The Weiner Component Vol.2 #6 – The Federal Reserve: Part 1

English: Monthly changes in the currency compo...

English: Monthly changes in the currency component of the U.S. money supply as reported by the Federal Reserve at the St. Louis Fed’s F.R.E.D. website at: http://research.stlouisfed.org/fred2/data/CURRNS.txt The data was copy/pasted into an OpenOffice.org Calc spreadsheet, the monthly changes were calculated using a simple formula, then this image was generated from that data. (Photo credit: Wikipedia)

Every industrial nation or group of countries like the Euro-pact, which uses a common currency, has a Central Bank that largely controls that controls its Monetary Policy, the flow of currency within its borders. In Europe it’s called the Central Bank and in the United States it is called the Federal Reserve System or the Fed.

 

Initially when the United States was founded under the Constitution in 1789 the Secretary of the Treasury, Alexander Hamilton, suggested that a Bank of the United States be established; and it was in 1791. The bank served as a repository for federal funds and as the government’s fiscal agent.

 

The bank was privately owned, as money for it was subscribed by private citizens, but its prime function was to serve the new government. It was granted a twenty year charter by Congress and had branches in eight cities. Consequently in addition to acting for the government the bank also conducted general commercial business. Although it was well managed and profitable critics charged that it was favoring the mercantile class over agrarian interests. This brought about its temporary termination after its charter expired in 1811. In 1816 the Bank of the United States was reestablished because the country had faced financial problems during the War of 1812 and it received a new twenty year charter.

 

The Second Bank of the United States would exist until and through most of the second term of Andrew Jackson’s presidency. It’s President, Nickolas Biddle, attempted to force Jackson to sign a Congressional bill chartering another twenty year extension to the bank. President Jackson reacted to this by moved all new government income to a group of western banks, that became known as his “pet” banks, and spent the funds already deposited in the Bank of the United States before withdrawing funds from his “pet” banks to pay for the needs of the Federal Government. The Second Bank of the United States got a state charter and would eventually go bankrupt. The western “pet” banks went on a lending spree which inflated the sale of western land by hundreds of percent, resulting in a depression, when the bubble burst, that affected the entire United States during the tenure of the next President, Martin Van Buren. In any event the nation no longer had a Central Bank.

 

In 1913, during the Presidency of Woodrow Wilson, a new Central Bank was set up by Congress. It was called the Federal Reserve and was supposed to regulate the flow of currency within the nation in order to avoid the large and regular economic dips of recession and depression.

 

Its initial mission was to control Monetary Policy, the flow of money through the entire economy. Gradually Congress extended it purpose by new legislation. These gradual extensions were a broadening of Monetary Policy.

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Keep in mind that at this point in the history of the United States money or currency was specie; that is, it was gold or silver in the form of coins. Paper money did exist but it was a promissory note that could be exchanged at any bank, theoretically at any time, for gold and silver coins. However if this was done on a massive scale there would be a run on the bank and it would run out of money and go bankrupt. In order for business to properly occur more bank notes were printed than there was gold available.

 

Basically these metals, gold and silver, were purchased by the National Government and then minted into different denominations. The coins denoted the weight of the metal. A one ounce gold coin was a $20 gold piece. A one ounce silver coin was a silver dollar. Money, then, was exchanging value for value. The basic value of the metals was agreed upon international; so money as gold or silver could be used anywhere in the world.

 

In 1929, for various reasons, the Great Depression occurred. Under a Republican administration, that of President Herbert Hoover, the country, and, for that matter, the world, went economically downhill for the next decade. Each industrial nation had to work out its own deliverance from the Great Depression.

 

In 1932, the Democrat, Franklin D. Roosevelt was elected President of the United States. He introduced the “New Deal.” His basic program was the three R’s: relief, recovery, and reform. He attempted to offer employment to many of the unemployed, an end to the reasons for the depression, and reform by legislation or otherwise so it could never happen again.

 

Roosevelt was the longest serving President in the history of the nation. He served for four terms, through the Great Depression and most of World War II, dying in office during his fourth term.

 

Sometime during his first administration he had a bill passed by Congress that changed the use of money, first in the United States and then it was copied throughout the rest of the world. The Federal Government collected all the gold coins, with the exception of a small number that could be kept as souvenirs, issued paper silver certificates for one and five dollar bills and Federal Reserve Notes for any amount above that. The gold coins were melted down into bars of gold and stored in underground depositories like Fort Knox, situated around the country, with gold certificates issued for the gold, which the government kept on deposit to verify the value of the Federal Reserve Notes.

 

In essence money being worth its weight in gold became a myth. The gold certificates were never on display or otherwise available. There was never any record kept of actual gold being added or subtracted from the gold supply in the depositories. Money became paper, a token of no real value; everything else was a fiction.

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Early on in World War II the countries that were to become allies of the United States shipped their gold supplies to the U.S. I don’t believe the gold was ever returned to those nations. They spent the gold on buying supplies with which to fight the war. After the gold was spent the United States used a system called “lend lease” to supply its allies with the necessary food and war materials. Those goods were never really paid for monetarily. But World War II ended the last hangovers of the Great Depression. The United States and later the rest of the world emerged in different levels of economic fitness in 1945. All actual money had become paper tokens that were used to exchange goods and services for goods and services. The basic world currency, upon which all the other national currencies were based, after the war was the American dollar. It is still that today.

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The Federal Reserve came into being because of the depression or panic of 1907 and other extreme downturns in the economy. Attempts had been made during the late 19th and early 20th Centuries, by the moneyed class, mainly bankers, to control the economy mainly for reasons of profit. These, in turn, particularly when they failed, had exacerbated economic shifts within the economy, usually in a downward direction.

 

The Panic of 1907 and 1908 was also known as the 1907 Bankers Panic or Knickerbocker Crisis. Its causes took place initially over a three week period when the New York Stock Exchange fell almost 50% from its peak the previous year. It lasted for slightly over a year.

 

Monetary panics occurred during this time of economic recession and there were numerous runs on banks and trust companies. It spread throughout the nation with many state and local banks and businesses going bankrupt. The primary cause of the run was a retraction of market liquidity by a number of New York City banks and a loss of confidence among depositors, exacerbated by unregulated side bets of bank funds by banking executives.

 

The panic was begun in 1907 by a failed attempt to corner the market on stock of the United Copper Company. When this failed, banks that had lent money to the cornering scheme suffered runs that later spread to affiliated banks and trusts, leading a week later to the downfall of the Knickerbocker Trust Company, New York City’s third largest trust. The collapse spread throughout the city trusts as regional banks withdrew reserves from New York City banks. Panic extended across the nation as vast numbers of people withdrew their deposits from regional banks.

 

To simply state what happened was that the object was for a group of investors to gain control of the stock shares of United Copper Company. The group concerned controlled numerous banks and trust companies. They believed that a large number of shares had been borrowed and sold short. (To sell short is to sell a stock at a higher price before one owns it, then when the price drops buy the stock at a lower price, and eventually pocket the profit.)

 

The group believed that a majority of the stock was held by the Heinze family and that a significant number had been borrowed and sold short on the belief that the price would drop considerably. Their aggressive purchasing would drive up the price of the stock. The short sellers would be forced to come to them in order to purchase stocks that they had already sold and they could charge whatever they wished.

 

United Copper rose in one day from $39 to $52 a share. It then went up to nearly $60 a share, but the short sellers were able to able to find United Copper from other sources. The group has misread the Market and the stock price began to collapse. It closed at $30 and then dropped to $10 a share. The manipulators and the banks they represented were ruined. As news of the collapse spread depositors rushed to pull their money out of these banks. The run on banks spread throughout the city. A week later many regional stock exchanges throughout the nation were closing or limiting trading.

 

The hero of the crisis was J.P. Morgan. He coordinated the heads of the banks and trust companies and was able to keep the total economy of the United States from collapsing. The Panic of 2007 was from May 2007 to June 2008, 13 months. While it started and was centered in New York City the entire nation was involved. There was bank panic, runs on banks and trusts with crowds of depositors withdrawing all their funds, and falling stock prices that resulted in massive economic disruption. Production fell 11% in the nation, imports went down by 26%, and unemployment rose to 8% from under 3% two years earlier. Even immigration dropped to 750,000. It had been 1.2 million two years earlier. J. P. Morgan lost about $21 million straightening the situation out.

 

The frequency of economic crises and the severity of the 1907 panic led to a national debate on reform of the system. In May 1908 Congress passed the Aldrich-Vreeland Act that established a National Monetary Commission to investigate the panic and propose legislation to regulate banking.

 

It was discovered that the major difference between European and American banking systems was the existence of a Central Bank which controlled Monetary Policy. They could easily move money to where it was needed. The European nations all had one, the United States did not. The European states were able to extend the supply of currency during periods of low cash reserves. The United States had a great problem doing this.

 

The final report of the National Monetary Commission was on January 11, 1911. For nearly two years Congress debated the proposal. On December 23, 1913 Congress passed the Federal Reserve Act. President Woodrow Wilson signed the bill immediately and the legislation was enacted on the same day, December 23, 1913, creating the Federal Reserve System as the Central Bank within the United States.

 

 

English: Flag of the United States Federal Res...

English: Flag of the United States Federal Reserve Bank (Photo credit: Wikipedia)