The origin story of the Federal Reserve is one of the most interesting stories I have ever heard. The real story of how the federal reserve was created and designed sounds exactly like a conspiracy theory, but even the Fed writes about their origin story with the same content that, if written by someone else, that someone else is deemed to be wearing a tinfoil hat. So how did the Federal Reserve start? On November 20th to November 30th, 1910, an estimated 25% of the worlds net wealth at the time congregated in secret on Jekyll Island off the coast of Georgia to plan the American monetary system that, with a little tweaking, we still know today.
Conspiracy, Fact, or Does it Matter?
A concept that is worth mentioning before diving too deep into what happened on Jekyll Island is deciding what really matters. Is it the intentions of those individuals or the consequences of what they built that are important? This is also a bit of a universal question; you can ask this of any fiscal policy or other policy decisions as well. This is where the narratives of what was told by the founders of the system and the so-called conspiracy theorists deviate. Also, to be honest, the word “conspiracy” should probably be placed in quotes since a lot of what is deemed conspiracy theory by the more mainstream is actually published openly by the Fed themselves. I just wanted to mention this because I have no opinion on where the line between fact and theory lies yet, people tend to make judgements about these types of things based off of their beliefs and feelings without the proper amount of study, which I think should be at least a few years. This is why cross referencing is important.
For a great starter book that gives a unique perspective on the Federal Reserve, check out The Creature from Jekyll Island by G. Edward Griffin. Griffin really attacks this topic from multiple angles and give an interesting perspective. I thoroughly enjoyed the book and it definitely makes you aware of all the different angles this topics can be viewed from.
Reformation Required
Before the advent of the Federal Reserve System, America was in a period of wildcat banking where banks and other financial institutions were more or less left to their own devices. One of the arguments against this system is that it was prone to liquidity freezes, thus leading to bank runs and currency drains. Since cash had to be physically moved between banks for settlement, when one city or location started to economically prosper, bank reserves would flow into the banks at that locale. However, during financial panics, these bank reserves tended to freeze in place and therefore weren’t able to alleviate the liquidity problems at locations throughout the country. This immobility of bank reserves led to volatile equity markets and financial instability.
On the other hand, across the pond in Europe their bank portfolios comprised more of short-term commercial paper leading to more liquidity therefore granting the banks the ability of come up with cash more readily in a crisis. In other words, their banks loaned more to businesses on a short-term basis, so when those businesses paid back their loans, which matured more quickly, the banks would receive the principal and interest more frequently, allowing for a steadier stream of cashflow for them to draw on in the event of systematic liquidity problems. Also, by giving loans for a shorter duration, they significantly decrease the amount of risk that would be acquire throughout the years. Example of these risks could be wars, famine, or just other events that could have a serious impact on the macroeconomics environment.
In terms of the currency, this was during a time when the U.S. dollar was on the gold standard. Therefore, the value of the currency was pegged to gold. Also, the supply of these dollars was pegged to the supply of government bonds. This led to an inelastic money supply and interest rates would vary drastically based on the seasonal needs of the population. This inelasticity of the money supply was one of the characteristics of the monetary system that the Jekyll Island goers thought necessary to change. It was deemed to be archaic and a sign that the American financial system was “at about the same point that had been reached by Europe at the time of the Medici, and by Asia, in all likelihood, at the time of Hammurabi” [2].
As a bit of an aside, American banks during this time had trouble clearing checks outside of city boundaries. This made commerce between cities and states troublesome and risky as cash had to be physically moved over long distances. This problem of moving cash over long distances is still a problem today and is something the Federal Reserve is trying to remedy. They are calling this new initiative Cash Visibility (CV). Here is a YouTube video where you can learn some more about it (link).
In 1908, senator Nelson Aldrich sponsored a bill that created the National Monetary Commission, of which he was the chairman, to study possible reforms to the financial system. The birth of this committee was most likely due to the Panic of 1907, yet another banking panic since the end of the civil war. Within this committee, Aldrich hired Henry Davidson, a partner at J.P. Morgan, and A. Piatt Andrew, the economics professor at Harvard, as advisors. From there they traveled to Europe multiple times to study their banking system, which would become the original model for the Federal Reserve.
The Panic of 1907
The Panic of 1907 was one of multiple financial panics between the civil war and the creation of the Fed. Depending on the how each one was classified, there are counted to be 2 other major banking panics and 8 more localized panics in the United States during this time frame [2]. Due to the inelastic money supply along with there being approximately 27,000 banks in the US that were all connected to larger banks in a complex system of interbank deposits and clearinghouses, strains on the financial system tended to spread quickly throughout the system. Thus, leading to systematic volatility that could be difficult to pinpoint its origins to the untrained eye.
Essentially, the panic of 1907 started in trusts and other financial entities that were outside of the purview of the national banks. This panic resulted in the need for J.P. Morgan, and supposedly John D. Rockefeller as well, to bail out the institutions that they deemed worthy. This caused New York bankers to realize if future panics were any larger, they might be unable to stop it, even with their collective amount of assets. Before this, a lot of the older bankers didn’t believe that a central bank was necessary, however, this panic changed their mind. Now, whether this change of heart was the source or just happened at the same time of Aldrich’s creation of the National Monetary Commission, I am not sure. However, it certainly did not hurt that the power players of the time were in favor of such a monetary development.
How Did The Federal Reserve Start? With Duck Hunting
After the trips to Europe and a few years of study of the European financial system, Aldrich convened a small group to help him draft a plan to set before congress to establish an American version of a central bank. This group included Aldrich’s private secretary Arthur Shelton, Henry P. Davidson (partner at J.P. Morgan), Abraham Piatt Andrew (assistant secretary of the U.S. Treasury), Frank Vanderlip (president of National City Bank), and Paul M. Warburg (partner at Kuhn, Loeb and Co). For this fateful trip in November of 1910, the façade of a duck hunting trip was used, and all of the members were to use their first names only as a way to hide their identities. Originally meeting in a train terminal in New Jersey, each member arrived one at a time to Aldrich’s private train car as not to be seen together and raise suspicion. All were aware that this meeting on Jekyll Island off the coast of Georgia was meant to be in secret, and the discussions there were not to be repeated.
The Plan Acquired
The plan they manufactured should sound very familiar. For one, the money supply must be made elastic, fixing what were deemed problems of an inelastic money supply (i.e., immobility of bank reserve). Essentially, the system that was theorized was designed to fix all of the problems of the former American financial system, as deemed by the participants, as well as being modeled off of the European’s version of a central bank.
Called the Reserve Association of America in the proposal, the system would have a single central bank with 15 regional branches where each branch was to be governed by a board of directors who were elected by the member banks within their respective region. The responsibilities of the branches were to hold reserves for their member banks, issue them currency, discount commercial paper (the discount is similar to interest paid), and settle accounts between the member banks. As for the national bank that oversaw the 15 branches, it was responsible for open market operations and setting discount rates for the entire system.
This was Aldrich’s plan which he presented to the National Monetary Commission in January of 1911. However, with a presidential election coming up the next year, democrats took advantage of the voters’ uneasiness of a centralized monetary authority, and with a democrat victory for the presidency (Woodrow Wilson) and control of both houses, the bill was killed.
However, leaders of the democratic party understood that reform was still necessary, so they devised their own version. Their version was very, very similar to Aldrich’s plan, essentially only varying in the political and decision-making structures. Most other technical details resemble those of Aldrich’s plan, to the point where some sections were verbatim. This version was written by Carter Glass and Robert Owen. It was this version that passed as the Federal Reserve Act of 1913. When Glass attempted to take all of the credit for its creation, the Jekyll Island crew decided to come out of the woodworks with information about their “duck hunting” excursion. Can’t let some politician take credit for what a banker created.
The Culprits
Part of the reason the meeting on Jekyll Island had to be done in secret and such extreme precautions were taken was due to the background of the meeting’s participants. If the public was aware that the world’s most influential financiers and businessmen meet to devise a plan for reforming the American financial system, to say it wouldn’t have gone over well would be a serious understatement. That being said, I’d like to give a little more background on each of the participants for reasons that will become obvious once stated.
Nelson W. Aldrich
As one of the more prominent republicans in the senate, he became the chairman of the National Monetary Commission which eventually led to the Federal Reserve system that we are familiar with today. He was also an alleged business associate of J.P. Morgan as well as the Father-in-law to John D. Rockefeller jr.
Frank A. Vanderlip
Vanderlip was an American banker and writer. He was the President of the National City Bank of New York at the time of passage of the Federal Reserve act and beforehand he was the Assistant Secretary of the Treasury a decade prior to its passage.
Abraham Piatt Andrew
Andrew was an American economist (at Harvard when he advised Aldrich before Jekyll Island) and Assistant Secretary of the Treasury during the escapade.
Henry P. Davison
Starting his career as a bookkeeper to a bank, he eventually worked his way to being a partner at J.P. Morgan and Co. His journey involved becoming the Vice President of the First National Bank of New York and founding the Bankers Trust Company, which he grew to the become the second-largest trust company in the country.
Benjamin Strong
Strong was the President of the Bankers Trust Company of New York and become the first Governor of the Federal Reserve Bank of New York. Interestingly, there is some debate about Strong’s presence on Jekyll Island for the meeting. There are records of family members of Strong stating that he was not present, however, Vanderlip states otherwise in his memoirs of the event.
Paul M. Warburg
Warburg was fundamental in the creation of the Federal Reserve system. As a German-born investment banker, he advised both Aldrich and Glass with their plans for what developed into the system we know today.
Final Words
The Federal Reserve system is one of the most interesting entities on the planet, at least in my opinion. The story of its birth screams conspiracy theory, but its creators came out into the open about it. However, its controversy doesn’t end with its origin story, from its operations to its structure, it creates so many different points of view and opinions that its hard to not get enthralled in its depths. Maybe its due to its role in the realm of money and its seemingly extensive power and influence on the global stage. It truly is a monster. Now, if it is just a monster due to its pure size, its role in global finance, or some malicious intent, I will leave that for you to decide. Regardless of those opinions, monster need to be place in the open for all to see, with sunshine being the best critic.
To your wealth and future,
James Forsythe
For more on the Federal Reserve
https://jamesdforsythe.com/overview-of-the-federal-reserve-system/
https://jamesdforsythe.com/federal-reserve/
References
[1] https://www.federalreservehistory.org/essays/jekyll-island-conference
[2] https://www.richmondfed.org/publications/research/econ_focus/2015/q1/federal_reserve
