America’s Money Machine

12.

The First Inundation

IT WAS A FORTUNATE CIRCUMSTANCE—we can hardly call it foresight—that the Congress included in the Federal Reserve Act a provision extending until June 30, 1915, the Aldrich-Vreeland emergency act of May 30, 1908. That act had been due to expire June 30, 1914. It permitted, as will be recalled,1 national currency associations to issue emergency currency.

It was the operation of this act rather than the Federal Reserve Act that permitted the monetary system of the country, such as it was, to meet the shock of the outbreak of World War I.

The Aldrich-Vreeland Act had been on the books more than five and a half years, but up to the signing of the Federal Reserve Act only twenty-one currency associations had been formed under its terms, and no currency had ever been issued nor had any individual bank applied for the issuance of currency notes. One reason, of course, was the prohibitive tax on such issues (as were secured by other than government bonds) imposed to discourage their issuance except for extreme emergencies. This tax was at the rate of 5 per cent per annum for the first month, with the rate increasing at the rate of one per cent a month to a maximum of 10 per cent per annum.

The Federal Reserve Act, in extending the Aldrich- Vreeland Act, reduced this tax to a minimum of 3 per cent per annum and a maximum of 6 per cent per annum.

The immediate effect of the war tension in Europe had been an unprecedented demand for gold from abroad. As the crisis mounted the gold flow increased. On Friday, July 31, 1914, the S.S. St. Louis of the American Line left New York carrying the largest cargo of gold ever to have been shipped from that port in one bottom—over $11,025,000. Earlier in the week the S.S. Kronprinzessin Cecilie carried out $10 million.

Although Russia and Germany have not yet come to the breaking point, all the developments yesterday indicated the swift approach of a crisis. The Kaiser declared all Germany except Bavaria to be in a state of war, Bavaria being allowed under the constitution of the empire to make such declaration herself. Mr. Asquith told the House of Commons that Russia had mobilized her army and navy and that Germany would answer with a similar mobilization.

The world looks on in a stunned, incredulous way while Europe is rushing forward to a stupendous catastrophe. . . . We have been told again and again that the financiers of the world, largely denationalized in their sympathies and interests, would never permit the great nations to impoverish themselves by a general war. A tightening of the screws of credit, it has been said, would bring most chancelleries to their senses. . . .

On Saturday, August 1, 1914, Germany took the irrevocable step of declaring war on Russia. Under the treaties by which they held themselves bound, France and Austria were thereupon involved, but Great Britain not until August 4 when Germany invaded neutral Belgium, while Italy, though bound by alliance to Germany, managed to avoid war for the time being.

The effect of the war declarations changed the nature of the financial panic. During the week the reserves in the New York banks had dropped $43 million, and there was a deficiency of over $17 million. Stock market selling had been mainly for European account, to raise cash, but when exorbitant insurance rates for the shipping risks made the export of gold prohibitive, this liquidation died down. On Monday morning, August 3, the Secretary of the Treasury announced that it was prepared to issue $100 million of emergency currency to the New York banks, under the Aldrich-Vreeland Act, and in the same way to assist banks throughout the country. The following day, the Congress with remarkable celerity removed the limitations upon the total emergency currency that could be issued.

New currency associations were now formed throughout the country, and during the following two months another twenty-three such associations were organized, with member banks in nearly every state.

During the critical month of August some $208,810,790 of emergency notes were issued under the terms of the act; during September the total rose to $326,789,380; and during October to $369,558,040, and the issue reached its maximum of $381,530,000 during November.

Thereafter, the demand for currency fell off, and by the end of the year 60 per cent of the emergency note issue had been retired, and by the following May all but $6 million had been redeemed.

In addition to the emergency currency, some twelve clearing house associations found it necessary during the height of the crisis to issue clearing house certificates.

The New York Clearing House Association began its issue on August 3, and made various issues until October 15. The total amount issued was $124,695,000, and the largest amount outstanding at any one time was $109,185,000.

Cancellations of clearing house certificates began on August 26, and the last of the entire issue was canceled on November 28.

The collateral put up by member banks to secure certificates issued to them by the clearing houses is of interest. Some $234,465,000, or 50.7 per cent, consisted of commercial paper; $163,873,000, or 35.5 per cent was in bonds and securities; and collateral loans provided $63,836,000, or 13.8 per cent. The maximum amount of collateral in the hands of the clearing house committees at any one time was reported at $158,327,000.

On December 1 the Comptroller of the Currency declared the termination of the monetary crisis in the following announcement:

Telegraphic advices received from the clearing house associations throughout the country show that all clearing house loan certificates have either been paid off or called for redemption.

Chicago wires that the banks there are ready to pay off the comparatively small balance still outstanding and are only delayed by the required notice of redemption which prevents the last of them from being paid for a few days longer. The Baltimore banks have given notice for redemption of the last of their loan certificates not later than the 15th instant. New York, Boston, Philadelphia, St. Louis, New Orleans, and all other cities throughout the country which issued any clearing house certificates report all now paid in full.

This encouraging fact is an acknowledgment and important evidence of the almost complete return to normal financial conditions in this country and marks our safe exit from the disquieting conditions which so recently confronted us.

Meantime, the crisis had passed from the financial to the commodity markets. The war scare had driven shipping to port, and exporters of wheat and cotton were unable to find bottoms to carry their merchandise. The problem was further aggravated by the demoralization of the foreign exchanges. Prices plummeted, particularly for cotton, and farmers throughout the South were in distress. The large mail order house of Sears, Roebuck & Co., whose trade was largely with farmers, offered to accept all cotton offered at 10 cents a pound.

On August 14, Secretary of the Treasury McAdoo convened a conference of leading bankers, business men and steamship and railroad managers to consider the grain export and foreign exchange and shipping situation, and on August 18 a similar conference convened to deal with the cotton problem. The cotton crisis was the more severe, for the war had broken out just at the beginning of the cotton picking season, and at a time when an exceptional crop brought upon the market the largest crop in the history of the country.

The wheat problem was largely solved by the War-Risk Insurance Act, but to meet the needs of the Southern farmers the Treasury agreed to accept warehouse receipts for cotton or tobacco, not having more than four months to run, as eligible security, at 75 per cent of their face value, for emergency note issue.

As an additional measure, Secretary McAdoo summoned a conference of bankers to form a loan fund to tide over the cotton farmers—and to provide a fund of cash by which to redeem the emergency notes issued against cotton. A loan pool of $100 million was the result.

A third emergency measure was a gold fund to support the dollar in the foreign exchanges. The war found the country with a short term foreign indebtedness of more than $500 million, and foreign creditors were eager to convert these claims into cash. Some $450 million was owing by business men and bankers and the City of New York had notes of $80 million payable abroad and coming due.

Sterling exchange in consequence was rising in relation to the dollar, and was now over $5 to the pound that at par was worth $4.87. Later, of course, the movement would set in the other direction; just now some means were needed to meet these maturities. The Treasury formulated what was known as the gold-fund plan by which leading banks, especially those in reserve and central reserve cities, were to contribute $150 million in gold, or gold certificates, to a gold fund to be used to buy foreign exchange as needed. The fund was to be managed by a select committee with authority to arrange for shipment of the gold abroad to acquire foreign exchange and in turn to sell the acquired exchange in the domestic market as needed to stabilize the market. The contributions of the participating banks would be in the form of deposits for which they would be issued depository receipts.

The plan was initiated early in September and came into operation on September 21, and a shipment of $10 million gold to Ottawa, Canada, was promptly arranged, with immediate effect on the market, and the need for gold was written down to $100 million.

By now, export trade was beginning to revive, and by the middle of November when the New York Federal Reserve Bank officially opened, exchange had returned to normal.

The re-opening of the Chicago exchange was followed by the reopening of the Philadelphia exchange on November 24 for limited transactions (by an auction, with the sellers setting minimum offering prices), and bond trading under similar limited conditions was resumed on the New York Stock Exchange on November 28. Full trading in the New York Exchange returned on December 13. By then the crisis of 1914 was past, resolved largely by the vitality of the economy, the initiative of the business and financial community, and the operation of conventional governmental power, rather than any new monetary mechanisms.

The test of the effectiveness of the Federal Reserve System in meeting panics and shocks to credit would come later.

 

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3See Chap. 6.

4Morgan senior died March 31, 1913.

• 1*See Chap. 6.
• 3IT WAS A FORTUNATE CIRCUMSTANCE—we can hardly call it foresight—that the Congress included in the Federal Reserve Act a provision extending until June 30, 1915, the Aldrich-Vreeland emergency act of May 30, 1908. That act had been due to expire June 30, 1914. It permitted, as will be recalled,* national currency associations to issue emergency currency.
• 4At 9:45 A.M. on July 31, the New York Stock Exchange authorities, facing a day of certain demoralization, ordered the doors of the Exchange to remain closed—for the first time since the panic of 1873. London, earlier that morning, had taken similar action, and had doubled the bank rate, from 4 to 8 per cent. J.P. Morgan—the junior*—perhaps recalling his father’s calming influence in the 1907 panic, issued a reassuring statement that, “alarming as the news is from Europe, I am still hoping there will not be a general war,” but history had already traveled beyond recall by either bankers or statesmen. The issue was now in the hands of the general staffs. As the New York Tribune reported, in horror, on August 1: