I recently read Roger Lowenstein’s new book America’s Bank: The Epic Struggle to Create the Federal Reserve. In his investigative work for America’s Bank Lowenstein has succeeded in taking apart the complex puzzle of the Fed’s origin and brings rationality to how all the parts fit together. By describing every single phase of the bill’s evolution, from the first Jekyll Island meeting with Aldrich, Warburg, et al., the Congressional drafting by Glass and Willis, Wilson’s championship of the plan, and the government bank plans of Treasury Secretary McAdoo and Vanderlip, each step in the process is given a legislative and personal origin. It is exciting as a reader to see such a complicated subject reduced to its component parts.

Lowenstein’s work also demonstrates that the struggle of different views is relentless in history. The results can only be understood by a nuanced understanding of the interaction of views. He has done a great service in bringing color to subjects about the history of the Fed which are often painted in black and white from uneducated theory.

Limitations before “America’s Bank” and the Primacy of Bank Credit

America’s Bank does an amazing job detailing the shortcomings of the National Banking System. He provides a great deal of letters and other primary source material about how the system’s own structure piled up too many cash reserves in New York, as well as how money shortages came about in the agricultural states during harvest season.

I thought Lowenstein missed one important reason for the repeated shortages of money from in the late 1860s through the 1890s. The original 1864 act specified only $300 million in banknotes. Congress failed to remedy the problem after 1865 despite repeated calls from Comptroller’s Freeman Clarke and Hiland Hulburd to expand the amount. Consequently, not only were there shortages of national bank notes, but importantly, there were always more legal tender notes than national bank notes, making the latter irredeemable. These factors were repeatedly stressed as causal to the inelastic nature of the currency, the shortage of national banks, the over reliance on correspondent banking, and the concentrations of reserves leading to speculation. This fact is important because it demonstrated that the failures of the National Banking System were not entirely intrinsic to its design, but due to inaction of Congress.

America’s Bank provides an excellent illustration of how arcane our cash based system was in comparison with Europe and why the Fed was in large part a means of bringing our banking system up to modern times. I also came upon this in my own research. Each national bank had its own cash reserves and at high levels. They were 25% in the major reserve cities and 15% in second tier cities. The Federal Reserve didn’t just make banks place cash in the reserve banks as their reserves, it did away with cash reserves. Instead, banks were required to keep deposits at the Fed, which are largely credits.

Ever since the end of the 1850s, the use of cash payments was very small in large cities and business required payment on credit. Only in the unpopulated areas without sufficient banks, or where there was great distance between people, was cash a requirement. The National Banking Act’s cash reserve problem was due to a holdover from the Independent Treasury system instituted due to the period of Jackson, Van Buren, and Tyler. Bank credit was deemed unsafe for government to use. We went from the second Bank of the U.S., where bank credit (including bank notes) was the basis of almost all payments in the country, to an insistence by the government to only receive and pay out gold in the Treasury. The rest of the public continued to use banks and their bank notes, but without the federal regulation supplied by the second Bank. The National Banking Act made national bank notes acceptable for government use as cash, and legal tender notes became a cash replacement for gold and silver. But the problem of using cash reserves remained because no bank had use for that much cash, since people didn’t want cash, they wanted credit. The economy had become based on credit payments from the simple evolution of the speed of transactions. Over 90% of all transactions were made with checks by the 1870s and 1880s. So, the demand for cash by the National Banking System, combined with government legislation that restricted the amount of national banknotes made it impossible to have an equitable distribution of cash throughout the country, and it piled up in places to be used for speculation.

A deposit at a Federal Reserve Bank was preferable to a cash reserve at one’s own bank because of the simplicity of transferring money. It became a clearing house system at the Fed where the transfer of money for payments was accomplished through the simple balancing of credits and debits on the books of the reserve banks rather than complicated network between individual banks as before (although some major cities like New York, Philadelphia, and Boston had clearinghouses for sometime).

A deposit at the Fed was also preferable to cash reserves because of inability of an individual bank to adjust in times of crisis. Idle money is lost profit, and each bank attempted to generally make full use of its cash by lending its reserves to New York. Then there would be a mad scramble for reserves when money was short, and by then it was too late. Having reserves at the Fed would make them less liable to be used for speculation, and having them based on credit allowed less money to remain idle and more useful for the economy.

Wilson, Bryan, and Theories about the Fed

America’s Bank has a lot of letters showing Woodrow Wilson’s internal thinking as to the Federal Reserve Act. Wilson wrote about the second Bank of the U.S., that its supporters “were in a measure justified in claiming that for such a purpose the very government itself had been set up.” This is interesting. For one, it is a true statement, since the formation of the Bank of North American and the first Bank of the United States by James Wilson, Alexander Hamilton, Robert Morris were directly connected to many of the leading powers that led into the Constitutional Convention. Second, it is important to see Wilson’s knowledge of history, instead of seeing him as simply a person who gave a rubber stamp to the bill. Lowenstein shows a tremendous correspondence between Wilson and the drafters of the Federal Reserve Act. He supported it for very practical reasons, such as those I describe above, not for ideological reasons. This played an important role in his ability to broker the Fed Act. He didn’t join anyone’s particular camp. The way in which Wilson put William Jennings Bryan in his cabinet reminded me of how Lincoln put Seward in his cabinet. Having a leading rival working for you is better than speaking against you on the outside.

Lowenstein also has a great illustration of Bryan and his role in the process of the Act. In my own research, I have come to understand the subtleties about legal tender notes and their positive and negative elements. They became disruptive to the National Banking System in the end of the 1860s and after the 1873 crash, the greenback and silver movement (government currency backed by silver) essentially became fatal to its ability to grow. H. Parker Willis described in his work that making the Federal notes an obligation of the U.S. was a way to appease the government currency coalition. He has a section toward the end that shows just how elaborate and varied were the number of drafts about the Federal Reserve Act, and how many forces were involved. It reads almost like a ping pong match at one point, going on between the government currency camp and the bank credit camp. It would appear that the anti-National Bank legal tender movement instituted a permanent government currency theme into the character of the currency.

America’s Bank also addresses the ideas that cast the Fed as plan wholly engineered by J. P. Morgan, the Rothschild’s, and the like, to control the money supply and monopolize credit for their own profit. These include, for example, the idea that the 1907 crash was orchestrated in order to provide the impetus for the Fed or that Jekyll Island was about creating a cartel to control all banking in the U.S. Lowenstein provides a useful service in connecting these arguments to the specific people who originated the statements about them in different newspaper articles.

I definitely recommend this book for anyone who wants to understand the origins of the Fed and the issues that were at stake at the time of its creation.