America's Bank: The Epic Struggle to Create the Federal Reserve - Softcover

Chapter One

The Forbidden Words

I am in favor of a national bank. —Abraham Lincoln, 1832

When Carter Glass was born in 1858, the United States was an industrializing nation with a banking system stuck in frontier times. As the country put up factories and laid down rails, the tension between its antiquated finances and its smokestack-dotted towns grew ever more acute. Heated battles over “the money question” came to dominate the country’s politics, but no matter how unsatisfied the people, any solution that tended toward centralization was, due to the prevailing prejudice, off the table.

America was a monetary Babel with thousands of currencies; each state regulated its own banks and they collectively provided the country’s money. Officially, America was on a hard-money basis, but the amount of gold in circulation was insignificant. In any event, as a contemporary would write, it was impractical for a traveler “to carry with him the coin necessary to meet his expenses for a protracted journey.” If he traveled with notes of any but a few of the biggest banks in New York, Boston, and Philadelphia, his money was likely to be refused, or greatly discounted. If he did carry gold, then, “at the hotel, in the railroad car, on the river or lake,” he would be of­fered slips of engraved paper that, in the words of a western banker, might include “the frequently worthless issues of the State of Maine and of other New England States, the shinplasters of Michigan, the wild cats of Georgia, of Canada, and Pennsylvania, the red dogs of Indiana and Nebraska, the miserably engraved notes of North Caro­lina, Kentucky, Missouri and Virginia, and the not-to-be-forgotten stump tails of Illinois and Wisconsin.”

In theory, these notes were redeemable in gold or in state bonds, but notes from western banks were notoriously unreliable. Bankers, not surprisingly, sought to circulate their paper as far as possible from the point of issue. That way, the notes might never—or not for a very long while—return and the bank avoided the annoying detail of having to redeem its debts. There was no institution to regulate either the quality or the quantity of money, and after states adopted so-called free banking, a promoter needed little more than a printing press to set up shop. In 1853, Indiana’s governor lamented, “The spec­ulator comes to Indianapolis with a bundle of banknotes in one hand and the stock in the other; in twenty-four hours he is on his way to some distant point of the union to circulate what he denominates a legal currency, authorized by the legislature of Indiana.” The system was certainly democratic—almost anyone could issue “money”—but it was just as certain to lead to credit booms and inevitable busts.

According to Jay Cooke, a Philadelphia financier, some banks issued notes equal to twenty-five times their capital “with no other security than the good faith of their institution.” Since such faith was often short-lived, Cooke hardly needed to add, “confusion . . . was the order of the day.” During the Civil War, the Chicago Tribune counted 1,395 banks in the Union states, each with bills of various denominations—some 8,370 varieties of notes in all. Even for the careful bank teller, scrutinizing this profusion of paper became an almost hopeless task. In addition to bank failures, the country was plagued by con men whose note forgeries could be worthy of a Rem­brandt. So widespread were phony notes that “Counterfeit Detectors” were published, and these guides were widely circulated.

This monetary chaos formed the tableau for late-nineteenth­century reformers, and it is key to understanding how people of Glass’s generation thought about money. Money—generally, gold or silver—was something of intrinsic value. Circulating paper, even though it served as a medium of exchange, was but a token, a promise of the real thing, discounted according to the degree to which people feared that the promise might not be kept.

Legislation during the Civil War provided a remedy—somewhat. With the government desperate for credit, Lincoln’s Treasury secre­tary, Salmon P. Chase, was left no choice but to propose, and Con­gress to approve, a new system of nationally chartered banks, which were permitted to issue circulating paper money in the form of National Bank Notes. These notes were to be a new, and mercifully uniform, currency, with a standard engraving on one side and the bank’s name on the other.

However, note circulation was tightly controlled. National banks had to hold a reserve and submit to federal banking examinations. Also, to issue notes, they had to invest in a proportionate amount of government bonds and deposit them with the Treasury as collateral. This requirement heightened the demand for government securities—which was, of course, Chase’s purpose. By giving banks an incentive to invest in government debt, the United States contrived a means of financing the war. National banks were formed at a rapid clip, and many state banks converted to federal charters so they could qualify to circulate notes.[i]

The new notes were surely an improvement, but they had the drawback of arbitrariness. The quantity in circulation was determined by the level of investment in government bonds, and this bore no re­lation to the needs of trade. Perversely, circulation often fell as busi­ness activity expanded and banks found better outlets for their capital. Just as worrisome, the note supply was inelastic—banks held the quantity of bonds that they held, and no new notes could be issued in a crisis. The modern notion of a central bank to supply extra liquidity when needed simply did not exist.

It is hard to overly blame Chase because, as he said, his goal was “first to provide for the vast demands of the war.” Chase was lauded for standardizing the currency and blunting the prior ability of banks to create inflation by circulating worthless paper. William G. Sum­ner, an influential economist at Yale, fairly rejoiced: “This system of currency has put an end at once and forever to the old bankers’ trick of expansion and contraction.” That economies do expand—and that currency needs to expand with them—was largely overlooked.

Also overlooked, for the moment, was the precarious manner in which the National Banking Act marshaled the country’s reserves. In Great Britain or in France, reserves were stored in the central bank. In America, the Banking Act introduced an intricate and fragile sys­tem, with the reserves of one bank piled upon another.

The law recognized three distinct tiers of banks. The smallest, so-called country banks, had to either keep reserves in their vaults or deposit a portion with middle-tier banks in the city. The latter, in turn, could hold cash in the vault or deposit a portion of their reserves with banks in the highest tier, those in the “central reserve cities” of New York, Chicago, and St. Louis. In practice, since banks did not want to hold idle cash, reserves flowed to New York. And since the New York banks did not want idle money either, they lent their spare cash to the stock market. Thus, America’s banking system was perched on a speculative pyramid. Whenever credit was in short sup­ply, the entire chain backed into reverse, with country banks calling their loans, by means of urgent telegrams, to banks in reserve cities and thence to New York. This could precipitate panicky selling in the stock market. As Glass was to write, the system was a “breeder of panics,” with the idle funds of the nation “congested at the money centres for purely speculative purposes.”

This defect quickly became apparent. In 1873, when the new era was not quite a decade old, Jay Cooke’s firm, having improvidently speculated on railroad bonds, collapsed. The failure touched off a depression, which lasted six years. In a telltale sign of the system’s defects, note circulation sharply declined. Even when business recov­ered, the country was visited by periodic shortages of cash, or “strin­gencies,” when interest rates would soar to as much as 100 percent. The problem was most acute in the fall, when farmers needed cash to move the crops. Farmhands had to be hired, horses fed, machin­ery operated, shipping procured. The agrarian economy, as it were, sprung to life and required bundles of cash. This imbalanced the relative currency demands of city and farm, resulting in regular short­ages. No central reservoir existed to smooth out the seasonal lumpi­ness. In short, the system suffered a serious deficit: it consistently failed to generate enough money.

One obvious solution was to supply more money, but that begged the question “Who should supply it, and what kind of money?” Though the new National Bank Notes served as walking-around money, the United States actually had seven different mediums of exchange circulating in varying amounts.[ii] During Glass’s early life(the first few decades after the Civil War), Americans of every station fiercely debated how to bring order to this fiscal cacophony. In par­ticular, they argued bitterly over whether gold should be supplemented by additional currency of some other type, including “greenbacks,” the colloquial name for the paper notes issued by the federal government during the Civil War. Because greenbacks were not supported by any metal or tangible asset, the banking class considered them abhorrent. They were mere paper, “fiat” money (exactly what circu­lates today) and, to nineteenth-century bankers, an unpardonable blasphemy. In time, Congress decided to make greenbacks exchange­able for gold, and people who wanted to add to the currency shifted gears and proposed that the money supply be enhanced with notes that were backed by silver, which was more plentiful than gold. To supporters of the gold standard, silver, too, would merely cheapen the currency; it was both morally and economically repugnant.

Gold’s champions tended to be creditors—people with capital. They didn’t want the currency debased because they didn’t want to be repaid in cheaper coin. Gold being scarcer than silver, it was more valuable. In the 1870s, much of the world had joined Britain and gone on a gold standard (agreeing to back their currencies with gold). In1879, the United States did so as well. But Congress, trying to appease the farm lobby, directed the Treasury to also mint limited amounts of silver dollars, and at the historic ratio to gold of 16 to 1. Since the bul­lion value of a silver “dollar” was, by then, appreciably less, owing to a divergence in the metals’ prices, bankers and Republicans regarded silver as a profane dilution. Grover Cleveland, a “gold Democrat” elected president in 1884 and again in 1892, spoke for Wall Street and for respectable opinion generally when he observed that if America went to a silver standard, “we could no longer claim a place among nations of the first class.”

As a practical matter, bankers were correct that the bimetallic sys­tem of gold and silver was inherently unstable, since people would seek to cash in the poorer coin (in this case, the silver) for the richer one. But the gold standard imposed severe hardships on a great many Americans. In plain terms, the production of gold was not sufficient to support an adequate supply of money.

The issue was extremely divisive, because money shortages af­fected Americans unevenly. American farmers, de Tocqueville noted, were less peasants than little businessmen. They took out loans for seed and equipment. When prices fell, their debts became crushing. Credit in farm communities was exceedingly scarce. The rigid rules of the Banking Act proscribed lending on real estate, which undercut the usefulness of national banks in rural areas. Cash was even scarcer. There were fewer bank notes issued in Iowa, Minnesota, Kansas, Missouri, Kentucky, and Tennessee combined than in the tiny East­ern Seaboard state of Connecticut.

The hardship, and its palpable inequity, spawned a political awakening—a cry for redress. People blamed the money scarcity on Wall Street or on its British equivalent, Lombard Street. Carter Glass was one of those. His sense of grievance was nourished by his diffi­cult beginnings. Glass had been born in Lynchburg, Virginia, three years before the Civil War. His mother died when he was two, and his father, a publisher and a major in the Confederate ranks, suffered painful setbacks during the war, when he forfeited a vast quantity of cotton and had to sell his newspaper. After the war, he was offered the job of postmaster but refused to work for the federal government. Major Glass also had political ambitions, but these were frustrated by Reconstruction. For his son, it was a bitter inheritance, compounded by the sight of federal troops occupying Virginia. Carter, though, was a determined lad. Frail, with sallow skin and thin lips, often sickly with digestive problems and only five foot four, he was known as “Pluck” owing to his stubbornness and fiery temper. At age fourteen, he was forced to quit school but continued his studies at night, read­ing his father’s copies of Plato, Burke, and Shakespeare by kerosene lamp. Although Glass found work at a newspaper, his prospects were dimmed by the depression that ensued in 1873. Glass’s view of this calamity was informed by his hostility to northern banks. For six straight years, as he tried to make his way in the world, the money stock shrank. Where did the money go? Gold had sucked it up—so he believed. New York and London were in on it together. He reck­oned that a malign conspiracy of financiers was to blame. Because he mistrusted power, he did not want more power. He did not want a central bank.

In 1880, Glass finally got the job he wanted—newspaper reporter. Rising to publisher within a decade, Glass ceaselessly editorialized for silver. “Why should gold be minted free [in unlimited amounts], any more than silver?” he thundered in the Lynchburg News. Glass’s crusade was as much emotional as deductive. “I confess that with all I have read on both sides of the currency questions, I understand very little about it,” he confided to a comrade. “But when I see the merci­less forces of corporate and individual wealth arrayed on one side, and the working, toiling masses on the other, I can but feel that you and I are right in the stand we have taken.”

Silver-money advocates are often portrayed this way—as emotional and ignorant. But their distress was real. Over the course of three decades—beginning when Carter Glass was a boy—prices in Amer­ica steadily declined. No American born after the Great Depression has ever experienced even two consecutive years of deflation but, as­tonishingly, from 1867 to 1897 prices skidded relentlessly lower, and over the whole of that period they tumbled well more than 50 percent. In 1867, when the future congressman was nine years old, a bushel of winter wheat fetched $2.84; thirty years later it was selling for a mere 90 cents.

Although the price of goods was falling, it is equally true, and more illuminating, to say that the price of money was rising. This was occurring fo...