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

by Murray N. Rothbard

  While secretary of commerce, Herbert Hoover had been a severe critic of Strong’s inflationary policies. Unfortunately, however, Hoover was in favor of a different form of easy money and cheap credit. When he became president, he tried, like King Canute, to hold back the tides by continuing to generate cheap bank credit, and then using “moral suasion” to exhort banks and other lenders not to lend money for the purchase of stock. Hoover suffered from the fallacious view that industrial credit was productive and “legitimate” while financial, stock market credit was “unproductive.” Moreover, he believed that valuable capital funds somehow got lost, or “absorbed,” in the stock market and therefore became lost to productive credit. Hoover employed methods of intimidation of business that had been honed when he was food czar in World War I and then secretary of commerce, now trying to get banks to restrain stock market loans and to induce the New York Stock Exchange to curb speculation. Roy Young, Hoover’s new appointee as governor of the Federal Reserve Board, suffered from the same fallacious view. Partly responsible for the Hoover administration’s adopting this policy was the wily manipulator Montagu Norman, head of the Bank of England, and close friend of the late Benjamin Strong, who had persuaded Strong to inflate credit in order to help England’s disastrous gold-exchange policy. Norman, it might be added, was very close to the Morgan, Grenfell bank.

  By June 1929, it was clear that the absurd policy of moral suasion had failed. Seeing the handwriting on the wall, Norman switched, and persuaded the Fed to resume its old policy of inflating reserves through subsidizing the acceptance market by purchasing all acceptances offered at a subsidized rate—a policy the Fed had abandoned in the spring of 1928.13

  Despite this attempt to keep the boom going, however, the money supply in the United States leveled off by the end of 1928, and remained more or less constant from then on. This ending of the massive credit expansion boom made a recession inevitable, and sure enough, the American economy began to turn down in July 1929. Feverish attempts to keep the stock market boom going, however, managed to boost stock prices while the economic fundamentals were turning sour, leading to the famous stock market crash of October 24.

  This crash was an event for which Herbert Hoover was ready. For a decade, Herbert Hoover had urged that the United States break its age-old policy of not intervening in cyclical recessions. During the postwar 1920–1921 recession, Hoover, as secretary of commerce, had unsuccessfully urged President Harding to intervene massively in the recession, to “do something” to cure the depression, in particular to expand credit and to engage in a massive public-works program. Although the United States got out of the recession on its own, without massive intervention, Hoover vowed that next time it would be different. In late 1928, after he was elected president, Hoover presented a public works scheme, the “Hoover Plan” for “permanent prosperity,” for a pact to “outlaw depression,” to the Conference of Governors. Hoover had adopted the scheme of the well-known inflationists Foster and Catchings, for a mammoth $3 billion public-works plan to “stabilize” business cycles. William T. Foster was the theoretician and Waddill Catchings the financier of the duo; Foster was installed as head of the Pollak Foundation for Economic Research by Catchings, iron and steel magnate and investment banker at the powerful Wall Street firm of Goldman, Sachs.14

  When the stock market crash came in October 1929, therefore, President Hoover was ready for massive intervention to attempt to raise wage rates, expand credit, and embark on public works. Hoover himself recalls that he was the very first president to consider himself responsible for economic prosperity: “therefore, we had to pioneer a new field.” Hoover’s admiring biographers correctly state that “President Hoover was the first president in our history to offer federal leadership in mobilizing the economic resources of the people.” Hoover recalls it was a “program unparalleled in the history of depressions.”15 The major opponent of this new statist dogma was Secretary of the Treasury Mellon, who, though one of the leaders in pushing the boom, now at least saw the importance of liquidating the mal-investments, inflated costs, prices, and wage rates of the inflationary boom. Mellon, indeed, correctly cited the successful application of such a laissez-faire policy in previous recessions and crises. But Hoover overrode Mellon, with the support of Treasury Undersecretary Ogden Mills.

  If Hoover stood ready to impose an expansionist and interventionist New Deal, Morgan man George L. Harrison, head of the New York Fed and major power in the Federal Reserve, was all the more ready to inflate. During the week of the crash, the last week of October, the Fed doubled its holdings of government securities, adding $150 million to bank reserves, as well as discounting $200 million more for member banks. The idea was to prevent liquidation of the bloated stock market, and to permit the New York City banks to take over the loans to stockbrokers that the nonbank lenders were liquidating. As a result, member banks of the Federal Reserve expanded their deposits by $1.8 billion—a phenomenal monetary expansion of nearly 10 percent in one week! Of this increase, $1.6 billion were increased deposits of the New York City banks. In addition, Harrison drove down interest rates, lowering its discount rates to banks from 6 percent to 4.5 percent in a few weeks.

  Harrison conducted these actions with a will, overriding the objections of Federal Reserve Board Governor Roy Young, proclaiming that “the Stock Exchange should stay open at all costs,” and announcing, “Gentlemen, I am ready to provide all the reserve funds that may be needed.”16

  By mid-November, the great stock break was over, and the market, artificially buoyed and stimulated by expanding credit, began to move upward again. With the stock market emergency seemingly over, bank reserves were allowed to decline, by the end of November, by about $275 million, to just about the level before the crash. By the end of the year, total bank reserves at $2.35 billion were almost exactly the same as they had been the day before the crash, or at the end of November, with total bank deposits increasing slightly during this period. But while the aggregates of factors determining reserves were the same, their distribution was very different. Fed ownership of government securities had increased by $375 million during these two months, from the level of $136 million before the crash, but the expansion had been offset by lower bank loans from the Fed, by greater money in circulation, and by people drawing $100 million of gold out of the banking system. In short, the Fed tried its best to inflate a great deal more, but its expansionary policy was partially thwarted by increasing caution and by withdrawal of money from the banking system by the general public.

  Here we see, at the very beginning of the Hoover era, the spuriousness of the monetarist legend that the Federal Reserve was responsible for the great contraction of money from 1929 to 1933. On the contrary, the Fed and the administration tried their best to inflate, efforts foiled by the good sense, and by the increasing distrust of the banking system, of the American people.

  At any rate, even though the Fed had not managed to inflate the money supply further, President Hoover was proud of his experiment in cheap money, and of the Fed’s massive open market purchases. In a speech to a conference of industrial leaders he had called together in Washington on December 5, the president hailed the nation’s good fortune in possessing the splendid Federal Reserve System, which had succeeded in saving shaky banks, restoring confidence, and making capital more abundant by lowering interest rates. Hoover had personally done his part by urging banks to discount more at the Fed, while Secretary Mellon reverted to his old Pollyanna mode in assuring one and all that there was “plenty of credit available.” Hoover admirer William Green, head of the American Federation of Labor, proclaimed that the “Federal Reserve System is operating, serving as a barrier against financial demoralization. Within a few months industrial conditions will become normal, confidence and stabilization in industry and finance will be restored.”17

  By the end of 1929, Roy Young and other Fed officials favored pursuing a laissez-faire policy “to let the money market ‘sweat it out�
� and reach monetary ease by the wholesome process of liquidation.”18 Once again, however, Harrison and the New York Fed overruled Washington, and instituted a massive easy-money program. Discount rates of the New York Fed fell from 4.5 percent in February to 2 percent at the end of 1930. Other short-term interest rates fell similarly. Once again, the New York Fed led the inflationist parade by purchasing $218 million of government securities during the year; the resulting increase of $116 million in bank reserves, however, was offset by bank failures in the latter part of the year, and by enforced contraction on the part of the shaky banks remaining in business. As a result, total money supply remained constant throughout 1930. Expansion was also cut short by the fact that the stock market boomlet early in the year had collapsed by the spring.

  During the year, however, Montagu Norman was able to achieve part of his long-standing wish for formal collaboration between the world’s major central banks. Norman pushed through a new central bankers’ bank, the Bank for International Settlements (BIS), to meet regularly at Basle, and to provide regular facilities for cooperation. While the suspicious Congress forbade the Fed from joining the BIS formally, the New York Fed and its allied Morgan interests were able to work closely with the new bank. The BIS, indeed, treated the New York Fed as if it were the central bank of the United States. Gates W. McGarrah resigned as chairman of the board of the New York Fed in February to assume the position of president of the BIS, while Jackson E. Reynolds, a director of the New York Fed particularly close to the Morgan interests, became chairman of the BIS’s organizing committee.19 Unsurprisingly, J.P. Morgan and Company supplied much of the capital for the new BIS. And even though there was no legislative sanction for U.S. participation in the bank, New York Fed Governor George Harrison made a “regular business trip” abroad in the fall to confer with the other central bankers, and the New York Fed extended loans to the BIS during 1931.20

  Late 1930 was perhaps the last stand of the laissez-faire, sound-money liquidationists. Professor H. Parker Willis, a tireless critic of the Fed’s inflationism and credit expansion, attacked the current easy money policy of the Fed in an editorial in the New York Journal of Commerce.21 Willis pointed out that the Fed’s easy-money policy was actually bringing about the rash of bank failures, because of the banks’ “inability to liquidate” their unsound loans and assets. Willis noted that the country was suffering from frozen wasteful malinvestments in plants, buildings, and other capital, and maintained that the depression could only be cured when these unsound credit positions were allowed to liquidate. Similarly, Albert Wiggin, head of Chase National Bank, clearly reflecting the courageous and uncompromising views of the Chase bank’s chief economist, Dr. Benjamin M. Anderson, denounced the Hoover policy of propping up wage rates and prices in depressions, and of pursuing inflationary cheap money, saying, “Our depression has been prolonged and not alleviated by delay in making necessary readjustments.”22

  On the other hand, Business Week, then as now a spokesman for “enlightened” business opinion, thundered in late October 1930 that the “deflationists” were “in the saddle.”23

  In August 1930, however, President Hoover took another decisive step in favor of inflationism by replacing Roy Young as chairman of the Federal Reserve Board by the veteran speculator and government official Eugene Meyer, Jr.

  THE ADVENT OF EUGENE MEYER, JR.

  Eugene Meyer, Jr., differed from Strong and Harrison in not being totally in the Morgan camp. Meyer’s father, an immigrant from France, had spent all his life in the employ of the French international banking house of Lazard Frères, finally rising to the post of partner of Lazard’s New York branch. Eugene, Jr., early broke out from Lazard on his on and became a successful speculator, investor and financier, an associate of the Morgans, and even more closely an associate of Bernard Baruch and Baruch’s patrons, the powerful Guggenheim family, in virtual control of the American copper industry. It is true, however, that Meyer’s brother-in-law, George Blumenthal, had left this post at Lazard to be a high official in J.P. Morgan and Company, and that Meyer himself had once acted as a liaison between the Morgans and the French government.24 By the 1920s, Meyer’s major financial base was his control of the mighty integrated chemical firm, Allied Chemical and Dye Corporation.25

  Before World War I, Meyer’s major financial involvement had been with the Guggenheims and the copper industry. By 1910, he was so prominent in the copper industry that he was able to arrange a cartel agreement between his old patrons, the Guggenheims, and Anaconda Copper, each agreeing to cut its production by 7.5 percent. In the same year, Meyer discovered in London a highly productive and profitable new process for mining copper, and was quickly able to become its franchiser in the United States.26

  It should not be surprising, then, that, under the regime of World War I collectivism, Meyer began, first, in early 1917, as head of the nonferrous metals unit of Bernard Baruch’s Raw Materials Committee under the Advisory Commission of the Council of National Defense. The nonferrous metals unit included copper, lead, zinc, antimony, aluminum, nickel, and silver. When the War Industries Board took over the task of collectivist planning of industry in August 1917, Meyer assumed the same task there—and was also to become the virtual “czar” of the copper industry.27

  More important for his eventual role in the Hoover administration was Meyer’s crucial part in the War Finance Corporation (WFC). The WFC had been set up by Secretary of the Treasury McAdoo in May 1918, ostensibly to finance industries essential to the war effort. Meyer was named the WFC’s managing director. The WFC massively subsidized American industry. During the war, it had two basic functions. One was acting as agent of the Treasury to prop up the market for U.S. government bonds. During the last six months of the war, Meyer spent $378 million to keep government bonds from falling by more than one-quarter point a day, and later resold the bonds to the Treasury at the cost of purchase.

  The second and dominant function of the WFC was to subsidize and bail out firms and industries in trouble, allegedly “essential” to the war effort. The WFC began with an authorized capital of $500 million supplied by the Treasury, and with the power to borrow up to $3 billion through the issue of bonds. Its major focus was on utilities, railroads, and the banks that had financed them. Banks were also under strain because many of their savings deposits had been drawn down to help finance the federal deficit. All in all, during the war, the WFC made loans of $71 million, in addition to its bond-price operations.

  It was clear that the essential mission of the WFC acted as a camouflage for a government subsidy operation. As Meyer’s approving biographer writes: “The WFC had been created as a rescue mission for essential war-disrupted industries, and Meyer had shaped it into a powerful instrument of public policy.”28

  If the WFC, and for that matter the rest of the apparatus of war collectivism, had been strictly war-related, they all would have been dropped swiftly as soon as the Armistice was signed on November 11, 1918. But on the contrary, Baruch, Meyer, the War Industries Board, and most business leaders were anxious to continue the benefits of collectivism indefinitely after the war was over. The goals were twofold: price controls to keep prices up during the expected postwar recession; and a permanent peacetime cartelization of American industry enforced by the federal government. Permanent cartelization was endorsed by the U.S. Chamber of Commerce and by the National Association of Manufacturers. President Wilson, however, prompted by Secretary of War Newton D. Baker, insisted on scuttling the WIB by the end of 1918. Other aspects of wartime government interventionism continued on, however, not the least of which was the War Finance Corporation.29

  The War Finance Corporation was a striking example of a wartime government agency that refused to die. After the war, the investment bankers were worried that Europeans, shorn of American aid, would no longer be able to keep up the bountiful wartime level of American exports. Hence, the Morgans urged their friends in the Treasury Department to use the WFC to provide credits
to finance American exports, specifically to pay American exporters and then collect the money from foreign importers. While the Wilson administration did not want a permanent government loan program, it persuaded Congress to extend the WFC in March 1919 and to authorize it to lend up to $1 billion over five years to American exporters and to American banks that made export loans.30 Particularly ardent in pressuring Congress was WFC head Eugene Meyer, who had been gravely disappointed when the Wilson administration scuttled the War Industries Board.31

  Meyer happily plunged into making and encouraging export loans and, while in Europe for the peace conference, he tried unsuccessfully to pressure British banks into issuing $600 million in loans to finance British imports, and to keep the overvalued pound from falling to its market levels. To counter the dangerously inflationary postwar boom, President Wilson shifted David F. Houston from the post of agriculture secretary to Treasury secretary, and Houston boldly set about shifting America to a more laissez-faire and deflationary course. Meyer worked feverishly to keep the inflationary boom going, the WFC approving loans totaling $150 million to finance the exports of cotton, tobacco, copper, coal, and steel. But Treasury Secretary Houston refused to give Meyer his required approval. Houston declared, in fact, that he was proposing ending the WFC, in order to complete the government’s withdrawal from all its wartime activities of government intervention in the economy. Houston pointed out that exports had already attained an unprecedented volume in 1919, and that it was important to bring down inflation. Meyer tried every device to persuade Houston, but he couldn’t go over his head to the president because of Wilson’s illness. Finally, Meyer threw in the towel and resigned his post in May 1920.32

  Unfortunately, however, Eugene Meyer was soon back in the saddle. Recession always follows an inflationary boom. A recession hit in the fall of 1921, and the newly burgeoning farm bloc began its long-term drive to get the government to bring the farmer back to the unprecedented good times he had enjoyed from the artificial export boom created by World War I. During the presidential campaign of 1920, Secretary of Treasury Houston bravely resisted the farm bloc, maintaining that the federal government should do nothing to interfere with the inevitable postwar recession. Eugene Meyer, working for the Harding ticket, put himself at the head of the interventionist forces battling his old laissez-faire enemy. When Houston addressed the annual meeting of the American Bankers Association (ABA) in Washington, he refused to speak if the ABA succumbed to pressure by a group of Memphis bankers and businessmen to have Meyer address the group at the same meeting. When Houston’s ploy was successful, the Memphis group of inflationist and interventionist bankers organized a rump meeting nearby featuring the address by Meyer, who led a fervent campaign for restoration of the WFC, this time stressing government financing of agricultural exports.