The Bankers' Bank

The Federal Reserve System does more than conjure up money from thin air. (That would be enough!) The Fed is also regulator/protector of the American banking industry. Indeed, as recent events amply demonstrate, we may think of the industry as a government-organized protectionist cartel, with the Fed as the hub. One need look no further for evidence than the relationship between the New York Federal Reserve Bank under now-Treasury Secretary Timothy Geithner, whom the New York Times calls “the leading architect of [bank] bailouts.” (See last week’s TGIF, “Of, By, and For the Elite,” for details.)

No one familiar with the origins of the Fed, or the other Progressive Era reforms, should be surprised. Those who have not studied the Progressive Era in any depth, however, are likely to believe those reforms were imposed by enlightened politicians to end abuses by big business. That is one of many fairy tales we learn in school. It’s not so, but it serves its purpose, which is to protect the left and right wings of the ruling party from the radical laissez-faire alternative. Those reforms, though of course cheered on by European-educated American intellectuals attracted to power and ambitious Progressive politicians, were in fact the brainchildren of the corporate elite. Its members disliked the vigorous market competition of the late nineteenth century because it cost them market share, and their efforts to stifle competition through mergers had failed miserably. So the elite turned to the state for protection. (See Roy Childs’s classic “Big Business and the Rise of American Statism” here.)

In no industry was this more true than in banking. There has hardly ever been anything we could call genuine free banking in America, even when a gold standard was in effect. States and the national government regulated the banks by, among other things, tying the issuance of currency to the holding of government bonds and banning interstate and intrastate branch banking.

“The banking system of the United States after 1865 was, therefore, a halfway house between free and central banking. Banking was subsidized, privileged, and quasi-centralized under the aegis of a handful of large Wall Street banks,” wrote Murray Rothbard (pdf), economist and historian. “Even at that, however, the large national banks and their financial colleagues were far from satisfied. There was no governmental central bank to act as the lender of last resort.”

The problem, Rothbard explained, was that when an inflationary boom went bust, the banks “were forced to contract and deflate to save themselves.” This was a problem of “inelasticity” of the money supply. “Translated into plain English, ‘inelasticity’ meant the inability of the banking system to inflate money and credit, especially during recessions.”

So, concerned about “inelasticity” and the rivalry of state and private banks and private trust companies, the national banks (Wall Street), led by J. P Morgan, turned their attention at the end of the nineteenth century to the establishment of a central bank.

Growing Consensus

To make a long story short, Rothbard writes in The Mystery of Banking: “The growing consensus among the bankers was to transform the American banking system by establishing a central bank. That bank would have an absolute monopoly of note issue and reserve requirements and would then insure a multilayered pyramiding on top of its notes. The Central Bank could bail out banks in trouble and inflate the currency in a smooth, controlled, and uniform manner throughout the nation.”

Essentially it would be a cartel that would allow concerted action free from competition. A cartel unsupported by government is vulnerable to independent competitors. To succeeded in defiance of market forces, a cartel needs government help, either to force everyone into it or to hamper outsiders.

While the New York bankers’ interest in central banking went back to the late nineteenth century, the Panic of 1907 provided the final impetus for action. Meetings were held, reports were issued, and legislation was drafted—all in the campaign for a European-style bank. Rothbard shows that the principals in this effort were associates of the most important groups in New York banking, particularly “the Morgans, the Rockefellers, and Kuhn Loeb.” Their point man in Congress was Sen. Nelson Aldrich, father-in-law of John D. Rockefeller, Jr.

Several men associated with these interests, including Aldrich, gathered on Jekyll Island, Georgia, in late 1910 “in a top secret conclave to draft a bill for a central bank.” As Rothbard commented, “There is no clearer physical embodiment of the cartelizing coalition of top financial and banking interests that brought the Federal Reserve System into being than the sometimes allied, often clashing Rockefeller-Kuhn, Loeb and Morgan interests, aided by economic technicians.” A plan for a central bank was drafted and, after modification, “introduced … as the Aldrich Bill, which in turn became in all essentials the final Federal Reserve Act passed in December 1913.” (With some technical changes, it later was known as the Glass bill.)

Rothbard added, “[T]he main difference between the draft and the eventual legislation is that in the former the national board of directors was largely chosen by the banks themselves rather than by the president of the United States. This provision was so blatantly cartelist that it was modified for political reasons to have the president name the board.” (The board of the New York Fed is dominated to this day by the Wall Street banking establishment. For an indication of its current difficulties see this.)

At a big conference in 1911 in Atlantic City, bankers from around the country embraced the draft legislation. As historian Gabriel Kolko summed things up: “[T]he real purpose of the conference was to discuss winning the banking community over to government control directed by the bankers for their own ends…. It was generally appreciated that the [Aldrich plan] would increase the power of the big national banks to compete with the rapidly growing state banks, help bring the state banks under control, and strengthen the position of the national banks in foreign banking activities.”

Rothbard added, “[T]he nation’s bankers, and especially the big bankers, were overwhelmingly in favor of a new central bank. As A. Barton Hepburn of the Chase National exulted at the annual meeting of the American Bankers Association in August 1913, in the course of his successful effort to get the bankers to endorse the Glass bill: ‘The measure recognizes and adopts the principles of a central bank. Indeed, if it works out as the sponsors of the law hope, it will make all incorporated banks together joint owners of a central dominating power.’”

Thus, summing up the thinking of Edward Hurley, vice chairman of the Federal Trade Commission in 1915, Rothbard wrote, “The railroads and shippers had the ICC [Interstate Commerce Commission], the farmers had the Agriculture Department, and the bankers had the Federal Reserve Board.”

Why does this matter now? The major banks wanted to inflate in unison and with impunity, reaping the profits of the perpetual boom they thought they could create. That, they understood, required a central bank. But fiat money inflation is the people’s nemesis. It knocks the economy out of alignment with their preferences, allocates incomes politically, robs people of their purchasing power, and throws them out of work when the inevitable bust comes. In this libertarian “class struggle,” the special interests prevailed. The people’s best interests lie in free banking and hard money.