A History of Money and Banking in the United States: The Colonial Era to World War II
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For Friedman and Schwartz, then, the central aim of economic history is the testing of hypotheses suggested by empirical regularities observed in the historical data. Accordingly, Friedman and Schwartz describe their approach to economic history as “conjectural history—the tale of ‘what might have been.’ “62 In their view, the primary task of the economic historian is to identify the observable set of circumstances that accounts for the emergence of the historical events under investigation by formulating and testing theoretical conjectures about the course of events that would have developed in the absence of these circumstances. This “counterfactual method,” as the new economic historians refer to it, explains the historical events in question and, at the same time, adds to the “tested knowledge” of theoretical relationships to be utilized in future investigations in economic history.63
Friedman and Schwartz exemplify this method in their treatment of the panic of 1907.64 During this episode, banks swiftly restricted cash payments to their depositors within weeks after the financial crisis struck, and there ensued no large-scale failure or even temporary closing of banks. Friedman and Schwartz formulate from this experience the theoretical conjecture that, when a financial crisis strikes, early restrictions on currency payments work to prevent a large-scale disruption of the banking system. They then test this conjecture by reference to the events of 1929–1933. In this case, although the financial crisis began with the crash of the stock market in October 1929, cash payments to bank depositors were not restricted until March 1933. From 1930 to 1933, there occurred a massive wave of bank failures. The theoretical conjecture, or “counterfactual statement,” that a timely restriction of cash payments would have checked the spread of a financial crisis, is therefore empirically validated by this episode because, in the absence of a timely bank restriction, a wave of bank failures did, in fact, occur after 1929.
Granted, Friedman and Schwartz do recognize that these theoretical conjectures cannot be truly tested because “[t]here is no way to repeat the experiment precisely and so to test these conjectures in detail.” Nonetheless, they maintain that “all analytical history, history that seeks to interpret and not simply record the past, is of this character, which is why history must be continuously rewritten in the light of new evidence as it unfolds.”65 In other words, history must be revised repeatedly because the very theory that is employed to interpret it is itself subject to constant revision on the basis of “new evidence” that is continually coming to light in the ongoing historical process. As pointed out above, this is the vicious circle that characterizes all attempts to apply the positive method to the interpretation of history.
As if to preempt recognition of this vicious circle, Friedman and Schwartz take as the motto of their volume a famous quote from Alfred Marshall, which reads in part:
Experience... brings out the impossibility of learning anything from facts till they are examined and interpreted by reason; and teaches that the most reckless and treacherous of all theorists is he who professes to let facts and figures speak for themselves.66
But clearly, reason teaches us that the observable—and, in some cases, countable, but never measurable—events of economic history ultimately are caused by the purposive actions of human beings whose goals and motives can never be directly observed. In rejecting the historical method of specific understanding, Friedman and Schwartz are led not by reason, but by a narrow positivist prepossession with using history as a laboratory, albeit imperfect, for formulating and testing theories that will allow prediction and control of future phenomena. Of the underlying intent of such a positivist approach to history, Mises wrote, “This discipline will abstract from historical experience laws which could render to social ‘engineering’ the same services the laws of physics render to technological engineering.”67
Needless to say, for Rothbard, history can never serve even as an imperfect laboratory for testing theory, because of his agreement with Mises that “the subject matter of history... is value judgments and their projection into the reality of change.”68 In seeking to explain the origins of the Federal Reserve System, therefore, Rothbard focuses on the question of who would reasonably have expected to benefit from and valued such a radical change in the monetary system. Here is where Rothbard’s scientific worldview comes into play. As an Austrian monetary theorist, he recognizes that the limits on bank credit inflation confronted by a fractional reserve banking system based on gold are likely to be much less confining under a central bank than under the quasi-decentralized National Banking System put in place immediately prior to the passage of the Federal Reserve Act in 1913. The praxeological reasoning of Austrian monetary theory also leads to the conclusion that those who stand to reap the lion’s share of the economic benefits from a bank credit inflation tend to be the lenders and first recipients of the newly created notes and deposits, namely, commercial and investment bankers and their clients. Guided by the implications of this praxeological knowledge and of his thymological rule about the motives of those who lobby for State laws and regulations, Rothbard is led to scrutinize the goals and actions of the large Wall Street commercial and investment bankers, their industrial clientele, and their relatives and allies in the political arena.
Rothbard’s analysis of the concrete evidence demonstrates that, beginning in the late 1890s, a full decade before the panic of 1907, this Wall Street banking axis and allied special interests began to surreptitiously orchestrate and finance an intellectual and political movement agitating for the imposition of a central bank. This movement included academic economists who covered up its narrow and venal economic interests by appealing to the allegedly universal economic benefits that would be forthcoming from a central bank operating as a benevolent and disinterested provider of an “elastic” currency and “lender of last resort.” In fact, what the banking and business elites dearly desired was a central bank that would provide an elastic supply of paper reserves to supplement existing gold reserves. Banks’ access to additional reserves would facilitate a larger and more lucrative bank credit inflation and, more important, would provide the means to ward off or mitigate the recurrent financial crises that had brought past inflationary booms to an abrupt and disastrous end in bank failures and industrial depression.
Rothbard employs the approach to economic history exemplified in this treatment of the origins of the Fed consistently and dazzlingly throughout this volume to unravel the causes and consequences of events and institutions ranging over the course of U.S. monetary history, from colonial times through the New Deal era. One of the important benefits of Rothbard’s unique approach is that it naturally leads to an account of the development of the U.S. monetary system in terms of a compelling narrative linking human motives and plans that oftentimes are hidden and devious to outcomes that sometimes are tragic. And one will learn much more about monetary history from reading this exciting story than from poring over reams of statistical analysis.
Although its five parts were written separately, this volume presents a relatively integrated narrative, with very little overlap, that sweeps across three hundred years of U.S. monetary history. Part 1, “The History of Money and Banking Before the Twentieth Century,” consists of Rothbard’s contribution to the minority report of the U.S. Gold Commission and treats the evolution of the U.S. monetary system from its colonial beginnings to the end of the nineteenth century.69 In this part, Rothbard gives a detailed account of two early and abortive attempts by the financial elites to shackle the young republic with a quasi-central bank. He demonstrates the inflationary consequences of these privileged banks, the First and Second Banks of the United States, during their years of operation, from 1791 to 1811 and from 1816 to 1833, respectively. Rothbard then discusses the libertarian Jeffersonian and Jacksonian ideological movements that succeeded in destroying these statist and inflationist institutions. This is followed by discussions of the era of comparatively free and decentralized banking that extended from the 1830s up to the Civil
War, and the pernicious impact of the war on the U.S. monetary system. Part 1 concludes with an analysis and critique of the post–Civil War National Banking System. Rothbard describes how this regime—which was aggressively promoted by the investment banking firm that had acquired the monopoly of underwriting government bonds— centralized banking and destabilized the economy, resulting in a series of financial crises that prepared the way for the imposition of the Federal Reserve System.
Part 2, on the “Origins of the Federal Reserve,” is a paper that lay unpublished for a long time and just appeared in a recent issue of The Quarterly Journal of Austrian Economics.70 Its main argument is summarized in the text above.
Part 3 contains a formerly unpublished paper, “From Hoover to Roosevelt: The Federal Reserve and the Financial Elites.” Here, Rothbard identifies the financial interests and ideology that drove the Fed to engineer an almost uninterrupted expansion of the money supply from the moment of its inception in 1914 through 1928. This part also includes an analysis of how concordance and conflict between the Morgan and Rockefeller financial interests shaped the politics and behavior of the Fed during the Hoover administration and the first Roosevelt administration as well as international monetary and domestic banking and financial policies under the latter administration.
Part 4, “The Gold-Exchange Standard in the Interwar Years,” previously was published as a chapter in a collection of papers on money and the State.71 The paper appears here for the first time in its original and unexpurgated version. Rothbard elucidates the reasons why the British and U.S. governments in the 1920s so eagerly sought to reconstruct the international monetary system on the basis of this profoundly flawed and inflationary caricature of the classical gold standard. Rothbard also analyzes the “inner contradictions” of the gold-exchange-standard system that led inexorably to its demise in the early 1930s.
Part 5, “The New Deal and the International Monetary System” is the topic of the fifth and concluding part of the book and was previously published in an edited book of essays on New Deal foreign policy.72 Rothbard argues that an abrupt shift occurred in the international monetary policy of the New Deal just prior to U.S. entry into World War II. He analyzes the economic interests that promoted and benefited from the radical transformation of New Deal policy, from “dollar nationalism” during the 1930s to the aggressive “dollar imperialism” that prevailed during the war and culminated in the Bretton Woods Agreement of 1944.
—Joseph T. Salerno
Pace University
Part 1
A HISTORY OF MONEY AND BANKING IN THE UNITED STATES BEFORE THE TWENTIETH CENTURY
A HISTORY OF MONEY AND BANKING IN THE UNITED STATES BEFORE THE TWENTIETH CENTURY
As an outpost of Great Britain, colonial America of course used British pounds, pence, and shillings as its money. Great Britain was officially on a silver standard, with the shilling defined as equal to 86 pure Troy grains of silver, and with silver as so-defined legal tender for all debts (that is, creditors were compelled to accept silver at that rate). However, Britain also coined gold and maintained a bimetallic standard by fixing the gold guinea, weighing 129.4 grains of gold, as equal in value to a certain weight of silver. In that way, gold became, in effect, legal tender as well. Unfortunately, by establishing bimetallism, Britain became perpetually subject to the evil known as Gresham’s Law, which states that when government compulsorily overvalues one money and undervalues another, the undervalued money will leave the country or disappear into hoards, while the overvalued money will flood into circulation. Hence, the popular catchphrase of Gresham’s Law: “Bad money drives out good.” But the important point to note is that the triumph of “bad” money is the result, not of perverse free-market competition, but of government using the compulsory legal tender power to privilege one money above another.
In seventeenth- and eighteenth-century Britain, the government maintained a mint ratio between gold and silver that consistently overvalued gold and undervalued silver in relation to world market prices, with the resultant disappearance and outflow of full-bodied silver coins, and an influx of gold, and the maintenance in circulation of only eroded and “lightweight” silver coins. Attempts to rectify the fixed bimetallic ratios were always too little and too late.1
In the sparsely settled American colonies, money, as it always does, arose in the market as a useful and scarce commodity and began to serve as a general medium of exchange. Thus, beaver fur and wampum were used as money in the north for exchanges with the Indians, and fish and corn also served as money. Rice was used as money in South Carolina, and the most widespread use of commodity money was tobacco, which served as money in Virginia. The pound-of-tobacco was the currency unit in Virginia, with warehouse receipts in tobacco circulating as money backed 100 percent by the tobacco in the warehouse.
While commodity money continued to serve satisfactorily in rural areas, as the colonial economy grew, Americans imported gold and silver coins to serve as monetary media in urban centers and in foreign trade. English coins were imported, but so too were gold and silver coins from other European countries. Among the gold coins circulating in America were the French guinea, the Portuguese “joe,” the Spanish doubloon, and Brazilian coins, while silver coins included French crowns and livres.
It is important to realize that gold and silver are international commodities, and that therefore, when not prohibited by government decree, foreign coins are perfectly capable of serving as standard moneys. There is no need to have a national government monopolize the coinage, and indeed foreign gold and silver coins constituted much of the coinage in the United States until Congress outlawed the use of foreign coins in 1857. Thus, if a free market is allowed to prevail in a country, foreign coins will circulate naturally. Silver and gold coins will tend to be valued in proportion to their respective weights, and the ratio between silver and gold will be set by the market in accordance with their relative supply and demand.
SHILLING AND DOLLAR MANIPULATIONS
By far the leading specie coin circulating in America was the Spanish silver dollar, defined as consisting of 387 grains of pure silver. The dollar was divided into “pieces of eight,” or “bits,” each consisting of one-eighth of a dollar. Spanish dollars came into the North American colonies through lucrative trade with the West Indies. The Spanish silver dollar had been the world’s outstanding coin since the early sixteenth century, and was spread partially by dint of the vast silver output of the Spanish colonies in Latin America. More important, however, was that the Spanish dollar, from the sixteenth to the nineteenth century, was relatively the most stable and least debased coin in the Western world.2
Since the Spanish silver dollar consisted of 387 grains, and the English shilling consisted of 86 grains of silver, this meant the natural, free-market ratio between the two coins would be 4 shillings 6 pence per dollar.3
Constant complaints, both by contemporaries and by some later historians, arose about an alleged “scarcity of money,” especially of specie, in the colonies, allegedly justifying numerous colonial paper money schemes to remedy that “shortage.” In reality, there was no such shortage. It is true that England, in a mercantilist attempt to hoard specie, kept minting for its own prerogative and outlawed minting in the colonies; it also prohibited the export of English coin to America. But this did not keep specie from America, for, as we have seen, Americans were able to import Spanish and other foreign coin, including English, from other countries. Indeed, as we shall see, it was precisely paper money issues that led, by Gresham’s Law, to outflows and disappearance of specie from the colonies.
In their own mercantilism, the colonial governments early tried to hoard their own specie by debasing their shilling standards in terms of Spanish dollars. Whereas their natural weights dictated a ratio of 4 shillings 6 pence to the dollar, Massachusetts, in 1642, began a general colonial process of competitive debasement of shillings. Massachusetts arbitrarily decreed that the Spanish dollar be val
ued at 5 shillings; the idea was to attract an inflow of Spanish silver dollars into that colony, and to subsidize Massachusetts exports by making their prices cheaper in terms of dollars. Soon, Connecticut and other colonies followed suit, each persistently upping the ante of debasement. The result was to increase the supply of nominal units of account by debasing the shilling, inflating domestic prices and thereby bringing the temporary export stimulus to a rapid end. Finally, the English government brought a halt to this futile and inflationary practice in 1707.
But the colonial governments had already found another, and far more inflationary, arrow for their bow: the invention of government fiat paper money.
GOVERNMENT PAPER MONEY
Apart from medieval China, which invented both paper and printing centuries before the West, the world had never seen government paper money until the colonial government of Massachusetts emitted a fiat paper issue in 1690.4, 5 Massachusetts was accustomed to launching plunder expeditions against the prosperous French colony in Quebec. Generally, the expeditions were successful, and would return to Boston, sell their booty, and pay off the soldiers with the proceeds. This time, however, the expedition was beaten back decisively, and the soldiers returned to Boston in ill humor, grumbling for their pay. Discontented soldiers are ripe for mutiny, so the Massachusetts government looked around in concern for a way to pay the soldiers. It tried to borrow £3,000–£4,000 from Boston merchants, but evidently the Massachusetts credit rating was not the best. Finally, Massachusetts decided in December 1690 to print £7,000 in paper notes and to use them to pay the soldiers. Suspecting that the public would not accept irredeemable paper, the government made a twofold pledge when it issued the notes: that it would redeem them in gold or silver out of tax revenue in a few years and that absolutely no further paper notes would be issued. Characteristically, however, both parts of the pledge went quickly by the board: The issue limit disappeared in a few months, and all the bills continued unredeemed for nearly 40 years. As early as February 1691, the Massachusetts government proclaimed that its issue had fallen “far short” and so it proceeded to emit £40,000 of new money to repay all of its outstanding debt, again pledging falsely that this would be the absolute final note issue.