The Fortuitous Fed

The massive U.S. loans to the Allies, and the subsequent American entry into the war, could not have been financed by the relatively hard-money, gold standard system that existed before 1914. Fortuitously, an institution was established at the end of 1913 that made the loans and war finance possible: the Federal Reserve System. By centralizing reserves, by providing a government-privileged lender of last resort to the banks, the Fed enabled the banking system to inflate money and credit, finance loans to the Allies, and float massive deficits once the U.S. entered the war. In addition, the seemingly odd Fed policy of creating an acceptance market out of thin air by standing ready to purchase acceptance at a subsidized rate, enabled the Fed to rediscount acceptance on munitions exports.

The Federal Reserve was the outgrowth of five years of planning, amending, and compromising among various politicians and concerned financial groups, led by the major financial interests, including the Morgans, the Rockefellers, and the Kuhn, Loebs, along with their assorted economists and technicians.

Particularly notable among the Rockefeller interests were Senator Nelson W. Aldrich (R.–R.I.), father-in-law of John D. Rockefeller, Jr., and Frank A. Vanderlip, vice president of Rockefeller’s National City Bank of New York. From the Kuhn, Loebs came the prominent Paul Moritz Warburg, of the German investment banking firm of M. M. Warburg and Company. Warburg emigrated to the United States in 1902 to become a senior partner at Kuhn, Loeb & Co., after which he spent most of his time agitating for a central bank in the United States.

Also igniting the drive for a Federal Reserve System was Jacob H. Schiff, powerful head of Kuhn, Loeb to whom Warburg was related by marriage. Seconding and sponsoring Warburg in academia was the prominent Columbia University economist Edwin R. A. Seligman, of the investment banking family of J. & W. Seligman and Company; Seligman was the brother of Warburg’s brother-in-law.

The Morgans were prominently represented in the planning and agitation for a Central Bank by Henry P. Davison, Morgan partner; Charles D. Norton, president of Morgan’s First National Bank of New York; A. Barton Hepburn, head of Morgan’s Chase National Bank; and Victor Morawetz, attorney and banker in the Morgan ranks and chairman of the executive committee of the Morgan-controlled Atchison, Topeka, and Santa Fe Railroad.

While the establishment of the Federal Reserve System in late 1913 was the result of a coalition of Morgan, Rockefeller, and Kuhn, Loeb interests, there is no question which financial group controlled the personnel and the policies of the Fed once it was established. (While influential in framing policies of the Fed, Federal Reserve Board member Warburg was disqualified from leadership because of his pro-German views.) The first Federal Reserve Board, appointed by President Wilson in 1914, included Warburg; one Rockefeller man, Frederic A. Delano, uncle of Franklin D. Roosevelt, and president of the Rockefeller-controlled Wabash Railway; and an Alabama banker, who had both Morgan and Rockefeller connections.

Overshadowing these three were three definite Morgan men, and a university economist, Professor Adolph C. Miller of Berkeley, whose wife’s family had Morgan connections. The three definite Morgan men were Secretary of the Treasury McAdoo; Comptroller of the Currency John Skelton Williams, a Virginia banker and long-time McAdoo aide on Morgan railroads; and Assistant Secretary of the Treasury Charles S. Hamlin, a Boston attorney who had married into a wealthy Albany family long connected with the Morgan-dominated New York Central Railroad.

But more important than the composition of the Federal Reserve Board was the man who became the first Governor of the New York Federal Reserve Bank and who single-handedly dominated Fed policy from its inception until his death in 1928. This man was Benjamin Strong, who had spent virtually his entire business and personal life in the circle of top associates of J. P. Morgan. A secretary of several trust companies (banks doing trust business) in New York City, Strong became neighbor and close friend of three top Morgan partners, Henry P. Davison, Dwight Morrow, and Thomas W. Lamont. Davison, in particular, became his mentor, and brought him into Morgan’s Bankers Trust company, where he soon succeeded Lamont as vice-president, and then finally became president. When Strong was offered the post of Governor of the New York Fed, it was Davison who persuaded him to take the job.

Strong was an enthusiast for American entry into the war, and it was his mentor Davison who had engineered the coup of getting Morgan named as sole underwriter and purchasing agent for Britain and France. Strong worked quickly to formalize collaboration with the Bank of England, collaboration which would continue in force throughout the 1920s. The Federal Reserve Bank of New York became foreign agent for the Bank of England, and vice versa.

The main collaboration throughout the 1920s, much of it kept secret from the Federal Reserve Board in Washington, was between Strong and the man who soon became Governor of the Bank of England, Montagu Collet Norman. Norman and Strong were not only fast friends, but had important investment banking ties, Norman’s uncle having been a partner of the great English banking firm of Baring Brothers, and his grandfather a partner in the international banking house of Brown Shipley & Co., the London branch of the Wall Street banking firm of Brown Brothers. Before coming to the Bank of England, Norman himself had worked at the Wall Street office of Brown Brothers, and then returned to London to become a partner of Brown Shipley.

The major fruit of the Norman-Strong collaboration was Strong’s being pressured to inflate money and credit in the U.S. throughout the 1920s, in order to keep England from losing gold to the U.S. from its inflationary policies. Britain’s predicament came from its insistence on going back to the gold standard after the war at the highly overvalued pre-war par for the pound, and then insisting on inflating rather than deflating to make its exports competitively priced in the world market. Hence, Britain needed to induce other countries, particularly the U.S., to inflate along with it. The Strong-Norman-Morgan connection did the job, setting the stage for the great financial collapse of 1929–1931.

As World War I drew to a close, influential Britons and Americans decided that intimate post-war collaboration between the two countries required more than just close cooperation between the central banks. Also needed were permanent organizations to promote joint Anglo-American policies to dominate the postwar world.