The rise of the greenback - US dollar - The Fortunes of Money

UNESCO Courier, Jan, 1990 by Jan Kregel

This instability was attributed by some to a lack of specie, an argument exploited by those interested in making silver the basis of the United States monetary system. A "Free Silver Movement" launched by William Jennings Bryan demanded the free coinage of silver as legal tender. The 1878 Bland-Allison Act provided for Treasury silver certificates which became legal tender in 1886 and the Sherman Silver Act of 1890 made the Treasury virtually liable to purchase the entire output of United States silver mines. In 1882 a similar provision was made for gold certificates, but neither measure gave the hoped-for elasticity to the currency.

The system created serious international as well as domestic problems, for fluctuations in the internal demands for liquidity could only be met by international gold movements, which in turn created instability in the international monetary system. This was particularly striking in 1893, when the fear that the United States would not honour its government debt in gold and would instead pay in silver, whose price was collapsing on world markets, led to a massive outflow of gold and widespread bank failures.

Creation of

the Federal Reserve system

The outflow was reversed by the Gold Standard Act of 1900, which set the dollar firmly on the gold standard 3 and required National Banks to back their note issues with gold. Between 1899 and 1910 the gold holdings of the public trebled, as did those of the Treasury. The proportion of the world's monetary gold stock held in the United States rose from around 15 to 30 per cent, at a time when many other countries (AustroHungary, Russia, Japan) were also adopting the gold standard. As the expansion of gold supplies was slowing, the accumulation of gold in the United States caused more difficulties than had the previous outflow, largely because once the gold entered the Treasury it could not be drawn out except to finance a balance of payments deficit (the country was then in surplus). Given the Independent Treasury System, gold could not be used as the basis to create money or to serve as lending of last resort.

Another banking. crisis in 1907 forcefully reminded legislators of the need for a national institution which could respond to fluctuations in the demand for liquidity in some other way than by attracting gold from abroad. Such an institution was finally set up by the Federal Reserve Act of 1913.

The Act divided the country into twelve districts, each with its own Federal Reserve Bank, which began operations on 2 November 1914. The existing National Banks were obliged to Join the system by purchasing stock in the Federal Reserve Banks. The latter were authorized to issue a new type of currency, the Federal Reserve Note, legal tender for all debts and the liability of both the banks and the United States government.

The new note was to replace National Bank Notes. The issue was backed by gold to a minimum of 40 per cent, the remaining notes being issued against commercial paper and other eligible assets acquired by discount from the member banks. This arrangement satisfied the need for an elastic means of payment which could expand and contract with fluctuations in trade and the situation of the banking system. A member bank that was short of liquidity could acquire it by discounting its assets in exchange for Federal Reserve Notes at its District Reserve Bank.