Published by EH.Net (May 2016)

John H. Wood, Central Banking in a Democracy: The Federal Reserve and Its Alternatives. New York: Routledge, 2015. xx + 222 pp. $160, ISBN: 978-1-138-01639-2.

Reviewed for EH.Net by Richard Timberlake, Department of Economics, University of Georgia.

John H. Wood, Reynolds Professor of Economics at Wake Forrest University, has put together a very valuable, historical, and timely study on the lack of control the electorate has over the central banking functions of the Federal Reserve System.

A reader who first sees the title to this book wonders what is implied by the words “in a Democracy.” Why a “Democracy,” and also, why not a “Constitution”? Wood treats this question in his preface (although it is not so-labeled): “Monetary stability (. . . the primary purpose of central banks) requires responsibility, meaning punishment for failure, instead of a remote and irresponsible (to the public) agency such as the Fed. It requires either private money motivated by profit or Congress disciplined by the electoral system as before 1913.” That is, either a system of private money operating under the rule of the law of the Constitution and competitive economics, or a system governed by the principles of majoritarian democracy. Wood’s choice, and the answer to “Why Democracy,” is that, “Change involving the least disturbance to the [existing] system suggests the latter.” In his “Introduction” (p. 9), he argues this crucial point further:
The world is full of unexpected problems that lawmakers have to contend with. “A well-run monetary system requires that Congress take the Constitution’s assignment ‘to regulate the currency’ seriously.” Policymakers, therefore, must be made more responsible to the electorate, which means “significant change in the institutions of American monetary policy.” There is reason for optimism, Wood writes, because of the performance of earlier institutions “that were richer in incentives in the public interest, in profits and losses and electoral rewards and punishments” (p. 9).

This statement implies many arguments. First, Congress was not given the power to “regulate the currency” — only the value of grains of precious metal in gold and silver coins, in order to keep both types of coins in circulation, and minimize the problem of inadequate denominations, a major problem throughout the nineteenth century. Nothing but gold and silver was to be a tender for debt. Second, the “earlier monetary institution” was the Gold Standard, which did not include any rewards or punishments, but only the realization that any government-run system would result in “bills of credit.”

Wood’s first two chapters review the political structures and monetary policies of what would become, or were, central banks, from 1694 when the Bank of England first appeared to the Federal Reserve System (the Fed) in 1913. The material in these chapters is well-documented with original sources, and with the findings of others who have used primary materials. The Bank of England, and the First and Second Banks of the United States were government-sponsored and, therefore, partly government-controlled institutions that sporadically acted like central banks, that is, deliberately and purposefully carried out monetary policies. His account includes the private clearinghouse system, whereby the private banking system innovated the means to protect itself (pp. 57-60). It was, however, “legitimatized” by being made a governmental institution — the Fed. Then came World War I and then the 1920s. Wood treats Benjamin Strong’s stable price level policy accurately, noting that it implied a hands-on Quantity Theory of Money for its application. But if a Fed policy using the Quantity Theory was legitimate, so were other man-made policies, such as the Real Bills Doctrine, especially its condemnation of speculation, which prevailed from 1929 to 1935. (Wood errs in dismissing the “real bills” era as unimportant.) Then came the gold confiscation of 1933-34, the Banking Act of 1935, and the doubling of member banks’ legal reserve requirements in 1937. Wood is properly critical of this last policy, as it reflected the Fed’s inattention to monetary fundamentals and the dominance of the Treasury. This dominance, Wood notes, was repeated under Presidents Johnson, Kennedy, and Nixon. Throughout these administrations, the Fed was a servant of the Executive-Treasury. Wood notes well that all of the Fed chairmen, regardless of party affiliation, adopted various rate-of-inflation policies trying to supply enough “credit” — money — to satisfy political demands, with predictable results: The price level kept rising, and the intrusions of the Executive branch became worse.

The Great Recession of 2008 was a disaster. Under Timothy Geithner, Henry Paulson and Ben Bernanke the Fed made “too big to fail” an avowed principle. Wood’s discussion of this episode is an all too accurate and damning report on what has become a political central bank having no responsibility to the private economy. It is, in fact, a frightening prospect for a constitutional republic, or a “democracy.” The Fed has one tool, Wood confirms in his Conclusion — control over the quantity of money. He would have that control by a “democracy.” Since the Fed is a “public choice” institution, how can it be controlled? Wood argues against a gold standard for various reasons that can be refuted, in favor of Congress! — that is a Congress “having a direct involvement in money and finance” without a central bank to screen its activities from the public. Wood’s final remark is: “The creation of the Fed was a powerful example of the advice: ‘Be careful what you wish for” (p. 194)

Wood’s book is both interesting and informative. He has a good style without significant pedantry. His conclusion, however, is not the answer. Congress would find ways to repeat all the wrong things. The monetary system in a “democracy” must be a constitutional constant so that neither Congress, nor any creature of Congress, is be able to violate its tenets. The gold standard was one such. And here this reviewer must stop. Anything more would be another book!

Richard Timberlake is the author of Constitutional Money: A Review of the Supreme Court’s Monetary Decisions (Cambridge University Press, 2013).

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