THE REAL HISTORY OF THE FED: WHY IT DIDN’T TAKE A MIRACLE (OR A CONSPIRACY!) TO PASS

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The following is a guest post by Steven Horwitz, Charles A. Dana Professor of Economics at St. Lawrence University.

Perhaps because money and finance are among the most complex and obscure parts of economics, a variety of cranks and conspiracy theorists have historically aimed their arguments against any number of monetary institutions and practices.  In the last hundred years, the US Federal Reserve System has been the subject of many wild stories about its origins and ongoing operation.  The Fed is believed by some to be part of the supposed international Jewish banking cartel of long-standing legend.  For others it is part of the supposed empire of the Rothschilds, and for yet others it is part of a plot by private bankers to control the US government.  Even among those who don’t subscribe to the more outrageous of these views, there are many who refer to the Fed as a “private bank” that has inappropriate influence over the US economy.

It is not possible to address every one of these stories about the Fed in detail, but what can be done is to offer a history of the Fed and a brief description of its structure that provides an alternative narrative about its origins and operations. That narrative relies on standard histories of both the US monetary system and the Progressive Era of US history.  The result is a story that situates the Fed as just another example of Progressive Era zeal for a larger role for the administrative state, which would remedy the supposed failures of capitalism by relying on well-meaning experts to execute its policies.

Like other legislation of that era, the Fed was a government intervention supported both by ideologically-motivated and well-meaning reformers and by the industry being regulated.  Rather than being this as some sort of unique conspiracy to take control of the US monetary system, it was a story very similar to those found in the history of everything from railroad regulation, to meatpacking regulation, to the regulation of monopolies and trusts as historians from Gabriel Kolko onward have documented.  Unique historical factors in the monetary system affected the particular form the Fed took, but its broad history places it squarely in the tradition of the Progressive Era.  If the Fed is the product of some nefarious conspiracy, so is a whole bunch of other legislation passed around that time.

The Fed emerged not as a response to failures of a free market in banking, nor as the result of shadowy banking conspiracies, but instead as a response to the failures of the National Banking System (1863-1913) that preceded it.  The US banking system has never been a free market, as the National Banking System (NBS) was itself a response to pre-existing state-level regulations on banking.  Under the NBS, and many of the state systems that came before it, banks were subject to three major regulations:  1) limits on the ability of banks to operate branches;  2) minimum reserve requirements; and 3) requirements that banks that produced currency buy up certain bonds or other financial assets as collateral.

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