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Encyclopedia > History of central banking in the United States

This article is about the history of central banking in the United States, from the 1790s to the present.

Contents

1791-1836: The First and Second Bank of the United States

First Bank of the United States

Alexander Hamilton, The Secretary of the Treasury convinced Congress in 1791 that the financial needs and credit of the new government required funding the national debt, and creating a national bank. In 1791 the First Bank of the United States (1791-1811) was chartered by Congress. It was modeled after the Bank of England and differed in many ways from today's central banks. For example, it was partly owned by foreigners, who would share from its profits. It was also not solely responsible for the country's money supply; its share was only 20%, while private banks accounted for the rest. The Bank was bitterly opposed by Thomas Jefferson and James Madison, who saw it as an engine for speculation, financial manipulation, and corruption. However their chief financial advisor, Albert Gallatin, recognized its value. Congress refused to extend its charter in 1811, and as a result Madison's government had great difficulty financing the War of 1812. The First Bank of the United States was proposed by Alexander Hamilton to relieve the war debt from the United States Revolutionary War, develop a national currency, and dispose of the western territories. ... Alexander Hamilton (January 11, 1755 or 1757 — July 12, 1804) was an American politician, leading statesman, financier, intellectual, military officer, and founder of the Federalist party. ... The First Bank of the United States was proposed by Alexander Hamilton to relieve the war debt from the United States Revolutionary War, develop a national currency, and dispose of the western territories. ... To meet Wikipedias quality standards, this article or section may require cleanup. ... The examples and perspective in this article or section may not represent a worldwide view. ... Thomas Jefferson (April 13, 1743 N.S. – July 4, 1826) was the third President of the United States (1801–1809), the principal author of the Declaration of Independence (1776), and an influential founder of the United States. ... James Madison (March 16, 1751 – June 28, 1836) was the fourth (1809–1817) President of the United States. ... Albert Gallatin Abraham Alfonse Albert Gallatin (January 29, 1761 – August 12, 1849) was a Swiss-American ethnologist, linguist, politician, founder of New York University, diplomat, and United States Secretary of the Treasury. ... Combatants United States Native Americans United Kingdom Canadian colonial forces Native Americans First Nations Peoples Commanders James Madison Winfield Scott Andrew Jackson Isaac Brock† George Prevost Tecumseh† Strength •U.S. Regular Army: 35,800 •Rangers: 3,049 •Militia: 458,463* •US Navy & US Marines: (at start of war): •Frigates:3...


Second Bank of the United States

After a five-year interval, the federal government chartered its successor, the Second Bank of the United States (1816-1836). It was basically a copy of the First Bank, with branches over the country. Andrew Jackson, who became president in 1828, denounced it as an engine of corruption that benefited his enemies. His destruction of the bank was a major political issue in the 1830s and shaped the Second Party System, as Democrats in the states opposed banks and Whigs supported them. The Second Bank of the United States was a bank chartered in 1816, five years after the expiration of the First Bank of the United States. ... The Second Bank of the United States was a bank chartered in 1816, five years after the expiration of the First Bank of the United States. ... Andrew Jackson (March 15, 1767 – June 8, 1845) was the seventh President of the United States (1829-1837), first governor of Florida (1821), general of the Battle of New Orleans (1815), a co-founder of the Democratic Party, and the eponym of the era of Jacksonian democracy. ... The Second Party System is the term historians give to the political system existing in the United States from about 1824 to 1854. ...


1837-1862: Free Banking Era

Period % Chng in Money Supply % Chng in Price Level
1834-37 + 61 + 28
1837-43 - 58 - 35
1843-48 + 102 + 9
1848-49 - 11 0
1849-54 + 109 + 32
1854-55 - 12 + 2
1855-57 + 18 + 1
1857-58 - 23 - 16
1858-61 + 35 - 4

In this period, only state-chartered banks existed. They could issue bank notes against specie (Gold and Silver coins) and the states regulated their reserve requirements, interest rates for loans and deposits, the necessary capital ratio etc. The Michigan Act (1837) allowed the automatic chartering of banks that would fulfill its requirements without special consent of the State legislature. This legislation eased creating unstable banks even further, lowering the supervision by the states that adopted it. The real value of a bank bill was often lower than its face value, and the issuing bank's financial strength generally determined the size of the discount. By 1797, there were 24 chartered banks in the U.S., while with the beginning of the Free Banking Era (1837), there were 712. A U.S. state is any one of the 50 states which have membership of the federation known as the United States of America (USA or U.S.). The separate state governments and the U.S. federal government share sovereignty. ... General Name, Symbol, Number gold, Au, 79 Chemical series transition metals Group, Period, Block 11, 6, d Appearance metallic yellow Atomic mass 196. ... General Name, Symbol, Number silver, Ag, 47 Chemical series transition metals Group, Period, Block 11, 5, d Appearance lustrous white metal Atomic mass 107. ... This article is about monetary coins. ... The reserve requirement (or required reserve ratio) is a government regulation, that sets the minimum reserves each bank must hold to customer deposits and notes. ... An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ... This article or section does not cite its references or sources. ... ... The ratio of a banks capital to its assets. ... State legislatures are the lawmaking bodies of the 50 states in the United States of America. ...


The banks were very unstable compared to today's commercial banks. The average lifespan of a bank was five years; about half of the banks failed, a third of which because they couldn't redeem their notes. Also, without a central bank responsible for monetary policy, the money supply and price level were much more volatile than today. Monetary policy is the government or central bank process of managing money supply to achieve specific goals—such as constraining inflation, maintaining an exchange rate, achieving full employment or economic growth. ... In economics, a consumer price index is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. ...


During the free banking era, some local banks appeared that took over the functions of a central bank. In New York, the New York Safety Fund acted as a deposit insurance for its member banks. In Boston, the Suffolk Bank guaranteed other banks on-par value of their notes in exchange for reserves. Another private institution that took up work of today's central banks was the clearinghouse. It acted as a lender of last resort when a bank needed liquidity, e.g. in a bank run. Boston is a town and small port c. ... Reserves are banks holding of deposits in accounts with their national bank (for instance, the Federal Reserve), plus currency that is physically held by banks (vault cash). ... A clearing house is an organization affiliated with a securities or derivatives exchange that completes the transactions on that exchange by seeing to validation, delivery, and settlement. ... This article needs to be cleaned up to conform to a higher standard of quality. ... Theatrical promotional poster depicting a bank run A bank run is a type of financial crisis. ...


1863-1913: National Banks

Some of the problems of the free banking era were solved with the National Banking Act, besides providing loans in the Civil War effort of the Union. The provisions were: The National Banking Act of 1863 raised money for the Union in the United States Civil War by enticing banks to buy federal bonds, and taxed state bonds out of existence. ... Combatants United States of America (Union) Confederate States of America (Confederacy) Commanders Abraham Lincoln, Ulysses S. Grant Jefferson Davis, Robert Edward Lee Strength 2,200,000 1,064,000 Casualties 110,000 killed in action, 360,000 total dead, 275,200 wounded 93,000 killed in action, 258,000 total... In this map:  Union states prohibiting slavery  Union territories  Border states on the Union side which allowed slavery  Kansas, which entered and fought with the Union as a free state after the Bleeding Kansas crisis  The Confederacy  Confederate claimed and sometimes held territories During the American Civil War, the Union...

  • To create a system of national banks. They had higher standards concerning reserves and business practices than state banks. The office of Comptroller of the Currency was created to supervise these banks.
  • To create a uniform national currency. In order to achieve this, all national banks were required to accept each other's currencies at par value. This eliminated the risk of loss in case of bank default. The notes were printed by the Comptroller of the Currency to ensure uniform quality and prevent counterfeiting.
  • To finance the war. National banks were required to back up their notes with Treasury securities, enlarging the market and raising its liquidity.

As described by Gresham's Law, soon bad money from state banks drove out the new, good money; the government imposed a 10% tax on state bank bills, forcing most banks to convert to national banks. By 1865, there were already 1,500 national banks. In 1870, 1,638 national banks stood against only 325 state banks. The tax led in the 1880s and 1890s to the creation and adoption of checking accounts. By the 1890s, 90% of the money supply was in checking accounts. State banking had made a comeback. The term national bank has several meanings: especially in developing countries, a bank owned by the state an ordinary private bank which operates nationally (as opposed to regionally or locally or even internationally) In the past, the term national bank has been used synonymously with central bank, but it is... A state bank is a bank that is owned by a state. ... The United States Comptroller of the Currency is the head of the Office of the Comptroller of the Currency. ... A counterfeit is an imitation that is made with the intent to deceptively represent its content or origins. ... Treasury securities are government bonds issued by the United States Department of the Treasury through the Bureau of the Public Debt. ... Greshams law is commonly stated as: When there is a legal tender currency, this bad money drives good money out of circulation. A more correct rendering of Greshams Law is that When there is a legal tender currency, this bad money drives out good if they exchange for... 1865 (MDCCCLXV) is a common year starting on Sunday. ... 1870 (MDCCCLXX) was a common year starting on Saturday (see link for calendar) of the Gregorian calendar or a common year starting on Monday of the 12-day-slower Julian calendar. ... // Development and commercial production of electric lighting Development and commercial production of gasoline-powered automobile by Karl Benz, Gottlieb Daimler and Maybach First commercial production and sales of phonographs and phonograph recordings. ... The 1890s were sometimes referred to as the Mauve Decade, because William Henry Perkins aniline dye allowed the widespread use of that colour in fashion, and also as the Gay Nineties, under the then-current usage of the word gay which referred simply to merriment and frivolity, with no... Includes demand deposits, ATS, NOW, and other checkable deposits. ... The 1890s were sometimes referred to as the Mauve Decade, because William Henry Perkins aniline dye allowed the widespread use of that colour in fashion, and also as the Gay Nineties, under the then-current usage of the word gay which referred simply to merriment and frivolity, with no...


Two problems still remained in the banking sector. The first problem was the requirement to back up the currency with treasuries. When the treasuries fluctuated in value, banks had to recall loans or borrow from other banks or clearinghouses. The second problem was that the system created seasonal liquidity spikes. A rural bank would have deposits at a larger bank that it withdrew when the need for funds was highest, e.g. in the planting season. When the combined liquidity demands were too big, the bank again had to find a lender of last resort.


These liquidity crises led to bank runs, causing severe disruptions and depressions, the worst of which was the Panic of 1907. Theatrical promotional poster depicting a bank run A bank run is a type of financial crisis. ... The Panic of 1907 was a relatively serious economic downturn in the United States caused by a New York credit crunch that spread across the nation and led to the closings of banks and businesses. ...


1913: Creation of the Federal Reserve System

Panic of 1907 Alarms Bankers

Early in 1907, New York Times Annual Financial Review published Paul Warburg's (a partner of Kuhn, Loeb and Co.) first official reform plan, entitled "A Plan for a Modified Central Bank," in which he outlined remedies that he thought might avert panics. Early in 1907, Jacob Schiff, the chief executive of Kuhn, Loeb and Co., in a speech to the New York Chamber of Commerce, warned that "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." "The Panic of 1907" hit full stride in October. [Herrick] Paul Moritz Warburg (August 10, 1868 - January 24, 1932) was a German-American banker and early advocate of the U.S Federal Reserve system. ... Kuhn, Loeb and Co. ... Jacob Schiff (January 10, 1847 – September 25, 1920) was a German-born New York City banker and philanthropist, who financed, among many other things, the Japanese military efforts against Tsarist Russia in the Russo-Japanese War. ... Chief Executive may refer to: Chief Executive of Hong Kong Chief Executive of Macau Chief Executive Officer This is a disambiguation page — a navigational aid which lists other pages that might otherwise share the same title. ... Kuhn, Loeb and Co. ... The Panic of 1907 was a relatively serious economic downturn in the United States caused by a New York credit crunch that spread across the nation and led to the closings of banks and businesses. ...

1908 cartoon argued that elastic currency is needed
1908 cartoon argued that elastic currency is needed

J. P. Morgan had single-handedly stopped the Panic of 1907. He did it not with his own control of money, but with the prestige that enabled him to bring all the powerful players together in one room, and keep them until they found solutions to the emergency. Only bankers seemed to appreciate the real problem: the United States was the last major country without a central bank that could provide stability and emergency credit in times of financial crisis, not to mention support for expanded foreign trade in good times. The threat perceived by the financial community was not so much excessive power around Morgan, but the frailty of a vast, decentralized banking system that could not regulate itself without the extraordinary interventions of one old man. Financial leaders who advocated a central bank with an elastic currency after the Panic of 1907 include Frank Vanderlip, Myron T. Herrick, William Barret Ridgely, George E. Roberts, Isaac N. Seligman and Jacob H. Schiff. They stressed the need for an elastic money supply that could expand or contract as needed; more accurately the need was for liquidity. That is, for a central bank that would loan money to banks on the basis of assets that would be hard to sell in a crisis. After the scare of 1907 the bankers demanded reform; the next year, Congress established a commission of experts to come up with a nonpartisan solution. Image File history File links Download high resolution version (623x897, 96 KB) Summary US cartoon 1908 Licensing This image is in the public domain in the United States. ... Image File history File links Download high resolution version (623x897, 96 KB) Summary US cartoon 1908 Licensing This image is in the public domain in the United States. ... J. P. Morgan John Pierpont Morgan I (April 17, 1837 – March 31, 1913) was an American financier and banker, who at the turn of the century, was one of the wealthiest men in America. ... Myron Timothy Herrick (October 9, 1854 - March 31, 1929) was a Republican politician from Ohio. ... Jacob Schiff (January 10, 1847 – September 25, 1920) was a German-born New York City banker and philanthropist, who financed, among many other things, the Japanese military efforts against Tsarist Russia in the Russo-Japanese War. ...


Aldrich Plan

Rhode Island Senator Nelson Aldrich, the Republican leader in the Senate, ran the Commission personally, with the aid of a team of brilliant economists. They went to Europe and were impressed at how well the central banks in Britain and Germany handled the stabilization of the overall economy and the promotion of international trade. The dollar was a second-rate currency in world trade compared to the pound. Aldrich's impartial investigation in the best tradition of Progressive Era fact-finding led to his plan in 1912 to bring central banking to America, with promises of financial stability, expanded international roles, control by impartial experts and no political meddling in finance. Nelson Wilmarth Aldrich (November 6, 1841 - April 16, 1915) was an American politician. ... // [edit] Overview In the United States, the Progressive Era was a period of reform which lasted from the 1890s through the 1920s, although some experts use the narrower time frame of 1900 to 1917. ...

Image File history File links Download high resolution version (1275x1753, 363 KB) Summary 1913 newspaper clipping USA Licensing This image is in the public domain in the United States. ... Image File history File links Download high resolution version (1275x1753, 363 KB) Summary 1913 newspaper clipping USA Licensing This image is in the public domain in the United States. ...

Regional System

Aldrich realized correctly that a central bank had to be (contradictorily) decentralized somehow, or it would be ganged up on by local politicians and bankers as had the First and Second Banks of the United States. His solution was a regional system. In Congress, Rep. Carter Glass of Virginia picked up Aldrich's core ideas; to be able to claim Democratic authorship, he made numerous small revisions such as headquartering a region in the financial backwaters of Richmond, Virginia. Glass had once been a fervent silverite; he now accepted the ideas proposed by the experts. President Woodrow Wilson added the provision that the new regional banks be controlled by a central board appointed by the president. Carter Glass Carter Glass (January 4, 1858–May 28, 1946) was an American politician from Virginia, who served many years in Congress, as well as U.S. Secretary of the Treasury under Woodrow Wilson. ... In economics, bimetallism is a monetary standard in which the value of the monetary unit can be expressed either with a certain amount of gold or with a certain amount of silver: the ratio between the two metals is fixed by law. ... Thomas Woodrow Wilson (December 28, 1856 – February 3, 1924) was the 28th President of the United States (1913–1921). ...


Agrarian Demands Partly Met

William Jennings Bryan, by now Secretary of State, long-time enemy of Wall Street and still a power in the Democratic party, threatened to destroy the bill. Wilson masterfully came up with a compromise plan that pleased bankers and Bryan alike. The Bryanites were happy that Federal Reserve currency became liabilities of the government rather than of private banks - a symbolic change - and by provisions for federal loans to farmers. The Bryanite demand to prohibit interlocking directorates did not pass. Wilson convinced the anti-bank Congressmen that because Federal Reserve notes were obligations of the government, the plan fit their demands. Southerners and westerners learned from Wilson that that the system was decentralized into 12 districts and surely would weaken New York and strengthen the hinterlands. One key opponent, Congressman Carter Glass, was given credit for the bill, and his home of Richmond, Virginia was made a district headquarters. Powerful Senator James Reed of Missouri was given two district headquarters in St. Louis and Kansas City. William Jennings Bryan, 1907 William Jennings Bryan (March 19, 1860 – July 26, 1925) was an American lawyer, statesman, and politician. ...


Congress passed the Federal Reserve Act or Owen-Glass Act, in late 1913. Wilson named Warburg and other prominent bankers to direct the new system, pleasing the bankers. The New York branch dominated the Fed and thus power remained in Wall Street. The new system began operations in 1915 and played a major role in financing the Allied and American war efforts. Wilson considered the Fed to be a private institution and refused to interfere in its working. [Link 1956 pp 199-240] The Federal Reserve Act, also known as the Act of December 23, 1913, ch. ...


1913-Present: Recent Changes

The Fed's power developed slowly in part due to an understanding at its creation that it was to function primarily as a reserve, a money-creator of last resort to prevent the downward spiral of withdrawal/withholding of funds which characterizes a monetary panic. At the outbreak of World War I, the Fed was better positioned than the Treasury to issue war bonds, and so became the primary retailer for war bonds under the direction of the Treasury. After the war, the Fed, led by Paul Warburg and New York Governor Bank President Benjamin Strong, convinced Congress to modify its powers, giving it the ability to both create money, as the 1913 Act intended, and destroy money, as a central bank could. Combatants Allied Powers: France Italy Russia Serbia United Kingdom United States Central Powers: Austria-Hungary Bulgaria Germany Ottoman Empire Commanders Ferdinand Foch Georges Clemenceau Victor Emmanuel III Luigi Cadorna Nicholas II Aleksei Brusilov Herbert Henry Asquith Douglas Haig John Jellicoe Woodrow Wilson John Pershing Wilhelm II Paul von Hindenburg Reinhard... The United States Department of the Treasury is a Cabinet department and the treasury of the United States government. ... An American War Bonds poster from 1942 War bonds were a form of savings bond used by many combatant nations to help fund World War I and World War II. They were also a measure to manage inflation by removing money from the economy heated up by the war efforts. ...


During the 1920s, the Fed experimented with a number of approaches, alternatively creating and destroying money and, in the eyes of many scholars (notably Milton Friedman), helping to create the late-1920s stock market bubble. In 1928, Strong died. He left a tremendous vacuum in Fed governance from which the bank did not recover in time to react to the 1929 collapse (as, for instance, the Fed did after 1987's Black Monday), and the Fed adopted what most would consider today to be a restrictive policy, exacerbating the crash. Milton Friedman (born July 31, 1912) is an American economist, known for his work on macroeconomics, microeconomics, economic history, statistics, and for his advocacy of laissez-faire capitalism. ... The New York Stock Exchange A stock market is a market for the trading of company stock, and derivatives of same; both of these are securities listed on a stock exchange as well as those only traded privately. ... The Great Depression was a worldwide economic downturn which started in 1929 (although its effects were not fully felt until late 1930) and lasted through most of the 1930s. ... our fence fell over DJIA (19 July 1987 through 19 January 1988) FTSE 100 Index (19 July 1987 through 19 January 1988) Black Monday is the name given to Monday, October 19, 1987, when the Dow Jones Industrial Average (DJIA) fell dramatically across the world. ...


After Franklin D. Roosevelt took office in 1933, the Fed became subordinated to the Executive Branch, where it remained until 1951, when the Fed and the Treasury department signed an accord granting the Fed full independence over monetary matters while leaving fiscal matters to the Treasury. FDR redirects here. ... The executive is the branch of a government charged with implementing, or executing, the law and running the day-to-day affairs of the government or state. ... The 1951 Accord, also known simply as the Accord, was an agreement between the U.S. Department of the Treasury and the Federal Reserve restoring independence to the Fed. ...


The Fed's powers have not significantly changed since 1951, though it has frequently adopted different policy approaches.


References

Part of this article is based on an excerpt of A Brief History of Central Banking in the United States by Edward Flaherty

  • J. Lawrence Broz; The International Origins of the Federal Reserve System Cornell University Press. 1997.
  • Vincent P. Carosso, "The Wall Street Trust from Pujo through Medina," Business History Review (1973) 47:421-37
  • Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867-1960 (1963)
  • William Greider, Secrets of the Temple: How the Federal Reserve Runs the Country (1989), on the 1980s
  • Myron T. Herrick "The Panic of 1907 and Some of Its Lessons", Annals of the American Academy of Political and Social Science, vol. 31 (Jan.-June 1908)
  • Charles P. Kindleberger "Manias, Panics, and Crashes" (4th ed.).
  • Gabriel Kolko, Triumph of Conservatism: A Reinterpretation of American history, 1900-1916 (1963) pp 230-54.
  • Arthur Link, Wilson: The New Freedom (1962)
  • James Livingston, Origins of the Federal Reserve System: Money, Class, and Corporate Capitalism, 1890-1913 (1986).
  • Allan H. Meltzer. A History of the Federal Reserve, Volume 1: 1913-1951 (2004)
  • Murray N. Rothbard. A History of Money and Banking in the United States: The Colonial Era to World War II (2002)* Frank G. Steindl, Monetary Interpretations of the Great Depression. (1995).
  • Shull, Bernard. The fourth branch : the Federal Reserve's unlikely rise to power and influence. (2005) Westport, Conn.: Praeger.
  • Donald R. Wells. The Federal Reserve System: A History (2004)
  • Robert Craig West, Banking Reform and the Federal Reserve, 1863-1923 (1977)
  • Elmus R. Wicker, "A Reconsideration of Federal Reserve Policy during the 1920-1921 Depression," Journal of Economic History (1966) 26: 223-238
  • John H Wood. A History Of Central Banking In Great Britain And The United States (2005)
  • Bob Woodward, Maestro: Greenspan's Fed and the American Boom (2000) on the 1990s.

 
 

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