The Creature from Jekyll Island

Yes the Fed began effectively as private consortium of banks to accomplish what J.P. Morgan did to rescue the banking system during the Panic of 1907 that saved the day. The banking crisis of that era was not because of blowing people up with their trading as inTransactional Banking today. The Panic of 1907 was the classic mismatch between demand and loans – the fractional banking element.

Indeed, such a period of a temporary shortage of cash burst forth during the Panic of 1907 and it was John Pierpont Morgan (“JP”)(1837-1913) who saved the day, although most have criticized him ignoring his great patriotism and contribution to the country. The Panic began when there was an attempt to manipulate the market in United Copper Company that was a short squeeze which backfired. This was the catalyst, not the cause. It was the spark that ignited the Panic that took place. They borrowed money to buy stock to create the squeeze from the Knickerbocker Trust and suddenly they could not pay back their loans bringing the bank into failure. J.P. Morgan gathered his associates to examine the books of the Knickerbocker Trust but found it was insolvent and decided not to intervene to stop the run. When it became clear the Knickerbocker Trust would fail, the run spread to other banks and a contagion grew.The Trust Company of America asked Morgan for help. Morgan now brought in First National Bank and National City Bank of New York (later Citi Bank), and the US Secretary of the Treasury. Morgan had a quick audit of the bank and declared that this was where to defend. As the run began, Morgan worked with his associates to sell the assets of the bank to free up cash for the depositors. The bank survived the close of business that day for this is always aCONFIDENCE game.Morgan knew that this collapse in CONFIDENCE would not the end by just saving the Trust Company of America. Morgan now summoned the heads of various banks in New York and kept them until they agreed to provide loans of $8.25 million. Morgan convinced the Treasury to deposit $25 million in NY banks. John D. Rockefeller, the wealthiest man in America deposited $10 million with City and called the Associated Press to announce his pledge to help the NY banks. Nonetheless, the New York banks then, as now, proved to be their worst enemy. Despite the efforts of Morgan to create this infusion, they were reluctant to lend any money for short-term stock trading. The stock market crashed as a result. By 1:30 pm Oct 24th, the president of the NYSE went to tell Morgan the exchange would close early.Morgan was livid. He understood that this would reinforce the Panic and he drew the line and would not allow it. Morgan warned that if the NYSE closed early, it would be catastrophic to say the least. Once again he summoned the bankers who arrived by about 2pm and Morgan pretty much yelled at them and warned that as many as 50 stock brokerage firms would fail unless $25 million was now raised in 10 minutes! By 2:16 pm, 14 banks pledged $23.6 million to keep the stock exchange alive. The money even reached the exchange by 2:30 pm, to finish trading at 3pm. The amount that was actually needed was only $19 million. Morgan himself hated the press that rarely treated him fairly, but this time he gave a rare comment.The next day, the NYSE needed more money and Morgan this time could only raise $9.7 million. Morgan directed the NYSE that the money could not be used for margin sales – short selling. The exchange made it to the close. Morgan knew he had to turn the minds of the people and to restore their critical CONFIDENCE to stop the Panic. Morgan now directed two committees to be formed to (1) persuade the clergy to preach calm to their congregations on Sunday, and (2) to sell the idea of clam to the press. Morgan was desperately trying to hold the nation together. Unknown even to his associates, the City of New York could not raise money through its bond issue and it informed Morgan that it needed $20 million by November 1st, 1907, or it would go into bankruptcy. Morgan himself contracted to purchase $30 million in New York City bonds.

On November 2nd, one of the largest stock exchange brokers, Moore & Schley, was heavily in debt using the Tennessee Coal, Iron & Railroad Co stock as collateral. The stock was thinly traded and the stock was under pressure. Their creditors would now surely call their loans. Morgan called another emergency meeting and a proposal was put forth that US Steel Corp, would acquire the stock in bulk. Yet another crisis was looming. Runs were now likely to hit two banks on Monday. Morgan summoned 120 banks and told them he would not proceed with the US Steel deal unless they supported the banks.

Morgan now locked them in his library and told them they had to come up with $25 million to save the banks. It took almost 2 hours. Morgan finally convinced them that they had to bailout the banks to save their own skins. They signed the agreement, and he unlocked the doors and let them leave.

Morgan was saving the nation again, singlehandedly. He then turned back to save the NYSE. He knew the problem would be the Marxist inspired Antitrust Laws (Sherman Antitrust Act), and the crusading Marxist/Progressive President Teddy Roosevelt (1858-1919). Breaking up companies he believed were monopolies was the main focus of Roosevelt’s administration. To save the day, he would have to see that the Antitrust Laws must yield.

Two men thus traveled to the White House to implore Roosevelt to set aside his Antitrust Laws to save the nation. As typical, Roosevelt’s secretary refused to let them in to even discuss the problem. The two men, Frick and Gary of US Steel turned to James Garfield who was Secretary of the Interior at that time (later President). They pleaded with him to go to the President directly. Garfield had convinced Roosevelt to at least review the proposal. Roosevelt was for the first time forced into a corner. He had to realize a collapse of the NYSE would take place if he did not yield in his ant-corporate beliefs. Roosevelt later lamented:

“It was necessary for us to decide on the instant before the Stock Exchange opened, for the situation in New York was such that any hour might be vital. I do not believe that anyone could justly criticize me for saying that I would not feel like objecting to the purchase under those circumstances.”

Following the near catastrophic financial disaster known as the Panic of 1907, the movement for banking reform picked up steam among Wall Street bankers, Republicans, and a few eastern Democrats. However, much of the country was still distrustful of bankers and of banking in general, especially after Panic of 1907. After two decades of minority status, Democrats regained control of Congress in 1910 and were able to block several Republican attempts at reform, even though they recognized the need for some kind of currency and banking changes. As always, it was more important to further political party power than actually do the right thing for the nation.

In 1912 President Woodrow Wilson (1856–1924) won the Democratic Party’s nomination for President, and in his populist-friendly acceptance speech he warned against the “money trusts,” and advised that a concentration of the control of credit may at any time become infinitely dangerous to free enterprise. It was the Anti-Wall Street agenda.

Behind the scenes, the Panic of 1907 revealed the weak underbelly to the American financial system. After the scare that the Panic of 1907 created among the bankers, they demanded reform. The very next year, Congress enacted the Aldrich Vreeland Act of 1908 establishing the National Monetary Commission which formed a study group of experts to come up with a nonpartisan solution. It was the lack of a central bank in America in contrast to Europe that was seen as the threat to economic stability among the bankers as filled by J.P. Morgan during that crisis.

A National Monetary Commissionwas formed and the Republican leader in the Senate, Senator Nelson Aldrich (1841-1915) took charge. Aldrich was a brilliant man who was passionate about revising the American financial system. The Commission went to Europe and was duly impressed at how well they believed the central banks in Britain and Germany handled the stabilization of the overall economy and the promotion of international trade. The Commission issued some 30 reports between 1909 and 1912 which preserved a wonderful detailed resource surveying of banking systems of the late 19th and early 20th centuries at that time. These reports examined also the Canadian banking history in addition to the
banking and currency systems of Belgium, England, France, Germany, Italy, Mexico, Russia, Switzerland, and other nations. They also provided an excellent review of domestic U.S. financial laws federally as well as state banking statutes. These reports contain essays of contemporary specialists as well as a host of data in tables, charts, graphs, and facsimiles of banking forms and documents. There are also transcripts of relevant political speeches, interviews, and various hearings.

Also in 1910, Aldrich met with Frank Vanderlip of National City Bank (Citibank), Henry Davison of Morgan Bank, and Paul Warburg of the Kuhn, Loeb Investment House secretly at Jekyll Island, a resort island off the coast of Georgia, to discuss and formulate banking reform, including plans for a form of central banking that would accomplish the role of J.P. Morgan played during the Panic of 1907. The meeting was held in secretbecause the participants knew that any plan they generated would be rejected automatically in the House of Representatives given the intense hatred of the bankersand Wall Street in the festering Marxist/Progressive atmosphere.

Unfortunately, because this meeting was secret involving Wall Street, the whole Jekyll Island affair has always been cloaked in conspiracy theories. Nevertheless, this intense bias and conspiracy theory has always overestimated both the purpose and significance of the meeting in light of the extensive work of the National Monetary Commission. Reform was essential. However, those two words, Political-Economy could not be divorced.

Upon his return, Aldrich’s investigation led to his plan in 1912 to bring central banking to the United States with all its promises of financial stability and expanded international roles in trade and money flow. Aldrich knew the dangers of American politics and insisted that control by impartial experts was essential. Placing bankers at the helm rather than politicians was really the only way to proceed. The two words Politic-Economy had to be divorced in his mind. There was to be absolutely NO political meddling in finance as had been the case under Andrew Jackson (1757-1845). Aldrich asserted that a central bank was essential yet the diversity and size of the United States presented a distinctly different twist to the European situation.

Aldrich concluded that Europe had many countries with diverse economic models. He realized that while the United States needed a central bank, paradoxically it also had to be simultaneously decentralized somehow to cope with both the economy and the self-defeating American political system. Aldrich was seasoned enough to appreciate that a central bank would be attacked by local politicians and bankers as had the First and Second Bank of the United States. The Aldrich plan was brilliant and it was introduced in 62nd and 63rd Congresses (1912 and 1913). As always, the political winds changed and the Democrats in 1912 won control of both of the House and the Senate as well as the White House.

The Aldrich Plan proposed a system of fifteen regional central banks, called National Reserve Associations, whose actions would be coordinated by a national board of commercial bankers to do NO more than be a lender of last resort as J.P. Morgan had acted during the Panic of 1907. The National Reserve Association would make emergency loans to member banks, would create money to provide an elastic currency that could be exchanged equally for demand deposits, and would act as a fiscal agent for the federal government. The Aldrich Plan was actually rejected by the Congress – defeated in the House as politics superseded the national good. However, its outline did become a model for a bill that eventually was adopted. The problem with the Aldrich Plan was that the regional banks would be controlled individually and nationally by bankers, a prospect that did not sit well with the populist Democratic Party or with President Wilson. The Democrats and Wilson were fearful that the reforms would grant more control of the financial system to bankers and the politicians could not meddle as they saw fit. The history of the First and Second Bank of the United States was repeating. It was that Political-Economy that cannot be divorced.

The need for a central bank was really far too great and even the Democrats recognized that behind closed doors. Eventually, the Federal Reserve Act was passed 43 to 25 and this now altered the actual role of currency. MONEY was now becoming “elastic” for the Federal Reserve would issue currency notes thereby creating a money supply that increases and decreases as the economy expands and shrinks. This new “Elastic Money” would become an essential function of the Federal Reserve System in its early days where it would regulate the amount of money supply that was allowed to be in circulation. This was seen as essential because of the wild swings during the 19th century in the economy caused by the chance discoveries of gold in California, Alaska, and silver that disrupted the economy and arbitrarily increased the money supply with nobody in charge.

Effectively, the 20th century saw unrestrained printing of paper dollars caused by political fiscal mismanagement whereas the 19th century was plagued by chance discoveries of precious metals that had the same effects. The California Gold Rush injected a huge wave of inflation because the sheer supply of money increased sharply. The same argument that paper money has caused inflation during the 20th century applied to gold during the 19th century.

Essentially, this new ability to have an Elastic Money Supply was now seen as necessary to make sure that the reserves held in trust by the government were adequate to back the amount of coins and currency that were allowed to circulate. It was now seen that a nonpartisan decision should deal with shifts in the economy whereas politicians could not be responsible no matter what. It would be the Federal Reserve that would now prevent excessive conditions that would lead the country into financial chaos and ultimate ruin as nearly took place during the Panic of 1907. The Fed would expand the money supply during periods of economic decline and contract the money supply during economic booms. Of course, the politicians would later seize control of the Fed and ensure it would be party time all the time.

Optimal monetary policy is supposed to facilitate exchange within the economy to avoid aggregate shocks that affect individuals and economic sectors (industries) unequally. Exchange may be conducted using either bank deposits that some see as “inside money” or “fiat” currency some refer to as “outside money” that is created by leverage – fractional banking. A central monetary authority both controls the stock of“outside money” and pursues an interest rate policy that is intended to affect the rate at which private banks create “inside money”. In the modern context, it is now seen as the optimal monetary policy requires management of both interest rates and the quantity of outside money. By controlling interest rates the monetary authority can affect the price level in the short-run and adjust households’ consumption, so they believe, and therefore this provides insurance against unfavorable aggregate shocks to the money supply tempering the boom-bust cycle.

However, the feasibility of manipulating the interest rate policy and the quantity of money, as we will see, is purely a fantasy in the new modern global economy. These concepts were quickly being proven to be far too parochial. The global economy was about to receive a major shock that would turn it on its head – World War I which July 28th, 1914 and lasted until November 11th, 1918. It involved more than 70 million military personnel, of which 60 million were Europeans, and more than 9 million soldiers were killed in combat. The assassination of Archduke Franz Ferdinand of Austria on June 28th, 1914 was the excuse for the war, but in reality, it was the culmination of centuries of contests for imperialistic power in Europe. Ferdinand was the heir to the Austria- Hungarian Empire throne, which was the remnant of the Holy Roman Empire. This allowed the hatred between many rivals bringing into the conflict the German Empire, Ottoman Empire, Russian Empire, British Empire, French Empire, and Italy. In the end, the Financial Capital of Europe, which migrated from Babylon to Athens, then Rome, Byzantine, Northern Italy centered in Florence/Genoa/Venice, to Amsterdam, and then to London in 1689, now migrated to the United States beginning in 1914.

With World War I, the American politicians began to alter the Fed. Its original design was brilliant. To stimulate the economy and suppress unemployment, they would buy corporate paper. With World War I, Congress order the Fed to then support US government debt. They would not return to the original design of the Fed set out in 1913.

With the Great Depression, the major banking collapse took place largely due to the Sovereign Debt Default of 1931. Banks failed as money vanished from circulation collapsing the velocity. Assets values collapsed and land, which had sold for $2.50 an acre during the mid-1800s, fell to 10 cents. No degree of limiting fractional banking would save the day when it is the bond market that collapses. We see the huge spike in foreign bonds listed in 1928 on the NYSE, and the collapse collapse as defaults began to rage from 1931 onward.

Franklin Roosevelt, every much a socialist as Teddy even though a Democrat, altered the Fed usurping all power to Washington. The branches remained, but they no longer served the purpose of managing the local economy. It was now one-size-fits-all. It would be Congress who appoints the directors and Fed Chairman, while the technical ownership of a rescue fund for bankers is only there in name – not reality. Goldman Sachs switched tactics and installed its people in the Treasury not for banking – but for trading. They were Obama’s biggest contributor, but make no mistake about it, Goldman Sachs is a trader, not a bank with branches taking deposits from little old ladies.

Today, the Fed is nothing like its design was intended. This has been altered NOT by bankers, but by politicians. It is now given authority to take over anything it thinks is too big to fail, which is not limited to banks. It could take over Google, McDonalds, or anything as long as it states it would harm the economy.

We need a central bank, but not one that is manipulated by government. It should be a simple insurance fund for banks as original intended without taxpayer’s money. It should not be restricted to buying government debt, it should protect jobs by its original focus to buy corporate paper in times of stress. We must look closely at the Fed and see that it has been manipulated by Congress for political reasons. It was order to support government bonds at par during World War II. That was not rescinded until 1951.

The Fed is not evil – it is the manipulation of the Fed by politicians. It is use to blame for economy booms and busts while Congress avoids all responsibility. The Fed is now caught in a very difficult position. It is charges with Keyensian/Marxist ideas of manipulating the economy when its original design was only to deal with a banking crisis.

Tomorrow we will look at the risks we now face from the REALITY of political manipulation of the Fed.

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