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

by Murray N. Rothbard

  Thus, we see the grave error of the familiar Milton Friedman-monetarist myth that the Federal Reserve either deliberately contracted the money supply after 1931 or at least passively allowed such contraction. The Fed, under Meyer, did its mightiest to inflate the money supply—yet despite its efforts, total bank reserves only rose by $212 million, while the total money supply fell by $3 billion. How could this be?

  The answer to the mystery is that the inflationary policies of Hoover and Meyer proved to be counterproductive. American citizens lost confidence in the banks and demanded cash—Federal Reserve notes—for their deposits (currency in circulation rising by $122 million by the end of July), while foreigners lost confidence in the dollar and demanded gold (the gold stock in the United States falling by $380 million in this period). In addition, the banks, for the first time, did not fully lend out their new reserves, and accumulated excess reserves—these excess reserves rising to 10 percent of total reserves by mid-year. A common explanation claims that business, during a depression, lowered its demand for loans, so that pumping new reserves into the banks was only “pushing on a string.” But this popular view overlooks the fact that banks can always use their excess reserves to buy existing securities; they don’t have to wait for new loan requests. Why didn’t they do so? Because the banks were whipsawed between two forces. On the one hand, bank failures had increased dramatically during the depression. Whereas during the 1920s, in a typical year 700 banks failed, with deposits totaling $170 million, since the depression struck, 17,000 banks had been failing per year, with a total of $1.08 billion in deposits. This increase in bank failures could give any bank pause, especially since all the banks knew in their hearts that, as fractional reserve banks, none of them could withstand determined and massive runs upon them by their depositors. Second, just at a time when bank loans were becoming risky, the cheap-money policy of the Fed had driven down interest returns from bank loans, thus weakening banks’ incentive to bear risk. Hence the piling up of excess reserves. The more that Hoover and the Fed tried to inflate, the more worried the market and the public became about the dollar, the more gold flowed out of the banks, and the more deposits were redeemed for cash.

  Professor Seymour Harris, writing at the time and years before he became one of America’s leading Keynesians, concluded perceptively that the hard-money critics of the Hoover administration might have been right, and that it might be that the Fed’s heavy open market purchases of government securities from 1930 to 1932 “retarded the process of liquidation and reduction of costs, and therefore have accentuated the depression.”43

  Herbert Hoover, of course, reacted quite differently to the abject failure of his inflationist program. Instead of blaming himself, he blamed the banks and the public. The banks were to blame by piling up excess reserves instead of making dangerous loans. By late May, Hoover was “disturbed at the apparent lack of cooperation of the commercial banks of the country in the credit expansion drive.” Eugene Meyer’s successor at the RFC, former Ohio Democratic Senator Atlee Pomerene, denounced the laggard banks bitterly: “I measure my words, the bank that is 75 percent liquid or more and refuses to make loans when proper security is offered, under present circumstances, is a parasite on the community.” Hoover also went to the length of getting Treasury Secretary Ogden Mills to organize bankers and businessmen to lend or borrow the surplus credit piled up in the banks. Mills established a committee in New York City on May 19 headed by Owen D. Young, chairman of the board of Morgan’s General Electric Corporation, and the Young Committee tried to organize a cartel to support bond prices, but the committee, despite its distinguished personnel, failed dismally to form a cartel that could defeat market forces.44 The idea died quickly.

  Not content with denouncing the banks, President Hoover also railed against the public for cashing in bank deposits for cash or gold. Stung by the public’s redeeming $800 million of bank deposits for cash during 1931, Hoover organized a hue and cry against “traitorous hoarding.” On February 3, 1932, Hoover established a new Citizens’ Reconstruction Organization (CRO) headed by Colonel Frank Knox of Chicago. The cry went up from the CRO that the hoarder is unpatriotic because he restricts and destroys credit. (That is, by trying to redeem their own property and by trying to get the banks to redeem their false and misleading promises, the hoarders were exposing the unsound nature of the bank credit system.) On February 6, top-level antihoarding patriots met to coordinate the drive; they included General Charles Dawes, Eugene Meyer, Secretary of Commerce Robert P. Lamont, and Treasury Secretary Ogden Mills. A month later, Hoover delivered a public address on the evils of hoarding: “the battle front today is against the hoarding of currency,” which prevents money from going into active circulation and thereby lifting us out of the depression.

  President Hoover later took credit for this propaganda drive putting a check on hoarding, and it is true that cash in circulation reached a peak of $5.44 billion in July 1932, not rising above that until the culminating bank crisis in February 1933. But if true, so much the worse, for that means that bank liquidation was postponed for a year until the final banking crisis of 1933.

  THE NEW DEAL: GOING OFF GOLD

  The international monetary system that the House of Morgan helped Great Britain cobble together in 1925 lay in ruins when Britain hastily abandoned the gold-exchange standard in late September 1931. The Morgans tried desperately to keep Britain on gold in 1931, and afterward tried to get their bearings in the newly chaotic monetary arena. By the time of Roosevelt’s accession to power in the spring of 1933, the Morgans had thrown in the towel on the American gold-coin standard; indeed, the Morgan-oriented leadership at the Treasury, Mills and Ballantine, had been agitating for going off gold considerably earlier.45 But the overriding Morgan concern was always their associates and colleagues in England, and they hoped for a rapid return to some kind of fixed-exchange-rate relation to Britain, and perhaps, by extension, to the other major European currencies as well. The Morgans wanted to reconstruct a regime of monetary internationalism as soon as possible.

  But for the first time since the turn of the century, the Morgans were no longer dominant over the monetary thinking of American financial and business elites. In the midst of the cauldron of depression, a new economic and monetary nationalism, a desire for domestic inflation untrammelled by international monetary responsibilities, began to take hold. Backed by proto-monetarist and proto-Keynesian economists eager to spur inflationist federal policies to cure the depression, the shift of business groups toward inflation centered in farm and agribusiness groups, which had been agitating for higher farm prices since the early 1920s, and in industrialists making products for the retail market, who wanted government to pour new money into consumption spending. Thus, in January 1933, powerful business groups formed The Committee for the Nation (more formally, The Committee for the Nation to Rebuild Prices and Purchasing Power), dedicated to getting the government to “reflate” prices back up to 1929 levels, and to get off the gold standard so that the government could issue fiat paper money for that purpose. The co-defenders of The Committee for the Nation were Vincent Bendix, head of Bendix Aviation, and General Robert E. Wood, head of the mighty retail combine of Sears, Roebuck. Others who soon joined them were Frank A. Vanderlip, former president of the National City Bank of New York—the flagship bank in the Rockefeller orbit; James H. Rand, Jr., president of Remington Rand Company, manufacturer of typewriters and other retail products; Lessing Rosenwald, major owner of Sears, Roebuck; Samuel S. Fels, producer of Fels Naptha; Philip K. Wrigley, head of William J. Wrigley Company; E.L. Cord of the Cord automobile company; William J. McAvenny, president of Hudson Motor Company; R.F. Wurlitzer, producer of Wurlitzer musical instruments; Frederic H. Frazier, chairman of the board of the General Baking Company; and a galaxy of farm leaders: Fred H. Sexauer, president of the Dairymen’s League Cooperative Association; Edward A. O’Neal, head of the American Farm Bureau Federation; and Louis J. Taber, head of the Natio
nal Grange. It should also be noted that Rockefeller’s petroleum products were of course goods largely sold at retail.46

  Another emboldened inflationist group was the silver mining interest, centered in the Mountain states, which seemingly had lost out permanently to the McKinley and Republican gold forces in the 1890s. Mountain-state senators led the silver bloc in Congress, and Senator Burton K. Wheeler (D-Mont.) introduced a bimetallic bill to reinstitute the silver-gold standard at the old nineteenth-century ratio of 16-to-1. Leading theoretician and lobbyist for the silver bloc was New York banker Rene Leon, who got himself appointed as adviser to the House Ways and Means Committee in unsuccessfully pressing for an international conference to raise silver prices.

  More generally, the Rockefeller and Harriman forces had been allied against the Morgans since the turn of the century, and now they and other rising financial groups banded together avidly to overthrow and dethrone the financial and political dominance achieved by the House of Morgan during the Republican decade of the 1920s. Again influential in the new Democratic regime was the veteran speculator and political manipulator Bernard Baruch, who had been czar of the collectivized economy as head of the War Industries Board in World War I, and who yearned to re-establish a similar, collectivist cartelized regime in peacetime, using the depression as the means for achieving this goal. Baruch, since childhood, had been a protégé of the powerful Guggenheim family, who controlled the American copper industry, but who liked to keep a low political profile and operate through Baruch and his network of operatives.

  Newer Jewish Wall Street investment banking houses, more anti-Morgan than Kuhn, Loeb, were also rising to help challenge Morgan: notably, Goldman, Sachs and Lehman Brothers, the Lehman family contributing New Deal governor of New York Herbert H. Lehman to the American political scene. Furthermore, Jewish retail interests, led by the Boston Filene brothers, were in favor of more inflation and consumer spending; and longtime Filene and retailer attorney Louis D. Brandeis had become powerful in the Democratic Party, and was helping run the New Deal surreptitiously from his seat on the U.S. Supreme Court. Brandeis was a longtime enemy of the Morgans, as attorney for opposing corporate interests, and a dedicated supporter of retail cartels supported by the government.

  Moreover, all these financial and industrial groups were swinging notably leftward, not simply in monetary matters, but also in advocating far more government intervention, including promotion of labor unions, than the Morgans were willing to accept. Thus, these anti-Morgan groups, now gathered in the Democratic Party, were happy to form a coalition with left-wing intellectuals, technocrats, economists, and social workers who wished to staff the planning agencies, all to advance their common New Deal and ultra-statist agenda.

  Particularly powerful in the New Deal and in the Democratic Party was the underrated W. Averell Harriman, scion of the great Harriman interests and longtime enemy of the Morgans. Harriman dominated a highly influential new agency set up in the New Deal, the Business Advisory Council (BAC) of the Department of Commerce, which transmitted the influence of the pro-New Deal wing of industry and finance. Also dominant in the BAC was Sidney J. Weinberg of Goldman, Sachs. The Franklin Roosevelt–Hyde Park–Democrat wing of the Roosevelt family had always been close to their Hudson Valley neighbors, the Astors and the Harrimans,47 whereas the Oyster Bay–Theodore Roosevelt–Republican wing of the family had always been close to the Morgans.48

  To return to monetary policy: Eugene Meyer, who, after all, had three years to go in a ten-year term as governor of the Federal Reserve Board, refused President Hoover’s request to resign immediately upon the inauguration of President Roosevelt. But Meyer found out quickly that he could not agree to going off the gold standard and an inflationary higher gold price, and he tendered his resignation as Fed chief in early May 1933.

  President Roosevelt’s early monetary appointments sent an important signal of his new orientation and policies. To succeed Meyer, Roosevelt appointed his friend, the young Georgia banker Eugene R. Black, who had been governor of the Federal Reserve Bank of Atlanta. Black’s orientation may be gauged by the fact that, when he left the Fed a year later, he was to spend 16 years climbing up the executive ladder at the powerful Chase National Bank, which by this time had shifted firmly from the Morgan to the Rockefeller camp (see “Banking and Financial Legislation: 1933–1935,” p. 308). Indeed, for the rest of his working life, Eugene Black was to serve at Chase as protégé of none other than the eminent Winthrop W. Aldrich, chairman of the board at Chase and a close kinsman of the Rockefeller family.49

  Roosevelt’s first secretary of the Treasury was William H. Woodin, who received the appointment after it was turned down by Melvin Traylor, president of the First National Bank of Chicago, one of the main commercial banks in the Rockefeller orbit. Woodin had spent most of his career as a high official of the American Car and Foundry Company in New York, and was now chairman of the board of the American Locomotive Company. Woodin was also a director of such important enterprises as the Harriman-controlled American Ship and Commerce Corporation, as well as the Rockefeller-dominated Remington Arms Company. He had also been a founding director of the County Trust Company of New York, along with the influential Vincent Astor and Herbert H. Lehman. Woodin’s financial associations in New York were therefore in the Harriman-Astor-Lehman-Rockefeller ambit rather than in the Morgan network.

  Ill health forced Woodin to resign in December 1933, however, and his place was taken by Henry Morgenthau, Jr., who was to be an important and controversial Treasury secretary for the remainder of Roosevelt’s reign in office. Morgenthau, who rose from undersecretary, was a longtime friend and neighbor of Roosevelt’s, and a gentleman-farmer interested in agriculture. He was backed by his wealthy father, who had been ambassador to Turkey under Wilson, but more important was Henry Jr.’s close links to the powerful investment banking family of Lehman Brothers. Indeed, Henry Jr. was married to a Lehman (her mother was a sister of Herbert H. and Arthur Lehman), and Henry’s nephew Jules Ehrich had married a sister of Philip Lehman. Moreover, Henry Sr. had long been a major stockholder of the Underwood Typewriter Company, and several of his fellow board members were Philip Lehman; Philip’s cousin Arthur Lehman; Maurice Wertheim, who had married Henry Jr.’s sister, Alma; and Waddill Catchings, a top official of Goldman, Sachs.50

  Two fateful monetary steps were taken in 1933 by the incoming Roosevelt administration. The first and most revolutionary deed, accomplished in April, was to go off the gold standard, to confiscate almost all the gold of American citizens and place it under the ownership of the Federal Reserve, to embargo the export of gold and to devalue the dollar to $35 a gold ounce. This swift policy carried out almost completely the program of The Committee for the Nation. But in March and April even the Morgans had been convinced by the banking crisis to go off gold. Democratic Morgan partner Russell Leffingwell was influential in urging Roosevelt to go off gold and devalue the dollar, and Jack Morgan himself applauded Roosevelt’s decision to inflate and go off gold.

  The major theoretician of the inflationists, who had liquidated the assets of his own prior Stable Money Association into The Committee for the Nation, was Yale Professor Irving Fisher, the intellectual forerunner of Milton Friedman (who has hailed Fisher as “the greatest economist of the twentieth century”) and who mechanistically had believed that since the price level was not rising in the 1920s, there was no inflation to worry about and no coming crash. Fisher strongly urged the inflationist devaluation and fiat standard upon Roosevelt, who had asked him for advice. When Roosevelt cast the die against gold, Fisher exulted to his wife, “Now I am sure—as far as we ever can be sure of anything—that we are going to snap out of this depression fast. I am now one of the happiest men in the world.”

  Fisher had a personal as well as an ideological stake in rapid inflation. Sure of a permanent prosperity and stock boom in the late 1920s, he had invested all of his wife’s and most of his sister-in-law’s substantial Hazard f
amily fortune in the stock market, and he was desperately anxious for Roosevelt to reflate and to drive up stock prices. As Fisher added in the same letter to his wife: “I mean that if F.D.R. had followed Glass [who had urged him to stay on gold] we would have been pretty surely ruined.” As it happened, the fiat money policy did not restore the stock market and Fisher’s and his wife’s and sister-in-law’s fortune was ruined by his unwise speculations—a mute testimony to the unsoundness of Fisherine monetarism in explaining or counteracting business cycles.51

  On the other side of the gold-standard decision were the bulk of the nation’s economists, who signed a mass petition urging immediate return to gold. They were led by two doughty hard-money men: Dr. H. Parker Willis, who had staunchly opposed the Strong-Morgan inflationism of the 1920s and urged rapid liquidation of unsound assets to promote recovery; and Dr. Benjamin M. Anderson, longtime hard-money economist of Chase National Bank, who had influenced Chase President Albert Wiggin in favor of hard-money and laissez-faire policies. In the executive branch, the major opponent of the new fiat regime was Lewis W. Douglas, Arizona scion of the Phelps Dodge copper mining interests, and Roosevelt’s head of the Bureau of Budget. The fiscally conservative Douglas had, in early 1933, persuaded Roosevelt to make severe cuts in the proposed appropriations of the executive agencies.

  Even though monetary nationalism had triumphed, the Morgan interests and the other monetary internationalists were anxious to re-establish fixed exchange rates with Britain, and to rebuild the special relationship with Morgan allies in Britain and western Europe. The ultra-inflationists, led by The Committee for the Nation, were strongly opposed to fixed exchange rates with Britain and wanted to press ahead with monetary or dollar nationalism, higher gold prices, and continued inflation.