The Case Against the Fed

Around 1900, two mighty financial-industrial groups, each consisting of investment banks, commercial banks, and industrial resources, confronted each other, usually with hostility, in the financial, and more importantly, the political arena. These coalitions were (1) the interests grouped around the Morgan bank; and (2) an alliance of Rockefeller–Harriman and Kuhn, Loeb interests. It became far easier for these financial elites to influence and control politicians and political affairs after 1900 than before. For the “Third Party System,” which had existed in America from 1856 to 1896, was comprised of political parties, each of which was highly ideological and in intense conflict with the opposing party. While each political party, in this case the Democratic, the Republican, and various minor parties, consisted of a coalition of interests and forces, each was dominated by a firm ideology to which it was strongly committed. As a result, citizens often felt lifelong party loyalties, were socialized into a party when growing up, were educated in party principles, and then rode herd on any party candidates who waffled or betrayed the cause. For various reasons, the Democratic and Republican parties after 1900, in the Fourth and later Party Systems, were largely non-ideological, differed very little from each other, and as a result commanded little party loyalty. In particular, the Democratic Party no longer existed, after the Bryan takeover of 1896, as a committed laissez-faire, hard-money party. From then on, both parties rapidly became Progressive and moderately statist.20

Since the importance of political parties dwindled after 1900, and ideological laissez-faire restraints on government intervention were gravely weakened, the power of financiers in government increased markedly. Furthermore, Congress—the arena of political parties—became less important. A power vacuum developed for the intellectuals and technocratic experts to fill the executive bureaucracy, and to run and plan national economic life relatively unchecked.

The House of Morgan had begun, in the 1860s and 70s, as an investment bank financing and controlling railroads, and then, in later decades, moved into manufacturing and commercial banking. In the opposing coalition, the Rockefellers had begun in oil and moved into commercial banking; Harriman had earned his spurs as a brilliant railroad investor and entrepreneur in competition with the Morgans; and Kuhn, Loeb began in investment banking financing manufacturing. From the 1890s until World War II, much of American political history, of programs and conflicts, can be interpreted not so much as “Democrat” versus “Republican,” but as the interaction or conflict between the Morgans and their allies on the one hand, and the Rockefeller–Harriman-Kuhn, Loeb alliance on the other.

Thus, Grover Cleveland spent his working life allied with the Morgans, and his cabinet and policies were heavily Morgan-oriented; William McKinley, on the other hand, a Republican from Rockefeller’s home state of Ohio, was completely in the Rockefeller camp. In contrast, McKinley’s vice-president, who suddenly assumed the presidency when McKinley was assassinated, was Theodore Roosevelt, whose entire life was spent in the Morgan ambit. When Roosevelt suddenly trotted out the Sherman Antitrust Act, previously a dead letter, to try to destroy Rockefeller’s Standard Oil as well as Harriman’s control of the Northern Pacific Railroad, this led to a titanic struggle between the two mighty financial groups. President Taft, an Ohio Republican who was close to the Rockefellers, struck back by trying to destroy the two main Morgan trusts, United States Steel and International Harvester. Infuriated, the Morgans created the new Progressive Party in 1912, headed by Morgan partner George W. Perkins, and induced the popular ex-President Roosevelt to run for a third term on the Progressive ticket. The aim, and the result, was to destroy Taft’s chances for re-election, and to elect the first Democratic president in twenty years, Woodrow Wilson.21

But while the two financial groups clashed on many issues and personalities, on some matters they agreed and were able to work in concert. Thus, both groups favored the new trend toward cartelization in the name of Progressivism and curbing alleged Big Business monopoly, and both groups, led by the Morgans, were happy to collaborate in the National Civic Federation.

On banking and on the alleged necessity for a central bank, both groups, again, were in happy agreement. And while later on in the history of the Federal Reserve there would be a mighty struggle for control between the factions, to found the Fed they were able to work in undisturbed harmony, and even tacitly agreed that the Morgan Bank would take the lead and play the role of first among equals.22

The bank reform movement, sponsored by the Morgan and Rockefeller forces, began as soon as the election of McKinley as President in 1896 was secured, and the populist Bryan menace beaten back. The reformers decided not to shock people by calling for a central bank right away, but to move toward it slowly, first raising the general point that the money supply must be cured of its “inelasticity,” The bankers decided to employ the techniques they had used successfully in generating a mass pro-gold standard movement in 1895 and 1896. The crucial point was to avoid the damaging appearance of Wall Street prominence and control in the new movement, by creating a spurious “grass roots” movement of non-banker businessmen, centered in the noble American heartland of the Middle West, far from the sinful environs of Wall Street. It was important for bankers, a fortiori Wall Street bankers, to take a discreet back seat in the reform movement, which was to consist seemingly of heartland businessmen, academics, and other supposedly disinterested experts.

The reform movement was officially launched just after the 1896 election by Hugh Henry Hanna, president of the Atlas Engine Works of Indianapolis, who had been active in the gold standard movement earlier in the year; Hanna sent a memorandum to the Indianapolis Board of Trade urging a heartland state like Indiana to take the lead in currency reform.23 The reformers responded with remarkable speed. Answering the call of the Indianapolis Board of Trade, delegates of Boards of Trade from twelve midwestern cities met in Indianapolis at the beginning of December, and they called for a large monetary convention of businessmen from 26 states, which met quickly in Indianapolis on January 12. This Indianapolis Monetary Convention (IMC) resolved: (a) to urge President McKinley to continue the gold standard; and (b) to urge the president to create a new system of “elastic” bank credit, by appointing a Monetary Commission to prepare legislation for a revised monetary system. The IMC named Hugh Hanna as chairman of a permanent executive committee that he would appoint to carry out these policies.

The influential Yale Review hailed the IMC for deflecting opposition by putting itself forward as a gathering of businessmen rather than bankers. But to those in the know, it was clear that the leading members of the executive committee were important financiers in the Morgan ambit. Two particularly powerful executive members were Alexander E. Orr, Morgan-oriented New York City banker, grain merchandiser, railroad director, and director of the J. P. Morgan-owned publishing house of Harper Brothers; and Milwaukee tycoon Henry C. Payne, a Republican leader, head of the Morgan-dominated Wisconsin Telephone Company, and long-time director of the North American Company, a giant public utility holding company. So close was North American to the Morgan interests that its board included two top Morgan financiers; Edmund C. Converse, president of the Morgan-run Liberty National Bank of New York, and soon to be founding president of Morgan’s Bankers Trust Company; and Robert Bacon, a partner in J. P. Morgan & Company, and one of Theodore Roosevelt’s closest friends.24

A third member of the IMC executive committee was an even more powerful secretary of the committee and was even closer to the Morgan empire. He was George Hoster Peabody. The entire Peabody family of Boston Brahmins had long been personally and financially closely associated with the Morgans. A George Peabody had established an international banking firm of which J. P. Morgan’s father, Junius, had been a senior partner. A member of the Peabody clan had served as best man at J. P. Morgan’s wedding in 1865. George Foster Peabody was an eminent, politically left-liberal, New York investment banker, who was to help the Morgans reorganize one of their prime industrial firms, General Electric, and who was later offered the job of Secretary of Treasury in the Wilson Administration. Although he turned down the official post, Peabody functioned throughout the Wilson regime as a close adviser and “statesman without portfolio.”

President McKinley was highly favorable to the IMC, and in his First Inaugural Address, he endorsed the idea of “some revision” of the banking system. He followed this up in late July, 1897 with a special message to Congress, proposing the establishment of a special monetary commission. A bill for a commission passed the House, but failed in the Senate.

Disappointed but imperturbable, the executive committee of the IMC decided in August to select their own Indian-apolis Monetary Commission. The leading role in appointing the new Commission was played by George Foster Peabody. The Commission consisted of various industrial notables, almost all either connected with Morgan railroads or, inonecase, with the Morgan-controlled General Electric Company.25 The working head of the Monetary Commission was economist J. Laurence Laughlin, head Professor of Political Economy at the University of Chicago, and editor of the university’s prestigious Journal of Political Economy. Laughlin supervised the operations of the Commission staff and the writings of its reports; the staff consisted of two of Laughlin’s graduate students at Chicago.

The then impressive sum of $50,000 was raised throughout the nation’s banking and corporate community to finance the work of the Indianapolis Monetary Commission. New York City’s large quota was raised by Morgan bankers Peabody and Orr, and a large contribution came from none other than J. P. Morgan himself.

Setting up shop in Washington in mid-September, the Commission staff pioneered in persuasive public relations techniques to spread the reports of the Commission far and wide. In the first place, they sent a detailed monetary questionnaire to several hundred selected “impartial” experts, who they were sure would answer the questions in the desired manner. These questionnaire answers were then trumpeted as the received opinions of the nation’s business community. Chairman of the IMC Hugh Hanna made the inspired choice of hiring as Washington assistant of the Commission the financial journalist Charles A. Conant, who had recently written A History of Modern Banks of Issue. The Monetary Commission was due to issue its preliminary report in mid-December; by early December, Conant was beating the drums for the Commission’s recommendations, leading an advance line of the report in an issue of Sound Currency magazine, and bolstering the Commission’s proposals with frequent reports of unpublished replies to the Commission’s questionnaire. Conant and his colleagues induced newspapers throughout the country to print abstracts of these questionnaire answers, and in that way, as the Commission’s secretary reported, by “careful manipulation” were able to get part or all of the preliminary Commission report printed in nearly 7,500 newspapers, large and small, across the nation. Thus, long before the days of computerized direct mail, Conant and the others on the staff developed a distribution or transmission system of nearly 100,000 correspondents “dedicated to the enactment of the commission’s plan for banking and currency reform.”26

The prime emphasis of the Commission’s preliminary report was to complete the McKinley victory by codifying the existing de facto single gold standard. More important in the long run was a call for fundamental banking reform to allow greater “elasticity,” so that bank credit could be increased during recessions. As yet, there were little specifics for such a long-run transformation.

The executive committee now decided to organize the second and final meeting of the Indianapolis Monetary Convention, which met at that city in January, 1898. The second convention was a far grander affair than the first, bringing together nearly 500 delegates from 31 states. Moreover, the gathering was a cross-section of America’s top corporate leaders. The purpose of this second convention, as former Secretary of the Treasury Fairchild candidly explained to the gathering, was to mobilize the nation’s leading businessmen into a mighty and influential banking reform movement. As he put it, “If men of business give serious attention and study to these subjects, they will substantially agree upon legislation, and thus, agreeing, their influence will be prevailing.” Presiding officer of the convention, Iowa’s Governor Leslie M. Shaw, was, however, a bit disingenuous when he told the meeting: “You represent today not the banks, for there are few bankers on this floor. You represent the business industries and the financial interests of the country.” For there were plenty of bankers there, too. Shaw himself, later to be Secretary of the Treasury under Theodore Roosevelt, was a small-town banker in Iowa, president of the Bank of Denison, who saw nothing wrong with continuing in this post throughout his term as governor. More important for Shaw’s career was the fact that he was a long-time leading member of the Des Moines Regency, the Iowa Republican machine headed by powerful Senator William Boyd Allison. Allison, who was later to obtain the Treasury post for Shaw, was in turn closely tied to Charles E. Perkins, a close Morgan ally, president of the Chicago, Burlington and Quincy Railroad, and kinsman of the highly influential Forbes financial group of Boston, long tied to the Morgan interests.

Also serving as delegates to this convention were several eminent economists who, however, intriguingly came not as academic observers but frankly as representatives of sections of the business community. Thus Professor Jeremiah W. Jenks of Cornell, a leading proponent of government cartelization and enforcement of trusts and soon to become a friend and advisor of Theodore Roosevelt as governor of New York, came as a delegate from the Ithaca Business Men’s Association. Frank W. Taussig of Harvard represented the Cambridge Merchant’s Association; Yale’s Arthur Twining Hadley, soon to become president of Yale University, came as representative of the New Haven Chamber of Commerce; and Fred M. Taylor of the University of Michigan came representing the Ann Arbor Business Men’s Association. Each of these men held powerful posts in the organized economics profession, Jenks, Taussig, and Taylor serving on the Currency Committee of the American Economic Association. Hadley, a leading railroad economist, also served on the board of directors of two leading Morgan railroads: the New York, New Haven and Hartford, and the Atchison, Topeka, and Santa Fe Railroads.

Both Taussig and Taylor were monetary theorists who urged reform to make the money supply more elastic. Taussig wanted an expansion of national bank notes, to inflate in response to the “needs of business,” so that the currency would “grow without trammels as the needs of the community spontaneously call for increase.” Taylor, too, urged a modification of the gold standard by “a conscious control of the movement of money” by government “in order to maintain the stability of the credit system.” Taylor went so far as to justify suspensions of specie payment by the government in order to “protect the gold reserve.”27

In late January, the Convention duly endorsed the preliminary report with virtual unanimity, after which Professor Laughlin was assigned the task of drawing up a more elaborate Final Report of the Commission, which was published and distributed a few months later. With the endorsement of the august membership of the Convention secured, Laughlin’s Final Report finally let the cat out of the bag: for the report not only came out for a greatly increased issue of national bank notes, but it also called explicitly for a Central Bank that would enjoy a monopoly of the issue of bank notes.28

The Convention delegates promptly took the gospel of banking reform and a central bank to the length and breadth of the corporate and financial communities. Thus, in April, 1898, A. Barton Hepburn, monetary historian and president of the Chase National Bank of New York, at that time the flagship commercial bank for the Morgan interests, and a man who would play a leading role in the drive to establish a central bank, invited Monetary Commissioner Robert S. Taylor to address the New York State Bankers’ Association on the currency question, since “bankers, like other people, need instruction on this subject.” All the Monetary Commissioners, especially Taylor, were active during this period in exhorting groups of businessmen throughout the nation on behalf of banking reform.29

Meanwhile, the lobbying team of Hanna and Conant were extremely active in Washington. A bill embodying the proposals of the Indianapolis Monetary Commission was introduced into the House by Indiana Congressman Jesse Overstreet in January, and was reported out by the House Banking and Currency Committee in May. In the meanwhile, Conant met also continually with the Banking Committee members, while Hanna repeatedly sent circular letters to the Convention delegates and to the public, urging a letter-writing campaign in support of the bill at every step of the Congressional process.

Amidst this agitation, McKinley’s Secretary of the Treasury, Lyman J. Gage, worked closely with Hanna, Conant, and their staff. Gage sponsored several bills along the same lines. Gage, a friend of several of the Monetary Commissioners, was one of the top leaders of the Rockefeller interests in the banking field. His appointment as Secretary of the Treasury had been secured for him by Ohio’s Mark Hanna, political mastermind and financial backer of President McKinley, and old friend, high school classmate, and business associate of John D. Rockefeller, Sr. Before his appointment to the Cabinet, Gage had been president of the powerful First National Bank of Chicago, one of the leading commercial banks in the Rockefeller ambit. During his term in office, Gage tried to operate the Treasury Department as a central bank, pumping in money during recessions by purchasing government bonds in the open market, and depositing large funds with pet commercial banks.

In 1900, Gage called vainly for the establishment of regional central banks. Finally, in his last annual report as Secretary of the Treasury in 1901, Lyman Gage called outright for a governmental central bank. Without such a central bank, he declared in alarm, “individual banks stand isolated and apart, separated units, with no tie of mutuality between them.” Unless a central bank could establish such ties, he warned, the Panic of 1893 would be repeated.

Any reform legislation, however, had to wait until the gold forces could secure control of Congress in the elections of 1898. In the autumn, the permanent executive committee of the Indianapolis Monetary Convention mobilized its forces, calling on 97,000 correspondents throughout the country to whom it had distributed its preliminary report. The executive committee urged its readers to elect a gold standard Congress, a task which was accomplished in November.

As a result, the McKinley Administration now could submit its bill to codify the single gold standard, which Congress passed as the Gold Standard Act of March, 1900. Phase One of the reformers’ task had been accomplished: gold was the sole standard, and the silver menace had been crushed. Less well-known are the clauses of the Gold Standard Act that began the march toward a more “elastic” currency. Capital requirements for national banks in small towns and rural areas were now loosened, and it was made easier for national banks to issue notes. The purpose was to meet a popular demand for “more money” in rural areas at crop-moving time.

But the reformers regarded the Gold Standard Act as only the first step toward fundamental banking reform. Thus, Frank Taussig, in Harvard’s economic journal, praised the Gold Standard Act, and was particularly gratified that it was the result of a new social and ideological alignment, sparked by “strong pressure from the business community” through the Indianapolis Monetary Convention. But Taussig warned that more reform was needed to allow for greater expansion of money and bank credit.30

More detailed in calling for reform in his comment on the Gold Standard Act was Joseph French Johnson, Professor of Finance at the Wharton School of Business at the University of Pennsylvania. Johnson deplored the U. S. banking system as the worst in the world, and pointed in contrast to the glorious central banking systems existing in Britain and France. In the United States, however, unfortunately “there is no single business institution, and no group of large institutions, in which self-interest, responsibility, and power naturally unite and conspire for the protection of the monetary system against twists and strains.” In short, there was far too much freedom and decentralization in the banking system, so that the deposit credit structure “trembles” whenever credit expansion leads to demands for cash or gold.31 Johnson had been a mentor and close friend at the Chicago Tribune of both Lyman Gage and Frank A. Vanderlip , who was to play a particularly important role in the drive for a central bank. When Gage went to Washington as Secretary of the Treasury, he brought Vanderlip along as his Assistant Secretary. On the accession of Roosevelt to the Presidency, Gage left the Cabinet in early 1902, and Gage, Vanderlip, and Conant all left for top banking positions in New York.32

The political pressure for reform after 1900 was poured on by the large bankers. A. Barton Hepburn, head of Morgan’s Chase National Bank, drew up a bill as head of a commission of the American Bankers Association, and the bill was submitted to Congress in late 1901 by Representative Charles N. Fowler of New Jersey, chairman of the House Banking and Currency Committee. The Hepburn–Fowler Bill was reported out of the committee the following April. The Fowler Bill allowed for further expansion of national bank notes; it also allowed national banks to establish branches at home and abroad, a step that had been illegal (and has still been illegal until very recently) due to the fierce opposition of the small country bankers. Third, the Fowler Bill proposed to create a three-member board of control within the Treasury Department to supervise new bank notes and to establish clearinghouses. This would have been a step toward a central bank. But, at this point, fierce opposition by the country bankers managed to kill the Fowler Bill on the floor of the House in 1902, despite agitation in its favor by the executive committee and staff of the Indianapolis Monetary Convention.

Thus, the opposition of the small country bankers managed to stop the reform drive in Congress. Trying another tack, Theodore Roosevelt’s Secretary of Treasury Leslie Shaw attempted to continue and expand Lyman Gage’s experiments in making the U.S. Treasury function like a central bank. In particular, Shaw made open-market purchases in recessions and violated the Independent Treasury statutes confining Treasury funds to its own vaults, by depositing Treasury funds in favored large national banks. In his last annual report of 1906, Secretary Shaw urged that he be given total power to regulate all the nation’s banks. But by this time, the reformers had all dubbed these efforts a failure; a central bank itself was deemed clearly necessary.

• 20See, among others, Paul Kleppner, The Third Electoral System, 1853–1892: Parties, Voters, and Political Cultures (Chapel Hill: University of North Carolina Press, 1979).
• 21Thus, see Philip H. Burch, Jr., Elites in American History, Vol. 2: From the Civil War to the New Deal (New York: Holmes & Meier, 1981).
• 22J. P. Morgan’s fondness for a central bank was heightened by the memory of the fact that the bank of which his father Junius was junior partner—the London firm of George Peabody and Company—was saved from bankruptcy in the Panic of 1857 by an emergency credit from the Bank of England. The elder Morgan took over the firm upon Peabody’s retirement, and its name was changed to J. S. Morgan and Company See Ron Chernow, The House of Morgan (New York: Atlantic Monthly Press, 1990), pp. 11–12.
• 23For the memorandum, see by far the best book on the movement culminating in the Federal Reserve System, James Livingston, Origins of the Federal Reserve System: Money, Class, and Corporate Capitalism, 1890–1913 (Ithaca, N.Y.: Cornell University Press, 1986).
• 24When Theodore Roosevelt became president he made Bacon Assistant Secretary of State, while Henry Payne took the top political job of Postmaster General of the United States.
• 25Some examples: Former Secretary of the Treasury (under Cleveland) Charles S. Fairchild, a leading New York banker, former partner in the Boston Brahmin, Morgan-oriented investment banking firm of Lee, Higginson & Company. Fairchild’s father, Sidney T., had been a leading attorney for the Morgan-controlled New York Central Railroad. Another member of the Commission was Stuyvesant Fish, scion of two long-time aristocratic New York families, partner of the Morgan-dominated New York investment bank of Morton, Bliss & Company, and president of the Illinois Central Railroad. A third member was William B. Dean, merchant from St. Paul, Minnesota, and a director of the St. Paul-based transcontinental railroad, Great Northern, owned by James J. Hill, a powerful ally of Morgan in his titanic battle with Harriman, Rockefeller, and Kuhn, Loeb for control of the Northern Pacific Railroad.
• 26Livingston, Origins, pp. 109–10.
• 27Joseph Dorfman, The Economic Mind in American Civilization (New York: Viking Press, 1949), vol. 3, pp. xxxviii, 269, 392–93.
• 28The Final Report, including the recommendation for a Central Bank, was hailed by Convention delegate F. M. Taylor in Laughlin’s economic journal, the Journal of Political Economy. Taylor also exulted that Convention had been “one of the most notable movements of our time—the first thoroughly organized movement of the business classes in the whole country directed to the bringing about of a radical change in national legislation.” F. M. Taylor, ‘The Final Report to the Indianapolis Monetary Commission,” Journal of Political Economy 6 (June 1898): 322.
• 29Taylor was an Indiana attorney for General Electric Company.
• 30Frank W. Taussig, “The Currency Act of 1900,” Quarterly Journal of Economics 14 (May 1900): 415.
• 31Joseph French Johnson, “The Currency Act of March 14, 1900,” Political Science Quarterly 15 (1900): 482–507.
• 32Gage became president of the Rockefeller-controlled U.S. Trust Company; Vanderlip became vice-president at the flagship commercial bank of the Rockefeller interests, the National City Bank of New York; and Conant became Treasurer of the Morgan-controlled Morton Trust Company.