America's Fiscal Constitution (26 page)

The Commission on Economy and Efficiency, authorized by Congress and appointed by Taft, urged the White House to prepare an annual budget proposal for submission to Congress at the beginning of each calendar year. Fearing a loss of power to the executive branch, Congress rejected this recommendation. Taft complained in 1912 that the “United States is the only great Nation whose Government is operating without a budget.”
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It may seem odd to many citizens a century later that the federal government rarely borrowed before it had a formal presidential budget submission, a distinct congressional budget, or any legal ceiling on total federal debt. Such was the power of the American Fiscal Tradition.

T
HE
N
EED FOR A
C
ENTRAL
B
ANK

The Panic of 1907 also highlighted the need for an institutionalized system of central banking. Some combination of the US Treasury, commercial banks, and, occasionally, Congress had exercised control over the money supply since 1790. Nineteenth-century politicians tended to blame downturns on various aspects of the banking system.

Classical economists of the nineteenth century thought that the supply of money played a relatively small role in the shaping of business cycles. They attributed market swings to the influence of “animal spirits,” notably greed and fear. Yet no one could dispute the fact that bank failures contracted credit and prolonged each of the nation’s two depressions, beginning in 1837 and 1893. Banks by their very nature were leveraged. As a result, bank failures during downturns caused credit to contract by more than simply the loss of equity in banks.

The Constitution gave Congress responsibility for the currency. As with the congressional power to authorize debt, the Constitution itself
provided no guidance about how that power should be exercised. Until the Civil War most commerce was conducted with bank notes and foreign coins. By the late nineteenth century, commercial transactions depended on entries in bank ledgers rather than “hand-to-hand” currency. Borrowers relied on bank credit. Since banks could make loans many times the value of their deposits held as reserves, any bank could be vulnerable to a run that jeopardized the security of deposits and availability of credit unless the bank could turn to some lender of last resort.

The federal government had long used its cash balances to bolster the reserves of the commercial banking system. Treasury Secretary Gallatin had shored up the reserves of a vulnerable bank in 1801, his first year in office. A subtreasury system—proposed by Van Buren and Calhoun and implemented by Treasury Secretary Walker during the Polk administration—institutionalized the Department of the Treasury’s role in performing some functions of a central bank. John Sherman used that power when he deliberately strengthened liquid bank reserves by exchanging gold for bank-held federal debt. Throughout the late nineteenth century and early twentieth century, the Treasury shifted its deposits to agricultural regions to support the capacity to make loans that came due after harvests. Roosevelt’s treasury secretaries, Leslie M. Shaw and George Cortelyou, aggressively used the Treasury Department’s control over federal deposits to strengthen reserves supporting bank credit. In fact, some reformers viewed a new central bank as a means of diffusing the treasury secretary’s enormous power over the entire banking system.

Private bankers themselves performed the functions of a central bank. Regional bank clearinghouses facilitated the daily clearing of drafts, or checks, as well as providing a means for clearinghouse members to boost their short-run liquidity. However, there was no formal mechanism for coordinating monetary actions across the regional clearinghouses.

Since 1790 national leaders had had difficulty balancing the roles of elected officials and private bankers in regulating the supply of money and credit. Placing this power exclusively with the president or his chosen treasury secretary could result in political abuse or the instability inherent in election cycles, while delegating this power to an association of private bankers could create conflicts of interest and lead to a concentration of power largely unaccountable to elected officials. Congress itself was a large and part-time legislative body that lacked the capacity and expertise to administer a central bank. The improvised response to the Panic of 1907
showed the benefits of having a “lender of last resort” that could call on the credit of the federal government and large pools of bank assets.

In 1908 Senator Aldrich—who was only the third chairman of the Senate Finance Committee in forty years, following Sherman and Morrill—decided to define the proper balance between federal and private control of central banking. No one was better prepared for the task than the Rhode Island Republican whom Taft admired for his “effectiveness, straightforwardness and clearheadedness.”
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Even those who disagreed with Aldrich respected his intelligence and candor. Powerful business tycoons, who treated most elected officials as supplicants, considered Aldrich a peer. The nation’s two most powerful businessmen, J. P. Morgan and John Rockefeller, detested each other, but both admired Aldrich. Aldrich vacationed with Morgan, and in 1901—at the year’s premier society wedding—the senator’s daughter Abby married Rockefeller’s sole heir.

The Aldrich-Vreeland Act of 1908 allowed banks to pool certain reserves to raise their capital, granted the Treasury additional authority to issue notes, and created the National Monetary Commission to recommend reforms. Aldrich chaired this commission and recruited an outstanding team of advisors to assist him. He spent months studying banking and meeting with European central bankers.

Other financial leaders of the era had also been studying the national banking system. Two respected New York bankers—Paul Warburg and Frank Vanderlip—criticized the lack of a US central bank with the power to call on bank reserves and public credit during a downturn. Vanderlip headed the City Bank of New York, which had underwritten the bond issue financing the Spanish-American War and served as the bank for Rockefeller interests. Warburg had moved to New York from Germany to manage his father-in-law’s Kuhn Loeb investment bank. Vanderlip and Warburg appreciated the long-standing political impediments to a central bank. For more than a century many Democrats had resisted a privately led central bank, while early-twentieth-century Republican congressmen often echoed the views of regional bankers who feared central control of their operations. Warburg proposed makeshift alternatives to a modern central bank in order to navigate around those perceived political barriers. Aldrich agreed with Warburg’s critique of the existing banking system but rejected his recommendations as being too “timid.” Aldrich bluntly told him, “You say that we cannot have a central bank, and I say we can.”
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In 1920 Warburg, Vanderlip, and other bankers traveled in secrecy, using assumed names, to meet with Aldrich at a remote resort on Jekyll Island off Georgia’s coast. There they fleshed out a plan for a National Reserve Association, which would consist of regional bank groups and a central governing board with the power to guide national interest rates. When leading bankers heard the details of that plan, they objected to the recommendation that the president be given the power to appoint the chairman of the national board. William Jennings Bryan, still a force to be reckoned with among rural Democrats, criticized the plan for giving bankers too large a role on the governing board. Perhaps Warburg had perceived the political hurdles better than Aldrich, who exited the Senate at the end of his term in 1910.

R
EFORMERS
T
RIUMPH

Voters gave reformers control of the federal government and the two major political parties in the pivotal election of 1912. The two leading candidates—Theodore Roosevelt and Woodrow Wilson—ran as progressive reformers. Along with socialist Eugene Debs, they received 77 percent of the popular vote.

The new mainstream political current that swept that election shaped the perspectives of a new generation of federal leaders. Some of them—including William McAdoo, Calvin Coolidge, John Nance Garner, Robert Doughton, Herbert Hoover, and Franklin Roosevelt—would make budget policy for decades. A younger group who came of age during the Progressive Era—like Robert Taft, Arthur Vandenberg, and Harry Truman—would set budget priorities until the early 1950s. They all believed in the limits on the use of debt embedded in the American Fiscal Tradition. Except for the traditional uses of debt during the Panic of 1893, the Spanish-American War, and the Panama Canal, the federal government had not borrowed during their lifetimes. The prevailing attitude of the era was expressed in 1888 by a young scholar, Woodrow Wilson: “Appropriation without accompanying taxation is as bad as taxation without representation.”
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William Gibbs McAdoo exuded the confidence of a businessman who had overcome setbacks and persevered until he succeeded. He emerged as a public figure in New York City by constructing two parallel subway tunnels that linked the city with New Jersey in 1908. Owners of other local rail lines had often shared the attitude of Cornelius Vanderbilt, famous for the maxim “The customer be damned.” McAdoo, however, trained
his employees to treat riders according to his company’s motto, “The customer is king.”

The restless and ambitious McAdoo undertook a new type of challenge when helping build the political career of Woodrow Wilson, a political scientist, historian, and president of nearby Princeton University. In a 1907 series of lectures on constitutional government in the United States, Wilson described the president’s power of leadership as anything that “he has the sagacity or force to make it.”
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Professor Wilson marveled at Roosevelt’s use of that power, though he personally preferred the older spirit of reform exemplified by former Democratic president Grover Cleveland. Wilson believed in a strong chief executive, but by 1908 Princeton University’s board—including Grover Cleveland—reined in Wilson’s authority as the school’s president. Wilson, like McAdoo, yearned to play on a larger stage.

McAdoo and Wilson had much in common. They were both Southerners who left small-town law practices to seek their fortunes in the Northeast, the nation’s financial and academic center. They were both tall, slender, courteous, well spoken, and disciplined. Though they rubbed shoulders with the nation’s wealthy business elite, they respected great deeds more than great fortunes. Each took pride in adapting traditional values to modern circumstances. Wilson had championed a more egalitarian culture at a college that had long been dominated by private clubs, while McAdoo implemented the novel practice of paying women the same wage as men for the same job.

New Jersey, the home of Wilson’s Princeton, was rapidly changing. During the nation’s largest wave of immigration, the state’s population swelled from 1.4 million in 1890 to 2.5 million in 1910.
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Urban bosses battled reformers within the state’s Democratic and Republican parties. A majority of New Jersey voters had supported Grover Cleveland in his three elections, but rejected the agrarian populism of William Jennings Bryan in all three of his presidential campaigns. New Jersey’s electoral votes could swing the outcome of a close presidential election.

National magazines and large newspaper chains often served as effective vehicles for mobilizing national opinion. McAdoo’s friend, publisher George Harvey, used
Harper’s Magazine
to promote a public career for Woodrow Wilson. New Jersey Democrats recruited Wilson to run for the governorship, a move that Wilson described to a friend as “the mere preliminary of a plan to nominate [him] in 1912 for the presidency.”
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A
Democratic landslide in 1910 gave Democrats control of the House of Representatives for the first time since 1892 and helped Wilson become governor of New Jersey.

The rising tide of reform had reached Capitol Hill even before the November 1910 midterm elections. That spring Democrats and progressive Republicans had limited the enormous power of Speaker Joseph Cannon. The House Ways and Means Committee was given responsibility for making committee assignments. This power, combined with the committee’s jurisdiction over all tax legislation, gave those who chaired the committee extraordinary influence on federal budgets for much of the twentieth century.

Roosevelt’s departure for a tour of Europe and an African safari created a political vacuum in the GOP after Taft entered the White House. Taft attempted to implement Roosevelt’s agenda without his predecessor’s characteristic sweeping rhetoric. When Roosevelt returned from abroad in June 1910, he was not impressed with Taft’s progress. In August 1910 Roosevelt returned to the public arena with a passionate speech promoting a “New Nationalism.” The senators who had led the charge on the income tax formed the National Progressive Republican Caucus.

Taft provoked Roosevelt’s anger in late 1911 by filing an antitrust action that claimed his predecessor had been duped into approving an antitrust violation. The former president, an amateur boxer, announced he would throw his hat “in the ring” for the next Republican presidential nomination. After the power of patronage allowed Taft to retain the Republican nomination, Roosevelt bolted from the GOP to head the ticket of the new Progressive Party.

Delegates to the 1912 Democratic National Convention in Baltimore arrived in high spirits after hearing of the GOP split. Many Democratic leaders, however, worried about their party’s own division between rural populists who still admired Bryan and urban voters represented by organizations such as New York’s Tammany Hall. House Speaker Champ Clark, who tried to keep Bryan at a distance, won most of the primaries against an amateurish Wilson campaign.