SOLUTION: San Jose State University Free Banking Challenge to Central Bank Book Report

How the Fed Was Born – Reason.com

How the Fed Was Born


FEDERAL RESERVE
How the Fed Was Born
A book about the birth of the Federal Reserve overlooks the flaws in the system.
JEFFREY ROGERS HUMMEL | FROM THE APRIL 2016 ISSUE
(Penguin Press)
America’s Bank: The Epic Struggle to Create the Federal Reserve, by Roger Lowenstein, Penguin Press, 368 pages,
$29.95
Conspiracy theories about the creation of the Federal Reserve System abound. Typically they give a prominent
place to a now infamous but then-secret meeting in November 1910 at an exclusive Georgia resort on the
secluded Jekyl Island (at that time spelled with only one l). Organized and chaired by the powerful pro-business
and pro-tariff Sen. Nelson W. Aldrich (R–R.I.), the small conclave included such prominent New York bankers as
Frank A. Vanderlip of National City Bank and Paul M. Warburg of Kuhn, Leob & Co. Together the group
hammered out a proposal known as the Aldrich Plan. Introduced into Congress with minor modifications in
January 1912, the plan become a template for the final Federal Reserve Act, passed in late 1913 with the crucial
backing of President Woodrow Wilson.
The actual story is both more complicated and more interesting than the simple conspiracy narrative. Roger
Lowenstein, a financial journalist—his previous books include a study of the hedge fund Long-Term Capital
Management and its collapse—has now ventured into this historical territory with America’s Bank: The Epic
Struggle to Create the Federal Reserve. Displaying extensive primary research into the personal papers of all the
Penguin Press
major players, he provides a readable narrative interwoven with well-sketched background biographies.
Unfortunately, Lowenstein renders this narrative as a simplistic morality play, with pro-central bank heroes (“patriotic conspirators,” as he styles
them at one point) and anti-central bank villains, leaving the book devoid of much economic insight.
The book is divided into two parts. The first covers the efforts, particularly after the Panic of 1907, that led up to the Jekyl Island meeting: A few
bankers, economists, and reformers exploited the defects of the prevailing national banking system to persuade influential citizens in business,
universities, and the press that a European-style central bank was the only viable path forward. The second part recounts how the Aldrich Plan was
translated into legislation that populist politicians who were traditionally hostile to central banking and Wall Street would be willing to embrace.
Andrew Jackson’s destruction of the Second United States Bank in the mid-1830s left a legacy of popular aversion to central banking of any sort.
1 of 4
3/3/21, 11:02 AM
How the Fed Was Born – Reason.com

How the Fed Was Born


Given these inauspicious prospects, several competing factions ended up playing major roles in the Fed’s founding.
There were populists, such as William Jennings Bryan, who had given up on their inflationist efforts to remonetize silver but were still a political
force to be reckoned with, especially within Democratic ranks. Their ideal system centered around a government-issued paper currency, like the
Greenbacks introduced during the Civil War, free from the machinations of Wall Street and bankers.
There were the small country bankers, who emphatically defended the prevailing system of unit banking, with its legal limitations on branch
banking. That system protected local rural banks from competition, so they effectively blocked all attempts to bring about interstate branching and
even most attempts to permit intrastate branching.
There were the Midwestern city bankers, centered in Chicago, who tended to support what was referred to as the asset-currency reform. This
approach would grant banks greater freedom to issue banknotes, especially during periods of financial stringency.
And then there were the major New York bankers, who ultimately came to believe that they could only preserve their financial dominance with a
government-sponsored but privately controlled centralized clearinghouse empowered to loan currency to banks in times of stress. This last scheme
was essentially what the original Aldrich Plan would have created.
These crosscurrents produced bitter, drawn-out debates about what form, if any, the country’s central bank should take. The struggle involved,
among other disputes, whether the institution would be privately or governmentally controlled, whether it would be a central organization with
branches or a loose federation of regional organizations, and whether the resulting currency would be solely a bank liability or governmentguaranteed. On all three of these questions, the second alternative gained critical concessions, thanks to Bryan’s influence and Wilson’s mediation.
When the final act passed, it was a complex brew of compromises. Indeed, by this time Aldrich, no longer in the Senate, was denouncing the act. In
light of his extreme unpopularity with progressives, that opposition probably assisted the plan’s passage.
Many of the principals in this struggle would subsequently claim primary authorship of the final act or have it claimed for them. The candidates
included the banker Paul Warburg, principle drafter of the Aldrich Plan; Rep. Carter Glass, a Virginia Democrat who introduced the initial House
version of the act; Sen. Robert Owen, an Oklahoma Democrat, who did likewise in the Senate; H. Parker Willis, an economist who assisted Glass; J.
Laurence Laughlin, an economist who was Willis’ teacher and advised him as he assisted Glass; and “Colonel” Edward M. House, Wilson’s enigmatic
intimate. This led Warburg, when asked to identify the Fed’s father, to quip that he didn’t know, but given how many made the claim, “its mother
must have been a most immoral woman.”
2 of 4
3/3/21, 11:02 AM
How the Fed Was Born – Reason.com

How the Fed Was Born


Lowenstein’s account of a few specialized aspects of the Fed’s creation is not as detailed as previous scholarly works, and he occasionally ascribes
motives beyond what scrupulous attention to sources would warrant. Still, America’s Bank provides a good, comprehensive overview to anyone
primarily interested in the personal, political, and ideological details of the story. But when it comes to objectively describing the economic
background behind the Fed’s creation, or to understanding the economic reasoning of its opponents and even some of its proponents, the book is
deeply flawed.
The problem is not just that America’s Bank unreflectively extols the Fed. It’s that this celebratory tone is informed by the author’s superficial
understanding of monetary theory and history. These weaknesses are clearest in the first few chapters, which offer a vulgar caricature of early U.S.
monetary history, sprinkled with more than a few outright factual errors. Contrary to Lowenstein’s account, James Madison, as president, did not
oppose but supported the rechartering of the first U.S. Bank. The second U.S. Bank, rather than muting the business cycle, presided over and
contributed to the Panic of 1819, the first major depression in U.S. history. And when Lowenstein describes America’s so-called free banking era as a
“monetary babel,” he ignores decades of scholarly research finding that the charges of reckless and fraudulent “wildcat” banking are highly
exaggerated and that, to the limited extent the phenomenon was real, it was mainly the result of a government-imposed restriction on the issue of
banknotes, known as the bond-collateral requirement.
That requirement was later embodied in the post-Civil War national banking system. The new system was therefore hardly the “remedy” Lowenstein
claims it was—before he goes on in future pages to contradict himself by overstating its real faults. The depression of 1873 did not last six years but
at most 27 months, according to the National Bureau of Economic Research. Nor was the secular deflation from 1867 to 1896 drastic; prices declined
about 2 percent per year, accompanied by robust secular growth of real gross domestic product per capita. When Lowenstein writes that “beginning
in 1887, there had been serious financial turmoil roughly every three years,” his “serious financial turmoil” must mean every spike in interest rates.
In fact, between the Civil War and the Fed’s creation, major bank panics followed by recessions occurred only in 1873, 1893, and 1907, and none of
those events approached the severity of the Great Depression. On the other hand, incipient bank panics in 1884 and 1890 were nipped in the bud by
bank clearinghouses issuing extralegal clearinghouse receipts that could serve as currency.
Even worse is the disdainful contempt Lowenstein displays toward opponents of central banking, particularly those who advocated alternative
reforms. To be sure, the national banking system did have serious drawbacks. Two were particularly harmful: It fastened the fragile and fragmented
unit banking system on the country, and it created what was known as an “inelastic currency.” But Lowenstein hardly touches on the ideal solution
to the first problem—the legalization of branch banking—and he does not fully appreciate the nature of the second. The term “inelastic currency”
does not properly refer to an inelastic money supply but rather to the inability of national banks to freely convert their deposits into banknotes.
The bond-collateral requirement rigidly tied the quantity of banknotes to a shrinking national debt. Despite the increasing importance of bank
deposits in the U.S. money stock, many transactions still required currency rather than less liquid and potentially more risky checks. (As late as the
Great Depression, most workers, having no checking accounts, were still paid with weekly envelopes of cash.) In a country with a large agricultural
sector, there were regular seasonal demands to convert deposits into currency. But because banks could not freely issue banknotes, these seasonal
demands drained reserves of gold and Greenbacks from the banks. This inelastic currency became a major source of potential panics.
Hence the asset-currency reform that America’s Bank so casually dismisses. It proposed relaxing the restrictions on issuing banknotes, thereby solving
the problem of an inelastic currency without creating a central bank. Proponents of this reform repeatedly pointed to the success of Canadian
banking, which faced the same seasonal fluctuations in currency demand that the U.S. banks did. But Canada—which had no central bank, had
nationwide branching, and allowed banks a nearly unrestricted freedom to issue currency—sailed through this era with no credit crunches, bank
panics, or major bank failures. The asset-currency reform movement emerged in the 1890s, and it initially had the support of influential economists
such as Laurence Laughlin and many bankers—even Frank Vanderlip. Asset-currency bills were regularly introduced in Congress, but they were
inevitably blocked by a coalition of small country and New York bankers. Laughlin, Vanderlip, and others eventually turned to some kind of central
bank as the only viable alternative.
Was the Federal Reserve actually an improvement over the flawed national banking system that preceded it, as Lowenstein assumes? Let us look at
the record.
Created just before the outbreak of World War I, the Fed helped finance U.S. participation in that war by generating the highest rate of inflation in
American history outside of the two hyperinflations during the American Revolution and in the Civil War Confederacy. After the war, it orchestrated
the most rapid rate of deflation in U.S. history, so severe that it makes the mild, benign deflation of 1867 to 1896 look like price stability by
comparison. During the Great Depression, the Fed presided over the most massive banking panic not just in the history of the U.S. but in the entire
history of the world, despite being created to prevent such a catastrophe. It also contributed to the recession of 1937, in the midst of high
unemployment lingering from the Great Depression; and it followed that with another bout of inflation during World War II, severe enough to inspire
comprehensive wage and price controls. During the postwar period, the Fed was responsible for the Great Inflation of the 1970s, which hit doubledigits and was accompanied by the country’s first inflationary recessions. And let’s not forget the financial crisis of 2007–08.
In fact, there are only three periods during the entire century of the Fed’s existence when one can plausibly claim that it performed satisfactorily:
during the 1920s, when the price level was stable; during the low-inflation 1950s; and during the two decades beginning in the mid-1980s, a spell
whose low inflation and two minor recessions earned the sobriquet “the Great Moderation.” Some critics would even question how satisfactory the
Fed’s record was during those three periods. (The ’50s, for example, were punctuated by three recessions.)
3 of 4
3/3/21, 11:02 AM
How the Fed Was Born – Reason.com

How the Fed Was Born


If we ignore the most recent panic affecting mostly investment banks and other components of the shadow banking system, bringing on the financial
crisis, the period since the Great Depression did see the elimination of contagious bank runs. But the timing suggests that this change owes more to
the introduction of deposit insurance than to the Fed. Yet since the Fed’s creation, the economy has experienced two periods with significant numbers
of bank failures unassociated with panics or depressions: the rural failures of the 1920s and the savings and loan crisis of the 1980s. Indeed, more
outbreaks of numerous bank failures occurred in the century under the Federal Reserve than in the century before, with the Fed presiding over the
most serious case of all: again, the Great Depression. By any objective measure, the Fed has been an abysmal failure.
Ironically, this makes Lowenstein’s book, with all its shortcomings, all the more instructive. It provides valuable insight not just into how a central
bank was foisted on the body politic but into how it became an object of superstitious reverence, notwithstanding the overwhelming evidence to the
contrary.
JEFFREY ROGERS HUMMEL is the author of Emancipating Slaves, Enslaving Free Men: A History of the American Civil War (Open Court). He teaches economics and history at San Jose State
University.
FEDERAL RESERVE
4 of 4
BANKING
3/3/21, 11:02 AM
CHAPTER
19
Money Supply, Money Demand,
and the Banking System
There have been three great inventions since the beginning of time: fire, the
wheel, and central banking.
—Will Rogers
T
he supply and demand for money are crucial to many issues in macroeconomics. In Chapter 4, we discussed how economists use the term “money,”
how the central bank controls the quantity of money, and how monetary
policy affects prices and interest rates in the long run when prices are flexible. In
Chapters 10 and 11, we saw that the money market is a key element of the IS–LM
model, which describes the economy in the short run when prices are sticky. This
chapter examines money supply and money demand more closely.
In Section 19-1 we see that the banking system plays a key role in determining
the money supply. We discuss various policy instruments that the central bank can
use to influence the banking system and alter the money supply. We also discuss
some of the regulatory problems that central banks confront—an issue that rose in
prominence during the financial crisis and economic downturn of 2008 and 2009.
In Section 19-2 we consider the motives behind money demand, and we analyze the individual household’s decision about how much money to hold. We
also discuss how recent changes in the financial system have blurred the distinction between money and other assets and how this development complicates the
conduct of monetary policy.
19-1 Money Supply
Chapter 4 introduced the concept of “money supply’’ in a highly simplified manner.
In that chapter we defined the quantity of money as the number of dollars held by
the public, and we assumed that the Federal Reserve controls the supply of money
by increasing or decreasing the number of dollars in circulation through openmarket operations. This explanation is a good starting point for understanding what
determines the supply of money, but it is incomplete, because it omits the role of the
banking system in this process. We now present a more complete explanation.
547
548 |
PART
VI
More on the Microeconomics Behind Macroeconomics
In this section we see that the money supply is determined not only by Fed
policy but also by the behavior of households (which hold money) and banks (in
which money is held). We begin by recalling that the money supply includes both
currency in the hands of the public and deposits at banks that households can use
on demand for transactions, such as checking account deposits. That is, letting M
denote the money supply, C currency, and D demand deposits, we can write
Money Supply = Currency + Demand Deposits
M
=
C
+
D.
To understand the money supply, we must understand the interaction between
currency and demand deposits and how Fed policy influences these two components of the money supply.
100-Percent-Reserve Banking
We begin by imagining a world without banks. In such a world, all money takes
the form of currency, and the quantity of money is simply the amount of currency that the public holds. For this discussion, suppose that there is $1,000 of
currency in the economy.
Now introduce banks. At first, suppose that banks accept deposits but do not
make loans. The only purpose of the banks is to provide a safe place for depositors to keep their money.
The deposits that banks have received but have not lent out are called reserves.
Some reserves are held in the vaults of local banks throughout the country, but most
are held at a central bank, such as the Federal Reserve. In our hypothetical economy, all deposits are held as reserves: banks simply accept deposits, place the money in
reserve, and leave the money there until the depositor makes a withdrawal or writes
a check against the balance. This system is called 100-percent-reserve banking.
Suppose that households deposit the economy’s entire $1,000 in Firstbank.
Firstbank’s balance sheet—its accounting statement of assets and liabilities—
looks like this:
Firstbank’s Balance Sheet
Assets
Liabilities
Reserves
$1,000
Deposits
$1,000
The bank’s assets are the $1,000 it holds as reserves; the bank’s liabilities are the
$1,000 it owes to depositors. Unlike banks in our economy, this bank is not making loans, so it will not earn profit from its assets. The bank presumably charges
depositors a small fee to cover its costs.
What is the money supply in this economy? Before the creation of Firstbank,
the money supply was the $1,000 of currency. After the creation of Firstbank,
the money supply is the $1,000 of demand deposits. A dollar deposited in a bank
reduces currency by one dollar and raises deposits by one dollar, so the money
supply remains the same. If banks hold 100 percent of deposits in reserve, the banking
system does not affect the supply of money.
CHAPTER
19
Money Supply, Money Demand, and the Banking System | 549
Fractional-Reserve Banking
Now imagine that banks start to use some of their deposits to make loans—
for example, to families who are buying houses or to firms that are investing
in new plants and equipment. The advantage to banks is that they can charge
interest on the loans. The banks must keep some reserves on hand so that
reserves are available whenever depositors want to make …
Purchase answer to see full
attachment

Order a unique copy of this paper
(550 words)

Approximate price: $22

Our Basic features
  • Free title page and bibliography
  • Plagiarism-free guarantee
  • Unlimited revisions
  • Money-back guarantee
  • 24/7 support
Our Options
  • Writer’s samples
  • Expert Proofreading
  • Overnight delivery
  • Part-by-part delivery
  • Copies of used sources
Paper format
  • 275 words per page
  • 12 pt Arial/Times New Roman
  • Double line spacing
  • Any citation style (APA, MLA, Chicago/Turabian, Harvard)

AcademicWritingCompany guarantees

Our customer is the center of what we do and thus we offer 100% original essays..
By ordering our essays, you are guaranteed the best quality through our qualified experts.All your information and everything that you do on our website is kept completely confidential.

Money-back guarantee

Academicwritingcompany.com always strives to give you the best of its services. As a custom essay writing service, we are 100% sure of our services. That is why we ensure that our guarantee of money-back stands, always

Read more

Zero-plagiarism tolerance guarantee

The paper that you order at academicwritingcompany.com is 100% original. We ensure that regardless of the position you are, be it with urgent deadlines or hard essays, we give you a paper that is free of plagiarism. We even check our orders with the most advanced anti-plagiarism software in the industry.

Read more

Free-revision guarantee

The Academicwritingcompany.com thrives on excellence and thus we help ensure the Customer’s total satisfaction with the completed Order.To do so, we provide a Free Revision policy as a courtesy service. To receive free revision the Academic writing Company requires that the you provide the request within Fifteen (14) days since the completion date and within a period of thirty (30) days for dissertations and research papers.

Read more

Privacy and Security policy

With Academicwritingcompan.com, your privacy is the most important aspect. First, the academic writing company will never resell your personal information, which include credit cards, to any third party. Not even your lecturer on institution will know that you bought an essay from our academic writing company.

Read more

Adherence to requirements guarantee

The academic writing company writers know that following essay instructions is the most important part of academic writing. The expert writers will, therefore, work extra hard to ensure that they cooperate with all the requirements without fail. We also count on you to help us provide a better academic paper.

Read more

Calculate the price of your order

550 words
We'll send you the first draft for approval by September 11, 2020 at 10:52 AM
Total price:
$26
The price is based on these factors:
Customer Academic level
Number of pages required
Urgency of paper