America’s Money Machine

WHEN CONGRESS CONVENED in December following the panic, it was universally agreed that the earliest object of attention should be the monetary system. But there was bitter argument as to what should be done. The White House offered no leadership. President Roosevelt boasted that he knew nothing of economics, and that he was essentially a moralist in politics; he had ideas as to the regulation of the corporations, but none to offer on the money system.

The cleavage between those who prefer to trust their liberties to a centralized government functioning through an authoritarian bureaucracy, and those who would rely upon the operation of individual freedom curbed mainly by an increasing sense of individual responsibility, appeared in the various proposals for monetary reform. As so often in history, the staunchest defenders of the people’s freedom were most vocal in demanding more authoritarian government. William Jennings Bryan—the “boy orator of the Platte,” the “Great Commoner” who had twice been the standard bearer of his party and twice the defeated candidate for President—urged a central bank issuing currency secured by government bonds and a government guarantee of bank deposits; but his views, seemingly, were not given much weight.

A poll by the Times of ninety members of Congress, on the eve of their convening, indicated three main bodies of opinion.

There were those who favored some form of “asset” currency—which meant presumably notes issued by individual banks and secured by bank assets, though the specification was not clear as to what assets might be included. Another substantial group advocated a currency issued by a central bank, and secured by government bonds. A third group favored only an emergency currency to be issued within limits by the national banks (as distinct from state banks or other banking institutions) on other than bond security, and to be subject to a sliding tax that would force its redemption as soon as the urgency had passed, and hence confine the circulation to a normal level of requirements.

None of the various schools was clear as to the details or effects of their proposals. It was nevertheless a general consensus, the Times found, that any changes in the currency should be in the direction of an “intimate connection between the currency and legitimate trade”—that is, an “elastic” currency fluctuating in accordance with the commercial demand for circulating media.

The bill which Aldrich introduced called for the appointment of a national monetary commission to examine into the whole monetary and banking question and to bring in recommendations. As an interim measure it authorized a currency to replace the clearing house certificates that were still outstanding. The bill would, in effect, replace these certificates by national bank notes. It would authorize an emergency issue of currency to the total of $250 million secured by bonds approved by a Treasury Department board. In addition to government bonds, however, the bill authorized the use of certain types of railway bonds as security. Over this stool his bill fell and something of Aldrich’s influence. For railways were in bad odor politically, and Democratic opponents as well as some Republicans were prompt to make political hay of this aspect of the bill. We shall come to the debate presently.

Meanwhile, a word about clearing house certificates. They were, as remarked, notes payable to bearer issued by the clearing house of the city or district, the notes being secured by notes, bonds, or other assets of the individual banks that received the certificates.2 The process worked as follows: a bank with insufficient cash to meet its depositors’ drafts would deposit with the clearing house such notes or other assets as the clearing house authorities considered acceptable, and receive in turn the certificates of the clearing house. These certificates, which were the obligation of the clearing house, would be accepted in lieu of cash by all member banks of the clearing house association, and consequently they were a limited currency. As rapidly as the banks were able to liquidate their own “frozen” assets, by obtaining payment of notes and bills owing by customers, they were able to pay off their own obligations to the clearing house and reclaim their collateral; at the same time the clearing house retired its certificates.

This whole operation, of course, depended upon the existence somewhere in the economy of sufficient cash to pay off this circle of obligations. The chain of reactions necessarily depended upon the success of the individual borrower in laying hands on sufficient cash to pay off his note to the bank; until he did so the bank could not pay off its note to the clearing house, and the clearing house could not retire its certificates. But where was the individual to find the cash in this period of stringency?

What added difficulty to the process was the unwillingness of those who had cash to release it except under pressure, for fear of another and greater stringency. This was especially true of the Western and country banks. Formerly they had been willing to send all their spare cash to the centers—to their big city correspondent banks—for the sake of the interest it would earn. The suspension of redemption—actually the default—of the central city banks during the Panic now made their country cousins more cautious. They were keeping this cash in their own vaults and hang the expense! Thus, enormous sums of money that normally were in circulation were now locked up in bank vaults all over the country. How to loosen up the flow of this cash was the monetary problem that Senator Aldrich hoped to solve by his bill.

Such was the theoretical argument and situation, and at the time the available banking statistics were too limited to permit a critical analysis of the case. Subsequent studies made by the National Monetary Commission indicated that the so-called country bank absorption of cash was less significant than it appeared at the time. Thus, the Commission tabulated the weekly movement of money from the interior into, and out of, New York City banks for the years 1899 through 1909. The figures showed that the movement was normally inward throughout the year, except for the months of September through November and the first half of December. The weekly movement ranged between $1 1/2 million and $6 million. This pattern was broken in 1906 when a heavy withdrawal by interior banks occurred in the latter part of April and the early part of May, coincident with the stock market decline of that year, with $42 million going out in two weeks, and with the drain persisting until the end of the month. Thereafter an inward movement resumed until the fall withdrawals began—this year somewhat earlier, beginning the first week in August. The spring of 1907 saw a resumption of interior withdrawals, though neither heavy nor consistent, and a renewal of an inward movement beginning in May and continuing, with some breaks in August, until the first week of September. The movements remained modest, however, but nevertheless inward, until the stock market crash, the first tremors of which began on October 16. Thereafter, between October 18 and the end of the year, New York City bank balances were drawn down by interior banks to the extent of $124 million. With the New Year, however, a heavy return movement of funds began and $68 million was recovered by the end of January.3

During the three years 1905-1907, the net annual outward movement of funds to the interior had been $37 million, $85 million, and $106 million, respectively. In 1908 the movement abruptly reversed and the net inward flow accumulated to the amount of $156 million by the year end.

A further item illuminating the nature of the October crash was the disclosure in January, 1908, that the total number of clearing house certificates that were issued between October 22, when this emergency measure was adopted, and the end of December, totaled only $97 million, or about 5 per cent of total deposits. By comparison, the issue of clearing house certificates in the 1893 crash amounted to $41.6 million, or about 10 per cent of the deposits then outstanding.

Senator Aldrich’s bill came under immediate criticism, on the grounds that it did not provide for a currency supply that would respond to the seasonal demand and fluctuate in accordance with the volume of trade. It made the condition of the bond market the determinant of the money supply rather than the state of trade. Even those who favored bond-secured currency found the bill objectionable. They pointed out that the restrictions in the bill upon the acceptability of certain types of bonds were so stringent—railways, for instance, had to have paid 4 per cent dividends for four years for their bonds to qualify—as practically to render the bill meaningless.

The moral was obvious. The attempt to increase bank earnings to the maximum by reducing cash reserves—in the case of country banks, by sending them to the central city banks where they would earn interest—was as unwise banking and monetary policy as to destroy or sell off equipment not in immediate use.

“There is no remedy for an alternate excess and deficiency of cars,” continued the Times. “They cannot be extemporized for nothing and burned up when not wanted. But that is exactly what a central bank exists to do in the case of bank notes. It creates them at a profit to itself, and at a cost to borrowers of nothing more than a fair price for the use of capital. And when the notes are in excess they are burned, again at no cost.”

Obviously the questions left hanging were deeper, lying in the realm of moralities and metaphysics, but none the less real and imperative on that account. They were: Is there a moral justification for confusing “circulation” with “capital,” that is, of treating as equal and tangible, both banknotes that are the fictitious creation of a financial institution and money, which is a form of tangible capital (or the certificate of title thereto), such as gold and silver or gold and silver certificates? What were the economic and juridical effects, upon the relative ownerships of wealth, of the process of creating purchasing power through fictitious money issued by a central bank? If one man may buy in the market only by the exchange of goods won at the cost of some human labor and effort, while another need only rub the Aladdin’s lamp of banking and thereby draw purchasing power from the air in the form of crisp banknotes, what are the effects upon the prices of goods in the market, the distribution of ownership of these goods, and the state of contentment or discontentment among the several classes of the citizenry as they are affected by this process?

Various alternative proposals now began to appear. Congressman Charles N. Fowler of New Jersey, a close associate with Aldrich on other matters, proposed a comprehensive reform including the retirement of the bond-secured circulation as well as the remainder of the Civil War greenbacks (which had no specific backing) and the issue of “national bank guaranteed credit notes” secured by reserves, in the form of “lawful money,” of 25 per cent for central city banks and 15 per cent for other banks. The American Bankers’ Association recommended a currency expanding and contracting with the needs of business and secured by “the property for the exchange of which they were issued.”

During the following months the Treasury applied every pressure and influence to induce the banking system to increase the circulation—a campaign that recalls that exerted by the government upon the steel industry in the late forties to increase steel production capacity. The bankers resisted, as the steel industry did later, for so rapidly had confidence been reviving that money was returning from the countryside into the city banks in such quantities as to create a plethora.

Among the more influential voices heard above the din of argument was that of Paul Warburg, whose views gained more and more adherents, and which we will look at further on.

Andrew Carnegie and William Jennings Bryan debated the issue extemporaneously when they jointly addressed the New York Economics Club—Carnegie roundly damning the existing system as “the worst in the world” and Bryan retorting that time did not permit an “answer to all the heresies that have been presented by Mr. Carnegie,” or allow him “to defend the honest dollar from all the attacks that have been made upon it.” Of one thing he was certain, he asserted with a wry reference to his own political defeats, the conditions described arose from nothing with which he had anything to do. Bryan, oddly enough for the moralist and humanitarian that he was, seemed to play into the very hands of those who would manipulate the money system to their profit, by deriding the view that currency should be backed by gold. There was not sufficient gold for the purpose, he declared, and implied that the system of issuing money against only government bonds was both adequate and honest.

More violent opposition to the Aldrich proposals came from the Wisconsin firebrand and “liberal,” Senator Robert M. La Follette, whose position was grounded in the prevailing antipathy to the railroads. He urged that the bill gave them an indirect subsidy by making their bonds legal reserve for note issue. It was dangerous, he argued, to legalize railroad securities as a basis for currency unless the actual value of the property which the bonds represented were established.4 He held correctly that without such valuation and without strict control over “capitalization” (i.e. the issue of new securities), a vast inflation of railway securities would ensue which would in turn impede any effort to reduce railroad rates. His point was that the attractiveness of railway bonds as a backing for note issues would run up the market price on all railway issues, both bonds and stock, and that investors paying such higher prices for the issues would in turn demand higher dividends, which in turn would compel the maintenance of high freight and passenger rates.

To placate La Follette, Aldrich agreed to accept an amendment to his bill to this effect, but he stipulated that the valuations should be limited to the physical valuation only of the properties securing the particular bonds used as note issue reserve. La Follette declined to accept this compromise, since he had long been agitating for an appraisal of the entire railway system.

The La Follette attack served to raise the deeper issues in the Aldrich proposals, and it soon became apparent that, emergency or not, no bill could expect an easy passage. For all his great influence, Aldrich found himself and the Senate playing second fiddle to Congressman Foster and the House.

Not the least of the frustrations of the able and sincere Senator from Rhode Island was a sudden assault upon his bill by one of his freshman colleagues, Senator Robert Latham Owen of Oklahoma. Oklahoma had been admitted to statehood only the year before and Senator Owen had taken the oath as Senator only two months earlier. Though Owen had been born in Virginia, son of a prosperous banker, he had Cherokee blood in his veins and there were some private jokes in the corridors that his chief service would be to keep Senator Curtis of Kansas, who was a member of the Kaw tribe, from growing lonesome.

One of the cherished Senate traditions is that a new senator should avoid speechmaking during his first session. Jefferson Davis had tried to break that tradition with disastrous results. For two months the lithe and handsome, black-eyed and square-jawed young man from the West kept an Indian taciturnity to the proceedings, and was, as someone commented, “a good Indian.”

Suddenly the “Oklahoma Indian” came to life. “In the course of three days in February,” the New York Times feature writer reported, “the young member not only galvanized the Senate into astonishment, but he managed to upset a whole rack of senatorial traditions.” As the Times reported:

Owen’s dramatic and spectacular transformation from the silent and saturnine Indian of the council fire to the rampant warrior of the warpath took place on Tuesday [Feb. 24, 1908]. He liked the change, evidently, for on Thursday he again whetted his oratorical tomahawk and dashed forth to garner a few more senatorial scalps in debate. . . .

On Tuesday the Senate received a twist that it will not recover from in some time. Owen had given notice that he would speak on the Aldrich currency bill. . . . The new Senator had not gone far in his speech when his hearers began to sit up. Here was eloquence, but here also was the argument of a man who knew what he was talking about. Certain of the leaders began to stir uneasily, and it was evident that the hazers were about to begin the inquisition.

But the young representative of the sovereign State of Oklahoma forestalled them. Sensing that he was about to be challenged, he paused suddenly in his reading and announced, enquiringly, “If any Senator wishes to interrupt me . . .”

When no one accepted the dare and the silence became painful, he resumed his speech.

Eventually the supporters of Aldrich rallied. Senator Reed Smoot of Utah undertook to defend the New York banks, but was overpowered by Senator Owen’s trenchant rejoinder and mastery of his subject. After several members attempted to answer Owen, Aldrich himself rose to the defense of his bill. But he fared no better.

“Why this discrimination against United States bonds?” Owen thundered. “Why should railroad bonds, the value of which is never stable, take precedence over the bonds issued by the government?”

Aldrich, suave and conciliatory, made lengthy reply, but there was in fact no answer. Neither party seemed to grasp that the root of the problem lay elsewhere—not whether government promises to pay were better backing for money than railroads’ promises to pay, but whether either offered a sound basis for a monetary system.

Owen’s early entry into the monetary controversy is of interest because of the influential part he was to play in the enactment of the Federal Reserve Act—a part, incidentally, which has never been properly appreciated.

Senator La Follette renewed his opposition to the bill, charging that it would encourage panics rather than prevent them.

Despite the opposition the Aldrich bill, much amended, passed the Senate on March 25, 1908, with a vote of 42 to 16.

Meantime, on the House side, the effort was being made to work out a satisfactory bill through the process of Party caucus rather than committee hearing and finding. Representative E. B. Vreeland of New York offered a bill that attempted to meet a consensus of opinion among the Republican membership, eager to redeem Administration promises of a currency bill. Some currency legislation was imperative, and the powerful Speaker of the House, Joseph Cannon, who wielded unprecedented influence but who was known to be at odds with Roosevelt, let it be known that he would use his prestige toward the Vreeland bill.

At a private hotel room meeting in the Arlington House, on April 14, between Aldrich, Cannon, and Vreeland, a compromise was worked out to accept the Vreeland bill as a substitute for the Aldrich bill.

The Times went on to say:

Finally, on May 11 after a stormy meeting lasting until midnight, during which one of the Congressmen is reported to have shaken his fist under the nose of the Speaker, the Republican membership agreed 128 to 16 on a currency bill that endorsed the principle of commercial paper as an asset of the currency reserve. In the compromise the name “Clearing House Association” was dropped from the bill, but the provision for note issuing associations open to membership by any bank was retained. No machinery was provided by which to discipline the member banks (as was the case with the clearing houses), a defect which opponents immediately used to advantage.

______________

5The Times was, as today, Independent Democrat, but this, as we have noted, meant something far different in 1907 from what it does in 1980.

6A “clearing house” was simply the association of banks that used a common agency or facility to clear their checks or drafts on each others’ banks. The clearing house matched debits and credits arising from these checks or drafts and then credited or debited the account of the particular member bank accordingly. This procedure economized time and cash in settling accounts.

7National Monetary Commission, Vol. XXI, Statistics for U. S.. pp. 229 ff. It should be noted that this inward movement reflected a restoration of confidence in the banking system just as the similar indices in 1932 showed a revival of confidence and trade well before any new legislation or administrative reforms had been enacted or even agreed upon.

8The attempt to evaluate the physical assets of the railways as distinct from the valuation of their earnings subsequently became a mammoth and ineffectual project that gave a career employment to a corps of economists and accountants.

• 2*A “clearing house” was simply the association of banks that used a common agency or facility to clear their checks or drafts on each others’ banks. The clearing house matched debits and credits arising from these checks or drafts and then credited or debited the account of the particular member bank accordingly. This procedure economized time and cash in settling accounts.
• 3*National Monetary Commission, Vol. XXI, Statistics for U. S.. pp. 229 ff. It should be noted that this inward movement reflected a restoration of confidence in the banking system just as the similar indices in 1932 showed a revival of confidence and trade well before any new legislation or administrative reforms had been enacted or even agreed upon.
• 4*The attempt to evaluate the physical assets of the railways as distinct from the valuation of their earnings subsequently became a mammoth and ineffectual project that gave a career employment to a corps of economists and accountants.
• 5Surveying the events of the year the Times came to the retrospective conclusion—which may not have been unbiased, considering its political complexion*—that government intervention in the economy, at the state as well as at the federal level, was a principal cause, leading as it did to loss of confidence in business and among businessmen. To support this view, it pointed out that the year had opened with anxiety over Federal regulation of railway profits in accordance with what it called “erratic views of the effect of capitalization upon rates.” So great was this anxiety that J. P. Morgan had visited the White House to protest, and the President had dismissed as “utter nonsense” any supposition that he contemplated anything prejudicial to railway investments. Nevertheless, such superficial approach to the problems of big business as that displayed by Attorney General Bonaparte in his proposal, as the Times reported it, “to bag trusts miscellaneously by shooting into a covey and to institute receivership for solvent concerns, unconvicted of violating any law,” did not allay disquiet. The Times cited the Presidential proposals for income and inheritance taxes, and noted especially the marks of a persecution complex which Roosevelt had manifested in a recent speech at Providence (R. I.) in which he attributed the stock market collapse to a conspiracy to discredit his policies entered into by certain “malefactors of great wealth.”
• 6Meanwhile, a word about clearing house certificates. They were, as remarked, notes payable to bearer issued by the clearing house of the city or district, the notes being secured by notes, bonds, or other assets of the individual banks that received the certificates.* The process worked as follows: a bank with insufficient cash to meet its depositors’ drafts would deposit with the clearing house such notes or other assets as the clearing house authorities considered acceptable, and receive in turn the certificates of the clearing house. These certificates, which were the obligation of the clearing house, would be accepted in lieu of cash by all member banks of the clearing house association, and consequently they were a limited currency. As rapidly as the banks were able to liquidate their own “frozen” assets, by obtaining payment of notes and bills owing by customers, they were able to pay off their own obligations to the clearing house and reclaim their collateral; at the same time the clearing house retired its certificates.
• 7Such was the theoretical argument and situation, and at the time the available banking statistics were too limited to permit a critical analysis of the case. Subsequent studies made by the National Monetary Commission indicated that the so-called country bank absorption of cash was less significant than it appeared at the time. Thus, the Commission tabulated the weekly movement of money from the interior into, and out of, New York City banks for the years 1899 through 1909. The figures showed that the movement was normally inward throughout the year, except for the months of September through November and the first half of December. The weekly movement ranged between $1 1/2 million and $6 million. This pattern was broken in 1906 when a heavy withdrawal by interior banks occurred in the latter part of April and the early part of May, coincident with the stock market decline of that year, with $42 million going out in two weeks, and with the drain persisting until the end of the month. Thereafter an inward movement resumed until the fall withdrawals began—this year somewhat earlier, beginning the first week in August. The spring of 1907 saw a resumption of interior withdrawals, though neither heavy nor consistent, and a renewal of an inward movement beginning in May and continuing, with some breaks in August, until the first week of September. The movements remained modest, however, but nevertheless inward, until the stock market crash, the first tremors of which began on October 16. Thereafter, between October 18 and the end of the year, New York City bank balances were drawn down by interior banks to the extent of $124 million. With the New Year, however, a heavy return movement of funds began and $68 million was recovered by the end of January.*
• 8More violent opposition to the Aldrich proposals came from the Wisconsin firebrand and “liberal,” Senator Robert M. La Follette, whose position was grounded in the prevailing antipathy to the railroads. He urged that the bill gave them an indirect subsidy by making their bonds legal reserve for note issue. It was dangerous, he argued, to legalize railroad securities as a basis for currency unless the actual value of the property which the bonds represented were established.* He held correctly that without such valuation and without strict control over “capitalization” (i.e. the issue of new securities), a vast inflation of railway securities would ensue which would in turn impede any effort to reduce railroad rates. His point was that the attractiveness of railway bonds as a backing for note issues would run up the market price on all railway issues, both bonds and stock, and that investors paying such higher prices for the issues would in turn demand higher dividends, which in turn would compel the maintenance of high freight and passenger rates.