Stocks, Gold and War

On July 28, 1914, Emperor Franz Joseph of Austria-Hungary declared war on Serbia. A month earlier, a Serbian nationalist had killed Archduke Franz Ferdinand, the emperor’s nephew and heir to the throne. By end-July, Serbia’s ally Russia would mobilize for war. Soon, most of Europe would be plunged into the First World War.

The United States would not enter the conflict until 1917. But the initial onset of war posed an immediate threat to the U.S. financial system. To finance their war efforts, the European powers would seek to get as much gold as possible. One way to do this would be to sell U.S. stocks on a massive scale and demand that U.S. banks convert the proceeds into gold, which the Europeans would then ship out of the country. That in turn could destabilize the dollar, which like other major currencies was backed by gold.

On July 30, the U.S. moved to block such a scenario. At the behest of the Woodrow Wilson administration’s Treasury Secretary William Gibbs McAdoo, the New York Stock Exchange’s governing board voted to close the exchange on July 31. It would remain shut until mid-December, its longest suspension then or since.

Shutting down a stock market is a serious step. During the Panic of 1907, J.P. Morgan Sr. specifically forbade an early closure of the exchange, since such a move would have panicked investors further. But the situation was different in 1914. Shutting the exchange, combined with other emergency measures such as an expansion of the money supply, kept the banks liquid and enabled the U.S. to stay on the gold standard.

In a 2007 book When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of American Monetary Supremacy, New York University economist William L. Silber (who is not related to the writer of this article) argues convincingly that McAdoo’s measures maintained America’s financial stability at a pivotal moment.

Indeed, by staying on the gold standard while most of the European combatants were going off it, the U.S. built a degree of financial credibility rivaling that of Great Britain, long the dominant power in global finance. Thus, the stage was set for a growing share of international financial activity to occur in New York rather than London, and for the dollar gradually to eclipse the pound sterling as the world’s most important currency.

Seeking Stability

In the Panic of 1907, America’s financial sector had avoided a meltdown, but the close call left lingering anxieties about the soundness of the nation’s financial institutions. Consequently, legislation was passed in late 1913 creating the Federal Reserve. However, as Europe marched into war, the Fed was not yet functional; its board was just starting to get sworn in during August 1914, and its regional banks did not open until November.

Responsibility for crafting a U.S. government response to the war-caused financial pressure thus rested mostly upon McAdoo, who was a lawyer-businessman by background and a take-charge executive by temperament. Indeed, during the legislative maneuvering of the previous year, McAdoo had argued for making the proposed Fed an arm of the Treasury; Wilson had overruled him, opting for an independent central bank (though in the Fed’s early decades, Treasury was represented on its board).

McAdoo, incidentally, had offered the president his resignation in May upon marrying Wilson’s daughter, to avoid possible criticism for entangling personal and official ties. Wilson wasn’t too worried about that.

On the morning of July 31, McAdoo told Wall Street, in the person of J.P. Morgan Jr., that the exchange needed to be closed — or more to the point, not even opened, since the opening bell was minutes away. J.P. Jr. and other financiers had just decided the exchange should stay open, and thought American investors would take up the slack in share prices as Europeans departed. But McAdoo’s concern was with gold, and only with stocks in that stocks were what Europeans would sell to get gold.

Wall Street’s titans acceded quickly to the treasury secretary’s view. Soon, the president of the stock exchange, Henry George Stebbins Noble, announced that the venerable institution was closed until further notice. In a curious historical echo, Noble’s grandfather, Henry George Stebbins, had been exchange president during the Panic of 1857.

McAdoo then moved to persuade Congress to amend a law that had passed in the aftermath of the Panic of 1907, the Aldrich-Vreeland Act, which permitted banks to issue emergency currency backed by securities the institutions were holding. The amendment loosened restrictions on how much currency could be issued. This meant that banks would have ready cash on hand to reassure worried depositors. And lest anyone think that meant a weakening of the gold standard, McAdoo had sent a conspicuous and well-armed convoy of trucks to deliver piles of the yellow metal to a Treasury office in New York.

Moreover, the Aldrich-Vreeland currency had a built-in safeguard against an explosion of inflationary paper. Banks issuing the emergency cash had to pay a tax, which escalated over a period of months to encourage them to make it a temporary thing.

Still, the dollar was under pressure against the pound. Typically, the greenback had stood around $4.86:?1, trading in a narrow range since both currencies were linked to gold. In the war’s early weeks, though, the buck fell below $5:?1. The British authorities were determined to keep their money as good as gold; whether their U.S. counterparts could do the same was in doubt.

In mid-August, McAdoo organized a conference “to provide sufficient ships to move our grain and cotton crops to European markets.” If U.S. exports proceeded despite the war, the resulting revenues would bolster the dollar. In September, the Treasury began providing war risk insurance, covering shippers against such exposures as being torpedoed. On another front, McAdoo and the new Fed board got a banking syndicate to bail out New York City, preventing a shortfall on obligations owed to foreign investors, something that would have damaged America’s credit standing and buffeted the buck.

The Crisis Fizzles

The dollar strengthened gradually in late October and early November. One reason was that the agricultural exports facilitated by McAdoo were bringing revenues back to America. Another was that the Fed’s regional banks were getting ready to open. McAdoo by this point wanted a serious central bank to help fix the crisis. Things were delayed by concerns about getting enough gold into the system first, but by late October McAdoo had put his foot down and set November 16 as opening date for the regional banks.