Federal Reserve Constitutional or
Merely Legal?
The
Federal Reserve is the Central Bank of the United States. It is in charge of
printing money issuing bonds and setting interest rates for those bonds.
Article 1, Section 8 of the Constitution says, “The Congress
shall have Power … to coin Money, regulate the Value thereof.” The Federal
Reserve is never mentioned. Has it always been this way? Does any other
country do this? How did the Federal Reserve get its power over our currency
and our economy? And the issue that so many are interested in today: is the
Federal Reserve constitutional?
Has
it always been this way?
At
the dawn of the Republic our first Secretary of the Treasury Alexander Hamilton
issued several reports which in many ways set the tone and pointed the way for
the development of America in the economic sphere. His first report on the
public credit recommended that the new central government not only honor the
debts contracted under the original government as established under the Articles
of Confederation but that it also assume the war debts of the States. This
recommendation was followed by Congress and the Washington administration
created what has evolved into a permanent national
debt.
In
1790 Hamilton submitted his second report which
asked Congress to charter the Bank of the United States. Several aspects of the
bank Hamilton proposed will sound familiar and it can be seen that they provided
the mold for the Federal Reserve. His plan was closely modeled after that used
by Great Britain’s Bank of England. According to Hamilton’s vision the Bank of
the United States would be a public/private hybrid. It would have an exclusive
charter for twenty years. Its initial capitalization would be ten million
dollars consisting of eight million from private investors and two million from
the government. Congress would give the Bank the right to print paper money up
to the ten million held in deposit. Most importantly the central government
would declare that the notes issued by the Bank would be the only notes which
would be accepted in payment for taxes. This would give the notes of the Bank
of the United States credibility and value, which none of its state chartered
competitors could match. This was Hamilton’s proposal. Now all he had to do
was get it passed into law.
The
report was introduced into Congress in 1790 and by February 1791 it passed both
the House and the Senate and arrived on the desk of President Washington. This
is when the battle of the Titans really began. Leading Anti-Federalists and strict
constructionists such as James Madison, Thomas Jefferson, and Edmund
Randolph, argued that the Constitution did not grant the government the power to
incorporate a Bank. According to their line of reasoning It was not an enumerated power
and therefore it was reserved to the States or the people. Those arguing for a
strict interpretation of the newly minted Constitution, which Madison and
Randolph had helped write, urged Washington in a written report not to sign the
bill.
Ever
the fulcrum between his philosophically divided advisors Washington presented
Hamilton with the argument opposing his plan and asked him to present his
argument in favor. Hamilton using his excellent reasoning and communication
skills presented President Washington with the original argument for the implied powers
granted to the central government by the Constitution. This report appealed
to what is now known as the “Necessary and Proper” clause. He argued that the
government was inherently empowered to do whatever was necessary to implement
the laws required to use the enumerated powers. President Washington accepted
Hamilton’s argument, signed the bill, and the first
Bank of the United States was born.
Beginning
on July 4, 1791the first
thing the new Bank did was inflate a financial bubble by offering the
largest initial stock offering the nation had ever seen. Investors showed their
confidence in Hamilton’s plan by quickly buying the options on the first issue
of stock. Many of these initial investors were members of Congress. The
initial price for the options was $25. This was soon bid up to over $300. It
soon crashed to $150. Thus within days of its first action this original
central bank inflated a bubble that soon burst. However, Secretary Hamilton
setting the example for the central bankers to follow, stepped into the breach
and averted a general financial panic by purchasing government securities with
public funds thus stabilizing the markets and rewarding those who had initially
speculated and “Too big to fail” was born.
The
bank opened for business in December of 1791. All manner of people, landowners,
manufacturers, merchants, politicians, and most important of all, the government
of the United States lined up to deposit money and to obtain the new Bank
script. Within months the Bank was the single largest economic enterprise in
the nation.
Beginning
a pattern that would be repeated over and over the bank which had been created
to ensure a firm foundation for the American economy inflated another bubble and
caused another crash.
First
the Bank flooded the market with easy loans and a massive issue of paper
dollars. This move added liquidity pushing the new securities market into a
sharp rise. However, then the Bank reversed course and began calling in many
loans. Investors and speculators were especially affected as they were forced
to sell securities to pay the loans. When the largest of the speculators William
Duer was forced to declare bankruptcy the markets collapsed. This in turn
caused the financial markets to freeze up putting a stop to much of the nation’s
credit and commerce. This is known as the Panic of
1792. The crash didn’t last long, because Secretary Hamilton once again
stepped in and bought government securities with public funds injecting much
needed capital into the economy.
Over
its 20 year life the first Bank of the United States functioned as the central
bank. It worked to regulate state banks, closing those that issued too much
paper. It attempted to guide the entire economy through its monetary and
interest policies. It coordinated all its branches up and down the east coast
to project a united front in its economic policy by either tightening or
loosening credit.
By
the time it came for a renewal of the bank’s charter the Federalists were no
longer in the seats of power and the newly ascendant Democratic Republicans, led
by Thomas Jefferson, defeated its bid for another twenty years, and the first
bank of the United States, America’s initial experiment with central banking,
was over.
Does
any other country do this?
Yes,
many
other countries have central banks. Today it is considered a hallmark of an
advanced economy.
How
did the Federal Reserve get its power over our currency and our economy?
There
were subsequent attempts to re-establish central banking in the United Sates.
There was a Second Bank of the United
States chartered in 1816, but after being blamed for a series of bubbles and
crashes its charter was not renewed and it ceased operations in 1836. In 1863
in the depths of the Civil War Congress passed the National Banking Act which
chartered numerous Federal Banks. This law also taxed paper money issued by
State banks but not paper money issued by the Federal Banks giving them a
decided advantage.
In
1913 the Federal
Reserve System was born. It established what is known as a decentralized
central bank in that it has semi-autonomous branches. It was given the power to
control the currency, issue bonds, and set interest rates for those bonds. It
was established as a public/private concern and actually owned by stock
holders. Who are these stock holders? They
are private banks, and ownership of stock is required to participate in the
system. The system was instituted to provide the foundation for a stable
banking industry and an elastic currency that could be used to smooth the rough
edges of the business
cycle. Whether this latest experiment in American central banking has
fulfilled its mission each citizen should judge for themselves.
Is
the Federal Reserve constitutional or merely legal?
The
first Bank of the United States was never challenged in court as to whether or
not the government had the power to create a central bank. But the second Bank
was. The Supreme Court in 1819 ruled
in McCulloch v. Maryland that it
was in fact constitutional due to the implied powers clause. Thus looking to
precedent, and unless the Supreme Court reverses itself, the Federal Reserve is
considered to be authorized within the confines of the broadly interpreted
Constitution.
There
was an important constitutional issue born with the creation of America’s first
Central Bank. With the birth of the First Bank of the United States the
acceptance and use of implied powers became the central government’s method to
expand its powers beyond those expressly delegated in the Constitution. This
in turn paved the way for our acceptance of things that are clearly
unconstitutional just because they are legal.
The
argument of Madison, Jefferson, and Randolph upholding a strict constructionist
view would be codified and added to the Constitution in the same year the Bank
was charted, and perhaps in response to it, in the 10th
Amendment, but this did not end the appeal to implied powers as a means to
the government’s ends. In theory this sounds good. In practice it has turned
our limited government into an out of control leviathan
crushing the free out of our free market and sucking the liberty out of the
American experiment.
As
my favorite American philosopher, Yogi Berra once said,
“In theory there is no difference between theory and practice. In practice
there is.”
by Dr. Robert Owens
by Dr. Robert Owens
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