The Federal Reserve: History & Conspiracy

Main Menu

Latest News

The Federal Reserve: History & Conspiracy

Sunday, 23 March 2008

Of all the conspiracy theories that may come up in American political discourse, there is one that requires nothing that is supernatural, or even particularly out of the ordinary. The players may only be vaguely familiar: Rockefellers, Morgans - and the Federal Reserve (whose part tonight will be played by Ben Bernanke, a PhD economist with education from Harvard and M.I.T.)

The scope is nothing short of a total underground or shadow government that directs hundreds of billions of dollars a year. But the cost of funding the operation would only be a few pennies on the dollar (quite literally).

Other conspiracies have come and gone, but the distrust of central banks has been with us for hundreds of years. The individuals involved are thought to possess incalculable wealth, and they entertain themselves with controversial social causes & international political activity. But they value their privacy and make their conclusions away from scrutiny. Some say the whole plot is so pervasive, so totalitarian, that it encompasses a massive international network. If you've been reading a while, you may have heard me brush on a few of these topics with a good bit of research & slightly more moderate skepticism.

The Promises of a Central Bank

The fundamental promise of a central bank like the Federal Reserve is economic stability. The theory is that manipulating the value of the currency allows financial booms to go higher and crash landings a little easier to handle. The results are mixed. A central bank is also supposed to keep value in the currency, "fixing" one of the problems some Wildcat banks encountered. In this regard, the Federeal Reserve has not succeeded by any stretch of the imagination.

A Revolutionary History

The period leading up to the American revolution was characterized by increasingly authoritarian legislation from England. Acts passed in 1764 had a particularly harsh effect on the previously robust colonial economy. The Sugar Act was in effect a tax cut on easily smuggled molasses, and a new tax on commodities that England more directly controlled trade over. The navy would be used in increased capacity to enforce trade laws and collect duties.

"The colonies suffered a constant shortage of currency with which to conduct trade. There were no gold or silver mines and currency could only be obtained through trade as regulated by Great Britain. Many of the colonies felt no alternative to printing their own paper money in the form of Bills of Credit." [1]

The result was a true free market of currency - each bank competed, exchange rates fluctuated wildly, and merchants were hesitant to accept these notes as payment. Of course, they didn't have 24-hour digital Forex markets, but I'll hold off opinions on the viability of unregulated currency for another time.

England's response was to seize control of the colonial money supply through the Currency Acts of 1764. This law forbid banks, cities, and colony governments from printing their own money. This Act, passed so soon after the Sugar Act, started to really bring revolutionary tension inside the colonies to a higher level. Free, competing currencies had become a part of the American experience before independence or the thought of revolution. America wasn't going to give away its right to currency to some distant central bank... not without a fight.

Establishing and Abolishing Central Banks

Following the (first) American Revolution, the "First Bank of the United States" was chartered to pay off collective war debts and effectively distribute the cost of the revolution proportionately throughout all of the states. Although the bank had vocal and prominent critics, it only controlled about 20% of the nation's money supply. Compared to today's central bank, it was nothing.

Thomas Jefferson argued against the institution of the bank, mostly citing constitutional concerns and the limitations of government found in the 10th amendment. There was one additional quote that hints at the deeper structural flaw of a central bank in a supposedely free capitalist economy:

"the existing banks will, without a doubt, enter into arrangements for lending their agency, and the more favorable, as there will be a competition among them for it; whereas the bill delivers us up bound to the national bank, who are free to refuse all arrangement, but on their own terms, and the public not free, on such refusal, to employ any other bank" [2]

Basically, the existing banks will fight over gaining favor with the central bank - not improve their performance relative to a free market. The profit margins associated with collusion would obviously outweigh the potential profits gained from legitimate business.

The Second Bank of the United States was passed five years after the first bank's charter expired. An early enemy of central banking, President James Madison, was looking for a way to stabilize the currency in 1816. This bank was also quite temporary - it would only stay in operation until 1833 when President Andrew Jackson would end federal deposits at the institution. The charter expired in 1836 and the private corporation was bankrupt and liquidated by 1841.

Jefferson Drives out the Bankers and Devils

President Jackson, shown here "driving out the devils and money changers"
with his order to withdraw public money from the central bank
-Edward Clay lithograph, published 1833

1863 & 1864:: National Bank Act(s)

While the South had been the major opponent of central banking systems, the end of the Civil War allowed for (and also made necessary) the system of national banks that would dominate the next fifty years.

The Office of the Comptroller of the Currency (OCC) says that this post-war period of a unified national currency and system of national banks "worked well." [3] Taxes on state banks were imposed to encourage people to use the national banks - but liquidity problems persisted as the money supply did not match the economic cycles.

Overall, the American economy continued to grow faster than Europe, but the period did not bring economic stability by any stretch of the imagination. Several panics and runs on the bank - and it became a fact of life under this system of competing nationalized banks. In 1873, 1893, 1901, and 1907 significant panics caused a series of bank failures. The new system wasn't stable at all, in fact, many suspected it was wraught with fraud and manipulation.

1907-1913: Triumph of the Robber Barons

"The most notable robber barons were J.P. Morgan (banking), John D. Rockefeller (oil), and Andrew Carnegie (steel)" [5]

Interlocking Directorates

As Congressman Arsène Pujo would discover in his Congressional investigation of the "robber barons" or "money trusts," the key to expanding wealth beyond typical monopolies is the practice of interlocking directorates. Railroad and oil monopolists could still expand their power and wealth by creating series of banks, and sponsoring directors at the institutions. Alliances across the insiders would be cemented with cross-institution investment. Tycoon A would found banks 1, 2, and 3 - Tycoon B would found 4, 5, and 6 - and each bank would be heavily invested in the various banks and monopolies they represented.

The result is a sort of conglomeration of monopolies - a system where each industry's dominant corporation merges into a larger entity, a goal short of nothing but monopolization of everything.

But such a entity could not be expected to exist or thrive in a purely efficient (competitive) market. It is important then to remember that the private national banks of this "Robber baron" period were effectively subsidized by a tax on their state-based competition. This is in addition to the interest gained from public deposits, and the fees that the government paid for the printing of currency.

From the onset, the National Bank system was little more than a federally subsidized profit opportunity

The resulting outrage and scandal would result in a chorus of calls all demanding the same thing: More government action, a stronger central bank, and stricter regulation. What few but the bankers understood is that the government action and stronger central bank subsidies allowed the creation the things the people feared the most: corruption, monopoly, and central planning of mundane activity and commerce.

The part that goes typically unreported: Part of the interlocking system was to sponsor politicians, journalists, and professors as well as bank executives and business managers.

Panic of 1907

The Federal Reserve Bank of Minneapolis is not shy about attributing the causes of the Panic of 1907 to financial manipulation from the existing banking establishment. "If Knickerbocker Trust would falter, then Congress and the public would lose faith in all trust companies and banks would stand to gain, the bankers reasoned." [4]

In timing with natural economic cycles, major banks including J.P. Morgan and Chase launched an all-out assault on Heinze's Knickerbocker Trust. Financial institutions on the inside started silently selling off assets in the competitor, and headlines about a few bad loans started making top spots in the newspapers. The run on Knickerbocker turned into a general panic - and the Federal Government would come to the rescue of its privately owned "National Banks."

During the Panic of 1907,

"Depositors 'run' on the Knickerbocker Bank. J.P. Morgan and James Stillman of First National City Bank (Citibank) act as a "central bank," providing liquidity ... [to stop the bank run]

President Theodore Roosevelt provides Morgan with $25 million in government funds ... to control the panic. Morgan, acting as a one-man central bank, decides which firms will fail and which firms will survive." [5]

1913 The Federal Reserve

Government interventionists got their wish in 1913 with the Federal Reserve (and income tax amendment). Just in time, too, because the nation needed a new source of unlimited cash to finance both sides of WW1 and eventually our own entry to the war. After the war, with both sides owing us debt through the federal reserve backed banks, the center of finance moved from London to New York.

But did the Federal Reserve reign in the money trusts and interlocking directorates? Not by a long shot. If anything, the Federal Reserve granted new powers to the National Banks by permitting overseas operations and new types of banking services. The greatest gift to the bankers was a virtually unlimited supply of loans when they experience liquidity problems [5] - but these promised loans would always seem to arrive in a selective process...

From the early 1920s to 1929, the monetary supply expanded at a rapid pace and the nation experienced wild economic growth. Curiously, however, the number of banks started to decline for the first time in American history. [6]

Toward the end of the period, speculation and loose money had propelled asset and equity prices to unreal levels. The stock market crashed, and as the banks struggled with liquidity problems, the Federal Reserve actually cut the money supply. Without a doubt, this is the greatest financial panic and economic collapse in American history - and it never could have happened on this scale without the Fed's intervention. The number of banks crashed and a few of the old robber barons' banks managed to swoop in and grab up thousands of competitors for pennies on the dollar.

2008: So What? What is this Great Conspiracy Theory?

The Federal Reserve, and a few of the old national banks dominate the 20th century. America booms economically following both World Wars. What's the problem, if the system works, why try to fix it?

Remember the Panic of 1907 and consider the recent Bear Stearns collapse of March 2008. In 1907, the president, through Congress, provided $25 million to JP Morgan to acquire the troubled Knickerbocker. In 2008, the Federal Reserve provided JP Morgan $30 billion of public insurance to acquire the troubled Bear Stearns.

Really, only two things have changed:

Real value and paper value

Inflation is the first clue. Sure, $25 million doesn't sound like all that much today, but back in 1907 it sure was significant - even to banks. Inflation is one of the most obvious costs of the Federal Reserve system. Some piece of the entire money supply goes through the Fed, into their balance sheets and some of the money supply goes directly to fewer and fewer private "National Banks." The constant creation of money rarely involves putting money out of circulation, unless its something like taking precious metals out of the coins and literally debasing the hard currency every generation.

Recently, the Federal Reserve has been more active than usual in its process of building bubbles and financing semi-hostile takeovers. Americans at large have been rewarded with a major decline in the value of the dollar - which, relative to stagnant wages - can only signal a loss in the standard of living. Most of this has come out of food quality, prices, and quantity, and energy costs. The "real value" of the dollars you're holding has never been so low - or dropping so rapidly.

Skipping Congress

In 1907, JP Morgan had to convince Congress, President Roosevelt, and the American people before getting the money for the buy-out, err "bail-out." You might imagine that, after a while, the American voters would get tired of financing particular banks in their pursuit to acquire their rivals at fractional costs.

People might start to wonder why all of these panics seem to resolve as soon as rumors sink a bank and the tax-payer ends up paying for a "deal of the decade." Who starts the rumors? Who stands to gain? Who pays for it again...?

We don't have to ask or answer any of those questions, thanks to the Federal Reserve. No, in their great wisdom, the central planners have decided just how much we have to pay to keep the system going. Not only does it work for the banks - it works for the politicians. The Federal Reserve allows them to spend money without legislating a source of the funds - infinite debt! See, much like the bail-outs, tax-payers probably wouldn't be too happy hearing a Congressional debate over tax cuts and spending cuts. The partisan bloodbath is sure to follow, and people might start demanding things like efficiency out of the government as a third alternative.

But we don't have to worry about that any more.

References:

[1] The Currency Act, 1764 - http://www.ushistory.org/declaration/related/currencyact.htm

[2] Jefferson's Opinion on the Constitutionality of a National Bank, 1791 - http://www.yale.edu/lawweb/avalon/amerdoc/bank-tj.htm

[3] National Bank Notes: A Uniform Curency (1865-1914) - http://www.occ.treas.gov/exhibits/histor4.htm

[4] F. Augustus Heinze of Montana and the Panic of 1907 - http://minneapolisfed.org/pubs/region/89-08/REG898C.cfm

[5] FDIC Learning Bank: 1900-1919 - http://www.fdic.gov/about/learn/learning/when/19-1919.html

[6] Depression-era bank failures: the great contagion or the great shakeout? - http://www.encyclopedia.com/doc/1G1-132680382.html