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A Brief History Of The Federal Reserve

The Federal Reserve is the central bank of the United States of America. It is a consortium of private banks, but effectively operates as an arm of the government. Including The Federal Reserve System, there have been three central banking systems in the United States of America. The first one was The First Bank of the United States which existed from 1791 to 1811. This was followed by The Second Bank of the United States which existed from 1817 to 1836. These banks accepted deposits, lent money and issued currency. They acted on behalf of the U.S. government's Treasury, and the government owned 20% of the banks' shares and it appointed 20% of the banks' directors. Otherwise the banks were privately owned. Both banks operated under twenty-year licenses issued by the government.

When it was time for the Second Bank to have its license renewed, President Andrew Jackson opposed the renewal as he disliked the size and power of the bank, which effectively gave it monopolistic control over America's banking system, and he believed it operated against the public's interests.

In 1863 finance was needed to fund the Civil War, so the National Currency Act was passed and a network of national banks was established. These banks could issue the nation's standard bank notes. In 1864 the Act was altered and renamed The National Bank Act. The American banking system was administered by the Office of the Comptroller of the Currency, run by the Comptroller of the Currency. This position still exists today. It is part of the U.S. Treasury Department and it oversees all of the nation's banks.

The Banking Reserve System

The amount of currency allowed to be in circulation was connected to the fluctuating value of U.S. Treasury bonds. When bond prices went down, the national banks had to reduce the amount of its own issued currency in circulation by refusing new loans and/or calling in existing loans. On top of this system there was a banking reserve system in which rural banks had to keep reserves of money with reserve city banks, which had to keep reserves with central city banks, which had to keep reserves with the national banks that oversaw all those banks and was the issuer of currency to those banks. If a national bank was sending money out from its reserves instead of taking money in and it felt it was in danger of running out of currency, it would sell bonds, sell shares in itself, call in loans, or borrow money. If people suspected their bank was running out of cash they would try to withdraw their money from their bank. If too many people did this and caused the bank to run out of cash there was said to be 'a run on the bank' and either a temporary crisis or a complete collapse of the bank would ensue. This weakness and interconnectedness led to a series of financial panics at the end of the 1800's and the beginning of the 1900's. There was a particularly bad one in 1907.

The National Monetary Commission

In 1908, in response to the previous year's financial panic, The bipartisan National Monetary Commission was set up to look into reforming the banking and currency systems. It was headed by the Senate Republican leader Nelson Aldrich. He himself set off to investigate central banking systems in Europe. Before departing he was opposed to the idea of a central bank, but he changed his mind when the saw the German system of central banking. He decided that it was better for America to have a central bank than to have the government issuing Treasury Bonds to a network of national banks so that those banks could then issue currency backed by those bonds in amounts that fluctuated according to the market value of those bonds. However, Aldrich was strongly opposed by other US politicians because he was connected to America's banking system and was therefore perceived as having a vested interest in creating a central bank that would presumably involve the nation's existing top bankers. Aldrich's was friends with J. P. Morgan amongst others, and his daughter was married to John D. Rockefeller, Jr.

In 1910 a now famous, or infamous, meeting took place at the Jekyll Island Club on the privately owned Jekyll Island off the coast of Georgia. (It was owned by John Eugene Du Bignon.) Aldrich, along with executives from the banks of Rockefeller, J.P. Morgan, and Kuhn, Loeb & Co., travelled in a private train carriage from New York to the island and stayed there for ten days while they thrashed out the details for establishing a privately owned bank that would operate as America's central bank. Amongst the executives were Paul Warburg, Frank A. Vanderlip, Henry Davison, Charles D. Norton, and Colonel Edward House. The latter would go on to found the Council on Foreign Relations.

In 1911 Aldrich put forward his proposal for a central bank, to be called The National Reserve Association. It was to have fifteen branches throughout America and to have capital of at least $100 million. The National Reserve Association was a consortium of private banks, and the various branches were to be governed by the member banks according to votes that were weighted according to the sizes of the member banks. The National Reserve Association would issue currency that it would be responsible for, rather than the government being liable for the nation's currency and any calls that might be made on it to be redeemed for bonds or gold. The fifteen bank branches throughout the country would have the power to elect thirty of the thirty-nine board members of the National Reserve Association. The government could appoint the other board members.

Congress refused to pass Aldrich's proposal because many politicians believed it was designed to channel yet more power and wealth to America's wealthy eastern elite.

In 1912 Woodrow Wilson was elected President, and he was in favor of banking and currency reform. He could see that a lot of Aldrich's proposal made sense, but he wanted it amended so that there could be a Federal Reserve Board appointed by the government to keep an eye on, and control, the bankers.

The proposal was suitable amended, and, with some opposition, was passed. In December 1913 the Federal Reserve Act was made law. In essence it contained much of Aldrich's Federal Reserve Plan. Although the government would be responsible for issuing money, private financial organizations would effectively control it - who could have it, at what rate of interest, in what amounts, and so on.

The Federal Reserve Act

Rather than the Federal Reserve having fifteen national constituents, it now had twelve. However, the Federal Reserve Bank of New York was very much the dominant one. For example, it has sole responsibility for conducting open market operations, which are controlled by the Federal Open Market Committee.

It was the Democratic Congressman Carter Glass who sponsored the Federal Reserve Act and wrote the legislation in its final form. However, the establishment of the Reserve Bank arose from the status and connections enjoyed by the big banks that existed at the time.

Initially 'the Fed' had to hold in gold the equivalent of a minimum of forty percent of its loan book. Later this requirement was dropped.

Since its establishment 'the Fed' has controlled (in agreement with the US government) the amount of money in circulation, interest rates, and the availability of credit. It creates money to buy debt that the US government creates and issues, so in effect it plays the major role in allowing America to be an indebted nation.

Finance


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