Lords of Finance

by Liaquat Ahamed

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

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

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

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

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

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

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

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

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

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

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

  Strong, though increasingly sympathetic to the French point of view—much to Norman’s discomfort—had arrived at the conference with his mind already made up. The only way to reduce selling pressure on the pound in the short run would be to cut U.S. interest rates. It helped that the domestic indicators he relied upon—price trends and economic activity—also justified a cut. And though he recognized that the stock market was a big stumbling block—he ruefully predicted to Charles Rist as the meeting got under way that a cut would give the market “un petit coup de whisky”—it was a risk he was willing to take.

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

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

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

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

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

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

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

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

  The summer of 1927 would prove to be the high point of Norman’s influence. The modest Fed easing in August brought a temporary reprieve. Gold flowed into Britain. But he still faced the same old problems with France. In February 1928, Norman and Moreau clashed yet again. Romania, one of the last Central European economies to get its house in order, approached the club of central bankers for a loan. Norman assumed that the Bank of England would take charge of the operation, much as it had in the case of Austria and Hungary. But with French finances now strong, Moreau could see no reason why France should not resume its old position of authority in Central Europe. After all, before the war, Romania had been part of the traditional French sphere of influence. On February 6, 1928, as the power struggle over monetary leadership in Eastern Europe reached its head, he wrote in his diary,

  I had an important conversation with M. Poincaré over the issue of the Bank of England’s imperialism.

  I explained to the Prime Minister that since England was the first European country to recover a stable and reliable currency after the war, it had used this advantage to build the foundation for a veritable financial domination of Europe. . . .

  England has thus managed to install itself completely in Austria, Hungary, Belgium, Norway and Italy. It will implant itself next in Greece and Portugal. It is attempting to get a foothold in Yugoslavia and it is fighting us on the sly in Rumania.

  We now possess powerful means of exerting pressure on the Bank of England. Would it not be in order to have a serious discussion with Mr. Norman and attempt to divide Europe into two spheres of financial influence assigned respectively to France and England?

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

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

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

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

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

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

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