the controversial creation of the federal reserve -- 9/13/21

Today's selection -- from An Illustrated Business History of the United States by Richard Vague.

"The lack of a central bank in the United States had long been a contentious and controversial subject, reaching back to legislative debates a century earlier around the authorization of the First and Second Banks. Opponents worried about a central bank’s potential misuse of power. Supporters, including much of the banking establishment, felt that European countries had experienced greater financial stability than the United States because they had central banks, though not everyone concurred with this view. 

"The powerful banker Paul Warburg of Kuhn, Loeb and Company supported a central bank, and his experience on both sides of the Atlantic positioned him well to influence the debate. He and others argued that a central bank could play the role that J. P. Morgan had reluctantly played in the crises of the 1890s and 1907: that of reassuring markets and arranging liquidity for banks subject to runs. 

Warburg c. 1910s

"Warburg’s partner, Jacob Schiff, had admonished the New York Chamber of Commerce in early 1907, saying 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.' A few weeks after the panic, the New York Times published a piece from Warburg, 'A Plan for a Modified Central Bank,' which outlined procedures that he thought could avert panics. 

"The Panic of 1907 hit in October of that year. Afterward, Congress prepared for the next one by passing the Aldrich-Vreeland Act of 1908, which allowed national banks to work in concert with the U.S. Treasury to issue emergency currency. This act went further to establish the National Monetary Commission to study banking law and search for a long-term solution to financial problems in the United States. The Republican leader in the Senate, Rhode Island’s Nelson Aldrich, ran the commission, assisted by a team of economists. They traveled to Europe to study the central banks in Britain and Germany and left impressed. 

"Aldrich and executives from certain banks, including J. P. Morgan and Kuhn, Loeb and Company, met on Jekyll Island in Georgia to hammer out a blueprint for a central bank, which became the plan Aldrich proposed in 1910. Broadly criticized because Aldrich was seen as the epitome of the Eastern Republican establishment, this plan never gained bipartisan support. Democrat Woodrow Wilson’s 1914 election as president killed any hope for this Republican plan, though President Wilson thought the overall concept of a central bank had merit. 

"Wilson sought advice from Virginia representative Carter Glass, who would become the chair of the House Committee on Banking and Currency, and economist H. Parker Willis, who devised an alternate plan that called for a network of twelve reserve banks in selected cities. This plan passed and became the Federal Reserve Act of 1913. It incorporated much of Aldrich’s original plan, which Wilson 'believed was 60–70 percent correct.'

"When the initial shots of World War I were fired in the summer of 1914, it caused a crisis and runs at U.S. banks. Treasury secretary William McAdoo quickly solved the banks’ liquidity problems by using the powers of the prescient Aldrich-Vreeland Act, whereby the country had $500 million in preprinted emergency banknotes on hand for these banks to use. The banks could deposit government bonds or short-term notes with the Treasury and receive these notes in return, and thus meet the runs. 

"Confidence in the power of newly established Federal Reserve was high. In 1915, the first chairman of the Federal Reserve, Charles Hamlin, predicted 'we will never have any more panics.'

"In Europe, the war raged on. The United States, though it did not enter combat until 1917, sold war materials and supplies to Britain and France and took gold as payment, and consequently, by the end of the war, it had the largest share of the world’s gold supply. It was also owed for large loans it had extended to the two countries. With these events, the dollar replaced the pound as the dominant international currency, and the United States began to replace Britain as the world’s financial center. And for the first time in U.S. history, American ownership of foreign assets exceeded foreign ownership of American assets and it had finally become a 'creditor nation.'” 


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author:

Richard Vague

title:

An Illustrated Business History of the United States

publisher:

Penn Press

date:

Copyright 2021, University of Pennsylvania

pages:

153, 155
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