A History of Money and Banking in the United States: The Colonial Era to World War II

by Murray N. Rothbard

  The commission used the old Indianapolis questionnaire technique: acquiring legitimacy by sending out a detailed questionnaire on currency to a number of financial leaders. With Johnson in charge of mailing and collating the questionnaire replies, Conant spent his time visiting and interviewing the heads of the central banks in Europe.

  The special commission delivered its report to the New York Chamber of Commerce in October 1906. To eliminate instability and the danger of an inelastic currency, the commission called for the creation of a “central bank of issue under the control of the government.” In keeping with other bank reformers, such as Professor Abram Piatt Andrew of Harvard University, Thomas Nixon Carver of Harvard, and Albert Strauss, partner of J.P. Morgan and Company, the commission was scornful of Secretary Shaw’s attempt to use the Treasury as central bank. Shaw was particularly obnoxious because he was still insisting, in his last annual report of 1906, that the Treasury, under his aegis, had constituted a “great central bank.” The commission, along with the other reformers, denounced the Treasury for overinflating by keeping interest rates excessively low; a central bank, in contrast, would have much larger capital and undisputed control over the money market, and thus would be able to manipulate the discount rate effectively to keep the economy under proper control. The important point, declared the committee, is that there be “centralization of financial responsibility.” In the meantime, short of establishing a central bank, the committee urged that, at the least, the national banks’ powers to issue notes should be expanded to include being based on general assets as well as government bonds.56

  After drafting and publishing this “Currency Report,” the reformers used the report as the lever for expanding the agitation for a central bank and broader note-issue powers to other corporate and financial institutions. The next step was the powerful American Bankers Association (ABA). In 1905, the executive council of the ABA had appointed a currency committee which, the following year, recommended an emergency assets currency that would be issued by a federal commission, resembling an embryonic central bank. In a tumultuous plenary session of the ABA convention in October 1906, the ABA rejected this plan, but agreed to appoint a 15-man currency commission that was instructed to meet with the New York chamber’s currency committee and attempt to agree on appropriate legislation.

  Particularly prominent on the ABA currency commission were:

  Arthur Reynolds, president of the Des Moines National Bank, close to the Morgan-oriented Des Moines Regency, and brother of the prominent Chicago banker, George M. Reynolds, formerly of Des Moines and then president of the Morgan-oriented Continental National Bank of Chicago and the powerful chairman of the executive council of the ABA;

  James B. Forgan, president of the Rockefeller-run First National Bank of Chicago, and close friend of Jacob Schiff of Kuhn, Loeb, as well as of Vanderlip;

  Joseph T. Talbert, vice president of the Rockefeller-dominated Commercial National Bank of Chicago, and soon to become vice president of Rockefeller’s flagship bank, the National City Bank of New York;

  Myron T. Herrick, one of the most prominent Rockefeller politicians and businessmen in the country. Herrick was the head of the Cleveland Society of Savings, and was part of the small team of close Rockefeller business allies who, along with Mark Hanna, bailed out Governor William McKinley from bankruptcy in 1893. Herrick was a previous president of the ABA, had just finished a two-year stint as governor of Ohio, and was later to become ambassador to France under his old friend and political ally William Howard Taft as well as later under President Warren G. Harding, and a recipient of Herrick’s political support and financial largesse; and

  Chairman of the ABA commission, A. Barton Hepburn, president of one of the leading Morgan commercial banks, the Chase National Bank of New York, and author of the well-regarded History of Coinage and Currency in the United States.

  After meeting with Vanderlip and Conant as the representatives from the New York Chamber of Commerce committee, the ABA commission, along with Vanderlip and Conant, agreed on at least the transition demands of the reformers. The ABA commission presented proposals to the public, the press, and the Congress in December 1906 for a broader asset currency as well as provisions for emergency issue of bank notes by national banks.

  But just as sentiment for a broader asset currency became prominent, the bank reformers began to worry about an uncontrolled adoption of such a currency. For that would mean that national bank credit and notes would expand, and that, in the existing system, small state banks would be able to pyramid and inflate credit on top of the national credit, using the expanded national bank notes as their reserves. The reformers wanted a credit inflation controlled by and confined to the large national banks; they most emphatically did not want uncontrolled state bank inflation that would siphon resources to small entrepreneurs and “speculative” marginal producers. The problem was aggravated by the accelerated rate of increase in the number of small Southern and Western state banks after 1900. Another grave problem for the reformers was that commercial paper was a different system from that of Europe. In Europe, commercial paper, and hence bank assets, were two-name notes endorsed by a small group of wealthy acceptance banks. In contrast to this acceptance paper system, commercial paper in the United States was unendorsed single-name paper, with the bank taking a chance on the creditworthiness of the business borrower. Hence, a decentralized financial system in the United States was not subject to big-banker control.

  Worries about the existing system and hence about uncontrolled asset currency were voiced by the top bank reformers. Thus, Vanderlip expressed concern that “there are so many state banks that might count these [national bank] notes in their reserves.” Schiff warned that “it would prove unwise, if not dangerous, to clothe six thousand banks or more with the privilege to issue independently a purely credit currency.” And, from the Morgan side, a similar concern was voiced by Victor Morawetz, the powerful chairman of the board of the Atchison, Topeka and Santa Fe Railroad.57

  Taking the lead in approaching this problem of small banks and decentralization was Paul Moritz Warburg, of Kuhn, Loeb, fresh from his banking experience in Europe. In January 1907, Warburg began what would become years of tireless agitation for central banking with two articles: “Defects and Needs of our Banking System” and “A Plan for a Modified Central Bank.”58 Calling openly for a central bank, Warburg pointed out that one of the important functions of such a bank would be to restrict the eligibility of bank assets to be used for expansion of bank deposits. Presumably, too, the central bank could move to require banks to use acceptance paper or otherwise try to create an acceptance market in the United States.59

  By the summer of 1907, Bankers Magazine was reporting a decline in influential banker support for broadening asset currency and a strong move toward the “central bank project.” Bankers Magazine noted as a crucial reason the fact that asset currency would be expanding bank services to “small producers and dealers.”60

  THE PANIC OF 1907 AND MOBILIZATION FOR A CENTRAL BANK

  A severe financial crisis, the panic of 1907, struck in early October. Not only was there a general recession and contraction, but the major banks in New York and Chicago were, as in most other depressions in American history, allowed by the government to suspend specie payments, that is, to continue in operation while being relieved of their contractual obligation to redeem their notes and deposits in cash or in gold. While the Treasury had stimulated inflation during 1905–1907, there was nothing it could do to prevent suspensions of payment, or to alleviate “the competitive hoarding of currency” after the panic, that is, the attempt to demand cash in return for increasingly shaky bank notes and deposits.

  Very quickly after the panic, banker and business opinion consolidated on behalf of a central bank, an institution that could regulate the economy and serve as a lender of last resort to bail banks out of trouble. The reformers now faced a twofold task: hammering out details of a new central ban
k, and more important, mobilizing public opinion on its behalf. The first step in such mobilization was to win the support of the nation’s academics and experts. The task was made easier by the growing alliance and symbiosis between academia and the power elite. Two organizations that proved particularly useful for this mobilization were the American Academy of Political and Social Science (AAPSS) of Philadelphia, and the Academy of Political Science (APS) of Columbia University, both of which included in their ranks leading corporate liberal businessmen, financiers, attorneys, and academics. Nicholas Murray Butler, the highly influential president of Columbia University, explained that the Academy of Political Science “is an intermediary between... the scholars and the men of affairs, those who may perhaps be said to be amateurs in scholarship.” Here, he pointed out, was where they “come together.”61

  It is not surprising, then, that the American Academy of Political and Social Science, the American Association for the Advancement of Science, and Columbia University held three symposia during the winter of 1907–1908, each calling for a central bank, and thereby disseminating the message of a central bank to a carefully selected elite public. Not surprising, too, was that E.R.A. Seligman was the organizer of the Columbia conference, gratified that his university was providing a platform for leading bankers and financial journalists to advocate a central bank, especially, he noted, because “it is proverbially difficult in a democracy to secure a hearing for the conclusions of experts.” Then in 1908 Seligman collected the addresses into a volume, The Currency Problem.

  Professor Seligman set the tone for the Columbia gathering in his opening address. The panic of 1907, he alleged, was moderate because its effects had been tempered by the growth of industrial trusts, which provided a more controlled and “more correct adjustment of present investment to future needs” than would a “horde of small competitors.” In that way, Seligman displayed no comprehension of how competitive markets facilitate adjustments. One big problem, however, still remained for Seligman. The horde of small competitors, for whom Seligman had so much contempt, still prevailed in the field of currency and banking. The problem was that the banking system was still decentralized. As Seligman declared,

  Even more important than the inelasticity of our note issue is its decentralization. The struggle which has been victoriously fought out everywhere else [in creating trusts] must be undertaken here in earnest and with vigor.62

  The next address was that of Frank Vanderlip. To Vanderlip, in contrast to Seligman, the panic of 1907 was “one of the great calamities of history”—the result of a decentralized, competitive American banking system, with 15,000 banks all competing vigorously for control of cash reserves. The terrible thing is that “each institution stands alone, concerned first with its own safety, and using every endeavor to pile up reserves without regard” to the effect of such actions on other banking institutions. This backward system had to be changed, to follow the lead of other great nations, where a central bank is able to mobilize and centralize reserves, and create an elastic currency system. Putting the situation in virtually Marxian terms, Vanderlip declared that the alien external power of the free and competitive market must be replaced by central control following modern, allegedly scientific principles of banking.

  Thomas Wheelock, editor of the Wall Street Journal, then rung the changes on the common theme by applying it to the volatile call loan market in New York. The market is volatile, Wheelock claimed, because the small country banks are able to lend on that market, and their deposits in New York banks then rise and fall in uncontrolled fashion. Therefore, there must be central corporate control over country bank money in the call loan market.

  A. Barton Hepburn, head of Morgan’s Chase National Bank, came next, and spoke of the great importance of having a central bank that would issue a monopoly of bank notes. It was particularly important that the central bank be able to discount the assets of national banks, and thus supply an elastic currency.

  The last speaker was Paul Warburg, who lectured his audience on the superiority of European over American banking, particularly in (1) having a central bank, as against decentralized American banking, and (2)—his old hobby horse—enjoying “modern” acceptance paper instead of single-name promissory notes. Warburg emphasized that these two institutions must function together. In particular, tight government central bank control must replace competition and decentralization: “Small banks constitute a danger.”

  The other two symposia were very similar. At the AAPSS symposium in Philadelphia, in December 1907, several leading investment bankers and Comptroller of the Currency William B. Ridgely came out in favor of a central bank. It was no accident that members of the AAPSS’s advisory committee on currency included A. Barton Hepburn; Morgan attorney and statesman Elihu Root; Morgan’s longtime personal attorney, Francis Lynde Stetson; and J.P. Morgan himself. Meanwhile the AAAS symposium in January 1908 was organized by none other than Charles A. Conant, who happened to be chairman of the AAAS’s social and economic section for the year. Speakers included Columbia economist J.B. Clark, Frank Vanderlip, Conant, and Vanderlip’s friend George E. Roberts, head of the Rockefeller-oriented Commercial National Bank of Chicago, who would later wind up at the National City Bank.

  All in all, the task of the bank reformers was well summed up by J.R. Duffield, secretary of the Bankers Publishing Company, in January 1908: “It is recognized generally that before legislation can be had there must be an educational campaign carried on, first among the bankers, and later among commercial organizations, and finally among the people as a whole.” That strategy was well under way.

  During the same month, the legislative lead in banking reform was taken by the formidable Senator Nelson W. Aldrich (R-R.I.), head of the Senate Finance Committee, and, as the father-in-law of John D. Rockefeller, Jr., Rockefeller’s man in the U.S. Senate. He introduced the Aldrich Bill, which focused on a relatively minor interbank dispute about whether and on what basis the national banks could issue special emergency currency. A compromise was finally hammered out and passed, as the Aldrich-Vreeland Act, in 1908.63 But the important part of the Aldrich-Vreeland Act, which got very little public attention, but was perceptively hailed by the bank reformers, was the establishment of a National Monetary Commission that would investigate the currency question and suggest proposals for comprehensive banking reform. Two enthusiastic comments on the monetary commission were particularly perceptive and prophetic. One was that of Sereno S. Pratt of the Wall Street Journal. Pratt virtually conceded that the purpose of the commission was to swamp the public with supposed expertise and thereby “educate” them into supporting banking reform:

  Reform can only be brought about by educating the people up to it, and such education must necessarily take much time. In no other way can such education be effected more thoroughly and rapidly than by means of a commission... [that] would make an international study of the subject and present an exhaustive report, which could be made the basis for an intelligent agitation.

  The results of the “study” were of course predetermined, as would be the membership of the allegedly impartial study commission.

  Another function of the commission, as stated by Festus J. Wade, St. Louis banker and member of the currency commission of the American Bankers Association, was to “keep the financial issue out of politics” and put it squarely in the safe custody of carefully selected “experts.”64 Thus, the National Monetary Commission (NMC) was the apotheosis of the clever commission concept, launched in Indianapolis a decade earlier.

  Aldrich lost no time setting up the NMC, which was launched in June 1908. The official members were an equal number of senators and representatives, but these were mere window dressing. The real work would be done by the copious staff, appointed and directed by Aldrich, who told his counterpart in the House, Cleveland Republican Theodore Burton: “My idea is, of course, that everything shall be done in the most quiet manner possible, and without any public announcement.” From
the beginning, Aldrich determined that the NMC would be run as an alliance of Rockefeller, Morgan, and Kuhn, Loeb people. The two top expert posts advising or joining the commission were both suggested by Morgan leaders. On the advice of J.P. Morgan, seconded by Jacob Schiff, Aldrich picked as his top adviser the formidable Henry P. Davison, Morgan partner, founder of Morgan’s Bankers Trust Company, and vice president of George F. Baker’s First National Bank of New York. It would be Davison who, on the outbreak of World War I, would rush to England to cement J.P. Morgan and Company’s close ties with the Bank of England, and to receive an appointment as monopoly underwriter for all British and French government bonds to be floated in the United States for the duration of the war. For technical economic expertise, Aldrich accepted the recommendation of President Roosevelt’s close friend and fellow Morgan man, Charles Eliot, president of Harvard University, who urged the appointment of Harvard economist A. Piatt Andrew. And an ex officio commission member chosen by Aldrich himself was George M. Reynolds, president of the Rockefeller-oriented Continental National Bank of Chicago.

  The NMC spent the fall touring Europe and conferring on information and strategy with heads of large European banks and central banks. As director of research, A. Piatt Andrew began to organize American banking experts and to commission reports and studies. The National City Bank’s foreign exchange department was commissioned to write papers on bankers’ acceptances and foreign debt, while Warburg and Bankers Trust official Fred Kent wrote on the European discount market.