America's Money Machine

106 PART II / THE GREAT REVERSAL
of government bonds. The main concession obtained by the Reserve
from the Treasury was that the Reserve banks should act as fiscal agents
for the government, as was originally contemplated by the Act but which
had until now been resisted by the Treasury. The effect of this transfer
offunction was to give the Reserve banks control of the large cash funds
previously held by the sub-treasuries.
In order to assure success of the various "Liberty" loan issues, the
Federal Reserve set a rediscount rate for customers' notes secured by
government bonds that would make it easy for patriotic citizens to subscribe·
for the bonds, and then pay for them by borrowing against them
at exactly the same rate as the bonds yielded. The first Liberty loan
carried a 3 1/2 per cent coupon, and the rediscount rate was 3 1/2 per
cent. As the Board frankly stated, in its 1917 Report:
It was necessary, in order to facilitate the operations of the Treasury, that
discount rates at the Federal Reserve banks be maintained on a basis in
harmony with the low interest rates borne by the Government loans.... It
was fortunate that this policy could be carried out without infringing too
greatly on the resources of the Federal Reserve banks, for it is obvious that
any advance in rates paid by the Government on its obligations was necessarily
gradual, moving up from 3 per cent, the rate paid on certificates issued
in May, to 3 1/2 per cent and later to 4 per cent, the rate carried by the second
Liberty loan issue.... As the rates advanced it became feasible for the
Federal Reserve banks to raise their rates. 7
It is worth a look at the effect upon the monetary system as a whole of
this subservience of the Federal Reserve to the Treasury. Between April,
1917, and the end of 1918, Federal Reserve note circulation increased
from $399 million to $2,629 million and deposit credit increased from
$804 million to $1,804 million. During this period the amount of gold
coin and gold certificates in circulation was reduced from $1,673 million
to $618 million, with most of this gold going into the coffers of the
Reserve banks to provide a base for increased credit and circulation.
Deposits and note issue became the basis, of course, for an expansion of
commercial bank credit and this is reflected in .the rise in loans and
investment of all banks from $24.6 billion (as ofJune 30, 1916) to $36.6
billion as ofJune 30, 1919, an increase ofnearly 50 per cent. Banks were
encouraged to invest directly in U. S. government obligations-principally
the various Liberty loans-and the holdings of government bonds
increased from $1.6 billion onJune 20, 1917 to $5.8 billion onJune 30,
1919.
The expansion ofFederal Reserve credit had been mainly through the