The Daily Reckoning
London, England
Tuesday, 6 April 2004
The Daily Reckoning PRESENTS: The 16th and 17th
constitutional amendments... the Federal Reserve... would it
surprise anyone to learn that these "tools" were
instrumental in shaping the past century? Below, our friend
Byron King takes a look at the man who first wielded them -
the 28th President of the United States.
WILSON'S DESTINY, Part I
by Byron King
At any given time in the life of a nation, events and
circumstances offer its leader the opportunity to
articulate and clarify key ideas that define its substance
and govern its destiny. Woodrow Wilson (b.1856, d.1924) was
such a figure, on both a national and international scale.
During his two terms as President of the United States,
Wilson inalterably changed the face of not just the United
States, but of the world. The community of nations of today
represents a world still spinning on a Wilsonian axis.
When Wilson took office in March of 1913, the U.S. was a
gold-standard nation, developing inwardly and filling its
own continent with people, industry and capital. Since
Colonial times, U.S. development had focused on westward
expansion across the continent. The U.S. in 1913 had few
historical precedents or cultural proclivities for
international adventurism, and in fact was experiencing a
bad case of indigestion of the modest fruits of the Spanish
American War, a sore spot with the voters.
When Wilson left office in 1921, he had involved the nation
in Europe's Great War, and was in no small personal measure
attempting to dictate the world's peace. Under Wilson's
stewardship, the federal government was large and getting
larger, the U.S. currency was beginning a long slide into
debasement, and no American could even buy a legal drink at
a bar.
No one can truly understand the issues of the modern era
without knowledge of the man who mid-wifed it into
existence. It is not too much to say that the 20th Century
was Wilson's Century, and that we live in Wilson's World.
Woodrow Wilson was the son of a preacher, born and raised
in Virginia, and certainly a Son of the South. He pursued a
career as an academic, making a name for himself as an
Anglophile scholar of government theory. Wilson taught at
several schools, Pennsylvania's Bryn Mawr College and
Connecticut's Wesleyan University among them, eventually
taking a position at Princeton, in New Jersey. He rose
through the ranks of college teaching and academic politics
to serve as president of Princeton University between 1902
and 1910.
Somewhat late in his career, at age 53, Wilson leveraged
his prestigious socio-academic position at Princeton into a
very short tenure as Governor of New Jersey (1911-1912).
Then, being the top political figure in an important state,
Wilson toured the country, and ran for and won the U.S.
Presidency in 1912.
The election of 1912 was a close, three-way race, with
about 43% of the votes cast for Wilson. The race was, in
reality, Wilson's to lose because it was marked by a
seismic fault line in the Republican Party. But while many
viewed the election as a reflection of internecine
Republican politics, Wilson saw the election results in a
somewhat different light. He is quoted as having told a key
supporter, after the ballots were counted, "Remember that
God ordained that I should be the next president of the
United States. Neither you nor any other mortal or mortals
could have prevented that." Certainly, that should have
settled things.
Historian Paul Johnson has described Wilson as having "... A
self-regarding arrogance and smugness, masquerading as
righteousness, which was always there and which grew with
the exercise of power." After all, how could one argue with
a man "ordained" by no less than God to hold the nation's
executive power?
Historian Robert Nisbet wrote that Wilson was, if not
ordained by God to lead the nation, "an ardent prophet of
the state, the state indeed as it was known to European
scholars and statesmen... (Wilson) preached it... " Thus,
according to Nisbet, from Wilson has come the
politicization, the centralization, and the commitment to
bureaucracy of American society during the 20th Century.
Historian Donald Miller has concluded that Wilson intended
from his first day in office to transform America as well
as the other nations. "From a domestic and economic
standpoint, as with his foreign policy, (Wilson) wanted to
expand the power of government to effect a revolution in
society. He sought to increase both the size and scope of
government. He said that he wanted to put government 'at
the service of humanity.'"
In March of 1913, when Wilson took his oath of office, the
nation, if not humanity at large, was in the process of
handing him the necessary tools that he would soon be
using. Wilson's ambitious political goals, refined during
his hard years of labor in the academic library stacks and
teaching in the sweat mills of Princeton, could not have
been accomplished without key changes in the power system
defined by the U.S. Constitution.
The Sixteenth Amendment to the U.S. Constitution, giving
Congress the "power to lay and collect taxes on incomes,
from whatever source derived," had been passed by Congress
in 1909. After several years of bitter political
infighting, ratification by three-fourths of the states was
completed on February 3, 1913, just in time for Wilson to
put it to the test.
The Seventeenth Amendment to the U.S. Constitution, which
called for the direct election of Senators, had been passed
by Congress in 1912. Ratification by three-fourths of the
states was completed on April 8, 1913. Again, only a true
scholar of governmental powers could discern the import of
this new enactment.
Both of these Amendments changed the fundamental power
structure of the nation, certainly altering the
relationship between individual citizens and their national
government. That they occurred in such close sequence of
time was the equivalent of another American Revolution.
The direct election of U.S. Senators diminished greatly the
republican form of governance envisioned by the Founding
Fathers, in which "the several states" had a semblance of
influence and control over half of the legislative branch.
That is, previously Senators were directly beholden to the
interests of their electors in state legislatures. This
system of selection insulated Senators, at least to some
degree, from the day-to-day whims and caprices of popular
will. Up until the ratification of the 17th Amendment, the
Senate had been traditionally focused on the interests of
the states, vis à vis the federal government, as opposed to
reflecting the will of, and acting like, a popular
assembly. With direct election becoming the law of the
land, Senators began to become simply another form of
populist politician.
The Sixteenth Amendment led directly to the enactment of a
national income tax in Wilson's first year in office,
albeit only on the wealthy. These "rich people" were
defined then as those earning over $4,000 per year, or the
modern equivalent of a household today earning about
$80,000. But wealthy or not, the power to tax incomes was
the breach in the dam holding back federal power and
influence based on spending by the central government.
Before Wilson was elected president, federal government
spending had never exceeded three percent of the Gross
Domestic Product, except during the War of 1812 and the
Civil War.
Federal revenues were derived primarily from customs
levies, import duties, and various other excises and
tariffs. During Wilson's two terms as president, the dam
burst and federal spending rose to more than twenty percent
of GDP.
With interests of "the several states" on the wane in the
Senate, and the prospect of federal revenues being raised
via a national income tax, Wilson's next alteration of the
structures of governance came with his support of the
Federal Reserve Act of December 23, 1913. Note the date.
This statute to create a federal central bank was signed
into law, with little fanfare, by Wilson at a time when
Washington, D.C. was all but deserted for the holidays.
Financial panics had plagued the nation throughout much of
the 19th Century. With its economy based for the most part
on a hard-money system of gold and silver coinage, and
paper currency backed by monetary metals, the nation had
gone through numerous cycles of boom and bust. Few people
complained during the boom times. But the busts were
another story entirely. Many critics viewed bank failures,
business bankruptcies, and economic downturns and
accompanying personal hardships as being caused by a poorly
integrated, unregulated banking system and the lack of a
flexible money supply.
A particularly severe financial crisis in 1907, in which
the national solvency was preserved only through the
intervention of New York banker J.P. Morgan, led Congress
to establish the National Monetary Commission. This
Commission was chartered to propose a solution that could
deal with banking issues and other monetary problems.
After considerable debate, the Commission proposed remedies
that were written into law as the Federal Reserve Act. The
Act stated that its purposes were to "provide for the
establishment of Federal Reserve banks, to furnish an
elastic currency, to afford means of rediscounting
commercial paper, to establish a more effective supervision
of banking in the United States, and for other purposes."
(Yes, it says that, "for other purposes.") But, to pose an
issue that has governed national history ever since, was
this new federal entity a cure for the economic problem of
"busts"? Or, by furnishing "an elastic currency" and thus
mitigating the effects of the busts, did the Federal
Reserve serve to push the booms along, such that they would
grow into bubbles? In all fairness, who could have even
asked such a question back in 1913?
Wilson's new organization, the Federal Reserve (FED), was
comprised of a Board of Governors in Washington D.C., and
twelve regional Federal Reserve Banks. The statutory
responsibilities of these entities are to:
* Conduct the nation's monetary policy by influencing the
money and credit conditions in the economy.
* Supervise and regulate banking institutions to ensure
safety and soundness of the nation's banking and financial
system.
* Maintain the stability of the financial system.
* Provide certain financial services to the U.S.
government, financial institutions, the public, and foreign
official institutions, including a major role in operating
the nation's payments system.
Then as now, the FED conducts monetary policy using three
major tools: (1) open market operations to control the
level of reserves in the depository system; (2) setting
reserve requirements for depository institutions, and (3)
setting the discount rate for lending reserves.
Policy regarding open market operations is the
responsibility of the Federal Open Market Committee (FOMC)
comprising the seven members of the Board, the president of
the New York Federal Reserve Bank, and the presidents of
four other reserve banks on a rotating basis. However, the
Board has sole authority over changes in reserve
requirements and the discount rate.
Since its inception, the Federal Reserve System was
considered an "independent central bank" - a European
concept reflecting the need to provide banking services to
the sovereign. But the Federal Reserve is "independent"
only in the sense that its decisions do not have to be
ratified by the president or anyone else in the executive
branch of government. It is more accurate to say that the
Federal Reserve is "independent within the government." But
still, it is a creature of government.
The Federal Reserve is, of course, subject to the oversight
of Congress, on the legal basis that the Constitution gives
to Congress the power to coin money and set its value. In
1913, with the assistance of Wilson, Congress delegated
that power to the Federal Reserve. Congress could, in
theory, reclaim its power at any time, but would it dare to
do so? Throughout its existence, the Federal Reserve has
tended to act within the framework of the overall
objectives of economic and financial policy established by
Congress.
Statutory provisions and lofty goals of monetary management
aside, the Federal Reserve is fundamentally a European-
style central bank that can create, on its own account and
subject only to indirect oversight of Congress, credit
denominated in U.S. dollars. In the world of 1913, these
dollar-denominated credits would enter the economic flow to
compete with the more traditional currency, or gold, as
money.
Thus Wilson was able, in his first year in office, to
establish an embryonic form of credit-backed U.S. fiat
currency - a currency in direct competition with
traditional gold money. Coupled with the ability of the
federal government to raise revenue via a direct tax on
"incomes, from whatever source derived," this was the seed
of an enlargement of central government based on spending
financed by taxes, borrowing against national credit, and
the resultant national debt.
If, as historian Donald Miller concluded, Wilson intended
from his first day in office to transform America, and to
increase both the size and scope of government, here were
Wilson's tools.
More to come on how Wilson wielded these tools, tomorrow...
Regards,
Byron King
for The Daily Reckoning
Editor's Note: Byron King has been engaged in the private
practice of law for 14 years and currently serves
as an attorney in Pittsburgh, Pennsylvania. He received his
Juris Doctor from the University of Pittsburgh School of
Law in 1981 and is a cum laude graduate of Harvard
University.