are thus held in the twelve Federal Reserve banks, which are controlled by the Reserve Board. They may be forced to use their re serves together, just as a central bank would do, if the Board wishes. Against these deposits and others the reserve banks must carry a 35 per cent reserve in lawful money.
If the reserves of one reserve bank begin to to the danger point the Board may require some other reserve bank, which presumably is in a stronger posi tion, to rediscount some paper for the weaker bank and thus enable it to build up its reserves again. Should excessive credit expansion and consequent gold exportation threaten the country the Reserve Board may require one of the reserve banks, or all of them together, to raise their discount rates and thus check the inflation, just as is done by the great cen tral banks of Europe. The Board has power to de termine the discount rates for each reserve bank and it may fix for one rates different from those specified for others.
It is quite natural that any one reserve bank should protest if it is required to raise its discount rate while the rates of other reserve banks remain low, as such action must necessarily curtail its lending operations and may reduce its profits. This is also true of re discounting paper for other reserve banks. Such re discounting lessens the lending power of the bank and transfers so much available funds to other districts. The separate reserve banks will always be influenced by customers to keep the rates as low as possible and thus make borrowing easy in the district. Each re serve bank will be pulling for capital for its own dis trict, and the interests of different districts are sure to conflict sooner or later. The Reserve Board needs to carry a steady and firm hand and to exercise its pow ers wisely, having regard for the best interests of the country as a whole. It is to be hoped and expected, moreover, that the men in charge of the various re serve banks will be too broad-minded to think only of profits for their banks and of the needs of their own districts.
3. Controlling the money market.—The Federal Reserve banks have two ways of influencing or con trolling the market rates of interest. Thru the mar ket rates they can, of course, influence the inflow and outflow of gold. The banks do not have an option of paying either gold or silver, as the Bank of France has. All obligations are redeemable in gold, so the banks cannot protect their reserves by charging a premium on gold. The two methods of control which they do have are (1) raising or lowering the rates of rediscount and (2) buying or selling securi ties and commercial paper.
If the rediscount rate is lowered to a point below the prevailing market rate, the market rate will be pulled down because banks can, if necessary, redis count in order to give their customers cheap accom modation. It is to be expected that competition among the banks will make the lower rate effective. If one bank rediscounts and lowers its rate, others must do likewise or lose their borrowers. Banks may object to this sort of a forced drop in the market rates, for they sometimes make a larger net profit by lending small amounts at high rates than by lending larger amounts at comparatively low rates.
When the reserve banks raise their rediscount rates they force up the market rates, provided the banks are actually rediscounting. It has been explained in a preceding chapter that 'a raise in the central bank rate cannot be made. effective in the market unless banks find themselves compelled to rediscount in or der to accommodate their customers. So long as their resources are ample they can afford to ignore the re discount rate and go on making loans at low rates. Of course, there may be a moral effect of more or less strength from the mere fact that the reserve banks think it wise to raise their rates.
The reserve banks have a way of reducing the funds available for loans in the market. They can sell any securities or commercial paper which they may have in their possession as a result of purchases allowed by the law. The sale of this paper will act as a spo lge in the market, soaking up funds which might be used for loans if they were not exhausted in buying paper from the reserve banks. If the reserve banks have enough paper to sell, they can so reduce the market funds that the banks will be forced to re discount in order to accommodate customers any fur ther. This is the desired result. As soon as the banks are brought to their knees and compelled to rediscount, the reserve bank rates become effective in the market.