Tuesday, December 7, 2010

Ditch the Fed? Not so fast!

True or false: the United States did not have a central bank before 1913, the year the Federal Reserve system was established.

Answer to follow. First, there are growing numbers of voices these days urging either to dis-establish the Fed or to revise its charter (which would not be the first time). Gerald O'Driscoll, writing in the Wall Street Journal, belongs in the former camp. He points out that that the Fed's financial record since 1913 has been far from admirable. Wartime inflation followed almost immediately, then a depression in the early 1920s. The rest of the decade's prosperity is credited to Treasury Secretary Andrew Mellon (and rightly so, I believe), but the Fed's performance during the Great Depression was simply disastrous. Since then, the Fed has hardly covered itself in glory since its charter is to provide price stability and full employment. These are "dueling mandates," say some economists, that set the Fed up to fail one or the other (such as nowadays).

But before we return to the halcyon days before the Fed, let's remember that they were the years of the "Panics" - of 1873-1879, 1893-1897, of 1907. And in fact, the US did have a central bank before 1913. His name was J.P. Morgan.

A severe depression that began in 1893 resulted in a run on gold until the Treasury could not redeem more gold because of statutory limits on reserve holdings. In 1895, Morgan loaned the Treasury Dept. $65 million in gold to stabilize the supply and the dollar, which was at the time linked to both gold and silver.

Another crisis, the Panic of 1907, was caused by a collapse of the stock market when the country was already in a recession. Brokerages and banks found their capitalization, based on the values of stock they held, to be worthless. Faced with impending bankruptcy of the nation's large banks and trusts, Morgan coordinated a plan among New York's bankers and the Treasury department to deposit tens of millions of dollars into still-healthy banks (letting the insolvent ones go under). Morgan and John D. Rockefeller put up many millions of their own money. They also set controls of the money supply among banks, solidified lines of credit and bought out stocks that were sharply falling in price. In other words, a TARP.

Morgan owned U.S. Steel. Before the Panic ended, he had taken over his chief competitor. He sailed right around the antitrust issues by getting President Theodore Roosevelt to guarantee immunity. Morgan bought the company, which saved the brokerage firm Moore and Schley from going under - had it done so, brokerages would have fallen like dominoes across all Wall Street. The Panic then ended almost immediately.

Although Morgan had saved the country from a sure and serious depression, the whole affair repelled Progressives. (Roosevelt, who had at least skirted with collusion to break the law, was himself the leading Progressive of the day).

Movement to create a federal central bank began almost right away, based on making sure that the US financial system would not again be subject to the power of an individual and all the under-the-table dealing that had gone on. Moreover, Morgan was already elderly in 1907 by standards of the day. Members of government realized neither he nor someone both as astute and wealthy as he was likely to be around the next time there was a crisis.

Coincidentally, Morgan died the same year the Fed was created, 1913.

None of this is to toot the Fed's horn or defend it. It is only to show that saying the US didn't have a central bank until 1913 is simply in error. We just didn't have a federal central bank until then.

(The Second Bank of the United States, a private bank whose cozy charter with the federal government expired in 1836, had been something of a hybrid between what Morgan did and what the Fed does now. But its history was not part of the move to establish the Fed.)