Is Bernanke Channeling Nicholas Biddle?

When the Federal Reserve began its quantitative easing program (QE2) earlier this month, it did not anticipate the subsequent firestorm of criticism. Foreign government officials, esteemed economists, and members of congress among others have complained that the Fed is "printing money" and "debasing the currency". Even Sarah Palin is making a lot of noise about it.

Admittedly the optics look bad. The Fed will buy $600 billion of Treasury bonds through June of next year, which is just about what the Treasury will issue to fund the budget deficit. If this isn't monetizing the debt, what is?

Certainly the Fed was caught off guard. Though conversations with Wall Street banks beforehand perhaps revealed little to worry about, the echo chamber is alive and well among the financial elite in lower Manhattan and Chairman Ben Bernanke's academic friends.

If Mr. Bernanke isn't careful he may end up like Nicholas Biddle, the nation's first central banker. Biddle presided over a prosperous and somewhat calm economy, in contrast to Bernanke's controversial tenure. Yet politics led to the ouster of Biddle and destruction of the Second Bank of the United States in 1836.

In the early days of the country, money was banknotes. These were issued by the myriad state chartered banks. The Second Bank of the United States, located in Philadelphia, was formed as a quasi central bank in 1816 to exercise some regulatory oversight of the state banks. By periodically presenting bank notes to the issuing banks for specie the Second Bank would keep them honest and prevent excess money creation. It also served as lender of last resort.

The bank was controversial. It was a monopoly and by disciplining the state banks it didn't make a lot of friends. Biddle opined before a congressional committee that, "there were very few banks that might not have been destroyed by an exertion of power by the Second Bank". The power of the bank, albeit benevolent in Biddle's eyes, was revealed.

This didn't sit well with President Andrew Jackson. The monopoly bank had too much power and Jackson meant to fix that. Like Thomas Jefferson before him, he hated banks, especially the "Chestnut Street monster".

Biddle, who was somewhat impolitic, said that Jackson's opposition to the Second Bank "should be treated as the honest though erroneous opinions of one who intends well". His patronizing tone raised the ire of Old Hickory who had fought a duel or two in his day. "This is intended as the first shot; it will pass without moving me" he said.

He told his vice president "The bank is trying to kill me, but I will kill it." And, he did. By vetoing the re-chartering of the Second Bank, Jackson set the nation on a course that ultimately had it free of a central bank from 1836 to 1913.

Without the constraints of the Second Bank, local banks printed and lent money (banknotes) willy nilly, leading to a land boom and inflation. Jackson wanted hard money, but what he got was easy credit. Seeing the error of his ways, he clamped down and demanded payment in specie (gold and silver) for government land sales. The panic of 1837 and a deep recession ensued.

Of course without a central bank, and despite enduring various booms and busts throughout much of the 19th century, the US economy grew by leaps and bounds. During this period free of central banking, the U.S. overtook Great Britain as the world's largest economy even though Britain had the Bank of England.

Perhaps the closest political personage to Andrew Jackson these days is Congressman Ron Paul. He has written a book called End the Fed and will oversee a congressional committee to which the Federal Reserve will report. If he can't end the Fed he would certainly like to strip our central bank of its dual mandate (maximum employment and price stability) and have it just focus on inflation.

While there's reason to be sympathetic to the Feds goals along with reasons to be skeptical about the broad commentary suggesting that QE2 will lead to inflation, the Fed's aggressive stance seems unnecessary, and worse for the world's foremost central bank, it is now threatening the Feds credibility and independence.

We don't have a liquidity problem anymore, rather we have a confidence problem. And all this controversy surrounding QE2 distracts from the real problem, which is rebuilding business and consumer confidence.

Mr. Bernanke is possibly right about the economics of quantitative easing, but he could still lose the political war and end up back at Princeton, Nicholas Biddle's alma mater.