Matt McDaniel

7 minute read

This piece is designed to be a springboard for future posts regarding the effort to Audit the Fed or regulate the monetary policies wielded by the Fed. In no way is this meant to be an exhaustive look at the Federal Reserve or its policies. Rather, in writing this, I hope to frame future discussions about the way the nation can effectively work within the constraints of the current financial system and bring about necessary reforms.

The Federal Reserve- A Brief History


The Federal Reserve System (the Fed) was created by the Federal Reserve Act in 1913 with the premise to generally regulate the American financial system to prevent the regular panics that periodically dogged the United States economy.

Despite being only 101 years old, the idea of a National Bank of the United States is as old as the Republic. The First National Bank of the United States was given its twenty-year charter in 1791. Alexander Hamilton, George Washington’s Secretary of the Treasury, was in large part responsible for the Bank’s coming into existence. Thomas Jefferson opposed the bank and opposed any attempt at renewing the Bank’s charter, which expired in 1811.

Portrait of Thomas Jefferson by Rembrandt Peale

The Second National Bank of the United States was more controversial than the First. While central banking was, even with regards to the First Bank, viewed as attempting currency manipulation and corruption, the war over the Second Bank dwarfed the controversy of the First. In short, a Second National Bank was chartered from 1816 until 1836. Andrew Jackson made it one of his principal goals to fight any renewal of the Bank’s charter as he viewed it as a corrupt institution. President Jackson was successful, ultimately, in the fight against the Second Bank, the charter of which was not renewed.

Andrew Jackson.jpg

For the next thirty years after the fall of the Second Bank, the nation was generally in a period of free banking where states were able to charter their own banks. These banks could issue notes against gold and silver and generally ran as laissez faire as the financial industry had ever been.

The National Banking Act of 1863, passed into law in the Union during the Civil War, sought to regulate loans and promote a uniform national currency. To that end, a system of national banks was established and was supervised by a federal Comptroller. However, this system necessarily pitted the federal banks against the state banks. Briefly, attempts to bring the system under control meant that much of the financial industry became tied to the fluctuations of treasuries and irregular liquidity demands. Thus, the financial dominoes could be set to fall with relatively minor panics.

File:Fed Reserve.JPGWithout diving too deeply into the murky waters of the banking industry of the early twentieth century and the alleged back room deals that fueled the creation of elite banking, the Federal Reserve was proposed as, what would ostensibly become, the Third National Bank of the United States. Originally subservient to the Executive Branch, the Fed would be a money creator of last resort that would, in theory, be able to ameliorate the instability caused by panics or liquidity crises. The science of economics at the level of the Federal Reserve in the United States was still in its infancy when, as Jefferson and Jackson had feared, the Fed began exercising its control over the monetary system to create and destroy currency to keep volume stable. While these actions led to a period of unprecedented prosperity, they had the unforeseen side effect of creating a massive bubble in the United States stock market by the end of the 1920s.

File:Federal Reserve Districts Map - Banks & Branches.png

The Federal Reserve remained de jure under the control of the Executive Branch until it was given full autonomy over monetary matters in 1951. In the 1970s, these monetary policy powers blossomed into a full suite of powers over banking regulations.

Modern Criticism

Criticism of the Federal Reserve is divided between the Jefferson-Jackson type of concerns regarding currency manipulation and corruption and the more conspiratorial claims that the Federal Reserve is a front for whatever dark powers surround money. Part of the shadowy charm of the conspiracy theory angle is that it brings to light the chief problem with the Federal Reserve today: very few people know anything about what it does. Many of the decisions of the Federal Reserve are made without Congressional oversight and without any real check from a monetary policy perspective. Thus, as any budding economics student could tell you, because money is nearly equal parts value and faith, the manipulation of currency necessarily affects public confidence. As some would see it, if there is a “religion of money” the Board of Governors of the Federal Reserve are its high priests.

Conspiracy theories have their place in showing the concerns over secrecy, but the Jefferson-Jackson concerns resonate more deeply in the American psyche. Especially following the financial crisis in 2008 where certain companies were allowed to fail while others, notably those with ties to Treasury Secretary Paulson, were allowed to survive, Americans have become deeply distrustful of banks and lenders. The reactionary progressives capitalized on this panic to institute the Dodd-Frank controls on the market. While, in theory, the goal of Dodd-Frank was at least altruistic, the idea that the Federal Government should move to control the market rather than the market manipulating monetary policies of the Federal Reserve seemed out of place.

It is in this climate that Senator Rand Paul from Kentucky, a putative candidate for President, has resurrected his father’s oft-proposed bill to audit the Federal Reserve. In support of the Pauline perspective, there is ample evidence to show that the central bank has, through control of the volume of money and interest rates, devalued the overall worth of the dollar.

Buying power of one U.S. dollar compared to 1774 USD
 Year   Equivalent  buying power
1774  $1.00
1780  $0.59
1790  $0.89
1800  $0.64
1810  $0.66
1820     $0.69
1830     $0.88
1840     $0.94
1850     $1.03
1860     $0.97
 Year   Equivalent  buying power
1870     $0.62
1880     $0.79
1890     $0.89
1900     $0.96
1910     $0.85
1920     $0.39
1930     $0.47
1940     $0.56
1950     $0.33
1960     $0.26
 Year   Equivalent  buying power
1970     $0.20
1980     $0.10
1990     $0.06
2000     $0.05
2007     $0.04
2008     $0.04
2009     $0.04
2010     $0.035
2011     $0.034
2012     $0.03

Source: (Yes, it’s Wikipedia, but the information is drawn from the citations there. Wikipedia just built the handy chart)

Is the entire devaluation of the dollar the responsibility of the Federal Reserve? Most likely not. It’s important to realize that, for the majority of the nation’s history, our currency was backed by gold. Coupled with the rise of the dollar as a global currency and the proliferation of international markets, there are strong indicators that the currency powers of the Federal Reserve are not the only things to blame for a weaker dollar.

However, the Jefferson-Jackson criticisms of Central Banking remain as strong today as they were when they were made against the previous Banks. Especially in the skeptical light of Americans’ distrust of financial institutions, the lack of transparency in the Federal Reserve is completely inappropriate in a time when disclosure is necessary.

A bill to Audit the Fed has been submitted to the Senate by Senator Rand Paul and seems to have a wide-array of support. This is not a bill to end the Federal Reserve, but merely to take a glimpse inside the arcane machinations of the quasi-governmental entity that controls the volume of American dollars across the globe. Not only is it Congress’ responsibility to undertake this effort on behalf of ordinary Americans who bear the brunt of a misstep in monetary policy, but it is nearly inexcusable that the Federal Reserve, or any institution with such broad power, is given such a free hand in dealing.

If you have the time, call your representatives and make it clear to them that an audit of the Federal Reserve is an appropriate check on the Fed given these trying economic times.