Central banking in the United States
Main article: History of central banking in the United States
The first paper money issued in the United States was by the Massachusetts Bay Colony in 1690. Soon other colonies began printing their own money as well. The demand for currency in the colonies was due to the scarcity of coins, which had been the primary means of trade at the time. A colony's currency was used to pay for its expenses, as well as a means to loan money to the colony's citizens. The bills quickly became the primary means of exchange within the colonies, and were even used in financial transactions with other colonies. However, some currencies were not redeemable in gold and silver, which caused their value to depreciate quickly.
The first attempt at a national currency was during the Revolutionary war. In 1775 the Continental Congress issued paper currency, and called their bills "Continentals". But the money was not backed by gold or silver and its value depreciated quickly.
In 1791, which was after the U.S. Constitution was ratified, the government granted the First Bank of the United States a charter to operate as the U.S.'s central bank until 1811. Unlike the prior attempt at a centralized currency, the increase in the federal government's power-granted to it by the constitution-allowed national central banks to possess a monopoly on the minting of U.S currency. Nonetheless, The First Bank of the United States came to an end when President Madison refused to renew its charter. The Second Bank of the United States met a similar fate under President Jackson. Both banks were based upon the Bank of England. Ultimately, a third national bank-known as the Federal Reserve-was established in 1913 and still exists to this day. The time line of central banking in the United States is as follows:
1791-1811 First Bank of the United States
? 1811-1816 No central bank
? 1816-1836 Second Bank of the United States
? 1837-1862 Free Bank Era
? 1846-1921 Independent Treasury System
? 1863-1913 National Banks
? 1913-Present Federal Reserve System
Creation of First and Second Central Bank
The first U.S. institution with central banking responsibilities was the First Bank of the United States, chartered by Congress and signed into law by President George Washington on February 25, 1791 at the urging of Alexander Hamilton. This was done despite strong opposition from Thomas Jefferson and James Madison, among numerous others. The charter was for twenty years and expired in 1811 under President James Madison, because Congress refused to renew it.
In 1816, however, Madison revived it in the form of the Second Bank of the United States. Early renewal of the bank's charter became the primary issue in the reelection of President Andrew Jackson. After Jackson, who was opposed to the central bank, was reelected, he pulled the government's funds out of the bank. Nicholas Biddle, President of the Second Bank of the United States, responded by contracting the money supply to pressure Jackson to renew the bank's charter forcing the country into a recession, which the bank blamed on Jackson's policies. Interestingly, Jackson is the only President to completely pay off the national debt. The bank's charter was not renewed in 1836. From 1837 to 1862, in the Free Banking Era there was no formal central bank. From 1862 to 1913, a system of national banks was instituted by the 1863 National Banking Act. A series of bank panics, in 1873, 1893, and 1907, provided strong demand for the creation of a centralized banking system.
Creation of Third Central Bank
Main article: History of the Federal Reserve System
The main motivation for the third central banking system came from the Panic of 1907, which caused renewed demands for banking and currency reform. During the last quarter of the 19th century and the beginning of the 20th century the United States economy went through a series of financial panics. According to many economists, the previous national banking system had two main weaknesses: an inelastic currency and a lack of liquidity. In 1908, Congress enacted the Aldrich-Vreeland Act, which provided for an emergency currency and established the National Monetary Commission to study banking and currency reform. The National Monetary Commission returned with recommendations which later became the basis of the Federal Reserve Act, passed in 1913.
Federal Reserve Act
The head of the bipartisan National Monetary Commission was financial expert and Senate Republican leader Nelson Aldrich. Aldrich set up two commissions-one to study the American monetary system in depth and the other, headed by Aldrich himself, to study the European central banking systems and report on them. Aldrich went to Europe opposed to centralized banking, but after viewing Germany's monetary system he came away believing that a centralized bank was better than the government-issued bond system that he had previously supported.
In early November 1910, Aldrich met with five well known members of the New York banking community to devise a central banking bill. Paul Warburg, an attendee of the meeting and long time advocate of central banking in the U.S., later wrote that Aldrich was "bewildered at all that he had absorbed abroad and he was faced with the difficult task of writing a highly technical bill while being harassed by the daily grind of his parliamentary duties." After ten days of deliberation, the bill, which would later be referred to as the "Aldrich Plan", was agreed upon. It had several key components including: a central bank with a Washington based headquarters and fifteen branches located throughout the U.S. in geographically strategic locations, and a uniform elastic currency based on gold and commercial paper. Aldrich believed a central banking system with no political involvement was best, but was convinced by Warburg that a plan with no public control was not politically feasible. The compromise involved representation of the public sector on the Board of Directors.
Aldrich's bill was met with much opposition from politicians. Critics were suspicious of a central bank, and charged Aldrich of being biased due to his close ties to wealthy bankers such as J. P. Morgan and John D. Rockefeller, Jr., Aldrich's son-in-law. Most Republicans favored the Aldrich Plan, but it lacked enough support in Congress to pass because rural and western states viewed it as favoring the "eastern establishment". In contrast, progressive Democrats favored a reserve system owned and operated by the government; they believed that public ownership of the central bank would end Wall Street's control of the American currency supply. Conservative Democrats fought for a privately owned, yet decentralized, reserve system, which would still be free of Wall Street's control.
The original Aldrich Plan was dealt a fatal blow in 1912, when Democrats won the White House and Congress. Nonetheless, President Woodrow Wilson believed that the Aldrich plan would suffice with a few modifications. The plan became the basis for the Federal Reserve Act, which was proposed by Senator Robert Owen in May 1913. The primary difference between the two bills was the transfer of control of the Board of Directors (called the Federal Open Market Committee in the Federal Reserve Act) to the government. The bill passed Congress in late 1913 on a mostly partisan basis, with most Democrats voting "yea" and most Republicans voting "nay".