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A m e r i c a ’ n d l e

W a r O v e r M o n e

By KEVIN GRANVILLE and BINYAMIN APPELBAUM APRIL 7, 2015

T h e “ A u d i t t h e F e d ” d e a t e i t h e l a t e t m a n i f e t a t i o n o f a c o n f l i c t a o l d a t h e n a t i o n , e t w e e n t h o e w h o

a r g u e t h a t a t r o n g c e n t r a l a n k i m p r o v e e c o n o m i c t a i l i t , a n d t h o e w h o e e a n o v e r e a r i n g g o v e r n m e n t

e n g a g e d i n h a r m f u l m e d d l i n g .

Photo

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The Federal Reserve Building in Washington. Credit J. David Ake/Associated Press

Battles over central banking have historically pitted financial elites who wanted

to limit the availability of money, 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 new money and holding short-term interest rates near zero.

Inevitably, that has angered creditors, and sparked efforts to swing the

pendulum in the other direction.

S o m e a c k g r o u n d : S t r o n g v .

W e a k C u r r e n c

Photo

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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.

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

1 . A P h i l a d e l p h i a S t o r : T h e a n k

o f t h e U n i t e d S t a t e

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than 70 years.

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

Philadelphia.

“ T h e a n k i t r i n g t o k i l l m e , u t I w i l l k i l l i t ! ”

—Andrew Jackon

Photo

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

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

2 . P e r p e t u a l P a n i c : L i f e W i t h o u t a

C e n t r a l a n k

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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.

“ U n l e w e h a v e a c e n t r a l a n k w i t h a d e q u a t e c o n t r o l o f

c r e d i t r e o u r c e , t h i c o u n t r i g o i n g t o u n d e r g o t h e m o t

e v e r e a n d f a r r e a c h i n g m o n e p a n i c i n i t h i t o r . ”

—Jaco Schiff, a prominent New York anker, in 1907

Photo

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 andCongressional leaders. Credit Woodrow Wilson Presidential Library, Staunton, Va.

3 . T h i r d T i m e ’ t h e C h a r m : T h e

F e d e r a l R e e r v e A c t o f 1 9 1 3

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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.

“ W e h a l l d e a l w i t h o u r e c o n o m i c t e m a i t i a n d a i t

m a e m o d i f i e d , n o t a i t m i g h t e i f w e h a d a c l e a n h e e t

o f p a p e r t o w r i t e u p o n ; a n d t e p t e p w e h a l l m a k e i t

w h a t i t h o u l d e . ”

—Woodrow Wilon, from hi firt inaugural addre

Photo

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

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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 money and 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 andresponsibilities. 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 w o u l d l i k e t o a t o M i l t o n a n d A n n a : R e g a r d i n g t h e

G r e a t D e p r e i o n . Y o u ' r e r i g h t , w e d i d i t . W e ' r e v e r o r r .

u t t h a n k t o o u , w e w o n ' t d o i t a g a i n . ”

—en ernanke, then a Fed governor, in a 2002 peech addreing Milton Friedman

and Anna Schwartz, whoe reearch documented the Fed’ role in cauing the Great

Depreion

4 . R e c e i o n a n d R e p o n e

Photo

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

5 . T h e L o n g R o a d t o I n d e p e n d e n c e

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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 h o p e o u h a v e e x a m i n e d o u r c o n c i e n c e a n d o u ’ r e

c o n v i n c e d o u ’ r e o n t h e r i g h t t r a c k . ”

—Lad ird Johnon, poken to William McChene Martin, on hi arrival at the LJ

ranch

Photo

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

Congress finally formalized its demands in 1978. A recession in the mid-1970shad 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.

“ v e r t i m e h e h a d a p r e c o n f e r e n c e o m e o d w a

u r g i n g h i m t o t a k e a l a p a t t h e F e d e r a l R e e r v e , u t h e

n e v e r d i d . ”

—Paul Volcker, referring to Preident Reagan

6 . T h e V o l c k e r R u l e : A n

I n d e p e n d e n t C e n t r a l a n k

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Photo

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

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.

“ S i n c e I ’ v e e c o m e a c e n t r a l a n k e r , I ’ v e l e a r n e d t o

m u m l e w i t h g r e a t c o h e r e n c e . I f I e e m u n d u l c l e a r t o o u ,

o u m u t h a v e m i u n d e r t o o d w h a t I a i d . ”

—Alan Greenpan, Fed chairman, in 1987, efore the central ank' communication

revolution

“ T h e F e d e r a l R e e r v e i t h e m o t t r a n p a r e n t c e n t r a l a n k

t o m k n o w l e d g e i n t h e w o r l d . W e h a v e m a d e c l e a r h o w

w e i n t e r p r e t o u r m a n d a t e a n d o u r o j e c t i v e a n d p r o v i d e

e x t e n i v e c o m m e n t a r a n d g u i d a n c e o n h o w w e g o a o u t

m a k i n g m o n e t a r p o l i c d e c i i o n . ”

—Janet L. Yellen, Fed chairwoman, in 2014, after the communication revolution

7 . S m o k e c r e e n a n d S u n h i n e :

T h e F e d O p e n U p

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Photo

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

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’sregulatory 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.

8 . T h e G r e a t R e c e i o n , a n d ‘ A u d i t

t h e F e d ’

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“ T h e F e d e r a l R e e r v e S t e m m u t e c h a l l e n g e d .

U l t i m a t e l , i t m u t e e l i m i n a t e d . T h e g o v e r n m e n t c a n n o t

a n d h o u l d n o t e t r u t e d w i t h a m o n o p o l o n m o n e . N o

i n g l e i n t i t u t i o n i n o c i e t h o u l d h a v e p o w e r t h i

i m m e n e . ”

—From “nd the Fed” (2009) Ron Paul

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