Origins of the Federal Reserve Banking System

By: Murray_N_Rothbard

The Progressive Movement

The Federal Reserve Act of December 23, 1913, was part and parcel of the wave of Progressive legislation on local, state, and federal levels of government that began about 1900. Progressivism was a bipartisan movement that, in the course of the first two decades of the 20th century, transformed the American economy and society from one of roughly laissez-faire to one of centralized statism.

Until the 1960s, historians had established the myth that Progressivism was a virtual uprising of workers and farmers who, guided by a new generation of altruistic experts and intellectuals, surmounted fierce big business opposition in order to curb, regulate, and control what had been a system of accelerating monopoly in the late 19th century. A generation of research and scholarship, however, has now exploded that myth for all parts of the American polity, and it has become all too clear that the truth is the reverse of this well-worn fable.

In contrast, what actually happened was that business became increasingly competitive during the late 19th century, and that various big-business interests, led by the powerful financial house of J. P. Morgan and Company, tried desperately to establish successful cartels on the free market. The first wave of such cartels was in the first large-scale business — railroads. In every case, the attempt to increase profits — by cutting sales with a quota system — and thereby to raise prices or rates, collapsed quickly from internal competition within the cartel and from external competition by new competitors eager to undercut the cartel.

During the 1890s, in the new field of large-scale industrial corporations, big-business interests tried to establish high prices and reduced production via mergers, and again, in every case, the merger collapsed from the winds of new competition. In both sets of cartel attempts, J. P. Morgan and Company had taken the lead, and in both sets of cases, the market, hampered though it was by high protective, tariff walls, managed to nullify these attempts at voluntary cartelization.

It then became clear to these big-business interests that the only way to establish a cartelized economy, an economy that would ensure their continued economic dominance and high profits, would be to use the powers of government to establish and maintain cartels by coercion, in other words, to transform the economy from roughly laissez-faire to centralized, coordinated statism. But how could the American people, steeped in a long tradition of fierce opposition to government-imposed monopoly, go along with this program? How could the public's consent to the New Order be engineered?

Fortunately for the cartelists, a solution to this vexing problem lay at hand. Monopoly could be put over in the name of opposition to monopoly! In that way, using the rhetoric beloved by Americans, the form of the political economy could be maintained, while the content could be totally reversed.

Monopoly had always been defined, in the popular parlance and among economists, as "grants of exclusive privilege" by the government. It was now simply redefined as "big business" or business competitive practices, such as price-cutting, so that regulatory commissions, from the Interstate Commerce Commission (ICC) to the Federal Trade Commission (FTC) to state insurance commissions, were lobbied for and staffed with big-business men from the regulated industry, all done in the name of curbing "big-business monopoly" on the free market.

In that way, the regulatory commissions could subsidize, restrict, and cartelize in the name of "opposing monopoly," as well as promoting the general welfare and national security. Once again, it was railroad monopoly that paved the way.

For this intellectual shell game, the cartelists needed the support of the nation's intellectuals, the class of professional opinion molders in society. The Morgans needed a smokescreen of ideology, setting forth the rationale and the apologetics for the New Order. Again, fortunately for them, the intellectuals were ready and eager for the new alliance.

The enormous growth of intellectuals, academics, social scientists, technocrats, engineers, social workers, physicians, and occupational "guilds" of all types in the late 19th century led most of these groups to organize for a far greater share of the pie than they could possibly achieve on the free market. These intellectuals needed the State to license, restrict, and cartelize their occupations, so as to raise the incomes for the fortunate people already in these fields.

In return for their serving as apologists for the new statism, the State was prepared to offer not only cartelized occupations, but also ever-increasing and cushier jobs in the bureaucracy to plan and propagandize for the newly statized society. And the intellectuals were ready for it, having learned in graduate schools in Germany the glories of statism and organicist socialism, of a harmonious "middle way" between dog-eat-dog laissez-faire on the one hand and proletarian Marxism on the other. Big government, staffed by intellectuals and technocrats, steered by big business, and aided by unions organizing a subservient labor force, would impose a cooperative commonwealth for the alleged benefit of all.

Unhappiness with the National-Banking System

The previous big push for statism in America had occurred during the Civil War, when the virtual one-party Congress after secession of the South emboldened the Republicans to enact their cherished statist program under cover of the war. The alliance of big business and big government with the Republican party drove through an income tax, heavy excise taxes on such sinful products as tobacco and alcohol, high protective tariffs, and huge land grants and other subsidies to transcontinental railroads.

The overbuilding of railroads led directly to Morgan's failed attempts at railroad pools, and finally to the creation, promoted by Morgan and Morgan-controlled railroads, of the Interstate Commerce Commission in 1887. The result of that was the long secular decline of the railroads, beginning before 1900. The income tax was annulled by Supreme Court action, but was reinstated during the Progressive period.

The most interventionist of the Civil War actions was in the vital field of money and banking. The approach toward hard money and free banking that had been achieved during the 1840s and 1850s was swept away by two pernicious inflationist measures of the wartime Republican administration. One was fiat money greenbacks, which depreciated by half by the middle of the Civil War. These were finally replaced by the gold standard after urgent pressure by hard-money Democrats, but not until 1879, 14 full years after the end of the war.

A second, and more lasting, intervention was the National Banking Acts of 1863, 1864, and 1865, which destroyed the issue of bank notes by state-chartered (or "state") banks by a prohibitory tax, and then monopolized the issue of bank notes in the hands of a few large, federally chartered "national banks," mainly centered on Wall Street. In a typical cartelization, national banks were compelled by law to accept each other's notes and demand deposits at par, negating the process by which the free market had previously been discounting the notes and deposits of shaky and inflationary banks.

In this way, the Wall Street–federal government establishment was able to control the banking system, and inflate the supply of notes and deposits in a coordinated manner.

But there were still problems. The national-banking system provided only a halfway house between free banking and government central banking, and by the end of the 19th century, the Wall Street banks were becoming increasingly unhappy with the status quo.

The centralization was only limited, and, above all, there was no governmental central bank to coordinate inflation, and to act as a lender of last resort, bailing out banks in trouble. As soon as bank credit generated booms, then they got into trouble; bank-created booms turned into recessions, with banks forced to contract their loans and assets and to deflate in order to save themselves.

Not only that, but after the initial shock of the National Banking Acts, state banks had grown rapidly by pyramiding their loans and demand deposits on top of national-bank notes. These state banks, free of the high legal-capital requirements that kept entry restricted in national banking, flourished during the 1880s and 1890s and provided stiff competition for the national banks themselves.

Furthermore, St. Louis and Chicago, after the 1880s, provided increasingly severe competition to Wall Street. Thus, St. Louis and Chicago bank deposits, which had been only 16 percent of the St. Louis, Chicago, and New York City total in 1880, rose to 33 percent of that total by 1912. All in all, bank clearings outside of New York City, which were 24 percent of the national total in 1882, had risen to 43 percent by 1913.

The complaints of the big banks were summed up in one word: "inelasticity." The national-banking system, they charged, did not provide for the proper "elasticity" of the money supply; that is, the banks were not able to expand money and credit as much as they wished, particularly in times of recession. In short, the national-banking system did not provide sufficient room for inflationary expansions of credit by the nation's banks.[1]

By the turn of the century, the political economy of the United States was dominated by two generally clashing financial aggregations: the previously dominant Morgan group, which began in investment banking and then expanded into commercial banking, railroads, and mergers of manufacturing firms; and the Rockefeller forces, which began in oil refining and then moved into commercial banking, finally forming an alliance with the Kuhn, Loeb Company in investment banking and the Harriman interests in railroads.[2]

Although these two financial blocs usually clashed with each other, they were as one on the need for a central bank. Even though the eventual major role in forming and dominating the Federal Reserve System was taken by the Morgans, the Rockefeller and Kuhn, Loeb forces were equally enthusiastic in pushing, and collaborating on, what they all considered to be an essential monetary reform.

The Beginnings of the "Reform" Movement: The Indianapolis Monetary Convention

The presidential election of 1896 was a great national referendum on the gold standard. The Democratic party had been captured, at its 1896 convention, by the populist, ultrainflationist antigold forces, headed by William Jennings Bryan. The older Democrats, who had been fiercely devoted to hard money and the gold standard, either stayed home on election day or voted, for the first time in their lives, for the hated Republicans.

The Republicans had long been the party of prohibition and of greenback inflation and opposition to gold. But since the early 1890s, the Rockefeller forces, dominant in their home state of Ohio and nationally in the Republican party, had decided to quietly ditch prohibition as a political embarrassment and as a grave deterrent to obtaining votes from the increasingly powerful bloc of German-American voters.

In the summer of 1896, anticipating the defeat of the gold forces at the Democratic convention, the Morgans, previously dominant in the Democratic party, approached the McKinley–Mark Hanna–Rockefeller forces through their rising young satrap, Congressman Henry Cabot Lodge of Massachusetts. Lodge offered the Rockefeller forces a deal: the Morgans would support McKinley for president, and neither sit home nor back a third, Gold Democrat party, provided that McKinley pledged himself to a gold standard. The deal was struck, and many previously hard-money Democrats shifted to the Republicans.

The nature of the American political-party system was now drastically changed: what was previously a tightly fought struggle between hard-money, free-trade, laissez-faire Democrats on the one hand, and inflationist, protectionist, statist Republicans on the other, with the Democrats slowly but surely gaining ascendancy by the early 1890s, was now a party system dominated by the Republicans until the depression election of 1932.

The Morgans were strongly opposed to Bryanism, which was not only populist and inflationist, but also anti–Wall Street bank; the Bryanites, much like populists of the present day, preferred Congressional, greenback inflationism to the more subtle, and more privileged, big bank–controlled variety. The Morgans, in contrast, favored a gold standard.

But, once gold was secured by the McKinley victory of 1896, they wanted to press on to use the gold standard as a hard-money camouflage behind which they could change the system into one less nakedly inflationist than populism but far more effectively controlled by the big-banker elites. In the long run, a controlled Morgan-Rockefeller gold standard was far more pernicious to the cause of genuine hard-money than a candid free-silver or greenback Bryanism.

As soon as McKinley was safely elected, the Morgan-Rockefeller forces began to organize a "reform" movement to cure the "inelasticity" of money in the existing gold standard and to move slowly toward the establishment of a central bank. To do so, they decided to use the techniques they had successfully employed in establishing a pro–gold standard movement during 1895 and 1896.

The crucial point was to avoid the public suspicion of Wall Street and banker control by acquiring the patina of a broad-based grassroots movement. The movement, therefore, was deliberately focused in the Middle West, the heartland of America, and organizations developed that included not only bankers, but also businessmen, economists, and other academics, who supplied respectability, persuasiveness, and technical expertise to the reform cause.

Accordingly, the reform drive began just after the 1896 elections in authentic Midwest country. Hugh Henry Hanna, president of the Atlas Engine Works of Indianapolis, who had learned organizing tactics during the year with the pro–gold standard Union for Sound Money, sent a memorandum, in November, to the Indianapolis Board of Trade, urging a grassroots, Midwestern state like Indiana to take the lead in currency reform.[3]

In response, the reformers moved fast. Answering the call of the Indianapolis Board of Trade, delegates from boards of trade from 12 Midwestern cities met in Indianapolis on December 1, 1896. The conference called for a large monetary convention of businessmen, which accordingly met in Indianapolis on January 12, 1897. Representatives from 26 states and the District of Columbia were present. The monetary reform movement was now officially underway.

The influential Yale Review commended the convention for averting the danger of arousing popular hostility to bankers. It reported that "the conference was a gathering of businessmen in general rather than bankers in particular" (quoted in Livingston 1986, p. 105).

The conventioneers may have been businessmen, but they were certainly not very grassrootsy. Presiding at the Indianapolis Monetary Convention of 1897 was C. Stuart Patterson, dean of the University of Pennsylvania Law School and a member of the finance committee of the powerful, Morgan-oriented Pennsylvania Railroad. The day after the convention opened, Hugh Hanna was named chairman of an executive committee, which he would appoint. The committee was empowered to act for the convention after it adjourned.

The executive committee consisted of the following influential corporate and financial leaders:

John J. Mitchell of Chicago, president of the Illinois Trust and Savings Bank, and a director of the Chicago and Alton Railroad; the Pittsburgh, Fort Wayne, and Chicago Railroad; and the Pullman Company, was named treasurer of the executive committee.

H. H. Kohlsaat, editor and publisher of the Chicago Times Herald and the Chicago Ocean Herald, trustee of the Chicago Art Institute, and a friend and advisor of Rockefeller's main man in politics, President William McKinley.

Charles Custis Harrison, provost of the University of Pennsylvania, who had made a fortune as a sugar refiner in partnership with the powerful Havemeyer ("Sugar Trust") interests.

Alexander E. Orr, a New York City banker in the Morgan ambit, who was a director of the Morgan-run Erie and Chicago, Rock Island and Pacific railroads, the National Bank of Commerce, and the influential publishing house of Harper Brothers. Orr was also a partner in the country's largest grain-merchandising firm and a director of several life-insurance companies.

Edwin O. Stanard, St. Louis grain merchant, former governor of Missouri, and former vice president of the National Board of Trade and Transportation.

E. B. Stahlman, owner of the Nashville Banner, commissioner of the cartelist Southern Railway and Steamship Association, and former vice president of the Louisville, New Albany, and Chicago Railroad.

A. E. Willson, influential attorney from Louisville and future governor of Kentucky.

But the two most interesting and powerful executive committee members of the Monetary Convention were Henry C. Payne and George Foster Peabody. Henry Payne was a Republican party leader from Milwaukee, and president of the Morgan-dominated Wisconsin Telephone Company, long associated with the railroad-oriented Spooner-Sawyer Republican machine in Wisconsin politics. Payne was also heavily involved in Milwaukee utility and banking interests, in particular as a long-time director of the North American Company, a large public utility–holding company headed by New York City financier Charles W. Wetmore.

So close was North American Company to the Morgan interests that its board included two top Morgan financiers. One was Edmund C. Converse, president of Morgan-run Liberty National Bank of New York City, and soon to be founding president of Morgan's Bankers' Trust Company. The other was Robert Bacon, a partner in J. P. Morgan and Company, and one of Theodore Roosevelt's closest friends, whom Roosevelt would later make assistant secretary of state.

Furthermore, when Theodore Roosevelt became president as the result of the assassination of William McKinley, he replaced Rockefeller's top political operative, Mark Hanna of Ohio, with Henry C. Payne as Postmaster General of the United States. Payne, a leading Morgan lieutenant, was reportedly appointed to what was then the major political post in the Cabinet specifically to break Hanna's hold over the national Republican party. It seems clear that replacing Hanna with Payne was part of the savage assault that Theodore Roosevelt would soon launch against Standard Oil as part of the open warfare about to break out between the Rockefeller–Harriman–Kuhn, Loeb, and the Morgan camps (Burch 1981, p. 189, n. 55).

Even more powerful in the Morgan ambit was the secretary of the Indianapolis Monetary Convention's executive committee, George Foster Peabody. The entire Peabody family of Boston Brahmins had long been personally and financially closely associated with the Morgans. A member of the Peabody clan had even served as best man at J. P. Morgan's wedding in 1865.

George Peabody had long ago established an international banking firm of which J. P. Morgan's father, Junius, had been one of the senior partners. George Foster Peabody was an eminent New York investment banker with extensive holdings in Mexico. He helped reorganize General Electric for the Morgans, and was later offered the job of secretary of the treasury during the Wilson administration. He would function throughout that administration as a "statesman without portfolio" (ibid., pp. 231, 233; Ware 1951, pp. 161–67).

Let the masses be hoodwinked into regarding the Indianapolis Monetary Convention as a spontaneous, grassroots outpouring of small Midwestern businessmen. To the cognoscenti, any organization featuring Henry Payne, Alexander Orr, and especially George Foster Peabody meant but one thing: J. P. Morgan.

The Indianapolis Monetary Convention quickly resolved to urge President McKinley to (1) continue the gold standard and (2) create a new system of "elastic" bank credit. To that end, the convention urged the president to appoint a new Monetary Commission to prepare legislation for a new, revised monetary system. McKinley was very much in favor of the proposal, signaling Rockefeller agreement, and on July 24 he sent a message to Congress urging the creation of a special monetary commission. The bill for a national monetary commission passed the House of Representatives but died in the Senate (Kolko 1983, pp. 147–48).

Disappointed but intrepid, the executive committee, failing a presidentially appointed commission, decided in August 1897 to go ahead and select its own. The leading role in appointing this commission was played by George Foster Peabody, who served as liaison between the Indianapolis members and the New York financial community. To select the commission members, Peabody arranged for the executive committee to meet in the Saratoga Springs summer home of his investment-banking partner, Spencer Trask. By September, the executive committee had selected the members of the Indianapolis Monetary Commission.

The members of the new Indianapolis Monetary Commission were as follows (Livingston 1986, pp. 106–07):

• The chairman was former senator George F. Edmunds, Republican of Vermont, attorney, and former director of several railroads.

• C. Stuart Patterson was dean of the University of Pennsylvania Law School, and a top official of the Morgan-controlled Pennsylvania Railroad.

• Charles S. Fairchild, a leading New York banker, president of the New York Security and Trust Company, was a former partner in the Boston Brahmin investment banking firm of Lee, Higginson, and Company, and executive and director of two major railroads. Fairchild, a leader in New York state politics, had been secretary of the treasury in the first Cleveland Administration. In addition, Fairchild's father, Sidney T. Fairchild, had been a leading attorney for the Morgan-controlled New York Central Railroad.

• Stuyvesant Fish, scion of two long-time aristocratic New York families, was a partner of the Morgan-dominated New York investment bank of Morton, Bliss, and Company, and then president of Illinois Central Railroad and a trustee of Mutual Life. Fish's father had been a senator, governor, and secretary of state.

• Louis A. Garnett was a leading San Francisco businessman.

• Thomas G. Bush of Alabama was a director of the Mobile and Birmingham Railroad.

• J. W. Fries was a leading cotton manufacturer of North Carolina.

• William B. Dean, merchant from St. Paul, Minnesota, and a director of the St. Paul–based, transcontinental Great Northern Railroad, owned by James J. Hill, ally with Morgan in the titanic struggle over the Northern Pacific Railroad with Harriman, Rockefeller, and Kuhn, Loeb.

• George Leighton of St. Louis was an attorney for the Missouri Pacific Railroad.

• Robert S. Taylor was an Indiana patent attorney for the Morgan-controlled General Electric Company.

• The single most important working member of the commission was James Laurence Laughlin, head professor of political economy at the new Rockefeller-founded University of Chicago, and editor of its prestigious Journal of Political Economy. It was Laughlin who supervised the operations of the Commission's staff and the writing of the reports. Indeed, the two staff assistants to the Commission who wrote reports were both students of Laughlin at Chicago: former student L. Carroll Root, and his then-current graduate student Henry Parker Willis.

The 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 heavy contributions to fill the quota came promptly from mining magnate William E. Dodge, cotton and coffee trader Henry Hentz, a director of the Mechanics National Bank, and J. P. Morgan himself.

With the money in hand, the executive committee rented office space in Washington, DC in mid-September and set the staff to sending out and collating the replies to a detailed monetary questionnaire, sent to several hundred selected experts. The Monetary Commission sat from late September into December 1897, sifting through the replies to the questionnaire collated by Root and Willis. The purpose of the questionnaire was to mobilize a broad base of support for the Commission's recommendations, which they could claim represented hundreds of expert views.

Second, the questionnaire served as an important public-relations device, making the Commission and its work highly visible to the public, to the business community throughout the country, and to members of Congress. Furthermore, through this device, the Commission could be seen as speaking for the business community throughout the country.

To this end, the original idea was to publish the Monetary Commission's preliminary report, adopted in mid-December, as well as the questionnaire replies in a companion volume. Plans for the questionnaire volume fell through, although it was later published as part of a series of publications on political economy and public law by the University of Pennsylvania (Livingston 1986, pp. 107–08).

Undaunted by the slight setback, the executive committee developed new methods of molding public opinion using the questionnaire replies as an organizing tool. In November, Hugh Hanna hired as his Washington assistant financial journalist Charles A. Conant, whose task was to propagandize and organize public opinion for the recommendations of the Commission.

The campaign to beat the drums for the forthcoming Commission report was launched when Conant published an article in the December 1 issue of Sound Currency magazine, taking an advanced line on the Commission report, and bolstering the conclusions not only with his own knowledge of monetary and banking history, but also with frequent statements from the as-yet-unpublished replies to the staff questionnaire.

Over the next several months, Conant worked closely with Jules Guthridge, the general secretary of the Commission; they first induced newspapers throughout the country to print abstracts of the questionnaire replies. As Guthridge wrote some Commission members, he thereby stimulated "public curiosity" about the forthcoming report, and he boasted that by "careful manipulation" he was able to get the preliminary report "printed in whole or in part — principally in part — in nearly 7,500 newspapers, large and small."

In the meantime, Guthridge and Conant orchestrated letters of support from prominent men across the country. When the preliminary report was published on January 3, 1898, Guthridge and Conant made these letters available to the daily newspapers. Quickly, the two built up a distribution system to spread the gospel of the report, organizing nearly 100,000 correspondents "dedicated to the enactment of the commission's plan for banking and currency reform" (Livingston 1986, pp. 109–10).

The prime and immediate emphasis of the preliminary report of the Monetary Commission was to complete the promise of the McKinley victory by codifying and enacting what was already in place de facto: a single gold standard, with silver reduced to the status of subsidiary token currency. Completing the victory over Bryanism and free silver, however, was just a mopping-up operation; more important in the long run was the call raised by the report for banking reform to allow greater elasticity.

Bank credit could then be increased in recessions and whenever seasonal pressure for redemption by agricultural country banks forced the large central reserve banks to contract their loans. The actual measures called for by the Commission were of marginal importance. More important was that the question of banking reform had been raised at all.

Since the public had been aroused by the preliminary report, the executive committee decided to organize the second and final meeting of the Indianapolis Monetary Convention, which duly met at Indianapolis on January 25, 1898. The second convention was a far grander affair than the first, bringing together 496 delegates from 31 states.

Furthermore, the gathering was a cross-section of America's top corporate leaders. While the state of Indiana naturally had the largest delegation, of 85 representatives of boards of trade and chambers of commerce, New York sent 74, including many from the city's Board of Trade and Transportation, Merchant's Association, and Chamber of Commerce.

Such corporate leaders as Cleveland iron manufacturer Alfred A. Pope, president of the National Malleable Castings Company, attended; as did Virgil P. Cline, legal counsel to Rockefeller's Standard Oil Company of Ohio; and C.A. Pillsbury, of Minneapolis–St. Paul, organizer of the world's largest flour mills. From Chicago came such business notables as Marshall Field and Albert A. Sprague, a director of the Chicago Telephone Company, subsidiary of the Morgan-controlled telephone monopoly, American Telephone and Telegraph Company.

Not to be overlooked is delegate Franklin MacVeagh, a wholesale grocer from Chicago, an uncle of a senior partner in the Wall Street law firm of Bangs, Stetson, Tracy, and MacVeagh, counsel to J. P. Morgan and Company. MacVeagh, who was later to become secretary of the treasury in the Taft administration, was wholly in the Morgan ambit. His father-in-law, Henry F. Eames, was the founder of the Commercial National Bank of Chicago, and his brother Wayne was soon to become a trustee of the Morgan-dominated Mutual Life Insurance Company.

The purpose of the second convention, as former Secretary of the Treasury Charles S. Fairchild candidly explained in his address to the gathering, was to mobilize the nation's leading businessmen into a mighty and influential 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." He concluded that "My word to you is, pull all together."

Presiding officer of the convention, Iowa's Governor Leslie M. Shaw, was however, a bit disingenuous when he told the gathering, "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." There were plenty of bankers there, too (Livingston 1986, pp. 113–15).

Shaw himself, later to be secretary of the treasury under Theodore Roosevelt, was a small-town banker in Iowa, and president of the Bank of Denison throughout his term as governor. More important in Shaw's outlook and career was the fact that he was a long-time close friend and loyal supporter of the Des Moines Regency, the Iowa Republican machine headed by the powerful Senator William Boyd Allison.

Allison, who was to obtain the Treasury post for his friend, was in turn tied closely to Charles E. Perkins, a close Morgan ally, president of the Chicago, Burlington, and Quincy Railroad, and kinsman of the powerful Forbes financial group of Boston, long tied in with the Morgan interests (Rothbard 1984, pp. 95–96).

Also serving as delegates to the second convention were several eminent economists, each of whom, however, came not as academic observers but as representatives of elements of the business community. Professor Jeremiah W. Jenks of Cornell, a proponent of trust cartelization by government and soon to become a friend and advisor of Theodore Roosevelt as governor, came as delegate from the Ithaca Business Men's Association.

Frank W. Taussig of Harvard University represented the Cambridge Merchants' Association. Yale's Arthur Twining Hadley, soon to be the president of Yale, represented the New Haven Chamber of Commerce, and Frank M. Taylor of the University of Michigan came as representative of 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 Morgan's New York, New Haven, and Hartford; and Atchison, Topeka, and Santa Fe Railroads.[4]

Both Taussig and Taylor were monetary theorists who, while committed to a gold standard, urged reform that would make the money supply more elastic. Taussig called for an expansion of national bank notes, which would inflate in response to the "needs of business." As Taussig (quoted in Dorfman 1949, p. xxxvii; Parrini and Sklar 1983, p. 269) put it, the currency would then "grow without trammels as the needs of the community spontaneously call for increase."

Taylor, too, as one historian puts it, wanted the gold standard to be modified by "a conscious control of the movement of money" by government "in order to maintain the stability of the credit system." Taylor justified governmental suspensions of specie payment to "protect the gold reserve" (Dorfman 1949, pp. 392–93).

On January 26, the convention delegates duly endorsed the preliminary report with virtual unanimity, after which Professor J. Laurence Laughlin was assigned the task of drawing up a more elaborate final report, which was published and distributed a few months later. Laughlin's — and the convention's — final report not only came out in favor of a broadened asset base for a greatly increased amount of national-bank notes, but also called explicitly for a central bank that would enjoy a monopoly of the issue of bank notes.[5]

Meanwhile, the convention delegates took the gospel of banking reform to the length and breadth of the corporate and financial communities. In April 1898, for example, A. Barton Hepburn, president of the Chase National Bank of New York (at that time a flagship commercial bank for the Morgan interests), and a man who would play a large 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 upon this subject." All the monetary commissioners, especially Taylor, were active during the first half of 1898 in exhorting groups of businessmen throughout the nation for monetary reform.

Meanwhile, in Washington, the lobbying team of Hanna and Conant were extremely active. A bill embodying the suggestions of the Monetary Commission was introduced by Indiana Congressman Jesse Overstreet in January, and was reported out by the House Banking and Currency Committee in May. In the meantime, Conant met almost continuously with the banking committee members. At each stage of the legislative process, Hanna sent circular letters to the convention delegates and to the public, urging a letter-writing campaign in support of the bill.

In this agitation, McKinley's Secretary of the Treasury Lyman J. Gage worked closely with Hanna and his staff. Gage sponsored similar bills, and several bills along the same lines were introduced in the House in 1898 and 1899. 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 gained 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 was president of the powerful First National Bank of Chicago, one of the major commercial banks in the Rockefeller ambit. During his term in office, Gage tried to operate the Treasury as a central bank, pumping in money during recessions by purchasing government bonds on 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 let the cat completely out of the bag, calling outright for a government 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 establishes such ties, Gage warned, the Panic of 1893 would be repeated (Livingston 1986, p. 153). When he left office early the next year, Lyman Gage took up his post as president of the Rockefeller-controlled US Trust Company in New York City (Rothbard 1984, pp. 94–95).

The Gold Standard Act of 1900 and After

Any reform legislation had to wait until after the elections of 1898, for the gold forces were not yet in control of Congress. In the autumn, the executive committee of the Indianapolis Monetary Convention mobilized its forces, calling on no less than 97,000 correspondents throughout the country, through whom it had distributed the preliminary report. The executive committee urged its constituency to elect a gold-standard Congress; when the gold forces routed the silverites in November, the results of the election were hailed by Hanna as eminently satisfactory.

The decks were now cleared for the McKinley administration to submit its bill, and the Congress that met in December 1899 quickly passed the measure; Congress then passed the conference report of the Gold Standard Act in March 1900.

The currency reformers had gotten their way. It is well known that the Gold Standard Act provided for a single gold standard, with no retention of silver money except as tokens. Less well known are the clauses that began the march toward a more "elastic" currency. As Lyman Gage had suggested in 1897, national banks, previously confined to large cities, were now made possible with a small amount of capital in small towns and rural areas.

And it was made far easier for national banks to issue notes. The object of these clauses, as one historian put it, was to satisfy an "increased demand for money at crop-moving time, and to meet popular cries for 'more money' by encouraging the organization of national banks in comparatively undeveloped regions" (Livingston 1986, p. 123).

The reformers exulted over the passage of the Gold Standard Act, but took the line that this was only the first step on the much needed path to fundamental banking reform. Thus, Professor Frank W. Taussig of Harvard praised the act, and greeted the emergence of a new social and ideological alignment, caused by "strong pressure from the business community" through the Indianapolis Monetary Convention. He particularly welcomed the fact that the Gold Standard Act "treats the national banks not as grasping and dangerous corporations but as useful institutions deserving the fostering care of the legislature."

But such tender legislative care was not enough; fundamental banking reform was needed. For, Taussig declared, "the changes in banking legislation are not such as to make possible any considerable expansion of the national system or to enable it to render the community the full service of which it is capable." In short, the changes allowed for more and greater expansion of bank credit and the supply of money. Therefore, Taussig (1990, p. 415) concluded, "It is well-nigh certain that eventually Congress will have to consider once more the further remodeling of the national bank system."

In fact, the Gold Standard Act of 1900 was only the opening gun of the banking reform movement. Three friends and financial journalists, two from Chicago, were to play a large role in the development of that movement. Massachusetts-born Charles A. Conant (1861–1915) a leading historian of banking, wrote his A History of Modern Banks of Issue in 1896, while still a Washington correspondent for the New York Journal of Commerce and an editor of Bankers Magazine. After his stint of public relations work and lobbying for the Indianapolis Convention, Conant moved to New York in 1902 to become treasurer of the Morgan-oriented Morton Trust Company.

The two Chicagoans, both friends of Lyman Gage, were, along with Gage, in the Rockefeller ambit: Frank A. Vanderlip was picked by Gage as his assistant secretary of the treasury, and when Gage left office, Vanderlip came to New York as a top executive at the flagship commercial bank of the Rockefeller interests, the National City Bank of New York.

Meanwhile, Vanderlip's close friend and former mentor at the Chicago Tribune, Joseph French Johnson, had also moved east to become professor of finance at the Wharton School of the University of Pennsylvania. But no sooner had the Gold Standard Act been passed when Joseph Johnson sounded the trump by calling for more-fundamental reform.

Professor Johnson stated flatly that the existing bank note system was weak in not "responding to the needs of the money market," i.e., not supplying a sufficient amount of money. Since the national banking system was incapable of supplying those needs, Johnson opined, there was no reason to continue it. Johnson deplored the US banking system as the worst in the world, and pointed to the glorious central banking system as existed in Britain and France.[6]

But no such centralized banking system yet existed in the United States: "In the United States, however, 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 system. In consequence, our massive deposit credit system "trembles whenever the foundations are disturbed," i.e., whenever the chickens of inflationary credit expansion came home to roost in demands for cash or gold. The result of the inelasticity of money, and of the impossibility of interbank cooperation, Johnson opined, was that we were in danger of losing gold abroad just at the time when gold was needed to sustain confidence in the nation's banking system (Johnson 1900, pp. 497f).

After 1900, the banking community was split on the question of reform, the small and rural bankers preferring the status quo. But the large bankers were headed by A. Barton Hepburn of Morgan's Chase National Bank, who drew up a bill as head of a commission of the American Bankers Association, and presented it in late 1901 to Representative Charles N. Fowler of New Jersey, chairman of the House Banking and Currency Committee, who had introduced one of the bills that had led to the Gold Standard Act. The Hepburn proposal was reported out of committee in April 1902 as the Fowler Bill (Kolko 1983, pp. 149–50).

The Fowler Bill contained three basic clauses. The first allowed the further expansion of national bank notes based on broader assets than government bonds.

The second, a favorite of the big banks, was to allow national banks to establish branches at home and abroad, a step illegal under the existing system due to fierce opposition by the small country bankers. While branch banking is consonant with a free market and provides a sound and efficient system for calling on other banks for redemption, the big banks had little interest in branch banking unless accompanied by centralization of the banking system.

Third, the Fowler Bill proposed to create a three-member board of control within the Treasury Department to supervise the creation of the new bank notes and to establish clearinghouse associations under its aegis. This provision was designed to be the first step toward the establishment of a full-fledged central bank (Livingston 1986, pp. 150–54).

Although they could not control the American Bankers Association, the multitude of country bankers, up in arms against the proposed competition of big banks in the form of branch banking, put fierce pressure upon Congress and managed to kill the Fowler Bill in the House during 1902, despite the agitation of the executive committee and staff of the Indianapolis Monetary Convention.

With the defeat of the Fowler Bill, the big bankers decided to settle for more modest goals for the time being. Senator Nelson W. Aldrich of Rhode Island, perennial Republican leader of the US Senate and Rockefeller's man in Congress,[7] submitted the Aldrich Bill the following year, allowing the large national banks in New York to issue "emergency currency" based on municipal and railroad bonds. But even this bill was defeated.

Meeting setbacks in Congress, the big bankers decided to regroup and turn temporarily to the executive branch. Foreshadowing a later, more elaborate collaboration, two powerful representatives each from the Morgan and Rockefeller banking interests met with Comptroller of the Currency William B. Ridgely in January 1903, to try to persuade him, by administrative fiat, to restrict the volume of loans made by the country banks in the New York money market.

The two Morgan men at the meeting were J. P. Morgan himself and George F. Baker, Morgan's closest friend and associate in the banking business.[8] The two Rockefeller men were Frank Vanderlip and James Stillman, long-time chairman of the board of the National City Bank.[9] The close Rockefeller-Stillman alliance was cemented by the marriage of the two daughters of Stillman to the two sons of William Rockefeller, brother of John D. Rockefeller, Sr., and long-time board member of the National City Bank (Burch 1981, pp. 134–35).

The meeting with the comptroller did not bear fruit, but the lead instead was taken by the secretary of the treasury himself, Leslie Shaw, formerly presiding officer at the second Indianapolis Monetary Convention, whom President Roosevelt appointed to replace Lyman Gage. The unexpected and sudden shift from McKinley to Roosevelt in the presidency meant more than just a turnover of personnel; it meant a fundamental shift from a Rockefeller-dominated to a Morgan-dominated administration. The shift from Gage to Shaw was one of the many Rockefeller-to-Morgan displacements.

On monetary and banking matters, however, the Rockefeller and Morgan camps were as one. Secretary Shaw attempted to continue and expand Gage's experiments in trying to make the Treasury function like a central bank, particularly in making open-market purchases in recessions, and in using Treasury deposits to bolster the banks and expand the money supply.

Shaw violated the statutory institution of the independent Treasury, which had tried to confine government revenues and expenditures to its own coffers. Instead, he expanded the practice of depositing Treasury funds in favored, big national banks. Indeed, even banking reformers denounced the deposit of Treasury funds to pet banks as artificially lowering interest rates and leading to artificial expansion of credit. Furthermore, any government deficit would obviously throw a system dependent on a flow of new government revenues into chaos.

All in all, the reformers agreed increasingly with the verdict of economist Alexander Purves, that "the uncertainty as to the Secretary's power to control the banks by arbitrary decisions and orders, and the fact that at some future time the country may be unfortunate in its chief Treasury official [has] … led many to doubt the wisdom" of using the Treasury as a form of central bank (Livingston 1986, 156; Burch 1981, pp. 161–62).

In his last annual report of 1906, Secretary Shaw urged that he be given total power to regulate all the nation's banks. But the game was up, and by then it was clear to the reformers that Shaw's as well as Gage's proto–central bank manipulations had failed. It was time to undertake a struggle for a fundamental legislative overhaul of the American banking system, to bring it under central-banking control.[10]

Origins of the Federal Reserve Banking System Part 2 Continues Here

Murray N. Rothbard (1926–1995) was dean of the Austrian School. He was an economist, economic historian, and libertarian political philosopher. See Murray N. Rothbard's article archives. Comment on the blog.

This article originally appeared in Quarterly Journal of Austrian Economics, Vol. 2, No. 3 (Fall 1999), pp. 3–51. It is also reprinted in A History of Money and Banking in the United States and as a monograph..

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