|Author(s):||Broz, J. Lawrence|
|Reviewer(s):||Wheelock, David C.|
Published by EH.NET (June 1999)
J. Lawrence Broz. The International Origins of
the Federal Reserve System. Ithaca: Cornell University Press, 1997. xiii
+ 269 pp.
Review for EH.NET by David C. Wheelock, Federal Reserve Bank of St. Louis.
Why was the Federal Reserve System established? The common view is that the
Fed was established as a public good to correct deficiencies in the U.S.
banking and payments system that made the system inefficient and prone to
crises. Reform proponents blamed crises on the nation’s “inelastic currency”–
stocks of currency and bank reserves that did not adjust with seasonal or
cyclical fluctuations in demand, let alone in response to bank runs. Other
proponents of reform pointed to the difficulty of making inter-regional
payments, citing long delays and high costs associated with the clearing of
checks and drafts. Still other reformers decried the concentration of bank
reserves in the central money markets and the investment of correspondent
balances in stock market call loans. A less import ant goal of reformers, the
traditional view argues, was to promote use of the dollar in international
trade and finance.
J. Lawrence Broz argues that the goal of promoting the dollar as an
international currency was in fact the primary consideration of reform
proponents, and that reform was achieved only by alignment of strong private
interests for promoting international usage of the dollar with the general
public interest of improving the stability of the U.S. payments system. The
establishment of the
Federal Reserve System thus fits a “joint products” model, in which
institutional change produces a public good, but occurs only because of the
efforts of a narrow interest group seeking private gain.
The United States’ share of world exports, particular ly of manufactured goods,
rose during the last decades of the nineteenth century, and by the early
twentieth century the Untied States enjoyed an increasingly persistent current
account surplus. Despite these gains, the dollar was not used widely in inter
national commerce because, Broz contends, U.S. banks were prohibited from
issuing bankers acceptances to finance international trade and the U.S. lacked
a central bank with the power to create liquidity as needed by re-discounting
commercial paper. Because the dollar was not an international currency,
American exporters faced exchange risk and high transactions costs, while
American banks were largely shut out of the market for financing international
transactions. A coalition of leading bankers and manufacturers thus developed
with the goal of enhancing the dollar’s role as an international currency by
reforming American banking laws and institutions.
For the dollar to be acceptable to international markets, the stability and
efficiency of the U.S. banking and payments system had to be enhanced.
Thus, the interests of large U.S. banks and exporters aligned with the public
interest generally. The creation of the Federal Reserve System, Broz argues,
was an institutional reform that was consistent with both sets of interests.
Various alternatives for improving the domestic payments system, such as
adoption of nationwide branch banking, were insufficient to meet the interests
of internationally-oriented bankers and businessmen, and hence failed
to inspire a
strong coalition to push for their adoption.
Broz points to two features of the Federal Reserve Act that were crucial for
gaining acceptance of the dollar for international payments. First, the act
permitted U.S. banks to issue bankers acceptances to finance foreign trade.
Second, the act established facilities to re-discount acceptances and other
commercial paper, thereby adding depth and liquidity to the U.S.
money market. Other features of the legislation directly benefiting large banks
included a reduction of reserve requirements and authority for banks with
capital of at least $1 million to establish foreign branches. The legislation
thereby solved, apparently, the problems of an inelastic currency and an
inefficient payments system, while promoting the dollar’s use as an
While the fundamental reforms embedded in the Federal Reserve Act provided the
key ingredients for promoting the dollar as an international currency,
specific features of the Act reflected give and take among various private and
public interests. Banks outside the central money market, for example,
were strong proponents of a currency backed by commercial paper, while New York
City bankers by and large preferred a currency backed by government bonds.
outside New York City also favored a decentralized system that limited the
ability of New York City banks to dominate. Bankers in general and many in
Congress favored a system controlled by banks themselves, but the Wilson
Administration, and especially
William Jennings Bryan, pushed for strong public oversight in the form of a
Federal Reserve Board. The Federal Reserve System was the product of compromise
at every stage and detail.
Broz supports his study of the origins of the Federal Reserve by examining how
well the founding of other central banks fit his joint products model.
The central banks he considers are the Bank of England, and the First and
Second Banks of the United States. In contrast to the Federal Reserve, each of
these banks was created
in part for government revenue. In exchange for providing loans on favorable
terms to the government, the owners of the banks were granted certain monopoly
privileges. The Bank of England was given a monopoly over note issuance, while
the First and Second Banks of the United States profited as the government’s
fiscal agents, as well as from their unique ability to branch nationwide. Broz
argues persuasively that the Bank of England survived, while the two U.S. banks
did not because in the United States federalism created a potent political
opposition that could be exploited by private enemies of the central bank.
While Andrew Jackson’s militant “hard money” philosophy explains his opposition
to the Second Bank, Wall Street bankers also sought to kill the
Bank on the grounds that its monopoly position as the government’s fiscal
agent gave the Bank advantages that state-chartered banks did not have.
I find little to quibble with Broz’s explanation of the origins of the Federal
Reserve System. Clearly the
most ardent proponents of establishing a central bank, especially the New York
bankers, sought to establish a major international money market in the United
States and to promote the dollar in international commerce and finance. There
was, however, strong
opposition to the establishment of a “central bank,” particularly one dominated
by New York bankers, and key players in shaping the Federal Reserve Act, such
as Carter Glass, William Jennings Bryan and Woodrow Wilson, sought to limit the
influence on the
System of New York banks.
Nonetheless, Broz has persuaded me that establishment of the Federal Reserve
required the ongoing support of leading banks and others who sought to firmly
establish the U.S. dollar as an international currency. I highly recommend
this book for anyone interested in either the history of the Federal Reserve or
other central banks, or for those interested in the origins of institutions and
institutional change more broadly.
David C. Wheelock is Assistant Vice President and Economist at the Federal
Reserve Bank of St. Louis. His research interests are the history of the
Federal Reserve System and other monetary policy institutions, and the
regulation and performance of commercial banks.
|Subject(s):||Financial Markets, Financial Institutions, and Monetary History|
|Geographic Area(s):||North America|
|Time Period(s):||20th Century: Pre WWII|