The Federal Reserve Bank

The fundamental promise of a central bank like the Federal Reserve is economic stability.  The theory is that manipulating the value of the currency allows financial booms to go higher, and crashes to be more mild.  If growth becomes speculative and unsustainable, the central bank can make the price of money go up and force some deleveraging of risky investments – again, promising to make the crashes more mild.  The period leading up to the American revolution was characterized by increasingly authoritarian legislation from England.  Acts passed in 1764 had a particularly harsh effect on the previously robust colonial economy.  The Sugar Act was in effect a tax cut on easily smuggled molasses, and a new tax on commodities that England more directly controlled trade over.  The navy would be used in increased capacity to enforce trade laws and collect duties.  Perhaps even more significant than the militarization and expansion of taxes was the Currency Act passed later in the year 1764.

“The colonies suffered a constant shortage of currency with which to conduct trade. There were no gold or silver mines and currency could only be obtained through trade as regulated by Great Britain. Many of the colonies felt no alternative to printing their own paper money in the form of Bills of Credit.”   The result was a true free market of currency – each bank competed, exchange rates fluctuated wildly, and merchants were hesitant to accept these notes as payment.  Of course, they didn’t have 24-hour digital Forex markets, but I’ll hold off opinions on the viability of unregulated currency for another time.  England’s response was to seize control of the colonial money supply – forbidding banks, cities, and colony governments from printing their own.  This law, passed so soon after the Sugar Act, started to really bring revolutionary tension inside the colonies to a higher level.  American bankers had learned early on that debasing a currency through inflation is a helpful way to pay off perpetual trade deficits – but Britain proved that the buyer of the currency would only take the deal for so long…  Following the (first) American Revolution, the “First Bank of the United States” was chartered to pay off collective war debts, and effectively distribute the cost of the revolution proportionately throughout all of the states.  Although the bank had vocal and harsh skeptics, it only controlled about 20% of the nation’s money supply.

Compared to today’s central bank, it was nothing.  Thomas Jefferson argued vocally against the institution of the bank, mostly citing constitutional concerns and the limitations of government found in the 10th amendment.  There was one additional quote that hints at the deeper structural flaw of a central bank in a supposedly free capitalist economy.  “the existing banks will, without a doubt, enter into arrangements for lending their agency, and the more favorable, as there will be a competition among them for it; whereas the bill delivers us up bound to the national bank, who are free to refuse all arrangement, but on their own terms, and the public not free, on such refusal, to employ any other bank” –Thomas Jefferson.  Basically, the existing banks will fight over gaining favor with the central bank – rather than improving their performance relative to a free market.  The profit margins associated with collusion would obviously outweigh the potential profits gained from legitimate business.  The Second Bank of the United States was passed five years after the first bank’s charter expired.  An early enemy of central banking, President James Madison, was looking for a way to stabilize the currency in 1816.  This bank was also quite temporary – it would only stay in operation until 1833 when President Andrew Jackson would end federal deposits at the institution.

The charter expired in 1836 and the private corporation was bankrupt and liquidated by 1841.  While the South had been the major opponent of central banking systems, the end of the Civil War allowed for (and also made necessary) the system of national banks that would dominate the next fifty years.  The Office of the Comptroller of the Currency (OCC) says that this post-war period of a unified national currency and system of national banks “worked well.” [3]  Taxes on state banks were imposed to encourage people to use the national banks – but liquidity problems persisted as the money supply did not match the economic cycles.  Overall, the American economy continued to grow faster than Europe, but the period did not bring economic stability by any stretch of the imagination.  Several panics and runs on the bank – and it became a fact of life under this system of competing nationalized banks.  In 1873, 1893, 1901, and 1907 significant panics caused a series of bank failures.

The new system wasn’t stable at all, in fact, many suspected it was wraught with fraud and manipulation.  The Federal Reserve Bank of Minneapolis is not shy about attributing the causes of the Panic of 1907 to financial manipulation from the existing banking establishment.  “If Knickerbocker Trust would falter, then Congress and the public would lose faith in all trust companies and banks would stand to gain, the bankers reasoned.”  In timing with natural economic cycles, major banks including J.P. Morgan and Chase launched an all-out assault on Heinze’s Knickerbocker Trust.  Financial institutions on the inside started silently selling off assets in the competitor, and headlines about a few bad loans started making top spots in the newspapers.  The run on Knickerbocker turned into a general panic – and the Federal Government would come to the rescue of its privately owned “National Banks.”  During the Panic of 1907, “Depositors ‘run’ on the Knickerbocker Bank. J.P. Morgan and James Stillman of First National City Bank (Citibank) act as a “central bank,” providing liquidity … [to stop the bank run]  President Theodore Roosevelt provides Morgan with $25 million in government funds … to control the panic. Morgan, acting as a one-man central bank, decides which firms will fail and which firms will survive.”  How did JP Morgan get so powerful that the government would provide them with funding to increase their power?  They had key influence with positions inside the Administrations.

They had senators, congressmen, lobbyists, media moguls all working for them.  In 1886, a group of millionaires purchased Jekyll Island and converted it into a winter retreat and hunting ground, the USA’s most exclusive club. By 1900, the club’s roster represented 1/6th of the world’s wealth. Names like Astor, Vanderbilt, Morgan, Pulitzer and Gould filled the club’s register. Non- members, regardless of stature, were not allowed. Dignitaries like Winston Churchill and President McKinley were refused admission.  In 1908, the year after a national money panic purportedly created by J. P. Morgan, Congress established, in 1908, a National Monetary Authority. In 1910 another, more secretive, group was formed consisting of the chiefs of major corporations and banks in this country. The group left secretly by rail from Hoboken, New Jersey, and traveled anonymously to the hunting lodge on Jekyll Island.  In fact, the Clubhouse/hotel on the island has two conference rooms named for the “Federal Reserve.”  The meeting was so secret that none referred to the other by his last name. Why the need for secrecy?

Frank Vanderlip wrote later in the Saturday Evening Post, “…it would have been fatal to Senator Aldrich’s plan to have it known that he was calling on anybody from Wall Street to help him in preparing his bill…I do not feel it is any exaggeration to speak of our secret expedition to Jekyll Island as the occasion of the actual conception of what eventually became the Federal Reserve System.”  At Jekyll Island, the true draftsman for the Federal Reserve was Paul Warburg. The plan was simple. The new central bank could not be called a central bank because America did not want one, so it had to be given a deceptive name. Ostensibly, the bank was to be controlled by Congress, but a majority of its members were to be selected by the private banks that would own its stock.  To keep the public from thinking that the Federal Reserve would be controlled from New York, a system of twelve regional banks was designed. Given the concentration of money and credit in New York, the Federal Reserve Bank of New York controlled the system, making the regional concept initially nothing but a ruse.

The board and chairman were to be selected by the President, but in the words of Colonel Edward House, the board would serve such a term as to “put them out of the power of the President.” The power over the creation of money was to be taken from the people and placed in the hands of private bankers who could expand or contract credit as they felt best suited their needs.  Why the opposition to a central bank?  Americans at the time knew of the destruction to the economy the European central banks had caused to their respective countries and to countries who became their debtors. They saw the large- scale government deficit spending and debt creation that occurred in Europe.  But European financial moguls didn’t rest until the New World was within their orbit. In 1902, Paul Warburg, a friend and associate of the Rothschilds and an expert on European central banking, came to this country as a partner in Kuhn, Loeb and Company.

He married the daughter of Solomon Loeb, one of the founders of the firm. The head of Kuhn, Loeb was Jacob Schiff, whose gift of $20 million in gold to the struggling Russian communists in 1917 no doubt saved their revolution.  The Fed controls the banking system in the USA, not the Congress nor the people indirectly (as the Constitution dictates). The U.S. central bank strategy is a product of European banking interests.  Government interventionists got their wish in 1913 with the Federal Reserve (and income tax amendment).  Just in time, too, because the nation needed a new source of unlimited cash to finance both sides of WW1 and eventually our own entry to the war.  After the war, with both sides owing us debt through the federal reserve backed banks, the center of finance moved from London to New York.  But did the Federal Reserve reign in the money trusts and interlocking directorates?  Not by a long shot.  If anything, the Federal Reserve granted new powers to the National Banks by permitting overseas branches and new types of banking services.  The greatest gift to the bankers, was a virtually unlimited supply of loans when they experience liquidity problems.

From the early 1920s to 1929, the monetary supply expanded at a rapid pace and the nation experienced wild economic growth.  Curiously, however, the number of banks started to decline for the first time in American history.  Toward the end of the period, speculation and loose money had propelled asset and equity prices to unreal levels.  The stock market crashed, and as the banks struggled with liquidity problems, the Federal Reserve actually cut the money supply.  Without a doubt, this is the greatest financial panic and economic collapse in American history – and it never could have happened  on this scale without the Fed’s intervention.  The number of banks crashed and a few of the old robber barons’ banks managed to swoop in and grab up thousands of competitors for pennies on the dollar.