The Economist and George Selgin have provided us with two complementary pieces of financial history that provide background on the founding of the Federal Reserve.
The Economist has a terrific essay on the history of financial panics, from the 1700s all the way up to the 2008 crisis. These types of articles are never deep dives into history, of course, so they tend to leave out key details.
Selgin’s post at FreeBanking.org fills in some of those details and provides much-needed context for the panic of 1907 and the subsequent creation of the Fed. For starters, the 19th-century U.S. banking system was a mess for many reasons, few of which are covered in the Economist essay.
Selgin sheds light on one of the more underreported problems of this era: The National Banking Acts of the 1860s greatly contributed to financial panics. During this time period, banks issued their own currency, and the National Banking Acts all but guaranteed future cash shortages. Selgin points out that the acts
provided for the establishment of federally (as opposed to state) chartered banks, subject to the requirement that any notes issued by the new banks be fully, or (at $110 nominal backing for every $100 of notes outstanding) more than fully, secured by U.S. government bonds.
When very few banks signed up for the national charters, the federal government didn’t have enough bond buyers. They still needed to raise money, though, so they instituted a 10 percent tax on state bank notes (currency). By the end of the Civil War, the national banks were essentially the only issuers of currency, and the system was doomed to fail for at least two reasons.
First, the total amount of U.S. currency (known as greenbacks) was capped by law until 1875. More importantly, as the federal government reduced its debt, there were fewer bonds to serve as security for new currency. Selgin notes, “Total national banknote circulation, which stood at over $300 million around 1880, had fallen to less than half that amount a decade later.”
Selgin’s post also provides a good summary of how the politics of William Jennings Bryan contributed to the passage of the Federal Reserve Act. These are some of the details that show how unpopular a central bank was in the U.S., contrary to what The Economist’s stylized version seems to imply.
The great irony in this story is that Bryan and his followers helped to create a monopoly far more powerful than anything that existed at the time, even though they were vehement enemies of a currency monopoly. Read together, the Economist essay and the Selgin post fill in some of these blanks.