Lords of Finance_ The Bankers Who Broke the World Part 14

Thus by the middle of 1930, while the official books gave the impression of a bank that had $250 million in deposits, $300 million in good quality a.s.sets and $50 million in equity, the operational reality behind these numbers was quite different. The true value of a.s.sets was worth no more than $220 million, all its equity had been wiped out, and the bank was $30 million in the hole.

In the fall of 1930, as rumors that the BUS might be in trouble circulated through the higher financial circles of New York, the Fed tried to engineer a merger with some of the other Jewish majority-owned banks in the city: the Manufacturers Trust, the Public National Bank, and the International Trust Company. The deal would have required the resignations of Marcus and his cronies who had presided over its mismanagement. But suspicion of Marcus within the financial community was so great that no one could bring themselves to trust the accounts, and the deal fell through at the last minute.

On the evening after the run began on December 10, all of the familiar Wall Street barons-George Harrison of the New York Fed, Thomas Lamont of J. P. Morgan, Albert Wiggin of Chase, Charles Mitch.e.l.l of National City, and another half dozen of the city's top bankers-gathered on the twelfth floor of the New York Fed to try to put together a rescue package. By 8:30 that evening they were close to striking a deal and Harrison had even begun preparing his press statement. To save the bank, they would collectively have to be willing to pump in $30 million. At the last moment, however, several key bankers balked.

These men had all been reared on Walter Bagehot's nineteenth-century cla.s.sic Lombard Street, Lombard Street, which described how the Bank of England, then the financial center of the world, handled financial crises and panics. Bagehot argued that during normal times a central bank should follow the gold standard rule book, allowing credit to expand and contract in line with bullion reserves. But in a financial crisis, it should throw away the rule book and "lend freely, boldly, and so that the public may feel you mean to go on." As he put it, "A panic . . . is a species of neuralgia, and according to the rules of science you must not starve it." In other words, a central bank had to be willing to inject as much money as was necessary to satisfy the public demand for cash and safe a.s.sets. which described how the Bank of England, then the financial center of the world, handled financial crises and panics. Bagehot argued that during normal times a central bank should follow the gold standard rule book, allowing credit to expand and contract in line with bullion reserves. But in a financial crisis, it should throw away the rule book and "lend freely, boldly, and so that the public may feel you mean to go on." As he put it, "A panic . . . is a species of neuralgia, and according to the rules of science you must not starve it." In other words, a central bank had to be willing to inject as much money as was necessary to satisfy the public demand for cash and safe a.s.sets.

But Bagehot did inject one caveat. Though he argued that in a panic the central bank should lend without hesitation or question, it should do so only to banks facing a temporary squeeze on liquidity and never to those actually insolvent. The problem this time was that the BUS was not just temporarily short of funds, it was insolvent and could not hope to cover its obligations.

There was another element involved in the decision not to bail out the Bank of United States, though it was unspoken. Marcus was a Jew and, moreover, a Jew of the wrong sort. There had always been a divide between the WASP houses and the Jewish houses on Wall Street. But firms such as Kuhn Loeb, Lehman Brothers, and J. W. Seligman represented "Our Crowd," the German Jewish elite, and for all the anti-Semitic bigotries of old dinosaurs like Jack Morgan, these firms were held in very high regard and viewed as reputable and very prestigious inst.i.tutions. But the Wall Street patricians gathering on the evening of December 10 would have found it hard to hide their distaste for bailing out a Jew like Marcus, an ex-garment manufacturer from the Lower East Side who was running a bank that, according to Thomas Lamont's son, Tommy, was patronized largely by "foreigners and Jews." Russell Leffingwell, the Morgan partner, described it as a bank "with a large clientele among our Jewish population of small merchants, and persons of small means and small education, from whom all the management were drawn."

When Joseph Broderick, the New York State superintendent of banks, learned of the decision, he insisted on coming to address the meeting. After being pointedly kept waiting until 1:00 a.m., he was finally admitted. He would testify later that "I told them that the Bank of United States occupied a rather unique position in New York City, that in point of people served it was probably the largest bank in the city and that its closing might affect a large number of smaller banks and that I was afraid that it would be the spark that would ignite the whole city." Broderick reminded the grandees that only two or three weeks before "they had rescued two of the largest private bankers in the city." One of them was Kidder Peabody, an investment bank run by Boston Brahmins, founded in 1865, which as result of the crash and of subsequent withdrawals of deposits by, among others, the government of Italy, had had to be bailed out in 1930 with $15 million from J. P. Morgan and Chase.

Though the meeting continued into the early hours of the morning, he was unable to persuade the few recalcitrants to change their mind. The Fed, believing that it could throw a ring fence around the BUS and prevent its troubles from spreading, decided to close the bank's doors the next morning. "I warned them that they were making the most colossal mistake in the banking history of New York," Broderick would later testify at a trial. Marcus and one of his lieutenants were tried, convicted, and sentenced to three years' imprisonment. Broderick was separately indicted for alleged negligence in not closing the bank earlier. The case ended in a mistrial; after a second trial, he was acquitted.

Dramatic as it was, the failure of the Bank of United States was in fact not that unusual. The United States had historically always suffered from an unstable banking system-the consequence of having no central bank compounded by an astoundingly fragmented banking structure. The creation of the Fed in 1913 had more or less solved the first problem, but did nothing to change the organization of banking in the country. During the 1920s, the United States was still populated with some 25,000 banks, many of them so tiny, undiversified, and dependent on the economic conditions of their localities that every year roughly 500 went under. In the first nine months of 1930, as a result of the deepening hard times, 700 had closed their doors. That October, two months before the BUS crisis, the terrible drought across the Midwest and South led to the collapse of the Tennessee investment bank, Caldwell and Company, which controlled the largest chain of banks in the South, leaving a string of failures in its wake-120 in all across Tennessee, Kentucky, Arkansas, and North Carolina.

After closing the BUS, the Fed did successfully manage to avoid a chain reaction among local banks. December 1930 and January 1931 saw a brief spike in bank runs in New York and Pennsylvania, but the sense of panic quickly died down. However, the failure of the BUS did mark a profound change in public sentiment toward banks.

Shaken by such a high-profile failure, depositors started becoming more cautious about where they placed their money. Unable to tell whether a bank was sound or not, they began pulling their cash indiscriminately out of all banks, good and bad. At first it was a mere ripple-in the months after the twin failures a total of $450 million dollars left the banking system, less than 1 percent of total deposits.

Because of the way banking works, however, such withdrawals had a negative multiplier effect. In an effort to maintain a prudent balance between their own liquidity and their loan portfolios, banks had to call in three or four dollars of loans for each dollar in cash withdrawn. Moreover, as their loans were called, borrowers in turn withdrew their deposits from other banks. The effect was to spread the scramble for liquidity right across the system. In this climate, all banks felt the need to protect themselves by building up cash reserves and thus called in even more loans. By the middle of 1931, bank credit had shrunk by almost $5 billion, equivalent to 10 percent of outstanding loans and investments.

FIGURE 7.

After a lull during the spring, in May 1931, the bank runs resumed. A real estate bubble in the Chicago suburbs collapsed, and thirty Chicago banks with $60 million in deposits were swept away. Over the summer, the virus spread to Toledo-every large bank but one was shut down; the remaining one being saved only when, at the last minute, trucks from the Federal Reserve Bank of Cleveland drew up at its doors laden with $11 million in crisp new currency notes. Seventy percent of the city's deposits were frozen, retail business came to a standstill, and even the Inverness Golf Club, scene of the most recent U.S. Open, was closed.

Within the Fed, officials were fully aware of the strains on the financial system-the h.o.a.rding of currency, the growing problem of bank failures, the reluctance of banks to lend, prices falling at a rate of 20 percent per annum. Somehow they were unable to put all these pieces of the jigsaw puzzle together. At the Federal Reserve Board, Meyer pressed for a more aggressive policy and even Adolph Miller, who with his natural contrarian streak seemed to end up so often in the minority, joined him. But the Board was legally powerless to initiate action.

Meanwhile, the governors of the various Federal Reserve banks, who could have taken the initiative, refused to act. A large number of the banks in trouble, particularly the small ones, were not members of the Federal Reserve System-only half of the twenty-five thousand banks in the country had joined the system, although they accounted for about three-quarters of all deposits. The regional bank governors did not feel any responsibility for these nonmember banks, despite their impact on the nation's overall supply of credit.

The real issue for the governors was that many of the banks closing their doors-by one estimate close to half-had sustained such large losses on their loans that they were, like the BUS, insolvent. Determined to follow Bagehot's rule of only lending to "sound" inst.i.tutions and believing that propping up failing banks would be throwing good money after bad, the regional governors made it a principle to let them go under. They failed to recognize that by doing so they were undermining public confidence in banks as a repository of savings and were causing the U.S. credit system to freeze up.

Strangely enough in the first quarter of 1931, as the world banking system was having to cope on one side with the h.o.a.rding of currency by a frightened American public and on the other by the piling up of gold bullion at the Fed and the Banque de France, the economy went through one of its little rebounds, both in the United States and across Europe. If the banking system can be compared, as it often is, to the plumbing of the world's economy, then the double drain of cash was like two invisible leaks. Their effects were not immediate and would only become apparent gradually.

It was during the spring of 1931 after Norman had returned from the United States that he wrote his infamous letter to Moret, foreseeing the wreck of "the capitalist system throughout the civilized world" within a year and asking that his prediction "be filed for future reference."48 He could sense that the world's credit supply was beginning to dry up. But he and his fellow central bankers had been unable to agree among themselves on what to do. Norman found himself increasingly without influence and powerless to act. The letter, a poor subst.i.tute for action, was undoubtedly shrugged off within the Banque de France as only old Montagu Norman going on about the end of Western civilization for the umpteenth time. He could sense that the world's credit supply was beginning to dry up. But he and his fellow central bankers had been unable to agree among themselves on what to do. Norman found himself increasingly without influence and powerless to act. The letter, a poor subst.i.tute for action, was undoubtedly shrugged off within the Banque de France as only old Montagu Norman going on about the end of Western civilization for the umpteenth time.

19. A LOOSE CANNON ON THE DECK OF THE WORLD.

1931.

Money has no motherland; financiers are without patriotism and without decency; their sole object is gain.

-NAPOLeON BONAPARTE

IN THE SPRING of 1931, the one major country most weighed down by a sense of collective despair and individual hopelessness was Germany. The official figures indicated that 4.7 million people, close to 25 percent of the workforce, double that in the United States, were without jobs. And this did not include another 2 million forced into part-time work. p.a.w.nshops multiplied as did astrologers, numerologists, and other charlatans. Even before Hoovervilles had become common in cities across America, shantytowns of tents and packing cases had sprung up in the parks and forests around Berlin. These camps, displaying the German gift for organization, soon had their own "mayors," "town councils," and community kitchens where women cooked turnips.

But then Germany, burdened by the twin problems of foreign debt and reparations, had been in a constant state of feverish turmoil ever since the middle of 1929. No sooner had the Young Plan been signed in Paris in July of that year, than the campaign to repudiate it had gone into high gear. A national committee led by Dr. Alfred Hugenberg, chairman of the right-wing German Nationalist Party-third largest in the Reichstag, where it held 73 seats out of a total of 491-was formed to organize a referendum on the plan. Known as the German Randolph Hearst, Hugenberg, a former chairman of the famed arms manufacturer Krupps, had branched out into the news business after the war and now controlled some of the country's largest papers, including Der Tag, Der Tag, the biggest movie production company, and the largest independent telegraph agency. the biggest movie production company, and the largest independent telegraph agency.

Norman and Schacht, 1935 Among those whom Hugenberg enlisted was Adolf Hitler, then still regarded as something of a joke, a minor figure from a fringe far-right group with an embarra.s.sing past as the leader of the 1923 "beer cellar Putsch Putsch." In the previous year's national elections, the n.a.z.is had won a bare 2.6 percent of the vote and only twelve seats in the Reichstag. They did, however, add their own distinctive brand of venom to the referendum campaign. Arguing that the Young Plan would submit Germany to "three generations of forced labor," they branded it a "Jewish machination" and a "a product of the Jewish spirit." The referendum, which would have required the government to renegotiate the repeal of the hated War Guilt clause, suspend all payments on reparations, and to make it a crime for any official to enter into any further agreement thereon, received 4,135,000 votes, a sign of the growing popular disenchantment with the policy of fulfillment.

No one provided a better weather vane for the shifting political winds than Hjalmar Schacht. The Young Plan negotiations left him disappointed and bitter. In the late 1920s, he and his old protector Gustav Stresemann had allowed Germany to borrow vast amounts of money from U.S. banks in the hope of forcing American involvement in the reparations question. Their strategy of binding the German republic to American money had, however, not paid off. In Schacht's view, the American bankers had failed to deliver. He and Stresemann had clearly exaggerated the power and influence of Wall Street to impose a resolution of the reparations issue.

In October 1929, three weeks before the Wall Street crash, Stresemann died suddenly of a stroke at only fifty-one, a victim of stress and overwork. After the grim letdown of the Young Plan negotiations and Stresemann's death, Schacht lost any remaining faith in the American solution.

He was now in a quandary. Disillusioned with the Americans, he was more willing to explore alternatives, including the unilateral repudiation being advanced by the nationalist right. But it was hard for him to jettison the Young Plan at this stage-after all, the doc.u.ment bore his signature-without looking like a shameless opportunist.

In November, during negotiations at The Hague, the German government agreed to modest adjustments to the Young Plan terms. In return, the Allies agreed to advance the date for withdrawing their remaining troops from the Rhineland, and reached a settlement on the status of German citizens in lands previously part of East Prussia but ceded to Poland at Versailles. The effect of all these modifications was to add some 4 to 5 percent to the Young Plan payments, amounting to about $25 million a year. The economic significance was trivial-nevertheless, it provided Schacht with just the excuse he needed to break with the government.

Moreover, as the German unemployment rolls kept rising, the cost of unemployment benefits mounted with them and the budget deficit kept increasing. The government, a grand coalition of all democratic parties led by the Socialist Hermann Muller, proposed to finance itself by more borrowing abroad. For Schacht, who had been on a campaign against excessive foreign debt since 1927, this was one more sign that a coalition that included the Socialists was incapable of governing Germany. Having failed to control either its spending or borrowing abroad during the good times, it was now repeating the mistake as times turned bad. He feared that Germany was heading for national bankruptcy.

On December 5, he dropped his bombsh.e.l.l on Berlin. Without warning he issued a public statement in which he accused the government in inflammatory language of "twisting" the Young Plan and failing to take the necessary steps to control its own finances. Declaring that it would be "self-deception" for the German people to believe that the nation could pay a pfennig more than it had agreed to in Paris, he publicly repudiated the plan's latest revisions. A few weeks later, he sabotaged the government's attempt to raise a loan in New York through the American investment house of Dillon Read.

Such an open declaration of war on the government by the head of the central bank in the middle of an economic crisis threatened to plunge the country into chaos. The government was barely able to survive financially and then only by tapping the loan from the munificent Ivar Kreuger.

The following weeks were a time of terrible stress for Schacht. While the ultimate severity of the coming Depression could not yet be foreseen, he could tell that after the Wall Street crash Germany was headed for a catastrophe and wished to avoid being buried by the coming disaster. And yet, if he resigned now, he would be giving up the most powerful economic position in Germany and stalking off into the political wilderness with no apparent way back. Having already alienated the right wing by signing the Young Plan, he was now falling out with the left and center by challenging the coalition's financial policy.

The tension of having to juggle all these competing considerations, some opportunistic, others heartfelt, began to tell. He seemed at times to be close to a breakdown. One foreign banker, meeting him in January 1930, described his paranoia as he ranted about how "he was about to be crucified by a gang of corrupt politicians." His old friend Parker Gilbert, increasingly baffled at such erratic behavior, could only say that he thought Schacht had gone "crazy."

The final and dramatic denouement occurred at an intergovernmental conference on the Young Plan that opened at The Hague in early January. Shaken by the demagoguery of the German Nationalist right and by Schacht's repudiation of the plan, the French revived the issue of what to do should Germany cease payment by introducing a new clause that in the event that Germany was held by the International Court at The Hague to have willfully defaulted on its obligations, the creditor powers would "recover full liberty of action" as envisaged by the Treaty of Versailles, a proposal that evoked memories of the occupation of the Ruhr in 1923, of French soldiers marching back into Germany.

Schacht had promised the government that though he had broken with it, he would do nothing to embarra.s.s Germany in an international forum. Once more his impulsiveness got the better of him. The new sanctions clause was a slap in Germany's face, representing a radical change in the "spirit" of the Young Plan. Though the Reichsbank was powerless to prevent the revised plan from going into effect, in order to register his protest "on the highest moral grounds," Schacht announced that it would refuse to subscribe a pfennig to the new Bank for International Settlements, declaring melodramatically that he "would stick to his position until he died."

The German delegation, led by the new foreign minister Julius Curtius, was furious. At a stormy closed-door meeting, Schacht was accused of fomenting "mutiny before the enemy," of grandstanding on an issue of no material importance, of using the issue as a political gambit aimed at rebuilding his credibility with the right-a rumor was circulating in Berlin that Schacht was contemplating a run for the presidency when Von Hindenburg, who was pushing eighty-five, retired in early 1932. It was, said the Times Times of London, an example of the sort of "flamboyant political moves which are expected of him." The left-leaning of London, an example of the sort of "flamboyant political moves which are expected of him." The left-leaning Die Welt Die Welt accused him of being "the head not only of a state within the State, but of a state above the State." accused him of being "the head not only of a state within the State, but of a state above the State."

The next day, however, he found himself outmaneuvered when the German delegation kept its nerve and proposed that if the Reichsbank refused to sign, the government would find a consortium of other German banks to subscribe the capital. Schacht's tendency to overplay his hand now undid him. He negotiated a face-saving formula under which the government would pa.s.s a law requiring the Reichsbank to subscribe, thus allowing him to declare that while he still thought the Young Plan an "immoral agreement," he was obliged as a good citizen to obey the "German law or else emigrate." Nevertheless, his histrionics at The Hague had put him in an untenable position. Back in Berlin, on March 7, he announced his resignation. "I will now become a country squire and raise pigs," he declared at a turbulent press conference where he lost his temper more than once at the journalists who questioned his motives for resigning a little too closely. One correspondent asked bewilderedly, "Dr. Schacht, is there any particular point to your resignation?" "My act has nothing to do with politics," replied an agitated Schacht. "It is merely the moral act of a self-respecting man."

The Vossische Zeitung Vossische Zeitung, the German national paper of record, equivalent to the Times Times or or Le Monde Le Monde, expressed the general sense of puzzlement in Berlin when it asked, "What is the actual reason for his resignation? n.o.body knows." Nevertheless, alert as ever to his own self-interest, Schacht did negotiate an attractive severance arrangement, waiving his annual pension for a lump sum of $250,000.

SCHACHT LEFT office believing that the Socialist-dominated coalition would lead Germany to financial disaster, precipitated by what he judged to be an inescapable foreign debt crisis. At this stage he still viewed Germany's problems through the prism of the 1920s; for him the central issue was that the country had profligately saddled itself with far too much foreign debt. The solution, he thought, was to curb government expenditure and avoid borrowing abroad. His recommendations were still very orthodox, designed to prevent an exchange crisis rather than to address the growing problem of unemployment.

Three weeks later, the government with which he had broken split over the unemployment question and fell, the Socialists wanting to finance an expansion in unemployment benefits by more foreign borrowing, the center parties to cut the budget deficit. A new center-right coalition, excluding the Socialists, took office and was led by a new chancellor, Heinrich Bruning, a dour Catholic, former army officer, and staunch monarchist.

Unable to get anything through a divided parliament, Bruning was forced to rule by decree, moving Germany in a more authoritarian direction by his reliance on the const.i.tution's provisions for emergency powers. Defeated in the Reichstag, he had Von Hindenburg dissolve it and hold new elections in September 1930, two years early. The results came as an ugly shock. In a campaign dominated by the deteriorating economy, Hitler appealed across cla.s.s lines, promising to reunite the nation, rebuild its prosperty, restore its position in the world, and purge the country of profiteers. He put a lid on some of his more extreme anti-Jewish rhetoric. Speaking at giant open-air rallies, many in sports stadiums lit by arrays of blazing torches, he mesmerized the tens of thousands who attended these events with his oratory. Meanwhile in the streets, his jack-booted paramilitary thugs, armed with truncheons and knuckledusters, clashed violently with Communists and Socialists. The n.a.z.is won 6.4 million votes, and vaulted into second place in the Reichstag with 107 seats.

The election panicked the financial markets; an estimated $380 million, about half of Germany's reserves, bolted. To halt the flight, the Reichsbank was forced to raise its rates, so that while in New York and Paris these stood at 2 percent, and in London at 3 percent, in Germany they went up to 5 percent. With prices falling at a rate of 7 percent per year, it meant that the effective cost of money had risen to 12 percent, gravely exacerbating the economic weakness.

As the economy lost ground, unemployment climbed, and the budget deficit widened, Bruning focused on balancing the budget. Unemployment benefits were restricted; salaries of all high federal and state officials, including the president's, were slashed by 20 percent. Wages of lower-level officials were cut 6 percent; income taxes were raised, taxes on beer and tobacco increased, and new levies imposed on warehouses and mineral water. All of these measures made the Depression worse.

Germany was unusual in the degree of deflation that the government imposed on the economy. In the United States, the Hoover administration had cut taxes and allowed the budget to go from a surplus of $1 billion in 1929 to a deficit of $2 billion in 1931, 4 percent of GDP. Britain ran a deficit of $600 million in 1931, 2.5 percent of GDP. By contrast in Germany, even though revenues fell as activity faltered, expenditures were cut even more, and the deficit was actually reduced from an already modest $200 million to $100 million, less than 1 percent of GDP.

Bruning, who was now being called the "Hunger Chancellor," would later claim that his austerity measures had been designed to prove to foreigners that Germany could no longer pay reparations, a reprise of the old perverse "hair-shirt" policy attempted in the early 1920s: to inflict so much damage on Germany's economy that her creditors would be forced to reduce their demands.

Historians have debated whether the government had any alternative. Borrowing abroad was not an option. By the middle of 1930, foreign lending throughout the world had collapsed. Moreover, Germany had borrowed so much during the boom years, living by the standards of the time so high on the hog that when bad times finally arrived and it really needed the money, it had exhausted its credit lines and loans were no longer available.

The problem was made much worse by one of the unintended consequences of the Young Plan. Under the Dawes Plan before it, private commercial lenders had priority over reparations at a time of crisis. In effect, Germany's public creditors, princ.i.p.ally the governments of France, Belgium, and Britain, had to stand last in line. The Young Plan's elimination of this "transfer protection," which incidentally Schacht had tried to resist, put an end to the guarantee. In the event of a payments crisis, private lenders did not automatically move to the front of the line but had to wait their turn with the big governments. Not surprisingly, private foreign lending to Germany collapsed.

No longer able to borrow abroad, Germany could only have avoided the Bruning austerity package if the government had borrowed from the Reichsbank-in other words, financed its budget deficit by printing money. But memories of the hyperinflation of the early 1920s were too fresh. Moreover, the Dawes and Young plans severely limited the Reichsbank's ability to buy government debt. The only way Germany could have followed such a policy was to cut loose from gold; and almost no one was ready for so drastic a move.

Out of office, Schacht was careful not to criticize Bruning's domestic policies, perhaps in the hope that he might return to power as part of a conservative Nationalist government. At the time, he did not realize how lucky he was. The new government adopted many of the austerity policies that he himself was advocating, with catastrophic results. But he was able to watch from the sidelines while the German economy fell apart, remaining free from any blame.

He could not, however, keep silent about reparations. The idea that the way to escape them was to inflict a terrible recession on Germany was to him completely absurd. Though he spent the first few months of his retirement at his estate at Guhlen, he quickly became frustrated at his confinement. In the summer of 1930, he embarked on a worldwide speaking tour, beginning in Bucharest, and thence to Berne, Copenhagen, and Stockholm. In September, he departed for two months to the United States.

He made something of a splash in America. With his pince-nez and his distinctive hair en brosse, en brosse, the "Iron Man" of Germany, as the "Iron Man" of Germany, as Time Time magazine labeled him, was immediately identifiable. He was certainly more familiar to the average reader of the London magazine labeled him, was immediately identifiable. He was certainly more familiar to the average reader of the London Times Times or the or the New York Times New York Times than any of the last few German chancellors. He traveled to over twenty cities, giving almost fifty talks to audiences of college students and professors, bankers and business a.s.sociations, at private clubs and in public meetings. than any of the last few German chancellors. He traveled to over twenty cities, giving almost fifty talks to audiences of college students and professors, bankers and business a.s.sociations, at private clubs and in public meetings.

Mostly he spoke about reparations, seeking to make his audiences understand German bitterness over the issue: "You must not think that if you treat people for ten years as the German people have been treated they will continue to smile." Germany, with its GDP of $16 billion, exports of $3 billion, and an overhang of private foreign debt now amounting to $6 billion, simply could not afford to pay $500 million a year to France and Britain. In Cincinnati, he declared, "Reparations are the real cause of the world-wide economic depression." Everywhere he went he was asked about the recent elections and Hitler. "If the German people are going to starve, there are going to be many more Hitlers," he would reply. Back in Europe, when a Swedish journalist asked him, "What would you do if you were to become Chancellor tomorrow?" Schacht replied with no hesitation, "I would stop making payments of reparations that very day."

In January 1931, he took his first tragic steps down the Faustian path. In December 1930, he had been introduced to Hermann Goring. Until then, despite his dealings with the Nationalist leader Hugenberg, he had had very little contact with the n.a.z.is, whom he would later claim to have dismissed as a fringe group of rabble mongers. Nevertheless, Schacht's wife was well known to hero-worship Hitler and was a devoted supporter of the party. In her diary, Bella Fromm, the diplomatic columnist of the Vossische Zeitung, Vossische Zeitung, recounts how she encountered the Schachts in February 1930 at the silver wedding reception of a prominent Berlin banker. Frau Schacht wore an expensive swastika of rubies and diamonds on her ample bosom and Fromm recorded the rumor that Schacht himself was "not above using the swastika as his insignia whenever he thinks it will suit his purpose." That night he even told her, "Why not give the National Socialists a break? They seem pretty smart to me." recounts how she encountered the Schachts in February 1930 at the silver wedding reception of a prominent Berlin banker. Frau Schacht wore an expensive swastika of rubies and diamonds on her ample bosom and Fromm recorded the rumor that Schacht himself was "not above using the swastika as his insignia whenever he thinks it will suit his purpose." That night he even told her, "Why not give the National Socialists a break? They seem pretty smart to me."

The conversation during his evening with Goring focused on the "economic situation, the rise in unemployment figures, the timidity of German foreign policy," and Schacht took to this "pleasant, urbane" man. On January 5, Goring invited Schacht, along with Fritz Thyssen, chairman of the giant United Steel Works, to meet Hitler at his modest apartment in a middle-cla.s.s neighborhood of Berlin-Goring did not yet have access to the government money that would allow him to become the corrupt voluptuary of later years. The n.a.z.i leader arrived after dinner dressed in the yellow and brown uniform of his paramilitary forces; Joseph Goebbels also showed up. Schacht admitted to being impressed. Hitler was surprisingly modest and unpretentious, especially for the leader of the second largest party in the country. During the next two hours, Hitler, "in spite of a hoa.r.s.e, somewhat broken and not infrequently croaking voice," dominated the discussion, doing 95 percent of the talking-about the restoration of Germany's position in the world, about the need to get the six and a half million unemployed back to work, and how this could only be done by state intervention. Hitler was articulate, speaking without any "propagandist pathos," but obviously "a born agitator." It was a fateful encounter for the fascinated banker.

ARNOLD TOYNBEE, IN his magisterial review of the year's events on behalf of the Royal Inst.i.tute of International Affairs, would later compare the events of the summer of 1931 to the summer of 1914. Both began with relatively minor events far from the hub of the world that nevertheless set in train a cascade that plunged out of all control and brought down an entire world order. In 1914, it was the a.s.sa.s.sination of the Austrian heir presumptive, the archduke Franz Ferdinand, at Sarajevo. In 1931, it was the failure of the Credit Anstalt, the oldest and largest bank in Austria.

On Friday, May 8, the Credit Anstalt, based in Vienna and founded in 1855 by the Rothschilds, with total a.s.sets of $250 million and 50 percent of the Austrian bank deposits, informed the government that it had been forced to book a loss of $20 million in its 1930 accounts, wiping out most of its equity. Not only was it Austria's biggest bank, it was the most reputable-its board, presided over by Baron Louis de Rothschild of the Vienna branch of the family, included representatives of the Bank of England, the Guaranty Trust Company of New York, and M. M. Warburg and Co. of Hamburg. After a frantic weekend of secret meetings, the government made the problem public on Monday, May 11, at the same time announcing a rescue package of $15 million dollars, which it would borrow through the BIS.

Austria was a small country, about a tenth the size of Germany, with a population of fewer than seven million and a GDP of $1.5 billion. Nevertheless, the news burst like a bombsh.e.l.l upon the City of London and the Bank of England. By an odd coincidence, Schacht was staying with Norman at Thorpe Lodge when the story broke. Harry Siepmann, one of the governor's princ.i.p.al senior advisers, knowing something of the scope of the tangled mess that lay behind the headlines, announced, "This, I think, is it, and it may well bring down the whole house of cards in which we have been living."

Like many German banks, the Credit Anstalt made direct investments in industry, similar to those of a modern private equity firm. It was, however, especially vulnerable not only because it borrowed short-term money to finance what were long-term, highly illiquid, investments but also because it had an unusually large amount of foreign borrowing on its books-some $75 million out of a total deposit base of $250 million.

It had grown over the last decade by absorbing a series of failing small banks and, in 1929, had been further "persuaded" by the Austrian National Bank to take over the Bodencreditanstalt, its next largest rival, whose losses turned out to be gigantic. In order to compensate Credit Anstalt for saving the Austrian banking system by taking on the burden of a such a large bankrupt inst.i.tution, the Austrian central bank had been funneling money secretly to it through London banks, a fact of which the Bank of England was well aware.

The announcement of the rescue package failed to stabilize the situation, perhaps because more people knew how deep the problems went than the government realized-when Credit Anstalt was finally wound up two years later, the acc.u.mulated losses amounted to $150 million. Over the next four days a run developed, not only on the Credit Anstalt but on all Austrian banks, which lost some $50 million in deposits, about 10 percent of the total. In an attempt to sh.o.r.e up its banking system, the Austrian National Bank followed Bagehot's principle and lent freely, injecting an extra $50 million, which caused an overnight jump of 20 percent in the national money supply.

Norman had a soft spot for Austria. After the war, he had provided it with the first loan to stabilize its currency-for his services to the country he had been awarded the Grosse Goldene Ehrenzeichen (Grand Decoration of Honor in Gold) from the Austrian amba.s.sador to the Court of Saint James, Baron Georg von und zu Franckenstein. For the next several days, having now discovered the remarkable advantages of international telephone calls, he was constantly on the line to Harrison in New York and Luther in Berlin. Fearing that a monetary breakdown in Austria would spread to neighboring countries, he was determined to mount an international rescue effort.

None of the central bankers had faced an international financial crisis before; they therefore had to make things up as they went along. In so doing they made two mistakes. Given the scale of the problem, they came up with far too little money; and believing that it was necessary to put together as international a consortium as possible, they did not act quickly enough. For all the frantic telephone calls, it took them three weeks to drum up the money, and then only came up with $15 million.

By the time the loans had been agreed to, the promised money had already been used up and the run on Austrian banks had become a run on the Austrian currency. The National Bank lost $40 million of its $110 million of gold reserves. Faced now with both a banking system under threat and a currency under siege, it now pleaded for another $20 million.

The crisis was made immeasurably more complicated by the politics of the situation. In March 1930, Germany and Austria had announced that they would form a customs union. Germany's neighbors, in particular the French and the Czechs, remembering that the nineteenth-century Zollverein, the historic customs union among the states of the German Confederation, had been a prelude to German unification, and fearing that this might be the first step to Anschluss Anschluss, union between Austria and Germany, had been agitating to block the move.

The French government now saw its opportunity. Indeed it helped to create it by secretly encouraging French banks to pull money out of Austria. By June 16, the situation was becoming more desperate by the hour. The cabinet, fearing the breakdown of law and order in Vienna, was on the verge of imposing a bank holiday. Austria was still waiting anxiously for the second loan when it received word that France had offered to provide it-but only if Austria would abandon the customs union. As if in an ultimatum, the Austrian government was given three hours to respond.

With its back to the wall, Austria might have accepted. In London, however, Norman was outraged at this blatant abuse of French monetary power in such a delicate financial situation and cabled that the Bank of England would provide the loan on its own. But if he thought he had succeeded in p.r.i.c.king the panic in its bud, he was mistaken.

ON JUNE 5, at 2.30 in the afternoon, Thomas Lamont put a call through to President Hoover. As soon as the Austrian crisis had broken, Germany had also begun to lose gold reserves. The contagion was not so much because Germany had a large amount of capital tied up in Austria, rather it was largely a matter of psychology. The world, which had never drawn much of a distinction between the banking situation in Berlin and that in Vienna, jumped to the conclusion that if the main Austrian bank was in such serious trouble, it was very possible that a German bank might soon follow. As money started escaping Germany, rumors circulated that Berlin might soon request a suspension of reparations. Lamont feared that to cope with the political turmoil and flight of capital that would ensue, Germany might impose exchange controls. With American inst.i.tutions holding about a billion dollars in short-term credits to Germany, such a move could threaten the solvency of more than one U.S. bank.

Saying that he was about to make a suggestion that the president would "more than likely throw out of the window," Lamont proposed that Hoover unilaterally declare a holiday on all payments on war debt and reparations. No European country could advance the idea, for it would immediately call into question its own credit, signaling to its creditors as he put it that "the jig is up." Only the United States was in a position to take the lead. Hoover was initially unconvinced. "I will think about the matter" he told Lamont, "but politically it is quite impossible. Sitting in New York as you do, you have no idea what the sentiment of the country at large is on these intergovernmental debts. . . . Congress sees France piling up lots of gold, increasing armaments. . . ."

Lamont tried to convince Hoover that it would actually help him politically. There were "a lot of people whispering about the 1932 convention," he warned, and such a dramatic move would quiet doubts about the beleaguered president's leadership. He signed off with the casual authority that went with being a senior partner at J. P Morgan & Co: "One last thing, Mr. President, if anything by any chance ever comes out of this suggestion, we should wish to be forgotten in the matter. This is your plan and n.o.body else's."

In response to Lamont's call, that same afternoon Hoover summoned his trio of senior advisers-Secretary of State Henry Stimson; Secretary of the Treasury Andrew Mellon; and Mellon's undersecretary, Ogden Mills-to work out a moratorium along Lamont's lines. Mellon declared his "unqualified disapproval" of such a move but left on vacation the very next day for Europe.

Stimson, however, was enthusiastic. A true American aristocrat, born into a wealthy New York family, a graduate of Phillips Academy in Andover, Yale and Harvard Law School, a member of Skull and Bones, and a partner in the white-shoe Manhattan law firm of Root and Clark, Stimson was the first of that breed of Wall Street wise men. He brought to the State Department a Victorian sense of propriety-he and his wife, for example, refused to receive divorced people in their home-and a strongly anti-isolationist international perspective. So committed was he to promoting goodwill among nations that when, in 1929, he discovered that the State Department's "Black Chamber" had been routinely breaking the coded communications between foreign emba.s.sies and their home governments, he immediately closed down the practice, arguing later that "gentlemen do not read each other's mail." Relying on his fellow Bonesman and internationalist, George Harrison of the New York Fed, to feed him advice on world finance, he had ever since taking office been an advocate of forgiving war debts.

On the very day that Hoover was proposing a moratorium to his cabinet colleagues, Chancellor Bruning had launched his own initiative. On June 5, he unveiled a new package of austerity moves that included a further lowering of civil servants' salaries, a cut in unemployment a.s.sistance, and new taxes. In order to sweeten the pill, Bruning accompanied the measures with a manifesto. Sensational and provocative in tone, the German proclamation announced that "the limit of privations that we can impose on the nation have been reached." The economic a.s.sumptions on which the Young Plan had been based had proved to be wrong, and thus "Germany had to be relieved of "the intolerable reparation obligations" and "tributary payments" to which it was subject.

That very weekend, Bruning was in London on a long-planned visit to the British prime minister, Ramsay MacDonald. The German delegation was spending the weekend at the prime minister's official country house, Chequers, in the Kent countryside, where Norman joined the party on Sunday, June 7. After a leisurely lunch for nineteen, which included such guests as John Galsworthy and George Bernard Shaw, both authors very popular in Germany, the officials withdrew to discuss financial issues. Bruning described the terrible situation in Germany. That year, when the Reichswehr needed six thousand new recruits, eighty thousand men applied, half of them undernourished. People were in despair. The social fabric was unraveling. The menace of n.a.z.i and Communist agitation was growing by the day.

While Bruning was holding forth, several frantic telegrams arrived from the British amba.s.sador in Washington, who had just heard from Stimson, who was infuriated by the manifesto's confrontational tone. On no account, warned the secretary of state, should the Germans take any unilateral action, which could only trigger a ma.s.sive flight of short-term funds out of Germany that would rob Hoover's planned moratorium, which was still a secret, of much of its benefit. The telegrams threw the British into shock. It was the first they had even heard of the manifesto, which had not even been published in the British newspapers. Their guests had omitted mentioning it, for it was a doc.u.ment designed for internal consumption and Bruning had no real plans to renegotiate reparations at least until the fall.

Any German move to suspend reparations now would be disastrous, Norman told the shaken table. Any more surprises like this to European confidence and we will soon be "conducting a post-mortem" on the corpse of Europe, he declared.

It was now a race. Could Hoover gather enough support for his initiative before Germany ran out of gold? In Washington, the temperature reached 102 as the teams at Treasury and State toiled eighteen-hour days to work out the details in offices that had no air-conditioning. They were besieged by New York bankers who "came crying down . . . and said they were busted," according to Stimson's economic adviser. Ogden Mills, acting as head of the Treasury in Mellon's absence, shuttled back and forth through the underground pa.s.sage that linked the Treasury Building to the White House to brief the president. Hoover himself was racked by doubts. The constant press criticism and the cynical jokes about his unpopularity had taken their toll. When H. G. Wells visited the White House later that fall, he found "a sickly, overworked and overwhelmed man." A siege mentality had taken over at the Executive Mansion. The president's gloom was so oppressive that Stimson complained that meeting with him in his room was "like sitting in a bath of ink."

Meanwhile during the first three weeks of June, Germany lost some $350 million, over half its gold reserves. In London, Norman spent the time cajoling British bankers not to pull their money out of Germany as currency and banking crises spilled across Europe into Hungary, Romania, Poland, and Spain.

On Sat.u.r.day, June 20, Hoover's plan was publicly announced. The United States would forgo one year's princ.i.p.al and interest of $245 million on the war debts due from Britain, France, Italy, and some of the smaller European powers, provided, and only provided, that the Allies themselves suspend $385 million in reparations due from Germany. The effect was electric. The following Monday, the German stock market jumped 25 percent in a single day.

Hoover had tried to consult everyone possible in the lead-up to his announcement-he was said to have already enlisted the support of twenty-one senators before publicly revealing the plan. Senator Arthur Vandenberg of Michigan, off junketing in Canada, was connected by phone to the president from a Toronto drugstore. Several senators and representatives had even been invited to spend the night at the White House. The secretary of state got up one morning at 5:30 a.m. to put a call through to Prime Minister MacDonald.

The administration had consulted everyone-everyone, that is, except the French. In the most astoundingly inept piece of diplomacy of his whole presidency, the one party Hoover neglected to prepare not only happened to be Germany's largest creditor but was at the moment the dominant financial power in Europe. The French government reacted with astonishment and then fury.

The U.S. amba.s.sador, Walter Edge, was due to spend the afternoon with the rest of the diplomatic corps at the Longchamps races as a guest of the president of the republic. He had spent his two years trying to dispel the suspicion within French government circles that "we [the Americans] and the British had been plotting against France." France had the world's largest standing army; with the second highest gold reserves in the world after the United States, it was financially the strongest country in Europe; its economy had weathered the global Depression better than almost any other. And yet, complained the men who ran France, the Anglo-Saxons still treated it as a mere second-rate power.

In the president's box at the races, Edge was peppered with questions by a phalanx of steaming French politicians. It was fine for the United States to forgive its debtors; but how could the United States unilaterally suspend Germany's debts to France without even bothering to consult France herself? She was being treated as a "stepchild." Pierre Laval, the prime minister, former Socialist now turned nationalist, demanded to know what guarantee the United States could provide that payments would resume after a year. Another minister launched into a highly colorful and sarcastic diatribe-France was being asked to pay the bill for the "reconciliation feast" in honor of the "prodigal Reich," while Wall Street and the City of London rejoiced over "the killing of the fatted calf." The foreign minister, Aristide Briand, called in Edge the next day to subject him to a tirade, singling out the Bank of England as the mainspring of the whole plot-he cited Norman's visit to the United States a few weeks earlier as inescapable confirmation of an Anglo-Saxon bankers' conspiracy.

The following Monday, the French press universally condemned any notion of a moratorium. The Journal des Debats Journal des Debats, the organ of French industry, said in a fume that "the more one reflects, the more one is stupefied by the initiative of Mr. Hoover."

In Washington, the president decided that Mellon, then in Britain to attend his son Paul's graduation ceremony from King's College, Cambridge, and to receive an honorary degree himself, his fifteenth, should be dispatched to Paris to bring the French around. For all that a world financial crisis was raging, Mellon had arrived in London and very deliberately avoided contacting any UK Treasury or Bank of England officials, believing that his vacation time was sacrosanct. When Norman tried to get in touch with him through his secretary in Washington, he was fobbed off with the excuse that Mellon was on a private visit and incommunicado. Finally, Norman got hold of young Mellon at Cambridge and tracked his father down at Claridges. After some persuading, Mellon reluctantly agreed to suspend his impending holiday at Cap Ferrat and go to Paris.

He arrived on June 25, to be greeted at the Gare du Nord by Robert Lacour-Gayet of the Banque de France. When asked, "Are you glad to be in Paris, Mr. Mellon?" the secretary of the treasury replied noncommittally with a barely perceptible smile, "M. Lacour-Gayet, we are here." Obviously unhappy, he kept reminding reporters that he had come to Europe planning on a pleasure trip in the Riviera with his daughter, Ailsa, and her husband, the young diplomat David Bruce.

For the next couple of weeks, Mellon engaged in a protracted bout of negotiation. Every day he would dutifully troop off with Amba.s.sador Edge to the ancient and musty building that housed the Ministry of the Interior and was also home to the French secret police. Mellon, who generally preferred a club sandwich at his desk, had to sit through the eight-course meals, each with its own wine, that were a customary part of French diplomacy.

The French team, who negotiated by day and had to sit though all-night sessions in the National a.s.sembly, was led by Prime Minister Laval. He was a protege of Tardieu, who had been compelled to resign in December, after becoming caught up in yet another banking scandal. At forty-six, Laval was the youngest premier in the history of the Third Republic. Born of peasant stock in the south of France, with his dark skin, straight black hair, and scraggly mustache, he looked "dopey in appearance, like an overworked headwaiter on his day off." He liked to wear dingy white bow ties and a straw boater.