THE RESERVES SITUATION IN THE FEDERAL
RESERVE SYSTEM

We are passing from a debtor to a creditor nation; we have come to hold a disproportionate share of the world's gold; our provincial finance is being transformed into a cosmopolitan finance; banking and financial problems, of huge proportions and in new spheres, are pressing for immediate solution. Luckily the reconstruction of our banking mechanism was well under way when Mars let loose his dogs of war in 1914; we had taken measures to supplant our rigid, restricted, decentralized national bank system with an elastic, freer, centralized federal reserve system. Among the chief elements of strength in a banking system are its reserves and the mechanism by which they are controlled. Size, mobility, and composition are the three factors of strength in bank reserves; they make for safety, elasticity, and accommodation. The federal reserve scheme changed the size, quality, location, and control of our bank reserves; it purposed to make them a more effective defense against panic and a more serviceable agent for accommodation to the business world; the primary reserves were to be rendered so mobile and consolidated and the secondary re- . serves so convertible that the size of the primary reserves might actually be reduced and yet provide greater safety, elasticity, and accommodation than were realized under our old banking scheme. It will be the aim of this article to present these changes and to note wherein expectations have or have not been fulfilled and how the original plan has been amended.

Reserves against Deposits

Secondary reserves: (1) of the federal reserve banks. Since the member banks are stockholders of the federal reserve banks they have the same interest in dividends as do stockholders in an ordinary bank. The Federal Reserve act provides that member banks as stockholders are entitled to receive an annual 6 per cent cumulative dividend on their stock. Up to 1916 the twelve federal reserve banks earned a net half million dollars and during 1916 two

and three quarter millions. The sum of these does not provide the 6 per cent; in fact, the figures for the whole system average about 3 per cent for the two years and 5 per cent for last year, on the yearly average paid-in capital of $55 millions. By the first of the year all the banks had declared dividends; when declared they are at 6 per cent and postdated to cover accumulated arrears between certain dates. Richmond has hers paid till October, 1916; Atlanta, till June, 1916; Dallas, till April, 1916; but New York, St. Louis, and San Francisco have not yet cleared their 1915 arrears. During 1916 three banks earned more than 6 per cent, eight more than 5 per cent, and ten more than 4 per cent. The system has, therefore, to date, in the light of the money market, been a net burden on the member banks.

Some persons believe this burden will be perennial, some are confident the federal reserve banks will ultimately pay their way. Let them become well established and get their organization expenses amortized; let them become better known and much used by member banks for rediscounting; let them develop their open-market transactions, particularly in acceptances; let them be freed from the handicaps created by war conditions and it is expected they can earn their 6 per cent dividend and be self-sustaining. They are expensive institutions, but not too expensive for the service they render. It is, of course, wrong in principle to judge the usefulness of the federal reserve banks by their earning capacity. They are dominated by a public interest, not a profit-making interest; the public interest may necessitate that they enter into transactions which will result in little if any profit.

Nevertheless, the fact of these low earnings has had a most telling effect on the attitude of the national and state banks toward the system, and has, together with other matters relating more directly to bank reserves, occasioned the chief movements for changing the system by legislation and board regulation. One of these movements is to reduce or abolish the capitalization of the federal reserve banks. The argument, occasioned as it was by the low earnings of the capital stock, was that the choice of 6 per cent subscriptions was arbitrary and a guess at what the capital requirements would be, and that the mere liability of the banks for the required capital would have been as effective as its payment; that the paid-in capital created a dividend responsibility which forced banking operations and earnings, i.e., forced the reserve banks into competition with the member owners, in open-market