Lords of Finance_ The Bankers Who Broke the World Part 10

Like every other financial official at the time, Strong was taken aback by the surprising strength of the stock market and was himself also worried about a potential bubble. His letters to Norman are filled with misgivings about the rise in prices on Wall Street. Though he had a somewhat jaundiced view of the stock market, dominated as it was by its motley crew of outsiders-its plungers and pool operators, all of whom were very much at the bottom of the Wall Street social ladder-he was acutely aware of its power to cause trouble. Stock market crashes and banking panics had always been closely linked in the pre-Fed world and many of the country's past financial crises had emerged from Wall Street: 1837, 1857, 1896, and 1907. In his early days as a stockbroker, he himself had been a witness firsthand to the crash of 1896, and had been an active partic.i.p.ant in restoring order after the panic of 1907.

But as an experienced Wall Street hand, he was quite aware of how difficult it was to identify a market bubble-to distinguish between an advance in stock prices warranted by higher profits and a rise driven purely by market psychology. Almost by definition, there were always people who believed that the market has gone too high-the stock market depended on a diversity of opinion and for every buyer dreaming of riches in 1925, there was a seller who thought the whole thing had gone too far. Strong recognized his own highly fallible judgment about stocks was a very thin reed on which to conduct the country's monetary policy. Even though his initial reaction was that the market might have gone too far, he asked himself, "May it not be the case the world is now entering upon a period where business developments will follow the recovery of confidence, so long lost as a result of the war? n.o.body knows and I will not dare prophesy." Given so much uncertainty, he was convinced that the Federal Reserve should not try to make itself an arbiter of equity prices.

Moreover, even if he was sure that the market had entered a speculative bubble, he was conscious that the Fed had many other objectives to worry about apart from the level of the market. He feared that if he added yet another goal-preventing stock market bubbles-to the list he would overload the system. Drawing a rather stretched a.n.a.logy between the Federal Reserve and its various and conflicting objectives for the economy and a family burdened by many children, he ruminated, "Must we accept parenthood for every economic development in the country? That is a hard thing for us to do. We would have a large family of children. Every time one of them misbehaved, we might have to spank them all." He wanted the Fed to focus on stabilizing the overall economy and was reluctant to allow its policies to be dominated by the need to regulate the "affairs of gamblers" who thronged the tip of Manhattan.

In Strong's view, something about the American character-the exuberance, the driving optimism, the naive embrace of fads-lent itself to periods of speculative excess. "It seems a shame that the best sort of plans can be handicapped by a speculative orgy," he mused almost philosophically to Norman at the end of 1925, "and yet the temper of the people of this country is such that these situations cannot be avoided."

Despite the agitation from Hoover and Miller in late 1925, Strong concluded that with absolutely no signs of domestic inflation, the pound having only just returned to gold and the European currency situation still fragile, this was not the time to tighten credit. For the moment he would just have to ignore the stock market.

Even in combination there was little that Hoover and Miller were able to do to force his hand. As secretary of commerce, Hoover had no remit to interfere in the deliberations of an independent agency like the Fed. Miller was in a minority on the Board. And while the two of them campaigned to change the Fed's policy by co-opting allies in Congress, senators and congressmen are rarely informed enough to be persuasive advocates for changes in monetary policy.

It helped Strong enormously that the Fed's charter had an inherent bias toward inaction. Under the then law, only the reserve banks could initiate changes in policy. While the Board had the power to approve or disapprove such changes, it could not force the reserve banks to act. It was a recipe for the worst sort of stalemate. Checks and balances may work well in politics, but they are a disaster for any organization-the military is one example; central banks are another-required to act quickly and decisively. But in 1925 and 1926, with Hoover and Miller pushing to tighten credit policy, Strong was able to hide behind the Fed's charter and do nothing.

Nothing ill.u.s.trates the dilemmas posed for monetary policy by the stock market than the push to tighten 1925. It turned out that Hoover and Miller had raised a false alarm. There was no bubble. Stock prices took a breather in the spring of 1926, falling by about 10 percent, and then resumed a steady but not yet spectacular rise. By the middle of 1927, the Dow stood at 168. Meanwhile, profits grew strongly and the price-earnings ratio, one measure of market valuation, remained around 11, well below the danger level of 20 that is often considered a sign of overvaluation.37 The Florida real estate bubble burst of its own weightlessness, helped by a devastating hurricane in 1926, and though there was much local disruption, its impact on the national economy was minor. Meanwhile, consumer prices remained almost completely flat. The Florida real estate bubble burst of its own weightlessness, helped by a devastating hurricane in 1926, and though there was much local disruption, its impact on the national economy was minor. Meanwhile, consumer prices remained almost completely flat.

In retrospect, Strong made the right decision in resisting the pressure from Miller and Hoover to tighten credit in late 1925 and 1926. In their enthusiasm to save the country from overspeculation, they had fallen into the first trap of financial officials dealing with complex markets-an excessive level of confidence in their own judgments. Miller, the academic economist, and Hoover, the engineer, were both insulated from doubt by their ignorance of the way markets operate. In their zeal to burst a bubble that did not exist, they would have damaged the economy without any tangible benefit.

There is no better way to understand the stock market of those years than to return to the story of General Motors. Between 1925 and 1927 the profits of General Motors went up almost two and a half times. With earnings of almost $250 million a year, it overtook U.S. Steel to become the most profitable company in America. Though its stock price quadrupled in those two years, and by the middle of 1927 the company was valued at close to $2 billion, with a price-earnings ratio of less than 9, it was still considered to be reasonably priced.

What of Billy Durant? If General Motors was the emblematic story of the 1920s boom, its founder came to symbolize the other face of that frenetic decade. Although the company he had started had gone on to become the most successful corporation in America, he refused to look back after losing control of it for the second time in 1920. At his peak, he had been worth $100 million. In 1920, the roughly $40 million he received for his stock in General Motors had largely gone to pay off his personal loans, and he had emerged with barely a couple of million dollars.

He was, however, obsessed with the stock market. He formed a consortium of multimillionaires-many of whom were also from Detroit and had made their money in the automobile industry-to play the market. Within four years, he had rebuilt his fortune. By 1927, he was running a fund of over $1 billion, and had indirect control of another $2 to $3 billion that friends would invest alongside him. It was as if Bill Gates had been forced out of Microsoft, only to reappear on Wall Street as one of the largest hedge fund managers.

THIS CHIMERA.

Central bankers can be likened to the Greek mythological character Sisyphus. He was condemned by the G.o.ds to roll a huge boulder up a steep hill, only to watch it roll down again and have to repeat the task for all eternity. The men in charge of central banks seem to face a similar unfortunate fate-although not for eternity-of watching their successes dissolve in failure. Their goal is a strong economy and stable prices. This is, however, the very environment that breeds the sort of overoptimism and speculation that eventually ends up destabilizing the economy. In the United States during the second half of the 1920s, the destabilizing force was to be the soaring stock market. In Germany it was to be foreign borrowing.

By the beginning of 1927, Germany seemed to have fully recovered from the nightmare years of hyperinflation. Schacht was in a position of una.s.sailable power at the Reichsbank. After the Dawes Plan, he had been appointed to a four-year term during which, by the new bank law, he enjoyed complete security of tenure and independence of the government. He had consolidated his position within the Reichsbank by getting rid of the old guard from the Von Havenstein era, who had opposed his appointment, and putting his own people in charge. Moreover, though a General Council consisting of six German bankers and seven foreigners was supposed to oversee him, it met only quarterly, leaving him to operate unhampered. As one senior German politician of the time remembered, he employed the "tactic of consulting everyone and then doing exactly what he pleases."

By virtue of position and personality, he dominated most discussions of economic policy within Germany. The liberal economist Moritz Bonn, an adviser to the Reichsbank, wrote of Schacht in those years, "He looked upon the world as Hjalmar Schacht's particular oyster, and was very sensitive to public criticism. Having clashed with many strong and ambitious personalities in the German banking and business world, he was full of resentment against colleagues who had at some time outdistanced him. Once he arrived at the head of the central bank, he gloried in being their boss."

To the public, Schacht remained "the Wizard," the savior of the mark. The visit by Strong and Norman in June 1925, his own trip to the United States that fall, and his acceptance as the third member of the central banking triumvirate running the world's finances had enormously enhanced his prestige. In the three years since their first meeting, he had developed a very strong personal bond with Norman-they met five times in 1924, three times in 1925, and four times in 1926. Norman admitted that Schacht could be difficult to work with, that among his peculiarities was a love of publicity and the habit of making too many speeches. But it was "a joy to talk finance" with Schacht, he used to say. His admiration for the German was so great that Sir Robert Vansittart, later head of the British diplomatic service, complained that Norman was "infatuated by Dr. Schacht."

Strong, however, had not taken to Schacht to the same degree. "He is undoubtedly an exceedingly vain man. This does not so much take the form of boastfulness as it does a certain naive self a.s.surance," wrote the American. Nevertheless, he was impressed by the way Schacht handled the Reichsbank. "He runs his part of the show with an iron hand. He does it openly, frankly, and courageously, and seems to have the support of his Government but it certainly would not do in America. . . . He doesn't gloss things over; he seems actually to relish the difficulties. . . ."

Power seemed to suit Schacht. The family had moved out of their villa in Zehlendorf into the official residence of the Reichsbank president on the top floor of its headquarters on Jagerstra.s.se. Financially he had little to worry about-his salary was the equivalent of $50,000 and he drew a further $75,000 from the pension that he had wrung from the Danatbank. To show he had arrived, he bought a grand country house some forty miles north of Berlin, which had been the hunting lodge and estate of Count Friedrich Eulenberg.

When in town, the Schachts entertained frequently. With his "ugly clown mask of a face, curiously alive and attractive," Schacht, always sporting a big cigar and accompanied by his matronly wife, Luise, who kept a "vigilant watch" on him-he was said to have a wandering eye-became something of a fixture on the social circuit. He had a pompous habit of wearing his culture conspicuously on his sleeve, which some found irritating, while others ridiculed him behind his back for his arriviste pretensions-one acquaintance remarked that "he dresses with the taste of a socially ambitious clerk." Nevertheless, he was a popular guest, something of a catch celebrated for his "cutting and devastating humor." The Aga Khan remembered the Schacht of those years as one of the most charming of dinner companions, who could hold "a whole table enthralled" with his sparkling conversation. Priding himself as something of a poet, he would compose amusing little pieces of doggerel to entertain his fellow guests.

Before the war, social life in Berlin had been especially stultifying. Under the oppressive hierarchy imposed by the Junker elite around the court, there had been little interaction between the various circles in the city. However, the overthrow of the old Prussian n.o.bility and the destruction of the middle cla.s.s by inflation had transformed Berlin into a rootless society of politicians and profiteers, former aristocrats and foreign diplomats. It would have been an arid soulless sort of place but for its demi-monde of artists. With its past swept away, the city had an unhinged nervous energy, an edge to it, that no other city in Europe could match, and it had attracted the best of the European avant-garde: writers, painters, architects, musicians, and playwrights. William Shirer, the journalist who would chronicle the rise of n.a.z.ism, first came to Berlin during those years and was captivated. "Life seemed more free, more modern and more exciting than in any place I had ever seen."

But for all its "jewel-like sparkle," the city was wrapped in an atmosphere of impending doom. Norman sensed it when visiting Schacht in late 1926: "You feel all the time that politically as well as economically Germany is still not far from a precipice." After the fiasco of the Beer Hall Putsch, most people treated Hitler as a laughingstock. Nevertheless, there were ominous undercurrents of the convulsions to come. On March 21, 1927, a band of six hundred n.a.z.i brownshirt storm troopers of the Sturmabteilung Sturmabteilung , the SA, beat up a group of Communists in eastern Berlin and marched into the center of the city, attacking anyone on the Kurfurstendamm who looked Jewish. The city authorities responded by banning n.a.z.i activity from Berlin for a year. , the SA, beat up a group of Communists in eastern Berlin and marched into the center of the city, attacking anyone on the Kurfurstendamm who looked Jewish. The city authorities responded by banning n.a.z.i activity from Berlin for a year.

But the economy was booming. Over the three years since the mark had been stabilized, output rose close to 50 percent and exports by over 75 percent. The GDP had surpa.s.sed its prewar level by a good 20 percent, unemployment was now at a modest 6 percent, and prices were steady. The recovery was reflected in the stock market. During the hyperinflation, few people had believed that capitalism would even survive in Germany and equities had become dirt cheap, having fallen to less than 15 percent of their 1913 inflation-adjusted value-the whole of the Daimler-Benz motor company, for example, could have been bought for the price of 227 of its cars. By 1927, however, the market had quadrupled in value from its low point in 1922.

The Dawes Plan had been an enormous success. In fact it had worked almost too well. American bankers, a.s.sured under the plan of being repaid first ahead of reparations owed to France and Britain, had fallen over one another in their enthusiasm to lend to Germany. In the two years since the plan, $1.5 billion flowed into the country, giving Germany the $500 million due for reparations and still leaving it an enormous surplus of foreign cash. Some of this money had gone to finance the reconstruction of industry; but a very large amount had been taken up by the newly empowered states, cities, and munic.i.p.alities of the budding democracy to build swimming pools, theaters, sports stadiums, and even opera houses. The zeal with which foreign bankers promoted their wares led to a great many imprudent investments and a lot of waste-one small town in Bavaria, having decided to borrow $125,000, was persuaded by its investment banks to increase the amount to $3 million.

With so much foreign money coming in, imports ballooned and the pressure on the government to lighten up on the austerity of 1924 and 1925 became irresistible. By 1926, the national government itself was back to running deficits. These were, however, modest-only $200 million, or less than 1.5 percent of GDP-compared to the giant shortfalls of the hyperinflation years, and financed as they were by hard currency from abroad, did not lead to inflation.

By every indication, Schacht, as one of the architects of this authentic economic miracle, should have been a happy man. Instead, he continued to be obsessed with reparations. Even at the time of the Dawes Plan, he had never been fully convinced that Germany could or even should pay the amounts envisaged. Nevertheless, he had grudgingly supported the plan and the foreign loans that came with it. He had hoped that as the credits from the United States built up and began to rival reparations as a claim on Germany's foreign exchange, they would create a powerful lobby of American bankers, who would share a common interest with the German authorities in getting future payments to the Allies reduced.

But Germany was now borrowing too much abroad. Schacht worried that the foreign debt buildup was becoming so large that when the day came for it to be repaid, it would precipitate a gigantic payments crisis and national bankruptcy. It made no sense to him for Germany to be borrowing dollars to build wonderfully modern urban amenities, such as opera houses, which could never generate the foreign currency to repay the loans. Moreover, Germany was so awash with foreign capital, and was being driven by so conspicuous a boom, that it was getting progressively harder for him to argue that the republic could not afford to meet its reparations obligations. The artificial boom was giving everyone at home and abroad a false sense of prosperity-a "chimera," as he called it.

His problem was that there was very little he could do about the situation. If he tried to tighten credit to curb the domestic boom, he would simply end up encouraging borrowers to look abroad for cheaper loans and thus exacerbate the already excessive foreign borrowing.

He was not a man to agonize too long over dilemmas. In many ways, for someone with the reputation of being a calculating opportunist, he was oddly impulsive. On Thursday, May 12, 1927, he made his move. The Reichsbank instructed every bank in Germany to cut its loans for stock trading by 25 percent immediately. The next day, nicknamed "Black Friday" by the Berlin press, stock prices fell by over 10 percent. Over the next six months, they would slide by another 20 percent.

By going after the stock speculators, Schacht was hoping to crack the atmosphere of overconfidence and curb inflows of foreign money into Germany. This proved to be a serious miscalculation. Even though stocks had gone up a lot in the last five years, this represented a recovery from the brink of disaster. The market was by no means overpriced-in early 1927, its total capitalization was only around $7 billion, less than 50 percent of GDP, still only 60 percent of its prewar level. More important, German munic.i.p.alities, which were immune to stock market fluctuations, kept on borrowing abroad. All that Schacht had achieved with this hasty maneuver was unnecessary damage to business confidence.

Having thus failed to dam the inflow of foreign loans with his broadside against the stock market, Schacht now began to talk about doing something dramatic over reparations. A New York Fed official, Pierre Jay, pa.s.sing through Berlin in June 1927, remarked that Schacht did "not wish to have things seem too good in Germany for fear that it will help the execution of the [Dawes] Plan," and speculated that he might take some other action deliberately to undermine Germany's fragile prosperity in order to prove that reparations were too burdensome. Parker Gilbert, the American agent-general for reparations, who was as close to Schacht as anyone, observed that he had begun "openly and actively working for a breakdown" of the Dawes agreement, and described him during this period as "changeable and moody," "temperamental and mercurial."

No one was quite sure what he had in mind. Berlin was rife with rumors that he might deliberately engineer a new crisis. It was the beginning of what one historian has described as Schacht's descent into "irresponsibility and unpredictability." His tendency to "extreme and erratic" behavior seemed to be a deliberate ploy to keep friends and enemies alike guessing. It certainly unnerved his counterparts, Norman and Strong. They feared that consumed as he was by reparations, he might try some reckless and foolhardy gamble to sabotage the Dawes settlement, which would not only plunge Germany into chaos and undermine its fragile new democracy, but might capsize the international monetary structure, which they had so painstakingly put together over the last few years.

They had always worried about Schacht's tendency to embroil himself in highly visible political conflicts. Never much of a diplomat, he had always been very open in his criticisms of government budgetary policy, particularly of the states and munic.i.p.alities borrowing so much abroad. Back in 1925 during the central bankers' visit to Berlin, Strong had remarked on Schacht's tendency to "get into political matters which would be [better] left alone by the head of the Reichsbank," and Norman had gently tried to warn him to be more discreet. But it always seemed that Schacht had enough of an instinct for survival to avoid rocking the political boat too hard. Now, however, he became increasingly indiscreet and strident in his remarks.

One episode in particular brought his confrontation with the government to a head. At a cabinet meeting in June, Schacht launched into a vituperative attack, which left the ministers speechless with outrage. It was typical of the man that having insulted the cabinet, he was not content to leave ill enough alone. He was overhead bragging to the other guests at a private dinner that evening about how he had taken on the politicians. He revealed confidential details of the whole cabinet debate, made insulting comments about individual ministers, dismissed the finance minister as incompetent, and called for his resignation. Even his old supporter Stresemann agreed that Schacht's behavior was a problem and that his constant and naked self-aggrandizement was becoming intolerable. It was but a small harbinger of things to come.

IMPERIALIST DREAMS.

The miracle of the franc's recovery may have been good for France but imposed its own financial strains upon Europe. The money drawn back to the franc on Poincare's coattails continued to flow in throughout the spring and early summer of 1927, mostly out of sterling. The Banque de France, in an effort to prevent this flood from pushing the franc to uncompet.i.tive levels, kept buying foreign currencies, and by the end of May, had acc.u.mulated a foreign exchange war chest totaling $700 million, half of which was in pounds.

The rebound in the financial position of the Banque took Norman completely by surprise. He had never made a secret of his disdain for the French and their way of doing things-the constant intrigue and infighting, the chronic instability of governments, the overweening role of the state. During 1924, and especially 1925 after Britain had gone back to the gold standard, he had indulged in a certain schadenfreude at France's financial travails. As the franc plunged, he confessed to Strong that the position of France, held up since the war as an example of the advantages of unorthodox financial management, made him "smile."

Moreau, for his part, reciprocated the enmity. From his very first few days in office, he had been irritated by the presumption of Anglo-Saxon bankers that the French would be unable to stabilize the franc without their help. Much of his animosity was specifically directed against Norman, a reflection of a wider and more pervasive suspicion toward the governor of the Bank of England throughout Europe, except in Germany. Strong had picked up on it in the summer of 1926, noting that Continental financial officials "seem to be afraid of him and somewhat distrust him."

With the Banque flush with hard currency and the franc stable, Moreau was determined to use his newfound independence to reestablish French financial prestige. He had not forgotten that before the war Paris had been the second most important money center in the world.

His first opportunity to a.s.sert himself on the international stage came in connection with a loan to Poland, which had regained its independence after the war and was historically seen as a partner of France in containing German power. In late 1926, a consortium of central banks, including the Federal Reserve, the Bank of England, the Reichsbank, and now the Banque de France, put together a financial package to help stabilize the Polish zloty. When Norman tried to grab the lead role, the French objected strongly to what they saw as a British attempt to muscle in on France's traditional sphere of influence in Eastern Europe. For Moreau it was one more example of Norman's "imperialist dreams."

In February 1927, the Banque also tried to renegotiate terms on a loan from the Bank of England dating back to 1916 and secured by French gold. As usual when it came to the French, Norman was unhelpful, putting numerous obstacles in the way. Frustrated by Norman's obstructionism, the Banque surprised the Bank of England in May by announcing that it would pay off the loan and take back the $90 million of gold reserves pledged as security. The next month, without even consulting the British, the Banque issued instructions that $100 million of its sterling balances be converted into gold. The effect would have been to drain almost $200 million of gold out of the Bank of England's reserves. Both actions came as a shock to Norman. Moreau's demands were "capricious" and would "menace the gold standard," he complained to Strong.

Norman and Moreau met repeatedly during the first few months of 1927-in Paris in February, in London in March, and at the Terminus Hotel in Calais in early April-to try to resolve some of these issues. Though the tensions between them never quite broke into open conflict-they were careful to maintain a frosty politeness in all their dealings-their mutual dislike and mistrust were apparent. Moreau had clearly not forgotten how unwilling Norman had been to come to the aid of France at the height of the previous year's crisis, a sharp contrast to the way the Englishman had bent over backward to help Schacht and the Germans in 1924.

The gold standard did offer a traditional safety valve for dealing with shifts in gold holdings. The shrinkage of reserves in the country losing bullion was supposed to lead to an automatic contraction in credit and a rise in interest rates, which would thereby shrink its buying power, while attracting money from abroad. Meanwhile, the country gaining gold would find its credit expanding and its capacity to spend increasing. These "rules of the game," as Keynes called them, were designed to set in train automatic gyroscopic forces to balance out the shifting tides of gold among countries.

But in early 1927, the Bank of England and the Banque de France could not agree how to apply these rules. A conference was arranged and on May 27, Norman revisited the Banque. It was a very different meeting from that first disastrous encounter a year earlier. Now it was Norman's turn to plead for help. He claimed that it would be politically impossible to tighten credit in Britain, that "he could not do so without provoking a riot." Arguing that most of the money flowing into France came from speculators betting that the franc would have to appreciate, he pressed Moreau to cut interest rates.38 Moreau, on the other hand, had just weathered a decade of high inflation, which he did not wish to risk repeating by easing credit. He insisted that under the rules of the gold standard, he had the complete right to convert his sterling holdings into bullion, and should this put Britain's reserves under pressure, the Bank of England could always raise rates.

Quite aware that too precipitate an action by the Banque de France would threaten the Bank's ability to keep the pound on gold, he tried to rea.s.sure Norman that he had no intention of destabilizing the gold standard or trying to undermine sterling, declaring melodramatically, "I do not want to trample on the pound." Both parties claimed to be committed to the game, but each was adamant that it was the other who was not following the rules.

The British were not completely on the defensive. They did point out that while France held some $350 million in sterling that it could convert into gold, the British government held $3 billion of French war debts on which it could theoretically demand immediate repayment. The meeting closed in an inconclusive truce. In the following weeks, both sides somewhat halfheartedly backed down, the Bank of England allowing rates in Britain to rise modestly and the Banque de France engineering a fall in its rates. For the moment, outright financial conflict had been averted.

Schacht, Strong, Norman, and Rist on the Terrace at the New York Fed, July 1927

15. UN PEt.i.t COUP DE WHISKY.

1927-28.

Not every mistake is a foolish one.

-CICERO

By THE END of 1926, this quartet of central bankers had already begun to worry about three of the factors-the U.S. stock market bubble, excessive foreign borrowing by Germany, and an increasingly dysfunctional gold standard-that would eventually lead to the economic upheaval at the end of the decade. None of them, however, yet antic.i.p.ated the scale of the coming storm. Hjalmar Schacht was locked in combat with his own government; Montagu Norman and emile Moreau were squabbling with each other; and Benjamin Strong was, as always, battling on two fronts-with his health and with his colleagues within the Federal Reserve System.

In 1926, after almost two years without an attack of tuberculosis, Strong developed pneumonia on his return from his summer in Europe. While lying sick with the new disease, at one point close to death, he was again scarred by personal tragedy, this one carrying with it a hint of scandal.

Confined to the Cragmore Sanatorium at Colorado Springs in 1923, he had struck up a friendship with another tubercular patient, Dorothy Smoller, a twenty-two-year-old actress from Tennessee. She had once been a dancer with Anna Pavlova's ballet company, had had several parts on Broadway, and had even had a bit part in a movie. After a few months in the sanatorium, her money had run out and Strong and some other rich patients stepped in to support her. In November 1926, she resurfaced in New York, to be treated by Dr. James Miller, a Park Avenue physician and Strong's personal doctor-like most tuberculosis patients, she had not fully shaken off the disease. She had just landed a part in another Broadway play when on the morning of December 9, after receiving a mysterious letter that reportedly distressed her, she killed herself by drinking a bottle of liquid shoe polish.

By her bedside were three letters, one for her mother in Long Beach, California, one for a friend, and one for Strong. She left instructions that the photograph of Strong in her possession be returned to him. No one can know whether she and Strong were romantically involved. Perhaps she was just a lost and unhappy young woman, a victim of the Broadway version of the boulevard of broken dreams, who had developed a fixation upon a distinguished and kindly man who had helped her. Whatever the case, her suicide, with its echoes of his wife's death twenty years earlier, must have shaken him profoundly.

In December, he again left New York to recuperate, for a few weeks at the Broadmoor Hotel in Colorado Springs and thereafter in North Carolina. He returned to work six months later, in May 1927, to find the strains and stresses within Europe again building. The quarrel between Moreau and Norman was threatening to derail the pound, and had the potential to undermine the stability of the entire structure of the worldwide gold standard. Meanwhile, Schacht was beginning to clamor for some sort of international initiative to control the flow of foreign money into Germany, which, he feared, would never be able to repay all of its various acc.u.mulating debts.

Strong had always hoped that once the other major countries were back on gold, the lopsided maldistribution, which had left so much of the world's gold stock in the United States, would correct itself. But that had not happened. Sterling had returned to gold at an unrealistically high exchange rate, leaving British goods expensive and difficult to sell in the world market. France, on the other hand, had done exactly the opposite. By pegging the franc at 25 to the dollar, the Banque de France had kept French goods very cheap. France was therefore in a position to steal a compet.i.tive edge over its European trading partners, particularly Britain. While this discrepancy between British and French prices persisted, the tensions could only fester. There was a natural tendency for money to move from overpriced Britain to underpriced France. To correct the situation, either prices had to fall further in Britain-which the authorities were trying to bring about without much success-or rise in France-which the Banque de France would not permit. The only alternative was to change the gold parity of sterling. But everyone feared that such a devaluation would so shock the banking world as to undermine any hope of order in international finances and even destroy the gold standard.

The Germans had avoided the British mistake. At the exchange rate of 4.2 marks to the dollar set by Schacht back in late 1923, German goods were cheap. Germany had a different problem. It had been denuded of gold during the nightmare years of the early 1920s and was now spending so much on reconstruction and reparations that, despite its large foreign borrowing, it was unable to build up new reserves. Thus, of all the countries in Europe, only France had enjoyed any success in attracting gold, although even this had been done, not so much by drawing gold from America as by weakening the position of Britain.

There was one way for the Fed to help Europe out of these dilemmas, or at least buy it some time. It could lower its interest rates further. In addition to giving Britain some breathing room, there were good domestic reasons to justify such a cut. Prices around the world were falling-not precipitously, but very gradually and very steadily. Since 1925, U.S. wholesale prices had fallen 10 percent, and consumer prices 2 percent. The United States had also entered a mild recession in late 1926, brought on in part by the changeover at Ford from the Model T to the Model A. The two main domestic indicators that Strong had come to rely on to guide his credit decisions-the trend in prices and the level of business activity-argued that the Fed should ease. But interest rates at 4 percent were already unusually low.

Ever since the early 1920s when he had embarked on his policy of keeping interest rates low to help Europe, a faction within the Fed, led by Miller, had argued that Strong was too influenced by international considerations and especially by Norman. During Britain's return to gold in 1925, he had been accused by some members of the Board of having exceeded his authority in providing the line of credit to the Bank of England. But at the time, there had been so much support within U.S. financial circles for Britain's return to gold, and when the British did not even have to draw on the line of credit, the dissenting voices had died away. In 1926, while Strong was in France, he was again criticized by Board members for freelancing and acting too much on his own initiative. He responded that unless they were willing to come to Europe as frequently as he did, and familiarize themselves with the people and the situation, they would just have to trust him. While he did not shy away from conflict-quite the contrary, according to one colleague he seemed to "thoroughly enjoy getting into a fight and coming out on top"-the constant sniping over international policy became so wearing that he even threatened to resign.

The same faction that had opposed him on Europe had pressed him to tighten in 1925 and 1926 to bring down equity prices. While they had then sounded a false alarm on a bubble in stocks, with the market still strong-the Dow was hovering close to 170-he knew that were he now to loosen monetary policy to bail out the pound, he risked severely splitting the Fed.

In the summer of 1927, still weak from his recent illness, Strong decided that rather than go to Europe as he usually did, he would invite Norman, Schacht, and Moreau to the United States.39 Before the war, when the gold standard had worked automatically, the system had simply required all central banks, operating independently, to follow the rules of the game. Collaboration had not needed to go beyond occasionally lending one another gold. Before the war, when the gold standard had worked automatically, the system had simply required all central banks, operating independently, to follow the rules of the game. Collaboration had not needed to go beyond occasionally lending one another gold.

Ever since the war, as the gold standard had been rebuilt and evolved into a sort of dollar standard with the Federal Reserve acting as the central bank of the industrial world, Strong had found it useful to consult frequently with his colleagues-he generally used his summers in Europe as an occasion to meet all of his European counterparts. This had begun with his getting together with Norman very informally and with minimum publicity once or twice a year-meetings of two friends who agreed on most essentials. After the stabilization of the mark in 1924, Schacht had joined the club, and the three of them convened in Berlin in 1925 and at The Hague in 1926. He now proposed a meeting of all four central banks, including the French.

Moreau, who spoke no English and feared being excluded from the most important discussions, decided to send his deputy governor, Charles Rist, in his place. Norman and Schacht traveled across the Atlantic together on the Mauretania, Mauretania, arriving on June 30. They took the usual precautions-their names did not appear on the pa.s.senger list and even their baggage was unmarked. But news of the meeting had leaked well in advance and the usual posse of reporters was waiting for them at dockside. Norman, nervous that Rist had arrived two days earlier and might have stolen a march on him, insisted on going straight from the ship to the downtown offices of the New York Fed. arriving on June 30. They took the usual precautions-their names did not appear on the pa.s.senger list and even their baggage was unmarked. But news of the meeting had leaked well in advance and the usual posse of reporters was waiting for them at dockside. Norman, nervous that Rist had arrived two days earlier and might have stolen a march on him, insisted on going straight from the ship to the downtown offices of the New York Fed.

Over the years, each of the central banks had acquired its distinctive architectural signature, somehow expressive of the inst.i.tution's character. While the Bank of England, for example, looked like a medieval citadel, the Banque de France like an aristocrat's palace, the Reichsbank like a government ministry, for some reason-perhaps in a salute to those first international bankers, the merchant princes of Renaissance Italy-the New York Federal Reserve had chosen to dress itself up as a Florentine palazzo. With its ground-floor arches, heavy sandstone and limestone walls pierced with rows of small rectangular windows, and loggia gracing the twelfth floor, it was an almost exact imitation, on a grander and more epic scale, of the Pitti or the Riccardi palaces in Florence.

It was on the twelfth floor of this faux Italian palace that the four great banking powers of the world first convened. That weekend, however, desperate to get away from the prying eyes of the press, they moved in great secrecy to an undisclosed location out of the city. Strong had chosen for their clandestine meeting the summer home of Ogden L. Mills, undersecretary of the treasury. In an administration whose secretary of the treasury, Andrew Mellon, was the third richest man in the United States, it was in keeping that his deputy should be the heir to a robber baron fortune. Ogden Mills was, however, by the standards of third-generation wealth, a serious man with a law degree from Harvard who had made a career with a respectable white-shoe New York law firm.

But he had not completely given up on the privileges of inherited wealth.40 His estate lay on the North Sh.o.r.e of Long Island, now buried under suburban sprawl and, to present eyes, an unlikely setting for a secret conclave of central bankers. But in the 1920s, this was the "Gold Coast," a Gatsby-esque world, now long gone, of mansions with gilded ceilings, of grand formal gardens and marble pavilions, of racing stables, foxhunts, and polo fields, boasting castles larger than those of Scotland and chateaus grander than along the Loire. Among those who summered there were J. P. Morgan, Otto Hermann Kahn of Kuhn Loeb, and Daniel Guggenheim, the copper king. His estate lay on the North Sh.o.r.e of Long Island, now buried under suburban sprawl and, to present eyes, an unlikely setting for a secret conclave of central bankers. But in the 1920s, this was the "Gold Coast," a Gatsby-esque world, now long gone, of mansions with gilded ceilings, of grand formal gardens and marble pavilions, of racing stables, foxhunts, and polo fields, boasting castles larger than those of Scotland and chateaus grander than along the Loire. Among those who summered there were J. P. Morgan, Otto Hermann Kahn of Kuhn Loeb, and Daniel Guggenheim, the copper king.

Its mere twenty rooms made the Mills house, a discreet and elegant neo-Georgian brick mansion with vine-covered walls, located on the Jericho Turnpike in the town of Woodbury, New York, a modest residence by the standards of some of its neighbors. A few hundred yards farther up the turnpike stood Woodlands, a thirty-two-room estate that Andrew Mellon had just bought for his daughter Ailsa as a wedding gift. Half a mile down the road stood Oheka, the second largest house in the United States, a mock chateau of 127 rooms owned by Kahn.

The four men remained in seclusion for five days, No official record of the discussions was kept. Although they socialized and had meals together, they rarely gathered as a group, relying instead upon bilateral meetings. Strong and Norman in particular spent hours "closeted together." The discussions were almost entirely devoted to the problem of strengthening Europe's gold reserves and to finding ways to encourage the flow of gold from the United States to Europe.

Norman dominated the proceedings, seated at one end of the conference room in a fan-backed oriental chair. In spite of the warm weather, he insisted on wearing his velvet-collared cape, which only added to the picturesque figure he evoked. He made it clear that his gold reserves were critically low. Any further erosion would force him to put up rates. The link between the pound and gold was seriously in peril. Moreover, he argued, the on-going worldwide decline in wholesale prices was a symptom of a mounting global shortage of gold as countries returning to the standard built up their reserves.41 And so it was imperative that countries with large reserves ease credit to spread the bullion around. And so it was imperative that countries with large reserves ease credit to spread the bullion around.

Rist, on the other hand, argued that the question of European gold was largely a British problem. Having made the mistake of fixing sterling at too high an exchange rate, Britain had no alternative but to continue its policy of deflation, however painful that might be.

Schacht proved to be more of an observer than a key partic.i.p.ant. His main goal was to curb the flow of hot money into Germany, which the others saw as largely a side issue. He did warn that this was but one symptom of a wider problem-that Germany was getting too heavily into debt and that a breakdown over reparations would soon occur, with damaging consequences for the whole world. While Strong and Norman had some sympathy for Schacht's desire to renegotiate reparations once more, they warned him to be patient, that nothing could be done till after the American, French, and British elections in 1928. Nevertheless, Strong was sufficiently concerned by Schacht's gloomy forecast that after the meeting, he asked Seymour Parker Gilbert, the agent-general for reparations, to begin work on a new deal on reparations.

Strong, though increasingly sympathetic to the French point of view-much to Norman's discomfort-had arrived at the conference with his mind already made up. The only way to reduce selling pressure on the pound in the short run would be to cut U.S. interest rates. It helped that the domestic indicators he relied upon-price trends and economic activity-also justified a cut. And though he recognized that the stock market was a big stumbling block-he ruefully predicted to Charles Rist as the meeting got under way that a cut would give the market "un pet.i.t coup de whisky" "un pet.i.t coup de whisky"-it was a risk he was willing to take.

Strong had very deliberately not invited any members of the Federal Reserve Board to the Mills house. After the meeting was over, on July 7, the four did go down to Washington for a day, during which they paid "courtesy calls" on members of the Board and had a "social" lunch at the Willard Hotel. They were all very careful to remain quite tight-lipped with officials in the capital. Before departing the United States, the Europeans had a final meeting in New York, to which Chairman Crissinger was invited, but none of the other members were even informed. Strong, bitter at the constant obstructionism he had met with over the years, was firmly set on keeping them out of the loop-a churlish decision that served no purpose but to irritate the Board and acc.u.mulate more enemies against him.

A few days after the European central bankers left, the New York Fed and eight of the other reserve banks voted to cut interest rates by 0.5 percent to 3.5 percent. It was a move that split the system. Four reserve banks-Chicago, San Francisco, Minneapolis, and Philadelphia-insisting that such a move would only fuel stock market speculation, refused to follow. Until then the Board had adopted the view that while it could veto reserve banks' decisions, it could not force them to change policy. Now, in a closely argued decision that also split the Board down the middle, it ruled that it did indeed possess the statutory authority to compel Chicago and the other intransigents to follow the majority. In the recriminations that followed, Crissinger resigned.

The two most vocal of Strong's critics happened to be out of town when the Fed decided to cut rates. Miller had left in the middle of July for two months' vacation in California, although he tried to exert every influence against the decision from afar. Hoover was in the South, managing relief operations to deal with the great Mississippi flood of that year. Returning in August, he submitted a stern memorandum to the Board, arguing that "inflation of credit is not the answer to European difficulties," and that "this speculation . . . can only land us on the sh.o.r.es of depression." He urged both the president and Secretary Mellon to act to forestall the Fed move. Coolidge, who had elevated inaction into a philosophical principle, had become increasingly irritated by his secretary of commerce's constant insistence not only that something must be done about everything but that he, Hoover, knew exactly what was needed. Coolidge would later complain, "That man has offered me unsolicited advice for six years, all of it bad!" Fobbing Hoover off with the excuse that the Fed was an independent agency, the president refused to intervene.

When Strong flippantly spoke to Rist of giving the stock market that pet.i.t coup de whisky, pet.i.t coup de whisky, in his wildest imagination he could not have foreseen the extent of the drunken ride that was to come. In 1925, he had kept money easy to help sterling, betting successfully that the stock market would remain under control. He was now trying the same gamble a second time. This time he was badly wrong. In August, following the Fed cut in rates, the market immediately took off. By the end of the year, the Dow had risen over 20 percent, breaking 200. In January 1928, the Fed revealed that the volume of broker loans had risen to a record $4.4 billion from $3.3 billion the previous year. in his wildest imagination he could not have foreseen the extent of the drunken ride that was to come. In 1925, he had kept money easy to help sterling, betting successfully that the stock market would remain under control. He was now trying the same gamble a second time. This time he was badly wrong. In August, following the Fed cut in rates, the market immediately took off. By the end of the year, the Dow had risen over 20 percent, breaking 200. In January 1928, the Fed revealed that the volume of broker loans had risen to a record $4.4 billion from $3.3 billion the previous year.

By early 1928, the calls on the Fed to do something about the market had become a clamor. The United States had come out of its brief recession, and for the first time since the war, gold was flowing into Europe. Even the pound seemed in better shape. In February 1928, Strong, recognizing that the cut might have been a mistake, bowed to pressure and agreed to reverse course. Over the next three months, the Fed raised its rates from 3.5 percent to 5 percent.

In 1931, Adolph Miller would testify before the Congress that the easing of credit in the middle of 1927 was "the greatest and boldest operation ever undertaken by the Federal Reserve System, . . . [resulting] in one of the most costly errors committed by it or any other banking system in the last years." Some historians, echoing the views of Hoover and Miller, see the meeting on Long Island as the pivotal moment, the turning point that set in train the fateful sequence of events that would eventually lead the world into depression. They argue that by artificially depressing interest rates in the United States to prop up the pound, the Fed helped fuel the stock bubble that subsequently led to the crash two years later.

It is hard to dismiss this view. Though the cut was small-only 0.5 percent off the level of interest rates-and short lived-reversed within six months-the fact that the market should begin the dizzying phase of its rally in the very same month, August 1927, that the easing took place has to be more than mere coincidence. The Fed's move was the spark that lit the forest fire.

As NORMAN TRAVELED back to England, he had every reason to be satisfied with the outcome on Long Island. He had achieved his primary goal of getting the Federal Reserve to support the pound by easing credit. Nevertheless, he had an uneasy feeling. It was clear that Strong was increasingly sympathetic to the French. Sounding like a jealous suitor vying for the attentions of a popular girl, Norman lamented that Strong "takes great interest in the Banque de France and has much personal liking and sympathy" for Charles Rist, which put Norman himself at "a disadvantage." But it was not simply that the Banque de France was beginning to supplant the Bank of England in the affections of the New York Fed. More important in Norman's mind was the central bankers' failure, as prices kept falling, to counter deflationary forces around the world. They had to find more permanent ways to keep "gold out of New York," and redistribute reserves more efficiently.

The summer of 1927 would prove to be the high point of Norman's influence. The modest Fed easing in August brought a temporary reprieve. Gold flowed into Britain. But he still faced the same old problems with France. In February 1928, Norman and Moreau clashed yet again. Romania, one of the last Central European economies to get its house in order, approached the club of central bankers for a loan. Norman a.s.sumed that the Bank of England would take charge of the operation, much as it had in the case of Austria and Hungary. But with French finances now strong, Moreau could see no reason why France should not resume its old position of authority in Central Europe. After all, before the war, Romania had been part of the traditional French sphere of influence. On February 6, 1928, as the power struggle over monetary leadership in Eastern Europe reached its head, he wrote in his diary, I had an important conversation with M. Poincare over the issue of the Bank of England's imperialism.I explained to the Prime Minister that since England was the first European country to recover a stable and reliable currency after the war, it had used this advantage to build the foundation for a veritable financial domination of Europe. . . .England has thus managed to install itself completely in Austria, Hungary, Belgium, Norway and Italy. It will implant itself next in Greece and Portugal. It is attempting to get a foothold in Yugoslavia and it is fighting us on the sly in Rumania.We now possess powerful means of exerting pressure on the Bank of England. Would it not be in order to have a serious discussion with Mr. Norman and attempt to divide Europe into two spheres of financial influence a.s.signed respectively to France and England?

On February 21, Moreau, irritated by the British "intrigues to prevent France from playing the dominant role" in Romania, arrived in London, declaring that he was going to "ask Norman to choose between peace and war." Norman, who hated outright confrontations, feigned illness at the last minute and begged off the meeting, leaving his directors to deal with the now doubly irritated Frenchman.

The Romanian issue, exacerbated by pettiness on both sides, threatened to escalate into a major diplomatic incident between the two great banks. Strong initially tried to act as a mediator but eventually came down on the side of the Banque de France. He was especially irritated by reports in European banking and political circles that his friend Norman was trying "to establish some sort of dictatorship over the central banks of Europe" and that Strong "was collaborating with him in such a program and supporting him." Norman had obviously taken advantage of their friendship to give everyone the impression that he had the Fed in his pocket.

By now, he had begun to regret his support for the doctrine that central banks be encouraged to hold pounds as a subst.i.tute for gold. The policy had allowed Britain to buoy its international position by using its status as a pivotal currency to postpone some hard choices. By avoiding an immediate crisis, the policy had set the stage for an even greater crisis in the future. As money continued to pour into France, the Banque had acc.u.mulated over a billion dollars worth of pounds, which at some point it would want to cash in for gold. Strong had some sympathy for its dilemma. The gold standard demanded that a central bank should allow all comers to switch their currency holdings freely into bullion. But unless Britain's position was to improve, such a move would completely drain the Bank of England's reserves and threaten the very viability of the gold standard.

He also began to realize that his policy of keeping U.S. interest rates low to bolster sterling had failed to solve the fundamental problem of the British economy-that its prices were too high and its currency overvalued. Furthermore, he had unintentionally provided the impetus for the growing bubble on Wall Street. And it had exposed him to constant criticism at home over his excessive focus on international affairs. That summer the Chicago Tribune Chicago Tribune denounced him for creating "speculation on the stock market that was growing . . . like a s...o...b..ll rolling down a hill" and called for his resignation. denounced him for creating "speculation on the stock market that was growing . . . like a s...o...b..ll rolling down a hill" and called for his resignation.

He was by now exhausted and disillusioned, particularly with the quarrelsome Europeans. His doctors warned him that if he wished to live, he could not continue to work. His lungs were failing. He was. .h.i.t by a bout of shingles that covered his face, temporarily blinding him in one eye and leaving only partial sight in the other. The virus brought on a severe case of neuritis and the ma.s.sive doses of morphine that cut back the pain sufficiently for him to work had destroyed his digestive system. The tuberculosis had come back in his left lung and, once more, he developed bronchial pneumonia.

In May 1928, Strong sailed for Europe. He had already decided to submit his resignation. Ironically, he seemed on the verge of finding some personal happiness. In 1926, his ex-wife Katharine had written to him, regretting her past mistakes and asking for reconciliation. He wrote back to say that would not be feasible, citing his illness as the reason. By 1928, however, he had begun a relationship with a much younger woman, an opera singer whom he intended to marry.

Deliberately avoiding London, he arrived at Cherbourg in the third week of May. Norman rushed over to see him. That last meeting was a difficult one. Losing his temper, Strong tried to make Norman see that he was his own worst enemy. He reminded his friend, in the "most vehement language" that Moreau's h.o.a.rd of sterling was a "sword of Damocles" over the Bank of England, making it "stupid beyond understanding" for Norman to pick a quarrel with the French when he was so "completely dependent upon the good will of the Bank of France." They parted on bad terms. Though Strong did write a letter over the summer to make up, he still grumbled to friends about Norman's obsessive scheming for power within Europe.

The strain of the quarrel with Strong and the tensions with the French had begun to tell on Norman's nerves. As the stresses grew, he withdrew more and more into himself, refusing to take his colleagues into his confidence. At one point, several frustrated senior directors of the Bank launched a campaign of noncooperation by pointedly refusing to speak at the weekly meetings of the Committee of the Treasury, the Court's policymaking group. Everyone remarked on the increased volatility of the governor's mood swings. "One moment he would be sunny and all smiles, the next, for no apparent reason his face would be like a thundercloud," recalled one colleague. He threw tantrums at the staff-in a fit of temper, he once flung an ink pot at Sir Ernest Harvey, the comptroller-and his bouts of "nervous exhaustion" seemed to become more frequent. In mid-February 1928, he collapsed and was bedridden for a few days. A week later, it happened again. In the middle of March he was forced to take three weeks off to recuperate in Madeira. A few weeks after that last difficult meeting at Cherbourg, he left for a three-month complete rest in South Africa and did not return to work until early September.

Strong spent a melancholy summer in France. After a few weeks in Paris, he went on to Evian and Gra.s.se, in the south of France. In July, he wrote to Norman of his decision to resign. "How hard and how cruel life is." Norman wrote back, "But what a stage ours has been over these ten or twelve years. . . . Your early dreams set a goal before a world, which was then so distracted as to be blind and incredulous. Now your dreams have come true."

After Strong returned to New York, on October 15, he underwent an operation to stem intestinal bleeding. The next day, he died in the hospital of a severe secondary hemorrhage. He was only fifty-five.

Norman took the blow very badly. "I am desolate and lonesome at Ben's sudden death," he wrote to a friend. They had been close for barely seven years. But in that time the friendship had become central to each of their lives. He would soon discover that Strong's death had not only robbed him of his best friend, but also of much of his power.