THE POWER OF THE FED

...Democratizing the Fed is often proposed as a solution...

...Among "banker positions" are stands on the desirability of "bank consolidations, bank mergers, and...

...Profits approached a ten-year high in 1981 and remained strong for most of last year, especially at the large banks...

...If the battles of that decade showed that the central bank could support large banks against even extremely powerful opposition, the 1970s demonstrated that the tables can sometimes be turned, and then turned again...

...The key role the Fed has played in slowing the economy is widely recognized, thanks to the regular denunciations hurled at it by politicians...

...Around the turn of the century, unplanned banking panics occurred every decade or so...

...economy...

...Yet, as in the 1930s, the monetary squeeze may have continued too long, even for bankers...

...It would make clear that control of the economy does not have to be in the hands of bankers...

...The American Bankers Association called the new Federal Reserve scheme "socialistic" because the Fed's ruling board was to be appointed by the Government, not by bankers...

...Moreover, Congress can change the bank's mandate whenever it wants—in principle...

...How successful such changes would be, however, is problematic...

...According to The New York Times, it urged the Federal Deposit Insurance Corporation, another bank regulator, to turn Dreyfus down, and it "sharply criticized attempts by other 'nonbanks' to move into commercial banking...

...But except for some changes made in the 1930s, it hasn't done so, for two reasons...

...economy, including the housing and auto industries...

...With a few telephone calls—at the touch of a few buttons—the Fed can change the rates its twelve regional branches charge commercial banks for money...

...Today, they're more concerned about bankruptcies, declining sales, and the lowest profits in ten years than they are with prices rising 5 or 6 per cent annually...

...What is already clear is that the politicians and capitalists knew no way out except a slump, and the Fed was central to their maneuvering...

...The agitation they confronted was significant, for the 1912 investigation reflected the sometimes far-reaching demands of the growing Progressive and Socialist movements...

...The chairman, who wields extraordinary influence, is appointed to a four-year term that overlaps the Presidential cycle, so that he is cushioned against political pressures...

...Business Week recently editorialized that the time had come "to go for growth...

...Holding down inflation was more important than ensuring consumer demand...

...As they had done in the past, Government and business leaders settled on a recession as the remedy of choice...

...Under Burns—and later under William Miller, previously the head of a major industrial corporation—the Fed switched its attention to the needs of the domestic economy and followed an expansionary policy...

...Whatever the mechanism, opening up monetary policy to elected representatives could weaken the grip bankers have on it...

...Sometimes they brought on serious depressions...

...Regulatory agencies, no matter how many consumer representatives initially sit on them, have historically been captured by the industries they were meant to regulate...

...they had been put aside to avert what the bankers saw as a great threat—control from below...

...One important instance is protection of the banks' turf...

...The same sort of consensus existed in 1929...

...Its normal operations generate all the income it needs to pay salaries, publish reports, and subsidize its cafeteria (reportedly the best in Washington except, perhaps, for the one at the World Bank...

...For seventy years, it has been run primarily by bankers...

...Power was shifted away from the New York Fed, which was dominated by New York bankers, to the board of governors in Washington...

...But few legislators really seek a radical change, because if the central bank were under their control, they would be held accountable for monetary policy...

...At least, democratizing the Fed would raise the possibility of putting monetary policy under popular control...

...Periodically, legislation is introduced to force the Fed to keep interest rates low...

...We have to encourage the economic recovery without losing our gains in inflation," says Volcker...

...Of course, the Fed is not wholly immune to political pressure: It has often had to moderate its policies to deflect criticism from the White House and Congress and maintain a working relationship with the executive and legislative branches...

...the run on banks spread across the country...

...banks have lent more than $50 billion to those three countries alone, and Foreign Affairs recently estimated that if they did not pay their interest, the before-tax earnings of the nine largest banks would decline by 75 per cent...

...Farmers were the most vocal...

...There is an even more serious problem...

...In testimony to the Joint Economic Committee last November, Paul Volcker did not even mention unemployment as a major problem facing the economy...

...This symbiotic relationship between banks and the Fed did not develop accidentally: It is something that bankers have fought to establish and maintain...

...Faced with such pressure, the bankers closed ranks and backed a bill that left many of them dissatisfied...

...An independent Fed, a more democratic Fed, or even the Congress would have to take that into account...

...commodity prices skyrocketed and the dollar slumped on foreign exchange markets...

...The New York banks, though still dominant, were no longer in full control...

...The only "possible explanation for not [expanding] is that we would like to see a large army of unemployed," said a staff member at the New York Fed who did favor an expansionary policy...

...In 1979 and 1980, manufacturers were worried about double-digit inflation...

...recovery is a prerequisite, in turn, if the Third World countries are going to repay their loans: Developing nations rely on the growing economies of industrial countries to provide markets for their goods...

...By 1979, inflation had been running so high for so long that policymakers, manufacturers, and financiers agreed that something had to be done— especially about rising wages, which these elites regard as the principal factor in lasting inflation...

...Sometimes, of course, banks benefit, as in the past year or so when the inflation rate fell below expectations...

...A recovery may help get some workers back on the job, but that would be only a lucky spin-off from the Fed's change of policy...

...Stung by high costs—in the 1880s, interest rates in the South and Middle West ranged from 15 to 30 per cent— and low availability of credit, farm organizations put forward several plans to ease the crunch...

...Morgan, stepped in to end the panics, if not the depressions...

...The near-default of Mexico last August, coupled with the trouble plaguing Brazil and Argentina, has sent major shock waves through the financial community, the Reagan Administration, and the Federal Reserve, and with good reason...

...Volcker, then President of the New York Fed, was a bankers' banker, and he promptly tightened up the Fed's loose reins...

...Moreover, when politicians do begin to push, the lobbying of large banks helps the Fed mobilize strong defenders in Congress...

...The National Association of Manufacturers, for example, wants a faster expansion...

...In return for their support, bankers can count on various kinds of help from the Fed...

...it was channeled into William Jennings Bryan's single-issue campaign for "free silver" in the 1896 Presidential race...

...In 1979, they got their way...

...Or the Fed's board of governors could be broadened to include representatives of consumers, workers, farmers, and owners of small businesses...

...it meant control by bankers from the Middle West and California and by other capitalists...

...Trapped by its parochial perspective on the economy's needs, the Fed contributed heavily to perpetuating an economic crisis that almost brought the whole system down...

...Making money more available helps banks continue lending to these countries and keep them afloat...

...Arthur Burns, President Nixon's appointee as Fed chairman, was an academic researcher of business cycles who lacked formal ties to the multinational banking community...

...But in 1907, five New York banks, speculating on the stock of copper mining companies, triggered a panic that couldn't be stemmed so easily...

...It came about because their role in the economy is a pivotal one: It is their power over capital and debt that gives bankers their influence...

...In either case, most Americans have no voice in the negotiations and are, in fact, unaware that they are taking place...

...Otherwise, stopping inflation has higher priority than boosting the profits of the manufacturing sector...

...a revision of wages in accordance with the cost of living," one Board member said...

...Carter responded by appointing Paul Volcker as chairman of the Fed...

...Usually, powerful New York bankers, led by J.P...

...those concerns were left to the politicians...

...Today, the parallels with the Great Depression are striking, although they should not be overdrawn...

...And because the Fed is running its own show, economic policy is dominated by one sector of the U.S...

...Its seven governors are appointed, not elected...

...the principle of Federal Reserve independence from the elected political leadership...

...Congress, for example, could set monetary policy, leaving the technical job of carrying it out to the central bank...

...The Fed, however, faces a more critical problem: Third World indebtedness...

...Today, as in the past, the financial system's needs are the driving force of Federal Reserve policy...

...Federal Reserve Board Chairman Paul Volcker, referring to high interest rates...

...But in the years following the Depression, the Fed's role was broadened to encompass responsibility for carrying out the Government's attempts at tuning the economy, and that task has occasionally brought it into conflict with the banks...

...They will aim for just enough growth to stave off a depression...

...Since the early years of the 1960s, each recession has had less effect on reducing inflation than the previous expansion has had on increasing it," one member of the Fed conceded in 1980...

...Although the nation's bankers agreed that a more stable system was needed, the competition and diffusion of power between Middle Western and Eastern banks stood in the way of a quick solution...

...And Congressional Democrats have put pressure on the Fed to ease up...

...Its policies instigated the most severe recession since the Great Depression: About eleven million Americans are unemployed, bankruptcies are occuring at near-record levels, and industrial production has dropped by 15 per cent in three years...

...Though banks can raise their interest rates, prices may rise faster than expected...

...Despite their qualms, the bankers' success in setting up a system of their own choosing was no small feat...

...Few lawmakers want to change the Fed's mandate, for if they gained control of the central bank, they would be held accountable for monetary policy The Government is accountable to the voters, at least in theory, but the Federal Reserve Bank has deliberately been insulated from the citizenry and the politicians...

...But it isn't easy for the politicians to handle a severe economic slump...

...The Fed, however, was able to do what the politicians could not—ignore the suffering of working people and squeeze the economy hard and long...

...Still, large banks, like other large corporations, prefer to control their environment, not gamble with it...

...Part of the Fed's freedom to keep the screws on the economy derives from the fact that banks—with the exception of savings-and-loans—have been doing well...

...The problem was how to make recession politically palatable...

...Furthermore, banking problems tend to get out of control...

...The results were even harsher after the crash of 1929...

...By the time the Congressional investigation was mounted in 1912, the banker-framers of the Federal Reserve System were aware of the threat posed by the attacks on their control of monetary policy...

...At various times in the late Nineteenth Century, the Populist Movement, the Farmers' Alliance, the People's Party, the Farmers' Union, and organized labor had called for a degree of democratic control over monetary policy...

...Lower interest rates are also a necessary prerequisite for economic recovery in the United States, and U.S...

...others, especially those who bear the brunt of the Fed's recessions, would be better able to make their voices heard...

...It also began to ease up on its tight monetary policies, reducing its discount rate from 12.5 per cent in June to the current 8.5 per cent...

...The current recession demonstrates how the process works...

...A slow recovery, Volcker style, won't help many companies now stretched to the limit...

...The Morgan-led forces tried to restore equilibrium but failed...

...Sometimes one side won, sometimes the other, but in every instance the interests of the American people were irrelevant to the debate...

...Gerald Epstein is an assistant professor of economics at Williams College and a staff member of the Center for Popular Economics...

...Democratic institutions have, after all, fallen far short when it comes to representing any but the powerful...

...Paul Volcker insists he and his colleagues at the Federal Reserve are not "dictators of high interest rates," but many people believe they are...

...Furthermore, high interest rates made it more costly to buy machinery and build modern factories...

...As one study by the House Banking Committee noted, "Since bank funds are easy to get, since bank issues are complex and therefore easy to camouflage . . . support for banker positions seem[s] entirely natural...

...But by broadening the interests represented at the bank, the Government hoped to head off another Depression...

...Such schemes are quite plausible...

...Senate...

...More surprisingly, the Reagan Administration, which has been muddling about in contradictory and inept policies, also took decisive steps: It supported increases in International Monetary Fund resources to help debt-ridden countries, and made direct loans to Brazil, Argentina, and Mexico—measures that it had rejected in the past...

...Still, the official's remark underscored the Fed's determination to govern the system in accord with the bankers' views...

...Behind the Fed's stance was its support for the large, multinational banks, much of whose business depended on U.S.-based multinational corporations which were, in turn, greatly aided in their investments abroad by a strong dollar...

...The rest is history—a painful history of a fight against inflation that has produced two recessions in three years...

...It was not devised to cope with unemployment, income distribution, or even Government aid to industry...

...Radical agrarians, for example, proposed that the Government ensure the availability of credit for farmers, and other groups sought to prevent the kind of interlocking directorships among banks that had made the Money Trust possible...

...Though the pressure is now being relaxed a bit, it remains to be seen whether the strategy worked— whether it permanently lowered inflation and paved the way for years of stable and steady growth, as its advocates claimed...

...If we don't do that, we'll lose both...

...At such times, the Fed makes choices between policies that benefit manufacturing capitalists on the one hand or financial capitalists on the other, or it carries out compromises reached among contending segments of the business community...

...The bankers would be only one of many groups—though still an influential one— vying for attention...

...And now, as then, the Fed stuck to its strategy long past the point when its manufacturing allies broke ranks with it...

...The reason for their turnaround is as apparent now as it was during the Depression...

...Industrialists were desperate for help...

...After the 1930s, the Fed was no longer just concerned with insulating bankers from popular agitation or resolving intra-banking disputes...

...The Fed was designed in 1913 to promote and protect the banking system...

...The bankers squabbled for six years...

...There were, as it happened, additional reasons for a tight money policy, especially maintenance of the gold standard...

...Banks make their money by lending money, but an inflationary economy means the dollars that are paid back are worth less than the dollars lent out...

...To them, a strong dollar meant lost sales...

...Public control, however, did not mean control by workers and farmers...

...The failure of some oil exploration companies last year caused the small Penn Square Bank to collapse, and that led to problems for Continental Illinois, the nation's sixth-largest bank...

...They want to get reelected, after all, and voters vote their pocketbooks—as Jimmy Carter learned in 1980 and Reagan supporters learned in 1982...

...what's good for the economy is not always good for bankers...

...The monetary squeeze may have continued too long even to suit the bankers: Loans are not paid back when customers go bankrupt In the 1960s, the bankers won...

...The Fed's recent high rates have squeezed commercial and individual borrowing and crippled important sectors of the U.S...

...When interest rates drop, foreign investors and banks tend to dispose of dollars and buy other currencies that offer a higher rate of return...

...Both the 1980 and 1982 elections took place in the middle of recessions, and those who backed existing economic policies were held to account...

...The farmers' proposals were never adopted, but the enthusiasm for them didn't fade...

...The Fed's governors, on the other hand, have their own priorities, and one is to prevent a system-wide collapse...

...In 1913, they finally compromised with each other and with Congress: The Federal Reserve Act, written largely by bankers, established a system of regional banks and a central bank—the bankers' bank—run by a board of governors appointed by the President...

...Bank loans, after all, are not paid back when customers go bankrupt...

...That meant the recession would have to be deep and protracted...

...Unemployment was only part of it: Bank failures were widespread, and by 1932 industrial production had dropped to half its 1929 level...

...At the outset of the recession, the Fed enjoyed a consensus of support for its contractionary policies, thanks to the overwhelming desire of capitalists to lower labor costs...

...The arrangement by which the Fed protects bankers arose not by historical accident or because bankers managed to fill positions of authority...

...But not nearly so well understood is the strange arrangement by which nonelected officials can manipulate the economy in defiance of the expressed wishes of elected officials...

...The Fed, for its part, played a direct role in promoting these bailouts...

...By the end of the 1950s, a deteriorating balance of payments was undermining international confidence in the dollar, and the Kennedy-Johnson push for low interest rates threatened to exacerbate the problem...

...they have floated around Capitol Hill for years...

...Many of the demands for reform found new life in the Progressive and Socialist programs...

...During the severe recession of 1921, the Fed delayed taking action to ease massive unemployment until "there is what is called a liquidation of labor...

...So, to protect the dollar, the Fed kept rates high...

...As prices rose, banks and financial institutions began feeling the pinch...

...BY MARK BREIBART AND GERALD EPSTEIN "I reject the implication that we have buttons to push on monetary policy to cure these problems...

...The President names them with the advice and consent of the U.S...

...Plagued by inflation, intense speculation on the dollar, another OPEC price rise, and the Iranian revolution, the financial markets gave President Carter a vote of no-confidence...

...During the first two years of the Depression, the Fed did virtually nothing to pump up the economy...

...Furthermore, unlike other Federal agencies, the Fed controls its own purse strings...

...They want the Fed to relax its grip enough to allow brisk growth...

...As a result, major changes were made in the Fed's structure in the 1930s...

...But by supporting the multinational banks, the Fed turned its back on domestic manufacturers...

...Without reducing that power, we'll be hard pressed to rein in their influence...

...The significance of a Federal Reserve Bank insulated from popular pressure became clear within a decade...

...Agitation for democratic control of the financial system had been fueled by a 1912 Congressional investigation into the Eastern "Money Trust...

...on the contrary, it kept the money supply tight, making matters worse...

...More than most businesses, banks are hurt by inflation, particularly when it is volatile...

...FDIC eventually approved the acquisition, over the Fed's objections...

...As a result, profits picked up, exports increased, and the dollar weakened...

...But the Fed turned Kennedy down, and when Johnson came knocking, it tightened monetary policy so severely that the California housing market almost collapsed in 1966 and another credit crunch almost sparked a financial panic in 1969...

...Debates over central bank policy shifted to conflicts between bankers and other capitalists...

...And the private banks look to the Fed's interest rates when they set their own...

...Still, democratizing the Fed would have an important virtue: Taking away the shield of independence, making monetary policy an acceptable subject of popular debate, would put all the issues on the table...

...The result has been a steady rise in the long-term trend of wages and prices...

...Presidents Kennedy and Johnson wanted a loose monetary policy and low interest rates—Kennedy to encourage investment after the economic stagnation of the Eisenhower years, Johnson to pay for the guns and butter of the Vietnam war and the Great Society...

...By the late 1970s, they were ready for a new policy...

...To be sure, the divisions between the banks hadn't healed...

...Mark Breibart is a member of the Dollars & Sense magazine collective...

...The banking system had expanded in tandem with the rapid growth and industrialization of the Middle West and the South...

...the change gave the impression of increased public control over the bank, since the board was appointed by the President...

...When the Dreyfus Corporation, a major mutual fund company which offers money market funds, tried late last year to purchase a commercial bank, the Fed balked...

...Yet because of the monetary expansion and sharp increases in the price of oil, among other factors, the inflation rate took off, rising from 5.9 per cent in 1970 to 13.5 percent in 1980...

...it made their exports more expensive and foreign imports cheaper...

...The current arrangement allows them to pass the buck...

...The Fed pumped extra money into the system to make it easier for the Chicago bank to meet its commitments and to reassure the banking community that a crisis was not in the offing...

...Considering the threat to some major banks and, indeed, to the entire financial system, the Fed had little choice but to swing into action...