Thursday, August 5, 2010

The Federal Reserve . . . This Time It's Personal

It's always tempting to label anything we don't understand or dislike (an area, it seems, of considerable overlap) as the product of a conspiracy or a conspiracy itself. Did I mention the Federal Reserve? Since the New Deal resulted in what, according to Harold G. Moulton, was an effective takeover of the Federal Reserve System, the story starting going around that the Federal Reserve was established as a conspiracy. As one of our readers reported:
I recently heard for the first time of the Jekyll Island meeting from a conservative gentleman in reference to what-was- wrong with the Federal Reserve; that the FRA was a conspiracy by bankers to hoodwink the citizenry into approving a central bank and then using it against them.

Following up on sources via Google ("Jekyll Island" AND "Federal Reserve"), it seems to me that the subsequent subversion of the FR into government debt is taken as the original intent of the act, because the actual reforms legislated are not understood by the authors of the books, articles, and web pages that attack the FR.

Of particular conspiratorial interest, to my source, was the attendance of Paul Warburg at the meeting. If his "European Banker" contribution was subversive, how was the act so progressive with respect to a flexible money supply?

I did not investigate to reasons that Woodrow Wilson later retracted his endorsement of the act; this was claimed by one author. Perhaps you could explain.

Another aspect of the arguments is the "unconstitutionality" of the FRA (and central banks) that goes back to Jefferson.

Have fun with these thoughts!!!
Uh, yeah. Thanks. Lots o' fun.

Anyway, some of this material was covered in the postings from March 9-15 in the "Own the Fed" series. We've turned these into drafts of Volume III and IV of a "short" history of the Federal Reserve. Volumes I and II are (sort of) outlined, and are planned to cover 1893 to 1906 (Volume I), that is, from the Panic of 1893 and the subsequent Great Depression (as it was known until the 1930s) to the eve of the Panic of 1907, and 1907 to 1913 (Volume II), covering the Panic of 1907 and its aftermath. What follows is from memory, so there may be some misstated facts.

According to Harold Moulton in his Financial Organization and the Economic System (1938), the Jekyll Island meeting did not have the influence that many people impute to it. Certain minor features were incorporated into the Federal Reserve Act of 1913, but the most important parts of the Aldrich proposal that came out of the Jekyll Island meeting (keeping control over money and credit concentrated in private hands in New York City and maintaining the dependency on existing accumulations of savings), were eliminated, and the system of a dozen autonomous regional development banks based on the real bills doctrine adopted, somewhat analogous to what Congressman George Tucker proposed in the 1830s.

The Aldrich proposal was, effectively, for a single, privately controlled national bank in New York ("reserve fund") to replace the National Bank system established in 1863 (heavily amended by the National Bank Act of 1864), taking away the individual National Bank's power to issue banknotes backed by government debt in an amount determined by the federal government. The single institution would be privately owned and would continue to back the currency with government debt as provided for in the National Bank Act, but the bank would instruct the federal government as to the quantity of currency, not the other way around, thereby putting control over the currency as well as the rest of the money supply into the hands of an elite group of private individuals.

The Federal Reserve System was designed along different lines. Right before the Jekyll Island meeting, some of the participants, such as Warburg, visited Europe and were impressed with the design of the commercial banking system of the Second Reich under the oversight of the Reichsbank. The German system functioned in accordance (more or less) with the real bills doctrine. It appears that their confidence in Aldrich's proposal to maintain a past savings-based system was thereby somewhat shaken. This was not enough to effect changes in the proposal, but it was sufficient to weaken support for it at a critical time, when the new Democratic Congress took their seats in 1912 and finally got to work reforming the system.

Far from being a hoodwinking or a secret conspiracy, the public debates and testimony on the Federal Reserve take up thousands of pages in the Congressional Record. One authority noted that the volume of documentation was greater than anything previous in the history of the country. All the newspapers covered virtually every detail; nothing was carried out in secret. The bill finally passed the House in September, and the Senate in mid-December. One commentator described the debates as the most violent he had ever seen. When it finally passed the Senate, it was immediate sent through the channels, getting to Wilson's desk right before adjourning for the holidays. Since the legislation had been pending for two years and everyone was anxious to get the system in place after waiting since 1907 for effective action, Wilson signed the bill immediately, to take effect January 1, 1914, rather than wait until after the holidays, and sent it back, where it was immediately adopted, there still being a quorum present, although just barely.

The effort to institute the Federal Reserve had been led by the Democratic Congressman from Louisiana, Arsene Pujo, and Carter Glass of Virginia, later to push for the Banking Act of 1933 that became known as Glass-Steagall. It would not have made it through Congress without the assistance of the Secretary of State, William Jennings Bryan, who saw, in the implementation of the real bills doctrine, the way to reconcile the populist demand for inflationary free silver and the supporters of the deflationary gold standard demand for financial responsibility and sound credit. One economic historian commented that the Federal Reserve — as designed, anyway — was a triumph of "Jacksonian hopes and financial responsibility."

Most of the conspiracy lore about the Federal Reserve dates from the 1930s, when the weaknesses of trying to use an institution designed to operate in accordance with the real bills doctrine as if it were a past savings-based bank of deposit became evident. The member banks have never "owned" the Federal Reserve in the sense the conspiracy theorists fear. The mandatory "shares" carry only a nominal rate of interest and no voting power. They are, in effect, an interest-paying membership deposit, not true ownership.

That is not to say that the Federal Reserve is independent. As a result of the New Deal the federal government completed its effective takeover of the Federal Reserve that it had begun in 1916 to finance the U.S. entry into the war, as Moulton related. The autonomy of the regional Federal Reserves was destroyed, and virtually all power vested in the new Open Market Committee of the New York Federal Reserve, under the direction of the Board of Governors in DC. Moulton rather strongly hinted that this was akin to financial fascism. Wilson's objections to the Federal Reserve possibly resulted from this hijacking of the system to finance the war, and its shift from the real bills doctrine to what became known as Keynesian economics — effectively "chartalism," or the belief that only the State has the power to create (not just regulate) money, and that all money comes from the State, making the State the effective owner of everything in the economy.

Chartalism is a socialist monetary theory, lauded by Keynes in his 1930 Treatise on Money, described by the Weimar socialist economist Georg Friedrich Knapp in his book, The State Theory of Money (1924). Although a socialist (and a few other things) one of the few "good" things Hitler did was repudiate chartalism, and insist on a predominantly asset-backed currency to restore the financial and economic power of the Third Reich. (That wasn't really Hitler's doing, of course. He was following the advice of Dr. Hjalmar Schacht, the "Old Wizard," the man who stopped the hyperinflation of the early 1920s . . . and who later tried to assassinate Hitler.)

As you point out, the authors of the numerous books and articles on the subject do not understand the original design of the Federal Reserve, or even the correct definition of money. Given that, they are not going to understand what it wrong with it today.

The alleged unconstitutional nature of the Federal Reserve results from misreading the part of the Constitution dealing with federal government regulation and setting of standards for weights and measures. The federal government has the responsibility to set the standard of value of the currency, but it cannot create money; it has a regulatory, not a creative function. Money is anything that can be used in settlement of a debt, and as long as the matter of an exchange is legal and both parties are satisfied with the consideration, it doesn't matter what they use as money.

Jefferson did not understand this. He believed that the only "real" money was gold and silver. He was an adherent of what would become known as the British Currency School. Alexander Hamilton was a bit more advanced in his thinking. He defined money the way the British Banking School would: anything that can be used in settlement of a debt. In an advanced economy, such as Hamilton was attempting to provide the foundation for, this meant that the bulk of the money supply would not be gold and silver (however important that might be for day-to-day transactions), but bills of exchange, which even today make up more than half the money supply in the U.S. If you want a uniform currency based on bills of exchange, however, you need some kind of central authority to maintain a stable and uniform value.

Depending on your lexicon, this is necessarily either a national bank or a central bank. When businesses and commercial banks are discounting and rediscounting bills of exchange, they need a "final authority" to put its stamp of approval on the value of the instruments, and to convert the bills into legal tender on demand. Otherwise banknotes and demand deposits, even the coinage, can have different values and will pass at a discount or premium, depending on which bank issued the notes or holds the deposits. This was, in fact, the case in the United States until 1864 when private bank note issues were replaced by a national currency, the United States Notes (greenbacks), backed by federal government debt and issued by the National Banks against government bonds on deposit. Until the coinage act of 1873, to enter populist legend in the 1890s as "the Crime of '73" as a result of the (first) Great Depression and people seeking someone to blame, silver coin passed at a discount with gold coin, and the greenbacks passed at a discount with both gold and silver coin.

Anyway, Jefferson never forgave Hamilton for allegedly swindling him to accept the establishment of the Bank of the United States. Because the bank was intended to deal primarily in bills of exchange and issue banknotes backed by the present value of the existing and future marketable goods and services represented by the bills brought to the bank for discounting and rediscounting, Jefferson believed the operation of the bank to be a fraud, and attempted to assert its unconstitutionality. Neither Congress nor the Supreme Court accepted Jefferson's argument, which did nothing to advance Hamilton's career. Jefferson wasn't exactly vindictive, but he let it be known that he considered Hamilton dishonest, and helped lay the groundwork for a couple of centuries of confusion over what money and credit really are.

As you can see, this issue is far from simple. The basic problem, however, is the fixed idea that "money" is whatever the State says it is and the rejection of Say's Law and the real bills doctrine. This "enslaves" humanity to existing accumulations of savings as the sole source of financing for new capital formation, with the result we see today, in "Great Depression III: This Time It's Personal."

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