The reserve banks gain one more advantage by holding a good supply of salable paper. In case of threatened gold export they can sell the paper abroad, thus building up balances there against which to draw exchange instead of shipping gold.
The purchase of paper has an effect opposite to that of selling it. It releases funds which may be loaned and tends to ease the rates of interest. Obvi ously, if the reserve banks wish to use the weapon of selling paper, or "borrowing from the market," as they say in London, they must lay in their supply ahead of time. No results can be brought about by buying and selling at the same time. It is evident that the control of the reserve banks over the money mar ket will grow in effectiveness as they become rela tively more important in the banking strength of the country.
4. Federal Reserve new kinds of bank notes are provided for in the Act. The first is the Federal Reserve bank note, which is secured by a bond deposit. This was described briefly in Chapter 16. The second is the Federal Reserve note, which is capable of expansion to meet the increasing needs of business. This feature eliminates one of the greatest defects of the national banking system. It is to be regretted, however, that the volume of these notes must for several years bear only a small proportion to the total supply of credit money. While the notes themselves are elastic, their relative unimportance in the total currency supply causes their elasticity to be less effective than could be desired. The foreign countries which enjoy the benefits of an elastic cur rency have in their money supply a large proportion of the elastic medium.
Reserve banks may exchange Federal Reserve notes for commercial paper which member banks bring in for rediscount. This renders the notes capa ble of expansion. The fact that member banks can rediscount their paper also makes the credit of banks capable of expansion. Smith comes in to the First National Bank for a loan at a time when the bank is near the end of its rope. It has loaned and ac cepted deposits until its reserves are reduced almost to the legal minimum. To make any more loans means one of two things to the bank. Either its de
posits will increase and thus lower the reserve ratio, or the borrower will take the proceeds of the loan out in cash and thus draw down, the reserves and lower the ratio all the more. Without a bank of rediscount the loan could not be made. With the resources of the reserve bank at hand, the member bank can ac commodate Smith by rediscounting some of its paper. If he wants cash, he can get Federal Reserve notes. If he wants a deposit account, the bank can give it to him and protect its reserves by building up its balance at the reserve bank film rediscounting. Of course, Smith will pay a rate somewhat higher than the re discount rate, but better something at a high rate than nothing at all.
Federal Reserve notes are obligations of the United States as well as of the issuing banks. They are re deemable in gold at the Federal Treasury and in gold or lawful money at any of the reserve banks. They are receivable for all debts to member banks, reserve banks and the United States. Each Reserve bank must deposit with the Federal Reserve agent of its district an amount of commercial paper equal to its reserve notes outstanding. The Reserve Board may require at any time the deposit of additional collateral and it may permit the substitution of new collateral in the place of paper which matures. Any reserve bank may reduce its outstanding circulation by depos iting lawful money or its reserve notes with the Fed eral Reserve agent.
Under the amendment of June 21, 1917, the re serve banks may also issue Federal Reserve notes, dol lar for dollar, against gold. The gold is deposited with the Federal Reserve agents just as commercial paper is when used as collateral security for note issue, and the gold so deposited may be counted as a part of the reserve bank's required reserve against their reserve notes outstanding. Thus a reserve bank with $100,000,000 gold can issue $100,000,000 in re serve notes against it and, then, counting it as legal reserve, issue additional notes against commercial pa per until the total issue reaches $250,000,000 ( 40 per cent being the reserve requirements) .