A devastating critique of an apology for the Federal Reserve.

San Jose State University economist and historian Jeff Hummel has written an outstanding review of Roger Lowenstein’s new book, America’s Bank: The Epic Struggle to Create the Federal Reserve. It is so good, while being relatively terse, that I intend to use it in the short macro section of an economics course that I teach in our Executive MBA program. The article is titled “How the Fed Was Born.”

Jeff is one of the fairest minded people I know. He will point out the good and the bad in the right proportions.

Some highlights follow.

The overall evaluation:

The actual story is both more complicated and more interesting than the simple conspiracy narrative. Roger Lowenstein, a financial journalist–his previous books include a study of the hedge fund Long-Term Capital Management and its collapse–has now ventured into this historical territory with America’s Bank: The Epic Struggle to Create the Federal Reserve. Displaying extensive primary research into the personal papers of all the major players, he provides a readable narrative interwoven with well-sketched background biographies. Unfortunately, Lowenstein renders this narrative as a simplistic morality play, with pro-central bank heroes (“patriotic conspirators,” as he styles them at one point) and anti-central bank villains, leaving the book devoid of much economic insight.

The pre-Fed setting:

The problem is not just that America’s Bank unreflectively extols the Fed. It’s that this celebratory tone is informed by the author’s superficial understanding of monetary theory and history. These weaknesses are clearest in the first few chapters, which offer a vulgar caricature of early U.S. monetary history, sprinkled with more than a few outright factual errors. Contrary to Lowenstein’s account, James Madison, as president, did not oppose but supported the rechartering of the first U.S. Bank. The second U.S. Bank, rather than muting the business cycle, presided over and contributed to the Panic of 1819, the first major depression in U.S. history. And when Lowenstein describes America’s so-called free banking era as a “monetary babel,” he ignores decades of scholarly research finding that the charges of reckless and fraudulent “wildcat” banking are highly exaggerated and that, to the limited extent the phenomenon was real, it was mainly the result of a government-imposed restriction on the issue of banknotes, known as the bond-collateral requirement.

That requirement was later embodied in the post-Civil War national banking system. The new system was therefore hardly the “remedy” Lowenstein claims it was–before he goes on in future pages to contradict himself by overstating its real faults. The depression of 1873 did not last six years but at most 27 months, according to the National Bureau of Economic Research. Nor was the secular deflation from 1867 to 1896 drastic; prices declined about 2 percent per year, accompanied by robust secular growth of real gross domestic product per capita. When Lowenstein writes that “beginning in 1887, there had been serious financial turmoil roughly every three years,” his “serious financial turmoil” must mean every spike in interest rates. In fact, between the Civil War and the Fed’s creation, major bank panics followed by recessions occurred only in 1873, 1893, and 1907, and none of those events approached the severity of the Great Depression. On the other hand, incipient bank panics in 1884 and 1890 were nipped in the bud by bank clearinghouses issuing extralegal clearinghouse receipts that could serve as currency.


The bond-collateral requirement rigidly tied the quantity of banknotes to a shrinking national debt. Despite the increasing importance of bank deposits in the U.S. money stock, many transactions still required currency rather than less liquid and potentially more risky checks. (As late as the Great Depression, most workers, having no checking accounts, were still paid with weekly envelopes of cash.) In a country with a large agricultural sector, there were regular seasonal demands to convert deposits into currency. But because banks could not freely issue banknotes, these seasonal demands drained reserves of gold and Greenbacks from the banks. This inelastic currency became a major source of potential panics.

Hence the asset-currency reform that America’s Bank so casually dismisses. It proposed relaxing the restrictions on issuing banknotes, thereby solving the problem of an inelastic currency without creating a central bank. Proponents of this reform repeatedly pointed to the success of Canadian banking, which faced the same seasonal fluctuations in currency demand that the U.S. banks did. But Canada [DRH, former Canuck: yay!]–which had no central bank, had nationwide branching, and allowed banks a nearly unrestricted freedom to issue currency–sailed through this era with no credit crunches, bank panics, or major bank failures. The asset-currency reform movement emerged in the 1890s, and it initially had the support of influential economists such as Laurence Laughlin and many bankers–even Frank Vanderlip. Asset-currency bills were regularly introduced in Congress, but they were inevitably blocked by a coalition of small country and New York bankers. Laughlin, Vanderlip, and others eventually turned to some kind of central bank as the only viable alternative.

The Fed’s record:

Created just before the outbreak of World War I, the Fed helped finance U.S. participation in that war by generating the highest rate of inflation in American history outside of the two hyperinflations during the American Revolution and in the Civil War Confederacy. After the war, it orchestrated the most rapid rate of deflation in U.S. history, so severe that it makes the mild, benign deflation of 1867 to 1896 look like price stability by comparison. During the Great Depression, the Fed presided over the most massive banking panic not just in the history of the U.S. but in the entire history of the world, despite being created to prevent such a catastrophe. It also contributed to the recession of 1937, in the midst of high unemployment lingering from the Great Depression; and it followed that with another bout of inflation during World War II, severe enough to inspire comprehensive wage and price controls. During the postwar period, the Fed was responsible for the Great Inflation of the 1970s, which hit double-digits and was accompanied by the country’s first inflationary recessions. And let’s not forget the financial crisis of 2007-08.

Other than that, Mrs. Astor, how was the ocean voyage?