Origins of the Federal Reserve: Wall Street Discontent

0:00Origins of the Federal Reserve, Wall Street Discontent By the 1890s, the leading Wall Street bankers were becoming increasingly disgruntled with their own creation, the national banking system. In the first place, while the banking system was partially centralized under their leadership, it was not centralized enough. Above all, there was no revered central bank to bail out the commercial banks when they got into trouble to serve as a lender of last resort. The big bankers couched their complaint in terms of inelasticity. The money supply, they grumbled, wasn't elastic enough. In plain English, it couldn't be increased fast enough to suit the banks.

0:49Specifically, the Wall Street banks found the money supply sufficiently elastic when they generated inflationary booms by means of credit expansion. The central reserve city banks could pyramid notes and deposits on top of gold and thereby generate multiple inverse pyramids of monetary expansion on top of their own expansion of credit. That was fine. The problem came when, late in the inflationary booms, the banking system ran into trouble and people started calling on the banks to redeem their notes and deposits in specie. At that point, since all of the banks were inherently insolvent, they, led by the Wall Street banks, were forced to contract their loans rapidly in order to stay in business, business, thereby causing a financial crisis and a system-wide contraction of the supply of money and credit.

1:47The banks were not interested in the contention that this sudden bust was a payback for a wiping out of the excesses of the inflationary boom that they had generated. They wanted to be able to keep expanding credit during recession as well as booms, hence their were called for a remedy to monetary inelasticity during recessions, and that remedy, of course, was the grand old nostrum that nationalists and bankers had been pushing for since the beginning of the republic, a central bank. Inelasticity was scarcely the only reason for the discontent of the Wall Street bankers with the status quo. Wall Street was also Increasingly Losing its Dominance over the Banking System Originally, the Wall Street bankers thought that the state banks would be eliminated completely because of the prohibition on their issue of notes.

2:46Instead, the state banks recouped by shifting to the issue of demand deposits and pyramiding on top of national bank issues. But far worse, the state banks and other private banks began to out-compete the national banks for Financial Business. Thus, while national banks were totally dominant immediately after the Civil War, by 1896, state banks, savings banks and private banks comprised a full 54 percent of all bank resources. The relative growth of the state banks at the expense of the nationals was the result of National Bank Act regulations. For example, the high capital requirements for national banks and the fact that national banks were prohibited from having a savings department or from extending mortgage credit on real estate.

3:41Moreover, by the turn of the 20th century, state banks had become dominant in the growing trust business. Not only that, even within the national banking structure, New York was losing its predominance vis-à-vis banks in other cities. At the outset, New York City was the only center reserve city in the nation. In 1887, however, Congress amended the National Banking Act to allow cities with a population over 200,000 to become center reserve cities, and Chicago and St. Louis immediately qualified. These cities were indeed growing much faster than New York. As a result, Chicago and St. Louis, which had 16 percent of total Chicago, St. Louis and New York bank deposits in 1880, were able to double their proportion of the three cities' deposits to 33 percent by 1910.

4:42In short, it was time for the Wall Street bankers to revive the idea of a central bank and to impose full centralization with themselves in control. A lender of last resort that would place the prestige and resources of the Federal Government on the line in behalf of fractional reserve banking. It was time to bring to America the post-Peel Act central bank. The first task, however, was to beat down the populist insurrection, which, with the charismatic, pietist William Jennings Bryan at its head, was considered a grave danger by the Wall Street bankers. For two reasons. One, the populists were much more frankly inflationist than the bankers. And two, and more importantly, they distrusted Wall Street and wanted an inflation which would sidestep the banks and be outside banker control.

5:40Their particular proposal was an inflation brought about by monetizing silver, stressing the more abundant silver rather than the scarcer metal gold as the key means of inflating the money supply. Brian and his populist had taken control of the Democratic Party, previously a hard money party, at its 1896 National Convention, and thereby transformed American politics. Led by the most powerful investment banker, Wall Street's J.P. Morgan and Company, all the nation's financial groups worked together to defeat the Brianite menace, Aideen McKinley to defeat Brian in 1896. and then cemented the victory in McKinley's re-election in 1900. In that way, they were able to secure the gold standard act of 1900, ending the silver threat once and for all. It was then time to move on to the next task, a central bank for the United States.