Michael Hudson: How the U.S. Avoided Chronic Deflation by Relinquishing Monetary Control to Wall Street

Yves here. This post is likely to frustrate readers who like simple Manichean readings of politics and history. Hudson, a long-standing critic of the financialization of the economy, describes the relationship between banks and the Treasury in the US in the 19th century versus in the post-crisis era. He points out that even though banks have normally favor deflationary policies, financiers in the US have a tension among various objectives that in recent years have produced a bias against deflation (although the Fed’s current interest rate conundrum and the fact that policymakers are discussing negative interest rates reflects the fact that the US may still fall prey to the exporting of deflation by its trade partners). First, the Fed was formed to stem the recurrence of the sort of deflation that plagued the 19th century, and thus was designed to have an inflationary bias (in the older term of art, provide for elasticity of the currency). Second, the US has moved since the 1980s of having asset bubbles serve as a means for creating short-term growth (until the bubbles deflate or implode) and transferring more wealth to top income groups (by making government policy more focused on asset markets than growth in wages, as witness the preoccupation with home prices and the stock market). This perverse economic model has had one positive side effect (despite the other costs that Hudson has long inveighed against): that of putting Wall Street on the side of opposing deflationary policies, unlike financial players in Europe, who exert similar influence over monetary and fiscal policy.

By Michael Hudson, a research professor of Economics at University of Missouri, Kansas City, and a research associate at the Levy Economics Institute of Bard College. His latest book is “KILLING THE HOST: How Financial Parasites and Debt Bondage Destroy the Global Economy.” Originally published at Social Sciences Research Network

The Eurozone today is going into the same deflationary situation that the U.S. did under Jackson’s destruction of the Second Bank, and the post-Civil War budget surpluses that deflated the economy. But whereas the Fed’s creation was designed to inflate the U.S. economy, Europe’s European Central Bank is designed to deflate it — in the interest of commercial banks in both cases.

1. Introduction

Deflation was the main U.S. financial problem prior to 1913. To replace the Treasury conducting its fiscal operations independently from the banking system, New York banks urged more power over public finances and to establish the Federal Reserve to increase the supply of money (a more “elastic” issue) in response to banking needs. Monetary policy since the Great Depression that started in 1929 has aimed at re-inflating the economy after downturns, fueling the post-2001 financial bubble and, since 2008, Quantitative Easing to provide banks with liquidity to support asset prices.

By contrast, Europe’s trauma of hyperinflation after World War I gave Europe’s bankers and bondholders a rationale for gaining power over governments to prevent them from monetizing their budget deficits. The rhetoric of fighting inflation has enabled German and French banks to impose tight money policies and smaller public self-funding than in the United States. On both continents, banks gained power over governments. But in America it was by insisting on more money creation and deficit spending, and in Europe by advocating limits on public money to finance deficits.

For most of the 19th century the U.S. Treasury conducted its monetary and fiscal policy in ways that imposed deflationary pressures on the banking system. President Andrew Jackson (1829-1837) of Democratic Party starved the economy of credit by his war on the Second Bank of the United States and removal of government deposits to sub- treasuries around the nation. His Democratic Party policy was backed by Southern plantation owners opposing Northern industry, seeing that its growth would increase urban industrial demand for food and other consumer goods. This would raise prices for the crops that plantation owners needed to feed their slaves.

The opposition Whig Party (1833-1854), followed by Republicans after 1853, was advocating a policy of recycling tax and land-sale receipts into Northern banks to help fund industrial growth. After the Civil War that started in 1861, the United States pursued a pro-industrial high-tariff policy, but this generated budget surpluses, which deflated the economy and drove prices for gold and other commodities back down to their pre-1861 level. That led to the 1873 crash and a depression until 1896, followed by an even greater crash in 1907.

In the wake of America’s 1907 financial panic, the Aldrich-Vreeland Act of 1908 created a “National Monetary Commission … to inquire into and report to Congress at the earliest date practicable, what changes are necessary or desirable in the monetary system of the United States or in the laws relating to banking and currency …”[1] The Commission’s thirty-five monographs provided an exhaustive study of central banking structures and commercial banking policies, laying the groundwork for what in 1913 became the Federal Reserve Act.

Money and banking textbooks typically portray the Act as modernizing the financial system “to correct certain serious shortcomings in the National Bank Act: to provide an elastic currency, efficient clearing, centralized reserves, readily available credit for banks, and unified control of the banking system.”[2] But David Kinley’s 1910 report (Kinley 1910) shows that the National Banking System had neither responsibility nor ability to steer the nation’s monetary course. Prior to 1913 the Treasury performed these functions, including open market bond purchases to provide the banking system with liquidity. It would be more accurate to view the Federal Reserve as shifting to Wall Street the financial power hitherto concentrated in the hands of the Treasury Secretary in Washington.

From the establishment of the Treasury in 1847 through 1914 the Secretary of the Treasury had held responsibility for regulating the money supply by shifting Treasury deposits among the subtreasuries and the national banks to relieve regional credit stringencies, and by engaging in open market operations to cope with cyclical difficulties. In fact, Kinley (1910) observed, the Treasury had come to perform most of the functions of a central bank:

(1) It issues and redeems paper money – United States and Treasury notes; … (4) it transfers money to move the crops; … (6) it acts as a regulator of the rate of discount by contracting and expanding the currency through its operations upon the deposits in banks and in its own vaults; (7) it keeps the gold reserve of the country.

In 1914 the Federal Reserve System took on these duties, regulating the money supply through open market operations similar to those the Treasury had been conducting since the 1850s to cope with the problems resulting from budget surpluses. The Comptroller of the Currency’s 1907 report noted:

For several years past the revenues of the Government have been largely in excess of expenditures, and there has been a constant problem presented to each successive Secretary of the Treasury as to the best means of replacing in circulation the money which the Government is forced to collect. The method of replacing it by deposit with the banks is probably the only one available and, although it has been handled with unusual skill and ability, is most unsatisfactory, unsystematic, and inefficient. It always is a matter which provokes criticism and complaint. It could be handled with far better results if the Government had under its control a central bank to which all revenues could be paid and through which all disbursements could be made.

The Federal Reserve System dispersed this fiscal management away from Washington. Its twelve regional reserve districts opened the path to abolish the Independent Treasury and its regional subtreasuries in 1921. The main beneficiaries were the leading New York banks. In effect, creation of the Federal Reserve shifted monetary control from Washington to Wall Street – hardly surprising when one looks at the list of attendees at the Jekyll Island meeting of leading bankers in 1910, where J. P. Morgan and Rhode Island Republican Senator Aldrich outlined plans for the Fed (see Griffin, 1994; Chernow, 1997).

2. Origins of the Independent Treasury in Jackson’s War on the Second Bank of the U.S.

Soon after taking presidential office in 1829, Andrew Jackson tried to coerce the bank’s directors of the Second Bank of the United States to perform certain political favors, starting with replacing Jeremiah Mason as the president of the bank’s branch in Portsmouth, New Hampshire. When the Bank’s directors refused to do this, Jackson turned to state banks to deposit government funds. In 1833, Jackson directed his new appointee as Secretary of the Treasury, William J. Duane, not to replenish these deposits as they were drawn down, but to put them in “pet” state banks run by his political supporters.

Duane refused to comply. Claiming that removing government deposits would disrupt the economy, he urged that the issue be decided by Congress, which already had declared the Bank to be safe. Jackson fired him after only four months, and replaced him with Roger B. Taney, whom Congress refused to confirm (the first rejection of a cabinet nominee in U.S. history). But as acting Treasury Secretary, Taney was able to carry out Jackson’s removal of deposits.

The pro-industrial Whigs accused this bank war of centralizing financial power in the hands of the President and whomever he might appoint as Treasury Secretary. As Calvin Colton accused in his biography of Henry Clay, while Jackson was re-depositing Treasury funds in his pet banks, Secretary of State Martin Van Buren was organizing political patronage via the banking system in his native state of New York:

… the old banks found themselves annoyed by unexpected runs upon them for specie, and … while laboring under these inconveniences, hints were passed to them, that, by appointing such and such directors, they would be relieved. The new banks were of course all furnished with suitable director. In this way, it is averred, that the whole banking system of the state of New York, from one of the bank parlors of Albany, was brought under the sway of the dominant political party, and forced to minister to their occasions.

It cannot be denied, that, of all men in the world, they who had accomplished such an achievement, were best qualified to know the power of banks as political engines, and to declaim against them when it should answer their purpose, as an enormity in the social state. Who was better qualified than Mr. Van Buren, when transferred to the state department at Washington, to give advice to the president of the United States on this subject? “Do you not see, sir, how admirably this system works in the state of New York? We govern the state by the banking system there, and force the banks (alias, the people) to pay all the costs of our party in maintaining our ascendency. You have only to adopt the same system with the bank of the United States, get such directors and presidents of the branches as are most suitable, and gradually bring the parent institution under the same discipline, and the politics of the nation will ever afterward be at command.”[3]

The Bank’s fate was sealed when its president, Nicholas Biddle, attempted to compensate for the drawdown of government deposits by a series of speculative business ventures. The Bank’s application for re-charter three years later was revoked. By this time the banking issue had become part of the sectional political conflict between North and South. The Southern slave states advocated monetary deflation for two reasons: to keep the price of cotton low, and hence competitive on world markets; and to thwart northern industrial growth so as to minimize the population voting against extension of slavery. Jackson rewarded the pro-slavery Maryland Democrat Taney by appointing him to the Supreme Court in 1836, where he became notorious for delivering the majority opinion in the 1857 Dred Scott case. His court also declared the Missouri Compromise unconstitutional, opening up the nation’s western territories to slavery. This sectional division colored the Democratic opposition to the Whigs and, after 1853, the Republicans, who advocated protectionism, internal improvements and a national bank.[4]

As for Van Buren, he became Jackson’s Vice President (1833-37) and succeeded him as President (1837-41). His administration started in 1837 with the depression that followed from closing down the Second Bank. Van Buren aggravated the monetary stringency by keeping federal deposits in the independent treasury instead of state banks.

3. Treasury surpluses drain the economy of liquidity

The sale of public lands during Jackson’s second term soared from $4 million in 1833 and $5 million the following year to $15 million in 1835 and $25 million in 1836, producing a large Treasury surplus. Jackson’s extermination of Native Americans cleared a vast territory for slavery in the South and colonization of the West. Most purchases during 1835-36 were made by land speculators, largely with borrowed funds.

The Treasury deposited proceeds from these land sales in state banks, which were assured that the government would not draw them down. New bank credit extended on the basis of these deposits fueled land speculation, which increased federal receipts from these sales by enough to liquidate virtually all the national debt, while maintaining a large cash surplus deposited in state banks.

Much as Whigs had warned, privileged banks were nurtured and bribery was not infrequent. States founded and operated their own banks, issuing notes to finance their budget deficits much as the Treasury would issue greenbacks during the Civil War. This basically corrupt chaos of private and state banking led to Jackson’s Specie Circular of July 1836, requiring all payments for public lands to be made in gold or silver bullion.

This pricked the inflationary bubble of speculative land grabbing. It helped terminate the government’s losses sustained from being obliged to accept worthless banknotes at their face value in payment for public lands, and also helped save the western states from largely non-resident proprietorship. But the Specie Circular also distressed the nation’s industrial finances by leading to widespread bank failures. Van Buren used this to justify his proposal the following year to keep government funds “safely” in subtreasury vaults across the nation.

4. Democratic versus Whig and Republican monetary policy

A party battle around the constitutionality of the subtreasury scheme set the free-trade Democrats as literal constitutionalists against the Whigs, who were federalist on the tariff and internal improvement issues but sought to “separate the power of the purse from the power of the sword.” The “independent” treasury scheme, they argued, was not true federalism but a form of monarchism (the popular Whig term for Jackson’s presidency) centralizing financial power in the Executive and his appointed bureaucracy. In its place, Whigs advocated using government finances to provide the credit base for northern industry. Whig Presidential candidate Henry Clay’s “American System” advocated protective industrial tariffs, internal improvements and a national bank to fund industry.

Recognizing that deflation would result from the subtreasury scheme, Southern plantation owners sought to support their slaves at a low enough cost to maintain the South’s dominant export position in cotton and tobacco. Creditors on the Northeast Seaboard also supported deflation. The result was a deflationary agrarianism aimed at countering the growth of northern industrial power. “The avowed object of the administration and its advisers,” asserted the protectionist Reverend Calvin Colton, associate and biographer of Henry Clay popularizing economic discussion of his “American System” of a national bank, protective tariffs and internal improvements, “was to suppress the paper medium of the country, and introduce a metallic currency; and the independent or sub-treasury, was to be the means of accomplishing the end, although, as shown by Mr. Clay, it must necessarily fail, and itself establish a paper medium of a most dangerous tendency.”[5] The Treasury’s drafts upon its public depositories, Clay argued in 1840, would soon circulate as money, driving state bank notes out of circulation.

There thus existed a sectional polarity to the Democratic-Whig controversy over whether the United States should be characterized by a deflationary monetary system segregating federal finances from the commercial banking sector, or by using government funds as the basis for a national banking system responsive to industrial needs, as was being done in France and Germany.

5. Treasury surpluses necessitate open market bond purchases

“Under the terms of the law establishing the independent treasury,” Kinley describes, “the Government was expected to keep its own money and have no connection with the banking institutions of the country.”[6] This policy proved impractical. Long before Civil War financing necessitated the National Bank Act to provide a means of recirculating government deposits into the banking system, the growing volume of Treasury finances necessitated compensatory activity following re-establishment of the Independent Treasury in 1847.

The main compensatory Treasury activity was to purchase government bonds from the banks. Thanks to the California gold rush, the Treasury ran its largest surplus yet by 1853, “so that there was a considerable accumulation of money in the treasury. To prevent any stringency that might be caused thereby the Secretary issued a circular, on the 30th of July, offering to buy $5,000,000 worth of 6 per cent bonds. He secured them by paying a premium of 21 per cent.”[7] This was the beginning of federal open market operations, often hailed by monetary historians as an accidental “discovery” of the Federal Reserve in the 1920s.[8]

Democratic Treasury Secretary James Guthrie’s used the budget surplus to pay down the national debt from $63 million in 1853 to $25 million in 1857. However, budget surpluses drain monetary resources from the economy. Guthrie’s report of December 1856 observed that the subtreasury might “exercise a fatal control over the currency, the banks, and the trade of the country, and will do so whenever the revenue shall greatly exceed the expenditures.”

Furthermore, he noted: “If there had been no public debt, and no means of disbursing this large sum [$45 million since March 1853 by Treasury bond repurchases] and again giving it to the channels of commerce, the accumulated [sterilized] sum would have acted fatally on the banks and on trade. The only remedy would have been a reduction of the revenue, there being no demand and no reason for increased expenditure.”[9] The Democrats’ opposition to high tariffs and spending on internal improvements would indeed have reduced federal tax revenue.

To avoid the deflationary effects of high tariff duties under the Independent Treasury system, Clay and other protectionists advocated abolition of the subtreasuries and a return to government financial operations such as had characterized the 1816-36 period dominated by the Second Bank of the United States.

When panic broke out in 1857 and dragged many banks under, Republicans (who had replaced the Whigs in 1853) accused the Treasury of having brought it on and contributed to its depth. But Democrats defended the Independent Treasury system by pointing to the safety of government finances achieved by virtue of their having been divorced from the banking system. The Treasury made bond purchases of nearly $5 million in 1858, but federal spending deficits fueled the recovery.

6. Civil War financing needs lead to greenbacks and the National Bank Act

The ultimate break between Republicans and Democrats occurred in 1860 over the slavery question, which threw presidential and congressional power to the Republicans. The outbreak of Civil War increased the government’s financial needs, and effectively ended Treasury “independence” from the banking and private sector.

The new Secretary of the Treasury, Salmon P. Chase, was appointed by Lincoln largely in recognition of his anti-slavery stance. The Civil War quickly derailed the country’s finances. If Chase kept the loans made by the New York banks locked up “in the government vaults in the form of specie … the banks could not keep it as a reserve against their notes.” The problem was that “the Government, under independent treasury law, was obliged to be independent of the banks in the sense that it must not use their notes. If, therefore, the Treasury was to get money to carry on its now extensive operations it must use specie or issue Treasury notes.”[10]

The Treasury became a bank of issue, monetizing its war debt. Bankers urged Chase to stop issuing greenbacks, which were driving their notes out of circulation and draining their specie. They pressed the Treasury to use their bank notes instead. When he refused to do this, the banks were forced to suspend specie payments in December 1861. “Had the Secretary withdrawn the treasury notes and accepted the bank issues” in lieu of gold, Kinley (1910) observed, “it would have been a departure from the independent treasury law.” Instead, Congress and the Treasury forced suspension by “trying to meet the expenses of the war by loans, with as slight an increase of taxation as possible.”[11]

The deflationary pattern of government finances under the independent treasury law made the National Bank Act a necessity. In order to enable the Treasury to recirculate government funds into the banking system to stabilize the currency and float further national debt, the National Bank Act permitted it to deposit all receipts with the newly chartered national banks as well as with the subtreasuries.[12] All national bank notes were to be received at par in all parts of the United States in all payments to or by the government, except for customs duties, which legally had to be paid in coin. These actions restored the circular flow of liquidity in the banking-fiscal system, but gold convertibility remained suspended until 1879.

Terminating much of the Treasury’s “independence” from the banking system drew criticism for its “interference.” The Commercial and Financial Chronicle warned in 1868: “The Treasury, so far as being severed from the banks, may now at certain critical periods take away their legal-tender reserves by sale of gold, by sales of bonds, or by drawing down the balances in the national bank depositories.”[13] This was the gist of criticism of the Treasury through 1914. It was a protest by bankers against government’s power over the banking and financial system. And the main concern was that the Treasury might once again pursue monetary deflation, not inflation.

Over the balance of the 19th century the Treasury helped stabilize the country’s finances by increasing its deposits in national banks (especially those in New York City) in times of credit stringency, and moving its deposits around the country each autumn to provide national banks in the farming districts with the reserve base necessary to finance the harvesting, transportation and sale of crops.

Meanwhile, protective tariffs increased to over half of the federal revenues. The Treasury used the resulting surpluses to buy its bonds from the banking system, severely depleting the stocks of these debt instruments. By 1903, Theodore Roosevelt’s Secretary of the Treasury, Leslie M. Shaw, departed from established policy and accepted “other than United States bonds as security for public deposits, and told the banks that they need not keep a reserve against them.”[14] This freed $100 million in credit for New York City banks alone. Four years later, in 1907, the laws were amended to allow the Treasury to deposit customs receipts in the national banks, effectively terminating the distinction between the subtreasuries and national banks as depositories for public funds.

By this time the Treasury’s role had vastly “increased, if not changed in character, by the growth of the fiscal operations of the Government,”[15] influencing prices “depending on the extent of its absorption, retention and disbursement of money.”[16] This impact obliged the Secretary of the Treasury to work actively to help stabilize the nation’s finances. “There have been times when the autumnal drain would all have fallen on the banks but for the subtreasury. Two channels were open for the Government to put out its accumulated surplus: the purchase of bonds, which was the usual policy in the autumn for some years before 1890, and making deposits of public money in the banks.” However, the contraction of the government debt had reduced the volume of Treasury bonds outstanding, severely restricting its open market operations.

This problem was aggravated by the federal budget surplus in the fact of an inelastic currency. The quantity of U.S. Notes (greenbacks) was fixed by law. The amount of gold specie depended on foreign trade surpluses and domestic mine output, and the volume of national bank notes was being diminished as the federal debt was retired (since the Treasury bonds were the sole legal backing for these notes). Such rigidities led successive Secretaries to relax the limitations of the Treasury’s law and spirit. “When the power to receive checks and to check against bank deposits is conferred on the Secretary,” Kinley concluded, “then, indeed, the repeal of the independent treasury will hardly be necessary. For the various amendments, made in recent years, which permit the use of the banks for practically all the business of the Government, have already virtually abolished the system.”[17]

Nonetheless, “the independent treasury system does not have such an automatic connection, so to speak, with business, as to make its operation responsive to the exigencies of the mercantile community.”[18] In the panic of 1873, “the support of the public purse was tardy, timid, and insufficient.”[19] Kinley concluded:

…the Secretary of the Treasury is not the proper person to determine these points. He is not in immediate touch with business matters. He must get his information of the situation largely at second hand from bankers and others. He is likely to be less experienced in judging such matters than men whose business it is constantly to watch them and care for them.

The National Monetary Commission was convened to draw up recommendations for a banking system that would not fall heir to the existing reliance on discretionary Treasury activities. Its ultimate Report, released in January 1912, concluded:

The provision of law under which the Government acts as custodian of its own funds results in irregular withdrawals of money from circulation and bank reserves in periods of excessive Government revenues, and in the return of these funds into circulation only in periods of deficient revenues. Recent efforts to modify the Independent Treasury system by a partial distribution of the public moneys among national banks have resulted, it is charged, in discrimination and favoritism in the treatment of different banks.

All parties were agreed that the major aim of the new banking act must be to provide greater elasticity to the currency. This was achieved two years later by granting the Federal Reserve System authority to issue its notes against commercial paper, not only government bonds. This made it primarily responsive to business financing needs.

7. Banks argue for more control over Treasury policy

During 1908-13 many political aspects of the Federal Reserve System were fought out between Democrats and Republicans. The Aldrich Bill, an early Republican draft of the Federal Reserve Act, called for a National Reserve Association to be dominated by bankers. They had used populist rhetoric to urge that government finance be removed from politics by removing discretionary monetary authority from Washington to the greatest extent possible. The Federal Reserve Act set staggered terms for the Federal Reserve Board members (selected by local business and financial leaders, not Washington politicians) so that the President could not “pack the bench” as Jackson had done in 1833 by removing Secretary Duane in favor of Taney.

Democrats sought to maintain some government regulatory oversight by insisting that the Federal Reserve be situated in Washington rather than New York City, and that its board include the Secretary of the Treasury. Pledged against the “Federal Reserve Association,” they won the 1912 elections behind Wilson and thus had the major say in the Federal Reserve’s structure.

Wilson agreed to leave control of the district banks to the local leadership of private banking and business interests, but urged that the system’s national Board of Governors be appointed entirely by the President rather than by the member banks as ultimately was the case. (The Secretary of the Treasury remained an official member of the Board of Governors until 1935, when he was dropped from the board along with the Comptroller of the Currency.) Once the Federal Reserve began its operations, however, Wilson remained strictly aloof from it.

To divorce the banking system from political influence, the Federal Reserve Board’s financial activities were exempt from reliance on Congressional appropriations. Finally, twelve district banks were established, whose bankers and businessmen possessed the balance of power in the early years of Federal Reserve operations, with New York quickly emerging as the policy-making center. Roosevelt shifted policy making to the Board and its Federal Open Market Committee in 1935, and the Fed remained largely under the thumb of the Treasury until the Accord of 1951 “freed” it from having to keep interest rates low to minimize the Treasury’s borrowing costs.

But apart from the Accord, the trend under the Democratic administrations of John F. Kennedy and Lyndon Johnson was to shift monetary power back toward the Treasury and the President. The Kennedy Administration in the early 1960s saw proposals to revamp the structure of the Federal Reserve by making the terms of the Governors coterminous with that of the President, returning to him the direct authority and control that he possessed prior to 1914, reappointing the Secretary of the Treasury as a permanent member of the Board of Governors, and even replacing the Board of Governors with a single head, as well removing district directors from the regional Federal Reserve Banks. Republicans replied with Milton Friedman’s proposal to remove discretionary “interference” altogether by increasing the money supply at a fixed rate each year.[20]

Regarding the latter proposal of “automaticity” by establishing a rigidly fixed growth in the money supply, Kinley’s study illustrates that this must soon lead to more active political control to avoid monetary instability. The question is, who will manage financial crises – Wall Street in its own interest, or Washington ostensibly in the public interest favoring debtors more than creditors?

8. Final comments and conclusion

By the 2008 banking crisis there no longer was a partisan political difference between Republicans and Democrats in the United States, or between social democratic and neoliberal parties in Europe. Today’s Federal Reserve has shifted financial and fiscal planning to Wall Street. Presidents of both U.S. parties rely on Wall Street for major political campaign contributions, as do heads of the key Senate and Congressional banking and finance committees. Leaders of both parties appointed Wall Street consultant-lobbyist Alan Greenspan as Federal Reserve Chairman, and promoted New York Federal Reserve President Tim Geithner to Treasury Secretary. In contrast to Jackson’s and Van Buren’s political patronage via banking privilege, the line of control now runs the other way around, from banking to politics.

Since 2008, Wall Street investment banks have obtained much more wealth by capital gains (asset-price gains for real estate, bonds and stocks) and investment fees than from interest. This has led them to press the government for policies to inflate asset sheets more than provide credit for industry. Europe has followed suit. The upshot is that banks both in Europe and America have gained control over government policy to become the main suppliers of the economy’s money and receive public subsidy and favors. Their capture of the government’s financial, regulatory and policy-making institutions has led to a policy bias favoring creditors over debtors. In terms of monetary policy, creditors always have advocated downward commodity prices and wages. But since the 1980s they also have favored debt-leveraged inflation of real estate, stock and bond prices to create “capital” gains via low-interest “soft money” policies.

The European Central Bank’s withdrawal of credit to Greek banks under the Syriza government is reminiscent of Jackson’s war against banks not favorable to his own political control. And the European Central Bank’s support of the largest banks and bondholders at the cost of domestic taxpayers has imposed monetary deflation on Eurozone countries, reminiscent of America’s 19th-century deflation before and after the Civil War.


Aldrich N. W. 1910. An address by Senator Nelson W. Aldrich before the Economic Club of New York, November 29, 1909, on the work of the National monetary commission, Washington, Government Printing Office
Burgess, W. R. 1964. Reflections on the Early Development of Open Market Policy, Federal Reserve Bank of New York, Monthly Review, vol. 11, 219–26
Chernow, R. 1997. The death of the banker: The decline and fall of the great financial dynasties and the triumph of the small investor, Toronto, Vintage Canada.
Colton C. 1846. The Life and Times of Henry Clay, New York, A. S. Barnes & Co. Griffin G. E. 1994. The Creature from Jekyll Island: A Second Look at the Federal
Reserve, Appleton, American Opinion Publishing
Haines W. 1961. Money, Prices, and Policy, New York, McGraw-Hill
Hudson M. 2010. America’s Protectionist Takeoff, 1815-1914: The Neglected American School of Political Economy, New York, ISLET
Kinley D. 1910. The Independent Treasury System of the United States and its Relations to the Banks of the Country, Washington, Government Printing Office
Warburg P. M. 1930. The Federal Reserve System: Its Origin and Growth, New York, Macmillan


[1] Aldrich (1910). For more documentary see Warburg (1930).

[2] Haines (1961, pp. 554f.) See also p. 153

[3] Colton (1846, pp. 23f). “It is to be observed, however,” Colton added (p. 26), “that the plan of the subtreasury was not matured, till that of establishing a new national bank in the city of New York, under the control of the partisans of the administration – who, on the principle of the New York state system, before noticed, expected to realize at least a two-million bonus, for private and political objects – had failed.”


4 This sectional aspect of U.S. trade and monetary policy is discussed in Hudson (2010).

[5] Colton (1846, pp. 49f)

[6] Kinley (1910, p. 8)

[7] Kinley (1910, p. 69). For a discussion of Treasury relief by bond purchases see pp. 272- 77, 217-23.

[8] Burgess (1964, p. 220) asserted: “The real significance of the purchase and sale of Government securities was an almost accidental discovery.” This myth is reiterated in the usual college texts (e.g., Haines, 1961, pp. 567, 573.)

[9] However, Guthrie opposed a national bank and, as a pro-slave strategist, supported monetary deflation and “hard money” convertible into gold on demand.

[10] Kinley (1910, p. 97). He adds (p. 319): “When the country committed itself to the policy of fiat paper money, its entry into the field of note issue made continued independence of the banks impossible.”

[11] Kinley (1910, pp. 76f).

[12] Inasmuch as the banks had suspended specie payments, depositing Treasury receipts in coin instead of greenbacks would have returned to the banking system a gold specie value in excess of its paper value.

[13] Kinley (1910, p. 114)

[14] Kinley (1910, p. 125). By 1908 railway, municipal, county and state bonds supplemented U.S. bonds as legal reserve backing for U.S. Government deposits in the national banks, much as the Federal Reserve would accept real estate mortgages as bank reserves after 2008. For these legal changes see Kinley (1910, pp. 132f).

[15] Kinley (1910, p. 149).

[16] Kinley (1910, p. 152).

[17] Kinley (1910, p. 206).

[18] Kinley (1910, p. 268).

[19] Kinley (1910, p. 270).

[20] Statements on Proposed Changes in the Federal Reserve System, Federal Reserve Bulletin, March 1964.

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  1. Michael Hudson

    It didn’t occur to me when I wrote this paper (50 years ago, then again last month) that it might well serve as a refutation of the recent books on the founding of the Fed.
    Most of these books describe the Fed as a step forward, centralizing money in Washington. The reality is the opposite. The Treasury HAD been performing the tasks that the Fed took on. The Fed sought to Decentralize these to the 12 Treasury districts — and in practice, to Wall Street banks and other financial centers.
    This always has been the Democratic Party’s ploy, ever since Van Buren/Jacksen (the “original” Rubinomics.
    I’ll participate in any discussion you may have.

    1. Leonard Tekaat

      Prof. Hudson
      Our monetary system has a bias towards inflation. So does the income tax code. A problem arises when tax policy is not in sync with monetary policy, We get what we have had since the Fed was created in 1913. Boom and bust cycles of high asset appreciation/inflation and deep recession and depression cycles, causing wide swings in interest rates, which is damaging to our capitalist economy. The Great Depression of the 1930s, the high inflation of the 1970s and the financial crisis of 2008 and Great Recession to name three occurrences that caused great harm to our economy.

      The problem can be helped with an automatic change in our income tax code based on how the economy was performing. I call it the 2% Appreciation/Inflation Taxation Policy. This Policy would put tax policy in sync with monetary policy before the Fed needs to increase or decrease interest rates excessively. For more information please read “Proposed Solution For Modern Economies That Create Financial Crisis And Bubbles” wp.me/p42WQA-7c http://www.taxpolicyusa.wordpress.com @Hall500Hall

  2. MikeNY

    So Wall Street has what it wants, asset inflation for itself, and deflation for everyone else. How do you think Wall St.’s puppet, the Fed, will act if we have another recession? How do they keep it going?

    1. MyLessThanPrimeBeef

      It could have been, ‘liquidate, liquidate and liquidate’ on Wall Street.

      That will hurt those workers impacted. Yes, we avoided chronic deflation by relinquishing monetary control to Wall Street.

      1. MikeNY

        Or we could have bailed out the people, and thus the banks.

        But that would have left the oligarchs relatively poorer, instead of absolutely and relatively richer. And we certainly can’t have that in any self-respecting oligarchy, can we?

        1. OpenThePodBayDoorsHAL

          Recall the original TARP, and imagine where we would be today if the $ gifted to banks had instead been sent directly to underwater homeowners:
          Seems to me the questions are “who makes our money, for whom, and for what purpose?”, there’s an obviously strong argument that it should be the government, not the banks, since they at least have some kind of link to the welfare of the nation as a whole and her citizens, as opposed to the banks and their shareholders. Asking for-profit corporations to benevolently manage something in the public interest is like demanding a leopard not to be so spotty.
          The interesting version is Ecuador, where the new digital mobile system is based on scrip issued directly by the nation’s central bank, not by for-profit commercial banks.

          1. MikeNY

            Exactly. Our elites made the choices they made because our elites work for the oligarchs. And the oligarchs don’t want to be poorer, ever. Not even relatively.

          2. Oregoncharles

            Ironically, GW DID send money directly to the people when faced with a recession. Technically, it was an advance on a tax rebate; in practice, it was a check in the mail. No wonder he was re-elected.

  3. fresno dan

    Nice article with some interesting history.
    Long story short – who do you protect and who do you screw? why, you protect the wealthy (your campaign contributors) and everybody else is a spear catcher.

    1. lord koos

      “…the problems resulting from budget surpluses…”

      As a layman, it is pretty difficult to understand this as a “problem”. If there is a surplus, it would seem sensible to use it to shore up public infrastructure, which benefits everyone.

      I noticed when there was a surplus at the end of Clinton’s last term, dubya managed to spend it ASAP on wars. Unfortunately, as usual, the spending benefited big business and not the average citizen.

      1. James Levy

        The problem is, if I’m reading all this correctly, that government surpluses suck capital out of the economy. The problem then is that reallocating those resources becomes a political football, with everyone in Washington fighting over the ball. I think they prefer not to have that headache and to leave the money in the hands of their campaign contributors! Otherwise, the excuse that “we have no money to help the poor” would go away and we as a society would have to answer the question, why in the riches society in history is there no money to help the poor?

  4. tegnost

    So, the more things change the more they stay the same, just the names are different. I’ve never pondered the desire of slaveholders for low maintenance costs for their…ummmm…commodity I guess. Is there a lesson to be learned? After all the south lost the war… As we laborers are still the commodity that needs be contained the game has shifted to a global playing field with much the same inspiration unfortunately, reaping profits from asymmetrical inputs, and add in trade agreements that ensure a lack of competition. Can anyone think of a way to inspire washington to oppose wall st and favor debtors over creditors, or at least strike a more favorable balance, and if they did would it be as good a thing as I think it would be, in other words, what catastrophe befalls us if student loan debt were to be expired that the bankruptcy prohibition is protecting us from?

    1. MyLessThanPrimeBeef

      We want to enlighten as many students as possible. And that should be free.

      It is unconscionable that we should produce human machine parts for the system, knowing that many will not be used (surplus). That’s what we have with degrees-for-jobs factories.

      “Son, you can be anything you desire in the world if you work hard,’ say all mothers, hoping theirs will grow to become supreme commanders.

      But the sad fact is, for example, there are only so many banking jobs on Wall Street.

      “You C-students, you are here as reserves in the system, in case of runaway wage inflation.”

      1. Gio Bruno

        Actually, some C-students (privileged, of course) become presidents and senators: GW Bush, John Kerry. Acquiring a good education, without debilitating debt, is the challenge; employing that education to the benefit of society is the goal. Bush and Kerry are abject failures.

        1. MyLessThanPrimeBeef

          They are very exceptional C students.

          We do need good education, and not just education that certifies one to be a non-defective, functioning cog for the machine.

    2. Steven

      “Can anyone think of a way to inspire washington to oppose wall st and favor debtors over creditors”

      Hudson has addressed this question in other writing. The general answer is, like ancient rulers, insuring the health and welfare of its ‘canon fodder’ and “laboring cattle”. That may ultimately require periodic ‘clean slates’ to counteract ‘the magic of compound interest’ and trickle-up economics. However, Washington could make a nice start with operational policies to insure the wealth-creating potential of the nation’s labor force remains in tact, i.e. competitive. By providing low cost health care, education and other public infrastructure and changing tax policies to favor genuine wealth – as opposed to debt (“Wall Street’s product”) – creation Washington could reduce if not eliminate the need for more disruptive ‘debt jubilees’ brought on by debt deflation.

      The skills required for real wealth creation largely overlap those required by the nation’s military in an age of industrialized mass slaughter. In addition to their health, today’s soldiers must possess the skills to operate and maintain modern high tech weaponry. The Nobel Prize winning chemist wrote 80 years ago that “…though as yet the applications of the knowledge to the economics of life are not generally realized, life in its physical
      aspect is fundamentally a struggle for energy…” WEALTH, VIRTUAL WEALTH AND DEBT, p. 49 The efficient use of, above all, energy but also other resources – and that includes the lives of its people – is the foundation of both national wealth and power.

      That focus on efficiency is not, of course, how the Pentagon currently conducts business. Forced at least in part to perform other functions such as serving as a sink for the nation’s and the world’s monetary ‘savings’, the Pentagon is given everything it requests – and more. The result has been an increasingly rapid erosion of the nation’s ability to defend its interests, at least with conventional weapons. See http://www.washingtonsblog.com/2015/10/5-reasons-china-and-russia-are-starting-to-catch-up-to-the-u-s-militarily.html The Australian economist and diplomat James Cumes published America’s Suicidal Statecraft. It doesn’t appear that anyone was listening.

      1. tegnost

        I like your answer but what has nagged me today is I don’t see any debt jubilee as likely while I do think a rational legislative fix much easier but just as unlikely… a trillion in undischargable student loan debt backs how much in derivatives? (serious question, really wonder what bets have been made)

      2. RBHoughton

        There is something that does not get publicity.

        US food production is based on corn. All chickens, pigs and cows are fed it and as a result all meat, eggs and dairy produce has an imbalance in omega fatty acids, a deficit of O3s. Humanity cannot make omega fatty acids itself – we get them from our diet.

        There are several research projects that show people with O3 deficiency are less able to concentrate and have poor memories.

  5. blert

    I can’t believe what I’m reading here.

    1) The Federal Reserve Bank System was founded for no other purpose than to replace the very mortal J. P. Morgan. (1837-1913)


    Morgan had been the lender of last resort from 1875 through to his death.

    The Federal Reserve picked up where he left off.

    ALL of the original Fed policies were cloned from Morgan’s First National City Bank.

    1) A Banker’s bank — no commercial dealings whatsoever.

    2) Its only assets were gold and US Treasury instruments… and some specie.

    3) It stood at the center of a voluntary syndicate of commercial banks — all of whom had to leave on deposit — without payment of interest — a fraction of their funds.

    4) Should a bank run occur, First National City Bank would shunt its massive gold horde to the afflicted (participating) bank.

    This did happen. Famously a run in up state New York was quenched when Morgan sent a private (express) train loaded with gold and specie — guarded by Pinkerton men — and lots of them.

    5) Morgan would audit the books of any syndicate bank — at will.

    During the various credit crunches, the Morgan syndicate sailed through. Non-syndicate banks imploded.

    And, famously, JP Morgan rescued the insolvent US Government… by placing a huge (for the time) US Treasury bond — syndicating it in Europe — with a staggering 6% coupon. That rate had President Grover Cleveland gagging. It was necessary as America was importing European capital goods at such a tempo that she was running out of gold.

    The Morgan syndicate placed payment — in gold — in London — The City — which instantly reassured the London ‘Bills Market.’ [ In the era before the modern money market, liquidity — in size — was by way of the ‘Real Bills Market’ in The City. The terms of settlement for all such instruments was in gold, gold specie, or good as gold British Pound Sterling.


    It is flatly false that the founders looked any further than maintaining the status quo.

    Maintaining the status quo was the entire basis for its political support.

    The Fed DID maintain the JP Morgan system right up through the Roaring Twenties.

    The Great Depression does NOT date from the Wall Street crash — in 1929. That tumble had virtually no impact on American economic life.

    ( Just big for New Yorkers — the primary locus of speculation)

    The Great Depression became great when The Bank of the United States was denied liquidity during a bank run. The Wiki is a poor recounting, BTW. It omits the attempt by BoUS to discount its assets with the various ‘city banks’ so as to provide enough liquidity to end the panic. THAT’S why that bank did not open its doors. It had already been tapped out.

    This one bank failure caused a cascade of bank failures… that reached just about everywhere. Suddenly, … to raise cash … farm commodities were thrown on to the market — at a rushed tempo — which just killed the open market prices.

    The declines fed on themselves, for it was grain that collateralized countless farm loans. (Typically taken out to mechanize the family farm. Previously, farmers just didn’t dare borrow — and with the homestead act — never needed to.)

    Getting this history wrong leads one astray.


    The Federal Reserve System was crafted to institutionalize JP Morgan’s policy suite — making his legacy immortal.

    No-one in 1913 ever dreamed of FDR or RMN — and their policy highjinks.

    ( FDR repriced gold// devalued the dollar — without ANY professional advice. He just picked a number — out of his ear — and when interviewed — admitted doing exactly that. !

    1. Yves Smith Post author

      With all due respect, I don’t understand your comment. This does not contradict with or refute Hudson’s account. Indeed, it can be used to enrich Michael’s article, not to discredit it.

    2. Tony Wikrent

      While a share your deep enmity for the House of Morgan – indeed, I fervently wish more people were as familiar with Morgan machinations as you appear to be – I must take issue with your assertion “It is flatly false that the founders looked any further than maintaining the status quo.”

      How do you dismiss the idea that there were, in fact, ideological origins of the American Revolution? (reference: Bernard Bailyn.)

      I think you fall into the trap that too many liberals and progressives fall into today: which is to assume that the corporatist authoritarianism we must deal with today is a direct result of the structure of government established by the Constitution. I view the issue entirely differently: the American republic has been under unceasing assault by its oligarchical enemies. The question to ask is: how was the American republic subverted and corrupted from within to erode its natural enmity to oligarchs and concentrations of economic power, as well as political power? What Dr. Hudson is offering here is a historical account of part of this story.

  6. Chauncey Gardiner

    As one who is both a slow reader and susceptible to Manichaean interpretations, I deeply appreciate Dr. Hudson’s historical overview and analysis. The various factors that have come into play in the formation of the current system, its complexity, and the ongoing need for evolution are in a way like viewing the sun through a prism. Rotate it a couple degrees and the light changes color.

    Thank you for this, although it isn’t easy.

  7. ewmayer

    The following passage has me puzzled:

    “[Jackson’s] Democratic Party policy was backed by Southern plantation owners opposing Northern industry, seeing that its growth would increase urban industrial demand for food and other consumer goods. This would raise prices for the crops that plantation owners needed to feed their slaves.”

    Wouldn’t many if not most of those crops be the very same ones said plantations also grew for their own consumption? As a plantation owner, given that you have the resources needed to grow some industrial commodity such as cotton, would it not be the height of foolishness to not also grow/raise most of your own foodstuffs and thus be forced to buy them from someone else, at marked-up prices?

    Hudson’s second explanation later in the piece makes more sense:

    “The Southern slave states advocated monetary deflation for two reasons: to keep the price of cotton low, and hence competitive on world markets; and to thwart northern industrial growth so as to minimize the population voting against extension of slavery.”

    o MLTPB wrote: “Yes, we avoided chronic deflation by relinquishing monetary control to Wall Street.”

    As with inflation, it depends on where you look for it – we certainly didn’t avoid chronic *wage* deflation.

    o Lord koos: “I noticed when there was a surplus at the end of Clinton’s last term, dubya managed to spend it ASAP on wars. Unfortunately, as usual, the spending benefited big business and not the average citizen.”

    And don’t forget the origin of much of that revenue boost: The unsustainable run-up of the dotcom bubble. To his fans Clinton looks like an economic genius mainly because he had the good fortune of not having the first of the Greenspan mega-bubble implode on his watch. Dubya can rightly say – as Obama likes to do – that he inherited a sea of economic troubles from his predecessor. But as you rightly point out, Bush deserves little sympathy because he doubled down on the stupid via tax cuts for the rich and ramping-up of the warmongering.

    1. tegnost

      I think sadly there are some serious parallels here. The monocrops of the day was cotton and tobacco, I think it’s an acreage issue keep the price cheap and sell as much as you can, growing food “wastes” acreage. I also noted the clinton surplus as maybe a harbinger? something that maybe wasn’t good in light of this article? I always thought good but for misguidedly puritanical reasons I think after reading this.

      1. John Zelnicker

        Almost every time the US has paid down the national debt substantially or had a budget surplus, a recession or depression has followed close behind. In Clinton’s case the recession came in 2001.

        National debt reduction/surpluses remove purchasing power from the non-government sector. Thus, effective demand is reduced and overall economic activity has to decline. The lost purchasing power of the domestic private sector can only be replaced by an export surplus (which we haven’t had in a long time), or by taking on private debt which eventually becomes unsustainable and we get events like the financial crisis of 2008-09. (Sectoral balances.)

        So, yes, the Clinton surpluses were a harbinger of a recession and they were not good for the private sector.

    2. Tony Wikrent

      The South never grew all of its own food. This was an acute problem during the Civil War. About a year into the war, most Confederate state legislatures passed laws mandating that plantation owners give increased acreage to food crops. Thus reassured, the South’s men marched off to repel the Yankee invaders. The price of cotton was driven to never before seen heights by the North’s blockade and seizures, and Southern planters, in their greed, planted more cotton than ever. Food riots broke out, often led by women trying to feed their children, As word reached the front lines, more and more Confederate soldiers deserted and returned home to try and help feed their families. By the end of the war, almost a third of Confederate soldiers had deserted.

      As I wrote here: http://www.correntewire.com/truth_about_confederacy

      “United States Senator from Georgia, First Secretary of State of the Confederacy, and Confederate General Robert Toombs, and a half dozen other planters in the area of his Georgia plantation, were upbraided by the local Citizens’ Committee of Public Safety for planting almost all their acreage in cotton. Toombs responded in the best fashion of today’s libertarians and conservatives: “My property, as long as I live, shall never be subject to the orders of those cowardly miscreants, the Committees of Public Safety . . . . you cannot intimidate me.”

      “By the fall of 1862, there was so much cotton being harvested that the South’s warehouses could not store it all. “

    3. Tony Wikrent

      I wanted to reply further to ewmayer, because he or she raises an issue that I think goes to the heart of our problems today. Most readers of NC are quite aware that the Obama administration averted a full plunge into economic depression (though I argued on DailyKos last year that averting catastrophe was more the work of “automatic stabilizers” such as Social Security and unemployment insurance, which pumped at least 5 or 6 times more money into supporting aggregate demand than did the “stimulus” bill), but at the same time, the real economy has continue to languish and even deteriorate, with average American incomes continuing the decline they began in the 1970s. There is not general agreement on this, but I consider the continued deterioration of the real economy to be the result of the continuation of neo-liberal / conservative free trade and free market policies.

      And it is an issue that fully shows the vulnerability of the left, as well as what I consider the more dangerous damage Obama has done, in that his inability or refusal to oppose the continuation of those policies has led to a general discrediting of the left in USA (with an accompanying resurgence of the right, as discussed in Thomas Franks’ recent brilliant book, Pity the Billionaire). But even Franks cannot identify the remedy, because he is apparently not familiar with the American School of political economy. Both British free market / free trade doctrine, and Marxism, are disastrous economic doctrines to pursue, and both are opposed by the one alternative that simply is not taught in USA economics departments. Nor, transparently, in History departments. Consider how ingrained in Americans’ minds is the idea of Manifest Destiny, and how much Dr. Hudson’s account below clashes with the accepted understanding of Manifest Destiny.

      I hope Dr. Hudson does not mind if I use some excerpts from his book America’s Protectionist Takeoff: The Neglected American School of Political Economy to further explain the nature of the South’s economy and the policy goals of the Southern cotton planter oligarchy:

      P ix
      ….economic historians have ignored Peshine Smith as if the American School never existed. The modern abhorrence of protectionism expunged from history the logic that guided U.S. industrialization under Republican leadership from 1860 through 1912. The American School’s trenchant critique of free trade and the theorizing of Ricardo, Malthus and other British writers caused a cognitive dissonance in the minds of professors eager to promote a view of American history driven by an inexorable drive for free trade and westward expansion as Manifest Destiny.

      Actually, westward expansion was a Democratic Party policy to extend slavery and plantation agriculture. In an epoch when protective tariffs were the principal source of revenue for the federal government (that is, until the 16th Amendment created the federal income tax in 1913) the South based its cotton and tobacco production on foreign markets, seeking to feed its slaves with low-priced grain from the West. The Whig and Republican industrial program called for concentrating industry in the Eastern urban centers, whose population would be fed by farms that would find their major market at home, not abroad. But industrialization threatened to bid up food prices, eroding the competitiveness of plantation agriculture. This prompted the Democratic Party to urge free trade, small government and credit aimed mainly at export financing not industry. The slave states in particular decried industrialization and urbanization as culturally decadent rather than the key to economic progress. At issue was the kind of cultural, social and political structure America would develop and national trade policy would act to bring about.

      P 6
      ….Indeed, what became known under the portmanteau term “tariff debate” was more accurately a debate as to the dynamics of economic growth itself. Its major issue was whether the nation should remain primarily agricultural or industrialize, whether the South should become the focal point of a westwards-expanding slave system, or the Northeastern and Middle Atlantic states become the focal point of an increasingly industrial national economy.

  8. Jim

    It’s really difficult to properly analyze the nature of a particular country’s banking system without taking into careful consideration the structure of the country’s fundamental political institutions.

    What is at the core of banking within every country appears to be some kind of deal between the bankers and the government.

    The original deal between people like Hamilton, the Federalist party and certain financial elites managed to limit the number of banks that received charters. In short the original Bank of the U.S. was a wealthy commercial bank owned and operated by wealthy federalist financiers–a deal was made between a select group of bankers financed by the State and the State in turn gave these same bankers lucrative concessions.

    But the U.S. political system, at that time was a true federalist structure and powerful state governments then formed an alliance between small unit bankers(operating with no branches) and many small farmers (remember the country at this time was primarily agrarian).

    This coalition of small bankers and farmers was largely able to dismantle the banking institutions set up by Hamilton and this same coalition was also central to the later defeat of the Second Bank of the U.S.–where Andrew Jackson vetoed the rechartering. Again, at that time banking legislation was largely under the control of the states.

    A book by Calomiris and Haber “Fragile by Design: The Political Origins of Banking Crises and Scarce Credit. does a good job of telling this historical story.


    1. tegnost

      “It’s really difficult to properly analyze the nature of a particular country’s banking system without taking into careful consideration the structure of the country’s fundamental political institutions.”
      I think you’re onto something here, like you can’t have a spirit without a body and actually move things, the gov’t represents the people theoretically and from the title of the post has relinquished it’s substantial power, we should get that back, i think. So how then deal with chronic deflation? I’m minding a weekend conversation where the solution was many small inputs creates a more robust economy

  9. RBHoughton

    I don’t know enough to commend this article unreservedly but sufficient to know its far closer to the truth than main-stream academic history. I am indebted to Professor Hudson. He is persuasive. The 6% interest that the Fed was obliged to pay government for its rights under the enabling act is not however mentioned.

    Settling a correct version of American economic history is the essential foundational step before considering where we go from here. Congratulations Naked Capitalism for once again leading the way and providing a forum for discussion.

    I have forwarded the link to a great many friends.

    1. Tony Wikrent

      The actual history of U.S. economic development simply is not taught. One example I like to use is Harvard economist H. Gregory Mankiw, whose introductory econ textbooks are the most widely used. He does not mention Alexander Hamilton at all. Now, many on the left argue that Hamilton favored the rich (which is wrong, he favored talent, merit and entrepreneurs) and don’t like him, but the plain fact is that the financial and monetary structures of the American economy were designed and launched by Hamilton. (I’ll take Hamilton over Marx any day: just compare results.)

      Dr. Hudson has written some great material on the forgotten history of US economics. In America’s Protectionist Takeoff: The Neglected American School of Political Economy, (Islet-Verlag, New York, 2010, page xiv} reveals (or rescues from neo-liberal imposed historical oblivion) the American School, and notes that there were three economic philosophies that were developed in the 19th century: British (Ricardo-Malthus); Marxism; and the American School.

      The British school believed that all labor had a static and equal level of productive powers, and that therefore densely populated countries have the lowest wage levels. Marxists developed a supply-and-demand theory of wages based on the “reserve army of the unemployed.” Like the British school, the Marxists generally assumed a static equality for labor power. The role of the state under socialism is to employ surplus labor.

      In stark contrast is the American School, which developed the “Economy of High Wages” doctrine. As Hudson explains this long-forgotten doctrine: “Productivity gains tend to exceed wage gains, enabling high-wage labor to undersell “pauper labor.” Hence, profits and wages may rise together. Higher income slows the growth of population, pushing up wages all the more. Also, higher wages spur capital substitution, increasing labor productivity. Finally, higher population density increases productivity and therefore increases wage levels.”

      As I have argued before, modern conservatism and neo-liberalism both reject the very philosophical bases of the United States. Not surprising, given that they were originated and promoted by European oligarchs.

    2. blert

      That famous interest rate was the CLASSIC rate in the 19th Century paid on PREFERRED Stock.

      Such stock was driven out of the market during the FDR reform era. It was the ancestor of today’s high yield bond market — that did not exist in the 19th Century.

      Andrew Carnegie built out his steel empire with retained earnings and the issuance of 6% preferred stock. In the era of declining prices, an income-tax free 6% was considered ‘fat city’ — so Carnegie could draw money from the Moon. IIRC, Andrew was able to place all of his securities privately. ( He had the great Scott to launch him on his way.)

      When JP Morgan set up First National City Bank he took its name from the popular banking terminology of his time. A ‘city bank’ always meant New York City… and was largely derivative of “The City” in the London sense — as in the financial center of a nation. His city bank was to be national in scope — working across all state boundaries. That WAS novel back then. And, of course, his bank would be the First of its kind.

      He was able to bypass ALL state laws against interstate banking — by being strictly a banker’s bank. Further, EVERY participating bank in his syndication HAD to put up a specified amount of equity capital — as 6% Preferred Stock. Morgan (and his buddies) held ALL of the common stock.

      As related above, the Federal Reserve Bank was the immediate successor to First National City Bank — in function.

      It also adopted all of Morgan’s rules about contributing permanent capital as preferred shares yielding 6%.

      This figure could and would be adjusted upwards at Morgan’s sole discretion — based upon the increased size of a given bank.

      First National City Bank made its money from interest on US Treasuries, and emergency activities. It held a massive portfolio because the banking syndicate had to leave on deposit — at no interest — a percentage of all deposits in each participant in turn.

      You might note that every one of these elements is carried on by the Federal Reserve Bank.

      The assertion that the US Treasury was active in preventing banking crisis in the 19th Century is flatly false. ALL of the big action was up in New York City, not Washington.

      That role was played by JP Morgan ( and largely by his father, before him )

      [ It’s hilarious to recount: his father thought that JP was a fool and a spendthrift ‘loser.’ So it was only in his final years that he let JP have much control of anything. Heh.

      Vanderbilt felt the same way about his kid. You know… the Vanderbilt that monopolized the American rails in the Northeast ! Heh. Heh.]

  10. financial matters

    Thanks for this, a lot of well researched insights.

    Luckily we have people who understand what you are saying and have productive ways forward. I know I am missing many but here are I few that come to mind.

    Jeremy Corbyn people’s QE

    Bernie Sanders friend of the 99%

    Stephanie Kelton sectoral balances

    Michael Hoexter has real plans against global warming

    Naomi Klein shock doctrine/this changes everything

    Ellen Brown public banking

    Yves Smith providing a forum for these sorts of discussions

  11. Jim

    RB Houghton above notes that “settling a correct vision of American economic history is the essential foundational step before considering where we go from here.”

    I couldn’t agree more with that sentiment and as Yves alluded to above this vision is probably far from a manichean one.

    Tegnost also raises a crucial issue when he asks “how then to deal with chronic deflation?

    Is it best to start such discussions with the primacy of the political or are the libertarians and orthodox Marxists more accurate with their respective forcuses on the primarcy of the economic?

  12. blert

    Andrew Jackson crushed the economy by liquidating the US Federal debt by selling off massive tracts to farmers roving west.

    Money in our modern economy starts life when debt is created. It is killed when that debt is paid off — or defaulted.

    Jackson made liquidity EVAPORATE.

    Hence, he triggered the famous Wooden Nickel — only now found in coin collections.

    Old Hickory was a generation before Young Hickory (Polk) and the California gold strike.

    America was STILL using alien specie in all everyday commercial trade. (Plenty of Spanish silver — and Austrian thallers, too.)

    The Spanish ‘Real’ was coined in such a way that Pirates could — in a pinch — make change by knifing through the coin. This Piece-of-Eight geometry became synonymous — and easier to pronounce correctly in English than ‘Real.’ ( for royal ) This was the basis for a ‘bit’ as in two-bits = a quarter. It also led to the minimum ‘tic’ for a stock trade to being 1/8th of a point. That tradition lasted until late in the 20th Century.

    The Thaller became the Dollar — and the dollar sign $ hails from the Spanish. Cute, no ?

    With no where near enough specie or bullion — the ONLY near-to-gold asset was US Treasury debt. So when Jackson zeroed that debt out — every banker was bereft of near-to-gold for his balance sheet. By custom and norms, he was then compelled to shrink his own balance sheet.

    The 1873 collapse was entirely due to the fact that silver bullion became — over night — NOT money — when Congress shifted to the BRITISH gold standard so as to participate inside the British trading bloc — and have access to the London Real Bills Market — a unique institution.

    This all ties into the minting of the Stella ( $4 specie ) which was ‘Plan B’ — ie the French trading bloc. Paris lost out to London. Quelle surprise !

    It’s interesting to note that Britain started with Pounds Sterling — a silver standard. She shifted to gold — because the Empire was hitting big gold strikes eveywhere. It suddenly became to her advantage. To enter into a gold backed currency, every other economic power had to either mine gold at quite a clip — or import BRITISH gold. Heh.


  13. blert

    BTW, when you think of London — you must also think in terms of German economic growth.

    For Germany and Britain had been best buddies for centuries. Hence, all significant German overseas trade traveled in British ships with payments handled via London’s (Real) Bills Market.

    So, the reason why Paris lost out to London was because Britain was allied to The Second Reich — and Germany was growing like topsy.

    American exports and imports between these two powers were on an exponential rise all during the back half of the 19th Century.

    The farm states became dependant upon German wheat imports. ( Germany includes half of Poland at this time.)

    It was the mining states that ‘kicked.’

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