The Federal Reserve is in the news a lot these days, but despite its prominence and importance to the world economy, not many people know about how it got its start just over 100 years ago. Although we take the Fed for granted today, its creation was bitterly contested over many years among warring factions and involved highly vitriolic public discourse.
“America’s Bank” is an exceptionally well-researched book that dives directly into this debate and describes the byzantine intellectual, political and legislative processes that led to the establishment of the U.S. Federal Reserve in 1913.
You don’t need to be an economist to read this book and establish a basic understanding of how and why the US came to embrace the concept of a central bank. The need was acute. Yet the concept was so radical at the time that it took many years for it to come to fruition. Given the challenges, it’s quite remarkable that the Federal Reserve Act was ever signed into law.
Roger Lowenstein is a seasoned financial writer who has a knack for covering complex material, and rendering it in a highly readable and accessible way. America’s Bank provides great background on the structure and mechanics of today’s Fed, since it outlines the arguments surrounding their establishment at the outset.
Lowenstein illuminates the context of the early debate as he describes in practical terms the day-to-day banking and monetary challenges experienced by farmers and businessmen of the era, and adds fascinating descriptions of conditions in the 1800s. The book is also peppered with quotes from a variety of sources, including newspapers, personal letters, and hearings, that provide an insider’s view of the political trends. It was truly an “epic struggle,” as Lowenstein observes.
What I like about the book?
One thing I really liked about the book is how it laid out the early history of money and currencies in the U.S., the various problems these created, and how the creation of a central banking system might remedy those problems.
At the turn of the 19th century in the U.S., a fractionalized financial system existed in which local banks issued their own currencies. In response to this chaotic situation, the federal government authorized a network of banks to issue a uniform currency – National Bank Notes. The banks were required, however, to invest a portion of their reserves in government bonds (which also allowed the government to finance the civil war). But this created a new problem: the quantity of notes in circulation was determined by the amount of government bonds the banks held, instead of by demand. Thus, when farmers needed cash for their fall harvest, money was scarce and interest rates soared. The currency lacked “elasticity” to accommodate the ebbs and flows of the business cycle. The currency was backed by both gold and silver, but as people began to redeem silver for gold at par, gold disappeared from circulation, culminating in the Panic of 1863, in which hundreds of banks failed, requiring the intervention of J.P. Morgan to bail out the Treasury. What was needed was a central institution that could flexibly redistribute capital and credit when and where it was needed.
The debate was highly politicized, since there was widespread populist mistrust of Wall Street and of the concept of a centralized Federal authority. When another panic swept the U.S. in 1907, with the stock market dropping 40%, once again it was J.P. Morgan who provided financing to stabilize the system. But Morgan was preparing to retire, and many were fearful of so much power residing in the hands of a private citizen. The notion of currency reform began to take on a more urgent tone in the country.
In a first step, Senator Nelson Aldrich drove legislation that allowed banks to issue National Bank Notes in an emergency. While stopping short of centralizing reserves, this was notable in that for the first time, such currency could be backed by bank assets (railroad bonds) rather than by government bonds. But there was more to do.
Aldrich embarked on a European tour to examine central banking institutions in England, Germany and France. Who owned the central banks? Who controlled them? What counted as reserves (e.g., cash, bills of trade, other liabilities)? What were reserve requirements? Who held the reserves?
Next, in 1910 Aldridge convened a secret meeting with bank executives at Jekyl Island, Georgia to design a central bank for the U.S. This was a pivotal point in the evolution of banking reform, and the book provides insight into the clash of personalities and debate at Jekyl Island that shaped the “Aldrich Plan,” and eventually the creation of the Reserve Association of the U.S., which introduced the pooling of reserves, a single interest rate for the country, and a centralized reserve authority that would set policy. These were the precursors to the Reserve Act and the subsequent creation of the Federal Reserve System we recognize today.
In many ways, the hero of the book (or at least my favorite character) is Paul Warburg, a German banker who settled in New York. Warburg was among the earliest advocates for a central bank, as existed in his native Germany, and he played a significant role at Jekyl Island. Warburg and Aldrich were the principle early architects of monetary system reform. Others played a role as well, including Frank Vanderlip, Carter Glass, Woodrow Wilson, and numerous others.
Lowenstein details their internal debates and discussions around the central bank question, such as public/private ownership of the Fed, government/private board representation, the number of branches, reserve requirements, the ability of member banks to borrow at the discount window, and the types of loans that qualified for conversion into currency. Over time, these debates emerged on the public stage and Federal Reserve Act was drafted and signed into law. The diligent efforts of these early architects enabled them to come to grips with these questions and ultimately unite the legislature and the court of public opinion. It was an extraordinary effort.
In the end, the creation of the Fed propelled the U.S. to global financial leadership and set the stage for the U.S. dollar to become the international currency. You can make a good argument that this was among the greatest legislative accomplishments of the 20th century.
While the exploration of the policy debates were the book’s strength, they were also a weakness at times. I became a little lost in some details -- especially when it came to the political and legislative back and forth as bills were being negotiated. Also, although the book was mostly chronologically organized, it detoured to follow policy tangents which I found confusing.
While I enjoyed getting a sense for the personalities, at times I felt Lowenstein went too far depicting personal histories, such as his description of Aldrich’s remodeled mansion with a “grand marbled stairway in the entrance hall.” Does this give you a sense for Aldrich’s priorities? Well sure, but I still felt some of this background was superfluous.
Yet although the book did sometimes read like a history text, Lowenstein’s lively style amply compensated for the occasionally dry subject matter. He’s a great writer.
I emerged from the book with a sound understanding of the big picture of the Fed’s history. Lowenstein provides a comprehensive overview of how the Fed came to be structured the way it is, and the debates that shaped it. It’s a great resource for anyone interested in the Fed and monetary policy.
It was fascinating to read about the practical limitations of the early banking system and how they led to an investigation of central banking solutions that seemed so intuitively appropriate to Warburg--a man ahead of his time--but were anathema to many others.
I gravitated to this book because the Fed has always seemed somewhat peculiar to me, and little mysterious. Now it all makes more sense; given this rich background, I have a deeper appreciation for the Fed’s current form and role. Lowenstein also adds some informative commentary relating to the modern Fed and how it has evolved from its earliest days that was also helpful to my own understanding.
I was struck by something else while reading the book. While the need for the Fed may seem obvious to some in retrospect, in many ways, in 2016 we’re not that far removed from the debates of that era. Here we are still having many of the same arguments 100 years later. We still hear voices calling for more or less restrictive monetary policy, for more or less regulation, or even for the Fed to be abolished. These are essentially the same issues that Warburg and his colleagues debated. As Mark Twain is reputed to have said, “history does not repeat itself but it rhymes.” And rhyme it does, across the ages. While people will no doubt continue to debate these issues far into the future, anyone who wants to be an informed participant in the debate should read America’s Bank. I highly recommend it.