In the previous posting on this subject, we closed by noting that the financier J. Pierpont Morgan saved the country from the “Panic of 1907” . . . which he had caused in the first place. Observant readers of this blog will not be slow to realize that a similar thing has happened with the recent bank failures. The federal government has been quick to assure the public that it will guarantee that the rich people who had money in the bank will be rescued from wanting to have their cake and eat it, too . . . and coincidentally take more control over the financial system.
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| Representative Arsene Pujo |
The only question now is whether anyone is going to catch on and realize that the system doesn’t need rescuing as much as it needs reform. Six years after the Panic of 1907, in light of Morgan’s extremely evasive and equivocal responses to questions, the Pujo Committee decided that Morgan had, indeed, been the cause of the Panic and had used it to seize more power over the financial system.
By then, however, the public and the historians had already enshrined Morgan as the financial savior of the nation, a position from which he has never been dislodged. Nevertheless, it was clear that the action of the National Bank of Commerce — an institution controlled by Morgan — in refusing clearinghouse services to the Knickerbocker was directly responsible for turning a delicate situation into a full-blown financial panic.
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| Senator Nelson Aldrich |
The next year, in 1908, Congress passed the Aldrich-Vreeland Act as an interim measure, to expire after five years, after a hurried examination of the situation. The Act provided for an emergency currency, making it possible for the National Banks, when necessary, to issue banknotes backed by state and municipal bonds or commercial paper in addition to the existing “fixed” currency backed by federal government bonds. As Harold G. Moulton explained,
The disastrous financial panic of 1907 raised anew the agitation for banking reform, both in and out of Congress. It was observed that whereas other countries were equally subject to periodic fluctuations of commerce and trade, the United States appears to be the only nation in which the banking machinery was incapable of alleviating the conditions that developed in time of crisis. (Harold G. Moulton, Financial Organization and the Economic System. New York: McGraw-Hill Book Company, Inc., 1938, 527.)
The Aldrich-Vreeland Act did not affect the power of the National Banks to expand credit by creating demand deposits backed by commercial paper. It affected only the issue of banknotes. This revealed that policymakers were still locked into the tenets of the British Currency School and did not truly understand that demand deposits are as fully “money” as were gold and silver coin, and banknotes backed by government debt.
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| J. Pierpont Morgan |
Despite that, when the Alrich-Vreeland Act was extended for another year to allow the Federal Reserve System time to become operational, the emergency currency that was issued in 1914 in response to the financial crisis precipitated by the outbreak of World War I was backed nearly 60% by commercial paper instead of state and municipal bonds. Matters were clearly heading in the right direction, but had a long way to go before the United States achieved a banking and financial system capable of supplying the country with a stable and elastic currency.
In addition, the Aldrich-Vreeland Act established a bipartisan National Monetary Commission under the direction of financial expert and Senate Republican leader Nelson Aldrich to study banking and currency reform. Senator Aldrich established two commissions. The first was to study the monetary system in the United States, and the other to study the central banking systems of Europe and report on them. Senator Aldrich took personal charge of the latter and went to Europe.
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| Harold G. Moulton |
After his return from Europe, Senator Aldrich and executives from the banks of J. P. Morgan, Rockefeller, and Kuhn, Loeb and Company, had a secret meeting at Jekyll Island, Georgia. The meeting doesn’t seem to have accomplished much more than provide decades of conspiracy theorists with grist for their mills, for the proposed legislation that was drafted during the meeting by Paul Warburg of Kuhn, Loeb, and Company was voted down. As Moulton explained the relationship between the Aldrich bill that came out of the meeting (the real “creature from Jekyll Island”) and the Federal Reserve Act of 1913,
The task of framing a currency law was conceived as one of modifying the Aldrich bill in such a way as to meet the fundamental objections that had been raised to that measure and to perfect a banking organization that would provide the necessary centralization of power without vesting too much control in the hands of the “financial interests”; it was felt that a democratic spirit should pervade the organization and that it should be developed in accordance with the “genius of our institutions.” The Democratic party thus reaped the fruits of the investigations that had been conducted by the National Monetary Commission and by other students of banking reform, as well as the advantage of the criticisms that had been made of the Aldrich bill; and especially it profited by the nation-wide discussion of the fundamental principles involved in banking reform. Great credit must, however, be given to the Democratic leaders for the efficient way in which the problem was handled and for the speed with which the bill was enacted into law. (Ibid., 530-531.)
True, the Federal Reserve System enacted three years later conformed to the broad outline of Warburg’s work, and several of the participants in the meeting took credit for being the guiding spirits of the central bank of the United States, but that was clearly an example of wishful thinking and self-glorification. As Moulton stated, “The Federal Reserve Act is an outgrowth of the Aldrich plan, though modified in numerous details and in some very important respects.” As Moulton explained the Aldrich plan as the precursor to the Federal Reserve Act,
The Aldrich plan, which was presented to Congress early in 1911, was discussed the country over perhaps more thoroughly than any other measure ever before Congress. The bill is generally conceded to have had many excellent provisions; many of them, indeed, subsequently became embodied in the Federal Reserve Act. But the prevalent distrust of Mr. Aldrich in consequence of his unsavory reputation on tariff matters, together with the fact that his proposal was undoubtedly a very strongly centralizing measure, made its enactment into law a political impossibility, especially after the coming of the Democrats to power in 1912. (Harold G. Moulton, ed., Principles of Money and Banking: A Series of Selected materials, with Explanatory Introductions. Chicago, Illinois: The University of Chicago Press, 1916, II.261.)
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