This year marks 100 years since the US Federal Reserve system was established.
It was among the final grafts attached to the executive branch of the federal state, in several decades of enlargement begun under Cleveland, McKinley and Roosevelt, which would reshape and beef up the federal apparatus, and stabilize its finances to fit the demands of a unified national market, the world’s new industrial workshop, and an aspiring imperial power.
State expansion took a literal form: the stock of federal assets was sharply increased from the 1890s by the addition of vast tracts of land reserves and natural resources in the country’s west and northwest. These 150 million acres contained valuable timber and mineral deposits.
The addition of such non-financial assets to the US federal government’s balance sheet helped to secure the state’s debts, including currency issues. If need be, the state could always sell its physical assets or borrow against the marketable resources they contained.
Most importantly, federal liabilities were backed by the largest non-marketable asset of the government: the discounted present value of future primary fiscal surpluses from tax and custom receipts.
State liabilities thus became more central to the workings of the monetary system.
Almost immediately following the Fed’s creation, and ever since, the exigencies of war and economic crisis have ratcheted upwards the role of the national central bank in monetary and credit arrangements.
Wartime collapse of the gold standard began the pattern: as the central bank evolved, so did capitalist money pass juddering through stages of development, with state liabilities (US Treasury bills and central bank notes) eventually taking over from gold as the supreme measure of value for commodities, as well as the basic means of payment and purchase.
The Fed, its initial reach extended beyond any imagining, thus became central to the functioning of a world monetary system that now operates on a US dollar standard.
This status has only strengthened the historically observed tendency for emergencies, economic and military, to prompt a wholesale renovation and sudden, spasmic swelling of the institution (the Fed) and augmentation of its authority in a compressed period of time.
Since the outbreak of crisis in 2008, for example, the Fed has been obliged to take large parts of the market-based credit system on to its own balance sheet, in an attempt to maintain liquidity and support asset valuations.
It extended currency swap lines to other central banks and introduced the novel Term Auction Facility, the Term Asset-Backed Securities Loan Facility, the Primary Dealer Credit Facilitiy and the Commercial Paper Funding Facility.
In 2009 the Fed began purchasing Mortgage-Backed Securities outright.
This new ‘market-making’ role led Jan Toporowski to describe the new ‘central bank as hedge fund’ and Perry Mehrling to name the Fed ‘dealer of last resort.’
The Fed’s balance sheet grew from $800 billion in 2007 to $3 trillion today.
The Fed’s maintenance of a liquid market in US Treasury securities, through open-market operations and lender-of-last resort facilities, comports with the United States’ global borrower-of-last-resort status.
Since 1945 the US has effectively been the creator of money for world capitalism. The emission of dollars — first through postwar trade surpluses recycled as loans and capital export, then more recently via the outflow of government liabilities — has provided liquidity to the global financial system.
The enthusiastic purchase of dollar liabilities by foreign governments and private lenders has effectively removed the budget constraint for US military activities and armaments spending.
How did such a position arise?
Following US entry into the Great War (and amendments to the Federal Reserve Act), the Fed’s chief task became to maintain a liquid market in US Treasury securities (‘shiftability’) so the wartime government could borrow cheaply.
As of 1917, the Signal Corps which then controlled US military aviation had received just 142 aircraft during the previous ten years.
Yet enormous Congressional appropriations (including the largest ever single authorization of $640 000 000), creation of an Aviation Board and tightly organized production allowed the War Department to order 22 500 Liberty engines and 15 000 aircraft were quickly built.
Federal debt grew from $1 billion in 1917 to $25 billion in 1919.
The Fed itself absorbed $2 billion in Treasury issues, financing these purchases by expanding its own deposit liabilities. This liquidity injection, swelling bank reserves and note issues, then funded private purchases of federal debt.
Treasury bonds thus became the preferred form of loan collateral and main source of liquidity support for the US private money and capital markets.
By 1923, with the Fed’s Tenth Annual Report, Benjamin Strong was positioning the Fed as a global central bank responsible for credit stabilization and returning European economies to the gold standard.
Over the next decade the US state leadership, holder of nearly half the world’s gold reserves, used this privileged status as a lever to intervene in the fiscal and monetary affairs of debtor governments, especially the European powers, and thereby to shape their foreign and security policies.
Here, in the years of so-called isolationism, was the seedbed for the protection racket established after 1945, and never dissolved: in which the other advanced capitalist states of Europe and East Asia were subordinated within a US-controlled Cold War military and security ‘alliance’: Tokyo reduced to a diplomatic underling and European troops serving deferentially under NATO integrated command.
I’ll discuss this period (the 1920s) in the following post.