One of the “Founding Fathers” of the United States, Alexander Hamilton (center), the first Treasury Secretary, promoted the establishment of a central bank after the Revolutionary War. ⓒUS Senate Collection Jerome Powell Will the US Federal Reserve (Fed) chairman be Arthur Burns (10th Chairman) or Paul Volcker (12th Chairman)? Burns is the worst-rated Fed chairman ever. The following is part of an article (December 1, 2022) written by former Fed director Randall Qualls for the American daily newspaper Deseret News. “Everyone associated with the Fed, from Chairman Powell to the staff who waters the office plants every Friday, knows one ‘Great Satan’. Arthur Burns. If you ever go to the Fed Building, ask the security guard at the entrance who X-rays your bag, ‘Who’s the main villain?’ I would answer without hesitation, ‘Arthur Burns’.” Arthur Burns (left) and Paul Volcker, who served as the 10th and 12th chairman of the US Federal Reserve, respectively. Burns took over as chair of the Fed in January 1970, when there were signs of inflation. At the time, President Richard Nixon, who wanted an economic boom, was reluctant to raise interest rates. Burns gave in. At the time of his inauguration, the benchmark interest rate, which was in the 8% range, was reduced to 3.0% by the end of that year. From 1973 to 1974, as prices skyrocketed due to soaring oil prices following the oil shock, the base rate was raised to 13.6% (July 1974). pulled down As a result, Burns resigned in January 1978, when the inflation rate in the United States soared toward double digits. In 1979 and 1980, the US inflation rate reached 11.25% and 13.55%, respectively. Inflation is one of the “symptoms” of a boom. Bizarrely, during Burns’ tenure, inflation was accompanied by a severe recession. so-called stagflation. To the Fed, Burns is a historical anti-war teacher who ruined the U.S. economy while being dragged by political and other external pressures. The Fed credits 12th Chairman Paul Volcker as the person who made it possible for him to regain control of prices. Volcker, who took office in August 1979, carried out ultra-high interest rate shock therapy for three years until 1982. In May 1981 he raised the benchmark interest rate to 19.29%. As a result, the unemployment rate, which was 6% when Volcker took office, went well over 10% in 1982-1983. Volker, who emerged as a target of national hatred, had to wear a pistol. However, the inflation rate fell to 3.21% in 1983, after which the US and world economy entered the so-called ‘The Great Moderation’ (named by the Fed). Reference from ‘Macrotrend’, an economic research institute). Chairman Powell has a record comparable to Volcker in the category of ‘speed of interest rate hikes’. He doesn’t carry a pistol, but Volker is the person Powell mentions most often in his speeches. Whenever he brings up Volker’s name, the audience thinks of Burns. Powell hopes to remain the ‘second Volker’. No matter how badly the world criticizes Powell, he will not give up his interest rate hike hastily. Powell controls prices and economics in America (and the world by extension), but is controlled by the history of the Fed. To guess where the Fed will lead the world economy in 2023, it is necessary to refer to the path the central bank has taken. ■ Central banks before the Fed The Fed was launched in 1913 with the enactment of the ‘Federal Reserve System Establishment Act’. However, even before the Fed, there was a ‘central bank-like’ institution in the United States. According to the ‘Federal Reserve History’ on the Fed’s website, the time when the need for a central bank was raised in the United States was before and after the Revolutionary War (1775-1783). It was the brainchild of Alexander Hamilton (the first Treasury Secretary), one of America’s “Founding Fathers,” who believed that the fledgling United States needed a central bank to stand up to the European powers. That central bank, like England’s Bank of England, would support the financing (warfare, etc.) of the United States federal government (established by ratification of the 1789 Constitution). Also, at that time, Americans were mainly trading in gold, silver, and British currency. Money was insufficient for the size of the transaction. Hamilton, who studied the Bank of England diligently, knew that if the central bank behind the country issued a national currency backed by gold, it could be widely circulated. Hamilton’s idea was realized in 1791 with the (first) establishment of The Bank of the United States. The Bank of America, a “national law bank” licensed by the federal government, has been embroiled in controversy since its birth. It was because a fierce debate was unfolding around ‘Which should have greater power, the federal government or the state government’. If Hamilton is the representative of the former (Federalism), Thomas Jefferson (3rd President) is the representative of the latter (Anti-Federalism). Prior to the launch of the Bank of America, some states already had ‘state law banks’ (banks licensed by the state) in operation. Each issued paper money (state-legal banknotes) and performed deposits and loans. Jefferson was concerned that American banks, backed by the federal government, would undermine the economic interests of state governments and state-law banks. Moreover, the ownership and control of the US banks were almost exclusively owned by the rich in the private sector (the federal government owns only around 20%). From an anti-federalist perspective, the US bank could become a ‘monster’, giving financial power to the federal government and the rich. In the end, it allowed the establishment of an American bank, but limited its operating period to 20 years, and closed it in 1811. However, with the outbreak of war with England in 1812, the following year, public opinion that ‘it would have been easier to finance the war had there been a central bank’ spread again. In 1816, the second American bank was established. The government of Abraham Lincoln (center) enacted the National Bank Act through several amendments from 1863 to 1864. ⓒAP Photo In fact, US banks had the potential to worry Jefferson. For example, banknotes issued by the Bank of the United States (US banknotes) were just one of the banknotes circulating in the United States at the time. However, taxes were regulated to be paid in US banknotes. So, no matter what state you lived in, you needed a US banknote to be a US citizen. This is the secret of how American banknotes were able to circulate nationwide beyond state boundaries. Moreover, the US bank was a ‘government bank’ that received and operated the national treasury (tax) as ‘government deposit’. That’s how much capital was available for business. The Bank of America also had large holdings of gold and silver. In fact, banknotes are just pieces of paper with numbers engraved on them. Only when it is guaranteed (conversion) that it can be converted into gold (an object of worship, which has value in itself) when taken to the issuing bank, the bill emerges as an object of desire. For that to happen, the bank’s gold holdings must be large. Small state-law banks had difficulty holding a lot of gold, issued paper money that could not be used in other states, and did not have enough capital to operate. In terms of competitiveness, US banks were not comparable to state banks. Thanks to that, the secondary US bank was able to greatly influence the US money supply. I even heard that it is a stronger organization than the government with taxation power. However, from the side of the dictatorship and concentration of economic power in check, the US bank could be the people’s enemy representing the federal government and the rich. President Andrew Jackson (7th), who took office in 1829, thought so. The era of American banking came to an end (1836) when President Jackson vetoed the second extension of the business period (20 years) for American banks passed by Congress. At the time, the power struggle between President Jackson and the second US bank was named the ‘Bank War’. ■ From the era of ‘free banking’ to the era of national law banks Over the next 30 years, the US financial system went through a period of extreme instability. From 1836, when the second U.S. bank closed, to the Civil War (1861-1865), numerous small state-law banks were established. According to historical data from the Federal Reserve, at the start of the Civil War there were as many as 1,600 state law banks in the United States. Thousands of banknotes were circulating, and even counterfeit bills were rampant. The value of the paper money itself was uncertain. When the issuing bank went bankrupt, the paper money became a piece of toilet paper. Private companies have experienced extreme difficulties in dealing. This is the so-called Free Banking era. The year after Abraham Lincoln was elected President of the Union (1860), the Civil War broke out. The Lincoln government also had to raise a huge amount of money for war, but there was no gold. In the long term, it was also necessary to stabilize the US monetary and banking system. The Lincoln government enacted the National Banking Act through several amendments between 1863 and 1864. According to data from the US Office of Currency Supervisory Service (OCC), if a business plan was submitted to the OCC, a newly established government agency at the time, and approved, a national bank (commercial bank licensed by the federal government) could be established. The founders had to buy government bonds (issued by the Ministry of Finance) with a third of the capital of the National Law Bank. If a national law bank is established with a capital of 1 million dollars, 333,000 dollars of it will be used to purchase government bonds. The capital of the national bank is composed of 333,000 dollars worth of government bonds and 669,000 dollars worth of gold and silver. The government bonds sold by Lincoln were, of course, to finance the Civil War. Instead, state-law banks enjoyed the privilege of issuing “national currency” backed by the government bonds. National banks in any region issued national banknotes with the same design, size, and color. The only difference was that the names of the issuing bank and executives were written on the corner of each banknote. These notes could be exchanged for gold or silver coins by taking them to the issuing bank. If the bank failed to convert, the government took responsibility. Compared to numerous state bank notes, state bank notes were very strong money with guaranteed value. National banks were no different from ordinary banks in that they earned profits from deposits and loans to households and corporations. However, it enjoyed a tremendous competitive advantage in that the main ingredient of sales was ‘national currency’. According to Federal Reserve historical data, most of the money used in the United States in the late 19th century was state bank notes. However, the problems with this system soon became apparent. During the Gilded Age, from the end of the Civil War to the early 20th century, the United States was achieving rapid economic growth through the Industrial Revolution. As the number of transactions increased, ‘liquidity’ (the amount of money everyone was willing to receive) was also needed. The national law banknotes were gaining enough trust (albeit less than gold) that ‘everyone is willing to receive it’. However, it was always lacking in quantity. This is because national banks could only issue banknotes equal to the amount of U.S. Treasury bonds they held in accordance with the law. In other words, the increase in the size of the national economy did not increase the number of bank notes (inelastic currency). In the United States during the Great Boom era, large-scale corporations were established in the railroad sector, and stock exchanges and brokers that brokered these stocks were active. It was an era when capitalists and speculators engaged in risky speculation and takeover wars in stocks and gold with money borrowed from banks. If the speculation fails, ‘bank panics’, in which the ‘bank run’ that occurred in the bank of the speculator’s transaction, spread to numerous other banks, periodically broke out. If the banks had been able to secure enough gold or state banknotes to hand over to customers and creditors, the panic would have been prevented early. However, aside from gold, which was fundamentally limited in quantity, there was not enough national banknotes. In the midst of this, in October 1907, the failure of speculation in the copper market, which was revealed, caused a financial panic that bankrupted numerous banks across the United States. However, at the time, there was no institution in the United States to act as the lender of last resort. In the end, JP Morgan, who had absolute influence in the economic world as a notorious monopoly capitalist and financier, organized bank presidents to solve the situation by giving unlimited funds to vulnerable financial institutions. A capitalist has played the role of a lender of last resort, one of the functions of a central bank. Since then, the public opinion that ‘a central bank should be established in the United States’ is formed around the political and financial circles. The financial panic of 1907 was the midwife for the Fed. Investors gathered in front of Federal Hall in New York on October 24, 1929, on “Black Thursday” when the stock market crashed. ⓒAP Photo ■ Establishment of the Federal Reserve and the Great Depression On December 23, 1913, the US Federal Reserve System Establishment Act (the Federal Reserve Act) was enacted. The Fed’s epochal task was largely twofold. One was the creation of an ‘elastic currency’ that could flexibly increase or decrease according to the scale of economic activity. If liquidity is determined by how much gold and Treasury holdings banks hold, a stable supply of the currency needed to develop the United States as an industrial nation is impossible. The other was the function of a lender of last resort to respond to the financial crisis. Then, how did the banknotes issued by the Federal Reserve System (Federal Reserve Notes = Dollars) become elastic? At that time, the Woodrow Wilson administration divided the United States into 12 sections and organized Reserve Banks for each region. The private banks located in the region paid the share of the capital of the reserve bank (local central bank). Private banks that are shareholders and members of the Reserve Bank can enjoy the benefit of obtaining loans from the Reserve Bank when needed in exchange for capital contributions. This is called discount window lending. Of course, to get a discount window loan, you must provide collateral to the Reserve Bank. The collateral is the ‘loan receivable’ (the right to be repaid from the debtor) obtained by the member bank lending money to private companies or farmhouses. However, liquidity increases only when member banks provide loans to the Reserve Bank as collateral and borrow money. For example, if a member bank lends $10,000 to a private company with a maturity of three years, the money is tied up until repayment is complete. However, if a member bank entrusts $10,000 in loans to the Reserve Bank and borrows $9,000, it can lend the money back to the private sector. That much money is released additionally. If private banks in the days of the National Bank Act could have liquidity only as much as they held government bonds, banks after the Federal Reserve Act could borrow more ‘national currency’ and use it. The money supply grew, and the dollar developed more resiliently. The 12 Reserve Banks that make the dollar elastic are ‘pure’ private corporations owned by local private banks. When profits were earned from interest on discount window loans, they were distributed to shareholders (member banks). However, the Federal Reserve Act stipulates that the Federal Reserve Board (FRB) established in Washington, the capital, exercise command authority over the reserve banks as a ‘central control tower’. Its directors are appointed by the president. From the beginning, the Federal Reserve was designed with the goal of harmonizing or compromising public and private interests, private interests and public interests, and regional and central interests. However, in the early days of the establishment of the Fed, the authority of the central control tower (FRB), which was set up as the representative of the federal government and public interest, was too weak. The event that revealed this problem was the Great Depression that broke out in August 1929. In the late 1920s, when the harbingers of a financial crisis appeared, the Fed was just watching the situation, rather than establishing a national monetary policy to respond to this situation. Regional reserve banks had different views, and the central Fed was powerless. The Great Depression notes that the prevailing theory at the time was the ‘real bills doctrine’. According to this, the central bank should supply additional funds to commercial banks only during boom times when corporate demand for funds is high. Inflation does not occur because production and money supply increase together. In times of recession, when demand for funds from businesses is low, the money supply should be reduced. This is because a recession will reduce production, and if only money is released, huge inflation will occur. It was even argued that ‘a financial crisis is a symptom of a recession, and that the entire economic system can be improved only when the money supply is reduced and insolvent financial institutions are destroyed’. Accordingly, the Fed actually raised interest rates in the late 1920s, when the boom (stock market boom) was turning into a recession. Bankruptcies began in 1930, but the role of the lender of last resort was abandoned in accordance with the principle of genuine promissory notes. Eventually, in 1933, the United States’ banking system led to a total collapse. According to Fed data, between the fall of 1930 and the winter of 1933, US money supply and price levels fell by nearly 30%. Unemployment soared to 25%. The United States and the world went through a decade-long recession. Ben Bernanke, the 14th Fed chairman, said in a 2002 speech when he was a board member that the Fed’s mistakes “contributed to the worst economic disaster in American history.” “We (the Fed) did something very wrong. I will never repeat the same mistake again.” On April 16, 1948, Thomas McCabe (left) was inaugurated as the 8th Fed chairman. ⓒThe Harry S. Truman Library ■ Fed Amendment and Political Independence President Franklin Roosevelt, who took office in March 1933 during the Great Depression, undertook sweeping reforms of the Fed system at the request of Mariner Eccles, whom he nominated as chairman. As a result, the most important change in the 1935 amendment to the Federal Reserve Act was the establishment of the Federal Open Market Committee (FOMC), the highest decision-making body that decides monetary policy, under the Federal Reserve. It also shifted the Fed’s center of gravity from its 12 reserve banks to the Fed and its chairman. Reserve banks, each relatively autonomous in formulating and executing monetary policy, were obliged to accept the FOMC decision unconditionally. Eccles has been called the ‘father of the modern Fed’. Meanwhile, the ‘political independence of the Fed’ came up on the agenda. This is because such a strengthened organization can cause great harm to the national economy if it arbitrarily adjusts the money supply according to the political interests of the administration. As a result, ex-officio members, such as the Treasury Secretary, were excluded from the Fed’s decision-making body, but the Great Depression and World War II emergencies did not leave the Fed alone. This is because the central bank’s cooperation was desperately needed to finance the administration’s war effort. The resulting conflict between the Fed and the Treasury reached its climax in early 1951, immediately after the outbreak of the Korean War. At the time, the Harry Truman government needed to keep the price of government bonds high in order to finance the war through government bonds. This is because no investor will buy a financial product (such as a government bond) whose price is expected to decline. So they put pressure on the Fed not to raise interest rates. This is because bond prices and interest rates are inversely proportional. However, the Fed was in no position to delay raising interest rates. Inflationary pressures were mounting because of the war-related fiscal spending. On January 29, 1951, when the conflict between the two sides was intensifying, President Truman summoned FOMC members to the White House and persuaded them to maintain the price of government bonds. This seat was only about checking the distance between the two sides. Thomas McCabe, chairman of the Fed at the time (8th), etc. returned to their offices after listening to Truman’s request respectfully. However, the White House announced in a statement the next day that ‘the FOMC promised to stabilize the price of government bonds by maintaining the current interest rate level’. In response, the Fed released the minutes of the White House meeting in the
ssn-general
Predict and control the ‘second natural phenomenon’
