Excess Excitement

Most laymen would be hard put to it to define excess bank reserves, much less their significance. Last week, however, the public manifested a sudden interest in this prime index of potential credit. Excess reserves of all members of the Federal Reserve System rose $80,000,000. That was not a notable weekly gain and it was easily explained by the continued flow of gold to the U. S. What aroused the public's curiosity was the fact that the rise carried total excess reserves above the ponderous and unprecedented figure of $3,000,000,000.

As far as a banker is concerned his reserves are his deposits in the district Federal Reserve Bank. He is not immediately interested in the fact that a Federal Reserve Bank's chief asset is gold (today gold certificates). But he knows that his reserves must equal 3% of all his time deposits. If he is a country banker he must maintain a 7% reserve against his demand deposits. In Manhattan and Chicago, the two "central reserve" cities, the reserve requirement for demand deposits is 13%. In all other large cities the figure is 10%. All reserves above those requirements are earmarked "excess."

Since the average legal reserve is approximately 10%, the "excess" will suffice for additional deposits up to ten times that surplus. Bankers do not have to wait for deposits; they can create them so long as they have "excess reserves." The deposits are created by making loans. Thus, for example, if a bank lends a businessman $10,000, it merely credits his checking account with $10,000. This increases the bank's deposits (i. e. liabilities) by $10,000, and its assets are equally increased by the businessman's note. Writing checks on the new $10,000 account does not destroy the credit that has been created, for the people who receive the checks will redeposit them. And the credit remains outstanding until the loan is paid off.

With $3,000,000,000 of excess reserves at their disposal, U. S. bankers today can create $30,000,000,000 of check money. The entire credit inflation that collapsed in 1929 was supported by an increase in total bank reserves of only $600,000,000. But there can be no flaming credit inflation until businessmen are again disposed to borrow. The current agitation is over the question of whether the Federal Reserve Board should use its fire-fighting equipment--such as its power to double present reserve requirements-- before or after the blaze begins. At the Investment Bankers Association convention last week, Economist Benjamin M. Anderson Jr. of Chase National Bank demanded action now, declaring: "It would be a very serious matter indeed if we came into a period of vigorous, active business and strong speculative temper on the part of the American people with anything like the present volume of excess reserves in the hands of the member banks."

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