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How The U.S. Treasury Avoided Chronic Deflation By Relinquishing Monetary Control To Wall Street

How The U.S. Treasury Avoided Chronic Deflation By Relinquishing Monetary Control To Wall Street

Michael Hudson

University of Missouri at Kansas City – Department of Economics ; Bard College – The Levy Economics Institute

October 21, 2015


The Eurozone today is going into the same deflationary situation that the U.S. did under Jackson’s destruction of the Second Bank, and the post-Civil War budget surpluses that deflated the economy. But whereas the Fed’s creation was designed to inflate the U.S. economy, Europe’s European Central Bank is designed to deflate it — in the interest of commercial banks in both cases.

How The U.S. Treasury Avoided Chronic Deflation By Relinquishing Monetary Control To Wall Street

Deflation was the main U.S. financial problem prior to 1913. To replace the Treasury conducting its fiscal operations independently from the banking system, New York banks urged more power over public finances and to establish the Federal Reserve to increase the supply of money (a more “elastic” issue) in response to banking needs. Monetary policy since the Great Depression that started in 1929 has aimed at re-inflating the economy after downturns, fueling the post-2001 financial bubble and, since 2008, Quantitative Easing to provide banks with liquidity to support asset prices.

By contrast, Europe’s trauma of hyperinflation after World War I gave Europe’s bankers and bondholders a rationale for gaining power over governments to prevent them from monetizing their budget deficits. The rhetoric of fighting inflation has enabled German and French banks to impose tight money policies and smaller public self-funding than in the United States. On both continents, banks gained power over governments. But in America it was by insisting on more money creation and deficit spending, and in Europe by advocating limits on public money to finance deficits.

For most of the 19th century the U.S. Treasury conducted its monetary and fiscal policy in ways that imposed deflationary pressures on the banking system. President Andrew Jackson (1829-1837) of Democratic Party starved the economy of credit by his war on the Second Bank of the United States and removal of government deposits to sub-treasuries around the nation. His Democratic Party policy was backed by Southern plantation owners opposing Northern industry and saw to that would have increased urban industrial demand for food and other consumer goods, raising prices for plantation owners.

The opposition Whig Party (1833-1854), followed by Republicans after 1853, was advocating a policy of recycling tax and land-sale receipts into Northern banks to help fund industrial growth. After the Civil War that started in 1861, the United States pursued a pro-industrial high-tariff policy, but this generated budget surpluses, which deflated the economy and drove prices for gold and other commodities back down to their pre-1861 level. That led to the 1873 crash and a depression until 1896, followed by an even greater crash in 1907.

In the wake of America’s 1907 financial panic, the Aldrich-Vreeland Act of 1908 created a “National Monetary Commission … to inquire into and report to Congress at the earliest date practicable, what changes are necessary or desirable in the monetary system of the United States or in the laws relating to banking and currency …”1 The Commission’s thirty-five monographs provided an exhaustive study of central banking structures and commercial banking policies, laying the groundwork for what in 1913 became the Federal Reserve Act.

Money and banking textbooks typically portray the Act as modernizing the financial system “to correct certain serious shortcomings in the National Bank Act: to provide an elastic currency, efficient clearing, centralized reserves, readily available credit for banks, and unified control of the banking system.”2 But David Kinley’s 1910 report (Kinley 1910) shows that the National Banking System had neither responsibility nor ability to steer the nation’s monetary course. Prior to 1913 the Treasury performed these functions, including open market bond purchases to provide the banking system with liquidity. It would be more accurate to view the Federal Reserve as shifting to Wall Street the financial power hitherto concentrated in the hands of the Treasury Secretary in Washington.


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