Around 1900, two mighty financial-industrial groups, each consisting of investment banks, commercial banks, and industrial resources, confronted each other, usually with hostility, in the financial, and more importantly, the political arena. These coalitions were (1) the interests grouped around the Morgan bank; and (2) an alliance of Rockefeller–Harriman and Kuhn, Loeb interests. It became far easier for these financial elites to influence and control politicians and political affairs after 1900 than before.

The origin of the Federal Reserve has been deliberately shrouded in myth spread by pro-Fed apologists. The official legend holds that the idea of a Central Bank in America originated after the Panic of 1907, when the banks, stung by the financial panic, concluded that drastic reform, highlighted by the establishment of a lender of last resort, was desperately necessary.

By the 1890s, the leading Wall Street bankers were becoming increasingly disgruntled with their own creation, the National Banking System. In the first place, while the banking system was partially centralized under their leadership, it was not centralized enough. Above all, there was no revered Central Bank to bail out the commercial banks when they got into trouble, to serve as a “lender of last resort,” The big bankers couched their complaint in terms of “inelasticity,” The money supply, they grumbled, wasn’t “elastic” enough.

It should now be crystal clear what the attitude of commercial banks is and almost always will be toward the Central Bank in their country. The Central Bank is their support, their staff and shield against the winds of competition and of people trying to obtain money which they believe to be their own property waiting in the banks’ vaults. The Central Bank crucially bolsters the confidence of the gulled public in the banks and deters runs upon them.

Before analyzing operations of the Federal Reserve in more detail, we should understand that the most important way that a Central Bank can cartelize its banking system is by increasing the reserves of the banks, and the most important way to do that is simply by buying assets.

The institution of Central Banking eased the free-market restrictions on fractional-reserve banking in several ways. In the first place, by the mid-nineteenth century a “tradition” was craftily created that the Central Bank must always act as a “lender of last resort” to bail out the banks should the bulk of them get into trouble.

Central Banking began in England, when the Bank of England was chartered in 1694. Other large nations copied this institution over the next two centuries, the role of the Central Bank reaching its now familiar form with the English Peel Act of 1844. The United States was the last major nation to enjoy the dubious blessings of Central Banking, adopting the’ Federal Reserve System in 1913.

Two kinds of warehouse receipts for deposit banks have developed over the centuries. One is the regular form of receipt, familiar to anyone who has ever used any sort of warehouse: a paper ticket in which the warehouse guarantees to hand over, on demand, the particular product mentioned on the receipt, e.g., “The Rothbard Bank will pay to the bearer of this ticket on demand,” 10 dollars in gold coin, or Treasury paper money, or whatever. For deposit banks, this is called a “note” or “bank note.” Historically, the bank note is the overwhelmingly dominant form of warehouse receipt.

We have so far emphasized that bank credit expansion under fractional-reserve banking (or “creation of counterfeit warehouse receipts”) creates price inflation, loss of purchasing power of the currency unit, and redistribution of wealth and income. Euphoria caused by a pouring of new money into the economy is followed by grumbling as price inflation sets in, and some people benefit while others lose. But inflationary booms are not the only consequence of fractional-reserve counterfeiting. For at some point in the process, a reaction sets in.

This unfortunate turn of the legal system means that the fractional-reserve banker, even if he violates his contract, cannot be treated as an embezzler and a criminal; but the banker must still face the lesser, but still unwelcome fact of insolvency. There are two major ways in which he can become insolvent.