Lords of Finance_ The Bankers Who Broke the World Part 13

The New York Sun New York Sun made the case that the crash would have a minimal impact on the economy, that Main Street could be decoupled from Wall Street. "No Iowa Farmer will tear up his mail order blank because Sears Roebuck stock slumped. No Manhattan housewife took the kettle off the stove because Consolidated Gas went down to 100. n.o.body put his car up for the winter because General Motors sold 40 points below the year's high." made the case that the crash would have a minimal impact on the economy, that Main Street could be decoupled from Wall Street. "No Iowa Farmer will tear up his mail order blank because Sears Roebuck stock slumped. No Manhattan housewife took the kettle off the stove because Consolidated Gas went down to 100. n.o.body put his car up for the winter because General Motors sold 40 points below the year's high."

Indeed, BusinessWeek, BusinessWeek, which had been one of the most vocal critics of the speculation on the way up, went one step further, insisting that the economy would be in even better shape now that the distracting bubble had burst. "For six years, American business has been diverting a substantial part of its attention, its energies and its resources on the speculative game. . . . Now that irrelevant, alien, and hazardous adventure is over. Business has come home again, back to its job, providentially unscathed, sound in wind and limb, financially stronger than ever before." which had been one of the most vocal critics of the speculation on the way up, went one step further, insisting that the economy would be in even better shape now that the distracting bubble had burst. "For six years, American business has been diverting a substantial part of its attention, its energies and its resources on the speculative game. . . . Now that irrelevant, alien, and hazardous adventure is over. Business has come home again, back to its job, providentially unscathed, sound in wind and limb, financially stronger than ever before."

The consensus, however, was that the crash would cause a transitory and mild business recession, particularly in luxury goods. B. C. Forbes, founder of Forbes Forbes magazine, thought that "just as the stock market profits stimulated the buying of all kinds of comforts and luxuries, so will the stock market losses inevitably have an opposite effect." magazine, thought that "just as the stock market profits stimulated the buying of all kinds of comforts and luxuries, so will the stock market losses inevitably have an opposite effect."

The immediate impact on the United States in fact proved to be much greater that anyone expected. Industrial production fell 5 percent in October and another 5 percent in November. Unemployment, which during the summer of 1929 had hovered at around 1.5 million, 3 percent of the workforce, shot up to close to 3 million by the spring of 1930. The country had become so emotionally invested in the vagaries of Wall Street that the psychological impact of the collapse turned out to be profound, particularly in consumer demand for expensive goods: the automobiles, radios, refrigerators, and other new products that had been at the heart of the boom. Car registrations across the country plummeted by 25 percent and radio sales in New York were said to have fallen by half.

The editor of the Economist, Economist, Francis Hirst, who had fallen ill on a trip to the United States and was convalescing in Atlantic City at year's end, captured the mood. "Rich people who have not sold their stocks Francis Hirst, who had fallen ill on a trip to the United States and was convalescing in Atlantic City at year's end, captured the mood. "Rich people who have not sold their stocks feel feel much poorer. . . . The first result therefore, has been a heavy decline in luxury buying of all sorts and also a large amount of selling of such things as motor cars and fur coats, which can now be bought secondhand at surprisingly low prices. The favored health resorts have suffered enormously . . . a very great number of servants, including butlers and chauffeurs, have been dismissed." much poorer. . . . The first result therefore, has been a heavy decline in luxury buying of all sorts and also a large amount of selling of such things as motor cars and fur coats, which can now be bought secondhand at surprisingly low prices. The favored health resorts have suffered enormously . . . a very great number of servants, including butlers and chauffeurs, have been dismissed."

Immediately after the crash, Hoover, who liked nothing better than emergencies, threw himself into action. He was one of the hardest-working presidents in the history of the office, at his desk by 8:30 a.m and still there into the early hours of the next morning. Within a month, his administration had pushed through an expansion in public works construction and submitted a proposal to Congress to cut the income tax rate by a flat 1.0 percent. The federal government, however, was then tiny-total expenditures amounted to $2.5 billion, only 2.5 percent of GDP-and the effect of the fiscal measures was to inject barely a few hundred million dollars, less than 0.5 of 1.0 percent of GDP into the economy.

Hoover had, therefore, to content himself with playing the part of chief economic cheerleader. Unfortunately, it was a role for which he was poorly suited. Shy, insecure, and stiff, he was ill at ease with people and surrounded himself with yes-men. He was also "const.i.tutionally gloomy," according to William Allen White, "a congenital pessimist who always saw the doleful side of any situation." Unable to inspire confidence or optimism, he resorted, according to the Nation Nation magazine, to "trying to conjure up the genie of prosperity by invocations" that things were about to get better. magazine, to "trying to conjure up the genie of prosperity by invocations" that things were about to get better.

On December 14, 1929, barely six weeks after the crash, he declared that the volume of shopping indicated that country was "back to normal." On March 7, 1930, he predicted that the worst effects would be over "during the next sixty days." Sixty days later he announced, "We have pa.s.sed the worst."

To some degree he was caught in a dilemma that all political leaders face when they p.r.o.nounce upon the economic situation. What they have to say about the economy affects its outcome-an a.n.a.logue to Heisenberg's principle. As a consequence, they have little choice but to restrict themselves to making fatuously positive statements which should never be taken seriously as forecasts.

The task of trying to talk the economy up was complicated by the fact that it did not go down in a straight line. At several points along the way it seemed to stabilize. After falling in the last few months of 1929, it found a footing in the early months of 1930. The stock market even rallied back above 290, a rebound of 20 percent. And the Harvard Economic Society, which was one of the few outfits to have predicted the recession, now argued that the worst had pa.s.sed. Clutching at whatever straws he could find, Hoover seized upon these brief interludes of good news, not realizing they were head fakes. In June 1930, when a delegation from the National Catholic Welfare Council came to see him to request an expansion in public works programs, he announced, "Gentlemen, you have come sixty days too late. The depression is over." That very month the economy began another down leg.

Eventually, when the facts refused to obey Hoover's forecasts, he started to make them up. He frequently claimed in press conferences that employment was on the rise when clearly it was not. The Census Bureau and the Labor Department, which were responsible for data on unemployment, found themselves under constant pressure to fudge their numbers. One expert quit in disgust over attempts by the administration to fix the figures. Finally, even the chief of the Bureau of Labor Statistics was forced into retirement when he publicly disagreed with the administration's official statements on unemployment.

In contrast to Hoover, Treasury Secretary Mellon refused even to make a show of joining the cheerleading. His view was that speculators who had lost money "deserved it" and should pay for their reckless behavior; the U.S. economy was fundamentally sound and would rebound of its own accord. In the meantime, he argued that the best policy was to "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. . . . It will purge the rottenness out of the system . . . . People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people."

One group who seemed to have taken Mellon's advice on liquidation to heart was the Russians. In 1930, desperately in need of foreign exchange, the Soviet government secretly decided to put its most treasured art works up for sale to its capitalist enemies. For Mellon, it was a once-in-a-lifetime opportunity to purchase a unique collection of art at throw-away prices, and he did not let it pa.s.s. Following a series of clandestine negotiations through art dealers in Berlin, London, and New York, Mellon arranged to purchase a total of twenty pieces. Each was a cloak-and-dagger operation. The money was wired to a dealer in Berlin, who placed it in a blocked account and paid out 10 percent to the Russians. Meanwhile, the pictures were surrept.i.tiously removed from the Hermitage, in Saint Petersburg, the surrounding paintings repositioned to disguise the disappearance. They were then handed over at a secret rendezvous and shipped to Berlin for transport to the United States. In this way, during 1930 and into the early months of 1931, the secretary of the treasury spent almost $7 million of his money buying up half of the Hermitage's greatest paintings. Among the paintings he bought were the Madonna of the House of Alba Madonna of the House of Alba by Raphael, the by Raphael, the Venus with the Mirror Venus with the Mirror by t.i.tian, the by t.i.tian, the Adoration of the Magi Adoration of the Magi by Botticelli, and by Botticelli, and The Turk The Turk by Rembrandt as well as several works by Van Eyck, Van Dyck, and Frans Hals. by Rembrandt as well as several works by Van Eyck, Van Dyck, and Frans Hals.

It was probably the greatest single art purchase of the century. Leaving mundane matters of economic policy to his deputy, Ogden Mills, Mellon became consumed by the whole transaction. On one occasion in September 1930, he was so engrossed in a discussion with one of his art dealers that he kept a group of bankers waiting for two hours.

With the federal government unable and unwilling to act-or in Mellon's case, perhaps otherwise occupied-the task of managing the declining economy fell almost entirely on the Fed. Between November 1929 and June 1930 the Fed eased monetary policy dramatically. It injected close to $500 million in cash into the banking system and cut rates from 6.0 percent to 2.5 percent-mostly the work of Harrison in New York. The Board in Washington only grudgingly registered the full force of what had happened. Not only did Harrison have to deal with its constant delaying tactics, but he also faced outright resistance from the majority of his fellow governors of the regional reserve banks-seven out of the twelve of them, from Boston, Philadelphia, Chicago, Kansas City, Minneapolis, Dallas, and San Francisco, opposed his attempts at a vigorous easing.

Most governors feared that "artificial" attempts to stimulate the economy by injecting liquidity into the banking system would not jump-start business activity, but just touch off another bout of speculation. Too much cheap credit had created the original bubble in the first place. Now that it had been p.r.i.c.ked and stock prices were falling to more reasonable levels, why short-circuit the process, they asked, by making credit too cheap once again. As one argued, further easing would only result in a replay of the "1927 experiment, now quite generally . . . admitted to have been disastrous." The recession was a direct consequence of the past overspeculation, during which money had been thrown down absurd and uneconomic avenues. The only way to return to a healthy economy was to allow it to suffer for a while, a form of penance for the excesses of the last few years.

Because the notion of an active monetary policy to combat the business cycle was so novel and the knowledge of how the economy worked so primitive, debates among the various factions within the Fed became highly confused and at times even incomprehensible. In September 1930, Governor Norris, an otherwise highly competent and respected banker, found himself arguing at a Fed meeting that by easing interest rates, they had their policy backward. "We have been putting out credit, in a period of depression, when it was not wanted and could not be used, and will have to withdraw credit when it is wanted and can be used." He failed to recognize that the logic of his premise would have led him to the oddly perverse recommendation that the Fed should contract credit in a depression so that it might supply lots of it during a boom.

Without a common vocabulary for expressing ideas, Fed officials resorted to a.n.a.logies. One of the governors likened any attempt by the Fed to revive the economy to a band desperately trying to keep the music going at a "marathon dance." On another occasion, he compared it to a physician's trying to bring a dead patient "back to life through the use of artificial respiration or injections of adrenalin."

In the early summer, the Fed stopped easing. It proved to be a mistake. For just as it went on hold, the economy embarked on a second down leg, industrial production falling by almost 10 percent between June and October. There is some debate about Harrison's reasons. Some argue that he thought he had done enough. Having staved off catastrophe by pumping a large amount of money into the system and cutting rates to an unprecedented low level, he believed that he had been as aggressive as he could. Others argue that he was operating with what might be called a faulty speedometer for gauging monetary policy. The usual indicators that he relied upon suggested that conditions were very easy-short-term rates were truly low and banks flush with excess cash. The problem was that some of these measures were now giving off the wrong signals. For example, when banks overflowed with surplus cash, this was generally an index, in a more stable and settled economic environment, the Fed had pushed more than enough reserves into the system to restart it. In 1930, however, in the wake of the crash, banks had begun carrying larger cash balances as a precaution against further disasters, and excess bank reserves were more a symptom of how gun-shy banks had become and less how easy the Fed had been.

IN SEPTEMBER 1930, Roy Young resigned as chairman of the Federal Reserve Board to become the head of the Boston Fed, a position that not only paid two and a half times as much-$30,000 as compared to $12,000-but also carried some executive authority. Finding replacements on the Board had never been easy; in the middle of a growing depression, it was doubly hard. Luckily Hoover had exactly the right candidate and promptly phoned his old friend, the noted banker and government financier Eugene Meyer, to offer him the job, saying, "I won't take no for an answer," and hung up without even waiting for a reply. He did not have to. He knew his man.

Few people were more enthusiastic or better prepared to take on the task of running the Federal Reserve than Meyer, a complete contrast to the second-rate figures who had so far inhabited the Board. A successful financier, he had acc.u.mulated a large fortune by the age of thirty-five, had run not one but two government-backed financial inst.i.tutions, and unlike most bankers, believed very strongly in activist government policy and a more expansionary Fed policy to reverse the slide in the economy and halt deflation.

Meyer had been born in California, the son of Marc Meyer, a self-made man who had become a partner in the investment house of Lazard Freres. After graduating from Yale in 1895, he, too, went to work at Lazards, but quit in 1901, embarking on his own as a Wall Street speculator. He cleaned up during the 1907 panic, and by 1916 had ama.s.sed a fortune of $40 to $50 million.

He came to Washington in 1917 as a dollar-a-year man working for Woodrow Wilson, and had stayed on, becoming director of the War Finance Corporation and then head of the Federal Farm Loan Board. A larger-than-life figure, he commuted between a grand house on Crescent Place off Sixteenth Street, full of Cezannes and Monets and Ming vases; a seven-hundred-acre estate in Mount Kisco in New York; a six-hundred-acre cattle farm in Jackson Hole, Wyoming; and a plantation in Virginia. His wife, Agnes, a difficult egocentric woman who put him through a rocky and unhappy marriage, ran the most fashionable salon in Washington, where poets, painters, and musicians might mingle with politicians and bankers.45 Meyer's was not an uncontroversial nomination-Huey Long, the populist governor of Louisiana, declared he was nothing but "an ordinary tin-pot bucket shop operator up in Wall Street . . . not even a legitimate banker." His confirmation hearings proved to be difficult. Senator Brookhart of Iowa came out against him, calling him a "Judas Iscariot . . . one who has worked the Shylock game for the interests of big business"-for all his wealth, he had had to struggle with anti-Semitism throughout his career.

If there was anyone who seemed capable of reversing the paralysis of the Fed, it was Meyer. Yet, even he was soon overwhelmed. He found a Board racked by petty intrigues and feuds. Adolph Miller was at war with Charles James. Some of the old guard, such as Hamlin, resented Meyer and thought that he was too closely identified with the president.

The system of decision making and authority within the Fed, complex as it had been, had become even more byzantine. During Strong's time, decisions about how much to inject into the banking system through open market purchases of government securities had been taken by the five-member Open Market Investment Committee (OMIC), comprising the governors of the Federal Reserve Banks of Boston, New York, Philadelphia, Chicago, and Cleveland. Strong, therefore, had to persuade only two others to get a majority vote his way.

In January 1930, policy decisions for open market operations were shifted to a new twelve-man Open Market Policy Conference (OPMC), consisting of all the governors of the reserve banks. Each of these, of course, had to refer to his own nine-member board of directors. The old five-member committee (OMIC), renamed the Executive Committee of the OPMC, retained responsibility for execution. Now three separate groups were jockeying for power-one body, the OPMC, could initiate policy but could not execute; another, the Board, had to approve policy decisions but could not initiate them; and a third, the Executive Committee of the OPMC, implemented decisions within certain discretionary limits. At each stage policy could be vetoed or stymied. As a consequence, even though the two most prominent members of the Fed, Harrison and Meyer, both believed that it should be more aggressive, they were defeated by the system.

THE GREAT CRASH was greeted in Europe with a combination of schadenfreude and relief. According to the New York Times New York Times, Black Thursday's "panicky selling left London's City in a comfortable position saying, 'I told you so.'" Contacted by the New York Evening Post New York Evening Post that same day, Maynard Keynes commented that "we in Great Britain can't help heaving a big sigh of relief at what seems like the removal of an incubus which has been lying heavily on the business life of the whole world outside America." The Wall Street collapse was, according to one French authority, like the bursting of an "abscess." The hope was that all the European capital that had been sucked into Wall Street would return home, alleviating the pressure on European gold reserves, and allowing such countries as Britain and Germany to ease credit and restart their economies. that same day, Maynard Keynes commented that "we in Great Britain can't help heaving a big sigh of relief at what seems like the removal of an incubus which has been lying heavily on the business life of the whole world outside America." The Wall Street collapse was, according to one French authority, like the bursting of an "abscess." The hope was that all the European capital that had been sucked into Wall Street would return home, alleviating the pressure on European gold reserves, and allowing such countries as Britain and Germany to ease credit and restart their economies.

Much to his delight, emile Moreau had not had to miss the fall hunting season in Saint Leomer that year. By the last week of October 1929, he and Hjalmar Schacht were at the Black Forest spa of Baden-Baden attending an international bankers' conference to finalize the Young Plan and draw up the by-laws of the newly created Bank for International Settlements. Schacht learned of the events on Wall Street when he happened to notice the American delegation looking especially glum on the morning of October 29 and could hardly contain his glee when he discovered the reason. To a visiting Swiss banker, he announced that he hoped that the coming chaos would finally put an end to reparations.

But of all the central bankers in Europe, Montagu Norman was the most relieved. The crash had arrived just in time to rescue sterling. Convinced that it had been the rise in British interest rates on September 26 that finally burst the bubble, he started claiming credit for the collapse. So relaxed was he about the events on Wall Street, that on the morning of October 29, Black Tuesday, while the financial world was falling apart, he kept his usual appointment for a sitting with artist Augustus John, who had been commissioned by the Bank of England to paint his portrait.

During the last week of October and the first weeks of November, George Harrison kept him in touch with developments on Wall Street by cable and transatlantic telephone, his voice drifting in and out under the usual atmospherics. On October 31, Harrison called to announce cheerfully that the market had pretty much completed its fall; the bubble had been p.r.i.c.ked without a single bank failure.

For the first few months, things went according to plan. European stock markets dropped in sympathy with Wall Street, but not having gone up so much, they fell much less precipitously. While the U.S. market slid almost 40 percent, Britain's went down 16 percent, Germany's 14 percent, and France's only 11 percent. Though the size of the British stock market was comparable as a percentage of GDP to that in the United States, the average British person preferred to bet on sports and left the stock market to the City bigwigs, while in France and Germany the size of the stock markets was tiny. Thus the crash did not exert the same hold on the psychology of European consumers and investors, and the effect on their economies was correspondingly less traumatic. Moreover, as credit conditions eased in the United States, foreign lending revived. Money suddenly became more freely available. Central banks across Europe, no longer having to defend their gold reserves against the pull of New York, were able to follow the Federal Reserve in cutting interest rates. By June 1930, with U.S. rates at their postwar low of 2.5 percent, the Bank of England was down to 3.5 percent, the Reichsbank to 4.5 percent, and the Banque de France to 2.5 percent.

Just as the threat of having to fight off an attack on sterling receded, Norman found himself hara.s.sed from another, and completely unexpected, quarter. In November 1929, a few weeks after the crash, the new British Labor government responded to criticisms about the endemically poor performance of the British economy by appointing a select committee under an eminent judge, Lord Macmillan, to investigate the workings of the British banking system. Half of its fourteen members were bankers; the remainder, an a.s.sortment of economists, journalists, industrialists, among them three of the staunchest critics of the gold standard: Maynard Keynes, Reginald McKenna, and Ernest Bevin of the Transport and General Workers Union, the country's most formidable trade union leader.

In setting up this committee, the allegedly radical government had made it clear that the issue of whether Britain should remain on the gold standard should be kept off the table. Even Keynes, the unremitting critic of the mechanism and the strains it had imposed on the British economy, was ready to concede that it was a fait accompli and that departing from gold at this stage would be just too disruptive.

Nevertheless, the Bank of England-and especially Norman-approached the committee with great suspicion. Within the City, it had always been said that the motto of the Bank of England was "Never explain, never apologize." That he and the Bank were now to be subject to the spotlight of public scrutiny filled him with dread. The committee began its hearings on November 28; Norman was to appear as one of the first witnesses, on December 5. As the date approached, his nervous ailments reappeared, and two days before he was due to testify, he predictably collapsed. His doctors recommended a short leave of absence and Norman duly departed for the next two months on an extended cruise around the Mediterranean, ending up in Egypt.

In place of Norman, the deputy governor, Sir Ernest Harvey, appeared. Even without its chief, the Bank found its habits of secrecy just too ingrained to abandon lightly. Consider this exchange between Keynes and Harvey:

KEYNES: "Arising from Professor Gregory's questions, is it a practice of the Bank of England never to explain what its policy is?"

HARVEY: "Well, I think it has been our practice to leave our actions to explain our policy."

KEYNES: "Or the reasons for its policy?"

HARVEY: "It is a dangerous thing to start to give reasons."

KEYNES: "Or to defend itself against criticism?"

HARVEY: "As regards criticism, I am afraid, though the Committee may not all agree, we do not admit there is need for defense; to defend ourselves is somewhat akin to a lady starting to defend her virtue."

Norman finally returned in England in February 1930 and agreed to provide evidence to the select committee. He was not a good witness. Witty and articulate in private, he became sullen and defensive in public settings, replying to the questions, which in deference to his position were never aggressive, in curt sentences and sometimes even in monosyllables. Unaccustomed to having to articulate his thought processes or justify himself, he said things that he did not mean or could not possibly believe, insisting, at one point, that there was no connection between the Bank's credit policies and the level of unemployment. He appeared to be callous and indifferent to the plight of the unemployed, reinforcing the stereotype of bankers among the Socialists of the new government and the voting public who were getting their first glimpse of this man. Confronted with Keynes's coldly precise questions, Norman seemed to be dull and slow, retreating behind plat.i.tudes.

Finally asked by the chairman what the reasons were for a particular policy decision, he initially said nothing but simply tapped the side of his nose three times. When pressed, he replied, "Reasons, Mr. Chairman? I don't have reasons. I have instincts."

The chairman patiently tried to probe further, "We understand that, of course, Mr. Governor, nevertheless you must have had some reasons."

"Well, if I had I have forgotten them."

Keynes would later describe Norman as looking like "an artist, sitting with his cloak round him hunched up, saying, 'I can't remember,' thus evading all questions." Norman testified for only two days-the bank's senior staff realized that he was doing more harm than good, and the remainder of the testimony was pa.s.sed back to the deputy governor. But the damage to Norman's standing had been done. In the aftermath, one banker confided to his colleagues that the governor "grows more and more temperamental, freakish, and paradoxical."

18. MAGNETO TROUBLE.

1930-31.

To what extremes won't you compel our hearts, you accursed l.u.s.t for gold?

-Virgil, The Aeneid

IN December 1930, Maynard Keynes published an article t.i.tled "The Great Slump of 1930," in which he described the world as living in "the shadow of one of the greatest economic catastrophes of modern history." During the previous year, industrial production had fallen 30 percent in the United States, 25 percent in Germany, and 20 percent in Britain. Over 5 million men were looking for work in the United States, another 4.5 million in Germany, and 2 million in Britain. Commodity prices across the world had collapsed-coffee, cotton, rubber, and wheat prices having fallen by more than 50 percent since the stock market crash. Three of the largest primary producing countries, Brazil, Argentina, and Australia, had left the gold standard and let their currencies devalue. In the industrial world, wholesale prices had fallen by 15 percent and consumer prices by 7 percent.

Despite all this bad news, at this stage Keynes was uncharacteristically sanguine. "We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand," he wrote. Comparing the economy to a stalled car, he declared it was a simple matter of some "magneto trouble" (a magneto was a device then commonly in use for creating an electric spark in the ignition system of automobiles), trouble that could be easily cured by "resolute action" by the central banks to "start the machine again."

There were in fact reasonable grounds for optimism. The downturn that had hit the United States in 1930 in the wake of the stock market crash had indeed been deep, but the U.S. economy had faced a similarly sharp decline in prices and production in 1921 and had bounced back. There had been as yet no major financial disaster or bankruptcy.

Keynes did recognize that it was hard for any single central bank to act alone. To jump-start the economy, a central bank had to have enough gold, the underlying raw material for credit creation under the gold standard. The international monetary system was now operating, however, in a very perverse way. Because of investor fear, capital in search of security was flowing into those countries with already large gold reserves-such as the United States and France-and out of countries with only modest reserves-such as Britain and Germany.

As it had been during the 1920s, the United States was major haven for gold flows. Far more damaging than the effect of the protectionist Smoot-Hawley Act was the collapse in capital flows. After a brief revival early in 1930, U.S. foreign investment into Europe suddenly dried to a trickle. American bankers became risk averse and cautious and, claiming that it was hard to find creditworthy borrowers, pulled in their horns. With American capital bottled up at home and U.S. demand for European goods shrinking-a result of the weak U.S. economy and of higher import tariffs imposed in June 1930 by the Smoot-Hawley Act-Europe could only pay for its imports and service its debts in gold. During 1930, a total of $300 million in bullion was shipped across the Atlantic into the vaults of the Federal Reserve system.46 Even more disruptive to international stability, however, was the flow of gold into France, the one country in Europe that had somehow remained immune from the world economic storm. emile Moreau's strategy of keeping the franc pegged at a low rate had meant that French goods remained attractively priced. As a result the economy held up very well in 1929 and 1930, and capital, in search of safety, started flooding into France: a total of $500 million of gold during 1930. It was one of the startling ironies of that whole period that France, viewed by bankers in the years after the war as irresponsible and suspect, had now become the world's financial safe haven. By the end of 1930, the Banque de France, in addition to the $1 billion it held in sterling and dollar deposits, had acc.u.mulated a gold reserve mountain of over $2 billion, three times that of the Bank of England. French officials, who only a few years before had been quick to blame their woes on the work of international currency "speculators," now began touting the superior wisdom of these selfsame "investors" for the votes of confidence they had cast on French economic management.

While everywhere else in the global economy consumers and businesses were cutting back and slashing their budgets, in France, money remained easily available and people continued to spend. French commentators were calling their country L'ile Heureuse. In the summer of 1930, Paris was still full of tourists, and business at Au Printemps, the famed Parisian department store, was booming. The contrast with its neighbors could not have been greater. While in Germany 4.5 million men were on the dole and in Britain 2 million, in France only 190,000 men were collecting unemployment benefits. And while prices across the rest of the world were dropping like stones, in France they continued to rise. French commentators were calling their country L'ile Heureuse. In the summer of 1930, Paris was still full of tourists, and business at Au Printemps, the famed Parisian department store, was booming. The contrast with its neighbors could not have been greater. While in Germany 4.5 million men were on the dole and in Britain 2 million, in France only 190,000 men were collecting unemployment benefits. And while prices across the rest of the world were dropping like stones, in France they continued to rise.

Quite without knowing what it was doing, France had backed into the position of the strongest economy in Europe. After a decade of suffering an inferiority complex created by the combination of "the war . . . fear of Germany [and] the franc's fall," it responded to its unexpected good for-was tune with an outburst of self-congratulation. According to the prime minister, Andre Tardieu, France, having successfully navigated the economic storm, was admired by the whole for its "harmonious economic structure . . . the natural prudence of the French people, their ability to adapt, their modernity and their courage." Tardieu, with his bejeweled pince-nez and his gold cigarette holder, his boulevardier taste in silk hats and fancy waistcoats, his fondness for raffish company, his involvement before the age of thirty-five in at least two financial scandals, was the embodiment of all that the British despised about French politicians. That this "glittering new embodiment of Gallic self confidence" could now lecture the world about prudence and indulge in his nation's habit of attributing its successes to the innate and inestimable advantages of French civilization profoundly irritated France's neighbors.

FIGURE 6.

British commentators, unable to understand why commodity prices kept falling, why, despite the ma.s.sive cuts in interest rates, production in their own country kept dropping and unemployment rising, blamed the operation of the gold standard as the primary cause of world depression, especially the role played by the Federal Reserve and the Banque de France. By the end of the year, the United States and France, between them, held 60 percent of the world's gold, and neither was doing anything to recirculate it.

The French came in especially for blame for starving the world of liquidity by short-circuiting the gold standard mechanism. Paul Einzig, author of the influential Lombard Street column for the Financial News, Financial News, wrote that it was "the French gold h.o.a.rding policy which brought about the slump in commodity prices, which in turn was the main cause of the economic depression; that it is the unwillingness of France to cooperate with other nations which has aggravated the depression into a violent crisis." Similarly, the prominent Swedish economist, Gustav Ca.s.sell, the primary exponent of the view that world deflation in commodity prices reflected insufficient circulation of gold, argued, "The Banque de France has consistently and unnecessarily acquired enormous amounts of gold without troubling in the least about the consequences that such a procedure is bound to have on the rest of the world, and therefore on the world economic position." wrote that it was "the French gold h.o.a.rding policy which brought about the slump in commodity prices, which in turn was the main cause of the economic depression; that it is the unwillingness of France to cooperate with other nations which has aggravated the depression into a violent crisis." Similarly, the prominent Swedish economist, Gustav Ca.s.sell, the primary exponent of the view that world deflation in commodity prices reflected insufficient circulation of gold, argued, "The Banque de France has consistently and unnecessarily acquired enormous amounts of gold without troubling in the least about the consequences that such a procedure is bound to have on the rest of the world, and therefore on the world economic position."

By the end of 1930, the Banque de France had begun to understand that this acc.u.mulation of gold was harming the rest of the world by starving it of reserves. It was especially damaging because of the idiosyncrasies of the French banking system. In most countries, banks worked to make every dollar of gold support a multiple of that amount in currency and credit. The French banking system, however, was unusually inefficient in putting its bullion to use. As a result, the newly arrived $500 million of gold was translated into less than $250 million in circulating currency.

French officials claimed that there was little they could do about this buildup, that the high demand for gold in France was a consequence of the rural character of the country or the innate thriftiness and risk aversion of its citizenry. In fact, it was clear that during 1930, the Banque under emile Moreau had been very consciously and deliberately offsetting-the technical term was sterilizing sterilizing-the natural tendency of an influx of gold to expand the currency, lest it lead to inflation. With prices around the world collapsing, this may sound strange, but it was a symptom of how badly scarred he and other French officials had been by the currency crises of 1924 and 1926.

Unknown to most people, much of the gold that had supposedly flown into France was actually sitting in London. Bullion was so heavy-a seventeen-inch cube weighs about a ton-that instead of shipping crates of it across hundreds of miles from one country to another and paying high insurance costs, central banks had taken to "earmarking" the metal, that is, keeping it in the same vault but simply re-registering its ownership. Thus the decline in Britain's gold reserves and their acc.u.mulation in France and the United States was accomplished by a group of men descending into the vaults of the Bank of England, loading some bars of bullion onto a low wooden truck with small rubber tires, trundling them thirty feet across the room to the other wall, and offloading them, though not before attaching some white name tags indicating that the gold now belonged to the Banque de France or the Federal Reserve Bank.47 That the world was being subject to a progressively tightening squeeze on credit just because there happened to be too much gold on one side of the vault and not enough on the other provoked Lord d'Abernon, Britain's amba.s.sador to Germany after the war and now an elder statesmen-economist, to exclaim, "This depression is the stupidest and most gratuitous in history." That the world was being subject to a progressively tightening squeeze on credit just because there happened to be too much gold on one side of the vault and not enough on the other provoked Lord d'Abernon, Britain's amba.s.sador to Germany after the war and now an elder statesmen-economist, to exclaim, "This depression is the stupidest and most gratuitous in history."

As the French h.o.a.rd kept piling up during the summer and fall of 1930-and with it tensions between Britain and France-the French went through the motions of proposing remedies. The return of French gold policy to the forefront of economic debate was too much for Norman. He happy to deal with the Americans, but having had his fingers burned by his experience with Moreau in 1927, he absolutely refused to have anything to do with French officialdom.

Instead, he wisely left it up to the British Treasury to try to negotiate with their counterparts in the Ministry of Finance. These conversations led nowhere. Indeed, they brought out the worst in the characters of both countries. The British insisted upon patronizing lectures on the primitive nature and deficiencies of the French banking system, without any sense that they themselves would have found such advice from abroad intrusive and insulting.

It soon became clear that France was motivated not so much by economic arguments but by strategic calculations. French officials tried to use their financial muscle to extract political concessions-money to them not being its own reward. Even the French Military High Command became involved. General Requin, a senior adviser to Minister of Defense Andre Maginot, wrote to General Weygand, chief of the General Staff, urging that France "lean on England while the pound is at our mercy. . . . We can make her understand . . . that if she wants our help as a lender, other questions must first be settled."

In September 1930, it was suddenly announced that Moreau was resigning. This had been rumored in Paris for months, but it still came as a great shock in British banking circles. Initially the talk was that he was being forced out by British pressure and that his departure might foreshadow a change in French policy.

In fact, having presided over the recovery of the franc, he had just been decorated as Grand Officier de la Legion d'Honneur and decided himself that it would be a good time to go. He was simply following the age-old practice in France whereby senior civil servants, unusually poorly paid by international standards, move to the private sector to build up a nest egg. He had accepted the position of vice president of the Banque de Paris et Pays-Bas, the most prominent of the private banques d'affaires, banques d'affaires, a distinctively French type of banking house that combined security underwriting with direct investments in industry. Indeed, he had already moved out of the official apartment a.s.signed to him as governor, which despite its "sumptuous tr.i.m.m.i.n.gs" was lit by kerosene lamps, had especially "antiquated heating," and smelled of "a miser's snuggery," into a magnificent a distinctively French type of banking house that combined security underwriting with direct investments in industry. Indeed, he had already moved out of the official apartment a.s.signed to him as governor, which despite its "sumptuous tr.i.m.m.i.n.gs" was lit by kerosene lamps, had especially "antiquated heating," and smelled of "a miser's snuggery," into a magnificent hotel particulier, hotel particulier, a large town house on the Rue de Constantine opposite Les Invalides. a large town house on the Rue de Constantine opposite Les Invalides.

He was succeeded by his deputy, Clement Moret, like Moreau a graduate in law, who had then gone on to Sciences Po, and also on to the Ministry of Finance-Moret, however, was not part of the elite Inspectorat des Finances. Instead, the self-effacing Moret had spent twenty-five years clambering up the Ministry of Finance hierarchy. Plucked from obscurity by Poincare, who described him as "abnormally honest," Moret had become a director general within the ministry and in 1928 had been a.s.signed to the Banque as deputy governor.

He was of a different generation-at the age of forty-five the youngest man to be appointed governor. And in contrast to Moreau, who had been blunt to the point of rudeness, Moret was courteous and thoughtful. But though there was a change in style at the Banque, there was to be no change in the substance of policy. Indeed, Moret thought of himself, even more than had Moreau, as a civil servant and the Banque de France as essentially an arm of the state. He did propose that if the goal was to redirect gold reserves from France to Britain, the British government should borrow directly in France. Of course, lacking any a.s.surance that the pound would remain stable, such a loan would have to be denominated in francs. For Norman, who thought that it was contrary to the "prestige" of London even to appear to "ask favors from the French," this would have been the ultimate humiliation. And so, as a combination of British pride and heavy-handedness locked horns with French selfishness and arrogance, the French gold mountain kept growing.

Norman instead latched onto a grandiose plan that, it was claimed, would provide a "blood transfusion" to cure the Depression. An international bank, a sort of forerunner of the World Bank, was to be set up and headquartered in a neutral country, Switzerland or the Netherlands, with capital of $250 million. It would be able to borrow another $750 million primarily in gold-rich France and America, which would be channeled to governments and businesses around the world in need of capital. Norman rolled it out at the February 1931 monthly meeting in Basel of the BIS, which had become a sort of club for central bankers. They would gather there on a Sunday night, have an informal and private dinner together, and spend the next day in meetings. Even before the wining and dining was over-for the monthly meetings at Basel would become a byword for good food-it was clear that the plan would go nowhere. Neither the French nor the Americans were willing to hand over large amounts of money to an internationally run organization likely to be dominated by Englishmen.

The following month Norman sailed for the United States, which he had not visited since the summer of 1929. It was obvious that in the intervening two years the American press had greatly missed him. From the very start, following the suddenly announced mission of what the New York Times New York Times called "England's elusive master banker" and "man of mystery," vaguely hinting that some great initiative to solve the world Depression was in the offing, they would not leave Norman alone. From his departure aboard the called "England's elusive master banker" and "man of mystery," vaguely hinting that some great initiative to solve the world Depression was in the offing, they would not leave Norman alone. From his departure aboard the Berengaria Berengaria on March 21, he was followed everywhere on his "secret mission" and his movements-his meetings at the New York Fed, attended by even the secretary of state, Henry Stimson; his trip to Washington; his visit to the White House; lunch with Secretary of the Treasury Mellon-were all examined in minute detail. He put on a wonderful performance, hamming it up for the crowd of reporters that pursued him. Looking more like "an orchestra leader than a banker of such eminence," he wished them "better luck next time" when they tried to extract the purpose of his visit. When they begged him for some tidbit of insight into the world financial situation, he teased them by gravely announcing that he thought the recent departure of King Alfonso of Spain into exile would have no effect on international finance. But for all the frenetic schedule of meetings, even his most devoted followers among the press had the suspicion that there was much less there than met the eye. on March 21, he was followed everywhere on his "secret mission" and his movements-his meetings at the New York Fed, attended by even the secretary of state, Henry Stimson; his trip to Washington; his visit to the White House; lunch with Secretary of the Treasury Mellon-were all examined in minute detail. He put on a wonderful performance, hamming it up for the crowd of reporters that pursued him. Looking more like "an orchestra leader than a banker of such eminence," he wished them "better luck next time" when they tried to extract the purpose of his visit. When they begged him for some tidbit of insight into the world financial situation, he teased them by gravely announcing that he thought the recent departure of King Alfonso of Spain into exile would have no effect on international finance. But for all the frenetic schedule of meetings, even his most devoted followers among the press had the suspicion that there was much less there than met the eye.

Even before Norman had arrived in the United States, J. P. Morgan & Co., usually his biggest supporter, had signaled that it had no intention of backing an "artificial" agency or any "form of international organization of credit." The New York Fed had cabled that it thought the whole scheme too "visionary and inflationary."

Norman tried to convince his American hosts of the "very gloomy situation" of Europe. The only hope for Britain now was a savage reduction in wages. In Eastern and Central Europe the position was even more desperate. "Russia was the very greatest of dangers," he told Stimson. Germany and Eastern Europe were not receiving enough "help from the capitalist system to stand the expense of remaining capitalist . . . and all the time while they wobbled and wavered Russia was beckoning to them to come over to her system." The specter of communism, which would persuade a later generation of Americans to pour vast amounts of money into Europe, did not have the same potency in 1931.

The United States was in a depression of its own, had over the previous seventeen years already committed some $15 billion to Europe, including war loans, and was eager to avoid any further entanglements across the Atlantic. Norman returned empty-handed. In May, when Thomas Lamont was pa.s.sing through London, Norman complained to him that the "U.S. was blind and taking no steps to save the world and the gold standard."

It was becoming apparent to most commentators that the continued flow of gold into France would eventually create a breakdown in the mechanism of international payments. As usual, Keynes put it the most graphically, "Almost throughout the world, gold has been withdrawn from circulation. It no longer pa.s.ses from hand to hand, and the touch of the metal has been taken from men's greedy palms. The little household G.o.ds, who dwelt in purses and stockings and tin boxes, have been swallowed by a single golden image in each country, which lives underground and is not seen. Gold is out of sight-gone back into the soil. But when the G.o.ds are no longer seen in a yellow panoply walking the earth, we begin to rationalize them; and it is not long before there is nothing left." The bullion reserves that backed the credit systems of the world, buried as they were in underground vaults-or in the case of the Banque de France, underwater, because its vaults lay below a subterranean aquifer-were invisible to the public eye. They had acquired an almost metaphysical existence. Keynes thought that perhaps gold, its usefulness now outlived, might become less important. He compared the situation to the transition in government from absolute to const.i.tutional monarchy. He would eventually be proved right but not before a wrenching upheaval.

IN EARLY 1931, a similar insidious process of paralysis also began to affect the U.S. banking system. It originated in the most unlikely of places-the Bronx, one of the outer boroughs of New York City-with the strangely named Bank of United States (BUS), which despite its official-sounding t.i.tle bore no relationship to the U.S. government but traced its very modest roots to the garment industry on the Lower East Side of Manhattan.

On the morning of December 10, 1930, a small merchant from the Morrisania section of the Bronx went to his local branch of the Bank of United States on the corner of Freeman Street and Southern Boulevard and asked that the bank buy back his modest holdings of its stock. This was not as strange a request as it sounds. In the middle of 1929, the bank had set out to support the value of its shares by selling them to its own depositors. As an inducement, investors were given informal a.s.surances that they could sell the stock back to the bank at the original purchase price-around $200 a share. If this sounds too good to be true, it was; but in the middle of 1929, people were willing to believe anything. By the fall of 1930, after the collapse on Wall Street and amid mounting concerns about the economic situation of New York, shares were trading at around $40.

Officials at the Bronx branch tried to convince the exigent depositor that he should hold on to his stock, that even at current prices it remained an excellent investment. No doubt irritated at this obvious attempt to renege on a clear promise, he stormed out and began reporting that the bank was in trouble. By the afternoon, a small horde of depositors had begun lining up outside the branch's tiny neocla.s.sical limestone building to withdraw their savings before closing time. Until now, despite the Depression, there had been no bank runs in New York, and soon a crowd of twenty thousand curious bystanders had gathered to watch. As the anxious depositors became restless, a squad of mounted police had to be sent in to control them and several customers were arrested; and when the mob became frantic, the police charged the crowd with their horses.

The Bank of United States had fifty-seven branches across the four larger boroughs of New York, and over four hundred thousand individual depositors, more than any other bank in the country. Rumors of the trouble quickly swept the city and similar scenes were enacted that afternoon at many other branches, with armored trucks being called in to deliver extra cash.

The bank had been founded in 1913 by Joseph S. Marcus, a Russian Jewish immigrant who had come to the United States in 1879, and having begun as a garment worker on Ca.n.a.l Street, had made good as a manufacturer of clothing and then as a local banker. The first branch of his bank, located on the corner of Orchard and Delancey Street, catered to the neighborhood's mostly Jewish garment workers and merchants. As a result of Marcus's reputation among the Lower East Side traders for honesty and fair dealing, the bank had done well, although it was undoubtedly helped by the name, which gave many of its Yiddish-speaking clients the impression that it was somehow backed by the full faith and credit of the national government. By the time the older Marcus died in 1927, the bank had grown into an inst.i.tution with $100 million in a.s.sets, a head office at 320 Fifth Avenue, and seven branches across the city. But its officers and its clientele remained predominantly Jewish, and it was snidely nicknamed "The Pants Pressers' Bank."

When Joseph Marcus died, the bank was taken over by his son Bernard Marcus, a brilliant but flamboyant businessman with a taste for conspicuous consumption far removed from his father's modest ways. When, for instance, Bernard went to Europe, he traveled with thirty pieces of luggage and always insisted on occupying the grandest suite on board ship. Over the next two years, he expanded his base through a series of mergers so that by 1929 it had grown to $250 million in a.s.sets.

Marcus resorted to a series of practices considered shady, even by the lax standards of the time. The bank lent some $16 million, a third of its capital, to officers of the company and their relatives to allow them to buy its stock. To finance its headlong growth-the bank more than doubled in size in two years-Marcus issued large slabs of equity, which he committed to buy back at the original price of $200. When the price began to fall in the spring and summer of 1929, many investors held Marcus to his guarantees. In order to take up all the stock coming on the market, he created a series of affiliate companies-in today's parlance, off-balance-sheet special-purpose vehicles-that repurchased the equity with money borrowed from the bank itself. Marcus was in effect using depositors' money to support the shares of his bank.

In its lending policy, the bank made a big bet on the value of New York City real estate. Half its loan portfolio, double that of comparable firms, went into real estate finance, though again the true exposure was hidden by channeling money through affiliate companies. When the crash hit, the bank was committed to two big projects on Central Park West: $5 million for the Beresford, a twenty-story building at Eighty-second Street with over 170 apartments and another $4 million for the San Remo on Seventy-fourth with 120. Though it was rumored that Marcus himself owned these two developments, his interest in them was disguised through dummy corporations, and every single penny for their construction came from the bank.