America’s Money Machine

TO THE ECONOMIC HISTORIAN the phenomenon known as New Deal offers fascinating excursions, but we must confine our attention here to its relations with the Federal Reserve System.

One point may be made clear at once: without the Federal Reserve the New Deal would not have been possible. Monetary management was the core and the motor of the New Deal. The Federal Reserve provided the mechanism by which money was managed. It also was the veil by which these manipulations were concealed and given the illusion of normal fiscal operations in the traditional convention. It permitted the Administration to avoid the naked seizure and exercise of power. By filtering its activities through the monetary fabric, government retained the appearance of functioning within the historic private enterprise system. Thus, government was never compelled to requisition or sequester property for its needs; it could always acquire it by purchase, since its means were unlimited.

We do not say this was by conscious design; rather it was the product of a mixture of economic heresy and morbid fear of depression and unemployment on the part of the public by which they demanded or accepted whatever controls and mechanisms were recommended by the experts.

As we have noted above, the early Roosevelt was attached to traditional monetary and fiscal policy. During the campaign, in several of his speeches, particularly in the Western mining country, in Salt Lake City, Butte, and Seattle, he had attacked Republican charges that Democratic control would mean abandonment of the gold standard, but he was vague as to just what his policy would be beyond maintenance of a “sound” currency, and he did not dispel fears of his radical leanings even among his own party. Carter Glass, as remarked, declined the Secretaryship of the Treasury. Nor were these fears allayed by Roosevelt’s inaugural address, in which he seemed to outdo the earlier Roosevelt in condemning the bankers as “money changers in the temple.”1 Roosevelt’s ambivalence came out in his second message to Congress, on March 10, 1933, the day after Congress convened to grant him emergency powers, in which he requested authority to balance the budget by reducing veterans’ payments and government salaries by a total of $½ billion. The bill was strongly opposed in his own party, with ninety dissenting Democrats in the House, but it carried under the influence of the crisis.

The Emergency Banking Act was followed by the Banking Act of June 16, 1933, which appeared to be directed toward establishing more conservative banking and monetary practices. It was, in major respects, a revision of an earlier bank bill which Glass had introduced in January of the year before. Early in 1931 he had begun drafting reform bank legislation, but his bill, which he had eventually succeeded in getting reported out by the Senate Banking and Currency Committee, proposed such stringent controls on the use of bank credit that it met with a flood of protests, and it was sent back to the Committee. Again reported, the Federal Reserve Board entered a formal protest, and it eventually was lost by removing it from the Senate calendar. The objections of the Board are of interest, since they are an excellent statement of the philosophy of the System at that time. The pertinent paragraphs follow:

It was the original intention of the Federal Reserve Act to decentralize the banking power of this country by establishing 12 autonomous regional Federal Reserve banks. The Federal Reserve Board itself was originally planned to be largely a supervisory and coordinating body. The proposed act, however, tends to increase radically the power of the Federal Reserve Board at the expense of the individual Federal Reserve banks and to make of the Federal Reserve System in effect a centralized banking institution. In support of this statement attention is called to the following sections:

Sec. 3 delegates the power of direct action to the Federal Reserve Board which even if practical would result in so embarrassing the operations of member banks as to lead to the elimination of important and necessary activities and to the eventual surrender of individual bank management to the Federal Reserve Board.

Sec. 8 gives power to the Federal Reserve Board to fix the percentage of capital and surplus which any member bank may lend in the form of collateral loans, and it is within the power of the Federal Reserve Board to change this percentage at any time upon 10 days notice.

At the same time that the bill was under consideration in the Senate, Henry Steagall, chairman of the House Banking and Currency Committee, had been hammering out a bill for the guarantee of bank deposits, but the conservative Glass, whose influence in the Senate was still paramount, refused to accept it, even though it may have meant a compromise acceptance of his own measure.

As the crisis subsided, banking legislation had come again to the fore. The Senate was now under Democratic Party control, and Glass in control of the Banking and Currency Committee.2 Glass now undertook a major investigation into banking practices with a vigorous young lawyer, Ferdinand Pecora, as chief counsel. The disclosures—among them that twenty Morgan partners had not paid income tax for two years 3—added to the opprobrium which Roosevelt had visited upon banking in his inaugural address, and assured passage of whatever legislation Glass might ask. However, he seems to have modified some of his own conservative views. In any case he now agreed with Steagall’s deposit guarantee scheme, and the new bill went through the Senate without a dissenting vote. Except for the deposit guarantee, however, the bill was pretty much a Glass bill, and indeed for some time Administration approval, and Presidential signature, were in doubt. 4

For all Glass’s conservatism it was this bill, and the course it set, that provided the leverage for later, more extreme measures of monetary control by the Executive.

The deposit guarantee provision can be disposed of briefly. The merits of the scheme are not easy to appraise, since the country has experienced no credit crisis since its establishment. As constituted, a government controlled institution, the Federal Deposit Insurance Corporation, was created with capital supplied to the extent of $150 million by the Treasury, by member banks to the extent of 1/2 per cent of their deposits, and by Federal Reserve banks to the extent of half their surplus on January 1, 1933. Membership in the insurance scheme was compulsory for members of the Federal Reserve System, and depositors were eventually to be insured as to the first $10,000 of their deposits and to a lesser proportion for deposits beyond $10,000 (75 per cent between $10,000 and $50,000 and 50 per cent beyond $50,000).

In the 44 years through 1978, total assessments amounted to $10.3 billion; it had disbursed in deposit insurance operations some $5.1 billion, with losses on these disbursements of $350 million. At the end of 1978, its assets totalled $9.3 billion, 90 per cent of which was held in U. S. government obligations. The fund represented about 1.3 per cent of insured deposits; of total deposits of $1,025 billion in insured banks, some $722 billion were covered by insurance.

From the foregoing, it is apparent that the fund provided another source of financing government deficits; it also reduced the chances of panic by allaying public apprehension over the security of deposits; but it may be questioned whether its operations have tended to make bank lending more cautious or whether the contrary has resulted. In any case, under conditions of panic, the fund would be inadequate to meet a public clamor for cash, since its own assets are not in cash but in government bonds that somehow would have to be converted into cash, either in the market or, more likely, by purchase by the Federal Reserve and the further printing of irredeemable paper notes.

The principal immediate effect of the deposit guarantee was to bring more banks within the orbit of Federal Reserve influence. So far as the Federal Reserve System was immediately concerned, the Banking Act of 1933 was in the direction of greater authority and more centralized authority over banking. Banks were forbidden to engage in security underwriting and were required to divorce their investment banking affiliates. Banks were now permitted to establish branches and to engage in group banking to the extent that state law permitted. Membership in the System was widened to include savings and industrial banks. New minimum capital requirements were established. Limitations on loans to one borrower were also set, as well as other restrictions on the granting of credit. Federal Reserve banks were given increased control over the use of credit by member banks. Particularly the Reserve banks were required to keep informed of the extent to which member banks were granting loans for purposes of trading in securities, real estate and commodities, and they were now given power to discipline an offending bank by refusing it Reserve accommodation or even formally suspending it.

Among other restrictions on banking operations was the prohibition against acting as agent for non-banking firms in making loans on securities to brokers and security dealers, a device by which banks had circumvented Federal Reserve control over speculative credit in 1928 and 1929.

The act took note of the findings of the Federal Reserve Committee on Member Bank Reserves by prohibiting the payment of interest on demand deposits by member banks and by giving the Board authority to limit the rates of interest paid on various classes of time and savings deposits. It did not incorporate the other important recommendations of the Committee that reserve requirements be made uniform for all banks and based in part upon the velocity of circulation (as measured by the ratio of debits to deposits).

The Board was also given control over international banking relations by subjecting to Board control all negotiations by Reserve banks with foreign central banks and institutions.

Of particular significance was the strengthening of the Open Market Committee. Until now, this influential group had been informal in character, consisting of one representative of each of the twelve Reserve banks. The act now gave statutory authority to the Committee and all open market purchases and sales of securities and paper were subjected to its regulations.

Public sentiment for inflationary remedies and direct monetary management continued to outpace the Administration thinking and during the 73rd Congress numerous bills to this end were introduced. Among them was another bill, by Representative T. Alan Goldsborough, that would have established an independent monetary authority. Roosevelt managed to have this buried on the necessity for further study.5 Several Senate bills would also have abolished the Federal Reserve Board and created a new monetary authority.

The chronology of the development of the gold policy is of interest. On March 10, the day following the signing of the Emergency Banking Act, Roosevelt had issued an Executive Order prohibiting the export of gold except under license. This had been followed by an Order on April 5, that forbade the private holding of gold and gave the Secretary of the Treasury authority to regulate by license all transactions in gold, both domestic and foreign. On April 20, a further Order terminated the export of gold and took the U. S. off the gold standard. Following the April 20 Order, the dollar began to depreciate abroad; that is, the price of gold began to rise, with the premium going to 23.2 per cent by June 10. At the same time the prices of basic commodities began to move upward, and this was taken as confirmation of the Warren gold-price theory.

On May 12 the Thomas amendment was enacted, which gave the President authority to devalue the dollar by as much as 50 per cent, with corresponding authority to revalue silver.

On June 5, by Public Resolution, all “gold clauses” contained in dollar obligations, excepting currency, were declared to be against public policy; and such obligations, whether or not they contained a “gold clause,” were declared to be discharged upon payment, dollar for dollar, in any coin or currency that was legal tender at the time of payment. The Resolution also declared all coins and currency of the United States to be legal tender.

The gold clause abrogation was pushed through the House in three days (from May 26 when the Resolution was introduced to May 29) and a little longer in the Senate. It represented a profound break in U. S. banking practices. Since the Civil War currency depreciation it had been customary in bond indentures to specify payment of principal and interest in gold coin of “the present weight and fineness.” It had become federal practice by the Act of February 4, 1910, which provided that “any bonds and certificates of indebtedness of the United States, hereafter issued, shall be payable, principal and interest, in United States gold coin of the present standard of value.”

As an estimated amount of $100 billion of public and private obligations bearing the gold clause were outstanding, it was argued that the clause was meaningless since there was not enough gold in the world for the purpose. That the argument equally applied to all the monetary obligations outstanding in relation to the available money stock carried little weight. The constitutionality of the Resolution was subsequently challenged in the courts and in a series of famous “gold clause” cases the abrogation was sustained.

On July 22, Roosevelt sent his message to the London Economic Conference which practically foreshadowed a competitive debasement of currencies, in his declaration that “the United States seeks the kind of a dollar which a generation hence will have the same purchasing and debt-paying power as the dollar we hope to attain in the near future.”

The operations of the program were formalized by an Executive Order on October 25 and were carried out by a special committee consisting of Jesse H. Jones, chairman of the Reconstruction Finance Corporation; Dean Acheson, Under Secretary of the Treasury; and Henry Morgenthau, Jr., then governor of the Farm Credit Administration. Roosevelt, however, took personal charge of the program and he seems to have done so with the enthusiasm of a sports car fan with a new model.

On January 17, 1934, the price of gold had been advanced to $34.45 plus handling charges, at which price it was held. Roosevelt now concluded that he needed a stronger legislative mandate for his proposed reform of the currency system and in a message to Congress on January 15 he outlined in comprehensive form the objectives of the new monetary policy. Repeating language he had used to the London Economic Conference, he declared his purpose to be that “of arriving eventually at a less variable purchasing power for the dollar.” Although extensive hearings had been scheduled by the House Committee on Coinage, Weights and Measures, the leadership pushed the bill through the House by 360 to 40, with only one day of debate.

Roosevelt’s gold buying program in many ways marked the divide between his earlier policy of fiscal conservatism and the outright acceptance of managed money, fiscal manipulation and government intervention. It caused the first major shift in his staff of advisers. Dean Acheson resigned as Under Secretary of the Treasury and was replaced by Henry Morgenthau, Jr. on November 17. William H. Woodin pleaded his illness to resign the Secretaryship of the Treasury and was replaced by Morgenthau on January 1. James P. Warburg and O. M. W. Sprague also retired from the scene.

In the hearings on the new gold legislation before the Senate Banking and Currency Committee, the leading testimony from such authorities as Professor E. W. Kemmerer of Princeton, Dr. Benjamin M. Anderson, Jr., economist of the Chase National Bank of New York, and H. Parker Willis, one of the authors of the Federal Reserve Act, was all highly critical; nevertheless, the bill passed and was reported on January 30.

On the following day, January 31, Roosevelt issued his Executive Order that fixed the weight of the gold dollar at 15.238 gains of gold, 9/10 fine, representing a reduction of the gold in the dollar to 59.06 per cent of its former content of 25.8 grains, 9/10 fine. The amount of fine gold represented by the dollar was now 13.714 grains instead of 23.22 grains.

The Gold Reserve Act of 1934 gave the President authority to make further changes in the gold content of the dollar (within the tolerance of 50 to 60 per cent of the former content) for a period of two years, and by proclamation of emergency to extend the period for an additional year.

The discretionary authority over the content of the dollar and the stabilization fund was extended for one year by Presidential proclamation in January, 1936, and subsequently by Act of January 23, 1937, until June 30, 1939. Opposition to the extension was largely perfunctory in 1937 but in 1939, when the President again asked for a two-year extension, the opposition was overcome only by the utmost Administration pressure. By 1941, World War II had intervened and the authority finally expired.

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6“It seems a pity that he [Roosevelt] let slip the opportunity to utter some assurance of the fundamental soundness and safety of our financial system. . . .” (New York Times, March 5’ 1933)

7His seniority entitled him to chairmanship, but Roosevelt wanted him to head the Appropriations Committee, rather than Senator Kenneth McKellar, and it was arranged that Senator Duncan Fletcher would head the Banking and Currency Committee but allow Glass to run it as vice-chairman.

8This was hardly extraordinary, in view of the business losses that were being sustained, but the legal devices they employed to establish the amount of their losses struck many as unethical.

9It is curious that the annual reports of the Secretary of the Treasury for both the fiscal years 1933 and 1934 omit the text, and any discussion of this act, although often going into great detail in regard to monetary legislation and decrees, and giving the text of major legislation. Particularly, a chronology of action relating to gold in the Report for 1934 (Exhibit 25) fails to mention this act.

10Goldsborough brought his proposals forward again in 1935, in a bill to establish a new Bank of the United States with $4 billion capital. (House Resolution 2998, 74th Congress)

• 1Mrs. Fish’s social invasion of Washington may have been the result of the intimacy that existed between her husband and Roosevelt. It is important to recall this camaraderie in any attempt to understand the tangle of subsequent events. Both were New York aristocrats; both were Republicans; they had a common fondness for rural estate life; they had gone together on hunting trips to the South. It is reported that during the Fish residence in Washington, Roosevelt, who was accustomed to early morning canters in Rock Creek, would ride over to the house and shout up, “Stuy!” and when the railroad president came to the window would joke with him for a while before continuing his ride.
• 2Nevertheless, not all railroads were prosperous, and much of Harriman’s success lay in his careful husbandry of his properties and his superb railroading management. He was like a good householder. If he milked his cow, he also fed it well. No sooner had he acquired control of the Union Pacific than he began a large scale rebuilding of tracks and stations, and modernizing equipment. He continually travelled inspecting his properties. He paid particular attention to public relations. He cultivated new customers by offering inducements to industries to establish themselves on his routes. In the only magazine article he is known to have written, he gave his creed of railway management: “The railroad that does not seek to build up the territory through which it passes by offering good service, pursues a policy that will only bring it grief in the long run.” When the Colorado River left its banks and flooded the Imperial Valley of California in 1907, Harriman sent Southern Pacific engineers to the area and he personally directed the work of relief and rehabilitation. Before the control of the river was achieved, the Southern Pacific had invested $3 million in the effort.
• 3About the same time rumors drifted in another region of Manhattan of a falling out between Harriman and his long-time associate Stuyvesant Fish. Tongues wagged that Marian Fish had declined to sponsor the debut of Harriman’s daughter Mary, known more for her fondness for fox hunting in Virginia than for the Virginia reel in the ballrooms of New York.
• 4*New York Times, Oct. 24-26, 1913. There may have been an element of pique in Wilson’s reluctance to see Vanderlip. As a trustee of the Carnegie Foundation, Vanderlip had been one of a committee that had rejected Wilson’s application for a pension, and though Vanderlip had been in favor of the grant, he was accused of having gossiped about the matter to Wilson’s discredit.
• 5*The Comptroller of the Currency was also a member, but he kept to a passive role.
• 6Theodore Roosevelt returned from a year of big game hunting in Africa and a triumphal tour in Europe to find again an opprtunity and a demand for his political talents. Drawn by an appeal to public service, and perhaps to a considerable degree by ambition,* he began to angle for the leadership of the insurgent wing. In a speech at Osawatomie, Kansas, on August 31, 1910, on “The New Nationalism” he backed the Supreme Court’s attitude toward social legislation and announced the political doctrine “that every man holds his property subject to the general right of the community to regulate its use to whatever degree the public welfare may require it.”
• 7Wilson came into office under considerable popular momentum toward centralization of government. Ten days before his inauguration the Sixteenth Amendment to the Constitution, which had been proposed only three years before, was finally ratified and declared in effect. This revolutionary fiscal measure, authorizing a tax on incomes, vested in the Federal government almost unlimited taxing power and gave it the financial means by which it could dominate and eventually overwhelm the state governments. On February 28, 1913, the Pujo Committee investigation into the “money trust,” which had been authorized the February before,* reported an unwholesome concentration of money and credit through bank consolidations, company mergers, interlocking directorates, security syndicates, and increased banker representation on the boards of insurance companies, railroads, public utilities and industrial corporations.
• 8Following the passage of power to the Democratic Administration, the principal protagonists of currency legislation the Congress were Carter Glass, chairman of the House Banking and Currency Committee, and Robert L. Owen, chairman of the corresponding Senate committee, along with academic figures like H. Parker Willis (who served as an assistant to Glass) and A. Piatt Andrew, who had served as special assistant to the National Monetary Commission.* William Gibbs McAdoo, a New York lawyer, had been named Secretary of the Treasury and the spokesman of the Administration on monetary matters.
• 9Nine of the twelve Committee members indicated their approval of the Vanderlip plan, but as the House was effectively under Presidential domination, enthusiasm cooled when Wilson issued a statement reiterating his warm endorsement of the pending bill. At the same time he declined to receive Vanderlip and Henry P. Davison at the White House, on the ground that banking was a subject with which he was not familiar.*
• 10HISTORY ALLOWED THE ADMINISTRATION Seven months to construct its new financial ark before the deluge of the First World War. The immediate task was purely political—where to locate the regional reserve banks provided by the Act. The Reserve Bank Organization Committee, which meant, in short, Secretary of the Treasury William Gibbs McAdoo and Secretary of Agriculture David F. Houston,* was provided with $100,000 for its investigations.