Fear and Loathing of Central Banks in America

Article excerpt

The Federal Reserve System is America's uneasy compromise between our wariness of concentrated financial power and our desire to promote efficiency in our national payments system. In fact, the Federal Reserve is the nation's third attempt to establish a large national bank-what we now call a central bank-that is in a unique position to influence a nation's money and credit. This Commentary retells the story of the rise and fall of the two earlier national banks, the Banks of the United States.

The history of money and banking in America reads like a novel, rich in political intrigue and colorful characters. Where students might expect an encyclopedic description of how each part of our financial system was carefully designed, they find a patchwork of institutions that has evolved in response to the pressing needs of our unique economic circumstances and political sensibilities.

Indeed, the story of the American financial system cannot be told without some appreciation for the great and continuing debate over the establishment of a large national bank-what we now call a central bank-that is in a unique position to influence a nation's money and credit. This is a story of how Americans' mistrust of power coexists, however uneasily, with the desire to promote efficiency in our payments system. In this Commentary, we recount the rise and fall of the Banks of the United States, our nation's early attempts at central banking and the precursors of the Federal Reserve System.

* The (First) Bank of the United States

The American Revolution was a painful lesson in the importance of an effective national payments system. With only a loose coalition of state governments, the revolutionaries nearly lost their struggle against British sovereignty for want of credit. America's first Secretary of the Treasury, Alexander Hamilton-a man whose abrasiveness was as legendary as his intelligence-foresaw continued peril if the nation failed to establish a strong national bank. Such a bank could more efficiently collect and disburse government funds and aid in the issuance of government debt. Hamilton's efforts to place such powers in the hands of a central authority earned him a reputation as a "monarchist." Nonetheless, in 1791, at his prompting, Congress established the (First) Bank of the United States (FBUS) under a 20-year charter. The bank had initial capital of SIO million, making it by far the largest bank of the time. Although the federal government provided one-fifth of its capital and appointed its directors, the bank was designed to be a largely private institution so that its management would have adequate incentive for maintaining its financial integrity. The FBUS thus established the "quasi-private" quality that would influence future incarnations of central banking in America.

Many, including the influential Thomas Jefferson, opposed the bank on the grounds that it was unconstitutional-- the federal government was not expressly granted the authority to charter banks. But what underlay the constitutionality issue was apprehension over the enormous power this institution might possess. In the hands of the federal government, such power would almost certainly be used to the disadvantage of the states and, ultimately, of the republic. Indeed, because the FBUS acted as the federal government's fiscal agent, it continually received state banks' obligations. As their creditor, it could affect their lending power-when the FBUS redeemed notes, state banks lost reserves, reducing their lending potential.

The FBUS's bid for renewal of its 20-year charter was defeated in Congress by one vote. But it seems the bank was killed by uneasiness about its very existence, not by a belief that it had exercised its power to the nation's detriment. In fact, the FBUS was generally thought to have managed the federal government's growing fiscal resources effectively and to have provided some modest oversight to the expanding network of state banking institutions that was becoming the backbone of the American financial system. …