A History of Money and Banking in the United States: The Colonial Era to World War II

by Murray N. Rothbard

  But the British task was not simply to induce the United States to be the willing guarantor of all the shaky and inflated currencies of war-torn Europe. For Great Britain might well have been able to return to the original form of gold standard at a new, realistic, depreciated parity of $3.50 to the pound. But it was not willing to do so. For the British dream was to restore, even more glowingly than before, British financial preeminence, and if it depreciated the pound by 30 percent, it would thereby acknowledge that the dollar, not the pound, was the world financial center. This it was fiercely unwilling to do; for restoration of dominance, for the saving of financial face, it would return at the good old $4.86 or bust in the attempt. And bust it almost did. For to insist on returning to gold at $4.86, even on the new, vitiated, gold-exchange basis, was to mean that the pound would be absurdly expensive in relation to the dollar and other currencies, and would therefore mean that at current inflated price levels, Britain’s exports—its economic lifeline— would be severely crippled, and a general depression would ensue. And indeed, Britain suffered a severe depression in her export industries—particularly coal and textiles—throughout the 1920s. If she insisted on returning at the overvalued $4.86, there was only one hope for keeping her exports competitive in price: a massive domestic deflation to lower price and wage levels. While a severe deflation is difficult at best, Britain now found it impossible, for the new system of national unemployment insurance and the new-found strength of trade unions made wage-cutting politically unthinkable.

  But if Britain would not or could not make her exports competitive by returning to gold at a depreciated par or by deflating at home, there was a third alternative which it could pursue, and which indeed marked the key to the British international economic policy of the 1920s: it could induce or force other countries to inflate, or themselves to return to gold at overvalued pars; in short, if it could not clean up its own economic mess, it could contrive to impose messes upon everyone else. If it did not do so, it would see inflating Britain lose gold to the United States, France, and other “hard-money” countries, as indeed happened during the 1920s; only by contriving for other countries, especially the U.S., to inflate also, could it check the loss of gold and therefore halt the collapse of the whole jerry-built international monetary structure.

  In the short run, the British scheme was brilliantly conceived, and it worked for a time; but the major problem went unheeded: if the United States, the base of the pyramid and the sole link of all these countries to gold and hard money, were to inflate unduly, the dollar too would become shaky, it would lose gold at home and abroad, and the dollar would itself eventually collapse, dragging the entire structure down with it. And this is essentially what happened in the Great Depression.

  In Europe, England was able to use its domination of the powerful Financial Committee of the League of Nations to cajole or bludgeon country after country to (1) establish central banks that would collaborate closely with the Bank of England; (2) return to gold not in the classical gold-coin standard but in the new gold-exchange standard which would permit continued inflation by all the countries; and (3) return to this new standard at overvalued pars so that European exports would be hobbled vis-à-vis the exports of Great Britain. The Financial Committee of the League of Nations was largely dominated and run by Britain’s major financial figure, Montagu Norman, head of the Bank of England, working through such close Norman associates on the committee as Sir Otto Niemeyer and Sir Henry Strakosch, leaders in the concept of close central bank collaboration to “stabilize” (in practice, to raise) price levels throughout the world. The distinguished British economist Sir Ralph Hawtrey, director of Financial Studies at the British Treasury, was one of the first to advocate this system, as well as to call for the general European adoption of a gold-exchange standard. In the spring of 1922, Norman induced the league to call the Genoa Conference, which urged similar measures.2

  But the British scarcely confined their pressure upon European countries to resolutions and conferences. Using the carrot of loans from England and the United States and the stick of political pressure, Britain induced country after country to order its monetary affairs to suit the British—that is, to return only to a gold-exchange standard at overvalued pars that would hamper their own exports and stimulate imports from Great Britain. Furthermore, the British also used their inflated, cheap credit to lend widely to Europe in order to stimulate their own flagging export market. A trenchant critique of British policy was recorded in the diary of Émile Moreau, governor of the Bank of France, a country that clung to the gold standard and to a hard-money policy, and was thereby instrumental in bringing down the pound and British financial domination in 1931. Moreau wrote:

  England having been the first European country to reestablish a stable and secure money [sic] has used that advantage to establish a basis for putting Europe under a veritable financial domination. The Financial Committee [of the League of Nations] at Geneva has been the instrument of that policy. The method consists of forcing every country in monetary difficulty to subject itself to the Committee at Geneva, which the British control. The remedies prescribed always involve the installation in the central bank of a foreign supervisor who is British or designated by the Bank of England, and the deposit of a part of the reserve of the central bank at the Bank of England, which serves both to support the pound and to fortify British influence. To guarantee against possible failure they are careful to secure the cooperation of the Federal Reserve Bank of New York. Moreover, they pass on to America the task of making some of the foreign loans if they seem too heavy, always retaining the political advantage of these operations.

  England is thus completely or partially entrenched in Austria, Hungary, Belgium, Norway, and Italy. She is in the process of entrenching herself in Greece and Portugal. She seeks to get a foothold in Yugoslavia and fights us cunningly in Rumania.... The currencies will be divided into two classes. Those of the first class, the dollar and the pound sterling, based on gold and those of the second class based on the pound and the dollar—with a part of their gold reserves being held by the Bank of England and the Federal Reserve Bank of New York. The latter moneys will have lost their independence.3

  Inducing the United States to support and bolster the pound and the gold-exchange system was vital to Britain’s success, and this cooperation was ensured by the close ties that developed between Montagu Norman and Benjamin Strong, governor of the Federal Reserve Bank of New York, who had seized effective and nearly absolute control of Federal Reserve operations from his appointment at the inception of the Fed in 1914 until his death in 1928. This control over the Fed was achieved over the opposition of the Federal Reserve Board in Washington, which generally opposed or grumbled at Strong’s Anglophile policies. Strong and Norman made annual trips to visit each other, all of which were kept secret not only from the public but from the Federal Reserve Board itself.

  Strong and the Federal Reserve Bank of New York propped up England and the gold-exchange standard in numerous ways. One was direct lines of credit, which the New York bank extended, in 1925 and after, to Britain, Belgium, Poland, and Italy, to subsidize their going to a gold-exchange standard at overvalued pars. More directly significant was a massive monetary inflation and credit expansion which Strong generated in the United States in 1924 and again in 1927, for the purpose of propping up the pound. The idea was that gold flows from Britain to the United States would be checked and reversed by American credit expansion, which would prop up or raise prices of American goods, thereby stimulating imports from Great Britain, and also lower interest rates in the U.S. as compared to Britain. The fall in interest rates would further stimulate flows of gold from the U.S. to Britain and thereby check the results of British inflation and overvaluation of the pound. Both times, the inflationary injection worked, and prevented Britain from reaping the results of its own inflationary policies, but at the high price of inflation in the United States, a dangerous stock market and real es
tate boom, and an eventual depression. At the secret central bank conference of July 1927 in New York, called at the behest of Norman, Strong agreed to this inflationary credit expansion over the objections of Germany and France, and Strong gaily told the French representative that he was going to give “a little coup de whiskey to the stock market.” It was a coup for which America and the world would pay dearly.4

  The Chicago business and financial community, not having Strong’s ties with England, protested vigorously against the 1927 expansion, and the Federal Reserve Bank of Chicago held out as long as it could against the expansion of cheap money and the lowering of interest rates. The Chicago Tribune went so far as to call for Strong’s resignation, and perceptively charged that discount rates were being lowered in the interests of Great Britain. Strong, however, sold the policy to the middle West with the rationale that its purpose was to help the American farmer by means of cheap credit. In contrast, the English financial community hailed the work of Norman in securing Strong’s support, and The Banker of London lauded Strong as “one of the best friends England ever had.” The Banker praised the “energy and skillfullness he [Strong] has given to the service of England” and exulted that “his name should be associated with that of Mr. [Walter Hines] Page as a friend of England in her greatest need.”5

  A blatant example of Strong’s intervention to help Norman and his policy occurred in the spring of 1926, when one of Norman’s influential colleagues proposed a full gold-coin standard in India. At Norman’s request, Strong and a team of American economists rushed to England to ward off the plan, testifying that a gold drain to India would check inflation in other countries, and instead they successfully backed the Norman policy of a gold-exchange standard and domestic “economizing” of gold to permit domestic expansion of credit.6

  The intimate Norman-Strong collaboration for joint inflation and the gold-exchange standard was not at all an accident of personality; it was firmly grounded on the close ties that both of them had with the House of Morgan and the Morgan interests. Strong himself was a product of the Morgan nexus; he had been the head of the Morgan-oriented Bankers Trust Company before becoming governor of the New York Fed, and his closest ties were with Morgan partners Henry P. Davison and Dwight Morrow, who induced him to assume his post at the Federal Reserve. J.P. Morgan and Company, in turn, was an agent of the British government and of the Bank of England, and its close financial ties with England, its loans to England and tie-ins with the American export trade, had been highly influential in inducing the United States to enter World War I on England’s side.7 As for Montagu Norman, his grandfather had been a partner in the London banking firm of Brown, Shipley, and Company, and of the affiliated New York firm of Brown Brothers and Company, a powerful investment banking firm long associated with the House of Morgan. Norman himself had been a partner of Brown, Shipley and had worked for several years in the offices of Brown Brothers in the United States.

  Moreover, J.P. Morgan and Company played a direct collaborative role with the New York Fed, lending $100 million of its own to Great Britain in 1925 to facilitate its return to gold, and also collaborating in futile loans to prop up the shaky European banking system during the financial crisis of 1931. It is no wonder that in his study of the Federal Reserve System during the pre–New Deal era, Dr. Clark concluded that “the New York Reserve Bank in collaboration with a private international banking house [J.P. Morgan and Company] determined the policy to be followed by the Federal Reserve System.”8

  The major theoretical rationale employed by Strong and Norman was the idea of governmental collaboration to “stabilize” the price level. The laissez-faire policy of the classical, prewar gold standard meant that prices would be allowed to find their own level in accordance with supply and demand, and without interference by central bank manipulation. In practice, this meant a secularly falling price level, as the supply of goods rose over time in accordance with the long-run rise in productivity. And in practice, price stabilization really meant price raising: either keeping prices up when they were falling, or “reflating” prices by raising them through inflationary action by the central banks. Price stabilization therefore meant the replacement of the classical, laissez-faire gold standard by “managed money,” by inflationary credit expansion stimulated by the central banks.

  In England, it was, as we have seen, no accident that the lead in advocating price stabilization was taken by Sir Ralph Hawtrey and various associates of Montagu Norman, including Sir Josiah Stamp, chairman of Midland Railways and a director of the Bank of England, and two other prominent directors—Sir Basil Blackett and Sir Charles Addis.

  It long has been a myth of American historiography that bankers and big businessmen are invariably believers in “hard money” as against cheap credit or inflation. This was certainly not the experience of the New Deal or the pre–New Deal era.9 While the most articulate leaders of the price stabilizationists were academic economists led by Professor Irving Fisher of Yale, Fisher was able to enlist in his Stable Money League (founded 1921) and its successor, the Stable Money Association, a host of men of wealth, bankers and businessmen, as well as labor and farm leaders. Among those serving as officers of the league and association were: Henry Agard Wallace, editor of Wallace’s Farmer and secretary of agriculture in the New Deal; the wealthy John G. Winant, later governor of New Hampshire; George Eastman of the Eastman-Kodak family; Frederick H. Goff, head of the Cleveland Trust Company; John E. Rovensky, executive vice president of the Bank of America; Frederic Delano, uncle of Franklin D. Roosevelt; Samuel Gompers, John P. Frey, and William Green of the American Federation of Labor; Paul M. Warburg, partner of Kuhn, Loeb and Company; Otto H. Kahn, prominent investment banker; James H. Rand, Jr., head of Remington Rand Company; and Owen D. Young of General Electric. Furthermore, the heads of the following organizations agreed to serve as ex officio honorary vice presidents: the American Association for Labor Legislation; the American Bar Association; the American Farm Bureau Federation; the Brotherhood of Railroad Trainmen; the National Association of Credit Men; the National Association of Owners of Railroad and Public Utility Securities; the National Retail Dry Goods Association; the United States Building and Loan League; the American Cotton Growers Exchange; the Chicago Association of Commerce; the Merchants’ Association of New York; and the heads of the bankers associations of 43 states and the District of Columbia.10

  Irving Fisher was unsurprisingly exultant over the supposed achievement of Governor Strong in stabilizing the wholesale price level during the late 1920s, and he led American economists in trumpeting the “new era” of permanent prosperity which the new policy of managed money was assuring to America and the world. Fisher was particularly critical of the minority of skeptical economists who warned of overexpansion in the stock and real estate markets due to cheap money, and even after the stock market crash, Fisher continued to insist that prosperity, particularly in the stock market, was just around the corner. Fisher’s partiality toward stock market inflation was perhaps not unrelated to his own personal role as a millionaire investor in the stock market, a role in which he was financially dependent on a cheap-money policy.11

  In the general enthusiasm for Strong and the new era of monetary and stock market inflation, the minority of skeptics was led by the Chase National Bank, affiliated with the Rockefeller interests, particularly A. Barton Hepburn, economic historian and chairman of the board of the bank, and Chase National’s chief economist, Dr. Benjamin M. Anderson, Jr. Another highly influential and indefatigable critic was Dr. H. Parker Willis, editor of the Journal of Commerce, formerly aide to Senator Carter Glass (D-Va.) and professor of banking at Columbia University, along with Willis’s numerous students, who included Dr. Ralph W. Robey, later to become economist at the National Association of Manufacturers. Another critic was Dr. Rufus S. Tucker, economist at General Motors. On the Federal Reserve Board the major critic was Dr. Adolph C. Miller, a close friend of Herbert Hoover, who joined in the critic
isms of the Strong policy. On the other hand, Treasury Secretary Andrew W. Mellon, of the powerful Mellon interests, enthusiastically backed the inflationist policy. This split in the nation’s leading banking and business circles was to foreshadow the split over Franklin Roosevelt’s monetary departures in 1933.

  THE FIRST NEW DEAL: DOLLAR NATIONALISM

  The international monetary framework of the 1920s collapsed in the storm of the Great Depression; or rather, it collapsed of its own inner contradictions in a depression which it had helped to bring about. For one of the most calamitous features of the depression was the international wave of banking failures; and the banks failed from the inflation and overexpansion which were the fruits of the managed international gold-exchange standard. Once the jerry-built pyramiding of bank credit had collapsed, it brought down the banking system of nation after nation; as inflation led to a piling up of currency claims abroad, the cashing in of the claims led to a well-founded suspicion of the solvency of other banks, and so the failures spread and intensified. The failures in the weak currency countries led to the accumulation of strains in other weak currency nations, and, ultimately, on the bases of the shaky pyramid: Britain and the United States.