The Federal Reserve--Who Controls the Nation's Funds, and Where Will the Money Be Put?

This lesson meets VA SOL standards USII.1a, USII.6b, CE.1a, and CE.13d, and is suitable for students in the upper grades of high school, especially those in Honors or Advanced Placement U.S. history and economics classes.  
The primary source documents used in the creation of this lesson plan are taken from the papers of Benjamin Strong, Jr., held in the New York Federal Reserve Bank, and made available to the Woodrow Wilson Presidential Library and Museum, courtesy of a grant from the Institute of Museum and Library Services.

I.  Introduction to the Lesson

“Often, in discussing the notable accomplishments of the federal reserve banking system, I have remarked that a person acquainted with the details could, if endued with a fertile facility of expression, write a history of federal reserve legislation which would read like a romance.”  So said the Virginian Carter Glass, one of the authors of the Federal Reserve System, in the first sentence of his book on the same subject.[1]  Whether or not the typical student would regard the history of the Federal Reserve a romance, there is no question that the 1913 battle to fix the nation’s banking and currency problems, which would finally result in the creation of the Federal Reserve System, had many of the elements of an epic struggle.  The story included protagonists and antagonists, plots and sub-plots, and a climax and resolution.  

But why was the attention of politicians, bankers, and business leaders turned to the nation’s financial landscape in the first place?  In a word, the nation had grown.  Since the Civil War, the population and commerce of the nation had increased by leaps and bounds, and by the early years of the twentieth century, it was obvious to many that the banking system currently in place in the United States was inadequate.  The Panic of 1907 offered proof.  Wilson biographer and scholar Arthur S. Link put it this way:  “Men might disagree over method, but no one denied the urgent need for reform of the nation’s antiquated banking and currency systems.”[2]  

This lesson will explore the need behind the call for a new banking and currency system, the concerns of some of the agitators in the conflict, and the resulting end-product:  the Federal Reserve System.  It is based primarily upon the letters and writings of Benjamin Strong, Jr., the first governor of the New York Federal Reserve Bank.

II.  Background Information for Teacher and Student

Anyone familiar with one of the great debates of our own time, that of whether government or the free enterprise system should be the primary agent in solving our nation’s ills, should have little difficulty recognizing in this lesson the same pull of competing perspectives.  Just as in our own day, the United States in the earliest years of the twentieth century faced dilemmas as big as the nation itself, and the problems were met with a rising cacophony of loud and strident voices, each one seeing in his solution the only way out of the financial fog.  

Proposals to modernize the national banking system gathered around two poles: at one end were those who wished to bring the power of the national government to bear on the predicament; at the other end were those who wanted to allow business interests to work according to laissez-faire principles for a better resolution of the problems they had helped to create.  This was the classic encapsulation of the two sides of citizen disagreement on the use of power:  public or government versus private or free enterprise.  Note:  For a comprehension of this lesson, it is very important to know that the word public will be used synonymously and interchangeably with the wordgovernment, and private with the term free enterprise.  

Until 1913, banks had operated under the organization set up by the National Banking Act of 1863.  This system performed as a three-tier pyramid: thousands of country banks made up the bottom tier; forty-seven reserve city banks comprised the middle tier, and three central reserve city banks in New York, Chicago, and St. Louis topped off the system in the highest tier.  Country banks and reserve city banks were required to deposit some of their cash reserves in the next level up.  This is how it worked: when a country bank needed more money than it had on hand to lend to customers, it would initiate a withdrawal of its reserves in the reserve city bank.  When pressure on a reserve city bank from numerous country banks became sufficient, it would turn to one of the three central reserve city banks to withdraw some of its reserve cash.  

One reason why country banks often started the upward push of pressure on the higher banks for cash was because they needed money in the fall to lend to farmers.  In the early years of the twentieth century, agriculture comprised a large section of the American economy, and farmers, especially those in the West and South, often needed to borrow money to harvest crops and transport them to market.  As all farmers needed money at roughly the same time, the local country banks often found themselves without enough cash to lend and not able to get money moved from the upper level banks quickly enough, if in fact they had enough held there in reserve in the first place.  

The situation described above illustrates the two problems that developed within this system as the commerce in the country began to expand: the problems of immobile reserves and inelastic currency.  "Immobile reserves" describes the problem of higher-tier banks not being able to shift money or reserves around the country easily or fast enough to help the country banks where the need was the greatest.  "Inelastic currency" was the problem of not being able to expand and contract money in the economy to meet periodic, pressing needs.

Sometimes the pressure put on banks would precipitate a crisis.  When individual depositors realized that a lot of money was leaving their bank to meet the seasonal demands around the country, they would fear for the safety of their own money and withdraw it.  Other depositors would hear that people were lining up to take out their money, so they too would rush to the bank to retrieve theirs.  When enough people did this, banks would run out of money and have to close their doors and shut down, sometimes for good.  (Banks never hold all of their deposits; they make money in part by lending to customers a sizeable percentage of their depositors' money and charging a fee for its use.)  At this time in history, there were no government guarantees or safeguards to protect the money in a bank.  If a bank was forced out of business because of a panic, depositors simply lost their money.  

In 1907 a banking panic, similar to the one described above, caused several banks in New York to fail.  Charges began to circulate that New York City bankers had caused the panic by "hoarding" their vault cash instead of lending it out as the system required. The Panic of 1907 did not cause a nationwide depression as some previous panics had done, but it did draw the attention of many public and private observers to the fact that the banking and monetary situation was no longer adequate for the needs of the nation and that a fix could not be delayed.  The nature of the change was to become the question.  

Into this financial volatility emerged an additional factor:  the political mood of the country was shifting from support for laissez-faire to activist government policies.  Called progressivism, this inclination on the part of the citizenry to demand solutions from their governmental representatives began to be felt in the area of banking and finance.  Solutions to the banking and currency quagmire became a matter of debate between progressives who favored governmental or public solutions, and conservatives who favored free market or private solutions.  

Enter the major contenders included in this lesson.  Benjamin Strong, who would later come to embrace the Federal Reserve System and even defend it, at first opposed many features of the Federal Reserve bill (the Owen-Glass bill) as it made its way through Congress.  He was a New York banker and favored a private solution.  William Jennings Bryan was a progressive Democrat and President Wilson's Secretary of State.  A powerhouse in national politics, he threw his considerable political weight behind a public cure.  Congressman Carter Glass, chairman of the House Banking Committee, was somewhere in the middle. President Wilson, too, was willing to adopt a new system that had both public and private elements.  

In fact, the Federal Reserve System that resulted from this tug of war did actually contain both public and private elements.  Carl H. Moore in his book The Federal Reserve System said, "Thus, as President Wilson on that December evening signed the Federal Reserve bill into law, a new ‘creature' was born. A unique creature, it was neither government nor private but part of both." [3]  The Federal Reserve Act, which established the Federal Reserve System, was to consist of 12 regional banks, privately owned by member banks, but governed and regulated by a president-appointed and Senate-confirmed Federal Reserve Board.  

The debate between those advocating public and private answers to this nation’s problems has not ceased, thus making this lesson a relevant one for today’s students.

III.  Comprehensive Questions

1.      Why was the nation’s banking and monetary condition so critical in the early years of the twentieth century?

2.      How did the government vs. free enterprise debate influence the formation of the Federal Reserve System?

3.      How did the creation of the Federal Reserve System help to solve some of the problems resulting from an inadequate banking network and currency shortage?

IV.  Learning Objectives

After completion of this lesson, students will be able to:            

1.  articulate the nation’s pre-1913 banking and monetary problems, including the Panic of 1907.

2.  explain the concerns of the advocates of each side of the government vs. free enterprise debate.            

3. describe several of the major components of the Federal Reserve System.            

4. judge whether the Federal Reserve System is primarily a public or private institution, or a mixture of both.

V.  Getting Ready To Teach

This lesson can be used in whole or in part. If used in part, adapt it to suit classroom needs. If used in its entirety, follow the instructions below.              

Read over the Introduction and Context Information sections to gain familiarity with the lesson.  Both essays are also available in the Documents file on pages 1-3 for printing and distributing to students; it is highly recommended that these be assigned to students for homework reading the day before the lesson begins.  

The Student Activities section below is sub-divided into three parts:  The Need, The Concern, and the Result.  Each of these sections contains excerpts from primary and/or secondary sources in the form of speeches, letters and books, along with questions which ask students to comprehend and analyze the material.  The worksheets are located in the Documents file and can be accessed by clicking on the provided link.  The non-excerpted primary source documents used in this lesson are available on the Woodrow Wilson Presidential Library and Museum website, by entering the Wilson e-Library here, then, under "Advanced Search," go to "Collections," click on "Benjamin Strong, Jr. Papers from NY Federal Reserve Bank," then click "Submit."   

To keep students motivated and involved in their groups, let them know at the beginning that the hardest working group or groups will be rewarded with “federal reserve notes,” which can be used at the end of the lesson to “purchase” privileges, such as a homework pass, extra credit points, a classroom "perk," or a similar incentive.  A facsimile of a Federal Reserve Note is available for printing and duplicating on page 4 of the Documents file, or a pack of fifty $100,000 bills with Wilson's image on the front can be obtained from the Woodrow Wilson Presidential Library Gift Shop.  Alternatively, “dollars” can be used at the Gift Shop to purchase an item at a 20% discount by visiting the shop at 18-24 North Coalter St., Staunton, VA 24401.  If purchasing online, call the store first at (540) 885-6202 to make arrangements for the student discount.   

Another inducement to effort is to reward the highest performers with real Federal Reserve notes in $1 denominations, obtained in crisp and new condition from the bank.  

Choose the incentives and announce them to students the day the lesson begins, with facsimile notes or $1 bills displayed on the desk.

VI.  Student Activities

 

On the first day of the lesson, spend a few minutes introducing the topic and discussing with students some of the background information that they read for homework. Then divide students into groups of three or four to work collaboratively on the activities.           

If students want to view images of four of the key figures in this lesson, they can go to the following links:

(1) Benjamin Strong, Jr., http://www.newyorkfed.org/aboutthefed/BStrongbio.html;

(2) William Jennings Bryan, http://wwl2.dataformat.com/Document.aspx?doc=27758;

(3) Carter Glass, http://wwl2.dataformat.com/Document.aspx?doc=29848; and

(4) Woodrow Wilson, http://wwl2.dataformat.com/Document.aspx?doc=28165.

1.  The Need      

Students will read and analyze primary and secondary sources on the problems of a loosely coordinated banking and currency system, immobile reserves and inelastic currency, troubles in the agricultural sector, and periodic banking panics.  These documents are located on pages 5 – 8 of the Documents file.  

2.  The Concern       

Students will read and analyze primary and secondary sources on the issue of whether the proposed banking and currency reform should be structured in such a way as to give control to the public sector or the private sector.  These documents are located on pages 9 – 11 of the Documents file.  

3.  The Result       

Students will read and analyze primary sources on the structure of some of the components of the Federal Reserve System, and an explanation of the system by Benjamin Strong, Jr.  These documents are located on pages 12 – 14 of the Documents file.

VII.  Assessment

Instruct students to write a one or two paragraph answer to the questions below:

a.  Explain some of the problems under the old U.S. banking and currency system that led many concerned citizens to call for a new system altogether.                          

b.  Summarize the concerns of each side in the public vs. private debate over solutions to the banking and currency problems.                          

c. What was the basic structure of the Federal Reserve System, and how was it influenced by the public/private contention?

VIII.  Expanding the Lesson

The Benjamin Strong, Jr., letters and writings touch on various topics other than the ones used in this lesson.  These could be pursued profitably if time permits or interest warrants. Several topics and links are listed below.  

1.  World War I       

a.  The question of U.S. loans to belligerent nations at http://wwl2.dataformat.com/Document.aspx?doc=33169

b. Passport requirements of the U.S. State Department while Europe was at war at http://wwl2.dataformat.com/Document.aspx?doc=33191 and http://wwl2.dataformat.com/Document.aspx?doc=33212

c. Raising money for the War through taxes and the Liberty Loan Campaign at http://wwl2.dataformat.com/Document.aspx?doc=33290 and http://wwl2.dataformat.com/Document.aspx?doc=34242

See also:                        
http://wwl2.dataformat.com/Document.aspx?doc=33290
http://wwl2.dataformat.com/Document.aspx?doc=33409
http://wwl2.dataformat.com/Document.aspx?doc=33410
http://wwl2.dataformat.com/Document.aspx?doc=33415
http://wwl2.dataformat.com/Document.aspx?doc=33422
http://wwl2.dataformat.com/Document.aspx?doc=33429
http://wwl2.dataformat.com/Document.aspx?doc=33453
http://wwl2.dataformat.com/Document.aspx?doc=33459


d.  Need for a draft system during World War I (Strong’s son had just enlisted) athttp://wwl2.dataformat.com/Document.aspx?doc=33277

See the response of President Wilson’s secretary at http://wwl2.dataformat.com/Document.aspx?doc=33278

e.  Summary of the economy during the War years at http://wwl2.dataformat.com/Document.aspx?doc=34242

2.  Other        

a.  The budgetary/fiscal powers of Parliament in the British system at http://wwl2.dataformat.com/Document.aspx?doc=33253

b.  Contrast between how the Civil War and World War I were financed at http://wwl2.dataformat.com/Document.aspx?doc=33473

IX.  End Notes

[1]  Carter Glass, An Adventure in Constructive Finance (Garden City: Doubleday, Page & Co., 1927) 1.

[2]  Arthur S. Link, Wilson: The New Freedom (Princeton, New Jersey: Princeton University Press, 1956) 199. 

[3]  Carl H. Moore, The Federal Reserve System: A History of the First 75 Years(Jefferson, North Carolina: McFarland & Company, Inc., 1990) 8.

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