Why was the Federal Reserve System established? After Andrew Jackson shut down the Second
Bank of the United States in the 1830s, the United States lacked a uniform and
stable currency. Gold and silver coin
did not circulate much outside cities in the East, and there wasn’t enough of
it, anyway. Most people made do either
with accounts with people and businesses with which they did business, or state
bank and private bank banknotes, many of which fluctuated wildly in value,
rarely passing at a full dollar-for-dollar.
During the Civil War, against the advice of businessmen and
bankers, the Union at first tried to finance the war using debt instead of
taxes. The U.S. saw its first paper
money issued at the national level under the Constitution. This upset those who still remembered the
debacle of the Continental Currency.
When Treasury Secretary organized the National Banking
System as a quasi-central bank in 1863, it embodied four serious flaws. One, small lenders were generally not able to
discount bills of exchange, limiting them to the rapidly shrinking pool of past
savings to finance small capital development.
Two, the currency issued by the National Banks was backed
100% by government debt.
Three, the currency was inelastic, with the amount fixed by
law.
Four, until 1879 and the restoration of convertibility of
the paper currency into gold, the paper currencies (the United States Notes —
“Greenbacks” — and the National Bank Notes) did not pass at par with gold and
silver coin. Prices in paper were higher
than prices in gold or silver.
The Panics of 1873, 1893 and 1907 revealed serious flaws in
the U.S. financial system, most of which were directly traceable to an
inelastic currency that was insufficient for the needs of commerce, especially
for financing small capital and carrying out the daily consumer transactions
that provide the backbone of a domestic economy.
This was the fertile ground on which grew the populist
demand for cheap money. Depending on
one’s particular sympathies or interests, this was usually either in the form
of increased government debt to inflate the United States Note or National Bank
Note currencies, or increased coinage of rapidly depreciating silver.
Despite the “Great Depressions” that followed the Panics of
1873 and 1893, there was no effective agitation for reform until the Panic of
1907. This is, perhaps,
understandable. Where there was
significant doubt in many people’s minds over the causes of the previous
Panics, the “Bankers’ Panic” could be traced to the machinations of one man:
financier J. P. Morgan. Morgan caused
the Panic by closing off clearinghouse privileges and refusing an emergency
loan of reserves to the third largest bank in New York, the Knickerbocker Bank
and Trust, when it got into trouble speculating in copper shares.
One of the biggest issues of the presidential campaign of
1912 was reform of the financial system.
Woodrow Wilson won the election when William Jennings Bryan gave Wilson
his endorsement, which allowed Wilson to defeat Theodore Roosevelt. Taft came in a distant third, trailed even
more distantly by Eugene C. Debs, the socialist party candidate. Wilson had originally run on a platform
supporting far-right capitalism, but was persuaded by Bryan and others that a
more progressive stance was essential to defeating Roosevelt.
