The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance

by Ron Chernow

  In many ways, the House of Morgan shared Japan’s jaundiced view of the Chinese, a common one in Western financial circles. China was unpopular on Wall Street and in the City. It was prone to default and adept at playing foreign bankers off against each other. Ever since the abortive China consortium under Woodrow Wilson, Lamont had looked upon the Chinese as wily and duplicitous. He perceived them less as victims of foreign intruders than as two-faced opportunists.

  It was an easy attitude to assume. Japan was a major Morgan client, and no business came from China, which was still in default on a substantial portion of its foreign debt. (National City Bank, on the other hand, did a thriving business in China, which generated almost one-third of the bank’s profits in 1930.) So Lamont was quick to find merit in Japanese claims that Manchuria was economically indispensable, lay well within her sphere of influence, provided a buffer against bolshevism, and had been won with Japanese blood and treasure in the Russo-Japanese War of 1905. With billions of yen invested in Manchuria and millions of Japanese living there, some nationalists saw the region as a simple extension of Japan.

  In mid-1931, while the West was distracted by the Credit Anstalt failure and the sterling crisis, the Kwantung army set in motion a plot to seize Mukden and other Manchurian towns. On September 18, it launched a surprise raid against Chinese barracks in Mukden; by the next day, the city had fallen to the Japanese. As a pretext for this aggression, the Japanese military manufactured stories of Chinese assaults against the Japanese-controlled South Manchuria Railway—stories that were later exposed as fraudulent or exaggerated. Emboldened by popular support in Japan, the military flouted civilian officials, such as Inouye and Foreign Minister Kijuro Shidehara, who opposed the use of force. Japan’s Foreign Office was afraid that if it tried to rein in the Kwantung Army, it might face an armed revolt in the ranks. As fifteen thousand Japanese troops swarmed across Manchuria, diplomats lamely said that the moves were temporary and that the troops would be evacuated shortly. As historian Richard Storry said, these were “weeks of public embarrassment and secret humiliation for the Wakatsuki government.”34

  Stunned by the Mukden raid, Secretary of State Henry L. Stimson swiftly protested to Japan, and Hoover later called it “an act of rank aggression.”35 Financial markets clamored for an explanation. As finance minister, the proud, dignified Inouye had to issue a statement. He was in a precarious spot, for he had spearheaded cabinet opposition to reinforcing troops in Manchuria. He was also identified with demands for cuts in the defense budget, which earned him the lasting enmity of the military (much as Dr. Hjalmar Schacht’s faith in old-fashioned balanced budgets would finally doom him with the Nazis).

  Inouye consoled financial markets with an amazingly artful statement about Mukden. The New York Times printed it verbatim on October 22 in a dispatch with a Tokyo dateline. Entitled “INOUYE SAYS JAPAN IS EAGER TO RETIRE,” it became the statement that defined Japan’s position for Western financial markets. Observant readers must have been struck by its clever analogies to the Panama Canal, its quoting of Daniel Webster, and its sure feel for American sensibilities:

  A clear understanding of the present state of affairs in Manchuria shows that the question is simply one of self defense. A long, narrow strip of territory, along which runs the vital nerve called the South Manchuria Railway, is and has been by treaty arrangements since the Russo-Japanese War of 1904-5 under the complete administration of Japan. By treaty with Russia, duly recognized and adopted by China, Japan administers this “South Manchuria Railway Zone”—polices and protects it much as the United States Government polices and protects the Panama Canal Zone.

  On the 18th of September last, a night attack was made on this zone by regular Chinese troops, and the railway line was destroyed. It was evidently necessary for Japan to take strong and immediate steps. When points under the protection of one’s army are invaded by regular troops, and the extent of the threatened invasion is utterly unknown, the obvious means of self defense is to proceed at once to the headquarters of the offending troops. The emergency was one which, in Mr. Webster’s classic words, was ’instant, overwhelming, leaving no choice of means, and no moment for deliberation.’

  The middle section of the statement portrays Japan as saving Manchuria from anarchy. It brushes aside as “minor military measures” the actions taken at Mukden. The closing is forceful:

  In the final analysis, there is nothing in the situation that should create a war and the whole affair has been magnified beyond reason in being deemed an actual danger to the peace of the world. The Japanese, as repeatedly stated, have no intention whatsoever of making war on China. On the contrary, the Japanese Government and people entertain the friendliest feelings towards the Chinese. They are probably more anxious than any other nation of the earth could possibly be, to maintain friendly relations with the Chinese.36

  The press release was actually drafted by Tom Lamont. It was issued, with only cosmetic changes, by Japan’s Ministry of Finance. (The preceding is quoted from the original in Lamont’s files.) The Japanese wanted Lamont to release the statement himself, but he replied that Morgans would be thought biased and might offend the Chinese—an understatement. Perhaps he also feared his reputation among American liberals would be blackened by any revelation of his authorship; as a former champion of the League of Nations, he probably didn’t want to side publicly with an aggressor. To assuage the Japanese, he explained that if Inouye “will let me know what day he plans to issue the statement, I will arrange to have it gain extra publicity here.”37

  Lamont now found himself in stark opposition to Washington’s policy and faced the dilemma always latent in his role as a banker cum diplomat. Why did he conspire with a foreign power in a military action condemned by the U.S. government and the League of Nations? Could he have accepted, at face value, Japan’s story about Manchuria? Reporters in China pointed out that versions of the Mukden incident originated with Japan’s military and were suspect. There were also widespread suspicions of a staged incident, a premeditated invasion. As the London Times said on September 21, the Japanese army, three days before taking Mukden, had conducted “something like a dress rehearsal” for the invasion, and “though it is reported that the incident of the South Manchuria Railway was the cause of the developments, the truth is that the whole movement was on foot before the alleged incident occurred.”38 There was, in short, plenty of evidence to give a reasonable man pause. Add to this the clear public impression that the cabinet was being duped by the army, and Lamont’s alacrity is puzzling.

  Cynicism toward China certainly explains much of the Morgan sympathy for the Mukden attack. Russell Leffingwell, in a hot-blooded letter to Walter Lippmann, said the indignation over Mukden was entirely misplaced. “It is grotesque for the League or for America to interfere on the side of Chinese raiders and revolutionaries, who have kept their people in war and fear and misery all these long years; and on the side of red Russia; and against the side of Japan, who in pursuance of her treaty rights has been keeping order in Manchuria and maintaining the only safe-asylum open to the fear-ridden Chinese.” He hoped the Japanese would “thumb their noses” at any League of Nations or U.S. protest against its action.39

  Along with his secret work for Mussolini, the Mukden incident is probably the most disturbing episode in Lamont’s career (although nobody knew about it then). Was he trying to impress the Japanese with elite Morgan services? Or was he simply trying to maintain the value of Japanese securities? He undoubtedly wanted to shore up Inouye’s tenuous position in the government. The finance minister had to demonstrate to the military that he wouldn’t betray or work against it. In fact, in November, Lamont warned the Japanese that if Inouye were expelled from the cabinet—as the military favored—there would be a “distinct chill” on Wall Street and in the City.40 But if Inouye felt a need to appease the military, why did Lamont join him?

  As with Mussolini, Lamont was going beyond public relations to something approa
ching propaganda for a foreign power. It was a strange new application of the Gentleman Banker’s Code of absolute loyalty to one’s clients. Any banker could underwrite securities, but only Lamont could lobby politicians, shape newspaper editorials, and sway public opinion. The Mukden press release exposed the dangers in having bankers act like politicians and adopt the same proprietary feeling toward foreign governments as toward industrial concerns. It pointed up the perils of blurring politics and finance in the Diplomatic Age.

  If Lamont were truly taken in by Mukden, then he was soon rudely stripped of his illusions. In December 1931, a less liberal Japanese cabinet took power, and Inouye was replaced by Korekiyo Takahashi, who promptly took Japan off the gold standard. In late January 1932, the world was horrified by Japanese bombing of Chinese civilians in thickly populated suburbs of Shanghai. Once again, the Japanese blamed Chinese provocation. The terrorist tactics were far more naked than those used in Mukden, and the evidence of brutality more graphic and abundant. Newsreels brought shocking pictures of the carnage into American movie theaters. Lamont was so dismayed he told his friend Saburo Sonoda of the Yokohama Specie Bank that Japan could no longer raise money in American markets—so ghastly was the impression left by Shanghai.41 For the House of Morgan, Shanghai initiated a slow process of disenchantment. A chastened Leffingwell wrote to Teddy Grenfell, “I confess to having had a good deal of sympathy with the Japanese in Manchuria, though none at all with the Japanese at Shanghai.”42

  Now Lamont was to absorb one stunning blow after another. Right-wing terrorism—which had already claimed the life of Prime Minister Hamaguchi in a 1930 shooting—turned on the world of finance. One by one, Lamont’s Japanese friends were killed. During the Shanghai fighting in February, he received a telegram from Sonoda that said: “WITH SORROWING HEART INFORM YOU OF ASSASSINATION AND DEATH OF MR. I. INOUYE IT SEEMS [AS] IF A GREAT LIGHT HAS BEEN EXTINGUISHED AND MY DEAR COUNTRY IS FALLING INTO DARK DAYS.”43

  Inouye, sixty-three, was in the midst of a general-election campaign. As leader of the Minseito, he was expected to become the next prime minister. As he stepped from his car at a suburban Tokyo school, a twenty-two-year-old rural youth stepped from the shadows in a tattered kimono and black felt hat. He shot Inouye in the chest. The assassin was a member of the secretive, superpatriotic Blood Brotherhood, a group of fanatic young nationalists. At the police station, he boasted of his deed and blamed rural poverty on Inouye’s deflationary policies. Speaking to reporters at the Imperial University Hospital, Inouye’s somber, dry-eyed widow explained that she had readied herself for this moment while her husband was in the cabinet.

  Lamont was profoundly upset; after all, it was Inouye who gave him hope that the old illustrious families and their liberal allies could keep militarism at bay. He wrote a touching letter of condolence to his friend Sonoda: “Such a gentle soul he was—it seems the more inexplicable that his end should be like this.”44

  The more Lamont resisted the truth about Japan, the more forcibly it intruded. A few weeks after Inouye’s assassination came the murder of Lamont’s other major Japanese friend, Baron Takuma Dan, the MIT-trained mining engineer and chief executive of Mitsui, who had hosted him at his villa in 1920. Baron Dan was shot as he emerged from his car at the white marble Mitsui Bank. Again the assassin was a rural youth and was apparently also a member of the Blood Brotherhood. Lamont wrote to Baron Dan’s family, recalling the 1920 trip: “I had thought at times of him as a poet in business and this impression came to me as he showed me his house and garden and we stood together looking at Fujiyama, a majestic picture towering above a superb landscape.”45

  Baron Dan’s killing was an act of revenge against the House of Mitsui, which rightists had accused of treacherous profiteering in the so-called dollar-buying scandal. After England left the gold standard in September 1931, Mitsui and other zaibatsu banks expected the yen to be forced off gold, too, an effective devaluation. So they furiously sold yen and bought dollars. These foreign-exchange transactions netted Mitsui an estimated $50 million. But they also triggered a patriotic uproar about banks speculating against their country’s currency. The issue proved an emotional one during the 1932 election. In the growing atmosphere of political extremism, many Japanese sympathized with Inouye’s and Baron Dan’s assassins, who received lenient sentences. Both were released from prison within a few years.

  Lamont didn’t readily admit error and didn’t know how to abandon clients. By now, the strong rightward shift of Japanese politics was evident. The Kwantung army had overrun Manchuria, creating the puppet state of Manchukuo in March and installing Pu Yi, the last Manchu emperor, as its pliant figurehead. The incident at Mukden, the bombing of Shanghai, the murders of Inouye and Baron Dan—these events should have opened Lamont’s eyes. He could no longer plead ignorance. His files from early 1932 do reveal a deep displeasure with the Japanese as he warned them not to repeat the Shanghai error, which had destroyed any sympathy they still had on Wall Street.

  Nevertheless, that spring, in a bizarre turn, Lamont and Martin Egan drifted back to a pro-Japanese stance. The two had become close friends with Count Aisuke Kabayama, who had been educated at Princeton, was married on Long Island, and was close to Emperor Hirohito. Kabayama’s grandfather had been an admiral and a governor of Taiwan. Lamont and Egan encouraged him to set up a Japanese information bureau in America on the Mussolini model and proudly briefed him on their Italian work. In the late spring, Egan went to Japan for talks about Manchuria. When he returned talking about “banditry and disorder in Manchuria” and blaming China for hostilities, he sounded like a Japanese militarist.46

  The House of Morgan no longer knew which master it served—America or Japan. A few days later, on May 15, 1932, another political murder blackened Japan’s image: the aging prime minister, Tsuyoshi Inukai, was gunned down in his official residence by nine young army officers, probably because he wanted to curb the military. He was replaced by Admiral Makoto Saito. It would be the end of party government in Japan until after World War II.

  In the fall of 1932, Lamont had to confront the unpleasant truth about Mukden, the knowledge that his press release for Inouye had been a hollow piece of propaganda. The League of Nations had dispatched an investigative commission to the Far East under Lord Lytton. Even before the Lytton report was endorsed by the League, Lamont’s assistant, Vernon Munroe, dined one evening with General Frank McCoy, the commission’s American member. The next morning, Munroe told Lamont, “The General said there was a grave question as to whether there was any explosion, that the Japanese had never been able to explain how the regular trains continued to run immediately after the explosion was supposed to have taken place and the more they had explained the more of a contradiction they had gotten into.”47 A month later, the Lytton report condemned Japanese aggression as violating the League’s Covenant and branded Manchukuo a puppet state. Although the report was critical of Chinese provocations, Japan walked out of the Assembly of the League and brazenly tightened its grip on Manchuria.

  By this point, Lamont was in a quandary. He wanted to maintain a belief in Japan’s good intentions amid overwhelming, contradictory evidence. To sort out his feelings, he sat down and wrote a memo marked “Secret and Strictly Confidential.” Whether he ever circulated it is uncertain, but it shows a man fleeing reality. “These are entirely my private thoughts,” it starts out, then continues, “American suspicions as to Japan’s motives are essentially these: that Japan has aggressive designs on the Asiatic Continent and that Japan may even be courting war with the United States—which are not true.” To correct such misconceptions, he recommends a joint U.S.-Japanese declaration on trade and peaceful relations. The conclusion is a desperate pipe dream: “If such a joint declaration can be made, all war talk will immediately be silenced, the psychology of men will undergo a change and whatever question may arise between our two countries will become capable of an easy solution.”48

  It became progressively more difficul
t for Lamont to sustain any belief in Japan’s imminent return to civil government. As lords of Manchukuo, the army built huge dams and industries to strengthen the nation’s preparedness for war. The new finance minister, Takahashi, known as the Japanese Keynes, boosted military spending to almost half the Japanese budget. The liberalism of the twenties, along with its foremost exponents, was dead.

  In 1934, Lamont underwent a sudden change of heart. Once his eyes were open, he felt fooled, and his trust turned to bitterness. He cut off subscriptions to Japanese cultural groups, snubbed visiting Japanese dignitaries, and warned Japan’s consul general that the Japanese should not mistake America’s peaceful spirit for cowardice. When he heard rumors that the British cabinet might renew an alliance with Japan, he lobbied against the move. He sent an impassioned letter to Grenfell, which he expected to be passed around Whitehall: “In place of the fair liberal government that existed in the first twenty years of this century there has arisen a military clique which . . . if accounts from the liberal elements in Japan are true, have been conducting itself a good deal as a lot of the young German Nazis have been conducting themselves.”49