When Washington Shut Down Wall Street: the Great Financial Crisis Of

When Washington SHUT DOWN Wall Street:

The Great Financial Crisis of 1914 and the Origins of America’s Monetary Supremacy

By William L. Silber could demand the precious metal in exchange for the proceeds of their stock sales. The When Washington Shut Down Wall biggest gold outflow in a generation imper- Street (Princeton University Press, 2007) iled America’s ability to repay its debts unfolds like a mystery story. It describes how abroad. Fear that the United States would Treasury Secretary William G. McAdoo turned abandon the gold standard pushed the the financial crisis threatening America at the value of the dollar to unprecedented outbreak of the First World War into a monetary depths on world markets. triumph. It also provides a blueprint for crisis The European assault on American control that merits attention today. This excerpt finance brought danger and opportunity. summarizes McAdoo’s battle for American In 1914 the United States was a debtor financial credibility during four months in nation with a history of financial 1914, from the end of July through the middle crises. Failure to meet its foreign of November, and explains how this brief period obligations could sink American changed the course of U.S. monetary history. dreams of world monetary leader- ship. If it passed the test, however, The Background the United States could jump to the head of the class. The Great War threatened the United States Less than three weeks after with financial disaster. Europeans began to the outbreak of the European liquidate their Wall Street investments during conflict, Woodrow Wilson the last week of July 1914 and transfer gold to reviewed a roadmap for Europe to pay for the war. Foreign investors America’s march to world owned more than 20 percent of American financial supremacy. Henry railroad securities, the largest category of Lee Higginson, an invest- securities traded on the New York Stock ment banker in Boston, Exchange.1 Under the gold standard, they wrote to the president on

Financial History ~ Winter 200726 www.financialhistory.org response to the gold exports signaled an unprecedented problem. On July 30, McAdoo rushed tons of gold to Treasury offices around the country to trumpet America’s commitment to redeem dollars in the precious metal.5 The following day, July 31, 1914, McAdoo shut the New York Stock Exchange for an unprecedented four months to hamper British sales of American securities. The British could not drain American gold without the S I

B dollar proceeds from sales of U.S. stocks R

O and bonds. On August 3 he flooded C / n

n the country with paper currency to a m

t prevent a repetition of the bank runs t e B that had embarrassed America only a © Wall Street after the suspension of trading on the New York Stock Exchange, July 31, 1914. few years earlier, during the Panic of 1907.6 Banks avoided suspending their obligations in 1914 by offering August 20, 1914, that “England has central bank since 1836, after Andrew depositors the emergency currency been the exchange place of the Jackson scuttled the Second Bank of dispensed under McAdoo’s orders.7 world, because of living up to every the United States, resembled a head- William McAdoo knew, however, engagement, and because the power less financial giant. The Federal that these finger-in-the-dike measures grew with the business. Today we Reserve System, authorized by Con- could not remain in place forever. can take this place if we choose; but gress on December 23, 1913, remained Shutting the stock exchange immobi- courage, willingness to part with on the drawing board. It could have lized the capital market and unlimited what we don’t need at once, real been a classic power vacuum, espe- supplies of emergency currency character, and the living up to all cially with President Woodrow Wilson tempted inflation. McAdoo recog- our debts promptly will give us this distracted by his wife’s fatal illness. nized that he needed an exit strategy power; and nothing else will. I McAdoo seized the opportunity to to replace these powerful weapons repeat that it is our chance to take confront the panic. He tried to get the before they disrupted the economy. first place.”2 Federal Reserve System up and run- He understood that the gold drain Wilson sent Higginson’s letter to ning to combat the danger. Benjamin could be reversed by promoting Treasury Secretary William G. McAdoo Strong, governor-elect of the powerful American exports of agricultural with the following covering message: Federal Reserve Bank of New York goods to offset European sales of U.S. “Here is a letter which is no doubt and a leading figure during the forma- securities. On August 14, 1914, worth your reading whether you think tive years of the central bank, wanted McAdoo met with businessmen at the the suggestions are practicable or to protect the new currency system Treasury to arrange for “sufficient not.”3 McAdoo had, in fact, launched from the crisis. He blocked McAdoo’s ships to move our grain and cotton a plan to defend American financial push for an early opening of the Fed- crops to European markets.”8 The honor before he received Higginson’s eral Reserve Banks. The reversal set conference created the Bureau of letter from Wilson. the stage for McAdoo’s improvisa- War Risk Insurance which supported tional skills. Failure to respond the dollar’s redemption in the foreign The Crisis promptly would have spelled disaster. exchange market. McAdoo also sub- In 1914, most developed countries – The sale of dollars for pounds ster- sidized a rescue of New York City including Austria, Belgium, Britain, ling in the foreign exchange market, from the brink of bankruptcy. America’s France, Germany, Italy, Japan, and and the jump in the exchange rate to largest city had to repay maturing Spain – could rely on central banks to four cents above the gold export point debts in London denominated in fight their financial battles.4 Even Czar on July 27, 1914, provoked record British pounds. McAdoo’s assistance Nicholas II had the Imperial Bank of gold shipments to Europe. The failure introduced the ‘Too Big to Fail’ doc- Russia. The United States, without a of the price of sterling to decline in trine in American finance.9

www.financialhistory.org27 Financial History ~ Winter 2007 As 1914 drew to a close, the flood of emergency currency receded and the New York Stock Exchange reopened. McAdoo had tamed the crisis without inflicting collateral damage. The Battle for Financial Supremacy

Britain ruled world finance in 1914. Two characteristics–the pound sterling as international money and London as global money lender – qualified Britain for the world financial crown. The pound served as the currency of choice for international transactions, just as the dollar does today, and borrowers throughout the world visited London, rather than Wall Street, to raise capital. The war would force London, at least

temporarily, to stop supplying capital S I B abroad but, according to British econo- R O C mist John Maynard Keynes, it could / n n continue as king of international a m t t finance by insuring that sterling remained e B as good as gold. Britain signaled its © intention in August 1914 to continue Crowd gathers outside the offices of The New-York Tribune as the world’s financial superpower by after the suspension of trading on the New York Stock Exchange. following Keynes’ advice. Treasury Secretary McAdoo recog- mitment to the gold standard while the dollar’s discount disappeared on nized America’s opportunity to shine every other country of the world, save world markets, and four years to the by remaining true to gold, just like for Britain, abandoned it because of day before the Armistice, marks the the world’s monetary superpower. A the war. How important was the gold turning point in America’s battle for suspension of the gold standard in standard at the outbreak of the Great international financial leadership. In 1914 would have been a setback to War? Keynes said that London’s posi- January 1915 the New York capital American dreams of international tion as the world’s leading financial market replaced London as money financial leadership. The Panic of 1907 center would surely be jeopardized if lender to the world. Argentina, had already damaged U.S. credibility. Britain suspended gold payments. He Canada, and China, traditional British A panic in 1914 would have been the advised the British government that clients, visited Wall Street to raise cap- second act in an American financial “we should not repudiate our external ital.14 It would take more than decade tragedy. Alexander Noyes, the con- obligations to pay gold until it is to complete the transfer of financial temporary business editor of The New physically impossible for us to fulfill power, but a tectonic shift in monetary York Times, highlighted the drama them.”11 Keynes knew that capital supremacy had begun.15 when he said:10 “It is not too much to markets forgive a country that sus- say that as a matter of financial history, pends specie payments during wartime The Man behind the Victory: the United States stood during those as long as it resumes its obligation William G. McAdoo two or three weeks of August at the after the emergency has passed.12 But a William Gibbs McAdoo was born in parting of the ways.” Suspending the financial superpower must meet a Marietta, Georgia, in 1863. He moved gold standard would have relegated higher standard.13 to Knoxville, Tennessee in 1877, when the dollar to second class status. Sterling McAdoo’s boost to the dollar’s his father became a Professor of History would have remained the undisputed credibility helped America challenge and English at the University of Ten- money of choice for international finance. Britain as the financial capital of the nessee. McAdoo entered the University McAdoo maintained America’s com- world. November 11, 1914, the day of Tennessee in 1879 and joined the

Financial History ~ Winter 200728 www.financialhistory.org academic training, McAdoo mastered someone who is “swift to note and the details of every prospective ven- swift to move. He picks his course ture. At age 30, before launching a quickly, moves fast upon it and with plan to electrify the Knoxville Street great audacity...Instinctively he prefers Railroad, he learned how to calculate the bold and the decisive to the pru- electric power and how dynamos are dent and the tepid course…”20 set up. Despite McAdoo’s preparation, Not everyone has the courage to the venture failed and wiped out his act, even when they know what to do. life savings.18 Leadership matters. The 1970s wit- Ten years later, before he under- nessed the greatest peacetime inflation took to build a railroad line under in the United States. The Federal Reserve the Hudson River, he investigated an System had been in operation for S I

B abandoned tunnel dressed in rubber more than half a century when infla- R

O hip boots, yellow oilskins, and carry- tion spiraled out of control. Arthur C / n

n ing an oil lantern. This time Burns, a former Columbia University a m t

t McAdoo’s groundwork succeeded. economist and president of the National e B As president of the Hudson and Bureau of Economic Research, sat at © Portrait of U.S. Secretary Manhattan Railroad Company, he the helm of the Federal Reserve System of the Treasury William McAdoo. inaugurated passenger rail service for nearly the entire decade. He had between Manhattan and New Jersey been appointed Chairman of the Federal in 1908.19 After McAdoo became Reserve Board by President Richard debating society. The upper classmen Woodrow Wilson’s Treasury Secre- Nixon in 1970. Economists knew how saddled McAdoo, a freshman with “a tary in 1913, his practical bent to stem the inflation that threatened to chip on his shoulder,” with defending helped to avert the monetary crisis destroy American economic stability. the unpopular side of every issue.16 He that began with the outbreak of war According to Milton Friedman, the enjoyed the limelight and knew that he in the summer of 1914. problem was not lack of knowledge wanted to be a lawyer. His heart settled but, rather, lack of leadership.21 He on studying at the University of Virginia What 1914 Teaches said: “The explanation for [the Great in Charlottesville, the best law program about Leadership Inflation] is fundamentally political, in the country from where McAdoo sat. not economic…I believe that Arthur McAdoo succeeded in August 1914 That was before he discussed it with Burns deserves a lot of the blame, and because he did not hesitate to bludgeon his father, William G. McAdoo Sr. he deserves the blame because he the crisis with a sledgehammer. He During the Christmas holidays in knew better.”22 wielded powerful weapons—suspend- 1881 young Will McAdoo worked in The American financial system could ing stock trading for four months and the United States Circuit Court at have survived the summer of 1914 even flooding the country with emergency Knoxville. He was then offered a per- if McAdoo had done nothing. The gold currency — that could have injured manent job as deputy clerk in the U.S. drain would have disappeared as the America. His exit plan — stimulating Circuit Court at Chattanooga. His war forced Britain to America’s agricultural exports with the Bureau of father urged him to take the job “to doorstep for provisions. But the clarity War Risk Insurance— avoided lasting learn law from actual contact with the of hindsight ignores contingencies that damage to the economy. McAdoo could courts.”17 In May 1882 McAdoo left failed to materialize. Alexander Noyes, apply massive force because he had Knoxville for Chattanooga, one year in his retrospective a decade later, implemented a plan to restore normal shy of his college degree. He never got said:23 “It should not be forgotten that functions. Failure to include a strategy to Charlottesville. the financial outlook for the United for withdrawal either promotes toothless McAdoo was admitted to the bar in States seemed desperate, even to a great emergency weapons, like a placebo to Chattanooga but did not practice law part of the banking community, at the treat a serious disease, or imposes for very long. His father’s advice to time when maintenance of gold pay- unnecessary costs. study law by apprenticeship imprinted ments was agreed on…[I]t is impossible McAdoo brought more than a blue- a pragmatic gene deep inside his brain. to be sure that a decision in August print and sledgehammer to the crisis. It altered his life. 1914, to suspend gold payments, even Walter Lippmann, the political com- William McAdoo abandoned his with the purpose of subsequently mentator and nationally syndicated fledgling legal career for the business resuming them, would not have given columnist, described McAdoo as world. To overcome his abbreviated to at least our immediately subsequent

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Financial History ~ Winter 2007 29 www.financialhistory.org A History of Employer Pension Plans continued from page 33

Dr. Robert L. Clark is Professor of sylvania Press, 2003) provide a lively maintained pension plans for their pub- Economics and Professor of Manage- account of the interesting history of lic school teachers separately from state ment, Innovation, and Entrepreneurship these pensions, how they were funded, teachers’ plans. at North Carolina State University. He and the many problems of managing 7. The movement to create public sector has written numerous articles and books pension funds in the nineteen century. pension plans reflected the emergence on the development of employer-pro- 3. The delay in providing survivors pen- of a professional (i.e. non-patronage) vided pension plans and social security sions continued throughout the first civil service and the growth of the wel- in the United States and also in Japan. half of the nineteenth century. It was 56 fare state. Many in the Progressive Dr. Lee Craig is Alumni Distinguished years after the War of 1812, before sur- Movement envisioned “cradle-to- Professor of Economics at North Car- vivors of that war were given retire- grave” programs as the precursor of a olina State University. He writes on ment pensions. better society. Although the ultimate U.S. economic and business history. goal of this movement, universal old- 4. Clark, Craig, and Wilson ibid provided age pensions, would not be realized Notes a detailed history of the spread of pen- until the creation of the social security sions across states and local govern- 1. Today the term “pension” generally system during the Great Depression, ments. They show the unique methods refers to cash payments received after the the initial objective was to have the that many governments used to finance termination of one’s working years, typi- government supply old-age security to their pension plans. cally in the form of an annuity. Histori- its own workers. cally, a much wider range of retiree ben- 5. In contrast, municipal workers in Aus- 8. Robert Clark and Ann McDermed, efits, survivor’s annuities, and disability tria-Hungary, Belgium, France, Ger- (The Choice of Pension Plans in a benefits were also referred to as pensions. many, the Netherlands, Spain, Sweden, Changing Regulatory Environment, However, disability was often liberally and the United Kingdom were covered Washington, DC: The AEI Press, 1990) defined and included superannuation or by retirement plans by 1910. document these changes. Other factors the inability to perform regular duties 6. Only one did not have a plan for police influencing the changing nature of pen- due to infirmities associated with old age. officers, and only one did not have a sions include shifts in the industrial 2. Robert Clark, Lee Craig, and Jack Wil- plan for firefighters. Several of those structure of the economy, a more son, (A History of Public Sector Pen- cities also had plans for their other mobile work force, and a decline in full sions, Philadelphia, University of Penn- municipal employees, and some cities career jobs.

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financial history a very different turn Collected Writings of John Maynard Papers of Woodrow Wilson, (edited by from that which it actually took.” Keynes, Volume XVI, Activities 1914- Arthur S. Link), Princeton University McAdoo’s imprint – decisive leader- 1919, (edited by Elizabeth Johnson), Press, Princeton, NJ, 1991. ship combined with a roadmap for crisis Macmillan, London, 1971. Silber, William L. When Washington Shut control – turned a potential financial Lewis, Cleona, America’s Stake in Interna- Down Wall Street: The Great Financial disaster into a monetary triumph. FH tional Investments, The Brookings Crisis of 1914 and the Origins of Amer- ica’s Monetary Supremacy Sources Institution, Washington, DC, 1938. , Princeton Uni- Lippmann, Walter, Men of Destiny, versity Press, Princeton, NJ, 2007. Bagehot, Walter, Lombard Street: A University of Washington Press, Taylor, John B. “A Half Century of Changes Description of the Money Market, J. Seattle, 1927. in Monetary Policy,” available at Wiley & Sons, New York, 1873, 1999. McAdoo, William G., Crowded Years, www.treas.gov/press/releases/docs/ Bordo, Michael, and Hugh Rockoff, “The Houghton Mifflin Company, 1931. fried.pdf, November 8, 2002. Gold Standard as a ‘Good Housekeeping Noyes, Alexander D., The War Period of Seal of Approval,’” Journal of Economic Notes American Finance, G.P. Putnam’s Sons, History, June 1996. New York, 1926. 1. C. Lewis 1938, p. 533, reports an esti- Conant, Charles A., History of Modern mate of $4.1 billion in railroad securities Papers of William G. McAdoo, Banks of Issue, G.P. Putnam and Sons, held by foreigners as of June 30,1914. Unpublished, Library of Congress, New York, Fifth Edition, 1915. The Historical Statistics of the United Washington, DC. continued on page 37

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