America's Money Machine

The Path of Retreat 103
Along with these steps to increase the "elasticity" of the monetary
system, that is, to extend the note issue and credit power of the Federal
Reserve System, the Congress allowed the gold reserve to count as part
of the reserve against note issues. (The Federal Reserve Act had somewhat
anomalously provided that note issues should be covered by the
deposit of collateral to the extent of 100 per cent of the notes issued,
which meant in effect 140 per cent coverage, including the gold reserve.)
Fortified with all these new powers, the Federal Reserve System was
like Alexander, bequeathed an army, looking for worlds to conquer. The
System had been constructed on the theory that circulation and bank
credit should expand in accordance with the needs of business as reflected
in the demand from the business world, acting through the banks,
for increased accommodation. But no demand was forthcoming. At the
end of 1914, the Federal Reserve banks, with gold and cash of $268
million to meet the needs of business, had discounted less than $10
million of bills and issued only $10.6 million of notes. During 1915, the
banking statistics reflect the evident desire and determination of the
Federal Reserve authorities to test their powers. Despite an increase of
money in circulation through gold and gold certificates of $250 million,
silver and silver certificates of nearly $40 million, and U. S. notes of $36
million, the Federal Reserve managed to put into circulation $168 million
of Federal Reserve notes. Part of this increase in total circulation may
have been issued to offset national bank notes that were retired from
circulation to the extent of $225 million; nevertheless, total money in
circulation increased during the year by 10 per cent-a not inconsiderable
increase. 5
The Federal Reserve now began the operation ofwhat has since developed
into its most significant and powerful mechanism for the control of
the amount ofbanking credit in circulation. This is what is known as open
market purchases. Since the commercial banks showed a reluctance, or
indifference, or a lack ofany necessity to discount their commercial paper
with the Federal Reserve banks, Federal Reserve authorities went into the
market and purchased such paper. During 1915 commercial· banks had
discounted $32 million of bills. The Federal Reserve System itself purchased
$16 million of government bonds and $24 million ofcommercial
bills. These purchases were made under Section 14 of the Federal Reserve
Act which provided originally that "any Federal Reserve bank may,
under rules and regulations prescribed by the Federal Reserve Board,
purchase and sell in the open market, at home or abroad, either from or