The Power of Gold: The History of an Obsession
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The mess was not just in the yawning gap between government spending and tax revenues. The worst of the deficit was in finding some way to finance it. With the wealthy and the banks reluctant to lend to, a Treasury that seemed incapable of putting its house in order, the government had no choice but to borrow from the Bank of France. Every time the government took that step, it was the equivalent of turning on the printing press. Then inflationary pressures intensified and the franc came under attack in the foreign exchange markets.
Both Left and Right stubbornly continued to hope that all these difficulties could be overcome if only Germany would take over the whole burden by paying up on the reparations guaranteed by the Versailles Treaty-"le Boche paiera" (the Hun will pay) was one slogan every French citizen liked.30 After all, in 1815 the French had paid seven hundred million francs to the victors at Waterloo and then five billion marks to the Germans in 1871. The French were now determined to be on the receiving end.;' In January 1923, in an effort to extract reparations by force, the French and Belgian armies invaded the Ruhr region of Germany, the heart of its coal, iron, and steel industries. German passive resistance succeeded in rendering this adventure fruitless, especially as the cost of the occupation force was adding to the woes of the French deficits. The Germans, with terrible domestic problems of their own, were just unable to meet the outsized demands that the Allies had placed upon them.
With the help of credits from the ever-helpful J. P. Morgan & Co., still trying to stabilize the world, the franc had been pegged after the Armistice at 5.4 to the dollar (18.5¢) and 25.22 to the pound. But when the Morgan loan matured in March 1919, the franc dropped in the foreign exchange markets to the point where a Frenchman had to pay eleven francs to buy a dollar; the following year it would go as high as twenty-which meant that an American could buy a franc for a nickel. The franc continued to swing up and down like a jumping jack for the next four years, rising when prospects of constructive action improved and plummeting as each possibility went into reverse. At its worst, the franc would be the equivalent of about 2¢.
By March 1924, with the budget deficit bulging and a large amount of government debt about to come due, the markets refused all accommodation to the Treasury. Earlier efforts to stop the printing-press consequences of borrowing from the Bank of France had led to an agreement that now blocked off even that source of finance. Panic broke out on March 4, with Frenchmen as well as foreigners rushing to con vert francs into dollars and sterling. There were rumors that the whole thing had been provoked by a secret conspiracy organized by the German government-and this was not the first time the French had been tempted to suspect that "strangers" were causing their troubles. Foreign tourists were attacked on the streets of Paris. The government took some halfhearted steps amounting to so little that they served only to intensify the drop into the abyss .3'-
The French in desperation turned once again to Morgan, asking for a loan of $50 million. The Morgan people thought that $50 million would be insufficient and offered twice that sum but with tough conditions: gold as collateral, a tax increase, a cutback on reconstruction, and no new spending programs. Even though this transaction stemmed the tide and started the franc moving back uphill, these conditions so angered the French populace that the government fell in the May elections. Nevertheless, the speculators against the franc took a ferocious beating, especially in Germany and Austria. Almost the entire Austrian banking community was involved. According to one newspaper, they were caught like "ants in the honey.";;
The victory of the franc in 1924 was only transitory, as the Morgan credits ran out and the old political merry-go-round started whirling once again. In the midst of all that, future borrowings from the United States were essentially shut off by the State Department, which followed American popular opinion by expressing an informal objection "to loans to countries that had not reached a settlement of their obligations under war debts to the United States."34
By July 1926, the franc was trading at 49 to the dollar, just about 10 percent of its pegged value of 1918, while wholesale prices were climbing at a monthly rate of almost 15 percent. With the nation exhausted by all the political infighting, a determined Right-Center government under Raymond Poincare now took over. Poincare was convinced that the only solution was to persuade the nervous and fickle French who had shifted large fortunes abroad that the franc would now be stabilized. To that end, he promptly lowered income taxes on the rich and raised the taxes on consumer goods that the masses paid-a politically tricky move that accomplished its strategic purpose.
The impact in the marketplace was dramatic. The franc had lost about a third of its value in terms of pounds and dollars just between June and July, but by October it had risen by a third and then climbed by about another third by November to a level that it would hold, within narrow margins, for the next ten years. France was back on the gold standard on a de facto basis.
Poincare's strategy was validated, for the French had picked a value that was irresistible to foreigners-at the expense of the British in particular but also of the Americans. The value was also irresistible to Frenchmen who had earlier speculated against the franc by sending their money to London to await this very moment. Capital poured back into France. After all the travail, France would run an uninterrupted surplus in its international transactions for the next four years.
All of this was hardly good news to London. The capital inflow had permitted the Bank of France to accumulate large sums to its credit in the City, from £5 million in November 1926 to £160 million by the end of May 1927.3' This was money that the Bank of France could withdraw on demand and represented a heavy potential claim against Britain's stock of gold. The relative positions were in any case shifting rapidly. From a position of approximate equality with the gold reserve of the Bank of England in 1926, the Bank of France's gold holdings were double Britain's by 1929; two years later, the French hoard would be approaching five times the size of Britain's.36
One of the ironies of this period was the rise in Germany's gold stock, which swelled from $181 million at the end of 1924 to $569 million at the end of 1928, while Britain's stagnated between $700 million and $800 million." Capital inflows from abroad, especially from the United States, poured into Germany, lured by the high interest rates maintained by the Reichsbank in the wake of the hyperinflation earlier in the decade.38
Britain was under constant pressure to hold onto its gold stock in the face of the gains being made by France and Germany. In February 1931, Norman would describe his situation as having been continuously "under the harrow"-a farmer's cultivating tool set with spikes for pulverizing the soil.
The growing financial tension between London and Paris turned into personal aggravation and frustration when Emile Moreau, former head of the Bank of Algiers, took over in June 1926 as the President of the Bank of France. Strongly patriotic, canny, and sophisticated in financial matters, Moreau was well aware of the power that the ownership of gold conveyed in the postwar monetary system. In terms of personality, however, he was a maverick, for he was a laconic provincial from Auvergne who lacked the traditional polish of the central banker. He had little interest in international concerns, disliked travel, and spoke no foreign languages.
It would be hard to imagine anyone less to the taste of the suave, aristocratic, and worldly Montagu Norman. Norman patronized Moreau without mercy. Although Norman spoke fluent French, he insisted on speaking English at his meetings with Moreau; this meant that Moreau always had to have an interpreter present. Norman, who had spent one period of his youth in Germany, was always partial to Germans and antagonistic toward the French; his warm friendship with the Reichsbank president, Hjalmar Horace Greeley Schacht, only added to the friction between him and Moreau.
Schacht was a powerful and brilliant financier who had been primarily responsible for ending the wild German hyperinflation of the early 1920s. In the later 1930s, he was both President of the Reichsbank and Minister of Economics under Hitl
er, but rivalry with Hermann Goering led to his dismissal in 1939. He was imprisoned after the assassination attempt on Hitler on July 20, 1944, and also faced the war crimes tribunal in Nurnberg after World War 11-where he was acquitted. He died in 1970, at the age of 93.
At their first confrontation a month after Moreau's appointment, Norman made no effort to disguise his dislike for the French, although he did emphasize that most of his animosity was directed at the politicians. Norman's great goal, in fact, was to make an international club out of all the European central bankers, in which the Bank of England would be the first among equals. This vision held no appeal for Moreau, who had his own agenda for France's financial relationships with the rest of Europe and would come to resent Norman's independent contacts with the other European central banks. Where Norman equated the happiness of the world with Britain's power and prosperity, Moreau's single-minded focus was limited to the fortunes of France.
The fiercest scuffle between the two men developed in the course of 1927, as France's balances in London were climbing at a rapid rate. Moreau made noises about wanting to convert these balances into gold by drawing from the Bank of England's gold stock; he suggested that Norman could avoid that unpleasant outcome by raising interest rates to persuade Frenchmen to stop converting their pounds. Norman could do no such thing in view of the high unemployment plaguing Britain. Instead, he insisted that France should legally restore the fixed relationship between francs and gold to halt the speculation that the franc might become even more expensive in terms of pounds. Benjamin Strong intervened in the conflict at this point, agreeing to provide the French with U.S. gold in exchange for their sterling balances, thereby taking the pressure off London.
The arguments persisted, however. In July, Ogden Mills, the U.S. Secretary of the Treasury, organized a peace conference at his Long Island home, to which he invited Strong, Moreau, Norman, and Schacht. As usual, Moreau declined to travel and sent a high-level representative in his place. Strong took the opportunity once again to step forward to help, agreeing that the Federal Reserve should lower interest rates in America to take pressure off the pound while also making additional amounts of gold available to the French in exchange for French sales of sterling.
Strong's gesture on interest rates was not totally selfless, because the U.S. economy was weak at that time and commodity prices were falling rapidly. Hindsight would bring bitter criticism against this move by those who believed that the policy of easy money in 1927 had fueled the most violent stages of the boom on Wall Street, leading to catastrophically restrictive actions little more than one year later. In March 1929, Leffingwell of Morgan, hearing that Norman was becoming agitated about overheated speculation in the stock market, observed that "Monty and Ben sowed the wind. I expect we shall have to reap the whirlwind. ... We are going to have a world credit crisis."39 Herbert Hoover, in scathing terms, would refer to Strong as a "mental annex to Europe. 1140
Despite Strong's earnest interventions, Norman and Moreau remained at loggerheads, with Moreau increasingly indignant about Norman's "imperialism." He complained to Poincare in February 1928 that Britain had been "the first European country to reestablish a stable and secure money [and] had used that advantage to establish a basis for putting Europe under veritable financial domination.... Are we to let this continue?" And then he noted with satisfaction that "M. Poincare's interest seems to be thoroughly aroused."41 Taking his lead from the Premier, Moreau was charged up enough to actually cross the English Channel "to offer Norman war or peace." Upon his arrival at the Bank, he was politely informed that Norman was indisposed. That did not stop Moreau, who proceeded to negotiate a set of congenial agreements with Norman's staff. But that did not stop Norman. He accomplished a miraculous recovery the instant Moreau had departed and lost no time in repudiating the agreements.
Norman's mental and physical troubles were by no means over, however. Moreau noted (with some pleasure?) in his diary in April that, "M. Norman [is ] in a state of sickly neurosis as a result of the incidents in recent months. "42 Norman would receive another personal blow when his beloved friend Benjamin Strong succumbed to tuberculosis in October 1928. Norman would miss Strong, but the atmosphere at the Federal Reserve was already in the process of shifting even before Strong's final illness.
Indeed, in the United States, domestic considerations were now taking priority over international issues, as the authorities watched with increasing concern the thundering momentum of the bull market on Wall Street. Like the late 1990s, each breathtaking rise in stock prices served only to whet investors' appetite for more. The Dow Jones Industrial Average had doubled between the end of 1924 and the beginning of 1928, a three-year achievement that had occurred only four times in the history of the market, the latest of which had been in 1905. The market jumped another 50 percent in the second half of 1928. Then, after going nowhere in the first five months of 1929, it roared upward by 25 percent over the next three months before making its final top in August 1929. In late 1928, when John J. Raskob, Director of General Motors, friend of the DuPonts, and Chairman of the Democratic Committee, wrote in the Ladies' Home Journal that "Everybody Ought to Be Rich," he evidently had plenty of believers.1
It is fair to ask why the unfolding miracles in the stock market were of any concern to the Federal Reserve, which had been established in 1913 to supervise commercial banks and to provide liquidity for the economy as needed. The concern was not misplaced. Much of the boiling stock market was being financed by people who borrowed money to buy their stocks, often at interest rates well over 10 percent. Banks began to lose their taste for financing anything except this speculative binge. Even worse, a flood of capital from other parts of the economy began to surge toward Wall Street. Stock-market financetechnically, brokers' loans-at banks grew from $1.5 billion in 1925 to $2.6 billion in 1928 and even higher before the market peaked out. But at the same time, loans from nonbank sources jumped from only $1.0 billion to $6.6 billion at the peak, including a substantial amount from abroad.44 Loans to brokers-payable on demand-by 1928 earned a lot more than normal commercial lending.45
The Federal Reserve authorities entered into an extended period of internal wrangling over what to do about all this. The Federal Reserve Board in Washington wanted the twelve regional Federal Reserve banks to use "direct pressure" on any commercial bank making "speculative loans" by denying that bank access to credit at its local Federal Reserve bank. The presidents of the regional banks, and the Federal Reserve Bank of New York in particular, were strongly opposed, insisting that this proposal was both illegal and impossible to administerhow do you identify beyond question a "speculative loan"? George Harrison, Strong's successor as President of the New York Federal Reserve, argued in favor of an earlier suggestion of Strong's to take "sharp, incisive action" to raise interest rates high enough to kill off the speculation, to be followed immediately by a decline in rates in order to avoid killing off the business prosperity. Strong had even persuaded Norman to support this notion, although Norman realized that any increase in rates in the United States would put further pressure on the Bank of England's gold stock. Central banks throughout Europe had been raising their interest rates all during the year.;'
In a series of steps, the Federal Reserve did start raising the Discount Rate-the rate they charged commercial banks-from 3 percent in 1925 to 5 percent in 1928. In February 1929, the Federal Reserve Bank of New York began to press for a further increase to 6 percent. Washington refused. Ten additional and emphatic efforts by Harrison were also turned back. It would be August 1929 before Washington caved in and the Discount Rate would finally move to 6 percent. That was the zenith of the bull market.
These decisions have remained a subject of controversy ever since, but the sequence of events is clear enough. The Federal Reserve rate was so far below what could be earned by lending to speculators that it failed in its purpose of serving as a serious deterrent. Its success, instead, was in rising high enough to contribute to w
eakness in the general economy; industrial production had already been falling for a few months before the big crash hit the stock market in October. Nor were the consequences of these moves limited to the United States The vital flow of American lending to Europe, and especially to Germany, was unable to survive the rapid rise in domestic interest rates. By the time the stock market touched its peak, American lending abroad had essentially dried up to zero.41 In fact, a rising stream of European capital had for some time been flowing to New York to join in the fun.
The outflow was no fun in the countries from which the capital moved, however, where interest rates shot upward in an effort to keep capital from leaving. Britain, Germany, Italy, and Austria were already on their way into depression at the moment the stock market crashed in October; German unemployment alone had quadrupled between the summer of 1928 and the end of 1929.4"
Gold played no role in the Federal Reserve's struggle with the stockmarket boom during 1928-1929, but this was one of the few occasions in the postwar years when gold was not the dominant consideration in policy decisions. Gold would soon return to center stage after the Great Crash, as all the stubborn maladjustments and unresolved dilemmas of the 1920s were thrown into sharp relief. the whole mess of unpaid war debts and reparations, the overvaluation of sterling and the undervaluation of the franc, falling commodity prices, and overextended banks.
The immediate impact of the cataclysmic events of 1929 was to intensify the worship of gold and to move it to an even more exalted position. As a result, appalling economic, financial, and human damage would tear across Europe and the United States before anyone in authority would stop to recall Churchill's rumination that perhaps gold might be a survivor of "rudimentary and transitional stages in the evolution of finance and credit." It was not just labor who was about to be crucified on the cross of gold.