An Early History of Central Banking in the United States

To what extent did the political climate in the U.S. influence the evolution of central banking from its inception to the creation of the Federal Reserve?

Central Banks and Washington

A political purpose

Dependence on gov't personalities

• Inception of 1st and 2nd BUS: War debt (Revolutionary war/War of 1812) --> a political necessity
• Not monetary policy and bank control, but "govt's fiscal agent"
• No central bank indepencence

"By the grace of the Eternal God, will rout you out!"

Federalists vs. Antifederalists

Introduction

vs.

Changes brought about by the Federal Reserve & evaluation of its efficacy

• End of the second BUS due to state bank competition

1836 - 1913: The Free Banking Era, National Banks and the creation of the Fed

Objectives of the Federal Reserve System

Historical context

Has the Fed been able to uphold its original objectives?

The "Free Banking" Era (1837-1862):

Central banks' role in the economy

-With the loss of the Second Bank’s charter in 1836, only state-chartered banks existed. Each state would have its own laws on banking, and banks had a high degree of freedom.

-The Michigan Act of 1837 made the creation of banks easier, which lead to the birth of many unstable banks (24 state chartered banks in 1797; 712 in 1837). These banks were short-lived, and half of them failed quickly.

-Emergence of “unofficial” central banks: the Suffolk Bank in Boston and the New York Safety Fund.

-Overall, highly unstable financial situation during these three decades.

Since the creation of the Federal Reserve System, the dollar has been inflated over 2,000%

- In 1776, the Continental Congress signed and adopted the Declaration of Independence, thus severing their ties with England and acting as government of the future USA.

National Banks (1863 - 1913):

• Control of the money supply
• Open-market operations
• A "banker's bank"
• Lending to other banks
• Stabilizing the economy
• Open-market operations
• Reserve requirements/deposit facility interest rate
• Discount rate/marginal lending facility

- But the Revolutionary War lasted up until 1783, when the British troops left the colonies. The United States were left devastated from the war, and with an astronomical debt, most of it to foreign investors such as France.

-The outbreak of the Civil War and the need for the Union to finance it led to interest in national banks, regulated by National Banking Act of 1863.

-This new “national banking system” created national banks ( more regulated than state banks), a uniform national currency and helped in financing the Union for the war.

-National banks were successful (in 1870, there were 1,683 national banks vs. 325 state banks).

-Two drawbacks of this system: necessity to back up currency with treasuries, and seasonal liquidity spikes, which lead to numerous panics and depressions (1873, 1893 and 1907).

-After panic of 1907, bankers and government understood the necessity for a federal central bank, and the Federal Reserve was created six years later.

John Trumbull, Declaration of Independence, 1817

Emanuel Leutze, Washington crossing the Delaware, 1851

Also, we must keep in mind that the United States was at the time limited to the Thirteen Colonies, located on the East Coast of the country. Territorial acquisitions in following years would expand the country's size.

The central bank's policy is dependent on the state of the economy: Inflation targeting, steady money supply, GDP targeting...

It seems, then, that the central bank's actions and characteristics are determined by economic necessity... Or aren't they?

Conclusion

1790-1836: The First and Second BUS

Centralize public debt under federal gov't!

• In its early history, central banking in the U.S. was a highly political endeavor
• Central bank independence was (to a certain degree) not achieved until 1913
• Today, criticism of the Fed resembles the constitutionality discussions of the early 1800s

Outline

• A historical overview of the development of central banking in the U.S.
• 1790-1836
• 1836-1913
• An analysis of the relationship between the political climate in Washington and central banking
• Heavy political dependence of earlier central banks
• Changes brought by the Federal Reserve
• Conclusion

The Early History of Central Banking in the United States

Benjamin Alt & Lorenzo Falchi