A History of Money and Banking in the United States: The Colonial Era to World War II Read online

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  A HISTORY OF MONEY AND BANKING IN THE UNITED STATES:

  THE COLONIAL ERA TO WORLD WAR II

  MURRAY N. ROTHBARD

  Cover art: Wall Street, 1886. Permission for use of this print is granted to the Ludwig von Mises Institute by Old World Prints, Ltd.

  Copyright © 2002 by the Ludwig von Mises Institute

  All rights reserved. Written permission must be secured from the publisher to use or reproduce any part of this book, except for brief quotations in critical reviews or articles. For information, write the Ludwig von Mises Institute, 518 West Magnolia Avenue, Auburn, Alabama 36849-5301; www.mises.org.

  ISBN: 978-0-945466-33-8

  CONTENTS

  Introduction

  Joseph T. Salerno

  PART 1

  The History of Money and Banking Before the Twentieth Century

  PART 2

  The Origins of the Federal Reserve

  PART 3

  From Hoover to Roosevelt: The Federal Reserve and the Financial Elites

  PART 4

  The Gold-Exchange Standard in the Interwar Years

  PART 5

  The New Deal and the International Money System

  Index

  INTRODUCTION

  In this volume, Murray Rothbard has given us a comprehensive history of money and banking in the United States, from colonial times to World War II, the first to explicitly use the interpretive framework of Austrian monetary theory. But even aside from the explicitly Austrian theoretical framework under-girding the historical narrative, this book does not “look” or “feel” like standard economic histories as they have been written during the past quarter of a century, under the influence of the positivistic “new economic history” or “cliometrics.” The focus of this latter approach to economic history, which today completely dominates this field of inquiry, is on the application of high-powered statistical methods to the analysis of quantitative economic data. What profoundly distinguishes Rothbard’s approach from the prevailing approach is his insistence upon treating economic quantities and processes as unique and complex historical events. Thus, he employs the laws of economic theory in conjunction with other relevant disciplines to trace each event back to the nonquantifiable values and goals of the particular actors involved. In Rothbard’s view, economic laws can be relied upon in interpreting these nonrepeatable historical events because the validity of these laws—or, better yet, their truth—can be established with certainty by praxeology, a science based on the universal experience of human action that is logically anterior to the experience of particular historical episodes.1 It is in this sense that it can be said that economic theory is an a priori science.

  In sharp contrast, the new economic historians view history as a laboratory in which economic theory is continually being tested. The economic quantities observed at different dates in history are treated like the homogeneous empirical data generated by a controlled and repeatable experiment. As such, they are used as evidence in statistical tests of hypotheses regarding the causes of a class of events, such as inflations or financial crises, that are observed to recur in history. The hypothesis that best fits the evidence is then tentatively accepted as providing a valid causal explanation of the class of events in question, pending future testing against new evidence that is constantly emerging out of the unfolding historical process.

  One of the pioneers of the new economic history, Douglass C. North, a Nobel Prize-winner in economics, describes its method in the following terms:

  It is impossible to analyze and explain the issues dealt with in economic history without developing initial hypotheses and testing them in the light of available evidence. The initial hypotheses come from the body of economic theory that has evolved in the past 200 years and is being continually tested and refined by empirical inquiry. The statistics provide the precise measurement and empirical evidence by which to test the theory. The limits of inquiry are dictated by the existence of appropriate theory and evidence.... The evidence is, ideally, statistical data that precisely define and measure the issues to be tested.2

  This endeavor of North and others to deliberately extend the positivist program to economic history immediately confronts two problems. First, as North emphasizes, this approach narrowly limits the kinds of questions that can be investigated in economic history. Those issues which do not readily lend themselves to formulation in quantitative terms or for which statistical data are not available tend to be downplayed or neglected altogether. Thus the new economic historians are more likely to seek answers to questions like: What was the net contribution of the railroad to the growth of real GNP in the United States? Or, what has been the effect of the creation of the Federal Reserve System on the stability of the price level and real output? They are much less likely to address in a meaningful way the questions of what motivated the huge government land grants for railroad rights-of-way or the passage of the Federal Reserve Act.

  In general, the question of “Cui bono?”—or “Who benefits?”—from changes in policies and institutions receives very little attention in the cliometric literature, because the evidence that one needs to answer it, bearing as it does on human motives, is essentially subjective and devoid of a measurable or even quantifiable dimension. This is not to deny th
at new economic historians have sought to explain the ex post aggregate distribution of income that results from a given change in the institutional framework or in the policy regime. What their method precludes them from doing is identifying the ex ante purposes as well as ideas about the most efficacious means of accomplishing these purposes that motivated the specific individuals who lobbied for or initiated the change that effected a new income distribution. However, avoiding such questions leaves the quantitative data themselves ultimately unexplained. The reason is that the institutions that contribute to their formation, such as the railroads or the Fed, are always the complex resultants of the purposive actions of particular individuals or groups of individuals aimed at achieving definite goals by the use of specific means. So the new economic history is not history in the traditional sense of an attempt to “understand” the human motives underlying the emergence of economic institutions and processes.

  The second and even more profound flaw in the new economic history is the relationship it posits between theory and history. For North, history is the source of the “empirical evidence”—that is, “ideally, statistical data”—against which the economic theory is tested. This means that the claim to validity of a particular theorem is always tentative and defeasible, resting as it does on its nonfalsification in previous empirical tests. However, this also means that economic history must be continually revised, because the very theory which is employed to identify the causal relations between historical events can always be falsified by new evidence coming to light in the ongoing historical process. In other words, what the new economic historians characterize as “the intimate relationship between measurement and theory” is in reality the vicious circle that ensnares all attempts to invoke positivist precepts in the interpretation of history.3 For if the theory used to interpret past events can always be invalidated by future events, then it is unclear whether theory is the explanans or the explanand in historical research.

  Rothbard’s approach to monetary history does not focus on measurement but on motives. Once the goals of the actors and their ideas about the appropriate means for achieving these goals have been established, economic theory, along with other sciences, is brought to bear to trace out the effects of these actions in producing the complex events and processes of history which are only partially and imperfectly captured in statistical data. This is not to say that Rothbard ignores the quantitative aspects of historical monetary processes. Indeed, his book abounds with money, price, and output data; but these data are always interpreted in terms of the motivations of those who have contributed to their formation. For Rothbard, a particular price datum is, no less than the Spanish-American War, a historical event, and its causes must be traced back to the subjective aims governing human plans and choices.

  In flatly rejecting the positivist approach to economic history, Rothbard adopts the method of historical research first formulated by Ludwig von Mises. In developing this method, Mises correctly delineated, for the first time, the relationship between theory and history. It is Rothbard’s great contribution in this volume—and his earlier America’s Great Depression—to be the first to consistently apply it to economic history.4 It is worth summarizing this method here for several reasons. First, Mises’s writings on the proper method of historical research have inexplicably been almost completely ignored up to the present, even by those who have adopted Mises’s praxeological approach in economics.5 Second, familiarity with Mises’s method of historical research illuminates the source and character of the remarkable distinctiveness of Rothbard’s historical writings. In particular, it serves to correct the common but mistaken impression that Rothbard’s historical writings, especially on the origin and development of the U.S. monetary system, are grounded in nothing more substantial than an idiosyncratic “conspiracy theory of history.” Third, it gives us an opportunity to elucidate the important elaboration of Mises’s method that Rothbard contributed and which he deploys to great effect in explicating the topic of this volume. And finally, we find in Mises’s method a definitive refutation of the positivist’s claim that it is impossible to acquire real knowledge of subjective phenomena like human motives and that, therefore, economic history must deal exclusively with observable and measurable phenomena.

  To begin with, Mises grounds his discussion of historical method on the insight that ideas are the primordial stuff of history. In his words:

  History is the record of human action. Human action is the conscious effort of man to substitute more satisfactory conditions for less satisfactory ones. Ideas determine what are to be considered more and less satisfactory conditions and what means are to be resorted to to alter them. Thus ideas are the main theme of the study of history.6

  This is not to say that all history should be intellectual history, but that ideas are the ultimate cause of all social phenomena, including and especially economic phenomena. As Mises puts it,

  The genuine history of mankind is the history of ideas. It is ideas that distinguish man from all other beings. Ideas engender social institutions, political changes, technological methods of production, and all that is called economic conditions.7

  Thus, for Mises, history

  establishes the fact that men, inspired by definite ideas, made definite judgments of value, chose definite ends, and resorted to definite means in order to attain the ends chosen, and it deals furthermore with the outcome of their actions, the state of affairs the action brought about.8

  Ideas—specifically those embodying the purposes and values that direct action—are not only the point of contact between history and economics, but differing attitudes toward them are precisely what distinguish the methods of the two disciplines. Both economics and history deal with individual choices of ends and the judgments of value underlying them. On the one hand, economic theory as a branch of praxeology takes these value judgments and choices as given data and restricts itself to logically inferring from them the laws governing the valuing and pricing of the means or “goods.” As such, economics does not inquire into the individual’s motivations in valuing and choosing specific ends. Hence, contrary to the positivist method, the truth of economic theorems is substantiated apart from and without reference to specific and concrete historical experience. They are the conclusions of logically valid deduction from universal experience of the fact that humans adopt means that they believe to be appropriate in attaining ends that they judge to be valuable.9

  The subject of history, on the other hand, “is action and the judgments of value directing action toward definite ends.”10 This means that for history, in contrast to economics, actions and value judgments are not ultimate “givens” but, in Mises’s words, “are the starting point of a specific mode of reflection, of the specific understanding of the historical sciences of human action.” Equipped with the method of “specific understanding,” the historian, “when faced with a value judgment and the resulting action... may try to understand how they originated in the mind of the actor.”11

  The difference between the methods of economics and history may be illustrated with the following example. The economist qua economist “explains” the Vietnam War-era inflation that began in the mid-1960s and culminated in the inflationary recession of 1973–1975 by identifying those actions of the Fed with respect to the money supply that initiated and sustained it.12 The historian, including the economic historian, however, must identify and then assign weights to all those factors that motivated the various members of the Fed’s Board of Governors (or of the Federal Open Market Committee) to adopt this course of action. These factors include: ideology; partisan politics; pressure exerted by the incumbent administration; the grasp of economic theory; the expressed and perceived desires of the Fed’s constituencies, including commercial bankers and bond dealers; the informal power and influence of the Fed chairman within the structure of governance; and so on.

  In short, the economic historian must supply the motives underlying the actions that
are relevant to explaining the historical event. And for this task, his only suitable tool is understanding. Thus, as Mises puts it,

  The scope of understanding is the mental grasp of phenomena which cannot be totally elucidated by logic, mathematics, praxeology, and the natural sciences to the extent that they cannot be cleared up by all these sciences.13

  To say that a full explanation of any historical event, including an economic one, requires that the method of specific understanding be applied is not to diminish the importance of pure economic theory in the study of history. Indeed, as Mises points out, economics

  provides in its field a consummate interpretation of past events recorded and a consummate anticipation of the effects to be expected from future actions of a definite kind. Neither this interpretation nor this anticipation tells anything about the actual content and quality of the actual individuals’ judgments of value. Both presuppose that the individuals are valuing and acting, but their theorems are independent of and unaffected by the particular characteristics of this valuing and acting.14

  For Mises, then, if the historian is to present a complete explanation of a particular event, he must bring to bear not only his “specific understanding” of the motives of action but the theorems of economic science as well as those of the other “aprioristic,” or nonexperimental, sciences, such as logic and mathematics. He must also utilize knowledge yielded by the natural sciences, including the applied sciences of technology and therapeutics.15 Familiarity with the teachings of all these disciplines is required in order to correctly identify the causal relevance of a particular action to a historical event, to trace out its specific consequences, and to evaluate its success from the point of view of the actor’s goals.

  For example, without knowledge of the economic theorem that, ceteris paribus, changes in the supply of money cause inverse changes in its purchasing power, a historian of the price inflation of the Vietnam War-era probably would ignore the Fed and its motives altogether. Perhaps, he is under the influence of the erroneous Galbraithian doctrine of administered prices with its implication of cost-push inflation.16 In this case, he might concentrate exclusively and irrelevantly on the motives of union leaders in demanding large wage increases and on the objectives of the “technostructure” of large business firms in acceding to these demands and deciding what part of the cost increase to pass on to consumers. Thus, according to Mises,