This article is about the
history of central banking in the
United States, from the 1790s to the present.
1781–1836: The Bank of North America; the First, and Second,
Bank of the United States
Bank of North America
Some
Founding Fathers were strongly
opposed to the formation of a central banking system; the fact that
England tried to place the colonies under the monetary control of
the Bank of
England
was seen by many as the 'last straw' of English
oppression and that it led directly to the American Revolutionary
War.
Other Founding Fathers were strongly in favor of a central bank.
Robert Morris, as
Superintendent of Finance, helped to open the Bank of North America
in 1782, and has been accordingly called by Thomas Goddard "the
father of the system of credit, and paper circulation, in the
United States." As ratification in early 1781 of the Articles of
Confederation & Perpetual Union had extended to Congress the
sovereign power to emit
bills
of credit, it passed later that year an ordinance to
incorporate a privately subscribed national bank following in the
footsteps of the Bank of England. However, it was thwarted in
fulfilling its intended role as a nationwide central bank due to
objections of "alarming foreign influence and fictitious credit,"
favoritism to foreigners and unfair competition against less
corrupt state banks issuing their own
notes,
such that Pennsylvania's legislature repealed its charter to
operate within the Commonwealth in 1785.
First Bank of the United States
In 1791, a
former aide to Morris, Alexander
Hamilton, the Secretary of
the Treasury, made a deal to support the transfer of the
capital from Philadelphia
to the banks of the Potomac in exchange for southern support for
his Bank project. As a result, the First Bank of
the United States
(1791-1811) was chartered by Congress in that same
year. The First Bank of the United States was
modeled after the Bank of
England and differed in many ways from today's central
banks. For example, it was partly owned by foreigners, who
shared in its profits. Also, it wasn't solely responsible for the
country's supply of
bank
notes. It was responsible for only 20% of the currency supply;
state banks accounted for the rest. Several founding fathers
bitterly opposed the Bank.
Thomas
Jefferson saw it as an engine for speculation, financial
manipulation, and corruption.
Second Bank of the United States
After a
five-year interval, the federal government chartered its successor,
the Second Bank of the United
States
(1816-1836). It was basically a copy of the
First Bank, with branches across the country.
Andrew Jackson, who became president in 1828,
denounced it as an engine of corruption that benefited his enemies.
His destruction of the bank was a major political issue in the
1830s and shaped the
Second Party
System, as Democrats in the states opposed banks and
Whigs supported them.
See Also: Bank War
1837–1862: "Free Banking" Era
|
Period |
% Change in Money
Supply |
% Change in Price
Level |
| 1834-37 |
+ 61 |
+ 28 |
| 1837-43 |
- 58 |
- 35 |
| 1843-48 |
+ 102 |
+ 9 |
| 1848-49 |
- 11 |
0 |
| 1849-54 |
+ 109 |
+ 32 |
| 1854-55 |
- 12 |
+ 2 |
| 1855-57 |
+ 18 |
+ 1 |
| 1857-58 |
- 23 |
- 16 |
| 1858-61 |
+ 35 |
- 4 |
In this period, only
state-chartered
banks existed. They could issue bank notes against specie (
gold and
silver coins) and the states regulated their own
reserve requirements,
interest rates for
loans
and
deposit, the necessary
capital ratio etc. The
Michigan Act (1837) allowed the automatic
chartering of banks that would fulfill its requirements without
special consent of the
state legislature. This
legislation made creating unstable banks easier by lowering state
supervision in states that adopted it. The real value of a bank
bill was often lower than its face value, and the issuing bank's
financial strength generally determined the size of the discount.
By 1797, there were 24 chartered banks in the U.S., while with the
beginning of the
Free Banking Era (1837), there were
712.
The banks were short-lived compared to today's commercial banks,
with an average lifespan of five years. About half of the banks
failed, a third of which went out of business because they couldn't
redeem their notes. During the free banking era (also see "
Wildcat banking"), the value of gold and
silver was very stable. Price stability and changes in price are
two different things. When monetary bases (such as gold or silver)
are allowed to stay relatively constant, that allows for all other
prices to adjust quickly. If a price is quick to adjust (a.k.a. NOT
'sticky') it is said to be a stable price.
During the free banking era, some local banks took over the
functions of a central bank. In New York, the
New York Safety Fund provided deposit
insurance for member banks.
In Boston
, the
Suffolk Bank guaranteed that bank notes
would trade at near par value, and acted as a private bank note
clearinghouse.
1863–1913: National Banks
The
National Banking Act of
1863, besides providing loans in the
Civil War effort of the
Union included provisions:
- To create a system of national
banks. They had higher standards concerning reserves and
business practices than state banks. The
office of Comptroller of the
Currency was created to supervise these banks.
- To create a uniform national currency.
To achieve this, all national banks were required to accept each
other's currencies at par value. This eliminated the risk of loss
in case of bank default. The notes were printed by the Comptroller
of the Currency to ensure uniform quality and prevent counterfeiting.
- To finance the war. National banks were required to back up
their notes with Treasury
securities, enlarging the market and raising its
liquidity.
As described by
Gresham's Law, soon
bad money from state banks drove out the new, good money; the
government imposed a 10% tax on state bank bills, forcing most
banks to convert to national banks. By
1865,
there were already 1,500 national banks. In
1870, 1,638 national banks stood against only 325 state
banks. The tax led in the
1880s and
1890s to the creation and adoption of
checking accounts. By the
1890s, 90% of the money supply was in checking
accounts. State banking had made a comeback.
Two problems still remained in the banking sector. The first was
the requirement to back up the currency with treasuries. When the
treasuries fluctuated in value,
banks had to recall
loans or borrow
from other banks or
clearinghouses.
The second problem was that the system created seasonal liquidity
spikes. A rural bank had
deposit
accounts at a larger bank, that it withdrew from when the need
for funds was highest, e.g., in the planting season. When combined
liquidity demands were too big, the bank again had to find a
lender of last resort.
These liquidity crises led to
bank runs,
causing severe disruptions and depressions, the worst of which was
the
Panic of 1907.
1907 - 1913: Creation of the Federal Reserve System
Panic of 1907 Alarms Bankers
Early in 1907, New York Times Annual Financial Review published
Paul Warburg's (a partner of
Kuhn, Loeb and Co.) first official reform
plan, entitled "A Plan for a Modified Central Bank," in which he
outlined remedies that he thought might avert panics. Early in
1907,
Jacob Schiff, the
chief executive officer of
Kuhn, Loeb and Co., in a speech to the
New York Chamber of
Commerce, warned that "unless we have a central bank with
adequate control of credit resources, this country is going to
undergo the most severe and far reaching money panic in its
history." "
The Panic of 1907" hit
full stride in October. [Herrick]
1908 cartoon argued that elastic
currency is needed
Bankers felt the real problem was that the United States was the
last major country without a central bank, which might provide
stability and emergency credit in times of financial crisis. While
segments of the financial community were worried about the power
that had accrued to JP Morgan and other 'financiers', most were
more concerned about the general frailty of a vast, decentralized
banking system that could not regulate itself without the
extraordinary intervention of one man. Financial leaders who
advocated a central bank with an elastic currency after the
Panic of 1907 include
Frank Vanderlip,
Myron T. Herrick,
William Barret Ridgely,
George E. Roberts,
Isaac N. Seligman and
Jacob H. Schiff. They stressed the need for an
elastic money supply that could expand or contract as needed. After
the scare of 1907 the bankers demanded reform; the next year,
Congress established a commission of experts to come up with a
nonpartisan solution.
Aldrich Plan
Rhode Island Senator
Nelson Aldrich,
the Republican leader in the Senate, ran the Commission personally,
with the aid of a team of economists. They went to Europe and were
impressed at how well they believed the central banks in Britain
and Germany handled the stabilization of the overall economy and
the promotion of international trade. Aldrich's investigation led
to his plan in 1912 to bring central banking to the United States,
with promises of financial stability, expanded international roles,
control by impartial experts and no political meddling in
finance.
Regional System
Aldrich asserted that a central bank had to be (contradictorily)
decentralized somehow, or it would be attacked by local politicians
and bankers as had the First and Second Banks of the United States.
His solution was a regional system. In Congress, Rep.
Carter Glass of Virginia picked up Aldrich's
core ideas; to be able to claim Democratic authorship, he made
numerous small revisions such as headquartering a region in the
financial backwaters of Richmond, Virginia. President
Woodrow Wilson added the provision that the
new regional banks be controlled by a central board appointed by
the president.
Agrarian Demands Partly Met
William Jennings Bryan, now
Secretary of State, long-time enemy of Wall Street and still a
power in the Democratic party, threatened to destroy the bill.
Wilson masterfully came up with a compromise plan that pleased
bankers and Bryan alike. The Bryanites were happy that Federal
Reserve currency became liabilities of the government rather than
of private banks—a symbolic change—and by provisions for federal
loans to farmers. The Bryanite demand to prohibit interlocking
directorates did not pass. Wilson convinced the anti-bank
Congressmen that because Federal Reserve notes were obligations of
the government, the plan fit their demands. Wilson assured
southerners and westerners that the system was decentralized into
12 districts, and thus would weaken New York City's Wall Street
influence and strengthen the hinterlands. The key legislators in
this compromise plan were Representative
Carter Glass, a Democrat from Virginia and
Chairman of the House Committee on Banking and Currency, and
Senator
Robert Latham Owen, a
Democrat from Oklahoma and Chairman of the Senate Committee on
Banking and Currency.
After much debate and many amendments Congress passed the
Federal Reserve Act or
Glass-Owen
Act, as it was sometimes called at the time, in late 1913.
President Wilson signed the Act into law on December 23,
1913.
Later Wilson stated "A great industrial nation is controlled by its
system of credit. Our system of credit is privately concentrated.
The growth of the Nation, therefore, and all our activities are in
the hands of a few men... We have come to be one of the worst
ruled, one of the most completely controlled and dominated,
governments in the civilized world—no longer a government by free
opinion, no longer a government by conviction and the vote of the
majority, but a government by the opinion and the duress of small
groups of dominant men."
[101705]
1914 – Present: Recent Changes
The Fed's power developed slowly in part due to an understanding at
its creation that it was to function primarily as a reserve, a
money-creator of last resort to prevent the downward spiral of
withdrawal/withholding of funds which characterizes a monetary
panic.
At
the outbreak of World War I, the Fed was
better positioned than the Treasury
to issue war bonds, and so
became the primary retailer for war bonds under the direction of
the Treasury. After the war, the Fed, led by Paul Warburg
and New York Governor Bank President
Benjamin Strong, convinced Congress to
modify its powers, giving it the ability to both create money, as
the 1913 Act intended, and destroy money, as a central bank
could.
During the 1920s, the Fed experimented with a number of approaches,
alternatively creating and then destroying money which, in the eyes
of many scholars (notably
Milton
Friedman), helped create the late-1920s
stock market bubble
citation needed.
In 1928, Strong died, leaving a tremendous vacuum in Fed
governance, from which the bank did not recover in time to react to
the
1929 collapse, unlike after
1987's
Black Monday. Because of
this power vacuum, the Fed adopted what most would consider a
restrictive policy by today's standards, exacerbating the
crash.
After
Franklin D. Roosevelt took office in 1933, the Fed
was subordinated to the
Executive
Branch, where it remained until 1951, when the Fed and the
Treasury department signed an
accord
granting the Fed full independence over monetary matters while
leaving fiscal matters to the Treasury.
The Fed's powers have not significantly changed since 1951, though
it has frequently adopted different policy approaches.
Recent activities
References
Part of this article is based on an excerpt of
A
Brief History of Central Banking in the United States by
Edward Flaherty
- J. Lawrence Broz; The International Origins of the Federal
Reserve System Cornell University Press. 1997
- Milton Friedman and Anna Jacobson Schwartz, A Monetary
History of the United States, 1867-1960 (1963)
- William Greider, Secrets of the Temple: How the Federal
Reserve Runs the Country (1989), on the 1980s
- Myron T. Herrick "The Panic of 1907 and Some of Its Lessons",
Annals of the American Academy of Political and Social
Science, vol. 31 (Jan.-June 1908)
- Charles P. Kindleberger "Manias, Panics, and Crashes"
(4th ed.)
- Gabriel Kolko, Triumph of Conservatism: A Reinterpretation
of American history, 1900-1916 (1963) pp. 230-254.
- Arthur Link, Wilson: The New Freedom (1962)
- James Livingston, Origins of the Federal Reserve System:
Money, Class, and Corporate Capitalism, 1890-1913 (1986)
- Jim Marrs, Secrets of Money and the Federal Reserve System,
Rule by Secrecy, HarperCollins, (2000)
pp. 64-78.
- Allan H. Meltzer. A History of the Federal Reserve,
Volume 1: 1913-1951 (2004)
- Murray N. Rothbard.
A History of Money and Banking in the United States: The Colonial
Era to World War II (2002)
- Shull, Bernard. The fourth branch : the Federal Reserve's
unlikely rise to power and influence. (2005) Westport, Conn.:
Praeger
- Frank G. Steindl, Monetary Interpretations of the Great
Depression. (1995)
- Donald R. Wells. The Federal Reserve System: A History
(2004)
- Robert Craig West, Banking Reform and the Federal Reserve,
1863-1923 (1977)
- Elmus R. Wicker, "A Reconsideration of Federal Reserve Policy
during the 1920-1921 Depression," Journal of Economic
History (1966) 26:223-238.
- John H Wood. A History Of Central Banking In Great Britain
And The United States (2005)
- Bob Woodward, Maestro: Greenspan's Fed and the American
Boom (2000) on the 1990s
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