Every semester I bring my students to the Federal Reserve Bank of New York for a seminar with Peter Backstansky, the head of public information, to see the open market traders in action — from behind a soundproof glass panel — and visit the gold vault.

The vault, several floors below ground level, is always the highlight for the students. And the discussion afterward of the history of gold helps dramatize how our monetary system has developed and what makes it work today. A similar visit should be on the agenda of every banker who comes to the Big Apple and wants a better understanding of our financial structure.

The gold my students see in the Fed’s basement is by far the largest aggregation at one place in history, yet none of it is American-owned. Our gold is mainly held at the New York Assay Office and in Fort Knox. The foreign gold was first sent to the Fed vault for safekeeping from Nazi plunder during World War II and has remained there out of convenience.

The bars are stacked in their respective nation’s “cages” and look like the walls of yellow brick houses.

Visitors are not told which country owns the gold in each cage. Since the gold is part of its country’s official reserves, revealing the ownership could lead to a fear for a nation’s strength. For example, an observer might notice that Sweden’s stack is smaller than it was during a previous visit.

Few transactions involve payment in gold these days, but when there is physical transfer of gold, the process is as simple as moving bars from one cage to another.

Over the years the protection of national gold stocks, especially those of the United States, has led to economic misery and political disaster.

Most significantly, had the Fed managers in the early 1930s been willing to ease credit and help banking and business expand, the Great Depression would not have been as severe as it was, and the electoral victories of the Nazis, which led to World War II, would have been less likely. The Fed feared that if it eased credit, interest rates would not stay high enough to keep foreign money invested in U.S. securities, so holders of dollars would take out gold instead.

We have changed our attitude toward holding and using gold to back our currency.

Until World War II we required the Fed to keep a 40% gold backing behind its deposit and note liabilities. But when we wanted to finance the war by creating more deposit money but did not have the gold available to back those deposits, we just changed the requirement to 25%.

Later, when we found that our gold supply was not keeping up with economic growth and the need for more deposit money, we just eliminated the reserve requirement.

In effect, we said that the integrity and wisdom of the individuals managing the Federal Reserve System would replace the size of our gold stock in determining credit conditions in the nation.

This decision is a basic reason why our economy has done so well in the past few decades. The gold in the Fed vault, and its insignificance in our economic and financial lives today, helps us realize how far we have come toward making money our servant rather than our master.

Mr. Nadler, an American Banker contributing editor, is professor of finance at Rutgers University Graduate School of Management in Newark, N.J.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.