In the opening paragraph of his multi-volume, quasi-official History of the Federal Reserve (2003), monetary policy scholar extraordinaire Allan H. Meltzer wrote: “The founders did not intend to create either a central bank or a powerful institution; had they been able to foresee the future accurately, they might not have acted.” They might not have acted—given a little time, those who started the Fed back in 1913 could well have looked upon the result and found it undesirable.
It is not difficult to see how the facts would have warranted such a judgment. The first phase of Fed history was brutal. From 1913 to 1920, the inflation rate in this country totaled 110 percent. Over the previous thirty-five years, the average level of prices stayed in a band of 20 percent. In 1920-21, the interest-rate hike that the Fed administered to stem the inflation led to a recession that was perhaps the worst in American history to date. A few years later, from 1929 to 1933, the Fed whirred away at its operations as thousands of banks failed and the United States plunged into a depression that was easily more severe than the event of the early 1920s, not to mention all previous examples of economic crisis. Early Fed history was a bloodbath.
In short order, the Fed ceased to exist as an independent institution. In 1935, Congress reorganized the Fed so that a disaster on the order of that of the early thirties might be averted in the future. In 1942, President Franklin D. Roosevelt, with Congressional acquiescence, subsumed the Federal Reserve into the Treasury. One of the reasons this happened was that the Fed’s reputation was in shreds. How could it not be after 1913-21, 1929-33, and the “little Great Depression” of 1937-38?
In 1951, the Treasury released its hold on the Fed. In due time, another indecent economic era came on the scene. From 1970-1982, this country experienced the “stagflation” era of uncommonly high inflation—totaling 160 percent—and stepped-up unemployment—averaging about 7 percent and crossing 10 percent on multiple occasions. To this day, in scholarly circles as well as in the popular precincts of “Fed-watching,” the Fed chairmen of the stagflation run, Arthur Burns and G. William Miller, are regarded as two of the most hapless public servants of modern memory.
Prior to the 1980s, the only periods in which the independent Fed did not have egg on its face, on account of gross economic developments coincident with its activities, were the 1920s and the 1950s and 1960s. These periods corresponded exactly to the respective dominance of two individuals at the institution, New York Fed president Benjamin Strong in the 1920s and board chairman William McChesney Martin from 1951-69.
Strong’s signature policy, in the Roaring ’20s, was to have to Fed “take” interest rates from the market, i.e., strive to have as non-interventionist a monetary policy as possible. Martin’s, in the era of postwar prosperity, was to finance the dollar economic area given a newly committed-to international gold standard. Like Strong, Martin strove to outsource monetary policy to market mechanisms.
Strong and Martin had their fair share of positive publicity—magazine cover profiles and so forth—but compared to what came later, neither man was anywhere near “the story” of the economy at large during their time at the Fed. The great private-sector economic booms drew public awe and admiration.
This state of affairs changed ominously in the 1980s. As the economy soared from 1982-2000 (growth averaged about 4 percent per year) while inflation collapsed, the Federal Reserve, for the first time ever, began to be lionized. Fed chairs Paul Volcker and Alan Greenspan became cultural rock stars, Greenspan a “maestro” to Washington Post reporter Bob Woodward, both Volcker and Greenspan “elevated in prestige beyond all reason,” in the words of another Post columnist, Robert D. Novak. Commencement speeches, fawning biographies, spreads in the financial (particularly the televised) press were Volcker’s and Greenspan’s lot. In the 2000s, as the economy tanked, the new Fed chair, Ben Bernanke, strove to associate himself with the popularity of his predecessors, adopting melodramatic “quantitative easing” policies and preparing a heroic autobiography called The Courage to Act.
The idea that the Fed (in particular its team of leaders) is impressive and maybe a little incredible is a new thing in American history—a neologism of the past generation. Before 1983, Americans generally saw the Fed either as a passive institution or a ship of fools.
Why that opinion changed is an interesting question. It probably owes to the progressive political class’s wishing to do anything to deny President Ronald Reagan credit for replacing the interminable stagflation of the 1970s with a non-inflationary and long-lasting boom in the 1980s. The reason, that is to say, probably lies not with the facts of Fed performance and history, which are alternatively innocuous and regrettable, but with the compensation-mechanisms of the worldviews of American elites.
Despite Greenspan and Volcker’s being rock stars, and as Bernanke and his successor Janet Yellen make their bids to leap up from the status of wannabe, latter-day Fed-praisers have generally kept their adulations confined to the contemporary era. Few venture back in history pre-Volcker, especially to the demonstrably bad old days, economically speaking, and say that the Fed people of those eras deserve to be thought of in larger-than-life terms too.
Roger Lowenstein’s America’s Bank: The Epic Struggle to Create the Federal Reserve represents a new development within this tradition. With this book, the founders of the institution, in Congress and on Wall Street from back over a hundred years ago, come out of the shadows and stand revealed as forbearers of the modern Fed Mensch. Here they are, the unduly forgotten group of skilled, far-seeing, and public-minded reformers who birthed the Federal Reserve.
America’s Bank starts with a series of questionable generalizations. The first sentence of the book is: “So pervasive is its influence that Americans today can scarcely imagine a world without the Federal Reserve.” Several years ago, of course, a book called End the Fed was a national bestseller. This is sufficient evidence to dismiss the claim of the first sentence outright. Then this connection is made of the early 1900s: “The United States boasted the world’s largest economy….Yet almost as if history had missed a turn, its banks were disconnected and isolated….” The problem here is that it is invalid to imply, when an economy is performing surpassingly well, that its banking system is not. The sufficient condition for a banking system to be successful is for the economy that it attends to be successful.
Further on come statements about the nineteenth century. Alexis “De Tocqueville was plainly bewildered [about American resistance to central banking]. To him…the Bank of France seemed…no less French than the Court of Versailles.” Yet Tocqueville, writing his great works on America and France in the era of the antebellum United States, manifestly thought Versailles (and very possibly the Bank of France) a gross imposition of false Frenchness upon the authentic variety that had pre-existed the absolutist Bourbon kings. Tocqueville abhorred the new nationalism of his age, his many readers have long recognized, while conceding it as a fait accompli.
The comments on Tocqueville come in the context of a central topic of America’s Bank—it is referred to throughout—namely, the experience of the First and Second Banks of the United States in the forty-five years following 1791. Lowenstein writes repeatedly of the intensity of the popular opposition to these Banks. We read of “Americans’ primal anxieties,” of “fear that hard won liberties would be crushed,” of “resentment” and “phobia,” of “fear of this demon,” and of “deep-seated prejudices” that lay behind the democratic swells that prevented the Congressional re-chartering of the Banks, beyond their initial twenty-year runs, in 1811 and 1836.
The expiring of the original Banks of the United States mattered, Lowenstein contends, because the popular mood that ran the Banks off lingered on as the sentiment that forestalled the creation the Fed until 1913. The effects of Americans’ anti-government-bank prejudice, Lowenstein stresses, included the incessant financial panics that the United States had to suffer in the decades after the civil war, as well as the inability to learn lessons from those European nations happily sprouting up central banks as the United States did nothing.
Lowenstein does little to demonstrate his expertise on the history of nineteenth-century banking. We read only once, and that in passing, that the primary statutory function of the Banks of the United States was to collect tax revenue so that the national debt could be retired. We do not read that this function was discharged in 1835, eliminating the grounds for the second Bank to be re-chartered.
Moreover, we do not get any sense of the empiricism and sophistication of the anti-Bank arguments from the time. One of these arguments was that given that the Bank of the United States had claims on tax revenue, and thus a vanishingly small chance of failure, it forced all other banks to attract deposits via high interest rates paid for by risky loans. The anti-Bank position turned on the effect that the national Bank in all its branches had upon the private banking system. This effect was, specifically, the introduction of an instability to the private banking system that had not existed before. Lowenstein adduces approximately no contemporaneous evidence pertaining to popular attitudes about the Banks of the United States as he writes of “primal anxieties” and so forth.
When he takes up the early twentieth century, Lowenstein refers perhaps a dozen times to the influence of the legacy of President Andrew Jackson, who smothered the second Bank of the United States into non-existence by paying off the debt. Here again, however, the contemporaneous evidence of the impress of “Jacksonism” (the author’s term) is nugatory. Lowenstein has perhaps two or three primary sources, at least one of these ex post facto, pertaining to Jackson in the national deliberations that resulted in the Fed in 1913. At one point, Lowenstein writes of a tour taken in 1909 by Rhode Island Sen. Nelson Aldrich to promote central banking: “And it was into Jackson territory—nine Midwestern cities, starting with Chicago and finishing in Detroit—that…Aldrich was bound.” Jackson territory? In the actual age of Jackson, eighty years prior, Chicago was essentially uninhabited and Michigan not a state.
The ratio of Lowenstein’s characterizations of the historical moods pertaining to central banking in this country to actual items of evidence connected to that question is alarmingly high—well into the whole numbers and far above any ratio that a credible historian would want to maintain. Fortunately, this condition is improved as Lowenstein moves into the main part of his narrative, the story of Aldrich and his associates’ working to introduce legislation in Congress that would institute a Federal Reserve. Here Lowenstein gives us a blow-by-blow that is based on primary sources.
But not before additional matters get glossed over. The most important of these is the real nature of the banking panics that ended up being the pretext for the creation of the Fed. Lowenstein does not disclose the very obvious point that the greatest panic of the era, that of 1893, derived from the federal government’s outlandish decision (at the behest of silver miners working federal land) to mint so much gold-convertible silver that it would empty the nation’s banking vaults of gold and thereby eliminate the monetary base. Nor does Lowenstein explain, as he should, that the gold loan to the U.S. government that J.P. Morgan arranged after this ridiculous episode could easily be interpreted as an example of the private sector’s bailing out the feds from their own mess.
Rather, we read of “laissez faire” being at the heart of the various panics. The one Lowenstein treats in detail is that of 1907. He recounts the harrowing events of that fall, when stocks plunged, outfits failed, and Morgan stepped in again, this time to make sure that as many financial concerns as could remained solvent. This section of the book is informative and empirical. But it suffers from lack of perspective. The “hidebound” banking system is the main culprit, its inadequacies exposed by insurance liabilities occasioned by the San Francisco earthquake of the year before. It would have been helpful to read about the government’s complicity in ginning up these liabilities—namely, its dominance of the land-distribution and rights-of-way systems of the West.
In both 1893 and 1907, the case is strong that the underlying problem was misguided government monetary and regulatory policy, the stress on the banking system being an effect. That both times the private operations of the banking system restored order and, in the case of 1893, served to address the underlying mismanagement emanating from the government, showed the suppleness and public-spiritedness of the American way of banking before the Fed reform of 1913.
The chief contribution of America’s Bank is its detailed chronicle of the legislative movement to create the Fed in the six years following 1907. The story is somewhat well known, thanks to the popular and illuminating history The Creature from Jekyll Island (1994) by G. Edward Griffin. Lowenstein is far more sympathetic than Griffin to Aldrich and his consorts in the banking world who in 1910 decamped in secret to the Georgia resort of Jekyl (one “l”) Island to come up with a national banking reserve plan. Lowenstein excuses the secrecy, because if word got out that East Coast power-brokers were planning a “central bank,” the old American atavism against such a thing would have strangled it in the crib.
There was a great deal of back-and-forth among Aldrich, the German émigré banker Paul Warburg, Rep. Carter Glass of Virginia, perennial presidential candidate William Jennings Bryan, Woodrow Wilson (inaugurated president in 1913), and others in the interim between Jekyl Island and the passage of the Fed bill in both Houses of Congress in late 1913. The degree of difference between the views of the various parties involved was, however, small. Aldrich held out for limits on how much member banks could draw upon their reserves at the new institution; Warburg for a federal as opposed to a nationally diffuse structure; Glass and Bryan for ample representation of the South and West; and Wilson for a widely agreed-upon bill in Congress.
Any number of these personages fought hard and artfully for pet points. But all were pushing on an open door. After Morgan’s 1907 crisis performance—and especially after the great man died in March 1913—no financial major domo in the United States had the heart or the will to take up Morgan’s role. There had to be a central reserve institution, putatively acting in the “public interest.” What Morgan had done in rescuing the United States Treasury and in staring down panics could not be replicated, in that nobody else had his capabilities. As his relentless critic Ida Tarbell observed in a moment of clarity (and as Lowenstein quotes her), “Who is to be Mr. Morgan’s successor?”
The capabilities that Morgan had did not necessarily include a big pile of his own cash. “And to think, he was not a rich man,” as Andrew Carnegie said of Morgan when he died. Morgan left an estate of $67 million, a sum a sixth or less of Carnegie’s fortune, even if Morgan had somehow bought Carnegie out in 1901. Morgan’s genius lay in arranging pools of capital from all available sources, to allay crisis quickly and efficiently and in a manner that engendered pan-economy confidence. It was not only genius. Morgan also had a driving public-spirited character that impelled him to call on those with means to maintain the markets, for the good of the nation, when that had to be done.
The darting, hypochondriac Aldrich, the demagogue Bryan, the ill-attuned Warburg, the suspicious small-time newspaperman Glass, the friendless Wilson—who was to take Morgan’s role? No one was available for such an assignment in this era. The potential “national managers” were, to a man, mediocre specimens. The Fed had to happen in 1913, the year of Morgan’s death, because the private sector had not coughed up, as it usually had, highly capable, determined, and philanthropic leadership to steer the banking system through the inevitable crises that government would put upon it.
The one thing that America’s Bank makes distressingly if inadvertently plain is that there was no “epic struggle” (as in the subtitle) to create the Federal Reserve. Everyone in Congress, Wall Street, and the old “Jackson territory” out on the prairie bolted for it in unison. (Lowenstein makes an issue of Minnesota Rep. Charles A. Lindbergh’s fulsome opposition to the Fed—even as Minnesota voted Progressive in 1912.) The only matters of contention were details and who would get the credit. Lowenstein seems unaware that the kind of squabbling he recounts so well, as the bill that gave us the Fed took form and wended its way to passage, occurs every time a measure of any consequence gets through Congress. It was not an epic struggle as Aldrich and the others lobbied for their own vain desires—it was insipid business-as-usual Washington politics.
Wilson signed the law on December 23, 1913, and the Fed was set up the following year. The greatest international monetary crisis since the dawn of the industrial revolution came right away, care of the World War that began that summer. Warburg, as Lowenstein paraphrases him, chided the pre-Fed American banks in military terms, for “resembl[ing] less an army commanded by a central staff than they did an inchoate legion of disjointed and disunited infantry.”
It is astonishing that Lowenstein makes no mention, aside from a glancing remark in the epilogue, of the commonplace in financial-history scholarship that central banking arose in Europe in good part to enable the materiel needs of the nation-state in time of war. Lowenstein even has the émigré Warburg give the game away in the quotation above and fails to make the association. Without question, the frenetic building of central banking institutions in Europe in the run-up to 1914 influenced Congress (susceptible as it was to the belief that America was a provincial place) to create the Fed. That the Fed was not, in fact, meant as an arm of war-finance adds a further dash of cluelessness to the story.
Lowenstein staggers to his conclusion in brief remarks about the Fed’s first years. “The Reserve Banks,” he writes, “by issuing more notes, were able to soak up much of the bullion previously stashed in people’s pockets and in the vaults of member banks.” There is no mention that such monetization doubled the price level and abruptly halved the value of the assets of all Americans, rich and poor alike. At one point, Lowenstein says that the average American had little savings at the time the Fed was created. Unfortunately this was not the case, and the nation’s first retirement crisis, care of the massive asset-devaluation, came in the teens. Lowenstein’s final words include the assertion that the Federal Reserve Act “unified the banking system, which unquestionably made it stronger.” The colossal banking disaster of 1929-33 kills this fly of an argument with a sledgehammer.
It is legitimate to contend that the pre-1913 American banking system did not fully serve the financial needs of the nation—the economy was a major capital importer, after all. Our curiosity in this matter should probably lead us to the profusion of state-level banking regulations that kept this nation’s system from growing organically, as opposed to all the psychologizing about “phobias.” One new thing that the Fed incontrovertibly brought to the American banking system was a transmission mechanism. If it made a big mistake, it would be felt far and wide.
America’s Bank is a useful reference work on the bigwig byplay that surrounded the gestation of the Fed from 1907 to 1913. It also serves to indicate that we should stop taking a shine to the Fed as we are lately prone to do. Rather, we should set to the more useful and becoming task of trying to recover the tradition of being public-spirited while wholly situated as persons of affairs in the private sector.