Behind The Vault Part 2: The Federal Reserve Solution
Welcome to Eagle Legacy Planning’s educational series on banking—a topic that may not seem exciting at first glance, but one that plays a central role in our daily lives, financial security, and long-term wealth planning.
For most people, banking is a routine, even mindless part of modern life. We deposit paychecks, use debit cards, apply for loans, and transfer money with a few taps on our phones. But behind the convenience lies a system that few truly understand—one with risks, flaws, and consequences that most people don’t see until it’s too late.
This series is designed to pull back the curtain. Our goal is to help you understand not only how banking works but also why it works the way it does—and what that means for your money, your future, and your family’s financial legacy. We'll explore alternatives to traditional banking, such as holding physical assets like cash or precious metals, and explain why these options are often overlooked in mainstream financial advice.
Let’s start at the beginning: how did our current system come to be? What problems were banks facing, and how did those problems lead to the creation of one of the most powerful financial institutions in the world—the Federal Reserve?
Why Do We Bank?
Have you ever asked yourself, “Why do I even use a bank?”
For most people, the answer is simple: convenience. Banks make it easy to receive a paycheck, get a loan, send money across the world, or use a debit card to buy groceries. In today’s global economy, banks are positioned as essential tools for participating in everyday life.
But beneath the surface, banking isn’t just about holding your money—it’s about creating money. And this is where things get interesting.
In our modern monetary system, most of the money in circulation isn't backed by anything physical, like gold or silver. Instead, it’s backed by debt. It may sound strange, but the truth is: if all debts were paid off today—student loans, mortgages, car notes, business loans—money would cease to exist. Tough topic to understand (which we will dive into later in the series), but that’s because money is created through lending.
Understanding this concept is crucial to understanding how banks operate, why they take the risks they do, and why you should care about the structure of the system they’ve built.
Before the Federal Reserve
Let’s rewind to a time before central banking, before the Federal Reserve Act of 1913.
Back then, the U.S. dollar was tied to gold. You could walk into a bank with your paper currency and redeem it for actual gold or silver. Gold was the universal language of money, accepted across nations and civilizations. It was real, tangible, and finite.
Banks operated on the gold standard, meaning they could only issue currency and make loans based on the amount of gold they held. But as banking became more competitive and as demand for credit grew, banks started finding ways to stretch the limits of what they could lend. This led to several fundamental problems in the system.
The Core Problems with Banking Before the Fed
Problem 1: Currency Drains
Banks make money by lending. When they issue a loan, they charge interest—and over time, that interest turns into profit. Back when gold was the primary reserve, that meant banks were collecting more gold from borrowers and using it to issue even more loans.
But the system had a problem: fractional reserve banking.
This practice meant that banks only held a small percentage—typically 10%—of their deposits in reserve. For every $100 deposited, the bank could lend out $90, assuming not everyone would withdraw their money at the same time.
Here’s where the issue arises: if the person who took a loan spent that $90 at a business that used a different bank, the second bank would want that money in real value, typically gold or silver, from the originating bank. If too many transactions like this occurred, the originating bank could quickly run out of reserves. This created a fragile system—one that could collapse if too many other banks demanded their money back at once.
This vulnerability was known as a currency drain, and it led directly to insolvencies across the banking industry.
Problem 2: Bank Runs
A more visible and devastating version of the currency drain was the bank run. If customers lost faith in a bank, they would rush to withdraw their funds. And because banks only held a fraction of those funds in reserve, they couldn’t pay everyone back. The bank would collapse, and depositors would lose everything. This wasn’t a rare occurrence—it happened frequently, leading to panic, instability, and widespread distrust in the banking system.
Even today, this problem hasn’t gone away. In fact, the 2023 failures of Silicon Valley Bank and Signature Bank were modern-day examples of bank runs. These banks failed because too many people tried to withdraw their money too quickly. The only difference today is that the government stepped in to guarantee the deposits—thanks to the mechanisms created by the Federal Reserve.
Problem 3: Elasticity of Money
As America grew, new banks began to appear across the country. Smaller, local banks started attracting more customers. This shift threatened the dominance of the large national banks.
The big banks realized that if they couldn't increase their deposits, they couldn’t issue more loans. And if they couldn’t issue more loans, they couldn’t grow. Worse, without a way to adapt quickly to the economy’s needs, the system remained inflexible. This lack of elasticity—the ability to expand or contract the money supply as needed—limited growth and increased the risk of systemic failure.
Big banks needed a way to create more money without relying entirely on physical reserves. They also needed a system that would give them more control and reduce the risk of competitors eating away at their profits.
Problem 4: Shared Control and Risk Mitigation
To stabilize the system—and maintain their dominance—the largest banks saw that if they could share reserves, they could back each other up during times of crisis. This would make the entire system appear safer and more stable.
But in reality, it created a monopoly—a concentrated control over money and credit. If one bank failed, others could absorb the shock. But if every bank experienced stress at once, even the pooled reserves wouldn’t be enough.
This led to the idea of centralization—not for the sake of the public, but for the security and profit of the banking elite.
The Secret Meeting That Changed Everything
In 1910, some of the most powerful bankers and financiers in the world met in secret to design a solution to the banking crisis—their crisis. Together, they represented a massive share of the world’s wealth—some estimates say as much as one-sixth.
Their goal was to create a central institution that could control the money supply, prevent bank runs, and allow banks to lend more without holding real reserves. But they also needed to make it sound appealing to the American public.
Their solution? The Federal Reserve—a name designed to sound official, stable, and beneficial for the country.
But as one of the members - Senator Aldrich of Rhode Island - later admitted:
“The organization proposed is not a bank, but a cooperative union of all the banks of the country for definite purposes.”
In other words, the Federal Reserve wasn’t created to serve you—it was created to serve the banks. After the Federal Reserve Act passed in 1913, Aldrich famously said:
“Before the passage of this Act, the New York bankers could only dominate the reserves of New York. Now we are able to dominate the bank reserves of the entire country.”
This quote offers a rare moment of honesty—and reveals the true nature of the Federal Reserve. It centralized control, protected the big banks, and ensured that the financial elite could pass losses onto the public while preserving their power and profit.
This is just the beginning of our journey.
In the next installment of this series, we’ll explore how bank bailouts work and who really pays for them.
You won’t want to miss it. Be on the look out next Friday!