Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (25 page)

It meant, in effect, that the Federal Reserve was so flush with gold that it had gone from being the central bank of the United States to being the central bank of the entire industrial world. Keynes’s main concern was that Britain and other major European countries would find themselves being dictated to by a Fed that focused primarily on the needs of the domestic U.S. economy, yoking the gold-starved Europeans to U.S. credit policy. Strong was in the process of constructing a one-legged gold standard, whose European limb would be firmly tied to classical rules while the American limb would be run by the Fed according to its own set of goals and constraints.

Keynes would have been even more horrified had he probed further into how the Fed operated and the character of the men who ran it. The Federal Reserve Act of 1913 had been a political compromise. Decisions about the level of interest rates and credit conditions were vested in the hands of the twelve banker-dominated regional reserve banks. This network was overseen by an eight-member central Board of Governors, all presidential appointees based in Washington. Broadly speaking, only the reserve banks could initiate policies, but these policies had to be approved by the Board.

It was not surprising that there should have been a certain amount of jockeying for control within the system. The precise locus of authority was ambiguous, and too many big egos—twelve governors of the reserve banks; the six political appointees on the Federal Reserve Board; the secretary of the treasury and the comptroller of the currency, both ex-officio members of the Board—were jostling for power.

From the start, the Board in Washington was an organization of unclear purpose and mandate. When it was created in 1913, Wilson conceived of it as a regulatory agency standing as a watchdog over the various regional reserve banks. He believed, therefore, that it should be comprised of individuals from outside banking. But he was unwilling to give it much stature. When the first governors of the Board complained to the president that the State Department expert on protocol had decided that as the most recently created of the government agencies, they should come last in social precedence, Wilson had replied that as far as he was concerned, “they might come
²⁵¹
right after the fire department.”

The Board did not even have its own quarters but operated from a dark and dreary suite of offices on the top floor of the Treasury Building, from which its long and narrow boardroom overlooked the grimy interior court. Members salaries were typical of the civil service, considerably lower than private sector compensation and even much less than the pay of the governors of the regional Federal Reserve banks. Not surprisingly, the Board
²⁵²
found it hard to attract good people—on one occasion six different candidates turned down an offer of a position before someone could be induced to accept.

As a result, the Board was, in J. K. Galbraith’s description, “a body of startling incompetence
²⁵³
.” In 1923, the chairman was Daniel Crissinger. Born in a log cabin in Marion, Ohio, he was a local eminence, a lawyer and banker who had risen to the position of general counsel of the Marion Steam Shovel Company and had twice run for Congress, albeit unsuccessfully. He also had the fortune to have been one of Warren Harding’s boyhood chums and, though by all accounts “utterly devoid of global
²⁵⁴
or
economic banking sense,” was appointed comptroller of the currency in 1922 after his old friend had become president. The following year the president elevated him to the chair of the Board.

Besides its chairman and its two ex-officio members, the Board comprised five other governors, carefully selected not for their expertise but to ensure due representation for the different regions of the country. From Memphis, Tennessee
²⁵⁵
, came George Roosa James, a dry goods merchant, a man of great energy, something of a diamond in the rough. His economic ideas, however, ran on the eccentric side. Firmly rooted in the past, he held that the basic foundation of the economy lay with the horse, the mule, and hay, and that the decay of the nation had begun with the advent of the automobile.

From Iowa came
²⁵⁶
Edward Cunningham, who had started life as a dirt farmer and gone on to become Speaker of the Iowa legislature; from Poughkeepsie, New York, came Edmund Platt, a local newspaper publisher, who had entered politics as a member of the town’s board of water commissioners and gone on to serve as its three-term Republican congressman. Boston furnished George Hamlin, longest serving of the governors, having been appointed chairman by Woodrow Wilson in 1914. By profession a lawyer, he had run unsuccessfully for governor of Massachusetts in 1902 and 1910—a failed political career, it seems, was not an impediment, indeed was almost a qualification, for Board membership.

One member, however, who could legitimately claim some relevant expertise was Dr. Adolph Miller. Having studied economics at Harvard, he had been a professor at the University of California at Berkeley for twenty-five years. A deeply insecure man, he resented that his qualifications were not fully appreciated by his colleagues—they in turn tended to dismiss him as an ivory-tower theoretician with no practical experience. He liked to argue, and when his colleagues grew weary of the interminable wrangling, would begin to argue with himself. Not surprisingly, he was often confused and indecisive, with a tendency to adopt extremely dogmatic but contradictory positions on many topics. He had also developed
a particular animus against Strong, resenting the younger man’s influence and authority.

It did not help that Miller had learned his economics at a time when monetary economics, as a discipline, was very much in its infancy, thus leading him to espouse a series of outmoded beliefs about the way monetary policy was supposed to work. Among these was the now defunct doctrine of “real bills,” that as long as the Federal Reserve and commercial banks restricted themselves to providing only short-term credit to finance inventories, nothing much could go wrong.

Faced with overseers such as this, it was not surprising that Strong was able to step into the vacuum of leadership and dominate the institution. Unlike his nominal superiors, he made a concerted attempt—particularly during those many trips to Europe—to educate himself about central banking. It was he, for example, who was most responsible for introducing the biggest innovation in the way the Fed operated—so-called open market operations. When the Fed was conceived, it was assumed that it would primarily influence credit conditions by changes in its discount rate, the interest rate it charged on loans to member banks. By the early 1920s, this technique was proving to be too passive, depending, as it did, for its impact on how much or how little bankers were willing to borrow at the discount window. Strong recognized that by buying or selling government securities from its portfolio, the Fed could directly and immediately alter the quantity of money flowing through the banking system.

It was inevitable that control of open market operations should become the object of an intense power struggle. The purchase and sale of securities out of their portfolios had initially been left to the reserve banks; but in 1923, the Board, recognizing the potency of the new tool, tried to take charge by requiring the committee that made these decisions to operate under its umbrella. Strong was away in Colorado at the time, recuperating from his bout of tuberculosis of the throat. He was furious. “I’ll see them damned
²⁵⁷
before I’d be dismissed by that timid bunch!” he wrote to one of his fellow governors. Eventually, though, he did acquiesce in giving the
Board oversight over such operations. But as the most knowledgeable official on the new open market committee, he was easily able to call the shots on virtually all decisions.

In the process
²⁵⁸
he stepped on a lot of toes, not concealing his impatience with the members of the Board. Some complained that he had an overblown sense of his own abilities, that he was too confrontational, that he lacked judgment, particularly about people. But as the intellectual leader of the Federal Reserve, he had acquired a large following within the organization and was “worshipped
²⁵⁹
” by the younger men.

If there was one problem with this whole process of making monetary policy, it was that it all depended too heavily on Strong—on his judgment, his skill, and his insight. He was too autocratic, operated on his own too much, and did not spend the time to build a consensus through the whole system. As a result, the rationale for many of his decisions was misinterpreted and his motives were constantly questioned. His failure to institutionalize policies and the thinking behind them meant that once he was no longer around, the Fed would become paralyzed by internal conflicts.

Keynes once compared the role of the Bank of England under the prewar system to that of the “conductor of an orchestra.” Even though the Bank had then been administered by a club of old and established City patricians, the gold standard had been managed well, in part because circumstances were so favorable, in part because the directors of the Bank, however dull and unimaginative, were solid. After the war, as the world struggled to emerge from economic chaos, with currencies still in turmoil and gold in short supply everywhere outside America, it did not bode well that the new “conductor of the orchestra,” the Federal Reserve, was a deeply divided organization that did not fully realize the role that had been thrust upon it and, but for Strong, would have been in the hands of a motley crew of small-town businessmen and minor-league political hacks with little expertise in finance or central banking.

^fn1
Fort Knox, where the Treasury gold is now held, was not constructed until 1936.

Let me issue and control a nation’s money and I care not who writes the laws.

—M
AYER
A
MSCHEL
R
OTHSCHILD
(1744–1812),
founder of the House of Rothschild

AT
10:00
P.M.
on November 8, 1923
²⁶⁰
, two men could have been seen arriving at the Hotel Continental in Berlin for an intimate dinner in one of its private dining rooms. Each was in his own way a caricature of a type of German and could almost have come from central casting. The tall, thin figure with the clipped military mustache, hair cut short and parted very precisely in the center, was Hjalmar Schacht, now one of the most prominent bankers in Berlin, a director and board member of the Danatbank, third largest in Germany.

The other was short and fat, with an enormous head, his bloated face pasty from overindulgence and lack of exercise. With his easy smile and gregarious manner, he looked like a classic lower-class Berliner, crude, brash, but good-hearted. This was Gustav Stresemann, who just three months before had become chancellor of Germany. He was indeed what he appeared to be: a Berliner from the lower middle classes, son of an innkeeper and beer distributor, though he had himself received a doctorate
in economics from the University of Berlin, and had been a professional politician and corporate lobbyist since the age of twenty-two.

November 9, the next day, was the fifth anniversary of the flight of the kaiser. The night before, the Soviet embassy had hosted a grand party to celebrate the joint anniversaries of its own revolution and that of Germany, but Stresemann had excused himself on the grounds of state business. For the last two days, he had been locked in conference with members of his cabinet trying to find a way of averting the country’s imminent bankruptcy.

On November 5
²⁶¹
, the price of a two-kilo loaf of bread had soared from 20 billion marks to 140 billion, sparking off nationwide riots. In Berlin, thousands of men and women had paraded the streets, shouting “Bread and work!” Over a thousand shops—bakeries, butchers, and even clothing stores—had been looted. Even in the city’s chic west end, cars had been held up and the occupants robbed. In the heavily Jewish areas to the east around the Alexanderplatz, anyone who was known to be Jewish or “looked Jewish” had been attacked by gangs of young hoodlums. The worst violence was directed at Galician Jews, many of whom had their distinctive beards scissored off or their clothes ripped away. The Börse, the stock exchange, had come under siege by a mob shouting, “Kill the Börse Jews.”