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

American banking after the Civil War and prior to the Federal Reserve Act had become more centralized but was still lacking a “lender of last resort” (403). In addition to the national banks created in the wake of the Civil War, many new banks opened in the south and west which refused to join the national system and competed with the national banks. Non-national banks outnumbered and outpaced national banks the year the Federal Reserve Act was passed. In addition to the direct banking competition, 70% of investment capital came from within businesses instead of through bank loans.

As the Morgan Firm and German banking firm Kuhn, Loeb & Company got larger, Griffin claims, they began to cooperate rather than compete. However, with new powers coming into the inner circle of banking, especially John D. Rockefeller, the small group at the top wanted to prevent any more newcomers. Griffin argues that within any cartel there is an inherent threat that one member will want to gain more power and money to rise above the others and potentially break the agreements that protect the whole. Therefore, after Rockefeller rose to financial power rivaling Morgan, they agreed to advance a strategy to protect their insular interests.

Griffin claims that the mechanism of protection was the federal government. In 1908, Congress passed the Aldrich-Vreeland Act, spearheaded by Nelson Aldrich. The Act allowed national banks to create emergency fiat currency and created a National Monetary Commission. The Commission was created to investigate and determine how to stabilize the banking system. It was led by Aldrich who focused all the Commission’s study on European central banking. Aldrich’s networking and study led to the Jekyll Island meeting.

In Griffin’s version of events, there was a five-part goal for those at the meeting: stop small bank competition; make the money supply elastic; pool bank resources to a central reserve; shift losses to taxpayers; and “convince Congress that the scheme was a measure to protect the public” (408). The first four goals would all be contained in a single piece of legislation. To accomplish the last goal, they would have to avoid the appearance of a central bank; instead, the bank would appear to be part of the government. They would use the public’s anger and frustration at recent banking instability as primary fuel. To further avoid public push-back, they would need academics to sanction the project, and the heads of Wall Street (especially Morgan and Rockefeller) would need to speak out publicly against the plan.

Aldrich publicly asserted that the Federal Reserve System would not be a bank. The movement to a true central bank, Griffin claims, would be gradual. Initially the System would appear decentralized and only over time would function similarly to the Bank of England. The Aldrich Bill was touted as a measure to prevent banking monopolies. In essence, the institution proposed in the Bill was like the previous Banks of the United States. The one major difference was that the Federal Reserve would be given the power to create legal tender in paper form.

Professor J. Laurence Laughlin at the University of Chicago was selected to head the National Citizen’s League whose mission was to educate the public and lobby the government for banking reform. Woodrow Wilson was another prominent academic who, Griffin says, had long been indebted to the high financiers. When the Aldrich Bill failed to be brought to a vote and Aldrich was voted out of the Senate, the Democrats came to power both in Congress and in President Woodrow Wilson, a Democrat.

Griffin traces the three-way presidential campaign in 1912 between incumbent William Howard Taft, Woodrow Wilson, and spoiler Teddy Roosevelt. Wilson, Griffin says, was the most attractive candidate to further the Federal Reserve plan. According to Griffin, Taft was only nominally funded to keep up appearances, while Wilson, who espoused supposedly anti-central bank views in keeping with his party, was indebted to Wall Street. Roosevelt, Griffin claims, was funded primarily by the Morgan Group as a third-party candidate. The goal was to elect Wilson, and although he didn’t receive the majority of the popular vote, he beat both Roosevelt and Taft to become President.

There was still a cadre of politicians opposed to central banking led by William Jennings Bryan. Wilson’s adviser, E.M. House, provided the strategy to defeat this opposition. Griffin describes the level of power and influence that House wielded in the Wilson presidency through biographies and excerpts from House’s personal journal. House provided Wilson with much of the information relevant to banking and banking reform and was the mastermind behind most of Wilson’s finance decisions for the nation.

After the failure of the Aldrich Bill, the National Citizens’ League advanced a plan to create a new bill centered around banking reform. The new bill was spearheaded by Virginia Congressman Carter Glass, who had vocally opposed the Aldrich Bill. Griffin claims that the drafting of the bill was deceptive in practice, primarily because, according to Griffin, the new Glass-Owen Bill was identical in substance to the Aldrich Bill. To lend credibility to the bill, Glass held public hearings to include bipartisan input on the Bill’s content. However, Griffin says that the Bill had already been written and was not changed in response to those hearings. Aldrich and Vanderlip publicly condemned the new Bill, which Griffin says they did to convince the smaller banks and the public that Morgan and the Rockefellers were fearful of the legislation. Glass directly told smaller banks that if they didn’t support his Bill, they were likely to fall prey to more controlling legislation.

The primary roadblocks to the Bill were Bryan’s objections that private banks would be issuing private money. Therefore, the Bill’s sponsors had to agree that the notes issued by the Fed would be Treasury currency and that the governing body of the Fed would be appointed by the federal government. These concessions were made, and Bryan became a supporter of the Bill, which passed as the Federal Reserve Act in 1913.

Griffin discusses the functions of the Federal Reserve and its role in the Great Depression of the 1930s. He asserts that the original Act was deliberately vague in order to invite new interpretations and revisions, and that there have been 195 amendments to the Act since its passage.

Benjamin Strong was the first Governor of the New York Federal Reserve Branch and acted as the leader of the system. He was closely connected to the major financiers in New York and England. Griffin claims that the inflation in the US which benefitted England was a function of the Federal Reserve under the influence of Benjamin Strong. He asserts that men like Strong who have served as Fed leaders have questionable loyalties.

Following WWI, farmers in America had become highly prosperous. They placed most of their money into local banks which had not joined the Federal Reserve System. The Federal Farm Loan Board offered these prosperous farmers large amounts of credit at low interest rates. The Fed then raised interest rates steeply, which prevented the farmers from either paying the interest or borrowing what they needed for maintenance. The farmers and the banks went out of business, and the entire nation was negatively affected by the Fed’s lowering and raising interest rates rapidly.

According to Griffin, there are two primary ways in which the Fed manipulates the economy. The first way is by setting the required reserve ratio, or telling banks what percent of their deposits they must keep in reserve. If the Fed lowers that ratio, then banks can loan more, without the loans getting repaid or getting new deposits which puts more currency into the economy. The other method is by influencing the commercial loan interest rate. It accomplishes this through the discount window. Once the bank has loaned out all it is allowed to loan, it either must collect loans, gain new deposits, put its profits in reserve, or borrow from an outside source. Most of the time, banks borrow from the Fed by “going to the discount window” (438). When the banks acquire that money, they loan it at the same reserve ratio. The more available loans, the lower the interest rate, so the Fed can lower or raise the interest rate on loans in the marketplace by adjusting the interest rate at the discount window.

Both these methods have limits. Eventually, the banks won’t need or want more loans because their customers won’t want more loans, and the lowest reserve ratio is zero. In that case, the Fed can buy and sell securities or government bonds in the bond market. That method also has a limit based on how many bonds are available for sale. The final method by which the Fed puts money into the economy is the “acceptance window.”

When a large international sale occurs, it is common practice for the buyer and seller to use Bankers’ Acceptances to facilitate the sale. The buyer’s bank promises the seller’s bank to cover the cost of the sale when the buyer receives the goods. The seller’s bank pays the seller the agreed-upon price. Both banks collect a small fee for this service, but the return comes out of the completed sale, and it can take time for the seller’s bank to collect the profit. The seller’s bank can offer the acceptance to the marketplace for a percentage of what their fee would have been. The percentage at which the acceptance is sold is called the “rate of discount.” These markets were unpopular in the US until the Fed set the discount rate of acceptances low enough to entice sellers to offer more for sale. That only takes care of the supply side of the equation, so the Fed promised to buy all the acceptances. According to Griffin, that action encouraged banks to buy more acceptances knowing that the Fed would cover them at any time. The creation of this market hugely benefitted a few financiers, but ultimately the fiat money flowing into the economy created an expansion of the money supply so large that, Griffin claims, it led to the Great Depression.

During WWI Congress funded the war effort primarily through the sale of Liberty and Treasury bonds. Some of these were purchased by the public with savings or loans, which only slightly inflate the economy. The majority were bought by the Fed. The bonds then became the basis of money in the US economy. The Fed bought the bonds in part to lower interest rates in the States to encourage borrowing from abroad which resulted in American money moving overseas.

Whether by accident or design, the government discovered that the Federal Reserve System could provide funding without formal taxation by using the open market. Benjamin Strong, Griffin argues, used the open market to transfer wealth from the United States to England. He created the Open-Market Committee that resulted in the New York Federal Reserve Bank, of which he was governor, to carry out all open-market operations on behalf of the Fed.

Because of artificially low interest rates, more credit was available to foreign nations, major companies, and average consumers in the 1920s. Although the currency in circulation remained relatively static, there was still significant inflation in the guise of “money substitutes, such as bonds and loan contracts” (446). Before the Fed, Griffin asserts, bank failures occurred, and affected some consumers, but largely these were isolated events, and the economy in those areas recovered quickly. After the Fed, however, the booms and busts were extended and seemed to build upon one another. Because the banking system was now connected and the banks weren’t allowed to fail, the challenges of one bank spread to the entire US economy.

Griffin follows what he calls a roller coaster of booms and busts throughout the 1920s, culminating in the Great Depression. He argues that the sixth reason to abolish the Fed is that instead of stabilizing the economy as it purports to do, it destabilizes it through the very measures it claims create stability.

Using the example of the tulip market in Holland in the 1600s, Griffin describes a tendency in people to behave like a herd. Griffin points to lotteries and casinos as evidence that people will often risk more than is prudent for the possibility of a big payoff. That tendency drove individuals and banks to speculate on the stock market during the cheap and easily available credit crafted by the Fed in the 1920s.

The difference between the stock market boom and the other booms and busts of the decade was that the Fed did not step in to smooth the coming bust as it had in the past. At least, Griffin argues, not for the public. In February of 1929, following a meeting between Secretary of the Treasury Mellon and Norman Montagu, the Fed warned its members to liquidate their stocks.

Even after the major players liquidated their stock holdings, the public was actively reassured by the financiers and government that the economy was strong. Griffin claims that following clandestine visits from Montagu and secret meetings between Treasury and Federal Reserve representatives, the Fed and the Bank of England began to shrink reserves in August of 1929 and raise interest rates in both nations. In late October, the market crashed and speculators sold everything. The buyers were largely those who had been warned and had shored up their wealth in cash and gold, so had the money to buy the steeply discounted stocks.

Griffin offers another law of human nature and economics: that any man given the temptation and opportunity is likely to privilege himself at the expense of others. The power to control the money supply of a nation will result in a few getting richer at the expense of everyone else.

The stock market crash didn’t result in the Great Depression on its own. Certainly, some people invested their life savings on risky loans and lost that, but those who had invested with real money largely kept their stocks and recovered as the market recovered. What Griffin says ought to have happened was a short panic and a quick recovery, but instead the government intervened. Legislation marketed as rescue plans to shore up from the Crash, in addition to more money pumped into the economy by the Fed, increased the economic devastation rather than counteracting it. At the end of the decade, even with all the reforms, it still took another World War to recover from the Depression.