THE ORIGINS OF THE
FEDERAL RESERVE

By Murry N. Rothbard

THE PROGRESSIVE MOVEMENT

The Federal Reserve Act of December 23, 1913 was part and parcel of the wave of Progressive legislation, on local, state, and federal levels of government, that began about 1900. Progressivism was a bipartisan movement which, in the course of the first two decades of the twentieth century, transformed the American economy and society from one of roughly laissez-faire to one of centralized statism.

Until the 1960s, historians had established the myth that Progressivism was a virtual uprising of workers and farmers who, guided by a new generation of altruistic experts and intellectuals, surmounted fierce big business opposition in order to curb, regulate, and control what had been a system of accelerating monopoly in the late nineteenth century. A generation of research and scholarship, however, has now exploded that myth for all parts of the American polity, and it has become all too clear that the truth is the reverse of this well-worn fable. In contrast, what actually happened was that business became increasingly competitive during the late nineteenth century, and that various big-business interests, led by the powerful financial house of J.P. Morgan and Company, tried desperately to establish successful cartels on the free market. The first wave of such cartels was in the first large-scale business—railroads. In every case, the attempt to increase profits, by cutting sales with a quota system and thereby to raise prices or rates, collapsed quickly from internal competition within the cartel and from external competition by new competitors eager to undercut the cartel. During the 1890s, in the new field of large-scale industrial corporations, big-business interests tried to establish high prices and reduced production via mergers, and again, in every case, the merger collapsed from the winds of new competition. In both sets of cartel attempts, J.P. Morgan and Company had taken the lead, and in both sets of cases,

EDITORS’ NOTE: Murray N. Rothbard (1926–1995) was the S.J. Hall distinguished professor of economics at the University of Nevada, Las Vegas. This is an unpublished manuscript from the Rothbard papers, written in 1984, and will appear as a chapter in a forthcoming book to be published by the Ludwig von Mises Institute entitled A History of Money in the United States: The Colonial Era to World War II. The Quarterly Journal of Austrian Economics vol. 2, no. 3 (Fall 1999): 3–51

the market, hampered though it was by high protective tariff walls, managed to nullify these attempts at voluntary cartelization.

It then became clear to these big-business interests that the only way to establish a cartelized economy, an economy that would insure their continued economic dominance and high profits, would be to use the powers of government to establish and maintain cartels by coercion, in other words, to transform the economy from roughly laissez-faire to centralized and coordinated statism. But how could the American people, steeped in a long tradition of fierce opposition to government-imposed monopoly, go along with this program? How could the public’s consent to the New Order be engineered?

Fortunately for the cartelists, a solution to this vexing problem lay at hand. Monopoly could be put over in the name of opposition to monopoly! In that way, using the rhetoric beloved by Americans, the form of the political economy could be maintained, while the content could be totally reversed. Monopoly had always been defined, in the popular parlance and among economists, as “grants of exclusive privilege” by the government. It was now simply redefined as “big business” or business competitive practices, such as price-cutting, so that regulatory commissions, from the Interstate Commerce Commission (ICC) to the Federal Trade Commission (FTC) to state insurance commissions were lobbied for and staffed with big-business men from the regulated industry, all done in the name of curbing “big-business monopoly” on the free market. In that way, the regulatory commissions could subsidize, restrict, and cartelize in the name of “opposing monopoly,” as well as promoting the general welfare and national security. Once again, it was railroad monopoly that paved the way.

For this intellectual shell game, the cartelists needed the support of the nation’s intellectuals, the class of professional opinion-molders in society. The Morgans needed a smokescreen of ideology, setting forth the rationale and the apologetics for the New Order. Again, fortunately for them, the intellectuals were ready and eager for the new alliance. The enormous growth of intellectuals, academics, social scientists, technocrats, engineers, social workers, physicians, and occupational “guilds” of all types in the late nineteenth century led most of these groups to organize for a far greater share of the pie than they could possibly achieve on the free market. These intellectuals needed the State to license, restrict, and cartelize their occupations, so as to raise the incomes for the fortunate people already in these fields. In return for their serving as apologists for the new statism, the State was prepared to offer not only cartelized occupations, but also ever-increasing and cushier jobs in the bureaucracy to plan and propagandize for the newly statized society. And the intellectuals were ready for it, having learned in graduate schools in Germany the glories of statism and organicist socialism, of a harmonious “middle way” between dog-eat-dog laissez-faire on the one hand and proletarian Marxism on the other. Instead, big government, staffed by intellectuals and technocrats, steered by big business and aided by unions organizing a subservient labor force, would impose a cooperative commonwealth for the alleged benefit of all.

UNHAPPINESS WITH THE NATIONAL BANKING SYSTEM

The previous big push for statism in America had occurred during the Civil War, when the virtual one-party Congress after secession of the South emboldened the Republicans to enact their cherished statist program under cover of the war. The alliance of big business and big government with the Republican party drove through an income tax, heavy excise taxes on such sinful products as tobacco and alcohol, high protective tariffs and huge land grants and other subsidies to transcontinental railroads. The overbuilding of railroads led directly to Morgan’s failed attempts at railroad pools, and finally to the creation, promoted by Morgan and Morgan-controlled railroads, of the Interstate Commerce Commission in 1887. The result of that was the long secular decline of the railroads beginning before 1900. The income tax was annulled by Supreme Court action, but was reinstated during the Progressive period.

The most interventionary of the Civil War actions was in the vital field of money and banking. The approach toward hard-money and free banking that had been achieved during the 1840s and 1850s was swept away by two pernicious inflationist measures of the wartime Republican administration. One was fiat money greenbacks, which depreciated by half by the middle of the Civil War. These were finally replaced by the gold standard after urgent pressure by hardmoney Democrats, but not until 1879, fourteen full years after the end of the war. A second, and more lasting, intervention was the National Banking Acts of 1863, 1864, and 1865, which destroyed the issue of bank notes by state-chartered (or “state”) banks by a prohibitory tax, and then monopolized the issue of bank notes in the hands of a few large federally chartered “national banks,” mainly centered on Wall Street. In a typical cartelization, national banks were compelled by law to accept each other’s notes and demand deposits at par, negating the process by which the free market had previously been discounting the notes and deposits of shaky and inflationary banks.

In this way, the Wall Street-federal government establishment was able to control the banking system, and inflate the supply of notes and deposits in a coordinated manner.

But there were still problems. The national banking system provided only a halfway house between free banking and government central banking, and by the end of the nineteenth century, the Wall Street banks were becoming increasingly unhappy with the status quo. The centralization was only limited, and, above all, there was no governmental central bank to coordinate inflation, and to act as a lender of last resort, bailing out banks in trouble. As soon as bank credit generated booms, then they got into trouble; bank-created booms turned into recessions, with banks forced to contract their loans and assets and to deflate in order to save themselves. Not only that, but after the initial shock of the National Banking Acts, state banks had grown rapidly by pyramiding their loans and demand deposits on top of national bank notes. These state banks, free of the high legal capital requirements that kept entry restricted in national banking, flourished during the 1880s and 1890s and provided stiff competition for the national banks themselves. Furthermore, St. Louis and Chicago, after the 1880s, provided increasingly severe competition to Wall Street. Thus, St. Louis and Chicago bank deposits, which had been only 16 percent of the St. Louis, Chicago, and New York City total in 1880, rose to 33 percent of that total by 1912. All in all, bank clearings outside of New York City, which were 24 percent of the national total in 1882, had risen to 43 percent by 1913.

The complaints of the big banks were summed up in one word: “inelasticity.” The national banking system, they charged, did not provide for the proper “elasticity” of the money supply; that is, the banks were not able to expand money and credit as much as they wished, particularly in times of recession. In short, the national banking system did not provide sufficient room for inflationary expansions of credit by the nation’s banks.1

By the turn of the century the political economy of the United States was dominated by two generally clashing financial aggregations: the previously dominant Morgan group, which began in investment banking and then expanded into commercial banking, railroads, and mergers of manufacturing firms; and the Rockefeller forces, which began in oil refining and then moved into commercial banking, finally forming an alliance with the Kuhn, Loeb Company in investment banking and the Harriman interests in railroads.2

Although these two financial blocs usually clashed with each other, they were as one on the need for a central bank. Even though the eventual major role in forming and dominating the Federal Reserve System was taken by the Morgans, the Rockefeller and Kuhn, Loeb forces were equally enthusiastic in pushing, and collaborating on, what they all considered to be an essential monetary reform.

THE BEGINNINGS OF THE “REFORM” MOVEMENT:
THE INDIANAPOLIS MONETARY CONVENTION

The presidential election of 1896 was a great national referendum on the gold standard. The Democratic party had been captured, at its 1896 convention, by the populist, ultra-inflationist anti-gold forces, headed by William Jennings Bryan. The older Democrats, who had been fiercely devoted to hard-money and the gold standard, either stayed home on election day or voted, for the first time in their lives, for the hated Republicans. The Republicans had long been the party of prohibition and of greenback inflation and opposition to gold. But since the early 1890s, the Rockefeller forces, dominant in their home state of Ohio and nationally in the Republican party, had decided to quietly ditch prohibition as a political embarrassment and as a grave deterrent to obtaining votes from the increasingly powerful bloc of German–American voters. In the summer of 1896, anticipating the defeat of the gold forces at the Democratic convention, the Morgans, previously dominant in the Democratic party, approached the McKinley–Mark Hanna– Rockefeller forces through their rising young satrap, Congressman Henry Cabot Lodge of Massachusetts. Lodge offered the Rockefeller forces a deal: the Morgans would support McKinley for president, and neither sit home nor back a third, Gold Democrat party, provided that McKinley pledged himself to a gold standard. The deal was struck, and many previously hard-money Democrats shifted to the Republicans. The nature of the American political party system was now drastically changed: what was previously a tightly-fought struggle between hard-money, free-trade, laissez-faire Democrats on the one hand, and protectionist, inflationist and statist Republicans on the other, with the Democrats slowly but surely gaining ascendancy by the early 1890s was now a party system dominated by the Republicans until the depression election of 1932.

1On the National Banking System background and on the increasing unhappiness of the big banks, see Murray N. Rothbard (1984, pp. 89–94), Ron Paul and Lewis Lehrman (1982), and Gabriel Kolko (1983, pp. 139–46). 2Indeed, much of the political history of the United States from the late nineteenth century until World War II may be interpreted by the closeness of each administration to one of these sometimes cooperating, more often conflicting, financial groupings: Cleveland (Morgan), McKinley (Rockefeller), Theodore Roosevelt (Morgan), Taft (Rockefeller), Wilson (Morgan), Harding (Rockefeller), Coolidge (Morgan), Hoover (Morgan), or Franklin Roosevelt (Harriman– Kuhn–Loeb–Rockefeller).

The Morgans were strongly opposed to Bryanism, which was not only populist and inflationist, but also anti-Wall Street bank; the Bryanites, much like populists of the present-day, preferred Congressional, greenback inflationism to the more subtle, and more privileged, big-bank-controlled variety. The Morgans, in contrast, favored a gold standard. But, once gold was secured by the McKinley victory of 1896, they wanted to press on to use the gold standard as a hardmoney camouflage behind which they could change the system into one less nakedly inflationist than populism but far more effectively controlled by the big-banker elites. In the long run a controlled Morgan–Rockefeller gold standard was far more pernicious to the cause of genuine hard-money than a candid free-silver or greenback Bryanism.

As soon as McKinley was safely elected, the Morgan–Rockefeller forces began to organize a “reform” movement to cure the “inelasticity” of money in the existing gold standard and to move slowly toward the establishment of a central bank. To do so, they decided to use the techniques they had successfully employed in establishing a pro-gold standard movement during 1895 and 1896. The crucial point was to avoid the public suspicion of Wall Street and banker control by acquiring the patina of a broad-based grassroots movement. The movement, therefore, was deliberately focused in the Middle West, the heartland of America, and organizations developed that included not only bankers, but also businessmen, economists and other academics, who supplied respectability, persuasiveness, and technical expertise to the reform cause.

Accordingly, the reform drive began just after the 1896 elections in authentic Midwest country. Hugh Henry Hanna, president of the Atlas Engine Works of Indianapolis, who had learned organizing tactics during the year with the pro-gold standard Union for Sound Money, sent a memorandum, in November, to the Indianapolis Board of Trade, urging a grassroots, midwestern state like Indiana to take the lead in currency reform.3

In response, the reformers moved fast. Answering the call of the Indianapolis Board of Trade, delegates from boards of trade from twelve midwestern cities met in Indianapolis on December 1, 1896. The conference called for a large monetary convention of businessmen, which accordingly met in Indianapolis on January 12, 1897. Representatives from twenty-six states and the District of Columbia were present. The monetary reform movement was now officially underway. The influential Yale Review commended the convention for averting the danger of arousing popular hostility to bankers. It reported that “the conference was a gathering of businessmen in general rather than bankers in particular” (quoted in Livingston 1986, p. 105).

The conventioneers may have been businessmen, but they were certainly not very grass-rootsy. Presiding at the Indianapolis Monetary Convention of 1897 was C. Stuart Patterson, dean of the University of Pennsylvania Law School and a member of the finance committee of the powerful, Morgan-oriented Pennsylvania Railroad. The day after the convention opened, Hugh Hanna was named chairman of an executive committee which he would appoint. The committee was empowered to act for the convention after it adjourned. The executive committee consisted of the following influential corporate and financial leaders:

John J. Mitchell of Chicago, president of the Illinois Trust and Savings Bank, and a director of the Chicago and Alton Railroad, the Pittsburgh, Fort Wayne and Chicago Railroad, and the Pullman Company, was named treasurer of the executive committee. H.H. Kohlsaat, editor and publisher of the Chicago Times Herald, the Chicago Ocean Herald, trustee of the Chicago Art Institute, and a friend and advisor of Rockefeller’s main man in politics, President William McKinley.

Charles Custis Harrison, provost of the University of Pennsylvania, who had made a fortune as a sugar refiner in partnership with the powerful Havemeyer (“Sugar Trust”) interests.

Alexander E. Orr, New York City banker in the Morgan ambit, who was a director of the Morgan-run Erie and Chicago, Rock Island and Pacific railroads, the National Bank of Commerce, and the influential publishing house of Harper Brothers. Orr was also a partner in the country’s largest grain merchandising firm and a director of several life insurance companies.

Edwin O. Stanard, St. Louis grain merchant, former governor of Missouri, and former vice president of the National Board of Trade and Transportation.

E.B. Stahlman, owner of the Nashville Banner, commissioner of the cartelist Southern Railway and Steamship Association and former vice president of the Louisville, New Albany, and Chicago Railroad.

For the memorandum, see James Livingston (1986, pp. 104–05).

A.E. Willson, influential attorney from Louisville and a future governor of Kentucky.

But the two most interesting and powerful executive committee members of the Monetary Convention were Henry C. Payne and George Foster Peabody. Henry Payne was a Republican party leader from Milwaukee, and president of the Morgan-dominated Wisconsin Telephone Company, long associated with the railroad-oriented Spooner–Sawyer Republican machine in Wisconsin politics. Payne was also heavily involved in Milwaukee utility and banking interests, in particular as a long-time director of the North American Company, a large public utility holding company headed by New York City financier Charles W. Wetmore. So close was North American to the Morgan interests that its board included two top Morgan financiers. One was Edmund C. Converse, president of Morgan-run Liberty National Bank of New York City, and soon to be founding president of Morgan’s Bankers Trust Company. The other was Robert Bacon, a partner in J.P. Morgan and Company, and one of Theodore Roosevelt’s closest friends, whom Roosevelt would make assistant secretary of state. Furthermore, when Theodore Roosevelt became president as the result of the assassination of William McKinley, he replaced Rockefeller’s top political operative, Mark Hanna of Ohio, with Henry C. Payne as Postmaster General of the United States. Payne, a leading Morgan lieutenant, was reportedly appointed to what was then the major political post in the Cabinet, specifically to break Hanna’s hold over the national Republican party. It seems clear that replacing Hanna with Payne was part of the savage assault that Theodore Roosevelt would soon launch against Standard Oil as part of the open warfare about to break out between the Rockefeller–Harriman–Kuhn, Loeb, and the Morgan camps (Burch 1981, p. 189, n. 55).

Even more powerful in the Morgan ambit was the secretary of the Indianapolis Monetary Convention’s executive committee, George Foster Peabody. The entire Peabody family of Boston Brahmins had long been personally and financially closely associated with the Morgans. A member of the Peabody clan had even served as best man at J.P. Morgan’s wedding in 1865. George Peabody had long ago established an international banking firm of which J.P. Morgan’s father, Junius, had been one of the senior partners. George Foster Peabody was an eminent New York investment banker with extensive holdings in Mexico. He helped reorganize General Electric for the Morgans, and was later offered the job of secretary of the treasury during the Wilson administration. He would function throughout that administration as a “statesman without portfolio” (ibid., pp. 231, 233; Ware 1951, pp. 161–67).

Let the masses be hoodwinked into regarding the Indianapolis Monetary Convention as a spontaneous grassroots outpouring of small midwestern businessmen. To the cognoscenti, any organization featuring Henry Payne, Alexander Orr, and especially George Foster Peabody meant but one thing: J.P. Morgan.

The Indianapolis Monetary Convention quickly resolved to urge President McKinley to (1) continue the gold standard and (2) create a new system of “elastic” bank credit. To that end, the convention urged the president to appoint a new Monetary Commission to prepare legislation for a new revised monetary system. McKinley was very much in favor of the proposal, signalling Rockefeller agreement, and on July 24 he sent a message to Congress urging the creation of a special monetary commission. The bill for a national monetary commission passed the House of Representatives but died in the Senate (Kolko 1983, pp. 147–48).

Disappointed but intrepid, the executive committee, failing a presidentially appointed commission, decided in August 1897 to go ahead and select its own. The leading role in appointing this commission was played by George Foster Peabody, who served as liaison between the Indianapolis members and the New York financial community. To select the commission members, Peabody arranged for the executive committee to meet in the Saratoga Springs summer home of his investment banking partner, Spencer Trask. By September, the executive committee had selected the members of the Indianapolis Monetary Commission.

The members of the new Indianapolis Monetary Commission were as follows (Livingston 1986, pp. 106–07):

Chairman was former Senator George F. Edmunds, Republican of Vermont, attorney, and former director of several railroads.

C. Stuart Patterson was dean of University of Pennsylvania Law School, and a top official of the Morgan-controlled Pennsylvania Railroad.

Charles S. Fairchild, a leading New York banker, president of the New York Security and Trust Company, was a former partner in the Boston Brahmin investment banking firm of Lee, Higginson and Company, and executive and director of two major railroads. Fairchild, a leader in New York state politics, had been secretary of the treasury in the first Cleveland Administration. In addition, Fairchild’s father, Sidney T. Fairchild, had been a leading attorney for the Morgan- controlled New York Central Railroad.

Stuyvesant Fish, scion of two long-time aristocratic New York families, was a partner of the Morgan-dominated New York investment bank of Morton, Bliss and Company, and then president of Illinois Central Railroad and a trustee of Mutual Life. Fish’s father had been a senator, governor, and secretary of state.

Louis A. Garnett was a leading San Francisco businessman. Thomas G. Bush of Alabama was a director of the Mobile and Birmingham Railroad.

J.W. Fries was a leading cotton manufacturer of North Carolina.

William B. Dean, merchant from St. Paul, Minnesota, and a director of the St. Paul-based transcontinental Great Northern Railroad, owned by James J. Hill, ally with Morgan in the titanic struggle over the Northern Pacific Railroad with Harriman, Rockefeller, and Kuhn, Loeb.

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