My Views on the Fed

There is no right or wrong way to view the Federal Reserve. It is not based on any scientific truth or physical law. It is an entity based on the pseudo-science of economics. But, even with that being said, one thing is for sure: considering the sheer importance of the Fed, it is a national folly that so few people actually understand what they’re trying to do and why.

*prepare yourself, we’re about to dive deep into the history books like Samwell Tarly at the Citadel*

The Federal Reserve was founded to be the guardian of the United States Dollar. Their mission is to defend against inflation, deflation, and to support the Dollar when it is threatened by unemployment or financial panic. They are the lender of last resort.

Woodrow Wilson, back in 1913, was the first President to enact the Federal Reserve. And Wilson was one smart dude. While it is clear he supported the Fed’s creation, he was not ignorant to the financial system that was taking control of the country. In his published work called A New Freedom he wrote:

“The great monopoly in this country is the monopoly of big credits. So long as that exists, our old variety and freedom and individual energy of development are out of the question. A great industrial nation is controlled by its system of credit. Our system of credit is privately concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men who, even if their action be honest and intended for the public interest, are necessarily concentrated upon the great undertakings in which their own money is involved and who necessarily, by very reason of their own limitations, chill and check and destroy genuine economic freedom.”

Woodrow Wilson

Political officials fought intensely over the creation of the Fed. If you watched wrestling as a kid, I want you to imagine it as Stone Cold Steve Austin vs. Mankind in a cage match. The political battle involved lobbying from Wall Street, opposition from progressives, and at one point, a giant wooden tombstone being carried through the halls of Congress meant to signify the death of capitalist money.

At first, people like Woodrow Wilson were critics of the Federal Reserve. He and others were worried about the people who would run this new Central Bank. A Senator named Nelson Aldrich, a man who wined and dined with the great Wall Street power houses, was suspiciously the one who spearheaded the first Federal Reserve bill. No one is entirely sure how Aldrich became the man responsible for the creation of the Federal Reserve, but to get a sense of who Aldrich was and his beliefs, you only have to look at how political cartoons were depicting him at the time.

File:Puck cartoon of Senator Nelson Aldrich 1906.jpg

In his original proposal to President Wilson, Aldrich suggested the Federal Reserve be controlled solely by the biggest Wall Street banks with no political interference. While everyone agreed that a Central Bank made sense, that they needed some form of backstop to the financial system, no one could entirely agree on who and how it should be run.

This is where the story of the Federal Reserve gets interesting. Because long before it was created, free market capitalists of the time hated it. Why would the booming capitalists ever want intervention, especially a central banking authority? They wanted to grow, compete, and win! What’s funny is that opinion quickly changed after the Panic of 1907 when they almost lost everything. It is the single event that set in motion America’s first Central Bank.

The Panic of 1907 was the first financial collapse in American banking history. Not many people are aware of the Panic of 1907, but it started when group of traders tried to corner the Copper market. They took out massive margin loans from banks, and bought gobs of copper. Their plan was to literally buy all the copper they could until they had monopolistic control over the price. The trade did not go as planned. I guess there is a lot of copper in the world, and when they failed to corner it, the price started to drop and their trade collapsed. The banks who lent those traders money quickly realized they were never going to see that cash money ever again. A chain reaction of panic followed. People started to pull their money from banks until there was none left. All of Wall Street was in shambles. As the gamers might say today:

After the panic, the banks realized the only way they could survive long-term, in this emerging society, was to have a Central Bank who could loan them money when all else failed. A passage between James Stillman, who was one of the great bankers of the time, and Paul Warburg, an academic working on the first draft of the Federal Reserve, shows how quickly the average banker’s opinion changed in the good times compared to the bad times after the panic of 1907:

“How is the great international financier?” he asked with friendly sarcasm. He then added, “Warburg, don’t you think the City Bank has done pretty well?”

I replied, “Yes Mr. Stillman, extraordinarily well.”

He then said (about founding a Federal Reserve), “Why not leave things alone?”

It was not without hesitation that I replied, “Your bank is so big and so powerful, Mr. Stillman, that when the next panic comes, you will wish your responsibilities were smaller.”

At this, Mr. Stillman told me that I was entirely wrong, that I had the mistaken notion that Europe’s banking methods were the most advanced, while, as a matter of fact, American methods represented an improvement upon, and an evolution of, the European system, America having already discarded its central bank. He had no doubt that progress would have to be sought, not by copying European methods, but by elaborating our own.

Four years later, in the midst of the panic of 1907, I found Mr. Stillman once more standing over my desk; and when I looked up, he asked, “Warburg, where is your paper about the Federal Reserve?”

Warburg Memoirs

The Fed was not exactly created for the goodwill of the average everyday American as much as it was to backstop the operators of the financial system. They witnessed 1907, and never wanted to do it again. The Fed today has evolved greatly to this day, and as you will come to read, I am impressed with their work, but it is still eery to consider the true intentions of its foundation.

I hope my post is not coming across as something nefarious. That’s not the point. What I’m trying to highlight is that the institution itself, its founding mandate, was literally designed to keep a certain class of people backstopped at all times. Bertie Charles Forbes, after the Panic of 1907, wrote about how the first draft of the Federal Reserve came to be. It started as a secret meeting between bankers in a far away location:

“Picture a party of the nation’s greatest bankers stealing out of New York on a private railroad car under cover of darkness, stealthily riding hundreds of miles South, embarking on a mysterious launch, sneaking onto an island deserted by all but a few servants, living there a full week under such rigid secrecy that the names of not one of them was once mentioned, lest the servants learn the identity and disclose to the world this strangest, most secret expedition in the history of American finance. I am not romancing; I am giving to the world, for the first time, the real story of how the famous Aldrich currency report, the foundation of our new currency system (the Federal Reserve) was written.”

Bertie Charles Forbes

The meeting Bertie Forbes writes about is called The Meeting at Jekyll Island. The history of that meeting is fascinating and the name of the meeting is hilarious on so many levels. So while my opinion on the Fed is generally positive, I do not ignore the way it was started. I don’t think it’s a coincidence that, of all the great American companies ever started, even going back to the 1800s, is that only a few are still around and thriving today. And they are almost ALL financial institutions. What I’m saying is, if you look around, the financial institutions from 100+ years ago, think JP Morgan, Wells Fargo, Goldman Sachs, are the only companies that are actually still thriving. Most other companies built in that time have either lost out to better technology, disappeared through mergers, or are hanging on by a thread today.

The thing is, whether the Fed realizes it or not, they are giving a specific industry a resource most others do not have. Today, a bank or a hedge fund in a perilous position can get instant liquidity or cash infusions from the Fed no matter what reckless behavior they have taken now or in the past. The same is not true for regular people, small businesses, or anything of the sort. If you were born randomly into a less fortunate area somewhere in middle America, and you messed up your credit score once, guess what, your liquidity is probably going to be frozen forever. The Fed is never there to bail out people like that. As I always say, the Fed never goes to the hood.

Wealth inequality is one of the great problems of our time. The destruction of middle America and small business is right behind that. And, as the Coronavirus wages ware on us all, I am sure we will emerge with both of those problems in even worse shape. Because while everyday people are failing, one group will never — those closest to the Fed. I recently read that the Fed is calling the Coronavirus outbreak a natural disaster and that it needs to be treated with aggressive actions. I got a chuckle from that, because during Katrina, also a natural disaster, the people impacted in New Orleans got nothing. Do you think any of them were given liquidity after that natural disaster? Not a chance. If anything, the majority of them them saw their credit wiped out. The only loans they could get from that day on were probably from loan sharks. It is not hard to see the asymmetry in the Federal Reserve’s support for different classes of people.

This is my criticism of the Federal Reserve. They continue to backstop and support the same class of people time and time again. It breads wealth inequality and worse, stagnation. There is no survival of the fittest in modern banking. That is why we stuck with the same banks doing the same thing. It’s also why I believe in the emerging fintech space today. I want to see Silicon Valley take this over. Crush old ways of thinking. Society does best when competition is thriving and we are a country built on the underdog and the redemption story not legacies and tradition.

This post was not meant to convey that I disagree with the Fed nor do I think we should ever get rid of them, but I am saying we need to push them to think more creatively. A liquidity line in a less fortunate area, or giving less fortunate people a second chance at credit in hard times, can do more good and long-term health for our country than any amount of money given to the same group of people over and over again.

That is all for now. Thanks for reading.

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