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  Trying to look forward and not, for once, to General Jackson, bankers and businesspeople met in Baltimore in 1894 and proposed reforms. The phrase “central bank” was studiously avoided. However, to the conference-goers, it was plain that the Civil War banking structure had outlived its useful life. The Panic had devolved into a full-blown depression. Railroads had failed by the dozen. Thousands of factories had shuttered and unemployment had soared. In rural areas, farmers could not pay their mortgages. Virginia’s farmers were ruined by debt; four in ten were forced into tenancy.

  Although the depression was America’s worst to date, it did not occur to Cleveland to offer federal relief. The son of a Presbyterian minister, as honest as he was corpulent, Cleveland held that people should support the government, not vice versa. This was the Democrats’ laissez-faire credo. But Glass was struggling to reconcile this philosophy with the plight of his state’s farmers.

  The moment was highly polarizing. Populists agitated for an income tax, tariff reform, regulation of railroads, and direct election of U.S. senators (who were chosen by the legislatures). Workers erupted in sometimes violent strikes—notably, the Pullman strike of 1894, which halted much of the nation’s rail traffic and led to rioting and acts of sabotage, and was ultimately suppressed by federal troops.

  Discontent with the currency was the glue that united these disparate rebellions. In the same year as the Pullman strike, Jacob Coxey, an Ohio businessman, led an army of the unemployed to Washington. Remarkably, they demanded increased circulation—the first popular protest to focus on the monetary system. Meanwhile, over country hill and dale, Americans bent over oil lamps to peruse their copies of William H. Harvey’s fetching parable, Coin’s Financial School, published in 1894. Harvey was a failed silver miner turned proselytizer for silver coinage. He sold hundreds of thousands of copies.

  In the next presidential election, silver was the overwhelming issue. With America mired in a depression, increasing the money supply was the perceived tonic. William McKinley, the Republican nominee, was wary of alienating the silver forces, but party bosses insisted that he stand for gold.

  The Democratic convention was held in Chicago. Carter Glass, a member of the platform committee, boarded the overnight train for the Midwest in an emotional state, having buried his father only six weeks earlier. He must have ruminated on the last convention attended by Major Glass—in 1860, when the Democrats had debated slavery. This convention seemed similarly momentous, and Glass felt ready to play a part in great events. Despite the hard times, Glass enjoyed a rising prominence, having acquired the three newspapers in Lynchburg and obtained the fastest printing press in the state. His editorials, a daily barrage for free silver, were read in the highest circles in Virginia. Other social and economic issues were coming to the fore, such as labor reform and monopolies, but neither Glass nor the majority of Democrats were ready to embrace them. Glass was a conservative reformer, wary of measures that might divide the party and weaken the solid South. Southern democracy was founded on racial segregation, and he earnestly editorialized in support of this system. To Glass, any sort of federal interference (such as a central bank) also threatened an end to white supremacy, and was out of the question.

  The Democrats, therefore, coalesced around silver as an encompassing solution for America’s ills and also as a safe, unifying mantra for the delegates’ lengthy list of grievances. An air of nativism, a Jacksonian Anglophobia, hung over the delegates, for whom gold represented a policy of enslavement by Britain. The platform inveighed against “financial servitude to London” and “trafficking with banking syndicates.” It was a farmers’ convention, steeped in the issues that mattered to farmers, and it turned to the son of an avid Jacksonian, who himself had been raised on a farm, for inspiration.

  William Jennings Bryan, only thirty-six years old, had practiced law, worked as an editor, and served two terms in Congress, representing Nebraska. He was a teetotaler and a fundamentalist Christian. Many of his positions were prescient (he favored an income tax and public disclosure of campaign contributions), but his chief qualification for public life was a talent for oratory. Bryan did not analyze issues so much as feel them. While easterners judged him a dangerous radical, Bryan was driven by a yearning for the past as much as by a vision for the future. He was animated by a conservative nostalgia for small towns, religion, and laissez-faire. His early campaigns had been backed by the liquor interests, who were grateful to have found a non-drinker opposed to Prohibition. Now, he was financed by the silver interests.

  Addressing the convention on the warm afternoon of July 9, 1896, Bryan recognized that leadership of the silver crusade was up for grabs, and while some of the phrases he employed had been tested in earlier speeches, never before had his rhetoric been so poetic, or so rousing. He spoke to the delegates, and to the country, as fellow farmers and rural inhabitants—as, indeed, more than six of ten Americans were. He serenaded farmers—“those hardy pioneers,” he called them—“who braved all the dangers of the wilderness, who have made the desert to blossom as the rose.” Indeed, Bryan spoke as a representative of “our” farms, not of “your” cities, a dichotomy he associated with silver versus gold, poor against rich, even good against evil. He paid the obligatory homage to Jefferson and Jackson, and he claimed to speak for the “producing masses,” the “commercial interests,” the “laboring interests,” and “all the toiling masses”—only Wall Street was excluded. To bankers and to all defenders of the money system he exuded biblical wrath. “You shall not press down upon the brow of labor this crown of thorns,” he bellowed in climax. “You shall not crucify mankind upon a cross of gold.”

  Eyewitnesses reported a momentary silence followed by a tremendous roar. The delegates erupted in cheers; they stood on chairs, gestured wildly, paraded about the hall—a few with Bryan on their shoulders. Glass felt his passions stir and joined the throng. When the frenzy broke, he dashed off a wire to his paper reporting that Bryan had secured the nomination.

  The campaign that fall was bitter. McKinley had no trouble raising a war chest on Wall Street. Even some Democrats were appalled by Bryan’s populism and supported a splinter candidate. Among those who voted for the gold Democrat rather than Bryan was a noted Princeton professor, Woodrow Wilson.

  Nearly eight of ten eligible adults voted, one of the highest turnouts ever. Bryan lost the popular vote by a margin of only 4 percent—not a bad showing, considering that his financial support came almost exclusively from silver mines. Having polled 6.5 million votes, Bryan was now the uncrowned king of a political movement. Not coincidentally, within a fortnight of the election, businesspeople made arrangements for a conference in Indianapolis to consider reforming the monetary system. The organizers saw that the system was outmoded—just as plainly, they were afraid that the silverites would hijack the public debate. They wanted to reform the system before Bryan beat them to it.

  The six-hundred-page report that the Indianapolis Monetary Convention was to issue bore a single, offhand reference to a “central bank.” The delegates were headed in the other direction—they wanted the government out of banking, not mixed up with high finance. Morgan’s bullion deal with the Treasury had left a sour aftertaste.

  Rather than a currency based on government bonds, the Indianapolis report proposed that each bank issue its own notes, backed by the loans that it made to farmers, merchants, and factories. In this way, the quantity of currency would expand and contract with ordinary business. Let a bank issue credit on a shipment of cotton and the bank’s note would incrementally add to the money supply. Let the cotton shipper repay the debt and the currency would contract.

  Loans to cotton merchants and such were dubbed “real bills,” to distinguish them from speculative credit supplied to stock market traders. According to the real bills theory, such loans were inherently sound because they were backed by a tangible asset—the cotton.

  A chief attract
ion of the real bills theory was that it took decisions regarding the money supply out of human hands. John Carlisle, Treasury secretary under Cleveland, maintained that issuing notes “is not a proper function of the Treasury Department, or of any other department of the Government.” The task was just too difficult. Rather, Carlisle said, currency should be “regulated entirely by the business interests of the people and by the laws of trade.” By the “laws of trade,” Carlisle was invoking a nineteenth-century notion of natural law—of an Edenic order in which the volume of money would self-adjust.

  The Indianapolis convention was guided toward this doctrine by James L. Laughlin, head of the economics department at the new University of Chicago, and the author of the Indianapolis report. According to Laughlin, an asset currency (based on each individual bank’s loans) would “adjust itself automatically and promptly” as the level of trade, and therefore of bank loans, expanded and contracted to meet demand from business.

  Laughlin and other theorists were supremely naïve; monetary management is far too complicated to submit to an “automatic” guide.* And they appeared not to notice that America’s growing financial strength was tugging the U.S. Treasury away from the laissez-faire principles they held so dear. Indeed, various Treasury secretaries had begun to experiment with lending government reserves to banks. This is what central bankers do. Lyman Gage, secretary of the Treasury under McKinley, was a perfect illustration: even though he preached the gospel of noninterference, in practice he began to act like a forerunner of Ben Bernanke.

  Born and educated in upstate New York, Gage was a former president of the First National Bank of Chicago and an enthusiastic supporter of the Indianapolis idea of getting the government out of banking. However, McKinley’s high-tariff policies tended to augment Gage’s power. Higher tariffs meant more government revenue to throw around in money markets. Secretary Gage, fashionably coiffed in a full beard and mustache, may not have wanted a government bank but, with tariff collections streaming into the Treasury, he had one.

  What further amplified the Treasury’s influence was an economic boomlet, spurred by a combination of bumper wheat crops at home and a string of gold discoveries, including in the Klondike region of the Canadian Yukon. With wheat sales surging and gold more plentiful, money growth soared; deflation was finally over. In a sense, Bryan was vindicated: more money had indeed fostered prosperity. It was Bryan’s ill luck that the additional metal, as it happened, wasn’t silver, but gold.

  Gage now faced a question unknown to his predecessors: What to do with the Treasury’s surplus? As Gage was aware, the bullion stowed in the Treasury’s vaults was idle; it wasn’t out stimulating trade. His solution was to increase deposits in the national banks. In other words, he began to try his luck as a central banker.

  War with Spain, launched by McKinley in 1898, raised the profile of the Treasury even more (wars inevitably involve governments in banking). To finance the battle of San Juan Hill, Gage offered $200 million in bonds, to which the public eagerly subscribed. The war spending ignited a genuine boom. Arthur Housman, a stockbroker who traveled the country by rail in 1899, testified to good times in a report to J. P. Morgan. “Money is plentiful throughout the country,” Housman wrote in June. “In the smallest towns, money is freely offered at 5%.” Chugging across the prairie, Housman approvingly observed that farmers were building new fences and barns and that ranchers were improving their breeds of cattle.

  Yet the McKinley prosperity did not disguise the underlying weakness in the banking system. In the fall, country banks, needing cash for the harvest, pulled their deposits. Liquidity in New York suddenly evaporated. The city’s banks had whittled their reserves to the legal minimum; now, they had little—or nothing—to lend. “The cry everywhere,” said the lawyer and investor Henry Morgenthau, “was for money—more money—and yet more money.”

  Gage did not have to ponder long before deciding on a use for the Treasury’s reserves. He loaned them to banks. Gage’s idea, again, was to get the Treasury’s money into circulation. Although he still affirmed the desirability of reducing the government’s profile, he observed with alarm in his report for 1899 that “havoc was wrought in the regular ongoing of our commercial life.” This he would not abide. The “periodical regularity” of autumnal shortages grated on him. The lack of “stability” in the currency, the want of flexibility for “needful expansion,” suggested a profound inadequacy in the system.

  By 1900, Gage had deposited more than $100 million of the American people’s money in four hundred different banks. Outraged, Congress investigated. Legislators were irate that Gage had distributed a disproportionate sum, in particular, to National City Bank of New York. Such coziness between Wall Street and Washington inflamed old fears of bankers’ conspiracies. The Coming Battle, a populist tract by M. W. Walbert, warned that money dealers had formed “a gigantic combination” to thwart the interests of the people.

  Impervious to the criticism, the restless Treasury secretary plowed ahead. In the same year that saw Walbert’s attack on banks, Gage averred, “It is a popular delusion that [a] bank deals in money.” For the most part, Gage elaborated, banks deal in credit. Expounding on this theme, he pointed out that no more than 10 percent of a bank’s daily receipts are in the form of cash. The rest consists of checks or, as Gage precisely put it, “orders for the transfer of existing bank credits from one person to another.”

  This 90 percent—the credit network—was where the breakdowns occurred. That credit could dry up at a time of prosperity and rising gold reserves was especially troubling. No sooner do the symptoms of trouble appear, Gage observed, than banks, guided by the “ruling principle of self-preservation,” suspend or greatly inhibit their loans. At that point, people carrying goods and securities are obliged to sell with little regard to cost. “Contemplated enterprises are abandoned; orders for future delivery of goods are rescinded.” Finally, what should be an orderly contraction becomes “a disorderly flight, an unreasoning panic.”

  Fearing such a panic, Gage intervened in the spring of 1901, when a raid on Northern Pacific Railway shares roiled the stock market, and again in September, after President McKinley was assassinated. At the start of 1902, uncomfortable with the meddlesome style of his new boss, Theodore Roosevelt, Gage resigned. His final report was a parting shot at the venerable National Banking system. After five years in office, he had concluded that the system, admirable in many respects, had been “devised for fair weather, not for storms.” He lamented that individual banks stood “isolated and apart, separated units, with no tie of mutuality between them.” He lamented, too, that no association existed “for common protection or defense in periods of adversity and depression.” Not since Alexander Hamilton had a Treasury secretary come so close to demanding a central bank.

  Gage even spoke the forbidden words. Perhaps, he mused, the time was ripe not for a “large central bank with multiplied branches”—in view of the sure opposition it would arouse—but for a more modest institution, one restrained by constitutional-style checks. He had in mind a bank, privately owned, with authority to loan reserves from areas of the country where credit was plentiful to regions where it was scarce. Such an entity could become the object of a “perfect public confidence,” he said hopefully—if its powers were properly circumscribed. “We justly boast of our political system, which gives liberty and independence to the township and a limited sovereignty to the State. . . . Can not the principle of federation be applied,” Gage wondered, “under which the banks as individual units, preserving their independence of action in local relationship, may yet be united in a great central institution?”

  CHAPTER TWO

  PRIVILEGED BANKER, SELF-MADE SENATOR

  Under our clumsy laws, the currency supply [is] often largest when demand . . . is least.

  —ALEXANDER D. NOYES

  The study of monetary questions is one of the great causes of insanity.
r />   —HENRY DUNNING MACLEOD

  PAUL MORITZ WARBURG, an immigrant German banker, had barely arrived in New York in 1902 when a tempest erupted on Wall Street. The drama may have seemed routine to jaded New Yorkers, but to the newcomer, it signaled that something in America’s financial system was seriously amiss. Market busts were increasingly common. Beginning in 1887, there had been serious financial turmoil roughly every three years. The latest trouble had begun earlier in 1902, when the stock market suddenly cracked. Due to the fragile chain that linked the market and banks, the anxiety migrated into credit markets. Interest rates soared and reserves in the New York banks plunged below the lawfully prescribed minimum. Warburg watched in astonishment as credit quickly evaporated.

  The crisis was defused by Roosevelt’s secretary of the Treasury, an Iowa banker named Leslie Shaw, who sprinkled government moneys among national banks, and who assisted the banks in more creative ways as well. Critics roundly debated whether Shaw had been right to intervene. From Warburg’s émigré perspective, this quarrel missed the essential point. That Shaw had been compelled to resort to such makeshift tactics was evidence of the crudeness of American banking. It proved that the system itself was the problem. “I was not here for three weeks,” he would say later, “before I was trying to explain to myself the roots of the evil.”

  Schooled in Germany’s refined financial system, young Warburg injected a sorely needed gust of fresh thinking into the stale arguments over National Banking. There was probably no one in America who better appreciated the workings of the European central banks, and how they contrasted with the system in his adopted home.

  Warburg was the third of five sons, heirs to the Hamburg banking firm M. M. Warburg, which traced its origins to the time of Napoleon. He was introspective and shy, and he harbored a melancholy whose physical manifestation was a thick mustache inevitably characterized as “drooping.” If his younger brothers, Felix and Fritz, were bons vivants, and Max, the second, was a headstrong banker, Paul had the soul of a poet, and the intellectual fire of the eldest brother, Aby, who became a prominent art historian. As the family biographer, Ron Chernow, noted, Paul seemed to make money without really caring for it. However, his training uniquely prepared him to be an authority in international finance.