The Great Financial Crisis of 1914: What Can We Learn from Aldrich-Vreeland Emergency Currency?

At the outbreak of World War I, the biggest gold outflow in a generation posed a double-barreled threat to American finance: An internal drain of currency from the banking system and an external drain of gold to Europe. The absence of an operational central bank encouraged Treasury Secretary William G. McAdoo to improvise the modern principle of aiming an independent weapon at each policy target. He employed a form of capital controls to deal with the external threat, shutting the New York Stock Exchange (NYSE) for more than four months to prevent Europeans from selling their American securities and demanding gold in return. And he invoked the emergency currency provisions of the Aldrich-Vreeland Act to deal with the internal threat, allowing banks to issue national bank notes without the normal requirement that the currency be secured by U.S. goverment bonds. According to Friedman and Schwartz (1963, p.196), by November 1914 "the country had recovered from... the declaration of war in Europe, thanks in no small part to the availability of Aldrich-Vreeland emergency currency." This paper tests Friedman and Schwartz's conjecture about the power of Aldrich-Vreeland emergency currency and draws lessons for monetary policy.