This drama played itself out in classic fashion. By the end of the 1880s, credit was pouring in so rapidly that service on the outstanding debts began. to outrun capacity to pay, the flood of money was clinging to the sticky fingers of the politicians, and inflation began to raise its ugly head. In just one year, money in circulation increased by $270 million.
Meanwhile, back in Europe, business activity was accelerating, stimulated in part by an enormous borrowing of J 11 million by the British government to build ironclad battleships, followed by similar efforts in France, Russia, and Germany. The stock markets across Europe were roaring ahead and building speculative froth of their own; on Wall Street from 1884 to 1889, stock prices appreciated by over 50 percent .*3' At the same time, capital was also moving to the newly discovered nitrate mines of Chile and the gold and diamond mines in South Africa.
In 1889, concerned about the swindling and greed that were sweeping the speculative manias, the Bank of England and the German Reichsbank sharply raised their key interest rates. The impact was immediate and fevers cooled-which meant that security prices fell and took an excruciating toll on those poor investors who had let themselves be lured in at the very top of the bubbles.
The timing was unfortunate. The Argentine wheat crop failed, followed by a bloody political revolution in the summer of 1890. Financial panic broke out in Buenos Aires. The repercussions on the leading banking houses in London were immediate, most notably on Baring Brothers. Baring Brothers had underwritten £42 million of Argentine securities during the 1880s-£28 million in 1888 and 1889 alone-a significant portion of which remained unsold, leaving Barings the unwilling owners. The message in the family motto that had become the company logo, Virtus in arduis (Fortitude under difficulty), now seemed very garbled indeed.
As the Barings were among the most respected families in Britain, the shock was devastating far beyond even the huge amounts involved. The diary of one contemporary reported, subsequent to the resolution of the crisis, that "The West End social life of Lord Revelstoke (the partner blamed for the crisis) so enraged the Stock Exchange that it was `ready to lynch him."'ss Barings had been a leader in international financial markets "when the Rothschilds still bought and sold old clothes."39 In 1792, they had played a primary role in financing the British war effort against the French Revolution and Napoleon. In 1803, they played the lead in the financing of the American purchase of the Louisiana Territory from the French. They led the European financing of U.S. foreign trade and the U.S. government up to the outbreak of the Civil War. In the early 1840s, the managing partner, Alexander Baring, later Lord Ashburton, was ambassador to the United States and negotiated the Maine-Canada border with Secretary of State Daniel Webster. Ashburton's direct descendants served as Chancellor of the Exchequer, as First Lord of the Admiralty, as Viceroy of India, and as de facto ruler of Egypt from 1883 to 1907.
The Barings crisis could not have hit at a worse moment. The Bank of England's gold reserve had been as low as k9 million in 1889 and was less than X11 million at the height of the crisis. Baring Brothers alone was going to require at least C4 million immediately in order to avoid closing its doors."' The Bank of England now anticipated withdrawals of gold by the Bank of Spain and the State Bank of Russia. Although the Bank's interest rate had just been raised to 6 percent, William Lidderdale, Governor of the Bank (as the office of chief executive was known) and no fool, was convinced that further increases in the Bank's interest rate would merely signal the intensity of the difficulties they were facing. "It would have taken a very high rate indeed to bring gold over in quantity," Lidderdale later explained to the Chancellor of the Exchequer.;' Nevertheless, The Economist magazine reported on November 15 that the Bank's gold reserve was `just about sufficient for ordinary home requirements, but it was too small to meet exceptional demands. "42
In desperation, the Bank turned to the Rothschilds, a powerful competitor of Barings. Rothschilds and the Bank together put up £15 million as a start to the complex and painful process of paying off the loans that Barings had been forced to make to finance their unwanted inventory of unsold Argentine issues. The Rothschilds were then asked to serve as intermediary for a loan of £2 million of gold from the Bank of France (on the previous occasion when the Bank had borrowed from the French, in 1839, Barings had served as the intermediary). The French agreed to the loan, at only 3 percent interest, and even shipped the gold across the Channel to British soil. Another £1.5 million in German gold coin was obtained from Russia, while the Russians also agreed to refrain from withdrawing their substantial deposits at Barings. At that point, the Bank of France offered an additional C1 million in gold. Follow-the-leader: always eager to be in good graces with the Bank of England, a consortium of domestic banks in London now stepped forward and agreed to put up most of the remaining funds required to satisfy the creditors of Baring Brothers.1
Perhaps the most remarkable aspect of the whole operation was the discretion and secrecy with which it was carried out. The Governor of the Bank of England had excellent sources of information on what was going on in the City, and on Friday, November 7, the first rumors reached him about some big houses that might be in danger. Three days later, Lidderdale had the Chancellor approach Rothschild; before the week was out, the Russians had come along. By the 14th, word "began to ooze out that something was up," but by that afternoon the entire deed was done.44
It was indeed an elegant performance. Charles Kindleberger, a leading historian of financial crises, has observed that the rescue operations in the Barings crisis were seen "as a measure of the strength of the London financial system more than the Baring failure was taken as a sign of weakness."45 He goes on to cite a judgment expressed by another historian just 25 years after the crisis that the Bank of England is "the leader of the most colossal agglomeration of financial power which the world has so far witnessed."46
Without the cooperation of the French and the Russians, the story would have had a horrible ending, but the tradition of cooperation was well established by that time. The Bank of England, supposedly the keystone of the system, drew on the support of the Bank of France nine times between 1826 (also with the help of the Rothschilds) and 1920, in addition to the help rendered in the Barings crisis; in other crises, the city of Hamburg and the Reichsbank came to England's aid. In 1861, the Bank of France drew on support from the Bank of England, the Russian State Bank, and the Bank of Amsterdam.47 The Swedish Riskbank borrowed from the Danish National Bank in 1882. In 1898, the Banks of France and England cooperated to help out the Reichsbank. The Bank of France and the Reichsbank came to the aid of the Bank of England in 1906 and 1907.
All this assistance was predicated on the assumption that preservation of convertibility into gold at fixed rates was the bedrock of economic policy, before which all other considerations had to give way. Without that assumption, the credits that gold-standard countries provided to one another would have been far less generous and would have come with much more onerous conditions.
The classic sequence of events when trouble developed is the opposite of what tends to happen in our own time. Who but the naive today would put such firm confidence in either credibility or cooperation? Now speculators flee a currency in trouble, putting it into ever greater trouble, destabilizing its relationships with the outside world until they become completely untenable. In the nineteenth century, a pledge to maintain gold parity was accepted at face value. At the end of the twentieth century, such a pledge was usually taken as a sign that whatever parity existed would soon go down the tube. In the contemporary scene, only grudging cooperation is forthcoming, and then with strings attached so lacerating that domestic political considerations may even necessitate rejecting the proffered aid.
Nevertheless, the magnitude of the emergency of 1890 brought home to all the central bankers the necessity of holding much larger gold reserves than they had considered adequate up to that point. Faith in the power of interest-rate policy to hold disaster at bay wa
s not abandoned, but emphasis began to shift toward accumulating a hoard of gold big enough to build credibility to a degree beyond question. This step would reduce the heavy reliance on managing the gold reserves solely by varying interest rates. The German war reserve accumulated after 1900, and held separate from the Reichsbank's reserve, became an object of envy. Shades of the emperors of Byzantium!
Barry Eichengreen, a leading authority on the history and functioning of the gold standard, emphasizes that the critical reason for the success of the gold-standard system was the unquestioning attachment to credibility-the rejection of any possibility that a nation would allow itself to go permanently off gold or to vary its gold parity-and to the cooperation that such credibility warranted. Other writers, such as Charles Kindleberger, are convinced that it was the hegemony of the Bank of England that kept the system functioning through thick and thin, leading the way toward interest-rate changes, serving as lender of last resort, and managing international cooperation. He echoed the views of John Maynard Keynes, who referred to the Bank as the "conductor of the international orchestra.""
All the experts agree that the gold standard operated in a congenial economic and political environment. Despite recurrent financial turbulence, the period between the end of the American Civil War and the outbreak of World War I was marked by a mighty force of economic growth and industrialization in both America and Europe. Peace helped, too: no major wars were fought within Europe from 1870 to 1914, while the only military activity to engage the United States was the SpanishAmerican War of 1898.
There was an additional element of great importance, more political than economic. An economy with a fixed rate of exchange between its currency and the currency of other nations must be prepared to see its domestic economy dominated by the requirements of the gold standard. If the gold stock was flowing outward, interest rates had to rise to attract foreign funds and the domestic economy had to be suppressed to curtail imports. No safety nets of any kind were allowed. That was bad news for the workers who lost their jobs and saw their wages cut as well as for business firms whose profits were slashed. But those were the rules of the game. The system simply could not have survived if the objectives of domestic economic stability and high employment had dominated the objective of defending the gold stock. No matter how intense the pain, the political arms of the governments-parliaments or executives-never dreamed of intervening, because the pain was for the Greater Good.40
Remember that this was the age of Queen Victoria and King Edward VII. The type of political outcry that we would expect today was in large part absent in the nineteenth-century environment of Europe, or, to the extent that voices were raised, men in positions of power paid little heed to them. Even among economists, macroeconomic considerations and business cycle analysis did not occupy the attention of mainstream theorists; it was only in the underworld of such people as Karl Marx that those concerns were expressed. The doctrine of laissez-faire and minimal government interference in business and financial affairs was the ruling philosophy for most of the period.
This viewpoint suggests that the success of the international gold standard might have been more symptom than cause. It did operate in an environment in which growth continuously bailed out policy errors, the burdens of international debts within Europe never expanded beyond manageable levels, and international cooperation could be taken for granted rather than depending on painful and conditional support.
A famous contemporary got the point at the time, without any benefit of hindsight: in 1895, Benjamin Disraeli told a group of Glasgow merchants that "It is the greatest delusion in the world to attribute the commercial preponderance and prosperity of England to our having a gold standard. Our gold standard is not the cause, but the consequence of our commercial prosperity. "5" If ever there was a time in human history when circumstances combined to make the world economic system function as people expected it to function, this was it.
The widespread failure to recognize the profound truth in Disraeli's observation is eloquent testimony to the power of the mystique that the gold standard acquired in the course of the nineteenth century, despite the choppy history from which it originated. The unquenchable conviction that the gold standard explained its benign environment is the dominant reason why the Europeans insisted on putting themselves through all the trials and tribulations associated with efforts to restore and then to maintain the gold standard from 1921 until its final demise in 1971.
Although much of this chapter applies equally to Europe and the United States, the differences between what happened on the opposite sides of the Atlantic Ocean may have been more profound than the similarities. The key distinctions were political in nature. All of these differences were shaped by the unique character of a brand-new country only one hundred years old when all of these events were taking place. The United States was also situated far away from Europe's two thousand years of shared history and the old-boy network that dominated its financial institutions. On top of all that, American society was more open and fluid than European society, the forces of democracy and the passion for liberty and equality were more vocal and more determined, and most of the wealth was "new wealth" rather than wealth handed down by a landed aristocracy or the ancestral fortunes like those of the Rothschilds or Barings. Until the very end of the nineteenth century, therefore, many Americans were reluctant to join in the European enthusiasm for the system, especially with the constraints it imposed on freedom of action.
The final years of the 1890s in the United States made a fitting climax to the story of the nineteenth-century gold standard. We shall now see what led up to those events and how the local variations on the theme of near-disaster played themselves out.
he United States strides the world today as a financial colossus, but this perception is a far cry from the America of the nineteenth century. In those days, bank failures were common, foreigners were fickle in their taste for American securities, and the U.S. gold stock was all too often on the verge of pouring out to other nations. The stability of the currency and the financial bases of growth were constantly vulnerable to attack from the outside.
Indeed, as this chapter makes clear, the so-called Gay Nineties were far from gay. The era is also known as the Gilded Age. The very rich did live like kings, but these years were marked by a persistent shortage of monetary gold in the United States. The decade was a sequence of cliff-hangers with the gold stock, record-high unemployment, political tumult, social unrest, and huge bear markets on Wall Street.
The nation had no easy means to cushion these blows. Americans enjoyed none of the credibility that permitted the central banks of the major powers-governing financial institutions such as the Bank of England and the Bank of France-to carry on their clubby habits of borrowing gold from one another whenever any of them happened to be in trouble. Consequently, Americans were denied the opportunity to receive credits from the others when they needed credits and were excluded from the process even when they were in a position to extend credits. Yet the United States needed the gold if Americans were to continue to do business with a world in which the gold standard was becoming the dominant monetary system among the major powers.
It was not just that the United States was considered an upstart nation, too young to be reliable as a financial partner. The consistency of the American attachment to the gold standard was always under suspicion. Uncle Sam's behavior did nothing to change this image. The management of nineteenth-century financial policy in America appeared to Europeans like a ship with no keel, where the passengers crowded together on the bridge and shouted the captain down, so that the ship's course was set by the loudest shouts and even then its route remained uncertain.
Popular opinion among Americans held that the gold standard was a devilish concoction of foreigners, especially the hated British and British Jews in particular. One typical cartoon of the 1890s carried the title, "THE ENGLISH OCTOPUS: It feeds on nothing but gold!" A map of the world appear
s below this caption, with the tentacles of the octopus extending out from Britain and wrapping themselves around every continent. A second caption appears below: "'The Rothschilds own 1,600,000,000 in gold.'-Chicago Daily Neu's. This is nearly onehalf the gold in the Chicago wheat pit."'
The Europeans had an additional reason to keep Americans outside the pale: the United States had no central bank like the Bank of England. Whatever management of financial policy did exist was in the hands of the Treasury Department in Washington, whose leadership was inherently political and answerable to Congress. Yet Americans were stubborn about changing their ways. From the very beginning, a largely rural and self-centered nation displayed an instinctive suspicion of city folks, bankers, and anyone who was suspected of fooling around with foreigners. Americans clung to their atomized commercial banking structure, with its thousands of little independent banks dispersed throughout the countryside and regulated by the states rather than by Washington. Much of this rickety edifice remained in place right through to the final moments of the twentieth century.
Most political rhetoric reflected these themes over and over again. America's financial provincialism persisted even as the country became more industrialized and a rising share of the population drifted toward the cities. As late as 1913, when the United States decided at last to join the world and establish a central bank, the structure of the Federal Reserve System was braced with strong regional checks and balances that restrained the power of the governing body in Washington.
Another and perhaps even more important problem festered throughout the nineteenth century: the United States waited until 1900 before legally committing itself to a gold standard. Until then, Americans remained officially on Hamilton's bimetallic standard, in which silver had equal standing with gold. These arrangements were supported by the powerful and boisterous silver interests, and not just because silver mining was an important economic activity in the western states. Farmers and others who were characteristically debtors favored the largest possible money supply and saw inflation as a blessing rather than a curse. Silver plus gold equaled more money in the system than gold alone. But silver became something bigger than just a viable candidate to serve with gold as a monetary standard. Silver was a potent symbol for the struggle of the Little Man against the Established Powers. Propelled by universal suffrage, the rallying cries of equality and democracy rang out louder here than in the Old World.
The Power of Gold: The History of an Obsession Page 30
