"Centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly."
~ Fifth plank of the Communist Manifesto, 1848

Statists have long prized and fueled crisis as the means for enlarging government.  They convince enough people that the federal government never does wrong, yet the evil that lurks in the world will on occasion strike us.  Sometimes the evil is external, as in 9-11, other times it is internal, as in the case of certain economic upheavals.  When the crisis is mostly economic, the culprit is always the private sector, and the guilty parties are usually big shots who got swept away with avarice.  With a lapdog media clamoring for "reform," politicians pass more laws and flood the airwaves with rhetoric about how their new legislation will crush the forces of greed.  

It was crisis that helped launch one of the greatest destroyers of our world, the Federal Reserve System.

In the era following the War of Secession, the federal government aggressively promoted development of the West through huge subsidies and other favors to business cronies.  Corruption flourished, and overextended banks occasionally failed, causing panics in 1873, 1884, 1893, and 1907.  Throughout this era there was growing opposition to sound money, eloquently expressed by railroad speculator Jay Cooke in 1869: "Why," he asked, "should this Grand and Glorious country be stunted and dwarfed--its activities chilled and its very life blood curdled by these miserable 'hard coin' theories--the musty theories of a bygone age." [1]  

The Panic of 1907 is especially significant because it led to government-directed banking "reform."  The panic got underway when United Copper's stock price collapsed.  Knickerbocker Trust of New York had invested heavily in United Copper, and depositors made a run on the bank to get their money out.  When Knickerbocker failed, depositors at other banks got nervous and demanded their money, igniting the panic. [2]    

J. P. Morgan got together with other banking leaders and met virtually nonstop for three weeks to solve the crisis.  They secured credit from foreign investors, redirected funds from strong banks to weak ones, and bought stock in foundering but still promising companies.  [3]  The panic died a few weeks later.

For the New York bankers, however, there remained a much more serious problem.  The growth of state banks over the previous 20 years had slowly eroded their power.  By 1896, state and other nonnational banks constituted 61% of the total, and by 1913, 71%.  More significantly, nonnationals commanded 57% of banking resources by 1913.  [4]

With such a troubling trend, what did the New York bankers do?  They turned to their pals in Washington.  As we've seen, from the time of Lincoln's administration government sought to partner with business, delivering special favors in return for political support.  This is mercantilism, the system we rejected in 1776.  By the early 20th century, we were neck-deep in Progressive propaganda, and there was no viable group opposing government takeover of our lives.  The once laissez-faire, sound-money Democratic Party died with the nomination of William Jennings Bryant for president in 1896.  From that point on, Republicans and Democrats alike were promoting more statism as the miracle cure for ills it had breeded.

Both Congress and the American Banking Association had been pushing for central banking since the 1890s.  The Panic of 1907 gave them another excuse to make it a reality.   Amid all the maneuvering and proposals for fundamental change, Morgan banker Henry Davison organized a duck hunting trip at Jekyll Island, Georgia in December, 1910.  The ducks they took aim at were not the web-footed kind, but the unsuspecting American citizen who had always thought of money as gold.

The hunters were major players in American mercantilism: Senator Nelson Aldrich (R., R.I.), who had headed up the National Monetary Commission, a congressional committee dedicated to developing ideas for central banking; Frank Vanderlip of Rockefeller's National City Bank; Paul Warburg of the investment firm of Kuhn, Loeb, & Co., who was there to promote the German central bank of Bismarck; Charles Norton of First National Bank of New York, a Morgan company; and Davison, a partner of J.P. Morgan's.  [5]

They devised a plan whereby a board of commercial bankers would supervise regional reserve banks.  When Aldrich later introduced it to Congress, Democrats blocked it.  In 1913, Carter Glass, a Democratic congressman from Virginia, used the Jekyll Island scheme as the basis for the Federal Reserve Act.  [6]

The Act created 12 regional reserve banks ruled by a board of Washington bureaucrats, including the Treasury secretary and presidential appointees.  Though the reserve banks are officially "private" institutions, they're little different than government agencies, as Murray Rothbard noted.

In this manner government seized what Rothbard called "a crucial command post" of the economy, and therefore of the American society.  [7]  It used crisis--repeated panics created by government meddling--and the economic illiteracy and trust of the public to achieve its purpose.

And what has it sown from its command post?  A subtle means of wealth transfer.  A method of taxing us without legislation.  A way of counterfeiting money legally.  "Through the purchase of [usually government] debt by a bank, fiat money is injected into the economy," Gary North writes. [8]  "Wealth then moves to those market participants who gain early access to this newly created fiat money," who are usually politically connected. The ones on fixed incomes or without close government connections are the losers, as the injection of money eventually jacks up prices.

The Fed greatly reduced reserve requirements during the 1920s, expanding credit recklessly and generating a false prosperity that ended in the crash of 1929.  People knew what the Fed was up to--manufacturing dollars out of thin air--and started a run on banks to pull their money out in the form of gold specie and certificates.  When Roosevelt took office, he slammed the bank door in their faces, then later ordered them to return their gold.  In 1933 he made the dollar a fiat currency domestically, but backed by gold internationally.

Roosevelt also created the Federal Deposit Insurance Corporation (FDIC) in 1933, providing federal guarantee of bank deposits.  Bank runs and the threat thereof have vanished, and most people believe this is good.  As Lew Rockwell observes, the threat of bank runs used to "to keep wanton investing at bay," but the government-banking cartel views such restrictions "as against the national interest.  As a result, the [banking] industry is perpetually shaky, and the largest banks are a menace to public life itself." [9]

Prior to 1929 the government had never intervened to help recovery from a recession.  Previous administrations had let recessions run their course, and recovery, at the hands of the market, usually occurred in a year or less.  Hoover, and then Roosevelt to a much greater degree, took the statist course and drove the economy into a prolonged depression.  For his part, Roosevelt has been deified.

The Fed, as the engine of inflation, bankrolls government wrong-doing.  Its creation marked the first step in the destruction of sound money--our gold standard.  As Ludwig von Mises wrote long ago, "Ideologically, [sound money] belongs in the same class with political constitutions and bills of rights."  [10]  In the name of civil liberty and civilization itself, the Fed should be abolished.

References

1.  The Mystery of Banking, Murray Rothbard, New York: Richardson and Snyder, 1983. p. 135. (PDF version)

2.  Separating Money and the State, Part I: Eighty Years of Destruction, Douglas E. French, http://www.fff.org/freedom/1094e.asp

3.  The Panic of 1907 and the Birth of the Federal Reserve, Jim Klann, http://www.lp.org/lpnews/0108/klann.html

4.  Rothbard, p. 136

5.  Rothbard, p. 137

6.  French

7.  Taking Money Back, Murray Rothbard, http://www.lewrockwell.com/rothbard/tmb.html

8.  Gary North, in Forward to Rothbard's Mystery of Banking

9.  Banks on the Dole, Llewellyn H. Rockwell, http://www.mises.org/freemarket_detail.asp?control=216&sortorder=articledate

10.  The Theory of Money and Credit, Ludwig von Mises, Yale University Press, 1953, p. 414