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Reprinted with permission•Mises Wire•George Ford Smith

Since the job that was actually assigned to [the Fed] by Congressman Carter Glass back in 1913 is now vestigial and long gone, and the financial system has been flooded with massive liquidity for decades on end, it might well be time to declare victory and let the free market take care of jobs, growth, inflation and prosperity. — David Stockman

Let’s take a closer look at the job Congressman Carter Glass assigned to the government’s new central bank, the Federal Reserve System, created by the Federal Reserve Act of 1913. The first thing to notice about the Fed is that it’s a creature of government, not the market, otherwise there would be no need to support the Fed with a legislative act, which gave it the status of a state-backed cartel.

It’s crucial to understand that the push for central banking was part of the Progressive Era feature of business partnering with government in its war against competition. Mergers on the free market had failed for various reasons, including internal conflicts among members, challenges from new entrants in the market, and new competing markets altogether, such as the new motor vehicle industry that emerged in 1893 and by 1895 saw “thirty American manufacturers producing 2,500 motor vehicles.” It became evident that large industries needed to partner with government to establish their cartels. As historian Gabriel Kolko explains:

The net effect of federal legislation, and usually the intent, was to implement the economic-political goals of some group within an industry. The pervasive reality of the period is big business’ control of politics set in the context of the political regulation of the economy.

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Big bankers’ goal in banking reform was a law that would authorize a central bank to create a more inflatable (“elastic”) currency and control uniform rates of inflation among member banks. In this way banks would avoid currency drains and hoped to reduce the likelihood of those dreaded and embarrassing bank runs.

The six-week Panic of 1907, triggered by Knickerbocker Trust Company’s president, Charles T. Barney, inaugurated the movement for a radical revision of the US monetary system. Barney had joined with two other speculators in a failed attempt to corner the market on copper, sparking a run on Knickerbocker. The Trust sought aid from J. P. Morgan but, based on its lack of solvency, Morgan refused. After losing $8 million in withdrawals, Knickerbocker closed its doors but the fear was already spreading to national banks. The New York Stock Exchange suffered a shocking rise in call money interest rates, and only Morgan’s ability to function as a central bank over a two-week period saved several trust companies and kept the NYSE open.

It was no surprise that the Panic hit the NYC trusts first. By law, the trusts held,

…a low percentage of cash reserves relative to deposits, around 5 percent, compared with 25 percent for national banks. Because trust-company deposit accounts were demandable in cash, trusts were just as susceptible to runs on deposits as were banks.

What was the economy like in the late 19th century?

The message we hear today is deflation is bad—but bad for whom? From 1870-1912, the dollar had an average annual deflation rate of -0.71%, producing a cumulative price change of -25.95%. Dollar holders increased their wealth just by holding dollars, as it only took $0.74 in 1912 to buy what $1.00 would in 1870. According to the St. Louis Fed, during the same period the economy increased total physical production by 550%, yielding one of the most prosperous economies in history. But during the years preceding the anticipated crisis, 1900-1907, bank credit expansion produced a cumulative price increase of 11.90%.

Because the solution they sought required a federal charter, the bankers united with politicians, who they already knew socially, to agitate for a central bank. The ultra-secret meeting at Jekyll Island in November of 1910, therefore, consisted of six of the most influential bankers and politicians of the day, representing an estimated one-fourth of the world’s wealth. Long denied as a groundless conspiracy theory, the meeting was confirmed in 1935 by one of the attendees, Frank Vanderlip, President of National City Bank (Citibank) and a century later celebrated publicly by the Fed itself, “in a remarkable show of both contempt and hubris.”

Paul Warburg, a partner at Kuhn, Loeb & Co, who had an extensive background in European banking, was the chief architect of the plan that emerged from Jekyll, but for political reasons it bore the name of another attendee, Nelson W. Aldrich, a Republican Senator from Rhode Island and Chairman of the National Monetary Commission.

The initial plan, which with only non-essential changes became the Federal Reserve Act, consisted of a National Reserve Association located in Washington that would preside over fifteen major regions. Private bankers from the regions would elect the forty-five board members in Washington, with each region electing no more than four members—thereby eliminating the possibility of Wall Street control. The attendees’ challenge was to secure political backing for the plan while avoiding any suggestion that it was a scheme of Wall Street.

Playing the Politicians

What followed from 1910 to the bill’s passage in 1913 was an exercise in mass psychology. The Jekyll attendees promoted the plan among bankers and the public through articles and speeches. Writes Kolko:

A special monetary conference of all business organizations, convened by the National Board of Trade in January, 1911, passed a resolution, written by Warburg, endorsing the Aldrich Plan. At the beginning of February twenty-two key bankers from twelve cities met in Atlantic City to consider the Aldrich Plan. Sessions were closed, and all the conference publicly declared at the end of three days’ discussion was that it endorsed the plan and would actively support it.

On the political side, progressive Democrats were winning favor with the public, Republican President William Howard Taft and former president Theodore Roosevelt were fighting over reforms, with the progressive Roosevelt deciding to run against him as a third party candidate in the election of 1912. The Republican split helped Democrat Woodrow Wilson win, with socialist Eugene Debs, the fourth candidate, gaining nearly a million popular votes.

With the Democrats running the show in Congress and the White House, the Aldrich Bill now faced a political firing squad, though in name only. Who better to pick up the issue of banking reform than the Democratic Chairman of the House Banking and Currency Committee, Congressman Carter Glass of Virginia, who, by his own admission, had virtually no technical knowledge of banking? To provide guidance and actually write the bill, he hired a young economics professor from Washington and Lee University, H. Parker Willis.

In a House report of September 9, 1913, Glass and his committee announced their reasons for rejecting the Aldrich Bill: It lacked adequate government control; it threw voting control into the larger banks; there was “extreme danger of inflation” in the bill; and it had “dangerous monopolistic aspects.” All of it true, of course.

Then he presented his own bill, drafted by Willis, which in every important detail was the Aldrich Bill brought back from the dead. Warburg, to assuage the cartel’s worries and establish himself as the real author of the bill, published a side-by-side comparison of the Aldrich and Glass proposals. Not only were they in agreement on all essential provisions, but in some cases were identical in wording.

With many of the biggest names on Wall Street objecting to the Glass-Owen Bill (Robert D. Owen was the sponsor in the Senate) and having been previously exposed during the Pujo hearings as constituting a powerful “Money Trust,” the proposed legislation seemed like the perfect antidote to Wall Street influence in banking. When President Wilson, himself a banking neophyte, signed Glass-Owen into law on December 23, 1913, it had the support of the majority of Congress. Had government finally solved the problem of monetary inelasticity? Perhaps the problem had been invented.

Returning to Mr. Stockman’s suggestion that it might be time for the Fed to “declare victory” and let the free market work, he wants nothing less than to save civilization. But Fed inflation is too opaque a method of theft and too much loved by those who profit from it for our overlords to get rid of it.