Rediscount Rate

To employ an Irish bull, the chief event of last week was one that didn't happen. Despite rumors in and out of Wall Street, the meeting of Governors of Federal Reserve Banks in Washington adjourned without proposing an advance in rediscount rates.

The confident but mistaken predictions that rediscount rates would be increased have proceeded partly from advocates of the classical theory that rediscount rates should stand above open market rates, and partly from apprehensive speculators in a temporarily bear stock market. The opinion of the latter group can be disregarded. But that of the former is entitled to genuine consideration. Undoubtedly as a general thing the bank rate should be above the market rate, and undoubtedly just the opposite is the case today. It may be that the Reserve authorities' decision to leave rates unchanged has been to some extent shaped by political pressure from the agricultural interests against higher rates. Nevertheless, taking the current Federal Reserve situation as it actually is, their decision is undoubtedly wise at this time, even though contrary to the general theory of rediscount banking.

The Treasury has been opposed to a rise in rediscount rates, since such an occurrence would be detrimental to government financing which will be in process until May 20 at the maturity of the Victory Notes. Higher rediscount rates meanwhile would increase the cost of such government financing.

But for other reasons, such an increase would prove equally unpopular with the banks themselves. Since the war, it has been increasingly difficult to persuade State banks to join the Reserve system, although the large number of such nonmember banks is a fundamental cause of the difficulties experienced in adequately financing agriculture. When member banks can profit by rediscounting, as they can today, such membership holds forth immediate inducements; but when rediscounting is penalized by the relation of bank and market rates, membership in the Reserve system will be discouraged accordingly.

Moreover, member banks are now increasing their mercantile loans by selling bonds rather than by rediscounting. In general, there is very little rediscounted paper in the Reserve banks, despite the current trade expansion. Several Reserve banks could not pay their running expenses today simply on interest accruing on their portfolio of bills and paper. Theoretically they should if necessary run at a loss in such cases; but this has been made impossible by the unjustifiable amounts of money taken from them by the government under the terms of the Reserve Act in 1919-21, under the euphemism of "franchise taxes. The Reserve Banks owe the government nothing, and should pay it nothing, except a fair rate of interest on government deposits. Certainly the British government, which needs funds more acutely than ours, should not think of profiteering at the expense of the Bank of England in any such way. Before a theoretically correct rediscount policy can be pursued by the Reserve Banks, such unjust and publicly harmful anomalies as this excessive "franchise tax" must be removed from the Reserve Act itself.