PART II: A Monetary Coup d'etat

Henry C K Liu

See also PART 1: Ruthless empire builders

The nature of money has been a controversial issue since the founding of the United States. The founding fathers recognized that the people's power to issue money was fundamental to the functioning of democracy, while the Federalists led by Alexander Hamilton advocated the need of a national bank controlled by the moneyed elite to support the development of the newborn nation's economy. Unlike Thomas Jefferson, who wanted to create a new, revolutionary democratic nation, Hamilton wanted to build a powerful new nation that would rival Britain, its former oppressor. Hamilton turned the American Revolution from a struggle to form a new democratic society as envisaged by Jefferson toward an oligarchic secession from Britain. Yet Hamilton's national bank was partially state-owned, quite unlike the Federal Reserve System, which is wholly owned by private banks that have usurped the people's sovereign power to create money.

The first national bank, modeled after the Bank of England, which had been instrumental in the emergence of the British Empire, was established by Federalists as part of a nation-building system proposed by Alexander Hamilton, the first secretary of the US Treasury, who realized that the new nation could not grow and prosper in a competitive world without the full application of sovereign credit with a sound financial system mediated through a national bank chartered, partially owned and fully controlled by the central government. The first national bank in the US was the Bank of the United States (BUS), which was founded in 1791 and operated for 20 years, until 1811. A second Bank of the United States (BUS2) was founded in 1816 and operated also for 20 years until 1836.

The national-bank charter was approved by Congress and signed into law by president George Washington in 1791 when the federal government of the new nation was only three years old. The new Bank of the United States was to handle the finances of the federal government. It held the government's funds and dispensed sovereign credit through the issuing of notes that would circulate as legal tender. The national bank was to maintain an adequate supply of stable money and extend sovereign credit to support an industrial policy to promote national economic expansion without having to succumb to foreign, mostly British, financial domination.

To understand the thinking behind Hamilton's proposal for a national bank, it is necessary to remember that the Treasury was restricted by law to limit its issuance of money to the coinage of gold and silver, and not to print paper money. According to the Quantity Theory of Money, specie (gold- or silver-backed) money was the only reliable currency, though it could be supplemented by banknotes fully and freely redeemable for gold or silver. Thus sovereign credit was limited by the amount of gold held by the Treasury and a national bank was needed to create money through partial reserve. Congress granted a 20-year charter for the BUS despite arguments by Jefferson that the constitution did not give Congress power to establish a national bank and the charge that the national bank was designed to favor mercantile interests over agrarian interests, and the rich over the common man, in the name of national interest. Jefferson believed that the path to a strong nation was through the cultivation of a strong citizenry of independent wealth, not a strong central government led by a financial elite who would control the nation's money supply for narrow sectional and class benefits at the expense of the general population.

The federal government subscribed one-fifth of the US$10 million capital of the BUS, with a loan of $2 million immediately advanced from the BUS to the government, with the remaining $8 million subscribed by private investors. The BUS acted as the exclusive fiscal agent for the government and also conducted commercial banking business. Despite being well managed and financially profitable, the BUS antagonized state-chartered banks and western frontier and southern agrarian interests, which formed a coalition that successfully blocked its rechartering in 1811.

Jefferson's opposition to the establishment of a national bank was the focus of his overall opposition to the entire Hamiltonian program of strong central government and elite financial leadership. Jefferson felt that a national bank would give a small group of elite private investors, mostly from the New England states, excessive power over the national economy with unfair opportunities for large certain profits. The constitutionality of the bank invoked the dispute between Jefferson's "strict construction" of the words of the constitution and Hamilton's doctrine of "implied power" of the federal government.

Throughout the history of the United States, up to the present time, this dispute, along with the controversy between specie money and fiat money, remains philosophically unresolved, although in practice both the constitutionality of the "implied power" doctrine and the legality of fiat currency have been repeatedly upheld by the US Supreme Court. Jefferson considered the whole Hamiltonian banking scheme an unconstitutional threat to the basic fabric of American civilization. Jefferson prophesied: "If the American people allow the banks to control the issuance of their currency, first by inflation, and then by deflation, the banks and corporations that will grow up around them will deprive people of all property until their children will wake up homeless on the continent their fathers occupied ... The issuing power of money should be taken from the banks and restored to Congress and the people to whom it belongs." It was a definitive statement against the political "independence" of central banks. This warning applies to the people of the world in the 21st century as well. All over the world, central banking has usurped the power of the people to issue money as legal tender and made money an instrument to serve those who already have it in excess at the expense of those who have not enough. The British saying "the rich get richer and the poor get children" has been transformed in the US as "the rich get richer and the poor can't afford children". A national bank is at least an instrument of economic nationalism; an international central banking regime is an instrument of the international financial elite for the perpetuation of poverty for the majority of the world's population as a natural law of finance, robbing them of their natural power to issue sovereign credit for their own development. Thenceforth, being creative and hard-working is insufficient for fulfilling one economic potential: one also needs capital, which can only be acquired from those who have excess money or those who exercise control on the issuance of money.

Andrew Jackson as Democratic president (1829-37), in advocating what came to be known as Jacksonian democracy, was also vehemently opposed to the idea of a national bank as a citadel of privilege and monopoly against the common man. Jackson maintained that a national bank was a threat to democratic institutions. BUS2, under Nicholas Biddle, a member of the financial elite from Philadelphia, sought political support by lending large sums to congressmen and newspaper editors without proper collateral and not pressing them for repayment. Roger Taney, Jackson's Treasury secretary, carried out the president's order to withdraw federal deposits from BUS2 beginning in September 1833 to a number of state-chartered banks in the west that, free of BUS2 supervision and buoyant by federal deposits, pushed the US economy quickly into a debt bubble, much of it unfortunately centering on speculation on the sale price of public land rather than infrastructure development. The boom produced a sudden increase of government revenue and, in 1835, for the first and last time in history, the US paid off its national debt completely, with a mounting surplus in the Treasury. In 1836, Congress passed a bill to distribute the surplus to the states. Far from being an economic blessing, this development turned out to be an economic disaster because it had the effect of shrinking the nation's money supply. Alan Greenspan's recent warning about US deficits is misplaced. A balanced budget or a fiscal surplus was the last thing the US's expanding economy needed at the time of Jackson, or ever. The problem with the fiscal deficit was not that it existed, but that the funds were spent on the land speculation that did not contribute to full employment and real economic growth. Today, the problem with the US fiscal deficit is that it is spent mostly on war, homeland security and interest payments, rather than on constructive projects such as infrastructure and education that will lead to further growth.

The fall in money supply led to a market crash in early 1837, precipitated by the Treasury secretary's issuance of the Specie Circular, requiring payment for public land sale be made only in gold or silver, not even partially gold-backed banknotes. The resultant depression lasted throughout Democrat Martin Van Buren's administration (1837-41), but despite consistent adherence to Jeffersonian and Jacksonian democratic principles, the new president's commitment to strict constitutional construction prevented him from taking any countercyclical federal action toward economic recovery. Van Buren's main focus was putting government's finances on a sound footing. The widespread failure of state-chartered banks highlighted the danger of trusting private banks with government funds. Van Buren decided thenceforth to separate government finance from private banking. The government would keep its money in an Independent Treasury, with "vaults" constructed in major cities where government officials would receive and pay out funds on a strict specie basis.

All the robber barons of this era were members of the new Republican Party, which throughout history has represented big business and finance. The party was founded before the Civil War as a result of a spontaneous outpouring of public anger after passage of the Kansas-Nebraska Act of 1854. The Great Plains area west of Missouri and Iowa had become a refuge for native Americans pushed earlier off their land in the east, but white settlers soon realized that these vast expanses of open land offered new opportunities for farming and ranching. The native Americans were again forced to give way to white encroachment. By 1854, the administrative organization of the vast Platte and Kansas River countries west of Iowa and Missouri was overdue. As a free-standing issue, territorial organization of this area presented no controversy. It was, however, irrevocably bound to the bitter sectional controversy over the extension of slavery into the new territories and was further complicated by conflict over the location of the projected transcontinental railroad.

Working on the railroad
In 1845, Asa Whitney presented to Congress a plan for federal government subsidy of the building of a railroad from the Mississippi River to the Pacific coast. The settlement of the Oregon boundary in 1846, the acquisition of western territories from Mexico in 1848, and the discovery of gold in California in 1849 increased support for the project. In 1853, Congress appropriated funds to survey proposed routes. Rivalry over the route was intense. When Illinois senator Stephen Douglas introduced in 1854 his Kansas-Nebraska Act intended to win approval for a line from Chicago, the ensuing sectional controversy between north and south forced a delay in the plans. During the Civil War, a Republican-controlled Congress enacted legislation on July 1, 1862, providing for construction of a transcontinental line, to be built by two companies, each receiving federal land grants of 10 alternate sections per mile (a section is an area nominally one mile square, containing 640 acres, or 259 hectares) on both sides of the line (the amount was doubled in 1864) and a 30-year government loan for each mile of track constructed. The transcontinental railroad system was in essence financed by sovereign credit granted to private companies. The transcontinental railroads, despite brazen fraud, immeasurably aided the settling of the west and hastened the closing of the frontier. They also brought rapid economic growth as mining, farming, and cattle-ranging developed along the main lines and their branches.

In 1863, the Union Pacific Railroad began construction from Omaha, Nebraska, while the Central Pacific broke ground at Sacramento, California. The two lines met at Promontory Point, Utah, and on May 10, 1869, a golden spike joined the two railways, thus completing the first transcontinental rail link. Other lines followed. Three additional lines were finished in 1883: the Northern Pacific Railroad stretched from Lake Superior to Portland, Oregon; the Santa Fe extended from Atchison, Kansas, to Los Angeles; and the Southern Pacific connected Los Angeles with New Orleans. A fifth line, the Great Northern, was completed in 1893. Each of those companies received extensive grants of land, although none obtained government loans as the rising value of land grants was providing adequate collateral to attract private capital. The profit incentive from land speculation often led to shoddy rail construction merely to qualify for land grants. Unsavory profiteering on a large scale became widespread. In 1872, the Credit Mobilier of America scandal was unearthed, exposing a short-lived holding company to which most of the Union Pacific's liquid assets had been transferred in 1867. The fraud, combined with mismanagement and cost overruns, left the Union Pacific with unmanageable debt, and in 1893 the company went into receivership.

The rise of Rockefeller
In 1868, John D Rockefeller struck a major deal with a railroad, guaranteeing a certain volume of shipments in exchange for rebates. The first of many, this deal was made with Jay Gould, owner of the Erie Railroad. The financial importance of controlling railroads was highlighted by the meteoric success of Rockefeller, who in 1871 struck secret deals with the oil-transporting railroads to not only give him rebates on the oil he shipped but also to pay him drawbacks on shipments by rival oil refineries. The refineries that were driven into bankruptcy and the oil drillers who were forced to accept whatever distressed price Rockefeller offered described him as a ruthless monster, although the methods Rockefeller used were common practice at the time. All the victims would not have hesitated to do what they denounced Rockefeller for doing if they had the foresight and discipline to do it. Rockefeller nevertheless became the lightning rod for the scandal surrounding the South Improvement Co scheme, a secret alliance between major refiners of which Rockefeller was one of several and the railroads. By March 1872, the 33-year-old Rockefeller had used this special relationship with the railroads and iniquitous financial tactics to take over 22 of the 26 refineries in Cleveland. Known as the Cleveland Massacre, this was the first step in his rise to unprecedented industrial supremacy.

Rockefeller created the original "trust" and after the state of Ohio outlawed the trust corporate structure, he engineered a change in New Jersey laws and moved to New Jersey in 1889 to form a giant holding company by the name of Standard Oil of New Jersey. Standard Oil employed a number of cutthroat business practices, including monopolization, buying up all the components needed for the manufacture of oil barrels in order to deny competitors the means of getting their oil to the market; waging rate wars by cutting the price of oil temporarily to force smaller competitors who could not sustain the short-term losses out of business; insisting on rebates on public rates offered by the railroads; and using intimidation by dispatching thugs to break up competitors' operations that could not otherwise be controlled. Often, Rockefeller did not personally partake in unethical conducts. His style was merely to lay down a corporate objective and leave it to his zealously aggressive managers to achieve the result by whatever means. Thus by focusing on the positive vision while isolating himself from the dirty tasks needed to achieve that vision, Rockefeller was able to believe honestly that he did no wrong and created much good. It's the "breaking eggs to make omelet" argument. The holding company expanded beyond oil by acquiring, with oil profits, ownership of railroads, iron and copper mines, public utilities, shipping, communication and real estate.

In Rockefeller's eyes, the state of the oil business was chaotic and wasteful. Because entry costs were low in both oil drilling and oil refining, the market was glutted with crude oil due to overcapacity accompanied with high levels of waste and redundancy. In his view, free competition worked only at the infancy of an industry when a dominant firm had not emerged. Free competition ceased to work well as soon as a few very large, efficient firms emerged amid many medium and small inefficient firms. His view was that the financially weak and badly managed firms, or evenly well-managed small firms that were structurally inefficient due to their small size, in their desperate attempts to survive drove prices down below production costs, hurting not only themselves but even the well-managed and well-capitalized large firms such as his own. This is an insight that is still applicable to globalized trade today in the so-called race-to-the-bottom effect.

Rockefeller's solution was an oligarchic-controlled market with a few large, vertically integrated firms to bring order into the growing industry. This was a pattern into which other industrial sectors eventually also evolved. This pattern of consolidation launched the US economy as a world power. The success of the industrial nationalization programs in the early history of the Soviet Union was modeled after the Rockefeller scheme of central planning and control, with the exception of state ownership replacing private ownership. Similarly, the economic miracle of the Third Reich was modeled after the Rockefeller vision of orderly markets with no wasteful competition and redundancy. Notwithstanding the neo-liberal myth of the linkage between free competition and growth, the American system was built by monopolies. Even today, with a century of antitrust efforts, every industry in the US is dominated by two or three major players who manage to fix prices and wages without the need of direct collusion, with a spattering of inconsequential minor companies tolerated for appearance' sake.

Trust and antitrust
Antitrust regulations are supposed to be the answer to capitalism's natural tendency toward monopolies. They are necessary for the preservation of a truly free market and for the maintenance of meaningful competition, the raison d'etre of market capitalism.

Free markets cannot exist when there is gross inequality among market participants in size and finance strength. Yet as the US became financially, economically and intellectually strong, it began to adopt excessively tolerant postures toward monopolies. It has become the leading global defender of intellectual property rights, which is in essence the protection of a knowledge monopoly, while it goes around the world promoting free competition by small private local companies and denouncing large state-owned enterprises.

The argument that protection of intellectual property rights is indispensable for economic growth has no basis in history. The socio-economic and political history of the US was shaped by the widespread piracy of a simple pattern held by Eli Whitney (1765-1825) on the cotton gin, the widespread use of which had immense socio-economic and political effects. Little cotton had been produced in America prior to 1793. During the colonial period, the main crop was tobacco, but tobacco farming had ceased to be profitable as a result of soil exhaustion. The tedious process of separating short cotton fiber from the seeds had to be done by hand and took too much time to be profitable. A few planters grew a long-staple strain called Sea Island cotton that was easier to separate, but this only grows in coastal areas, not inland, where only short-staple cotton can be grown. Whitney's cotton gin made it possible to grow short-staple cotton inland for profit. The cotton kingdom then stretched quickly over a vast area from Georgia and South Carolina westward as far as Texas. With the growth of the British textile industry, cotton growers in the US were assured of a market for all they could produce. But cotton growing was labor-intensive, which perpetuated the south's slavery economy, which until the arrival of the cotton gin was fading as an economic institution because of a dwindling need for cheap labor. Cotton, unlike rice and sugar, was a more democratic crop, being equally profitable for large landowners with hundreds of slaves and for small farmers with a couple of hundred acres and two or three slaves. Right up to the Civil War, half of the cotton was grown by small farmers with fewer than six slaves each. The widespread piracy of the cotton gin pattern created a socio-economic condition that became one of the causes of the Civil War.

In recent years, the US judiciary and some highly placed US government economists have been claiming that in the knowledge-based economy, antitrust laws may threaten economic liberty, turning antitrust on its head. The Appeals Court's decision (District of Columbia circuit) on Microsoft in July 2001 raised the issue with timely urgency. The justices acknowledged that tying browsers (Internet Explorer) or other add-on programs to computer operating systems (DOS-based Windows) may not be bad for economic freedom. The court, while upholding a lower court's finding that Microsoft had engaged in unlawful monopolistic acts, said broadly that it is unclear how the "current monopolization doctrine should be amended to account for competition in technologically dynamic markets". And given these conditions of uncertainty, courts must demand "considerable experience with certain business relationships", such as software packages that bundle services together, before jumping to the conclusion that they are unlawful. The court said that in the future, all cases of tying involving platform software (upon which other computer programmers build) should be judged by a higher standard of proof.

Existing antitrust law requires only the "per se" test, which merely requires proof of the existence of a tie involving a dominant producer. But the court now says that platform-software cases must be judged by the "rule of reason", which requires courts to balance the pro-competitive aspects of the tie against the anti-competitive ones. The new standard will almost certainly make it harder for government regulators to prove illegal tying in platform-software cases. This may make it easier for software firms to defend themselves when they bundle services together and offer them as one product. Thus whichever firm manages to establish an "industry standard" in one module can force the market to accept its bundling in a clearly anti-competitive manner.

The court defended its deliberate indecisiveness at least partly on the grounds that no one else had yet decided how the monopolization doctrines of the old economy should apply to the new. It feared that a ban on bundling, unless carefully considered, might "stunt valuable innovation". And in general, the court noted, "we decide this case against a backdrop of significant debate among academics and practitioners over the extent to which 'old economy' monopolization doctrines should apply to firms competing in dynamic technological markets characterized by network effects".

While the market has decidedly punctured the myth of the new economy being exempt from laws of financial gravity, the court appears to be still a willing victim of self-delusion. Microsoft's operating system, the cumbersome and memory-gluttonous DOS, aside being a long way from the most innovative, became the industry standard by its dubious grafting on to Windows, which was not an original Microsoft innovation but somehow became Microsoft's legal intellectual property. Moreover, the fee charged by Microsoft for Windows is outrageously excessive compared with typical pattern fees. Microsoft does not merely demand a copyright fee for the use of its pattern, it forbids others from manufacturing Windows, which must be bought from Microsoft as a product, additional copies of which Microsoft can produce with no significant additional cost.

In some markets, customers might in fact want one company to dominate because if it does, it will set a standard everyone can follow and that will make the product more valuable to all. The court's difficulty was that no one knew how to apply antitrust principles to such markets. But an industry-standard operating system for computers is very similar to an industry-standard gauge of railways. Should the company that adopted a gauge that became the industry standard be permitted to prevent other firms from manufacturing rolling stock of the gauge without paying the company a fee?

The court cited the overused example of the traditional telephone system. The more people who subscribe to it, the more calls all consumers may make or receive. Each individual phone user thus benefits from the network in proportion to the number of other people who use it. Once a product like that, or a standard, achieves such wide acceptance, consumers definitely want the supplier of that product to be bigger rather than smaller. Under those circumstances, antitrust laws should intervene only cautiously, to avoid making matters worse for the consumer. But this is a confused argument. The issue is not that industry standards are themselves anti-competitive. The issue is that a single firm's ownership of industry standards is anti-competitive. The law should recognize that the benefits of being an industry standard must be balanced by responsibilities and obligations to the industry and the community at large.

For example, English has become the international language of finance. Should all bankers pay a fee to the queen of England? Industry standards imply socialization. It is a very sound principle that if a standard is adopted industry-wide, that standard is owned by all users and must be freely available to all. Microsoft can bundle all it wants to serve the public better, but it should then make Windows free to all users and charge only for its new add-ons to compete with those offered by other firms.

The court concluded, amazingly, that in the end the goal of US competition law is not to promote competition for its own sake but to promote efficiency. This is a very peculiar attitude for an US court, for the whole US argument against monopolistic planned economy is its alleged inefficiency. Larry Summers, former US Treasury secretary and now president of Harvard University, when he spoke to antitrust lawyers at a 2001 meeting of the American Bar Association was at pain to stress the point that monopolies may be good. "First, do no harm," he advised, borrowing from the Hippocratic Oath. Where the need for common standards naturally leads to monopoly power, he argued, antitrust enforcement actions may divide those markets in ways that will harm efficiency and the consumer. "We shouldn't jump too quickly to the conclusion that because something increases competition it is necessarily good," he said. But that is a socialist argument against a competitive society versus a cooperative society. Funny, he did not say anything against the deregulation of airlines and energy. "The nature of competition is going to shift in the knowledge-based economy. The real question is whether there will be an enduring monopoly in something that is inferior," he said, adding that the history of the software market made that seem unlikely. Unlikely? The DOS-based Windows software is universally considered by programmers a grossly inferior product; the only advantage in using it is that it is an industry standard.

The only time a monopoly is good for the consuming public is when the entire industry has become uneconomic by deregulation, such the rail industry. Unfortunately, this is becoming commonplace in energy, air transportation, health services, telecommunications and the entire new economy. There is no data to support the contention that Microsoft bundling has been good for consumers. It has been good only for Microsoft.

The rise of Standard Oil
The race to the bottom characteristic of world trade today is very similar to the infancy of the oil industry in the 1850s. Thus the neo-liberal ideological mantra of free competition and the antitrust regime being the indispensable conditions for growth has no basis in historical fact. Chaotic markets are directly responsible for the excess capacity and waste that plague the globalized economy of today. Those who promote privatization and balkanization of state-owned enterprises in former socialist economies have much to learn from Rockefeller.

During 1871 Rockefeller formulated his plan for consolidating all oil-refining firms into one great organization, with the aim of eliminating excess capacity and price-cutting. All the major Cleveland banks joined the Standard Oil organization in 1871 and later backed Rockefeller and his partners unconditionally in their rapid expansion. Rockefeller was clear-headed in his vision, took no undue risks and was cautious and methodological in his implementation. He understood the systemic benefits of a controlled market. One only needs to look at the disastrous results of deregulation on first the railroads and then the airlines to appreciate the destructiveness of chaotic competition.

The South Improvement Scheme of 1871 interrupted Rockefeller's careful planning. Tom Scott of the Pennsylvania Railroad came up with the scheme, which was inspired by the Anthracite Railroad combination of 1868-71 in which five railroads and two coal companies bought up all the coal pits along the five railroads in order to control output and prices. The South Improvement Co had been created by the Pennsylvania legislature in 1870 and its charter allowed the company to hold the stocks of other companies outside the state. This was an unusual power at the time and made it ideal for Scott's scheme. Scott arranged for the purchase of the charter by a group of Philadelphia and Pittsburgh refiners with Scott in the background.

The scheme was in essence a plan to unite the oil-carrying railroads in a pool; to unite the refiners in an association, the South Improvement Co; and to tie the two elements together by agreements that would stop "destructive" price-cutting and restore railroad freight charges to a profitable level.

To enforce the cooperation of refiners, a set of rebates was agreed to for participating refiners. This alone would have undoubtedly forced all the refiners into the combine, but the scheme did not stop there. In what turned out to be a public relations disaster, the participants decided to add a drawback on every barrel shipped by any non-participant equal to the ordinary rebate. In effect, this would be a tax on non-participants, the proceeds of which would be transferred to the participating oil refiners.

The scheme neglected to include the producers. Despite efforts to reassure the drillers in the Oil Regions that the scheme would benefit them as well by keeping prices up, the Oil Regions revolted and organized an effective boycott of all the refiners and railroads they suspected of being part of the scheme. Consequently, the scheme collapsed in 1872 before it was ever implemented.

Subsequent historians repeated the view of many at the time that Rockefeller had been one of the originators of the South Improvement Scheme. In fact he had not been, but he did agree to participate and worked hard to set up the scheme. Rockefeller's most important error of his career was not to go public at the time with his side of the story. This was the first time that a broad public became aware of Rockefeller, and the episode was forever to tarnish his reputation. He said of it later, "Our silence encouraged the wildest romancers to spread wild tales about us"; and on another occasion, "I shall never cease to regret that at that time we never called in the reporters." The fact was that Rockefeller would have succeeded with his plan to consolidate the oil-refinery industry even without the drawbacks.

In December 1871, during the uproar over the South Improvement Scheme, Rockefeller set in motion its plan to consolidate the industry. He began by buying up all his competitors in Cleveland. He was not the author of the South Improvement Scheme, merely a participant. The strategy and tactics used by Rockefeller were based on the South Improvement Scheme and he handled the negotiations with the rival refiners personally. He began with the strongest refineries first. He believed that if he bought up the weak refineries first, he would be faced with higher prices later and stiffer resistance. Consequently, he approached the strongest first and bought them out.

His technique was always the same. The merger would be effected by an increase in the capitalization of the Standard Oil Co. The rival refinery would be appraised and the owners would be given Standard Oil stock in proportion to the value of their property and goodwill and they would be made partners in Standard Oil. The more talented owners would also be brought into Standard Oil management. If they insisted upon cash, they would receive it without question.

Later some owners who had been bought out complained to the press that they had been treated unfairly. The evidence is overwhelming that Standard's rivals were paid fair - even generous - prices for their property and if they had the wisdom to take Standard Oil stock, they ended up very rich indeed.

By March-April 1872, Rockefeller had bought up and/or merged with almost all the refineries in Cleveland. The inefficient and poorly constructed refineries were dismantled, while the better-quality ones were upgraded to Rockefeller's standards. After the consolidation of Cleveland, Standard inexorably expanded. All the transactions were kept secret. Standard Oil was so successful in this secrecy at times that many rival independent refiners were totally unaware of what was going on.

On September 18, 1873, known as Black Thursday, the stock-exchange crash set off a depression that lasted six years. Standard Oil took advantage of the economic downturn to absorb refineries in Pittsburgh, Philadelphia, New York, and Pennsylvania's Oil Region. In 1874, Standard Oil made a deal with Jay Gould's Erie Railroad and gained control of important terminal facilities in New York Harbor in exchange for shipping half of Standard's oil on the Erie. Standard Oil expanded into the Oil Regions, gaining control of the Imperial Refinery near Oil City and bringing J J Vandergrift into the Standard management. Two large refineries in Titusville joined Standard and John Archbold, later the president of Standard Oil, was brought into the management. Standard Oil expanded into Pittsburgh by merging Warden, Frew & Co and Lockhart, Frew & Co, thereby acquiring half the refining capacity of Pittsburgh, and expanded into Philadelphia by buying the largest refinery. In 1875, Standard Oil bought more pipelines and firms in the oil-buying business and merged them all into the United Pipe Lines in 1877. Rockefeller negotiated an agreement with the railroads: Pennsylvania 51% of Standard Oil shipments; Erie 20%; NY Central 20%; and B&O 9%, and obtained rebates from all the railroads for being an "evener", that is, Standard Oil was charged with making certain that the railroads all got their "fair" share.

In 1877, Standard Oil bought the Columbia Conduit Co of Pennsylvania and gained control of its pipelines and refineries. The Columbia Conduit Co had tried to bypass the Penn Railroad by building a pipeline from the Oil Regions down to the new B&O railroad line near Pittsburgh. The Penn Railroad used armed guards to prevent them from laying a pipeline under its right-of-way north of Pittsburgh. Standard gained control of most of the property of the Empire Transportation Co - a subsidiary of the Penn Railroad that had its own fleet of tank cars, pipelines, lake steamers, and terminals in New York Harbor. Empire had briefly threatened Standard Oil but Rockefeller built 600 new tank cars, cut prices, and canceled all his shipments over the Penn Railroad. The Penn Railroad capitulated and sold Rockefeller Empire's assets.

By 1879 Standard Oil did about 90% of the refining in the United States, with almost 70% being exported overseas. "Oil for the lamps of China" was a Standard Oil slogan. The business had become so large and so complex that Rockefeller, at age 40, only dealt with the major problems and the larger outlines of his affairs.

The bankrupt Union Pacific Railroad came under the management of Edward H Harriman in 1897. Harriman (1848-1909) at various times controlled the Illinois Central, Union Pacific, and Southern Pacific railroads. He lost a fight with James Hill (1838-1916), who promoted the Great Northern Railway and who, with J P Morgan, wrested control of the Northern Pacific Railroad from him in a stock-market struggle that provoked the Panic of 1901. Hill, Harriman and Morgan then combined forces to create a monopoly, the Northern Securities Co. Under pressure from president Theodore Roosevelt, the giant holding company was dissolved by the Supreme Court in 1904. Four years later, the court ordered the Union Pacific Railroad Co to relinquish its control of the Southern Pacific, and in 1913 the separation was completed.

Seeds of civil war
The opening of the west by rail, while bringing economic growth to the nation, sowed the seeds of a destructive Civil War. Pro-slavery congressmen opposed a free territory (Kansas) west of Missouri. Yet territorial organization, despite the slavery dispute, could no longer be postponed as the rate of new settlement accelerated. Four attempts to organize a single territory for this area had already been defeated in Congress, largely because of southern opposition to the Missouri Compromise. By 1818, Missouri Territory had gained sufficient population to warrant its admission into the Union as a state. Its settlers came largely from the south, and it was expected that Missouri would be a slavery state. To a statehood bill brought before the House of Representatives, James Tallmadge of New York proposed an amendment that would forbid importation of slaves and would bring about the ultimate emancipation of all slaves born in Missouri. This amendment passed the House in February 1819, but not the Senate. The bitterness of the debates sharply emphasized the sectional division of the United States.

In January 1820, a bill to admit Maine as a state passed the House. The admission of Alabama as a slavery state in 1819 had brought the slavery states and free states to equal representation in the Senate, and it was seen that by pairing Maine (certain to be a free state) and Missouri, this equality would be maintained. The two bills were joined as one in the Senate, with the clause forbidding slavery in Missouri replaced by a measure prohibiting slavery in the remainder of the Louisiana Purchase north of 36 degrees 30 minutes north latitude (the southern boundary of Missouri). The House rejected this compromise bill, but after a conference committee of members of both houses was appointed, the bills were treated separately, and in March 1820, Maine was made a state and Missouri was authorized to adopt a constitution having no restrictions on slavery.

A provision in the Missouri constitution barring the immigration of free blacks to the state was objectionable to many northern congressmen, and necessitated another congressional compromise. Not until the Missouri legislature pledged that nothing in its constitution would be interpreted to abridge the rights of citizens of the United States was the charter approved and Missouri admitted to the Union in August 1821. Henry Clay, as Speaker of the House, did much to secure passage of the compromise, so much, in fact, that he is generally regarded as its author, even though senator Jesse B Thomas of Illinois was far more responsible for the first bill. The 36-30-latitude proviso held until 1854, when the Kansas-Nebraska Act repealed the Missouri Compromise.

Although the last of these attempts to organize the area had nearly been successful, Stephen A Douglas, chairman of the Senate Committee on Territories, decided to offer territorial legislation making concessions to the south. Douglas's motives have remained largely a matter of speculation. Various historians have emphasized Douglas's desire for the presidency, his wish to cement the bonds of the Democratic Party, his interest in expansion and railroad building, or his desire to activate the unimpressive administration of president Franklin Pierce. The bill he reported in January 1854 contained the provision that the question of slavery should be left to the decision of the territorial settlers themselves. This was the famous principle that Douglas now called "popular sovereignty", though actually it had been enunciated four years earlier in the Compromise of 1850. In its final form Douglas's bill provided for the creation of two new territories: Kansas and Nebraska, instead of one. The obvious inference, at least to Missourians, was that the first would be slave, the second free. The Kansas-Nebraska Act flatly contradicted the provisions of the Missouri Compromise under which slavery would have been barred from both territories; indeed, an amendment was added specifically repealing that compromise. This aspect of the bill in particular enraged the anti-slavery forces, but after three months of bitter debate in Congress, Douglas, backed by president Pierce and the Southerners, saw it adopted. Its effects were anything but reassuring to those who had hoped for a peaceful solution. The popular-sovereignty provision caused both pro-slavery and anti-slavery forces to marshal strength and exert full pressure to determine the "popular" decision in Kansas in their own favor. The result was the tragedy of "bleeding" Kansas, when murder, mayhem, destruction and psychological warfare became a code of conduct in eastern Kansas and western Missouri. In May 1856, at Pottawatomie Creek, John Brown and his sons killed five pro-slavery advocates. Northerners and southerners were aroused to such passions that sectional division became beyond reconciliation. A new political organization, the Republican Party, was founded by opponents of the bill, and the United States was propelled unstoppably toward the Civil War.

In 1856, Douglas offered a grant of 10 acres (four hectares) of land to Presbyterians "for a site for a University in the City of Chicago". The Presbyterians declined the offer, which the First Baptist Church of Chicago immediately accepted. The first part of the building - the South Wing - was completed in February 1859, while the first students had been enrolled in the fall of 1858, attending class in St Paul's Universalist Church. In 1863, the board of trustees decided to start the construction of the main building, Douglas Hall, as well as that of Dearborn Tower, which would accommodate an observatory. The trustees relied on the subscriptions of wealthy Chicagoans to finance the building of the university; however, the Great Fire of 1871 and the Panic of 1873 rendered worthless a large proportion of the subscriptions that had been secured without conditions. These calamities left the university heavily in debt, which it never managed to pay back, and the commencement of June 16, 1886, marked the end of the first University of Chicago.

A few trustees tried to keep the university alive and decided to ask John D Rockefeller, a devout Baptist, for his financial support. At the time, Rockefeller was willing to create a great Baptist university in New York. After harsh negotiations between New York and Chicago through the intermediation of Frederic Gates and William Harper, Rockefeller opted for Chicago. With the Interstate Commerce Act of 1887 and of the coming of the Sherman Antitrust Act of 1890, Chicago had the advantage of being relatively far from Wall Street and would prevent people from seeing a relationship between the latter and the university. In 1899, Rockefeller agreed to fund the building of a college in Chicago. Nonetheless, Harper, the first president of the university, foresaw a prestigious future for the University of Chicago, which would rival Ivy League schools such as Harvard and Yale. Harper opened the new University of Chicago on October 1, 1892, without ceremony. Five buildings were completed in 1892, and another five in 1893, the year of the Columbian Exposition in Chicago, during which the grounds of the new school were used by Standard Oil to exhibit a miniature refinery. Rockefeller made his first visit to the university in 1897, having declined all previous invitations, being a very private person who hated public occasions. The university grew into one of the greatest in the world. The University of Chicago marked the beginning of a super-program of Rockefeller philanthropy in education.

The Democrats lost influence in the north and became the regional pro-slavery party of the south. Democrats supported the expansion of the money supply. Farming and debtor elements within the Democratic Party pushed for maintenance of the greenbacks and for the coinage of silver, favoring inflation to the rigors of the gold standard. Since little industry existed in the south, Democrats viewed protectionism as a regional benefit for the northeast.

The Whig Party, which had opposed the Kansas-Nebraska Act, dissipated in the south and was weakened in the north. Established in 1834, the Whig Party had been a reaction to the authoritarian policies of president Andrew Jackson. "King Andrew", as his critics labeled him, had enraged his political opponents with his actions regarding the second Bank of the United States, native Americans and the Supreme Court and his use of presidential war powers. The term "Whig" was taken from English politics, the name of a faction that opposed royal tyranny. A new Republican Party emerged as an immediate political force, drawing in anti-Nebraska Whigs and Democrats.

Opponents of the Kansas-Nebraska Act who gravitated to the Whig Party included Jackson critics, states' rights advocates, and supporters of the American System, including Henry Clay, Daniel Webster, John C Calhoun and John Quincy Adams. The System was a new form of federalism that included support for a high tariff to protect US industries in the northeast and generate revenue for the federal government to avoid fiscal deficits; maintenance of high public land prices to generate federal revenue; preservation of the Bank of the United States to stabilize the currency and rein in risky state and local banks; and development of a system of internal infrastructure improvements (such as roads and canals) that would knit the nation together and be financed by the tariff and land-sales revenues.

The ranks of the emerging Republican Party were filled by, among others, the Know-Nothing movement, whose roots lay in the fear of immigrants in general and Roman Catholics in particular. In the 1840s, large numbers of immigrants came to America; many Irish settled on the eastern seaboard and Germans moved out to Midwest farmlands. Numerous newcomers were Roman Catholics. The majority became associated with the Democratic Party.

Opposition to immigrants developed quickly. Eastern factory workers feared job losses to immigrants who were often willing to work for very low wages, as they do now. Others feared the newcomers simply because they were different - in looks, language, customs and religion. These fears led to the growth of "nativism", a belief that only native-born or long-established citizens should have a voice in public affairs. By the late 1840s, secret anti-immigrant organizations began to form in a number of states. They used different names, but collectively they were referred to as the "Know-Nothings". This moniker arose from the members' reluctance to talk about their organizations: When asked about their activities they would often say, "I know nothing." One of the most famous of these groups was the Order of the Star Spangled Banner in New York state; others used similarly high-sounding names.

In 1854, an effort was made to expand the movement through the formation of the American Party. The organization advocated a 25-year residency requirement for citizenship and the limitation of public office to native-born Americans. State houses throughout the country were captured by the Know-Nothings and governors were elected in Massachusetts and Delaware.

The new Republican Party experienced almost overnight success, winning control of the House of Representatives in the autumn of 1854. Issues that brought the Republicans together included repeal of the Kansas-Nebraska Act (the Republican opposition to the extension of slavery was based more on economic concerns than moral ones); support of the central route for the construction of the transcontinental railroad; support of a Homestead Act, which would ease the process for settlers to own western lands; and support of high protective tariffs and liberal immigration laws, both being attractive to northern manufacturers who needed low-wage workers.

Importantly, the Republicans were the party of free working white men; they were opposed to the spread of slavery because they did not want to compete against unpaid labor in the lands opening in the west. They were not supporters of racial equality, let alone desegregation, slave or free. Further, the Republicans were purely a sectional party; they did not attempt to run candidates in the slavery states. Their plan was to gain complete political control in the north; if they did, they would have sufficient electoral strength to elect a president. The debates between Stephen A Douglas and Abraham Lincoln held during the 1858 campaign for a US Senate seat from Illinois were illustrative of this twisted politics.

Douglas, a Democrat, was the incumbent senator, having been elected in 1847. He had chaired the Senate Committee on Territories, and his achievements are described above. Lincoln (1806-65) was a relative unknown at the beginning of the debates. In contrast to Douglas's popular-sovereignty stance, Lincoln stated that the US could not survive as a nation of half slave and half free states. The Lincoln-Douglas debates drew the attention of the entire nation. Although Lincoln lost the Senate race in 1858, he beat Douglas in the 1860 race for the US presidency. The Republican Party henceforth refers to itself as the party of Lincoln.

Lincoln gained attention early in his political career as a pragmatic segregationist cloaked under the high-minded rhetoric of democratic ideals. He finally overcame his previous political rationalization and made peace with his personal morals by issuing the Emancipation Proclamation in 1862. Lincoln, the man who opposed the exclusion of slavery in the new territories with his perversely righteous and dubiously motivated declaration, "A house divided against itself cannot stand," and who declared himself to be personally opposed to racial equality, ended up abolishing slavery for the whole nation four years later as a political expediency brought about by a poorly conducted, ongoing civil war, notwithstanding his earlier belief that while "Negroes" should enjoy the right to life, liberty and pursuit of happiness promised to all men by the Declaration of Independence, the extinction of slavery could only be a gradual and lengthy process, with no near-term target date.

Greenbacks and the money controversy
The money controversy again became a public issue after the Civil War. When the war began in 1861, newly installed president Abraham Lincoln, finding the Independent Treasury empty and payments in gold having to be suspended, appealed to the state-chartered private banks for loans to pay for supplies needed to mobilize and equip the Union Army. At that time, there were 1,600 banks chartered by 29 different states, and altogether they were issuing 7,000 different kinds of banknotes.

Met with little cooperation from the banks, Lincoln immediately induced Congress to authorize the issuing of government notes (called greenbacks) promising to pay "on demand" the amount shown on the face of the note in dollars. These notes were not issued as "dollars" but as promissory notes authorized under the borrowing power of the constitution. The total cost of the war came to $3 billion. The government raised the tariff, imposed a variety of excise duties, and imposed the first income tax in US history, but only managed to collect a total of $660 million during the four years of Civil War. Between February 1862 and March 1863, $450 million of paper money was issued. The rest of the cost was handled through war bonds, which were successfully issued through Jay Cooke, an investment banker in Philadelphia, at great private profit. The greenbacks were supposed to be gradually turned in for payment of taxes, to allow the government to pay off these greenback notes in an orderly way without interest. Still, during the gloomiest period of the war when Union victory was in serious doubt, the greenback dollar had a market price of only 39 cents in gold. Undoubtedly these greenback notes helped Lincoln save the Union. Lincoln wrote: "We finally accomplished it and gave to the people of this Republic the greatest blessing they ever had - their own paper to pay their own debts." The importance of the lesson was never taught to Third World governments by neo-liberal monetarists in the post-Cold War era.

The money debate centered on the greenbacks. Agrarian interests wanted to keep the greenbacks in circulation and even urged that more be printed to facilitate postwar economic recovery and expansion, even if such a move would likely generate inflation, which was regarded as favorable by debtors, who would pay off old debts with "cheaper" money. Politically, this position was adopted by many Democrats who floated a scheme to redeem $2 billion of outstanding war bonds in greenbacks. The Republicans, representing wealthy creditor interests, wanted the greenbacks removed from circulation and the return to a gold-backed currency. This would halt inflation and ensure that war debts would be repaid in full value in the form of hard money.

The federal government had no further connection with the banking industry until the National Bank Act of 1863. Although the Independent Treasury did restrict reckless speculative expansion of credit, it also tended to create a new set of economic problems. In periods of prosperity, revenue surpluses accumulated in the Treasury, reducing hard-money circulation, tightening credit, and restraining even legitimate expansion of trade and production. In periods of depression and panic, on the other hand, when banks suspended specie payments and hard money was hoarded, the government's insistence on being paid in specie tended to aggravate economic difficulties by limiting the amount of specie available for private credit.

The 1863 US National Bank Act amended and expanded the provisions of the Currency Act of the previous year. Any group of five or more persons with no criminal record was allowed to set up a bank, subject to certain minimum capital requirements. As these banks were authorized by the federal government, not the states, they are known as national banks, not to be confused with a national bank in the Hamiltonian sense. To secure the privilege of note issue they had to buy government bonds and deposit them with the comptroller of the currency.

In 1863, in the midst of the Civil War, Congress passed the National Bank Act. While its immediate purpose was to stimulate the sale of war bonds, it served also to create a stable paper currency. Banks capitalized above a certain minimum could qualify for federal charter if they contributed at least one-third of their capital to the purchase of war bonds. In return, the federal government would give these banks national banknotes to the value of 90% of the face value of their bond holdings. This measure was profitable to the banks, since with the same initial capital, they could buy war bonds and collect interest from the government, and at the same time put the national banknotes in circulation and collect interest from borrowers. As long as government credit was sound, national banknotes could not depreciate in value, since the quantity of banknotes in circulation was limited by war-bond purchases. And since war bonds served as backing for the notes, the effect was to establish a stable currency.

The system did not work perfectly. The currency it provided was not sufficiently elastic for the needs of an expanding economy. As the government redeemed war bonds, the quantity of notes in circulation decreased, causing deflation and severe hardship for debtors. Money seemed to be concentrated in the northeast, and western and southern farmers continued to suffer chronic scarcity of cash and credit, not unlike current conditions faced by Third World debtor economies.

After the Civil War, the Independent Treasury continued in modified form, as each administration tried to cope with its weaknesses in various ways. Treasury secretary Leslie M Shaw (1902-07) made many innovations; he attempted to use Treasury funds to expand and contract the money supply according to the nation's credit needs. The Panic of 1907, however, finally revealed the inability of the system to stabilize the money market; agitation for a more effective banking system led to the passage of the Federal Reserve Act in 1913. Government funds were gradually transferred from sub-treasury "vaults" to district Federal Reserve Banks, and an act of Congress in 1920 mandated the closing of the last sub-treasuries in the following year, thus bringing the Independent Treasury System to an end.

John P Altgeld, a German immigrant populist who became the Democratic governor of Illinois in 1890, attacked big corporations and promoted the interest of farmers and workers, gave the state an able, courageous and progressive administration. The question of currency was central to the US populist movement. Farmers knew from first-hand experience that the fall in farm prices was caused by the policy of deflation adopted by the federal government after the Civil War and only ineffectively checked by the Bland-Allison Act of 1878, coining silver at a fixed ratio of 16:1 with gold, and the Sherman Silver Purchase Act of 1890. The Treasury's redemption of silver with gold increased the value of money and deflated farm prices.

Despite the rapid growth of business, the government engineered a sharp fall in the per capita quantity of money in circulation. The National Bank Act of 1863 also limited banks' notes to the amount of government bonds held by banks. The Treasury paid down 60% of the national debt and reduced considerably the monetary base, not unlike the bond-buyback program of the Treasury in 1999. To farmers, it was unfair to have borrowed when wheat sold for $1 per bushel and to have to repay the same debt amount with wheat selling for 63 cents a bushel, when the fall in price was engineered by the lenders. To them, the gold standard was a global conspiracy, with willing participation by the northeastern US bankers - the money trusts who were agents of international finance, mostly British-controlled.

President Grover Cleveland, despite winning the 1892 election with populist support within the Democratic Party, gave no support to populist programs. Cleveland saw his main responsibilities as maintaining the solvency of the federal government and protecting the gold standard. Declining business confidence caused gold to drain from the Treasury at an alarming rate. The Treasury then bought gold at high prices from the Morgan and Belmont banking houses at great profit to them. Populists saw this effort to save the gold standard as a direct transfer of wealth from the people to the bankers and as the government's capitulation to international finance capital. Cleveland even sent federal troops to Illinois to break the railroad strike of 1894, over the vigorous protest of governor Altgeld.

'A cross of gold'
The election of 1896 was about the gold standard. Cleveland lost control of the Democratic Party, which nominated 36-year-old William Jennings Bryan, who declared in one of the most famous speeches in US history (though mostly shunned these days): "You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold." The banking and industrial interests raised $16 million for William McKinley to defeat Bryan, who suffered a defeat worse than Jimmy Carter's by Ronald Reagan. With the McKinley victory, the Hamiltonian ideal was firmly ordained, but with most of its nationalist elements sanitized. In many ways, it was not dissimilar to the Reagan victory over Carter in 1980.

The 16th Amendment to the US constitution calling for a "small" income tax was enacted to compensate for the anticipated loss of revenue from the lowering of tariffs from 37% to 27% as authorized by the Underwood Tariff of 1913, the same year the Federal Reserve System was established. "Small" now translates into an average of 50% with federal and state income taxes combined.

The Glass-Owen Federal Reserve Act was passed in December 1913 under the administration of president Woodrow Wilson. The system set up five decades earlier by the National Bank Act of 1863 had two major faults: 1) the supply of money had no relation to the needs of the economy, since the money in circulation was limited by the amount of government bonds held by banks; and 2) each bank was independent and enjoyed no systemic liquidity protection. These problems were more severe in the south and the west, where farmers were frequently victimized by bank crises often created by northeastern money trusts.

The money elite wanted a central bank controlled by bankers, along Hamiltonian lines, but internationalist rather than nationalist. But the Wilson administration, faithful to Jacksonian democratic tradition despite political debts to the moneyed elite, insisted that banking must remain decentralized, away from the control of northeastern money trusts, and control must belong to the national government, not to private financiers with international links, despite the internationalist outlook of Wilson. Twelve Federal Reserve Banks were set up in different regions across the country, while supervision of the whole system was entrusted to a Federal Reserve Board, consisting of the Treasury secretary, the comptroller of the currency and five other members appointed by the president for 10-year terms. All nationally chartered banks were required and state-chartered banks were invited to be members of the new system. All private banknotes were to be replaced by Federal Reserve notes, exchangeable at regional Federal Reserve Banks not only for bonds or gold, but also for top-rated commercial paper, with the hope of causing the money supply to expand and contract along with the volume of business. With the reserves of all banks deposited with the Federal Reserve (Fed), systemic stability was supposed to be assured.

The circumstances that created the climate in the US for the adoption of a central bank came ironically from internecine war on Wall Street that spread economic devastation across the nation during 1907-08, the direct result of one huge money trust trying to cannibalize its competition.

J P Morgan and the Panic of 1907
The Rockefeller interests of "Amalgamated Copper" had a plan to destroy the Heinze combine, which owned the Union Copper Co. By manipulating the stock market, the Rockefeller faction drove down Heinze stock in Union Copper from 60 to 10. The rumor was then spread that not only Heinze Copper but also the Heinze banks were folding under Rockefeller pressure. J P Morgan joined the Rockefeller enclave to announce that he thought the Knickerbocker Trust Co would be the first Heinze bank to fail. Panicked depositors stormed the tellers' cages of the Knickerbocker Bank to withdraw their money. Within a few days the bank was forced to close its doors, making Morgan's prediction self-fulfilling. Similar fear spread to other Heinze banks and then to the whole banking world. The crash of 1907 was on.

The Panic of 1907 was a credit crunch that spread from New York to the whole country, closing banks and businesses. It was the major impetus for the formation of the Federal Reserve System. While the nation had considered central banking systems in the past, it was the severity of the Panic of 1907 that inspired congressional action leading to establishment of the Fed.

The man at the forefront of the financial battle that resulted in the October 1907 panic, F Augustus Heinze, was a member of a Montana copper-mining family. He sold most of his mining shares for $12 million in 1906, moved to New York, bought a bank and became a director in a national financial chain involving banks and trusts - an affiliation that embroiled him in the growing battle between banks and trust companies.

At the turn of the century the banking industry felt threatened by the new trust companies (and their young, wealthy financiers) and decided to sway public and congressional opinion by making an example of a trust company with connections to Heinze, namely Knickerbocker Trust. If Knickerbocker Trust would falter, then Congress and the public would lose faith in all trust companies and banks would stand to gain, the bankers reasoned.

"Silent runs" began on Heinze's bank and Knickerbocker Trust, and Heinze made a questionable loan to his brothers, who were faltering as owners of a copper company. In October 1907, Heinze's brothers made a failed attempt to corner the copper market on the stock exchange, which allowed a competitor to exploit the Heinze family's financial problems. Heinze was then forced to resign as president of his bank, "scare headlines" appeared in newspapers, runs started on both Heinze's bank and Knickerbocker Trust, and both institutions were initially denied financial aid to keep from failing - each event purposely caused.

Millions of people were sold out penniless and rendered homeless by bank foreclosures, and their savings wiped out by bank failures. The destitute and the hungry fended for themselves as best they could, which was not very well. Circulating money was hoarded by any who happened to still have some, so before long a viable medium of exchange became practically non-existent. Many business concerns began printing private IOUs and exchanging these for raw materials as well as giving them to their workers for wages. These "tokens" passed around as a temporary medium of exchange.

At this critical juncture, J P Morgan and his assembled team working out of his library offered to salvage the last operating Heinze bank (Trust Co of America) on condition of a fire sale of the valuable Tennessee Coal and Iron Co in Birmingham to add to the monopolistic US Steel Co, which he had earlier purchased from Andrew Carnegie.

This arrangement violated existing antitrust laws but in the prevailing climate of depression crisis, the proposed transaction was quickly approved in Washington. Morgan was also intrigued by the paper IOUs that various business houses were allowing to be circulated as a medium of exchange. He persuaded Congress to let him put out $200 million in such "tokens" issued by one of the Morgan financial entities, claiming that this flow of Morgan "certificates" would revive the stalled economy. As these new forms of Morgan "money" began circulating, the public regained its confidence and hoarded money began to circulate again as well. Morgan circulated $200 million in "certificates" created out of nothing more than his own "corporate credit" with formal government approval. The business press was full of praise on how a selfless Morgan risked his own money to save finance capitalism. It was in fact a superb device to make millions with no risk. GE Capital in the 1990s did the same thing with commercial papers and derivatives to create hundreds of billions in profits. Sovereign government in theory can do the same to finance the development of nations. But dollar hegemony in the past two decades has prevented all sovereign governments from exercising what J P Morgan did as a private banker. The only government exempted by the dictate of dollar hegemony is that of the US, whose central bank can issue dollars by fiat with apparent immunity.

Conspiracy theorists assert that the seeds for the Federal Reserve System had been sown with the Morgan certificates. On the surface J P Morgan seemed to have saved the economy - like first throwing a child into the river and then being lionized for saving him with a rope that only he was allowed to own, as some of his critics said. Woodrow Wilson, presented by history as a towering figure of democracy, wrote: "All this trouble [the 1907 depression] could be averted if we appointed a committee of six or seven public-spirited men like J P Morgan to handle the affairs of our country." Both Morgan and Wilson were elitist internationalists. J P Morgan's father, Junius Spencer Morgan (1813-90), born in Springfield, Massachusetts, went to London in 1854 to become a partner of a firm that eventually became JS Morgan & Co, which handled most of the British funds invested in the US. John Pierpont Morgan was born in Hartford, Connecticut, and became the New York agent of his father firm in 1860 at age 23. In 1879, he wrested control of the Albany and Susquehanna Railroad from Jay Gould and Jim Fisk and developed a railroad empire by reorganization and consolidation in all parts of the US. He also led a syndicate that broke the government bond monopoly of Jay Cooke. Morgan helped form Drexel Morgan & Co in 1871, which became JP Morgan & Co in 1895. On his father's death in 1890, J P became sole manager of JS Morgan & Co, which later became Morgan, Grenfell & Co. In 1901, Morgan formed US Steel with Rockefeller participation, the first billion-dollar enterprise in the world. He financed manufacturing and mining, and controlled banks, insurance companies, shipping lines and communication systems. Morgan was severely criticized for backing the sale of obsolete carbine to the Union army and for gold speculation during the Civil War.

By 1908, J P Morgan was working with senator Nelson Wilmarth Aldrich, who had become the father-in-law of John D Rockefeller Jr seven years earlier, and after whom his grandson, the future vice president Nelson Aldrich Rockefeller, was named. Aldrich was seen in the southern and western farm and mining states as the embodiment of the "eastern establishment" made up of the super-rich families and big corporations of the northeast that ran the country. Hence the National Reserve Association proposed by the Aldrich Plan was derided as giving undue power to the banking industry of the northeast. Many independent small country bankers also opposed the Aldrich Plan because they believed it would mainly benefit big northeast banks. With neither party controlling both Houses of Congress prior to 1912 and with the Republican Aldrich unable to muster even decisive partisan support, the pro-bank Aldrich Plan was politically unfeasible.

Ironically, the initial idea of the need for a central bank came from the populist movement, which began in Lampasas County in Texas when a group of desperate farmers formed in 1877 the Knights of Reliance to educate themselves speedily against the time "when all the balance of labor's products would become concentrated into the hands of a few, there to constitute a power that would enslave posterity". Uninhibited by the awesome high science of economics, average citizens in the late-19th-century United States were pragmatically aware of the political implications of monetary policy. The Farmers Alliance, renamed from the Knights of Reliance, held regular traveling lectures that quickly concluded that the causes of their members' financial ruin were the gold standard and the private banking system that enforced its confiscatory terms.

The populists proposed a solution in August 1886 in a convention in Cleburne, Texas. The "Cleburne Demand" called for federal regulation of the banking system and a fiat national currency to meet the liquidity needs of an expanding economy. Public pressure was making increasingly vocal demands for a plan to eliminate Wall Street control and exploitation of the economy for narrow private benefit.

In response, Morgan's ally, senator Aldrich, arranged to become chairman of the National Monetary Commission, which received a mandate from Congress to study the US monetary system and make reform recommendations. Paul Warburg, whose brother Max was in charge of the Reichsbank, the privately owned national bank of Germany, emphasized the absolute necessity of setting up a new national banking system that would prevent Wall Street from putting the US economy through devastating "boom and bust" cycles as it had in the past.

On November 22, 1910, a handful of powerful people met at the J P Morgan estate on Jekyll's Island, Georgia. This secret meeting included Aldrich; A P Andrews, professional economist and assistant secretary of the Treasury; Frank Vanderlip, president of the National Bank of New York City, which later became Citibank; Harry P Davidson, senior partner of the J P Morgan Co, which after several mergers is now JP Morgan/Chase; Charles D Norton, president of Morgan's First National Bank of New York; Paul Warburg, partner of the investment banking house of Kuhn, Loeb Co in New York; and Benjamin Strong of the J P Morgan Co central office in New York, who later became the first president of the New York Fed and dominated the new central bank for the first two decades. After nine days, they produced a draft bill for Congress that was later submitted as the "Aldrich Plan". Conspiracy theorists have made much of this infamous secret meeting.

The main resistance to the Aldrich Plan came from the House of Representatives, where an official investigation had revealed some of the ruthless operations of powerful financial interests on Wall Street and definitely fixed responsibility on Wall Street (especially Morgan and Rockefeller) for the crash of 1907-08, similar to recent public indignation over Enron, WorldCom, Global Crossing, Citibank and AIG.

With the tide of populist opposition rising, it was obvious that the Republicans were not going to be able to get the Aldrich Plan adopted. Strategy then switched to influencing the Democratic Party, which immediately came up with an "alternative" plan to be called the Federal Reserve Association. It was in essence the Aldrich Plan with a different name. The next task was to defeat the sitting Republican president, William Howard Taft of Ohio, in the 1912 election and get a more sympathetic Democratic administration in power. Taft was popular, but he opposed the Aldrich Plan. Ohio was the native home of Rockefeller, a state littered with countless Rockefeller victims in the course of his oil-empire building. The Taft Republicans were hostile to the Aldrich-Rockefeller union and its alliance. The political strategy was therefore redesigned to induce another Republican, popular Teddy Roosevelt, to run as a spoiler on a Progressive ticket against a conservative Taft and thus to divide the Republican Party for certain defeat.

Morgan officers provided both the money and the strategy to help Roosevelt win Republican votes away from Taft. George Harvey, president of the Morgan-controlled Harpers Weekly, and Rockefeller money got behind Wilson. The Wilson team included Cleveland H Dodge of Rockefeller's National City Bank, J Ogden Armour, James Stillman, George F Baker, Jacob Schiff, Bernard Baruch and Henry Morgenthau, whose son would become Treasury secretary under Franklin D Roosevelt in 1934, and would initiate an elaborate system of marketing war bonds by arranging for the Federal Reserve to support Treasury borrowing and purchase at a pre-arranged rate bonds not bought by the public. Also included was the publisher of the New York Times, Adolph Ochs. The Morgan officials who managed Teddy Roosevelt's campaign were also found to have put extensive money behind Wilson. As might have been expected, the strategy worked and Wilson was elected with 6.29 million votes, while Roosevelt drew 4.12 million votes and Taft, who won with 7.68 million votes over William Jennings Bryan's 6.4 million in his first-term victory, drew only 3.46 million votes.

The birth of the Fed
Progressivism reached its high-water mark in the 1912 campaign. Taft plainly had no chance of re-election, the main contest being between Roosevelt and Wilson. Both men proposed to revitalize economic democracy by limiting the powers of big business. Wilson, winning 42% of the popular vote, polled fewer votes than Bryan had done in each of his three unsuccessful campaigns. But with the Republicans split between Taft and Roosevelt, Wilson carried 40 states to become a minority president.

When Woodrow Wilson took over the White House in 1913, he brought with him his Wall Street advisers, including "Colonel" Edward Mandell House, who is now known to have been the major policymaker and manager of the entire Wilson administration. In his personal writings, House describes the pile-driver tactics that were used to force a bill through Congress that would authorize the setting-up of the new Federal Reserve System as a privately owned central bank.

The leading financiers of Wall Street pretended to protest vehemently against the bill. In his autobiography, William McAdoo, Wilson's son-in-law, who became secretary of the Treasury, says he was very impressed by the way the "bankers fought the Federal Reserve legislation - and every provision of the Federal Reserve Act - with the tireless energy of men fighting a forest fire. They attacked it as populist, socialistic, half-baked, destructive, infantile, badly conceived and unworkable." But McAdoo found that when he engaged these bankers in private conversation, he realized their opposition was merely a smokescreen to hide their true feelings. He wrote: "These interviews with bankers led me to an interesting conclusion. I perceived gradually, through all the haze and smoke of controversy, that the banking world was not really as much opposed to the bill as it pretended to be."

On December 22, 1913, with the prospect of the Christmas holiday pressuring Congress into final action before the session closed, the House voted 298-60 in favor of the new Federal Reserve System, and the Senate passed it 43-25.

From its beginning, the dominant guiding principle of the Fed was financial rather than economic, though its charter directed it to "accommodate the needs of commerce and industry". Fed policymakers concentrated on preventing inflation to calm investor fear, not on lowering unemployment or restoring falling farm prices. Fed officials spoke of "liquidation of labor" as part of sound central-banking principle, which harbors a bias toward preserving the health of the financial sector over the real economy. In order to restore the former, it was necessary to punish the latter. Lose weight to save the heart.

The year 1913, when the Federal Reserve System came into existence, was also the year the Armory Show in New York introduced modern art to the United States.

NEXT: 1913: The Year of Contradictions