In early 1930, the Fed launched a massive cheap-money program, lowering rediscount rates during the year from 4.5 percent to 2 percent, with acceptance rates and call loan rates falling similarly. The Fed purchased $218 million in government securities, increasing total member bank reserves by over $100 million. The money supply, however, remained stable and did not increase, due to the bank failures of late 1930. The inflationists were not satisfied, however, Business Week (then as now a voice for “enlightened” business opinion) thundering in late October that the “deflationists” were “in the saddle.” In contrast, H. Parker Willis, in an editorial in the New York Journal of Commerce, trenchantly pointed out that the easy-money policy of the Fed was actually bringing about the bank failures, because of the banks’ “inability to liquidate.” Willis noted that the country was suffering from frozen and wasteful malinvestments in plants, buildings, and other capital, and that the depression could only be cured when these unsound credit positions were allowed to liquidate.107
In 1930, Montagu Norman got part of his wish to achieve a formal intercentral bank collaboration. Norman was able to push through a new “central bankers’ bank,” the Bank for International Settlements (BIS), to meet regularly at Basle, to provide clearing facilities for German reparations payments, and to provide regular facilities for meeting and cooperation. While Congress forbade the Fed from formally joining the BIS, the New York Fed and the Morgan interests worked closely with the new bank. The BIS, indeed, treated the New York Fed as if it were the central bank of the United States. Gates W. McGarrah resigned his post as chairman of the board of the New York Fed in February 1930 to assume the position of president of the BIS, and Jackson E. Reynolds, a director of the New York Fed, was chairman of the BIS’s first organizing committee. J.P. Morgan and Company unsurprisingly supplied much of the capital for the BIS. And even though there was no legislative sanction for U.S. participation in the bank, New York Fed Governor George Harrison made a “regular business trip” abroad in the fall to confer with the other central bankers, and the New York Fed extended loans to the BIS during 1931.
During 1931, many of the European banks, swollen by unsound credit expansion, met their comeuppance. In October 1929, the important Austrian bank, the Boden-Kredit-Anstalt, was headed for liquidation. Instead of allowing the bank to fold and liquidate, international finance, headed by the Rothschilds and the Morgans, bailed the bank out. The Boden bank was merged into the older and stronger Österreichische-Kredit-Anstalt, now by far the largest commercial bank in Austria, capital being provided by an international financial syndicate including J.P. Morgan and Rothschild of Vienna. Moreover, the Austrian government guaranteed some of the Boden bank’s assets.
But the now-huge Kredit-Anstalt was weakened by the merger, and, in May 1931, a run developed on the bank, led by French bankers angered by the announced customs union between Germany and Austria. Despite aid to the Kredit-Anstalt by the Bank of England, Rothschild of Vienna, and the BIS (aided by the New York Fed and other central banks), to a total of over $31 million, and the Austrian government’s guarantee of Kredit-Anstalt liabilities up to $150 million, bank runs, once launched, are irresistible, and so Austria went off the gold standard, in effect, declaring national bankruptcy in June 1931. At that point, a fierce run began on the German banks, the Bank for International Settlements again trying to shore up Germany by arranging a $100 million loan to the Reichsbank, a credit joined in by the Bank of England, the Bank of France, the New York Fed, and several other central banks. But the run on the German banks, both from the German people as well as from foreign creditors, proved devastating. By mid-July, the German banking system collapsed from internal runs, and Germany went off the gold standard. Since the German public feared runaway inflation above all else and identified the cause of the inflation as exchange-rate devaluation, the German government felt it had to maintain the par value of the mark, now highly overvalued relative to gold. To do so, while at the same time resuming inflationary credit expansion, the German government had to “protect” the mark by severe and thoroughgoing exchange controls.
With the successful runs on Austria and Germany, it was clear that England would be the next to suffer a worldwide lack of confidence in its currency, including runs on gold. Sure enough, in mid-July, sterling redemption in gold became severe, and the Bank of England lost $125 million in gold in nine days in late July.
The remedy to such a situation under the classical gold standard was very clear: a sharp rise in bank rate to tighten English money and to attract gold and foreign capital to stay or flow back into England. In classical gold standard crises, the bank had raised its bank rate to 9 or 10 percent until the crises passed. And yet, so wedded was England to cheap money, that it entered the crisis in mid-July at the absurdly low bank rate of 2.5 percent, and grudgingly raised the rate only to 4.5 percent by the end of July, keeping the rate at this low level until it finally threw in the towel and, on the black Sunday of September 20, went off the very gold-exchange standard that it recently had foisted upon the rest of the world. Indeed, instead of tightening money, the Bank of England made the pound shakier still by inflating credit further. Thus, in the last two weeks of July, the Bank of England purchased nearly $115 million in government securities.
England disgracefully threw in the towel even as foreign central banks tried to prop the Bank of England up and save the gold-exchange standard. Answering Norman’s pleas, the Bank of France and the New York Fed each loaned the Bank of England $125 million on August 1, and then, later in August, another $400 million provided by a consortium of French and American bankers. All this aid was allowed to go down the drain on the altar of inflationism and a 4.5-percent bank rate. As Dr. Anderson concluded,
England went off the gold standard with Bank Rate at 4.5 percent. To a British banker in 1913, this would have been an incredible thing.... The collapse of the gold standard in England was absolutely unnecessary. It was the product of prolonged violation of gold standard rules, and, even at the end, it could have been averted by the return to orthodox gold standard methods.108
England betrayed not only the countries that aided the pound, but also the countries it had cajoled into adopting the gold-exchange standard in the 1920s. It also specifically betrayed those banks it had persuaded to keep huge sterling balances in London: specifically, the Netherlands Bank and the Bank of France. Indeed, on Friday, September 18, Dr. G. Vissering, head of the Netherlands Bank, phoned Monty Norman and asked him about the crisis of sterling. Vissering, who was poised to withdraw massive sterling balances from London, was assured without qualification by his old friend Norman that, England would, at all costs, remain on the gold standard. Two days later, England betrayed its word. The Netherlands Bank suffered severe losses.109 The Netherlands Bank was strongly criticized by the Dutch government for keeping its balances in sterling until it was too late. In its own defense, the bank quoted repeated assurances from the Bank of England about the safety of foreign funds in London. The bank made it clear that it was betrayed and deceived by the Bank of England.110
The Bank of France also suffered severely from the British betrayal, losing about $95 million. Despite its misgivings, it had loyally supported the English gold-standard system by allowing sterling balances to pile up. The Bank of France sold no sterling until after England went off gold; by September 1931, it had amassed a sterling portfolio of $300 million, one-fifth of France’s monetary reserves. In fact, during the period of 1928–31, the sterling portfolio of the Bank of France was at times equal to two-thirds of the entire gold reserve of the Bank of England.
Despite Montagu Norman, who began to blame the French government for his own egregious failure, it was not the French authorities who put pressure on sterling in 1931. On the contrary, it was the shrewd private French investors and commercial banks, who, correctly sensing the weakness of sterling and the British refusal to employ orthodox measures in its support, decided to make a run on the pound in exchange f
or gold.111 The run was aggravated by the glaring fact that Britain had a chronic import deficit, and also was scarcely in a position to save the gold standard through tight money when the British government, at the end of July, projected a massive fiscal 1932–33 deficit of £120 million, the largest since 1920. Attempts in September to cut the budget were overridden by union strikes, and even by a short-lived sit-down strike by British naval personnel, which convinced foreigners that Britain would not take sufficient measures to defend the pound.
In his memoirs, the economist Moritz J. Bonn neatly summed up the significance of England’s action in September 1931:
September 20, 1931, was the end of an age. It was the last day of the age of economic liberalism in which Great Britain had been the leader of the world.... Now the whole edifice had crashed. The slogan “safe as the Bank of England” no longer had any meaning. The Bank of England had gone into default. For the first time in history a great creditor country had devalued its currency, and by so doing had inflicted heavy losses on all those who had trusted it.112
As soon as England went off the gold standard, the pound fell by 30 percent. It is ironic that, after all the travail Britain had put the world through, the pound fell to a level, $3.40, that might have been viable if she had originally returned to gold at that rate. Twenty-five countries followed Britain off gold and onto floating, and devaluating, exchange rates. The era of the gold-exchange standard was over.
EPILOGUE
The world was now plunged into a monetary chaos of fiat money, competing devaluation, exchange controls, and warring monetary and trade blocs, accompanied by a network of protectionist restrictions. These warring blocs played an important though neglected part in paving the way for World War II. This trend toward monetary and other economic nationalism was accentuated when the United States, the last bastion of the gold-coin standard, devalued the dollar and went off that standard in 1933. The Franklin Roosevelt branch of the family had always been close to its neighbors the Astors and Harrimans, and American politics, since the turn of the twentieth century, had been marked by an often bitter financial and political rivalry between the House of Morgan on the one hand, and an alliance of the Harrimans, the Rockefellers, and Kuhn, Loeb on the other. Accordingly, the early years of the Roosevelt New Deal were marked by a comprehensive and successful assault on the House of Morgan, that is, in the Glass-Steagall Act, outlawing Morgan-type integration of commercial and investment banking. In contrast to the Morgan dominance during the Republican era of the 1920s, the early New Deal was dominated by an alliance of the Harrimans, Rockefellers, and various retailers, farm groups, the silver bloc, and industries producing for retail sales (for example, automobiles and typewriters), all of whom were now backing an inflationist and economic nationalist program. When the British, backed by the Morgans, convened a World Economic Conference in London in June 1933, to try to restabilize exchange rates, the plan was scuttled at the last minute by President Roosevelt, under the influence of the inflationist-economic nationalist bloc. The Morgans were taking a shellacking at home and abroad.
It was only in 1936, by the good offices of leading Morgan banker Norman Davis, a longtime friend of Roosevelt’s, and of Democrat Morgan partner Russell Leffingwell, that the Morgans would begin to recoup their political losses. The beginning of the return of the Morgans was symbolized by the September 1936 Tripartite Monetary Agreement, partially stabilizing the exchange rates of the currencies of Britain, France, and the U.S., a collaboration that was soon extended to Belgium, Holland, and Switzerland. These agreements, in addition to the dollar’s still remaining on an international (but not domestic) gold bullion standard at $35 an ounce, set the stage for the Morgan drive organized by Norman Davis, head of Morgan’s Council of Foreign Relations, to bring a new world gold-exchange standard out of the cauldron of World War II. The difference is that this inflationary “Bretton Woods” system would be a dollar, not a sterling, gold-exchange standard. Moreover, this inflationary system under the cloak of the prestige of gold, was destined to last a great deal longer than the British venture, finally collapsing at the end of the 1960s.113
PART 5
THE NEW DEAL AND THE INTERNATIONAL MONETARY SYSTEM
THE NEW DEAL AND THE INTERNATIONAL MONETARY SYSTEM
The international monetary policies of the New Deal may be divided into two decisive and determining actions, one at the beginning of the New Deal and the other at its end. The first was the decision, in early 1933, to opt for domestic inflation and monetary nationalism, a course that helped steer the entire world onto a similar path during the remainder of the decade. The second was the thrust, during World War II, to reconstitute an international monetary order, this time built on the dollar as the world’s “key” and crucial currency. If we wished to use lurid terminology, we might call these a decision for dollar nationalism and dollar imperialism respectively.
THE BACKGROUND OF THE 1920S
It is impossible to understand the first New Deal decision for dollar nationalism without setting that choice in the monetary world of the 1920s, from which the New Deal emerged. Similarly, it is impossible to understand the monetary system of the 1920s without reference to the pre–World War I monetary order and its breakup during the war; for the world of the 1920s was an attempt to reconstitute an international monetary order, seemingly one quite similar to the status quo ante, but actually based on very different principles and institutions.
The prewar monetary order was genuinely “international”; that is, world money rested not on paper tickets issued by one or more governments but on a genuine economic commodity— gold—whose supply rested on market supply-and-demand principles. In short, the international gold standard was the monetary equivalent and corollary of international free trade in commodities. It was a method of separating money from the State just as enterprise and foreign trade had been so separated. In short, the gold standard was the monetary counterpart of laissez-faire in other economic areas.
The gold standard in the prewar era was never “pure,” no more than was laissez-faire in general. Every major country, except the United States, had central banks which tried their best to inflate and manipulate the currency. But the system was such that this intervention could only operate within narrow limits. If one country inflated its currency, the inflation in that country would cause the banks to lose gold to other nations, and consequently the banks, private and central, would before long be brought to heel. And while England was the world financial center during this period, its predominance was market rather than political, so it too had to abide by the monetary discipline of the gold standard. As H. Parker Willis described it:
Prior to the World War the distribution of the metallic money of gold standard countries had been directed and regulated by the central banks of the world in accordance with the generally known and recognized principles of international distribution of the precious metals. Free movement of these metals and freedom on the part of the individual to acquire and hold them were general. Regulation of foreign exchange... existed only sporadically... and was so conducted as not to interfere in any important degree with the disposal of holding of specie by individuals or by banks.1
The advent of the World War disrupted and rended this economic idyll, and it was never to return. In the first place, all of the major countries financed the massive war effort through an equally massive inflation, which meant that every country except the United States, even including Great Britain, was forced to go off the gold standard, since they could no longer hope to redeem their currency obligations in gold. The international order not only was sundered by the war, but also split into numerous separate, competing, and warring currencies, whose inflation was no longer subject to the gold restraint. In addition, the various governments engaged in rigorous exchange control, fixing exchange rates and prohibiting outflows of gold; monetary warfare paralleled the broader economic and military conflict.
At the end of the war, the major po
wers sought to reconstitute some form of international monetary order out of the chaos and warring economic blocs of the war period. The crucial actor in this drama was Great Britain, which was faced with a series of dilemmas and difficulties. On the one hand, Britain not only aimed at re-establishing its former eminence, but it meant to use its victorious position and its domination of the League of Nations to work its will upon the other nations, many of them new and small, of post-Versailles Europe. This meant its monetary as well as its general political and economic dominance. Furthermore, it no longer felt itself bound by old-fashioned laissez-faire restraints from exerting frankly political control, nor did it any longer feel bound to observe the classical gold-standard restraints against inflation.
While Britain’s appetite was large, its major dilemma was its weakness of resources. The wracking inflation and the withdrawal from the gold standard had left the United States, not Great Britain, as the only “hard,” gold-standard country. If Great Britain were to dominate the postwar monetary picture, it would somehow have to take the United States into camp as its willing junior partner. From the classic prewar pound-dollar par of $4.86 to the pound, the pound had fallen on the international money markets to $3.50, a substantial 30-percent drop, a drop that reflected the greater degree of inflation in Great Britain than in the U.S. The British then decided to constitute a new form of international monetary system, the “gold-exchange standard,” which it finally completed in 1925. In the classical, prewar gold standard, each country kept its reserves in gold, and redeemed its paper and bank currencies in gold coin upon demand. The new gold-exchange standard was a clever device to permit Britain and the other European countries to remain inflated and to continue inflating, while enlisting the United States as the ultimate support for all currencies. Specifically, Great Britain would keep its reserves, not in gold but in dollars, while the smaller countries of Europe would keep their reserves, not in gold but in pounds sterling. In this way, Great Britain could pyramid inflated currency and credit on top of dollars, while Britain’s client states could pyramid their currencies, in turn, on top of pounds. Clearly, this also meant that only the United States would remain on a gold-coin standard, the other countries “redeeming” only in foreign exchange. The instability of this system, with pseudo gold-standard countries pyramiding on top of an increasingly shaky dollar-gold base, was to become evident in the Great Depression.
A History of Money and Banking in the United States: The Colonial Era to World War II Page 37
