A History of Money and Banking in the United States: The Colonial Era to World War II (53 page)

“more comfortable than they used to be.” The only thing to be done, counseled Cannan, was to return to gold immediately at $4.86, and get it over with. As Cannan wrote at the time, the necessary adjustments “must be regarded in the same light as those which a spendthrift or a drunkard is rightly exhorted by his friends to face like a man.” Ibid., pp. 45–46; Edwin Cannan,
The Paper Pound: 1797–1821
, 2nd ed. (London: P.S. King, 1925), p. 105, cited in Murray Milgate, “Cannan, Edwin,” in
The New
Palgrave: A Dictionary of Economics,
Peter Newman, Murray Milgate, and John Eatwell, eds. (New York: Stockton Press, 1987), 1, p. 316.

Cannan’s sentiment and passion for justice are admirable, but, in view of the antagonistic political climate of the day, it might have been the better part of valor to return to gold at a realistic, depreciated pound.

20Moggridge,
British Monetary Policy
, p. 72.

The Gold-Exchange Standard in the Interwar Years
367

April 28, and putting the new gold standard into effect immediately.21

It cannot be stressed too strongly that the British decision to return to gold at $4.86 was not made in ignorance of deflationary problems or export depression, but rather in the strong and confident expectation of imminent American inflation. This dominant expectation was clear from the assurances of Sir John Bradbury to Churchill; from the anticipation of even such cautious men as Sir Otto Niemeyer and Montagu Norman; from the optimism of Ralph Hawtrey; and above all in the official Treasury memorandum attached to the Gold Standard Act of 1925.22, 23

21Actually, the old Gold Embargo Act remained in force until allowed to expire on December 31, 1925. Since gold exports were prohibited until then, the gold standard was really not fully restored until the end of the year. Palyi,
Twilight of Gold
, p. 71. The Churchill dinner party included Prime Minister Stanley Baldwin, Foreign Secretary Austen Chamberlain, Keynes, McKenna, Niemeyer, Bradbury, and Sir Percy Grigg, principal private secretary to the chancellor of the Exchequer. Sir Percy James Grigg,
Prejudice and Judgment
(London: Hutchinson, 1948), pp. 182–84. On Churchill’s early leaning to Keynes, see Moggridge,
British Monetary
Policy
, p. 76.

22Moggridge,
British Monetary Policy
, pp. 84ff.

23In a memorandum to Churchill, Sir Otto Niemeyer delivered an elo-quent critique of the Keynesian view that inflation would serve as a cure for the existing unemployment. Niemeyer declared: You can by inflation (a most vicious form of subsidy) enable temporary spending power to cope with large quantities of products. But unless you increase the dose continually there comes a time when having destroyed the credit of the country you can inflate no more, money having ceased to be acceptable as a value. Even before this, as your inflated spending creates demand, you have had claims for increased wages, strikes, lockouts, etc. I assume it will be admitted that with Germany and Russia before us [that is, runaway inflation] we do not think plenty can be found on this path.

Niemeyer concluded that employment can only be provided by thrift and accumulation of capital, facilitated by a stable currency, and not by doles
368

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

AMERICAN SUPPORT FOR THE RETURN TO GOLD

AT $4.86: THE MORGAN CONNECTION

Why were the British so confident that American prices would rise sufficiently to support their return to gold at the overinflated $4.86? Because of the power of the new United States central bank, the Federal Reserve System, installed in 1914, and because of the close and friendly relationship between the British government, its Bank of England, and the Federal Reserve. The Fed, they were sure, would do what was necessary to help Britain reconstruct the world monetary order.

To understand these expectations, we must explore the Federal Reserve–Bank of England connection, and particularly the crucial tie that bound them together: their mutual relationship with the House of Morgan. The powerful J.P. Morgan and Company took the lead in planning, drafting the legislation, and mobilizing the agitation for the Federal Reserve System that brought the dubious benefits of central banking to the United States in 1914. The purpose of the Federal Reserve was to cartelize the nation’s banking system, and to enable the banks to inflate together, centralizing and economizing reserves, with the Federal Reserve as “lender of last resort.” The Federal Reserve’s new monopoly of note issue took the de facto place of gold as the nation’s currency. Not only were the majority of Federal Reserve Board directors in the Morgan orbit, but the man who was able to become the virtually absolute ruler of the Fed from its inception to his death in 1928, Benjamin Strong, was a man who had spent his entire working life as a leading Morgan banker.24

Benjamin Strong was a protégé of the most powerful of the partners of the House of Morgan after Morgan himself, Henry and palliatives. Unfortunately, Niemeyer neglected to consider the crucial role of excessively high wage rates in causing unemployment. Ibid., p. 77.

24See Murray N. Rothbard, “The Federal Reserve as a Cartelization Device: The Early Years, 1913–1930,” in
Money in Crisis,
Barry Siegel, ed.

(San Francisco: Pacific Institute for Public Policy, 1984), pp. 93–117.

The Gold-Exchange Standard in the Interwar Years
369

“Harry” Pomeroy Davison. Strong was also a neighbor and close friend of Davison and of two other top Morgan partners in the then-wealthy New York suburb of Englewood, New Jersey, Dwight Morrow and Thomas W. Lamont. In 1904, Davison offered Strong the post of secretary of the new Morgan-created Bankers Trust Company, designed to compete in the burgeoning trust business. So close were Davison and Strong that, when Strong’s wife committed suicide after childbirth, Davison took the three surviving Strong children into his home. Strong later married the daughter of the president of Bankers Trust, and rose quickly to the posts of vice president and finally president.

So highly trusted was Strong in the Morgan circle that he was brought in to be J. Pierpont Morgan’s personal auditor during the panic of 1907. When Strong was offered the crucial post of governor of the New York Fed in the new Federal Reserve System, Strong, at first reluctant, was convinced by Davison that he could run the Fed as “a real central bank . . . run from New York.”25

The House of Morgan had always enjoyed strong connections with England. The original Morgan banker, J. Pierpont Morgan’s father Junius, had been a banker in England; and the Morgan’s London branch, Morgan, Grenfell and Company, was headed by the powerful Edward C. “Teddy” Grenfell (later Lord St. Just). Grenfell’s father and grandfather had both been directors of the Bank of England as well as members of Parliament, and Grenfell himself had become a director of the Bank of England in 1904. Assisting Grenfell as leading partner at Morgan, Grenfell was Teddy’s cousin, Vivian Hugh Smith, later Lord Bicester, a personal friend of J.P. Morgan, Jr.’s. Not only 25Rothbard, “Federal Reserve,” p. 109; Lester V. Chandler,
Benjamin
Strong, Central Banker
(Washington, D.C.: Brookings Institution, 1958), pp. 23–41; Ron Chernow,
The House of Morgan: An American Banking
Dynasty and the Rise of Modern Finance
(New York: Atlantic Monthly Press, 1990), pp. 142–45, 182; and Lawrence E. Clark,
Central Banking Under the
Federal Reserve System
(New York: Macmillan, 1935), pp. 64–82.

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

was Smith’s father a governor of the Bank of England, but he came from the so-called “City Smiths,” the most prolific banking family in English history, originating in seventeenth-century banking. Due to the good offices of Grenfell and Smith, J.P. Morgan and Company, before the war, had been named a fiscal agent of the English Treasury and of the Bank of England. In addition, the House of Morgan had long been closely associated with British and French wars, its London branch having helped England finance the Boer, and its French bank the Franco-Pruss-ian War of 1870–1871.26

As soon as war in Europe began, Harry Davison rushed to England and got the House of Morgan a magnificent deal: Morgan was made the monopoly purchaser of all goods and supplies for the British and French in the United States for the duration of the war. In this coup, Davison was aided and abetted by the British ambassador to Washington, Sir Cecil Arthur Spring-Rice, a personal friend of J.P. Morgan, Jr. These war-based purchases eventually amounted to an astronomical $3 billion, out of which the House of Morgan was able to earn a direct commission of $30 million. In addition, the House of Morgan was able to steer profitable British and French war contracts to those firms which it dominated, such as General Electric, DuPont, Bethlehem Steel, and United States Steel, or to those firms with which it was closely allied, such as DuPont Company and the Guggenheims’ huge copper companies, Kennecott and American Smelting and Refining.

To pay for these massive purchases, Britain and France were obliged to float huge bond issues in the United States, and they made the Morgans virtually the sole underwriter for these bonds. Thus, the Morgans benefited heavily once more: from the bond issues, as well as from the fees and contracts from war purchases by the Allies.

26France also appointed the House of Morgan as its fiscal agent, having long had close connections through the Paris branch, Morgan Harjes.

Chernow,
House of Morgan
, pp. 104–05, 186, 195. Sir Henry Clay,
Lord
Norman
(London: Macmillan, 1957), p. 87.

The Gold-Exchange Standard in the Interwar Years
371

In this way, the House of Morgan, which had been suffering financially before the outbreak of war, profited greatly from and was deeply committed to, the British and French cause. It is no wonder that the Morgans did their powerful best to maneuver the United States into World War I on the side of the English and French.

After the United States entered the war in the spring of 1917, Benjamin Strong, as head of the Fed, obligingly doubled the money supply to finance the war effort, and the U.S. government took over the task of financing the Allies.27 Strong was able to take power in the Fed with the help of and close cooperation from Secretary of the Treasury William Gibbs McAdoo after U.S. entry into the war. McAdoo, for the first time, made the Fed the sole fiscal agent for the Treasury, abandoning the Independent Treasury System that had required it to deposit and disburse funds only from its own subtreasury vaults. The New York Fed sold nearly half of all Treasury securities offered during the war; it handled most of the Treasury’s foreign exchange business, and acted as a central depository of funds from other Federal Reserve banks. Because of this Treasury support, Strong and the New York Fed emerged from the U.S. experience in World War I as the dominant force in American finance. McAdoo himself came to Washington as secretary of the Treasury after having been befriended and bailed out of his business losses by J.P. Morgan, Jr., personally, and by Morgan’s closest associates.28

27On the interconnections among the Morgans, the Allies, foreign loans, and the Federal Reserve, and on the role of the Morgans in bringing the United States into the war, see Charles C. Tansill,
America Goes to
War
(Boston: Little, Brown, 1938), pp. 32–143. See also Chernow,
House of
Morgan
, pp, 186–204. It is instructive that the British exempted the House of Morgan from its otherwise extensive mail censorship in and out of Britain, granting J.P. Morgan, Jr., and his key partners special code names.

Ibid., pp. 189–90.

28Rothbard, “Federal Reserve,” pp. 107–08, 111–12; Henry Parker Willis,
The Theory and Practice of Central Banking
(New York: Harper and
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A History of Money and Banking in the United States:
The Colonial Era to World War II

Scarcely had Benjamin Strong been appointed when he began to move strongly toward “international central bank cooperation,” a euphemism for coordinated, or cartelized, inflation, since the classical gold standard had no need for such cooperation. In February 1916, Strong sailed to England and worked out an agreement of close collaboration between the New York Fed and the Bank of England, with both central banks maintaining an account with each other, and the Bank of England regularly purchasing sterling bills on account for the New York bank. In his usual high-handed manner, Strong bluntly told the Federal Reserve Board in Washington that he would go ahead with such an agreement with or without board approval; the cowed Federal Reserve Board then finally decided to endorse the scheme. A similar agreement was made with the Bank of France.29

Brothers, 1936), pp. 90–91; and Chandler,
Benjamin Strong
, p. 105. The massive U.S. deficits to pay for the war, were financed by Liberty Bond drives headed by a Wall Street lawyer who was a neighbor of McAdoo’s in Yonkers, New York. This man, Russell C. Leffingwell, would become a leading Morgan partner after the war. Chernow,
House of Morgan
, p. 203.

29Rothbard, “The Federal Reserve,” p. 114; Chandler,
Benjamin Strong
, pp. 93–98. While some members of the Federal Reserve Board had heavy Morgan connections, its complexion was scarcely as Morgan-dominated as Benjamin Strong. Of the five Federal Reserve Board members, Paul M.

Warburg was a leading partner of Kuhn, Loeb, an investment bank rival of Morgan, and during the war suspected of being pro-German; Governor William P.G. Harding was an Alabama banker whose father-in-law’s iron manufacturing company had prominent Morgan as well as rival Rockefeller men on its board; Frederic A. Delano, uncle of Franklin D.

Roosevelt, was president of the Rockefeller-controlled Wabash Railway; Charles S. Hamlin, an assistant secretary to McAdoo, was a Boston attorney married into a family long connected with the Morgan-dominated New York Central Railroad and an assistant secretary to McAdoo.