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The Fed At Last: Morgan-Controlled Inflation

The new Federal Reserve System had finally brought a central bank to America: the push of the big bankers had at last succeeded. Following the crucial plank of post-Peel Act Central Banking, the Fed was given a monopoly of the issue of all bank notes; national banks, as well as state banks, could now only issue deposits, and the deposits had to be redeemable in Federal Reserve Notes as well as, at least nominally, in gold. All national banks were “forced” to become members of the Federal Reserve System, a “coercion” they had long eagerly sought, which meant that national bank reserves had to be kept in the form of demand deposits, or checking accounts, at the Fed. The Fed was now in place as lender of last resort; and with the prestige, power, and resources of the U. S. Treasury solidly behind it, it could inflate more consistently than the Wall Street banks under the National Banking System, and above all, it could and did, inflate even during recessions, in order to bail out the banks. The Fed could now try to keep the economy from recessions that liquidated the unsound investments of the inflationary boom, and it could try to keep the inflation going indefinitely.

At this point, there was no need for even national banks to hold onto gold; they could, and did, deposit their gold into the vaults of the Fed, and receive reserves upon which they could pyramid and expand the supply of money and credit in a coordinated, nation-wide fashion. Moreover, with reserves now centralized into the vaults of the Fed, bank reserves could be, as the bank apologists proclaimed, “economized,” i.e., there could be and was more inflationary credit, more bank “counterfeiting,” pyramided on top of the given gold reserves. There were now three inverted inflationary pyramids of bank credit in the American economy: the Fed pyramided its notes and deposits on top of its newly centralized gold supply; the national banks pyramided bank deposits on top of their reserves of deposits at the Fed; and those state banks who chose not to exercise their option of joining the Federal Reserve System could keep their deposit accounts at national banks and pyramid their credit on top of that. And at the base of the pyramid, the Fed could coordinate and control the inflation by determining the amount of reserves in the member banks.

To give an extra fillip to monetary inflation, the new Federal Reserve System cut in half the average legal minimum reserve requirements imposed on the old national banks. Whereas the national banks before the onset of the Fed were required to keep an average minimum of 20 percent reserves to demand deposits, on which they could therefore pyramid inflationary money and credit of 5:1, the new Fed halved the minimum reserve requirement on the banks to 10 percent, doubling the inflationary bank pyramiding in the country to 10:1.

As luck would have it, the new Federal Reserve System coincided with the outbreak of World War I in Europe, and it is generally agreed that it was only the new system that permitted the U.S. to enter the war and to finance both its own war effort, and massive loans to the allies; roughly, the Fed doubled the money supply of the U.S. during the war and prices doubled in consequence. For those who believe that U.S. entry into World War I was one of the most disastrous events for the U.S. and for Europe in the twentieth century, the facilitating of U.S. entry into the war is scarcely a major point in favor of the Federal Reserve.

In form as well as in content, the Federal Reserve System is precisely the cozy government-big bank partnership, the government-enforced banking cartel, that big bankers had long envisioned. Many critics of the Fed like to harp on the fact that the private bankers legally own the Federal Reserve System, but this is an unimportant legalistic fact; Fed (and therefore possible bank) profits from its operations are taxed away by the Treasury. The benefits to the bankers from the Fed come not from its legal profits but from the very essence of its operations: its task of coordination and backing for bank credit inflation. These benefits dwarf any possible direct profits from the Fed's banking operations into insignificance.

From the beginning, the Fed has been headed by a Federal Reserve Board in Washington, all appointed by the President with the consent of the Senate. The Board supervises the twelve “decentralized” regional Federal Reserve Banks, whose officers are indeed selected by private banks in each region, officers who have to be approved by the Washington Board.

At the outset of the Fed, and until the “reforms” of the 1930s, the major control of the Fed was not in the hands of the Board, but of the Governor (now called “President”) of the Federal Reserve Bank of New York, Wall Street's main man in the Fed System.35 The major instrument of Fed control of the money and banking system is its “open market operations”: its buying and selling of U.S. government securities (or, indeed, any other asset it wished) on the open market. (We will see how this process works below.) Since the U.S. bond market is located in Wall Street, the Governor of the New York Fed was originally in almost sole control of the Fed's open market purchases and sales, and hence of the Federal Reserve itself. Since the 1930s, however, the crucial open market policies of the Fed have been decided by a Federal Open Market Committee, which meets in Washing-ton, and which includes all the seven members of the Board of Governors plus a rotating five of the twelve largely banker-selected Presidents of the regional Feds.

There are two critical steps in the establishment and functioning of any cartel-like government regulation. We cannot afford to ignore either step. Step one is passing the bill and establishing the structure. The second step is selecting the proper personnel to run the structure: there is no point to big bankers setting up a cartel, for example, and then see the personnel fall into the “wrong” hands. And yet conventional historians, not geared to power elite or ruling elite analysis, usually fall down on this crucial second task, of seeing precisely who the new rulers of the system would be.

It is all too clear, on examining the origin and early years of the Fed, that, both in its personnel and chosen monetary and financial policies, the Morgan Empire was in almost supreme control of the Fed.

This Morgan dominance was not wholly reflected in the makeup of the first Federal Reserve Board. Of the seven Board members, at the time two members were automatically and ex officio the Secretary of the Treasury and the Comptroller of the Currency, the regulator of the national banks who is an official in the Treasury Department. The Secretary of Treasury in the Wilson Administration was his son-in-law William Gibbs McAdoo, who, as a failing businessman and railroad magnate in New York City, had been personally befriended and bailed out by J. P. Morgan and his close associates. McAdoo spent the rest of his financial and political life in the Morgan ambit. The Comptroller of the Currency was a long-time associate of McAdoo's, John Skelton Williams. Williams was a Virginia banker, who had been a director of McAdoo's Morgan controlled Hudson & Manhattan Railroad and president of the Morgan-oriented Seaboard Airline Railway.

These Treasury officials on the Board were reliable Morgan men, but they were members only ex officio. Governor (now “Chairman”) of the original board was Charles S. Hamlin, whom McAdoo had appointed as Assistant Secretary of Treasury along with Williams. Hamlin was a Boston attorney who had married into the wealthy Pruyn family of Albany, a family long connected with the Morgan-dominated New York Central Railroad. Another member of the Federal Reserve Board, and a man who succeeded Hamlin as Governor, was William P. G. Harding, a protégé of Alabama Senator Oscar W. Underwood, whose father-in-law, Joseph H. Wood-ward, was vice-president of Harding's First National Bank of Birmingham, Alabama, and head of the Woodward Iron Company, whose board included representatives of both Morgan and Rockefeller interests. The other three Board members were Paul M. Warburg; Frederic A. Delano, uncle of Franklin D. Roosevelt and president of the Rockefeller-controlled Wabash Railway; and Berkeley economics professor Adolph C. Miller, who had married into the wealthy, Morgan-connected Sprague family of Chicago.36

Thus, if we ignore the two Morgan ex-officios, the Federal Reserve Board in Washington began its existence with one reliable Morgan man, two Rockefeller associates (Delano and a leader of close Rockefeller ally, Kuhn, Loeb), and two men of uncertain affiliation: a prominent Alabama banker, and an economist with vague family connections to Morgan interests. While the makeup of the Board more or less mirrored the financial power-structure that had been present at the Fed's critical founding meeting at Jekyll Island, it could scarcely guarantee unswerving Morgan control of the nation's banking system.

That control was guaranteed, instead, by the identity of the man who was selected to the critical post of Governor of the New York Fed, a man, furthermore, who was by temperament very well equipped to seize in fact the power that the structure of the Fed could offer him. That man, who ruled the Federal Reserve System with an iron hand from its inception until his death in 1928, was one Benjamin Strong.37

Benjamin Strong's entire life had been a virtual preparation for his assumption of power at the Federal Reserve. Strong was a long-time protege of the immensely powerful Henry P. Davison, number two partner of the Morgan Bank just under J. P. Morgan himself, and effective operating head of the Morgan World Empire. Strong was a neighbor of Davison's in the then posh suburb of New York, Englewood, New Jersey, where his three closest friends in the world became, in addition to Davison, two other Morgan partners; Dwight Morrow and Davison's main protege as Morgan partner, Thomas W. Lamont. When the Morgans created the Bankers Trust Company in 1903 to compete in the rising new trust business, Davison named Strong as its secretary, and by 1914 Strong had married the firm's president's daughter and himself risen to president of Bankers Trust. In addition, the Davisons raised Strong's children for a time after the death of Strong's first wife; moreover, Strong served J. P. Morgan as his personal auditor during the Panic of 1907.

Strong had long been a voluble advocate of the original Aldrich Plan, and had participated in a lengthy August, 1911 meeting on the Plan with the Senator Davison, Vanderlip and a few other bankers on Aldrich's yacht. But Strong was bitterly disappointed at the final structure of the Fed, since he wanted a “real central bank ... run from New York by a board of directors on the ground”—that is, a Central Bank openly and candidly run from New York and dominated by Wall Street. After a weekend in the country, however, Davison and Warburg persuaded Strong to change his mind and accept the proffered appointment as Governor of the New York Fed. Presumably, Davison and Warburg convinced him that Strong, as effective head of the Fed, could achieve the Wall Street-run banking cartel of his dreams if not as candidly as he would have wished. As at Jekyll Island, Warburg persuaded his fellow cartelist to bow to the political realities and adopt the cloak of decentralization.

After Strong assumed the post of Governor of the New York Fed in October, 1914, he lost no time in seizing power over the Federal Reserve System. At the organizing meeting of the System, an extra-legal council of regional Fed governors was formed; at its first meeting, Strong grabbed control of the council, becoming both its chairman and the chairman of its executive committee. Even after W. P. G. Harding became Governor of the Federal Reserve Board two years later and dissolved the council, Strong continued as the dominant force in the Fed, by virtue of being named sole agent for the open-market operations of all the regional Federal Reserve Banks. Strong's power was further entrenched by U.S. entry into World War I. Before then, the Secretary of the Treasury had continued the legally mandated practice since Jacksonian times of depositing all government funds in its own sub-treasury branch vaults, and in making all disbursements from those branches. Under spur of wartime, however, McAdoo fulfilled Strong's long-standing ambition: becoming the sole fiscal agent for the U.S. Treasury. From that point on, the Treasury deposited its funds with the Federal Reserve.

Not only that: wartime measures accelerated the permanent nationalizing of the gold stock of Americans, the centralization of gold into the hands of the Federal Reserve. This centralization had a twofold effect: it mobilized more bank reserves to spur greater and nationally-coordinated inflation of bank credit; and it weaned the average American from the habit of using gold in his daily life and got him used to substituting paper or checking accounts instead. In the first place, the Federal Reserve law was changed in 1917 to permit the Fed to issue Federal Reserve Notes in exchange for gold; before that, it could only exchange its notes for short-term commercial bills. And second, from September, 1917 until June, 1919 the United States was de facto off the gold standard, at least for gold redemption of dollars to foreigners. Gold exports were prohibited and foreign exchange transactions were controlled by the government. As a result of both measures, the gold reserves of the Federal Reserve, which had constituted 28 percent of the nation's gold stock on U.S. entry into the war, had tripled by the end of the war to 74 percent of the country's gold.38

The content of Benjamin Strong's monetary policies was what one might expect from someone from the highest strata of Morgan power. As soon as war broke out in Europe, Henry P. Davison sailed to England, and was quickly able to use long-standing close Morgan ties with England to get the House of Morgan named as sole purchasing agent in the United States, for the duration of the war, for war material for Britain and France. Furthermore, the Morgans also became the sole underwriter for all the British and French bonds to be floated in the U.S. to pay for the immense imports of arms and other goods from the United States. J. P. Morgan and Company now had an enormous stake in the victory of Britain and France, and the Morgans played a major and perhaps decisive role in maneuvering the supposedly “neutral” United States into the war on the British side.39

The Morgan's ascendancy during World War I was matched by the relative decline of the Kuhn, Loebs. The Kuhn, Loebs, along with other prominent German-Jewish investment bankers on Wall Street, supported the German side in the war, and certainly opposed American intervention on the Anglo-French side. As a result, Paul Warburg was ousted from the Federal Reserve Board, the very institution he had done so much to create. And of all the leading “Anglo” financial interests, the Rockefellers, ally of the Kuhn, Loebs, and a bitter rival of the Angle-Dutch Royal Dutch Shell Oil Company for world oil markets and resources, was one of the very few who remained unenthusiastic about America's entry into the war.

During World War I, Strong promptly used his dominance over the banking system to create a doubled money supply so as to finance the U. S. war effort and to insure an Anglo-French victory. All this was only prelude for a Morgan-installed monetary and financial policy throughout the 1920s. During the decade of the twenties, Strong collaborated closely with the Governor of the Bank of England, Montagu Norman, to inflate American money and credit so as to support the return of Britain to a leading role in a new form of bowdlerized gold standard, with Britain and other European countries fixing their currencies at a highly over-valued par in relation to the dollar or to gold. The result was a chronic export depression in Britain and a tendency for Britain to lose gold, a tendency that the United States felt forced to combat by inflating dollars in order to stop the hemorrhaging of gold from Great Britain to the U.S.

  • 35. Because of the peculiarities of banking history, “Governor'' is considered a far more exalted title than “President,” a status stemming from the august title of “Governor” as head of the original and most prestigious Central Bank, the Bank of England. Part of the downgrading of the regional Federal Reserve Banks and upgrading of power of the Washington Board in the 1930s was reflected in the change of the title of head of each regional Bank from “Governor” to 'President,” matched by the change of title of the Washington board from 'Tederal Reserve Board” to “Board of Governors of the Federal Reserve System.”
  • 36. Miller's father-in-law, Otho S. A. Sprague, had served as a director of the Morgan-dominated Pullman Company, while Otho's brother Albert A. Sprague, was a director of the Chicago Telephone Company, a subsidiary of the mighty Morgan-controlled monopoly American Telephone & Telegraph Company. It should be noted that while the Oyster Bay-Manhattan branch of the Roosevelt family (including President Theodore Roosevelt) had long been in the Morgan ambit, the Hyde Park branch (which of course included F.D.R.) was long affiliated with their wealthy and influential Hudson Valley neighbors, the Astors and the Harrimans.
  • 37. On the personnel of the original Fed, see Murray N. Rothbard, “The Federal Reserve as a Cartelization Device: The Early Years, 1913–1939,” in Money in Crisis, Barry Siegel, ed. (San Francisco: Pacific Institute for Public Policy Research, 1984), pp. 94–115.
  • 38. On Benjamin Strong's seizure of supreme power in the Fed and its being aided by wartime measures, see Lawrence E. Clark, Central Banking Under the Federal Reserve System (New York: Macmillan, 1935), pp. 64–102–5; Lester V. Chandler, Benjamin Strong: Central Banker (Washington, D.C.: Brookings Institution, 1958), pp. 23–41, 68–78, 105–7; and Henry Parker Willis, The Theory and Practice of Central Banking (New York: Harper & Brothers, 1936), pp. 90–91.
  • 39. On the Morgans, their ties to the British, and their influence on America's entry into the war, see Charles Callan Tansill, America Goes to War (Boston: Little, Brown, 1938).