Monetary Policy, Federal

Monetary Policy, Federal. Encompassing two major components, the coining of currency and the creation of a banking system, U.S. monetary policy is as old as the national government itself.

Currency.

Following Alexander Hamilton's recommendations, the Coinage Act of 1792 established the dollar as the official unit of account and established a bimetallic standard that defined the dollar in relation to gold and silver. The silver dollar contained fifteen times as much silver as the gold in the gold dollar. Originally the fifteen‐to‐one ratio was close to the prevailing market value, but as market values changed over time, one of the metals became overvalued at the mint price. In the early nineteenth century, silver became overvalued, and its possessors presented silver to the mint for coinage. Gold coins began to disappear from circulation. In 1834 the Treasury adjusted the mint ratio to around sixteen to one, now overvaluing gold. Hence, gold began to replace silver in circulation, causing the latter to be hoarded or exported.

This system whereby the value of the dollar and foreign currencies was defined by their specie (gold or silver) content in turn fixed the value of currencies relative to each other. In other words, a system of fixed exchange rates enabled specie, dollars, and foreign exchange all to be freely convertible. Civil War economic exigencies, however, led Congress to pass the Legal Tender Act of 1862, which provided for the issue of fiat money, commonly know as greenbacks, not convertible into specie at a fixed rate. Market forces determined the value of the greenback (paper) dollar relative to gold and foreign currencies in a system of floating or flexible exchange rates. At one point, greenbacks in New York fell to a gold price as low as thirty‐five cents on the dollar.

To restore the prewar parity between the U.S. dollar and the British pound sterling (the standard for global exchange rates), the post–Civil War American government adopted fiscal policies to deflate prices and bring greenbacks onto a par with gold. The ensuing sharp deflation, which hurt debtors and aided creditors, caused fierce opposition. The Greenback Labor party (founded in 1874) appealed to debtors and entrepreneurs who wanted to expand the issue of greenbacks, increase the money supply, and raise the price level. Later, the free silver movement advocated the free and unlimited coinage of silver at the old ratio (16 to 1) to accomplish the same ends. Only after a decade of deflation did Congress pass the Resumption Act of 1875 and commit the Treasury to exchange gold dollars and paper dollars at par. On 1 January 1879 greenbacks became freely convertible to gold with fixed exchange rates restored at the prewar parity.

The victims of deflation, however, continued to condemn the gold standard as the congressional “Crime of ’73.” (In 1873, ancillary to its deflationary policy, Congress had “demonitized” silver by ordering the U.S. Mint to stop making silver coins.) The 1880s and early 1890s remained a period of intense controversy as to the appropriate monetary standard. The election of William McKinley over William Jennings Bryan in 1896 and, subsequently, rising prices stilled the protests of debtors and free‐silver advocates. In 1900 the U.S. formally committed itself to the gold standard.

After the financial crises and disruptions of the 1930s and World War II, the United States and its major allies agreed to restore fixed exchange rates at the 1944 Bretton Woods Conference. The dollar, set at a price of thirty‐five dollars per ounce of gold, replaced the pound sterling as the international currency of record. The Bretton Woods system lasted into the early 1970s when domestic inflation prompted President Richard M. Nixon to end fixed exchange rates. Afterward the dollar floated against other currencies, its value determined by the demand and supply of foreign exchange.

Banking.

Congress chartered the first Bank of the United States in 1791 as proposed by Alexander Hamilton, who modeled it after the Bank of England. The bank was a combined public and private enterprise with branches in major cities, the authority to issue notes, and a role as a commercial bank as well as the fiscal agent of the government. When the bank's charter came up for renewal in 1811, the recharter bill failed in the Senate after a hotly contested debate about its constitutionality.

Shortly thereafter, however, in 1816, Congress established a second Bank of the United States with charter provisions similar to those of the first. After a rather undistinguished early history, the Second Bank came into its own in 1823 with the appointment of Nicholas Biddle of Philadelphia as director. Biddle actively pursued a policy of pressing state banks to redeem their outstanding banknotes at promised par or face value in specie. Such a policy restrained the temptation of such banks to “overissue” notes, dampened inflation, and increased public confidence in circulating banknotes. During the 1820s Biddle's policy narrowed the range of discounts among state banknotes. This policy promoted soundness and confidence in the banking system but produced discontent in western regions and among individuals desirous of easier credit.

President Andrew Jackson, who vetoed a bank recharter bill in 1832, represented the enemies of Biddle. In his veto message, Jackson criticized the bank's monopoly status, its domination by financiers and foreigners, and its regulation of economic growth in the West. He even questioned its constitutionality. Jackson resolved to cripple the bank's power by removing government deposits and redepositing them in selected state banks known as “pet banks.” Jackson's war against the Second Bank was followed by a speculative boom (with the highest peacetime inflation rate before the 1970s) and an ensuing financial panic and deep depression (1837–1843). After 1836 the federal government withdrew from the banking system altogether, later establishing an independent treasury to administer revenues and their disbursement. This system lasted nearly three‐quarters of a century until the establishment in 1913 of the Federal Reserve System.

To replace the circulation of heterogeneous state banknotes with a uniform currency and simultaneously increase the demand for government bonds, the National Banking Act of 1863–1864 established a national banking system. Banks with national charters were allowed to issue banknotes backed by U.S. government bonds. The dominance of national banks proved short‐lived. Increasing use of checks and demand deposits made banks’ inability to issue notes less of a disadvantage, so that by 1890 the non‐national banks surpassed national banks both in number and assets. This system of small, independent local banks (as opposed to branch banks) proved particularly vulnerable to financial crises. In the late nineteenth century, financial panics and subsequent suspensions of cash payments by banks became common. A panic in 1907 was the last straw, leading Congress to establish the congressional National Monetary Commission to consider banking reform. The result was the Federal Reserve Act of 1913.

The Federal Reserve System created a central bank to alleviate the problem of recurrent panics. The new institution was to furnish “an elastic currency,” smooth seasonal money‐market stringencies, and act as the lender of last resort during crises. The law established a decentralized structure that dispersed power and reflected popular and congressional suspicion of the concentration of economic power in Washington or among Wall Street bankers. Twelve regional Federal Reserve Banks operated under a coordinating board in Washington.

In its initial years the new system appeared successful in adjusting seasonal credit flows and smoothing seasonal interest rates. The Federal Reserve, however, failed to avert the Great Depression of the 1930s. Indeed, many economists cite its inaction as the principal factor underlying the severity of the depression. The failure of the Federal Reserve System between 1929 and 1933 led the Franklin Delano Roosevelt administration to propose further reforms. The Banking Act of 1933, known as the Glass‐Steagall Act, created the Federal Deposit Insurance Corporation (FDIC) to protect depositors’ accounts. Glass‐Steagall also divorced investment and commercial banking operations. The Banking Act of 1935 further centralized and extended the power of the Federal Reserve Board, now called the Board of Governors. Thereafter, the Federal Reserve Board had greater power to regulate the money supply and set interest rates.

The high inflation and interest rates of the 1970s created great problems for regulated banks, which were limited as to the loans they could make and the rate of interest they could pay. Depositors thus withdrew funds from banks and redeposited them in unregulated money market mutual funds that offered higher interest rates. The Depository and Monetary Control Act of 1980 partly deregulated commercial banks and savings‐and‐loan associations, allowing them to offer higher interest rates by making more diverse investments. The ensuing pattern of highly speculative investment led to the savings‐and‐loan scandal of the 1980s. As the twentieth century ended, however, further deregulation of banking seemed likely.
See also Banking and Finance; Bank of the United States, First and Second; Depressions, Economic; Federal Government, Executive Branch: Department of the Treasury; Taxation.

Bibliography

Bray Hammond , Banks and Politics in America from the Revolution to the Civil War, 1957.
Milton Friedman and and Anna Schwartz , A Monetary History of the United States, 1867–1960, 1963.
Paul Studenski and and Herman Krooss , Financial History of the United States, 1963.
Peter Temin , The Jacksonian Economy, 1969.
Richard Timberlake , The Origins of Central Banking in the United States, 1978.
Eugene N. White , The Regulation and Reform of the American Banking System, 1900–1929, 1983.

John A. James