The Creature from Jekyll Island: A Second Look at the Federal Reserve

In the preview to the fourth section, Griffin states that the Fed is the fourth central bank in America. “The Creature Comes to America” is the story of the first two central banks. The Bank of North America was chartered in 1781 by the Continental Congress, modeled on the Bank of England. It could practice fractional reserve banking and grant loans but had to keep some gold and silver in reserve. The bank notes were accepted by the government for tax payments and duties, but there were no legal tender laws associated with the bank notes. In a short time, the bank’s unpopularity resulted in its charter expiring, and it became a commercial bank.

In 1790 Alexander Hamilton proposed the establishment of The First Bank of the United States. He was opposed by Thomas Jefferson, who argued that Congress had not been given the right to create a bank. Hamilton argued that a certain amount of debt was good for the economy and that there wasn’t enough money in circulation, which a central bank could fix. Congress, in 1791, sided with Hamilton and established The First Bank of the United States with a 21-year charter. The bank primarily loaned money to the government, as it could only charge 6% interest on loans, making small loans less profitable. Although the Bank caused inflation, the fractional banking it practiced had sufficient controls to limit that inflation.

At the same time as The First Bank of the United States was operating, there were plenty of smaller banks, often called Wildcat banks because of their remote locations. These banks were required by law to keep some reserve specie. However, the banks would often share on-hand specie, moving it from bank to bank when state inspectors arrived. The First Bank would refuse to accept notes from banks that didn’t prove sound in their reserve practices. As a result, the First Bank provided some controls on fractional reserve lending. Griffin argues that a free market would serve the same function but concedes that the Bank had some positive effects.

The First Bank of the United States failed to gain a new charter in 1811 largely because Jefferson’s Republicans were joined by bankers and industrialists who wanted to be free of the Bank’s controls. The smaller banks, now free from the effects of the central bank, drove up inflation and caused general discontent. Griffin asserts that the market would have regulated itself in a short period of time, but the War of 1812 intervened. The war, Griffin asserts, was publicly unpopular and the political justification for it was unsound. However, it benefited the banks, allowing them to loan massive amounts to the government for armaments.

The Second Bank of the United States was established in 1816, ostensibly to bring the small banks back in line. Its initial investments mirrored the Bank of North America and the First Bank of the US in that its specie reserve was much lower than promised and many of its principal investors were not American. The Second Bank initially refused to accept bank notes from banks that would not produce specie on demand. The smaller banks responded in kind leading the Second Bank to adjust its policies. In response, many more state banks were created and began fractional reserve banking leading to inflation.

The Second Bank responded to inflation differently than the two previous banks. It began to reduce its loans and recall outstanding loans. The rationale was to cool down inflation to stabilize the economy. Many small banks went out of business as a result and their depositors were left with nothing. Griffin points out that this can happen in a free market, but it would be localized to a single bank or a couple of banks. After this, states passed laws imposing a tax on paper notes distributed by a bank that was not locally chartered.

The Second Bank was taken to the Supreme Court when it refused to pay a tax levied by Maryland on its notes. The Court upheld both its existence and its ability to refuse a state tax. The decision in McCulloch V. Maryland is problematic because it both held that the Second Bank was not a government institution and therefore could print money, and held that the Bank was an instrument of government and so could not be required to pay state tax.

In the 1820s, Jefferson’s opposition to a central bank was revived in Andrew Jackson’s Democratic Party. Jackson was elected to the Presidency in 1828 and began to try to dismantle the Second Bank. Nicholas Biddle, head of the Second Bank, asked Congress to renew the Bank’s charter early. Jackson vetoed the re-charter, arguing that the Bank’s profit system was unjust because the average depositor was paying far more for banking services than the richest citizens, and a significant portion of the proceeds went to foreign investors. Biddle and Jackson’s opposing positions dominated Jackson’s campaign, but Jackson won re-election.

Jackson’s first full attack on the Second Bank was his order to put all new government deposits in state banks and drain the government’s account in the Second Bank. When his Secretary of the Treasury refused, Jackson fired him and replaced him to accomplish his aim. Biddle steeply decreased loans which sent the economy into a panic depression. The Senate censured Jackson in 1834, but Biddle stated what he was doing with the Bank’s power, and both the public and Congress were swayed back to Jackson’s side. Congress began to recall the vote of censure and passed three resolutions to support Jackson’s actions: one stating the Bank should not be rechartered, the second supporting Jackson’s removal of deposits, and the third establishing a committee to investigate the Bank’s role in the economic problems.

Biddle refused to cooperate with the investigation but avoided a contempt charge. There was an assassination attempt on Jackson which Griffin implies was engineered by European financiers. In 1836, the Second Bank’s charter ended, and it became a state bank in Pennsylvania, closing permanently within five years. Biddle was arrested but not convicted for fraud.

Griffin concludes with a discussion of the pitfalls of Jackson’s presidential term. Although Jackson succeeded in destroying the Second Bank, he changed the political atmosphere of the nation. Until Jackson, Presidents were seen as public servants, but Jackson established the potential of a national leader acting as a monarch or despot.

Jackson continued to try to extricate the US economy from the fractional reserve banking problems by passing monetary reforms including limiting the issuance of paper bank notes. The goal was to return to an economy of specie rather than paper. However, even with the dissolution of the central bank, the banking system was functioning as fractional reserve and the death of the Second Bank resulted in a depression. The political response was to attempt to stabilize the banking system. Griffin describes four methods that could be used for stabilization.

The first is exemplified in Massachusetts. The state attempted to limit the issuance of bank notes based on vault reserves. Although banks were still allowed to loan more than they held in assets, they could only issue up to twice their capital. This failed to consider the effect of checkbook money. Massachusetts ended up in economic trouble in the mid-19th century because of checkbook money treated as capital.

A second approach was a security fund in case a bank needed a bailout, which Griffin compares to the FDIC. All the banks had to contribute a small percentage of their capital to the fund so all would be equally responsible. These safety funds, however, required responsible banks to rescue irresponsible banks and rewarded risky loans. Most of those funds were quickly depleted.

A third option was government-backed securities, which resulted in massive inflation. The fourth method was to create individual state banks, but they simply functioned like central banks in miniature. They created massive inflation and then failed, leaving depositors destitute and fleeing the state.

The Free Banking movement arose from these reforms. Banks with no state charter began to operate across the country. However, these banks were still beholden to regulations, and their leadership was insulated from consequences for failing to return deposits. These banks had the same problems as other fractional banks.

The mid-19th century saw Western expansion on the frontier. Fractional banking is often praised for funding expansion and business development, but Griffin argues that if the bank system were entirely gold-backed, there may have been fewer business failures.

Griffin turns to the Civil War, arguing that it was primarily about economics and not about slavery or states’ rights. He offers several quotes from Lincoln which state his primary goal was to preserve the union regardless of how that affected slavery. Griffin then explores the reasons the union was in jeopardy leading up to the Civil War.

The Southern states were agrarian and depended on enslaved human labor to produce the cotton which made up most of their profitable exports. They imported their manufactured goods from the industrial Northern states or from Europe. European goods were less expensive, which put pressure on the Northern states to reduce costs. Instead, the Northern states put pressure on Congress to impose import duties on European goods. These duties put economic pressure on the Southern states.

Griffin asserts that a further economic threat to the South came from the threat of national abolition. If the South’s primary means of production—enslaved human labor—were made illegal, production would stall and the plantations would fail, leaving the South in a serious economic depression. Because Lincoln was a Northern politician and beholden to the Northern industrialists, Griffin argues, his fundamental goal was to protect the industrial Northern interests.

The additional pressure between North and South came from foreign interests. The Monroe Doctrine had established the Americas as an area no longer available for conquest by Europe. France, England, and Spain wanted to control South American markets with Mexico as a primary goal. If the US became embroiled in conflict between North and South, their military would not be available to enforce the Monroe Doctrine. Further, the Rothschilds and other European central banking financiers were concerned about a financially and politically independent, strong nation. A civil war that split the nation would serve the interests of central bankers in Europe.

The intervention of England and France to support the Confederacy put massive military pressure on the North. However, Russia was threatened by England, France, and Spain at the time and dispatched ships to blockade Southern harbors. There was never an overt alliance between Russia and the Union or England and France and the Confederacy, but the presence of military forces in harbors and at borders affected the outcome of the war. The presence of the Russian warships made it difficult for England and France to provide supplies to the South.

Griffin claims that because the war was initially about business interests, the Union had difficulty inspiring the public to join the fight or to fund the war. Therefore, the war’s purpose shifted to abolition. Lincoln’s Emancipation Proclamation, Griffin argues, functioned as propaganda changing the focus of the War to freedom. The immediate result was that the European powers stopped supporting the Confederacy and there was a surge of Northern recruits to the war. That initial surge waned quickly, and both North and South resorted to enlistment bonuses and conscription to fill their armies. When bonuses were insufficient in the North, Lincoln instituted a highly unpopular draft which resulted in riots and demonstrations eventually leading to the army firing on civilians. Lincoln suspended habeas corpus and imprisoned many citizens without due process. Griffin argues that Lincoln’s willingness to ignore the Constitution with respect to individual rights supported his actions to create money to fund the war.

There was no central bank to provide loans for war funding. Sale of government bonds provided some funding, but ultimately the Union printed fiat money to make up the difference. Greenbacks (so called because of their green ink) were issued and required to be accepted for all private debts while not acceptable for taxes or government duties/fees. Lincoln’s position was that it was better for the government to issue its own money than to accept loans from banks at high interest rates.

Under pressure from the banking and finance powers unhappy with greenbacks, Congress passed the National Banking Act in 1863 as a temporary war measure. The Act established a network of national banks controlled by the federal government. The Act allowed the national banks to purchase government bonds with gold and issue bank notes which could be used to pay taxes and duties by the public. The bonds would still mature and be profitable for the banks and the bank notes were lent out for interest, so the banks made profit on both sides. These banks were required to reserve roughly 12% of their gold for depositors and there was no legal tender law tied to the bank notes issued. The fiat money created by the national banking system as well as the fiat money created in the Confederacy created massive inflation and economic insecurity at the close of the war.

Griffin reflects on Lincoln’s actions during and after the War. His portrait of Lincoln is of a man who was more concerned with protecting the Union than the Constitution. On the other hand, Griffin notes that Lincoln offered amnesty to Southern states after the war and vetoed the Wade-Davis emancipation bill which, Griffin claims, would have benefitted the Rothschilds and financiers over the people of the South. Partially because of Lincoln’s split decisions, Griffin says, there arose a powerful society comprised of Northern Republicans, industrialists, and financiers as well as Confederate sympathizers. This society was called the Knights of the Golden Circle, and its twofold purpose was to oust Lincoln and gain power in the North, and to conquer Mexico in the South to preserve slavery as an institution. The Knights of the Golden Circle, according to Griffin, eventually became the Ku Klux Klan.

Griffin ends with a musing on the mystery of John Wilkes Booth and Lincoln’s assassination. He suggests that the conspiracy theories which abound surrounding that event may be more credible than initially apparent.