3 - Peculiar economics of the founding of the Fed

Summary

It is almost literally true that the Federal Reserve System, as originally conceived, was simply the nationalization of the private clearinghouse system.

(Gorton, 1985, p. 277)

Introduction

The quote by David Gorton provides a concise, although slightly misleading, statement of the hypothesis that forms the basis of this chapter. The quote suggests that the founders of the Fed intended to create a national clearinghouse rather than a modern central bank. It is misleading, however, in that the founders did not necessarily intend full nationalization. The hypothesis to be presented in this chapter is that the Federal Reserve consisted of national clearinghouse banks that were to compete along side the private clearinghouse system.

One goal of this chapter is to provide a conceptual framework for evaluating this narrow version of the nationalization hypothesis. In so doing, it will be necessary to investigate the conditions leading to the passage of the Federal Reserve Act. The US monetary system in the nineteenth century was governed by the National Banking Act of 1864. This legislation created a new type of currency, the national bank note, with collateral backing of government bonds. The rationale was to provide a source of revenue for financing the outlays associated with the Civil War. Subsequent changes in financing conditions in the early twentieth century made the National Bank System obsolete and led to the founding of the Fed.

A peculiar aspect of the founding of the Fed has gone largely unnoticed in the modern literature.