America's Bank: The Epic Struggle to Create the Federal Reserve (5 page)

When he arrived in the Senate,
the hot issue was the tariff
. Contemporary Americans can scarcely grasp how controversial the tariff was throughout the nineteenth century. After the Civil War, business had persuaded Congress to erect a complex schedule of duties to protect textiles, manufactured products, machine tools, commodities such as sugar, and a host of other goods from imports. America was still an emergent economy, its businesses less efficient than those of Great Britain and other European states. Even as America’s competitive disadvantage dissipated—that is, as the economic basis for the tariff vanished—northern manufacturers, through some combination of fearfulness and greed, supported the maintenance of high tariffs with near-religious fervor. At the same time, residents of farm states, who were consumers of industrial goods, resented having to
pay more for such items. Geographically, therefore, the tariff debate mimicked that of silver, with agricultural regions fiercely resenting the tariff as an eastern, and Republican, policy prejudicial to their interests.

Aldrich immersed himself in reading on this dense topic, and
had 170 volumes shipped
to his home in Washington (he had a fondness for his books, mostly dry tomes). He read on both sides of the tariff issue, including Adam Smith, who in the late eighteenth century expounded the classical view that “
the general liberty of trade
” increased the average prosperity of all. This fine theory did not sway Aldrich, who at ground level observed that the tariff was a blessing for Rhode Island, which had the
highest concentration of industry
of any state in the union. Always practical in his thinking, the new senator judged that the tariff was vital not only to the manufacturers in his state but also to the “comfortable homes” and “material prosperity” of its ordinary citizens. In other words, he saw in the tariff a nineteenth-century version of trickle-down, in which factory owners insulated from overseas competition reaped higher profits and paid more lucrative wages. Aldrich did not have to be arm-wrestled into hearing out his business constituents; he avidly sought their opinion and genuinely trusted their expertise. He bonded, in particular, with the Sugar Trust, the colossus that in the late nineteenth century monopolized the sugar-refining industry. Aldrich was friends with Theodore Havemeyer, a member of the stupendously wealthy
family that ran the Sugar Trust
, and the owner of a mansion in Newport, Rhode Island. And the senator faithfully legislated in the Trust’s interests, at times securing to the penny the tariff rate that Havemeyer requested.

On currency questions, Aldrich lined up against silver and was instrumental in 1896 in
persuading William McKinley
to run on a gold platform. Nonetheless, during his first two decades in the Senate, Aldrich was only intermittently involved in banking. It was the money shortages of the early twentieth century that shifted his focus. After the market break that also attracted Warburg’s attention,
bankers desperate to halt
the never-ending succession of stringencies called on Aldrich to fashion some sort of new currency to enlarge the total in circulation and relieve the stress. Aldrich, grounded in the conservatism of the era, had no wish to dabble with the currency. He feared that supplying a new currency, by enhancing the total money supply, would likely cause inflation. Barton Hepburn, the former comptroller and now president of the Chase National Bank, urged him to support reform, to which Aldrich replied, “
Our currency is as good as gold
. Why not let it alone?” (Hepburn rejoined that the currency was both as good and as bad as gold, namely “quite inelastic.”)

To appreciate the extent to which Aldrich was a roadblock to reform, one has to realize how influential he was not only within the Senate but with Theodore Roosevelt. Although the two did not see eye to eye on popular issues such as trust-busting, labor reform, and railroads, Roosevelt valued Aldrich’s intelligence and superior financial sense. What’s more, he had to deal with Aldrich’s hold on the Finance Committee. As Roosevelt confessed to the crusading journalist Lincoln Steffens, “
Aldrich is a great man
to me; not personally but as the leader of the Senate. He is a king pin in my game. Sure I bow to Aldrich. . . . I’m just a president, and he has seen lots of presidents.”

The President
did
bow to Aldrich. Behind closed doors, Roosevelt had promised Hepburn that if the American Bankers Association were to propose legislation for an asset currency, Roosevelt “
would adopt it as his own
.” When a bill was submitted, he failed to do anything of the kind. When Hepburn sought an explanation, the Rough Rider admitted that he had cut a deal with Aldrich, as well as with Joe Cannon, the Speaker of the House, under which the legislators “let” the President have his way with “certain reforms,” probably including railroad rate regulation, and kept currency and the tariff for themselves. And when Roosevelt ran for another term in 1904, currency reform was on hold.

Meanwhile, Paul Warburg continued to study the banking regime
that Aldrich stoutly defended, and his critique of it deepened. Warburg found fault, in particular, with the system’s rigid rules for bank reserves. The National Banking Act required banks in New York to keep a reserve equal to 25 percent of their deposits locked in their vaults, with similar restrictions applying to other banks.
*
This “stupid condition
,” Warburg concluded, immobilized the country’s assets, just as if an army were required to garrison its troops in thousands of scattered barracks rather than be allowed to shift them to the front and concentrate them where they were needed most. “
To a person trained under
the central banking system of European countries,” he would write, “such conditions seemed bewildering and strange.”

In various other ways, Warburg judged that the American system, adequate perhaps for an agrarian society, was unsuited to the fast-growing industrial and commercial economy of the early 1900s. In Europe, a bank holding short-term loans could sell this paper in a liquid secondary market. (This was true both for the bills of trade mentioned earlier, which were issued by banks, and for commercial paper, which consisted of promissory notes issued by merchants and other businesses.) As a result, Europe’s credit markets were fungible and highly liquid, similar to the stock market. In the United States, a bank that held such paper was stuck with a fixed, immobile asset. The lack of trading could not but be a drag on business. America needed a banking system, Warburg wrote, that was up to handling “
a lively and intimate daily exchange
.” As business grew, the system’s shortcomings were bound to surface.

Check clearing was a good example. Each bank maintained a
battalion of clerks to process checks and handle communications with other banks, a process that was unwieldy and at times comically inefficient. Its salient feature was a lack of coordination, in particular between banks across city and state boundaries—manifest in the seemingly simple task of routing checks to their bank of origin. A contemporary writer demonstrated the waste in the system by tracing the path of a single check for $43.56, drawn by Woodward Brothers, a general store in Sag Harbor, New York, on eastern Long Island, on its account at the local Peconic Bank and paid to Berry, Lohman & Rasch, a wholesale grocer in Hoboken, New Jersey. The check was deposited in the Second National Bank of Hoboken, which sent it along to a New York bank, which—not having a regular correspondent in Sag Harbor—bundled it with other checks to their Boston correspondent. The latter, inexplicably, transferred the nomadic debit to the First National Bank of Tonawanda, New York, near Niagara Falls. The Tonawanda bank, realizing the check had wandered off course, shipped it to a bank in Albany, which endeavored to get it nearer to home and relayed it to the First National Bank of Port Jefferson, only sixty miles from its point of issue. Alas, the check took another detour, to the Far Rockaway Bank, thence to the Chase National, the weary check’s second visit to New York City. After two more stops, it was returned to the Peconic and duly laid to rest. As the writer concluded, “
Once started, the poor check
gets pushed along from station to station.” In an economy humming with iron ore furnaces and factories, such methods were laughably archaic. In nearly every other field, combination and economy of scale were the watchwords. Industries were rapidly congealing into trusts (
more than two hundred trusts
were created from 1898 to 1904) and, largely in response to these giant combines, labor was recruiting workers into nationally affiliated unions. The country was knit by rail tracks and telegraph wires; electrification was advancing apace.

Only banking, or so it seemed, remained so fractured and so atomized. Even adjusting for the size of its population,
America had
far more banks
than other countries. Most of its banks were small, rural affairs, and two-thirds were chartered by individual states rather than by Washington. Such state banks, although uninhibited by the considerable burdens of the National Banking Act, were, of course, prohibited from issuing National Bank Notes. This meant that the “national” currency was accessible to only a minority of the country’s banks. As Warburg summarized this confusing picture, “
there existed as many disconnected
banking systems as there were States.” Larger cities, it is true, had clearinghouses (local associations to provide banking functions such as check clearing and emergency liquidity), but clearinghouses were not universal, and their capacity was limited, and beyond the municipal level no collective machinery for banking existed.

Warburg frequently unburdened himself
to Schiff as they walked downtown to the new Kuhn, Loeb skyscraper, a twenty-two-story token to modernity in the financial district. Schiff repeatedly insisted that, for cultural and historical reasons, America was not yet ready for a central bank. As Warburg acclimated to his new country, he came to better appreciate the political obstacles. Increasingly, his frustrations centered on the person who had the power (had he chosen to use it) to legislate reform: Senator Aldrich.

Aldrich, partly to mollify bankers, did offer his own currency bill, but it was less a reform measure than a reaffirmation of the status quo. In truth, the present arrangement suited him. High tariffs (which Aldrich largely dictated) enriched the Treasury and were used to buoy the banks in time of need. To Aldrich, the tariff, the gold standard, and National Banking constituted a sacred trinity best preserved intact.
His one innovation was to suggest
that
railroad
bonds be deemed acceptable collateral for government deposits in the national banks. This enraged progressives, who saw it as a plot to drive up the value of railroad securities, and thus make federal banking policy subservient to the interests of corporations.

In the marriage of business and government, Aldrich felt no
discomfort. Like many politicians of the Gilded Age, he genuinely believed that society benefited when its elected leaders were guided by men of wealth.
A card-playing companion of J. P. Morgan
, he treated his own lack of a fortune as a providential error, one to be duly rectified. In fact, in the early 1890s, he had flirted with leaving the Senate; however, a Rhode Island business tycoon, Marsden J. Perry, offered him a way to stay in Congress and still maintain the lavish lifestyle that he, Abby, and their eight children had come to enjoy. Perry made Aldrich a partner in a plan to consolidate and electrify the state’s trolleys; critically, the millions in capital needed to fund the modernization were provided by the Sugar Trust. Buoyed by this investment, Aldrich soon had a personal fortune that ran into the millions, and he could attend to his legislative work without the distraction of material concerns.
*

Aldrich saw nothing wrong in such a convenient partnership with sugar—the industry over which he held so much power. He would have said that his votes for sugar tariffs were votes of conscience. His links to the business elite were further sealed by the marriage of his daughter Abby, in 1901, to John D. Rockefeller Jr. In a perceptive senior thesis submitted at Harvard six decades later, Michael Rockefeller, the senator’s great-grandson, would write that “
it became easy for Aldrich
to conceive of legislation as being primarily a problem of consultation with the economic aristocracy followed by the application of personal authority.”
*

Aldrich generally ignored public criticism, believing that the Rhode Island machine shielded him from the vicissitudes of politics. But he was foolish to be so cavalier about his reputation. The American public was developing an appetite for scandal; journalists such as Ida Tarbell were writing hard-hitting articles exposing corruption in politics and unscrupulous behavior in business. American magazines had previously catered to a literary audience, but scandal sold better, and with technological innovations such as glazed paper made from wood pulp, publishers were able to cut prices and reach a mass audience.
Many articles focused on the gross inequities
in American society—the squalor of tenement living as opposed to the gilded lives of the ultrarich.

Predictably, Aldrich became a target. In 1905, William Randolph Hearst’s
Cosmopolitan
commissioned David Graham Phillips, a well-known novelist, to write a series of exposés, published the next year under the overwrought title “The Treason of the Senate.” The second
installment—“Aldrich, the Head of It All”—vilified Aldrich as “
the chief exploiter of the American people
.” Phillips’s prose was so soaked in innuendo and overstatement that President Roosevelt objected. He likened Phillips to the mythical collector of filth in
The Pilgrim’s Progress
,
who could “
look no way but downward
, with a muck-rake in his hand.” Thus “muckraking” was officially christened.
Critics also thought the attacks
on Aldrich were unfair. Whether the reading public was so discriminating is impossible to say. But Phillips’s larger point—that Aldrich typified a Congress too cozy with corporate interests and too distant from the people—was correct.