We will address this question in four parts. Part 1, will give a brief history of the national banking system. Part 2, will describe the responsibilities and relationships between the Federal Reserve, the Federal Open Market Committee, and the US Treasury. Part 3, will compare the Fed’s actions through the Federal Open Market Committee or FOMC with the state of the US economy from 1980 to the present. Part 4, will attempt to demonstrate how actions today by the Federal Reserve Bank and the FOMC will impact our individual financial well-being in the future. We hope these “rants” as we call them will help you better understand our national crisis to protect your individual finances.
Before we explore the title question so the readers can reach their own conclusion, we believe one needs to understand the history of central banking in the United States.
US Congress passed and President Woodrow sign into law on Decmeber 23, 1913, the Federal Reserve Act creating the United States Federal Reserve Banking System. The concept of having a “national bank” started during the American Revolution. To finance the American Revolution, the Continental Congress printed the new nation’s first paper money. Known as “continentals.” From 1775, to 1913, several attempts were made by the US Congress to create a national banking system. Each time the laws had “sunset dates” and were allowed to expire through the efforts of those that resisted the idea to allow the national bank law to expire. The 1913 law passed the US Senate by one vote.
Following World War I, Benjamin Strong, head of the New York Fed from 1914 to his death in 1928, recognized that gold no longer served as the central factor in controlling credit. Strong’s aggressive action to stem a recession in 1923 through a large purchase of government securities gave clear evidence of the power of open market operations to influence the availability of credit in the banking system. During the 1920s, the Fed began using open market operations as a monetary policy tool. During his tenure, Strong also elevated the stature of the Fed by promoting relations with other central banks, especially the Bank of England. (1)
Throughout history there have been opponents to having a central bank controlling the “free enterprise” economy of the United States and the role of the Federal Reserve today continues to be challenaged and questioned by many but supported by most. The 1913 law created a partneship between the new Federal Reserve Bank and the US Treasury Department with the Treasury maintaining control over the bank.
In reaction to the Great Depression, Congress passed the Banking Act of 1933, better known as the Glass-Steagall Act, calling for the separation of commercial and investment banking and requiring use of government securities as collateral for Federal Reserve notes. The Act also established the Federal Deposit Insurance Corporation (FDIC), placed open market operations under the Fed and required bank holding companies to be examined by the Fed, a practice that was to have profound future implications, as holding companies became a prevalent structure for banks over time. Also, as part of the massive reforms taking place, Roosevelt recalled all gold and silver certificates, effectively ending the gold and any other metallic standard. (1)
The Banking Act of 1935 called for further changes in the Fed’s structure, including the creation of the Federal Open Market Committee (FOMC) as a separate legal entity, removal of the Treasury Secretary and the Comptroller of the Currency from the Fed’s governing board and establishment of the members’ terms at 14 years. Following World War II, the Employment Act added the goal of promising maximum employment to the list of the Fed’s responsibilities. (1)
The Federal Reserve System formally committed to maintaining a low interest rate peg on government bonds in 1942 after the United States entered World War II. It did so at the request of the Treasury to allow the federal government to engage in cheaper debt financing of the war. To maintain the pegged rate, the Fed was forced to give up control of the size of its portfolio as well as the money stock. Conflict between the Treasury and the Fed came to the fore when the Treasury directed the central bank to maintain the peg after the start of the Korean War in 1950. (1)
President Harry Truman and Secretary of the Treasury John Snyder were both strong supporters of the low interest rate peg. The President felt that it was his duty to protect patriotic citizens by not lowering the value of the bonds that they had purchased during the war. Unlike Truman and Snyder, the Federal Reserve was focused on the need to contain inflationary pressures in the economy caused by the intensification of the Korean War. Many on the Board of Governors, including Marriner Eccles, understood that the forced obligation to maintain the low peg on interest rates produced an excessive monetary expansion that caused inflation. After a fierce debate between the Fed and the Treasury for control over interest rates and U.S. monetary policy, their dispute was settled resulting in an agreement known as the Treasury-Fed Accord. This eliminated the obligation of the Fed to monetize the debt of the Treasury at a fixed rate and became essential to the independence of central banking and how monetary policy is pursued by the Federal Reserve today. (1)
The 1970s saw inflation skyrocket as producer and consumer prices rose, oil prices soared and the federal deficit more than doubled. By August 1979, when Paul Volcker was sworn in as Fed chairman, drastic action was needed to break inflation’s stranglehold on the U.S. economy. Volcker’s leadership as Fed chairman during the 1980s, though painful in the short term, was successful overall in bringing double-digit inflation under control. (1)
The Monetary Control Act of 1980 required the Fed to price its financial services competitively against private sector providers and to establish reserve requirements for all eligible financial institutions. The act marks the beginning of a period of modern banking industry reforms. Following its passage, interstate banking proliferated, and banks began offering interest-paying accounts and instruments to attract customers from brokerage firms. Barriers to insurance activities, however, proved more difficult to circumvent. Nonetheless, momentum for change was steady, and by 1999 the Gramm-Leach-Bliley Act was passed, in essence, overturning the Glass-Steagall Act of 1933 and allowing banks to offer a menu of financial services, including investment banking and insurance. (1)
This action by Congress allowed mega-banks like J. P. Morgan, Bank of America, Morgan Stanley, and Citibank to expand their control and influence over the US Stock Market and world markets around the world in addition to holding depositer’s money and lending to commercial enterprises. In 1970, 8 out of the 10 largest banks in the world were in the United States. Today, none of our banks are in that category.
For a more detailed explanation of the Federal Reserve, you are directed to federalreserveeducation.org.
(1) History of the Federal Reserve; Federalreserveeducation.org.
The Redneck Economist