Who needs a Central Bank? – How we got to the US Fed

Who needs a Central Bank? – How we got to the US Fed

There is arguably no more influential financial body in the world than the US Federal Reserve or ‘Fed’.  Few, however know about its predecessors and how the US got to what is only the latest incarnation of a ‘central bank’ for the US. Today take a short stroll thought history…

Who needs a Central Bank? – How we got to the US Fed

There is arguably no more influential financial body in the world than the US Federal Reserve or ‘Fed’.  Few, however know about its predecessors and how the US got to what is only the latest incarnation of a ‘central bank’ for the US.

Much like the Federal Reserve, the Second Bank of America (Actually the 3^rd Federal Bank America had created) was created in response to the collapse of regional banks and a government debt crisis.  It operated between 1817 and 1834, and saw both political influence and mismanagement lead to its demise. It took 75 years of operation without a Central Bank and the 1879 reversion to the gold standard and preceding ‘golden age’ to usher in the Federal Reserve we now know.

The second bank of America and its creation

The Second Bank of the United States was chartered in February 1816 in response to the War of 1812 (18^th June 1812- 17^th of February 1815). The US economy had started to falter with the US’ biggest trading partner, Britain blockading the US trading routes with their navy.  This stopped US farmers and manufacturers from exporting and trading with the rest of the world.  At the time most government revenue was obtained through tariffs on imports and exports. So, with little revenue and the financing of a war, the US found itself heavily in debt by 1815.  President Madison at the time opposed a central bank (he also opposed the creation of its predecessor in 1791), but with the deteriorating financial position and pressure from congress the Second Bank of America was created in 1816, and began operations in Philapdelphia in January 1817.

The bank operated by holding the federal government deposits, making its payments and issuing debt to finance the ‘indebted’ government.  The bank also took control of the oversight of state banks’ issuance of bank notes.  In contrast to the modern Federal Reserve, this bank was enabled to accept public deposits and make loans to the public. 

Plagued by Mismanagement

The Bank was set up with a 20 year charter, but its downfall was primarily due to the boom bust bank leaders that led its charter (sound familiar?).  With different modus operandi each of these leaders saw the US economy swing wildly between inflationary and deflationary eras.  The bank was initially capitilsed with $35 million in debt. Subscriptions were less than anticipated which saw the remaining scrips ($3 milllion – nearly 10%) being bought by Philadelphia banker Stephen Girard.  The bank itself did not set ‘monetary policy’, but was required to hold gold reserves of around 20% of the monetary supply, however was enabled to moderate this to stabilize the currency.  This ability, however, meant the bank reserves swung wildly in its 20 year existence from 12%-65%.

The first Appointee was William Jones, a pollical appointee and the Secretary of the Navy, who in a previous career had been bankrupted.  Like most bankrupted gamblers, Jones opened the banks coffers too quickly, extending credit at a rapid rate, only to see him reverse just as quickly when debts were due, creating the banks first recession by 1819.

In 1819 a more conservative attorney from Carolina, Langdon Cheves, previous speaker of the House of Representatives was put in place.  Much like his conservative background, Cheves cut the number of bank notes in half, foreclosing on mortgages and sending regional banks into bankruptcy as they didn’t have adequate gold and silver on hand which led the economic cycle into a Depression – high unemployment and deflation.  As it foreclosed on mortgages, it also saw the Second Bank as a large land holder.

In 1823, Nicholas Biddle, a member of a prominent Philadelphia family became head of the bank, by restraining the expansion of bank notes some stability was finally bought to the US economy, with some anger diminishing towards the bank during this time. 

Plagued by Political Influence

In 1828 Andrew Jackson was elected President of the United States.  His opposition to the Central bank was well known driven possibly by the rumor that the central bank may have politically and financially supported his political opposition, John Quincy Adams, through Henry Clay, a Kentucky Congressman’s influence over the Second Bank.  Jackson’s distrust of ‘paper money’ also stemmed from his near financial ruin, two decades earlier, with his sale of land for paper money, with the issuing bank’s bankruptcy seeing the paper money suddenly worthless.

His distrust of the bank can be seen in his quote:

"Gentlemen! I too have been a close observer of the doings of the Bank of the United States. I have had men watching you for a long time, and am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country.

When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin!

Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I have determined to rout you out, and by the Eternal, (bringing his fist down on the table) I will rout you out."

Basically, in this quote – Jackson sees the bank as servicing few (the banks) and bankrupting the many only to be bailed out by government (or many) – which sounds awfully like what is currently going on in the Federal Reserve.  Since the Global Financial Crisis the banks have made enormous profits for their shareholders and employees only to be bailed out by the government and therefore paid through taxes by everyone.

By 1832 – Andrew Jackson used his Presidential veto overriding 2/3 of Congress to remove Federal deposits from the Second Bank.  This saw Biddle, retaliate by reducing available credit and attempting to punish Jackson and US citizens.  However, as the credit ‘crunch’ impacted the economy and the retaliation backfired as it supported exactly what Jackson had been trying to show – the Bank served the interest of the wealthy and did not meet the nation’s needs. By 1834 the Second Bank was dissolved and in the proceeding years 400 regional or state banks collapsed.

The US government recapitalized through the sale of land for gold and silver and it wasn’t till 75 years later, in 1913, that a new Federal Reserve was born but influenced by the new financial powerhouse -  JP Morgan…..