Your agreement with your bank when you make a deposit is that they will return your money to you whenever you demand it if it is in a checking account, or within a period of a few months if it is in some form of a savings account.
This is a promise that the banker only presumes he can keep. Your money is then taken, and the majority of it is loaned to someone who may not be required to repay the money for perhaps twenty or thirty years. Obviously, the bank cannot technically keep both agreements. History has proven, however, that if the element ofconfidence is present, new depositors will put more money into the bank, and out of that new deposit you can receive your money if you so demand.
In the late 1700s, the young government of the United States quickly realized the need for some type of control over banking. Independence and freedom, however, were the key items in the development of early America, and the fear of federal control and “money monopoly” frustrated any successful attempt by the government to bridle banking. “Wildcat banking” was prevalent, and since all banks were scrambling to make a profit, many banks failed due to undisciplined management. The bank panics of 1819, 1837, and 1857 brought about the National Banking Act of 1864.
In 1900, the United States went on the gold standard that was intended to stabilize the economy by making all forms of U.S. currency redeemable with gold. But following the panic of 1907, Congress was persuaded that the reason for all the country’s economic “ups and downs” was that there was no central banking system.They claimed that with such a system there
- Would be control over the nation’s total money supply.
- The central bank could step in and protect the depositors of any bank that had become overextended.
It was argued that this would guarantee once and for all the confidence in the banking system. Thus, two days before Christmas, 1913, (after most Congressmen had left Washington D.C. and returned to their homes for Christmas holidays), President Woodrow Wilson signed the Federal Reserve Act.
There was strong reluctance on the part of the individual banks to create a strong central system in Washington D.C. or New York, so the Federal Reserve Act became somewhat of a compromise. It divided the country into twelve districts with each district containing a Federal Reserve Bank and additional branch banks. All banks with “National Bank” designation were required to join, but the state banks only joined if they so desired.
The Federal Reserve Bank is a separate organization, not under the direct control of Congress or the President of the United States. The stated intent was to establish an impartial “referee” to oversee the banking system. The current President, however, does appoint any vacancy on the Board of Governors. The Board consists of seven members. Each member is appointed for a fourteen year term and they completely supervise the Federal Reserve System.
You could not walk into a Federal Reserve Bank and make a deposit or negotiate a loan. A Federal Reserve Bank is a “banker’s bank” that receives deposits, holds reserves, issues notes and currency, and clears checks . . . just for banks. You are affected, however, by an agency known as the Federal Depositors Insurance Corporation (FDIC) that serves to bolster your confidence in the Federal Reserve System by claiming that every bank account is guaranteed up to $250,000, and that since 1934 no depositor has lost any insured funds as a result of bank failure. That guarantee is supposed to alleviate your fears of making deposits in your local bank, even though you subconsciously know that the institution could ultimately only cover a fraction of a penny for every dollar on deposit.
The U.S. Treasury prints paper money and mints coins, but the Federal Reserve System alone is authorized to place them into circulation. The U.S. Treasury also maintains its deposits from taxation, fees, etc., in the “Fed,” as it is often called.
The Board of Governors is assisted by a Federal Advisory Council and the Federal Open Market Committee that is in charge of buying and selling government securities (we will see the importance of this committee later, in the role of inflation)
Of course, the old established banks had no desire to be controlled, but, they had lobbied Congress for government regulations to make it more difficult for additional banks to enter into the competition and to keep the other established banks from initiating competitive practices that would have affected their profits. Perhaps it was due to these ulterior motives that the Federal Reserve System failed so miserably in helping ward off the Great Depression and the bank crashes of 1929.
A most important fact to remember is that the Federal Reserve Board has ultimate control over the money supply of the United States of America. They have the power to either increase or decrease the total amount of money, including the ethereal numbers of computer money digits in the monetary system.
Next Week: The three basic methods the Federal Reserve uses in its alteration of the money supply.
(Research ideas from Dr. Jackson’s new writing project on Cultural Economics)