America's Longest Debate

By Randall Margo, PhD
Commentator/Global Economy & Administration, G.L.O.B.A.L Justice

A debate stretching back to America’s founding recently resurfaced during this election cycle, with Donald Trump’s suggesting the U.S. Federal Reserve Bank’s monetary policy favors the incumbent party’s bid to retain political power. From the beginning of our nation’s origins, our leaders have quarreled over the power and influence of a central bank. Initially, opposition led by Thomas Jefferson, centered on the concentration of economic clout a central bank would necessarily possess, claiming it would benefit manufacturers and traders in New England over agrarian interests in other states. However, with war debts still needing to be repaid, merchants and farmers having to rely on credit from one another or on banks in England, and each state issuing its own currency, the argument favoring a central bank prevailed. At the time of its creation, just three local banks operated in all of the 13 states, one in Boston, New York City and Philadelphia.

As part of a political compromise, the first U.S. Bank’s charter was for 20 years, expiring in 1811. When the central bank’s charter came up for renewal, the over 100 banks chartered by state legislatures that now populated the United States chaffed at the restrictions placed upon them by the central bank, such as “regulating their ability to make loans, to branch across state lines and to have the federal government’s banking business to itself.”ii With many congressional legislatures acting on the behalf of their state banks, the charter was not renewed when the vice-president broke a tie vote in the senate.iii.

After the war of 1812 ended, the government again found itself unable to finance its war debts and the US. Bank Charter was renewed in 1816 for another 20-year period.iv President Andrew Jackson inherited Jefferson’s distaste for the U.S. Bank, vetoing renewal of the bank’s charter in 1836 that could not be overridden by the congress.

Between 1837 and the civil war, financial crises periodically occurred, causing banks to fail when too many borrowers defaulted on loan payments. Currencies also experienced wild fluctuations in value. For example by 1860, there were approximately 1500-1600 banks in
the United States, all of which issued their own dollars, resulting in multiple thousands of “…different-looking pieces of paper, each with the name of a bank on it and a number of dollars which the named bank promised to pay in coin if the note were presented to it. It was
costly, of course to return a note of , say, a Georgia bank received in New York to the bank of Georgia, so such notes circulated at discounts the farther they were from the issuing bank.” v Besides the inefficiency of such a system, “…counterfeiting of bank notes thrived because with so many different-looking notes in circulation, it was hard to tell a real one from a fake.”vi

As the civil war progressed the federal government sought to assert some control over the banking system without attempting to create another central bank. What resulted were the National Banking Acts of 1863 and 1864. These Acts served three essential purposes: “(1)
create a system of national banks, (2) create a national currency, and (3) create an active secondary market for Treasury securities to help finance the Civil War (for the Union’s side).vii

Through the incorporation of national chartered banks, a national currency was established greatly improving the efficiency and simplicity of the existing banking system and reducing the counterfeiting of bills. Furthermore, because these banks were required to maintain a high level of Treasury securities as collateral, this created an active secondary market for Treasury bonds to finance the war.viii

The National Banking Acts of 1863 and 1864 didn’t put all the state chartered banks out of business, as about 800 remained after 1865. To reduce the number of state banks and more importantly, their discounted bank notes, the Congress imposed a ten percent tax on all
outstanding state banknotes. Consequently, only 325 state banks survived by 1870, compared to 1638 nationally chartered banks.ix

But, the remaining state banks began to innovate by instituting checking accounts at their branches. “Checking accounts became so popular that by 1890 the Comptroller of the Currency estimated that only ten percent of the nation’s money supply was in the form of
currency. Combined with lower capital and reserve requirements as well as the ease with which states issued banking charters, state banks again became the dominant banking structure by the late 1880s.”x

Meanwhile, banking panics still continued to arise, most prominently in 1907 when a near collapse of the financial system was averted only through the leadership and capital resources deployed by J.P. Morgan and his cohorts. By this time, the United States economy was the world’s largest while its banking system held more than a third of the world’s deposits.xi Concerned about the incessant risk and chaos caused by these banking failures, U.S. financial leaders looked abroad to European nations such as France, Germany and Great Britain for a central bank model that could prevent, or at least alleviate the fiscal harm resulting from these panics. Eventually, the U.S. created a Federal Reserve System, with our own proclivity for decentralized, by dispersing its power among twelve regional banks.

The Federal Reserve Act of 1913 enabled a national check-clearing system, introduced Federal Reserve Notes and was granted the power to expand and contract currency and credit, thereby controlling the money supply, interest rates, in order to preserve economic stability.xii Unfortunately, the Federal Reserve took few actions during the early Great Depression years of 1929-1933 to provide financial liquidity, or to use a more pejorative term ( bailout) to the banks, resulting in many banks becoming insolvent and depositors losing most if not all of their savings held in these failed banks. Among President Roosevelt’s first actions was to declare a 4-day national banking holiday to stem the run on the banks as people scrambled to remove their money from all banks. During this period, the Congress passed the Emergency Banking Act of 1933. In essence, this act assured depositors that their funds would be guaranteed against losses within the banks allowed to reopen. Further, it indemnified the Federal Reserve against losses so that the Fed could loan money freely to the banks without concern of being repaid against any future losses.xiii Later that year, Congress approved the Glass-Steagall Act, which provided $2,500 deposit insurance for all bank customers and separated investment banking from commercial banking. Over time, deposit insurance climbed to its present level of $250,000, while the Glass-Steagall act was repealed in 1999.

Unlike the 1930s, whereby the Federal Reserve was criticized for doing too little, now it is being criticized for playing a too active role in the economy by forcing interest rates well  3 below historical norms, which provides a negative return for most depositors with savings or
short-term money market accounts and by printing more money through quantitative easing. In a key regard, the Federal Reserve is following the lead of the central banks in Europe and Japan, who now issue government debt with negative interest rates. Moreover, Japan began its quantitative easing program back in March 2001, over seven years prior to the Federal Reserve’s first foray into this venture.

Whether the Federal Reserve and other foreign central banks are masking or ameliorating a more dire global economy through such efforts as quantitative easing and interest rates, as Mr. Trump seems to suggest, is an interesting subject for debate. More importantly, from a historical standpoint, the economic power given to the Federal Reserve without Congressional or Presidential approval raises the same concern voiced against the establishment of a central bank back in the days of our government’s creation. While it would seem utterly implausible not to have a central bank for a United States economy of about $18 trillion, the independent nature of the Federal Reserve in a democracy along with its economic influence are topics that deserve greater discussion during this political campaign and beyond, because the Fed has assumed such a prominent role and in shaping our nation’s economy.

(Sylla, R. 2009)…pg2
ii Ibid
iii Ibid
iv ibid
ibid pg3
vi ibid
vii http://www.let.rug./nl/usa/essays/general/a-brief-history-of-central-banking/national-banking-acts-
viii ibid pg2
ix ibid
xi ibid
xii ibid
xiii See William Silber, Why Did FDR’s Bank Holiday Succeed? Economic Policy Review, July 2009, Volume 15
Number 1.

The views and opinions expressed are those of the author(s) and do not imply endorsement by G.L.O.B.A.L. Justice. We are a faith-based, nonpartisan organization that seeks to extend the conversation about justice with a posture of dignity and respect.