The Rise of the Fed

There has been a lot of discussion in the financial world about the Federal Reserve and their decisions related to interest rates. In 2018 the Fed flexed its proverbial muscle and raised rates four times. The quasi-independent central bank has received criticism from not only the press and financial pundits but also from the President who said in October of last year when asked about the rate hikes that “The fed had gone crazy”. The concern is that interest rates are being raised too quickly and aggressively. On March 22 of this year we saw the treasury yield curve invert; a 3-month T-bill is actually paying a higher yield than a 10-year T-bond. This is a very unusual economic happening, and in the past, has been a very consistent predictor of a recession in the not so distant future. When the Fed tries to impact the economy by raising or lowering interest rates it is like pushing on a string. Imagine a string stretched out on a table. If you push on one end will the other end move? No, the string will just bunch up at the end you are pushing on. Today’s interest rate environment is not that dissimilar.

The Fed plays a pivotal role in our nation’s economy, but believe it or not, that was not always the case. Prior to The Federal Reserve Act of 1913, the US had gone nearly 80 years without a central bank. The time leading up to the Fed’s creation was a period of extreme volatility in the money supply, which was accentuated by the Panic of 1907. The first decade of the 20th century was marked by changing politics and voter sentiment towards the economy. The 26th President of the United States, Theodore Roosevelt led the charge with his fellow “progressive republicans”. Attacks on big businesses and trusts like Standard Oil became the norm in the public square. But when the federal government had to turn to a private banker in JP Morgan to provide liquidity to its banking system during the Panic of 1907, voters had had enough. They wanted a central bank like the rest of the developed world to ensure a sound money supply.

So, in 1908 congress passed the Aldrich-Vreeland Act. It provided emergency currency and established The National Monetary Commission to study banking and currency reforms in America. Eventually, a few years later, a secretive weekend meeting was established on Jekyll Island in Georgia between politicians and executives from some of the countries leading financial institutions. Together they wrote the legislation that would eventually become the Federal Reserve Act of 1913. The details of the meeting were kept from the public because of the lack of trust at the time surrounding the big banks, financiers and particularly the “malefactors of great wealth” as Teddy Roosevelt would say.

It is ironic that once the Fed was created it would only take a few decades before the country would experience its worst financial panic: The Great Depression. There were many contributing factors to the depression but the illusion of safety from the newly minted central bank is cited as one of contributing factors. The important thing to remember about the Fed is that it is a bank, and banks are made up of humans, and humans get it wrong from time to time. But it is time and time alone that will judge the recent moves by the Fed.