would tax the poor, and the result would be that in posterity, the rich would be living on the poor. Today it is almost the other way around. As we are distributing the bonds very widely the poor who subscribe are becoming creditors and, in the future, through big income taxes, it will not be at all surprising to find the rich ones paying the poor.

One difference in paying for the war in taxes and paying for the war in loans is this-when you get a tax receipt you have not a negotiable instrument but when you get a bond receipt for payment to the government you have something that you can use as collateral security at the bank, because a bond dissects out your future right to payment but does not dissect your future burden to pay, making a bond a one-sided instrument. You can use it as collateral security for a loan. Germany has financed the war almost wholly by bonds. That is bad finance for several reasons, but particularly because it tends to encourage the use of these bonds as collateral security for debts and make people less thrifty and more willing to borrow in order to lend.

One other fallacy that I might mention is the idea that if you buy a bond today and then pass it along to someone else tomorrow, say to buy a suit of clothes with it, you have done your full duty. Some merchants advertise the fact that they accept liberty bonds and much is made of the fact that liberty bonds are very salable. It is all right to lay stress on the fact that they are salable but it is all wrong to sell them unless you have to. It is a comfort to know when you buy a liberty bond, that if, later, you get in a tight place, you can sell the bond and get full value for it immediately. Nevertheless, when you encourage the sale of bonds you are fighting the idea of thrift, which is the basic idea of finance. What good does it do the government if I lend it a thousand dollars today and get a liberty bond and then tomorrow sell that bond to someone else for a thousand dollars? I simply carried it for one day and the other person who bought it of me might just as well have subscribed for it in the beginning! He is the one carrying the burden and not I. If we do our full duty we must not only subscribe and not only save in order to make good our subscription, but we must hold the bond to the end of the war.

The upshot of the whole matter is, therefore, that our real part in financing the war is good old-fashioned thrift or saving.

SOME TENDENCIES IN THE FEDERAL RESERVE SYSTEM

BY E. M. PATTERSON, PH.D.,

University of Pennsylvania.

There is no doubt in the minds of careful observers that the first great economic task before the people of the United States today is production. By this is meant not only the raising of agricultural products, the extraction of ores, and the processes of manufacture but also the transportation of men and materials to our seaboard and to Europe. Our second task is to save from our annual production the amounts needed by our Allies and ourselves in the conduct of the war. If we could increase our production by this amount the saving might be accomplished with no curtailment of our ordinary expenditures and with no lowering of our standards of living. Since a great part of the amount cannot be secured in this manner, there must be a reduced standard or we shall not furnish to our Allies the promised assistance. To secure this saving with the maximum of fairness and in a manner that will not lessen our productivity is our second task. The third is to devise the most satisfactory method of transferring to the government the ownership of the wealth that we produce and save. Congress has made unprecedented appropriations, tax legislation has been enacted, and huge bond issues have been authorized. A vast fiscal program has been evolved and its machinery set in motion.

In the midst of these activities stands our banking system, including many varieties of banks but especially the federal reserve banks, and their members, which are for the most part national banks. This structure performs numerous functions three of which are of particular concern in this discussion. (1) The federal reserve banks are fiscal agents of our government while both federal reserve banks and member banks are depositaries of government funds. Through them government bonds and certificates of indebtedness are marketed. They are thus an important part of the government's fiscal machinery. (2) These banks issue various kinds of money for use in the community. From the national banks come the national bank notes and from the federal reserve banks the federal reserve bank notes and the federal reserve notes, while on the

deposit liabilities of all of them are drawn checks and drafts-the most important part of our currency. (3) These banks directly and indirectly make loans to private individuals and corporations, furnishing the financial aid required by our business institutions.

IMPORTANCE OF THE BANKING SYSTEM

This paper attempts to analyze the influence of this banking system in performing the three great economic tasks mentioned. Primarily the system is concerned with the third, assisting in the transfer to the government of the ownership of our wealth, but in doing this it may exercise a very important influence upon the other tasks in which we are engaged the production and saving of wealth. Although only a device for facilitating transfers of wealth, it may greatly affect our whole national budget. A powerful banking machine will either help us to mobilize effectively our economic power, encourage production, stimulate saving and thus increase our wealth for war uses; or, improperly utilized, will retard production, discourage saving, encourage extravagance, and prevent our acquiring the funds we so much need.

The federal reserve system (a term which may be used to include both federal reserve banks and member banks) exists primarily to aid commercial banking as distinct from other financial operations, particularly speculative and investment banking. The national banks have always been restricted in their functions, not being allowed to own or deal in stocks, to acquire real estate (except for their own accommodation in the transaction of business), nor, except to a very limited extent, to lend on mortgage security. Even bonds may be acquired by them only because of a somewhat technical interpretation of the national bank act and, until 1913, savings accounts were not legally authorized. National banks are expected to specialize in commercial banking. Their customers are for the most part the business men of the community who are concerned. primarily with transferring goods from producers to consumers. Accordingly their funds should not become imperilled in speculative operations nor be invested in transactions from which they cannot quickly be withdrawn. In other words, the assets of any bank must be safe but those of a commercial bank must also be liquid, i.e., easily converted into cash.

Under the national bank act there was not the desired liquidity

and the entire system lacked elasticity. To remedy these and other defects the federal reserve act was passed in 1913. Its leading provisions need not be repeated here. It will suffice to point out that the entire act places emphasis on the importance of the banks of the federal reserve system having liquid assets. The liabilities of the federal reserve banks, i.e. their notes and deposits, are demand liabilities and their customers are chiefly member banks whose liabilities are of the same kind. Therefore the reserve banks must above all things keep their assets liquid. To this end they may discount for their member banks only "notes, drafts and bills of exchange issued or drawn for agricultural, industrial or commercial purposes, or the proceeds of which have been used, or are to be used, for such purposes." Further the law specifically excludes "notes, drafts, or bills covering merely investments or issued or drawn for the purpose of carrying or trading in stocks, bonds or other investment securities, except bonds and notes of the Government of the United States."

The federal reserve board, which was required by law to indicate more precisely the kind of paper eligible for rediscount, held as follows:

(a) That it must be a bill the proceeds of which have been used or are to be used in producing, purchasing, carrying, or marketing goods in one or more of the steps of the process of production, manufacture or distribution:

(b) That no bill is "eligible" the proceeds of which have been used or are to be used:

(1) For permanent or fixed investments of any kind, such as land, buildings, machinery.

(2) For investments of a merely speculative character, whether made in goods or otherwise.

The general intent of the law and of the rulings is evident. The reserve banks' assets are to be kept liquid in order that these banks may be of the highest possible service as commercial banks. To that end only "commercial" paper is to be acceptable for rediscounting. Speculative paper and even investment paper are ruled out with the single exception of bonds and notes of the government of the United States. Only a few concessions of a minor nature or of a temporary character are to be found in various sections of the act.

CONCENTRATION OF THE COUNTRY'S GOLD SUPPLY

Since the passage of the law in 1913, three particularly significant changes have occurred. The first is the concentration of a large part of the gold supply of the country in the possession of the reserve banks. Scattered bank reserves mean a lack of mobility, while concentration brings flexibility or ease of adjustment in financing business transactions. Our former system of decentralized reserves was too rigid and their concentration in the federal reserve banks was a distinct improvement. Greater elasticity of credit transactions has been made possible; funds can now be shifted more readily from one place to another; relief can quickly be granted to sections of the country where it may be needed; and the concentrated gold is placed definitely under the direction of a central body which may control gold exports.

The law as originally passed provided for a gradual shifting of reserves and along with this change a reduction in the reserve requirements of the member banks, but soon the European war brought us so large a flood of gold that it was thought wise to hasten the concentration, and three steps were taken. (1) Reserve requirements for member banks were still further reduced and are now 7, 10 and 13 per cent respectively for the different classes of banks. These percentages may be contrasted with the 15 and 25 per cent requirements of a few years ago. (2) These required reserves must all be kept with the reserve banks, and member banks are distinctly urged to turn over to the reserve banks all of their cash holdings with the exception of such amounts as they think it wise or necessary to hold for daily needs. This too is in marked contrast with our former banking practice under which our national banks were required to hold from 40 to 100 per cent of their legal reserve as cash in their own vaults. (3) At first the law did not permit the federal reserve banks to count as part of the 40 per cent reserve which they are required to hold against their issues of federal reserve notes, the gold and gold certificates in the possession of the federal reserve agents. Since June 1917 this accumulation of gold and gold certificates is to be counted, a change which permits a great expansion in note issues.

These three modifications in reserve requirements are of great importance. On January 2, 1915, there was $1,875,000,000 of gold