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Rh while in reserve cities (eventually nearly 50 in number) the requirement was 12½% cash in vault and 12½% in the form of balances in banks in the central reserve cities. All other banks were required to keep 15% reserve, of which 6% had to be cash in vault and 9% might be in the form of balances in the banks of central reserve cities.

This system had proved inadequate because in time of stress or panic there was no recognized means for relieving hard-pressed banks; also the currency was inelastic, being limited by the amount of bonds available, and being slow in its issue and even slower in redemption. During and shortly after the panic of 1893, an agitation was started in favour of some plan for the issue of “emergency currency” as a means of preventing the development of acute panics; this ultimately grew into a demand for a currency not purely of emergency nature but elastic as required by business needs, and therefore including issues of ordinary bank-notes protected by the joint guarantee of the banks. The only practical outcome of this agitation was seen in certain sections of the Gold Standard Act of 1900. These provided for refunding the outstanding U.S. bonds at a rate (2%) which precluded the growth of a premium while it authorized banks of $25,000 capital in places with less than 3,000 people. Both provisions tended to make the issue of notes easier. Although numerous bills were urged, especially after 1907, the proposed plan for a really elastic note issue was never seriously considered by Congress because of the unwillingness of the larger banks to guarantee notes issued by a great many small institutions. After the panic of 1907 the so-called Aldrich-Vreeland Act was adopted (May 30 1908). This made provision for the organization of “national currency associations” which would have been allowed to issue notes based upon commercial paper or other securities deposited by constituent banks with the associations in question. At the time, however, the plan did not get into practical operation, partly because the difficulties attendant upon the panic of 1907 had been overcome before the Act was enacted. Contemporaneously with the Aldrich-Vreeland Act, provision was made for the creation of a body called the National Monetary Commission, which continued investigations for several years and eventually proposed a bill for general banking reform, ordinarily described as the Aldrich bill. This measure contemplated the creation of a central banking organization with branches. The plan still retained the fundamental concept of an emergency currency, but the proposed institution was not equipped with the ordinary powers, duties and responsibilities which had been found necessary in central banking experience abroad. It has been supposed that the Aldrich bill would have been adopted in its original or a modified form if the Republican party, under whose auspices it had been developed, had not been defeated in Nov. 1912. The Democratic party having come into office in the spring of 1913, the duty of enacting banking legislation was necessarily assumed by it and in June of that year a bill embodying what afterward became the Federal Reserve Act was introduced into congress. The measure had been under construction and preparation from about March 1912 onward, and a first draft of it had been presented to President-elect Wilson soon after the election of 1912. It was then approved by the President-elect, and the process of perfecting and improving it went on during the winter of 1912-3 under direction of a House of Representatives Committee. This bill when introduced had thus been under consideration at the hands of the special committee of the House Banking and Currency Committee for about 15 months prior to the date of its introduction, while preliminary studies had been undertaken even earlier. The bill consequently was quickly completed, went through Congress during the middle of 1913 and became law on Dec. 23 of that year.

Theory of Federal Reserve System.—The theory of the Federal Reserve Act was the separation of the central banking functions of the past from practical bank operation, the latter being carried on through distinct reserve banks under the general direction of a board vested with the banking functions of the past. To carry out this idea, the Federal Reserve Act provided for the creation of a number of central institutions whose membership was to consist of national banks, while institutions organized under state law (banks and trust companies) might at will also become members. Each such bank was obliged to contribute a sum equal to 3% of its capital and surplus and to become liable for an additional 3% which might be called in case of necessity. The central directing mechanism of the system was the Federal Reserve Board, which consisted of five members chosen by the President of the United States with the Secretary of the Treasury and the Comptroller of the Currency as members exofficio. No two of these five selected members were to be chosen from the same Federal Reserve district. An essential and fundamental requirement of the Act was the compulsory transfer of the reserves of member banks to the Federal Reserve banks, the reserve provisions requiring a minimum of vault cash and a minimum of balances on the books of the Federal Reserve bank, while a certain percentage of the required reserve might be either in vault or in the Federal Reserve bank. This was the so-called “divided reserve.” The maximum required reserve (in central reserve cities) was 18%, of which 5% was to be in vault, 6% with the Federal Reserve bank, and 7% either in vault or with the reserve bank at the discretion of the member. Each reserve bank was authorized to issue currency protected by notes and bills growing out of commercial, industrial or agricultural operations. These notes and bills were to have a maximum maturity of 90 days, except where they were the product of agricultural transactions, in which case the maturity was raised to 180 days. Deposits of these notes were to be made with an officer known as the Federal Reserve Agent, there being one such officer at every Federal Reserve bank. Each Federal Reserve bank was governed by a board of directors, six of whose members (three bankers and three business men) were chosen by constituent member banks voting in three separate groups according to size of capital, while three (including the Federal Reserve Agent who was also the chairman) were chosen by the Federal Reserve Board. The Federal Reserve Board was given the function of passing on and establishing rates of discount, such rates, however, being originally named by the boards of directors of the several Federal Reserve banks. The task of dividing the country into districts was placed in the hands of an organization committee with instructions to establish not less than eight nor more than twelve such districts. This committee eventually divided the country into 12 districts with a Federal Reserve bank in each, and the President of the United States named the Federal Reserve Board in accordance with the new law, the new organization taking office Aug. 12 1914. On coming into existence, the board proceeded to organize a Federal Reserve bank in each district; the member banks paid in their stock subscriptions Nov. 2, and the Federal Reserve banks opened for business Nov. 16 1914. As thus organized the initial paid-in capital of the system at opening was about $18,000,000, while the gross reserve balances were $256,000,000. These balances at the outset were obtained chiefly through actual transfers of specie and legal tender money ($205,000,000), although in some cases rediscount credits were granted to aid members in establishing the necessary legal balance. Each bank was at the outset equipped with a small staff of officers and employees and a uniform accounting system. The beginning of the year 1915 found the system in operation, but with its transactions upon a small scale. Its first duty was to aid in the retirement of the emergency currency which had been issued shortly after the opening of the World War under the terms of the Aldrich-Vreeland Act as modified by Congress just after the outbreak of the war in such a way as to render the working of its provisions rather more flexible than was possible under the original legislation. At the outset, however, the system was of considerable service in controlling the outflow of gold which had proved to be an embarrassing feature of the economic changes that immediately succeeded the opening of the war, while it also aided in other emergency measures. Various measures were adopted with this end in view the best known being the so-called hundred-million-dollar “gold pool” formed after the outbreak of the war to provide exchange and to check gold losses.