A History of Money and Banking in the United States: The Colonial Era to World War II (34 page)

Young and William W. Cumberland. In the mid-1920s, the
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A History of Money and Banking in the United States:
The Colonial Era to World War II

money doctor served as president of the American Economic Association.53

JACOB SCHIFF IGNITES

THE DRIVE FOR A CENTRAL BANK

The defeat of the Fowler Bill for a broader asset currency and branch banking in 1902, coupled with the failure of Treasury Secretary Shaw’s attempts of 1903–1905 to use the Treasury as a central bank, led the big bankers and their economist allies to adopt a new solution: the frank imposition of a central bank in the United States.

The campaign for a central bank was kicked off by a fateful speech in January 1906 by the powerful Jacob H. Schiff, head of the Wall Street investment bank of Kuhn, Loeb and Company, before the New York Chamber of Commerce. Schiff complained that in the autumn of 1905, when “the country needed money,” the Treasury, instead of working to expand the money supply, reduced government deposits in the national banks, thereby precipitating a financial crisis, a “disgrace” in which the New York clearinghouse banks had been forced to contract their loans drastically, sending interest rates sky-high. An “elastic currency” for the nation was therefore imperative, and Schiff urged the New York chamber’s committee on finance to draw up a comprehensive plan for a modern banking system to provide for an elastic currency.54 A colleague who had already been agitating for a central bank behind the scenes was Schiff’s partner, Paul Moritz Warburg, who had suggested the plan to Schiff as early as 1903.

Warburg had emigrated from the German investment firm of M.M. Warburg and Company in 1897, and before long his major 53For an excellent study of the Kemmerer missions in the 1920s, see Robert N. Seidel, “American Reformers Abroad: The Kemmerer Missions in South America, 1932–1931,”
Journal of Economic History
32 (June 1972): 520–45.

54On Schiff’s speech, see
Bankers Magazine
72 (January 1906): 114–15.

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235

function at Kuhn, Loeb was to agitate to bring the blessings of European central banking to the United States.55

It took less than a month for the finance committee of the New York chamber to issue its report, but the bank reformers were furious, denouncing it as remarkably ignorant. When Frank A. Vanderlip, of Rockefeller’s flagship bank, the National City Bank of New York, reported on this development, his boss, James Stillman, suggested that a new five-man special commission be set up by the New York chamber to come back with a plan for currency reform.

In response, Vanderlip proposed that the five-man commission consist of himself; Schiff; J.P. Morgan; George Baker of the First National Bank of New York, Morgan’s closest and longest associate; and former Secretary of the Treasury Lyman Gage, now president of the Rockefeller-controlled U.S. Trust Company. Thus, the commission would consist of two Rockefeller men (Vanderlip and Gage), two Morgan men (Morgan and Baker), and one representative from Kuhn, Loeb. Only Vanderlip was available to serve, however, so the commission had to be redrawn. In addition to Vanderlip, beginning in March 1906, there sat, instead of Schiff, his close friend Isidore Straus, a director of R.H. Macy and Company. Instead of Morgan and Baker there now served two Morgan men: Dumont Clarke, president of the American Exchange National Bank and a personal adviser to J.P. Morgan, and Charles A. Conant, treasurer of Morton and Company. The fifth man was a veteran of the Indianapolis Monetary Convention, John Claflin, of H.B. Claflin 55Schiff and Warburg were related by marriage. Schiff, from a prominent German banker family himself, was a son-in-law of Solomon Loeb, cofounder of Kuhn, Loeb; and Warburg, husband of Nina Loeb, was another son-in-law of Solomon Loeb’s by a second wife. The incestuous circle was completed when Schiff’s daughter Frieda married Paul Warburg’s brother Felix, another partner of Schiff’s and Paul Warburg’s. See Birmingham,
Our Crowd
, pp. 21, 209–10, 383, and appendix. See also Jacques Attali,
A Man of Influence: Sir Siegmund Warburg, 1902–82
(London: Weidenfeld and Nicholson, 1986), p. 53.

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

and Company, a large integrated wholesaling concern. Coming on board as secretary of the new currency committee was Vanderlip’s old friend Joseph French Johnson, now of New York University, who had been calling for a central bank since 1900.

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

56See Livingston,
Origins
, pp. 159–64.

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237

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

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.

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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

57Livingston,
Origins
, pp. 168–69.

58See the collection of Warburg’s essays in Paul M. Warburg,
The
Federal Reserve System,
2 vols. (New York: Macmillan, 1930). See also Warburg, “Essays on Banking Reform in the United States,”
Proceedings of
the Academy of Political Science
4 (July 1914): 387–612.

59When the Federal Reserve System was established, Warburg boasted of his crucial role in persuading the Fed to create an acceptance market in the U.S. by agreeing to purchase all acceptance paper available from a few large acceptance banks at subsidized rates. In that way, the Fed provided an unchecked channel for inflationary credit expansion. The acceptance program helped pave the way for the 1929 crash.

It was surely no accident that Warburg himself was the principal ben-eficiary of this policy. Warburg became chairman of the board, from its founding in 1920, of the International Acceptance Bank, the world’s
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A History of Money and Banking in the United States:
The Colonial Era to World War II

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 bank, and more important, mobilizing public opinion on its behalf. The first step in such mobilization was to win the support of the largest acceptance bank, as well as director of the Westinghouse Acceptance Bank and of several other acceptance houses. In 1919, Warburg was the chief founder and chairman of the executive committee of the American Acceptance Council, the trade association of acceptance houses. See Murray N. Rothbard,
America’s Great Depression,
4th ed. (New York: Richardson and Snyder, 1983), pp. 119–23.