The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
December 30, 1983
Origins
specie the currency issued by state banks,
thus placing the latter under some constraint
to limit the issue of such notes. Both Banks
also acted as fiscal agents of the U.S. government (receiving and disbursing government funds) and engaged actively in direct
lending to businesses.
Since the federal ReserveSystem reached
the 70th anniversary of its creation by the
Congress on December 23, a review of some
of the principal events that led to its establishment and which subsequently shaped its
structure and expanded its objectives and
responsibilities, including the concept of
monetary policy and Fed "independence,"
is timely. This Letter will focus on the developments leading up to the passageof the
Federal Reserve Act. In particular, it will
review the structure of early banking in this
country and the inadequacies the Act was
intended to correct.
Neither U.S. Bank survived because of
hostile attitudes toward centralized control
embodied in federal chartering, as well as
potential implications of restricted credit
availability. Many farmers, in particular,
welcomed the inflation caused by state
banks as a means of repaying their debts in
"cheaper" dollars than those they borrowed. Moreover, both Banks were 80
percent privately owned and controlled and
much of the opposition towards the First
Bank, at least, stemmed from the fact that
English interests held a significant share of
the Bank's stock. The Second Bank's charter
expired largely because of opposition by
President Andrew Jackson, who was concerned that it would lead to a concentration
of economic power in large banks in the
Northeast.
In the beginning...
Except for two brief periods early in its
history, the United Statesdid not have a
federal "central bank" until the passageof
the Federal ReserveAct in 1913. Banks chartered by their state legislatures dominated.
Derived from English banking, these banks
issued private banknotes backed by deposits
of gold and silver in their vaults. Knowing
that not all notes would be redeemed at the
same time, some banks issued more notes
than there was backing in gold and silver
specie, leading to what we call inflation.
Also, because each bank issued its own
banknotes, transfers among banks was difficult. Moreover, their variety was confusing
and allowed easy counterfeiting.
Many also were hosti Ie to the concept of a
national bank because they doubted that the
Constitution allowed the Congress to charter
banks. However, in a landmark decision in
1 81 9 (McCu 1I0ch vs. Maryland), the Supreme Court upheld the constitutionality of
the Second U.s. Bank as a "necessary and
proper" exercise by the Congress of its
power "to coin money and regulate the
value thereof."
In the periods 1791 to 1811 and 1 81 6 to
1836, the United State?Congress chartered
two national banks, known as the First and
Second U.S. Banks, respectively. In part, the
purpose of these banks was to control both
the expansion of state banks and the proI iferation of banknotes. In the five-year
interval between the two U.s. Banks, for
example, the volume of state banknotes
almost tripled and prices rose by about 20
percent. They were able to achieve a substantial degree of monetary stabi I ity by
periodically presenting for redemption in
Following President Jackson's veto of the bill
to renew the charter of the Second Bank of
the United States,the Treasury undertook
various central banking functions. Meanwhile, the number of state banks more than
doubled to 1,600 between 1 836 and 1860.
Among them were issued almost 9,000 different kinds of notes that were subject to
widely varying, and in many cases, very
substantial discounts.
1
I f cd! @.lill«
cO>
\l
I f IT'Pc;\,i\\\
ceil
IT'\o/
Opinions expressed in this newsletter do not
necessarily reflect the views of the rnanagement
of the Federal Reserv(;, Bank of San Francisco,
or of the floard of Covernors of the' Federal
Reserve System,
depend upon national banks' holdings of
bonds. CreateI' control over currency issues
also was achieved by the imposition in 1865
of a confiscatory 10 percent federal tax
on all state banknotes (which, in 1860,
accounted for almost one-half of all currency and coin in circulation). The tax
forced all but a small volume of these notes
out of circulation, and for a while, led most
state banks to switch to a national charter.
However, the development and spread of
checking deposits enabled state banks to
make loans by crediting deposits rather than
simply by issuing notes. As a result, the
number of state banks soared from 325 in
1 870 to 5,000 by 1900.
The National Banking Act
In 1 864, the National flanking Act was
passed to provide a market for government
bonds and to help establish a uniform currency. The Act was also designed, in part, to
help stabilize the currency as prices had
risen over 65 percent from the outbreak of
the Civil War in April 1860. Millions of
dollars of non-interest bearing "greenbacks" not officially redeemable in specie
had been issued by the government to meet
its financing needs and these had contributed to the inflation during the War.
The Act provided for the federal chartering
of private banks on the basis ofstipulated
minimum capital requirements and the
maintenance of required reserves against
deposits. National banks were divided into
three tiers: central reserve city banks
(originally banks in New York, Chicago, and
SI. Louis), reserve city banks, and country
banks. Country banks had a 15 percent
reserve requirement, 9 percent of which
could be kept as deposits with their correspondent reserve city banks. Reserve city
banks had a 25 percent reserve requirement,
up to half of which could be kept asdeposits
with their correspondent central reserve city
banks. Central reserve city banks had to
keep all of their 25 percent reserve requirement as vault cash. This system of reserve
"pyramiding" meant that, in particular
cases, a given dollar of reserves held in
support of deposit liabilities could be
counted as reserves three times.
By 1910, state banks numbered 1 4,000double the number of national banks -but
national banks now accounted for a quarter
of all currency and coin in circulation, while
gold and gold certificates accounted for 45
percent, and silver certificates, coins and
miscellaneous coins, the remainder. The
relative influence of these currency and
deposit developments is evident in the fact
that over the entire period since 1860, per
capita currency in circulation increased
from $30 to $34, while per capita deposits
soared from $19 to $194.
The National Monetary Commission
The various efforts at currency and banking
reform notwithstanding, the period from
1873 to 1913 was marked by six financial
"panics" of varying degrees of intensity, the
most serious occurring in the 1890s and in
1907. The "panics" resulted in the suspension of specie payments by large numbers of
banks, in the inability of businessmen and
farmers to obtain credits to finance inventories and the production and transportation
of crops, and in large numbers of business
failures. After "The panic of '07," the
Congress called for the creation of a
National Monetary Commission "to enquire
and report to the Congress at the earl iest date
practicable" what changes were necessary
In addition, national banks were given
aythority to issue their own notes to the
value of 90% oltheir holding of specific U.S.
government bonds. In this way, the amount
of notes in circulation at any time would
2
or desirable in the monetary system to avoid
a recurrence of the financial panics that
periodically had gripped the nation.
the Commission's recommendations in a
bill, generally known as the "Aldrich Plan,"
to establish a "National ReserveAssociation
of the United States." The measure garnered
strong banker support but was specifically
rejected, along with any proposal for a
"central bank," by the Democratic party in
its 191 2 platform. The attitudes toward centralized control had not died with the First
and Second Banks of the United Statesand
President-elect Woodrow Wilson was particularly unreceptive to the Aldrich bill's
provisions for a centralized organization
controlled by private interests.
The National Monetary Commission was
chaired by Senator Nelson Aldrich, a Rhode
Island Republican who also was chairman
of the Senate Finance Committee, and
included in its studies an examination of
the central and private banking systems in
Western Europe. Submitted to the Congress
in January 1912, the Commission's Report
attributed the" currency problem" and the
recurring financial panics to several specific
and widely recognized factors.
Consequently, under Wilson's guiding
hand, Congressman Carter Glass (D-Va),
the incoming chairman of the House Banking Committee, drafted and submitted an
alternative proposal "to provide for the
establishment of Federal Reservebanks, to
furnish an elastic currency, to afford means
of rediscounting commercial paper, and to
establish a more effective supervision of
banking." It immediately came under
savage attack from supporters of the rival
"Aldrich Plan," including the American
Bankers Association, as being, among other
things, "socialistic."
First, the Commission identified the lack of
provision for the mobilization of the cash
reserves of banks and for their use wherever
needed in time of trouble. Reserve pyramiding meant that a shortage in currency at
country banks could lead to claims on a
central reserve city bank's reserves.The central reserve city bank wou Id sometimes have
to meet this demand by calling in its shortterm loans. As a result, interest rates could
rise very sharply. Of course, if it failed to call
in its loans, country banks would not get the
needed currency and might fail, creating a
financial panic. Second, due to its rigid dependence on the amount of
bonds,
national banknote currency was unable to
respond to the changing needs of business,
that is, the supply of money cou Id not be
adjusted to meet the changes in the demand
for money. Third, the Commission cited a
lack of cooperation "of any kind" among
banks outside the clearing house cities, and
fourth, the lack of a wf'lI-developed discount market and a market for commercial
paper available for investment by banks.
The last was blamed for an "unhealthy congestion" offunds in the main money centers,
where they were used in "dangerous speculation" that often resulted in "injurious
disturbance" to bank reserves.
u.s.
In spite of subsequent (and current) claims of
various Fed critics, the two proposals differed in their emphases upon government
and private participation and centralism vs.
regionalism, as well as in their specific
provisions for reserve mobilization , note
issue and discounting. These differences,
and the resulting adoption of the Federal
Reserve Act, will be the subject of the next
Letter.
Verle 8. Johnston
Subsequently, Senator Aldrich formalized
3
SS",:> lSl:Il:I
U018U!4SPM. LjInn • u08,:)10 • epelloN • 0Ljepl
!!E'Ml?H • E'!UJOJ!fE!
J,:. I?UOZPV • I?>fSPIV
© 1l!'\ill'@<tdI
·me.) IO:lSpueJ:I
ues
oSL 'ON llWBld
OIVd19V1SOd 's'n
llVW
1)\ill<;\l\illJlllJJ\W0]@(Qj \\lJ;JJ
JJ\W<;\l',B@(Q]
BANKING DATA-TWELFTH FEDERAL
RESERVE
DISTRICT
( Dollar amounts in millions)
SelectedAssetsandLiabilities
LargeCommercialBanks
Loans (gross, adjusted) and investments·
Loans(gross,adjusted)- lotal#
Commercialand industrial
Realestate
loans to individuals
Securitiesloans
U,S.Treasurysecurities'"
Other securities·
Demanddeposits- total#
Demanddeposits- adjusted
Savingsdeposits- totalt
Time deposits- total#
Individuals,part.& corp.
(large negotiableCO's)
WeeklyAverages
of Daily Figures
Member BankReservePosition
ExcessReselVes
(+ )/Oeficiency(-)
Borrowings
Net freereselVes(+ )/Net borrowed{-)
,
Amount
Outstanding
12/14/83
164,861
144,694
43,949
57,629
25,568
3,436
7,862
12,305
43,636
30,516
66,366
70,183
64,256
17,285
Weekended
12/14/83
55
5
49
Change
Changefrom
. year ago
from
Dollar
Percent
1.0
1,653
1.7
2,350
2.5
1,113
0.8
435
7.5
1,775
473
16.0
12.0
845
- 1,542 - 11.1
1.0
431
2,091
7.4
29,044
77.8
- 23,281
- 24.9
- 19,260
- 23.1
- 15,057
- 46.6
Weekended
Comparable
year-agoperiod
12/7/83
12/7/83
65
10
- 247
20
196
42
79
4
-1,801
- 632
- 303
- 157
- 220
- 128
80
5
75
113
110
3
* ExcludestradingaccountseCUritIes.
# Includesitemsnot shownseparately.
t IncludesMoneyMarketDepositAccounts,Super-NOWaccounts,and NOW accounts.
Editorialcommentsmaybeaddressed
to theeditor (GregoryTong)or to theauthor•••• Freecopiesof
this andother FederalReservepublicationscan be obtainedby callingor writing the Public
Information Section,FederalReserveBankof SanFrancisco,P.O.Box7702,SanFrancisco94120.
Phone (415) 974-2246.
@FedFRASER