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 This is an unpublished manuscript from the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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