 By MARY DEIBEL Scripps Howard News Service January 02, 2006
Before Congress chartered the Fed in 1913, it fell to Wall Street financiers, principally J.P. Morgan, and thousands of small community banks to bankroll American business and territorial expansion. The economy was based on a constant currency supply pegged to the price of gold so that money couldn't expand in case of a bank run.
After a century of these panics, Congress set up the Federal Reserve System in hopes of maintaining an adequate supply of currency and credit and to try stabilizing a mushrooming industrial economy. Meantime, the United States and other nations gradually moved away from the gold standard, which the U.S. severed entirely in 1971 when President Nixon announced the United States would no longer redeem dollars for gold. Still, the Fed remains custodian for a quarter of the world's monetary gold reserves at the New York Federal Reserve Bank 80 feet below sea level on Manhattan bedrock in a gold vault visited by more than 20,000 tourists each year. The Federal Reserve Board of Governors, led by the Fed chairman, was established with 12 regional Federal Reserve Banks to supply the nation with money through commercial banks. The Fed also was set up to supervise nationally chartered commercial banks' operations, including lending practices. It also serves as a credit regulator whose recent actions have ranged from requiring clearer terms for car-leasing and mortgage disclosure to new rules that take effect in January requiring credit-card issuers to raise minimum monthly payments to cover interest, fees and some outstanding balance on credit-card debt. The Fed also handles check-clearing duties, although its fleet of trucks and airplanes got replaced with electronic fund transfers after the 9/11 terrorist strikes temporarily grounded check-clearing nationwide. The Fed's policy-making Open Market Committee has charge of monetary policy and is made up of the chairman, the board members and a rotating group of regional Federal Reserve Bank chiefs. The committee uses interest rates that it charges member banks and the banks charge each other for overnight borrowing to increase or contract the supply of currency and credit and try keeping the economy on an even keel. "Open market operations" are the principal tool for changing the money supply in which the New York Fed buys and sells U.S. Treasuries and other federal agency securities to change the amount of cash reserves or the cost of money as denominated in interest rates. The 1970s oil shocks and the end of all ties between the greenback and gold made the Fed's controlling of the world supply of U.S. currency central to its role, says Pacific Research Institute economist Lee Hoskins, a member of the "Shadow Fed," a curmudgeonly committee formed in the 1970s to keep an eye on the central bank. Arthur Burns, the White House economic adviser Nixon made Fed chief in 1970, came to believe "the logic of events" dictated expansive growth of the U.S. money supply on his watch, according to Burns biographer Wyatt Wells. Eventually, inflation soared to double digits as the wage-price spiral raced out of control, and it fell to President Jimmy Carter's choice of Paul Volcker as Fed chief in 1979 to break the back of inflation by ratcheting up interest rates, sending mortgage and car loans soaring to 20 percent. As Volcker's successor in 1987, Greenspan stayed on the inflation-control course through interest rates. Inflation was targeted implicitly under Greenspan, whose verbal obfuscations were studied from Wall Street to Main Street for clues even after the Fed finally went public with announcements of interest rate decisions in 1994. Historian Martin Mayer, author of "The Fed: The Inside Story of How the World's Most Powerful Financial Institution Drives Markets," credits Greenspan with realizing the Fed couldn't survive its super-secret ways in an information age that expects worldwide disclosure in the click of a computer mouse. Greenspan came to enjoy mythic stature, enough so that "Maestro" was the title of Bob Woodward's celebrity bio that praised Greenspan's rapid response to the 1987 stock-market crash, the '90s Mexican peso crisis and Asian "contagion." Fed accommodation when the tech bubble burst and the 2001 terrorist strikes only added to his luster. But the concept of Fed chief as financial rock star is a recent phenomenon and a role Bernanke isn't likely to repeat, Fed-watchers agree. For one thing, globalization and deregulation of financial markets, along with America's reliance on foreigners to finance our twin trade and government deficits, make it tougher for Fed actions to have the same force at home and abroad and for future Fed chiefs to reach Greenspan's status. For another, Bernanke is one of a number of monetary economists to foresee focusing a central bank's role on fighting inflation through controlling the money supply. He's been "hooked" ever since he read Milton Friedman and Anna Schwartz' seminal 1963 tome "Monetary History of the United States" as a graduate student, Bernanke told a celebration of Friedman's 90th birthday. To advance monetary policy, Bernanke has theorized in favor of "inflation targeting," in which the Fed sets explicit goals for inflation control "to anchor public expectations about inflation." Were he to translate inflation targeting theory to fact by winning the consensus of the Fed's Open Market Committee, "It would make the Fed accountable because now there's no way to challenge what the Fed does," says Shadow Fed founder Schwartz, now 90 as well. Bernanke is also a student of the Depression, the Fed's most dismal failure. With mounting bank failures and depositor runs on banks that fought to stay open in the wake of the 1929 stock market crash and deepening recession, Congress moved to create a new array of bank, thrift, securities and insurance regulators. Those Depression-era firewalls separating banks, brokerage houses and insurance companies stayed largely in place until the 1990s. In 1999, Congress and President Bill Clinton agreed on a financial deregulation bill that made the Federal Reserve the super-overseer of a U.S. financial system that now promises one-stop financial shopping. It is a role and responsibility to which the Fed is still adjusting, says University of Pennsylvania political scientist Donald Kettl, author of "Leadership at the Fed." Kettl notes that Greenspan hasn't hesitated to speak out the "significant risks" of the federal budget deficit, an "irrationally exuberant" stock market and other issues not strictly in the Fed's purview _ something Bernanke says he doesn't plan to do. At his Senate confirmation hearing, Bernanke promised to maintain Greenspan's policy of focusing on inflation and price stability "as monetary policy's greatest contribution to general economic prosperity and maximum employment." But he also pledged not to inject himself in political fights over tax cuts, federal spending and other policies that marked Greenspan's rule.
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