What Jerome Powell could learn from Nelson Aldrich

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As if Federal Reserve Chairman Jerome Powell doesn’t have enough on his mind as he struggles to tame a surge in inflation without causing a US recession and a global financial crisis, he makes facing a drumbeat of calls to further expand the Fed’s mandate.

activistsbacked by influential voices in government and the investment community, believe that the Fed, through its oversight of the banking system, should join the fight against climate change.

According to the National Oceanic and Atmospheric Administration, the United States suffered 20 major weather and climate disasters in 2021, with damages totaling approximately $145 billion. With Hurricanes Fiona and Ian the most recent events, 2022 will also provide expensive accounting.

These disasters have the potential to offer real political leverage to Congress. In 2021, Senators Jeff Merkley (D-Ore.) and Ed Markey (D-Mass.) introduced legislation that would force the Fed to compel banks stop funding fossil fuel projects. Proposals like this will continue to keep the pressure on the central bank.

the original Federal Reserve Act of 1913 assigned a decentralized Federal Reserve System modest responsibilities by today’s standards. The Fed was designed as a lender of last resort, tasked with providing the currency and bank reserves needed to limit the financial panics that had been all too common in the turn-of-the-century economy.

In a revealing 1907 review, Paul Warburg, a partner in the firm of Kuhn Loeb, had lamented that the financial system of the United States was “about the same as that reached by Europe in the Medici era”. So how did the necessary changes in American finance finally take place?

In light of today’s climate debate, it is ironic to point out that the path to the creation of the Federal Reserve System began in response to a natural disaster, which reverberated around the world.

In April 1906, San Francisco was hit by an earthquake. measuring 7.9 on the Richter scale. In a city built largely of wood, the ensuing four-square-mile fires destroyed 28,000 buildings. The death toll probably exceeded 3,000 and 250,000 were left homeless. Damage to insured property amounted to $235 million — nearly $7 billion in today’s dollars.

But in a fascinating 2004 analysis, Professors Kerry Odell and Mark Weidenmier documented the earthquake’s impact on global financial markets. Here, the aftershocks were also catastrophic.

In a world governed by the gold standard, where investors were protected from currency risk, 50% of fire insurance policies in San Francisco were underwritten by British companies. The business was very profitable, but in retrospect the premiums charged did not take earthquake risk into account.

The San Francisco policyholders brought claims to London totaling $108 million ($3.2 billion in today’s dollars) and asserted their right to be paid in gold. A total of $48 million was eventually paid, leading to a massive outflow of British gold reserves to the United States. This change required the Bank of England to tighten monetary conditions in the UK.

The Bank then took the extraordinary step of abandoning its laissez-faire principles by urging UK banks to refrain from rolling over US commercial paper in the London Money Markets. Gold reserves returned from New York to London, causing a severe liquidity shortage in the United States as interest rates hit double-digit levels.

The nation suffered a 30% drop in industrial production during the second half of 1907. More significantly, the New York money market entered the fall with very low reserves.

In October, an investor’s attempt to corner the copper market (reminiscent of the Hunt brothers’ attempt with silver in 1980) combined with the failure of the Knickerbocker Trust Company, contributed to bank runs in New York that led to a national financial panic. After severe losses, the damage was finally limited when prominent figures in private finance, led by JP Morgan, set up funds to bail out institutions they deemed solvent.

In the process, the financial community turned to its allies in the government to find a solution to Paul Warburg’s complaint. In 1908, the senator from Rhode Island Nelson AldrichRepublican Chairman of the Senate Finance Committee (and grandfather of Nelson Rockefeller) sponsored a bill that created a National Monetary Commission to propose financial system reforms.

Aldrich and the bankers came with the notion of a decentralized reserve association that would perform the key functions of a central bank on a region-by-region basis. It eventually became the basis for legislation signed by Woodrow Wilson in December 1913.

Spurred by the depressions of the 1920s and 1930s and the need to support the financing of two world wars, the Fed assumed in its first half-century a more active role than its creators envisioned in managing the flow of funds. money and credit in the economy.

Then, under the impact of a decade of stagflation, the so-called dual mandate – to effectively promote the objectives of maximum employment (and) stable prices – was enshrined in a 1977 law amendment to the original Federal Reserve Act. It is under these two pillars that Jerome Powell and his colleagues deliberate today.

Hurricane Ian, flooding in Pakistan or another outbreak of wildfires in California are unlikely to trigger a financial panic any time soon. And the current global energy crisis has given fossil fuels a respite from widespread calls for their eradication.

But it should be remembered that if the earthquake of 1906 is considered an event that occurs once every 200 years, there is no way of knowing what others”black Swan“Events could be looming on the horizon today. Once the current inflation crisis passes, if the markets were hit hard by a catastrophe deemed climate-induced, the Fed could well find itself operating under a third term.

Paul C. Atkinson, a former Wall Street Journal executive, is editor of the New York Sun.

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