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Ron Paul on the Origins of the Fed

Politics / Central Banks Dec 02, 2011 - 11:15 AM GMT

By: Dr_Ron_Paul

Politics

Diamond Rated - Best Financial Markets Analysis ArticleThe Federal Reserve cartelizes the banking industry, allowing individual banks to inflate together, earning them and the government enormous profits, while making sure that they are never held accountable for their fraudulent practices.


The Federal Reserve Cartelizes the Banking Industry

Here's how we got saddled with this monstrosity: In the early 1900s — during the so-called Progressive Era — the US government began a radical program of intervention into the economy. Pundits hailed this as fostering a new "spirit of cooperation" between business and government. In fact, the new system was a precursor of socialism and fascism.

Government-business cooperation took several forms, all of which conferred special privileges on favored firms, insulating them from the competition of the free market. Individual businesses and whole industries lobbied and bribed government officials for laws that benefited them at the expense of the consumer, and the whole operation was sold to the public as antimonopoly measures. This illegitimate and unconstitutional process happened time and time again, and government intervention became a permanent part of manufacturing, railroads, agriculture, and many other industries in the United States.

This was the era when the US free market received a beating, and, for lovers of liberty, its effect was much worse than the New Deal's.

In the free market, opportunity is granted to all and privilege to none. Laws affect all equally, businesses seek to meet the needs of the people, and the consumer is king. But in a system of government intervention, industries are no longer accountable to the needs of the people. They receive special privilege and status from the state. They are guaranteed profits, prices, and sales. Liberated from the dictates of the people, businesses are free to indulge themselves in plundering consumers.

These were the years of many evils: the income tax, "making the world safe for democracy" through World War I, centralization through direct election of senators, the imperial presidency, Prohibition, and the Federal Reserve System. Academics, as is still the case, provided intellectual cover for these crimes. Thornton Cooke, writing in the pro-big-government American Economic Review in 1911, explained why banking needs to be centralized: "American banking has made little use of the principle of cooperation, yet for a generation that principle has been the greatest single factor in American economics." The railroads have their "community of interest arrangements" and manufacturing "has been integrated" so now, he said, it's time to consolidate banking.

But in a System of Government Intervention, Industries Are No Longer Accountable to the Needs of the People

Cooke was arguing for a government-enforced banking cartel, similar to the railroad industry's. The new "collective spirit" of the American economy naturally leads to centralizing money and credit to argue for bank cartelization:

American banks, however, remain independent, almost isolated units. The effect of isolation has been heightened by the lack of power in any of the 2,300 units to issue a credit note. It is unnecessary to rehearse the arguments showing that our bank note currency is absolutely inelastic.… There is not one country bank, however small, that has assurance that any correspondent, however large, is powerful enough to save it if it needs saving in a general panic.

Cooke's arguments were typical, repeated again and again by promoters of the Fed. They said, the current system was inadequate, it was out of step with the times, it caused banker isolation, and most importantly, bankers needed stronger guarantees of monetary inflation when it was needed; i.e., they wanted bailouts and guaranteed profits.

About the then-current National Banking System (NBS), Cooke was lying. In fact a true gold standard monetary system with almost-free banking had not existed since two decades before the Civil War. The NBS actually represented a halfway point between free banking and central banking. And it did have problems, but these existed because of the government.

Chiefly responsible for passing the National Banking Act of 1863 was Ohio investment banker Jay Cooke, who gained a government-granted monopoly on public debt underwriting. His success in the bond business gained him enormous influence with the Republican administrations during the Civil War and after, and especially with Salmon Chase, secretary of the Treasury, from Ohio, and Senator John Sherman from Ohio. Together they were able to push through Congress and past the public the National Banking Acts, all of which would benefit banking tremendously. Fractional-reserve banking was guaranteed by the government at 15 and 25 percent reserves. A 10 percent annual tax on state bank note issues was required, to force state banks into the NBS. Legal tender status was imposed on the national-bank notes.

There was plenty of government intervention in the banking system already. The banks were not "isolated" and independent, as the advocates of the Federal Reserve Act suggested.

Because of a general dissatisfaction with the NBS, banking-reform movements began to emerge in the 1890s. Most historical accounts tend to concentrate on the political movements for reform, like the proinflation free-silver position of Bryanite populism and the arguments for the "correct" gold/silver ratio. The future, though, did not lie with these political movements. The reform to follow was more far-reaching and more fundamental.

Most of these vocal political movements had died out and were rejected by both parties by 1914. From the beginning of the debate, the business and banking community who wanted cartelization opposed the agenda of the political movements without any equivocation. Bankers wanted reform of the banking system, but of their own kind, for their own ends.

Many proposals for monetary reform were presented to Congress after the NBS-generated monetary panic of 1893, all of them designed by elements within the banking community. There was ignorance concerning the complexities of banking from virtually every other sector. Typical was Theodore Roosevelt who, like many politicians, bragged of his ignorance saying: "I do not intend to speak … on the financial question — because I am not clear what to say." Among the first to call for a modern totally centralized bank was Lyman J. Gage, President McKinley's secretary of the Treasury and former president of the American Bankers Association.

The central-banking movement began to grow a year before the Panic of 1907 in New York. Jacob H. Schiff, an investment banker, persuaded the New York Chamber of Commerce to advocate banking reform.

A committee was established, led by the most powerful investment and commercial bankers in New York, which concluded that the solution lay in establishing a central bank "similar to the Bank of Germany." The chairman of the board of Chase National Bank (now Chase Manhattan), A. Barton Hepburn, came next with his plan. He did not openly advocate a central bank; he urged creating regional clearinghouses that would issue bond-secured currency in varying amounts. These would be guaranteed by a common fund built up by taxes on the notes.

The Panic of 1907 brought about a sudden loss of confidence in the banking system, and the bankers seized the moment. Not everyone, however, wanted further centralization. The New York Times, standing alone, concluded that government intervention in the economy at all levels was responsible for the loss of confidence. Their opposition to a central bank was snuffed out. They were, of course, speaking against the desires of the establishment of powerful businessmen and bankers.

The Times polled Congress and found that they were either thoroughly confused, had a limited understanding over monetary affairs, or that their proposals were too vague to characterize. The Times did find, though, there was a consensus that any changes should be in the direction of an "intimate connection between the currency and legitimate trade. "They wanted "elasticity," the ability to inflate on demand. Into this vacuum stepped influential bankers.

In 1908 Congress passed a bill similar to Hepburn's plan called the Aldrich-Vreeland Act. (Senator Nelson Aldrich [R-RI] was the son-in-law of John D. Rockefeller.) It was established as a temporary measure to provide liquidity during emergencies. It wasn't used until after the Federal Reserve was established six years later, so the measure was relatively insignificant. But it did contain a clause that would prove to be highly significant. It called for a National Monetary Commission to study the National Banking System and make recommendations for future monetary reform.

The National Monetary Commission (NMC) was comprised of nine senators and nine representatives. Heading up the commission, holding the seat as chairman, was Nelson Aldrich, Rockefeller's "man" in the Senate. As with most congressional commissions, much of the work was done by intellectuals and powerful figures from outside Congress who came in to help with research and writing. Among these were Henry P. Davison, a J.P. Morgan partner, and George M. Reynolds, president of the American Bankers Association.

Also associated directly or indirectly with the NMC were the most vocal advocates of centralized banking reform: O.M.W. Sprague of Harvard, Edwin W. Kemmerer of Princeton, M.L. Muhleman, James Laurence Laughlin of the University of Chicago, H. Parker Willis of Washington & Lee University, Thornton Cooke, William A. Scott, and many others.

The commission produced a huge pro-central-bank document, assumed to be definitive, though really a boring monetary history under the National Banking System. The document's real function was to serve as the unanswerable critique of the status quo. Today, the Federal Reserve's own "Purposes and Functions of the Federal Reserve System" identifies the commission's research as the primary historical case for establishing the Federal Reserve.

The commission was given an unlimited budget and broad investigative power, and they used them in part to travel to Europe to observe their central-banking systems. It was during these travels that Senator Aldrich educated himself about the intricacies of central banking and became an open advocate of central banking.

The bankers themselves were not unified on the precise nature of the reform they wanted. And by 1909, as an issue, banking-reform discussion was limited to a small segment of the banking community. The bankers searched the whole year for a unified plan which they could support, and by the end of that year, they emerged unified. Their communications were generally aired through the Banking Law journal.

Several ingredients tied all reform plans together: central banking, the ability to inflate, and regional banking centers of the type endorsed by the American Banking Association. Also important among the bankers was avoiding the appearance of a banking system controlled by Wall Street. This was a strategic move designed to avoid the strong anti–Wall Street sentiment in America at that time. During 1910 the issue would have been dormant were it not for the influence of Paul M. Warburg, who played a primary role in establishing the Fed. He emigrated from Germany and became a member of the distinguished banking house of Kuhn, Loeb and Co. Long an advocate of central banking, his behind-the-scenes work propelled the NMC toward the direction of the German banking experience.

Warburg argued, as do current advocates of central banking, that certain sectors of the economy are unnecessarily strained during some seasons but not in others. For example, he argued, certain crops like wheat are harvested seasonally, and merchants and buyers are strained for sufficient cash to purchase what they might need for supplying the commodity during the upcoming months. The farmers then sell the wheat for below market prices, "dumping" it, which ultimately causes cyclical price fluctuations within the market for crucial commodities. These market fluctuations cause losses in all sectors, producers and sellers, and provide a disincentive to produce.

Inflating the Money Supply Benefits the Banker Who Is in Charge of Distributing Credit

Would an emergency currency help solve the problem? As Warburg says in his 1907 pamphlet "A Plan for a Modified Central Bank," it would not because during a crisis "the run of the depositors would have been carried into the ranks of the note holders, to the disaster of the entire money system." The answer, he says, lies in patterning the American banking system after the European model, in which money as credit is centralized and circulating notes are issued against sound commercial paper. These notes would meet the additional demand during seasonal changes, and the amount would naturally contract as the obligations are paid off.

As Warburg explained,

Most of the paper taken by the American banks still consists of simple promissory notes, which rest only on the credit of the merchant who makes the notes, and which are kept until maturity by the bank or corporation that discounts them. If discounted at all they are generally passed on without endorsement, and the possibility of selling any note depends on the chance of finding another bank which may be willing to give the credit. The consequence is that while in Europe the liquid assets of the banks consist chiefly of bills receivable, long and short, which thus constitute their quickest assets, the American bank capital invested in commercial notes is virtually immobilized.

The proposal was then for a modified central bank, with shares to be owned half by the US government and half by the national banks, and a capital base of $50–100 million ($1 billion in real terms). The bank would be a depository for the Treasury and also be a bank's bank. It would be able to issue notes of legal-tender status. These notes would circulate the process of banks' exchanging them for commercial paper endorsed by a member bank — limiting the number that could circulate at any given time. The commercial paper itself could also serve as money, if doubly and triply secured by the endorsement of the bank. It would do so by the individual bank itself issuing a note verifying the holding of such commercial paper. This eventually became the foundation of the Federal Reserve System.

The bankers, by now more properly called Banksters, wanted the ability to inflate together uniformly. Why inflate? In the same way counterfeiting benefits the counterfeiter, so inflating the money supply benefits the banker who is in charge of distributing credit.

Warburg as much as admitted that was their goal:

We need some centralized power to protect us against others and to protect us from ourselves-some power able to provide for the legitimate needs of the country and able at the same time to apply the brakes when the car is moving too fast.

Under his system, he assures us, banking crises would be minimized, if noticed at all.

Whatever causes may have precipitated the … crisis [Panic of 1907], it is certain that they never could have brought about the outrageous conditions, which fill us with horror and shame, if we had had a modern bank and currency system.

Further, he argued, America was way behind, and to keep up with "modern" banking methods, the National Banking System put America "at the same point that had been reached by Europe at the time of the Medicis, and by Asia, in all likelihood, at the time of Hammurabi."

Warburg always insisted his plan did not provide for a central bank, but rather a "modified" version. His plan, though, contained the elements considered to be part of centralization: all reserves would be controlled by central authority, enforced through governmental, i.e., coercive, means.

Warburg's brother-in-law became the chief advocate of the plan, Edwin R.A. Seligman of the investment banking family J. & W. Seligman and Company. Seligman was chiefly responsible for assuring the public that Warburg's plan did not involve total bank centralization and that his modified version would not be controlled by Wall Street. (A poll recently showed 59 percent of the bankers wanted a system that appeared to be free from "Wall Street or any monopolistic interest.")

During the year 1910, the NMC was releasing its proposals for monetary reform. Their plan bore remarkable resemblance to Warburg's. It called for substantial backing of notes with commercial paper rather than public or private bonds, and banks would obtain money through sale or rediscount of "notes and bills of exchange drawn for agricultural, industrial, or commercial purposes, and not including notes or bills issued or drawn for the purpose of carrying stocks, bonds, or other investment purposes."

The new bank, the National Reserve Association, was to issue notes secured by one-half gold, and a technical provision would allow banks to back currency with US government bonds at par value to the extent of half their value. This little-noticed provision would later become the basis of open market operations in the Federal Reserve System.

The authority over the quality maintenance of notes would rest entirely with the NRA. On the issue of the quantity of notes in circulation, the commission again adopted the view of Warburg: market demand for money would determine that by member banks' rediscounting their commercial paper with the National Reserve Association and issuing notes on that basis. The paper would mature and the notes expire after demand returned to normal.

The Only Disagreement That Occurred between the Conferees at Jekyll Island Was over the Issue of Partial or Total Centralization

The commission offered a 17-point criticism — with alternatives — of the then-current banking system. They complained, for example, that the current system "has no provision for the concentration of cash reserves of the banks and for their mobilization and use wherever needed in time of trouble." What they tried to make appear as a shortcoming was actually a blessing, as we now know.

Rockefeller and Warburg played a greater role in the drafting of the commission's actual bill than providing passive intellectual influence. Just before the release of NMC's final legislative recommendations, someone associated with Aldrich (no one knows who) proposed getting all leading big bankers and advocates of banking reform together for a secret meeting and drafting a bill. The supersecret meeting was to be held at the Jekyll Island Club in Georgia. The press reported only that they were going there for a duck-hunting expedition. The members all assumed names and traveled on a private railroad. During that week at the luxury resort, the bill that the commission would release (what would later become the Federal Reserve Act) was drafted. Among the shady participants at the important Jekyll Island meeting were

  • Senator Nelson W. Aldrich (Rockefeller in-law) Henry P. Davison (Morgan partner)

  • Paul M. Warburg (Kuhn, Loeb & Co.)
    Frank A. Vanderlip (VP of Rockefeller's National City Bank)

  • Charles D. Norton (president of Morgan's First National Bank of New York)

  • A. Piatt Andrew (Harvard economist, assistant to Aldrich on the National Monetary Commission, and banking expert)

The result of this meeting was the commission's bill, the Aldrich Plan, the basis of the Federal Reserve Act. The only disagreement that occurred between the conferees at Jekyll Island was over the issue of partial or total centralization. All wanted total centralization, but some were more politically astute than others and knew that Congress would never approve of a totally banker-controlled central bank.

Senator Aldrich, who strangely did not understand why centralization could not be presented outright, was overridden by the more politically astute Warburg, who endorsed the Morawetz version of regional banking centers under the cover of decentralization. The board of directors in the original Aldrich plan was to be chosen solely by bankers, but that was later changed in the spirit of decentralization to make half of them appointed by the president of the United States.

The bill was delayed for one year and finally presented before the Congress in January 1912 so that support for the bill could be consolidated. This was done by means of a conference in Atlantic City during February 1911 where 22 top bankers met to discuss the Aldrich Plan. It was warmly endorsed with the resolution written by Paul Warburg. As Gabriel Kolko says, "Indeed, the plan was endorsed at the outset. The real purpose of the conference was to discuss winning the banking community over to government control directed by the bankers for their own ends."

There was still the stigma of the bill's being the product of Wall Street, Rockefeller interests, and Senator Aldrich. To solve the problem, Warburg and other New York bankers created the National Citizens' League for the Promotion of a Sound Banking System. This would be a "grassroots" lobbying group headed up by economist J. Laurence Laughlin of the University of Chicago. Its purpose was "to carry on an active campaign for monetary reform on the general principles of the Aldrich Plan without endorsing every detail." This, of course, wasn't a "grassroots" movement. It was a get-rich-quick scheme promoted by the top-brass bankers in the country.

For the first time, during the year 1911, academic, economic, and banking journals were overflowing with praise for the Aldrich Plan. In June, William Scott of the University of Wisconsin wrote that the Aldrich Plan would solve the "most fundamental defects in our currency system, namely: its lack of elasticity; the uneconomical use of banking reserves, their connection with the stock market, and their control by Wall Street." The plan would "greatly increase the efficiency of our banking reserves" and would eliminate the "evil effects of our present independent Treasury system."

According to Scott,

Persons who suspect that any measure proposed by Senator Aldrich must necessarily be designed to play into the hands of 'the interests' will look for a joker in his plan. They will have considerable difficulty, however, in finding it.

Further,

Wall Street could control the new institution only by absolutely controlling a majority of the banks that will purchase stock in the new institution, and even then its control would be tempered by the influence of the federal government … which will be great.

So the plan should be adopted because it would "complete and perfect our present national banking system." It is, therefore, clear that the articles contained all the information thought most important by the League, Rockefeller, and Warburg.

Strange, isn't it, that an academic journal wouldn't concentrate primarily on debating the economic virtues and vices of the Fed, but would concentrate on selling it to the public?

In the same issue, Harvard economist O.M.W. Sprague, closely aligned with the commission, called the plan an "equitable means of banking reform" that reflects "the skillful handiwork of its experienced author." Every specific objection or fear which has been expressed … has been successfully met." The rest of the article was spent arguing for the placement of some regional banks in the West to insure that Wall Street would not control the new institution, once again reflecting what Warburg and Aldrich saw as the main obstacle to bank cartelization: the public's fear of Wall Street.

Thornton Cooke's echo argued for the plan in the same manner. He had glowing praise for the plan and assured the reader that "Wall Street cannot 'make money' out of the activities of the Association." The bank will only "furnish sufficient reserve of credit for ordinary seasonal needs," just as Warburg argued. In May of that year, the American Bankers Association approved the Aldrich Plan and endorsed a broader number of notes eligible for rediscounting.

Only later in the year did a split occur within the ranks. The split was not over the goals of cartelizing the banking industry, of course, but again over political tactics of doing so. President of the Citizen's League J. Laurence Laughlin was a political realist and knew that Aldrich's name had to be removed from the bill. H. Parker Willis, his good friend and close aide, had warned him about this earlier and now Laughlin was convinced. Even Warburg later separated himself in public from the name Aldrich but, of course, this had no bearing on the facts.

The Aldrich plan was presented to Congress in January of 1912, but with Aldrich about to retire and the Democrats about to win a victory later in the year, the bill never came to a vote; and banking reform was a dead issue for a while. The Citizens League continued, though, to function as a powerful and large-scale propagandist for banking reform, issuing pamphlets and brochures all over the country, especially in the South and West, educating people on the evils of the National Banking System and the benefits of centralized banking reform and a conglomerate banking cartel.

The league's periodical "banking reform" was made into a book with 23 chapters dealing with all aspects of banking reform, but 11 were written by H. Parker Willis, a student of Laughlin's, who received $1,000 (over $9,100 in real terms). Willis had taught at Washington and Lee University, and two of his ex-students recommended Parker to their father to be his administrative assistant. Their father was Carter Glass of Virginia, ranking member of the House Committee on Banking and Currency. Willis accepted. Glass needed an assistant for two reasons: first he had no technical knowledge of the banking business, and secondly, he was given responsibility of considering monetary reform and working against the efforts of Arsene P. Pujo to assign the problem of banking reform to the Pujo Subcommittee who was soon to hold hearings on the "Money Trust."

In June of 1912, Willis drew up a bill for Glass and reported to Laughlin in a letter, "After a good deal of talk with Mr. Glass, I drew up a bill along the lines of which you and I spoke, and turned it into him." The Pujo committee swung into high gear with its investigation into alleged abuse of power emanating from Wall Street. The result, though inconclusive, was to stir the public into a frenzy over Wall Street.

Through some remarkable "spin control," the new Glass legislation (the Fed bill) was promoted as an anti–Wall Street bill, building on a foundation established earlier with the Aldrich Bill. The Pujo Committee never won the legislative control from the Glass Committee, which still left Glass (i.e., Willis, Laughlin, and ultimately Warburg) in charge of the bill.

A final bill setting up the Federal Reserve was passed in December 1913 by a large majority in the House (the Aldrich Plan and the Glass bill were virtually identical). As Kolko says,

The entire banking-reform movement, at all crucial stages, was centralized in the hands of a few men who for years were linked, ideologically and personally, with one another … the major function, inspiration, and direction of the measure was to serve the banking community in general, and large bankers specifically.

Who authored the bill? No one knows. The controversy sprang up immediately but was never resolved.

H. Parker Willis later denounced the institution of the Federal Reserve and its inflationary policies and became extremely critical just prior to the Great Depression. Laughlin also attacked the Fed during his later years, although like Willis, not to the extent of repudiating his own role in its establishment.

There is one reason why we have a Federal Reserve System today, and it has nothing to do with what the Fed's publications say. The Federal Reserve exists to give a special privilege to the banking industry. And they have profited greatly from it. But at what expense? The banksters have diluted the value of the 1914 dollar to about eight cents. And its value is still shrinking.

As the Federal Reserve expands the money supply, it reduces the value of all existing dollars. The process happens, though, unevenly because not all prices rise at the same time. The first party to get the new money can spend it at its old purchasing power. Only after filtering through the economy does the money bid up prices for goods.

The Federal Reserve Exists to Give a Special Privilege to the Banking Industry

But who gets the new money first? Who experiences the boon from the credit injection? The bankers and insiders, of course. They wouldn't have it any other way.

As Ludwig von Mises has shown, the Federal Reserve is responsible for the business cycle as we know it today. With credit injections, the Fed lowers interest rates causing businessmen to invest in new capital equipment. They produce goods that consumers can't afford, and they eventually find that their plans don't pan out. This process spreads throughout the entire economy and creates ever-growing waves of booms and busts. A gold standard economy wouldn't have such a problem. There is no economic, constitutional, or moral justification for giving special privilege to big bankers over the rest of business or industry. They should be subject to competition in the free market, and the legal constraints against fraud, like everyone else.

Dr. Ron Paul
Project Freedom

Congressman Ron Paul of Texas enjoys a national reputation as the premier advocate for liberty in politics today. Dr. Paul is the leading spokesman in Washington for limited constitutional government, low taxes, free markets, and a return to sound monetary policies based on commodity-backed currency. He is known among both his colleagues in Congress and his constituents for his consistent voting record in the House of Representatives: Dr. Paul never votes for legislation unless the proposed measure is expressly authorized by the Constitution. In the words of former Treasury Secretary William Simon, Dr. Paul is the "one exception to the Gang of 535" on Capitol Hill.

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