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For R e l e a s e on D e l i v e r y
N o v e m b e r 16, 1 9 8 8
5:30 P.M. Central European Time
H : 3 0 A.M. E.S.T.




H. R o b e r t H e l l e r
M e m b e r , B o a r d of G o v e r n o r s o f the F e d e r a l R e s e r v e S y s t e m

A n n u a l M e e t i n g of the S w i s s A s s o c i a t i o n f o r M o n e t a r y S t u d i e s
Zcirich, S w i t z e r l a n d
N o v e m b e r 16, 1 9 8 8


I i


It is a great pleasure for me to be with you today in
the wonderful city of Zurich.

When your esteemed

Association invited me to reflect upon the American
experience with central banking and to draw possible
implications for European monetary integration,
I gladly accepted the challenge.

Having spent half my life in Europe and half my life
in the United States, it goes without saying that I
remain keenly interested in European events.

I also

believe that American central banking history is well
worth studying, because it represents a rich lode of
experience gathered over two centuries.

Let me therefore follow your invitation to offer my
personal views on this topic within the limited
framework of a half-hour lecture.

Needless to say, the

topic is so vast that it could fill several scholarly
volumes, and much will have to remain unsaid and

Europe is now embarking on an historic endeavor toward
greater economic, financial, and monetary integration.
Living at the end of the twentieth century, and
accustomed to viewing the United States as a mature,

integrated economy, we may forget that it, too, once
confronted the problems of consolidating its economy
and of developing appropriate institutions.


problems were compounded and complicated by the fact
that the young nation was still expanding
geographically - but so is the European Community.

The differences between America then and Europe now are

But America's experience was so rich and varied,

and the issues that arose in America were so much like
those now discussed in Europe, that a review of the
American experience may yield some useful lessons for
European integration as well.

Those who ignore history, we are told, are condemned to
repeat it.

And the American experience is replete with

mistakes that do not bear repeating.

The First and Second Bank of the United States

The first Congress of the United States convened in
1789 in New York.

After electing George Washington as

President, naming Philadelphia as the temporary capital
of the new country, and establishing Washington as the
permanent capital, attention quickly turned toward
financial matters:

the need to raise revenue and the

founding of the First Bank of the United States.

Alexander Hamilton, the first Secretary of the
Treasury, urged the creation of a national bank.


Bank was to be chartered for 20 years with headquarters
in Philadelphia.

The bill establishing the First Bank of the United
States won by a comfortable margin in the House of
Representatives —

39 to 20.

But 19 of the "No" votes

came from the representatives of the largely rural
southern states.

They feared that the bank would serve

mainly the interests of the merchants and investors of
the North by restricting the supply of money and thus
depriving the farmers and the yeomen of the South of
the easier money they wanted.

Thus, at its very

inception, the Bank was already seen as the servant of
particular regional interests.

In spite of these problems, the First Bank served the
new nation well, and proved essential in the early
development of the nation by providing the country with
a sound and elastic currency.

To prevent overissue,

the bank redeemed excess bank notes in specie.


much like a modern central bank, it offered fiscal
services for the government such as transferring
government funds and providing a safe depository for
bank notes. In addition, it helped to collect
revenues and provided the bullion needed by the mint

for coinage.

The First Bank of the United States dissolved when its
charter ran out in 1811 during James Madison's

Although a strong opponent of the original

bill in 1791, Madison rethought his initial
constitutional objections and favored rechartering the
bank for economic expediency.

Even so, the bill to

recharter failed in both houses by a one-vote margin.

After the overextended structure of credit granted by
state banks collapsed'under the pressure of the British
invasion of Washington in 1814, President Madison
pushed for the establishment of the Second Bank of the
United States.

By 1816, the Second Bank of the United

States was in operation, again with a 20-year charter.
After fueling an inflationary boom, the Bank was blamed
for the bust of 1819 —

which was actually part of a

world-wide collapse.

Animosity toward the "Federal Banking Monster" became
so strong that individual states attempted to tax the
operations of the national bank in an effort to close
its doors.

However, in 1819, the Supreme Court upheld

the constitutionality of the Bank in the celebrated
case of McCulloch v. Maryland.

"The power to tax is

the power to destroy," wrote Chief Justice John
Marshall in a decision that had historic ramifications
far beyond the issue of the legitimacy of the central

He argued that individual states did not have

the power to nullify acts of the Congress by attacking
its agencies.

The Bank had withstood the threat to its


In 1823, Nicholas Biddle became president of the Second
Bank, and for nearly a decade the Bank maintained a
sound and stable currency.

At the same time, however,

statue-chartered private banks often overextended
credit, and financial instability was widespread.


bankers viewed the Second Bank of the United States as
an unnecessary constraint on their activities, and the
traditional opponents from the southern and western
states continued to voice their displeasure at the
bank's monopoly.

When President Andrew Jackson, along

with conservative groups, questioned the Bank's
constitutionality, the institution was doomed.


Bank had lost its popular support, and President
Jackson vetoed its rechartering.

Thus ended the Second

Bank of the United States.

The lesson to be drawn is that no central bank —
matter how well managed —

can survive without the

support of the people it serves.


The Era of free Banking

An era of free banking ensued, in which individual
state-chartered banks issued bank notes that circulated
as currency, and credit was freely granted to all

Land speculation was rampant, and prices


Needless to say, the same conservatives

who had opposed the Second Bank for the constraints it
imposed viewed these developments with deep misgiving.
They demanded that the government sell its land only
for gold or silver.

When this policy was implemented

in the summer of 183 6, the speculative land boom burst.
It did not take long for commodity prices and the stock
market to collapse, and the Panic of 18 3 7 was on.

Matters were further complicated by the failure of
three large British banks in 183 6.

When their credit

lines to American banks were cut off, American
financial woes worsened.

Banks failed everywhere and

bankruptcies multiplied, pulling the economy into a
severe recession.

But these were also the years when the American Midwest
was settled and when the push to the Pacific Ocean
were on.


The days of the "Wild West" and free banking

During the following decades, two powerful
undercurrents dominated the American economic and
financial scene.

On the one hand, western and southern

farmers, ranchers, and miners saw easy money and credit
in their interest because it enhanced the monetary
value of the commodities they produced.

On the other

hand, those in commerce, trade, and manufacturing in
the East felt that their interests would be served best
by "sound" money and a "strong" dollar, both at home
and abroad.

During this period, the U.S. Treasury exercised various
central banking powers, along with some of the stronger
private banks.

But no institution was formally charged

with the responsibility of controlling money and credit
in the public interest.

At times, the nation was

effectively on a gold standard; at other times, it was
on a bi-metallic standard.

Private banks freely issued

bank notes that were supposed to be convertible into
specie or "lawful money", but it was not always easy to
track down the bank and actually to get paid in gold or

News circulars published the current value of

bank notes issued by various banks, just as today's
newspapers publish exchange rates and stock market

Speculative booms and busts alternated with

frustrating rapidity.

And apart from the tragic

consequences it had for the nation's political and

social history, the Civil War had a devastating
economic and financial impact.

What kept the nation

going was the tremendous westward expansion and the
riches that could be amassed by enterprising men.

To the late nineteenth-century observers in Europe,
the American monetary and economic boom-and-bust cycles
were distressing —

a distress that was more than

purely intellectual.

Many European investors

participated in the speculative excesses in the United
States; and many paper fortunes were lost, along with
hard-earned investment funds .that had been gambled away
in alluring but risky investments.

Eventually, the Panic of 1907 forced politicians and
the public to face up to the need for monetary and
currency stability.

Bitter experience had taught the

nation that a central bank fulfilled essential
functions; and the search for an appropriate framework

The Federal Reserve System

This was the environment in which the Federal Reserve
System was formed.

When it came into being in 1913,

the new institution was seen as a bulwark against
periodic collapses of the financial system like those

that had plagued the United States since the Second
Bank of the United States went out of existence.

The commission charged with planning the new
organization drew extensively from the experience of
European countries with central banks.

The European

central banks served the public and national interests
by providing for a sound currency and through
controlling the amount of money and credit in

They also intervened in financial markets

during liquidity crises to forestall cumulative
monetary contractions.

The U.S. Congress and the administration saw clearly
that these powers, as exercised successfully in Europe,
were also desirable for a central banking system in the
United States.

However, the United States consisted of a collection of
individual states, each with its own banking laws and
with its own interests dictated by its special economic
plans —

Various factions proposed alternative

some calling for a strong central institution,

some favoring a system of regional reserve banks.
Nelson Aldrich, a conservative Senator from Rhode
Island, urged the establishment of a strong central
bank, while Carter Glass, a Representative from

Virginia, sponsored a plan calling for the
establishment of 20 privately controlled reserve banks.
The division of North versus South, merchant versus
farmer, federal power versus state power, persisted.

In the end, President Woodrow Wilson and the Congress
crafted a unique institution that balanced regional and
private interests with the interests of the nation as a

Within the Federal Reserve System were twelve

regional Federal Reserve Banks, each under the
direction of a Board of Directors that represented the
banking, commercial, and public interests of that

The System as a whole was placed under the

direction of a federal agency, the Federal Reserve
Board, which consisted of the Secretary of the
Treasury, the Comptroller of the Currency, and five
persons appointed by the President.

The Congress explicitly refrained from creating one
all-powerful central bank for the United States that
might ignore the needs and interests of a far-flung and
diverse nation.

Instead, the system devised was

intended to be responsive to the special circumstances
of each District.

The District Banks were to provide

reserves and liquidity to the banks that were members
of the System as the needs of the local economy

The discount rate of each Reserve Bank was

to be established by its Board of Directors with the
approval of the Federal Reserve Board.

It was fully

anticipated that discount rates would differ among the

Similarly, when the Reserve Banks more or

less discovered open market operations as they invested
the reserves the member banks deposited with them, each
began to buy and sell Treasury securities as it deemed
desirable for the needs of its local economy.

As you might expect, in an economy with no geographic
constraints on trade or credit flows, differentials in
regional interest rates could not persist; and
different open market operations by Reserve Banks meant
simply that one District's actions offset another's
in the national total.

In an attempt to avoid the

pursuit of conflicting policies, the Federal Reserve
set up a committee to oversee the System's open market

But it was not until 1935 that Congress

created the official Federal Open Market Committee to
determine and to implement open market operations.
Even here, the regional principle had a strong

the FOMC comprised five of the twelve

Reserve Bank presidents and the seven Members of the
Board of Governors of the Federal Reserve System.


The composition of the Federal Reserve Board itself was
also changed.

To underscore the independence of the

Federal Reserve from the administration, the Secretary
of the Treasury and the Comptroller of the Currency
were dropped, and the Board henceforth consisted of
seven governors serving 14 year terms, with a chairman
and vice chairman appointed for four year terms.
again, regional interests were acknowledged:



Governor was to be from the same district as another

Thus, the Federal Reserve "System became one central
bank that conducts and implements a unified monetary
policy for the United States.

Yet it still reflects

its regional and decentralized foundations and draws
strength from them.

In particular, the regional Boards

of Directors and the Presidents of the Reserve Banks
bring important regional and sectoral information to
bear on the decisionmaking process.

This experience offers two important lessons:


there is strength in diversity and an institution that
reflects a broad spectrum of information and policy
perspectives is appropriate for a large and diversified

Second, in a dynamic world, economic

institutions must change to reflect the changing needs
of the economy they serve.

Possible Lessons for Europe

How might the American experience help you in Europe as
you move toward economic, financial, and monetary

Certainly, our institutions differ; and

certainly, the times are different.

But the long and

sometimes painful history of the American central bank
may well provide important lessons as you debate the
future financial system for Europe.

First of all, as the economic integration of Europe
proceeds, it will bring with it an increasing need for
financial and monetary integration as well.


first steps have already been taken through the
creation of the European Monetary System, and one
should build upon that experience to bring about a
further and more complete financial and monetary

Second, the early experience of the United States
exposes the perils awaiting an institution that does
not recognize the legitimate interests of its diverse
constituencies, and that does not have the full support
of the political establishment and of the people it is
designed to serve.

While the majority may impose such

an institution, it will be vulnerable to dissension and
to attacks that ultimately may doom it.

Most of the European currencies are already tied
together in the European Monetary System, which sets
narrow bands for the permissible fluctuations in the
various currency values.

One may well build upon that

successful framework for monetary cooperation and in
effect create a set of conditions that might result in
the general acceptability throughout Europe of any of
the member currencies, and therefore, the de-facto
creation of a commonly acceptable means of payment.

To implement this plan one would simply multiply the
value of each currency by the reciprocal of its central
rate versus the European Currency Unit, the ECU, and
new bank notes, all similar in design, would be issued
by the European central banks.

What would result from this simple step?


multiplying the value of each currency with the
reciprocal of its current value of the ECU, the value
of all the European currencies would be equal to each

One mark would now be equal to one franc, one

guilder, or one lira.

No further conversion

calculations would be necessary.

Furthermore, because all the currencies would be
similar in design, perhaps distinguishable only by
pictures of the various national heroes, the European

public would soon come to accept the various national
currencies throughout the continent.

In effect, a

common European means of payment would be created.
Life would be simpler for tourists and businessmen as
shops, restaurants, hotels, ticket vendors, and toll
collectors could all accept at par the bank notes
issued by the central banks.

The still permissible

margins of fluctuations in currency values should be
compensated by the lack of transaction costs at the
exchange bureau.

The situation would be similar to the

one prevailing centuries ago, when gold coins issued by
the various princes and kings of Europe circulated
throughout the continent.

The proposal simply revives

an ancient and workable practice.

This proposal sidesteps the thorny political and
administrative problems that the immediate creation of
a central bank for Europe would pose; it preserves the
current administrative structures; it does not require
a formal cession of national sovereignty.

On the other

hand, it gives the advocates of a common European
currency much of what they want: a generally acceptable
means of payment and a symbol of European togetherness.

Under this proposal, the existing European monetary
councils could evolve from institutions that facilitate
monetary cooperation to institutions of monetary


Eventually, they might design and

implement a common monetary policy.

But the process of

achieving monetary unification would be a gradual one,
not marked by the instant delegation of national
sovereignty to a central organization.


In conclusion, I believe that just as the United States
gained greatly from a study of the European experience
with central banks when it designed the Federal Reserve
System 75 years ago, Europeans may find it profitable
to consider the American experience with a
decentralized system.

It should also be possible to

take the important symbolic step toward a commonly
acceptable European means of payment without creating
immediately a central European monetary authority.

I hope that my observations and suggestions regarding
some of the possible avenues for further progress
toward European monetary integration will be taken in
the friendly spirit in which they are offered.

In any

case, I wish Europe well in this historic endeavor to
bring the economies and the people of the Continent
closer together.

Thank you very much.