The Federal Reserve Cartelizes the Banking Industry
Here's how we got saddled with this monstrosity: In the early 1900s — during the so-called Progressive Era — the US government began a radical program of intervention into the economy. Pundits hailed this as fostering a new "spirit of cooperation" between business and government. In fact, the new system was a precursor of socialism and fascism.
Government-business cooperation took several forms, all of which conferred special privileges on favored firms, insulating them from the competition of the free market. Individual businesses and whole industries lobbied and bribed government officials for laws that benefited them at the expense of the consumer, and the whole operation was sold to the public as antimonopoly measures. This illegitimate and unconstitutional process happened time and time again, and government intervention became a permanent part of manufacturing, railroads, agriculture, and many other industries in the United States.
This was the era when the US free market received a beating, and, for lovers of liberty, its effect was much worse than the New Deal's.
In the free market, opportunity is granted to all and privilege to none. Laws affect all equally, businesses seek to meet the needs of the people, and the consumer is king. But in a system of government intervention, industries are no longer accountable to the needs of the people. They receive special privilege and status from the state. They are guaranteed profits, prices, and sales. Liberated from the dictates of the people, businesses are free to indulge themselves in plundering consumers.
These were the years of many evils: the income tax, "making the world safe for democracy" through World War I, centralization through direct election of senators, the imperial presidency, Prohibition, and the Federal Reserve System. Academics, as is still the case, provided intellectual cover for these crimes. Thornton Cooke, writing in the pro-big-government American Economic Review in 1911, explained why banking needs to be centralized: "American banking has made little use of the principle of cooperation, yet for a generation that principle has been the greatest single factor in American economics." The railroads have their "community of interest arrangements" and manufacturing "has been integrated" so now, he said, it's time to consolidate banking.
But in a System of Government Intervention, Industries Are No Longer Accountable to the Needs of the People
Cooke was arguing for a government-enforced banking cartel, similar to the railroad industry's. The new "collective spirit" of the American economy naturally leads to centralizing money and credit to argue for bank cartelization:
American banks, however, remain independent, almost isolated units. The effect of isolation has been heightened by the lack of power in any of the 2,300 units to issue a credit note. It is unnecessary to rehearse the arguments showing that our bank note currency is absolutely inelastic.… There is not one country bank, however small, that has assurance that any correspondent, however large, is powerful enough to save it if it needs saving in a general panic.
Cooke's arguments were typical, repeated again and again by promoters of the Fed. They said, the current system was inadequate, it was out of step with the times, it caused banker isolation, and most importantly, bankers needed stronger guarantees of monetary inflation when it was needed; i.e., they wanted bailouts and guaranteed profits.
About the then-current National Banking System (NBS), Cooke was lying. In fact a true gold standard monetary system with almost-free banking had not existed since two decades before the Civil War. The NBS actually represented a halfway point between free banking and central banking. And it did have problems, but these existed because of the government.
Chiefly responsible for passing the National Banking Act of 1863 was Ohio investment banker Jay Cooke, who gained a government-granted monopoly on public debt underwriting. His success in the bond business gained him enormous influence with the Republican administrations during the Civil War and after, and especially with Salmon Chase, secretary of the Treasury, from Ohio, and Senator John Sherman from Ohio. Together they were able to push through Congress and past the public the National Banking Acts, all of which would benefit banking tremendously. Fractional-reserve banking was guaranteed by the government at 15 and 25 percent reserves. A 10 percent annual tax on state bank note issues was required, to force state banks into the NBS. Legal tender status was imposed on the national-bank notes.
There was plenty of government intervention in the banking system already. The banks were not "isolated" and independent, as the advocates of the Federal Reserve Act suggested.
Because of a general dissatisfaction with the NBS, banking-reform movements began to emerge in the 1890s. Most historical accounts tend to concentrate on the political movements for reform, like the proinflation free-silver position of Bryanite populism and the arguments for the "correct" gold/silver ratio. The future, though, did not lie with these political movements. The reform to follow was more far-reaching and more fundamental.
Most of these vocal political movements had died out and were rejected by both parties by 1914. From the beginning of the debate, the business and banking community who wanted cartelization opposed the agenda of the political movements without any equivocation. Bankers wanted reform of the banking system, but of their own kind, for their own ends.
Many proposals for monetary reform were presented to Congress after the NBS-generated monetary panic of 1893, all of them designed by elements within the banking community. There was ignorance concerning the complexities of banking from virtually every other sector. Typical was Theodore Roosevelt who, like many politicians, bragged of his ignorance saying: "I do not intend to speak … on the financial question — because I am not clear what to say." Among the first to call for a modern totally centralized bank was Lyman J. Gage, President McKinley's secretary of the Treasury and former president of the American Bankers Association.
The central-banking movement began to grow a year before the Panic of 1907 in New York. Jacob H. Schiff, an investment banker, persuaded the New York Chamber of Commerce to advocate banking reform.
A committee was established, led by the most powerful investment and commercial bankers in New York, which concluded that the solution lay in establishing a central bank "similar to the Bank of Germany." The chairman of the board of Chase National Bank (now Chase Manhattan), A. Barton Hepburn, came next with his plan. He did not openly advocate a central bank; he urged creating regional clearinghouses that would issue bond-secured currency in varying amounts. These would be guaranteed by a common fund built up by taxes on the notes.
The Panic of 1907 brought about a sudden loss of confidence in the banking system, and the bankers seized the moment. Not everyone, however, wanted further centralization. The New York Times, standing alone, concluded that government intervention in the economy at all levels was responsible for the loss of confidence. Their opposition to a central bank was snuffed out. They were, of course, speaking against the desires of the establishment of powerful businessmen and bankers.
The Times polled Congress and found that they were either thoroughly confused, had a limited understanding over monetary affairs, or that their proposals were too vague to characterize. The Times did find, though, there was a consensus that any changes should be in the direction of an "intimate connection between the currency and legitimate trade. "They wanted "elasticity," the ability to inflate on demand. Into this vacuum stepped influential bankers.
In 1908 Congress passed a bill similar to Hepburn's plan called the Aldrich-Vreeland Act. (Senator Nelson Aldrich [R-RI] was the son-in-law of John D. Rockefeller.) It was established as a temporary measure to provide liquidity during emergencies. It wasn't used until after the Federal Reserve was established six years later, so the measure was relatively insignificant. But it did contain a clause that would prove to be highly significant. It called for a National Monetary Commission to study the National Banking System and make recommendations for future monetary reform.
The National Monetary Commission (NMC) was comprised of nine senators and nine representatives. Heading up the commission, holding the seat as chairman, was Nelson Aldrich, Rockefeller's "man" in the Senate. As with most congressional commissions, much of the work was done by intellectuals and powerful figures from outside Congress who came in to help with research and writing. Among these were Henry P. Davison, a J.P. Morgan partner, and George M. Reynolds, president of the American Bankers Association.
Also associated directly or indirectly with the NMC were the most vocal advocates of centralized banking reform: O.M.W. Sprague of Harvard, Edwin W. Kemmerer of Princeton, M.L. Muhleman, James Laurence Laughlin of the University of Chicago, H. Parker Willis of Washington & Lee University, Thornton Cooke, William A. Scott, and many others.
The commission produced a huge pro-central-bank document, assumed to be definitive, though really a boring monetary history under the National Banking System. The document's real function was to serve as the unanswerable critique of the status quo. Today, the Federal Reserve's own "Purposes and Functions of the Federal Reserve System" identifies the commission's research as the primary historical case for establishing the Federal Reserve.
The commission was given an unlimited budget and broad investigative power, and they used them in part to travel to Europe to observe their central-banking systems. It was during these travels that Senator Aldrich educated himself about the intricacies of central banking and became an open advocate of central banking.
The bankers themselves were not unified on the precise nature of the reform they wanted. And by 1909, as an issue, banking-reform discussion was limited to a small segment of the banking community. The bankers searched the whole year for a unified plan which they could support, and by the end of that year, they emerged unified. Their communications were generally aired through the Banking Law journal.
Several ingredients tied all reform plans together: central banking, the ability to inflate, and regional banking centers of the type endorsed by the American Banking Association. Also important among the bankers was avoiding the appearance of a banking system controlled by Wall Street. This was a strategic move designed to avoid the strong anti–Wall Street sentiment in America at that time. During 1910 the issue would have been dormant were it not for the influence of Paul M. Warburg, who played a primary role in establishing the Fed. He emigrated from Germany and became a member of the distinguished banking house of Kuhn, Loeb and Co. Long an advocate of central banking, his behind-the-scenes work propelled the NMC toward the direction of the German banking experience.
Warburg argued, as do current advocates of central banking, that certain sectors of the economy are unnecessarily strained during some seasons but not in others. For example, he argued, certain crops like wheat are harvested seasonally, and merchants and buyers are strained for sufficient cash to purchase what they might need for supplying the commodity during the upcoming months. The farmers then sell the wheat for below market prices, "dumping" it, which ultimately causes cyclical price fluctuations within the market for crucial commodities. These market fluctuations cause losses in all sectors, producers and sellers, and provide a disincentive to produce.