NYT: Absolving Aldrich and Vilifying End the Fed

Critics of the Federal Reserve are many, and one congressman has proposed creating the Centennial Monetary Commission to recommend ways to revamp the central bank. http://www.nytimes.com/2015/10/25/business/dealbook/the-central-bank-skeptic-who-helped-give-birth-to-the-fed.html?_r=0 Blue-ribbon panels typically end up gathering dust, but a century ago such a commission — one that actually involved a cabal of Wall Street bankers — played a pivotal role in the founding of the Fed itself.

In 1907, a panic virtually shut down the banking system. America did not have a central bank to act as lender of last resort, and banks across the country ran out of money. The United States Treasury’s efforts to stem the panic were meager. Many banks were forced to turn away depositors; hundreds of others stayed open by distributing improvised certificates (paper i.o.u.s) that circulated until the crisis abated. Not surprisingly, there were widespread calls for reform.

The next year, Congress passed a law to provide for more currency in an emergency, but the legislation was halfhearted and fell short of an overhaul. As if to acknowledge the insufficiency of the legislation, lawmakers also chartered the National Monetary Commission to study the banking system.

Little was expected of the commission, because the chairmanship was awarded to Senator Nelson W. Aldrich, a Republican from Rhode Island and the powerful

head of the Senate Finance Committee. (His daughter married into the Rockefeller family, and his grandson was Gov. Nelson A. Rockefeller of New York.) Aldrich was a bastion of the conservative establishment and an ardent legislative friend of business — ties he had exploited to become personally wealthy — and he was opposed to establishing a central bank like those that existed in other industrialized countries.

But Aldrich, whose reputation had been tarnished by corruption charges, hoped to use the commission to burnish his legacy. He ordered a number of studies on banking practices in America and abroad. More consequentially, he and some of the other commissioners embarked on a fact-finding tour of the monetary systems, and in particular the central banks in London, Paris and Berlin. He even brought along a Harvard professor to tutor his group.

Aldrich was deeply impressed by the European systems. In Paris, he gazed at a century-old dispatch penned by Napoleon, in which the general opined that the Bank of France, chartered in 1800, was as vital to France as were his armies in the field.

The critical difference between Europe and America, Aldrich concluded, was that in America each bank kept its own reserve, and — for reasons of self-preservation — was apt to hoard reserves in times of stress. In Europe, reserves were centralized and thus more effective. Moreover, since banks could borrow from the central bank, they lent more freely.

Aldrich was well aware that a central bank was a sensitive topic in American politics. Ever since 1776, Americans had resisted ceding too much power to government and — as they are today — many deeply mistrusted banks.

Nonetheless, Aldrich became a convert. Upon his return, he sought out the Wall Street banker Paul Warburg, an ardent proponent of reform, who had reluctantly concluded that the public would not accept a fully centralized system. “You say we cannot have a central bank; I say we can,” Aldrich said. Warburg was stunned.

Over the next two years, Aldrich worked to build support. But people did not like the idea of a big government bank. And they did not trust Aldrich. Deciding he needed cover from public scrutiny, at the end of 1910, Aldrich, 69, invited a trio of bankers, including Warburg, and an assistant secretary of the Treasury to Jekyll

Island off the coast of Georgia. The group put up at an exclusive club where Morgan (Aldrich’s card-playing companion) was a member, and operated in absolute secrecy.

Over a week, while the staff plied them at mealtimes with wild turkey, quail and fresh scalloped oysters, the bankers hashed out the details of a new banking system. Their plan — Aldrich did not reveal that he had conspired with Wall Street — was rubber-stamped by the Monetary Commission, which Aldrich controlled. Colloquially, it was known as the Aldrich Plan. It called for a version of a central bank, similar in many respects to the eventual Federal Reserve but with bankers rather than political appointees in charge.

Although Aldrich’s tactics were hardly democratic, his effort to reform the banking system was genuine. But his bill was never brought to a vote. By 1912, progressivism was sweeping the country and Aldrich was vilified. Opposition to the Aldrich Plan became a litmus test for progressive candidates, including the Democratic nominee for president, Woodrow Wilson.

The next year, Wilson and the Democrats, who had won a majority in Congress, enacted the Federal Reserve Act. Though the chief sponsors were critics of the Aldrich Plan, their bill in fact was adapted from it. In particular, they borrowed from the Aldrich Plan the idea of a central reserve, and also the hub-and-spokes framework. Thus, the Fed was designed with 12 reserve banks and a central board in Washington.

The economists Milton Friedman and Anna Schwartz concluded in “A Monetary History of the United States” (1963) that the Aldrich bill and the Federal Reserve Act were “identical in many details” and “very similar in general structure.” But Aldrich, who bitterly resented being shoved aside, refused to acknowledge the connection. He died 16 months after the creation of the Fed.

Aldrich used his commission to broaden the appeal of the Wall Street doctrine of centralized banking, which had seemed so threatening to the American public. Proposals to study and potentially reform the monetary system today — the one by Representative Kevin Brady, Republican of Texas, to create the Centennial Monetary Commission, and also various bills in the Senate — are animated by a contrary goal.

Contemporary bills are supported by conservatives and populists (on both political extremes) who denounce the Fed’s power. They are motivated by mistrust of centralism and popular abhorrence of the banking establishment. By increasing congressional oversight and reining in the Fed, they would seek to constrain the very institution that Aldrich helped inspire.

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