America’s Money Machine

THE ALDRICH-VREELAND BILL, as the Emergency Currency Act of May 30, 1908, was known, embraced the principles of an “asset currency” which represented a revolutionary innovation in U. S. currency practice, and prepared the way for the theories and practices later embodied in the Federal Reserve System.

The bill took a step toward centralization of the note issue by conferring control over the issue upon associations of banks, and by widening their discretion as to the acceptable reserves behind the currency. Recall that the reserve for the principal paper money—the national bank notes—was narrowly restricted to government bonds, but that within this restriction the determination of the amount of notes to be issued lay with the individual bank and the play of economic and other forces that affected their decisions.

Under the new act, any ten national banks having aggregate equity funds1 of at least $5 million could organize themselves into an association with power of note issue, subject to an overriding but nominal control of the Treasury. That is, the associations were authorized to receive, to validate, and to hold for note issue purposes, certain kinds of security or collateral, and in return to issue to the depositing bank an equivalent amount of circulating notes which the association in turn received from the Comptroller of the Currency.

The mechanics of this process need not detain us. The essential features of the system were: (a) Banks could obtain and issue legal tender paper money secured by a wide range of collateral, including state and municipal bonds, corporation bonds, and commercial paper, (b) The kinds of acceptable security were within the discretion of the associations, within certain limits. For example, “commercial paper” was defined simply as notes representing actual commercial transactions, bearing the endorsement (guarantee) of two responsible parties, and having a maturity not exceeding four months, (c) Note issue privilege was limited to banks that had already outstanding notes secured by government bonds to the extent of 40 per cent of their capital. (The purpose of this provision was to restrict the additional issues to “emergency” needs.) The amount of the additional notes was further limited to 75 per cent of the cash value of the securities or commercial paper deposited (but 90 per cent in case of state and municipal bonds). These additional issues were also restricted to a finding by the Secretary of the Treasury that business conditions in the locality required the issuance of the additional notes.

Although commercial paper was qualified as acceptable security for note issue, it was apparent from the bill that the general expectation was rather that the principal reserve would be state and municipal bonds and other bonds.

An additional deterrent to over-issue of notes, and incentive to their prompt retirement, was the heavy tax laid upon the emergency issues. While the regular national bank notes were taxed at 1/2 per cent to 1 per cent per annum of the notes issued (depending upon the coupon rates of the securing bonds), notes secured by other forms of collateral were to be taxed up to 10 per cent per annum.

A final provision of the act was the creation of a National Monetary Commission composed of nine Senators and nine Representatives, with the duty to enquire into and report to the Congress at the earliest date practicable upon whether changes in the monetary and banking systems were desirable and necessary.

The act decreed its own expiry on June 30, 1914; but by that time the Commission had reported and the Congress had enacted the Federal Reserve Act which came into effect December 23, 1913. This act extended the life of the Emergency Currency Act to June 30, 1915. The subsequent events relating to this legislation are bound in with the story of the Federal Reserve Act and the outbreak of World War I and will be related in that connection.

However, no additional currency, that is, emergency currency, was issued throughout this period until the outbreak of World War I.

In retrospect, the Aldrich-Vreeland Act fulfilled its function of creating an emergency currency power. It continued the system of fiat money of the old National Bank Act, which permitted the issue of paper notes secured only by government bonds. It introduced one novel feature in U. S. currency practice: it gave validity to the view that if fiat money was to be issued at all, sound promissory notes of short maturity made for commercial transactions were good collateral for such a purpose.

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2A prevailing misunderstanding—paradoxical in such a period of sophisticated financiers—was as to the nature of “capital.” The bill insisted that only banks with “surplus” equal to 20 per cent of “capital” were eligible for membership in an association. No one seemed to realize what a later generation did, that capital and surplus are simply accountants’ descriptions of the forms of stockholders’ equity, that is, the excess of corporate worth over corporate liabilities to others. Later, it became common to create “surplus” or to cause it to disappear by stockholders’ action. A better term would have been “earned surplus,” but it is common today to capitalize earned surplus and absorb it into “capital.” Likewise, surplus is frequently created by issuing stock for consideration in excess of par and treating the excess as “surplus.”

• 1*A prevailing misunderstanding—paradoxical in such a period of sophisticated financiers—was as to the nature of “capital.” The bill insisted that only banks with “surplus” equal to 20 per cent of “capital” were eligible for membership in an association. No one seemed to realize what a later generation did, that capital and surplus are simply accountants’ descriptions of the forms of stockholders’ equity, that is, the excess of corporate worth over corporate liabilities to others. Later, it became common to create “surplus” or to cause it to disappear by stockholders’ action. A better term would have been “earned surplus,” but it is common today to capitalize earned surplus and absorb it into “capital.” Likewise, surplus is frequently created by issuing stock for consideration in excess of par and treating the excess as “surplus.”
• 2Under the new act, any ten national banks having aggregate equity funds* of at least $5 million could organize themselves into an association with power of note issue, subject to an overriding but nominal control of the Treasury. That is, the associations were authorized to receive, to validate, and to hold for note issue purposes, certain kinds of security or collateral, and in return to issue to the depositing bank an equivalent amount of circulating notes which the association in turn received from the Comptroller of the Currency.