This archived content originally appeared at, the predecessor site to, and does not carry the sponsorship of the Cato Institute.

"Why Was the Fed Created?"

Was the subject assigned to me for my "Tea Lecture" to congressional staffers last week. The lecture is one of a series being sponsored by Ron Paul's office. The true story of the Fed's origins needs to be more widely known, so please do pass it on!

  • Bill Stepp

    Re: the last question in the Q&A, here's the reference to the article on the origins of the Bank of Canada, Michael D. Bordo and Angela Redish, "Why Did the Bank of Canada Emerge in 1935?," J. Economic History 47 (June 1987).
    Did Canada's banking history more closely mirror Scotland's rather than Uncle Sam's because it was settled in part by Scottish immigrants?

  • BillWoolsey

    Great lecture.

    By the way, if "inflation" was desirable in Canada in 1935, the solution would be devaluation. It would be pretty implausible that Canadian prices, or nominal expenditure on output, could move much relative to the U.S. with a fixed exchange rate in terms of gold.

  • Great Lecture. Glad to see Ron (or someone on his staff) is incorporating a wider array of monetary experts and reaching out across the FRB aisle. Will you be delivering any more of these lectures, George?

  • RickDiMare

    Great, again, great presentation. I finally understand what you've been saying about branch banking.

    Two points come to mind:

    I think there's more to the greenback period that needs to be considered. You identified it as "important," but quickly jumped to talking about the national bank experience.

    Regarding the graph you posted, I think there's an unexplored possibility that elasticity deficiencies during harvest periods could also been addressed by allowing money to enter the economy directly through laborer's wages (though more power goes to bankers the other way).

    • RickDiMare

      I wish this blog allowed edits. Sorry, meant: "George, again, great presentation."

    • RickDiMare

      But stepping back and looking at the bigger picture for a minute as to "Why Was the Fed Created?," I think we also need to consider the possibility that those who controlled federal greenback policy and the first currency-regulating income tax ( at the start of the Civil War really liked the degree of discretionary power they experienced, and sincerely believed they could do lots more for the country if they were not bound by the Constitution's Borrowing Clause, which forced a return to specie redeemablity and the Specie Payment Resumption Act of 1875:

      Viewed from this angle, the Fed was created with the ultimate goal of creating a privately-issued currency that was not bound by specie redeemabilty … and the Great Depression was nothing more than a transitional phase, with the 1937 Helvering v. Davis currency-regulating income tax and the 1963-series irredeemable Federal Reserve Note being the real reason the 1929 crash was allowed to occur.

  • jehoceanwave

    With regards to banking history, can you recommend a good primer on the origins of banking in Europe at the time of the late Middle Ages or Renaissance time period? If Dr. Selgin or anyone else could recommend, I would greatly appreciate. I want to get one for my teenage son who is interested in banking history.

  • Warren

    Yes, that was excellent. The youtube commentators that didn't get it add to the value for me.

    More needs to be said about the differences between Canada and the US in regards to the panics and lack thereof in the two countries. Those differences are the ultimate argument for refuting the central bankists contention that without the Fed we would have been much worse off and therefore we need all the regulations and protocols that a strong central bank requires.

    This is an easier point to make about the Great Depression that trying to explain the difference between the gold exchange standard and the normal gold standard, France's zany gold hoarding hijinks, and Smoot-Hawley and what those meant to the crisis.

    Keep up the good work, G-Money.

  • Most excellent lecture!

  • RickDiMare

    Maybe the Fed was created because those who controlled federal policy during the greenback period (and our first currency-regulating income tax: really liked the degree of discretionary power they experienced, and sincerely believed they could do lots more for the country if they were not bound by the Borrowing Clause, which forced a need to pass the Specie Payment Resumption Act of 1875:

    Viewed from this angle, the real purpose of the Federal Reserve Act was to create a privately-issed alternate currency that was not bound by the Borrowing Clause … and the Great Depression was nothing more than a transitional period, with the 1937 Helvering v. Davis currency-regulation income tax and the 1963-series irredeemable Federal Reserve note being the real reasons the 1929 crash was allowed to occur.

  • Paul Marks

    The origins of the Fed are indeed deeply dishonest.

    As the late M.N.Rothbard was fond of pointing out,the Fed was sold to the public as somehow a limitation on bankers and their credit bubbles. Whereas, in reality, it was drawn up by the representatives of the leading banks of the time – as a way of backing up their credit bubbles (so they could take them to a level never before seen in peacetime in the United States). Of course such interventionism as allowing the "suspension of cash payments" in 1907 was also totally wrong (either banking is a free industry or it is not – if it is a free industry is must be under the same laws as all other economic activity).

    As for Canada…..

    The key question is why prices did not fall in the late 1920s (some prices did fall – but, if price indexes are to believed, not prices generally).

    Output was rising – so general prices should have fallen in Canada in the late 1920s, yet they did not. Why not?

    The only reasonable explination is that there was a rise in the money supply (if only the credit money supply – i.e. broad money), as there was in the United States.

    If this is correct – then the bursting of the credit money bubble was, at some point, inevitable.

    Nor, of course, would any effort to reinflate the credit bubble be really desirable.

    Prices and wages should have been allowed to adjust to the collapse of the credit bubble, as quickly as possible.

    And government interventionism (such as pro union laws) should not have been followed.

    And government itself (its spending) should have been dramatically rolled back.

    All this was followed in the United States in 1921 – and allowed the United States to quickly recover from the bursting of the World War One credit bubble.

    As for banks themselves.

    It is (of course) not true that no Canadian banks ever went bankrupt (an industry without failures would be an odd industry indeed) – but it is true that Canadian banking did not suffer from the mass panics that American banking (both under the National Banking Acts and under the Federal Reserve Act) did.

    Without being a slave to empiricism, I must say that it is clear that George Selgin has a valid point.

    In the face of such an important fact (the lack of general panics with vast numbers of small banks failing and the major banks always being close to collapse) there must have been something right about the structure of Canadian banking of that time.

    Branch banking, with no Central Bank. And (of course) no "deposit insurance".

    Sadly Canada has moved away from all this – with the exception of branch banking.

  • Paul Marks

    Rick – some of the people involved in the Civil War Greenback policy did like the power.

    However, others were horrified by it.

    After all it was Salmon P. Chase (the person who pro Confederate types with their "the war was not about slavery" mantra, do not like mentioning – as his political life had been all about opposing slavery, he was "the slaves lawyer") was the man who introduced the Greenback (as an emergency war finance measure) – but he was also the man who, as Chief Justice of the Supreme Court, ruled that Greenbacks were unconstitutional.

    A ruling later overturned in the infamous second Greenback case. Which basically held both that the words in the Constitution have no fixed meaning, and that evidence on the intentions of the Founders is not relevant – this level of contempt for the United States Constitution is rare in 19th century Supreme Court judgements, but (of course) became the norm in the 20th century.

    People who support paper money (which did not come back till long after the case anyway) normally yawn with boredom at talk of the United States Constitution – if only they would understand if this "coin" bit of the Constitution can be overturned (as it was overturned) the rest of the Constitution can also be overturned on the same grounds (i.e. the grounds that the words in the Consitution have no fixed meaning, and the grounds that evidence concerning the intentions of those people who wrote the words is not relevant) – which is exactly what has been done.

    Sorry for not replying for so long – the other comments only got to me this morning (strange are the ways of computers…..).

  • vikingvista

    Best lecture I've seen in ages. An hour well spent. Thanks.