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Monday, May 11, 2009

History of Central Banking in the USA

Wikipedia has a decent article on this subject. (I feel dirty linking to Wikipedia.)

The first US central bank was created in 1791, shortly after the Federal government was created. It was given a 20 year charter. It was a disaster and the charter was not renewed in 1811. Some people say this was the true cause of the War of 1812. The War of 1812 was retaliation for Congress not renewing the charter of the central bank.

The second US central bank was created in 1816. It was also given a 20 year charter. In 1836, Andrew Jackson vetoed the renewal law. Andrew Jackson then placed all Federal government deposits in state banks. Andrew Jackson fully repaid the national debt.

From 1836-1863, the banking industry was nearly completely unregulated at the Federal level. It was still regulated at the individual state level.

In 1863, the National Bank Act effectively nationalized the banking system. I liked this quote from Wikipedia:

all national banks were required to accept each other's currencies at par value

This was a legal tender law. If bank A was nearly insolvent, but bank B was sound, then bank B was forced to accept money from bank A at par. Sound banks were unable to protect themselves from insolvent competitors, by refusing to accept their paper.

Further, state regulation of the banking industry forced banks to operate under unsound fractional reserve principles. Competing alternatives, such as warehouse receipt banking or time deposit banking were essentially illegal.

In Santa Clara County v. Southern Pacific Railroad (1886), the US Supreme Court ruled that corporations were entitled to the same rights as humans, as a consequence of the 14th Amendment. This wasn't the main issue of the case. The Chief Justice made a remark to that effect during the trial, which was repeatedly cited later.

This was a prime example of the Supreme Court "legislating from the bench". Congress didn't explicitly pass a law saying that corporations had the same rights as humans, regarding property ownership and making contracts. It was implemented via a Supreme Court decision.

Now, every bank was incorporated using limited liability incorporation. This gave bank management and owners a free put option to declare bankruptcy and cheat their depositors and creditors. Limited liability incorporation, combined with State regulation of the banking industry, led to several severe banking crises.

This led to the creation of the Federal Reserve in 1913. Whenever a big "Reform industry X law!" is passed, the regulation is written by insiders and lobbyists from that industry. That's what happened when the Federal Reserve was created. A handful of insiders wrote the Federal Reserve regulation, and presented it to the general public as a law that would limit abuse of the financial industry.

Except for President Lincoln's Greenbacks, which were not gold-redeemable, the Federal Government didn't issue banknotes before 1913. The Federal Government only minted coins. Banknotes were printed by private banks. If a bank was insolvent, then all its paper became worthless. Regulation of the banking industry forced people and banks to accept banks' paper at parity with gold. In 1913, Federal Reserve Notes were issued indirectly by the Federal government. They were gold-redeemable until 1933, so people didn't complain that much as they were introduced. Anybody who objected to Federal Reserve Notes could redeem them for gold. People who took this sensible precaution were thwarted by President Roosevelt's default and gold confiscation in 1933.

In 1791 and 1816, the central bank was given only a 20 year charter that had to be explicitly renewed by Congress. The Federal Reserve was given an indefinite charter. Do you think the Federal Reserve could have gotten its charter renewed in 1933 during the Great Depression?

There also were other provisions that made the Federal Reserve politically untouchable. The 14 year terms for the Board of Governors made the Federal Reserve not subject to the control of the President or Congress.

Theoretically, Congress could reform/repeal the Federal Reserve with a majority vote and the signature of the President. The Federal Reserve is politically untouchable. Most Congressmen do not understand the corrupt nature of the US monetary system (except for Ron Paul and maybe a few others). The financial industry receives *MASSIVE* State subsidies. Some of this money is spent on lobbying to prevent reform. Some of this money was used to purchase or control mainstream media corporations, making it impossible for them to do a critical analysis of the Federal Reserve.

There's another important point. In 1811 and 1836, the bad guys lost. The State still existed, and the bad guys merely tried again later. In 1886 and 1913, the bad guys won, and the free market in the USA was severely eroded. If the bad guys attempt to erode individual freedom and fail, then they merely try again later. The State, which is the primary source of the bad guys' power, still exists, even if an attempt to erode individual freedom fails.

People are allowed limited illusions of freedom, because this makes them more productive workers/slaves.

In the present, reform of the banking system is practically impossible. There are too many people who benefit from the current corrupt system. Complete collapse is more likely than reform.

1 comment:

Scott said...

Good article.

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