The Gold Standard and the Federal Reserve Act

21
December

In learning about the gold standard and the Federal Reserve Act, you can see two different ideas about money afloat: the first is that currency should be tied to something valuable and tangible; the second is that currency is just a medium of exchange, and only gains value based on how goods and services are priced.

The gold standard means that any given government declares that its basic unit of currency can be exchanged for a set weight in gold. Why gold? Because it’s a relatively stable commodity with a relatively predictable amount produced each year. Governments have also used a silver standard, in which they agree that their currency can be exchanged for a set amount of silver. Use both gold and silver as mediums of exchange for currency, and that, my friends, is called bimetallism.

But, as attractive as gold or silver are, using precious metals as a basis for pegging your currency’s value has inherent difficulties. One such problem is that the value of gold or silver can fluctuate. Another is that it can be difficult to distribute and keep in constant supply at local levels an adequate amount of gold. After all, the gold standard would mean that a person could legally exchange currency for gold–right there in the bank. If the bank doesn’t have the amount of gold available for that customer, the customer’s paper money becomes worthless. This can become a logistical nightmare. It can lead to restrictions on bank withdrawals, and, therefore, has also historically led to bank panics.

Once upon a time, however, the United States and other governments used the gold standard in trade and for debt service. The gold standard was in play between participating nations between the years 1879 and 1914. All currencies held their respective gold value, and gold was shipped between participating nations as a way to pay for trade. And on the ground in the United States, say, from the end of the Revolutionary War until halfway through the Civil War, currency–based on the gold standard–was valued at a local level. Banks–other than a mere two operated by the US Government–were owned by private companies or via state charters. A county bank could issue currency based on the amount of gold it chose, and this of course varied from locale to locale. Given America’s growth over time, and the mobility of its population, this became a recipe for chaos.

To clarify monetary matters, Congress passed a National Bank Act in 1863, which allowed for federal supervision of a national banking system. This act served to standardize capital reserves, defined how banks would make and administer loans, and, in effect, taxed state banknotes (or locally-created currency) out of existence.

Moving forward to the turn of the century, McKinley made good on a campaign promise and signed into law the Gold Standard Act of 1900. However, gold was discovered more plentifully during this time, which affected price. America eventually entered a mild recession in 1907, and, coupled with this financial uncertainty, and fueled by the downfall of the Knickerbocker Trust Company, American banks were hit with panicked depositors demanding funds. At the time, there was no real safety net in place for banks and their depositors. If J. P. Morgan hadn’t stepped in to pledge personal funds, and convince other financiers to do likewise, the Panic of 1907 would have had greater damage. This financial scare prompted further attention to banking reform.

Based on a federal commission’s findings, the chairman of the House Banking and Currency Committee shepherded through Congress a financial reform bill which would be known as the Federal Reserve Act. The bill was signed into law in 1913 by Woodrow Wilson, then newly elected president.

The Federal Reserve system has undergone several permutations, but basically functions as the financial services arm of the federal government with various governmental agencies, and domestic and foreign financial entities.

This post was written by

jason – who has written posts on Budget Clowns.
Father of three and married to a lovely women. Always looking for ways to save money, and invest it properly for my children's future.

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