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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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