CHAPTER 14 The Federal Reserve as a Cartelization Device: The Early Years, 1913–1930

To most economists, historians, and lay people, a modern economy without a central bank is simply unthinkable. With that kind of mindset, the creation of the Federal Reserve System in December 1913 can be attributed to a simple, enlightened acceptance of the need to bring the economy of the United States into the modern world. It is generally held, in addition, that a central bank is necessary to curb the natural instincts of free-market banks to inflate and, as a corollary, to level out economic fluctuations. It has become all too clear in recent years, however, that the Fed has scarcely succeeded in this supposed task. For since the establishment of the Fed, we have suffered the longest and deepest depression in American history, and we have, since World War II, experienced the unique phenomenon of a chronic, accelerating secular inflation. Since instability, inflation, and depressions have been far worse since the inception of the Federal Reserve, many economists have concluded that the Fed has failed in its task and have come up with various suggestions for reform to try to get it on the correct task.

It is possible, however, that the current critics of the Fed have missed the essential point: that the Fed was designed to meet very different goals. In fact, the Fed was largely fashioned by the banks as a cartelizing device. The government interventions of the Progressive era were systemic devices to restrict competition and cartelize industry, stratagems that followed on the previous failure of industry to sustain successful voluntary cartels. Just as other industries turned to the government to impose cartelization that could not be maintained on the market, so the banks turned to government to enable them to expand money and credit without being held back by the demands for redemption by competing banks. In short, rather than hold back the banks from their propensity to inflate credit, the new central banks were created to do precisely the opposite. Indeed, the record of the American economy under the Federal Reserve can be considered a rousing success from the point of view of the actual goals of its founders and of those who continue to sustain its power.

A proper overall judgment on the actual role of the Fed was delivered by the vice-chairman and de facto head of the Federal Trade Commission, Edward N. Hurley. The Federal Trade Commission was Woodrow Wilson’s other major Progressive reform, following closely on the passage of the Federal Reserve Act. Hurley was president of the Illinois Manufacturers Association at the time of his appointment, and his selection and subsequent performance in his new job were hailed throughout the business community. Addressing the Association of National Advertisers in December 1913, Hurley exulted that “through a period of years the government has been gradually extending its machinery of helpfulness to different classes and groups upon whose prosperity depends in a large degree the prosperity of the country.” Then came the revealing statement: The railroads and shippers had the ICC, the farmers had the Agriculture Department, and the bankers had the Federal Reserve Board. Hurley concluded that “to do for general business that which these other agencies do for the groups to which I have referred was the thought behind the creation of the trade commission.”[1] What, then, did the Federal Reserve do for the nation’s bankers?