The problem came when, late in the inflationary booms, the banking system ran into trouble, and people started calling on the banks to redeem their notes and deposits in specie. At that point, since all the banks were inherently insolvent, they, led by the Wall Street banks, were forced to contract their loans rapidly in order to stay in business, thereby causing a financial crisis and a system-wide contraction of the supply of money and credit.
The banks were not interested in the contention that this sudden bust was a payback for, a wiping out of the excesses of, the inflationary boom that they had generated. They wanted to be able to keep expanding credit during recession as well as booms. Hence their call for a remedy to monetary “inelasticity” during recessions. And that remedy, of course, was the grand old nostrum that nationalists and bankers had been pushing for since the beginning of the Republic: a Central Bank.
The banks desperately desired a Central Bank, not to place fetters on their own natural tendency to inflate, but, on the contrary, to enable them to inflate and expand together without incurring the penalties of market competition.
Just as big bankers, in trying to setup a Central Bank, had to face a public opinion suspicious of Wall Street and hostile to central banking, so the financiers and industrialists faced a public steeped in a tradition and ideology of free competition and hostility to monopoly. How could they get the public and legislators to go along with the fundamental transformation of the American economy toward cartels and monopoly?
The answer was the same in both cases: the big businessmen and financiers had to form an alliance with the opinion-molding classes in society, in order to engineer the consent of the public by means of crafty and persuasive propaganda. The opinion-molding classes, in previous centuries the Church, but now consisting of media people, journalists, intellectuals, economists and other academics, professionals, educators as well as ministers, had to be enlisted in this cause.
For their part the intellectuals and opinion-molders were all too ready for such an alliance. In the first place, most of the academics, economists, historians, social scientists, had gone to Germany in the late 19th century to earn their Ph.D.s, which were not yet being granted widely in the United States. There they had become imbued with the ideals of Bismarkian statism, organicism, collectivism, and State molding and governing of society, with bureaucrats and other planners benignly ruling over a cartelized economy in partnership with organized big business.
It was not enough, however, for the new statist alliance of Big Business and Big Intellectuals to be formed; they had to agree, propound, and push for a common ideological line, a line that woud persuade the majority of the public to adopt the new program and even greet it with enthusiasm. The new line was brilliantly successful if deceptive: that the new Progressive measures and regulations were necessary to save the public interest from sinister and exploitative Big Business monopoly, which business was achieving on the free market.
Government policy, led by intellectuals, academics and disinterested experts in behalf of the public weal, was to “save” capitalism, and correct the faults and failures of the free market by establishing government control and planning in the public interest.
Throughout this successful “corporate liberal” imposture, beginning in the Progressive Era and continuing ever since, one glaring public relations problem has confronted the big business-intellectual coalition. If these policies are designed to tame and curb rapacious Big Business, how is it that so many Big Businessmen, so many Morgan partners and Rockefellers and Harrimans, have been so conspicuous in promoting these programs?
The answer, though seemingly naive, has managed to persuade the public with little difficulty: that these men are Enlightened, educated, public-spirited businessmen, filled with the aristocratic spirit of noblesse oblige, whose seemingly quasi-suicidal activities and programs are performed in the noble spirit of sacrifice for the good of humanity. Educated in the spirit of service, they have been able to rise above the mere narrow and selfish grasp for profit that had marked their own forefathers.
The new Federal Reserve System had finally brought a central bank to America: the push of the big bankers had at last succeeded. Following the crucial plank of post-Peel Act Central Banking, the Fed was given a monopoly of the issue of all bank notes; national banks, as well as state banks, could now only issue deposits, and the deposits had to be redeemed in Federal Reserve Notes as well as, at least nominally, in gold.
All national banks were “forced” to become members of the Federal Reserve System, a “coercion” they had long eagerly sought, which meant that national bank reserves had to be kept in the form of demand deposits, or checking accounts, at the Fed. The Fed was now in place as lender of last resort; and with prestige, power, and resources of the U.S. Treasury solidly behind it, it could inflate more consistently than the Wall Street banks under the National Banking System, and above all, it could and did, inflate even during recessions, in order to bail out the banks. The Fed could now try to keep the economy from recessions that liquidated the unsound investments of the inflationary boom, and it could try to keep the inflation going indefinitely.
Whereas the national banks before the onset of the Fed were required to keep an average minimum of 20 percent reserves to demand deposits, on which they could therefore pyramid inflationary money and credit of 5:1, the new Fed halved the minimum reserve requirement on the banks to 10 percent, doubling the inflationary bank pyramiding in the country to 10:1.
Murray N. Rothbard, The Case Against the Fed