Our nation suffered its first stock market crash not long after winning its independence. During the Panic of 1792, George Washington stepped in to rescue the banks at the center of the fiasco. Thomas Jefferson lamented that the "fate of the nation seems to hang on the desperate throws and plunges of gambling scoundrels."
Sound familiar? Wall Street shenanigans are nothing new. Neither are banking crises, deep economic recessions or government tinkering.
To hear today's inflammatory political commentary, you'd think that the bailout efforts had no precedent, that the liberty of the free-market system was being irrevocably corrupted and that the levers of power had been lost to "fat cat" bankers. Yet such sentiments echo throughout the country's history.
Much of today's disapproval is directed at the Federal Reserve, an institution that now carries a lower approval rating than the Internal Revenue Service. The Fed's fall can be blamed on the aftermath of the housing bubble, which many now believe was caused by the missteps of then-Fed chief Alan Greenspan, something of an economic hero until recently. And the most furious fire is aimed at the rescue of the financial industry, engineered in part by Greenspan's successor, Ben Bernanke. Bernanke's Fed has dumped unprecedented amounts of currency into the economy.
What's to come of all this outrage? Well, there's a growing movement that calls for reining in -- or even abolishing -- the Fed. But is that realistic, or have proponents gone off their political rockers?
Rage against the Fed machine
The furor over the Fed is fueled by the same energy that has spawned tea party activism and impassioned protests against health care reform, bailouts, executive bonuses and President Barack Obama himself.Informally led by Republican U.S. Rep. Ron Paul of Texas, the Fed doubters call for a return to the gold standard, the monetary system that prevailed around the world until the 1930s and allowed the redemption of currency into some amount of gold. This stands in contrast to the fiat currency we now use, which has no backing.
Paul is leading a push in Congress to audit the Fed's interest-rate decisions. The thinking is that by limiting the amount of money that the central bank can create, economic volatility will be lessened and we can avoid the painful boom-and-bust cycle of the past 30 years, as well as the risk of 1970s-style inflation.
Fed criticism is often dismissed offhandedly, because the Federal Reserve has been a target of conspiracy theorists almost from its beginning. But this time, the doubters have a case to make.
What the Fed is
Some background is needed. The Federal Reserve is the country's central bank, with the exclusive right to issue currency. It is tasked by Congress with maintaining both full employment and price stability via a system of 12 privately owned banks scattered throughout the country and controlled by the presidentially appointed Board of Governors, based in Washington, D.C. A public-private hybrid, the Fed turns a profit, pays a 6% dividend to shareholder banks and delivers the surplus to the U.S. Treasury.Created in 1913, the Fed is the country's third central bank. Both of its predecessors were known as the Bank of the United States in their time, but they were privately owned and operated. The first was started by then-Treasury Secretary Alexander Hamilton (who graces the $10 bill) in 1791 and operated until 1811. The second operated from 1816 to 1836. Both banks were given 20-year charters by Congress and were successful, but they weren't renewed for fears a central bank would concentrate power among the banking elite.
Déjà vu, anyone?
Before the Fed, the U.S. monetary system was based on currency backed by gold and silver coin. Individual banks issued their own currencies, redeemable for coin created by the U.S. Mint at fixed prices set by Congress.
Individual banks were limited in the amount of currency they could issue, which reduced the growth of the money supply and kept a lid on inflation.
However, the first two central banks had only limited ability to adjust the money supply and couldn't step in when banks got into trouble. As a result -- under these banks and during the periods when there was no central bank operating -- the economy suffered frequent recessions with high rates of unemployment.
This tangled system eventually led Congress to create unbacked paper currency, which wasn't tied to gold or silver. Most notable was the "greenback" dollar issued during the Civil War. The greenback's value rose and fell based on the battlefield successes of the North. The withdrawal of this paper money and a return to a metal currency standard contracted the money supply and resulted in what's known as the Long Depression, a period of deep economic despair that lasted from 1873 to 1879.
Further tightening resulted from a move to a gold-only standard after the business community feared inflation would follow the discovery of significant silver deposits in Nevada. The silver lode threatened to increase the amount of money in circulation, leading business leaders to call for "sound money." Farmers weighed down by heavy debt burdens rallied behind "free silver" and easy money. Sound money won, and the monetary contraction that followed set off a string of recessions and mass bankruptcies that led to the Panic of 1907. The financial system was then rescued by John Pierpont Morgan, who locked bankers in his office and demanded loans with which to save the stock market.
After that, people realized that maybe a central bank wasn't such a bad thing after all. A congressional commission was created to research the matter, resulting in the Federal Reserve Act, which President Woodrow Wilson signed into law in December 1913. We've had the Fed ever since, though seldom without controversy.