Magazine article Reason

How the Fed Was Born; A Book about the Birth of the Federal Reserve Overlooks the Flaws in the System

Magazine article Reason

How the Fed Was Born; A Book about the Birth of the Federal Reserve Overlooks the Flaws in the System

Article excerpt

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 1). Organized and chaired by the powerful pro-business and pro-tariff Sen. Nelson W. Aldrich (R-R.L), 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 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. 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. …

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