A History of Money and Banking in the United States: The Colonial Era to World War II (6 page)

Granted, Friedman and Schwartz do recognize that these theoretical conjectures cannot be truly tested because “[t]here is no way to repeat the experiment precisely and so to test these conjectures in detail.” Nonetheless, they maintain that “all analytical history, history that seeks to interpret and not simply record the past, is of this character, which is why history must be continuously rewritten in the light of new evidence as it unfolds.”65 In other words, history must be revised repeatedly because the very theory that is employed to interpret it is itself subject to constant revision on the basis of “new evidence” that Fogel and Stanley L. Engerman, eds. (New York: Harper and Row, 1971), pp. 8–10; and Donald N. McCloskey, “Counterfactuals,” in
The New
Palgrave: The New World of Economics,
John Eatwell, Murray Milgate, and Peter Newman, eds. (New York: W.W. Norton, 1991), pp. 149–54.

64Friedman and Schwartz,
A Monetary History
, pp. 156–68.

65Ibid., p. 168.

Introduction

39

is continually coming to light in the ongoing historical process.

As pointed out above, this is the vicious circle that characterizes all attempts to apply the positive method to the interpretation of history.

As if to preempt recognition of this vicious circle, Friedman and Schwartz take as the motto of their volume a famous quote from Alfred Marshall, which reads in part: Experience . . . brings out the impossibility of learning anything from facts till they are examined and interpreted by reason; and teaches that the most reckless and treacherous of all theorists is he who professes to let facts and figures speak for themselves.66

But clearly, reason teaches us that the observable—and, in some cases, countable, but never measurable—events of economic history ultimately are caused by the purposive actions of human beings whose goals and motives can never be directly observed. In rejecting the historical method of specific understanding, Friedman and Schwartz are led not by reason, but by a narrow positivist prepossession with using history as a laboratory, albeit imperfect, for formulating and testing theories that will allow prediction and control of future phenomena. Of the underlying intent of such a positivist approach to history, Mises wrote, “This discipline will abstract from historical experience laws which could render to social ‘engineering’ the same services the laws of physics render to technological engineering.”67

Needless to say, for Rothbard, history can never serve even as an imperfect laboratory for testing theory, because of his agreement with Mises that “the subject matter of history . . . is value judgments and their projection into the reality of change.”68 In seeking to explain the origins of the Federal Reserve System, therefore, Rothbard focuses on the question of 66Ibid., p. xix.

67Mises,
Theory and History,
p. 285.

68Mises,
Human Action
, p. 48.

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

who would reasonably have expected to benefit from and valued such a radical change in the monetary system. Here is where Rothbard’s scientific worldview comes into play. As an Austrian monetary theorist, he recognizes that the limits on bank credit inflation confronted by a fractional reserve banking system based on gold are likely to be much less confining under a central bank than under the quasi-decentralized National Banking System put in place immediately prior to the passage of the Federal Reserve Act in 1913. The praxeological reasoning of Austrian monetary theory also leads to the conclusion that those who stand to reap the lion’s share of the economic benefits from a bank credit inflation tend to be the lenders and first recipients of the newly created notes and deposits, namely, commercial and investment bankers and their clients. Guided by the implications of this praxeological knowledge and of his thymological rule about the motives of those who lobby for State laws and regulations, Rothbard is led to scrutinize the goals and actions of the large Wall Street commercial and investment bankers, their industrial clientele, and their relatives and allies in the political arena.

Rothbard’s analysis of the concrete evidence demonstrates that, beginning in the late 1890s, a full decade before the panic of 1907, this Wall Street banking axis and allied special interests began to surreptitiously orchestrate and finance an intellectual and political movement agitating for the imposition of a central bank. This movement included academic economists who covered up its narrow and venal economic interests by appealing to the allegedly universal economic benefits that would be forthcoming from a central bank operating as a benevolent and disinterested provider of an “elastic” currency and “lender of last resort.” In fact, what the banking and business elites dearly desired was a central bank that would provide an elastic supply of paper reserves to supplement existing gold reserves. Banks’

access to additional reserves would facilitate a larger and more lucrative bank credit inflation and, more important, would provide the means to ward off or mitigate the recurrent financial crises that had brought past inflationary booms to an
Introduction

41

abrupt and disastrous end in bank failures and industrial depression.

Rothbard employs the approach to economic history exem-plified in this treatment of the origins of the Fed consistently and dazzlingly throughout this volume to unravel the causes and consequences of events and institutions ranging over the course of U.S. monetary history, from colonial times through the New Deal era. One of the important benefits of Rothbard’s unique approach is that it naturally leads to an account of the development of the U.S. monetary system in terms of a compelling narrative linking human motives and plans that often-times are hidden and devious to outcomes that sometimes are tragic. And one will learn much more about monetary history from reading this exciting story than from poring over reams of statistical analysis.

Although its five parts were written separately, this volume presents a relatively integrated narrative, with very little over-lap, that sweeps across three hundred years of U.S. monetary history. Part 1, “The History of Money and Banking Before the Twentieth Century,” consists of Rothbard’s contribution to the minority report of the U.S. Gold Commission and treats the evolution of the U.S. monetary system from its colonial beginnings to the end of the nineteenth century.69 In this part, Rothbard gives a detailed account of two early and abortive attempts by the financial elites to shackle the young republic with a quasi-central bank. He demonstrates the inflationary consequences of these privileged banks, the First and Second Banks of the United States, during their years of operation, from 1791 to 1811 and from 1816 to 1833, respectively. Rothbard then discusses the libertarian Jeffersonian and Jacksonian ideological movements that succeeded in destroying these statist and inflationist institutions. This is followed by discussions of the era of 69Rep. Ron Paul and Lewis Lehrman,
The Case for Gold: A Minority
Report of the U.S. Gold Commission
(Washington, D.C.: Cato Institute, 1982), pp. 17–118.

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

comparatively free and decentralized banking that extended from the 1830s up to the Civil War, and the pernicious impact of the war on the U.S. monetary system. Part 1 concludes with an analysis and critique of the post–Civil War National Banking System. Rothbard describes how this regime—which was aggressively promoted by the investment banking firm that had acquired the monopoly of underwriting government bonds—

centralized banking and destabilized the economy, resulting in a series of financial crises that prepared the way for the imposition of the Federal Reserve System.

Part 2, on the “Origins of the Federal Reserve,” is a paper that lay unpublished for a long time and just appeared in a recent issue of
The Quarterly Journal of Austrian Economics.
70 Its main argument is summarized in the text above.

Part 3 contains a formerly unpublished paper, “From Hoover to Roosevelt: The Federal Reserve and the Financial Elites.” Here, Rothbard identifies the financial interests and ideology that drove the Fed to engineer an almost uninterrupted expansion of the money supply from the moment of its inception in 1914 through 1928. This part also includes an analysis of how concordance and conflict between the Morgan and Rockefeller financial interests shaped the politics and behavior of the Fed during the Hoover administration and the first Roosevelt administration as well as international monetary and domestic banking and financial policies under the latter administration.

Part 4, “The Gold-Exchange Standard in the Interwar Years,” previously was published as a chapter in a collection of papers on money and the State.71 The paper appears here for the first 70Murray N. Rothbard, “The Origins of the Federal Reserve System,”
Quarterly Journal of Economics
2, no. 3 (Fall 1999): 3–51.

71A version of this piece appeared as Murray N. Rothbard, “The Gold-Exchange Standard in the Interwar Years,” in
Money and the Nation State:
The Financial Revolution, Government and the World Monetary System,
Kevin Dowd and Richard H. Timberlake, Jr., eds. (New Brunswick, N.J.: Transactions Publishers, 1998), pp. 105–63.

Introduction

43

time in its original and unexpurgated version. Rothbard elucidates the reasons why the British and U.S. governments in the 1920s so eagerly sought to reconstruct the international monetary system on the basis of this profoundly flawed and inflationary caricature of the classical gold standard. Rothbard also analyzes the “inner contradictions” of the gold-exchange-standard system that led inexorably to its demise in the early 1930s.

Part 5, “The New Deal and the International Monetary System” is the topic of the fifth and concluding part of the book and was previously published in an edited book of essays on New Deal foreign policy.72 Rothbard argues that an abrupt shift occurred in the international monetary policy of the New Deal just prior to U.S. entry into World War II. He analyzes the economic interests that promoted and benefited from the radical transformation of New Deal policy, from “dollar nationalism” during the 1930s to the aggressive “dollar imperialism” that prevailed during the war and culminated in the Bretton Woods Agreement of 1944.

—
Joseph T. Salerno

Pace University

72Murray N. Rothbard, “The New Deal and the International Monetary System,” in
Watershed of Empire: Essays on New Deal Foreign
Policy,
Leonard P. Liggio and James J. Martin, eds. (Colorado Springs, Colo.: Ralph Myles, 1976), p. 19.

Part 1

A HISTORY OF MONEY AND BANKING

IN THE UNITED STATES

BEFORE THE TWENTIETH CENTURY

A HISTORY OF MONEY AND BANKING

IN THE UNITED STATES

BEFORE THE TWENTIETH CENTURY

As an outpost of Great Britain, colonial America of course used British pounds, pence, and shillings as its money.

Great Britain was officially on a silver standard, with the shilling defined as equal to 86 pure Troy grains of silver, and with silver as so-defined legal tender for all debts (that is, creditors were compelled to accept silver at that rate).

However, Britain also coined gold and maintained a bimetallic standard by fixing the gold guinea, weighing 129.4 grains of gold, as equal in value to a certain weight of silver. In that way, gold became, in effect, legal tender as well. Unfortunately, by establishing bimetallism, Britain became perpetually subject to the evil known as Gresham’s Law, which states that when government compulsorily overvalues one money and undervalues another, the undervalued money will leave the country or disappear into hoards, while the overvalued money will flood into circulation. Hence, the popular catchphrase of Gresham’s Law: “Bad money drives out good.” But the important point to note is that the triumph of “bad” money is the result,
not
of perverse free-market competition, but of government using the

[
Previously published in a volume edited by U.S. Representative Ron Paul (R-Texas) and Lewis Lehrman,
The Case for Gold: A Minority Report of the U.S.

Gold Commission
(Washington, D.C.: Cato Institute, 1983), pp. 17–118.
—

Ed.]

47

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

compulsory legal tender power to privilege one money above another.

In seventeenth- and eighteenth-century Britain, the government maintained a mint ratio between gold and silver that consistently overvalued gold and undervalued silver in relation to world market prices, with the resultant disappearance and outflow of full-bodied silver coins, and an influx of gold, and the maintenance in circulation of only eroded and “lightweight” silver coins. Attempts to rectify the fixed bimetallic ratios were always too little and too late.1

In the sparsely settled American colonies, money, as it always does, arose in the market as a useful and scarce commodity and began to serve as a general medium of exchange. Thus, beaver fur and wampum were used as money in the north for exchanges with the Indians, and fish and corn also served as money. Rice was used as money in South Carolina, and the most widespread use of commodity money was tobacco, which served as money in Virginia. The pound-of-tobacco was the currency unit in Virginia, with warehouse receipts in tobacco circulating as money backed 100 percent by the tobacco in the warehouse.

While commodity money continued to serve satisfactorily in rural areas, as the colonial economy grew, Americans imported gold and silver coins to serve as monetary media in urban centers and in foreign trade. English coins were imported, but so too were gold and silver coins from other European countries.

Among the gold coins circulating in America were the French 1In the late seventeenth and early eighteenth centuries, the British maintained fixed mint ratios of from 15.1-to-1 of silver grains in relation to gold grains, to about 15.5-to-1. Yet the world market ratio of weight, set by forces of supply and demand, was about 14.9-to-1. Thus, silver was consistently undervalued and gold overvalued. In the eighteenth century, the problem got even worse, for increasing gold production in Brazil and declining silver production in Peru brought the market ratio down to 14.1-to-1 while the mint ratios fixed by the British government continued to be the same.