Birth of the Federal Reserve: Crisis in the Womb
William L. Silber
Revised October 2003
The author is the Marcus Nadler Professor of Finance and Economics, Stern School of Business, New York University. He wishes to thank Stephen Cecchetti, Kenneth Garbade, Allan Meltzer, Anna Schwartz, Richard Sylla, Josh Sullivan, Paul Wachtel, and Ingo Walter for helpful comments. Contact information: NYU, Stern School of Business, 44 West 4th Street, New York, N. Y. 10012. Telephone: 212-998-0714. Email: wsilber@stern.nyu.edu
Abstract
Birth of the Federal Reserve: Crisis in the Womb
The outbreak of World War I shut the New York Stock Exchange for more than four months. The conventional explanation maintains that the closure prevented a collapse in stock prices that threatened a repetition of the Panic of 1907. This paper shows that the Wilson Administration encouraged the suspension of trading to pave the way for launching the Federal Reserve System, which was in the process of being born. Closing the Exchange helped to forestall an outflow of gold. Federal Reserve insiders considered an adequate stock of gold crucial to the success of the new monetary system.
JEL Classification: E42, N22, E58
Keywords: Federal Reserve, Gold Standard, Financial Crises, World War I
I. Introduction
A confrontation between systemic risk and market liquidity occurred at the outbreak of World War I, just as the Federal Reserve System was being organized. On July 31, 1914, European investors seemed poised to liquidate their holdings of U.S. stocks and bonds to transfer gold to Europe to pay for the war. Policymakers worried that a stock market crash and gold outflow would cause an economic collapse similar to the consequences of the 1907 bank suspensions. [1] The crisis called for central bank intervention. The problem was that Congressional hearings on President Wilson’s nominations to the Federal Reserve Board were still in progress and the regional Federal Reserve banks had not yet been organized.
How did policymakers respond to the crisis? They shut the New York Stock Exchange (NYSE) on July 31, 1914 to prevent a collapse of stock prices and to help stem the gold outflow. The Exchange remained closed for more than four months, until December 12th, despite the United States not yet being a combatant in the war.
Sprague [1915, p. 513], in a
follow-up to his classic 1910 study of crises under the National Banking
System, applauds the decision to close the Exchange: “If the stock exchange had
not closed on Friday, July 31, it is certain that the decline in the price of
securities during the day would have been so extreme as to have occasioned
numerous failures of brokers and their customers and presumably much loss to
the banks as well.” Friedman and Schwartz
[1963, p.172] accept Sprague’s account of the crisis. Chandler, in his celebrated
biography of Benjamin Strong[2]
[1958, p.55], extends Sprague’s observation: “A general money panic would
almost certainly have occurred if the Exchange remained open with falling
security prices, widespread calling of loans collateralized by securities, and
large foreign sales increasing the burden of foreign payments.”
Sprague’s contemporary
analysis and Chandler’s retrospective articulated what could have happened, but
my evidence will demonstrate that the threatened stock market crash evaporated
before the end of August. My data also undermine the speculation that stock
prices would have collapsed had the New York Stock Exchange been open on July
31st.
Why did the Stock Exchange remain closed for more than four months? [3] I will show that individuals at the Federal Reserve fostered the delay to insure a successful launch of the System. The Federal Reserve Act, signed into law on December 23, 1913, required that gold be held as backing for Federal Reserve Notes. The Fed would not be effective, according to influential insiders, if it were rushed into existence without sufficient gold. Keeping the Exchange closed helped restrain the gold outflow, paving the way for the new currency system.[4]
President Wilson and Treasury Secretary McAdoo recognized that the United States was in the midst of a major shift in institutional structure. To insure a smooth transition to the new monetary order they agreed to sacrifice stock market liquidity. An effective substitute market emerged after the trading suspension,[5] although they had no way of knowing that when the decision was made to close the Exchange.
Wilson and McAdoo followed a two-part strategy with respect to the Federal Reserve System. They satisfied their instincts and rushed the Board of Governors into existence to provide wise counsel. They heeded the warnings of gold enthusiasts at the Fed and deferred the opening of the individual Reserve Banks until the horizon cleared.
II. Countering the Immediate Threat
Like
many crises under the national banking system (see Sprague [1910]), the
outbreak of World War I threatened to force banks to suspend the convertibility
of deposits into gold if they could not meet their customers’ demand for
currency. This time it was European investors who would liquidate their dollar
denominated securities on the New York Stock Exchange, receive checks drawn on
U.S. banks and then demand payment in gold, as was their right under the gold
standard. With a fractional reserve system there simply was not enough gold to
go around. And without a central bank to supply an alternative reserve asset,
bank suspensions would trigger a repeat of the economic contraction that
followed the Panic of 1907.
On
August 1, 1914 the Wall Street Journal reported a three-pronged defense against
the financial threat: “President Wilson
has taken strong steps to protect the United States against the tremendous
financial and commercial pressure caused by the European war. He practically
made up his mind to send one and possibly two nominations for the Federal
Reserve Board to the senate before the close of the day… He directed Secretary
of the Treasury McAdoo to take all possible steps to insure the financial
stability of the nation and he approved the closing of the New York Stock
Exchange…McAdoo said: ‘The Aldrich-Vreeland Act, as amended by the Federal
Reserve Act, is still in force…currency may be issued under that act… to meet
any emergency.’”
Wilson succeeded almost
immediately in legislating each part of his crisis management strategy. Of
the three components, the relatively obscure Aldrich-Vreeland emergency
currency was by far the most important in combating the economic threat,
despite Treasury Secretary McAdoo’s reference to it
[1931,
p.214] as “a feeble emergency measure.” Closing the Exchange merits an assist
but the Federal Reserve System arrived after the battle had been won.
II.1 Aldrich-Vreeland Currency
The
issuance of emergency currency, originally authorized by the Aldrich-Vreeland
Act of 1908 and extended by the Federal Reserve Act until June 30, 1915, was
designed precisely to avoid a repetition of the Panic of 1907. According to
Friedman and Schwartz [1963, p.441], the Aldrich-Vreeland Act enabled banks “to
convert their assets into additional high-powered money,” by authorizing groups
of banks, known as National Currency Associations, to apply to the U.S.
Treasury for emergency currency in exchange for approved bank assets. A number
of features of the Act were archaic, especially the provision that the
emergency currency could be issued only by banks already having banknotes
(currency) outstanding secured by U.S. bonds equal to 40 percent of their capital.
In 1914 many large banks had no such currency notes outstanding.[6]
On Tuesday, August 4th,
Congress amended the terms of the Act to expand its scope and magnitude. The
New York Times [August 5,1914] reports: “President Wilson signed the bill
amending the Aldrich-Vreeland Emergency Currency Act to provide a
practically unlimited supply [my italics] of emergency currency. More than
$1,000,000,000 may be added. Under the amended bill…banks will be able to issue
currency notes equal to 125 percent of the combined capital and surplus of the
banks.”
The Wall Street Journal reported on August 5th and 6th
that $11 million of the emergency currency has actually been issued and that
“$100 million had been shipped to the sub-treasuries in New York, Chicago, St.
Louis, Cincinnati, San Francisco, Boston and Philadelphia in order that the
needs of the banks may be promptly supplied. In many cases banks have applied
for additional currency merely as a precautionary measure.” At the peak in
October, 1914, banks needed less than $400 million[7]
out of the one billion dollar allotment.
The speed of the policy response to the perceived emergency no doubt contributed to its success. Crises disappear if they fail to get started. Friedman and Schwartz [1963, p. 196] summarize: “By the time the Federal Reserve Banks opened for business in the middle of November 1914, the country had recovered from the immediate shock of the declaration of war in Europe, thanks in no small part to the availability of Aldrich-Vreeland emergency currency.”
II.2 Closing the Stock Market
If Aldrich-Vreeland currency
saved the day, why did the New York Stock Exchange have to close? Despite the
decline of 8.05 percent on Thursday, July 30th in the New York Stock
Exchange’s average of 50 stocks, almost no one expected the NYSE to suspend
trading on July 31st. On
that same morning the front page of the New York Times carried a headline that
read: “Bankers Here Confer on War: Closing of Stock Exchange Not Necessary,
Meeting at Morgan Offices Decides.” The
public explanation for the suspension of trading was summarized in the Times
the next day (August 1st): “There had been no call for the meeting, and the
understanding was that the Exchange would open as usual…but the discovery that
the market was loaded down with big selling orders and almost bare of buying
orders…alarmed the brokers so much that they hurried upstairs to urge a
reconsideration of the decision to remain open.”
We know now, thanks to
McAdoo’s autobiography [1931, p. 290], that at 9:30 on Friday morning, July 31st,
J. P. Morgan, Jr. relayed a message to the Governing Board of the New York
Stock Exchange from Treasury Secretary McAdoo, suggesting that the NYSE close.
According to Henry Noble [1915, pp.11-12], President of the New York Stock
Exchange, the Board voted to suspend trading less than fifteen minutes before
the scheduled 10am opening bell on that Friday.
Although President Wilson
did not legislate the Exchange closing, the Administration obviously did more
than just approve it. Moreover, once the Exchange was closed, McAdoo used his
influence to keep it shut. As early as
August 2nd, the New York Times wrote: “It would not surprise
officials in Washington if Mr. McAdoo used his influence in New York to keep
the New York Stock Exchange closed for some time. No direct proposal of this
kind may be made but he is expected to show that the Government does not look
kindly upon the reopening of the exchange at this time.” Was that because of the
‘clear and present danger of a stock market collapse’ or was it something else?
It must have been something
else because the evidence shows:
(1) Stocks probably would not have declined very
much had the Exchange remained open on the 31st; (2) Even if the
uncertainty justified a ‘circuit breaker’ closure on the 31st, the
threat of a market collapse was over by the end of August.
II.2.1 Stock Prices on July 31, 1914
No
one has verified the conventional wisdom, published in the August 1st
New York Times, and memorialized by Sprague [1915, p. 513], that brokers
experienced an overnight build-up of sell orders to be executed on July 31st.
The NYSE closed before the opening. However, the Consolidated Stock Exchange[8],
located in New York and trading primarily “odd-lots” of NYSE listed securities
opened (as usual) at 9:30 on July 31st, but then closed at 10am when
the NYSE voted to close.
Table 1 shows the six stocks
that traded during that 30-minute session. Column (1) lists the stock, column
(2) lists the July 31 closing price at 10am on the Consolidated Exchange and
the percentage change from the NYSE close on July 30, and column (3) lists the
closing price on the NYSE for July 30 and the percentage change from July 29.
All of the stocks showed considerable declines on July 30th. In the abbreviated trading session on the
Consolidated Exchange on the 31st, two stocks rose, two remained
unchanged and only two declined. Western Union dropped the most – a decline of
4.4 percent.
European investors probably
would not have directed their orders to the Consolidated Exchange. Only a few
hundred shares of each stock traded during that first half hour. But the
information of a substantial overhang of sell orders on the NYSE should have
been reflected in the prices on the Consolidated Exchange. The transactions
prices on the Consolidated Exchange fail to confirm rumors of the overnight
build-up of sell orders.
II.2.2 Stock Prices During August and
September
Evidence
that stock prices were stable accumulated during August and September. I have
shown (see Silber [2003]) that prices on New Street, the substitute market that
traded NYSE listed stocks in the street, were virtually unchanged during the
last few days of August compared with the closing prices on July 30th.
During September prices hovered about 2 ½ percent below July 30th.
Moreover, I have also shown that even though the popular press blacklisted New
Street prices, Henry Noble, President of the NYSE, monitored New Street
quotes. And if Noble knew that stock
prices on New Street were stable, so did Secretary McAdoo.
Although European investors
would have found it difficult to transact in New Street because of the absence
of clearing facilities, transactions prices on New Street would have reflected
war related information, including the threat of European liquidation.[9]
Thus, the stability of stock prices on New Street suggests that if the NYSE had
reopened at the end of August the expected deluge of selling would not have
materialized.[10] The Wall
Street Journal [September 10, 1914] confirmed that judgment by reporting:
“Liquidation of foreign holdings of the shares of United States Steel
Corporation during the trying period preceding the closing of the Stock
Exchange[11] was surprisingly small. If the selling of
Steel shares by foreigners can be regarded as a barometer…then the many reports
of… [liquidation] have been greatly exaggerated.”
If stock prices were
relatively stable, why did McAdoo use his influence to keep the Exchange shut?[12]
Part of the answer is that the Exchange could remain closed without creating
investor resentment because an effective substitute source of liquidity had
emerged. The public could trade on New Street, which offered liquidity to those
who needed it (see Noble [1915, pp. 38]). The clamor to re-open the Exchange came
from the brokers,[13]
who had lost their livelihood. But to McAdoo that was less important than
insuring the successful launch of the safety net of the future – the Federal
Reserve. We will see that keeping the Exchange closed helped protect the birth
of the new monetary system.
II.3 A Split Opening for the Federal Reserve
Treasury
Secretary McAdoo knew how important the Federal Reserve System could be in
dealing with the crisis. On August 1st, the New York Times
reported: “After a conference with the President,
[Treasury] Secretary McAdoo expressed the belief that there should be no
further serious delay in getting the new reserve bank system fully organized…
The international character of the Federal Reserve banks under the new law is
broad and flexible in the matter of dealing with gold coin and bullion…”
But McAdoo also knew how
much the bankers opposed the new system. He observed [McAdoo, 1931, p.213]:
“Bankers fought the Federal Reserve legislation – and every provision of the
Federal Reserve Act – with the tireless energy of men fighting a forest fire.”[14]
The bankers invoked the crisis of World War I as a delaying tactic. On August 5th
the New York Times reported that the general sentiment among bankers was: “…the
present is not an auspicious time for the installation of the new banking
system.”
To get the System going but
to avoid unnecessary pitfalls, McAdoo engineered a split opening. The Board was
confirmed on August 7th, only days after President Wilson rushed the
last two nominees -- Paul M. Warburg and Franklyn A. Delano -- before the
Senate for approval. After the swearing-in ceremony on August 10th
McAdoo said [New York Times, August 11, 1914]: “We are going to be able to make
this System a bulwark against financial disaster...These banks could have been
organized by the 1st of August, but due to causes over which we had
no control the organization was not perfected by that date. The fact that the
Board itself has been organized means that the Banks can certainly be organized
by the 1st of October, or sooner.”
The Federal Reserve Act
conferred the right to set the date for opening the regional Banks on the
Secretary of the Treasury (see Meltzer [2003, p.74fn]). McAdoo clearly wanted
the banks to open sooner, rather than later. Nevertheless, the twelve Federal
Reserve Banks did not open until November 16th. What caused the delay?
III. The Gold Problem
On
Sunday night, August 2nd, McAdoo traveled to New York to meet with
leading bankers to hear their views about gold.[15]
In 1914, gold and foreign exchange were intertwined by the gold standard.
Under the rules of the gold
standard, the exchange rate between U.S. dollars and British pounds (Sterling)
fluctuated in a narrow range around $4.8665 per British pound, the mint parity
exchange rate determined by the gold content of the dollar and the pound (see
Yeager [1966]). The demand for British pounds versus dollars should never,
under normal circumstances, force the exchange rate above the mint parity by
more than the cost of shipping gold to London. Under those conditions, it would
pay to ship gold to satisfy obligations abroad rather than to buy Sterling
above the ‘gold export point’.
Estimates of the gold export
point varied with shipping costs and insurance. The Wall Street Journal noted [July
31, 1914]: “…the most experienced operator would never have dreamed that any
combination of circumstances could have arisen to drive demand sterling to
4.98, or about ten cents above the ordinary gold export point.” Thus the
Journal calculated the gold export point at $4.88 on July 31st, and
reports that sterling sold at $4.98. On August 5th the Journal
quoted Sterling between “6.25 @ 6.75 … with practically no business done.”[16]
As long as Sterling stayed
above the gold export point, the pressure to send gold abroad would continue.
The Wall Street Journal noted on July 29th “…the engagement of gold on a large
scale for shipment to Paris and London.” Only the jump in the real cost of
shipping gold, because of war related risks, deterred gold exports.[17]
When the Bank of England established a gold depository in Ottawa, Canada,
however, everyone knew the shipping barrier disappeared. The New York Times
[August 12th] reported: “Owing to the severe straits into which the
war had plunged foreign exchange, the news [about Ottawa] aroused instant
opposition among New York financiers.”
The disarray in the foreign
exchange market hurt business, but what mattered most to bankers was that U.S.
obligations were payable either in dollars or in gold. Failure to pay gold, if
it were demanded, would cause irreparable damage to the credit worthiness of
U.S. corporate and municipal securities. Bankers always worried about credit
worthiness, but especially in 1914. Back then bankers had placed many of these
securities with their European counterparts. The Europeans would surely demand
gold rather than dollars under wartime conditions.
Bankers supported the
suspension of trading on the New York Stock Exchange and the issuance of
Aldrich-Vreeland currency because they both served to conserve gold.[18]
The New York Times said on August 1st: “…the closing of the Exchange
put an additional barrier in the way of gold export, and perhaps it was the
only means to that end which was at hand.” Closing the Exchange would help
prevent gold exports even if every potential European seller were met by a
domestic U. S. purchaser to produce stable stock prices. European sellers were
likely to present checks for payment to domestic U.S. banks and demand gold,
the only universally acceptable medium of exchange.[19]
Domestic investors did not represent the same threat to the U.S. gold supply,
especially with bank access to Aldrich-Vreeland currency for meeting cash
withdrawals.[20] The New York Times article emphasizes the
connection by noting: “…an additional measure of protection for our gold
supplies [is the] circulation provided under the Aldrich-Vreeland Act…which
will supply any local demand for cash without putting it out in a form that
could be immediately taken for export.”
Note the specificity of the
Aldrich-Vreeland Act. It resolved the problem of a domestic shortage of gold
because it provided legal tender within the U. S. but it did not satisfy
international requirements. How did the bankers prepare to meet foreign
obligations? They formed a gold pool.
III.1 The Gold Pool
On
August 28th the Federal Reserve Board called a conference at the
Treasury Department for the following week to discuss “a solution to the
foreign exchange problem.” Representatives of Bank Clearing House Associations
were invited to attend [New York Times, August 28, 1914] and to bring: “…such
data as it is possible to furnish regarding the present United States cash
indebtedness to Europe [including] maturing obligations, and vice versa.”
Some
of the most prominent bankers in the country responded to the invitation. On
September 4th, the day of the conference, the New York Times
reported: “Messrs. A.H. Wiggin [President of the Chase National bank] and
Benjamin Strong, Jr. [President of Bankers Trust Co.][21],
who will represent the New York Clearing House, carried with them to Washington
data supplied by most of the international banking houses showing the amount of
money owed in Europe and the amounts of credit available... It was understoood
in the financial district that [Wiggin and Strong] will propose the formation
of a gold pool to provide at least $200 million in gold for shipment abroad.”
The
New York bankers did not disappoint. Wiggin and Strong proposed the gold pool
and suggested that “the Reserve Board should name committees at the reserve
centers to apportion the balance needed among the Clearing House Banks.” The
proposal had an immediate effect on foreign exchange. On September 5th
the Wall Street Journal reported: “There is a good deal easier tone to the
foreign exchange market…attributed in large measure to the meeting taking place
in Washington. Sterling was quoted at $5.01½, a decline of 2 cents since
Thursday and 5 cents since the high this week.”
The Federal Reserve Board
appointed a Committee headed by James B. Forgan, president of the First
National Bank of Chicago, to implement the gold pool plan. The “Forgan
Committee” consisted of Benjamin Stong of New York, L.L. Rue of Philaelphia, S.
Wexler of New Orleans, and T. P. Beal of Boston. Despite the wide geographic
representation, Benjamin Strong dominated subsequent events. According to the
New York Times, on September 10th, Strong, J.P. Morgan, Jr., and
Jacob Schiff met with Treasury Secretary McAdoo for 2 ½ hours to discuss the
Plan. Later that day the three New York bankers met with the Federal Reserve
Board.
As these discussions proceeded, a series of fortuitous
developments obviated the pressing need for the gold pool. The Wall Street
Journal reported on September 15th that: “Consummation of the plans
to meet the $100 million of New York City’s maturing securities, $80 million of
which are held in England and France, was the most constructive development
that has taken place since the war started…There has been evidence that
England, the largest foreign holder of our securities, is not as anxious to
liquidate as might be supposed. About 75% of the holders of… Lake Shore
one-year notes elected to take new notes…in exchange for maturing securities.
One of the bankers in charge of that financing said: ‘When they know they can
get their money, they are not so eager to have it.’”
The success at rolling over
maturing obligations held abroad, combined with anouncement on Septemebr 11th
(see above) that U. S. Steel experienced much less foreign liquidation during
the period preceding the closing of the Stock Exchange, should have put the
gold pool to rest. It also should have advanced the timetable for a resumption
of trading on the NYSE. It did neither.[22]
Foreign exchange remained above the gold export point and that posed a danger,
especially to Benjamin Strong, Jr, who was about to become a central banker.
IV. Benjamin Strong, Central Banker
On
October 5th, Benjamin Strong, Jr., President of Bankers Trust, was
elected Governor of the Federal Reserve Bank of New York. Strong had refused
the offer to become Governor of the New York Fed as recently as August 27th
(see Chandler [1958, p.38]). He reversed his decision after Henry Davison (J.
P. Morgan & Co.) and Paul M. Warburg, who had become a member of the Federal
Reserve Board, spent a weekend convincing him of his public duty to accept
[Chandler p.39].
None
of the Federal Reserve Banks were open for business when Strong became the
chief executive officer of the New York Bank. McAdoo, who had committed to
opening the individual Banks before October 1st, had been
preoccupied with a series of internal squabbles within the Board, ranging in
substance from a philosophical dispute about the relationship between the Board
and the Treasury to questions concerning appropriate quarters for Board members
[McAdoo 1931, pp. 285-6]. Once Strong assumed his position in New York, McAdoo
faced the most formidable obstacle to opening the banks.
As
a private banker, Strong had taken an active roll in the formation of the gold
pool because he believed that only gold could insure U.S. credit worthiness in
Europe [Chandler, p.58]. As a central
banker, Strong believed that the Federal Reserve Banks should hold far more
gold than required by law. Chandler [p.83] quotes Strong as saying: “We need an
immense safety factor beyond the legal minimum and it is for this reason that I
have been so urgent about accumulating gold.”[23]
Strong also wanted to make the dollar “an international currency by [creating]
confidence in the redeemability of dollars in gold at all times [Chandler,
p.84].”
As long as Sterling remained
above the gold export point, Strong worried that the stock of gold in the U.S.
would ebb towards Europe. On October 10th he wrote to Paul Warburg:
“If the Federal Reserve Banks refuse to pay gold they will be discredited at
the outset, and gold will certainly be demanded of them if they expand their
note issues when gold will be at a premium…the premium as reflected in the
price of sterling [Chandler, p.61].” Figure 1 plots Sterling exchange rates
collected from the Wall Street Journal between July 15, 1914 and December 31,
1914.[24] On October 1st, Sterling sold at
$4.965 and on October 15th it stood at $4.975, both well above the
gold export point, which was now $4.90.[25]
The Wall Street Journal reported almost daily shipments of gold to Canada
during October.[26]
McAdoo
had the legislative authority to open the banks, but Strong’s misgivings surely
restrained him. The two had met numerous times after McAdoo’s August 2nd
trip to New York,[27]
and Strong was not shy about articulating his views.[28]
McAdoo also received a communication in October (see Meltzer [2003, p.74]) from
Paul Warburg and W.P.G. Harding, members of the Federal Reserve Board,
confirming Strong’s concern that the System had very little gold. McAdoo also says [1931, p.288]: “I talked in
October with the governors and chairman of most of the Federal Reserve Banks
and nearly all of them thought that the necessary preparations [for opening the
banks] would take considerable time.”
Despite these objections,
McAdoo felt that “the delay could not be justified.” On October 25th he announced that all Reserve Banks
would open on November 16th. McAdoo quotes President Wilson [New
York Times, October 27th] as giving the best reason for avoiding
further delay: “…an effort to protect the [Federal Reserve] System against the
strains of the emergency which it is designed to relieve is to cast doubt on
the system itself.”
McAdoo [p.289] singles out
the “representative of the Federal Reserve Bank of New York (FRBNY),” in an
almost comical interchange, as trying to overturn the decision:
FRBNY:
“…the bank has no vault or safe place for keeping…gold”
McAdoo:
“There is a sub-Treasury in New York…[use] its vault.”
FRBNY:
“Our bookkeeping system is not…ready for the printing of forms.”
McAdoo:
“Surely you can have enough printing done by November 16…”
FRBNY:
“We can’t get our office furniture by that time.”
McAdoo:
“Buy a few chairs and pine-top tables.”
The
November 16th date set by McAdoo held firm despite the delaying
tactics of the Federal Reserve Bank of New York and its chief executive
officer, Benjamin Strong, Jr. Chandler [p.61] emphasizes that Strong did not
want to derail the system, as some of his fellow bankers tried to do. Strong
sought the delay because “the System might be jeopardized if the Reserve banks
were subjected to heavy demands when they were…weak in resources.” The
communication from Warburg and Harding to McAdoo mentioned above legitimizes
Strong’s concern about the System’s shortage of gold. Chandler [p.65] also
supports at least one additional resource shortage in New York: “the newly
formed bank did, in fact, use the vaults of the New York sub-treasury.”
V. McAdoo’s Insurance Policy
Why didn’t McAdoo set a date
for opening the NYSE, just as he had done for the Reserve Banks? The simplest
answer is that he had stuck his neck out on August 11th by promising
to open the Federal Reserve Banks on or before October 1st. He had
never said anything publicly about the Exchange, except to approve its closure
on August 1st. Also, contrary to the Federal Reserve Banks, he did
not have the legislative responsibility to open the NYSE. On the other hand,
McAdoo surely could have used the same influence to open the Exchange as he had
used to close it,[29]
unless he really wanted the NYSE to remain shut.
McAdoo kept the NYSE closed
as his insurance policy. He worried about the fundamental risks of shifting to
a new monetary regime. In his autobiography, McAdoo says [p.278]: “The entire
scheme was novel and untried. We were dealing with experimental formulas, with
principles that had existed only in theory and which were to be put to the most
practical of tests.” Chandler [p.15] emphasizes the risks by noting: “So severe
were the financial strains that many questioned the wisdom of opening the
Reserve Banks in November.” McAdoo’s concern as a prudent policymaker, combined
with the Strong’s arguments about gold, prevented him from doing too much too
soon. He opened the Reserve Banks because he (and Wilson) felt they would help
solve the crisis that began on August 1st. He kept the Exchange
closed because he thought the financial strains were not completely gone. On
November 7th the Wall Street Journal quotes McAdoo as saying: “The chief
thing that is needed [to re-open the Exchange] is a restoration of
international confidence. This is, in my opinion, almost [my italics] an accomplished fact.” ‘Almost’ was just not
good enough while the Federal Reserve System was being launched.
McAdoo announced the
November 16th opening for the individual Reserve Banks on October 25th.
Figure 1 shows that Sterling was above the $4.90 gold export point throughout
the month (except for a temporary decline to $4.890 on the day after McAdoo’s
announcement). The Wall Street Journal continued to report gold exports to
Canada (see footnote 26). Stock prices on New Street had fallen about 9 percent
below July 30 closing prices as a result of war related developments (see
Silber [ 2003] and Noble [1915, p.43]). Under those circumstances, the NYSE
might easily have served as a teller’s window (see Noble [p. 65]) for European
access to our gold. Keeping the Exchange closed helped mollify Strong and
sheltered the birth of the Federal Reserve System.
V.1 The Risks Abate
The middle of November
brought a much kinder environment for a resumption of NYSE trading. The New
York Times [November 13th] heralded a bullish stock market by
publishing, for the first time, a list of prices for 27 stocks trading on New Street.
The most encouraging development, however, came from foreign exchange. The Wall
Street Journal [November 13th] reported: “The foreign exchange
market broke sensationally at one time to…$4.87½ for cable transfers, well
within the present gold export basis, which is usually considered to be $4.90
The present level of exchange is the lowest point the market has touched since
before the declaration of war, and marks the restoration of normal conditions.”
Figure 1 shows that Sterling remained below the gold export point after
November 12th.
Henry Noble [1915, p. 74],
President of the NYSE, describes a series of favorable meetings during
mid-November with George Paish and Basil Blackett, representatives of the U.K.
government discussing foreign exchange with Washington. They encouraged the
re-opening of the Exchange at that time.
The improved conditions cast
doubt on the press report of November 16th (see footnote 29) saying
that the government preferred to continue the suspension of trading on the
NYSE. It turns out that the reported objection was erroneous. Noble [p.79] says
that his Committee set Monday, November 23rd, as the date for
restoring limited bond trading to the Exchange floor. He then notes: “On
Thursday (the 18th) a well meaning but misguided go-between reported
that he had communicated with Washington…and [they] expressed a desire to see
some member of the [stock Exchange] Committee before any further steps were
taken [to open the Exchange].” Noble reports [p. 80] that he contacted the ‘Government
official’ and received a telegram explaining “that the suggestion of an
interview had in no way emanated from him.”
Bond trading on the NYSE
floor resumed on Saturday November 28th. Noble [p.82] says that the
success with bonds encouraged the Exchange Committee to formulate a plan for
“carrying the reopening a step further.’ On December 12th, stocks that were
“not international in character” (see Noble [p.83]) were brought to the
Exchange floor and on December 15th, all stocks were admitted for trading.
VI. Conclusion
The outbreak of World War I
threatened to repeat the conditions that led to the Panic of 1907. Most of the
credit for averting the crisis belongs to the Wilson Administration’s speedy
issuance of Aldrich-Vreeland currency. According to Benjamin Strong, private
banker and central banker, the export of gold to Europe jeopardized the birth
of the Federal Reserve System. Treasury Secretary McAdoo responded to the
danger by encouraging the suspension of trading on the NYSE for more than four
months to minimize the outflow of gold and to smooth the way for the new
monetary system. On August 28, 1914, the Wall Street Journal got it almost
right when it said: “To put it frankly, the bankers closed the Stock Exchange
and the bankers will reopen it, after wise counsel with the Federal Reserve
Board.”
References
Chandler, Lester V., 1958, Benjamin Strong, Central Banker, Washington, D.C., The Brookings Institution
Nelson, Samuel Armstrong, 1907, The Consolidated Stock Exchange of New York, New York, The A. B. Benesch Co.
Noble, Henry George Stebbins, 1915, The New York Stock Exchange in the Crisis of 1914, Garden City, N. Y., The Country Life Press.
Silber,
William L. 2003, “What Happened to Liquidity When World War I Shut the NYSE?”
NYU Salomon Center Working Paper No. S-03-13.
Sobel, Robert, 1968, Panic on Wall Street; a History of America's Financial Disasters, New York, Macmillan.
______________, 1972, Amex: A History of the American Stock Exchange, 1921-1971, New York, Weybright and Talley.
Sprague, Oliver Mitchell Wentworth, 1910, History of Crises Under the National Banking System, Washington, D.C., Government Printing Office.
_______________, 1915, “The Crisis of 1914 in the United States,” American Economic Review, Volume 5, No. 3, pp. 499-513.
Wall Street Journal, 1914, 1915, Various Issues.
Yeager, Leland B. 1966, International Monetary Relations: Theory History, and Policy, Harper & Row, New York.
Table 1: Selected Closing Prices for Stocks on July 31, 1914 and July 30, 1914
|
(1) Stock |
(2) July 31 Percent Close Change |
(3) July 30 Percent Close Change |
||
|
American Smelting |
52 1/2 |
- |
52 1/2 |
-13.0% |
|
Chicago, Milwaukee & St. Paul |
87 |
+2.1% |
85 1/4 |
-7.8% |
|
Reading Railroad |
141 |
+ .7% |
140 |
-9.2% |
|
Union Pacific |
113 1/2 |
- |
113 1/2 |
-5.4% |
|
U.S. Steel |
51 1/8 |
-1.4% |
51 7/8 |
-8.6% |
|
Western Union |
51 |
-4.4% |
53 3/8 |
-6.2% |
Source: New York Times, August 1, 1914
Source: Wall Street Journal, July 15, 1914
through December 31, 1914