America’s Endless War Over Money, K. Granville and B. Applembaum (via NYT, 08/04/2015)

 

The “Audit the Fed” debate is the latest manifestation of a conflict as old as the nation, between those who argue that a strong central bank improves economic stability, and those who see an overbearing government engaged in harmful meddling.

Some Background: Strong vs. Weak Currency

Battles over central banking have historically pitted financial elites who wanted to limit the availability ofmoney, thus preserving its value, against farmers, businessmen and other borrowers who wanted money to be plentiful — and cheap. Each side has sometimes regarded the central bank as its great ally in that fight, and sometimes as its bitter enemy.

Since the Great Recession the Fed has mostly sided with the borrowers, creating vast amounts of newmoney and holding short-term interest rates near zero. Inevitably, that has angered creditors, and sparked efforts to swing the pendulum in the other direction.

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A cartoon satirizing Andrew Jackson, shown raising a cane labeled “veto,” and his battle against the Bank of the United States and its supporters among state banks.

1. A Philadelphia Story: The Banks of the United States

The nation’s first two central banks, both called the Bank of the United States, were private, for-profit organizations chartered by Congress. The first (1791-1811) was created to help the government pay its Revolutionary War debt, stabilize the country’s currency and raise money for the new government. It was the dream of Alexander Hamilton, secretary of the Treasury, who overcame resistance from Thomas Jefferson (who wrote “I believe that banking institutions are more dangerous to our liberties than standing armies”) and other Southern lawmakers. When its 20-year charter expired, Congress chose not to renew it.

The Second Bank of the United States was chartered a few years later, in the aftermath of the War of 1812, after Congress decided it had a mistake. But it lasted just 17 years. President Andrew Jackson said the bank concentrated too much economic power with a corrupt moneyed elite and vetoed a bill to extend its charter in 1832. Supporters of the the bank rallied around Henry Clay, Jackson’s opponent for reelection that year, but the “Bank War” ended when Jackson won easily. United States Treasury funds were withdrawn and deposited in state banks; the nation would be without a central bank for more than 70 years.

The headquarters of both banks still stand about a block apart in downtown Philadelphia.

“The bank is trying to kill me, but I will kill it!”—Andrew Jackson.

 

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Crowds gather across the street from a failed New York bank in 1908. CreditGeorge Grantham Bain Collection/Library of Congress

2. Perpetual Panic: Life Without a Central Bank

A severe financial crisis drove the economy into a deep recession in 1837, just one year after the demise of the Second Bank. Such crises became a recurring event in American life and, as the economy grew, so did their size and the frequency. Banks created the New York Clearing House as a private-sector backstop, but it proved inadequate for the task. The government also was hamstrung. In the absence of a central bank, the United States regulated the value of its currency by guaranteeing that dollars could be exchanged for gold, and sometimes silver. This meant the government could not respond to financial crises, and the resulting economic downturns, by increasing the supply of money.

In 1907, yet another crisis was brought about by a failed attempt to corner the stock of the United Copper Company. Government officials and financial executives jerry-rigged a response: an emergency lending pool orchestrated by J. Pierpont Morgan. But the crisis proved to be a tipping point in the political debate about the need for a central bank. There was a growing political consensus that Wall Street needed a permanent fire department.

“Unless we have a central bank with adequate control of credit resources, this country is going to undergo the most severe and far reaching money panic in its history.”—Jacob Schiff, a prominent New York banker, in 1907

 

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President Woodrow Wilson signing the Federal Reserve Act of 1913, in a painting by Wilbur G. Kurtz Sr. He is surrounded by members of his cabinet and Congressional leaders. CreditWoodrow Wilson Presidential Library, Staunton, Va.

3. Third Time’s the Charm: The Federal Reserve Act of 1913

In November 1910, Senator Nelson Aldrich met with a group of bankers at a resort on Georgia’s Jekyll Island and hammered out a plan for a new central bank. The idea touched on many of the great political battles of the age: The states against Washington; Wall Street financiers against smaller banks, particularly in the South and West; populists against the Gilded Age elite. The bill that emerged from several years of debate, signed by President Woodrow Wilson, was an awkward compromise: There would be 12 privately owned reserve banks in major cities across the country, preserving the power of financial elites. But the banks would be overseen by a board of presidential appointees, including the Treasury secretary, granting the public a new measure of control over the financial system.

Before the Fed was fully established, however, the old system took a final bow. A financial crisis struck in 1914, and roughly twice as many banks failed as in 1907.

“We shall deal with our economic system as it is and as it may be modified, not as it might be if we had a clean sheet of paper to write upon; and step by step we shall make it what it should be.”—Woodrow Wilson, from his first inaugural address

 

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In 1933, after some banks limited withdrawals to 5 percent or less, customers waited to enter the National City Bank in Cleveland. CreditAssociated Press

4. Recession and Response

Instead of preventing crises, the Federal Reserve helped to cause the Great Depression. The Fed was supposed to manage the gold standard — to make sure the economy was not choked by a lack of moneyand a resulting spike in interest rates. Instead, the Fed was paralyzed by disagreements between regional banks and the central board. It let the money supply shrink by one-third. The result was the worst economic crisis in the nation’s history.

Congress responded to the Fed’s failure by greatly increasing its power and responsibilities. In 1934 it authorized the president to devalue the dollar, beginning the long process of replacing the gold standard with a currency whose value is managed by the Fed. In 1935 it gave the Fed responsibility for “the general credit situation of the country.” The act also removed the Treasury secretary from the Fed’s board and created a new policy-making committee where board members would outnumber reserve bank presidents.

“I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”—Ben Bernanke, then a Fed governor, in a 2002 speech addressing Milton Friedman and Anna Schwartz.

 

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The Federal Open Market Committee in 1966, led by the Fed chairman, William McChesney Martin, seated center. CreditFabian Bachrach

5. The Long Road to Independence

The central bank now had the freedom to encourage growth by printing money, and the responsibility not to print too much. Politicians who were focused on short-term problems were quick to demand money and, for the next several decades, the Fed hesitated to say no.

In 1942, at the request of the Treasury Department, the Fed agreed to hold down interest rates on government bonds to help finance military spending for World War II. It kept rates low for almost a decade, through the beginning of the Korean War, until rising inflation finally induced the Treasury to sign a 1951 accord affirming the Fed’s autonomy to raise rates.

In the 1960s, Wright Patman, a populist Democrat congressman from Texas and chairman of the House banking committee, repeatedly introduced legislation to roll back the Federal Reserve Act of 1913, maintaining that, in the Fed, “a body of men exist who control one of the most powerful levers moving the economy and who are responsible to no one.”

And in 1965, President Lyndon B. Johnson, who wanted cheap credit to finance the Vietnam War and his Great Society, summoned Fed chairman William McChesney Martin to his Texas ranch. There, after asking other officials to leave the room, Johnson reportedly shoved Martin against the wall as he demanding that the Fed once again hold down interest rates. Martin caved, the Fed printed money, and inflation kept climbing until the early 1980s.

“I hope you have examined your conscience and you’re convinced you’re on the right track.”—Lady Bird Johnson, spoken to William McChesney Martin, on his arrival at the LBJ ranch.

 

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Paul A. Volcker, shown in 2009. He was appointed Fed chairman in 1979 with the task of controlling galloping inflation. CreditBrian Snyder/Reuters

 

6. The Volcker Rule: An Independent Central Bank

Congress finally formalized its demands in 1978. A recession in the mid-1970s had pushed the unemployment rate as high as 9 percent, and Democrats, frustrated by what they saw as the Fed’s inadequate response, won passage of legislation establishing the so-called dual mandate. The Fed was instructed to pursue maximum employment and price stability.

It turned out to be a high-water mark for Congressional interference. Inflation rose by 11 percent the following year, and President Jimmy Carter agreed to appoint a new Fed chairman, the independent-minded Paul A. Volcker. Over the next several years, Mr. Volcker would raise interest rates sharply, driving the economy into a deep recession but ultimately bringing inflation under control. President Ronald Reagan, meanwhile, made a point of respecting the Fed’s independence. Volcker was still subjected to sharp Congressional pressure, but it was mostly political theater. The Fed had declared its independence.

“Every time he had a press conference somebody was urging him to take a slap at the Federal Reserve, but he never did.”—Paul Volcker, referring to President Reagan.

 

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Ben Bernanke, the Fed chairman, takes questions from reporters at an April 2011 news conference. CreditJim Watson/Agence France-Presse — Getty Images

 

7. Smokescreens and Sunshine: The Fed Opens Up

Between the great inflation of the early 1980s and the Great Recession that began in 2008, the Fed and the economy enjoyed more than two decades of relative peace and quiet, a period that Fed officials sometimes call the Great Moderation. Inflation trended downward and, except for a few short recessions, unemployment stayed down too. And Fed officials came to see these trends as a validation of their newfound independence.

The Fed also began to change its secretive culture. The trend began reluctantly, under pressure from critics who argued that independence required transparency. In 1983, for example, the Fed promised Congress that it would begin to release its Beige Book, a summary of economic reports from its regional reserve banks, as a way of distracting attention from more important reports that it was determined to keep secret. But the Fed gradually concluded that transparency could increase the power of monetary policy. In 1994, it began to announce changes in policy at the end of each policy-making session. In 2004, it began to publish edited accounts of its discussions three weeks after each session. And in 2011, its chairman, Ben S. Bernanke, began to hold quarterly news conferences.

“Since I’ve become a central banker, I’ve learned to mumble with great coherence. If I seem unduly clear to you, you must have misunderstood what I said.”—Alan Greenspan, Fed chairman, in 1987, before the central bank’s communications revolution.

“The Federal Reserve is the most transparent central bank to my knowledge in the world. We have made clear how we interpret our mandate and our objectives and provide extensive commentary and guidance on how we go about making monetary policy decisions.”—Janet L. Yellen, Fed chairwoman, in 2014, after the communications revolution.

 

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Protesters in April 2009, outside an event where Ben Bernanke, the Fed chairman, was speaking. CreditJason Miczek/Reuters

 

8. The Great Recession, and ‘Audit the Fed’

The Fed’s long run as a political darling came to a crashing end in 2008. Its lax oversight of the financial system was one reason for the severity of the crisis, and the smartest guys in Washington had failed to see it coming. The Fed’s response was also controversial: It provided expansive support for the financial system, preserving some of America’s least popular companies, not to mention foreign banks. And then it embarked on an expansive stimulus campaign to revive the economy.

In the aftermath of the crisis, Congress moved quickly to strengthen the Fed’s regulatory responsibilities. It also imposed some limits on the Fed’s ability to repeat its rescue of the financial system. But it is the stimulus campaign that has prompted the most controversy.

In an inversion of the historical pattern, congressional Republicans have criticized the Fed for printing too much money, arguing higher inflation will be the inevitable consequence. And they have put forward proposals to constrain the central bank. One bill, known as “Audit the Fed,” would authorize the General Accountability Office to review the Fed’s monetary policy decisions. Another approach, backed by the House Financial Services Committee, would require the Fed to publicly articulate a set of rules it intends to follow in making monetary policy, and then explain any deviations.

“The Federal Reserve System must be challenged. Ultimately, it must be eliminated. The government cannot and should not be trusted with a monopoly on money. No single institution in society should have power this immense.”—From End the Fed (2009) by Ron Paul.

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