WEBVTT NOTE Origins of the Federal Reserve: The Advent of the National Banking System 1 00:00:00.000 --> 00:00:06.000 Origins of the Federal Reserve, the advent of the national banking system 2 00:00:06.000 --> 00:00:11.000 It should now be crystal clear what the attitude of commercial banks is 3 00:00:11.000 --> 00:00:15.000 and almost always will be toward the central bank in their country. 4 00:00:15.000 --> 00:00:21.000 The central bank is their support, their staff and shield against the winds of competition 5 00:00:21.000 --> 00:00:26.000 and of people trying to obtain money which they believe to be their own property 6 00:00:26.000 --> 00:00:29.000 waiting in the bank's vaults. 7 00:00:29.000 --> 00:00:38.000 The central bank crucially bolsters the confidence of the guld public in the banks and deters runs upon them. 8 00:00:38.000 --> 00:00:46.000 The central bank is the bank's lender of last resort and the cartelizer that enables all the banks to expand together 9 00:00:46.000 --> 00:00:54.000 so that one set of banks doesn't lose reserves to another and is forced to contract sharply or go under. 10 00:00:54.000 --> 00:01:08.000 The central bank is almost critically necessary to the prosperity of the commercial banks to their professional career as manufacturers of new money through issuing illusory warehouse receipts to standard cash. 11 00:01:08.000 --> 00:01:23.000 Also, we can now see the mendacity of the common claim that private commercial banks are inflation hawks or that central banks are eternally guarding the pass against inflation. 12 00:01:23.000 --> 00:01:33.000 Instead, they are all jointly the inflation creators and the only inflation creators in the economy. 13 00:01:33.000 --> 00:01:40.000 Now, does this not mean, of course, that banks are never griping about their central bank? 14 00:01:40.000 --> 00:01:48.000 In every marriage there is friction and there is often grousing by the banks against their shepherd and protector. 15 00:01:48.000 --> 00:01:59.000 But the complaint, almost always, is that the central bank is not inflating, is not protecting them, intensely or consistently enough. 16 00:01:59.000 --> 00:02:08.000 The central bank, while the leader and mentor of the commercial banks, must also consider other pressures, largely political. 17 00:02:08.000 --> 00:02:27.000 Even when, as now, their notes are standard cash, they must worry about public opinion, or about populist complaints against inflation, or about instinctively shrewd, if often unsophisticated, public denunciation of the money power. 18 00:02:27.000 --> 00:02:39.000 The attitude of a bank toward the central bank and government is akin to general belly-aching by welfare clients or by industries seeking subsidies against the government. 19 00:02:39.000 --> 00:02:53.000 The complaints are almost always directed not against the existence of the welfare system or the subsidy program, but against alleged deficiencies in the intensity and scope of the subventions. 20 00:02:53.000 --> 00:02:59.000 Questions. Ask the complainers if they wish to abolish welfare or subsidies, and you will 21 00:02:59.000 --> 00:03:03.760 see the horror in their response if indeed they can be induced to treat the question 22 00:03:03.760 --> 00:03:10.240 seriously. In the same way, ask any bankers if they wish to abolish their central bank, 23 00:03:10.240 --> 00:03:14.600 and the reaction of horror will be very similar. 24 00:03:14.600 --> 00:03:20.720 It is a commonly accepted myth that the state banks, the state chartered private commercial 25 00:03:20.720 --> 00:03:29.720 This strongly supported Andrew Jackson's abolition of the second bank of the United States, the central bank of that time. 26 00:03:29.720 --> 00:03:39.720 However, apart from the fact that this was a pre-Peel Act central bank that did not have a monopoly on bank notes 27 00:03:39.720 --> 00:03:45.720 and hence competed with commercial banks as well as providing reserves for their expansion, 28 00:03:45.720 --> 00:04:02.720 This view is sheer legend based on the faulty view of historians that since the state banks were supposedly restrained in their expansion by the Bank of the United States, they must have favored its abolition. 29 00:04:03.720 --> 00:04:14.720 On the contrary, as later historians have shown, the overwhelming majority of the banks supported retention of the Bank of the United States, as our analysis would lead us to predict. 30 00:04:15.720 --> 00:04:24.720 For the first century of the history of the American Republic, money and banking were crucial policy issues between the political parties. 31 00:04:24.720 --> 00:04:29.720 A central bank was a live issue from the beginning of the American nation. 32 00:04:29.720 --> 00:04:40.720 At each step of the way, the champions of the central bank were the enthusiastic nationalists, the advocates of a big central government. 33 00:04:40.720 --> 00:05:01.720 In fact, in 1781, even before the Revolutionary War was over, the leading nationalist, Philadelphia's merchant tycoon Robert Morris, who was Congress's virtual wartime economic czar, got Congress to charter the First Central Bank, his own Bank of North America, BNA. 34 00:05:01.720 --> 00:05:11.720 Like the Bank of England, Congress bestowed on Morris's private BNA the monopoly privilege of issuing paper notes throughout the country. 35 00:05:11.720 --> 00:05:21.720 Most of these notes were issued in the purchase of newly issued Federal debt, and the BNA was made the depository of all Congressional funds. 36 00:05:21.720 --> 00:05:26.720 Over half the capital of the BNA was officially subscribed by Congress. 37 00:05:26.720 --> 00:05:45.720 Congress. When Morris failed to raise the specie capital legally required to launch the B&A, he simply appropriated specie, loaned to the U.S. Treasury by France, and invested it for the U.S. government in his own bank. 38 00:05:45.720 --> 00:06:03.720 On this episode, and on the history of the war over a central bank in America from then through the 19th century, see the Minority Report of the U.S. Gold Commission of 1981 in the latest edition, the Ron Paul Moneybook. 39 00:06:03.720 --> 00:06:16.720 The BNA notes were supposedly redeemable in specie, but of course the fractional reserve expansion indulged in by the BNA led to the depreciation of its notes outside its home base in Philadelphia. 40 00:06:16.720 --> 00:06:32.720 After the end of the Revolutionary War, Morse lost his national political power and he was forced to privatize the BNA swiftly and to shift it to the status of a regular private bank shorn of government privilege. 41 00:06:32.720 --> 00:07:02.720 Throughout the first century of the Republic, the party favoring a central bank, first the Hamiltonian high Federalist, then the Whigs, and then the Republicans, was the party of big central government, of a large public debt, of high protective tariffs, of large-scale public works, and of subsidies to large businesses in that early version of partnership between government and industry. 42 00:07:02.720 --> 00:07:08.920 Tariffs were to subsidize domestic manufacturers, while paper money, fractional reserve banking 43 00:07:08.920 --> 00:07:15.160 and central banking were all advocated by the nationalists as part of a comprehensive 44 00:07:15.160 --> 00:07:22.160 policy of inflation and cheap credit in order to benefit favored businesses. 45 00:07:22.280 --> 00:07:27.300 These favorites were firms and industries that were part of the financial elite, centered 46 00:07:27.300 --> 00:07:34.380 from the beginning through the Civil War in Philadelphia and New York, with New York assuming 47 00:07:34.380 --> 00:07:38.940 first place after the end of that war. 48 00:07:38.940 --> 00:07:45.100 Ranged against this powerful group of nationalists was an equally powerful movement dedicated 49 00:07:45.100 --> 00:07:54.100 to laissez-faire, free markets, free trade, ultra-minimal and decentralized government, 50 00:07:54.100 --> 00:08:01.060 And in the monetary sphere, a hard-money system based squarely on gold and silver, with banks 51 00:08:01.060 --> 00:08:08.780 shorn of all special privileges and hopefully confined to 100 percent specie banking. 52 00:08:08.780 --> 00:08:15.020 These hard-money libertarians made up the heart and soul of the Jeffersonian Democratic 53 00:08:15.020 --> 00:08:23.120 Republican and then the Jacksonian Democratic Party, and their potential constituents permeated 54 00:08:23.120 --> 00:08:31.920 Every occupation except those of banker and the bankers favored elite clientele. 55 00:08:31.920 --> 00:08:36.560 After the first bank of the United States was established by Hamilton, followed by a 56 00:08:36.560 --> 00:08:45.400 second bank put in by pro-bank Democrat Republicans after the War of 1812, President Andrew Jackson 57 00:08:45.400 --> 00:08:51.200 and managed to eliminate the central bank after a titanic struggle waged during the 58 00:08:51.200 --> 00:08:52.200 1830s. 59 00:08:52.200 --> 00:08:59.360 While the Jacksonian Democrats were not able to enact their entire hard money program during 60 00:08:59.360 --> 00:09:06.400 the 1840s and 1850s because of the growing democratic split over slavery, the regime 61 00:09:06.400 --> 00:09:13.160 of those decades, in addition to establishing free trade for the last time in the United 62 00:09:13.160 --> 00:09:19.920 States also managed to eliminate not only the central bank but all traces of centralized 63 00:09:19.920 --> 00:09:22.180 banking. 64 00:09:22.180 --> 00:09:29.720 While the new Republican Party of the 1850s contained many former Jacksonian Democrats, 65 00:09:29.720 --> 00:09:36.560 the economic agenda of the Republicans was firmly fixed by the former Whigs in the party. 66 00:09:36.560 --> 00:09:42.240 The victorious Republicans took advantage of the near one-party Congress after the secession 67 00:09:42.240 --> 00:09:50.120 of the South to drive through their cherished agenda of economic nationalism and statism. 68 00:09:50.120 --> 00:09:56.120 This nationalist program included a huge increase in central government power fueled by the 69 00:09:56.120 --> 00:10:04.120 first income tax and by heavy taxes on liquor and tobacco, vast land grants as well as monetary 70 00:10:04.120 --> 00:10:12.120 subsidies to new transcontinental railroads and the reestablishment of a protective tariff. 71 00:10:12.120 --> 00:10:19.120 Not the least of the Republican statist revolution was effected on the monetary and financial front. 72 00:10:19.120 --> 00:10:25.120 To finance the war effort against the South, the Federal Government went off the gold standard 73 00:10:25.120 --> 00:10:33.120 and issued irredeemable fiat paper money called greenbacks, technically U.S. notes. 74 00:10:33.120 --> 00:10:40.120 When the irredeemable paper after two years sank to 50 cents on the dollar on the market in terms of gold, 75 00:10:40.120 --> 00:10:46.120 The Federal Government turned increasingly to issuing public debt to finance the war. 76 00:10:46.120 --> 00:11:00.120 Thus, the Republican Whig Program managed to dump the traditional Jefferson-Jackson Democratic devotion to hard money and gold, as well as their hatred of the public debt. 77 00:11:00.120 --> 00:11:06.200 Debt. Both Jefferson and later Jackson in their administrations managed for the first 78 00:11:06.200 --> 00:11:14.160 time in American history to pay off the federal public debt. In addition, while the Republicans 79 00:11:14.160 --> 00:11:19.900 did not yet feel strong enough to bring back a central bank, they effectively put an end 80 00:11:19.900 --> 00:11:27.800 to the relatively free and non-inflationary banking system of the post-Jacksonian era 81 00:11:27.800 --> 00:11:34.800 and created a new national banking system that centralized the nation's banks and established 82 00:11:34.800 --> 00:11:40.020 what amounted to a halfway house toward central banking. 83 00:11:40.020 --> 00:11:45.840 The state banks had been happy from the beginning of the war to pyramid an expansion of fractional 84 00:11:45.840 --> 00:11:52.240 reserve notes and demand deposits on top of the increase of federal green banks, thus 85 00:11:52.240 --> 00:11:55.520 expanding the total supply of money. 86 00:11:55.520 --> 00:12:00.440 Here in the Civil War, the Federal Government created the National Banking System in the 87 00:12:00.440 --> 00:12:07.360 Bank Acts of 1863, 1864 and 1865. 88 00:12:07.360 --> 00:12:14.000 Whereas the Peel Act had granted to one Bank of England the monopoly of all banknotes, 89 00:12:14.000 --> 00:12:21.000 the National Banking Acts granted such a monopoly to a new category of federally charted national 90 00:12:21.000 --> 00:12:22.360 banks. 91 00:12:22.360 --> 00:12:28.760 The existing state banks were prohibited from any issue of notes and had to be confined to 92 00:12:28.760 --> 00:12:36.560 issuing bank deposits. Strictly, this prohibition was accomplished by a prohibitive 10% tax 93 00:12:36.560 --> 00:12:44.160 on state bank notes, levied by Congress in the spring of 1865, when the state banks disappointed 94 00:12:44.160 --> 00:12:50.180 Republican hopes by failing to rush to join the national banking structure, as set up 95 00:12:50.180 --> 00:13:07.180 In other words, to obtain cash or paper notes, the state banks had to keep their own deposit accounts at the national banks, so as to draw down their accounts and obtain cash to redeem their customers' deposits if necessary. 96 00:13:07.180 --> 00:13:14.180 For their part, the national banks were established in a centralized, tripartite hierarchy. 97 00:13:14.180 --> 00:13:24.180 At the top of the hierarchy were leading center reserve city banks, a category originally confined to large banks in New York City. 98 00:13:24.180 --> 00:13:35.180 Beneath that were reserve city banks, in cities of over 500,000 population, and beneath those were the rest, or country banks. 99 00:13:35.180 --> 00:13:41.260 The new legislation featured a device pioneered by Whig state governments, especially New 100 00:13:41.260 --> 00:13:49.020 York and Michigan, in the 1840s. Legal, minimum fractional reserve requirements of bank reserves 101 00:13:49.020 --> 00:13:55.600 to their notes and deposits. The reserve requirements fashioned an instrument of control by the 102 00:13:55.600 --> 00:14:01.100 upper strata of the banking hierarchy over the lower. The crucial point was to induce 103 00:14:01.100 --> 00:14:14.100 The Federal Reserve had to increase the lower tiers of banks to keep much of their reserves, not in legal cash, gold, silver or greenbacks, but in demand deposit accounts in the higher tier banks. 104 00:14:14.100 --> 00:14:23.100 Thus, the country banks had to keep a minimum ratio of 15% of reserves to their notes and demand deposits outstanding. 105 00:14:23.100 --> 00:14:30.100 15 percent? Only 40 percent had to be in cash. The rest could be in the form of demand deposits 106 00:14:30.120 --> 00:14:36.820 at either Reserve City or Central Reserve City banks. For their part, the Reserve City 107 00:14:36.820 --> 00:14:43.580 banks, with a minimum reserve ratio of 25 percent, could keep no more than half of these 108 00:14:43.580 --> 00:14:49.940 reserves in cash. The other half could be kept as demand deposits in Central Reserve 109 00:14:49.940 --> 00:14:56.820 of City Banks, which also had to keep a minimum reserve ratio of 25%. 110 00:14:56.820 --> 00:15:02.180 These various national banks were to be chartered by a federal controller of the currency, an 111 00:15:02.180 --> 00:15:04.980 official of the Treasury Department. 112 00:15:04.980 --> 00:15:11.180 To obtain a charter, a bank had to obey high minimum capital requirements, requirements 113 00:15:11.180 --> 00:15:14.620 rising through the hierarchical categories of banks. 114 00:15:14.620 --> 00:15:24.620 Thus the country banks needed to put up at least $50,000 in capital, and the reserve city banks faced a capital requirement of $200,000. 115 00:15:24.620 --> 00:15:34.620 Before the Civil War, each state bank could only pyramid notes and deposits upon its own stock of gold and silver, 116 00:15:34.620 --> 00:15:42.620 and any undue expansion could easily bring it down from the redemption demands of other banks or the public. 117 00:15:42.620 --> 00:15:46.620 Each bank had to subsist on its own bottom. 118 00:15:46.620 --> 00:15:52.620 Moreover, any bank suspected of not being able to redeem its warehouse receipts 119 00:15:52.620 --> 00:16:00.620 found its notes depreciating on the market compared either to gold or to the notes of other sounder banks. 120 00:16:00.620 --> 00:16:04.620 After the installation of the national banking system, however, 121 00:16:04.620 --> 00:16:12.620 Each bank was conspicuously not forced to stand on its own and be responsible for its own debts. 122 00:16:12.620 --> 00:16:24.620 The U.S. government had now fashioned a hierarchical structure of four inverse pyramids, each inverse pyramid, resting on top of a smaller, narrower one. 123 00:16:24.620 --> 00:16:32.620 At the bottom of this multi-tiered inverse pyramid were a handful of very large, center reserve city Wall Street banks. 124 00:16:32.620 --> 00:16:33.620 Banks. 125 00:16:33.620 --> 00:16:39.380 On top of their reserves of gold, silver and green banks, the Wall Street banks could pyramid 126 00:16:39.380 --> 00:16:43.980 an expansion of notes and deposits by 4 to 1. 127 00:16:43.980 --> 00:16:49.020 On their deposits at the Central Reserve City Banks, the Reserve City Banks could pyramid 128 00:16:49.020 --> 00:16:51.060 by 4 to 1. 129 00:16:51.060 --> 00:16:58.260 And then the country banks could pyramid their warehouse receipts by 6.67 to 1. 130 00:16:58.260 --> 00:17:01.260 On top of their deposits at the Reserve Banks. 131 00:17:01.260 --> 00:17:07.660 Finally, the state banks forced to keep deposits at national banks could pyramid their expansion 132 00:17:07.660 --> 00:17:13.940 of money and credit on top of their deposits at the country or reserve city banks. 133 00:17:13.940 --> 00:17:18.700 To eliminate the restriction on bank credit expansion of the depreciation of notes on 134 00:17:18.700 --> 00:17:24.620 the market, the Congress required all the national banks to accept each other's notes 135 00:17:24.620 --> 00:17:26.180 at par. 136 00:17:26.180 --> 00:17:32.280 The Federal Government conferred quasi-legal tender status on each national bank note by 137 00:17:32.280 --> 00:17:40.140 agreeing to accept them at par in taxes, and branch banking continued to be illegal as 138 00:17:40.140 --> 00:17:46.620 before the Civil War, so that a bank was only required to redeem notes in specie at the 139 00:17:46.620 --> 00:17:49.880 counter at its home office. 140 00:17:49.880 --> 00:17:56.140 In addition, the Federal Government made redemption in specie difficult by imposing a $3 million 141 00:17:56.140 --> 00:18:04.140 and the dollar-per-month maximum limit on the contraction, that is, net redemption, of national bank notes. 142 00:18:04.140 --> 00:18:13.140 Thus the country was saddled with a new centralized and far more unsound and inflationary banking system 143 00:18:13.140 --> 00:18:19.140 that could and did inflate on top of expansion by Wall Street banks. 144 00:18:19.140 --> 00:18:25.140 By being at the bottom of the pyramid, Wall Street banks could control as well as generate 145 00:18:25.140 --> 00:18:29.140 A Multiple Expansion of the Nation's Money and Credit 146 00:18:29.140 --> 00:18:47.140 Under cover of a wartime emergency, the Republican Party had permanently transformed the nation's banking system from a fairly sound and decentralized one into an inflationary system under central Wall Street control. 147 00:18:47.140 --> 00:18:55.140 The Democrats in Congress, devoted to hard money, had opposed the national banking system almost to a man. 148 00:18:55.140 --> 00:19:00.140 It took the Democrats about a decade to recover politically from the Civil War, 149 00:19:00.140 --> 00:19:09.140 and their monetary energies were devoted during this period to end greenback inflationism and return to the gold standard, 150 00:19:09.140 --> 00:19:16.140 a victory which came in 1879 and which the Republicans resisted strongly, 151 00:19:16.140 --> 00:19:30.140 Particularly active in pushing for continued greenback inflation were the industrial and financial power elite among the radical Republicans, the iron and steel industrialists and the big railroads. 152 00:19:30.140 --> 00:19:45.140 It was really the collapse of nationalist bankers, tycoons and subsidized and over expanded railroads in the mighty panic of 1873 that humbled their political and economic power and permitted the victory of gold. 153 00:19:45.140 --> 00:19:54.140 The Panic was the consequence of the wartime and post-war inflationary boom generated by the new banking system. 154 00:19:54.140 --> 00:20:02.140 And such dominant financial powers as Jay Cooke, the monopoly underwriter of government bonds from the Civil War on, 155 00:20:02.140 --> 00:20:11.140 and the main architect of the national banking system was, in a fit of poetic justice, driven into bankruptcy by the panic. 156 00:20:11.140 --> 00:20:31.140 But even after 1879 gold was still challenged by inflationist attempts to bring back or add silver to the monetary standard and it took until 1900 before the silver threat was finally beaten back and gold established as the single monetary standard. 157 00:20:31.140 --> 00:20:42.140 Unfortunately, by that time, the Democrats had lost their status as a hard-money party and were becoming more inflationist than the Republicans. 158 00:20:42.140 --> 00:20:58.140 In the midst of these struggles over the basic monetary standard, the dwindling stock of hard-money Democrats had neither the ability nor the inclination to try to restore the free and decentralized banking structure 159 00:20:58.140 --> 00:21:01.780 and Structure as it had existed before the Civil War.