“Money is power.” We’ve all heard this aphorism many times before. Too often it’s a lazy shorthand dismissal of the finding of mainstream economics, which show that the pursuit and possession of money often entails innocuous or even beneficial consequences for society. Dr. Johnson was right after all: “There are few ways in which a man can be more innocently employed than in getting money.”
But there are some contexts in which the saying is apt. An obvious case is the Federal Reserve. The Fed has a monopoly on the creation of base money, the fundamental asset underlying the banking and financial system. And over decades, with each instance of financial turbulence, the Fed has become less constrained in how, when, and why it creates base money. Since the Great Recession, the Fed has been able to bestow purchasing power, liquidity, and solvency on just about any financial organization it pleases. If that isn’t power, there’s no such thing.
The Federal Reserve System was created in 1913. It was intended to be a formalization of the interbank clearing system that then existed in the National Banking System. It was not intended to be a central bank. Even in the early 20th century, economists and politicians had some idea of what central banks did and how they behaved, and the existence of such an institution was widely regarded as inherently un-American, in the sense that it could not be reconciled with a self-governing society. That’s why so many proponents of the Federal Reserve System bent over backward to insist they were not advocating the creation of a central bank. And at the time, their repudiations were reasonable; there was no reason the Federal Reserve System had to acquire the powers it did.
But then the US entered the First World War. Wars have a way of eroding society’s long-established institutions. And the political process has a logic of its own. These forces combined to transform the Fed into what its critics feared it might become: a genuine central bank.
The Fed began supporting the market for US government debt during the First World War using techniques that were the forerunners of modern monetary policy.