2. The Road to the Federal Reserve[8]

During the McKinley and Roosevelt administrations, treasury secretaries Lyman J. Gage and Leslie M. Shaw respectively tried to operate the Treasury Department as a central bank, pumping in money during recessions by purchasing government bonds on the open market and depositing large funds with commercial banks. In 1900, Gage called for the establishment of regional central banks, and Shaw suggested in his last annual report in 1906 that he be given total power to regulate the nation’s banks. Their efforts failed, and these failures helped to spur the big bankers to seek a formal central bank.[9]

Neither Gage nor Shaw was an isolated treasury bureaucrat whose power was suddenly going to his head. Before his appointment, Gage was president of the powerful First National Bank of Chicago, one of the major banks in the Rockefeller orbit. He also served as president of the American Bankers Association. After leaving the Treasury Department, Gage became president of the Rockefeller-controlled U.S. Trust Company, and his hand-picked assistant at the department, Frank A. Vanderlip, left to become a top executive at the Rockefellers’ flagship bank, the National City Bank of New York.[10] Gage’s appointment as treasury secretary was secured for him by Mark Hanna, close friend, political mastermind, and financial backer of President McKinley. Hanna, a coal magnate and iron manufacturer, was a close business associate as well as an old friend and high school classmate of John D. Rockefeller, Sr.[11]

Leslie Shaw was a small-town Iowa banker who became governor of his state in 1898 and continued as president of the Bank of Denison until the end of his term. He reached his post as governor by being a loyal supporter of the Des Moines Regency, the Republican machine in Iowa, and a close friend of the Regency’s leader, the powerful and venerable U.S. senator William Boyd Allison. Allison was the one who secured the treasury position for his friend Shaw and in turn was tied closely to Charles E. Perkins, a close Morgan ally, president of the Chicago, Burlington and Quincy Railroad, and kinsman of the Forbes financial group of Boston, long associated with the Morgans.[12]

After the failure of Shaw’s interventions, and particularly after the Panic of 1907, the big bankers turned in earnest to a drive for the establishment of a central bank in the United States. The movement was launched in January 1906 when Jacob H. Schiff, the head of the powerful investment banking firm of Kuhn, Loeb & Co., urged the New York Chamber of Commerce to advocate fundamental banking reform. Heeding the call, the New York chamber immediately established a special committee to study the problem and propose legislation. The committee was comprised of leaders from commercial and investment banking, including Isidor Straus of R.H. Macy’s (a close friend of Schiff) and Frank A. Vanderlip of the National City Bank. In March, the special committee report, not surprisingly, called for the creation of a strong central bank “similar to the Bank of Germany.”

The New York chamber proved reluctant to endorse this far-reaching scheme, but the big bankers had the bit in their teeth. In mid-1906, the American Bankers Association followed suit by naming a commission of inquiry of leading bankers from the major cities of the country, headed by A. Barton Hepburn, chairman of the board of Chase National Bank. The Hepburn commission was more cautious, and its report of November 1906 called for imperative changes in the existing banking system, including a system of regional clearing houses for the issue of bank notes. The notes would be guaranteed by a common pool built up by taxes levied on the notes.[13]

A variant of the Hepburn plan was passed by Congress in May 1908, after the Panic of 1907, in the Aldrich-Vreeland Act. Aldrich-Vreeland provided for the issuance of “emergency” currency by groups of bankers clustered in “National Currency Associations.” Although this regional cartel scheme was devised as a stopgap measure, the congressional authorization was to be for seven years, a rather long “temporary” period.[14]

In fact, however, Aldrich-Vreeland provisions were used only once, and that was in 1914, shortly after the launching of the Federal Reserve System. By far the most significant aspect of Aldrich-Vreeland turned out to be its clause setting up a National Monetary Commission to study the American and foreign banking systems and to emerge with a plan of reform. The commission consisted of nine senators and nine representatives and, in standard bureaucratic procedure, the chairman of the commission was Senator Nelson W. Aldrich and the vice-chairman was Representative Edward B. Vreeland.

Representative Vreeland was a banker from the Buffalo area of New York, and little more need be said about him. Far more important was the powerful Senator Nelson W. Aldrich, a Republican from Rhode Island who made millions during his long years of service in the U.S. Senate. One of the prime movers in the creation of the Federal Reserve System, Nelson Aldrich was the father-in-law of John D. Rockefeller, Jr., and may be fairly regarded as Rockefeller’s man in the Senate.[15]

From the inception of the National Monetary Commission until the presentation of its Aldrich plan to Congress four years later, Senator Aldrich and the commission were a vitally important nucleus of the drive for a central bank. Particularly influential in the deliberations of the commission were two men who were not official members. Aldrich asked J.P. Morgan to recommend a banking expert, and Morgan happily responded with Henry P. Davison, a Morgan partner; the other unofficial member was George M. Reynolds of Chicago, president of the American Bankers Association.[16]

Aldrich and the National Monetary Commission, however, were by no means the only focus of the movement for a central bank. Another was Paul Moritz Warburg, one of the most vital influences on the creation of the Federal Reserve System. Warburg, scion of the great international banking family and the German investment banking firm of M.M. Warburg and Company, of Hamburg, emigrated to the United States in 1902 to become a partner in the influential New York banking house of Kuhn, Loeb & Co.[17] From the moment he came to the United States, Warburg worked tirelessly, in person and in print, to bring the blessings of European central banking to this monetarily backward land. Sensitive to American political objections to the idea of centralization or of Wall Street control, Warburg always insisted disingenuously that his plan was not really a central bank. His first printed banking reform essay came in January 1907 in his “A Plan for a Modified Central Bank.” The plan called for centralized reserves and a centralized note issue as a key to assuring economic stability. The most elaborate versions of Warburg’s reform plan were presented in two speeches in 1910: “A United Reserve Bank of the United States” and “Principles that Must Underlie Monetary Reform in the United States.”

Warburg’s United Reserve Bank delineated the major features of the future Federal Reserve System. The key to its power was to be its legal monopoly on all note issue in the United States; to obtain such notes, the banks would have to keep their reserves at the Reserve Bank. Reserves would therefore be centralized at long last. Depositors at the Bank would be strictly limited to the member banks and the federal government. The Bank was to be governed by a board selected equally by three groups: the member banks, the stockholders of the Reserve Bank, and the federal government. Not surprisingly, Warburg’s plan repeated the essential features of the operation of the German Reichsbank, the central bank in his native Germany.[18]

The greatest cheerleader for Warburg’s plan, and the man who introduced his banking reform essays to Columbia University’s Academy of Political Science, was Warburg’s kinsman, the Columbia economist Edwin R.A. Seligman, of the investment banking family of J. & W. Seligman and Company.[19]

The top bankers were clear from the beginning that, to assuage widespread fears of centralized and Wall Street control, they would have to avoid the appearance of an orthodox central bank on the lines of England or Germany. The chosen course was a spurious “regionalism” and “decentralization,” the appearance of a virtually uncoordinated set of regional central banks. The idea was in the air when Victor Morawetz made his famous speech in November 1909 calling for regional banking districts under the ultimate direction of one central control board. Although reserves and note issue would be pro forma decentralized in the hands of the regional reserve banks, all would really be centralized and coordinated by the central control board. This specious decentralization was, of course, the scheme eventually adopted in the Federal Reserve System.

Who was Victor Morawetz? He was a distinguished attorney and banker and in particular the counsel and chairman of the executive committee of the Morgan-controlled Atchison, Topeka and Santa Fe Railroad. In 1908, Morawetz had been, along with J.P. Morgan’s personal lawyer, Francis Lynde Stetson, the principal drafter of an unsuccessful Morgan-National Civic Federation bill for a federal incorporation law that would have cartelized and regulated American corporations. Later, Morawetz was to be a top consultant to another “progressive” reform of Woodrow Wilson’s, the Federal Trade Commission.[20]

In late 1910, someone in the Aldrich circle, probably Henry P. Davison, got the idea of convening a small group of leading advocates of a central bank in a top secret conclave to draft a bill for a central bank. The clandestine meeting was held in November at a duck-shooting retreat for wealthy members, the Jekyll Island Club on Jekyll Island, Georgia. The cover story given to the press was that the conferees were going down for a duck-hunting expedition. Extraordinary measures were taken to ensure secrecy, with the conferees traveling down to Georgia under assumed names in a private railroad car chartered by Aldrich. Some reporters got wind of the meeting, but Davison managed to talk them out of any publicity.[21]

The blue-ribbon participants at the week-long Jekyll Island meeting were:

Senator Nelson W. Aldrich, Rockefeller in-law

Henry P. Davison, Morgan partner

Paul M. Warburg, Kuhn, Loeb & Co. partner[22]

Frank A. Vanderlip, vice-president of Rockefeller’s National City Bank

Charles D. Norton, president of Morgan’s First National Bank of New York

A. Piatt Andrew, Harvard economist and staff assistant to Aldrich on the Monetary Commission

There is no clearer physical embodiment of the cartelizing coalition of top financial and banking interests that brought the Federal Reserve System into being than the sometimes allied, often clashing Rockefeller-Kuhn, Loeb and Morgan interests, aided by economic technicians.

Using the research of the National Monetary Commission, the Jekyll Island conclave drafted a bill for a central bank. The ideas of this draft, which eventually became the Aldrich Bill, were basically Paul Warburg’s, with a decentralized soupcon taken from Morawetz. The final writing was contributed by Vanderlip. The main disagreement at the meeting was that Aldrich wanted to hold out for a straightforward central bank on the European model, whereas Warburg and the other banks, oddly enough more politically astute on this issue than the veteran senator, insisted that the reality of central banking be clothed in the palatable garb of decentralization. The Jekyll Island draft was presented by Aldrich to the full National Monetary Commission in January 1911. Slightly revised, it was introduced, together with the commission report, a year later as the Aldrich Bill, which in turn became in all essentials the final Federal Reserve Act passed in December 1913.

In the Aldrich-Jekyll Island plan, the central bank with branches was called the National Reserve Association; the main difference between the draft and the eventual legislation is that in the former, the national board of directors was largely chosen by the banks themselves rather than by the president of the United States. This provision was so blatantly cartelist that it was modified for political reasons to have the president name the board. The economist Henry Parker Willis, who played a large role in the enactment of the Federal Reserve System, lamented this alteration: “Political prejudice proved too strong for the establishment of this form of financial self-government or ‘integration’.”[23]

Aldrich and the Monetary Commission took the unusual step of delaying their report to Congress for 12 months, from January 1911 to January 1912. With the Democratic victory in the congressional elections of 1910, it was necessary to spend a year drumming up support for a central bank among Democrats, bankers, and the lay public. Accordingly, at the beginning of February 1911, twenty-two top bankers from 12 cities met for three days behind closed doors in Atlantic City to consider the Aldrich plan; the conference warmly endorsed the plan. In the private deliberation, James B. Forgan, President of the Rockefeller-dominated First National Bank of Chicago, declared outright that everyone there approved of the Aldrich plan and that, as Kolko puts it, “the real purpose of the conference was to discuss winning the banking community over to government control directed by the bankers for their own ends. ... It was generally appreciated that the [Aldrich plan] would increase the power of the big national banks to compete with the rapidly growing state banks, help bring the state banks under control, and strengthen the position of the national banks in foreign banking activities.”[24]

In November 1911, Aldrich won support for his plan from the American Bankers Association. In his address to their convention, he declared: “The organization proposed is not a bank, but a cooperative union of all the banks of the country for definite purposes.”[25]

The major propaganda organization created for the benefit of the lay public by Aldrich and his colleagues in the spring of 1911 was the National Citizens’ League for the Creation of a Sound Banking System. The league grew out of a resolution that Paul Warburg had pushed through a meeting of the National Board of Trade in January 1910, setting aside January 18 of the following year as a “monetary day” devoted to a “Business Men’s Monetary Conference.” At that January 1911 meeting the conference appointed a committee of seven, headed by Warburg, to organize a business-leaders’ monetary reform league. A group of leading Chicago businessmen, headed by John V. Farwell and Harry A. Wheeler, president of the U.S. Chamber of Commerce, established the National Citizens’ League, with economist J. Laurence Laughlin of the University of Chicago as operating head.

Warburg and the other New York bankers chose Chicago as the site of the Citizens’ League to give the organization a bogus appearance of grass roots populism. In reality, banker control was virtually complete. The stated purpose of the league was to advance the cause of “cooperation, with dominant centralization of all banks by an evolution out of our clearing-house experience”; a decade later, Professor Henry Parker Willis, Laughlin’s top assistant at the league as well as former student and long-time disciple, conceded that the Citizens’ League had been the propaganda organ of the nation’s bankers.[26]

There is no need to go into the minutiae of the splits within the Citizens’ League or of the shift by the incoming Democrats in 1913 from the dreaded Republican name of Aldrich to a bill named by their own Representative Carter Class. Much of this conflict revolved around the desire by Laughlin and the Democrats, and to some extent by Warburg, to shed the name Aldrich for a more palatable one. Nevertheless, there was very little substantive difference between the Glass bill, which became the Federal Reserve Act, and the original Aldrich plan. Friedman and Schwartz are surely correct in insisting on the “near identity” of the two plans.[27] The important point is that whatever the difference on minor technical points, the nation’s bankers, and especially the big bankers, were overwhelmingly in favor of a new central bank. As A. Barton Hepburn of the Chase National exulted at the annual meeting of the American Bankers Association in August 1913, in the course of his successful effort to get the bankers to endorse the Glass bill: “The measure recognized and adopts the principles of a central bank. Indeed, if it works out as the sponsors of the law hope, it will make all incorporated banks together joint owners of a central dominating power.”[28] Precisely.

All in all, Professor Kolko sums up the point well:

The entire banking reform movement, at all crucial stages, was centralized in the hands of a few men who for years were linked, ideologically and personally, with one another. The problem of the origin of the Federal Reserve Act, and the authorship of specific drafts, was later hotly debated by [men] who greatly exaggerated their differences in order that they might each claim responsibility for the guiding lines of the Federal Reserve System. Yet ... although they may have differed on details they agreed on major policy lines and general theory. The confusion over the precise authorship of the Federal Reserve Act should not obscure the fact that the major function, inspiration, and direction of the measure was to serve the banking community in general, and large bankers specifically.[29]