Byron King
Learning Centre: Banking, Economics, Money, US Government, US History

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...


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

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