| Book Review | The American Historical Review 105, 1 February 2000

J. Lawrence Broz. The International Origins of the Federal Reserve System.

Ithaca: Cornell University Press. 1997. Pp. xiii, 269. $35.00.

A political economy model underpins J. Lawrence Broz's well-crafted study of the origins of the Federal Reserve System. The model is designed to explain how a convergence between private and social interests achieved institutional change. Banking reform, according to the model, became possible after the 1907 panic because it encompassed two inseparable products. One product was enhancement of the stability of the payments system, a domestic public good available to everyone, regardless of whether an individual had contributed to the effort. The other product was internationalization of the dollar, which generated excludable private benefits to the New York money center banks. For these benefits, the banks were willing to pay the bulk of the intellectual, financial, and organizational costs of developing a reform program and moving it through Congress.

Having concluded that the model gives a good account of the origins of the Federal Reserve, Broz then evaluates the explanatory approach of the joint-products model to the formation of the Bank of England and the First and Second Banks of the United States that were also producers of collective goods. He finds that, despite differences between the public and private goods involved in the founding of these institutions and those of the Federal Reserve, the processes followed the same logic.

A main argument of the study is that students of the Federal Reserve System have not paid enough attention to the role of international factors in explaining its creation. What Broz regards as international factors was, from the banks' viewpoint, simply taking advantage of profit opportunities. They wanted to provide banking services abroad to their domestic corporate customers and to conduct corporate foreign exchange business as well as their own. The aim was modest: to cement the bank's relations with corporate customers. Rather than a high-minded pursuit of the dollar as an international currency, the banks' emphasis was on business opportunities, were the pre-1913 restrictions on branching abroad and on trade acceptances to be removed.

Broz suggests in a summary that internationalization of the dollar was in fact achieved soon after the act was passed, when he should have noted that it was a temporary wartime phenomenon. "[D]uring the war and immediate postwar period, the position of the United States in international financial affairs progressed far along the lines envisioned by . . . currency internationalists. The dollar acceptance increased in use as an instrument of trade finance. American banks formed a worldwide network of foreign branch banks, and the New York discount market attained worldwide status" (p. 260). In fact, bankers' acceptances, which the Federal Reserve hoped would replace the call loan as the most widely available liquid asset, never developed into a market for temporarily idle balances. The reason was that, for much of the 1920s, with discount rates below market rates, there was little incentive for commercial banks to invest in acceptances. In addition, the postwar London discount market recovered. The volume of acceptances there was more than double what was outstanding in New York. The pound stabilization in 1925 made sterling once again the principal currency of invoice for foreign trade, although America's own imports and exports were mainly invoiced in dollars.

The chapter on "Collective Action for Banking Reform" is especially rewarding in detailing all the compromises that were needed over a five-year period to bring the Federal Reserve Act to fruition. Schisms between note-issuing midwestern banks and the eastern banking community with minimal note issues had to be finessed, in part through the establishment of a bipartisan eighteen-member congressional National Monetary Commission. The reformers enlisted banker and grass-roots support, with the costs of lobbying allocated among clearinghouses that assessed their member banks. A final struggle between populists and bankers occurred over monetary control at the Federal Reserve.

On balance, the book presents an interesting set of ideas that illuminates how enactment of Federal Reserve legislation overcame many obstacles. Broz, however, goes out on a limb in insisting on the primacy of international factors and the subordination of the pursuit of domestic financial stability. He is equally vulnerable in claiming that the act authorized the Federal Reserve to intervene in the foreign exchange market (p. 48). The Federal Reserve Act authorized the reserve banks to purchase foreign exchange for the limited purpose of facilitating the collection of checks and other drafts, bills of exchange, and cable transfers. In 1961, when the Treasury requested the Federal Reserve to supplement its own intervention, the Federal Open Market Committee engaged in an extensive discussion of its legal authority to intervene. The Federal Reserve relied on the opinion to that effect of Howard Hackley, its general counsel, although Hackley acknowledged that there was no explicit statutory authority for intervention. If the matter had been settled by the Federal Reserve Act in 1913, as Broz believes, why is there no support in the record for his belief?

Anna J. Schwartz

National Bureau of Economic Research