America’s Money Machine

THE FIFTH DECADE of the Federal Reserve System was a period of placidity, like the uneventful years of senility, as the System drifted in the overhung backwaters of Treasury influence—and later State Department policy. The significant development of the period was the rise of State Department influence, and the subservience of Federal Reserve activities to the changing objectives of diplomacy rather than to the needs of domestic business. Illustrative is the dichotomy that arose regarding interest rates—the effort to maintain a high rate to attract deposits from abroad and deter the export of gold, at the same time a low rate to encourage capital investment and business expansion. But of that later.

The post-war years had witnessed a remarkable shift in American public sentiment, from isolation and noninvolvement in world affairs to assumption of world wide responsibilities and commitments for which the political experience and the economic power of the people were of doubtful adequacy. The first manifestation was U. S. sponsorship of a series of international agencies to interlace the political and economic fabric of the world. The most imposing of these was the United Nations Organization, which came into existence June 25, 1945, following a conference of delegates of fifty nations at San Francisco. More influential, however, in effecting practical solutions to the world’s problems were two international economic institutions, gestated a year earlier by the Bretton Woods (N.H.) Conference of July 1–22, 1944. These were the International Monetary Fund and the International Bank for Reconstruction and Development.1

The International Monetary Fund was set up to provide a reserve pool of the currencies of the members and to make them available on application to meet currency needs of indigent members, and thereby prevent exchange fluctuations, and international currency crises. The significant thing about the International Monetary Fund was that it restored to sanctity the gold exchange system, first hallowed by the Geneva Conference of 1922, but so thoroughly discredited thereafter by the worldwide collapse of 1932.

The heart of the new gold exchange standard was the U. S. dollar, which was equated with gold in the Fund’s Articles of Agreement.

Let us say Country A (one of those nations now called “less developed” or “developing”) had a deficit in its international transactions—that is, it was unable to sell abroad as much as it wished to buy abroad—and needed money to pay its foreign creditors. Its own currency was unacceptable to its creditors. It could, under the rules, apply to the Fund and obtain dollars to tide it over, hopefully, until it could set its house in order. In exchange for the dollars the Fund would receive currency of the borrowing country in an amount equivalent—that is, theoretically equivalent—to the dollars obtained. Obviously, the currency of Country A would not be of equivalent value of the dollars received or the foreign creditors themselves would accept Country A’s currency in settlement of debts owing, and Country A would not be under necessity of applying to the Fund for aid.

The subordinate currencies were not equivalent mainly because their central banks were unable, or unwilling, to deliver gold for their currencies on demand, and importantly because many of them had no nominal gold equivalents—that is, in the language of the Fund, no par values had been established. One of the first tasks of the Fund was to get the member countries to establish par values, or gold convertibility, for their currencies. This required more internal fiscal discipline than most countries were willing or able to exercise.

The Fund started business with a pool of $7.47 billion nominal value of currencies subscribed by the participating members, of which $2.75 billion was subscribed by the United States. The United States, however, was the only member country that maintained gold convertibility of the dollar,2 that is, that freely delivered gold at the statutory parity of $35 an ounce to foreign governments and central banks in exchange for dollar deposits or dollar currency. It followed that for the following decade the Fund was really a device for making sound dollars available to various countries in exchange for their less valuable currencies, and after a time the Fund’s quotas were increased, with the devious object of making more dollars available to indigent countries. By 1963, the total subscribed capital of the Fund was $15 1/2 billion, of which the U. S. share was $4.125 billion.

The International Bank for Reconstruction and Development was created to provide funds, by way of loans, under long-term repayment conditions, to member governments and their agencies, for strictly economic development purposes. Member governments were required to subscribe to the capital of the Bank in varying proportions, and the total authorized capital was $10 billion. Again, as the sellers of goods and services needed for the projects wanted payment in good money, it fell out, not unexpectedly, that most of the loans were made in dollars. To provide a sufficient supply of dollars, the Bank could borrow dollars in the ordinary capital markets, against the credit of the United States, but eventually an increase of the subscribed capital became necessary. By the end of 1963 this capital subscription had been increased to $21.1 billion, of which the U. S. subscription was $6.35 billion.

At the end of 1963 the Bank had outstanding loans in the amount of $5 billion, and to provide this sum it had gone into the market and borrowed $1.9 billion in U. S. dollars, and $620 million in other currencies; the balance it had provided from its own capital reserves, mainly U. S. dollars.3

That the financial power of the U. S. should undergird the world’s economy during the period of reconstruction was a proposition increasingly understood and accepted by the American electorate. This electorate had been suffering a form of guilt complex ever since the close of World War I for what was called abroad its grasping self-interest in regard to repayment of the war loans it had made to its allies.

Abroad the popular caricature of the United States had become Uncle Shylock, and American travellers in Europe were slyly taunted on our ingratitude to the mother cultures. The argument was made that European economic stagnation was due to the transfer problem which the U. S. had created by requiring war debt payments and at the same time making obstacles through its high tariff policy which impeded the entry of merchandise by which to discharge the debt.

This theory overlooked the fact that U. S. imports from Europe rose from $765 million in 1921 to $1,334 million in 1929, whereas U. S. exports to Europe actually declined slightly, from $2,364 million in 1921 to $2,344 million in 1929, and that Europeans were at the same time earning large sums from shipping and other services to the U. S. economy and from the spending of U. S. tourists. It also neglected the fact that Europeans could also have reduced their buying of U. S. goods, not all of which went—contrary to popular belief—to feed hungry mouths or to rebuild bomb damage.

Nevertheless, U. S. popular opinion was greatly influenced by the arguments and this was reflected in various official steps to repair that fault. The burden of the war debts was eased by a stretch-out of the payments and later by a moratorium granted by President Hoover, which is still in effect. Under President Roosevelt a general reduction of tariffs was undertaken under what is known as the reciprocal trade policy, whereby it became settled that the U. S. tariff rates should be steadily lowered.

Following World War II the cry again arose from Europe for assistance to avert economic and political collapse. It played upon the sense of discomfort suffered by many Americans over their seemingly undeserved material blessings4 which combined with a natural philanthropy on the part of many more, and a growing suspicion of Soviet Russia by everyone, to lead this country eventually to assume the burden of Atlas supporting the globe.

Since the fiscal sinews of this undertaking were nourished from the vascular streams pumped by the Federal Reserve System like an inexhaustible heart, a sketch of the process by which U. S. world responsibilities multiplied and became an Old Man of the Sea upon the back of the American electorate is in order.

During the war the U. S. had joined an inter-allied relief organization to provide assistance in liberated areas; this became the United Nations Relief and Rehabilitation Administration to which the U. S. eventually contributed, until it ceased operations in 1947, some $2.67 billion of its total resources of $3.66 billion.

The first overt assumption of political responsibility in post-war Europe, however, occurred in Greece and Turkey. The Soviet drive to dominate the Middle East, through pressure on Turkish and Greek sovereignty, had led the U. S. to agree with Great Britain in 1946 to provide economic aid to these two countries while Great Britain provided military aid. In February, 1947, Great Britain notified the U. S. that its own financial difficulties were forcing it to stop further assistance. This put the business squarely on American shoulders. President Truman went before Congress on March 12, 1947, for approval of an appropriation of $400 million for military and economic aid to the two countries.

The appropriation was voted, and the ink was hardly dry on the bill when the press was filled with portents of European collapse unless U. S. aid were extended there also. The data were impressive. In 1947, it was pointed out, over-all production of goods and services in Western Europe was still 7 per cent below pre-war. This output had to be shared among a population that had increased by some 8 per cent. Recovery lagged in the key sectors of coal and steel. This had produced shortages of tools and articles manufactured from steel and slowed down production, due to lack of fuel. This in turn hampered the export of goods needed to buy necessary supplies and equipment from abroad. The deficit, it was urged, could only be met by supplies provided by loan or grant. During 1947, particularly, Europe had suffered a series of crises. A cold winter had aggravated the fuel shortage and a drought the following summer had curtailed the harvest. In 1947, also, the British effort to restore the convertibility of the pound had collapsed after six weeks, and this had spread a fog of gloom and despair throughout the markets of Europe.

The American people were not surprised therefore on June 5, 1947, when General George C. Marshall, then Secretary of State, in an historic address at Harvard University, accepted on behalf of the United States a moral and financial commitment for the support of Europe. Marshall declared:

“Europe’s requirements for the next three or four years of foreign food and other essential products—principally from America—are so much greater than her present ability to pay, that she must have substantial help or face economic, social, and political deterioration of a very grave character.”

Congress assembled in January, 1948, to be confronted with an imposing array of reports on European necessities prepared by three Presidential committees. In addition, representatives of sixteen countries of Western Europe had met in Paris during the summer and had prepared their own report of the needs and resources for economic reconstruction. Their report estimated that they would need some $22.4 billion from the United States in the next four years. The three Presidential committees all concluded that the United States could well afford the cost and if it were not forthcoming, “free institutions everywhere, including those in the United States, would be in jeopardy.” On March 13, 1948, after extensive hearings, the Senate voted 69 to 17 to support the European Recovery Program as outlined, and on March 31 the House by a vote of 329 to 74 accepted the financial commitment. The total amount of the commitment was never explicit but it was commonly understood that the program would extend over a four-year period and would be in the neighborhood of $14 billion, of which $5.3 billion would be provided in the first year.

The Greek-Turkish aid program did not, of course, terminate in 1948, nor did the Marshall Plan end in 1952. In 1948 the Greek-Turkish program was merged with the European Recovery Program. This in turn was soon to be expanded into a worldwide program of foreign aid. President Truman, in his inaugural address on January 20, 1949, announced “a bold new program for the making the benefits of our scientific advances and industrial progress available for the improvement and growth of underdeveloped areas.” This became known as the Point 4 program, for its being the fourth item in his Administration’s program. It evoked world wide enthusiasm, and the Congress went along.

Meantime, although the Marshall Plan had been designed for European necessities, it had soon been expanded to include economic stabilization and development in non-European areas. The China Aid Act of 1948 (Title IV of the Economic Cooperation Act) authorized technical and other (military) aid to China. On January 1, 1949, Truman gave the Economic Cooperation Administration (EGA) responsibility for administering economic aid in Korea, and thus shifted the emphasis from relief to economic development. Indonesia first received aid as a Dutch dependency. Aid programs began in Burma, Indo-China and Thailand when the ECA suggested to Congress that funds left over from the mainland China program be expended in the “general area of China.” The earlier post-war relief and reconstruction operations in the Philippines were expanded to include economic development.

Truman’s Point 4 program of technical assistance to underdeveloped areas now opened the door to long-term, though presumably inexpensive, advisory operations throughout Asia, Africa and Latin America. This was followed up in July, 1949, after the ratification of the North Atlantic Treaty Alliance, by a Presidential request for authority to give “military aid to free nations to enable them to protect themselves against the threat of aggression”—a carte blanche that included practically every country in the world that could maintain a reasonably persuasive diplomatic representative in Washington. This became the Mutual Defense Assistance Act of 1949 which in turn became the first of a long series of enactments, each broader and more vague in the limits it set to the outpouring of U. S. dollars.

This is not the place to explore the philosophy or the results of this concept in foreign policy; our interest here is with its effects upon the Federal Reserve System with which we are primarily concerned in this work. We need note that by the end of fiscal year 1963 the total post-war foreign aid expenditures had exceeded $103 billion; that the Greek-Turkish Aid Program, originally budgeted at $400 million with a termination date of 15 months, still was in existence and total outlays had cost $7.7 billion; and that Western Europe, excluding Greece and Turkey, had received more than $45 billion (a figure which includes some $16 billion of military supplies) and despite economic recovery and boom time prosperity was the recipient of $900 million in fiscal year 1963.

By 1963 the cost of the foreign aid program had grown to in excess of $7 billion annually. The figure does not include the payments made abroad in support of U. S. garrisons, particularly in Germany and Korea, and of a long list of military, air, and naval bases around the world. These overseas military costs (that is, only the costs that must be paid in foreign currencies) were of the order of $3 1/2 billion annually. Nor does the figure include the large sums made available indirectly, through loans by the various international lending agencies and assistance institutions that sprang up following World War II. We have already mentioned two, the International Bank for Reconstruction and Development and the International Monetary Fund: these have proliferated into the International Finance Corporation; the International Development Association; the Inter-American Development Bank; the Social Progress Trust Fund; and a number of agencies of the United Nations Organization to which the U. S. contributed, chief among them being the United Nations Special Fund and the Expanded Technical Assistance Program.

The total cost to the U. S. taxpayer of all these various assistance operations was actually around $10 billion annually—a magnitude not generally realized by the American public, largely because of the multiplicity of the programs in which the cost had been concealed in the various appropriation bills.

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5 These institutions did not begin actual operations until 1946.

6 International convertibility, that is. Since 1933 U. S. citizens have been unable to obtain gold for their paper currency.

7 An interesting question is why the Bank, with $21.1 billion capital subscriptions, and loan investments of only $5 billion should be obliged to go into the market for funds to lend. The explanation is an illustration of the sophistries in which international financial diplomacy operates. In the first place, most of the Bank’s assets were in currencies that no one wanted to borrow, and its holdings of U. S. dollars (from the U. S. subscription) were insufficient to meet the demand for loans. In the second place, the capital subscriptions of the Bank are illusory since subscriptions had to be paid up only to the extent of 10 per cent. Thus, of total subscriptions of $21.1 billion, only $798 million had been paid in U. S. dollars.

8 Prof. Helmut Schoeck of Emory University has given most thought to this phenomenon. See “The Evil Eye: Forms and Dynamics of a Universal Superstition,” Emory University Quarterly, October, 1955, pp. 153–61, and “The Envy Barrier,” ch. 5 in Foreign Aid Re-Examined (Washington: Public Affairs Press, 1958). The general presuppositions in John Kenneth Galbraith’s The Affluent Society are manifestations. See also Edward G. Banfield, American Foreign Aid Doctrines. Monograph. (Washington: American Enterprise Institute, 1963)

• 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.
• 5Theodore 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.”
• 6Wilson 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.
• 7Following 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.
• 8Nine 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.*